The Political Economy of Saving and Investment: Evidence from Taiwan Kenneth S. Lin

Introduction Even though the formal barriers to international capital flow are small in developed counties, the saving retention ratios in developed countries are much higher than those in developing countries. This positive relation between the saving retention ratio and the degree of economic development has not received a great deal of attention.

Introduction This paper investigates the time varying patterns of saving retention ratio in Taiwan over the period of 1970 and We allow for possible effects of democracy, and financial openness on the standard deviations of national saving and domestic investments and the covariance between these two variables in a DCC GARCH-X model.

Saving retention ratios in developed and developing countries

Stylized facts on the saving- investment Correlation The co-integration relationship between saving and investment rations is not stable. The effects of changes in the S.D. of saving and investment on the correlation between saving and investment is a dominant determinant in the time varying investment-saving correlation.

Taiwan’s saving, investment and current account: 1971:1 – 2008:2

The relation between saving retention ratio and the saving-investment correlation

The rising correlation between saving and investment after 1985

The 10-year moving windows for covariance and S.D. of saving and investment

Motivation for this paper: Do democratization and financial globalization have similar channels of influence on the saving-investment correlation?

Since voters are risk-averse, they penalize incumbent government for economic volatility, and hence democratic governments respond accordingly. In non-democracies, elite groups are more likely to seek risk that voters would reject. Therefore, economic policy in democracy is risk-avoiding relative to policy in non- democracy. This implies that the volatility of macroeconomic growth should vary with the degree of democracy, other things equal. (Quinn and Woolley, 2001) How Democracy affect the volatility

Democratic Societies are more likely to respond to economic shocks through burden-sharing compromises, that is, more fairly. Because external shocks are unavoidable, societies with deep social cleavages are particularly likely to exhibit higher volatility. In divided societies, democracy bring about compromise without resort to social conflict or to redistributional measures. (Rodrik, 2000) How Democracy affect the volatility

Investment from abroad consists of FDI and foreign portfolio investment. FDI GDP is not sensitive to changes in domestic saving rate. Companies make FDI in response to a variety of direct business needs – being close to customers, obtaining lower cost of labor, responding to pressure from government where sales occur, rather than as a way of shifting capital from countries where capital has a low marginal product to countries where the marginal product of capital is high. How Financial Openness Affects the Covariance

There is one-for-one displacement of demostic investment by outbound FDI. - The nature of corporate capital budgeting in multinational corporations. - When outbound FDI depresses the volume of funds available for domestic investment, there is no automatic tendency for foreign portfolio capital to replace it. Financial Openness has negative effects on the covariance. How Financial Openness Affects the Covariance

Kasuga (2004) argues that financial development raises transparency in investment opportunities. A higher degree of transparency leads to a higher saving retention ratio. Financial development, as measured by financial openness, has positive effects on the covariance.

How current account affects the covariance VAR in small and open economies is much higher than that in large and closed economies. Therefore, small and open economies have a relatively low covariance between and.

Institutional change in Taiwan

A DCC GARCH-X model

For the law of motion for, is a vector of ones and is the Hadamard product of two identically sized matrices, which is computed simply by element-by-element multiplication. With in the law of motion for, even if A, B and are positive (semi-)definite, is not necessarily positive (semi-) definite.

A DCC GARCH-X model

The first stage estimation

Empirical finding in the first stage estimation GARCH effect is significant in the movement of the volatility of both saving and investment over time. Democracy reduces the volatility of both saving and investment. Financial openness is not contributing factors for the decreasing standard deviations of saving and investment over time.

The 10-year moving windows for S.D. of saving and investment after considering GARCH and institutional effects

The 10-year moving window for the saving- investment correlation after considering GARCH and institutional effects

The second stage estimation

Empirical finding in the second stage estimation GARCH effect is evident in the saving- investment covariance. Neither democracy nor financial openness are significant contributing factors in account for the time-varying covariance between saving and investment. Oil shock has positive effect for the time- varying covariance between saving and investment, as Baxter and Crucini (1993) conclude.

Financial openness has non-linear effects on the covariance between S and I

Concluding Remarks The reasoning for the negative impact of democracy on the standard deviations of both saving and investment is needed. If there is a one-to-one relation between outward FDI and domestic investment, then we need to clarify the channel of influence for the negative relation between financial openness and national saving.

Concluding Remarks To understand more on the relation between the rising saving retention ratio and the degree of economic development, we need to conduct more empirical studies using time-series data of other countries.