The amount of wealth in an economy must be related to the amount of income.
For example, real estate wealth will be linked to the income people have to pay for their housing. Wealth in the form of corporate shares should be linked to corporate profits. From the 1970s to the 1990s, for the world economy as a whole, total wealth was a multiple of about 4.2 times GDP. But over the past two decades, the wealth-to-GDP ratio has increased and is now a multiple of around 6.1 times GDP. The McKinsey World Institutesets out some facts and suggests some possible interpretations in “The Rise and Rise of the Global Balance Sheet: Are We Using Our Wealth Productively?” Â»(November 15, 2021).
The report focuses on ten countries that account for around 60% of global GDP: Australia, Canada, China, France, Germany, Japan, Mexico, Sweden, the United Kingdom and the United States. United. For each country, wealth has three main components: âreal assets and net worth; financial assets and liabilities held by households, general government and non-financial corporations; and financial assets and liabilities held by financial corporations. Here is the wealth / GDP pattern over time for these countries:
Interestingly, the United States is not leading the way here in terms of the growth of national wealth. In the more detailed discussion, while it is true that wealth in the form of real estate and stock market values ââof companies has increased in the United States, it is also true that foreign ownership of American wealth has increased faster than ownership. US foreign wealth, which has kept the US headline ratio relatively unchanged.
The MGI report describes the overall dynamics as follows:
Thus, the report notes: A central conclusion of this analysis is that at the level of the world economy, the historical link between the growth of wealth, or net worth, and the value of economic flows such as GDP no longer holds . Economic growth has been slow over the past two decades in advanced economies, but net worth, which has long followed GDP growth, has skyrocketed. This divergence came about as asset prices rose sharply and are now almost 50% above the long-term average relative to income. The increase was not the result of 21st century trends such as the increasing digitalization of the economy. On the contrary, in an economy increasingly driven by intangibles, a savings glut has struggled to find investments that provide sufficient economic returns and lasting value to investors. These (ex-ante) savings have instead found their place in a traditional asset class, real estate, or in corporate share buybacks, driving up asset prices.
One possible explanation for this growth in wealth would be if these large global economies were going through a major investment boom, in which case the additional wealth could be a natural reflection of much greater productive capacity. But that doesn’t seem like the main story. Instead, most of the wealth gains and most of the world’s wealth exist in the form of real estate. The MGI report puts it this way:
Two-thirds of global net worth is stored in real estate and only around 20% in other fixed assets, raising the question of whether corporations are storing their wealth productively. The value of residential real estate stood at almost half of global net worth in 2020, while buildings and land for businesses and government accounted for an additional 20%. The assets that drive much of economic growth (infrastructure, industrial structures, machinery and equipment, intangible assets) as well as mineral stocks and reserves make up the rest. With the exception of China and Japan, non-real estate assets represented a smaller share of total real assets than in 2000. Despite the rise of digitization, intangible assets represent only 4% of net worth : they generally lose value in favor of competition and commodification, with exceptions. Our analysis does not address non-market value reserves
like human or natural capital.
What possible scenarios could emerge from this change in the wealth / GDP ratio? There is basically one happy interpretation and another not so happy one. The MGI report puts it this way:
In the first case, an economic paradigm shift has occurred which makes our societies richer than in the past in relation to GDP. From this perspective, several global trends, including an aging population, a high propensity to save among those at the higher end of the income spectrum, and the shift to larger investments in intangibles who quickly lose their private value are potential game changers that affect savings. investment balance. Together, these elements could lead to persistently lower interest rates and stable expectations for the future, thus favoring higher valuations than in the past. Although there was no clear and noticeable upward trend in net worth to GDP at the global level prior to 2000, the variation between countries was still large, suggesting that significantly different levels are occurring. possible. High equity valuations, in particular, could be justified by placing more value on intangibles, for example, if companies can capture the value of their intangible investments more sustainably than the depreciation rates economists assume. …
Conversely, this long period of divergence could come to an end and high asset prices could eventually revert to their long-term relationship to GDP, as they have done in the past. Increased investments in the post-pandemic recovery, in the digital economy or in sustainability could change the savings-investment dynamic and put pressure on the unusually low interest rates currently prevailing around the world, for example. This would result in a significant drop in real estate values ââthat have supported the growth in global net worth over the past two decades. At current loan-to-value ratios, lower asset values ââwould mean that a high share of household and corporate debt will exceed the value of the underlying assets, threatening borrowers’ ability to repay and straining their debt. financial systems. We estimate that net worth to GDP could decline by up to a third if the relationship between wealth and income reverts to its average over the three decades to 2000.â¦ Not only is the sustainability of the larger balance sheet in question; So too is its timeliness, given some of the drivers and potential consequences of the expansion. For example, is it healthy for the economy that high house prices rather than investment in productive assets are the engine of growth, and that wealth is built mainly from price increases on existing wealth? ?
I have no clear idea of ââthe likelihood of a negative scenario i.e. a substantial collapse in world assets. The figure above suggests that the effect could be a little more moderate for the US economy than for some others. But a global collapse in wealth would be difficult news for the financial sector, as well as for the future financial plans of individuals and businesses. The MGI report suggests that there might be a way to thread the needle here. If one is worried about the possibility of a collapse in wealth, one way to cushion the blow would be to focus on redirecting wealth and capital away from real estate and towards investment-type options. which will tend to increase future productivity. The report notes: â[R]Orienting capital towards more productive and sustainable uses seems to be the economic imperative of our time, not only to support growth and the environment, but also to protect our wealth and our financial systems.