Stiglitz: What the IMF Must Do to Reestablish Legitimacy

Joseph Stiglitz says the IMF must identify the U.S. as the major cause of global imbalances in order to have legitimacy as an institution, and the U.S. must begin to reduce its budget deficit to address the problem:

The IMF's Problem Called America, by Joseph Stiglitz, Resource Investor, Business Day: The International Monetary Fund’s (IMF’s) recent meeting was lauded as a breakthrough, with officials given a new mandate for “surveillance” of the trade imbalances that contribute significantly to global instability. The new mission is crucially important, both for the health of the global economy and the IMF’s own legitimacy. But is the fund up to the job?

There is obviously something peculiar about a global financial system in which the richest country in the world, the U.S., borrows more than $2 billion a day from poorer countries - even as it lectures them on fiscal responsibility. So the stakes for the IMF ... are high: if other countries eventually lose confidence in an increasingly indebted U.S., the potential disturbances in the world’s financial markets would be massive.

The task facing the IMF is formidable. It will, of course, be important for the fund to focus on global imbalances, not bilateral imbalances. ... China can have a trade deficit with the Middle East and a trade surplus with the U.S., but these bilateral balances indicate nothing about China’s overall contribution to global imbalances. ... If one looks at multilateral trade imbalances, the U.S. stands head and shoulders above all others. Last year, the U.S. trade deficit was $805 billion, while the sum of the surpluses of Europe, Japan, and China was only $325 billion. So any focus on trade imbalances should centre on ... the U.S.

The task of assessing trade imbalances - whom to blame and what should be done - involves both economics and politics. Trade imbalances are the result, for instance, of decisions about how much to save and how much - and what - to consume. They are also the result of government decisions: how much to tax and spend (which determines the amount of government savings or deficits), investment regulations, exchange-rate policies, and so forth. These decisions are interdependent.

For example, huge U.S. agriculture subsidies contribute to its fiscal deficit, which translates into a larger trade deficit. But agricultural subsidies have consequences for China and other developing countries. Were China to revalue its currency, its farmers would be worse off...

This poses a dilemma for Chinese policy makers. Subsidising their own farmers would divert money from education, health, and development projects. Or China can try to maintain an exchange rate that is slightly lower than it would be otherwise. If the IMF is to be even-handed, should it criticise American farm policies or China’s exchange-rate policies?

Ascertaining whether a country’s trade imbalances are the result of misguided policies or a natural consequence of its circumstances is also no easy task. ... Moreover, a change in China’s exchange rate would do little to alter the multilateral trade deficit in the U.S. Americans might simply switch from buying Chinese textiles to imports from Bangladesh. It is difficult to see how a change in China’s exchange rate would have a significant effect on either savings or investments in the U.S. - and thus how it would redress global imbalances.

With the U.S. trade deficit the major global imbalance, attention should focus on how to increase U.S. national savings... While it is true that tax preferences might yield slightly higher private savings, the loss of tax revenues would more than offset the gains, thereby actually reducing national savings. There is only one solution: reduce the fiscal deficit.

In short, the U.S. bears responsibility both for trade imbalances and the policies that might quickly be adopted to address them. The IMF’s response to its new mission of assessing global imbalances will thus test its battered political legitimacy. ...

If the IMF’s analysis of global imbalances is not balanced, if it does not identify the U.S. as the major culprit, and if it does not direct its attention on the U.S.’s need to reduce its fiscal deficits, through higher taxes for America’s richest and lower defence spending, the fund’s relevance in the 21st century will inevitably decline.

Dean Baker has another perspective on the budget deficit and global imbalances in his comments on a NY Times editorial. He ends with:

An over-valued dollar, regardless of the cause, creates imbalances (i.e. trade deficits) that inevitably imply a painful correction process. The current over-valuation was not caused by budget deficits (remember, we had a huge budget surplus in 2000, when the dollar was considerably higher than it is now). The correction from the over-valued dollar is going to hurt regardless of what we do with the budget deficit. The price of imports will rise between 10-20 percent, raising the rate of inflation and reducing living standards in the United States.

There are good arguments for reducing the budget deficit, but it’s just silly to pretend that the pain from a falling dollar is attributable to the budget deficit, or that a lower deficit will somehow prevent this pain.