The world witnessed a large build-up of current account and merchandise trade imbalances, both in absolute and relative terms, prior to the global financial and economic crisis (see Table 1 and Figure 1). Current account/merchandise trade surpluses were most pronounced among the East Asian economies (e.g. China), oil exporters (e.g. Saudi Arabia) and the ‘core’ Eurozone countries (e.g. Germany). The US and the Eurozone periphery countries had large and persistent deficits. While imbalances contracted after the crisis, they remained large both in absolute terms and in relation to GDP. Even after falling from its peak in 2007, the US merchandise trade deficit amounted to $783 billion in 2011, about 5% of its GDP.
Table 1 Current account balance, selected countries: 2000-11
Source: World Economic Outlook Database (October 2012).
Figure 1 Global merchandise trade balances, 2007
Complexity and failures in global governance
A number of papers have linked these large imbalances to misaligned exchange rates – i.e., exchange rates that are above or below their equilibrium level – and proposed the use of WTO sanctions as a deterrent (Hufbauer et al. 2006, Matoo and Subramaniam 2009, Goldstein 2010). We have a more nuanced take on the issues than these authors (Marchetti, Ruta and Teh 2012).
- The relationship between exchange rates and the trade balance is far more complex than assumed in these papers.
- The persistence of the imbalances is a manifestation of a failure in global governance on a range of policy issues beyond exchange rate policy – macroeconomic, financial, and structural.
- While we agree with other authors that the WTO has a role to play in global rebalancing, we see the WTO's role rather differently.
The WTO can help reduce imbalances through greater market opening in services trade and government procurement – an issue often overlooked in the current debate. Services liberalisation could help address some of the structural factors contributing to the build-up of current account surpluses. In addition, many of the countries with large merchandise trade deficits, which have obtained the lion’s share of attention, also have significant surpluses in services trade (see Table 2). These countries can move towards greater rebalancing if given better market access in services. Moreover, investment in infrastructures, a key priority for many emerging economies in the years ahead, will represent an opportunity for rebalancing as long as increasing public spending may be accompanied by opening up government procurement markets (see Jensen 2012).
On the other hand, the often invoked WTO-triggered sanctions can be a meaningful tool for rebalancing only on condition that there is international cooperation to deal with all the contributing factors to the imbalances. We do not believe, however, that trade sanctions alone would compensate for the weaknesses in global governance in macroeconomic, exchange rate and structural policies1.
Table 2 Services trade balance, selected countries: 2007-11
Source: WTO Secretariat and World Economic Outlook Database (October 2012).
Note: Based on balance of payments data.
What is the problem with global imbalances?
Imbalances reflect international differences in aggregate savings and investment behaviour. In the absence of market imperfections and distortions, they allow a more efficient allocation of savings globally. However, some of the identified causes of the imbalances leading up to the crisis appeared to mirror imperfections and distortions that had built up in both surplus and deficit countries. These include financial repression and poorly regulated financial markets; weak social safety nets; inflexible product, services and factor markets; large fiscal deficits; and exchange rate misalignment.
These imbalances created systemic risk in the global economy by leading to low interest rates and to large capital inflows into US and European banks, which in turn contributed to a search for yield, higher leverage, and the creation of riskier assets. Should the financial flows associated with current account imbalances suddenly reverse course, economies with large deficits will suffer disorderly currency depreciations, and financial sectors might also struggle to efficiently absorb the financial inflows that are the counterpart to the current account imbalance (Blanchard and Milesi-Ferretti 2009).
This analysis implies that the economic conditions that bred the imbalances need to be unwound. Furthermore, the existence of systemic risks means that individual countries may not be fully taking into account the cost of the distortions nor the benefits from rebalancing, which means that any solution will require international cooperation.
The role of multilateral trade cooperation
The WTO's market opening efforts in services, especially in the area of financial services, and in government procurement can contribute to rebalance the global economy by reducing policy-related distortions and market imperfections in surplus countries and by providing better market access to deficit countries.
Let us give few examples.
- In the case of China, the WTO can provide a suitable forum for ending financial repression by negotiating and implementing financial sector reforms, in particular those dealing with the elimination of market access barriers (e.g. foreign ownership restrictions, limitations on business scope) and the creation of a level playing field between domestic and foreign financial service suppliers.
- With respect to Germany, a broad reform agenda, for services and for the financial sector in particular, could improve productivity growth in the services sector and enhance incentives to invest, increasing potential output and income and thus consumption.
- For Saudi Arabia, opening its domestic procurement market, combined with increased public spending, could increase imports (while ensuring at the same time an efficient allocation of public sector's resources), thus helping reduce the current account surplus.
While currency misalignments can have trade effects and, therefore, affect the rebalancing of the global economy (Auboin and Ruta 2011), the current debate on the role of the WTO dispute resolution in these matters seems to miss an important point on the nature of exchange rates. Currency misalignments are caused by a multiplicity of factors. For example, while both high foreign reserve accumulation and aggregate savings may lead to currency undervaluation, there is an essential difference between the two causes of the misalignment. The first is a policy action under the direct control of the monetary authority, while excess savings are influenced by structural conditions (such as the lack of adequate social security) that a policymaker can only change in the medium term. More importantly, correcting these macroeconomic and structural distortions uniquely through the multilateral trade system does not seem efficient from a global governance perspective.
The simple reason is that the root cause of such distortions is not trade itself. Rather, trade is simply the channel through which distortions spill-over into other countries.
The need for a broader approach
In our view, the first-best solution would be a broad international effort to coordinate macroeconomic, exchange rate and structural policies to deal with the causes of imbalances. All the policies, regulatory weaknesses and structural features that created the imbalances need to be examined. Both surplus and deficit countries need to contribute to rebalancing. While steps have been taken in the context of the G20 to identify and monitor policies that are at the root of imbalances, the failure of international cooperation so far to systematically address these problem areas reflects a ‘coherence gap’ in global governance. In the context of a broad system of rules to address imbalances, a general efficiency argument could be made for the use of sanctions to enforce cooperative behaviour. WTO-triggered trade actions on exchange rate misalignment could be one tool in this enforcement toolkit. But other tools, i.e. non-trade sanctions, need to be there as well so that enforcement is made more effective. Examples include the idea of taxes on new debt or on all new financial instruments issued by deficit countries who fail to take steps to rebalance (Krueger 2010) or financial penalties along the lines of those envisaged in the EU for surplus and deficit countries.
Operationalising WTO sanctions may require negotiations to develop a new rule or to clarify and strengthen existing ones. This is because, while there are existing GATT and GATS rules on balance of payments and exchange action, they have seldom been invoked and there is very little jurisprudence about them. Some attribute this to the legal ‘vagueness’ of the provisions (Hufbauer et al. 2006). This may explain in part why members have resorted to ‘ad hoc’ measures (e.g. anti-dumping, safeguards and countervailing duties) whose use appears to be closely linked with episodes of real exchange rate appreciation (Knetter and Prusa 2003, Bown and Crowley 2012). However, these are imperfect substitutes for an efficient exchange rate rule because other conditions are required to invoke them (e.g. the existence of dumping and subsidies) and they do not alleviate competitive pressures in third country markets.
To conclude, there exists a first-best policy response to the hazards posed by large and persistent trade imbalances. This first-best response consists of expanding and deepening (multilateral) institutional mechanisms that allow governments to correctly internalise the costs of existing distortions and the benefits from rebalancing. The WTO has a clear-cut role in this international effort, reducing the build-up of surpluses by contributing to making financial markets and government procurement more efficient and by deterring countries from either free-riding or defecting from the cooperative outcome.
Authors’ note: The views expressed here are those of the authors and do not necessarily represent those of the institutions with which they are affiliated.
Auboin, M and M Ruta (2011), “Currencies and Trade: Looking at the Recent Literature”, VoxEU.org, 13 November.
Blanchard, O and G M Milesi-Ferretti (2009), "Global Imbalances: In Midstream?", IMF Staff Position Note, SPN/09/29.
Bown, C P and M A Crowley (2012), "Import Protection, Business Cycles, and Exchange Rates: Evidence from the Great Recession", World Bank Policy Research Working Paper, 6038.
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Knetter, M M and T J Prusa (2003), “Macroeconomic Factors and Antidumping Filings: Evidence from Four Countries”, Journal of International Economics, 61(1), 1-17.
Krueger, A O (2010), "Persistent Global Imbalances", in Stijn Claessens, Simon Evenett and Bernard Hoekman (eds.) Rebalancing the Global Economy: A Primer for Policymaking, Centre for Economic Policy Research (CEPR), 185-190.
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1 The term "sanctions" stands for "suspension of concessions and other obligations under the covered agreements" of the WTO's Dispute Settlement Understanding (DSU).