Too much saving, too little investment

Raghuram Rajan, Project Syndicate

Talk abounds of a global savings glut. In fact, the world economy suffers not from too much saving, but from too little investment.

To remedy this, we need two kinds of transitions. How well the world makes them will determine whether the strong global growth of the last few years will be sustainable. This is the central message of the IMF's World Economic Outlook, which will be released this week.

First, consumption has to give way smoothly to investment, as past excess capacity is worked off and as expansionary policies in industrial countries normalize. Second, to reduce the current account imbalances that have built up, demand has to shift from countries running deficits to countries running surpluses. Within this second transition, higher oil prices mean consumption by oil producers has to increase while that of oil consumers has to fall.

The current situation has its roots in a series of crises over the last decade that were caused by excessive investment, particularly the bursting of the Japanese asset bubble, crises in emerging Asia and Latin America, and the collapse of the IT bubble in industrial countries. Investment has fallen off sharply since, and has since staged only a very cautious recovery.

The policy response to the slowdown in investment differs across countries. In the industrial countries, expansionary budgets, coupled with low interest rates and elevated asset prices, has led to consumption- or credit-fueled growth, particularly in Anglo-Saxon countries. Government savings have fallen, especially in the United States and Japan, and household savings have virtually disappeared in some countries with housing booms.

By contrast, the crises were a wake-up call in many emerging- market countries. Historically lax policies have become far less accommodative. Some countries have primary fiscal surpluses for the first time, and most emerging markets have brought down inflation through tight monetary policy. With corporations cautious about investing and governments prudent about expenditure -- especially given the grandiose investments of the past -- exports have led growth. Many emerging markets have run current-account surpluses for the first time.

We should celebrate the implicit global policy coordination that enabled the world to weather the crises of recent years. However, the fact that rich countries are consuming more, and are being supplied and financed by emerging markets, is not a new world order; it is a temporary and effective response to crises. Now it needs to be reversed.

Indeed, it is misleading to term this situation a "savings glut," for that would imply that countries running current- account surpluses should reduce domestic incentives to save. But if the problem is weak investment, then a reduction in such incentives will lead to excessively high real interest rates when the factors holding back investment dissipate. Policy, instead, should be targeted at withdrawing excessive stimulus to consumption and loosening the constraints that are holding back investment.

There are reasons to worry whether the needed transitions will, in fact, occur smoothly. First, with asset prices like housing fueled by global liquidity, goods prices kept quiescent by excess capacity and global trade, and interest rates held down by muted investment, domestic and external imbalances have been easily financed. The traditional signals provided by inflation expectations, long-term interest rates, and exchange rates have not started flashing.

Instead, bottlenecks are developing elsewhere, as in oil. It may well be that easy financing has given economies a longer leash. The worry, then, is that when the signals change -- as they must -- they will change abruptly, with attendant harsh consequences for growth. Alternatively, prices such as that of oil will have to move more in order to effect the most pressing transitions, creating new imbalances. Policymakers should not see higher oil prices as an aberration to be suppressed, but should focus on underlying causes.

Second, more investment is needed, particularly in low-income countries, emerging markets, and oil producers (though less in China, the exception that proves the rule). But the answer is not a low-quality investment binge led by government or fueled by easy credit; we know the consequences of that. Instead, product, labor, and financial markets must be reformed so that high- quality private-sector investment emerges.

It is here that the good may have been the enemy of the perfect. Strong exports and decent government policies have enabled some countries to generate growth without the reforms that can create the right incentives for investment. These countries are overly dependent on demand elsewhere, which in turn is unsustainable.

With the right reforms, adopted in concert, the world can make the needed transitions. But one of the risks associated with the large current-account imbalances we now face is that politicians may decide to blame one or another country and espouse protectionist policies. That could precipitate the very global economic downturn that we all want to avoid.

The writer is Economic Counselor and Director of the Research Department at the International Monetary Fund (IMF).