Two sets of twins? An exploration of domestic saving-investment imbalances.

Author:Medlen, Craig
 
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The United States is on course to increase its net external liabilities to around 40 percent of GDP within the next few years-an unprecedented level of external debt for a large industrial country. This trend is likely to continue to put pressure on the U.S. dollar, particularly because the current account deficit increasingly reflects low saving rather than high investment.

--International Monetary Fund

The twin deficits are back. Their return from the 1980s and early 1990s is now unaccompanied by even a hint that curing the domestic fiscal deficit might well cure the trade deficit, too. The simultaneous expansion of the fiscal surpluses of the late 1990s with the trade deficit dashed that hope. While there is a significant amount of dissonant opinion, a large group of economists is persuaded that the nub of the chronic trade imbalance is the low U.S. saving rate. According to this view, domestic saving has been inadequate to fund current levels of investment. Consequently, offshore capital has moved in to fill the gap, keeping the dollar from falling to levels that would correct the ongoing trade imbalance.

The saving-investment imbalance explanation of the trade deficits can best be understood as a "default" explanation dependent on the failure of traditional trade theory to explain why exchange rate adjustments have been unable to correct the chronic trade imbalance. This is not to say that the textbook story is without a measure of explanatory power. While certain bilateral balances, most particularly the Japanese-USA balance, show positively perverse relationships between the exchange rate and the trade balance, the real weighted exchange rate of the dollar moves in rough inverse correspondence with trade imbalances expressed as a percentage of gross domestic production. (1) It is simply that such adjustments have not been sufficiently powerful. Paul Krugman has given us a partial explanation in suggesting that a lower dollar makes foreign acquisitions of U.S. corporations appear cheap, encouraging a continual inflow of foreign capital (1989, 32), and, indeed, recent cross-border merger and acquisition activity seems to substantiate the claim. (2) But such an explanation begs the question of why trade adjustments are not potent enough to offset such movements of capital. If textbook theory operated unimpeded, the dollar would fall sufficiently to expand exports and restrict imports so as to close the trade deficit and choke off the concomitant inflow of capital. The expansion of exports would generate sufficient domestic income to allow the expansion of sufficient domestic saving so as to equilibrate saving and investment at that higher level of income.

The case for the saving-investment imbalance thesis would be stronger if the dollar had exhibited a strong upper trend corresponding to the "pull" of the U.S. gap between saving and investment. No such trend is exhibited-quite the contrary. For the bulk of the post-Bretton Woods period the dollar has tended downward and, in certain outlier cases, particularly that of Japan, the decline has been spectacular. The proponents of the saving-investment thesis have, of course, recognized this apparent contradiction and have added addenda to their thesis, such as a relative decline of U.S. competitiveness (Krugman 1990, 1994, 118) or lags in the adjustment process relating to the trade balance (Lawrence 1990a, 85; Krugman 1989, 32).

This paper accomplishes two tasks. The first task is to briefly summarize some of the more important literature surrounding the institutional and historical aspects of U.S. multinational trade that have escaped the "clean room" of textbook economics. (3) The intractability of the trade balance after the fall of the dollar in 1985 gave rise to an extensive discussion starting in the late 1980s and early 1990s that was directed at explaining the long-term sluggish response of trade balances to exchange rate adjustments that could not be explained by short-term J-curve effects. I concentrate here on one aspect that has sometimes been noted but never adequately explored, namely, that exports from the United States compete, at least potentially, with sales from affiliates abroad. Currently, and for some time back, multinational sales abroad have been much larger than U.S. exports. The largest U.S. multinational firms tend also to be the largest exporters. Being on both sides of the fence, U.S. firms have had to adjust prices and sales arrangements so as not to compete on an intrafirm level. Consequently, exchange rate changes, even large ones, have not had the self-corrective properties associated with the textbook portrayal of the exchange rate adjustment mechanism.

In the first part of the paper, I place the above argument in a historical context. I argue that the multinational presence of the United States in world markets during the Bretton Woods period constituted a historical echo dating from the period after World War II. Unlike the corporations of Japan and Europe, whose presence in foreign markets depended critically on exports, the corporations of the United States depended primarily on multinational affiliate sales and an ancillary export trade. Such asymmetry resulted from the hegemonic power of the United States after World War II and the high dollar associated with the Bretton Woods system. The argument here is that much of the current intractability of the current account deficit can be traced to these historical and institutional roots.

The second task is to investigate the U.S. domestic saving-investment imbalance. The low-U.S.-saving thesis--while conceptually correct in terms of accounting identities-is misleading in its aggregation of the corporate sector and the world of noncorporate business, housing, and personal finance (hereafter the noncorporate sector). I show below that the saving-investment imbalance in the corporate sector is operative in the direction opposite that of the aggregate imbalance. This disaggregation is instructive for it puts a finer lens on the components of the saving-investment imbalance. In their published form, the NIPA accounts combine the investment totals of all business enterprise--corporate business (typically large business) and smaller partnerships and sole proprietorships. Present studies that use published NIPA data to examine the domestic balances of the business sector and personal sector have not disaggregated the data sufficiently to uncover the plenitude of corporate savings relative to new investment carried out by the corporate sector. (4) Disaggregating the components of business enterprise allows a closer look at the corporate sector taken alone. The other difficulty with the NIPA accounts is that they record some large portion of the total saving not at the point of corporate origin but rather at the level of personal income. Most particularly, dividends and net interest are monies originating at the corporate level but yet are understood as personal income from which personal saving is then abstracted. For measuring personal income, this makes sense. Yet both dividends and net interest are monies originating in the corporate sector and their payout suggests--as I will argue below--the existence of excess cash relative to corporate investment opportunities. At no time in the post-WWII period has corporate investment outpaced a broad measure of internally generated cash. On the contrary, in every year, and particularly during boom times when the export-import imbalance would be expected to show deficits and net a foreign inflow of capital, internally generated cash exceeded new corporate investment, often by wide amounts. Consequently, the aggregate current saving-investment imbalance must be traced to the noncorporate world.

On the basis of these findings, one might expect the corporate world to be awash in liquidity and the noncorporate sector, cash strapped and debt ridden. The latter is certainly in evidence--indeed, notoriously so--and I show below the magnitude of this deficit. But, in seeming contradiction to the ample amounts of internally generated saving, the corporate sector too shows increasing indebtedness. Paradoxically, one of the most important factors behind this corporate indebtedness is the excess saving imbalance itself (what Michael Jensen has called "free cash flow" [1986]). This "free cash" has allowed down payments on mergers and acquisitions and stock repurchases. The full volume of these extra-investment purchases has required large amounts of debt, which, in turn, has tended to generate even more debt as the corporate world has become increasingly vulnerable in its use of leverage. The two debt piles--that of the corporate sector and that of the noncorporate sector--I call the "second set of twins." One of the twins grows as a result of too much money; the other twin grows as a result of too little.

In a final section, I propose higher taxes on "free cash" and a government redirection of this cash toward the noncorporate sector. To the extent that the current account deficit is determined by an aggregate saving-investment imbalance, such taxes and expenditures would help correct the ongoing current account problem.

The Breakup of Bretton Woods and the Coming of Floating Rates

The last three decades have witnessed an increasing cross-border integration of Europe and a cross-border escape of Japan's largest corporations into America, East Asia, and Europe. Against this backdrop, it is hard to fully remember the overwhelmingly predominant role of U.S. corporations in foreign direct investment and worldwide sales at the time of the collapse of Bretton Woods (1971-1973). In contrast to the approximate 25 percent share of outward FDI that U.S. corporations have had in recent years, U.S. firms had approximately 50 percent of the total thirty years ago. (5) A comparison of world sales by the world's largest firms shows the same relative predominance, with...

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