Coming to Terms with Fiscal and Trade Deficits has recently published by American Affairs, and is summarised below by author and economist Andrew Smithers
You can read the American Affairs Journal article here.
Your own copy can be downloaded as a PDF on this link
Andrew Smithers’ summary
We appear to have a worldwide persistent ex ante private sector net savings’ surplus. It is a structural not a cyclical liquidity trap and thus not solvable solely by interest rate adjustments. To prevent a world recession, monetary policy therefore needs to be supplemented by fiscal deficits.
The deficits are concentrated in a few countries and the resulting rise in national debt ratios has reached a point at which their sustainability is in doubt and the declared policy of the US administration is to end its deficit.
Either those with trade surpluses must accept the main burden of adjustment by increasing their fiscal deficits, or those with trade deficits must use the inflow of savings to finance business investment rather than consumption.
Persistent trade surpluses represent the preferences of companies for investing abroad rather than domestically, based on their assessment of potential returns and risk, which cannot easily be altered by policies which do not damage the domestic economy.
Chinese fears of wealth appropriation by their own government will not be changed by tariffs; the mercantilist belief that trade surpluses are both morally and economically beneficial also inhibit the helpful shifting of fiscal deficits.
To avoid a world recession the main adjustment must thus come from using trade deficits to finance investment rather than consumption.
Maintaining demand by boosting consumption raises debt but not growth and readily leads to damaging ratios of external and public sector debt. If used to boost business investment, growth rises faster than the cost of servicing the finance, even for foreign inflows of equity, because NDP, which rather than GDP measures a country’s taxable capacity, rises by a multiple of the cost as the labour share of income is many times the profit share.
Corporation tax reduces investment, not profits. Cutting corporation tax and increasing taxes on consumption boosts demand without increasing fiscal deficits and therefore allows larger deficits to be sustainable. Importantly, it also stimulates demand and allows full employment to be maintained at lower deficit levels. The combination offers a solution to the problem presented by unsustainable debt levels. It also appears to be the only solution currently proposed.