The Feldstein–Horioka Puzzle, a Global Glut of Savings, and Omitted Variable Bias: 1970–2023

Feldstein and Horioka in 1980 estimated (I/GDP)i = α + β(S/GDP)i where “i” is for a given country over time, “I” is domestic investment, and “S” is domestic savings. Feldstein and Horioka found βs that were insignificantly different from one and significantly different from zero. According to Feldstein and Horioka, these results conflict with an assumption of perfect capital mobility because, if capital were perfectly mobile, then β should be zero. We estimated (I/GDP)it = α + β(S/GDP)it using data from 22 countries from 1970 to 2023, where i denotes the country and t denotes the year. We found βs to be significantly less than 1 but greater than 0. We then used Reiterative Truncated Projected Least Squares, which was designed to solve the omitted variable problem (and helps a researcher visualize the effects of heteroscedasticity), to estimate a βit for every observation. We find that βit decreases for countries that export capital and increases for countries that import capital. We argue that the Feldstein-Horioka “puzzle” is based on a confusion—when the effect of both exporting and importing capital is considered, β should equal approximately one. Feldstein and Horioka focus on single countries, but when pairs of savings exporters and importers are considered, their “puzzle” disappears. However, the fact that βit is now much less than 1 and falling over time suggests that a global glut of savings is worsening.