By Vinnie Aggarwal
As individual governments look to revive their damaged economies from the financial crisis, it becomes clear that they will not be able to act unilaterally to do so. Of the many factors that led to the crisis in the first place, an overwhelming theme was an inability to sustainably balance the needs of one country with that of another's. Any world that produces a situation in which not only poor countries borrow beyond their means from rich countries, as in the case of Greece and Germany, but rich countries borrow beyond their means from poor countries, as with the United States and China, is clearly not a healthy one. Failures in policy were certainly made on the national level for all parties involved, but they were also made on the bilateral and systemic level. Though these two cases showcase idiosyncratic problems, they can also illuminate general problems with imbalanced demand and the necessity, moving forward, for international communication and cooperation in establishing a more sustainable and stable global economy.
On the most basic level, actions on the national scale should take responsibility for some of the economic distortion. In the U.S.-China case, China failed to develop adequate social institutions, stunting domestic consumption as Chinese nationals saved at higher rates to pay for medical and social services governments in other countries normally provide. In the Greek-EU (Germany) case, the government reverted to excessive spending following accession to the EU, while the EU failed to keep adequate tabs on Greece to ensure that it was behaving responsibly. Germany in particular, as the largest member of the EU bloc, has been criticized for policies that boost exports at the expense of its own domestic consumption and Greece's (and other EU members') trade deficits.
However, countries do not operate in isolation. International pressures like bilateral economic benefits and outside regional political pressures should also be held accountable. In the U.S.-China case, in a bid to make its exports more attractive, China kept its exchange artificially low against the United States, buying up U.S. Treasuries, which helped enable increased U.S. consumption. Although both countries recognized that such a relationship was unsustainable in the long-run, there was little incentive for either to change it as it produced substantial profits. In the Greek-EU case, when Greece joined the EU, detractors argued that Greece was not economically ready, but supporters pushed its case through, arguing that accession would stabilize Greece's fragile democracy and allegiance to NATO. Formed on the basis of economic cooperation, in implementing its expansion, the EU placed a greater emphasis on political cohesion, undermining its original mission.
Finally, while not directly responsible for the imbalance between these countries, systemic conditions made it possible. Though China can be blamed for implementing a distortionary currency regime, the fact that the U.S. dollar holds a unique role as the unofficial international currency made such a large trade deficit possible in the first place. Similarly, though Greece should be faulted for irresponsible fiscal spending, it would be naïve to think that an EU system in which monetary but not fiscal authority is centralized would not eventually run into difficulties.
Finding solutions to these problems will not be easy, as each case is unique. Although Greece presents the EU with an existential crisis, and the U.S. and China continue to dance around the sensitive issue of currency readjustment, the overall take away from this crisis seems to be that global demand should be rebalanced to be more domestically rather than export-driven. This is far from an argument against globalization, but merely a policy that seeks to ensure that countries spend within their own means and not off of those of others. Part of achieving this entails stronger social institutions in developing countries without which production for foreign consumption rather than domestic consumption is more likely.
Stronger financial regulation to curb risk-taking and increase oversight will also be necessary on an international scale. To be sure, other reforms will also play important roles, but whatever the necessary measures, the crisis has also shown that reform must be undertaken collaboratively if it is to be executed sustainably. Ironically, John Maynard Keynes's efforts in the discussion of the Bretton Woods regime to force surplus as well as deficit countries to adjust—an idea that was shot down by Harry Dexter White of the U.S.—now looks very prescient. Institutions like the G20 and reforms within the International Monetary Fund must acknowledge the increasing interconnectedness between developing and developed countries and will be integral to paving the road to recovery.
Wall Street Journal, January 29, 2009.
Wall Street Journal, March 16, 2010.
Newsweek, May 10, 2010.