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The Emerging Pattern of Global Investment

Jamus Lim's picture

Beginning in 2000, the world experienced a dramatic shift in the pattern of global investment. For much of postwar economic history, the total amount of investment by developing countries accounted for a fairly small and stable share of global output---averaging around 5 percent---while high-income economies captured a share several times that, of around 19 percent (see figure below); the resulting global investment rate has hovered around about 22 percent or so for many decades.[*] Beginning in 2000, however, a structural break appears in the data: investment rates for the developing world as a whole inflect sharply, so that by the end of the first decade of the 21st century, developing countries' investment share of world GDP has reached almost 10 percent, in the context where the developed world saw a decline to roughly 13 percent or so. Should this trend persist, the developing world will, for the first time in modern economic history, invest more as a share of global production compared to their high-income counterparts.

Source: World Bank staff calculations, from World Bank WDI database.
Notes: Total gross investment includes fixed capital formation and inventory accumulation. Values are measured in current USD. The global pattern in gross fixed investment is similar.

The natural questions that arise, of course, is why this change appears to have taken hold, and how persistent this change may be.

With regard to the first issue, the most immediate question whether this is just a China and India centric story. The answer is that it is actually reasonably more broad-based: even in the absence of these two giants, developing countries' investment shares are larger than they have ever been since 1965 (see figure below). Of course, given the economic size of China and India in the developing world---and their large populations---it would be illogical to exclude them in any understanding of developing-world phenomena. But the point is simply that this phenomenon appears to not have been limited to a few major developing countries.

Source: World Bank staff calculations, from World Bank WDI database.
Notes: Total gross investment includes fixed capital formation and inventory accumulation, and are measured in current USD.

Nor are the changes due to size differences alone. It is possible to break down the contribution of changes in two separate components that comprise the investment share of global output: changes due to the investment rate, and changes due to economic size.[] When this decomposition exercise is performed, one indeed finds, for the past decade, that the contribution from changes in the investment rate was substantial (about a third of the total change). So, while a significant part of the increase in developing countries' share of global investment activity can be explained by their larger size, they have also displayed an increased tendency toward greater investment in their own economies (see figure below).

Source: World Bank staff calculations, from World Bank WDI database.
Notes: The decomposition attributes changes according to the decomposition of a group's share of global output into changes in the group's investment rate, and changes in its relative size; see [].

To answer the second issue---of how persistent this change is likely to be---requires us to examine the factors that may have driven the increase in investment rates on a deeper level. These factors, in turn, are likely to be due to structural transformations in developing countries over the past decade: changes in factors such as financial development or institutional quality, for which developing countries appear to have made strides since 2000. For example, between 2004 and 2011, an index measuring the strength of creditors' legal rights (using the Getting Credit: Strength of Legal Rights Index in the Doing Business database) rose by 26 percent in developing countries, versus just 3 percent in high-income nations. Likewise, an index of political stability (the Political Stability Index in the World Governance Indicators database) shows a 20 percent improvement in the developing world between 2000 and 2010, compared to a 10 percent gain in the developed world.

Why this a big deal? In light of how rapidly the developing world is changing, grasping the true scale and scope of how these changes will play out for the global economy requires a keen understanding of how changes in underlying structural factors can drive the evolution of important economic variables such as investment. By tracing out different scenarios for how these factors are likely to evolve, we can peer into futures that may be dramatically different from what we might envision today, and possibly even when compared to simple extrapolations of existing trends. The recent shifts in investment flows thus portend a future world where high-income countries may no longer dominate the global distribution of capital stocks, as they did in the 1980s (see figure below), and as they still do today.[] This approach then allows us to answer important questions, such as which countries are likely to be the important investment destinations in a multipolar world economy.

Distribution of global capital stocks, 1980
Source: World Bank staff calculations, from World Bank WDI and GEM databases.
Notes: Capital stocks were calculated using a perpetual inventory method with assumed constant depreciation rate of 5 percent, and presented in billions of 2000 U.S. dollars. Countries with insufficient data in the constant investment series were backcasted using a regression of the investment deflator on the GDP deflator and available investment data. Data for the 2010 chart are either for 2010 or the latest year since 2006. Computations assuming hyperbolic discounting yield similar results.

Of course, at the global level, we cannot disconnect investment from saving, since the world is ultimately a closed system (Paul Krugman's fantasies (PDF) notwithstanding). At the most fundamental level, for example, the amount of (domestic and foreign) investment undertaken to any given country will be constrained by the total saving of the world's citizens. When we look forward, then, it is crucial that we take into account the way that global saving will likely pan out; but that is the topic of another post.

*. Even in the aftermath of the global financial crisis, the global investment rate has remained remarkably stable; in 2010, it was about 23 percent, the same as the average since 1965.

. The math is straightforward, and requires first recognizing that the share of investment by either income group, Ii, of world output Y is equivalent to the product of its share of its own group's output, Ii/Yi, and the output share of that group, Yi/Y. Taking logarithms followed by total derivatives on both sides then yields the contribution of each (in practice, since the data are discrete, the partial derivatives were computed as changes in the particular variable).

. Estimates of the global distribution of capital stocks in 2010 indicate that approximately 70 percent of the global capital stock currently resides in

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