Living with Global Imbalances

Over the years, the Brookings Panel has focused overwhelmingly on the U.S. economy. That emphasis reflected the principal interests of its founders, Arthur Okun and George Perry. The United States is by far the largest economy in the world, accounting for a quarter to a third of global output, so understanding the U.S. economy is important. And this economy is rich in data. But that still leaves over two-thirds of the world economy. The Brookings Papers has made excursions into this area from time to time. At various points Europe, Japan, and most recently China have been addressed. There was a flurry of interest in the transition economies some years ago, in the international financial crises of the mid- to late 1990s, and more rarely in developing countries more broadly.

The U.S. economy and the economies of the rest of the world intersect through international transactions. These have received more attention in the Brookings Papers, although again largely with a U.S. focus. I will address this intersection with respect to the large global imbalances that exist today, although I will deviate from the usual practice here by adopting a rest-of-the-world rather than a U.S. perspective.

In this brief paper I want to cast doubt on two related propositions that are widely accepted as truths: that Americans save too little, and that the U.S. current account deficit is unsustainably large, risking a disorderly adjustment that would be damaging to the world economy in the relatively near (but usually unspecified) future. These remarks should not be treated as new truths, but as plausible alternative hypotheses about how the world works these days, how we reached our current circumstances, and what the future may bring.

U.S. National Saving in Perspective

I begin with U.S. saving because I will say less about it. The question of whether Americans save enough relates to the broader topic of global imbalances through the national accounts identity linking the current account deficit to the difference between domestic investment and national saving. A current account deficit cannot be reduced without reducing the excess of investment over saving. Few argue that the United States should invest less (except perhaps in housing during the housing boom, or in routers and fiberoptic cable in the technology boom), which implies that if the U.S. current account deficit, around 6 percent of GDP in recent years, is to be reduced, national saving—the sum of private and public saving—must be increased. If, as some analysts suggest,¹ the current account deficit should not exceed 3 percent of GDP, and if investment is to be protected, then saving must increase by 3 percent of GDP, or from 13 percent of GDP to 16 percent in terms of 2006 shares. I will refer to gross saving and investment throughout, as is appropriate in a world of rapid technological change. "Replacement" investment is typically technologically superior to its predecessor, and in any case a well-run firm will evaluate all large investments afresh, moving depreciation allowances into new activities if that is economically appropriate. Thus gross saving can be considered as available for new allocation.

The U.S. current account deficit has grown over the last decade or so, from 1.5 percent of GDP in 1995 to 6.1 percent in 2005 and 2006.² Such growth implies a widening gap between saving and investment. Investment rose in the late 1990s, as did government saving as the federal budget moved into surplus; meanwhile private saving declined. In the early 2000s investment declined, but public saving declined even more, by an extraordinary 6 percent of GDP between 2000 and 2004, as a result of recession, federal tax cuts in 2001 and 2003, and increased expenditure for the military, for homeland security, and under other headings. Private saving recovered somewhat with the growth in corporate earnings from 2001 to 2005, despite a continued decline in recorded household saving.

Ratios of U.S. saving and investment to GDP have been below those in other rich countries and in some poor countries for...