By Michael Prowse
One of the striking aspects of today’s global economy is a distribution of external surpluses and deficits seriously at variance with what textbook theory leads us to expect.
The advanced economies ought to be running current account surpluses and the emerging economies current account deficits. As the counterpart to their trade surpluses the rich nations ought to be lending to, and investing in, the poor developing world. Why? Because returns on investment ought to be much higher in regions of the world where capital is scarce and labour abundant. In effect, young workers in emerging economies ought to be paying the pensions of the ageing populations of the developed world.
Regrettably this is not happening. China, the world’s largest emerging economy, is running a current account surplus of more than 6 per cent of GDP and, via the purchase of US Treasury bills, lending on a massive scale to the US, the world’s richest and most technologically advanced nation. The US, meanwhile, is running a current account deficit of more than 3 per cent of GDP, having borrowed from poorer countries consistently for the past three decades.
China is not alone. According to IMF projections, all the emerging Asian economies are running significant surpluses this year, with the exception of India and Vietnam. Japan, of course, is running its usual big surplus. Australia and New Zealand, although richer and technologically more advanced than emerging Asia, are busily importing capital to support domestic consumption, just like the US.
One might have hoped that the European Union would follow the textbook model, generate a significant current account surplus, and invest its excess funds in the developing world. Instead as a bloc it is roughly in balance externally. But this overall balance masks bizarre internal differences. Every northern European economy is running a current account surplus (led, of course, by Germany which the IMF expects to run a surplus of 5.5 per cent of GDP this year, second only to China’s as a proportion of output). The UK, France and all of southern Europe, meanwhile, are heavily in deficit. Frugal Europeans are exporting capital but mainly, it seems, to their spendthrift partners.
Elsewhere common sense mostly rules. In the former Soviet Union, Latin America, the Middle East and Africa, energy exporters are mostly running external surpluses whereas energy importers are mostly running deficits.
Should we worry about this strange pattern of current account surpluses and deficits? What causes these apparently irrational discrepancies? And if they do matter, how can we create a better balanced world economy?
To illustrate the range of opinions, one need only consider the disagreements among commentators at the Financial Times. Martin Wolf takes imbalances very seriously. In a pair of intriguing recent articles he drew inspiration from one of Aesop’s fables. Germans and Asians, in his view, are akin to industrious ants whereas the Americans, British and southern Europeans are lazy grasshoppers. The ants cannot stop saving and lending. The grasshoppers cannot stop spending and borrowing. Each feeds on the weakness of the other. Eager lenders play into the hands of eager borrowers. Spenders need savers. But given the ingrained characters of ants and grasshoppers, Mr Wolf appears sceptical that anything much can be done to resolve the problem.
In an implicit rebuke, the FT’s other main economic commentator, Samuel Brittan, argues that imbalances are a non-problem. Adopting a staunch laissez faire line, Sir Samuel argues that individuals and families should be free to spend or save as they please – provided, presumably, that they bear the consequences of their decisions. It does not matter particularly if the aggregate results of these individual decisions lead to high or low national savings, or to current account surpluses or deficits. The whole point of having banks, investment managers and international capital flows is to allow spending to diverge from saving.
My own view is that although readers will find much of value in the articles of both Mr Wolf and Sir Samuel, neither pundit is entirely on target. For my taste both adopt too individualistic an approach and overlook the importance of social rules and institutions. Sir Samuel argues that individuals should be free to save or spend, borrow or lend, as they please. Yet as he would be the first to acknowledge, economic decisions are always taken against a backdrop of rules that influences the outcome of those decisions. “Free” choices will have very different outcomes depending on the institutional backdrop. Does one endorse “free” spending and borrowing decisions subject to American rules or subject to Asian rules? It makes a big difference.
For his part, Mr Wolf appears to exaggerate the intrinsic differences between individuals. There is only one kind of human being with one kind of nature – at least this is what many evolutionary biologists now believe. But humans faced with one set of economic rules, institutions and practices will tend to behave like ants whereas those faced with different set of background conditions will tend to behave like grasshoppers. Again the salient issue is not so much individual choice as institutional background.
There are several ways to see that it is differences in national rules and institutions – itself a reflection of incomplete globalization of markets – that mostly produces the different behaviour. When individuals from all over the globe settle in the US, they tend over time to behave like Americans rather than like the compatriots they have left behind. This is because they respond rationally to new rules and opportunities. It is much easier for individuals to borrow to buy houses and cars and to finance lavish spending on imports and vacations in the US than it is in either Asia or Germany. So ants transmute into grasshoppers – or at least the children of ants do.
Equally the notion that Anglo-Saxons have a greater appetite for risk than Germans or Asians is not necessarily valid. When Germans and Asians operate outside their national frontiers – when they are free of domestic restraints, whether formal or informal - they can be pretty aggressive. Look at the huge volume of risky loans German bankers extended to Greeks. The counterpart to every risky borrowing decision is a risky lending decision. Greed is just as much a factor of life in Asia and Germany as in the deficit nations; it is just exercised differently – mainly by business people, rather than consumers, and mainly in overseas, rather than domestic, markets.
I think the current pattern of imbalances does matter, for two reasons. First, the flow of capital to emerging economies is almost certainly smaller than it would be if the institutional playing field were levelled in the rich developed world. The north-south divide is thus entrenched. Second, imbalances tend to generate financial instability – capital inflows into the US kept interest rates low and contributed to the sub-prime mortgage crisis while capital inflows into southern Europe helped cause the sovereign debt crisis. Unsustainable debt invariably results in severe recessions in which nearly everyone loses.
How can the G20 reduce future imbalances? Part of the answer, according to finance ministers in Busan, lies in fiscal retrenchment by the profligate, as this should reduce the gap between domestic saving and domestic investment. But this is a risky strategy while the global economy remains so weak. Where possible, appreciation of surplus nations’ currencies relative to those of deficit nations would be helpful. But whereas the renimbi can rise relative to the dollar, no currency adjustments are feasible within the EU.
Longer term, the answer lies in more complete globalization, by which I mean convergence of domestic economic rules and practices. It is not helpful to think of the global economy as a set of sovereign domestic economies linked by trade and investment. Rather there needs to be common rules of the economic game internally as well as externally. Thus mercantilist Asia and Germany need to introduce more liberal rules for domestic borrowing and spending – for instance make it easier for young people to buy homes, which will generate much spin off consumption. By contrast the market-oriented US and UK need to impose tougher borrowing rules for consumption and home purchase, and introduce tax and other policies that favour saving and production. As structural policies converge imbalances will shrink.