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ESSAYS ON ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

MARCH 1995
NUMBER 91

Chicago Fed Letter
Foreign trade and the
U.S. economy
The international trade sector of the
U.S. econom y continues to draw
attention in econom ic and political
circles. Rightly so, for the interna­
tional m arket has becom e increas­
ingly im portant as a source of de­
m and for U.S. production and a
source of supply for U.S. consum p­
tion. Indeed, it is substantially m ore
im portant than is im plied by the
usual measures that relate the size of
the international sector to the over­
all economy. This article explores
the role international trade now
plays in the U.S. economy.
Intense debate has developed in the
past couple of years over a broad
range of old issues related to the
international sector. These include
the desirability of open markets,
specifically with regard to regional
or m ultilateral trade agreem ents
such as NAFTA, GATT, and the
WTO; the depreciation of the dollar
in foreign exchange markets, espe­
cially against the yen; the sustain­
ability of U.S. competitiveness in
world markets; and the persistent
and once again increasing trade
deficit, especially vis-a-vis Japan.
The revival of econom ic growth
abroad during 1994 focused atten­
tion on the potential for m ore rapid
expansion in U.S. export growth
and in turn a greater positive im pact
on U.S. econom ic growth em anating
from the international sector. The
stimulative im pact of expanding
foreign dem and is of particular in­
terest to econom ists and policymak­
ers who expect some slowdown in
U.S. domestic dem and as the cur­
rent year progresses. Interest in the
foreign sector has been intensified
by the recent Mexican peso depreci­

ation and turm oil in that economy.
Prospects that the Mexican economy
will slow abruptly during 1995, possi­
bly to the point of sliding into reces­
sion, hold the potential for signifi­
cantly slowing U.S. export growth
during 1995.
In this environm ent, it is not surpris­
ing that attention to the im pact of
the trade sector on the economy
continues to intensify. In one form
or another, U.S. international trade
issues have been and continue to be
routinely placed in the public
spotlight for review and dissection.
In short, international m arkets are
becom ing ever m ore im portant to
the U.S. econom y as the nation par­
ticipates in an increasingly interde­
pendent world economy. While
international interdependence is
not universally popular, it is one of
those facts of life that we ignore at
our risk, for as we shall see, the
degree of interdependence of the
U.S. domestic econom y with the
international econom y is extensive.
Indeed, international trade is vital to
the health of U.S. industry and to
the interests of U.S. consumers.

How we measure makes a difference

If we are to understand the im­
portance of the international sector
of the economy, it is critical to
choose an appropriate measure.
Different measures can suggest sub­
stantially different conclusions. A
key issue is which questions are to
be addressed, since different ques­
tions may require different m ea­
sures. For instance, while a question
such as How im portant are exports
to the economy? may be interesting,
it is nonetheless so general as to
require an answer that is am biguous
in its interpretation. Such an an­

swer may tell us less than would
appear on its face. A m ore narrowly
defined question can be answered
less ambiguously. For example,
because most goods are potentially
exportable, an appropriate question
m ight be, How im portant are ex­
ports of goods relative to the na­
tion’s total output of goods, or what
proportion of the nation’s total out­
put of goods is exported?
O ne needs to be similarly careful in
assessing the im portance of im ports
to the economy. Such questions
m ight vary slightly from those posed
for exports. The interpretation of a
com parison of goods im ported rela­
tive to domestic goods output is
rather m ore obscure, for example,
than is a com parison of goods im­
ported relative to goods consum p­
tion in the domestic economy. In
the final analysis, what is critical to
understanding the im portance of
exports or im ports to an econom y is
not so m uch which standard of com ­
parison one uses, but rather, whatev­
er the standard, to recognize its
strengths and limitations.
The general standard for m easuring
the overall size of the natio n’s eco­
nom ic activity is the value of gross
dom estic product (GDP). O ne of
the com ponents of GDP is a m ea­
sure of the value of exports and
im ports of goods and services. The
hitch is that GDP includes a large
com ponent of nontradeables that
do not or cannot enter into inter­
national trade flows to any signifi­
cant degree—for exam ple, most
buildings and structures, and per­
sonal and governm ent services.
Consequently, even though inter­
nationally traded items such as
financial services and travel and
transportation services are included
in GDP, when we com pare the size

Exports

W hat proportion of
the nation’s output
that is potentially
exportable is in fact
exported? O ne way
to address this m ore
narrow question is to
begin with the do­
mestic output of the
goods-producing
sectors of the econo­
my, as m easured by
the value of final
sales of goods, plus
exports of goods,
plus change in goods
inventories, less im­
of the foreign sector with the size of ports of goods.2 This m easure sug­
the domestic economy, we end up
gests a dram atic increase in the im­
com paring apples with apples and
portance of exports to the economy.
pom egranates. As a result, com par­ As figure 2 shows, in 1994 exports of
ing exports or im ports of goods and U.S. goods were equivalent to 24%
services to GDP may understate the
of the dom estic output of goods.
im portance of international trade to This is up from 8% in 1960, and
relevant sectors of the domestic
16% as recently as 1980. With for­
economy.
eign dem and accounting for nearly
one-quarter, on average, of the de­
m and for the U.S. goods-producing
International trade: Vital to the
industries, it is clear that the eco­
U.S. economy
nom ic condition of export m arkets
Regardless of which m easure one
is of vital concern to those indus­
uses, it is clear that international
tries.
trade has becom e markedly m ore
Further refinem ent of the output of
im portant to the U.S. econom y in
the goods industry into durables and
recent decades. But different stan­
nondurables provides an even m ore
dards indicate substantially different
impressive view (see figure 2). It
m agnitudes for this im portance.
Moreover, the im pact has been espe­ also shows that these two groups
differ substantially in their depen­
cially great in particular broad sec­
dence on the interna­
tors of the economy.
tional m arket. In
Preliminary figures for 1994 indicate 1994, one-third of
that exports of goods and services
domestically produced
(measured in constant 1987 dollars)
durable goods entered
were equivalent to 12% of GDP,
export markets; only
more than 2.5 times the share in
12% of nondurables
1960 (see figure l) .1 Imports were
did the same. (In
equivalent to just over 14% of GDP,
1960, the figures were
nearly 3 times the share recorded
14% for durables and
in 1960. From these general mea­
6% for nondurables.)
sures, it is apparent that the interna­
tional sector has come to play a sig­
Imports
nificantly larger role in the U.S.
economy. But a m ore narrowly de­
As with exports, a nar­
fined specification of the relationship rower m easure than
produces an even more dramatic
total GDP provides a
picture.
markedly different
Note: For comparative purposes, the scale in figures 1-3 is held constant.

picture of the im portance of im ports
to the domestic economy. With
imports, however, goods output as a
standard of com parison does not
contain the same intuitive interpre­
tation as it did for exports. Thus,
rather than looking at goods output,
let us now consider goods consum p­
tion as the standard of com parison.
W hat change has occurred in the
relation of goods im ported to total
goods consumed? (We m easure the
latter as the value of final sales of
goods, domestic and im ported, to
dom estic purchasers in constant
1987 dollars.) The answer is strik­
ing. In 1994, im ports acccounted
for 28% of total goods consum ption
(see figure 3). Further refining the
m easure by separating goods into
durables and nondurables generates
an even m ore impressive statistic. In
1994, im ported goods were 39% of
total domestic durables consum p­
tion. Im ports were less im portant to
nondurables consum ption— 17%.
(In 1960 im ports were only 9% of
durables consum ption and 5% of
nondurables.)
Not surprisingly, im ports of durable
goods were strongly dependent on
the strength of consum ption in the
domestic economy. The stronger
the domestic consum ption of dura­
ble goods, the stronger the rate of
growth in durable goods im ports
(see figure 4). In particular, it is
interesting to note that in years
when durable goods consum ption
growth was at or above 5%, signify-

ing especially strong growth in the
dom estic economy, the rate of
growth of durable goods im ports has
typically been well above the rate of
growth of consum ption. This ex­
plains the increase over time in the
im port share of consum ption.

Implications for the U.S. economy

Over the past thirty years the inter­
national sector has becom e progres­
sively m ore im portant to the U.S.
economy. Indeed, within the dura­
ble goods industries, the interna­
tional environm ent has becom e vital
to the econom ic well-being of do­
mestic producers and consumers.
Export-oriented durable goods in­
dustries dare not ignore conditions
in markets that in the aggregate
account for one-third of their out­
put. Recession or expansion in

these foreign m ar­
kets potentially holds
far greater conse­
quences for these
domestic industries
and in turn the U.S.
econom y than was
the case a few de­
cades ago. Thus it is
not surprising that
the prospect for a
m ore broadly-based
resum ption of eco­
nom ic expansion
abroad that began
in 1994 and is ex­
pected to continue
through 1995 is viewed with consid­
erable enthusiasm in the U.S., espe­
cially in capital goods industries.
The recent econom ic turm oil in
Mexico— the third largest m arket
for U.S. exports— has been viewed
with some trepidation by U.S.
export industries and by those econ­
omists and policymakers who looked
to strong export m arkets to counter
an expected slowdown in domestic
dem and.
With im ports of durable goods ac­
counting for two-fifths of durable
goods consum ption, a far larger
share than a decade or so ago, the
domestic econom y has becom e
m ore dependent on foreign suppli­
ers. Some view this developm ent
with m ixed em otions. Certainly it
m eans that there is a higher degree
of com petition in dom estic markets
than previously. For those who have
forgotten the central
prem ise of a m arket
economy, com peti­
tion is what it’s all
about. A conse­
quence of com peti­
tion is greater variety
of selection for con­
sumers, lower prices,
and better quality.
For producers, it
m eans m eeting or
beating the com peti­
tion, or losing out.
The last three de­
cades have seen im­
portant segments of

the U.S. econom y transform ed into
an international market. In a very
real sense, there is no clear distinc­
tion any m ore between domestic
and foreign markets. No longer can
U.S. m arkets exist in isolation. Ex­
port markets and im port m arkets
go hand in hand. W orld markets
have becom e dramatically m ore
interdependent in recent years,
and goods industries in the United
States are prim e examples of this
developm ent.
—-Jack L. Hervey
’Data used in this article are derived
from the U.S. Department of Commerce,
Bureau of Economic Analysis, National
Income and Product Accounts, various
years. All values are in 1987 dollars.
2A more detailed examination of the
impact of trade by industry might use as
the standard of comparison the annual
estimates of gross domestic product by
industry, “gross product originating”
(GPO), as reported by the U.S. Depart­
ment of Commerce’s Bureau of Econom­
ic Analysis.

David R. Allardice, Vice President and Director
of Regional Economic Programs and Statistics;
Janice Weiss, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are
the authors’ and are not necessarily those of
the Federal Reserve Bank of Chicago or the
Federal Reserve System. Articles may be
reprinted if the source is credited and the
Research Department is provided with copies
of the reprints.
Chicago Fed Letter is available without charge
from the Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois, 60690, (312) 322-5111.
ISSN 0895-0164

Car and light truck production closed out 1994 on a strong note. In Decem­
ber and January, light vehicle assemblies posted two of the highest m onthly
output rates since 1979. Strikes at parts plants curtailed some assemblies in
January, but total assemblies still m anaged to eke out another increase on a
seasonally adjusted basis.
The onset of interest rate increases in early 1994 prom pted some consum er
hesitancy and slower output around midyear, but dem and and production
both staged strong renewed growth in the latter half of the year. Some evi­
dence is beginning to suggest that higher interest rates are again reining in
expansion in dem and, but current production schedules still imply a gain in
vehicle assemblies in the first quarter of 1995.

Sources: The Midwest Manufacturing Index (MMI)
is a composite index of 15 industries, based on
monthly hours worked and kilowatt hours. IP rep­
resents the Federal Reserve Board industrial pro­
duction index for the U.S. manufacturing sector.
Autos and light trucks are measured in annualized
units, using seasonal adjustments developed by the
Board. The purchasing managers’ survey data
for the Midwest are weighted averages of the sea­
sonally adjusted production components from the
Chicago, Detroit, and Milwaukee Purchasing Man­
agers’ Association surveys, with assistance from
Bishop Associates, Comerica, and the University of
Wisconsin-Milwaukee.

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