The Political Economy of Recovery and Rebalancing

Jeffry Frieden, Professor of Government at Harvard, has a new Council of Foreign Relations working paper “Global Imbalances, National Rebalancing, and the Political Economy of Recovery” :

Global macroeconomic imbalances — massive borrowing by some countries and massive lending by others — drove the financial boom and bubble that eventually burst into the current crisis. There is now nearly universal agreement that such imbalances cannot be sustained, and that the former deficit and surplus nations need to move toward macroeconomic balance.

However, rebalancing requires a fundamental reorientation of some of the world’s major economies, a reorientation that will lead to major economic, social, and political tensions. Foreign borrowing by the deficit countries fed an orgy of consumption that was wildly popular so long as it continued; but the accumulated foreign debt that has resulted will now begin to impose sacrifices that will be just as wildly unpopular. Nations that have relied on foreign borrowing to fuel government and household spending will have to cut back drastically. They face a reduction in real wages, in consumption, in the standard of living. At the same time, nations that have relied on exports as the engine of economic growth will have to figure out how to power their economies without relying on foreign
markets. These political economies dominated by powerful export interests face fundamental challenges to those interests, as their export orientation may no longer be sustainable.
In deficit and surplus nations alike, the attempt to adjust to a new international economic reality will almost certainly lead to major conflicts within nations and among nations. What are these conflicts likely to be, and what do they say about prospects for the future? For guidance, one turns to history and theory. First, this paper reviews some of the extensive historical record on how the world
economy, and the countries within it, has attempted to redress macroeconomic imbalances. Then it explores what theory says about the adjustments necessary to rebalance, and how this is likely to play out in national and international political economies.

For some related commentary, see our joint work in this examination of the causes of the ongoing financial and economic crisis in this post (and this article).

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20 thoughts on “The Political Economy of Recovery and Rebalancing

  1. Get Rid of the Fed

    “Nations that have relied on foreign borrowing to fuel government and household spending will have to cut back drastically.”

    I don’t believe that is quite right. Is it more likely that the central bankers and the rich in the high wage countries and low wage countries want the lower and middle class (and if necessary their gov’ts) in the high wage countries to go further into debt (loans based on currency) to prevent price deflation from cheap labor and positive productivity growth so they can “trick” the lower and middle class in the high wage countries into working longer and being debt slaves?

  2. Get Rid of the Fed

    “They face a reduction in real wages, in consumption, in the standard of living.”

    Isn’t that what the fed wants, to drive wages and standards of living in the high wage countries down to the chinese level without asset prices of their rich friends going down?

    That way the rich can own all the assets and make the rest of the people lifelong rentiers?

  3. Drewfus

    Global macroeconomic imbalances — massive borrowing by some countries and massive lending by others — drove the financial boom and bubble that eventually burst into the current crisis.

    So what drove the global imbalances?

  4. purple

    They face a reduction in real wages, in consumption, in the standard of living.
    The author means working class people face these things. We know billionaires and the ‘elite’ won’t.

  5. Anonymous

    “Isn’t that what the fed wants, to drive wages and standards of living in the high wage countries down to the chinese level without asset prices of their rich friends going down?”
    In a word, “no”.

  6. RicardoZ

    Jeffery Frieden writes:
    The more exposed citizens feel to the dangers these transformations entail, the more likely they are to attempt to shift the adjustment burden onto others, at home or abroad. One way to facilitate a more orderly rebalancing, then, would be to enhance the panoply of compensation mechanisms, social safety nets, and adjustment assistance available to those liable to be hardest hit by the process of rebalancing. Governments that provide adequate assistance to those who will be harmed, or who fear they will be harmed, by global economic trends thereby reduce the risks associated with rapid economic change. This will not be easy, especially as deficit countries emerge from the crisis with even greater debt burdens than when they entered, but the alternative to compensating the dissatisfied socially is confronting them politicallynever an enviable prospect.
    Most analysis of this type is focused on the borrower and such phrases as “orgy of consumption” are intended to vilify the borrower while the analysis almost totally ignores the lender. In truth the lenders are looking for the best return on their investment so they seek the strongest economy with the greatest potential for growth. This is why the supply side model recognizes that contracting economies tend to export bonds while growing economies tend to import goods.
    This kind of analysis flies in the face of the modern sentiments and is usually prejudically rejected without clear thought. This is actually no problem until authorities begin to attempt to “fix” the problem.
    The IMF is the most dangerous institution in the world when it comes to these fixes. The IMF formula is 1. borrow from the major banks in the world, most in New York City, 2. increase social spending, 3. raise taxes to pay for the social spending and the borrowing.
    Frieden give us few suggestions of how to solve the “problem” he has discovered, but notice the solution quoted above (2. on the IMF hit parade). It appears that Marx was wrong to call religion the “opium of the people.” As Frieden points out governmental sending on social programs is actually the “opium of the people.”

  7. MarkS

    Its interesting to note that massive currency depreciation by itself is insufficient to rebalance trade. Access to markets is also necessary. Contracting market access in the 1930′s for deficit economies lead to totalitarianism, agression and war. Expanding international markets during the 1980′s allowed trade rebalancing in Latin America with less tragic results.
    Conclusion? The obvious- International markets have to remain open for trade finance to come into balance. If markets shrink, trade balance becomes more difficult and the risk of totalitarianism, international conflict or war increases.

  8. Get Rid of the Fed

    Anonymous post said: “Isn’t that what the fed wants, to drive wages and standards of living in the high wage countries down to the chinese level without asset prices of their rich friends going down?”

    In a word, “no”.

    Why not and imo isn’t that what is happening?

  9. Get Rid of the Fed

    MarkS said: “Conclusion? The obvious- International markets have to remain open for trade finance to come into balance. If markets shrink, trade balance becomes more difficult and the risk of totalitarianism, international conflict or war increases.”

    What if the global labor market is oversupplied, most goods globally are oversupplied, and there is too much debt globally?

    Was the goods market mostly oversupplied in the 1930′s globally vs. not so much in the 1980′s?

  10. Mike Laird

    This whole notion of “imbalances” is a rat hole – down which a lot of smart minds have been sucked for no good result. Macroeconomics talks about complex systems, hence they are always in balance. They are complex and non-linear so they exhibit behavior that is a surprise to some “linearly-oriented” folks, but economic systems are always in balance.

  11. Mark G.

    “Global macroeconomic imbalances — massive borrowing by some countries and massive lending by others — drove the financial boom and bubble that eventually burst into the current crisis”
    ”””””””’
    Caused by Greenspan and now Bernanke.

  12. ppcm

    The essence of the globalisation is driving a world pauperization of the working classes in the industrialised countries.
    This phenomenom is not new as it occurred in Europe at several occasions throughout the industrialisation process (Napoleon III in France).
    The agricultural world left the farms in hope of getting better reward for their works in the plants.
    The new comers were asking for lower wages. throughout this process lowering the average pay,introducing a more competitive labour market and globally lower salaries.
    Tocqueville in Memoires sur le pauperisme 1835 is highlighting the contradictions between the poor and the rich countries where the poverty gaps are more stressed in the later.
    The tenants of the liberalism will certainly be confronted to the requirements of social order.

  13. ppcm

    The essence of the globalisation is driving a world pauperization of the working classes in the industrialised countries.
    This phenomenom is not new as it occurred in Europe at several occasions throughout the industrialisation process (Napoleon III in France).
    The agricultural world left the farms in hope of getting better reward for their works in the plants.
    The new comers were asking for lower wages. throughout this process lowering the average pay,introducing a more competitive labour market and globally lower salaries.
    Tocqueville in Memoires sur le pauperisme 1835 is highlighting the contradictions between the poor and the rich countries where the poverty gaps are more stressed in the later.
    The tenants of the liberalism will certainly be confronted to the requirements of social order.

  14. tj

    Ignore the obvious. The ‘imbalances’ are one of the key drivers of wealth creation in developing countries. Had the US and others not borrowed and spent on foregin goods produced in developing countries, then developing countries would be much less developed today.

  15. Anonymous

    Nicely written article by Frieden. He would appear to be making a case for the redux of the Great Depression, reflecting a kind of emerging consensus that the effects of the crisis will be with us for a long time.

  16. Jan

    The Frieden article is a good start but too abstract. The reduction of the Canadian Federal government deficit over the 1980-1990′s is an example of how the U.S. could resolve its deficits.
    The wages of Federal public servants were frozen for roughly a decade – leading to a one third reduction in real income. The transfer of tax revenues and subsidies from the Federal to the provincial governments was significantly reduced.
    Provincial public sector expenditures were cut and the transfer of funds to municipalities was reduced. Expenditure on education and on public welfare was slashed; welfare payments were frozen; public housing expenditure was cut, physical infrastructure neglected and so on.
    While there probably is not the same level of intergovernmental transfer in the U.S. you can expect that the poorest and least politically powerful will be hit the hardest.

  17. rookie_parisian

    If emerging economies like China are going to produce more for their internal markets, as the global imbalances get corrected, then is it safe to assume that chinese corporates will be much less profitable in the future?
    Old business model : build a flat TV screen in China for 100$ and sell it to an average American worker for 500$. Pocket a 400$ profit.
    New business model : sell it to a local Chinese average worker for 120$. Pocket a 20$ profit.
    ok we should take into account foreign exchange moves (the yuan should appreciate, increasing the $ value of the profits), but still, I am not quite sure that current valuation levels for emerging markets take into account the massive change of business model that is going to take place.

  18. Tom

    There are two reasons why the unbalances are so difficult to solve. One is that the US government is badly addicted to deficit spending, and in particular to Chinese purchases of Treasuries, so the US government has very little leverage with China on trade disputes. Whenever the US talks tough on trade imbalances, China starts threatening to sell its Treasuries, and then the US gets quiet.
    The other is that Americans, especially Republicans, tend be naively optimistic about how to achieve fair trade – Americans tend to believe that by maintaining open trade policies with countries such as China that have closed trade policies, those countries will eventually “see the light”. The sort of automatic tit-for-tat response policy practiced by Europe, or globally in the field of diplomacy, works much better, in my view.

  19. Buzzcut

    Jan, very interesting comment regarding Canadian “rebalancing”. That’s exactly where I think that we need to go: massive, societal austerity.
    Okay, we don’t have the federal to state to local government transfers, but we have massive elderly entitlement transfers. How about eliminating the COLA for Social Security. Maybe even reduce SS checks a certain amount per year, say 1% per year for a decade.
    Medicare and Medicaid are ripe for cutting, as even the Obama administration has noticed.
    Real austerity would certainly involve cutting back on federal salaries. Federal employees are massively overpaid, perhaps on the order of 50%.
    Real austerity would also involve eliminating entire departments. At some point we need to decide if we can afford for the Feds to do what they’re doing. Do we really need a Department of Education? Can we afford to have one?

  20. don

    Agree with tj. China could probably benefit in the near term by forgiving past loans and then relending to build up exports. However, the imbalances would certainly come home to roost later. The other side of ‘imbalances’ is massive misallocation of resources – China produces and exports a lot of stuff in which it has no comparative advantage.
    Disagree with Mike Laird. Would you deny that there is substantial misallocation of resources now? I think this may become even more obvious when the current Chinese investments tank, as they are based on fundamentally misaligned prices created by the unvervalued renminbi. I agree there is balance in the trivial sense – as a tautology, everything is at the value or level determined by the net sum of forces acting upon it at the moment.
    Disagree with Tom. As Krugman points out, the immediate effect of a dollar crash would be massive improvement in the CA balance and a big boost to U.S. aggregate demand. The downside would be an increase in commodity prices and inflationary pressures, but we could use some inflationary pressures right about now. China and other U.S. trading partners, on the other hand, would face collapsing exports and collapsing aggregate demand (particularly the world’s biggest exporter – Germany).

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