Features: By Steve Stein Making sense of the trade deficit In october, the United
States posted a 12-month
trade deficit of nearly $600 billion. That figure has been rising steadily and breaking its own
record month by month. Each increment adds to the United States’
external debt, which is now estimated at over $2.6 trillion. The chart below shows how each has been increasing
as a percentage of gdp.
Are these increases in the trade deficit and the
external debt matters of great immediate concern? No, say a remarkably
large number of respected economists, adding that the only imminent danger
in these figures is that they might provoke unwise but irresistible calls
for protectionism and other equally harmful measures.
One of those respected economists is Federal Reserve
Board Chairman Alan Greenspan. Addressing a bankers’ conference in
May, Greenspan acknowledged that the trade deficit, at over 5 percent of gdp, was testing historic limits,
especially since it was accompanied by a record budget deficit and record
household debt. So why isn’t Greenspan alarmed? Because, as the
chairman said, the United States is simultaneously benefiting from a
“one-time shift in the degree of globalization and innovation.”
Rapid industrialization and freer trade have lowered the cost of
merchandise. The internationalization of investment and banking, coming at
a time when America’s robust capital markets are so attractive
throughout the world, has lowered the cost of credit. The growing
flexibility of world financial markets has made it easier for equity
prices, product prices, and exchange rates to reestablish global balance
without the sort of abrupt impacts on the U.S. economy that create crises.
U.S. External Debt and Primary Trade Deficit (share of GDP)
However, Greenspan stressed that one-time shifts
don’t last forever, and lately his optimistic outlook appears
somewhat dampened by the large and ongoing accumulation of dollar assets by
Asian central banks. In November, when he told another banking conference that “net
claims against U.S. residents cannot continue to increase forever in
international portfolios at their recent pace,” Wall Street reacted
as though it had received new and unpleasant information. At any rate,
those massive currency interventions, particularly by China and Japan, have
kept the dollar artificially high and Asian imports artificially cheap, and
they trouble some economists much more than they do Greenspan. Former
Treasury Secretary Lawrence Summers, for one, worries that the United
States has found no effective way of preventing these currency
transactions.
In fact, Summers shares little of Greenspan’s
calm view of the trade deficit, and is especially concerned about the
geopolitical implications of the rising external debt. “There is
surely something odd,” Summers told a group at the International
Institute of Economics, “about the world’s greatest power being
the world’s greatest debtor.” He has a point. While it
isn’t easy for other nations to use the threat of calling that debt
in order to achieve other political ends, neither is it impossible. The
situation of the U.S. today stands in sharp contrast, for example, to that
of the British Empire in the nineteenth century, when it was both the
world’s major power and major creditor.
Divided commission
It is no surprise that a Federal Reserve chairman and a former secretary
of the Treasury from different political parties view a highly charged
issue like the trade deficit from dissimilar perspectives. International
trade has always been a subject from which professionals can draw vastly
different conclusions using the same set of facts. At least Summers and
Greenspan do share large areas of agreement, which is more than can be said
of some of their colleagues.
When Congress established the Trade Deficit Review
Commission in 1999,
it may have foreseen an end product that would represent bipartisan
consensus. The commission’s final report was well-researched and
thorough, but bipartisan it definitely was not. Most of its chapters
consist of a set of Republican recommendations and Democratic
recommendations; the two could hardly be farther apart. Since the two blocs
on the commission saw the causes, consequences, and sustainability of the
trade deficit so differently, it wasn’t surprising that they had
different views as to what to do about the problem (or even whether there was a problem). The final report
was not a likely document upon which to base law or policy. The only ones
happy with the report were those who believed that legislative gridlock was
insurance against overly intrusive government — a not uncommon view
during the heady bull market of 1999 and early 2000.
The chairman of that commission was Murray Weidenbaum,
formerly chairman of the Council of Economic Advisers. Weidenbaum told an
audience at a Cato Institute conference that the Republicans originally had
no intention of writing separate statements. They decided to do so only
after the Democrats had surprised them with the announcement that they were
writing their own versions of several chapters. So in the final report, the
Republicans emphasized the benefits of imports, and the Democrats
emphasized importers’ effects on the domestic job market. Republicans
emphasized the quality of the United States’ capital markets, which
made it much easier for foreign capital to come here than for American
capital to go abroad. Democrats emphasized the dangers of so large an
external debt.
And so the commission’s report went, chapter
after chapter. The causes of the trade deficit? Republicans saw them mainly
in macroeconomic terms: “In the 1990’s, the relative strength of the U.S. economy led to
substantially increased imports, while the relative weakness of many of our
trading partners led to much slower growth in exports.” Democrats saw
other factors at work: “Unequal relationships with America’s
major trading partners. Predatory practices, such as dumping, that have
increased U.S. imports. Foreign government subsidies . . . . The failure of
other nations . . . to enforce their labor and environmental laws.”
The only major cause that both sides agreed on was the low rate of savings
in the United States, and even on this point, there were vastly different
emphases.
The two sides were even farther apart regarding the
consequences of the trade deficit. The Democrats saw “A sharp rise in
income inequality since 1979 . . . elimination of millions of good manufacturing jobs . . .
depressed wages . . . and declining U.S. competitiveness on world
markets.” The Republicans saw a trade deficit that “had played
a very important role in rising U.S. prosperity . . . rapid economic
growth, a higher U.S. standard of living and job creation . . . and
helped keep inflation low.”
Nor did the two blocs see eye to eye on the
sustainability of the trade deficit. Few would suggest that large trade
deficits can continue forever, but “sustainability” is much
more narrowly defined in the area of international trade. Economists
generally speak of trade deficits as sustainable if they are likely to
diminish gradually through market forces and without sudden currency
devaluations or traumatic recessions. The commission’s Republicans
thought this was probable; the Democrats did not.
If, today, a successor panel were to reexamine the
trade deficit (or the current account deficit, a slightly broader measure
that includes interest and dividend payments), might it achieve more
practical conclusions? Maybe such a panel should start with the sustainability
question. After all, if it turns out that the trade deficit will ultimately
adjust itself without problems for this generation or the next, wrangling
over the deficit’s root causes or possible consequences may not be a
valuable use of time. But if sustainability is doubtful, then finding
common ground on the causes of the trade deficit takes on new urgency.
Sustainability 1: Debt
In the trade Deficit Review Commission’s report, both the Democrats
and the Republicans cited a book by Catherine Mann, a senior fellow at the
Institute of International Economics, titled Is
the U.S. Trade Deficit Sustainable? (1999), which remains an
authoritative work on the subject. The book generally concludes that
America’s ongoing trade deficits are unlikely to produce any sudden
flight from the dollar or any other crisis of the kind associated with a
large buildup of foreign debt in weaker economies, but the experience of
the past four years, including the return of large budget deficits, has led
Mann to add two caveats. The first is that a somewhat unhealthy
relationship, or “codependency,” has developed between the
United States and several of its Asian trading partners. The Chinese and
Japanese continue to support our currency and finance our debt in order to
protect their export markets, and we continue to pursue policies that make
their support necessary.
Mann’s second caveat, as she explained in a
recent telephone interview, is more subtle. The very size of the American
economy, combined with the strength of its capital markets and banking
system, forestalls the typical monetary pressures that international
markets normally bring to bear — mainly exchange rate adjustments
— which then cause imports to fall and exports to rise. Prolonging
the period of high trade deficits increases the likelihood that some major
unforeseen event will upset the applecart.
By definition, the precise nature of such an event is
unpredictable, but in light of recent experience, some possibilities can be
envisioned. Consider, for example, the crisis in the autumn of 1998 precipitated by the collapse
of Long Term Capital Management, the highly leveraged currency trading
hedge fund. The collapse could have precipitated a liquidity crisis had the
Federal Reserve Board not decisively managed the necessary infusion of cash
into the banking system. At the time, foreign central banks were not
players in that process. Yet today, with over $1.6 trillion of dollar reserves held by Japan, China, Taiwan,
and Korea, would their central banks be content to remain mere spectators
if an lctm-type
crisis loomed? Or if not, would their independent currency moves exacerbate
the situation rather than help it?
Currently our large external debt is financed at such
low interest rates that the debt service is fairly easily offset by the
growth of our domestic economy. As interest rates rise, the economy will
have to perform even more strongly.
Sustainability 2: Equity markets
It is a simple accounting truth that every dollar of the current
account deficit has to be offset by a loan from foreigners or a sale of
assets to them. Most of the lending is in the form of government securities
and, rightly or wrongly, is seen as closely related to the size of the
budget deficit. Financing the trade deficit by sales of assets —
publicly traded stock, real estate, or private businesses — is seen
as somewhat more benign. Most such sales are between businesses and
individuals, rather than governments, and thus seem part of the trend
toward globalized markets.
But financing trade deficits through equity purchase
also has limitations. One constraint is that foreign portfolios, especially
those that already contain U.S. Treasury instruments, can become
uncomfortably concentrated in American securities. The higher the
concentration of U.S. securities, the more skittish foreign money managers
may become in difficult times. Parts of the equity market are notoriously
volatile, as illustrated by the 75 percent decline in the nasdaq from its high in March 2000 to its low in September 2002. Had foreign holdings been an even larger share of the
market than they were, the nasdaq’s downdraft might have spread even farther. So what
will happen in the next down-market cycle? The global integration of
capital markets is a factor that is supposed to add stability to the system, but
surely it can work both ways.
The connection between the equity markets and the trade
deficit also points to an even broader concern: Every dollar earned from an
export to America and reinvested in an American stock represents a decision
that this particular American company will itself be a strong revenue and
profit producer. In an increasingly global economy the logical assumption
is that much of that revenue will come from foreign trade.
There’s a slight problem here. For decades,
optimistic trade economists have been saying it’s ok to run trade deficits today if
they’re financing the promise of greater productivity tomorrow.
Sooner or later, the continuing existence of the trade deficit itself casts doubt upon the
credibility of the promise. This is not a question of America’s
ability to innovate. It is a question of America’s ability to reap
the market benefits of that innovation. During the height of the nasdaq bubble, the conventional
wisdom was that the Internet changed everything, but the unanswered
question was always, “How then do you make money out of it?”
The venture capitalists and the investment bankers knew how: float an ipo and execute a good exit
strategy. But if the subject is “sustainability,” that
isn’t very comforting.
As always, winners and losers emerged, and now the
Internet is certainly producing lots of revenue for the former. Moreover,
many of its successes might never have happened if the American economy had
followed the example of those of its trading partners whose economic
systems try to pick winners and losers in advance. But consider how
dramatically the process is speeding up. As Ernest Preeg, a senior fellow
at the Manufacturer’s Alliance, pointed out recently, even in the
area of highly advanced technology products (atp), United States trade has gone from a surplus of $30 billion in 1998 to a deficit of $27 billion in 2003. Sectoral deficits in
“information and communications” and “life sciences
technology” simply don’t square with the notion that America
will muddle through its other trade problems by maintaining its
technological edge. As Preeg suggests, sooner or later a trade deficit in
advanced technology products begins to put pressure on r&d expenditures, threatening
future innovation itself.
American companies earned strong profits from the
manufacture of television sets for decades, before the comparative
advantage in that business went entirely abroad. Today, the
profit-generating products of major industries become
“commoditized” more quickly. As this shift from high margin
business to low-margin business occurs, the pattern in many American firms
has been to move on to newer products where the margins are still strong.
Among the other things that a rising trade deficit tells us, it signifies
that the search for high-margin businesses is becoming more arduous.
Attracting capital to finance those businesses may become more difficult as
well.
Sustainability 3: The dollar
Optimistic scenarios that foresee the trade deficit gradually diminishing typically
assume that the dollar will remain the world’s major reserve
currency. The experience of the past 50 years shows that the dollar can lose value against other
strong currencies but still be the currency of choice for settling
international accounts. As recently as 1971, the dollar was worth 357 yen and 4.31 Swiss francs; at the time of this writing, it is worth 107 yen and 1.20 francs. The dollar also lost more
than half its value against the German mark from 1971 until that currency was
phased out by agreement with the European Union a few years ago.
The International Monetary Fund estimates that over 65 percent of all foreign
reserves are still held in dollars. The dollar’s closest competitor,
the euro, comprises only about 20 percent of foreign reserves. The United States obtains
considerable economic advantage from the dollar’s reserve status.
Major commodities, such as oil, wheat, and copper, are generally invoiced
in dollars, which means that American dealers in these items don’t
have the currency risks or hedging costs of their foreign competitors. This
economic advantage builds on itself: Since the dollar is the preferred
medium of exchange, other nations have an interest in keeping its value
stable. The massive interventions by Asian central banks have drawn
deserved criticism as currency manipulations designed to protect their own
exports. But the Chinese and Japanese have additional interests in the
dollar’s stability. Like us, they are huge importers of oil, which is
still priced in dollars, and they recall the oil shocks of 1973 as vividly as we do. If
China were to revalue the yuan against the dollar, it might temporarily be
able buy oil a little more cheaply — but at the risk of significant
market volatility in the future.
Has the dollar’s reserve currency status tempted
America into overreliance on imports simply because it is able to print
money to pay for them? Certainly, there are advantages of having a currency
in whose value everyone has a stake. The situation has been caricatured as
other countries having a comparative advantage in producing goods and
America having a comparative advantage in producing money to pay for them.
Protectionists see America’s trade deficit as the
product of just such a dream world, with little hope of self-corrective
feedback developing in time to avert crisis. Some of this can be dismissed
as the scare talk of the politically disaffected; after all,
America’s monetary policy has been quite carefully managed,
especially for the past several decades. But Warren Buffett, chairman of
Berkshire-Hathaway, is no disaffected outsider. He worries that the United
States may experience the “abrupt shutoffs of credit that many
profligate nations have suffered in recent decades.” Nor is Federal
Reserve Board Governor Edward Gramlich an outsider or a protectionist, but
he has his own concern that market forces may not work smoothly and
efficiently to revalue the dollar. As Gramlich noted in a speech to the
Euromoney Bond Investors Congress in London (February 25, 2004):
Countries with large trade deficits often have their external liabilities denominated in a foreign currency. Hence, when their own currency depreciates, the value and burden of foreign debt automatically increases. The United States does not have this problem because most of its debt is denominated in dollars — say, foreign holdings of U.S. Treasury bills. If the dollar were to fall, the value of our debt in terms of foreign currencies would then automatically decline, inducing foreign wealth-holders to make further portfolio shifts, perhaps even including increasing their stock of dollar-denominated debt. This denomination effect would not permanently prevent any relative price adjustment, but it could lengthen the process.
The United States has held commanding economic status
for so long that we need to remind ourselves this is not a preordained
condition. When the country first established the Federal Reserve System in
1913, the U.S.
economy was already more than three times the size of its two closest
rivals, Great Britain and Germany. Because of the effect of World War i on England’s finances,
the dollar soon replaced the pound as the leading reserve currency. By the
end of World War ii
the United States had the only viable major economy. In 1944, the conference at Bretton Woods, New Hampshire agreed that
every participating nation’s currency would be fixed to the dollar
and the dollar would be fixed to gold — an unprecedented
concentration of economic power.
Bretton Woods worked reasonably well until the mid 1960s, when the United States
experienced rapid inflation and the dollar’s official exchange rate
— $35 per
ounce of gold — began to lose credibility. When Richard Nixon
“closed the gold window” in 1971 and announced that the dollar would be allowed to float, it
was seen as a setback for U.S. international monetary policy. Actually,
demand for the dollar as a reserve currency has increased. The opec cartel, for instance,
drastically raised the price of oil but nevertheless continued to price it
in dollars, which were still seen as the world’s safest currency. The
“petro-dollars” that resulted from this arrangement represented
a claim on U.S. assets but also added to the attractiveness of the U.S. as
an investment target. The three years of back-to-back double- digit
inflation from 1979
to 1981 resulted
in some flight from the dollar to gold, but not to other currencies.
When the Federal Reserve regained a firm grasp of
monetary policy and reined in both the money supply and inflation, even the
combination of large trade deficits and large budget deficits that existed
in the late 1980s
didn’t threaten the dollar’s reserve currency status. So when
we again hear warnings of the impact of the trade deficit on the dollar, is
this not another case of crying wolf?
Possibly not. As Nobel Laureate Robert Mundell told an
audience in Buenos Aires in 2000, “Currency power configurations . . . evolve along
predictable lines with the growth and decline of nations. . . . Now, at the
close of the ‘American century,’ the euro has appeared as a
potential rival, the countervailing power, to the dollar.” Another
currency expert, Stanford economist Ronald McKinnon, believes that if the
euro had been created in the 1970s when the dollar was relatively much weaker, it might have
been an immediate challenger as the dominant reserve currency.
Serious talk has already begun about an East Asian
equivalent to the euro. Increasingly, Asian central banks are experimenting
in currency swaps designed to safeguard against the type of speculation
that precipitated the “Asian contagion” of 1997, when the currencies of Thailand,
Malaysia, Indonesia, and South Korea collapsed so dramatically. As the Wall Street Journal noted in an
editorial (June 8, 2004), “the main obstacles to an Asian ‘euro’ are
political.” If Japan and China, in particular, reach a required level
of mutual trust, it is conceivable that the requirements for a currency
configuration such as Mundell describes will be nearly met.
So the dollar may have to share reserve status with
other currencies, regardless of the future patterns of our foreign trade.
That may turn out to be no particular detriment, but shouldn’t the
dollar’s loss of supreme reserve status be factored into trade
forecasts? When an optimistic economist claims that the best thing to do
about the trade deficit is to allow natural economic forces to take their
course, those forces should include the possible diminution of economic
leverage America obtains from the dollar’s reserve status.
Asking whether the dollar is “too big to
fail” is too apocalyptic a question, but the related inquiry —
might the dollar become a lot smaller in the future? — is sobering
precisely because it is more realistic. Thus, there is enough uncertainty
about the trade deficit’s sustainability that it becomes necessary to
face the subject that “trade libertarians” don’t like:
Are other countries’ national trade policies creating disadvantages
for us that aren’t offset by the operation of the free market?
American competitiveness
Policies that directly target the trade deficit can easily morph into
protectionism. Therefore, some economists prefer to focus almost entirely
on causes of the trade deficit that relate to the state of the entire
economy — the “macroeconomic” causes. Chief among these
is America’s low rate of savings, which, since the early 1980s, has declined from over 8 percent of gdp to less than 2 percent. The Germans, whose
labor costs are even higher than our own, run consistent trade surpluses.
The most obvious difference is the two countries’ savings rates.
But as one of the few consensus sections of the Trade
Deficit Review Commission report stated, “Waving a magic wand over
U.S. consumers and producing an increase in national saving of $400 billion would not simply
eliminate the trade deficit.” The relationship between capital flows
and trade flows is much more complex than that. A higher savings rate might
be desirable for many reasons. But from 2001 through 2003, maintaining a high level of consumption appeared to be the only
way to stave off recession, since business investment opportunities often
seemed so dismal.
Sometimes we discount the obvious: One element of the
trade deficit is that, historically, exporting just hasn’t been a
high priority in America. Catering to the export market is an ingrained
tradition for our trading partners, but not for us. Separated by two oceans
and favored with a huge economy able to consume most of what it produced,
most American industries never needed to develop large export markets. In 1960, foreign trade amounted to
less than 7 percent
of America’s total gdp, whereas in most Western European countries it was over 25 percent. As globalization has
gained momentum, trade has increased to about 20 percent of gdp for us but is now 50 percent for Europeans. The experience of the fast-growing Asian
economies closely resembles the European experience, and for a city- state
like Singapore, trade averages nearly 300 percent of gdp.
“Export or die,” a popular campaign poster
in post-World War II Britain, became a sentiment embraced seriously by the
Japanese. Both of those island nations perceived their ability to sell
abroad as vital to maintaining their standard of living. While the British
believed in free trade and the Japanese were strongly protectionist, each
country considered exports vital, as did the Koreans and Taiwanese, taking
Japan as a model. Continental European nations, in direct proximity to each
other, often saw exports as a natural extension of domestic economic
activity.
Finally, there is China. Although their history
includes a long, disastrous period of isolation, the Chinese have learned
from their mistakes and their neighbors’ successes and have turned
exporting into a national obsession. A recent electronics show at the
Shanghai Exhibition Center advertised that it gave “buyers from around the world
direct access to hundreds of export-quality manufacturers from Greater China, all under one
roof.” “Export quality,” a term often used in poor
countries like Sri Lanka and Bangladesh, suggests that the best merchandise
is somehow reserved for outsiders. It’s not a phrase most Americans
would appreciate from domestic manufacturers.
Protection and subsidies
The largest components of the trade deficit are petroleum, consumer goods, and
automobiles. Even though the U.S. also has large auto and truck exports,
its imports are far greater. For both automobiles and consumer goods,
several administrations have occasionally attempted to combat the tactics
of some of our trading partners. These efforts tend to be even greater when
it comes to protecting America’s competitive position in heavy
industry, and nowhere are the political pressures to protect or subsidize
industry stronger than for steel. Far more steelmaking jobs have been lost
to gains in productivity than to foreign competition, but that unemployed
steelworker in Youngstown, Ohio remains a powerful symbol of unfair
competition, partly because the symbolism retains an air of plausibility.
When nations become intent upon rapid
industrialization, there is something about steelmaking they seem to find
irresistible. The Soviet Union poured extraordinary resources into its
steel plants even when the country couldn’t adequately feed itself.
Lenin’s successor, Josef Dzhugashvili, adopted as his last name a
word that means “man of steel” — Stalin.
But even for market economies, investment in the steel
industry is often motivated by more than pure economics. Arcelor,
headquartered in Luxembourg, has become the largest steel producer in the
world as the result of the merger of several European firms. Its history is
deeply intertwined with the history of the European Union itself, which
originated in 1952 as
the European Coal and Steel Community. When the French and Germans were
still deeply suspicious of each other, Luxembourg came close to being
neutral ground.
In most countries, no matter how completely the steel
industry dominates its domestic market, it must still sell abroad in order
to be profitable. The Japanese have become the largest exporters of steel
in the world. The Koreans built their huge posco steel plant, considered the world’s most
efficient, directly at a seaport, making it simple and economical to get
ore to its blast furnaces. That location, much more than the cost of labor,
is an advantage which few American mills can overcome. With steel deemed so
important by so many nations, the industry is threatened with a chronic
state of oversupply.
It never escaped America’s attention that so much
foreign steel development was the result of direct or indirect government
subsidy. Since 1980,
according to a Department of Commerce publication “nearly 40% of unfair trade cases
investigated in the United States have been related to steel products. More
than half of these have resulted in some form of relief.” Of course
the American steel industry always viewed the relief as inadequate and even
persuaded George Bush to institute protective tariffs, which the wto, not surprisingly, ruled
illegal. Steel, ever a powerful symbol in international trade, has now come
to symbolize as well the asymmetrical nature of trade conflicts. Export
subsidies are much harder to identify and oppose than are protective
tariffs.
The Bush tariffs were wrongheaded, of course. They were
simply another tax on American businesses and consumers and would have done
more harm than good to our own economy. But unlike tariffs, the pros and
cons of subsidies
are more difficult to identify. Some opposed agricultural price supports
well before they became an issue at the recent wto meeting in Cancun, but farming has long enjoyed a privileged
position in this country for reasons that most Americans never even
associate with foreign trade. And in truth, some subsidies really are
motivated entirely by domestic considerations. Consider the history of the
Internet. How long would its creation have been delayed if the Defense
Department hadn’t done the heavy lifting by establishing Arpanet in
the 1960s? There are
subsidies which trade organizations don’t try to rule on because it
is nearly impossible to do so.
Countries that have subsidized their own industries
have indirectly subsidized the American consumer as well. The United States
often chooses not to compete with those subsidies, choosing instead to
invest in newer, more profitable industries. There has been a decisive
comparative advantage in being early, but that advantage is becoming
increasingly hard to maintain. However globalism is defined, it surely
means that nations’ economies are increasingly interdependent.
Innovations get copied quickly, and foreign trade becomes a larger part of
our gdp. The trade
deficit may indicate something about our low rate of savings, but it is
also telling us a lot about the rest of the world’s competitiveness.
The robust state of our banking system, together with the globalization of
the financial markets, makes capital cheaper and more available, but
globalism does not assure that investment opportunities will be greatest in
the country that houses the biggest banks. By definition, globalism
diminishes rather than increases home field advantage.
Not all neglect is benign
Among those mainstream economists who profess to see no current threat in the trade
deficit, are some more ambivalent than they care to admit? Eamonn
Fingleton, who takes a decidedly nonmainstream view of foreign trade
issues, wrote a piece in the Atlantic Monthly for which he interviewed 10 recent Nobel economists. Of them, only Gary Becker was, in
Fingleton’s words, “prepared to endorse the media and Wall
Street view that deficits pose no policy problem for the United
States.” Interestingly, seven of the 10 laureates didn’t want to speak on the record at
all.
Maybe those economists just didn’t want to talk
at length with Fingleton, but another possibility is that they’ve
discovered how difficult it is to comment seriously on the trade deficit
without unintentionally handing ammunition to protectionists. This is a
dilemma that, sooner or later, can confront any economist who firmly
believes in free trade but also believes that national policy can be
brought to bear on the trade deficit. Focusing political attention on trade
issues too often results in laws like the Byrd Amendment, which directs
U.S. Customs to distribute to injured domestic producers the duties
collected as a result of antidumping orders. In effect, the Byrd Amendment
turns American firms into bounty hunters. The provision was ruled illegal
by the wto, but a
large Senate majority opposed its repeal.
Trying to avoid yet another pernicious trade law is
understandable. But meanwhile the trade deficit is not diminishing and the
strategy of benign neglect is not working. Many legislative actions, in
fact, seem long overdue. America’s international competitiveness
could, for instance, be enhanced through reform of both tort and product
liability law. But the broadest area of agreement in the trade deficit
debate is that Americans’ rate of savings must improve, so that seems
a logical starting point for policy proposals, especially since, through
tax reform, it is possible to promote savings and competitiveness at the
same time.
Shifting some taxation away from savings and capital
formation and toward consumption could have several favorable consequences.
The United States’ statutory corporate tax rates are higher than
those of all of our major trading partners, with the exception of Japan.
Meanwhile, many of our trading partners, who do have higher taxes on
consumption — mostly in the form of a value-added tax — are
permitted to rebate the vats to foreign buyers because the wto deems them “direct” taxes. On the other hand,
the United States’ attempts to level the playing field, using its own
corporate tax adjustments, have consistently been ruled illegal as
“indirect” taxes. The recently passed American Jobs Creation
Act of 2004 is
Congress’s latest attempt to comply with wto requirements. That bill did repeal the extraterritorial
income tax exclusion, but it simultaneously enacted a hodgepodge of tax
breaks, most of which are unlikely to have significant impact on foreign
trade or American competitiveness.
Not that tax reform alone is the answer. But
intelligent tax reform is a vehicle whereby free traders can raise the
profile of the trade deficit without giving support to protectionists. In
any event, the trade deficit and the rising external debt that has
accompanied it deserve a higher place in the hierarchy of policy concerns
than they now receive. The principle of free trade is strong and
defensible, and it will not collapse under the weight of serious discussion
of related issues.
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