If we assume that the return on this capital was 4%, this would be equivalent to owning $900 billion in foreign capital. So, if we do the accounting, the US today must owe the rest of the world roughly $12.4 trillion (13.3 minus 0.9). At 4%, this should represent an annual payment of $480 billion. Right?
Wrong – and by a long shot. The US pays nothing in net terms to the rest of the world for its debt. Instead, it earned some $230 billion in 2013. Assuming a 4% yield, this would be equivalent to owning $5.7 trillion in foreign capital. In fact, the difference between what the US “should” be paying if the Piketty calculation was right is about $710 billion in annual income, or $17.7 trillion in capital – the equivalent of its yearly GDP.
The US is not the only exception in this miscalculation, and the gaps are systematic and large, as Federico Sturzenegger and I have shown.
At the opposite extreme are countries such as Chile and China. Chile has borrowed little in net terms for the past 30 years, but pays to the rest of the world as if it had borrowed 100% of its GDP. China has lent to the rest of the world, in net terms, over the last decade, about 30% of its annual GDP but gets pretty much nothing for it. From the point of view of wealth, it is as if those savings did not exist.
What is going on? The simple answer is that things are not made just with capital and labor, as Piketty argues. They are also made with knowhow.
To see the effect of this omission, consider that America’s net borrowing of $13 trillion dramatically understates the extent of gross borrowing, which was more like $25 trillion in gross terms. The US used $13 trillion to cover its deficit and the rest to invest abroad.
This money is mixed with knowhow as foreign direct investment, and the return to both is more like 9%, compared to the 4% or less paid to lenders. In fact, 9% on $12 trillion is more than 4% on $25 trillion, thus explaining the apparent puzzle.
Chile and China put their savings abroad without mixing them with knowhow – they buy stocks and bonds – and as a consequence get just the 4-5% or less that Piketty assumes. By contrast, foreign investors in Chile and China bring in valuable knowhow; hence the gross capital that flows in yields more than the gross savings abroad. This return differential cannot be arbitraged away, because one needs the knowhow to get the higher returns.