Factors that have contributed to the current global imbalance
Introduction
Global imbalance is an aspect of the economy which is as a result of imbalance of exports and imports where the imports add to a higher monetary value that the exports. This means that the overall consumption and investments in the entire world exceeds the overall savings of the economy. This causes what is informally called a global trade gap or a global trade deficit. The Global trade imbalance that has widely spread in the whole world has been the cause of the ongoing financial crisis in several countries in the world. Most nations are loosing confidence due to the financial crisis because it has led to great impacts in the entire world (Haddad and Ben, p. 21). This has been due to overreliance on donations or funding sources by the available banks in some of the countries. Research indicates that when the financial crisis emanating from global trade imbalance begun, there has not been an agreement among various stakeholders. In particular, this is between the people who have joined together to make trade policies in order decide the root causes and cure for this. According to Haddad and Ben, in their research on trade and the oriented growth after the crisis, this may be a combined result of monetary policies and the on going global imbalances that may have caused the emerging financial imbalances (p. 29).
The measure of the global trade imbalance, which has increased the level of crisis, can be the rapid expansion credit. Usually, the rapid expansion credit is sourced from the wholesale funding markets. This may have been increased by increased liquidity after the crisis. It has been found that difference across countries which is in the strength of the flow of capital has a strong effect on the emerging global imbalances. There is also a great difference between the long rates and the short rates. These rates have in turn been a contributing factor to the increasing global trade imbalances. All these do not only contribute to global economic crisis but also lead to reduction in flow of capital (Blanchard and Milesi-Ferretti, p. 3). A large dispersion of the positions of current accounts in the banks across different countries and capital inflow increase has greatly increased the global trade imbalances. This global imbalance has been a major cause of long term reduced interest rates in the entire world.
Facts on the current global imbalances
There are various facts that indicate and explain the origin of the current global trade imbalance taking place in the world. Detailed research clearly indicates that the U.S current account position is the major source of the on going global trade imbalances and the capital flows. According to the research done by Dunaway, the U.S government recorded a total trade deficit of 5.7% of US GDP in 2004. Though, the figure was seen to be too high it was still expected to rise in the year 2005. The state of the U.S current account has been seen to increase to higher levels in subsequent years. This has resulted to increased levels of the global trade imbalance. The chart below shows the trend of the U.S current account since 1990s (Claessens, Evenett, and Hoekman, p. 15).
However, there are several counterparts of the U.S current account. These include countries like Japan, China and some other emerging Asian countries. A study shows that these countries have recorded current account surpluses. These followed the Asian financial crisis that occurred between 1997 and 1998. These surpluses were found to go as high as 400 billion US dollars up to 2005. As from the chart, it can be observed that for from the year 1190 to 2005, Euro area recorded just a small current account surplus. This is an indication of compatibility with the Euro area position because it is known to be among the economies of the whole world that are classified as richest and most productive. This clearly shows that Euro area is not among the contributors of the current global trade imbalances in the world. All the above mentioned continents that have acted as counterparts have contributed to the increased flow of capital on the financial account side of the balance of payments (Claessens, Evenett, and Hoekman, p. 23).
Chart 1: Current account positions of selected economies, 1990-2005 (USD billions)
Adapted from: European Central Bank
Chart 2: Financing the US current account (breakdown by instrument) 1990-2004 (USD billions)
Adapted from: European Central Bank
Chart 2 analyzes the net flows that have aided the United States in financing its deficit as reflected in the current account. This is meant to reduce the impact that the deficit has caused on global trade. It is clearly indicated that the flows arising from fixed income have highly overwhelmed the net flows on the finance side of the current account. Some of these include portfolio bonds and notes. Therefore, it can be said that the United States current account has been a major factor that contributed to the build up of the global trade imbalance.
The role of macroeconomic policies
These are a variety of macroeconomic policies that have contributed to the on going global trade imbalance. This is a conclusion made from observations realized for a couple of years. Some of these policies are as discussed below.
Investment imbalances and productivity
Any surplus or deficit recorded in the current account of any country is derived from the difference between what a country can save and invest. This is a combination of the savings and investments from both private and the public sectors (Evanoff, Kaufman and LaBrosse, p. 20). This takes in to consideration both the public and the private sector. With reference to the U.S current account and the macroeconomic developments between 1980 and 2004 as shown in chart 3, there has been a more or less decline in the balance obtained from savings – investments in the private sector. The overall investment from the private sector has remained at a steady rate of 15-20% of GDP. In contrast, the net savings that were derived from the private sector in the United States were seen to decline from 8% to values below 2% in the subsequent years. This indicated a fluctuation with the economic cycle. The balance derived from the savings and investments in the private sector is supposed to record a higher value during the period of general slow down in the economic activities; the case of United States was totally opposite (Evanoff, Kaufman and LaBrosse, p. 21).
This imbalance between the savings and investments in the private sector within the United States is what has contributed to the current account deficit. This has pushed the level to 6 % of the gross domestic product (GDP). As gauged from a stock perspective, the United States has been found to be one of the top leading net debtors in the entire world. The continued fall of the savings in the private sector within United States has been due to decisions of the policies. This can be reversed when the policies are changed to reduce the high levels of global imbalance. A decline in savings means a corresponding increase in the consumption. This translates to a rise in the level of global imbalance (Cova, Pisani and Rebucci, p 11).
The second reason that might have led to the continuous decline of the savings in United States is structural changes in the economy. This has greatly contributed to the high current account deficits hence increased global trade imbalance. Sometimes there can be justification of the current account deficit if there is an observed growth in the country than its partners whom they trade with. An increase in productivity in a country raises the income of households and firms hence increases consumption and a corresponding decline in savings. The increased productivity means that there are high investment returns. This attracts capital from foreign countries and enhances the financing of the deficits in the current accounts leading to reduced global imbalance. Improved productivity is a major determinant of the level of the position of current accounts in any country. Chart 4 below tries to analyze the relationship between net savings in the United States and the real short-term interest rates. The same chart indicates that a decline in the net savings rates over the given period is closely related to the decline in real interest rates. Again, it can also be concluded that, the evidence from the chart shows an increased the current account deficit leading to an increase in the global imbalance (Cova, Pisani and Rebucci, p. 9).
Chart 3: United States – Current account and the savings-investment balance: 1980-2004 (as a percentage of GDP)
Adapted from: European Central Bank
Chart 4: United States – Real interest rate and savings as a percentage of GDP: 1980-2004 (quarterly)
Adapted from: European central bank
Role of fiscal policy
Fiscal policy is a strategy where the government uses the expenditure and the income it gains from its investment and tax collection to influence the economy of the nation. Fiscal policy is one of the key factors contributing tom the low amount of savings which in turn alters the position of the current account. With reference to the United States being the great contributor of the global imbalance, fiscal policy has been found to cause a great deficit in the current account of the United States. This has in turn led to the continued increase of the global trade imbalances. This is because any change in the fiscal deficit is reflected in the balance noted in savings and investments from the private sector. On the issue of taxation, imposition of taxes in the overall trade system causes imbalance of the global trade (Welfens, p. 183).
Some of the taxes are multilateral, bilateral and unilateral. These taxes increase the cost of importing goods and services across countries leading to increased investments on trade rather than saving. This automatically imbalances the trade because there will be a current account deficit, if the cost of imports is higher than the exports. Therefore, an increase in the fiscal deficit leads to an increase in the current account deficit as gauged from the perspective of accounting. According to Ricardian equivalence, there is a slight relationship between the fiscal policy balances and the position of the current account. This is as observed with the United States and other countries. This weak relationship implies that the position of the fiscal balance should not have a notable effect to the current account of a certain country. This is because it causes a change in savings from the private sector. In fact, a change in the fiscal position should always be related to the net savings in that country, meaning that a rise in the fiscal deficit should be related to a rise in the net private savings. Again, the relationship between the position of the fiscal balance and the current account is limited (Welfens, p. 186).
Global savings glut
According to Bernanke, this refers to a situation where the amount of savings opportunities is more than the investment opportunities (p.50). In the countries that face current account deficit, a savings glut forces the net savings in that country to finance the current account deficit instead of the investment. The current account of any given country has two sides that determine its position; the real side and the financial side. The real side of the current account indicates a country’s rate of consumption and investments. On the other hand, it shows how much the country finances its current account deficit. With increased focus on the global savings glut, Bernanke opined that the discrepancy noted in the current account might not be resulting from high consumption and investment rates by the countries with a deficit (53). This is as a result of the increased amount of savings in nations characterized by a surplus in the current accounts. Therefore, those countries recording surpluses in their current accounts should implement policies in order to increase the rate of absorption and imports. This will in turn reduce their surpluses hence a corresponding reduction in the level of global imbalance (Bernanke, p. 54).
An example of the countries with such surpluses is the Asia continent. A research study carried out in Asia clearly indicates that the increased market opportunities record high rates of savings. Its values are found to be higher than in the European and North American countries. The chart 5 below shows the gross national rates of savings in some of the newly industrialized countries in Asia. Then, chart 6 indicates the case for developing countries. In the newly industrialized countries, it is observed that the rate of savings is recorded as 30-35 % as observed since the year 1990. On the other hand, for poorer developing countries, the net savings have been recorded as a rise from 32% to 40%. This percentage rise was contributed by the Asian crisis. After recovery from the Asian crisis, the result was an increase in the current account surpluses among the emerging Asia. Therefore, the increasing difference between the savings and investments has led to corresponding surpluses in the current accounts in the whole continent for quite a number of years (Carbaugh, p. 352).
Chart 5: Savings and investment in Asia’s newly industrialized countries (as a percentage of GDP)
Adapted from: European central bank
Chart 6: Savings and investment in developing Asia (as a percentage of GDP)
Adapted from: European central bank
Though most of the above discussed facts about the savings glut are found to be true, it is difficult to make the debtor countries responsible for their high rates of consumption. This is because there are two contributors of the current account imbalance. The first one is that there may be a high net saving, and thus a surplus is recorded. The other is that there can be excess consumption and high rates of investment meaning a deficit are recorded. With reference to the above scenario, some of the countries can continue accumulating their surpluses. Again, in other countries, nothing forces them to consume or invest at a high rate more that they are supposed to save. This explains the reason why a country should not be blamed either for preferring to continue saving or making others responsible for their investments. An important point to note is that, some of the surplus countries can use some other channels to alter the state of financial markets that in turn affects the prices of various assets leading to global imbalances (Carbaugh, p. 350).
Exchange rate policies
The exchange rate policies contribute to the effects on the current account position in a significant way. These policies are in relation to the currency exchange rate. A country’s currency appreciates in response to the surpluses in the current account as compared to those with deficits in their current accounts. This leads to a corresponding reduction in the imbalances of the countries with surpluses. When this is a noted appreciation of currency in one of the countries, this signals the entire region to be committed in reduction of the global imbalances. This is done by release of policies which they adopt in conjunction with low surpluses and reduced deficits in debtor countries like United States (Aghevli, Khan and Montiel, p. 20).
A research study indicates that, an exchange rate adjustment of a country’s currency is needed in order to reduce the overall current account deficit in order to solve the problem of global trade imbalance. This should occur in comparison to other countries with which a certain country has a trade deficit. The exchange rate adjustment policy may not be sufficient to address the on going global imbalance. However, with this in place, it is important to note that, the surpluses recorded in the current accounts of some countries should be addressed with a lot of concern. An overall conclusion is that the appreciation of currency of countries with surpluses, will limit the rate of exchange of debtor countries hence the impact on current account imbalances will be limited.
Structural policies
The structural reform of any country is an important factor for enhancing the overall economic growth. This can in turn help in addressing the global imbalance issue in the world. These structural policies play an important role in the position of the current account of a certain country in that it leads to high economic growth and demand. The relationship between structural policies and the position of current account of any country depends on policies, time, and whether the policies affect the trade. Different policies have different impacts on the overall global trade imbalance. For example, policies that are concerned with the labor market may have an impact on the effectiveness of the supply of labor. Therefore, this has a corresponding reduction in wages and prices as seen from medium term. This improves the profitability of domestic capital in the long run. In turn, this tends to improve the position of the current accounts. This may lead to a positive impact of the global imbalance. Other types of policies like the product market policies increase the income elasticity of demand for imports. This increases current account deficit. These policies also accelerate inflow of capital which in turn affects the current account position. All these have a corresponding effect on the global imbalance (Aaronson and Zimmerman, p. 151).
Impacts to the possible adjustment process
Understanding aspects that have contributed to the on going global trade imbalance is critical. This is because they assist some countries in the knowledge of the future adjustments to be made in the overall trade system. A good example of an adjustment is changes in some of the government structural policies used in most of the countries. This can help reduce the current account deficits hence reducing the global trade imbalance (Aaronson and Zimmerman, p. 153). With reference to the information obtained from various research studies, it can be resolved that the on going global trade imbalance is a result of the imbalances in savings from the private sector. This continued imbalance can be resolved by use of Economic policies in deficit countries that raise the net private savings. Again, another adjustment is that policies that lower accumulated savings and increase the rate of investments in surplus countries should be used. These will help address the issue of global trade imbalance (Claessens, Evenett, and Hoekman, p. 85).
Conclusion
The large trade imbalance experienced in the world, and the effect on the current account has caused a hard time to researchers in the economic sector and policy makers. This happened when most of the countries started to accumulate large deficits. Detailed research should aim at the need for policies for changing and switching of expenditure during spending. This is in respect to the sustainability of global imbalances. It can also be concluded that political sustainability has been emphasized as the most serious constraint. From the discussion on factors contributing to global trade imbalance, global savings are seen as a leading cause of the global imbalance. Again, global trade imbalance has been seen to shrink in a faster manner after the global crisis. However, large sums of capital inflow are required in the sustainability of surplus and deficit. An analyzed and a detailed research on the current account reversals are highly required. This is to ensure that whatever a country has in its current account, and the Gross Domestic Product (GDP) balances in the world economy. Also, both analyzes facts about behavior of policies of macroeconomic and structure around structural breaks. It is recommended that the above discussed policies should be used where applicable in the affected countries so as to reduce the risks of global trade imbalance. These policies try to highlight the scope for reducing global trade imbalances in order to enable the governments avoid indebtedness and reduce the rate of consumption and increase savings in the country. The different policies used give a vision and a direction for accumulation of capital inflows into the world. This is meant to finance the global imbalances realized in the world at a future date.
Although much has been analyzed about global trade imbalance and its impact, a detailed analysis of the same is a major requirement. This is to ensure that more details are obtained about the same through further investigation and a detailed research by experts. It is imperative to note that the continued accumulation of these imbalances, in the countries that are affected, means that the investment position of the global economy will continue to increase. However, this is on the negative side of the equation. Therefore, the global community should hold some assets to enable the financing of deficits so as to make imbalances sustainable. This can only be realized if the global community investors are willing and able to finance these deficits. Otherwise, once they get to a point where they are unable to finance the deficits, there will only be one policy to address the issue. In essence, the only possible policy will be centered on the currency exchange value of the affected country. The current account deficits resulting to the global imbalances can be resolved by the above mentioned policies to bring sustainability to the global imbalances. If the affected country is unable to reach its target, then it should strive towards avoiding those practices that may cause imbalance in the global economy. This may help in ensuring that the country remains relatively stable in economic terms.
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