164 European Journal of Economics, Finance and Administrative Sciences - Issue 18 (2010) A long-standing view of the macro-economic dynamics of the growth process was thatincreasing savings when transformed into productive investment would help achieve an economic“take-off” (Harrod, 1939; Domar, 1946; Lewis, 1954; Solow, 1956). Solow (1970) argue that theincrease in the savings rate boosts steady-state output by more than its direct impact on investmentbecause the induced rise in income raises savings, leading to a further rise in investment. Theendogenous growth theories since the mid-1980s, typified by Romer (1986, 1990), Lucas (1988) andBarro (1990) reconfirm the view that the accumulation of physical capital is the critical driver of long-run economic growth. Bacha (1990) and Jappelli and Pagano (1994) also claim that savings contributeto higher investment and higher GDP growth in the short-run. Since then economists have beenstudying the relationship between saving and investment with renewed vigour. The next sectionpresents a brief review of the related literature.2. Related StudiesThe genesis of the study of saving - investment relationship in the empirical economics literature maybe attributed to the seminal study by Fledstein and Horioka (1980). They examined the degree of theassociation between saving and investment rates across 16 OECD countries using data for the timeperiod 1960-74, and found a high degree of correlation between domestic savings and investment thatsuggested the existence of limited capital mobility. Following this finding, the relationship betweensaving and investment has been the subject matter of intense research over the past three decades. Inthe cross-sectional framework, the findings of Penati and Dooley (1984) and Dooley et al (1987)suggest a significant relationship between domestic saving and investment rates. Obstfeld (1986)considering seven OECD countries found that saving-investment correlation differed significantly from1. Frankel et al (1986) using a sample of 64 countries (14 developed and 50 developing countries) in astudy on savings-investment relationship found that in case of all the countries except a few lessdeveloped countries, savings and investment are highly correlated and shared a long-run equilibriumrelationship. Miller (1988) using the time series data for a period 1946 to 1987, found that in U.S bothsavings and investment were I(1) and shared a cointegrating relationship prior to the Second WorldWar period and that the long-run relationship did not exist in the post-war period. The paper concludedthat this phenomenon could be explained by the increased international mobility after the War.Bayoumi (1990) argued that to a large extent the saving-investment correlation reflects endogenousinventory investment behaviour. Arginon and Roldan (1994) investigated the observed correlationbetween domestic savings and investment in European countries using annual data for the period1960–1988 and suggest the causality flowing from savings to investment without any feedback effect. De Hann and Siermann (1994) found cointegration between savings and investment for someOECD countries. Ghosh and Ostry (1995) used a current-account solvency model for some developingcountries to explain the correlation of savings and investment co-movement in advanced anddeveloping economies. Their approach takes into account demand-side factors. Krol (1996) examinedthe relationship between savings and investment using annual data pooled for 21 OECD countries overthe period 1962-90 and found that the estimated impact of saving on investment is considerablysmaller than the estimates of the earlier researcher that were used averaged data (Pelagidis andMastroyiannis, 2003). Apergis and Tsoulfidis (1997), for 14 EU countries found that savings andinvestment are cointegrated which suggests that capital mobility is not as high even after the movetowards economic integration in Europe has gained momentum. The study also finds that savingsGranger-causes investment using Vector Error-Correction Model. Mamingi (1997) estimated the relationship between saving and investment correlations for 58developing countries by assessing the degree of capital mobility in the Feldstein -Horioka sense forthese developing countries. They found that the relationship between savings and investment in case ofmiddle-income countries tend to be lower than those that of low-income countries. Levy (1998)
165 European Journal of Economics, Finance and Administrative Sciences - Issue 18 (2010)examined the relationship in the short run as well in the long run and found the evidence in favour oflong run and cyclical relationship between savings and investment. This study also found strongerrelationship between savings and investment relationship in the post-war period than during pre-warperiod. Jansen (1998) suggests that correlation between savings and investment in the long run isdetermined by one or more of these factors - limited capital mobility, current account targeting by theGovernment and inter-temporal budget constraint and the short-run co-movements are due to capitalmobility. In addition, the study also finds that the short-run correlation seems to vary across countriesand is determined by country-specific business cycles (Leachman, 1991; Jansen, 1996 and Taylor,1996). Coakley, Hasan and Smith (1999) found that the correlation between savings and investment islow in less developed countries, which could be attributed to country-specific macroeconomic policiesand not high mobility. Corbin (2001) recognized the importance of controlling for the heterogeneity ofcountries in a cross-section analysis of the savings and investment correlation for a group of countriesusing panel data. And, concluded that high saving and investment correlation is more due to countryspecific effect than to the existence of common factors affecting all the countries in his sample. DeVita and Abott (2001) found that there is high correlation between saving and investment in the U.S.Aby applying Autoregressive Distributive Lag (ARDL) bounds testing. This correlation howeverweakened during the more liberalized floating exchange rate period. Sinha (2002) found that savings and investment rates are cointegrated for Myanmar andThailand indicating the growth of savings rate causes the growth of investment rate. Interestingly,reverse causality between savings rate and investment rate has been observed for Hong Kong,Malaysia, Myanmar and Singapore. Kasuga (2004) employed cross sectional analysis and concludedthat the impact of domestic savings on investment depended on financial systems and theirdevelopment. Usually in developing countries with bank-based and/or relatively inefficient financialsectors, the lower saving and investment correlation is not unexpected. Sinha and Sinha (2004) used a huge sample of 123 countries to estimate the short run and long-run relationship between savings and investment rates in an Error Correction framework. And, theresults suggest capital should be more mobile for the countries with high per capita income. They alsofound that the capital is mobile for 16 countries most with a low per-capita income. Narayan (2005)showed that low capital mobility also causes high saving and investment correlation in a study onChina during the period of restricted capital mobility as indicated by low foreign direct investment.Seshaiah and Sriyval (2005) investigated the relationship between savings and investment in India. Theresults reveal that there is unidirectional causality from savings to investment in the country during thesample period 1970-71 to 2001-02. Chinn and Ito (2007) found that increased financial liberalization may also encourage outflowsof funds, resulting in fewer resources available to fund domestic investment projects, and therebycurtail the correlation between saving and investment. Moreover, the effect of financial liberalizationon the relationship is further confounded by the theoretically ambiguous effect of financialliberalization on savings, although its effect on investment has generally been found to be positive.Verma (2007) considered savings, investment and economic growth for India using annual time seriesdata for the period 1950-51 to 2003-04. The study finds that saving unambiguously determinesinvestment in both the short run and long run. And, no evidence has been found to support thecommonly accepted growth models in India, that investment is the engine of economic growth.
166 European Journal of Economics, Finance and Administrative Sciences - Issue 18 (2010) Wahid, Salahuddin, and Noman (2008) using Fixed Effect, Random Effect and between or CSmodels, found that there is low correlation between saving and investment in Bangladesh, India,Pakistan, Srilanka and Nepal. But this result does not necessarily imply high capital mobility in thesecountries as capital mobility is influenced by other factors such as economic size, differences infinancial structure across countries, fiscal policy coordination etc. Ang (2009) examined the dynamicrelationship between the domestic savings and investment rates in India over the period 1950-2005 bycontrolling for the level of financial liberalization. The results indicate that greater financialliberalization enables more domestic resources to be channelled to investment activities. This literature review has made significant contributions to our understanding of the saving-investment relationship. It is well inferred that a number of factors have been emerged empirically toexplain the savings and investment correlation in both developed and developing countries. Theimportant among them are capital mobility, current account targeting by the government, inter-temporal budget constraint, and economic liberalisation. It is also cleared that the literature lacks satisfactory studies on savings and investmentrelationship in an emerging market economy like India. Secondly, the literature is silent about a studyon this relationship that takes into account the period of recent global financial crisis. The inclusion ofthe period of recent global financial crisis may provide an ideal testing ground for further analysis onthe relationship between saving and investment. Finally, the database for India is considered relativelygood by developing country standards. Therefore, this paper is an attempt to enrich the literature by revisiting the savings andinvestment relationship covering the period of recent global crisis. The revisiting the issue is at leastsignificant for two reasons. First, it may hold the key to the positive correlation between savings andeconomic growth. Second, it may be crucial for assessing the validity of the view that raising savings isthe most efficient way to achieve higher rate of economic growth. However, the study shall be limitedto only savings and investment causality analysis and is not intended to single out a factor that maysubstantially explain this causal relation. The rest of the paper is organised as: Section 3 outlines the data and methodology of the study;Section 4 makes the empirical analysis; and Section 5 concludes.3. Data and MethodologyThe objective of this paper is to investigate the cointegration and causal relationship between domesticsavings and investment in India for the period 1950-51 to 2008-09. The study uses the annual data onselect variables for the sample period. The use of annual data covering the period 1950-2009 issufficiently long to allow for a meaningful time series investigation. The relevant annual data ondomestic savings and investment for the sample period have been collected from the Handbook ofStatistics on Indian Economy published by Reserve Bank of India. The variables of the study are grossdomestic savings and gross domestic capital formation in India. The study examines the saving-investment relationship in India by dividing the entire period ofstudy into two sub-periods: first for 1950-51 to 1979-80; second 1980-81 to 2008-09. The first subperiod signifies pre-liberalisation era whereas second sub period reflects the effects of liberalisationand includes the periods of cross-border crisis. As a part of the empirical exercise, we have tested the time series of research variables for unitroots by employing the Augmented Dickey-Fuller and Phillips-Perron Unit Root Tests (Dickey andFuller, 1979; Phillips and Perron, 1988). Then we have investigated the cointegration, i.e., theexistence of a long-run equilibrium relationship between savings and investment in India applyingJohansen’s Cointegration Test. At last, we have examined the short-run dynamics, i.e., the causalrelation between the variables using Granger Causality Test in the Vector Autoregressive framework.
167 European Journal of Economics, Finance and Administrative Sciences - Issue 18 (2010)4. Empirical FindingsIt is a well accepted fact that the growth of income, output and employment of an economy depend onthe volume capital formation which in turn determined by the rate of savings in the economy. Thus,real growth of an economy presumes not only a high rate of savings and investment but a high degreeof positive correlation between them. Indian economy has been showing a steep increase in the domestic savings as a percentage ofGDP, driven by increases in savings by the households, corporate and government sectors. This ratiohas gone up by about four times, from a meagre 9.3% in 1950-51 to as high as 37.7% in 2007-08.Interestingly, the countrys gross domestic savings has fallen to 32.5 per cent of GDP at market pricesin 2008-09 as against 36.4 per cent in the previous year as per CSO estimates. But, in absolutenumbers, the savings at current prices in 2008-09 had gone up to Rs 18,11,585 crore from Rs18,01,469 crore in 2007-08. The fall in the rate of gross domestic savings has been mainly attributed tothe fall in rates of savings of public sector (from 5 per cent in 2007-08 to 1.4 per cent in 2008-09) andprivate corporate sector (from 8.7 per cent in 2007-08 to 8.4 per cent in 2008-09). In respect ofhousehold sector, the rate of saving has remained at the same level of 22.6 per cent in 2007-08 and2008-09. Figure 1: Gross Domestic Savings and Investment in India for 1950-51 to 2008-09 2000000 2000000 1800000 1800000 1600000 1600000 G D S a n d G D C F ( R s . in C ro re s ) 1400000 1400000 1200000 1200000 1000000 1000000 800000 800000 600000 600000 400000 400000 200000 200000 0 0 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 GDS GDCF The gross capital formation has also gone up sizeably since the fifties, with significant jumpups during 2000s. The rate of gross capital formation has been increased about four fold, from around10% in 1950-51 to 39.1% in 2007-08. According to CSO estimates, the gross domestic capitalformation at current prices has increased from Rs. 18,65,899 crore in 2007-08 to Rs. 19,44,328 crore in2008-09. But, the rate of gross capital formation at current prices has fallen to 34.9 per cent in 2008-09from 37.7 per cent in 2007-08. This infers that the surge in India’s saving ratio has continued to be matched by acommensurate increase in its investment ratio. The movements of gross domestic savings and capitalformation in India over the period 1950-51 to 2008-09 are shown in Fig.1 which suggests thatinvestment is greater than savings in almost all the periods. This inference contradicts the classicaleconomists’ view that planned savings are always equal to planned investment. Hence, we have madean attempt to examine the behaviour of savings and investment in Indian economy.
168 European Journal of Economics, Finance and Administrative Sciences - Issue 18 (2010) The correlation between gross domestic savings and gross domestic capital formation in Indiaduring the whole sample period, that is from 1950-51 to 2008-09, is very high which indicates a strongassociation between them (see Table-1). The correlations are also obtained very high for both the sub-periods.Table 1: Correlation between Savings and Investment in India For the Period 1950-51 to 2008-09 Variables GDS GDCF GDS 1.00 0.99 GDCF 0.99 1.00 For the Period 1950-51 to 1979-80 Variables GDS GDCF GDS 1.00 0.99 GDCF 0.99 1.00 For the Period 1980-81 to 2008-09 Variables GDS GDCF GDS 1.00 0.99 GDCF 0.99 1.00 As the essential part of the empirical research, first we have tested the existence of unit root ineach of the time series for the entire time series as well as for sub-periods using Augmented Dickey-Fuller and Phillips-Perron (PP) tests.Table 2: Results of Unit Root Test with Intercept and Trend Unit Root Test for the Period 1950-51 to 1979-80(Phillips-Perron Test) Test Form Gross Domestic Savings (GDS) Gross Domestic Capital Formation (GDCF) Level 5.47 6.67 1st Difference -3.62* -3.37** Unit Root Test for the Period 1950-51 to 1979-80(Phillips-Perron Test) Test Form Gross Domestic Savings (GDS) Gross Domestic Capital Formation (GDCF) Level 1.72 7.03 1st Difference -4.26* -5.02* Unit Root Test for the Period 1980-81 to 2008-09(ADF Test) Test Form Gross Domestic Savings (GDS) Gross Domestic Capital Formation (GDCF) Level 1.45 1.71 1st Difference -5.23* -4.46** and ** refer to the significance of test at 5% and 10% levels respectivelyTable 3: Cointegration Test between Savings and Investment in India For the Period 1950-51 to 2008-09 Hypothesized No. of CE(s) Eigenvalue Trace Statistic Critical Value at 5% Probability None* 0.341 37.12 15.49 0.0000 At most 1* 0.208 13.34 3.84 0.0003 For Period 1950-51 to 1979-80 Hypothesized No. of CE(s) Eigenvalue Trace Statistic Critical Value at 5% Probability None* 0.611 38.03 15.49 0.0000 At most 1* 0.337 11.54 3.84 0.0007 For the Period 1980-81 to 2008-09 Hypothesized No. of CE(s) Eigenvalue Trace Statistic Critical Value at 5% Probability None* 0.347 16.58 15.49 0.03 At most 1* 0.171 5.07 3.84 0.02* refers to the significance of test at 5% level
169 European Journal of Economics, Finance and Administrative Sciences - Issue 18 (2010) The results of unit root test are reported in Table-2 which suggests that all the variables arenon-stationary in levels, but stationary in first differences over the entire period as well as sub-periodsof the study. Thus, all variables are integrated of order 1, i.e., I(1). Though the variables areindividually integrated of order 1, it is quite possible that a linear combination of them may be I(0),i.e., stationary. In this case variables exhibit a dynamic equilibrium relationship among them in thelong run (Engle and Granger, 1987). Therefore, we applied Johansen’s cointegration test to detect anypossible long run equilibrium relationship between these variables. The results of the cointegration test are shown in Table-3 which indicates that the null of nocointegrating vector is rejected by the Trace test for all the variables used in the study over the entiresample period and for sub-periods as well. And the empirical evidence supports the conclusions aboutthe presence of long-run equilibrium relationship between savings and investment in India.Table 4: Granger Causality Test between Savings and Investment in India For the Period 1950-51 to 2008-09 Null Hypothesis F-Statistics Probability Causal Relation GDCF does not Granger Cause GDS 8.71* 0.0005 GDCF → GDS GDS does not Granger Cause GDCF 13.67* 0.00001 GDS → GDCF For the Period 1950-51 to 1979-80 Null Hypothesis F-Statistics Probability Causal Relation GDCF does not Granger Cause GDS 10.51* 0.0005 GDCF → GDS GDS does not Granger Cause GDCF 6.36* 0.004 GDS → GDCF For the Period 1980-81 to 2008-09 Null Hypothesis F-Statistics Probability Causal Relation GDCF does not Granger Cause GDS 19.51* 0.00005 GDCF → GDS GDS does not Granger Cause GDCF 16.12* 0.0001 GDS → GDCF* refers to the rejection of the null hypotheses at 5% level Since the variables included in the study are found to be cointegrated, the next step is toperform the Granger Causality test which consists of more powerful and simpler way of testing longrun relationship between savings and investment (Granger, 1986). The results of Granger causality testare summarized in Table-4. The Granger causality test indicates that the gross domestic capital formation causes grossdomestic savings and gross domestic savings also causes gross domestic capital formation in India.This result holds for the whole period of study and also for the two sub-periods. Therefore, it can beinferred that savings in India has positive effect on investment and the other way around.5. ConclusionThis paper examines the empirical relationship between savings and investment in India using theannual data for the period 1950-51 to 2008-09. For univariate time series analysis involving stochastictrends, Phillips-Perron unit root test has been calculated for individual time series to provide evidenceas to whether the variables are integrated. And, the empirical analysis suggests that the variables of thestudy, viz., Gross Domestic Savings and Gross Domestic Capital Formation present a unit root. Thus,all the variables are stationary in their first differences and integrated of order one, i.e., I(1). Then theJohansen’s cointegration analysis has been performed taking into account the maximum likelihoodprocedure. It is found that both the variable are cointegrated thereby exhibiting the long-runequilibrium relationship between them which may be interpreted as the classical economists’ equalitybetween planned savings and planned investment. But Fig.1 shows that investment in India remainedgreater than the savings in almost all the periods since 1950-51 to 2008-09. This study, on the onehand, validates the classical notion of saving-investment equilibrium through empirical findings and onthe other hand, justifies the Keynes’ belief that these two are independent variables (investments being
170 European Journal of Economics, Finance and Administrative Sciences - Issue 18 (2010)greater than savings). Furthermore, the Granger causality test in the vector autoregressive model hasbeen carried out to find the direction of this relationship. And, it is suggested that there runsbidirectional or feedback causality between the variables of the study. . Therefore, from the policymakers’ perspective an optimal combination of monetary and fiscal policies would go a long way inestablishing a dynamic long run relation between savings and investment in India.References1] Ang (2009): “The Saving-Investment Dynamics and Financial Sector Reforms in India”, MPRA Paper No. 14498, Retrieved from http://mpra.ub.uni-muenchen.de/14498/.2] Apergis, N. and Tsoulfidis, L (1997): “The Relationship between Saving and Finance: Theory and Evidence from E.U. Countries”, Research in Economics, 51, pp. 333–358.3] Arginon, I. and Roldan, J. (1994): “Saving, Investment and International Capital Mobility in E.C. Countries”, European Economic Review, 38, pp. 59–67.4] Attanasio, O., L. Picci, and A. Scorcu (2000): “Saving, Growth, and Investment: A Macroeconomic Analysis Using a Panel of Countries,” Review of Economics and Statistics, 82(1).5] Bacha, E.L (1990): “A Three Gap Model of Foreign Transfers and the GDP growth Rate in Developing Countries”, Journal of Development Economics, 32, pp. 279-96.6] Barro, R. J. (1990): “Government Spending in a Simple Model of Endogenous Growth”, Journal of Political Economy, 98, pp. S103-S125.7] Bayoumi, T. (1990): “Saving-Investment Correlations: Immobile Capital, Government Policy, or Endogenous Behaviour? International Monetary Fund Staff Papers, 37, pp. 360–387.8] Baxter, M. and Crucini, M.J. (1993): “Explaining Saving-Investment Correlations”, American Economic Review, 83, pp. 416-436.9] Cadoret, I. (2001): “The Saving Investment Relation: A Panel Data Approach”, Applied Economic Letters, 8, pp. 517-520.10] Chinn, M.D. and Ito, H. (2007): "Current Account Balances, Financial Development and Institutions: Assaying the World "Savings Glut"." Journal of International Money and Finance 26, pp. 546-569.11] Coaley, J. and Kulazsi, F. (1997): “Cointegration of Long Span Saving and Investment”, Economic Letters, 54, pp. 1-6.12] Coakley, J., Hasan, F. and Smith, R. (1999): “Saving, Investment, and Capital Mobility in LDCs”, Review of International Economics, 7, pp. 632–640.13] Corbin, A. (2001): “Country Specific Effects in the Feldstein-Horioka Paradox: A Panel Data Analysis”, Economics Letters, 72, pp. 297-302.14] De Haan, J. and Siermann, C. L. J., (1994): “Saving Investment and Capital Mobility: A Comment on Leachman”, Open Economies Review, 5, pp. 5-17.15] De Vita, G. & A. Abott, (2002): “Are Saving and Investment Cointegrated? An ARDL Bounds Testing Approach”, Economics Letters, 77(2), 293-299.16] Dickey, D.A. and W.A. Fuller (1979): “Distribution of the Estimators for Autoregressive Time Series with a Unit Root,” Journal of the American Statistical Association, 74, pp. 427–431.17] Domar, E.D. (1946) “Capital Expansion, Rate of Growth, and Employment,” Econometrica, 14, pp. 137-147.18] Dooley, M.P., Frankel, J. and Mathieson, D.J. (1987): "International Capital Mobility: What Do Saving-Investment Correlations Tell Us?" International Monetary Fund Staff Papers 34, pp. 503-530.19] Engle, R. F. and C. W. J. Granger (1987): “Co-integration and Error Correction: Representation Estimation, and Testing”, Econometrica, 55(2): pp. 251-276.
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