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Asymmetric Financial Developments and
Global Economic Imbalances:
A Lucus’ Paradox between the U.S. and China
by
Peter C.Y. Chow
The City College and Graduate Center
City University of New York
1
The global financial crisis offered an excellent opportunity to review the chronicle
issue of the persistent widening of global imbalances; the chronicle trade deficits in the
U.S., the persistent trade surplus in the trade-dependent economies, especially China and
emerging Asian economies. The cumulated trade deficits in the U.S., which was mainly
financed by the issuance of Treasury bonds, were to a great extent, purchased by the trade
surplus countries to become their major foreign exchange reserves. It led to the “Lucus’
Paradox” of having ‘uphill” capital flows from low to high income countries in the past
decades and was alleged to aggravate the global financial crisis in 2007-08. While policy –
driven surplus reversals need not necessarily slow down the growth of the trade-surplus
economies, the neo-mercantilist mindedness still prohibits them from taking proactive
policies to correct their external imbalances through currency appreciation. In spite of the
pledges of G-20 Leaders made at Pittsburgh Summit, little progress was made in sectoral
readjustments in both trade surplus and deficits countries. This study argues that the
asymmetrical financial developments between the trade surplus and trade deficit countries
generated the unique phenomena of having excessive savings in the major trade surplus
countries in China and under savings in the U.S. Among other structural re-adjustments to
rebalance the global economy, financial development and upgrading the institutional
quality in China and emerging Asian countries as well as re-regulations of financial sector
in the U.S. seem to be the first task to rebalance global economy for long term sustainable
development.
2
Introduction
Citing Greenspan’s “conundrum” and Bernanke “savings glut” theses,
Kawai (2010) argued that global payment imbalance, macroeconomic policy
mistake and regulatory failure were the three major causes of the global
financial crisis.
Feldstein (2008) noted that, prior to 2000, most the current account
deficits in the U.S. were financed by private foreign direct investment
attracted by the productivity and profitability of the U.S. economy. But, after
2000, the U.S. trade deficits were financed through the issuance of Treasury
Bonds, which mainly were purchased and being held as foreign exchange
reserves by the central banks in many of the trade surplus countries.
Hence, the “twin deficits” in the U.S. became a chronicle issue which
not only undermines the confidence of the U.S. dollar, but also challenges
the sustainability the U.S. economy and the international payment system.
3
It also led to the “Lucus’ Paradox” of having ‘uphill” capital flows
from low to high income countries in the past decades and was alleged to
aggravate the global financial crisis in 2007-08. While policy –driven surplus
reversals need not necessarily slow down the growth of the trade-surplus
economies, the neo-mercantilist mindedness still prohibits them from
taking proactive policies to correct their external imbalances through
currency appreciation. In spite of the pledges of G-20 Leaders made at
Pittsburgh Summit, little progress was made in sectoral readjustments in
both trade surplus and deficits countries. This study argues that the
asymmetrical financial developments between the trade surplus and trade
deficit countries generated the unique phenomena of having excessive
savings in the major trade surplus countries in China and under savings in
the U.S. Among other structural re-adjustments to rebalance the global
economy, financial development and upgrading the institutional quality in
China and emerging Asian countries as well as re-regulations of financial
sector in the U.S. seem to be the first task to rebalance global economy for
long term sustainable development.
4
Figure 1: Trade Dependency of Japan and the First Tier of the NICs
5
Figure 2: Trade Dependency of China and ASEAN-5
6
Figure 3: U.S. Trade deficits with Asian Countries as A percentage of
Total U.S. Trade Deficit
7
The study is organized in the following order: Section II illustrates
the theoretical underpinning of sector balance in national income account
and how sector re-adjustments in the trade surplus and trade deficit
countries would reduce the trade imbalance.
Section III cites the IMF study on five major currency appreciations
in the trade surplus countries in the post-war era to demonstrate that
currency appreciation in the trade surplus countries won’t slow down their
economic growth. Nevertheless, the neo-mercantilist mindedness in China
and other Asian countries may prohibit them to appreciate their currencies
too much.
Section IV addresses the dilemma of rebalancing the global economy
by sectoral re-structuring in both the trade surplus and trade deficit
countries.
Section V addresses the argument that financial development has
strong effects on domestic savings and investment and the resultant effects
on the balance of trade account, and points out the issue of asymmetrical
financial developments in the trade surplus and trade deficit countries. The
final section is for summary and conclusions.
8
II.
Sector Balance in National Income Identity
9
To examine the global imbalance, it would be necessary to start with the sectoral balance in
the national income identity. Sector imbalance in any economy could be derived from
variants of the national income identity equations as shown in equations (1) and (2) below:
C+I+ G+X-M=GDP
C+S +T=GDP
……… (1)
……… (2)
Where the sum of private consumption ( C) , investment( I) , government spending ( G) and
net export ( X-M) are added to the total GDP as indicated in (1), which could be re-written as
the sum of consumption , saving ( S) and tax ( T) as indicated in (2) as well.
The macro imbalance can be exemplified by subtracting (2) from (1) to equations get 3A or 3B
(I-S) + (G-T) + (X-M) = 0
(3A)
(S-I) = (G-T) + (X-M)
(3B)
(X-M) = (S-I) + (T-G)
(3C)
OR
10
Figure 4: Global Current Account Balances as Percentage of GDP in
China, oil-exporting countries, Germany, Japan and Emerging Asia.
Source: Cheung, Furceri and Rusticelli (2010)
11
Since the study deals with the global imbalance, so the U.S. as the major trade deficit
country, and China as the major trade surplus countries are further investigated. Figures 5
and 6 shows the respective balances in current account, government budget and saving –
investment gaps of these two countries since 1980.
Figure 5: Sectoral Balances of National Income Account of the U.S. 1980-2008
12
Figure 6: Sectoral Balances of National Income Account of China, 1980-2008
13
III.
Expenditures Switching Approach through Surplus
Reversal Policies
14
In general, policy –driven surplus reversals have two-folds; one is the
expenditure-switching policy through adjustments of trade sector by
currency appreciation. The other is expenditure-enhancing policy
through re-adjustment of the macro economy by reducing the national
savings, both private (reducing the excessive savings) and public
(reducing the budget surplus). While correcting the trade account
through currency adjustment is a partial equilibrium approach, the way
of reducing national saving is a general equilibrium approach. It could be
demonstrated from the right In the World Economic Outlook 2010, the
IMF provided empirical analysis of policy adjustment in five major trade
surplus economies in the past 50 years; Germany in 1970, The divergent
patterns on their respective sector imbalances provide us with a pair of
dissimilar cases of global imbalances for further studies in sections III
and IV below.
15
IMF study (2010) also showed some legacies of trade surplus reversals;
that is over reactions to currency appreciation , i.e. mismanagement of
macroeconomic policies, such as the “too” easy money and” over”
expansionary fiscal policy in Japan and Taiwan after the Plaza Accord led
to the boom-bust cycles in real estate and financial assets. The legacies
of currency appreciation in Japan and Taiwan were resulted from the fact
that monetary and fiscal policies in both countries had more than offset
the declining next export through currency appreciation. The drawback
of the surplus reversal re-adjustment policies undertaken in Japan and
Taiwan offered a wrong lesson for some trade surplus countries and may
discourage them to undertake exchange realignment to correct their
trade surplus. Moreover, somebody even attributed Japan’s “lost decade”
in the 1990’s as a result of the Plaza Accord of currency realignment.
Neither argument is valid in post-transition period as shown Figure 7,
seen next:
16
Figure 7a: Economic Performances in the Post-transition Period after Exchange Rates
Appreciations in Germany 1970, Japan in 1973 and 1988, Korea and Taiwan in 1988-89.
17
Figure 7b: Economic Performances in the Post-transition Period after Exchange Rates
Appreciations in Germany 1970, Japan in 1973 and 1988, Korea and Taiwan in 1988-89.
18
The following figures further illustrate the cases of Japan following the Plaza Accord
in 1985. One can find that Japan’s GDP growth, after the less than one year lag, picked
up steadily and had a descent growth rates in the late 1980’s before the “lost decade”.
Figure 8: Japan’s Economy after the Plaza Accord
19
The IMF study could provide a convincing lesson for China and other
emerging trade surplus countries to restructure their macro imbalance
through currency appreciations without hurting their respective economic
growth rates. Nevertheless, the neo-mercantilist mindedness in those trade
surplus countries still prohibits them from taking any proactive policy
actions to correct their external imbalances. Take China for example, the $
204.3 billion of stimulus package, which accounted for 4.8% of China’s total
GDP, didn’t slow down the global imbalance at all; With 85% of China’s
stimulus package are government subsidies for public enterprises, at most,
one could expect that there will be a rise in public investment to offset a fall
in private investment, but not increase total investment in China at all.
Moreover, the percentage of private consumption in total GDP in China is
about 40%, which is far below most industrialized countries. Therefore,
there is plenty room for further expansion of domestic consumption in
China to re-structure its macro economy.
20
IV.
The Dilemmas of Restructuring in the
Trade Deficit Economy
21
Politically, increasing government expenditures and cutting tax in the trade
surplus countries in the trade surplus countries is much easier and less
social resistant than fiscal austerity in the trade deficit countries to correct
their respective trade imbalances. Socially, reducing the excessive savings by
increasing household consumption in the trade surplus countries is also
more popular and socially acceptable than reducing private consumption in
the trade deficit countries as well. From equation 3 C, one knows that U.S.
trade deficits could be reduced by cutting the saving –investment gap and
trimming government budget deficit. That means the U.S. has to increase
its personal saving and consuming less, and the U.S. government has to
reduce its budget deficits. Nether is easy to pursue without political pains.
(S-I) + (T-G) = (X-M)
(3C)
22
Other than fiscal austerity and more frugality for the American
people, there are several dilemmas in restructuring the current
account imbalances for the U.S.; first and foremost, the U.S. has
been and still is the largest market which imports $ 2 trillions of
merchandise trade from the rest of the world.
This is due to the fact that the U.S. and EU accounted for more than 30%
of total exports from Asia. Moreover, roughly around 40 to 50% of intraregional trade in Asia is for re-export to the markets outside the region.
Should the American people save more and import less from the rest of
the world, especially from Asia, it would be a direct drawback for the
recovery of Asian countries whose growth rates are pending on export (
46% of total Asian GDP ) and 30% of their exports are destined to the
U.S. and EU.
23
According to Fred Bergsten, for every $1 billion of U.S. export increases,
there will be 6,000 to 10,000 more jobs to be created. For agricultural
export, it was estimated that $ 1 billion of export will create 9000 jobs. To
fulfill President Obama’s plan of creating 2 million jobs, it would require
that the U.S to increase its annual exports by $200 Billion to $333 billion
in the next five years. The question is where is the market to absorb those
exports from the U.S.?
Even though the Obama Administration has some policy measures to
boost U.S. export such as increase of export loan through the exportimport bank, lifting control on export of dual use of high-tech products,
the growth of U.S. export, in addition to trade competitiveness, also
depends on the world market demand, and its probable impacts on
crowding out the existing suppliers from other rival countries.
24
The second dilemma is the difficulties of sectoral adjustment in
both the U.S. and those trade dependent countries; the sectoral
adjustment problem has two different aspects; the first one is U.S. export
commodities may not match the domestic demand in those trade
dependent countries. Except for the high-tech sectors, much of U.S.
export in agricultural commodities and consumer products could hardly
penetrate into the markets in those trade dependent countries. Hence,
unless the industrial restructure in both the U.S. and those trade
dependent countries could be re-adjusted substantially, the prospects for
promoting U.S. export are dim, at least, in the foreseeable future.
25
The third aspect
of re-adjustment dilemma is the mismatch
between of supply of and demand for tradable commodities in those
trade dependent countries. If the U.S. substantially cut its imports from
those trade dependent countries, then those manufactured exports from
Japan, China and other trade dependent countries may not be absorbed by
their domestic demand and or alternative markets due to different
consumption patterns between the U.S. and those exporters; Japan’s aging
population may demand more non-tradable goods such as health care rather
than those tradable goods such as consumer electronic products and
automobiles. Industrial re-structuring usually has a longer time lag than the
shifts of macro and trade policies. The Hatoyama government in Japan faced
a strong challenge from Japan’s manufacturing industries for not taking
enough policy actions to avoid the appreciation of the Japanese yen during
his tenure, which had undermined Japan’s export competitiveness amidst
the coming rivals from more advanced developing countries such as China,
Korea and Taiwan.
26
The fourth dilemma is a plausible revival of under consumption scenario in Keynesian economics in the world
economy. Given that the federal deficits in the U.S. need to be trimmed
in the next few years to avoid the swollen national debt, if the U.S.
consumers truly become more frugal by increasing their savings ratios,
how to boost the aggregate demand to avoid another recession?
Reportedly, savings ratio as percentage of disposable in the U.S.
increased from 4.5% to 4.8% after the financial crisis, still below the
historic level of 6%. If American consumers save more and spend less,
how to fill up the gap left by the declining personal consumption
expenditures and to maintain the momentum of economic recovery?
27
V.
Asymmetric Financial Developments in the U.S.
and Trade Surplus Emerging Market Economies
28
The neo-mercantilist mindedness in the trade surplus countries may
prohibit them from taking proactive policy actions to correct their
current account surplus through currency appreciations; Moreover, there
is also a fundamental dilemma of international payment system, i.e. the
“structural deficit” dilemma in the key currency country as recognized in
the “ Bretton Woods II” thesis ( Dooley et al.2009)
29
V.1.
Econometric Models on Global Current Account Balances
30
This section analyzes the “asymmetric developments “of financial sector
between the developed countries with trade deficits and the developing
countries with trade surplus to readjust the saving ratios in both groups
of countries so to mitigate the current account imbalances of the global
economy. It argues that the asymmetric developments of financial sector
between the trade deficit and trade surplus countries in the world
economy, notably i.e., U.S. and China had led to under saving in the U.S.
and excessive saving in China. Hence, not surprisingly, the asymmetrical
developments had caused the “Lucus Paradox” (Lucus, 1990) of having
the “uphill” capital flows from low income to high income countries in
the past two decades under the “Bretton Wood II”. It emphasized that restructure the financial sector in both the trade surplus and trade deficit
countries is less painful and politically more feasible to rebalance the
global economy.
31
By using panel data for 94 countries from 1973 to 2008, an OECD study
conducted by Cheung, Fuceri and Rusticelle (2010) found that the
widening global imbalances in the years prior to the financial crisis
reflects in part the flows of capitals from emerging countries with
excessive savings and under developed financial markets to developed
countries with under savings but with more advanced yet underregulated financial system.
32
The approach used by Cheung, Fuceri and Rusticelle (CFR, 2010) is to assess the
effect of “structural determinants” on current-account balances (CA) by
regressing CA with a set of macroeconomic, financial and institutional variables.
Since current account in any country is determined by the behaviors of
investment and saving, the factors that would plausibly affect the savinginvestment models, notably demographic, income, financial development and
quality of regulatory institutions, are included in their model as follows;
CAtt = α + β Xtt + θ Dtt + δ Ftt + γ Ptt + εtt (1)
Where CA is the current account balance as percentage of GDP, X is a vector of
macroeconomic and demographic variables, F is a vector of financial
development indicators, and P is a set of institutional variables.
Since current-account balances are relative measures and their movements
depend on developments in the rest of the world, all the explanatory variables
(with the exception of net foreign assets and dummy variables) are converted
into deviations from their GDP-weighted world mean in the CFR model.
33
V.2.
Structure of Current-Account Positions
34
To assess the “structural” factors behind current-account balances, the
focus on medium-term trends in all of the variables are estimated via
OLS:
(2)
Where
are the medium-term trend values of the
explanatory variables in equation (1). To approximate these trend values,
they used non-overlapping five-year averages of all variables, which allow
them to iron out cyclical fluctuations while limiting the possibility of
measurement errors.
35
For financial development as an explanatory variable, the result in the
full sample was significantly negative. The interpretation of the negative
relationship between financial development and current account balance
varied country by country; it was argued that the negative relationship
between financial development and current account balance “may reflect
the “bypass effect” of capital flowing from emerging market economies
toward countries with more efficient financial institutions and markets”.
Therefore, it implies that an improvement of financial market in those
countries would lower the need for precautionary savings, hence, to
reduce the current-account balances; this is an issue to be further
discussed in V 4.
36
However, it was also pointed out that for China, the variable of financial
development as proxied by private credit/ GDP ratio may not fully reflect
the levels of its financial development because much of the data of
private credit were provided to state-owned enterprises within the nongovernment sector. For other countries, the highly developed private
credit market may generate excessive household borrowing that lowered
private saving. Easy credit condition and excessive borrowing in the
industrialized countries experienced the asset price booms. This
phenomenon, which is typically exemplified by the sub-prime mortgage
in the U.S., may capture the “wealth effect” that has offset the effect of
efficient financial market on personal savings.
37
Moreover, poor financial regulatory quality in China and lack of social
safety nets also boosted the levels of precautionary savings, and self –
insurance behavior appeared to dominate financial planning of
household in China and emerging Asian countries, especially following
the Asian financial crisis.
To specifically identify the factor contributing to current account balance
in some major economies with current account imbalances, a
decompositions of the contributions from each factor to current account
balances in the U.S., China and other Emerging Asian countries are
reported in Figures 9 A-C seen next:
38
Figure 9 A: Decomposition of Current Account Balances in the U.S.
39
Figure 9B : Decomposition of Current Account Balances in China
40
Figure 9C : Decomposition of Current Account Balances in Emerging Asia Countries except for China
41
V.3.
Decomposition of Medium-Term Current Account Balances under CFR Model
42
For China, except for the variable of “relative income”, all explanatory
variables are positively contributed to its current account surplus.
Among them, the regulatory quality and openness have contributed the
most to its current account surpluses. While the increasing degree of
economic openness is consistent with the trend of globalization, a
country could not rely on the backwardness of its institutional quality to
maintain its current account surplus forever. Hence, there is substantial
room for improvement in China’s institutional quality for its sustainable
development.
43
China’s case has shown that capital inflows have been more than offset by capital
outflows “bypassing” its weak institutions and underdeveloped financial system toward
countries perceived to possess more efficient regulatory and financial systems.
Essentially, one could argue that, due to lack of financial development, trade surplus
countries like China have to invest their assets in some “safe haven” countries. This
explains well the ‘up- hill” capital flows of the Lucus Paradox. In fact, Caballero and
Krishnamurthy (2009) argued that the demand of riskless assets from the rest of the
world “not only triggered a sharp rise in U.S. asset prices, but also exposed the U.S.
financial sector to a downturn by concentrating risk onto its balance sheet”. Caballero
further provocatively argued that the rest of the world has had “an insatiable demand
for safe debt instruments that put an enormous pressure on the U.S. financial system to
bridge the “safe –assets gap”. Having advocated the different degrees of risks associated
with the asymmetrical financial developments between developed and developing
countries, Dooley and Garber (2010) further argued that “a balance of trade in assets
create an imbalance of risks for residents in the rich and poor countries” ( p. 51).
An interrelated issue is the degree of financial openness and financial development in Asian countries. Dooley et
al (2005) pointed out that in the absence of a well integrated and well –functioning financial market domestically
and regionally, East Asia countries, with trade surplus essentially lend their capitals to the U.S. even at a lower
interest rate than what they could get from the region.
44
Furthermore, the inefficient financial system also boosted the
precautionary savings in China and emerging Asian countries; Relatively
low social expenditures in government budget in China may have
motivated households to maintain high levels of precautionary savings.
Under developed credit markets also forced consumers in those
countries to save more, rather than financing their purchase of durable
goods and housing through consumer and mortgage loans. Restricted
mortgage loans with proportionally high down payment requirements
also contributed the high saving ratios in those countries. Meanwhile,
beyond the demographic factor which contributed positively to China’s
current account surplus, Wei and Zhang (2009) argued that increase of
household saving rates since the 1990 was attributed by the increasing
proportion of male adults resulted from “one child policy”, which
motivated greater wealth accumulation to better prepare in the marriage
market.
45
For the U.S., other than its oil intensity which accounted for large part of
its current account deficit, the fiscal deficit, private credit and openness
have persistently affected negatively on its current account balances. The
relatively advanced financial system in the U.S. made easy credit possible
and contributed to the consumption oriented economy with private
consumption accounted for 70% of total GDP. Much of the private
consumption was financed through consumer credit and made the U.S.
itself as the prime recipient of capital flows from emerging economies
with excess savings and underdeveloped financial markets.
The highly developed but under-regulated financial industry has fueled
the asset prices bubbles and stimulated excessive household borrowing
and corresponding declines in saving rates in 2004-2008, on the eve prior
to the global financial crisis. Wealth effects have also contributed to
external deficits in the country that experienced asset price booms as a
result of un-regulated financial industries.
46
The above study has some significant policy implications for restructuring
the global imbalances; Except for fiscal deficit, none of these structural
factors could be re-adjusted in the immediate aftermath of the financial
crisis. Even trimming the fiscal deficits is not an easy job politically in the
industrial democracies. Reducing trade imbalances through currency
appreciation of Renminbi is one approach if China could be convinced by
the IMF study showed in Section III. Unfortunately, not only China was not
quite ready to adjust its exchange rates, it is also highly politicized by
politicians in the U.S. as well. Hence, re-structuring financial sector in China
and emerging Asian countries seems to be a more feasible approach to
rebalance the global economy for sustainable economic growth in the
medium and long term.
It was pointed out by Cheung, Furceri and Rusticelli (2010) that the global imbalances,
which were reduced by half between mid-2008 and mid-2009 probably, will reappear after
the global economy is recovering from the financial crisis unless structural readjustments
are carried out in the near future.
47
V.4.
Reexamine the Financial Repression Thesis on Saving-Investment in China
48
In the study by Ito and Chinn (2007), financial development was
measured in terms of the market size, which was defined as the sum of
private credit creation and stock market capitalization, both measured as
ratios of GDP. It showed that the size of financial market has significant
negative effect on current account balance only in industrialized
countries, but not in the restricted samples in LDCs (with or without
including African countries). However, after adding the indicators of “
activeness” of stock market, “efficiency of financial market” and the
interaction terms, then the “ size “ of financial market became a
significant factor in determining current accounts in all country groups,
with positive effect for industrial countries and negative effect for LDCs (
with or without Africa) and emerging markets ( Table 2. ).It implies that
the financial development alone may not be able to fully catch the
complexity of the effect of financial sector on current account, but has to
be complemented by the stock market activeness, efficiency of financial
market, the degree of financial openness and their mutual interactions
as well.
49
Since China and emerging Asian countries had accounted for more than
60% of the U.S. trade deficit, it is imperative to further the study on
saving –investment gap and its impacts on the current account surplus in
those Asian countries. Jha, Prasad and Terada-Hagiwara ( JPT hereafter ,
2009) examined the sectoral contribution of Asian economic growth first
by decomposing the domestic sources, foreign demand and welfare effect
and then examined the components of national saving in selected Asian
countries ; For all sample countries, the unweighted median growth rate
is 5.3% and domestic consumption contributed 3.8% ( 3.6% exclude
China) to it. But, in China, Hong Kong and Taiwan, domestic
consumption contributed less than half of their GDP growth rates in the
2000-2007 periods. Meanwhile, for most Asian countries, private
consumption growth accounted for about three quarters to total growth
except for China where government rather than private consumption
dominated the domestic consumption as showed in Table XX below.
50
For investment, the average contribution growth was at 1.2% percentage
point toward the average growth rate of the 5.3% in the region.
Nevertheless, China’s investment stood out an outstanding example of
much larger shares of 4.5 percentage points toward its 9.8% of average
annual growth rate in the 2000-2007 period. In other word, the high
growth rate in China was mainly contributed by its high investment
rather than private consumption. It further confirms that that there is
room for improvement in reducing its current account surplus in China
by boosting its private consumption. This approach is more feasible and
less political sensitive than the exchange rate appreciation to reduce its
trade surplus against the U.S.
51
Though the thesis on “financial repression” a la McKinnon was initially
referred to the underdevelopment of financial sector in Latin American
countries, it could be partly applied to China and emerging Asian
countries with some qualifications as well. While most developing Asian
economies have got rid of the “vicious circles of saving” and registered a
more than 30% of average saving rate since the mid-1980’s, the
underdevelopment of their financial sectors, except for Hong Kong and
Singapore, could have contributed to the excessive savings and the
resultant global imbalances. First of all, one has to ask where do those
savings come from? And then to ask where did they dispose their
savings?
52
The JPT model (2009) found that, among the three sources of domestic
saving, i.e. households, corporate, and the government, corporate saving
dominated the sources of domestic savings in the region. While savings
ratio in total GDP is around 50% in China, corporate saving accounted
more than 50% of total domestic savings in 2006. It is a mirror image of
China’s state-owned enterprises (SOEs) and policy-induced factors such
as government subsidies on energy and land cost, underfunding of
company pensions and imperfect capital market. The administrative
monopolies in some key sectors of China’s economy plus those distorted
policies in factor markets led to high level of profitability for them in the
boom period until the 2008 financial crisis. Moreover, it was reported
that about half of the listed companies in China paid no dividends, and
even for those which paid dividends to their shareholders, most of them
went to people in high income bracket with higher propensities to save
than would be otherwise. This is one of the fundamental causes of the
high saving in China.
53
Others studies like Lin ( 2009) and Prasad ( 2009B) cited in the JPT
study also argued that high level of corporate saving in China was partly
attributed to financial structure dominated by the state-owned banks, an
equity market and the repressed financial system. All of these factors are
favorable to large SOEs. The state-owned banks probably made loan
decisions based more on administrative discretions rather profitability of
investment projects undertaken by the SOEs, and squeezed out other
investors- a scenario similar to McKinnon thesis of “financial repression”.
Those frustrated investors who were discouraged from the repressed
financial market in China were led to rely on internal finance by
retaining their earnings rather than borrowing from the curb money
market as prescribed by McKinnon model on financial repression. That
is another reason why more than 50% of total investment in China came
from corporate saving, which is insensitive to the changing interest rate.
This phenomenon offered a mirror image on the inefficacy of monetary
policy as an instrument for stabilization policy as well.
54
While household saving behavior is well documented in literature, Asian
countries have their own unique factors; among them, precautionary
motives are the most important determinant. In the absence of social
safety nets, health insurance, educational loans, limited pension
coverage and low unemployment compensation funds were identified as
the most significant factors for the precautionary savings in China. Much
of the precautionary savings could be mitigated if financial institutions
and markets in China could be further developed.
55
The other factor contributed to precautionary saving in China is the rising
housing prices in urban area with limited availability of mortgage loans
and high down payment requirement. Without well developed financial
market to smooth consumption patterns over the life-cycle in a growing
economy, China has encountered the phenomenon of a growing economy
with an ever rising ratio in the household saving. Further development of
China’s financial markets and institutions could reduce household saving
rates by reducing the rate of return risks and easing liquidity constraints
through systematic development of consumer credits and mortgage loans.
Hence, provision of accessible credit for Chinese consumers would
substantially reduce their precautionary savings and encourage them to
consume more. This will contribute to the reduction of China’s current
account surplus which is much more feasible politically than the
appreciation of its currency against the U.S dollar.
56
At the present, consumption as percentage of total GDP only accounted
for an average of 40% in China. As per capita income increases, it is
reasonable to predict the ratio will increase over time as well. Further
development of consumer credit and mortgage loan markets should be
pushed to support further consumption expenditures on durable goods
and housing. This argument is also consistent with the stages theory of
economic development (W.W.Rostow, 1971) that there is a trend of
increasing consumption along the path of economic development.
57
V.5.
Policy Implications: The Role of Financial Development in Readjusting the
Global Current Account Imbalances
58
The export-led, external demand –driven development policies under
taken by China and other trade dependent countries, though has its merits
in the past decades, need to be readjusted in the aftermath of the global
financial economy. The proliferations of regional trading agreement in
Asia, if proceeds to lead further intra-regional trade as anticipated, would
provide a clue to diversify the export destinations of China and those Asian
countries.
On sectoral re-adjustment in the trade surplus and deficit countries, the
most significant finding from OECD study (2010) is the asymmetry of
financial development between the trade surplus and deficit countries; the
widening global imbalance was tandem with the asymmetry of financial
development and the over savings through the capital flows from trade
surplus countries to the trade deficit country. The phenomenon
contributed to the “Lucus Paradox” of capital flows of having the “up-hill”
capital movements from poor to rich countries (1990).
59
But, the OECD study merely pointed out the fact of asymmetric financial
developments in the trade deficit-notably the U.S. and the trade surplus-notably
China and emerging Asian economies without dealing with the causality. Moreover,
the effect of financial development on saving is not without ambiguity because
efficiency of financial market/ institution has both income and substitution effect.
Edwards (1996) toke the view that financial deepening would generate more saving
due to higher rate of return and lower risk involved in an advanced and sophisticated
financial system. McKinnon argued that financial liberalization which leads to higher
real rate of interests would further enhance household saving as well. Obviously,
McKinnon-Edwards thesis is different from the OECD study that financial
development in China would reduce personal savings. Nevertheless, financial
development could have both demand side and supply side effect on the savinginvestment equation. On the demand side, financial development could channel
savings effectively into productive investment rather than buying low-yielding U.S.
Treasury Bonds. On the supply side, a more developed financial system could
encourage business investment by providing them with the necessary financial
capitals. Hence, the net effect of financial development on the saving-investment gap
(S-I) is an empirical question pending on the relative effects of financial development
on both the saving and investment, not just saving alone.
60
It is also noted that there is a contrasting view that a more developed financial
system would make credit more readily available and reduced the precautionary
demand for saving and the “saving glutting” theses of Bernanke. Ito and Chinn(
2007) found “ that it is unsurprising that China, with a large closed financial
market, equipped with a mediocre index of institutional development, is
running a large current account surplus” (p.14). Hence, it is reasonable to
propose that one feasible approach to correct global external imbalance is
through the financial development in China and other the trade surplus
countries emerging Asian countries; i.e. the underdevelopment of financial
system in China and other emerging Asian economies, which led to the excessive
savings in the private sector for precautionary purposes, needs to further
develop to undermine their excessive savings when their incomes increase.
One counter argument may cite the high savings ratios in Japan and Singapore and
their relatively well developed financial markets and institutions. Yet, Singapore’s
mandatory savings through the “ central provident fund” may override its financial
development on saving whereas the high housing price and more rigid mortgage
lending in Japan may also force the Japanese to save more.
61
The other issue is the measurement of financial development in
empirical studies. Literature provided us with a handful of indicators of
financial development; in addition to the private credit as ratio of GDP,
stock market capitalization as a share of GDP, stock market turnover as a
share of GDP, the growth rate of stock market capitalization as a share of
GDP, private bond market capitalization as a share of GDP, liquid
liabilities as a share of GDP, index of financial liberalization and
financial openness. Since the indicator of financial development is the
ratio of private credit as percentage of GDP in the OECD study and the
data from China mixed up with the credits provided with the SOEs
affiliated sectors, further study with alternative measurements of
financial development in China is needed.
62
On the other hand, the advanced financial system and efficient financial
institutions which had made easy credit for American people had
enabled them not only to finance their housing and consumer durable
goods through mortgage loan and credit creation easily, but also
facilitated multiple credit expansion through securitization of mortgage
loans and financial leverages. In the aftermath of the financial crisis,
both financial instruments need to be scrutinized to rebalance the global
economy for sustainable development. This argument would echo
Feldstein (2008) that “low national saving is the fundamental cause of
the U.S. trade deficit”. The financial regulatory bill signed by President
Obama is the first step in the correction direction. Yet, more policy
incentives for American people to encourage their savings are needed.
63
Therefore, to mitigate the global external imbalance, one has to promote
financial development to facilitate credit expansion, to enhance the
institutional quality, and to increase the social safety nets to reduce the
precautionary savings in China and other emerging Asian economies.
Specifically, the OECD study ( 2010) pointed out, a few policy distortions
in those trade surplus countries need to be removed to reduce the
institutional distortions which led to the high corporate savings in
China. The excessive savings over and above investments due to the
under development of financial markets to finance mortgage, the
inadequate retirement pension and safety nest system, and the lack of
mechanism of sudden capital flows need to be corrected.
64
VI.
Conclusion
65
Global imbalances is a secular, not a cyclical, issue in the world economy.
National accounts need not be balanced all the time. Yet, if resulted from
distorted regulatory and undeveloped financial sector, it would undercut
macroeconomic performances. Structural re-adjustment to correct the
global current account imbalance faced critical challenges in both trade
deficit and trade surplus countries. The export-led, external demand
driven development strategy in China and many emerging Asian
countries need to re-direct their market destinations toward more
domestic-oriented, intra-regional trade rather than do their businesses
as usual in the post-crisis era. Yet, it won’t be accomplished in the short
term.
66
Currency realignment in China and other trade surplus countries would
not necessarily deter their economic growth as the lessons from five
major exchange rates appreciations in German, Japan, Korea and Taiwan
had shown. Nevertheless, the neo-mercantilist ideology in the trade
surplus countries may prohibit them to adopt exchange appreciation
policy any time soon.
Demand management policy to shift the inter-sectoral resources in the
macro economies may not be feasible politically in the short term.
Restructuring macro imbalances by trimming fiscal deficit faces the
political difficulties in the trade deficit country, whereas cutting
consumption or increasing export may encounter the mismatch of
supply and demand in the trade dependent countries. One more feasible
method to restructure the global imbalance is to re-examine the role of
financial development in savings. The asymmetric financial
developments between the trade surplus and deficit countries seem to be
an important clue to resolve the global imbalance.
67
The “ up -hill” trend of capital flows from trade surplus but lower income
countries to trade deficit but high income countries could be reversed by
restructuring their respective financial sector for sustainable
development; excessive saving in trade surplus country, other than
cultural and demographic factors, is due to under development of
financial sector, lack of social security net etc. Once financial
development in those trade surplus countries has been enhanced and
mortgage financing as well as social security nets are more accessible, the
need for the precautionary savings will be reduced. By so doing,
household consumptions in the trade surplus countries will increase
through credit expansion and more efficient financial markets and
institutions. Hence, the quality of life will be improved and more people
will be benefitted from their high economic growth. With a decreasing
saving in both private and public sector in the trade surplus countries,
then their current account surplus will be trimmed.
68
On the other hand, under saving in the trade deficit countries is due to highly
developed bur under-regulated financial market on the speculative funds
which need to be checked. Trade deficit economies with advanced financial
markets would need to re-regulate its financial institutions, reduce their
consumptions by tighter monitor of credit and government budget deficits.
The wealth effect of un-regulated financial assets from the speculative hedge
fund, which totaled to $ 62 trillion, needs to be scrutinized.
Political feasibility of the policy mixture on demand management to correct
global imbalances support the argument that enhancing financial
development and institutional quality in the trade deficit countries-notably
in China and emerging Asian countries and to re-regulate financial sectors in
the U.S. as one of the most feasible tasks to re-balance the global imbalance
for sustainable economic growth.
69
Appendix
Sectoral Components of National Income Account in the U.S. and China
70
Table A:
Sectoral Composition of GDP in the U.S.
The US data are from the St. Louis
Federal Reserve’s FRED database.
Data
GDP
C
S
I
X
M
G
T
Series
GDPA
PCECA
GSAVE
GPDIA
EXPGSA
IMPGSA
AFEXPND
AFRECPT
71
Year
S/GDP
C/GDP
I/GDP
G/GDP
T/GDP
(X-M)/GDP
(S-I)/GDP
(T-G)/GDP
1980
20.97127
62.97479
17.19092
21.14343
19.10979
-0.46627
3.780352
-2.03364
1981
21.43086
62.02827
18.30626
21.64193
19.82538
-0.40297
3.1246
-1.81655
1982
17.29067
63.79872
15.89819
23.13414
18.97824
-0.61478
1.392475
-4.15591
1983
18.26232
64.74849
15.96503
23.18508
18.20008
-1.45985
2.29729
-4.98501
1984
19.60874
63.62665
18.71327
22.42489
18.06202
-2.61263
0.895469
-4.36287
1985
17.3278
64.43628
17.45584
22.59632
18.36159
-2.73148
-0.12804
-4.23474
1986
15.50189
64.94697
16.73729
22.66093
18.29555
-2.97303
-1.2354
-4.36537
1987
17.811
65.38721
16.57377
22.08217
18.92788
-3.05929
1.237227
-3.15429
1988
18.22798
65.68308
16.10854
21.50616
18.79264
-2.15865
2.119442
-2.71351
1989
16.3897
65.56794
15.95921
21.37867
18.93435
-1.6034
0.430492
-2.44432
1990
15.74347
66.12361
14.84355
21.70847
18.66736
-1.33782
0.899922
-3.04112
1991
15.72737
66.42246
13.39931
22.03401
18.38921
-0.44892
2.328065
-3.6448
1992
14.44429
66.80384
13.63543
22.87025
18.10069
-0.51716
0.808855
-4.76956
1993
14.80337
67.2466
14.29793
22.56202
18.35948
-0.96589
0.505444
-4.20254
1994
16.08705
67.05245
15.48721
21.77073
18.66002
-1.30836
0.599842
-3.11071
1995
17.04587
67.26233
15.42881
21.76757
18.98661
-1.22325
1.617058
-2.78096
72
Year
S/GDP
C/GDP
I/GDP
G/GDP
T/GDP
(X-M)/GDP
(S-I)/GDP
1996
17.91797
67.27818
15.8219
21.36506
1997
18.84211
66.85469
16.66627
1998
18.83664
67.3054
1999
18.3418
2000
(T-G)/GDP
19.47311
-1.22855
2.096064
-1.89194
20.59791
19.87663
-1.21694
2.175844
-0.72128
17.18087
19.83624
20.21834
-1.84
1.655768
0.3821
67.81205
17.54958
19.20351
20.2598
-2.80216
0.792217
1.056289
17.53002
68.63689
17.80837
18.81023
20.67126
-3.83962
-0.27835
1.861026
2001
15.21359
69.49894
16.1566
19.24715
19.64088
-3.60677
-0.94301
0.393731
2002
14.48465
69.90218
15.47598
19.84627
17.47085
-4.01417
-0.99133
-2.37543
2003
14.75036
70.04066
15.524
20.29689
16.91871
-4.52428
-0.77364
-3.37818
2004
14.73483
69.81159
16.58774
20.16718
16.96945
-5.21327
-1.85291
-3.19773
2005
15.88967
69.7794
17.1873
20.35938
18.12017
-5.71829
-1.29763
-2.23921
2006
16.63122
69.5781
17.36859
20.36212
18.8411
-5.74152
-0.73737
-1.52102
2007
14.01741
69.73716
16.32223
20.62325
18.87881
-5.07759
-2.30483
-1.74444
2008
11.71194
70.32104
14.59173
21.70839
17.42002
-4.94394
-2.87979
-4.28837
2009
11.06665
70.83575
11.25575
24.48828
15.62292
-2.73603
-0.18911
-8.86536
73
Table B:
Sectoral Composition of GDP in China
All data are from the IMF’s IFS database
74
Year
S/GDP
C/GDP
I/GDP
G/GDP
T/GDP
(X-M)/GDP
(S-I)/GDP
(T-G)/GDP
1980
32.8224
50.7566
28.79227
14.73361
23.62777
-0.32006
4.030133
8.894163
1981
29.90287
52.46566
26.73894
14.64622
21.75172
0.341399
3.163931
7.105494
1982
34.2975
51.93023
26.89088
14.52415
20.10733
1.627907
7.406619
5.583184
1983
34.3986
51.9787
27.72272
14.40269
20.09266
0.81722
6.675879
5.689971
1984
34.82823
50.82375
29.1605
14.99857
20.39877
0.017657
5.667731
5.400193
1985
34.36114
51.64212
29.43801
14.31027
20.56254
-4.04442
4.923133
6.252272
1986
34.8374
50.45535
29.87772
14.46163
20.19318
-2.42851
4.95968
5.731551
1987
36.30321
49.89737
30.94059
13.67146
17.91422
0.087967
5.362617
4.242755
1988
35.7451
51.12941
30.55444
12.81078
15.31783
-0.9819
5.190661
2.507051
1989
35.72984
50.90663
25.52899
13.58419
15.39399
-1.07213
10.20085
1.809801
1990
38.58599
48.84741
24.95271
13.64289
15.18054
2.637509
13.63329
1.537643
1991
38.70827
47.52806
26.88662
14.8879
13.94758
2.735036
11.82164
-0.94032
1992
38.60005
47.16128
30.89765
15.24821
12.63695
0.999811
7.702393
-2.61126
1993
40.47214
44.43136
36.03109
14.85675
11.77375
-1.83956
4.441051
-3.083
75
Year
S/GDP
C/GDP
1994
42.30279
43.49927
1995
41.04985
1996
I/GDP
G/GDP
T/GDP
(X-M)/GDP
(S-I)/GDP
(T-G)/GDP
34.4755
14.73195
10.39102
1.26271
7.827287
-4.34093
44.87677
33.03705
13.25358
9.874258
1.579641
8.012794
-3.37932
39.62465
45.78513
32.42575
13.43462
9.988728
1.967542
7.198909
-3.4459
1997
40.45149
45.21452
31.79706
13.73905
10.59424
4.347251
8.654433
-3.1448
1998
39.19921
45.33523
33.01568
14.28253
11.41317
4.194075
6.183521
-2.86936
1999
38.69374
46.74594
34.04136
15.29543
12.76134
2.649171
4.652381
-2.53409
2000
36.83074
46.21759
34.11232
15.78538
13.50104
2.409121
2.71842
-2.28434
2001
37.58131
44.88003
34.43026
16.10971
13.4604
2.120013
3.151046
-2.64931
2002
40.30222
43.68818
36.25946
15.88916
15.9337
2.571281
4.042756
0.044543
2003
43.99849
41.84446
39.38265
15.17792
16.13652
2.19867
4.615838
0.958601
2004
46.8176
39.92638
40.72962
14.51069
9.848259
2.551383
6.087986
-4.66243
2005
50.61633
38.87057
42.19303
14.52114
10.00917
5.579777
8.423307
-4.51197
2006
37.97442
42.53926
14.21189
10.63532
7.858478
2007
36.37805
40.97689
13.67667
9.086691
2008
36.05015
41.97592
13.54322
8.02704
-3.57657
76