The Difficulties of Macroeconomic Coordination: A Risk of a Long Period of Su-

Par Global Growth?

Paolo Guerrieri

Professor of Economics, University of Rome ‘Sapienza’ and Vicepresident IAI

We are very far from rebalancing the world economy

It is now becoming clear that the consequences of the 2008-2009 global crisis are far

from over. The global recovery since mid-2009 has been the cyclical result of massive

stimulus combined with short-term inventory corrections. Once these factors recede, as

is already happening in many countries, economic growth is softening.

These and other factors are leading to increased talk of a global double-dip recession.

Although a double-dip recession is unlikely, process of adjustment will bring to the fore

many structural problems left over from the crisis, including weak banks and the need

for fiscal austerity, households and the need for working off debts incurred during the

credit bubble. Among these structural problems is that global imbalances are about to

rise again.

Although the recent global downturn has led to a natural rebalancing of economies, the

latest IMF estimates suggest that by 2012 the current account surpluses of developing

Asia will rise significantly, and that world current account imbalances are likely to

remain substantial through 2015. Along with the large Asian surpluses, the German and

new European surpluses will probably increase the American current account deficit

The seed of a new financial crisis?

This is very far from the rebalancing strategy agreed by the Group of 20 leading

economies as critically important for sustaining global expansion. And it is a very risky

trend since current and expected account deficits and surpluses are indeed a threat to

global macroeconomic and financial stability in the medium and longer term. The

1

2

higher imbalances themselves could sow the seeds of a new financial crisis just as they

were the fundamental cause of the last crisis. Under many respect the Great Crisis of

2008-2009 was a very visible effect of a reckless decade of increasingly unbalanced

global growth. Therefore in order to promote future stable economic growth the world

needs to move towards a balanced global economy.

Global imbalances need to be seen in the context of the shift in economic power from

the West to the East. The West – or at least countries like the US, the UK, and Spain –

need to spend less and save more. In contrast, regions like the Middle East and Asia

need to save less and spend more. What is needed globally is for both debtor and

creditor countries to rebalance their economies. The debtors need to tidy their balance

sheets, while the creditors need to bump up domestic consumption, let currencies float

and reduce export dependence. A shift in the mix of international saving and

consumption flows would be the only effective way to neutralize the imbalances. The

incentives to change are indeed very high but yet the obstacles to change are even more

formidable.

The ascendancy and changes of East Asia

There is much optimism in this post crisis era that China and the rest of Asia economic

growth will spill over and benefit the rest of the world, including the most developed

countries. The ascendancy of the East is assumed as well of being able to solve the

problem of a global rebalancing of the world economy.

In effect Asia has changed dramatically in the past decade and in the more recent

period. In the wake of the global crisis in late 2008, China and most countries of East

Asia responded with decisive and timely fiscal and monetary policy measures. Most

East Asian economies have staged a rapid recovery from late 2009 and are going to

register robust growth in 2010.

Furthermore the global economic crisis have prompted East Asian governments to

reflect on the direction of their long-run development strategies and the contours of

structural reforms in terms of the rebalancing the economy for sustained growth, the

3

development of more knowledge- and skill-intensive sectors and the recalibration of

development models.

Equally important, the crisis has generated renewed incentives for East Asian

governments to push for deeper and broader regional co-operation, particularly in the

domains of trade and financial policy management.

National attempts to recalibrate long-term development strategies have run parallel with

renewed regional efforts to achieve deeper economic integration in East Asia and to

strengthen trade and financial links within the region. Such regionalization is expected

to energize both domestic demands and trade and investment flows so to reduce the

vulnerability of East Asia to extra-regional shocks.

Too soon for Asian decoupling

As a follow up of these changes according to an optimistic scenario China and East

Asian growth would be increasingly driven by domestic demand and intra-regional

market, so that trade patterns could contribute to support a larger and deeper trade

network in the Pacific-Asia. The new course would enable a more balanced growth

since the East Asian region will be able to absorb more exports from outside, thus

easing the balance of payment problems of the United States and sustaining most East

Asian countries growth.

But that is a forecast of a future medium-long term growth. A seamless transition from

the West to the East, spurred on by the powerful dynamism of a China-centric Asia is

not more than an hope for the future. Developing Asia hasn't done enough. Most

importantly, it has failed to wean itself from the export-led growth model that has long

defined its economic character. In fact it is extremely difficult to shift growth in a short

time away from investment and export towards private consumption. In most Asian

countries, consumption and capital linked to export—key growth drivers in 2009-10—

as well as labor markets, manufacturing remain structurally tied to exports destined for

the U.S. and EU. Over 60% of Asia’s exports go to advanced economies. This, in turn,

has driven much of the investment across the region. Around 40-50% of intra-Asia trade

is meant for re-export outside of the region, and over 60% of the exports from Asian

4

Tigers, Malaysia and Thailand to China—their key export market—ultimately are

bound for the U.S. and EU. That leaves the region still very dependent on external

demand.

In particular for China, while there is much optimism that Chinese domestic demand

will spill over and benefit the rest of Asia, the country’s import data tells a more

different story. The problem is that China is still an emerging economy and faces many

challenges. These should not be underestimated. And the economic main challenge

remain to change the growth model from export-led to domestically driven.

Policies proposed by China to rebalance economic activity toward private consumption

are only the beginning of a multi-year process and need greater political will. In Asia

economies with sizeable labor forces and/or rising domestic demand—like China - will

require politically difficult structural and financial reforms and liberalization to increase

their potential growth.

A painful and prolonged pause in global growth?

As things stand today, the long-awaited global rebalancing is still very far from being

realized. The export dynamism of East Asian countries is therefore likely to continue an

is bound to pose serious threats to the countries outside of the region, especially the

United States and Europe.

Even more so since the world economy operated under a ‘market-led international

monetary system’ in which incentives incorporated in it did not induce any correction of

the imbalances. The present state of world affairs has made clear that our international

monetary arrangements have not provided a needed element of discipline either for

surplus or deficit countries.

All this underscores a potential risk for a failure in global rebalancing: a painful and

prolonged pause in the global growth dynamic. Post-crisis aftershocks are likely to

hobble demand growth in the major western developed economies for years to come.

Thanks to a profusion of asset and debt bubbles, Japanese-like outcomes are now

prevalent throughout the developed world. Even more so since debt-ridden Europe must

5

now come to grips with a fiscal consolidation that should restrain economic growth for

many years.

On the other hand persistently weak demand from the West is also a major risk to the

more open Asian emerging-market economies. The story is a simple one: the US and

other western nations have been shocked into saving more and lowering private and

public debts over the coming years. It follows that, if the world system is to function

smoothly, someone has to save less. China and the other creditor nations are now in

pole position to take the needed initiatives.

In fact surplus economies like Asian countries can go back to their potential growth rate

only if their domestic demand – especially private domestic demand – rises faster than

GDP.  But if domestic demand of the surplus countries does not grow fast enough the

resulting lack of global aggregate demand relative to supply – or equivalently the excess

of global savings  relative to investment spending – will lead to a medium term weaker

recovery at global level with most economies growing much less than their potential

growth rate.

All that could point in addition to risky and worrisome trade tensions between the West

and the East, as the former takes actions to protect hard-pressed workers while the latter

point on export-led growth as the antidote to poverty and a massive overhang of surplus

labor.

To sum up until, or unless, developing Asia is able to shift its reliance from exports and

external demand to private consumption and internal demand, it is not in a position to

take the baton of global leadership from the developed world. If, however, it fails to

make the necessary changes, it also has much to lose from a post-crisis stagnation in

external demand from the developed world.

6

The main problems of an effective coordination of economic policies

To avoid this risky trend in the paper I will sustain that policymakers should return with

renewed vigor to implement the Pittsburgh framework. At their Pittsburgh Summit in

September 2009, the G20 committed to the “Framework for strong, sustainable and

balanced growth,” a concerted effort to contain global imbalances

One should emphasize that macroeconomic cooperation is a coordination device to

overcome a collective action problem in today international macroeconomic relations.

In this regard it is important to emphasize that in terms of cooperation there is a key

difference between supply and demand policies coordination.

Coordination tasks are extraordinarily challenging, because they challenge established

patterns of economic structures and influence, both within countries and among

countries. In this perspective the Pittsburgh framework can be criticized since it

comprises many broad principles but very few specifics and enforcement mechanisms.

Although the critical success of the global crisis management response last year the

focus on better global governance is already weakening. The global imbalance issue

does not represent anymore a top priority for policymakers. National and, in the case of

Asia and particularly Europe, regional issues are again becoming predominant. The last

G20 Toronto meeting and the its low final compromise was a clear evidence of it.

In the paper I will assess the main problems of an effective coordination of

macroeconomic policies and some suggestions to favor it. The key questions is that who

will bear the burden of adjustment? How will the cost of these adjustments be

distributed, both among countries, and within countries? How do we promote the

collaboration and initiative of the main International Financial Institutions?

What is needed is global leadership. Unfortunately, both Washington, Bruxelles and

Beijing have been distracted by domestic constituencies.

7