October 3, 2006
How to Fix the Global Economy
THE International Monetary Fund
meeting in Singapore last month came at a time of increasing worry
about the sustainability of global financial imbalances: For how long
can the global economy endure America’s enormous trade deficits — the
United States borrows close to $3 billion a day — or China’s growing
trade surplus of almost $500 million a day?
These imbalances simply can’t go on forever. The good news is that
there is a growing consensus to this effect. The bad news is that no
country believes its policies are to blame. The United States points
its finger at China’s undervalued currency, while the rest of the world
singles out the huge American fiscal and trade deficits.
To its credit, the International Monetary Fund has started to focus
on this issue after 15 years of preoccupation with development and
transition. Regrettably, however, the fund’s approach has been to
monitor every country’s economic policies, a strategy that risks
addressing symptoms without confronting the larger systemic problem.
Treating the symptoms could actually make matters worse, at least in
the short run. Take, for instance, the question of China’s undervalued
exchange rate and the country’s resulting surplus, which the United
States Treasury suggests is at the core of the problem. Even if China
strengthened its yuan relative to the dollar and eliminated its $114
billion a year trade surplus with the United States, and even if that
immediately translated into a reduction in the American multilateral
trade deficit, the United States would still be borrowing more than $2
billion a day: an improvement, but hardly a solution.
Of course, it is even more likely that there would be no significant
change in America’s multilateral trade deficit at all. The United
States would simply buy fewer textiles from China and more from
Bangladesh, Cambodia and other developing countries.
Meanwhile, because a stronger yuan would make imported American food
cheaper in China, the poorest Chinese — the farmers — would see their
incomes fall as domestic prices for agriculture dipped. China might
choose to counter the depressing effect of America’s huge agricultural
subsidies by diverting money badly needed for industrial development
into subsidies for its farmers. China’s growth might accordingly be
slowed, which would slow growth globally.
As it is, however, China knows well the terms of its hidden “deal”
with the United States: China helps finance the American deficits by
buying treasury bonds with the money it gets from its exports. If it
doesn’t, the dollar will weaken further, which will lower the value of
China’s dollar reserves (by the end of the year, these will exceed $1
trillion). Any country that might benefit from China’s loss of export
market share would put its money into a strong currency, like the euro,
rather than the unstable and weakening dollar — or it might choose to
invest the money at home, rather than holding more reserves. In short,
the United States would find it increasingly difficult to finance its
deficits, and the world as a whole might face greater, not less,
Nothing significant can be done about these global imbalances unless
the United States attacks its own problems. No one seriously proposes
that businesses save money instead of investing in expanding production
simply to correct the problem of the trade deficit; and while there may
be sermons aplenty about why Americans should save more — certainly
more than the negative amount households saved last year — no one in
either political party has devised a fail-proof way of ensuring that
they do so. The Bush tax cuts didn’t do it. Expanded incentives for
saving didn’t do it.
Indeed, most calculations show that these actually reduce national
savings, since the cost to the government in lost revenue is greater
than the increased household savings. The common wisdom is that there
is but one alternative: reducing the government’s deficit.
Imagine that the Bush administration suddenly got religion (at
least, the religion of fiscal responsibility) and cut expenditures.
Assume that raising taxes is unlikely for an administration that has
been arguing for further tax cuts. The expenditure cuts by themselves
would lead to a weakening of the American and global economy. The
Federal Reserve might try to offset this by lowering interest rates,
and this might protect the American economy — by encouraging
debt-ridden American households to try to take even more money out of
their home-equity loans to pay for spending. But that would make
America’s future even more precarious.
There is one way out of this seeming impasse: expenditure cuts
combined with an increase in taxes on upper-income Americans and a
reduction in taxes on lower-income Americans. The expenditure cuts
would, of course, by themselves reduce spending, but because poor
individuals consume a larger fraction of their income than the rich,
the “switch” in taxes would, by itself, increase spending. If
appropriately designed, such a combination could simultaneously sustain
the American economy and reduce the deficit.
Not surprisingly, these recommendations did not emerge from the
International Monetary Fund meetings in Singapore. The United States
retains a veto there, making it unlikely that the fund will recommend
policies that aren’t to the liking of the American administration.
Underlying the current imbalances are fundamental structural
problems with the global reserve system. John Maynard Keynes called
attention to these problems three-quarters of a century ago. His ideas
on how to reform the global monetary system, including creating a new
reserve system based on a new international currency, can, with a
little work, be adapted to today’s economy. Until we attack the
structural problems, the world is likely to continue to be plagued by
imbalances that threaten the financial stability and economic
well-being of us all.
Joseph E. Stiglitz, a
professor of economics at Columbia and the author, most recently, of
“Making Globalization Work,” was awarded the Nobel in economic science