Given the current global en- vironment， China’s growth seems likely to slow significantly if it continues to rely on increasing exports to fuel its growth. External demand is muted and is likely to remain so for some time， given the slow pace of economic recovery from the global financial and economic crisis in the developed countries that have long been the major markets for China’s exports.

The unprecedented scale of capital investment in China relative to the size of its economy in recent years also will encounter sharply diminishing returns. The heightened level of investment since 2003 reflects two factors. First， the government decided to accelerate infrastructure investment in 2009-10. Second， financial repression has contributed to a massive increase in real estate investment. Accelerating infrastructure development to offset the softening of external demand during the global downturn was rational， but a super-elevated level of infrastructure investment can’t be the basis for sustained long-term economic growth. Similarly， the highly elevated level of real estate investment of recent years also is unlikely to be sustainable in the medium run.

In the current environment， the cost to the global economy if China’s external surplus were to begin to expand again would be higher than in the last decade. There are three reasons for this. First， much of the developed world is in a “l(fā)iquidity trap，” meaning that monetary policy is not effective in stimulating demand because of the zero bound on the policy interest rate. Second， developed countries’ internal debt rose so much during the crisis that cutting budget deficits has become an imperative and has effectively ruled out additional fiscal stimulus in virtually all cases. In short， while previously the rest of the world had some flexibility in using expansionary monetary and fiscal policy to offset China’s drag on global growth， after the crisis the economic policy options of governments in the rest of the world are much more constrained. Third， China is now a larger factor in the global economy. In the middle of the past decade it accounted for 9.5 percent of global GDP， by 2010 that share had increased to 13.6 percent， according to IMF statistics. The risk of a rising Chinese surplus is that growth would stall in the United States and other advanced industrial countries that are now limited in their ability to offset China’s subtraction from growth in the rest of the world. Thus the risk associated with a resurgence of China’s global external surplus is an aborted global recovery， making it harder for the United States and countries in Europe to deal with their fiscal challenges.

Global imbalances

The supercharged global economic growth that preceded the global financial and economic crisis was accompanied by a historically unprecedented buildup of current account imbalances. Imbalances are not inherently bad. For example， they may be generated by an expectation of brighter growth prospects in some countries， leading to an inflow of foreign direct investment and portfolio capital seeking to gain a share of anticipated profits. In this situation the countries with relatively high growth prospects generally run current account deficits. This appears to be roughly the position of the United States in 1996-2000. Capital inflows into the United States allowed increased investment linked to the high-tech boom.

In the next period， starting in around 2001， the US current account deficit widened substantially， largely because of a substantial decline in private savings. The composition of capital inflows into the United States changed， with debt assuming a much larger role. The nature of the investors changed as well， with official investors becoming increasingly more important relative to private investors. The widening of global imbalances reflected not only the widening imbalance of the United States but also the decision in many Asian countries in the wake of the Asian financial crisis to run current account surpluses. These countries wanted to build up larger official foreign exchange reserves to serve as a buffer against future financial crisis. Additionally， higher global oil prices gave oil-exporting countries larger surpluses， much of which they invested in US debt.

Global economic imbalances subsequently increased sharply after 2004. While the US contribution to global imbalances was unchanged， China’s current account surplus， which earlier had averaged only 0.1 percent of global GDP， jumped to an average of 0.6 percent in 2006-08. Surpluses of oil exporters continued to rise sharply， on the back of higher oil prices. European imbalances increased as well， with a group of countries on the periphery (including Ireland， Greece， Portugal， and Spain) experiencing much higher external deficits， while external surpluses rose in“core” Europe， according to Blanchard and Milesi-Ferretti’s research.

It is relatively easy to describe the trends in global imbalances， identify where they originate， and set forth details of the associated financial flows. It is considerably more difficult， however， to demonstrate the precise linkages， if any， between these imbalances， on the one hand， and the global financial crisis that emerged strongly in 2008， on the other. Thus， as Obstfeld and Rogoff said， “controversy remains about the precise connection between global economic imbalances and the global financial meltdown”. The paragraphs that follow provide a summary of three alternative views. The first is that global imbalances are mostly benign and thus efforts to reduce imbalances are misguided. A second view is that while imbalances may pose challenges， particularly in deficit countries with large capital inflows， these challenges can be overcome with appropriate adjustments in domestic monetary policy. The third view is that global economic imbalances， combined with excessive deregulation of financial markets， weak financial regulation， and distortions in financial markets， led to the global financial crisis.

The Group of Twenty (G-20)， which is now the premier forum for international economic cooperation， has embraced this dual mandate. At the G-20 meeting in Pittsburgh in September 2009， the leaders adopted the G-20 Framework for Strong， Sustainable， and Balanced Growth. This framework agreement called specifically for G-20 members with sustained， large external deficits to undertake policies to sup- port private savings and to undertake reductions of fiscal deficits in order to reduce their external deficits. And in a symmetric fashion the framework called for G-20 members with sustained， large external surpluses to strengthen domestic sources of growth. The G-20 enlisted the IMF to oversee a mutual assessment process to evaluate the implications of national economic policies for strong， sustainable， and balanced growth of the world economy. Among the factors identified for analysis are foreign exchange developments and the growth of foreign exchange reserves.

This process underwent a significant step forward at the meeting of G-20 finance ministers and central bank governors in Washington in April 2011. At this meeting， members “agreed on a set of indicative guidelines that complete the first step of our work to address persistently large imbalances.” A country’s current account position is one of the key indicators. The G-20 finance ministers and central bank governors outlines a two-stage process that starts by using four separate empirical approaches to measuring whether a country has a “persistently large imbalance.”In the second， more analytical stage， a country that is judged to have a large external imbalance by two of the four methodologies will be subject to more in-depth analysis both to determine the nature and root causes of the imbalance and to identify impediments to adjustment.

Since China has been a key member of the G-20 from the outset and approved the indicative guidelines approach to reducing large external imbalances， there now appears to be a happy congruence of China’s domestic and international economic policy objectives. Reducing imbalances， including China’s still large external imbalance， is a top domestic objective embraced by China’s top leadership and enshrined in many Chinese policy documents， including the 12th Five-Year Plan. With the G-20 agreement China has also acknowledged that reducing external imbalances will contribute to strong and sustainable global economic growth.