Explaining World Savings

Data on the world saving distribution reveals three key features: (i) saving rates are significantly different across countries and they remain different for long periods of time; (ii) the average saving rate has remained relatively unchanged but the dispersion in saving rates has risen; and (iii) some countries and regions have shown very sharp changes in their average saving rates over short periods of time. These facts are problematic for the standard model with time-additive preferences where the rate of time preference has to be equal for all countries. Without equal rates of time preference, the asymptotic distribution of world wealth is typically degenerate. This paper provides an alternative explanation for the observed saving patterns. We formalize a model of the world economy that is comprised of open economies which are inhabited by infinitely-lived agents. Our main point of departure from the standard exogenous growth neoclassical model is that we endow agents with recursive preferences. Specifically, we follow Farmer and Lahiri (2002) and use a modified version of recursive preferences. The key implication of the Farmer-Lahiri specification is that it generates a determinate steady state wealth distribution within a growing world economy, a feature that typical models with recursive preferences cannot generate. The problem with the standard recursive preference specification is that it is inconsistent with balanced growth. The existence of balanced growth requires homothetic preferences. However, under homothetic preferences, the asymptotic wealth distribution in multi-agent environments is either degenerate or reflects the initial wealth distribution. The Farmer-Lahiri approach avoids this problem by making preferences time dependent. Agents in our model care about their relative position in the world distribution. World average wealth enters our preferences as an external effect. This time dependence in the model allows for preferences to exhibit increasing marginal impatience which is a necessary condition for a non-degenerate asymptotic wealth distribution. A positive productivity shock in our model induces a rise in saving which ultimately reverts back to its prior level due to the increasing marginal impatience of agents as their wealth rises relative to world wealth, thereby preserving an determinate asymptotic wealth distribution. In our quantitative work we divide the world into three regions: the G7, sub-Saharan Africa, and Emerging countries. We calibrate a three-country version of the model to match the world saving distribution in 1970 across these three groups. Using only the measured productivity shocks in these three groups between 1970 and 2010 as exogenous drivers, we then show that the model can generate both the stable average saving rate as well as the rising dispersion of saving observed in the data. Lastly, we show that the model can also generate sudden and long-lived switches in savings, a feature that is also observed in the data.