naked capitalism

An ongoing discussion in the financial media and among economists is how to characterize the causes of the so-called global imbalances, namely, that the US is importing capital from high savings nations, primarily China, Japan, Taiwan, and the Gulf states, to fund its high consumption. Some like to focus on the “savings glut” hypothesis, which says it’s the fault of all those underspending economies, and they need to do their part and consume more. Or the villain can be the profligate, big spending Americans.

Even though, intuitively, it is seems easier to blame fat-and-getting-fatter Americans than hardworking, thrifty Chinese, I’ve never found this way of framing the issue to be particularly helpful, either from an analytical or policy perspective.

Thomas Palley, in “Through the Looking Glass: Saving Glut or Demand Shortage,” takes up the issue and frames the issue somewhat differently. He sees it as an advanced economy/developing economy problem (although that conveniently omits Japan) and sees the issue as advanced economies treat emerging economies as places to manufacture goods to export to mature economies, rather than as markets to be developed. Japan still fits that pattern even though it is an advanced economy because it is export driven and highly resistant to letting foreign companies penetrate its domestic market.

The difficulty is that Palley’s analysis implies that not only do international companies need to change their approach to third world countries dramatically, but also that young economies also need to adopt policies that lead to lower income disparity. That won’t be an easy sell.

From Palley:

Both the saving shortage and saving glut hypotheses confuse accounting outcomes with causes. Trade deficits reflect transactions between producers and buyers, and those transactions are the product of incentives and price signals. U.S. consumers buy imports rather than American-made goods because imports are cheaper. This price advantage is often due to under-valued exchange rates in places like China and Japan, which often swamps U.S. manufacturing efficiency advantages.

Under-valued exchange rates are only one of the policies countries use to boost exports and restrain imports, so that they run trade surpluses while their trading partners (including the U.S.) run deficits. Other policies for export-led growth include export subsidies and barriers to imports.

In the modern era of globalization export-led growth is supplemented by policies to attract foreign direct investment (FDI), a pairing that has been particularly successful in China. Such FDI policies include investment subsidies, tax abatements, and exemptions from domestic regulation and laws.

These policies encourage corporations to shift production to developing countries, which gain modern production capacity. This increases developing country exports and reduces their import demand. Meanwhile, corporations reduce home country manufacturing capacity and investment, which reduces home country exports while increasing imports. Once again, China provides clear evidence of these patterns, with almost sixty percent of Chinese exports being produced by foreign corporations.

This is a fundamentally different story from both the saving shortage and saving glut hypotheses, and it leads to dramatically different policies. Developing countries need to grow, but in today’s globalization it is easier to acquire capacity and grow through FDI than it is to develop domestic mass consumption markets. Consequently, rather than facing a saving glut problem, the global economy faces a problem of market demand failure in developing countries.

The challenge is getting corporations to invest in developing countries, but for purposes of producing for local consumers. That requires expanding markets in developing countries, which means tackling income inequities and getting income into the right hands. That is an enormous organizational challenge that is off the radar because economists focus exclusively on saving and supply-side issues.

Labor standards, minimum wages, and unions are part of the solution. That is the unambiguous history of successful developers. Unions have historically been especially important since they engage in decentralized wage bargaining that tie wages to firm productivity. Consequently, wages are market sustainable.

Government spending can also help, but its role is limited. Countries that substitute government spending for market spending either generate excessive inflationary budget deficits, or end up with excessively high tax rates that destroy incentives.

Both the saving shortage and saving glut hypotheses fail to connect today’s global financial imbalances with global production patterns and inadequate market demand in developing countries. Tortuous claims that saving is merely the flip side of consumption and investment spending are the equivalent of Humpty Dumpty’s argument in Through the Looking Glass: When I use a word it means just what I choose it to mean”.