Falling savings weigh down on economy
Hong Jun-pyo is a research fellow at the Hyundai Research Institute.
By Hong Jun-pyo
The rate of Korean domestic household savings has rapidly decreased since the early 1990s, leading the country to be one of the most under-saving OECD member states. According to the Bank of Korea, the domestic household savings ratio had been at more than 20 percent in the early 1990s. Since then it has dropped to 2.7 percent in 2011. What happened to the high savings that we had been proud of and that had provided industries with financial ammunition?
The reasons for the decrease in the rate of domestic household savings are explained by three facets that nowadays Korean households suffer from: (1) low income, (2) increased expenditure, and (3) weak financing status.
First, households’ capability to save has shrunk because of both a decrease in disposable income and deterioration in the terms of trade. The growth rate of annual disposable income had been over 10 percent on average in the 1990s but it fell to around 5 percent in the 2000s. The steep decline is attributed to an income reduction caused by both economic growth without generating employment and an intensified competition among the self-employed. The other reason for the low income, the deterioration in the terms of trade, led the rate of real national income growth to be lower than that of GDP growth. The low growth rate in the real national income reduced disposable income, causing households to be reluctant to save.
Second, a higher tendency for households to spend non-consumption expenditure such as both national pension and health insurance premiums more than before has had a negative influence on capability and willingness to save. The ratio of non-consumption expenditure to an income of urban households was 15.6 percent in 1990 but increased by 18.8 percent in 2012.
Another explanatory factor why households become hesitant to save is an institutional change such as an expansion and an implementation of the national pension. The national pension is thought to be another type of low-term savings and most Korean join it. Therefore, they are not inclined to open savings accounts any more.
Third, from a financial perspective, both the continuation of low interest rates and the accumulation of a household debt prevent individuals from saving.
While the annual real interest rate approached to 10 percent on average in 1990s, it went through several economic crises (the foreign exchange crisis in 1997, the credit card crisis in 2003, and the global financial crisis in 2008) and fell greatly by 0.41 percent in 2011 and by 1.57 percent in 2012. Because of the low interest rate, households expect a smaller return from savings accounts and, therefore, fewer save than before.
Furthermore, high pressure on interest payments due to the sudden increment in household debt forces individuals from saving. For example, because of expanding mortgages from the financing sector, household debt continuously mounted from 465 trillion won in 2002 to 959 trillion won in 2012.
The low income in the low interest rate era, the increased expenditure on the non-consumption sector, and the piling up of household debt affect both national and individual economy in diverse ways. First, it has a negative impact on national economic growth.
One percentage point reduction in the household savings rate causes a 0.25 percentage drop in investment, leading to a 0.19 percent point drop in the GDP growth. In both theoretical and empirical studies, a decrease in private savings mostly composed of individual net savings reduces private investment, leading the GDP growth rate to decline.
Second, a decrease in household savings may exacerbate issues related with a credit delinquent and with an individual bankrupt, as it aggravates a household financial structure.
Specifically, most domestic household assets are composed of real and tangible assets with low mobility and, therefore, they are short of financial assets in a recession.
When they have to redeem the debt and run out of financial assets, they are likely to be overdue in payments or declare a default. If the tangible assets are not to be disposed, the possibility of the default increases.
Third, the decrease of the household savings can raise individual anxiety about old age. Nowadays, the Korean aging pace is so fast that sustenance cost for the aged and the age index were respectively 7.4 percent and 20 percent in 1990, but in 2012 they went up to 16.1 percent and by 77.9 percent.
However, the decrease in both household savings and the value of tangible assets do not help the aged prepare for their remaining lives.
If the low savings ratio continues, it might keep investments lower and deter economic growth. In order to enhance the savings ratio, we need to find out measures to increase the real income of individuals.
Then, public savings such as pension funds should be managed effectively and transparently to ease the national burden. Lastly, considering the fast aging society, it is necessary to design a financing plan suitable for a baby boomer who is retiring shortly. Most of all, it is urgent to construct a virtuous cycle in which investment leads to an economic growth, an income increment, and an expansion of savings.