A dirge and a riddle
Larry Summers reckons rich countries are suffering from long-term stagnation. If accurate, the former U.S. treasury secretary’s view is chilling. It has also revived an old, unresolved puzzle: Why doesn’t the world’s capital willingly go where it’s most needed?
Summers argued in a recent speech that the real “natural” rate of interest at which rich nations will achieve full employment may now be negative. Since actual rates can’t fall that low without a big pickup in inflation, that’s another way of saying these countries aren’t investing enough – or that the world is pushing too much of its savings into developed economies. A decade of low interest rates amidst large increases in borrowing – first by consumers and later by governments – points to a global savings glut.
Rather than drown in excess savings, why don’t rich countries export some of the surplus to emerging markets that can easily absorb it by investing more? That’s the paradox Nobel laureate Robert Lucas identified in 1990. And it’s become more befuddling since then.
Instead of helping to solve the problem, emerging markets have made matters worse by acquiring U.S. Treasuries and other developed-world financial assets. In other words, they export capital when they ought to be importing it. To be sure, some of the money is channelled back to them in the form of foreign direct investment, bank loans and bond and equity inflows. On balance, though, emerging markets are net exporters of capital.
Between 1995 and 2005, countries in East Asia, the world’s fastest-growing region, increased the stock of machines, factories and equipment available to each of their 1.8 billion people by $2,700 in real terms, after adjusting for inflation and differences in purchasing power of currencies. Rather than supplement this capital accumulation by borrowing from abroad, the region exported an average of $300 per person to the West.
Nor was East Asia a special case. Even poorer countries in South Asia and Sub-Saharan Africa exported capital. OECD countries, by contrast, sucked in savings worth $600 per person from the rest of the world. That’s puzzling, because the real stock of capital per person in these rich countries is 16 times the level in China, and 50 times as large as in India.
Trying to solve the paradox is a cottage industry of sorts. One possibility is that risk-adjusted returns on capital in emerging markets aren’t as high as they look. In many developing countries, productivity growth is slow, which may inhibit inflows. Alternatively, inefficient financial systems and weak property rights may mean these countries are better off exporting capital: it’s a safer road to prosperity.
But whatever the explanation, the unnatural flow of capital from poorer to richer countries has usually been viewed as a problem for emerging markets: If only they could accumulate physical capital faster, they could get rich quicker, pulling everyone else up with them.
Summers’ somber hypothesis, however, suggests that uphill capital flows are a bigger problem for rich countries. Like companies with too much cash on their balance sheets, they have excess capital at their disposal and not enough good uses for it. More of it should be pumped out to emerging markets. Boosting investment would not only help poorer countries; it would also bring benefits to the developed world. After all, nine rich countries make 80 percent of the world’s machines and equipment.
But developing countries are understandably wary of depending on fickle investment flows from the West. Indeed, it was the 1998 Asian crisis that persuaded many countries they needed to accumulate more reserves. It may take a new global financial order to assure developing nations that access to capital won’t get cut off in the middle of an investment boom.
One option is to repurpose the International Monetary Fund to play the role of a guarantor of private capital flows. But that would require the world’s largest nations to pool their financial resources. If the stagnation that Summers is warning of turns into a global depression, such a surge in political will is likely to be lacking.