With excess supply and weak demand plaguing the world economy, the United States has been the only market where many foreign producers could sell during the five-year business recovery. Long ago, it became clear that no small thing like the free fall of the dollar would induce U.S. trading partners to give up their shares of the U.S. market.
Only a slowdown in consumer spending would bring about substantive improvements in the imports picture. But that could also cause a recession in the United States that would rapidly spread abroad.
I predicted that it would probably take some kind of outside shock to precipitate such a spending slowdown. Consumers are overburdened with debt as they continue trying to finance life styles that they can no longer afford but don't want to give up. By the end of the third quarter of 1987, personal savings had fallen to a post-Korean low of 2.8% and consumer installment debt was up to 19% of disposable personal income, while growth in inflation-adjusted, or real, income had stagnated.
The stock market crash on Oct. 19 may have been that shock, causing consumers to pull in their horns and plunging the economy into a recession. Auto sales in the post-crash months and consumer spending after a lackluster Christmas season may be an important test in determining whether consumers have indeed cut back spending in response to the crash.
Retailers deeply discounted their wares in the final days before Christmas; by mid-December, car sales had fallen 18% compared to last year and probably would have been even lower if not for intensive sales incentives. Already, auto makers are planning production cuts in 1988 and the Commerce Department's leading indicators, due mostly but not entirely to the crash, slid 1.7% in November, the biggest drop in almost 3 1/2 years.
Nevertheless, the consensus is that there is no need to worry about a consumer retrenchment leading to a recession. Most observers believe that part of the U.S. consumer cutbacks will come out of imports, as opposed to U.S. products. The rest, they believe, will be matched by rising exports, as cost control and the weak dollar improve the international competitiveness of U.S. producers. In effect, they say improvements in the American trade balance will offset consumer weakness and allow the U.S. economy to putter along relatively unscathed.
Hooked on Imports
But there are several problems with the consensus view. True, less consumption spending will translate into a drop in imports. In past recessions, imports usually fell much more steeply than overall domestic spending, reflecting both what was then the limited impact of importers on consumer buying habits and efforts by domestic manufacturers to recapture market share. That decline, coupled with the continued growth of exports until the recession spread to other industrialized countries, usually some two quarters later, did cause the U.S. trade balance to improve appreciably.
However, in the past five years, U.S. consumers have become hooked on imports and many foreign companies have established a strong marketing and distributing presence in this country. Today, no videocassette recorders or compact disc players are made in the United States and the majority of color television sets are imported. Imports are thus not expected to decline much more than domestic goods production, limiting the extent to which consumer spending weakness comes at the expense of weaker imports.
But suppose that, even if this is true, the consensus is right and the weakness in domestic consumer spending is offset by big increases in exports, fueled by a weaker dollar and productivity gains from business restructuring. The question is, who will take more of our exports?
Not Canada or the economically healthiest newly industrialized countries (NICs) with large trade surpluses, such as South Korea, Taiwan and Hong Kong, all of which virtually peg their currencies to the U.S. dollar. Even if the NICs didn't do this, costs of production there are so low that they could always undercut the United States. In manufacturing, American unit labor costs are 10 times those of Korea and eight times those of Taiwan.
And not the debt-ridden Third World countries like Mexico and Brazil, already short of U.S. currency to repay loans. And not an indecisive OPEC, suffering from an oil glut that is likely to lead eventually to single-digit prices for a barrel of oil.
That leaves the strong-currency countries--the major European countries and Japan--to offset any decline in U.S. consumer spending. For perspective, inflation-adjusted or real consumer spending declines during recessions have occurred in the United States only twice before in the postwar period--by only 0.9% in the 1980 dip and 0.6% in the 1973-75 recession. However, the consumer is now very overextended and the first consumer-triggered recession since World War II seems likely. If people regain their financial sobriety, a 2% decline in real consumer outlays seems likely, even modest, since it would move the saving rate only up to 5%, still far below the 6% to 8% postwar norm.
How badly will the decline damage major European countries and Japan? In our example, a 2% drop in U.S. consumption based on a 1987 estimated total of $2.49 trillion in 1982 dollars would require an offsetting $50-billion increase in net exports--which would reduce total foreign real GNP by 0.8%. If this were concentrated in Japan and major European countries, they would experience some combination of increased imports from the United States or reduced exports to the tune of $50 billion; in any case the improvement in the U.S. trade deficit would be directly at the expense of their economic growth.
According to statistics on total U.S. trade--imports plus exports--with the rest of the world, U.S. trade with major European countries and Japan is 26% and 17.8% of the total, respectively. This means that of the U.S. total trade with these European countries and Japan, Europe accounts for 59% and Japan 41% and distributing the $50-billion trade cut by those percentages would reduce Europe's real GNP by 0.7% and Japan's by 1.7%.
With economic growth this year expected to be 3.8% in Japan and 1.5% in West Germany, an amount indicative of that in the rest of Europe, the magnitude of the declines in GNP in this model would wipe out about 50% of growth in Europe and Japan. Throw in a multiplier effect of at least 2--the trickle-down effect on the economy as weaker exports and more imports reduce production, jobs and incomes--and no growth, if not a recession, is likely.
It is clear, then, that enough improvement in net exports to offset the significant weakness in U.S. consumer spending would be detrimental to the rest of the world--unless there are economic revivals in Europe and Japan, the only areas where meaningful increases in economic activity seem feasible. Yet, so far, nothing on the horizon indicates that this is likely.
Last year Japan did cut taxes and interest rates and the economy shows strength, but the officially estimated growth in 1988 is still only 3.8% of real GNP. West Germany made minor reductions in its interest rates but the moves were largely cosmetic. Overall, Europe is languishing; growth is sluggish and unemployment is high.
In a way, the next move is up to the European countries and Japan: Do nothing and they resign themselves to the negative effects of weaker trade with the United States and resulting recession, even if a U.S. downturn is avoided. Their recent support of the U.S. dollar shows their concern, but the question is whether they will loosen monetary and fiscal policy or otherwise generate adequate growth soon enough to save the day.