Saturday, June 25, 2011

Trade: The New Normal Was the Old Normal Too

Matthew Yglesias is puzzled by
the fundamental weirdness of having so much savings flowing uphill from poor, fast-growing countries into the rich, mature economy of the United States. It ought to be the case that people in fast-growing countries are eager to consume more than they produce, knowing that they’ll be much richer in the near future. And it ought to be the case that people in rich countries are eager to invest in poor ones seeking higher returns. But it’s not what was happening pre-crisis and it’s not what’s been happening post-crisis.
He should have added: And it's not what's ever happened.

I'm not sure what "ought" is doing in this passage. If it expresses pious hope, fine. But if it's supposed to be a claim about what's normal or usual, as the contrast with "weirdness" would suggest, then it just ain't so. Sure, in some very artifical textbook models savings flow from rich countries to poor ones. But it has never been the case, since the world economy came into being in the 19th century, that unregulated capital flows have behaved the way they "ought" to.

Albert Fishlow's paper "Lessons from the Past: Capital Markets During the 19th Century and the Interwar Period" includes a series for the net resources transferred from creditor to debtor countries from the mid-19th century up to the second world war. (That is, new investment minus interest and dividends on existing investment.) This series turns negative sometime between 1870 and 1885, and remains so through the end of the 1930s. For 50 years -- the Gold Standard age of stable exchange rates, flexible prices, free trade and unregulated capital flows -- the poor countries were consistently transferring resources to the rich ones. In other words, what Yglesias sees as the "fundamental weirdness" of the current period is the normal historical pattern. Or as Fishlow puts it:
Despite the rapid prewar growth in the stock of foreign capital, at an annual average rate of 4.6 percent between 1870 and 1913, foreign investment did not fully keep up with the reflow of income from interest and dividends. Return income flowed at a rate close to 5 percent a year on outstanding balances, meaning that on average creditors transferred no resources to debtor nations over the period. ... Such an aggregate result casts doubt on the conventional description of the regular debt cycle that capital recipients were supposed to experience. ... most [developing] countries experienced only brief periods of import surplus [i.e. current account deficit]. For most of the time they were compelled to export more than they imported in order to meet their debt payments.
A similar situation existed for much of the post World War II period, especially after the secular increase in world interest rates around 1980.

There is a difference between the old pattern (which still applies to much of the global south) and the new one. Then, net-debtor poor countries  ran current account surpluses to make payments on their high-yielding liabilities to rich countries. Now, net-creditor (relatively-) poor countries run current account surpluses to accumulate low-yielding assets in rich countries. I would argue there are reasons to prefer the new pattern to the old one. But the flow of real resources is unchanged: from the periphery to the center. Meanwhile, those countries that have successfully industrialized, as scholars like Ha-Joon Chang have shown, have done so not by accessing foreign savings by connecting with the world financial system, but by keeping their own savings at home by disconnecting from it.

It seems that an unregulated international finance doesn't benevolently put the world's collective savings to the best use for everyone, but instead channels wealth from the poor to the rich. That may not be the way things ought to be, but historically it's pretty clearly the way things are.


  1. @Josh:

    I wasn’t able to read the Fishlow paper because I cannot access academic archives—apologies. I notice that the period he looks at, 1870-1930s, was the heyday of European imperialism, and I’m wondering whether Fishlow weeded out finance and trade occurring within formal empires. Financial flows within imperial systems will obviously depart drastically from any model of unregulated capitalist investment and trade involving autonomous creditors and debtors.

    I’m afraid I missed the point of this post. Why are we amazed, or disgusted, that the flow of money back to creditors in rich nations from their investments in poor nations is larger than the actual investments themselves? Isn’t investment supposed to work that way? Why is international finance supposed to be a net transfer of resources from rich to poor, i. e., a free gift? It doesn’t work that way in domestic finance. A bank channels money from savings-rich creditors to savings-poor debtors, but then the backward flow of repayments has to be larger than the initial investments, or else the bank and its depositors go bankrupt. In that sense, successful domestic bank lending is also a net channeling of wealth from borrowers to creditors, from the savings-poor to the savings-rich. But clearly a profitable banking system is immensely useful to debtors as well as creditors, as long as the increase in production and wealth stimulated by investments is larger than the repayments.

    You seem to feel that that is not the case for international finance—that instead the net result of international investment is one-way extraction and the net immiseration of debtor nations. Is that your contention? Do you believe that the growth stimulated by investments in developing nations by creditors in the developed world has been outweighed by the net transfer of interest and dividends on those investments from debtors to creditors? That might be true in certain regions—Africa, the Caribbean—but I doubt that it is true in most of Asia, Brazil, etc

  2. I feel like you are in fact talking about two different things and not one long chain. It is actually different that the "developed" world had an "excess of capital" in the late 1800s and that now it is the developing world that has the excess.

    Also, dividends etc are returns on investment, so at least in principle those dividend payments are a return on value added to developing world economies and not just simple appropriation of resources.

  3. Bill,

    It's infuriating that scholarly articles aren't accessible to everyone. No excuse for it, it violates the core supposed norms of academia. Anyway, I put the article up on as a google doc here; let me know if that works.

    I half feel I should take this post down, at least until or unless I can articulate the argument better. But anyway, the relevant section of the Fishlow article runs from 387 to 391. Take a look and see if it's clearer in the original than in my abridged version.

    In any case, the argument I'm suggesting is that the the persistence of the net debtor status over decades, despite continuous current account surpluses, casts doubt on the idea that borrowing abroad was a boon to development. I think that poor countries could have developed more successfully -- as late industrializers in fact did -- by mobilizing domestic savings and limiting their exposure to international financial markets. There's a big literature on this, which Ha-Joon Chang (in the linked book and elsewhere) does a good job summarizing.

    And yes, of course the half-century before World War I was the high tide of imperialism, and that shaped capital flows. But the biggest recipients of European foreign investment were the (at least formally) independent countries of Latin America, Eastern Europe and the Middle East, not the colonial empires. And of course financial flows today are not uninfluenced by politics either.

  4. You realize that you only ever use U Mass internal links, right? It's not even sufficient to have access to JSTOR. You actually have to be at U Mass to see the paper.

  5. Hello.

    Did you take down your "Blanchard rule" post on purpose? Came back for a second look, and it was gone.

    P.S. Good use of the Blogger Pages.


  6. No, I didn't realize that. Thanks!

  7. Arthurian-

    Yes, I decided it needed a bit more work. Will be up again shortly.

  8. "It ought to be the case that people in fast-growing countries are eager to consume more than they produce, knowing that they’ll be much richer in the near future. And it ought to be the case that people in rich countries are eager to invest in poor ones seeking higher returns. But it’s not what was happening pre-crisis and it’s not what’s been happening post-crisis."

    I think the mistake may be to characterize "savings" in either poor or rich countries on a per capita basis. Savings is usually calculated as an aggregate and a residual: GDP minus consumer expenditure. Thus, "savings," also includes debt repayment by households. Whether and how this residual is distributed is assumed.

    I believe that the "high" savings rate of ordinary Chinese is largely a myth. The distribution of wealth in fast-growing countries is highly unequal. In China, savings are concentrated in companies that have high export earnings. These savings are really high profits that are recycled into speculative assets (e.g., property, stock) or safe ones (e.g. foreign bonds).

    I'm sure the average Chinese consumer would love to consume more than he or she produces.

  9. Anonymous-

    You are certainly right that retained earnings constitute an important category of savings in industrialized countries (and quite possibly poor countries too, I'm not sure.) And you're right that the conventional economics discourse that treats all savings as household savings misses this. How this is relevant to this post, I'm not sure. It may be! but I'll have to think about it more.

    The point here, which I could have made better int he original post, is that the conventional model says that returns on financial assets are proportional to national growth rates, and growth rates are higher in poor countries than rich ones; poor countries should be net debtors and run current account deficits, consuming/investing more than they produce; and rich countries should be net creditors and run current account surpluses, producing more than they consume/invest. But in the liberal eras, both pre-WWI and post-Bretton Woods, we don;t see that; we see poor countries run current account surpluses for decades, while remaining poor and remaining net debtors; in terms of aggregate financial flows, at least, most poor countries would have been better off not participating in international financial markets at all. The experience of e.g. post-default Argentina is a perfect example. Being cut off from global capital markets turns out to be a recipe for record growth.