Wednesday, August 11, 2010

Reframing Rebalancing

I have a couple of overdue reports to get out, so I have to be brief. Raghuram Rajan has played an important role in keeping attention focused on global imbalances, but his solutions are hardly solutions at all.

1. Differential savings rates, too low in the US and other deficit countries, too high in China and the other surplus countries, are primarily the consequence and not the cause of imbalances. I presented the evidence for this three years ago and see no reason to change my assessment. In any case, the surplus-deficit conundrum has been with us for more than a century, and historians have no trouble in identifying the problem. Deficit countries are uncompetitive; surplus countries have organized their economy to take maximum advantage of export opportunities.

2. China’s main problem in rebalancing is not simply the structural difficulty of converting an export-oriented capital stock to one that serves the domestic market. This will be hard, but my rough reading of history is that it is a mistake to assume that capital is all clay and no putty. (Vice versa too.) The real challenge is that successful surplus countries have managed to outcompete those who are less successful, and it is all but impossible to simply discard these victories. Can China adopt policies whose result is the conquest of markets by other developing countries that China used to dominate? This is an economic problem, because the shift of export production out of any one country in a competitive environment can be uncontrollable. It is a political problem, because Chinese firms will use all available influence to prevent it. (See this sensible overview by Jeffrey Frieden.)

3. The US problem is not that consumers spend too much, but that (1) given a trade deficit that is a substantial share of GDP, consumption can be maintained only by borrowing, and (2) US producers are uncompetitive in tradables. This will not be fixed overnight, and we won’t even begin repairs until we see what’s broken. Of course, the root cause of the US external deficit is not poor eyesight, but political economy: wealthy individuals and institutions changed the rules over several decades so they could maximize their global returns. They still run the show.

4. The conventional short run/long run dichotomy is associated with fiscal policy: we need deficits today to shore up demand and fiscal rectitude in the long run to achieve sustainability. In a sense, this is right, but it is drastically incomplete because it fails to take account of the relationship between public budgets, private budgets and the trade (or current) account. The real short run problem is that, given the lack of US competitiveness, a devastating austerity can be avoided only through high levels of borrowing, either by households, firms or the government. Since private borrowing is at a standstill, that leaves the US Treasury as the last line of defense. But this solution is not sustainable. The long run goal has to be approximate trade balance, especially since there is no reason why private investment prospects, and therefore global demand for US financial assets, should be counted on to be superior to foreign prospects over the long haul. Only by balancing trade can the US households, firms and government all achieve viable budget positions.

5. Can the US rebalance trade on its own? I doubt it. Will a coordinated dollar devaluation do the trick? Maybe, if you can get coordination (no easy feat), but it is also possible that US capacity in tradables has deteriorated too far for price adjustment alone to succeed. My view: we need a trading system that institutionalizes the collective interest in avoiding destabilizing imbalances. That will take a global political movement that I can’t even begin to visualize.

9 comments:

JW Mason said...

Serious question. Why is US current account balance desirable?

If you compare the experience of Asian countries today and in the late-90s crisis, it's been infinitely better this time around. Stimulus instead of austerity, stable employment, incomes and investment instead of catastrophic falls.

Why the difference? Because then Korea, Malaysia, Indonesia, etc. were running big current account deficits and had to drastically reduce domestic demand when capital inflows abruptly halted. This time, those countries came into the crisis with c.a. surpluses, so they faced no balance of payments constraint on their ability to maintain domestic demand in the crisis. The amount of human suffering averted, I'm sure you'll agree, was enormous.

Meanwhile, the US, despite its c.a. deficit, also faced no balance of payments constraint, because -- contrary to everything predicted by the "global imbalances" crowd -- the crisis saw a flight *to* the dollar, not away from it. This is a very different dynamic from Europe, where the redirection of financial flows toward the country that already had a c.a. surplus created severe balance of payments problems for the European periphery.

It's hard not to conclude that the past few years would have been far worse, if the US and its Asian trade partners had entered the crisis from a position of current account balance.

At least, we should think critically about what is the optimal level of (im)balances, and not follow the mainstream in assuming a priori that large imbalances are always a bad thing.

Peter Dorman said...

JW,

First off, it's my view (many EconoSpeak posts on this) that global imbalances were central to the cause of the crisis. Second, the usual deficit country constraints have not (yet) impinged on the US because of the reserve currency status of the dollar and the absence of any compelling alternative. This buys us time, which is good, but we have to use it.

BTW, it's the mainstream position that imbalances are justified as an expression of differences in investment opportunities and preferences. Those worried about imbalances were Cassandras, and I'm in a minority within the minority for thinking that the root cause is not savings behavior but trade competitiveness.

JW Mason said...

it's my view (many EconoSpeak posts on this) that global imbalances were central to the cause of the crisis.

OK, but there are lots of ways of being central. The specific scenario many were predicting -- a flight from the dollar -- did not occur. Exactly the opposite in fact. This has to have some informational content, no?

the usual deficit country constraints have not (yet) impinged on the US because of the reserve currency status of the dollar and the absence of any compelling alternative. This buys us time

Of course. But it makes a difference how much time. The dollar's reserve status has not been seriously challenged by thirty years of large US current account deficits. Where is the evidence that the dollar will not remain the world reserve currency for another twenty, thirty, forty years?

And note, as long as the dollar is the reserve currency, the US c.a. deficit is no more unsustainable than pre WWI gold exports were. In fact, the rest of the world needs a US c.a. deficit if reserves are to grow in proportion to world trade and financial flows.

And you didn't respond to my key point: That the current crisis would have been much worse if it had begun from a position of c.a. balance in the US-Asia trading system, since Asian countries would be much more balance-of-payments constrained if they did not have c.a. surpluses, while the US would be no less BoP-constrained if it did not have a deficit. Do you disagree?

it's the mainstream position that imbalances are justified as an expression of differences in investment opportunities

Fair point. I shouldn't have written that last clause.

Peter Dorman said...

JW,

If your point is that it is much better for all sides if the main deficit country is the one with the reserve currency, rather than the other way around, well of course. The idea of US-as-Greece (or Argentina etc.) is apocalyptic. What we have is bad enough.

A comment is not the place to repeat arguments made at length elsewhere. Suffice it to say: the willingness of foreigners (esp CBs and sovereign funds) to purchase dollar assets is not the same as the ability of specific US entities to sustain borrowing. (This is the distinction I made between currency and credit recycling.) The dollar did not plunge in 2008, quite the contrary, but the ability of US households and financial institutions to continue to expand their leverage collapsed. All the borrowing pressure is now on the Treasury. But if this continues, the arithmetic says we do not hold out for another generation.

JW Mason said...

If your point is that it is much better for all sides if the main deficit country is the one with the reserve currency, rather than the other way around, well of course.

OK, now we are making progress. And by the same logic, it is also better for the reserve-currency country to run a current account deficit, than to be in balance. Right?

The idea of US-as-Greece (or Argentina etc.) is apocalyptic. What we have is bad enough.

Seriously, why is it bad? In a world that has (a) significant cross-border financial flows and (b) no automatic mechanism to produce public flows to countries facing BOP constraints (not my ideal world, or yours either, I'm sure), it seems to me the pattern of c.a. balances between the US and Asia is the optimal one. Remember what Keynes was arguing for in the 1940s and at Bretton Woods. He was *not* arguing for a world without current account imbalances. Rather, he was arguing for a world where the current account surplus countries had to reliably lend enough money to cover the imbalance to the deficit countries, at concessionary rates, so that the deficit countries were not constrained in their ability to pursue full employment. And to a first approximation, that's exactly what we now have in the US-Asia system.

A comment is not the place to repeat arguments made at length elsewhere.

No doubt. I'm currently working on a piece on this (I'm finishing up a PhD in the UMass-Amherst econ program) which I'd love to get your thoughts on when it's done. And if you want to point me to a good couple of pieces of your that lay out your thinking on this in more detail, I'll read them right away.

Peter Dorman said...

JW,

This is time to shift to paper-swapping. You will find a link to mine at:

http://econospeak.blogspot.com/2009/11/from-global-imbalances-to-financial.html

Feel free to send yours, although, if it's long, it might end up in a queue.

highlowbrow said...

Seems like a simplification to say the US problem is that tradeable is big and the US in uncompetitive. It is that this uncompetitiveness has caused various institutions to fail. To fix things, one can either make tradeables more competitive or fix the institutions.

Once upon a time the debate was NAFTA and there was a sincere belief that open trade flows would lead to prosperity via comparative advantage. But it lead to job loss and wage pressure in large groups. And it lead to huge capital inflows. The benefit of capital inflows was largely captured by a small group operating in the financial sector.

But American institutions such as schools, health care, GSEs depend on a robust middle class. What happens to say the health system when jobs move from high wage employers to basic service jobs? Workers and their families lose catastrophic coverage. What happens when a neighborhood loses a solid incomes? Tax revenues decline, families stop directly supporting schools, and so on.

The point is that American institutions seem designed to work when incomes are solid across society. These institutions are really fraying now.

I understand your point about competiveness. Your focus on tradeables seems to preclude internal, structural solutions for the US. Is that your intention?

highlowbrow said...

Also looks like the host website for your paper above is down.

http://econospeak.blogspot.com/2009/11/from-global-imbalances-to-financial.html

Peter Dorman said...

Sorry -- you're right. The paper is no longer available at the website I gave. I'll have to find another host. Maybe in a day or two.

My apologies.