[Economic Report of the President (2011)]
[Administration of Barack H. Obama]
[Online through the Government Printing Office, www.gpo.gov]

 
CHAPTER 4

The World Economy

Like the U.S. economy, the world economy moved toward recovery in
2010 with positive economic growth reestablished in most regions and
rebounding world trade. emerging-market economies made substantial
contributions to world growth, demonstrating their increasing
importance to the world and U.S. economies. International policy
coordination continued to play an important role: two leadersï¿½ summits
of the Group of twenty (G-20) were held in 2010, and significant
agreements were reached on important global challenges such as ensuring
a strong, sustainable, and balanced global recovery and setting core
elements of a new financial regulatory framework, including bank
capital and liquidity standards.


The world economy, however, must not only recover but also shift away
from its pre-crisis pattern of growth that was too dependent on U.S.
consumption. Global imbalances narrowed significantly during the
crisis. Now, a fundamental challenge is to restore growth without
restoring the old growth model and patterns of demand that led to those
imbalances. even without the economic crisis, however, the world
economy would be undergoing substantial change. China has grown from
the sixth- to the second-largest economy in just a decade, and the
Group of Seven (G-7) advanced countriesï¿½ share of the world economy
continues to shrink as numerous emerging markets grow onto the world
stage. these changes are generating shifts in world production and
trade, but the growth of emerging markets need not portend a
de-industrialization of advanced economies or a fall in the standard of
living of Americans. the United States is home to many of the most
innovative firms in the world, universities that attract more students
than any other country, and the most productive workers of any major
economy. In addition, output per capita is higher in the United States
than in any of the other G-7 nations and much higher than in any
emerging economy. these shifts do require, however, that the United
States evolve to meet both new opportunities and new challenges. the
same forces described in Chapter 3 on long-run growthï¿½innovation,
education, and infrastructure investmentï¿½coupled with a smart trade
policy are crucial to the evolving role of the U.S. economy in the
world.

The United States, both as part of the economic recovery and as part
of its engagement with the global economy, must increase its exports
over time. Substantial import growth in rapidly growing regions around
the world helped drive U.S. exports at a fast pace in 2010, moving the
United States closer to the Administrationï¿½s goal of doubling exports
by the end of 2014. emerging-market economies are playing a growing
part in U.S. trade relationships, and that role will only strengthen in
the coming years. Robust enforcement of market access agreed to in
previous trade accords, new trade agreements to guarantee access to
these important emerging markets, and encouragement of balanced growth
around the world will all help spur faster export growth. A range of
additional policy initiativesï¿½advocacy, export credit, and improvements
in the U.S. transportation and supply chain infrastructureï¿½can also
contribute to export growth.

STATUS OF THE WORLD RECOVERY

The world economy in 2008ï¿½09 faced its most wrenching economic crisis
in a generation. the recovery from that crisis has been quite rapid in
many regions, leading to a rebound in world economic growth and trade.
Many challenges remain, however. Regions are growing at different
paces, and many countries are facing some combination of slow growth, a
need for fiscal consolidation, or complications from rising prices or
increased capital inflows. Fortunately, institutions like the G-20,
which were platforms for increased economic cooperation during the
crisis, have been able to continue to play a positive role in the world
economy.

Crisis Fading, But Challenges Remain

The world economy has experienced both a remarkable setback and
rebound in the past three years. the global contraction in the second
half of 2008 and first quarter of 2009 was sharp but relatively
short-lived. By the second quarter of 2009, the worldï¿½s growth rate
(the weighted average of the growth rate of countriesï¿½ real gross
domestic product or GDP) was positive, and by the third quarter, the
average growth rate had returned to its 2007 levels. the International
Monetary Fund (IMF) projects that, for the four quarters of 2010, the
world economy grew more than 4 percent and will continue at that pace
in 2011 (IMF 2010).

Although average growth coming out of the crisis has been rapid, it
has not been evenly distributed, as Figure 4-1 demonstrates. the
financial market shocks of the recession were concentrated in the
advanced economies, and those economies have rebounded more slowly.
Most emerging-market economies rebounded quickly; some, in fact, never
saw a contraction, just a slowdown in their rapid growth. In the first
half of 2010, real GDP in the emerging-market countries of the G-20
grew 7.9 percent on average (at an annual rate), compared with 3.3
percent for the G-7 countries (growth slowed slightly in both groups in
the third quarter).1 the IMF projects that substantially faster
emerging-market growth will persist, predicting growth of 7 percent in
emerging and developing economies in 2010 and 2011, compared with
roughly 2.5 percent in advanced economies.

\1\ The G-20 is made up of 19 major economies plus the european Union.
The G-7 includes the largest 7 advanced economies of that group (by
size of economy, the United States, Japan, Germany, the United Kingdom,
France, Italy, and Canada). the remaining members of the G-20 are
Australia and South Korea along with major emerging-market nations:
Argentina, Brazil, China, India, Indonesia, Mexico, Russia, Saudi
Arabia, South Africa, and turkey. throughout this chapter, division of
countries into emerging and advanced is based on IMF definitions.



It is not surprising to see advanced economies grow more slowly than
emerging ones. emerging markets tend to have faster population growth--
and hence a growing labor supply--and can converge toward advanced
economies through rapid productivity growth as they upgrade the
education of their workforce and the technology they use. Still, a gap
of roughly 4.5 percentage points in the growth rates of emerging and
advanced economies is unusually large. Such a gap existed in the years
immediately preceding the crisis, but between 1980 and 2007, the gap
was much narrower: emerging and developing economies grew at an average
of 4.4 percent, whereas the average for advanced economies was 2.8
percent.

Several serious challenges to sustained global growth remain. The
unemployment rate in many advanced nations is still unacceptably high.
As Figure 4-2 shows, the unemployment rate in the euro area is still at
its peak, and the U.S. rate is trending down only very slowly. At the
same time, many advanced economies face substantial fiscal deficits.
The U.S. Federal fiscal deficit in 2010 was 8.9 percent of GDP, the
euro-area deficit was 6.3 percent, and Japan's was 7.7 percent. Over
the next few years, those deficits will have to come down. they will
likely fall significantly because of the business cycle (deficits tend
to shrink as economies recover), but further fiscal consolidation will
be needed over time. Maintaining sufficient growth to lower the
unemployment rate while simultaneously implementing credible
medium-term fiscal consolidation will be a challenge in many countries.
Further, some euro-area countries have faced pressure from financial
markets in the form of rising yields on their debt, forcing them to
lean toward faster consolidation. Because the advanced economies are
operating below capacity, their inflation rates have been low. Core
rates were close to 1 percent in the United States and the euro area,
and deflation continued in Japan. thus far, central banks have
maintained an accommodative monetary policy stance, with the Federal
Reserve and Bank of Japan adding new quantitative easing measures in
2010, and the Bank of england and the european Central Bank keeping
policy rates low.

In contrast, rising inflation is a concern in emerging-market
countries where growth has been faster. the 12-month change in consumer
prices in China breached 5 percent (above the 3 percent target for
2010, and China is now reported to have raised its target to 4 percent
for 2011); wholesale price inflation in India rose above 10 percent
during the spring and summer of 2010; and inflation rates began to
creep up in 2010 in many other emerging-market countries. Many central
banks have raised policy rates or taken other action to calm inflation.
The contrast between fast growth with rising interest rates in the
emerging world and slower growth with lower interest rates in advanced
economies has put pressure on capital flows and exchange rates. After
depreciating during the crisis, the currencies of emerging-market
nations of the G-20 appreciated 5 percent on average over the first 10
months of 2010 on a real trade-weighted basis, and capital flows into
these countries increased as well.\2\ thus far, emerging nations have
responded with a varying mix of currency appreciation, currency
intervention, and capital controls. total foreign exchange holdings by
emerging and developing countries rose by roughly $500 billion in the
first three quarters of 2010 (more than double the amount in the first
three quarters of 2009 after adjusting for valuation changes),
reflecting increased currency intervention aimed at slowing or
preventing appreciation.

\2\ Net portfolio investment flows into emerging-market G-20 countries
turned negative at the peak of the crisis but rebounded in 2009 and
2010.



While overall world growth has rebounded, another crucial challenge
to the world economy is to make up for the output lost during the
recession. By the end of June 2010, the world economy had recovered to
the level of output before the recession, but world GDP remains
considerably below the output trend it was on before the crisis struck.
Research suggests that financial recessions are long and deep, and
whether the output lost is completely recovered is an important
issue.\3\ For the world economy to return to its previous output trend,
several years of above-average growth will be necessary.

\3\ Reinhart and Rogoff (2009) demonstrate that financial recessions
are longer and deeper than other kinds of recessions, but the authors
do not comment on whether the output loss is permanent. IMF (2009)
argues that, on average, countries do face a medium-term output loss
and thus never recover to the pre-crisis trend level, but that study
(which looked at earlier recessions) found wide variation in outcomes,
with the top quarter of countries more than 5 percent above their
pre-crisis output trend seven years after a banking crisis. In
addition, a variety of methodological choices may bias the IMF results
toward finding a permanent loss. Other work finds that most countries
recover all output lost in a financial recession over the medium term
(see, for example, Cecchetti, Kohler, and Upper 2009).

The Rebound in World Trade

A particular difficulty during the recession was the collapse in
world trade. even countries with little connection to the financial
aspects of the recession were nonetheless affected as demand for
imports plummeted and financing conditions for export credit tightened
(Baldwin 2009). trade fell even faster than GDP: the unprecedented
collapse of world trade during the last quarter of 2008 and the first
quarter of 2009 saw an almost simultaneous, precipitous decline of
exports and imports across all major regions of the world.

Trade has recovered more quickly than GDP has: exports and imports
picked up during the second and third quarters of 2009 and continued
the V-shaped recovery in 2010, advancing significantly ahead of
expectations. In October 2009, the IMF expected real world trade
(adjusted for prices) to grow just 2.5 percent in 2010. Only months
later, the Organisation for economic Co-operation and Development
projected a 6 percent increase. In April 2010, the IMF forecast a 7
percent increase, and in the fall of 2010, both institutions expected
over 11 percent growth for the year.



Important regional differences mark both the contraction in trade
during the recession and the expansion of imports and exports during
the recovery. Figure 4-3 shows the import volume (adjusted for prices)
and Figure 4-4 the export volume of various regions relative to their
levels in the first quarter of 2007. Asiaï¿½s emerging economies
experienced a sharp decline of imports and exports, but they were among
the quickest to recover and were the first in 2010 to reach their
pre-crisis levels. Japan, whose exports plunged nearly 40 percent from
peak to trough in the crisis, also rebounded in 2010, closing the year
with exports less than 10 percent below the pre-crisis peak. Japanï¿½s
imports fell by only half as much as its exports, and they too were
recovering but had not attained their pre-crisis levels by the end of
2010.



The export decline in the United States was similar to that in the
euroarea countries, but U.S. exports have recovered more quickly. U.S.
imports initially declined more sharply than those in the euro area,
but they also have rebounded substantially. Among all of the major
regions of the world, the euro area has had the slowest resumption in
import growth.

Finally, despite the substantial progress in the V-shaped trade
recovery, as of the third quarter of 2010, none of these economies had
yet achieved the level of trade that had been projected to take place
had pre-crisis trends continued in the absence of the 2008-09 trade
collapse.

Global Policy Coordination

During the crisis, world leaders established the G-20 as the premier
international body for international economic coordination. the G-20,
whose members account for nearly 90 percent of world GDP, continued to
play a pivotal role in 2010, holding two leadersï¿½ summits as well as
finance ministers' and deputies' meetings, along with continual staff
work. At the leaders' summit in Pittsburgh in 2009, under U.S.
leadership, the G-20 committed to work toward strong, balanced,
sustainable global growth. In toronto in June 2010, leaders made
commitments to boost demand where needed and to strengthen public
finances and financial systems. In Seoul in November 2010, they agreed
to undertake macroeconomic policies to ensure ongoing recovery and
sustainable growth, including making exchange rates more
market-determined and adopting other policies to temper global
imbalances.

The G-20 also followed up on significant commitments to reform the
international financial system and its institutions. through the Basel
Committee on Banking Supervision, nations around the globe negotiated a
new framework for banking supervision that is intended to improve the
ability of the global financial system to absorb shocks and reduce the
risk of spillover from the financial sector to the real economy. the
framework involves raising capital standards, broadening the coverage
of supervision, introducing global liquidity standards, and promoting
the buildup of capital buffers in good times.

G-20 nations also followed through on their commitment to change the
governance structure of the two major international financial
institutions: the IMF and the World Bank. the governance structure of
these two organizations was heavily weighted toward advanced countries,
and each is now being changed to incorporate more leadership from major
emerging-market countries, including changes to quota shares and board
seats.

Finally, policy coordination has continued as various financial
difficulties have appeared throughout the year. the focus of much of
the concern during 2010 has been on sovereign debt in europe. First,
central banks, including the Federal Reserve, coordinated to ensure
sufficient liquidity across markets. More importantly, in May, european
leaders worked with the IMF to create a european Financial
Stabilization mechanism with up to $1 trillion committed to stabilizing
the debt markets for various euro-area nations. the funds were first
used in Greece to provide a necessary backstop as that country tried to
rebalance a precarious fiscal situation. toward the end of the year,
the mechanism was used to backstop Ireland as it struggled with the
costs of its banking system.

THE EVOLUTION OF THE WORLD ECONOMY

The world economy has begun a transformation. Rapidly growing
emerging-market countries and some advanced countries with high savings
will need to provide more demand to the world economy, and countries
that are borrowing too much will need to save more. Changes are already
taking place in the composition of U.S. exports as services play a
larger role, but there will likely be continuity as well, as the United
States maintains its exports of products that rely on sound legal institutions, an innovative economy, and the high skills and
productivity of U.S. workers. More of those products, though, are
likely to be headed toward rapidly growing emerging markets, a change
that will be essential if the U.S. economy is to meet the
Administration's goal of doubling exports in five years.

Global Imbalances

As the G-20 actions show, world leaders have recognized that more
balanced growth is essential to the world economy. the United States
had a large current account deficit before the crisis, and the
Administration has been clear that the United States must find a more
balanced growth model, one that involves more exports and investment.
The trade balance, or net exports, represents the bulk of the current
account (net income on overseas assets and unilateral transfers such as
foreign aid and remittances make up the rest). At the same time, the
current account represents the net lending of a country to the rest of
the world because if a country exports less than it imports, it must
either borrow or sell foreign assets to pay for that consumption from
abroad.

The issue of global imbalances is a problem not just for the United
States but for all nations. A single country's saving behavior can
affect saving and investment around the globe. A large deficit, for
example, can take up too much world savings and crowd out borrowing in
other countries. Conversely, a current account surplus means a country
is not contributing as much to world demand as it is to world supply
and may be lowering world interest rates and encouraging deficits in
other countries. Surpluses become particularly contentious when global

output is below potential output. thus, the macroeconomic behavior and
outcomes of different countries are linked.\4\ Before the crisis, when
the United States was too reliant on consumption, other countries
around the world were also too reliant on U.S. consumption and exports
to the United States.

\4\ Current account deficits or surpluses are not always a bad thing.
Where many productive opportunities exist, a country may borrow to
invest more than its savings allow and may therefore want a deficit;
alternatively, a country may temporarily have an excess of savings.
However, large persistent surpluses or deficits can be a sign of more
structural imbalances in an economy.

The United States accounts for roughly one-quarter of the world
economy, and consumption has historically accounted for roughly
two-thirds of the U.S. economy. thus, one might normally expect 16-17
percent of world aggregate demand growth to come from U.S. consumers.
But emerging and developing economies often grow faster than more
mature economies. thus, a larger portion of world growth would be
expected to come from emerging economies than their share of the world
economy would warrant.

From 1996 to 2006, though, U.S. consumption played an outsized role
in the world economy, with roughly 22-23 percent of the growth in the
world economy coming from growth in U.S. consumption. this level was
simply not sustainable. During this period, U.S. consumption rose to 70
percent of the U.S. economy, personal saving fell to very low levels,
and U.S. business equipment and software investment growth lagged
behind GDP growth. At the same time, the fiscal position of the U.S.
Federal Government moved from substantial surpluses at the end of the
1990s to substantial deficits in the mid-2000s. these deficits also
contributed to lower national saving. Such macroeconomic behavior had
important implications for the world economy. the rapid growth in
consumption and decline in saving (both personal and government) meant
that the United States increasingly borrowed from the world and had a
growing current account deficit.

At the same time that consumption was outpacing income in the United
States, many other countries had export growth well in excess of GDP
growth. Falling transport prices and the rise of globally integrated
production supply chains mean that the production of a single good may
generate far more recorded exports and imports than the value of the
final good itself. to illustrate, consider a smartphone whose various
parts may be traded across many borders at different stages of
production before final assembly and sale of the phone. each time a
component crosses a border to move to the next stage of processing, it
counts as an import for one country and an export for another. As a
result, the total value of exports and imports for various countries
from that one phone will likely exceed the total final value of the
phone, leading to faster export growth than GDP growth when one more
phone is made. From 1998 to 2008, exports grew faster than GDP in
nearly every major economy. Of the largest 20 exporters, though, the
United States had the lowest rate of export growthï¿½96 percent, compared
with an average of 243 percent among the other top 20 exporters. even
among other advanced countries, the average was 143 percent. the United
States still exports more goods and services than any other country in
the world, but over the past decade, it relied too much on domestic
consumption to drive growth and not enough on the rest of the world. As
a result its export growth lagged and its lead shrunk significantly.
Some countries, such as India and Brazil, opened up to the world
economy and saw both their exports and imports rise substantially over
the decade before the crisis. their exports as a share of GDP
increased, but they were not dependent on external demand for growth
because they were both selling to and buying from the world. Yet other
countries experienced the mirror image of the U.S. model of the 2000s.
Rather than imports and consumption rising faster than incomes, exports
and savings increased so that both exports and the trade surplus
continued to grow as a share of their economies. these surplus
countries thus effectively funded the borrowing of deficit countries
and provided less demand support to the world economy. From 2000 to
2008, Chinaï¿½s current account rose from a surplus of 2 percent of GDP
to 10 percent, while Germany's moved from a deficit to a 7 percent
surplus. While Germany's surplus rose, other countries in the euro area
(France, Greece, Italy, Portugal, and Spain) experienced rising
deficits.

Figure 4-5 shows that as the decade of the 2000s wore on, the global
imbalances worsened. the U.S. deficit and the Chinese and German
surpluses grew not just as a share of their own GDP but as a share of
world GDP as well. By 2007, the U.S. deficit was shrinking as a share
of both U.S. and world GDP, but China's surplus continued to rise as a
share of world GDP, and the euro-area deficit countries' combined
current account deficit was expanding as well.

The crisis brought about a sharp change in these imbalances.\5\ the
U.S. current account deficit shrank from 5 percent of its GDP to less
than 3 percent in 2009. At the same time, Chinaï¿½s surplus fell from 9.6
percent of its GDP in 2008 to 5.9 percent in 2009. Still, as is clear
from the figure, imbalances remain and have begun once again to widen,
albeit slowly. the U.S. current account deficit is still less than 4
percent of U.S. GDP and, given that the United States is growing
somewhat slower than the world as a whole, this deficit is shrinking
further as a share of world GDP. the surpluses in both Germany and
China remain above 5 percent, however. Furthermore, when a fast-growing
country such as China has a constant surplus as a share of its GDP,
that implies the surplus is growing as a share of the world's GDP.
Also, while U.S. borrowing in the early 2000s was larger than the
surpluses in Germany, Japan, and China combined, over time the current
account surpluses in these countries grew, and by the third quarter of
2010, their combined total was considerably larger than the U.S.
current account deficit. As noted, the G-20 continues to work on how to
reorient countriesï¿½ policies so they are more mutually consistent and
growth is more balanced and sustainable.

\5\ U.S. personal consumption increased to more than 23 percent of the
world economy in 2001 and 2002, measured in current dollars, but over
time, that share began to shrink. A depreciating real exchange rate and
rapid growth in emerging markets meant that by 2007, U.S. consumption
as a share of the world economy had declined to 18 percent. Despite
growing by 6 percent in 2007, U.S. imports as a share of the world
economy fell that year. the simple fact that emerging markets often
grow faster suggested that U.S. consumers and U.S. imports could not
continue to absorb such a large share of the world economy. the crisis
abruptly and sharply changed the relationships, but they were already
shifting well before the crisis erupted.


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Box 4-1: What do We Owe the Rest of the World?

Because the current account represents net borrowing in a year, it
indicates the net capital flows (such as securities purchases, bank
deposits, and direct investment) into a country. Along with adjustments
for changes in exchange rates and asset prices, the current account
measures the change in a country's net foreign wealth (all of the
assets its investors own abroad minus all the claims on its economy by
foreign investors). Net borrowing by U.S. residents over the past
decade has left a negative net international investment position of
roughly 20 percent of U.S. GDP. Relative to other countries, this
negative position is still fairly small as a share of GDP.\a\

\a\ The U.S. net international investment position has not become as
negative as one might have expected based on the amount of borrowing
over the 2000s. In addition to borrowing in any given year, the values
of U.S. foreign assets and liabilities change in response to changes in
market conditions. Over the past decade, the United States has had, on
net, positive ``valuation effects'' (Lane and Milesi-Ferretti 2009).
Strong asset performance in the United States and changes in currency
may have led to a decline in the net international investment position
in 2010.

In addition, foreign investors own only about 11 percent of the
overall financial assets in the U.S. economy. This fact is sometimes
obscured by foreign investors' preference for U.S. Treasury bills.
Because so much of U.S. net foreign debt is concentrated in one asset
class, the United States is often viewed as a massive debtor to the
world. Foreign investors own roughly one-third of U.S. Treasury
securities (roughly one-half if Treasury securities held by government
trust funds--such as the Social Security Trust Fund--are excluded) (see
box figure). China is the largest foreign holder of U.S Treasuries, but
China's investors own just 7 percent of the total-one-fifth as much as
U.S. bondholders (some foreign holdings may be misclassified if, for
example, China buys Treasuries through a London investment bank that
buys them from the United States).



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Determinants of Exports

The United States is well positioned to spur growth through exports,
even if the precise composition of the goods and services America will
sell to the world in the future is not known today. the pattern of
trade  between one economy and another, quite different, economy is
determined in part by the forces of comparative advantage, that is,
what it is that differentiates the two economies. Comparative advantage
can lie in differences in labor productivity, the relative availability
of a countryï¿½s natural and physical resources, the educational
priorities that help to determine the skill sets of its people, and
even the institutions that can create different conditions across
national markets. For example, the United States exports high-tech
machinery to other countries that may not have the high-skill labor or
advanced technology required to make those goods. Also, high judicial
quality and good contract enforcement give the United States an
advantage in the production of goods and services that require
businesses to invest to tailor products to particular consumer needs.
Thus, the United States has a comparative advantage in highly complex
products that are difficult to commoditize. Such products may require
teamwork in the design and production process and substantial financial
investment in research and development (R&D) and hence commitment to
the protection of intellectual property.

But comparative advantage does not explain the determinants of and
benefits to the back-and-forth trade of similar products (intraindustry
trade), especially that taking place between similar economies. A
modern-day example is trade in smartphones. Beginning in the late
1990s, a Canadian firm was a first entrant to the wireless
communications market, and U.S. business consumers flocked to import a
mobile device that could send and receive e-mail messages. Soon
thereafter, U.S. firms innovated and engineered different varieties of
these mobile products with additional features that increasingly
appealed to individual consumers as well. Consumers in other countries
(including Canada) imported substantial quantities of these
U.S.-designed smartphones. the ability to trade internationally let
these firms produce for multiple markets and take advantage of scale
economies, and it encouraged their entrepreneurship and innovation by
providing a larger potential market. But manufacturers are not the only
ones that gain; consumers in the United States and Canada also benefit
through access to foreign-designed varieties of the product in addition
to those that are conceived and produced domestically.

Product quality is also important to understanding the determinants
of intraindustry exports. Generally speaking, richer countries tend to
specialize in higher-quality goods within the same product type, while
developing and emerging economies tend to focus on goods further down
the quality ladder. For example, Italy may import low-cost t-shirts
from China, but it is a leader in exporting high-quality, high-fashion
shirts to the world. those products that have wide variation in quality
allow advanced-country firms to differentiate their goods and services
away from imported varieties from low-wage countries.

Manufacturing Exports. While the United States is still the largest
combined exporter of goods and services, America has slid from being
the worldï¿½s leading exporter of goods at the beginning of the century
to the third position, behind China and Germany. Nevertheless, the
United States continues to export over $1 trillion of goods annually,
more than three-quarters of which are manufactured, and these exports
support more than one-fourth of the manufacturing jobs in the United
States. As Figure 4-6 indicates, manufacturing and agriculture goods
combine to make up more than two-thirds of total U.S. exports.



Experience from other high-income countries shows that a shift in the
world share of exported goods does not mean a shift entirely out of
manufacturing and into a service-only economy. Germany, the
second-place goods exporter, maintains a substantial share of
manufacturing in its economy and exports many of these products
(including to emerging markets). Manufacturing is also a larger share
of the economy in Japan than it is in the United States. Like the
United States, these countries have a floating currency and highly
paid, high-skilled workers. the rise of emerging marketsï¿½with lower
wages but also lower productivityï¿½has not forced these high-income
countries out of manufacturing. Richer countries do tend to produce and
consume more services than do emerging-market countries. Nevertheless,
manufacturing, especially of complex products, continues to play a
substantial role in advanced economies, including the U.S. economy.

Services Exports. Services are of increasing importance to
high-income economies. Some services are nontraded, such as restaurant
meals, live entertainment, and cleaning services. But services such as
consulting, finance, architecture, accounting, law, and tourism are
traded. With improvements in communications technology as well as
infrastructure, many services are becoming increasingly tradable. As
noted, nearly one-third of total U.S. exports annually are in services.
Figure 4-7 shows the rapid growth of U.S. services exports as well as
the growing surplus in U.S. services trade.



Some of the largest and fastest-growing U.S. services exports are in
business, professional, and technical services. Other important
categories are insurance, finance, and education services. Analogous to
the case of goods exports, U.S. service exports are in sectors where
U.S. firms and employees offer world-class, high-quality performance
and thus give the United States a strong comparative advantage.

Changing Composition of Goods and Services Exports. economic forces
have traditionally allowed the United States to produce and export many
of the goods and services in which it had a comparative advantage at
that point in time. there is no reason to think that those forces will
cease to operate going forward.

As the next section documents in more detail, the growth in U.S.
exports is coming from new demand, much of it from emerging economies.
Some emerging markets are quickly urbanizing and shifting away from
subsistence agriculture, thus increasing foreign demand for U.S.-grown
farm exports such as soybeans, corn, and wheat. these emerging
economies are developing a sizable middle class, newly able to afford
the higher-quality goods and services that they may not have been able
to buy in the past. And the expansion of home-grown businesses in
emerging economies creates new demand for R&D-intensive, highly complex
products, such as aircraft, turbojets, oil and gas field machinery,
electronic integrated circuits, and medical instruments. these products
frequently sit at the top of the U.S. export list, and U.S. exports of
these products will likely sit at the top of the quality ladder.

The details may be impossible to forecast accurately, but past
experience suggests that the U.S. export industry is likely to be built
on high-quality goods and services that tap into entrepreneurial
talents and that reflect the United Statesï¿½ commitment to reward an
innovative workforce. Many of the policies and programs described in
Chapter 3 as essential to long-run innovation and growth are also
critical to the successful evolution of the United States as it adjusts
to changes in the world economy.

Evolving U.S. Trade Patterns

Even before the global economic crisis and recession of 2007-09, the
United States had been in the midst of a longer-term reorientation of
its international trade patterns. Understanding the relative shift in
these trade patterns is as important as coming to terms with the
shifting trends in the underlying goods and services that the United
States produces and exports. While historical trading partners such as
Canada, Japan, and the european Union continue to be a strong component
of overall U.S. trade, the new and most dynamic sources of U.S. trading
relationships are coming from other places in the world.

Increasing Trade with Emerging Economies. the share of total U.S.
exports sent to mature trading partners has been declining for decades.
The share of total U.S. goods exports consumed by the 27 countries of
the european Union (eU) dropped from nearly one-third (31 percent) in
1948 to one-fifth (21 percent) in 2009, even though these economies
have grown increasingly wealthy. the share of total U.S. goods exports
to historically important high-income economies like Japan and Canada
has also shown signs of decline (Figure 4-8). But the european Union,
Canada, and Japan are not buying less from the United States than they
did in the past. Rather, U.S. exporters are now shipping an increasing
amount of goods to other, faster-growing economies, in addition to
maintaining their historical trading relations (Figure 4-9).



U.S. trade with China exemplifies this story. As late as 2000, the
year before China joined the World trade Organization (WtO) and
substantially opened its market to imports, only 2 percent of all U.S.
goods exports went to China. By 2009, after a decade of rapid growth,
China had become the fourth-largest destination market for U.S. goods
exports after the european Union, Canada, and Mexico. Mexico is another
prime example. Mexicoï¿½s import tariffs in 1982 averaged 16 percent with
a maximum rate of 100 percent (de la torre and Gonzï¿½lez 2005). Mexico
signed onto the General Agreement on tariffs and trade (GAtt) in 1986,
and by 1992 it had cut those tariffs under the GAtt to an average of 11
percent with a maximum rate of only 20 percent. In recent years, the
share of total U.S. goods exports to Mexico has remained steady at 12
percent, nearly double its level in the early 1980s before Mexico
liberalized its economy, signed onto the GAtt, and negotiated the North
American Free trade Agreement (NAFtA).



U.S. exports to several other emerging economies still have room to
grow. the share of total U.S. goods exports going to Brazil, India, and
a number of other emerging economies (see Figure 4-9) has increased
slightly from its mid-1980s low point, hitting a recent peak in the
mid-1990s when some of these economies went through an initial phase of
trade liberalization. U.S. export growth to these economies has since
leveled off. Whether future U.S. export growth to these other emerging
economies replicates the experience of earlier U.S. export expansions
into China and Mexicoï¿½and even to Japan through the 1980s (see Figure
4-8)ï¿½depends partly on the extent to which these other emerging
economies commit to liberalizing their import markets. A key item on
the Administrationï¿½s trade agenda is therefore continued work to open
these markets through the Doha Round of WtO negotiations.

U.S. import patterns are also experiencing a reorientation. At the
end of the 1940s, Japan and the european Union countries were still
devastated by World War II and far from being the mature economies they
are now. After these economies rebuilt, however, they quickly became
large sources for U.S. imports. the european economies peaked at
supplying nearly 30 percent of U.S. goods imports in the late 1960s;
Japan peaked at roughly 20 percent of U.S. imports in the mid-1980s.
Imports from Canada peaked at nearly 30 percent around 1970. U.S.
imports from Canada, the european Union, and Japan continue to grow,
but the share of U.S. imports from these countries has declined as
imports from fast-growing export markets, including China and Mexico,
have increased (Figure 4-10).



Doubling U.S. Exports. In his January 2010 State of the Union
address, the President established a goal of doubling U.S. exports of
goods and services in five years, meaning that nominal exports would
double from their 2009 level of $1.57 trillion to an annual level of
$3.14 trillion by the end of 2014. to meet that goal, U.S. exports need
to grow an average of 15 percent a year. So far, exports are on track
to meet or exceed that pace. through the first three quarters of 2010,
U.S. exports of goods and services increased by 17 percent relative to
the same period in 2009. Doubling exports over five years will increase
the number of jobs supported by exports, and importantly, these are, on
average, higher-paying jobs.

Goods exports have been rising faster than total exports, increasing
22 percent through the first three quarters of 2010. But that total
masks significant variation in exports to different regions. U.S. goods
exports to the Pacific Rim (east Asia and Oceania) increased by 32
percent, to Latin America by 29 percent, to Canada and Mexico by 26
percent, but to europe by only 9 percent. this slow export growth to
europe means that even though it is a key export partner, the european
market contributed very little to export growth in 2010. Some of this
variation is attributable to the longer term, pre-crisis trends in
which U.S. exports to many emerging economies were already increasing.

The extent to which a region drives U.S. export growth is not simply
a function of the growth rate of U.S. exports to the region. the size
of the trading relationship matters. even though exports to our NAFtA
partners grew more slowly than those to the Pacific Rim, exports to
Canada and Mexico contributed more to total export growth because they
represented roughly a third of all U.S. exports. Still, increasing
demand from emerging markets is essential to the growth of U.S.
exports. emerging markets accounted for 43 percent of U.S. goods
exports during the first nine months of 2010, but they generated half
of the export growth during that period and might have generated even
more than half had not excellent U.S. export performance to Canada and
Korea helped keep up export growth to advanced regions. Faster growth
of exports to emerging economies means their share of U.S. exports will
rise over time.

A crucial determinant of U.S. export growth to a region is the pace
at which that market is growing, that is, the speed and depth of
trading partnersï¿½ domestic economic recoveries. Figure 4-11 illustrates
this fact by showing the strong positive relationship between growth in
foreign real GDP and nominal growth in U.S. goods exports between the
second quarter of 2009 and the second quarter of 2010. the relationship
suggests that each percentage point of economic growth in a country is
correlated with more than 2 percentage points of additional U.S.
bilateral export growth. eliminating Singapore, the sole outlier, leads
to a relationship of roughly three to one.\6\ thus, growth abroad is good
for the United States--the global economy is not a zero-sum game.

\6\ These findings are consistent with standard results on aggregate
relationships across countries, which suggest that growth of real
exports increases roughly 2 percent for every 1 percent of world real
GDP growth; see Chinn (2005) and IMF (2007). In addition, one would
expect U.S. export prices to rise in fast-growing markets, so the
result that nominal growth of U.S. goods exports rose at a faster pace
than the anticipated real growth is also to be expected.



U.S. export growth also benefits from changes in relative prices
caused by faster inflation in growing emerging markets because faster
inflation abroad means U.S. goods are cheaper on world markets relative
to goods from these countries. these price and growth relationships
suggest that if the United States is to double exports, an overwhelming
portion of that new export growth will come from faster-growing
emerging and developing economies. Figure 4-12 shows the share of
projected growth of U.S. nominal exports by region using IMF forecasts
for GDP and price growth in different regions. trade with America's
traditional partners will remain important. For example, trade with the
european Union is likely still to be roughly 20 percent of U.S. exports
by 2014, and growth in exports to eU countries will be roughly 10
percent of U.S. export growth over the five-year period. But more than
70 percent of U.S. export growth is projected to come from Mexico,
China, and other emerging and developing countries. Growth in these
countries and active engagement in trade with them will be essential to
meeting the Administrationï¿½s goal of doubling U.S. exports in five
years.

TRADE POLICY

Recent economic research has focused on U.S. firm productivity and
the fixed cost of exporting as fundamental determinants of which U.S.
businesses are able to enter new markets and export successfully
(Bernard et al. 2007). Some costs to firms of market entry are well
known--for example, learning about customer-specific attributes and
tailoring products accordingly, establishing new distribution networks
to reach a market, and targeting advertising to attract those new
customers. Nevertheless, U.S. businesses that seek to enter a new
foreign market sometimes have to overcome additional costs, such as
foreign import tariffs. Another such cost is nontariff barriers,
including foreign requirements that the exporting firm undertake a
costly modification of its export product to fit local standards, even
in the absence of any recognized technical, safety, or customer benefit
for doing so.

Appropriately tailored government policy can reduce some of the costs
that firms must incur to export to new foreign markets. In particular,
the Presidentï¿½s National export Initiative includes several policy
instruments aimed at reducing these costs. these instruments include
negotiating the reduction of foreign tariffs and removal of nontariff
barriers to trade, enforcing existing market access agreements, and
increasing advocacy and access to credit for U.S. exporters.

Negotiating to Open New Markets

Any import tariff in a foreign market is an additional cost to market
entry that U.S. firms must factor into their export decisions. Despite
the trade liberalization of the past few decades, U.S. exporters still
encounter substantial unevenness in the tariff treatment they receive.
For example, U.S. exporters enjoy low tariffs and open markets in U.S.
NAFtA partners Mexico and Canada. equally important are the relatively
open markets of several high-income economies with which the United
States has partnered for more than 60 years under the WtO and the GAtt
before it. As table 4-1 shows, the european Union and Japan offer U.S.
exporters most-favored-nation (MFN) tariff rates that are on average
only moderately higher than the average rate the United States applies
toward their exports. the applied import tariffs of these high-income
economies are also quite close to their ï¿½boundï¿½ ratesï¿½that is, the
upward limits that their applied tariffs cannot legally exceed without
compensation to their trading partners. the third column of the table
provides an alternative and more sophisticated measure of import
``restrictiveness,'' the overall trade restrictiveness index (OtRI),
that takes into account not only import tariffs but also some nontariff
measures and the potential responsiveness of imports and exports
(elasticities) to changes in trade barriers (Kee, Nicita, and Olarreaga
2009); it does not take into account trade distortions caused by
undervalued exchange rates. the United States is also quite open based
on this index, but Japanï¿½s OtRI is nearly twice as large, indicating
that its nontariff measures are an important constraint to the ability
of trading partners to export to its market.



There are substantial differences between the openness of these
particular high-income economies and other important U.S. trading
partners, however. First, consider Korea, a country with which the
United States recently concluded negotiations on a trade agreement, as
well as Colombia and Panama, countries with which the United States is
seeking free trade agreements. Relatively high tariffs in these
countries (see table 4-1) are likely to remain in place until trade
agreements negotiated with them are ratified and implemented.
Completion of these agreements has the potential to lower and secure
these import tariffs for U.S. exporters at rates much closer to zero
and also to remove many other burdensome nontariff measures (Box 4-2). However, these gains will be realized only if the agreements address
these burdensome measures in a sustainable way, which is why the
Administration is committed to supporting only agreements that secure
serious concessions and that overall are in the interest of U.S.
workers and the U.S. economy.

-----------------------------------------------------------------------
Box 4-2: The Korea-united States Free Trade Agreement

In December 2010, the Administration announced the successful
resolution of the outstanding issues with the Korea-United States free
trade agreement (KORUS). The agreement is the most economically
significant free trade pact that the United States has negotiated and
signed in nearly 20 years. A study by the U.S. International Trade
Commission estimated that the agreement could boost U.S. annual goods
exports to Korea, including agriculture products and autos, by as much
as $11 billion. The agreement also includes Korean commitments expected
to result in considerable expansion of U.S. services exports.

Table 4-1 highlights why agreements like KORUS are especially
critical for the competitiveness of U.S. exporters. In its absence,
U.S. exporting firms face an average Korean import tariff of 12.2
percent; under the agreement, this rate will eventually reach zero and
will help U.S. exports compete in Korea against Korean firms. Without
KORUS, U.S. exporters would also be at a competitive disadvantage with
other foreign competitors that also export to Korea. The European Union
has signed a similar trade agreement with Korea, scheduled to be
implemented in July 2011, that would give its exports a leg up. Indeed,
in little more than 10 years, the United States has already fallen from
being the number one exporter to Korea to being the fourth-largest
supplier, trailing China, Japan, and the European Union. Implementation
of KORUS and the lowering of Korea's tariffs toward U.S. exporters are
expected to help stem further erosion.


The KORUS may also result in changes to the composition and source of
U.S. imports. Korea's exporters already face a relatively low average
U.S. tariff of 3.5 percent even without the agreement. KORUS would
eventually lower that rate to the level enjoyed by the United States'
other free trade partners, including Canada and Mexico.
-----------------------------------------------------------------------

Second, the major emerging economies also tend to have more
restrictive import regimes than the high-income economies. economic
growth in China, India, and Brazil has surged in part because these
nations lowered their import tariffs significantly from their levels of
20 years ago. U.S. firms have responded to those reductions by
increasing exports to these new markets over the past 15 years,
providing these economies with key goods and services that contribute
to their growth. Nevertheless, table 4-1 indicates that the import
tariffs that remain in these economies are still relatively high.

Just as U.S. trade shows a reorientation toward emerging economies,
U.S. trade liberalization negotiations have turned toward these same
emerging economies, especially through forums such as the WtOï¿½s Doha
Round of multilateral negotiations. Dubbed the Doha Development Agenda,
the negotiations are focused in part on the power of trade
liberalization to enhance the development prospects of low-income
countries. the Administration is pushing for an ambitious set of trade
liberalization commitments under the Doha Round not only to enhance
opportunities for U.S. exporters of manufactured goods, services, and
agricultural products, but also to increase opportunities for
development-enhancing trade among developing countries. emerging
economies such as China, India, and Brazil will have a particular
responsibility to further reduce and bind their import tariffs to
produce such an outcome.

The need for partners to commit to additional trade liberalization
is confirmed by evidence from the last column of table 4-1, which
reports a separate World Bank index (the market access-overall trade
restrictiveness index, or MA-OtRI) of the average trade restrictiveness
facing a country's exporters from all of its foreign markets combined.
The index is based on tariff levels and some nontariff measures that
trading partners impose (again, not including an undervalued exchange
rate), and the importance of those measures is weighted by the
composition of the exporting country's exports in addition to the
exporter's and its trading partners' responsiveness (elasticities) to
trade. Lower numbers reflect fewer trade barriers confronting the
country's exporters. By this measure, the average U.S. exporter faces
trade restrictions surpassed only by those facing exporters from Panama
and Brazil. One reason for this high index number for the United States
(and a main driver of it for Brazil and Panama) is that it is a major
agricultural exporter and agricultural trade barriers around the world
remain high: they need to be negotiated and reduced. Nevertheless, U.S.
exporters face trade barriers that are higher than they are for Japan,
the european Union, and other important competitors in global export
markets. the Administration is therefore committed to negotiating
better terms for U.S. exporters to help level the playing field. In
addition to completion of free trade agreements with Korea, as well as
Colombia and Panama, and a successful conclusion of the Doha Round, the
Administration is placing increased emphasis on persuading Asian
economies to reduce trade barriers and open themselves to U.S.
exporters through the trans-Pacific Partnership.

Encouraging Exports by Enforcing Existing Agreements

The Administration works to increase U.S. exports through regular
engagement in bilateral and regional trade policy forums in a way that
encourages trading partners to live up to their international
commitments and obligations. these trade dialogues facilitate policy
reforms, yield additional foreign market access, and level the playing
field for American workers and companies. For example, in December
2010, the Administration worked with China through the Joint Commission
on Commerce and trade to improve Chinaï¿½s intellectual property rights
protection, better ensure nondiscriminatory treatment of foreign
suppliers and products, and provide fair treatment for new
technologies. Similar successes are occurring through other dialogues,
notably in other emerging economies throughout Asia, Africa, and Latin
America.

Nevertheless, enforcement of existing trade agreements sometimes
means that the U.S. Government resorts to dispute settlement provisions
to resolve trade frictions, whether under a free trade agreement or
more commonly under the WtOï¿½s multilateral auspices. the total number
of disputes the United States has filed at the WtO has declined over
time, dropping from 68 initiated between 1995 and 2000 to only 29
initiated between 2001 and 2010. As trading partners increasingly
commit to open their markets to U.S. exporters, enforcement becomes
increasingly important to ensure that trading partners live up to their
agreements. enforcement is a fundamental role for the Federal
Government; under WtO rules, exporting firms themselves cannot
challenge another countryï¿½s trade actions. As such, U.S. trade
Representative Ronald Kirk has frequently stated the Administration's
commitment to step up enforcement on behalf of U.S. exporting
interests.\7\

\7\ See, for example, his speech at Georgetown University on April 23,
2009.

A growing share of the complaints the United States has filed with
the WtO is now being filed against emerging economies. As Figure 4-13
shows, nearly two-thirds of all disputes the United States brought
between 2001 and 2010 were against emerging economies, up from roughly
one-third between 1995 and 2000. this increase is not surprising given
the importance the United States places on maintaining current and
future trade with these emerging economies. During the 2008-09 crisis,
for example, the number of import restrictions imposed on U.S.
exporters by emerging markets increased substantially relative to those
imposed by high-income trading partners (Bown 2010). Historically, many
U.S. disputes allege that some element of a newly imposed import
restriction that is obstructing U.S. exports is inconsistent with WtO
rules.



At the same time, as Figure 4-13 indicates, the share of disputes
filed against the United States by foreign exporters in emerging
economies attempting to protect their access to the U.S. import market
has also grown. Because an increasing share of U.S. imports derives
from emerging markets, these economies are now the most frequent
challengers to U.S. trade policy.

Two additional points regarding the U.S. Government role in WtO
disputes are worth highlighting. First, use of the WtO dispute
resolution mechanism represents attempts to resolve differences between
trading partners through rulings based on the application of agreed
international trade rules. During 1995-2000, when more U.S. exports
were destined for high-income economies, most U.S. disputes filed at
the WtO were lodged against these economies, even though they were and
continue to be strategic allies. the process was designed to prevent
trade issues from escalating in a manner that would increase barriers
to international trade.

Second, despite the growing importance of enforcement to keep foreign
markets open to U.S. export interests, the U.S. Government's
enforcement role has become ever more complex. the production process
of many goods is increasingly fragmented into supply chains that cross
international borders. As a result, domestic stakeholders often have
varied interests with respect to the issues that may arise in a
particular dispute.

When the U.S. exporter facing a new foreign trade barrier is also a
multinational firm with significant affiliate activity in that foreign
market, that firm may be hesitant to publicly support U.S. Government
actions to have the trade impediment removed. the company could face
many forms of reprisal from the foreign government in ways that the
U.S. Government is legally unable to help fight and that may cost the
company more than it loses under the trade restriction. The
complexities facing U.S. enforcement of the rights of U.S. exporters
and the interests of the U.S. workforce are likely to continue to
escalate as technology improves, transport costs continue to fall, and
production processes continue to be integrated among operations in
various nations.

Advocacy to Encourage Exporters, Credit, and Trade Facilitation
Part of the fixed cost of exporting can be learning about a market or
making the necessary investments in building relationships. In many
cases, the Federal Government may already have that information and can
thus lower the cost of exporting by sharing it. As such, several
WtO-consistent policies may help boost the visibility of U.S. exports,
especially those produced by small- and medium-size firms, and lower
the hurdle that each firm faces in entering new markets.

One approach, contained in the President's National export
Initiative, is for the U.S. Government to improve advocacy abroad. For
example, trade fairs can showcase export-ready enterprises that may be
too small or too young to be a part of the larger industry associations
that often organize promotions. Advocacy could also involve better
support from consular offices abroad, such as providing exporters with
contacts and buyer-seller information.

The government can facilitate trade by offering trade credit to match
the terms available to firms in other countries. Investments in the
U.S. transportation and supply chain infrastructure are critical to
enabling U.S. exporters to move their goods to ports quickly and
inexpensively. the Administration is also committed to negotiating
agreements on trade facilitation abroad so that U.S. exports can be
shipped to foreign customers more efficiently. At an even more basic
level, the Government, through the Small Business Administration, the
export-Import Bank, or the International trade Administration, can work
with U.S. firms (especially small businesses) to help them navigate the
process of exporting.

In the end, the decision whether to export to a given country is a
private market decision made every day by thousands of U.S. firms.
Nevertheless, the National export Initiative sets out an ambitious
agenda by which the Federal Government can play a more constructive
role for U.S. businesses and their workforce.

CONCLUSION

As the United States orients its economy toward more exports and more
investment, growth in exports will be determined by U.S. interactions
with a complex and changing world economy. trade relationships of today
look little like those of 50 years ago, when different countries led
the world economy and played leading roles in U.S. trade. Recognizing
those changes and engaging constructively with the world as it is today
can be a significant source of growth for the U.S. economy for decades
to come.