Prior to the crisis, current account imbalances, measured as the sum (in absolute value) of the world’s current account surpluses and deficits, had risen gradually to reach about 5% of the world’s GDP in 2008. The US accounted for the lion’s share of the world’s combined current account deficits. Germany, Japan, China and the oil-exporting countries made up the bulk of the world’s surplus. Global imbalances nearly halved in the aftermath of the crisis, reflecting not least the slowdown in activity around the world and falling oil prices. Tensions over such external imbalances are not new, but experience shows that living with sizeable imbalances can be risky. Until the 2000s, global imbalances had rarely exceeded 3% of world GDP, except for brief spells. Corrections usually took place on the back of large, often abrupt, capital and exchange rate movements. In the early 1970s, mounting current account mismatches led to the demise of the Bretton Woods system. In the 1980s, they resulted in international efforts to co-ordinate exchange rate movements, such as the G5/G7 Plaza of 1985 and Louvre agreements two years later.
What is interesting today is that the mix of surplus countries is also changing. Japanese surpluses used to be the main counterparts to the persistent (albeit variable in size) current account deficits of the US, particularly in the 1980s through the mid- 1990s. But since then, Germany, China and the oil exporting countries have also become important surplus counterweights to the US deficits.
Larger imbalances are not a problem as long as they reflect a more efficient reallocation of savings between surplus and deficit countries. Globalisation and financial market deepening may have made it easier for savings to flow from surplus to deficit countries, which is a positive development. Deficit countries can therefore turn to foreign savings to finance investment and growth. By the same token, people in surplus countries may find higher rates of return for their savings and investments abroad. This interaction leads to greater efficiency and helps support global growth.
But now, other, less desirable forces may be driving global imbalances. A case in point is a lack of exchange rate flexibility in many emerging-market economies and oilexporting countries.
How does this work? To maintain a stable exchange rate with the US, certain countries with high domestic savings have accumulated international reserves. It is a process that some refer to as Bretton Woods II, after a fixed exchange rate system that prevailed until the early 1970s. By implication, the current account deficit of the US is often said to be driven essentially by demand by surplus countries, such as China, for liquid assets which they use to invest their savings in more developed, liquid financial markets.
High savings in several emergingmarket economies tend to reflect caution. Households save–probably more than they need–because they cannot rely on social safety nets, such as healthcare and unemployment insurance, that would allow them to smooth consumption when confronted with an illness or a job loss. They also need to save for retirement, because pension schemes are usually underdeveloped. This is the experience of several Asian countries, including China. Governments in Asia also save too much for a similar reason; by building up their international reserves, they create a large cushion against possible international shocks. Fresh memories of the Asian crisis of the late 1990s, when investors withdrew huge sums of money from the region, causing currencies to decline, make this strategy hard to argue against. Nevertheless, by expanding the reach of social protection programmes on a durable basis, governments would reduce their own saving and at the same time make for lower precautionary household savings.
But that is for the longer term. For now, export-led growth coupled with inflexible exchange rates will continue to mean capital, in the form of loans and investments, flowing from poor to rich countries. This could lead to unsustainable tensions in terms of exchange rates. Of course, current account surpluses are not exclusive to large emerging-market economies. They often reflect demographic structure too, as in Japan, whose large surpluses are now dwindling, as an ageing population prepares to tap the vast pool of savings accumulated in previous years. In addition, if financial markets are underdeveloped, firms may decide to retain, rather than distribute, large chunks of their profits. In more mature economies, a surplus may come from investing too little, rather than saving too much. This is the case with restrictive regulations in product markets, which shield domestic firms from foreign competition and so discourage entrepreneurship and investment. This is the case of Germany, for example, as recent analysis carried out by the OECD shows.
The common point between these underlying drivers of global imbalances is that they are essentially structural. The trouble is, in the absence of policy action, the world’s current account gaps will likely widen again as the recovery takes hold. They may not reach pre-crisis levels, given that at least some of the drivers of excessive consumption and risktaking are no longer in place.There is plenty of room for remedial action. To begin with, greater exchange rate flexibility would be a great help. This is especially the case for the US dollar and the Chinese renminbi parity. But exchange rate flexibility is not enough.
Measures to address the root structural causes of surpluses and deficits are needed. From the above, that means actions directed at savings and investment: strengthening social protection in surplus emergingmarket economies, for instance, and financial and product market reforms to encourage companies to invest. These policies would foster greater social cohesion and so should be welcome in their own right, but would have the added bonus of lowering savings and rebalancing growth towards domestic sources. OECD policy advice to China has included policy action in all these areas.
There is no shortage of options to induce less heated consumption and higher savings in deficit countries. They include for example scrapping income tax deductibility for mortgage payments in the US or shifting the tax base from incomes to consumption.
The panoply of economic and structural initiatives that can be put in place to correct global imbalances also requires an appropriate time horizon and policy coordination to succeed. The G20 Framework for Strong, Sustainable and Balanced Growth, which the OECD supports, offers an instrument for addressing these challenges by facilitating policy coherence across countries.
Padoan, Pier Carlo (2010), “Beyond the crisis: Shifting gears”, in OECD Observer No 278, March
©OECD Observer No 279 May 2010