G-20 and rebalancing

The latest summit has an incredibly ambitious agenda. Reallocating voting rights in the IMF is small potatoes compared to the US "Framework for Sustainable and Balanced Growth." This involves the US saving more and cutting its budget deficit, Europe doing more to boost business investment, and China relying less on exports and more on domestic demand for growth.

I really don't understand the logic of this sort of coordination. Did the global imbalances contribute to the financial crisis and the resulting deep recession? Only in a second order manner, and not as an inevitable consequence. My colleague Mike Dooley argued that it was a natural process. China is using export led growth because consumers in the US and Europe are richer -- what better way to grow faster than making things that relatively rich people want (even if they are middle class by home standards)? The Japanese did it too. The US went after them too, back in the 1980s. Now they are not villains any more (even though they are running up current account surpluses still). Mike Dooley explained the process as one of the Chinese lending the US money to buy their goods -- a standard technique for boosting sales. Car companies in the US also made a lot of money for a while through financing their cars. Mike also reckoned that the US was the natural place for money to flow into, and through, because of the sophistication and safety of its system of financial intermediation.

That's where it went wrong -- the US financial system was not all it was hyped up to be. Poor regulatory enforcement and poor institutions undermined the good parts of the system. Essentially, foreigners were supposed to be parking money in the US for safety, but Wall Street found a way to effectively steal some of that money. It may also be that, like democracy, Wall Street is terrible, but still much better than the alternatives. In any case, none of this has much to do with global coordination.

Global coordination of some aspects of financial regulation makes sense, to prevent a race to the bottom, but different growth rates, levels of development, and domestic political compulsions are always going to lead to some imbalances. Households and firms sometimes go heavily into debt, at other times they save -- intertemporal exchange is a fact of life in market economies. The point is to make sure that equilibrating mechanisms such as exchange rates and interest rates do their job.

I don't think trigger mechanisms and punishments are a workable mechanism for a grand global coordination of macroeconomic policies. It's hard enough to keep the world trading system in order. Interestingly, the US seems to be one of the keenest for extending trade system rules and penalties to labor standards, environmental standards and the like.

The ostensible worry is about growth, and certainly crises cost a big chunk of output. But I think some careful, limited rethinking and redesign of financial regulations (and modernization of archaic, anti-competitive Wall Street institutions) should be enough. If the US really wants growth, it should be pushing technology transfer and innovation into the developing world as rapidly as possible. With that will come institutional innovations in developing countries. Domestic demand will take care of itself. Innovation is the lever of riches, and that's where the US could do so much more. The US should be sending dozens of Norman Borlaugs out into the developing world to deal with deficits in energy production, sanitation, health, education and a host of other constraints on growth.

The developing countries in the G-20 should rebalance the global agenda away from the US's short-term preoccupations, and towards what matters for global growth and well-being.