China’s Macroeconomic Imbalances: Causes and Consequences

In recent years, China has experienced two forms of extreme macroeconomic imbalance: an expenditure imbalance in the sense of very high investment and very low consumption, giving rise to rapid capital accumulation; and an imbalance between expenditure and production, producing external imbalance, i.e. a huge surplus on the current account of the balance of payments. Both imbalances imply a low rate of time discount by both government and society: consumption in the present is forgone in favour of consumption in the future. The paper examines how these imbalances came about and goes on to consider whether they can be sustained and how they might be redressed. There is no evidence that the rapid capital accumulation has reduced the rate of profit on capital and thus the incentive to invest. However, persistent external imbalance poses a threat to investment if it generates excess liquidity and asset bubbles. The current account surplus rose remarkably in the years 2004–07. This was associated with exogenous increases in competiveness and in saving, both attributable to the economic reform policies. On current policies, the surplus is likely to rise again once the world economy recovers from its recession. This poses three sorts of problems, each of which is examined in turn: difficulties for macroeconomic stabilisation policies; risk of capital loss on the foreign exchange holdings; and the threat of retaliation by China’s trading partners. A combination of internal and external policies will be required to redress the imbalance.     

Capital liberalization and the US external imbalance

Differences in financial systems are often named as a prime candidate for the current state of global imbalances. This paper focuses on cross-country heterogeneity in access to international financial markets that derives from the presence of capital controls and argues that the process of capital liberalization over the past decades can explain a substantial fraction of US net external liabilities. We present a simple two-country model with an internationally traded bond, in which capital controls are reflected in the presence of borrowing and lending constraints on that bond. In a US versus the rest of the world (RoW) scenario, we perform experiments that are largely consistent with countries' liberalization experiences. A reduction in the RoW's controls on capital outflows and/or a tightening in the RoW's borrowing constraint enable the US economy to better insure against consumption risk relative to the rest of the world, and therefore decrease its motives for precautionary asset holdings relative to the rest of the world. As a result of these asymmetric shifts in countries' barriers to capital mobility, the US runs a long run external deficit.     

Private Foreign Investment in India: Pain or Panacea?

Private foreign capital, whose presence in Indian industry was long regarded with concern and suspicion, is now presented as a panacea for India's poor industrial and export performance. This paper examines available evidence to compare the behaviour and performance of domestic and foreign‐controlled firms in India over the last five decades. It discusses the contribution of foreign capital to aggregate investment, balance of payments and economic growth. We assess the effects of government policy towards foreign investment, review recent changes, and outline implications for the future.     

THE KALDOR-PASINETTI PROCESS RECONSIDERED(*)

In this pape we extend Pasinetti's model in two ways: (i) taking into account both direct and indirect taxation we allow the government to own explicitly part of the capital stock and to get profits; (ii) opening the economy to international trade and allowing a non-zero current/capital account balance. We show that such extensions do not violate the essential features of the Cambridge result, provided that the external rate of savings is not affected by some kind of interest rate.     

Anmerkungen zu „Irrungen und Wirrungen mit der Leistungsbilanzstatistik“ von Georg Erber

Priewe rejects several propositions: The current account balance is not a sound indicator of the competitiveness of an economy, the direct use of gross capital inflows is not pre-determined by anyone other than foreign investors, capital flows do not determine the current account balance, bilateral capital flows between member countries of the eurozone are not relevant for the balance of payment, and absolving the surplus countries and solely blaming the deficit countries for improper use of capital inflows obfuscates the fact that both surplus and deficit countries are involved in the making of imbalances. In his reply, Erber stresses that the intention of his article was to point out that the empirical facts blaming Germany for being responsible for the current eurozone crisis are not supported by the data. Furthermore, current accounts are mere accounting identities. Therefore, focussing on the current accounts alone is insufficient for identifying the causes of the euro crisis.     

MONETARY POLICY WITH INVESTMENT–SAVING IMBALANCES

Financial instability is the new challenge for monetary policy. Most studies indicate that financial crises follow prolonged unwinding of investment–saving imbalances (ISI). These phenomena are not contemplated by the standard theoretical framework of continuous intertemporal equilibrium. This paper's aim is to take a first step into the analysis of monetary policy in the context of ISI. First, a dynamic model of a flex‐price, competitive economy is presented where ISI are allowed to develop. Second, upon introducing different types of Taylor rules, some indications for the conduct of monetary policy emerge, which are at variance with the standard view.     

India and the Impossible Trinity

In the 1990s, India responded to the well‐known trilemma of macroeconomic policy by adopting an intermediate exchange rate system combined with selective capital controls. This regime enabled the country to balance exchange rate stability, exchange rate targeting and monetary autonomy, and to weather successfully various shocks that included contagion from the East Asian crisis. India's experience serves to reinforce doubts about the desirability of bipolar exchange rate regimes for developing countries as an integral element of a new international financial architecture.     

Aid and Trade Sustainability under Liberalisation in Least Developed Countries

This study investigates the effect of trade liberalisation on export growth, import growth, the trade balance and the current account of the balance of payments in 17 Least Developed Countries (LDCs) over the period 1970 to 2001. The paper also assesses the marginal relation between capital flows (e.g. aid flows) and import growth, and the trade balance and the current account of the balance of payments. The higher import growth contrasts with the more modest export growth following trade liberalisation and that has fundamental policy implications, especially for the balance of trade and the balance of payments. However, the financing and sustainability of the trade deficit in the reforming countries will depend not only on the outcome of trade liberalisation, but also on other macroeconomic policies, developments in the real exchange rate and the inflows of foreign capital.     

Trade Costs and Current Accounts

Are trade cost reductions a plausible explanation for growing global current account imbalances? I advocate that changes in trade costs affect trade and production structures, which is likely to affect national savings and investment. Explicitly adding trade costs à la Markusen and Venables into Jin's framework, this augmented model predicts that trade cost reductions affect the current account through changes in the industrial structure. Empirical evidence confirms that the interaction of trade costs and capital intensity drives current account balances. I also provide evidence that the response of current accounts to changes in trade costs depends on the capital intensity of production and on the depth of regional agreements on trade and factor mobility. Aside from the direct effect generally emphasised in standard macro‐level analysis, changes in production patterns could therefore be an additional channel of impact of regional integration on current accounts.     

What Drives India's Surge in Service Exports?

India's prowess in the service sector has been recognised the world over. Sustaining services exports is important not only to sustain India's high growth rate but also to compensate for a consistent deficit in merchandise trade and to maintain stability on the external sector. In this context, we analyse the factors of India's performance in services exports over the past three decades. The results reveal that endowment factors such as human capital, improvement in physical infrastructure and financial development are key drivers for India's surge in services exports along with world demand, exchange rate and manufacturing exports. While factors such as institutions, R&D expenditure, telecommunication, foreign direct investment and financial development significantly impact the export of modern services, traditional services exports are more dependent on infrastructure development, manufacturing exports, world demand and exchange rate. India's economic reforms in the financial sector, FDI, communication so far have helped the services exports, but India needs to focus on supply‐side factors to improve the competitiveness – and thereby volume – of services exports.     

Currency Boards and Debt Traps: Evidence from Argentina and Relevance for Estonia

This paper analyses the November 2000 liquidity crisis that brought Argentina near default on its foreign debt. The main purpose of this paper is to assess whether this crisis may be taken as a warning signal for Estonia, given the similar exchange‐rate system shared by the two countries. It seems that with a low level of public debt and a balanced budget, Estonia will not face a similar liquidity crisis as its Latin American counterpart, which remained heavily reliant on foreign borrowings. But the substantial real exchange‐rate appreciation of the kroon under the Currency‐Board Arrangement has resulted in serious external imbalances, which will need to be corrected to avoid balance of payments pressure and reduce Estonia's high dependency on the level of foreign direct investments.     

Das europäische Verfahren zur Vermeidung und Korrektur von Leistungsbilanzungleichgewichten

The Macroeconomic Imbalance Procedure (MIP) is part of a institutional framework known as the so-called “sixpack“, which has come into effect on December 13th 2011 in response to the European financial and debt crisis. The crisis has shown that internal and external imbalances (in particular current account deficits) are strongly intertwined. The MIP should identify external imbalances at an early stage and thus compel countries to correct these imbalances to forestall potential crises. Methodological questions are discussed, which are to be resolved to ensure the effectiveness of the MIP.     

Risk,external adjustment and capital flows

This paper studies the process of external adjustment. I develop an open economy model with endowment and preference shocks that can account for the empirical behavior of real exchange rates, interest rates and consumption in the U.S. and Europe. The model includes cross border holdings of bonds and equity, and financial frictions that impede international risk-sharing. I find that external adjustment following endowment shocks predominantly takes place via trade flows, consistent with the intertemporal approach to the current account. In contrast, preference shocks that change investors' risk aversion induce adjustment via the trade and valuation channels; where the latter includes the effects of unexpected capital gains and loss on existing cross border holdings and changes in the expected future return differentials between foreign assets and liabilities. The model estimates imply that the valuation channel of external adjustment is more important for the U.S. than the trade channel. Consistent with this implication, I show that forecasts of future return differentials contributed most to the volatility of the U.S. net foreign asset position in the post Bretton-Woods era.     

资本市场与国际收支:来自工业化国家的经验数据

本文从理论和经验上论证了资本市场与国际收支的关系。通过分析18个工业化国家的经验数据得出:一国如果拥有一个发达的资本市场,往往吸引较多的国外资金通过证券投资大量流入,引起资本账户顺差,与之同时往往伴随着经常账户逆差。这一结论的政策含义是:发达的资本市场是一国合理利用外资的一个重要前提;与之同时,发达的资本市场可能是一国国际收支平衡过程中实现自我调节的缓冲器。我国多年来一直保持资本账户巨额顺差,但主要是通过FDI实现的,这种格局的形成也与我国资本市场的缺陷有关。对我国而言,建设一个发达的资本市场对我国国际收支管理有着多方面的积极意义。     

On the connections between intra-temporal and intertemporal trades

This paper develops a new theory of international economics by introducing Heckscher–Ohlin features of intra-temporal trade into an intertemporal trade approach of current account. To do so, we consider a dynamic general equilibrium model with tradable sectors of different factor intensities, which allows for substitution between intertemporal trade (current account adjustment) and intra-temporal trade (goods trade). An economy's response to a shock generally involves a combination of a change in the composition of goods trade and a change in the current account. Flexible factor markets reduce the need for the current account to adjust. On the other hand, the more rigid the factor markets, the larger the size of current account adjustment relative to the volume of goods trade, and the slower the speed of adjustment of the current account towards its long-run equilibrium. We present empirical evidence consistent with the theory.     

Boom‐and‐bust Cycles,External Imbalances and the Real Exchange Rate

When the current account balance and net capital outflows do not exactly offset each other, international payment flows arise. Payment flows into a country push the real exchange rate up, payment outflows push it down. This article uses a model of optimal consumption and portfolio choice to determine the factors that drive international payment flows during boom‐and‐bust cycles. It shows that during such episodes, capital inflows first exceed the deficit on current account, strengthening the currency. Later on, when the return on domestic capital reverts to its normal level, the current account recovers, yet the overall decline of the net foreign asset position provokes a fall of the real exchange rate even below its initial level. Case studies of countries experiencing rapid economic expansions followed by economic and financial meltdowns confirm the article's theoretical predictions.     

An asset-pricing view of external adjustment

Recent literature has argued that conventional measures of external sustainability - the trade balance and current account - are misleading because they omit capital gains on net foreign asset positions. We adjust the definition of the current account to include the capital gains and discuss how this may affect our thinking about external adjustment and sustainability. We do so in the context of a two-country macro-finance model of Pavlova and Rigobon (2008a) that allows exploration of the interconnections between equilibrium portfolios and external accounts' dynamics. We calibrate the model and find that it generates several testable implications, some of which have already been validated empirically. First, we establish dynamic properties of the capital-gains adjusted current account and show that they are fundamentally different from those of the conventional current account. Second, we find that capital gains have a stabilizing effect on the trade balance and the current account. Finally, we demonstrate that in response to a shock, the conventional and the capital-gains adjusted current accounts may move in opposite directions.     

Comparative Advantage and the Gains from Financial Trade: A Reappraisal

Emerging market crises have suggested that a national benefit‐cost assessment of external financial liberalisation could well prove unfavourable. This paper re‐examines the principle of comparative advantage in its application to financial trade to seek guidance on measures that might permit a fuller realisation of the potential benefits involved. Drawing a parallel with Balasubramanyam's work on the gains from FDI and international migration we distinguish between those arising in financial trade from the net transfer of capital, and those deriving from the contemporaneous exchange of financial claims or services of equivalent value. In the first interpretation a country's comparative advantage is manifested by its role in ‘intertemporal’ trade (as a borrower or lender). Our alternative emphasis is on the contractual risk‐return characteristics of the financial claims exchanged. This perspective is applied firstly to portfolio diversification gains arising from further international stock market integration. Secondly, price risk management for developing countries in international primary commodity trade is discussed. Both applications imply the need for significant institutional development but could realise approximately contemporaneous gains reminiscent both of those involved in merchandise trade and in the skills and product (or service) flows that Balasubramanyam has emphasised in relation to FDI and international migration.     

Current Accounts in the Long Run and the Intertemporal Approach: A Panel Data Investigation

This paper is a theory‐based study of the long‐run determinants of the current account (CA). For many OECD economies after the Second World War, there has been more long‐run variation in the CA data than is emphasised by a ‘Permanent Income’ version of the intertemporal approach that is based on consumption‐smoothing and that allows only transitory CA imbalances. A theoretical model of the CA is developed, based on the ‘broader’ variant of the intertemporal approach that stresses the long‐term component of the CA. We find that some key theoretical predictions hold, while others fail, validating the approach but also pointing to its limitations.