Although these factors point to a positive relation between relative output per capita and the
net foreign asset position, an effect operating in the opposite direction may be at work in developing
countries operating under credit constraints. In models in which an improvement in net worth or cash
flow relaxes financial constraints, an increase in production may allow greater recourse to foreign
credit, possibly implying a negative relation between net external assets and relative output at least
over some interval.
The second variable we consider is the stock of public debt. In a world that exhibits
departures from Ricardian equivalence, higher levels of public debt may be associated with a decline
in the external position. For instance, in the Blanchard-Yaari finite-horizon model, an increase in
public debt is not fully offset by an increase in private asset accumulation since public debt is
perceived as net wealth by current generations, who will bear only part of the tax burden implied by
its higher stock (Blanchard, 1985, Faruqee and Laxton, 2000).
Third, demographic factors are also potentially important determinants of the net foreign
assets. For instance, countries with an ageing population can prepare for an increase in the ratio of
retirees to workers by accumulating overseas assets to supplement domestic income streams.
Domestic investment in these countries will also be curtailed as the marginal product of capital is
diminished by a reduction in the growth of (or a decline in) the working-age population and the labor
force.
At the other end of the population distribution, a society with a high youth dependency ratio
may require heavy investment in social infrastructure (education, housing). A high youth dependency
ratio may also reduce the savings rate, as households with children attempt to smooth consumption.
Accordingly, we may expect to see a decline in net foreign assets in countries experiencing a rise in
the youth dependency ratio (see also Taylor, 1994, Obstfeld and Rogoff, 1996, Higgins, 1998).
However, the impact of demographic factors on the net foreign asset position is not just a
function of the youth and old-age dependency ratios but also of the age structure of the working-age
population (Mundell, 1991). For instance, a relatively young workforce may be associated with