Don’t blame the savers

Sep 16th 2005
From The Economist Global Agenda

Some economists argue that the imbalances in the world economy can be blamed, in part, on a glut of savings from developing countries gushing into American assets. New reports from the IMF and the World Bank say the problem lies elsewhere

AMERICAN conservatives are fond of prescribing personal responsibility as a cure for the financial ills of the poor. There is a certain amount of pleasure, therefore, in seeing America’s fiscal profligacy chided for contributing to the imbalances that currently threaten the health of the world economy. That is precisely the verdict of the newly released chapter on savings and investment in the International Monetary Fund’s World Economic Outlook. The document highlights the danger posed by the world economy’s heavy dependence on ravenous American consumers to snap up exports from the rest of the world.

To be sure, it is hard to be too gloomy. Though Europe has been sluggish and the global economy hasn’t quite lived up to last year’s lively pace of growth, world GDP is still growing at an above-average clip. Even Japan, stuck in an economic quagmire for the past decade, has begun looking perky.

But dark clouds have been gathering on the horizon for some time. Emerging-market economies, particularly in Asia, are running high current-account surpluses, keeping their economic fires stoked with a steady stream of exports, especially to America. In mirror image, America’s current-account deficits have soared past 5% of GDP. Household savings have dwindled to negligible levels as Americans have run down assets and taken on debt to keep the spending binge going. Yet if the American consumer falters, as things stand now, the rest of the world will tumble too.

Moreover, economists are increasingly worried that America’s economic health (and by extension the world’s) rests on a housing market that looks decidedly bubbly. When the bubble bursts, they fear, the whole thing could come crashing down.

But if economists are agreed that America’s debt levels are dangerous, they cannot agree on whom to blame. Economists with little time for the Bush administration point the finger at the government’s profligate budget deficits—predicted to be roughly $330 billion in 2005—which run down national savings. The administration’s supporters prefer to point to spendthrift consumers and the frothy housing market, and argue that a “global savings glut” is pouring excess capital from abroad, particularly Asia, into America’s financial markets. This, they say, is why long-term interest rates have remained low even as the Federal Reserve has progressively tightened monetary policy.

America is not the only country where savings have fallen. Worldwide savings began declining in the late 1990s, hitting bottom in 2002. They have recovered only modestly since then. The drop is mainly due to industrial countries, where savings and investment have been on a downward trend since the 1970s, thanks to a sharp decline in personal savings that an increase in corporate savings failed to offset. Savings in emerging markets and oil-producing countries have risen over that period, but not enough to reverse the trend.

So why the sudden talk of a savings glut? And even if there is a surplus, why is it flowing the “wrong way”—from the developing world, where returns on capital should be higher, to more mature economies like America?

The IMF report offers an explanation. What the world is suffering from is not so much a savings glut as an investment deficit, in both rich and poor countries. In emerging markets and oil-exporting nations, still feeling the lingering effects of the Asian financial crisis of 1997-98, demand for capital has failed to keep up with supply. Scrimping consumers have instead sent their money to the West.

The IMF’s figures suggest that this is not as irrational as it seems. Though in theory returns on capital should be much higher in the developing world, where economies remain labour-intensive, in practice the story is more complicated. Emerging markets saw a return on aggregate capital of 13.3% over the 1994-2003 period, compared with 7.8% in the G7 group of industrialised nations. But investments in emerging markets are riskier, because their economies tend to be more volatile and their institutions weaker.

Moreover, the return on aggregate capital may not be a good guide to the returns that investors can actually expect. Growth could be concentrated in smaller firms that are harder to invest in, for instance, or the data could be unreliable. Indeed, the IMF’s analysis suggests that the internal rate of return on invested capital in publicly traded firms in emerging markets has been very poor over the past decade, even before currency risk is taken into account.

But investment has fallen in the rich world too: the rivers of capital have flowed not directly into businesses but into markets for consumer and government credit, where they are presumably doing little to increase the recipient economy’s ability to repay the loans in the future. That means consumer retrenchment when interest rates rise or the bills come due, which will hurt emerging markets if they do not work harder to generate domestic demand, instead of relying on exports for growth.

A better way to crunch the numbers

So what is the cure? Lower savings rates in emerging markets? That would be a disaster, according to a new report from the World Bank, “Where is the Wealth of Nations?”. Many developing countries, says the Bank, are already saving too little, if you do the figures right.

Traditionally, national saving is calculated as simply national income minus consumption. But this, the Bank argues, ignores important underlying changes in the productive capacity of the society. Should education, for example, be counted as consumption, or as an investment in human capital that will enable the nation to produce more in future years? On the flip side, every dollar earned by selling finite natural resources like oil or diamonds represents an incremental decrease in the country’s ability to generate wealth in coming years. If you account for things like this, says the Bank, a lot of developing countries, especially in Africa and the Middle East, are running down wealth at a fast pace—though in Asia, even with those adjustments, savings rates are still high.

Like the World Bank, the IMF does not think lower savings rates in developing countries are the answer. It identifies several other things that could make a difference: higher national savings in the United States, an investment recovery in Asia, and an increase in real GDP growth in Japan and Europe.

Easy to say, difficult to pull off. Raising interest rates would, the IMF concedes, have only a limited effect on America’s savings rate. Balancing the budget would do more, but there seems to be little political will to tell Americans they must pay for their government programmes. Across the Atlantic, European governments are finding it hard to make the kind of structural reforms that could boost their sluggish growth rates, and the European Central Bank has remained unwilling to provide monetary stimulus by cutting rates. Nor has Japan’s government, despite the signs of fledgling recovery, yet found a formula for boosting its long-term growth rate. It is easier to diagnose the illness than effect a cure.

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