January 2003
Federal Reserve Bank of Dallas

Can the World Economy Give Ours a Boost?

Right now the U.S. is moving through a slow economic upturn. A common question is whether we’re going to see a surge in foreign economies that might pave the way for more growth here. This presentation discusses what is happening to our principal trading partners and how that might affect us.

Trade Plays a Smaller Role in Our Economy Than in Almost Any Other
We often hear how world economic events affect the United States. However, the U.S. does not really trade much relative to its size. By trade, here I refer to total exports of goods and services plus total imports. We want to sell what we can produce most efficiently and buy what others produce most efficiently. Total U.S. trade as a percentage of gross product comes in at 24 percent. As a share of gross domestic product, only five countries trade less than we do. They are the Sudan with 23 percent of GDP, Brazil with 22 percent, Argentina with 21, Japan with 18, and Myanmar at 1 percent. In absolute dollar terms the United States does trade a lot. Our total trade is about 2½ trillion dollars a year. But as a share of output, our 24 percent of GDP in trade compares with France’s 50 percent, Germany’s 58 percent, Ireland’s 161 percent and Singapore’s 313 percent. Trade doesn’t make us or break us the way it does Singapore or Ireland.

The way things look across the rest of the world now, if we want much growth it will have to come from us. When the U.S. economy slowed, so did economies elsewhere. Most of our principal trading partners are growing below trend. Their imports from us aren’t rising much, nor are our imports from them. Except for Japan, most larger Asian economies are growing faster than the U.S., but Japan is far larger than other Asian economies. Canada is growing, but most of the larger Latin American economies are showing little expansion, if any. No major European economy is growing as rapidly as the United States.

Principal U.S. Trading Partners
Since the focus of this discussion is how other countries may affect our economy, it is useful to identify our principal trading partners. Figure 1 gives a broad breakdown. Our principal trading partner is Canada. Second is Mexico. Asia is obviously extremely important. Japan and mainland China are usually our third and fourth largest trading partners. Europe is clearly significant. Next come the non-NAFTA western hemisphere countries. Of particular note is how small our trade is with either the Middle East or Africa. With respect to how other countries may affect our growth, much economic literature suggests that the more countries trade, the more alike their business cycles become. Figure 2 presents indexes of trade as a percentage of GDP starting in 1965 for nine countries and shows how each index has grown since then. Note that these are indices, so they don’t show the actual percentages of trade’s share of GDP. They only show how much that share has changed from the 1965 index value of 100. Japan’s ratio has not changed much. Singapore’s has increased somewhat, but its ratio always was huge. The rest of these countries have increased their trade as a share of gross domestic product between 1965 and 2001 by at least fifty percent (that’s what the 150 means on this figure). Note that Mexico and South Korea have increased their trade share of GDP by more than 200 percent over this period. Let me re-emphasize that as the importance of trade grows, so does the correlation of business cycles. Note that trade as a share of U.S. GDP has increased from an index value of 100 in 1965 to an index value of 250 in the year 2001. Recall that our GDP itself has grown a great deal over this period. No wonder other countries’ business cycles move more with ours than they used to. No wonder we have to create our own recovery.

In considering factors of economic importance across the world, I shall begin with a consideration of the United States’ top thirty trading partners. Figure 3 breaks down the United States’ top thirty trading partners by four categories: Asia, Latin America, Europe, and Other. Note that all but four of our top thirty trading partners are in Asia, Latin America, or Europe. The largest trading partner in the Other category is Canada. Because of the importance of Asia, Latin America and Europe, the rest of this discussion will focus on those three regions, with occasional references to Canada. The United States and Canada are very heavily economically integrated.

Asia
With respect to the three large geographic regions that are the focus of this discussion, I shall begin with Asia. Figure 4 highlights the Asian economies among our top thirty trading partners and lists them. Five of our top ten trading partners are Asian countries: Japan, China, South Korea, Taiwan and Malaysia.

One of the most important details of the Asian economies is not only that they are growing, but that most of them are growing fairly rapidly—considering the economic circumstances of the rest of the world. Figure 5 shows indexed gross domestic product since 1996 for the U.S and the five Asian countries that are amongst our top ten trading partners—that is, Japan, China, South Korea, Taiwan and Malaysia. While Japan’s slow economy is receiving a good deal of attention, the other four Asian economies depicted here grew faster than the U.S. between the third quarter of 2001 and the third quarter of 2002—as best we can tell from the statistics we receive. One problem is that these countries are heavily oriented toward international trade and if the rest of the world does not pick up, their growth may not continue as fast. Particularly in the cases of Korea and Taiwan, their own domestic consumption growth has been carrying them forward for long enough that its sustainability is being called into question.

Nevertheless, there is some evidence of a basis for continued growth in non-Japan Asia overall, provided demand holds up. Figure 6 shows net private capital flows to seven Asian emerging market economies: China, India, Indonesia, South Korea, Malaysia, Philippines and Thailand from 1992 to 2001. The figure shows that capital flows now are not nearly as large as those of the mid-1990s. Nevertheless, there has been a significant pickup in international flows of capital to Asia since the Asia crisis of 1997 and the continued problems in 1998. Since this figure depicts international capital flows, however, it is important to realize that a great deal of investment in Asia is domestically funded. China has shown large increases 0in gross fixed capital investment, including big increases over the last year. Indeed, of our five largest Asian trading partners, only Japan has not shown an increase in gross fixed capital investment over the last year. This contrasts markedly with both Europe’s and Latin America’s recent investment experience, in which our principal trading partners’ gross fixed capital investment have generally declined over the last year. More investment now can mean more capacity and so more output in the future.

In considering Asia nowadays, some of the most important details involve China. Something most Americans seem not to have noticed is that 2002 was the first year in which China’s exports to the United States (at least when they are lumped in with Hong Kong’s) exceeded Japan’s exports to us (Figure 7). Much of the value of what China ships to the United States contains inputs manufactured in other countries and then assembled in China, but this shift in trade importance is nevertheless an historic event. Statistics like these tell us something significant not only about China’s growing economic power, but perhaps about the political power that can come with it. In 2002 China showed another kind of trade leadership as well. China proposed a free trade pact between itself and the ten ASEAN countries and signed a formal framework agreement to start the negotiations.

Another example of China’s rising importance appears in Figure 8, which depicts China’s gross domestic product as a percentage of Japan’s gross domestic product starting in 1980. It should be emphasized that this figure depicts overall gross domestic product and not GDP per capita. Note that China’s GDP still has not reached one-fourth of Japan’s. In fact, the combined gross national products of China, India, South Korea, Taiwan, Thailand, Malaysia and the Philippines are still less than two-thirds of Japan’s GDP. Even so, by this measure, China’s economic importance relative to Japan’s has nearly quadrupled in a little more than two decades.

Latin America
I now move to Latin America, a more troubled region than Asia. Since an important focus of this presentation is U.S. links to the rest of the world, I should note that five Latin American countries figure among our top thirty trading partners. Figure 9 highlights those countries in green. Mexico is our number two trading partner. Brazil is number fifteen. Venezuela, Colombia and the Dominican Republic are also in the top thirty and there are seven more Latin American countries amongst our top fifty trading partners.

Nation by nation, the Latin American economic circumstances range from slow growth to depression. Figure 10 offers indices of gross domestic product starting in 1996 for Argentina, Brazil, Chile, Colombia, Mexico and Venezuela, and for the United States and Canada. Recall that a similar figure was presented for Asia (Figure 5). Most Asian countries were growing faster than the U.S., but the Latin American countries are not. Between the third quarter of 2001 and the third quarter of 2002, every one of the Latin American economies depicted here grew more slowly than the United States. Argentina and Venezuela had large absolute declines. Note also that the Canadians have lately outstripped U.S. growth. As for Latin America, the World Bank estimates that 2002 was economically the worst year since 1983—back in what came to be called Latin America’s lost decade. When Latin American economies are weak, so are their purchases of our output. One of the motivations for the Brady Plan, in which U.S. Treasury Secretary Nicholas Brady created a debt resolution program to pull Latin American countries out of their 1980s crisis, was that their economic troubles had depressed their demand for U.S. products. In Figure 10, the economies of Argentina, Colombia and Venezuela have shown some recent upturns but their outputs are well below where they were four years ago, when investor fears over the 1998 Russian crisis began to slam Latin American capital markets. Despite some problems that can be seen in Figure 10, Chile and Mexico have both improved since then.

Besides gross domestic product, some other Latin American comparisons with Asia may be useful. Figure 6 presented Asian emerging market net international private capital inflows. The figure was intended to suggest something about increases in productive capacity. Latin America’s recent capital flow experience offers less evidence of such increases. Figure 11 presents the sum of private international capital flows for nine Latin American countries: Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay and Venezuela. International private capital flows have fallen by more than two-thirds in Latin America in the wake of the Russian 1998 financial crisis. Markets are discomfited about Argentina’s fiscal crisis. Some analysts have expressed concerns about Brazil. Political events in Venezuela have shocked markets. But regardless of what causes or discourages it, investment is an important foundation of economic growth. Figure 11 suggests that Latin America’s opportunities for growth are diminished.

When credit is available in Latin America, it can be very expensive in the most troubled countries. Figure 12 shows sovereign dollar-denominated debt interest rate spreads over U.S. Treasury rates for Argentina, Brazil, Colombia, Mexico, and Venezuela. Obviously Mexico doesn’t have to pay a lot more than the United States for credit. However, Venezuela has to pay more than ten percentage points over U.S. rates and Brazil pays even more than that. Argentina has to pay over 60 percentage points more—that is, more than three times as high as the typical American consumer’s credit card.

Supply problems in Latin American can affect the United States. Figure 13 tracks the price of West Texas Intermediate crude oil for a very short period: last November through early January. Last December 2nd, groups dissatisfied with Venezuelan president Hugo Chavez declared a general strike. By mid-December ninety percent of the nation’s productive capacity was shut down. Venezuela’s principal export, petroleum, was not leaving the country and therefore was not arriving here. As a result, over the month of December, U.S. oil prices rose from 26 dollars per barrel to more than 32. It is hard to separate the effects of what went on in Venezuela from the effects of concerns about a Middle Eastern conflict. All that Figure 13 really shows us is an example of a so-called terms of trade shock, in which there is a shift in the relation of the cost of things we sell abroad to the cost of things we buy from overseas, such as Venezuelan oil. However, on the night of December 12, strikers passed resolutions on behalf of combative resistance in contrast to the passive resistance by which the strike had been described up to then. It is interesting to see the sudden price rise right at that time. When terms of trade shocks persist, they can change the outlook for everybody.

Overall what we are seeing in Latin America is policy fragmentation. Ten years ago market reforms were sweeping the region. These days, some nations are market-oriented and some are not. Mexico has stuck to its market reforms. Its increased trade with the United States has led to cyclical behavior that is very much like ours. Venezuela turned away from market reforms, electing an anti-market ex-colonel who has brought his country into political and economic turmoil. In 2002, Brazil and Ecuador also elected presidents with less market orientation than had been typical in the recent past. Argentina remains in crisis but has at least bottomed out for now, unless further debt problems make things even worse this spring.

Europe
Figure 14 depicts the United States’ top thirty trading partners, highlighting Europe. Among our top ten trading partners, Germany is number five, the United Kingdom is sixth and France is ninth. Italy, Ireland, Belgium and Switzerland are all in the top twenty.

If Asia is growing fast and Latin America is very sluggish, Europe is somewhere in the middle—but at the low end of the middle. For the first three quarters of 2002 the eurozone overall—by which I mean countries that use the euro as their currency—actually grew slower than Japan. Figure 15 compares U.S. growth with Europe’s since 1996. The United States is on the top, with more growth than France, Germany, Italy or Great Britain. The U.S. has also outgrown every one of those four economies just over the last year. Many forecasts show Europe growing faster in 2003 than in 2002, but still slower than the United States.

As Figure 16 shows, not only is economic growth slow in Europe but we have seen a particularly strong drop-off in gross fixed capital investment in the fastest growing European country, Great Britain, raising questions about the viability of expansion there. On the other hand, Figure 16 does offer support for some current perceptions that the European growth leader in the near future may be France.

Right now the United States is contemplating another round of fiscal pump-priming even though our growth is stronger than any of the larger European economies. Eurozone economies can’t do much fiscal pump-priming. As part of their agreement to create a euro zone, they have pledged not to run fiscal deficits larger than 3 percent of GDP. Presently German and Portugal are over their limits. France is very close to its deficit limit. Meanwhile, the long-time European structural problems remain. The difficulty of firing people makes hiring difficult, and the two together make labor force adjustments to increases in demand in one industry and decreases in demand in another very hard.

Conclusion
Having discussed the regions from which almost all of our principal trading partners come, it should be re-emphasized that if we want a pickup in growth, it looks as if we’ll have to do the picking up. The increase in economic integration over the last few decades means that other countries tend to weaken when we do. Not surprisingly, then, most countries are not growing any faster than we are and many are doing worse. Of course this also means that our own pickup will have a compounding effect. When our growth accelerates so will that of our trading partners. Behind these patterns, possible problems with terms of trade shocks—shocks to the relation between prices of what the United States sells and what it buys—present a risk to watch for.

—William C. Gruben

About In Depth This article is based on a presentation by William C. Gruben, director for the Center for Latin American Economics and vice president, in the Research Department of the Federal Reserve Bank of Dallas. The views expressed are those of the authors and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or the Federal Reserve System.