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GLOBAL imbalances have shrunk somewhat in recent years,mainly because of the globaldownturn rather than deliberate

policy actions. But the imbalances remainstubbornly high and there is a growing risk that, as before the global financial crisis, theworld may be lulled into harmful inaction.

In the run-up to the Great Recession,such imbalances were acknowledgedwidely but not subject to any sustained pol-icy corrections. The IMF did convene con-sultations involving countries ringing uplarge and persistent balance of paymentsdeficits, such as the United States, and

those accumulating significant surpluses,such as China and major oil producers. Butthese consultations did not get very far.

In the meantime, too many people fellinto the trap of citing special reasonsfor why historically unsustainable imbal-ances could in fact be sustained. Instead,the imbalances ended up adding fuel to theglobal economic crisis.

Once again, there is a growing risk that the world will fail to tackle theimbalancesthis time not just because of complacency but also because of the inabil-ity of economists and policymakers toconverge on a common analysis. Withouta common analysis it is difficult to forgeeffective policy agreements and a propersense of shared responsibility between sur-plus and deficit economies.

There will eventually come a point whendeficit nations will find it difficult to con-tinue to spend massively more than they take in. Meanwhile, surplus countries willfind that their persistent surpluses under-mine future growth. For both sides, the

imbalances will become unsustainable,

with potentially serious disruption to theglobal economy.

sl w r c v ryThe world has yet to recover properly fromthe global financial crisis that erupted in2008. Advanced economies are still try-ing to overcome sluggish growth, insuf-ficient job creation, and rising inequality in income and wealth. Geopolitical risks,including those that push oil priceshigher, have increased. And too many U.S. and European politicians dither andbicker rather than devise solutions to thestructural impediments that undermine

employment and growth.Emerging economies continue to out-pace their advanced counterparts, buttheir growth is slowing. The problems inadvanced economies are a factor, but sois the difficulty of navigating the policy challenges of what Nobel Prize winnerMichael Spence calls the middle-incometransitionwhen a countrys productioncosts rise to levels that make it harder tocompete with low-income countries but itsinstitutional capacity does not yet allow itto break into advanced economy territory.

It is in this global economic scenario thatthe rate of adjustment in current accountimbalances that started after the globalfinancial crisis has not been sustained (seechart), and the composition of the imbal-ances looks worrisomely similar to what itwas before the crisis.

The adjustment that occurred happenedfor negative rather than positive reasons. Itreflected the impact of the Great Recessionon demand in advanced economies, withtrade deficits in countries such as the

United States declining as unemployment

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28 F a c & D v l m June 2012

rose to unusually high and persistent levels. The adjust-ment was later partially reversed as these economies beganto recovernot on the back of sustained reforms but inlarge part due to massive liquidity injections by centralbanks and a once-and-for-all decline in the householdsaving rate.

The United States still accounts for a significant chunk of the underlying deficitsone-third today comparedwith one-half before the crisis. On the other side, just fivecountries account for half of the global surplus, similar tothe precrisis situation.

In the most delicate and systemic of all bilateral imbal-ancesthe China-U.S. trade balancedeterioration hascontinued, with the imbalance now greater than it wason average during 200608. Meanwhile, the major imbal-ance between Germany and countries on the periphery of Europe continues to serve as a complicating factor in analready complex and perplexing regional debt crisis.

ex la g mbala cThe persistence of imbalances has come with little reso-lution in the related academic debate over their causes,their significance, and what can or should be done toremedy them. If anything, economists seem more at oddsthan ever.

Without a common analysis, it should come as nosurprise that policy initiatives have also disappointed.

In country after country, domestic considerations havetrumped global concerns. The glory days of interna-tional policy coordination that culminated in the highly successful April 2009 London Summit of the Group of 20 advanced and emerging economies (G20) have givenway to rather bland meetings. And because the Mutual

Assessment Program the G20 asked the IMF to overseeis still evolving, policy-driven progress on resolving theglobal imbalances has been limited.

Academic explanations tend to stress different factorsfor both the emergence of persistent global imbalancesand the failure to address them. This adds to the prob-lems of policymakers who already confront imperfecttools and reduced flexibility after what was, by any stan-dard, an unusually aggressive use of fiscal and monetary measures to avert a global depression.

Some experts argue that the global imbalances are theoutcome of macroeconomic policy choices. Others high-light the structural role of national savings and the easewith which surplus funds can be invested across nationalborders. Then there are those who view the imbalances asa reflection of the increasingly outdated structure of theinternational monetary system.

No single explanation dominates the literature andattains a critical level of consensus, which is more areflection of the confusing times than a failure of the eco-nomics profession.

Imbalances persist

The narrowing of global balance of payments imbalances did not continue after the Great Recession.

(global current account imbalances, percent of world GDP)

Source: IMF, World Economic Outlook (2012).Note: The global statistical discrepancy is not shown.

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2.5

3.5

20022003

20042005

2006 2007 2008

20092010 2011 2012

proj.

Other advanced economies with surplus

United States

Other advanced economies with de cit

Low-income countries with surplus Emerging market countries with de cit

Low-income countries with de cit Emerging market countries with surplus

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F a c & D v l m June 2012 29

The global economy today is in the midst of secular and structural realignments at the national, regional, andinternational levels as relative dominance and dynamismshift from the older advanced economies to emergingmarket economies. These realignments are occurringduring a period that includes a highly unusual economic

downturn that spawned a degree of policy experimenta-tion in advanced economies trying to shake the recessionthat not long ago would have been deemed unthink-able. These developments also explain why markets havetended to fluctuate violentlyas investors alternate frombeing risk friendly to risk averse.

th u l kGiven these conditions, the best that we can expect fromsurplus and deficit economies in the months ahead ispolicy tinkering rather than major and sustained policy initiatives.

The U.S. economy will continue to heal gradually butis unlikely to see the set of structural reforms required tobreak out into vigorous and sustained growth. In Europe,the talk will be of reform, but financing issues will con-tinue to dominate. And in emerging market countries,

hesitancy about the uncertain global environment willpreclude any major attempt to realign policies to favorboth consumers and producers.

Unless there is an economic catastrophe, it is difficultto envision much change in either the level or composi-tion of global imbalances in the short term. The mostlikely baseline is one in which the world experiencesmore of the same.

This short-term outlook is far from comforting. Indeed,where most academics do not differ is in their concernthat persistent imbalances expose the global economy to sudden stops in investment flows, as happened in thefourth quarter of 2008. At that time funds ceased flow-ing to emerging markets and sought safe havens like U.S.government securities, which is what happened morerecently in Europe.

The extreme worries relate to currency fragmenta-tion in Europe and worsening funding conditions for theUnited States. Both of these low-probability tail eventsentail catastrophic disruptions, with virtually no coun-

try in the world immune to negative spillover effects.

Economists also point to mounting risks of currency warsand protectionism (a concern expressed on many occa-sions by Brazilian Finance Minister Guido Mantega).

The global imbalances are best characterized as being ina stable disequilibrium. They can persist for a while. Butif they do, the global economy will continue to travel far-

ther afield from the equilibrium associated with high globalgrowth, sustainable job creation, and financial soundness.

tw a hThere are two ways to resolve the inherentand ulti-mately unsustainablecontradiction of a stable disequi-librium over the medium term.

The unpleasant resolution involves the advanced econ-omies tipping once again into recession. This could occurfrom another flare-up in Europes debt crisis, a furtherspike in the price of oil due to geopolitical disruptions, ora market accident due to still-excessive leverage in certaininstitutions and market segments. The policy responseswould inevitably be less effective now that central bank balance sheets have ballooned to 20 to 30 percent of GDPin the major advanced economies while deficits and debtremain high.

The better resolution is one in which policymakers areproactive and preemptive. Such a resolution would likely have three facets: a simultaneous attack on both short-and long-term policy challenges; a series of midcoursecorrections as more information about the effects of thosepolicy changes becomes available; and a high degree of international coordination with the IMF playing a moreeffective and assertive role as conductor, information

clearinghouse, and trusted advisor.In this scenario the United States regains competi-tiveness and growth, Europe reforms itself into a morerobust and harmonious economic union, and systemically important emerging markets encourage their growingmiddle class to consume as well as produce. All of thesedevelopments would have to take place simultaneously and would require the IMF to act as an effective and cred-ible coordinator.

We should not underestimate the potential upside of such a comprehensive policy evolution. In addition tolifting impediments that have repeatedly underminedthe global economy and exposed it to financial crises,such changes would have the added advantage of entic-ing the substantial private capital that is now standing onthe sidelines. Such an influx of capital would be a furthershot in the arm for investment, production, employment,trade, and more equal income distributions.

The well-being of millions of people around the worlddepends on the international community stepping up tothis difficult challenge. Mohamed A. El-Erian is Chief Executive and Co-Chief Investment Officer of the global investment firm Pimco,

which manages $1.8 trillion in assets.

The best that we can expect romsurplus and defcit economies in

the months ahead is policy tinkering

rather than major and sustainedpolicy initiatives.