MINOR ADJUSTMENTS - The world economy has to overcome the diktats of finance capital Prabhat Patnaik

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MINOR ADJUSTMENTS - The world economy has to overcome the diktats of finance capital

Prabhat Patnaik

There is a peculiar asymmetry in the world economy: while countries with current account deficits on their balance of payments are obliged to make adjustments to eliminate such deficits, countries with current account surpluses are under no such obligation. Since deficits and surpluses must cancel out in the aggregate (barring errors and omissions), this means that the burden of adjustment for current account imbalances falls exclusively upon the deficit countries. This has a very important implication. Consider, for simplicity, a world consisting of only two countries, A and B, where A has a current account surplus of 100 and B a corresponding deficit of 100. Now, to eliminate the deficit, B can (in the absence of protectionism) either depreciate its currency vis-à-vis A's or contract its domestic income, and hence absorption, at the going exchange rate, or both. For a variety of reasons, including retaliation from partners, currency value changes are difficult to effect. If B's import propensity at the margin is 1/3, then to eliminate the deficit, B's income has to fall by 300 with A's income remaining unchanged. (Of course when B's deficit is eliminated, A's surplus is ipso facto also eliminated, in which case A has to enlarge its domestic absorption of goods and services that it was earlier exporting through, for instance, a higher fiscal deficit, to keep its income unchanged). In this case, world demand and world output, taking the two countries together, falls by 300 compared to the pre-adjustment situation. But suppose A makes the adjustment. It can absorb 100 extra units domestically, again through a larger fiscal deficit for instance, with its income remaining unchanged. But B, which now has 100 less of imports, has a corresponding increase in demand for its domestically- produced goods, which increases its output not just by 100, but by a multiple of it through generating further rounds of demand via the consumption of newly-employed workers. If the propensity to save out of income is 1/4, then the value of this multiplier will be 4, so that total increase in income in B will be 400. In this case, world demand and world output, taking the two countries together, increases by 400 compared to the pre-adjustment situation. Adjustment by the surplus country therefore has a net expansionary effect on world output, while adjustment by the deficit country has a net contractionary effect. In fact adjustment by the surplus country benefits the people of both countries, compared to the pre-adjustment situation. In the surplus country itself, even though income does not increase, its use changes: the amount that would have otherwise gone as an export surplus vis-à-vis the deficit country is now used domestically to benefit the people; at the same time in the deficit country, employment, output and consumption increase. This happy denouement alas is not the one that must necessarily occur, while the unhappy one is. But it may be asked: even though the surplus country is not obliged to take on the burden of adjustment, why does it not do so nonetheless? The obvious answer is that it prefers to hold claims on the deficit country rather than improving the living conditions of its own population. It prefers, in short, a "mercantilist" policy. Since improving the living conditions of the population has the effect of strengthening the workers' bargaining strength, "mercantilism" of this sort is usually the preferred option under capitalism, which is paradoxical because bourgeois economic theory began, starting from Adam Smith, with a critique of "mercantilism". John Maynard Keynes, an architect of the Bretton Woods system, along with Harry Dexter White of the United States of America, had wanted adjustment by the surplus countries, at least some adjustment, to be made mandatory. Keynes had suggested an international clearing union through which inter-country claims had to be routed; and a part of the unused claims, or what we call "reserves", was to lapse periodically, putting pressure on surplus countries to use up their claims, that is, to take such steps that their current account surpluses got reduced. But Keynes' idea was never accepted. At that time, the US was a country with a persistent current account surplus and did not want to be hustled into making adjustments to reduce or eliminate that surplus. Matters of course changed quickly: in the 1950s, thanks to its overseas expenditure in running a number of military bases all over the world, the US became a country with a current account deficit, while Japan and West Germany were the major surplus countries. But the latter preferred "mercantilism"; and the US, because the dollar was a reserve currency, "as good as gold", which every country at the time was more than willing to hold, was under no pressure to reduce its current account deficit. Eventually, however, its current account deficit reached such enormous magnitudes because of the Vietnam war that other countries' (especially France's) desire to hold the torrent of dollars pouring out of the US dwindled, and the Bretton Woods system collapsed. But till date, there is no mechanism for making it obligatory for surplus countries to make adjustments. What is more, in addition to the "old" barriers to adjustment by surplus countries, such as capitalism's preference for "mercantilist" policies and the preference for reserves among the newly-industrializing countries of Asia (including China) after the 1998 Asian financial crisis, a new and powerful barrier has now emerged. And this consists in the opposition of finance capital to fiscal deficits that is far more effective now than before. Since the entity that runs a fiscal deficit is a nation state, while the entity opposed to it, namely finance capital, is now globalized, hence international, this opposition has become decisive. We saw earlier that if the surplus country was to undertake adjustment, then the obvious way it could do so is through a fiscal deficit. (The alternative way of a domestic wage-increase is unacceptable to capitalism, and even a country such as China may wish to avoid its cost-side effect on competitiveness.) But if "sound finance" in the sense of a ceiling on the fiscal deficit becomes the accepted economic policy under the pressure of finance capital, then the question of a surplus country undertaking any adjustment simply goes out of the window. What this means is not only that world demand and output remain lower, even in a pre-adjustment case, than what it would have been (if surplus countries did make adjustments), but also that in a situation where world demand shrinks for some independent reason (as is the case now because of the collapse of the housing "bubble"), a disproportionately heavy burden falls on the deficit countries. This is because the burden of any reduction in demand usually falls on producers that are less successful in marketing, which the deficit countries typically are; and since the surplus countries make no effort to expand their domestic absorption and hence world aggregate demand, the deficit countries are saddled with impossible imbalances which many of them find difficult to finance. This is basically the problem of European debt. The problem is often seen as a fallout of the oddities of the European Union, or even as a consequence of the profligacy of the southern European governments. The latter is factually incorrect (since the build-up has usually been in private debt, with Greece being a major exception); the former misses the macroeconomic picture. A reduction in world demand must express itself as a reduction in the demand for the goods and services of particular countries; southern European countries have been among these. And what is now being insisted is that these countries reduce their incomes to make the adjustments. The plight of southern Europe merely demonstrates the consequence of making the deficit countries shoulder the entire burden of adjustment. However, their doing the adjustment will make the world economic crisis even more acute. What is required in the world economy today is an overcoming of the diktat of finance capital with regard to "sound finance". However, unless individual nation states de-link themselves from global financial flows, they will be incapable of doing this. A coordinated fiscal stimulus by a group of major economies can certainly revive the world economy; but such coordination can come about only if there is an eschewing of "mercantilist" considerations. Both these conditions, such as those confronting international finance capital and eschewing "mercantilism", are unlikely to be satisfied under capitalism. Since the emergence of international finance capital is the latest stage of capitalism, putting the clock back within the system remains a chimera. The author is a former professor, Centre for Economic Studies, Jawaharlal Nehru University, New Delhi