Development and Growth Constraints - Savings Gaps | tutor2u Economics
Study notes

Development and Growth Constraints - Savings Gaps

  • Levels: A Level
  • Exam boards: AQA, Edexcel, OCR, IB

Savings are needed to provide finance for capital investment.

What is a savings gap?

In many smaller low-income countries, high levels of poverty make it almost impossible to generate sufficient savings to provide the funds needed to fund investment projects. This increases reliance on tied aid.

This problem is known as the savings gap. In Africa for example, savings rates of around 17 percent of GDP compare to 31 percent on average for middle income countries. Low savings rates and poorly developed or malfunctioning financial markets make it more expensive for African public and private sectors to get funds for investment. Higher borrowing costs impede capital investment.

The saving gap and the foreign exchange gap

  • i) Many poorer countries do not have sufficient domestic savings to be able to finance the required rate of capital investment to promote economic growth
  • ii) Many developing countries suffer from a shortage of foreign exchange that can be used to finance imports of consumer goods and services, raw materials and components and new capital inputs

Deriving the savings gap and the foreign exchange gaps

Thinking back to introductory national income accounting

  • Y is total output produced in a given year (GDP)
  • C is private consumption
  • I stand for total investment
  • G is government consumption
  • X denotes exports
  • M represents imports
  • S is savings
  • T stands for total government tax revenue

We know that

Y (GDP) = C+I+G+X-M

Y is also the sum of C + S + T

Rearranging

C+I+G+X-M = C+ S + T

Therefore

S-I = (X-M) + (G-T)

This gives us an equation explaining the total resource gap of an economy into internal balance (i.e. the government budget) and external gap (balance of trade)

Limited Scale and Efficiency of Financial Markets

  • Many of the least developed countries have limited financial markets such as banking, money and credit systems, insurance markets and stock markets.
  • Worldwide, approximately 2.5 billion people do not have a formal account at a financial institution. Access to affordable financial services is linked to overcoming poverty, reducing income disparities, and increasing economic growth
  • These are essential for providing long term capital for the private sector and helping to channel savings and provide funds for investment projects.
  • Some progress is being made in Sub-Saharan Africa – there are now 19 stock markets in operation – but most of these are small by international standards. The Nigerian stock market accounts for only 3% of Brazil’s or India’s stock market capitalization.

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