Why The Trade Deficit May Not Loom So Large

Sales by foreign units of U.S. companies brighten the outlook

By Laura D'Andrea Tyson

In 2003, after more than a decade of persistent and sizable increases, the U.S. trade deficit hit a high of 5% of gross domestic product. In March of this year the deficit reached $46 billion, shattering previous monthly peaks and putting the economy on course for another annual record. Since the trade imbalance is the most widely watched -- and politically sensitive -- indicator of America's international economic position, its unexpected March surge renewed selling pressure on the dollar and fueled protectionist sentiments. Yet the trade deficit is a misleading gauge of the nation's economic health.

Discussions of trade imbalances are often cast in "us-vs.-them" terms. According to popular rhetoric, if we export more than we import, we live within our means, and our companies and workers are beating their foreign counterparts. If we import more than we export, we spend more than we produce, and our companies and workers lose to foreign competitors. But who are we? As multinational companies expand their global production, sales, and sourcing networks, trade statistics give a deceptive answer.

U.S.-BASED MULTINATIONALS account for 25% of American GDP and 20% of its employment. Despite their growing foreign operations, they remain decidedly American. In 2001, 77% of the global production, 80% of the global capital spending, and 74% of the global employment of U.S. multinationals occurred at home. From 1991 to 2001, these companies added five jobs in the U.S. for every three overseas.

U.S. multinationals are also significant traders. In 2001, they accounted for about 58% of U.S. merchandise exports and about 38% of U.S. merchandise imports. Trade within U.S. multinationals -- between parents and their foreign affiliates -- accounted for a quarter of U.S. exports and 16% of U.S. imports. Such trade -- and the bilateral imbalances it generates -- should be understood not only as a reflection of the state of the U.S. economy but also as a manifestation of the economic decisions of individual U.S. companies.

The nation's trade statistics also overlook the reality that most U.S. multinationals rely more on their own overseas operations to sell goods and services around the world than on traditional trade channels. According to Rebecca McCaughrin, a Morgan Stanley (MWD ) economist, global sales through foreign affiliates were roughly equal to total U.S. exports in 1990. In 2002, these foreign affiliate sales totaled $17.7 trillion, more than double global exports of about $8 trillion. Now the global sales of the foreign affiliates of U.S. multinationals are about three times as large as total U.S. exports. Indeed, adding these sales to U.S. exports would reduce the U.S. trade imbalance by almost a full percentage point of GDP. Since U.S. multinationals are largely "us," that makes sense. We should consider reporting our trade data that way in addition to our conventional method.

Contrary to popular belief, U.S. multinationals continue to set up foreign operations not primarily to serve the U.S. market from low-wage production platforms but rather to serve overseas markets from local operations. In fact high-wage countries, such as those in Europe, accounted for more than 60% of the employment of the foreign affiliates of U.S. multinationals in 2001, and nearly two-thirds of these affiliates' sales went to local customers. Some 24% went to other foreign markets. Only 11% of affiliate sales went to U.S. customers.

So far, at least, the pattern of foreign direct investment by U.S. companies reveals a mostly make-where-you-sell rule, and affluent countries offer the most attractive sales opportunities. That could change soon, though, with the rapid development of China.

What do the facts about U.S. multinationals imply for American economic policy? First, the goal of policy should be to enhance the allure of the U.S. as a production location. A recent report by the Electronic Industries Alliance contains many sound proposals, including fast-track visa approval and broadening trade-adjustment assistance to all workers. Second, the primary goal of U.S. trade policy should be to make sure that companies based in the U.S. have access to foreign markets on fair terms -- companies should not be forced to produce in foreign markets in order to sell in them. Third, the U.S. tax code should be adjusted to correct for the fact that over the past two decades the U.S. has become a less attractive production location from a corporate tax perspective. Finally, national trade statistics should be reported in ways that better capture the realities and complexities of our borderless world.

Laura D'Andrea Tyson is dean of London Business School.

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