The Problem Is That No One Wants to Invest

There is another way to look at policy options regarding global imbalances than the one that predominated at the G-20 meeting in November. In Seoul discussions were focused on fiscal adjustment by the current account deficit countries and currency appreciation by the surplus economies. That cast the negotiations once again in the long-familiar terms of the spendthrift Americans contending with the miserly East Asians-that is in terms of relative national savings rates, or their converse, rates of consumption.

Yet the current account balance is defined by the difference between an economy's savings and investment, not just by consumption. Countries that invest more than they save import capital and, as a result, export either title to assets or accumulate debt-that is, run a current account deficit. In fact relative investment prospects are the primary driver of capital flows between countries, and thus determine the course of exchange rates and in turn movements in imbalances. Cross-national differences in investment demand vary far more over the business cycle, and are more consistently susceptible to policy interventions, than savings rates, which are predominantly driven by longer-term demographic and cultural factors.

Our analysis of policy options to resolve global imbalances therefore should concentrate at least as much on the investment side of the equation as on the savings/consumption side. This emphasis was largely absent from the discussion at the G-20, as it has been throughout the period of large US current account deficits. Revealingly, though, what got surplus economies really incensed was the supposed prospect of further quantitative easing in the United States leading to capital inflows. In other words it is the significant global shift in investment sentiment away from the Western economies, particularly-but not solely-the US, toward the major emerging markets, which is the pressing force for global adjustment.

Ultimately capital now wants to run back downhill toward growth prospects in emerging markets, because they look more promising than those in the developed economies over both the short and long term. Governments in emerging markets seek to defy that gravitational pull because in their view there are not enough investment projects at home to usefully absorb their domestic savings, let alone more savings coming from abroad. We have an excess of savings globally because there is insufficient demand to invest and governments are fighting over who gets stuck parking the world's money within their borders.

Yes, this is a variant of the "savings glut" argument of the early 2000s, now politically incorrect due to the desires to moralize against excessive consumption and to place blame for global imbalances on the weakened United States. The savings glut argument, however, also is valid in identifying the underlying source of the problem. If anything, it is all the more true today in the aftermath of the financial crisis than a decade ago for three reasons: (1) risk-averse and liquidity-preferring savers are increasing their savings on average while driving down the appetite for private investment; (2) the largely justified relative downgrading of US and other Western growth prospects pushes investment flows toward places that already have high rates of saving; and (3) policymakers' desires to reverse macroeconomic stimulus undertaken in response to the crisis tends to further diminish investment demand, at least in the short run. While inflexible, undervalued exchange rates do impede adjustment of imbalances, the underlying need for adjustment arises from the crisis' impact on investment demand globally, and on the relative attractiveness of the formerly booming regions for investment.

From this perspective, the G-20 policy agenda should shift its approach to resolving imbalances away from targeting current account levels via fiscal policies and potentially exchange rate interventions. Instead, the G-20 economies should be working to increase the rate of investment in the major emerging markets and the ability of rich country savers to invest in those economies. In the short term this means dealing with concerns about "overheating" and bubbles in China and elsewhere through structural and financial policies, rather than through monetary constriction. In the longer term, this means moving toward international agreement on investment standards and property rights for portfolio investors and private innovators, while deepening financial infrastructure in emerging markets.

This set of recommendations stands in stark contrast to the mistaken emphasis on capital inflow controls and on tightening of macroeconomic policy encouraged for some major emerging markets. Global savings need to be well and fully employed, and an increasing share of that productive investment has to take place in emerging markets. This is both a structural and an attitudinal issue for the major surplus economies, requiring solutions that address the property rights and transparency concerns that currently misallocate capital there and encourage a disproportionate share of it to flow abroad. Treating increased private cross-border investment as a threat instead will worsen global imbalances, thereby promoting instability and risk of international economic conflict. So doing would also diminish the future sustainable growth rate of the world economy, starting in those very emerging markets. Moreover, it risks locking in risk-aversion among savers, which will harm us all.