Comments and Discussion

Willem H. Buiter:

This paper by Olivier Blanchard and Francesco Giavazzi addresses two distinct issues. The first concerns the behavior of the current account in a country that is undergoing greater international financial and trade integration while, starting from low levels of productivity and income per capita, catching up with, or converging on, the higher productivity of its main trading partners. The paper argues, from both theoretical considerations and empirical observation—based mainly on the experience of countries that have joined or are about to join the European Union and Economic and Monetary Union (EMU)—that convergence plus greater international integration means larger current account deficits in these countries.

This issue is of particular interest to me because of my recent work in and on the Central and Eastern European candidate countries for EU accession. These ten countries moved very swiftly from almost perfect financial and trade autarky vis-à-vis the market economies outside the Soviet bloc to a high degree of international financial and trade integration with the West. They also started from low levels of income and productivity per capita. In quite a few of these countries, especially the Baltic states, large and persistent current account imbalances fit the authors ' story—that of catch-up, integration, and (a worsening) current account, or CICA—quite well.

Second, the paper argues that, as financial and trade integration proceeds among a group of countries, we should see a greater uncoupling of national saving from domestic capital formation. The Feldstein-Horioka puzzle becomes less puzzling. This applies not only to poorer, less developed countries but also to countries at comparable levels of development and income per capita.

My comments will deal only with the CICA nexus. Unlike the Feldstein-Horioka puzzle, the CICA nexus has important policy implications, relating to the assessment of whether current account imbalances are sustainable. As regards Feldstein-Horioka, I will only state the view that running regressions of the investment rate on the saving rate is one of the more pointless exercises in open-economy macroeconometrics, even when the regression includes time-varying parameters. There must be fifty different ways to account for changes in the contemporaneous correlation between saving and investment. No matter what pattern one finds in the data, the questions "and?" and "so what?" are unavoidable. For instance, a country could have a perfect positive correlation between saving and investment while running a persistent current account deficit of 25 percent of GDP. And? So what? I will show that, in the authors' model, perfect international financial integration will produce a current account balance that is always zero. Of course, the current account is likewise always zero if there is no international financial integration at all.

Catch-Up, Integration, and the Current Account.

Rather few explicit theoretical underpinnings are available to constrain the estimating equations that can be taken to the data, and part of what is available does not get used in the authors' specifications. Only household saving is modeled, and the current account surplus as a fraction of national income is the same as the household saving rate. Household saving is driven by the gap between current income and the present value of future income (or between current income and permanent income). Because the logarithmic utility function used by the authors has exactly offsetting income and substitution effects, a lower interest rate reduces saving only through a valuation effect: a lower discount rate increases the present value of future income, as long as future income is positive.

Formally, consumption in period 1 by residents of country k is given by

where W^k₁ is the present value in period 1 of household lifetime resources in country k.¹ Let Y_j,k, j = 1,2; k = 1,…, N be the endowment in period j of country k (that is, country k's GDP) and P_j,k the price of that endowment in terms of the composite consumption good. With a completely non-diversified portfolio of real assets—the only case the authors consider—only residents of country k can possess title to country k's...