Created 3/6/1996
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Trade and American Business

Brad DeLong

Associate Professor of Economics, Evans 601
University of California at Berkeley
Berkeley, CA 94720-3880

for the World Affairs Council of Northern California's March 13, 1996 panel discussion on U.S. Trade and Economic Policy: Help or Hindrance to U.S. Business? (Soda Activity Center, St. Mary's College, Moraga, CA).

Let me begin with a fact seemingly far removed from trade: that for the past fifteen years, ever since the tax cuts proposed by President Reagan as the first item of business in his presidency, the United States budget has been running a large deficit. Large deficits had been seen before during wartime, and during deep recessions when there is an argument that they are beneficial to the economy to raise employment. But peacetime deficits, large in size relative to total federal spending and to the size of the economy, in both bad times and good times had never been seen before.

The $200 billion or more federal deficit (reduced under President Clinton, from $300 billion to $160 billion) that we have seen for the past fifteen years has been a new factor, placing previously unknown stresses on the American economy. What are these stresses? Well, every year the federal government has gone into the New York financial markets and snapped up $200 billion in extra borrowing that would otherwise have gone to fund investment in capital goods and structures to make America's private sector more productive. And as a result businesses seeking to raise capital in New York have been forced to try to outbide the Treasury: offering higher interest rates when they do borrow, and cutting back on investments to make their firms more productive where they do not feel they can afford to pay the higher interest rates caused by the presence of the $200 billion gorilla called the U.S. Treasury on the borrowers' side of New York's financial markets.

One thing that could have happened--that President Reagan's CEA Chairs Murray Weidenbaum and Martin Feldstein feared was going to happen--was that investment in the U.S. might have fallen by the full $200 billion a year sucked out of the capital market by the government: we might now be a country with $300 billion a year--$5,000 per year per family--lower incomes because of Reagan's mistake.

Instead, things aren't that bad. Estimates of the reduction in American productivity levels and living standards as a result of Reagan's miscalculation are only half as large. Why? Because foreign investment flowed into the United States in the 1980s and early 1990s. People in London, Frankfurt, Paris, and Tokyo took a look at high interest rates and ample profit opportunities in the U.S., and poured their money into this country in the form of foreign-financed investment. The $200 plus billion annual federal deficit was mostly matched by a $200 minus billion annual inflow of foreign-owned capital.

And here we--finally--have the link to trade and the international economy. Foreigners can only buy shares in or make loans to U.S. companies, or invest directly in U.S. operations, if they have dollars to spend: dollar-denominated deposits at U.S. banks. They can get these deposits in two ways: (i) by taking financial flows that would otherwise or previously have been spent buying American goods and shipping them overseas as exports from America to other countries, or (ii) by increasing how much they import into America, and taking the proceeds from the sales of these increased imports and using them to finance investment in America.

In either case U.S. producers--shareholders, bondholders, managers, and workers--take it in the neck. Firms producing for export find that foreign demand has dried up--because the dollars that used to buy their products and ship them overseas are now buying Treasury bonds or New York real estate or equipping a NEC plant in Roseville. Firms that face competition from imports suddenly find that competition fiercer because there are lots of investors in Tokyo or Frankfurt willing to pay handsomely for the dollar-denominated assets earned by selling to the U.S. market.

So this shift in demand away from export industries and import-competing industries as a result of the U.S. budget deficit is unfair, right? We should do something about it, right? It is unfair, and we should do something about it, but the something that should be done is to eliminate the federal deficit. Suppose we took steps to shut off our current trade deficit, and were successful. We would find production and employment in our import-competing and our export industries booming. But we would alsoo find that one of the important sources of funds financing investment--and thus employment in construction, and in capital-goods producing industries--drying up.

Unless the Federal Reserve could be persuaded to substantially lower interest rates to boost investment, and allow unemployment to fall so that the expansion in employment in export industries was not accompanied by an equal and opposite fall in employment in capital goods-producing industries--and that is not going to happen; the Federal Reserve is pinning the unemployment rate between 5.5 and 6.0 percent because it fears a lower unemployment rate would reignite inflation. So should we manage to undertake economic policies that eliminate the trade deficit but do not touch the budget deficit, we would find that we would have boosted employment in export and import-competing industries by about 4,000,000 workers--with associated gains for managers, shareholders, and so forth--but at the price of starving our construction sector and our capital goods-producing sectors of demand, and destroying some 4,000,000 jobs in those industries.

So which is better? Best is probably to eliminate the budget deficit, so that we can maintain a high level of investment in America and a high level of exports. Second-best is probably the path we have implicitly followed: to sacrifice some of our export industries in order to allow the inflow of foreign investment needed to keep the American economy--and American productivity--growing. In the long run we would probably be better off with a higher productivity level here at home than with greater world market share in traded-goods industries.

Worst would be to have preserved our export industries at the price of our investment goods-producing industries--and thus to have further slowed productivity and real income growth.

So if you ask the question, "Are America's international economic policies and its economic links to the wider world helping or hurting America's businesses?" The right answer is "Yes."

The right way to think of it is that, once we had embarked on a policy of large federal deficits, some particular industrial sector or sectors had to get the short straw. Our close linkages with the world economy meant that the sector that drew the short straw was the exporting sector. And that was probably best for the rest of us.

But it was not best for those who have worked or invested in export or import-competing industries over the past fifteen years. And it is in no sense "fair": the people who benefited from the 1981 Reagan tax cuts, or from the inflow of foreign investment, are not the people who lost as a result of the chronic U.S. trade deficit.

Better to have kept the federal budget in rough balance in the 1980s and early 1990s (as it had been between 1945 and 1981), and to have avoided the entire chain of events.


Created 3/6/1996
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Brad DeLong's Home Page

Associate Professor of Economics Brad DeLong, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax