Changing the balance of China’s growth: moving the world onto a more sustainable footing

It has been argued by some that among the deeper causes of the current financial crisis are the enormous economic imbalances that have built up in the world, particularly that between the US and China, but also between the former and other East Asian countries, as well as some of the oil-producing countries of the Middle East. The large current account surpluses of these countries, and the corresponding large deficit of the US have as their corollary flows of capital from emerging markets to the rich world which, it is claimed have contributed to inflated asset-prices and fuelled the credit and housing bubbles which subsequently led to bust and the crisis in which we find ourselves. The economies of East Asia, particularly China, and also the Middle Eastern oil-exporters accumulated large foreign reserves, which were invested in large part in US Treasuries, which raised their prices and lowered their yields and the key long-term interest rate affecting the US economy. The monetary policy of the Federal Reserve from 2001 to 2005 has also been loose. This discouraged saving and promoted borrowing, which financed consumption and housing booms. These in turn sustained the growth of exports in the East and elsewhere, and hence the whole process.

The Economist magazine has also argued that economies in East Asia have become too dependant on export-led growth and with the end of the US-led boom, they need to rebalance their economies towards domestic demand and consumption, and somewhat away from exports. This rebalancing of the world economy may in turn help to prevent such a major crisis from occurring again, at least until the next bubble, which is bound to take on a different form.

Despite all this, Alan Greenspan in his memoirs and Joseph Stiglitz in a recent book ‘Making Globalization Work‘, have argued that if East Asian, and maybe oil-exporting countries were to revalue their exchange rates, relative to the US dollar, all else being equal, they may well reduce their current account surpluses, but in the medium-term, some production would shift to lower cost countries whose exports would increase, particularly to the US, and simply replace the supply to those markets lost to the countries that had revalued. In other words, the current account deficit of the US is the fault of the US low saving rate, both by private households and by government. The running up of debt by the US is also partly caused by the dollars role as a reserve currency, and the structure of international finance and payments needs to be changed, according to Stiglitz. Greenspan admits that US debt levels are unsustainable, but predicts an orderly unwinding of imbalances thanks to his belief in the rational collective power of private agents. 

What is needed as well as a shift in relative currency values, which only redistribute purchasing power between countries and, other things being equal, do not raise global demand overall, is a change in saving propensities within countries, by households, firms and governments.

Returning to our central topic: that China needs to help rebalance the global economy by reducing its excess domestic savings as a counterpoint to the US and some other Western countries increasing theirs and thereby reduce the sum of global current account imbalances, there are policies on both the demand and supply-side that can help. China can allow its currency to appreciate although it has already done so to some degree. It can loosen fiscal policy, which it is also doing, and can allocate increased public expenditure to health, education and welfare, as well as in rural areas particularly. These would help to shift aggregate demand towards domestic consumption. Would China’s productive system be able to respond to such a shift? The latter is likely to be helped by structural policies, which help the development of agriculture on the one hand, helping rural incomes to rise, and the service sector on the other.

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