Superior Products May Be U.S. Trade Deficit Solution

Don’t tell Digital Equipment Co. that a trade deficit is sapping America’s economic vitality.

In the west of England, Digital’s computers integrate design, production and testing for Westland Helicopters Ltd. West Germany’s huge Commerzbank uses a Digital computer network to link its headquarters in Frankfurt to 10 foreign branches. In Vienna’s ornate and venerable Rathaus, another Digital system automates and coordinates management of city services.

A growing number of economists believe Digital is doing what American business must do much more frequently if it is to survive against increasingly stiff worldwide competition. What Digital sells abroad--and more often than not manufactures there--is a product that attracts buyers through superior design and service, not through prices lower than the competition can offer.

The trouble is that the United States does not have enough Digitals. Outside of high technology and a few other fields, most American companies make products that other nations can easily match. And many of the companies with Digital’s potential have not taken the steps to realize it.

Consequently, the nation’s staggering trade deficit, which is sapping vitality from the faltering U.S. economy, is not about to go away. “We are going to see red ink in trade data until well into the next decade,” said Robert Gough, a senior vice president of Data Resources Inc., an economic forecasting firm.

Other remedies simply are not working--at least not yet. The greatest disappointment of the last year has been the negligible effect of a weaker dollar.

It was exactly a year ago that the world’s major industrial powers held an extraordinary meeting at New York’s Plaza Hotel and agreed that the value of the high-flying dollar had to fall. Treasury Secretary James A. Baker III, using the understated language of financial diplomacy, called the move “a positive means of addressing concerns about the large trade imbalances among our countries.”

The strong dollar, it was thought, had made foreign goods irresistibly cheap in the United States and made U.S. goods excessively expensive abroad. So long as the dollar remained mighty, U.S. goods would be permanently overpriced on world markets and the U.S. trade deficit would only mount.

Sliding for Six Months

In fact, the dollar had already begun sliding six months before the Plaza Hotel agreement. And it has continued to fall, propelled by the sale of dollars by the central banks of some U.S. trading partners. The dollar has declined by more than 25% against a basket of 15 major international currencies, and it now buys 40% fewer Japanese yen than it did 18 months ago.

Yet the dividend is nowhere in sight. The merchandise trade deficit, having hit an all-time high of $148.5 billion last year, is ringing up more records this year--$83.9 billion in the first six months followed by $18 billion in July.

Many economists remain confident that the weaker dollar will eventually begin to reduce imports and boost exports--perhaps in another six months. It takes up to two years, they argue, for shifts in currency values to work their way down to the prices of goods traded internationally. For a brief period, in fact, currency shifts probably aggravated the trade deficit as foreign goods already on order continued to pour into the United States carrying the higher price tags dictated by the weaker dollar.

May Have Slowed Deficit

Economists who are still counting on the impact of the weaker dollar point out that the trade deficit might be much greater today without it. “If there had been no correction in the dollar, the deficit would have kept rising at a much faster rate, with imports running double exports,” said William R. Cline of the Institute for International Economics.

Robert Z. Lawrence of the Brookings Institution said the trade deficit might have reached $200 billion this year. “We have no idea what we have avoided,” he said.

But the declining dollar may never live up to its full promise. It has hardly dropped at all against the currencies of the world’s four most aggressive trading nations--Taiwan, South Korea, Singapore and Hong Kong--and risen slightly against the dollar of Canada, America’s single biggest trading partner.

Michael P. Kercheval, an economist with Equitable Life Assurance Co., estimates that the dollar has declined a mere 4% since early 1985 against the currencies of the top 15 U.S. trading partners.

Beyond that, Lawrence cautioned that the dollar had grown so strong by early last year that many foreign manufacturers maintained comfortable profit margins even as they sold their wares in the United States for less than the price of U.S.-made goods. As the dollar fell, Lawrence said, these manufacturers maintained some of their price advantage simply by cutting their profit margins.

Want to Recoup Costs

Foreign producers paid the start-up costs of entering the U.S. market when the dollar was strong and now want to recoup those costs rather than withdraw from the market, even if it means slashing profit margins. “You may need the dollar to fall substantially below its starting point just to get back to the same point where you were,” he said.

Similarly, U.S. companies that built plants abroad to take advantage of cheap overseas labor when the dollar was strong do not want to abandon those investments. Caterpillar, for example, built a tractor plant in Leicester, England, when $1 was worth nearly a full British pound. Now $1 buys only 68 pence in England, but Caterpillar is not about to abandon its operations in Leicester.

For Caterpillar and other traditional companies making traditional products, the search for a competitive edge will remain anchored in cost: labor cost and the costs imposed by exchange-rate fluctuations.

But many economists believe the United States should seek its future in products in which concerns about labor costs and exchange rates are secondary to design, inventiveness and service as denominators of competitive edge. Never again, they insist, will it be enough to keep making cars in Detroit or producing textiles in North Carolina or growing corn in Iowa.

Producers Lose Out

“U.S. producers tend to lose competitiveness, whether in textiles or in electronics, when the technologies are established,” said Sven W. Arndt, director of international economic policy studies at the American Enterprise Institute. “Then the product becomes a standardized commodity. And then the U.S. producers lose out to countries that duplicate the technology with low-cost labor.”

Long-held views about trade have turned upside down as the low-paid but reasonably well-educated labor forces of Third World countries, working in foreign-designed manufacturing plants, have begun making products that had once been the unique province of the major industrialized nations.

“In the traditional theory of comparative advantage, you never thought of countries like Korea as serious trade competition,” said Ago Ambre of the Commerce Department’s Bureau of Economic Affairs. “Undeveloped countries--Africa or Asia or Latin America--were supposed to be granaries. With mobile capital and technology, it’s a whole new competitive world out there.”

In Arndt’s view, however, that does not mean the United States must be reduced to a nation of overpaid fast-food workers.

‘Where the Edge Is’

“The United States remains competitive where the quality of the product depends on human capital inputs: high-technology products such as computers, pharmaceuticals and other chemicals, some engineered products,” he said. “That’s where the edge is, and that’s what we need to do in the long run.”

Gough, of Data Resources, said that only the most aggressive U.S. manufacturers can hold their own against the new, global competition. His successful clients, he said, “are the ones doing their homework and getting out ahead of the pack. The ones sitting around and waiting for the presumed benefits of a declining dollar are still losing ground.”

Those successful clients include Digital, which offers a high-tech, high-quality product with a unique feature--its ability to link computers of different capacities into networks and to add or subtract computers like building blocks.

“The approach of our organization is that competitive advantages go far beyond just cost,” said Jeffry Gibson, Digital’s corporate information manager. “We need to look at markets, the quality of the labor force, service, networking, delivery. All those things contribute to a competitive advantage. Whereas companies that just chase after the cheapest production are always chasing it.”

Digital has found a range of benefits from locating manufacturing plants overseas.

Market Presence

“The main reason we have gone abroad over the past 13 years is not because labor is cheaper there,” Gibson said. “The main reason is being close to where our computers are sold. Being there contributes to market presence. Manufacturing there simplifies distribution.”

But it does not reduce the trade deficit. By convention, goods have to cross national borders before they are counted as exports or imports. Digital computers that are manufactured and sold abroad never leave the United States and are not tallied as U.S. exports.

Digital’s $3.1 billion in sales from foreign operations in the year ending last June 30--41% of all revenues during the year--could at least have made a dent in the nation’s trade deficit. But only when Digital repatriates net earnings does any of the company’s growing penetration of industrial and commercial computer market abroad show up in the nation’s balance sheet--as service exports, not as merchandise exports. And like most U.S. companies with extensive operations abroad, Digital reinvests at least half of its foreign sales revenues in the countries where they are earned.

Sales Should Count

Today’s system of reckoning the trade balance does not make sense to Kenichi Ohmae, head of the Japanese office of the U.S. consulting firm of McKinsey & Co., who contends that the sales of U.S. companies operating in Japan should be counted against Japan’s massive trade surplus with the United States.

Solving the U.S. trade deficit, Ohmae wrote recently, “may require more changes in our understanding than in our trade. We may need to redefine what we mean by ‘foreign goods.’ Are, for example, the $4 billion to $5 billion of Japanese exports to the United States by American companies in Japan ‘foreign’?”

And this would make a growing difference as U.S. companies expand their sales abroad by shifting manufacturing and service operations close to their new markets.

“It now makes more sense to make many products closer to end market, no matter what the cost of labor,” Gough said. “The present trade deficit is the result of far more complex elements than was its equivalent a few years ago, so you don’t fix such a deficit the same way you used to through currency exchange rates. If you try to, then you only exacerbate the situation.”