By Noah Smith
A HUGE SHIFT has taken place in the global economy during the past few decades. Financial capital was once scarce and it’s now abundant. This has huge implications for policies ranging from taxation to fiscal austerity to financial regulation. Economists and commentators who haven’t internalized that shift can sound irrelevant and out of touch.
It’s getting easier for companies and governments to borrow. Interest rates have come down steadily since their peak in the early 1980s.
Some of this represents a decline in inflation, which reduces nominal interest rates. But real rates have come down, too. Nor is it simply a return to normalcy after the high interest rates of the 1980s. Economists Marco Del Negro, Domenico Giannone, Marc Giannoni, and Andrea Tambalotti estimate that global real interest rates are lower now than at any time on record. Stock returns, meanwhile, are very hard to predict, but historically high price-to-earnings ratios suggest that future returns will be lower than in past decades.
Why are interest rates dropping? One possibility is that growth is simply slowing and that all that capital is chasing a shrinking pool of profitable investments. Although that explanation could apply to the US and other rich countries, it makes less sense in a global context. World economic growth has held steady at about 3% since the 1970s.
Del Negro et al. crunch the numbers and find that growth isn’t a major reason for falling real interest rates. Instead, they cite an increasing desire for safety and liquidity. But this doesn’t mean investors are abandoning riskier investments; corporate borrowing spreads, apart from recessions, have remained roughly constant since the 1970s.
It’s not just governments that are finding it easier to borrow money; it’s corporations, too. The flood of investment dollars into high-profile projects with low expected returns, such as WeWork, is a sign of the times.
There are many potential reasons for capital abundance, including the rise of China, changes in the global population structure, the increase in wealth inequality, the increased ease of investing online and so on. But capital abundance also changes the way elected officials, central bankers and economists should think about policy.
A number of government policies are designed to spur investment in financial assets. Capital gains and dividends are taxed at a lower rate than ordinary income to encourage investment in stocks and bonds. One argument against wealth taxes and estate taxes is that they deter people from saving. But in a world of capital abundance these fears seem overblown. Why is it necessary to lure more dollars into the markets when people are already throwing their money at governments and companies alike?
There are implications for macroeconomic policy as well. Traditionally, the argument against government deficits is based on the idea of “crowding out.” More government borrowing, the idea goes, sucks up investment dollars that would otherwise be used to fund more productive private enterprises, starving businesses of financing. But with interest rates so low, this fear seems remote and overblown. Olivier Blanchard, former chief economist of the International Monetary Fund, estimates that low interest rates mean that the US could increase its ratio of debt-to-gross domestic product by 60 percentage points (from 104% today) without adverse consequences. Of course, the government money would have to be put to some useful purpose, although even borrowing to redistribute might make sense.
Higher government deficits might even help monetary policy do its job. If government borrowing did manage to raise interest rates from near zero, it would give central banks more space to stabilize the economy by cutting rates if a recession hits.
Governments might shy away from raising taxes on capital and wealth and borrow more out of fear of harming business investment (which is a very different thing than financial investment). A drop in capital spending would then hurt wages and reduce long-term living standards. But the fact of low interest rates means that if businesses aren’t investing, it’s not because of a lack of capital in the system; it’s because capital is being showered on some borrowers while selectively being withheld from other businesses that could put it to better use. Financial regulation that encourages lending to companies with high employment growth might therefore be a better tool for boosting investment than efforts to keep interest rates at historic lows.
So there’s a danger that governments will apply old solutions designed for the era of capital scarcity to today’s age of abundance. But there’s also the possibility that a shift to new approaches could go too far. Even as governments take advantage of capital abundance by increasing taxes and deficits, they must monitor conditions carefully should capital scarcity return.