The IMF’s meeting this spring was lauded as a breakthrough, with officials given a new mandate for “surveillance” of the trade imbalances that contribute significantly to global instability. The new mission is crucially important, both for the health of the global economy and the IMF’s own legitimacy. But is the Fund up to the job?
There is obviously something peculiar about a global financial system in which the richest country in the world, the United States, borrows more than $2 billion a day from poorer countries – even as it lectures them on principles of good governance and fiscal responsibility. So the stakes for the IMF, which is charged with ensuring global financial stability, are high: if other countries eventually lose confidence in an increasingly indebted US, the potential disturbances in the world’s financial markets would be massive.
The task facing the IMF is formidable. It will, of course, be important for the Fund to focus on global imbalances, not bilateral imbalances. In a multilateral trading system, large bilateral trade deficits are often balanced by bilateral surpluses with other countries. China might want oil from the Middle East, but those in the Middle East – with so much wealth concentrated in so few hands – might be more interested in Gucci handbags than in China’s mass-produced goods. So China can have a trade deficit with the Middle East and a trade surplus with the US, but these bilateral balances indicate nothing about China’s overall contribution to global imbalances.
The US is jubilant about its success in expanding the IMF’s role, because it thought that doing so would ratchet up pressure on China. But America’s glee is shortsighted. If one looks at multilateral trade imbalances, the US stands head and shoulders above all others. In 2005, the US trade deficit was $805 billion, while the sum of the surpluses of Europe, Japan, and China was only $325 billion. Any focus on trade imbalances thus should center on the major global imbalance: that of the US.
The task of assessing trade imbalances – whom to blame and what should be done – involves both economics and politics. Trade imbalances are the result, for instance, of household decisions about how much to save and how much – and what – to consume. They are also the result of government decisions: how much to tax and spend (which determines the amount of government savings or deficits), investment regulations, exchange-rate policies, and so forth. All of these decisions are interdependent.
For example, America’s huge agriculture subsidies contribute to its fiscal deficit, which translates into a larger trade deficit. But agricultural subsidies have consequences for China and other developing countries. Were China to revalue its currency, its farmers would be worse off; but in a world of free(r) trade, US farm subsidies translate into lower global agricultural prices, and thus lower prices for Chinese farmers. By extending its largesse to rich corporate farms, the US may not have intended to harm the world’s poor, but that is the predictable result.
This poses a dilemma for Chinese policymakers. Subsidizing their own farmers would divert money from education, health, and urgently needed development projects. Or China can try to maintain an exchange rate that is slightly lower than it would be otherwise. If the IMF is to be evenhanded, should it criticize America’s farm policies or China’s exchange-rate policies?
Ascertaining whether a country’s trade imbalances are the result of misguided policies or a natural consequence of its circumstances is also no easy task. A country’s trade deficit equals the difference between domestic investment and savings, and developing countries are normally encouraged to save as much as they can. Evidently, China’s population has more than responded to such admonitions. Stronger safety net programs might reduce the need for precautionary savings in the future, but such reforms cannot be accomplished overnight. Investment is high, but further investment growth risks misallocating money, so reductions in China’s trade imbalance may be hard to achieve.
Moreover, a change in China’s exchange rate would do little to alter the multilateral trade deficit in the US. Americans might simply switch from buying Chinese textiles to imports from Bangladesh. It is difficult to see how a change in China’s exchange rate would have a significant effect on either savings or investments in the US – and thus how it would redress global imbalances.
With the US trade deficit the major global imbalance, attention should focus on how to increase its national savings – a question that US governments have struggled with for decades, and one that was frequently debated when I was chair of President Clinton’s Council of Economic Advisers. While it’s true that tax preferences might yield slightly higher private savings, the loss of tax revenues would more than offset the gains, thereby actually reducing national savings. We found only one solution: reduce the fiscal deficit.
In short, the US bears responsibility both for trade imbalances and the policies that might quickly be adopted to address them. The IMF’s response to its new mission of assessing global imbalances will thus test its battered political legitimacy. At its spring meeting, the Fund failed to commit itself to choosing its head on the basis of merit, regardless of nationality, and it did not ensure that voting rights are allocated on a more limited legitimate basis. Many of the emerging-market countries, for example, are still underrepresented.
If the IMF’s analysis of global imbalances is not balanced, if it does not identify the US as the major culprit, and if it does not direct its attention on America’s need to reduce its fiscal deficits – through higher taxes for America’s richest and lower defense spending – the Fund’s relevance in the twenty-first century will inevitably decline.