Milken Institute Review

When more may be less

How countries and companies adjust to this divergence between wealth and income and address growing financial imbalances will determine prospects for economic prosperity and stability in coming years. Readers are invited to read the full report, which includes statistical analyses broken down to the country level. Here, we’ll very briefly summarize the aggregate analysis and then offer some educated speculation on how relatively recent changes in the global balance sheet could play out. Consider, for starters, some new realities of global economic dynamics.

  • The market value of the global balance sheet tripled in the first two decades of this century. Net worth grew from about $150 trillion in 2000 to over $500 trillion in 2020, with China accounting for one-third of global growth.

  • Wealth accumulation has far outpaced GDP growth during these two decades. Until the turn of the millennium, net worth and GDP moved in sync at the global level, with country-specific deviations followed by corrections (as in Japan in 1990). However, in the countries in our sample, aggregate net worth reached 6.1 times GDP in 2020, nearly half-again higher relative to income than the average of this ratio between 1970 and 1999.
  • The mix of sources of wealth accumulation has changed. Asset-price increases above the general level of inflation, propelled at least in part by low interest rates, account for most of the recent wealth-GDP divergence. Saving and investment, by contrast, accounted for an anemic 28 percent of net worth growth.

  • Variations in wealth across countries, sectors and households are glaringly large. In our sample countries, net worth per capita ranged from $46,000 in Mexico to $351,000 in Australia. Meanwhile, in the two largest economies, China and the United States, the top 10 percent of households owned two-thirds of wealth.
  • Two-thirds of global net worth is stored in real estate. The value of residential real estate amounted to almost half of global net worth in 2020, while corporate and government buildings and land accounted for about 20 percent.
  • Only about one-fifth of net worth is embedded in assets most clearly linked to economic growth, raising questions about whether societies store their wealth productively. Indeed, despite the rise of digitization, intangibles such as software represent just 4 percent of net worth and typically lose value to the depredations of competition and commoditization. (A big asterisk here: our analysis does not include some formidable stores of value and sources of productivity that do not have a market price, notably human capital.)
  • Financial leverage has ballooned. For every $1 in net new investment, the global economy created almost $2 in new debt. Financial assets and liabilities held outside the financial sector grew much faster than GDP, at an average of 3.7 times cumulative net investment between 2000 and 2020. While the cost of debt capital declined sharply relative to GDP thanks to lower interest rates, high loan-to-value ratios do raise questions about both the financial system’s stability in the face of shocks and the societal consequences of how the financial sector allocates capital.

We see three potential scenarios following from these new realities. One is a new paradigm in which the value of assets relative to income remains historically high, in part because of the high propensity to save among aging workers and high-income households. A second is a reversion to the historical mean in asset prices, implying a sharp fall in market values. A third possibility consists of a relatively smooth rebalancing of the balance sheet propelled by faster GDP growth, as investment and productivity growth accelerate (along with inflation).

The impact of any of these scenarios is not, of course, uniform across stakeholders. Households, corporations, financial institutions and policymakers could assess the potential impact of those scenarios on their own balance sheets and hedge the downsides while benefiting from the upsides. Growing out of potential imbalance in a felicitous manner — as in scenario three — would require key sectors to redirect capital into productive and growthenhancing investments such as environmental sustainability, affordable housing and digital infrastructure, along with yet-to-be-identified contemporary stores of value for savers.


Is the Global Balance Sheet Healthy?

The patterns that have emerged from our research on national balance sheets lend themselves to different interpretations. Here, we lay out some of the implications as well as ask a few questions that have arisen as we have sought to understand global trends. Most notably, there’s the issue of the impact of dramatic expansion of the balance sheet as savings pumped up asset market values instead of flowing into assets that have traditionally driven productivity.

Is High Net Worth Better?

Most individuals, institutions and countries regard high net worth as unequivocally good. This makes a certain amount of sense; regardless of the source, the wealth that individuals command affords them purchasing power that supplements or replaces income from their labor.

In the context of the global economy, however, more may not always be better. As noted above, wealth has historically moved in tandem with GDP. And in the past, when the two were out of sync because net worth had risen disproportionately, the divergence proved a sign of asset-price inflation that eventually led to a correction.

High net worth relative to GDP, it’s worth remembering, also generates negative externalities, such as a bidding-up of housing prices that squeezes average families from more desirable residential areas, high construction costs that make public infrastructure investments difficult to fund, and bloated net international investment positions that distort trade balances and generate instability.

The dynamic of wealth accumulation mostly from asset-price gains rather than real investment also makes it more likely that wealth will grow more concentrated. Net worth has been highly concentrated among relatively few households for a long time. If the asset-value-inflation trend continues, those owning assets will see real valuation gains, while those without assets will find wealth accumulation ever further out of reach.

Our research has further shown that returns from the operations of assets have declined, while valuations have increased. The financial incentives that have traditionally driven money into new, productive investments and spurred business managers to focus on productivity improvement are thus reduced. Instead, investors have more reason to chase valuation gains.

It could therefore be argued that a healthy net worth trajectory is one that moves in sync with the growth in output and societal benefits generated by real assets. In that scenario, housing is available at broadly affordable prices; tangible and intangible assets used in production accumulate at a steady, solid pace; and international investment portfolios aren’t distorted in ways that undermine efficiency gains from global trade or generate instability in international financial flows.

Correspondingly, accumulating pension savings at a much faster rate than GDP growth may also prove unsustainable if it drives up asset prices rather than stimulating productive investment. Those savings will, in the end, always be a claim on income generated by workers. So a better answer to the world’s aging challenge appears to be accelerating GDP growth through productivity gains rather than raising pension savings in an environment of slow economic growth.

Finally, governments should pay attention to the dynamic of their own net worth. Many have substantially increased their debt — often with good intent. Building the asset side of their balance sheets by increasing high-return public investment in, among other things, infrastructure, affordable housing, climate change abatement and public health would make this additional debt sustainable.

Has the Relationship Between Net Worth and GDP Irrevocably Changed?

There are multiple ways to interpret the divergence of net worth and GDP growth since 2000. One school of thought holds that the extraordinarily low interest rates of the past three decades, which contributed to everhigher valuations, reflect permanent societal changes. In this view, a higher propensity to save by aging populations and increasing concentration of income among highincome households will sustain the low interest rates underpinning higher valuations for the foreseeable future.

Declining net investment, including declines in digital and other intangible investments where reproduction costs are low and the availability of talent is constrained, further plays into a dynamic in which high savings fuel asset inflation. One could also argue that the most attractive cities are bumping against practical (and political) barriers that will keep real estate scarce and valuable. This reinforces the view that the global economy has undergone a major paradigm shift.

An alternative view suggests that the current period of comparatively high net worth will eventually end, and that the prices of real assets will once again more closely track the trajectory of GDP. In this case, a reversion to historical averages could occur in a gradual and orderly way — provided nominal GDP growth accelerates to close the gap. But it could play out as an asset-price correction with repercussions for the viability of debt backed by those assets.

Optimists see a ray of hope in the shape of the post-pandemic recovery, with its evidence of increased investment in the digital economy, infrastructure and climate sustainability. This investment has both raised returns on savings and put upward pressure on the unusually low interest rates that have prevailed for the past decade. Note, too, that the peculiar nature of the current supply-constrained recovery has at least temporarily spurred inflation, and some central banks seem poised to raise interest rates to keep it contained. That could lead to an acceleration in nominal GDP growth and a cap on further increases in real estate values, both keys to a non-traumatic rebalancing of net worth to GDP ratios.

How Much Finance Is Too Much?

Creation of financial assets and their twin liabilities serves worthwhile purposes, ranging from helping savers and borrowers to smooth consumption over time to supporting productivity growth and cutting the real cost of capital by increasing liquidity. Yet the expansion of the quantity, variety and complexity of financial services inevitably raises questions. Is cheap credit driving, rather than merely reflecting, asset-price increases? Are there diminishing returns to societal welfare in expanding balance sheets? Do flaws in the structure and regulation of the financial services industry undermine forces directing savings into the most productive investments?

Over the past 20 years, the global financial balance sheet has not expanded much relative to real assets and so may simply reflect increases in real asset stocks and valuations. Yet while cheap credit did not generate goods price inflation in response to massive financial dislocation during the 2008 financial crisis, it may have contributed to soaring asset prices. The financial system has created nearly $2 in debt and about $4 in financial liabilities for every new dollar invested, and much of financing has found its way into the prices of existing assets. If asset valuations did correct to historical averages relative to GDP (or for that matter, to trends in corporate earnings), hundreds of billions of dollars’ worth of leveraged assets could end up underwater.

We all have a pretty good idea of what we want: a strong financial system that, on the one hand, facilitates optimal household savings and consumption behavior over time and steers capital into productive and sustainable investment, while on the other limiting upward pressure on the value of existing assets. To get from here to there, some national regulators have already put in place “macroprudential” policies that tighten lending standards when real estate prices escalate (including a countercyclical capital buffer requirement, for example). China, for instance, has moved to curb real estate prices.

Policymakers should aim for a mix of fiscal and monetary policy that can effectively stimulate the economy when capital and labor are underutilized without contributing to asset-price inflation. They could also reconsider the tax advantages the law grants to debt financing. Many financial institutions, for their part, are thinking about their role as “responsible” lenders — and in that context, could assess how they are contributing to funding sustainability initiatives and economic growth instead of real asset transactions at ever-rising prices.

As Economies Become Intangible and Societies Age, What Assets Become Stores of Value?

High savings in some pockets of the economy have mostly found their way into real estate appreciation. If we don’t want to limit the desire to save as a means of smoothing consumption over time — but do want to avoid further asset-price escalation — it will be important to find alternative long-term stores of value. We identify four possible pathways. All but one come with marked drawbacks.

Intangibles. Although intangibles — think software or industrial design, for example — have attracted plenty of investment, they have not served as a long-term store of value at scale. Measured without reference to the broader societal value they generate, intangibles constitute a tiny part of total net worth. But intangibles have unique features that make this sort of comparison misleading. Most can be scaled at near-zero marginal cost and are not “used up” in production — the first build-out of Windows 11 may have cost billions, but delivering the next hundred million copies will cost virtually nothing. By the same token, the market value of that hundred- millionth copy will turn almost entirely on market conditions.

This means the returns to investment in intangibles can be divided in many ways. At one extreme, if competition is strong and IP protection light, all the value will pass through to users, increasing real income and standards of living for many but not serving as a source of wealth for those making the investment. At the other extreme, a combination of government protection (patents, copyrights, trademarks, etc.) and lack of competitive substitutes can sometimes allow those investing in intangibles to skim off virtually all the economic surplus — in effect, all the area under the demand curve.

In such a setting, intangibles investments could become long-term stores of value for savers, but at the expense of competition and consumer welfare. And that raises a big issue: what public policy is needed to extract value and return from intangibles investment for the long-run, and yet preserve customer surplus and incentives for innovation by potential competitors?

Financial assets. Individual savers can store value in all sorts of financial assets without increasing collective net worth if debtors take up the corresponding liabilities. This mechanism of saving has been in widespread use in recent decades. Governments, for example, have become borrowers of last resort, increasing public debt obligations as a way for savers to store money that is essentially a claim on taxes to be paid by themselves or by future generations.

Increasing household mortgage debt to finance transactions in existing real estate stock has similar features, providing a store of value for savers via a claim on future income of the next generation of mortgage holders. Pay-as you- go pension systems can also be seen in this light. Could expansion of debt and finance thus continue to serve as a store of value for savers, even while debt levels and finance already appear high by many metrics?

New digital assets. Some might regard private digital currencies as a form of real asset that is “mined” with computer algorithms rather than earth-movers. However, doing so requires devoting economic resources — not to mention energy and carbon emissions — to create something that has no productive value. Could non-fungible tokens, or NFTs — which hold the value of reproduced digital files like photos, videos and artwork — be a better approach, allowing easier and more storage of value in digitally produced assets?

This article originally appeared in Milken Institute Review