Summary of Remarks of Franklin L. Lavin
Under Secretary of Commerce for International Trade
Foreign Policy Research Institute
“Political Dimension of International Trade”
Philadelphia, PA
June 7, 2006

As Prepared

Introduction

I would like to talk to you today about how international trade and international commerce relate to foreign policy. In particular, I’d like to focus on how trade shapes the international position of the United States, and how America’s international position shapes trade policy.

To give the discussion some perspective, it is important to remember that the volume of U.S. exports to the world in the last 50 years has gone up 60-fold, from $17 billion to about $1.2 trillion. This is the direct result of trade liberalization and the three trends I see as transforming our era.

There has developed a strong consensus about the benefits of trade liberalization among leadership and policy makers across the political and philosophical spectrum. Indeed, one would be hard-pressed to find an issue over which there is a stronger consensus. Yet there is a paradox, because this unanimity breaks down when you survey general public and review congressional votes, so while there is strong support for continued trade liberalization, there is also opposition to it from different quarters that is significant. I will now take this premise and put it in the context of three elements that will define and shape the architecture of our economy for this half of the 21st century.

Three Trends

When historians and economists look back at our era, these three trends will define it:

The first trend is that there are three billion new customers and competitors for American businesses to engage with. This is a result of our ability to do business in countries that have not been active in international trade in a significant way with the United States in recent times. The most important of these is China, but there is also India, the countries of Central Europe that were part of the Soviet sphere, many countries in Southeast Asia, and others in Latin America. If you add them up, this is about three billion people, or almost half of the world’s population.

This is a one-time, seismic jolt to the architecture of the global economy. We are not going to see such a massive economic shift again in this era.

This movement started when China began to liberalize in 1978 –1979, and developed more momentum when the Soviet sphere disappeared in the early 1990’s. This had a number of implications for the United States. For the first time, a truly global market began to form 20 to 30 years ago. There was international trade and international economic activity before this time, of course, but it was in large part limited to what we now call the developed economies of the OECD, mainly along old historical corridor routes.

The U.S. was not a very open economy 50 years ago when our imports were about three percent of our GDP. As a nation, we really weren’t interested in international trade and most businesses did not face international competition and thought they never would. Today, imports account for 13 percent of our GDP, with companies thinking, planning and operating with the prospect of international competition in mind, even if they are not facing it at the moment.

To give some context to this burgeoning growth in trade: in 2005, Wal-Mart imported $18 billion from China. This is more than all of the products the United States imported from India or Italy. This one American company has a trade program greater than the entire economies of some of our major trading partners.

The second major trend is the death of distance.

Let me give you some figures on cell phones and internet connectivity to illustrate how communications has compacted and connected the world. Today in the U.S. there are about 200 million internet hookups. In China there are about 111 million, with 50 million in India. There are more than 335 million cell phones in China, with 194 million in the U.S. Cell phones, e-mail, the internet, web pages, jet airplanes and a host of other connections are making a difference in terms of how people understand, develop relationships, and do business with one another.

Combine this connectivity with the trend toward trade liberalization. At the first GATT round in 1948, the average rate of tariffs in the United States was 40 percent. Now we are at four percent. GATT, WTO, free trade agreements, and other agreements have reduced barriers to trade and cross border economic activity. These, combined with technological changes, have led to a death of distance.

One company that has helped shrink the world is Federal Express. Of their total revenues last year, 37 percent were from international shipping. While domestic revenues were growing at seven percent, their international revenue growth is around 20 percent. When we look at what has happened with global management structures, air services, supply chains, and express delivery of supply parts, all of them are becoming integrated across borders. This makes it easier and easier for companies to move and adapt to changing environments.

The third phenomenon is the rise of the service sector.

This is frequently described as implying that there is a related decline of the manufacturing sector in the U.S. By some measurements, such as manufacturing’s contribution to the US GDP, or employment in manufacturing in the U.S., this might be accurate.

On the other hand, manufacturing has not declined in absolute terms in the U.S. The dollar value of manufactured goods produced in the United States has continued to grow, and manufacturing remains central to America’s economic success, yet we are increasingly becoming a service economy.

This rise of the service economy is reshaping our social and political realities in ways we have not fully come to terms with. For example, manufacturing tends to be much more geographically specific. People have to come together to partake in certain tasks. Raw material comes in and the final product goes out. The service sector doesn’t have the limitations that manufacturing has in this respect: the service sector’s inputs can be disaggregated with different activities taking place in different locations.

An example of this desegregation of inputs in a service-based business would be an accounting firm with multiple nodes that create value. They can outsource work and move data across borders very easily. Normal activities like bookkeeping or auditing can be done in places like India, while other activities may take place in Philadelphia for example, with the final customer contact in London. Further, services allow for greater labor flexibility and cross border activity than manufacturing usually does. People can enter and leave employment in the accounting firm on a regular basis, and work on a part time or full time basis. Accountants can be employees or consultants, and accounting activities can be ramped up or down quickly as needed. Although these kinds of efficiencies can take place in manufacturing, it is easier to do in the service sector.

Other results of the shift from manufacturing to services have to do with job security, sense of self, and a sense of stability in people’s lives. Because services don’t have the same kind of boundaries as manufacturing, and because there has been an expectation of not having to make transitions as often or as quickly as is necessary today, some people in some professions are less able to make these kind of changes. That is one reason why some people are concerned about, or even against, trade liberalization.

Consequential Effects of Trade Competitiveness

One effect of an increasingly globalized economy is the magnification effect. This is when the internationalization of an economy magnifies a company’s competitive position. If the company was already essentially competitive internationally, now it has a platform that allows it to compete across the entire international economic system. This ability to compete globally magnifies its potential- for new customers, new business and greater profits.

Some say that the result of globalization is a stark division between the winners and the losers. In my mind this is not fully accurate because it misses a very important point. The element that is missing is that there is the ability to improve. There is a period of time where strategies that can be implemented and a company can get its act together. That time commences at the first break of bad news, the time when foreign competition is beginning to take market share. Then, you can slowly figure things out and turn things around.

The magnification effect works on a national, industry, and an individual business basis, but it also works when you look at the competitiveness of individuals within a rapidly changing society. If you accept the thesis about the dislocation that comes from internationalization and its magnification effect, then consider its impact on employment based on education levels in the U.S. workforce.

When the U.S. economy had a 4.6 percent unemployment rate last month, the rate for college graduates was 2.2 percent, which is considered full employment. When we look at high school graduates, the unemployment rate was 4.2 percent, which is still pretty good. For high school dropouts, it goes up to seven percent. The lesson is that, for whatever set of reasons, if you don’t get your high school diploma, watch out because the price you will pay for that deficiency is much higher than it has been in the past. This is because if work requires semi-skilled or unskilled labor, that can be found cheaply in Mexico or in China. This puts unskilled labor in a directly disadvantageous position. This is one of the more striking examples of the magnification effect on an individual level.

Another point is that in a seamless, integrated and globalized world there is a shift in power from what is called in game theory the “collaborators” to the “disruptors.”

A disruptor’s power is enhanced in a globalized economy. If the world economy depends on a seamless cross border movement of goods, finances, people, and ideas, disrupting that movement causes a great deal of problems. There is a heightened temptation to be a disruptor because those that cause these disruptions gain stature. Structural threats like burglary or terrorism can cause tremendous problems by shutting down international economics. On another level, the rise of the populist left in this hemisphere can also cause disproportionate disruptions.

Conclusion

I speak in a lot of countries that have free trade agreements with the United States. Sometimes these economies are underperforming, and people are mystified as to what happened. “We did what we were supposed to do. You told us this would work. We worked it through. We got it. So why isn’t our economy performing?”

I tell them that a free trade agreement isn’t the finish line; it’s the starting line. A free trade agreement is not a magic wand. With a free trade agreement one element of their economic development has been fixed. If the rest of the economy has impediments such as corruption, bad policy choices, or mismanagement, they aren’t going to be able to fully take advantage of it.

Market-based economics and open economic systems should be encouraged, and not just because of the moral argument that we want our own society to be successful. We want hundreds of millions of people in China to move out of poverty. We want societies outside the United States to have hospitals, universities, and jobs. We also want to encourage market liberalization because it strengthens the U.S. economy, and a strong economy is a necessary condition for the U.S. to continue to have a leading international role. Only through leadership will we be able to shape a consensus on trade as a mechanism for connecting with other countries.

In a practical sense, that is why I am here: we need your help and your commitment to get behind and support international trade. That means keeping on a path of liberalization. We have to keep on a course of moving toward a more open trading system, even though we know that there will be some anxiety and political tension as we do it.

Not every step you take is going to enjoy applause. To my mind, this is the challenge of leadership: to do things because they are the right things to do for our country over the long run.