IX IMPACT OF THE WORLD ECONOMY Today, virtually every country in the world is affected by what happens in other countries. Some of these effects are a result of political events, such as the overthrow of one government in favor of another. But a great deal of the interdependence among the nations is economic in nature, based on the production and trading of goods and services.

One of the most rapidly growing and changing sectors of the U.S. economy involves trade with other nations. In recent decades, the level of goods and services imported from other countries by U.S. consumers, businesses, and government agencies has increased dramatically. But so, too, has the level of U.S. goods and services sold as exports to consumers, businesses, and government agencies in other nations. This international trade and the policies that encourage or restrict the growth of imports and exports have wide-ranging effects on the U.S. economy.

As the nation with the world’s largest economy, the United States plays a key role on the international political and economic stages. The United
States is also the largest trading nation in the world, exporting and importing more goods and services than any other country.. Some people worry that extensive levels of international trade may have hurt the U.S. economy, and U.S. workers in particular. But while some firms and workers have been hurt by international competition, in general economists view international trade like any other kind of voluntary trade: Both parties can gain, and usually do. International trade increases the total level of production and consumption in the world, lowers the costs of production and prices that consumers pay, and increases standards of living. How does that happen?

All over the world, people specialize in producing particular goods and services, then trade with others to get all of the other goods and services they can afford to buy and consume. It is far more efficient for some people to be lawyers and other people doctors, butchers, bakers, and teachers than it is for each person to try to make or do all of the things he or she consumes.

In earlier centuries, the majority of trade took place between individuals living in the same town or city. Later, as transportation and communications networks improved, individuals began to trade more frequently with people in other places. The industrial revolution that began in the 18th century greatly increased the volume of goods that could be shipped to other cities and regions, and eventually to other nations. As people became more prosperous, they also traveled more to other countries and began to demand the new products they encountered during their travels.

The basic motivation and benefits of international trade are actually no different from those that lead to trade within a nation. But international trade differs from trade within a nation in two major ways.
First, international trade involves at least two national currencies, which must usually be exchanged before goods and services can be imported or exported. Second, nations sometimes impose barriers on international trade that they do not impose on trade that occurs entirely inside their own country.

A U.S. Imports and Exports

U.S. exports are goods and services made in the United States that are sold to people or businesses in other countries. Goods and services from other countries that U.S. citizens or firms purchase are imports for the
United States. Like almost all of the other nations of the world, the
United States has seen a rapid increase in both its imports and exports over the last several decades. In 1959 the combined value of U.S. imports and exports amounted to less than 9 percent of the country’s gross domestic product (GDP); by 1997 that figure had risen to 25 percent.
Clearly, the international trade sector has grown much more rapidly than the overall economy.

Most of this trade occurs between industrialized, developed nations and involves similar kinds of products as both imports and exports. While it is true that the U.S. imports some things that are only found or grown in other parts of the world, most trade involves products that could be made in the United States or any other industrialized market economies. In fact, some products that are now imported, such as clothing and textiles, were once manufactured extensively in the United States. However, economists note that just because things were or could be made in a country does not mean that they should be made there.

Just as individuals can increase their standard of living by specializing in the production of the things they do best, nations also specialize in the products they can make most efficiently. The kinds of goods and services that the United States can produce most competitively for export are determined by its resources. The United States has a great deal of fertile land, is the most technologically advanced nation in the world, and has a highly educated and skilled labor force. That explains why U.S. companies produce and export many agricultural products as well as sophisticated machines, such as commercial jets and medical diagnostic equipment.

Many other nations have lower labor costs than the United States, which allows them to export goods that require a lot of labor, such as shoes, clothing, and textiles. But even in trading with other industrialized countries—whose workers are similarly well educated, trained, and highly paid—the United States finds it advantageous to export some high-tech products or professional services and to import others. For example, the
United States both imports and exports commercial airplanes, automobiles, and various kinds of computer products. These trading patterns arise because within these categories of goods, production is further specialized into particular kinds of airplanes, automobiles, and computer products. For example, automobile manufacturers in one nation may focus production primarily on trucks and utility vehicles, while the automobile industries in other countries may focus on sport cars or compact vehicles.

Greater specialization allows producers to take full advantage of economies of scale. Manufacturers can build large factories geared toward production of specialized inventories, rather than spending extra resources on factory equipment needed to produce a wide variety of goods.
Also, by selling more of their products to a greater number of consumers in global markets, manufacturers can produce enough to make specialization profitable.

The United States enjoyed a special advantage in the availability of factories, machinery, and other capital goods after World War II ended in
1945. During the following decade or two, many of the other industrial nations were recovering from the devastation of the war. But that situation has largely disappeared, and the quality of the U.S. labor force and the level of technological innovation in U.S. industry have become more important in determining trade patterns and other characteristics of the U.S. economy. A skilled labor force and the ability of businesses to develop or adapt new technologies are the key to high standards of living in modern global economies, particularly in highly industrialized nations. Workers with low levels of education and training will find it increasingly difficult to earn high wages and salaries in any part of the world, including the United States.

B Barriers to Trade Despite the mutual advantages of global trade, governments often adopt policies that reduce or eliminate international trade in some markets. Historically, the most important trade barriers have been tariffs (taxes on imports) and quotas (limits on the number of products that can be imported into a country). In recent decades, however, many countries have used product safety standards or legal standards controlling the production or distribution of goods and services to make it difficult for foreign businesses to sell in their markets. For example, Russia recently used health standards to limit imports of frozen chicken from the United States, and the United States has frequently charged Japan with using legal restrictions and allowing exclusive trade agreements among Japanese companies. These exclusive agreements make it very difficult for U.S. banks and other firms to operate or sell products in Japan.

While there are special reasons for limiting imports or exports of certain kinds of products—such as products that are vital to a nation’s national defense—economists generally view trade barriers as hurting both importing and exporting nations. Although the trade barriers protect workers and firms in industries competing with foreign firms, the costs of this protection to consumers and other businesses are typically much higher than the benefits to the protected workers and firms. And in the long run it usually becomes prohibitively expensive to continue this kind of protection. Instead it often makes more sense to end the trade barrier and help workers in industries that are hurt by the increased imports to relocate or retrain for jobs with firms that are competitive. In the
United States, trade adjustment assistance payments were provided to steelworkers and autoworkers in the late 1970s, instead of imposing trade barriers on imported cars. Since then, these direct cash payments have been largely phased out in favor of retraining programs.

During recessions, when national unemployment rates are high or rising, workers and firms facing competition from foreign companies usually want the government to adopt trade barriers to protect their industries. But again, historical experience with such policies shows that they do not work. Perhaps the most famous example of these policies occurred during the Great Depression of the 1930s. The United States raised its tariffs and other trade barriers in legislation such as the Smoot-Hawley Act of
1930. Other nations imposed similar kinds of trade barriers, and the overall result was to make the Great Depression even worse by reducing world trade.

C World Trade Organization (WTO) and Its Predecessors

As World War II drew to a close, leaders in the United States and other
Western nations began working to promote freer trade for the post-war world. They set up the International Monetary Fund (IMF) in 1944 to stabilize exchange rates across member nations. The Marshall Plan, developed by U.S. general and economist George Marshall, promoted free trade. It gave U.S. aid to European nations rebuilding after the war, provided those nations reduced tariffs and other trade barriers.

In 1947 the United States and many of its allies signed the General
Agreement on Tariffs and Trade (GATT), which was especially successful in reducing tariffs over the next five decades. In 1995 the member nations of the GATT founded the World Trade Organization (WTO), which set even greater obligations on member countries to follow the rules established under GATT. It also established procedures and organizations to deal with disputes among member nations about the trading policies adopted by individual nations.

In 1992 the United States also signed the North American Free Trade
Agreement (NAFTA) with its closest neighbors and major trading partners,
Canada and Mexico. The provisions of this agreement took effect in 1994.
Since then, studies by economists have found that NAFTA has benefited all three nations, although greater competition has resulted in some factories closing. As a percentage of national income, the benefits from
NAFTA have been greater in Canada and Mexico than in the United States, because international trade represents a larger part of those economies.
While the United States is the largest trading nation in the world, it has a very large and prosperous domestic economy; therefore international trade is a much smaller percentage of the U.S. economy than it is in many countries with much smaller domestic economies.

D Exchange Rates and the Balance of Payments

Currencies from different nations are traded in the foreign exchange market, where the price of the U.S. dollar, for instance, rises and falls against other currencies with changes in supply and demand. When firms in the United States want to buy goods and services made in France, or when
U.S. tourists visit France, they have to trade dollars for French francs.
That creates a demand for French francs and a supply of dollars in the foreign exchange market. When people or firms in France want to buy goods and services made in the United States they supply French francs to the foreign exchange market and create a demand for U.S. dollars.

Changes in people’s preferences for goods and services from other countries result in changes in the supply and demand for different national currencies. Other factors also affect the supply and demand for a national currency. These include the prices of goods and services in a country, the country’s national inflation rate, its interest rates, and its investment opportunities. If people in other countries want to make investments in the United States, they will demand more dollars. When the demand for dollars increases faster than the supply of dollars on the exchange markets, the price of the dollar will rise against other national currencies. The dollar will fall, or depreciate, against other currencies when the supply of dollars on the exchange market increases faster than the demand.

All international transactions made by U.S. citizens, firms, and the government are recorded in the U.S. annual balance of payments account.
This account has two basic sections. The first is the current account, which records transactions involving the purchase (imports) and sale
(exports) of goods and services, interest payments paid to and received from people and firms in other nations, and net transfers (gifts and aid) paid to other nations. The second section is the capital account, which records investments in the United States made by people and firms from other countries, and investments that U.S. citizens and firms make in other nations.

These two accounts must balance. When the United States runs a deficit on its current account, often because it imports more that it exports, that deficit must be offset by a surplus on its capital account. If foreign investments in the United States do not create a large enough surplus to cover the deficit on the current account, the U.S. government must transfer currency and other financial reserves to the governments of the countries that have the current account surplus. In recent decades, the
United States has usually had annual deficits in its current account, with most of that deficit offset by a surplus of foreign investments in the U.S. economy.

Economists offer divergent views on the persistent surpluses in the U.S. capital account. Some analysts view these surpluses as evidence that the
United States must borrow from foreigners to pay for importing more than it exports. Other analysts attribute the surpluses to a strong desire by foreigners to invest their funds in the U.S. economy. Both interpretations have some validity. But either way, it is clear that foreign investors have a claim on future production and income generated in the U.S. economy. Whether that situation is good or bad depends how the foreign funds are used. If they are used mainly to finance current consumption, they will prove detrimental to the long-term health of the
U.S. economy. On the other hand, their effect will be positive if they are used primarily to fund investments that increase future levels of
U.S. output and income.

X CURRENT TRENDS AND ISSUES

In the early decades of the 21st century, many different social, economic and technological changes in the United States and around the world will affect the U.S. economy. The population of the United States will become older and more racially and ethnically diverse. The world population is expected to continue to grow at a rapid rate, while the U.S. population will likely grow much more slowly. World trade will almost certainly continue to expand rapidly if current trade policies and rates of economic growth are maintained, which in turn will make competition in the production of many goods and services increasingly global in scope.
Technological progress is likely to continue at least at current rates, and perhaps faster. How will all of this affect U.S. consumers, businesses, and government?

Over the next century, average standards of living in the United States will almost certainly rise, so that on average, people living at the end of the century are likely to be better off in material terms than people are today. During the past century, the primary reasons for the increase in living standards in the United States were technological progress, business investments in capital goods, and people’s investments in greater education and training (which were often subsidized by government programs). There is no evident reason why these same factors will not continue to be the most important reasons underlying changes in the standard of living in the United States and other industrialized economies. A comparatively small number of economists and scientists from other fields argue that limited supplies of energy or of other natural resources will eventually slow or stop economic growth. Most, however, expect those limits to be offset by discoveries of new deposits or new types of resources, by other technological breakthroughs, and by greater substitution of other products for the increasingly scarce resources.

Although the U.S. economy will likely remain the world’s largest national economy for many decades, it is far less certain that U.S. households will continue to enjoy the highest average standard of living among industrialized nations. A number of other nations have rapidly caught up to U.S. levels of income and per capita output over the last five decades of the 20th century. They did this partly by adopting technologies and business practices that were first developed in the United States, or by developing their own technological and managerial innovations. But in large part, these nations have caught up with the United States because of their higher rates of savings and investment, and in some cases, because of their stronger systems for elementary and secondary education and for training of workers.

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