Abstract
This thesis discusses the European Sovereign Debt crisis and US-China trade war in light of the theory of economic imbalance. Economies of the world are starkly different from each other and can be classified into broad categories i.e. manufacturing and financialized economies. These economies depend on each other for meeting domestic demand in different sectors, however, it has been studied that this interaction also results in economic imbalances between the countries. The manufacturing economies like Germany and China are found to maintain an economic surplus over financialized economies like the UK and US. In this thesis, two cases of US-China and UK-Germany have been discussed in detail in order to understand how the two types of economies interact with each other in order to meet their domestic demand in different sectors. This study discusses how the divergence of growth in different economies results in economic problems such as the European Sovereign Debt crisis on a global scale and investigates whether the economic imbalance is a factor behind the prevailing US-China trade war.
Chapter 1
1.1. Introduction
The macroeconomic imbalance has been defined by the European Commission as any activity or a trend that results in macroeconomic development, which can negatively impact or has the potential to negatively impact the economy of a member state of the union or the overall economy of the Economic and Monetary Union (Rott & Purnhagen, 2014). Similarly, in other parts of the world, economic developments, which can negatively affect or has the potential to negatively affect the economy of the country can be defined as the economic imbalance. The economic imbalance is associated with micro-financial risks that can result in the accumulation of net financial claims. These net financial claims may occur in different sectors of the economy giving rise to a situation of economic imbalance. There are a number of different economic developments that result in the accumulation of net financial claims and macro-financial risks such as current account deficit, private sector credit expansion, asset price surges, competitiveness, etc. (Hume, 2018). These economic developments are also viewed as evidence for a prevailing imbalance in an economy and when these developments persist for a longer time, they can lead to problems for economies on a global scale.
Over the course of time, economies around the world have evolved and become different from each other in such a way that some economies have become industrial or manufacturing-oriented while other economies have specialized in financial services (Esteban, et al., 2018). The industrial economies are usually export-oriented as they invest in the development of the industrial sector and the manufacturing of products for export to other parts of the world. The manufacturing economies operate on a long-term perspective as it takes time and investment to establish large-scale industrial complex for substantial growth of exports (Pollard, 2013). In this way, the industrial sector plays a vital role in generating national income as well as the stability of labour market (Kalpana & Narayan, 2012). The distribution of income among the labour force in the manufacturing economy is more stable and streamlined even though the levels of income inequality may still be substantial. The manufacturing-oriented economies are regulated and the accumulation of public and private debt in these economies is usually low.
On the other hand, financialized economies have shifted away from industrial capitalism while focusing on specializing in financial services and strategic investments (Stolbova, et al., 2017). In a financialized economy, the financial sector of the country takes center stage as compared to the overall economy of the country (Krippner, 2005). Financialization of an economy is usually driven by the prevailing new liberal growth models in different countries around the world in which the markets are deregulated and the financial sector is allowed to take the high risks and speculate (Welch & John, 2003). Therefore, financialization is usually focused on making money from money in a short period with no substantial plan for the long-term growth of the economy. In this way, the financialized economies are usually able to generate higher profits as compared to the manufacturing economies in a short period; however, greater levels of risk can also lead to losses and major problems for these economies. The level of income inequality is usually higher in a financialized economy as compared to the manufacturing economy with the top executives taking substantially higher packages (Palley, 2008). Similarly, the financialized economies are usually driven by debt, which in extreme cases can lead to severe levels of economic imbalance.
The interaction between manufacturing and financialized economies in terms of their codependency is an area of interest for researchers in order to better understand the theory of macroeconomic imbalance. In order to meet the domestic demand, the two types of economies have to regularly interact with each other. However, their interaction in terms of trade might not be balanced with one economy running a trade surplus over the other running a trade deficit. A review of global trade analytics suggests that manufacturing economies usually maintain a trade surplus over the financialized economies due to which the current account deficit becomes a major problem for the financialized economies. In order to meet their trade finances, these economies have to raise debts. In case of an unsustainable fiscal policy, the debt crisis can reach unprecedented levels causing severe problems such as observed during the European Sovereign Debt crisis. The macroeconomic imbalance has also been considered as a cause of economic disputes between different countries around the world. Therefore, a comprehensive analysis of the interaction between the two types of economies is required in order to investigate real-world problems in light of the theory of economic imbalance.
In this study, two cases of US-China and UK-Germany have been discussed in order to understand the interaction of financialized and manufacturing economies. USA and UK have become financialized economies over the course of time while China and Germany are among the world’s biggest manufacturing economies. The total trade between the UK and Germany is in the range of $91.2 billion (Knight, 2019) while the total trade between the US and China is in the range of $659.8 billion (USTR, 2018). Therefore, in both cases, the countries maintain huge bilateral trade portfolio, which makes them suitable for the sake of this study.
Europe has recently witnessed a sovereign debt crisis where a number of different countries in the Union including Greece, Spain, Cyprus, Ireland, and Portugal became unable to repay their government debts as well as bailout their debt-stricken banks in the wake of 2008 financial crisis (Lane, 2012). All these countries ran fiscal deficits for a long period in order to drive their growth. However, this also resulted in the accumulation of debts to a higher percentage of GDP of these countries, which resulted in macroeconomic imbalance. Similarly, in some countries, high levels of public debt mainly invested in the housing bubble resulted in a crisis after the 2008 financial crisis (Jorda, et al., 2013) where the governments had to bail out the financial sector, which resulted in a sovereign debt crisis. These countries relied heavily on debt from external creditors in order to maintain their finances, however, after the 2008 financial crisis; they were not able to raise a substantial amount of funds in order to repay their existing loans. Germany, the European Central Bank (ECB), and the International Monetary Fund (IMF) had to step in for bailing out these countries. The role played by Germany was significant as the debt crisis was more severe in the financialized economies as compared to the manufacturing economies. A number of these countries such as Greece are still ailing from the debt crisis due to which a detailed investigation of the relation between economic imbalance and the debt crisis is necessary in order to enable policymakers to understand the factors behind the debt crisis and take measures to avoid such occurrences in future.
Similarly, the US-China trade war is another important macroeconomic development, which has been triggered by a large current account deficit maintained by the USA in the bilateral trade between the two countries. China has dominated the manufacturing economy for a long period and since 1979 when the trade relationships between the two countries were restored, China has continued to increase its trade surplus over the USA. Currently, both countries have imposed high tariffs up to 25% on imports resulting in a crisis disrupting the balance of global markets. Therefore, it is also important to understand the link between economic imbalance and China trade war and other major economic disputes between countries. It is also important to analyze whether financialization of the US economy has resulted in the exacerbation of economic imbalance between the US and China since increased financialization can also result in negatively impacting the manufacturing sector of an economy.
These two cases will help in understanding the relationship between economic crisis and economic disputes with the economic imbalance. Similarly, they will also help in understanding how the financialization of an economy affects the economic imbalance due to the accumulation of net financial claims and macro-financial risks.
1.2 Structure of the thesis
This thesis has been divided into different chapters in order to present the findings of the research in a sequential manner. In chapter 2, a detailed analysis of the literature review has been carried out in order to develop a comprehensive understanding of various aspects related to the thesis of the research. In chapter 3, a discussion of the two cases has been carried out in light of the theory of economic imbalance and an understanding of the thesis has been developed by the interpretation of economic data that is relevant to the cases. In chapter 4, research methodology has been developed in order to investigate the factors behind the European Sovereign Debt crisis and US-China trade war. In chapter 5, significant favorable literature and evidence from Engelbert Stockammer have been investigated for the purpose of analyzing the factors behind the European Sovereign Debt crisis. Similarly, regression analysis has been carried out in order to determine the link between the US-China trade war and economic imbalance between the two countries. In the last section of the thesis, a discussion on the two cases has been carried out while the results of the research have been stated.
Chapter 2
2.1 Literature review on Economic Imbalance
The European Commission has defined economic imbalance as any trend or activity which adversely affects the economy of a country while also identifies factors i.e. current account deficit, private sector credit expansion, asset price surges, competitiveness, etc. that give an account of a prevailing economic imbalance situation in a country. Various studies have been carried out in order to explain these factors and their occurrence in the economy as well as to explain how they can lead to a situation of economic imbalance. These factors are significant on both micro and macroeconomic levels and especially in a more financialized economy. Assa (2016) has discussed that financialization of an economy takes place when the financial activities and profits of an economy are mainly driven by the financial sector while Assa (2012) and Kedrosky and Strangler (2011) have identified the ratio of financial assets over GDP as a reliable indication of the extent of financialization of an economy.
Stockhammer (2012) discusses that financialization affects both micro and macro-level indicators of an economy. On a microeconomic level, it affects various economic factors such as financial institutions, firms, workers, and households while on the macroeconomic level, it results in economies driven by movement in the value of real estate and financial assets. It has increased the access of households to credit due to which they may experience high levels of debt on a household level. On the macroeconomic level, countries may accumulate large current account deficits due to the liberalization of capital flows. In these countries, the level of consumption and expenditure are usually high while the levels of savings on both domestic and commercial levels are usually low. However, on the other hand, some countries have an export-driven model where they are able to maintain a current account surplus, reduced domestic consumption, and increased savings. This results in an international imbalance between different countries which along with debt-driven consumption is among the primary reasons for economic crisis around the world (Horn et al., 2009 & Hein, 2011a)
Financialization has been popularized since the 1970s and ever since a number of different economies around the world have undergone a shift from manufacturing towards the financialization of the economy. Various studies have been carried out in order to investigate the effects of financialization on the social and economic indicator of an economy. One of the major impacts of financialization is an increase in the income inequality among workers in different sectors of the economy. A study by Epstein (2005) has discussed that in the Organization for Economic Cooperation and Development (OECD) countries, a major share of the national income has been significantly dominated by the financial sector of the countries since 1980. The financialization has resulted in the creation of more wealth in a short time but in most cases, it has been achieved at the expense of the manufacturing sector, which has undergone a contraction in countries where sustained financialization has taken place. This has also resulted in a loss of jobs since the financial sector is capable of generating more income with lower labour force as compared to the manufacturing sector.
A study carried out by Sum, et al. (2008) has found out that the average income of the workers in the financial sector of the United State is 20 times higher as compared to the workers in other sectors. Similarly, a study by Arnum, et al. (2013) found out that in the financial sector of an economy, human capital does not play a significant role in wage growth. Another study by Lindley and McIntosh (2014) found out that the highest earners in the United States are employed in the financial sector of the country. This has resulted in higher levels of income inequality in the working class which coupled with stagnated average income has resulted in higher household debt. Similarly, an imbalance in different sectors of an economy due to the transferring of a major share of the income in the finance sector (Lin & Devey, 2013). The overreliance of countries on the financial sector instead of manufacturing and production results in the depletion of surplus generated through production and sales leading to both internal and external imbalances. This has resulted in various economic disputes and crisis over the course of time and an analysis of major crisis and disputes in light of the theory of economic imbalance is warranted for developing a comprehensive understanding. In this literature review, we will investigate in depth the European Sovereign Debt crisis and the US-China economic dispute from the perspective of economic imbalance between different countries.
Various studies have been carried out in order to investigate the effects of economic imbalance in terms of the identified factors on economies of the countries, major economic crisis and disputes on a global scale.
Studies have linked the emergence of debt crisis to the start of the EMU and a study by Blanchard and Giavazzi (2002) found out that the correlation between saving and investment witnessed a sharp decline in the beginning due to higher levels of financial integration. Lending of capital from economically strong countries to economically weak countries resulted in building up of benign imbalances while these countries did not consider these current account deficits a source of concern for longer period. Therefore, they did not maintain appropriate fiscal policy rules for better allotment of the resources, which resulted in the emergence of the debt crisis after the 2008 financial crisis. A study by Chen et al. (2012) found out that productivity sector continued to shrink in these countries as major investment was directed towards the real estate boom. This resulted in a continuous decline in the productivity and since the non-productive investment results in high levels of debt with lower prospects of refinancing them, a study by Giavazzi and Spaventa (2010) found out that it undermined the ability of the countries to repay their debts. This also resulted in a process of economic divergence in most of the European countries as discussed in a study conducted by Holinski, et al. (2012).
Over the course of time, the domestic economy of these countries continued to accumulate higher credit despite a mismatch between asset-liability maturities due to which financial imbalances continue to rise as discussed in a study by Veron (2013). The prevailing low interest rates in the region made it highly convenient for these countries to continue raising debt for meeting their domestic demand without concerning about the ever-increasing current account deficit problem. A study by Lane (2006) also found out that low interest rates continued to boost the borrowing of these countries due to which the current account deficit continued to rise to higher levels of GDP. Similarly, these countries could not properly manage their fiscal policy and continued to meet the fiscal deficit by borrowing higher sums of money, which also resulted in exacerbating the debt crisis. Weak institutions and powerful financial sector startled the implementation of meaningful reforms.
Similarly, various studies have found out that those countries, which have higher debt obligations, are more likely to be affected adversely by shocks such as observed during the 2008 financial crisis as compared to those that have lower levels of debt obligations. The reason behind this is that in case of a shock, countries are unable to get access to credit facility since lenders are reluctant to lend in the wake of a crisis. This leads to debt-ridden countries unable to repay their loans since they mainly rely on more loans in order to repay the previous ones. A similar situation occurred during the European debt crisis when the countries that were maintaining high levels of debt to GDP ratio were unable to have access to sufficient credit from the lenders in order to meet their debt obligations. High levels of debt have also been found to have a negative impact on the GDP of a country, as an increased debt above a certain level will not be able to boost the economy. The same has also been corroborated in a number of different studies such as (Baum, et al., 2013; Cecchetti, et al., 2011) which found out that increased level of debt above a certain level will have a negative impact on the economy of countries in the Eurozone.
2.2. Literature Review of US-China Trade War
The US and China are among the biggest trading partners in the world with bilateral trade between the two countries ranging around $659.8 billion. However, since mid-August 2018 both countries are involved in a trade war, which has witnessed both countries imposing tariffs on imports up to 25%. Trade war started on March 22, 2018, when the US administration imposed tariffs on $50-60 billion of Chinese imports to the USA (Diamond, 2018). This included around 1300 different categories of products that US imports from China, including medical devices, flat panel televisions, parts, satellite, etc. In response to the imposition of tariffs on its imports to the US, on April 2, 2018, the Chinese Ministry of Commerce responded by imposing tariffs of up to 25% on 128 products imported from the US. These products included steel piping, aluminum, cars, soybeans, fruits, nuts, etc. (Caixinglobal, 2018) On June 15, 2018, the US administration again imposed tariffs of up to 25% on $50 billion of goods imported from China. These goods included products that were termed as “industrially significant technology” and a complete list of products was made public on July 11 2018. Similarly on July 19, 2018, the Chinese Ministry of Commerce retaliated by imposing tariffs up to 25% on $50 billion of goods imported to China from the US. These theories came on effect alongside us tariffs on Chinese products on August 23, 2018.
On September 17, 2018, the USA increased the previously imposed tariffs on Chinese goods from 10% to 25% on $60 billion worth of goods (CNBC, 2019). Similarly, China responded on September 18, 2018, by imposing 10% tariffs on around $60 billion worth of US goods imported to the country while taking its total tariffs imposed on around $110 billion of US goods. On May 5, 2019, the US administration again raised tariffs imposed on $200 billion worth of Chinese goods imported to the country from previous 10% to 25%. Similarly, in retaliation the Chinese administration raised tariffs imposed on $60 billion of US goods imported to the country on June 1, 2019. On August 1, 2019, the US administration announced that it would levy tariffs of up to 10% on remaining $300 billion of Chinese goods imported to the country. In this way, the US administration has imposed tariffs on total portfolio of Chinese goods being imported to the country.
During this period, the US administration has also imposed a ban on Chinese major telecommunication equipment manufacturer named Huawei and barred its companies from doing business with the company. Similarly, the Chinese administration has also announced that it would impose restrictions on the US companies from doing business in the country that pose a threat to the national interests of Chinese companies.
The trade war between the two countries has been going on for over a year and despite various efforts of negotiations and discussions, the two countries have not been able to reach a common ground. On August 14, 2018, the Chinese administration filed a complaint with the World Trade Organization with reference to the imposition of US tariffs on solar panels manufactured by Chinese companies and their import to the USA. The Chinese administration stated that the ban on solar products is in contradiction to the rules of the World Trade Organization and they clash with the legitimate interests of China to carry out global trade. On August 23, 2018, China again filed a complaint with the World Trade Organization against the imposition of tariffs by the US on its products.
Both countries have also carried out several attempts of negotiating a trade deal for mutual benefit of the two countries; however, they have not been able to reach a common ground (Edwards, 2018). On May 15, 2018, the economic teams from both countries carried out trade talks in Washington, DC in order to reach an agreement. Similarly, on August 22, 2018, the US treasury undersecretary and Chinese Commerce Minister again conducted trade talks in Washington, DC in order to continue the negotiations for reaching a common ground. The US team negotiating US-China trade talks also visited China in order to continue the ongoing negotiations. On June 29, 2019, the presidents of the two countries met during G20 summit organized in Osaka, Japan where they reached an understanding to observe a truce in the trade war while continuing efforts to reach a deal for mutual benefits.
2.3 Literature review behind the causes of US-China trade war
A study by Qiua, et. al. (2019) has stated various reasons behind major economic disputes by evaluating trade literature. Some of the common reasons stated in the study are data modelling, terms of trade argument between countries, distributional effects, imperfect competition, increasing returns, WTO and other national security related reasons that prompt countries to engage in economic disputes. Imperfect competition as stated in this study is one of the major factors behind economic disputes where one country complains of unfair treatment at the hands of the trading partner, which affects the ability of its traders to exports its products in the market of the partner country. This may include tariffs and other trade policies that make it difficult for the traders to explore their products in other markets. A study published by White House Office of Trade and Manufacturing Policy, USA (2018) have also stated similar concerns about China and suggested that the Chinese administration strives to protect its local market from competition and imports while imposing regulatory hurdles for other companies which want to enter the Chinese market. Similar concerns were expressed in another study by US China economic and security commission (2017). Another study by US international trade commission (Linton & Hammer, 2010) raised concerns about intellectual property theft by Chinese administration in order to impose its dominance on industries of the future.
A study conducted by Li and Qiu (2015) found out that a deviation from free trade policy between countries leads to economic disputes between them. It analyzed 1,162 economic disputes during the period of 1995 to 2017 involving 110 different countries and found out that a deviation from free trade policy is one of the major factors behind the trade disputes while countries regularly involved in such practices because they have significant incentive. A study by Ossa (2014) found out that countries tend to make gains at the expense of other countries by deviating from free trade policies and imposing tariffs on imports, however, it also results in an economic dispute between the countries when the other trading partner retaliates. This suggests that a deviation from free trade between the two countries promotes a situation of economic imbalance or trade imbalance between the two countries as the country allowing free trade without imposing tariffs on imports will most likely run a deficit with other countries imposing tariffs on imports. The USA administration has raised similar concerns about China and suggested that the Chinese industrial policy always intends to make the best use of free market policies in other countries while it does not allow other countries to avail similar benefits in its market. A study conducted by Sundar (2016) also corroborated similar concerns of the US administration about the trade policies of china.
However, trade imbalance is not always the primary reason behind economic disputes as suggested in a study conducted by Battiston, et al. (2016). The study found out that multilateral trade deficit instead of bilateral deficits are of primary importance and play a significant role in influencing the economic imbalances and trade disputes between the countries. The multilateral trade deficits include the gap between domestic savings and investments as an important factor behind affecting economic disputes. In a financialized economy, the gap between domestic savings and investment is much higher as compared to a manufacturing or an export-oriented economy where the gap between domestic savings and investment is low. This is also an important consideration owing to the nature of US and China economies since US is mainly a financialized economy while the economy of China is export or manufacturing oriented. In this study, an analysis of US-China trade war from the perspective of trade deficit between the two countries will be conducted by using historical data in order to make significant observations regarding the ongoing economic dispute.
Chapter 3
3.1 Industrialization of Germany
The industrial revolution in Germany started at least a century later than it did in the United Kingdom but over the course of the last few centuries, it has become the biggest industrial giant in Europe as well as one of the biggest manufacturing-oriented economies in the world (Kopsidis & Bromley, 2014). The industrialization of Germany started in the 1800s when German chemical and electrical industries started to capture the world’s market with large-scale manufacturing of high-quality products. The industrial revolution of Germany was aided by various factors such as the availability of natural resources i.e. iron, coal, etc. which made it possible for the German industries to carry out large-scale manufacturing. In the 1800s, Germany had a rapidly growing population and workforce that enabled German industries to set up cost-effective and quality manufacturing industrial operations producing products having high demand in other parts of the world. In the 19th century, Germany significantly improved its shipping infrastructure that was only behind Britain in Europe during the time enabling German industries to export their products to other parts of the world and expand their manufacturing infrastructure.
Over the course of time, German industrial complex continued to expand with the House of Krupp becoming one of the leading producers of “Steel and Weapons” having a worldwide market that enabled German manufacturers to reach diverse world markets and significantly enhance the export portfolio of the country (Bernhard, 2013). In consequence, small-scale steel producing factories set up by business tycoons like August Thyssen became world’s biggest streel manufacturing empires employing thousands of people by 1914 (Encyclopedia, 2019). Other inventors such as Carl Zeiss set up large-scale manufacturing of optical equipment i.e. Telescopes, microscopes, etc. Germany invested heavily in building infrastructure road and railway network for linking major industrial complex with other parts of the country in order to efficiently meet the domestic and industrial demand that has significantly benefited the industrialization of the country.
In the late 20th and early 21st century, the German economy slowed down and witnessed high levels of unemployment ranging from 9.2% in 1998 to 11.1% in 2005, which prompted economists to refer to it as “sick man of Europe” (Dustmann & Schönberg, 2013). However, the German economy witnessed a remarkable transformation through a series of reforms enacted by the German government starting with Hartz Reforms, which significantly improved the competitiveness of the German industry and made it one of the biggest and modern industrial giants in the world. During the 2008 financial crisis, Germany witnessed a decrease in unemployment levels i.e. 7.7% in 2010 (Arbeit, 2011), which has reached below 4% in 2019 (Trading Economics, 2019) while it has continued to grow significantly when and other countries have slowed down in the wake of the financial crisis.
Presently, Germany has become one of the biggest exporting countries in the world with the export levels reaching 1.3 trillion Euro in 2017 while the total imports of the country are in the range of 1 trillion euro (OEC, 2019). This shows that the German economy is currently running a surplus of around 300 billion euro. The major industrial products of the country include automotive, machinery, equipment, chemicals, etc. which are exported all over Europe (67% of all exports to European countries while 58% of all exports to the members of the European Union) and other parts of the world making for the remarkable export portfolio of the country. Currently, German companies make up for 10% of total industrial manufacturing companies present in Europe will make up for 28% of the total production in the European manufacturing sector. The German industrial sector mainly comprises of Small and Medium Enterprises (SMEs), which according to the German Economic Overview (2018) data, there are 3.5 million in total making up for 99.6% of all companies present in the country. These SMEs specialize in various sectors such as energy, healthcare, transportation, electronics, chemicals, textile, consumer goods, etc. These companies are also employers in the country making up for 60% of the total German workforce. Similarly, some of the biggest industrial behemoths of the world such as Daimler, Volkswagen, Siemens, Bayer, BSF, etc. are present in Germany.
3.2 Industrialization of China
China is the world’s biggest manufacturing economy in the world and leads the global output of industrial sectors such as fertilizers, steel, cement, etc. A major industrial revolution has taken place in China since mid of the 20th century when the country shifted from being a mainly agricultural economy towards industrialization. In the 1950s and 1960s, there was a major emphasis on building a heavy industrial complex due to which the industrial sector grew rapidly and reached twice the size of the agricultural sector (CRS, 2019). Until 1978, the government-owned enterprises represented the majority industrial portfolio of a country 77.6% of the total industrial output produced by state-owned enterprises while the public sector only represented 22.6% of the total industrial output. During the period between 1950 and 1979, the industrial sector of China witnessed extraordinary growth of 13.3% on an annual basis. However, by 1979, the Chinese market underwent liberalization, which opened up the industrial sector to the private and foreign direct investment. Township & village enterprises (TVEs) entered the industrial sector of the country and became a major source of production by the early 1990s (Naughton, 2007). By 1991, the TVEs made up for 32% of the total industrial production in the country.
The industrial sector witnessed a growth of 10.1% during the period of 1979 to 1985 while the introduction of major policy reforms in 1984 also resulted in significantly boosting the output of the industrial sector that reached 20.8% by 1988. The trend in growth in the industrial sector continued through 1990 between 18 to 20% until 1994. During this period, the share of state-owned enterprises in the industrial sector also decreased from around 75% to 50% by 1995. The sector has continued to experience a high percentage of growth ever since making China the biggest manufacturing and export-oriented country in the world while the economy of the country has also surpassed Germany and Japan to become the second-biggest economy of the world after the United States.
The industrial output makes up for a high percentage of up to 40.5% of the Gross Domestic Product (GDP) of the country in 2017 which is a high percentage though it has decreased from 61.2% of the total portion of GDP in 1990 (Shu, 2019). The industrial sector of the country is also one of the biggest employers with 30% of people working in the manufacturing sector. The manufacturing sector of china is diverse with specialization in significant industries such as machinery, cement, chemical, fertilizers, four processing, electronics, telecommunication, information technology, energy automobile, steel, etc. Mass production in different areas of the industrial sector is carried out which significantly surpasses the domestic demand due to which a major portion of the industrial output is exported to other parts of the country. China has a large export portfolio of $2.41 trillion, which is highest among all countries in the world while the import portfolio of the country is $1.54 trillion only behind the United States (OEC, 2019). Therefore, China maintains a large trade surplus with other countries in the world up to $870 Billion on an annual basis.
3.3 Financialization of the United States
The economy of the United States has undergone financialization over the course of the last few decades where the financial sector of the economy has become influential as compared to the manufacturing sector of the country. Financialization has its roots in late 19th century when the speculation tendencies started to be employed for the means of maximizing short-term profits in the financial sector. The trend of accumulation of financial assets continued across the economy of the United States due to which it continued to become more financialized. The capital investment that was readily available for the creation of manufacturing firms started to be shifted towards the financial sector and absence of suitable protection for the non-financial sector only exacerbated financialization over the course of time. However, the mainstream financialization of the United States economy started in the 1980s when the financial sector became highly concentrated due to the deregulation of the market. The heavily inflated corporations started to consider smaller firms ineffective for maximizing profits (Davis & Kim, 2015) due to which various small firms were dismantled in order to maximize profits in the financial sector, which adversely affected the manufacturing base of the economy.
The financialization of the US economy has had an adverse effect on the economy of the smaller firms in the country, which have witnessed high levels of death rate as compared to the larger firms in the country. Large corporations, shadow banks, and institutions termed as “Too big to fail” have continued to grow at an unprecedented level due to which smaller firms find it highly difficult to compete in the market. A study conducted by Berdford (2017) shows that in all parts of the United States, the death rate of smaller firms has been much higher as compared to the larger firms and the phenomenon is potentially related to the financialization of the economy which has made it difficult for smaller firms to raise funds for growth due to which they become debt-stricken while they have to face unprecedented levels of competition in the face of the emergence of behemoth companies in almost all sectors of the economy. This has also dealt a significant blow to the manufacturing orientation of the US economy, which has become mainly oriented towards the services sector. The bailing out of larger firms by the US administration in the wake of a crisis or a failure has also resulted in decreasing the power and share of small and medium enterprises (SMEs), which are generally considered the major drivers of production in an economy.
The financialization of the economy has also resulted in the loss of jobs in different sectors of the economy while the income inequality has also been on the rise. A study by Arnum, et al. (2013) found out that 40 years ago when the manufacturing sector of the US economy accounted for 40% of the GDP, it also accounted for about 20% of total jobs in the country. However, with 40% of share in the GDP of the US economy, the financial sector only accounts for 5% of total jobs in the country. Similarly, a study by Kedrosky and Stangler (2011) found out that when the financial sector accounts for 25% of corporate profit, it only accounts for only for persons of total jobs in the economy. This shows that the financial sector growth has significantly resulted in shrinking the labour market of the country while the accumulation of a higher percentage of profits. Similarly, a study by Lin and Devey (2013) found out that manufacturing, transportation, and construction industries in the United States have continued to experience a decline in national share of income since the 1970s with national income in this sector falling by 6% over this period.
3.4 Financialization of the UK economy
The economy of the United Kingdom has undergone significant financialization over the course of time and according to a study conducted by Davis and Walsh (2016), it has become more financialized than any of its major economic rivals in the world while the process of deindustrialization has also been carried out at an unprecedented level. United Kingdom has been a major financial hub for centuries where the financial sector held a significant portion of the economy, however, a major impetus towards financialization of the economy started in late 1970s and early 1980s when liberal deregulations of the market were enacted. According to a study conducted by Coates (1995), the financial sector of the United Kingdom witnessed investment of 20.3 % from the period of 1979 to 1989 while the manufacturing sector only witnessed investment levels of 12.8%. This shows that the financial sector grew much more rapidly as compared to the manufacturing sector and quickly became the greatest portion of the economy.
The UK bank assets rose exponentially during this period and by Mid-2000s became five times the total GDP of the country despite the fact that they had been only half of the GDP of the country for over a century until 1970s (Haldane, 2010). Similarly, in the late 1970s and early 1980s, the total value of the stock market only represented 40% of the government income but by 2012, the equity value of the stock market rose to three times of the national income of the United Kingdom. Financialization of the economy also resulted in accumulation of high levels of debt to GDP ratio of the country, which increased by 88% during the period 1997-2013. The financialization of the economy has also happened at the expense of the manufacturing sector, which has experienced a significant decline since 1970. According to the study of Coates, the manufacturing sector of the economy of the United Kingdom accounted for 30% of the total GDP of the country while it also made up for 16.3% of total world’s exports, however, over the course of time, the manufacturing sector shrunk significantly and by 2010, it only represented 13% of the GDP. Similarly, labour employed in the manufacturing sector has also decreased significantly since 1970 i.e. 35% of total employment in this sector in 1970 to only 10% of total employment by 2010. Owing to this, the United Kingdom, which maintained a trade surplus of 4-6% in this sector in the 1970s, started to maintain a trade deficit of 2-4% in the manufacturing sector.
The government of the United Kingdom has played a significant role in the financialization of the economy by enacting policies, which encouraged investments in the financial sector while discouraging investment in the manufacturing sector. Significant changes took place in treasury and the Department of Trade & Industry (DTI) in 1976 and onwards having profound economic impacts. The decision making mainly prioritized deregulation of the financial markets, privatization, deregulation of finance and trade, corporate governance, etc. which shifted the paradigm of the UK economy from manufacturing towards the financial sector.
3.5 The codependency of the United States and China
The United States and China are among the biggest trading partners in the world with the bilateral trade between the two countries in the range of $695 billion while the two countries heavily depend on each other for meeting the domestic demand of their consumers as well as providing the necessary inputs for different sectors of their economies. However, an analysis of trade data between two countries shows that it is highly shifted in favour of China while the United States runs heavy annual trade deficit.
United States is the second biggest export market for China and as per the data available from 2010, the US market accounted for 18% of the total Chinese exports. Similarly, in 2012, 19% of the total US imports originated from China accounting for higher percentage of imports than the neighboring trade partners i.e. Canada (14%) and Mexico (12%). Major reasons behind high exports from China to the United States include large scale and cheap manufacturing of products in China due to the availability of cheap and skilled labour, presence of manufacturing units of major US companies in China exporting their products to the United States, devaluation of Chinese currency making it more convenient for importers to purchase Chinese products, etc. China became a major trading partner of the United States after the liberalization of its market in 1979. However, in the 1980s, the exports of China to the US mainly consisted of low value consumer products such as toys and semiconductor chips but over the course of time China has significantly carried out value addition in its trade portfolio and revamped its manufacturing sector. China started to export hi-tech and heavy machinery products to the United States such as motor vehicles, parts, electronic products, telecommunication equipment, etc. by mid 1990s.
Similarly, the United States is a major source of imports for China and according to the trade data of 2017; the total imports of China from the United States are in the range of $133 billion. The US imports agricultural and technological products to China. In agricultural, Soybeans is the major agricultural product imported to China while integrated circuits, motor vehicles, civilian aircrafts, etc. make up for the rest of the import portfolio. US exports of Soybean to China has significantly increased over the course of the last few decades as it has risen from 19% in 2001 to 57% in 2017. Similarly, the US exports of motor vehicles and other technological products to China have significantly increased from less than 1% in 2001 to greater than 19 % in 2017 while the demand of civilian aircraft have reached 13% in 2017, which is a significant boost from previous numbers. China also relies on integrated circuits and semiconductor chips manufactured in the United States for functioning of its major industries in the technological sector. There are a number of major US companies operating in China and according to the statistics available from 2010, their number reached 1,31,000. These US companies provide significant services to the Chinese consumers in a number of different sectors due to which China depends on US foreign direct investment for meeting the needs of its domestic consumers. According to the data available from 2012, the US foreign direct investment in China has reached $51.4 billion.
The economy of the United States and China are starkly different from each other as China is the world’s biggest manufacturing economy while on the other hand the United States is the world’s biggest financialized economy. United States have significantly shifted from manufacturing orientation with its financial sector making up for the major portion of the economy while on the other hand China continues to heavily invest in its manufacturing sector by mass producing goods in almost all sectors. The US economy is highly debt-stricken while the foreign reserves of the country are in the range of $128 billion. China on the other hand keeps large savings in its foreign exchange reserves, which are currently in the range of $3.119 trillion. The economic imbalance between the two countries has been linked with the ongoing US-China trade war due to which it is important to investigate their mutual relationship. Therefore, in this study, an investigation of the relationship between trade deficit between the two countries and the ongoing economic dispute will be carried out in order to make meaningful conclusions.
3.6 The codependency of Germany and UK
Germany and the UK are two biggest trading partners in Europe with total trade between the two countries in the range of $134.9 billion as per the data available from 2017. The bilateral trade between the two countries make up for 10.7% of the total UK trade. Exports to Germany account for 9.1% of total exports while imports from Germany made up for 12.3% of total UK imports. Similarly, according to the foreign trade data of Germany, the UK is the fourth biggest export market for Germany while it is the 11th biggest source of imports for the country. The two countries rely heavily on each other for meeting their domestic demand and trade between the two countries have continued to expand over the course of time i.e. an increase of 10.7% on an annual basis since 2016.
An assessment of the trade data between the two countries shows that Germany runs a trade surplus over the UK since according to the 2017 trade data, the total exports of Germany to the UK were £78.6 billion while the total imports of Germany from the UK were £56.4bn. This shows that Germany maintains a trade surplus of around £22.2 billion. The major reason behind this lies in the fact that the economies of the two countries are significantly different from each other since Germany is mainly an export-oriented economy having heavy manufacturing infrastructure while the UK is one of the biggest financialized economies in the world operating mainly in the services sector.
Germany holds significant trade surplus over various other countries in the region, which have shifted their focus from manufacturing towards financialization. These countries have become debt-stricken since they need to raise debt from major creditors in the world in order to meet their fiscal deficit on an annual basis. This results in a situation of economic imbalance in the region, which can be the source of major economic crises such as the European Sovereign Debt crisis, which arose in the wake of the 2008 financial crisis. In this study, an investigation on the relation between macroeconomic imbalance in the region and debt crisis will be carried out from the literature of Engelbert Stockammer.
Chapter 4
Methodology
In this study, the relationship between economic imbalance and major recent economic disputes and crises have to be investigated. Therefore, US-China trade war and the European Sovereign Debt crisis have been selected for carrying out an in-depth analysis. Methodologies for the two cases have been developed as follows:
4.1 Case 1: US-China Trade War
It can be evaluated by analyzing the timelines of the US-China trade war that the United States considers high levels of imports from China detrimental to its national interests and intends to curb it by imposing high tariffs. By curbing imports, the United States wants to reduce its trade deficit with China and achieve a level of economic balance between the two countries. However, the trade deficit is dependent upon both imports and exports and it can increase in the case of a decrease in US exports or increase in its imports. Therefore, it is important to understand whether imports have been one of the major reasons behind the trade deficit between the two countries, as the trade deficit itself is dependent upon both imports and exports. It is pertinent to study the economic imbalance between the two countries over the course of the last few decades by analyzing the relationship between US imports from China and the rising trade deficit of the US.
In order to investigate the relationship, a linear regression analysis will be performed with US imports from China as the independent variable and the US trade deficit with China as the dependent variable. The regression analysis will investigate the dependency of the trade deficit on US imports in order to rationalize the concerns of the US administration. The linear regression analysis will help in understanding the extent of dependency between the two variables and analyze whether high imports are one of the major reasons behind the US-China trade war.
4.2 Case 2: European Sovereign Debt Crisis
The European Sovereign Debt crisis has turned out to be a major economic crisis in the region and it has significantly impacted those countries which had higher debt obligations as compared to those which had lower debt obligations. Debt is considered a major problem for those countries that experience high levels of economic imbalance for a sustained period because these countries have to borrow money from lenders in order to balance their current account and fiscal deficits. The King’s College London professor Engelbert Stockhammer has conducted significant research on the debt crisis. Therefore, in this study, evidence from the research work of Engelbert Stockhammer will be discussed in order to study the relationship between economic imbalance and the debt crisis.
Chapter 5
Analysis and Discussion
5.1 Case 1: US-China Trade War
In order to perform the linear regression analysis, 34 years of trade data during the period of 1986-2019 between the United States and China have been obtained from the official website of the United States Census Bureau (2019). The detailed data has been provided in Table 1. The data contains total exports, imports, and US trade deficit statistics during the highlighted period, which makes it highly convenient to perform the linear regression analysis in order to analyze the correlation between US imports and trade deficit with China over the course of time.
| US-China Historical Trade Data | ||||
| Sr. No | Year | US Annual Imports (Millions) | US Annual Exports (Millions) | US Trade Deficit (Millions) |
| 1 | 1986 | 4771 | 3106.3 | 1664.7 |
| 2 | 1987 | 6293.6 | 3497.3 | 2796.3 |
| 3 | 1988 | 8510.9 | 5021.6 | 3489.3 |
| 4 | 1989 | 11989.7 | 5755.4 | 6234.3 |
| 5 | 1990 | 15237.4 | 4806.4 | 10431 |
| 6 | 1991 | 18969.2 | 6278.2 | 12691 |
| 7 | 1992 | 25727.5 | 7418.5 | 18309 |
| 8 | 1993 | 31539.9 | 8762.9 | 22777 |
| 9 | 1994 | 38786.8 | 9281.7 | 29505.1 |
| 10 | 1995 | 45543.2 | 11753.7 | 33789.5 |
| 11 | 1996 | 51512.8 | 11992.6 | 39520.2 |
| 12 | 1997 | 62557.7 | 12862.2 | 49695.5 |
| 13 | 1998 | 71168.6 | 14241.2 | 56927.4 |
| 14 | 1999 | 81788.2 | 13111.1 | 68677.1 |
| 15 | 2000 | 100018.2 | 16185.2 | 83833 |
| 16 | 2001 | 102278.4 | 19182.3 | 83096.1 |
| 17 | 2002 | 125192.6 | 22127.7 | 103064.9 |
| 18 | 2003 | 152436.0969 | 28367.94286 | 124068.154 |
| 19 | 2004 | 196682.0339 | 34427.77246 | 162254.2615 |
| 20 | 2005 | 243470.1048 | 41192.01012 | 202278.0947 |
| 21 | 2006 | 287774.3526 | 53673.00834 | 234101.3443 |
| 22 | 2007 | 321442.8669 | 62936.89158 | 258505.9754 |
| 23 | 2008 | 337772.6278 | 69732.83754 | 268039.7903 |
| 24 | 2009 | 296373.8835 | 69496.67861 | 226877.2049 |
| 25 | 2010 | 364952.6336 | 91911.08094 | 273041.5527 |
| 26 | 2011 | 399371.2326 | 104121.5236 | 295249.709 |
| 27 | 2012 | 425619.0826 | 110516.6157 | 315102.467 |
| 28 | 2013 | 440430.0196 | 121746.1886 | 318683.831 |
| 29 | 2014 | 468474.8949 | 123657.2034 | 344817.6915 |
| 30 | 2015 | 483201.6554 | 115873.3653 | 367328.2901 |
| 31 | 2016 | 462419.9916 | 115594.7845 | 346825.2071 |
| 32 | 2017 | 505220.2333 | 129797.5872 | 375422.6462 |
| 33 | 2018 | 539675.5908 | 120148.1411 | 419527.4497 |
| 34* | 2019 | 219044.2636 | 51999.96819 | 167044.2954 |
| *Available until June, 2019 | ||||
Table 1 US-China Historical Trade Data
5.1.1 Regression Analysis Results
The regression analysis was performed in MS Excel and the results of the analysis have been provided in Table 2.
| SUMMARY OUTPUT | ||||||||
| Regression Statistics | ||||||||
| Multiple R | 0.99836615 | |||||||
| R Square | 0.996734969 | |||||||
| Adjusted R Square | 0.996629645 | |||||||
| Standard Error | 7882.425926 | |||||||
| Observations | 33 | |||||||
| ANOVA | ||||||||
| df | SS | MS | F | Significance F | ||||
| Regression | 1 | 5.87995E+11 | 5.87995E+11 | 9463.548977 | 4.15603E-40 | |||
| Residual | 31 | 1926111793 | 62132638.48 | |||||
| Total | 32 | 5.89921E+11 | ||||||
| Coefficients | Standard Error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% | Upper 95.0% | |
| Intercept | 3075.235406 | 2128.226543 | 1.44497559 | 0.158498027 | -1265.311246 | 7415.782057 | -1265.311246 | 7415.782057 |
| 0.752364727 | 0.007733951 | 97.28077393 | 4.15603E-40 | 0.73659123 | 0.768138224 | 0.73659123 | 0.768138224 | |
Table 2 Regression Analysis Output
5.1.2 Discussion
It can be analyzed from the results of the regression analysis that there is a strong correlation between US imports and the trade deficit maintained by US with China. The Multiple-R value obtained through the regression analysis is significant and shows that the maximum correlation between the two variables has been reflected by the data. Similarly, the adjusted R square value reflects that a strong correlation between the two variables has existed for the period for which the data have been evaluated. The p-value obtained through the regression analysis is much less than 0.5 i.e. 1.45555E-19 < 0.5, which also reflects a strong correlation between the two variables.
Therefore, it can be analyzed from the results of the regression analysis that high levels of US imports with China play a significant role in affecting its trade deficit with the country. Since the trade deficit between the two countries is an indication of economic imbalance, it can be analyzed that it is one of the reasons behind the ongoing trade war. However, it can also be analyzed from the data that while the US imports with China have significantly increased over the course of the study period, it has not been able to substantially increase its export portfolio, which has also played a significant role in exacerbating the trade deficit situation. The main reason behind this is the inability of US to increase the competitiveness of its manufacturing sector due to its overemphasis on the financial sector, which has resulted in the current economic imbalance situation between the two countries leading to the ongoing trade war.
5.2 Case 2: European Sovereign Debt Crisis
Engelbert Stockhammer has discussed the European Sovereign Debt crisis in various studies (Stockhammer et. al., 2016; Stockhammer, 2015; & Stockhammer, 2012). He discusses that the ideals of neoliberalism have led to the financialization of economies in different parts of the world, which is also responsible for the emergence of the recent debt crisis in Europe. Financialization has resulted in significantly enhancing the size of the financial sector of an economy since most of the investment gets shifted towards this sector as investors intend to earn short-term high profits instead of relying on long-term sustained returns through the production sector. Similarly, it has also resulted in increasing the fragility of the financial system and made it more vulnerable to external shocks, which in severe cases such as a global recession can lead to a financial crisis.
Another important effect of financialization is the distribution of income in the market since in economies which experienced financialization, an increasing wage gap between labours have been witnessed while the top executives in the financial sector entertain most power. Increasing Household imbalances have been experienced as a result. A majority of households in the labour market struggle to meet their household demands due to stagnant wages in their sector and increased wage gap between different sectors of an economy as well as between hierarchies in a specific sector. Consequently, the households tend to borrow money in order to meet their requirements leading to accumulation of high-private debt.
In the Eurozone, this significantly affected the domestic demand of a country, which consequently resulted in countries employing a number of different strategies in order to meet the shortfall of demand that they had to cope in their domestic markets. The debt level of household in these countries significantly increased over the course of time, which resulted in debt driven consumption in the economy as a whole. Similarly, the real estate bubble witch emerged prior to the 2008 financial crisis also resulted in accumulation of private debt to unprecedented levels and significantly adding to the debt driven consumption of economies. In order to meet the current account deficit, these countries had to borrow money from lenders in the global financial markets. However, these economies were able to raise significant amount of debt from financial markets for a long period but the emergence of financial crisis in 2008 stifled the flow of the money from the creditors, which left them unable to repay or finance their previous debts.
Similarly, the international financial liberalization also resulted in different growth trajectories in different countries across the world, as some countries were able to maintain substantial trade surpluses over other countries while maintaining lower consumption in their domestic consumer markets while other countries maintained significant trade deficits with higher consumption in their consumer markets. The countries that maintain trade surplus over other countries are generally export-oriented economies while those countries that maintain trade deficit are mainly financialized economies. The economies with high trade deficits with other countries also have to borrow money from lenders in order to meet their current account requirements that result in high debt over the course of time. However, these imbalances are vulnerable as in case of a global recession, countries find themselves unable to raise significant amount of debts in order to meet their current account deficit requirements as well as service their previous debts.
Therefore, Engelbert Stockhammer has discussed that debt-driven consumption and international imbalances maintained by countries in the Eurozone mainly due to the widespread ideals of neoliberalism resulted in the emergence of the European Sovereign Debt crisis.
Conclusion
The study has analyzed two cases i.e. European Sovereign Debt crisis and US-China trade war in light of the theory of economic imbalances in order to study the relationship between imbalances and economic crises and disputes taking place in different parts of the world. It can be analyzed that economic imbalances play a significant role in affecting the health of an economy and make it more vulnerable to external factors. In the case of the European Sovereign debt crisis, those countries which invested heavily in their financial sector due to the prevailing neoliberal ideas in the economy faced a severe debt crisis. These countries defaulted on their loans and mainly relied on export-oriented economies in order to secure a bailout. Similarly, it has been analyzed that international trade deficit between US and China results in significantly contributing to the overall trade deficit of the US, which is currently in the range of $890 billion and results in economic imbalances. The US considers the situation detrimental to its national interests due to which the US administration has engaged in economic disputes with its major trading partners and especially China.
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