About That Big Bad Capital Shortage: Relaxby
Brother, can you spare a dime? Eastern Europe needs to modernize obsolete factories, Kuwait has a multibillion-dollar repair bill to pay, and the U. S. faces a costly savings and loan bailout and a crumbling infrastructure. Even Japan and Germany have new spending priorities at home. With all the new demands on the capital markets, some financial economists are predicting a global capital shortageone that would mean dramatically higher
interest rates and much less private investment.
But a careful look at the numbers suggests that a global capital shortage over the next five years is unlikely. The economy of the industrial world has grown by more than 30% over the past 10 years, and it's now large enough to easily fund this new wave of public investment, big as it looks (table). Moreover, the demand for capital in Eastern Europe, the Middle East, and even here in the U. S. is going to be smaller than feared. So, homeowners, growing businesses, and other private borrowers won't be crowded out of the capital markets, even when the economy recovers from the recession.
NO FLOOD. To be sure, not everyone is going to get all the investment dollars they want. From the Soviet Union to the Sahara to Latin America, countries with enormous capital needs will have trouble borrowing at any interest rate. And for good reason: Lenders worry that they'll be throwing money down a black hole.
That's certainly true in Eastern Europe, for example, which is able to absorb much less capital than most had predicted. The original estimates of the cost of modernization were astronomical. But because these economies are in such bad shape, profitable investments are few and far between. The countries also lack management skills and a legal system for doing business with the West. "The problem in East Europe is not a matter of capital shortage for the moment," says Jacques Attali, president of the European Bank for Reconstruction & Development. "It's a problem of the efficient use of capital."
As a result, the expected flood of investment funds into Eastern Europe has so far been just a trickle. Many Western companies are looking but not investing, and Western banks, suggests Attali, are haunted by the ghost of bad Latin American loans. PlanEcon Inc., a Washington-based consulting firm, estimates that Poland, Czechoslovakia, and Hungary will receive only $15 billion in foreign direct investment between now and 1995, and only $11 billion in multilateral lending from institutions such as the World Bank. Says Rudiger Dornbusch, an international economist at Massachusetts Institute of Technology: "Like Africa, the needs are fantastic, but who's going to give them money?"
Some of the other potential drains on world capital markets are also turning out to be busts. The estimated cost of repairing the damage in Kuwait, at first put around $100 billion, has now dropped into the $25 billion to $50 billion range. That amount, which can be covered by Kuwait's own reserves, will barely make a ripple in the global markets.
In the U. S., the government bailout of the thrift industry, which will cost hundreds of billions of dollars, should also have little effect on interest rates. Economists generally agree that the money, which is being used to pay off depositors in failed banks, is going right back into the financial system, where it's ready to be lent out again.
POTHOLES PREVAIL. And no matter how many people complain about congested airports and decaying highways, there's still no infrastructure building boom in the works in the U. S. According to many studies, the country should be boosting its spending on roads, bridges, and other infrastructure by as much as 50% in order to keep the U. S. economy competitive. Yet public works spending, adjusted for inflation, has risen by only 15% over the past five years, and the next five years don't promise much more. It's not that interest rates are too high or that too much money is going to Kuwait or Poland. Instead, state and local governments are struggling with widening budget gaps, notes George A. Christie, chief economist at F. W. Dodge Group, and "they are getting increasingly pinched to come up with any money to initiate things." Indeed, they're having enough trouble just maintaining their current level of capital spending.
The only real boost in infrastructure spending is coming from the federal government. The Bush Administration is requesting $105 billion over the next five years in highway and mass transit money. Still, on an annual basis, that works out to only an increase of $5 billion over this year's spending level.
GEARING UP. True, other countries suffering from fewer budget constraints have embarked on much more ambitious capital spending programs. Japan, for one, is building parks, ports, roads, and sewer systems at an estimated cost of $3 trillion over the next 10 years. And Germany is shouldering the ever-mounting bills for that country's reunification, even if it means raising taxes. The cost of rebuilding East Germany was put at $65 billion a year for the next decade, but emergency spending for 1991 has pushed this year's tab alone up to $85 billion.
In total, these new demands on the capital markets will come to $625 billion to $850 billion over the next five years, or about $125 to $170 billion annually. That's nothing to sneeze at, but it's far less than the $3 trillion that private companies and governments in the industrialized countries invest each year.
Moreover, the new public investment programs are gearing up just at about the same time that an enormous surge of private investment is coming to an end. So there should be plenty of capital available to meet the new financial demands. In the U. S., the speculative real estate boom of the 1980s is over, and the falloff in residential and office construction will free up funds for other uses. Also, according to the latest forecast from the Organization for Economic Cooperation & Development, Japan's investment in plants and equipment, which grew at a 16% annual rate from 1988 to 1990, will slow to a more modest 5% to 6% annual rate in the first half of the 1990s.
For these reasons, the new capital spending programs in Germany and Japan shouldn't put much upward pressure on U. S. interest rates. Long-term rates in the U. S., adjusted for inflation, are now at their lowest level in years (chart). Although that's partly because the recession has slowed down economic activity, it also reflects the capital market's evaluation that any new burst of Japanese and German spending will not be pushing up U. S. rates anytime soon.
Indeed, the U. S. is less dependent on foreign funds than it was just a few years ago, notes Steven Nagourney, international strategist at Shearson Lehman Brothers Inc. In the 1980s, the U. S. had to borrow heavily overseas to pay for its soaring imports. But the gap between imports and exports has been closing. Excluding oil, it fell by 50% in 1990. If this improvement continues, rather than suffering from a capital shortage, the U. S. may be surprised to find itself exporting capital to the far corners of the globe.