In a highly visible book, Capital in the 21st Century, Thomas Piketty argues that financial liberalisation contributed to rising wealth and income inequality. However, it also made it possible for ordinary people to invest and build up a substantial amount of assets, notably in pension funds that manage more than USD 45 trillion.
Some argue that the increase in savings caused a savings glut and suggest that this may partially explain low bond yields as well as why asset prices in the West are inflated as ever-increasing savings chase existing savings opportunities.
These two challenges – reducing poverty and finding profitable investments for our savings – have a common solution: harnessing the financial system to channel savings from the wealthy to invest in the poor. The growth potential of lesser developed economies offers potential high returns, estimated between five percent to more than 10 percent annually, compared with historical pension fund returns of less than four percent and future bond yields that currently offer returns close to zero.
A large fraction of world savings is directed to Wall Street. Only three percent of the total global investment between 1990 and 2018 was directed to Africa, where more than 14 percent of the world’s population resides. Annual capital formation in all lesser developed economies combined is about USD 250 billion; the combined investment in education is similar. These numbers should be compared to the USD 45 trillion in pension funds.
In the 19th century – the previous era of financial globalisation – the London capital market channeled development finance to the rest of the globe to build railways and infrastructure on five continents. Then, as now, the return on British bonds was two percent and a portfolio of emerging market bonds offered a return that was three times higher. Admittedly, not every investment was successful, but a diversified portfolio of these investments was. The railways of the past could be equated to renewable energy and the information and communication technology (ICT) infrastructure today.
The Fintech industry allows more people to be connected and benefit from the financial system. Financial inclusion can go a long way in creating investment opportunities in lesser developed economies. One specific proposal is to invest in children. If a savings account were opened for every child in Africa, they could invest and share in the fruits of economic growth. These savings, which could be made available at the age of 18 and which I estimate to be from USD 3,500-8,000, would then allow these youths to open a business or attend college.
Implementing this solution involves overcoming many challenges: markets and new assets have to be created, regulation needs to be adjusted and legal and contractual issues have to be resolved. However, this an opportunity that the world cannot afford to miss.
Keywords: international economics, Centre for Finance and Development