The Chief Economist’s Note

Time for policymakers outside the US to step up to the plate

With concerns about the outlook for the global economy starting to build, thoughts are turning to what policymakers might do to support growth. A common refrain is that the current low level of real interest rates and high levels of public debt limit the room for conventional monetary and fiscal stimulus. That’s true but, as we argued earlier this month, it doesn’t mean that central banks are entirely impotent. And it’s likely that, faced with a slowdown in growth, bond markets in most developed economies – with the probable exception of Southern Europe – would tolerate additional fiscal stimulus too.

However, what’s particularly striking about the debate around the scope for policy stimulus is that it has centred on what the authorities in the US might do. This is perhaps inevitable given the size of the US economy and its role as the world’s consumer of last resort. But the global economy can’t continue to rely on the US to sustain demand at its current rate. US import volumes (excluding energy) have expanded at an annual rate of just under 6% over the past two years. Irrespective of any policy stimulus, the current pace of import growth is unlikely to continue since US GDP growth is running at above its potential rate and must at some point slow back to trend.

This shifts the focus to other countries, and brings us to the thorny issue of global trade imbalances. As we’ve noted before, while President Trump’s trade war may have a political constituency, it is economic nonsense. The US is not worse off as a result of running a trade deficit. However, there is an important sense in which trade balances do matter that doesn’t feature in the President’s rhetoric.

Countries that run large trade surpluses are a drain on global demand. Offsetting trade deficits are then run by other countries, thus making up the shortfall in demand. Over the past decade or so, the latter role has been played by the US, with some help from the UK and, at various points, a handful of emerging economies in Latin America and Emerging Europe. But this leaves the global economy vulnerable to demand weakness in the deficit countries – and it argues for a greater focus on what the world’s surplus countries (or net savers) can do to support growth.

As it happens, the combined surpluses of the world’s major net savers are now smaller than they were prior to the 2008-09 Global Financial Crisis. (See Chart.) The countries that are running large surpluses have changed too. Asian surpluses have generally fallen and the surpluses of the oil producers in the Gulf have vanished altogether. At the same time, the aggregate current account position of the euro-zone has swung from deficit to surplus. Germany’s surplus is now equivalent to over 8% of its GDP.

Chart: Combined Current Account Positions of Major Surplus & Deficit Economies (% of World GDP)

Combined Current Account Positions of Major Surplus & Deficit Economies (% of World GDP)

However, while the combined surpluses of the world’s net savers has fallen from the highs seen in 2008-09, they still amount to around 1.5% of global GDP. This is far larger than in the 1980s or 1990s. Moreover, the bulk of this surplus is accounted for by just eight countries: China, Korea, Japan, Taiwan, Thailand, Singapore, Germany and the Netherlands.

Taken together, the combined surpluses of these eight countries are now equivalent to just over 1% of world GDP. Halving the surpluses of these countries via a reflation of their domestic economies (and thus a rise in imports) would therefore provide a direct boost to global demand equivalent to 0.5% of world GDP. And given that it would require an even larger increase in domestic spending to produce such a reduction in surpluses, the overall boost to global GDP growth is likely to be even larger. This may not sound like much, but it would represent a significant shot in the arm for a world economy that we expect to grow by less than 3% in 2020.

So far, so good, but how might this be achieved? Different policies are needed in different countries, but in general we should be watching for three things. The first is fiscal stimulus, particularly in those countries that run “twin” budget and current account surpluses (most obviously Germany, but also Korea, Singapore and the Netherlands). The second is real exchange rate appreciation in the surplus countries, either via an increase in their nominal exchange rate or a rise in their domestic price level. And the third is structural reforms to tackle the underlying causes of these surpluses. Such reforms encompass everything from measures to raise consumption in China (including increases in social spending and income tax cuts for low-income workers) to policies to boost business investment in Germany and Korea (such as tax incentives for investment in green technology).

Governments in the surplus countries have nodded in the direction of some of these reforms but, as things stand, the prospects of a significant shift in policy appear to be slim. Yet if they were to grasp the nettle of reform it would make the response to the global economic slowdown that we expect in 2019-20 more effective – and the subsequent recovery more durable. It’s time for policymakers outside of the US to step up to the plate.

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