from Follow the Money

Stephen Roach gets it, the IMF does not …

November 8, 2005

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Subtitle: some parts of the IMF might want to reread Keynes.

China, as we have discussed, saves too much and consumes too little.  It consequently finances both its own (exceptionally rapid) industrial development and the US housing sector.

But not all rapidly growing Asian economies are the same:  as Steve Roach has pointed out, India consumes much more and saves much less.

The private consumption share of Chinese GDP fell to a record low of 42% in 2004, and is likely to fall further this year.  By contrast, Indian consumption currently accounts for 64% of GDP -- more than 50% higher than China's share.  China could learn a lot from India's increasingly potent consumption dynamic.

That's why India now has a current account deficit, and China, despite high oil prices, ran a current account surplus of 8% of GDP in the first part of the year.

The chief economist of the arch-capitalist firm Morgan Stanley (better known as the world's leading bear) has an interesting policy recommendation for China: social security.

Secondly, China needs to develop a safety net in order to deal with the job and income insecurities that arise from the massive and ongoing headcount reductions associated with state-owned enterprise reform.  That requires a national social security system, unemployment insurance, worker retraining, and a pension system -- programs that are now in their embryonic phase in China. 

That policy recommendation makes sense: as the Los Angeles Times points out, insecurity equals precautionary savings in China (tho for some reason not in the US ... ).

The IMF's Asia-Pacific regional outlook as one would expect, provides a useful overview of  developments in Asia.  I thought the third chapter, on savings and investment in Asia was particularly well done.  It highlights the very divergent evolution of China's current account (a growing surplus) and the current accounts of other Asian economies (generally, falling surpluses or growing deficits on the back of higher oil imports and slower export growth). 

I don't entirely agree with the conclusions of the chapter on exchange rates and the current account  -- the IMF argues that exchange rate moves would have a modest impact on Asia's current account.   In other words, their analysis concluded that factors other than the shift in the exchange rate account for the emergence of Asia's current account surplus after 97.  I disagree slightly there, though i lack the econometrics to back my views up.  But I mostly disagree with their forward looking conclusion, which is that real exchange rate appreciation in Asia wil have only a modest impact on global imbalances.  I don't think the IMF took into account how potential capital market channels (i.e. an appreciation in China that reduced China's reserve accumulation might push up real rates in the US) might augment the direct trade impact of a real appreciation of a range of Asian currencies.  But the analysis was still well done; there is a real debate here.

However, I found the second chapter of the report, on policy developments and issues, quite disappointing.

The key bolded recommendations for Asia - an oil importing region with a substantial current account surplus: fiscal consolidation and structural reform.  

The headlines of Chapter of the Asian regional outlook:

The need for fiscal consolidation rules out stimulus.   Pretty clear.  Asia cannot gear its macro policy to support global demand growth.  The Executive Summary noted: "This [Domestic demand growth] will need to be driven by structural reform; there is little room for activist macroeconomic policy, as government debt remains high."

Monetary and exchange rate policy: a balancing act between growth and inflation.   Pretty unclear.   The final policy conclusion is not allow more real appreciation, but rather "monetary authorities need to remain vigilant."  the Executive summary is a bit better.

Supporting growth through a reinvigorated structural reform agenda.  The specific list of reforms includes "removing restrictions on layoffs and contract work and easing employment protection" along with retraining programs and targeted safety nets.  The development of Chinese version of social security is not mentioned - tho it does come up in the savings and investment chapter

Not exactly an innovative list.   It reads like IMF standard policy recommendations for Europe.

And also a list that in many ways strikes me as wrong - at least directionally - for emerging Asia's largest economy.

Why does China, an economy that saves 8% of GDP more than it invests - while still investing far more than any major economy - need "fiscal consolidation"?    Fiscal consolidation tends to increase national savings, though one can debate by how much.  And low levels of national savings is decidedly not China's problem.   This seems like a policy recommendation better directed at a low savings economy on the other side of the Pacific.

Why couldn't China use public funds to recapitalize its banks, and rather than raise taxes to pay for the higher (on budget) interest bill, instead run a larger fiscal deficit?

And why is it more important for China to take steps to make its labor markets more flexible rather than develop a stronger system of social insurance to reduce precautionary savings?  It seems to me that one of China's problems is that it got rid of the social insurance provided by the old iron ricebowl state-owned firms without putting much of a new system in place ...

To be fair, the IMF's recommendations are written for the entire region, and a low savings country with large debts like the Philippines would benefit from a bit of fiscal consolidation.    But if the IMF is going to play a constructive role in the resolution of global imbalances, its regional policy recommendations need to help address global problems.  That means fiscal consolidation in the US to help increase US national savings (read the fine print of the CBO monthly budget data; it looks like the recent improvement in the fiscal deficit is over).  But why should China, a savings surplus country, be encouraged to do the same thing? 

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