ROTTERDAM – There is little dispute that global imbalances in trade and capital flows are at least partly to blame for the financial crisis and ensuing recession that have rocked the world economy since 2008. But not all imbalances are created equal, so it is important to weigh the consequences of individual countries’ external accounts for global economic stability and prosperity.
The conventional story of the crisis is well known: rising home prices fueled private consumption in the United States in the early 2000’s, despite tepid wage growth. Together with the widening US budget deficit, America’s current-account deficit – already large – ballooned, mirrored by bulging external surpluses in China and, as oil prices spiraled, in oil-producing countries like the United Arab Emirates.
Europe, meanwhile, looked wonderfully well balanced, at least superficially, whether one considered all 27 European Union members or the 16-member eurozone. While the US ran current-account deficits of up to 6% of GDP, the EU and the eurozone rarely had a deficit – or surplus – exceeding 1% of GDP.
In the past year, however, it has become all too clear that all this was just an illusion. Beneath the surface, huge imbalances were building up, resulting in debt-fueled real-estate booms in the euro periphery. Germany and the Netherlands ran surpluses in the range of 7% to 9% of GDP, balancing the current account for the eurozone as a whole. But, by 2006, Portugal, Spain, and Greece were running current-account deficits of 9% of GDP or more.
The China-US relationship resembles that between a mail-order company and a not-so-solvent client. The world’s most populous country is the largest foreign creditor of the US government and government-sponsored enterprises such as Fannie Mae and Freddie Mac. China’s official foreign-exchange reserves of more than $2.5 trillion, stemming from double-digit current-account surpluses and capital inflows, are mostly invested in dollar-denominated bonds.
Some commentators argue that Germany plays the same role within the eurozone that China plays in “Chimerica,” the term coined by Niall Ferguson and Moritz Schularick to describe the symbiotic China-US economic and trade relationship. If one focuses solely on the current-account side of the balance of payments, it may look that way. In 2007, as its external surplus reached a record of 7.5% of GDP, Germany’s biggest bilateral surplus was with the US (€29.5 billion), followed by Spain, France, the United Kingdom, and Italy. It ran its largest bilateral deficit (€21.2 billion) with China, followed by Norway, Ireland, and Japan.
But Germany did not accumulate foreign reserves the way that China did. On the contrary, German foreign reserves actually declined between 2000 and 2008. Whereas China is a large net recipient of foreign direct investment (FDI), Germany is a large net exporter of FDI. China’s net FDI inflow totaled $94 billion in 2008, compared to Germany’s net FDI outflow of $110 billion.
Indeed, net FDI makes up about one-third of Germany’s capital account. More than half of these investments are within other EU countries, with a further 30% going to the US. According to the Bundesbank, German FDI accounts for almost six million jobs abroad. That number does not include the additional jobs resulting from increased economic activity in a region.
German’s surplus is thus less damaging than China’s, as it is used for investments that foster productivity gains, economic growth, and job creation – and that often include technology transfers that help to develop human capital.
The Chinese surplus, on the other hand, being heavily skewed towards US government bonds, primarily boosts personal consumption – a process whose apotheosis came in the early 2000’s, as the Bush administration’s tax cuts, together with cash-out home refinancing and home-equity loans, turned US sovereign debt into consumer credit. Of course, the demand generated by Chinese credit also fosters economic growth, but mostly in China, owing to booming exports to the US.
With the bulk of its baby boomers retiring in the coming decade, Germany has a valid motive to save. In view of the country’s shrinking workforce and already high capital-to-labor ratio, it is also understandable that German investors do not see many domestic investment opportunities, and instead choose to invest abroad.
It is, of course, unfortunate that German banks and pension funds lent money to debt-laden countries such as Spain, Greece, and Portugal on overly favorable terms, inflating asset bubbles that eventually had to burst. As with any creditor who makes an unwise investment, the banks and pension funds should pay the price.
Nevertheless, the differences between China and Germany are far more substantial than the similarities – not least in terms of how they put their surpluses to use. Lumping all surplus countries together – or all deficit countries, for that matter, will not help us find a way to rebalance the world economy.