Hamish McRae: Emerging nations must help to rebalance world economy, but can they be persuaded?
Economic Life: A decade ago, the West could assume it would be listened to. Its own reputation for reasonable competence was intact. That has gone
Friday 12 November 2010
A punch-up in Seoul? Or more that the world looks different viewed from the East than it does from the West? We'll have to wait a bit to see what actually emerges from the Group of 20 meeting, the first to be held in a G20 country that was not previously a G7 member, but already one thing is abundantly clear. It is that the perceptions of the causes of the recession are quite different in the emerging economies from the perceptions in the developed world. Indeed for much of the developed world there has been no recession at all.
It is an important difference because it leads to different policy prescriptions. Is the principal problem that the West went on a consumption binge financed by borrowing, which led to a banking crisis and hence recession? Or is it that the East used the fact that many of its currencies are undervalued to boost its own growth at the expense of the rest of the world? Everyone agrees there are global trade and payments imbalances that are unsustainable but the apportioning of the blame is completely open. And until you can agree on the causes it is impossible to agree on the treatment.
But if you start from the data, some things do become evident. One is that current account imbalances are particularly a problem for the US rather than for the developed world as a whole. As you can see from the first graph the US current account has not been in surplus since the early 1990s and deteriorated in pretty much a straight line until 2006, when the deficit exceeded 6 per cent of GDP. As the recession stuck and import demand was curbed there was a sharp improvement but the gap remained above 2 per cent of GDP and now that the economy is growing again the deficit has started to widen.
The rest of the developed world, excluding the US that is, has remained close to balance or in modest deficit right through the past 20 years. This is remarkable because that period has included the early 1990s recession, the early 2000s slowdown (and recession in some places), the most recent recession and of course the two growth periods in between. Of course there are imbalances within the developed world, but taken as a whole there is no evidence of trade distortion.
If you take the emerging economies as a whole over the same period there was indeed a gradual shift from deficit to a very large surplus but that surplus has now come right down. You could make a case that the emerging countries did to some extent exploit their position as exporters during the boom years, for example by resisting imports from the West and by holding down their currencies, but it is rather harder to make that case now.
But before anyone concludes that the adjustment is well and truly under way, note the different amounts of slack in the economies of the developed world vis-à-vis the emerging world. That is shown on the other graph. The developed world ex the US is running way below capacity and the US is running with even more slack than the rest. But the emerging world is, if anything, running ahead of this long-term sustainable capacity.
Now the point here is that as we in the West return to full demand we will tend to suck in more imports. Meanwhile the East, for want of a better shorthand expression, is in surplus even when running at pretty much full speed. The imbalances have been corrected to a fair extent but only because we are still way below full output. So there is still a structural problem.
What should be done about it? Well, Goldman Sachs, which did the research illustrated in these graphs, looked at some of the policy shifts needed. One would be a further dollar devaluation, particularly against emerging market currencies. The number it came up with was a 14 per cent devaluation overall, big but not utterly unmanageable. But there would have to be a larger fall against the emerging market currencies and a smaller one against the developed world.
A second shift would be a sustained boost to US and other developed market demand, which will presumably require continued easy money policies. And the third would actually be some modest curb on demand in the emerging world, taken of course as a whole.
That all sounds hunky-dory until you look at the practical difficulties. For a start, the emerging markets, particularly China, will resist a revaluation of 20 per cent, the sort of level implied. Slowly, the yuan is being allowed to creep up against the dollar, but China is desperately anxious to avoid what it sees as the mistake of Japan in allowing its currency to become overpriced.
The other key difficulty is how to boost demand in the developed world, given the burden of debt, national and personal, that we are all carrying. If you add all the debts together, personal debt, company debt, banking debt, national debt and so on, the least indebted of the G7, Germany, is carrying nearly double the debt of the most indebted of the large emerging countries, China.
Put this way, there is no easy solution. Goldman argues that whatever else happens there will have to be a rise in the emerging market currencies against the dollar and other developed world currencies. "No prettying up of language or rewriting will ultimately change this hard fact."
But there is also a responsibility of the developed world to boost demand, and here the Goldman position is controversial. It argues that the big developed countries should hold back on "premature fiscal consolidation", believing that only small and highly indebted countries need to move right away.
Finally, Goldman makes the point that we need to keep in mind what the correct current account position should be. Should the emerging markets, given their stage in economic development, actually be running deficits rather than surpluses? Or given the age structure of their populations, is it natural at the moment for them to save a lot and run surpluses? Either way, since the emerging countries have come very well through this crisis, it will be hard to persuade them to alter their policies.
That surely in the most difficult point of all in these Seoul talks. A decade ago, after the Asian and Russian debt crises, the West could assume it would be listened to. Its advice might not be taken but its own reputation for reasonable competence was intact. That has gone. Why should countries that have had a good crisis take lessons from those that have had a bad one? Actually, it is powerfully in the self-interest of the emerging world to support the open trading system that has enabled it to have such a successful decade. That support now includes allowing their currencies to appreciate and cutting current account surpluses. But it is not the easiest set of ideas to sell to countries that have rightly increased in self-confidence and don't like being told what to do.
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