Global Imbalances: Stop Thinking Saving, Start Thinking Demand

The Economist magazine (September 24, 2005) recently ran a story about the threat posed by global financial imbalances. The front cover showed a picture of a teeter-totter (see-saw in English) atop the globe. On the upper-end of the teeter-totter was a small stars-and-stripes piggy bank representing thriftless America; on the lower-end was a plump piggy bank representing the thrifty rest of the world. The moral of the story was that the U.S. is saving too little, the rest of the world is saving too much, and the net result is a dangerous global saving imbalance that requires an adjustment of saving patterns.

An equally valid representation could have reversed the slope of the teeter-totter, having an obese American consumer at the bottom and a thin foreign consumer up high. Rather than focusing on saving, such a representation would have focused on demand and the need for adjusting global patterns of demand.

Having been brought up on resurrected classical (pre-Keynesian) economics, today’s economists instinctively focus on saving. But Keynes taught us that a demand focus is very different from a saving focus, and attempts to increase saving can lower demand. If U.S. households were to increase their saving, domestic demand would fall, causing unemployment to rise. Imports would also fall, thereby reducing foreign incomes and saving. The U.S. would therefore increase its saving, and foreigners would decrease theirs, just as recommended by The Economist. But the global economy would wind up in deep recession.

A Keynesian demand management perspective provides a different view. The U.S. needs to change the “composition” of its spending, and shift from imports to domestically produced goods. This will reduce imports and improve the trade deficit. It will also increase U.S. incomes and saving. Such an outcome can be achieved by depreciating the dollar, thereby making foreign goods relatively more expensive.

If the U.S. is constrained by insufficient production capacity, this will call for additional policies to restrain U.S. demand. However, such measures will only be needed when the economy bumps against its capacity limits. Moreover, policy should aim to keep interest rates low so as to encourage investment in new capacity, and any restriction of demand should therefore take the form of discouraging consumption (private and public).

Side-by-side, foreign economies must also change the composition of their demand, and switch from reliance on exports to reliance on domestic consumption. Exchange rate adjustment will reduce their exports, but these economies lack mechanisms to increase their domestic consumption. That is why they rely so heavily on the U.S. market. In this connection, developing countries are especially problematic. For two decades, they have been instructed to go for export-led manufacturing growth, making them especially reliant on the U.S. market. China exemplifies this condition.

This is the nub of the global imbalance problem. Industrializing countries must build a middle class that can consume more of what they produce. This needs an appropriate structure of income generation. A Keynesian demand management perspective is not just concerned with budget deficits, interest rates, and exchange rates. It is also concerned with the structures governing income distribution, which must be designed to also preserve incentives to produce.

That is why proposals for global labor standards are so important. Such standards are not just about preventing exploitation. They are also about enabling countries to consume their production. In the 20th century countries could develop such standards and structures themselves. Globalization makes this impossible because mobile capital will abandon a country and move elsewhere. Additionally, such standards must be accompanied by rules governing exchange rates to prevent unfair competition based on devalued currencies.

The global economy cannot save its way out of the current impasse. It has been living on borrowed time provided by U.S. consumption funded by back-to-back equity and house price bubbles. What are needed are rules facilitating appropriate income distribution and patterns of demand. Country participation in the international system must be contingent on adopting these rules. Countries can of course stay out if they choose, but no country can be allowed to be a spoiler within the system. Today, we have the exact opposite. The international system lacks these rules, erodes what national rules there are, and actively promotes the participation of countries that are the most egregious rules violators.

4 Responses to “Global Imbalances: Stop Thinking Saving, Start Thinking Demand”

  1. Michael Dorkoski Says:

    I’ve just stumbled upon your site, via a news release concerning the Delphi debacle. The economic theories you are putting forth here are no doubt correct, to a point. I say that with confidence, because in my job I see it every day – I work with entrepreneurs who are attempting to bring new products to the marketplace. The overwhelming majority would like to have their manufacturing in the U.S…and the overwhelming majority find it to be economically infeasible, or the manufacturing infrastructure they seek no longer exists. There is no doubt in my mind that we are becoming a two tier society as the economy continues to part, with those already controlling capital gaining ground and those forced to the lower skill service sector, losing ground. The divide is becoming very pronounced as manufacturing in the U.S. (i.e., creation of tangible goods and accompanying spread of wealth) continues to erode.

    That said, I’d like to see you address two other items that I believe are part of a triad of erosion of our citizen’s standard of living. First, it just so happens that I had the opportunity to do some consulting work at a Delphi site some years ago. I found the UAW workers there to be paid wages that seemed quite out of step with similar skill levels in other industries, which no doubt contributed to the flight of the Big 3 automakers to affect our national policies in favor of offshoring of production. The unions must accept some blame for the inflated expectations of their membership and the resulting economic realities that drive policy on the national level.

    Lastly, in some respects we do as a society benefit from cheap imports, in that goods of high quality are readily available now to everyman, whereas only a generation or two ago that was truly unthinkable. The quality, variety and technology leaps the last few decades are astounding and yes, free trade has in large part been instrumental in that evolution. Perhaps, we’ve simply gone too far.

    There are a chosen few atop, a growing number of unfortunates at the bottom…and the rest of us, losing ground with every passing day. As a white collar worker, I feel your pain and really, don’t expect an actual “retirement.” The money’s just not there, nor are my last 3 manufacturing employers.

  2. Paul McCartney Says:

    I love the way you say “moreover”!

  3. Proud UAW Member Says:

    It’s obvious that capitalism is no longer a viable economic system. When we threw off the British political system and became our own democratic nation, we should have made the economy democratic. Yes, I’m talking about socialism.
    The advent of the industrial revolution showed us what unbridled capitalism does. Children working and dying in coal mines and factories and exploitation of every kind by greedy companies. Chinese industry probably looks much like 19th and early 20th century America did. Unbridled capitalism is still exploiting humanity today.
    The American people must be able control their economy democratically. Socialism isn’t totalitarian communism, where there are no personal freedoms. It merely takes industry from personal ownership and places it in the peoples’ hands. This isn’t accomplished by an armed revolution, but democratically, through a revolution of reason.
    If you take profit from the economic equation, then industry will serve the needs of all man, rather than a greedy few. Maybe at one time capitalism was needed because the working class lacked the education to control industry. That’s hadly the case anymore. We’re the most educated people in the world and we can run industry better than anyone.
    If capitalism were used morally, it could be a good thing. But the greed and immorality of men has made it a terrible system. Most people in the working class are moral and the economy would be more just to everyone if we controlled it.
    Think about it.

  4. David Says:

    What is a feasible solution to reduce the United States trade deficit with China?