On the appropriate specification of the life cycle savings rate model: The roles of sectoral shares, financial intermediation and foreign capital

Abstract

Cross-country tests have tended to show aggregate savings rates rising with per capita incomes. This conflicts with a key life cycle prediction. One explanation may be that previous tests were misspecified by failing to include potentially important explanatory variable(s) that are also correlated with per capita income. The lower (higher) shares of industry (agriculture) and the lower levels of financial maturity associated with lower income countries were examined in this context, as was their higher capital inflow rates. The results confirmed that the lower savings rates in poorer countries are more a reflection of these variables than their low incomes. They also suggested that rapid growth rates and large shares of industry are especially strong in their impacts on savings rates while larger shares of agriculture were found to have no adverse affect. Evidence for financial intermediation (net capital inflows) having a role in promoting (discouraging) domestic savings was also found.