President Clinton cited the benefits of deficit reduction in lowering interest rates, raising investment and spurring economic growth as he waged his recent battle with Congress over a five-year budget plan.
One point, however, seems to have been overlooked and it is one the president could use as he tries to persuade Congress to ratify the North American free-trade agreement: The plan to slash the deficit will enhance America's competitiveness in global markets.Mr. Clinton argued, correctly, that the reduced deficit will keep interest rates low at home, thereby raising investment spending by companies and consumer spending by households.
What he didn't say is that lower interest rates also will reduce the demand for dollars internationally, causing the dollar's value to decline toward a more competitive level. That, in turn, will help American products in international markets, leading to faster growth in exports and a reduction in the U.S. trade deficit.
Already, passage of the Clinton budget has shown results. The dollar has declined to a point where it is more in line with the yen, and to a lesser extent European currencies, than it has been in years, reflecting the foreign exchange market's faith in the plan.
One need only consider the value of the dollar and the course of the U.S. international trade position following the rapid growth of the budget deficit during the Reagan administration to understand how important these international effects can be.
Between fiscal years 1981 and 1983 the budget deficit as a share of output increased from 2.7 percent to 6.3 percent and then remained above 5 percent for the next three years. Following this shift in the deficit the dollar soared in value, appreciating by more than 30 percent through 1985, after accounting for inflation, relative to the currencies of our trading partners.
The effect on U.S. export industries was devastating, as illustrated by an unprecedented decline in the value of inflation-adjusted exports from 1981 to 1985. At the same time, imports grew rapidly, leading to a burgeoning trade deficit and the emergence of the United States as the world's greatest debtor nation.
The Clinton plan aims for a reduction in the budget deficit as a share of output from its current level of about 5 percent to about 2.7 percent by 1997. While the effects of this shift in budget policy on the value of the dollar and exports will be significant, the possibility of the dollar depreciating by as much now as it appreciated during the first half of the 1980s is low. That's because of Federal Reserve Chairman Alan Greenspan's commitment to keeping inflation in check and the improbability that the Fed will shift gears toward a much more expansionary monetary policy.
Although a depreciating dollar will likely cause a temporary rise in inflation due to higher import prices, the Fed's vigilance and a current overall consumer price inflation rate of under 3 percent should keep any rise in inflation manageable.
Furthermore, the reduction in the deficit will be carried out gradually over a five-year period, unlike the sharp increase in the deficit that occurred over a two-year period in the early 1980s. By spreading the adjustment out, the budget program helps to dampen any impulse toward severe depreciation of the dollar.
A reasonable prediction is that the proposed reduction in the deficit will generate about a 15 percent decline in the value of the dollar, adjusted for inflation, over the next four years. Assuming a response similar to that observed in the recent past, the volume of exports should rise by about 20 percent.
This would amount to approximately $90 billion measured in 1992 prices, a substantial additional stimulus for the economy which should offset the Clinton plan's domestic spending cuts and tax increases, and keep the current economic recovery moving forward.
An additional gain from increased international competitiveness is a U.S. economy that is better able to reap benefits from the proposed North American free-trade agreement. When trade barriers with Canada and Mexico are removed, the amount of economic stimulus and net job creation will vary directly with the degree of U.S. international competitiveness.
A strong, vibrant and productive export sector is far better able to withstand assault from low-wage competition than one that is weak, stagnant and contracting. Accordingly, deficit reduction, through its effect in lowering the value of the dollar and increasing international competitiveness, will work in tandem with the North American free-trade agreement to spur economic growth and expand employment in the United States.
Likewise, improved competitiveness for the U.S. economy should make it politically easier for the administration to push through to completion the much-delayed Uruguay Round of international trade negotiations.
The trade advantages of cutting the budget deficit have received too little attention from the administration. Emphasizing those effects will be all the more important in the coming weeks, as the administration tackles ratification of Nafta in Congress and seeks a conclusion to the Uruguay Round.