Not your grandfather’s economy

Conceptually, many observers seem to work with informal models that have foreign demand being met by exports, and strong demand in the U.S. being met by imports. This may have been true once, but it is no longer a valid description of the way the international economy works.

U.S. companies service foreign markets not so much by exporting, but rather by producing and selling goods locally. Specifically, the U.S. will export around $1 trillion worth of goods this year. However, foreign affiliates of U.S. companies will sell approximately $3 trillion worth of goods overseas this year. Truth be told, sales by foreign affiliates of U.S. companies have outstripped U.S. exports since at least the mid-60s, when the U.S. Commerce Department began recording such data. According to data from Japan’s Ministry of Finance, local sales by affiliates of Japanese companies began outstripping their exports in the late 90s.

Consider the auto sector. Previously, a large chunk of the U.S. trade deficit with Japan could be traced to automobiles and auto parts. Owing in part to such protectionist measures as voluntary export restrictions and orderly market agreements, Japanese companies shifted production facilities. The increasing share of the U.S. auto market they are securing is coming through local production using U.S. workers.

The U.S. Bureau of Economic Analysis (BEA) recognizes the importance of this transformation. For several years they have been experimenting with an alternative measure of the U.S. current account. Rather than simply considering the movement of goods and services over national boundaries, they want to take into account who owns the goods being sold.

Using this “ownership-based framework,” the U.S. current account deficit appears materially smaller. Specifically, this past January the BEA provided a preliminary estimate of the 2003 current account deficit using the ownership based framework of $377.6 billion, which is nearly $119 billion less than the conventional measure based purely on location of production. The irony of this is the ownership-based framework’s estimate would place the U.S. current account deficit close to what economists claim is a sustainable proportion of GDP.

It seems likely this alternative measure, or something like it, will replace the conventional measure in the not too- distant future. Recall that previously the U.S. used to report the merchandise trade balance, which was consistently in deficit. Separately, the U.S. reported the service trade balance, which was consistently in surplus. During the presidency of Ronald Reagan, the two were combined; it made both economic and political sense. Service trade was growing in importance and combining both gave a more complete reading of the U.S. trade position. Politically, the combined result showed a smaller deficit and may have helped undermine protectionist sentiment. The same general arguments favor adopting an ownership- based framework for measuring the U.S. current account balance.