From a Baffled Admirer of Stephen Roach

Dave writes to me, describing himself as a baffled admirer of Stephen Roach, with the following conundrum:

I've been reading Roach on the problem of US-centric growth for several years now, and have been largely in agreement with his analysis. One telling statistic he is fond of citing, and which I too have frequently used, is that the US has accounted for more than 60% of world GDP growth in the period 1995 - 2002, roughly twice its share of would output. Yesterday I was challenged to duplicate this result, which I tried to do using IMF data for real GDP growth. To my surprise, the result turned out to be not 60%, but 31.4%, versus an output share of 26.4% in 1995. When I tried calculating the number using current US$ data, out came the 60%+ figure, against a 1995 share of 25.7%, rising to 32% by 2001. What possible justification could there be for using current-price data in this calculation? As far as I can tell, the 60% result reflects dollar appreciation and very little else - the IMF shows a 35% rise in the real effective exchange rate over these seven years.

I don't think this undermines all of Steven Roach's argument - obviously, much of Asia is dangerously dependent on the US trade imbalance. But the heart of the problem seems to me to be an unsustainable US current account deficit, rather than the caricature of a world hooked on US growth.Am I missing something?

No dave, I don't think you are misisng anything. I think the two sets of data are for different purposes. The IMF numbers are to make a comparison in 'real' terms across economies. I imagine the numbers you used from the IMF were based on PPP or Purchasing Power Parity calculations. The answer here is probably: it depends what you want to use the calculations for.

If you want to use the numbers to make calculations about comparative living standards, then the PPP version is much nearer the reality. That is, if you want to say something about whether you live better in Chicago or Frankfurt on salary x, the PPP numbers are the ones for you. On the other hand, if you want to make a calculation about the impact on global growth of a 30% reduction in the US growth rate, then you need the current price data, since this is the data which reflects the real impact. In this sense I think Roach is entirely justified.

Of course behind all this is a bigger can of worms. There is no economics version of the 'rosetta stone'. There is no magic number you can pull out of a box to settle an argument. In the first place: all our economic data are social constructs, much as it would hurt most economists to have to say this out loud. The whole idea of a GDP deflator and a CPI involves the application of a consensually derived set of criteria. In the case of the eurozone HICP, there is not even a compatability of methodology so you may as well take your old phone number and divide it by 2 for all its worth. What gives the HICP, or the PPP numbers value is that we agree to work around them.

In this sense, the use of the terms 'nominal' and 'real', which really come from a medieval scholastic debate about essences, is a bit misplaced. In fact what is real is the current price data which Roach uses, since this is what the economy as an abstract complex system works with. If you want to be anthropomorphic, you could think of an economy as a man in John Searle's Chinese Room, receiving lots and lots of symbols which are essentially meaningless (current prices) and then operating a transformation procedure according to a set of rules.

Bottom line. I think Roach is justified, even if I don't agree with him about the US current account deficit giving the US first priority for devaluation.

Why can’t the world economy simply stay its present course? That’s at the top of my most-frequently-asked-questions list. The main reason is that the current arrangement is unstable. Since 1995, America has accounted for about 60% of the cumulative growth in world GDP -- essentially double its share in the global economy. This powerful US growth impetus has been driven by a spectacular drawdown in national saving. America’s net national saving rate -- the combined savings of households, businesses and the government sector (net of depreciation) -- fell from about 5% of GDP in the mid-1990s to just 1.3% in the second half of 2002. Lacking in domestic saving, the United States has no choice other than to import increased flows of foreign saving -- running ever-widening current account deficits in order to attract that capital. As a result, the world’s dependence on dollar-denominated assets is now at extremes. Currently, about 75% of the world’s total foreign exchange reserves are held in the form of dollar-denominated assets -- more than twice America’s 32% share of world GDP (at market exchange rates). At the same time, foreign investors hold about 45% of the outstanding volume of US Treasury indebtedness, 35% of US corporate debt, and 12% of US equities. All of these ratios are at or near record highs. Never before has the world put more stock in America -- both as an engine of growth and as a store of financial value.............

If the resistance to structural change isn’t disconcerting enough, there’s another set of forces coming into play that is also at odds with global rebalancing -- competitive currency devaluation. The intent is simple -- to counteract a fundamental realignment of foreign exchange rates that may weaken external support to economic growth and thereby force structural change. The Japanese are leading the way in this regard through increasingly heavy intervention in foreign exchange markets; official data, plus our guesstimates, suggest they have intervened to the tune of at least $50 billion in the first five months of 2003 in an effort to limit the appreciation of the yen. While Europe has yet to play its cards on the currency front, an ever-strengthening euro may well elicit a similar response at some point in the not-so-distant future. The lessons of history are painfully clear in one respect: Weak economies always feel that they are deserving of weak currencies. The problem, of course, is that this is a zero-sum game -- currencies are relative prices and not all of them can weaken. The economics I practice tells me that the nation with the current account deficit is the one deserving of the weaker currency. The last time I checked, that was America -- and the dollar. In the end, competitive currency devaluations are doomed to failure. They don’t work and they tempt nations to resort to other more draconian measures to buffer the pain -- such as trade frictions and protectionism. That’s the very last thing an unbalanced world needs.
Source: Morgan Stanley Global Economic Forum
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