China can no longer behave like China, because the U.S. intends to behave much more like China, according to Larry Summers, director of U.S. president Barack Obama’s National Economic Council. There is widespread consensus that global account imbalances – in particular the large current account deficit of the U.S. and the large Chinese current account surplus – contributed to the financial crisis of 2008-09 by adding to excess liquidity in U.S. financial markets and encouraging the development of toxic financial products. There is even greater agreement on the need to rebalance world demand to support and sustain recovery.
American households and businesses have to rebuild their balance sheets, which requires higher private savings and a lower current account deficit. This means lower net U.S. demand for goods and services, which should be compensated for by higher demand elsewhere, requiring the rest of the world to have more imports net of exports.
In this debate the rest of the world is often taken to mean China. But neither the U.S. deficit nor the Chinese surplus is, of course, determined bilaterally. China’s current account surplus was $426bn in 2008 compared with a U.S. deficit of $706bn. Both these current accounts – as with all others – were the sum of bilateral deficits and surpluses with all countries. Nonetheless, the Chinese surplus has been huge as a percentage of Chinese gross domestic product – close to 10 per cent – and large in absolute terms. It is reasonable to ask how it might be reduced to compensate for a decline in net demand from the U.S. The International Monetary Fund, however, currently expects the Chinese surplus to rise again, after a temporary decline, to $595bn in 2012.
Yet the focus on China has been excessive. While it certainly would be desirable for the Chinese surplus to decline, this cannot happen overnight without negative effects on Chinese growth. China can alter its growth model only over a number of years by gradually shifting more resources into non-tradable sectors away from exports and import substitutes, letting its real exchange rate appreciate. If China tried to do this too quickly, domestic supply-demand imbalances would lower the growth rate, with large excess capacity in tradable goods acting as a break on growth and employment because capital could not shift rapidly enough into non-tradable activities. Lower Chinese growth would not only be bad for China but also for all countries exporting to China, as it would swamp the effects of a reduction in China’s current account surplus. We should not forget that Chinese growth has been good for world growth.
The large surplus projected by the IMF for China in 2012 could perhaps be lowered by a few percentage points of GDP, maybe to $400bn, but lowering it further may not be desirable from the point of view of world growth in that timeframe. Another problem is that the Gulf oil exporters are also likely to run a large surplus, projected at close to $250bn by the IMF, with oil prices forecast to be on the high side as the recovery gains strength. Japan, too, will continue to have a surplus, in part reflecting the need to save more, given its ageing population. So where should the increase in net demand needed to “rebalance” the world economy come from? Who should be running larger deficits?
The obvious answer is the emerging and developing economies, outside of China. Their balance of payments and economic prospects vary widely, but as a whole they have not been net importers of capital in the recent past, despite improving macroeconomic frameworks, a great need for investment and, on average, high returns on capital. Instead, many of these countries have tried to hoard foreign exchange reserves to self-insure against risks from world capital markets.
The other part of the story is that, individually, many are still considered high-risk destinations by foreign investors. Taking 2012 as a reference point, if these countries as a group were able to run a current account deficit of about $500bn, close to about 3 per cent of their GDP on average, that would constitute a significant addition to net demand for the rest of the world and contribute to allowing a more “gentle” rebalancing of the world economy than an abrupt large decline in the Chinese surplus would.
What is needed to make this happen is: more investment from China and the Gulf oil exporters in the developing world; more lending from the multilateral development banks; multi-lateral and bilateral insurance schemes to mitigate the risks faced by long-term private investors; precautionary IMF finance reducing the demand for reserves; significant carbon market-related resource flows to developing countries; and solid economic policies in those countries themselves. Greater focus on these challenges, alongside the valid concern about the Chinese surplus, would be good for job creation and growth worldwide.