European Economic Review 21 (1983) 153-156. North-Holland Publishing Company

COMMENTS

‘Domestic Saving and International Capital Movements in the Long Run and the Short Run’

by M. Feldstein

James TOBIN Yale University, New Haven, CT 06520. USA

Feldstein argues here, and in his previous paper with Horioka, that in spite of the significant increase in capital mobility across national borders and currencies, domestic saving is a very much more important source of finance of national investment than foreign saving. The opposing hypothesis is that savings regardless of countries of origin are pooled and allocated via an international capital market and a common world structure of interest rates. Another way to put Feldstein’s view is to say that the OECD countries are not the states of the American union.

Feldstein wants to argue that a higher national propensity to save - note that domestic saving includes the saving of the public sector, business, and households - will lead to more capital formation - nearly dollar for dollar. This would be the happy result, for example, of reduced taxation of capital income or of smaller government budgets and budget deficits.

I don’t completely follow this motivation. Greater saving invested abroad will, like saving invested at home, augment the welfare of future generations. Indeed it will do better than domestic capital formation if the foreign return, after foreign taxes, exceeds the marginal efficiency of domestic investment, before domestic taxes.

In any case, my a priori belief agrees with Feldstein and his findings. Saving in Japan, Germany, or Greece is not as likely to show up in U.S. investment as is American saving. Indeed European saving is considerably less likely to finance American investment than Massachusetts saving is to finance Texas investment. However, I think there is some local bias in the geographical allocation of saving even among states or regions within a common nation and currency.

There are, it is true, considerable advantages of diversification across currencies and economies remaining to be exploited. Only in the last two or three years, for example, has Yale University begun to invest part of it’s

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154 J. Tohin, Comments on rhe Feldstein paper

endowment in foreign securities. Maybe our portfolio managers were at the corner described by Feldstein in his section 5. The question arises, both for Yale and for Feldstein’s hypothetical investor: why not borrow from abroad if you don’t want to lend?

Feldstein mentions a number of barriers - exchange and sovereignty risks, legal difficulties, transactions costs, and information limitations. I would add some localizing factors that would exist even within a single country. It is no contradiction of Keynes’s famous dictum that savers and investors are not identical to observe that much saving goes directly into investment, especially if we refer to gross saving and investment. Some directly invested saving is tied to residence, as for housebuilders, or to labor input, as for self-employed farmers, entrepreneurs, and professionals. A large share of company investment is financed by retention of gross earnings.

A direct test of the perfect international capital market (PICM) hypothesis might be to examine the tendencies to equality of returns on capital in various economies. This is difftcult, maybe impossible, as Feldstein observed, because of taxation complexities. The tax depends not only on the countries of investor and investment, but on characteristics specific to the investor and the type of investment. That projects are not internationally allocated to those savers with the least potential tax liability on them already refutes PICM, but also makes obscure what implications PICM would have for the numerical international comparisons presented in the paper.

The model

Though I agree with the paper’s major conclusion, rejection of the PICM hypothesis, I have misgivings about the author’s model. I am not sure my prior beliefs are greatly reinforced by the regressions.

To begin with, I am skeptical about what can be proved by calculations confined to three quantities related by an identity: I + N =S. Sachs has also played with this identity, aka the absorption approach, to claim that countries with high investment opportunities borrow a lot, as from OPEC countries after 1973, so that their N’s depend negatively on their 1’s. He is assuming S is pretty stable. Feldstein, on the other hand, sees S as varying and determining I, viewing N as pretty stable. Since Sachs is talking about changes over time and assuming marginal efficiencies of investment change more rapidly than saving propensities, while Feldstein is concerned with longer-run relationships and comparisons across countries, their approaches may not ultimately be inconsistent. But both are exploiting and interpreting correlations among variables connected by an identity.

In this vein, I wonder how to interpret Feldstein results for policy purposes? That the Japanese have both higher I and S ratios than the U.S. may help to refute PICM, but what does it tell us about the results of

J. Tohin. Comments on fhe Feldstein paper 155

policies in the U.S. to increase the saving ratio? Assuming national. capital markets are of central importance, perhaps a country has already adjusted its saving pretty close to its investment opportunities. Perhaps extra saving would spill abroad. Perhaps it would spill into unemployment - it is noteworthy that Feldstein recognizes no Keynesian problem at all. Given monetary policy, such wastage might well happen in the U.S. today. Anyway the cross-section results may be influenced by government policies with respect to N, the current account balance. If policies have tried to balance the current account on average, the Feldstein results would be easy to understand. Of course, if these policies continued when saving was increased, and if full employment were maintained, the extra saving would raise domestic investment.

(a) Small-country assumption. The theoretical analysis of the paper is all for one country at a time, a small country at that. Thus nowhere does the model account for the international identity for the group of seventeen countries. Aggregate N must equal the group’s total investment in the rest of the world, positive or negative, a constraint especially important in comparing pre- and post-OPEC periods. Even in a pooled PICM, more saving by a large country would not have zero effect on its own investment.

(b) Why ratios to GNP? Since it is saving in dollars or equivalent that may move around the world, it is hard to see why ratios to domestic product are used in the analysis, and why means are removed in the cross-section regressions. Indeed in the simple theoretical model provided to rationalize the empirical calculations, the variables are absolute amounts, not ratios and not deviations from means. Feldstein does not work out the derivatives of the ratios with respect to the different kinds of shocks. In any event, the bearing of the theoretical model on the cross-section comparisons is far from clear.

(c) An alternative approach. Confined to observations of I, S, N, how could one go about specifying and testing the PICM and F models? I should have thought he would go about it as follows:

Here Ij, Sj, Nj (i= 1,2,. . ., n) refer to individual countries, I, S, N to the group aggregates,

I, =a,,S, +a,,S,+...+a,.S,+a,O(-N),

I,=a,,S,+a,,S,+...+a,,S,+a,,(-N).

Because ~jIj=~j6j-N,

cajk= 1 and ~ajO=l. j j

156 J. Tohin, Commenfs on the Feldsteirl papa

The PICM hypothesis is that all saving is allocated the same way, wherever it originates,

ajk = ccjO = crj for all k, 2 aj= 1

The Feldstein hypothesis, in contrast, is

lyjj= 1 for all j, Crjk=O, j#k.

The aj0 might be regarded as the portfolio preferences of OPEC.

This procedure would require time-series regressions, not just cross- sections of multi-year averages. For long-run purposes. a stock version of the model, substituting capital stock for I, wealth for S, and net foreign assets for N, would be preferable.

(d) Another alternative approach. As I emphasized above and as Feldstein agrees, the interdependence of I, S, N among themselves and with other variables, also across countries, creates severe analytical and statistical problems. The paper tries to talk itself around these problems, but not very convincingly. I don’t believe it is satisfactory to ignore the endogeneity of income Y, or the dependence of saving, public and private, and current account balances on income, interest rates, and exchange rates. These and other interdependencies very likely had different consequences for the variables under study in post-OPEC period and before, partly because the joint deficit to OPEC made the portfolio preferences of oil exporters so decisive. The distribution of the Nj across countries, and their evolution over time, depend on the sources of disturbance, policy and nonpolicy. The relationship of S to Y will vary depending on these sources. Among the disturbances that matter are those to financial asset demands and supplies, propensities to consume and save, government expenditure and taxes, export demands, supplies and terms of trade. A much more complete macro model is needed to distinguish their effects on investment and saving, both over time and across countries.