Why is capital so often flowing out of emerging economies?

Sam asks me:

I was struck by something that Peter Thiel has talked a bit about in recent months, namely that capital is flowing ‘uphill’ from China to the U.S., which is not what the neoclassical model would predict. I’ve read a few of the general objections to this “Lucas Paradox” (e.g. differences in human capital, credit risks etc.), but would love to know what your take on this phenomenon is.

I would cite a few factors:

1. China is a high-savings country with high political risk.  In general savings don’t have that many safe outlets, noting the third largest government debt market in the world is that of Italy.  So of course much of this money flows into the United States.  And China is hardly the only high-savings emerging economy.

2. China makes it costly or impossible for many kinds of American firms and individuals to invest directly in China, this now being a familiar story.  The Chinese stock market also is limited and unrepresentative of the Chinese economy as a whole.

3. American capital will not flow to Russia the way British capital once sopped up opportunities in Argentina and elsewhere in the late 19th and early 20th centuries.  The end of gunboat diplomacy is one but not the only reason for this.

4. State-owned industry is a bigger factor today than in earlier times.  For instance, if Aramco is privatized, plenty of private Western capital will invest in the company.  But so far it is not.

5. Savings rates are often especially high during times of rapid income growth, because preferences have not yet caught up with income (an underrated mechanism, which perhaps someday will get its own blog post).  Emerging economies in much earlier times did not have such rapid growth, and therefore they did not have comparable huge savings surpluses to dispose of.

6. The United States has issued a lot of debt, whereas the earlier Great Britain ran a balanced budget at least intertemporally.

7. America has accumulated enough wealth so that flows of household savings can be relatively low.  Plus we are irresponsible — so good at marketing and spending! — and thus we do not save enough either.

8. If you counted holdings of American dollars, as a reserve currency, as “America exporting its rule of law,” the flow of funds would look less strange.

Which other reasons?


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