Global Imbalances and the Evolving World Economy Global Imbalances and the Evolving World Economy edited by Jane Sneddon Little Federal Reserve Bank of Boston Boston, Massachusetts Contents ©2008 Federal Reserve Bank of Boston. All rights reserved. Acknowledgments vii No part of this book may be reproduced in any form by any electronic or 1 Introduction 1 mechanical means (including photocopying, recording, or information storage Rebalancing Act: Global Imbalances in a Changing World 3 and retrieval) without permission in writing from the publisher. Jane Sneddon Little This edited volume is based on a conference held in June 2006 Box: The Economic Importance of the Emerging Giants 7 by the Federal Reserve Bank of Boston. Selva Bahar Baziki 2 Dancing with Giants: The Geopolitics of East Asia in the 39 Conference Series No. 51 Twenty-First Century This book was set in Sabon by Sztrecska Publishing and Stephen W. Bosworth was printed and bound in the United States of America. 3 Lessons from History 51 Losing Our Marbles in the New Century? The Great 53 Rebalancing in Historical Perspective Christopher M. Meissner and Alan M. Taylor Comments 131 Suzanne Berger Comments 145 John F. Helliwell 4 Labor Market Imbalances 157 Labor Market Imbalances: Shortages, Surpluses, or What? 159 Richard B. Freeman Comments 183 Surjit S. Bhalla Comments 189 Alan V. Deardorff vi Contents 5 The Essential Complements to Capital 197 Capital and Its Complements in Economic Growth 199 Acknowledgments J. Bradford DeLong Comments 215 Abhijit V. Banerjee Comments 221 Lixin Colin Xu 6 Imbalances between Savings and Investment 235 Understanding Global Imbalances 237 Richard N. Cooper Comments 263 The Research Department of the Federal Reserve Bank of Boston and Guy Debelle the editor thank all of the many people who contributed to the confer- Comments 275 ence and to this book. To single out a few, we thank Patricia Geagan Laurence J. Kotlikoff for superb management of the conference arrangements; she was ably 7 Adjustment Mechanisms 281 assisted by Selva Baziki, Tom DeCoff, Donna Dulski, Nancy Gillespie, Interest Rates, Exchange Rates, and International Adjustment 283 Ralph Ragsdale, and Teresa Foy Romano. As managing editor, Elizabeth Michael P. Dooley, David Folkerts-Landau, and Murry worked creatively with the authors to shape the preliminary con- Peter M. Garber ference presentations into final copy; her contributions were key. Suzanne Comments 313 Lorant and Tyler Williams put together the illustrations in the volume Catherine L. Mann while Selva Baziki, Sheila Bodell, Heidi Furse, Adrienne Hathaway, Comments 325 Krista Magnuson, Teresa Foy Romano, Puja Singhal, Sally and Steve Eswar S. Prasad Sztrecska, and Julie Weinstein also made valuable contributions to the 8 Appropriate Adjustment Considerations and Policies 333 preparation of this book. An Indian Perspective on Global Imbalances and Potential 335 Policy Responses Shankar Acharya The Effects of Globalization on Inflation and the 341 Implications for Monetary Policy Donald L. Kohn Five Policy-Relevant Observations and an Epilogue for 2008 351 Lawrence H. Summers Contributors 361 Author Index 373 Subject Index 375 1 Introduction Rebalancing Act: Global Imbalances in a Changing World Jane Sneddon Little In June 2006 when the Federal Reserve Bank of Boston conference on global imbalances took place, the world had been confronting unusually large current account imbalances for so long that international policymak- ers had almost stopped warning that these misalignments represented a major risk to the world economic outlook. Almost—but not completely. To avoid accusations of crying wolf, many analysts were continuing to include disruptive-adjustment scenarios involving sharp dollar deprecia- tion, financial market crises, and global slowdowns in their published forecasts. But they had begun placing these warnings in boxes, outside the main text, where the reader could easily ignore these alternative sce- narios. Today, while somewhat reduced and overshadowed by the (not unrelated) U.S. house price correction and its repercussions, these imbal- ances are still with us.1 How big a threat do these imbalances actually represent to the global economy? And how did these imbalances develop—with the United States, on one side, accounting for the bulk of the global deficit and a more variable group—currently China, Japan, Germany, and a collec- tion of oil-exporting nations—accounting for the bulk of the global surplus, as shown in Figure 1.1? This state of affairs means that the United States has consumed more than it has produced and invested more than it has saved since 1991—a situation that has lasted well over 15 years. Equivalently, our trading partners, some of whom are very poor on a per capita basis, have willingly lent us, a wealthy country, the funds needed to import the resources to fill the gap—now equal to about 5 percent of our GDP, as illustrated in Figure 1.2. If the United 4 Introduction Jane Sneddon Little 5 Shares of World Surplus Shares of World Deficit States were a developing country, such behavior would have triggered a crisis long ago. But, of course, the United States is not a developing 1995 1995 country. Other United States In assigning blame, foreign policymakers tend to highlight American Japan Other policy “mistakes” as having led to a decline in public and household sav- Singapore ing rates in this country, while U.S. policymakers tend to point to Asian Belgium countries’ “ill-advised” decision to manage their currencies in terms of the dollar. Such a dollar peg has led, they claim, to too much produc- France Hong Kong tion with too little domestic consumption—a global savings glut, in other Germany Switzerland Netherlands Thailand Australia words, although some observers interpret this imbalance as a surplus- Italy United Kingdom Brazil country investment dearth instead. 2000 2000 But cyclical imbalances are generally short-lived, and policy mistakes Japan Other are usually quickly punished. By contrast, persistent imbalances may reflect something more fundamental than short-run policy errors. Indeed, Australia such enduring imbalances may more likely reflect a major structural shift Other Mexico Spain in the distribution of the world’s resources associated with the arrival Russia Brazil Germany Percent Switzerland United 10 Kingdom Netherlands France Norway United States China Canada Germany 5 2007 2007 Japan Canada China Other 0 Other France Turkey Greece United Kingdom Italy −5 Japan Australia United States Australia Norway United Germany Kingdom Spain Switzerland United States −10 Saudi Arabia Spain Russia 1989 1993 1997 2001 2005 2009 Figure 1.1 Figure 1.2 Global Current Account Imbalances, 1995, 2000, and 2007 Current Account Balances as a Percent of GDP, Selected OECD Source: IMF World Economic Outlook Database, April 2008. Countries, 1989–2009 Note: Some 2007 data are IMF estimates. Source: OECD Economic Outlook 82 Database. Note: 2008 and 2009 data are OECD projections. 6 Introduction Jane Sneddon Little 7 of the new giants—China, of course, but also India and the ex-Soviet Déjà Vu? bloc countries—as key players in the global economy. In particular, the recent addition of hundreds of millions of Chinese and Indian workers Does history hold any lessons for the contemporary world economy? A to the globally active labor force represents a significant re-weighting of wave of international activity between 1870 and 1913, often characterized world labor markets. In addition, now Japan and Germany (and in a few as the “First Globalization,” represents an earlier time when technologi- decades, China) are stepping into an unprecedented demographic future cal, economic, and political developments suddenly provided improved of secular population decline. In scope and significance, these global global access to previously untapped resources and the incentive to take resource shifts are not unlike the flows of capital and labor that accom- advantage of them. The resulting flows of capital and people led to very panied the European migrations to the New World and the colonization persistent current account imbalances lasting through much of the period, of India and other regions in earlier periods. (See the following brief essay a condition which offers some possible parallels to today’s situation. in this section for a discussion of the economic importance of the emerg- Beginning in the nineteenth century, improvements in shipping and com- ing giants.) munications technology and widespread adoption of the gold standard But in contrast with these previous episodes, this time around the led to a surge in international migration, trade, and investment through capital flows are heading the “wrong way”—from fast-growing devel- the world’s first truly global markets.3 Steam replaced sail, the telegraph oping countries, where returns on investment would presumably be arrived in the 1830s, the first transoceanic cable was laid in 1866, and high, to mature wealthy countries. Is this situation sustainable? Sim- the Suez Canal opened in 1869. Driven by poverty, famine, religious per- ply stabilizing the U.S. current account deficit at its present level rela- secution, and failed revolutions, the stream of people from the European tive to GDP would require foreign investors to add U.S. assets worth core to sparsely populated British offshoots in North America, Austra- about 5 percent of U.S. GDP to their portfolios year after year—an lia, and New Zealand became a flood as 55 million people, one-quar- uncertain proposition.2 But if these imbalances do turn out to be sus- ter of the European population in 1850, emigrated between 1815 and tainable, is that outcome desirable? If not, will adjustment occur 1924;4 60 percent of the migrants landed in the United States. Capital smoothly or in response to a crisis? How concerned should policymak- followed them to the New World, while investment in densely populated ers be? Opinions run the gamut from Apocalypse Now to Panglossian Asia accelerated as well.