Rewiring the global economy

Rewiring the global economy

How long will it take the global economy to rebalance?

If you happen to know the answer to that, get yourself a ticket to Stockholm, Sweden. Economists and policymakers have been wrangling over the current imbalances for so long that this is now being anointed the primary narrative of the 2007-09 financial crisis. So it’s interesting to see the recent evidence, in the form of academic literature and government action, to suggest improvement.

According to this narrative, China’s excess dollars went into US debt, driving down yields and persuading investors to look for higher returns in riskier assets. China accumulated these dollars because the US consumed too much, and China too little. Then rebalancing would require these consumption trends to change.

Two separate International Monetary Fund (IMF) papers published this month hint at some rebalancing. On the US side, Jaewoo Lee, Pau Rabanal and Damiano Sandri write that, after this recession’s shock, consumption will be subdued and savings will rise to 5-7% of disposable income.

On the China side, Steve Barnett and Ray Brooks wonder if a rise in government spending on healthcare and education would make households save less and consume more. Many economists think it’s China’s lack of safety nets that forces people to save as a precaution. Ray and Brooks conclude that higher public health spending will at least reduce urban savings.

And the Chinese government is stepping up healthcare spending through a new strategy for 2009-11: It’s spending $124 billion to provide insurance to 90% of its citizens. Throughout 2009, Beijing also spent to stimulate local consumption directly— $14.8 billion on subsidies and tax breaks for cars alone.

Whether such changes alone will rebalance these economies, there’s room for scepticism. Doesn’t the current regime of low interest rates and fiscal spending in the US privilege consumption over savings? And doesn’t China’s undervalued exchange rate privilege producers over consumers as much as, if not more than, precautionary savings? None of this is about to alter any time soon.

Considering the US and China are joined at the hip, it will take a lot more to achieve balance. But if these changes are anyhow a small step for the two countries, it may well prove a giant leap for the global economy.

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