Through the Looking Glass: Saving Glut or Demand Shortage
The old saying is that â€œIf you only have a hammer everything looks like a nailâ€. For economists, the hammer is â€œsavingâ€ and a host of problems are reduced to questions of saving. Nowhere is this clearer than discussions of the U.S. trade deficit and global financial imbalances, which are often explained as a saving problem. Unfortunately, this focus on saving distorts understanding and distracts from the real challenge of creating mass consumption markets in developing countries.
Within national income accounts trade deficits represent the excess of country consumption over production. From an accountantâ€™s perspective that makes it logical to label trade deficits as negative saving.
Most economists go a step further, asserting the U.S. deficit is caused by a saving shortage. However, one countryâ€™s trade deficit is anotherâ€™s surplus, which has prompted Federal Reserve Chairman, Ben Bernanke, to argue for turning the conventional logic on its head. Thus, rather than resulting from a saving shortage, the U.S. trade deficit is the result of a global saving glut â€“ especially in China.
Both stories are flawed. How does a saving glut translate into exports since households do not export? Likewise, the saving shortage story also lacks logic. If the U.S. is consuming too much, why has it been closing manufacturing capacity and why is there so much continuing labor market softness?
Both the saving shortage and saving glut hypotheses confuse accounting outcomes with causes. Trade deficits reflect transactions between producers and buyers, and those transactions are the product of incentives and price signals. U.S. consumers buy imports rather than American-made goods because imports are cheaper. This price advantage is often due to under-valued exchange rates in places like China and Japan, which often swamps U.S. manufacturing efficiency advantages.
Under-valued exchange rates are only one of the policies countries use to boost exports and restrain imports, so that they run trade surpluses while their trading partners (including the U.S.) run deficits. Other policies for export-led growth include export subsidies and barriers to imports.
In the modern era of globalization export-led growth is supplemented by policies to attract foreign direct investment (FDI), a pairing that has been particularly successful in China. Such FDI policies include investment subsidies, tax abatements, and exemptions from domestic regulation and laws.
These policies encourage corporations to shift production to developing countries, which gain modern production capacity. This increases developing country exports and reduces their import demand. Meanwhile, corporations reduce home country manufacturing capacity and investment, which reduces home country exports while increasing imports. Once again, China provides clear evidence of these patterns, with almost sixty percent of Chinese exports being produced by foreign corporations.
This is a fundamentally different story from both the saving shortage and saving glut hypotheses, and it leads to dramatically different policies. Developing countries need to grow, but in todayâ€™s globalization it is easier to acquire capacity and grow through FDI than it is to develop domestic mass consumption markets. Consequently, rather than facing a saving glut problem, the global economy faces a problem of market demand failure in developing countries.
The challenge is getting corporations to invest in developing countries, but for purposes of producing for local consumers. That requires expanding markets in developing countries, which means tackling income inequities and getting income into the right hands. That is an enormous organizational challenge that is off the radar because economists focus exclusively on saving and supply-side issues.
Labor standards, minimum wages, and unions are part of the solution. That is the unambiguous history of successful developers. Unions have historically been especially important since they engage in decentralized wage bargaining that tie wages to firm productivity. Consequently, wages are market sustainable.
Government spending can also help, but its role is limited. Countries that substitute government spending for market spending either generate excessive inflationary budget deficits, or end up with excessively high tax rates that destroy incentives.
Both the saving shortage and saving glut hypotheses fail to connect todayâ€™s global financial imbalances with global production patterns and inadequate market demand in developing countries. Tortuous claims that saving is merely the flip side of consumption and investment spending are the equivalent of Humpty Dumptyâ€™s argument in Through the Looking Glass: When I use a word it means just what I choose it to meanâ€.
Copyright Thomas I. Palley