Wallets and borders must open

Policymakers should seize economic opportunities rather than engage in endless debates about the Stability and Growth Pact and…

Policymakers should seize economic opportunities rather than engage in endless debates about the Stability and Growth Pact and fears over the European Constitution, writes Danny McCoy.

One of the most remarkable - but least commented upon in the mainstream media - aspects of the current juncture, is that the world's largest economy, the US, is borrowing heavily on international capital markets, while developing nations in particular are significant net savers. This would appear to, and ultimately does, defy a basic premise that nations with demonstrable developmental needs should be net borrowers from the more prosperous nations of the world. But we live in fairly abnormal times, no where more evident than the low interest rates that permeate international capital markets.

The world economy has gone through tumultuous events in the last eight years ranging from the contagion financial crises in Asia in 1997/98, the boom and bust in the stock markets around 2000 and the erosion in international confidence that geo-political tensions have brought forth that included the spectre, until quite recently, of widespread deflation that in turn encouraged a response to drive interest rates to generational lows.

US consumers drove their savings down to historical lows during the upswing of the 1990s and then continued on spending after the dip - acting as an importer of the last resort when others' pessimism appeared to have ratcheted up savings in spite of the poor returns that low interest rates were reflecting.

READ MORE

The US has been an engine of growth internationally during the last decade, with China now revving up to support the efforts more recently. The euro area and Japan have been noticeable by their absence in providing a much needed injection of growth, with domestic demand in both regions being particularly poor and an over reliance in either case on benefiting from world trade. While the US is running what everyone seems to suggest is an unsustainable deficit on its current account of the balance of payments, its counter-party is that others are running surpluses implying a build-up of assets which are in effect liabilities for the US.

If it were the case that other industrial countries were supplying the liquidity it may be readily understandable, given the presence of unfavourable demographic trends relative to the US and lack of investment opportunities, it would still amount to a global imbalance. However, given that developing nations are running surpluses something is more seriously amiss.

The glut of global savings continues to pour into the US and is becoming not just a problem for the US but for the whole world. The old adage of owe the bank a thousand it's your problem, owe them a million it's theirs can be turned around here. Being holders of US assets makes the wealth effect of one correction channel - a falling dollar - a problem for all countries in surplus positions. Ireland is a modest deficit nation in this regard but still not immune to how these global imbalances are likely to unfold.

Countries that are in receipt of long-term capital inflows, which should include by definition all developing countries, should move towards current account deficits in their balance of payments if a global adjustment is to occur.

Adjustment ultimately will be a two-way street. Tendencies to blame the other party is rife, be it disapproving European voices of the US's apparent profligate behaviour or US finger wagging at China stealing a trade march by an undervalued currency. No doubt the US must reduce its domestic consumption demand, both by its consumers and government, otherwise its economy will be ironically increasingly foreign owned at a time when most political commentators worry about its global expansion ambitions. Savings must rise in the US but not only a reduction in output demand is required, there must also be a shift to tradeable goods and services. Many predict that such a shift will come about from a sharp dollar depreciation through the trade channel making US exports cheaper and foreign imports dearer.

It is here that the rest of the world must step up to the mark. China and many other Asian economies need to allow their exchange rates to adjust to take the burden while European and Japan need to substantially raise domestic demand.

Focusing on Europe - the signs here are not encouraging. The euro area has witnessed five years of sluggish growth with interminable debates about the arcane features of the Stability and Growth Pact limiting fiscal stimulatory options and fears stoked up in pursuit of worthless piety over the terms of a constitution that engenders despair or at best apathy within the population about the ability of policymakers to view the wider global picture.

Never missing an opportunity to miss an opportunity appears to be the order of the day in not seizing the opportunity to advance the EU services directive when the world and his mother says that the destiny of the wealthier global blocks are in this domain and not in manufacturing. Migration is another potential boon if harnessed positively but is typically perceived as a threat.

Europe is fearful when it should be confident. Productivity per hour worked is on a par and in some countries well ahead of the acclaimed US model. The gap in output is that Europe has ended up working less hours. The question is this by choice or the deliverance of the social model? On the week after the US trade deficit came in at $55 billion for a single month encouraging yet more hand wringing this side of the Atlantic, European MEPs voted to restrict flexibility in hours worked in all its member states.

The disconnect continues. Global balancing needs multilateral co-operation and that ultimately requires showing up rather than resorting to the fortress mentality. For the developing world, this is where Europe can show the global leadership it so craves. Start at home and open up both our wallets and borders.

Danny McCoy is a senior economist at the Economic and Social Research Institute