Chapter 13

Forms of Saving (Simple Summary)

There are three main groups in society that save money:
1. Households (people and families) – save part of their disposable income
(personal saving).
2. Businesses – save from their profits.
3. Government – saves when it collects more in taxes than it spends (budget
surplus).
 Private saving = households + businesses
 Public saving = government saving

Types of Saving
Savings can be divided into three types:
1. Voluntary saving
2. Involuntary saving
3. Forced saving

1. Voluntary Saving
 Meaning: People choose to save money instead of spending it.
 It happens when households or businesses decide to cut their consumption
to put money aside.
 Example:
o A person decides to save part of their salary each month in a bank
account.
o A company keeps some profits to reinvest later.

✅ Key idea: Saving is done by choice.

2. Involuntary Saving
 Meaning: People save money without intending to, because something
forces them to spend less.
 It happens when the government or institutions reduce people’s income
or spending power through things like taxes or compulsory contributions.
 Example:
 o Paying taxes or social insurance contributions automatically from your
salary.
o Government schemes that take part of your income for future benefits
(like pensions).
✅ Key idea: Saving happens without personal choice, often through government
policy.

3. Forced Saving
 Meaning: People save more because prices rise (inflation) — not because
they want to, but because they can’t buy as much with the same money.
 It can also happen when people try to maintain the value of their money (the
real balance effect).
 Example:
o During inflation, prices go up, so people buy less food and clothes —
leaving them with unspent money (savings).
o Some might invest more to protect the value of their money.

✅ Key idea: Saving happens because of inflation or price changes, not by choice.

Summary Table

Type of Voluntary
How It Happens Example
Saving or Not

Voluntary People choose to save instead Putting part of salary in a

Voluntary ✅
Saving of spending savings account

Involuntary Savings caused by government Social security Not

Saving deductions or taxes contributions, income tax voluntary ❌

Forced Savings caused by inflation or Spending less because Not

Saving higher prices prices rose voluntary ❌

🏦 Three Approaches to Financing Investment

from Domestic Resources
Countries need money (capital) to invest in development.
There are three main economic approaches that explain how this money can be
raised within a country — that is, from domestic (local) savings rather than from
foreign aid or loans.

1. The Prior Savings Approach

  Main idea:
Investment can only happen after people save money first.
Saving comes before investment.
 How it works:
o The government encourages people and businesses to increase
savings, either:
 Voluntarily (by choosing to save), or
 Involuntarily/forced (through taxes, compulsory schemes, or
inflation).
o These savings are then used to finance investment in industries and
infrastructure.
 Economic view:
o Based on classical economics.

o Believes that saving automatically finds investment opportunities.

o Prefers low inflation (strong opposition to price rises).

 Example:
o Government promotes saving through high interest rates, pension
schemes, or taxes that reduce consumption.
🔗 Link to forms of saving:
This approach depends on voluntary, involuntary, and forced saving to collect
funds for investment.

2. The Keynesian Approach

 Main idea:
Investment creates saving, not the other way around.
When investment increases, it boosts income and output, which then allows
more saving.
 How it works:
o The government or private sector invests first, even if savings are low.

o This investment increases employment and income.

o As people earn more, they begin to save more naturally.

o Redistribution (from rich to poor) also helps, since poorer groups tend to
spend and save more proportionally.
 Economic view:
o Based on Keynesian economics.

o Supports active government spending to create jobs and stimulate

growth.
 Example:
 o A government builds roads or schools to create jobs; workers’ higher
income later leads to more savings.
🔗 Link to forms of saving:
Mostly results in voluntary saving after income increases, though inflation or
redistribution could cause forced/involuntary saving.

3. The Quantity Theory Approach

 Main idea:
The government can create more money (monetary expansion) to finance
investment.
 How it works:
o The government prints or injects more money into the economy to fund
development.
o This increases spending and investment, but may lead to inflation
(higher prices).
o Inflation then causes forced saving, because people can buy less with
their money.
 Economic view:
o Based on the Quantity Theory of Money, which says that increasing
the money supply eventually raises prices.
o Treats inflation as a tool for transferring resources from consumers to
investors.
 Example:
o A government increases the money supply to finance housing projects or
factories.
🔗 Link to forms of saving:
Closely related to forced saving — inflation reduces people’s purchasing power,
freeing up resources for investment.

🧩 Comparison Table

Type(s) of
Approach Main Idea Role of Saving Example Saving
Involved

Prior Saving must People save Voluntary,

Savings finance
Savings happen before through bank Involuntary,
investment
Approach investment deposits or taxes Forced

Investment Mainly
Government job
Keynesian Investment increases income, Voluntary,
programs boost
Approach creates saving which leads to some
incomes
saving Involuntary
 Type(s) of
Approach Main Idea Role of Saving Example Saving
Involved

Inflation
Quantity Government Printing money for
redistributes
Theory creates money development Forced Saving
income, causing
Approach to invest projects
saving

🧠 Simple Summary
 Prior Savings: Save first → then invest. (Classical theory, cautious about
inflation)
 Keynesian: Invest first → income rises → then saving grows. (Focus on jobs and
growth)
 Quantity Theory: Print money → inflation → forced saving funds investment.
(Risky but sometimes used in early development stages)

The Capacity and Willingness to Save: Their Determinants

and Links to Domestic Investment and Forms of Saving
Saving plays a vital role in the process of economic development. It provides the
resources for investment, which in turn stimulates production, employment, and
income growth. However, the level of saving in any economy depends on two key
elements — the capacity to save and the willingness to save. While capacity
refers to the ability or potential of individuals or sectors to save, willingness relates to
their motivation or desire to do so. Both must work together to generate adequate
domestic savings for financing investment and promoting economic growth.

1. The Capacity to Save

The capacity to save refers to the economic ability of individuals, businesses, or
governments to set aside part of their income instead of consuming it. According to
Keynes, income is the most important determinant of saving capacity. He introduced
the concept of the consumption function, showing that saving is primarily a function
of income rather than the interest rate. This is known as the Keynesian absolute
income hypothesis, which states that as income rises, both consumption and saving
rise, but saving rises at a faster rate.
Several factors affect the capacity to save:
(a) Level and Growth of Income
Higher levels of income increase the potential to save. Similarly, when incomes grow
over time, individuals often aim for higher future standards of living, leading to higher
savings ratios.
(b) Life-Cycle Hypothesis
Proposed by Modigliani and Brumberg, this theory suggests that individuals plan
their savings and spending over their lifetime. They borrow or spend in youth, save
during middle age, and dissave during retirement. Thus, a country with a higher
proportion of working-age people has a higher saving capacity.
(c) Dependency Ratio
The ratio of non-working (dependents) to working people strongly affects savings. A
high dependency ratio reduces national saving because more income must be used to
support dependents rather than being saved.
(d) Distribution of Income
The way income is shared among different groups influences saving capacity.
Wealthier individuals tend to save a larger proportion of their income, so an unequal
distribution may increase overall savings but reduce consumption and social welfare.

2. The Willingness to Save

While capacity shows how much can be saved, willingness to save determines how
much people actually choose to save. It depends largely on psychological,
institutional, and economic factors that make saving more or less attractive.
Key factors influencing the willingness to save include:

(a) Rate of Interest

A higher rate of interest encourages saving because it increases the reward for
postponing consumption. However, extremely high rates may reduce borrowing and
investment, potentially slowing down economic growth.
(b) Financial Institutions and Availability of Saving Facilities
The existence of a well-developed financial system — banks, credit unions, and
savings schemes — greatly enhances people’s willingness to save. When individuals
have easy access to safe and convenient saving instruments, they are more likely to
save.
(c) Inflation
Inflation can both encourage and discourage saving. When prices rise, people may
want to maintain the real value of their money holdings (the real balance effect),
leading to more saving. However, if inflation becomes excessive, it discourages saving
as money loses value rapidly.
(d) Economic Confidence and Stability
People are more willing to save in stable economies where they trust the banking
system and expect steady growth. In uncertain environments, people may prefer to
spend or invest in physical assets instead.
(e) Cultural and Social Factors
Attitudes toward thrift, future security, and consumption vary across societies and can
strongly affect saving behavior.
3. Linking to the Forms of Saving
The forms of saving — voluntary, involuntary, and forced — are closely related to
both the capacity and willingness to save.
 Voluntary saving arises when individuals willingly set aside part of their
income. It depends on both capacity (income level) and willingness (interest
rates, confidence, and culture).
 Involuntary saving results from government policies such as taxes or
compulsory pension contributions, where individuals have little choice.
 Forced saving occurs when inflation or other factors reduce people’s
consumption automatically, causing them to save unintentionally.
These forms of saving help determine how resources are mobilized within an economy.

4. Linking to The Three Approaches to Financing Investment from Domestic

Resources
There are three main theoretical approaches that link domestic saving to investment
and economic development: the Prior Savings Approach, the Keynesian
Approach, and the Quantity Theory Approach.
(a) The Prior Savings Approach
This classical approach emphasizes that saving must come before investment. It
argues that development policies should encourage people to save more, either
voluntarily or through involuntary or forced measures. A strong belief in this approach
assumes that savings will automatically find productive investment outlets. Thus, this
method depends heavily on both the capacity and willingness to save.
(b) The Keynesian Approach
This approach rejects the idea that saving precedes investment. Instead, it argues that
investment creates its own saving. When investment increases production and
income, people’s capacity to save also increases. This means that government policies
should focus on stimulating investment and output rather than simply encouraging
saving. It is therefore closely linked to capacity to save, as higher income levels
enable greater saving.
(c) The Quantity Theory Approach
This approach highlights the role of monetary expansion and inflation in generating
resources for investment. By increasing the money supply, governments may cause
prices to rise, leading to forced saving as consumers’ purchasing power declines. It
relies more on involuntary or forced savings rather than voluntary saving and is linked
to the willingness to save only indirectly.

5. Conclusion
In summary, the process of generating domestic savings for investment depends on
both capacity and willingness to save. Capacity is mainly determined by income,
income growth, and population structure, while willingness is influenced by interest
rates, financial institutions, inflation, and social attitudes. The forms of saving —
voluntary, involuntary, and forced — express how these savings are realized in
practice, while the three approaches to financing investment explain different
policy routes to mobilize these savings. For sustainable economic development,
policies must aim to increase both the capacity to save through higher income
and employment, and the willingness to save through stable financial
systems and favourable incentives.

How can high inflation or limited access to financial assets

affect the ability and willingness of households to save in
developing economies?

1. Effect on the Capacity (Ability) to Save

The capacity to save — or the ability of households to set aside income — largely
depends on income levels, stability, and the real value of money.
(a) High Inflation
 When inflation is high, the purchasing power of money decreases. Households
need to spend more to afford basic goods and services.
 This reduces disposable income, leaving little or nothing to save.
 For example, in countries like Zimbabwe or Venezuela, high inflation has
caused prices to rise rapidly, eroding real income and forcing households to
consume almost all their earnings.
 Inflation also discourages long-term saving because the value of money saved
today is worth less tomorrow.
→ Thus, high inflation lowers the capacity to save by reducing real income and
making it difficult for families to meet even basic needs.
(b) Limited Access to Financial Assets
 In many developing economies, people lack access to banks, credit unions,
or formal saving instruments.
 Without safe and convenient saving facilities, households may prefer to keep
money in cash or in non-productive forms (like gold or livestock).
 These informal savings are often insecure and earn no interest, so people have
little incentive or ability to build wealth.
→ Therefore, limited access to financial assets weakens the capacity to save,
as individuals lack the institutional support to convert income into productive savings.

2. Effect on the Willingness to Save

The willingness to save depends on people’s motivation and confidence in the
financial system — factors like interest rates, inflation, and trust in institutions play
key roles.
(a) High Inflation
 From the willingness perspective, inflation creates uncertainty.
  When prices rise unpredictably, people may prefer to spend now rather than
save, fearing that money will lose value later.
 This reduces the psychological motivation to save.
 However, in some cases, inflation can cause forced saving, where people are
unable to buy as much as before, unintentionally saving more in real terms —
but this is usually harmful and unstable.
→ So, high inflation mainly discourages willingness to save by reducing trust in the
financial value of money.
(b) Limited Access to Financial Assets
 When there are few banks or poor financial infrastructure, people are less
willing to save.
 The absence of attractive saving instruments — like interest-bearing accounts,
mobile banking, or microfinance options — makes saving seem pointless or
risky.
 For instance, in many rural African regions, people avoid saving in banks due
to distance, high fees, or mistrust, preferring informal saving clubs instead.
→ Therefore, limited access reduces willingness to save, as people lack both
confidence and convenience in financial systems.

3. Linking to Capacity vs Willingness

Factor Effect on Capacity to Save Effect on Willingness to Save

High Reduces real income, lowering Creates uncertainty and discourages

Inflation the ability to save. saving; may cause forced saving.

Limited Prevents safe or productive

Reduces trust, convenience, and
Financial saving, limiting actual saving
motivation to save.
Access capacity.

4. Connection to Economic Development and Saving Theories

 In the Keynesian view, saving is mainly determined by income — so high
inflation that lowers real income directly reduces the capacity to save.
 The Quantity Theory approach highlights that inflation can lead to forced
saving, but this form of saving is not sustainable for development.
 The Prior Savings approach suggests that building reliable financial systems
and stable prices is crucial to mobilize domestic savings for investment.
Thus, for developing economies, stable prices and financial inclusion are essential
to strengthen both the capacity and willingness of households to save — which, in
turn, supports higher investment and long-term growth.
Explain how the financial system encourages saving and
channels it into productive investment in an economy.

Introduction
The financial system plays a crucial role in promoting economic development by
encouraging saving and transforming these savings into productive investments. It
acts as a bridge between savers (households, businesses, and government) and
investors who need funds for productive activities. A well-functioning financial system
increases both the capacity and willingness of people to save, and ensures that
those savings are efficiently used to finance economic growth.

1. How the Financial System Encourages Saving

The financial system — which includes banks, microfinance institutions, capital
markets, insurance companies, and cooperative societies — encourages saving in
several ways:
(a) Providing Safe and Accessible Saving Facilities
 The availability of financial institutions gives households a secure place to
deposit their money.
 This increases the capacity to save, as people can store funds safely and earn
interest instead of holding cash, which can lose value due to inflation.
 Example: In Kenya, the development of mobile banking systems like M-Pesa
has made saving easier and safer, even in rural areas.
(b) Offering Incentives and Returns on Savings
 Financial institutions pay interest or dividends on savings, which motivates
people to save more — enhancing the willingness to save.
 This aligns with the financial liberalization hypothesis, which suggests that
higher real interest rates can stimulate saving.
(c) Encouraging Different Forms of Saving
 The financial system supports voluntary savings (through savings accounts
and investments), involuntary savings (through taxes and social
contributions), and even forced savings (through inflation or compulsory
schemes).
 By providing structured options for each, it helps mobilize resources from
various sectors of society.

2. How the Financial System Channels Savings into Investment

Once savings are mobilized, the financial system directs them into productive
investments, ensuring that resources are used efficiently for growth and
development.
(a) Intermediating Between Savers and Investors
  Banks and other financial institutions act as intermediaries, collecting savings
from households and lending them to businesses or entrepreneurs for
investment.
 This helps convert idle funds into capital for production, infrastructure, and
innovation — driving economic development.
(b) Allocating Capital to High-Return Projects
 Through credit assessment and financial markets, funds are channelled to
the most productive uses.
 For example, loans may go to small and medium enterprises (SMEs),
agriculture, or manufacturing — sectors that expand output and employment.
(c) Encouraging Long-Term Investment
 The existence of stock markets and bond markets provides opportunities for
firms to raise long-term funds.
 This supports sustained economic growth and complements short-term savings
held in banks.

3. Linking to Capacity and Willingness to Save

 The capacity to save depends largely on income levels and the real value
of money. The financial system increases this capacity by providing interest-
bearing accounts and protecting savings from inflation.
 The willingness to save is strengthened when people have confidence in
financial institutions, trust that their deposits are safe, and can see visible
returns.
 In developing economies, limited access to financial assets or instability (like
high inflation) weakens both capacity and willingness — so the presence of a
strong financial system helps overcome these barriers.
4. Connection to the Three Approaches to Financing Investment

Approach Relation to Financial System

Prior Savings Financial institutions help mobilize voluntary, involuntary, and forced
Approach savings, creating a pool of funds for investment.

Investment creates income, which in turn generates savings. A strong

Keynesian
financial system ensures these new savings are captured and
Approach
reinvested efficiently.

Quantity Through monetary policy and financial intermediation, the system can
Theory expand money supply to stimulate investment, though excessive
Approach expansion may lead to inflation.

5. Importance for Developing Economies

In developing countries, where saving rates are typically low, the financial system
plays a transformative role:
  It increases inclusion, allowing even low-income groups to participate in
formal saving.
 It reduces dependency on foreign capital by mobilizing domestic resources.
 It supports economic stability by channelling funds into productive sectors
rather than unproductive consumption.
For instance, in Bangladesh, microfinance institutions like Grameen Bank have
successfully mobilized rural savings and used them to fund small-scale investments,
improving incomes and reducing poverty.

Why is domestic saving often insufficient in developing

countries, and how can foreign resources supplement it?

Introduction
Domestic saving — the portion of national income not spent on consumption — is a
key source of funds for investment and economic development. However, in most
developing countries, domestic savings are often too low to meet the investment
needs required for sustained growth. This “savings gap” makes it difficult for these
economies to finance productive investments internally. As a result, foreign
resources such as aid, loans, and foreign direct investment (FDI) become essential to
supplement domestic savings and accelerate development.

1. Reasons for Insufficient Domestic Saving

(a) Low Income Levels (Limited Capacity to Save)
According to the Keynesian absolute income hypothesis, the ability to save
depends mainly on income. In developing countries, most people earn low and
unstable incomes, which leaves little room for saving after meeting basic needs.
 Example: In many Sub-Saharan African countries, a large portion of income is
spent on food, housing, and health, leaving minimal disposable income for
savings.
(b) High Dependency Ratios
A high proportion of dependents (children and elderly) relative to the working
population reduces national savings. Fewer working adults must support more non-
working individuals, which decreases the overall savings rate.
(c) Weak Financial Systems
Limited access to banks, credit unions, or investment institutions discourages saving.
As seen earlier, when people lack access to safe and rewarding financial assets, both
their capacity and willingness to save are reduced.
 Example: In rural areas of developing countries, many people still rely on
informal saving methods (cash, livestock) which do not mobilize funds for
productive investment.
(d) High Inflation
Inflation reduces the real value of money, discouraging people from saving in formal
financial institutions. When prices rise quickly, people prefer to spend money before it
loses value, weakening both their ability and motivation to save.
(e) Cultural and Institutional Factors
Low financial literacy, lack of trust in banks, and political instability can also reduce
saving. In some societies, people view saving as less important than family spending
or social obligations.

2. Economic Implications of Low Domestic Savings

Low saving levels lead to:
 Low investment in infrastructure, education, and industry.
 Dependence on external borrowing to fund development.
 Vulnerability to foreign debt and inflationary pressures, if investment
relies too heavily on printing money or foreign aid.
This situation relates to the low-level equilibrium trap, where low income leads to
low savings, causing low investment and low productivity — which in turn keeps
incomes low.

3. How Foreign Resources Can Supplement Domestic Saving

When domestic savings are insufficient, foreign resources play a vital role in
bridging the savings-investment gap. These include:
(a) Foreign Aid (Official Development Assistance)
Foreign aid from developed countries or international organizations (like the World
Bank) provides funds for infrastructure, health, and education projects. This boosts
capital formation and can help stimulate domestic investment.
(b) Foreign Direct Investment (FDI)
FDI brings not only financial capital but also technology, managerial expertise, and
access to global markets. It increases overall investment levels and complements
domestic savings, especially in sectors where local investors lack funds.
(c) External Borrowing (Loans)
Governments may borrow from international financial institutions (IMF, World Bank) or
issue bonds in global markets to finance development projects. However, this must be
managed carefully to avoid excessive debt burdens.
(d) Remittances
Money sent home by citizens working abroad often forms a large share of savings in
developing countries. For example, remittances to the Philippines and India provide
crucial funds for family welfare and small-scale investments.

4. Linking to Theories of Saving and Investment

  Prior Savings Approach: Low domestic savings mean fewer funds are
available for investment, reinforcing the need for foreign capital inflows.
 Keynesian Approach: Investment can itself generate income and savings —
hence foreign investment can stimulate economic activity and raise future
domestic savings.
 Quantity Theory Approach: Governments may use monetary expansion
(creating money) to finance investment, but this risks inflation if not matched
by real growth.
Thus, foreign resources can act as a catalyst, helping developing countries escape
the low-savings trap and build the foundation for future domestic saving growth.

Conclusion
Domestic saving in developing countries is often insufficient due to low incomes, high
dependency ratios, weak financial systems, and inflation. These factors limit both the
capacity and willingness to save. Foreign resources — including aid, investment,
and remittances — can supplement domestic savings by providing the capital needed
for growth and development. However, long-term progress requires strengthening
domestic saving capacity through income growth, financial inclusion, and stable
macroeconomic policies, ensuring that reliance on foreign resources gradually declines
over time.

✅ Summary:
Low domestic savings in developing countries arise from poverty, inflation, and weak
financial systems. Foreign resources such as aid, loans, and FDI can fill the savings
gap, promote investment, and support economic development — but sustainable
growth depends on building strong domestic saving mechanisms.

💡 Savings as a Form of Development – Thirlwall’s

Perspective
In many old economic ideas, especially the Harrod–Domar model, savings are seen as the main
way to make a country grow. The idea is simple: when people and governments save more money,
that money can be used for investment — like building factories, roads, and schools. These
investments help the country produce more goods and services, which increases income and
development.

But economist Anthony Thirlwall did not fully agree with this view. He believed that for most
developing countries, the biggest problem is not a lack of savings, but a lack of foreign exchange
— money earned from selling exports. Developing countries often need to import machines, tools,
and raw materials to grow their industries. If they cannot earn enough money from exports to pay
for these imports, growth will slow down, even if people are saving more.

Thirlwall explained this idea in what is known as Thirlwall’s Law. He said that a country’s long-
term growth rate depends mainly on how fast its exports grow and how much it needs to import. In
other words, a country can only grow as fast as its ability to pay for its imports allows.
This means that savings are helpful but not enough on their own. A country might have high
savings, but if it cannot buy the goods it needs from abroad, those savings will not lead to real
growth. Thirlwall summed it up by saying: “Savings may finance growth, but exports permit it.”

Because of this, Thirlwall said that developing countries should focus not just on increasing
savings, but also on improving their export performance, diversifying what they sell to other
countries, and reducing heavy dependence on imports.

In short, while savings are still important for development, Thirlwall’s theory teaches that what
really limits a country’s growth is its balance of payments — how much it earns from exports
compared to what it spends on imports.