Understanding the drivers of the current chaos in international trade and politics
I am always on the look out for books that help me understand the world around me a little better. I have to admit though that the world of business, economics and investing and is somewhat more interesting to me. This summer, I read “The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy” by Michael Pettis. While too ponderous for a beach read, I highly recommend picking up the book (or downloading it on your Kindle) for your next getaway or weekend read.
The author of the book, Michael Pettis used to be a macro trader at Bear Stearns and is now a professor at Peking University. I first came across Pettis in Financial Times Alphachat and was highly intrigued by Pettis’ counter-intuitive yet compelling insights on international trade. Written in 2014, it is fascinating how many of the author’s predictions in the book have come true. These predictions include the rising trade conflicts, tensions in the Euro-zone and global demand malaise.
The book’s main argument is that the world economy has large savings / investment imbalances which will rectify (or get “rebalanced”) over time. Countries like China and Germany have excess domestic savings due to policies aimed at subsidizing the producers at the cost of the households in order to maintain high domestic employment. These excess savings are “exported” to (or aggregate demand is “imported” from) open economies like United States and peripheral Europe where policies (or the lack of thereof) results in household consumption being subsidized at the expense of the producers. Eventually, net capital importing nations will facing rising unemployment (such as in peripheral Europe) or debt rising unsustainably (such as in U.S.). These imbalances hurt the world economy in the long run. The rebalancing requires not just some level of austerity in consumer countries (as is often argued) but just as importantly, higher domestic consumption in producer countries.
The author presents complex arguments cogently and succinctly. Indeed, China has been pivoting from a investment-led economy to consumption-led economy albeit much slowly than the author prescribes. While reading the book, I pondered how powerful vested interests work against correcting these very obvious imbalances. For example, is leaving the Euro-zone an good outcome for peripheral Europeans, especially those who are not rent-seekers and have years of human capital ahead? The answer is undoubtedly, yes (albeit some immediate pain involved). However, powerful vested interests such as those of politicians and rent-seekers in Greece, Spain and Italy would not allow such devaluation. In this context, it is not at all surprising to see the rise of populist movements across Europe. Germany needs to recognize this sooner rather than later and boost domestic consumption, otherwise, a potentially disorderly breakdown of Euro-zone would be highly detrimental to its interests.
One aspect the author missed out was the discussion of the principle of comparative advantage in relation of savings / investment imbalances. The author seems to attribute all of Germany and China’s excess savings to their domestic protectionist policies while not having any discussion of genuine technology, human capital and other investments these nations made in order to be able to compete with other exporting countries with similar policies. Nonetheless, Michael Pettis book is a must-read for understanding the macroeconomic and policy drivers resulting in current turbulence in international trade and politics.
