NOVEMBER 10, 2010.
A Better G-20 Agenda
The real source of global 'imbalances' and how freer trade can help
Exchange rates seem fated to dominate this week's Group of 20 summit in Seoul, though at this point without much agreement. One problem is that leaders, especially the Americans, are focused on the symptoms rather than on the underlying economic fundamentals, and thus are missing an opportunity to press for better solutions.
President Obama and Treasury Secretary Tim Geithner have a point about global "imbalances," but they're framing the issue the wrong way. Talk about trade surpluses and deficits on their own—including Mr. Geithner's proposal to limit them to 4% of GDP—is more distracting than helpful.
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A country's trade balance is simply an accounting identity that by definition matches the flow of goods and capital. Some countries export goods (a trade surplus) and also export capital to help other countries pay for those goods (a capital deficit). Others import goods (a trade deficit) while importing the capital with which to buy them (a capital surplus). Japan and Germany fall in the first category, the U.S. and India in the second. Either is perfectly normal.
The real problem is that for several decades many economies, especially in East Asia, have attempted to thwart these natural flows by running both trade and capital surpluses, and thus accumulating extraordinary levels of foreign currency reserves. Japan has done this for so many years that it is running a capital account deficit even as it sits on an enormous pile of U.S. Treasurys. China and South Korea do the same today.
Trade barriers have long been a central policy tool for governments trying to keep their economies oriented toward exports.
This is where freer trade becomes so important. Trade barriers have long been a central policy tool for governments trying to keep their economies oriented toward exports. Trade barriers raise domestic prices by depriving consumers of the benefits of competition, while also artificially limiting their consumption options. Meanwhile, consumers and businesses aren't sending as much capital overseas to pay for imported goods.
With fewer options for spending capital inflows on consumption or for sending the money overseas in payment for imports, capital ends up boosting investment in overcapacity for exporters. Pre-1990 Japan is the epitome of this bad policy mix. Tokyo employed tariffs and a bewildering array of regulatory trade barriers to suppress imports. A former Japanese official once tried to justify low quotas on American beef imports by arguing that Japanese have longer intestinal tracts unsuited for digesting beef.
Tokyo also forced its citizens to sacrifice their consumption for the sake of its national export machine. Companies and unions, through close links to the bureaucracy, helped tamp down wages. Policies to boost land prices siphoned household income into real estate instead of consumption on imports. So it's little surprise that Japan's imports as a percentage of domestic consumption are, at 16%, the lowest in the developed world, according to the OECD. Since trade barriers stifle productivity-boosting domestic competition, the country remains dependent on exports to fuel growth.
India shows a better way. As part of its big bang reforms in 1991, New Delhi lowered its outrageously high tariffs to a level that is merely unreasonable. The country's fractious and slow-acting democracy never had the political capacity to force on Indians the consumption sacrifices that East Asian governments have imposed. One result is that India runs a trade deficit as it imports goods to fuel growth, and a capital surplus as it attracts the global investment to finance that growth.
This is why no one ever hears complaints about India's reserve accumulation. It's also why New Delhi has been relatively relaxed amid rapid rupee appreciation against the U.S. dollar: Policy makers understand that because they run a trade deficit, the ability to pay fewer rupees for the same amount of dollar-denominated imports will dampen the inflationary effects of large capital inflows.
Which brings us to the G-20 opportunity. Rather than focusing on trade balances as a percentage of GDP—which is merely a symptom of underlying economic realities—Mr. Obama and other global leaders would do better to attack the root causes of trade and capital imbalances. The real key to rebalancing the global economy is to ensure that both goods and capital are free to flow wherever they're wanted or needed.
Free trade agreements can play a central role in this adjustment process. For example, Mr. Obama could promise in Seoul to ask Congress to ratify the pending Korea-U.S. trade deal as it is, without any further modification. Korea is a serial import-blocker and this pact would go far to removing trade hurdles, whether high tariffs or needlessly onerous safety standards for imported cars and the like. American exporters would immediately see more opportunities, as would Korea's domestic entrepreneurs.
Meanwhile, Tokyo seems newly amenable to joining the Trans-Pacific Partnership on trade that Washington has discussed with other Asian partners. Lower Japanese trade barriers could begin to unleash the domestic competition and animal spirits the economy needs to shake off its deflationary malaise.
To exploit these opportunities, Mr. Obama will have to overcome the antitrade bias of his first two years. It is hard to persuade China to lower its barriers to U.S. imports when the White House has imposed a 35% tariff on low-cost Chinese tires, and when its union allies persuade the Commerce Department to grant antidumping duties on Chinese goods.
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Pursuing a trade agenda at the G-20 doesn't mean abandoning monetary debates, but it would put them in proper context. The danger is that by pursuing destabilizing monetary priorities like a revaluation of the yuan (with its concomitant weakening of the dollar), Mr. Obama and other leaders will thwart genuine rebalancing by sending currency markets into further turmoil and making it harder to allocate capital and goods efficiently. A sharp dollar devaluation could also spur more protectionism against American exports.
The linchpin of a "balanced" trading world must be a system of stable exchange rates so that entrepreneurs and investors can judge where goods and capital are most needed across borders. Mr. Obama's best chance for G-20 success is to focus on trade liberalization and exchange-rate stability and then leave the trade flows to the market.
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