Rich countries should be forced to spend money in poor countries, professor George Irvin argues in a new article. The idea of forcing surplus counties to spend money in deficit countries was first introduced by John Maynard Keynes at Bretton Woods in 1944.
“A new euro zone economic structure which provided it with a Federal Treasury could capture such surpluses and direct them towards an extended solidarity fund.”
Force surplus countries to spend money in deficit countries. Recycling trade surpluses is a win-win game. Alternatively, insisting on budgetary balance will almost certainly lead to prolonged recession with high social costs, professor Irvin writes in a recent article.
The article was first published by The Guardian on Saturday, March 13th.
Here’s the full transcript:
How is the global economy to be rebalanced? Is there a distinction worth making between Chinese and German mercantilism? One can argue that China’s astonishing growth has sucked in other countries’ imports while lifting millions out of poverty. But growth continues to be export-led, and the Central Bank of China has accumulated the world’s largest stash of dollar-denominated assets. Germany runs an even larger current account surplus, but much of it is recycled into buying companies in the US and elsewhere.
Is exchange rate adjustment the answer? While the US Congress seems to believe so, a large revaluation would in practice serve nobody’s interests. Chinese export-driven growth rate would slow, and Americans would find themselves poorer in real terms having to buy dearer goods at Wal-Mart.
In the EU, things are slightly different because the euro has appreciated strongly against the dollar. But appreciation has had only had a marginal effect on Germany’s surplus; Germans have accepted slower wage growth as a price worth paying for the prize of being the world’s leading exporter. By any measure, exchange rate adjustment – even allowing for lags – seems to have done little to re balance the world economy.
The financial crisis has complicated matters, with fiscal deficits growing alarmingly. The German response to resulting downward pressure on the euro has been to insist that all countries should balance the books like Germany. But as Martin Wolf correctly observes: “Germany is in a trap of its own devising. It wants its neighbors to be as like itself as possible. They cannot be, because its deficient domestic demand cannot be universalized”.
In macroeconomics, the basic savings identity says that the sum of the private sector surplus (of savings over spending) and of government’s fiscal deficit must equal the current account (or external) balance. Thus, if a country is in approximate external balance, but an external shock like the credit crisis leads to a sudden increase in the private sector surplus, this must be mirrored by a similar increase in the fiscal deficit. In plain English, as the private sector pays off its debts by spending less, this is reflected by an increase in public sector spending.
There are only two ways out: the first is getting the private sector to start spending again and the second is for net exports to expand rapidly. The problem with the first solution is that, by definition, private consumption falls in a credit crunch; in consequence, business confidence falls dragging down private investment.
The problem with the second solution is slightly more complex and involves what philosophers call the “fallacy of composition”. While one country may be able to boost its exports, all countries taken together cannot. Because my exports are your imports, everyone trying to boost their exports simultaneously by means of, say, currency devaluation leads to a 1930s style “beggar my neighbor” result. This is broadly the logical flaw of those who argue that Britain was fortunate in not joining the euro and retaining its own currency.
What of the weaker members of a currency union, eg Greece and the “Club Med” countries? The German solution, currently dressed up as a debate about the merits of a European Monetary Fund (EMF), is for all countries to adhere to strict fiscal discipline and slash the public deficit. The EMF in its present guise is simply another version of the EU stability and growth pact. This “solution” only works through cutting the real wage and driving down national income to such a degree that the private sector surplus falls and imports contract drastically – ie though expenditure cutting rather than expenditure switching. The rub is of course that were a number of euro zone countries forced to adjust in this way, Germany’s current account surplus would contract.
Is there another answer? John Maynard Keynes proposed a perfectly sensible solution at Bretton Woods in 1944, namely, forcing surplus countries to spend their extra money in deficit countries, thus both their private spending and export capacity. The “Keynes solution” as is has been dubbed by the US economist Paul Davidson, was unfortunately vetoed by the Americans. In fairness, one must add that America rechannelled part of its surplus at the time into the Marshall Plan, thus enabling Europe to grow and to overcome its deficit.
Under such a scheme applied to the euro zone, the EMF would use the German euro surplus to create new sources of income and jobs in the Club Med countries, thus raising their ability to buy future German exports. In the absence of an EMF, a new euro zone economic structure which provided it with a Federal Treasury could capture such surpluses and direct them towards an ‘extended’ solidarity fund.
Too idealistic? Not at all. Just as Keynes and Marshall recognized that the failure to reflate Europe after the war might be catastrophic for the west as a whole, so Germany should draw the same lesson today – just as China now seems to be recognizing that the new mercantilism leads nowhere. Recycling trade surpluses is a win-win game.
Alternatively, insisting on budgetary balance will almost certainly lead to prolonged recession with high social costs.
By George Irvin
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