On saturday I was asked to give a talk on the world’s economic problems to an international conference of young conservatives at Oxford.
I wanted to talk about the huge imbalances,as economists call them, that have caused the problems of boom and bust and Credit Crunch over the last decade. I decided to talk about two pairs of countries.
The first is the USA and China. Over the last decade the US has developed a large appetite for cheap Chinese goods. It wanted to buy many more than it could afford, so it borrowed the money to buy them. China was happy to keep her exchange rate down, to pay relatively low wages, and to sell the US more and more good value goods. China built up ever larger surplus funds from the profits of this trade. The US lent itself more and more money to buy these goods. China had to lend her surplus back to the US to prop up the US state and banks.
The US state paid poorer people in the US entitlements with money borrowed from China, so they could afford Chinese goods. It paid larger salaries and contract fees to individuals and companies to supply US defence and other programmes, also from money borrowed from China. These people could also then buy Chinese goods. Chinese people saved, as they do not have the same generous welfare system. Their country bought around $2 trillion of claims on the USA.
You can only do this for so long. To adjust, China has to pay itself better wages, and the US has to experience a fall in real incomes. The Chinese state can spend more, and the US state has to spend less. The Chinese currency has to go up, and the US currency to fall. More Chinese production has to be used to supply China, and less to supply America. The US has to expand its production, supplying more at home and exporting more abroad. These adjustments are beginning to happen. Chinese wages are rising well, and US real incomes are falling. US exports are rising.
The second pair of countries I looked at was Germany and Greece. Like the US and China, Greece has been spending too much and borrowing too much, and Germany has been building up a large surplus out of successful exporting. Greece has taken its excess further than the US and has a much weaker economy to try to correct. Worse still, by locking itself into the same currency as Germany, Greece has made it more difficult to adjust its economy to the new realities. It cannot devalue as the US is doing. Real incomes have to fall through cuts in wages, rather than through an adjustment to make imports dearer and exports cheaper via the exchange rate.
The adjustment has to happen through Germany sending Greece more money as grants and gifts, or lending Greece more money to pay the bills. If Germany refuses to send enough money, the downward spiral of the Greek economy could get out of hand. Greece needs to buy far fewer German goods, and supply herself with more. Greek people need to work more to export, and accept the lower living standards the Euro scheme is forcing on them.
The nearest the Greeks can get to a devaluation to solve part of their problem would come from a big move in tax policy. Greece could abolish or slash taxes on employment and earning, and impose much higher taxes on spending, to the extent that EU rules allow. This would make Greek goods cheaper by cutting the tax costs of production, and make consumption dearer, limiting the amount of imported goods that Greek people buy.