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China, current account, current account surplus, current deficit, Germany, Global Imbalances, globalization, IMF, International Monetary Fund, Japan, tariffs, The Netherlands, Trade, Trade Deficits, Trump, {What's Left of) Our Economy
One of my greatest professional disappointments has been my failure to help make many converts to the idea that one of the biggest – and possibly the biggest – reason that trade deficits matter a lot (contrary to the insistence of most economists) is that they can lead to global financial crises like the one that struck in 2007 and 2008. The idea is that these deficits lay at the heart of the broader economic imbalances run up during the previous decade – which flooded borrowing- and spending-happy economies (especially America’s) with oceans of cheap credit, and inevitably produced the reckless use of such credit and the inevitable – and terrifying – bursting of the resulting bubbles.
You see? It’s a thesis that’s tough to summarize briefly – even though it’s widely accepted by some of the world’s leading economists, who nonetheless remain reluctant to acknowledge any connection to trade flows.
So I’m gratified that the International Monetary Fund has just lent additional support to this thesis, but I’m under no illusions that the determinedly oblivious conventional wisdom is going to budge – especially since the Fund goes out of its way absolve lopsided trade flows of any blame.
According to the Fund’s new External Sector Report (click here for a link to the PDF), these imbalances (measured in their broadest form, the current account) stayed at about the same share of the world economy last year as they did in 2016 (some 3.25 percent). Yet in the IMF’s view, between 40 and 50 percent of these imbalances were “excessive (that is, not explained by countries’ fundamentals and desirable polices).”
Why should anyone care? Because, as the Fund explains, “Large and sustained excess external imbalances in the world’s key economies—amid policy actions detrimental to external balances—pose risks to global stability.” Specifically, “Over the medium term, sustained deficits, leading to widening debtor positions in key economies, could constrain global growth and possibly result in sharp and disruptive currency and asset price adjustments.”
That last reference to “sharp and disruptive currency and asset price adjustments” is a fancy, and deliberately understated, way of saying “financial crisis.”
The danger is underscored by Figure 1 from the Report (on page five) – which shows how the world’s current account situation has changed over time. Optimists might take comfort from the fact that the overall global imbalance today (showed by the thick, solid line), is considerably smaller as a share of global output than it was at the peak of the last decade’s bubble. Also of interest: China’s current account surplus has shrunk in relative terms, while those of Japan, Germany, and the Netherlands have remained about the same. (For evidence that the better Chinese numbers are largely smoke and mirrors, see this analysis from the Council on Foreign Relations – not exactly a hotbed of protectionist thought.)
But here’s what the pessimists would note – and what should worry everyone: Although the total worldwide current account imbalances is down, so is global growth. During the peak bubble years, it was about 4.30 percent annually after inflation. During the current recovery, it’s been much lower, and last year, it was 3.15 percent. Worse, a new slowdown may well be in the cards.
That is, the world economy seems to be facing all the dangers of a new financial crisis without having received many of the (dubious) benefits of a preceding bubble.
The IMF has a solution: The persistent surplus countries should spend more (which will presumably pull in more imports from the deficit countries) and the deficit countries should take “actions to strengthen public and private sector balance sheets” (that is, in large measure, spend less).
And it sends a warning: “[P]rotectionist policies should be avoided as they are likely to have significant deleterious effects on domestic and global growth, while limited impact on external imbalances.”
These are pretty standard prescriptions. The trouble is, as usual, neither the surplus nor the deficit countries are showing any interest in following them. Moreover, the IMF’s views on the relationship between trade flows on the one hand, and national borrowing and spending and savings rates on the other, seems to repeat the canard that net savings levels determine trade flows. Nowhere do its economists acknowledge that the fundamental mathematical relationship is that of an identity – which says nothing about causation at all. As a result, they also ignore all the ways in which trade flows can determine savings rates.
It’s anything but realistic to expect the Fund to endorse President Trump’s tariffs or any of the rest of his trade policies. But it also seems to remain anything but realistic to expect the Fund to identify any plausible alternative ways to prevent today’s global imbalances from turning into Financial Crisis 2.0.
Benjamin Cole said:
There have been some Fed studies that nations with large current account trade deficits have real estate and house-price explosions.
Click to access sr541.pdf
I think this problem is exacerbated by property zoning, a whole ‘nother discussion.
BTW tell me if you think there are any errors in the following:
“Say a nation primarily relies on VAT taxes which are applied on all imports, and domestic industries serving servicing domestic markets, but not on exporters, even on exporters that export to nations that do not rely in VAT taxes. (This describes European, Chinese and Singapore exports to the US).
Okay, in Europe the VAT taxes primarily pay the cost of running government, making for a good place to host a business—the infrastructure, schools, national defense, fire and police, civil courts, etc. Importers help pay the freight, domestic industries help pay the freight, but exporters—they piggyback for free. Exporters who export to the US are subsidized. They pay no taxes to help support the nation in which they operate, nor the one they export to. I do not see how this is refutable.
Now, of course, there are endless complications and some other taxes. In Singapore, for example, all the land is owned by the government of Singapore. Businesses in Singapore pay rent to the government of Singapore. But suppose Singapore offsets the VAT taxes with cut-rate rents? Who knows?
In the Singapore case, the VAT taxes (dubbed “7% sales taxes” on imports) look much more like a tariff.
We do not know to what extent European or Chinese governments effectively offset VAT taxes through other gizmos, through it is certainly easy enough in China and Singapore. Just cut the rent, and offset VAT taxes.
In sum, to flatly declare VAT taxes are not tariffs, or to insist they are, is probably not possible.
As I said, macroeconomists are peering at trade through a very thick fog of structural impediments and institutional frictions.”
Alan Tonelson said:
Your description of VATs and their major trade effects in places like Europe and China is spot on!
William Holland said:
External Sector Report URL in your essay does not work . Fix link please.
Alan Tonelson said:
Thanks for letting me know, and apologies!