Roach clip; don't bogart it, Rat.
(or,los escribidos de Esteban de la Cucaracha)
The modern-day global economy has never been more unbalanced than it is today. The most visible sign of such imbalances is an unprecedented divergence between current account deficits (predominantly America) and surpluses (mainly Asia and, to a far lesser extent, Europe). By our reckoning, the spread between these surpluses and deficits hit a record of more than 3% of world GDP in 2004. Related tensions are building on other fronts as well — both on the funding side of the equation, underscored by America’s need for $2.6 billion of capital inflows every business day, as well as in the political arena with respect to trade policy. In my view, these persistent and ever-widening imbalances pose an increasingly urgent danger to sustainable growth in the world economy.
Today’s global imbalances are very much an outgrowth of the world’s new uni-polar growth dynamic. Over the 1995 to 2002 period, the United States — which has a share of about 30% of world output — accounted for fully 98% of the cumulative increase in world GDP. Putting it another way, the remaining 70% of the world economy accounted for only 2% of the cumulative increase in world GDP over this same period. These results are calculated at market exchange rates. As such, they reflect both a widening of the real growth disparities between the US and the rest of the world, as well as a sharp appreciation of the dollar over this seven-year interval. Rebalancing will undoubtedly involve reversals on both counts — growth disparities and currencies. Not only will this entail a shift in the mix of global consumption away from the US, but it will also require a further decline in the dollar and a concomitant increase in US interest rates. Only then can the world get on with the heavy lifting of global rebalancing.
There is, of course, no quick and painless fix to all that ails the world. Rebalancing is best seen as a process with many moving parts that involve all the major actors in the global economy — especially, the United States, Europe, Japan, and China. In my view, there are three key building blocks to a successful global rebalancing — a shift in the mix of global saving and consumption, enhanced structural and financial flexibility, and a new architecture of international policy coordination. The successful execution of rebalancing will require a careful application of traditional macro policies — monetary, fiscal, and currency policies — as well as a comprehensive micro agenda of structural reforms. And the sooner the better. Like asset bubbles, the longer you wait to address mounting global imbalances, the greater the chance of an abrupt correction, or hard landing. The good news is that the imperatives of rebalancing are finally on the radar screen in global policy circles. The bad news is that the authorities have waited too long to tackle these thorny problems.
America’s medicine
In terms of the “global fix,” the place to start is with the United States — not only the dominant growth engine in the global economy but also the source of some of the world’s most serious imbalances. America’s biggest problem, in my view, is an unprecedented shortfall of domestic saving. The net national saving rate — stripping out depreciation and reflecting the combined saving of households, businesses, and the dis-saving of the government sector — has held at a record low of around 1.5% since 2002. Lacking in domestic saving, the US must import surplus saving from abroad in order to keep growing. And it must run massive current account and trade deficits in order to attract that capital. America’s record current account deficit — 5.6% of GDP in the third quarter of 2004 — hardly came out of thin air. It is very much an outgrowth of a profound and worrisome shortfall of domestic US saving.
America’s role in global rebalancing is thus relatively straightforward — finally facing up to the daunting challenge of fixing its saving problem. There are two main lines of attack — boosting personal saving from its present rock-bottom level and fixing the Federal budget deficit. Amazingly enough, there are many who believe that US consumers don’t have a saving problem. Never mind the personal saving rate of 0.2% in October 2004, they argue; after all, rational consumers have figured out new and creative ways to save through their wise and prudent investments in asset markets. This mindset first took on a life of its own during the equity bubble of the Roaring 1990s; and now the baton has been passed to the biggest bubble of all — housing.
The tradeoff between America’s income-based saving strategies of yesteryear and the asset-based-saving strategies of today has become a central feature of what I have called the Asset Economy. An important outgrowth of this transformation is a new bias toward depressed levels of income-based domestic saving and ever widening current account deficits. The global implications of this arrangement are equally profound — an asset-based US consumption dynamic that not only drives exports of externally-dependent foreign economies but also requires cut-rate financing through open-ended capital inflows in order to feed the beast of ever-appreciating US asset markets.
What a reckless way to run the world! The problem comes, of course, when asset appreciation goes to excess. Then, bursting bubbles leave saving-short US consumers no choice other than to rebuild income-based saving rates — an outcome that would restrain US consumption and impede externally-led economies elsewhere in the world. In a rebalancing framework, a major challenge for US authorities is to pre-empt this painful endgame by seeking policies that boost personal saving. Unfortunately, the orthodox approach to saving policy — creating new accounts such as IRAs and 401Ks — has had a terrible track record in boosting aggregate saving. These instruments have mainly succeeded in shifting the mix of saving from one type of account to another rather than by generating net new saving. I would, therefore, be in favor of a more radical approach — namely, a consumption tax. For the sake of simplicity, my preference would be a national sales tax over a more cumbersome value-added tax; and for the sake of equity, any such scheme should be designed to buffer any regressive impacts on the lower portion of the income distribution. A saving-short nation needs to tilt the incentive structure away from the excesses of open-ended personal consumption. A national sales tax could well be a very important step in that direction.
Proposals for improved public sector saving are equally contentious. I would add only two points to the now voluminous debate on the budget deficit: First, most forecasts place the US budget gap at around 2.5% of GDP over the next five years. While, as David Greenlaw notes, this is basically in line with the post-1969 average, today’s (and tomorrow’s) deficits matter much more than those in the past — mainly because of the extraordinary shortfall of private saving. For that reason, alone, Washington should not take false comfort in running “average” deficits. Second, tax reform is a luxury that only fiscally prudent nations can afford. America is not in that position. It is fiscally irresponsible to push a supply-side agenda —i.e., making the temporary tax cuts of 2003 permanent under the dubious premise they will be self-financing. Moreover, notwithstanding the compelling philosophy of an “ownership society,” Dick Berner and I both agree that it is equally irresponsible to embrace social security privatization and healthcare reform schemes — especially if the former involves large transitional costs of incremental Federal borrowing; in my view, any such efforts must be subjected to a saving-neutral litmus test.
Deficit reduction will not happen by osmosis. With Washington having lost the discipline on budgetary control that was so important in the late 1980s and early 1990s, a new approach is needed. That is especially important, given rising military and homeland security commitments. Consequently, I would be in favor of reinstituting the “sequestration” enforcement framework of the now-discarded Gramm-Rudman fiscal restraints of the late 1980s. An acceptable alternative would be to establish a new set of pay-as-you-go requirements that would put the government’s discretionary budgetary commitments on a very tight leash. I would also note that a sales tax is a very efficient way to raise revenue. By our reckoning, every one percentage point of tax on discretionary consumption — exempting essentials such as food, housing, medical care, and education — would yield about $40 billion in revenue. It wouldn’t take a huge national sales tax to make a significant dent in the budget deficit.
Finally, the US also needs a further weakening of the dollar, in my view. On a broad trade-weighted basis, the dollar’s real effective exchange rate is down about 15% from its early 2002 peak. This is a relatively small decline for a US with a current account deficit that is expected to rise to at least 6.5% of GDP over the next year. Back in the latter half of the 1980s, when the current account deficit peaked at 3.5%, the broad dollar index fell about 30% in real terms. In other words, America today has a current-account problem that is almost twice as bad as it was in the 1980s but a dollar that has fallen only about half as much. For that simple reason, alone, I would argue that the dollar has at least another 15% to go on the downside. While a weaker dollar will not alleviate America’s imbalances, it could well trigger the interest rate adjustments that might — especially since the current-account conundrum means that marginal changes in US rates are increasingly in the hands of America’s overseas creditors. A saving-short, asset-dependent US economy needs higher real interest rates to temper excess consumption. To the extent a further decline in the dollar sparks such an adjustment, the US will have taken an important step on the road to global rebalancing.
Europe and Asia’s medicine
Lest I be accused of offering nothing more than a US-centric global action plan, it is equally important to stress that America’s “fix” is only one part of the world’s solution. In many respects, the prescriptions for the US are the mirror image of the approach needed by the rest of the world. That’s because the corollary of America’s excess consumption is under-consumption elsewhere in the world; US consumption growth averaged 3.9% over the 1996 to 2004 period — nearly double the 2.1% gains in the advanced countries of the world. As a result, America’s saving shortfall stands in sharp contrast with excess saving elsewhere in the world; the US gross national saving rate averaged 16% over the 1996 to 2004 period — far short of the 23% average for other advanced nations. These disparities underscore a key common challenge for Europe and Asia — the need to draw down excess saving and stimulate domestic demand, especially private consumption.
That’s easier said than done, of course. But there are a few obvious and important steps that can be taken: For Europe, productivity should be the focus. At a minimum, this will require a combination of aggressive corporate restructuring, improved labor market flexibility, and a step-up in IT-enabled investments. As Eric Chaney points out, there are good reasons to be cautiously optimistic on all of those counts over the next several years. If Corporate Europe is able to execute this strategy successfully, the result will be increased competitiveness and enhanced job-creating prospects. This is hardly a sure thing — especially for Germany, increasingly the odd man out in a Euro-zone where the mantra of “one size fits all” can now be drawn into serious question. But to the extent that Europe can regain momentum on the hiring front, the incremental growth in labor income that would follow would go a long way in supporting the re-birth of the long-dormant European consumer. As the dollar continues to slide and the euro strengthens further in response, Europe’s externally-led growth paradigm becomes all the more vulnerable. In such a climate, the urgency of reform takes on even greater importance in driving Europe’s pro-consumption productivity agenda.
Asia has a similar need to shift the mix of its growth dynamic from external to internal demand. The Asian consumer has long been missing in action. The export- and investment-led growth model has been the cornerstone of Asia’s development strategy. But I agree with Andy Xie that this approach has now outlived its usefulness and, in fact, has helped perpetuate the world’s imbalances. In large part, that’s because Asian officials have focused on doing everything they can in order to prevent their currencies from rising and jeopardizing export competitiveness. Central to this approach is Asia’s recycling of massive flows of foreign exchange reserves back into dollar-denominated assets — providing capital inflows that not only fund America’s current account deficit but that also subsidize US interest rates, asset markets, wealth effects, and, ultimately, personal consumption. Asia unwittingly is perpetuating the excesses of the American consumer and all of the imbalances they spawn.
Consequently, it would be in Asia’s best interest — and, in fact, in the world’s best interest — to move to a more balanced growth model. A more flexible currency regime would complement that shift. Not only would that force Asia to wean itself from a subsidized export growth strategy but it would allow the burden of additional dollar depreciation to be shifted away from Europe. Japan and China, in particular, need to lead the way in dismantling currency pegs and quasi-pegs. The longer such moves are deferred, the greater the risk that pressures arising from external deficits will be vented in the political arena through trade frictions and possibly protectionist actions. That would be the last thing either of these countries needs, especially China. Yet the longer China holds out and pegs its currency to a falling dollar, the more it will stick out in a world where most other currencies are adjusting to the imperatives of rebalancing. China also needs to move ahead on the safety net front — especially with respect to social security, healthcare, and retraining assistance. Only then can Chinese workers enjoy a greater sense of income security -- sorely needed in a climate of ongoing massive job losses driven by state-owned enterprise reform. That’s what it will take to put China’s emerging consumer culture be on more solid footing.
New architecture for policy coordination
An increasingly integrated global economy has problems that transcend the sum of its parts. For starters, there is a broader global agenda that requires policy coordination among nations and regions. The world is lacking in that collaborative mindset — operating under the mistaken presumption that the best global policies are a loose collection of the best national policies. Yet nothing could be further from the truth. The globalization of trade flows, capital flows, and information flows needs an integrated policy architecture. The lack of such a framework is a serious impediment to rebalancing. This shows up all too painfully in the form of what I have called the “global blame game” — the inclination for nations to blame others for their problems. America continues to blame the rest of the world for a growth deficit. China has become aggressive in blaming the US for its saving problem. Japan has threatened to intervene again in foreign exchange markets. And leading European officials have been quick to characterize recent currency adjustments as unnecessarily “brutal.” Such scapegoating runs the risk of taking on a life of its own — leading to an outbreak of trade frictions and protectionism that would all but derail any hope for a successful global rebalancing.
The destructive tendencies of the blame game suggest that time is long overdue for a serious revamping of the global policy architecture. Whether it’s the G-7, the G-10, or the G-20, nations need to come together and collectively develop a more robust framework of shared goals and responsibilities. I would start with a major streamlining of the G-7 — long the heart and soul of international policy consultation on key economic issues. This body is a creature of a different era. Its failure to include China is ludicrous. Equally absurd is that it gives a now-unified Europe three votes — Germany, France, and Italy — and offers a fourth voice to the UK.
With apologies to my Canadian friends and a nod to the Brits, I would be so bold as to suggest replacing the G-7 with a newly constituted G-5 — the US, Euroland, Japan, the UK, and China. This should be a permanent and well-staffed organization — not one that simply comes together for periodic summits. As such, it needs a well-defined charter that is aimed at dealing with all economic aspects of global imbalances — from currency misalignments and balance of payments disparities to matters of trade policy and structural reform agendas. Formal meetings should be held at least twice a year, taking the form of direct consultations between the permanent staff of the new G-5 and the finance ministries and central banks of each member. The permanent staff should also be charged with producing a biannual report on the state of global balance that would serve as the agenda for the formal meetings of this organization. Such a new organization would have important implications for other institutions charged with the stewardship of the global economy — namely the IMF and the World Bank. In my opinion, the time is equally ripe to give serious consideration to the long overdue consolidation and possible merger of these two organizations. The largely ad hoc policy architecture currently in place does a real disservice to an increasingly integrated global economy. A serious revamping is in order.
In the end, this action plan is best seen as a wish list for alleviating the key sources of tension in an unbalanced world economy. Maybe I am naïve in presuming that the major powers see the logic of seizing the moment. Maybe the world will only respond in the face of crisis, as Robert Feldman argues. Yet as complex and challenging as the task is, my intent is to offer a very simple message: Global rebalancing is an increasingly urgent imperative for an extremely unbalanced world economy. The United States must figure out how to save again, and the rest of the world has to start consuming. Financial capital needs to flow to its highest returns — not toward subsidizing currencies, export competitiveness, or asset markets. And the world needs to come together in establishing a new framework of consultation and deliberation on these key issues. Globalization is far too important to be left to the self-serving interests of individual nations. An unbalanced global economy is sending a wake-up call that cannot be ignored.
Steven Roach
morganstanley.com |
