Going Beyond the Savings Glut/Overconsumption Debate

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”.

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  1. Anonymous

    Very interesting take on a tragically convoluted subject.

    The accounting consequence can’t be denied – although even that gets muddled. From this perspective, there obviously can’t be a global savings glut as a consequence of deficient US saving that is offset by non-US excess saving.

    Yet Bernanke persists with the global savings glut paradigm.

    This is not only false from an accounting outcome perspective, but misguided from a causal perspective as described in this article.

  2. minka

    Two points that support this view:

    In India a stunning 48% of children are malnourished. That is higher than sub-saharan Africa, countries that are far, far poorer than India.

    In China, the percentage of the economy related to consumers and consumer spending is actually declining.

  3. Lune

    The India / China comparison is interesting because I think it adds another wrinkle. Much of China’s growth has been through foreign corporations basing their manufacturing in China. But because they’re still foreign companies, they’re focused on meeting the needs of their original countries’ consumption patterns.

    OTOH, a lot of India’s growth has come from homegrown companies that took advantage of local conditions. Although they export quite a bit as well, because they’re local companies, they also tailor products to the local market.

    Ironically, I think part of why this split between China and India came about was because India protected its domestic manufacturers for years (hence their 10 year “delay” in opening up their markets compared to China), allowing them to grow to the point that they could compete with foreign companies, while China opened their markets before their local companies were truly competitive (in their defense though, since much of Chinese industry was state-owned, they had a tougher time making it competitive than India, although India also had a significant state-owned sector).

    To make a long story short, perhaps ensuring the long-term success of globalization by preventing these savings/consuming imbalances requires protecting domestic firms in the short-term until they’re able to compete, rather than the rapid reforms of the type often advocated by the developed world, which often destroy local industries and leave a dearth of home-grown companies interested in satisfying local demand.

  4. Yves Smith


    Very helpful information.


    Per your point, Japan had (and may still have) a highly protected market. They were famous for having all sorts of goofy import restrictions. My favorite was when they tried keeping Western beef out because Japanese colons could only digest the meat of home-grown cows. I’m not on top of it now, but I know they have a mad cow inspection regime that puts ours to shame. Their tough safety regime leads to considerable prejudice among Japanese customers for Japanese goods, a de facto trade barrier.

    And in the 1980s in electronics, the Japanese sold their products at very high margins at home which enabled them to sell them at razor thin profit abroad to gain market share. Domestically, they would also introduce zillions of new products and product variants to see which ones proved popular.

    The Japanese also had a strong prejudice against selling domestic firms at all, much the less to foreigners, until the post-bubble collapse forced them to at least tolerate mergers. The inability of foreign firms to buy their way in (and to hire decent local staff, given the earlier lifetime employment system) was yet another obstacle to foreigners getting much of a foothold.

    And culturally, Japan is about as close to a socialist country as you get in terms of its philosophy on income distribution. The formal safety nets are not strong, but disparity of wages is low. For example, in the low-growth post bubble era, there has been tremendous wage compression. The top corporate types in Japan were never paid spectacularly by Western standards. My Japanese sources tell me there is now pretty much no increase in take home pay once you hit 40, which is a change from the past (the very top guys still get nice perks, however).

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