An Outline of the
American Economy

Part 1
Introduction

PART 10

Foreign Trade and Global Economic Policies

U.S. foreign trade and global economic policies have changed direction dramatically from the early days of the nation, when the United States mostly pursued the development of its own economy, irrespective of what went on abroad. In the years since World War II, the United States has generally pursued the liberalization of international trade and coordination of the world economic system.

The United States dominated many export markets for much of the postwar period, thanks to an industrial machine untouched by war damage as well as advantages in technology and manufacturing techniques. But in the 1970s and 1980s, the gap between the United States and other countries' export competitiveness narrowed, and -- for some types of products -- other countries' exports increased more rapidly than those of the United States.

The oil price shocks of the 1970s, the ensuing worldwide recession, and increases in the foreign exchange value of the dollar acted to hurt the U.S. trade balance and to reduce domestic support for trade liberalization in the 1980s.

As a result of these events, hundreds of protectionist bills were introduced in Congress during the 1980s. Although some protectionist measures were enacted, U.S. leaders were to a large extent successful in deflecting the most regressive proposals. In fact, the United States led the drive to begin the most recent series of multilateral trade negotiations, known as the Uruguay Round (the agreement to begin the round took place at talks in Punta del Este, Uruguay), which was launched in September 1986 as a vehicle for achieving greater trade liberalization.

FROM PROTECTION TO LIBERALIZED TRADE

Historically, however, the United States has from time to time experienced a strong impulse toward economic protectionism -- the practice of using tariffs or quotas to limit imports of foreign goods in the interest of protecting native industry. At the beginning of the republic, statesman Alexander Hamilton advocated a protective tariff as a way to encourage American industrial development. By and large his advice was adopted. Throughout the 1800s, domestic political considerations, including the desire to expand exports of such important commodities as cotton, determined U.S. trade policy.

U.S. protectionism peaked in 1930 with the enactment of the Smoot-Hawley Act, a tariff law which intensified the effects of the Great Depression. Smoot-Hawley sharply increased U.S. tariffs and quickly met with foreign retaliation. The act contributed to the world economic crisis.

The U.S. approach to trade policy since 1934 has been a direct outgrowth of this experience, and following World War II, the United States endorsed trade liberalization. Many U.S. leaders argued that the domestic stability and continuing loyalty of U.S. allies would depend on economic recovery. U.S. aid was important to this recovery, but these nations needed export markets -- particularly the huge U.S. market -- in order to regain economic independence and achieve economic growth.

Secretary of State Cordell Hull understood this connection long before World War II. He wrote in support of the Trade Agreements Act of 1934, which provided the basic legislative mandate to cut U.S. tariffs:

"Nations cannot produce on a level to sustain their people and well-being unless they have reasonable opportunities to trade with one another. The principles underlying the Trade Agreements Program are therefore an indispensable cornerstone for the edifice of peace."

The Reciprocal Trade Agreements Act of 1934 gave the president the authority to negotiate trade agreements with individual countries, and greatly reduced duties on their exports to the United States in return for similar concessions on U.S. exports to their countries.

U.S. support for liberalizing trade was instrumental in creation of the General Agreement on Tariffs and Trade (GATT), an international code of tariff and trade rules that was signed by 23 countries in 1947 and represented over 90 countries by the end of the 1980s. In addition to setting codes of conduct for international trade, GATT has sponsored several rounds of multilateral trade negotiations, and the United States participated actively in each of them, often taking a leadership role.

PRINCIPLES OF TRADE

America's official policy has been to apply certain principles to trade agreements; these principles are also the cornerstones of the GATT. The first is nondiscrimination. According to this principle, also known as most-favored-nation (MFN) treatment, all trading partners must be given the same customs and tariff treatment given to the so-called "most-favored-nation." The United States now applies this policy to its trade with all of its trading partners except for those that, for foreign policy reasons, are specifically excluded by law.

The extension or withdrawal of nondiscriminatory treatment has sometimes been used to further foreign policy objectives. For example, the United States granted MFN status to China as part of an effort to improve relations with that country. The United States has also withheld MFN status from nations for human rights reasons. There is an ongoing debate within Congress and the federal agencies about the efficacy of using trade policy to further foreign policy objectives.

A second principle that the United States applies to trade is reciprocity. This says, in effect, that one nation has to make no greater internal adjustment than the other in the implementation of trade agreements. In the 1980s this concept was used to buttress several so-called sectoral reciprocity proposals. These proposals would have required the U.S. government to restrict access to the U.S. market for any major trading partner, on a sector-by-sector basis, if that partner denied U.S. exports comparable market opportunities. Although most analysts concede that the threat of sectoral reciprocity can be a useful negotiating tactic, it is generally believed that such legislation would constrain negotiations and reduce the opportunity for achieving trade liberalization through broad, cross-industry compromises.

The United States has for the most part also followed a principle of multilateralism, as outlined in the Trade Expansion Act of 1962. This act authorized the president to negotiate multilateral trade liberalization in the so-called "Kennedy Round" of trade negotiations, which aimed at reducing tariffs between the United States and its trading partners. In this round of negotiations, 53 nations accounting for 80 percent of international trade agreed to cut tariffs by an average of 35 percent.

The principle of multilateralism was for many years the basis for U.S. participation and leadership in successive rounds of international trade negotiations. In 1979, as a result of the success of the Tokyo Round, the United States and approximately 100 other nations agreed to further tariff reductions, and to the reduction of such nontariff barriers to trade as quotas and licensing requirements.

In the 1980s the United States led the call for a new set of multilateral trade negotiations, which culminated in the launching of the Uruguay Round in September 1986. In these negotiations, the United States pushed for the development of rules to eliminate the use of agricultural subsidies and to extend GATT codes of conduct to services trade, among others.

Despite general adherence to the principles of nondiscrimination, the United States has been party to certain preferential trade arrangements. These arrangements include the U.S. Generalized System of Preferences program, the Caribbean Basin Initiative, the U.S.-Israel Free Trade Area Agreement, and the U.S.-Canada Free Trade Agreement. In the early 1990s, efforts were under way to reach agreement on another bilateral trade arrangement, this one between the United States and Mexico. And in 1990, President George Bush unveiled his Enterprise for the Americas Initiative, which would, among other things, pave the way for free trade throughout the Western hemisphere.

The Generalized System of Preferences program aims at promoting economic development in poorer countries by providing duty-free treatment of imports into the United States from these countries. Under this program, preferences are given to a country for exports of certain products; the preferences cease when the producers of a product no longer need assistance to compete in the U.S. market, as shown by actual trade performance. The GATT includes a general waiver from the principle of nondiscrimination for generalized system of preferences programs.

The Caribbean Basin Initiative is a program that was created in the 1980s to give economic support to a region that was struggling economically and was considered politically important to the United States. This program, which is scheduled to continue until the end of 1995, gives duty-free treatment to all imports to the United States from the Caribbean area except textiles, some leather goods, sugar and petroleum products.

Bilateral free trade arrangements are permitted under conditions specified in the GATT articles. The first free trade agreement entered into by the United States, the U.S.-Israel Free Trade Area Agreement, took effect on September 1, 1985, and the second, the U.S.-Canada Free Trade Agreement, took effect on January 1, 1989. Historically, geographic proximity has fostered vigorous trade among the United States and its two neighbors, Canada and Mexico. In August 1992, after more than a year of talks, these three countries completed negotiation of a comprehensive free trade agreement aimed at eliminating all tariffs on trade between them, reducing barriers to trade in services and investment, and ensuring adequate protection of intellectual property (including copyrights, patents and trademarks). Before taking effect, the agreement must be approved by the national legislature of each of the countries. Some U.S. trade unions opposed the agreement, fearing U.S. workers would lose jobs because of a flood of manufactured goods produced with cheap labor in Mexico. President Clinton supports the North American Free Trade Agreement, but is interested in negotiating supplemental agreements on environmental issues and labor standards.

THE U.S. TRADE DEFICIT

The twin oil price shocks of 1973-1974 and 1979-1980 vividly exposed the interdependence of the United States and the world economy. Exports as a share of total U.S. production had increased dramatically since World War II, and more U.S. workers were exposed to the vagaries of the international marketplace.

The global recession that followed the second oil price shock caused international trade to stagnate; global trade actually fell in 1982 and 1983. The United States and many other nations struggled to overcome inflation and recession, and to achieve economic recovery and growth.

At the same time shifts in international competitiveness were beginning to be felt. By the late 1970s, many countries, particularly newly industrializing countries, had begun to demonstrate increased ability to compete on a global basis. South Korea, Hong Kong, Mexico and Brazil are just a few of the countries that had become efficient international producers of such products as steel, textiles, footwear, auto parts and many consumer products. These new conditions altered the global trade environment and the dominant position of the United States within that milieu.

As other countries became more successful, U.S. support for liberal trade began to erode. U.S. workers in export industries worried that other countries were unfairly winning markets in third countries through foreign industrial targeting -- the direct support that foreign governments give to select industries, such as steel -- and through trade policies that explicitly promote exports over imports.

During this period, many U.S.-based multinational firms began moving production facilities overseas. Technological advances made such moves more practicable, and a change in locale was often made to allow a firm to take advantage of lower wages, fewer regulatory hurdles or other conditions that would reduce production costs. Many goods that the United States had previously exported began to be produced overseas.

Yet the event that had the most adverse affect on the U.S. trade balance -- the ratio of imports to exports -- was the unexpected jump in the foreign exchange value of the dollar. Between 1980 and 1985, the dollar's value rose some 40 percent in relation to the currencies of major U.S. trading partners. It was as if a tax had been placed on U.S. exports, while a subsidy had been given to foreign imports.

In 1972 foreign imports exceeded U.S. exports by $5.7 thousand-million. By 1985 the value of imports over exports had ballooned to well over $100 thousand-million, and the merchandise trade deficit hit a high of $152 thousand-million in 1987. However, as the effects of the depreciated dollar began to be felt, the trade deficit started downward; by 1990, it had dwindled to $101 thousand-million. But why did the dollar appreciate? The answer can be found in U.S. recovery from the global recession of 1981-1982 and in huge U.S. federal budget deficits, which acted together to create a need for foreign capital. U.S. recovery from the recession began in the end of 1982, earlier than it did in other countries. With recovery came an increase in U.S. demand for goods including imports. U.S. imports jumped 24 percent from 1983 to 1984. Foreign demand for U.S. goods did not grow at the same rate since recovery had not yet begun in other countries.

At the same time U.S. recovery brought an increase in demand for funds for domestic investment. Yet U.S. savings were not large enough to meet expanding demand for investment at a time of record federal budget deficits. The combination of large budget deficits and a tight monetary policy, which was being maintained to inhibit inflation, kept U.S. interest rates high relative to rates in other industrialized countries. High interest rates induced foreigners to invest in the United States. Thus, foreign demand for dollars bid up the dollar's value.

In the short term, the strong dollar provided significant benefits to the U.S. economy. By making imports cheaper, it inhibited inflation, while making it possible for the United States to finance both an enormous budget deficit and increases in private investment. But, by increasing the relative price of U.S. exports, the strong dollar engendered the huge U.S. trade deficit.

Dollar appreciation was not the only cause of the U.S. trade deficit, but most policymakers and economists attribute about 50 percent of the deficit to the dollar's rise. Decisionmakers came to agree that the trade deficit would only fall significantly if the federal deficit and, thus, the need for international borrowing, were reduced.

Congress responded to this situation in 1985 by enacting the Gramm-Rudman-Hollings deficit reduction legislation, which was designed to force annual deficit cuts through mandatory spending reductions. (This law was tempered by a Supreme Court review of its constitutionality, and its original deadlines had to be scrapped as a result of a ballooning deficit in the 1990s.)

The executive branch also took action to promote orderly reduction in the dollar's value. In 1985, the U.S. secretary of the treasury met with the finance ministers of France, Germany, Japan, and the United Kingdom to discuss actions each could take to promote the orderly depreciation of the dollar against the currencies of major trading partners. With central bank intervention in foreign exchange markets, the dollar gradually fell, losing almost half its value between September 1985 and January 1988. By 1988, the dollar depreciation had contributed to a falling U.S. trade deficit.

THE AMERICAN DOLLAR AND THE WORLD ECONOMY

In the 1980s Americans faced the problem of an overvalued dollar, which priced many U.S. goods out of international and domestic markets, and widened the U.S. trade deficit.

But an undervalued dollar also has costs for the U.S. economy. The costs became obvious in the late 1960s, during the Vietnam War, when heavy purchases of relatively inexpensive foreign goods -- and increased foreign and military aid -- caused many dollars to flow out of the country. As dollars became readily available, the dollar's value declined significantly on the world's foreign exchange markets. U.S. economists deplored this decline in the purchasing power of the dollar because it tended to exacerbate inflation.

The problem of coping with inflation and variation in the dollar's value, as well as the generally volatile nature of the world economy, has led many observers to call for adjustment or reform of the world monetary and financial system. Concrete efforts at reform began as early as 1944, when most of the world's leading nations sent representatives to a conference at Bretton Woods, New Hampshire. The International Monetary Fund (IMF) was established for the purpose of stabilizing national currencies. It was created with a fund of $8.8 thousand-million, of which the United States contributed approximately 25 percent.

The IMF extends short-term credit to nations that are unable to meet their balance-of-payments debts by conventional means, usually increased exports and long-term loans. The IMF expects to be paid back and can enter into consultations with chronic debtor nations in order to advise them on how best to repay their debts.

The conference at Bretton Woods also resulted in agreement to maintain fixed exchange rates between nations, but this has since been abandoned. In 1971, with the U.S. trade deficit continuing to grow, the United States proposed that Germany and Japan, both with favorable payments balances, appreciate their currencies. But when they acted, it was too little, too late. The fixed value of the dollar was abandoned and allowed to "foat," that is, to fluctuate in relation to other currencies -- with supply and demand determining its value. In the United States, prices and wages were frozen for a time, and a 10-percent surcharge was imposed on imports. The purpose was to persuade Europe and Japan to reduce trade barriers against American products.

A world conference was called at the Smithsonian Institution in Washington, D.C., to try to revive the old system. The dollar was officially devalued, and the Japanese yen and German mark were raised in value. When the U.S. trade position still did not improve enough in 1972, the fall of the dollar was made official, and the world reverted to floating exchange rates.

Some economists argue that more potent methods must be used to correct long-term and deep-seated trade imbalances. Two of the more popular ideas have been the use of somewhat flexible exchange rates and Special Drawing Rights (SDRs). Somewhat flexible exchange rates represent a compromise between the days of rigid (and usually outdated) exchange rates and the post-Smithsonian free-floating situation, where supply and demand can cause extreme fluctuations in a currency's value. One proposal for a system of somewhat flexible exchange rates calls for establishing a "target zone," in which each currency could fluctuate by a certain maximum amount, perhaps 1 percent or 2 percent a year.

Special Drawing Rights (SDRs) are what is known as "paper gold." Limited supplies of gold relative to the world money supply, along with the fall in value of the dollar (which, as the world's strongest currency, had been used in lieu of gold to pay for international transactions), have led to the need to find an alternative. The IMF has responded by agreeing to create paper gold and distribute it to member nations in proportion to the amount of their subscription to IMF funding. Some poorer nations hope that the IMF will allow them a share of SDRs based on need that is out of proportion to their economic size.

DEVELOPMENT ASSISTANCE

The Bretton Woods Conference also resulted in the establishment of the World Bank, a multilateral institution designed to promote world trade and economic development by making loans to nations that might not otherwise be able to raise the funds necessary for participation in the world market. The World Bank receives its capital from member countries, which subscribe in proportion to their economic importance. The United States contributed approximately 35 percent of the World Bank's original $9.1 thousand-million capitalization. The members of the World Bank hope they will be paid back in full by nations that have used their loans to strengthen weak economies. Eventually, it is hoped, these countries will have developed to such an extent that they can become full trading partners with the more developed countries, manufacturing their own products and trading them for other goods.

Large-scale U.S. involvement in providing development assistance outside the aegis of the World Bank may be traced back to the U.S. decision to help Europe undertake recovery after World War II. Although assistance to nations with grave economic problems evolved slowly, the American people felt a sense of achievement when the Marshall Plan, launched in April 1948, proved successful as a catalyst to European recovery from the war. President Harry S. Truman decided to build on this success by helping developing nations grow along Western democratic lines. Others supported such aid for purely humanitarian reasons. Some foreign policy experts worried about a "dollar shortage" in the war-ravaged and underdeveloped countries, and believed that as nations grew stronger they would be willing and able to participate equitably in the international economy. President Truman, in his 1949 inaugural address, set forth an outline of this program, and seemed to stir the nation's imagination when he proclaimed it a major part of American foreign policy.

The program was reorganized in 1961 and subsequently was administered through the U.S. Agency for International Development (USAID). In the 1980s USAID was still providing assistance in varying amounts to 56 nations. In recent years, USAID programs have moved away from grand development schemes such as building huge dams, highway systems or basic industries. Increasingly, USAID has emphasized food and nutrition; population planning and health; education and human resources; specific economic development problems; famine and disaster relief assistance; and Food For Peace, a program that sells food and fiber on favorable credit terms in the amount of $1 thousand-million annually and makes outright grants to the poorest nations.

THE GLOBAL ECONOMY

The global economic interdependence of the United States and other nations has grown geometrically since the Second World War. It is evidenced in resource utilization, production decisions, raw materials trade and consumer demand. It can be seen in such efforts to create order in international economic relationships as the International Monetary Fund, the World Bank and the General Agreement on Tariffs and Trade. It has also been demonstrated through the wide-ranging effects of single dramatic events, such as each of the oil price shocks of the 1970s.

Another sign of increased interdependence is the growth of foreign investment. In 1989, U.S. direct investment in other countries grew to $373.4 thousand-million, up from $207.8 thousand-million in 1982, valued historically. Foreign direct investment in the United States grew even faster, rising $400.8 thousand-million in 1989 from only $124.7 thousand-million in 1982, as measured by the same valuation. Through foreign investment, the U.S. industry has helped develop major industries in other countries, such as copper production in Chile -- a main source of foreign exchange for that country. At the same time, many U.S.-based firms have sought to serve foreign markets from local plants. For example, the Ford Motor Company and General Motors Corporation are among the largest producers of automobiles in Britain.

About one-third of foreign investment in the United States is in manufacturing. Such foreign ventures as Honda in Ohio, Mitsubishi in Illinois, and Nissan in Tennessee have received much attention. In part, these ventures reflect a larger trend in which successful foreign firms, like their U.S. counterparts, are setting up plants in other countries to serve local markets where demand for their products is high.

The growth of foreign investment has raised new questions about the international economic relationships of nations. What types of firms conduct work that is too critical to national security to allow foreign investment? What about investment in the United States by a nation that restricts U.S. investment in that nation's economy? The United States has proposed that a set of rules to govern foreign investment be developed during the Uruguay Round of trade negotiations.

The direction that the global trade regime would take in waning years of the 20th century remain unclear as the 1990s opened. The original targets for completing the Uruguay Round in late 1990 were not met, largely as a failure to come to terms over agricultural subsidies; but in 1991 the leading industrialized nations professed a determination to complete the round successfully. Those American "trade revisionists" opposed to free-trade-based policies argued forcefully that continued large U.S. trade deficits, particularly with Japan, meant the United States should move away from a "rules-based" approach and toward a "results-oriented" approach to trade. They cited as one step the passage by Congress in 1988 of the Omnibus Trade and Competitiveness Act, which contained some reciprocity provisions and other measures designed to open closed foreign markets to U.S. exports. Some argued that the GATT had become obsolete as a vehicle for reducing trade barriers.

However, U.S. policymakers in the Bush administration agreed that pursuance of successful completion of the Uruguay Round of trade negotiations would remain an important priority, along with reaching a bilateral free trade treaty with Mexico, and eventually a system of free trade for the Western hemisphere.

An Outline of the American Economy