Given all this discussion of the regulation of risks, I should conclude with the reminder that it is not meant to supersede the emphasis on integration earlier in this chapter and in the rest of this book. Some degree of cross-border integration usually makes sense for the purposes of reducing risk through diversification as well as ADDING value in other ways. But trouble can develop, and prudence provides a better basis for dealing with that possibility than panic. Hence the idea of keeping alarms activated, breakers on standby, and cushions ready just in case in order to manage the risks associated with cross-border capital flows in particular. And the example of food is a reminder that risk management doesn't always mean restricting flows—sometimes it means opening them up. The key is to evaluate particular flows on their merit and shape globalization to maximize the gains while managing the risks—rather than to seek an illusory safety behind closed borders or effectively ignore the risks altogether.
Chapter Eight
Global Imbalances
Source: John Coe
THE LAST THREE CHAPTERS focused on economists' standard trilogy of market failures: small numbers, externalities, and informational problems. This chapter deals with a different kind of phenomenon—one subject to a spirited debate about whether leave-it-to-the-market policies really are prone to create problems (as they do in the presence of the standard sorts of market failures) or not.
The phenomenon concerns cross-border imbalances. These are illustrated by the cartoon, which depicts the imbalance that has resulted from the chronic U.S. trade deficit and accumulation of debt obligations vis-à-vis China. Dividing out the world's biggest sovereign debt obligation across the respective populations, the average American owes some $3,300 to China, which amounts to $800 lent to the United States per Chinese citizen. Pretty striking, considering that at the prevailing exchange rate, the United States' per capita income is about twelve times higher than China's. When was the last time you came across someone who had already lent more than 20 percent of his or her annual income to someone twelve times richer, and continued to lend more?1
There has been a broad increase in trade and capital imbalances in recent years (and not just between the United States and China), to the point where, by late 2010, they were making headlines—and setting the global policy agenda. Thus, the meeting of the G20 leaders in Seoul in late 2010 was mostly focused on limiting such imbalances, and they basically managed to agree that these imbalances needed to be managed.
If that doesn't sound like much, remember that there is still fundamental disagreement about whether such imbalances really require (additional) policy intervention. Fans of World 2.0 tend to think not, asserting that markets do a better job of balancing supply and demand than the alternatives. The Chinese concur, although they employ a somewhat different argument. Meanwhile, countries that run large trade deficits, most notably the United States, are more receptive to World 1.0 arguments for protectionism or mercantilism as ways of reducing external borrowing requirements.
The first half of this chapter focuses on capital imbalances, helping round out the previous chapter's discussion of capital risks. It summarizes evidence on cumulating imbalances before looking in more detail at the imbalance between the United States and China. The specifics of this case inform a simple model of growth in which market processes can lead to problematic outcomes, suggesting a need for intervention—ideally on a multilateral basis.
The second half of this chapter focuses on another important imbalance, involving labor instead of capital. Populations are shrinking in Japan and parts of Europe but swelling in some of the poorest areas in Africa and South Asia. And it's not only population growth rates that vary widely: age distributions are diverging as well. We will see that imbalances within and across countries could be alleviated through more cross-border migration. In other words, more active management of imbalances isn't always code for restricting openness; depending on the context, it can involve more of an emphasis on integration than on regulation.
Capital Imbalances
Before looking at evidence on capital imbalances over time, it is useful to review how they are related to trade imbalances. In a closed economy, there are no imbalances of either kind: trade is zero, and savings equal investment. Trade has the potential to drive a wedge between savings and investment: if a country runs a trade surplus, domestic savings exceeds domestic investment, and if it runs a trade deficit, the reverse is true. With no other cross-border capital flows, domestic savings minus domestic investment is equal to the trade balance: exports minus imports. And adding in other kinds of capital flows, savings minus investment becomes equal to the current account balance: the trade balance plus net factor income from abroad (earnings/losses on foreign investments) and net transfer payments (e.g., foreign aid received).
Figure 7-4 in the previous chapter tracked the evolution of current account balances for twelve countries over more than a hundred years and underlined a recent surge in the sum of their absolute values, from 2 percent of GDP in 1990 to nearly 5 percent in 2007. Data for a broader sample of countries indicates a precrisis peak of nearly 6 percent—and shows that two-thirds of the increase since 1990 in current account (im)balances was due to increased trade (im)balances.
Figure 8-1: Historical and estimated world current account balances, 1990–2015
Notes: This chart reflects summation of positive and negative current account balances by year. Country income categories are based on World Bank classifications. 2009 figures reflect actual data for 66 countries and estimates for 105 countries. All data in current-year USD (not adjusted for inflation).
Source: IMF, World Economic Outlook, April 2010.
What figure 7-4 did not highlight was the persistent nature of the imbalances in recent years. This is clearer in figure 8-1, which also provides data on overall magnitudes: certain countries, most notably the United States, have run and are forecast to continue to run current account deficits that they import capital to fund, whereas others, such as Germany, Japan, and China, have typically run current account surpluses, that is, had capital left over to export.
Chronic surpluses or deficits at the country level matter because they imply that imbalances will tend to cumulate—as opposed to canceling out from one year to the next. These effects show up in the form of sustained changes in countries' net international investment positions (NIIPs, or the stock of foreign assets owned by citizens of a particular country minus the stock of that country's assets owned by foreigners), as depicted in figure 8-2.
Of course, current account balances are just one influence—albeit an important one—on NIIPs. Thus, despite the massive current account deficits that the United States ran from 2003 to 2007, figure 8-2 indicates its NIIP declined only moderately, and revised estimates indicate it even improved over this period.2 How could that be? The U.S. dollar fell over this period and the United States invested in higher-yielding foreign assets (portfolio equity and FDI) while foreign investors in the United States mainly held lower-yielding government bonds. But the United States' negative NIIP almost doubled in 2008 as the dollar rose and equity values fell, so Americans shouldn't take too much comfort from that aspect of the chart. Also, keep in mind that these are net figures that balance out larger gross stocks. At the end of 2009, the United States owned $18.4 trillion of foreign assets and foreign owners held $21.1 trillion of U.S. assets, leaving the United States with a NIIP of negative $2.7 trillion, or about 19 percent of GDP.3
Figure 8-2: Historical world net international investment positions, 1990–2007
Note: No distinction is made here between Net Foreign Assets and Net International Investment Position.
Source: Based on Net Foreign Assets series from Philip R. Lane and Gian Maria Milesi-Ferretti, “The External Wealth of Nations Mark II,” Journal of International Economics 73 (November 2007; August 2009 update): 223–250.
Returning to current account (im)balances, many explanations have been offered as to why they have widened in recent
years. Some invoke fundamental factors, such as demographics, which are discussed in the second half of this chapter. Note for now that the connection between age and propensity to save is quite intuitive: young people can't save much and many borrow to pay for education; adults save in their working years but then dissave in retirement. One recent study defines people aged thirty-five to sixty-nine as “prime savers” and finds a correlation between the proportion of a country's population in this range and its current account balance.4 This suggests, among other things, that since prime savers' share of the population will peak in developed markets well before emerging ones, the imbalances—with developed markets increasingly running current account deficits and emerging markets surpluses—will widen through 2025.
Demographics, however, don't fully explain today's current account imbalances. China's surplus and the United States' deficit in 2009 were more than four and two times, respectively, what one would expect based on the calibration of demographics and growth trends in the study cited above. Let's look at those two countries' imbalances, and their relationship with each other, in more detail.
Chimerica Continued
In recent years (2007–2009), China's merchandise trade surplus with the United States has accounted for about two-thirds of China's total current account surplus, and more than one-third to one-half (in 2009) of the United States' total current account deficit. China's trade surplus adds to its foreign currency reserves, as do its purchases of foreign currency coming into the country that are aimed at holding down the renminbi. These reserves are used to underwrite further borrowing by the U.S. government—China is the largest holder of U.S. treasuries in the world—and help prop up the U.S. dollar. This, in turn, fuels U.S. consumption and trade deficits, perpetuating imbalances. It is this complementarity that Niall Ferguson and Moritz Schularick had in mind when they coined the term “Chimerica”—in happier, precrisis times—to describe the two countries' relationship.5
To dig deeper into how a relatively poor country such as China has been able to finance a good part of the large current account deficit posted by the United States, it is useful to analyze both countries' current accounts on the basis laid out in the previous section. Note that imbalances can be caused both internally (by a savings-investment gap) and externally (through trade deficits and currency disparities). Tables 8-1 and 8-2 break down the internal imbalances for China and the United States, respectively, by the sources of savings (households, corporations, and government) and investment before listing external contributors.
As table 8-1 illustrates, China's current account surplus reflects a complex mix of factors, many of which the Chinese government has long recognized as problematic. Back in March 2007, Premier Wen Jiabao stated that “the biggest problem with China's economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable.”6 Since then, there have been some dramatic shifts. Thus, health insurance coverage has expanded from 15 percent of the population in 2003 to 85 percent in 2008.7 And boomtowns in China's interior such as Chongqing are visible manifestations of the attention now being paid to boosting domestic demand. Overall, however, China's government is judged unlikely to significantly change its overall policy framework very quickly, given its dependence on continuing growth for its legitimacy and the interlocking character of its various market interventions. That's why the IMF's current account projections through 2015 in figure 8-1 forecast a swelling rather than shrinking Chinese current account surplus—as do other sources.8
Table 8-2 presents a parallel analysis for the United States. While the reasons for the U.S. deficits are not quite as complex as China's, figure 8-1 indicates that they have persisted over an even longer period. And although 2009 saw a rise in the risibly low U.S. household savings rate and a narrowing of the U.S. trade deficit, decisive policy shifts aren't expected there either, leading to forecasts that U.S. current account deficits will start to widen again (e.g., in figure 8-1).
Such predictions that imbalances would, after a correction in 2008–2009, continue to widen in the short to medium run precipitated global acrimony over exchange rates and trade imbalances in fall 2010. The global nature of the problem is highlighted by the fact that it was Brazil's finance minister rather than a U.S. or Chinese official who termed the situation a “currency war”—and effectively forced the G20 to rush to defuse such talk. But before discussing the policy interventions that are being proposed to deal with such imbalances, it seems useful to ask whether there really is a problem here that market forces cannot sort out. Some think not. Thus, according to Larry Lindsey, the first director of the National Economic Council under President George W. Bush,
America, however, benefits from this arrangement. The Chinese clearly undervalue their exchange rate. This means American consumers are able to buy goods at an artificially low price, making them winners.
In order to maintain this arrangement, the People's Bank of China must buy excess dollars, and has accumulated nearly $1 trillion of reserves. Since it has no domestic use for them, it turns around and lends them back to America in our Treasury, corporate and housing loan markets. This means that both Treasury borrowing costs and mortgage interest rates are lower than they otherwise would be. American homeowners and taxpayers are winners as a result.
There are losers, of course, most notably American producers of goods that are now made in China. Yet the losses to these producers are outweighed by the benefits from Chinese subsidies of our imports of consumer goods and the reductions in our borrowing costs from generous Chinese lending.9
Table 8-1: China's current account decomposition and potential causes
Decomposition
Potential causes
Gross savings: 54% of GDP
Household savings: 23% of GDP
Preventive savings: Social safety nets (such as health insurance) were dismantled during reforms and are only gradually being redeveloped.
Underdeveloped credit markets: With limited access to credit, families must save more for expensive big-ticket items like housing.
Catch-up and culture: Families are building wealth after near-zero savings rates under planned economy; culture supports saving.
Bride competition: Gender imbalance (20% more boys at birth) may spur parents to save to boost sons' marriage prospects.*
Corporate savings: 19% of GDP
Low cost of capital and dividends: State-owned firms access low-cost bank credit; until recently did not have to pay out dividends for use of state assets; encouraged to reinvest profits.
Corporate governance: Insiders may save to keep control of funds.
Underdeveloped capital markets: Uncertain access to funds later.
Government savings: 12% of GDP
Rising government revenues: Dividends from state-owned firms, land sales, tax collection.
Investment over consumption: Government traditionally prefers to spend on investment (e.g., infrastructure) versus consumption.
Gross capital formation (investment): 43% of GDP
[China's level of investment is already very high; raising investment would reduce the current account deficit but risk allocating funds to wasteful uses.]
Current account balance: 11% of GDP
Undervalued currency and employment: Cheap currency enhances export competitiveness, supporting employment and contributing to domestic political stability.
Accumulation of reserves: Asian countries after the 1997 crisis prioritized building up foreign currency reserves to improve macroeconomic stability; holding large amounts of reserves also increases China's foreign policy leverage.
Note: Potential causes shown in [brackets] in tables 8-1 and 8-2 reduce the size of current account imbalances or otherwise make them less problematic.
Source: The percentage of GDP figures are 2007 data from World Bank, World Development Indicators, with savings distributed among sources based on the ratios (but not the exact amounts) shown in “China's Savings Rate and Its Long-Term Out
look,” Goldman Sachs Global Economics Paper 191, October 16, 2009. Potential causes are drawn from a variety of sources; for China, the same Goldman Sachs report was particularly useful.
* Sex ratio is from 2005. Broader argument is elaborated in Shang-JinWei and Xiaobo Zhang, “The Competitive Saving Motive: Evidence from Rising Sex Ratios and Savings Rates in China,” NBER Working Paper 15093, June 2009.
Table 8-2: U.S. current account decomposition and potential causes
Decomposition
Potential causes
Gross savings: 14% of GDP
Household savings: 3%
Asset price gains (wealth effects): Rising stock market and housing values led households to perceive less need to save.
Credit availability: Access to credit reduces need to save up for major purchases and to engage in preventive saving.
Stagnant wages among the less skilled: Borrowing to maintain and/or raise living standards without accustomed wage gains.
Corporate savings: 10%
[Generally, corporate savings have been high across OECD economies in recent years. This partially offsets low household and government savings rates in the U.S.]
Government savings: 1%
Fiscal deficits: Since the brief period of budget balance under the Clinton administration, G. W. Bush tax cuts, wartime military spending, and, more recently, stimulus measures have all led to large fiscal deficits.
Gross capital formation (investment): 18% of GDP
[Optimists point to profitable investment opportunities in the U.S. in excess of savings as a positive rationale for the current account deficit, but this is countered by the high proportion invested in treasuries.]
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