10 there to be a rapid growth in consumption and imports in China, Japan, Germany and other economies in trade surplus. Here the portents are not positive. Scarred by its history of inflation during the 1920s, Germany has made it clear that it wishes to minimize deficit financing. It has also explicitly committed itself to remaining an economy with a substantial trade surplus. Japan, despite efforts to reflate consumption in the past, also does not suggest itself as an economy capable of pulling-in significant imports from the deficit economies, and allowing them to benefit from rapid exportled growth. As a recent IMF Report concluded, “the scope for advanced economies such as Germany and Japan to contribute to rebalancing is limited, given their need to build savings to prepare for population ageing” (IMF, World Economic Outlook, 2009:33). So China, and to a lesser extent India, hold the hopes of sustaining the V, U or W scenarios.

The problem is that there is little realistic sign that China-led reflation will draw in the imports to allow the major deficit economies to resume past levels of consumption growth whilst at the same time rebalancing their external payments accounts. It is true that the Chinese government has embarked on a major spending program. But, much of this has focused on infrastructure and on public services where, in 2009, government spending expanded rapidly in health (38 percent), education (24 percent), and social safety (22 percent) this year (Source: World Bank China Quarterly Update March 2009). These infrastructural expenditures do have derived import requirements but, as we will see below, these are unlikely to have a direct first-round impact on the exports of the US and the EU.

Of course there are indirect trade multipliers operating in both these forms of domestically-oriented expenditure in China, but they are likely to be small in nature, at least insofar as they affect the demand for goods and services exported by highincome northern economies<sup>1</sup> . Moreover, employment-growth in China has been key in sustaining political stability in the face of rising inequality, and insofar as China’s labor-intensive exports decline, the emphasis will necessarily be placed on promoting domestic production to meet rising consumer demand. In addition, despite China’s rapid economic growth and large size, it remains a small player in international trade. In 2008, total Chinese demand was equivalent to less than one-quarter of total consumption in the US and the EU. All of these factors also apply to India, but since its global footprint is smaller than that of China, its capacity to stimulate exports from the northern economies is even more limited.

From this we conclude that beyond the short-term unsustainable deficit financing by governments in the large deficit economies, in reality the rebalancing by these economies will occur through a reduction in consumption, and hence in imports. We should not see this as an historical aberration. Rather, it was the post 1990s boom in consumption in the large deficit economies which was aberrant, arising from a series of financial bubbles and leading to growing consumption in the (high-income) deficit economies being subsidized by high savings in some (low-income) surplus economies (notably China and India). We can also anticipate that this fall in northern

> 1 There will, of course be a positive second round general equilibrium impact on high-income country exports to those countries whose exports to meet China’s infrastructure investments are expanding. But these indirect impacts are likely to be delayed and, moreover, increasingly lowincome countries imports are being sourced from China and India rather than the EU and the US.