Public policies and saving in developing countries

This paper draws on estimates of consumption functions for 13 developing countries to analyze the effectiveness of public policy in raising saving. First, it provides evidence from time-series and panel data on how liquidity constraints affect consumption functions. This suggests that a rise in public saving does not produce an equal reduction in private saving. Second, it presents direct evidence of thelink between private consumption and government saving. These show that indirect effects of public policies on private saving are negligible, but that cuts in current public spending and current tax hikes significantly affect private saving. Increasing public saving by cutting current-period public expenditures by $1 reduces private saving by only 16 to 50 cents. Permanent cuts in public spending reduce private saving by 47 to 50 cents. A higher permanent tax hike has less of an effect on private saving than a transitory tax hike. For each $1 increase in permanent taxes, private saving declines only 23 to 26 cents. Increasing only current-period taxes reduces private saving between 48 and 65 cents. Increasing taxes and improving tax compliance are the most efficient ways to reduce public deficits when traditional tax revenue is low and inefficient tax levies are high and widespread. Finally, public policy can help raise private saving and make their use more efficient by providing a macroeconomic framework in which inflation is low and incentives are predictable.