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Capital, like water, should flow downhill to capital-scarce countries
By Wu Jiayin |
July 28, 2009, Tuesday
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Print Edition
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WATER is supposed to flow downhill because of gravity.
Professor Roger Myerson has identified an exception, however, in which "water" flows uphill: that is, nowadays, money often flows from capital-scarce countries to capital-rich countries. Myerson is 2007 Nobel Laureate in Economics and professor at the University of Chicago.
"International flows of capital, in theory, should go from countries where capital is rich to countries where capital is scarcer and where opportunities are more plentiful. Yet in the past decade or so, capital flows the wrong way," Myerson observed at a forum in Shanghai co-organized by the Shanghai National Accounting Institute and Arizona State University on July 18.
A typical example, according to Myerson, is that capital continuously flows from China, a good place for investment, to the United States, a country that already is rich in capital.
Indeed, despite the fact that the US has triggered the global financial crisis, China has largely increased its holdings of US Treasury bonds in the past year.
And the US is still widely considered as one of the best places for investment.
Yet excessive flow of money into the US causes serious problems, Myerson pointed out.
For example, the flow of Chinese wealth to the US allows Americans to buy goods and services simply by giving IOUs (issuing treasury bonds). And if the US is to pay back its debts, it might simply issue more dollars. Yet excessive issuing of US dollars might cause such problems as inflation, not to mention a credit crisis.
Good policy
In view of this, Myerson suggested that China stop increasing its holdings of US bonds. On the contrary, "I would suggest that a very good policy might be (for China) to cash some of them (US treasury bonds) in and buy investment goods," Myerson said.
His proposal was echoed by experts at the forum.
"What's the point for China to invest its long-accumulated savings in the US to earn the meager interests from US Treasury bonds now that the capital would have done more good if invested domestically?" Professor Ker-Wei Pei asked. Pei is associate dean of W.P. Carey School of Business at Arizona State University.
True, the Chinese government came up with a 4 trillion yuan (US$586 billion) stimulus package last year to boost economy so that China could weather the deepening global financial crisis.
But the economic growth spurred by such government investments has limits, as most of the investments go to the improvement of infrastructure.
In the long run, if China is to ensure sustainable economic growth, it must find ways to expand domestic demand, Professor Zhou Lin, a colleague of Pei, emphasized.
He mentioned that two-thirds of US GDP growth depends on domestic consumption. By contrast, in recent years, domestic consumption has contributed slightly above one-third of GDP growth in China.
"China's economic growth is largely spurred by exports, which is by no means a sign of a mature economy," Zhou stressed. For China, the key to expanding domestic consumption lies in "investing more in social security and welfare so that ordinary people would be more willing to consume," said Zhou.
Change of mind
Pei added that more money should be invested to encourage scientific research and innovation. This meanwhile requires a change in the pervasive risk-averse mindset in China. In other words, "the mechanism that does not allow failure, or over punishes failure, must be changed," Pei said.
In the long run, making full use of domestic investments is not enough. Myerson believes that China should and has the ability to attract more overseas investment.
Yet the premise is that China should improve its business environment so as to give investors confidence that their investments in the market will be protected.
In Myerson's words, China should "create a safe market for people to invest in business and where millions of people of countries (the world over) make decisions about businesses following the signals of the price system to find out where their needs are."
This will involve a lot of effort, including the further opening of China's capital market, the building of a strong, healthy banking industry, as well as improving corporate governance.
Professor Roger Myerson has identified an exception, however, in which "water" flows uphill: that is, nowadays, money often flows from capital-scarce countries to capital-rich countries. Myerson is 2007 Nobel Laureate in Economics and professor at the University of Chicago.
"International flows of capital, in theory, should go from countries where capital is rich to countries where capital is scarcer and where opportunities are more plentiful. Yet in the past decade or so, capital flows the wrong way," Myerson observed at a forum in Shanghai co-organized by the Shanghai National Accounting Institute and Arizona State University on July 18.
A typical example, according to Myerson, is that capital continuously flows from China, a good place for investment, to the United States, a country that already is rich in capital.
Indeed, despite the fact that the US has triggered the global financial crisis, China has largely increased its holdings of US Treasury bonds in the past year.
And the US is still widely considered as one of the best places for investment.
Yet excessive flow of money into the US causes serious problems, Myerson pointed out.
For example, the flow of Chinese wealth to the US allows Americans to buy goods and services simply by giving IOUs (issuing treasury bonds). And if the US is to pay back its debts, it might simply issue more dollars. Yet excessive issuing of US dollars might cause such problems as inflation, not to mention a credit crisis.
Good policy
In view of this, Myerson suggested that China stop increasing its holdings of US bonds. On the contrary, "I would suggest that a very good policy might be (for China) to cash some of them (US treasury bonds) in and buy investment goods," Myerson said.
His proposal was echoed by experts at the forum.
"What's the point for China to invest its long-accumulated savings in the US to earn the meager interests from US Treasury bonds now that the capital would have done more good if invested domestically?" Professor Ker-Wei Pei asked. Pei is associate dean of W.P. Carey School of Business at Arizona State University.
True, the Chinese government came up with a 4 trillion yuan (US$586 billion) stimulus package last year to boost economy so that China could weather the deepening global financial crisis.
But the economic growth spurred by such government investments has limits, as most of the investments go to the improvement of infrastructure.
In the long run, if China is to ensure sustainable economic growth, it must find ways to expand domestic demand, Professor Zhou Lin, a colleague of Pei, emphasized.
He mentioned that two-thirds of US GDP growth depends on domestic consumption. By contrast, in recent years, domestic consumption has contributed slightly above one-third of GDP growth in China.
"China's economic growth is largely spurred by exports, which is by no means a sign of a mature economy," Zhou stressed. For China, the key to expanding domestic consumption lies in "investing more in social security and welfare so that ordinary people would be more willing to consume," said Zhou.
Change of mind
Pei added that more money should be invested to encourage scientific research and innovation. This meanwhile requires a change in the pervasive risk-averse mindset in China. In other words, "the mechanism that does not allow failure, or over punishes failure, must be changed," Pei said.
In the long run, making full use of domestic investments is not enough. Myerson believes that China should and has the ability to attract more overseas investment.
Yet the premise is that China should improve its business environment so as to give investors confidence that their investments in the market will be protected.
In Myerson's words, China should "create a safe market for people to invest in business and where millions of people of countries (the world over) make decisions about businesses following the signals of the price system to find out where their needs are."
This will involve a lot of effort, including the further opening of China's capital market, the building of a strong, healthy banking industry, as well as improving corporate governance.
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