The increase in global imbalances in the last decade posed a theoretical challenge for international macroeconomics. Why did some less-developed countries with a higher need for capital, like China, lend to richer countries? The inconsistency of standard open-economy dynamic models with actual global capital flows had already been stressed before (e.g. by Lucas 1990), but the sensitivity to this issue became more acute with increasing global imbalances. This stimulated the development of several alternative theoretical frameworks. Gourinchas and Rey (2014) provide a recent survey of these theories. But in the aftermath of the Global Crisis we have observed a substantial reduction in global imbalances. For example, China’s current-account surplus has declined from 10% of GDP in 2007 to about 2.5% currently. Are these recent theories consistent with this decline, and are they useful in shedding light on the process of ‘global rebalancing’?
Several theories of global imbalances are based on the ‘savings glut’ perspective, based on strong saving needs in emerging countries, especially emerging Asia. Most analyses focus on increased saving by households. However, there has also been a significant increase in corporate saving. This is documented in Figure 1. From 1998 to 2007, the GDP-weighted average of the corporate saving rate in six emerging Asian countries increased by 8.1 percentage points, from 9.4% to 17.5% of GDP. This increase is much larger than in other emerging countries or in developed countries. The increase in corporate saving coincided with an increase in investment rates and impressive growth rates.
Figure 1. Change in corporate saving and investment rates – average annual real GDP growth rates, 1998–2007
Sources: World Bank, CEIC, United Nations.
Notes: Emerging Asia: China, India, Philippines, Republic of Korea, Thailand, and Taiwan. Other emerging countries: Czech Republic, Kazakhstan, Kyrgyzstan, Mexico, Poland, Republic of Moldova, Tunisia, and Ukraine. Figures are GDP-weighted.
Data on corporate saving is published with long lags and only for a subset of countries. But available data seems to indicate that the trend in corporate saving is being reversed. Figure 2 shows an increase in US corporate saving, while we see a decline in 2009 in China.
Figure 2. Corporate saving rates
Sources: National Bureau of Statistics of China, United Nations Statistics Division.
We obviously need to wait for more data to determine whether this trend is confirmed. In the meantime, we can analyse the implications from recent theories. In earlier work (Bacchetta and Benhima 2014a), we developed a theory of global imbalances based on corporate saving. We have recently applied this framework in the context of rebalancing (Bacchetta and Benhima 2014b). We consider an asymmetric world economy with an Emerging country and a Developed country, basically representing China and the US. We examine the impact of three shocks: a credit crunch and a growth slowdown in the Developed country, and a growth slowdown in the Emerging country.
We find that all three shocks lead to global rebalancing through changes in corporate saving. However, these shocks have a different impact on the world interest rate. The two shocks originating in the Developed country have a negative impact on the interest rate, while the shock in the Emerging country has a positive impact. This implies that the initial phase of rebalancing was associated with a downward pressure on real interest rates, but the recent period is more likely to be associated with an increase in world interest rates. Hence, while the economic contraction originating in developed countries has pushed interest rates towards the zero lower bound, the recent growth slowdown in emerging countries could push them out of it. We also notice that slower growth in the Emerging country improves the trade balance of the Developed country.
Corporate saving, liquidity, and growth
The framework we developed in Bacchetta and Benhima (2014a) presents an explanation for why fast-growing emerging countries may lend to slower-growing economies – a feature difficult to reconcile with standard international macroeconomic models. The basic mechanism is based on liquidity needs by credit-constrained firms, in the spirit of Holmstrom and Tirole (2001, 2011). To introduce this aspect in a dynamic macroeconomic model, we follow Woodford (1990), where entrepreneurs have two-period projects. In their first period, entrepreneurs invest in illiquid capital and decide on their liquid asset holdings. In their second period, they produce using a labour input. To pay for wages, firms can either borrow or use their liquid assets. When borrowing is limited, firms need more liquid assets. This is the reason why fast-growing countries with tight borrowing limits have higher liquid asset holdings and higher corporate saving. Moreover, higher growth leads to a joint increase in saving and in investment. When we consider an asymmetric two-country model, we assume that the liquidity motive is strong in the Emerging country and weaker in the Developed country. Consequently, the Developed country behaves similarly to standard open-economy models, while the Emerging country has a different behaviour.
The strong need for liquid assets in the Emerging country introduces a new channel of international transmission. A decrease in the world interest rate has a negative impact on surplus economies holding liquid assets. This negative liquidity channel is combined with two other, more standard channels. First, there is a substitution channel as firms substitute capital for labour. Second, there is a collateral channel as credit constraints are looser with a lower interest rate. We analyse theoretically and numerically the different factors determining the strength of these different channels. With tight borrowing limits, the liquidity channel dominates and low world interest rates have a negative effect. With mild borrowing constraints, low interest rates have more standard positive effects.
In addition to affecting the spillover mechanism of interest rate changes, the large liquidity holdings in the Emerging country affect the response of the world interest rate to fundamental shocks. An interesting aspect of the model is a positive output comovement in the presence of productivity shocks. This contrasts with standard intertemporal open-economy macroeconomic models, where productivity shocks have negative spillovers (e.g. Obstfeld and Rogoff 1996). However, the mechanism leading to this positive comovement is different depending on whether the shock originates in the Developed or in the Emerging country. Nevertheless, the liquidity needs of the Emerging country play a key role in these mechanisms, as it affects either the direct impact of the shock on the world interest rate or the spillover channel.
A numerical illustration
As a simple illustration consider two shocks: declines in productivity in the Developed and in the Emerging countries. Figure 3 and 4 show the impact of a decline in productivity by 1% for 10 periods for these two shocks. Both shocks imply a reduction of the net asset position b of the Emerging country, which implies a reduction in global imbalances. But the two shocks have different transmission mechanisms and an opposite impact on world interest rates.
Figure 3. Productivity decline in the Developed country
First consider the negative productivity shock in the Developed country represented in Figure 3. This shock reduces corporate borrowing in the Developed country, which depresses the world’s interest rate. In a standard framework, this would benefit the Emerging country. However, the cost of liquid assets, which are essential in the production process in the Emerging country, increases. As a result, output and bond holdings decrease in the Emerging country and global imbalances unwind. A deleveraging shock in the Developed country would have the same impact, as it also reduces corporate borrowing.
Consider now Figure 4. While a decline in productivity in the Developed country reduces the supply of liquid assets, a decline in productivity in the Emerging country reduces the demand for liquid assets, which increases the equilibrium interest rate and contributes to global rebalancing. This increase in the interest rate is detrimental to the Developed country as borrowing is costlier. Contrary to conventional wisdom, the slowdown in the Emerging country would improve the trade balance in the Developed country, as the Emerging country would be less willing to lend to the Developed country, making the financing of its trade deficit more costly.
Figure 4. Productivity decline in the Emerging country
Among the various explanations behind global imbalances, the role of corporate saving has received less attention. We show that it is quantitatively relevant, and propose a theory that is consistent with the stylised facts. We argue that this approach is useful in understanding the current phase of global rebalancing. But it should obviously be combined with the other significant factors suggested in the literature.
Bacchetta, Philippe and Kenza Benhima (2014a), “The Demand for Liquid Assets, Corporate Saving, and International Capital Flows”, mimeo.
Bacchetta, Philippe and Kenza Benhima (2014b), “Corporate Saving in Global Rebalancing”, mimeo.
Gourinchas, Pierre-Olivier and Hélène Rey (2014), “External Adjustment, Global Imbalances, Valuation Effects”, in G Gopinath, E Helpman, and K Rogoff (eds.), Handbook of International Economics, Vol IV, North Holland.
Holmstrom, Bengt and Jean Tirole (2001), “LAPM: A liquidity-based asset pricing model”, Journal of Finance, 56(5): 1837–1867.
Holmstrom, Bengt, and Jean Tirole (2011), Inside and Outside Liquidity, MIT Press.
Lucas, Robert E Jr (1990), “Why doesn’t capital flow from rich to poor countries?”, American Economic Review, 80: 92–96.
Obstfeld, Maurice and Kenneth Rogoff (1996), Foundations of International Macroeconomics, MIT Press.
Woodford, Michael (1990), “Public debt as private liquidity”, American Economic Review, 80(2): 382–388.