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.