Gross National Product: Leakages and Injections of Purchasing Power

Leakages and Injections of Purchasing Power A leakage of spending represents a portion of income that is not used to purchase domestically produced products during the year. There are three types of leakage of spending power from the circular flow: 1. Net taxes the difference between total taxes paid to governments and transfer payments made by governments. 2. Saving. 3. Import purchases. Leakages of spending from the circular flow cause decreases in the current demand for U.S. final products. Other things being equal, the more saving, the greater the difference between taxes and transfers, and the greater the import purchases, the less national income is used to buy U.S. goods and services during the year. An injection of spending is a purchase made by business firms, governments, or foreign buyers that increases the flow of income in a nation. Injections of purchasing power for purposes other than consumption by U.S. households increase demand in the economy. The injections illustrated in the circular flow diagram are: 1. Investment. 2. Government purchases. 3. Exports. A reduction in business investment purchases during the year or a decline in export purchases could spell trouble for the economy by causing a reduction in current income. On the other hand, an increase in government purchases will increase the demand for goods and services. You can think of real GNP as a volume of liquid flowing through the tubes of the circular flow diagram in Box 7. When the injections of spending exceed the leakages of spending, the volume of liquid in the tubes will increase, meaning that current real GNP will increase. On the other hand, when the injections of spending fall short of the leakages of spending, the volume of liquid in the tubes will decline, meaning that current real GNP or the price level will decrease. The task of macroeconomic theory is to understand the economic forces that influence these leakages and injections in order to forecast changes in real GNP and develop policies that stabilize fluctuations in real GNP. Flows of Saving and Investment in the United States: Do We Save Enough? National saving is the sum of personal saving by households, business saving, and saving by the government sector. Box 8 shows how national saving has varied as a percent of GNP since 1950. In the 1980s national saving in the United States was only 14.1 percent of GNP-down from the 16.3 percent average that prevailed from 1950-1979. The U.S. savings rate has dropped substantially (by 13.5 percent) from the historical average that prevailed during the 30-year period since 1950. Now let's examine the savings rate of three sectors of the domestic economy: households, businesses, and government. Notice that the bulk of national saving is accounted for by business firms, mainly in the form of capital consumption allowances and undistributed corporate profits. The business saving rate has actually increased since 1950 and it has averaged 12.9 percent of GNP from 1980-1988. Next look at how household (or personal) saving has declined substantially in the 1980s from its 1950-1979 average. From 1980 to 1988, household (personal) saving was only 3.8 percent of GNP. But households aren't the sole culprits responsible for the decline in national savings in the 1980s. To illustrate, look at saving by the government sector of the economy. Notice that government saving is negative. This means simply that the government sector in the United States spends more than it takes in. On net the government sector absorbs savings in the United States because it must borrow to cover expenses that are not financed by taxes, fees, and charges. The savings rate of the government sector during the 1980s averaged -2.6 percent. This negative saving rate largely reflected the federal budget deficits during this period. In fact, state and local governments actually ran surpluses during the same periods and contributed 1.3 percent of GNP to national saving. The federal budget deficit on average from 1980-1989 subtracted 3.8 percent of GNP from the national savings rate! After looking at Box 8, we can conclude that the national savings rate has declined substantially in recent years and that lower saving by households and increased borrowing by the Federal government are largely responsible for the poor savings performance of the United States in the 1980s. The U.S. national saving rate is now considerably lower than it is in some other advanced nations. Box 9 shows how the national savings rate in the United States stacks up against Canada, Japan, and several European nations from 1975-1987. Note that the Japanese have saved over 30 percent of GNP for that period. Of the six nations shown in the graph, the United States has the lowest savings rate for the period. Because savings fuels the process of investment, which in turn fuels the process of economic growth, many economists are concerned that the declining rate of national savings in the United States means that living standards will not rise as quickly as they have in the United States since the end of World War II. There is also concern that productivity and the rate of improvement of living standards in other nations will surge ahead of that of the United States. The decline in the national savings rate in the United States is of concern because it could affect future living standards. If we do not improve our savings performance soon, you might not enjoy the same standard of living improvements that your parents have enjoyed over their lives! How Foreigners Have Helped Finance U.S. Investment in the 1980s Between 1980 and 1988, national saving averaged only 14.1 percent of GNP while investment averaged 15.8 percent of GNP. Americans have not saved enough to finance investment purchases by U.S. businesses. This shortfall in national saving has been overcome by the net inflow of foreign saving. Foreigners save in the United States when they use the dollars they acquire during the year in foreign exchange markets to acquire U.S. assets rather than spend those dollars on U.S. exports. Net foreign saving in the United States is the difference between total foreign saving in the United States and U.S. saving abroad and is positive whenever we have a balance of trade deficit. The table in Box 8 shows that net inflow from foreign saving in the United States averaged 1.6 percent of U.S. GNP from 1980 to 1988. When these funds are added to national saving, total saving in the United States exactly equals gross private investment. Total saving in the United States is the sum of national saving and the net foreign saving in the United States. The circular flow diagram shown in Box 7 shows how foreign saving in the United States is added to national saving to help finance investment purchases. You have probably read quite a bit about foreign saving in the United States— some of it takes the form of direct investment in United States as is the case when Japanese savers use dollars they have acquired in foreign exchange markets to buy U.S. real estate and acquire U.S. businesses. Most foreign saving in the United States, however, involves acquisition of paper assets, such as stocks, bonds, and certificates of deposits in banks. Foreign saving, including the portion of such saving that is direct investment in the United States, has served a valuable function in the U.S. economy in recent years by allowing the rate of investment to exceed that of the national savings rate. Because of foreign saving, we have been able to create more jobs and we are likely to have more rapid economic growth in the future than would otherwise have been possible. In effect, foreign saving in the United States in the 1980s has allowed U.S. spending to exceed U.S. income! The world is becoming more and more economically integrated. Despite increased foreign investment in the United States by the Japanese and others, U.S.-owned assets in foreign nations generally exceed foreign-held assets in the United States. For example, the United Kingdom owns more U.S. investment assets than any other foreign nation. In 1988, the United Kingdom had capital investment in the United States amounting to 2.1 percent of U.S. gross domestic product. In the same year, it was estimated that U.S. holdings of investment goods in the United Kingdom amounted to 5.7 percent of the United Kingdom's gross domestic product.