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Must We Compete?

The summer’s renewed decline of the dollar against the yen, at long last making one US cent worth less than one Japanese yen, has once again concentrated public attention on America’s difficulties in international economic relations. Concerns along such lines were also widespread a decade or so ago, when a combination of surging American demand for foreign goods and weak demand abroad for American-made products resulted in an overall US trade imbalance that widened to record proportions. But in the mid-1980s the dollar was expensive in relation to most foreign currencies, and it was plausible to suppose that both the rise in US imports and the weakness of US exports were in large part just the consequence of an overvalued dollar. Today the dollar is cheap, yet America’s trade imbalance is once again large and growing steadily larger.

Not surprisingly, a much discussed question in recent months has been what, if anything, the Clinton administration intends to do to support the dollar, and what the administration intends to do to reverse the nation’s widening trade deficit. Also not surprisingly, much of this discussion has centered on America’s economic relationship with Japan. Although lately the dollar has fallen against other major currencies too, the major decline—12 percent since the beginning of this year—has been against the yen. And although America now has a trade deficit with many more countries than just Japan, in 1993 our $60 billion bilateral deficit with Japan accounted for almost half of the $132 billion overall US trade deficit. (The same $60 billion imbalance accounted for a modestly smaller share of Japan’s overall trade surplus, which amounted to $142 billion when measured in dollars.) By not intervening to support the dollar against the yen, is the Clinton administration deliberately pursuing a “cheap dollar policy” (which is the same as an “expensive yen policy,” although somehow nobody calls it that) in order to slow down Japanese exports and open Japanese markets to American products? If so, does this mean the administration has abandoned its highly publicized effort to gain access to Japanese markets by direct negotiations over restrictive trade practices?

And beyond these immediate questions about current policies and the specific actions they imply, which understandably absorb the daily attention of both the interested public and, especially, the financial markets, what about the more fundamental issues at stake? Should Americans care whether the dollar is expensive or cheap in foreign currency terms? Should we care whether we import more than we export, or vice versa? At a deeper level still, what does it mean for a nation to be competitive in the world economy, and why should we care whether America is competitive or not?

The conventional answer, at least among economists, is that Americans should care about such matters—but in specific ways, and for specific reasons, that are at odds with many of the suppositions on which popular discussion is usually based. In particular, citizens should want their nation to be competitive in the sense of exporting as much as it imports, on average over time, while maintaining (a) an exchange rate that is advantageous for its consumers, (b) a price level that is profitable for its producers, and (c) a wage level consistent with its workers’ aspirations for their and their families’ standards of living. Continually running large trade deficits and therefore having to finance the excess of US imports over US exports by borrowing heavily from abroad, as we have done ever since 1982, is not in America’s interest. But neither is correcting the imbalance by driving the dollar so low that US imports shrink because Americans can no longer afford to buy foreign-made goods. Nor is increasing US export sales by cutting American firms’ prices to levels where they risk going out of business, or forcing down American wages, and therefore American standards of living, so they will be closer to those of countries with “cheap labor.”

Indeed, the main reason why continually running large trade deficits and borrowing from abroad is not in America’s interest is that, sooner or later, market forces will bring about exactly the undesirable outcomes mentioned just above, in one combination or another. Lenders are often glad to accumulate a borrower’s IOUs, but the reason for doing so is to cash them in later on—at the borrower’s expense. Thinking of the cheap dollar (the expensive yen) as a deliberately chosen device of the Clinton administration to combat the US–Japan trade imbalance therefore misses the point. When two countries chronically run a large bilateral trade imbalance, and the country with the bilateral deficit has an even larger overall trade deficit while the country with the bilateral surplus has an even larger overall trade surplus (so that the two countries’ bilateral trade imbalance is not just an inconsequential aspect of multilateral trading), movement in the bilateral exchange rate of those two countries is simply the market’s way of restoring some balance to their respective trading activities. That fewer Americans can afford Japanese-made cameras or VCRs after the dollar-yen rate falls is in no way intentional; but it is, nevertheless, an important and inevitable part of the adjustment process. And there is no reason for American consumers to be happy about it.

How, then, does a country manage to be competitive—that is, to balance its trade while keeping its exchange rate favorable to its consumers, its prices favorable to its producers, and its wages favorable to its workers? The main requirement is to be highly productive (in other words, to produce as much output as it can from the hours its workers put in and the capital its businesses provide) and that in turn means having a well-trained work force, up-to-date technology, and an ample stock of factories and machines, and combining all three with efficient management and creative entrepreneurship.

These are the same characteristics that would make for high productivity, and therefore a high standard of living, in a society that trades with nobody and just consumes domestically whatever it produces. But in addition, to the extent that trading with other countries offers opportunities to raise living standards still further—by allowing even more Americans to produce what they make best, while bringing in from abroad products that we don’t want to make or can’t make very well—it is important to keep those opportunities open. Some restrictions, for example those imposed both formally and informally by the Japanese, bar American-made goods from foreign markets when making those goods would be a better use of Americans’ effort than the substitute economic activities we carry on when foreigners simply will not buy from us. Such restrictions impair our competitiveness and ultimately reduce our standard of living. Policies aimed at eliminating those restrictions are not as important as policies that promote productivity by encouraging worker training, or new research, or capital investment, but they can be important nonetheless. So can even more specific actions, like President Clinton’s recent successful effort to persuade Saudi Arabia to order airplanes from Boeing rather than Airbus.

Paul Krugman, a highly distinguished economist who has recently left MIT for Stanford, believes instead that the notion of “competitiveness” should be eliminated altogether from discussions of economics and economic policy. In a series of writings, including his new book, Peddling Prosperity, as well as contributions to such widely circulated journals as Foreign Affairs, Scientific American, and the Harvard Business Review, Krugman argues that not only the general public but also supposedly well-trained professionals, who should know better—including key members of the Clinton administration—persistently misunderstand the basic principles of international economics and, far worse, go on from these misunderstandings to advocate foolish and potentially counterproductive policies. As Krugman forcefully summarizes this view in Peddling Prosperity, “the alleged competitive problem of the United States is…a fantasy.” Worse yet, “the rhetoric of competitiveness will be destructive, because it can all too easily lead to bad policies and to a neglect of the real issues.”

Krugman’s case against “competitiveness” has two main elements. First, he argues—no doubt correctly—that most people tend to overestimate the importance of international trade in accounting for America’s recent and current economic problems. The fact that American workers and their families face stagnating average standards of living, fewer “good” jobs, and widening income inequalities is true in large part for reasons that have far more to do with internal failures than with any kind of competition, fair or otherwise, from abroad.

The main issue here is productivity. As is well known, growth of workers’ productivity in the United States slowed from 2.5 percent per annum on average during 1948–1973 to 0.7 percent per annum during 1973–1990. Productivity growth improved for a while after the 1990–1991 recession ended, in a repetition of the usual cyclical pattern, but more recently the growth has slowed once again. Productivity growth is central to the problems America now faces because over long periods of time the average worker’s wage inevitably outpaces price inflation by just about the increase in productivity achieved by the economy as a whole.

Just why American productivity growth slowed so dramatically remains a subject of debate. The standard list of contributing factors includes too little investment in factories and machines, inadequate research and development, poor education and worker training, and burdensome government regulation. Krugman’s main point is that each of these impediments to US productivity growth, and hence ultimately impediments to rising US living standards, mostly reflects either public policies or private behavior here in America—not the effects of foreign competition. (Moreover, while the precise timing varies from country to country, other industrialized economies have also experienced a slowing of productivity growth in recent years. Hence it is also incorrect to suppose that our losses in this regard are necessarily someone else’s gains.)

Krugman concentrates his criticism in particular on concerns over the decline of America’s manufacturing sector, which is widely thought to have resulted from the transfer of advanced production technologies to countries where wages are low compared to what Americans earn. While 27 percent of US workers were employed in manufacturing in 1970, only 16 percent were in 1993. And the United States exported $91 billion less in manufactured goods than it imported last year. If we had balanced or trade in manufactured goods—that is, if American firms had produced an additional $91 billion of goods, and either exported these goods or sold them here at home to people who bought foreign-made products—that extra production would have required approximately one million additional workers. The share of American workers employed in the manufacturing sector would therefore have been 17 percent instead of 16 percent. (These figures update Krugman’s calculation, which is for 1991.)

Blaming foreign competition for the fact that manufacturing no longer employs 27 percent of the work force, as it did a quarter century ago, is therefore simply wrong. Moreover, it is also wrong to suppose, as many people do, that even these one million additional manufacturing jobs would have represented net job creation for the American economy. It is mostly our government’s monetary and fiscal policies—that is, interest rates and the federal budget—that determine how close to full employment our economy is at any time, and so the effect of balancing our manufacturing trade would mostly have been to shift one million people to jobs in factories from other jobs that they held elsewhere in the economy.

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