Going It Alone Exacts a High Price
It is easy to demonstrate in principle that nations can achieve their own economic objectives better if they coordinate their fiscal and monetary policies with other nations rather than if each conducts its policies in isolation. This is true even if nations have very different objectives for key economic variables such as employment levels, inflation rates and trade balances. Despite its potential benefits, policy coordination has rarely been achieved, though it has often been attempted.
Policy coordination is rarely achieved in practice because politicians do not act on the basis of economic models linking policies to conventional economic goals. President Reagan will not raise taxes because, for him, not raising taxes is the overriding objective. He does not conduct his budget deficit policy on the basis of how economic models predict that policy will affect the trade deficit. Similarly, officials in West Germany and Japan today seem committed to achieving budget surpluses for their own sake, not for what the budget will do to the trade balance or employment in their countries.
When attempts at policy coordination fail, the loss may not be confined simply to not getting the gains that were available from coordination. Rather, failed attempts to achieve cooperative behavior may dramatize policy conflicts between nations. That is the case today, when a growing sense of conflict in economic policies may be increasing the risk of a trade war.
Group of Five Agreement
The United States has been trying to achieve some coordination for the past two years, ever since James A. Baker III took over as Treasury secretary and made a priority of reducing the trade deficit. But after the stunning initial agreement among the Group of Five industrial nations in 1985 to cooperate in bringing down the exchange value of the dollar, there has been growing disagreement about what policies to pursue. Even the initial agreement that the dollar should fall has evaporated, with both West Germany and Japan resisting the continuing decline in the dollar for most of the past year.
The policy conflict has now spread well beyond the exchange rate. For its part, the U.S. Treasury has been urging Japan and West Germany to stimulate domestic demand in their economies through tax reductions and lower interest rates. The reasoning is that, if the U.S. trade balance is to improve, the trade surpluses of West Germany and Japan will have to decline, and stronger domestic demands will be needed to make up for the loss of some of their exports. In fact, the volume of exports in both West Germany and Japan has already started to fall, and, with domestic demand not filling the void, total industrial production has already declined in both countries.
For their part, West Germany and Japan have resisted any call to run more expansionary budgets. They have, instead, called on the United States to achieve a less expansionary budget--that is, to reduce its budget deficit--and have been skeptical about the promises that our officials have made to do so. Their reasoning is the mirror image of ours. If our trade balance is to improve, our domestic demand must be reduced so as to lower our demand for imports. The straightforward way to shrink our domestic demand is to reduce our budget deficit.
If monetary policies could be counted on to maintain appropriate growth of output and employment, either their prescription or ours could work. But if monetary policies are not flexible enough, their call for lower budget deficits here runs the risk that overall policy would be too restrictive, and our call for tax cuts abroad runs the risk that overall policy would be too expansionary.
For political reasons, neither side seems willing or able to accommodate the other. Instead of policy coordination, we have a growing risk of economic conflict among the major trading nations, centered on the huge U.S. trade deficit and its effect on exchange rates.
Protectionist Pressures
In the United States, frustration with the trade deficit keeps stirring up protectionist pressures from Congress. In recent months, there have been skirmishes over trade issues with Canada and the European Economic Community. But the greatest resentment is directed at Japan, whose firms sell a great deal into the U.S. market and compete successfully against U.S. firms in third markets at the same time that U.S. firms are impeded from selling in Japan.
Last month, the U.S. government moved to impose severe tariffs on a range of Japanese products in retaliation for the Japanese not enforcing an agreement on semiconductor trade that was reached last summer. The semiconductor dispute was the last straw in an increasingly tense political situation. And the existence of trade barriers is a major rallying point for those political feelings.
Many Japanese admit the existence of trade barriers. They merely ask us to be patient and to understand the cultural and political problems they face in opening some of their markets. On the U.S. side, patience has worn thin, and the excuse that important political constituencies cannot be ignored is seen as patently irrelevant to a range of newer products, such as super-computers and telecommunications facilities, whose sales into Japan are restrained in a variety of ways.
Could all of this get out of hand and lead to a trade war, with barriers rising between the United States, Japan and Europe? It is not likely, but neither is it unimaginable.
If Europe’s economies expand, the U.S. trade balance improves and Japan succeeds in conspicuously opening its market to U.S. goods, rather than just promising to do so, the threat would be minimized. If Europe slips into recession, pulling down world demand and with it the needed expansion in U.S. exports, the risk would grow.
Thus, how policy-makers resolve their differences in the coming months could have a major effect on world prosperity.
