Global Rebalancing: Now or Never

Time and again, the lessons of a troubled world economy are the same: An unbalanced world is an unsustainable world.

A decade ago, the world had just come through three difficult events in the span of three years – the Asian financial crisis, the Y2K scare, the bursting of the US equity bubble. The unbalanced world was ill equipped to deal with the asymmetrical shocks bound to follow. Steeped in denial, an unstable global economy continued its race to the edge.

The price for denial was steep. The world peered into the abyss in late 2008, experiencing the greatest financial disaster since the Great Depression of the 1930s. Sadly, this was just the latest in a steady string of crises over the past 30 years, including the 1980s Latin American debt crisis, the subprime crisis and the European sovereign debt crisis raging today. Behind most of these crises is a major macro imbalance, which could have been avoided with pro-active, disciplined and responsible policies. But the temptations of false prosperity proved far too alluring.

It’s essential to understand the forces at work on both sides of the unbalanced global macro equation. The demand side is dominated by the American consumer. With about 4 percent of the world’s population, US consumers spend about $10.7 trillion annually. By contrast, China and India, collectively comprising nearly 40 percent of the world’s population, have combined consumption of about $2.5 trillion.

Based on this unbalanced mix of global demand, the outlook for global consumption is likely to be weak. The main source of this weakness can be traced to the United States. Reflecting bursting of US property and credit bubbles, the American consumer has pulled back as never before. Anemic consumption growth is also likely to persist in crisis-torn Europe and in Japan. China and India, with solid prospects for consumer demand, lack the scale to offset the US-led shortfall of consumer demand in the developed world.

The supply side is dominated by the Asian producer. But the fastest growing economic region in the world has severe imbalances of its own. Specifically, the private consumption share of developing Asia’s pan-regional GDP has never been lower, its export share never higher, after recovering from the crisis-induced plunge of 2008-09. With anemic consumption growth likely to persist in the advanced economies, persistent imbalances on the Asian-led supply side of the global growth equation remain a worrisome feature of the post-crisis climate.

Nowhere is that more evident than in China. In 2007, Premier Wen Jiabao spoke of the great paradox of the Chinese economy: The economy looked strong on the surface, but was characterized by a model that he depicted as increasingly “unstable, unbalanced, uncoordinated, and ultimately unsustainable.” The 2008-09 crisis and collapse in world trade hit China’s most dynamic source of economic growth – exports – with an unprecedented shock. Lacking support from external demand and the backstop of internal private consumption, China relied on an aggressive stimulus of fixed investment.

China did what it needed to do to sustain economic growth and maintain social stability in the midst of wrenching crisis. Still, renewed weakness on the demand side of the global equation has pushed its GDP growth back down to 7.6 percent in mid-2012 – holding to a soft-landing trajectory, but yet another important reminder that China must change its growth model to derive greater support from internal demand, especially private consumption.

China has made the transition to a pro-consumption growth strategy the centerpiece of its newly enacted five-year plan. It features three building blocks:

• China has the smallest services sector of any major economy in the world, yet services in China generate about 35 percent more jobs per unit of GDP than do manufacturing and construction. By shifting from capital-intensive manufacturing to labor-intensive services, China could grow more slowly and still hit labor absorption targets.

• Per capita income of urban workers in China now runs about three times that of their counterparts in the countryside. With China’s urban population exceeding its rural population for the first time in history, ongoing rapid urbanization, coupled with services-led employment opportunities, is a plus for boosting aggregate wage incomes.

• China must build a social safety net. Lacking financial security, workers will continue fear-driven precautionary saving, an impediment to a flourishing Chinese consumer culture.

Fortunately, China is in good shape, with plenty of ammunition to deploy countercyclical stimulus in order to avoid the dreaded hard landing and get on with structural rebalancing. Short-term policy benchmark lending rates of 6.0 percent are well above CPI inflation of 2.2 percent and a fiscal deficit of less than 2 percent of GDP is one of the lowest in the world.

Predicting sources and timing of the proverbial next crisis are near impossible, but there are two destabilizing scenarios to ponder:

First, the full risks of a sovereign debt overhang haven’t played out yet. With long–term government interest rates remaining low, there’s a false sense of complacency. In 2011, debt exceeded 100 percent of GDP for the broad collection of so-called advanced economies for the first time since the end of World War II. The overly-indebted can finesse this problem for the time being, but probably not much longer.

Second, the world’s most important economic relationship between the United States and China could fall victim to its own set of imbalances. Particularly troublesome is Washington’s bipartisan penchant for China bashing, with demands that China be forced to raise the value of the renminbi or face trade sanctions.

This is the wrong response. The US suffers from a multilateral trade deficit – characterized by imbalances with 88 countries in 2010. It’s impossible to fix a multilateral imbalance by putting pressure on a bilateral currency. Instead, Washington must come to grips with its own unprecedented shortfall in national saving. Lacking saving and still wanting to grow, the US must import surplus saving from abroad – running massive current account and multilateral trade deficits to attract the foreign capital.

Unfortunately, the currency issue and the false hopes it spawns in resolving tough problems bearing down on US workers have hijacked the US-China trade agenda. The renminbi has risen 31.4 percent against the dollar since mid-2005 – well in excess of the 27.5 percent increase long demanded by Washington politicians. Of the two current account imbalances, the US deficit remains a far more destabilizing force. According to dollar-based International Monetary Fund estimates, the US deficit is likely to be 2.8 times the magnitude of the Chinese surplus in 2012.

The global rebalancing agenda would be better served if the US-China trade relationship were recast as an opportunity. For a growth-starved US economy hobbled by sluggish consumer demand, exports could become an important source of growth. China is America’s third largest and most rapidly growing export market. The US focus needs to shift toward market access – ensuring that its companies have a fair shot at Chinese markets as that nation ushers in what could be the greatest consumption story of the modern era.

In short, the outlook for sustainable world growth depends critically on how the United States and China address rebalancing imperatives. Advanced economies, especially the United States, must consume less and save more. The developing world, especially China, has no choice other than to draw down its excess saving and consume more. The sooner the world faces up to these urgent rebalancing imperatives, the better.

(Stephen S. Roach, a member of the faculty at Yale University, was formerly chairman of Morgan Stanley Asia, and is the author of “The Next Asia. This is reprinted with permission from the Yale Center for the Study of Globalization)