Domestic Savings-Investment Gap and Growth : A Cross-Country Panel Study

Standard neoclassical growth models assume that foreign savings are perfect substitutes of domestic savings in financing domestic capital. Therefore, domestic saving rates are supposed to have no impact on investments and growth rates of countries. However, these models fail to explain the divergence of growth rates between East Asian countries with high domestic saving rates and other emerging market economies with low saving rates. This study forwards the view that saving-investment gaps, if not domestic savings themselves, may explain to some extent the divergence of growth rates among countries. We borrow the methodology of Aizenman et al. (2007) in calculating self-financing ratios (cumulative saving-investment gaps) of 46 countries for the period of 1993-2010. Surprisingly, we find that countries on average financed a larger fraction of their capital by domestic savings in the 2000s when international financial integration has intensified and there has been a surge in capital flows across countries. Our empirical findings suggest that increasing the fraction of domestic savings in the financing of domestic capital, i.e. a rise in self-financing ratios, contributes to growth performance of countries. This finding is more pronounced for low-middle income countries and countries with low self-financing ratios. Evidence also shows that countries with low and declining self-financing ratios have been more affected from the recent global financial crisis.