A Plug for a Leaky Economy
Can foreign trade keep the U.S. economy afloat? So far it's doing a yeoman's job, especially in support of manufacturing and corporate profits. Through the end of last year export growth showed few signs of cooling, despite some emerging softness in a few overseas markets. At the same time, the ongoing slowdown in U.S. demand is stemming the tide of imports. In fact, December's sharply narrower trade deficit means last quarter's puny economic growth of only 0.6% might even be revised a tick higher, instead of lower or into negative territory as some had feared.
In 2008 the outlook depends crucially on how much downward pull the housing slump and credit crunch will have on domestic spending. The full extent of those drags isn't known yet. Both business and consumer confidence plunged in January, but the data on real activity still portray an economy dead in the water, not sinking. January retail sales and industrial production were weak but holding up.
The buoyancy from foreign trade is helping. Exports rose strongly in December, as imports dropped, resulting in a sharp narrowing in the monthly trade deficit. Last quarter's shrinking gap means trade again contributed positively to economic growth. The real, or inflation-adjusted, deficit by yearend had shrunk by some 20% from late 2005 to the smallest gap in four years. Last year that narrowing accelerated, accounting for about 0.6 percentage points of the economy's 2.2% annual growth rate.
The deficit will continue to narrow. Imports have already slowed notably, and the weakness in U.S. demand has further to run. The big question is exports: How much will the U.S. slowdown depress overseas economies and the demand for U.S.-made products? Since the credit turmoil began last August, real U.S. imports of nonpetroleum goods have fallen 3.7%, the largest five-month drop since the 2001 recession. As a result, global industrial activity is showing signs of cooling, especially in Europe and Britain. Canada and Mexico are getting hit, too.
However, while all economies will feel the U.S. slowdown, the impact will vary. Importantly, emerging-market economies, which contribute almost half of world growth, will be less vulnerable to U.S. credit problems compared with Europe. Also, Asia will derive much of its growth from China. Japan, for example, posted a surprisingly strong 3.7% annual rate of economic growth last quarter, even though exports to the U.S. fell 4% from a year ago. Overall, Japanese exports rose nearly 11%, with double-digit gains to China and all of Asia.
The plus for the U.S. is that emerging economies account for about half of U.S. exports, and they are spending heavily on infrastructure, which plays to a U.S. strength: Not only do U.S. manufacturers now export nearly half of their output, but capital goods and industrial materials account for almost half of all shipments.
The benefits are already evident. Despite the slower pace of U.S. consumer spending, manufacturing is not weakening the way it typically does when the economy is falling into a recession. Factory production held steady in January after small gains in November and December. This pattern suggests the effort to cut business inventories, which was such a huge drag on economic growth last quarter, is beginning to run its course. That would lessen the chances that big cutbacks in output will be necessary in coming months.
Manufacturers are not the only beneficiaries of global growth. U.S. exports of services, such as financial, accounting, legal, and other business services, rose strongly in the fourth quarter. Over the past five years, the trade surplus in services has doubled.
In the coming year the two biggest risks to global growth, and thus U.S. exports, are a severe slump in U.S. spending and an abrupt downshift of growth in China as its government tries to rein in an overheated economy. But barring that, trade will continue to support U.S. growth by providing an offset to softer domestic demand.