The world has previous experience with multilateral policy efforts targeting global rebalancing. One well-known example is the Plaza Accord introduced by the G5/7 in early 1985. At its core, the Plaza Accord contains two policy subscriptions: currency appreciation in surplus countries like Japan and Germany and fiscal contraction in deficit countries like the US.

But how successful was the Plaza Accord for tackling current account imbalances? Economic data indicate that the Accord did not really eliminate the imbalances, let alone their root causes. Princeton historian Harold James puts it bluntly in the text Rebalancing the Global Economy: A Primer for Policymaking: ‘The lesson of the past clearly indicates that a more sophisticated approach is required rather than exerting massive pressure for exchange rate adjustment and looser monetary and fiscal policy.’

There is no denial that exchange rates are an important parameter determining exports, imports and, therefore, imbalances. But the mechanisms through which the exchange rate affects the current account are complicated. For instance, during the decade preceding the subprime crisis, the US dollar exchange rate moved up and down, but the US current account deficits continued to climb. Again, the renminbi appreciated by more than 16 per cent from mid-2005 to mid-2008, but China’s current account surplus surged. Clearly, there are more important factors determining current account imbalances in both the US and China.

It should be much more effective for the G20 to deal with the imbalance issue by focusing on structural reforms – and exchange rates – in respective countries. Exclusive focus on the exchange rate would be politically difficult and practically ineffective. It might also be poisonous for other G20 agendas. It is best for the G20 to avoid a Plaza II, or repeat of the G5/7 policy approach of the 1970s and 1980s.

And this is consistent with what was agreed by G20 leaders in September 2009 in Pittsburgh. Specifically,

G20 members with sustained, significant external deficits pledge to undertake policies to support private savings and undertake fiscal consolidation while maintaining open markets and strengthening export sectors.

G20 members with sustained, significant external surpluses pledge to strengthen domestic sources of growth. According to national circumstances this could include increasing investment, reducing financial markets distortions, boosting productivity in service sectors, improving social safety nets, and lifting constraints on demand growth.

In China, for example, the large current account surplus was caused mainly by broad distortions of the factor markets, which generally decreased costs of production and artificially improved competitiveness of China exports. Exchange rate misalignment is only a part of that broad distortion picture. Relying exclusively on currency adjustment to correct the overall external imbalance requires an outsized appreciation, which is difficult for China to accommodate at this stage, both politically and economically.

Likewise, the exceedingly low saving ratio in the US before the subprime crisis was caused by a number of factors. Simply depreciating the US dollar by a significant margin is unlikely to be sufficient to substantially lift the saving ratio. In addition, such currency moves within a short period are likely to destabilise the economy and financial markets.

The good news is that global rebalancing is already occurring. In the US the current account deficit as a share of GDP has already halved from its pre-crisis peak, while in China the surplus as a share of GDP has already shrank by two-thirds. Obviously, part of the recent adjustments must be cyclical, given the global economic recession. But the World Bank’s Caroline Freund discovered (in the aforementioned text) that bulk of the decline in global imbalances from 2007 to 2009 was a result of countries rebalancing export and import growth.

Again, taking China as an example, recent adjustment of its external imbalance was – to a certain extent – a result of changes in domestic factor markets. Factor costs have been on the rise despite the global financial crisis. And this was most evident in labour and resource markets due to changes in both policies and demand-supply conditions – during the past year, the Chinese government began to reduce price distortions for most resource products in order to improve economic efficiency, and the impending labour shortage pushed up wages by close to 20 per cent.

PBOC deputy governor Hu Xiaolian recently argued that adjusting factor prices is an important means to change the renminbi’s real effective exchange rate. Therefore, such price adjustments are bound to have important impacts on China’s trade composition. A rapid rise in wages, for instance, not only directly benefits consumption but also forces industries to move toward inland provinces, another positive factor for promoting domestic demand.

Clearly, adjusting factor prices is only at the beginning. This pertinent policy issue should be the main focus at the Seoul Summit. Of course, all governments will need to entertain domestic political demand. Therefore, it is important for participants to coordinate on the policy agenda. It may even be possible for G20 leaders to set specific targets or guidelines for global rebalancing. But, it is better to promote autonomous domestic policies and the pace of such policy implementation. Such strategy is likely to be more effective and lasting compared with the G5/7’s exclusive focus on exchange rate and fiscal policy.

Yiping Huang is professor of economics at the China Center for Economic Research at Peking University and in the Crawford School of Economics and Government in the Australian National University.

This article first appeared here at VoxEU.