DEMOGRAPHICS ARE UPSETTING THE BALANCE OF CAPITAL FLOWS / THE FINANCIAL TIMES MARKET ANALYSIS ( A MUST READ )

Demographics are upsetting the balance of capital flows

By John Plender

Published: August 24 2010 17:17

For those who worry global imbalances are dangerously entrenched there was always consolation in the thought that when high savers in persistent current account surplus countries moved into retirement, imbalances would shrink as their savings declined.

If the consequences of their lower saving were higher real interest rates and falling equity, bond and property prices, that was a less pressing problem than the prospect of a global savings glut causing a 1930s-style depression in the meantime. Yet this simple demographic scenario is almost certainly misguided.

In a recent paper, Dominic Wilson and Swarnali Ahmed of Goldman Sachs remind us that balance of payments current accounts are significantly driven by life cycle savings. Up to the age of 35, people invest more than they save. Since the current account represents the difference between savings and investment, this is a drag on the current account. Between what they call the prime saving age of 35 and 69 people are, by contrast, working to improve the current account position. The relative proportion of these two groups across different countries helps explain the pattern of global savings and capital flows.

Using this framework, the Goldman duo offers persuasive evidence that the global pool of prime savers will keep rising for the next 20 years. The savings glut could thus become a more persistent feature of the world, ensuring continuing downward pressure on real interest rates. They foresee demography pushing towards larger surpluses across a broad group of emerging market countries, including China, because the proportion of prime savers in the developing world rises more and peaks later than in the developed world.

Yet there is a further dimension to the savings equation that could make the imbalances even more intractable. For there is a risk that the corporate sector might offset the rundown of household savings as people in the developed world retire. In fact the global corporate sector has acquired a habit of saving substantially more than it invests. Witness recent experience in Japan.

Many still think of the Japanese as obsessive high savers. Yet in reality their household savings have, according to the Organisation for Economic Co-operation and Development, declined from 10 per cent of disposable income in 1999, when the Japanese bubble burst, to just 2.3 per cent in 2009. Yet today’s national savings rate of about 27 per cent is at much the same level as a decade ago thanks to a huge increase in the surplus of Japanese corporate savings over investment.

This corporate savings habit is endemic across Asia, with China accounting for the bulk of the nest egg outside Japan. In part this reflects a very rapid build-up in profits in fast growing economies. In China’s case, the state-owned corporate sector enjoys considerable subsidies, light taxation and administrative monopolies. Negative real returns on bank deposits encourage inefficient corporate investment in low return projects financed by retentions, while in the non-state sector companies have to save to grow because they are starved of credit. As in Japan, dividend pay-outs are paltry compared with those in the west. This would not be worrying if the household sector – the ultimate owner of the corporate sector – dissaved because the increasing net worth of the quoted corporate sector was perceived to be making people richer. Yet that has not happened. Asia’s corporate sector has thus unwittingly exacerbated global imbalances.

The corporate sector in the west does admittedly provide some offset. The US national income and product accounts, for example, show that from being net borrowers in 2007, businesses became net lenders to the rest of the economy to the tune of $657bn last year. Yet this is wildly in excess of anything seen in the past 40 years and must therefore primarily be a response to the credit crunch rather than a permanent feature.

What can be done to prevent this combination of demography and excess corporate savings further exacerbating imbalances and so increasing the risk of protectionism? Clearly Asian currencies should appreciate much further against those of the developed world, a policy option that finds little enthusiasm in the region. A more fruitful avenue may therefore be to focus on the development of financial infrastructure and capital markets to ensure that companies have better access to credit and capital both internally and externally.

Equally important is corporate governance reform. Without greater accountability to owners, there will be no pressure to raise dividends. A higher pay-out ratio would anyway be helpful in underpinning fledgling funded pension schemes across Asia. Setting up such schemes will at least be easier if demography is no longer perceived to threaten collapsing markets.

Copyright The Financial Times Limited 2010