Narrowing Trade Gaps Makes Bullish Case for Global Growth
In October 2010, the world’s top finance ministers and central bankers flew to the South Korean resort town of Gyeongju to discuss how to protect a fragile economic recovery.
Treasury Secretary Timothy F. Geithner arrived from the U.S. with a goal in mind. He wanted an agreement to even out the imbalances in global trade -- reducing the surpluses of exporters such as China and Germany and cutting the deficits of the U.S. and other countries that are net buyers of the world’s goods.
These so-called current-account imbalances grew before the financial crisis in 2008 and helped trigger the global recession. When trade gets far enough out of whack, something has to give, Bloomberg Markets magazine reports in its January issue. Those with the consumer demand that helps drive economic activity go deeper and deeper in debt, while exporters accumulate their IOUs and worry about getting paid. Look no further than China’s holdings of more than $1 trillion in U.S. Treasury securities to understand what can happen.
More from the January issue of Bloomberg Markets:
Geithner argued at the summit that addressing the imbalances would strengthen global growth and make it more likely to last. The U.S. pushed to commit each Group of 20 nation to keeping its surplus or deficit to less than 4 percent of gross domestic product.
The agreement wasn’t to be, shot down by China, Japan and other countries with export might. Rainer Bruederle, then Germany’s economy minister, opposed the idea. “We should lean toward a market economy process and not a command economy,” he told his counterparts at the meeting. The Gyeongju talks ended with a tepid accord to pursue policies conducive to reducing excessive imbalances.
Here’s the twist: Two years later, the 4 percent limits are being met by the U.S. and China -- a sign that the global economy is healing even as it suffers the pain of recession and subpar growth.
The U.S. current-account deficit, which measures trade balances, income from foreign investments and cash transfers, will be 3.1 percent of GDP in 2013, down from 6 percent in 2006, according to an International Monetary Fund forecast. China’s surplus will be 2.5 percent, shrunk from a 10.1 percent peak in 2007. The world’s two biggest economies are likely to keep within the 4 percent bounds through 2016, the IMF predicts.
“The world is definitely becoming more balanced,” says Jim O’Neill, chairman of Goldman Sachs Asset Management in London. This shift marks an adjustment by the global economy to the root causes of the financial crisis and recession, in his view. “I’m amazed people aren’t a lot more acknowledging what’s going on,” he says. “It’s among the reasons I tend to be a bit more optimistic than other people.”
New Growth Drivers
Smaller imbalances, if they persist, would mean the world is shifting to new growth drivers. The U.S., whose consumers helped boost global demand, particularly in the years just prior to 2008, is pivoting toward manufacturing. China may be succeeding in efforts to foster domestic consumption. Some European countries are changing labor rules in ways that make their exports more competitive.
The trends may or may not last. The IMF attributes most of the trade improvement to weak global demand and urges policy makers to redouble their efforts to address the imbalances.
In the optimistic case, President Barack Obama, re-elected even after presiding over sputtering growth and high unemployment in his first term, gets a healthier economy with continuing export strength during his second. Restrained wages and cheaper energy are giving Americans an edge over rivals in Europe and Japan. Average expenses for U.S. companies, including labor and raw materials, will be 15 percent less than in Germany by 2015 and 21 percent below Japan, according to a Boston Consulting Group report released in September. Among the winners is the chemical industry, helped by a boom in domestic natural gas drilling that gives it a cost advantage versus overseas competitors.
Global growth is unlikely to bounce back right away, even if trade imbalances continue to shrink, says Ron D’Vari, chief executive officer of New York-based financial advisory firm NewOak Capital LLC. “In the long term, we’ll have a healthier world economy and more diversification, but it’s going to be patchy in the meantime,” says D’Vari, who’s a former BlackRock Inc. managing director. “You can’t just turn these things on and off quickly.”
The U.S. saw exports rise to 13.8 percent of GDP in 2011, up from 12.7 percent in 2010. Exports have never been higher in statistics that go back more than half a century. Since the 18- month recession ended in June 2009, they have added close to 1 percentage point to annualized growth each quarter -- almost double the 0.58 percentage point contribution, on average, since 1990. Export growth accounts for about half of the 2.2 percent annual expansion of GDP during the recovery, Commerce Department data show.
“The U.S. is transitioning from nontradables to tradables,” says Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., which manages the world’s biggest bond fund. “This is the healthy part of the rebalancing,” he says, while Europe is going through what he calls a “bad rebalancing.”
The bad part in the euro zone is the hardship inflicted on the citizenry as its leaders, reacting to soaring borrowing costs, hack budget deficits and watch their economies fall back into recession. Unemployment is more than 25 percent in Spain, and Greeks are rioting over budget cuts and the decline in their living standards.
And yet, governments are making some progress in pushing labor costs lower so that their goods will be cheaper relative to those produced elsewhere. Italy has eased rules on firing workers and opened up industries previously closed to competition. Spanish companies can now opt out of central wage deals and negotiate directly with unions, as new pension requirements reduce early retirements. Greece cut its minimum wage by 22 percent, and Portugal now has fewer national holidays.
These steps toward greater competitiveness will yield benefits, says Christoph Weil, an economist at Commerzbank AG in Frankfurt. He estimates that, with the exception of Italy, peripheral euro-zone countries have eliminated more than half of their labor cost disadvantage relative to the region’s most competitive economies. In July, Spain recorded its first current-account surplus since the euro began trading in 1999.
“Labor market reforms suggest that the peripherals will continue to gain competitive ground,” Weil says.
That view was underscored this week in a study published by Germany’s Berenberg Bank and the Lisbon Council, a Brussels- based research group. It concluded that Europe’s internal imbalances are diminishing and labor cost differentials narrowing, with Greece leading the way in adjusting its economy.
On the other side of the equation, Europe’s export powerhouse, Germany, should do more to dilute its reliance on foreign markets and to spur domestic spending, says Neville Hill, head Europe economist at Credit Suisse Group AG in London. The lack of progress on this score can be seen in data such as monthly German retail sales, which have been flat on average since 1999.
Chancellor Angela Merkel hails her nation’s export abilities. The country’s budget is almost in balance, unemployment is at 6.9 percent, close to a two-decade low, and the nation has run a current-account surplus every month since January 2003.
There are some hints of change. Volkswagen AG, Europe’s biggest carmaker, agreed in May to a 4.3 percent pay raise in a 13-month contract for employees in western Germany. That outpaces inflation in Germany, which has been running about 2 percent.
Higher wages erode the country’s export advantage, which has benefited greatly from declines in the euro caused by the economic weakness of other members of the currency union. Another sign: The Bundesbank, Germany’s central bank, says it expects inflation to accelerate.
Global economic activity may remain weak for several years even if the shift to more-sustainable growth engines is succeeding. The excesses of the past leave the global economy low on power in the interim, Pimco’s El-Erian says. He argues that lasting improvement in trade imbalances requires a level of international cooperation by policy makers -- something like the initial reaction to the financial crisis in 2008 and 2009 -- that’s difficult to muster.
The 3.3 percent global growth that the IMF forecasts for all of 2012 would be the lowest since the recession year of 2009. Europe’s persistent debt crisis, the U.S.’s need to tackle its fiscal deficit and slower expansion in emerging markets such as China are all restraining growth.
The IMF sees a 17 percent chance of a renewed global recession in 2013. The lender warned in its October World Economic Outlook that trade gaps are likely to remain well above desirable levels unless governments take more action.
“When growth picks up, these imbalances are likely to widen again,” IMF Managing Director Christine Lagarde said at the organization’s annual meeting in Tokyo.
The World Trade Organization estimates that commerce will expand 2.5 percent in 2012. That’s less than half its average for the past two decades and a sign of the lingering effects of the 2008 to 2009 financial crisis and Europe’s sovereign-debt debacle.
“You’ve ended up with a collapse in demand and, therefore, demand for the world’s exports,” says Stephen King, chief economist at HSBC Holdings Plc. That’s the primary explanation for the reductions in China’s surplus and the U.S. trade deficit, he says.
In part, the ability to work out global imbalances depends on how emerging economic powers react. Countries such as Brazil and India need to refocus as slower growth and increased competitiveness abroad mean they no longer can lean on exports, Morgan Stanley economist Manoj Pradhan says.
India in October cut a tax on local companies’ overseas borrowings and allowed more foreign investment in aviation and retailing. Brazil is paring payroll taxes and offering licenses to companies to build and operate roads and railways.
China’s actions will matter most. The country’s leaders are trying to embrace domestic consumer spending in preference to infrastructure investment and foreign markets. The government has moved to expand public housing and encourage wage gains rather than responding to the slowest growth in three years with fiscal stimulus.
Andrew Kenningham, an economist at Capital Economics Ltd. in London, is more dismissive. He’s still waiting to see a significant acceleration in Chinese consumption growth. He points out that the country’s relatively high growth rate means its surplus will rise as a share of global GDP even if staying stable as a proportion of its own.
So policy makers may yet have to reach the kind of agreement they declined to embrace in South Korea in 2010 if they’re going to get the world economy back into balance in 2013 and beyond.
“The vexed issue of global imbalances may have slipped down the G-20’s agenda for the time being, but we doubt that it has disappeared forever,” Kenningham says.