There is lots of talk about trade imbalances these days, with surplus countries pitted against deficit countries. There is the U.S. versus China, of course, but there is also Germany versus Greece. The U.S.-China issue gets more press attention (at least here in the U.S.), and the situations are different because Germany and Greece share a currency.
So what, if anything, should be done about these imbalances? In this post and the next one, I quote from two papers that suggest various options for actions that might be taken in this regard, focusing on the U.S.-China situation but with occasional references to euro zone issues.
First up is John Williamson of the Peterson Institute, who has a new policy brief which discusses various proposals for the adjustment of trade imbalances. The second post is based on a recent paper by Martin Feldstein.
Williamson begins by talking about two much older proposals (by Keynes and the Committee of Twenty), and then turns to some recent propoosals dealing with today's problems:
Morris Goldstein
proposes that any country that runs a current account surplus greater than (say) 4 percent of GDP over a one-year period should automatically receive an ad hoc consultation by the Fund [the IMF] (meaning the staff) to discuss its exchange rate policy. The Fund (meaning its Executive Board) would summarize its views at the end of the process by issuing a verdict, or ruling, as to whether the member in question is fulfilling its international obligations on exchange rate policy. He writes that in broad terms “the test should be whether the country’s real effective exchange rate is seriously misaligned, whether the country’s policies—intentionally or not—contribute materially to that misalignment, and whether the misalignment harms significantly the country’s trading partners.”
...
Penalties should be graduated to the size of the failing. For misalignments of under 10 percent and up to a year’s duration, Goldstein envisages only intensive (but private) consultations with the Fund. For misalignments of 10 to 25 percent and a duration of one to two years, the Fund should go public and ask for a specific plan (and the country would not be able to veto publication of the report). For countries with even larger misalignments that refuse to commit credibly to a proposed plan of action to improve the situation, he proposes that the WTO approve trade policy retaliation.
Mattoo and Subramanian
[propose] that a country that felt threatened by another country’s exchange rate policy could refer its complaint to the WTO. The WTO could then ask the IMF for expert advice on the facts of the situation, just as for many years the GATT askedthe Fund for advice on whether a developing country had a balance of payments deficit that might justify the imposition of import restrictions. Specifically, the WTO should ask the IMF two questions: (1) whether an exchange rate is substantially undervalued, and, if so (2) whether the undervaluation is demonstrably attributable to government action.
C. Fred Bergsten
has recently proposed that a reserve currency country should be able to engage in counterintervention to push up the value of a currency that is being deliberately held down to an undervalued rate through intervention. If the counter-intervention was equal to that of the intervention that induced it, the presumption is that the exchange rate would be unchanged; correction of the rate would require larger intervention (or a policy change in the country with the undervalued currency). Thus correction of the rate by the reserve currency country would face the issues of deciding upon the scale of the intervention or the target rate toward which it was aiming. The immediate motivation is clearly to enable the United States to retaliate against China, but this faces an additional difficulty in that the renminbi is not a convertible currency and therefore the United States would not be able to invest any renminbi it acquired.
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There are at least two versions of the proposal presented in Bergsten’s op-ed. In the first, a reserve currency country takes the initiative but can be challenged in the IMF; if the IMF takes the side of the surplus country, the reserve currency country has to back off. In the second version, the IMF authorizes a reserve currency country to act.
Secretary Geithner
proposed at the Gyeongju meeting of the G-20 Finance Ministers that each of the G-20 countries should aim at limiting the size of its imbalance below 4 percent of GDP ... . He acknowledged that there would need to be exceptions for countries exporting natural resources but urged the others to agree that they would pursue structural, fiscal, and exchange rate policies consistent with a maximum imbalance of 4 percent of GDP. This was presented as an alternative to exchange rate targeting, but that can be questioned.
Daniel Gros
has proposed that the main Western countries invoke the principle of reciprocity and declare that they will henceforth sell public debt only to official institutions from countries in which they have a reciprocal right to purchase public debt.
Gary Hufbauer
proposes the use of taxation to penalize Chinese accumulation of dollars. He envisages the United States giving notice that it would terminate the US-China Tax Treaty, and then following this up by Congress allowing the Treasury secretary to impose a 30 percent withholding tax on the income accruing to a foreign government that maintains a seriously undervalued currency.
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Williamson then offers some thoughts on these proposals, coming out in favor of a combination of the Goldstein and Mattoo-Subramanian proposals:
The Bergsten proposal seems to me to assume that the rest of the international community would be happy to go along with giving a special position to the United States. I have just argued that the Geithner proposal is not adapted to this particular role. The Gros proposal would be ineffective because it ignores the possibility of China holding private assets. I in fact think it likely that some version of the Hufbauer proposal will ultimately be implemented by the United States, if China maintains its current policy, but I take it that an ideal policy would work through an international mechanism rather than reliance on national action. That leaves two of the proposals for consideration.
The first point is that it is not clear that the Goldstein and Mattoo-Subramanian proposals have to be considered as alternatives. Why not require that the Fund examine the policies of any country with a surplus above a certain level (presumably relative to GDP) and also allow any member to initiate action in the WTO?
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It has been argued that both of the past two proposals to hold surplus countries responsible for initiating adjustment suffer from the same problem: the impossibility of devising a suitable test of whether a country needs to adjust on the basis of its reserve holdings in the contemporary world. In many ways the Mattoo-Subramanian proposal represents an attractive alternative: It focuses attention on the exchange rate rather than reserve holdings, it seeks to use the IMF in an area where it undoubtedly has expertise, but it also seeks to exploit the greatest success in international cooperation in recent years, namely the dispute settlement mechanism of the WTO.
This proposal suffers from two limitations, however: It requires agreement by the Chinese government, and it is unable to address the problem created when a member of a monetary union runs an excessive surplus. It is argued that the best chance of addressing the first limitation is by adding a threat of additional taxation of Chinese government-held securities unless China were to agree to the Mattoo-Subramanian proposal (in addition to the incentives they propose, WTO guarantees that their sovereign wealth fund would have right of investment plus US recognition of market economy status for China). The second could be addressed by running the Goldstein proposal (perhaps operated by the ECB rather than the IMF) in parallel to the Mattoo-Subramanian proposal. This could enable the international community to address this problem also, although it would be necessary to tweak the Goldstein proposal so that in this case it was not focused on the exchange rate issue but was prepared to recommend demand expansion even at the cost of faster national, as opposed to eurowide, inflation.
The division of the burden of adjustment between surplus and deficit countries is an issue that has been with us for at least 70 years. It is doubtful if the world can wait another 70 years before the international community addresses it.
So Williamson suggests a number of very proactive approaches. In the next post, Martin Feldstein thinks the problem will be solved with much less effort.
