Claims Ratio of Life Insurance companies calculated by the amount of Claims...
Have you wondered why it is that Asians, even the ones who are affluent, have a lower quality of life than the average guy from the developed world? Now why would that be so? Critics might say that this is due to bad infrastructure; population being very high etc. etc.; implying that the services available need to be shared by many. But the fact is that all our lives we save and save for a better tomorrow – but better tomorrow for whom?
Going by text book economics, savings is the best thing that would lead to long-term economic growth right? Refer back to the oft used equation; Savings (S) = Investment (I). Although I have tried to be an ardent economics student, apart from mugging this for exams, I have never really understood the practical implications of this. In a single country model, this might work. Statistics also bear fruit to this. Savings rate of China and India are one of the highest, 14% and 27% respectively and that is perhaps one of the reasons why these economies are the fastest growing in the world. But let’s delve a bit deeper since we are definitely not living in a single country world.
It’s a well known fact that the average Asian saves a huge amount. Where do savings come from? It means we produce more than we consume. We produce goods and services. The fact that we don’t consume all of it means we export the excess. We get paid for the services in foreign currency. The central bank keeps some of this foreign currency and injects an equivalent amount of rupees in the system. Then they devise ways to mop up the excess liquidity since they start fearing inflation. So far so good right? Confused? So am I. Let’s use simple numbers then.
Say we produce 100kg of rice as a nation. We consume 50kg of it ourselves and export the balance. The international market pays us USD 50 for that exported rice. We sell this to a bank and get Rs. 2500 to be spent on our other requirements. But we are middle class Asians, so instead of saving a little we set aside a substantial amount of this in our savings account. Moreover, the central bank buys back a part of this USD 50 from the bank, say USD 20. Although there are several reasons why they do so, the primary reason is to build foreign exchange reserves. Since the central bank pays the bank in Rs. for the amount of USD bought, they inject an additional Rs. 1000 in the monetary system.
Now we have all heard of the multiplier effect in the financial sector right? This Rs. is further lent by the bank to borrowers, which in turn is further deposited in an iterative manner and the effective value of the money keeps growing to a much larger amount. Since the Central Bank is now worried about stoking inflation they ask banks to park part of this back with them via cash and government bonds so that this money does not multiply indefinitely.
Now comes the question of what does the Central Bank do with the USD 20 they had bought from the bank. They go and invest in US government bonds since that’s perceived to be the safest asset. When all Asian countries do the same (which is definitely a fact), the US and other developed country governments get to enjoy the cash from all the hard work we had originally put in to produce the goods. Even after consuming them, they effectively borrow back some of the money they had paid for the goods via a long term loan. As long as the perception is that they are of superior credit rating and therefore our USD 20 is safe, they continue to use our money, to provide among others, healthcare and developmental benefits to their citizens. So while it is true that we are partly saving for our future, we are also effectively saving for the developed world.
Two questions come to my mind, a micro and a macro. The micro question is very critical - Why do we save so much? The most common answer I have received is that “Unlike the West, the Government here does not provide us healthcare and retirement benefits and we need to have enough for a rainy day”. Very logical answer but what constitutes a rainy day? If we are hard-working and most importantly healthy then we should always be able to produce (not procreate mind you but earn for oneself and family). So if health and life are the two biggest risks, doesn’t it make sense to have large life & health insurance policies (accompanied with things like critical illness covers) so that we cover all the potential “rainy day” situations? And once we have done that we can then enjoy the money that we have without saving any further.
A related question might arise. Since we don’t save enough how do we ensure a better future for our children? The answer to that is also quite simple. Instead of saving if we consume, we would effectively be creating more demand for the products that we buy, thereby creating more jobs for the whole country. Economics teaches us money multiplier, but what about people’s skills multiplying. We are a nation who can leverage people much more than we can leverage capital and that is where our focus should be. As more people get skills, their capacity to innovate increases, therefore the productivity per individual also increases. That way if all of us consume more today, we would as an aggregate nation ensure a better future for our kids. But yes, only “I” saving more than my next door neighbor would give my kids a better head-start than that of my neighbors. So by excessive saving more aren’t we being selfish, thinking myopic?
The macro question that needs to be answered is – What is a logical end to this conundrum? The developing countries are saving, subsequently investing in the developed countries at low fixed bond returns. Using that same money, the developed countries are re-deploying that back but not in low fixed returns, but attractive equity returns via foreign direct investments and institutional flows. Who is the winner? I don’t think I need to answer that. The more hard work we put in to increase the profitability of our companies, a significant part of it is enjoyed by the developed nations while we continue to earn 2% long term US treasury bond returns? The logical end-game is that over time the US currency should depreciate, thereby ending this balance. But here again our Central Banks would be the biggest losers since they are holding huge amount of US assets. Which means that we will continue to further invest in the US (to support the currency) and the cycle might continue indefinitely?
While bashing the government and central bank may seem simple and fashionable, given the fact that we have had balance of payments crisis and the fact that we are a poor nation, the task of the government and central banks is not so easy. Even they think of “rainy days”. Increasing exports and thereby increasing our reserves was definitely a good strategy for the better part of the last two decades. But now that we have enough reserves, even the Central Bank should stop worrying about excessive saving of foreign currency.
As for us citizens, we should also learn to handle our “rainy day” situations better. Not by saving most of what we earn, but by removing the risks with adequate insurance protection. Save, but a prudent amount, not an excessive amount. Capital starved countries saving more than capital rich countries is something that has to and should change quickly. Going back to our simple numerical example, we should ourselves consume a significant part of the excess 50 kg of rice that we have been exporting all this while. The exports should just be sufficient to ensure that it covers the cost of our imports (like oil etc.) and nothing more. So let’s go out and buy the cars and dream houses that we have always wanted to instead of saving for the developed nations.
~ Resident Expert @ MyInsuranceClub.com