Global imbalances and the collapse in world trade

Many observers believe that global imbalances have a lot to do with the economic crisis the world has been experiencing. The non-academics among you may have come across the argument on David McWilliams’ recent TV show, for example. So, the fact that these imbalances have been shrinking rapidly over the past year ought to be good news.

Richard Baldwin and Daria Taglioni have a very nice piece pointing out that these declining imbalances can be mechanically explained by the global trade collapse, and are likely to reemerge as world trade recovers. They also do an excellent job of surveying the reasons why trade fell so rapidly during 2008-9.

25 replies on “Global imbalances and the collapse in world trade”

It is commonplace to assert that what is unsustainable usually won’t last. So we need to think about what will happen when these imblances recur or what might prevent them recurring. On the latter point, I suspect the single most obvious problem with a simple recurrence is the absence of finance: the gentle decline in the dollar will become a collpase if it becomes obvious that we have simply reinstated the imblances. If financing is absent, growth collpases again. Or growth simply doesn’t return in any significant way for quite some time. We know who financed the imblances last time. Perhaps they will be daft enough to do it again.
If saving surplus countries are, in fact, happy to do the vendor financing thing again, then we are simply setting ourselves up for another big fall. I can’t see how all of this doesn’t add up to a big appreciation of the yuan, and other Asian currencies. Plus strutural policies to double China’s consumption share of GDP, currently about 1/3.
Incidentally, it is quite clear that Germany can take further dollar declines but it is less obvious that other eurozone countries can do so.

One question, I have to ask to all.

David Duffy wrote this piece of the business section of the Irish Independent newspaper on Thursday last which is very informative of the way in which Permanent TSB home price index is put together.

From David Duffy’s piece:

“The value of housing assets is a major component of individual wealth and, as such, would be expected to influence consumer confidence and spending.”

I have listened to David speak in the past. He often relates how the important the factor of consumer confidence is, in terms of home price recovery and so on. It seems to me though, that we have environmentalists possibly trying to pull in one direction and some very good economists trying to pull in another.

Mark Maslin of UCL was one of the first people who drew this to my attention. He attended a Feasta workshop many months ago in Dublin. He made a comment – I am going propose something very daring he said, we could continue to have the same standard of living, if we can do it without using carbon.

He warned of the attraction to use carbon free society as a stick to beat ourselves with – in which carbon free or carbon negative, can only happen by a loss of standards of living. Which is not necessarily true Maslin believes. Maslin’s work involves a lot of research into accounting methods to quantify carbon stored in forest of equatorial countries. How to incentive-ise those countries to preserve those carbon sinks as opposed to converting them to lumber, as their economy at the moment revolves around lumber.

Yeah, Breda O’ Brien’s article in today’s Irish Times goes beyond carbon and goes into other materials and necessity to extract materials as a result of our impulse to consume.

Any thoughts or input? B.

@ Brian: Duffy’s article misses the most crucial element: ability to repay!

The price you pay for your principal private dwelling (your home) MUST NOT EXCEED 2.5 times your REAL income. (for a single earner: x3 for two earners) You MUST put 20% CASH on the table (25% for two earners) – no funny, off-the-page loans or interest only (suicide loans). This used to be the way home loans were originated. We must return to this, no ifs, no buts, no exceptions. Anyone who disagrees with this financially sound procedure will have some explaining to do – except of course they have discovered a way to repeal the math Law of Exponentials!

O’Brien’s Piece: Right on the button. But is anyone ‘at home’? We are, regrettably, going to learn about this the hard way. Malthus WAS correct. He was approx 250 years a tad previous!

A Carbon Free Society is an oxymoron. Just like Sustainable Development. Pieces of ideological claptrap that violate the laws of physics and chemistry.

Which brings me to Baldwin + Taglioni: nice piece. Would challenge their projections for ‘growth’.

Energy, (fossil fuel), supply situation is precarious; demand is falling in OECD, but RISING in OPEC and non-OECD. I would keep a real close watch on energy production levels. If these remain on plateau, then expect real predicaments ahead for OECD-lands.

B Peter

@ BP

I am playing catchup to you, in terms of getting through the Baldwin + Taglioni paper.

I challenged Brian Lucey and a couple of others on the subject of mortgages in a workshop question time earlier in the year. The discussion from many present at the workshop, some of whom were familiar with auctioneering, selling, mortgage business etc – focussed around rules which you describe. Mortgages being some many times the income, and how the rules are then adjusted for dual earning couples etc.

I tried to establish the point, they were not seeing it through the eyes of someone who ‘grew up’ during the Celtic Tiger years in Ireland. The people who were in their early 20s say in the late 1990s, and are now approaching or beyond their mid 30’s. That is, they could now be married, settled down etc.

I said, the folks who grew up during the Celtic Tiger years did not know how to work in order to borrow. They only know how to borrow in order to work. As one person said to me, I feel like leaving Ireland for good. But instead I got out this massive loan, and now I have to stay here simply to work it off. That was how people rationalised things in my generation. Brian Lucey accepted my point and suggested he might have done a similar thing, if offered the money in the 1980s as a young kid.

But we should be careful not to try to understand folk who ‘grew up’ during the Celtic Tiger years using models which would have applied to older generations. Lucey’s suggestion was that my generation, will have a painful transition to make.

Some of you might find this useful.

I hadn’t realised that Norman Bodek had done a trip to Ireland. It almost deserves an Irish economy blog entry in itself. For those of you interested in listening to podcasts, and how we might work our way out of difficulties.

Norman Bodek was one of the first people in the US to make studies of Japanese manufacturing systems.

Cam anybody tell me if any of the last 5 comments have anything at all to do with the subject of the thread? Or is it me?

I know, yeah, you are correct Chris it goes all over the shop. I am involved with an environmental think tank and I can tell you sitting at one of those meetings is enough to drive anybody nuts.

But what do the last 5 no. comments have to do with the thread. I will admit, I am still reading through the Baldwin + Taglioni paper as I do other stuff. But all 5 no. comments above, have to do with the elimination of ‘waste’ out of the system. Be it human resources, guys in jobs where they are told not to think. Be it waste in capital. Be it waste in emissions, or waste in physical resources. Not only are these things not environmentally friendly, they don’t make good business sense either.

There is a growing belief nowadays that imbalances in the system of global trade are a lot to do with unnecessary waste of all kinds. The way forward and possibly achieve balance may be to learn how to find the areas of waste and come up with solutions.

Allow me to add a little more elaboration. Norman Bodek relates how massive amounts of jobs and employment is being lost in Ireland at the moment. There is your balance of trade right there. We are losing our ability to export, we import more than we export. We are not able to compete. A lot of it has to do with our ability to organise and eliminate wasted effort, wasted time.

Norman Bodek speaks in detail about his experiences in Ireland, where he talks in the podcast interviews of companies in Ireland struggling to survive. Norman was able to relate his ideas gained from visits to Japanese companies, to what Irish companies were doing. One example springs to mind – he was given ear plugs in an Irish medical products factory because the noise of the equipment was so loud. He compared that to a Japanese company, where they worked to eliminate noise in all machinery so that workers could talk to one another.

This contribution is on the topic of global imbalances. How useful it is a different question.

The supposed global imbalances relate to the current account deficits/ surpluses of the leading economies. As these are accounting identitities, a deficit in one or a number of countries must be met by surpluses elsewhere. The US’s big c/a deficit has been mirrored by a surplus in Japan and, in the last 5 years, China.

However, within those economies the surpluses- the excess (or otherwise) of national savings over natonal investment, has undergone a transformation. US national (not just personal but also corporate and government) savings have barely increased, and has arisen solely because of the recent decrease in the current account deficit. This is entirely a function of decreased import demand and is probably already coming to an end (the US trade gap is widening once more in the katest 3 months).

By contrast, China’s current account surplus has diminished rapidly for the opposite reason; more of Chinese domestic savings have been directed towards investment in China, rather than purchasing US debt.

So, the US is increasing its savings by (temporarily) constrained consumption, while China is running down its savings by increasing domestic investment.

Thus the global external accounting identities are brought into balance. But which economy will benefit in the long run is clear; China. It is increasing investment while the US reduces consumption.

There are clear and obvious implications for Ireland too.

Sorry, but I think you have reached the wrong conclusion. China already has abundent investment. But it’s savings are even more excessive. While it does need to raise investment relative to saving (that’s the accounting identity at work) it has to do this by reducing saving. That is, more consumption. It needs to raise the consumption share of GDP, currently at one third. That’s probably half what it should be. Why consumption is so low, what might be done about it and the implications are explored here:

I believe that there is no such thing as savings that are excessive. It was a clever line trotted out to persuafe everyone in the USA that credit was good. Borrowing was a patriotic act.
We know they were wrong!

BPW et al
In a society that was dedicated to sustaing a healthy rate of inflation, it is folly not to borrow. In defaltionary spirals, it is folly to borrow. But Nama and fiscal collapse will ensure that Ireland is devastated. Savings are useful now!

Great posts!

I read a book by Chris Farrell once, called Deflation, in which he tried to explain the western world is entering a period of deflation after dealing with the inflation problem for many decades. He explained in his book, how central bankers love to go to dinners and events and speak about the difficulty of coping with inflation. Because it is much more benign than the opposite. Farrell raised a lot of interesting points in his book I thought, well worth a read. It is only a slim volume too, a bit like Paul Krugman’s books usually are.

May I suggest that people reread or read if you have not already done so and if not shame on you. Limits to Growth, Meadows et al.

If people read this book carefully you will understand what is going on and why. Breda O’Briens article is excellent and something that ecologists have been warning about for decades.


At the risk of striking some people as being off topic, I think the following quote from Brian Arthur’s new book The Nature of Technology, should be ingrained in every economists brain. It seems particularly relevant to the global imbalances conversation which despite its apparently crucial role in the creation of the last crisis, seems a bit of a mystery to many people, not least economists who write and disagree about it.

“I sometimes think of the economy as a World War I battlefield at night. It is dark and not much can be seen over the parapets. From a half mile or so away, across in enemy territory, rumblings are heard and a sense develops that emplacements are shifting and troops being redeployed. But the best guesses of the new configuration are extrapolations of the old. Then someone puts up a flare and it illuminates a whole pattern of emplacements and disposals and troops and trenches in the observers’ minds and all goes dark again.
So it is with the economy. The great flares in economics are those of theorists like Smith or Ricardo or Marx or Keynes. Or indeed Schumpeter himself. They light for a time, but the rumblings and redeployments continue in the dark .We can indeed observe the economy, but our language for it, our labels for it, and our understanding of it are all frozen by the great flares that have lit up the scene, and in particular the last great set of flares.”

To develop a little bit more on the idea of elimination of waste and unnecessary material in a system, I will leave you with this nice video link guys. Matthew May is an author of 2 no. books, on ideas he found and learned in the Toyota company. May talks about his book, in pursuit of elegance.

One of May’s key influences in looking at how Toyota do their business, was Jim Collins the management guru.

Donal Casey published the above opinion piece in the Irish Times lately, which is loosely based on Collin’s ideas too.

@ Chris Johns

Indeed compared to Western economies Chinese investment appears to be super-abundant. But there is no a priori limit on either the savings rate or on the growth of investment. Given that investment is the main determinant of future growth, the outlook for the Chinese economy looks exceptionally positive. They have alreday begun to correct the domestic imbalance by increased consumption of public goods, so for example, intend to initiate a universal public health system within 10 years.

Interestingly, so too does President Obama (in even shorter order). Without quibbling over the details, both are highly laudable aims; the production of a public good at a lower cost than the private sector is able to achieve.

But Obama is attempting to do this against a background of stagnating US national savings and investment at very low levels. That is problematic, to say the least. And highlights the source of the ‘global’ imbalance. China had what now appears to be a very large but temporary c/a surplus. But the US appears to have a permanently large c/a deficit. One effect is that the Chinese, or Asian Model was more resilient in weathering the recession, and recovery has more quickly gathered pace.

“China has emerged as the most significant winner from the global financial and economic crisis. “:-

Meanwhile, Ireland’s investment collapse approaches Great Depression proportions and a current account deficit beckons with any renewed upturn in import demand.

@ Mark

“Meanwhile, Ireland’s investment collapse approaches Great Depression proportions and a current account deficit beckons with any renewed upturn in import demand.”

You seem to imply that the collapse in investment is very heavy in the productive sector of the economy. Do you have any statistical basis for this?

The CSO provides a breakdown of imports by main use, (go to database direct: Value of Merchanise Imports by Main Use by Month, Area of Origin and Statistic). It shows that the import of capital goods has been weak, though it is hard to see the dramatic decline that you are talking about. When you conisder that the house building industry at its height must have been a significant importer of capital goods, which is capital investment we won’t have back (or want back at that scale), then the capital imports data starts to look a bit resilient. There appears to be a genuine adjustment in the CA, driven by falling demand for final consumables.

@chris johns

Morgan Stanley economists say that service consumption is underestimated, in particular housing.

The fear of incurring high health care costs because of the poor public health service, has been cited in recent times as a concern among the emerging middle class.

Pay levels remain very low for migrant workers.

In the southern industrial heartland of Guangdong, a supervisor with 10 years experience and with responsibility for dealing with export customers, can earn $350 a month; a factory operative would earn up to $150.

Living conditions would generally be very primitive.

In Malaysia, a factory operative from Nepal, working 12 hours per day (including overtime), could earn $280 a month for a 7 day week –  – 84 hours.

@ Ronnie O’Toole

GFCF fell by over 52% between Q1 2007 and Q1 2009. Within that investment in dwellings fell by 69% and other buliding and construction fell by 48%. Machinery and other equipment fell by 68% to Q4 2008 -CSO.

Imports in August were 33.5% below the seasonally adj. peak in Feb. 2007, while exports were 12.3% below the March 2007 peak. Machinery & equipment imports fell by a 23% in the first 6 months of this year compared to 2008 while office equipment fell by 28%.

Any pick-up in import demand from exceptionally depressed levels will have a negative impact on the current accont balance. The current account was already in deficit in Q2, by €1.2bn despite a large trade surplus of €9.3bn, due to a large and growing deficit on the investment income account of €7.7bn, itself a reflection of the huge rise in external indebtedness.


Any impact on export demand will obviously have the opposite effect, and the forecasts that I have seen (e.g. ESRI) expect the emergence of a substantial surpus, as Irish consumption won’t bounce back in the same way as it will in the rest of the world.

Capital acquisition by industry fell 30% in H1 2009 compared to H1 2008, consistent with the measured fall in imported capital goods. My point is you are pointing to data dominated by non-productive capital investment, and hinting (only hinting though) that somehow productive capital investment has also stopped, which isn’t true, though it is a lot weaker.

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