A Few Thoughts on the Dearth of Investment (or was it a Glut of Savings)

Brad Setser provides a link to “the IMF’s most recent paper on global imbalances” or chapter 2 of its World Economic Outlook:

Global saving and investment rates have fallen and current account imbalances have widened to unprecedented levels, yet real long-term interest rates remain low in most countries. How did the global economy arrive at this position?

Before turning to how the IMF answered this question, let go back four years when certain pro-growth liberals were hammering the Bush Administration for its fiscal irresponsibility and resulting lower national savings, which we have illustrated in the first diagram. We can all recall some of the Bush apologists saying something along the line of the U.S. being just a small part of a large financial market. I guess if we wanted to be mean we might have fired back “and your point was what”.

Ben Bernanke’s global savings glut thesis provided an answer. You see – our story would have predicted higher real interest rates and Bernanke suggested the fact that real interest rates fell might suggest an outward shift of the world savings curve – as in figure 2. Note, however, the X in both diagrams indicating that both price (real interest rates) and quantity (world saving = world investment) have fallen.

The IMF notes:

Some have argued that the catalyst is the substantial changes that have taken place in Asia, where saving has risen but investment has collapsed since the late 1990s. According to this view, the swing in the saving-investment gap – from deficit to large surplus – in emerging Asia has resulted in an excess global supply of saving (a global saving “glut”) that has been channeled to the United States to finance its large current account imbalance (Bernanke, 2005). At the same time, this would explain the low level of long-term real interest rates, which is needed to equilibrate desired saving and planned investment on a global basis. Others have argued that the sharp drop in national saving in the United States – reflecting the
deterioration in the fiscal position and the increase in housing wealth – and the recent rebound in investment are at the root of current account imbalances (see, for example, Roubini and Setser, 2005). Thus, according to these observers, current global imbalances are mainly the result of policy decisions – both fiscal and monetary – in the United States. By itself, however, this would not explain the low level of real interest rates, as a higher demand for net saving from the United
States would lead (everything else equal) to higher, not lower, global interest rates … unusually low investment rates across the globe are a contributing factor to low real long-term interest rates. In addition, the chapter also finds that the current pattern of external imbalances largely reflects a series of diverse and unrelated regional developments.

The IMF report includes figure 2.1 (Global Saving, Investment, and Current Accounts Percent of world GDP), which shows world savings and investment since 1970:

Global saving and investment have been trending downward since the early 1970s. They reached historic lows in 2002, and have recovered modestly since then … These global trends mainly reflect developments in the industrial countries, where both saving and investment have been trending downward since the 1970s. In contrast, saving in the emerging market and oilproducing economies has risen over this period, while investment, after increasing substantially up to the time of the Asian financial crisis, has since fallen and remains below the levels of the mid-1990s. As a result of these trends, the industrial country share of global saving and investment has dropped from about 85 percent in 1970 to 70 percent at present.

Our third figure shows an inward shift of the investment demand. However, note that with our assumption of a low saving schedule elasticity with respect to interest rates (which the IMF suggests is the case), an inward shift of the invesment demand schedule does not fully explain the decline in world saving = world investment.

James Hamilton provided a similar time series graph for the U.S. alone showing how our savings rate has declined over time. Figure 2.2 of the IMF report extends the time series to the Euro Area, Japan, and other industrial nations. While these other industrial nations are not running current account deficits, their contributions to world savings have declined over time as well.

If we compare Hamilton’s measure of U.S. net national savings, which is running at approximately 2% of U.S. income to Michael Mandel’s measure of real wealth over time, we would get a similar result for the past five or six years. Wealth accumulation has been slower than population growth for the U.S. In other words, the U.S. propensity to borrow rather than save for its investment has led to a fall in per capita wealth as well as an inward shift of the world savings schedule.

The IMF report does have a glimmer of good news. Savings and investment in the U.S. have recently increased. As James Hamilton noted, more savings is a good thing.