Optimal Savings

Abstract

How much should a nation save or, to put it differently, what is the optimal rate of growth? This question is at the heart of the extensive literature on ‘optimum savings’ which developed as a complement to the literature on descriptive growth models in the 1950s and 1960s. Let it be noted that the reasonableness of the question presupposes a utilitarian welfare-theoretic outlook, which locates a source of ‘market failure’ in the intertemporal context stemming from what A.C. Pigou (1928) had described as a defective telescopic faculty. While Böhm-Bawerk, Fisher and other economists had noted the fact the individuals show a preference for advancing the timing of future satisfaction, they refrained from making any normative statement. Instead they constructed theories of interest which utilized this crucial behavioural characteristic on the part of individual economic agents. Pigou, however, read into the fact that individuals discount future satisfaction at a positive rate, that is display impatience, ‘a far reaching economic disharmony’ (1928, p. 26). This made him seriously question the ‘optimality’ of the rate of savings thrown up by an otherwise fully competitive market even under conditions of full employment. Pigou’s ideas on this question received support from the Cambridge philosopher-mathematician Frank P. Ramsey, who took the next most important step of determining a rule for determining the optimum rate of savings based on the logic of intertemporal utility maximization, one of the early exercises in economics using the technique of classical calculus of variations. Ramsey was relatively precise in laying down the normative postulates underlying his enquiry, ingenious in deriving the characteristics of the optimal path and not so much concerned with demonstrating that an optimal solution will always exist even on the premises laid out by him.