September 14, 1999
|Contact:||Catherine L. Mann||(202) 328-9000|
Washington, DCThe US merchandise trade deficit will hit an annual rate of $350 billion by the end of this year. The current account deficit will reach an historic high of almost 4 percent of GDP. When these deficits hit similar levels in the middle 1980s, the dollar fell by 50 percent and protectionist trade pressures surged.
In Is the U.S. Trade Deficit Sustainable? Catherine L. Mann concludes that foreign funding may remain sufficient to enable the United States to continue running external deficits at the present level "for two or three more years." However, the current deficits may be financially unsustainable beyond that horizon. Moreover, the apparent rise in protectionist trade pressures suggests that the sustainability of the deficits in domestic political terms is already being approached.
One possible response in the short run is a decline of perhaps 25 percent in the value of the dollar. Such a decline could be readily absorbed, by both the United States and the world economy, if it occurs gradually in a context of faster economic growth in Europe and Japan. It could cause severe disruptions, however, if it were to transpire precipitously under present economic conditions: inflationary pressures would be generated and interest rates would be pushed up in the United States, and the nascent recovery abroad would be significantly retarded.
Taking a longer-term perspective, Dr. Mann notes that the US trade and current account deficits have undergone a secular deterioration throughout the postwar period. That deterioration has now worsened because the United States has become a large debtor country, with a rising burden of interest payments to its foreign creditors. Even a large decline of the dollar would not remedy this secular trend. Dr. Mann proposes three sets of structural remedies:
After describing and analyzing the record US external deficits, Dr. Mann notes that the United States is also enjoying the longest economic expansion in its history. At 4.2 percent, the unemployment rate is the lowest in a generation. Inflation is the lowest in 30 years. Household wealth has never been greater and is distributed widely across America. Confidence is high. Spending by individuals and businesses is brisk. The United States has maintained robust growth in the face of global financial volatility and downturns in the economies of virtually all its trading partners.
What is the relationship between these two unprecedented economic phenomena? Is the United States an "oasis of prosperity," or are we living beyond our means? Will the trade and current account deficits precipitate a dollar crisis?
Dr. Mann concludes that international forces are in fact allowing the current robust expansion to continue and enhancing the long-term ability of the United States to grow without generating inflation. The rise of the dollar, lower import prices, and enhanced technology fueled by international production have lowered inflation. Lower inflation benefits all Americans, especially poorer groups, who consume a large fraction of their income. Faster productivity growth, due in part to global integration of the US economy, is the foundation for both lower unemployment and higher wages. It allows monetary policymakers to keep interest rates low for longer periods without concern about higher inflation.
Hence the trade and current account deficits represent mostly good news-for both the United States and the rest of the world-in the short run. The United States may be able to support the resumption of global growth by running those deficits for two or three more years. The increase in US productivity growth, in association with the globalization of production and distribution, makes it possible for the imbalances to grow larger and to be sustained for a longer time than in the 1980s. The liberalization and globalization of international financial markets and institutions make it easier and more attractive for investors to diversify their wealth portfolios to include high-return, relatively safe US investments.
But the United States cannot forever consume beyond its long-term means. Nor will financial investments in the dollar always be so favored. Hence the United States must take a number of steps to deal with its external deficit.
First, US policymakers should review the structural issues now, when the economic climate is so good. Household savings rates are too low; to the extent that today's consumption and savings profiles are driven substantially by volatile capital gains, they are not sustainable. Current and future worker preparedness for current and future jobs is inadequate and worsening. Adjustment to economic dynamics is difficult and costly for firms and workers alike. A partnership must emerge between government, business, unions, schools, and individuals to enable all Americans to benefit from globalization.
Second, trade negotiations must resume and should focus on multilateral liberalization of trade in services. The United States has a global comparative advantage in services, many of which remain highly protected abroad. Liberalized services trade would unleash higher productivity and faster growth at home and abroad and generate a larger market for American exports, all of which would narrow the US deficit.
A third key concern is the continued economic doldrums of the rest of the world. The "lost decade" in Japan, the tepid growth in most of Europe's economies, the tentative rebound in Asia, and the teetering of Latin America could be setting the stage for a rerun of the 1980s. If sustained growth around the world is delayed for several more years, US investments will continue to yield returns higher than those abroad and the dollar could continue to strengthen. The trade deficit would continue to grow until a sharp decline in the exchange value of the dollar became inevitable, as in the middle 1980s.
A significant depreciation of the dollar would have a dramatic corrective effect on the trade and current account deficits. However, it would not put them on a sustainable trajectory for the long term. Without structural changes and more robust productivity growth, a one-shot decline of the dollar would simply perpetuate the traditional cycle: the depreciation narrows the trade and current account deficits initially but is followed by their renewed widening as structural instabilities and net investment payments dominate the dynamics. The dollar has been on such a roller coaster for almost thirty years, but with today's negative net international investment position, the ride could get wilder. Moreover, in the current robust economic environment, it would be difficult for the United States to produce the additional goods and services needed to cut the external deficit without raising the risk of inflation and a monetary policy response that would slow the economy.
A more congenial scenario could evolve if other countries were to grow faster. The rate of return on investments elsewhere would then rise, and the dollar could depreciate gradually as investors diversified their portfolios instead of overweighting toward US securities. Faster growth abroad and a drifting down of the dollar would help to close the current account gap without severe disruption, and could complement structural reforms to achieve a long-term sustainable economic climate not only for the current account but also for domestic workers and firms.