Don’t Blame Just Us

By John W. Snow, secretary of the Treasury (THE WASHINGTON POST, 21/04/06):

This weekend finance officials from across the globe will gather in Washington to discuss the opportunities and challenges facing the international economy. The outlook is strong, with 2006 set to be the fourth straight year of above 4 percent global growth — the first time that has happened since the early 1970s. And this prosperity is widespread, with signs of solid growth in Japan and the beginning of a recovery in Europe.

But it’s when times are good that we must be especially vigilant in looking for clouds on the horizon. Today the International Monetary Fund is hosting a conference on global imbalances, the popular catchphrase for the capital and trade flows that have resulted from uneven regional growth, inflexible exchange rates and some regions’ overdependence on exports — especially to the United States — to fuel their growth.

This isn’t a new topic for finance officials, but I would hope that today will be the start of a more comprehensive phase of the discussion, pointing to real action. Too many discussions of this topic have labeled the United States the sole cause of, and solution to, the challenge. For example, if only the United States would take more aggressive action to address its fiscal deficit — read: raise taxes — the argument goes, then global imbalances would disappear without affecting anyone else.

This narrow view ignores two important points. First, while fiscal policy is a powerful tool for domestic economic policy, it’s a poor one for addressing external imbalances. Second, an eventual move to a current account balance in the United States would require a reduction in the current account surpluses everywhere else.

Now that the U.S. economy is growing strongly, the Bush administration is on track to cut the deficit to a projected 1.4 percent of gross domestic product by 2009. Today’s deficit, at 2.6 percent of GDP, is below the 40-year historical average and well below the fiscal deficits of major economies in Europe and Asia.

Reducing the budget deficit is good policy, but history and empirical research show that cutting the U.S. fiscal deficit is unlikely to have a meaningful impact on the U.S. current account deficit. Between 1996 and 2000, the U.S. federal fiscal balance moved from a deficit to a surplus, yet the current account deficit increased from 1.6 to 4.2 percent of GDP. Nor is the U.S. experience unique: Analysis of 13 advanced economies over the past 20 years suggests that there is no statistical relationship between fiscal balances and current account balances.

More formal analyses by the Federal Reserve and the IMF cast further doubt on the relationship between fiscal deficits and the current account. The Fed study found that reducing the fiscal deficit by 1 percent of GDP would shave just 0.2 percent of GDP from the U.S. current account deficit. A similar IMF study suggests that the effect would be 0.4 percent of GDP. Even using the IMF’s larger estimate would imply that bringing the federal budget into balance would only reduce the current account deficit from the present 7.0 percent of GDP to 5.9 percent. Yet this small adjustment would probably come at significant cost: The IMF study suggests a five-year loss of more than $300 billion in U.S. output and thousands of jobs, while the Fed study suggests much higher costs. Clearly it is important to sustain good U.S. growth rates while addressing the current account.

Addressing global imbalances is a shared responsibility. The United States is doing its part — we have adopted policies to reduce our fiscal deficit and increase national savings — but the other major economies must do their parts as well.

Many countries have become completely dependent on exports to the United States for their economic growth. These and other countries, in Europe, Asia and elsewhere, should address this question: What is being done to prepare for an eventual reduction in U.S. relative demand for imports, which would be a part of the adjustment? Their answer should include increasing the flexibility of their economies and expanding their potential for domestically led growth. Doing so would provide major benefits to the global economy and a basis for sustainable growth.

The U.S. current account deficit reflects relatively low investment in many other countries as capital seeks higher returns in the fast-growing U.S. economy. For major economies in Japan and Europe to attract more capital for investment at home, they must undertake structural reforms to modernize their product, labor and financial markets and raise their potential growth rates. Likewise, financial reforms in emerging markets can boost domestic investment and increase the efficiency of asset allocation.

Emerging Asia, and China in particular, should adopt policies to rebalance their growth, moving away from dependence on exports by promoting increased domestic consumption. A key element of this process must be the adoption of more flexible exchange rates, to allow for a gradual adjustment of these economies. Higher investment in oil exporters is also needed, not only to boost domestic demand but also to increase oil production capacity and thereby reduce the price volatility that threatens medium-term global economic growth. And we must continue to reduce trade barriers.

With global growth strong, now is the time for all nations to take on the challenge of imbalances. Today’s conference provides an opportunity for my colleagues and me to begin an intellectually honest debate on the responsibility we all share.