More Keynes in China rather than in the US?

January 20, 2009

On the historical day of Obama’s inauguration as the first African-American and most rhetorically talented US president, the United States braces itself for a one trillion US$ stimulus package and years of excessive government debt, in the name of a Keynesian policy approach to stimulate demand. In this context, the analysis of Finance Professor Michael Pettis comes in very handy. Pettis, who runs a brilliant blog on Chinese finance, is based in Beijing and has written extensively on the global imbalances that have now started destabilizing the world economy. Among others he analyzed the “chimeric” global macroeconomic imbalance based on an excessive current-account surplus supporting China’s export-oriented economy vs. an excessive deficit fuelling the US’s recent consumption and private borrowing binge. In an article in the Financial Times back in December, he warns:

“There are three ways the system can adjust. One way is for the underlying global imbalances to remain in place. (…)”

“The second way is for trade-surplus countries to engineer sharp increases in domestic consumption, most likely though massive fiscal expansion, that match the decline in US household consumption and so reduce the overcapacity problem. (…)”

But he argues that both are either not feasible or not likely. Therefore:

“That leaves one other way to adjust – a sharp decline in global production, with massive factory bankruptcies to end overcapacity. The burden of the adjustment will fall on trade-surplus countries, unless trade-deficit countries are willing to absorb a large part of it.”

Pettis takes his argument further in a longer article in the current edition of the Far Eastern Economic Revue (subscription required). He likens today’s China with the US in the 1930s when the Depression set in. The US was the world’s main supplier of capital, but, as a response to the crisis unleashed in 1929, contracted consumption and sought to support production (i.e. supply), not least through protectionism. This was a recipe for disaster. This is also why Keynes developed the view that in a slump, economies must inject money into the economy to keep demand afloat. But in today’s case in the US, Pettis thinks that:

“This is not what Keynes would have recommended. If declining U.S. private consumption is met with increasing public consumption, the world will simply continue playing the game that has already led into so much trouble. The only difference would be that instead of having one side of the global imbalance accommodated by private overconsumption and rising debt [as has been the case so far], it would be accommodated by public overconsumption and rising debt”.

Pettis fuerther adds:

“Might China and smaller Asian countries repeat the U.S. mistake of the 1930s? Perhaps. Beijing already seems to be in the process of defending its ability to export overcapacity. Although there has been an attempt to boost fiscal spending, most analysts argue that this so far has been too feeble to matter much. On the other hand it has tried to protect an and strengthen its export sector by lowering the financing costs for producers and have little impact on consumers.”

Outlook?

“In order to make the transition [to a more balanced global economy] workable and avoid trade friction, the world’s major economies must engineer a joint program of fiscal expansion”

But:

“The problem is that U.S. (and European) demand contraction is occurring at a shockingly rapid pace. There is a real risk that the adjustment process in China will careen out of control […] If major economies focus only on domestic adjustment, China will almost certainly choose the path of defending its ability to export overcapacity onto the rest of the world, while the trade-deficit countries [i.e. mainly the US] will discover the expansionary impact of trade constraints [i.e. protectionism]. In that case it is hard to imagine how China and the world can avoid disaster.”

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One Response to “More Keynes in China rather than in the US?”

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