What has been the experience of economies that decided to transition out of large and sustained current account surpluses? What policies worked best? Answers to these questions will help policymakers in economies with large surpluses adopt the best policies to rebalance their growth, as global demand for their exports is likely to be weak and large surpluses are creating tensions with their trading partners.
Global imbalances narrowed sharply last year, but a strong and sustained global recovery requires that this narrowing be made more durable. As demand in countries with large external deficits before the crisis is likely to be weak, a key challenge facing large surplus economies is to rebalance growth from external demand to domestic demand. However, policymakers in these economies may hesitate to adopt policies to help rebalance demand because of concerns that this could slow economic growth. Are these concerns justified?
While there is a vast literature that examines transitions from large current-account deficits, very little is known about past surplus reversals. To fill this gap, we have examined the experience of countries that made a policy-induced transition away from large, sustained current-account surpluses (Abiad et al. 2010). In particular, we look at 28 surplus reversal episodes in advanced and emerging market economies over the past 50 years. The methodology for identifying surplus reversal episodes mirrors those used to examine deficit reversals (Milesi-Ferretti and Razin 1998 and Freund and Warnock 2007).
Despite a sharp narrowing of the current account, surplus reversals were not associated with lower growth in output or employment. Output growth in the three years following the start of a reversal was, on average, higher than in the preceding three years by 0.4 percentage points, although the change was not statistically distinguishable from zero. Perhaps more importantly, the quality of growth in these economies improved. Demand frequently shifted from external to domestic sources, with rising consumption and investment offsetting a fall in net exports. Moreover, the level of employment increased slightly as the increase in employment in the non-tradables sector more than offset the decline in employment in the tradables sector. This finding contrasts with the output growth slowdown observed during deficit reversals.
Figure 1. Output and employment growth during surplus reversals (percent)
Source: IMF staff calculations. Note: Figure reports average growth of real GDP per capita and employment in the three years before the reversal and the three years starting with a reversal. An asterisk indicates that change in growth is statistically significant at the 10% level. "Policy-induced appreciation" denotes cases in which there was a policy-induced appreciation of at least 10%. "Macroeconomic stimulus" denotes cases in which there was fiscal or monetary stimulus.
What factors are behind this result?
Although real exchange rate appreciation itself seems to have slowed growth, other factors tended to offset this adverse effect. In many cases macroeconomic policy stimulus boosted domestic demand. In some cases, exporters regained their competitiveness by improving the quality of their products. Lastly, improvements in global demand and terms of trade helped in a number of episodes.
Importantly, the best results were achieved when real-exchange-rate appreciation was accompanied by macroeconomic stimulus and structural reforms that addressed underlying saving and investment distortions. In some historical cases, however, macroeconomic stimulus was kept in place for too long, leading to overheating of the economy and resulted in asset price booms.
Figure 2. Contributions to growth (percentage points before and after reversal)
Source: IMF staff calculations. Note: Because of limited data availability, the size of the sample is 26 observations for the demand-side decomposition and 20 observations for the factor-input decomposition.
Policy-induced surplus reversals are accompanied by demand rebalancing – from net exports to consumption and investment. At the same time, employment and capital contributions increase, while total factor productivity falls slightly. None of these changes, however, are statistically significant.
What are the lessons for economies wanting to transition out of large surpluses?
There are three key lessons.
- First, a surplus reversal need not undermine growth. The average effect on output growth and employment is small, and the quality of growth improves – there is a better balance between external and domestic demand, and between growth in the tradables and non-tradables sectors.
- Second, although exchange-rate appreciation played a key role in many surplus reversals, the best results were achieved when appreciation was complemented with macroeconomic policies that supported domestic demand and, in some cases, structural reforms that addressed distortions that gave rise to the large current-account surpluses.
- Finally, macroeconomic stimulus should be gradually withdrawn to avoid overheating the economy and fueling asset price booms.
The views expressed in this article are the sole responsibility of the authors and should not be attributed to the International Monetary Fund, its Executive Board, or its management.
Abiad, Abdul, Daniel Leigh and Marco E Terrones (2010), “Getting the Balance Right: Transitioning out of Sustained Current Account Surpluses”, World Economic Outlook, Chapter 4.
Freund, Caroline and Frank Warnock (2007), “Current Account Deficits in Industrial Countries: The Bigger They Are, the Harder They Fall?” in Richard Clarida (ed.), G7 Current Account Imbalances: Sustainability and Adjustment, University of Chicago Press.
Milesi-Ferretti, Gian Maria, and Assaf Razin (1998), “Current Account Reversals and Currency Crises: Empirical Regularities,” NBER Working Paper 6620.