[Economic Report of the President (2001)]
[Administration of George W. Bush]
[Online through the Government Printing Office, www.gpo.gov]

 
Chapter 4
The New Economy in a Global Context




Participation in the global economy has made a vital contribution
toward U.S. economic performance. It is no coincidence that a New
Economy has emerged in the United States at the same time that our
involvement in the global economy has reached new heights. Indeed,
globalization and the recent advances in information technology at
the core of the New Economy are inextricably linked. On the one hand,
globalization has played a crucial role in promoting the technological
innovation and investment and facilitating the  organizational
restructuring that built the New Economy. On the other hand,
improvements in information technology have spurred deeper integration
between the United States and the world economy.

An increasingly open global economy--which the policies of this
Administration have helped promote--boosts innovation in several ways.
First, it makes available the expanded markets that yield the scale
economies so important for activities that require large up-front
research and development expenditure. Second, it gives producers
access to key imported  components and machines at lower prices and
in greater variety. Importing these goods allows U.S. innovators to
concentrate on activities that make the best use of their knowledge
and skills. Third, by heightening competition, globalization spurs
not only innovation but also the adoption of new  technologies. This
in turn creates still larger markets for innovative goods and thus
greater rewards for those who innovate. In addition, the availability
of information technologies facilitates the global reorganization of
production and the continued increase in trade. It allows multinational
firms to  coordinate their activities and to manage supply chains on
a global scale.  It also brings increased numbers of buyers and
sellers into global markets. Globalization has also helped support
the high rate of investment that  has played an important role in the
current economic expansion. Increased capital flows into the United
States have made it possible to maintain  investment in excess of
domestic saving.

An example of the importance of global markets can be seen in the
increased production and use of computers in the United States in
recent years. Domestic purchases of computers, peripherals, and parts
grew at an annual rate of more than 12 percent from 1993 to 1999, far
outstripping growth in the value of domestic shipments of these goods,
which averaged only 9 percent. Filling the gap has been a rise in
imports, which now account for more than 60 percent of the value of
new U.S. computer purchases--nearly twice the level in 1987. At the
same time, half of U.S. computer shipments are exported. The United
States gains in both directions from this two-way trade in computers
and parts. U.S. computer firms can lower their costs by obtaining
components from efficient foreign producers, and later profit from
selling finished computers in the larger global market. At the same
time, lower prices for computer imports are good for consumers and
for businesses.

In an age of international economic integration, continued success
in the United States requires effective engagement with the global
economy, strengthening international connections and building larger
markets overseas. At issue is not whether we should welcome the
emergence of a truly global market economy, but rather what kind of
global market economy we should work to build. To ensure that
globalization proceeds in a constructive way, the policies of the
Administration have sought to make international institutions both
more effective in helping to maintain global economic  stability and
more transparent in their operation.

This Administration has consistently stressed that making economic
integration work means making it work for all people--and making sure
that all voices are heard when policies are decided. Toward this end,
even as it has adopted policies that promote globalization, the
Administration has sought to address genuine and deeply felt concerns
about its effects. These include its effects on the incomes of working
people, the health of the environment, social and labor standards, and
the divergence of incomes between rich and poor countries across the
globe. The goal has been to foster an interconnected global economy
that both increases prosperity and provides genuine opportunity for
people everywhere.

The Role of Trade Liberalization
in Promoting Globalization

Trade policy has been an important factor in our prosperity here
at home. The focus of this Administration has been on fostering a
world of open markets governed by the rule of law, in which lower
tariff and nontariff barriers allow all countries, including the
United States, to enjoy the benefits of increased trade and
investment. The achievements of the past 8 years include numerous
international agreements--over 300 in all--that have  liberalized
both trade and investment, helping to ensure that foreign markets are
open to U.S. exports. Among these are a number of especially notable
accomplishments, including passage of the North American Free Trade
Agreement (NAFTA), completion of the Uruguay Round of multilateral
trade negotiations, enactment of legislation to extend permanent
normal trade relations to China, a moratorium on customs duties on
electronically delivered products, and agreements to liberalize trade
in such crucial technology-related sectors as telecommunications,
computer technology, and financial services. In addition, the member
countries of the Organization for Economic Cooperation and Development
(OECD) have benefited from an agreement to reduce subsidies in tied
aid export credit competition. This agreement limits the ability of
countries to make the financial aid they offer to developing countries
contingent on purchases from their domestic producers, and thus helps
level the playing field for U.S. exporters. A host  of other bilateral
and regional initiatives have also helped create more open markets.
These include initiatives that encourage trade with developing
countries in Africa, the Caribbean and Central America, the Middle
East, and Southeast Asia. These programs not only benefit the United
States through more diverse and cheaper imports and expanded exports,
but also afford developing countries an important opportunity for
growth through increased access to the U.S. and other markets.

The trade agreements to which the United States has been a party
nearly always result in a lowering of barriers on both sides, but
typically it is the  foreign barriers to American firms operating
abroad, rather than barriers to foreign firms in U.S. markets, that
fall the most. This is true for the simple reason that, in nearly all
cases, the U.S. barriers were lower to begin with. This was the case
with both the Uruguay Round agreement and NAFTA, both of which removed
substantial impediments to U.S. exporters. Similarly, the bilateral
agreements concluded with Japan under the 1993 Framework Agreement
and the 1997 Enhanced Initiative on Deregulation and Competition
Policy have helped eliminate obstacles to U.S. exports to that
country, in the form of border barriers and domestic regulations that
unnecessarily hindered trade and investment. Opening foreign markets
can stimulate exports by providing firms with a larger arena in which
to sell  their goods and services. For example, one result of China's
recent trade  liberalization was that exports of U.S. oranges to that
country grew from less than 350,000 kilograms in all of 1999 to more
than 10 million kilograms in the first 9 months of 2000.

Trade liberalization has also focused on industries of special
relevance for the improved communications and technology that are
at the heart of the New Economy. Several multilateral treaties have
been negotiated under the auspices of the World Trade Organization
(WTO). The 1996 Information Technology Agreement eliminates tariffs
on the preponderance of world trade in semiconductors, computers,
software, telecommunications equipment, and other high-technology
products. The Agreement on Basic Telecommunications Services, which
came into force in February 1998, has already made an important start
toward opening world telecommunications markets to competition. The
Financial Services Agreement, which took effect in March 1999,
similarly opens markets in banking, insurance, and securities
transactions. This allows U.S. financial services companies to
better serve overseas markets through investments in foreign banking
institutions, brokerages, and insurance concerns. Work is now under
way to expand these agreements to include new products and services
and achieve further  deregulation and liberalization. The United
States stands to reap sizable gains from increased exports in these
industries where U.S. firms are strong competitors. But all countries
will benefit from these agreements through lower prices and the
diffusion of knowledge that goes hand in hand with trade and investment.

Globalization and Economic Performance

Trade and investment spur innovation and competition and thus
contribute to better economic performance. This benefits society at
large through the development of new goods and technologies, through
higher productivity, and ultimately through lower costs for consumers
and entrepreneurs.

Scale and Network Effects

Openness to the global economy increases the size of markets. This
is particularly important for the development of goods and services
subject to scale and network effects, including items that are
central to the New Economy, such as technology and communications.
Production of these items is subject to economies of scale--that is,
the average cost of production declines with the quantity sold. Among
these products are those characterized by learning curves: the more
the firm produces, the more it learns how to reduce production costs,
so that, on average, each additional unit costs less to produce than
the one before. Scale effects are present as well for products with
high fixed costs of development; because these fixed costs do not
depend on the number of units produced, the average cost per unit
falls as the number produced rises. This kind of cost structure
describes most pharmaceuticals: developing and testing a new drug is
expensive, but the cost of producing it, once the formula is known,
is typically quite small. For goods like computer software and
entertainment, development costs  are again quite high, but the
products, once created, can be reproduced relatively cheaply.
Moreover, these products can be used by many consumers simultaneously
without diminishing their value. The availability of a global
marketplace gives firms a greater incentive to undertake the costly
research and development necessary to create these kinds of products.

Globalization is similarly important in industries characterized by
network effects. In most such industries, which include
telecommunications, the value of the network grows as more users are
added. Indeed, this value grows exponentially, in a phenomenon known
as Metcalfe's law. Expansion of markets from a local or national to a
global scale clearly benefits network industries. An example is the
expansion of the Internet itself, which after all is a network of
computer networks. As the number of global Internet users grows, the
Internet becomes more valuable to all, including those who were
already on line. The larger market that the growing Internet
community represents provides added incentives for innovation by
entrepreneurs, thus contributing to increased employment and wealth
creation. The new products and services thus made available entice
still more users throughout the world to seek access to the network.
In this way, technology and openness combine to encourage innovation,
which in turn further enhances globalization itself.

Competition and Innovation

Firms in an open global economy can choose from a broader range of
inputs, thereby increasing efficiency and lowering production costs.
Consumers are also made better off from access to a wider choice of
goods and services. Even a large economy such as the United States
benefits from greater specialization in a global economy, because it
allows Americans to pick and choose from the best ideas and the most
advanced and cost-efficient sources of goods from all over the world.
These include not only consumer goods but also capital goods and
intermediate inputs, which make our own final products more competitive.

Globalization increases the number of competitors in a market, and
increased competition compels firms to continually innovate and
improve their productive efficiency. For example, in the early 1980s
U.S. computer firms and other manufacturers that used memory chips in
their products are reported to have preferred chips from Japanese
rather than American  producers, because the Japanese-made chips had
lower defect rates. This led the U.S. producers to study and apply
Japanese quality management techniques, so that by the early 1990s
their defect rates matched those of their Japanese competitors.

Changes in the Global Organization of Production

Together, competition, globalization, and technological innovation
induce changes in the organization of firms and in the geographic
division of production. The worldwide reach of the Internet and open
access to global transportation networks make it easier for businesses
everywhere to go global, by reducing the cost of setting up an
international presence. Increased openness and improved communications
expand the scope of the firm, allowing multinationals to apply
advanced production techniques to larger markets and thus benefit
from scale economies (Box 4-1). At the same time, the countries that
host the multinationals' expanded activities gain from the transfer
of technology and production experience that often accompanies such
activity. To help ensure that the operations of multinational
enterprises are in harmony with government policies, in June 2000
the OECD  member countries, joined by several nonmembers, adopted a
set of voluntary  guidelines for multinational enterprises.

The opening of national economies and markets has given rise to
global supply chains, in which production is spread across numerous
locations worldwide, to take advantage of different countries'
relative strengths in producing different goods and services. This
again results in improved efficiency for firms and lower prices for
consumers. U.S. producers of  computer hard disks, for example, have
kept most of their product development operations in the United
States but have shifted production to  countries in Asia to take
advantage of low costs of raw materials there. (It turns out that
this consideration is more important in this industry than low labor
costs.) But they have not gone so far as to outsource assembly to
independent suppliers; it continues to be done almost entirely by
the U.S. firms themselves, through foreign subsidiaries. And these
firms remain among  the world leaders in innovation. This runs
counter to the argument that manufacturing must be done at home to
maintain competitiveness.

A different approach to production organization can be seen in the
semiconductor industry, where the trend has been toward a split
between ``fabless'' firms that design chips but do not operate
fabrication facilities, and

_____________________________________________________________________________
Box 4-1.  A New Role for Multinational Firms

Firms become multinational corporations when they perceive
advantages to establishing production and other activities in foreign
locations. Firms globalize their activities both to supply their home-
country market more cheaply and to serve foreign markets more directly.
Keeping foreign activities within the corporate structure lets firms
avoid the costs inherent in arm's-length dealings with separate
entities while utilizing their own firm-specific knowledge such as
advanced production techniques. By internalizing what would otherwise
be cross-border transactions, multinationals can bridge the information
obstacles that often hinder trade. For example, they may be able to
more carefully monitor product quality or worker conditions in
factories they own than in those of contractors, or adapt the
composition of output more quickly to changes in market conditions.

Improvements in information technology have reduced the impediments
to exerting corporate control across borders. These advances have
combined in recent years with an increased openness on the part of
governments to foreign multinationals, as the economic benefits of a
foreign presence to the host country have become more widely
recognized. These benefits include the increased investment and the
associated jobs and income that the multinational firm brings, as
well as technological transfer and improved productivity. The role of
multinationals in spreading industry best practices is likely to be
especially important in services, many of which are not easily traded
across national boundaries.

Evidence of the heightened role of multinationals can be seen in the
quickened pace of foreign direct investment (FDI) in recent years. In
1999 FDI flows both in and out of OECD countries reached record levels:
over 2.5 percent of their combined GDP for inflows and 3.0 percent for
outflows. Most FDI is between developed countries: since 1982, 75
percent of FDI outflows from OECD countries have gone to other OECD
members.

Multinationals are increasingly opting to acquire existing
enterprises rather than develop a foreign presence from scratch. In
developed countries from 1991 to 1997, cross-border majority mergers
and acquisitions accounted for 62 percent of total FDI inflows in OECD
countries. The value of these mergers and acquisitions rose from $85
billion in 1991 to $558 billion in 1998. The average size of such
deals rose substantially, from $29 million in 1990 to $157 million
in 1999. Acquiring a foreign firm offers a relatively quick route to
enter a foreign market. It can also provide intangibles in the form of
country-specific knowledge, including familiarity with the host-country
business culture and regulatory structure.

The posts and telecommunications sector appears to be particularly
fertile territory for restructuring. The value of cross-border
majority mergers in this sector in the period from 1995 to 1998 was
nearly 10 times that from 1991 to 1994. This reflects two factors.
First, dramatic changes in technology such as the growth of mobile
telephony, the Internet, and the rising importance of broadband
capabilities require both increased capital and first-rate
technological prowess. Firms may seek to combine in order to amass
the capital and technological capabilities needed to compete. Second,
a worldwide movement toward deregulation in the telecommunications
industry, together with policies such as auctions of cellular licenses
and the liberalization of fixed telephone networks, has allowed new
entrants to compete in this once-protected sector. Complementing
this, the Agreement on Basic Telecommunications Services, which took
effect in February 1998, has made progress in opening global
telecommunications markets to competition.

In the air transportation industry the trend has been toward global
alliances rather than mergers and acquisitions. This stems from the
bilateral system of route rights established under the 1944 Chicago
Convention, and foreign ownership and control provisions established
to protect those rights. Nonetheless, deregulation and the advent of
these alliances have meant that airlines are able to serve customers
through global networks. Technology has enabled these alliances to
act as multinationals in some respects, with improved information
technology helping to provide reasonably seamless global travel
(although flights may not always be on time or provide the utmost of
comfort) through the linkage of computerized reservations services.
Information technology similarly allows multinational express cargo
carriers to ship, track, clear through customs, and deliver goods to
customers' doors--whether the address is in Beijing or New York.
----------------------------------------------------------------------

``pure-play foundry firms'' that produce chips from other companies'
designs. Like that of hard disks, most semiconductor design is still
done in the industrial countries--North America was the home of the
majority of fabless firms in 1998--while production takes place
mainly in Asia. This division of labor allows U.S. firms to focus on
their core competencies while benefiting from improved production
techniques devised by the specialized foundries. And of course, this
arrangement is feasible only because new technology allows the
designing firms to rapidly transmit chip designs to the foundries,
because cost-effective cargo services are available to transport
finished products to markets worldwide, and because intellectual
property laws are in place  to safeguard the rights of designers in
the producing countries.

Older, more established industries can also benefit from the use of
a global supply chain. In the apparel industry, for example, it is
typical for high-value-added activities such as design and marketing
to be performed in the United States, with assembly carried out in
locations with lower production costs. The exceptions occur mainly
in niches where capital-intensive techniques can be applied, such
as the production of socks, or in specialty items for which labor
costs are relatively less important. This division generally
results in lower prices for consumers. This is not to deny, however,
that there are costs to these developments, notably in the
dislocation of some U.S. workers as production has shifted overseas.
The effects of this dislocation and the Administration's response are
discussed at length later in this chapter.

Evidence of the increased globalization of inputs to production
can be seen in statistics on the activities of American multinationals.
The foreign share of inputs in production by U.S.-based parent
companies more than doubled from 1977 to 1997, although domestic
content continues to account for more than 90 percent of their total
inputs (Table 4-1).



Better Technology, More Trade

Just as globalization spurs innovation, so, too, do improvements in
technology contribute to increased globalization. Improved
communications and  technology, in effect, make the world smaller.
They bring a wider variety of the world's goods, services, and
information to consumers everywhere, and they lower the costs of
cross-border transactions in goods, services, and financial flows.
These lower transactions costs should lead to increased trade and
investment, which in turn lead to higher incomes. Examples of how
technology lowers transactions costs abound. Firms can use sophisticated
information technology to implement cost-reducing just-in-time inventory
practices while managing a vast flow of components from a global web
of suppliers. The cost of air freight is a fraction of what it was
just 20 years ago, thanks not only to better technology but also to
deregulation of global air services and the expanded use of open skies
agreements. These agreements permit unrestricted service by the
airlines of each country to, from, and beyond the other's territory.
The United States has entered into numerous such agreements, most
recently in November 2000 with Brunei, Chile, New Zealand, and Singapore.

Novel though some of these cost-saving technologies are, they are
in one sense nothing new, but simply the continuation of a centuries-
long procession of human innovation. Declining transport costs, for
example through more efficient ship design and improved navigation
techniques, have been linked to the expansion of trade in Europe at
least since  the Middle Ages. More recently, the introduction of
standardized shipping containers and systems for handling them has
revolutionized the international shipping industry, yielding enormous
increases in productivity. Together with improved communications,
containerization has made integrated global production and distribution
networks a reality. A comprehensive list of innovations that have
improved the speed and lowered the cost of telecommunications would
include the telegraph, the telephone, radio, television, fax machines,
and most recently the Internet.

Like the other advances in telecommunications that preceded it,
only more so, the Internet transcends the barrier of physical
distance and helps overcome geographic obstacles to economic
integration. Its power to transmit vast quantities of information to
and from individual users gives it great promise for lowering
transactions costs and facilitating trade. Its commercial reach
extends across borders; for example, one major on-line retailer
reports that consumers from more than 160 different countries have
visited its website. And the Internet allows not just information
about products but some products themselves, such as software and
entertainment, to be delivered electronically at minimal cost. This
type of globalization clearly benefits consumers and entrepreneurs by
expanding the variety of products available for consumption and use
and providing easier access to low-cost suppliers, wherever they are
located.

The effect that the Internet is having on international trade is
difficult to estimate, in part because it is hard to accurately
measure Internet usage in some countries. One analysis of trade flows
found no clear effect of the Internet in 1995 or 1996, but an
increasing effect in later years. This result was found after taking
into account a number of other factors that influence a country's
trade, including the size of its economy, its distance from other
countries, and common borders, languages, and colonial heritage.
Moreover, poor countries appear to gain more from expanded Internet
access than rich countries. This suggests that access to the Internet
might lessen the burden of shortcomings in traditional infrastructure
that presently hinder trade for developing countries. In other words,
bridging the international ``digital divide'' between rich and poor
countries can have measurable economic benefits, not just in
high-technology areas but in all sectors.

The effect of the Internet on international trade might indeed be
larger than even these encouraging results suggest, because that
analysis covered only trade in goods--it did not include services,
such as education, financial, medical, and other professional
services. Yet these are likely to reap especially large benefits from
the possibilities of electronic commerce. Improved communications
allows for commerce in these services that were previously difficult
to deliver without a physical presence.

Technology and Knowledge-Based Products
in U.S. Trade and Investment Flows

The growing importance of technology in the U.S. economy is evident
not just from anecdotal examples but in the broad patterns of the
Nation's international transactions as well. The clearest sign is the
rapid growth of U.S. trade in capital goods, a category that includes
items such as computers, machinery, and telecommunications equipment
(Chart 4-1). Capital goods today make up  45 percent of the value of
U.S. exports, by far the single largest component (Table 4-2). They
also constitute the largest share of the value of U.S. imports.
Since 1996, increased trade in capital goods has accounted for about
70 percent of the growth in the value of U.S. exports and nearly 30
percent of that of imports. Strong growth in both imports and exports
partly reflects roundtrip trade, as components such as semiconductors
are exported from the United States and then return inside computers.
But it also reflects the role of trade in supporting investment
through equipment imports. Within the category of capital goods,
trade in information technology products has grown especially rapidly
(Chart 4-2). Computers, semiconductors, and telecommunications goods
now account for nearly half of the value of capital goods imports
and exports.

There has also been strong growth in exports of services,
reflecting the growing value of ideas and of knowledge-based
activities. Income from royalty and licensing fees grew by 8.3
percent each year on average from 1992 to 1999, compared with 6.5
percent a year for all services exports. Business, technical, and
professional services grew at an 11 percent clip over the same
period, and financial services income grew on average by 19.4
percent a year. Sales of these services are examples of
``weightless'' trade, since the value is in the idea or



service itself rather than in a material good. Although some services,
such as haircuts, are not tradable (at least under current technology),
there remains substantial scope for services trade to continue to
grow. In 1999 services still accounted for less than 30 percent of
the value of U.S. exports and less than



16 percent of imports, even though service-producing industries
(excluding the government sector) accounted for 65 percent of U.S.
GDP in 1998, the most recent year for which data are available.
Stronger growth in our trading partners may actually favor U.S.
services exports over goods exports, since there is evidence that
higher income abroad stimulates foreign demand for services more
than it does foreign demand for goods.

New Challenges

The confluence of increased globalization and improvements in
communications and technology have raised U.S. economic performance
and contributed to our prosperity. But these developments bring with
them new challenges. The rest of this chapter focuses on six such
challenges:

 raising U.S. saving and thus contributing to adjustment of
the current account deficit

 increasing growth in our major trading partners

 making sure that developing countries are not left behind

 adjusting to the changes at home brought about by globalization

 safeguarding the environment and labor standards, and

 addressing the challenges that technologies pose for
international legal institutions.

These challenges and the policy responses of the Administration are
discussed below.

The U.S. Trade Balance and Current Account

The recent rapid growth in investment and the resulting strong
performance of the U.S. economy have contributed to an increase in the
Nation's trade deficit. Robust income growth and increased wealth from
rising asset prices have contributed to higher domestic consumption,
and thus to rapid growth in imports. Growth was slower in major U.S.
trading partners in Europe and Asia than in the United States in 1998
and the first part of 1999 (Chart 4-3). This contributed to weaker
import demand in those regions and slower growth of U.S. exports. A
strong dollar, reflecting in part capital inflows from foreigners
eager to participate in attractive investment opportunities in the
United States, has also contributed to the growing trade deficit by
lowering prices of foreign-made goods relative to those of U.S.
products. Through the first three quarters of 2000, the trade balance
in goods and services was about $270 billion in deficit. That would
correspond to roughly $360 billion for the whole year, or about 3.6
percent of GDP (Chart 4-4). Meanwhile the current account (a
comprehensive measure that comprises not only the trade balance in
goods and services but also net income and transfers) recorded a
deficit of roughly 4.3 percent of GDP (Chart 4-5).





The current account balance equals by definition the difference
between national saving and national investment. A current account
deficit reflects an excess of investment over domestic saving, and
thus an inflow of foreign capital that makes up for the shortfall.
The widened current account deficit reflects the fact that although
net saving has risen, net domestic investment has risen even more.
The share of net domestic investment in GDP  (Chart 4-5) grew by 4.6
percentage points from 1992 through the first three quarters of 2000
(from 4.8 percent to 9.4 percent), while the share of net national saving
rose by only 2.3 percentage points (from 3.5 percent to  5.8 percent).

What explains the willingness of the rest of the world to provide
the United States with the capital inflows needed to finance its
current account deficit? The answer is simply that the attractive
opportunities for investment in the United States today exceed those
in other countries. This can be seen by comparing the deficits of
today with the comparably large (as a percentage of GDP) deficits of
the 1980s. In the earlier decade, most of the inflows went to the
purchase of U.S. government debt securities. The more recent inflows,
in contrast, have mainly been invested in privately issued assets.
Indeed, much of the inflow has come in the form of foreign direct
investment (equity investment for purposes of control of the enterprise)
rather than purchases of bonds or portfolio equity participation: the
value of inward direct investment into the United States rose from $51
billion in 1993 to $271 billion in 1999.

With saving from the rest of the world continuing to flow to the
United States, the U.S. net international investment position--the
value of U.S. assets abroad less the value of foreign assets in the
United States--will continue to turn more negative. At the end of
1999 the net international investment position was approaching a
negative $1.5 trillion, or almost 16 percent of GDP that year;
foreigners held more than $8.6 trillion of U.S. assets, while
Americans held foreign assets valued at more than $7.1 trillion. Part
of the income from these international investment holdings consists of
retained earnings and reinvested dividends and interest payments,
which are recorded as an outflow in the current account and an
offsetting inflow in the capital account. This would tend to raise the
apparent magnitude of capital flows. On net, however, income on
investment now flows out of the United States, as foreigners
repatriate earnings on their U.S. investments by a greater amount
than Americans are bringing their earnings on foreign investments
back to the United States.

The availability of foreign saving has permitted the United States
to maintain the high rate of investment that has expanded productive
capacity and raised economic performance. This shows that foreign
capital inflows are not in themselves a bad thing: it is better to
finance attractive investment opportunities using foreign capital
than not to undertake them at all. But our income would be even
higher if that investment were financed instead by domestic saving.
Saving trends in the United States over the last several years
present a mixed picture. From 1992 through the third quarter of 2000,
the share of net saving by the public sector (Federal, State, and
local governments) in GDP has risen by 7.8 percentage points. But
this rise has been largely offset by a decline in the share of net
private saving of 5.5 percentage points. Higher private saving would
help to ensure the continued ability of the United States to finance
domestic investment. The saving rate can be raised without threatening
continued strong growth in income if the composition of demand for
U.S. goods shifts, with external demand replacing some domestic
consumption. In the meantime, it is important to maintain public
saving, through continued fiscal discipline at all levels of
government, in order to support national saving.

It is difficult to say what level of the current account balance
would be most appropriate. But if some adjustment in the current
account is deemed necessary, the way it is accomplished matters. It
would be better to reduce the current account deficit through higher
domestic saving than through lower investment, because reducing
investment would mean a smaller capital stock and thus lower national
income than would otherwise be the case. In the best of all possible
world economies, increased growth in the rest of the world would lead
to increased U.S. exports, which would compensate for the reduced
domestic demand that higher domestic saving would entail, and thus
maintain strong income growth in the United States. More rapid growth
abroad would cause saving by foreigners to shift from the accumulation
of U.S. assets to investment in their own domestic economies, made
newly attractive by their increased domestic growth. The rebound in
investment abroad would further spur U.S. exports, which, as we have
seen, consist largely of capital goods.

Opening foreign markets can play a role in adjustment by encouraging
U.S. exports. In contrast, efforts to narrow the trade deficit or
the current account by raising barriers to imports into the United
States would likely make the economy less efficient and thus lower
national income, without necessarily increasing national saving.

Raising Performance in Other Countries

At present, the U.S. current account deficit is supporting too
large a share of the global economic expansion. It would be desirable
for other countries to take steps to accelerate their growth and
promote a smooth return to a more balanced global distribution of
growth. As this adjustment occurs, the U.S. current account deficit
should return to levels in line with the historical U.S. saving and
investment relationship. To ensure sustained, balanced  global growth,
the major industrial economies need to maintain supportive fiscal
and monetary policies and push ahead with structural reforms to remove
barriers to investment opportunities (including opportunities for new
technologies).

The same innovations that have raised economic performance in the
United States would likewise be expected to raise foreign productivity
and growth as those innovations are adopted abroad. The global
diffusion of innovative technology is thus one avenue through which to
increase growth in other countries. Technological development is not a
race, where the first to make a discovery is the only winner. The
spread of our own technological discoveries to other countries leads
to higher productivity and economic growth in those countries,
raising their incomes and thus creating new opportunities for
innovative and competitive U.S. firms to export. And when productivity
rises in other countries, the prices of the goods they  produce fall,
and to the extent that these goods are exported to the United States,
Americans benefit from lower prices and greater choice.

Throughout the 1990s, the beneficial effects of technology on
productivity and growth appear to have been enjoyed most strongly in
the United States. Although growth has rebounded in Europe and the
emerging market economies of East Asia, these events so far appear
to be cyclical rather than structural in nature. That is, recovery in
these countries seems to be bringing them back up to their economic
potential, but not yet accelerating the expansion of that potential.
The situation in the United States has been  otherwise. From 1995 to
2000, according to OECD estimates, potential output in the United
States grew at an annual rate of 3.5 percent, compared with only 2.2
percent for the countries that have adopted the euro, and only 1.4
percent for Japan (Chart 4-6). Growth in total factor productivity--
the



efficiency with which capital and labor are used in combination--
also lags  in most European and other industrial countries, with
little sign of the  acceleration the United States has experienced
over the past several years (Chart 4-7).

The lagging pace of investment in information technology in much
of Europe compared with the United States may be one reason for the
divergence in trend growth. This lag is evident even after taking
into account  differences in the measurement of purchases of high-
technology products (Box 4-2). The United States also leads other
industrial countries on several measures of the usage of information
technology, including numbers of  telephone lines, Internet hosts,
and secure servers used in e-commerce  (Chart 4-8). Yet the United
States is not ahead in every aspect of information technology:
wireless technology has taken off in Europe far more than in the
United States.

There are some signs that the use of the new technologies whose
pervasiveness has so benefited the United States is beginning to
approach critical mass in other advanced economies, including
Germany, the  Netherlands, the Nordic countries, and the United
Kingdom. For example, Germany now boasts a technology-oriented stock
market similar to the  Nasdaq, the Neuer Markt, and is reported to
have the largest European contingent of Internet enterprises, larger
even than in the United Kingdom. Firms in Scandinavia are innovators
in important areas of technology, notably wireless communication.
Perhaps not coincidentally, the Nordic



____________________________________________________________________________
Box 4-2. Information Technology and Cross-Country Differences in Measuring
Economic Growth

The rapid rate of technological improvement in information  technology
products makes it difficult to distinguish between changes in prices and
changes in quantities produced. Statisticians face the problem that
traditional price indexes fail to adequately account for quality changes in
the face of rapid technological change: a computer that cost $2,500 in 2000
provides several times the computing power of a $2,500 computer only a few
years earlier. To account for rapid quality upgrading in computing equipment,
the United States has adopted a hedonic price deflator for computers and
hardware, which measures computing power as a combination of characteristics
such as processor clock speed, memory capacity, and hard disk size. Using this
methodology, computer prices in the United States are estimated to have fallen
at an average rate of 17 percent per year since 1990, and 24 percent per year
since 1997. Growth in the volume of computer sales contributed nearly 1
percentage point to real GDP growth in 1999, even though the value of computer
spending in current dollars accounted for less than 0.1 percentage point of
nominal  GDP growth.

The use of this hedonic index makes international comparisons  of information
technology spending difficult, since most other  countries do not use hedonic
price indexes (exceptions include  Canada, France, and Japan). Using
traditional measures that do not fully adjust for quality improvements
understates real computer expenditure and thus overall real investment. This
in turn lowers the statistical measure of output and affects productivity
calculations. Compared with the United States, a country using a traditional
price deflator appears to produce less high-technology output for any given
amount of inputs such as workers and nontechnology capital. Applying the U.S.
deflator to German information technology investment, for example, results in
a substantially larger measure of real investment--as much as 170 percent
larger--than with the traditional deflator. Over the period since 1991, use of
a hedonic price index would have implied that real investment in information
technology equipment in Germany increased at a rate of 27.5 percent per year,
versus 6 percent using the traditional approach.

However, even after correcting for the different statistical methodologies,
investment and GDP growth in the United States remain far stronger than in
Europe. A study that applied the U.S. deflator for information technology
investment to France found that the contribution of this investment to growth
was similar for the two countries     from 1973 to 1990, but that investment
then grew by twice as much in the United States from 1995 to 1998. An
alternative approach found that the contribution of information technology
investment to growth in France was smaller than in the United States before
1990 as well as in more recent years. Another study took the difference
between the price index for U.S. information technology investment and the
price index of all other investment goods and applied this to non- information
technology price indexes in other G-7 countries to derive a new price index.
The contribution of information technology equipment to GDP growth from 1990
to 1996 was found to be still nearly twice as large in the United States as in
most other G-7 countries. Only the United Kingdom and Canada experienced
contributions to growth of even two-thirds that of the United States.

The difficulty of accurately measuring the rapid technological change
occurring in information technology makes international growth comparisons
difficult, but it does not qualitatively affect a comparison of growth in the
United States with that in many other industrial countries. The success story
of the U.S. economy is more than a statistical artifact.
------------------------------------------------------------------------------



countries (excluding Denmark) benefited more from higher total factor
productivity growth in the latter half of the 1990s than did other
European countries. Meanwhile other developed countries that have
lagged in productivity growth are attempting to catch up. Japan, for
example, has recently taken steps to deregulate its telecommunications
industry and provide incentives for firms to upgrade their information
technology equipment and employee skills. Burgeoning information
technology sectors have also begun to appear in some developing
countries. One notable example is the development of an Indian software
programming industry. However, additional policy steps are needed to
ensure that these countries fully enjoy the benefits of the new
technologies.

The Importance of Institutions and Policy

In addition to removing barriers to international trade, improved
economic performance requires a combination of institutions that
facilitate the allocation of human and financial resources to
activities with the highest rates of return. These include flexible
labor markets, efficient capital markets, and government regulatory
structures that encourage competition.

Labor Market Flexibility

Flexibility of labor markets has been an important aspect of
economic success in the United States. This flexibility encompasses
both the ability of workers with desirable skills to switch to more
rewarding jobs, and the ability of firms to adapt their work force to
changing economic prospects. It also entails a work force that can
adapt to new technologies and production techniques, businesses that
effectively manage human resources, and pro-competitive government
policies, such as supportive tax regimes that encourage investments
in new skills and technologies. Among OECD  member countries from
1980 to 1997, those with relatively low tax rates on labor income,
and low costs to firms of restructuring their work force,  generally
had lower rates of unemployment and higher rates of job creation than
other countries.

Labor market flexibility is particularly important in high-technology
industries, where the pace of innovation and industry evolution is
especially rapid. The important role of research and development in
these industries means that sophisticated human capital--strong
education, specialized skills, and the ability to innovate--becomes an
essential input. Expanding  firms must be able to attract skilled
workers, who are the main users and producers of technology; indeed,
the movement of labor between technology firms has been found to be an
important channel for knowledge transfer. This includes movement of
skilled workers across borders. Immigrants,  especially from India
and Taiwan, have made important contributions  to high-technology
firms in the United States. Here too, U.S. policy has  supported
labor market flexibility, by allowing firms to bring in highly
skilled foreign workers through the recently expanded H-1B visa
program, while providing assistance for training of U.S. workers.

Capital Market Efficiency

The efficiency of capital markets in the United States has also
contributed to the superior economic performance we have seen. The
more widespread availability in this country of equity finance,
including venture capital, facilitates business creation and propels
the development of new technologies. In contrast, in Japan and some
European countries, banks and other large financial institutions
provide most business financing, hold some firm equity, and usually
exert a measure of corporate control. These differences between the
two systems give rise to different incentive structures. Returns to
bank loans are limited by the interest rate; returns to equity
investments are determined by profits and capital gains. This makes
bank lending better suited to financing low-risk activities, whereas
an equity-based system has the potential to generate greater capital
investment in activities where expected returns are high but uncertain.

When most job creation and investment are undertaken by large and
established firms, these differences in the mode of financing are not
likely to be important, since such companies finance most investment
out of their own retained earnings. However, it is likely that the
performance of the two systems will diverge in high-technology
sectors, for at least two reasons. In the telecommunications sector,
the large outlays required to finance the emerging new technologies
could well exceed the financing available from retained earnings and
from banks. In other areas of information technology, banks have not
been especially successful in supporting the new firms that play an
important role in generating innovation. These considerations put the
bank-centered systems of Europe and Japan at a relative disadvantage.

In contrast, economies that have liquid, efficient capital markets
tend to invest more heavily in research and development activity, and
particularly in high-technology startups. Venture capital has
flourished in the equity-based U.S. system as an important financing
mode for risky new enterprises, since the returns on venture capital
can best be realized when firms can readily issue new equity to the
public. Of course, it is not impossible for information technology
startups to be financed within the framework of bank-oriented systems,
but such systems have had difficulty matching the success of the
equity finance model. In Europe and Japan, for example, venture
capital is supplied primarily through the financing arms of banks
and other financial corporations. Venture capital in these countries
has thus far tended to focus on the later stages of firm development,
or to finance leveraged buyouts of existing firms rather than fund
the creation of new ones. The distinctions between the two systems
may be eroding in continental Europe. For example, the ratio of stock
market capitalization to GDP has been trending upward in many of these
countries since the mid-1990s, although in most of them it remains
well below the U.S. level.

The form of firm ownership and control also influences the creation
and diffusion of information technology. In the ``outsider'' model of
corporate governance common in the United States and the United
Kingdom, management is given incentives to focus on stockholder
returns, and minority shareholders enjoy substantial protections.
In contrast, the ``insider'' model common in Japan and continental
Europe gives more power to other stakeholders, including large
ownership groups such as banks as well as employees and management
itself. The insider model may allow stakeholders to more  effectively
monitor management efforts in a way that avoids a focus on short-term
financial results. But there is evidence that in recent years the
outsider model has fostered superior performance, including a more
rapid pace of research and development, investment, and technological
diffusion.

The Role of the Regulatory Framework

The need for flexibility applies to the institutions of government
as well. Regulatory frameworks must be transparent and avoid raising
hurdles to the creation of new businesses. Startup firms are a vehicle
for the introduction of new products and techniques, since they face
a lower opportunity cost of switching to newer, better technologies.
Moreover, the presence (or the threat) of new entrants limits the
possibility of monopolistic behavior by incumbents. A challenge in
this regard is how to distinguish regulation that is necessary to
prevent anticompetitive behavior, and thus promote innovation, from
regulation that hinders innovation. This can be a difficult task when
large, potentially monopolistic firms are also among the most
innovative.

Ensuring that domestic markets are open to competition has been
found to be particularly important in the telecommunications industry.
Here as elsewhere, competition leads to lower prices; in
telecommunications it also spurs increased investment and network size.
But it is in the nature of  networks to tend toward monopoly, in part
because of the scale economies discussed above. Hence regulatory
authorities must be vigilant.

Privatization of state-owned telecommunications firms has also been
found to lead to lower costs and increased usage. But for this to
occur, privatization must be complemented by effective regulatory
oversight so that a dominant firm does not impede competition by new
entrants, through such means as excessive charges for connecting
competitors' calls over the ``last mile'' of telephone line to homes or
businesses. An inexpensive, high-quality telecommunications network
is not only a basic element of the business infrastructure of any
modern economy but also an important determinant of the adoption of
information technology, in particular the Internet.

Raising Incomes in Developing Countries

The global imperative to combat poverty and support economic
development in the poorest countries gains added urgency today, when
the AIDS epidemic, international and civil conflict, and other
catastrophes threaten to reverse years of gains in many countries.
The divergence in national incomes between the developed and the
developing world continues not because so many countries are
effectively integrating themselves into the global economy, but
because so many are not. Bridging this gap remains a challenge for
economic development. Meanwhile the emergence of new technologies
threatens to create an international ``digital divide'' parallel to,
and to some degree predicated on, that in economic development.

Economic integration holds out enormous potential for improving the
lives of the world's people through increased access to goods,
services, and ideas. Economies that are relatively open to
international trade and investment appear to grow faster than closed
economies, although it is difficult to separate out the causal
linkages between openness and growth. The growth-enhancing effects of
economic integration are especially vital for the poorest of developing
countries, because a central lesson of history has been that rapid
and sustained economic growth is essential to rapid and  long-lasting
reductions in poverty. But for this to happen, globalization must
proceed in a stable global economy, so that it can be harnessed to
advance a prosperity that is shared by all.

Ensuring a Stable Global Economy

Growth in global flows of private capital has accompanied and in
many cases supported growth in trade. Access to global capital helps
countries finance their expanding trade. It is also a vehicle for the
development and transfer of new technology and a creator of new
economic opportunities. But wherever there is finance, there is the
inherent risk of financial crisis. In  tandem with the global
expansion of capital flows, therefore, policies and institutions must
be developed that minimize this risk while maximizing the potential
of capital flows to support rapid growth. A well-functioning system
that ensures a strong and stable flow of capital to emerging economies
is a crucial part of building a successful, truly global, economy.

The recent financial crises in Asia and elsewhere have underlined
the economic and humanitarian imperatives of a stronger international
financial architecture. The memory is still fresh of how millions of
people around the world, many of them poor people going about the
business of improving their lives, instead saw their lives turned
upside down when their countries' financial systems were thrown into
crisis. The international community must work diligently to provide
the greatest possible assurance that such crises will be less
frequent--and less costly--in the future.

Making crises less frequent and less costly means having a clear
understanding of what has caused them in the past. There is now
widespread agreement that the financial crises of the late 1990s
were caused by two elements coming together. The first was weakness
in many countries' economic fundamentals, including weak banking
systems, questionable investments, domestic credit bubbles (supported
by large amounts of short-term external debt), unsustainable exchange
rates, and in some cases, deteriorating fiscal positions. These
weaknesses were thrown into relief when international investors began
to reassess these countries' capacity to safely absorb large amounts
of foreign capital. The second element was an element of panic, as the
focus of domestic and foreign investors shifted from being the first to
discover the latest new opportunities in these countries, to how to
avoid being the last out the door.

This understanding of the causes of the crisis is increasingly
informing the redesign of the international financial architecture.
This shows itself in three fundamental ways:

 More effective means of preventing crises. The International
Monetary Fund (IMF) has strengthened its surveillance of the global
economy, with a focus on preventing the adoption of policies that
create vulnerabilities and thus augment the risk of financial panic.
Reform is proceeding on several fronts: toward a revolution in the transparency of national macro-economic frameworks that will make
surprises less likely; toward the development of a wide-ranging
framework of international codes and standards, to provide benchmarks
for national policies in areas such as bank supervision and securities
market regulation; and toward more systematic incorporation of
indicators of liquidity and balance sheet risks in IMF surveillance reports.

 Safer policies in the emerging market economies. Here there
are already  signs of progress as a result of greater global
understanding and wariness of economic risks. For example, the ratio
of short-term external debt to foreign reserves has nearly halved
since 1996 in those countries that experienced liquidity crises in
the late 1990s. In the same countries, short-term debt fell from 34
percent of total external debt in 1996 to 21 percent in 1999. Some 14
countries have moved away from unstable pegged exchange rate systems.
But constant vigilance is needed to make sure that problems do not
reemerge.

 An IMF that is better equipped for modern crisis response.
With the creation of the Supplemental Reserve Facility and the
Contingent Credit Line, and more recently with the November 2000
decision of the IMF's executive board on the reform of IMF facilities,
the IMF now has tools that are a match for the kinds of crises that
today threaten the global economy. The design of these facilities
seeks to avoid, as far as possible, distorting the incentives both of
private investors and of governments. IMF policy is increasingly
oriented toward providing short-term, emergency finance, priced to
discourage its casual use and to encourage rapid repayment. These
changes have been accompanied by efforts to increase the flow of
information to financial markets and to improve communication between
borrowing countries and their creditors. They also build on the
experience gained in recent cases of debt restructuring, putting in
practical terms the broad guidelines on private sector involvement in
crisis resolution  outlined by the Group of Seven (G-7) major
industrial countries in July 2000.

A stable international economy is not enough to ensure rapid and
sustained growth. Governments need to put in place institutions and
rules that allow markets to function well. Governments also need to
promote the effective rule of law, through good governance,
transparent decisionmaking, and support for the emergence of a
healthy civil society.

Overcoming the Global Digital Divide

In the same way that a lack of access to international trade and
capital markets hinders growth in the least developed countries, an
issue now arises with the new networks of information. The rapid
pace of technological advance threatens to create an international
digital divide that leaves some developing countries lagging ever
further behind the more advanced economies. This is a particular
concern for less developed countries in Sub-Saharan Africa; it is
less of a concern for many emerging market economies in East Asia
and Latin America, which are already experiencing rapidly expanding
use of technology and increased access to the Internet.

Some argue that acquiring advanced technology should be a relatively
low priority for countries still struggling to meet basic needs, such
as clean water and adequate health care, and to lower their poverty
rates. Recent studies suggest, however, that information technology
(including telecommunications) not only can address some of these
basic needs, but may also generate higher social returns than more
traditional infrastructure investment. The effects of information
technology on growth and development are difficult to assess, but
some studies have found a positive correlation between the stock of
telecommunications capital and economic growth. Evidence on the
success of individual projects suggests that this association
reflects more than just rising demand for technology as a country's
income rises. Information technology holds great potential to raise
incomes and improve the quality of education, health care, and public
services. It makes it easier for individuals to both obtain and
disseminate the information they need to empower themselves, and it
promotes a more active civil society. Of course, information
technology is not a panacea for the problems of development; each
country's circumstances will ultimately govern its decision whether
to invest in technology or in other projects.

Seizing the opportunities that technology offers to developing
countries requires the right policies. Despite the potential for high
returns, gaps in policies and institutions can lead to significant
underinvestment in information technology in these countries.
Obstacles to the diffusion of information  technology and its
applications, such as e-commerce, are in large measure the same as
the impediments to economic development more broadly. These include a
lack of well-developed credit markets to channel domestic saving to
productive investments, deficiencies in basic infrastructure, and
shortcomings in education. Moreover, institutions in many developing
countries lack the capabilities to enforce property rights and provide
an effective set of commercial laws. The result is that individuals
and firms hesitate to invest in costly equipment and software even
when the potential rates of return are high.

Developing countries also face a number of underlying problems that
hinder the increased use of new technology. These include:

 High costs to users. At current prices, information technology
may be prohibitively expensive for most potential users in developing
countries. And in many countries the presence of a monopoly
telecommunications provider keeps prices high and network size and
usage low. However, creative financing structures and business plans
can overcome this obstacle, as exemplified by thriving Internet cafes
in several developing countries. Another example comes from Bangladesh,
where individuals (often women) use microcredit financing to purchase
a single cell phone, which they then profitably rent out to others in
the community.

 Human capacity. A country's successful assimilation of
information technology requires a generally educated populace.
Developing countries cannot make full use of information technology
without the right training and skills.

 Applications. Applications of information technology that
have been successfully marketed in developed countries may not be
well suited to conditions in developing countries. Local communities
and nongovernmental organizations have demonstrated remarkable
ingenuity in adapting information technology to local uses such as
micro e-commerce, distance education, and the dissemination of public
health information. However, software companies must still be
encouraged to develop applications that do not require high bandwidth
or high levels of literacy or English proficiency.

Not all the elements are yet in place for market forces to close the
international digital divide. Developing countries need help in
narrowing the parallel gaps in policy, infrastructure, and training
before they can successfully harness information technology for
economic development. In 1999 the United States launched the Internet
for Economic Development Initiative to provide targeted assistance in
these areas to a number of developing countries. The United States
has also been active in providing direct support for high-technology
infrastructure in developing countries. The Leland Initiative has
provided African countries with financial and technical assistance
aimed at helping them benefit from increased Internet connectivity.
The Overseas Private Investment Corporation has established a $200
million credit line for U.S. companies seeking support for projects
that will help developing countries close the digital divide. The
United States has also provided assistance with policy development;
for example, the Federal Communications Commission has helped
developing countries devise appropriate regulatory regimes. The
Okinawa Charter promulgated by  the G-8 countries (the G-7 plus
Russia) in July 2000 provides a framework within which work can proceed
on policy development, human capacity building, and brokering of
private-public partnerships to diffuse information. It also established
the Digital Opportunity Task Force, or DOTforce, to coordinate policy
formation to implement these general principles and help catalyze
resource allocation to remedy shortcomings that the private sector
alone cannot.

Investment in information technology can contribute greatly to
economic development. Market forces will ultimately provide the
dynamism to drive information technology investment, but policymakers
need to establish the conditions in which these forces can flourish.

Adjusting to Change at Home

Globalization and the effects of technology pose challenges at home
as well. Even though the increased openness of the United States to
the international economy provides substantial benefits for the Nation
as a whole, not everyone gains. The rewards of improved technology and
increased  globalization are not spread equally: for some, change
inevitably means dislocation. Therefore an important complement to the
Administration's international economic policy has been assistance to
those here at home adversely affected by changes in technology or
increased globalization.

A number of Federal programs help individuals obtain the tools
they need to succeed in the New Economy. The Dislocated Worker Program
provides services to workers who have lost their jobs and are unlikely
to return to their previous industry or occupation, as well as to
formerly self-employed persons and displaced homemakers no longer
supported by the income of another family member. The available
benefits include assistance with job search and placement, individual
counseling and career planning, and training assistance. Some workers
also receive financial support toward transportation and child care
expenses. It is estimated that around 836,000 people participated in
the program in fiscal 2000. Workers affected by international
competition receive support from programs such as Trade Adjustment
Assistance and NAFTA Transitional Adjustment Assistance. Benefits
include training, job search aid, and relocation allowances. An
estimated 175,000 workers were eligible for assistance in fiscal
1999; of these, nearly 40 percent were cited as having been affected
by trade with our NAFTA partners.

In addition to giving financial support to individuals, government
can serve as a catalyst in helping whole communities adjust to
dislocation.  The Administration has proposed the Community Economic
Adjustment Initiative, now being implemented in a pilot program in
Connecticut.  This initiative would bring together resources from
across the Federal  Government to provide coordinated assistance and
information on new employment opportunities, along the lines of the
successful approach taken in response to military base closures.
Assistance would be provided to  communities in two stages: first to
assess their resources and needs, and then to develop an economic
response. Government agencies would also help connect displaced
workers with enterprises seeking to bolster their work force or
looking for locations in which to expand. As a further step, a
Commission on Workers, Communities, and Economic Change in the New
Economy, established by the President, will examine the effectiveness
of Federal programs that help with adjustment and identify the best
practices of employers, communities, and public-private partnerships
that have responded successfully to economic dislocations.

Dislocation is an unavoidable side effect of economic growth and
technological change. Economic progress--whether it results from changes
brought about by globalization, technology, institutions, or regulation--
affects workers in various ways, not always for the better. Wages change in
industries impacted by new competition, jobs shift from industry to industry
and from location to location, and the range of jobs available within a firm
or factory changes as well. All these factors interact: competitive pressure,
domestic or foreign, might lead a firm to adopt new technology, which in turn
might eliminate the need for some workers while creating jobs for others to
develop and manage the technology. Such changes in the skill mix have been the
predominant factor in past changes in employment: around  70 percent of
changes in employment in U.S. manufacturing as a whole in the 1980s resulted
from a shift from relatively low-skilled workers to high-skilled workers
within the same industry. That is, jobs did not, as a rule, move from
industries that faced foreign competition to those that did not; instead the
types of jobs available changed as firms shifted their labor force toward more
highly skilled workers. This evidence suggests that worker  displacement is
largely the result of changes in technology rather than the result of import
competition, since the latter would have been expected to lead to employment
declines in certain affected industries rather than changes in the composition
of employment.

A similar phenomenon can be observed in the behavior of multinational firms.
Increased production by foreign affiliates of U.S. multinational enterprises
in the 1980s and early 1990s has been found to lead to increased domestic
employment--in other words, parent and foreign employment rose together, not
one at the expense of the other. But here, too, the composition of jobs
changed, with domestic employment shifting to jobs requiring higher skill,
such as design and management, while production jobs often moved overseas. A
number of studies of U.S. multinationals in the 1980s and early 1990s
similarly found that the shift of production activities to developing
countries had little overall effect on wages in the parent company. To be
sure, these findings mean only that import competition and out- sourcing did
not have large overall effects on employment or wages. Behind the aggregate
numbers are individual people whose lives have been disrupted by the shift
toward more highly skilled workers and high-technology jobs.

The differing impact of globalization on different groups of workers is
reflected in public opinion surveys, which suggest that how one perceives the
effects of increased trade depends on one's level of skill. Less skilled
workers are more likely to favor trade protection than are workers with
relatively high skills. This is understandable: globalization contributes, as
we have seen, to technological change, and technological change favors workers
with higher levels of skills and education. This makes globalization
especially threatening to less skilled, less educated workers. Anxiety about
dislocation and job loss will thus likely remain so long as the pace of
technological change remains rapid. This evidence further emphasizes the need
for policies to ensure that individuals adversely affected by globalization
and technological change  are not left behind but instead receive help to take
advantage of new  opportunities created in the dynamic U.S. economy.

Trade and the Environment and Labor Standards

This Administration has made a commitment that at the same time that trade
fosters openness and prosperity, it must also protect global natural resources
and be consonant with our national values. This means making sure that trade
liberalization takes account of the environmental effects of economic activity
and complements policies that seek cleaner air, cleaner water, and protection
of our natural heritage, while still promoting growth. It also includes making
sure that trade liberalization does not hinder countries' adherence to labor
standards. Indeed, growth in trade and the economy should be accompanied by
respect for recognized core labor standards and the elimination of practices
such as exploitative child labor.

In support of the Nation's environmental goals, the President in November 1999
issued an executive order mandating environmental review of certain trade
agreements, including multilateral and bilateral free-trade agreements and
major agreements in natural resource sectors. The recently signed free-trade
agreement between the United States and Jordan includes provisions addressing
trade and the environment and, for the first time ever in the text of a trade
agreement, provisions on labor standards. (Such standards were addressed in
side letters to NAFTA but not in the agreement itself.)

Increased globalization need not conflict with improved environmental
standards and social protections. To the contrary, international trade can
contribute to a cleaner environment, by giving all countries access to
technologies and production methods that help prevent pollution and conserve
natural resources. Examples include technologies that promote energy
efficiency and reduce polluting emissions from automobiles and factories.
Liberalized international investment policies can also contribute: multi-
national corporations that invest in new plants in developing countries can
bring with them global best practices in environmental and labor standards.

Challenges for Legal Frameworks

Technological change and globalization present a number of new challenges for
international legal frameworks.


Law Enforcement

Globalization and the possibilities created by new technology raise new
challenges for the legal system in combating cross-border criminal activities.
These activities include the unleashing of destructive computer viruses,
violations of computer security, and the use of the Internet for the sale of
illegal products, for tax evasion, and to disguise the origin of illegally
generated funds. An important issue here is that of determining jurisdiction.
Using the Internet, a single person with modest resources, operating  from
anywhere, can undertake criminal activity that has consequences for the entire
world. A recent example is the proliferation of the ``I Love You'' computer
virus, which allegedly originated in the Philippines but caused worldwide
problems with e-mail systems.

To begin to address these issues, the National Plan for Information  Systems
Protection established the first national strategy for protecting  computer
networks from deliberate attack, and the Partnership for Critical
Infrastructure Security was set up to maximize cooperation between  government
and private sector initiatives in the area of cybersecurity. The  G-8
countries have also agreed to work together to combat the use of the Internet
for international criminal activity.

The same improvements in technology and communications that have made global
capital flows more liquid also pose new challenges for law enforcement. A
computer network that can efficiently transfer massive amounts of capital to
productive uses can with equal ease transfer funds obtained illicitly without
being detected. The challenges include both tax evasion and the illegal
practice of money laundering, in which individuals seek to disguise the origin
of funds generated through criminal activity. To combat these activities
within an international framework, the United States has participated in the
Financial Action Task Force on Money Laundering (FATF), a multilateral group
that develops recommendations covering  criminal justice systems, law
enforcement, financial market regulation, and international cooperation. The
FATF took a major step forward in June 2000, when it identified 15
jurisdictions as noncooperative in the fight against money laundering. That
action prodded several of the listed jurisdictions to take steps to combat the
practice. Meanwhile the finance ministers of the G-7 countries announced the
coordinated issuance of advisories to their domestic financial institutions,
urging them to give enhanced scrutiny to transactions involving the identified
jurisdictions.

Taxation

The growing globalization of financial transactions also raises issues for
taxation, because technological advances in this area can facilitate tax
evasion as well as tax avoidance. Tax evasion is any effort to escape the
payment of taxes actually due, and is illegal. The OECD has taken steps to
combat tax evasion in cross-border transactions, notably by promoting the
exchange  of information among national tax authorities. This includes
evaluating barriers to the effective exchange of information as well as
examining ways in which information technology can be used to combat the
problem. Tax inspectors from the OECD countries regularly meet to share
information about the detection of evasion and avoidance schemes in financial
transactions.

Tax avoidance, in contrast, is the arrangement of one's affairs so as not to
incur taxes on one's economic activity in any national jurisdiction. Unlike
tax evasion, tax avoidance is not illegal per se--indeed, a major reason why
it exists is that some countries actively encourage it, by setting up
preferential tax regimes to attract multinational corporations. However, tax
avoidance can distort the global allocation of capital and lead to an unequal
distribution among countries of the burden of raising tax revenue. The United
States has participated in OECD initiatives to identify and limit policies
that give rise to harmful tax avoidance and erode countries' tax bases. Such
policies include the lack of effective exchange of tax information with other
countries, lack of transparency within national tax systems, and
discrimination in favor of foreign investors. OECD members have committed not
to introduce new measures that strengthen such features of their tax systems,
and to remove the identified harmful features by April 2003. The initiative
has also identified 35 jurisdictions as tax havens--locations in which the tax
regime facilitates harmful tax avoidance. Six jurisdictions examined as tax
havens but not included on this list have already agreed to eliminate harmful
features of their tax regimes by the end of 2005. The 35 listed jurisdictions
have been given the opportunity to consider such cooperation in advance of a
July 2001 publication of a list of uncooperative tax havens, and the adoption
by OECD members of policies aimed at directly addressing the concerns  thus
raised.

Tax practices will also have to evolve to address the new possibilities  of a
globalized economy. For example, a software product might be conceptualized in
the United States, programmed in India, manufactured in  Singapore, and then
sold all over the world. In such situations it may be  difficult to allocate
the resulting income in an accounting sense for  purposes of assigning tax
liability. This issue arises as well with electronic commerce. The global
nature of the Internet confounds present definitions of geographic origin and
even of what constitutes a transaction. This complicates both the
identification of the jurisdiction to which taxes are due and the collection
of those taxes. Because the structure of the Internet makes  it difficult to
trace the identity or even the location of those involved in a  taxable
activity, national authorities are understandably concerned about the erosion
of revenue as activities shift away from ``bricks and mortar'' firms to
amorphous entities operating in cyberspace. Indeed, countries have already
encountered difficulties in assigning and collecting taxes on goods ordered
through the Internet but delivered in physical form.

Future trade agreements will have to address the status of cross-border trade
in electronically delivered products, many of which combine features of both
goods and services. To foster growth in electronic commerce, the
Administration led the 1998 initiative in the WTO in which members agreed to
place a temporary moratorium on duties on electronic transmissions. But
electronic commerce is transforming what was formerly trade in goods, such as
software diskettes or music on compact disks, into the bits and bytes of
purely electronic transmissions. Under the 1998 moratorium these transactions
escape international duties, even though otherwise identical products
delivered in physical form face the customary tariff regime.  The leaders of
the Asia-Pacific Economic Cooperation countries, in their November 2000 Brunei
declaration, called for a WTO task force to address the treatment of these
items in international commerce.

Intellectual Property

Protection of the intellectual property generated by innovation is crucial  to
preserving the incentives for the creators of knowledge to continue to
innovate. In an international context, differences in legal frameworks and
social attitudes toward property rights for these intangible goods can make
such protection difficult to establish or enforce. The Administration has been
instrumental in pushing for international standards of intellectual property
protection, notably through the Trade-Related Aspects of Intellectual
Property Rights Agreement included in the Uruguay Round agreement. That
agreement has led most U.S. trading partners to adopt modern laws to protect
intellectual property and improve enforcement. In addition, the Administration
has continued the rigorous review of our trading partners' intellectual
property protection. This includes use of the Special 301  provision of U.S.
trade law, under which the United States identifies countries that do not
provide adequate and effective protection of intellectual property or that
deny equitable market access to U.S. holders of intellectual property.
Enforcement has been a priority. Since 1996 the United States has filed 14
intellectual property-related complaints with the WTO against countries with
lax intellectual property laws. These actions have paid off  in increased U.S.
exports to countries that are technology imitators. The  U.S. Patent and
Trademark Office has also provided assistance to numerous foreign countries
seeking to improve their intellectual property systems.

The Administration has also taken steps to assist developing countries in
addressing certain critical health issues peculiar to those countries, while
encouraging the implementation of international treaty obligations concerning
intellectual property rights. The United States is helping developing
countries gain access to essential medicines through the Millennium Vaccine
Initiative, which is designed to accelerate the development of vaccines  for
such diseases as AIDS, malaria, and tuberculosis. These are diseases that
disproportionately affect poor countries and to which private firms might not
otherwise devote concentrated research efforts. The initiative includes a
proposal for sharply increased funding for disease and vaccine research, as
well as $50 million for the vaccine purchase fund of the Global Alliance for
Vaccines and Immunization, a $1 billion tax credit for sales of new vaccines,
and the securing of over $150 million in vaccine donations from U.S.
corporations. The Administration has also called on multilateral  development
banks such as the World Bank to increase their concessional lending to basic
health care services by $400 million to $900 million  annually. In addition, a
joint initiative of the U.S. Trade Representative and the Department of Health
and Human Services is seeking ways to provide direct and effective assistance
to developing countries to help them  effectively address major health crises.

Making Globalization Work

The continuing challenge for international economic policy will be to ensure
that globalization proceeds in a way that allows the United States and the
rest of the world to enjoy its benefits, while at the same time seeing that
the gains are universally shared. Policies aimed at continued liberalization
of capital, labor, and goods markets will help speed economic growth, the
diffusion of technology, and the expansion of international trade and
investment. It is all too easy--and wrong--to frame the choice as one between
unfettered, unregulated global capitalism on the one hand, and  protectionism
and self-imposed isolation on the other. The reality is more comforting, but
also more complicated. We can build a vibrant, more  inclusive global economy,
but it means finding some way between these  two extremes.

Building the right kind of integrated global economy depends on the  success
of the international community in developing an institutional  framework in
which global integration can take place and in providing  assistance to
developing countries so that they benefit from it. To help  maintain a stable
international economy, the Administration has made  considerable efforts to
ensure that multilateral institutions such as the IMF, the World Bank, and the
WTO foster economic growth and operate in a transparent manner that promotes
economic and social harmony (Box 4-3).

____________________________________________________________________________
Box 4-3. Reforming International Institutions

The United States has taken the lead in efforts to make sure that
international institutions such as the IMF, the World Bank, and the WTO are
equipped to meet the challenges presented by changes in the global economy.

The IMF has taken several important steps, among them to:

 increase dramatically the transparency of its operations

 strengthen its surveillance of member countries' policies, in
particular with a view to reducing vulnerability and encouraging
implementation of internationally agreed best practices in areas such as
banking supervision and data dissemination

 increase the focus on poverty reduction and growth in its support for
the poorest countries, and

 streamline its financing instruments, discourage persistent reliance
on IMF lending, and encourage early repayment.

The United States has also helped promote important dialogues on international
financial issues between industrial and developing economies through forums
such as the new G-20 finance ministers group.

In the World Bank and other multilateral development banks,  policies and
practices have similarly evolved in response to the  challenges of
globalization. There is now broad agreement that good  governance,
participation of civil society, country responsibility for sound development
strategies, performance-based lending, and effective coordination are key
pillars of development assistance. The United States has been a leading
advocate of a greater emphasis  on the policies that most contribute to
poverty reduction and is  promoting an agenda for reform that includes:

 greater selectivity in lending, across both sectors and countries

 multiyear operational frameworks that would map out commitments to
support governments in tackling social, institutional, and  economic barriers
that prevent the poor from contributing to  and benefiting from growth

 expansion of the provisioning for global public goods, which tend to
be underfinanced and undersupplied, particularly in areas where the benefits
accrue predominantly to developing countries

 establishment of performance-based frameworks for the allocation of
resources to borrowers, and

 increased transparency and accountability, including a presumption of
openness in information disclosure policies and a serious set of internal
controls that ensure that policies are clearly defined and consistently
applied.

The United States is seeking to make the WTO more transparent and thus better
understood. The avenues being explored include crafting an agreement among
members to provide for more rapid release of documents, ensuring that citizens
and nongovernmental organizations can file amicus briefs in dispute settlement
proceedings, and opening these proceedings to public observers. As a first
step, the Administration has offered to open any dispute panel in which the
United States is involved, provided the partner to the dispute also agrees.
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To assist the poorest countries, the
Administration has also pressed international institutions to focus on
increased provision of global public goods such as environmental protection
and control of infectious disease. The Administration has also worked to offer
debt relief to heavily indebted poor countries serious about undertaking
economic reform.

Successful globalization requires a parallel international process of
harmonization of national rules, including rules governing the financial
system. Such an effort has been going on largely silently for many years in
the central banking community: for example, a revision of the Basel capital
accord of 1988 is now under way. More recently, in the wake of the Mexican and
Asian financial crises of the 1990s, these efforts at harmonization have
accelerated, with a focus on the role of international standards and codes in
the discussion of reform of the international financial architecture.

Opening Markets to Trade and Investment

Continued progress in opening markets to international trade and  investment
will contribute to increased growth. One possible direction is to revitalize
efforts to expand on the Uruguay Round agreement through a new round of
multilateral trade liberalization. Even without a new multilateral round,
however, the challenge remains of building on the landmark trade agreements of
the past 8 years. This includes extending the Information Technology Agreement
to cover a wider range of high-technology products and to begin to address
nontariff barriers, and expanding the market-opening initiatives in services
trade under the Financial Services Agreement and the General Agreement on
Trade in Services. Increased market access for services is particularly
important for the United States given the rising importance of services in
U.S. exports. Much work also remains to be done in liberalizing trade in
agricultural products. Steps to be taken include lowering tariffs, improving
U.S. access to potential markets, and reducing trade-distorting domestic
supports and export subsidies. An important priority is to remove barriers to
trade in biotechnology products, which offer great promise to make agriculture
both more productive and friendlier to the environment (Box 4-4). Continued
progress in the accession of new WTO members will also help liberalize global
markets by extending the reach of WTO disciplines.

As this chapter has argued, trade policy that leads to greater openness  helps
ensure competition in domestic markets. Although this puts pressure on certain
domestic interests--notably on stakeholders in industries newly exposed to
international competition--society at large is the real winner, through
expanded choice and lower prices for goods and services. This is likely to be
particularly true in sectors such as information technology, where lower
prices

______________________________________________________________________________
Box 4-4. The Global Promise of Biotechnology

Agricultural biotechnology based on the application of cellular and molecular
biology, by dramatically improving the productivity and environmental
sustainability of global food production, has the potential to usher in a new
agricultural revolution. Biotechnological methods can be used to increase a
plant's ability to control pests and disease or tolerate environmental stress,
or to enhance food qualities such as flavor, texture, shelf life, and
nutritional content. Biotech- nology can also be used to develop diagnostic
techniques for testing food safety, to genetically incorporate specific
proteins into plants for harvesting as pharmaceuticals, and in animal
husbandry to diagnose disease, promote growth, and develop vaccines. Perhaps
the greatest gains from agricultural biotechnology are in store for developing
countries, where an estimated 840 million people, or 13 percent of the global
population, are subject to uncertain food supply, including 200 million
estimated to suffer from malnutrition. Use of drought- tolerant, pest-
resistant, and nutrition-enhanced crops leads to improved yields and thus
enhances food security. Moreover, since their introduction in 1996, the use of
genetically modified crops has allowed insecticide and herbicide use in those
crops to be reduced in the United States. Lower reliance on toxic insecticides
has important benefits for farm workers and wildlife and may reduce the
dietary exposure of children and adults to these chemicals.

Applications of agricultural biotechnology have not been developed and
introduced as rapidly as medical applications. In part this can be attributed
to the uncertain economics of new crops and the need to evaluate risks to
human health and the environment. The latter concerns are reflected in
consumer resistance to biotechnology  products, especially in Europe. By 2000
about 70 million acres of transgenic crops were under cultivation in the
United States, out of more than 255 million total acres planted with major
crops. However, several U.S. farm and commodity groups have alerted their
members to potential economic risks from planting biotech crops. These risks
are increasing as some food processors have banned genetically engineered
crops from their products. Increased economic risk is also reflected in other
countries' export restrictions on certain agricultural products derived from
biotechnology. For example, a lengthy EU approval process and a virtual
moratorium since 1998 on  bioengineered grain varieties were significant
factors behind the 90 percent decline in the volume of corn exports to the
European Union in 1998. Restrictions on agricultural commodities and food
products derived from biotechnology in industrial countries have raised
concerns in developing countries as well. However, wide differences exist
within the developing world, with some countries strongly embracing the
technology for reasons of food security and other potential economic gains,
while others have shown reticence.

A central goal of this Administration has been to ensure that  decisions on
the use and regulation of biotechnology products are made on the basis of
scientific evaluation--a principle enshrined in the Agreement on Sanitary and
Phytosanitary Measures concluded as part of the Uruguay Round. The agreement
requires that food, animal, and plant health and safety regulations that
affect trade flows be based on scientific evidence. The Codex Alimentarius of
the United Nations' Food and Agricultural Organization provides a universal
food standard that may be used as a basis for countries' regulatory measures.
Scientific evaluation is the appropriate basis on which to define which
measures are appropriate to achieve the legitimate goal of public health
protection.

The United States continues a more than 20-year program to evaluate the
implications of scientific advances such as biotechnology on  public health.
This includes assessment of the long-term impacts of genetically modified
foods on human health and the environment. The National Academy of Sciences
has undertaken a series of  projects to examine the efficiency and integrity
of U.S. biotechnology regulation. These include analyses of the assessment and
monitoring of environmental risks and a broad review of available evidence on
human health effects associated with genetically engineered foods. The Council
on Environmental Quality and the Office of Science and Technology Policy are
coordinating an interagency assessment of Federal environmental regulations
pertaining to agricultural biotechnology. As a complement to these two steps,
the Administration has also called for an expanded program of research
focusing on current and future biotechnology safety issues.
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that lead to increased network usage will have positive spillovers for
the entire economy. In many developing countries, these are also sectors with
dominant local firms for which foreign entry is likely to provide the only
sustainable competition. Continuing efforts to open foreign markets to U.S.
exports can thus lead to a win-win situation for the United States and its
trade partners. To make this happen, it is vital to ensure that the market-
opening provisions of trade agreements are fully implemented and U.S. trade
laws vigorously enforced. Efforts at enforcement have included recourse to the
improved dispute settlement mechanism at the WTO and, at home, creation of a
trade compliance center at the Department of Commerce.

Arguments for the benefits of open markets apply with equal force here at
home. Here the task is to extend the decades-long process of reducing U.S.
trade barriers, particularly those faced by the least-developed countries,
while spreading the benefits of trade liberalization as widely as possible and
taking care that the costs of adjustment are not borne solely by a few.
Substantial progress has been made in this regard, including the elimination
of tariffs on some 2,000 items. Moreover, through the Generalized System of
Preferences, the United States provides duty-free access to some 4,600 items
from developing countries. This program promotes economic growth and
development in these countries by stimulating their exports. Additional
liberalization has been targeted to particular regions, including Sub-Saharan
Africa through the African Growth and Opportunity Act, and the Caribbean
through the Caribbean Basin Trade  Partnership Act.

One challenge for trade policy is to know when to do nothing--to resist the
inevitable domestic pressures for protection from imports while at the same
time enforcing U.S. trade laws that aim for trade to be free and fair. The
political economy of trade protection is well understood: the benefits of
trade liberalization are spread over a large number of consumers, each of whom
gains only a little, whereas the beneficiaries of trade restrictions tend to
be more concentrated and thus have greater incentives to push for protection.
The challenge for policymakers is to remain focused on the benefits of free
trade while helping those individuals and communities adversely affected by
change.

Conclusion

Access to global trade and investment flows has played a vital role in
creating the New Economy in the United States. Openness gives us crucial
inputs of goods and capital that have lowered costs and raised efficiency. And
the availability of the larger world market allows U.S. firms to enjoy scale
economies and thus increases the rewards from innovation. The achievements of
the past 8 years have provided solid momentum toward opening markets and
expanding trade. Building on this progress is vital for both the United States
and the rest of the world. Continued globalization is central to ensuring that
the diffusion of technology and knowledge to other countries leads to improved
economic performance on a global scale, mirroring what has already occurred in
the United States. Stronger world growth is in the profound national interest
of the United States. Global prosperity is not only likely to result in
increased U.S. exports and continued strong growth in domestic employment and
income; it can also be a major contributor to international harmony.