U.S. Slump Could Be Felt Globally
In the early 1980s, the United States, driven by domestic demand, grew faster than the non-communist world’s other major economies and sucked in vast quantities of imports, providing a major stimulus to growth in Japan and Europe.
But since 1985, the U.S. role as a locomotive for other major industrial economies has diminished. Japan is now growing faster than the United States, and Europe is growing almost as fast. The accelerated growth in Japan and Europe has been driven by domestic demand and by exports to countries other than the United States, raising hopes that the world may now be less vulnerable to the effects of a slowdown in the U.S. economy.
Moreover, some believe that growth in Europe and Japan may increase demand for U.S. exports and help pull the United States out of a slump. Current robust growth in Japan and West Germany--year-on-year growth rates in excess of 4% in both countries--has reinforced this view.
Such hopes may be no more than wishful thinking, however. Growth in Japan and Europe is unlikely to generate demand for U.S. goods in the same way that the reverse happened between 1982 and 1985. Much of the increased trade in goods from the major European countries stems from booming demand in the United Kingdom, France, Spain and Italy, which have been importing capital goods to support growing industrialization. But these countries now face soaring trade deficits with West Germany and escalating inflationary pressures. As a result, they are forcing interest rates higher--both to cool their economies and to defend their currencies.
Other major industrial countries are also tightening monetary policy. The Organization for Economic Cooperation and Development’s June, 1989, economic outlook forecasts that the three-percentage-point rise in interest rates in the seven major economies in the past year threatens growth while doing no more than holding inflation steady. Following a 1% pick-up in the past year, this would leave the overall OECD rate of inflation at a dangerously high 4.5% and bodes for further tightening in most OECD nations to keep inflationary expectations from becoming entrenched.
In the face of this monetary tightening, Europe’s boom looks increasingly fragile. West Germany, with the OECD’s largest account surplus as a percentage of gross national product, could help balance the trade flows by stimulating its sluggish domestic demand, but its deep-seated fears of inflation have so far blocked this. West Germany is likely to keep its monetary policy tight and to tighten its fiscal policy--both to keep a grip on its domestic economy and to keep out imported inflation caused by the West German mark’s weakness against the dollar.
Japan of Little Help
Nor can the United States expect much help from Japan. Although Japanese domestic demand is now growing impressively, Japan’s low propensity to import limits demand for other countries’ goods. In addition, Japan has been tightening monetary policy, and its fiscal policy, already the most restrictive of the major OECD countries, is likely to become more so.
Japan is more likely to be dragged down by a U.S. recession than to offset a U.S. downturn. Europe, by turning inward, has reduced its dependence on exports to the United States, and this trend will be reinforced as the remaining barriers to trade among Europeans come down as part of the 1992 single-market proposals.
But Japan still depends heavily on the American market. Last year, 34% of Japan’s exports went to the United States, compared to only 8% of West Germany’s. Moreover, this figure understates Japanese companies’ dependence on the United States as an outlet for their products. Asia’s newly industrializing countries--Hong Kong, Taiwan, South Korea, Singapore, China, Thailand, Malaysia and the Philippines--took another 26% of Japan’s exports in 1988. Many of these goods, after further processing in these low-cost areas, are also shipped to the United States.
The Japanese economy thus remains very vulnerable to any slowdown in the United States. In such a slowdown, U.S. imports would fall more sharply than the overall economy; in the last three U.S. recessions, imports have fallen from 2.3 times to 5.6 times faster than GNP.
The limited export opportunities offered by the other major economies coupled with a stronger dollar make it unlikely that U.S. exports will grow fast enough to offset a further consumer-led slowing of the U.S. domestic economy. To offset a further 1% slowdown in the growth of consumer spending in the next quarter, merchandise exports would have to increase at an annual rate of more than 30%. That would mean more than doubling the already strong 13% annualized rate of increase for U.S. exports in the second quarter of this year.
What’s more, for the United States’ trading partners in Japan and Europe, the fall in U.S. imports as the U.S. economy slides into recession may combine with their own monetary and fiscal restraint to cause a slowdown in their economies as well, and probably a worldwide recession.
