World Works to Adjust : Perils Seen as U.S. Trade Deficit Dips

AMBERG, West Germany — Three years ago, in a tidy factory tucked inside this medieval walled city, the Grammer manufacturing company was turning out tractor seats that posed serious competition for American producers. With the dollar at astronomical heights, the German firm had at least a 20% price advantage over U.S. suppliers when it bid for contracts with companies such as Caterpillar.

So critical was Grammer’s advantage that its chief U.S. rival, Sears Manufacturing Co. of Davenport, Iowa, felt compelled to cut its own costs by shifting part of its production--and a bundle of jobs--from the Midwest to Britain.

“Sad as it may seem,” Sears President I. Weir Sears said at the time, “we’re now at the point where we can make parts in Wales and bring them over here more cheaply than we can make them here.”

Germans Cry the Blues

Today, however, with the dollar sharply lower, it is Grammer’s turn to cry the blues. Although the German firm has trimmed profit margins and pared workers’ hours, Sears won a big contract earlier this year with Caterpillar’s European subsidiary. Sears is “really giving us competition,” Johann Singer, the export manager at Grammer’s sprawling international headquarters here, lamented recently.

In its own small way, the shift in fortunes for Grammer and Sears mirrors a sweeping change now under way in the world economy. The mammoth U.S. trade deficit is beginning to decline. Most analysts believe that it will inevitably continue to do so. That, in turn, is forcing the world’s major industrial nations into a period of profound change and adjustment.

Although the end result could be beneficial to all, the forced restructuring also could produce serious economic, social and political pain and disruption.

The key question facing the world economy today is “whether or not trade adjustments of this magnitude . . . can be made without disrupting the economic and social fabric” of nations that have come to depend heavily on the U.S. market, according to economists Richard L. Drobnick and Selwyn Enzer of the University of Southern California.

The answer remains uncertain. On the outcome hangs nothing less than the continuing prosperity of the world’s industrial nations.

The dollar has declined for three years since reaching its peak in early 1985, making American products less expensive and thus more attractive compared to those of other countries. And the United States, after massive cost-cutting and rapid productivity gains by its industry in the 1980s, is beginning to import less and to sell more abroad.

Already, economic change in the United States--growing U.S. exports and weakening American demand for some consumer goods--is beginning to take its toll in Europe. For instance, Porsche, the Stuttgart-based auto maker, has been forced to pare one-seventh of its work force because of poor sales of some of its lower-priced models in the United States.

Wine Sales Off

In France’s grape-growing country, wine maker Alexis Lichine is feeling the change in exchange-rate patterns where it hurts most--in his pocketbook. Three years ago, with the dollar at its peak, Lichine recalls, locally made wines were selling faster than his winery could produce them. But this year, Americans have become more price-conscious, and when Lichine walked into the offices of the board of trade in the city of Margaux, he was greeted with a new air of coolness.

“They said they were hesitant about buying large quantities,” he says, “because they are not sure that they can sell them.”

Lichine has had to cut prices by 30% since 1985 just to stay even.

“Most likely, we won’t have any profit at all,” he laments.

Indeed, after ballooning to record levels in each of the last six years, the U.S. trade deficit is starting to swing rapidly back toward balance--although it did move upward again in June, when the last trade figures were reported. During the last 12 months, U.S. exports directly contributed $80 billion of the $143-billion growth in the output of the nation’s economy.

Good News, Bad News

This may appear to be good news for American industry, but it potentially bodes ill for the rest of the world, which has relied heavily on sales to the United States to maintain economic growth. No other single country has the capacity to replace the United States as the pre-eminent customer for the world’s goods. So, other nations must scramble to develop other markets, domestic or foreign, if the world economy is to avoid a serious slump.

The contracting trade deficit also poses a direct challenge for the United States. Unless America can rapidly expand its production capacity, it will not be able to manufacture enough goods both to supply its own needs and to meet the increased demand for exports. Unmet demand would fuel inflation, forcing the Federal Reserve Board to tighten the money supply. That, in turn, could create a recession.

Either outcome--a slump overseas or a recession here--could quickly reverberate around the globe. With the world now so interdependent economically, a slump in any of the leading industrial nations could quickly become a recession everywhere.

As a result, economists caution that policy-makers in all the major industrial countries must manage the adjustment carefully. The world’s often-contentious industrial powers must learn to swim more closely together or else they will sink separately, the economists say.

Must Produce More

“The U.S. has to begin producing more than it consumes,” says Alan J. Stoga, an economist at Kissinger Associates, an economic consulting firm in New York, “and the rest of the world has to grow more.”

More specifically, the analysts say:

- The major exporting countries in Asia and Europe must reduce their dependence on the United States and instead expand previously lackluster markets at home and in nearby developing countries.

- Depressed Third World nations, which have barely managed to survive their burdensome debts through sales abroad, mostly to the United States, must find fresh outlets or risk a default that would threaten the world’s financial system.

- The United States will have to adopt policies aimed at curbing domestic consumption and increasing the economy’s capacity to produce. Nearly all analysts say that the U.S. government must reduce its still-enormous budget deficit, thus freeing funds for today’s more productive use--commercial expansion.

Until recently, both U.S. and foreign officials had asserted that they were satisfied with the progress already being made. Overall domestic demand in the United States, particularly for imported consumer goods, had slowed and manufacturers were beginning to expand their production capacity. Japan had spurred more demand at home to offset the falloff in its exports to America.

And West Germany, although too afraid of inflation to follow Japan’s course, had found new markets in Europe to replace what it had lost in the United States.

“We’re really pretty pleased with the way the adjustment is being made,” said then-Treasury Secretary James A. Baker III earlier this year. “We see the U.S. economy as making the transition with a minimum degree of dislocation.”

Francois David, France’s deputy trade minister, said: “The progress is fantastic. Right now there’s really no reason to believe the pessimists.”

Uncomfortable Pace

But demand is expanding at an uncomfortable pace again in the United States, while growth in West Germany is slowing. As a result, economists who take a more pessimistic view are sounding alarms again.

“We’re in a zone of high danger, high risk,” warns Gabriel Francois, economist for Banque Nationale de Paris, one of France’s largest financial institutions.

As one sign of the looming difficulties, Airbus Industrie, the European aircraft consortium, has begun to fall behind in the competition with Boeing and McDonnell Douglas for new orders. Only a few weeks ago, the West German government concluded that it would have to double its subsidies to the multinational firm to help stem its losses.

The reasons for the upheaval are rooted in the unbalanced world economy of the 1980s. For most of this decade, America’s economic expansion provided virtually the only major stimulus for global economic growth. The United States went on a buying spree, purchasing far more than it could produce and soaking up exports from every corner of the globe. The U.S. consumer boom rescued the economies of the rest of the world, which were mired in stagnation.

Distortion in Trade

It also contributed to the soaring federal budget deficit and a tremendous distortion in global trade. America’s own trade deficit rocketed up from a relatively modest $36 billion in 1982 to a record $170 billion last year. America’s major trading partners--the behemoths of Japan and West Germany and newly industrial nations such as Taiwan and South Korea--accumulated equally outsized surpluses.

“The twin (trade and budget) deficits . . . spurred growth that, in the formative years of the global economy, substantially eased an economic slump that could have become the Great Depression of the 1980s,” wrote James Griffen, chief economist at Aetna Investment Management Group, in a recent analysis. “When others shrank from leadership, the U.S. accepted a disproportionate share of the burden.”

But the U.S. spending spree could not be sustained indefinitely, in part because it was being financed largely from abroad. Lured by America’s booming economy, lower taxes and a generous return on their capital, foreign investors poured their funds--more than $500 billion in the years from 1982 through 1987--into the United States. Americans promptly sent the money back overseas by buying imports. The cycle repeated itself over and over.

Cycle Is Ending

Now the cycle is ending. In early 1985, world investors, already wary about having piled up too many dollars in their portfolios, began to scramble out of dollar assets, driving the value of the U.S. currency down. Later that year, top economic officials of the major industrial countries, concerned that the imbalances were getting out of hand, began a concerted campaign to help drive down the U.S. trade deficit. The dollar, which had already peaked in February, 1985, continued to plunge.

For some time, the trade deficit seemed to continue growing. The reason was that the deficit is measured in dollars, which were losing value internationally, and it took progressively more dollars to buy fewer goods.

Now that the dollar has stabilized in value for about six months, however, the underlying improvement in the volume of U.S. trade is beginning to produce a conspicuous--and unexpectedly rapid--narrowing of the deficit.

Despite the upward blip in June, Commerce Department figures show that the merchandise trade deficit is likely to fall to about $130 billion in 1988 from last year’s $170 billion. And some analysts believe that it will plunge below $100 billion in 1989. If the trade gap continues narrowing at the rate it has shrunk since late last year, it will all but disappear by 1991.

“I think we’re going to be surprised at how quickly (the U.S. trade deficit) comes down--and how unprepared we are to cope with that,” says Paul Krugman, a Massachusetts Institute of Technology economist.

Self-Fulfilling Prophecy

What’s more, analysts say, the reduction is likely to continue no matter what. Any signs of a reversal would shake currency traders’ confidence in their economic projections, prompting them to sell dollars, thus making their prophecy of a declining dollar a self-fulfilling one.

As the U.S. trade deficit shrinks, the surpluses of U.S. trading partners will have to come down just as fast. Annual swings of $30 billion to $50 billion represent only about 1% of economic activity in the United States, but they can translate into massive disruptions for U.S. trading partners that rely most heavily on the U.S. market.

Taiwan, the most extreme case, shipped more than one-quarter of its entire economic output to the United States as recently as 1986.

“The rest of the world will suffer, and you are likely to see a very strong rise in anti-Americanism,” warns Tadashi Nakamae, a Tokyo economic consultant to many of Japan’s largest corporations.

Far more than Europe, Japan seems to be managing the transition. Makoto Kuroda, a recently retired Japanese trade ministry official, says that the surge in Japan’s imports of manufactured goods shows that the “imbalances are changing at a quite remarkable pace now. We are doing our part by successfully stimulating domestic demand.”

Shock of High Yen

Tokyo has pushed through a round of tax cuts and new government spending for public works projects, resulting in new domestic markets to replace deteriorating export prospects caused by the shock of the high yen to the economy.

The results have been spectacular by any measure. One particularly striking example is the giant Sony Corp., which for decades has sold more goods to America than it has in Japan. Last year, it reversed that pattern and sold more at home than it did in the United States.

“We’ve long been a much more globally minded firm than many other Japanese companies,” says Mark Kato, a corporate planner at Sony’s headquarters in Tokyo. “We’re not giving up that basic approach, but for now--and the foreseeable future--the local market is where the action is.”

Japan is also rapidly expanding its economic ties with the newly industrial Asian economies of South Korea, Taiwan, Hong Kong and Singapore, if only to prevent them from making even more rapid inroads into the Japanese market.

Hold Down Prices

In contrast to Japan’s performance, adjustment is moving much slower in Europe. Many French and West German exporters, with high unemployment and slow-growing markets at home, see little alternative but to hold down their prices enough to hang on to much of their hard-won share of the global market.

So far, at least, that strategy has paid off.

“The kind of squeeze that was anticipated has not occurred,” says Etienne Davignon, an executive of Societe Generale de Belgique, Belgium’s largest financial conglomerate.

Still, many analysts believe that the Europeans may not be as sanguine in the near future.

In contrast to the boom seen in much of Asia and North America, Europe until very recently has remained relatively stagnant. Despite the substantial stimulus from sales to the United States, manufacturing output in France edged up only 6% from 1977 to 1987, with much of the gain coming in just the last year.

Even Germany’s industry, long admired for achieving an “economic miracle” in Europe, produced only 16% more in 1987 than 1977. By comparison, industrial output in the United States surged by 31% during the decade; in Japan it leaped by 50%.

At the same time, the dollar’s decline has made America more attractive to foreign tourists. Frank and Claudia Hill, of Ratingen, West Germany, have wanted to visit the United States for years but found it too expensive when the dollar was high.

Less Expensive Vacation

This year, the Hills are flying to San Francisco, where they will rent a car and see Los Angeles, Las Vegas and Santa Barbara, with a stop at the Grand Canyon. With the deutschemark now so high in relation to the dollar, the trip will cost 1,000 deutschemarks less than it would have a year ago, Claudia Hill exults.

Wollny Schenker, a Cologne travel agent, says that her bookings to the United States are up 40% from 1985. “This country has been empty this summer because everyone was in the U.S.,” she says. “We’ve never had so much business before.”

What is good news for European tourists and their travel agents is not so good for European businesses that will see thousands of deutschemarks and francs spent overseas instead of at home.

It is fine for the United States to eliminate its trade deficit, says Tyll Necker, chief executive at Hako-Werck, a manufacturer of automatic scrubbing equipment in Bad Oldesloe, West Germany, but it “shouldn’t come too fast.”

“The current U.S. trade deficit accounts for about 2 million jobs worldwide,” he notes. “Reducing it too rapidly would mean a lot of frictions.”

Some Benefits

Even for the United States, the scaling back of the massive trade deficit will require some uncomfortable adjustments. That is because the deficit, more than just the sign of economic weakness that conventional wisdom assumes, also confers some important economic benefits and points up some potential long-term economic strengths.

The enormous flow of foreign goods into the United States has included not only consumer goods but also the capital goods needed to help modernize local production facilities. And the flip side of the trade deficit--the surge of foreign capital into the United States--has helped underwrite the cost of U.S. industrial expansion even as it has allowed foreigners to buy and profit from U.S. businesses and real estate.

“Significantly, the periods of heaviest foreign investment (in the past) coincided with the periods of the U.S. economy’s most rapid expansion, providing the financing that ultimately helped American industrial firms overcome all European competitors,” argues Joel Kotkin, co-author of a forthcoming book on changes in the global economy. “Today, that process is repeating itself.”

As imports and foreign investment decline, the United States will need to generate more funds at home.

Inflation Risk

The other drawback to reducing the trade deficit is the risk of much higher inflation. David Levine, chief economist at Sanford C. Bernstein & Co., a New York investment house, calls it “an inherently inflationary process” because as the competition from imported goods declines, American manufacturers tend to raise prices. U.S. producers have not yet fully raised their prices to match price hikes on imported goods, and if the dollar falls further, they will have even more room to boost prices.

“To be sure, the eradication of the deficit will stimulate employment and profits in those areas of the economy that were battered by foreign competition in the early 1980s,” says Levine. “But the fact that the trade correction is likely to be concentrated between 1987 and 1990,” when inflation is already expected to be heating up, “means that it will happen at the worst possible time.”

“There’s no question at all that having a recession would be the quickest way to resolve the trade gap effectively,” Albert Bressand, director of Promethee, a Paris-based economic research organization, asserts. America’s appetite for imports would shrink almost overnight. The West German and Japanese surpluses would evaporate. But virtually every country--particularly Latin American debtors--would suffer.

Many also fear that such a setback would rekindle protectionism around the globe. “If the dollar falls 20% to 25% more, you’ll start a trade war,” says Alain Chevalier, chairman of Moet Hennessy Louis Vuitton, the Paris-based producer of luxury goods. “Everyone will look to protect his own markets. Japan would come back to Asia; America would be a closed market. And Europe would turn protectionist.”

But for now, at least, Grammer’s Johann Singer is continuing to cope, trying to cut costs further and promote new, more upscale products.

“We’ve been in some hard discussions here,” Singer says, “but we’re still optimistic about the future.

“The thing to understand,” he adds, “is that it’s a matter of time. You can’t do this overnight.”

THE U.S. TRADE DEFICIT: BACK DOWN TO EARTH

In billions of dollars

with world with Japan with W. Germany 1980 $25 $12 $1 1981 35 18 2 1982 36 19 3 1983 64 22 4 1984 122 37 9 1985 134 50 12 1986 155 59 16 1987 170 60 16 1988 130* 52* 13* 1989 115* ** **

* estimate ** no estimate available

Source: Morgan Guaranty Trust Co.