Saturday, January 14, 2012

Does Debt Crisis Vindicate Mercantilism?

Currently, there seems to be a positive correlation between current account balances and economic growth. Countries with big deficits like Greece, Spain and Britain are performing really bad, while surplus countries like Hong Kong, Singapore, Germany and Sweden are performing really good. And China with its large surplus are outperforming India with its deficit.

There are exceptions to this rule, of course. While having roughly as large (proportionally) a current account surplus as its northern and northern neighbors growth in Denmark has been very weak, and another surplus country, Japan has also had weak growth. Similarly, Turkey's economy has had extremely high growth even as it has a very large current account deficit. But despite these exceptions, surplus nations seems to be generally doing better right now.

This might seemingly vindicate mercantilism against non-mercantilist economics that says that we should expect higher growth in deficit countries because they get to invest the savings of the surplus nations in in their economy, creating jobs and production in the deficit countries.

But as it happens, non-mercantilist economics doesn't say that that deficits, or more accurately the capital inflows that are the flip side of them, will necessarily strengthen an economy. It will if it goes to finance sound investments , but not if it finances excess consumption or malinvestments. Even in the latter cases it might provide a short-term boost to economic growth (Turkey's boom for example contain some unsound elements), but once the unsuatainablity of the excess consumption or malinvestments become evident for investors, it will weaken the economy.

So the lesson is not that it is good to have a surplus or bad to have a deficit in the current account balance. The lesson is that it is bad to have excess consumption or malinvestments while good to have sound investments. This is escpecially true considering that surplus countries during problems in deficit countries are hurt too. Though still stronger than the deficit countries, growth in the surplus countries have weakened too because of falling exports and furthermore the surplus countries are likely too lose much of their formal export earnings because of inflation, formal defaults or both.


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