Savings Rates and Living Standards

How does a higher savings rate lead to a higher standard of living?

Economists often refer to savings as the "seed-corn" of the economy.  In other words, the act of saving is similar to a farmer who does not eat all his corn at harvest time but instead, puts some aside to plant next year.  He could eat better today if he ate everything, but it would come at the expense of sacrificing the future.

Savings are the primary source of capital, which is the lifeblood of an economy.  Capital refers to accumulated funds (savings) that an entrepreneur invests for future production.  When a person starts a small business, for instance, he has no revenue yet from sales because he hasn't yet produced a product.  Yet, he needs funds to buy the machinery, plant and equipment and hire the workers that he'll need to get things going.  He funds these early start-up necessities either by using his own savings or by borrowing the savings of others from a bank.  If everyone consumed all their income in the present and saved nothing, there would be no concentrations of savings that entrepreneurs could borrow to make these important, long-term investments.

Businesses save, just as individuals do.  When a businessman takes some of the company's profits and plows them back into the business--investing in new technologies or plant expansion, for example--he is utilizing a form of "savings."

Savings, by the way, should not be thought of as simply cash in the bank.  Savings can be in the form of the build-up of equity in a person's home, or the stocks and bonds he has purchased and thereby allowed others to use for productive purposes in business.

Think of savings as a pool of capital, without which we would all be starting from scratch every time we wanted to try out a new idea, start a business, or expand a factory.  The greater a nation's savings rate, all other things being equal, the greater the pool of capital available for investment to produce more and better goods and services.