The external wealth of nations: measures of foreign assets and liabilities for industrial and developing countries

Capital flows were tracked continuously, yet the stocks of foreign assets and liabilities those flows accumulate into were essentially unmeasured outside a small group of industrial countries – a gap the authors call “a severe empirical constraint,” because net foreign assets are a state variable in open-economy growth and business-cycle models, because the gains from financial integration attach to gross rather than net positions, and because the equity-versus-debt composition of a country’s balance sheet bears on its vulnerability to shocks and its degree of risk sharing. This paper builds such estimates for 67 industrial and developing countries over 1970-1998, disaggregated into direct investment, portfolio equity, debt and foreign exchange reserves. Its methodological contribution is an accounting framework showing exactly how balance-of-payments flows relate to the underlying stocks, and therefore where naive cumulation goes wrong: capital transfers (Canada received 58 billion dollars of them over 1988-97, close to 10 percent of 1997 GDP, against a cumulative current account deficit of 146 billion), debt reduction and forgiveness (Chile’s external debt fell by over 8 billion dollars, more than 25 percent of 1990 GDP, over 1987-90 while its cumulative current account deficit was only about 2 billion), exchange-rate revaluation of debt (the yen’s appreciation added 4.4 billion dollars to the dollar value of Indonesia’s external debt in 1994, against a current account deficit of 2.8 billion), and equity-market valuation (a 1996 UK portfolio equity inflow of about 9 billion dollars corresponds to an estimated 66 billion dollar rise in the stock of equity liabilities, close to the 59 billion officially reported). The authors construct three distinct measures – an adjusted cumulative current account available for all countries and all years, an adjusted cumulative-flows measure used for developing countries, and the officially reported International Investment Position, available for around 30 countries and typically only from 1980 – and use the overlap as a validation test rather than assuming their method works: the adjusted measures track both the levels and, in Table 2, the short-run year-to-year variability of the official positions more closely than the current account does, including for Australia, the Netherlands, Switzerland, the UK and the US, where the current account tracks the official position poorly or negatively. Where the measures diverge, the divergence is itself informative: the gap between the cumulated-current-account estimate and the official position correlates 0.75 with cumulative errors and omissions across industrial countries, consistent with the paper’s identifying assumption that errors and omissions represent unrecorded capital outflows. Two valuation choices are stated openly as compromises – FDI at book value rather than market value, because market-value data exist for almost no country, even though the US case shows a 1998 gap of 119 billion dollars at current cost against 356 billion at market value; and debt for industrial countries unadjusted for cross-currency fluctuations for want of comparable data. The stylized facts drawn from the resulting dataset are presented as a “first cut”: gross stocks of FDI and portfolio equity relative to GDP rose substantially from the mid-1980s in industrial countries and especially after 1990 in developing ones; among developing countries GDP per capita is positively correlated with the net external position, consistent with the “stages” hypothesis, though the weaker industrial-country relationship “suggests that the true relationship may be nonlinear”; country size raises net foreign assets across subsamples; and trade openness is strongly associated with a shift in the composition of developing countries’ external liabilities away from debt and towards equity. The authors close by listing the margins for error in their own estimates before claiming only that they are “constructed on a consistent basis across countries, they match existing stock data quite closely and they fill an important gap.”

Gian Maria Milesi-Ferretti | Macro Paper Warehouse

The external wealth of nations: measures of foreign assets and liabilities for industrial and developing countries