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, todayâ€™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 â€œcompositionâ€ 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.