Global Trade Imbalances and China’s Role Raghuram Rajan

Outline Where did the global imbalances come from? U.S. China What role are current policies playing in perpetuating them? How might the imbalances narrow? Is G-20 or IMF led policy coordination necessary or even feasible? What are the risks?

Where did the imbalances come from? The Spenders: U.S., U.K., Spain, Latvia… The Producers: China, Germany, Japan… The Resource Rich: Middle East, Latin America including Brazil, Africa

United States as spender Consumption boom. Financed by credit, especially housing credit. Why? Structural – growing income inequality Cyclical – thin safety net Global savings glut?

Source: Golden and Katz 2009 Growing income inequality in the United States

Let them eat credit As more Americans left behind in perception if not in fact, increasing polarization. But education difficult to tackle Redistribution? No political support + huge costs But people care about consumption. So what if they don’t have income growth. Consumption growth through credit growth Better still, home ownership: stake in the future as well as means to borrow Affordable housing (Clinton), ownership society (Bush) Instruments: FHA, Fannie, Freddie, CRA

Consumption inequality has not increased commensurately…

Debt has filled the gap… as in the 1920s Source: Kumhof and Ranciere (2010)

Jobless growth in the United States and an inadequate safety net Past recoveries 2 quarters typically for growth 8 months for recovering lost jobs Thin safety net – 6 months: Created for in and out recoveries => incentive to search and match 1991: 3 quarters for growth, 23 months for jobs 2001: 1 quarter for growth, 38 months for jobs Safety net inadequate for jobless recoveries

Consequences Substantial government stimulus But in the shadow of a crisis, opens the way for substantial excess …and Fed stimulus Which central banker would be brave enough to raise rates when unemployment is still high? Bernanke/Greenspan Put QE II Jobless recoveries and inadequate safety net makes the U.S. the reliable stimulator of first resort

Summary: U.S. as spender Structural forces: Consumption and credit to compensate for stagnating incomes Cyclical: Frenetic policy as a response to a slow job market and a weak safety net. Easy money: The “savings glut”

Outsourcing spending: The Producers Exports as a strategy for growth China, Germany, Japan Savings and exchange reserves as a response to crisis Malaysia, Thailand, Korea, Phillipines

Export-led strategies Post-war Germany and Japan, followed by Korea, Taiwan, ASEAN, and now China: Government and bank intervention to create a bias towards producers and develop strong firms Discriminate against households But Small domestic market => Emphasize exports It worked!

Source: JP Morgan

Producer biased growth China Low wages Low deposit rates for households, cheap credit to corporations Low corporate taxes, low requirement to pay dividends Low compensation for land acquisition Low costs for inputs – energy, resources

Chinese consumption is low because household income has fallen as share of national income.

Current policies…U.S. U.S. stimulating spending once again. Fiscal measures – First time home buyers credit, Cash for Clunkers, etc. Easy monetary policy: QEII Is the cost of capital really holding corporations back from investing? Asset price channel Exchange channel Households have started to borrow and spend again: savings rate stabilized at 5 percent.

Source: New York Times

Silver lining: Manufacturing productivity increased and exports are climbing. Source: The Economist

Current Policies…China Nominal renminbi appreciation halted for a long time to revive exports China stimulated investment via massive credit expansion. Plus tax benefits for consumption

Important changes are taking place China is moving to expand domestic demand Increase household incomes Higher wages Expand production in interior Higher interest rates Higher corporate taxes and more transfers to households Higher value of renminbi Source: JP Morgan

How might the imbalances narrow? Slow growth in industrial countries, and high government and household debt will force slower spending. Large exporters like China will have to adopt policies to expand the domestic market. Real renminbi appreciation will be one of the channels of adjustment.

Why adjustment is inevitable!

Is there a need for G-20 coordination? Yes, even as U.S. domestic demand contracts, Chinese demand can expand to keep world growth growing. No, policy lags are variable and uncertain, so even if we could coordinate policy, no reason to believe global demand would be smoothed. No, impossible that large countries would agree to tailor domestic policies to a global timetable.

What role is there for G-20 /IMF? Financial sector regulation, especially cross-border, and macro-prudential measures To make sure countries don’t adopt harmful policies Trade protectionism Barriers to investment International Currency? SDR?

Risks: Political Global integration and technological change are creating winners and losers within, and between, countries. Rising inequality Fear will result in strange policies Anti-immigration Protectionism Populism Political upheaval and conflict will have wide effects

Risks for EMs Emerging market policies have to focus more on domestic and regional demand. All this has to be managed while keeping government finances under control, investment from becoming excessive, and debt-fuelled consumption from exploding. Emerging markets typically do not have a track record of macro management except when the industrial world is doing well.

Bottom line Good news: global imbalances will likely adjust as emerging markets expand demand Bad news: Policy makers are typically not helping. Hope: The adjustments takes place anyway.

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