The rhetoric and reality of the U.S. trade deficit are sharply at odds. Listen to the rhetoric, and the United States is slowly becoming an economic has-been. Slipping technological prowess and a poor work force are making us an oversized Paraguay. Look at the reality, and another story emerges. The trade deficit doesn't reflect a lack of competitiveness so much as the huge pulling power of the U.S. market. It's the world's richest, most accessible market: an enormous global bazaar where everyone wants to sell.
If the United States were so uncompetitive, then U.S. exports would be faring poorly in world markets. They aren't. Since late 1985, the volume of American exports has risen more than 20 percent. That's impressive, especially because economic growth abroad has been slow. Once the dollar began to fall from the heights of the early 1980s, U.S. exports responded. But imports didn't. The trade deficit remains massive because imports haven't yet declined.
Go to a well-stocked toy store and you can see what's happening. There are jigsaw puzzles from West Germany and Britain. American companies are also buying and manufacturing products abroad to defend their traditional markets. Fisher-Price sells plastic roller skates made in Taiwan. Another U.S. firm offers a 24-piece tool set with tools made in Hong Kong and Poland.
Little wonder that everyone so covets the U.S. market. In 1985, consumer spending was three times higher in the United States than in Japan and 25 percent higher than in the European Community. U.S. investment spending was 86 percent higher than Japan's and 14 percent higher than the European Community's. The U.S. market is also more open. Europe is a jumble of national markets with separate languages and customs; Japan has a cumbersome and closed distribution system. By contrast, the United States offers a vast national market with one language and an efficient distribution system.
The dollar's 60 percent appreciation between 1980 and 1985 was a competitive windfall for foreign exporters. They could either cut prices or fatten profits. They did a bit of both. Economist Richard Baldwin of Columbia University makes an important point: fatter profit margins enabled many foreign firms to establish a beachhead in the U.S. market. The higher profit margins covered heavy start-up expenses for advertising and distribution networks. Strong U.S. economic growth further expanded the demand for imports.
But the dollar's subsequent drop isn't quickly reversing the flood of imports precisely because the U.S. market is so big and important. In theory, a depreciating dollar makes U.S. exports more competitive while imports become more expensive and less competitive. So far, only the export half of the theory is working. Imports are less affected for at least three reasons:
Few companies gracefully withdraw from the U.S. market. Their dependence is too great. In 1986, Volvo sold more cars in the United States (110,000) than in Sweden (65,000). Japan sends two-fifths of its exports to the United States. A third of the exports of eight major developing countries (Hong Kong, Taiwan, South Korea, Brazil, Mexico, India, China and Singapore) come here. To stay in the U.S. market, exporters are shaving profit margins instead of raising prices. Since early 1985, only half the dollar depreciation has been passed along in higher import prices, estimates the Bureau of Labor Statistics.
Even when exports to the United States become unprofitable, foreign firms may not stop. Rather than abandon the market, they may export until they can shift production to a profitable location -- either the United States or another country. The dollar's depreciation has already increased foreign direct investment in the North America. Japanese car companies plan factories that, by the early 1990s, could produce more than two million cars. Assuming all those plants are built, they may ultimately reduce car imports. In 1986, motor vehicles and parts accounted for a third of the $156 billion U.S. trade deficit.
American companies can't quickly undo decisions to manufacture or buy abroad. The decisions were often made when the dollar was high and competition from foreign firms was intense. In some cases, new plants were built. In others, long-term supply contracts were signed. Sometimes alternative domestic suppliers are no longer available. Overseas sourcing was especially strong in electronics, says Washington trade consultant William Finan. The U.S. trade balance in electronics dropped from a surplus of $7.4 billion in 1980 to a deficit of $13.1 billion in 1986.
This picture contradicts the conventional wisdom of America slipping into economic collapse. Of course, the United States has lost its huge technological superiority. But good U.S. companies still succeed overseas by adapting to the multitude of foreign markets. A new study of 34 fast-growing U.S. companies (average sales: $360 million) finds that they increased exports even in the early 1980s when the dollar's value was so high. These companies hired foreigners -- Frenchmen in France, Germans in West Germany -- to run foreign operations. Products were changed to suit local tastes and market conditions.
The trouble is that higher exports alone won't quickly reduce the trade deficit. Protectionism isn't a solution, because it would give other countries a pretext to retaliate against rising U.S. exports. What will happen? Imports could drop sharply when foreigners shift production to new U.S. factories. The dollar may continue to depreciate, forcing some importers to quit. The United States could suffer a recession, dampening demand for imports. No one knows: that's why the outlook for the world economy is so worrisome.
What's clear is that the U.S. trade deficit isn't only an American problem. If Americans are addicted to imports, import producers are also addicted to America. The U.S. market is everyone's first choice. Getting in isn't easy, but once companies succeed the opportunities are vast. Exploiting those opportunities fostered the postwar growth of world trade, but now they have spawned a dangerous dependence. Whether it can be gently broken is an open question.