International Economic Policy

   

Germany’s economy is slowing by more than can easily be explained by the obvious slowdown in exports (see Gavyn Davies, who, to be fair, believes there were some one-off drags to German growth in h2 2018). Germany ended 2018 with a fiscal surplus of something like 1.75 percent of its GDP. Germany has under-invested in public infrastructure for years. See Alexander Roth and Guntram Wolff of Bruegel: "since the 2000s, Germany has exhibited very low and even negative public fixed net capital formation ratios—below most other European countries." And President Trump has a point when he criticizes Germany's failure to meet its NATO defense spending commitments. Germany’s coalition agreement implies a modest stimulus this year. But Germany has a history of delivering less stimulus than many expect. The IMF has been forecasting Germany’s fiscal surplus would fall for many years now, yet the surplus has kept on rising.* This time may be different, but, well, Germany needs to prove it…and frankly it should throw in a bit of extra stimulus now just to make sure.    The German finance ministry's worries that Germany's scope for stimulus is limited—because it might possibly run a deficit of well under a percent of GDP in 2023—just aren't that convincing. Shahin Vallee has noted that Germany's finance ministry has a recent history of systemically underestimating revenues, by something like half a point a year.** In 2017 and 2018 the argument that Germany needed to stimulate essentially rested on the need to move toward a more balanced global economy, and the value additional German stimulus would provide to its trading partners. Demand growth inside Germany was solid, and the German economy was humming off the combination of okay domestic demand growth and solid external demand. The hope was that a bit of stimulus (or a less restrictive fiscal policy if you prefer, as Germany could provide a positive impulse to demand while still running a budget surplus) would spill over to Germany’s partners through higher German imports. And maybe help to support ongoing wage growth in Germany too. Now, well, Germany itself has clearly slowed, and its economy could use a boost. A sharp deceleration in growth caused in part by a weakening of external demand provides an opportunity for Germany to, more or less seamlessly, bring its own economy into better balance by strengthening the economy's internal motor, and thus naturally starting to replace some of the outsized role external demand has played in keeping Germany's economy humming. And there is basically no downside. The stimulus could be financed without any borrowing—Germany just needs to save less.   If Germany did need to borrow a bit, it could do so at a negative real interest rate. Ten year bunds have a yield of 10 basis points right now; even if the ECB consistently misses its inflation target that would still imply a real rate of negative one. Inflation is currently low.  A stimulus could put Germany’s massive excess savings to work at home, and thus reduce the risks that German savers are now taking abroad. Keeping the labor market relatively tight would help German wages continue to grow (real wage growth hasn't been that strong in 17 and 18, judging from the FT's chart), helping to support demand throughout the euro area—and right now Germany’s European partners could use a bit of a lift. A relatively tight German labor market would also help speed up the integration of the 2015 migration wave. Stronger domestic demand growth would provide a bit of insurance against a disruptive Brexit. What’s not to like? (By the way, the same basic argument applies to several other "twin surplus" countries in Europe, including the Netherlands. Dutch growth also decelerated in the third quarter, and the Dutch don't really need to continue to run sizable fiscal surpluses given their low debt levels.) * The IMF noted in its 2017 Article IV (emphasis added) "Fiscal policy was again neutral in 2016, as the government posted its third consecutive yearly surplus. The general government balance climbed to 0.8 percent of GDP—almost a full percentage point higher than planned—, while the structural balance stood at 0.7 percent." The IMF went on to note "In fact, fiscal plans proved overly conservative through the whole post-crisis period, mostly because tax revenue consistently exceeded official estimates." Yet even after noting this history, the IMF still forecast a fall in Germany's surplus in 2017...a fall which failed to materialize (see the chart above). ** I thought the FT jumped the gun a bit in its claim that the euro area has now turned toward stimulus. The biggest stimulus in the FT's chart appears to come from Italy, and, well, the Commission didn't go along with Italy's fiscal plans. The expansion of over a percentage point of GDP appears to come from an October document (the November numbers were similar), and it corresponds with a headline fiscal deficit of around 2.9 percent of Italy's GDP. The final compromise with Italy authorized a fiscal deficit of about 2 percent of GDP. Germany's coalition agreement makes some overall stimulus for the euro area likely given that France clearly isn't going to consolidate in 2019. But, as I noted in the previous footnote, the German finance ministry has a history of underestimating revenues and that has led the Commission to join the Fund in underestimating the growth in Germany's surplus in the last few years. And, well, the aggregate result of the Commission's projections (with the large fiscal relaxation in Italy that was not approved) was a rise in the headline fiscal deficit for the euro area from 0.6 pp of GDP to 0.8 pp of GDP. And with German borrowing costs still falling, a 0.4 pp primary expansion in Germany implies something like a 0.3 pp change in the headline fiscal balance, so a general government surplus that would still be close to 1.5 pp of German GDP...

Although the global rate of extreme poverty is at a historic low, the pace of poverty reduction is slowing and the World Bank estimates that more than 700 million people still live on less than $1.90 a day. The 2019 Robert B. Menschel Economics Symposium, held on March 6, 2019, discussed the ways behavioral economics can inform development policy to create effective solutions to poverty at the international, national, and local levels. The Robert B. Menschel Economics Symposium, presented by the Maurice R. Greenberg Center for Geoeconomic Studies, is made possible through the generous support of Robert B. Menschel. Session I: Keynote with Abhijit Banerjee  In the keynote session, Abhijit Banerjee and presider Isobel Coleman discuss behavioral economics and the impact of work on randomized controlled trials on policy. Banerjee also touches on some of the work he's done on women’s empowerment and women’s leadership.  Click here for the full transcript.  SESSION II: Policy in Practice: Addressing Poverty with Behavioral Economics During this session, Varun Gauri, Elizabeth Hardy, Matthew Klein, and presider Afsaneh M. Beschloss discuss evidence based policy, as well as how to take advantage of the recent research on behavioral economics and how it impacts poverty-reduction programs. Click here for the full transcript. 

China, it now seems, has entered into a real slump. There were plenty of leading indicators. I should have given more weight, for example, to the slowdown in European exports to China over the course of 2018. China's total imports remained pretty strong though until the last couple of months. But they have now turned down. Sharply. In a deep sense, China’s slowdown shouldn’t be a surprise. China tightened last year. Goldman's Asia team had a useful chart in an early January paper showing a sharp consolidation in the “augmented fiscal deficit”—and it looks like China’s efforts to slow the growth of shadow banking and introduce a bit of market discipline into lending have curbed the flow of credit to private firms (see Nathaniel Taplin of the WSJ). And China has a history of tightening too much, and slowing an economy that still structurally relies on credit to generate internal demand (the flip side of high savings) whenever it tries to wean the economy off bank and shadow bank lending. Look at the weakness in Chinese imports in the chart above in late 2014 and most of 2015. That’s the last “tightening” cycle. But the extent of the current slowdown is now increasingly clear in a broad set of data, both data from China and data from China’s trading partners. And that raises the question of how a Chinese slowdown impacts the world. There is a bit of good news here—China (still) isn’t that important a market for the rest of the world’s manufactures. China’s overall imports (of goods) are significant, at around $2 trillion. But about a third are commodities, about a third are parts for re-export (think $800 billion of processing imports vs. exports of around $2.4 trillion), and a bit less than a third are imports of manufactures that China actually uses at home. And that means that China matters far less for global demand for manufactures than say the United States. China’s imports of manufactures for its own use (net of processing imports) are roughly a third of U.S. imports of manufactures. Actually a bit less than a third. The United States doesn’t break down its imports for re-export, but U.S. exports of manufactures are so low—only around 5 percent of U.S. GDP—that imports for re-export can largely be set aside. The imported content of U.S. exports is still—per the OECD—relatively low. Bottom line: when it comes to supplying the rest of the world with demand for their manufactures, the United States is still in a league of its own. China remains in the second division. That doesn’t mean Chinese import demand doesn’t matter at all—$600 billion in imports is real money. When China’s imports were rising quite strongly in late 2017 and early 2018 that provided a bit of help to regions around the world with slow demand growth and weak currencies. I am, of course, thinking of Europe in general, and Germany in particular. Europe’s share of the $150 billion rise in China’s manufactured imports (net of processing) from end 2016 to mid-2018 was something like €30 billion—enough to matter. But on the manufacturing side, China's largest impact on the rest of the world continues to stem from its export machine. China’s exports of manufactures, net of processing, are roughly two and a half times bigger than its imports of manufactures, also net of the processing trade—think $1500 billion vs. $600 billion (for 2018). That’s why the recent stability of China’s currency matters. For now (and of course things could change) China isn’t trying to offset domestic weakness through depreciation and a weaker currency. A 10 percent fall in China’s imports is a much smaller shock to global demand than a depreciation that reallocates global demand toward China and raises China’s exports by 10 percent. While a Chinese depreciation would be a negative to shock to the world, China’s apparent willingness to use fiscal tools to restart its economy should be helpful to the world, at least directionally.* It is an inadvertent benefit, perhaps, from the trade truce, and Trump’s apparent willingness to cut a deal, almost any deal, to restart soybean exports and avoid a new round of tariff escalation. Looking only at manufacturing trade of course is too narrow: China is now a very important net source of demand for commodities. It increasingly has the kind of impact on the oil market it once had on the market for industrial metals. China accounted for a quarter of the growth in global oil demand last year. And the United States is increasingly more important as a source of marginal supply for oil—a reversal of its traditional role. The Permian is giving Saudi Arabia's best oil field a run for its money.** Current energy pricing reflects the confluence of expectations of strong U.S. supply growth (in the face of significant reductions in Venezuelan and Iranian exports) as pipelines connect West Texas to the Gulf of Mexico—and weaker demand growth out of China. A fall in Chinese auto demand has a big impact on Chinese domestic output (most Chinese cars are made in China, with largely Chinese parts, thanks to China’s tariff wall), a measurable impact on the profits of some foreign firms with successful Chinese JVs, a modest impact on German exports and, at the margin, a measurable impact on global growth in oil demand. China matters for the entire world, no doubt. But its impact on the world isn’t totally symmetric.   * UBS recently argued that the net fiscal stimulus would be between 1.5 and 2 percent of GDP in 2019—with roughly 1.5 percentage points of GDP in central tax cuts offset in part by central government spending cuts of around 1 percentage point of GDP, and a roughly 1.5 percentage points of GDP fiscal loosening at the local level to support increased infrastructure investment. I of course would prefer a somewhat different kind of fiscal stimulus, one less focused on pro-business tax cuts and one more focused on raising low levels of social benefits and reducing the relatively large social contributions paid by some workers. ** I left services—a poorly measured category often heavily influenced by trade in tax that gets inordinate attention because of the widespread perception that it is the United States’ comparative advantage—for a footnote. But that’s more or less right for China. Its imports of tourism services (vacations) are significant (around $300 billion in 2018), though poorly measured. But they certainly matter for some individual countries that have been at the center of the tourism trade, most notably Thailand. China's imports of other services are still trivial. And China isn’t (yet) a big services exporter. The impact of a slowdown in China on global demand for non-travel related services can largely be ignored. Many articles highlighting the great potential services offer for the United States blur the line between actual trade in services and the ability of a foreign firm to provide services in China if it establishes in China (an important distinction in my view; U.S. firms setting up shop in China to provide services inside don't support many jobs back in the United States).

“Our Steel Industry is the talk of the World,” President Trump tweeted in September. “It has been given new life, and is thriving.” Yet nearly a year after Trump slapped tariffs on imported steel, the U.S. steel industry is not thriving. It is reeling. Steel prices have fallen back to pre-tariff levels. Employment is stagnant. The clearest sign that tariffs are not working, however, is the stock market. If the president’s policies were working as planned, the steel industry should outperform other sectors. Yet as the graphic above shows, since Trump announced steel tariffs on March 1, 2018, steel-producer stock prices have plummeted 22 percent—while the S&P 500 index has fallen only three percent. So why has the market soured on American steel? One reason is that Trump’s tariffs, overall, hurt the industry far more than they help. Here is how we know. For the first half of 2018, steel-producer stocks followed broad market performance, even after steel tariffs took effect. Then, while the S&P index kept rising, steel stocks took two dives—in mid-June and early August, as the graphic highlights—before re-tracking the market. What happened in June and August? Just before each drop, Trump released lists of imports covered by tranches of his first $50 billion in China tariffs. Since 95 percent of these imports were intermediate goods, purchased by American firms, markets anticipated that the tariffs would push up their prices, reduce their output, and hurt their sales. Tariffs would, in turn, drive down their purchases of domestic inputs, like steel. That tariffs are hurting American steel, the very industry they were imposed to help, shows just how misguided they are.

Worry about China’s slowing economy in 2019, not its balance of payments…

   

The world's surplus countries have the ability to do more to support global growth.

  

Both China and the U.S. provided their respective snapshots on the state of global trade earlier this month… The U.S. October trade data showed that the U.S. imports continue to grow at a robust clip. The Chinese November trade release by contrast showed a significant weakening in Chinese import demand. Up until now China’s imports had been surprisingly strong even as other signs suggested that China’s overall economy was slowing.  Both are important data points going into 2019. Combined growth in both Chinese import demand and U.S. import demand (Trump’s stimulus has overwhelmed his protectionism) in 2017 and 2018 drove the recovery in global trade, and helped propel Europe’s growth. With Chinese demand now faltering and Europe showing signs of weakness, the United States is now at risk of becoming the sole remaining engine of global demand. And that feels risky, as, well, Trump has consistently been against a rising import bill. At least in theory. His fiscal policies of course have predictably pushed U.S. imports up, something that is likely to be increasingly apparent as the q4 data continues to roll in. The October U.S. trade data release. The overall U.S. trade balance these days is the tale of two very different stories—a falling trade deficit in oil (higher production, and now, again lower prices) and a rapidly rising deficit in non-petrol goods trade.* There just isn’t much of a story in services trade in the past few years; the U.S. services surplus has been broadly constant—the action has been on the goods side. Because the overall trade deficit hasn’t changed that much, I don’t think the rise in the deficit in non-petrol goods trade (and in manufacturing trade) has gotten as much attention as the scale of the underlying shift warrants. Since 2014, the non-oil goods deficit has basically doubled in dollar terms—initially because of a fall in exports after the dollar’s rise, increasingly because the stimulus has raised U.S. import demand. That’s a big swing, one big enough to overwhelm the dramatic improvement in the oil balance. That story this year was complicated because the trade deficit unexpectedly fell in the second quarter of 2018. But it is now clear that this was a false positive signal, as it was a function of a set of one-offs—the soybean pre-tariff surge, a pause in the growth in imports are a large rise in q4 of 2017—rather than a break in the basic narrative. In q3 the non-petrol deficit rose steadily, and October’s deficit was higher than that of q3. The trade deficit in manufactures is now consistently topping exports—e.g. for every dollar of manufactures the United States exports, it now imports two. Manufactures here is adjusted to exclude refined petroleum. Obviously, the manufacturing deficit isn’t new. But the scale of it is. In a world of regional supply chains, North America's deficit supplies the net demand for manufactures needed to sustain large surpluses in Asia and Europe. The deficit in manufactures—as Eduardo Porter highlighted in a recent article—has important geographic consequences. Manufacturing was once an important source of employment in a number of small towns. The “real” goods data is if anything a bit worse, as the price of imports has been falling a bit, so the rise in real imports top the rise in nominal imports. Real non-petrol imports are now up more than two times as much as real non-petrol exports in the post-crisis period. Nominal GDP has been growing—so the swings are smaller as a share of GDP (and until recently the widening deficit largely reflected a fall in exports as a share of GDP). But as the data from the last half of 2018 rolls in, the non-petrol goods (and non-petrol goods and services) deficit is starting to widen as a share of GDP too. The broader balance of payments still benefits from the post-crisis fall in nominal interest rates (which has held down the interest bill on a net external debt that approaches 50 percent of GDP if you leave out the “gold” at Fort Knox) and the United States' substantial offshore profits (largely in the world’s low tax jurisdictions). But the q3 current account deficit rose significantly, after a surprise fall in q2. Why care—well, Trump was elected on a promise that he would make American manufacturing great. But his policies really have been a boon to the United States' trade partners. The surpluses that both China (reflecting the broader East Asian manufacturing ecosystem) and the euro area run with the United States are up substantially. Trump’s stimulus was in many ways a global stimulus. U.S. imports of manufactures are now rising by around 10 percent y/y (a bit faster than the overall economy), well up from the 2 percent growth rate (an admittedly slow pace of growth) in the last four years of the Obama administration. And, well, it isn’t clear that U.S. imports will continue to grow at this current pace— Most obviously, because demand growth is likely to slow a bit from its rapid 2018 pace, and import growth reflects strong demand growth (as well as the strength of the dollar). And, if Trump does go ahead with either the threatened tariffs on China or the threatened tariffs on autos it will in the short-run add a substantial fiscal drag to the United States—as there is no realistic way to replace all imports from China or all imports of autos with U.S. production in the short-run. So higher tariffs will result in higher prices for consumers (less spending) and a rise in government revenue (as many firms will have no choice but to pay the tariff). Frame this however you want: Trump undermining his own stimulus with his trade policies, or as an end to a free ride the U.S. fiscal stimulus provided to the world over the last year. Either way, it would put new pressure on the rest of the world—and Europe in particular—to find domestic sources of growth. And then there is China— China isn’t quite as big a source of global demand—at least for manufactures—as its rapid growth would imply. Since 2012 China’s economy has expanded by about 41 percent (in real terms) but its imports (in dollars) of manufactures are only up about 15 percent if you take out semiconductors—where there has been a big price hike that is now reversing. U.S. imports are up far more (off a bigger base). But China still matters. The recovery in its non-semiconductor import demand, along with Trump’s stimulus, helped drive the broader revival of global trade in 2017 and 2018. Chinese demand wasn't all commodities either, imports from both Europe and the rest of Asia jumped (after broadly stalling after 2012). And it now seems that China’s demand growth is faltering. Admittedly, the story is complex. Oil import volumes are up, coal and iron imports may be down for administrative reasons, and China (still) imports in order to export. Real export growth of only 1 percent y/y (per Tao Wang of UBS) implies less need for imported parts. But it is now hard to believe that Chinese demand itself has not slowed. The downturn in imports in November was fairly broad based. And perhaps slowed by more than has been officially reported. See Keith Bradsher and Ailin Tang. Now China is poised to do some sort of stimulus, one that may help support import demand over the course of 2019. But for now, one of the main engines of the global trade recovery of the past two years has faltered. And the other, well, its President never liked being an engine supporting the rest of the world’s growth— One final point before signing off. China stands to benefit from a sizeable positive shock to its terms of trade. What are China’s two biggest imports? Integrated circuits/semiconductors ($300 billion in 2017) and crude oil and petroleum products (over $200b). Together, these two products account for about a quarter of China’s total imports (to be sure, some imported semiconductors are re-exported as finished electronics, but China’s new economy uses some domestically as well). And the price of both are now falling. Memory chip prices are down by about 10 percent, and could fall by more. Oil is now well under $60 (WTI is even lower). That’s going to help China’s trade balance. It isn’t clear to me that—absent a Trump tariff shock—China’s trade deficit will continue to shrink and that the current account will swing into deficit. I suspect that we are at least at a temporary inflection point on China’s import growth, with a clear shift down for a few months. China’s surplus could rise even as its export growth slows sharply. And I am waiting for signs that the recent surge in the non-oil trade deficit in the United States is fading—with strong overall demand growth it has had a bigger impact on the composition of output and employment than on the level of output and employment. But, unlike some, I do think the absence of any sustained (non-oil) export growth since the dollar appreciated in 2014 is an underlying point of weakness for the United States. When the tides turn and the United States needs to draw on global demand to support its growth, it may lack the export base needed to benefit from the opportunity… a 10 percent fall in the dollar that boosted real manufacturing exports by 10 percent would now only deliver a half point boost to U.S. growth… and the numbers don’t get that much better if you add in agriculture.   * Service trade is in my view a bit over hyped for the United States—the transport of people and goods is still the biggest category of services trade, and, well that is really a function of tourism and goods trade. A bit too much trade in intellectual property and in financial services currently involves a low tax jurisdiction for my intellectual comfort. The monthly data also doesn’t provide much information, as services trade is poorly measured in general and largely estimated in the monthly data.

   

China's low of level of imports of manufactures stands out, and China 2025 would reduce imports further