Less Globalization Than You Think: The DHL Global Connectedness Index

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Pankaj Ghemawat of the IESE Business School at the Univesity of Navarra in Spain, together with Steven A. Altman, is the author of the DHL Global Connectedness Index 2012. The report has a lot of interesting angles for looking at the extent of globalization in recent years, but I was especially interested in an argument I've made a few times--that while globalization has definitely increased by historical standards, the movement toward globalization is nowhere close to complete, and has in fact stalled in the last few years. The report looks at many dimensions of global connnectedness: here, I'll focus on international flows of goods and services, flows of capital, and international flows of communication and information.

For international flows of goods and capital, this figure shows total exports of goods and services as as share of world GDP. Of course, the estimates from the 19th century and first half of the 20th century are based on less data, but the overall patterns are clear: a first wave of 19th century globalization that lasted up until about the start of World War I, the stagnation or even decline of globalization until after World War II, and then the second wave of globalization since then. Globalization is near an all-time high by this measure, but notice that it after the drop associated with the Great Recession, this measure of globalization is about the same in 2011 as it was in 2007.


A couple of other thoughts to help put this figure in perspective. While the levels of exports/world GDP is high by historical standards, there's still a lot of room for it to expand further. As the report says: "Furthermore, while 20% (or even 30%) of goods and services being traded across borders is far more than the same ratio mere decades ago, it is still far short of the 90% or more that one would expect if borders and distance did not matter at all. If the world truly became “flat,” countries’ exports-to-GDP ratios would tend toward an average of 1 minus their shares of world GDP since buyers would be no more likely to purchase goods and services from their home countries than from abroad. Borders and distance still matter a great deal, implying that even the most connected countries have substantial headroom available to participate more in international trade."

In addition, although the volume of trade has risen, the distance that trade travels on average, between the sending and the receiving country, has not risen. In that sense, geographical distance still very much affects trade."The global connectedness patterns traced in this report also highlight how distance, far from being dead, continues to depress connectedness of all types. While the distance
between a randomly selected pair of countries is roughly 8,500 km, the average distance traversed by merchandise trade, foreign direct investment flows, telephone calls, and human migration all cluster in the range from 3900 km to 4750 km. This accords with the finding that most international
flows take place within rather than between continental regions. ...

[F]ocusing on trade in goods only rather than goods and services combined, as of 2011, 47% of trade took place between countries in different regions rather than within the same region, a proportion that has typically been between 40% and 50% since 1965. The average distance traveled by a dollar worth of traded merchandise in 2011 was roughly 4,750 kilometers, also in line with historical norms over the past four decades ... Thus, while the depth of merchandise trade (the volume of goods traded in comparison to total economic output) has scaled new heights in recent decades, that trend has not been matched by an extension of the distances traveled by traded goods on average. Rather, much of the action in terms of trade integration has been the weaving together of national economies within the same region."

When it comes to flows of foreign direct investment, a similar pattern holds: it's at an historically high level, but it's still recovering from the Great Recession. Here's the figure.


More detailed analysis shows that the "breadth" of  foreign direct investment, as measured by gthe range of different countries receiving such investment, has declined since 2007.The report expalins this way: "This pattern of declining breadth scores was not matched by declines in the average distance “traveled” by FDI or the proportion that occurs between rather than within regions.
Rather, the average distance “traveled” by FDI flows rose from 2007 to 2010 from roughly 4000 to 4900 kilometers and the proportion taking place within regions declined from 58% to 52%. These patterns suggest that while investors are indeed keeping more money at home (declining
depth), they are not generally shifting their foreign investments from distant countries to neighbors. Rather, they are selectively choosing a narrower set of investment destinations, some of which may be distant safe havens, selected in part to diversify risks in investors’ home regions."

We all know that the internet and related technologies have opened up extraordinary possibilities for information and communication to flow across national borders. But by and large, people are still using those technologies to connect with others closer to home. Here are some comments from the report:

"While new technologies indeed have made it far easier and cheaper to share information with people on the other side of the world, we actually tend to use these technologies much more intensively to connect to people close to home. Consider, first of all, postal communications. As a result of efforts spearheaded by the Universal Postal Union, organized in 1874 and one of the world’s first global institutions, it has long been fairly simple to send mail anywhere in the world. And yet, only about 1 percent of all letter mail sent around the world is international.

"What about telephone calls? Only 2 percent of voice calling minutes are international despite rapidly falling costs and improving call quality. These figures do exclude calls placed over the internet via services such as Skype, but including calls over such services would not push this ratio up past 5%. ...

"Global data on information flows over the internet, however, indicate that while internet traffic is more international than phone calls or mail, it remains primarily domestic, with international internet traffic accounting for about 17% of the total. And what about communications on social media? Facebook aims to provide a platform for “frictionless” sharing that theoretically makes it as easy to “friend” someone around the world as one’s next door neighbor. But the reality is that relationships on social media reflect offline human relationships that remain highly distance sensitive. Less than 15 percent of Facebook friends live in different countries. ...

"While the growth of international internet bandwidth implies that we can just as easily read foreign news websites as domestic ones, people still overwhelmingly get their news from domestic sources when they go online: news page views from foreign news sites constitute 1% of the total in Germany, 3% in France, 5% in the United Kingdom and 6% in the United States (and are in single digits everywhere else sampled – as low as 0.1% in China). Furthermore, news coverage by domestic sources itself tends to be very domestic. In the U.S., 21% of U.S. news coverage across all media was international according to a recent study, and of that 11 percent dealt with U.S. foreign affairs (such as U.S. diplomacy and military engagements), leaving only 10% of coverage for topics entirely unrelated to the U.S."

When it comes to focusing on the U.S. economy in particular, our particular experience of globalization differs from most other countries. The U.S. has a huge internal economy, and so our international trade--relative to the size of the huge domestic U.S. economy--is actually much smaller than most other countries. However, U.S. economic ties are very widespread: in the terminology of the report, U.S. global connectedness has a lot of "breadth." In addition, U.S. global connectedness is more related to finance than to goods and services. Here's the report:

"The United States ranks 20th overall [in global connectedness] and has the world´s second highest breadth score, reflecting its significant ties to nearly every other country around the world. It has a more modest rank on depth (89th), which is not unusual for a country with a very large internal market. The U.S. has its strongest position on the capital pillar on which it ranks 6th overall and 1st on breadth. On the other hand, the U.S. has a remarkably low score on the trade pillar, 76th overall and 139th (next to last) on depth. Merchandise and services exports account for only 14% of U.S. GDP and imports add up to only 18%. The U.S. has maintained a stable level of connectedness since 2007."

For those who doubt and oppose the movement to globalization, there is a good news/bad news story here: sure, globalization has risen, but it remains far from dominant. For those who welcome and support the movement to globalization, there's a converse good news/bad news story here: sure, globalization has risen, but there is so very much further to go. The report takes the second view, and offers an interesting argument that the potential gains from additional trade may be substantially larger than many economic models suggest:

"[I]n calculating the benefits of additional trade, these kinds of models focus almost exclusively on growth generated by reductions in production costs as each country’s output becomes more specialized, a limited fraction of the potential gains. To broaden the range of benefits covered, consider a modified version of the ADDING Value Scorecard, a framework originally developed to help businesses evaluate international strategies. ADDING is an acronym for the following sources of value: Adding Volume, Decreasing Costs, Differentiating, Intensifying Competition, Normalizing Risk, and Generating and Diffusing Knowledge. Because traditional models assume full employment (especially problematic in times like these) and leave out scale economies, they capture only part of the gains in the first two categories, Adding Volume and Decreasing Costs. And they entirely leave out the last four categories, whose benefits can be seen clearly, for example, in the U.S. automobile industry. Decades ago, Japanese automakers started offering consumers differentiated (more reliable) products. Increased competition prompted U.S. automakers to improve their own quality. Now, GM sells more cars in China than in the U.S., diversifying its risks and helping it recover from the crisis. And cars are becoming “greener” faster because of international knowledge flows."

Taking these sorts of factors into account, the report estimates that reasonable expansions of globalization could generate gains on the order of 8% of world GDP: in round numbers, call that $5 trillion or so per year in benefits.


A final note: My discussion of the report touches on some of the main points that caught my eye, but completely leaves out other points, like discussions of specific countries, of regional differences, international migration, industry studies of mobile phones, cars, and pharmaceuticals, and more. Thus, those interested in additional detail and insights will find a lot more in this report.

Too Much Concern about International Reserves?

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A few weeks back on December 19, I posted on "Can $12.1 Trillion be Boring? Thoughts on International Reserves." In that post, Edwin Truman explained the reasons why the enormous size of international reserves should be a legitimate policy concern. As a contrasting point of view, the Independent Evaluation Office of the International Monetary Fund has published a report on "International Reserves: IMF Concerns and Country Perspectives," which makes the case that the IMF and others have overemphasized the potential problems of large international reserves and understated their benefits. 

(For the record, the IMF deserves credit for the existence of the Independent Evaluation Office, which was set up in 2001 with a staff of 11, mostly recruited from outside the IMF, to provide an alternative evaluation of IMF policies.)

Everyone agrees that international reserves have taken off in recent years, largely driven by changes in China, along with other emerging and developing nations.

Worrying about large and growign international reserves may be part of the intellectual DNA of the IMF; after all, the organization was formed in large part to provide a way of dealing with balance of payments problems imbalances across countries. But as the Independent Evaluation Office report points out, countries holding these reserves feel that the IMF should be turning its attention to other targets. Here are some of the arguments (footnotes omitted). 

International reserves are modest relative to overall global capital markets--and the private-sector portion of those markets in particular should be the real cause of instability and concern.

"International reserves remain small relative to the global stock of financial assets under private management ... There is considerable historical precedent and economic analysis to suggest that concerns about global financial stability should focus more closely on trends in private asset accumulation and capital flows. Country officials and private sector representatives also noted that the IMF should be more attentive to the accumulation of the private foreign assets that are the consequence of persistent current account surpluses, and which from a historical perspective have arguably been more destabilizing than official reserve accumulation." For illustration, here's a figure showing those international reserves in comparison with other global financial assets. 




Countries that hold large international reserves see them as providing a number of benefits. 

"There was a common view among country authorities that the IMF tended to
underestimate the benefits of reserves. Thinking about the tradeoff between costs and
benefits of reserves, country officials often mentioned a range of benefits that they
considered important but were not easily incorporated into either single indicators or formal
models. In addition to precautionary self-insurance (also emphasized by the Fund), they
mentioned other important advantages: reserves provide a country with reliability of access
and the policy autonomy to act quickly, flexibly, and counter cyclically, and, as was evident
during the global crisis, they inspire confidence. Reserves have also allowed authorities to
avoid the stigma associated with approaching the Fund for resources—an issue that is very
much alive in a number of countries."

Large international reserves are a symptom of the concerns that countries have about instability of capital flows in the global economy, and rather than worrying about this symptom, policy-makers should focus on underlying causes. 


"Most country officials interviewed for this evaluation also felt that in a discussion of
the stability of the international monetary system, there were more pressing issues to be
considered. These included the fluctuating leverage in global financial institutions and its
impact on global liquidity conditions and hence capital flows and exchange rate volatility;
the role and effectiveness of prudential regulations and supervision in mitigating risks
associated with cross-border finance; and the difficulty in managing capital flows in recipient
countries."

A final point made in the IEO report, which seems to me to have a ring of truth, is that a lot of the concern over outsized international financial reserves is really about the reserves held by China. The enormous reserves held by Japan, for example, don't seem to stimulate the same amount of angst. It's probably not wise to try to set a wide-ranging international reserve policy for countries across the world based heavily on the experience of China, which is an extraordinary case in so many ways. 

Biofuels and Hunger in Low-Income Countries

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TBack in late 2011, I amused myself for a time tracking the reports in which various well-known agencies pointed out the flaws in subsidizing biofuels. a June 2011 post, "Everyone Hates Biofuels," I pointed out a report in which 10 international agencies made an unambiguous proposal that high-income countries drop their subsidies for biofuels. I followed up with "The Committee on World Food Security Hates Biofuels" in August 2011 and  "More on Hating Biofuels: The National Research Council" in October 2011.

But of all the problems with subsidizing the production of ethanol from corn--the cost, the distortions in price of farmland, the lack of any reductions in carbon dioxide emissions, and others--clearly the most serious problem is that that it is causing people in low-income countries to go hungry. Timothy A. Wise lays out "The Cost to Developing Countries of U.S. Corn Ethanol Expansion" in a working paper published in October 2012 by the Global Development and Environment Institute at Tufts University.

The article offers a lot more detail, but the basic outline is simple enough. Primarily because of government subsidies, the share of the U.S. corn crop going to produce ethanol has risen dramatically in the last few years, up to about 40%.

There are  number of reasons why global prices for corn have gone sky-high in the last few years, like the drought in summer 2012 that cut the U.S. corn harvest, but one of the major factors is clearly that government subsidies are diverting large share of corn production into ethanol. Here's a graph of global corn ("maize") prices.

This rise in corn prices has hit many low-income countries especially hard. Wise explains: "Over the last fifty years, and particularly since the 1980s, the world’s least developed countries have gone from being small net exporters of agricultural goods to huge net importers. ... The shift came when structural reforms in the 1980s, usually mandated by the International Monetary Fund and the
World Bank, forced indebted developing country governments to open their economies to
agricultural imports while reducing their own domestic support for farmers. The result: a flood of cheap and often-subsidized imports from rich countries forcing local farmers out of business and off the land." Here's a figure showing how the agricultural trade balance for low-income countries has evolved.

Wise estimates: "Using conservative estimates from a study on ethanol and corn prices, we find that from 2006-2011 U.S. ethanol expansion cost net corn importing countries worldwide $11.6 billion in higher corn prices with more than half of that cost, $6.6 billion, borne by developing countries." Of course, the  high prices for corn hit the pocketbooks of low-income people in low-income countries the hardest.

It's been clear for awhile now that subsidizing the production of corn-based ethanol was primarily a subsidy that flowed to large agri-business concerns that grow and process most of the corn in the United States. These subsidies aren't just a costly and ineffective way of pursuing lower energy imports and reduced carbon emissions--they are also causing higher food prices and hunger for some of the poorest people in the world. They should be stopped.

Checkerboard Puzzle, Moore's Law, and Growth Prospects

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My father the mathematician first posed the checkerboard puzzle to me back in grade-school, perhaps on some rainy Saturday. His version of the story went something like this:

The jester performs a great deed, and the king asks him how he would like to be rewarded. The jester is aware that the king is a highly volatile individual, and if the jester asks for too much, the king might just kill him then and there. The jester also knows that the king views his promise as sacred, so if the king says "yes" to the jester's proposal, then the king will honor that promise. So in a way, the jester's problem is how to ask for a lot, but have the king at least initially think it's not very much, so that the king will give his consent.

So the jester clowns around a bit and then says: "Here's all I want. Take this checkerboard. On the first square, but one piece of gold. On the second square, two pieces. On the third square, four pieces, and on the fourth square, 8 pieces. Double the amount on each square until you reach the end of the checkerboard."

In the story, the king laughs at this comic proposal and says,  "Your great deed was so wonderful, I would have happily done much more than this! I grant your request!"

But of course, when the king starts hauling up gold pieces from the treasury, he will discover that 2 raised to the 63rd power, the final spot on the checkerboard requires about 9 quintillion gold pieces (that is, 9 followed by 18 zeros). 

I've had some sense of the power of exponential growth ever since.  But what I hadn't thought about is the interaction of Moore's Law and economic growth. Moore's Law is of course named for Gordon Moore, one of the founders of Intel, who noticed this pattern back in 1965. Back in the 1970s, he wrote a paper that contained the following graph showing how much it cost to produce a computer chip with a certain number of components. Here's his figure. Notice that the numbers of component on the horizontal axis and the cost figures on the vertical axis are both graphed as logarithm (specifically, each step up the axis is a change by a factor of 10). The key takeaway was that the number of transistors ("components") on an integrated circuit was doubling about every two years, making computing power much cheaper and faster.


Ever since I started reading up on Moore's law in the early 1980s, there have been predictions in the trade press that it will soon reach technological limits and come to and end. But Moore's law marches on: indeed, the research and innovation targets at Intel and other chip-makers are defined in terms of making sure that Moore's law continues to hold for at least awhile longer. Stephen Shankland offers a nice accessible overview of the current situation in an October 15, 2012, essay on CNET: ""Moore's Law: The rule that really matters in tech"  (The Gordon Moore graph above is copied from Shankland's essay.)

As Shankland writes: "To keep up with Moore's Law, engineers must keep shrinking the size of transistors. Intel, the leader in the race, currently uses a manufacturing process with 22-nanometer features. That's 22 billionths of a meter, or roughly a 4,000th the width of a human hair." He cites a variety of industry and research experts to the effect that Moore's law has at least another decade to run--and remember, a decade of doubling every two years means five more doublings!

It's hard to wrap one's mind around what it means to say that the power of microchipo technology will increase by a factor of 32 (doubling five times) in the next 10 years. A characteristically intriguing survey essay  from the January 10 issue of the Economist on the future of innovation uses the checkerboard analogy to think about the potential effects of Moore's law. Here's a comment from the Economist essay:

Ray Kurzweil, a pioneer of computer science and a devotee of exponential technological extrapolation, likes to talk of “the second half of the chess board”. There is an old fable in which a gullible king is tricked into paying an obligation in grains of rice, one on the first square of a chessboard, two on the second, four on the third, the payment doubling with every square. Along the first row, the obligation is minuscule. With half the chessboard covered, the king is out only about 100 tonnes of rice. But a square before reaching the end of the seventh row he has laid out 500m tonnes in total—the whole world’s annual rice production. He will have to put more or less the same amount again on the next square. And there will still be a row to go.

Erik Brynjolfsson and Andrew McAfee of MIT make use of this image in their e-book “Race Against the Machine”. By the measure known as Moore’s law, the ability to get calculations out of a piece of silicon doubles every 18 months. That growth rate will not last for ever; but other aspects of computation, such as the capacity of algorithms to handle data, are also growing exponentially. When such a capacity is low, that doubling does not matter. As soon as it matters at all, though, it can quickly start to matter a lot. On the second half of the chessboard not only has the cumulative effect of innovations become large, but each new iteration of innovation delivers a technological jolt as powerful as all previous rounds combined."

Now, it's of course true that doubling the capacity of computer chips doesn't translate in a direct way into a higher standard of living: there are many steps from one to the other. But my point here is to note that many of us (myself included) have been thinking about the changes in electronics technology a little too much like the king in the checkerboard story: that is, we think of something doubling a few times, even 10 or 20 times, and we know it's a big change, but it somehow seems within our range of comprehension.

But when something has already been doubling every 18 months or two years for a half-century--it is continuing to double!--the absolute size of each additional doubling is starting to get very large. I lack the imagination to conceive of what will be done with all this cheap computing power in terms of health care, education, industrial process, communication, transportation, entertainment, food, travel, design, and more. But I suspect that these enormous repeated doublings, as Moore's law marches forward in the next decade and drives computing speeds up and prices down, will transform lives and industries in ways that we are only just starting to imagine.

A Future of Low Returns?

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Through the dismal stock market performance and low interest rates of the last few years, many savers and investors have held on to the hope that, when the economy eventually recovered, their financial investments would start earning the sorts of returns that they did through most of the second half of the twentieth century. However, in the Credit Suisse Global Investment Returns Yearbook 2013, Elroy Dimson, Paul Marsh, and Mike Staunton poor a few buckets of cold water on these hopes in their essay,"The low-return world." (Thanks to Larry Willmore and his "Thought du Jour" blog for the pointer to this report.)

Here are a few of their figures showing the investment world as many of us summarize it in our minds--based of course on evidence from recent decades, and with something of a U.S. focus. Thus, here's a figure showing returns on equity and on debt for a number of markets around the world. equity. The bars on the right show a time-frame since 1950; the ones on the right show a time frame since 1980. Bonds have done comparatively better since 1980, because declining interest rates have meant that bonds purchased in the past--at the higher rates then prevailing--were worth more.

Here's a figure showing U.S. experience in the long run. The bars on the far right show how annual returns on equity have outstripped those for bonds and for bills from 1900-2012. The middle bars show a similar pattern, a bit less extreme, for the last half-century from 1963-2012. The bars on the far right show the 21st century experience from 2000-2012. Stocks have offered almost no return at all; neither have bills. Bonds have done fairly well, given the steady fall in interest rates, but as interest rates have headed toward zero, the gains from bonds seem sure to diminish, too.


 
Dimson, Marsh, and Staunton have some grim news for those waiting for a bounceback to 20th century levels of returns: "[M]any investors seem to be in denial, hoping markets will soon revert to “normal.” Target returns are too high, and many asset managers still state that their long-run performance objective is to beat inflation by 6%, 7%, or even 8%. Such aims are unrealistic in today’s low-return world. ... The high equity returns of the second half of the 20th century were not normal; nor were the high bond returns of the last 30 years; and nor was the high real interest rate since 1980. While these periods may have conditioned our expectations, they were exceptional."

In thinking about bond prices in the future, they point out that central banks around the world are pledging to keep interest rates low for at least the next few years. There is little reason to think that real interest rates on bonds are rising any time soon.

In terms of equities, they restate the well-accepted insight that over time, equities will be priced in a way that will provide a higher return than bonds, to make up for the higher volatility and risk of buying equities. But how much more will stocks pay than bonds? How high will this "equity premium" be? They write:

"Until a decade ago, it was widely believed that the annualized equity premium relative to bills was over 6%. This was strongly influenced by the Ibbotson Associates Yearbook. In early 2000, this showed a historical US equity premium of 6¼% for the period 1926–99. Ibbotson’s US statistics appeared in numerous textbooks and were applied worldwide to the future as well as the past. It is now clear that this figure is too high as an estimate of the prospective equity premium. First,it overstates the long-run premium for the USA. From 1900–2012, the premium was a percentage point lower at 5.3%, as the early years of both the 20th and 21st centuries were relatively disappointing for US equities. Second, by focusing on the USA – the world’s most successful economy during the 20th century – even the 5.3% figure is likely to be an upwardly biased estimate of the experience of equity investors worldwide. .. To assume that savers can confidently expect large wealth increases from investing over the long term in the stock market – in essence, that the investment conditions of the 1990s will return – is delusional."

Here are their estimates for long-run returns on stocks and bonds over the next few decades. Essentially, they forecast real stock returns in the range of 3-4% per year, and real bond returns in the range of 1/1-1% per year--well below the expectations many people are carrying around from their experiences in the 1980s and 1990s.

If their predictions of a low-return world over the next few decades hold up, it will impose heavy difficulties on those saving for the future--not just those doing individual saving, but also pension plans. Moreover, it can be hazardous to a solid economic recovery. They write: "Today’s low-return world is imposing stresses on investors. ... For how long are low returns bearable? For investors, we fear that the answer is “as long as it takes.” While a low-return world imposes stresses on investors and savers in an over-leveraged world recovering from a deep financial crisis, it provides essential relief for borrowers. The danger here is that if this continues too long, it creates “zombies” – businesses kept alive by low interest rates and a reluctance to write off bad loans. This can suppress creative destruction and rebuilding, and can prolong the downturn."

 For those who are already retired, or on the verge, prudence suggests that you base your spending plans during retirement on these kinds of low returns. For those still saving for retirement, prudence suggests trying to save more. For those trying to figure out pension plan funding, the fund may well be worse off than you think. If rates of return on equities and bonds do rebound well above these projections, it will be a happy surprise for today's savers and investors. But the prudent don't base their plans on the hope of happy surprises.

U.S. as a Capital Importer

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For a few years now, one of my mental images of the world economy is that the U.S. economy is by far the major importer of capital, while the major exporters of capital are China, Germany, and Japan. While that mental image remains true, the situation isn't as extreme as a few years back.

Here's are the pie graph for 2005, from the Global Financial Stability Report of the IMF. That year, the U.S. economy absorbed nearly two-thirds of all global capital imports. Japan was the major exporter of capital that hear, followed by China and Germany, with Saudi Arabia and Russia also playing large roles.

Now here's the comparable graph for 2011. The U.S. economy is now absorbing only about one-third of all global capital imports. Germany has become the world's largest capital exporter, edging out  China, and then followed by Saudi Arabia and Japan.

On the U.S. side, a large part  of what is driving this change is the reduction in the U.S. trade deficits. Here's a figure showing U.S. current account balances as a share of GDP, created with the ever-useful FRED website run by the St. Louis Fed. After the trade deficit had truly plummeted around 2006, at the worst of housing bubble, it is now back to the depths plumbed during the mid-1980s.


And here's a figure showing quarterly inflows of foreign capital to the U.S. economy. Notice how the U.S. economy became dramatically more dependent on inflows of foreign capital as the housing price bubble inflated during the mid-2000s. In addition, one the reasons behind the financial crisis and lack of available capital during the darkest times of late 2008 and early 2009 was that inflows of international dropped so dramatically--actually turning into outflows for a brief time. The inflow of international capital then rebounded before plummeting again, and turning into outflows during the second quarter of 2012.

Thus, it's fair to note that the U.S. economy is not absorbing the same share of global capital imports as it was a few years back--but it still absorbs an outsized share of global capital imports. In addition, the sharp drops in the quantities of foreign capital coming into the U.S. economy, both during the Great Recession and then from mid-2010 into early 2012, show how the U.S. has come to depend on these inflows of capital imports--and how the U.S. economy can be vulnerable to these inflows being disrupted.
 

Wealth-Income Ratios in the Long Run

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Thomas Piketty and Gabriel Zucman have been building up an intriguing set of estimates of wealth/income ratios, both over time and across countries. The U.S. wealth/income measures look quite mainstream by European standards, both in the last few decades and when looking back to 1870. The graphs that follow are from an October 2012 presentation called  "Capital is Back:Wealth-Income Ratios in Rich Countries 1870-2010." 

 Just to be clear, "income" to economists is a "flow" concept over a period of time--for example, it might be what you receive in compensation for your labor and in return on your savings in a certain year. Wealth, on the other hand, is a "stock" concept of the accumulation of assets over time--for a person, it would include the value of equity in your home, as well as the value of what's in your savings account or other financial investments. High income and wealth do tend to go together. But it's possible to have high income, spend it all, and have little wealth; alternatively, it's possible to have low income but steady saving, or perhaps the good luck to invest in the early days of IBM or Apple or Google, and end up with high wealth.

For starters, here's the wealth/income ratio for nine countries from 1970-2010. To help make sense of the graph, let's pick out a few of the countries. The line that peaks far above other countries in the middle of the figure, at around 700% in 1990, is Japan at the height of its stock market and property bubble. The country with the highest wealth/income level in 2010 was Spain, presumably driven by a property-market price bubble in that country. The line of black squares, marching higher in recent years, is Italy. In short, a high wealth/income ratio can be a danger signal of possible bubbles in asset markets. Meanwhile, fundamentally healthy economies like Germany (dark triangles) and Canada (light triangles) have seen a rise in wealth/income ratios, but are at the bottom of the range of this group of countries. The U.S. (hollow triangles) is in the middle of the pack. If you look closely, you can see a rise in the U.S. wealth/income ratio in the late 1990s for the dot-com bubble, and again in the mid-2000s for the housing price bubble, but the 2010 value for the U.S. is near the bottom of the range.



Now here's a longer-term perspective, from 1870 to 2010, comparing several major economies of Europe and the United States. In this long-run perspective, both Europe and the U.S. have had a U-shaped pattern of wealth/income ratios over time, but the European U rises higher and dips deeper than the American U.

Just what the wealth/income ratio telling us? Here are some thoughts:

1) When wealth/income spikes up, it's a potential danger sign of financial instability in the economy.

2) Wealth is typically much more concentrated than income, and so when the wealth/income ratio is high, the political power of those holding lots of assets is probably stronger. The power of mega-rich billionaires, not just in the U.S. and Europe, but also in China and across fast-growing economies of the world, is large and growing. 

3) The long-run data suggests that the wealth/income ratios observed from, say, 1940 up to about 1980, were historically on the low side. Thus, it may be that the rise in wealth/income ratios in the last few decades is a return to historical norms. (Piketty and Zucman make this case in more detail.)

4) As Picketty and Zucman write: "There’s nothing bad about the return of capital: k is useful; but it raises new issues about k regulation & taxation." In general, as wealth becomes relatively more important, it deserves a larger share of our social discussion and public policy attention.



For those who are interested, here's a post from June 13, 2012, on "Wealth by Distribution, Region, and Age" in the United States.