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A New Foreign Economic Policy for the United States

February 9, 2005

Contact:    C. Fred Bergsten    (202) 328-9000

Washington, DC —Globalization increases the standard of living of the United States by about $1 trillion per year. The average American household is about $9,000 per year richer as a result of the country's integration with the world economy since 1945. Achievement of completely free global trade would increase US income by a further $500 billion per year (and average household income by another $4,500 annually). These key findings underpin the new strategy for US foreign economic policy proposed in The United States and the World Economy: Foreign Economic Policy for the Next Decade by C. Fred Bergsten and the Institute for International Economics. The book includes chapters on each key issue facing US foreign economic policy by members of the senior staff of the Institute.

The United States faces three sizable and immediate international economic risks (chapter 1, Bergsten):

  • The US current account deficit is approaching $700 billion annually (almost 7 percent of GDP) and continues to rise sharply. The United States must borrow $5 billion from the rest of the world every working day to finance the deficit and America 's own foreign investments. This foreign financing could decline precipitously at virtually any moment and trigger a free fall in the exchange rate of the dollar that would drive up interest rates, perhaps to double digits, and cut growth dramatically in the United States and the world as a whole.
  • The world oil price could rise back to its recent highs, or indeed further to $60 to $70 per barrel. The effects on US and world inflation, interest rates, and growth would be severe. The energy and currency risks reinforce each other because a lower dollar leads to higher oil prices and vice versa.
  • Trade protectionism is rising, especially against China in light of a bilateral trade deficit that has reached $160 billion. The Congress will take up several major pieces of trade legislation in early 2005 on which these pressures could materialize. A key problem, in addition to the huge current account deficit and continuing large overvaluation of the dollar, is the inadequacy of US domestic programs to cushion the impact of trade-induced dislocation on American workers and to equip them to compete effectively in a global economy.

Over the longer run, the United States faces four additional major international economic challenges:

  • the advent of a European economic superpower, as the economy of the expanded European Union becomes as large as America's and hosts a single money (the euro) that provides the first rival to the dollar since it became the world's key currency almost a century ago;
  • the meteoric rise of China, already the world's third largest trading nation and second largest economy with exchange rates calculated at purchasing power parity (chapter 4, Nicholas Lardy), with India perhaps coming in its wake;
  • the evolution toward an East Asian economic bloc that could create a tripolar world economy, along with the existing European and North American (perhaps to become Western Hemisphere) blocs, with significant geopolitical as well as economic implications for the United States; and
  • continued high levels of poverty and underdevelopment in the poorer countries, mainly in Africa, which raise security as well as economic and humanitarian challenges for the United States.

The United States therefore needs to adopt a number of new policy initiatives to defend and strengthen its position in the world economy. The most urgent is to correct the current account deficit in an orderly manner by launching a credible program to reduce the budget deficit substantially over the next few years and subsequently move it back into surplus, thereby reducing America 's need for foreign funds and prompting a gradual rather than disruptive adjustment of the dollar. A second requirement is to persuade China and a number of other Asian countries to stop blocking the needed currency realignment; China should revalue by 20 to 25 percent ( rather than float its currency), thereby encouraging the other Asians to contribute as well to the needed international adjustment. It will also be essential for other surplus countries (especially in Europe) to boost their domestic demand to offset the coming declines in their trade balances, as their currencies rise against the dollar, through both structural reforms and more expansionary macroeconomic policies (chapter 6, Michael Mussa).

To avoid damaging new increases in global energy prices, the United States and other oil-importing countries should announce their willingness to sell oil from their strategic petroleum reserves if prices again rise excessively (chapter 7, Philip K. Verleger Jr.). For the longer run they should be willing to deploy those reserves as part of a new international agreement between consuming and producing countries to replace manipulation of the world oil price by the OPEC producers. As part of that new energy strategy, the United States should enact a substantial gasoline tax to be phased in as market prices decline, to cut US energy demand and strengthen its international negotiating position. It should work with Canada and Mexico to develop a North American energy strategy that promotes greater investment in energy production and distribution channels in all three NAFTA countries.

A major conclusion of the new book is that market manipulation by key foreign countries is a major component of both the current account and energy problems facing the United States. China, Japan, and other Asian countries have intervened massively in the currency markets to retard an orderly correction of dollar overvaluation and the needed sharp reduction in the US current account deficit (chapter 12, Morris Goldstein). The OPEC producing countries have consistently limited their oil output to keep world prices well above levels that would be determined by market forces. The proposed new initiatives would, to an important extent, be directed at eliminating or countering these distortions in global markets. More aggressive measures may be needed to do so if the preferred cooperative approaches suggested here fail to achieve the needed results.

The United States also has a major interest in further trade liberalization (chapter 8, Jeffrey J. Schott). It should give heightened priority to liberalization of services and sharp cuts in agricultural supports and import restrictions in the Doha Round at the World Trade Organization. It should initiate negotiations for new free trade agreements (FTAs) with several countries with significant economic size, foreign policy importance, and potential for major economic reform, including Egypt, India, Korea, and/or Japan. The United States should also provide strong support for APEC's pursuit of a Free Trade Area of the Asia Pacific to respond to the growing discrimination against its trade from the proliferation of FTAs in East Asia and to avoid the foreign policy as well as economic risks of “drawing a line down the middle of the Pacific.”

Trade liberalization is also the most effective US policy instrument for reducing poverty in the poorer countries of the world (chapter 13, William R. Cline and John Williamson). Elimination of all trade barriers, by both the rich countries and the poor countries themselves, could lift 500 million people earning less than $2 per day out of poverty by 2015 and add $200 billion to annual incomes in the developing nations. Foreign assistance should be expanded, but complete trade liberalization would transfer about twice as much benefit to the poor countries as all current aid programs.

The new study estimates that the US economy suffers adjustment costs of about $50 billion per year from globalization. This is a small fraction of the current annual benefits of $1 trillion, or the potential further benefits of an additional $500 billion per year (chapter 2, Gary Clyde Hufbauer et al.), but it causes significant human dislocation and thus political backlash that could jeopardize the huge gains from the process (chapter 3, J. David Richardson). The United States should therefore substantially expand the present program of Trade Adjustment Assistance (TAA), on which it now spends only $1 billion to $2 billion per year (chapter 10, Lori G. Kletzer and Howard Rosen). TAA should henceforth include eligibility for services workers, who are affected by a growing share of US trade and are the focus of most of the recent concerns over “outsourcing” (chapter 9, Catherine L. Mann). Trade-impacted industries rather than individual groups of workers should be qualified to receive TAA to simplify and speed the delivery of all its available remedies. Community adjustment programs should be revived to counter the broader impact of trade-related dislocations. A Human-Capital Investment Tax Credit should be enacted to encourage private companies to adopt worker training programs.

The conduct of the new US foreign economic policy will require substantial modification to effectively pursue these initiatives. At the multilateral level, the G-20, which includes China and several other rapidly emerging economies, should steadily replace the G-7 as the informal steering committee for the world economy (chapter 5, Jan E. Boyer and Edwin M. Truman). At the bilateral level, the United States should pursue special “G-2” relationships with the European Union (for macroeconomic, monetary, and some other issues), China (for global growth, exchange rates, and energy), Japan (for trade and to counter China's rise) and Saudi Arabia (for energy). The US government will also have to reform its internal governmental organization to provide a new focus on the large emerging markets (especially Brazil, China, India, Russia, and South Africa) as a priority for policy attention in the years ahead.

About The Authors

C. Fred Bergsten has been director of the Institute for International Economics since its creation in 1981. He is also chairman of the "Shadow G-8," which advises the G-8 countries on their annual summit meetings, and the TransAtlantic Strategy Group, created by the Bertelsmann Foundation. He was chairman of the Competitiveness Policy Council, which was created by Congress, throughout its existence (1991–95) and chairman of the APEC Eminent Persons Group throughout its existence (1993–95). He was assistant secretary for international affairs of the US Treasury (1977–81) and functioned as under secretary for monetary affairs (1980-81); assistant for international economic affairs to Dr. Henry Kissinger at the National Security Council (1969–71); and a senior fellow at the Brookings Institution (1972–76), the Carnegie Endowment for International Peace (1981), and the Council on Foreign Relations (1967–68). He is the author, coauthor, or editor of 34 books on a wide range of international economic issues, including Dollar Adjustment: How Far? Against What? (2004), Dollar Overvaluation and the World Economy (2003), No More Bashing: Building a New Japan–United States Economic Relationship (2001), Global Economic Leadership and the Group of Seven (1996), and The Dilemmas of the Dollar (2d ed., 1996).

This volume contains contributions from Institute Senior Fellows and Visiting Fellows Jan Boyer, Scott C. Bradford, William R. Cline, Morris Goldstein, Paul L. E. Grieco, Gordon H. Hanson, Gary Clyde Hufbauer, Lori G. Kletzer, Nicholas R. Lardy, Catherine L. Mann, Michael Mussa, J. David Richardson, Howard Rosen, Jeffrey J. Schott, Edwin M. Truman, Philip K. Verleger Jr., and John Williamson.

About the Institute

The Institute for International Economics, whose director is C. Fred Bergsten, is the only major research center in the United States that is devoted to global economic policy issues. The Institute's staff of about 50 focuses on macroeconomic topics, international money and finance, trade and related social issues, and international investment, and covers all key regions—especially Europe, Asia, and Latin America. The Institute averages one or more publications per month; holds one or more meetings, seminars, or conferences almost every week; and is widely tapped over its popular Web site.

The United States and The World Economy: Foreign Economic Policy for the Next Decade
by C. Fred Bergsten and the Institute for International Economics
January 2005 • 488 pp. • $26.95
ISBN paper 0-88132-380-2