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The following OECD assessment and recommendations summarise Chapter 4 of the Economic Survey of the United States 2005 published on 27 October 2005.
What is the best strategy to address current account imbalances?
When the Committee last met to discuss the US economy in early 2004, the US current account deficit was below 5% of GDP and projected to stay in that range. However, the deterioration in the external accounts has continued, and the shortfall has now gone well beyond 6% of GDP, the largest in the nation’s history. At the same time, net external debt reached some $2½ trillion or 22% of GDP at the end of 2004. Few other OECD countries have ever managed to sustain imbalances of that magnitude without eventually experiencing sharp downward pressure on the value of their currencies. Nevertheless, not only has the dollar’s depreciation since 2002 been quite gradual, but this year it has reversed part of the decline, setting the stage for a further widening of the deficit in years to come. The reasons for this unexpected strength are to be found on the capital flows side of the ledger: global investors perceive the United States to be a more attractive investment location than most others, although they have preferred their financial positions to take the form of interest bearing securities rather than equities and much has come from foreign public entities such as central banks seeking to mitigate upward pressure on their exchange rates. How likely it is that such net inflows will continue to grow in line with US residents’ strong demand for imported goods and services is impossible to predict with any degree of certainty. But the political and economic risks inherent in the current constellation of trade balances and currency values are great, both to the US and to the wider global economy: a disorderly adjustment, involving substantial strains in domestic financial markets, cannot be ruled out.
There is accordingly a natural urge to do something to lower the deficit. The problem is that anything that could be done that would directly target the current account would have heavy costs on economic performance by reducing growth at home and abroad. Protectionist measures to restrict imports, for example, would merely squeeze out exports too by putting upward pressure on the dollar and eliciting foreign retaliatory action. There is a legitimate question as to whether, in the context of a floating exchange rate and unrestricted capital flows, a strategy of benign neglect – leaving adjustment to the workings of the markets – would not be optimal. Nevertheless, there are actions that should be taken both by the United States and other nations for other reasons that would probably also lessen the US current account deficit, thereby easing the pressures on the system. Countries with weak economic performance and/or excess saving should seek faster growth of domestic demand, while those lacking exchange rate flexibility should move steadily toward that goal. As for the United States, there are measures that could be implemented to boost national saving that would be appropriate in their own right:
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As argued above, it would be prudent for the federal government to move more resolutely than is currently planned to bring down the federal budget deficit, even if the benefits for the external imbalance are far less than one for one.
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As also argued above, one of the key objectives of tax reform should be to remove the most obvious anti saving biases in the tax code, whether or not income is retained as the primary basis for taxation. The most egregious is the deductibility of mortgage interest payments and the availability of that deduction for private consumption expenditure. Broadening the tax base in this way would eliminate the advantage currently given to residential investments over other forms of capital and, if implemented gradually, withdraw some of the current frothiness in housing markets. Health care spending is also given an inappropriate fillip by the unrestricted exclusion of employer paid health insurance premiums: this should be capped.
Another set of relevant policy lessons derives from a recognition that whenever the trade deficit comes down, and by whatever means, the burden on economic agents will be lessened by enhancing the economy’s flexibility in re allocating resources from non tradable to tradable goods sectors. Fortunately, the evidence is strong that the structure of the US economy does shift comparatively smoothly between these types of industries in response to currency changes. No doubt this is at least partly attributable to the long list of structural policy settings where the United States is a leader in performance enhancing reforms. First among these features is a high labour market adjustment capacity by international comparison. Indeed, there are signs that its resilience to local or regional shocks improved sharply at the end of the 1980s. In addition, its product market regulations are also among the most conducive to competitive outcomes. Nevertheless, there are a few areas where the United States does not rank highly and could clearly do better:
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The education system is still underperforming, at least at the compulsory level, and the lack of skills is already causing adjustment problems for many individual workers. While enrolments are increasing, average attainment is falling, in contrast to many other Member countries. More disturbing is the fact that quality shows no signs of improvement: standardised (PISA) test results show modest deterioration from 2000 to 2003. If the No Child Left Behind Act does not manage to turn things around, further reflection as to what ails the US system will be called for.
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Resources are held for too long in shrinking firms and industries due to the inefficiencies of the bankruptcy law. Chapter 11 of the code is not only costly, but it is biased against liquidation. The upshot is that too few firms emerge from the process as successful entities. At a minimum the time spent under court protection should be limited.
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The agriculture sector is also retaining a small amount of superfluous resources owing to public support. It is to be hoped that a successful completion of the Doha Round will involve the reduction of such assistance worldwide.
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Exporters are likely to become increasingly constrained by a lack of transport infrastructure, especially port capacity. The authorities should be urgently planning upgrades.
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Return to the Economic Survey of the United States 2005
A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.
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For further information please contact the United States Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by Hannes Suppanz and Thomas Laubach under the supervision of Peter Jarrett.
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