Finally: Rebalancing Legitimized!

Rebalancing Legitimized!

Time For A New Global Architecture

by Stephen Roach (Hong Kong)

At long last, global rebalancing is center stage in the world policy theater. That’s an important conclusion to take out of the results of April’s power councils — the G-7 meeting as well as the annual gathering of the full complement of some 184 members of the IMF. This is good news for an unbalanced world. It is not, however, the silver bullet for dealing with a very tough problem. The road to global rebalancing is likely to be long and arduous, and the new approach still has some problems. But as someone who has led the charge in worrying about the pitfalls of an unbalanced world, I am delighted that the Wise Men have finally seen the light.

Policy makers have always communicated in strange and almost ritualistic ways. That’s true at the national as well as at the global level. Statements typically are steeped in jargon and opaque phraseology. Nuanced language allows for multiple interpretations — providing the cover, or hedge, if things go awry. All those caveats aside, there can be no mistaking a very important message sent on 21 April by the G-7 finance ministers and central bank governors after their recent meeting in Washington: Global imbalances have now been officially anointed as a major concern by the stewards of globalization. Not only were they given prominent mention in the official G-7 communiqué, but they were also the focus of a rare “annex” to the statement. In G-7 circles, that’s about as loud as an alarm ever gets.

The annex lays out three basic principles that shape the G-7’s approach to global rebalancing: One, it is a shared responsibility — an obvious but very important statement that readers of my work will also recognize. It is policy jargon for saying “no” to scapegoatting — pinning the blame unfairly on a nation like China. Two, rebalancing requires, first and foremost, a realignment of global saving and investment flows; this identifies disparities between current account surpluses and deficits as the major source of global instability — again, quite consistent with my own thinking and clearly putting the US, with its world record current account deficit, at the top of the problem list. Three, the G-7 annex stresses that rebalancing strategies must be designed with an aim toward maximizing sustained economic growth; in my view, that’s the weakest element of the G-7’s proposed strategy. While rapid growth is an understandable goal, its emphasis may obscure the heavy lifting that will ultimately be required of an effective global rebalancing strategy.

This latter point deserves elaboration. Economic growth has become the elixir of political angst — the perceived remedy for all that ails a nation’s economy. Pro-growth politicians win elections — and re-elections — while the anti-growth set is doomed to a quick oblivion. Growth has become such an important part of the policy rubric that it has spawned its own theoretical framework — supply-side economics. A broad array of pro-growth policies — especially tax cutting — has come into fashion as the rising tide that lifts all boats. Supply-siders believe that self-financing budget deficits, narrowing income inequalities, and surging productivity are all part of the growth miracle. Never mind America’s gaping budget deficit and the recent widening of disparities in the US income distribution — the pro-growth principles of supply-side economics have taken on almost a religious fervor in Washington and on Wall Street.

America’s current account deficit — the world’s most serious imbalance — is, first and foremost, an excess consumption problem. I make that statement on the basis of three facts: One, tradable goods imports by the US are currently 89% larger than its exports of tradables. That means exports now have to grow twice as rapidly as imports just to hold the US trade deficit constant. Two, import penetration has reached very high levels in America; tradable goods imports now account for a record 37% of US expenditures on goods. That means that the faster US domestic demand grows, the faster imports will grow — implying that faster growth begets an ever-widening US trade deficit and ever-mounting global imbalances. Three, US consumption is currently holding at a record 71% of US GDP — a huge breakout from the 25-year average of 67% that prevailed over the 1975 to 2000 period. These three points imply that it will be extremely difficult for the US to accept its role in the shared responsibility of global rebalancing without coming to grips with its excess consumption problem. And that, I’m afraid, could well spell slower economic growth in America. Such a conclusion not only flies in the face of the pro-growth principles of the G-7’s newly-articulated rebalancing strategy, but it is also very much at odds with the supply-side policy biases that currently dominate the Washington consensus.

I don’t want to come across as too negative in assessing the implications of the G-7’s epiphany. As an unabashed champion of the imperatives of global rebalancing for longer than I care to remember, I believe the 21 April communiqué was something close to an historical breakthrough. Moreover, it was followed by an equally impressive effort from the IMF at its companion annual meeting — an endorsement of the principles of “multi-lateral surveillance and consultation.” This is policy jargon for a big change in the modus operandi of the Fund, which has long conducted its work mainly on the basis of single-country missions and consultations. By taking its functionality to the multi-lateral level, the IMF is accepting the very important task of coming to grips with the “spillovers” across nations that arise from imbalances of trade and capital flows. The surveillance aspect of this task essentially empowers the IMF to sound warnings when multi-lateral imbalances reach dangerous levels — a welcome development for a world that is inclined to ignore such problems until it is too late. The multi-lateral consultation function will undoubtedly be a good deal thornier to execute, since it could conceptually involve arbitrating the costs and benefits of a shift in US fiscal policy versus structural reforms in Europe, weighing in reserve management practices of the oil producers and Asian exporters, and so on. Globalization is not just about integration — it is also about navigating the ever-contentious waters of cross-border structural and policy tradeoffs.

For the IMF, this new role could well be a key to its survival as a relevant global institution. In my view, it is unconscionable that the stewards of globalization could have allowed the world’s imbalances to reach such dangerous proportions. The Fund will now be able to demonstrate if it is up to the challenge of its mandate. The IMF, in effect, has been charged with the execution of the G-7’s newly stated principles of global rebalancing. By accepting this important responsibility, the IMF has the opportunity to provide an unbalanced world with legitimate hope on the road to rebalancing. Success could lay the groundwork for a major breakthrough in the reform of the world’s policy architecture. Failure could spell curtains for the IMF as we know it — portending a painful slip into the obscurity that Governor Mervyn King of the Bank of England has raised as a worrisome possibility (see my 24 April dispatch, “Time for a New Global Architecture”).

There’s one element of this new rebalancing agenda that continues to gnaw at me — the insistence on Chinese currency flexibility as an important element of the global adjustment process. I definitely believe that China has an important role to play in global rebalancing. I also think that China accepts its responsibility to do just that. As I have noted, the newly enacted 11th Five-Year Plan has rebalancing written all over it, as China attempts the Herculean task of shifting the mix of its economic growth from exports and investment to private consumption (see my 24 April 2006 Special Economic Study, “China’s Rebalancing Challenge”). Instead of fixating on the currency as the main lever of rebalancing — and implying that a sharp revaluation of the RMB is needed — the G-7 and the broader global policy councils need to give China credit where credit is due: China is attempting to do something that Japan, Korea, and the rest of the so-called Asian dynamos have utterly failed to do — embracing and delivering on a pro-consumption growth strategy. Success of this plan will turn China into a very positive force in the rebalancing sweepstakes. Conversely, large currency movements — especially for a poor country with a still shaky financial system — borrow a page right out of the script of the “yen blunder” that Japan acceded to in the 1980s (see my 21 April dispatch, “Bad Advice”). Global rebalancing needs enlightened policies from China — not a replay of the painful mistakes that led Japan astray 20 years ago.

Globalization is a complex and challenging transformation of the world order. The stewards of globalization have been asleep at the switch — allowing unprecedented imbalances of trade and capital flows to mount. The G-7 and the IMF have finally come together to recognize the dangers of these problems. In doing so, they have rejected (thankfully) the “new paradigm” views of those who argue that imbalances are a perfectly sustainable attribute of a new world order. The long march down the road of global rebalancing may have just begun. Notwithstanding some of my quibbles noted above, this is excellent news for an unbalanced world. If the G-7 strategy works, it is also good news for financial markets. In particular, a successful rebalancing should lower the risks of a global hard landing — tempering the fears of a crash in the US dollar and/or a related sharp increase in real long-term US interest rates. So far, the hope is all on paper — buried in the rhetoric of a communiqué. Now it’s time for the heavy lifting.