We’re all by now well aware of the dangers of global imbalances, those massive surpluses and deficits – most notably in China and the U.S. — that underpinned the Great Recession. Economists agree that the world economy will not return to a stable, healthy growth path until those giant imbalances are reduced. That means Americans will have to spend less and save more, and Chinese will have to spend more and save less. This is far from an easy process. It entails major shifts in lifestyles on both sides of the Pacific, as well as significant changes in macroeconomic policy. The U.S., for example, has to get its debt and budget deficit under control; China has to build a social safety net to encourage consumer spending and restructure its invest-and-export growth model (by, some believe, reforming its controversial currency regime). The big question economists have had as the world begins to recovery is: How quickly are the U.S. and China able (or willing) to bring their economies into balance?
The good news is that we’ve made some serious progress. Global imbalances were significantly reduced in 2009. The current account surplus of China fell from about 9.5% of GDP in 2008 to 5.75% in 2009, while the deficit of the U.S. fell from about 5% of GDP to some 3%, according to the International Monetary Fund. That’s a major adjustment in a very short period of time.
However, to a certain degree, those reductions were a result of temporary factors – the collapse of manufacturing and trade during the Great Recession, the shock of the housing bust on the U.S. consumer and massive public spending in China as part of the government’s anti-recession stimulus plan. That’s leading to fears that the imbalances will just return as the recovery picks up pace. Will the world economy once again get smothered in an avalanche of imbalances? Or are the reductions of the Great Recession sustainable?
Those questions are sparking a lively debate in the world of economics. In a recent report, Barclays Capital economist Piero Ghezzi says “global rebalancing is for real.” He argues that global trade is already returning to normal, but the imbalances aren’t returning with it. Here’s what he says:
Global trade and economic activity have already bounced, in some cases quite sharply, and while some of the overshooting in global rebalancing is naturally being reversed, there are no signs that we are going back to a pre-2008 world.
Ghezzi believes that about 30% of the collapse seen in imbalances is “permanent or quasi-permanent.” That would mean a contraction in global imbalances from the 5.4% of GDP reached before the Lehman bankruptcy to 4.8%, which would bring imbalances back to where they were in 2004. He’s basing this view, in part, on a degree of confidence that the Chinese economy is truly on a course to significantly overhaul its growth model, and thus shrink its perpetual surpluses. Here’s more from Ghezzi:
The Chinese process of domestic rebalancing continues to an extent that is certainly not appreciated at a global level…We expect the Chinese current account deficit to halve over the next few years. In our view, the shifting of the Chinese development model from export driven to domestic consumption driven is an irreversible, if relatively slow phenomenon.
Yet (of course) not everyone agrees. Economists at HSBC recently put out their own report that portrays 2009’s reduction of imbalances as a recession-created phenomenon. The world economy, they contend, may be destined to return to its old, unstable ways. Here’s what HSBC said:
Whereas in almost all previous recessions since the late 1970s, the U.S. current account deficit temporarily vanished, the latest recession has delivered a different outcome: to date, the current account deficit has fallen, but only to 2.9% of GDP. Following the deepest U.S. economic collapse since the 1930s, this is a rather surprising outcome, suggesting that any recovery in U.S. domestic demand will be associated with a renewed widening of imbalances, possibly to grotesque proportions.
HSBC is no more confident that China’s can reform its growth model and shrink its surpluses in any reasonably short period of time. Simple macroeconomic policies – like appreciating the Chinese yuan – won’t have the desired effect, HSBC says:
China’s surplus partly reflects deep-seated structural constraints which are difficult to remove overnight or, indeed, over decades… Our main objection to the currency appreciation argument is tied to our view that China’s excess savings are the result more of micro- than macroeconomic forces within the Chinese economy. China lacks a social security structure on a Western scale and, as a result, individuals tend to save more than, collectively, should be necessary. China also lacks a well-defined consumer credit system. Credit systems ultimately work through trust and information: these things cannot be conjured up out of thin air overnight and any attempt to boost demand through premature reliance on rapid growth in credit is likely to end in tears…Put another way, it’s unlikely that China can shift easily from its current position as a net exporter on a sustained basis anytime soon.
The HSBC outlook, then, is much gloomier:
As a result, relations…between the US and China are likely to remain politically charged. With deficit nations facing unprecedented austerity in the years ahead, it’s easy to see how imbalances could contribute to increased protectionism and financial market turbulence.
I tend to lean towards the HSBC view. Altering the structure of an entire economy like China’s is not something that will happen in a year or two; it will take significant changes in Chinese policy priorities and a revolution in the mindset of the Chinese consumer. Eventually, China will rebalance; its leadership realizes the economy must change the sources of its growth. But it won’t be easy. In the U.S., meanwhile, that commitment to reform doesn’t really seem to be there. Everyone is still waiting and watching that all-important consumer spending data, hoping for a revival that would once again drive American growth. Nor is there enough being done to encourage savings at a national level on a long-term basis. That means imbalances will inevitably grow. Then the questions become: How big will imbalances get? And at what level do they become unstable again?