With economic liberalisation, free capital flows and the efficiency of financial markets under increasing scrutiny, critics are asking whether the recipe used by policymakers during the past three decades is sustainable.
Against this uncertain background, two eminent economists discussed whether trade imbalances and currency disputes could derail global growth at the 14th annual Credit Suisse Asian Investment Conference in Hong Kong yesterday.
“The good news is that the world economy has not gone into freefall as doomsters predicted; the bad news is that it remains vulnerable,” said Jagdish Bhagwati, professor of economics and law at Columbia University and senior fellow for international economics at the Council on Foreign Relations
But, a focus on trade imbalances is misleading.
“Surpluses and deficits come and go; history tells us that they don’t remain a constant,” he argued. So obsessions about these global imbalances — notably high surpluses in China and deficits in the US — are unwarranted.
China has built up huge cash reserves due to its rapid growth, parked much of them in low-yielding financial assets, but will eventually (and soon) repatriate them to develop the country’s physical infrastructure, which hasn’t kept pace with overall economic expansion.
The same is true for India; no one would drive on India’s roads unless they had to, he joked.
Developing countries will turn to major Western construction firms, so outbound payments will inevitably reduce their surpluses.
“There will always be global imbalances. They are a sign of incomplete globalisation, and cannot be resolved, just managed,” agreed Y Vengogapal Reddy, emeritus professor at the University of Hyderabad and former governor of the Reserve Bank of India between 2003 and 2008.
But, it is important to understand that shifting those imbalances is not self-correcting.
The Chinese authorities, for example, must choose to intervene and direct investment towards infrastructure development and other targets. It is in their interests to do so to sustain China’s economic growth.
Reddy pointed out that both the US and China are focusing on their domestic economies, and the world simply has to accept that. The US, because of its size and the status of the dollar, has the manoeuvrability to correct its internal imbalances, and can determine the pace and sequencing of its restructuring.
China, as the leading creditor country, also has a similar autonomy. Meanwhile, the eurozone, with its multiple fiscal policies and single currency, has to cope with the “spill-over effects”, and the rest of the G20 nations can only react and adjust.
But, the reason for the US dollar’s decline and the, arguably, depressed level of the renminbi is different. Chinese policymakers clearly want to protect exports; the US, through quantitative easing and Keynesian fiscal spending, is correctly trying to stimulate its economy, argued Bhagwati.
And the level of the renminbi, as such, is not the real issue; instead, the underlying fiscal and monetary policies, as well as fundamentals such as demographics, are far more important.
Nobody knows what the “correct” renminbi rate should be. The Chinese authorities, as “practical people”, have let the currency appreciate under US pressure, but US policymakers themselves don’t really believe the renminbi level is the real problem.
Also, there is the principle of “penny-wise, pound-foolish”, said Bhagwati. The interdependence of world trade itself acts as a constraint on trade wars, and Western firms certainly don’t want to be caught up in a battleground of tariffs and protectionism.
Reddy also argued that the renminbi exchange rate shouldn’t be examined in isolation. Besides, “policy will always be made at the national level and occasionally coordinated in the international sphere”.
More critical for the next few years, according to Reddy, is the concentration of post-crisis economic thinking on the nature, direction and composition of worldwide capital flows. Emerging countries suffer when capital flows are volatile as companies struggle to make long-term plans because of the instability of their funding sources.
Restrictions and some controls are inevitable as governments insist on more “policy space”, but Reddy expects an increase in capital flows between emerging countries.
Bhagwati agreed that one problem caused by the US fiscal stimulus and quantitative easing is that cash pours out into emerging countries, pushing up their exchange rates, prompting policymakers to act to protect their exporters. On the other hand, that is really “a secondary effect”.
More important are the benefits that these countries, including those in Asia, gain through investment. Sure, policymakers will want to curb disruptive speculative activity, but otherwise there is “no need to make a fuss”.
Premature capital account liberalisation precipitated the Asian crisis in the late 1990s, after the region had benefited enormously from trade liberalisation. The proliferation of new financial instruments, which amounted to “destructive creation”, largely caused the 2008 global crisis. Capital flows were not an issue that time, Bhagwati pointed out.
The acceptable rate of inflation is also a major issue, added Reddy. The general level is expected to be higher (maybe 2% more), but unemployment is a bigger priority for Western governments. Advanced countries have piled up huge public debt and to some extent will look to inflate to reduce their borrowing burden. Price stability rather than price containment will be their focus.
Bhagwati concluded by sharing his bigger concerns. Most of all there is “a lack of leadership on crucial issues, in particular, climate change and the structural upward shift in food prices”.
The US Congress has adopted a sceptical consensus on climate change — and there is little resolve to addressing the long-term inflationary effect of food on the poorest countries and the potential that has for provoking further incidents of social unrest such as those taking place now in the Middle East and North Africa.
More immediately, Bhagwati fears that US policymakers haven’t given sufficient thought about what happens when its emergency spending ends. The danger is that the country is left with uncompleted or unnecessary infrastructure projects.
The state of the global economy remains, inevitably, unstable. More worrying is that it is rudderless and has no clear direction.
And, as Reddy warned, “the social and political consequences of the management of the global crisis are still unfolding, and there will be long-term effects which can’t yet be predicted”.