Misesian Insight: Cantillon Effects among Trading Nations
Mises’s insight into the importance of Cantillon effects — which we discussed in detail in Part 2 — can help illuminate not only income and wealth inequalities among individuals, but also some of the reasons for the economic disparities among national economies around the globe.
Most of the economics profession has argued for the past few decades that the 21st century will be the century of the emerging world. Since 2000, India and China increased their GDP by more than 10% every year, and as a result, it was believed that this will soon lead to convergence with the developed world (Rodrik 2011). Nevertheless, these cross-country studies have mainly focused on the evolution of GDP per capita or Net National Income levels. In this context, catch-up rates for Brazil, China, India, or South Africa have been rather volatile between the 1960s and 1990s. Over the last two decades, however, it appeared that emerging markets had finally settled on a steady course, with average catch-up rates peaking at 6% to 7% before the financial crisis (World Bank Database data, 1960-2013, author's calculations).
However, these growth rates have considerably slowed down after 2008, leveling off at around 1% according to most recent data. More importantly, the forces which appeared to be driving GDP growth and economic convergence were soon revealed to be artificial increases in investments, unsustainable in the long run: after 2008, global capital inflows retrenched rapidly, and the growth in international merchandise trade—which was double that of output for several years—was followed by a collapse in the volumes of exports, as well as of the global supply chains which had integrated most of the developing countries in the global economy. The rise in commodity prices, which had rapidly increased incomes in some emerging economies, was soon reversed by the recession and the difficult recovery afterwards. Moreover, most developing countries returned to heavy fiscal policies and high trade barriers after 2008, which represented a further drag on growth.
While it is true that cross-country idiosyncrasies—such as population growth, technological development or government policies—contributed to a significant extent to such differences, this does not eliminate the important contribution of the international monetary system to such economic disparities. The evolution of GDPs, therefore, which include government spending, did not capture the actual development of a country’s wealth and prosperity.
A better indicator of underlying disparities would require some disaggregation, e.g. the rate at which households from different countries and regions can catch up to the average level of wealth in other countries. One (imperfect) proxy for this rate is the difference between the annual increases in wealth per adult in every region compared to the wealth growth in the wealthiest region, North America. Because wealth growth has slowed down in the former regions (between 1% and -6%), and because wealth per adult in the North American region rose back to its previous crisis levels (around 6% year-on-year change), the gap between North America and the rest of the world has widened (Figure A), and the catch-up rate has dropped to negative levels over the last few years.
The developing regions depicted in Figure A, and which are being left behind by the pace of wealth growth in rich countries constitute the ‘periphery’ of the economic and financial system. For example, African countries have only a few traded stocks and bonds on financial markets, banking systems are underdeveloped—with most of the population preferring to hoard their savings—while state nationalizations and heavy regulations usually keep foreign investors away. As a result, these nations are getting only a small part of the inflationary increases in money supplies in financial centers such as the US, EU, or Japan through capital inflows. They are also getting the new money much later, because the African continent is one of the last destinations for these funds, which usually go to developed and high-income economies.
More importantly, the monetary policies of these governments also reduce household wealth at a much faster past than in developed economies: with no developed financial markets or banking systems, monetary expansion runs its course quicker through the economy (albeit with a lower incidence of malinvestments), depreciating the value of the currency, and making imports more expensive. So while other regions of the world receive the new money sooner, the periphery of the world economy has to surrender most of the wealth. In a similar situation are Latin American countries and India: they uphold government policies which throttle foreign investments, and they also receive global monetary expansion at a later time. However, because there are more investment opportunities in these regions and capitalists are more willing to bear the associated risks, these countries are faring slightly better than states on the African continent.
In a much better position are the high-income emerging economies in Asia Pacific, where investment prospects and attractive policies bring in a large share of global foreign investment, and sooner after the expansion of the money supply in the US, for example. Although these inflows of capital funds bring with them a waste of capital goods though malinvestment, and an unsustainable trade bubble, these countries gain in the short run because they are closer to the point of monetary injections from the developed economies.
However, the best positioned countries in the world hierarchy are the centers of international finance: Western European countries, United States, and Japan, with China slowly emerging as a contender to the status of financial powerhouse. These countries’ monetary policies direct and dictate the course of global monetary inflation and credit expansion. They have the best developed financial markets and banking systems, and their central banks cooperate to inflate at similar rates and coordinate depreciation rates and monetary injections. But their policies of inflation and reflation are also made possible by other countries which use their currencies (dollar, euro, and yen) as reserve currencies, and match or even pyramid more fiat inflation to maintain a stable exchange rate. This permits financial markets to continue growing, mainly to the benefit of rich countries and to the detriment of already poorer countries.
A further comparison between household incomes in the less developed regions and net wealth levels in rich countries gives further indication of the width of the income-wealth gap among nations. For example, in 2014, mean wealth in the United States was $US 347,845, while the average household income in Mexico was $US 12,850. At an interest rate of 10%, it would take the average Mexican household approximately 270 years to catch up to the average level of wealth in the US. Currently, however, the deposit interest rate in Mexico is about ten times lower (around 1%), and as a result, it would actually take about ten times more. Similarly, it would take an average Romanian household about 360 years of savings to accumulate the average level of wealth in the United Kingdom at a 10% interest rate. But currently, the deposit interest rate is 2% in Romania, which means it would actually take about 1.800 years. Alternatively, households in Africa or Latin America would require between one and two centuries of savings at a 10% interest rate to catch up to the average world level of wealth (approximately $US 30,000). In turn, it would have taken an average world household approximately 54 years in 2000 to catch up to the wealth level in North America, and approximately 61 years in 2014 (data from Credit Suisse Global Wealth Databook 2014 , author calculations).
As long as current monetary policies are kept in place, Cantillon effects will continue to redistribute wealth from peripheral economies to the ultimate centers of world finance, and the ever decreasing interest rates will make it more and more difficult to bridge the income wealth gap. Otherwise put, all possible options for these economies to enjoy a healthy growth—through saving and capital accumulation, import of technology, and foreign direct investments—are throttled by expansionary monetary policies and a host of additional government policies stifling private enterprise. To be sure, it is important to point out that individuals in developing countries can in fact escape poverty even with rising inequalities, so it is important to put these growing inequalities in context. At the same time, it is also important to highlight that the levels of poverty reduction and inequality can also be due to different causes: while technological development, trade, and globalization help reduce poverty, this improvement could have counterfactually been much larger had it not been for monetary policies redistributing wealth to the detriment of the poorest strata of the society.
This being said, there are three main tendencies going on in today’s global economy, whose interaction maintains and prolongs what Mises called “the plight” of peripheral economies.
First and foremost, monetary expansion in developed countries leads to the waste and consumption of the capital stock through malinvestment, capital which could be invested in less developed countries. In the longer run, this also means that capital and technological development become scarcer and more expensive for developing countries, making it more difficult to absorb technology. At the same time, capital inflows from developed countries have a “bubble-thy-neighbor” effect on these countries, and chances are that part of the foreign investments peripheral economies do receive are malinvestments. The changes in the pattern of trade, artificial and unsustainable, also affect developing countries to an even larger extent, as these countries tend to rely overwhelmingly on a limited number of exported commodities.
Second, developing countries waste their own capital stock with similar inflationary policies leading to misallocation of resources and capital consumption. The reduction in the national as well as global capital stock is the most important impediment to the development of these countries. Developing countries also adopt trade policies that promote export-led growth and discourage foreign investments, which further interfere with their comparative advantage. They are also quick to adopt expansionary monetary policies and financialization, and developing country governments are happy to engage in heavier redistributive schemes.
Third and finally, sound capital and wealth accumulation are possible only with sound money. A sound international monetary system, then, is crucial to economic progress in general, and especially to the development of peripheral economies. But there is also another important element that makes these conditions above possible, and that is the mentality of economic freedom and private enterprise. Unfortunately, as Mises explained, in both the developed and developing world, economists and statesmen are “pacemakers of inflation, deficit spending and confiscatory taxation” ( Mises 1990 , 171 ). As a result, Mises continued, “the problem of rendering the underdeveloped nations more prosperous cannot be solved by material aid. Prosperity is not simply a matter of capital investment. It is an ideological issue” ( Mises 1990 , 173 ).
The only lasting solution for a reconstruction of the international trade and monetary system, and especially for the development of poorer countries is a radical change in social mentalities. The abandonment of economic nationalism and government intervention, but especially of policies of monetary expansion, will be possible only if and after a transformative change in social ideology and social morale occurs. What the international trade and monetary system needs in order to grow healthy are free markets, sound money, and entrepreneurs to maintain, accumulate, and employ capital for best satisfaction of consumers around the world.