FROM THE OFFICE OF PUBLIC AFFAIRS

Introduction

Mr. Chairman, thank you for the opportunity to testify before you on the important issues that this Commission is considering. You asked me to discuss the ability of the U.S. economy to absorb the recent, large increases in our trade and current account deficits, and whether they will affect our continuing, record-setting prosperity.

With the widening of the trade and current account deficits, it is natural that there should be increasing questions raised about their effects. The Administration is closely monitoring and analyzing them. In my judgment, much of the recent discussion tends to overemphasize the possible adverse consequences. As my colleague Robert Lawrence stressed in his testimony before you, not all current account deficits are created equal. The rise in U.S. imports has played an important role in keeping price pressures contained during the expansion. In addition, the net capital inflows have helped finance large increases in private investment. This investment has helped put in place new technologies that will help increase future growth, future labor productivity, and living standards. It is important to note that the recent widening of our external deficits has been associated with strong growth in U.S. employment and output. That widening has not been caused by a decline in U.S. competitiveness. On the contrary, productivity growth has accelerated. Between 1973 and 1995, it grew at an annual rate of 1.5 percent per year. From 1995 to the present, growth increased to 2.9 percent per year, and in 1999, growth was even higher still, at 3.6 percent. Performance in the manufacturing sector has been equally impressive; in 1999, manufacturing productivity grew 6.9 percent, the fastest pace on record, and unit labor costs have declined 6.9 percent since the third quarter of 1993.

The basic consensus is that our widening current account deficit has been largely caused by two factors: the gap in growth between the United States and the rest of world, and forces causing an acceleration in U.S. private investment that was not matched by increases in U.S. national saving. The fiscal move from deficits to substantial surpluses has helped support U.S. national saving, but the continuing low rate of U.S. personal saving has exacerbated this latter shortfall.

The gap between U.S. and foreign growth was at its widest during the fourth quarter of 1998, when the U.S. growth rate was approximately 31/2 percentage points higher than foreign growth, due to recessions and slow growth in Asia, South America, Europe, and Japan. While this gap has begun to narrow, several quarters of rapid U.S. growth and slow global growth have resulted in stagnant export growth. By the second quarter of 1999, U.S. exports of goods and services were still $456 million lower than two years before. Exports to emerging market economies account for 44 percent of our total exports. The Asian financial crisis and its spillovers severely disrupted our export markets. It is for that reason that we have supported financing packages with strong reform components for the crisis-affected countries; those efforts have been successful in helping to restore growth. With the resumption of global growth, exports in the second half of 1999 increased at a seasonally adjusted annual rate of 3.6 percent in the third quarter and 3.0 percent in the fourth. During the period of relatively weak U.S. export growth, imports continued to grow at traditional rates, supporting global growth. As a result, imports in the second quarter of 1999 were 16 percent higher than in the second quarter of 1997 -- an increase of $41 billion.

To close this gap in growth and restore a more balanced distribution of growth, we have been urging our trading partners to stimulate their growth, inter alia, through economic reforms to increase flexibility and openness. In particular, we have focused on Europe and Japan. As Secretary Summers recently stressed:

Governments, workers and businesses in Europe and Japan are increasingly recognizing that they, too, do not have to limit themselves to the hope that growth will return to traditional estimates of potential... [Instead,] the right aspiration for policy is much higher than that: achieving a sustained period of growth above what has recently been considered their potential, and encouraging the kind of investments that are necessary to raise the rate at which the economy can expand. This will also help bring about a more balanced pattern of growth in the global economy as a whole."

Europe has, in recent years, taken some steps toward a more dynamic economy with the development of the single market and introduction of the Euro. Additional structural reform is required, especially in their labor market. Such reforms can have tangible results. In the four European countries that have moved furthest with structural reforms (Denmark, Ireland, Netherlands, and United Kingdom), real fixed investment in the 1990s has risen between three and ten times faster than for the EU as a whole.

Similar structural challenges are presented on a larger scale in Japan. Steps have been taken to reverse the poor economic performance of recent years. But as the Japanese authorities recognize, enormous obstacles remain if Japan is to achieve the kind of dynamic market-driven growth that its people deserve. Successful structural change will also depend on the maintenance of a supportive macroeconomic policy environment; private sector estimates from Consensus Economics suggest that the Japanese economy will grow less than one percent this year.

While a substantial portion of our current account deficit reflects weak foreign growth, the deficit also reflects the strength of recent, rapid increases in private U.S. investment that has not been matched by domestic saving. As a result, we have had to "import" foreign savings. This shortfall reflects long-term trends in U.S. personal saving. During the 1980s and early 1990s, net national saving fell steadily, from a high of nearly 10 percent of GDP in 1979 to a low of approximately 3 percent of GDP in 1993. More recently, net national saving has risen substantially and has recovered to 6.5 percent of GDP, thanks to our dramatically improved fiscal stance as a consequence of the budgetary discipline applied by the President and Congress. However, continuing declines in personal saving rates have resulted in a leveling off of this trend, while investment has continued to increase.

At the same time, foreign investors have found the United States a relatively attractive place to invest, so foreign inflows have taken the place of domestic saving. Expected returns have been high, the economy healthy, and productivity has risen remarkably. U.S. macroeconomic policies are fundamentally sound, and the U.S. economy is one of the most flexible and open economies in the world. As a result, returns are higher in the United States than in many other destinations for capital. A recent McKinsey report showed that the relative returns to financial investments in the United States are 20 to 25 percent higher than in Japan or Germany. It is this difference in relative returns that has helped to attract strong capital inflows to the United States in recent years.

The United States remains an attractive place to invest, but we face the task of increasing national saving and remaining open to competition and market forces. The federal government can set a good example by maintaining fiscal discipline and continuing to run budget surpluses. We must also keep our markets open. Attempts to close our markets are likely to backfire and damage the high level of confidence foreign investors have in the U.S. economy.

As our current account deficit expands, so too have concerns by some about our ability to finance it smoothly. By the third quarter of 1999, the deficit reached $360 billion, or 3.9 percent of GDP, at an annualized rate. Some recent forecasts, such as Consensus Economics, place the 2000 deficit above $400 billion. As Chairman Greenspan indicated in his recent Humphrey-Hawkins testimony:

Growing net imports and a widening current account deficit require ever larger portfolio and direct foreign investments in the United States, an outcome that cannot continue without limit."

It is helpful, however, to put the current account deficit and the counterpart net capital inflows, in perspective. For the first three-quarters of 1999, the deficit represented the difference between current account receipts of $1.2 trillion and payments of $1.5 trillion, both at annual rates. During the same period, recorded capital inflows were $760 billion at an annual rate and recorded outflows were $362 billion. On a gross basis, total U.S. international capital transactions are considerably higher -- totaling $12 to 13 trillion for the first three-quarters of 1999 on an annual basis. These transactions reflect movements and reallocations in investor portfolios as well as new investment. As long as we maintain sound economic policies and open and flexible labor, capital, and goods markets, global financial markets can reasonably be expected to cover the gap between our investment and saving smoothly, and we need not be overly concerned about the financial counterpart of our current account deficit.

In addition to promoting sound economic polices in the United States and encouraging reforms to help restore domestic demand-led growth abroad, a crucial component of our approach to the trade deficit is the opening up of foreign markets to U.S. goods and services. To this end, as you heard from Richard Fisher, the Clinton Administration has completed nearly 300 separate trade agreements - some sectoral and others, like NAFTA, more broadly based. One of our highest priorities this year is to work closely with Congress to secure Normal Trade Relations with China in connection with China's entry into the WTO, which we believe is strongly in our national interest.

Some have pointed to the service sector as an untapped potential for U.S. exports. At the Treasury Department, we have focused our efforts on liberalizing trade in financial services, where American financial institutions are recognized as world leaders in product innovation and management. For foreign economies, financial liberalization can lower the costs of capital to their companies and citizens while inviting in highly capitalized firms that raise the standards of financial practices domestically, and many countries have recognized these benefits. One hundred and seven countries have made financial services commitments under the World Trade Organization, by far the most of any services sector. We intend to broaden and deepen these commitments as part of the GATS (General Agreement on Trade in Services) 2000 negotiations, which are now getting underway in Geneva.

Let me summarize my remarks. In order to reduce our current account deficit over time, which is desirable, other countries must do their part to restore robust global growth, and we must increase our national savings rate. A return to a more balanced pattern of global growth should help to relieve pressure on the U.S. current account. It is far better to achieve adjustment through faster growth abroad than low growth in the United States. In addition, our economy's flexibility has helped us prosper over most of the past decade; this flexibility should also help boost our saving and ease the transition to lower trade and current account deficits in the future.

Thank you for your attention. I will be pleased to respond to your questions.