Rebalancing economies: A Tale of Two Countries (US and China)

Nice speech by John Williams of FRBSF.

It is often said that when America sneezes, the world catches cold. This adage is a modern adaptation of the 19th century saying—attributed to Prince Klemens von Metternich—that, “When Paris sneezes, Europe catches cold.” Today, economic developments in China have obvious repercussions across borders as well, affecting everyone from small emerging economies to Europe and the United States. We live in a world where our economic fates are increasingly intertwined. Indeed, Metternich’s saying is now often heard with China as the proverbial sneezer.

Of course, this audience already knows of the growing influence of China and Asia more broadly. California is at the forefront in terms of business and cultural connections with Asia. Indeed, I often hear from people here that the outlook across the Pacific is more relevant to their businesses and organizations than events in Europe or elsewhere. With that in mind, I’d like to talk to you today about how two countries—alike in some ways, very different in others—need to rebalance their economies over the next decade. Those shifts will be similar in some aspects, divergent in others; but both face the challenge of how to best manage the transition to longer-run rebalancing. 

China needs to rebalance investments and US consumption:

China’s remarkable growth over the past 30 years has been fostered by an emphasis on investment and exports. As the returns to investment have declined over time, and slower global growth provides diminishing opportunities for exports, this model has become less sustainable. The focus must instead shift—as China’s leaders have indicated they would like—to domestic household consumption.

The United States, by contrast, has for decades consumed and invested more than it produced, relying on imports to fill the gap. The question for America is: How long can it sustain this imbalance? With every passing year that we don’t live reasonably within our means, and do not produce the goods to pay for our consumption, our debt to creditors outside the country grows. This reduces our net wealth and makes us more dependent on foreign lenders.

Response to the crisis:

China responded to the crisis with a large-scale stimulus program, increasing lending by banks to large, state-owned enterprises that totaled 4.4% of GDP over three years (Horton and Ivanova 2009). These loans were used largely to finance infrastructure and housing projects. China’s growth had fallen from a recent high of 14%, in 2007, to 9% in 2009. With the boost from the government stimulus, growth rebounded to 10% in 2010. That is, in the face of the worst global financial crisis in many decades, China’s economic growth actually increased.

While China’s growth has been greatly affected by forces outside its borders, the U.S. economy has been influenced by many internal conditions. In the United States, the response to the crisis was threefold: federal government fiscal stimulus in the form of tax cuts and increased spending; programs aimed at restoring confidence and strength to the financial system; and, last but not least, a large dose of monetary stimulus.

How to rebalance:

If China is to rebalance the economy away from exports and towards domestic consumption, there must be an increase in household incomes. That means higher wages and dividend payments from firms. Further liberalization of the financial system will also help, as higher deposit rates and more investment options would boost spending power. Furthermore, China’s citizens must feel a sense of stability and certainty regarding their future. When we’re worried about the future, the natural response is to want to save more. So, even if these steps were to be taken, the question remains whether China’s middle- and rural-class citizens are willing to become bigger spenders anytime soon.

Turning to the United States, over the longer run we need to increase investment in education, physical capital, technology, and infrastructure. We will also need to put federal fiscal policy on a sustainable path, which involves making some tough decisions about taxes and spending. Importantly, spending less on current consumption will free up resources for investment areas that foster greater production and will increase the size of the economy over the long term.

Nice summary..

Rebalancing the Economy: A Tale of Two Countries

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