In the video below from the Real News Network, former economist at UNCTAD, Heiner Flassbeck, discusses some of the problems besetting today’s global economy and claims that they have deep historical roots. Germany may be heading for a recession due to shrinking exports linked to the ongoing US-China trade war and weak demand in Europe.
Flassbeck argues that the cause of sluggish global demand lies in the weakness of corporate investment compared to corporate saving alongside stagnant wages and the insufficient response of governments in Europe to counter this with more expansionary fiscal policy.
This has been brewing since the 1970s. The US under Reagan, Bush junior and most recently Trump has on a number of occasions responded to sluggish growth with higher fiscal deficits. The exception came under Clinton, when a booming economy and fiscal tightening produced several years of budget surpluses, which ultimately proved unsustainable.
In contrast, many European economies have remained wedded to tighter fiscal policies and austerity in the run-up to the creation of the euro. Since 2000 Germany has relied on foreign demand to drive growth, and now runs, in absolute terms, the largest current account surplus in the world.
Corporate surpluses are also excessively large in Japan, but the government continues to run a moderately large budget deficit which absorbs some of these savings and sustains aggregate demand to a degree. The German government is now running a budget surplus, which withdraws demand from the economy, leaving net exports as the driver of growth.
Ideally, corporations would use more of their retained earnings for investment, rather than running up surpluses as they are doing at the moment, particularly in Germany. This would increase spending on the demand side, and the capital stock on the supply side, boosting growth in output and some combination of employment and productivity.
In the absence of strong corporate investment growth, sufficient demand to support economic growth has to come from household consumption, net exports, or from the government. With insufficient household income growth, Germany has relied excessively on growth in exports enabled by sluggish wage increases for twenty years. In a weakening global economy, it is now suffering again and could be on the brink of recession.
A more sustainable return to healthy economic growth and fuller employment with rising living standards would see household incomes rising for the majority through significant wage increases, stimulating consumption and providing greater incentives for companies to increase investment in new capacity and employment. Also needed is some degree of fiscal expansion which includes public investment in necessary infrastructure and support for those on the lowest incomes.
The corporate sector surplus (the excess of savings over investment) in a number of large economies needs to shrink as wages and household incomes rise alongside corporate investment. This would lessen the need to rely on large and persistent fiscal deficits, which have supported demand in Japan on and off for well over two decades but have not by themselves created the conditions for a return to more balanced economic growth over the longer term. It would also lessen the need for consumption to be excessively dependent on rising debt, as in the UK and US.
More balanced global growth and reduced inequality within countries which have seen the latter soar since the end of the 1970s can be achieved together.
Flassbeck does not really discuss the reasons behind excessive corporate savings relative to investment, aside from a brief reference to neoliberalism, and he ignores the problem of private debt in China, but the interview is interesting and worth a watch.
The IMF recently published its Economic Outlook for Germany. The report itself is quite long but a brief description of the key points can be found here. I have written before on the problems caused by Germany’s supposedly ‘prudent’ saving behaviour and export prowess, and the IMF covers this issue quite well, although as a report focused on one country, it does not consider the global implications. Here I want to focus on one aspect of the report: the financial imbalances of Germany’s economy and their relationship to both inequality and future growth prospects, both domestically and in the rest of the world.
In macroeconomics, one can consider the financial balances (net borrowing or net lending) of the three main sectors in the economy as a whole: the private sector (firms and households together), the public sector (government) and the foreign sector (the rest of the world). Together these balances can be used to analyse the total flows of expenditure and income between the three sectors, both within that economy and between that economy and the rest of the world.
If a sector runs a financial surplus over a particular period, its income for that period will exceed its expenditure and it will either be accumulating financial assets from another sector or paying down debt owed to another sector. For example, if the government runs a surplus, then revenue from taxation will exceed public spending and it will be able to pay down government debt held by the private sector, either domestically or abroad. Continue reading →
A useful short paper by post-Keynesian economist Jan Kregel of the Levy Institute, focusing on the nature and causes of global financial and trade imbalances, and how they might be resolved in a way that supports global growth and employment.
Kregel argues that in today’s global economy, financial flows dominate trade flows, and are the cause of significant capital account imbalances, which drive concomitant current account imbalances.
Trade policy, such as the imposition of tariffs, and escalating trade wars, are unlikely to resolve these imbalances. On the contrary, controls on capital flows would be much more effective. An alternative to this is Keynes’s original proposal for an international clearing union, able to create liquidity not based on a national currency such as the dollar, and promote international cooperation. This seems a long way off in today’s world.
All this is along the lines of arguments made by Michael Pettis, whose ideas I refer to often on this blog. However, Pettis also links global imbalances to national savings behaviour, so that a ‘savings glut’ not invested domestically in one country can be exported abroad, and can create financial bubbles and rising debt, potentially leading to stagnation or crisis in the longer term.
Donald Trump’s signature policy of 2017, the so-called Tax Cuts and Jobs Act, cut taxes sharply for the richest earners and corporations. As so often in recent decades, many Republicans claimed that this would pay for itself via the increased revenue generated by faster economic growth, which would incorporate higher investment and higher wages for ordinary Americans. There would therefore be little need to cut spending to prevent the deficit from rising.
Such supply-side policies are part of the essence of ‘trickle-down’ economics, which boils down to the argument that making the richest members of society richer will make everyone richer, including those at the bottom. As with previous such policies, this remains to be seen, but the signs are not good.
On the other hand the US budget deficit is rising and is set to rise further. The national debt is also now growing faster than previously. While growth has been stimulated for a while, perhaps more from the demand-side than the supply-side, it seems that it is now slowing once more. This is a long way from the vaunted economic miracle from the President’s State of the Union address. Continue reading →
The Levy Economics Institute of Bard College is ostensibly non-partisan but much of its published output is in the post-Keynesian tradition, and inspired by the work of Hyman Minsky and Wynne Godley, who both worked at the Institute in their later years. Continue reading →
There is a nice piece in this week’s New Statesman by economics commentator Grace Blakeley on the dangers of the unresolved eurozone crisis, with Germany at its heart. With growth in the eurozone currently slowing, after a brief spurt, unemployment is set to remain unsatisfactorily high in a number of countries, not least Greece and Spain. Germany itself is teetering on the brink of recession.
As Blakeley argues, resolving the crisis requires the northern states of the currency block to expand domestic demand. This is particularly necessary in Germany, the largest economy in the eurozone, which is running a current account surplus of nearly eight percent of GDP. It is thus overly dependent on external demand, and growth in world trade.
What the piece misses, maybe in order to avoid unnecessary complexity, is that a decade of wage stagnation in the 2000s, while rendering German exporters more competitive and profitable, and boosting employment, has also squeezed household incomes and raised national savings relative to investment. This is reflected in the aforementioned large current account surplus, which is by definition equal to the gap between domestic savings and investment. Continue reading →
David Pakman’s videos are well worth watching for his incisive and progressive analyses of US current affairs. But on the question of the global role of the US dollar, which he describes below, I think he is wrong. Watch this short video first, before reading my critique below.
Is the US dollar’s dominant role in world trade and reserve policy an exorbitant privilege or an exorbitant burden? I go with the latter. The argument that it is a privilege and benefits the US economically is often made. This argument draws the conclusion that the US is able to borrow and spend beyond its means as a result. The US current account deficit is therefore a good thing, as it reflects the higher consumption and lower savings that can be sustained. It also apparently allows the US to sustain a higher level of debt, whether on the part of the private sector or the government, which boosts aggregate spending or demand.
But as Michael Pettis argues in his book The Great Rebalancing, it is perhaps just as accurate to say that the dominance of the US dollar in global payments and reserves forces the US to consume beyond its means. It results in lower US savings relative to investment, reflected in the current account deficit, and higher savings relative to investment in the rest of the world.
The stronger demand for US dollars in the rest of the world produces a stronger dollar than would otherwise be the case. This makes US exports more expensive abroad, and imports cheaper in the US, and will thus tend to widen the trade deficit (exports minus imports) and the current account deficit, other things being equal. Production and employment will be lower among US exporters, who will find it harder to compete with rivals abroad. US firms producing for the domestic market will similarly find it harder to compete with cheaper imports.
Larger trade and current account deficits act to drain demand from the US economy. A larger capital account surplus is the flipside of a larger current account deficit, and represents the net inflow of funds required to fund the latter, or what the US is borrowing from the rest of the world. These funds will either be used to fund domestic investment, which can be productive or unproductive, or to fund domestic consumption.
The result is that the US savings rate will be lower relative to the US investment rate than it would otherwise have been. The savings rate could fall, while the investment rate stays the same, necessarily leading to a higher rate of consumption. Or the savings rate could remain the same, while investment, whether productive or unproductive, rises.
If the new investment is productive, and generates flows of income in the future greater than its overall cost, then the US economy will end up larger and more productive, while employment should be higher. If the new investment is unproductive, such as takes place in a housing bubble, then this will ultimately raise the debt burden and slow future growth in output and employment.
So a larger current account deficit need not be a negative factor for an economy, if the funds borrowed from abroad are used to fund productive investment. But this only tends to be the case for an economy which is short of domestic sources of finance for investment. For an economy like the US, with sophisticated and liquid financial markets, there is little evidence that domestic investment is constrained by a shortage of domestic saving. So capital inflows will tend not to lead to higher productive investment, but rather to higher unemployment or higher debt.
The capital inflows to the US, resulting in a capital account surplus, and reflected in the gap between domestic investment and savings, described by some commentators as a shortage of savings, are the consequence of excessive savings relative to investment in the rest of the world, or a ‘savings glut’.
Savings and investment must be equal for the world economy as a whole, but can be out of balance for individual countries. If savings rise in one country but investment does not, the surplus must be exported abroad, and lead either to higher investment or lower savings in the rest of the world, so that global savings and investment continue to balance.
The US can only be a net borrower from the rest of the world and therefore continue to run a current account deficit if foreign economies are net savers in aggregate relative to the US. Economies such as China, Japan and Germany have run the largest current account surpluses (meaning that they are net savers) in recent years. It is their policies as much as those in the US which lead to a lower savings rate in the latter.
This is because, for the world as a whole, the balance of payments must balance! Current account deficits in some countries must be offset by current account surpluses in others. The major surplus countries are avoiding significant appreciations of their currencies by accumulating dollar reserves. They do this in part to sustain relatively weak currencies which boosts net exports by making their exporters more competitive.
These surplus countries are relying on their exporting sectors to boost demand, growth and employment because the growth in their domestic demand is relatively weak. So any rapid appreciation of their currencies would hobble their exporters and growth would falter. It would also probably take some time for the necessary adjustment and certain economic reforms in order for domestic demand to take up the slack.
The surplus countries therefore have a strong incentive to sustain the status quo, which helps to maintain the dollar as the dominant world currency, keeping it stronger than it otherwise would be. This is the exorbitant burden which the US, and ultimately the world, must carry.
All this played a significant role in causing the global imbalances which led to the Great Recession of 2008. These imbalances need to be resolved in order for the world to begin a new period of sustained growth. So Trump and his advisers may be on to something when they complain about the US trade deficit. It may therefore be a good thing if the dollar becomes less widely used for global trade and the accumulation of reserves, whether this is intended or not. Everything else being equal, a decline in the dollar would help the US economy rebalance in the longer run, boosting growth and employment and reducing the debt burden.
Is there a solution to all this, which would go beyond Trump’s muddled bluster? There is, and it has been around since the formation of the Bretton Woods institutions in 1944. It was then that Keynes proposed the creation of an international currency, bancor, which would be used to prevent excessive international payments imbalances and the unsustainable buildup of debt, which he strongly believed would tend to stifle growth. His US counterpart Harry Dexter White rejected the idea.
We have been left with Special Drawing Rights (SDR), a basket of international currencies maintained by the IMF, which were created in 1969 as the Bretton Woods system of fixed exchange rates and managed international payments began to unravel.
If, as Keynes had hoped, something like the SDR were used more widely, then global payments imbalances should be less severe and more easily resolved. But this would, in the short to medium run, and contrary to the arguments of many economists, benefit the US economy and harm the major surplus countries which would be less able to run up large current account surpluses by keeping their currencies relatively weak and boosting their exports. Despite this, the argument should be made that it would create a more balanced global economy, and more sustainable growth.
Perhaps the trick is to appeal to the right vested interests, since ultimately consumers in the current surplus countries would benefit. Exporters in the US, and also in other major and long-standing current account deficit nations, such as the UK, would gain too.
As ever, one can’t ignore the politics. For Trump, whose muddled policies are currently encouraging a stronger dollar, a successful reduction in the US current account deficit might reflect a reduced global role for the US, as Pakman argues in the video, but a less dominant dollar would ultimately be good for US growth and stability. There might be some debate over whether the outcome would be making America ‘great’ again or not. But more widely-used SDR would also be a good thing for the prosperity and stability of the global economy, though this is perhaps a long way off, if it happens at all. Politics will get in the way of good economics, and not for the first time.