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.