The declining value of the US dollar was supposed to restore balance to global trade, discounting US exports while making imports prohibitively expensive. But record deficit numbers have created a stir of concern. The deficit numbers should be a surprise. Nor should they prompt a protectionist response.
The declining value of the US dollar was supposed to restore balance to global trade, discounting US exports while making imports prohibitively expensive. Yet, when the Commerce Department released November's trade data, the US trade deficit had soared to a record $60.3 billions (Euros 47bn), with imports up and exports down.
In truth, those numbers should not have been a surprise. Nor should they prompt a protectionist response. A large and growing share of that deficit reflects the international reach of the strongest US-based companies. Roughly one-third of the current account deficit results from US-owned subsidiaries abroad: Ford importing cars made in Mexico, for instance, or a US bank using call centres in India. These activities create value for US consumers, companies and shareholders, even if they add to the nation's trade imbalance. But they are unlikely to be responsive to even large changes in exchange rates.
Trade between foreign affiliates (as offshore subsidiaries are called) and US companies and consumers can either inflate or diminish the current account balance. When Ford or General Motors produce vehicles in Mexico they sell many to American consumers, causing US imports to rise. But they also sell a significant number in Mexico, generating a positive income flow to the US current account, and they use technologies and components produced north of the border, boosting US exports.
Any net negative impact on the trade balance caused by foreign affiliates is more of an accounting anomaly than a cause for economic concern. Methods for measuring the current account date back to the 1940s, when few companies had operations outside their home countries. Today, many companies have established subsidiaries abroad to tap new markets and take advantage of lower labour costs. Trade accounting methods have not kept pace with these changes: goods bought from US foreign affiliates count as imports on the current account, even though American companies produce them.
To say that today's record current account deficit reflects a weak US economy or spells doom for the nation is thus incorrect. Sales through US foreign affiliates abroad have topped $2,900 billions, roughly three times the value of US exports. These sales generated $134 billions in income for their US parent companies in 2002, and added nearly $3,000 billions to their market capitalisation.
For at least the next decade, multi national company investment abroad should continue to add to the US current account deficit. In 2004, worldwide foreign direct investment flows topped $600 billions, a record. Much of it went to emerging markets, where labour or land costs are one-tenth of those in the US Even a significant fall in the value of the dollar is unlikely to affect this.
Instead of adopting protectionist legislation to "correct" trade imbalances that are not as meaningful as presumed, it makes more sense to update the way the US measures the trade balance. That means taking an "ownership-based" view of trade. According to the Bureau of Economic Analysis, in 2002 an ownership-based view would have reduced the current account deficit by at least 25 percent.
To address the rest of the current account deficit, US policymakers should work towards fairer trade agreements. They should encourage other countries to open their markets to foreign investment and trade, and urge them to resist keeping currencies artificially weak. If the US could double its service exports to the European Union—making them equivalent to its service imports from the EU—over 30 percent of the current account deficit would disappear.
The US should also ensure the fruits of globalisation are shared among the population. Workers displaced by trade and offshoring should be given expanded benefits and job retraining, and more Americans should have a stake in corporate returns.
The US should also tackle the part of the global economic imbalance that is directly under its control: the fiscal budget deficit. Closing the $413 billions deficit racked up last year would improve the nation's very low savings rate and reduce its dependence on foreign savings. It would also uphold the attractiveness of the dollar and help ensure that the foreign savings that do come here are channelled to the more productive activities of US companies.
The activities of foreign subsidiaries create value for the nation and for the world, even if the trade accounts look worse. The bigger threat the US may face is the fiscal irresponsibility in Washington, which puts the country's economic health and future at risk.
Diana Farrell is director of the McKinsey Global Institute, McKinsey's economics think-tank.
Reprinted from the Financial Times © 2005 All rights reserved.