During the 1990s, large trade imbalances developed in different regions of the world, with the United States running persistent deficits, and Japan and the euro area first, and later emerging Asia and fuel-exporting countries, running surpluses (Figure 1). Today the United States absorbs three quarters of the world’s current account surpluses, and net U.S. liabilities are at record-high, representing over a fifth of U.S. GDP.
The debate about the sources and hence possible resolutions of these external imbalances is polarized. Some argue that global imbalances should not be resisted. This is because they largely manifest an equilibrium phenomenon, generated by the interaction of growth and financial development differentials among countries, that will resolve themselves slowly over time (see, for example, Engel and Rogers, 2006; Blanchard, 2007; Caballero, Fahri, and Gourinchas, 2007; Mendoza, Rull, and Quadrini, 2007; Perri and Fogli, 2007; and McGrattan and Prescott, 2007). Many, however, trust that these imbalances originate in economic distortions, and they should be resolved primarily through policy adjustment, including significant changes in effective exchange rates and fiscal policies or both (e.g., IMF, 2005 and 2006, Blanchard, Giavazzi and Sa, 2007; Mussa (2004), Obstfeld and Rogoff (2007), Roubini and Setser (2004), and Yoshitomi (2006)).
One issue that, by contrast, is relatively undisputed is that differences in relative productivity across world regions have likely played a non-negligible role in the emergence and evolution of the today’s trade imbalances. This general perception is supported by empirical evidence. Glick and Rogoff (1995), for example, estimate that a one percent increase in country-specific productivity decreases the current account balance by 0.15 percent of GDP. Estimates by Bems, Dedola and Smets (2007), Edwards (2007), and Corsetti, Dedola, and Leduc (2007) detect even larger elasticities between shocks to productivity and imbalances. A few recent studies also examined the potential role of total factor productivity (TFP) differences across countries in explaining the global imbalances, based on multi-country dynamic general equilibrium models with calibrated TFP processes. Erceg, Guerrieri, and Gust (2002) and Hunt and Rebucci (2005), for instance, find that a permanent shock to the level of TFP in the U.S., combined with uncertainty or learning about its persistence, can explain at least in part the behaviour of the U.S. trade deficit in the late 1990s.
As Obstfeld and Rogoff (2007) note, however, productivity could only help to reduce the large U.S. trade deficit if it were concentrated either in the tradable sector of the United States (as foreign goods become less attractive to both U.S. and non U.S. residents) or in the non-tradable sector in the euro area and Japan (as this boosts their wage and capital income and hence thus their demand for U.S. goods). Reasoning along these lines, they infer that much of the widening of the U.S. trade deficit over the past 10 years or so must have originated from the boom in relative productivity in the U.S. non-tradable sector, consistent with findings of Engel and Rogers (2006).
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