Rectifying the Global Economic Imbalance


Dr. M.D. Baby
Reader & Head
Department of Commerce
St. Dominic's College


The article analyses the logic and feasibility behind the framework put forward by US at the G-20 meet to remove the 'imbalances in the global economy', which was one of the critical causes for the current global economic crisis.
The last meeting of the heads of states of G-20 countries discussed a framework put forward by the US on building a 'balanced global economy'. It proposes to create a framework to shrink the huge current account surpluses in countries like China and to boost savings in debt laden countries like US. It also suggests a greater role for International Monetary Fund (IMF), in advising the member nations to ensure compliance with the framework.  The world economic growth in the past few years has been led by the consumers in the US and the exporters in countries like China, Germany and Japan. 

Now the world economy has reached a juncture where it cannot afford to carry on the practices of the past. It's in this context that US has raised the issue before the G-20. British Prime Minister Gordon Brown had echoed the same solution at the previous G-20 meet where he remarked "Now in these challenging times, it makes sense for countries with large deficits to boost exports and countries with high current account surplus, to increase demand for goods and services from other countries."We will first analyse whether US has sufficient logic in its new argument.

Rationale behind the proposal

Firstly, US runs trade deficit with all its major trading partners, most importantly China (Fig.1). This was possible because of the huge consumer market in the US and dollar's status as the world's reserve currency.

                Fig: 1 (US trade deficit (million $) with its leading trade partners) Source: Bloomberg

Now, the US consumer is unable to spend unlike the past. Consumer spending, which accounts for nearly two thirds of the US economic activity, has been badly hit because of the current crisis. Though consumer spending has slightly recovered, it is nowhere near its peaks. The chances of jobless recovery add on to the view that the US consumer spending wouldn't reach the pre- recession levels in the coming years. Therefore, US now feels that the world's dependence on its consumers no longer makes economic sense to it. US needs the consumers in other major markets to provide it market for its goods.

Secondly, US feels that it hasn't been able to tap the market potential in other countries, like the way they have used its domestic market. US has been consistently critical on China in this regard. It has often accused it of keeping the value of Yuan low, to boost its exports. US President Barack Obama had recently added Germany also into this list by calling it as a country that exports too much and imports very little. Analysis shows that US has got backing for its argument. The trade data of China shows this clearly. As seen in the Fig 2, China exports a lot to US and imports very little from it. US lags behind many other countries, when it comes to exports to China.

              Fig 2: (China's foreign trade with major economies in million $) Source: Bloomberg

Why US may find it tough?

US may have a point. But is it possible for it to 'rebalance the world economy' in its favour at this juncture? Its prospects look grim. There are certain critical reasons why it would find it tough.

Firstly, the framework may not win the support from China, which has a critical clout in the world economy now. US is dependent on China for funding its huge current account deficit. China is still the largest buyer of US debt. The Doha round of World Trade Organization (WTO) has been in limbo due to the objections from the emerging market economies led by China and India. US therefore cannot pressurize China into changing the current system. Even the European Union may find the proposal tough. The US trade deficit with European Union has gone up by 76% over the last month from $4510mn to $7958mn. It may not support their interest if they go ahead and support the US proposal as they would be risking their future prospects for the benefit of US.

                                   Fig 3: China's holding of US debt; Source: Bloomberg

Secondly, the suggested framework seeks to empower the IMF in advising the countries on policy decisions. It suggests that IMF should advise G-20 every six months from the end of the current year.  The success of the proposal is dependent on the kind of response shown by countries like China and India. They have been consistently seeking reforms in the IMF, giving them more representation in its decision making forum.

It has to be noted that China had serious problems with IMF in 2007. It had blocked the IMF's annual assessment of the economy, when it changed its exchange monitoring rules in 2007. China was under the view that it was an attempt by US to push for a stronger Yuan.

Thirdly, US lacks the power to be an export powerhouse now. Over the last few decades labour oriented manufacturing has been outsourced to countries with lower labour costs. A recent report by Newsweek magazine carries a report that US is losing the edge it had in high tech manufacturing. This would add on to the troubles before US.

So, the new framework suggested by US may not have much practical relevance. Though everybody recognizes the imbalance and the need to rectify it, no country would want to risk its prospects of recovery for the sake of US. After all US, is in a pit that it had dug on its own.

Dr. M.D. Baby
Reader & Head
Department of Commerce
St. Dominic's College

Source: E-mail April 12, 2010


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