"[L]abour union lobbies and their political friends have decided that the ideal defence against competition from the poor countries is to raise their cost of production by forcing their standards up, claiming that competition with countries with lower standards is “unfair”. “Free but fair trade” becomes an exercise in insidious protectionism that few recognise as such."
Jagdish Bhagwati,
"Obama and Trade: An Alarm Sounds," Financial Times. January 9, 2009.
Featuring:
Murray Weidenbaum, Chairman, Trade Deficit Review Commission;
Dan Griswold, Associate Director, Center for Trade Policy Studies;
Robert Z. Lawrence, Member, President's Council of Economic Advisors;
and Ernest Preeg, Senior Fellow, Manufacturers Alliance
MR. NISKANEN: Now that the election has sorted out all of the important issues, we can address the trade deficit. As moderator of this panel, however, I must acknowledge that I am puzzled by why the trade deficit is perceived to be a problem. The area that became the
Fortunately, for most of that period, we didn't have numbers on the trade deficit, so an issue was not made about it. But it has led me to think that maybe if we didn't measure the trade deficit, it would be very difficult to tell whether we had one or whether we should be concerned about it.
We have a distinguished panel of friends and colleagues and former colleagues here today, and I hope to be educated about this issue. I am puzzled about whether the trade deficit, whether we have a surplus or a deficit, now a deficit maybe in the $400 billion a year range, should be perceived as a major policy problem. And as I say, I hope to be educated about this issue.
Our first speaker is a friend and former colleague of mine, Murray Weidenbaum.
MR. WEIDENBAUM: I think I am going to enjoy this role reversal: Bill is the Chairman, and I'm the member of his panel. I'm sure we'll get along just as well as we did in our earlier incarnation.
By the way, if you ever make a good forecast -- and this is a rule of forecasting -- if you ever make a good forecast, never let them forget it. The first week of my service as chairman, I forecast that the trade deficit would rise all during our tour of duty; it has doubled. So whether you think it's good or bad, the Commission is ending. So you may want to revise your forecast of the future of the trade deficit.
In that serious vein, let me report that I wore two hats at the Trade Deficit Review Commission. As the elected chairman, I focused on the common ground that the commissioners agreed upon. And that was my role on Capitol Hill yesterday. I'm also an economist, who was appointed by the Republican leadership. It's in that role, that second role, that I am delighted to be at Cato today. And I'm tempted to say, "Free at last."
(Laughter.)
MR. WEIDENBAUM: So what I want to do, briefly, today is to present the strong, pro-free trade portions of the Commission's report, which have been downplayed or ignored. I know you are nonpartisan in this fine 501(c)(3) organization; nevertheless, I must report that the following 10 points are gleaned entirely from the Republican chapters of the Commission's report.
By the way, and I've been asked to elaborate on that, we only started to write separate Republican statements after the solid Democratic bloc surprised us with an announcement that they were writing their own versions of three chapters. It turned out the number was four. Maybe some Republicans can't spell too well, but Democrats, I must recall, are notoriously lousy on arithmetic. But here goes my 10. And, in counting, they are 10.
One, we, the good guys, we emphasize the benefits of imports. Consumers have access to a wider array of goods and services. Domestic companies get lower-cost components. Producers are prodded to improve productivity and advance technology. The data show that nations open to trade tend to grow faster than those that are closed.
Point two, the
Third point, and this is gleaned from the Republican chapters, we see a soft, not a hard, landing, as the most likely end result of the large trade deficits. We cite the experience of the 1980's: Under far less favorable economic circumstances than today, the dollar declined substantially, the trade deficit came down. It had practically no adverse effects on the
Point four, the large trade and current account deficits are fundamentally macroeconomic phenomenon. As we see it, they are the consequence of differential performance in the
Five, we deal with the concern over large trade deficits with
Point six, we oppose adding labor, environmental and human rights standards to trade agreements. We know disguised protectionism when we see it. Imposing costly social regulation on developing countries is counterproductive to the stated aims of the highly -- and I should say, really, noisy -- lobbyists, high-minded, noisy lobbyists, who are advocating those restrictions. The most effective way to help developing countries improve their working conditions and environmental protection is to trade with them, to invest in them.
By the way, environmental factors, studies show, are not important influences in business location decisions. For that matter, most
Seven, we also deal with sanctions and export controls. And we say there is little evidence -- and "little" is an understatement -- that unilateral sanctions are an effective tool to induce nations to change their policies or actions.
Eight, we put the concerns about the alleged erosion of
Point nine, we call for the repeal of the Byrd amendment, giving selected
Point 10, we conclude that the trade deficit should not be a target of economic policy. In fact, we present the results of some econometric simulations that we commissioned. To wit, we would not be enjoying the current prosperity if policy had tried to curb the trade deficit during the past decade. The American people would be suffering from such misguided action.
P.S.: Unlike our Democratic colleagues, we did not march in lock step. In quite a few places, for example, the Republican chapters have language like the following: "A majority of the undersigned members recommend..." and we let it go at that.
Thank you very much. I will be pleased to elaborate.
(Applause.)
MR. NISKANEN: Thank you,
Our second speaker is now serving in the Niskanen Chair at the Council of Economic Advisors.
(Laughter.)
MR. NISKANEN: He is currently on leave from Harvard, where he teaches at the
Bob.
ROBERT Z. LAWRENCE, MEMBER, PRESIDENT'S COUNCIL OF ECONOMIC ADVISORS
DR.
So, what should the next President do about the current account deficit? I begin by observing that the next President is going to inherit a remarkably robust
To some, it's obvious that deficits are a bad thing and that, therefore, something should be done about that. And, indeed, if you think about our language, people often talk about a bigger deficit as indicating a deterioration. And they talk about smaller deficits as indicating improvements. But I think we have to be very careful. I would like to emphasize that not all deficits are created equal and that it's very important to ask why we have the deficits, to get behind the aggregate number, in order to understand what is causing them and what their consequences are.
In particular, it is important because some people believe, automatically, that if you have large trade deficits, it's costing you jobs. And, indeed, there is kind of a metric that people take a billion dollars and they work out the employment equivalent, and then they assume that there has been an equivalent displacement of
A second concern is that the deficits have actually caused a depression in
Now, I don't want to rule out these concerns. It is certainly possible that you could see a country with a deficit and see it losing employment. In particular, if the deficit reflected a slump in exports, a depression in domestic incomes in an economy, you could certainly see job loss and a large deficit. It's also possible you could see these effects on wages. And, indeed, for some economies, when we look at what they're doing with the money that they're borrowing, we may voice concern.
But I would submit that if we look at the
Firstly, it's very striking that our economy has been creating employment as the deficit has been getting larger. Indeed, since 1993, we have seen 22.5 million new jobs being created in the
The same is true of income growth in the
This actually comes as quite a puzzle to many, because there was a debate about the growing inequality that we did see in our labor force up until the mid-1990's. And one group of people heavily placed the blame on globalization. Another group of people said it was technological change, fundamentally, that was causing this inequality -- so-called skill-bias technological change. But what's striking is that, over the last five years, we have had even larger trade deficits, our economy is more globalized than it ever has been, on the one hand; in addition, we have actually seen a speed-up in technological change and innovation.
You might have expected, then, growing inequality during this period. But I would submit, if you look at the data, what you find is very little change over this period. Some series can be nudged in a direction that suggests some inequality; others show that those at the bottom have actually had slightly higher gains. I would submit also that what we need to focus on is this most recent period.
A lot of the data that we are still hearing referred to tell us changes since 1979. And I don't think anyone would doubt that there was the growing inequality until the mid-nineties. But it has been striking that as the economy has reached full employment, those at the bottom have been able to share in the gains. And so I think if we view the trade deficit as one of the safety valves that has allowed the economy to grow rapidly, then we should also acknowledge that it has been part of the story by which robust demand has created employment growth and wage opportunities in our economy.
Now, I think it is fair to say, then, that the emergence of this deficit fundamentally reflects the strength of the U.S. economy and, in particular, the comparative strength of the U.S. economy, because we saw the deficit really grow during the period of the Asia crisis and the slowdown in the rest of the world. That was the period in which this very significant increase in the foundation has been experienced. I think it is also fair to acknowledge that part of that phenomenon was a strengthening of the U.S. dollar, as capital was attracted to the
But when we look at that deficit, we also should ask, why have we been borrowing? What, in essence, are we doing with the money in the
In the eighties, what we saw was a savings bust. In essence, we saw a decline in net national savings and, indeed, a drop in national investment. The investment actually didn't drop as much as the savings did, so we had a deficit, but we also saw a decline in investment as a share of our GNP.
In the nineties, it has been different. What we have actually seen is an increase in national savings. True, the private sector has had a decline, but the public sector, government savings, has increased by even more. So Americans are, as a nation, saving more today than they were in the early nineties, but investment has increased by even more. And that is basically what is driving our new economy.
So we need to understand, then, that this is an investment-led deficit, and it has been an important source of the growth of our economy. And if we look at the composition of that investment, what we discover is we are acquiring huge volumes of high-tech equipment from the rest of the world. We are investing in the
And while it is true that output of manufacturing has been robust, employment in manufacturing was solid through until a few years ago; but since that time we have seen declines in employment. We have also seen major declines in the textile industry over a longer period of time. So we should not avoid talking about the kind of reallocation that has been required within our economy in response to this deficit. And our policies ought to be, and I believe are, directed towards assisting workers in that adjustment process, but it is a part of that process.
Let me turn, in the time that's remaining, to look forward, and to think about what needs to be done. I believe that no one can be sure about how long this deficit is going to be sustainable. I think, in fact, what is important is to allow it to evolve, fundamentally being driven by the policies in the
First, it is better to reduce the current account through faster growth abroad than it is through a recession or slow growth in the
Second, it is better to reduce this deficit through increased domestic saving than through reduced domestic investment. So what we need to see as this deficit adjusts is a rise in U.S. savings. We are seeing the rate of consumption declining already. But, in this regard, maintaining fiscal discipline is crucial, because that is a powerful complement. And, in my judgment, and I think in this administration's judgment, one of the pillars of our policy has been fiscal discipline. We believe it should be sustained, because higher domestic savings are a key part of that adjustment.
The third proposition would be that it is better to complement the adjustment through opening foreign markets than to closing the market in the United States. I do not believe this administration needs to be lectured on the merits of free trade and open trade. In fact, on our watch, we have seen major liberalizing efforts. And I believe that these ought to be sustained.
At the same time, I think it's also important to understand that we do need rules ensuring that trade is also not only perceived but actually fair, and that this is an important complement to a liberal trade policy. So I don't think we should close our market, but nor do I think we should give up on our efforts to try to ensure that we have a fair trade system.
And, finally, our interest in adjustment is seeing this occur, as much as possible, through faster foreign growth, more open markets abroad, and, as little as possible, through a weakening in our currency. As Secretary Summers has emphasized, a strong currency is in our national interest. It keeps our incomes strong. Technically speaking, we do not want to see a decline in our terms of trade as a driver in the adjustment process. We would like to see that part of the adjustment minimized. Perhaps the markets will change the value of the dollar. The dollar does fluctuate. But I think we shouldn't lose sight of the fact that a strong currency remains in our national interest.
So I think the next President ought to continue the policies which this administration has followed, emphasizing, one, fiscal discipline, encourage savings; two, investing in people and technologies, making sure that our economy is comprehensive and is able to adjust; and, three, emphasizing open foreign markets, so that as we adjust our deficit we can enjoy sales in the rest of the world.
Thank you.
(Applause.)
MR. NISKANEN: Thank you, Bob.
Our third speaker is Ernie Preeg. Ernie is now a Senior Fellow at the Hudson Institute, here in town. After a decade of being at the Center for Strategic and International Studies and a long record, 20-30 years nearly, of being a Foreign Service Officer. He has written widely and, most importantly, a recent book, called "The Trade Deficit, the Dollar, and the U.S. National Interest," which may have all the answers to our questions.
ERNEST PREEG, SENIOR FELLOW, MANUFACTURING
MR. PREEG: Thank you, Bill. Although you're one job behind. I can't keep a job anywhere. I'm currently at the Manufacturers Alliance, a Senior Fellow on Trade and Productivity, actually, but the book is Hudson.
The Commission report, which I'll be commenting on, really makes abundantly clear how complicated and confusing this trade deficit issue can appear to people. In fact, it's disturbing, with 12 distinguished experts, to come up with a report that is so radically different in terms of conclusions and assessment, and strictly, or almost strictly, heavily on a partisan basis, Republicans versus Democrats. And, goodness knows, with the now virtual 50/50 split we have in the Congress and the electorate, it's pretty bleak in terms of thinking of how we are going to have U.S. leadership in the years ahead in dealing with these issues.
In any event, my own view, elaborated in the book -- and I should say that I do appreciate how much nicer it is to be a single author than part of a 12-author group, so I can be a little more consistent and clearer maybe -- but my bottom line conclusion is that this chronic record trade deficit -- record now, 20 years -- the consequent buildup of net foreign debt, almost $2 trillion and headed for $3 trillion or $4 trillion, that this is having significant actual and potential adverse impact on U.S. national interests, and we should be taking some actions to try to reduce substantially this deficit in an orderly way.
Because, otherwise, if we wait for markets to react, they will probably overreact at the worst time -- when our economy is weakening, for whatever reasons. There is also just the interest and, ultimately, the principal that will have to be paid on this buildup of foreign debt. No nation has ever had debt in the trillions of dollars before.
So this puts me at odds with both the Clinton administration benign neglect, essentially, policy on the trade deficit, as well as the Republican half of this Commission, which is not really something we have to worry too much about or do much about. The Democratic half of the Commission does express a level of concern comparable to mine, but I do have some major differences in terms of both how they access the causes and the cures.
So the details, again, are book-length, but let me just make four points that relate to the major lines of policy for dealing with the deficit that come out throughout the Commission report. The first is trade policy, all kinds of trade policy recommendations from both sides; more trade liberalizing on the Republican side, some of them tending to be more protectionist on the Democratic side.
But the basic fact is that trade policy, and it has been discussed here today, needs to be discussed on its own merits about how it affects the economy, not related to the trade deficit. In fact, the impact of these various trade proposals, with a couple of exceptions, probably would have a very small impact over the next several years on the level of the trade deficit. There are other causes much more related to macroeconomic policy adjustment and to international finance. One significant exception on the trade side is China, because my statement was based on a world of flexible exchange rates, that that's when the trade imbalances reflect more financial markets and macro policy actions.
China, of course, has a fixed exchange rate. It's a nonconvertible currency, and it has a highly protectionist trade policy, as elaborated in the report. Therefore, I think there is a real concern, trade policy-wise, in this one particular relationship. And the other point, which is not mentioned in the report but it should be there -- and in fact, I think, Murray, you ought to make it point 11, maybe -- is what we call the protectionist backlash.
Now, the protectionist arguments are that the trade deficit is a demonstration of the failure of a liberal U.S. trade policy. Now, that may be a spurious analysis, but it's an effective argument. With these record trade deficits, that was an argument that helped defeat fast-track legislation in the Congress. It was an argument in Seattle for the failure of that meeting -- one of several -- against a liberal trade policy.
It will come up again, as long as we have a $400 billion or $500 billion current account deficit each year. It will be even worse if our economy begins to falter and we don't have full employment. So that's the trade policy elaborate discussion of the report, but that's not really what is going to be determinant as to what happens to our trade deficit.
The second line of policy response in the book, which has been raised particularly by Bob Lawrence, is that it's the cyclical impact of a national economy performance up or down that has trade impact -- the income effect, if you will. But, looking ahead, it's an easy one to make, because you really don't have to do that much in the United States. Others should grow faster; we shouldn't have a recession. That's pretty easy to sustain that point of view. But, unfortunately, looking ahead, there is not much mileage on this cyclical impact on the trade deficit.
Looking backward, in the nineties, there were some ups and downs. The reason is that the OECD, the IMF, they projected the $400 billion-plus current account deficit for the next several years even with some slowing of the U.S. economy, the soft landing scenario; even with 3 to 3.5 percent growth in Europe, which is about the most we can expect; even with 5-6 percent growth in Asia, which probably is the most we can expect. So, obviously, that's the way we should do it: not a recession here but more growth abroad. But I really don't see much mileage. We're still projecting $400 billion to $500 billion deficits even with the best scenario on that one.
So that brings me to a third line of policy response, which to me is the most important by far, and by far the most disappointing in the report from both the Republican and Democratic sides. And that is that the principal cause is the low, inadequate level of savings in our economy. We are a high-growth economy, which needs a lot of investment to sustain that growth. And, at this stage, we either have to save enough for the investment or we have to borrow abroad to make up for it.
And now we're in the second alternative. Therefore, it's a tough choice. We either have to rein in our consumption -- the deficit is 4 percent of GDP; you want to balance it -- you really have to save 4 percent more or consume 4 percent less. That's what we need to do. But there are tough choices in how do you do that. Do you move to a consumption tax? Do you change things to make people consume less? Most of the tax proposals you see from both sides in the Congress tend to stimulate consumption rather than investment, when the tax is being reduced.
And on this issue, is the savings gap a major cause? The Republican side says yes, it is, but we don't need to do anything. It's sort of a long-term issue. It's not something we should deal with more immediately, in terms of reforming our tax system or other measures. On the Democratic side, they reject the concept in the report almost categorically, that this is not the problem, and presenting, quite frankly, in my judgment, an erroneous macro policy presentation of several pages.
Maybe the reluctance to really deal with this problem is that it's so unpopular politically to do the kinds of things that would mean Americans consume less and save more. It's painful. You're going to be consuming less. And I want to just add one point on this, which I think is quite important and where there is a difference in my assessment here as well as in the administration, in the last two CEA reports, and in the Republican side of the Commission report. The basic point is when we borrow $400 billion-plus a year in our current account deficit, that means we have disposable income of $400 billion more than what we produce. We can use it for investment or consumption, or both. And how much is one way or the other?
My assessment, and there is a whole chapter in here and it's the most involved, is that probably about 80 percent of our borrowing abroad goes for immediate consumption and only a relatively small part for investment. It's a complicated macro policy-type assessment, and I'll just make two empirical points, factual points, to support my side, but it needs more care. One is that consumption in absolute terms is four times larger than investment. After macro adjustment through interest rates, stock market prices, inflation, the influences in both, more or less neutral of that extra $400 billion, you will have 80 percent consumption, 20 percent investment.
The other thing is that in the last three years is when the foreign deficit has really taken off. It has tripled, from $140 billion current account deficit in 1997, to a projected $430 billion or $440 billion this year. And during those three years, the investment as a share of GDP has been pretty flat; it has not fluctuated that much. And I go into earlier periods, too. So it's just not there, in my assessment, although this is a debatable point, but there is a big difference in how you come out.
And if you think most of the borrowing is for productive, incremental investment, you can take a benign view of it, even a positive view, that it's a mutual interest. On the other hand, if it's mostly 80 percent consumption, what we're doing is we are having a consumption binge now and letting children and grandchildren pay the interest and, ultimately, the principal on this $2 trillion, $3 trillion, $4 trillion debt building up.
The fourth and last point has to do with exchange rate policy and whether other countries -- to use the IMF word, in Article V -- manipulate their exchange rates to increase their trade surplus higher than it would be based on market forces alone. On this one, the Democrats raise this point and elaborate it. They say it is a concern. I've done a fair amount of work; I certainly believe so. And they have proposals of how this might be limited -- disciplines on this kind of manipulation. Which, incidently, is on the floating rates for foreign central banks to buy up a lot of dollars to keep their currency down and the dollar up.
The Republican side on this issue, which I think is an important issue, quite frankly, they just copped out. They say, well, on the one hand, some experts say it is a major problem; on the other hand, some others say it's not. No conclusion or position. I think it is, and I'll just close with two specific additions to the Democratic presentation on this.
One is that they raise the fact that this manipulation of currencies through exchange intervention is in our Omnibus Trade Act of 1988, which it is, and that we should take actions at the Treasury, and they elaborate on that. But it's also in the IMF. And the IMF does say that members should avoid manipulating exchange rates to gain unfair competitive advantage.
And the surveillance criteria is that there should not be protracted large-scale intervention in one direction in the exchange market; in other words, consistent buying of dollars, if you will. In fact, the basic prima facie case on manipulation is a country that has a sustained large current account surplus year after year, has an exceptionally large amount of reserves in the first place by any comparable standards, and still keeps buying dollars. Therefore, in my view, that is where the problem is.
And it is a problem today, particularly in Asia, particularly Japan, China, Taiwan, and more recently South Korea. There is a little article out there that shows, on this score, in the last 12 months, Japan has had a current account surplus of $118 billion and the Central Bank has bought $95 billion in additional foreign exchange. They've taken 80 percent of their current account surplus -- that means dollars accumulated -- off the market, and that keeps the yen from strengthening.
So on these basic tests and criteria, as drawn from the IMF, I would say these Asian economies are failing the test. And what we need are greater disciplines to let market forces, essentially, on the floating rates, determine exchange rates and not have foreign central banks try to keep their rates down below market levels and the dollar stronger than it should otherwise be.
Thank you.
(Applause.)
MR. NISKANEN: Thank you.
Our fourth speaker is my colleague, Dan Griswold, who is a member of our very productive Trade Policy Study Group here at Cato. Dan is a graduate of the London School but, more importantly, he writes much better than most economists, having served as an editorial page editor for a long period of time and basically has a journalism perspective. And we look forward to his remarks.
DAN GRISWOLD, ASSOCIATE DIRECTOR, CENTER FOR TRADE POLICY STUDIES, CATO INSTITUTE
MR. GRISWOLD: Thank you, Bill.
Just a couple of program notes for a moment. If you wanted to get a copy of the Trade Deficit Review Commission's report -- and we did run out of them -- I understand it's going to be online in a few days. And their Web site is www.ustdrc.gov, U.S. Trade Deficit Review Commission. Just look under "Reports" and you can find it.
And the second thing is we did, in putting this panel together, extend an invitation to a couple of members of the Democratic side of the Commission, but they were not available to join us. We do have the remarks of the Democratic Vice Chairman out there, so you can get the Democratic point of view, as well.
The U.S. trade deficits are routinely blamed for a host of ills: lost jobs, declining manufacturing prowess, slower growth -- it's supposedly a drag on growth. News stories routinely, every month when the figures come out, report the trade deficit as the one black mark in an otherwise stellar U.S. economic performance. And the Democratic chapters in particular, in the Trade Deficit Review Commission, tend to share many of those assumptions.
Well, I would like to spend a few minutes today testing this almost ubiquitous assumption that the trade deficit is bad news and our record trade deficit is bad news. One stark fact jumps out when you look at the trade deficit and the performance of the U.S. economy over the past three decades. And that is that the trade deficit is strongly pro-cyclical. That is, it tends to expand along with the general performance of the U.S. economy. In fact, during the last 25 years, growing trade deficits have been associated with economic expansions; shrinking deficits have been associated with slower growth or outright recessions.
If you look at figure 1, and I don't know if some of you have the handout out there, but if you look at figure 1 -- and you don't necessarily need the handout to follow but it just helps to illustrate it -- you can see that during each of the last three periods in which the current account deficit has been in surplus in the United States, the mid-1970's, the early 1980's, and in 1991, the U.S. has been in recession. So, basically, a current account surplus has been more or less synonymous with recession over the last 25 years.
And we can see the same pattern abroad. Nations that are growing relatively fast compared to other countries have current accounts that are moving in a negative direction. Those that are struggling economically tend to have current accounts that are moving in a positive direction. When Mexico suffered its peso crisis/meltdown in 1995, almost overnight it went from a large current account deficit to virtually a balanced current account. And you can see that in figure 2.
During the East Asian financial crisis of 1997-1998, South Korea, Thailand and Indonesia all went from large current account deficits to large current account surpluses. In the case of South Korea specifically, it flipped from a current account deficit of 2 percent to a surplus of almost 13 percent from one year to the next. Now, you could say that the huge surpluses were the one bright spot in an otherwise gloomy economy, but I think that was small comfort to the Korean workers in business suits that were sleeping in the subway.
In fact, if I were to wish ill will to other nations, I would place this curse upon them: May you enjoy a sharp improvement in your current account balance.
If we look more closely at the U.S. economy since 1973, we can see that rising trade deficits generally accompany periods of rising investment and expansion. Since 1973, there have been 16 years in which the current account, as a percentage of GDP, expanded, and 11 years in which it contracted or "improved." By almost any measure, the American economy has performed better in years in which the trade deficit rose compared to years in which the trade deficit shrank.
And here, if you look at figure 3, during years of rising deficits, which is supposed to be a bad thing, deteriorating deficits, real gross domestic product averaged 3.5 percent a year -- growth in real GDP -- compared to 2.6 percent during years of shrinking deficits. In other words, our economy typically grows about a third faster when we have a rising deficit, as we've seen in recent years, compared to when we have a shrinking deficit. Now, of course, I'm not arguing that larger deficits cause more growth. Actually, the causation goes the other way. An expanding economy sucks in capital from abroad, increases the purchasing power of American workers, which tends to raise the consumption of imports.
On the issue of jobs, the story is much the same. During those years in which the trade deficit expands, typically the American unemployment rate drops by four-tenths of a percentage point. During years in which we have an improving trade deficit, the unemployment rate typically goes up by four-tenths of a percentage point. Again, it's not that the trade deficit causes the unemployment rate to go down, it's that expanding payrolls that come with an expansion raise the appetite for imports. Once again, the protectionists have it wrong. Imports do not destroy jobs. Job creation fuels imports.
Critics of the trade deficit argue that it's causing the de-industrialization of America. While our economy may be producing service jobs, we're supposedly shipping good manufacturing jobs overseas. And you will see echoes of this, again, in the Democratic sections of the report. But, again, the evidence of the last three decades points in the opposite direction. During years of rising current account deficits as a percentage of GDP, manufacturing output over the last 25 years has typically risen about 4.5 percent during those years, compared to a much less robust 1 percent during years in which we've had shrinking or improving deficits.
The hallowed automobile industry that is the symbol of American industrial might, basically, we produce more cars and light trucks during years or rising deficits; we produce fewer, the number drops, during years of shrinking deficits. Employment in the manufacturing sector, it grows slightly during years of expanding deficits. The number of manufacturing jobs drops by 100,000, typically, during years in which we have a shrinking or "improving" deficit.
This evidence, again, directly contradicts the frequently heard claim that imports displace domestic production, by definition. Every time we debate a new trade agreement, somebody trots out a study that says it's going to expand the deficit this amount, costing X thousands of jobs. For example, the day before the House voted in May to grant permanent normal trade relations with China, Richard Trumka, of the AFL-CIO, said on national television that the agreement was going to cost 1 million jobs because of an expanding trade deficit.
But here I would invite you to turn to figure 5, where I show the correlation between rising imports of real goods, the volume of goods, compared to manufacturing output. And you see a strong correlation there, that basically the more imports, the more real goods we import into the United States, the more we produce ourselves. And, again, it isn't a --
MR. GRISWOLD: But there is a correlation there, because both reflect an expanding economy.
And, finally, even Americans on the margins of poverty appear to fare somewhat better when the trade deficit expands. Basically, the poverty rate falls during years when we have an expanding deficit and increases slightly when we have an "improving" deficit.
The contention that trade deficits somehow damage the U.S. economy is directly challenged, I think, by the empirical evidence. If it were true that trade deficits dragged down growth, destroyed jobs, decimate manufacturing, and hurt the poor, then why are bigger trade deficits associated with faster growth, falling unemployment, accelerating industrial output, and fewer people living in poverty?
Well, let me spend a moment talking about America as a "debtor nation" and the sustainability of the trade deficit. Now, it's true that the deficits have led to an accumulation of a net asset position that is negative. We're up to about $1.5 trillion, approaching $2 trillion, in which foreigners own more U.S. assets than we own assets abroad.
Well, first, I would like to put this in context. This is not foreign debt in the technical sense of the term. About half of that is equity investment, either portfolio investment or foreign direct investment. And this is not debt in the sense that we're obligated to pay a certain amount at a certain period of time.
If the investments go sour, as many Japanese investments have in Pebble Beach and other places like that, we're under no obligation to repay it. They basically get back the market value of that. All these claims are denominated in dollars, which protects us from wild swings in the exchange rate. And, really, when you look at net foreign investment, the asset position in the United States, it comes to about 5 percent of total U.S. wealth, which is approaching $40 billion.
Now, our payment on that has shifted to the negative. We're now paying more to foreigners to service their investment than we're earning abroad, but that difference is relatively small. It's going to be this year about $24 billion. Now, that's a lot of money to you and me, but in the context of a $10 trillion economy, that's a pretty manageable amount. To put it in perspective, if you had a household that had an annual income of $75,000, it would be a net interest payment of about $180.
I think it's manageable. That number is not going to explode in the near future. I think we can manage the debt. And all signs, as Dr. Lawrence pointed out, all signs indicate that we have used that borrowing to raise our productive capacity, which more than offsets the increased payments. And Ernie's 80/20 rule, actually I think that's about right, in that if we invest 20 percent of what is coming in, that's basically our historic level. In fact, I think our national investment rate is about 17 percent. So, by that measure, we're perhaps using that foreign investment to actually raise our investment rate.
Two more points on the sustainability question. I don't think the trade deficit and this accumulated foreign obligation is a threat to our prosperity. The line of reasoning you see in the newspapers -- they usually have a little paragraph there on all the trade deficit stories -- they say the rising trade deficit could scare off foreign investors, causing a flight of capital, a plunging dollar, rising inflation, rising interest rates, and a hard landing if not an outright crash landing.
Well, I think this scenario is somewhat based on circular reasoning. And that is, if the trade deficit is caused by a net inflow of investment, we're basically saying an inflow of foreign investment is going to scare away an inflow of foreign investment. Well, there is no reason to think that. As long as our fundamentals are sound, there is no reason why we cannot continue to be an attractive haven for foreign investment, and there is no reason why investors would somehow wake up one day and decide to leave en masse from the United States.
Australia, for example, has run a current account deficit over the last decade approaching somewhere between 4 and 6 percent; it was 6 percent of GDP last year. They're showing no signs of running into economic problems.
Capital flight can strike an economy whether it has a surplus or a deficit. If you look at
Finally, on this, the trade deficit and the accumulated asset position of foreigners is supposedly a threat to our sovereignty. And I won't deal with this at length, but the notion is that foreigners could manipulate the
One, a lot of the foreign investment is privately owned, and there is no reason why they would coordinate. Other investors are ready to step in when they attempt to sell. And, really, the debtor may have more influence over the creditor, in that nations around the world have a stake in our economic health because of their investment. If the United States economy goes into the tank, it's going to hurt foreigners, both as exporters and as investors in the United States.
Well, to conclude, what should the next President and Congress do about the U.S. trade deficit? The short answer is nothing. It doesn't require a policy response. But even if you're convinced that action is necessary, the policy options are limited. I think Dr. Lawrence did a very nice job of outlining the approach to that. If you want to increase savings, some ideas are converting the Social Security system to a system of private accounts. I had to get that in.
(Laughter.)
MR. GRISWOLD: Tax reform, to eliminate the bias in the tax code, and avoiding Federal budget deficits. In the end, the trade deficit is not an economic problem but a political one. My greatest worry is not about the trade deficit itself but what politicians might do to "fix" the trade deficit. In the past, trade deficits have been the pretext for seeking higher trade barriers, and they come up every time we have an opportunity to expand trade liberalization.
Finally, when it comes to the record trade deficit, we have nothing to fear but fear itself.
Thank you.
(Applause.)
MR. NISKANEN: We now have some opportunity for questions, but I would like to ask the first two. Murray, what explains the very strong partisan division in the report? Trade typically has not been that much of a partisan issue. It has been a debate, in many cases, between the administration and Congress, or a debate within each party, but not that much between parties. But there is a very strong partisan split in this report, and I would like some sense of why that happened.
MR. WEIDENBAUM: First of all, listening to Bob Lawrence, a distinguished member of a Democratic administration, if there were six Bobs who were the Democratic appointees to the Commission, it would not have been a problem. We would have had a unanimous report.
(Laughter.)
MR. WEIDENBAUM: Secondly, until very recently, we were working on a single bipartisan draft. Out of the clear blue, late in the process, my Democratic colleagues, as a bloc, suddenly announced that they were going off on their own -- I mentioned that briefly at the outset of my remarks -- and preparing three chapters. And, as it turns out, four.
We then, the Republican members, quickly, under time duress, started amending what had been our honest attempt at common ground. In fact, if you read the Republican summary, it has all of the earmarks, with just the fewest modifications, of something that was a common-ground effort.
Why the Democrats voted as a bloc? As I pointed out, the Republicans didn't really vote as a bloc. If you read the Republican drafts carefully, they're not always unanimous. I'm tempted to say, Republicans being intelligent people, don't always agree. We didn't introduce the partisanship. The six people who happened to be Democratic appointees introduced the partisanship. And I would suggest that the so-called Republican sections are rather close to the mainstream of the economics profession. I would not make a similar accusation of the Democratic chapters.
MR. NISKANEN: Ernie, I want to make your position clear. Do you regard the current account deficit as a problem by itself or, under certain circumstances, a reflection of a problem, like the low savings rate?
MR. PREEG: I think it's a problem for three principal reasons. The most immediate is that when the adjustment takes place, if we wait for the markets to react, there could be an overreaction and a harder landing, because that will probably take place when we're already in a more vulnerable position.
The second reason it's a problem, which is related, is the fact that -- whatever you want to call it -- the borrowing, the debt abroad, is going up mainly to finance immediate consumption. And there is the payments on the debt, which are not just the $25 billion now, but it would have been a big plus of $100 billion a year if we had not had the deficit. So there is that equity issue.
And the third is the protectionist backlash. As long as we keep $400 billion a year, you're not going to see, and it's going to be very difficult to get, a fast-track piece of legislation through in the next few years. So that's the third reason.
So, for all those reasons, I don't see why we shouldn't save more as an economy and we shouldn't take the steps of a more consumption-based tax, a VAT or whatever, and more incentives, and get things back into better balance.
MR. NISKANEN: But if we did save a great deal more and still had a current account deficit, would that bother you?
MR. PREEG: Oh, it would, because one has to also adjust. So there would be some exchange rate adjustment, a somewhat weakening dollar, presumably. And others would have to do some adjustment, too. I go into this in great detail in the book. Others have to have a more domestically oriented growth strategy, not depend on an export surplus, a huge one, to keep growth up.
We have to reverse. We have too much domestic-oriented growth, and there has to be more balance toward exports. So it has to be coordinated. And almost certainly there would be some downward adjustment of the dollar. But, if we could do that, we could certainly maintain high growth and relatively full employment while restructuring to a higher rate of savings and a higher rate of domestic supported investment.
MR. NISKANEN: Do any members of the panel want to make comments first, other comments, reply comments?
DR.
MR. NISKANEN: Yes, Bob.
DR. LAWRENCE: Just one. There was an observation on Ernie's statement that growth in the rest of the world, what he termed "cyclical growth," isn't going to do much for our trade deficit. I don't necessarily disagree with that statement, but I think it needs to be amplified.
What has happened over the last five years is that American potential growth has accelerated considerably. If you were to ask people how fast can our economy grow five or eight years ago, they would tell you 2.25. If you asked them today, they will tell you it's a debate, but it's well over 3. So we've had an acceleration in our long-term growth rate. And as Dan Griswold pointed out, typically, with prosperity and growth in the United States, we see a bigger deficit. But the critical question is: How long can we sustain this?
And it does seem to me that the best way out is to see a similar acceleration in growth in the rest of the world -- not just cyclical, but, rather, an increase in their potential growth rates. And that's why I think the next President has to continue our emphasis, in discourse with foreign countries, about the need for structural adjustments. Because it's only through improved structural policies, both in Europe and in Japan, that they are likely to see the full benefits of the new economy.
By the way, our emphasis on trying to close the digital divide with developing countries has also pointed to this need for faster growth in the rest of the world. It is not just the cyclical issue, it is a long-term issue. And it is directly in the interest of the United States to see more rapid growth in the rest of the world.
MR. NISKANEN: We now have an opportunity for questions from the audience. Please raise your hand. And when I recognize you, then wait for the microphone to come. Stand, introduce yourself, and address your question to a particular member of the panel.
MR. BULLIN: Pierce Bullin,
A couple of speakers mentioned the need for appropriate fiscal policy, without saying whether that means maintaining a large surplus or going down to a zero balance, or something in between. I would appreciate a comment on that from someone, perhaps Mr. Weidenbaum.
MR. WEIDENBAUM: In our report, we advocate fiscal policy that would increase national saving. We don't specify how to get there, because there are obviously many routes. But the end is to increase the saving in the public sector to augment saving in the private sector. The end result would be more of our domestic investment financed by domestic saving and supposedly, presumably, a smaller inflow of foreign capital.
DR. LAWRENCE: I would also emphasize both the direct savings of the government -- that is to say, using as much of the current forecast surpluses for debt repayment as we can; we have room, as Vice President Gore has indicated in what I think is a comprehensive program to provide some tax cuts, to provide some increases in expenditure -- and to emphasize debt repayment.
In addition, I would also point to his program as an example of what Murray is talking about: basically, mechanisms to induce private savings through matching grants, if you will. When private citizens who aren't able to take advantage of things like IRA's or Roths put their money into savings accounts, his program would match them in order to induce more saving. So I think this emphasis is very important.
At the same time, I think it also needs to be said that a major source of the declines in our national saving, many believe, comes from the increase in our wealth, basically through the stock market. The average person doesn't feel poorer today, doesn't feel like they've saved less. Indeed, they feel like they have saved more; and the adjustment has been, therefore, to do less.
As the stock market has leveled out, and if it continues to sort of remain at these current levels, one might expect to see the private savings rate, on its own, now move upward. You would have to see continuous increases in the stock market and in national wealth to maintain these very low savings rates.
MR. WEIDENBAUM: By the way, to increase the amount of government regulation of saving I think works in the wrong direction. If we are going to reform taxation to encourage saving, we ought to deregulate the saving process and let each individual decide the form and the amount of saving, and eliminate the transaction costs associated with -- what's the expression -- the Mickey Mouse approach to tax reform.
MR. NISKANEN: Yes?
MR. ALEXANDER: Arthur Alexander, from
I detect a certain amount of split personality between discussions about trade flows and discussions about capital flows here, coming down it seems, in conclusion, to looking at this as a capital issue. And if we focus on that, it looks like we've had an experiment over the last 10 years, where we have gone, in the Federal Government, and in governments all over the country, from huge deficits to huge surpluses, and still the current account deficit remains. Which suggests that perhaps what we are looking at here is a shift in the supply of savings from the rest of the world, who want to invest and save and put their money in the United States.
And even if we had another experiment in the next 10 years, of shifting the balance to increased private savings, if the rest of the world still wanted to invest in the U.S., we might just find somebody else dis-saving, business or maybe the 501(c)(3)'s dis-saving, but somewhere it's going to have to come from somewhere.
I would like to get a reaction. Bob Lawrence mentioned that the rest of the world, in the last few years, has wanted to save in the U.S., invest in the U.S. What are we looking at, demand or supply here, or both? And what might change?
DR. LAWRENCE: I would agree with your observation. With respect to the last few years, clearly the United States has been a very attractive location for international investment. And that has allowed us to have more capital formation than we would otherwise have. And in that regard, we can be relatively sanguine about the current account that we've seen over the past few years. That is why I guess I'm somewhat more sanguine than Ernie is.
Now, no one knows how long these flows will continue to come here. One might see, if the prospects in other parts of the world improve, that more of their money remains at home and then we would see a necessary adjustment in the United States. On the other hand, if we continue to be as attractive as we are and they as unattractive as some countries are, this process could continue for some while. As long as the money is going to finance capital formation in the United States and, indeed, as Dan Griswold pointed out, heavily involved in equity types of arrangements, it seems to me that it's a process that we can welcome and sustain.
MR. PREEG: I agree with what Bob says. I also agree very strongly that we should keep pushing others to adopt the American model of supply-side deregulation and structural reform so they will grow faster, as we have been doing. And that would bring about the balance. But, as I say, the projections for the next three or four years don't necessarily show too much more.
However, and this is another chapter in the book, what I've come up with, particularly in the 1990's, because of this asymmetry, that we are out front on the new economy, the deregulation and the high investment, we've got this great asymmetry in the globalization process, if you will. We are way out in front with domestically driven growth, with high investment; others are regulated and their domestic economies are behind the curve in terms of modernization and such. So they need current account surpluses in order to reach just a minimal lower rate growth.
So what you have is it is the capital and current accounts, sort of the bottom lines on this, you have a situation where we end up with a now chronic and very large imbalance on current account and not enough savings. And that asymmetry goes on year after year, and we need to work bringing it about. And others should do a certain amount of it, but we also, if we are going to be way out front with a high-growth, investment-driven economy, we have got to bring our own savings up substantially, unless we want this thing just to keep accumulating over the years.
So there is this very interesting asymmetry in the pace of technology driven globalization. We are way out front; others are behind us to relative degrees. And one of the results is that we have this continuous external deficit.
MR. NISKANEN: Yes?
MR. MILLIKAN: Al Millikan, Washington Independent Writers. This is to the Commission Chairman in particular, but anyone else possibly, too.
I wanted to know if any of the Commission members, or someone like Wayne Angel, who has been a part of the Federal Reserve, did he have any significant disagreement with the other members? And with the Federal Reserve meeting, how seriously are they taking this report, do you believe?
MR. WEIDENBAUM: I don't have the vaguest idea of how the Federal Reserve is responding to our report. Half of it I hope they pay no attention to whatever.
(Laughter.)
MR. WEIDENBAUM: Now, one thing I can tell you is that we did enjoy very spirited discussions on a great variety of issues. And Wayne Angel certainly was among the spirited discussants. But those were months of discussions, and the end result is written in our respective sections of the report. Wayne, of course, can always speak for himself, but he didn't add any dissenting note, by the way. None of the Republicans did.
MR. NISKANEN: Yes?
MR. SMITH: I'm Russell Smith, Willkie, Farr & Gallagher, here in Washington. I would like to address this question to Mr. Lawrence.
You made mention at the end of your discussion of fair trade, which sometimes, in this town, is a buzz word for things that are worse than fair trade, I would say. Two questions. First, do you believe the Byrd amendment, that Mr. Weidenbaum mentioned, in fact is a manifestation of fair trade? And, second, do you really believe that excluding imports for any reason from the United States, whether it's through dumping cases or 201 cases or anything else, in fact serves either the purpose of fair trade or helping the trade deficit?
DR. LAWRENCE: Let me begin with the second point. I do think that we have to have rules governing what's fair in international commerce. And I think we need to negotiate, and we have negotiated in the past, about what those rules ought to be. And it seems to me that we have to continue to enforce our laws until we negotiate others.
We have on the books a 201 law, and, indeed, it's part of the rules of the World Trade Organization. And I think, in fact, the experience with 201 has been a very good one. Indeed, I've studied it over the decades. And what we have found is that, on occasion, trade can cause immense disruption. And where industries can show, to the satisfaction of an impartial group of commissioners, that they are being substantially and significantly injured by international trade, there is a case to be made for giving them a temporary respite.
The key question is, does it remain temporary? And, indeed, the history of 201 is that it has. So I think there is a case for safeguards. And I think, likewise, we do need to have rules for other kinds of private practices. We should not just abandon these, and certainly not unilaterally. We, as a large, significant player in international negotiations, do have negotiating power. It's certainly true we are better off when we open our markets. But we are even better off when, as we open ours, foreigners do the same. So we should not give up our leverage.
I think the role of the Byrd amendment is not something which the administration was strongly endorsing. And I stick with that.
MR. NISKANEN: Yes, one more question.
MR. GILSTON: Sam Gilston, Washington Tariff and Trade. This is a question for Dan Griswold.
In your data, you give concurrent numbers, looking at the years where there are rising trade deficits and decreasing unemployment. Is there a possibility that these numbers, the deficit numbers, might be sort of a leading indicator that, rather than the year that they are rising, it's the year or two before that precipitates the turn in the economy later?
MR. GRISWOLD: I didn't look at staggering the data at all. I don't know if that would be bear anything out. If you look, the deficit tends to, instead of swinging wildly one year to the next, you tend to go through periods where you have four- or five-year periods where you have a rising deficit, four- or five-year periods where you have a contracting deficit. And so I don't know if that would have shown anything.
I will add, though, if you notice, I didn't talk about it, but I have the stock market in there. And that was the one thing, the stock market tended to do a little better in years when the trade deficit was shrinking. But I concluded there that was probably because the stock market itself tends to be a leading indicator. Some of the best stock market years are during recession, but the market anticipates the turnaround. And so I did stagger that one, one year, and found that the stock market does a lot better in years before the trade deficit expands.
But, no, and I probably should do that with the data. But I didn't really think that that would yield anything different.
MR. NISKANEN: Here, one more.
MALE VOICE: I am interested in the composition and structure of
MR. NISKANEN: I think the best response to that would be to look in any number of government reports. That detail is available in the Economic Report of the President and any number of other reports.
DR. LAWRENCE: I would just say it's a very, very wide range of products. What has increasingly happened is there is a large amount of intra-industry trade. So that we will tend to see exports and imports of similar products going to and from the United States. There has been a shift, over the last few years, towards growth in the share of capital goods in our imports, particularly high-technology capital goods, particularly from Asian countries that produce those kinds of products.
So, when we look at the structure, we actually appreciate the role that globalization is playing in providing us with the necessary inputs and capital to drive this strong investment, which has led growth in the
MR. GRISWOLD: I just wanted to add that if you look at what we import, only about half of it is consumer-type goods. The other half is, just as Dr. Lawrence said, capital goods and intermediate inputs, flat-panel display screens, hard disk drives, steel. The debate last year over imported steel, one thing we pointed out here is that steel is a very important input into a number of other products, in construction, automobiles, prefabricated metal products. So, just in the broadest terms, imports are both directly for consumers, but about half of what we import goes to businesses which, in turn, make them more competitive in the U.S. economy.
MR. NISKANEN: There will be lunch upstairs right away. You are all invited to participate in that lunch. And let's give the panel a final thank you.
(Applause.)
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