Sustained national saving and financial system development

A sustained increase in national saving (10-15 years) could have significant impacts on financial system development with knock-on effects for firm growth and productivity

Based on international experience, a sustained increase in national saving could have significant impacts on financial system development. However, the experience of Australia and Chile suggests that the full benefits of increasing saving are likely to accrue slowly over time. After a sustained period (say 10-15 years), material increases in saving could produce significant financial system development with knock-on effects for firm growth and productivity.

Enlarging and deepening the financial system through higher savings

International evidence suggests that sustained increases in national savings, for example brought about through the introduction of compulsory superannuation schemes, can enlarge and deepen the financial system.

• Corbo and Schmidt-Hebbel (2004) describe the main effects of the Chilean pension reform on its capital markets. They highlight the contribution of pension reform and increased savings to the quality of regulation, improvements in corporate governance and transparency, increased specialisation, innovation and the creation of new financial instruments, as well as secondary effects on the structure of the financial system and other markets (e.g. insurance, mortgage markets etc). In terms of quantitative effects, they argue that pension reform significantly increased the breadth and depth of the financial system.
• Gizycki and Lowe (2000) describe key changes in the Australian financial system in the 1990s following, firstly, the privatisation of government-owned assets and financial deregulation and, subsequently, the introduction in 1991 of compulsory retirement savings. They argue that these changes have resulted in a major transformation of the household sector’s balance sheet, which has reshaped the financial system[18][19]. In particular, the increase in financial assets has led to the development of markets in a wider range of securities, a proliferation of investment products, and a more important role for institutional investors. It has also helped prompt changes in the nature of financial regulation.

The development of contractual saving institutions can improve the functioning of the financial system

There is further evidence to suggest that the development of contractual saving institutions (e.g. superannuation funds) can improve the functioning of the financial system in a variety of ways, including deepening stock and bond markets (Catalan et al, 2000; and Impavido et al, 2003). Vittas (2000) argues that “institutional investors can potentially act as a countervailing force to the dominant position of commercial banks and thus promote competition and efficiency in the financial system. They can also stimulate financial innovation, modernise capital markets, enhance transparency and information disclosure, and strengthen corporate governance, and improve financial regulation.” Specifically, institutional investors:

• provide an institutional framework that favours the accumulation of long-term capital;
• foster competition for savings thereby lowering management fees;
• foster competition for investments thereby lowering the cost of capital;
• promote financial innovation by demanding new securities and products in order to diversify portfolio risks; and
• promote market discipline through their demands as shareholders for greater transparency and accountability.[20]

Other possible benefits

Although supported by less evidence, there are a range of other possible benefits linked to financial system development that could flow from a sustained increase in savings in New Zealand:

• Domestic investment may increase, depending on the extent to which firms currently face finance constraints.
• Existing and potential exporters may benefit through a reduction in the current account deficit and the exchange rate, although the precise adjustment paths to a new equilibrium exchange rate are not predictable.
• A reduction over time in New Zealand’s external liabilities would in turn lower the country risk premium and reduce the cost of capital.
• A reduction in the tendency of the housing market to overheat and create excess demand and rising debt in the economy.
• Increased New Zealand ownership of New Zealand based firms, helping address concerns around “hollowing out”.
• Increased ownership of offshore assets in line with sensible portfolio diversification, potentially narrowing the gap between Gross National Income (GNI) and GDP.