Global Imbalances Are Much More than the US-China Relations

Triple Crisis Blog invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. This piece is based on a question from a reader on the over-valuation of the Yuan.

Martin Khor

The problem of global imbalances is widely seen as a major issue to be resolved if the world economy is to be on track for a sustained recovery.  And this problem is also usually discussed as arising from the economic relations between the United States and China.

In this view, the US has been over-consuming beyond its means, thereby having a large trade deficit, while China has been growing as a result of exports, thus earning large trade surpluses and investing them in US treasuries, thereby making the US over-consumption possible.

There are strident calls from US Congress members and economists for the Obama administration to take action against China, such as levy of 20% or more on Chinese imports, if it does not revalue its currency.

However, it is misleading to portray global imbalances as mainly or merely a US-China affair, or to imagine that a change in the currency levels between the US and China will get rid of the United States’ economic woes.

A more useful way of looking at the prospects for economic recovery is to view the main weakness of the global economy as one of a lack of global effective demand. We would then examine the sources of this deficient demand and see how demand can be appropriately boosted, while taking care not to build new financial bubbles and to prevent the types of financial speculation that helped create the financial crisis.

These are some of the themes covered by a recent paper by the South Centre, “Global economic prospects: The recession may be over but where next?” which is written by the Centre’s Special Economic Advisor Yilmaz  Aküyz  (formerly a Director at UNCTAD).

The paper  examines how the major economies—the United States, Germany, Japan and China  – are contributing to global demand, what their weakness are and what policies they should take.  The followinhg are some of its main points:

US has to adjust

The US economy (with its problems of high household debt and trade deficit) has to adjust. It has to tackle its over-consumption and increase exports to reduce the trade deficit. But this adjustment will cause its own problems for many developing  countries as it may result in increased interest rates (which are bad for  indebted countries) and a higher dollar (exerting a downward pressure on  currencies in developing countries in deficit, and on commodity prices).

Germany and Japan have to play a more positive global role

Much attention has been on the US-China relation, to the neglect of the role of Germany and Japan. These countries, like China, have been having large current account surpluses (7.5% of GDP in Germany and 4.8% in Japan, before the crisis).   They also have large trade surpluses with the US ($50 billion for Germany  and $75 billion for Japan).

The overall trade surplus of China (11% of GDP) and its trade surplus with the US ($270 billion) is higher. However the contribution of Japan and Germany to global demand and growth is much smaller than China’s and their reliance on exports is much greater.

Firstly, the real domestic value of China’s trade surplus with the US is  actually lower than the gross figure because there are a lot of imported   components in Chinese exports.  Thus in 2005, the trade surplus of China   with the US was $172 billion in conventional terms, but it was only $40 billion in value-added terms (the amount after deducting the import content of the exports of both counties).

In the same year Japan’s surplus with the US was $85 billion.  Since the foreign content of Japan’s exports is lower than the foreign content of US  exports, in value added terms Japan’s surplus with the US turns out to be higher than China’s surplus with the US.

Secondly, and more importantly, “Japan and particularly Germany have been  siphoning global demand without adding much to global growth.”  During 2002-07, exports grew 25 times faster than domestic demand  in Germany and 8.5 times in Japan while the figure is less than 3 for  China.

While exports contributed 34% to GDP growth in China, they contributed 50% to Japan’s GDP growth and 143% to Germany’s growth in 2002-2007.   In other words, even if there had been no export growth in China, the GDP     would still have enjoyed high growth, but without export growth Germany’s GDP would have fallen by about 1% a year during 2002-07.

Under-consumption is a major problem in Germany and Japan.  In Germany, there has been high unemployment and stagnant wages because of an over-focus on price stability.  In both countries, the share of wages has fallen, thus suppressing consumption.

These two advanced countries need to increase their contribution to global demand (and thus to the global recovery) by expanding their domestic consumption through faster wage growth.  Their increased domestic demand   and higher growth is needed to spur more imports and reduce their trade surplus, which would contribute to other countries’ exports and GDP growth.

China should adjust, but don’t expect it to be the world’s growth engine

China, through its high growth and its reliance on both its own domestic  demand and exports, has contributed relatively more than the two  industrial countries to global growth, the report implies.

However, China obviously also needs to adjust.  It cannot rely as much as  previously on exports and it thus has to generate domestic demand through    significantly increasing its consumption, whose share of GNP fell from 55% in the late 1990s to 36% at present.

Under-consumption is thus a major problem.  Consumption has to grow faster than both national income and investment in China in the future.  The significant fall in the share of wages would need to be reversed.

The report suggests a combination of policies for China — promoting higher wages, elimination of the gap between wage and productivity growth, increased  budgetary transfers especially to rural households, and increased public-sector  social spending.

However, even if China maintains its high GDP growth, it cannot be expected to become the locomotive for global growth.  This is because there are a lot of imported inputs going into China’s exports, whereas imports make up only 8% of China’s domestic consumption.

Consequently, a $100 shift in the composition of aggregate demand from exports to domestic consumption would reduce Chinese imports by some $40.  This has serious implications especially for South-east  Asian countries which supply a lot of the parts and components to China  for its exports.

The exchange rate issue

The report also comments on currency exchange-rates, an issue made topical by the high level of criticism of China’s currency policy by the U.S. administration and Congress members, and the threat to take trade measures such as an import surcharge on Chinese goods.

The paper says that exchange rates are an important issue in the  adjusting of global trade imbalances, but currency movements do not create  additional demand for the global economy.  They alter relative growth rates rather than raising the overall global growth.

Thus, currency movements cannot address the problem of global  under-consumption associated with sluggish wages.

A depreciation of the dollar against the Chinese currency could reduce Chinese exports and its trade surplus with the US, but would not increase  domestic demand and could even aggravate the under-consumption problem.  Thus the exchange rate is not an appropriate instrument to address under-consumption problem and excessive reliance on exports in China.

Dollar depreciation against the Chinese currency would also not address the root cause of the US problem of  over-consumption.  It is unlikely to produce significantly faster growth  of exports to China.  Even if it reduces China’s exports to the US, this may be replaced by imports from other developing countries as long as US consumers continue to live beyond their means.

The US has run current account deficits in the past four  decades regardless of the strength of the dollar against the currencies of its main trading partners, blaming Germany in the 1970s, Japan in the  1980s and now China.  The yen has been rising against the dollar during this period but this had no impact on the surplus of Japan with the US.

Thus, the paper concludes that: “The solution should be sought primarily in  national policies designed to address problems of over-consumption in the  US and under-consumption in surplus countries.”