If the current account deficit matters, how can we fix it?
Last week, Jim was kind enough to let me expound my thoughts on the origins of the current account deficit, and the sustainability of large imbalances as the ones we see today.
Along these lines, Charles Engel and I at the University of Wisconsin have started a website that links to academic and policy papers on the debate over these issues — so if you’ve already seen enough of my
views, you should take a look at the alternatives represented there, including the well known BW2 view of my former UCSC Economics colleague Mike Dooley.
Otherwise, I’d like to start off the debate over what should be done. I’ve laid out my arguments in a Council on Foreign Relations
Report on “Getting Serious about the Twin Deficits”, published last week, but here, I’ll lay out my views more briefly.
- Reduce the budget deficit.
- Reduce oil imports.
- Coordinate greater exchange rate flexibility in East Asia.
Let me deal with each of these policy prescriptions in turn.
Fiscal Issues
In my previous post, I argued that U.S. fiscal policy is at the heart of the imbalance.
One can argue over the extent, but the macroeconometric models indicate between (approximately) 0.20 to 0.40 (Fed and OECD respectively). New dynamic stochastic general equilibrium models (DSGE)
models imply something between 0.20 and 0.50 (Fed’s Sigma and IMF’s GEM). In both cases, both model characteristics and the policy assumptions differ (what happens to debt to GDP, what does monetary policy
do?). Panel cross-section work by myself and Hiro Ito suggests that the coefficient is 0.20 or so,
although the standard errors bracket values as high as 0.40 (which is a value we obtain using fixed effects).
Clearly, given this viewpoint, it’s no surprise that I believe the CA deficit has to be addressed primarily by fiscal means. If the fiscal position were to swing by 6 percentage points of GDP, much like what the Clinton Administration achieved during its eight years, then this implies an improvement of between 1.2 to 3 percentage points of GDP,
which is not insignificant even as the 2005 deficit seems poised to reach about 6.3 ppt according to the Economist survey, and perhaps above 6.5 ppt according to Brad Setser.
This argument holds regardless of whether one believes in the global “savings glut”, or not.
Oil Imports
Of the deterioration in the U.S. trade balance between 2001q4 and 2005q1, 40% was accounted for by the increase in spending on petroleum imports (using BEA data, so I believe this doesn’t
include natural gas imports). You might think that the main reason to reduce oil imports is to reduce imports in general. I think in the short run that’s true; but if
one believes that macroeconomic balances (savings, investment, public sector savings) drive the evolution of the current account balance over the medium term, then reducing oil imports would in this context mean higher non-oil imports, to the first approximation.
Rather, it is that oil imports, comprising roughly 15% or more of total imports, are almost completely insensitive to fluctuations in the value of the dollar. Hence, large energy imports short-circuit the
expenditure switching effect of exchange rate movements. So, reducing oil imports enhances the ability of the tradable sector to respond to changes in the willingness of the rest-of-the-world to finance
U.S. current account deficit. In the short term it would also reduce imports and hence the rate at which foreign debt is accumulated.
How can this be accomplished? Clearly, if this were easy, it would’ve been done before. For sure, it won’t be done by having the temperature dropped a couple degrees in the White House. So we are left with
options such as taxing energy, or enforcing conservation via regulatory means. As an economist, I would certainly prefer a gasoline tax over increases in the fuel economy standards (see the CBO study on this issue), but at this point, since
policy makers have abdicated responsibility for so long on this issue, any move would be preferable to none.
Additional domestic supplies would be welcome; and certainly higher prices will elicit more domestic production. However, readers of this blog will probably know that there are serious
geological and technical impediments to increasing output rapidly. Hence, what progress will be made on this front will be primarily accomplished by way of reducing consumption.
(I’m not an energy expert, but I did attend the early meetings of the working group associated with the Vice President’s group on the National Energy Policy Development while working at the CEA, and also examined some of the macro implications of
higher energy prices, then at an astounding $21 per barrel for WTI, and $5.62 per million BTU natural gas!).
Greater Exchange Rate Flexibility in East Asia
In some ways, the first two items are easy — at least easy in the sense that they only concern domestic policy-makers. The third point requires the cooperation of foreign state actors.
Let’s first clarify why greater exchange rate flexibility is necessary. The other central banks of East Asia are managing their currencies in order to retain competitiveness with respect to
China. China in turn has pegged and now ostensibly manages its exchange rate vis a vis a currency basket, since July 21. The importance of the Chinese peg and basket is not really that it maintains the
Rmb at a low value relative to the dollar and hence accumulates dollar assets. Those who are familiar with this debate recognize that a lot of the accumulation of reserves pre-2005 was due to hot money flowing in.
(going into 2005-06 may be a separate matter). If there is greater flexibility of the Rmb, then speculation on one-way bets will decrease, and reserve accumulation will fall.
Right now, no actor has an incentive to move. With the Chinese economy cooling, the Chinese want to keep export growth up. As long as China does not allow greater appreciation of the Rmb, the other
East Asian governments will be reluctant to allow their currency to appreciate. What is needed is somebody to coordinate a generalized appreciation. The only actor big enough
to do that is the U.S. So progress on this front would require high level USG involvement, and a willingness to engage in multilateral dialogue. If the U.S. can recast
Chinese revaluation in the context of being the acts of a “good citizen” in the global economy, and at the same time bring on board the other regional monetary authorities (thereby allowing the Chinese to save face),
then this route may have a chance. It certainly is better than bashing, or having the IMF bash, the Chinese in public fora. so a new “Plaza Accord” is called for (not my original idea but I’ll second it; Brad Setser mentioned it back in 2004, as has Jeffrey Frankel).
If reserve accumulation declines, then interest rates on Treasury securities will rise. Work by Warnock and Warnock indicates that long term yields
are about 150 basis points below where they should be on the basis of a standard bond yield model, and they attribute that difference to foreign capital inflows. Jeff Frankel and I argue that the underprediction of U.S. yields is
attributable to foreign official capital inflows (i.e., foreign central bank purchases of U.S. Treasuries).
Once long term interest rates rise, the housing prices will decline, measured (NIPA) savings will rise and the current account imbalance will shrink (note that there isn’t much of a discussion of how appreciating East Asian exchange rates
will induce expenditure switching; that’s because most estimates indicate this effect will be small).
One last caveat. The last two measures are adjuncts, not substitutes, for action on fiscal policy. Implementation of the latter two only delays the day of adjustment, and likely makes it more discrete.
And despite the results of some very good analyses by Freund and Warnock,
Croke, Kamin and Leduc, and Gagnon, who really knows what will happen if and when asset prices have to move quickly and a lot in the largest economy in the world.
Menzie –
Very well argued and perhaps persuasive – so now, exactly how are we to see any of the three acted upon considering the current group in power? Having been on the inside, do you really expect Snow et alia to act on #3, or Bush to even consider any effective means to accomplish #1 and #2?
It is all very well to deal in elegant theory, but the reality on the ground is that we have no chance of seeing any (repeat, any) positive action on your thoughts until and unless the current crop is no longer in power. If you disagree, please let me know – I have a bridge for sale.
I agree that regulation isn’t the best way to reduce energy consumption and I agree that increased taxes on gas will help, but what about increasing taxes on new car sales based on MPG? Sure the system would be gamed to a degree, but it would be much more effective than the CAFE system.
Good job Menzie. But why are you worried now because of the deficit raise ? Is it because this is never happened before.
Mike Mandell writes
“The wealth of Americans just keeps rising.
I like to keep track of what I call “real net household wealth”. That is, household net worth, subtracting out federal government debt, and adjusting for inflation. In effect, this measure assumes that households will have to eventually pay back all of the debt, and it accounts for debt owned to foreigners as well.
And guess what? This measure hit a new high of $45.3 trillion in second quarter, up 7% over a year earlier, and significantly higher than the boom peak of $44.4 trillion. ”
When this going well, why is everyone useless worried about deficits.
I know most economists are confused because of discussing too much leaving their minds very cloudy.
for you all, let me explain simplistically…
You borrow 10$ from me… but at the same time your wealth goes up by 50$ (by whatever means..)
Will you be worried about 10$ you owe or the 50$ you have some how raised.
Any substantial, long-run increase in domestic oil and natural gas production is just not in the cards. Oil and gas imports will increase, barring major US economic collapse.
What we have to remember is that energy is a critical factor of production. We must make the most of the “comparative advantage” we offer for the oil and gas we import. Can the US turn a barrel of oil or a tanker of LNG into more exportable product than our economic competitors?
My biggest worry is that the US is rushing to vastly increase LNG imports as domestic production peaks. Today we worry about oil; will tomorrow’s topic be natural gas?
Would you argue to add a consumption taxes on natural gas too? Maybe just a tariff? A “gas-guzzler” tax on large homes or hot tubs? (BTW, such a tax would be greatly to my personal advantage!)
Go ahead – you’ll be lynched this winter. Professors get silk rope!
Thanks for the comments.
Fatbear: All I can say is that hope springs eternal. Perhaps some day, policy will be wrested away from the political types in the White House, and logic will prevail.
Nick Owen: This is an intriguing idea, but it strikes me that first best would be a gasoline tax, since the activity we want to discourage is use of gasoline, not ownership of gas-guzzlers per se. Taxing the vehicles might accomplish the same goal, but might introduce other distortions. Some people might be willing to incur the guzzler tax, then drive with abandon.
USD: Not all net worth is created equal. How much of net wealth is in the form of housing valuations, which might be more ephemeral (this time around) than other assets? And I didn’t pluck this idea out of thin air — consumers appear to spend different proportions of wealth, depending upon type, with the variation depending upon the “persistence” of the form of wealth.
In any event, the United States is becoming more indebted with respect to the rest of the world, at a pretty fast clip (net foreign debt to GDP didn’t rise last year due to valuation effects, but this year, watch out since the dollar hasn’t depreciated).
“Perhaps some day, policy will be wrested away from the political types in the White House”
That’ll be the day when something other than politics puts people in the White House, and Congress too.
Until then, the policy people will have to find a way to impress all the politicians in politics as best they can.
“As long as China does not allow greater appreciation of the Rmb, the other East Asian governments will be reluctant to allow their currency to appreciate. What is needed is somebody to coordinate a generalized appreciation. The only actor big enough to do that is the U.S.”
Actually, no. Not even close.
The WTO is the key player that can quietly persuade China to play ball with any imbalances associated with its currency valuation.
Thereafter, as necessary, the WTO can initiate a routine or special Trade Policy Review at the request of WTO leadership or member nations of WTO.
The WTO card hasn’t been played thus far.
And China blew off the U.S. with its currency basket shell game. It’s a black box and they can do with it as they please. Amateur slick move. Enough to walk around the U.S. Congress.
Jim Glass: I know that in these times, it is all too easy to be cynical about the policy process. But I think there is an ebb and flow; sometimes expertise is valued, and the policy process is insulated from politics. At other times, expertise is devalued, and cronyism reigns.
Let me make this more concrete. I thought the Clinton Administration’s finest hour during the time I was there was, when on the eve of the Presidential election, Administration policymakers refused to impose steel tariffs. The people in charge had every political reason to impose the tariffs, but they resisted because they knew it was bad policy. That probably lost the Democrats key electoral votes in the 2000 election.
At other times, politics dominates. When this happens, the only defense for the common good is a strong, professional civil service. That’s why I think those of us on the outside can do a lot of good by defending the independence of career analysts, rather than just giving up on the policy process.
I read your CFR paper. Fine effort.
Four key points worthy of consideration or analysis in future papers or other presentations:
1. As long-term U.S. interest rates increase, Treasury debt obligations will increase as the relatively short-term instruments roll over. Such yield increases may require additional financing above and beyond the present costs of existing, not additional, Federal debt obligations. Otherwise, further discretionary spending cuts will have to be achieved to absorb this growing budget element.
2. Any potential for increasing U.S. production of goods for import substitute consumption by American consumers or for export will require additional energy, resource supply, and logistical support. At a minimum, provision of resources and perhaps crude oil for additional subassembly cargo movements may involve greater levels of imports, thereby serving as offsets to any anticipated import reductions.
3. U.S. exports are increasing, but represent a declining share of exports to each of the seven global trading regions according to WTO statistical data. As such, U.S. dollar currency valuation changes will need to extend beyond adjustments with East Asia in order to support intentions to improve U.S. exports to all global trading regions.
4. U.S. dollar valuation adjustments against the currencies of East Asia serve as no guarantee or high probability that production of finished goods destined for U.S. markets will shift to the U.S. from East Asia. As I noted early on, and as Greenspan noted earlier this year, U.S. currency revaluation changes against China’s currency may simply result in the partial or complete relocation of such production to other parts of the developing world. If production shifts to India, Latin America, South America, Africa, North Korea, or wherever, that source of the U.S. trade deficit remains intact in general dollar terms though units imported may decline.
@Chinn: the virtues of bureaucracy are often undervalued – after all, the reason why we invented bureaucracy was so things still worked if the king turned out to be a retard..
Menzie: I read your introduction as a confirmation that there is nothing much to do.
1) If the effect of cutting the federal budget deficit by 6 % point on CA may be only about 1 % point, this means that the price is very high for a slight improvement. As this would mean not only higher taxes but also diminishing expenditure it would be hurt a lot. Worse still, improvement this small might by eaten away by other factors. Remember, there is a war going on and a new one can be in the making.
2) Can the US really do much to cut oil and natural gas imports? Gasoline tax could help a little but then it should be rather high. The European level would double the gasoline price. And in every case a large share of the oil use must be exempted.
It may be impossible to cut fuel imports as fast as the import prices are rising, especially if the dollar starts depreciating (oil exporters will rise their prices accordingly).
3) If the Chinese reserves boost is caused mainly by financial inflows why should the Chinese agree that their currency is undervalued from the viewpoint of goods exports and imports? Besides they can point to the fact that the US dollar has depreciated a lot, the dollar index has gone down from the level of 120 to under 90, but the US trade deficit has grown all the time.
I think that Movie Guy has some good points. To say that the fiscal means are the primary means to address the problem in this context is to say that nothing really can be done. Is this so? Of course not. Everybody knows how the deficit can be killed: by putting the brakes on. A recession deep enough will collapse the imports and wipe off the deficit. So the hard landing. This is no alternative – or is it the only one? I could read the introductory analysis like saying that.
It might be that the situation is in fact even worse than that. The hard landing my be not possible – yet. The Asians don’t want it now and they keep on financing the US deficits with so easy money that everything just keeps rolling on.
That said, what will happen? Something will give in eventually. My guess is that it will be China. When the Chinese growth slows there will appear an investment glut and real estate crash. The present nearly 50% investment rate is unsustainable. The Chinese recession will draw the rest of the world along. In this situation the present US-Asian deficit-surplus system will unwind and the necessary corrections will happen.
Any policy recommendations based on this? What about introducing legislation to prevent the collapse of the finacial system in a crisis? This means, plan some damage controls.
I’m afraid that those who advocate increased gasoline taxes have not answered a fundamental question:
Why shouldn’t we extend your proposal and arguments to natural gas? Would you also impose higher taxes on gas to heat homes? Why not a tariff on imported LNG?
Such a natural gas tax is a logical extension of the arguments for a higher gasoline tax. A tariff on LNG imports has the advantage of being on a import stream that is just taking off so will cause less screaming.
Menzie:
It seems your proposal is to tax the country into prosperity.
When examining every question it is often valuable to view the flip side. If China is becoming more productive then the short term impact is to add a bit more of wealth to each participant. $100 each to a few billion people becomes an immense sum.
Folk with money to invest generally seek safety, and the low interest rates in the US are basically a product of a world perception that the US is more stable than most places to put money.
Long term, as the Chinese (and other Asian) people gain wealth, they will become larger consumers. Consumption reduces the funds available for investment, and absorbs excess labor driving up labor costs (Post war Japan).
As Asia become a greater consumer, the balance of trade will change.
One of the danger to the US is that immigration restrictions have limited the growth of the labor force. The US has built its growth on the importation of labor since the founding of Jamestown. The post war baby boom, and the second wave of that boom, changed the need for immigration. However, with birth rate now at about population maintenance level, productive growth in the US is becoming limited. The proxy for importing labor is the imporation of products that have a high labor content.
The wealth of the US is also built upon the value of applied intellegence, and is enabled by a social system that allows, perhaps encourages, the formation of new businesses by individuals. Persistence of our economic leadership does not depend upon the limitation of our consumption. It depends upon our future productivity.
Bill
Menzie-
You said “USD: Not all net worth is created equal. How much of net wealth is in the form of housing valuations, which might be more ephemeral (this time around) than other assets? ”
Mike Mandell seems to know that some economists might ask this Question. He had already answered as below
1. “wealth up 7% Y-o-Y…And it’s not just housing either. Real household net worth would have risen by 3% over the past year, even taking out the value of real estate”
On your comment that its EPEMHERAL..
2. “in effect, a foreign investor can be at the end of the chain, buying up mortgage-backed securities. That housing wealth has passed the market test..somebody is willing to put up money for it who doesn’t have to live in the home.
Housing wealth can now be monetized in the same way that stock market wealth is. It’s now real wealth. ”
Somehow the arguments you make sound HOLLOW.
“If the U.S. can recast Chinese revaluation in the context …”
its too boring.. I have hearing this from 2003. !!
The biggest problem with ‘household networth’ excuse for why the Cheney Rule (deficits don’t matter) is wrong is simple:
The bulk of the increase in household net worth is due to DIRECTLY to housing valation increases… the driver behind the increase is liquidity from off-shore sources keeping interest rates low (into Treasuries & MBS instruments)… that and ‘creative financing’.
Pull those out and the valuations collapse leaving nothing left but the ‘debt’ that was once collateralized against those phantom asset valuations.
As my prof’s used to say over-n-over: “Assets valuations are ‘for now’… liabilities are ‘forever’!”
We will learn that lesson the hard way.
Bill,
A deduction from your assertion that excess labor is vital for the US economy (“The US has built its growth on the importation of labor since the founding of Jamestown.)
Would you then link the Great Depression to the immigration restrictions imposed after WWI?
Professor Chinn,
Regarding Chinese RMB appreciation:
If the adjustment channel works through higher interest rates in the US, there is a more direct way to accomplish this: convincing Asian central banks to dump their US treasury debt. In fact, Andy Xie at Morgan Stanley suggested such a year or so ago. He argued that this would be a less painful way for the Asian countries to contribute to the global re-balancing. I never quite understand his argument, and would like to hear your thoughts on this issue.
You left out one vital component. A solid, export base.
The US needs to develop an industry, like the internet was or at least promised to be, where it is the leader and where money flows in rather than flows out. This could be energy technology, it could be medical, advanced internet. Weapons systems which the US is able to disable in case they are used against it.
The US can’t fix the current account deficit unless it is imported from more than it imports from others. To make this happen there need to be products/services uniquely or mainly available from the US that are not easily substitutable.
Massive incentivizing to the alternative energy industry might be a good specific start.
A note: currency flexibility will never do it as long as wage differentials are so great between the US and the Far East.
Menzie. Those of us without academic jobs to fall back on might have been a bit happier if the Clinton Administration had been a bit more politically minded in the fall of 2000. Afterall, John Taylor — a true free trader — found it possible to work for an Administration that supported the “I want to win WV (and a few other states)” steel tariffs. I am joking, but there is a serious point: politics matters alongside policy, and if good policy does not generate political support, it will not last. in retrospect, the (very sensible) counter-cyclical fiscal policy of Rubin-Summers created a politically tempting target (america is being overcharged) — the political base for good policy did not exist/ was not quite as strong as some (myself influced) thought. At least not in 2000 when the American people where given a simple alternative.
TI wrote:
“If the Chinese reserves boost is caused mainly by financial inflows why should the Chinese agree that their currency is undervalued from the viewpoint of goods exports and imports? Besides they can point to the fact that the US dollar has depreciated a lot, the dollar index has gone down from the level of 120 to under 90, but the US trade deficit has grown all the time.”
A few points in response:
1) US trade deficit is a function of more than just the dollar. it also is a function of the growth of US doemstic demand and oil prices. the run up in oil combined with strong domestic demand in my view overwhelmed the impact of dollar depreciation, because both pushed import growth way up. But that does not mean dollar depreciation had no impact — US export growth has been very strong, over 10% in both 04 and 05. That is largely because of the dollar. put differently, without the extra exports generated by dollar depreciation, the trade deficit would have risen even more.
2) the dx index is a poor proxy for the dollar’s trade weighted strength or weakness, since it basically a composite of europe/ canada and japan. sweden is in the index, korea, mexico, brazil and China are out. Broadly speaking, as the dollar depreciated v. industrial country currencies, particularly european currencies/ the canadian dollar, it was constant or even appreciated relative to many emerging market currencies (remember the brazilian real tanked in 02).
3) I also think the evidence that China’s currency is undervalued is also a bit stronger than menzie does: a) China’s trade surplus has ballooned this year, and probably will clock in at $120b (roughly 6% of China’s GDP) — with a current account surplus in the 7% of GDP range; b) add the 3% of GDP FDI flows that China attracts and its basic balance, independent of hot money flows, will be around 10% of GDP this year; c) China imports a ton of oil/ has an energy intensive economy, so higher oil prices should have lowered china’s surplus d) China invests a ton, and investment grew like mad as a share of GDP from 02 on. that kind of investment boom should have produced a trade deficit — the fact that it did not suggests a high degree of undervaluation to me. Trade balances needed to be judged relative to a country’s position in the cycle.
4) I also think China’s trade is a bit more responsive to the exchange rate than the “labor is so cheap that the exchange rate does not matter argument allows”. My evidence? The RMB depreciated signicantly v. the euro since 02. europe has grown more slowly than the US. If exchange rates truly did not matter for China’s trade, domestic demand differentials would argue that China’s exports to the US should exceed China’s exports with Europe. What actually happened? China’s exports to Europe have grown even faster than China’s exports to the US …
My apologies for the delay in responding, but it appears that the debate has not suffered as a consequence. Since there’s been so much written, I’ll just respond selectively.
Movie Guy: I agree that there is a difficulty in using the exchange rate to effectively induce expenditure switching from imports to exports. The U.S. has a relatively small tradables sector, as stressed by Maurice Obstfeld and Kenneth Rogoff in their analyses. Hence, the dollar depreciation associated with smaller inflows will have to be fairly large; I believe they forwarded numbers around 40%. In addition, I
noted in my Council on Foreign Relations report that adjustment costs might be high, if one considers hysteretic effects of the long dollar overvaluation.
So, in sum, I agree with much of what Movie Guy stated. For a further analysis, take a look at my papers: “Doomed to Deficits”, and the more prosaically titled “Supply Capacity, Vertical Specialization and Tariff Rates: The Implications for Aggregate U.S. Trade Flow Equations”; these are at:
http://www.ssc.wisc.edu/~mchinn/ustradebalance_RWE.pdf
http://www.ssc.wisc.edu/~mchinn/Trade_supply_vertspec_tariffs.pdf
Bill Ellis: With the tax to GDP ratio at 40 year lows, arguments that tax revenues should be increased seem a bit hyperbolic. In any event, I also argued for getting discretionary spending (remember the energy bill, the transportation bill) and entitlements (remember the famously mis-estimated Medicare prescription drug bill) under control.
I agree that current account deficits could be a function of future prosperity. This is the present value model of the current account, and has been thoroughly examined by legions of open-economy macroeconomics — and rejected. Take a look at the most recent econometric analysis, by Nason and Rogers (forthcoming, Journal of International Economics):
http://www.federalreserve.gov/pubs/ifdp/2003/760/default.htm
Brad Setser: I largely agree with Brad’s assessment. My largest difference would be on the extent of Rmb undervaluation. I agree that as we go into this year, the Chinese current account surplus is likely to widen, so that the Prasad-Wei characterization of reserve accumulation as being capital flow driven is less appropriate; I think I’ve hedged my statements to allow for this change of events.
But there is one philosophical sense in which I’m unsure that even with a large CA surplus, we can say the Rmb is undervalued. And that is highlighted by asking the question of whether a single relative price (the exchange rate) can hit both internal and external balance (technically, Y=AD and CA= normal CA). In general, it can’t (think of a Swan diagram). This issue is thrown in high relief when one thinks of the CA balance improving largely because of decreasing domestic absorption (investment).
USD: I’m an economist. I’m paid to be boring. The last time I was asked to “think outside of the box”, I was working in the Bush Administration. So I stick with what models and data tell me, instead of thinking of something that is new, merely to say something new.
Menzie:
I concur that contolling government spending is at the heart of many of our country’s problems. The Medicare drug benefit is of very realistic concern, and it is been my observation that the current congressional attention to “fixing” Social Security was simply an issue used to avoid facing the problems with the drug benefit.
While we would like Congress to act fiscally responsible, as well as the state legislatures and local governmental entities there are certain realities about the process. You cannot give our government more money than they can spend. Any sign of prosperity brings on new programs to spend that prosperity. The only way to control government spending is to control the government’s access to funding. While we can argue that there is no control because they continue increasing the national debt, throwing more tax revenue to the government is like throwing more food to a fat man. It isn’t going to help the problem.
Bill
Menzie — Suppose investment, which is still very high in China, falls further and consumption, rather than rising, stays flat or even falls (as it did in the past when investment fell) — implying a huge (10% of GDP) current account surplus would be needed for internal balance. What would your set of policy recommendations for both the US and China be in that context?
Menzie: even if we agree that the action in the fiscal policy is the core in reducing the CAD, the numbers are disturbing.
The US current account deficit will be over 6% of GDP this year and it has been up by about 1% a year. Extrapolation gives that it will be 14% in eight years time (probably it won’t). If we have eight years to correct the fiscal deficit and the effect will be 1.3% – 3% points the CAD will be 11% – 12.7% after the budget is in balance. You can take much more optimistic view on trend of the CAD, but even then the fiscal policy won’t bite enough.
We cannot count on oil prices going down or import volumes shrinking significantly. More likely oil effect will only increase the CAD. And China: just how much should they revalue their currency to make any real difference in this scale? And any case this is up to the Chinese.
Do you really think there is a solution?
I am missing something here?
Bill Ellis: I want to remind you that as recently as five years ago, the United States ran a Federal budget surplus. That was accomplished in part by virtue of tax increases and fiscal restraint.
TI: Fiscal restraint has an impact of between 0.2 to 0.5, so 6 ppt of budget deficit to GDP adjustment results in 1-3 ppt of GDP CA adjustment.
Adjustment of long term interest rates (my baseline estimate is 150 bp due to central bank reserve accumulation) induces decline in housing market (indications of decline we already see), thereby inducing further reduction in consumption via wealth effects.
Chinese revaluation is necessary not to induce expenditure switching per se (although this would be helpful), but rather to choke of reserve accumulation due to speculative inflows.
Just guessing, but 20% sounds as good a figure as anything. Barry Eichengreen has a good paper on this subject.
Regarding energy prices, while the price elasticity of oil is low, the short run income elasticity is fairly high, so deceleration of GDP growth can affect imports substantially. Long dated forwards seem to be indicating a drop in oil prices eventually (although stabilizing at relatively high levels). So there is medium term hope. Over the longer term, we need action, in line with the action that induced a drop in the Btu/GDP ratio in the wake of the 1979 energy crisis: either serious CAFE standard revisions, or better yet, a tax on gasoline. If one could be imposed on energy use in general, so much the better. From the perspective of the CA deficit, since oil is used primarily for gasoline and heating oil (rather than electricity production), it seems to me that gasoline is where the scope for action is.
Brad Setser: Yup, tough question. But it is important to remember that corporate savings is driving the rise in Chinese savings — and that this is procyclical. This may drop substantially.
But we have been assuming that all excess savings from China *must* flow to the U.S. Dooley et al. have an argument for why this happens. I don’t think this tendency need to be durable — especially if the Chinese start worrying about having so many US Treasuries and investing physically within the political jurisdiction of the US. Europe or rest-of-Asia might start looking better (and remember, when you look at those region’s CA surpluses or small deficits, remember these are *endogenous* variables).
But no doubt about it, realigning China’s macro balances will not be a trivial task.
I put here some some numbers about the impact of China in the world economy. They may be slightly off-topic here but I think they tell something about what is happening.
We look here at the “US-China pair” and its impact to the rest of world through their imports demand growth. In 2004 the US imports (excluding oil) from the rest of the world (excluding China) increased by $116 billion. At the same time the Chinese imports (excluding oil) from the rest of the world (excluding US) increased by (about) $125 billion. This makes the combined demand growth impact 241 billion dollars and China has a bigger share in it.
I think this entitles us to speak about a US-China tandem engine of the world economy. It is the growth volume that matters. And we know that the Chinese end of this axis of growth is growing more than the US end. There is no doubt that these developments mean a fundamental structural change in the global economy.
Professor Chinn,
So you’d like to increases taxes on ALL energy? Wouldn’t that be inflationary?
It still seems that a logical extension of your argument for increased gasoline taxes would be applicable to a tariff on imported LNG. We are hurtling towards greatly increased LNG imports – why not nip in the bud? The LNG terminals today and in the future are seeing “excess profits” as yesterday’s Henry Hub closing was $14.18/mmBTU while one could land LNG at $6 or $7.
An advantage is that substitutes exist for LNG while few are available for gasoline.
I’d really like you to convince me on an LNG tariff, I really would.
Joseph Somsel: Tariffs on LNG would not be WTO compliant. In any case, it would accelerate extraction and depletion of domestic natural gas reserves. Better to tax it all.
Placing a tax when prices are already high would be inflationary. However, if we phase in the tax, perhaps as the pre-tax price declines, then — as long as the Fed retains credibility — then inflation need not accelerate. Then the tax would effect a relative price change, which is the desired effect.
TI: Once again I refer you all to Kamin et al.
China has lots of trade with the US, but it still looms small in the world economy (evaluated at market exchange rates which is more appropriate, not at PPP).
http://www.federalreserve.gov/pubs/ifdp/2004/791/default.htm
A little bit more on China, Menzie. A compeletely closed economy, however big, don’t have any impact on the rest of the world, it doesn’t interact. So the absolute size of Chinese domestic economy matters as little as the US housing markets and domestic services. The interaction is important. It is mostly through trade. And here the focus is on the marginal effects, change. We are seeking for dynamics, the growth engine.
The Chinese foreign trade growth is relatively and absolutely unprecedented. The OECD countries make the world demand volume but China makes a sizable part of the growth. My numbers were a perspective from Europe. They tell what we see in Europe. China is all important for the growth of the export demand and hence for the domestic growth in Europe.
And there are the volumes. Chinese imports were last year in the level of $550 billion and growing 20% – 40% a year. This means doubling in 2 -4 years. So we can expect the Chinese imports to be well over one trillion in 2010, may be earlier. This is not insignificant. And these are all real market price dollars. If the Chinese currency will be revalued the imports will increase still more. And this is not all: if the US CAD will be curbed by cutting imports, as you recommend, it would mean that China will be almost alone in sustaining the world growth.
I think sincerely that China is the “new parameter” in the econometric models. Changes this big should cause an “out of range” error in the fine-tuned world trade models.
TI — your argument about China’s imports may need to be revised in light of the 2005 data. import growth — particularly in volume terms — has fallen dramatically during the course of 2005. it is now running at around 15% y/y; with higher oil prices accounting for much of the increase.
And for the US, even when overall Chinese import demand was booming, the stimulus provided to the export sector was modest. This year, US exports to China are up by maybe 10% y/y — and with a base of say (ballpark $35-40b), that is not enough to have much of an impact on the US economy. US exports of debt to China, on the other hand, have continued to grow rapidly.
A final note of caution — some of the increase in Chinese import demand from 2002-2004 reflected an unsustainable surge in investment, which led to extremely rapid increases in demand for certain imported inputs. Capacity has now caught up with slowing growth in investment in sectors like steel and basic chemicals, leading to a slowdown in import growth. And some of the increase in Chinese demand was an echo of increased US demand. As say computer assembly shifted to China, higher US demand for computers led to higher Chinese demand for microprocessors and other components that go into chinese exports.
Your story is basically correct — and certainly true for commodities. But I also think some important changes have taken place this year — changes that show up in China’s surging trade surplus, which largely reflects a fall in import growth, not an acceleration in export growth.
Interesting analysis, series of posts, counterposts, and replies.
Oil : Agreed. One way or another, we must conserve. I would both regulate and tax. Encourage alternate energy through tax incentives and rebates. Government must take the lead here. The stakes are too high. We are coming close to the time when economists simply must look at peak oil not simply in terms of supply and demand.
Currency : Yes. But as your reply to movieguy admitted, a revaluation may not effectively reduce the trade deficit. Furthermore, China and East Asia alone are not the issuesIndia, Mexico, to name a few others, must be considered as well. (The history of NAFTA has not been inspirational, despite the Clintons promises. See the growing trade deficit there. And the poor still flood the borders.) Revaluation will slow Chinese imports, but companies are quite mobile and can find another home. How to stem offshoring must be discussed directly. No mincing words anymore.
Some other things that should be done :
Free trade must be fair trade. Inordinate tax breaks, cheap labor, and non-existent environmental regulations are as much a part of the playing field as currency exchanges. These must be addressed by the WTO and IMF. These are double-edged swords. If the U.S. truly wants fair trade, then it must abide by it as well: Sugar and lumber industries pay attention.
Health Care: U.S. health care is an enormous competitive burden on companies within the states as well as a national disgrace. A single payer, government run system is the only way to go. Is it politically feasible? Maybe we must wait until it completely collapses. And it will. Nonetheless, I think the time is almost ripe to attack the issue once again. Keep Hillary out of it.
Tax Havens: Shut them down. There are plenty of ways to do this. No one wants to tackle this because vested interests are too powerful. If that truly is the case, we should all be openly ashamed. No guts. The MNCs and rich do rule the roost then. Admit it.
Mortgages : Discourage 30-year mortgages. Encourage 20- and 15-year mortgages. Doing this will have a number of well-intended effects: (1) put a lid on any future housing and property bubble and (2) encourage real home ownership.
First, let me note an excellent survey of the world economy in the FT today.
http://news.ft.com/reports/worldeconomy2005
TI and Brad: Let me thank Brad for bringing us up to date on what’s going on with China. I agree — the impact is mostly on the asset/liability trade side rather than in terms of trade in goods.
Let’s put things in context. One estimate of 2005 exports is $740 billion. This is definitely big relative to the Chinese economy (Rmb 15.5 trillion, or about $1.9 trillion at market rates), and seems large relative to US exports of about $1.3 trillion. Two observations:
1. Chinese exports are about 0.15 of world GDP.
2. Chinese exports have a large imported component. According to Deloitte, 40% of Chinese imports are inputs into exports
( http://www.deloitte.com/dtt/article/0,1002,sid%253D1011%2526cid%253D89373,00.html
and see also
http://www.foreignaffairs.org/20040701faessay83405-p10/george-j-gilboy/the-myth-behind-china-s-miracle.html
)
This particularly high import content of imports means two things: (a) the value added component of Chinese exports is fairly low; (b) exchange rate revaluation will only have a small impact in trade terms, because the revaluation decreases the prices of both imports and exports.
Regarding the hypothesis of slowing Chinese growth (and hence China as a growth center for 2005-06), see:
http://www.fxstreet.com/images/graf/danske/danske-China-062305.pdf
Stormy: Glad you agree on the energy front. But, I really am not focusing on revaluation/flexibility as directly affecting trade flows, but working on the capital account side via expectations.
Regarding free trade vs. fair trade: somehow, in the calculus of building a textile plant in China vs. the US, I suspect differential labor and environmental standards are second order concerns. Ditto on health care (although this may be relevant vis a vis the Japanese or the French…)
I look forward to hearing how one could close down tax havens. And I must confess I don’t see how prohibiting 30 year mortgages would stop bubbles. Wouldn’t getting rid of no-interest loans, etc., be more efficacious (if one could do such a thing)?
Menzie,
If I may, let me address an issue that is off subject but should have an impact on the U.S. current account deficit, trade deficit, and oil consumption.
American businesses in the retail and hands on service call sectors of the economy are dealing with increased transportation fuel costs whether such are tied to cargo deliveries or as a cost of providing onsite support. This is becoming a common concern among some business owners and franchise operators.
If most of the businesses are attempting to absorb higher transportation costs in order to remain competitive, what happens when the U.S. economy slows down? How will the same businesses handle such transportation costs when such are spread across smaller volumes of goods sold or service calls? Will they not be forced to pass them along at that point?
Is it possible that the delayed effect of rising transportation costs will be faced by consumers and serviced businesses in a brief surge of pass along costs which may worsen the general economic conditions among such supporting businesses and those customers they support?
It strikes me that the retail and hands on service call businesses will be trapped in a declining profit position as volumes sales and service calls decline unless they are willing to pass along the “fuel surcharge” costs than truck carriers (LTL and long haul) currently pass along.
Lastly, will this problem serve as a stimulator for worsening the next recession cycle?
30-year mortgages, ARMS, and 40-year mortgages :
We all know that the shorter a mortgage term, the greater the savings to the buyerin short, greater personal savings and real equity. Right now we are attacking the housing bubble with higher interest rates. An approach with an equally sanguine effect would be to shorten the term of the mortgage. It is no accident that finding 20-year lenders is far more difficult than finding 30-year lenders.
I would suggest that a salutary side effect would be to depress the price of housing. One reason housingin some areashas been allowed to grow so fast is that credit instruments have been fashioned to make that possible: ARMS, for example. Not surprisingly, we now see 40-year mortgages as an option in the states.
Tax Havens : There are many kindsbut let us take one example and some possible solutions.
A company sets up a subsidiary in an offshore tax havenCayman Islands or the Bahamas. The subsidiary then buys the home company. The company keeps its U.S. employees and operations in the states, but avoids paying U.S. taxes. Right now this is legal.
For some background, see:
http://www.house.gov/neal/news/news24.html
http://www.afscme.org/action/ala/ala0506.pdf
http://news.bbc.co.uk/1/hi/business/806236.stm
http://www.oecd.org/dataoecd/15/57/35120166.pdf
For an interesting example and statistic, see page 179 of the OECD report.
Unfortunately, much of the OECD report deals with money laundering and drug profiteering. Nonetheless, it is appropriate that MNC tax havens are identical to those used by criminals for money laundering and drug profiteering.
What to do? Legal remedies have clearly failed. Attempts to move pension fund investments away from these companies are gestures at best. My approach is a bit more straightforward, since this is theft on a truly grand scale. As the OECD report states,
The equivalent of one third of one years global GDP is estimated to be held in tax havens and the majority of this wealth is undisclosed and untaxed.
(1) Sharp punitive economic sanctions on all such tax havens and the companies who use them. Any American company determined to be using such tax havensall are well known–should be assessed accordingly.
(2) If #1 fails, simply invade a couple. (Tongue in cheek, I sort of like this option. Fits Americas image. But that is what we used to do with pirate strongholds. LOL) I recommend this half jokingly but heythats my money they got!
Tax havens point the way to an even larger issue: the role of the MNC and how it is moving beyond the reach of any country. These are no longer entities tied to any country. We behave as if they are. We will pay for this mistake. Some day we will have to address this issue.
Now, I realize that none of my suggestions to both issues may be either politically feasible or maybe even doable. But, who knows?
I offer them so that we all may consider a wider range of options than I have heretofore seen in these blogs. We replay the same list of options again and again. No one moves outside the box. Unless we look at how credit is being used (housing bubble) and how MNC’s function (Tax Havens), we are going to repeat ourselves and put nothing new on the table.
Movie Guy: Sure, the scenario you laid out could happen. Rising input prices into transport sector means profits are squeezed unless they pass on prices. However, how much they can increase prices depends upon the market structure (competitive or monopolistically competitive, or oligopolistic) and demand conditions. Rising prices could erode consumer power; or the Fed could take a very anti-inflationary stance, and squelch upward price pressure. This would reduce inflationary pressure in the economy at the cost of exacerbating contractionary tendencies in the economy.
There’s an interesting article in today’s NYT business section that suggests that these negative shocks might be smaller than in the past due to just-in-time technologies, etc.
http://www.nytimes.com/2005/10/08/business/08fedex.html
Stormy: If we arbitrarily outlawed 30 year mortgages, then derivative instruments would arise that would replicate what 30 year mortgages could do. And if the 20 year mortgage rate became standard, why would that do anything to the likelihood of bubbles arising? I’m not certain what the underlying model is.
On tax havens, I would be happy if one could coordinate policies across political jurisdictions so that they were no longer a viable option for MNCs. But even then, it would be tempting to locate in jurisdictions with lower tax rates. And the entire panoply of transfer pricing and tax shifting would still exist.
What you’ve highlighted is the general characteristic of increasing globalization: increasingy labor and especially capital mobility due to regulatory liberalization and technological (communication) advances. These conditions make it all the more urgent that nations pursue rationale macroeconomic policies.
30 year mortgages: there are of course many ways to curb the mortgage lending – Fannie Mae and others are somewhat government controlled. The rules could be changed a bit. But now this is obviously too late. To tighten now would mean the housing bubble blowing.
China: Before giving recommendations to curb the US CAD I wanted to ask, is it necessary – or even possible – to do anything?
There are those “deficits don’t matter” -people who say just that. We cannot dismiss them – they have had right so far and the serious macroeconomists with their sinister warnings have had wrong. This means that there must be something that is missing from the analysis. And if the analysis has not been correct the recommendations based on that cannot be the right ones. And it would be politically very difficult to demand those belt-tightening measures to cut CAD if there seems to be no real problem.
As mainstream economists we know that it is of course nonsense to say that deficits don’t matter. There always comes a deficit level that matters.
Well, basically they are saying that the present levels don’t matter but they don’t give a stop level either. And then they say that the situation will be corrected by itself. But there is no evidence of the latter. But nevertheless the deficit shot up through the 5% and 6% levels with no real problems. Those who warned that 5% would cause a serious dollar problem had it wrong. The deficits don’t really matter. So far.
So I made a hypothesis that there is some new factor that prevents the expected consequences of the growing CAD and budget deficit. China is a good candidate for that. Here the two last years have been critical – those years we saw the the US CAD going over 5% of GDP and Chinese foreign trade having an exceptionally high growth. May be we could say that China caused a large part of the deficit and at the same time helped to sustain it. (this is not a new idea, of course). This effect was not only between the US and China but China upheld largely the world growth and created “secondary surpluses” in third countries (Japan and others) that helped finance the the US CAD.
But why should the Asian countries finance the US deficits? What other choices would they have had? The dollar is the reserve currency. The rates are lower in the US but shifting those massive money flows to anywhere else would have lowered them there, too. They might have suffered heavy currency losses, too. And who else could have been able to absorb so much in so short a time? It was not possible to invest them in new production capacity: the Chinese and the other Asian new “big tigers” were already building so much capacity as was possible (here comes the energy in the picture).
We could simply say that the US has so big CAD because it can. It was offered the opportunity and it has used it. the Fed wanted low rates and high growth and got it – on debt.
But why the US domestic production has not grown enough to pay the growth induced imports and to satisfy the domestic demand? Because it was not possible. The goods imported from China could not be made in the US. The goods needed for increasing exports could not be produced. To boost its exports at the present rate China has had to increase its domestic energy production roughly by 10% a year. We know that the US cannot do the same. The US domestic energy production is decreasing. Importing a lot more energy would not help balancing the trade deficit.
Importing a lot more energy would not have been even possible. Besides oil also more natural gas is needed. But importing more is not physically possible now. Could the US produce or import 200 million tons of coal more in a year? The Chinese do produce. The US cannot match that.
So now we know. What will happen? If Brad has right the Chinese surplus will grow so they could still sustain the US deficit. But slowing Chinese imports growth could mean slowing world economy and smaller surpluses for the third countries. In any case the US cannot export or grow out of the problem. It can go on increasing the deficit because the others (Asians) will do it as long as they can. When they cannot it can only cut the imports. This means slowing down the economy – even a recession (at best). I see that most recommendations here mean just that. Sorry.
When credit becomes too easy over an extended time, asset prices can become inflated. I would posit that that is exactly what has happened with housing; 30-year mortgages are just another form of easy credit. If purchasing a home is made more costly (20-year mortgage), then pricing will have to reflect this factwith fewer buyers, the prices will have to fall. I am sure some bright bulb will conceive of some new offering to make credit easier; these should be discouraged. (By the way, 30-year mortgages are very rare in Canada. Twenty-year is normal.)
In short, we should pursue every avenue to tighten credit. The growing availability of 40-year mortgages is a signal that something is out of control. But I suppose that bright bulb will figure out how to make such a derivative possible. LOL
Vis–vis countries pursuing rational macroeonomic policies: I see little evidence of that. Nor do I see any economic models that study the effects of mobile capital and cheap labor. But these are arguments for another day.
Environmental and labor regulations, from my view, are as important as currency exchanges. Again, arguments for another day.
I want to thank you for your dialogue and patience. Your responses are direct, to the point, and refreshing. I deeply appreciate them.
Menzie,
Interesting FedEx article.
That’s fine for long or short haul air and those customers who depend on JIT deliveries. But even FedEx is dealing with fuel prices.
“Companies are busy enough moving boxes around the world that FedEx has recently increased its prices.”
Look at the businesses, though, that haven’t passed along transportation fuel surcharges. The ones that have been trying to ride out fuel costs, such as retail and service onsite businesses.
They’re going to have to deal with covering their higher trans costs once volume sales, whether retail or service onsite, decline further. It’s just a matter of time. Right now, volume is the key for spreading the higher trans expenses. If volumes decline, they have to make a decision. These businesses have already cut their employee levels. The next step will be more difficult.
I’m not sure that Fed research is fully up to speed on this potential problem.
My post above…
Thanks to all. I’m impressed the debate has continued four days after posting. Here goes!
TI:
Housing: The longer the housing boom continues, the more indebted Americans become, both trying to speculate on housing, and in supporting consumption on anticipated capital gains. So the sooner we can tighten up, the better. When the bubble is blown, then standards can be loosened to mitigate the credit crunch(regulatory forbearance redux).
Do current account deficits matter? As I mentioned before, standard theory in the absence of asymmetric information or implicit guarantees (as in the literature on financial crises in East Asia) implies that current account deficits are neither good nor bad, but merely the reflection of saving and investment decisions of intertemporally optimizing agents.
Since the world seems to be full of liquidity constrained agents, asymmetric information, implicit government guarantees that distort decision-making, I have a prior that the situation could be made better — especially by conducting fiscal policy in a rational way.
Assuming something should be done, the question is whether anything can be accomplished. I believe that commentators who take China’s behavior as exogenous have it wrong. China’s economy is 1/7 that of the U.S., and China’s exports about 1.5 percentage points of world GDP, evaluated at market rates.
China’s impact on the U.S. has come mostly from the asset side — due to reserve accumulation in dollar assets associated with speculation on Rmb appreciation. This speculative component can shift quickly if there is a discrete adjustment sufficiently large. This won’t relieve all the pressure, but if the other East Asian countries follow, thereby relieving pressure for reserve accumulation, then a lot will be accomplished.
I was reading the IMF’s World Economic Outlook Chapter 2. One interesting graph on a rebalancing scenario showed the effects of East Asian realignment — the resulting reduction of the US CA deficit was significant for a few years, but still tailed off close to baseline. What had the biggest bang was fiscal retrenchment in the US; thus the fiscal element is critical.
Stormy: It seems like we’re largely on the same page. I would say that there are probably lots of models of analyzing dynamics of trade and growth in the context of capital mobility. Try punching in the words in scholar.google.com.
Movie Guy: I agree that JIT doesn’t solve the problem of business cycles. What this does is make the inertial component of the economy a little smaller at high frequencies. Big swings (like into recession) are going to be driven by changes in anticipated income streams and wealth stocks.
Ooops, my URL was listed wrong in the last post; it is now correctly listed on this post.
Hey TI,
According to the EIA, we net export about 20 million tons of steam coal a year (as of 2004) out of a total domestic comsumption of a billion tons. We’ve done a lot better in years past and the trends are towards a break even, maybe within the decade.
Why? Imports are probably up due to our low sulfur requirements but that’s trivial. Exports are down because of competition, Australia largely, for the Asia market. Globally, most coal is used locally and little is hauled to the other side of the planet, unlike oil.
If the major importers remain in Asia, we’ll remain at a competitive disadvantage since most of our exportable coal is east of the Rockies and land transport is much more expensive than by water.
So coal is not a problem with our balance of trade. The growth in imported LNG is what we should be worried about and trying to stem. I know that our California energy policy is absolutely dependent on new LNG.
But go buy a sack of coal and burn it in your fireplace this winter. It still stinks, literally.
As to transportation costs, don’t they track volume one-for-one, ie unit costs are close to constant? I would suspect that there is little economy of scale effects within a mild business cycle.
Menzie,
Thanks! Your suggestion about scholar.google.com is a whole new ballpark. I love it. I live deep in the boonies of Canada…no library to speak of–except my own.
Feel like Xmas came early this year!
Joseph: the coal is a problem for the US deficit. It is part of the US energy problem. Check in the BP energy statistics. The US total domestic energy supply has not grown since the beginning of the ’80s – it has been stagnant and decreasing for a quarter of century. The Chinese energy production has been grown fourfold in the same time.
We have recent news that the US fertilizer industry is in a crisis and moving out because of the natural gas shortage. Much of the heavy industry has already gone. China is mostly exporting manufactured goods. The are made in modern factories that demand a lot of energy, mainly electric power. Increasing manufacturing needs increasingly more power. That is mostly generated by coal or natural gas. You cannot produce more goods without more energy.
We speak here of huge amounts of energy and growth rates. The US coal production is 1 billion tons, the Chinese about 2 billion, but the Chinese can produce nearly 200 million tons more a year (may bo not long any more). This is the difference. The Chinese domestic oil production has also been growing – the US production is decreasing.
And you are right: coal is a local fuel. This is exactly the reason why industry is outsourcing in China. They have the coal there. We have cheap labor everywhere but nowhere do we have this much coal (=energy growth) but in China. Cheap labor helps but is not the decisive factory here. So we can say that investments will not go elsewhere from China as long as they can provide the energy.
Remember: there was a time when the fastest growing industrial nation had the highest wages in the world. That was the US long time ago – when the US domestic energy production was growing at a pace of 10% a year (this was 1850 – 1910).
I throw here in one more “China thought”: It is exactly the Chinese energy growth that is behind the deflationary pressure we are seeing. This pressure has so far prevented the rising oil prices from starting rapid inflation. We are now experiencing same phenomenon as in the US in the end of the 19th century. And for the same reason. The massive energy growth, productivity gains and increasing scale of production means in practice that China can easily meet the huge and rapidly growing demand of cheap products and this way absorb the inflationary pressures. This has also helped to keep the rates down in the US. Think: exports growth of 35%, unlimited labor force, domestic energy production supplies 94% of the consumption. This was the US decades ago. Now it is China.
Besides: The US (United States) exports are about 1.5 percentage points of world GDP, evaluated at market rates. We cannot dismiss China so easily. It doesn’t really matter much how big domestic economy is. What matters is the interaction with the global economy through trade and financing.