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Katrin Rabitsch

Video Katrin Rabitsch

Katrin Rabitsch

Researcher of the Month

For­eign trade im­bal­ance: How the USA has racked up the world’s largest for­eign debt

Start­ing from the late 1980s, the USA has moved from be­ing a net cred­itor to hav­ing the world’s highest for­eign debt. In the period from 2006 to 2014, the USA’s for­eign li­ab­il­it­ies came in at an aver­age of 23% of the gross do­mestic pro­duct. A study con­duc­ted by Kat­rin Rabitsch from WU’s In­sti­tute for In­ter­na­tional Eco­nom­ics and Devel­op­ment poses the ques­tion of whether this makes the US in­her­ently dan­ger­ous. Her res­ults show that part of the USA’s for­eign debt can be ex­plained by struc­tural dif­fer­ences: Be­cause of its well-developed fin­an­cial mar­ket and its high level of open­ness to in­ter­na­tional fin­an­cial mar­kets, the US has less mo­tiv­a­tion to hold as­sets, as com­pared to other coun­tries.

Today, the states of na­tional econom­ies are strongly in­ter­con­nec­ted both through for­eign trade in goods and through in­ter­na­tional as­set trad­ing. The past few dec­ades have seen an un­pre­ced­en­ted surge in in­ter­na­tional cap­ital mar­ket in­teg­ra­tion, dur­ing which the USA has in­curred the world’s highest for­eign debt. The US’ net for­eign as­set pos­i­tion is cal­cu­lated based on the bal­ance between fin­an­cial as­sets held by US in­vestors abroad and fin­an­cial as­sets held in the US by non-US in­vestors. Cur­rently, this bal­ance is neg­at­ive. This means that the USA has more for­eign li­ab­il­it­ies than re­ceiv­ables, mak­ing the coun­try a net debtor. The coun­try’s ma­jor cred­it­ors in­clude Ch­ina and Ja­pan as well as other Asian emer­ging na­tions. Con­trary to the­ory “The com­mod­it­ies trade has grown con­sid­er­ably over the last 30 years, but fin­an­cial trad­ing has grown by about eight times as much,” ex­plains WU re­searcher Kat­rin Rabitsch. She and her col­leagues at WU’s In­sti­tute for In­ter­na­tional Eco­nom­ics and Devel­op­ment have ob­served that ex­ternal im­bal­ances have in­creased over the past few dec­ades, mean­ing that a num­ber of coun­tries have long-stand­ing for­eign debts. “At first glance, the fact that the US has in­curred the world’s largest for­eign debt ap­pears sur­pris­ing, based on stand­ard eco­nomic the­or­ies. Ac­cord­ing to the­ory, poorer coun­tries are usu­ally in debt to more pros­per­ous na­tions, to fin­ance their eco­nomic pro­gress and help them catch up, rather than the other way around,” she con­tin­ues.

Struc­tural ex­plan­a­tion

This devel­op­ment is not auto­mat­ic­ally grounds for con­cern, ac­cord­ing to Rabitsch. “Our mod­els show that part of the USA’s ex­ternal im­bal­ance can be ex­plained on a struc­tural level and does not ne­ces­sar­ily im­ply the threat of in­stabil­ity. A bet­ter developed fin­an­cial mar­ket and sim­pler ac­cess to in­ter­na­tional fin­an­cial mar­kets give the US bet­ter risk cov­er­age. Coun­tries without this op­tion can only coun­ter the risk of a bad year by hold­ing as­sets in re­serve, to have them on hand for bad times.” Coun­tries with un­der­developed fin­an­cial mar­kets or coun­tries that opened them­selves to the in­ter­na­tional cap­ital mar­ket re­l­at­ively late have a higher mo­tiv­a­tion to hold as­sets in re­serve as com­pared to the US. Ac­cord­ing to the study, these coun­tries are more likely to be net savers, i.e. more likely to be cred­it­ors to the US, while the US is more likely to be in debt to the rest of the world. The ar­gu­ment that developed coun­tries are bet­ter able to cover their risks may be one of the reas­ons why the data in­dic­ates that developed coun­tries, espe­cially the US, are more likely to in­vest their for­eign as­sets in high-risk as­sets than devel­op­ing or emer­ging na­tions.  

The big pic­ture

In­ter­na­tional fin­an­cial trad­ing has in­creased so rap­idly in today’s economy that there are con­stantly new devel­op­ments to un­der­stand, and eco­nomic the­ory often lags be­hind. The USA’s high level of for­eign debt re­mains un­der crit­ical ob­ser­va­tion, par­tic­u­larly be­cause it has grown even more in the last few years, reach­ing a level of -41.6% of the US gross do­mestic pro­duct in 2016 (Bur­eau of Eco­nomic Ana­lysis, pre­lim­in­ary es­tim­ate, 3rd quarter of 2016). Ac­cord­ing to Rabitsch, this means that re­search­ers need to con­tinue to work to un­der­stand these con­stant changes, so that they can assess the in­her­ent risk of in­stabil­ity to the in­ter­na­tional fin­an­cial sys­tem. She says, “It is im­port­ant to start get­ting a grasp of these devel­op­ments as a sys­tem. The most re­cent eco­nomic crisis showed clearly that it’s not enough that in­di­vidual in­sti­tu­tions are found to be in good work­ing order, but rather that everything is part of a sys­tem. The same th­ing ap­plies to the in­ter­na­tional fin­ance sys­tem.”