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Trade Brightens, Deficit Stands in the Way

April 12, 1987|MARTIN FELDSTEIN and KATHLEEN FELDSTEIN | Martin Feldstein is the former chairman of President Reagan's Council of Economic Advisers. His wife, Kathleen Feldstein, also is an economist.

There may be no economic subject that concerns and confuses Americans more than the trade deficit. We thought that it might be helpful to answer four of the important questions about trade that we frequently hear.

When will the trade deficit begin to improve?

Although it is not widely recognized, the trade deficit actually began to improve nearly six months ago. In the final quarter of 1986, the real value of our exports (measured in the constant prices of 1982) rose at a 16% annual rate while imports actually declined. As a result, our real trade deficit, again measured in constant 1982 prices, fell by $15 billion between the third and fourth quarters of 1986. That improvement was enough to more than offset the increase in the trade deficit that had occurred in the previous quarter. We still have a long way to go, but the shrinking of our trade deficit is at last under way.

This sharp turnaround in the real value of the trade deficit has been obscured by the fact that the falling dollar means that American exporters get fewer dollars for their products and that we pay more dollars for imports. Measured in today's prices, the trade deficit has therefore not yet declined even though the volume of exports is up and the volume of imports is down.

The physical volume of exports is expanding rapidly in a wide range of products. Exports of consumer goods jumped at a startling 23% annual rate in the third quarter of last year and an even faster 28% rate in the fourth quarter. Exports of machinery and other capital goods rose at a more than 14% rate in both quarters. The rapid increase in exports and the actual decline in imports will soon mean that the current dollar measure of our trade deficit will improve as well.

Is the dollar at the right level?

No. Although the finance ministers of the major industrial countries at their February meeting in Paris asserted that the dollar currently was at an appropriate level relative to other major currencies, the dollar still has substantially further to fall. Indeed, it took only a few weeks after the Paris meeting for the dollar to resume its rapid decline relative to the Japanese yen.

The dollar must continue to fall for two reasons. First, since the U.S. rate of inflation is about three or four percentage points higher than in Germany, Japan and other industrial nations, the dollar must fall 3% or 4% a year just to maintain its current competitiveness. But the current competitiveness of the dollar isn't enough to return us to trade balance, let alone to permit the United States to achieve the trade surplus that will be needed to pay the interest and dividends on the debt that we are accumulating to the rest of the world. The real inflation-adjusted dollar must therefore fall by at least another 15% or 20% relative to the other major currencies taken as a whole.

Would faster economic growth in Japan and Germany make it unnecessary for the dollar to fall?

Absolutely not. Faster growth abroad would increase the demand for U.S. exports but not by nearly enough to close the trade gap at the current level of the dollar. Japan imports only about $30 billion a year from the United States. A booming economy in Japan would only mean an extra $1 billion or $2 billion a year of imports from the United States. Even if every industrial country in the world were to double its real growth rate for the next two years, the U.S. trade deficit of about $150 billion would shrink only by an extra $20 billion if the dollar were to remain at its current level.

Can the trade deficit be eliminated without eliminating the government's budget deficit?

Yes. Although the sharp increase in the budget deficit was a primary cause of the original rise of the trade deficit, it is possible for the trade deficit to shrink and disappear even if the budget deficit declines very little.

The key link between the budget deficit and the trade deficit is that the rising budget deficit meant increased spending by households (financed by lower taxes) and by the government. And since any country that spends more than it produces must import the difference from abroad, the United States' trade deficit has ballooned.

If foreigners now become reluctant to finance a continued trade deficit by lending more to the United States, the dollar will fall and the trade deficit will shrink. Without the extra imports from abroad, spending in the United States will have to decline. If the government doesn't cut its spending or raise taxes to force consumers to cut their spending, the declining trade deficit will mean less investment in plant and equipment and in housing.

For the past few years we have had an enormous budget deficit without suffering the traditional adverse impact on investment in plant and equipment and in housing. But now that the trade deficit is on the way down, we must either reduce the government's budget deficit or see a long-run decline in investment that will lower our productivity growth and decrease the quality of our nation's stock of housing.

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