Go to Brad DeLong's Home
Trade and American Business
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,
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
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
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."
- Export industries (and import-competing industries) have been harmed
by policies that have pushed up interest rates (and kept the dollar higher
than it would otherwise been), and attracted foreign investment with the
consequence of boosting imports and retarding exports.
- Capital goods-producing and construction industries have been helped
because the inflow of foreign investment has prevented the federal deficit
from causing economic disaster in those sectors.
- Other businesses have gained because they have been able to boost their
productivity through investment more easily than otherwise.
- And consumers have probably gained too by having cheaper access to
a lot of imported consumption goods.
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.
Go to Brad DeLong's Home
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