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.