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Global Economy & Imbalances

by wchurchill Thu Nov 24th, 2005 at 01:42:46 PM EST

Migeru asked the following question on another thread, "WChurchill, what do you have to say to the IMF's warnings about the imbalances in the US economy, and its global consequences?"  It led me to some research, some good articles, one in particular, and a long response that I thought might be worth a diary.
So, Migeru, your note prompted me to Google this subject and the first item on the search was a great talk,

The Global Economic Outlook and Risks from Global Imbalances
Remarks by Rodrigo de Rato
Managing Director of the International Monetary Fund
At the Spain-U.S. Chamber of Commerce
Miami, Florida
September 30, 2005
Migeru, since he is an IMF spokesman, and the title of the article is so close to your question, I'm assuming his positions are what you are addressing but perhaps you could link over to it and make sure.
I'm a little surprised to find that I agree with basically everything he says.  First, he is quite positive on the overall global outlook,
The global economy has been strong over the past couple of years. Growth in 2004 was the highest in three decades, with world output increasing by over 5 percent. We also expect growth to continue at a good pace in 2005 and 2006, despite a number of recent shocks, including higher oil prices and two hurricanes in the United States. Even with an expected dip in U.S. growth in the fourth quarter, we expect global real GDP growth to be over 4 percent in 2005 and 2006.
Yet he identifies a number of risks for the world economy:

The outlook then is generally good. However, there are risks, and some of the most serious of these come from global imbalances. Put simply, the world needs to move away from a pattern of growth where investment in most of Asia is too low, and high consumption in the U.S. is financed by rapidly increasing debt, and where growth of domestic demand in Europe and Japan is too weak.
He then goes on to address each of these risks in more detail, the first being the budget deficits in the US:
As so often in the recent past, the United States economy has been one of the main engines driving global growth. But the vulnerabilities of the U.S. economy are increasing. The persistent and large U.S. external current account deficit has caused U.S. net external liabilities rise to unprecedented levels--that is, as foreigners own more and more U.S. assets--relative to the size of the economy. In the face of this, we have to ask when the appetite of the private sector for U.S. debt will weaken. If this happens, it could be accompanied by an abrupt increase in interest rates, a cooling of housing and other asset markets, and a sharp slowdown in demand by U.S. households. The best way the U.S, can reduce its external current account deficit is to reduce its budget deficit. Reducing the budget deficit is in any case important given the impending pressure on entitlement programs from the retirement of the baby boom generation.
There is no question that the budget deficits are very concerning.  They must be fixed, and the question is will current economic policies address the issue, and will the politicians have the political will to control spending.  I'm somewhat hopeful that current growth will drive increasing revenue.  I'm also somewhat hopeful that the spending on Iraq will be decreasing beginning in the second half of '06.  those are two very important factors moving IMHO in the right direction.  I also agree that tax simplification would be a plus to the economy, but am concerned that the political will to do that is not there.  And politicians always have trouble controlling overall domestic spending.  But overall, I think the deficits will start to fall, and investors around the world will continue to favor the US economy as the most stable and consistently growing, and will therefore continue to invest,eg buy dollars.  My biggest concern is that we are not addressing the social security issue that he refers to, and I'm afraid the politicians will toss it around as a political football, and not get anything done.  So I'm concerned in the next decade for US investments, and if nothing changes, will dramatically change my positions--but that's a long time away, and things could change.
But he also makes points on other areas that he feels should be addressed to correct global imbalances:
But it is not only the U.S. which needs to take action to reduce global imbalances. Europe and emerging Asia can help by taking measures that will increase domestic demand in their economies:

In Europe, governments need to articulate comprehensive, growth-oriented strategies that address both unemployment and aging, mainly through reducing the rigidities prevailing in labor, product, and service markets. They should also extend the Single Market to the provision of services, including financial services.

In emerging Asia, more exchange rate flexibility is needed. China and Malaysia have made some welcome changes to their exchange rate regimes lately, and I hope that the authorities will use the flexibility afforded by their new arrangements, and that other countries in Asia which have been managing their exchange rates more flexibly will continue to do so. In addition, Asian countries should pursue structural reforms--including to encourage higher investment in some countries and better investment in others.

And, do I hear European and American farm subsidies being addressed in what follows?
Let me conclude by saying a few words about another issue--trade. There are a set of meetings coming up on trade in December--the meetings of the World Trade Organization in Hong Kong--that are very important for the world economy. Why do these meetings matter? Because free trade is essential to maintain strong and sustained global growth, because these meetings offer the best chance of significant progress on the Doha Round of discussions on trade liberalization, and because there are rising protectionist sentiments in a number of countries, which must be resisted. Leadership is needed from the large countries, which have much to gain from these negotiations in terms of the opening up of markets, and which have an opportunity to help developing countries while making goods less expensive for their own consumers. Developing countries also have a lot to gain from undertaking ambitious trade liberalization, not only because of the opportunity to improve their access to industrial country markets but because greater openness to trade can lead to stronger institutions and better growth prospects. Governments must grasp this opportunity.
I think his view on the global economy is very much right on, and in addition identifies programs in all parts of the world that could bolster growth, and increase economic well being around the world.  But then again, my glass tends to always be half full, and never half empty.  Maybe he has the same glass.

IMF? That's the bright boy who've "helped" Argentina, right (besides a host of other countries)?

Note: Some years ago I had to write a paper about the mess which happened in Argentina. Actually, during the research I found papers on the IMF website which were written by some lowly scientists and very were true and predicted everything which finally happened. Needless to say, the bigwigs didn't listen. As this article is written by the Managing Director of the IMF, I would be careful.

Me personally, I'm just sick of the "growth, free trade, growth, flexibility, liberalization" mantra.

by srutis on Thu Nov 24th, 2005 at 04:45:49 PM EST
...lowly scientists never get the creds when they have it right.

</snark time>

by Nomad on Thu Nov 24th, 2005 at 06:30:21 PM EST
[ Parent ]
Good diary.

Here's some food for thought for you on the budgetary front:

Dépenses = Spending
Recettes = Income

both as a % of GDP.

This is the only time that spending has increased after the recession instead of going down. 9/11 changed everything.
This is also the most massive cut in income that you can see. Coming back on the insane tax cuts for the rich might be a good thing, don't you think? (And the increase in recent months is due to the one-off repatriation of profits by US corporates thanks to the law allowing these to be taxed less than usual)

I'd argue that a good way for Europe to consume more would be for the English language commentators to stop saying that everything is going badly in the eurozone. This has a bad influence on morale, and thus consumption, and happens not to be true:

As to Asia - indeed, they should invest more domestically. But they fear inflation, they fear losing their competitivity if they devalue, and they fear that the US economy will close to them if they stop buying US Treasuries, so it's not so easy.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Nov 24th, 2005 at 04:56:26 PM EST
Any idea how the employment situation has changed from 2001-2005 in Europe?  I suspect much of the job growth, both in America and Europe, came during the Dot-Com Boom, and that the growth has been poor in both since the recession began.

The US unemployment rate is also, as you all know, not only 5%, but more on the order of 6-7%, if you calculate the statistics properly.  So I suspect Europe is in slightly better shape, comparatively, than these numbers suggest.

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (pedobear@pennstatefootball.com) on Thu Nov 24th, 2005 at 06:17:34 PM EST
[ Parent ]
Jerome, the first chart you showed from the BEA was significantly differnt from the numbers in the US annual budgets.  The BEA figures show revenues and expenditures around the 30--35% of GDP level, while the US numbers show more like a 20% level.  It might be at least partially due to handling social security differently, but I just didn't have time to track it down.  PS: I commented more broadly below--look forward to your comments.
by wchurchill on Fri Nov 25th, 2005 at 02:28:15 AM EST
[ Parent ]
Well, I sure am glad I made that comment.

I was actually referring to the 2002 IMF World Economic Outlook. I must have originally learnt about it from this article (most likely the scavenged version at CommonDreams.org) but, given the standards of discourse on ET, I suppose I should refer to the original source, which is Chapter II: Essays on Trade and Finance:

How Worrisome Are External Imbalances?
External imbalances across the main industrial country regions widened steadily during the 1990s. Current account surpluses in many countries and regions, including Japan, the euro are and (in the late 1990s) emerging markets in east Asia, were counterbalanced by deficits elsewhere, most notably in the United States . Indeed, in the United States and Japan, the ration of the current account balance to trade flows—perhaps the best measure of the degree of underlying imbalance—have risen to levels almost never seen in industrial countries in the postwar period. A a result, Japan is exporting 1.5% of world saving and the United States is importing 6%.
One of the major concerns associated with the global imbalances is the possibility of an abrupt and disruptive adjustment of major exchange rates. At the outset, it should be emphasized that exchange rates are highly volatile and unpredictable, and economists have had little success in forecasting exchange rate movements over the short term(Meese and Rogoff, 1983). Over the medium term, however, real exchange rates do tend to revert back toward the fundamental values (Taylor, 2001, and Engel, 2002). While it is difficult to know when adjustment will take place, it is essential to anticipate the potential risks and costs that may be associated with adjustment, and whether these can be mitigated by policy actions.

Evolution of Global Imbalances
There is now a gap of some 2.5% of global GDP between the current account surpluses of continental Europe and east Asia (dominated by the euro area and Japan, respectively) and the deficit countries, dominated by the United States.
In short, the expansion in the imbalances in the deficit countries in the 1990s reflected faster growth combined with financial excesses involving buoyant expectations about future economic prospects associated with the IT revolution.
Large external surpluses and deficits have also led to increasing divergences in net foreign asset positions across countries, with Japan building up net assets and the United States, net liabilities (Figure 2.3). Indeed, the foreign asset position in both countries is approaching or beyond their own historical records.
Are the Imbalances Viable and How Might They Adjust?
in the absence of revaluations of asset prices, the current forecasts implies that Japanese net assets as a ratio to GDP would rise by about one-third (to about 40% of GDP) between now and 2007, and US net liabilities would double (again to about 40% of GDP). In both cases, this would be unprecedented by the countries' own historical standards. Indeed, even the existing net asset position of these two countries are difficult to explain on the basis of underlying fundamentals.
Large external adjustments would be needed to stabilize net foreign asset positions as a ratio to GDP. [...] Past experience indicates that significant reductions in external deficits generally occur through a combination of a slowdowns in output growth, which lowers demand relative to output through its effect on consumption an investment, and a depreciation of the real exchange rate, which switches spending from foreign to domestic goods. The time over which external adjustment occurs is also important . An extended period allows more time for countries to adjust their production structure, thereby reducing the size of the needed exchange rate adjustment (Obstfeld and Rogoff, 2000).
The historical analysis suggests the likelihood of a reduction in external imbalances over the next few years, involving slowing output growth in the deficit countries and a depreciation of their currencies a year or so before these reductions are seen. Given the size of the deficit countries in the global economy, this in turn implies—all else being equal— appreciations of the currencies of the surplus countries. History also suggests that a rapid and potentially more disruptive adjustment is a significant possibility.

I realize that I was 3 years out of date (I'll have to read the 2005 outlook to see if the analysis is substantially different) but it does not seem to me that the imbalances have been corrected. On the contrary, the US government (and the Fed) has run a reckless economic policy based on huge domestic and foreign debt to fuel consumption of imported goods, so that the trade and exchange-rate imbalances with China are now very serious.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Thu Nov 24th, 2005 at 07:02:11 PM EST
Please take a look at my comments below, in terms of historical comparisons, and forecasted results, and let us know what you think.  Also any updates on the 2005 reports would be greatly appreciated.
by wchurchill on Fri Nov 25th, 2005 at 03:30:44 AM EST
[ Parent ]
These questions and comments are great for me, because they make me research areas more thoroughly, data that I normally just breeze through.  And frankly, my findings here surprised me a lot.  As a preface, I am somewhat of a hawk on balanced budgets, and deficits being a bad thing.  I have mentioned before that I'm economically conservative, and socially liberal--to the extent that you can generalize things like that.  So from an economic perspective, I don't like these deficits we are running in the US.

But my research surprised me, in the sense that I found that these deficits we are incurring are not out of line historically.  Let me refer you to my data sources, first USA Historical Budget Data, and then second Budget Outlook 2005--2014.  I have looked at the average annual budget deficit, as a % of the GDP, for each of the last three decades, and the projected annual average deficit for 2000--2009 for the USA.  In addition I have shown the highest budget deficit in each decade for one particular year.  Following is the summary chart, and as you will see, the current decade is not at all out of line with the previous three.  

            Avg % deficit         Highest % in one year

`70's             -2.1%                  4.0%
`80's             -4.1%                  6.0%
`90's             -3.1%                  5.4%
`00's             -2.3%                  5.0%

In fact, the first decade of this century will be better than the '80's and '90's, and only slightly worse than the '70's.

A legitimate criticism of the above, is that the first decade of the 2000's is half forecast, and half actual.  So maybe the forecasts won't be achieved.  my own perspective on that is that I think the tax revenue numbers will be overachieved, because they underestimate the growth of the economy, and that overachievement will offset the tendencies of these political loonies to spend as much as they can on "pork".  <snark,,,or maybe partial snark>

If you want to compare to the EU, my understanding is that the goal is to have annual deficits below 3% of GDP, and the USA beats that in this table for every decade except the '80's.

So that puts into perspective the annual borrowing of the US.  But a second question would be, how much does the US owe in total--in other words the cumulative effect of all of this borrowing.  As of today, this number has built to roughly 38% debt, as a % of US GDP.  It is projected to climb to the lower 40%, but be back down in the mid 30's% by the end of the decade.  I was a little disappointed in my ability to find data for other countries, but in what I found, it appeared that France was in the 40% zone, Germany a little higher, and Japan much higher being in the upper 70% of GDP.  I think the UK may be lower than all of these.  So I became convinced that the US is not out of line by any means on this measure--but there are economists on this site who may want to comment here--and perhaps set me straight, as I may have misinterpretted some data.

But my conclusion is that from an economic perspective, the US is going to weather this storm--the 9/11, Iraq war, dotcom plunge storm,, that is.  Though in my business, I'm going to watch this like a hawk for any slipping off this plan, or these assumptions changing.  I'm just encouraged as I see things now.

by wchurchill on Fri Nov 25th, 2005 at 02:17:51 AM EST
"highest % in one year" figures should have minuses.  But you probably knew that.
by wchurchill on Fri Nov 25th, 2005 at 02:44:39 AM EST
[ Parent ]

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