[Economic Report of the President (1997)]
[Administration of William J. Clinton]
[Online through the Government Printing Office, www.gpo.gov]

[DOCID: f:erp_c7._]
Economic Report of the President - - - - - - - - - - - - H. Doc. 105-002
[From the online service of the U.S. Government Printing Office]
[wais.access.gpo.gov]


CHAPTER 7--American Leadership in the Emerging Global Economy

SEVENTY-EIGHT YEARS AGO, after the end of World War I, an
isolationist America made a tragic mistake by retreating from
international engagement. The punitive economic conditions imposed on
Germany in the 1919 Treaty of Versailles, along with protectionist
pressures culminating in the Trade Act of 1930 in the United States (the
origin of the infamous Smoot-Hawley tariff) and other measures
elsewhere, destabilized the international economy and deepened the Great
Depression. These events in turn are widely believed to have contributed
to political instability in Europe, thus helping bring on World War II.
After that war the United States, determined to get it right this
time, did pursue a policy of international engagement. American
leadership fostered the creation of a stable and predictable
international economic environment and of international institutions,
such as the International Monetary Fund (IMF), to promote cooperation on
economic matters. The United States also played a key role in designing
the postwar multilateral trading system. Mutually agreed rules,
formulated under the General Agreement on Tariffs and Trade (GATT),
underpinned the development of a trading regime in which countries could
prosper. All these efforts greatly enhanced America's well-being,
economically as well as politically. In the Cold War years, the United
States led an economic partnership with other industrial democracies in
Europe, North America, and the Pacific Rim. These countries flourished
as economic cooperation took root.
The Cold War era also saw the decolonization of much of Africa,
Asia, the Middle East, the Pacific, and the Caribbean. The new countries
that emerged, together with the already independent lower and middle-
income countries of Latin America, became known collectively as the
developing world. Through its own direct assistance and through
institutions such as the World Bank, the United States led the
international coordination of aid and lending to these countries and,
more recently, to the countries in transition from central planning.
Now a new era is beginning. Fundamental changes have reshaped the
world economy. One of the previous central motivations for U.S.
leadership, that of superpower competition with the Soviet Union, is
gone. Yet the United States and other countries continue to benefit from
U.S. leadership in international economic policy. U.S. economic
leadership must move forward with a renewed vision, adapted to these
changed political and economic realities.
This chapter examines how the world economy has changed, and how
U.S. leadership remains necessary in international economic
relationships. A policy of economic openness and engagement, supporting
the kind of international economic system the United States has worked
hard to establish over the past half century, will continue to yield
great benefits to the Nation, through access to new markets and through
enhanced international stability and cooperation. In this area some of
the current policies on which the Administration places priority are:
 facilitating economic reform in the transition economies
and their integration into world markets, including their
accession to the World Trade Organization (WTO)
 providing adequate resources for multilateral development
efforts, including full funding of U.S. commitments to the World
Bank's International Development Association (IDA)
 supporting the rules-based international trading system
centered on the WTO
 continuing a wide variety of efforts to open foreign
markets to U.S. exports, encouraging U.S. companies to take
advantage of these opportunities, and working with the Congress
to negotiate further international market opening
 furthering U.S. efforts toward greater economic linkages
within the Asia-Pacific Economic Cooperation (APEC) forum and
the proposed Free Trade Area of the Americas (FTAA) agreement
 strengthening the international financial system and
increasing the capacity of international financial institutions
to respond to crises.
 fostering cooperation on common challenges in the Group of
Seven at the summit of heads of state that the President will
host in Denver in June 1997.

THREE SWEEPING CHANGES

At the core of the international economic system that emerged after
World War II was what came to be called the liberal international
trading system. It was liberal in the sense that it worked to free the
flow of goods and capital from the restrictions that had often
characterized the interwar regime. A few widely shared, basic premises
underlay this system.
Just as competitive markets within economies had helped deliver
remarkable increases in standards of living in the industrial world, so
competition between economies could help sustain and enhance these
increases. The economic principles underlying this belief were long
established. One was that international trade allows countries to find
their comparative advantage, concentrating their production on those
goods in which they have the largest cost advantage over others. Another
was that bigger markets spell greater scope for the gains that come from
specialization.
The trading system had other, noneconomic purposes as well. The
Western democracies believed that prosperity was the best insurance
against the spread of Communism. Indeed, trade liberalization is a
natural corollary of the paradigm of democratic market capitalism, which
won an important intellectual and strategic victory in the Cold War.
Three recent changes have had a profound effect on the international
economic environment: the end of the Cold War, the emergence of growing
markets among the developing countries of East Asia and Latin America,
and the increasing globalization of the international economy. These
changes have also created important opportunities for the United States.
Understanding these changes helps us see where the international economy
is headed in the future, so that we can more effectively respond to
these challenges, fulfill our responsibilities, and take advantage of
these opportunities.

THE END OF THE COLD WAR

In 1989 the Soviet Union relaxed its control over the Eastern
European countries that had suffered its domination for over 40 years.
These countries immediately seized the opportunity to throw off
authoritarian Communist rule. Two years later the Soviet Union itself
underwent a political and ideological upheaval, which quickly led to its
breakup into 15 independent states. Most of these and the other formerly
centrally planned economies are now, to varying degrees, engaged in a
process of transition from central planning and state ownership to
market forces and private ownership.
An essential part of the West's victory in the Cold War was that it
decided once and for all the contest between two radically different
approaches to organizing political and economic life. The industrial
democracies had allowed markets to guide most economic decisions. The
Communist countries had relied on central planning, in which state-owned
producers acted on instructions handed down from government ministries.
By the 1980s the success of the market democracies stood in sharp
contrast with the evident stagnation of the Communist economies that had
stuck by central planning.
This triumph of democracy and markets was as much an intellectual
victory as a political and economic one. The idea that state planners
could effectively guide every aspect of production in an entire economy
was thoroughly discredited. The amount of information required for
planning to work far exceeded the planners' ability to gather and
process it. In any case, without private property, hard budget
constraints, and competition both from other domestic firms and from
abroad, the managers of socialist enterprises lacked incentives to
streamline production or to innovate. Consumers in these countries had
to make do with increasingly shoddy products. Industrial productivity
fell far short of that in the industrial democracies. Lacking a system
of flexible, market-determined prices to convey information about
relative scarcities, and lacking decentralized decisionmakers with the
freedom and incentives to act on that information and allocate resources
accordingly, the centrally planned economies fell far behind the West.
The Communist countries made another major blunder: as a matter of
policy, they insulated themselves from the world economy and ignored the
opportunities that international trade offers to raise living standards.
This is not to say that the Communist countries did not trade. They did,
but mostly with each other. In 1989, for example, Czechoslovakia,
despite its location adjacent to affluent Western Europe, conducted 54
percent of its trade with its fellow Communist countries, and almost 60
percent of that trade was with the Soviet Union. Given these countries'
other economic handicaps, such limited trade failed to reap many of the
potential gains of comparative advantage or of expanded competition.
Trade became just another misguided planning decision, and was often
undertaken merely for political reasons as well.

INDUSTRIALIZATION AND GROWTH COME TO THE DEVELOPING WORLD

The second great change of recent years has been the rapid
industrialization and economic growth of a number of developing
countries in several parts of the world. The first of these emerging
markets were the four Asian ``tigers'': Hong Kong, Singapore, South
Korea, and Taiwan. Now Malaysia, Thailand, and some other Asian
countries are following in their footsteps, and some of the Latin
American countries, having overcome the debt crisis of the 1980s and
undertaken economic and political reforms, have also begun to see
faster, more sustained growth.
The success of these countries offers valuable insights into the
necessary ingredients for successful development. It has implications
for U.S. international economic policy as well. Again, because trade,
and economic relations more generally, are a positive-sum enterprise,
the rise of these countries also brings opportunities for the United
States and the other established economies. As a major exporter of
capital goods--the tools of development--and of agricultural products,
consumer goods, and commercial services, the United States is especially
well poised to benefit from these economies' growing demand.

The Success of East and Southeast Asia

From 1960 to 1993, 8 of the world's 10 fastest-growing economies
were all in the same region: East and Southeast Asia. Japan's gross
domestic product (GDP) per capita, adjusted for differences in relative
prices, grew from 30 percent of that of the United States in 1960 to 82
percent in 1994, and South Korea's from 9 percent to 40 percent. The
four ``tigers'' experienced growth in GDP per capita averaging over 6
percent per year, during a period in which U.S. income per capita grew
less than 2 percent per year (Chart 7-1). Malaysia's growth has averaged
over 4 percent a year, and Indonesia's only slightly less (Chart 7-2).
China, the world's most populous country with more than a billion
inhabitants, has seen phenomenal growth in GDP per capita, averaging 8.1
percent per year since 1978. Although still under Communist rule, China
has begun to recognize the tenets of market economics, including the
importance of incentives and entrepreneurship, which have awakened the
country's vast potential.


Although their approaches to development have differed in various
ways, the success of these economies teaches important lessons on the
elements of a sound development strategy. These include attention to
human and physical capital, a limited role for government, and export-
oriented policies. Another lesson is that rapid development need not be
accompanied by large income disparities.
The development of human capital has made a critical contribution to
Asia's success. The region's successful economies have invested in
nearly universal primary and secondary education, while at the same time
developing their scientific and engineering capabilities. This has given
them a labor force equipped to work with increasingly complex production
processes, and has permitted them to move to increasingly sophisticated
technologies over time. A particularly noteworthy aspect of their
educational strategy has been its emphasis on female as well as male
education.
Investment in physical capital has also contributed greatly. In the
successful economies, most of this investment has been financed
domestically, thanks to relatively high domestic saving rates. Some East
Asian economies have achieved gross saving rates of more than 30 percent
of GDP.
The role of government in many successful East Asian economies has
generally been to complement markets and make them work better, rather
than to replace them. Governments made it their first responsibility to
keep their fiscal affairs in order. Deficits were small, and some
governments actually ran surpluses. Government expenditure focused on
investment, both in people and in infrastructure. Governments also took
charge of maintaining macroeconomic stability, avoiding extremes of high
inflation and high unemployment.
The successful East Asian economies also adopted policies of outward
orientation. Firms were expected to compete in export markets, where
they would have to adopt international standards and best practices.
Engagement in the international economy also facilitated the increase of
technological capacity. Empirical evidence indicates that economies in
East Asia and elsewhere that adopted such outward-oriented strategies
enjoyed superior performance in terms of exports, overall growth, and
employment. One study found that, during the 1970s and 1980s, the more
open economies in a large sample of developing countries grew on average
by 4.5 percent per year, compared with only 0.7 percent for more closed
economies. Not a single open developing economy in the survey grew at
less than 2 percent per year during this period. Of course, some of the
observed correlation between openness and growth may be due to reverse
causality: countries tend to liberalize trade as they develop. But even
when one isolates exogenous differences in trade levels across countries
(e.g., due to geography), it appears that trade leads to faster growth.
The East and Southeast Asian economies recognized the importance of
exports to their economic growth, but they were not always as receptive
to imports. Although they avoided the extremes of protracted import
substitution policies (discussed below), which insulated the industries
of many other countries behind walls of protection, they did erect a
variety of barriers to trade, which were distortionary and may have
impeded growth at home and abroad.
The East Asian experience upset the conventional wisdom on the
relationship between growth and income equality. The established
theories held that inequality was necessary to promote economic growth,
because growth requires saving, and the wealthy tend to save more than
the nonwealthy. Theory also held that inequality increased in the early
stages of growth, as an income gap emerged between workers in the new
industrial sector and those left behind in the traditional agrarian
sector. The poor would eventually benefit from the growth in national
prosperity, in this view.
Confounding these theories, several East Asian economies succeeded
in growing rapidly while not only maintaining a more even income
distribution than many other countries but actually reducing inequality.
More-equal distribution of income contributed to rapid growth through
several channels. For instance, it facilitated the accumulation of human
capital, as more households could afford to pay for their children's
education. Land reform in Taiwan and some other economies after World
War II both improved equality and enhanced peasants' incentives,
stimulating growth.

The Revival of Growth in Latin America

For many economies in Latin America the 1980s were a ``lost
decade.'' After growing robustly in the 1960s and 1970s (Chart 7-3),
these countries took on large foreign debts in the late 1970s and early
1980s. They pursued inward-oriented economic policies, developing their
industries to supply domestic demand behind high trade barriers that
reduced competition and distorted prices. These policies left them ill
equipped to service this mounting debt, much of which financed
consumption rather than productive investment. In 1981-82, high dollar
interest rates pushed these countries' debt-service requirements upward,
a deep recession in the United States lowered demand for their exports,
and prices for their export commodities declined. Debt-service payments
thus rose sharply in relation to export earnings. When these problems
erupted into a crisis in Mexico in August 1982, a number of countries
were forced to suspend these payments. Many were compelled to make
painful adjustments to continue debt payments, while investors remained
reluctant to extend new financing. Through cooperative efforts led by
the United States with other industrialized creditor countries and the
IMF and the World Bank, many Latin American countries reformed their
economies and restructured their debts, and by the early 1990s the
crisis had unwound.
Most of these countries have resumed growth in the 1990s. Their
governments now intervene less in their economies, and they have adopted
more outward-oriented policies. The star performer has been Chile, whose
relatively open, liberal economy has seen growth averaging more than 6
percent per year since 1983 while moving more than a third of the
country's poor above the poverty line. Other economies have also
expanded. Since 1993, real growth in Brazil, Latin America's largest
economy, has averaged over 4 percent per year. Brazil has also quashed
inflation after more than a decade of extreme price instability.
Argentina's economy, which contracted by 1 percent per year during the
1980s, has seen an even more striking recovery.
The reentry of a dynamic Latin America into the international
economy offers especially great opportunities for the United States. Our
historical ties with that region as well as our geographical proximity
make it likely that the United States will benefit greatly from Latin
America's resurgence.


INCREASED GLOBALIZATION

The third major change in the international economic environment is
even more sweeping than the first two. National economies are becoming
steadily more integrated. Technological barriers have fallen as
transportation and communication costs have plummeted. Man-made barriers
have also fallen, as tariffs have been drastically reduced in a series
of multilateral trade negotiations since World War II, and as efforts to
reduce nontariff barriers have gathered speed.
Some numbers help illustrate the shrinking economic distance between
countries. Advances in shipping technology have reduced average ocean
freight charges per short ton from $95 in 1920 to $29 in 1990 (these
figures are for U.S. trade only and are in 1990 dollars). Between 1930
and 1990, average air transport revenue per passenger-mile fell from 68
cents to 11 cents, and the cost of a 3-minute phone call from New York
to London dropped from $244.65 to $3.32 (again in 1990 dollars).
Trade has increased faster than output in the postwar era. In 1960,
total world exports amounted to $629 billion (in 1995 dollars). By 1995
they had risen to over $5 trillion. In real terms, world exports have
grown at an annual rate of 6.1 percent per year since 1960, while world
output grew at 3.8 percent (Chart 7-4). This growth of trade has led to
wider competition, allowing countries to benefit from their comparative
advantage and raising living standards everywhere.


Globalization has made great strides but still has a long way to go.
The physical and information costs of international trade are still
substantial, although current trends and the history of economic and
technological advancement suggest that these costs will continue to
shrink. As they do, however, other barriers to trade will take on
greater importance.

The Evolution of International Institutions

A number of international institutions have evolved under strong
U.S. encouragement to handle the challenges posed by increased global
integration. Two that are central are the International Monetary Fund
and the World Bank, both created at the Bretton Woods conference at the
end of World War II. The World Bank's first task was to finance Western
Europe's postwar reconstruction. It has since become a major financier
of infrastructure and other projects and programs in developing
countries--and now transition economies as well--around the world. On
its successful model, regional multilateral development banks have also
been set up for Africa, Asia, Latin America and the Caribbean, and most
recently for Eastern Europe and the former Soviet Union.
The IMF was designed to provide temporary financing to countries
with balance of payments shortfalls, as a means of supporting the
international system of fixed exchange rates that the Bretton Woods
conference also established. That system pegged members' currencies to
the dollar, which in turn was made convertible into gold for foreign
governments. Since the fixed exchange rate system collapsed in the early
1970s, the IMF has taken on several other important roles, including
financing structural adjustment programs in developing and transition
economies. These programs, in conjunction with funding for structural
adjustment reforms by the World Bank and other multilateral development
banks, involve a negotiated set of economic reforms designed to
stabilize the domestic economy and facilitate the development of
institutions and markets that will maximize future growth.
The architects of the Bretton Woods system also sought to create a
new order in international trade, to reduce friction between trading
partners and prevent a return to the beggar-thy-neighbor policies of the
1930s, in which countries imposed tariffs and devalued their currencies
in an ultimately futile effort to increase domestic employment at
foreigners' expense. The Bretton Woods proposal for an International
Trade Organization was never ratified, but the General Agreement on
Tariffs and Trade, an accord originally intended as a precursor to the
ITO, was concluded in 1947. Subsequent negotiations under the GATT's
auspices have done much to liberalize trade. The code of conduct that it
embodies introduced two important principles to trade relations: first,
that countries should eventually renounce import quotas and similar
quantitative restrictions on trade, and second, that they should adopt a
policy of nondiscrimination, opening their markets to all participating
countries equally.
The GATT has provided a framework for countries to negotiate large
reductions in tariffs and, more recently, in nontariff barriers.
Successive GATT negotiating rounds have achieved reductions of over 90
percent in tariffs on industrial products traded between the major
industrial countries. The GATT's Uruguay Round, completed in 1993, made
landmark reductions in nontariff barriers in textiles and apparel,
product standards, and intellectual property, among other areas. It also
extended GATT principles both to agriculture, where certain nontariff
barriers were converted to tariffs, later to be progressively reduced,
and to services.
A key outcome of the 1993 Uruguay Round agreement was to set up an
international trade body along the lines envisioned at Bretton Woods
nearly 50 years earlier. The establishment of this body, the World Trade
Organization, recognizes the need for a forum for discussion,
negotiation, and liberalization. The WTO also encompasses a system for
the impartial and expeditious adjudication of trade disputes, to help
ensure that countries operate fairly in international trade. The WTO's
dispute settlement system applies in integrated fashion to the whole
range of Uruguay Round agreements.
The WTO system respects national sovereignty. Each country retains
ultimate authority for making and implementing national policy. But
decades of GATT negotiations have resulted in a set of internationally
accepted rules of the game. A country that is found to be engaging in an
unfair trade practice has a choice: it can either desist from that
practice or face appropriate retaliation from the injured country.
Within the WTO, judgments are reached in a quasi-judicial framework on
the consistency of countries' trade practices with WTO obligations.
Section 301 of U.S. trade law has in fact always required the United
States to use GATT (and now WTO) dispute settlement mechanisms where
available. A problem under the former GATT system was that many
restrictions and distortions of international trade did not violate any
specific GATT obligation, and thus were not subject to treatment under
GATT dispute settlement mechanisms. Given the success of the Uruguay
Round and the resulting broader scope of the WTO, this problem has been
significantly lessened, though not eliminated, for the United States and
other countries. Section 301 also provides a mechanism for addressing
unfair trade practices not covered by the WTO.
The WTO benefits its members individually by establishing clearer
multilateral trading rules and a more effective means of enforcement.
Its presence makes the international trading system more predictable,
thereby facilitating trade and the advantages that derive from it.
Under U.S. leadership, the industrial countries have also created
procedures to coordinate their bilateral assistance to developing
countries. The primary mechanism for this coordination is the
Development Assistance Committee (DAC), run under the auspices of the
Organization for Economic Cooperation and Development (OECD), whose
members include most of the world's richest and a growing number of
upper-middle-income countries.
The major industrial countries have developed some other, less
formal mechanisms to manage economic issues. The annual summit meetings
of the Group of Seven major industrial economies (Canada, France,
Germany, Italy, Japan, the United Kingdom, and the United States) offer
an opportunity for heads of government and their senior ministers to
deal with issues of mutual importance, such as appropriate macroeconomic
policies. The United States will host this year's meeting in Denver in
June. Group of Seven finance ministers and central bank governors also
meet several times a year to address these issues.

The Increasing Openness of Developing Economies

Aided by policies that have opened developing-country markets,
globalization has increased the involvement of developing countries in
world trade and investment flows. The share of the developing countries
and today's transition economies in world trade has increased
dramatically over the last 30 years. These economies accounted for 27
percent of total world exports in 1965; by 1995 their share of a many-
times-larger world export market had grown to 33 percent (Chart 7-5).
Within this growing share, that of the Asian developing economies more
than doubled, from 8 percent to 19 percent of total world trade;
meanwhile the shares of the African and Latin American countries fell
considerably.


The developing world's strategy toward trade and development has
undergone a remarkable change. In the 1950s and 1960s many developing
countries adopted policies of import-substitution industrialization:
countries would build their economies by making for themselves the
manufactured goods that they were used to importing. Infant-industry
protection was a corollary to this argument, combining protection of new
domestic industries from foreign competitors with state support. The
import substitution approach seldom succeeded, however, in encouraging
the development of internationally competitive manufactures. Once
granted protection, firms tended to settle comfortably into home-grown
monopolies rather than strive to duplicate world standards of technology
and productivity.
In the 1980s, engulfed by the debt crisis, many of these countries
responded at first by further raising trade barriers. But as the crisis
deepened, they were forced to change direction. Dismantling of trade
barriers was one of the cornerstones of the structural adjustment
policies many countries adopted as part of their debt-restructuring
packages. Trade liberalization not only helped establish powerful,
direct linkages between their domestic economies and the world system,
but also compelled action on other promised reforms under the pressures
of international competition. Meanwhile governments scaled back the
scope of their activities, privatizing state enterprises they had set up
in steel, chemicals, and other heavy industries.

ACHIEVEMENTS AND OPPORTUNITIES

A cornerstone of this Administration's economic policies has been to
position the United States to benefit from the global changes described
above. The United States has worked hard, through the negotiation of
bilateral, regional, and multilateral agreements, to open foreign
markets to American products. The past 4 years have seen perhaps the
most rapid progress ever in this area, including the completion of the
North American Free Trade Agreement (NAFTA), the conclusion of the
Uruguay Round of the GATT, and over 200 trade agreements in all (see
Economic Report of the President 1995 and 1996 for details of some of
these agreements). The Nation has reaped huge benefits from these
policies and has experienced strong export growth, leading to strong job
and income growth as well. One of the many economic successes of the
last 4 years has been a surge in exports, which have grown by 42
percent--over $185 billion. By one reckoning, exports account for almost
a third of the Nation's strong overall growth. Exports are critical to
creating high-wage, high-tech jobs, because they allow the United States
to expand production in those high-productivity sectors in which we have
comparative advantage. Since 1992, the number of high-wage, export-
related jobs in the U.S. economy has increased by 1.5 million. These
jobs pay more--13 to 16 percent more on average--than the average job.
Implemented in 1994, NAFTA joins the U.S. and Canadian economies in
a free-trade area with that of Mexico. In the first 3 years since NAFTA
went into effect, trade between the United States and its NAFTA
partners, which are our largest and third-largest trading partners, has
grown by about 33 percent. NAFTA's value was proved during Mexico's 1995
financial crisis. Despite the extreme adjustments and the sharp economic
contraction that the crisis forced upon Mexico, the agreement ensured
that Mexico would keep its markets open to U.S. products. The result was
in sharp contrast to the restrictive policies that followed Mexico's
1982 financial crisis. In 1996 U.S. exports to Mexico rose to record
highs. This forestalling of any potential reversion to insular and
protectionist policies also benefited Mexico.
The United States is actively pursuing further market opening in the
Western Hemisphere, building on NAFTA through ongoing talks toward a
Free Trade Area of the Americas. Under the proposed FTAA, 34 Western
Hemisphere countries will be linked in a free-trade area by 2005. Trade
with countries in this hemisphere (including Canada and Mexico)
accounted for over $170 billion in U.S. exports--well over a third of
the total--in the first three quarters of 1996. A useful first step
toward this goal would be completion of a free-trade agreement with
Chile.
The United States is also benefiting from market opening and
expanded trade with the other Pacific Rim countries. Progress within the
Asia-Pacific Economic Cooperation forum has been rapid. At the 1996
leaders' summit at Subic Bay in the Philippines, the 18 APEC members--
which include both industrial and developing economies and account for
over half of world income--committed themselves to take the initial
steps toward free and open trade and investment and a free-trade area by
2020. In addition, the Information Technology Agreement (ITA), a U.S.
initiative that would liberalize trade in semiconductors, computer and
telecommunications equipment, and software exports, was broadly embraced
by the APEC nations at the December summit.
With strong support within APEC, completion of the ITA was a
centerpiece of U.S. efforts at the WTO's first ministerial meeting, held
in Singapore a few weeks later. There 28 countries endorsed the
agreement, including almost all the industrial countries, several
developing economies in East and Southeast Asia, and Turkey. The
agreement would cover products accounting for some $500 billion in
annual world trade and over $90 billion in annual U.S. exports.
One of this Administration's first initiatives was the establishment
of the Trade Promotion Coordinating Committee (TPCC), which coordinates
government policies affecting U.S. exports across agencies. In September
1993 the TPCC unveiled the National Export Strategy, which laid out 65
concrete recommendations for leveraging export promotion resources and
removing government-imposed obstacles to exporting. The Administration
quickly implemented the strategy, which includes opening export
assistance centers around the country, providing ``one-stop shopping''
for new exporters, leveling the playing field for U.S. companies by
countering the advocacy efforts of foreign governments, and eliminating
unnecessary export controls and licenses. The National Export Strategy
also includes specific initiatives for each of the ``big emerging
markets''.
As early initiatives are successfully implemented, the National
Export Strategy continues to evolve through the identification of new
areas and the development of initiatives by the TPCC. For example, the
TPCC concluded that the use of illegitimate practices such as bribery
was far more widespread than previously known. The TPCC was able to
identify $11 billion in contracts lost to U.S. exporters over a 2-year
period because of bribery by foreign firms. Last year's report on the
National Export Strategy contained a blueprint for government-wide
action to combat bribery. And this year the TPCC is developing a
strategy against the use of product standards as barriers to U.S.
exports.
At the same time, the United States has continued to take steps to
ensure that globalization lifts living standards in all countries,
through a serious commitment to promoting labor standards throughout the
world. In its efforts within international organizations, the
Administration has sought to establish a framework for multilateral
discussion on how best to promote core labor standards: freedom of
association, the right to organize and bargain collectively,
nondiscrimination in the workplace, prohibition of forced labor, and
elimination of exploitative child labor.

EXPLAINING THE BENEFITS OF INTEGRATION

Virtually all economists agree that international trade and economic
integration raise the living standards of U.S. residents overall, while
also increasing economic well-being in other countries. The benefits of
international trade have become increasingly apparent as it has fueled
growth over recent years. When unemployment is significant, as it was in
1993, an expansion of exports raises demand for U.S. goods and services
and therefore increases employment. Even as the economy approaches full
employment, the benefits of trade continue to manifest themselves in the
form of higher incomes, and continue to influence the pattern of job
creation and change.
The effects of trade opening are similar to a major technological
innovation: both may require economic restructuring. It is also widely
acknowledged that some companies and workers may be hurt by the opening
of markets as they adjust to increased foreign competition. The U.S.
Government undertakes various measures to assist workers and companies
injured by trade (Box 7-1). Moreover the core of this Administration's
education policies is to ensure that all Americans have the tools they
need to compete and succeed in the international economy.

Box 7-1.--Trade Adjustment Measures

Government programs such as the transitional adjustment assistance
(TAA) help workers adversely affected by trade retrain and take
advantage of the economic opportunities trade offers. The NAFTA-TAA
program provides a short-term safety net in the form of an adjustment
allowance for workers who suffer from a shift of production to or
increased imports from Mexico or Canada (whether or not related to
NAFTA); it also provides employment services and training to help them
acquire the skills they need to enter new jobs. In fiscal year 1995,
over 2,000 workers entered training under this program, and almost 1,400
began receiving adjustment allowances. Also important to adjustment is
the phasing in of trade liberalization over time. Changing the rules
gradually gives import-competing industries time to adjust to new
competition. However, such delays must not become a device to postpone
agreed liberalizations indefinitely.
Are trade deficits a source of concern? As last year's Economic
Report of the President emphasized, trade deficits and surpluses are
primarily determined by macroeconomic factors, in particular the balance
between domestic saving and investment. Trade barriers have little
lasting influence on the Nation's overall trade balance, although they
may have marked effects on bilateral deficits, and they do affect the
extent to which countries can reap the benefits of trade. It is even an
oversimplification to think that deficits are necessarily bad, and
surpluses necessarily good. A current account deficit merely means that
a country is, on balance, borrowing from the rest of the world; a
surplus means it is a net lender to the world. Whether such borrowing or
lending is proper depends, as it would for any individual or company, on
what the borrowing is used for or why the country is lending.
The United States has run trade and current account deficits every
year since 1982. In the 1980s these deficits were a red flag that the
United States was failing to save enough. The budget deficits run up
during those years generated vast government dissaving: the economy was
living beyond its means. In the last 4 years, however, this
Administration has successfully worked with the Congress to reduce the
government budget deficit and increase national saving. Nonetheless,
trade deficits have persisted, although they are much smaller in
proportion to GDP than in the peak years of the 1980s. But in contrast
to the surge in the trade deficit in the 1980s, this most recent
increase appears to be financing a surge in U.S. investment,
particularly in business equipment. The implication is that the
improving economy will continue to grow and will generate the resources
necessary to repay our net borrowing from the rest of the world. (The
national saving rate is still low, however. The most effective way to
raise it is to continue efforts to reduce the budget deficit.)
Investment, like trade, yields benefits to both sides of the
transaction. Capital goes to those who are best able to make productive
use of it, and the suppliers of that capital receive a higher return,
for a given level of risk, than they could get elsewhere. These mutual
benefits may be particularly pronounced in the case of foreign direct
investment (FDI). FDI occurs when a foreign investor either sets up an
enterprise in another country or obtains a large enough share in an
existing enterprise to give the investor effective influence over its
management. FDI benefits the country receiving it in many ways: besides
the funds themselves, direct investors bring managerial, technical, and
marketing know-how, which often spills over to other parts of the
economy.
FDI by American companies can open the way for U.S. exports, both as
inputs to foreign production and as consumer goods to supply foreign
demand. It also offers U.S. companies a toehold in foreign markets from
which they can further expand sales. In many cases, investment in
distribution and other essential services increases a supplier's ability
to export into a market. Trade between firms and their foreign
affiliates (intrafirm trade) can be an efficient means of international
trade, particularly when problems of imperfect information exist. Over a
third of U.S. exports and two-fifths of U.S. imports are estimated to be
intrafirm. Worldwide, about a third of trade is intrafirm trade.
In short, whatever the short-run effects on the economy and the
trade deficit, over longer periods increased globalization increases
incomes both in the United States and abroad. Globalization produces
greater gains from trade, through specialization according to
comparative advantage and through realization of scale economies in
production. And by allowing capital to flow across borders, it lowers
the cost of financing investment in the recipient country, and increases
the return to saving and allows for portfolio diversification in the
country providing the funds.

U.S. POLICY ON TRADE WITH DEVELOPING COUNTRIES

Much of our strong recent export growth is due to demand from
developing countries. During the 1990s U.S. exports to other industrial
countries have grown at a satisfying rate of 5 percent per year in real
terms--but U.S. exports to developing countries have grown at almost
twice that rate (Chart 7-6). U.S. exports to Latin America have been
particularly strong, rising from 0.9 percent of U.S. GDP in 1990 to 1.4
percent in the first three quarters of 1996. Exports to other developing
and transition economies rose from 1.6 percent to 2.2 percent of GDP.


The United States is committed to encouraging the involvement and
integration of developing countries in the global trading system. To
this end, a number of policies have been put in place that not only
benefit U.S. consumers, but also provide special encouragement for
developing countries to expand and diversify their exports. By
encouraging openness and economic growth, our policies also promote
democracy and stability.
One of the main U.S. programs for promoting trade with developing
countries is the Generalized System of Preferences (GSP). Under the GSP,
instituted in 1976, roughly 4,600 products from 148 beneficiary
countries and territories are eligible for duty-free entry into the
United States. In 1995 the United States imported $18.3 billion in duty-
free goods under the program, accounting for 16 percent of total U.S.
imports from GSP beneficiaries. Over two-thirds of all GSP imports in
that year originated in six countries: Brazil, India, Indonesia,
Malaysia, the Philippines, and Thailand. As countries develop they are
graduated from the program, to allow lower income countries to take
better advantage of available preferences. (Malaysia, for example,
graduated January 1, 1997.) The President intends to seek a renewal of
the GSP arrangement beyond its presently scheduled expiration in May
1997.
Implemented in 1984, the Caribbean Basin Economic Recovery Act
provides preferential access to the U.S. market for 24 Caribbean
countries and territories. In 1991 the United States implemented a
similar program under the Andean Trade Preferences Act for four South
American countries. This program is a centerpiece of U.S. efforts to
encourage these countries to reduce their production and exports of
cocaine. These two programs help support growth and development in some
of the hemisphere's less developed nations, which in turn have become
better customers for U.S. products.

PATTERNS OF FOREIGN INVESTMENT IN DEVELOPING AND TRANSITION ECONOMIES

Developing countries tend to be importers of capital: their
investment needs are massive and the potential returns large. But in the
1980s, as already noted, the debt crisis reduced and in some cases
reversed the net flow of capital into these countries. At the same time,
relatively large public sector deficits in the high-income countries
absorbed private saving, increasing competition for international
investment funds.
During the 1990s, private investment in developing countries has
undergone a marked revival. Those that have restored economic and
political stability have been rewarded with greatly increased access to
international capital. The significant and continuing restructuring of
developing countries' external public debt has greatly aided their
mobilization of external private capital, by lowering the risk perceived
by investors. Long-term net private capital flows to developing
countries have nearly quadrupled in the 1990s, reaching $167 billion in
1995 (Chart 7-7). Most of this growth occurred in East Asia and the
Pacific, where net resource flows rose from $35 billion in 1991 to over
$100 billion in 1995. Flows to Eastern Europe rose sharply, too, from $6
billion in 1992 to $24 billion in 1995.
International private capital flows take three forms: FDI, portfolio
investment in securities, and bank lending. FDI in developing countries
has grown without interruption over the last decade. Cumulative FDI
flows during the 1990-95 period totaled $345 billion. Developing
countries' share of global FDI has risen rapidly, from 12 percent in
1990 to 38 percent in 1995. But the bulk of FDI into developing
countries has gone to a small number of countries. In


1994, Indonesia, Malaysia, and Mexico accounted for almost 60 percent of
total FDI flows into developing countries (excluding the transition
economies). East Asia has done relatively well this decade in attracting
FDI, while the share of FDI going to Latin America has declined.
Only 6 years ago, less than one-quarter of the stock of U.S. outward
FDI was in the world's poorer countries, a smaller share than in 1970
(Chart 7-8). Since 1990, however, in keeping with the general trend of
global capital flows discussed above, U.S. investment in emerging
markets has boomed. The stock of U.S. investment in these economies
increased to 27 percent of all U.S. external investment. While total
U.S. investment abroad rose 65 percent between 1990 and 1995, investment
in developing countries nearly doubled.
The surge in FDI in the 1990s may have resulted in part from the
improvements in the economic structure of developing countries already
mentioned. Economic stabilization and reforms that have reduced external
indebtedness and lowered the risk of balance of payments crises have
also reduced transfer risk--the danger that host countries would block
the remittance of earnings to the parent companies. In addition, reform
of legal and regulatory regimes and the adoption of outward-oriented
economic policies have probably reduced other risks perceived by foreign
investors.


Portfolio investment--the acquisition of bonds or corporate equity
in the absence of a significant ownership stake in the enterprise--has
grown dramatically. Portfolio investment gives firms that are already up
and running the extra finance they need to increase performance.
Portfolio equity flows to developing countries have been highly
volatile. After increasing 12-fold during 1990-93, they fell 23 percent
in 1994 and another 37 percent in 1995, to $22 billion. The sharp drop
in 1994-95 was partly a reaction to events surrounding the Mexican
crisis. It also reflected higher U.S. and European interest rates and
concerns about possible overheating in some Asian economies.
Corporate bond flows have grown more steadily, from $3 billion at
the beginning of the decade to $34 billion in 1995. In keeping with
their rapid growth and history of macroeconomic stability, East Asian
borrowers enjoyed maturities three times longer than those of Latin
American borrowers. Average spreads (differences in interest rates) over
government bonds in the United States and other major industrial
countries were one-half of those for Latin American debt.
Finally, commercial bank lending has been highly volatile, jumping
from less than $2 billion in 1990 to nearly $14 billion in 1993, then
reversing course to a $5 billion net outflow the following year. By
1995, commercial bank debt inflows in developing countries had risen
again to $17 billion.

OTHER ASPECTS OF U.S. POLICY TOWARD EMERGING MARKET ECONOMIES

The U.S. economy no longer dominates the world economy by its sheer
size, but even so the United States carries a disproportionate weight in
world economic affairs. We are looked to for leadership in part because
our economy remains the largest in the world, and in part because we are
the sole remaining superpower. How do we intend to exercise that
leadership? Among the most important objectives of U.S. economic policy
are to ensure that the United States itself benefits fully from the
integration of these emerging markets into a globalized economy; to
guarantee that the former Communist countries make a successful
transition to the market and become integrated into the international
trading system; and to help developing countries in their quest for
growth and development, by fostering both their economic institutions
and their human resources.

INTEGRATING THE TRANSITION ECONOMIES INTO THE WORLD ECONOMIC SYSTEM

One way in which the United States has led the pursuit of these
objectives has been by promoting an international economic system that
reflects our values of openness, competition, and private enterprise. A
key challenge in this regard, as already noted, is to ensure that
economies that are newly embracing these values undertake reforms and
are assisted in integrating into this system. This will ensure that
these emerging economies have a stake in preserving the system that U.S.
leadership has helped create. History teaches that outcasts can make
trouble.
The task of transition is daunting, especially in the newly
independent republics of the former Soviet Union, where Communism had
its deepest roots. By far the most important element of a successful
transition is market-oriented economic and political reforms. In
addition, these countries will need generous support from the
established market economies through the international financial
institutions, as well as private investment. Foreign assistance can help
encourage the development of the political and social institutions that
will allow markets and democratic principles to flourish in the
countries of the former Soviet bloc. The United States has led efforts
here: it has provided direct assistance to these countries (as discussed
below) and has worked within the IMF and the World Bank to assist the
transition. In particular, the United States has strongly supported a
major focus of the international financial institutions on building a
foundation for market-driven growth through the sale of state-owned
enterprises, sweeping legal and regulatory reform, financial sector
modernization, and comprehensive redesign of social safety nets.
If these countries are to benefit fully from their conversion to
market economics, they must also be able to put their comparative
advantage to work. Just as it is also in the best interests of the
transition economies to play by the rules of the international
marketplace, so too is it in the best interests of the established
industrial economies to apply the trading rules fairly to the economies
in transition. The markets of the established industrial economies must
remain open to trade and investment opportunities with the transition
economies. Consumers--as well as producers buying inputs--will gain from
lower prices, and other producers will gain from exporting back to these
new market economies and from increased opportunities for investment. In
addition, all peoples will benefit from a more stable world as the
transition economies successfully leave their Communist past behind.
Russia and the United States have rapidly deepened relations since
Russia reemerged as an independent state at the end of the Cold War. At
a series of meetings in Vancouver, Tokyo, Moscow, and Washington, the
President and his Russian counterpart laid the basis for a lasting U.S.-
Russian partnership. In the economic sphere, a commission headed by the
Vice President and the Russian Prime Minister has worked to advance
bilateral cooperation through eight working committees covering health,
space, energy policy, agribusiness, defense conversion, business
development, the environment, and science and technology. The commission
last met in Moscow in July 1996 and is scheduled to meet in Washington
in February 1997. In the area of trade, a Partnership for Economic
Cooperation, signed by the two presidents at their September 1994 summit
in Washington, serves as a framework for reducing barriers to expanded
economic cooperation. A number of U.S. agencies--in particular, the
Overseas Private Investment Corporation, the Export-Import Bank, the
Trade and Development Agency, and the Department of Commerce--have
programs in place aimed at facilitating trade and investment in Russia.
The United States is also actively supporting the transformation of
Russia from a centrally planned to a market economy. Since 1992 the U.S.
Agency for International Development (USAID), which coordinates U.S.
bilateral foreign development assistance, has devoted approximately $2
billion in assistance under the Freedom Support Act to helping Russia
develop democratic and market institutions.
Meanwhile significant developments in the security sphere have
reduced the threat of military confrontation in the post-Cold War era,
while also providing economic benefits for the United States. Most
recently, Russia and the United States signed an agreement that will
transfer substantial amounts of Russia's supplies of highly enriched
uranium from Russian warheads to U.S. energy facilities--a real-life
example of turning swords into plowshares. The Administration has been
working to develop institutional arrangements to ensure that these
mutually advantageous transactions, an effective part of our policy to
prevent nuclear proliferation, continue.
Both China and Russia are currently negotiating accession to the
WTO. Their successful integration into the multilateral trading system
requires that they continue their market reforms, agree to provide
mutually beneficial access to their markets, and abide by multilateral
rules and obligations. Likewise, by keeping open our markets and those
of our traditional allies to these new economic powers, we can increase
the stake they have in maintaining the international rules-based
economic system.
China and the United States together account for almost 16 percent
of global trade and 30 percent of global output. Whether we meet
regional and global goals for freer and more open trade--among the APEC
countries and among all the members of the WTO--depends in part on the
strength of the bilateral relationship between China and the United
States. Recognizing this, the Administration is committed to pursuing a
regular and intensive dialogue with China. Significant progress was made
with the beginning of a dialogue between China's State Planning
Commission and the Council of Economic Advisers in August 1996. Progress
continued at the September 1996 meeting of the Joint Commission on
Commerce and Trade, with the establishment of a consultative group on
business operational issues and with commitments to engage in further
discussions on export controls and commercial law. In the November 1996
session of the U.S.-China Joint Economic Committee, China and the United
States pledged further cooperation in the areas of customs, tax
collection, and financial sector reform.
With the end of the Cold War, an important rationale for foreign
aid--to cement alliances with the world's poorer countries against the
threat of Communism--has disappeared. But there are other important
rationales. Beginning with the Marshall Plan after World War II, foreign
assistance has been part of a broad effort by the United States and the
other industrial democracies to foster a world order based on freedom,
prosperity, and stability. In an increasingly interdependent world,
these ideals retain enormous relevance.
Some foreign aid is purely an expression of our sense of humanity:
Americans find it difficult to turn their backs on children starving
during a famine or left homeless after an earthquake. But just as we
believe, as a matter of domestic policy, that it is better to extend a
helping hand up than a handout, so we believe it is better to create the
economic conditions that will enable countries abroad to stand on their
own feet.
For half a century the United States has used its international
influence to spread democratic and market institutions. U.S. higher
education has also promoted markets and democracy overseas (Box 7-2).
Aid, although much less important than trade economically, is
nevertheless an essential instrument by which the United States and the
other industrial democracies help less developed economies become
stronger and more self-reliant. We also believe--and not without
evidence--that countries with higher living standards are likely to be
politically more stable, especially when improvements in living
standards are spread widely within a population. By contributing to the
world's political stability, these improvements in living standards
contribute to America's security.

Box 7-2.--How Educating Foreign Students Promotes Markets and Democracy

The United States has clear comparative advantage in higher
education. Many foreign students, especially from developing countries,
come to America to study for college and graduate degrees. Their
spending on tuition counts as U.S. exports of educational services and
rivals U.S. exports of corn or wheat, our two largest agricultural
exports. When these students return home, they take with them an
appreciation of the benefits of an open society and an open economic
system. The U.S. system of higher education has done much to spread our
values throughout the world, including our belief in democracy and the
market system.
This phenomenon is particularly evident with respect to Latin
America. Many Latin Americans have come to the United States to study
for graduate degrees in economics or public policy, and many have
entered government service on returning home. The last two presidents of
Mexico and the finance ministers of Argentina, Brazil, Chile, and
Mexico, for example, all received doctorates in economics from U.S.
universities. Partly because of their leadership, Latin America has
embraced market-oriented economic policies.
This is one example of how the United States itself benefits from
aid given to others. But we realize important economic benefits as well.
When our aid helps countries grow, we benefit from increased exports.
For example, 20 countries have achieved a sufficient level of
development to graduate from lending programs of the International
Development Association (the World Bank affiliate that lends to the
poorest countries on a concessional basis). These countries bought $61
billion in U.S. exports in 1995, or 6.3 percent of our total exports.
And by deepening our economic relationship with developing countries
through aid, we also make it more likely that they will turn to U.S.
firms for products in the future. More broadly, U.S. assistance in
setting up legal and commercial institutions in developing countries
leads to foreign business environments that are transparent, open, and
predictable. This makes it easier for U.S. exporters and investors to
operate in these markets. Familiarity breeds trade.
How developing countries treat their environment is increasingly
relevant to Americans. The decimation of a rainforest, or the use of
inefficient coal-burning power plants, may affect the climate of the
entire globe. The explosion at Chernobyl brought home forcefully that
badly designed nuclear reactors in one country can have far-ranging
effects. We all share the same planet. But poor countries may have
difficulty raising the resources to do what is necessary to help
preserve the global commons. Financial aid is one way we can pursue
these objectives.
To respond to these varied rationales, USAID has spelled out five
goals for its work: encouraging broad-based growth, protecting the
environment, building democracy, helping to stabilize world population
growth, and providing relief through humanitarian assistance. The web of
international institutions created under U.S. leadership also plays a
key role. The World Bank, together with the several regional development
banks, lend on both a concessional and a nonconcessional basis,
depending on the income of the borrowing country. Other international
organizations also provide lending and technical assistance. The United
States contributes to the capital of these institutions and to their
special concessional lending funds, but the impact of these institutions
is many times the level of U.S. contributions. They therefore provide an
efficient means for the United States to leverage its international
leadership.

A Brief History of Aid

The targets and strategies of foreign assistance have undergone a
steady evolution since the end of World War II. Immediate postwar
assistance was focused on countries hard hit by the war. The Marshall
Plan channeled assistance to Western Europe on a vast scale, to promote
economic recovery while preserving social stability and democracy. In
the Marshall Plan years of 1949-52 the United States gave $18.6 billion
in aid, equivalent to 1.5 percent of our gross national product (GNP) in
those years. As a percentage of our output, the aid we send overseas
today is far smaller than it was then.
The United States and the other industrial countries provided
relatively little assistance to what are now the developing countries
before the early 1960s, and what was offered usually came in the form of
specific technical assistance. It was widely assumed that the income gap
between these countries and ours would close over time, without much
special effort on our part. In addition, many of what are now high-
income countries were still well behind the United States, so that
concern was not focused exclusively on the developing world.
In the early 1960s, under the leadership of President Kennedy, the
United States greatly increased the resources devoted to assisting
developing countries. U.S. foreign economic assistance rose from $13
billion in 1958 (in 1996 dollars) to $22 billion by 1962. The United
States accounted for the great bulk of official development assistance
throughout the 1960s. Apart from providing direct assistance ourselves,
the United States also led efforts to coordinate bilateral assistance
from other countries. In 1961 the DAC, the primary mechanism for
coordinating aid among the OECD countries (see above), was established.
The United States also led the way in providing development assistance
and nonconcessional development finance through the multilateral
development banks. The IDA was organized in 1960 to provide concessional
financing to the poorest countries. The first two regional development
banks, the Asian Development Bank and the Inter-American Development
Bank, began operations in the 1960s, with the United States as a
founding member of both.
U.S. development assistance has contributed to many successes since
the 1960s. Some of the world's fastest-growing countries today have been
major recipients. Targeted programs have achieved particular success.
During the 1960s and 1970s, for example, USAID assistance to India for
higher education and agricultural research was instrumental in the rapid
growth in cereal production in that country--the so-called Green
Revolution. In various countries, USAID programs have helped reduce
infant mortality and population growth rates and improved basic
education programs.
Over time, the intellectual focus of development assistance changed.
By the early 1960s it was clear that most developing countries were not
catching up with the United States as fast as Western Europe and Japan
were. It was assumed that a shortage of investment resources was behind
this lack of growth. Long-term growth models developed in the 1950s
posited a direct relationship between a country's investment level and
growth of its GDP. Countries unable to generate enough resources to fund
high investment levels would fail to generate rapid growth. The role of
aid was to alleviate bottlenecks to growth, by filling the gap between
the desired level of investment and the saving and private foreign
capital available to finance it. The idea that resource transfers were
an important determinant of growth was in keeping with our successful
experience with the Marshall Plan.
In the 1970s the focus of assistance shifted to the direct
alleviation of poverty. Although rapid economic growth held the promise
of alleviating poverty over the long term, it was feared that poverty
could actually worsen in the initial stages of development. Aid
increasingly was allocated to projects directly designed to meet basic
needs of the poorest populations in developing countries. These efforts
were focused on measures targeted to population control, health,
education, and rural development.
The growth rates of developing countries began to diverge widely in
the 1970s, with the Asian and Latin American countries generally growing
steadily and many African countries beginning to stagnate. Investment
bottlenecks were not the only factor inhibiting development. How
investment was used, and the environment in which it was made, were also
important. The focus of development broadened to include the need to
develop agriculture, exports, and human resources, as well as industry
and infrastructure.
As it became clear that no simple causal relationship existed
between the quantity of assistance, rates of economic growth, and
changes in poverty, the policy focus in the 1980s changed once again,
this time to the influence of a country's domestic economic and social
policies on development and growth. The quantity of aid, which had been
the focus of the earlier models, came to be seen as just one of many
factors influencing development. Aid was seen as having an impact on a
country's growth only if sound domestic policies were in place. Those
concerned about poverty also focused on the policy environment. Growth
did not necessarily cause poverty to worsen; in fact, the East Asian
experience showed that growth was the most effective antidote to poverty
and that egalitarian policies could facilitate growth.
This view led to an increased emphasis on conditionality: aid would
only be given if a country agreed to a specific set of reforms, which
generally included fiscal discipline, open capital and trade flows,
deregulation and reform of public enterprises, the establishment of
efficient banking systems, legal reforms, and the liberalization of
prices, exchange rates, and interest rates. The IMF and the World Bank
led the way in negotiating the structural adjustment programs that
embodied these reforms, establishing them as a condition for providing
funds to developing countries, many of which had been hard hit by the
debt crisis that began in 1982. Several empirical studies during this
period confirmed that reforms of this kind were a necessary, though not
a sufficient, condition for economic growth.
The United States' dominance in foreign assistance diminished in the
1970s and 1980s, as other industrial countries channeled increasing
resources toward this purpose, in line with their increased economic
capacity. In the 1950s and most of the 1960s the United States had
accounted for over half of all official development assistance provided
by the market democracies. Since that time, other industrialized
countries have shouldered an increased share of the burden, rising to 55
percent in 1970, 72 percent in 1980, and 88 percent in 1995.
Most of the industrial countries have reduced their bilateral
assistance, and the resources of the multilateral institutions and
regional development banks are coming under increased strain. The end of
the Cold War has led to an increased demand for assistance to the
transition economies as well, stretching development resources ever
thinner. Political support for development assistance has eroded, as the
need to battle Communism in the developing countries has virtually
disappeared and as donor-country budgets have been squeezed. Yet the
need for development assistance has continued. Countries without the
social, economic, and political bases for development, in Africa and
elsewhere, are likely to be left behind as other developing countries
experience rapid growth.
Official development assistance from the 21 DAC members has declined
by almost 6 percent in real terms since 1991 (12 percent when accounting
for exchange rate fluctuations), to $59 billion, or only 0.27 percent of
their aggregate GNP in 1995. Bilateral disbursements accounted for about
two-thirds of the total in 1995; multilateral sources provided the
remainder.

Patterns of U.S. Aid Today

In 1996, the Congress authorized $6.7 billion for foreign
assistance spending. That amounts to 0.1 percent of GDP, or a per capita
expenditure of $27. Contrary to conventional wisdom, evidence indicates
that American public attitudes are sufficiently supportive of foreign
assistance to justify a modest increase (Box 7-3). The Administration
has requested an increase of 10 percent in its budget request for fiscal
year 1998. If approved, that would restore spending to fiscal 1988
levels in real terms.
Over 1993-95, 30 percent of U.S. non-military bilateral aid was
allocated to Egypt and Israel. Other major allocations went to Ethiopia,
Haiti, India, Peru, Russia, South Africa, Turkey, and Ukraine. The share
of U.S. aid going to the sub-Saharan African countries has grown in
recent years, while the share to Latin America and East and South Asia
has diminished. A special initiative to assist the transition to
democracy in South Africa allocated over $600 million, to be disbursed
over 1995-97. During the 1990s the United States and other donors have
also developed assistance programs for the transition economies. U.S.
aid has supported a

Box 7-3.--Foreign Aid and U.S. Public Opinion

Most Americans think the U.S. Government spends far too much on
foreign aid, to the neglect of domestic needs. Yet a number of surveys
and polls have found that this widespread attitude toward aid is based
on false premises. In one survey the median respondent guessed that the
United States provides 40 percent of all aid to developing countries;
the true figure, according to the OECD, is 12 percent. Likewise, most of
those surveyed believe that the United States spends a larger percentage
of its GDP on aid than other industrial countries, whereas in fact we
spend the smallest. Those surveyed estimated that 18 percent of the
Federal budget goes to foreign aid; the true figure is well below 1
percent. The median respondent (before being told the actual level of
aid) would raise the amount of aid provided to 20 percent of all
international aid and 5 percent of the Federal budget. Focus groups and
polls have found that Americans, in general, retain some sense of moral
obligation to help those in need.
wide range of projects, including privatization programs in the Czech
Republic and Russia; legal reform in Kazakstan, the Kyrgyz Republic, and
Russia; public health programs in Russia and Ukraine; and humanitarian
assistance in Bosnia and Herzegovina. A large portion of U.S. aid goes
to social infrastructure such as health and education; less than 6
percent of U.S. bilateral development assistance is spent on economic
infrastructure--in sharp contrast with Japan, which expends almost one
quarter of its aid on the promotion of transport and communications
alone. An increasing amount of aid from the United States and other
countries is absorbed by crises and humanitarian relief.
In addition to providing bilateral aid, the Administration strongly
supports the international financial institutions which provide
multilateral aid. In its 1998 budget request, the Administration has
asked that funding for multilateral development banks be restored to
fiscal 1990 levels of more than $1.4 billion.
As already noted, in addition to their regular nonconcessional
lending the international financial institutions provide concessional
financing for the poorest countries that lack access to alternative
financing. Funds for these ``soft'' loans come from contributions by the
wealthier countries and income earned from past projects. The World
Bank's IDA remains the single most important source of such funding,
having approved an annual average of $6 billion in concessional lending
over the past 5 years. It is therefore vitally important that the United
States deliver in full on its outstanding commitments to the IDA. The
IMF's Enhanced Structural Adjustment Facility (ESAF), established in
1987 to provide concessional financing to low-income countries
experiencing balance of payments problems, has been enlarged to $15
billion--roughly double its original size. Thus far, over 40 countries
have borrowed from the ESAF; in return for these funds they agree to
undertake 3-year structural adjustment programs. Recently the United
States, together with the World Bank and the IMF, spearheaded a new
initiative to reduce debt burdens for highly indebted low-income
countries (Box 7-4).

A FRAMEWORK FOR FUTURE LEADERSHIP

For half a century the Cold War defined the principal objective of
U.S. international policies: contain Communism. As we have seen, with
the end of the Cold War the United States has had to rethink its
objectives. We can all agree that the government should seek to increase
economic growth, raise living standards, protect the environment, and
enhance security in all its dimensions. But in this Report we have tried
to be more precise: What are the special roles of the Federal
Government? And how have these roles changed as the environment we face
has changed--with the end of the Cold War, the emergence of new economic
powers, and the globalization of the world economy? Markets, individual
responsibility, community--all are essential to the society that we have
created and are creating still.
Some guidance here is provided by the theory of international public
goods. Pure public goods have two properties. First, they are nonrival
in consumption. That is, their consumption by one person does not
diminish the benefit another person derives from consuming them. Another
way of putting this is that the cost of providing the good to the second
person, given that it has already been provided to the first, is zero.
The second feature of public goods is that they are nonexcludable. That
is, it is difficult or impossible to prevent someone from enjoying the
good, regardless of whether he or she has paid for it. Classic examples
of such goods are national defense and basic scientific research.
It has long been recognized that the market, if left to itself, will
tend to underproduce public goods. As discussed in Chapter 6, this
creates a rationale for government action to provide public goods for
the benefit of the entire community. The efficient provision of such
services is essential to long-term growth, and without the government
they would be inefficiently underproduced.
Some public goods are local in nature; they affect people only in a
limited geographic area. Examples include police protection and urban
parks. Other public goods are national, such as the defense of a
country. Still other public goods are international, benefiting

Box 7-4.--Reducing the Debt Burden of Developing Countries

Heavy debt burdens have severely constrained the economies of many
developing countries for well over a decade. At the end of 1995, the
total external debt of developing countries was estimated at over $2
trillion, equivalent to 150 percent of their annual exports. The debt
burden varies dramatically across regions: the sub-Saharan African
countries faced an average debt-to-exports ratio of 270 percent in 1995,
whereas in East Asia the ratio was only 83 percent. The successful
reduction of commercial bank debt combined with economic policy reforms
in the first half of the 1990s has helped launch many middle-income
developing countries on a path of sustainable growth. For many low-
income countries, however, debt remains a barrier to growth and
development.
The U.S. Government has actively pursued several multilateral and
bilateral initiatives to reduce the debt burden of the poorest
developing countries. In mid-December 1994 the Paris Club of creditor
countries (including the United States) agreed on more-generous debt
reduction terms--called ``Naples terms''--which would lower the debts of
heavily indebted poor countries by up to 67 percent. During the 1996
fiscal year, the United States entered into debt-reduction agreements
with seven countries under Naples terms. In February 1996 the Congress
authorized a pilot debt buyback and swap initiative for lower income
Latin American and Caribbean countries that are actively engaged in
economic reforms, particularly investment reforms. Countries must also
meet certain political criteria: they must have democratic governments
and not have an egregious record in the areas of human rights,
narcotics, and terrorism.
The United States has taken a leadership role in developing the
newest multilateral debt initiative with the World Bank, the IMF, and
the Paris Club. The Heavily Indebted Poorest Countries (HIPC) debt
initiative would enable heavily indebted poor countries with a strong
record of policy reform to achieve sustainable debt burdens, by offering
them comprehensive debt relief from all creditors, including the
international financial institutions. The HIPC focuses on those
economies that adopt programs of adjustment and reform supported by the
IMF and World Bank, but still face an unsustainable debt situation even
after the full application of current debt-relief measures. Eligibility
will be determined on a case-by-case basis.
people across the globe. Four important types of international public
goods are international economic cooperation, international peace and
order, some forms of environmental protection, and basic scientific
knowledge. In all these areas the United States can benefit itself and
other countries by promoting international cooperation.

INTERNATIONAL ECONOMIC COOPERATION

All countries can benefit from economic cooperation. But as with all
public goods, countries have an incentive to free-ride on the
cooperative efforts of other countries, deriving satisfaction from the
existence of public goods but letting others bear the costs. They also
have an incentive to take actions to serve their own interests, which
may turn out to be short-sighted. Despite these inherent obstacles, the
United States has led the international community to many notable
successes in economic cooperation. One important success has been the
coordination of macroeconomic policies among the major industrial
countries through the annual Group of Seven summits. All nations gain
from the increased international macroeconomic stability that this
coordination provides. The President has also initiated separate labor
summits among the Group of Seven, to provide a forum for collective
exploration of how best to promote job creation and alleviate
joblessness.
The Organization for Economic Cooperation and Development has served
as a catalyst for successful economic cooperation. Within the OECD the
industrial countries discuss policy in a host of areas, including
macroeconomic policy. Another OECD accomplishment was a 1993 agreement
that established a set of international principles for shipping policy,
to promote a freely competitive environment for shippers and prohibit
discriminatory fees and charges based on port of origin. A Maritime
Transport Committee serves as a forum for dialogue, consultation, and
harmonization of OECD member policy in this area.

The International Trading System

One of the most important dimensions of international economic
cooperation has been the efforts led by the United States and its
partners to strengthen the international trading system. This chapter
has discussed the many benefits that accrue from this process. The work
of expanding and reinforcing this system is ongoing, however, and there
is still much to do.
As successive GATT rounds have reduced tariffs to a small fraction
of their earlier levels, an important part of the agenda for trade
policy now is the reduction of nontariff barriers to trade. Nontariff
barriers are more complicated than tariffs and more difficult to
eliminate. Indeed, many arise out of the legitimate pursuit of domestic
policy goals, yet their effect is to restrict imported goods and
services. The fact that they may serve or appear to serve legitimate
domestic goals makes them often hard to remove. For example, although
health and safety standards usually serve legitimate domestic purposes,
they may be applied in ways that discriminate against imports. This is
particularly the case when these policies are not set in a transparent
and open manner.
Nontariff barriers are also more difficult to measure. They are not
easily expressed by a single number like the average tariff rate.
Although limited progress has been made in calculating tariff
equivalents for some nontariff barriers, much room for improvement
remains.
The United States and other countries have made progress in reducing
nontariff barriers of various kinds. Some success has been achieved in
the area of product standards, which historically have been based on the
attributes of domestically produced goods. Provisions of the WTO and
NAFTA require that product standards have a scientific rationale; they
also promote the use of internationally recognized standards.
Another consequence of globalization is the increase in cross-border
competition within industries. Trade officials are concerned that this
competition be fair. Antidumping and countervailing duty laws are
intended to ensure fair competition. Countervailing duties may be
imposed when imported goods benefit from subsidies by a foreign
government and injure a domestic industry. The duties are designed to
offset the subsidies, restoring a level playing field for the injured
domestic producers. Antidumping duties are intended to offset
international price discrimination that causes injury to a domestic
industry. Both measures are covered by WTO agreements, which authorize
and set boundaries on the application of the rules.
Separate domestic laws also govern competition (antitrust) policy.
When barriers between markets were high, these two sets of laws,
domestic and international, could operate more or less independently.
With globalization proceeding apace, and with international market
barriers falling, the two increasingly overlap, yet they embody distinct
criteria. Competition promotes economic efficiency, and the goal of both
sets of laws should continue to be to promote competition and
efficiency.
In static trade theory, under perfect competition U.S. customers may
actually gain from accepting foreign subsidies, which lower the cost of
imports. This gain more than outweighs the loss to U.S. producers harmed
by the subsidized competition, and the winners can in theory compensate
the losers. However, dynamic considerations and imperfect competition
may yield a different conclusion. Government subsidies may allow foreign
firms to engage in predatory behavior, permanently altering strategic
dynamics in favor of foreign firms and, in the extreme, driving U.S.
firms out of business. There are questions, however, about the
prevalence of circumstances in which predation is likely.
Subsidy ``wars,'' in which governments compete for market share by
offering subsidies to some of their most promising firms, may occur.
Such competition results in excessive investment in the subsidized
industry, to the detriment of economic efficiency and welfare. To
prevent subsidy wars in shipbuilding, to take one example, the OECD
countries have signed an agreement to curb subsidies to shipbuilders.
The President has asked the Congress to ratify this agreement, which was
slated to go into effect in 1996.
Protecting the Rules-Based System. The international trading system
applies a set of rules to countries' trading behavior. One of the most
important is the requirement that countries not take arbitrary measures
such as raising tariffs. Other core rules include the most-favored-
nation principle, in which countries agree generally to extend the same
tariff rates to all other countries, and national treatment, which
requires countries to give foreign-based companies treatment equivalent
to that received by domestic companies.
Economic dislocation may result from trade liberalization, and the
Federal Government is committed to helping those adversely affected, for
example through trade adjustment assistance. Safeguard provisions in WTO
agreements permit a variety of temporary measures, including increased
duties, to allow an industry injured by imports to adjust to the
increased competition.
WTO rules permit the use of these measures, as well as
countervailing duties and antidumping measures, under carefully
circumscribed conditions. As traditional tariffs decline, countries are
increasingly resorting to such remedies to shield their domestic
industries from import competition. In certain instances it has become
clear that the rules are being improperly interpreted or applied, or it
is simply difficult to discern how proceedings are being conducted or to
understand the basis for decisions. U.S. firms are frequently the
targets. This is not surprising, given the role of the United States in
the international trading system and the competitiveness of U.S. firms,
which often operate with low profit margins. The United States has had
to monitor closely the implementation of foreign trade remedy laws in
order to discourage, identify, and correct such irregularities. The
United States is committed to the active use of WTO dispute settlement
provisions to address such irregularities and to ensure the fairest
possible treatment for exporters.
Regional Trading Agreements. Free trade is an international public
good from which all nations benefit. Regional trading arrangements can
serve as a bridge to broader, even worldwide agreements--true global
public goods. Toward the end of the 1980s the proliferation of regional
trading agreements picked up speed. These arrangements have always had
both costs and benefits. The main benefit is that they create trade by
reducing barriers between member countries. The cost is that they can
also divert trade from more efficient producers outside the region to
less efficient producers within the region. WTO rules permitting
regional trade agreements are designed to make it more likely that the
trade creation effects dominate. For the North American Free Trade Area,
the benefits of trade creation are likely to have outweighed the costs
of trade diversion, because its members have relatively low trade
barriers for most products from outside the region and because members
are free to lower their external tariffs individually.
Regional trading arrangements have also proved to be powerful tools
for liberalizing trade more widely, and thus increasing economic
efficiency. The President has led efforts within APEC and the FTAA talks
to provide fora for neighboring countries with common interests to
negotiate pathbreaking arrangements. These arrangements can then serve
as a pattern on which multilateral efforts within the WTO can build. For
example, the United States-Canada Free Trade Agreement contained a
chapter on services that became a model for the Uruguay Round
negotiation on services. When regional trade arrangements are structured
on this model, the danger of their succumbing to the temptation of trade
diversion is diminished.

Cooperation in Competition Policy

Noncompetitive conditions in global markets can interfere with the
efficient allocation of resources and harm consumers and producers
throughout the world. Global cartels restrict output and increase prices
of both consumer goods and producer inputs. Anticompetitive exclusionary
or predatory practices can insulate firms from competition and exclude
more efficient or innovative firms from the market. Such practices
reduce economic welfare and retard economic growth.
Noncompetitive conditions in a domestic market can also serve as a
barrier to trade. An example is the $4.5 billion Japanese market for
flat glass. Three large domestic producers, with separate, exclusive
distribution systems, have dominated this market. It can be extremely
difficult for new producers, foreign or domestic, to enter such a
market. Under a 1995 agreement with the United States, the Japanese
government and the Japanese flat glass industry agreed to a set of steps
to open this market to greater competition.
International cooperation in competition policy can help prevent or
mitigate the harm resulting from anticompetitive practices. Such
cooperation can take three basic forms. First, authorities can reduce
unnecessary regulation (which can often act as a market barrier) and
eliminate legal barriers to competition by both domestic and foreign
firms. Second, they can promulgate and vigorously enforce appropriate
competition policies, designed to prevent such conduct as price fixing,
carving up of markets, and anticompetitive mergers. Third, they can
cooperate in bilateral and multilateral efforts to investigate and share
information regarding potential violations, and to enforce their
competition policies.

International Capital Markets and Rules for Investment

We have already discussed the benefits to developing countries from
receiving foreign investment, as well as the benefits to investor
countries, including the United States, from investing in developing
countries, and from the trade that accompanies foreign direct investment
in particular. Impediments to FDI therefore may act as a nontariff
barrier, making it more difficult to export into a market. This is a
complicated issue: countries often are genuinely sensitive to the
perceived loss of economic sovereignty associated with inward foreign
investment, yet such concerns are often difficult to distinguish from
efforts to protect domestic companies from competition. In that sense,
countries engage in negative-sum behavior when they restrict foreign
investment without a clear rationale for doing so, such as national
security. These restrictions harm both their domestic consumers and
foreign producers.
The United States has engaged in several efforts to improve the
international climate for direct investment. The United States has a
vigorous program to negotiate bilateral investment treaties with
developing and transition economies, to ensure that U.S. firms are able
to invest abroad on the same liberal terms under which foreign companies
may invest here. To date, the United States has signed 38 such treaties,
of which 26 are in force. Several more are pending ratification, and
negotiations with other countries are ongoing. NAFTA included an
agreement that substantially lowered barriers to cross-border investment
and established procedures for settling investment disputes. The United
States has been engaged in extending this work through the negotiation
of the Multilateral Agreement on Investment (MAI) under the aegis of the
OECD. This Administration helped launch the MAI negotiations in May
1995, and they are scheduled to be completed in 1997. The United States'
objective in these talks is an agreement that will substantially
liberalize foreign investment by establishing clear legal standards on
expropriation, providing access to binding international arbitration of
disputes (as in NAFTA), and allowing unrestricted investment-related
transfers across borders. It is envisioned that accession to the MAI
will be open to both members and nonmembers of the OECD, thus making
possible an extension of MAI rules to developing and transition
economies.
Funds also flow across borders in the form of securities and bank
loans. Although these flows may be less stable than direct investment
flows, which cannot readily be withdrawn, they can provide an important
source of funding. The Group of Ten participate in the General
Arrangements to Borrow, which is prepared to make roughly $24 billion
available to the IMF in time of financial emergency that might pose
systemic risks. Recently the Group of Ten and some other countries
agreed to double the amount of emergency funding by creating an
additional mechanism, the New Arrangements to Borrow. Contributors will
include some of the fast-growing developing countries.
Ad hoc international coordination has also facilitated such actions
as the liquidity support provided to Mexico during its early-1995
financial crisis, discussed in last year's Report. This U.S.-led
international support helped Mexico implement the policies necessary to
avert default, regain access to international capital markets, and
restore the basis for sustainable growth. Confidence has now returned,
and Mexico has repaid its borrowings from the United States ahead of
schedule. The temporary support extended to Mexico also helped protect
vital U.S. interests: American exports and jobs, the security of our
common border, and the stability of other emerging market economies.
The United States worked at the June 1995 Group of Seven summit in
Halifax to reduce the likelihood of similar crises in the future.
Initiatives launched at Halifax included the New Arrangements to Borrow
and the IMF's Special Data Dissemination Standard, which aims to
increase the quality and availability of economic and financial data for
emerging markets and other countries. This and other initiatives,
including the IMF's capital markets surveillance, help promote a
transparent and rules-based international financial system, benefiting
both providers and users of capital.
In banking, the Bank for International Settlements, which promotes
the cooperation of central banks and acts as agent for international
financial settlements, has recently enlarged its membership to include
the central banks of key emerging markets. The BIS is also the
secretariat for the Basel Committee on Banking Supervision, the source
of many agreements aimed at strengthening the supervision of
internationally active banks. The committee is made up of
representatives from 12 industrialized countries (Belgium, Canada,
France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden,
Switzerland, the United Kingdom, and the United States), but in recent
years it has extended its outreach to other countries. It is currently
working with a group of developing and transition economies to formulate
guidelines for effective bank supervision.

International Development and Humanitarian Assistance

The greatest contribution that the industrial countries can make to
growth in developing and transition economies is to preserve these
countries' access to international markets for trade and investment.
Despite the dramatic increase in private investment flows, however, many
developing countries, especially the poorest, still require assistance
from the high-income countries and international organizations. It is
important that these programs continue if the poorest countries,
especially in Africa, are to persevere in the political and economic
reforms that many have undertaken in recent years. These countries
particularly benefit from aid that encourages their development of the
necessary human resources and institutions in which a growing economy
can take root. The development of such an institutional base helps
ensure that aid flows are used effectively.
As growth in the poorest countries begins to accelerate, the United
States and other donor countries will benefit from new and expanding
export markets and investment opportunities, as well as from greater
international political stability, because it means that countries have
an increasing stake in preserving the international rules-based system.
Effective assistance depends on international cooperation, both through
the coordination of bilateral aid within the DAC and elsewhere, and
through multilateral agencies. One aspect of this cooperation has been
negotiated limits on the tying of aid to the import of products and
services from donor countries (Box 7-5).
Another important aspect of assistance is humanitarian assistance.
Human suffering in poor countries due to war, natural disaster, or
famine concerns us all; these are circumstances in which countries can
be most effective if they coordinate their efforts. Much of this
coordination takes place through the United Nations; thus the United
States and other countries benefit from continuing to support this
organization. The multilateral development banks also provide
humanitarian assistance. Continued support for development assistance
can also serve as preventive medicine, to forestall the social,
political, and economic deterioration that creates these crises in the
first place.

INTERNATIONAL PEACE AND ORDER

All the international activities discussed in this chapter
presuppose an international environment in which nations act peacefully
and respect international order. Throughout the 20th century the United
States has led world efforts to create such an environment. Besides
military and diplomatic efforts, the United States has also employed
economic means to achieve peace and order. Although economic sanctions
may be viewed as a somewhat blunt instrument, they are one available
tool to use against countries that threaten international stability,
particularly when the situation

Box 7-5.--Tied-Aid Agreements

Tied aid is officially supported concessional financing linked to
procurement in the donor country. It distorts trade when used to win
contracts for capital goods exports rather than to provide true aid.
Tied aid can misallocate resources from more efficient to less efficient
producers whose governments offer such financing.
When used for export promotion, tied aid can also distort aid
flows by directing scarce resources away from high-priority development
projects to projects of interest to industries in donor countries.
Traditionally, tied aid has directed donor support toward, for example,
large electric power generation and telecommunications projects and away
from social sector projects. This skewing of resource allocation in
developing countries increases the capital intensity of development and
burdens the recipient country with high maintenance expenditures in the
future.
In response to complaints from exporters that they often faced
tied-aid competition for capital goods projects, the United States
negotiated rules in the OECD to govern tied-aid programs. The rules,
dubbed the Helsinki Package, became effective in February 1992. They
apply to nonconcessional financing and stipulate that higher income
developing countries (those with incomes per capita above $3,035) are
ineligible for all tied aid. The least developed countries remain
eligible for all types of financing because of their desperate shortage
of capital. For countries in between, such as China, Indonesia, and
India, tied aid is prohibited for projects that can generate cash flows
sufficient to repay debt on commercial terms.
It is hoped that the Helsinki rules will reduce distortions and
maximize the total resources--aid and commercial financing--available to
promote economic development. Last year the OECD issued guidelines for
the use of tied aid, to draw the line between projects that should
receive export credits on commercial terms and those that may receive
tied aid. Since 1992, under the Helsinki Package, annual tied aid has
declined from $10 billion to about $4 billion. The tied aid that remains
has been shifted away from major capital projects capable of supporting
financing on commercial terms to legitimate aid projects such as water
and sewerage, and health and other social services.
calls for something stronger than diplomatic protest, but less strong
than military engagement.
Sanctions come in a variety of forms. Sanctioning countries can
restrict exports, impede imports, freeze assets, prohibit investments,
restrict financing, withdraw government aid, or ban commercial airline
flights. Throughout the 20th century, sanctions have been used primarily
to restrict exports to and investment in a targeted nation. Import
controls are rare. Examples include the ban on oil imported from Iran in
response to the 1979-81 hostage crisis and from Libya in response to
terrorist threats, a 46-year ban on all imports from North Korea, and a
recent prohibition on oil imports from Iraq. Formerly employed
predominantly to complement war efforts or destabilize hostile regimes,
sanctions have been used since the 1960s to express condemnation of
human rights abuses, force compliance with international treaties (such
as nuclear nonproliferation treaties), promote democracy, and secure
compensation for expropriated property.
As with any policy tool, the rational evaluation of sanctions
involves a weighing of the costs and benefits. This can be difficult;
whereas the costs of sanctions can often be expressed in economic terms
(e.g., reduced output and growth), the aims of sanctions are frequently
noneconomic. Sometimes sanctions may have mainly symbolic value, as part
of the imposer's efforts to demonstrate resolve and commitment.
Certain characteristics increase the likelihood that sanctions will
contribute to the desired outcome. As one would expect, sanctions that
inflict higher costs on the target nation tend to be more effective. The
costs, to both the sanctioner and the target, depend among other things
on the type of sanction employed, the extent of trade and financial
linkages, the relative size of the two nations, and the ease with which
the target product or transaction can be substituted.
Like other public goods, sanctions are generally more effective when
more nations participate in imposing them. Multilateral sanctions
usually impose greater costs than unilateral sanctions; the ability of
target nations to access alternative suppliers and providers of aid
decreases as the number of sanctioning countries increases. Multilateral
sanctions may also reduce the likelihood of long-term costs on those who
impose sanctions. Multilateral sanctions on South Africa contributed to
the decision to dismantle apartheid. United Nations-sponsored sanctions
against Serbia in connection with the recent Bosnian conflict
contributed to a severe contraction of Serbia's economy and pressured
Belgrade to negotiate a peace agreement. The success of these sanctions
was due in part to the coordinated action of the international
community, Serbia's high dependence on foreign trade, and the narrow
production base of the Serbian economy.

ENVIRONMENTAL ISSUES

Many environmental issues can be viewed through the analytic lenses
of public goods and externalities. (Externalities occur when actions
taken by one person have unintended and uncompensated positive or
negative effects on others.) Clean air, for example, is nonrival, in
that anyone can breathe it without impairing the ability of others to
breathe; it is also nonexcludable, in that it is next to impossible to
charge people for the right to breathe fresh air. As we have seen, some
environmental issues are local or national in scope, whereas others are
international or global and can therefore benefit from international
coordination. We have already touched on some of the environmental
challenges facing the United States as they relate to aid to developing
countries. International coordination among all nations is important in
such areas as global warming and preservation of the ozone layer. U.S.
leadership is needed if such coordination is to take place.
All nations benefit from efforts to reduce emissions of greenhouse
gases that may lead to global warming. However, in the absence of an
international agreement on emissions, every nation has an economic
incentive to avoid taking action on its own. That is why the United
States is working toward an effective agreement entailing global
reductions of greenhouse emissions. The goal of these negotiations is
the signing of an international agreement in Kyoto in December 1997 to
limit these emissions.
Another example is the overharvesting of ocean fisheries. Each user
ignores the marginal cost of his or her use on the stock of fish
required for regeneration. All potential fishing countries benefit from
the efforts of all other parties to curtail fishing, but each has an
incentive to deviate and overfish now. At the November 1996 annual
meeting of the International Commission for the Conservation of Atlantic
Tunas, the United States took a leading role in establishing an
international fishery management organization to enforce fishing quotas
in order to protect a declining stock of bluefin tuna. The United States
was also one of the first nations to ratify the 1995 United Nations
Agreement on Conservation and Management of Straddling Fish Stocks and
Highly Migratory Fish Stocks, which promotes regional commissions to
coordinate the management of ocean fishing and provides for binding
dispute settlement in accordance with the Law of the Sea.

BASIC RESEARCH

Knowledge may be the purest of public goods, and the most important
for economic growth and development. All nations benefit from increases
in scientific knowledge that form the basis for technological advances.
As with other public goods, however, there is a temptation to free-ride.
Some countries have specialized in adapting basic research done in other
countries into profitable business opportunities. If the quest for
greater basic knowledge and improved technology is to continue, it is
important that all countries contribute to the support of basic
research. Free-riding on other's efforts can also be minimized if owners
of intellectual property are adequately compensated.
International research cooperation is a complex issue. The lines
between basic and applied research are increasingly blurred. Tension
often arises between the goal of increasing the competitiveness of
domestic companies, by channeling research funding to them, and the goal
of increasing the world's stock of scientific and technological
knowledge, from which we all gain.

CONCLUSION

Enormous changes are taking place in the international economic
environment, made possible by U.S. international leadership throughout
the postwar era. The United States has led the development of a stable
international economic system based on a clear set of rules. These rules
have made possible our Nation's preeminence in exports, and thus have
served our own interest, but they allow other countries to benefit from
exports, too. And that, as we have seen, serves our interest as well.
Rules also encourage a more stable world economy, avoiding the
calamities of the 1930s and 1940s.
With the emergence of developing and transition economies onto the
stage long dominated by the United States and the other industrial
democracies, the need is great to ensure that the international system
welcomes these new participants and allows both them and the established
powers to derive mutual benefit from the system. The new participants
themselves must continue to liberalize their trade regimes and their
domestic markets, so that all countries can realize the gains from
trade. Efforts should also continue to spread prosperity to those
countries that have yet to see sustained growth, in part through
assistance in developing the necessary economic institutions and human
resources.
The United States must also continue to lead the ongoing effort to
improve the international economic system. The international public
goods of economic cooperation, peace and order, environmental
protection, and basic research promise great benefits if countries work
together, but such cooperation requires strong leadership.
To exercise that leadership role, we must understand the lessons of
the changes that are sweeping the globe. The collapse of central
planning tells us of the dangers of overreaching by governments, and
reminds us of the key role of Western governments in ensuring a rules-
based domestic and international marketplace. The rise of the East Asian
economies and the revival of Latin America teach us about the
fundamentals of economic growth: saving, education, technological
progress, stability, openness to international trade, and equity. We
must work to maintain these conditions at home and assist other
countries in implementing them abroad. Finally, increased globalization
reminds us of our interdependence with other nations and the benefits
that we all receive from our economic interactions.
If the United States continues to exercise economic leadership in
the world, maintaining the international rules-based system that we,
above all others, helped develop, we will contribute to our own
prosperity as well as to that of the rest of the world.