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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. Ul9-Zm (2l£) h£80-06909 slouHII ‘oSteono h£8 xo9 Od J31U33 uopmmojuj ai|9nd OOVOIH3 30U N W 3A33S33 3V33a33 JOTP] poq ohiPiii:)