Rebalancing the Global Economy
Raghuram G. Rajan, formerly chief economist of the International Monetary Fund, is a professor at the University of Chicago’s Booth School and author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Chicago—There is a fair amount of consensus that the world economy is in need of rebalancing. Countries like Iceland, Greece, Spain and the United States overspent prior to the crisis, financing the spending with government or private borrowing, while countries like Germany, Japan and China supplied those countries goods even while financing their spending habits. Simply put, the consensus now requires US households to save more and Chinese households to spend more in order to achieve the necessary rebalancing. Indeed, many believe that if only the US toned down its consumerist culture and its households tried to stay within a monthly budget instead of having a Micawberish optimism about the future, and if only Chinese households stopped fearing Armageddon and started spending more, all would be well.
Of course, it is simplistic to reduce global trade imbalances to a bilateral imbalance between two countries. But since this is how the popular debate is posed, it is useful to ask whether rectifying the imbalances is only a matter of US and Chinese households switching personalities.
Clearly, consumer behavior is driven by habits formed over time, many of which are culturally determined—driving a Hummer, the gigantic low-mileage SUV, used to be an acceptable means of signaling the size of your wallet in the US before concerns about global warming spread. No longer! However, the focus on consumer behavior misses the deeper policy underpinnings of the behavior we see.
In the US, for example, credit-fueled consumption may have been exacerbated by the government’s push to expand home ownership, especially among low-income households. As house prices rose, households felt wealthier and borrowed against the home equity they had built to finance their lifestyle. Indeed, this bought successive administrations political peace as debt-fueled consumption helped paper over the fact that incomes for the median household had barely increased.
A second factor pushing US households to take on debt and consume has been the Federal Reserve’s policies. With US recoveries proving slow in creating jobs, and with consumption accounting for about 70 percent of demand, the political pressure on the Fed to revive the economy forces it to try to discourage household savings in downturns by keeping policy rates at ultra-low levels for sustained periods of time.
But if households do not save in downturns, how likely are they to save as the economy recovers and euphoria kicks in?
Finally, as other countries come to see that the US is willing to be the world’s consumer of first and last resort, they are happy to rely on it to provide the extra demand to lift the world out of recessions, even while Americans get their finances in order. So policies around the world make the US household the world’s designated spender. With the Obama administration intent on propping up the housing market as best as it can with government credit, with the Fed on hold at near-zero rates, and with the US exhortations to other countries to spend eliciting little enthusiasm at the recently concluded G-20 meetings, change seems very far away.
What about the Chinese household? Here again, policies are important.
While undoubtedly the absence of a significant old-age safety net (and the paucity of children, the traditional Asian safety net) offers Chinese households a strong incentive to save, Chinese household savings rates are not significantly higher than savings rates in other Asian countries. China’s overall savings rate has gone up in recent years because Chinese corporations are earning and saving more, while Chinese household consumption is low because Chinese households earn a much lower fraction of the income generated by the economy than in other countries.
Why is this? Because the Chinese economy has a strong bias favoring its corporations and against its households; interest rates on household bank deposits are really low so that corporations can get cheap credit and so that the central bank can maintain an undervalued exchange rate; corporations get cheap inputs like energy, natural resources and land; taxes on corporations are low, so their after-tax profit is high; and state-owned corporations pay very little of the gigantic profits they generate back to the state as dividends. As a result, household after-tax income is low, and consumption is low.
All this means that if China is to rebalance growth, it has to start being kinder to its households. The recent willingness of the Chinese authorities to tolerate worker strikes for higher wages suggests they want to increase household incomes. Higher deposit interest rates, higher corporate taxes (with a commensurate reduction in household taxes), and fewer subsidized inputs for corporations will also help.
But these changes will not come easily, for they will put enormous pressure on corporate profits, something corporations will resist. And profitable corporations have a lot of power of resistance, even in a one-party state. Moreover, the Chinese authorities will be wary of imposing large adjustment costs on corporations too quickly and causing large job losses. The recent crisis has convinced the Chinese of the dangers of relying so much on foreign demand, so they do want to boost household consumption, but the steps they take will again be gradual.
The bottom line is that rebalancing requires more than cultural change, it requires policy changes that will imply considerable political pain in the short term. After this brutal recession, the natural tendency is to try to go back to the old patterns of growth before attempting change—the US is trying to revive consumption while China is trying to revive exports. Unfortunately, though, it is unlikely that if the will to change is not found in the midst of a deep crisis, it will be found as the recovery gathers steam. It is easier for politicians to emphasize the need for other countries to change while neglecting their own responsibilities. Stay tuned, but don't hold your breath.