Climate Policy meets Macro
The Chinese 5 year Plan and the Biden Climate Plan will drive international macroeconomic coordination (or the lack thereof)
Dear All,
Over the years, I have been writing several newsletters and economic policy blog reviews. I started a Weekender Note during the Global Financial Crisis and then one with Jeremie Cohen-Setton at Bruegel. As the new co-head of the Geo-economics Programme at DGAP, I wanted to start a new one on Geoeconomic issues. Feel free to share it broadly as I want this to be an opportunity for exchanges and debates.
The first issue is on the articulation between Climate Policy and the Macroeconomic outloo. Indeed, I don’t think there is enough of a realization of how much climate policy has become central to understand global macro policy.
This will become more apparent in the coming months as the US prepares to disclose its new Nationally Determined Contribution (NDC) that will set out its plan to achieve carbon neutrality in 2050 and its interim target of 2030. This set of policies will determine to a large extent the future fiscal plans that the Administration will put in place a critical set of policies (introduction of national carbon tax, possibly a carbon border adjustment mechanism…) and is likely to be at the heart of the US’s foreign policy to be fleshed out and formally announced for the US Climate Summit on April 22nd.
This will not take place in a vacuum and after a very bold announcement of climate neutrality by 2060 by China, all eyes are now on the Chinese 14th Five Year Plan and how it will outline the policies necessary to achieve these targets.
These two announcements are central to the evolution of the global macro-outlook and to the evolution global imbalances and international economic policy coordination:
In China, what appears increasingly clear, in particular with Li Keqiang’s ‘Work Report’ and the release of a draft outline of the 14th Five Year Plan released last week, is its relative conservativeness and the modesty of the implementation of the climate targets. Indeed, the growth target was set at 6% for 2021, which is incredibly low. There is no call for local authorities to pursue faster growth and the fiscal numbers deficit for 2020 to the tune of 8.4% of GDP (possibly Y9tn, or 9% of GDP if you include special funds). This stands out as remarkably low for a covid year. The budget for 2021 is looking at a deficit of 6.5% of GDP.
In the US, the 2021 deficit at this stage is planned to be in the range of 15% of GDP but this excludes the Biden climate/infrastructure plan. Economists broadly agree that the most cost-effective way of achieving rapid climate and energy transition is to introduce a steep carbon tax and tight regulatory changes. This is also the most politically difficult and the Biden team is likely to choose a more acceptable plan that includes large subsidies an infrastructure investment to accompany the transition pushing the deficit even higher in the years to come.
This divergence between the US and the Chinese climate cum economic policy is already fuelling ballooning imbalances that ought to deepen. According to the Chinese Customs data China ran a trade surplus of USD150bn in January and February, placing the surplus on track to reach nearly USD900bn annualised in Q1, the largest in 10 years.
This divergence between the US and China, which maps a policy divergence on climate policy will undoubtedly create frictions between the US and China and international economic policy coordination challenges. The US cannot shoulder the costs of reflating the global economy and underwrite the cost of a more aggressive climate/energy transition, when China sits still.
This will raise several critical questions for the Chinese leadership:
· Climate policy implementation and the acceleration of emissions reductions.
· FX policy with appreciation of the RMB necessary to contain the growth in imbalances.
· Capital account restrictions create domestic bubbles
· Trade policy frictions and intensification of pressure from the US administration.
This will also raise profound challenges for the US administration:
· Does it have to introduce a carbon border adjustment tax to force action in China?
· How to drive the Dollar policy with a gaping current account deficit but potentially higher long end rates that might exert offsetting forces on the nominal exchange rate?
· Does it have to lead a more aggressive currency policy and demand more floating of the RMB/less intervention from the PBoC?
· Can these issues be addressed in a truly multilateral setting? Or is the G2 able to deliver the sort of adjustment achieved in 2015 when Yellen was at the helm of the Federal Reserve?
These issues are central to the economic outlook and not discussed very much. They are also critical in Europe where policymakers tend to behave as though the EU was a small open economy that played no part in these global tectonic shifts.
The reality is that with its current policy mix, the EU is also likely to be an important contributor to the build-up of global macro imbalances and the EUR real effective exchange rate (and to a lesser extent the yen) should be the natural variable of adjustment (so long as the RMB manages and limits the appreciation of the RMB). In short, deep international macro challenges ahead rooted in climate policy in a world where macroeconomist don’t understand climate policy and climate specialists don’t understand international macro.
Best Regards,
Shahin