The Paradox of Thrift and the Drag on the Nigerian Economy

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Thursday, October 08, 2020 / 12:16 PM /  By FDC Ltd / Header Image Credit: FDC Limited

 

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The savings rate in an economy is theoretically a function of households' disposable income, which is the income level of individuals and households after the payment of taxes. Nigeria's national savings rate was last estimated at 19.25% in 2018, 3.4% above the 15.85% recorded in 2016 when the economy was in recession.2 With the economy at the verge of another recession in 2020, the national savings rate is likely to dip again. Household income levels have been affected by the rise in unemployment levels as companies implemented cost reduction strategies to cope with COVID-induced economic disruptions. The sharp drop in income levels is likely to translate into a reduction in household savings. However, households can also become thriftier after an economic crisis based on a heightened consciousness about their previous experiences. This is evident in the uptick in savings in Nigeria after the 2016 economic recession. Hence, as much as it is expected that savings would rise as the economy rebounds, too much thriftiness among households could become detrimental to the economy

 

Paradox of thrift and the Nigerian economy The paradox of thrift opines that in an economic crisis with prevailing uncertainties, such as the current pandemic, people generally save to protect against further unforeseen circumstances. This implies that instead of a decline in savings to reflect lower income levels, uncertainties about the recovery of the global and domestic economy could keep savings elevated. Empirical evidence from the Nigerian economy however revealed otherwise as savings fell by 1.09% to 15.85% in 2016 from 16.94% in 2015 aligning with the reduction in income. However, in 2017 and 2018, in the aftermath of the recession and with incomes still low, Nigerians remained cautious and savings rose significantly.

 

A higher savings rate post-recession, despite a relatively low-income level, suggests an uptick in precautionary savings reflecting a lagged effect of the recession on savings. Invariably, as economic activities recover from the severe hit of lockdown measures, improvements in household disposable income may not impact significantly on aggregate demand due to the likely surge in precautionary savings.


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Implications of Higher Precautionary Savings for the Nigerian economy

The tendency of individuals and households becoming thriftier post COVID-19 could prolong the anticipated recovery of the Nigerian economy. Already lock down measures, such as the restrictions on social gatherings, have compelled many households to curb spending on ceremonies as they embrace virtual mediums of interactions. Although the Nigerian government has started to gradually ease these restrictions, there is a possibility that a proportion of the citizenry will continue with the virtual platforms. Nonetheless, relaxed lockdown measures are expected to promote a rebound in economic activities, which is favorable for the country's economic growth trajectory.

 

Meanwhile, the likelihood of an uptick in precautionary savings, as households begin to recover from the impact of the pandemic, could weigh on the economy and slowdown the pace of recovery. The Nigerian economy contracted by 6.1% in Q2'20 from an economic growth of 1.87% in Q1'20, hinged largely on pandemic-induced economic disruptions due to lockdown measures implemented during the period.7 Nigeria is headed towards an economic recession in Q3'20 in the absence of informed policy decisions and reforms to stimulate economic growth. There is also the risk of a long road to recovery as prevailing macroeconomic conditions such as negative growth, increasing inflation, external sector weakness and growing unemployment promote higher precautionary savings among the citizenry. The attendant decline in consumption and investment levels suggests the need for increased government spending as well as the implementation of crucial economic reforms to facilitate the recovery of the economy.

 

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