Global Imbalances: Petrodollars in the Lead

Fuad Hasanov, Rabah Arezki - August 2012


The Facts

 

The late 1990s and 2000s witnessed the emergence and substantial growth of large and persistent current account surpluses in some countries and large current account deficits in others, often referred to as global imbalances. Not even the global financial crisis of 2008 has managed to do away with these imbalances. While the crisis initially shrank the imbalances as global output and trade collapsed in 2009, global imbalances started widening once again following the recovery in 2010. These, as well as the debate on their origins and ways to resolve them, are now back on the international finance agenda.

 

So far, the discussion about global imbalances has chiefly focused on Asia and the United States. While Europe’s current account has been broadly in balance, the cumulative current account surplus in China has amounted to about 2.3 trillion dollars while the rest of emerging Asia has accumulated another 1.5 trillion dollars in surpluses since 1990.[2] Japan, outpaced by China, has run substantial current account surpluses as well, about 3 trillion dollars. When taken together the surplus of all emerging Asia, including China, does not measure up against the US’s accumulated current account deficit of about 8.3 trillion dollars. Another major player has taken a center stage, the oil exporters.[3] In fact, oil-exporting countries have contributed more to global imbalances than China or all of emerging Asia (Figure 1). As discussed in a recent article “Petrodollar Confusion” in the Economist, the cumulative current account surplus in oil-exporting countries since 1990 has amounted to about 4.6 trillion dollars, twice as large as China’s surplus.

 

The oil exporters’ current account surplus has skyrocketed from the early 2000s until the global financial crisis of 2008, but has picked up substantially after the crisis. The annual surplus tripled to about 600 billion dollars in four years by 2008, whereas China’s current account surplus has shot up at a higher rate from about 70 billion dollars in 2004 to a still lower total of about 400 billion dollars in 2008. Current account surpluses declined substantially during the global output collapse of 2009 but have since recovered. China’s current account has increased to about one-half of its pre-crisis level, but oil exporters have witnessed their surpluses go back essentially to the previous level (Figure 1). Whether current account surpluses will persist into the future depends on many factors, but understanding what drives these surpluses (and current account deficits of large deficit countries) can assist our thinking in resolving global imbalances.

 

Figure 1. The Evolution of Current Account (1990-2012)[4]





The Debate

 

There has been a lot of discussion among policymakers about the causes and consequences of global imbalances. Chinn, Eichengreen, and Ito (2011) re-examined the determinants of current account balances and analyzed potential explanations such as the “saving glut” hypothesis, the effect of fiscal deficits, self-insurance motives, distortions in financial markets, and the lack of financial development in emerging markets. The authors found that the “saving glut” cannot explain the bulk of the current account movements and pre-crisis patterns are due to stock market and house price booms in late 2000s as well as a rise in household leverage. In addition, fiscal deficits matter, but they cannot reduce current account balances substantially for deficit countries. For China, financial development coupled with capital account liberalization may help reduce its large current account surplus. The authors conclude that global imbalances may be here to stay unless there is a shift in policy by the  major players.

 

Blanchard and Milesi-Ferretti (2010) examine the rise in global imbalances since the mid-1990s and suggest that a variety of factors played different roles over time. External demand for the US assets, a declining US saving rate, asset price booms, high oil prices and high saving in oil exporters, large saving rate in China, and an investment decline in emerging Asia have all contributed to global imbalances. The authors conclude that global imbalances could be lower in the future if domestic and international distortions, which increased in the 2000s, are tackled. These include an increase in public and private US saving rates, a switch from export-led to domestic demand-led growth in some emerging market economies, and provision of global liquidity to reduce self-insurance motives. Without easy access to global liquidity, the financial crisis of 2008 may yet encourage a further accumulation of foreign currency reserves and may result in widening of global imbalances. Indeed the Asian crisis of 1997-1998 contributed to policy shifts and accumulation of foreign reserves in many Asian countries to self-insure against potential external risks.


Accumulating Petrodollars

 

As in the Asian countries, high saving by oil exporters is an important factor driving global imbalances. High oil prices, especially in the 2000s, mostly due to high global growth, resulted in a huge influx of oil money into oil-exporting economies. A lot of oil income was saved while investment stayed flat (Figure 2). Yet oil prices alone do not explain large current account surpluses of oil exporters. Why would oil exporters save so much? Why would they not invest a lot? Oil exporters’ saving and investment policies would determine the current account dynamics. In particular, fiscal policy and exchange rate policy of oil exporters and the destination of petrodollars accumulated in sovereign wealth funds (SWFs) would have implications on the evolution of global imbalances.

Figure 2. Average Saving and Investment Rate in Oil Exporters and Real Oil Price (deflated by the US CPI)

There are several explanations why oil windfalls are not and should not be invested en masse. One of them is limited absorptive capacity, which can simply result from the reduced domestic investment opportunities in oil-exporting countries. Limited absorptive capacity may also arise from weak administrative capacity, which leads to overrun costs and misallocation of capital. The propensity to waste is higher in oil exporters as revenues from oil exports go directly to the government’s coffers and can thus be more easily captured and misallocated in the absence of strong checks and balances (Arezki and Brueckner, 2011). Optimally, a weaker administrative capacity calls for a smaller increase in public capital following an oil windfall (Arezki, Dupuy and Gelb, 2012). The absorptive capacity can be improved but in practice it tends to be quite a pervasive factor. While oil-exporting countries significantly ramped up their public spending programs during the 2000s, the increase was smaller than in the previous oil booms of the 1970s. The lessons of the wasteful investment and a subsequent collapse in the oil price were learned well.

Another reason behind the high saving of oil exporters and their relatively low investment rate is oil price volatility. Oil accounts for a large share of export revenue in many oil-exporting countries. With high volatility of oil price, therefore, the income received by oil exporters is much more volatile than that of other countries. In addition, a drop in oil price could persist for a long time as in the 1980s-90s. As a result, the saving rate would be high and the investment rate would be low (Cherif and Hasanov, 2012a). In particular, with export volatility of an average oil exporter, and a horizon of 50 years and no initial assets, optimal precautionary saving in safe assets would be 30 percent of GDP while the investment rate would be about 15 percent of GDP. With initial assets of about 100 percent of GDP, similarly to some Middle Eastern producers, the optimal precautionary saving would be 20 percent of GDP, still relatively high saving in the safe assets. The high saving rate of oil exporters observed could then be explained by a large uncertainty about oil price dynamics. Since 2000, the average saving rate of oil-exporting countries has been 35 percent of GDP similar to the model’s prediction (total saving is the sum of precautionary saving in the safe asset and investment). Other saving motives such as intergenerational equity concerns could further contribute to high saving.

Oil exporters have invested on average about 25 percent of GDP since 2000, and investing more requires high productivity of the tradable sector. Cherif and Hasanov (2012a) show that a low productivity of the tradable sector in oil-exporting countries implies a low optimal investment rate, about 15 percent of GDP. The observed investment rate already exceeds that predicted by the model. The IMF (2011) shows that in Gulf Cooperation Council (GCC) countries, total factor productivity growth has been about zero for the past 40 years. Oil exporters have been investing a lot in the past, especially in the 1970s-early 1980s, but high investment has not materialized into the development of the tradable sector, and has not resulted in high total productivity. Perhaps even the current investment rates are too high given the productivity observed thus far.

 

High saving, relatively low investment, and thus high current account surpluses of oil exporters seem optimal, but whether this is desirable from the global perspective remains debatable. High oil prices driven by high global growth have resulted in a huge inflow of petrodollars to oil economies, transferring wealth from oil importers. Despite the wealth redistribution, the outcome is not necessarily “bad” for the world economy. If the accumulation of oil money is a concern, a similar argument can be made about oil companies that earned substantial sums of income in the 2000s. Five big oil companies collected a trillion dollars in profits from 2001 to 2011 (Weiss, Weidman, and Leber, 2012). When oil prices peaked in 2008, ExxonMobil’s annual profit was about 45 billion dollars with revenues of about 500 billion dollars. It seems oil companies can rival some of the oil producers in terms of the accumulation of petrodollars.

 


Helping Resolve Global Imbalances: Oil Exporters’ Policies

 

Since oil exporters save most of the oil income, recycling of petrodollars, however, may have different implications on global imbalances and world or regional economies. A precautionary saving motive and high volatility of oil prices suggest parking petrodollars in safe and liquid assets (e.g. Treasury bills). Eventually, the banking system of the destination country would make use of the excess funds. SWFs could also park a fraction of the oil wealth in risky assets such as foreign direct investment, real estate, or equity portfolio in other parts of the world. In either case, the global imbalances evolution and global or regional economies may be affected by the recycling of petrodollars. If the recycling results in asset booms and bubbles, the global imbalances could further widen and global growth may not be sustainable. However, if the recycling is used for productive purposes (e.g. foreign direct investment), it can increase production and the export potential of recipient countries and help shrink global imbalances and improve global growth prospects. Where petrodollars flow does matter, therefore.

 

To contribute to the reduction of global imbalances, fiscal policy is a more potent tool for many oil exporters than the exchange rate policy. Arezki and Hasanov (2009) show that a 10 percent of GDP decrease in the fiscal balance reduces current account by about 10-15 percent of GDP on average for a group of oil exporters, which is a much larger effect than that for oil-importing countries, about 3-4 percent of GDP. In contrast, an appreciation of the real exchange rate by a whopping 100 percent would only reduce current account balance by 2.5 percent of GDP. This result is quite intuitive since oil exports are priced in US dollars and thus may not be affected by changes in the exchange rate. Thus, increasing public spending could be an effective option to reduce the current account surplus. However, it is important to stress that fiscal expansion during an oil boom could exacerbate volatility, increase inflation, and merely waste money on unproductive projects or transfers. Focusing spending on developing the tradable sector, improving productivity, relieving supply bottlenecks, and promoting economic diversification would mitigate concerns about higher spending (Arezki, Gylfason and Sy, 2012).

 

Another way to induce oil exporters to reduce high current account surpluses is to decrease the volatility of oil income received by oil exporters. With lower income volatility, precautionary saving is minimal and investment is relatively high (Cherif and Hasanov, 2012b). The model in Cherif and Hasanov (2012a) suggests that a floor on the oil price would provide a hedge against low oil prices for oil exporters. It would require commitment on the part of major oil importers or an international agency. If oil importers could commit to a floor, oil exporters would not need to build up large reserves in case oil price plummets and does not recover for a long time. Both oil exporters and importers would benefit from oil exporters’ reduced saving and increased investment, reducing current account surpluses and shrinking global imbalances.

 


Concluding Remarks

 

Oil exporters are important players on the global economic imbalances stage. These countries have amassed large amount of petrodollars, much larger than China’s export surpluses and even larger than all of emerging Asia. Oil exporters will stay in the lead, accumulating huge reserves if oil prices remain high and current policies continue. A high volatility of oil income explains to some extent why oil exporters save a lot and invest relatively little. Although a high oil price has contributed to a substantial rise in current account surpluses, oil exporters’ policies also play a role in affecting the size and distribution of global imbalances. Fiscal policy has a strong effect on the current account in oil-exporting countries while exchange rate appreciation is less effective. Engineering a floor on the oil price might also reduce the need for precautionary saving. In addition, the flow of petrodollars to other countries and various asset classes could affect how global imbalances might evolve. The recycling of petrodollars for productive uses rather than consumption or speculation would be beneficial for both world long-run growth and global imbalances dynamics.

 

References

 

Arezki, R. and M. Brueckner, 2011. “Oil Rents, Corruption, and State Stability: Evidence from Panel Data Regressions,” European Economic Review 55(7), 955-963.

 

Arezki, R., A. Dupuy, and A. Gelb, 2012, “Optimal Public Investment in Resource Rich Countries: The Role of Total Factor Productivity and Administrative Capacity,” manuscript.

 

Arezki, R., T. Gylfason, and A. Sy, (eds.), 2012. Beyond the Curse: Policies to Harness the Power of Natural Resources, Washington, DC: International Monetary Fund.

 

Arezki, R. and F. Hasanov, 2009, “Global Imbalances and Petrodollars,” IMF working paper 09/89.

 

Blanchard, O., and G. M. Milesi-Ferretti, 2010, “Global Imbalances: In Midstream?” KDI/IMF Conference on Reconstructing the World Economy, February 25, Seoul, Korea.

 

Cherif, R. and F. Hasanov, 2012a, “The Oil Exporters’ Dilemma: How Much to Save and How Much to Invest,” IMF working paper 12/4.

 

Cherif, R. and F. Hasanov, 2012b, “The Volatility Trap: Precautionary Saving, Investment, and Aggregate Risk,” IMF working paper 12/134.

 

Chinn, M., B. Eichengreen, and H. Ito, 2011, “A Forensic Analysis of Global Imbalances,” manuscript.

 

IMF, 2011. “Why Should Qatar Focus on Productivity Gains?” in Qatar: 2010 Article IV Consultation—IMF Country Report 11/64.

 

“Petrodollar Confusion,” 2012, The Economist, April 28, print edition.

 

Weiss, D., J. Weidman, and R. Leber, 2012, “Big Oil’s Banner Year: Higher Prices, Record Profits, Less Oil,” Think Progress, February 8. Available: http://thinkprogress.org/climate/2012/02/08/421061/big-oil-higher-prices-record-profits-less-oil/

 



[1] Rabah Arezki and Fuad Hasanov. International Monetary Fund, Washington, DC 20431. We would like to thank Reda Cherif for valuable comments and suggestions. The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.

[2] Emerging Asia (except China) comprises Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan Province of China, Thailand, and Vietnam.

[3] Oil/gas exporting countries are Algeria, Angola, Azerbaijan, Bahrain, Congo, Ecuador, Equatorial Guinea, Gabon, Iran, Kazakhstan, Kuwait, Libya, Nigeria, Norway, Oman, Qatar, Russia, Saudi Arabia, Syria, Turkmenistan, United Arab Emirates, Venezuela, and Yemen.

[4] The 2012 data are IMF’s World Economic Outlook (April 2012) forecast.