Small and medium income earners have few
capital assets, have limited resources to save or smooth out income
fluctuations, and are therefore unable to skim off risk premiums on assets. Political
Germany has therefore recently been increasingly discussing the creation of a Sovereign Wealth Fund (SWF) as a solution to societal challenges such as increasing poverty among the
elderly, increasing income and asset polarisation or intergenerational justice.
Following Corneo's lead (2017)[1] and inspired by Thomas Piketty,
it is now recommended that a broader diversified capital stock be built up with the
creation of an SWF investing in securities and distributing the return annually
to the population at equal amounts per capita without any further conditions
than a minimum duration of residence in Germany.
The original motivation for the creation of
SWFs was to preserve intergenerational justice in countries that exchanged
their exhaustible natural resources for foreign exchange by extracting and
exporting them. Without the establishment of sovereign wealth funds, such
countries would have effectively used up their total assets at the expense of future
generations, i. e. their total savings would have been negative[2].
But what is to be thought of sovereign wealth funds in countries such as China
and Germany, which generate excess savings and export surpluses as a result of
domestic investment and consumption deficits? Would the establishment of an SWF
for Germany come at a favourable time in the long term? This essay tries to
approach these questions.
World champion of net
capital exports
Germany is not only the world champion in soccer,
but also in net capital exports. The German current account surplus in 2016
amounted to 297 billion US dollars (268 billion euros) and China took second place
with a surplus of 245 billion US dollars. Both China and Germany are
characterized by a rapidly aging population. Rapid aging coupled with an
aversion to immigration does incite to save for old age. Indeed, Germany's surpluses
are structural in nature: since the turn of the century, it has not recorded a
current account deficit; its domestic savings have always exceeded domestic
investment. While China's current account surplus has been declining as a
fraction of its GDP since the Great Financial Crisis, the German surplus has
since then fluctuated between 6 and 8 per cent of its GDP.
In 2016, the German external surplus amounted
to 8.5 per cent of GDP. As formerly in China, corporate savings, or rather corporate
investment deficits, and the public sector budget have contributed to the high
saving ratio in Germany[3].
In 2016, Germany saved 12.2 per cent of its disposable income; the savings rate
of non-financial corporations was 4.3 per cent. The saving ratio of the consolidated
government sector was 1.7 per cent, due to Wolfgang Schäuble´s 'Black Zero'
policy. The corporate and government investment deficit and the consumer
deficit corresponded to a savings surplus of 10.3 percent for Germany with the
rest of the world. If Germany were a closed economy, it would suffer from a
large demand deficit, low capital returns and deflation.
High returns are rarely achieved through
massive net capital exports, however. Formerly known as a producer of 'cheap goods´,
China has long been referred to as provider of 'cheap savings', which the
country made available to the USA. As a large part of the FX reserves were
invested in low interest rate US Treasury bonds and the US had (and still has)
a corresponding current account deficit with China, China granted the Americans
cheap vendor loans[4]. The
accumulated FX reserves became a legacy burden due to the
build-up of interest rate and exchange rate risks and the threat of the central
bank losing monetary control. This was
followed by speculative bubbles on the real estate and equity markets. As a
result, China turned part of its financial assets into tangible assets -
through accelerated growth of sovereign wealth funds. According to the latest
SWF Institute data, four Chinese sovereign wealth funds are among the top ten,
with total assets of over USD 2 trillion at the end of September 2017, compared
with Norway's Government Pension Fund Global, the world's largest single sovereign
wealth fund, which has reached a total of USD 1 trillion[5].
Although Germany, as a member of the
euro zone, does not hold exorbitant FX reserves, factors comparable to China
have a negative impact on the economic return of its capital exports. German banks and insurance companies have
invested their savings in US subprime and Greek government bonds over the past
few decades, resulting in heavy losses on these foreign investments. 2,200
billion euros have been invested abroad on a net basis since 2000, but in 2016
Germany's foreign assets amounted to only 1,600 billion euros. Germany's
capital loss amounted to 600 billion euros, 7,500 euros per capita[6].
Since the outbreak of the euro crisis, German savings have no longer been
transferred abroad primarily via commercial bank loans, but via public channels,
as Germany´s voluntary private transfer dried up. Since then, the Deutsche
Bundesbank's net foreign position has multiplied; at the end of September 2017,
Target II claims amounted to around 850 billion euros. Since the beginning of
2016, the ECB has been paying interest zero percent on these balances.
In the autumn of 2017, after the German
federal elections, the question arises as to how much German capital exports
will collapse if the (liberal party) FDP's refusal to make the Eurozone a transfer union
prevails. Would SWFs be a way out for Germany if its capital exports collapsed
within the euro zone?
Dynamic inefficiency, aging and return on investment
For China and Germany, dynamic
inefficiency can be diagnosed. An economy is dynamically efficient if gross
investment income exceeds gross fixed capital formation on a sustained basis,
whereby investment income is defined as the sum of profit, rent and interest
income. If this is the case, then the financial sector will provide more
resources for future consumption than it consumes. Conversely, if investments
exceed investment returns, the financial sector withdraws resources from the
economy. This is inefficient, because the whole purpose of investment is to
increase future consumption opportunities[7]. In Germany today (as in China before) too little
is being consumed.
However, the creation and financing of SWFs from excess savings would only perpetuate the dynamic inefficiency in countries, such as Germany, where SWF financing does not derive from the export earnings of exhaustible raw materials (Arab Gulf States or Norway). SWFs that are financed from domestic demand deficits (instead of raw material revenues) do not therefore promote intergenerational justice but undermine it at the expense of today's generation.
However, the creation and financing of SWFs from excess savings would only perpetuate the dynamic inefficiency in countries, such as Germany, where SWF financing does not derive from the export earnings of exhaustible raw materials (Arab Gulf States or Norway). SWFs that are financed from domestic demand deficits (instead of raw material revenues) do not therefore promote intergenerational justice but undermine it at the expense of today's generation.
In a closed economy where savings by
definition equal investments, investment income would fall below investment
expenditure as a result of excessive capital accumulation. If the return on
capital falls below the growth or wage rate, a pay-as-you-go pension scheme is
superior to funded pensions in a closed economy. To be sure, pay-as-you-go
schemes for old-age pensions are largely influenced by changes in real wage
growth and the ratio of contributors to pensioners (support ratio). The
pay-as-you-go system is therefore essentially enclosed into the ageing economy
and cannot escape the demographic pressure resulting from the expected drop in
the support ratio, except by raising the retirement age.
However, even fully funded pension
systems cannot escape demographic pressure, even if there are significant flows
of capital between the ageing and younger parts of the world. Firstly, higher
life expectancy will put pressure on the calculation of funded pensions.
Secondly, the ageing of the population will exacerbate the pressure on returns
by reducing the profitability of pension funds and insurance companies. An
economic-demographic simulation model (MacKellar and Reisen, 1998) with two
scenarios (relative self-sufficiency versus financial globalisation of pension
schemes) predicts a decrease in the return on investment due to the fall in the
labour force for both scenarios. In the autarchy scenario, the capital
intensification associated with ageing will reduce investment income by 150
basis points by 2050 and by 110 basis points in the globalisation scenario[8].
Piketty (2011)[9]
has postulated in his famous book, based on many years of empirical evidence,
that the rate of return on capital, r, has usually been higher than the growth
of production, g. If wealth is not heavily taxed or decimated by the
consequences of war, the inequality r > g leads to a concentration of
wealth, according to Piketty. The formula refers to the return on investment
(r) to the growth rate (g), where r comprises profits, dividends, interest,
rent and other investment income before taxes; g denotes the growth of
disposable income or wages. Note that Piketty´s formula would preclude the
formation of a middle-class, especially in fast-growing countries.
However, Piketty conceded that the tendency to higher wealth inequality was reversed between 1930
and 1975, in his judgement due to one-off circumstances. Interestingly, 1975
coincides with the beginning of the integration of 50 percent of the unskilled
labour force into the world economy, triggered by the opening of China, India
and the disintegration of the Soviet bloc (in my terms: Shifting Wealth Phase
I). A simple Cobb Douglas production
function, in which capital contributes a third of the income (the rest is
provided by unskilled labour and know-how), shows that doubling the global
labour supply has reduced unskilled labour productivity by a good 16 percent[10].
This led to a corresponding reduction in equilibrium wage for basic skills. Meanwhile,
the original wage effects of the integration of China, India and other emerging
markets have been coming to an end.
It cannot be ruled out that
"Piketty is history", as Goodhart and Pradhan predict in a recent BIS
study[11],
as longstanding demographic developments that caused income and wealth
inequality will now change. This is supported by the fact that several trends,
which have been valid for forty years since the entry of post-communist states
and emerging Asian countries into the market-economy organized world economy,
have ended. Goodhart and Pradhan forecast for the coming decades:
·
The
ageing and shrinkage of the world's labour force (outside the Sahel Zone) and
thus a higher share of wages in world income;
·
The
decline in massive outsourcing to China and Eastern Europe, thus putting an end
to price deflation for labour-intensive goods and hence provide scope for a
more restrictive monetary policy in advanced economies, probably leading to
asset price deflation; and
·
The
trend reversal in the global development of factor relations with an increase
in the capital ratio in production and a reduction in returns on capital[12].
Both pay-as-you-go and funded
pension systems are being burdened by the ageing process (especially in
Germany, China and Japan). However, the predicted improvement in real wages relative
to return on capital discourages to persue wealth and generational equity
by building SWFs. While pay-as-you-go systems of old-age provision will be less
burdened by global wage trends, the projected reduction in the return on
capital employed will put a strain on funded old-age provision and sovereign
wealth funds.
[1] Giacomo Corneo (2017): Ein Staatsfonds, der eine soziale
Dividende finanziert,
Freie Universität Berlin Fachbereich Wirtschaftswissenschaft,
Diskussionsbeiträge 2017/13, Mai.
[2] Helmut
Reisen (2008), How
to Spend It: Commodity and Non-Commodity Sovereign Wealth Funds, OECD
Development Centre Policy Briefs No. 38, OECD, Paris, September.
[3] OECD (2010), Perspectives on Global
Development: Shifting Wealth, Figure 2.6., OECD, Paris; Statistisches Bundesamt (2017), Volkswirtschaftliche
Gesamtrechnungen: Sektorkonten, Destatis, Wiesbaden.
[4] The term vendor loan needs to be handled with caution, as there is
no bilateral link between current account and capital account balances in an
open global economy; for example, the USA was not only indebted to China via
its purchase of government bonds but also through loans provided by European
banks.
[5] Chinas four
SWFs listed by the SWF Institute are China Investment Corporation; Hong Kong
Monetary Authority Investment Portfolio; SAFE Investment Portfolio; National
Social Security Fund. See https://www.swfinstitute.org/sovereign-wealth-fund-rankings/
[7] See A. Abel,
G. Mankiw, L. Summers , R.
Zeckhauser (1989), „Assessing Dynamic Efficiency: Theory
and Evidence“,
The Review of Economic Studies, 56.1, Januar, S. 1–19.
[8] Landis
Mackellar und Helmut Reisen (1998), A Simulation Model of Global Pension Fund
Investment, Technical
Paper No. 137, OECD Development Centre, Paris.
[10] Helmut Reisen (2006), „Globalisierung, Proletariat und Prekariat“, Internationale
Politik, January 2006.
[11] Charles Goodhart and Manoj Pradhan (2017), “Demographics will reverse three multi-decade global trends“, BIS Working Paper No. 656, Bank
for International Settlements, Basel.
[12] Piketty (2013) argues that the capital deepening goes is compatible
with an increase in the return on capital. This, however, requires a
substitution elasticity between labour and capital greater than one.
