Commentary
Michael Pettis
{
"authors": [
"Michael Pettis"
],
"type": "legacyinthemedia",
"centerAffiliationAll": "dc",
"centers": [
"Carnegie Endowment for International Peace",
"Carnegie Europe",
"Carnegie China"
],
"collections": [
"China’s Foreign Relations"
],
"englishNewsletterAll": "asia",
"nonEnglishNewsletterAll": "",
"primaryCenter": "Carnegie China",
"programAffiliation": "AP",
"programs": [
"Asia"
],
"projects": [],
"regions": [
"Western Europe",
"Asia",
"Russia",
"Europe",
"India",
"China"
],
"topics": [
"Economy",
"Trade",
"Foreign Policy",
"EU"
]
}
Source: Getty
In The Media
A Bail-out by BRIC Nations Would Leave Europe Even Worse Off
Although tempting in the short run, a sudden influx of foreign capital into the European Union would raise both unemployment and debt without addressing the root of Europe's economic woes.
Published on Sep 25, 2011
Source: Financial Times
But more foreign investment will not help Europe – and may make things worse. National governments, it turns out, are suffering from skewed incentives, so that actions benefiting individual countries in the short term may hurt Europe as a whole. If many governments take such action, everyone is worse off.
It would seem that a country struggling to fund itself at manageable interest rates should welcome any big new investor, no matter what his provenance, as a valuable resource.
But foreign investors are not the same as domestic investors. Any net increase in foreign purchases of euro-denominated local government bonds has an impact far beyond short-term funding. It also affects trade.
This is an automatic consequence of the way the balance of payments works. Today, Europe runs a current account surplus. By definition, this means that far from being starved of capital, European savings exceed European investment, and it exports the excess to the rest of the world.
Any big increase in the amount of official foreign capital directed at purchasing the bonds of struggling European governments – unless there were offsetting outflows – would inevitably cut the European trade surplus. What is more, if Europe began to import rather than export capital, the automatic corollary would be that its current account surplus would vanish and become a deficit.
How would this happen? There are many ways, but the most obvious is that as foreign central banks sell large amounts of dollars to buy euros, the euro strengthens against the dollar. As this happens, European manufacturers would become less competitive globally and their exports would drop.
This would cause a rise in European unemployment. It would also cause total European savings to decline as income drops more quickly than consumption. The only way to prevent a rise in unemployment is if all the new foreign funding was used to fund direct investment – which, given the need for transfer and welfare payments, is very unlikely.
In that case, the increase in foreign investment would simply be matched either by a reduction in domestic savings or an increase in domestic debt to counteract the rise in unemployment. So rather than easing the burden, foreign investment simply replaces domestic savings, undermines manufacturing and raises unemployment or debt.
Yet it is easy to see why desperate governments welcome official money from the developing world. European savers are increasingly refusing to provide financing, so any new source of funding is seen as a godsend.
But although afflicted European governments benefit in the very short term from the help of foreign investors, the adverse impact on European manufacturers and on European savings overall more than makes up for it. An increase in foreign funding creates slower growth and, with it, the need to increase fiscal deficits in order to prevent a rise in unemployment.
The idea that capital-rich Europe needs help from capital-poor Bric nations is absurd. European governments are unable to fund themselves not because Europe needs foreign capital but rather because many of them lack credibility.
Turning to foreign sources of capital will only aggravate the problem. Even assuming developing countries are willing to take on risks that Europeans find prohibitive, their help will not improve prospects for Europe. On the contrary, it will hurt growth prospects and make it harder than ever to resolve the debt crisis. The Bric nations should be exporting more demand, not more capital.
It is important that the desperate short-term funding needs of certain governments do not lead to a worse outcome overall for Europe. If Europeans do not want to fund credit-impaired governments, they should not ask foreigners to do so. Slower growth and foreign debt will not help resolve insolvency.
About the Author
Michael Pettis
Nonresident Senior Fellow, Carnegie China
Michael Pettis is a nonresident senior fellow at the Carnegie Endowment for International Peace. An expert on China’s economy, Pettis is professor of finance at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets.
- The Plaza Accord and Its Relevance for China
- Who Paid for China’s Last Debt Cleanup, and Who Will Pay for the Next?Commentary
Michael Pettis
Recent Work
Carnegie does not take institutional positions on public policy issues; the views represented herein are those of the author(s) and do not necessarily reflect the views of Carnegie, its staff, or its trustees.
More Work from Carnegie China
- The Spring and Autumn of Chinese PoliticsCommentary
China’s political future will be shaped between now and next October. As the Communist Party enters its intense “campaign season” to prepare for a major political transition in 2027, reading Beijing's actions and responses may become more difficult as domestic politics weigh on its behavior more than usual.
Damien Ma
- Can China Turn Its Small Modular Reactor Ambitions into Commercial Reality?Article
China has showcased its engineering prowess with small modular reactor demonstration projects. But turning these technological achievements into commercial success will be a greater challenge.
Tong Zhao
- The Plaza Accord and Its Relevance for ChinaCommentary
The Plaza Accord was not an externally imposed punishment of Japan but part of a broader restructuring that Japanese economists and policymakers themselves recognized was necessary. Its effects were undermined, however, when Tokyo responded to the resulting slowdown with policies that exacerbated investment, credit expansion, and the very imbalances the adjustment was intended to resolve.
Michael Pettis
- Untangling the Nuclear Knot: A Constructive Agenda for Managing China’s Nuclear Relations with the United States and Its AlliesPaper
The nuclear relationship between China and the United States is increasingly shaped by widening perception gaps rather than deliberate strategic design.
Tong Zhao
- Who Paid for China’s Last Debt Cleanup, and Who Will Pay for the Next?Commentary
China’s banking crisis in the 2000s was resolved by transferring the costs to households through financial repression—a decision that recapitalized the banks while exacerbating the structural imbalances that continue to shape the Chinese economy today.
Michael Pettis
