Area Man Says "It Depends."
This is something I wrote for Most Favoured Nation, the substack of my friend, trade expert and all round good-guy, Sam Lowe. So apologies if you have already read it under that flag, but I will try to write more regularly here as well. I will also be importing some older content from my Tumblr and Medium lives in here, particularly things having to do with the politics and economics of exchange rates and globalization. This will allow gluttons for punishment the ease of one-stop shopping.
Anyway, the intent of the below piece is to take issue with the idea that trade surplus countries (such as China) always reduce growth in the rest of the world, and trade deficit countries (such as the US) always increase it, and to inject an (in my view) healthy dose of “it’s complicated” into such discussions. So here goes
One common interaction in online economics discussion involves some hapless journalist or publication saying that China has contributed X% to global growth followed by angry rejoinders that by running large trade surpluses, China is actually subtracting from growth in the rest of the world because its exports replace domestically produced goods elsewhere more than its imports support other economies.
Now, while this is true as an accounting identity, it is also little more than a truism. And the reason is that growth patterns and economic outcomes in one country spill over into the rest of the world through many more channels than just trade alone. Helpfully, this web of influences has now become a noun in standard economic commentary —the ‘spillover’.
Large economies influence growth beyond their borders not just through the simple arithmetic of trade balances but also through a range of financial channels. This includes, among other things, their impact on global interest rates, currencies, and commodity prices, each of which can affect economic activity as much as — and often more than — an excess of exports over imports in displacing domestic production elsewhere.
Market commentators do seem to recognize this about the US in particular—it is generally acknowledged that high US interest rates and dollar strength can lead to a substantial tightening of global financing conditions because the US currency is the predominant denomination for both cross-border invoicing (particularly for commodities) and cross-border borrowing. The combination of high interest rates and dollar strength can heighten financial distress in commodity-exporting emerging markets that typically have a greater portion of their debt denominated in dollars.
The classic example is the Reagan-Volcker shock of the early 1980s. As is well known, the US trade deficit expanded dramatically in the period reflecting both a tax-cut driven boom (albeit after a brutal recession), and runaway dollar strength. But while US appetite for imports eventually helped Western Europe and Japan (commodity-importing industrial economies largely indebted in their own currency), the combined impact of high US interest rates and dollar strength helped tip developing economies in South America and Eastern Europe into serial financial crises, from which some of them are yet to emerge.
And it can get even more complicated than that. The US impact on the world is not just about its trade balance (where goods imports can support production elsewhere) or even the worldwide turbulence occasioned by moves in the dollar and US interest rates. One of the most consequential shifts in the global economy over the past decade has been the US shale revolution. This not only brought the US closer to self-sufficiency in energy but also put downward pressures on global oil price. Shale helped the US recover from the 2008 financial crisis without undergoing a substantial widening of its aggregate trade deficit — something that hadn’t happened since the 1970s.
Outside the US, the fall in oil prices benefited large oil importers in Europe, Japan, and emerging Asia, easing pressures on their trade balance and on imported inflation. Falling headline inflation made space for the ECB to start quantitive easing and allowed many developing countries like India and Indonesia to withdraw fiscally expensive energy subsidies without causing undue hardship. Needless to say, the drop in oil prices was not painless—oil exporters found themselves on the wrong side of a shock in their terms of trade (the relative price of their export and import baskets)—and forced into devaluations, as happened with Nigeria.
Following from the above exposition, I would suggest that for all the indignation lobbed at China as a persistent leech on global demand (which it undoubtedly benefits from), it might make sense to look at the other ways beyond just the simple trade balance that it affects the world. Here too it makes sense to consider China’s impact beyond its borders not just through the goods balance but through a broader accounting of terms of trade (the relative price of exports and imports), exchange rates, interest rates, and broader financing conditions.
The early 2000s were famous for large US trade deficits — at about 6% of GDP, they were twice as large as what was considered alarming in 1984-85. They were also the peak years of the infamous “China Shock” that led to significant geographically concentrated job losses in areas focused on mid-tier manufacturing. But the employment shock was most damaging precisely where (and because) it was concentrated, and that the overall impact on jobs across the US was likely more one of geographic (interior to coast) and sectoral (manufacturing to services/nontradeables) reshuffling. This last is a somewhat controversial statement in some quarters, but in my opinion, not an overly outlandish one. Here is a recent summary of the debate.
And spillovers from China in other parts of the world were less severe than in the US —large exporters of sophisticated capital goods such as Germany, Japan, Korea, and France did well overall, and Chinese demand boosted global commodity prices, a boon for exporters. Critically, unlike what happened in the early 1980s, outsize US trade deficits were accompanied by a weak dollar, not a strong one, and reserve accumulation in Asia (with China leading) helped hold down global benchmark long rates.* High commodity prices and easy global financial conditions helped turn Brazil’s balance of trade around and created room for rate cuts and fiscal space for incoming President Lula’s spending programs.
I also have a more controversial take on recent developments. If one thinks that the shale revolution was a positive supply shock that benefited the global economy in aggregate, even at the expense of incumbent exporters, then China’s rapid ascent in producing technologically advanced capital goods at lower prices should look similar. Like shale, it is a terms of trade shock that benefits importers (who outnumber incumbent exporters). There are obviously immense political and (potentially) geopolitical difficulties that follow from this, but it seems to me consistent with the logic of spillovers laid out above.
Further, one of the aggregate macroeconomic effects of an influx of cheap tradable goods in a large, relatively-closed economy should be an increase in real incomes available to spend on non-tradable goods. One factor that may determine whether this leads to an actual improvement in living standards is whether non-tradable supply expands sufficiently to meet such increased demand. Yes, Anglosphere housing markets, I’m looking at you.
But even beyond that, countries with consistent excess of exports over imports typically don’t just hoard the the proceeds of their surpluses. They invest them, usually by buying something overseas, which in the modern fiat currency world is mostly the financial liabilities of other countries — though some money might be allocated to commodity stockpiles. And the acquisition of such financial liabilities often funds new activities—it could be the construction of second homes in Las Vegas or the Canary Islands (though it might also have been another runway at La Guardia or Heathrow); or a railroad line from Nairobi to Mombasa. As an aside, here are some impressions of a recent ride on this train.
The point is that the accusation of consumption foregone at one side of the trade balance arithmetic frequently has its counterpart an increase in investment on the other side (or in a third place). And the impact on global growth and welfare now and in the future will be a function of i) the quality of a trade surplus country’s overseas investment and the multipliers over time versus a counterfactual of more consumption or investment at home ii) the mechanisms to distribute the losses if the investment goes bad, and the consequences for growth of such a distribution.
My personal belief is that the second issue (loss distribution) has typically been much more problematic than the first for global growth and equity than the first. And, of course, this is a topic that has become more contentious because of differences between China and other bilateral and multilateral creditors over restructuring terms, opacity of lending etc. But South America’s lost decades from the 1980s are a reminder that the growth hit from disputes over burden-sharing long precede China’s ascent. (One dark joke I have made before is that I’m old enough to remember when Communism was associated with subjecting domestic creditors to a process of liquidation, rather than doing the same to overseas debtors).
I think the first issue — the relative merits of domestic consumption versus overseas investment — is more complicated. This is precisely because it seems very clear to me that there are massive welfare gains that could come from boosting consumption in China by increasing education and health spending in particular —this is a country where a good part of the growth impetus on coming years has to come from internal convergence. Equally, there are large parts of the world that are capital constrained, and tied project-funding from a country that has had a lot of experience in building out capital-goods intensive logistics and infrastructure may make sense, even if this occasionally is greeted with outrage. There are times when I think the new Great Game should just be called Dudgeons and Dragons. Anyway, this does seem like a disingenuous response because — with the exception of Japan in parts of Asia — no-one else seems to have been particularly inclined to provide much of this in Africa, Central Asia, or Latin America until China arrived on the scene.
Conversely (and I admit this is a reductio-ad-absurdum argument), it would be perverse to argue that it would been have been better for Saudi Arabia to pay half a billion dollars to Lionel Messi to come play football there (intermediate good import boosting domestic consumption) rather than investing that in a new green hydrogen plant somewhere. Yes, I am aware that they invested in WeWork, but still… My point is that this is a question that does not always lend itself to easy moralizing on the basis of accounting identities.
To sum up, when I’m thinking about trade balances and the larger patterns of interactions between different economies, and I’m pondering the question “is this good or bad” I can’t help but answer “it depends.” I guess that’s a personal twist on Dependency Theory.
*Long-term interest rates in the US were lower than the Federal Reserve’s target of the overnight interbank rate, a phenomenon that Fed Chair Alan Greenspan described as a “conundrum,” while noting that many observers ascribed a role in causing it to reserve accumulation by foreign central banks.
Not Much Bonus Content (though you did get at least one more bad pun here than via Sam). However.
In recent discussions of the appropriateness of the hash-brown (rather than bread) breakfast sandwich, I would like to note that a) it is a logical extension of the McGriddle b) Gluten-free for those who need it and c) leads to my amazing Indian sandwich hack—two toasted hash-browns (Trader Joe’s or Simply) topped with tomato and cucumber between two slices of bread slathered on the inside with a store-bought mint or coriander chutney on one side and mayo on the other.
A couple of years ago, I traced the fortunes of the Dollar in the era from Louvre to Rubinomics via changes in the value of the DEM bearer bonds Axel Foley found in Victor Maitland’s warehouse from Beverly Hills Cop 1 through 3. Continuing in that vein, I was recently watching The French Connection and calculated that the 500,000 USD that Alejandro Rey wanted for his heroin shipment would have been about 2.75 million FRF in 1971 (when the film was made, but only 2 million FRF by the time they got the 1975 sequel, which I have never seen. I will try to come up with similar calculations for the Gung-Ho or other strong dollar eras referenced in the body of the text.