In Praise of Global Imbalances
SINGAPORE – In recent weeks, there has been a chorus of opinion arguing for a sharp increase in global investment, particularly in infrastructure. Former US Treasury Secretary Lawrence Summers asserted that public investment really is a free lunch, while IMF Managing Director Christine Lagarde has argued that an investment boost is needed if the world economy is to “overcome a new mediocre.”
These comments suggest that the world has been under-investing for many years. In fact, according to International Monetary Fund data, the current overall global investment rate, at 24.5% of world GDP, is near the top of its long-term range. The issue is not a lack of overall investment, but the fact that a disproportionate share of it comes from China.
China’s share of world investment has soared from 4.3% in 1995 to an estimated 25.8% this year. By contrast, the United States’ share, which peaked at 36% in 1985, has fallen to less than 18%. The decline in Japan’s share has been more dramatic, from a peak of 22% in 1993 to just 5.7% in 2013.
China dominates global investment because it saves and invests nearly half of its $10.5 trillion economy. But this investment rate is likely to decline sharply over the next 5-10 years, because the country already boasts new infrastructure, has excess manufacturing capacity in many sectors, and is trying to shift economic activity to services – which require less investment. Moreover, China’s rapidly aging population and declining working-age population will reduce long-term investment demand.
Because the current-account balance is the difference between the investment and savings rates, the decline in investment will generate large surpluses unless savings also decline. And the experience of other aging societies, such as Germany and Japan, suggests that domestic investment falls faster than savings rates.
Thus, China can expect large external surpluses to transform the country from the world’s workshop into its main financier. Indeed, the scale of capital outflows could be so large that long-term capital will remain cheap even after the world’s major central banks tighten monetary policy. How the world absorbs those surpluses will define the next period of global economic expansion.
Emerging markets may be able to take some advantage of this low-cost financing. India would undoubtedly benefit, though it is unlikely to absorb a significant portion of China’s excess savings. India’s share of world investment is only 3.4%; and even a large expansion will not compensate for a small decline in Chinese investment. Furthermore, East Asia’s growth model has been sustained ultimately by mobilizing rising domestic savings and pumping out exports. So, although India might initially absorb some international capital, it might ultimately prefer to build foreign reserves by running small external deficits or even a surplus.
Other emerging countries are also unlikely to absorb much of China’s capital. Notwithstanding its advocacy of public investment spending, even the IMF accepts that a sudden increase in public investment is more likely to cause developing-country indebtedness than growth.
That is why calls by the IMF and others to scale up public infrastructure spending are really aimed at developed countries. Yet this, too, may prove insufficient. Germany’s investment-savings gap is so large that, even if it increases domestic investment, the most we can expect from Europe is that it does not add to the global savings glut.
Only a revival in US infrastructure investment can create a sustained global economic recovery. The US has the necessary scale to absorb China’s surplus, and its inadequate infrastructure provides plenty of avenues for fruitful investment.
Ironically, the IMF’s new investment mantra ultimately leads back to large global imbalances. But, far from decrying this as a major failure of global policy coordination, economists should accept imbalances as the natural state of the world and try to manage the resulting distortions.
Indeed, almost every period of globalization and prosperity has been accompanied by symbiotic imbalances. They have always caused economic distortions and political complaints, but many have endured for surprisingly long periods.
Consider, for example, the Indo-Roman trade that drove the world economy in the first and second centuries AD. India ran a current-account surplus while the Romans complained about the loss of gold, yet the system endured. Similarly, the first Bretton Woods system was sustained with European capital, and Bretton Woods 2 was fueled by Asian capital, with the US providing the deficits in both cases.
There is no reason why Bretton Woods 3 should not experience similar imbalances. But if, for whatever reason, the global economy fails to take off, we will have to reconcile ourselves to a long period of mediocre growth in which cheap capital depresses yields, drives up asset prices, inflates bubbles, and seeks out trophy assets. These are not the sort of imbalances to which the world’s policymakers should aspire.
Sanjeev Sanyal is Deutsche Bank’s Global Strategist and a World Economic Forum Young Global Leader.