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Many analysts and observers believe that the globalimbalances that characterized the world economy in the years before the 2008crisis have substantially dissipated. But, whileit is true that China’s current-account surpluses and America’s deficits havesomewhat moderated since then, have the imbalances really been corrected? Moreimportant, can the post-crisis global economy enjoy both growth and balance?
To answer these questions, it is important to understandthe imbalances’ underlying dynamics. An economy’s current account is thedifference between its investment rate and its savings rate. In 2007, theUnited States had a savings rate of 14.6% of GDP, but an investment rate of19.6%, generating a current-account deficit. By contrast, China had a fixedinvestment rate of 41.7% of GDP and a savings rate of 51.9%, reflected in alarge surplus.
Since 2007, the US current-account deficit has narrowed,but not because of a higher savings rate. Rather, the external deficit has beensqueezed by a collapse in investment activity, while America’s overall savingsrate has fallen below 13% of GDP, owing to worsening government finances.Meanwhile, China’s savings rate remains stubbornly high. The surplus hasnarrowed because investment has been ramped upeven higher, to roughly 49% of GDP. In other words, the Americans save evenless today than they did before the crisis erupted, and the Chinese invest evenmore.
Any future recovery in the US economy will almost certainlytrigger a revival in investment activity. American businesses have postponedmuch-needed capital spending and, with American airports and bridges in appalling condition by developed-country standards,investment in infrastructure is crucial as well. Indeed, it is very likely thatreviving growth will lead to larger current-account deficits, even if thesavings rate improves and domestic energy production curtailsoil and gas imports.
China has the opposite problem. In order to sustain growth,it needs to continue to invest half of its $9 trillion annual GDP – no easytask for a country that already has brand new highways and airports. In fact,over the next decade, as China attempts to move up the value chain intoservices and adjusts to a shrinking workforce, its investment requirements willshrink – and its investment rate will fall sharply.
Of course, China’s savings rate will also decline, butJapan’s experience since the 1980’s demonstrates how a sharp fall in investmentcan generate large and persistent current-account surpluses, even when thesavings rate is falling and the currency is appreciating. Indeed, a strongercurrency can paradoxically feed external surpluses, while discouraginginvestment in export-oriented industries.
The implication is that the post-crisis global economy willnot be characterized by balance, but by a return to large macroeconomicimbalances. But, although many economists will consider this problematic,history shows that symbiotic imbalances havecharacterized virtually all periods of global economic expansion.
The Roman Empire ran a persistent trade deficit with Indiafor centuries. Although the resulting outflow ofgold caused monetary debasement in the RomanEmpire, Indo-Roman trade remained the backboneof the global economy.
Similarly, Spain ran persistent deficits in the sixteenthand seventeenth centuries, paid for by Andean silver. The resulting flood ofliquidity caused a global boom that benefited economies from ElizabethanEngland to Mughal India. And 1870-1913, another period of rapid growth andglobalization, was not characterized by balance; it was funded by the UnitedKingdom, acting as the world’s “bank.”
In the last 60 years, the US has underpinned global growthby running persistent current-account deficits. Under the Bretton Woods system,the US ran deficits that enabled war-torn Europe and Japan to rebuild. Inreturn, Europe funded the US deficits.
The system broke down when European countries, particularlyFrance, decided to stop funding those deficits. But the economic modelpersisted, with Asian economies stepping in to finance the US deficits, whileusing the US market to grow rapidly. China is the latest and largestbeneficiary of the economic model dubbed “Bretton Woods II.”
Clearly, periods of global growth are almost always characterizedby symbiotic imbalances. But, while each of these episodes was characterized bymacroeconomic distortions caused by the imbalances, they lasted for years, oreven decades. So, the real question is what the next generation of symbiotic imbalances will look like.
It is likely that China will soon return to running verylarge current-account surpluses – potentially large enough to fund the US, withplenty left over for the rest of the world. As this capital cascades through the global financial system, it willre-inflate the economy.
In the “Bretton Woods III” system, China will transformfrom “factory to the world” to “investor to the world.” Like all imbalancedsystems, it will have its distortions, but the arrangement could last for manyyears.
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