Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: Why is India moving towards full capital account convertibility, even though it knows about financial market volatility and the recent crisis?

Chandrasekhar: India has adopted a peculiar position on the issue of convertibility. Just before the East Asian financial crisis of 1997 broke, India was all set to make the rupee fully convertible on the capital account. A road map for full convertibility had been drawn up. This would have allowed residents in India to convert their wealth into foreign exchange and transfer it abroad. The crisis sent out a clear signal that this is bad policy and can pave the way for instability and even a currency crisis. That signal prevented the government from opting for such a misguided policy.

Since then Indian policy makers have been proud of the fact that cautious policies with regard to capital flows and financial integration had helped the country avoid financial crises and reduce the impact of the 2008 crisis on the country. Yet there is a strong segment of government opinion which is still in favour of full convertibility. This is only partly because of the beliefs (i) that India is “different” and can handle convertibility much better than other developing countries; and (ii) that convertibility is a requirement for India to move from developing to developed country status.

More importantly, it is the result of pressure from wealth holders within the country who want the option of transferring wealth abroad both to earn returns and hedge against any possible weakening of the rupee. That this could be at the expense of instability that undermines the living standards of the less well-to-do obviously does not bother them.

However, at the present moment, the problem India faces is one of excessive inflows of foreign capital, which is resulting in an appreciation of the rupee. Such appreciation adversely affects the competitiveness of Indian exports. Hence, there is a strong lobby that not only wants the central bank to intervene and stall rupee appreciation, but also to adopt policies that can moderate the surge in capital inflows. This is holding back the transition to full capital account convertibility for the time being.

Triple Crisis Blog invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: There has been a lot of discussion recently about the over-valuation of the Chinese currency. How do we know how much it is overvalued? What would the implications be for US and Chinese workers if the government were to decide to devalue it?

Chandrasekhar: The argument really is that the Chinese currency is undervalued (because it is pegged to the dollar through central bank intervention) and needs to appreciate so as to make the dollar prices of Chinese exports higher and the RMB price of Chinese imports lower.

This is expected to reduce China’s exports and increase its imports and correct the imbalance in the form of current account surpluses in China and current account deficits in the US (for example).

One difficulty with the “under-“ or “overvaluation” argument is that it presumes that there is some equilibrium exchange rate at which the deficit or surplus on the current account of a country’s balance of payments would equal some predetermined and acceptable level of inflow or outflow of capital. However, in a world where capital flows are substantial and free, no such equilibrium exchange rate can be presumed to exist, since uncontrolled capital flows themselves tend to affect the exchange rate of a currency.

The real issue in the Chinese case is, however, different. Capital and technology are freely mobile across borders but labour is not. As a result, some developing countries are becoming locations for production of manufactures aimed at global markets because they have surplus labour and low wage costs.

These countries, then, are characterized by global productivity levels but low labour costs. This allows transnational and domestic firms located in China to outcompete US and other developed country manufacturers in their markets. What the demand for an appreciation of the Chinese RMB amounts to is that currency adjustment rather than labour flows should be used to correct for the low unit costs of production in China. If such appreciation does occur it would have negative consequences for Chinese workers. But it is unclear whether this would serve the interests of US workers, since capital would possibly just migrate to some other low wage developing country which would now become the leading exporter to the US.

Triple Crisis Blog invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. This piece is based on a question from a reader on the over-valuation of the Yuan.

Martin Khor

The problem of global imbalances is widely seen as a major issue to be resolved if the world economy is to be on track for a sustained recovery.  And this problem is also usually discussed as arising from the economic relations between the United States and China.

In this view, the US has been over-consuming beyond its means, thereby having a large trade deficit, while China has been growing as a result of exports, thus earning large trade surpluses and investing them in US treasuries, thereby making the US over-consumption possible.

There are strident calls from US Congress members and economists for the Obama administration to take action against China, such as levy of 20% or more on Chinese imports, if it does not revalue its currency.

However, it is misleading to portray global imbalances as mainly or merely a US-China affair, or to imagine that a change in the currency levels between the US and China will get rid of the United States’ economic woes.

A more useful way of looking at the prospects for economic recovery is to view the main weakness of the global economy as one of a lack of global effective demand. We would then examine the sources of this deficient demand and see how demand can be appropriately boosted, while taking care not to build new financial bubbles and to prevent the types of financial speculation that helped create the financial crisis.

These are some of the themes covered by a recent paper by the South Centre, “Global economic prospects: The recession may be over but where next?” which is written by the Centre’s Special Economic Advisor Yilmaz  Aküyz  (formerly a Director at UNCTAD).

The paper  examines how the major economies—the United States, Germany, Japan and China  – are contributing to global demand, what their weakness are and what policies they should take.  The followinhg are some of its main points:

US has to adjust

The US economy (with its problems of high household debt and trade deficit) has to adjust. It has to tackle its over-consumption and increase exports to reduce the trade deficit. But this adjustment will cause its own problems for many developing  countries as it may result in increased interest rates (which are bad for  indebted countries) and a higher dollar (exerting a downward pressure on  currencies in developing countries in deficit, and on commodity prices).

Germany and Japan have to play a more positive global role

Much attention has been on the US-China relation, to the neglect of the role of Germany and Japan. These countries, like China, have been having large current account surpluses (7.5% of GDP in Germany and 4.8% in Japan, before the crisis).   They also have large trade surpluses with the US ($50 billion for Germany  and $75 billion for Japan).

The overall trade surplus of China (11% of GDP) and its trade surplus with the US ($270 billion) is higher. However the contribution of Japan and Germany to global demand and growth is much smaller than China’s and their reliance on exports is much greater.

Firstly, the real domestic value of China’s trade surplus with the US is  actually lower than the gross figure because there are a lot of imported   components in Chinese exports.  Thus in 2005, the trade surplus of China   with the US was $172 billion in conventional terms, but it was only $40 billion in value-added terms (the amount after deducting the import content of the exports of both counties).

In the same year Japan’s surplus with the US was $85 billion.  Since the foreign content of Japan’s exports is lower than the foreign content of US  exports, in value added terms Japan’s surplus with the US turns out to be higher than China’s surplus with the US.

Secondly, and more importantly, “Japan and particularly Germany have been  siphoning global demand without adding much to global growth.”  During 2002-07, exports grew 25 times faster than domestic demand  in Germany and 8.5 times in Japan while the figure is less than 3 for  China.

While exports contributed 34% to GDP growth in China, they contributed 50% to Japan’s GDP growth and 143% to Germany’s growth in 2002-2007.   In other words, even if there had been no export growth in China, the GDP     would still have enjoyed high growth, but without export growth Germany’s GDP would have fallen by about 1% a year during 2002-07.

Under-consumption is a major problem in Germany and Japan.  In Germany, there has been high unemployment and stagnant wages because of an over-focus on price stability.  In both countries, the share of wages has fallen, thus suppressing consumption.

These two advanced countries need to increase their contribution to global demand (and thus to the global recovery) by expanding their domestic consumption through faster wage growth.  Their increased domestic demand   and higher growth is needed to spur more imports and reduce their trade surplus, which would contribute to other countries’ exports and GDP growth.

China should adjust, but don’t expect it to be the world’s growth engine

China, through its high growth and its reliance on both its own domestic  demand and exports, has contributed relatively more than the two  industrial countries to global growth, the report implies.

However, China obviously also needs to adjust.  It cannot rely as much as  previously on exports and it thus has to generate domestic demand through    significantly increasing its consumption, whose share of GNP fell from 55% in the late 1990s to 36% at present.

Under-consumption is thus a major problem.  Consumption has to grow faster than both national income and investment in China in the future.  The significant fall in the share of wages would need to be reversed.

The report suggests a combination of policies for China — promoting higher wages, elimination of the gap between wage and productivity growth, increased  budgetary transfers especially to rural households, and increased public-sector  social spending.

However, even if China maintains its high GDP growth, it cannot be expected to become the locomotive for global growth.  This is because there are a lot of imported inputs going into China’s exports, whereas imports make up only 8% of China’s domestic consumption.

Consequently, a $100 shift in the composition of aggregate demand from exports to domestic consumption would reduce Chinese imports by some $40.  This has serious implications especially for South-east  Asian countries which supply a lot of the parts and components to China  for its exports.

The exchange rate issue

The report also comments on currency exchange-rates, an issue made topical by the high level of criticism of China’s currency policy by the U.S. administration and Congress members, and the threat to take trade measures such as an import surcharge on Chinese goods.

The paper says that exchange rates are an important issue in the  adjusting of global trade imbalances, but currency movements do not create  additional demand for the global economy.  They alter relative growth rates rather than raising the overall global growth.

Thus, currency movements cannot address the problem of global  under-consumption associated with sluggish wages.

A depreciation of the dollar against the Chinese currency could reduce Chinese exports and its trade surplus with the US, but would not increase  domestic demand and could even aggravate the under-consumption problem.  Thus the exchange rate is not an appropriate instrument to address under-consumption problem and excessive reliance on exports in China.

Dollar depreciation against the Chinese currency would also not address the root cause of the US problem of  over-consumption.  It is unlikely to produce significantly faster growth  of exports to China.  Even if it reduces China’s exports to the US, this may be replaced by imports from other developing countries as long as US consumers continue to live beyond their means.

The US has run current account deficits in the past four  decades regardless of the strength of the dollar against the currencies of its main trading partners, blaming Germany in the 1970s, Japan in the  1980s and now China.  The yen has been rising against the dollar during this period but this had no impact on the surplus of Japan with the US.

Thus, the paper concludes that: “The solution should be sought primarily in  national policies designed to address problems of over-consumption in the  US and under-consumption in surplus countries.”

Triple Crisis Blog invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: Do you think that carbon/pollution/energy taxes could be a mechanism that helps us reduce our use of fossil fuels, while bringing funds to the governments that need them to pay their climate debt?

Boyce: Pricing carbon – via taxes or permits – is crucial to reduce the use of fossil fuels. Taxes and auctioned permits are equivalent: the only difference is that taxes set the price and let the quantity of emissions vary, whereas permits set the quantity and let the price vary. Both yield revenues to governments.

But it is important to recognize where these revenues come from: carbon taxes or permit prices will be passed by firms to consumers. And because fuels generally are necessities rather than luxuries, carbon pricing will hit the poor harder than the rich as a percentage of their incomes. In other words, it’s a regressive tax.

From the standpoint of political sustainability as well as distributional fairness, it would be a mistake to rely mainly on carbon revenues to fund international transfers for climate change mitigation and adaptation. A cap-and-dividend policy (like the CLEAR Act proposed by U.S. Senators Maria Cantwell and Susan Collins) or the tax-and-dividend alternative (advocated by climate scientist James Hansen) would reverse the regressive impact of carbon pricing by returning most of the carbon revenue to the people as equal per-person dividends. Such a policy would affirm the principle of equal and common ownership of each country’s share of the atmospheric commons. Payments on the climate debt are another important element of policies to combat global warming. These transfers can and should be financed by progressive taxes, just like other government expenditures.

Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: Will we finally see an IMF/WB policy that truly acknowledges the rights of the poor and the least developed countries?  Will the reforms of the IMF/WB push for localization and food sovereignty as ways to face poverty?

Grabel: Certainly the IMF/WB have been discussing the poor and the poorest developing countries a good deal of late, especially in relation to the effects of the financial crisis on the most vulnerable. And some of the assistance packages that they’ve negotiated have paid somewhat more attention to the most vulnerable groups, such as pensioners (though concrete financial support for the most vulnerable groups has been pretty scant).

But whether the IMF/WB will move in directions that truly address the needs of the poor and the poorest countries is very uncertain at this point. Indeed, a good deal of the assistance funds provided by the IMF/WB during the current crisis have gone to wealthier countries, especially to struggling countries in Europe and not to the poorest countries in the world.

As far as the IMF/WB pushing for localization and food sovereignty in practical ways, well that, unfortunately, seems to me less likely in the foreseeable future.

Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: Do economists have a successor paradigm to the “invisible hand” theory, in which it is NOT expected that everyone should need to be employed? Perhaps something like Random Welfare, coupled with more environmental respect.

Nadal: First, the invisible hand paradigm should have been abandoned since 1974, when the Sonnenschein-Mantel-Debreu theorem was first published. This result showed that after 200 years, the invisible hand metaphor remained just that, a metaphor. There was never an invisible hand “theory” showing how, in the general case, equilibrium prices were formed. If this was a paradigm, it was more for ideological reasons than “scientific” superiority.

Second, in general equilibrium theory, and in mainstream macroeconomics, it is not expected that everyone needs to be employed. The initial endowment of resources may permit some agents not to seek a job.

Third, there are several alternative theoretical options vying for attention. Perhaps the important question is how to reconcile equity with environmental responsibility in monetary economies where uncertainty is important. Although the environment has not received adequate attention in post-Keynesian economic theory, I still think this is the best bet.

Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: What is the role of the EU in the changing economic environment of the world?

Grabel: A couple of triple crisis entries have dealt with the EU and its relevance for the development community.  See, e.g., here, here, here and here.

In connection with the specific question posted here, I’d add that how the eurozone ultimately navigates its current difficulties (ranging from the severe contractions being experienced by economies such as Latvia and Estonia; the uncertain state of Greek affairs, particularly involving whether the country will ultimately have to draw on the funds now promised to it by other European countries or perhaps by the IMF with which it is talking now; and whether countries such as Portugal, Spain, and Italy eventually follow down the same road as Greece) will have important implications for the pace of a global recovery, a European economic recovery, and for discussions in the developing world about the form and institutional structure of new regional financial architectures.

Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: The IMF and the World Bank claim that the only way to deal with the current crisis is through further liberalization. Aren’t globalization and free trade what caused poverty and global warming in the first place?

Gallagher: I’m not sure that these two institutions claim that “the only way” to deal with the crisis is through further liberalization. The IMF has just called for a levy on bank balance sheets and has cautiously endorsed capital controls to stem inflows of speculative capital. They also called for fiscal stimuli a year ago.

That said, the IMF’s general policy recommendation is for a “gradual and sequenced liberalization of the capital account.” This is a problem for developing countries. Kose, Prasad, and others show that capital account liberalization is not associated with economic growth in developing countries.

The Bank is different and has advocated more for trade liberalization as a partial solution to the crisis. Yet, as Tim Wise and I show in a number of policy briefs the World Bank itself estimates that the gains from trade will be less than a penny-per-person per day in 2015. Moreover, the Bank advocates for financial services liberalization under the WTO. This could be a real problem. A recent IMF report shows that the liberalization of FDI in financial services was associated with an accentuation of the financial crisis in developing countries.

There has also been a great deal of attention regarding the fact that trade and investment treaties will make it harder for nations to put in place regulations to prevent and mitigate financial crises. I have written two pieces on this: one regarding how the WTO and Bi-lateral investment treaties (BITs) may make it harder for developing countries to deploy capital controls; another on how BITS may make it more difficult to forge proper financial regulatory reform and manage sovereign debt restructuring.

In a nutshell, the claim that further liberalization will get us out of the crisis is unfounded. And, current liberalization commitments may make it more difficult to prevent the next crisis.

Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: The Financial Transfer Tax (FTT) has received a lot of notice in Europe but few mainstream economists in the US are engaging the issue. Is the FTT a realistic option and is it feasible?  How could it be implemented?  Is the IMF likely to include it in the paper they are preparing for the G20 on options to pay for the economic crisis?

Grabel: Many progressive economists and civil society organizations have come out in favor of a FTT. For example, on this blog, see discussion and references to studies of FTTs, and also see the discussion of a recent study of a FTT referenced in the Bretton Woods Update.

However, an IMF report (prepared as an interim report for the G-20) that was made available just yesterday on the BBC website reveals that the Fund is not throwing support behind a FTT, as many progressives hoped it would.  (See the IMF’s analysis of a FTT on pp. 15-18 of the interim report. The assessment it offers of a FTT seems far more measured than what we might have expected of the Fund, not least because it does not dismiss FTTs as being infeasible on grounds of administrative impracticality, a usual criticism of this policy.)

This same interim IMF report does propose two other kinds of taxes on financial firms that should cause progressives to be pleased.  Under the proposal, all financial institutions would pay a “Financial Stability Contribution” which is a bank levy (initially at a flat rate), and a “Financial Activity Tax,” which would be a tax levied on the profits and pay of financial institutions. These measures are designed to make banks shoulder at least some of the costs of future financial and economic rescue packages.

Robert Preston, BBC Economics Editor says of these proposals, “The proposals are likely to horrify banks, especially the proposed tax on pay.”  In my view, not exactly your grandfather’s IMF.  This shows again that despite the many reasons why we might still press the IMF for change in many dimensions, some of the ideas promoted by the institution are in fact changing — even if change is uneven, slow, and comes in fits and starts.

(Relatedly: see also my response to another question posed in the “Ask an economist” feature:  “Absolute poverty and increasing inequality remain serious issues in spite of WB/IMF development loans, even in countries with high economic growth…..? How can these organizations take steps to move away from the ideology of neo-liberalism towards developing scientifically-based economic policies that are pro-poor?”)

Triple Crisis Blog has invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: Would financial reforms that seek to de-link services and overturn Volcker’s rule present an opportunity for banks in emerging countries who still follow these principles to overtake their more established northern counterparts?

Vernengo: The preliminary question to be asked would be why banks in the developed world have an edge in the first place.  Credit creation and international trade in different periods have been for the most part denominated in a single national currency that functions as world money.  The pound had that role during the Gold Standard and the dollar since World War II.  The advantage of financial institutions in the hegemonic country derives from the fact that they lend in the world currency, and have access to a risk free asset (domestic government bonds) and a lender of last resort that can act on a global basis.

This is not the case in a developing or peripheral (emerging market was the term used by the neoliberals to sell the reforms in the developing world) country.  For example, the Fed recently pumped billions of dollars into the system, but in 2001 the Argentinean central bank was unable to do the same.

The Volcker rule would fundamentally reduce the size of banks in the US to restrict the perils associated with the “too big to fail” doctrine.  Wall Street banks oppose that rule fiercely, but it is not clear that breaking up banks would be sufficient to preclude the sort of activities that led to the crisis, as noted recently by Paul Krugman.

The risks associated with the functioning of a shadow banking system, unregulated by the government, will not be checked by Volcker’s rule.  Also, and more important for the question, Volcker’s rule will not directly affect the position of financial institutions in the center vis-à-vis their counterparts in the periphery.  The advantages associated with borrowing and lending in the hegemonic currency remains.  If a Brazilian firm wants to borrow in international markets (in dollars), the corporate bonds will still be sold by a Wall Street firm.

In that sense, what would be more threatening for the American institutions would be the demise of the dollar as the key reserve currency in the world economy.  Note, however, that even after the fall of the pound, and the unraveling of the British centered financial order, the City of London and its banks remained important players in global markets.