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Saturday Feature
Global problems require global efforts
David Dodge

          The communiqué issued by G7 finance ministers and central bankers in Washington in late September added some new language about the issue of global savings-investment imbalances. The Group of Seven (G7) leading industrialised nations called the resolution of global imbalances a "shared responsibility", which must be carried out in a way that maximises growth. G7 countries have a critical part to play in the adjustment process, the communiqué noted; but so do others.
The comment about shared language is truly welcome. It makes clear that imbalances are a global problem and their resolution requires a global effort. But the urgency comes not just from today's situation. I am also concerned about an imbalance looming over the longer term, one related to global growth trends and demographics. If policymakers do not move quickly to help resolve today's imbalances, the world could, in the, next decade, face widespread demand deficiency and a persistent deflationary gap.
There is general agreement on both the diagnosis and policy prescriptions required. In Asia and many oil-exporting nations, it is clear there should be fewer savings and more investment. In contrast, the US is not saving enough while at the same time it has become the world's investment destination of last resort. The net result is a growing global imbalance in savings and investment that could correct itself in an abrupt and disorderly way, leading to widespread economic loss, aggravated by protectionism.
To avoid this, authorities must implement policies now that will maximise both the chances of a benign resolution and global growth. But I would argue that evolving economic and demographic trends have raised the stakes. Consider two trends. First, Asia's shares of the world economy and world income are likely to keep growing. With traditionally high savings rates in that region, increased growth should translate into higher desired global savings, that is, the total amount that households, businesses and governments want to save. Second, demographic trends suggest that over the next decade, desired savings are likely to rise in most industrialised economies. In the same period, a large proportion of the working-age population in such countries will be in the 50-65 age bracket, which is typically a period of high savings. So households are likely to increase their savings as the baby-boom generation prepares for retirement. In addition, governments -- in preparation for higher healthcare costs and other spending on ageing populations -- are likely to slow current spending growth. Combined, these trends strongly suggest that global desired savings will increase.
This higher level of desired savings implies lower global demand unless these savings can be channelled into increased investment. What would spur this increased investment? One could look to monetary policy. Theoretically, interest rates should decline to the point where planned investment rises to match desired savings. But the future additional impetus to save may be too strong to overcome at positive nominal rates, so real interest rates may not be able to fall sufficiently to match desired savings with investment. Keep in mind that global inflation and interest rates are already low, particularly in Europe and Japan. I am not making a prediction, but one could argue that if there is no increase in planned investment when the expected increase in desired savings materialises, then global nominal interest rates could hit zero before real interest rates fall sufficiently to restore the desired savings-investment balance. After monetary policy, one could look to fiscal policy to spur investment. In most developed countries, scope for future fiscal stimulus appears limited. Indeed, Europe, the US and Japan need fiscal consolidation, not expansion.
With these possible constraints on future monetary and fiscal policies, the urgency of structural reforms becomes all the more clear. This is what the G7 authorities mean when they say all countries have a part to play in resolving imbalances. Each country has specific policy prescription for its circumstances. But all governments should quickly implement structural policies that promote economic flexibility and stimulate investment.
Specifically, improved labour market policies are required almost everywhere, particularly in Europe. Well-functioning credit markets are crucial so that households can borrow against future income, and businesses can invest for the future. Policies to make financial markets more efficient are particularly important in Asia. Furthermore, in emerging Asia, comprehensive income-security policies could reduce the need for households to hold large amounts of precautionary savings. Policy actions such as these would boost demand to help with today's imbalances and encourage investment. To be clear, I am not saying a disorderly correction of global imbalances is certain, nor that the global economy is inevitably headed for a deflationary shortfall in demand over the next decade. But the risks of these outcomes are real. Prudent policy-makers must not rely on good fortune to help us muddle through. We must get going now, before it is too late.
The writer is governor of the Bank of Canada.


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