Financial sector development - Sida

3.3 Driving forces behind savings
Whereas there is a positive correlation between the income level of a country and the
savings rate, at least up to a certain level of income, there is no clear evidence that the
income distribution of a country affects the savings rate. Possibly this may be because
saving is driven by many different motives, which may affect different groups of the
population in various ways, depending on the specific conditions in each country.
People save for several reasons. First, there is the income smoothing motive. According to
the permanent income hypothesis, the consumer distinguishes between permanent and
temporary income, and will save temporary income increases (or dissave - i.e. borrow or
use up the savings in case of temporary income reductions) so that consumption remains
equal to the individual’s permanent income. Also, people behave differently over their lifecycle:
dissaving when young, saving in mid-life and again dissaving during retirement.
These hypotheses may explain how saving adapt to a given income stream, but they have
difficulties, among other things, in explaining the positive correlation between savings and
growth.
Another reason for saving is the precautionary motive. The individual may save for "the
rainy day": if unemployment strikes, if the harvest goes bad, if the children will not provide
for you as old. Precautionary saving depends on the individual's opportunity to insure
himself. In the developed world, there are formal insurance companies as well as social
transfer systems which reduce uncertainties about future income. In developing countries,
a substitute may be the extended family, which may guarantee that the individual will be
provided for in case of health problems, old age or bad luck, thus reducing this savings
motive.
Partly related to both of these two arguments is the bequest motive: people save for the
future generation. Some empirical studies suggest that bequests are more important for the
wealthy than the poor. Bequests may still be important in developing countries, and among
poor, for example manifested in keeping the small farm within the family (and not sell it off
at old age, as suggested by the life-cycle hypothesis). It should be noted that a bequest
may not only be a sign of altruism, but may also be control motivated (the bequestor makes
sure he is able to influence decisions until his death), or have a precautionary motive.
In conjunction with these arguments, demography obviously affects aggregate saving,
although relationships are ambiguous. High fertility rates may have a negative effect on
saving, if people have many children as a substitute for saving for their old age. Reductions
in mortality rates may have a positive effect on saving, because investments in education
are more profitable (people live longer). Moreover, a growing population may mean a
growing labor force which causes growing incomes and growing savings. On the other
hand, there is a fairly robust negative relationship between dependency ratios (the
proportion of young and old people to the number of people active on the labor market) and
savings rates.
Another category of savings motives are sociological. For example, consumption habits
may lag behind income changes. This explanation would fit empirical findings of the
savings and growth correlation. Urbanisation may also affect savings, although it is unclear
in what direction. On the one hand, urban life may bring more investment opportunities,
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