A BALANCE GLOBAL DIET / THE NEW YORK TIMES OP EDITORIAL ( RECOMMENDED READING )

October 29, 2009

Op-Ed Contributor

A Balanced Global Diet

By NOURIEL ROUBINI

Global imbalances — roughly defined, the different emphasis the world’s leading economies place on savings, spending and debt — is a phrase much used and little acted upon.
Well before the current financial crisis began, world leaders pledged to address this disconnect. At an International Monetary Fund meeting in 2007, for instance, representatives of the United States and the European Union agreed they should change economic incentives to encourage more savings and less spending; officials speaking for China, Japan and Germany, meanwhile, pledged to take steps to encourage spending. At the end of the day, nothing much happened, and these imbalances helped grease the skids for the global decent toward the economic abyss.

This might not be readily apparent from current numbers; in fact, the financial crisis has contributed to a significant narrowing of global economic imbalances. Consumers in so-called “deficit countries” — states like the U.S., Britain, Spain and the countries of Eastern Europe that have huge trade deficits — are saving more as the crisis has exposed the dangerous extent of their indebtedness. Meanwhile, in China and other large export-driven economies, fiscal stimulus spending and some other policy moves have encouraged more domestic consumption.

The reduction in the U.S. current account deficit — the broadest measure of trade in goods and services — is particularly striking and serves as an example. This reduction holds true across other, less robust economies, too. Many of the emerging economies of Eastern Europe had easily financed wide deficits during the boom years. Now they find they are reducing private consumption in light of the lack of credit.

In more desperate cases like Ukraine and Kazakhstan, this has necessitated currency devaluation that boosts the costs of imports. Others, especially Eastern European countries in line for E.U. membership, have clung to their currency pegs. This leaves room for adjustment only via a sharp reduction in domestic demand.

Changing ingrained habits — whether the tendency is to be too thrifty, or too loose with money — is never easy. There is a powerful temptation to point at current trends and argue that rebalancing is taking place naturally. That would be a big mistake.

All evidence suggests that this rebalancing is temporary — the result of reactive policy measures among exporters and retrenchment among the profligate.

China, the world’s sovereign wealth machine over the past decade, is a case in point. My colleague, Rachel Ziemba, projects China’s current account surplus will likely narrow to $350-370 billion depending on the import trajectory, down from a record $420 billion in 2008. China’s trade surplus was just under $100 billion in the first half of 2009. A trade surplus of about $30 billion in the third quarter of this year is expected, which is well below 2008 levels. Increased spending at home rather than savings could further reduce the surplus. Yet with China reluctant to allow currency appreciation, reserve accumulation has resumed at a strong pace.

Although the export-oriented growth model has been shaken by the crisis, many countries seem reluctant to recalibrate. The beginning of inventory restocking has buoyed Asia significantly, as companies that cut back sharply have now increased output. Avoiding currency appreciation will exacerbate this trend, adding to reserve accumulation and distortions.

The most recent I.M.F. estimates — released in the October 2009 World Economic Outlook — suggest that imbalances could widen again but remain lower (as a share of G.D.P.) than their 2006 peak. Yet the dollar values of these imbalances could be very large.

In the I.M.F.’s forecast, China’s surplus will widen again in 2010, even as a retrenched U.S. consumer remains weak.

So who offsets the U.S. deficit? The I.M.F. suggests a diffusion of imbalances, where surpluses of Germany and Japan will remain in shrinking mode even in 2010, while the deficits of Canada and Australia, as well as emerging economies like Brazil, will offset the growth of China’s surplus.

However, the I.M.F. five-year projections also show a widening current account surplus for the entire world. This could suggest that some of the underlying export assumptions are too optimistic given the growth estimates.

Global imbalances are back on the policy agenda with the G-20 agreeing to create a peer review of macroeconomic policies including imbalances to avoid another crisis. The details are limited so far, but focus once again on an agreement that the U.S. will consume less and save more; Japan, Germany and China will spend more and will reallocate investment away from the export sector.

These are the right goals, to be sure. But a joint communiqué from a nascent international organization isn’t much to hang the world’s hat upon. The I.M.F. needs teeth, perhaps along the lines of the W.T.O.’s authority to prod member states toward “out of court” settlements, in order to enforce these difficult political and economic goals.

These imbalances represent serious misallocations of capital in domestic economies that, projected globally, raise the risks considerably of future financial crises and asset bubbles.

While imbalances did not cause the current financial crisis — I believe lax regulation bears a far greater onus — these imbalances certainly helped create the conditions for this crisis. Easy money and low long-term interest rates created an incentive to invest in seemingly-safe high-yield assets. An orderly unwinding of imbalances might put a lid on global growth during the adjustment, but is fundamental to achieve sustainable global growth.

Nouriel Roubini is a professor of economics at the Stern School of Business, New York University.