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Session 1
The Multilateral System and National Economic Strategies

Moderator:

Mark Dadd, AT&T

CHARLES WESSNER: To discuss the interaction of national economic strategies and the multilateral trading system, we have a particularly distinguished panel, chaired by Mark Dadd, the chief economist for AT&T. His responsibilities include the analysis of economic developments and their implications for AT&T. Mr. Dadd has also served as the director of international and commodity economics with W.R. Grace in New York, and as an economic advisor to the United Kingdom's Treasury Delegation here in Washington. He has also been an advisor to the Prime Minister's Office of the United Kingdom on their dealings with the European Community, always a challenging task.

MARK DADD: This morning we are going to talk about the different economic strategies for growth around the world, how and why economic strategies vary between nations, and what those differences mean for the world trading system. This session is designed to provide a descriptive and a theoretical framework for our deliberations.

We have three speakers this morning. Bruce Scott will talk about the different national economic strategies around the world and how they impact growth. He will put these strategies into an economic framework for us.

James Fallows will talk about the different ways countries look at economic policy from a societal and an institutional perspective, focusing on East Asia.

And third, Lawrence Chimerine will talk about the role and importance of trade in U.S. policy and the consequences for the international trading system.

I would like you to bear in mind three things as we go through this session. First, it is clear that the global economic and business environment is changing rapidly. We, in the international business community, are acutely aware of this.



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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Session 1 The Multilateral System and National Economic Strategies Moderator: Mark Dadd, AT&T CHARLES WESSNER: To discuss the interaction of national economic strategies and the multilateral trading system, we have a particularly distinguished panel, chaired by Mark Dadd, the chief economist for AT&T. His responsibilities include the analysis of economic developments and their implications for AT&T. Mr. Dadd has also served as the director of international and commodity economics with W.R. Grace in New York, and as an economic advisor to the United Kingdom's Treasury Delegation here in Washington. He has also been an advisor to the Prime Minister's Office of the United Kingdom on their dealings with the European Community, always a challenging task. MARK DADD: This morning we are going to talk about the different economic strategies for growth around the world, how and why economic strategies vary between nations, and what those differences mean for the world trading system. This session is designed to provide a descriptive and a theoretical framework for our deliberations. We have three speakers this morning. Bruce Scott will talk about the different national economic strategies around the world and how they impact growth. He will put these strategies into an economic framework for us. James Fallows will talk about the different ways countries look at economic policy from a societal and an institutional perspective, focusing on East Asia. And third, Lawrence Chimerine will talk about the role and importance of trade in U.S. policy and the consequences for the international trading system. I would like you to bear in mind three things as we go through this session. First, it is clear that the global economic and business environment is changing rapidly. We, in the international business community, are acutely aware of this.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings National economies are becoming more interdependent. Competition is intensifying between companies and countries. Technology is becoming more readily transferrable from one country to another. That puts added pressure on us all to work for new cooperation in these technology and trade policy issues. Second, trade and economic policy does not have to be a zero-sum game in which one country can gain only at another's expense. The challenge for us is to find a combination of policies that leads to higher income and growth for all participants; in other words, "win-win" in terms of the latest business jargon. Third, countries have a variety of cultural and historical traditions that lead to different views about the role of government and the nature of economic policy. And the fact that many countries do not share a U.S. or even a European view does not mean that they are, in any sense, wrong. In trying to persuade other nations of the merits of a U.S. view or a European view, we need to bear in mind that we are dealing with sovereign powers who are reasonably and properly trying to manage their affairs in a manner that they think is in their national interest. Let us not fall into the trap of looking at these issues in terms of right and wrong. Our first speaker is Bruce Scott. He is Paul W. Cherington Professor of Business Administration at Harvard University in the Graduate School of Business Administration. He is currently writing a book on national economic strategies. He is the coauthor of a 1984 book on U.S. competitiveness in the world economy. In 1991 he was appointed to the U.S. Competitiveness Policy Council, which was established by the Trade and Competitiveness Act of 1988. Our second speaker is James Fallows, who has been the Washington editor of The Atlantic Monthly since 1979. Prior to joining The Atlantic, he was President Carter's chief speech writer. Among his recent books is Looking at the Sun: The Rise of the New East Asian Economic and Political System. Lawrence Chimerine is our third speaker. He is the managing director and chief economist of the Economic Strategy Institute in Washington, D.C. His previous positions include chairman, chief executive, and chief economist of Chase Econometrics and of the WEFA Group. He has also served as manager of U.S. Economic Research and Forecasting at IBM for 14 years. Producer versus Consumer-Oriented Economies Bruce Scott, Harvard University I approach the issue of economic strategies from a business school and a mix of business administration and economics. Some of our economics faculty in the real economics department would find it curious that I am here in any role as an economist at all, to put it mildly. First, let me raise a point as to what an economic strategy does not mean. The most familiar form of economic strategy for those of us who have lived in the

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings United States or Western Europe since World War II has been based on the ideas of Maynard Keynes. These ideas were formulated in the 1930s, a period when there was very little international trade. They were based on the notion that governments could reduce or eliminate recessions on the basis of pumping up aggregate demand. This became the prevailing idea by the 1960s at the time that the system was opened to international trade. By the time Richard Nixon had decided "we are all Keynesian," these ideas were clearly obsolete. So, what was once the familiar form of economic strategy has now become completely obsolete in an open trading system: pumping up demand simply leads to increased imports and a trade imbalance that is unsustainable. What is an economic strategy in today's circumstances? I start with the notion that any significant business has to have some vision of where it is going. That allows it to set some goals that are viewed in terms of purposeful intervention. I believe that there are three broad categories of intervention that are possible: mobilization of resources; allocation of resources; and, promotion of efficiency. Only one of them, allocation, is really controversial. Mobilization of resources is familiar to all of you. It means that government could promote additional investments, savings, R&D, the types of programs Senator Bingaman talked about; but above all, education. You could think in terms of the work week. The fraction of your resources that you try to mobilize for productive purposes is obviously important. At the same time, it is no end by itself. If you are going to invest resources, you do not consume them. Time and again, the familiar reference is, if you invest more, your productivity goes up and your growth rate goes up. There is a direct correlation between the level of investment and the level of productivity growth. But they are over long time periods, and they are almost meaningless when you take them in a shorter time period. Let me give you the most obvious example. Japan saves and invests today roughly what it has since the 1950s when they had almost a 10 percent growth rate. Since 1973, it dropped to approximately 4 percent. Since 1991, it is 2 percent from roughly the same levels of saving and investment. In Japan the rate of return on investment has dropped by 80 percent. Mobilization of resources is very important, but it is only a part of the story. For the promotion of efficiency, government can do something there, too, but that is largely a matter of markets and competition. Markets are created by governments. They depend on property rights, the influence of law, and many other factors. The really controversial part, I believe, and the part that will be germane to your discussions the next two days, has to do with the allocation issue. There are

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings different ways to think about allocation. The familiar way, if you are an economist, is to think of allocating resources on the basis of advantage. A second way is to allocate not on the basis of current advantage but that of future opportunity. There is a third way, if you are in a rich country, where resources are often allocated neither by advantage or by opportunity. Increasingly, in countries like the United States, we have been allocating resources on the basis of disadvantage (or need), not advantage and certainly not opportunity. This is where the real issue is. Comparative advantage is where this discussion needs to start, and it needs to start by recognizing that it has a very long tradition. Paul Samuelson once said that it is the most important proposition in economics that is not simply obvious common sense. Let me restate the original example. Most of you know that it was David Ricardo who suggested that, if Portugal was a lower-cost producer of both wine and textiles than the British, then the Portuguese should specialize in wine where they had a comparative advantage and leave the textile industry to the British. And, obviously, with British climate and technology, they were not a threat to anyone in the wine business. What is it that is really the reasoning behind this? This is a static, short-term picture of comparative cost, focused on the short-term advantage that will accrue in both societies. I believe that it still dominates economic thinking, at least in countries such as the United States. However, it does not have much to tell us about economic development, certainly not nearly what we have thought. Economic development is not a question just of incomes, let alone of short-term comparative costs. Economic development involves the transformation of society. Take the example just mentioned. Let us suppose that the Portuguese incomes could have kept up with the British. An agricultural society is not the equivalent of an industrial society, even if their incomes are the same. If you want today's example, the oil-based economies in the Middle East are hardly modern economies by any standard. The second thing to say was that the real issue was not wine and textiles. It was cotton textiles, which at that stage was the first modern industry. The wine business grew approximately 11/2 percent a year. Wool and textiles grew approximately 71/2 percent a year. At the time of Adam Smith and David Ricardo, cotton textiles became the first industry in history that began at approximately 71/2, and it is where we traditionally date the beginning of the industrial revolution. Are you better off to have an advantage in an industry that grows 11/2 than one that grows 71/2? For anyone running a business, that is a no-brainer. You have to ask, "Are my advantages comparable to someone who is in a higher growth industry that has better opportunities?" Anyone doing strategic planning in a business recognizes that you have to think of both advantage and opportunity, and if you do not have the advantages, then consider where you want them. You are going to draw resources from one area and try to shift them to another.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings You are going to draw resources from your cash cow and shift in the direction of opportunity. You can also do that as a society, but it is taking a business planning idea and trying to move it to the national level. One obvious question is, if I look at the world economy, where is the opportunity? The answer is that, as we have opened the trading system, world trade has grown much more rapidly than GDP [gross domestic product]. If you are not out there in the world economy, you are missing a higher-growth opportunity. In the trading system, it is not everything that has grown equally; manufacturing has been the key area. And if you go into manufacturing, you are going to find that it is increasingly knowledge-intensive, and, more recently, tradeable knowledge-intensive services. So, it is not GDP. It is trade. And it is increasingly knowledge-intensive exports that have been the premiere opportunity. The question is, can your allocation system have any effect as you begin to think about that premiere opportunity? I believe that our way of thinking about this and teaching about it in this country is a handicap. If you think back, Adam Smith was writing in 1776, at the dawn of the industrial revolution. The first version of Wealth of Nations was published 15 years after the usual dating of the beginning of the industrial revolution. Smith lived for approximately another 15 years. David Ricardo was writing into the 1840s. Neither one of them paid any attention to industry. Adam Smith's example was a pin factory. That is fairly low technology, but the really interesting thing is his notion that the key is the division of labor. The real changes are division of labor, the creation of machines that create a standardized product, and the application of power to the machinery. An example is the Springfield Rifle with interchangeable parts that can be standardized and mass produced. Beyond this is the automation of production. All of this was taking place as this debate was being framed in Britain, and it was being ignored. What we think of today as the industrial revolution was not recognized in economic history until approximately 1880. In Ricardo's example, the real difference is not just higher income and vineyards versus woolens or textiles. If you are going to develop textile machinery, somebody is going to have to design it. Somebody else is going to have to have a training system to teach people how to operate machinery and then automate machinery. You are going to need a much more complex financial system to finance equity debt, short-term working capital, and all the rest of it. Ricardo might say it is in the Portuguese advantage, short-term static advantage, to pick wine, but if they pick wine, they are also picking underdevelopment. Portugal has the advantage in a low-growth, low-opportunity industry, and it represented a way to marginalize themselves as a society. I used to believe that this was something that was an intellectual swindle. In a way it is, but I do not believe that it was done that way. I believe that Ricardo would have had exactly the same idea if he had been in Portugal. He simply did not recognize the importance of industry and

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings of the fact that an industrial civilization is different from one that is based on agriculture. Now, that is the opportunity. The countries that have had the most obvious massive advantage in anything identifiable since World War II are the countries that have oil. The countries in Asia that have no oil, no iron ore, no natural resources of any type outperformed the oil producers better than two to one during the oil bonanza in terms of raising their income, and since then, there is no comparison whatever. A focus on where the opportunities are and mobilizing and shifting your resources in the direction of opportunity beats advantage. Advantage and opportunity are not mutually exclusive, but there is just no question which is more important. So I believe we end up with some preliminary conclusions: Opportunities can be more important than advantages; manufactured exports have been the number one opportunity. At the turn of this century, world trade was 80 percent agriculture and raw materials. These sectors now represent less than 20 percent. It is hard to build a nation' s future on something that continues to shrink in the world market. Knowledge-intensive exports, whether they are manufacturered goods or services, is where the obvious opportunity is. As you think forward, the question is, what does your society do to move in that direction? I believe that all the successful strategies have an element of mercantilism involved in them, that the move toward the opportunities requires a society doing much the same thing that a company does, which is that some sectors are going to subsidize others. Here is a way to think about the economic strategies of countries. It is a simple two-by-two matrix, but I believe that there are some things that it helps us see. The usual way to think about economic strategies is in terms of a trade regime or a resource allocation scheme. According to this resource allocation scheme, economic strategies can be inward oriented, outward oriented, or neutral. An inward orientation means import substitution and a protectionist regime. However, to suggest more possibilities is to have a very different perspective than, for example, the World Bank. The Bank's economists have said, in effect, economic strategies are either based on import substitution and protection or based on neutrality, which they call ''outward" oriented. In the resource allocation scheme, there are three possibilities. The key characteristic that has a bearing on what you are thinking about is the exchange rate. If you look back over the postwar period, outward-oriented countries have all been driven during the high-growth period by an undervalued exchange rate. This was not accidental. One of these outward-oriented nations that one could quibble about is Korea. This has a bearing if you think forward, when you think of what the Chinese are doing at this stage. China's currency is the most obviously undervalued of any major country today, and the magnitude of that undervaluation is enormous.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings The other dimension in this approach is the transfer of resources from producers to consumers. In producer-oriented countries, the consumer subsidizes the producers. These countries are building their standard of living around a higher rate of productivity growth and a higher salary rather than cheap consumer prices. The high-growth countries have not been the neutral consumer-oriented countries. They have been outward-oriented nations with an undervalued exchange rate. They can also be characterized as producer-oriented in the sense of creating a system in which the consumer is overcharged and the producer typically controls the channels of distribution. This is a system in which the consumer subsidizes the producer. You reinforce that system with export growth, which takes you down the manufacturing learning curve faster than someone can on the basis of their domestic market. This has some substantial implications for the trading system. The other part of this that needs to be thought about is that most of the older industrial countries are, in fact, doing the opposite. Earlier, Senator Bingaman discussed the R&D curve. You can duplicate that with public infrastructure and other investments. The extent to which resources are being shifted either toward areas of opportunity or advantage is declining, especially in the United States. U.S. allocation of resources is increasingly on the basis of disadvantage, for which no performance is required. Transfer payments to people with low incomes have gone up by ten times in real terms since 1965. They dwarf anything that we do to promote advantage. It is 5 percent of GDP. Senator Bingaman talked about 0.07 percent going into R&D. As we open the trading system, two things are happening: average incomes are going up, and inequalities in income are going up. The dilemma for the high-income countries is they have a rising share of the population whose incomes are going down. If you live in Europe, you have a minimum wage. Consequently, more people are unemployed or the government employs them, as in Sweden or Denmark. Faced with increased inequality, the rich countries are tempted to allocate, not on the basis of advantage or opportunity, to the disadvantaged. The Challenge of the East Asian Economic System James Fallows, The Atlantic Monthly What I have to say follows directly on what Professor Scott very eloquently and valuably pointed out. He established a point that should be obvious to anyone who has operated in international economic competition. Yet, it is one which has escaped notice in American political discourse and, it seems, in American economics departments. That point, of course, is that there are different strategies with which nations approach the pursuit of economic advantage, and that consumer welfare is not the only idea any society brings to its economic strategy.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings I am going to talk about the part of the world in which this difference—between American modern notions of consumer sovereignty and the longer-term producer notions—has the sharpest importance right at the moment. That region is East Asia. I will argue that most of the opportunity for cooperation that this seminar is designed to discuss, and most of the potential for the disruption that this seminar is supposed to understand and avoid, will lie in East Asia. It will show up in East Asia's interactions with Europe, its interactions with North America, its interactions with the rest of the world. It seems to me there are four dimensions to this interaction—four ways to think about the impact of East Asia and the consumer-producer tensions around the world. Let me first say that since I agreed with everything in Professor Scott's presentation except one sentence, I will, with my journalist's mentality, focus on that one sentence. He pointed out that transfers to people in economic need were growing much faster than other efforts to promote advantage. I believe that the only thing growing faster than transfers to people with economic need are transfers to people with no economic need. This has been the story of American budgeting over the last generation as non-means-tested retirement payments have ballooned. Back to my main agenda. The four reasons why East Asia will be the arena for the contrast of these systems are as follows. SCALE First is the scale involved in the East Asian economies, at the moment and prospectively. In talking about scale, I do not mean simply that the Japanese economy is at today's exchange rate something like 85 percent as large as the U.S. economy and that if the yen were to appreciate into the mid-seventies, the Japanese economy would be, in theory, larger than the U.S. economy at that point. I do not mean simply that China could, by many possible projections, be the largest economy in the world over the next decade or two. I mean instead that there are three subdimensions of this scale issue that make the contrast in economic theories and economic styles particularly important in East Asia. Sustained growth: One of these subdimensions is the sustained rapid growth of East Asia, which means that, whatever happens, there will be a disproportionately large impact on the rest of the world. As all of you are aware, year by year over the last two decades, if you took the ten economies in the world with the fastest growth rate, seven, eight, or nine of them would have been in East Asia. And there has been a compounding effect of growth over the decades. The growth prospects for East Asia as a whole and for many of its constituent countries are strong over the next ten years. It seems likely that some rate of growth will continue. So the continued growth in East Asia gives it an importance that other regions do not have.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings A regional system: The second subdimension of scale that has particular importance is the increasing systematic nature of what is happening in East Asia. Despite all the obvious differences of language, history, religion, and ethnic sentiment found in East Asia, as the years go on, East Asia is functioning more and more as a regional system. To me, the most interesting economic story of the last decade is the unintended consequences of doubling the value of the yen in 1985 and 1986. That was the catalyst for creating an integrated East Asian system, as Japanese companies used their newly valuable yen to invest in the rest of the region and integrate a Pan-Asian production base. And with the passage of years, I argue that this systematic integration is increasing and has impacts for the rest of the world. Influence: A third subdimension of scale is the influence that Asian economies now have on every place in the world. Americans should be aware that over the last decade, Japan's trade surplus with the United States has averaged approximately $50 billion a year. So has the surplus from the rest of Asia with the United States. So there has been an average of approximately a $100 billion trade impact from Asia as a whole on the United States. With this producer orientation, the Asian system has an increasing impact on other economic systems as well. In sum, what happens in Asia matters because of the region's scale, its rate of growth, and its influence and spillover effect on the rest of the world. POLITICAL IDEOLOGY The second reason why the Asian system has particular importance and impact involves what I call their "political" ideology. The reasons for calling it that will become obvious later when I discuss dimension four. I have in mind here again three subcategories, three aspects of political ideology that make the Asian growth case particularly significant as a source of both competition and of potential cooperation. Growth as a national objective: One of these categories is a particular purposefulness about economic growth and about government-directed economic and technology growth that is distinctive in the world. Richard Samuels, who will address you tomorrow, has written the definitive book on this subject, Rich Nation, Strong Army, about Japanese technonationalist policy. I believe that you can find milder versions of the same mentality in many other countries, particularly China at the moment. Mark Dadd pointed out earlier today that, according to Western-style economic theory, we should not view economic commerce as a zero-sum game because, after all, we can all prosper from it. I submit that, in many of the leadership positions of these Asian countries, there is still a zero-sum mentality. That is, to make themselves stronger relative to the rest of the world, it is important to gain technological advantage. And I believe that there is still a purposeful drive in many of these countries.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Confidence: A second subcategory is the increasing confidence within Asia about an Asian route to development, to the steering of technology, and an Asian sense of being on the winning side of the world's technological exchanges. I will give one illustration here. It is interesting that Japanese foreign aid administrators increasingly say, "Do it our way and you will prosper. Do it the World Bank way, do it the American way, and you will flounder." And the Russians' mistake, they say, was to open up their national market too rapidly, unlike the Chinese. Barriers: A third aspect of what I call their political ideology is the barriers within many Asian societies to democratic pressures that might make them more consumer oriented in the long term. Americans have a long track record of predicting the imminent collapse of Japan's productive system—because consumers will rise and revolt, salaried men will stop working, the youth will revolt, etc. All these things may happen at some point, but I am impressed by the robustness of many Asian political systems in keeping the lid on these tensions. And, indeed, the most interesting test case here is Korea, which did loosen its belt over the last four or five years and is now trying to tighten it again. GEOPOLITICAL SPILLOVER The third reason why we should concentrate on what happens in East Asia is the geo-strategic spillover of economic and technological tensions. What I have in mind here about the geostrategic impact of economic and technological competition also includes three subthemes. Strategic and military balance: The first one, and the one that has been concentrated on most consciously by American strategists, is the potential—indeed, the inevitability—of overturning what has been a very important strategic and military balance in Asia for the last 40 years. One could argue, and I would, that what has kept the peace in Asia since World War II (with the exceptions of the wars in Vietnam and Korea) have been two conditions that are no longer sustainable: One is the U.S. security presence, with the 7th Fleet and its allied forces. The other is the U.S. role as the final market for most Asian producers. This role results in a $100 billion annual trading deficit with Asia. It is hard to see how these two conditions can last in the long run, how the U.S. can both have a $100 billion deficit every year and still send out the 7th Fleet. The question is, what happens to the Asian system if those conditions are no longer present? This is one strategic consequence. Economic polarization: A second strategic consequence is one Professor Scott mentioned, which is that the trading difficulties that the United States is now having with East Asia have the potential of aggravating the worst political problem inside the United States. That worst political problem is not even racial tension, it is not even gun violence. It is, instead, the continued polarization of

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings the United States on economic grounds. Economists argue about the many sources of this polarization, but they all agree that trade has something to do with it. So, if the trading differences between the United States and East Asia aggravate this main tension, that has a strategic effect. The "right way": A third subtheme here is an emerging ideological confrontation between the United States and East Asia about the "right" way to organize society. One sees signs of this in the Singapore caning case last year and in the arguments with China over human rights. What is emerging from these cases is a challenge to the Western idea that the Enlightenment-style, liberal, Western democracy is the supreme way to organize human beings. Increasingly, you will find rich and confident Asians saying ''no," saying that perhaps a role for the individual is dangerous to a successful society. AMERICAN IDEOLOGY I will now move on to dimension four, which is about why East Asia matters. This point concerns what I call our political ideology about the economy. Speaking mainly of the United States, but more broadly about Britain and the English-speaking Western world, it is this political ideology that makes it so difficult for us to perceive accurately what is happening outside our borders. Professor Scott mentioned at the beginning of his presentation that he was from the business school and not the economics department. Then he went on to give a very realistic description of what was happening in the world. I think the juxtaposition of those two things—first that he is realistic and second that he is not in the economics department—is very important. It is not an accident that it is hard to find people with a similar perspective from "real" economics departments. I contend that 50 years from now, people will marvel at the temporary prominence and preeminence of Western-style economics in the mind set of the Western world in the late twentieth century. With today's theoretical economics, we have something that is similar to the problem of Ptolemaic astronomy, earth-centered astronomy, in which you have a theory that is harder and harder to fit to the facts of the real world. As Professor Scott pointed out, the Ricardo example, which students are still taught, is very hard to fit to a world of aircraft producers and semiconductor producers. It is very, very, very hard to fit anything argued by Western-style economists to what happened in the last ten years in world currency markets. Ten years ago they were predicting that the doubling of the yen from 250 to 120 would cause a complete change in the Japanese export performance. It was, indeed, a change, but not the one they predicted. To conclude, I have a long argument to make here, which I will boil down to the fact that America has prided itself historically on being a pragmatic, Yankee-ingenuity-type society. I contend that the most ideological aspect of today's world affairs is American economic thinking. There is no clearer case of the conflict between empirical evidence and pure theory than what is happening as

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings economics departments try to say that the Japanese are doing things wrong. They are just hurting themselves. They are cheating in world trading rules and they are not succeeding. So this dimension, that is, how we can adjust our ideology to square with the facts of the East Asian world will also be significant. Thank you. Consequences for the International Economic System Lawrence Chimerine, Economic Strategy Institute I agree with the observations that James Fallows made about East Asia and, quite frankly, about economic thinking in the United States and its slowness in adapting to what is happening in the real world on trade issues. That is my subject this morning—to give you some perspective of what is happening with respect to U.S. trade and to put that in the context of overall U.S. economic performance and, in fact, overall global performance. A record deficit: All of you know the numbers or have read about them. We set a new record last year in the United States for the merchandise trade deficit, and based on data for the first two months of this year, it looks as if 1995 will be another record year for the U.S. merchandise trade deficit. However, there seems to be some complacency about this. Many people, particularly many people in my own profession, are not really overly concerned about it, in part because the economy seems to be doing well anyway, although I believe that is temporary. But more than that, we are told frequently that it is really a sign of strength. Savings and exchange rates: Some economists claim that the reason our trade deficit is so high is because our economy is growing rapidly and we are drawing in imports, and so that the deficit is a macroeconomic problem. In addition, they argue that we do not save enough, and the Japanese save a lot. We are told that we are always going to have a huge trade deficit until we raise our savings or until everybody else cuts their savings. We have also been told that exchange rates will solve the problem. The dollar will get weaker and weaker until the trade deficit declines. Of course, we only have about 80 yen to go. We started at 360 yen to the dollar. I am not sure how anyone can keep making that argument, but, nonetheless, you keep reading it. And the final argument of the "not to worry crowd" is, it is okay that we have a $180 or $190 billion merchandise trade deficit, we will make it up in services because we do have competitive advantages in a number of service industries. Services will bail us out. Structural issues: All of these arguments in my judgment are either completely inaccurate or highly misleading. They focus excessively on the macroeconomic dimension of our trade deficit, in which it has become increasingly apparent that a large fraction of our trade imbalance is what I call structural, unrelated to macroeconomic trends.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings Let me give you some of the broad arguments in support of this assertion, and then we will go on to some of the other issues. First, the argument is that the United States is growing rapidly, thereby pulling in imports. Look at the numbers. In the last five or six years, real imports coming into the United States have risen at a rate more than four times faster than GNP growth. Imports are income elastic, that is, historically, they have grown more rapidly than GNP. Historically the elasticity has been in the range of two. So in the last four years, the rate of import growth relative to the rate of GNP growth has more than doubled from the already high ratio that existed previously. So import growth has dramatically accelerated. Second, on the export side, while our exports have grown at a healthy rate over the last several years, most studies would suggest that our exports should have been rising even faster than they have been rising, in view of the improvement in U.S. competitiveness, particularly price competitiveness resulting from a significant decline in the dollar. So although macroeconomics may be a part of the problem, it is clear that it is not the full explanation of why our trade imbalance has been growing so rapidly. And, in fact, look back three or four years ago. The United States was in the middle of a prolonged period of recession and stagnation that lasted four or five years. Western Europe and Japan—this is before the Japanese recession or stagnation developed—were growing rapidly and we still had a $90-$100 billion a year trade deficit. So, even under ideal, relative economic growth patterns, we still had large deficits. The truth is that we have had a huge and persistent trade deficit in the United States for more than 15 years, regardless of the trends in underlying economic growth. Third, my favorite argument is the saving and investment argument. I do not know how many of you remember your elementary economics. If you do, you know that there is a well-known identity that the difference between saving and investment equals the trade deficit, or the current account deficit. I will call it the trade deficit for simplicity. Unfortunately, a lot of economists have naturally assumed that the causality goes completely from savings to trade. Identities tell you nothing about the direction of causality, but if you have a structural trade deficit caused by closed markets overseas or foreign predatory trade practices, or other factors, it is ultimately going to depress savings in your country and probably raise savings in those countries that have adopted such measures. For example, suppose this were to happen in the United States. Suppose our trade deficit rose because of an increase in import penetration caused by any number of factors—some new foreign products are of better quality, exchange rates change, etc. Obviously this would displace some domestic production that in turn would reduce jobs and income, which is likely to lower savings, and reduce tax receipts, both of which would contribute to a decline in net national savings.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings The causality, to some extent, goes in the other direction in Japan as well. Prices in the Japanese market are extremely high. Is it not reasonable that those high prices to some extent discourage consumption, push up savings, particularly for items you must save for if you want to afford them in the future such as housing and autos? The Japanese are thrift oriented, and they have a number of tax policies and other policies designed to encourage savings. But to some extent, the high saving rate does reflect the high cost of living in Japan, reflecting in my opinion the absence of import competition, which enables prices to remain at those high levels in essentially what is a sanctuary market. So the saving and investment argument does not impress me. Based on calculations we have done at the Economic Strategy Institute, perhaps a third of the causality goes in the other direction. That is a big number. If you take a third of our overall trade deficit as being structural, rather than a saving or macroeconomic phenomenon, you are at approximately $50 billion a year. And, quite frankly, I believe that a third is a very conservative estimate. Twenty or 25 years ago, the dollar was trading at 360 yen. Ten years ago, it was 250. It recently hit 80. The weak dollar is not a recent phenomenon. This is a secular trend, and the reasons are obvious. If there is a regular $60 billion trade imbalance between two countries, the one with the trade surplus is likely to experience an appreciation of its currency, and the country with the deficit will find its currency falling in value. And now the Japanese are far less willing to recycle the dollars they are earning from their exports into dollar-based assets because of the huge losses they incurred during the 1980s in U.S. real estate—in fact, in anything they invested in the United States. Some of the losses were asset price losses, but probably the bigger portion was the result of currency losses. I believe that the Japanese have caught on. As long as their markets are closed and they run this big trade surplus, their currency is going to keep appreciating. Japanese investors have now realized that dollar-based assets are not the best investment under these conditions. This just accelerates the appreciation of the yen, and, in fact, if it had not been for massive Bank of Japan intervention in the last four to five months (buying up a lot of the dollars sold by Japanese exporters, banks, and others), the exchange rate would probably be in the sixties by now. This is a clear sign of the structural nature of the trade deficit. Do you remember hearing that when the exchange rate was at 200 yen to the dollar, that at 180 we will get rid of this trade imbalance? Of course, when 180 came, it became 160 and then it became 140. We were chasing ourselves down. The ineffectiveness of exchange rates to solve the problem is a clear sign of a structural trade imbalance caused largely by closed markets in Japan. Anyone who has tried to sell into Japan is familiar with the cultural and structural barriers that essentially keep that market closed, making it very difficult to export into that market. And, closed markets allow the Japanese to charge

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings high prices in their market, generating huge profits that are frequently used to subsidize their exports. So it shows up on both sides of the equation—lower than warranted exports to Japan and, to some extent, higher imports from Japan because of the subsidies on their exports, which they finance, of course, with the high profits earned in their own market. Every study that has been done shows that Japan under-imports by a substantial amount relative to other industrial countries—at least $100 billion a year, probably a third which would come from the United States if their markets were truly open. That is the structural element of the trade imbalance between these two countries. Importantly, it is no longer just Japan. We are now running a $30 billion trade deficit with China. Six years ago, our trade imbalance with China was $3 billion. China has grown at 10 percent a year in real terms during this period. We have grown 2 percent a year. If this was purely a macroeconomic problem, how do you explain our trade deficit going from $3 billion to over $30 billion over this six-year period? The trade deficit is becoming a structural problem with most of East Asia and, in fact, almost two-thirds of our trade imbalance is now with East Asia, a large fraction of which is structural in nature. Also, the Japanese run trade surpluses with almost everyone, high-saving countries, low-saving countries, high-budget-deficit countries, low-budget-deficit countries, etc. There are possibly one or two exceptions. Australia is one exception because it exports the raw materials that Japan does not produce. Not a purely macroeconomic problem: So clearly, the argument that this is purely a macroeconomic problem does not square with the evidence. To return to the dollar for a moment, not only is its depreciation not correcting the problem, but even if it did, this is not the ideal way to eliminate the trade deficit. A weaker and weaker dollar has undesirable side effects. It creates upward pressure on inflation and interest rates, squeezes purchasing power, makes us poorer, makes our assets cheaper for foreign acquisition, makes it more expensive for us to invest overseas, which in the long run makes it even more difficult to address the trade imbalance. So even if it did work, which, in my judgment it does not, this is not the way you solve what is largely a structural trade imbalance. One-way free trade? There are some economists who will say "So what? Let them keep their markets closed. It is their consumers that suffer. We should keep our markets open anyway," they claim. I consider myself a free trader, but I know the difference between one-way, unconditional, unilateral free trade and the two-way free trade that represents a win-win for all countries, and consumers in all countries. One-way free trade of the type that we have had for the last five or ten years can be just as destructive, in my opinion, as widespread protectionism. Look at the performance of the U.S. economy over the last 15 years. Average economic growth has been a percentage point lower than it was earlier. Average unemploy-

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings ment has been a percentage point higher. Real earnings have stagnated over this period. Productivity growth has slowed. Not all of this is the result of trade, trade may not even be the dominant factor, but it is hard to make the case that our unbalanced trade accounts have not made a contribution to this less-favorable economic performance in the United States. Consumers vs. producers: Again, you will hear from some that one-way free trade is okay because it maximizes consumer welfare. But, consumers have to have an income to have welfare or to spend. This is another false choice, just like the false choice between free trade and protectionism. In the long run, if you lose jobs and income as a result of predatory trade practices, consumer welfare will be lower. It might be a little better in the short term because consumers benefit from lower prices, but you also have to consider the production side of the economy. And if that is damaged in the process in the long term, it is very likely consumers will be worse off. It is my judgment that the public in the United States is ahead of the economics profession in many respects because, clearly, the constituency for free trade has diminished. Many of the new people in Congress are also much more nationalistic and isolationist. Most people in this country realize that, under current "free trade" policies, we have suffered to some extent. They want free trade, but they want real free trade, two-way free trade, the type of free trade that we will all benefit from. That is not what we have had in this country, and in my judgment the Clinton administration is correct in trying to force open foreign markets and, until that happens, maintaining effective trade laws in the United States. Thank you. DISCUSSION SYLVIA OSTRY: I am not clear what the combined panel was trying to say. Perhaps it is unfair to put them all together. Is there a feeling on the part of some members of the panel that the problems in the United States are the result of an East Asian model, which is either deliberately or inadvertently predatory and threatens the whole existence of the United States? I am usually quite ingenious about policy proposals, but I must say that I do not know what I would do in this case. JAMES FALLOWS: It is significant to me that you have used a concept that appeared in neither Professor Scott's or my presentations—that of moral opprobrium, that of "predation," that of some kind of deliberate erosion of someone else's welfare. In my 13-minute presentation, I was trying to compress something I have written about over the last ten years. What I have argued at greater length is that there are simply different models of national welfare and different models for national strategy. The point is not to shriek in horror about "predatory" impulses, but to recognize that there are systems with different trajectories

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings and that we need realistically to understand what the trajectory is. My four classifications of where there would be points of conflict, where there would be points of strain, were designed to address this point. The concept of predation is one that we should expunge from our minds. It is rather a matter of where there will be disequilibrium, where there will be conflicts of interest and how we can manage the sources of those conflicts. LAWRENCE CHIMERINE: I did not mean to suggest that we are being destroyed by the Japanese or anyone else. My point is very simple, that the Japanese system and their approach to trade are different than ours, and our economy has been hurt by that over the last 15 years. CARLOS PRIMO BRAGA: I found the panel presentation quite interesting, particularly the reference to how you should do policy in developing countries. I was a bit puzzled that no one mentioned the multilateral trade system and its role. What is going to be the role of the multilateral trade system if the world works as per your view of the world? What should the World Trade Organization do? Or should we just get rid of it? BRUCE SCOTT: Because you are from the World Bank, the obvious place to take the reference is the Japanese request to the World Bank that it recognize reality as it is. It took a Japanese-financed study approximately three years before the Bank was able to recognize that the high-growth countries have had a systematic intervention inconsistent with what they have been recommending. It has been very hard for the Bank to recognize that, and the report that does so makes very awkward reading. Robert Wade has written a very interesting paper, "The World Bank and the Art of Paradigm Maintenance," in which he discusses the Bank's efforts to maintain a paradigm that simply no longer fits the facts. It is hard to change this, but at this stage there is no one that has had more influence in maintaining obsolete concepts than the World Bank. The dilemma that we face is that, for most countries, the economic strategies have been overwhelmingly import substitution, what I characterize as inward looking. Pursued too long, they perform badly everywhere. So if you asked for the track record of governments with economic strategies, especially since 1973, numerically the track record is poor. The unfortunate part is that most of the really outstanding performances are also connected to government intervention. If you are an organization, such as the Bank, making recommendations, this puts you in an awkward position. The Bank would be saying there is another economic strategy, but you simply do not have the competence to do it, which happens to be true. The Japanese are saying, "Well, there is an additional strategy. Much of the recommendations that you are making to third-world governments are simply

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings wrong. You are recommending that it is okay to subsidize them when they are subsidizing consumers, but it is wrong to subsidize producers. It is wrong to take a long-term approach. It is wrong to try to accelerate your industrialization." In essence, that is what they asked. And it takes you back to the same old concepts, with reasoning like Adam Smith and David Ricardo. And some of our institutions, such as The Wall Street Journal, act as though they have not learned a thing and that Adam Smith said it all. Quite simply, Adam Smith's economics is preindustrial economics. LAWRENCE CHIMERINE: I have a quick comment about the current auto and auto parts dispute and the WTO. I am a supporter of the multilateral approach, but it is not clear that the WTO is going to have jurisdiction over the type of trade practices that the Japanese regularly use. If you go back and look at the Uruguay agreement, many of theese practices were not even addressed. I believe that the Clinton administration is correct in filing an Article 23, but it is not clear the WTO has jurisdiction. JAMES FALLOWS: A correct analogy to keep in mind for the WTO is the role of the United Nations during much of the post-World War II era. Nobody pretended that the United Nations could deal with all great power conflicts. There were certain issues it was not structurally set up to deal with and yet we were better off having it than not having it. In my view, that is how the world trading system will operate. We are better off having it than not having it, but it is not going to contain all of these disputes. TAKASHI CHIBA: I address my question to Dr. Chimerine. Despite your argument, I hope you share my view that this difference of the savings in both the United States and Japan is that Japan is producing more than it consumes and the United States is consuming more than it produces. This type of difference remains a major portion of the qualities of imbalance of trade between our two countries. It is very important that we address these types of issues and find some positive solution to this type of problem. Otherwise, it is not useful to continue these discussions. I hope we can learn from you what we should do in both countries, both in Japan and in the United States, to rectify this situation. LAWRENCE CHIMERINE: Good question. Let me make two comments. First, the argument that the United States consumes more than it produces is true, but the question is why, and is production held down by our inability to sell into Japan? Have we lost economies of scale by not being able to sell in some markets, and has that hurt competitiveness in some industries, which in turn hurts our production? The perception is that we are on a major consumption boom in which consumer spending growth in the United States in the last 15 years has been less than

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings it was in earlier decades, which is not true. What I am trying to tell you is that, to some extent, our production has been somewhat constrained by predatory trade practices and that is why we are consuming more than we spend. It is not as if we have all of a sudden gone on a big binge in spending. Second, I agree with you—we need to find a solution to this problem, but I think the history is that, whenever we have had negotiations with Japan in the past, unless there is great pressure exerted by the United States, unless there is an indication that there is some way of monitoring progress, nothing ever seems to happen. I do not like tariffs. I wish we did not have to impose tariffs, but the issue is that we have to force open the Japanese market. We have to get directly at those cultural and structural barriers that make it very difficult to sell into the Japanese market. That is the crux of the issue. HORST SIEBERT: I thought the role of this session would be to find a common intellectual basis for the discussion of our project and also, of course, for the future meeting in Germany. I want to give the view of how we see the world economy. There are firms competing in the product markets and indirectly competing in the labor markets. Governments are competing with the infrastructure, with the institutional setting, and with a taxation system that favors the mobility of capital. Basically, you have a world economy where the immobile factors of production compete for the mobile factors, and it is apparent that this locational competition is at the center of modern international economics, not David Ricardo from 200 years ago. And there are interdependencies among these three levels of competition. Apparently, the competition in these three areas has long-term implications. Is the market so shortsighted that they would concentrate on the production of a certain product that has a profit only today but not tomorrow? The market should have some long-sightedness. Maybe we do have an American problem here that American firms are shortsighted. But this is not a policy issue, but rather an issue of the internal organization of American firms. I have heard many things about friction and about cooperation. The word "competition" has not been heard much this morning. Have we forgotten that we believe in competition? Do we not believe in competition anymore? Of course Asia is changing, and this changes the world economy, the locational advantage, and the dynamic interpretation of the United States. We are challenged, but then if we are challenged, we need to look at the competition and stand up to it. LAWRENCE CHIMERINE: I, for one, believe in competition. I would like to see U.S. companies have the ability to compete on an equal basis in markets that they now cannot enter. That is what this is all about. KARL-HEINZ PAQUÉ: I wanted to come back to a point that Bruce Scott made

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings about comparative advantage. And as an economist, you will not be surprised that I stand up a little bit in defense of comparative advantage. Actually, it is somewhat misleading to look back at the specialization example of David Ricardo regarding Portugal because we know with the benefit of hindsight that wine growing was not a fast-growing industry. Today, if you translate that example into a modern setting with different industries and try to design a technology policy, which really picks the winners and the right sectors, it is much more difficult. I do not know what direct policy conclusions can be drawn. I will give you an example. If you look at a country such as Holland, which has traditionally had a large agriculture and a large sector introducing technology into agricultural production, it has been quite successful. It is not quite what we mean with high-technology industries, compared to microelectronics, but can we really conclude that the Dutch experience was a disaster? In other words, the issue of translating the learning effects involved in the change of sectoral specialization is a much more complicated matter than just looking back at an historical example, which can be easy to categorize. We have to face up to the fact that, currently, the definition of "sectors" as high technology and low technology is becoming more and more difficult. We should, therefore, be much more careful about drawing the right policy conclusions in such cases. BRUCE SCOTT: I certainly agree with you that, if you look at the track record of most countries trying to intervene, they would have been better off if they had not done anything at all. The dilemma is that you have half a dozen countries that have intervened and have been remarkably successful. The question is, what policy lesson do you want to draw from that? And I think reasonable people can differ. Difficulties aside, sectoral targeting is a policy to be recognized and dealt with. It is not focused on comparative advantage, but rather on opportunity. There was a comment that we have not been looking at this relative to the three levels: the strategy of governments, the strategy of firms, and the strategy of units. These three levels should be part of what we are talking about. I am interested to hear what people say with regard to these strategies. Are they easy? Do we know a lot about them? Are there a lot of successes? I think the answer for these questions is "no." Are you going to apply a test that says if there are mistakes, you do not do it? If you apply that test for a business strategist, you would have to say that we have a lot of people that are grossly overpaid and ought to be fired. No business runs on the notion that they never make mistakes. The dilemma today is the role of people. We have free movement of goods. We have free movement of money. But we are not going to accept free movement of people. Japan does not accept immigrants, and the Europeans are rapidly heading in the same direction. We have had a very different experience in the United States.

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International Friction and Cooperation in High-Technology Development and Trade: Papers and Proceedings North Dakota does not need an industrial policy. There is nobody left. They have all gone somewhere else. You cannot do that when you are crossing national frontiers. Therefore, the question of looking at this in terms of creating opportunities for the people who stay here becomes quite important. We are not going to have mobility of people in any time in the foreseeable future. MARK DADD: Let us bear in mind one of the comments I made when we first started this session, that people in different countries have very different cultural traditions and simply view policy issues differently. One way of looking at policy issues in one part of the world is not necessarily wrong simply because it differs from ours. To move forward positively over the next couple of days, we need to keep this uppermost in our minds. Let me give you one quick example. I was working in London at the time when the first discussions took place about the appropriateness of having a fixed exchange rate regime in the European Community. There were intense discussions about whether the United Kingdom should be part of such an arrangement. The United Kingdom would have to give up some of its independence to determine economic policy and particularly monetary policy in favor of a common policy. The question was, would the United Kingdom make the same policy trade-off between growth rates and inflation that, say, Germany would? My conclusion was that Germany, the country potentially with the most influence over a common European monetary system, would have a different trade-off because of their historical experiences with rapid inflation in the 1930s, which would be politically unacceptable in the United Kingdom.