The Global Dearth of Investment

The Economist argues that low long-term interest rates are not due to a global glut of saving as some have claimed, but rather to a lack of global investment.  We’ve had this debate before based upon an article in The Economist, e.g. see here, particularly Brad DeLong, William Polley, PGL at Angry Bear, and this paper from the NBER. I agree with the conclusion reached at that time – low long-term rates are explained by both a lack of global investment relative to saving and by excess liquidity.  In IS-LM jargon, this is an inward shift of the IS curve and an outward shift in the LM curve as shown in DeLong.  Unlike the previous editorial in The Economist that claimed excess global liquidity explained low long-term rates, this article focuses on the inward shift in the IS:

Don’t blame the savers, The Economist:  …America’s fiscal profligacy … contribut[es] 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. … world GDP is still growing at an above-average clip. ... 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 … rests on a housing market that looks decidedly bubbly. … But if economists are agreed that America’s debt levels are dangerous, they cannot agree on whom to blame. … the government’s profligate budget deficits … which run down national savings. …[or] … spendthrift consumers, … the frothy housing market, and … a “global savings glut” … pouring excess capital from abroad, particularly Asia, into America’s financial markets...

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... 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? ... 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. … investments in emerging markets are riskier, because their economies tend to be more volatile and their institutions weaker. Moreover, … the IMF’s analysis suggests that the internal rate of return ... 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… 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 … 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.