At first, it seems difficult to grasp: Global capital is flowing from poor to rich countries. Emerging-market countries run current account surpluses, while advanced economies have deficits. One would expect fast-growing, capital-scarce (and young) developing countries to be importing capital from the rest of world to finance consumption and investment. So, why are they sending capital to richer countries, instead?
China is a case in point. With its current account surplus averaging 5.5 percent of GDP from 2000 to 2008, China has become one of the world’s largest lenders. Despite its rapid growth and promising investment opportunities, the country has persistently been sending a significant portion of its savings overseas.
And China is not alone. Other emerging markets — including Brazil, Russia, India, Mexico, Argentina, Thailand, Indonesia, Malaysia and the Middle Eastern oil exporters — have all increased their current account surpluses significantly since the early 1990s. Collectively, capital-scarce developing countries are lending to capital-abundant advanced economies.
Many observers believe that these global imbalances reflect developing economies’ financial integration, coupled with underdevelopment of domestic financial markets. According to this view, these countries’ demand for assets cannot be met — in terms of both quantity and quality — at home, so they deploy part of their savings to countries like the US, which can offer a more diverse array of quality assets.
While plausible, this argument suggests that, as financial markets improve over time in developing countries, the global imbalances are bound to shrink. However, such a reversal is nowhere in sight. Why?
A crucial dimension of globalization has been trade liberalization. For China, foreign trade as a percentage of GDP soared from 25 percent in 1989 to 66 percent in 2006, largely owing to its admission to the WTO in 2001.
Most of what China and other developing countries produce and export are labor-intensive goods, such as textiles and apparel. This has allowed advanced economies, in turn, to produce and export more capital-intensive, higher-value-added products. Globalization of trade enabled countries to tap the efficiency gains that specialization in their sectors of comparative advantage has brought about.
With a slight mental stretch, one can imagine that what a country produces and trades might affect its savings and investment decisions. An economy in which the main productive activity is berry picking, for example, has little need for investment and capital accumulation. Its laborers earn wages, consume and save part of that income. Since the production process requires little capital, there is no demand for domestic investment — and thus no savings vehicles. Instead, the only way to save is by purchasing capital abroad — in economies with capital-intensive production and demand for investment. This economy will always export its savings.
That might be an extreme example, but it illustrates a more general point about how merchandise trade can influence financial flows. Countries that produce and export more labor-intensive goods — perhaps owing to increased trade openness, or faster labor force and productivity growth, all of which are true of China — might experience a rise in saving, but a less-than-equivalent increase in demand for capital.