Rebalancing a lopsided global economy

• Published date: 01 November 2019
• Date: 01 November 2019
• DOI: http://doi.org/10.1111/twec.12839
• Author: Adam Triggs

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wileyonlinelibrary.com/journal/twec World Econ. 2019;42:3188–3234.

© 2019 John Wiley & Sons Ltd

Received: 5 June 2018

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Revised: 3 February 2019

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Accepted: 13 June 2019

DOI: 10.1111/twec.12839

ORIGINAL ARTICLE

Rebalancing a lopsided global economy

AdamTriggs1,2

1Brookings Institution, Washington, District of Columbia

2Crawford School of Public Policy,Australian National University, Canberra, Australian Capital Territory, Australia

KEYWORDS

computable general equilibrium models, econometric modelling, fiscal policy, international trade and finance, intertemporal

choice, macroeconomics, mathematical methods, structural reform

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INTRODUCTION

In 2010, the US Treasury Secretary Timothy Geithner wrote a letter to G20 finance ministers.

Concerned about the growth in current account imbalances between 2000 and 2007, he recommended

a radical approach: that each G20 country pledge to keep current account surpluses and deficits within

4% of GDP (Davies, 2010).

Geithner's idea was politely rejected. But what he tried to do highlighted the level of concern among

policymakers over the growth in global current account and trade imbalances since 2000. These po-

litical concerns have intensified significantly since the election of Donald Trump as President of the

United States (see Donnan, 2017).

International discussions on global imbalances are helpful to policymakers in under-

standing the overall effects of their policies, how others view their policies, how policies

affect one another and so on. So I think those discussions were useful. –

Ben Bernanke, former Chair of the Federal Reserve, United States, interviewed 7

August 2017

The current account measures the difference between the level of domestic savings and investment in

an economy. Many East Asian and European economies have large current account surpluses because their

firms, households and governments collectively save more than is invested in the economy. This surplus of

savings goes overseas and finances investment in economies which are in the opposite situation: economies

which have firms, households and governments that collectively save less than is invested in their econo-

mies. These economies, such as the United States, United Kingdom and Australia, have current account

deficits.

Having a current account deficit or surplus is not necessarily a bad thing. A country might run a

current account deficit because it has strong future development prospects, encouraging its citizens

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TRIGGS

to smooth consumption by borrowing today in anticipation of a prosperous tomorrow. Conversely, a

country might run a current account surplus because it has an ageing population which is saving for

retirement, because it has a mature economy with fewer investment opportunities such that its savers

explore opportunities offshore, or because the government is accumulating foreign exchange reserves

in the light of an insufficient global financial safety net.

But economists such as Maurice Obstfeld,1 Kenneth Rogoff,2 Ben Bernanke3 and Mervyn King4

argue that the rise in global imbalances (Figure 1) was intimately linked, if not a key cause of, the

global financial crisis by fuelling unsustainable booms in credit and asset prices. More recently, Brad

Sester from the Council on Foreign Relations has suggested that global imbalances might be a critical

contributor to depressed global interest rates, with implications for long‐run stability (Sester, 2016).

Current account imbalances can be particularly problematic for deficit economies. Growing deficits

raise the risk of a “sudden stop” – a change in sentiment where investors suddenly become unwilling

to finance a country's deficit. International linkages and poor cross‐border processes for the resolution

of troubled banks and financial institutions mean sudden stops can quickly become global events.

Similarly, Blanchard and Milesi‐Ferretti (2011) have warned that current account imbalances are,

in many instances, not benign because they are being driven by domestic distortions. For deficit econ-

omies, these distortions can include poorly regulated financial systems that fuel asset price bubbles

or irresponsible fiscal authorities reducing national savings through excessive spending. For surplus

countries, distortions can take the form of a lack of social insurance driving up precautionary saving

or inefficient financial intermediation leading to low investment. Globally, an inadequate global fi-

nancial safety net can lead to governments opting to self‐insure through the accumulation of foreign

exchange reserves.

1 See Obstfeld & Rogoff (2018).

2 See Obstfeld & Rogoff (2018).

3 See Bernanke (2009).

4 See King (2016).

FIGURE 1 Average current account balance from 2000 to 2016 as a per cent of G20 GDP.

Source: IMF world economic outlook database, October 2017

–1.2 –1 –0.8 –0.6 –0.4 –0.2 0 0.2 0.4

United States

United Kingdom

Spain

Australia

Brazil

Turkey

India

Mexico

Italy

Canada

South Africa

Indonesia

Argentina

France

Korea

Saudi Arabia

European Union

Russia

Japan

Germany

China

Per cent of G20 GDP

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TRIGGS

Concerns about global imbalances are not new. The deflationary bias in the global economy was

a critical concern of Keynes in the 1920s and many others since then. The international gold standard

which prevailed at the time was supposed to automatically adjust current account imbalances through

price rises in the gold‐gaining countries and price falls in the gold‐losing countries. The problem, as

Keynes identified, was that adjustment was “compulsory for the debtor and voluntary for the creditor”.

Surplus countries faced little incentive to reduce their surpluses while debtor countries still needed to

roll over their debts.

Keynes' clearing union plan of 1941 was designed to address this. It was designed to create pressure

on both deficit and surplus economies to return to balance to prevent the build‐up of global imbalances.

But after being vetoed by the United States, the International Monetary Fund was created to instead pro-

vide support to deficit countries facing balance of payments difficulties, provided they corrected their

policies (Joshi & Skidelsky, 2010). Many authors have noted, however, that the current system leaves

the issue of global imbalances unresolved (see Joshi & Skidelsky, 2010; Mann, 2010; Portes, 2010).

Concerns around global imbalances have been particularly prominent in international forums since

2000.5 In 2008, the newly minted G20 leaders' forum picked up this agenda and has continued it ever

since. Leaders identified “unsustainable global macroeconomic outcomes” as a root cause of the crisis

and committed to move towards “a more balanced pattern of global growth” and “adequate and bal-

anced global demand” (G20, 2008, 2010). They developed the G20 framework for strong, sustainable

and balanced growth and a Mutual Assessment Process, with a focus on addressing global imbalances.

They described it as “a compact that commits us to work together to assess how our policies fit to-

gether” and to “establish a pattern of growth across countries that is more sustainable and balanced”.

The G20 has been largely ineffective on global imbalances. It failed to create a new po-

litical consensus that you cannot simply have permanently exporting countries without

creating significant imbalances for the rest of the world which, ultimately, creates prob-

lems in financial, trade and political systems –

Kevin Rudd, 26th Prime Minister of Australia, interviewed 8 September 2017Our argu-

ment at the Bank of England for reducing global imbalances is that countries could focus

more on liberalising trade in services. The countries that tend to have the largest trade

deficits in goods, such as the United States, also tend to have a comparative advantage

in the export of services. Liberalisation of services trade would help some economies

reduce their trade deficits –

Mark Carney, Governor of the Bank of England and Chair of the Financial Stability

Board, interviewed 16 February 2018

G20 leaders tasked finance ministers and central bank governors to develop indicative guidelines to

identify the nature and root causes of global imbalances. They used the G20's mutual assessment process

5 In 2003, the G7 warned there were significant risks posed by large imbalances between countries. In 2004, the European

Central Bank voiced concern that the large and growing current account deficit in the United States posed significant risks for

global financial stability. In 2005, Alan Greenspan added his voice to these concerns, warning that the US current account

deficit “could not widen forever.” In June 2007, the IMF’s first multilateral consultation looked at this issue. Talks included

China, the euro area, Japan, Saudi Arabia and the United States. All countries agreed that reducing global imbalances was a

multilateral challenge and that resolving them in a manner compatible with sustained growth was a shared responsibility.

They stressed that an orderly unwinding of imbalances was in the interest of the world economy, including because sustained

imbalances in trade and current accounts could result in a sharp rise in protectionism.