Savings boost critical to overcome fiscal difficulties, economic stagnation in Latin America and Caribbean, IDB study shows

The region’s growth is weighed down by a savings crisis, with households, firms and governments saving too little and inefficiently

SANTIAGO, Chile – Latin America and the Caribbean faces a savings crisis, with fiscal and demographic realities making the outlook worse in the coming years, according to a new study by the Inter-American Development Bank (IDB) released here today.

The region faces major fiscal challenges in the years ahead and the report argues that more savings is a key element to ensure both economic growth and resilience.

The gross national saving rate in Latin America and the Caribbean was just 17.5 percent of GDP between 1980 and 2014, far below the 33.7 percent for Emerging Asia and 22.8 percent for advanced economies. Only sub-Saharan Africa saved less, at 13.8 percent.

The report analyzes the reasons behind the region’s chronically low savings by households and governments, and its economic impacts, from behavioral biases among individuals to structural inadequacies in financial systems and fiscal budgets. It also looks at inefficiencies in savings by firms, which invest too little.

On the upside, the book provides a roadmap for policymakers and other key actors to reverse the situation to bring savings rates more in line with successful economies. Even small gains in savings could have big impacts. For instance, for every 1 percentage point increase in national saving, domestic investment in the region increased by almost 0.4 percentage points. This means $20 billion in more money available to finance vital infrastructure projects.

“We can’t just shrug off our poor savings rates by saying we are bad at putting money away,” said IDB Chief Economist José Juan Ruiz. “This book shows governments, businesses and even families have it within their power to ensure we have the resources we need during the bad times and the good times, and to care for an aging population.”

Savings gaps

The book Saving for Development: How Latin America and the Caribbean Can Save More and Better is part of the IDB’s flagship Development In the Americas series. It lays out the big gaps in the savings system in the region.

The median banking system has grown to provide around 30 percent of GDP in loans to the private sector, much lower than the banking systems of the median OECD or Emerging Asia economy, which provide over 80 percent of GDP in loans to the private sector.

Households, especially poor ones, have limited access to financial instruments to save and face high costs when they do. The problem is compounded by low trust in formal banks, widespread financial illiteracy and labor informality. Only 16 percent of adults report savings through a bank, compared to 40 percent in Emerging Asia and 50 percent in advanced economies.

Pension systems are another savings constraint. Less than half the population in Latin America and the Caribbean saves for retirement through a contributory pension system, a problem that, unless corrected, will get worse as the population ages.

The savings crisis means the region is struggling to find the resources needed to finance new and much-needed airports, ports, roads and other infrastructure that can boost future growth. The region must increase investment by between 2 and 4 percentage points of GDP per year (depending on the country) for decades to loosen this binding constraint to growth, or by between $100 billion and $200 billion a year.

Fiscal policy has also impacted savings. Governments spend too much on current expenditures such as subsidies, and too little on capital investments. Recent economic downturns have made this worse as governments have opted to cut investment spending.

The book identifies key areas where governments could save more and spend in smarter ways. Social assistance, tax expenditures and energy subsidies suffer from high “leakages,” meaning they end up benefitting the rich more than the poor, to the tune of $100 billion per year. Inefficiencies in health and education account for another US$50 billion in potential lost savings per year. The magnitude of leakages is so important that they can provide sufficient funds to bring the region’s infrastructure up to par with advanced economies.

In addition, governments are struggling to collect taxes, with evasion estimated at 52 percent of potential tax collection in Latin America.

The book outlines how to increase savings in ways that are sustainable, but stresses six important steps that should be tackled first.

• Governments need to address broken pension systems, looking beyond whether systems should be based on individual accounts or pay-as-you-go, but rather by rectifying the underlying deficiencies in each option.
• Governments need to focus on infrastructure and capital spending, in part by designing fiscal rules and targets that direct a higher share of total expenditures to public investment, and working to reduce leakages in transfer programs that end up benefitting those that don’t need it.
• Tax policies need to be better targeted, by avoiding double taxation of savings, first when they are generated by the firm and then when distributed to households as dividends, and ensuring taxes on income, corporations and other actors work to increase the tax base and fall in line with international standards.
• Governments (and banks) need to promote household savings by addressing the multiple bottlenecks that distort savings, including tailoring saving products to the demand of potential clients, creating incentives to use the formal financial system, and ensuring governments pay social transfers through bank accounts, and using technological innovations to help save, among other measures.
• Research shows that incentives to save are higher when productivity grows faster. One way of promoting productivity growth is by eliminating distortionary taxes and regulations that generate small, informal and unproductive firms. This would ensure that savings are channeled to productive investment opportunities.
• Banks need quality information about potential borrowers, and the high cost of enforcing financial contracts needs to be reduced.

“The agenda to get countries to save more can seem overwhelming, requiring us to act on many fronts,” said IDB lead economist Eduardo Cavallo, one of the book’s coordinators and editors. “It may seem more convenient to rely on foreigners to provide us with their surplus savings. The book shows this is not a viable option anymore. Saving more and better will allow us to stand on our own two feet, and provide resources for people to achieve their aspirations.”