The warning sirens over the record U.S. current account deficit, the broadest measure of trade in goods and services, have risen a few decibels recently.
The increased volatility of the U.S. stock market is the ostensible cause of the heightened worry over the deficit and the willingness of foreigners to finance it.
officials, congressmen and well-respected economists have proffered a nearly universal opinion that the yawning gap is unsustainable and potentially a source of instability.
I demur. Despite all the talk of globalization, most observers are still wedded to pre-modern mercantilist ideas and do not fully appreciate significant changes in the world economy.
Companies, Not Countries
Traditionally, mercantilists have focused on the nation-state as the chief unit of analysis and stressed the importance of a trade surplus in creating wealth. The fact is that this just doesn't jibe with the facts of the current global political economy.
Globalization is more than a slogan. In practice, it means the production and distribution of goods and services are being reorganized across national borders. Multinational corporations are the main agents of change. They are building the global economy through foreign direct investment, which unlike portfolio investment, seeks the ownership of real assets like plant and equipment in other countries.
was scribbling one of his most famous essays, "Imperialism, the Highest Stage of Capitalism," the world's stock of direct investment peaked at near 9% of the world's output. The World Wars destroyed the first attempts to build a global economy. It took more than 60 years for the world's stock of direct investment to surpass the level seen on the eve of World War I. In 1997, the most recent year for which authoritative data are available, the stock of direct investment was nearly 11.5% of the world's
gross domestic product.
Trading in Archaic Concepts
One of the most significant implications of the growing stock of foreign investment is that the way foreign markets are serviced has changed profoundly. Traditionally, foreign markets have been serviced through exports. Not so now.
Indeed, sales by majority-owned affiliates of multinational companies have surpassed exports as the primary way of meeting foreign demand. Data from the
suggest the crossover took place in the late 1980s. By 1997, sales by majority-owned foreign affiliates of multinational companies reached $9.5 trillion compared to the world trade in goods and services of around $6.5 trillion.
This has been true for the U.S. for several decades. Majority-owned foreign affiliates of U.S.-based multinationals sell nearly twice as much as the U.S. exports. According to data from Japan's
Ministry of International Trade and Industry
, sales by affiliates of Japanese-owned companies surpassed the value of exports for the first time in 1996. Although there is much variance among the
member countries, as a whole, this change is also evident in Europe.
This means that multinational corporations are increasingly building and selling locally rather than relying on exports. It means that the trade balance is an archaic and misleading way to think about market penetration. For example, between 1977 and 1996, U.S. exports to Japan rose from $10.5 billion to $66 billion. But during the same time, sales by majority-owned affiliates of U.S. companies rose from $11.8 billion to more than $100 billion. America's bilateral trade balance with Japan is therefore only a small and shrinking part of corporate America's penetration of the Japanese market.
Keeping It in the Company
Another significant consequence of the globalization of production through direct investment is the increased importance of "intrafirm" trade. Cross-border transactions between multinational enterprises and their affiliates account for a significant part of world trade. The United Nations estimates that a full third of world trade is accounted for by intrafirm activity.
According to the
U.S. Commerce Department
, intrafirm trade accounts for about 40% of U.S. imports and about 33% of U.S. exports. This suggests that the U.S. trade deficit is, to an underappreciated extent, a function of the particular expansion strategy of U.S.-based corporations. Does it really set the stage for a dollar crisis if
Japanese unit sells computers to the U.S. headquarters, or if
produces cars in Mexico and Canada and exports them to the U.S.?
The increased importance of intrafirm trade means that what once would have been market-based activity now takes place within companies and outside the competitive marketplace. Just as modern corporations internalized numerous activities, like accounting and marketing, once performed by other economic agents, the modern multinational company is internalizing trade flows. This helps insulate a business from the foreign-exchange markets. After all, they can set their own internal exchange rates.
The Strangelove Solution
My mercantilist friends who think currency depreciation is a solution to the U.S. current account deficit ought to seriously think again. As the recent history of the dollar has demonstrated, a lower dollar has a limited direct impact on trade flows. And at the same time, a weaker dollar raises the costs of pursuing a strategy of expansion based on direct investment.
Conventional wisdom misunderstands the U.S. current account deficit in another crucial way. Sure, there is a cyclical dimension to the U.S. current account deficit. The growth differentials between the U.S., Europe and Japan alone would dictate a widening of the U.S. deficit. What most traditional economists miss, however, is the function of the U.S. current account deficit in the global economy.
The U.S. absorbs the world's surplus output and capital. This has allowed for example a quicker recovery in East Asia from the 1997-1998 financial crisis than otherwise would have been possible. The same is true for Mexico and most of Latin America. Europe typically exports its way out of recession or periods of sluggish growth, and a good part of those goods are destined for the U.S. In addition, the challenge of finding risk-adjusted profitable outlets for surplus savings remains critical to the stable development of the market economy, and the U.S. plays an indispensable role in its absorption.
The U.S. foreign direct investment strategy and the current account deficit are superior to the alternatives. The U.S. current account deficit does more to promote world growth more than the trade surpluses of the EU and Japan. The U.S. strategy is not zero-sum, while the mercantilist strategy is.
Like Dr. Strangelove and the Bomb, stop worrying about the current account deficit and learn to love it.
In an earlier
column on the wealth effect, I argued that the role of the stock market was being exaggerated and that the real source of the wealth effect has been the country's incredible job creation. If I am correct, the recent stock market turbulence should not have undermined personal consumption. Even though the stock market did not do nearly as well as it did in the fourth quarter of 1999, personal consumption appears to have accelerated in the first quarter of 2000.
Editor's note: Global Briefing will not appear next week as Marc Chandler will be on holiday.
Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at