The Competitive Realities of the Global Economy and the United States
Does an economic upturn in the United States signal the beginning of a recovery?
October 2, 2003
Many economists see annual GDP growth rates in the 4-5% extending through 2004. U.S. business investment — which has been weak up to now — is expected to gain considerable momentum in the near future as well. That, of course, would mark the onset of a much more robust economy.
Although I would like to share this sunny outlook, I do not. The current prevailing optimism rests on too many questionable assumptions, particularly when it comes to expectations about strong corporate investment. So let’s look a bit more closely at the current state of that vital engine of economic growth.
Excess capacity — at home and abroad — now stands uncomfortably high. While that is a common feature in the early stages of an economic recovery, with strong capital spending kicking in eventually, there are some strong countervailing forces in the current environment.
One is pricing power — or, rather, corporate America’s present lack of it. And pricing power is not about to return any time soon, because excess capacity is chronic around the world.
Moreover, the globalization of business activity continues to constrain not only the ability of U.S. (and other) corporations to raise prices, but also investment spending in the United States. This is a far-reaching structural change, one whose impact is probably grossly undercounted in official government statistics.
Globalization encourages decisions to put in place the lowest-cost production facilities where the facilities are not only the most technologically advanced, but where the cost of labor is low. It is one of the key reasons why American firms are opening plants in China, Mexico and elsewhere.
In addition, U.S. corporations are increasingly outsourcing a myriad of services in foreign lands. Today, many high-value services can be quickly transmitted and received from low-cost producers.
These activities include the work of design engineers, software-programming, accountants and back-office processing. Considering that services account for around 80% of U.S. private employment, a further transfer abroad is highly likely.
Globalization also helps to explain why domestic business inventories continue to remain low. Why build inventories when access to foreign markets is open and easy? Of course, none of these structural changes will abate in the coming year.
I am not suggesting, as some students of political economy have argued, that globalization is endangering the economic fate of the developing nations. But rather, the competitive realities of globalization certainly will continue to bear down on the world’s more advanced economies for the foreseeable future.
As emerging economies around the world become more and more willing and able to produce goods and services at lower costs than their first-world counterparts, the latter will see more of its key industries hollowed out.
In the face of rapidly diffusing technology and political freedom, the developed nations face the choice of shaping up or continuing to dissipate their wealth to comfort their own citizens.
These competitive realities underline the question of whether free trade will continue to reign as an American policy objective. But I doubt the issue will be met head-on in the near term.
Consider, for example, our trade relations with China. We have been prodding China to revalue its currency, but our policy stance is a bit shaky.
Unlike the situation a decade or so ago with Japan — when Japanese exports to the United States were climbing rapidly and its economy was stalling — we do not possess a similar measure of influence over policy-making in the world’s most populous nation.
In addition, U.S. direct investment in China now stands at a high-water mark, so that an impressive number of American investors are benefiting from the Chinese boom. Keep in mind, too, that China will remain a large customer for U.S. government securities — a role we hardly want to discourage on the eve of a burgeoning federal budget deficit.
China is not about to revalue its currency by 10-20% — but even if it did, that would hardly eliminate its competitive advantage. Besides, economic history shows that revaluations of this kind take many years to significantly influence trade relations.
One consequence of the intensified competition from abroad is the continued pressure on the American work force. The impact thus far is difficult to quantify. But it certainly has contributed to the job squeeze in recent years.
Since the trough in business activity in November 2001, private non-farm payrolls have dropped by 1.2 million people. This compares with gains of 3.2 million people in the comparative period during the six previous expansions.
Government fiscal and monetary policies will continue to play a central role in the economic trajectory of the coming year. We can expect a budget deficit of about $450 billion in 2004, but the stimulating effect of all of that excess spending will diminish.
Given the huge size of the budget deficit, another round of tax cuts — even if called for to bolster a weakening economy — is quite unlikely. This seems to leave a heavy increase in federal spending as the most likely fiscal option for boosting growth. This, of course, would bring new political risks for the Bush Administration.
The huge and growing national debt raises important questions about monetary affairs. How much pressure does the federal government’s debt service place on financial markets?
The credit markets do not appear to be posed and ready to supply the simultaneously large demands for new credit from corporations, households and the U.S. Treasury. This, in turn, will drive up interest rates — which will stifle the expansion, especially when U.S. household spending retreats.
This is not to say that the U.S. government will have trouble satisfying its appetite for capital. Foreign official institutions will continue to purchase U.S. government debt. For their part, the major exporters to the United States — China, Japan, Taiwan and others — are virtually captive buyers if they wish to continue importing heavily to American shores.
All in all, the market constraints and other realities that I have described eventually will bring down high-flying expectations about business and economic activity in 2004 when they clash with the reality of a much more moderate recovery.
In short, we won’t see a boom next year, but nor will we see a bust. And that, after all, is not such a dismal prospect, given the realities we face today — from continuing volatility in financial markets, to tighter corporate oversight, to the massive structural changes that continue to reshape the world economy.
President, Henry Kaufman & Company Henry Kaufman is president of Henry Kaufman & Company, Inc., an investment management and economic and financial consulting firm. For 26 years, Dr. Kaufman worked for the Wall Street investment bank Salomon Brothers, where he was managing director, a member of the executive committee and ran the firm’s four research […]