How deficits could save global growth
The global economic engine is sputtering.
The International Monetary Fund (IMF) cut its forecast for global GDP growth in 2019. The three big drivers of the world economy — the United States, China, and Europe — are all showing signs of weakness. If they fall, observers fear, global GDP falls with them.
The thing is, repairing the world's economic engine will require doing something that might seem totally counterintuitive: National surpluses — in both fiscal budgets and trade flows — are going to need to turn into deficits for key countries.
Recent headlines have focused on distinct crises as the big threats to global growth: Think of President Trump's trade war or Brexit. These ongoing events certainly aren't helping, but they're also just flesh wounds masking a deeper injury. "The world does not look like an otherwise healthy economy hit by an idiosyncratic shock," the editors of the Financial Times recently wrote. "Rather it looks like an economy deficient in demand."
That's the thing about the nations running both budget surpluses and trade surpluses — the "twin surplus countries" as the Council of Foreign Relations' Brad Setser calls them. Running a budget surplus literally means you're reducing demand in your economy — taxing more than you're spending. Meanwhile, running a trade surplus means you're producing more than you're consuming — and relying on demand from other countries to make up the difference. Combine the two, and the "twin surplus" countries aren't just sucking demand out of their own economies, they're sucking demand out of the rest of the world as well.
Germany is the most prominent and important offender here. But others include South Korea, Sweden, Switzerland, and the Netherlands. (China is a bit of a wild card — they're running a big trade surplus, but also a fiscal deficit. We'll get back to them in a minute.)
Fortunately, as a matter of policy, the solution here should be pretty straightforward. These are all advanced economies with large welfare states and sophisticated macro-economic policymaking apparatuses. They need to spend more and tax less. As Setser points out, this spending should focus on social insurance: retirement security and pensions, health care, cash aid to families and the poor, and the like. The kind of stuff that will drive up consumption by the largest share of the population. Tax cuts should have the same focus. And a healthy dose of new infrastructure investments and public works programs would help as well.
All those policy changes will start adding demand to these countries rather than taking it away. And by running their economies hot, they'll drive up their imports and increase the value of their currencies, smoothing out their trade balances.
Of course, this will mean buildups in national debt. But South Korea, Switzerland, and Sweden control their own national currencies, in which they'd be doing all this spending and borrowing. Under those conditions, national debt loads are relatively harmless. Germany and the Netherlands are in a trickier position, since they're part of the euro currency union, which is controlled by the ultra-hawkish European Central Bank. But most everyone agrees eurozone policies largely answer to German leadership. They could get themselves the fiscal and monetary wiggle room if they wanted.
Now about China. Its situation is more nuanced.
China may be piggy-backing off other countries' demand — particularly the United States — with its trade surpluses. But it's also running budget deficits and thus adding to its domestic demand.
There are certainly different currency policy reforms China could undertake to close its trade imbalance. But China is still an up-and-coming economy in terms of living standards, with different forces pushing the value of the yuan in all directions. Even under ideal circumstances, it's not clear China would be running trade deficits. It's just that China is so huge that it still imports a ton regardless.
The IMF's solution is for China to rein in its national borrowing and tighten credit conditions within the country. But this would drag down aggregate demand and widen its trade surpluses further. The IMF ignores the fact that China's banks are mostly owned and backstopped by the national government, which again controls the domestic Chinese currency. Excessive lending by the Chinese banking system isn't going to create a financial crisis the way it could in a "market-based" system like America's.
So how should China respond? As Setzer notes, Beijing could do more on the social insurance front too. A lot of China's economic stimulus is done through credit and lending to big companies. Meanwhile, its citizens save a ton. The government could get a lot of economic bang for its buck by giving Chinese consumers more spending money through various government aid programs.
As for America, we're certainly helping out the rest of the world with our big trade deficits. But we also need more demand. That will require reforming or re-staffing the Federal Reserve to push it in a more dovish direction on interest rates. In terms of fiscal policy, anything from a big public infrastructure investment to Medicare-for-all would certainly get demand back on track.
Unfortunately, that will probably require massive Democratic victories in the next few elections. Which gets at a key point: There's no hard economic reality forcing the economic powerhouses of the world to do what they do. Their mistakes are political choices based on the blinkered ideological conviction that budget surpluses and trade surpluses are "responsible."
In truth, the former can wreck your economy. And when combined with the latter, they can drag the rest of the world down with you.