The Economy

Dec. 21, 2004
Imports serve as a safety valve

Last year, the surge in growth in the U.S. economy was accompanied by virtually no growth in exports but a huge increase in the trade deficit. Exports of goods rose only from $682 billion to $695 billion, while the merchandise trade deficit zoomed from $230 billion to $330 billion. Yet while the rise in the trade deficit last year was twice as large as the increase in 1998, the country breakdown was quite different. In 1998 the increase in the trade deficit occurred almost exclusively with Europe and Asia. In 1999 the trade deficit increased a whopping $35 billion with the Western Hemisphere, $22 billion with Europe, $22 billion with China and Japan, and only $3 billion with the rest of Asia excluding OPEC. The rise in the deficit with OPEC last year reflects higher oil prices rather than increased volume and will be reversed this year. What difference does it make if the trade deficit continues to balloon if the U.S. economy remains prosperous? Fed Chairman Alan Greenspan hinted darkly at unseen but nonetheless fierce dragons lurking just below the surface if our trade deficit continues to increase indefinitely. But in this case, he is being disingenuous. The burgeoning trade deficit is not only benign but actually helps the U.S. economy by serving as a safety valve for excess demand, keeping inflation well under control. Of course, an increase in the trade deficit is not always a positive development. If the trade deficit rises because American goods are being priced out of world markets, causing real growth to slump and unemployment to rise, that is clearly a sub-optimal situation. Conversely, if the dollar is so strong that the manufacturers are priced out of world markets, as occurred in the mid-1980s, that scenario is also undesirable. Today, however, the economy is growing at rates considered virtually impossible just a few years ago, yet inflation is low and stable. Furthermore, after dragging behind the rest of the economy for a few quarters, industrial production has regained its momentum, rising an impressive 5.5% over the past 12 months. It is, of course, impossible to say precisely what would have happened if imports had not risen so sharply, but I am convinced that without the rise in imports, inflation would have risen significantly last year, boosting higher interest rates and retarding real growth. Indeed, if the U.S. economy continues to rise at better than 4% again this year, imports of goods will probably increase another 12.5%. The recent regional pattern of net exports reflects the fact that the fallen Asian growth tigers have fully recovered, so the trade deficit with that region probably will not rise further this year. Much of the additional increase in the U.S. trade deficit last year occurred with the Western Hemisphere, representing a clear substitution of foreign for domestic production. I think this pattern has helped keep wages and prices from accelerating, and should continue throughout 2000. In my view, the U.S. economy can continue to expand at what are still considered by policy makers to be above-average rates without boosting the inflation rate. However, Greenspan is not about to admit that. Over the last six years, unit labor costs (ULC) have risen only 1.3% per year, consisting of a 3.4% growth in average hourly compensation and a 2.1% growth rate in productivity. For the most recent four quarters, the figures look even better: a gain of 4.4% in wage rates has been offset by a 3.3% increase in productivity. Over the last six years the core rate of inflation has averaged 2.4%; last year it rose 1.9%. Thus, in recent years inflation has risen about 1% faster than ULC. This suggests that even if wage gains accelerated to 5.5%, that would not boost the inflation rate if productivity growth remains near current levels. Hence the chances of wage-induced inflation occurring in the near term are quite remote, as long as imports continue to perform their important function as a safety valve when the U.S. economy is at full employment. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill. His e-mail address is [email protected].

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