Lawrence B. Lindsey - Federal Reserve Governor
Published April 1, 1992 | April 1992 issue
Reprinted with permission of the Wall Street Journal, copyright 1992 Dow Jones & Company, Inc. All rights reserved.
Two leading Japanese politicians, Prime Minister Kiichi Miyazawa and Speaker of the House Yoshio Sakurauchi have caused a firestorm by questioning the quality and work ethic of America's workers and this country's ability to compete in the world. But doubts about America are not confined to foreigners. Not too long ago, some American leaders warned that the country is at risk of a future of flipping hamburgers and sweeping up around Japanese computers.
Fortunately, the evidence is strong that those who are bearish about America's future are wrong about both the past and the future. But the pessimism about America is so widespread that talk of protectionism and a retreat from active involvement in international economic and political affairs is again fashionable. The facts suggest that those seeking a truly effective industrial policy should actually favor active American promotion of rapid worldwide economic growth in the context of free trade.
Research by Andrew Warner of Harvard University and the Federal Reserve shows that, contrary to popular belief, America's advantage is in the production of high-technology capital goods, and that this advantage has been growing. A key reason for the recent boom in exports has been the rapid rise of worldwide spending on capital goods.
Back in the late 1960s, when by all accounts the United States was the world's industrial giant, manufacturing amounted to about 22 percent of real gross domestic product (GDP). Much of this manufacturing went into defense and the production of consumer goods from shirts to automobiles. Only 28 percent of the manufacturing base was devoted to capital goods such as computers, aircraft and industrial machinery, and only 20 percent of American capital goods were exported. The total value of U.S. capital-goods exports was just 1.4 percent of GDP.
Today, when some assert that the United States has lost its manufacturing base, manufacturing output has risen to 23 percent of real GDP. The share of the manufacturing base devoted to capital goods has risen to 38 percent. This capital-goods boom has been made possible by exports: About 45 percent of capital goods output is now sold abroad, more than double the proportion of the late 1960s. Capital-goods exports now amount to 4 percent of GDP.
Contrary to the pessimists' view, a major part of this improvement occurred during the 1980s, and particularly the late 1980s. During the 1980s, the growth in real exports amounted to one-fifth of the real growth of the economy. Inflation-adjusted growth in exports of capital goods outpaced overall growth by better than two to one. Since 1986, the story is even more striking. Nearly half of America's real economic growth over the past five years has been in exports.
Also contrary to the pessimists' claims, U.S. exports have become less based on farm and other primary goods and more focused on high technology. Capital equipment has risen to 41 percent of U.S. exports from 30 percent in the late 1960s, largely as a result of the worldwide investment boom: As other countries develop their economies, they purchase increasing amounts of American-made machines, computers and airplanes.
During the pasts two decades, the investment share of world product has risen to 26 percent from 22 percent. In dollar terms, gross world investment outside the United States in 1992 will be roughly $5 trillion.
We should hope that this process continues, not only for humanitarian reasons, but also to benefit the American economy. Each 1 percent in world investment spending produces a 1.5 percent increase in exports of capital goods, and almost a full point increase in total merchandise exports. Strikingly, not only does the relationship between worldwide investment and U.S. exports pass traditional statistical tests easily, the relationship stands up to a wide variety of mathematical and statistical specifications. In fact, the link between U.S. exports and worldwide investment shows some signs of having strengthened in recent years.
It is interesting to contrast the U.S. performance with that of Japan. There is no evidence of a statistical relationship between Japanese exports and world investment spending over the past quarter century. There does appear to be some improvement over time for Japan, although this improving trend does not pass statistical muster. Further, even at its highest, the sensitivity of Japanese exports to worldwide investment spending remained below America's.
One reason for the popularity of the pessimists' view is that America's strengths are not apparent in goods that consumers normally buy. To see them, one has to visit factories, construction sites and airport hangars--not your usual tourist stops.
The regional composition of investment also appears to be shifting in America's favor. Latin America as a whole and Mexico in particular are increasing their pace of investment. During 1989, the United States exported twice as many capital goods to Latin America as did Japan. The other area of potential investment in the years ahead is the former communist bloc, which could become a staggering source of future growth of U.S. capital-goods exports.
The most urgent message of this analysis is that encouraging faster worldwide economic development might be the single most effective policy for promoting the growth of exports. The export-promotion policy that many suggest as an alternative to freer trade is a reduction in the exchange value of the dollar. This has three potential drawbacks. First, it's not clear that a country's monetary authorities can control the value of their currency. Second, if foreign-exchange markets perceive that devaluation is an intended policy of the U.S. government, interest rates in assets denominated in dollars might rise to offset the exchange-rate loss. Third, devaluation would reduce Americans' purchasing power and standard of living.
Recent history provides a good test of the relative efficacy of worldwide investment and exchange-rate depreciation. The late 1980s were a period not only of rapidly growing worldwide investment spending, but also of real dollar depreciation. During the five years following the Plaza Accord of 1985, the dollar fell 38 percent on a trade-weighted basis. Worldwide investment spending rose 38 percent over the same period.
Over those five years, total U.S. merchandise exports rose $192 billion in inflation-adjusted terms. $106 billion of the additional merchandise exports, or 55 percent, was statistically associated with the rise of global investment.
Let there be no mistake: Neither America nor any other country can expect to enjoy an economic free ride. Americans should continue their efforts to reform the nation's schools, increase the investment rate, encourage the natural entrepreneurship of the population and subject government spending and regulation to rigorous cost-benefit tests. But these are common-sense ideas that we would be well advised to undertake regardless of the international trading situation.
There may be some advantage in having Mr. Miyazawa and his countrymen think that America is in decline. It probably pays to be underestimated. But we would be foolish to underestimate ourselves. World economic trends are moving our way and we do not need to be protected from them. If anything, we need to reinforce them and to increase our exposure to them. The best industrial policy for America to pursue is active involvement in the world's affairs to promote global economic development and free trade.