The issue of global imbalances will be high on the agenda when G7 leaders gather in Evian-les-Bains this month. They are right to be concerned. The build-up of imbalances was also a defining feature of the years preceding the 2008 global financial crisis.
But this is not a repeat of those dynamics. Today’s imbalances are less about debt-fuelled consumer excess and more about geopolitics, industrial competition and the shifting balance of global economic power.
What are imbalances and why do they matter
The concept of ‘global imbalances’ might seem abstract, but the idea is relatively simple: it refers to persistent gaps between countries’ current account positions. This is the part of the balance of payments that covers trade in goods and services as well as investment income. Because the balance of payments must sum to zero globally, large surpluses in some economies are necessarily mirrored by large deficits elsewhere.
Imbalances are not inherently problematic. Indeed, some degree of imbalance is both natural and economically efficient. Capital should flow to economies where returns are highest. Because the capital and current accounts of the balance of payments must necessarily balance, these countries run current account deficits (since they have a surplus on the capital account). Similarly, those exporting capital run current account surpluses.
But problems arise when these imbalances become large and persistent. This is especially true for deficit economies, which depend on continued capital inflows to finance spending that exceeds their productive capacity. A reversal in these flows can create difficulties servicing external liabilities and force a painful adjustment in domestic demand.
History offers plenty of warnings. The most notable example is the 2008 crash. But large external imbalances contributed to a series of emerging market crises in the 1980s and 1990s. Intra-eurozone imbalances also culminated in the early-2010s sovereign debt crisis there.
A changing configuration
Today’s pattern of imbalances differs in important ways from that of the early 2000s. Back then, large surpluses in China, Germany, Japan and the major oil exporters were mirrored by substantial deficits in the US and parts of Europe, notably the UK, Spain and Greece.
While the US remains the world’s principal deficit economy, its external shortfall has narrowed relative to global GDP. Its current account deficit peaked at 1.6 per cent of global GDP in 2006 but was ‘only’ 0.9 per cent last year. Part of the reason is the transformation of the US into a major energy producer, which has cut energy imports and boosted energy exports. The US private sector deficit has also contracted, reflecting the fact that, unlike during the mid-2000s property bubble, American households are in aggregate no longer living well beyond their means.
But while the US’s external deficit has decreased in global terms, China’s surplus has increased, and now exceeds its pre-2008 crisis peak relative to world output. According to an adjusted measure, China’s current account surplus reached 0.8 per cent of global GDP last year, above the 0.7 per cent peak recorded in 2008.
This raises an obvious question: how can the world’s largest surplus economy (China) now run a larger surplus relative to global GDP, while the world’s largest deficit economy (the US) now runs a smaller one?
The answer lies in what has happened elsewhere. Surpluses among oil exporters, most notably Saudi Arabia, are much smaller than in the mid-2000s, partly because of the shift in the US energy balance. However, China has also moved up the value chain, taking market share from other export-oriented economies – most notably Germany and the rest of the eurozone, but also Japan and South Korea. As a result, their surpluses have diminished relative to the mid-2000s.
Why it matters
The risks associated with imbalances have therefore changed since the mid-2000s. For deficit economies, the risk of a sudden stop in capital inflows appears less acute than in the past. External deficits are generally smaller than they were in the mid-2000s and there are fewer signs of private sector financial excess.
Instead, attention has shifted away from financial vulnerabilities in deficit countries and more towards the economic implications of China’s growing export dominance and continued large surplus. Two issues stand out.
The first is the growing pressure on other surplus economies from intensifying competition with Chinese firms. Europe is particularly exposed. The loss of global export share shown in the second chart above has come across a wide range of industries, including vehicles, machinery and metals. The challenges for German industry are becoming especially pronounced.
The second concerns the geopolitical dimensions of imbalances. The backdrop today is very different from the era of globalization that defined the 1990s and 2000s. Multilateralism and integration have given way to increasing geopolitical rivalry between the US and China.
China’s growing dominance in sectors such as electric vehicles, batteries and advanced manufacturing raises questions that extend beyond economics into national security and industrial resilience. The efficiency gains from trade must now be weighed against concerns over supply-chain security and technological dependence.
Prospects for adjustment
Exchange rate adjustments have a role to play in narrowing trade imbalances. China’s real exchange rate appears undervalued, perhaps by around 10 per cent. Any successful attempt to reduce global trade imbalances is likely to require an appreciation in China’s real exchange rate. But currency moves alone are unlikely to deliver sustained rebalancing without deeper structural changes.
In China’s case, that would require a shift away from high savings and investment towards stronger household consumption. For now, there is little evidence of such a transition. China’s policy priorities remain focused on expanding industrial capacity and achieving technological self-sufficiency. While the IMF expects China’s surplus to narrow over the coming years, I suspect it is more likely to rise than fall.
But surplus economies cannot bear the burden of adjustment alone. Deficit countries must also adjust by bringing spending more closely into line with productive capacity. For the US, that ultimately means reducing the federal budget deficit through fiscal consolidation. This marks another important difference from the mid-2000s. Back then, the roots of US overspending were primarily in the private sector. Today, they stem primarily from the public sector.
