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Global Economic Imbalances: Who Has to Balance?

GRK Murty

Imbalances in trade between countries are, of course, as old as trade

itself. In the normal course, they tend to get corrected gradually. This
phenomenon has however changed considerably in the recent past.
Particularly, post the breakdown of the Bretton Woods system in the
early 1970s, followed by the globalization, as capital—not backed by
trade in merchandise—started flowing around the world financial
markets, the global imbalances widened to near unprecedented levels,
causing greater consternation to both the surplus and deficit nations.

And in the aftermath of the global

economic crisis of 2009, as demand
in the world’s major economies fell
by around $2.5 tn, high liquidity
and continued economic weakness
in rich countries led to a surge in
capital flows into emerging markets that are strong in macroeconomic
fundamentals and are open to free flow of capital seeking better
Aside of this, in today’s system, there has emerged another kind of
capital flow: capital from emerging market economies—countries like
China and oil-exporting countries which have been enjoying current
account surpluses—started flowing into some advanced economies
such as the US and the UK that are running large current account
deficits, that too, persistently. This ‘uphill’ flow of capital from
countries where the marginal product of capital is high to countries
where the marginal product of capital is low is puzzling, for it does not
anyway raise the global output. Besides, there are also other countries
such as Japan and Germany exporting capital to the US: the net
external asset position of Japan rose by around $1.7 tn and that of
Germany by $0.8 tn, as against the rise in the external liability of the US
by $3.5 tn in 2008, almost 25% of its GDP.

Irrespective of the countries involved, such a capital flow supposedly

into safe assets has its own consequences: one, it results in a fall in the
interest rates in rich countries, which incidentally means low returns to
capital exporting countries, at times inflicting high cost on the
governments of these countries that intervene in handling the domestic
savings for investment abroad; two, a rise in the asset prices of capital
receiving countries; three, a surge for financial innovation, perhaps, to
secure a better yield; four, a boom in residential construction, as it
happened in the US in 2006-08, and ultimately, all culminating in a
financial crisis.

So, the emerging reality is: if the global economy has to move towards
a steady long-run growth, these imbalances have to be rebalanced.
There are, however, opposing views as to how this feat is to be
accomplished. Emerging market economies, such as BRIC countries,
worry that advanced countries will use exports to reduce their
imbalances at the expense of emerging economies’ exports rather than
address their structural problems. On the other hand, advanced
economies see the exchange rate of major emerging economies, such
as that of China, as manipulated to keep it low to nurture their export-
led growth model.

But the truth is: in a globalized interdependent world, the pattern of

imbalances, as seen above, cannot be ‘blamed’ on any one party.
Therefore, the need of the hour is for all parties to take action and work
together. It is worth bearing in mind here that any attempt to answer
the problem by solely aiming at fixing the US deficit might pull down
the aggregate demand from the world economy, leading to the risk of a
1930s-type trade depression. Similarly, any attempt to correct the
surpluses solely by expanding the domestic demand in surplus nations
risks igniting the global inflation as in the 1970s. In the same vein, it
cannot be expected that a mere change in the exchange rate of the US
dollar vis-à-vis currencies of surplus countries will solve the problem,
for experience shows that exchange rate changes have very limited
short-run effects on current account positions. Even other factors such
as rigidities in demand elasticities, differences in economies of scale
and cost structures across economies might negate the effects of
exchange rate changes.

Coming to the emerging economies, they have indeed started moving

beyond the traditional export-led growth model. But as many of these
countries have relatively underdeveloped financial markets, and low
per capita income with poor access to credit, they find it a big challenge
to reap the full benefits of the standard macroeconomic policies. So is
the case with regard to stimulating the domestic demand, for
investment in services is low, and the retail and financial sectors are
underdeveloped. Nevertheless, by launching structural reforms, they
can unlock the consumer demand, at least in sectors such as education
and healthcare.

So, the only way forward for rebalancing the global imbalances is for
the creditors (surplus nations) and debtors (deficit nations) to sit
together and, as suggested by Mervyn King, discuss about the right
speed of adjustment to the real pattern of spending and arrive at a
consensus; else, policies will invariably conflict. Simultaneously, policy
tools regarding exchange rates, control of capital flows, plans to raise
savings rate in deficit countries, structural reforms needed to boost
domestic consumption in surplus countries, and the role and
governance of international financial institutions must be devised for
uniform practice. Unless the problems are dealt with collectively, we
might unwittingly pave the way for the next financial crisis.