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Attention-to-Deficit Disorder: U.S. Trade Deficit Demands Long-Term Focus
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Attention-to-Deficit Disorder: U.S. Trade Deficit Demands Long-Term Focus

Jonathan Jacoby explains why a focus on short-term fixes to the growing U.S. trade deficit inhibits our ability to lead the global economy.

Watch Jonathan Jacoby Discuss Trade Strategies (YouTube.com)

Newly released figures today confirm that the U.S. posted a record trade deficit in 2006 despite a fall in the value of the dollar against the currencies of almost all of our main trading partners and a growing surplus in our nation’s trade in services with the rest of the world. The $763.6 billion trade deficit in 2006 is not a welcome development, yet U.S. policymakers in the Bush administration and in Congress need not reach for an array of short-term fixes to our nation’s chronic trade imbalances.

Instead, they should take the opportunity to pursue longer-term solutions that demonstrate U.S. engagement and leadership in the global economy. Hearings on the direction of U.S. trade policy later this week in both chambers of Congress will give key administration and congressional leaders the opportunity to demonstrate such leadership against the backdrop of two important releases this week: the 2006 trade deficit figures and the Economic Report of the President.

Chances are the exchange rate policies of our trading partners will grab all the attention, but there are a number of more important long-term factors contributing to our record trade deficit last year, which in turn require a multiplicity of long-term policy responses. But first, the numbers.

The 2006 Trade Deficit Figures

The U.S. trade deficit figures released today by the Census Bureau show an ever-widening gap between our nation’s imports and exports. After registering a record trade deficit in 2005, the United States imported $763.6 billion more goods and services than it exported in 2006—another record. With the U. S. generating a gross domestic product of $13.5 trillion in 2006, the trade deficit represents 5.7 percent of GDP—a slight increase from last year’s 5.6 percent.

While the top-line trade deficit figure is startling in its magnitude, it masks some meaningful improvements in the import-export mix of the American economy. Exports experienced a robust increase last year, owing in part to a relatively weak dollar. U.S. companies shipped goods and services overseas totaling $1.44 trillion, an increase of 12.8 percent over the 2005 export total of $1.28 trillion.

Imported goods and services totaled $2.20 trillion, growing at the slightly lower rate of 10.5 percent. Even if exports were to outstrip imports in absolute terms, it would take many more years of sustained export growth to reduce the U.S. trade deficit significantly. Although oil prices decreased on the world market toward the end of the year, the U.S. still spent $270.9 billion more on petroleum imports than petroleum exports in 2006—a significant portion of the overall trade imbalance. If it were not for the economy’s continued dependence upon foreign sources of oil, the trade deficit would have come in 35.5 percent lower.

A rare bright spot in the trade figures is the surplus the American economy enjoyed in services trade in 2006—the highest since 2000. In particular, the export of financial, insurance, professional, and other technical/business services grew from $158.2 billion in 2005 to $178.5 billion in 2006, a 12.8 percent increase linked in part to rising share prices on most of the world’s leading stock markets. Relative to the overall economy, the services surplus has grown from 0.52 percent to 0.54 percent of GDP. Travel services also got a boost from the relatively low value of the dollar last year.

Trade surpluses in services, however, are not going to correct overall trade imbalances anytime soon. Continuing U.S. bilateral trade deficits with major trading partners reflect a more complex set of long-term factors. It would seem, for example, that favorable changes in foreign exchange rates go a long way in explaining the import-export mix of these international economic relationships. After all, the American dollar lost value on average against the Canadian dollar and the Euro in 2006, making U.S. exports more competitive. And indeed the trade deficits declined with both Canada and the European Union during that period.

The deficit with Canada, our largest trading partner, dropped from $78.5 billion in 2005 to $72.8 billion last year, while the imbalance with our European counterparts declined from $122.3 billion in 2005 to $116.6 billion in 2006. Conversely, the Japanese yen dropped to a 20 year low against the dollar in real (inflation-adjusted) terms, and the U.S. bilateral trade deficit with Japan reached an all-time high of $88.4 billion.

But swings in the value of the dollar do not fully explain underlying trends in other bilateral trade figures. Cases in point: U.S. trade deficits with Mexico and China. The bilateral deficit with Mexico increased 28.8 percent in 2006 despite only a minor average appreciation in the dollar against the peso. The imbalance with China—often the sole scapegoat for our growing trade deficits because of its undervalued exchange rate—grew 15.4 percent to $232.5 billion despite a 3.4 percent strengthening of the yuan during the year.

Clearly, the problems associated with the U.S. trade deficit are broader and more complex than short-term policy fixes aimed at influencing foreign exchange rates can accomplish. There are a number of long-term factors contributing to the nation’s chronic trade imbalances that require a multiplicity of long-term policy responses.

One part of the solution is to reduce our government’s fiscal deficit, which would lessen the need to borrow funds overseas and thus weaken demand for dollars. Another critical policy response is to tackle our long-standing addiction to oil imports by seizing the economic opportunity to produce renewable fuels domestically. It is also essential to address the underlying challenges of competitiveness, as well as to stimulate domestic demand in our trading partners.

Yet U.S. trade policy can also be brought to bear on our chronic trade imbalances, so long as it is represents a strategic vision of the world a decade or more from now, rather than a remedy for what will surely be another set of trade deficit figures in 2007.

U.S. Trade Policy: “The Vowels,” the Battles, and the New Frontier

Conversations about the size of the trade deficit inexorably lead to conversations about U.S. trade policy. Indeed, the Economic Report of the President released yesterday argues that opening overseas markets for American businesses is the way to reduce the trade deficit.

Multilateral and bilateral trade agreements and their enforcement do play a role in addressing trade imbalances, but their importance is often exaggerated. Tackling the trade deficit—like most other challenges related to international economic policy—requires use of the full economic diplomacy toolbox.

In the case of our economic engagement with China, Treasury Secretary Hank Paulson has initiated a strategic economic dialogue that takes an integrated, high-level, and long-term approach to an intricate set of issues. This is clearly a step in the right direction.

But Paulson and the rest of the administration have not been so forward-looking when it comes to strategic economic engagement with Japan, Mexico, and other major trading partners. Secretary Paulson, for example, missed the opportunity at a weekend meeting of the G7 finance ministers to address the potentially destabilizing weakness of the Japanese yen, which The Economist calls “perhaps the world’s most undervalued currency.”

The United States’ reassertion of global economic leadership, however, rests upon its ability to cultivate a shared vision of a sustainable 21st century global economy—not currency values. Central to this task is the reform of the Bretton Woods institutions—the International Monetary Fund, the World Bank, and what became the World Trade Organization—all of which would be eligible to collect Social Security by now if they were living, breathing human beings.

As the single largest shareholder at the World Bank and IMF, the United States should more actively promote changes in the mission, operations, management, and governance structure of these multilateral organizations in order to address 21st century economic challenges. For example, IMF Managing Director Rodrigo de Rato’s ideas for tackling global imbalances through an international monetary forum deserve serious consideration.

But owing to its high profile and political sensitivity, U.S. trade policy is the economic diplomacy tool on display this week for two reasons. First, the president’s annual economic report to Congress highlights the need for greater trade liberalization to spur U.S. economic growth. Second, U.S. Trade Representative Susan Schwab will testify before the two powerful congressional committees that oversee U.S. trade policy: the House Ways and Means Committee and the Senate Finance Committee.

The chairmen of the two committees, Rep. Charles Rangel (D-NY) and Sen. Max Baucus (D-MT), are keen to test the Bush administration’s commitment to forging a new bipartisan course on trade after six years in which consultation and accommodation with Congress were seldom seen. When Schwab testifies, she should bear in mind the trade policy priorities of the new Democratic majority in Congress, which can be summed up as The Vowels:

Accountability
Enforcement
Implementation
Oversight
Undervalued currencies

To demonstrate that the administration takes Democrats in Congress seriously, Schwab will no doubt point to the case against China that the U.S. recently filed at the WTO for that country’s use of indirect subsidies that allegedly violate global trade rules. The administration’s decision was clearly aimed at showing it had learned “the vowels” lesson.

Yet Schwab faces a formidable challenge in persuading lawmakers to pass two types of trade legislation: several bilateral free trade agreements currently awaiting an up-or-down vote in Congress; and an extension of so-called trade promotion authority under which trade agreements negotiated by the executive branch are granted an up-or-down vote in Congress. In order to pursue more of the former, Schwab is calling for more of the latter.

Some members of Congress will no doubt attack China’s managed currency, while others are sure to note that directly challenging China—a relative newcomer to the WTO, having joined only six years ago—may complicate Secretary Paulson’s ability to secure long-sought commitments from his Chinese counterparts on currency revaluation, domestic demand stimulation, energy cooperation, and intellectual property. More importantly, though, is whether the administration has actually demonstrated a strategic and commercially meaningful trade policy worthy of Congress’ delegated authority.

After all, from 2001 through 2006, the United States entered into new trade agreements that account for not even five percent of American exports. Moreover, given that over nine in 10 Americans support the inclusion of minimum labor and environmental standards in trade agreements, Congress also has ample cause for concern about the adequacy of such provisions in bilateral trade pacts negotiated with Colombia, Peru, and Panama, all of which are now awaiting a vote.

But rather than shy away from shaping the future direction of U.S. trade policy by simply rejecting everything the Bush administration asks for, Congress instead has an opportunity to send a strong affirmative message to the administration—and to the rest of the world—about the importance of multilateral engagement, economic development, and the global common good. By making a limited extension of trade promotion authority for the express purpose of completing the WTO Doha round of multilateral negotiations, Congress will afford itself the chance to approve or reject the global deal on the basis of the internationally agreed objectives of the Doha Development Agenda.

Congress also has the power to innovate in the trade policy realm. Saddled with small, sub-optimal trade agreements and eager for enhanced efficiency and effectiveness, it might be ready to rethink the efficacy of narrowly defined bilateral free trade agreements and begin formulating an integrated and comprehensive model for economic engagement on a regional level.

The policy vacuum left by the demise of the proposed Free Trade Area of the Americas, an idea that collapsed in late 2005, coupled with Latin American and Caribbean nations’ clarion call for the United States to respect their commitment to socioeconomic development and decent work, offers a distinct opportunity to forge a regional economic partnership agreement akin to the pacts that the European Union has signed with various Latin American countries.

Such an agreement would go beyond the scope of traditional free trade agreements, which place greater emphasis on punitive measures such as trade sanctions, to include partnership-oriented “carrots,” such as technology transfer, development assistance, labor rights capacity building, and energy cooperation.

Whether the goal is reducing the trade deficit or forging deeper and more cooperative economic engagement with developing regions, the president will have to make full use of the economic diplomacy toolbox if he is to reestablish U.S. global economic leadership.

Jonathan Jacoby is the Associate Director for International Economic Policy at the Center for American Progress.

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