Long term trend in wealth to income ratios
The wealth to income ratio in the USA and UK has been relatively stable for most of the past century, although upward ‘breakouts’ occurred during the Great Depression and during the recent Credit Crisis. Household debt to income ratios are now at an all time peak in high income nations. Emerging markets have considerable scope to increase personal wealth, since the ratio of net financial assets to income in mature economies is more than twice as high, and the debt-income ratio is five times greater.
Many factors influence the evolution of household wealth, including property rights and other institutional considerations, the maturity of financial markets and financial instruments, and the extent to which public provision of retirement pensions and health care mitigate the need for private accumulation. But the single most important factor in developed economies is household income. As real incomes grow and price inflation erodes purchasing power, the value of household wealth also tends to rise. The interesting question is the relation between income and wealth over time, and the reasons for deviations from the long-run pattern.
A century of wealth data
Figure 1 shows wealth to income ratios for France, the UK and the USA dating back to 1900. The most striking feature is the relatively stable pattern observed for the USA. For most of the period since 1900, household wealth in the USA has fluctuated in a narrow band between about four and five times disposable income. Furthermore, there is no upward trend over the whole period: the wealth-income ratio in 2009 is almost identical to that recorded a hundred years earlier.
Deviations from the typical range in the USA have occurred twice, both involving breaks through the top of the band. The first episode is associated with the disruption caused by the Wall Street crash and the onset of the Great Depression. The wealth-income ratio remained consistently above 5.3 during the period 1928–39, and reached 7.3 in 1932, a level never since repeated.
The second divergence episode occurred from 1997 to 2007, when the wealth-income ratio again broke the 5.3 barrier. In fact, two sub-episodes are evident in the “Greenspan era”: the first from 1997 to 2002 came to an end when the dot.com bubble was punctured; the second from 2002 to 2007 ended with the global financial crisis. The overall impression is thus one of remarkable stability in the USA wealth-income ratio for the most part, with a few departures from the long-run equilibrium followed promptly by a return to the normal range.
In France and the UK, the wealth-income ratio has also averaged between 4 and 5 for much of the time, but departures from this range have been more frequent and longer lasting. The ratio in the UK has followed the general pattern observed in the USA, with high values during the Great Depression and a recent spurt halted by the global financial crisis. But abnormally high values also occurred after the end of the Second World War, and the recent episode of high values has been both more sustained – beginning around 1985 – and more pronounced – peaking at a multiple of 9 in the year 2007. In fact, the wealth-income ratio in the UK has trended upwards since the start of the Thatcher era in 1979, and is now more than double the level seen in the mid-1970s.
The French experience during the past century shows long periods of relatively stable wealth-income ratios punctuated by three periods of significant change. The ratio fell sharply from about 7 during 1900–1914 to less than half that figure ten years later, then climbed back up to 5.4 by 1944, after which it again quickly halved in value. Most of the decline in the wealth-income ratio during 1913–1949 was due to falling house prices, high inflation, and poor stock market performance, with only 10% of the decline attributed to wartime loss of capital.
For a half century after the war, the wealth-income ratio in France rose gradually, from 2.7 in 1950 to 4.8 in 1999. But, since the year 2000, a booming housing market has propelled the ratio above 8, a level similar to the UK and significantly above the USA.
Evidence for G7 countries
From 1960 onwards, data on the wealth-income ratio is available for a larger group of countries than just France, the UK and the USA. Figure 2 shows markedly different experiences for G7 countries during the first and second halves of the period. Until 1985, the ratios changed very little over time and fell within the band from 3.5 to 5.5 for most countries in most years. After 1985, there is considerable variation in the evolution of net worth as a multiple of disposable income, both across countries and over time; but in each country there is an upward trend.
Possible explanations for the upward trend since 1985 include the liberalization of financial markets, the aging of the population, declining interest rates and inflation rates pushing up asset prices, and a shift in emphasis towards greater “personal responsibility” in preparing for retirement, children’s education and other expenses. Each of these factors has no doubt made its contribution, but their relative importance remains an open question.
Canada and Germany display the highest stability among G7 countries, and show especially clearly the underlying rise in the wealth-income ratio experienced elsewhere. The wealth-income ratio in Germany rose steadily from 4.7 in 1991 to 6.1 in 2008. Wealth in Canada rose even more gradually and steadily from four times income in 1985 to 5.5 times income in 2009. Alone among the G7 countries, the wealth-income ratio in Canada did not decline as a result of the global financial crisis, probably due to the conservative nature of both its banking regulations and bankers.
At the other end of the scale, the greatest volatility — at least initially — was experienced in Japan, where the wealth-income ratio exploded from 4.4 in 1977 to peak at 9.4 in 1989, a level never reached by any other country for which data are available. Although house-price and land-price inflation contributed most to this growth, the stock market also fuelled the rise. When the asset price bubble burst, the wealth-income ratio in Japan declined rapidly to 7.5 in 1993, and has remained very close to this level ever since.
As already noted, the UK has also experienced explosive growth in the wealth income ratio since 1985, and greater volatility than Japan. France has also shown abnormal wealth growth, although without the volatility observed in Britain. By those standards, the experience in the USA during the past two decades looks relatively stable, even allowing for the short-term peaks in 1999 and 2006.
Wealth components in history
Similar series for sub-components of wealth as multiples of disposable income provide further insights into the historical trends. The graphs for gross financial assets in Figure 3 again show relatively little change up to 1985, after which a regular pattern of growth is the norm, so that by 2008, the gross financial wealth-income ratio is typically higher by a factor of 1–2. However, the volatility seen in Figure 2 has almost vanished. With the exception of Canada, the financial crisis caused the financial wealth-income ratio to decline in all countries, although the ratio has rebounded in all countries with 2010 data.
France and Germany have marched steadily and in tandem since 1990, while the graph for Canada has been exceptionally smooth and quite flat for the past 15 years. Even Italy and Japan exhibit relatively smooth growth of financial wealth punctuated with occasional fluctuations. Britain and the USA are outliers, moving in tandem since 1985, but showing almost pure cyclical movement since 1995, rather than steady growth.
How indebted are Western households?
A significant rise in household debt relative to income is evident in all G7 countries since 1980 (Figure 4). The UK experienced the greatest absolute rise in the debt-income ratio, which tripled from 0.6 in 1980 to 1.8 in 2008; but the greatest proportionate rise occurred in Italy and France, where the ratio almost quadrupled between 1978 and 2009. The ratio doubled in both Canada and the USA from 1985 to 2009, but has remained unchanged in Japan since the mid-1990s, and even declined slightly in Germany during the past decade.
As expected, the evolution of net financial wealth is very similar to the pattern for gross financial wealth (Figure 5). But it now emerges that the ratios of net financial wealth to income in 1980 were confined to a narrow range between 1.0 and 1.5 for all G7 countries except the USA, for which the ratio was about 2.5 from 1973 to 1988. After the gyrations of the Greenspan era, the US ratio has returned to its long-term norm. In the meantime, the other G7 countries have closed most, if not all, of the gap with the USA. This convergence to US levels of the net financial assets to income ratios is an important trend to which little attention has been given.
Data on real (i.e. non-financial) assets as a multiple of disposable income yields quite a different picture, showing more variation across countries and much more erratic behavior. The trends shown in Figure 6 are closely related to the evolution of real asset prices, particularly the price of real estate.
The evolution of real assets in the USA has been remarkably constant over time, close to double the level of income from 1960 until 1995, when the multiple rose steadily to 3 in 2007 before returning back to 2, the lowest level among G7 countries. The real asset-income ratios in Canada, Germany and Italy have all been on a rising trend since 1995, and show no sign that housing prices have been adversely affected by the financial crisis. In contrast, the graphs for France and Britain show a dip following the financial crisis, although both countries have experienced a sustained house price boom since the late 1990s, almost doubling in value, so that real assets remain a high multiple of disposable income. In fact, the graphs for France and the UK are eerily similar from 1990 onwards.
The experience of Japan provides a salutary lesson in allowing real estate prices to run out of control. The explosive growth from 1984 to 1990 has been followed by declining property prices for three decades, reducing the real assets-income ratio from 6.5 at its peak in 1990 to 3.5 in 2008. This reversal of fortune has been so pronounced that Japan is now on a par with Canada, and ranks below every other G7 country except the USA. Based on the Japanese experience, toleration of housing booms in Britain, France and Italy seems reckless in comparison to the slow and steady progress of Canada and Germany.
Determinants of wealth: The role of savings
While share prices and house prices are often the proximate reason for variations in household wealth relative to income, very little is known about the underlying causes of the different country experiences.
The level of savings is one obvious source of wealth differences, with increased savings translating into greater aggregate wealth and a higher wealth-income ratio. In practice, it is often difficult to identify the connection. Among G7 countries, the household saving rate shows substantial heterogeneity, ranging in 2009 from as little as 2% in Japan to 16% in Italy and 17% in Germany. During the past 15 years, saving rates decreased in the UK, the USA, Italy, Japan and Canada, but remained unchanged in France and even rose slightly in Germany. The link to aggregate wealth is not immediately evident.
Determinants of wealth: The role of institutions
Viewing differences across countries, the low wealth (especially financial wealth) to income ratios in Austria, Germany and Norway may reflect high levels of public pensions and good state provision of health services, which people expect to be maintained in the future. Growing populations and land scarcity are expected to correlate with high values of real assets relative to income, but the link has become less evident in recent years given the low real asset figure for Japan and the very high value for Australia.
The provision of more sophisticated financial instruments is likely to result in higher levels of financial assets, as is the general tendency to replace defined benefit pensions with defined contribution pensions offering lower benefits. The impact of financial innovation on debts is even more evident. The explosion of household debt in the past two decades is undoubtedly linked to greater access to credit for mortgages and consumer expenditure, reinforced by the growing availability and acceptance of student debt, for example in Denmark and Sweden.
Historical lessons for emerging markets
What implications can be drawn for wealth accumulation in emerging markets from the past experience of high income countries? The average wealth-income ratios for 16 high-income countries and nine emerging markets (Chile, China, Colombia, Czech Republic, India, Slovakia, Slovenia, South Africa and Ukraine) show striking differences between high-income countries and emerging markets (Figure 7). Over the period 2000–08, the average ratio for high income countries is 6.35, with Great Britain, Belgium and Switzerland recording ratios above 7.5. In contrast, the average for emerging markets is 3.25, and several countries struggle to achieve wealth levels equal to twice disposable income.
The comparison is even starker for net financial assets. The average asset-income ratio is exactly 1 in emerging markets, barely 40% of the 2.4 figure recorded in high-income countries. There are also major differences in debt levels. On average, households in emerging markets owe just 30% of their annual income, while households in developed countries owe almost 1.5 years of income. Bear in mind, however, that net worth, net financial assets and debt levels in high-income countries have all risen significantly since 1980. The wealth figures recorded for emerging markets now are not so different from the historical values for France, Britain and the USA displayed in Figure 1, or the G7 values prior to 1980.
China is the exception among emerging market economies. Its wealth-income ratio of 6.9 lies within the top third of the range of the high-income table, close to the level of Japan, and well above the figure for the USA. The household savings rate in China has exceeded 20% of GDP since the early 1990s, and has even risen slightly in recent years, due to increases in income uncertainty and changes in pension provision. This may help account for the different pattern in China relative to other emerging markets, alongside frothy house prices and intense international demand for Chinese equities. It may also be the case that asset values in China are already close to rich country levels, but household income has yet to catch up.
Goldsmith (1986) claims that the wealth-income ratio does not necessarily rise during development, because capital is used more efficiently and generates more income; but financial development increases the ratio of financial assets to non-financial assets. Figure 8 shows that the ratio of financial to non-financial assets is typically higher in rich countries, with an average just below 1 for the period 2000–08, compared to 0.6 for emerging markets. Goldsmith anticipated a ratio of 1 for mature economies. In practice, ratios above 2 are now found not only for high-income countries, but also for at least one emerging economy: South Africa.
Noticeable exceptions to the general pattern are South Africa and China among the emerging markets, and France, Norway and Australia in the high-income country list. The high financial to non-financial assets ratio in South Africa reflects a dynamic stock market and mature life insurance and pension industries together with relatively low real estate prices. China’s position is explained by the high savings rate and relatively well-developed financial markets. In contrast, at just 0.53, the financial to non-financial ratio in Australia is below the average even for emerging markets. This reflects a sparsely populated country with a large endowment of land and natural resources, but also high urban real estate prices.
Available evidence suggests that household wealth in mature economies was a fairly constant multiple of income for much of the 20th century until 1980, after which the wealth-income ratio has trended upwards and more volatility has been experienced.
Financial assets in G7 countries also show little change relative to income up to 1985, when a regular pattern of growth began. Canada alone survived the financial crisis without a fall in the ratio of financial wealth to income, although the ratio has rebounded in all G7 countries with 2010 data. The ratio of non-financial assets to income shows greater variation across countries and much more erratic behaviour.
Household debt has risen significantly in all G7 countries since 1980, but the rise has been especially pronounced in the UK, Italy and France. As a multiple of income in 1980, net financial wealth in the USA was about double the level in all other G7 countries, but the gap has eroded over time, and the ratio of net financial wealth to income is now much more similar across the G7 nations.
The ratio of net worth to income tends to be considerably lower in emerging markets, and the same is true of the ratio of financial assets to non-financial assets, but there are exceptions to the general pattern, China in particular. While not guaranteed, it seems likely that household wealth will grow faster than household income in emerging markets, raising the wealth-income ratio over time, although stopping short of the inflated levels seen in rich countries in recent years.
Increasing life expectancy and longer retirement, ageing populations, and increasing uncertainty about labor earnings and future health costs are all factors that point to an increase in the need for private wealth.