Last Updated 22 Jun 2020

Global Financial Imbalances Essay

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Global Financial Imbalances Essay – How the arrangements of global trade act as a driver of global imbalances
Abstract

This paper looks at the different factors causing trade imbalance on the global trade arena. This global financial imbalances essay identifies the different factors that affect the global trade imbalances of trade as envisioned in the global trade agreements. The findings reveal that there is need for countries to look into better ways of ensuring that a level playing field is provided for all and proper mechanisms enacted to ensure that no member state flouts the rules and policies.

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Introduction

Pettis (2013, p. 65) claims that trade is a very controversial issue around the world because many people hold the perception that trade agreements and even trade itself undermines some human rights like labour rights, and even affordable medicine in some cases.

Many international institutions have emerged to act as a means for countries to foster new economic order. Some of the institutions include bodies like World Trade Organisation which has eventually replaced the General Agreement on Tariffs and Trade to help reduce trade tariffs; the European Union (EU), the North American Free Trade Agreement (NAFTA) and the Asian Pacific Economic Cooperation Group (APEC). These trade agreements are being formed to help regions integrate and enable smooth trading among the trading partners. In addition to the aforementioned regional trade agreements, countries are still negotiating other bilateral trade agreements in all parts of the world. (Rebucci et al 2009, p.44).

All these efforts are being directed at liberalising the world economy in order to ensure smooth flow of goods and services in the global market. This liberalisation of trade and investment around the globe has made a large contribution to an increase in global trade volumes, portfolio investment and foreign direct investments, all of which have made significant impacts on the member countries. Despite all the advantages that accompany neoliberalism, it has flaws because it has created trade imbalances in the member states.

Liberalisation of trade has been appealing to states because of the logic of comparative advantage as it relocates the factors of production to areas where they would yield a greater advantage through subjection to international competition and trade. This is what guided the formation of associations like World Trade Organisation and the European Union. However, this is part of the causative agents for global trade imbalance because the international economy and the financial system are increasingly becoming vulnerable to the policies of the surplus countries as some countries intentionally refuse to play along the rules of liberalisation (Koo 2011, p. 77).

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Global Financial imbalances

Liberalisation of trade is pursued by states because it defends international mobility of investment in sites of production, free trade, trade and financial liberalisation in services. Therefore economic efficiency lies in the increase in specialisation in production and circulation of goods and services, and reallocation of capital in the global market. However, the recession being suffered by the developed states has leftthe future of trade liberalisation in the balance as these countries may decide to opt for protectionism in order to shield their economies from such adverse effects (Fardoust et al 2011, p. 54).

In contrast to the situation in 2008, countries now have some tools which they can use to mitigate the renewed economic downtown which increases the chances of it generating into a recessionIf the economic downtown continues then the protectionist pressure is likely to increase. However Koo (2011, p. 19) asserts that the first countries that will erect trade barriers to cushion themselves against economic downtown will obviously be blamed for the eventual damage that will be made to the global trading system. However, the countries that will be more responsible for this are the ones that skew their industrial structures, exchange rate policies and tax systems to gain competitive advantage.

The irony of this scenario is that the governments that are most dependent on the free trade i.e. the ones that produce more commodities than they can consume will be the biggest hindrance to the sustainable recovery of the global economy (Pettis 2013, p. 55). It is therefore advisable for these countries to change course before it is too late for them to act, or else they will suffer adversely if other governments decide to erect new trade barriers because it will affect their market segments.

The countries with surplus production have a tendency of exhorting the governments with deficits to live within their means, pay their debts and save more. However the real challenge facing the global economy is the acute lack of aggregate demand. The globe is already awash with savings but profitable investment opportunities are very minimal which manifests itself in the weakness of consumption (Morrison et al 2007, p. 31).

The implication for this is that saving more is not a solution to the countries with trade deficits. Indeed saving more will be extremely disastrous as it will reduce consumption. Reducing consumption will depress investment because households will no longer be buying more and as a consequence, aggravate the fiscal problems. If the governments with big trade deficits opt to save more, then those with surplus will be forced to spend more and save less.

Fund (2010, p. 66) claims that the weakness of domestic demand in the United Kingdom, United States and the rest of the Eurozone is grossly affecting the global demand but there is nothing to offset it. The governments with big surpluses like Japan, Germany and China are not doing anything to help ease the contraction in demand elsewhere. Such a situation is fraught with risks because for the world to continue enjoying the benefits of global trade and finance, then there must be a mechanism for unwinding the global trade imbalances. This then leads the discussion to the definition of trade imbalance in order to be able to identify its causes and effects.

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What is trade imbalance?

Duncan (2013, p.65) defines trade balance of a government as a reflection of what it spends less what it produces. A country has a trade surplus if its income exceeds its expenditure which enables it to lend the surplus to the countries where their expenditures exceed their income. In so doing these countries are able to accumulate international assets. The countries with a deficit on the other hand are on the flipside of this as they spend more than their income and have to borrow from the governments with surpluses to cover for the difference. However, in the process of covering their difference, they end up accumulating international debts or liabilities. Surplus economies are dependent on the deficit economies just like the deficit economies are dependent on the surplus economies which imply that there is a mutual relationship of dependency. Therefore it is not possible for all governments to run in surpluses or deficits as both must be in existence for the relationship to subsist. This then leads to the question of whether trade imbalances are sustainable or not.

Trade imbalances and the eventual capital flows between governments are not necessarily the problem. The fast ageing wealthy governments often have excess savings which enables them to make investments in economies with insufficient savings to meet their investment needs (Duncan 2013, p.90). Historically, this meant putting more investments in the rapidly developing economies.

As long as the current account deficits remain modest and governments invest the surplus in ways that promote economic growth, then such imbalances are sustainable. However, the current trade imbalances around the world are of a different type (Hall et al 2011, p. 70). They are much bigger than was ever anticipated. For instance the most serious is that between China and the United States where China is still maintaining a huge trade surplus with the United States. Most of the other trade imbalances are between economies with the same levels of development, for example Japan and the United States, and between the Eurozone members. Such imbalances are far from benign as they destabilize the flow of capital between economies. For instance the 2007 global financial crisis and the resultant Eurozone crisis were caused by capital flaws between countries (Haddad and, Shepherd 2011, p. 43).

The banks that were overleveraged made matters worse as they further amplified the crisis. However, the underlying reason for the capital outflows was economies with surpluses seeking higher returns. The surplus economies like the United Kingdom, United States and the rest of the Eurozone failed to find productive uses for their surpluses. Instead of boosting productivity, the inflow investments ended up raising assets prices leading to excessive borrowing by the households.

The trade imbalances survived both crisis and are even growing again at high levels. However, this is not sustainable. Unlike in the period preceding the 2007 crisis, the current deficit has nothing to do with excess demand in the economies with deficit. It is occurring against a backdrop of stagnation and a decrease in the living standards of these economies. Firms and households of the deficit economies are even saving more and there is no offsetting decline in savings in the private sector within the economies with surpluses (Chen et al 2012, p. 47). Against such kind of economic activities, the trade deficits constitute a major hindrance to economic activities as they reduce employment and demand and as a consequence forces governments to intervene by running huge fiscal deficits. The external demand that the surplus economies rely on is heavily dependent on unsustainable policies in the economies with deficits.

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Theoretical foundation – Unger: institutional arrangements and outcomes

Roberto Unger proposes an institutional arrangement for the organisation of civil societies, democracies and market economies. He claims that neo-liberalisation of trade is based on theory of comparative advantage that is too partial. It is this partiality that has created global trade imbalances. Roberto Unger argues that the current model of comparative advantage used for free trade arguments is not only partial but is also incomplete and empirically inaccurate to permit the formulation of global business policies. His major concern is the trade policies and designs of the global trading systems which he thinks are inherently designed to create trade imbalances (Claessens, et al 2010, p.81).

The theory of comparative advantage is incomplete because it has as a premise the existence of an established comparative advantage. The comparative advantage in the real world is a function of a complex array of economic, social, and political factors. As such it is not possible to determine a case for free trade until fully taking into account the manner in which these factors interact to create the regime of an economy. It is these differences relative to unit costs across countries that create comparative advantage.

Different trade agreements often have an effect on the patterns of advantage that an economy can develop and then eventual gains it can attain from free trade. In addition to this, the trade theories often find that multiple world equilibriums exists both in the presence of increasing returns and scale economies as well as the conventional return models (Unger 2005, p. 89). Whichever of these equilibriums the global economy leads a country into affects the aggregate efficiency and distribution of the gains from trade across nations.

In the process of selecting equilibrium, broader political and social processes are likely to play a significant role. Only once the effects of trade restrictions on social and political forces have been determined and the eventual selection of an equilibrium made, can a definitive case for or against liberal trade policies be made. This is the reason why Unger proposed the development of a more complex theory of trade premised on a set of basic ideas that play analogous role for labelling the assumptions of a formal model. Without the formal model that takes into account all the factors that affect equilibrium, then the trade imbalances will continue to exist.

Other Causes of Trade Imbalance

Some countries like China are fuelling imbalance in the global economy by devaluing the Yuan like the Japanese did 26 years ago (Aaronson & Zimmerman 2008, p.81). The country is accused of intentionally devaluing its exchange rates. Although it is not easy to accurately calculate the exchange rate of the Yuan, economists believe it is undervalued by up to 40% and consensus indicate that the policy of China of stockpiling foreign exchange reserves is responsible for this (Aaronson & Zimmerman 2008, p.33).

The country has been able to use its huge trade surplus to buy US currency and treasuries in order to maintain a high demand for the US Dollar and make the Yuan appear relatively cheap. This raises the price competitiveness of China against the United States. Acts of money intervention by China to create trade imbalance is deliberate as it spends a lot of money in the market to keep the Yuan undervalued.

This market interference by China is fuelling trade deficits in the United States because American companies are forced to outsource jobs to China in order to be able to enjoy cheap labour (Claessens, Evenett & Hoekman 2010, p. 64). The purchasing power of the Chinese is equally suppressed because they are less able to afford foreign products and increase their living standards. This makes it hard for foreign companies to sell their products in the country because the weak Yuan renders them expensive for the average Chinese consumer.

The manipulation of trade by China is also fuelling overconsumption in the United States by buying up government treasuries. The artificial suppression of the value of Yuan allows the treasury department to lower the long term interest rates. This fuels the western and American debt, over consumption and ensures that the demand for the Chinese exports is sustained. Although such a practice is not illegal, it creates imbalance in the global trade arena. Although the East and China have played a major role in the provision of attractively priced commodities and financing the western debts, the west has also been responsible for the creation of trade imbalance owing to their inability to control their over consumption (Berger and Nitsch 2010, p. 62).

Other than the manipulation of currency by China, the country also supresses labour rights thus lowering the costs of production in the country. The repression of labour by the Chinese government has lowered the manufacturing wages of the workers by approximately 47% to 86% (Chen et al 2012, p.86). The country also provides huge direct export subsidies to its major industries in order to boost production for the export market.

Finally, China maintains strict non-tariff barriers to imports. This has ensured that the country maintains trade imbalance with other countries and as at 2011 the Chinese exports to the US were more than four times what the United States exported to China. This trade imbalance from China was further enhanced partly when the country was accepted into the World Trade Organisation without inclusion of a clause to improve the environmental standards and the labour conditions. The entry of China into the economic playing field has further worsened things for the domestic workers in the United States in favour of the multinational companies working in China.

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Conclusion

This essay has identified the different factors affecting the balance of trade on the international arena. Some countries are deliberately carrying out actions to influence the balance of trade in their favour at the expense of the other partners. Although there are countries that are interfering with the global balance provided by the international market, there is need for countries to look into better ways of ensuring that a good business environment is provided for all and proper mechanisms enacted to ensure that no member state flouts the rules and policies

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References

Aaronson, S. A., & Zimmerman, J. M. (2008). Trade imbalance: The struggle to weigh human rights concerns in trade policymaking. New York, N.Y., : Cambridge University Press.
Berger, H., Nitsch, V., & International Monetary Fund. (2010). The Euro?s Effect on Trade Imbalances. Washington, D.C: International Monetary Fund.
Chen, R., Milesi-Ferretti, G.-M., Tressel, T., International Monetary Fund., & International Monetary Fund. (2012). External imbalances in the Euro area. Washington, D.C.: International Monetary Fund.
Claessens, S., Evenett, S. J., & Hoekman, B. M. (2010). Rebalancing the global economy: A primer for policymaking. London: Centre for Economic Policy Research.
Duncan, R. (2013). The dollar crisis: Causes, consequences, cures. Hoboken, N.J: Wiley.
Fund, I. M. (2010). European Financial Linkages. Washington: International Monetary Fund.
Haddad, M., Shepherd, B., & World Bank. (2011). Managing openness: Trade and outward-oriented growth after the crisis. Washington, D.C: World Bank.
Hall, P. V., McCalla, R. J., Comtois, C., & Slack, B. (2011). Integrating seaports and trade corridors. Farnham, Surrey: Ashgate.
Koo, R. C. (2011). The Holy Grail of Macroeconomics: Lessons from Japans Great Recession. Hoboken: John Wiley & Sons.
Korea-World Bank High Level Conference on Post-Crisis Growth and Development, Fardoust, S., Kim, Y., Sepulveda, C. P., World Bank., & Taeoe Kyo?ngje Cho?ngch’aek Yo?n’guwo?n (Korea). (2011). Postcrisis growth and development: A development agenda for the G-20. Washington, D.C: World Bank.
Morrison, C. E., Pedrosa, E., Pacific Economic Cooperation Council., APEC Business Advisory Council., & Institute of Southeast Asian Studies. (2007). An APEC trade agenda?: The political economy of a free trade area of the Asia-Pacific. Singapore: Institute of Southeast Asian Studies.
Pettis, M. (2013). The great rebalancing: Trade, conflict, and the perilous road ahead for the world economy. Princeton: Princeton University Press.
Rebucci, A., Batini, N., Cova, P., & Pisani, M. (2009). Global Imbalances. Washington: International Monetary Fund.
Unger, R. M. (2005). What should the Left propose?. London: Verso.

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