Power Relationships and the Political Economy of Global Imbalances

Large global economic and financial imbalances have already contributed to the global financial crisis and the euro zone crisis. A substantial retreat into protectionism may be generated. Huge current account surpluses and deficits have caused economic and financial dislocations in both emerging and advanced economies. In this paper, we argue that such global problem is a result of domestic political pressures that generate strong incentives for governments to postpone needed policy adjustments and the inability of international power relationships to force such adjustments prior to the outbreak of crises. Our analysis leads to the pessimistic conclusion that the pressures from both the public and private sector to bring about substantial policy adjustments before a crisis breaks out are quite weak. In the case of U.S.-China economic imbalances, we find that although China does not have a major policy objective to maintain large current account surpluses as would be implied by the frequent charges that China is practicing mercantilism, political polarization in the USA might make it almost impossible to secure agreement on effective actions. In the case of euro crisis, nor are we optimistic that euro zone will undertake any time soon the types of forceful policy actions necessary to bring the euro crisis under control.