Where To Focus with the Issue of Trade Imbalances: Exchange Rates vs. Domestic Economic Policies
I spend a lot of time on this blog criticizing op-eds and other articles, so I'm happy to have come across one for which I can offer an endorsement. The Economist has a piece by economists Gita Gopinath, Pierre-Olivier Gourinchas and Hélène Rey on trade imbalances, in which they explain that there is too much focus on the undervalued yuan when what is really needed is a good look at the domestic economic policies of both China and the U.S. In my view, lots of people are getting things wrong on trade imbalances, and it's nice to see these folks getting things right (as I see things anyway!).
They start by noting that "the Chinese yuan is no doubt undervalued," but then say "the emphasis on the exchange rate as the lever of adjustment [for imbalances] is misplaced." As set out in a G7 expert report and an IMF policy paper on global imbalances, the yuan-dollar exchange rate is not a culprit but rather an outcome, "an undesirable but predictable consequence of a particular configuration of domestic policies." They explain further that:
A country that suppresses household consumption while simultaneously facing a collapse of property investment will run persistent current-account surpluses and will, other things equal, have a weak currency. A country with insufficient private savings and unsustainably large fiscal deficits will run persistent current-account deficits and will, other things equal, have a strong real exchange rate against other other currencies. The currency is misaligned because the underlying policy mix produces too much or too little saving. The exchange rate is a symptom, not the disease.
Then on the China side, they say:
... [China's] surpluses are real, large and a legitimate concern for the rest of the world, including for a European economy that cannot serve as the absorber of last resort. What China needs to do—and what is in its own long-term interest, given its ageing population and an investment model overly reliant on the tradable sector—is to raise the share of household income in GDP, expand social insurance so that families feel able to spend, and stop financing tradable-sector expansion at the expense of consumption. Do those things, and a real appreciation of the yuan will follow.
And on the U.S. side, they say:
... America will also need to tackle its unsustainable fiscal policy, as well as its persistently low private savings. That, too, cannot be addressed by exchange-rate gimmicks.
They conclude with this:
The G7 and the IMF locate the problem correctly: it lies in the constellation of domestic macroeconomic choices on both sides of the imbalance. A policy package, whereby China pivots to consumption and services-led growth, and America reins in fiscal deficits, is less spectacular than a grand currency bargain. But it has the advantage of being both effective and achievable.
When it comes to getting China to move on issues such as expanded social insurance and higher consumer spending, I have no sense of how to do this. What might the Chinese leadership be willing to do? How can they be nudged in a particular direction? Are Chinese citizens willing to spend more? I'd be interested in what China experts have to say on all this.
On the U.S. side, I feel like I understand the issues better, but it's still not clear how to get anyone to budge. We now have about 5 and a half years of Trump as president, and it's pretty clear that fiscal responsibility is not on his agenda. The question is, what would it take for some future administration to embrace this? It's strange to have to ask this, because from what I can tell fiscal responsibility is somewhat popular. If a presidential candidate were to say "I'm going to cut spending and raise taxes because we need to bring down the budget deficit and reduce the debt," I think that general pronouncement could get decent support. You can't satisfy everyone, of course, and the specific spending and tax adjustments would be a challenge to work out, but I can imagine that at least a small majority would recognize this policy as sensible and support it. Instead, though, we have been getting pro-cyclical, deficit spending stimulus and presidents who are not very popular. There may be a lesson in there for anyone who is willing to learn it.
Getting back to exchange rates, if I understand the authors' main point correctly, they are saying that it doesn't make sense to push for a currency adjustment without also undertaking some changes to domestic policies/consumer behavior, and I think that makes sense. I do wonder, though, what happens if, in practice, you can only get partial changes on the domestic side. I raise this because I think a shift in savings patterns may be hard to achieve, as this could be more cultural than policy-driven. In that case, the exchange rate may need some adjustment, and it would be nice if both countries would be amenable to allowing that to happen.