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Greenspan's Concerns About Over-Consumption Apply to the Trade Deficit Also

By William R. Hawkins
Wednesday, March 09, 2005

Federal Reserve Chairman Alan Greenspan has been making strong statements about the need to restrain both private and government spending in order to boost national savings rates and reduce debt.  His focus has been on the Federal budget deficit and the tax system, which is supposed to pay for government programs, but which has been falling short of that goal.

But the country also faces a massive trade deficit, one that is larger than the Federal budget deficit and growing rapidly.  The trade deficit shares several problems with the budget deficit, and threatens the national economy in ways even more direct.  Greenspan has been reluctant to address the trade problem, but many of the same recommendations he has made about the domestic economy apply just as well to the international economy.

In his recent testimony before the House and Senate committees on the budget, Greenspan noted certain “market pressures, which appear poised to stabilize and over the longer run possibly to decrease the U.S. current account deficit and its attendant financing requirements.” This pressure is manifest in the decline in the value of the dollar.  In November 2004, the euro broke through the key mark of $1.30 per euro.  This represented a rise of 52 % for the euro against the dollar since early 2002.  But the dollar fell less in Asia where America runs its largest trade deficits.  This is because China, Japan and other Asian states manipulate their currencies to prevent an adjustment that would reduce their exports.  They buy American financial assets rather than products.  Consequently, the dollar has declined by only about 15 % over the last year when indexed against all U.S. trading partners, while the trade deficit jumped by 24 % to $618 billion.  No wonder Greenspan’s “optimism” about a market solution to the trade problem was so low-key and gloomy.

In his March 2 testimony before the House Committee on the Budget, Greenspan also cited some market help for the budget deficit: “The cyclical component of the deficit should narrow as the economic expansion proceeds and incomes rise....But, as the latest projections from the Administration and the Congressional Budget Office suggest, our budget position is unlikely to improve substantially in the coming years unless major deficit-reducing actions are taken.” He then called on the lawmakers to determine “whether the nation was living within its fiscal means” and even suggested higher taxes would be preferable to continued deficits.

In both of these appearances on Capitol Hill, Greenspan called for an increase in net national saving.  The “market” will not create this change unaided.  Greenspan told President Bush's tax-reform commission on March 3, “Many economists believe that a consumption tax would be best from the perspective of promoting economic growth...because a consumption tax is likely to encourage saving and capital formation.”

Greenspan also talked about the need to broaden the tax base, simplify the tax code for Americans and consider any “distortions” that might arise from different tax systems.  What he did not mention, but should have, is a tax that would fill all the goals he set out: tariffs on imported goods.

As the trade deficit has exploded and public sentiment has grown hostile towards the current “free trade” approach that has clearly failed, the increasingly shrill defenders of the globalization ideology have placed more and more emphasis on the supposed benefits to the country of the consumption of  “cheap” imports.  Yet, as Greenspan has argued, an overemphasis on consumption to the neglect of investment risks economic stagnation.

To the global consumptionists, tariffs are bad because they make imports more expensive.  Yet, this is exactly what the devaluation of the dollar does, and what new domestic consumption taxes would do.  Indeed, if over-consumption is the problem, then the solution should aim as directly as possible at the source of the problem – and that is spending on imports.  The U.S. propensity to buy imports has been growing over time.  According to economists at the French  banking group Société Générale, for each extra dollar Americans spend today on consumer goods, excluding autos, 45 cents go to imports.  That share is up from 25 cents in 1997 and just 15 cents in 1990.   This trend must be reversed or the trade deficit will never be brought under control.

A tax on imports would be a simple way to broaden the tax base, by adding foreign corporations to it.  If the tax was high enough to substantially reduce imports, then the tariffs would not collect much revenue.  But as consumers shifted their purchases to American-made goods, the domestic tax base would expand and generate more revenue for the federal government.  The effect would be to reduce both the trade and budget deficits at the same time.

Tariffs have another important advantage over dollar devaluation.  When the dollar falls, it makes all products more expensive, even those the country might want or need to import.  Tariffs can be applied selectively, on items and in amounts calculated to provide the best advantages to the American economy.  And the dollar is a critical strategic asset to the United States as the world’s leading political and military power.  Rather than gut the dollar to solve the trade problem, policy should aim to solve the trade problem so that the dollar can remain strong and continue to serve as the world’s primary currency.

The argument for dollar devaluation over tariffs is that a cheaper dollar helps American exports.  But is it clear by now that America cannot export its way out of its trade deficit.  Foreign tariffs and other barriers are already in place to prevent the kind of expansion of U.S. exports into overseas markets that would be needed.  As Greenspan noted on February 4, "Exports must grow half again as quickly as imports just to keep the trade deficit from widening – a benchmark that has yet to be met." Indeed, the latest trade data show that in 2004, U.S.  exports rose only 11.2% while imports grew 16.8% even with the dollar falling.  The domestic market that has been lost to imports is far larger than any possible foreign market share that can possibly be gained by exports.

Refocusing on growing the domestic economy through selective tariffs would put an end to outsourcing and stimulate a true “insourcing.” It would cause a wave of “greenfield investment” in new plants, bringing new technologies and jobs, as foreign and expatriate American firms relocated industry back in the United States to avoid the tariffs. Such a trend would be the opposite of the current “brownfield investment” or purchasing of existing American companies with surplus trade dollars that the globalization cheerleaders falsely label as “insourcing.” A consumption tax on foreign-made products, i.e. tariffs, is the kind of “distortion” that should be encouraged by national policy, as it would reduce the trade and budget deficits, and pay real dividends for the future development of the American economy.

William R. Hawkins is Senior Fellow for National Security Studies at the U.S. Business and Industry Council.