By Robert Z. Lawrence
How well is the United States performing compared to other economies? Note that this concept of competitiveness does not refer specifically to performance in trade. Although growth, inflation, unemployment, and income equality are all legitimate measures of performance, probably the most important indicator is living standards.
To evaluate competitiveness by this criterion, we need to decide how living standards should be measured. The most straightforward evaluations compare the buying power of residents in other countries with the market basket of goods and services that the average American’s income can purchase. Of course, such a measure fails to capture some important qualitative aspects, such as the purity of the environment, the security of employment, and the quality of life. Nonetheless, the measure of purchasing power suggests that American living standards are higher than those in other major industrial economies. According to the Bureau of Labor Statistics, GDP (gross domestic product) per capita in France, Germany, and Japan in 1989 were 85.9, 82.0, and 72.7 percent of that in the United States.
One reason U.S. living standards are high is that the share of the U.S. population in the labor force is higher than in most other countries. Primarily, however, high U.S. living standards reflect the productivity of the work force: output per worker in the United States exceeds that in other countries. Output per worker in U.S. manufacturing is, likewise, the world’s highest.
What is striking, however, is how the relative position of the United States has changed. In 1960, GDP per employed person in France and Germany was less than 50 percent the U.S. level, while in Japan it was less than a quarter. But productivity growth in the United States has been slower than productivity growth elsewhere since then. As a result, foreign living standards and productivity levels are catching up with those of the United States.
This convergence of other economies with U.S. output levels has been the subject of much debate. Some believe that the burden of military spending (so-called “imperial overstretch”) has been the chief cause of America’s relative decline. But this argument presumes that if the United States had not spent as much on defense, it would have used the money for technological improvements and domestic investment. It seems more likely, however, that any dividend from reduced defense spending would have been spent in the same proportions as the rest of U.S. incomes—at least 90 percent would have been consumed and only a small proportion devoted to growth-enhancing investment.
Another view is that America’s productivity growth has been slower because it has moved more rapidly out of the manufacturing sector (i.e., that it has deindustrialized). But judged by the quantity of goods it produces, the United States has not deindustrialized. The share of manufacturing in GNP was about the same in 1989 (i.e., 22.6 percent) as it was in 1979 (22.3 percent) and 1960 (20.3 percent).
A more viable reason for America’s relatively slower productivity growth has been the relatively slower increase in U.S. investment in plant, equipment, and infrastructure. Americans have saved and invested lower shares of their incomes than citizens in other major industrial nations.
The most powerful explanation for America’s slower productivity growth, however, is a simple fact of life: it is easier to copy than to innovate. As the country at the technological frontier, America has had to innovate to increase productivity growth. Foreigners, on the other hand, could increase productivity by adopting and copying U.S. practices.
Increasingly, however, foreigners have shifted from catching up to sharing the lead. U.S. productivity in overall manufacturing remains the world’s highest. But in some industries (automobiles, electronics) and in some technologies, Japan has surpassed the United States in productivity. This change in relative technological advantage has been reflected in patterns of direct foreign investment. In the past, reflecting their technological and managerial advantages, U.S. firms found opportunities to set up manufacturing and marketing operations abroad. Today, foreign firms increasingly find their technological capabilities afford them profitable opportunities for direct foreign investment in the United States.
It is important to recognize that this relative decline of the United States has differing implications for American power and for American living standards. The power of a nation (i.e., its ability to influence the actions of other nations) flows in large part from its relative economic capacity—the economic performance of the United States compared with other nations, particularly its adversaries. In this respect the power of the United States is less in a richer world economy. On the other hand, the welfare of a nation’s citizens is largely a function of its absolute economic capacity. A nation’s living standards are primarily based on its productivity and on its ability to exchange its products for those of others on international markets. Both of these effects are enhanced when increased innovation abroad provides U.S. consumers access to better products and U.S. manufacturers more opportunities to emulate foreign products and processes. The United States no longer has to carry the burden of global innovation alone—increasingly, American firms can learn from others.
In addition to providing benefits, however, the growing equalization of technological capabilities also increases competitive pressures on the United States. This equalization makes many nations close substitutes as locations for production. Thus, trade and investment flows are much more sensitive to differences in other factors that influence costs, including wages and skills and differences in national tax, regulatory, and trade policies. In this more competitive environment what once was thought of as purely domestic economic policy now has international consequences.
How well has America performed in international trade? First, it should be stressed that trade between economies is not like competition in sports. A sports contest is a zero-sum game. If one competitor does better, its opponents are, by definition, doing worse. However, because trade allows each nation to specialize in making the products it produces relatively well, trade simultaneously makes all nations better off.
How should trade performance be measured? It is tempting to use the trade balance (the difference between a nation’s exports and imports) as a measure of trade competitiveness. But a nation’s trade balance is more revealing of its spending patterns than of its products’ attractiveness in world markets. The only way a country can consume more than it produces is to import the difference from abroad. Nations with trade deficits are spending more than their incomes. They must be borrowing from the rest of the world or selling domestic or foreign assets. Conversely, nations with trade surpluses accumulate claims on others or reduce others’ claims on them. The U.S. trade deficit in the eighties, therefore, reflected American spending patterns. A big part of this pattern was the U.S. government’s large budget deficits. If the government increases its borrowing, either the private sector must increase its lending or the country as a whole must borrow from abroad. For the private sector to lend more it must save more. In the eighties, however, when the government increased its borrowing, the private sector’s saving rate actually declined. Thus, the rise in the federal budget deficit was associated with an increase in overall borrowing from abroad—and therefore a larger trade deficit.
Are trade deficits good or bad? Just as with individual borrowing, it depends on how the borrowed money is used. If an individual borrows to fund education or to start a business, his spending will create income-earning assets that will aid in future repayment. Likewise, if a trade deficit reflects increased borrowing to fund investment, there could be no need for concern. The money would finance capital formation that would make workers more productive in the future.
The U.S. trade deficit in the eighties, however, reflected increased borrowing for consumption rather than investment. In 1990, gross fixed private investment was only 13.6 percent of GNP, versus 16 percent in 1980. Had Americans saved the same share of income in 1990 as in 1980—16.3 percent—they could have financed their investment and run a trade surplus of $148 billion!
Of course, simply running a trade surplus does not necessarily indicate that a nation is performing well. After all, some very poor countries have trade surpluses and some rich countries have deficits. What counts for competitiveness in trade, therefore, is not simply the level of the trade balance, but the living standards associated with it. Indeed, one widely accepted definition of competitiveness is “the ability of a country to sell its products in international markets, while enjoying rising living standards.”
Everything else being equal, a nation’s living standards will be higher, the higher the prices it receives for its exports and the lower the prices it pays for its imports. The level of living standards associated with a given trade balance will, therefore, depend on the terms of trade—the ratio of export to import prices. Since the early seventies the U.S. terms of trade have had a strong downward trend. To maintain any given trade balance, the prices of U.S. products relative to imports have had to fall.
One mechanism by which America’s terms of trade have been lowered has been declines in the value of the dollar. If the dollar, measured in foreign currencies, falls, U.S. export prices tend to fall relative to the prices of foreign products. According to the Federal Reserve board, the dollar declined by 13.6 percent between 1973 and 1990, taking into account inflation differences in the United States and the rest of the world.
This discussion about the exchange rate highlights the difference between the perspective of American firms and that of the economy as a whole. A lower dollar makes American products more attractive to foreigners. In that sense American producers will be more competitive in world markets. On the other hand, a lower value of the dollar will, all other things equal, reduce the nation’s international buying power—and thus its living standards. Thus, the nation becomes less competitive from the standpoint of workers and consumers.
The alternative, and more desirable, way of making a nation’s products more attractive in world markets is to innovate and improve quality in products and production processes. In contrast to exchange rate depreciation, such technological improvements allow the nation simultaneously to sell more products in world markets and to raise living standards. Ultimately, therefore, both types of competitiveness depend on improved productivity.
Are we doing the best we can? Nations find themselves in different circumstances: some are richly endowed with natural and human resources while others are not. The most important concept of competitiveness is not, therefore, how national performances compare or even how well countries perform in international trade. The critical issue for each economy is whether it is making the best use of its resources.
Many people would argue that both the U.S. government and private sector could be more efficient than they are. In this sense, regardless of what other countries are doing, there is room for America to improve its competitiveness. The United States could learn much from practices in other countries. Ultimately, however, we must follow policies and practices that will work best in the American environment.
Robert Z. Lawrence is the Albert Williams Professor of Trade and Investment at the John F. Kennedy School of Government at Harvard University. He was formerly a member of President Clinton’s Council of Economic Advisers and a senior fellow at the Brookings Institution. He has served as a consultant to the Federal Reserve Bank of New York, the World Bank, and the Organization for Economic Cooperation and Development. He writes a monthly column for the Nikkei Financial Journal.
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