Monday, October 11, 2010
This commentary is crossposted with Angry Bear Blog.
Dean Baker finds gaping holes in deficit hawk rhetoric using the simple accounting identity that national saving must equal the current account (S-I = CA). If the domestic private-sector's desire to save is positive, then the only way for the public sector (i.e., government) to net save is for the economy as a whole to run a sizable current account surplus.
Singapore does just that. Spanning the years 2004-2009, the average current account surplus was near 21% of GDP, which enabled the government to run surpluses near 5% of GDP and the private sector to save 16% of GDP. Singapore is a net-saver in all sectors of the economy: private, public, and international. However, it's Singapore's huge current account surplus that allows the domestic sector to net save, and not all financial balances are created equally.
Let's use a slightly different version of Rob Parenteau's 3 Sector Financial Balances Map to illustrate that not all financial balances are created equally.
The chart illustrates the combination of private and public surpluses (or deficits) that prevail at each of three "zones" of the Balanced Current Account Line (BCAL). The BCAL zones are: CA > 0 to the right of the red line, CA < 0 to the left of the red line, and CA = 0 on the red line. The World Economic Report database, October 2010, is used to construct the average 3-Sector Financial Balances Map for the IMF's Advanced Economies spanning the years 2004-2009. (Note: Singapore, Norway, and Iceland are not illustrated because their respective sector financial balance points lie outside the normal range and distort the map.)
The public-sector financial balance (PubS) for each economy is the IMF's measure of general government net lending as a percentage of GDP. The domestic private-sector financial balance (PrivS) is the residual of the current account as a percentage of GDP less PubS such that the following identity holds:
(please see Rob's post for further detail on the sectoral balances approach)
In the chart, the four quadrants of public-sector and private-sector financial balances that account for the CBAL zones across the Advanced Economies are:
I. PubS > 0 (public-sector surplus) and PrivS < 0 (domestic private-sector, households and firms, deficit)
II. PubS < 0 and PrivS < 0
III. PubS > 0 and PrivS > 0
IV. PubS < 0 and PrivS > 0
The quintessential savers are listed in quadrant III and to the right of the BCAL: Sweden, Hong Kong, Luxembourg, and Singapore (not shown). The classic debtors are listed in quadrant II and to the left of the BCAL: Ireland, Spain, Portugal, Greece, and a couple of other Eurozone economies that are not labeled (Cyprus, Malta, and Slovak Republic). Finally, quadrants I and IV list economies that have positive saving in one of the domestic accounts: public (I) or private (IV).
The point is pretty clear: in order for the government to net-save, PubS > 0, either the private sector must dissave and/or the current account must be in surplus. It's that simple.
Notice that the financial balances of Spain, Portugal, Ireland, and Greece are in quadrant II and to the left of the CABL. These are averages, and the fiscal deficit worsened markedly in 2009 and 2010 as the private sector incentive to save surged. Currently, though, the fiscal adjustment requirements are huge (deep into quadrant II). For example, Spanish policymakers announced a deficit reduction path to take the PubS < 0 from 11.2% of GDP in 2009 to 9.3% in 2010, with a colossal further reduction of 4.9 percentage points to 4.4% of GDP in 2012.
Given that Spain, for example, is starting from a point of hefty private-sector deficits over the last five years, on average, the sole hope for a successful policy tightening lies with external demand growth (the current account). Spain needs massive export income in order to finance such reductions in the government deficits.
So who will succeed in reducing their public fiscal deficits? Pretty much any country with private surpluses has a fighting chance: Germany, France, the Netherlands, Belgium, the UK, and the US even (on the corporate side). The problem is, that policy makers can't just tell the private sector to start dissaving. Well, it can, but incentives may be needed.
All else equal, recent FOMC announcements furthered a dollar sell-off, and along with recent disinflation the economy has a fighting chance if policy does move toward austerity. But as Dean Baker suggests, more currency re-valuation is needed.