by Robert Rubin, Citigroup
Luncheon Address at the conference "US Trade Policy in 2005"
Institute for International Economics
February 15, 2005
Some time ago, Fred Bergsten and I were talking about the fact that, if trade liberalization is to move forward and retrogression is to be prevented, the focus of the policy community and the public on the benefits of trade—in the full sense, including imports—and on the issues around trade needs to increase. The adverse effects trade has on some people are very keenly felt and often lead to vociferous opposition, while the benefits of trade for a far greater number of people are diffuse and usually little if at all understood—for example, by consumers—and seldom generate political activity on behalf of trade.
While testifying before the House Ways and Means Committee on a trade measure a few years ago, I spoke, despite the urgings of some Treasury staff to the contrary, about the benefits of imports—lower prices, lower interest rates, the traditional comparative advantage argument, and, very important, the pressure on domestic producers for competitiveness and productivity. Rep. Philip Crane (R-IL), not ordinarily in agreement with me on economic policy, said that I was the first public official whom he could remember testifying on trade before that committee who spoke about the benefits of imports. Similarly, during the NAFTA debate, the Clinton administration focused aggressively on arguing for the export benefits of NAFTA and tended to avoid the subject of imports. Thus, it is no surprise that the American public and most elected officials have so little awareness of the benefits of imports to consumers and manufacturers.
However, at another level, this question of the effects of trade is far more complex than the more usual discussion, both substantively and in terms of public awareness. I would like to talk about the complex web of economic policies related to trade that can realize the potential of open global trading markets and the political dimensions of such policies.
A deeply troubling fact of American economic life is that, over the past 25 years, median real wages in the United States have been roughly stagnant, and median real incomes increased by a small fraction of real growth—with the exception of approximately five years in the 1990s—despite substantial economic growth. Thus, for many US citizens, wages and incomes have not benefited much if at all from the great economic success of the United States during that period. That is not only a serious social issue but also a serious economic issue because people with rising incomes are able to provide better nutrition, education, health care, and other resources for their families that can increase productivity and because people who are not benefiting economically are less likely to support trade liberalization, even though other factors, like technology, play a much larger role.
To take this further, income distribution and economic policy more generally have become more complex because of a historic change in international economic circumstances. This change has two parts. First, I believe there is a historic change occurring in the economic and geopolitical positions of the major regions of the globe, not unlike the emergence of the United States more than a hundred years ago. China, India, and non-Japan Asia are generally viewed—rightly, I think—as likely to be the most dynamic part of the global economy, with China, at some point, becoming the world's largest economy and a tough-minded geopolitical power equal to any other country. Obviously, these countries also face serious challenges, but I think the evidence suggests a high likelihood that those challenges will be met. Japan, even if it meets its challenges, as its history seems to suggest is likely, will probably still have quite moderate growth due to demographics. Continental Europe would seem likely to have slow growth and relative decline unless there is a major change in the political willingness to address structural reform—which competitive pressure from the new entrants to the European Union (EU) could catalyze. And finally, the United States, which despite all that is happening elsewhere will still be key to the global economy for a long time, is at a critical juncture. The second contextual change, related to the first, is that the United States faces a historic competitive challenge from the increasing numbers of well-educated workers in low-wage environments, especially China and India, connected to the industrial countries by real-time communications that eradicate distance as a factor in locating many types of activities, including high value-added knowledge-based activities.
This second dynamic creates extremely complicated substantive challenges. Paul Samuelson published a piece recently discussing the possibility that globalization may no longer produce gains for all countries. In any case, the traditional distributional issues around trade—with many people benefiting while others lose—become more complicated as the range of tradable goods and services expands substantially.
Another contextual factor, also related to globalization, is that ever increasing capital flows across borders make the United States more vulnerable to unfavorable international reactions to its economic policy regime, and that vulnerability is especially critical at a time when the United States, with its saving rate so low and its dependence on large inflows of foreign capital so great, is a substantial debtor nation.
Putting all this together, substantively and politically, trade cannot be viewed in a vacuum but rather as one piece of the full, interconnected fabric of economic policy. Most fundamentally, as best said by President Clinton while advocating NAFTA, trade liberalization is the best path forward, but it needs to be inextricably combined with a parallel agenda of domestic programs—such as world-class public education, retraining, basic research, health care, and much else—to help those who are hurt by trade and to promote competitiveness in the global economy. Clinton also said that too often those who support trade oppose the domestic agenda, and those who support the domestic agenda oppose trade, and that the right answer is to combine the two. Bringing those two conflicting groups together, however, makes for difficult politics.
Major shortcomings can seriously affect the United States in a highly competitive global economy with interconnected capital markets. On the other hand, if handled correctly, these changes in the global economy offer US citizens enormous opportunities. Too often the developments in China, India, and elsewhere are seen as a threat, but those countries can be rapidly growing markets for US goods and services as their incomes rise.
However, this brings me back to my comment that the United States, at least in my judgment, is at a critical juncture economically. The United States has immense strengths: its dynamic society, its historic embrace of change, its willingness to take risks, its flexible labor markets, and the sheer size of its economy and economic infrastructure. On the other hand, in the areas just mentioned—public education, basic research, health care, as well as critically important fiscal imbalances, geopolitical risk, tort reform, and so much else—the United States faces immense challenges. Realizing its potential and opportunities requires meeting challenges, and failing to meet those challenges could well lead to serious difficulty.
Though all of these challenges are critically important, I would like to focus on the imbalances because their possible effects on interest rates, the dollar, and the US economy make them so central. To start, the 10-year projected fiscal position of the US government has deteriorated over the past three years by about $9 trillion, assuming the administration's proposal to make the 2001 and 2003 tax cuts permanent is enacted and assuming realistic levels of spending growth. Looking forward, on that same basis, independent analysts mostly agree on a projected 10-year deficit of between $5 trillion and 5.5 trillion. While numbers based on 10-year forecasts are highly unreliable, the likelihood that deficits will be higher is as great as the likelihood that they will be lower. The 2001 and 2003 tax cuts are estimated by the Congressional Budget Office to cost roughly $4 trillion over the next 10 years, if made permanent, and, as a consequence, these tax cuts are at the heart of the 10-year fiscal problem; the United States could have obtained all the stimulus necessary from temporary tax cuts, when conditions were difficult, at substantially lower cost-per-dollar stimulus and could have thus avoided this fiscal morass.
Moreover, projected fiscal conditions become far more difficult with each passing year after the 10-year federal budget window because baby-boomer generation retirements will then begin to increase rapidly, with the principal problem being federal health care programs, on which there is at present no serious reform focus. The proposals on Social Security reform on which the administration is focusing, as reflected in a reported document plus the details in the 2005 State of the Union address, would create additional deficits and debt of $1 trillion in the first 10 years of operation, $3 trillion in the second 10 years, and continued additional deficits and debt for a total of 40 or 50 years, depending on what is measured. These added deficits and debt are created because of the vast, immediate, and ongoing cost of establishing private accounts and because there is no means to pay for them except through increased debt and increased savings through benefit cuts that begin slowly in the second 10 years and only equal the costs of establishing private accounts roughly 40 years from the starting date.
Entitlement programs, defense spending, and interest on the federal debt constitute roughly 80 percent of the federal budget. Beyond these functions, the American people want and need government to maintain many activities, such as law enforcement, education, basic research, infrastructure, and many other programs. Meanwhile, tax revenues are roughly 16 percent of GDP, the lowest ratio since roughly the 1960s. Given these realities, reestablishing sound fiscal conditions will be exceedingly difficult both substantively and politically and will require major change, not adjustments at the margin or the time-honored resort of both political parties to unrealistic budgeting projections. Nonetheless, this change is imperative, but it must be done in a manner that enables the funding of programs critical to national security, the economy, and the social well-being of US society, while heeding mainstream views of what is critical on these issues and the political realities of budgetary matters.
Virtually all mainstream economists agree that sustained long-term deficits will crowd out private investment, increase interest rates, and reduce productivity and growth. The Federal Reserve Board and others have models that predict that, with deficits of the magnitude projected, these effects would be serious. However, even more dangerously, if both domestic and foreign markets begin to fear long-term fiscal disarray, and those markets—especially the foreign providers of the capital inflows on which the United States is now so dependent—also become concerned about the dollar because of the combination of these fiscal deficits and the US current account deficits, then the markets may begin to demand sharply higher interest rates for long-term debt, which could lead to other problems. Interest rates have not been materially affected so far because private demand for capital has been relatively limited and because of the large inflow of foreign capital from central banks motivated by their own trade concerns. However, a change in either of these circumstances, or simply a change of market psychology, could lead to these risks becoming realities. Also, the evidence of the early 1990s suggests that prolonged deficits could have serious adverse effects on business and consumer confidence more generally.
In addition to bond market interest rates, all of this also obviously raises complicated questions about the dollar. With a 6 percent current account deficit, large fiscal deficits, the conversion of the United States from a creditor to a debtor nation, and a personal saving rate under 1 percent over the last 12 months, the dollar is widely thought likely to decline over time. One contrary view is that the decline of the dollar thus far will be sufficient to correct the US trade imbalance considerably, so that further declines of the dollar will not be that great. The exact opposite view is that there is at least some chance that existent conditions could lead to abrupt and substantial declines. Making all this even more complicated, Japan and Europe may have relatively unattractive growth and investment prospects, and the foreign central banks upon which the United States is now so dependent may have great staying power or could adjust their positions because of concerns about US interest rates and the dollar or because of their own internal reasons.
As to policy, the best way to avoid a sharp deterioration, with all the effects that could have, is to reestablish sound fiscal policy in order to engender confidence in US economic policy and in the long-term prospects for the US economy. More generally, in my view, the US objective should be to have a strong currency based on sound policy, the dollar should not be used as an instrument of trade policy, and all economies should be encouraged to move toward floating exchange rates as their financial systems become ready. Finally, with respect to imbalances, the United States has very high levels of consumer debt, which at the very least make the US economy more vulnerable to significant interest rate increases.
Putting all of this together, an effective policy response to US fiscal imbalances is a bedrock requisite for the interlocking policy regime that, combined with trade liberalization, is the right path forward.
With this, I would like to return to the topic of the stagnation of median wages over the past 25 years and worsening income distribution, both of which may be affected by globalization. The kind of policy regime just discussed hopefully would be responsive to this issue. But there may be some very basic dynamics that are actually quite difficult to address. For example, the most skilled or the most effective workers in American society may now have greatly enhanced market value in an environment where global demand rather than just national demand is the relevant market, while many others—including many in knowledge-based activities such as certain parts of software development—may have a lower market value due to foreign competition. To a much greater degree, technology, changes in management practices, and developments in distribution—such as the further growth of marketing giants and e-commerce—contribute to productivity and rewards for some but may adversely affect others, even after taking into account benefits to them as consumers.
None of these possible effects of globalization should impede moving ahead with trade liberalization, technological developments, or more efficient distribution. They are the pathways to best promote growth, but within that context these distributional issues must be addressed to have an economy that works for the great preponderance of the US populace and to maintain political support for trade and for a market-based economy.
Finally, trade cannot be discussed without referring to the question of labor and environmental conditions. My own view is that the United States does have a strong self-interest in how income is distributed in the economies of its trading partners, especially lower-wage trading partners—for example, the creation of large middle classes creates larger markets for the United States—and a strong self-interest in sound environmental regimes around the world. On the other hand, too often the suggestions concerning labor or environmental conditions do not relate to the economic realities of the countries involved and, more broadly, in a world where China and other countries are entering into trade agreements that do not include the United States, insisting on labor and environmental conditionality may simply impede the United States from being part of the global trading system to the most beneficial extent. Thus, these objectives may need to be pursued through other mechanisms, such as the International Labor Organization (ILO) or the World Trade Organization (WTO).
Let me conclude by saying that—the private and public sectors of many Asian countries seem to have a sense of mission about economic policy and productivity that is grounded in facts and analysis. I do not think that the United States has that same sense of mission today, and I think it must be resurrected to achieve the enormous potential I believe the United States has in an ever more globalized economy. The United States is a dynamic society with a history of great resilience in meeting fast challenges, and that should augur well for the future. But there are no guarantees, and there is much work to do.
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