A Dose of Our Own Medicine : U.S. Must Accept a Recession to Correct the Trade Imbalance

In 1986 this country’s international economic position continued to deteriorate--a deterioration that, if unchecked, almost certainly presages a decline in the American economy and standard of living.

The balance-of-trade deficit widened to more than $170 billion as imports continued to rise to nearly $400 billon. As a result, America’s foreign debt grew to about $250 billion, making us by far the largest international debtor.

Optimists argue that the deficit has stopped rising, that the Administration’s efforts to improve American export competitiveness and to level the playing field of international trade are beginning to work. Indeed, the dollar has fallen dramatically, making our exports cheaper in some markets and making imports from these countries more expensive.

While Congress has become more protectionist in rhetoric, the Administration has become more protectionist in fact--ordering quotas on Japanese machine tools and reducing tariff benefits to key developing countries--even while loudly protesting its adherence to free trade. And the United States has become less and less diplomatic in demanding that Japan and West Germany adopt more expansionary economic policies to stimulate world and U.S. trade.

But there is little evidence that the U.S. trade position, and more generally the relative competitiveness of the American economy, is fundamentally improving.

On the one hand, American manufacturers and farmers are not finding it much easier to sell their goods in international markets; on the other hand, they seem to be finding that many American consumers simply prefer imported goods. Even the enthusiasts among policy analysts are now forecasting only a $40-billion improvement in the trade deficit. This means that the country’s net foreign debt would continue to grow at a rate of about $100 billion per year.

In one sense the underlying problem is simple: Americans are consuming more than they are producing. The difference is made up with imports and is financed by foreign borrowing. From this perspective the problem does not look much different from that which has affected other high-debt countries. And there the solution has been simple: The time-honored U.S. government and International Monetary Fund sanctioned method of correcting an excessive deficit has been to induce a recession, which brings consumption into line with production, and savings into line with investment. If it is reinforced by simultaneous structural changes in underlying economic incentives, the quick fix of a recession can be translated into sustained recovery and expansion; if it is not reinforced by these changes, however, at least the country learns to live within its means.

Of course, translating the IMF prescription for Mexico to the United States is potentially dangerous in a world that still looks to America for international economic leadership and still conducts most of its commercial activity in dollars. However, sooner or later the world’s creditors willdemand higher returns for the risk of financing U.S. deficits or will shun U.S. investments altogether. The result would be financial chaos and economic depression for the United States as well as the rest of the world economy.

The premise, then, is that the U.S. balance of trade is so misaligned that only a recession can correct it, and the longer a recession is delayed the more severe and painful will be the ultimate correction.

The goal of policy-makers now should be to minimize the pain while maximizing the effect of the corrective effort.

If the core of the problem is excessive U.S. consumption (as manifested in the trade gap) and inadequate U.S. savings (as manifested, in part, in the U.S. budget deficit), then economic policy should be aimed directly at these issues. This could be done through an emergency economic program built around the following elements:

--A temporary tariff on all imports, with the proceeds used to finance an accelerated domestic adjustment process, including worker retraining and relocation, and accompanied by a presidential commitment to forgo new protectionist measures for the duration of the program.

--A two year income-tax surcharge applied entirely to deficit reduction, along with renewed efforts toward the control of expenditures.

--An agreement with West Germany and Japan to help finance our deficits so that interests rates do not rise excessively.

The immediate result of such shock therapy would be a U.S. recession as consumption of both domestically produced and imported goods fell. The trade balance and the budget deficit would improve. Foreigners would scream that we were trying to solve our problems at their expense, conjuring up the specter of the Smoot-Hawley tariff that helped precipitate the Great Depression, but they might be made to understand the greater danger to the world economy if we continued on our present course.

This would set the stage for more fundamental improvements in the structure of the U.S. economy that are essential to restoring American competitiveness and rebuilding the standard of living. But without a dramatic initiative such changes will be too slow in coming and too gradual in their effect.

This is the cure that American financial experts have prescribed to other debtor countries for years. It is time for us to take a dose ourselves.