Friday, November 28, 2014

The Real Heroes of the Global Economy

PRINCETON – Economic policymakers seeking successful models to emulate apparently have an abundance of choices nowadays. Led by China, scores of emerging and developing countries have registered record-high growth rates over recent decades, setting precedents for others to follow. While advanced economies have performed far worse on average, there are notable exceptions, such as Germany and Sweden. “Do as we do,” these countries’ leaders often say, “and you will prosper, too.”

Look more closely, however, and you will discover that these countries’ vaunted growth models cannot possibly be replicated everywhere, because they rely on large external surpluses to stimulate the tradable sector and the rest of the economy. Sweden’s current-account surplus has averaged above a whopping 7% of GDP over the last decade; Germany’s has averaged close to 6% during the same period.

China’s large external surplus – above 10% of GDP in 2007 – has narrowed significantly in recent years, with the trade imbalance falling to about 2.5% of GDP. As the surplus came down, so did the economy’s growth rate – indeed, almost point for point. To be sure, China’s annual growth remains comparatively high, at above 7%. But growth at this level reflects an unprecedented – and unsustainable – rise in domestic investment to nearly 50% of GDP. When investment returns to normal levels, economic growth will slow further.

Obviously, not all countries can run trade surpluses at the same time. In fact, the successful economies’ superlative growth performance has been enabled by other countries’ choice not to emulate them.

But one would never know that from listening, for example, to Germany’s finance minister, Wolfgang Schäuble, extolling his country’s virtues. “In the late 1990’s, [Germany] was the undisputed ‘sick man’ of Europe,” Schäuble wrote recently. What turned the country around, he claims, was labor-market liberalization and restrained public spending.

In fact, while Germany did undertake some reforms, so did others, and its labor market does not look substantially more flexible than what one finds in other European economies. A big difference, however, was the turnaround in Germany’s external balance, with annual deficits in the 1990’s swinging to a substantial surplus in recent years, thanks to its trade partners in the eurozone and, more recently, the rest of the world. As the Financial Times’ Martin Wolf, among others, has pointed out, the German economy has been free-riding on global demand.

Other countries have grown rapidly in recent decades without relying on external surpluses. But most have suffered from the opposite syndrome: excessive reliance on capital inflows, which, by spurring domestic credit and consumption, generate temporary growth. But recipient economies are vulnerable to financial-market sentiment and sudden capital flight – as happened recently when investors anticipated monetary-policy tightening in the United States.

Consider India, until recently another much-celebrated success story. India’s growth during the past decade had much to do with loose macroeconomic policies and a deteriorating current account – which recorded a deficit of more than 5% of GDP in 2012, having been in surplus in the early 2000’s. Turkey, another country whose star has faded, also relied on large annual current-account deficits, reaching 10% of GDP in 2011.

Elsewhere, small, formerly socialist economies – Armenia, Belarus, Moldova, Georgia, Lithuania, and Kosovo – have grown very rapidly since the early 2000’s. But look at their average current-account deficits from 2000 to 2013 – which range from a low of 5.5% of GDP in Lithuania to a high of 13.4% in Kosovo – and it becomes evident that these are not countries to emulate.

The story is similar in Africa. The continent’s fastest-growing economies are those that have been willing and able to allow yawning external gaps from 2000 to 2013: 26% of GDP, on average, in Liberia, 17% in Mozambique, 14% in Chad, 11% in Sierra Leone, and 7% in Ghana. Rwanda’s current account has deteriorated steadily, with the deficit now exceeding 10% of GDP.

The world’s current-account balances must ultimately sum up to zero. In an optimal world, the surpluses of countries pursuing export-led growth would be willingly matched by the deficits of those pursuing debt-led growth. In the real world, there is no mechanism to ensure such an equilibrium on a continuous basis; national economic policies can be (and often are) mutually incompatible.

When some countries want to run smaller deficits without a corresponding desire by others to reduce surpluses, the result is the exportation of unemployment and a bias toward deflation (as is the case now). When some want to reduce their surpluses without a corresponding desire by others to reduce deficits, the result is a “sudden stop” in capital flows and financial crisis. As external imbalances grow larger, each phase of this cycle becomes more painful.

The real heroes of the world economy – the role models that others should emulate – are countries that have done relatively well while running only small external imbalances. Countries like Austria, Canada, the Philippines, Lesotho, and Uruguay cannot match the world’s growth champions, because they do not over-borrow or sustain a mercantilist economic model. Theirs are unremarkable economies that do not garner many headlines. But without them, the global economy would be even less manageable than it already is.

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    1. CommentedRobert Mullen

      The way to progress is to make goods with some value, goods that are demanded by others. Tradable goods are -- at least -- known to be demanded by others. It's true: not every country can run a surplus at the same time. But we don't really need surpluses all around. What we need is everyone -- at the same time -- making goods, capital equipment, or infrastructure that is actually useful to themselves or others. Trade is essentially benchmarking; the trade-balance tells us who is providing useful goods and services and who is burning resources. It is "sending a signal". It would not be a bad thing if it signaled that all economies were running efficiently. To get there from here we need the less efficient need to become more efficient -- not so they all run a surplus, but so that all sides are productive. This won't work if the Germans and Chinese stand down, only if the others stand up and compete.

    2. Portrait of Pingfan Hong

      CommentedPingfan Hong

      It is true that not every country can run trade surplus simultaneously, but it is also true that some countries must run trade surplus in order for others to tun trade deficit. One merit of promoting international trade, or promoting global economic integration is extractly to allow some countries to be able to use more resources that they can produce in certain period. Trade imbalances between countries, just like borrowing and lending between individuals, are mutually benefiting, and the imbalances are the dynamic force for global growth.

      The imbalances become a problem only when they are forced to excessively large magnitude by wrong policies or market distortion.

    3. CommentedJose araujo

      IIs there any growth from capital inflows that are transformed into trade deficits? I think if you look at the equations of national accounts you will find that Imports don’t contribute to GDP, quite on the contrary. So growth was never achieved by borrowing capital to consume foreign goods.
      That brings us to the SUDDEN STOP explanation, I presume taken from Fargas, the problem is that it makes no sense to talk about sudden stops. Bear with me on this one, the current more publicized explanation is that periphery countries had at their disposal funds from Germany that they used to spend on German consumption goods. When capital was redrawn, hence the sudden stop, the periphery economies went into shock,, because they had no money.
      Now let’s think a bit about that, if all conditions were the same, and the capital borrowed from Germany was for German Goods consumption, if you stopped the capital inflows, imports would go down, and nothing much would happen. GDP would remain the same, and countries would continue to honor the loans.
      My alternative explanation is that: First capital inflows are caused by trade deficits, not the opposite (there is no pool of money available to withdrawn, the inflows are normal commercial relations), Second what happened was the change of financial conditions, namely the possibility of default caused by the lack of solidarity in the Euro Zone, that became evident with the financial crisis, leading to increased interest rates and changing in financial conditions. Interest rates went up, austerity settled in, product decreased, and countries had no conditions to pay the loans because rates went up and production went down. There is no sudden stop here, like there wasn’t a sudden push before.

    4. CommentedProcyon Mukherjee

      Imbalances in the external sector, as Taylor has shown in his seminal NBER paper, "External Imbalances and Financial Crises", could be far less potent than the dynamics of credit in the domestic economy; he points out, "It is when financial flows of local or foreign origin build up into large credit exposures in the domestic financial system, that the risks of a financial crisis are elevated, and the likelihood of future deleveraging costs is increased." Therefore instead of reading too much into current account surplus-deficit we should rather look at internal variables that made more meaningful impact to the country's bottom line.

    5. CommentedAndrey Kovakin

      Maybe Russia is a economic hero, because Russia had high growth in 2000's and now has low debt/GDP level?

    6. CommentedEdward C D Ingram

      A great essay. Thanks. It is an eye opener for people like me wanting a safe place to invest their money.

      It also highlights the need for a new way of managing the value of currencies - a subject that I invite anyone to discuss with me.

      If currencies were correctly priced most of imbalances would be impossible. And the whole world economy would grow much better.

      Current worl imbalances, domestic and otherwise are caused by the mis-pricing of savings, debts, and currencies. The solution is not to be found by economists tweeking things or by central banks distorting everything, but by creating better and safer fianancial services. These must protect wealth, not money.

      That is the subject of my forthcoming book and my blogs.

    7. CommentedRichard Gorton

      Liberalism, being based upon the Milton Friedman Free to Choose concept of floating currencies, featured a mercantilist economic model, which benefited Sweden, with its ALV, Germany, with its SAP, SI, South Korea, Ireland, with its STX, IR, COV, and Netherlands, with its PHG, CLB, ST, NXPI, ASML, LYB, which became export driven nations having current account surpluses.

      But with the death of fiat money on October 23, 2013, as seen in Aggregate Credit, AGG, failing, and the Major World Currencies, DBV, and Emerging Market Currencies, CEW, both collapsing, a regional integration economic model will emerge under authoritarianism as fountainheads of regionalization emerge out of credit, banking, and investment crisis.

      These new talking heads, such as Angela Merkel, and her More Europe proposal; and new thought leaders, such Jeroen Dijsselbloem, Olli Rehn, Michel Barnier, Klaus Regling, Werner Hoyer, Jorg Asmussen and Viviane Reding, will come to the forefront of economic and political leadership in the Eurozone. These will move society away from constitutionally limited government, free markets, individual liberty, personal responsibility, and traditional property rights, and show the way forward through regional framework agreements, which renounce nation state sovereignty, and announce regional pooled sovereignty, for regional security, stability, and security.

    8. Commentedstanton braverman

      I wish to point out that none of the countries that are discussed have healthcare costs as high as the US. They are all at least half of the US. Healthcare in the US is approaching 20% of GDP which is about one trillion dollars a year too much. This amounts to $16,000 a year for a family of four and about a half million dollars for thirty years. This is the money the family needs to pay down student loans, pay down the mortgage and save for retirement. At the present time most families are not able to achieve this goal. Until we bring our healthcare costs in line with the world market the US will continue to move along of a variety of financial steroids at 1% to 1 1/2% growth in GDP which just about keeps up with population growth.

    9. CommentedVal Samonis

      A wise observation but too late in this long cycle. Europe is already descending into the deflation, depression, conflicts; kind of deja vu of the 'Dirty Thirties".

      Val Samonis
      Vilnius University

    10. CommentedLuca Filippa

      Global demand matters, but labor market and public expenditure reforms may play a relevant role on external surplus.