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THE INTERNATIONAL ECONOMY AND ITS IMPACT ON GEORGIA Remarks by Robert P. Forrestal, President Federal Reserve Bank o f Atlanta To the University o f Georgia, College o f Business, Alumni Association April 24,1987 Good afternoon! Tm pleased to have this opportunity to discuss the international economy with you people who are involved in keeping our own economy on the move. I know that with your academic and practical experience in business you are aware that the economies o f the world's nations are becoming more interdependent on a daily basis. Within the past two months, the Wall Street Journal has moved its international news pages from the second to the first section—a symbol, I think, o f the American business community's rising consciousness o f the global market in which they compete. I like to refer to this shift in consciousness as the re-internationalization o f our thinking, because through much o f our history we Americans were traders, intent on keeping the doors o f other countries open for our products. Over time, however, we found ourselves rich enough in labor and resources to be nearly self-sufficient, a blessing that also had the ill effect o f making us somewhat self-centered. During the last decade or so events such as the rise and collapse o f oil prices and the ballooning o f the trade deficit reminded us that the rest o f the world does not necessarily need us more than we need it. In the aftermath o f this rude awakening, we have returned to the reality that events outside our own borders resonate increasingly within them. What I would like to do today is sketch the major themes o f the current international economic scene as I see them, beginning with the outlook for the United States in the year ahead and then turning to the other advanced industrialized countries as well as the developing nations. By way o f conclusion, PH discuss how these international developments will a ffect economic activity here in Georgia and leave you with some thoughts about the major issues that could alter this international outlook—and prospects here at home—if they're not resolved. - 2- Economic (Conditions and Prospects in the United States In the year ahead, I look for a continuation o f last year’s performance as measured by the major economic indicators. Real GNP expanded at a rate o f 2 1/2 percent in 1986 and should repeat that or even grow at a bit better rate this year. Given this expectation, it is difficult to project an unemployment rate for 1987 much better than the current 6.6 percent, since the number o f new jobs will probably just keep pace with the number o f people who want them. The third major indicator, and the one by which we did best in 1986, is inflation. The consumer price index rose just over 1 percent last year, primarily as a result o f the sharp drop in oil prices. The benefits o f that one-time occurrence have been for the most part absorbed by the economy, and this measure o f inflation will probably return to a higher level, rising to 4 or even 4 1/2 percent in 1987. The importance o f international developments to our domestic economy is driven home in the outlook for 1987. The higher prices in my outlook-higher even than in 1985—are in large part due to international developments These include not only the stabilization o f OPEC but also the rise in import prices, which as o f last year were up 8 percent when you exclude energy. The international sector is also critical to the outlook for GNP growth. I look to the foreign trade front for the stimulus that will maintain our moderate growth rate. The other major components o f GNP—consumption, investment, and government purchases—don't look all that strong. I don't think consumption will be weak, but neither do I expect it to be the main source o f growth in the economy as it has bedn in recent years. It is true that consumer assets are high in concert with gains in the stock market and home values. Debt-to-income levels are also very high, though, and the savings rate has fallen to quite low levels. Consumers may very well want to bolster their balance sheets, and this makes faster growth in consumption unlikely. - 3- Sluggishness in the consumer component o f GNP reflects the beginning o f a trend we at the Fed have been predicting for some time, namely, smaller annual increases in per capita consumption. It’s largely the inevitable "morning after" following the spending binge that we as a nation have been on—both publicly and privately—almost since the start o f this decade. Now we must embark on what will be a rather long period o f paying back some o f the debt to the rest o f the world that we amassed to finance that binge. With consumption expected to slow, we must look elsewhere for economic stimulus. Investment, a second component o f GNP, is unlikely to lead growth either. On the one hand, there is a temporary need for new investment to replace the considerable drawdown o f inventories in the last quarter o f 1987. This cleared stocks and set the stage for resumed production growth at least in the early part o f this year as inventories are replenished. The positive impetus to production will probably be balanced, however, by the fact that business investment, particularly in structures like offices, along with multifamily residential construction, is hobbled by excess supplies and new tax provisions. As for government purchases, budget deficits are thankfully on a downward slope, but this means less fiscal stimulus than in the past. This leaves us net exports as an engine for the expansion. It follows from both the two-year decline in the value o f the dollar in the exchange markets as well as the need to start reducing our debt abroad. For some time now we have been spending more on consumption, investment, and government than we actually produced domestically. The substantial expansion o f the government sector contributed to this. To meet our aggregate demands we imported far more than we exported and borrowed from abroad to finance this. Of course this cannot go on forever. Our creditors may become less willing to lend, and, just as any borrower eventually learns, the debt service inevitably rises with that debt and becomes a burden. So the time has com e to start repaying. While GNP or - 4- national output will grow at about the same rate in 1987 as it did last year, more o f that increase in output will be exported and less o f the growth will be available for use domestically. I believe an improvement in the trade deficit will materialize because the dollar's depreciation relative to other currencies has made American goods cheaper and foreign goods more expensive. The extent to which the dollar has fallen already should be sufficient to provide U.S. manufacturers with stronger demand at home as well as overseas. In fact, exports began picking up in real terms in the last 3 months o f 1986 while imports flattened. It is true that the latest figures for February seemed to show a reversal o f this trend, as the merchandise trade deficit widened to $15 billion from $12 billion in January. Since imports cost much more in terms o f dollars while export prices are pretty much the same, the trade deficit measured in current dollars may not start falling until some time after the real deficit turns around. Ill return to this subject in a moment, but first, since I pin so much o f my forecast on an improvement in international trade balances, let's examine briefly the prospects for America's major trading partners. Conditions and Prospects for Other Major Industrialized Nations The overall picture for GNP growth in Canada, West Germany, Japan, Great Britain, and France is for a continuation o f expansion in the 2 to 3 percent range. France, Germany, and Japan will probably be on the lower end o f that spread—which is, by the way, a significant amount in terms o f GNP. Their projected growth, then, is best described as sluggish. Canada's growth is likely to be moderate, with a rate o f 2 1/2 percent and England's a bit better. By the standards o f advanced industrial economies, unemployment is and will probably remain high in all these countries. France are in double-digits at 11 and 12 percent, respectively. England and Canada is just under 10 percent and Germany below 9, while Japan is at a post-war high o f 3 percent. Inflation is - a mixed bag. 5- Canada, France, and England face the likelihood o f inflation at levels comparable to what I expect for the United States—4 to 4 1/2 percent. By contrast, West Germany and Japan are currently in the midst o f a deflation—prices are actually falling, and whether or not that condition persists, their inflation rates will remain considerably below our own. The low domestic inflation rates in Germany and Japan are the beneficial result o f the rapid appreciation o f those countries* currencies against the dollar and the drop in energy costs which are denominated in dollars. Goods that they import from the United States cost them far less now than they have in the past two years or more. However, the appreciation o f a currency is a two-edged sword, particularly for countries whose growth has been linked to exports. Even as foreign goods becom e cheaper to consumers in Japan and Germany, their products become more expensive elsewhere. It is the reduction in demand for Japanese and German exports that leads to a forecast o f slower overall growth in their economies. They need to start adjusting to less export-driven growth just as we need to start reducing our need to borrow from abroad. Outlook fo r LDCs The outlook for these advanced economies looks brighter when we compare it with the situation in the less developed countries, which are burdened by massive debts and repayment difficulties. The extent o f these problems has been exemplified most dramatically by recent events in Brazil. A year ago Brazil was held up by many as a beacon o f hope. Today it is in default. In preceding years, reduced imports had enabled Brazil to accumulate the foreign exchange necessary to meet its interest payments. Last year, in the face o f internal political pressure to end this austerity regime, Brazil greatly stimulated domestic demand and was able to return to rapid real growth. However, higher demand engendered by that growth increased imports from the low level called for - by austerity measures. 6- Higher imports in turn narrowed Brazil's trade surplus, which then forced the country to draw down its foreign exchange reserves sharply until most foreign interest payments had to be suspended. More recently an earthquake disrupted Ecuador's oil shipments, two-thirds o f its total exports, raising a similar foreign-exchange problem that a ffected debt service. The question raised by the actions o f Brazil and Ecuador is whether other major debtors will follow their pattern o f default. I think not; at least we have not as yet seen any evidence that they will. Despite its recent prominence in the news, the overall LDC debt situation has not really changed much. We still need to approach it on a case-by-case basis. The outlook is for not much change, insofar as we seem to be closer to neither a full resolution nor a systemic crisis, but this doesn't give hope for much growth in that part o f the world. Thus, the overall prospects for the world economy are for modest but continuing growth. This is a positive tendency to be sure, but one that will act as a constraint on sales o f U.S. exports and so limit the impetus we can expect from the improvements in our own trade sector. Nonetheless, we will have some gains as a result o f the substantial price changes occasioned by the dollar's two-year decline. Implications for the Georgia Economy What does all this imply for Georgia's economic outlook? Of course, along with the rest o f the nation, we in Georgia would benefit from a turnaround in the trade deficit, but any improvement would probably not be dramatic in the short run. The dollar has only recently begun to decline against the currencies o f international competitors for some Georgia products, such as apparel, and so improvement in those industries will probably be slow. In other cases, such as textiles, substantial improvement has already - 7- occurred. Foreign auto prices have risen, and if sales o f new cars maintain their recent strength, that sector o f the state's economy could be a beneficiary o f the trade shift. Georgia farmers won't be helped as much as farmers in other states because they don't raise an abundance o f the grain crops that dominate international flows o f farm goods. Looking beyond these immediate effects, however, there are unmistakable signs that Georgia is positioning itself to play an active role in the international arena. We have our outlet to the sea in the ports o f Savannah and Brunswick and a world-class gateway by air in Hartsfield Airport. We can be confident that our transportation advantages combined with the fact that Georgia is home to multinationals like GeorgiaPacific, Coca-Cola, and soon RJR Nabisco will continue to encourage urban expansion. The multinational presence will help generate a service infrastructure to support the international needs not only o f those large companies but also o f smaller businesses and local manufacturers who wish to export their products. Atlanta is already the seventh leading U.S. city in the number o f foreign banks represented, and there are plans for two domestic banks designed specifically to handle international transactions. With this trend in motion, it is essential for Georgia's business leaders to incorporate into their planning a sense o f the issues and problems that will shape international economic developments over the next several years. Issues and Problems There are several weighty issues that could, if unattended, arrest or reverse the » anticipated modest rate o f expansion. These issues include imbalances in global trade patterns, inappropriate fiscal policies, protectionism, and LDC debt. First, world trade patterns need to undergo a major correction. To begin with, the United States must increase its exports. I believe that in the short run, net exports are being pushed in this direction by the exchange rate realignment. In the long run, however, the American - business community's heightened 8- awareness of international conditions translated into greater sensitivity to foreign markets. must be We must find ways to sell as aggressively in outside markets as we do at home, and this means becoming more familiar with other cultures, learning to speak the languages o f foreign purchasers, and interpreting their unspoken signals. With Americans' experience in the psychology o f marketing, it should be obvious that the product's appeal to overseas consumers is conditioned by subtleties o f local taste and custom. Yet we persist in remaining international illiterates, paying much less attention to understanding foreign cultures than foreigners pay to investigating ours. It may be that the loss o f our competitive edge that so many mention, is due more to our failure to understand others than it is to inefficient production and lack o f quality. Aside from the steps America might take to bring balance to trade flows, other advanced industrial economies need to rely less on exports and more on domestic demand. Japan and West Germany could stimulate their economies by accelerating tax cuts and implementing a generally more expansive fiscal policy. economies could benefit from such policies. Both countries' As I mentioned a moment ago, both have high unemployment rates. Not only would fiscal stimulus relieve joblessness, but it would make more money available for consumption o f both imported and domestically manufactured goods. Greater Japanese and German purchases o f imports would speed the reduction o f America's trade deficit while helping to move the LDCs back on the track o f faster economic growth by broadening markets for their exports. Economic growth in the LDCs is essential for raising the living standards o f their inhabitants, a concern that should be on the minds o f the world's bankers as they weigh their loan policies for these countries. Many LDCs are at the point where the only returns likely from further austerity would be the negative ones o f social and political - 9- upheaval. It's therefore in the best interest o f banks in advanced economies to work out creative solutions to the debt problem because improved living standards in LDCs make the option o f revolution—which would probably mean repudiation o f debt and a total loss o f principal—less likely. A renewed ability on the part o f the LDCs to import would also help the United States, since they could buy many o f our manufactured goods if they weren't strapped with so much debt. I am concerned that if the world's industrialized economies don't act soon to bring about this shift in trade patterns, the forces o f gloom could undermine our economy along with the rest o f the world's by burdening American trade policy with protectionist baggage. While I sympathize with the agony o f industries, some o f them here in Georgia, which are losing ground to foreign competition, I look with dismay upon the many calls for protection. protected Tariffs, subsidies, and other trade barriers cannot guarantee that industries will become more viable—a fa ct which the experience o f agriculture, one o f the most heavily insulated industries, illustrates all too well. Rather it weakens them further by shielding them from competition. It almost certainly guarantees retaliation from our trading partners, and erosion o f our purchasing power and free choice as consumers. Rather than overreacting to short-term imbalances, it is critical for us to continue expanding our vision to include all the possibilities held out by the evolving international order. Our recent positive experience with Canada convinces me that through i negotiation rather than confrontation we can convince our trading partners to assume more o f their own responsibility for keeping the exchange o f goods and services as well as labor and capital as unrestricted as possible. We should continue to call on Taiwan and Japan in particular, two nations with extraordinarily high trade surpluses and substantial import barriers, to lower the protective walls which make it impossible for many o f our - 10- goods and services to penetrate their markets. Raising protectionist barriers is an attempt to beggar your neighbor and get a larger share o f the output pie. Instead it only reduces the size o f the pie and ends up hurting everybody. Our experience in the 1930's amply demonstrates this. If Congress truly wants to alleviate the trade deficit, there are methods at its disposal that would prove far more effective than protectionism. If I have been somewhat critical o f Japan and Germany for dragging their feet on easing their fiscal policies, I must also emphasize that we have been far too slow ourselves in correcting the intemperate fiscal policy that has contributed in no small measure to our trade deficit. Government borrowing to finance the deficits o f the early eighties pressed beyond the ability o f American citizens, with their relatively low rate o f savings, to carry the debt. This pushed interest rates to a level that made government securities attractive to foreign investors. The subsequent scramble for dollars to buy our dollar-denominated assets eventually made our currency so expensive relative to others that our goods lost (vice competitiveness on foreign markets. In order to maintain the momentum I see building toward a turnaround in international trade, we in the United States need to sustain the attack on federal budget deficits. Solutions to the final problem—LDC debt—are less clear cut. For Ecuador, the problems are related more to a natural disaster than to econom ic ills, and fairly routine measures like loaned oil from Venezuela, along with some loan restructuring and postponements o f scheduled debt service, could bring relief. For Brazil more funding seems to be necessary, at least as a transition mechanism. From a broader perspective, we must ensure that the LDCs are brought back into partnership with the United States and other advanced countries for the reasons I outlined earlier. Higher domestic living standards would provide growth markets for advanced economies like the U.S. We all - 11- agree on the long-term goal o f boosting living standards, since the alternative seems to be impoverishment o f these countries and the possibility o f political turmoil and debt repudiation. The problem is how to get there. The U.S. policy debate pivots on the ideas advanced by Secretary Baker, who focuses on additional funding and a variable payment schedule, and Senator Bradley, whose program involves some forgiveness o f current loans. There's also the idea o f converting some o f the debt to equity, a move the Japanese seem to be taking the lead in experimenting with. Personally, I favor the Baker plan, which is being tested in Mexico. However, I admit the complexity o f the situation will require flexibility and compromises. Conclusion In sum, I am worried about the LDC debt situation. I think we have in place the mechanisms to deal with it, but it is likely to take a very long time. Meanwhile, I am concerned that protectionist sentiment might spill over into actual policy measures. Ultimately this would adversely a ffe ct Georgians—not only by raising prices we as consumers must pay and through retaliatory measures hurting some o f our industries but also by foreclosing future export growth opportunities for business not even born yet. Fortunately, the moderate rate o f growth I have projected for the world's advanced economies and the turnaround in the U.S. trade deficit which I foresee should allow us a breathing space in which we can work to resolve the debt situation and defuse protectionist sentiment. In these ways we can keep on course to a re- » internationalization o f American business, a process that holds great potential for us and our fellow citizens o f the world.
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