Getting Rebalancing Right

Ben Bernanke’s most recent assessment of the world economy was phrased with the requisite diplomatic tact. “Persistent imbalances” in global trade, the U.S. Federal Reserve chairman explained in a speech at the European Central Bank on Nov. 19, “represent a growing financial and economic risk.” But Bernanke’s target was unmistakable: In what has become a constant refrain from the U.S. government, the Fed chief put the onus on China and other emerging markets for jeopardizing global recovery by not doing enough to reduce their trade surpluses. U.S. President Barack Obama tried to be equally judicious in the letter he sent to G-20 leaders before their recent meeting in Seoul, but he had the same clear message to countries with persistent trade surpluses: “A rebalancing of the sources of global demand … [is] the best base for the shifts needed to bring about the vigorous and well-balanced recovery.”

German Chancellor Angela Merkel, German Finance Minister Wolfgang Schäuble, and Chinese President Hu Jintao are having none of it. Schäuble said in an interview with Der Spiegel before the G-20 summit, “There are many reasons for America’s problems, but they don’t include German export surpluses.” Schäuble blames countries with persistent deficits — the United States above all — for the current mess, and expects them to impose fiscal austerity and tighter monetary policy to right the global economic ship. Germany, with its expected 3.7 percent GDP growth in 2010 and a current account surplus of 6 percent of GDP, is convinced that its surplus is the result of prudent economic policy and that it is not to blame for troubling global imbalances.

But as a simple matter of accounting, a German or Chinese current account surplus must be offset by another country’s deficit. In a recent interview, IMF Managing Director Dominique Strauss-Kahn rightly stated, “You can’t defend your own surplus and at the same time criticize others’ deficits.” Germany’s chronic surpluses are destabilizing to the global economy because they are an integral part of deficits elsewhere in the world.

That’s precisely why those surpluses are unsustainable. Demand in deficit economies remains impaired for the near future due to the Great Recession and the collapse of the credit bubble. After providing the bulk of demand for exports for the past decade, deficit economies are now overwhelmed with record private debts and rising public debt. While the U.S. government may be able to continue to borrow and support global demand for a time, American consumers are mostly tapped out. In other deficit economies, such as Portugal, Italy, Greece, and Spain, governments can no longer borrow at reasonable interest rates from international capital markets. They have had to impose severe austerity programs and seek international assistance to enable them to manage their debt through the crisis.

Thus, export-dependent economies will be fated to slow down. And sure enough, Germany is expected to slow from 3.7 percent growth in 2010 to 2.2 percent in 2011, according to advisors to the German government. According to the IMF, Japan may grow 2.8 percent in 2010 after a better-than-expected third quarter, but will slow to 1.5 percent in 2011. Similarly, Singapore’s economy will grow at 15 percent in 2010, but the government expects it to slow to between 4 and 6 percent in 2011. China, the poster child of the economic recovery, might also slow in 2011 due to government efforts to tame inflation.

And yet, in the wake of the Great Recession, many surplus economies still continue to rely on export-oriented policies. China, for example, has continued along this path by allowing its trade surplus to rise steadily since the beginning of the year. Consumer demand growth in Japan, meanwhile, has been anemic.

The IMF expects annual current account surpluses — the sum of the world’s positive national trade balances — to rise from $1.23 trillion in 2009 to $1.93 trillion in 2015, an increase from 2.13 percent to 2.36 percent of estimated global GDP.

International institutions ought to do something to right those imbalances, but the intransigence of several G-20 leaders who refuse to concede their trade surpluses has made that impossible. So while the summit’s final communiqué acknowledged the danger of global imbalances and recognized a need for greater monitoring and structural reform, like many of the previous communiqués, it lacked details on how that should be achieved.

In light of the need to monitor large imbalances and highlight the measures surplus economies can take to stimulate demand in their own economies, the New America Foundation released a new economic indicator, the Current Account Surplus Watch. The Surplus Watch is the first comprehensive list of all major economies with persistently large current account surpluses that have inadequate measures to increase demand in their economies or otherwise offset their surpluses by creating demand abroad. Five of the largest surplus economies on the Surplus Watch are members of the G-20 (China, Germany, Japan, Saudi Arabia, and Russia). The 16 other countries with chronic surpluses range from export-economies in Asia such as Malaysia and Taiwan, to advanced economies in Europe like Switzerland, Sweden, and the Netherlands. They also include a number of oil-exporting economies such as Kuwait and Russia.

But simply having a surplus is not enough to be put on the Surplus Watch. While U.S. Treasury Secretary Timothy Geithner proposed setting a hard numeric target of 4 percent of GDP for current account surpluses and deficits, the Surplus Watch rewards surplus countries for pursuing policies that increase domestic and international demand, like expansionary fiscal policy and exchange rate appreciation. If they pursue them sufficiently, they are removed from the Surplus Watch entirely.

Stimulative policies do indeed have an effect. Take Sweden as an example. As a result of export oriented policies and weak domestic demand, Stockholm’s current account surplus averaged 7.8 percent between 2007 and 2009, higher than its neighbor to the south, Germany. Sweden pursued some mitigating policies to reduce its surplus by running a budget deficit, allowing its exchange rate to appreciate, having rising real wages, and contributing over 1 percent of gross national income (GNI) to international development assistance. During the first nine months of 2010 these policies contributed to an average monthly increase in Sweden’s imports of 17.2 percent, while exports climbed only 12.1 percent. As a result of faster import growth, Sweden’s trade surplus fell from 72.2 billion krona ($10.5 billion) during the first nine months of 2009 to 48.4 billion krona ($7.1 billion) during the first nine months of 2010. The Surplus Watch rewarded Sweden’s falling surplus and the measures it took to increase demand by moving it below Germany on the Surplus Watch.

Stimulating domestic demand has to be at the center of efforts to readjust surplus economies. Pushing China to substantially revalue its currency, as the U.S. Congress has proposed, could be futile if it were offset by government measures to increase the competitiveness of its exporters, such as easier credit from state-owned banks. Hard current account targets of 4 percent, as Geithner proposed, would probably do more harm than good to countries with large current account surpluses, like Singapore, and would not help resolve the surpluses in oil-exporting economies. Rather than relying on a short-run punitive framework, the G-20 should reward countries for their efforts to increase demand and reduce their current account imbalances over time.

This framework would also allow the G-20 to address the large current account surpluses in resource-based economies that predominantly export crude oil. Because surpluses in resource-based economies are fundamentally different from economies that export manufactured goods — due to their dependency on volatile crude oil prices — the IMF and the G-20 have largely ignored the role resource economies can play to reduce or offset their surpluses. But it would be a mistake to absolve them of the responsibility to foster a global adjustment. Surpluses in these economies played a central role in global imbalances leading up to the crisis, growing from $156 billion in 2000 to $561 billion in 2008. Resource-based surpluses declined to $218 billion in 2009 due to falling crude prices, but since the end of 2009 oil prices have increased, pushing the surpluses in resource economies to potentially unprecedentedly higher levels.

Resource economies have no choice but to trade hard commodities for financial assets and run large current account surpluses. This allows them to accumulate savings for periods when crude prices fall or if commodity reserves run out entirely. For example, Saudi Arabia ran a current account deficit for much of the 1990s when crude prices were relatively low and it invested in equipment for drilling. But regardless of the unique need to accumulate savings for periods of low commodity prices, resource economies should still be encouraged to play a positive role in rebalancing the global economy by diversifying their domestic economies and encouraging greater human development. Investment in higher living standards, better health outcomes, and higher educational achievement for their domestic populations can lay the foundation for more balanced growth and wean these economies off their reliance on volatile oil prices. Resource economies can also increase demand through international development assistance, which offsets their surpluses by creating demand abroad. Saudi Arabia is a model in this respect, contributing 1.19 percent of GNI in development aid in 2008, the highest among all countries on the Current Account Surplus Watch.

Of course, it’s hard for deficit economies to convince economies that are now exporting their way to recovery that their policies are destructive. But the fact is, the ideas offered by surplus countries would be disastrous. Leaders in Germany and elsewhere suggest that deficit economies should drastically reduce their borrowing, but absent an increase in global demand, those policies would plunge the world into a second Great Depression. G-20 leaders have to take the lead, building on their recent communiqué by agreeing to penalize economies that continue to rely on chronic surpluses for growth — through greater monitoring, censure, and ultimately, financial sanctions. There’s no quick fix to the global downturn, and after a series of band-aids, the world is long overdue for a sustainable economic solution.