Could Bush's Tax Cut Spark a Trade Crisis?
In the '80s and early '90s, many economists worried that huge U.S. government budget deficits were exacerbating a large trade deficit. The notion was that government spending helped drive up demand for imports, thus putting the U.S. into a deep international hole.
In recent years, as the federal budget deficit disappeared and a surplus developed, the theory disappeared. But the trade deficit has grown larger and larger. Now, Lester C. Thurow, the well-known economics professor at the Massachusetts Institute of Technology and former Dean of the Sloan School, is reviving that analysis. Thurow asserts that President-elect George W. Bush's tax-cut plan could trigger a foreign trade crisis -- one with severe consequences.
Thurow issued his dire warning on Jan. 5 at a New Orleans policy forum held in conjunction with the annual meeting of the American Economic Assn. He argues that the Bush tax plan could add about $200 billion per year to the already unsustainable deficit in the nation's current account, a measure that includes the balance on trade and international investment. "If you could think of anything that might cause a [trade] crisis, this comes pretty close to it," Thurow said.
The Bush plan and foreign trade are linked because funds from abroad will be needed to sustain U.S. investment when taxes fall, Thurow argues in a paper distributed at the forum. Since the nation's personal savings rate is near zero, tax cuts are expected to turn money that the government would have saved into dollars that consumers will spend. In an economy already spending approximately $400 billion per year above production levels, that means additional foreign capital will be needed to substitute for the lost savings. If that doesn't happen, investment will fall.
Thurow says it's unreasonable to expect the rest of the world to provide the needed funds, especially now that stock market values have fallen. The result: The current slowdown would worsen, making it even harder to attract foreign and domestic funds for investment. And because the nation's trade imbalance is already great, he sees no soft-landing scenario for the resulting downturn. "Given the tax-cut plans now being floated in the newspapers, I would suggest the Bush Administration begin immediate contingency planning for a foreign trade crisis," argues Thurow.
Some economists dismiss Thurow's arguments as unfounded. John B. Taylor, a Stanford University economics professor and Bush adviser, rejects Thurow's analysis: In an interview in New Orleans, Taylor argued that the experience of the past few years reveals a weak link between budgets and trade. If the recent budget surpluses haven't eased the trade problem, then there's no reason to suggest trade will worsen as consumers get back some of this surplus, he suggested. The tax cut "is not a factor in the trade deficit," concluded Taylor.
WRONG, BUT NOT TOTALLY.
Still other economists view the Thurow thesis as too simplistic. Edward Leamer, professor of economics and director of the UCLA Anderson Forecast, says the connection between the tax plan and trade is more complex than Thurow indicates. Says Leamer: "I wouldn't instinctively link the tax cut with an external crisis."
Leamer and other economists do agree that Thurow is right to focus attention on the threat posed by the trade gap. Although a few scholars have trumpeted the danger, particularly Wynne Godley, of the Jerome Levy Economics Institute, the issue was ignored during the Presidential election campaign. Even if tax cuts don't provoke a crisis, trade remains an economic problem "along the lines that Thurow identifies," Leamer says.
Warns David Wyss, chief economist at Standard & Poor's, a unit of BusinessWeek's publisher, McGraw-Hill: "You get trade deficits this large in almost any country and you have a foreign-exchange crisis." The trade gap needs to be adjusted, he says, adding: "It's surprising we've been able to get away with it this long." People have grown used to thinking of foreign-exchange crises as economic disasters that happen only to small developing countries. But if Thurow is right, it could happen to the U.S. as well.
By Charles Whalen in New York
Edited by Douglas Harbrecht