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The Transpacific Imbalance:
An East Asian Perspective
Jong-Wha Lee
Korea University and ANU
Warwick J McKibbin
ANU and Lowy Institute
Yung Chul Park
Korea University
Prepared for Western Economic Association Meetings, Vancouver, 30 June 2004
1
Motivation



What has contributed to global current account imbalances?
What are the consequences of these imbalances?
What would be feasible policies to reduce the imbalances?
 We provide estimates for the effects of the proposed polices based on a
multi-country intertemporal general equilibrium model- the G-cubed
(Asia Pacific) Model.
2
Overview
1.
Causes and Development of Global Imbalances
2.
Implications and Policy Challenges of the
Imbalances
3.
Estimating the Effects of Adjustment Policies
4.
Concluding Remarks
3
How Serious is the Transpacific Imbalance?
 US current account deficits increased significantly since the
1990s.
– In 2003, a deficit of $542 billion(4.9% of GDP);
 Japan, China and four Asian Newly Industrialized Economies
have large current account surpluses (2003).
– Japan: $136 billion(3.2% of GDP),
– East Asian NIEs: $87b(7.6% of GDP),
– China:$30b (2.1% of GDP)
 Significant bilateral trade deficit of the U.S. with East Asian
economies.
– In 2003, US trade deficit with 10 East Asian countries
amounts to $248 billion.
4
What Caused the Transpacific Imbalances?

Global imbalances of saving(S) and investment(I)
– The U.S. (S-I)<0 widened.
– Japan and East Asian NIEs (S-I)>0 increased.

US fiscal deficits and low saving
– The U.S. gross saving rates declined significantly since 2001
mainly due to loose fiscal policies.
– Public saving rates dropped from 4.4% in 2000 to –1.9 % of GDP
in 2003.
– Federal budget balance shifted from 2.5% in FY2000 to over –
4.0% in FY 2003.
5
What Caused the Transpacific Imbalances?

Low investment in East Asian economies
– After the financial crisis of 1997, investment rates declined
significantly, and have not recovered yet in East Asia.
– In Japan, investment rate dropped from 28.6% in 1997 to 23.5 %
of GDP in 2003.
– In four East Asian NIES, investment rates dropped from 31.6% in
1997 to 22.9 % of GDP in 2003.
– Both private and public investments have declined in East Asia
NIES: Public investment-to-GDP rate from 9.6% in 1997 to 6.2 %
of GDP in 2002.
6
Figure 1. Saving, Investment and Current Account
The U.S., 1981-2004
(% of GDP)
25
20
15
10
5
0
1981~88
1989~96
1997
1998
1999
2000
2001
-5
-10
Saving
Investment
Current Account
2002
2003(est)
2004(p)
Figure 2. Private and Public Saving, and Current Account
The U.S., 1981-2004
(%)
25
20
15
10
5
-10
Private
Public
Current Account
20
04
(p
)
20
03
(e
st)
20
02
20
01
20
00
19
99
19
98
19
97
-5
19
89
~9
6
19
81
~8
8
0
Figure 3. Saving, Investment and Current Account
JAPAN, 1981-2004
(% of GDP)
35
30
25
20
15
10
5
0
1981~88
1989~96
1997
Saving
1998
1999
Investment
2000
2001
2002
Current Account
2003 (est)
2004 (p)
Figure 4. Saving, Investment and Current Account
Four East Asian NIEs, 1989-2004
(% of GDP)
40
35
30
25
20
15
10
5
0
1989~96
1997
1998
Saving
1999
Investment
2000
2001
2002
Current Account
2003 (est)
2004 (p)
Implications of the Transpacific Imbalance
 Theory Implies:
– The huge U.S. deficits ultimately lead to (real)
depreciation, thereby switching demand from imports to
domestic output.
– The widening of negative saving-invest gap pushes U.S.
interest rates up, thereby helping the gap to diminish.
 But, the imbalance has sustained:
– This would be expected from theory but in addition the
U.S. deficits are manageable for longer because East
Asia is willing to finance them by accumulating an
unlimited amount of dollar reserve assets in order to
keep exchange rates undervalued.(Dooley, FolkertsLandau, and Garber).
11
What Role for East Asia’s “Export-led growth” policy?

East Asia (the periphery) pegs to the US dollar (the center’s
currency) -- “The Revived Bretton Woods System”
– “Fear of floating” – East Asia maintains exchange rates stable
vis-à-vis the US dollar.
– Distort real exchange rate to keep competitiveness of export
sector (but how long can this work?).
– Accumulate low interest-rate reserve assets.

East Asia’s exchange rate policy is not the principle cause of the
growing global imbalances.
– Many East Asian countries ran large current account deficits
before the crisis.
– much of the increase in current account surpluses is
explained by low investment demand since the crisis.
12
Figure 7. Real Effective Exchange Rate
(China, Japan, and Korea)
(Avg of 2000 = 100)
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
1995
1996
1997
China
1998
1999
2000
Korea
2001
2002
Japan
2003
2004
Figure 8. Real Effective Exchange Rate
(Indonesia, Malaysia, Philippines, Singapore, and Thailand)
160.0
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
1995
1996
1997
Malaysia
1998
1999
Philippines
2000
Thailand
2001
2002
Singapore
2003
Indonesia
2004
Figure 9. Real Effective Exchange Rate
(Hong Kong and Taiwan)
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
1995
1996
1997
1998
1999
Hong Kong
2000
2001
Taiwan
2002
2003
2004
Table 4. International Reserves of East Asia, 1999~2003
$US billions
1999
2000
2001
2002
2003
287,019
354,927
395,240
461,349
663,303
Subtotal
287,019
354,927
395,240
461,349
663,303
Hong Kong
96,270
107,549
111,179
111,935
118,362
Korea, South
74,014
96,137
102,775
121,388
155,287
Singapore
76,871
80,138
75,391
82,050
95,748
Taiwan
106,238
106,749
122,237
161,714
206,636
Subtotal
Indonesia
353,393
26,454
390,573
28,504
411,582
27,252
477,087
30,980
576,033
34,963
Malaysia
30,599
29,525
30,481
34,234
44,516
Philippines
13,234
13,053
13,445
13,149
13,463
Thailand
34,075
32,018
32,362
38,060
41,078
157,784
262,146
168,289
271,389
215,651
319,191
291,230
407,653
408,151
542,171
902,558
1,016,889
1,126,013
1,346,089
1,781,507
Japan
China
Subtotal
Total
Source: IMF, International Financial Statistics
Consequences of the Imbalances
 Increasing pressures on East Asian economies
–
–
–
–
Reserve accumulation began to result in inflation.
Real appreciation is already occurring.
Widening gap between tradables and non-tradables.
Pegging exchange rates invites speculative capital inflows which
can lead to boom and bust cycles.
 Concerns about the persisting U.S. fiscal deficits.
– The loose fiscal policy expects to put fiscal balance in deficits
into the next decade.
– Current U.S. dollar depreciation reflects that people begin to
worry about the sustainability of the U.S. deficits.
17
What Can Be Done by East Asia?



1. Increase exchange rate flexibility
– Who will move first? No collective exchange rate policy.
– Is China ready for a more flexible regime?
– The bilateral trade imbalances between countries in the region
add complications.
– Will the exchange rate adjustment have much impact on
transpacific imbalance?
2. Expansionary aggregate demand policy
– Little room for monetary expansion
– Regionally concerted fiscal expansion (Eichengreen and Park,
2004).
– Would it work to improve the US balance?
3. Others
– Status quo: gradual adjustments anyway occur.
– Accelerated Trade liberalization
18
Estimating the Effects of Alternative
Shocks and Policies
19
The G-Cubed (Asia Pacific) Model
www.gcubed.com
20
The G-Cubed Model
• Key features
– Based on explicit intertemporal optimization by
households and firms in each economy in a
dynamic setting
– Substantial sectoral dis-aggregation with
macroeconomic structure
– Explicit treatment of financial assets with
stickiness in physical capital differentiated from
flexibility of financial capital
– Short run deviation from optimizing behavior due
to stickiness in labor markets, myopia
– Short run “New Keynesian” Model with
Neoclassical steady state
21
G-Cubed Model
• 12 sectors production in each economy
– Plus a capital good producing sector
– Plus a household durable production sector (I.e. housing)
• Estimation of KLEM technology in production and consumption
• Tracks flows of international trade at the sectoral level
• Tracks flows of international capital
• Distinguishes between relatively traded and non trade goods (all
goods are potentially tradeable)
22
Economies
United States
Japan
Australia
New Zealand
Canada
Europe
Korea
Thailand
Indonesia
China
Malaysia
Singapore
Taiwan
Hong Kong
Philippines
India
Oil Exporting Developing Countries
Eastern Europe and the former Soviet Union
Other Developing Countries
23
Sectors
•
•
•
•
•
•
Energy
Mining
Agriculture
Durable Manufacturing
Non-Durable Manufacturing
Services
24
Simulations
• Sustained fall in Asian Investment
– rise in equity risk premia of 2% in non Japan/non China Asia; 0.5% in
Japan)
• Permanent US fiscal expansion financed by debt
– Rise of 4% of GDP fiscal deficit
• 1% of GDP on Goods/services
• 1% of GDP on labor
• 2% of GDP of income tax cuts
• Revaluation of Chinese Exchange Rate of 10%
• Fiscal Stimulus in non-Japan Asia
– 2% of GDP comprising 1% GDP goods/ services and 1% GDP on labor
25
Adjustment Story: Asian Investment Decline
• Rise in equity risk premium implies rate of return on
capital must rise above other assets
– Capital stock must fall to generate the higher return
– Investment declines
– Portfolio holders substitute out of equities into bonds
(r falls), into housing (housing prices rise) and into
foreign assets (capital outflow)
– Real exchange rate depreciates and GDP falls
• raising exports and lowering imports
– Consistent with excess savings relative to investment
• Current account improves
26
Adjustment Story: US Fiscal Policy
• Similar to Mundell-Fleming story except intertemporal
overlay and asset adjustment
• Higher spending/lower taxes initially raises GDP but over
time GDP falls as resources are extracted from the
private sector to finance the fiscal deficit
• Partial Ricardian adjustment in Consumption but long
term real interest rates rise to free up resources to
finance the deficit
• Net capital inflow which appreciates the US real
exchange rate
– Exports fall, imports rise
27
Adjustment Story: US Fiscal Policy
• Investment rises initially but then falls, private saving
rises but total savings falls by more than investment
– US Current account deteriorates
• High long term real interest rates lowers global
investment improving Asian current accounts
28
Adjustment Story: Chinese Revaluation
• Real exchange rate initially appreciates
– Over time prices rise less quickly and the real exchange
eventually returns to base
– Chinese GDP falls relative to base by 4% in the first year
– Exports less competitive but domestic slowdown reduces
imports
• Trade balance worsens slightly
– GDP in other countries ambiguous depending on competition
with China versus fall in Chinese demand from trading partners
– Overall impact on US/Asia trade balances is neglible
29
Adjustment Story: Asian Fiscal Stimulus
• Similar story to US policy except partial exchange rate
targetting in some countries causes larger rises in GDP
in Asia
• Less impact on long term real interest rates because of
economic size and less crowding out of foreign
investment
• Capital flows in to finance the fiscal deficit
• Real exchange rate appreciation
– Trade balance deteriorates
30
Table 2: Change in Trade Balances due to Asian Investment Decline
(%GDP)
year 1
year 5
year 10
USA
-0.18
-0.25
-0.22
Japan
0.91
1.04
0.89
Canada
-0.24
-0.36
-0.33
Australia
-0.22
-0.44
-0.49
New Zealand
-0.52
-1.17
-1.19
Indonesia
1.32
2.38
2.51
Malaysia
1.39
2.71
2.60
Philippines
2.52
4.88
4.24
Singapore
-0.20
-0.59
-0.76
Thailand
0.62
1.35
1.91
China
-0.28
-0.36
-0.30
India
-0.23
-0.34
-0.30
Taiwan
1.43
2.31
2.33
Korea
1.88
2.78
2.40
Hong Kong
0.63
1.05
1.24
Europe
-0.23
-0.30
-0.27
Source: G-Cubed Asia Pacific Model version 58n
Table 2: Change in Trade Balances due to US Fiscal Policy
(%GDP)
year 1
year 5
year 10
USA
-1.52
-1.41
-1.04
Japan
1.01
0.86
0.69
Canada
1.31
1.43
1.17
Australia
0.88
0.77
0.64
New Zealand
1.80
2.29
1.85
Indonesia
1.09
1.24
0.94
Malaysia
1.61
2.28
1.67
Philippines
1.55
1.28
0.62
Singapore
1.64
2.77
3.24
Thailand
1.26
1.45
1.21
China
0.45
0.78
0.51
India
0.63
0.63
0.41
Taiwan
1.38
1.43
1.32
Korea
1.00
1.12
0.68
Hong Kong
1.21
0.67
0.33
Europe
0.77
0.59
0.47
Source: G-Cubed Asia Pacific Model version 58n
Table 2: Change in Trade Balances due to Chinese Appreciation
(%GDP)
year 1
year 5
year 10
USA
0.01
0.00
0.00
Japan
0.01
0.00
0.00
Canada
0.02
0.00
0.00
Australia
0.03
0.00
0.00
New Zealand
0.04
-0.01
0.00
Indonesia
0.03
-0.01
0.00
Malaysia
0.04
-0.01
0.00
Philippines
0.02
-0.01
0.00
Singapore
0.06
-0.02
0.00
Thailand
0.05
-0.01
0.00
China
-0.48
0.05
-0.02
India
0.02
0.00
0.00
Taiwan
0.10
0.00
0.01
Korea
0.04
-0.01
0.00
Hong Kong
-0.22
-0.01
-0.01
Europe
0.01
0.00
0.00
Source: G-Cubed Asia Pacific Model version 58n
Table 2: Change in Trade Balances due to Asian Fiscal Stimulus
(%GDP)
year 1
year 5
year 10
USA
0.05
0.04
0.02
Japan
0.11
0.08
0.05
Canada
0.07
0.07
0.04
Australia
0.09
0.09
0.06
New Zealand
0.17
0.28
0.21
Indonesia
-0.83
-0.65
-0.37
Malaysia
-0.68
-0.21
0.14
Philippines
-0.84
-0.09
0.21
Singapore
-1.02
-0.50
-0.01
Thailand
-0.90
-0.88
-0.60
China
-0.60
-0.50
-0.31
India
0.08
0.07
0.04
Taiwan
-1.01
-0.91
-0.65
Korea
-0.78
-0.61
-0.35
Hong Kong
-0.31
-0.03
0.17
Europe
0.07
0.05
0.03
Source: G-Cubed Asia Pacific Model version 58n
Conclusions
• Predominant contribution to the transpacific trade
imbalance is US fiscal policy
• Weak Asian investment since the 97 Crisis also
important for the Asian trade surpluses but less
important for the transpacific balance
• US fiscal contraction and Asian fiscal expansion plus a
recovery in Asian investment rates would have a
significant impact on reducing each country’s overall
trade position and would also reduce the Transpacific
trade imbalance
35
Conclusions
• Chinese exchange rate revaluation has significant
effects on slowing China but not in changing global trade
balances
• The worsening in Chinese competitiveness plus weaker
Chinese growth tends to offset each other in the spillover
to other countries and have a minor impact on the
relative saving and investment balances across the
region.
36
Background Papers
www.sensiblepolicy.com
www.notwrong.com
37