Rebalancing the Global Economy

This just in: caterpillar—the maker of earthmoving equipment, including bulldozers and monster mining trucks—reported first-quarter profits of 55 cents a share, up from a loss of 19 cents a year earlier. More important, the improvement stemmed heavily from surging demand in developing countries. Although machinery sales dropped in North America and Europe, they rose by 40 percent in Asia and 7 percent in Latin America. With more exports, Caterpillar is hiring again. The U.S. job increase, though only 600, reverses the roughly 10,000 layoffs since late 2008 that had reduced CAT’s American workforce to about 43,000.

What is significant about this is that it suggests a “rebalancing” of the global economy. The world needs an en-gine of growth to replace free-spending American consumers and their appetite for other countries’ exports. Greece’s problems are a harbinger; advanced countries can no longer borrow their way to prosperity. Hence, rebalancing. Developing countries, especially in Asia, that pursued export-led growth would shift to domestic spending. The debt-ridden American and European economies would rely more on exports to these countries. Almost everyone, even China, favors rebalancing in principle. But can it happen?

By some measures, it seems underway. China, India, Brazil, and many “emerging market” countries escaped the worst consequences of the Great Recession. Their economies are generally growing much faster than ours (almost 6.5 percent annually in 2010 and 2011, compared with a 2.9 percent rate for the United States, reckons the International Monetary Fund). This boosts their demand for the advanced equipment, instruments, and basic industrial supplies (chemicals, coal) that constitute two thirds of U.S. exports. Of Boeing’s 3,350-jet backlog, three quarters (77 percent) will go to foreign customers.

Domestic spending is strengthening in these countries, as incomes and tastes expand. In 2002 consumption spending in developing countries was 23 percent of the world total, and the U.S. share was 36 percent, estimate economists David Hensley and Joseph Lupton of JPMorgan Chase. By 2008, developing countries were 32 percent, the United States 28 percent.

This is classic economic catch-up, as poor countries adopt the products and technologies of rich countries. It’s a two-step process, says economist Arvind Subramanian of the Peterson Institute. “First, countries have to cross the Hobbesian threshold”—that’s after philosopher Thomas Hobbes (1588–1679), who declared that life without strong government is “nasty, brutish, and short.” Governments must provide security and sanitation, create some rule of law, and establish protections for property, says Subramanian. Otherwise, the stability doesn’t exist to pursue step two: allowing markets to work; practicing economic virtues (controlling inflation and government budgets).

Parts of Africa and Latin America still haven’t crossed the Hobbesian threshold, says Subramanian. But elsewhere, many countries (China and India, most spectacularly) have reaped the rewards of moving to step two.

So is rebalancing going according to script? Well, not necessarily. True, massive trade imbalances have dropped sharply. The U.S. trade deficit fell from $760 billion in 2006 to $379 billion in 2009; China’s trade surplus also contracted. But these changes mostly reflect the Great Recession. As the slump worsened, people and companies stopped buying. Global trade collapsed—and with it the size of imbalances. But as the recovery has strengthened, trade and imbalances are growing again.

What’s missing is a sizable revaluation of China’s currency, the renminbi. Fred Bergsten of the Peterson Institute thinks the renminbi may be 40 percent undervalued against the dollar. This gives China’s exports a huge advantage and underpins its trade surpluses. Other Asian countries fear altering their currencies if China doesn’t change first. “They’ll lose ground to China,” notes Hensley. The European Union, Brazil, and India all feel threatened by the renminbi. President Obama wants U.S. exports to double in five years. That’s probably unrealistic, but it’s impossible if the renminbi isn’t revalued.

“It’s the single most important tool we have to increase exports and decrease imports,” says Scott Paul of the Alliance for American Manufacturing, a business-labor group. True. The global economy is at a crossroads. Will it muddle through? Or will every nation’s desire to maximize its own production and employment unleash self-defeating protectionism and nationalism?