Economics India

Tuesday, March 28, 2006

Larry Summers in India: Provokes Serious Discussion On United States' Unsustainable International Borrowings

Speaking at the Reserve Bank of India in Mumbai to give this year’s L.K. Jha Memorial Lecture on March 24, 2006, Dr. Summers complemented India for her achievements over the past decade, in terms of remarkable changes in the economy, financial system, education, and health care - and the vast improvement realised in the lives of literally hundreds of millions of people as a consequence. Dr. Summars noted that the change in India's relations with the United States has been a profoundly positive development - he hoped that it will prove lasting.

Dr. Summers focused his speech on three aspects of the prevailing global financial flows which stand out as being without precedent: first, the net flow of capital is substantially from developing countries and emerging markets towards the industrialized world and principally to the United States, as the world's greatest power as well as the world's greatest borrower. Second, the build up in U.S. net foreign debt is substantially mirrored in reserve accumulation by emerging markets. And third, the expected the real returns on the reserve accumulation tend to be low and risks very high.

Dr. Summers called this as the "capital flows paradox" and remarked that it requires a careful thought especially because it is simply nsustainable and problematic. "There is a hard-landing risk – not just an American risk, but a global risk at a time when the U.S. external deficit is creating nearly an export stimulus demand approaching 2 percent of global GDP!"

Dr. Summers suggests that this "capital flows paradox" has made prevailing G7/G8 obsolete, as a dominant forum for international financial discussion. It is neither in a position to discuss many of the most important domestic policy adjustments necessary for global stability nor does these groups include the largest official suppliers of cross border flows of capital. Any attempt to manage jointly any increase in U.S. savings and an offsetting increase in global demand from global sources will clearly require a forum that is broader than the G7/G8 -- so also for any global attempt to think through the implications of the massive reserve accumulation by some of the developing countries. A food for thought to the IMF and the World Bank!

Dr. Summers noted that there is a need for creating a new forum that structurally has political clout over the international institutions and at least some ability to influence domestic policy decisions of individual countries. He noted three areas of focus in the next several years: "First, the formulation of a global strategy for managing U.S. current account deficit downwards without excessive risk to global growth; Second, the role and governance of the existing international financial institutions in the current environment; and Third, the question of (effective and efficient) deployment of developing countries' reserves with acceptable levels of real returns and risk management. Thanks to Dr. Summers for choosing this topic and addressing it so forcefully.

Let us hope Dr. Summers gets back into a key policy-making position where he can make a difference in the changing the course of the World Financial System including the two international institutions, the IMF and the World Bank.

You can read Dr. Summer's full speech on Reserve Bank of India's website.

19 Comments:

  • Dear Ramesh:

    There is nothing new in what Larry Summers has said. He is simply describing the situation which many economists already know. I do not think that people in his position forsaw this in the past. Also his solutions are not clear and hence can not be implemented.

    We are dealing with just the beginning of globalization and as its intensity increases there will be forces opposing globalization. You already see it in the fringes of major cities in the World. In between will work the invisible hand and not the hand of any institutions or groups. We need to look at the situation with a new model..Something that includes non-tradeables..something that new books could throw light on. And I know that there are people who have already started thinking differently.

    Chandra

    By Anonymous Anonymous, at 3:07 AM  

  • I agree that the issues are not new but these are not being discussed in depth in public domain, especially in East and South Asia.

    If USA reduces imports, it will affect growth rates in major East Asia countries including China -- India is still somewhat insulated with its more diversified international trade.

    The IMF and the World Bank need to focus more on new global financial architecture -- perhaps using SDRs as the global currency for holding international reserves.

    By Blogger Ramesh G. Deshpande, at 5:08 AM  

  • Ramesh:

    I do not think that the answer lies in monetary or foreign exchange policies but it lies in the consumer economics about which we know little. Much of consumer economics is studied outside the mainstream economics. For example, the issues studied in the Sports Economics. The recent victory in Basketball by George Mason University has increased admission there but not of basketball players but of the others! Monetary and financial policies can not deal effectively with externalities.

    Chandra

    By Anonymous Anonymous, at 5:27 AM  

  • Dr. Deshpande,

    You missed one of the important points that Larry Summers made that the WB/IMF should create a facility so that they can intermediate the reserves and earn a high return on it (~6%) and plow them for development in those countries.

    FT and Bloomberg have carried articles on it.

    Any comments on that????

    Kautilya

    By Anonymous Anonymous, at 4:17 AM  

  • As for Kautilya's comments, yes, I did not touch upon explicitly Dr. Summer's suggestion that WB/IMF should attempt to intermediate in national reserves. I think that with WB/IMFs current institutional mandates, they can play only a marginal role, if at all, in this area. The global financial system would need either a reconstituted IMF or a totally new international central bank operating on a commercial basis -- offering financial instruments as alternatives to US treasury instruments.

    By Blogger Ramesh G. Deshpande, at 7:31 PM  

  • I would like to suggest that one should read the forthcoming works of the Noble Lauriate (2001) George Akerlof which combines sociology, utility theory and Keynes. He gave a seminar in the World Bank this week and I think his work has lead answers to what has been happening around the world and in the USA in the recent times. The answers are in understanding how consumers and not in assuming how they demand, and in understanding what the psychology behind it is.

    By Anonymous Anonymous, at 4:29 AM  

  • In response to the Anonymous' comment above, Noble Lauriate, Prof. George Arthur Akerlof is best known for his article: The Market for Lemons: Quality Uncertainty and the Market Mechanism", in which he identified the severe problems that may afflict markets characterized by asymmetrial information. Prof. Akerlof looked at economics through a different lens given his keen interest in social issues. At the invitation of the Statistical Institute of New Delhi, Prof. Akerlof spent some time in India during 1960s, where he attempted to solve the economic riddle of involuntary unemployment in India's castes. Prof. Akerlof said, "my interest in caste was related to solving the unemployment problem. Caste says that people should not do certain things. You are expected to not do jobs outside your lot in life. This sounds like a case where markets did not clear. My attempt to create an efficiency wage theory was to look at equilibrium in the caste system." At that time, Prof. Akerlog probably did not envisage, just as one example, that brahmins in India would start eating chickens and running poultry farms -- and take the jobs that previously belonged to lower castes!" Indeed, economics cannot ignore the influence of social change on the way markets function! We will surely be watching keenly the release of forthcoming work of Prof. Akerlof.

    By Anonymous Anonymous, at 8:04 AM  

  • Professor Deshpande,

    World Bank is already managing reserves for 12 countriesm so there is nothing new here. In fact Larry Summers is going to address the Executive forum this uear.

    Also IMF is now facing a revenue problem, as Argentia and Brazil have repaid , cutting their loan book into half. In fact, they are facing a budget crisis and will not pay their highly paid economists.

    Chankya

    By Anonymous Anonymous, at 3:28 PM  

  • It is interesting to note that IMF is already managing reserves of some twleve countries...may be these are small economies -- we have to think of China, Brazil and India as well as G7-G8 countries. We will watch the outcome of Larry Summers' discussions with IMF and World Bank. Clearly, there seems to be a need to redefine IMF charter or create a new international institution. More later as we go deep into these issues.

    By Blogger Ramesh G. Deshpande, at 3:42 PM  

  • Not IMF .....World Bank is,,,,

    By Anonymous Anonymous, at 4:30 PM  

  • Dear Ramesh:

    This comment is not related to the thoughts of Larry Summers. But this is related to one of the past postings of the Blog on Farmer Suicides.

    There is an article giving the statistical analysis of Farmer Suicides in Vidarbha in the latest issue of Sakal. The data analysis is worth reading and it rejects the earlier null hypothesis you had considered in the Posting. We will have to now accept the alternative hypotheses regarding the reasons behind farmer suicides. I am using statistical terminology now since the terminologies used in the World Bank and IMF are becoming outdated.

    Chandra

    By Anonymous Anonymous, at 3:16 AM  

  • About Farmer Suicides: I could not locate the article in Daily Sakal. Please feel free to summarize here the main points made in the Sakal article. Tnanks.

    By Blogger Ramesh G. Deshpande, at 9:27 PM  

  • About Farmer Suicides in Maharashtra's Vidharbha Region.

    I looked at the results of the elaborate survey done by the Pune-based Daily "SAKAL". I will bring out a summary of this survey on this sad subject very soon.

    As for the conclusions of the survey, these are not very much different from those listed in the blog posted in January 2006 on the basis of our prior knowledge of the rural situation.

    The main reason for farmer suicides is farmer indebtedness mainly to monely lenders at high rates of interest; the lack of their access to formal credit system for a variety of reasons inclding the collapse of cooperatives; and insulting treatment received by indebted farmers from moneylenders and their henchmen in public or in the presence of family members.

    GOI's recently introduced interest rate subsidies do not reach farmers who are indebted to money lenders -- only farmers who are fortunate to receive Bank credit receive subsidies --- while those who really need some help do not get any. What a tragedy! More later

    By Blogger Ramesh G. Deshpande, at 6:55 PM  

  • In continuation of the comments on Larry Summers in India, the issue is not about which agency manages international reserves (IMF or Word Bank), but about the sustainability of USDollar as an international reserve currency?

    Current US fiscal and trade policies are hurting US dollar -- and government's soft stance vis-a-vis China on the latter's exchange rate policy is exacerbating the situation.

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