The Problems Associated with Global Imbalances

And what causes them

Consequences of global imbalances on the world economy

Global imbalances occur when a large surplus in one country causes a significant deficit in another. After contracting during the global financial crisis of 2007–8, surpluses and deficits have started to rebound. They cause economic development obstacles by depressing interest rates, promoting reckless borrowing and imposing demand drains.

Firstly, global imbalances cause problems for the development of the world economy as they depress interest rates and encourage reckless borrowing in surplus countries. Due to abnormally high savings rates during the 2000s, governments lowered interest rates to stimulate demand in the economy. As a result, low interest rates initiated lowering borrowing costs, causing firms and investors to take extra risks. It ultimately built up, especially within the housing market, and prompted the mortgage crisis in the latter half of the 2000s. This crisis rippled through the global economy, creating considerable dents in nations’ GDP and reversing the progress made up to that point. Hence, global imbalances cause problems for the development of the world economy by encouraging reckless borrowing and risk-taking, ending in financial crises.

Additionally, global imbalances cause problems for the development of the world economy as they result in the imposition of demand drains, the loss of economic activity due to large deficits that prevent the flow of spending abroad. It becomes an issue when policymakers have extracted maximum use from their policy tools, both monetary and fiscal, and run into a brick wall. Interest rates may hit their lower bound and become impotent, while the political constraints of the government may restrict additional fiscal policy decisions. The solutions to stimulate demand will become redundant, and the economy may experience persistently low demand and economic growth. Hence, global imbalances cause problems for the development of the world economy as they can exhaust policy tools to the point where they become ineffective, causing maintained periods of low economic growth.

Causes of global imbalances

In the short term, global imbalances fluctuate due to shifts in consumer demand or changing exchange rates, for example. Though in the long-term, some trends sustain. Countries like America have encountered persistent deficits, while China, for example, has endured a persistent surplus. There are some viable explanations for the causes of persistent current account deficits or surpluses within a country: the state’s credibility, government objectives, and the nature of its industries.

Firstly, a country may experience persistent current account surpluses or deficits due to the reliability of its government and central bank. The capability to repay government debt attracts inflows of money from abroad which count as imports. For example, the British government has never defaulted on its debt, so investors take assurance in the institution’s competency since the process of lending money is built on the foundations of trust. Some East Asian countries may not have the same status of repaying debt, or investors may have little confidence in their supremacy. Consequently, investors are unlikely to purchase securities from these nations, so their exports are lower than in distinguished states. Hence, countries with renowned governments are likely to undergo persistent deficits, while economies with governments in which people distrust are likely to experience persistent surpluses.

Furthermore, a country may experience persistent current account surpluses or deficits due to government aspirations. Policy aims may target surpluses or deficits. For example, in China, they hold considerable dollar reserves to suppress the yuan’s value against the dollar, supporting their world-leading export industries to accelerate growth. Hence, it is no surprise that they have persistently run a surplus on their current account as their currency is persistently undervalued, allowing the US to import more cheaply from China.

Finally, it is observed that countries running a deficit specialise in the export of high-value financial services, whereas countries running a surplus export visibles. Britain, for example, has a robust banking sector that exports its products across Europe and America, which maintains its large deficit. Contrarily, Germany is a leading manufacturing nation, exporting more physical goods and consequently running a surplus on the balance of payments. As spending on materials outweighs spending on services (poorer nations are unlikely to import complex financial services), the countries exporting goods are likely to have a positive balance on their current account due to higher demand. On the other hand, countries that predominately export services, which are consumed less by developing nations, are likely to run deficits. Hence, an individual country might experience persistent current account surpluses or deficits due to the composition of its exports.

To conclude, persistent deficits may be caused by significant inflows of money from investors that trust the government to repay their debts. They may also occur due to government policies, such as manipulating the exchange rate, that either help or hinder their exporting industries. The nature of trade and global demand for services vs global demand for goods also influences the persistence of surpluses or deficits.

The solution

As previously discussed, global imbalances result in problems for the world economy by halting economic growth, so governments must obtain a way to alleviate them to avert future crises and savings gluts. It can be achieved by targeting the source of the problem — global inequality. By cultivating poorer nations’ governments and institutional structures, investors will have more options for safe bond purchases, and technology will advance in developing nations. Hence, they will become active participants in global trade by attracting foreign investors and increasing demand for complex services, reducing the disparities between global trade imbalances.

Therefore, the answer to this global issue is to incorporate developing nations into the modern economic environment.

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Ted Jeffery

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A student passionate about economics and how the world works. New blog post every Monday.

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Ted Jeffery

Ted Jeffery

A student passionate about economics and how the world works. New blog post every Monday.

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