years. But the quality of the data, both South Korea's in earlier years and
China's today, limits the clarity with which we can gauge changing rates of
migration. Moreover, given the differences between today's China and the
South Korea of a quarter century earlier with respect to size, political orientation,
and economic policies, analogies can be only suggestive.
The critical time for the world economic outlook and for policymakers
will not be when the shifting of workers comes to an end, but when its rate
of increase starts to slow. We know it must slow, since, at some point, however
distant, the transition to competitive markets will be complete. As the
rate of worker flows peaks, the disinflationary effects will start to lift and
higher inflation pressures will emerge. That turning point may well be several
years in the future, as the Korean analogy suggests. But early evidence
that such a process is under way would enlist the increasingly anticipatory
aspects of global finance to bring the market-turning date forward, possibly
to three years or less.
While the marked reduction in inflation and inflation expectations
after the fall of the Berlin Wall lowered inflation premiums embodied in
long-term debt issues worldwide, its effect on real interest rates has been
limited to the lowered risk premiums resulting from the reduced market
volatility that lower inflation fosters. The rest of the decline in real interest
rates appears to be the result of a significant increase in the world's average
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effective propensity to save relative to its propensity to invest those savings
in productive assets. Excess potential savings flooded global financial markets,
driving real interest rates lower. But this too appears to be the consequence
of the post-Soviet shift to competitive markets among developing
countries and their resulting surge in growth.
Global investments in plant, equipment, inventories, and homes must
always be equal to global savings—the net means of financing these investments.
Every asset must have an owner. The market value of "paper" claims
against newly created capital assets must equal the market value of those
assets. In a sense, the world's checkbook must balance. Savings, in the end,
must equal investment for the world as a whole. But businesses and households
plan their investments before they can know which savers in the
world will ultimately finance them. And the world's savers plan their savings
before they know what investments they will finance. Accordingly, the
intended investment for any period almost never equals intended saving.
When both investors and savers try to achieve their intentions in the
marketplace, any imbalance forces real interest rates to change until actual
investment and actual savings are brought into equality. If intended investment
exceeds intended savings, real interest rates will rise enough to dissuade
investors from investing and/or persuade savers to save more. If intended
savings exceeds intended investment, real interest rates will fall. Outside the
textbooks, this process is not sequential but concurrent and instantaneous.
We never observe actual global investment as different from actual global
savings.
Despite their lower incomes, households and businesses in developing
countries save greater shares of their income than do households and businesses
in developed countries. Developed countries have vast financial networks
that lend to consumers and businesses, most often backed by collateral,
enabling a significant fraction to spend beyond their current incomes. Far
fewer such financial networks exist in developing nations to entice people
to spend beyond their incomes. Moreover, most developing nations are still
so close to bare subsistence that households need to insure against future
contingencies. They seek a buffer against feared destitution, and since few
of these countries have government safety nets adequate to protect against
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adversity the only way for the households to do so is to set money aside.
People are forced to save for a rainy day and retirement.*
As reported to the IMF, savings as a percentage of nominal GDP for
advanced economies (that is, developed nations) during the 1980s and
1990s tended to hover in the vicinity of 21 to 22 percent. Developing
countries averaged 23 to 24 percent over those decades. But starting in
2000, the developing world's embrace of competitive markets and capitalist
practices finally began to pay off. Foreign direct investment to employ a
low-paid domestic workforce encouraged by increasingly credible property
rights began to accelerate export-led growth.1
During the past five years, developing-country growth has been twice
that of developed countries. Their savings rates, led by China, rose from 24
percent in 2001 to 32 percent in 2006 as consumption in these culturally
conservative societies lagged, and investment fell far short of the rise in saving.
Saving rates in the developed world have slipped below 20 percent
since 2002. World investment has risen very modestly as a percentage of
GDP, almost wholly in developing countries.* Oil-exporting countries
chose to spend only a modest share of their increased revenues on new oil-
productive capacity.
Economists, of course, can measure savings, but since saving intentions
are rarely recorded anywhere, estimates of intentions are little better than
an informed guess. However, it is not unreasonable to surmise that world
intended savings has exceeded intended investment in recent years, as evidenced
by the worldwide decline in real long-term interest rates—that is,
*One of my earliest statistical analyses for the National Industrial Conference Board, more
than a half century ago, showed that American farmers, despite lower average incomes, saved a
larger share of their income than did city dwellers. Urban incomes were not subject to the vagaries
of weather that afflicted almost all farm families in those days. Note that back then,
farmers' peer groups were other farmers and hence urban spending patterns had not fully infiltrated
the farm community.
tForeign direct investment in China, as I've noted, rose gradually from 1980 to 1990, but then
rose seventeenfold by 2006, as the evidence that market capitalism was the most effective
force for prosperity became widespread. Whether rightly or wrongly, foreign investors must
have believed that lesson had been absorbed by Chinese governing authorities and was being
implemented in their sometimes ambiguous rule of law.
+A minor problem in doing such an evaluation is that recorded world savings and investment
are separated by a statistical discrepancy.
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TH E "CON UNDRUM"
those adjusted for inflation expectations. Even with no change in intended
savings behavior by anyone, the growing share of world incomes accruing
to developing economies with chronically higher savings rates would move
intended world savings persistently higher year after year. And that trend
would continue as long as developing economy growth rates exceeded
those of developed economies, as they have since 2000. Ordinarily, when
real interest rates fall, economists have difficulty determining whether it
was a rise in intended savings or a fall in intended investment that was the
proximate cause. But the surge in developing country savings, only half of
which was invested in the developing world, suggests strongly that it was the
spillover of developing country savings that drove real interest rates lower.
Since actual recorded developed-country investment rose only modestly
(driven by lower rates), intended investment in the developed world must
have been stable, or close to it, as a share of GDP. In fact, as I note in chapter
25, intended investment in the United States has been lagging in recent
years, judging from the larger share of internal corporate cash flow that has
been returned to shareholders, presumably for lack of new investment opportunities.
These data are consistent with the notion that this decade's decline
in long-term interest rates, both nominal and real, is mainly the effect
of geopolitical forces rather than that of the normal play of market forces.
If developing countries continue to grow at a rapid rate and financial
networks expand to lend more readily to the increasing number of citizens
with rising discretionary incomes, developing-country savings rates are
bound to fall, at least back to 1980s and 1990s levels. The inbred human
desire to keep up with the Joneses is already manifest in the nascent consumer
markets of the developing world. Increases in consumption would
tend to remove the downward pressure of excess savings on real interest
rates.* But that would likely occur even if the rate of growth of developing
country incomes should slow. In all economies, spending rarely keeps up
with unexpected surges in income; hence savings rates rise. As income
growth slows back to trend, savings rates tend to fall.
So, as erstwhile centrally planned workforces complete their transition
to competitive markets, and as developing countries' increasingly sophisti
*Provided, of course, that intended investment as a share of GDP does not fall in tandem.
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THE AGE OF TURBULENCE
cated financial systems facilitate the inbred propensity toward higher consumption
and less saving, inflation, inflation premiums, and interest rates
will gradually lose their disinflation buffer of the past decade. I will address
the timing of these events in the final chapter.
The ability of developing economies to continue to grow faster than
developed economies will fade unless developing nations can supplement
their borrowed technology with new insights and innovations from their
scientists and high-tech engineers. New ones are currently being schooled
in China, India, and elsewhere in the technologies of the past century developed
in the West. Some could reasonably be expected to move beyond
the technological levels of developed economies. But more important to
economic growth—and perhaps even a necessary condition for the technology
of China, India, or Russia to move beyond that of, say, the United
States—is political certainty.
How much has America's political system—its protection of individual
rights, especially property rights, and its relatively low degree of regulation
and low incidence of corruption—contributed to the gap between standards
of living of U.S. residents and those of developing countries? I suspect
a great deal. However, although we may have world-class universities, our
primary and secondary education system, as I note in chapter 21, is deeply
deficient in providing homegrown talent to operate our increasingly complex
infrastructure, which pours out levels of goods and services that no
country has been able to match.
Citizens of developing countries unable to find adequate risk-adjusted
rates of return at home invest in the United States, where, for more than
two centuries, property rights of all—U.S. citizens and foreigners—have received
firm and equal protection under the law. Few developing countries
protect the property rights of even their own citizens as we do the property
rights of foreigners. When I say "risk-adjusted" rates of return, I'm referring
to the degree of risk in developing countries, and in a number of developed
countries as well, of outright confiscation of investments or its equivalent
in the form of deadening regulation, capricious taxation, spotty enforcement
of laws, or rampant corruption.
The point I wish to emphasize is that any proper measure of the degree
of property rights in a country must encompass such factors as regulation
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TH E "CON UNDRUM"
and arbitrariness in the enforcement of laws. Corruption, in addition, drives
up the cost of ownership. Most developing countries rate poorly on all
these counts. In fact; a major reason they remain "developing" and find it
difficult to graduate to "developed" is their low scores on property-rights
enforcement. The United States ranks high. Its "political risk premiums" are
among the lowest in the world.*
I can readily imagine the technology knowledge gap between developed
and developing economies narrowing significantly However, I find it
difficult to foresee so marked a short-term change in China's authoritarianism,
India's smothering bureaucracy or Russia's erratic enforcement of
property rights. In fact, investor perception of such political risk changes
so slowly that it would likely be years following any fundamental and credible
changes before such risks were largely excised from economic decision
making.
I have always thought that measured inflation at a rate as low as 1 percent
cannot be sustained in an economy using a fiat currency in a competitively
democratic society with any remnant of populism (is any country
immune?).1 Such a currency, by its very nature, has as the only constraint on
its supply the actions of the central bank, and cannot be entirely insulated
from political influences. The U.S. inflations of 1946, 1950, and the late
1970s remain too vivid in my memory. (I had that view challenged in 2003
by the Japanese deflation, though, in the end, deflation did not take hold in
the United States.) If a typical inflation rate of a democratically mandated
fiat currency is north of 1 to 2 percent, what force could keep inflation below
that mark as the two major disinflationary forces that I have discussed
in this chapter recede? The most obvious answer is monetary policy. There
will come a point at which central bankers, as I note in chapter 25, will be
pressed once again to contain inflationary pressures.
Central bankers over the past several decades have absorbed an important
principle: Price stability is the path to maximum sustainable economic
