Global trade imbalances do not figure on most people’s lists of things to worry about, but they should. Excessive and sustained surpluses and deficits have been, and are today, the proximate cause of profound economic and geopolitical problems. The IMF recently issued a warning that global imbalances, which reflect domestic imbalances between savings and investment, are getting bigger and more entrenched. It is telling us in a more abstract way what we already know, which is that protectionism and global tension are on the march. 

This matters because surplus nations, of which the most egregious example is China, can distort global finance, and force their own domestic problems, such as unemployment or overcapacity, onto other countries. The latter might then experience negative effects and larger deficits, which end up causing greater protectionism and international tension. Deficit nations, among which the US, the UK and other Anglo countries are the most prominent, can also be forced by adverse market reactions, such as rising bond yields, into painful and abrupt policy changes.

It was precisely to manage these imbalances that the architects of Bretton Woods designed a system to prevent a repetition of the chaos and breakdown of the global commercial and political order that took place in the 1930s. They would be horrified, but perhaps not surprised, that the world’s trading and financial system is today fragmenting under the weight of global imbalances, and by the intrusion of expanded areas of national security, greater coercion in trade, and the prominence of a zero-sum mindset among policymakers. 

Bretton Woods gave birth to and nurtured institutions such as the IMF, the World Bank and the General Agreement on Trade and Tariffs, or GATT, which later became the World Trade Organisation. These centrally managed institutions were inclusive and rules-based. They established a global order built around the US, as the largest and most pivotal postwar economy, the US dollar as a reserve currency and means to access liquidity, and a fixed relationship of the US dollar to gold and of currencies to one another to support monetary stability.

The British economist, John Maynard Keynes, had proposed that, in rebuilding the global trading system after the war, countries should not be permitted to run large, persistent surpluses. His argument was that such countries might think they have a green light to develop manufacturing and exports, at the cost of weaker domestic demand, and by doing so, worsen the situation for everyone else. He lost the argument to the US, which was a surplus country, and which had economic interests different from Britain. 

In any event, the system they devised eventually ran into problems. The so-called Nixon shock in 1971, arising from the increased supply of US dollars in the world but limited supply of US gold reserves, saw the link of the US dollar to gold broken. The fixed exchange rate system later collapsed, and, since the early 1970s, floating exchange rates have been both a source of instability from time to time, but also a kind of shock absorber, allowing the global system to adapt. 

The Doha round of trade liberalisation broke down in 2007. Since then the WTO has become increasingly less influential and relevant. It failed to remain a credible negotiating and monitoring forum for trade disagreements, and it has been failed by its two biggest members. The US has refused to nominate judges to the WTO’s dispute settlement architecture since 2019, effectively paralysing it. China spins its support for free trade but on a platform of extensive protectionist and industrial measures intended to underpin its own self-reliance in key industries and supply chains, and to realise its geopolitical ambition of industrial dominance.

Other shocks have undermined the global economic and financial order, including de-industrialisation under threat from Chinese imports, first in richer economies, and more recently among new industrialisers such as India and Brazil; the effects of unfettered globalisation; the 2008 global financial crisis; and now, we could add, the economic constraints imposed by both high levels of public debt, and the economic consequences of AI on jobs. 

The biggest shock by far though has surely been China’s unique rise in the global system, quintupling its share of world GDP to about 17 per cent, first as feisty competitor and subsequently as strategic rival and geopolitical adversary. Xi Jinping has been in power for 13 years, and has from the start championed China’s ambition to be self-reliant, using distinctly non-market industrial and technology policies to drive domestic innovation and growth, gradually cutting out foreign, especially American, suppliers in key areas from China’s supply chains.

Pursuing these policies, China has already risen to account for about a third of global manufacturing, and its single-minded focus on industrial and technological dominance could in theory lift this proportion still further, but only by forcing other nations’ shares down. The implicit conflict potential between nations then becomes clear. 

This certainly has implications for the US and the EU and other rich nations that have relatively small but highly productive manufacturing sectors which still have a crucial role to play in the overall economy supporting services and skill formation. Yet it also affects a number of emerging and middle income countries seeking to develop their own domestic industries, in steel, textiles, and electric vehicles, in the face of low-priced Chinese exports looking for new homes and bigger markets. 

China’s burgeoning external surplus reflects the low share of consumption in the economy, a problem about which the leadership has become more vocal in the last year or two, but without a full-blooded or effective response as yet. And, in an important way, it seems unlikely that the government will voluntarily make such a response for as long as its principal focus is on industrial policy, dominance and self-reliance. This focus entails government-directed largesse to support state enterprises and requires large sums of money in the form of research and development subsidies, grants, cheap loans and land, subsidised borrowing, and favourable technology and procurement policies.  

How then can we look forward to any satisfactory closure to the imbalances issue?

While China is a big part of the problem, it is fair to point out that the US also has some agency for the policies that are driving its fiscal and trade imbalances, and that the current administration is no longer setting a good example as a defender of free trade. Tariffs will change the pattern of trade but have no impact on excess savings in China or on imbalances. Systemically, the world has no mechanisms to oblige creditor or surplus countries like China to change tack. 

This might lead to greater pushback against Chinese trade practices, and knock-on effects in the mainland. China’s own self-reliance strategies could cut the country off in key areas from the rest of the global economy. A lot is also riding on the ability of a considerable number of countries to remain aligned with the US in a fractious world in which bifurcated trade, technology and finance systems are evolving, centred on the US and China. 

Global imbalances are unsustainable, and always unwind eventually. Yet, the circumstances under which they do, absent a new Bretton Woods type of international coordination, are never trivial.