Savings and Education: A Life-Cycle Model Applied to a Panel of 74 Countries

August 1995 In the long run, education improves the national saving rate and hence growth. But this positive effect takes time to be completely realized, and it varies across regions and levels of development. Morisset and Revoredo analyze how education contributes to savings. There are many reasons to believe that education and savings may be linked, either positively or negatively. It is generally expected that people with higher education will earn greater income, thereby leading to higher savings, even if the positive relationships between education and income and between income and savings take time to be completely realized. The relationship between education and income can be negative at first because education expenses initially increase consumption and reduce current disposable income. Another argument for a negative link concerns precautionary savings. If there is a precautionary motive for savings, education should reduce income volatility because educated people are less likely to be unemployed, or, if unemployed, they are covered by unemployment insurance. With less need for precautionary saving among the more educated, education and savings would be negatively correlated. The authors' major findings for a panel of 74 countries over the period 1960 - 90 are: ° Education positively influences savings in the long run. For each percentage point increase in education stock, the savings rate increases 0.37 percent. But it takes more than five years for the positive effect, through income, to compensate for the initial negative impact on savings. ° The lagged effect (five years) of a change in the stock of education appears positive in all regions except Latin America. The negative correlation in this region can be explained by the worsening quality of education, which reduces the ability to implement new technologies, and by the traditional focus on university education instead of primary and secondary education. Moreover, well-educated people in Latin America seem to have a lower precautionary motive for saving than in other regions. ° People are more productive, invest more, or are a better complement to physical capital in an environment where many people are well-educated. Accordingly, the positive effect of education on savings appears higher in industrial countries, given their higher initial stock of human capital, than in developing countries. ° The effects of primary and secondary education on savings are positive and significant in all regions, while the effect of university education is positive only in industrial countries. One explanation might be that industrial countries tend to invest in new projects rather than to adopt existing technology. Morisset and Revoredo derive several policy recommendations from their conclusions. First, the positive effect of education on savings is enhanced by a reduction in the cost of education, which automatically increases disposable income. In many countries, the unit costs of education may be reduced by exploiting economies of scale and by developing incentives for greater cost-consciousness among consumers and providers. Many education systems may also need to upgrade their internal efficiency. Second, a focus on primary education should be encouraged, specifically in developing countries. The empirical results indicate that the positive long-run effect associated with primary education is twice as large as that for secondary and tertiary education. Latin America's traditional neglect of primary education contrasts sharply with the policy of Asian countries. Finally, it is important to increase the coverage of education, not only for equity but also for efficiency reasons. Indeed, how much a child learns is influenced by the nature of the learning environment, as supported by the role played by externalities and the initial level of education in the relationship between education and savings. This paper --- a product of the Country Operations Division, Latin America and the Caribbean, Country Department I --- is part of a larger effort in the region to understand the determinants of domestic savings. Jacques Morisset may be contacted at jmorisset@ifc.org.