More on Wealth, Trade and Productivity

Brad Setser disagrees with my post
Michael Mandel

Brad Setser disagrees with my post "Not so scary? Why national wealth matters"

He has two objections. First, that the end of the global savings glut will raise interest rates and reduce national wealth.

The US would be in trouble if global savings just stopped flowing into the US at current rates. Higher interest rates would simultaneously: increase the burden of servicing the existing stock of US debt, make it harder to raise the financing needed to sustain ongoing external deficits and reduce US household wealth.

Brad's second objection is that I should be comparing external debt to external assets, not domestic assets.

Remember that external debt ultimately is a claim on the United States future export revenue.

New homes – and higher prices on existing homes – won’t help pay the interest on the US external debt. A new Boeing production line would.

Of course, the US could sell off some of the new homes now being built in the US to its foreign creditors to pay down its debt – but that only really works if the United States’ creditors ultimately want to come and live in the US.

Before addressing Dr. Setser's individual objections, let me make a big point first (I call him Dr. Setser because he was nice enough to call me as Dr. Mandel). The Federal Reserve publishes data on household wealth, which is what I used. But the wealth of a country can also be thought of as the flow of future returns on its assets, discounted appropriately. These future returns include profits, interest, and the use value of residential real estate.

If we expect the economy to grow faster in the future, then it's reasonable to expect that future profits, interest payments, and the use value of residential real estate will grow faster as well (assuming that everything stays at the same share of GDP). That would lead to a higher estimate of today's wealth.

Guess what? Over the past ten years, there's been a dramatic increase in expected sustainable productivity growth. Back then, the consensus of economists was that the U.S. could sustain an annual whole-economy productivity gain of roughly 1% a year. Today, the expectation is that 2% is roughly the right rate of sustainable productivity growth.

A little calculation shows that a shift from 1% long-term productivity growth to 2% long-term productivity growth produces a 40% increase in real wealth (Assumptions: 75 year time horizon, labor force growth following the intermediate scenario of the Social Security Trustees, real interest rate of 2.5%)(Note: a 4% real rate still gives a real wealth increase of 30%).

To put it differently: If productivity was still growing at the slower rate, household net worth today might be closer to $35 trillion, instead of the current $49 trillion. In real terms, household net worth would be at 1996 levels.

Isn't that interesting?

I see the increase in U.S. wealth as something real, based on expectations of future productivity growth. And I see the influx of foreign capital as an attempt to tap into the future expected growth of that wealth.

From that perspective, I disagree wholeheartedly with Dr. Setser's second objection, that I should only be comparing external debt with external assets. In a world with diminishing home bias, there's less and less difference between domestic assets and external assets, especially for a country like the U.S. Foreigners buying U.S. homes and renting them out is no different than Toyota opening up a factory in the U.S., or Intel opening up a factory in Ireland.

Dealing with his first objection is a bit more complicated. I can imagine a world in which productivity accelerates in Japan and Europe, so that they become more attractive places to invest. In that event, real wages and consumption in those areas should pick up as well. In such a world, the global real interest rate might very well rise.

But I'm afraid that I can't view a world in which our main trading partners finally manage to dig themselves out of the productivity doldrums, and create more domestic demand, as ultimately a bad thing for the U.S. An increase in global wealth can only be a plus.

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