Structural reforms and global rebalancing

Without major structural reforms across the world current-account imbalances are likely to continue given the economic structure and demographic trends.

Current-account imbalances declined sharply during the crisis. A part of this improvement is likely to persist, after asset price bubbles have burst, that were fuelling the deficits in the United States and in several European countries. Higher saving rates and lower investment rates in those countries are likely to persist as measures are being taken to prevent the reappearance of bubbles. Fiscal consolidation in the large current-account-deficit countries, to the extent it exceeds that in the surplus countries, should also help limit the increase in global imbalances, at least in the short run. Another part of the recent narrowing of imbalances, however, was of a temporary nature and has already started to reverse. This reversal reflects the comparatively faster recovery in demand in large-deficit countries and the rebound in commodity prices. The unwinding of cyclical effects is also likely to lead to some increase in global imbalances: as all economies return to full capacity, both the US trade deficit and the Chinese trade surplus will increase. Thus, in the absence of changes to policies that affect international imbalances, global current-account imbalances are set to rise again.

Recent empirical work done at the OECD suggests that demographic trends will tend to further exacerbate global current-account imbalances in the medium run. It is the case in particular for both China and the United States, although demography should also reduce the surplus in Japan. In addition, based on past trends, catch-up in per capita incomes in many emerging and developing economies is not likely in itself to significantly reduce the scale of current-account imbalances in the absence of additional structural policy changes.

A baseline scenario, assuming only moderate fiscal consolidation across the OECD (more precisely, in which the fiscal stance would be progressively tightened in order to stabilize the debt to GDP ratio by 2025), foresees a widening of the US current-account deficit to about 4% of GDP by 2015 followed by a subsequent stabilisation, while the Chinese surplus would rise from about 4% in 2015 to about 5½ per cent of GDP in 2025. A recovery in oil and commodity prices would also bring about a rise in the current account surpluses of the main net oil-exporting countries. In Japan the net effect of the unwinding of cyclical factors and of ageing populations imply a surplus of around 2-3% of GDP going into the next decade. The current-account balance of the euro area would stabilise at about 1% of GDP, although much bigger imbalances would remain within the area.

In summary, under this baseline scenario of mild fiscal consolidation and otherwise unchanged policies, no significant rebalancing of growth should be expected and the overall scale of global external imbalances, though remaining below its immediate pre-crisis level, would edge higher over the medium term. The risks of a disorderly unwinding, including abrupt changes in exchange rates, would thus persist.

A variant policy scenario can be constructed, in which (1) more fiscal consolidation takes place in  the OECD, so that countries (except Japan) revert to their pre-crisis debt to GDP ratio by 2025; (2) these consolidation paths are sufficiently credible for expectations and thus relative prices to adjust as soon as fiscal plans are announced; (3) exchange rates are allowed to participate freely to the adjustment in relative prices; and (4) structural reforms are put in place in all countries with the double objective of enhancing domestic growth and contributing to a reduction in saving-investment imbalances.

Under this stylised alternative scenario, growth is reduced during the very first years, compared to the baseline, because of stronger and faster fiscal consolidation. But soon enough, the combined effects of stronger growth due to the structural reforms and of a lower debt burden due to faster consolidation result in a catch-up in growth and in GDP level. Compared to the baseline in 2025, public debt is reduced by 33% of GDP in the OECD, and by more than that in the United States (-54%) and in Japan (-50%). The current account imbalances are reduced by about 40%, with the US deficit down by more than 3 % of GDP and the Chinese surplus down by about 2½ %.  

The combination of structural reforms that would allow to obtain these favourable results, in addition to fiscal consolidation and sufficient exchange rate flexibility, include: (1) a strengthening of financial regulations and the elimination of distortionary tax-incentives toward homeownership in the United States; (2) higher spending on social welfare and an improvement in the functioning of financial markets in China and other dynamic Asian countries; (3) the easing of regulations in sheltered sectors in European surplus countries and in Japan; (4) more generally, reforms in the product and labour markets to boost productivity in Europe.

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