The survey by Gary Gorton and Andrew Metrick on what happened during the 2008-9 financial crisis, “Getting Up To Speed on the Financial Crisis,” to be published by the Journal of Economic Literature, focuses on an important cause of this crisis: global imbalances in the world economy. As Gorton and Metrick suggest, such imbalances include the “institutional cash pools” caused by sovereign wealth funds and the “global savings glut”.
While the United States has been amassing large current account deficits, China, Japan, other Asian emerging market economies and some oil exporters have been generating trade surpluses. Similar structural imbalances were occurring within major regional economies, such as the European Union, where the large current account surpluses of France and Germany were offset by deficits in Ireland, Greece, Portugal, Spain and the United Kingdom. The result was that economies with chronic trade deficits were receiving large and sustained capital inflows from surplus economies seeking new asset investments. These massive credit flows precipitated the bubble and subsequent bust in financial markets, and the persistence of such global imbalances continues to add to the uncertainty and instability of the world economy.
Understanding how the global imbalances caused the financial crisis and subsequent recession is important. But addressing these imbalances in the world economy will need a much more profound change in global economic development.
In a paper published in World Economics in November 2010, “Green Stimulus, Green Recovery and Global Imbalances”, I argued that a global green recovery strategy of reducing carbon dependency and improving energy security may therefore help to control both the large current account deficits incurred by major oil-importing economies, such as the United States, and to reduce the trade surpluses of fossil fuel exporting economies. To the extent that global green recovery can help to reduce both the volume of fossil fuel imports into deficit economies such as the United States, and help stem the rise in world prices, then it may help alleviate global imbalances by curbing current account deficits and surpluses in oil exporting economies.
Although reducing the chronic trade surpluses in Asian and other emerging market economies is more complex, a necessary step will be to rebalance the pattern of economic growth in these economies to absorb more of their savings domestically. Expanding clean energy investments and adopting low carbon technologies could be key to this strategy. Policies to target and develop clean energy, sustainable transport and other green sectors as new growth poles in emerging market and developing economies should foster production of modern tradable goods and services to meet expanding domestic demand. Increased spending on safety net programs, education, sanitization and improved water supplies, health care and other government insurance mechanisms could help reduce the precautionary motives for saving by households in developing countries. The result would be a multiplier effect through lowering economy-wide excess saving while promoting higher household consumption.
It is important to get up to speed on how we got into the current economic crisis, but it is also essential that we do not rush into “business as usual” solutions that will fail to prevent future crises from occurring.
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