Exchange Rate Flu: How Bad?

It's weakening U.S. competitiveness

Many observers tend to blame the exploding U.S. trade deficit on the economic debacle in Asia. And there's little doubt that collapsing exports to the region, along with a pickup in imports, are the main factors behind America's deteriorating trade position. But a closer look at trade statistics suggests that something more may be at work: the erosion of U.S. competitiveness due to shifting currency exchange rates.

The fact is, the accelerating decline in U.S. exports this year is evident in almost all product groups, including agricultural items, industrial materials, and capital goods. And slowdowns are apparent in shipments to Mexico, Canada, and Latin America, as well as to Asia and Eastern Europe. Even exports of services have started to decline.

A recent Labor Dept. report underscores how much currency swings have changed the global labor-cost rankings in a few short years. As recently as 1995, the U.S. was the preeminent low-cost major producer in the industrial world, with an hourly compensation rate of $17.19, well below rates of $31.85 in Germany, $23.66 in Japan, $19.34 in France, and $29.30 in Switzerland. By last year, however, Japan's costs exceeded U.S. levels by a mere 6%, and the labor-cost premium for all of Europe had shrunk from 29% to 12%.

Relative labor costs have also been dropping among other U.S. trading partners. From 1996 to 1997, compensation rates fell from 94% to 91% of U.S. levels in Canada, for example, and from an average 39% of American levels to 36% among the Asian Tiger contingent of Hong Kong, Korea, Singapore, and Taiwan. Although Europe's currencies have strengthened a bit recently, most of these nations' currencies have fallen even more against the dollar over the past year.

Currency shifts are only part of the story, of course. Economists Stephen S. Roach and Joseph P. Quinlan of Morgan Stanley Dean Witter note that U.S. industry is still far ahead of the game in the kinds of measures that foster long-term competitiveness: labor flexibility, restructuring, and technology investment. At last count in 1996, for example, the U.S. spent 4.1% of gross domestic product on information technology, vs. Japan's 2.5% and Germany's 2.1%.

The question is for the short run. Especially over the past year, the U.S. has acted as the buyer of last resort to an increasingly troubled world economy. As long as the U.S. economy was strong (and inflation-free), the widening trade gap was regarded as a positive development. The big fear now is that trade's impact could turn sharply negative if the U.S. economy slows significantly in the year ahead and other economies remain mired in recession.

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