Deficits and globalization

Does globalization help or hurt? And do current account deficits matter? In recently released paper looking specifically at the link between multinational corporations and the current account deficit, the McKinsey Global Institute clearly coming down on the “help” side. And their analysis is that the deficit is nothing to worry about. As reported in WSJ.com – U.S. Multinationals Reap Overseas Bounty:

In a recent paper on the subject, analysts at McKinsey & Co. conclude record U.S. trade deficits aren’t as threatening as they appear, because they are being driven in part by increasingly profitable U.S. companies, producing in places like China, Mexico and India, and shipping their goods and services back to the U.S. It concluded overseas profits account for $2.7 trillion in stock-market capitalization and those profits are helping to promote investments in new technologies and jobs abroad and back home.
“Far from reflecting the weakness of the U.S. economy, at least a third of the current-account deficit is actually evidence of its strength,” the report says. “The U.S. acts as the world’s financial intermediary, gathering up and allocating global savings to companies that then invest them around the world,” it later concludes.
McKinsey argues the important role of U.S. multinationals means today’s record trade deficits — a source of so much uncertainty about the economic outlook — could last much longer than many economists expect.
The U.S. current-account deficit hit 6.3% of gross domestic product in 2004, a level that has triggered financial crises in other countries in the past. Classic economic theory holds the trade gap should make foreigners less willing to hold U.S. assets. That, in turn, should push down the value of the dollar, making U.S. products more competitive abroad and making foreign products more expensive at home. Theory holds this would ultimately correct the trade imbalance.
But McKinsey argues that labor is so much cheaper in countries like China and India that U.S. multinationals are unlikely to alter their international strategy anytime soon, meaning the old corrective mechanisms won’t work the way they used to. “For at least the next decade, we would expect foreign investment by U.S. multinationals to go on adding to the current account deficit as it is currently measured,” McKinsey says.
Last week, Goldman Sachs fired back at McKinsey’s conclusions about the U.S. economy’s place on the global stage. Edward McKelvey, a senior economist at Goldman, argues that it doesn’t matter who is driving the deficit wider. The end result is still that the world is awash in dollars and because of that the currency is still prone to sharp — and potentially destabilizing — depreciation.
For now at least, McKinsey’s rosy view of the world is holding up. The current-account deficit was 25% wider in 2004 than it was in 2003 and shows no sign of letup. And while the dollar has weakened, it hasn’t touched off a much-feared financial crisis.
But Diana Farrell, director of the McKinsey Global Institute and co-author of the study on multinationals, says that doesn’t mean there aren’t pockets of truly vulnerable Americans in this process. The $2.7 trillion in stock-market capitalization created by multinational profits overseas doesn’t reach individuals who don’t own shares in these companies. These are often the same low-skilled workers most vulnerable to lose their jobs to inexpensive low-skilled workers overseas. The real worry in today’s economy, Ms. Farrell says, isn’t the current-account deficit. It is finding ways to equip and enrich those workers least prepared for the globalization of profits.

There are two comments in the above story I agree with and one that raises a concern. The comment that concerns me whether we need to worry. The WSJ story quotes the paper’s author as saying 1/3 of the current account deficit is really strength because it represents funds of US based multinational – and therefore productive investment that really isn’t from foreigners. That may well be true — I don’t know. But even if it is, it is no source of comfort. There is still the other 2/3 of our huge current account deficit to worry about. If the deficit was only one-third the size of what it is now, I would sleep easier and might be inclined to buy the argument about the US being the “financial intermediately to the world.”
The two points I agree with are: 1) that traditional macroeconomic measures will not self-correct the problem and 2) that many people are not benefiting from the increased corporate profitability.
On the first point – see my earlier posting on dueling on the dollar. Macroeconomic models assume instantaneous and seamless adjustments. It can not account for the phenomena that McKinsey report describes: labor so cheap that an extraordinarily large change would be required to alter behavior and the increasing need for companies to locate production closer to emerging new consumer markets, such as China.
On the second point, let’s first leave aside the link between profitability and stock prices, and the fact that companies rarely share their profits with their stockholders, i.e. pay dividends, any more. Most American’s — even high-earning people like sports figures, CEOs and movie stars — still get their money through earned income (wages and salaries). The Trust-Fund Society (aka Ownership Society) is still some political operative’s dream. Thus, the link between corporate profits and the economic wellbeing of most Americans is indirect at best (i.e. profitable companies stay in business and hire more workers).
And now we have the Bush Administration apparently attempting to downplay this link in order to rationalize their projections for Social Security that assume slow economic growth (and therefore lower contributions to Social Security) but high rates of return for private accounts. According to a story in The New York Times, “Social Security, Growth and Stock Returns”

In barnstorming the country over Social Security, administration officials predict that American economic growth will slow to an anemic rate of 1.9 percent as baby boomers reach retirement.
Yet as they extol the rewards of letting people invest some of their payroll taxes in personal retirement accounts, President Bush and his allies assume that stock returns will be almost as high as ever, about 6.5 percent a year after inflation.
“For the life of me, I can’t imagine why anybody would argue against young workers having the ability to invest and build a better retirement for their future,” Treasury Secretary John W. Snow said Wednesday in a speech in Bozeman, Mont.
A growing number of economists, however, including many who favor personal accounts, say Mr. Bush’s assumptions are optimistic.
Many believe that stock returns will be lower than they have been in the past, closer to 5 percent than 6.5 percent, and that returns on a balanced mix of stocks and bonds will be much lower than that.
“Most economists would argue that, over a long period of time, there is a linkage between what the stock market will return and how well the economy does,” said David Blitzer, chairman of the Standard & Poor’s index committee, which oversees the S.&P. 500 stock index.

I firmly believe that stock prices are tied to how well the overall economy does. I’m not so convinced that these factors are that strongly linked to the economic prosperity of the average American any more. A robust stock market, corporate profitability and a healthy GDP growth rate may turn out to be necessary but not sufficient conditions for economic prosperity. We have seen repeated job-less recoveries and periods of robust GDP growth with anemic income growth. As the intangible economy continues to globalize, the WSJ story highlighted the challenge: to equip and enrich those workers least prepared. Unfortunately, I worry that this category is including more and more of us.

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