Monday, June 22, 2009

Alternative Approaches to solve Global Imbalances

The World Bank has proposed a provocative way to get the world out of recession: Expand developing countries aggregate demand. This really makes sense. Remember that current imbalances show that rich economies save too little, and emerging ones save too much.

Despite differences among emerging economies, one truth abides: imbalances must be corrected. There are three straightforward ways: either China, India, Brazil and alike consume more; the U.S. the U.K. Spain and alike save more; or both.

Some aspects of political economy in the second and third alternatives are important; they automatically imply that rich countries must renounce to some extent to its quality of life. Saving more resources imply consuming less, or as the basic economics lessons say: exchange more current consumption to get more future consumption.

The latter idea respects the same spirit as the World Bank's. According to this approach economic policy pulling aggregate demand should be seen, far more among developing countries than in rich countries. One setback of the World Bank's approach relies in the principal-agent issue. If rich countries are not credit worthy, then how a developing country can fulfill the lower-risk demand of financial markets?

The idea from the World Bank is clear, capital flows into emerging economies are just a quarter of what they just to be a year ago. Rich countries' currencies are appreciating, then higher risk aversion is a binding constraint in capital markets.

So there are at least two major obstacles to shift the power of aggregate demand from rich to emerging economies. However difficult, this would correct global imbalances, would also strengthen infrastructure in rich economies and would create jobs in developing ones. It will probably lower wages in the former and increase them in the latter. Sounds like a nice solution, if the loss of quality of life was not true. Unfortunately this sounds like a dead-end: there is not enough wealth for all countries in the world.

Neo-Classical theory states that further investment should be done in order to create wealth, this sounds like a feasible way out of the dead-end. The latter needs capital flows restored from rich to emerging economies, maybe this is a necessary endeavor the World Bank and the International Monetary Found will have to undertake.

1 comment:

Salvador Rodrigue said...

I think that the key factors to increase demand from developing countries would be: increase the role of financial markets in their economies (maily, stock markets and increase the banking services to provide mortgage loans and to purchases of durable goods),increase the quality of health services, increse public and private investments on infrastructure, etc. Without forget those actions to increase private and public productivity.