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.”

The new open economy macroeconomics: a survey

Since Obstfeld and Rogoff’s 1995 Redux model, open-economy macroeconomics has been rebuilt around dynamic general equilibrium models with explicit microfoundations, imperfect competition and nominal rigidities, with the declared aim of replacing the Mundell-Fleming model “still widely employed in policy circles as a theoretical reference point.” This survey describes that literature, focusing “almost exclusively on the analysis of monetary shocks” because nominal rigidities matter most starkly there, and organises it around a single diagnostic question: which of the benchmark’s conclusions are results about the world and which are artefacts of its assumptions? The answer is that very few survive. In the Redux model itself – two countries of yeoman-farmers, identical preferences, the law of one price, prices preset one period ahead, a single riskless real bond, labour the only factor – a surprise permanent home monetary expansion raises home output and consumption, lowers the world real interest rate, puts the home current account into surplus, makes money non-neutral in the long run through the resulting permanent net-foreign-asset position, rules out exchange rate overshooting, and raises home and foreign welfare by exactly the same amount. Each of those results is then shown to be contingent. Allow a fraction of firms to price to market with prices sticky in local currency and the expenditure-switching effect disappears, overshooting becomes possible, home and foreign consumption growth delink while output correlations rise (matching the international business-cycle evidence better), and under full pricing to market the current account stays in balance and a depreciation improves rather than worsens the depreciating country’s terms of trade – turning the Redux equal-gains result into a beggar-thy-neighbour effect. Replace symmetric CES preferences with a unitary home-foreign substitution elasticity (Corsetti and Pesenti) and the model becomes solvable in closed form with a permanently zero current account, but the terms of trade re-enter as a welfare channel, so the optimal monetary surprise becomes finite and it is no longer optimal to expand output to its competitive level. Add capital and a monetary shock may produce a current account deficit rather than a surplus; add non-traded goods or home bias and overshooting appears and the welfare gains stop being equally shared. Persistence beyond the imposed rigidity requires specific ingredients – convex demand, rigid real wages, or translog preferences with intermediate inputs – since with constant markups and rising marginal costs “a firm will raise its price as soon as it is given the opportunity.” Financial structure turns out to matter less than expected for monetary transmission, because equilibrium current account movements are quantitatively small, though it matters qualitatively and matters a great deal for fiscal shocks. The policy-interdependence results invert with the pricing assumption: under the law of one price spillovers are positive and coordination means faster joint monetary expansion, whereas under full pricing to market spillovers are negative and coordination means a slower common inflation rate. Stochastic versions permit the first utility-based welfare comparison of exchange rate regimes, with flexible rates dominating pegs under pricing to market for any risk aversion at least logarithmic, but fixed rates preferred under producer-currency pricing if risk aversion is high enough. The empirical section is short by the survey’s own account – “[t]hus far, the literature has been primarily theoretical in focus” – and its verdict is explicitly a warning: because “many welfare results are highly sensitive to the precise denomination of price stickiness, the specification of preferences and financial market structure … any policy recommendations emanating from this literature must be highly qualified.”

Philip R. Lane | Macro Paper Warehouse

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

The new open economy macroeconomics: a survey