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DECEMBER 2010 ‡ Richard Dobbs, Susan Lund, and Andreas Schreiner

Short-term doldrums aside, the world¶s

corporations would seem to be in a strong
position to grow as the global economy
recovers. They enjoy healthy cash balances,
with $3.8 trillion in cash holdings at the end
of 2009, and they have access to cheap
capital, with real long-term interest rates
languishing near 1.5 percent. Indeed, as
developing economies continue to pick up
the pace of urbanization, the prognosis for
companies that can tap into that growth over
the next decade looks promising.
Yet all those new roads, ports, water and
power systems, and other kinds of public
infrastructure²and the many companies
building new plants and buying
machinery²may put unexpected strains on
the global financial system. The McKinsey
Global Institute¶s (MGI) recent analysis
finds that by 2030, the world¶s supply of
capital²that is, its willingness to save²will
fall short of its demand for capital, or the
desired level of investment needed to
finance all those projects.1 Indeed,
household saving rates have generally
declined in mature economies for nearly
three decades, and an aging population
seems unlikely to reverse that trend. China¶s
efforts to rebalance its economy toward
increased consumption will reduce global
saving as well.
The gap between the world¶s supply of, and
demand for, capital to invest could put
upward pressure on real interest rates, crowd
out some investment, and potentially act as a
drag on growth. Moreover, as patterns of
global saving and investment shift, capital
flows between countries will likely change
course, requiring new channels of financial
intermediation and policy intervention.
These findings have important implications
for business executives, investors,
government policy makers, and financial
institutions alike.

  

Several economic periods in history have
required massive investment in physical
assets such as infrastructure, factories, and
housing.2 These eras include the industrial
revolution and the post±World War II
reconstruction of Europe and Japan. We are
now at the beginning of another investment
boom, this time fueled by rapid growth in
emerging markets.
Across Africa, Asia, and Latin America,
the demand for new homes, transport
systems, water systems, factories,
 offices, hospitals, schools, and shopping
centers has already caused investment to
jump. The global investment rate
increased from a recent low of 20.8
percent of GDP in 2002 to 23.7 percent
in 2008 but then dipped again during the
global recession of 2009. The increase
from 2002 through 2008 resulted
primarily from the very high investment
rates in China and India but reflected
higher rates in other emerging markets as
well. Considering the very low levels of
physical-capital stock these economies
have accumulated, our analysis suggests
that high investment rates could continue
for decades.
In several scenarios of economic growth, we
project that global investment demand could
exceed 25 percent of GDP by 2030. To
support growth in line with the forecasters¶
consensus, global investment will amount to
$24 trillion in 2030, compared with about
$11 trillion in 20083 (Exhibit 1). When we
examine alternative growth scenarios, we
find that investment will still increase from
current levels, though less so in the event of
slower global GDP growth.

The mix of global investment will shift as

emerging-market economies grow. When
mature economies invest, they are largely
upgrading their capital stock: factories
replace old machinery with more efficient
equipment, and people make home
improvements. But the coming investment
boom will involve relatively more
investment in infrastructure and residential
real estate. Consider the fact that emerging
economies already invest in infrastructure at
a rate more than two times higher than that
of mature economies (5.7 percent of GDP
versus 2.8 percent, respectively, in 2008).
The gap exists in all categories of
infrastructure but is particularly large in
transportation (for instance, roads, airports,
and railways), followed by power and water
systems. We project global investment
demand of about $4 trillion in infrastructure
and $5 trillion in residential real estate in
2030, if the global economy grows in line
with the consensus of forecasters.
ï



The capital needed to finance this
investment comes from the world¶s savings.
Over the three decades or so ending in 2002,
the global saving rate (saving as a share of
GDP) fell, driven mainly by a sharp decline
in household saving in mature countries.
The global rate has increased since then,
from 20.5 percent of GDP in 2002 to 24
percent in 2008, as household saving
rebounded in mature economies and many
of the developing countries with the highest
rates²particularly China²have come to
account for a growing share of world GDP.
Our analysis suggests, however, that the
global saving rate is not likely to rise in the
decades ahead, as a result of several
structural shifts in the world economy.
First, China¶s saving rate will probably
decline as it rebalances its economy so that
domestic consumption plays a greater role.
In 2008, China surpassed the United States
as the world¶s largest saver, with the
national saving rate reaching over 50 percent
of GDP. But if China follows the historical
experience of other countries, its saving rate
will decline over time as the country grows
richer, as happened in Japan, South Korea,
Taiwan, and other economies (Exhibit 2). It
is unclear when this process will begin, but
already the country¶s leaders have started to
adopt policies that will increase
consumption and reduce saving.4 If China
succeeds at increasing consumption, it
would reduce the 2030 global saving rate by
around two percentage points compared
with 2007 levels²or about $2 trillion less
than China would have accumulated by
2030 at current rates.
Moreover, expenditures related to aging
populations will increasingly reduce global
saving. By 2030, the proportion of the
population over the age of 60 will reach
record levels around the world. The cost of
providing health care, pensions, and other
services will rise along with the ranks of the
elderly. Recent research suggests that
spending for the retired could increase by
about 3.5 percentage points of global GDP
by 2030.5 All of this additional consumption
will lower global saving, either through
larger government deficits or lower
household and corporate saving.
Skeptics may point out that households in
the United States and the United Kingdom
have been saving at higher rates since the
2008 financial crisis, especially through
paying down debt. In the United States,
household saving rose to 6.6 percent of GDP
in the second quarter of 2010, from 2.8
percent in the third quarter of 2005. In the
United Kingdom, saving rose from 1.4
percent of GDP in 2007 to 4.5 percent in the
first half of 2010. But even if these rates
persist for two decades, they would increase
the global saving rate by just one percentage
point in 2030²not enough to offset the
impact of increased consumption in China
and of aging.
Together, these trends mean that if the
consensus forecasts of GDP growth are
borne out, the global supply of savings will
be around 23 percent of GDP by 2030,
falling short of global investment demand by
$2.4 trillion. This gap could slow global
GDP growth by around one percentage point
a year. What¶s more, sensitivity analysis of
several scenarios suggests that a similar gap
occurs even if China¶s and India¶s GDP
growth slows, the world economy recovers
more slowly than expected from the global
financial crisis, or other plausible
possibilities transpire, such as exchange-rate
appreciation in emerging markets or
significant global investment to combat and
adapt to climate change (Exhibit 3).
v 


Our analysis has important implications for
both business leaders and policy makers.
Businesses and investors will have to adapt
to a new era in which capital costs are
higher and emerging markets account for
most of the world¶s saving and investment.
Governments will play a vital role in setting
the rules and creating the conditions that
could facilitate this transition.
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Nominal and real interest rates are currently
at 30-year lows, but both are likely to rise in
coming years. If real long-term interest rates
returned to their 40-year average, they
would rise by about 150 basis points from
the level seen in the autumn of 2010. The
growing imbalance between the supply of
savings and the demand for investment
capital will be significant by 2020.
However, real long-term rates²such as the
real yield on a ten-year bond²could start
rising even within the next five years as
investors anticipate this structural shift.
Furthermore, the move upward isn¶t likely
to be a one-time adjustment, since the
projected gap between the demand for and
the supply of capital widens continuously
from 2020 through 2030.
Capital costs could easily go even higher.
Real interest rates can also include a risk
premium to compensate investors for the
possibility that inflation might increase more
than expected. History shows that real
interest rates rise when investors worry
about the possibility of unexpected spikes in
inflation. Today, investors are beginning to
anticipate higher inflation resulting from
expansive monetary policies that major
governments have pursued.
Finally, as the recent crisis demonstrated,
short-term capital isn¶t always available in a
capital-constrained world. Companies
should seek more stable (though also more
expensive) sources of funding, reversing the
trend toward the increasing use of short-term
debt over the past two decades. The portion
of all debt issued for maturities of less than
one year rose from 23 percent in the first
half of the 1990s to 47 percent in the second
half of the 2000s. Financing long-term
corporate investments through short-term
funding will be riskier in the new world,
compared with financing through equity and
longer-term funding. To better align
incentives, boards should revisit some of
their inadvertent debt-oriented biases, such
as using earnings per share (EPS) as a
performance metric.
O

 
If capital costs increase, companies with
higher capital productivity²greater output
per dollar invested²will enjoy more
strategic flexibility because they require less
capital to finance their growth. Companies
with direct and privileged sources of
financing will also have a clear competitive
advantage. Traditionally, this approach
meant nurturing relationships with major
financial institutions in financial hubs such
as London, New York, and Tokyo. In the
future, it might also mean building ties with
additional sources of capital, such as
sovereign-wealth funds, pension funds, and
other financial institutions from countries
with high saving rates.
Moreover, for companies whose business
models rely on cheap capital, an increase in
real long-term interest rates would
significantly reduce their profitability, if not
undermine their operations. The financing
and leasing arms of consumer-durables
companies, for example, would find it
increasingly difficult to achieve the high
returns of the recent past as the cost of
funding increases. Companies whose sales
depend on easily available consumer credit
would find growth harder to achieve.



 

Investors will want to rethink some of their
strategies as real long-term interest rates
rise. In the short term, any increase in
interest rates will mean losses for current
bondholders. But over the longer term,
higher real rates will enable investors to earn
better returns from fixed-income
investments than they have in the years of
cheap capital. This change could shift some
investment portfolios back to traditional
fixed-income instruments and deposits and
away from equities and alternative
investments.
For pension funds, insurers, endowments,
and other institutional investors with
multidecade liabilities, the world¶s growing
infrastructure investment could be an
attractive opportunity. Many of these
institutions, however, will need to improve
their governance and incentive structures,
reducing pressure to meet quarterly or
annual performance benchmarks based on
mark-to-market accounting and allowing
managers to focus on longer-term returns.
This change would be required as
institutions come to manage portfolios with
a growing proportion of less liquid, long-
term investments, since volatility in market
prices may reflect market liquidity
conditions rather than an investment¶s
intrinsic, long-term value.6
Emerging markets, though they may present
attractive opportunities, also pose many
risks and complexities, and returns could
vary significantly across countries. As
incomes in emerging markets rise and
capital markets develop, nonfinancial
businesses can expect healthy growth from
investing in both physical and financial
assets. Returns to financial investors are less
certain, however, particularly in countries
with low returns on capital or savings
trapped in domestic markets by capital
controls or a ³home bias´ among domestic
savers and investors.7 These countries will
remain susceptible to bubbles in equity, real-
estate, and other asset markets, with
valuations exceeding intrinsic levels.
Foreign investors will need to assess
valuations carefully before committing their
capital. They will also have to take a long-
term perspective, since volatility in these
bubble-prone markets may remain higher
than it is in the developed world.
ï   

Governments will need to encourage the
flow of capital from the world¶s savers to
places where it can be invested in productive
ways while minimizing the risks inherent in
closely intertwined global capital markets.
Governments in countries with mature
markets should encourage more saving and
domestic investment, rebalancing their
economies so they depend less on
consumption to fuel growth. Policy makers
in these countries, particularly the United
Kingdom and the United States, should start
by putting in place mechanisms to sustain
recent increases in household saving. They
could, for instance, implement policies that
encourage workers to increase their
contributions to saving plans, enroll in
pension plans, and work longer than the
current retirement age. Further, governments
can themselves contribute to gross national
savings by cutting expenditures.
To replace consumption as an engine of
economic growth, governments in these
countries also should adopt measures aimed
at boosting domestic investment. They
could, for example, provide accelerated tax
depreciation for corporations, as well as
greater clarity on carbon pricing²the
current uncertainty is holding back clean-
tech investment. They should also address
their own infrastructure-investment backlog,
although this could require them to revise
government accounting methods that treat
investment and consumption in the same
way.
In emerging economies, governments should
promote the continued development of deep
and stable financial markets that can
effectively gather national savings and
channel funds to the most productive
investments. Today, the financial systems in
emerging markets generally have a limited
capacity to allocate savings to users of
capital. We see this in these countries¶ low
level of financial depth²or the value of
domestic equities, bonds, and bank deposits
as a percentage of GDP.8 Policy makers
should also create incentives to extend
banking and other financial services to the
entire population.
At the same time, policy makers around the
world should create the conditions to
promote long-term funding and avoid
financial-protectionist measures that
obstruct the flow of capital. This will require
removing constraints on cross-border
investing, whether through restrictions on
pension funds and other investors or on
capital accounts. Policy makers must also
create the governance and incentives that
enable managers of investment funds with
long-term liabilities, such as pension funds,
insurance companies, and sovereign-wealth
funds, to focus on long-term returns and not
on quarterly results that reflect market
movements and can deviate from long-term
valuations.
At this writing, global investment already
appears to be rebounding from the 2009
recession. The outlook for global saving is
less certain. A climate of costlier credit will
test the entire global economy and could
dampen future growth. The challenge for
leaders will be to address the current
economic malaise and simultaneously create
the conditions for robust long-term growth
for years to come.
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