Paying the Bill: Manufacturing and

America's Trade Deficit

June 1988

NTIS order #PB88-229539
Recommended Citation:

U.S. Congress, Office of Technology Assessment, Paying the Bill: Manufacturing

and America’s Trade Deficit, OTA-ITE-390 (Washington, DC: U.S. Government

Printing Office, June 1988).

Library of Congress Catalog Card Number 88-600548

For sale by the Superintendent of Documents

U.S. Government Printing Office, Washington, DC 20402
Foreword

In the 1980s, the United States has experienced large current account deficits, particularly in manufactures trade. This special report analyzes the causes of the deterioration in America’s trade performance and examines the importance of U.S. manufacturing in helping the nation improve its position in international trade. The report was

requested by Senator John Heinz as part of an assessment of technology, innovation

and U.S. trade requested by the Senate Committee on Finance; the Senate Committee on Banking, Housing and Urban Affairs; and the House Committee on Banking,

Finance and Urban Affairs. A final report will be published in 1989.

In recent years, the Federal budget deficit, the overvalued dollar, and high real interest rates have helped to boost domestic consumption and increase imports. Some

countries have concentrated on exporting to the U.S. market, while keeping their own

markets relatively closed. Another very important factor is that the United States has

lost its once substantial edge in manufacturing technology. Reversing these trends will

not be easy.

The relative decline of U.S. manufacturing is worrisome. Although services trade

and employment is growing, manufacturing remains vitally important to the U.S.

economy. Manufactured goods continue to dominate in international trade, many service industries depend heavily on manufacturing, and manufacturing remains an important source of well-paid jobs. The United States has to improve its manufacturing

performance if it is to maintain its economic strength.

A weaker dollar has helped to increase exports of U.S. manufactures in the first

quarter of 1988, but counting on the lower dollar alone to sell American manufactured

goods is a shaky strategy with risks of painful adjustments. Changes in fiscal and trade

policies will be needed. Additionally, improved manufacturing competitiveness – the

ability to make high-quality goods at reasonable costs, without sacrificing our standard

of living to get costs down – will be crucial for the United States to eliminate the trade

deficit.

OTA thanks the panel members, reviewers and other individuals in government,

business, labor, and academia who provided data and advice. As with all OTA reports,

the responsibility for content is OTA’s alone.

JOHN H. GIBBONS

Director

Ill
Technology, Innovation, and U.S. Trade

Advisory Panel

Lewis Branscomb, Chairman

Harvard University

Michael Aho

Council on Foreign Relations

Ralph Gomory

IBM

Joseph Grunwald

The Institute of the Americas

Thomas Hout

Boston Consulting Group

Ramchandran Jaikumar

Harvard Business School

Franklin P. Johnson, Jr.

Asset Management Company

Lester C. Krogh

3M

Paul R. Krugman

National Bureau of Economic Research

Alvin P. Lehnerd

Steelcase, Inc.

Ann Markusen

Northwestern University

Ray Marshall

University of Texas

Regis McKenna

Regis McKenna, Inc.

Richard S. Morse

Consultant

David Mowery

National Academy of Sciences

Paula Stern

Carnegie Endowment for International Peace

Brian Turner

AFL-CIO

Gus Tyler

International Ladies Garment Workers

Union

Lewis C. Veraldi

Ford Motor Company

Ezra F. Vogel

Harvard University

NOTE: The Advisory Panel provided advice and comment throughout the assessment, but the members do not necessarily approve,

disapprove, or endorse the report for which OTA assumes full responsibility.

iv
OTA Project Staff - Paying the Bill: Manufacturing and America’s Trade Deficit

Lionel S. Johns, Assistant Director, OTA

Energy Materials, and International Security Division

Audrey Buyrn

Industry, Technology, and Employment Program Manager

Julie Fox Gorte, Project Director

Katherine Gillman, Deputy Project Director

Philip Shapira, Analyst

Brenda A. Brockman, Analyst Carol Henriques, Research Assistant

Administrative Staff

Edna M. Thompson, Administrative Assistant

Diane White, Secretary

Acknowledgments

This special report was prepared by the staff of the Industry, Technology, and Employment Program of the Office of Technology Assessment. The staff wishes to acknowledge

the contribution of the Advisory Panel, and to thank the following organizations for their

generous assistance:

Congressional Budget Office

Congressional Research Service

U.S. Department of Commerce

Bureau of Economic Analysis

Office of Trade and Investment Analysis

U.S. Department of Labor

Bureau of Labor Statistics
Contents

Page

Summary . . . . . . . . . . . . . . . . . . . . . . .

The Trade Deficit: In What and To Whom?

Causes Of The Trade Deficit . . . . . . . . .

Signs of Weakness in U.S. Manufacturing .

A Manufacturing and Service Economy . . .

Conclusion . . . . . . . . . . . . . . . . . . .

A Note About the Special Report . . . . . .

U.S. Trade Performance . . . . . . . . . . . . .

What is the Trade Deficit? . . . . . . . . , .

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Manufacturing and the Merchandise Trade Deficit

The Causes of the Deteriorating Trade Balance . . . .

The Macroeconomic Forces . . . . . . . . . . . . .

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The Declining Competitiveness of U.S. Manufacturing

U.S. Leadership in Technology . . . . . . . . . . . . . . . .

U.S. Manufacturing Performance . . . . . . . . . . . . . . .

The Share of Manufacturing in the U.S. Economy . . .

Manufacturing Employment and Wages . . . . . . . .

Productivity Growth: International Comparisons . . .

Why Manufacturing Matters . . . . . . . . . . . . . . . . .

Links Between Manufacturing and Services . . . . . .

Manufacturing and the Quality of Jobs . . . . . . . . .

High Technology Industries . . . . . . . . . . . . . . .

The Anatomy of Trade . . . . . . . . . . . . . . . . . . . . .

Products . . . . . . . . . . . . . . . . . . . . . . . . . .

Countries . . . . . . . . . . . . . . . . . . . . . . . . . .

International Companies . . . . . . . . . . . . . . . . .

Climbing Out: How To Reduce the Trade Deficit . . , . .

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vi
List of Tables

Table No. Page

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

Simplified U.S. Balance of Payments Statement . . . . . . . . . . . . . . . . . . . .11

Business-Funded R&D As a Percentage of Gross Domestic Product . . . . . . . .27

Manufacturing Share of Gross National Product, 1979-86 . . . . . . . . . . . . . .39

Real per Capita Spending On Goods and Services . . . . . . . . . . . . . . . . . . .41

Annual Percent Changes in Manufacturing Productivity, Seven Countries

(1960-86) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..45

Index of Manufacturing Output and Employment, 1986; and Productivity

Growth Rates, 1979-86 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47

Average Annual Changes in Real Gross Domestic Product per Employed

Person, 1960-86 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Workforce Involved in Manufacturing and Average Full-Time Equivalent

Compensation, 1984 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56

Productivity in Manufacturing and All Businesses, 1960-87 . . . . . . . . . . . . . .59

Value-Added per Hour, by Industry, 1986 . , . . . . . . . . . . . . . . . . . . . . .60

U.S. High Technology Manufacturing Industries . . . . . . . . . . . . . . . . . . . .63

12. Trade Balance in Selected Manufacturing Industries . . . . . . . . . . . . . . . . .67

13. Major U.S. Imports From and Exports to Japan, 1986 . . . . . . . . . . . . . . . . .70

14. Major U.S. Imports From and Exports to Canada, 1986 . . . . . . . . . . . . . . . .72

15. Major U.S. Imports From and Exports to Western Europe, 1986 . . . . . . . . . .73

16. Major U.S. Imports From and Exports to East Asian NICs, 1986 . . . . . . . . . .74

17. Major U.S. Imports From and Exports to Latin America, 1986 . . . . . . . . . . . .75

18. Balance of Merchandise Trade, U.S. Parent Companies and MajorityOwned Foreign Affiliates, 1977 and 1982-85 . . . . . . . . . . . . . . . . . . . . . .76

19. Balance of Merchandise Trade, Foreign Companies and U.S. Affiliates,

1977-85 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78

20. Average Prices, Imports to the United States . . . . . . . . . . . . . . . . . . . . . .81

List of Figures

Figure No. Page

1.

2.

3.

4.

5.

6.

7.

8.

9.

lo.

U.S. Current Account Balance, 1960-87 . . . . . . . . . . . . . . . . . . . . . . . . . 1

U.S. Manufacturing Trade Balance, 1971-86 . . . . . . . . . . . . . . . . . . . . . . 3

Largest U.S. Trade Deficits by Country, 1987 . . . . . . . . . . . . . . . . . . . . . . 3

Goods and Services Trade, Percent of GNP (1960-87) . . . . . . . . . . . . . . . . 9

Net U.S. International Investment Position, 1971-87 . . . . . . . . . . . . . . . . .13

Composition of U.S. Merchandise Exports and Imports, 1967-86 . . . . . . . . . .15

All Government Purchases, Percent of GNP . . . . . . . . . . . . . . . . . . . . . .19

Federal Government Purchases, Percent of GNP . . . . . . . . . . . . . . . . . . .19

Personal Consumption, Percent of GNP . . . . . . . . . . . . . . . . . . . . . . . .19

Short Term Real Interest Rates, United States, Japan, and West Germany . . . .21

vii
Figure No. Page

11. U.S. International Investment Position (Cumulative, 1971-86) . . . . . . . . . . .21

12, U.S. Share of World Import and Export Markets, 1955-85 . . . . . . . . . . . . . .23

13. Index of Effective Exchange Rages for the U.S. Dollar, 1976-86 . . . . . . . . . .23

14. Non-Defense Research and Development, Percent of GNP . . . . . . . . . . . . .27

15. Scientists and Engineers in Research and Development . . . . . . . . . . . . . . . 28

16.

17.

18.

19.

20.

21.

22.

23.

24.

25.

26.

27.

28.

29.

U.S. Science and Engineering Bachelors Degrees Granted, Percent of

Total Degrees Granted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

U.S. Engineering Ph.D.s Granted to U.S. Citizens and Foreign Citizens,

1960-86 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

Trends in Technological Innovation . . . . . . . . . . . . . . . . . . . . . . . . . .31

U.S. Patent Grants by Nationality of Inventor, 1960-86 . . . . . . . . . . . . . . .31

External Patent Application by Nationality of Applicant . . . . . . . . . . . . . . .32

Manufacturing Share of U.S. Gross National Product (current dollars) . . . . . .38

Manufacturing Share of U.S. Gross National Product (constant dollars) . . . . . .38

Distribution of U.S. Employment by Sector, 1870-1986 . . . . . . . . . . . . . . .43

Gross Fixed Capital Formation in Manufacturing, 1973-85 . . . . . . . . . . . . .50

Manufacturing Productivity in Japan and the United States . . . . . . . . . . . . .51

Balance of Trade in Automotive Products, 1976-85 . . . . . . . . . . . . . . . . . .66

Volume of U.S. Exports, 1978-86 . . . . . . . . . . . . . . . . . . . . . . . . . . . .69

Volume of U.S. Imports, 1978-86 . . . . . . . . . . . . . . . . . . . . . . . . . . . .69

Average Price, Imported Motor Vehicles and Parts . . . . . . . . . . . . . . . . . 81

Vlll
Summary

In the 1980s, the United States lived

beyond its means to an extent unimaginable

a few years before. Consumption rose — both

in absolute terms and as a percentage of

GNP–with consumption of foreign-made

goods leading the way. Imports grew at an

average rate of 8 percent per year between

1980 and 1987, far outpacing exports. Investment recovered soon after the 1982 recession. Federal government spending surged

ahead of reduced tax revenues, causing the

biggest peacetime budget deficits in U.S. history. And in the process, the United States,

a creditor nation since World War I, quickly

became the world’s leading debtor. Its net indebtedness exceeded $400 billion in 1987,

and could reach $1 trillion by the early 1990s.

The U.S. current account balance–the

most comprehensive measure of trade in

goods and services —was stable throughout

the 1950s and 60s and experienced some

tremors in the 1970s. Then, beginning in

1981, it nosedived (figure1). The only way

the United States was able to sustain this

deficit was with loans and investments from

abroad. A massive infusion of foreign capital

allowed Americans to live beyond their

means. It cannot continue, though, and

therein lies the problem.

No nation, not even one as rich as the

United States, can go on forever paying its

current account deficit with foreign capital.

A time of reckoning will come. As the

United States sinks deeper into debt, foreign

investors and creditors — central banks, individuals and firms –will be less inclined to

commit ever-increasing amounts of capital

to a $4 trillion economy on a spending spree.

The trade deficit will go away. As the flood

of foreign capital ebbs, the United States will

be forced to rein in government spending,

business investment, or consumption – or all

Figure 1.

U.S. Current Account Balance

1960-87

Billions of dollars

50

0

-50

-100

-150

-200

/’-

\ ,

1960 1965 1970 1975 1980

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Business Statistics:

ment Printing Office, 1987) Appendix II, U.S. International Transactions, p. 250; U.S.

Economic Analysis, Survey of Current Business, March, 1988, p. 31, table D.

1985

1986, (Washington, DC: U.S. GovernDepartment of Commerce, Bureau of

1
2 ● Paying the Bill

three. Whether this comes about through

slower growth, or through a recession that

cuts investment and consumption in absolute terms, will depend on how competitive American manufacturers are and how

fast other major economies are growing.

One way or another, exports will have to exceed imports. A recession could force this to

happen, by cutting consumption and thus

restraining imports. So could a further drastic fall in the value of the dollar, raising the

price of imported goods beyond the means

of many consumers, making video cassette

recorders, imported cars, and so on luxury

items for the few.

A less painful course is not only to make

needed macroeconomic adjustments, but

also to get better at manufacturing — to make

a wide range of high quality goods at competitive costs. That is the most constructive

way to recapture some of our own markets

and raise exports. Such gains will not be easy

to win, however; they will require concentrated efforts on the part of U.S.

producers to improve manufacturing

productivity and quality. And they will require redoubled efforts on the part of the

U.S. government to promote American

manufacturing; for example, through export

promotion and through policies that will

ease the pressures on manufacturers to pursue short-term profits at the expense of

longer term investments in technology and

market share.

The Trade Deficit: In What and To

Whom?

The U.S. trade deficit is mostly a deficit in

the trade of manufactured goods. Of the

$161 billion current account deficit in 1987,

85 percent was in manufacturing trade

(figure 2). The growing U.S. service sector

cannot generate sufficient trade to offset

continuing deficits in manufactured goods

trade. The services trade is simply not big

enough; goods can be stored and shipped

while services by and large cannot.

Moreover, the surpluses the United States

has enjoyed in services trade are shrinking.

Other nations have become more competitive in an array of services that are traded internationally – from engineering to banking

and software design.

Nearly three-quarters of the U.S. manufacturing trade deficit is in three product areas:

● motor vehicles and parts (a $53 billion deficit);

● textiles, apparel and shoes (a $28

billion deficit);

● electronics, especially semiconductors, telecommunications equipment and consumer electronic

items (a $22 billion deficit).

The countries with which the United States

runs the largest trade deficits are, in order:

Japan, Taiwan, West Germany, Canada,

South Korea, Hong Kong, Italy, Mexico,

Brazil, and Great Britain (see figure 3).

Japan accounted for 36 percent of the U.S.

merchandise trade deficit in 1987— about

$57 billion. From Japan came 21 percent

($85 billion) of U.S. merchandise imports,

but to Japan went only 11 percent ($28 billion) of U.S. merchandise exports. The leading Japanese import by far was motor

vehicles and parts – about 30 percent of all

imports from that country. Other major imports from Japan include consumer

electronic products, telecommunications

equipment, computers and their attachments, other office machinery (e.g., copying

machines), and semiconductors.
Summary ● 3

Figure 2.

U.S. Manufacturing Trade

1971-86

Billions of dollars

40

20 -

0

-20 -

-40

-60

-80

-1oo

-120 I

-140 -

-160 I 1 I I

1971 1973 1975 1977 1979 1981 1983 1985

‘ BEA OTIA

NOTE: Bureau of Economic Analysis firgures are merchandise trade less petroleum imports and agriculture exports,

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, Table 3, June 1982 and 1987;

U.S. Department of Commerce, Office of Trade and Investment Analysis, Presentation by Allen Lenz, “U.S. Trade Deficits

and International Competitor. ”

Figure 3.

Largest U.S. Trade Deficits

Mexico

Italy

Hong Kong

South Korea

Canada

West Germany

Taiwan

Japan

by Country,

I

1 1 I I 1 1

0 10 20 30 40 50 60

Tens of billions of dollars

1987

SOURCE: U.S. Department of Commerce, Office of Trade and Investment Analysis, 1988 unpublished data.
4 ● Paying the Bill

The deficit with Japan has accounted for

one-third to one-half of the U.S. merchandise trade deficit for the last decade, growing

tenfold in that time from $5.5 billion to almost $57 billion. The U.S. merchandise

trade deficit with Asian countries other than

Japan has also grown significantly over the

past decade. By 1987 it had reached $47 billion, of which nearly three-quarters was with

Taiwan, South Korea, Hong Kong, and Singapore.

In 1980, the United States had a merchandise trade surplus of $20 billion with

Western Europe. By 1987, this surplus had

turned into a deficit of $27 billion, with West

Germany accounting for more than half ($15

billion). Automotive products are the number one item in the U.S. merchandise trade

deficit with Western Europe.

As the U.S. deficit declines, the countries

exporting most to the United States will have

to adjust to exporting less –or at the least,

slowing the growth of exports. Although the

adjustment will not be easy for anyone,

countries that can expand consumption in

their own economies, and that have low unemployment rates, strongly competitive

manufacturing industries, and healthy trade

surpluses, are best equipped to weather the

changes.

Causes of the Trade Deficit

There is no one cause and no single cure.

Macroeconomic policies certainly contributed to the deficit. In the 1980s, the

United States has pursued expansionary fiscal policies, while most other industrialized

nations acted to restrain their deficits. As a

result, the United States needed to borrow

money, and real interest rates had to rise to

attract it. In response countries such as Japan

and West Germany invested their savings in

the United States. This, in turn, increased the

demand for dollars and pushed up the

dollar’s value. The strong dollar made goods

produced in the United States more expensive for foreigners and foreign goods

cheaper for Americans.

But the strong dollar is only part of the story

behind the U.S. trade deficit. The dollar

peaked in the first quarter of 1985 and since

then its value has fallen by one-third relative

to other major currencies. It is now at

postwar lows against the yen and the German

mark. Despite this 3-year decline, and

despite the recent upsurge in exports, the

U.S. merchandise trade deficit was running

at an annual rate of well over $100 billion in

1988. The deficit with Japan hit a new record

in 1987, and only began to decline in the first

months of 1988. It seems that the devalued

dollar spurred U.S. exports, but it did not

reduce merchandise imports until April

1988.

There is further evidence that something in

addition to currency exchange rates is at

work here. U.S. manufacturers of products

as diverse as automobiles, integrated circuits

and color televisions began to lose their

world market share well before the dollar’s

rise. Moreover, since about 1970, U.S.

manufacturers have been able to hold on to

their shares of world markets only when the

dollar’s value is falling, making U.S.-made

goods progressively cheaper compared to

goods made in other countries. This suggests

loss of competitiveness.

Of course, the United States cannot expect

to dominate world markets to the extent it

did in the first couple of decades after World

War II. War-damaged industrial countries

recovered, and the diffusion of capital and

technical knowledge made it possible for

some of the poorer countries to achieve
Summary ● 5

vigorous economic growth. The world

economy became richer — a desirable result,

and one which has long been the aim of U.S.

policy.

The fact remains that the U.S. market – the

largest and richest in the world, and one of

the most open to foreign goods – is the best

prospect for both developed and developing

countries to cultivate. Some of these

countries have concentrated on exports and

kept their own markets relatively closed, as

a development strategy. Few nations have

faced the kind of competitive pressure the

United States is under. While some

developed nations have labor costs comparable to those of the United States, most

nations have much lower wages. U.S. capital

costs have also been higher than those of

most other developed nations. The combination of these disadvantages and the attractiveness of the American market to most

foreign producers (in developed and

developing countries alike) means that the

United States must do a great many things

very well, just to stay even with the competition.

Quite a few signs indicate that U.S.

manufacturing is not staying even.

Signs of Weakness in U.S.

Manufacturing

U.S. pre-eminence in many manufacturing

industries has evaporated. For example, only

one U.S.-owned company is still making

color TV sets, and most of its production

takes place in Mexico. No U.S. company

makes video cassette recorders or compact

disc players. Mass production of

automobiles was invented in the United

States, but others (especially the Japanese)

are now leaders in the technology and

management of auto manufacture. Of the

10.3 million passenger cars bought by

Americans in 1987, 3.1 million came from

Japan, despite the quota on these imports.

Another 620,000 cars were built in North

America in Japanese-owned plants; still

another 1 million cars were imported from

other countries.

What is behind these losses? There are

signs that the United States is losing its once

substantial edge in technology, a crucial factor in competitiveness for an advanced, highwage nation. For example, the United States

is spending a smaller share of gross national

product on the kind of research and development likely to pay off commercially than its

major competitors; U.S. civilian R&D

spending was less than 1.9 percent of GNP in

1985, compared to Japan’s 2.8 percent and

West Germany’s 2.5 percent. Japanese

private businesses are even farther ahead in

spending on R&D, devoting 2.1 percent of

GNP to the purpose in 1986, compared to 1.4

percent for U.S. businesses.

In the human skills needed for technologically advanced manufacturing, the United

States is also losing ground. We are graduating and using just over half as many engineers per capita as Japan; and our public

schools are turning out young people who do

not measure up internationally, especially in

math and the sciences.

The heart of the matter, however, is

whether American manufacturers have fallen behind in the practical application of

technology. The available evidence suggests

that they have. One study of flexible

manufacturing systems – computer controlled systems that are designed to make different kinds of parts in small

batches–concluded that American firms
have no edge at all in this advanced form of

automated manufacturing. On the contrary,

they used the technology far less effectively

than the Japanese. The American flexible

manufactured systems produced many fewer

kinds of parts, took longer to develop, and

performed less reliably.

Another example comes from auto design

and manufacture. U.S. auto companies

spend, on average, over 5 years taking a

model from the initial concept to full

production. Japanese companies take only a

little over 3 1/2 years to do the same–and

they do it with about half as many engineering hours. The Japanese advantage appears

to come from such things as putting a single

boss in charge of the project, getting the

company’s research/development/design

people and its production people to communicate with each other, ironing out conflicts early, and treating product and process

design as simultaneous rather than sequential.

There are other Japanese strengths.

Among those most often cited are close attention to product quality and reliability,

consensus building, and emphasis on longterm market share rather than short term

profit. Not all Japanese firms share these

characteristics, and some American firms

do. But firsthand observation, case studies,

and the remarkable record of Japanese industrialization and adaptation in the postwar

period support the basic point: Japanese

manufacturers have moved into a commanding position in many industries and have surpassed U.S. rivals in many important

markets, by developing and applying technology.

U.S. manufacturers have responded to the

Japanese challenge (and the challenges from

Taiwan, Korea, Germany, and so on) in a

variety of ways, some effective, and some less

so. Overall, American manufacturing has not

yet recouped the losses of recent years. As

one departing chief executive officer of a

major U.S. manufacturer told the New York

Times: “Yes, American industry has improved over the past four or five years, but

so have our competitors.”1

A Manufacturing and Service

Economy

The United States cannot

strong manufacturing sector.

do without a

Manufactured

good are indispensable for trade with other

nations. It is also clear that America has not

entered a post-industrial stage in which

demand for goods gives way to demands for

services. Demand for manufactured goods is

as great as ever – greater, for everything but

the basics, food and fuel. American consumers, businesses and government now

devote over 30 percent of all their spending

to manufactured goods other than food and

fuel, compared to 23 percent 30 years ago.

More fundamentally, to speak of services

as taking the place of manufacturing is to

overlook the strong interdependence of the

two kinds of activities and the blurring of distinctions between them. Many service industries depend heavily on manufacturers

for business. And some manufacturing industries could hardly exist without allied services –for example, the manufacture of

computers and design of software, often by

an independent firm.

I Robert Anderson, former chief executive officer, Rockwell International Corporation, quoted in Claudia H. Deutsch, “U.S. Industry's

Unfinished Struggle,” The New York Times, Feb. 21,1988, sec. 3.
Summary ● 7

Manufacturing remains extremely important for employment in the U.S. economy.

Nearly 28 million Americans–about onequarter of the work force – make their living

in manufacturing, either directly or in

providing services or materials to manufacturing. Far from replacing manufacturing as

source of employment, in the manner that

manufacturing took the place of agriculture,

service industries include a good many jobs

that depend on manufacturing – and by and

large, these are well-paying jobs. Not only

are manufacturing wages, on average, higher

than wages in the service sector; most of the

jobs in services that are closely tied in with

manufacturing also pay better than average.

To keep those good jobs, America has to

compete effectively in the production of

goods, as well as the provision of services.

High technology industries cannot take the

place of traditional manufacturing, any more

than services can simply replace the

manufacturing sector as a whole. Certainly,

high tech industries are vital to the generation of jobs, wealth, exports, and the advance

of technology in other industries. But they do

not stand alone. The best customers of high

tech industries such as semiconductors are

other industries, both high tech (e.g., computers) and traditional (e.g., autos). Nor can

the high technology industries, by themselves, compensate for trade deficits in declining traditional industries. The trade balance

in high technology products shrank from a

surplus of $27 billion in 1980 to a surplus of

only $600 million in 1987— with an intervening deficit of $2.6 billion in 1986. U.S. high

technology industries are still quite competitive, but they are unlikely to regain the

dominance they enjoyed 10 years ago or to

generate the large trade surpluses of that

lime.

Conclusion

Counting on the lower dollar alone to sell

American manufactured goods is a shaky

and potentially painful strategy. If the

United States is to maintain its standard of

living and live within its means, it will have

to reduce the Federal budget deficit, increase its access to foreign markets, and

make its manufacturing sector more competitive. As yet, some progress has been

made on some of these fronts, but more

ground remains to be gained. Improving

manufacturing competitiveness — the ability

to make high-quality goods at reasonable

costs, without sacrificing our standards of

living to get costs down – will be crucial if the

United States is to remain a

economic power.

A Note About the Special Report

first-class

This special report is an interim product of

the full assessment Technology, Innovation

and U.S. Trade. This report describes the

causes and anatomy of the U.S. trade deficit,

and discusses the role and health of

manufacturing within the U.S. economy.

The full assessment will analyze the record

of American manufacturing companies in

developing and applying new product and

process technologies, with particular emphasis on how we have lost or could bolster

technological advantages. The full assessment will also examine the extent to which

high capital costs, and relationships of

manufacturers with providers of capital,

have limited the ability of U.S. manufacturers to make needed investments in technology development.
8 ● Paying the Bill

In addition, the full assessment will discuss

how Federal government policies promote

or hinder technology development and its

application to manufacturing. It will assess

how foreign government trade, industrial,

and technology policies affect U.S.

manufacturers’ access to foreign markets

and their ability to compete in the U.S.

market. That part of the assessment will concentrate on Japan and Asia’s newly industrializing countries, where the most

significant technological progress has been

and will likely be. The full assessment will

also evaluate how U.S. trade policies have affected American manufacturing, both in

promoting increased exports and in coping

with rapidly rising imports. Policy options

will focus on fostering technology development and application in manufacturing,

building technological advantage, promoting exports and opening foreign markets,

and alternatives for dealing with imports.
U.S. Trade Performance

A nation’s economic health can be

measured in many ways. Common measures

include Gross National Product, per capita

income, wages and unemployment rates, life

expectancy, literacy rates and educational attainment. The balance of international trade

is one important indicator of the ability of a

nation’s firms and industries to compete internationally. A nation’s economic and technological strength and weaknesses are

reflected in its trade figures.

In the mid-1980s, for the first time in recent

history, the trade accounts of the United

States have gotten seriously out of balance.

In the 1950s and 1960s, the U.S. was accustomed to running modest trade surpluses. In

the 1970s and early 1980s, small deficits

began to appear, but both deficits and

surpluses remained lower than one percent

of GNP. In the mid- 1980s, the trade deficit

ballooned; in 1987, the current account

deficit was a record-high $161 billion, or 3.6

percent of GNP2 Before 1983, the current

account surplus or deficit had not exceeded

1.2 percent of GNP.3

Simultaneously, the importance of international trade to the American economy was

growing: imports of goods and services increased from 4.7 percent of GNP in 1960 to

12.2 percent in 1987, while exports expanded

from 5.8 percent to 9.5 percent (figure 4).4

The expansion was not smooth. In 1980, exports totaled nearly 13 percent of GNP, and

have since fallen in percentage terms. Imports grew at about 8 percent per year, on

average, from 1980 to 1987; meanwhile, exports grew unevenly, falling and then rising

again for an average annual growth rate of

Figure 4

Goods and Services Trade, Percent of GNP

1960-87 “

Percent of GNP

14

12

10

8

6

4

1960 1965 1970 1975 1960 1985

— Export s Imports

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts, Table 1.1, 1987

electronic data,

2 The United States keeps account of trade balances using a variety of partial balances, as discussed below.

3 U.S. Department of Commerce, 13ureauof Fkonomic Analysis, The National Income and Product Accounts of the United Slates, 1929-82,

(Washin on, IX: U.S. Government Printing Office, September, 1986); and U.S. Department of Commerce, Bureau of Ikonomic Analysis,

Survey o Current F’ 13usinexs, various issues.

4 Ibid.

9
10 ● Paying the Bill

3.2 percent over the period. Before 1983, exports and imports tended to grow or fall

together, as percentages of GNP. It is the

marked divergence of imports and exports

that accounts for the unprecedented deficits

of the 1980s.

The dominance of the United States in

world markets in the 1950s and 1960s was

never expected to be a permanent condition.

Europe and Japan were rebuilding their industrial bases after the devastation of World

War II, often using newer and more efficient

technologies. The international trading system of the General Agreement on Tariffs

and Trade, and various programs of

economic development aid, were designed

to help both war-ravaged industrial nations

and developing countries along. The fact that

many newly industrialized nations in Asia

and Latin America were able to achieve

rapid growth in the past few decades is at

least partly testament to the success of such

programs. Often, in order to develop or

rebuild, developing and developed countries

alike controlled access to their own markets,

using them as incubators for their own

developing industries. While these developments can all be viewed positively, as contributing to world economic growth and

development, they have also begun to

present problems for American industries.

Limited access to many foreign markets

presents problems for U.S. exporters, while

relatively open access to our own market

given to countries such as Japan, Taiwan,

West Germany, South Korea, etc. increases

the competition at home.

In short, the fact that American dominance

in world goods markets has slipped is expected and even partly self-imposed. So why

do we view our trade deficits as a problem?

In part, the speed of the decline in the late

1970s and throughout the 1980s has been unsettling; but more fundamentally, we are

concerned that the responses U.S. manufacturers and government have made to the

decline are inadequate to stem further losses. The losses are beginning to hurt. Many

manufacturing industries are in trouble,

employment has fallen, whole communities

in older industrial areas are in decline, and

wages of manufacturing workers have stabilized well below their historical peak, in real

terms. The trade deficit, then, is a manifestation of a set of problems that could well become much worse.

Proposals for “solving” the deficit are nothing if not diverse, ranging from upgrading the

skills of the workforce to crafting new ways

of dealing with unfair trade. Some observers

counsel little action at all. They see the

deficit as self-correcting, and caution that

government interference with trade regimes

or factors determining trade will prove

counterproductive in the end. Different

views on what should be done — or not

done–about the trade deficit stem partly

from different opinions on the importance of

its causes. Regardless of the policy prescription, however, an overview of the composition of the trade deficit makes it clear where

the potential problems are, and equally important, where they are not.

What is the Trade Deficit?

Strictly speaking, there is no such thing as

“the trade deficit.” Most often, “the trade
U.S. Trade Performance ● 11

deficit” is synonymous with the merchandise ternational flows of goods, services, and

(or goods) trade deficit, which is only one of capital are included in the U. S. balance of

the partial balances commonly used to ex- payments statements (table 1). Partial balanpress the position of the United States in in- ces —such as the current account, the merternational flows of goods and services. chandise trade account, and the balance on

There is no single indicator that accurately goods and services –reflect the net debit5 and wholly reflects this position. Rather, inTable 1.– Simplified U.S. Balance of Payments Statement

Credits (receipts) Debits (payments)

Current accounts: Current accounts:

1 U S merchandise exports 1. U S. merchandise imports

2 U S services sold to foreign residents 2. Services purchased from foreign residents

a

b.

c.

d

Foreign tourist expenditures in the U.S. a.

Fees and royalties from foreigners b.

Transportation, insurance and other private and c.

government services

Receipts of income from U S (government d.

and private) investments abroad

U.S. tourist expenditures abroad

Fees and royalties paid to foreigners

Transpiration, insurance and other private and

government services

Payments of income on foreign (government

and private) investments in the U S

3. Unilateral transfers received from abroad 3. Unilateral transfers sent abroad

a. Private remittance

b Pension payments

c Government grants

Capital account:

1 Net change in investment by foreigners in the U S.

a Direct investment

b. Indirect investment

c Foreign bank loans to U S residents

d Deposits by foreigners in U S banks

e Other

2 Net change in foreign official reserve assets in the U S

a. Private remittance

b. Pension payments

c. Government grants

Capital account:

1. Net change in U S. investment abroad

a. Direct investment

b. Indirect investment

c. U.S. bank loans to foreigners

d. Deposits by U S. residents in foreign banks

e. Other

a U S Government securities held by monetary a.

authorities b.

b. Other dollar and dollar -denominated assets held c.

by foreign monetary authorities d.

3 Allocations of special drawing rights (SDRs)*

Total credits

2. Net change in U S official reserve assets abroad

Gold -

Special drawing rights (SDRs)

U S. reserve position in the IMF

Foreign currencies

Total debits

● Capital account 3 has an entry only in years when the International Monetary Fund allocates SDRs to member countries

SOURCE Arlene Wilson, “U S Trade and Payment Balances. What Do They Mean?” Congressional Research Service Report 85-26E (Washington, DC: Library of Congress, 1985)

5 Arlene Wilson, “U.S. Trade and Payments Balances: What Do They Mean?” Congressional Research Service Report No. 85-26 E,

January 23, 198.5.
12 ● Paying the Bill

credit position of that part of U.S. international trade and transactions.

The entire balance of payments account

must, as the name implies, balance. Its two

components, the capital account and the current account, mirror each other, at least in

theory. 6 A current account deficit must be

balanced by a capital account surplus of the

same amount; without capital funds coming

in from abroad, something else would have

to give — consumption, investment imports, 7

government spending, or all four. The current account measures international flows of

goods, services, and unilateral transfers,

while the capital account includes flows of

direct and indirect investment and changes

in official reserve assets.

The current account– the most comprehensive measure of trade in goods and

services — was relatively stable for two

decades following World War II, becoming

more volatile after 1970 and plunging deeply into deficit after 1981 (see figure 1). The

capital account, therefore, had to show a corresponding surplus –also unprecedented.

As a corollary, the international investment

position of the United States has shifted

from surplus to deficit in the 1980s, roughly

balancing the shifts in the current account.

That is, foreign investment in the United

States exceeded American investment offshore by nearly $424 billion in 1987 (figure

5). This infusion of capital allows the United

States to sustain its current account deficit,

or to consume more goods and services than

it produces.

A nation’s ability to consume more than it

produces is attractive from the standpoint of

the consumer–while it lasts. In this sense,

the current account deficit has benefitted

many Americans in the short term. But a nation cannot go on forever paying for its current account deficit through a surplus in the

capital account. The capital account surplus

consists of savings from other nations, which

are invested in the United States in order to

Figure 5.

Net U.S. International Investment

Position

B

r

— — —--1

100

-100

-XXI

-300

-400

1971 1973 1975 1977 1979 1981 1983 1985 1987

SOURCE: U.S. Department of Commerce, Bureau of Economic

Analysis, Survey of Current Business, June, 1987,

U.S. International Transactions, table 1

provide future returns. Those returns will

eventually drain away funds that, if they had

gone into the hands of U.S. nationals, might

have been used for American consumption,

investment, or public spending. Moreover,

foreign investors cannot invest larger and

larger amounts of money in the United

States indefinitely. At some point, cone In practice, there are differences (called statistical discrepancies) between the dollar amount of the capital and current accounts.

Moreover J the capital and current accounts do not necessarily balance at any particular point in time it may take many months for the

adjustments in one account to cause changes in the other to show up. I:or a discussion of these accounts and explanations of the items in each

account, see Arlene Wilson, op. cit.

7 For further discussion of the relation between the current account deficit and an influx of foreign capital, see the section on The Guscs

of the Deteriorating Trade Balance, The Macroeconomic Argument.
U.S. Trade Performance ● 13

fidence that U.S. investments can continue

to yield higher returns, or more reliable

returns, will erode, or the supply of foreign

savings will be curtailed, and the massive

flows of foreign capital into the United

States will dry up.

No one can pinpoint the time when this will

happen. But most analysts expect that foreigners will cease to finance our large current account deficit within a few years at

most.

The trade deficit for 1988 promises to be

smaller than the one in 1987– the first

change in this direction since 1980. While

this reduction in the trade deficit is relatively small, further, more consequential changes in our current account are coming, and

they will necessitate adjustments on our part.

What kind of adjustments? To get some insight on this question, it is helpful to look at

the components of international trade –

what kinds of goods, services, or other exchanges are most important to trade, and

where the United States is running its biggest

deficits.

Manufacturing and the

Merchandise Trade Deficit

The current account measures what we

commonly think of as international trade –

exports and imports of goods and services,

plus unilateral transfers.8 The merchandise

trade deficit, reflecting international flows of

goods, is larger than the current account,

mainly because the United States runs a

surplus in international trade in services. In

1987, the current account deficit was $160.7

billion, with a surplus of $14.3 billion in services trade and a deficit of $159.2 billion in

merchandise trade.9

To reduce the current account deficit, the

United States must reverse the deficit in

merchandise trade.10Surpluses in services

alone cannot make much of a dent in the current account; they are dwarfed by the deficit

in merchandise trade. Two kinds of activities

are included in the services accounts: investment income (e.g., dividends and interest),

and trade in services such as banking, insurance, travel, and license and royalty payments. In 1987, investment income,

according to Commerce Department

figures, produced a surplus of $14.5 billion,

but trade in service activities was slightly in

deficit, to the tune of $200 million.

In an earlier assessment, OTA found that

the official figures have consistently understated the surplus from services trade (banking, travel, and the like) .11 For example, the

Commerce Department figures showed a

small surplus for services trade of $2 billion

in 1984, whereas the OTA mid-range esa Unilateral transfers include U.S. C~ovemment grants (excluding milita~ grants of goods and seticcs), U.S. government pensions and

other transfers, and private remittances and other transfers.

9 The remaining deficit of $12.8 billion was accounted for by unilateral transfers. In this section, trade figures are drawn from the national

income and prcduct accounts, which are calculated by the Commerce Department’s Bureau of E.conom ic Analysis on the free-along-side

(f.a.s.) basis. Other trade figures, kept on a more current basis by the Commerce Department’s International Trade Adm inist rat ion, calculate

imports on the cargo-insurance -freigh t (c.i. f.) basis. Imports figured on the c.i.f. basvs are higher, and thus make the U.S. t rade deficits appear

higher (or the surpluses lower).

10 Much of this section depends on a presentation entitled “U.S. Trade Deficits and International Competitive ness,” by Allen 1,.erw, former

director, Office of Trade and Investment Analysis, Department of Commerce.

I I U.S. Congress, Office of Technology Assessment, Trade in Services: Exports and Foreign Revenues, OTA-ITE316 (Washington, DC:

U.S. Government Printing Office, .September 1986), ch. 4,
14 ● Paying the Bill

timate of the surplus for that year was $14 billion. Nonetheless, even using OTA estimates, the surplus for services is small

compared to the merchandise trade deficit.

Furthermore, the surplus from services

trade was shrinking in the years OTA made

its calculations (1982 to 1984). Investment

income has been quite considerable in previous years, peaking at $34.1 billion in 1981,

but it too is declining. Because the United

States is now the world’s leading debtor, it

seems likely that investment income will

continue to decline for some years.

Are services on the brink of assuming much

greater importance in international trade,

perhaps eclipsing goods? OTA judges that

they are not. Goods can be shipped and

stored; services, by and large, cannot. Most

services are produced very near the place

they are consumed. For that fundamental

reason, goods are much more important to

international trade than services and are

likely to remain so for a longtime. This situation may change as telecommunication becomes cheaper and more reliable, but the

changes are likely to be gradual, not revolutionary. Moreover, it is not realistic to think

of services trade as a replacement for trade

in goods. The manufacture of goods and

provision of services is highly interdependent. If American-made goods become

more in demand and sell better around the

world, many services will be bundled along

with sales of those manufactured items. For

example, the companies that have succeeded

best in selling computers in the world market

are also very good at providing services such

as systems integration, training, maintenance of hardware and provision of up-todate software.

For different reasons, agriculture cannot

do much either to reverse the current account deficit. Agriculture, where America is

generally thought to be internationally competitive, contributed fairly strong trade

surpluses in the 1970s, helping to offset the

petroleum deficits of that time and to keep

the current account more or less in balance

during the decade. But agricultural trade

surpluses have dwindled in recent years.

Farm support programs and the widespread

dispersal of production-enhancing agricultural technology throughout the world have

reduced the potential for American exports.

Even if U.S. agriculture were to recover

some foreign markets, agricultural trade,

like trade in services, is too small to much affect the huge merchandise trade deficits of

the 1980s.

Manufactured goods dominate merchandise trade. (Figure 6 shows the composition

of merchandise trade over the past two

decades.) About 80 percent of merchandise

trade, both imports and exports, is in

manufactured items. Thus, most of the merchandise trade deficit – and therefore, the

current account deficit — is in manufactured

goods. The great deterioration of the 1980s

in the merchandise trade balance was due almost entirely to manufacturing. The deficit

in petroleum trade, once a major drag on

merchandise trade balances, improved by

over $40 billion between 1981 and 1986, as

oil prices fell and U.S. production increased,

though this situation is temporary. The

agricultural trade surplus declined from $25

12 U.S. Congress, Office of Technology Assessment, International Competition in Services, O’I’A-lTE-328 (Washington, DC: U.S.

Government Printing Office, July 1987), ch. 1.

13 For reasons why this is so, see U.S. Con ess, Office of Technology Assessment, U.S. Oil Production: The Effect of Imw Oil Prices,

Spcial Report (Washington, DC: U.S. GPO, n Press). F
U.S. Trade Performance ● 15

Figure 6.

Composition of U.S. Merchandise EXpOrtS and lmports

100%

80%

60%

4 0 %

2 0 %

o %

1967-86 “

Percent of merchandise exports

19671969197119731975 19771979198119831985

Percent of merchandise imports

1 00%

80%

60%

4 0 %

20%

o%

1967196919711973197519771979 19811 ’2831985

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Business Statistics:

ment Printing Office, 1987), Appendix II, U.S. International Transactions, p. 246; U.S.

Economic Analysis, Survey of Current Business, March, 1988, p. 44-46

Merchandise Exports

Food, Feed, Beverage

Industrial Supplies *

Other Goods

Consumer Goods

Automotive Goods

Capital Good s

1986, (’Washington, DC: U.S. GovernDepartment of Commerce, Bureau of
16 ● Paying the Bill

billion to $3.4 billion. But the trade balance

on manufactured products, having fluctuated moderately during the 1970s, plunged

into deep deficit in the 1980s (see figure 2).

Despite the upturn in exports in 1987, the

manufacturing trade balance dropped to a

record deficit of $138 billion as imports of

manufactured goods continued apace.

One way to reverse the current account

deficit is for U.S. exports to grow much faster

than imports, and continue doing so for some

time. But this is now likely. If import growth

continues unchecked, it is highly unlikely

that exports could grow fast enough to close

the trade deficit; this would require extremely rapid expansion of exports, and assumes

an improbably high rate of growth in world

markets. It is more likely that U.S. import

growth will slacken or reverse, either because of a recession that cuts consumption,

or because the falling dollar makes imports

too expensive for Americans to afford, or because we replace some imports with domestic production. At the same time, exports are

likely to pick up, as foreign firms and consumers adjust to lower-priced American

products. Indeed, U.S. merchandise exports

grew consistently throughout 1987, rising to

$258 billion. The degree to which exports can

expand further will depend on many factors,

including the value of the dollar, the competitiveness of U.S. manufacturing firms,

and the economic and trade policies of many

countries, not least our own.14 The following

section considers how these same factors

were involved in causing the deepening

trade deficits of the 1980s.

14 Why the trade deficit must turn around and how it may occur is discussed in more detail in the concluding sections of this report.
The Causes of the Deteriorating Trade Balance

The trade deficit cannot be attributed to

any single cause. The rising value of the dollar, for example, is behind some of the

deterioration in the trade accounts, but what

caused the dollar’s value to rise and remain

high for such a long time? And how do we

explain the fact that merchandise trade

deficits –albeit modest ones, from the

perspective of 1987 –were becoming

routine in the 1970s, during which time the

dollar’s value fluctuated? Teasing apart the

various factors behind the trade deficit is like

untangling a plate of spaghetti. A complex of

forces, acting together, created the situation

we have now. These can be divided into two

basic categories: macroeconomic forces and

the declining competitiveness of U.S.

manufacturers.

The Macroeconomic Forces

The role of macroeconomic factors in shaping U.S. trade has been and will continue to

be enormously important. Note that the emphasis here is on macroeconomic forces –

there are many. Many analyses have seized

upon one factor – the U.S. federal budget

deficit, for example, or the overvalued dollar – as the explanation. This kind of analysis

implies (and some state) that making the

needed change in the one variable would

solve the trade deficit.

Undoubtedly, the rise of the dollar and its

persistently high value during much of the

early 1980s was important. Similarly the

Federal budget deficit was an important part

of the chain of events and actions that led to

the dollar’s ascent. Focusing exclusively on

either of these factors, however, is like identifying two strands of spaghetti as the whole

meal.

To understand the complex of macroeconomic factors behind the trade deficit, it

is important to remember that the current

account deficit must be matched by a capital

account surplus. In effect, the United States

has been able to consume more goods than

it has produced since 1981 (or run a current

account deficit) by borrowing from abroad

(or run a capital account surplus). That the

United States was able to attract so much

capital was unexpected. Before the 1980s,

conventional economic wisdom, based on

previous experience, held that consumption

in excess of production was a transitory

phenomenon; the current account deficit

would set in motion a series of events

(primarily, currency devaluation) that would

eliminate the deficit. To understand why

these events did not happen – or more

precisely, have not happened yet – we must

look at a series of actions, in the United

States and abroad, in the 1980s.

One of the most significant changes effected by the Reagan administration in its

early months was a shift to a more expansionary fiscal policy. The tax cuts for individuals

and businesses were intended as a stimulus.

It is doubtful that the primary purpose of the

other major shift — an increase in government spending, primarily in defense —was

fiscal stimulus, but combined with the tax

cuts, that was the result.

Between 1981 (when the Economic

Recovery Tax Act was passed and the

administration’s fiscal policies began to take

effect) and 1987, Federal government purchases of goods and services increased by 7.8

17
18 ● Paying the Bill

percent annually; total government purchases of goods and services (including purchases by State and local governments) rose

at an annual rate of 7.7 percent. Expenditures for defense dominated the increase in

Federal purchases. They rose at an annual

average rate of 9.9 percent; nondefense expenditures increased at an annual rate of 2.3

percent. l5 Significantly, government purchases of goods and services grew at a faster

rate than the GNP, which rose at the annual

rate of 5.9 percent.

While government expenditures were

rising at a relatively rapid pace, receipts grew

sluggishly. Federal government receipts —

including personal tax and nontax receipts,

corporate profits tax accruals, indirect business taxes, and contributions for social insurance —went up only 5.3 percent per year

between 1981 and 1986. That difference of

3.3 percentage points per year between

government expenditures and receipts inexorably deepened the Federal government

deficit, which increased from $64 billion in

1981 to $205 billion in 1986–the largest

peacetime Federal deficit ever. In 1987, the

gap was narrowed, as expenditures stayed almost flat while receipts rose over 10 percent;

the resulting deficit was still $152 billion.

What happened to the other components

of GNP, while the Federal government’s

share was increasing? GNP can be disaggregate in a variety of ways, but the basic

formulation is this: GNP equals the sum of

government expenditures for goods and services, gross private investment, personal

consumption, and net exports. All government expenditures for goods and services —

which, in terms of its percentage of GNP, has

been on a general downward trend over the

postwar period –began to increase from its

low point in 1979 (about 19 percent of GNP)

to reach its current level, about 20.5 percent

in 1987. The increase is disproportionately a result of Federal government spending

for goods and services, whose share of GNP

increased from about 7 percent in 1979 to

about 9 percent in 1987 (figures 7 and 8).

Gross private investment is composed of

investment in nonresidential structures,

producers’ durable equipment, residential

investment, and change in business inventories. In the past 40 years, gross private investment has fluctuated without any

discernible long-term trend. Investments

in producers’ durable equipment, however,

has been trending slightly upward since the

early 1960s, and maintained a share of GNP

well within the recent historical range of

variation during the 1980s. The tax cuts of

the Economic Recovery Tax Act of 1981

(ERTA) affected both businesses and individuals. ERTA made it more profitable for

businesses to invest, particularly in buildings

and equipment. As a result, private investment increased 5.8 percent per year between

1981 and 1986. This rate of growth is slight15 U.S. Department of Commerce, Bureau of Ezonomic Analysis, “National Income and Product Accounts Tables,” Survey of Current

Business, June 1987; and U.S. Department of Cammerce, Bureau of Economic Analysis, The National Income and Product Accounts of the

United States, 1929-1982 Statistical Tables (Washington, DC: U.S. Government Printing Office, September 1986).

16 Thk does not include transfer payments, such as Social Security, Medicare, welfare payments, and Medicaid. Transfer payments have

risen greatly during the postwar period. In the GNP accounts, tmnsfer payments are included in pemonal consumption.

17 No trend is discernible in nominal dollars. A1thou@ GNP disaggregations are available in deflated dollars, man of the constantdollar

series show trends that seem to belie other well-estabhshed data and evidence. For example, in deflated (1982) do lam, net exports in the /’

national income and product accounts were negative (implying trade deficits) during much of the 1960s, but positive during much of the 1970s.

OTA is currently investigating how constantdollar series are generated, in order to undemtand the apparent anomalies of constantdollar

figures. For now, trends m components of GNP over time are reported in nominal dollars.

IS Ste hen A. Me er, “Trade Deficits and the Dollar A Macroeconomic Perspective,”

k 436

Federal Resew Bank of Philadelphia Business

Review, pt.-Oct. 1 .
The Causes of the Deteriorating Trade Balance ● 19

Figure 7.

All Government Purchases, Percent of

GNP

1947-87

Percent of GNP—

24%

SOURCE: U.S. Department of Commerce, Bureau of Economic

Analysis, National Income and Product Accounts,

Table 1.1, electronic data, 1987.

Figure 8.

Federal Government Purchases,

Percent of GNP

Percent of GNP —

1796

15%

1947 1952 1957 1962 1967 1972 1977 1982 1987

SOURCE: U.S. Department of Commerce, Bureau of Economic

Analysis, National Income and Product Accounts,

Table 1.1, electronic data, 1987,

ly slower than the rate of growth of GNP, but

this is partly a result of the fact that gross

private investment was already quite high in

1981, compared with any previous year or

with 1982 and 1983. If 1980 is chosen as the

starting point, the rate of growth of private

investment was 7.8 percent annually; if 1979

is the starting point, the rate of growth was 6

percent. In short, private investment roughly kept pace with GNP in the 1980s, and fluctuated within a range that was normal for the

postwar period. What is surprising about

this, however, is that investment maintained

its share of GNP during a period of high (by

historical standards) real interest rates.

Personal consumption is composed of expenditures on durable goods, nondurable

goods, and services. Personal consumption,

as a percent of GNP, has risen sharply in the

1980s. The percentage share fluctuated

without much sign of a long term trend from

the 1950s through the 1970s, varying between about 62 percent of GNP and 64 percent (figure 9). In 1982, after the recession,

personal consumption expenditures shot up

to about 65 percent, and rose again in 1984

to two-thirds of GNP. According to many

economists, consumer spending has buoyed

the economic recovery since the 1982 recession.

The story is different for net exports. From

the 1950s until 1983, net exports’ share of

GNP fluctuated within historical norms.

After 1983, as would be expected from the

performance of other trade accounts, the

percentage share plummeted, becoming a

drain on-GNP to the tune of nearly -3 percent per year by 1987.

Figure 9.

Personal Consumption,

GNP

Percent of

Percent of GNP

69% —

66%

67%

66%

65%

64% ‘v’

63%

/’

1947 1952 1957 1962 1967 1972 1977 1982 1987

SOURCE: International Monetary Fund, International Financial

Statistics, 1987 Yearbook, and Vol. 41, No. 4,

(Washington, DC: International Monetary Fund,

1987, 1988) p. 229, 299, 523.
20 ● Paying the Bill

In sum, the three largest components of

GNP –government spending, consumption,

and investment — continued at normal or

higher-than-normal rates, while the Federal

government deficit mushroomed. The large

budget deficits increased the demands on

capital and raised interest rates, particularly

relative to interest rates in other developed

nations (figure 10). Rather than crowding

out private investment, though, the high interest rates unexpectedly served to draw in

capital from other countries. At about the

same time, around 1982, the growth of U.S.

investment abroad slowed (figure 11).

As noted, this sequence of events was quite

unexpected. International interest rates

have diverged before without causing the

massive and sustained inflow of foreign capital that the United States experienced in the

1980s. One important difference with past

periods was that, in contrast to the United

States, most developed nations were pursuing different macroeconomic policies, contracting their national budget deficits and

easing the pressure on capital. In the rest of

the OECD nations, the public sector

budget deficit rose only 1 percentage point

of GNP between 1979 and 1982, while in the

United States it rose 5.5 percentage points.

Moreover, there were surplus savings in the

other OECD nations during the recovery

from the 1982 recession.20 Since these

surplus savings were not needed in these nations to finance their own deficits, and U.S.

interest rates were high, the United States

became an attractive place to invest foreign

savings. 21

The demand for dollars to invest in dollardenominated assets pushed the dollar’s

value up relative to the currencies of most of

our trading partners.22 By 1981, the real exchange value of the dollar was headed upward, and the rising trend persisted until the

first quarter of 1985.23 Overall, the dollar appreciated 49 percent, in real terms, against

the deflated currencies of major trading

partners of the United States, between 1980

and 1985. Imports were cheaper, exports became more difficult to sell, and the trade accounts of the U.S. plunged into deep deficit.

The macroeconomic forces responsible for

this situation were multiple. The combination of fiscal stimulus in the United States

and contraction abroad, rising consumption

and rapid recovery of investment after the

1982 recession, changes in tax law, rising interest rates in the United States and relatively constant interest rates abroad, and the

slow recovery of investment in other OECD

nations all played apart. In addition, the debt

crisis in countries such as Brazil and Mexico

IS OECD is the Organization for Economic Co-operation and Development, and its member nations are Australia, Austria, Belgium,

Canada, Denmark, Finland, France, the Federal Republic of Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, the Netherlands,

New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.

m Stephen Marris, Deficits and the Dollar: The World Economy at Risk (Washington, DC Institute for International Fxonomics, December

1985), pp. 8-11.

21 Another e Ianation that was advanced for the stron flow of foreign investment funds to America was that the United States

represented a sa e haven in a troubled and uncertain world. ? %lis argument, while popular, is not particularly persuasive. First, inflows of

foreign capital were much the same in 1979-80, when the U.S. economy was perceived as unstable, as in 1983-84, when a strong recovery led

to

r

rceptions of a safe haven in America. Furthermore, the pull of high real interest rates is probably a sufficient e Ianation for the inflow

of orei

$

capital. See Marns, op. cit.,

8

p. 28-9, and William H. Branson, “CAuses of Appreciation and Volatility of the%ollar,” NBER Reprint

No. (Cambridge, MA: National ureau of Eeonomic Research, Inc., 198S).

22 Canada is something of an exception; the Canadian dollar was already weak relative to the American dollar, but became weaker. Some

of the Asian NICS’ currencies did not depreciate vexy much, in some cases because they were pegged to the dollar.

m See, for example, Paul R Krugman and Richard E. Baldwin, ““ I’he Persistence of the U.S. Trade Deficit,” Brookings Papers on Economic

Activity, 1:1987; and Meyer, op. cit. Meyer also points out that the dollar’s value rose by 18 percent relative to Canadian dollars, 18 percent

against the Japanese yen, 89 percent a ainst the German mark, 117 percent against the British pound, and 149 percent against the French

franc between 1980 and its peak in 1 . !X#
The Causes of the Deteriorating Trade Balance ● 21

Figure 10.

Short Term Real

United States, Japan,

Interest rate

008 r

—– — —

Interest Rates,

and West Germany

I

0.06

---

0.02 .“

.’

o

-0.02 /

I

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987

— U.S. — Japan --- W. Germany

SOURCE: International Monetary Fund, International Financial Statistics, 1987 Yearbook, and Vol. 41, No. 4, (Washington, DC: International Monetary Fund, 1987, 1988) p. 229, 299, 523.

Figure 11.

U.S. International Investment Position

Cumulative, 1971-86

Billions of dollars

14 

12

10

8

6 -

4 .

1971 1974 1977 1980 1983 1986

Foreign Investment U S Investment

in United States overseas

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, June, 1986, U.S. International

Transactions, table 1,
22 ● Paying the Bill

curtailed U.S. exports to those countries. It

is tempting to zero in on one thing—most

commonly, the value of the dollar or the

budget deficit –but this kind of oversimplification is misleading when it comes to

choosing the policies necessary to remedy

the situation, and raises false hopes of a

single silver-bullet solution.

It is equally wrong to focus on macroeconomic causes of the trade deficit, and

macroeconomic solutions, ignoring the competitiveness issue. Far too much analysis has

been devoted to trying to prove that either

macroeconomic factors or competitiveness

is the root of the trade deficit, without recognizing the interplay and synergism between

them.

The Declining Competitiveness of

U.S. Manufacturing

Several features of the trade picture in the

past two decades indicate that the United

States – more specifically, U.S. manufacturing – has lost competitive prowess. Since the

1970s, it appears that the United States has

been able to keep its international trade accounts out of the red only when the dollar is

declining. The strength of the dollar in the

1980s was not a unique occurrence in our history: by some measures, the dollar’s peak

value in 1985 was comparable to its exchange-rate value in 1970. But in 1970 the

United States had a current account surplus

of $2.3 billion, compared with deficits of

$107 billion in 1984 and $116 billion in

1985.24

It is noteworthy that U.S. current account

and manufacturing trade performance

began deteriorating before the rise of the dollar (see figures 1 and 2). When agricultural

exports and petroleum imports — the two

largest sources of nonmanufactured items in

the merchandise trade account–are subtracted from merchandise imports and exports, the picture that emerges is one of

deepening U.S. trade deficits since the early

1970s. Significantly, the few years of

surplus — 1974, 1975, 1980 and 1981 –were

associated either with serious recessions

(which generally jampen demand for imports) or with an exceptionally low dollar.

The trends in U.S. share of world markets

tell much the same story. American

manufacturers have been losing their share

of both domestic and foreign markets for

some time. Between 1970 and 1980, the U.S.

share of world imports rose slightly, from

12.1 to 12.5 percent, but its share of world exports dropped from 13.6 percent to 10.9 percent (figure 12).25 Between 1980 and 1986,

American exporters’ sales of manufactured

items fell 15 percent, while countries outside

the United States were increasing their imports from all sources by 22 percent (in Another calculation shows volume terms).26 

a general drop in the world market share of

U.S. manufactures after 1975 (interrupted

only by a brief rise at the end of the decade

when the dollar fell), and then a steep

24 Krugman and Baldwin, op. cit., pp. 2-S. ‘Ilese authors present evidence suggesting that the real value of the dollar that would bring our

trade into balance has declined over the long term.

m United Nations, 1980 Yearbook of International Tmde Statistics, Volume I: Trade by Count T, Department of International Economic

and Social Affaim Statistical Office, (New York: United Nations, 1981).

‘m Rimmer De Vries and Derek I Iargreaves, “The Dollar’s Decline and Trade: Mission Accomplished?” Challenge, January-Feb~ary

1987, p. 39.
The Causes of the Deteriorating Trade Balance ● 23

Figure 12.

U.S. Share of World Import and Export Markets

1955-85

18%

17% ’ ,

\

16%

15% -

- - . . . .

. . .

-. .

14% -

.

,

13% -

12% -

11% -

10% , , , , , , ( , , I , I , 1

1955 1961 1967 1973 1079 1965

— Import s-

-- Exports

SOURCE: United Nations, International Trade Statistics Yearbook (United Nations: New York), Volume 1, table A, various years

1962-84.

decline of 8 percentage points from 1980 to

1985.27

Even U.S. exports of high-technology

products–from the very sectors in which

American firms are supposed to shine –

have lost market share. Often high-technology sectors, only two – office, computing and

accounting machines, and agricultural

chemicals – gained in share of world exports

between 1965 and 1980. Seven high-technology industries (engines and turbines, professional and scientific instruments, electrical

equipment and components, optical and

medical instruments, drugs and medicines,

plastic and synthetic materials, and industries chemicals) lost shares of world exports, and one (aircraft and parts) remained

about the same. These losses of market

share occurred before the rise of the dollar in

the 1980s. Since the dollar’s fall after 1985,

America’s high technology trade picture has

improved somewhat. Following a deficit in

1986, high technology goods trade showed a

small surplus of $600 million in 1987.

Another indicator of a decline in competitiveness is the remarkably slow response of

U.S. imports and exports to the dollar’s fall.

From its peak in the first quarter of 1985, the

dollar has fallen back to the lows of the late

1970s (figure 13). But the trade deficit has

Figure 13.

Index of Effective Exchange Rates for

155

150

145

140

135

130

125

120

115

110

105

100

the U.S. Dollar, 1976-86

1980 = 100

Exchange rate index

95’

1970 1972 1974 1976 1978 1960 1982 1984 1986

27 Paul R Krugrnan and George N. Hatso

r

UIOS, “The Problem of U.S. Competitiveness in Manufacturing,” New l~ngland Fxonomic

Rc\lew, Jan./Feb. 1987, p. 20. Krugman and atsopoulos have adjusted U.S. world market share data to eliminate two extraneous factors,

First, the adjustment screens out the effects different economic performance of different regions or countries. For example, an economic

slump In F.urope might curtail European imports, thus reducing the American manufacturers’ share of world markets without reflecting a

fundamental improvement in competitiveness. Second, the adjustment includes the U.S. market is included in the world market,

28 Global Competition: The New Reality, Report of the President’s Commission on Industrial Competitiveness (Washington, DC: U.S.

(~ovemrnent Printing Office, Janua~ 198S), p. 6.
24 ● Paying the Bill

only just begun to fall substantially. In 1987,

over 2 years after the dollar began to fall, the

merchandise trade deficit set anew record of

$159 billion.

That trade deficits should continue to rise

for a time after a drop in the dollar’s value is

not unexpected. Since firms buying from

overseas suppliers tend to make extended

commitments, U.S. importers would normally continue to buy from offshore suppliers even after the dollar’s adjustment. At

the same time, importers must pay more for

foreign-made goods when the dollar is falling, thus making imports more expensive.

The case of exports is parallel. Even after the

dollar’s fall, U.S. firms wishing to sell offshore have to make special efforts to overcome buyer-supplier relationships built

during the time when U.S. product prices

were higher, and such efforts take time. This

accounts for the usual and expected lag–

known as a J-curve –between the adjustment of currency value and and a turnaround

in the trade deficit.

However, a lag of 3 years since the dollar

peaked before seeing any really significant

turnaround is unusual and surprising. The

merchandise trade deficit abated somewhat

in early 1988, but the deficit was still running

at an annual rate of well over $100 billion. In

contrast, the response to the dollar’s rise — a

rise in imports of manufactured goods and a

drop in exports – was much swifter than the

opposite adjustment when the dollar fell.

This fact, in combination with others, suggests that U.S.-made goods are less attractive

than foreign-made goods, the price effects of

currency adjustment aside. In some cases,

the attractiveness of foreign products

reflects very low labor costs or government

subsidy; in other cases it arises from high

quality and reliability.

The trade picture outlined above is certainly not what one would expect of a nation

whose manufacturing industries are holding

their own in international competition.

While trade and market share figures do not

indisputably prove the case for loss of competitiveness, they are signs of trouble – especially since manufacturing trade slipped into

deficit in the 1970s, with surpluses appearing

thereafter only when the dollar’s value

dropped, or in recession years. And behind

the aggregate trade figures are the experiences of individual industries: American

manufacturers of consumer electronics,

steel, automobiles, and semiconductors successively lost out to competitors who offered

better quality goods or lower prices, and

these losses began well before the damaging

rise of the dollar.

Other indicators as well point to loss of

competitiveness in manufacturing. There is

evidence that the share of the manufacturing

sector in the U.S. economy has declined,

while consumption of manufactured goods,

as a share of total spending, is greater than

ever – the difference, of course, being made

up by imports. Productivity growth of

American manufacturing has lagged, especially behind Japan’s. In addition, there are

signs that American leadership in technology-the foundation for high productivity

and excellence in manufacturing – is eroding. Further discussion of these trends and

indicators appears in the following sections.

m It is important to note, however, that while exports have risen since the drop of the dollar, imports have not fallen.
The Causes of the Deteriorating Trade Balance ● 25

To put the different indicators into

perspective, it is useful to define competitiveness. For a firm, competitiveness is the

ability to design, develop, manufacture, and

market products at home and in other nations, in competition with other firms.30 For

a nation, it means doing all this without a

decline in the real standards of living of its

citizens.31 This means, for an advanced nation like the United States, exploiting technology, in its broadest sense, to provide the

rising productivity and superior product

quality that make goods from high-wage na- & tions attractive and affordable. Even with

the dollar’s fall, most nations have lower

wages than the United States. Moreover, the

range of products low-wage nations make is

rapidly expanding. It is very risky — in fact,

probably infeasible – to limit our production

to only the most knowledge-intensive goods

and services and jettison traditional sectors

where low-wage nations have production

cost advantages. We must compete effectively in many product lines with low-wage

nations, and with producers from developed

nations who have excellent records in

product design and performance.

Not all the signs are negative. Some

American industries perform much better

than others; the United States is by no means

at the bottom of the list among nations in

competitive performance and some of the

signs (e.g., growth in manufacturing productivity) have recently improved. Nor is it

necessary for the United States to outstrip

everyone else. Economic growth and rising

living standards in other countries are inevitable and desirable. However, a relative

decline in U.S. performance is a matter of

concern, for that is the road to second-class

economic status.

We have to recognize that it is difficult for

a high-wage, highly productive nation like

the United States to make the cost-saving,

productivity-enhancing, quality-improving

adjustments necessary to stay at the cutting

edge. Despite the difficulties, it is necessary,

in view of the efforts many developed and

developing nations are making to catchup in

technology and penetrate the American

market – the richest, largest, and one of the

most open in the world. Catching up is not

easy, but is often a more straightforward and

manageable proposition than staying ahead.

Moreover, development aid and parts of the

international trade regime (e.g., the

Generalized System of Preferences, allowing special exemptions from tariffs to

developing countries) are intended to help

the process along. Policies of individual

countries also have an important effect.

Many nations –developed, less developed,

and newly industrializing – have trade and

industrial policies aimed at promoting exports while keeping their home markets relatively protected.33

w U.S. Congress, Office of Technology Assessment, International Competitiveness in Electronics, OTA-ISC-XXl (Washington, IX: U.S.

Government Printing Office, November 1983), p. 4.

31 Global ~mmpetition, op. cit. p. 13.

w Technology is here used to mean not only hardware and machlneq’, but also the software, human sk]lls, and managerial know-how to

put together all the elements of production effectively.

33 The conduct and performance of policies aimed at industrial development and competitiveness in several nations, including Japan and

newly industrializing Asian countries, will be explored in the full assessment of Technology, 1nno\ation, and U.S. Trade.
U.S. Leadership in Technology

If the United States can maintain a competitive advantage, it is likely to be built on The reason is simply ‘hat ‘he technology.34

United States has substantial competitive

disadvantages relative to most other nations

in some areas – for example, wage rates and

capital costs. U.S. wages are among the

highest in the world, and during the first half

of the 1980s probably were the highest. The

falling dollar has lowered American wages

vis-a-vis those of a few other developed nations – in particular, West Germany and

Japan – but, in general, American wages are

still high compared with those of most of our

trading partners. As for capital costs, U.S. interest rates were substantially higher in the

1980s than those in much of the rest of the

world.

Technology has been a traditional source of

U.S. strength, compensating for these disadvantages. Our technological advantage in the

past rested on the invention of new products

(e.g., Nylon, photocopy machines, integrated

circuits), ‘swift adoption and efficient

manufacture of products invented elsewhere

(e.g., electric generators, stainless steel, jet

engines), and improvements in the manufacturing process. The last includes not only

designing and using better equipment but

also organizing work and managing people

so as to make efficient use of the equipment.

The commonly used measures of technological advantage or progress are not very

satisfactory. Most are indirect; for example,

many are measures of inputs, such as spending on research and development, or they are

rough proxies for outputs of R&D, such as

patent grants. In general, they do not tell us

much about how well technology is being

used in the production of goods. It is impressive, however, that most of the conventional

technology indicators point in the same

direction, and so do case studies that

measure more directly the practical use of

technology in manufacturing. In relation to

other countries and to our own history, the

United States is losing ground.

The dominating technological lead the

United States enjoyed in the 1950s and 1960s

was bound to narrow or disappear in many

fields, since our advantage was in part the

result of wartime destruction of European

and Japanese industry. There are indications, however, that America’s relative

decline is not just the natural effect of growth

in other countries but also reveals a fundamental weakening in our ability to use

technology to make things cheaply and well.

Japan and Germany are ahead of the

United States in the kind of R&D spending

most likely to pay off commercially. Spending by American companies and government

agencies for non-defense R&D rose quite

steadily (in constant dollars) in the 1970s and

1980s, and in absolute terms the United

States leads the world. But that lead simply

reflects the size of the U.S. economy. In

civilian R&D as a percentage of gross

w In a few industries, competitive advantage may also be built on unique endowments of natural resources. For example, the American

paper and lumber industries have substantial advantages over most other nations because of their access to a large, high quality softwood

resource.

26
U.S. Leadership in Technology ● 27

domestic product, we are trailing Japan and

Germany by increasing margins (figure

14).350ur civilian R&D spending was 1.9

percent of GDP in 1985, compared to 2.8

Figure 14.

Non-Defense Researc 

Development, Percent 

1971-86

Percent of GNP

3 -‘ - 1

2 . 8

2 . 6

2 . 4

2 . 2

2

1 . 8

1 . 6

1 4

1.2

1

1971 1973 1975 1977 1979 1961 1963 1965

 U S Japan -- W. Germany

NOTE: Latest data for West Germany are NSF estimates based

on preliminary national data.

SOURCE: National Science Foundation, International Science

and Technology Update 1987 (NSF 87-319)

(Washington, DC: 1987). p.7.

percent in Japan and 2.5 percent in Germany. If defense R&D is included, total U.S.

spending for R&D is about equal to Japan’s

and Germany’s, as a percentage of GNP.

However, the commercial payoff from

defense R&D is uncertain; although it has

sometimes been seminal for commercial applications, such spinoffs tend to be longrange and indirect.

Japan has spurted still farther ahead in

private business spending for R&D. In the

early 1970s, the United States, Germany,

and Japan were about on a par in businessfunded R&D, as a percentage of gross

domestic product (table 2). Today, Japanese

companies are far ahead of their American

counterparts, an indication of the seriousness of their commitment to technological

eminence. German companies are also raising their rates of R&D spending faster than

U.S. businesses, though not at the pace of the

Japanese. Money spent on research and

development is of course an imperfect

measure of effective efforts toward technological progress; the money spent may or

may not pay off in the marketplace. Even so,

the fact that the Japanese and German leads

are widening is reason for concern about

America’s future technological prowess.

In human resources devoted to R&D–

another input measure — the United States is

ahead, but the gap with other countries,

especially Japan, is narrowing. In 1984, the

Table 2.-Business-Funded R&D As a Percentage

of Gross Domestic Product

1972 1981 1983 1985 1986

United States 0.99% 1.22% 1 32% 1.3% 1.42%*

Japan ., 1.15 1.73 1.99 2.09 2 14*

Federal

Republic

of Germany 1.08 146 1.56 1.64 1 69*

● Estlmatad

SOURCE: U S Congress, Office of Technology Assessment, International Competition Services, OTA-ITE-328 (Washington, DC: U S Government

Printing Office, July 1987), p 19

35 .Some analysts argue that the total amount of R&D spending in a nation is more significant than the amount of spending relative to

GNP. IIowever, spending as a share of GDP takes into account the size of the nation’s economy and indicates how R&E) ranks in importance

In the nation’s total expenditures.

36 U.S. Clmgress, Office of Technology Assessment, “R&E) in the United States and in Other OECD Guntries,” staff paper prepared for

the Subcommlt tee on Ekonomic Stabilization, I louse Committee on IIanking, Finance and Urban Affairs, November 1’383.
28 ● Paying the Bill

number of scientists and engineers engaged

in R&D, as a percent of the labor force, was

still higher in the United States than in other

market-oriented countries (figure 15), but

Japan had almost closed on the U.S. levels’

(There is no international information on

the proportion of researchers working in the

civilian versus the defense sector, but the

Japanese defense sector is relatively small;

most resources devoted to R&D are on the

civilian side.)

Figure 15.

Force Population

Per 10,000 labor force population

60 -

4 0 -

- -- - - - - - -

. --

--- -

- -

--- -

--- -

20 -

1965 1973 1 1977 1979

— U s . Japan -

-- W. Germany

SOURCE: National Science Board, Science and Engineering indicators -1987, (Washington, DC: National Science

Foundation, 1987) p. 227, Appendix table 3-17

Other measures also document the

Japanese challenge. For example, in 1983,

Japanese universities graduated 69,600

bachelor-level engineers, while only slightly

more – 73,000 engineers – received

bachelor degrees in the United States.

Japan’s labor force is barely more than half

the size of ours. 38 University education of

engineers in Japan may not be the equal of

that in the United States; most Japanese engineers extensive additional training on

the job.39 Nevertheless, Japanese industry

has nearly twice the engineering graduates,

per capita, to choose from and train if necessary. Moreover, in the United States,

defense industries siphon off about 20 percent of the Nation’s engineers. Engineering

talent, as opposed to scientific, is indispensable for applying research to the development of new products and manufacturing

processes.

In terms of our own past history, the number of engineers and scientists graduating

from American universities is rising; in particular, more engineers than ever are receiving bachelor’s degrees (figure 16). Doctoral

degrees in engineering dropped off sharply,

however, in the 1970s and despite a recovery

had not regained the 1972 peak by 1985

(figure 17). The recovery depended almost

entirely on an infusion of foreign students. In

1985, 57 percent of engineers getting doctoral degrees were foreigners.40

these foreign engineers remain in the United

States, at least for a time, contributing especially to university faculties and to nondefense technology, since most defense work

is done by U.S. citizens. But eventually a substantial number return home. Many

American engineers see no need for a doctoral degree, since they can get a good job

with a bachelor’s or master’s degree. But the

sharp dropoff in doctoral degrees awarded to

37 The Soviet Union claims a hi her share of scientists and engineers in the labor force than any other major count~. The Soviet Union’s

uneven record in technological ~$ormance (e.g., high in space exploration, low in production of consumer goods) reflects factom other than

human resources devoted to saence and technology.

m National Science Foundation, International Science and Technology Data Update 1986, NSF-307, p.28. In 1982, more engineem received

bachelor level degrees in Japan than in the United States (74,000 vs. 67,000).

w See U.S. Con ss, Office of Technology Assessment, International Competitiveness in Electronics, OTA-ISC-200 (Washington, DC:

U.S. Government nnting r Office, November 1983), pp. 314-17.

40 National Science Foundation, Foreign Citizens in U.S. Science and Engineering: History, Status, and Outlook NSF 86-305 Revised

(Washington, DC, 1987).
U.S. Leadership in Technology ● 29

Figure 16.

U. S. Science and Engineering Bachelor Degrees Granted,

Percent of Total Degrees Granted

S/E bachelor degrees as percent of total

14%

12%

.

8% ‘<

‘ . . .

. .

6% -.

‘ . . .

. .

-.

4% . 

. .

.

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986

Sciences -

- Engineering

SOURCE: Office of Technology Assessment contractor report, “Federal Funding of Science and Engineering Education: Effect on

Output of Scientists and Engineers, 1945-85,” Betty M. Vetter (Commission on Professionals in Science and Technology)

and Henry Hertzfeld (Consultant), NTIS order #PB 88-177 928/AS.

Figure 17.

U.S. Engineering Ph.D.s Granted to U.S. Citizens

and Foreign Citizens, 1960-86

Thousands of Engineering Ph. D.s granted

4,000 

3,000 -

2,000 -

I

1,000

. . -

. . -

19 1964 1968 1972 1976 1980 1984

To U.S. Citizens -

-- To Foreign Citizens

NOTE: The totals do not equal U.S. recipients plus foreign recipients because the citizenship of some students is not known.

SOURCE: National Science Foundation, Foreign Citizens in U.S. Science and Engineering: History, Status and Outlook @Washington,

D. C.: National Science Foundation, 1986), table B-21.
30 ● Paying the Bill

U.S. citizens may signal a serious problem in

finding well-qualified engineers for research

and teaching in universities — the seedbed

for future engineering progress.

In other ways as well, Americans are lagging in the human skills needed to use technology to improve manufacturing. Our

public schools are turning out graduates who

do not measure up internationally. This is

especially true in mathematics; for example,

in an algebra test given to thousands of 12th

grade students in 1982, American students

came in 14th, just ahead of Thailand and behind Hungary. Hong Kong ranked first,

slightly ahead of Japan. Maintenance and

repair jobs, which are vitally important to

computerized automation in manufacturing,

require technicians with mathematical

abilities. People who operate the computerized equipment need certain basic

skills. They have to be able to read instructions, grasp the concept of statistical quality

control, communicate with fellow workers,

and understand their own part in a complex

manufacturing process. However, it is not

easy to measure how the lack of these skill;

exerts a dragon American manufacturing.

A strong argument can be made that failure

of managerial skills has also been a serious

handicap in the past 10 or 15 years, as one

U.S. industry after another has lost competitive position. It is axiomatic, though, that a

well-trained, well-educated work force is a

positive force in maintaining technological

advantage.

One way of evaluating the results of a

nation’s R&D efforts is to count up, in some

fashion, the innovations it contributes. A

well-known attempt at a cross-country comparison of innovativeness was the study

sponsored by the National Science Foundation in the mid-1970s. Experts from six

countries (the United States, Great Britain,

West Germany, France, Japan, and Canada)

selected and examined 500 technological innovations that were introduced into the international marketplace from 1953 to

1973.42 Included on the list were such things

as lasers, disc brakes for autos, fiber optics, a

new antibiotic, and a camera with selfdeveloping color film. The great majority of

the innovations the group considered occurred in the United States (319 of the 500),

but the share of U.S. innovations showed a

declining trend over the 21 years (figure 18).

No new international study of this kind has

been done.

Another conventional indicator of R&D

results is patent applications or grants. These

data support the story of former American

dominance and current decline, with the

Japanese as principal challengers. U.S.

patent data are especially telling. Patents

granted to U.S. inventors peaked in 1971

(figure 19). By 1985, patents of foreign origin

accounted for 46 percent of the total granted

in the United States, with Japan — once again

the leader among foreign nations – representing 19 percent. This record is all the

more impressive in light of the fact that foreigners tend to patent only their more

proven and useful developments in the

United States, since it is expensive and inconvenient to apply for patents in countries

other than one’s own.

41 There is, however, a strong correlation between higher income and higher education, and low levels of education are strongly correlated

~~!h%%~p@hin@on, DC: U.S.GPO,lNj

ent rates. See U.S. Cmgress Office of Technology Asessment, Technology and the American Ikonornic Transition,

a Gellman Research Associates, Inc., Indicators of International Trends in Technological Innovation, report prepared for the Nationa]

Science Foundation under contmct no. NSF-(X89, April 1976.
U.S. Leadership in Technolog y ● 31

Figure 18.

Trends in Technological Innovation

Number of innovations

150

100

50

0

1953-59 1960-66 1967-73

Period of market introduction

SOURCE: Research Associates Inc., Indicators of International Trends in Technological Innovation, report prepared for the National

Science Foundation, 1976, table 3-1.

Figure 19.

U.S. Patent Grants y Nationality of Inventor b

1960-86

Thousands of patents granted

90

60 -

70 -

60 -

40

30 - ,

-----

20 - .- ,

.- ._.

10

o

I I I I I f I I 1 1 1 1 I 1 1 1 1

196 0 196 4 196 6 1972 1976 1960 1964

— Total — US Invtrs ---- Non-US Invtrs

SOURCES: National Science Board, science Indicators -1965, (Washington, DC: National Science Foundation, 1986) p. 256; U..S.

Department of Commerce, United States Patent Office, Office of Technology Assessment and Forecast, Technology Assessment and Forecast Report, (Washington, DC:U.S. Government Printing Office, 1973).
32 ● Paying the Bill

Not only has the domestic share of U.S.

patents declined; patents to U.S. nationals

have fallen sharply in absolute numbers

since 1971. In a recent assessment, OTA considered possible reasons for this decline,

considering that R&D spending has risen

steadily .43 Was the R&D process ineffective

in getting results, or had U.S. firms decided

deliberately not to seek patent protection?

The analysis found evidence that the first

possibility is more likely. In a recent survey,

100 U.S. firms reported that they sought to

patent a greater percentage of developments

in the period 1980-82 than in 1965-69.44 If

the propensity to patent is greater, and

spending is higher, then it appears that

spending has become less effective.

Moreover, the National Science Foundation

reports that, in thousands of influential journals throughout the world, research publications by American authors in the fields of

engineering and technology fell steadily

from 42 percent of the total in 1973 to 38 percent in 1982.45

Patenting in OECD countries by residents

of other countries shows a brighter picture

for the United States (figure 20). External

patenting, as mentioned above, is a good indicator of the value companies place on their

new technical developments since the expense and bother of applying in a foreign

country tends to weed out trivial innovations.

In OECD countries, U.S. nationals are the

undisputed leaders in external patenting;

they even had something of a surge in 1983

while Japanese applications dropped slightly. The Germans, despite recent declines, are

still a strong second. Whether the U.S. surge

in 1983 represented a one-time backlog or a

real trend can only be proven when data for

later years become available. The Japanese

record remains impressive. Starting with

about 3,000 applications in 1960, the

Japanese advanced to more than 55,000 in

1983.

Figure 20.

External Patent Application By

Nationality of Applicant

Thousands

140 -

120 -

100 -

80 -

60 -

, -

40 -

. .

. .

---

- - -

. - -- - -

20 -

- ‘

- -

---- -

r

1972 1975 1978 1981 1983

— U.S .

-

- Japan Germany

SOURCE: Organization for Economic Cooperation and

Development, Science and Technology Indicators II:

R&D, Inventiveness and Competitiveness (Paris:

OECD, 1986), tables 24 and 26.

The main failing of patents as a measure of

technological advance is that most patents

are not commercialized; even external

patents may or may not lead to commercial

development. Productivity, another commonly used indicator, does not have this

defect, since technology must be put to use

in industry before it can contribute to a rise

in productivity. Although productivity is but

one factor in competitiveness, it is an important one. The U.S. record in improving

manufacturing productivity is, all-in-all, not

a bad one compared to Europe, especially in

recent years; in the 1980s, our productivity

43 U.S. Congress, Office of Technology Assessment (1987), op. cit., p. 200.

u Id., citing E. Mansfield, “Studies of Tax Policy, Innovation, and Patents: A Final Report,” report to the National Science Foundation,

October 198S, p. 6.

45 National Science Foundation, op. cit., p. 38.
U.S. Leadership in Technology ● 33

growth rates have been as good or better

than those of most of the big European

countries. But Japan continues to beat all the

advanced countries in productivity growth.

That story is told below.

The core question, however, is whether

American manufacturers are falling behind

in the practical application of technology–

using it to produce high quality goods at affordable cost. There are no aggregate data

that really answer this question. The best way

to approach it is to analyze firms and industries, case by case, to see how much and

how well technology is contributing to U.S.

competitiveness. OTA is doing that for the

full assessment of Technology, Innovation,

and U.S. Trade, of which this report is an interim product. A number of such case studies

have already been done, by OTA and others.

It is fair to say from the work already completed that the reputation of U.S.-made

goods for quality and reliability has suffered

in recent years and that American manufacturing methods are no longer the paradigm

for the world.

One of the best examples of such work is

Jaikumar’s study of flexible manufacturing

systems (FMS) in the United States and

Japan. % A flexible manufacturing system is

a production unit which is designed to

manufacture different kinds of parts (for example, transmission cases or clutch housings

for trucks and farm machinery) in relatively

small batches. The FMS is made up of semiindependent work stations (such as numerically controlled machining centers),

connected by automated material handling

systems (conveyor belts, robots) and controlled by computer. Jaikumar compared how

Japanese and American firms used FMSs,

and concluded that American firms had used

the technology far less effectively than the

Japanese. The American systems produced

many fewer kinds of parts, took longer to

develop, and performed less reliably. For example, U.S. firms typically took 2.5 to 3 years

to develop FMSs, compared with 1.25 to 1.75

years in Japan; produced only 10 different

kinds of parts compared with the Japanese

average of 93; and produced an average of 88

units per day compared with 120 in Japan. In

Jaikumar’s words, “[r]ather than narrowing

the competitive gap with Japan, the technology of automation is widening it further.”47

Jaikumar attributed the relatively poor

performance of FMS in the United States to

management, not to differences in machine

quality or performance, or in the complexity

or size of parts produced. American

managers tended to prevent workers from

making changes to the system once it was

operating, treating the flexible automated

technology in much the same way that dedicated, hard-wired automated equipment is

used for mass production, and losing both efficiency and flexibility in the process. “If it

ain’t broke, don’t fix it,” was the attitude

common among American managers.48

Having spent much more time than the

Japanese getting their FMSs up and running,

American managers tried to nail down a

standard operating procedure and stick to it.

Japanese managers, on the other hand, were

willing to continue tinkering and changing

and improving their FMS installations. This

constant emphasis on incremental redesign

and improvement is in fact widely cited as a

@ Ramchandran Jaikumar, “Postindustrial Manufacturing,” Harvard Business Review, Nov-Dee, 1986

47 Ibid., p. 69.

u Ibid., p. 71.
34 ● Paying the Bill

strength throughout Japanese industry, and

a major factor behind the rapid improvement c)) Japanese productivity in manufacturing.

Japanese firms emphasize process technology more than American firms. In a study of

industrial innovation in 50 Japanese and 75

American firms, Mansfield found that the

U.S. firms devoted about two-thirds of their

R&D resources to improvement in product

technology and one-third to improved

process technology. The proportions were

reversed for the Japanese firms. Mansfield

also found that Japanese firms spend twice

as much as their U.S. counterparts on tooling and manufacturing equipment and

facilities for new products, and half as much

on manufacturing and marketing start-up.

While the Japanese have taken pains to

master process technology, they have not

neglected product development. Many new

Japanese products were indeed based on

American or European innovations, but the

incremental adaptations made by Japanese

firms often culminated in a product essentially different from the original innovation.

The development of the videocassette recorder has become a classic example of how

continual incremental refinement of someone else’s basic invention, combined with

heavy emphasis on manufacturing process

development, enabled Japanese firms to

come up with a product that was wholly

new 

51 Moreover, the Japanese emphasis ‘

n

.

excellence in process technology has shown

up in a stream of production-related innovations that American producers in a variety of

industries are eager to adopt, such as design

for manufacturability, just-in-time inventory

control, and statistical quality control. It

should be noted that many of the Japanese

strengths in production organization were

first formulated by American efficiency experts like W. Edwards Deming and J.M.

Juran, although it was in Japanese, not

American, factories that they were applied

with the most diligence.

One of the factors that helps explain the

relatively poor American showing in

manufacturing performance and technology

is the link between production and research/development/design. Constant flows

of people, information, and ideas between

research and production is characteristic of In American firms, the

Japanese firms.52

processes of research (or design) and

production are more often sequential, with

the results of developmental work handed

over to a different set of people for management of production. There is much less interaction between the designers of the product

and the production managers. Japanese auto

companies, for example, require just 43

months to take a model from the initial concept to full production; U.S. auto companies

require 63 months to do the same.53 What

accounts for this 20-month lead, which can

be crucial in adapting to market trends? Not

49 See, for example, Christopher Freeman, Technology Policy and Economic Performance: Lessons from Japan, University of Sussex,

Science Policy Research Unit (London: Pinter Publishers, 1987), and A. Altshuler, M. Anderson, D. Jones, D. Roos, and J. Womack, The

Future of the Automobile: The Report of MIT’s International Automobile Program (Cambridge, MA: MIT Press, 198S).

w Edwin Mansfield, “The Speed and Cost of Industrial Innovation in Japan and the United States: External vs. Internal Technology,”

mimeo, n.d.

51 See, for example, James Lardner, Fast Fonvard: Hollywood, the Ja

r

nese, and the VCR Warn, (New York: W. W. Norton & Company,

1987), and M.B.W. Graham, RCA and the VideoDisc: The Business of esearch (Cambridge.: Cambridge University Press, 1986).

52 See, for example, U.S. Congress, Office of Technology Assessment, Strategies for Commercialization of High-Temperature

Superconductivity, (Washington, DC: U.S. Government Printing Office, forthcoming); and Altshuler, et. al, op. cit.

w Kim B. Clark and Takahiro Fujimoto, “Overlapping Problem Solving in Prcxiuct Development,” Haxvard Business School Working

Paper 874M8, March 1987.
from spending more: Japanese automakers

use only about half as many engineering

hours to complete a comparable project

(“clean sheet” design of a new automobile

and its production) as American

Clark and his colleagues con- automakers. 54

eluded that the Japanese automakers’ design

processes are more efficient because they

give a single “heavy manager” authority over

the whole project; the people doing research, development and design are in constant communication with the people

responsible for manufacture; conflicts are

aired and settled early; product and process

design are treated as simultaneous rather

than sequential activities.

There are other Japanese strengths.

Among those most often cited are greater attention to product quality and reliability,

consensus building, and emphasis on longterm market share rather than short term

profit. All are difficult to quantify, but

firsthand observations, case studies, and the

remarkable record of Japanese industrialization and adaptation in the postwar

period support the basic point: Japanese

manufacturers have moved into a commanding position in many industries and have surpassed U.S. rivals in many important

markets by developing and applying tech5 5 nology.

While the record of technology development and application is mixed in different

European countries and industries, there are

also European examples of aggressive use of

new technology to create a competitive advantage. One of the best known is textile industry machinery. Nearly all new weaving

machines in American textile mills come

from Europe (West Germany and Switzerland) or Japan. Unlike American suppliers,

European manufacturers have introduced a

new generation of equipment every couple

of years. The new equipment is often

programmable, can weave a variety of

widths, and is faster and quieter than the best

American weaving machines. Little wonder,

then, that import penetration in textile

machinery has increased from 7 percent of

the U.S. market in 1960 to nearly 58 percent

in 1986. Import penetration in weaving

machinery was nearly 85 percent.56

The improvement in Japanese and other

foreign producers’ manufacturing efficiency,

quality and performance has elicited a number of responses from American firms. Some

responses have been helpful, and others

have not. Overall, however, the responses

made by U.S. manufacturers have not stabilized or improved America’s position in

world manufacturing.

w Kim B. Clark, W. Bruce Chew, and Takahiro Fujimoto, “Product Development in the World Auto Industxy Strategy, Organization and

Performance,” paper presented to the Brookin~ Institution Macroeconomics tinference, December 3,1987.

= We should not attribute too much of the Japanese record to this one set of factors, hcnvever. The Japanese home market is and has been

much Ie= peMous to imports, particular in sectors targeted for development, than the American market, despite such widely-cited exam Ies

of growing American protectionism as t e 1 Multifiber Arrangement and Volunta~ Restraint Agreements on Japanese auto imports. Ais

subject – how foreign governments use tmde and industrial @icies to promote industrial development and maria e competition from

American and other developed -countxy products – is taken up m the full assessment, Technology, Innovation and U.S. rade. %

w U.S. International Trade Commission, U.S. Global Competitiveness: The U.S. Textile Mill Industry, Report to the Committee on

Finance, U.S. Senate, USITC Publication 2048, December 1987,
U.S. Manufacturing Performance

This war–and it is a war–is

being fought not with dollars, or

oil or steel, or even with modern

machines. It is being fought with

creative imagination and organizational talent.

This admiring, if slightly defiant, description of a powerful foreign economic challenger is not an American’s view of the

Japanese competition in the late 1980s. It is

a Frenchman’s view of America in 1969.57

Twenty years later, this description of

American industry as all-conquering has

come to sound quaintly out of date.

American pre-eminence in a great many

manufacturing industries is gone. Take consumer electronics. Only one major U. S.-

owned company is still making color TV sets,

and most of its production takes place in

Mexico; no American-owned company

makes video cassette recorders or compact

disc players. Mass production of

automobiles was invented in the United

States, but others (especially the Japanese)

are now leaders in the technology and

management of auto manufacture. Despite

the U.S.-Japanese agreement restricting

Japanese imports and despite the rise of the

yen, 21 percent of the passenger cars sold in

the United States in 1987 were Japanesemade (another 6 percent were made by

Japanese companies in North America);

another 9 percent were imports from other 58 In semiconductors,

foreign countries.

another native born American product and

industry, U.S. companies are still strong,

especially in microprocessors and advanced,

custom designed chips. Yet, overall, U.S.

companies have continually lost market

share to Japanese competitors since the late

1970s. By 1987, they had almost ceded

dynamic random access memory devices

(DRAMs) –a large market segment that has

been both cash cow and technology driver

for the industry-to the Japanese. In all of

these industries, trouble started before the

rise of the dollar.

Against the evidence of a decline, some

have argued that U.S. manufacturing is

faring quite well, that productivity growth

has been strong in the 1980s, and that the

high dollar – not poor performance by

manufacturing — is responsible for the massive manufacturing trade deficits of the

decade. The prescription that usually follows

from this argument is to do nothing in trade

or industrial policy to support U.S. manufacturing. One part of the argument is the statement that manufacturing output, measured

in constant dollars, has not declined as a

share of gross national product, and that if it

eventually does, that alone is not an “omen

of decay or loss of competitiveness.”59 Instead, it may simply reflect a natural evolution to a different pattern of demand in a

maturing economy, and to the successful

economic development of our trading

partners.

57 Jean-Jacques .Seman-schreiber, The American Challenge (New York: Atheneum, 1969), p. xiii.

5a The remaining 64 percent were made in the United States and Canada. Production in both countries is considered “traditional North

American’ ’because of the U.S.-Canadian agreement establishing free trade in motor vehicles and parts.

w Molly McUsic, “U.S. Manufacturing :

$

Any Cause for Alarm?” New En land Economic Review, JanuaV/Februaty 1987. For other

examples of this point of view, see Robert . . Lawrence, Can America Corn

r

te. (Washington, DC: The F Brookings Institution, 1984); Office

of the U.S. Trade Representative, Annual Report of the President of the nited States on the Trade Agreements Program, 1985, p. 20.

36
U.S. Manufacturing Performance ● 37

This argument does not really stand up to

scrutiny. The United States is not and gives

no sign of becoming a post-industrial

economy. But because the question of

manufacturing share is closely linked with

policy, it is worth examining.

The Share of Manufacturing in the

U.S. Economy

Though the record is not entirely clear,

there is evidence that the share of manufacturing in gross national product (GNP) is

falling. And while it is falling (or at best staying even), the demand for manufactured

goods by American consumers, businesses,

and government is rising.

In current dollars, the share of manufacturing in GNP fell from 29 percent in 1960 to

just under 20 percent in 1986, and the rate of

decline has been faster since 1979 than

formerly (figure 21). However, this current

dollar measure has the defect that it does not

take rising productivity into account.

Manufacturing has performed better than

the economy as whole in raising productivity,

and some of that productivity growth has

been passed on to consumers in lower-thanaverage price increases. In fact, Commerce

Department data on the constituents of GNP

data show the share of manufacturing, in

constant 1982 dollars, hovering quite steadily around 21 or 22 percent of total output

since the late 1940s (figure 22). This series,

prepared by the Department’s Bureau of

Economic Analysis (BEA), is the only

regularly published official set of data on

constant dollar shares of GNP. It is the basis

for the statement that manufacturing’s share

of GNP has held steady for many years.

However, estimating the size of various

parts of the economy in constant dollars is a

difficult task; the uncertainties are great

enough to cast doubt on the constant-share

conclusion. In the BEA series based on constant 1982 dollars, one difficulty in particular

looms large. That is the unique role assigned

to the non-electrical machinery industry,

which includes computers, in pulling up the

whole manufacturing sector.

According to the BEA series, 15 of the 21

major manufacturing industries in the

United States experienced a declining share

of GNP from 1979 to 1986, while five stayed

even or rose only moderately (see table 3) –

not enough of a rise to offset the decline in

the majority of industries. The only major industry showing a big increase in share was

non-electrical machinery; and more than 100

percent of that industry’s increase was due to

the zooming sales, rapidly improving quality

and productivity, and falling real price of

computers. By the logic of the numbers, it

would appear that computers, which contribute only 2 or 3 percent of manufacturing

output, singlehandedly held up the share of

the whole manufacturing sector.

Another difficulty is that the choice of base

year for constant dollars greatly influences 60 The more recent the base year the results.

chosen, the smaller appears the share of

manufacturing in past years (see figure 22).

For example, when 1958 is used as the base

year, the share of manufacturing in real GNP

for the year 1948 appears as 29.7 percent; on

m Nicholas S. Pema, “The Shift from Manufacturing to !$ewices: A Concerned View”, New England Fxonomic Review, JanuaV/Feb~aY

1987.
36 ● Paying the Bill

Figure 21

Manufacturing Share of .S. Gross U.

Percent of GNP

(current dollars)

35

30

25

20

National Product

I I I I I 1 I 1 1 I I I 1 1 1 I 1 I 1 1 I I I I 1 1 I 1 1 I I I 1 I I I

1947 1951 1955 1959 1963 1967 1971 1975 1979 1963

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts, electronic data,

Table 6.1

Figure 22

Manufacturing Share of Gross National Product

Percent of GNP

(constant dollars)

35

30

25

20

‘ . . ’

15 I I 1 1 I I I I 1 I I 1 I 1 I I I 1 1 I I I I I 1 I 1 I I 1 I I 1 I 1 I I I

1947 1951 1955 1959 1963 1967 1971 1975 1979 1983

— $195 6 ‘ --- $197 2 — $196 2

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts, electronic data, table

6.2
U.S. Manufacturing Performance ● 39

0

*

u

0)

0

u)

co
40 ● Paying the Bill

a 1972 base, the share in 1948 appears as 24.8

percent; with the 1982 base, the 1948 share

shrinks to 21.5 percent – just about the same

as the 1982 share, which was 21.8 percent.

The difficulty with applying an updated constant dollar base to earlier years is that the

new base contains new weights for the inputs

to industries, and these new weights do not

represent the economy as it really was in earlier years. Perna, in discussing this problem,

said: “The further one gets from the base

period, the less representative it is of the

economy’s actual structure.

In order to analyze the changing structure

of the economy for its assessment Technology and the American Economic Transition,

OTA independently prepared estimates of

various parts of the economy in constant

1980 dollars for selected years. 63 The OTA

estimates show manufacturing’s share

declining by 2.5 percentage points from 1972

to 1984, with an accelerated decline after

1977. The complications and uncertainties of

constructing these constant dollar estimates

are great; OTA’s estimates have their share

of flaws. The point is that constant dollar estimates are not graven in stone, but must be

taken with a degree of caution.

Suppose it is true that manufacturing is

fading as a contributor to the economy as a

whole. The next question is: does it matter?

It is not ordained that the share of manufacturing in GNP should remain constant. In

fact, the current dollar figures show it declining gradually in the 1950s and 1960s, when

American manufactured goods were still

dominant in the world (however, the decline

hastened in the 1970s and 1980s, as

American products lost world market share).

Moreover, agriculture is often held up as an

example of a sector of the economy that grew

greatly in output and productivity while

declining from a 22 percent share of the national economy at the turn of the century to

2.2 percent in 1986.

A critical difference between manufacturing and agriculture is that the latter has continued to fulfill domestic demand (more

precisely, to produce enough that imports

are fully covered by exports, and sometimes

to generate sizable trade surpluses as well).

Over the years, Americans have devoted successively smaller shares of their total purchases to products of farms, forests, and

fisheries, and more to other goods and services. The same is not true of manufactured

goods. While per capita spending for services has grown greatly in the past 40 years

(table 4), it was not at the expense of demand

for manufactured products. While consumers spent smaller shares of their growing

incomes on food and fuel, they spent more

on items such as cars, television sets, and

sports gear. Altogether, American consumers, businesses, and government increased their share of spending on

manufactured goods other than food and

fuel items from 23.4 percent of all their purchases in 1948 to 30.7 percent in 1986. Clearly, the U.S. economy is not passing into a

post-industrial state in which demand for

manufactured goods is giving way to demand

for services.

61 The weights are used to construct price deflators, which are the basis for constant dollar estimates of GNP and its constituents.

w Id. For another study that questions BEA’s methods for developing the constantdollar series, and concludes that manufacturing has

declined as a share of GNP, see Lawrence R Mishel, Manufacturing Numbers: How Inaccurate Statistics Conceal U.S. Industrial Decline

(Washington, DC: Economic Policy Institute, 1988).

m U.S. Congress, Office of Technology Assessment, Technology and the American Economic Transition: Choices for the Future

OTA-’IT7r-283 (Washington, DC: U.S. Government Printing Office, May 1988).
Table 4.– Real per Capita Spending on Goods and Services (1960-86)

Per capita spending in 1982 dollars Percent of real apparent consumption

1948 1960 1973 1979 1986 1948 1960 197 3 1979 1986

Apparent consumption $7,43 2 $9,233 $13,099 $14,166 $15,97 3 100.0% 100.0% 100 o% 100 o% 100.0%

Gross national product 7,56 3 9,21 1 12,95 0 14,18 2 15,37 0 101 8 998 989 100 1 96. 2

Goods purchase s 3,437 3,966 5,613 6,200 7,250 462 43.0 429 43.8 45.4

Consumer manufactures, except food and fuel 1,038 1,253 2,076 2,320 2,873 140 136 159 164 18.0

Producers’ durable equipment 525 461 942 1,150 1,298 71 5 0 7 2 81 81

Government goods purchases 181 400 461 733 2 4 4 3 3.1 3.3 4.6

Consumer food and fuel purchases 1,693 1,851 2,187 2,269 2,346 228 20.1 167 16.0 14.7

Service purchases 2,961 3,956 5,629 6,287 7,041 398 429 43.0 444 441

Consumer services 1,920 2,455 3,710 4,315 4,925 258 266 28.3 305 30.8

Government services 1,042 1,501 1,919 1,972 2,116 140 16.3 14.6 13.9 13.2

NOTE Apparent consumption equals gross national product less exports plus imports

SOURCE: U S Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts, electronic data, consumer goods and services purchases from Table23, government goods and services

spending from Table 3 BB producers’ durable equipment spending from Table 57
42 ● Paying the Bill

Until about 1970, U.S. production of

manufactured goods generally kept pace

with consumption, or stayed ahead; but then

output began to dip below consumption, as

shown in the recurring manufacturing trade

deficits of the decade. In the 1980s, of course,

manufacturing output fell far short of consumption, creating the mounting manufacturing trade deficits. Foreign suppliers have

filled the ever-widening gap between

production and consumption of manufactured goods in the United States in the 1980s.

Manufacturing Employment and

Wages

Other measures that may tell us something

about the performance of U.S. manufacturing are the number of people working in it

and what they get paid. Jobs in manufacturing have declined in the past decade, not just

in relative terms, but in absolute numbers.

Real wages of production workers in

manufacturing (adjusted for inflation) have

also dropped, by about 6 percent over the

past 10 years. Real compensation per

manufacturing worker, including employerprovided benefits, has stayed almost flat – in

striking contrast to Japan and major

European countries, where manufacturing

compensation rose about 20 percent in the

same period.64

The decline in manufacturing jobs has been

hard on millions of displaced workers and

their families and scores of communities, but

it does not necessarily signify weakness in the

manufacturing part of the economy. Since

the nineteenth century, and throughout the

period of American industrial dominance,

the share of employment in services has been

larger, and has grown faster, than in

manufacturing (figure 23). As the output of

manufactured goods grew, employment rose

less because of improving labor productivity.

While the share of employment in U.S.

manufacturing started a gradual decline in

the 1950s, the absolute number of manufacturing jobs kept growing until 1979, when

manufacturing employment peaked at 21

million. In 1986, it averaged 19.1 million.

With the strong expansion of exports and

manufacturing output toward the end of

1987, employment recovered to 19.4 million–still 1.6 million below the peak.

An absolute loss of manufacturing jobs is

not necessarily a sign of weakness either.

Some of the shrinkage in employment was

certainly due to rising productivity. Some

was also certainly due to the enormous

growth in net imports of manufactured

goods over the same period. And much of it

was due to a combination of the two factors,

in which actions to improve productivity –

automation, for example, or closure of older,

less efficient plants – were forced by foreign

competition. If demand for a product is

growing fast enough, then imports, productivity, and employment can rise simultaneously. If not, rising net imports are likely

to cost jobs. For example, employment in

three traditional industries –steel, textiles,

tM U.S. Department of Labor, Bureau of Labor Statistics. The figure for wages is the real hourly wage for production workers, who make

up about two-thirds of manufacturing employment. The figure for compensation is real weekly compensation for all persons employed in

manufacturing, includin wage and salaV earners, the Self+ mployed, and unpaid family workers, in the United States, and for all employees

in other countries. The Eo nsumer Price Index was used as the basis for calculating real wages and real compensation.
U.S. Manufacturing Performance ● 43

Figure 23

Distribution of U.S. Employment, by Sector

1870-1986

Percent of total U.S. employment

. .

-

60

t

..-

.’ I

40 -

. .

.

---- -

. . --

. . -

0

1 I I I I I I I

1870 1885 1900 1915 1930 1945 1960 1975

— Primar y— Manufacturing -

--- Service s

SOURCE:

U.S. Department of Commerce, Bureau of the Census, Historical Statistics of the United States, (Washington, DC: 1975) p. 137,

series D127-141

and motor vehicles –dropped by 600,000

from 1979 to 1986. In each of these industries, productivity improved and imports

rose; at the same time, demand for the

industries’ products either declined or grew

slowly.

One study, following the ripple effects of

imports and exports through the economy by

means of an input-output model, concluded

that the United States gains 7.5 percent more

jobs from a given amount of exports than it

loses from the same amount of imports.65

Every $10 billion of exports generates

193,000 jobs, the study found, while 179,000

jobs are lost with $10 billion of imports.

However, the trade deficits have been so big

in recent years that job losses due to imports

have swamped the job-creating effect of exports. In 1987, for example, exports of goods

and services amounted to $428 billion while

imports were $547 billion. The deficit of

$119 billion spelled a net loss of 1.5 million

jobs, according to the analysis.

It has been suggested that the loss of

manufacturing jobs in recent years maybe at

least partly illusory, because it simply reflects

the trend in many manufacturing companies

to contract out services that they formerly

paid their own employees to perform. For

example, if General Motors lays off engineers and contracts with an engineering

design firm to do the work once done inhouse, that shows up in national employment

data as a loss of jobs in manufacturing and a

gain in the engineering and architectural services category. In the same way, if firms unm Richard S. Belous and Andrew W. Wyckoff, “Trade Has Job Winners, Too,” Across the Board, September 1987. The authors used the

OTA input-output model for this study.
44 ● Paying the Bill

bundle legal, accounting, auditing, janitorial,

or clerical activities, then the employment

figures would show a shift from manufacturing to services. A recent analysis, done by a

U.S. Department of Labor economist, concludes that unbundling has been a very small

factor in the growth of employment in

producer services in the last decade.66

Within manufacturing firms, the proportion

of workers in managerial, professional, and

technical occupations has actually risen (and

the rise is not accounted for by a changing

mix of manufacturing industries). While the

proportion of clerical and service workers in

manufacturing has dropped slightly, these

occupations are not very significant in the

growth of employment in producer services.

Thus, unbundling is not happening industrywide, though it may well be happening

in some individual firms. Firms may be

buying more services from outside, but not

at the expense of already existing jobs in the

manufacturing sector.

It is fair to conclude that the job losses in

manufacturing are real, not illusory. And

though it maybe hard to calculate the exact

number of jobs lost to import competition,

the number is probably large –above 1 million at the least.

It also seems evident that import competition has been a powerful factor holding down

the wages of manufacturing workers. Until

the 1970s, wages of manufacturing workers,

like wages of American workers generally,

rose strongly and steadily. Since then,

manufacturing workers have made few lasting gains, and the real wages of production

workers (i.e., blue collar workers on the shop

floor) had not regained their 1978 peak a

decade later. While manufacturing workers

in the other advanced industrial nations enjoyed strong growth in real compensation

(wages plus benefits) from 1977 to 1986–

growth that ranged from 14 percent in Italy,

to 19 percent in Japan and Germany, to as

much as 24 percent in Britain — Americans

employed in manufacturing gained less than

2 percent.

What happened to manufacturing wages

has happened to real wages and salaries of

all Americans: the long-term, consistent

growth of the postwar period came to a halt

in 1973, and there has been an unsteady but

overall decline since 1978.68 Part of this

change may have been due to demographics;

the surge of young people from the baby

boom and the increased participation of

women in the labor force probably held

down wage growth in the 1970s. However,

the rate of growth in the work force has been

falling since 1978, and is now back to earlier

norms. Since 1978, a combination of factors

has restrained real wage growth: first, inflation, and then the deep recession of 1981-83,

the decline of labor unions and, not least, the

loss of manufacturing jobs to foreign competition and the threat of further losses.

a6 John Tschetter, “Producer Sewices Industries: Why Are They Growing So Rapidly?” Monthly Labor Review, December 1987.

67 Some analysts have argued that the loss of U.S. manufacturing jobs since 1979 simply matches improvement in manufacturing

productivity, and draw the conclusion that imports had no effect on job loss. However, rising im

r

rts of manufactured goods during the 1980s

almost certainly replaced some domestic production of these goods –and the jobs that wou d have been devoted to producing them. In

addition, as discussed in a later section, the official figures may overstate the growth in manufacturing productivity in the 1980s.

aa Weekly earnings of full-time wage and sala~ eamem declined 3 ~rcent from their 1978

K

ak to 1987; hourly earnings of production

and nonsupetisory workers on private nonagricultural payrolls declined 8 percent from 19 to 1987. Earnings figures are from U.S.

Department of Labor, Bureau of Labor Statistics, Empl

T

entand Eamin ,tables A-73(published quarterly) and B-1 (published monthly).

Real earnings are figured on the basis of the Consumer rice Index for U an Consumers x (CPI-U), 1982= 100.
U.S. Manufacturing Performance ● 45

Productivity Growth: International

Comparisons

Another measure of how U.S. manufacturing is doing in comparison with other nations

is trends in productivity. The bare figures

suggest that, over the past quarter of a century, the United States did not measure up

to other nations in raising labor productivity 69 The U.S.. growth ‘ate in manufacturing.

was less than 3 percent per year, on average,

from 1960 to 1986; this compares with nearly 8 percent for Japan, about 5 percent for

France, Italy, and Germany, and over 3 percent for Great Britain and Canada (table 5).

Behind these 26-year averages lies a more

complex story. Since 1979, the American

record has been about as good as Europe’s —

better than some major countries and not far

behind the leaders. But, as noted earlier,

America’s number one trade competitor,

Japan, has continued to excel, achieving

higher growth than any other industrialized

country in the 1980s, with an average of 5.6

percent growth per year from 1979 to 1986

compared to 3.5 percent for the United

States. Another distinction for Japan is that

its productivity growth, more than that of any

other advanced country, continues to be

linked with rising output and employment.

Faster productivity growth in other industrialized countries was in part a catchup

phenomenon. From 1960 to 1973, U.S.

manufacturing productivity rose at the respectable rate of 3.2 percent per year; but

this rate was bettered by nearly all European

countries, most of which were repairing war

damage and investing in new industrial

equipment. Japan, starting from a lower

prewar base and suffering more war destruction than most European nations, was advancing even faster, at the remarkable

average annual rate of 10.3 percent.70

From 1973 to 1979, productivity growth

slowed to some degree in all the industrialized countries but (except for Britain’s dismal record) the U.S. growth rate dropped to

Table 5.–Annual Percent Changes in Manufacturing Productivity, Seven Countries (1960-86)

United United

Year states Canada Japan France Germany Italy Kingdom

Output per hour:

1960 86 ., ., . . . . . 2,8 3.3 7.9 5.2 4.6 5 7 3 6

1960 73. . 3.2 4.5 10.3 6.5 5 8 7.5 4 2

1973 79 . . . 1.4 2.1 5.5 4,9 4,3 3 3 1,2

1979 -86..... . . . : : ., ., 3.5 2.3 5.6 3.1 2.7 4.3 4.5

NOTE: Rates of change based on the compound rate method

SOURCE: Arthur Neef and James Thomas, "Productivity in Manufacturing at Home and Abroad,. Monthly Labor Review, Decemer 1987 U S Department of Labor, Bureau of

Labor Statistics, Monthly Labor Review, December 1987, Table 47

m Productivity of other factors of production besides labor, especially capital, is also ve~ important to good manufacturing performance.

I Iowever, international comparisons are usually limited to labor productivity since data on multifactor productivity are fragmentary.

70 A number of economic historians have discussed the political and social conditions that made it possible for many nations –especially

Germany and Japan – to rebuild rapidly and catch u afterword War II; see, forexam Ie, Moses Abramovitz, “Catching U , Forgin Ahead,

and Falling Behind,” Journal of Fxonomic IIisto~, une 1986, XLV1 (2), 1’ p~. 38 S-406; dancur Olson, ‘Ile Rise and Fall of Nat Ions. p “ ~ð•€) E!20nomic

Growth, Stagflation and Social Rigidities (New Haven, CT: Yale University Press, 1982).
much the lowest of any major country. The

U.S. manufacturing productivity growth rate

has apparently recovered in the 1980s, both

in relation to this nation’s own history and to

the current experience of European

countries. The caveat implied by “apparently” is this: growth rates in manufacturing

productivity are based on the BEA (Commerce Department) constant-dollar figures

for GNP. As discussed earlier, there are

major difficulties in constructing such a

series; in particular, since 1982, the real, constant-dollar share of the manufacturing sector in GNP may be overstated because the

contribution of computer manufacture may

be exaggerated. If this is so, then the rate of

productivity growth in manufacturing in

recent years is also overstated. Excluding

non-electrical machinery (SIC 35, which includes computers), the growth rate for all

other manufacturing was 2.2 percent per

year for 1979 to 1986, compared to 3.5 percent when the non-electrical machinery segment is included. A realistic estimate for

manufacturing productivity growth probably

lies between the two figures.

Despite these statistical problems, the picture drawn from productivity growth figures

over the past 26 years is reasonably consistent with common sense observations.

European countries rebuilt in the 1960s and,

except for Britain, continued to grow in the

1970s (although at a rather slower pace)

while U.S. growth slowed drastically. In the

1980s, the United States has more or less

kept pace with Europe (again except for

Britain, which has recently posted the best

growth rate among major European

countries). On the evidence of the productivity figures, it seems possible that our

deteriorating trade balances with Europe in

the 1980s were due more to the high dollar

than to subpar performance in manufacturing; indeed, the United States maintained a

positive trade balance with Europe until

1983, and the balance with Europe was the

first to improve as the U.S. trade deficit finally began to decline in 1988. This does not

imply that U.S. manufacturing is equal to the

Europeans in all sectors or products, but

American producers do have areas of

strength vis-a-vis the Europeans.

The Japanese challenge is different. Starting from a lower base, the Japanese improved much faster than everyone else until

1973. Relying almost entirely on imported

oil to run its industries, Japan was even harder hit by the oil shocks of the 1970s than

Europe, and certainly than the United

States; yet Japan managed to stay on top in

productivity growth throughout the 1970s,

and has continued to improve in the 1980s at

rates matched by no other advanced industrial country. Impressively, the Japanese

have continually raised output and employment while improving productivity. From

1979 to 1986, Japan’s manufacturing output

grew 60 percent, and employment in

manufacturing nearly 10 percent, despite a

slight drop in 1986 caused by the rising yen

(table 6).71

It is quite another story for the European

leaders in productivity growth. Britain,

which boasted a 4.4 percent annual productivity growth rate from 1979 to 1986, did it,

at least in part, by drastic cutbacks in the

manufacturing sector in the early 1980s.

71 Manufacturing employment in Japan declined from 1974 to 1979, following the oil shock; it regained the 1974 level in 1986. However,

real compensation m manufacturing rcw steadily eveq year, to a level 27 ~rcent higher in 1986 than in 1973. Real compensation in U.S.

manufacturing rose 7 percent during the same period, with nearly all the gam occurring before 1978.
U.S. Manufacturing Performance ● 47

Plants were closed, workers were laid off,

and unemployment soared to 20 percent and

above in the industrial North. Through 1982,

Britain’s manufacturing output declined

sharply; it has since turned backup, showing

a moderate overall loss for the 7 years of 4.4

percent. Manufacturing employment fell

steadily with no recovery, for a loss of 27.5

percent. France, with a productivity growth

rate of 3.1 percent per year, had a 2 percent

cut in manufacturing output and lost 16 percent of manufacturing employment. Italy’s

large rise in productivity went along with a

sharp drop in manufacturing employment.

Germany and the United States were in the

middle, with medium to good productivity

growth, rising output, and moderately

declining employment.

While jobs in U.S. manufacturing dropped

by 10 percent from 1979 to 1986, real output

rose over 16 percent (according to the BEA

constant dollar series). At least some of the

Table 6.– Index of Manufacturing Output and

Employment, 1986; and Productivity

Growth Rates, 1979-66

Annual average

manufacturing

1986 productivity

output Employment growth

(1979 = 100)* 1979-86

United States 1165 906 3 5

Canada 114.2 97.1 2.3

West Germany 105.8 92.1 3.1

France 978 84.4 2,7

Italy 1122 825 4.3

Japa n 159,9 109.5 5 6

United Kingdom 95.7 72.5 4 5

● Adapted from Labor Department data published on a 1977 = 100 basis

SOURCE: Arthur Neef and James Thomas, “Productivityy in Manufacturing at

Home and Abroad, - Monthly Labor Review, December 1987, U S Department of Labor, Bureau of Labor Statistics, Monthly Labor Review,

December 1987, Table 47

turnaround in American manufacturing

productivity was due to shutdown of older,

less efficient plants. With this restructuring

came some massive worker displacement; an

average of 2 million workers per year, half of

them in manufacturing, lost jobs due to plant

closures or production cutbacks from 1979

to 1985.72 Steel is an extreme example. Jobs

in basic steel numbered 570,000 in 1979 and

by the end of 1987 were down to 280,000. The

USX company, formerly U.S. Steel, contracted from over 100,000 employees in 1980

to fewer than 20,000 in 1987. But meanwhile,

USX productivity improved from 10.8 manhours per ton of steel shipped in 1983 to 3.8

manhours in 1987.73

In the last half of 1987, as exports finally

began to rise briskly in response to the low

dollar, manufacturing employment climbed

a little (but still remained 8 percent below

the 1979 peak) while output grew to 30 percent above the 1979 level. During the expansion, productivity growth held up; the growth

rate was 3.7 percent in 1986 and 3.3 percent

in 1987. To some degree, this simply

reflected greater use of plant capacity, which

generally has the effect of raising productivity. But there are some signs that it also

reflects more fundamental changes — investment in productive new equipment, more efficient organization of work, and better use

of people.

A measure for comparing levels of labor

productivity from one country to another (as

distinguished from growth rates) is gross

n These figures are from two surveys of worker displacement, designed and analyzed by the Bureau of Labor Statistics, U.S. Department

of Labor, and conducted by the Bureau of the Census, U.S. Department of Commerce, in JanuaT 19M and January 1986.

73 David Ignatius, “What’s Left of Big Steel?” The Washington Post, Mar. 20, 1988, p. Cl.
48 ● Paying the Bill

domestic product per employee. This

economy-wide measure includes private services and government activities as well as

manufacturing. By this measure, the United

States was still ahead of most other advanced

nations in 1986. Several European countries

stood at 80 to 90 percent of the U.S. level

and Japan had reached 69 percent.74

However, the rate of productivity growth in

the whole U.S. economy has recovered only

slightly from the doldrums of the 1970s.

Other major industrialized nations are now

improving at much faster rates, Japan the

fastest of all (see table 7).

It is a common observation that although

agriculture, many kinds of services, and

some manufactures are not highly productive in Japan, the Japanese have put

prodigious effort into raising productivity in

industries such as steel, autos, and

electronics that have been central to their export-led growth strategy. It would be helpful,

in comparing productivity levels in the

United States with Japan, to break out

manufacturing, by industry, from the rest of

the economy. However, various international comparisons of levels of manufacturing

productivity have come to quite inconsistent

conclusions; in some, Japanese manufacturing productivity is shown as barely 70 percent

of the U.S. level, while in others it is over 90

percent for all manufacturing and well above

100 percent for certain industries.75

Several case studies of individual industries

have found that Japan has not only caught up

with the United States in productivity, but

has forged ahead. For example, the International Motor Vehicle Program found that in

the mid-1980s it took, on average, 19.1 hours

to build a car in Japanese assembly plants

Table 7.-Average Annual Changes in Real Gross Domestic Product per Employed Person, 1960-86

United United

Year states Canada Japan France Germany Italy Kingdom

1960-66 . . . . . . 1.2% 1.9% 5.5% 3.6% 3.1% 37% 2.2%

1960-73 . . . . . . . . . . . . . 1.9 2.6 8.2 4.9 4.1 5.8 2.9

1973-79 . . . . . . . . . . . . . . 0.0 1,3 2 9 2.7 2 9 1.7 1.3

1979-86 . . . . . . . . . . . . . . 08 1,0 2 8 1,9 1.6 1.6 1.7

SOURCE: U S Department of Labor, Bureau of Labor Statistics, Office of Productivity and Technology, unpublished data, mimeo, August 1887

74 These cross country comparisons are based on purchasing power parity (PPP) exchange rates, which show what it costs in one unit of

foreign currencies to buy goods and setices equivalent to what a dollar will buy. At market exchange rates, rather than PPP exchange rates,

Japan’s GDP

&

r employee reached 90 percent of the U.S. level in 1986. The market exchange rate for 1986 was 168.5 yen to the dollav the

PPP rate was yen to the dollar. Another measure ofeconomy-wide productivity is GDP per hour worked. Since Japanese workers ut in

mom hours

r

ryear than U.S. or European workem, this measure shows Japan at only58 percent of the U.S. level in 1986, using PPP exc ange !

rates, and 6 pereent using market rates.

75 See, forcxample, Elliot S. Grossman and George E. Sadler, Comparative Productivity Dynamics: Japan and the United States (Houston,

TX: American Productivity Center, 1982); George E. Sadler, Update: International Productivity Comparisons (Houston, TX: American

Productive Center, 1986); Elliot S. Grossman, Pace Univemi %’ 7

“Productivity and International Competition: United States and Japanese

Industries, papcrprepared for conference on Interindustry Dif erences in Productivity Growth, Amertcan Enterprise Institute, Washington,

DC, October 1984; Martin Bailyand Alok Chakrabarti, Innovation and the Productive Crisis (Washin on, DC: The Brookin Institution,

1988); Japan Productivity Center, Productivity Research Institute, International &mpansons of Lbor Productivity @ho o: Japan

Productivity Chter, 1988 ; Molly McUsic, o .

J

cit.; and calculations based on data in Organization for Economic Cooperation and

Development, Industrial tructure Statistics, 1 k (Paris: OECD, 1987).
U.S. Manufacturing Performance • 49

and 19.5 hours in Japanese-managed plants

in America. In American-managed plants

the average time for assembly was 26.5

hours. The quality of the Japanese autos was

better too, judging by the record of defects

owners discovered in the first three months

of use. The U.S. plants were improving, were

generally more productive than European

plants, and had about as good a record as the

European car makers in freedom from

defects; but the Japanese were getting better

too. 76 For another example, Japanese

productivity and quality is conceded to be superior in parts of the semiconductor industry, especially in the manufacture of 256K

dynamic random access memory chips.

The solid conclusion that can be drawn

from available data is that Japan remains the

leader in productivity growth. It is normal

and expected that countries developing from

a rural past to an industrialized future should

show high rates of productivity growth; witness Japan in the 1950s and 1960s and Korea

now. What Japan has accomplished in the

past decade is to keep on raising productivity

at a rapid rate, after becoming world class in

many industries, raising output, employment, and wages through times of a rising yen

as well as a falling yen.

One element supporting Japan’s progress

is a high rate of investment in manufacturing.

As figure 24 shows, Japan consistently invested more in manufacturing, per dollar or

yen of manufacturing output, than the

United States did, from 1973 to 1985.77 As

for capital invested each year per manufacturing worker, the Japanese investment (expressed in U.S. dollars) climbed rapidly from

1978 on, and b 1985 was 11 percent above

the U.S. level.78 These figures do not tell the

story for the whole economy. For example,

taking services together with manufacturing,

the Japanese rate of investment in

machinery and equipment, per employee,

was about on a par with the U.S. rate in 1985.

If Japan’s rate of capital investment is higher

in manufacturing, the U.S. rate is almost certainly higher in many service industries. For

example, optical scanners of bar codes and

computerized systems for inventory control

are now commonplace in American supermarkets and retail stores. Japan has poured

most of its investment and management efforts into the manufacturing industries that

its leaders see as critical for competing in

world markets. Many services have been

relatively neglected, though not all; certain

services important to international trade,

such as banking, do very well.79

76 Information provided by the International Motor Vehicle Program, Center for Technology, Policy, and Industrial Development,

Massachusetts Inst]tute of Technology.

77 Tle source of this information is the Organization for Ezonomic Cooperation and Development (see figure 24 for source details); 1985

is the latest year for which data are available. Investment in manufacturing means gross capital formation, including buildings and producers’

durable equipment. Manufacturing output is the share of manufacturing in gross domestic product, that is value added in manufacturing.

78 How U.S. and Japanese investment per worker compare depends a great deal on what exchange rate is chosen. ~lis is not i rue of

investment as a share of manufacturing output, which can be fi

8

red in each country’s own currency.) The figures here are in L’. S. doilan,

based on 1985 prices and the 198S purchasing-power-parity (PP exchange rate for fried capital formation in machinery and equipment, Pi>[)

exchange rates are developed by the Organisation for Ezonomic Cooperation and Development (OECD) to show what it costs to buy the

same amount of goods and semices in different currencies. The PPP exchange rate for machinery and equipment in 1985 was 2!46 yen to the

dollar.

79 U.S. (km ess, Office of Technology Assessment, International Competition in Services, (1987), op. cit., see espcciai!y chapter 3,

“International ~repetition in Banking and Financial SeMces.”
50 ● Paying the Bill

Figure 24

Gross Fixed Capital Formation in Manufacturing, 1973-85

Percent of manufacturing GDP

25 1

20

15

10

5

1973 1975 1977 1979 1981 1983 1985

— u s –— Japan Germany

Dollars per manufacturing worker

5000 

1000 –

19 1981 1983 1985

— u s —Japa n Germany

NOTE: Converted to U.S. dollars at 1985 Purchasing Power Parities for Machinery and Equipment Capital Formation

SOURCE: Organization for Economic Cooperation and Development, Flows and Stocks of Fixed Capital, 196085, (Paris: OECD, 1987);

OECD, National Accounts, Detailed Tables, 1960-85, Volume 11, (Paris: OECD, 1987)
U.S. Manufacturing Performance ● 51

Large investment in equipment does not by

itself assure either productivity growth or

good performance in manufacturing; how

work is organized and people used with the

new equipment make a big difference. Here,

the Japanese seem to excel. Managerial

competence is an important source of

productivity growth in Japan, especially in

complex manufacturing where many steps

are required and many operations must be

coordinated. For example in automobile

manufacture, assembly requires over 1,000

independent operations; a report of a few

years ago found that Japanese auto assembly plants were twice as productive as in In engine plants’ American plants.80 with

about 200 operations, Japanese labor

productivity was 50 percent higher. In iron

foundries, where only about 30 steps are

needed, the Japanese advantage disappeared (see figure 25).

Since the turn of the century, America has

been in first place in the most generally used

economy-wide measure of productivity,

GDP per employed person. If others, starting from a lower base, are to catch up and

enjoy the same benefits Americans get from

Figure 25.

Manufacturing Productivity in Japan and the United States

--- US/Japan mfg. labor content per unit

2 0 0

1 8 0

1 6 0

1 4 0

1 2 0

Auto Assembly .

Fork Lift Assembly

Axle Assembl y

Auto Engines

. .

Stampings

Iron Foundry

.

.

Color TVs

1 0 0

.

Ž Men’s Dress Shirts Automatic Transmission

80 1 I I I I I I I -.–u - -l-L- -. !

10 1 0 0

100 -

Manufacturing Steps

NOTE: As the number of steps in manufacture increases, the ratio of total factory labor content per unit of output of U.S. factories increases relative to Japanese factories,

SOURCE: James Albegglen and George Stalks, Jr., Kaisha, Tha Japanese Corporation (New York: Basic Books, 1985)

so James Abegglen and George Stalk, Jr., Kaisha: The Japanese Corporation (New York: Basic Books, 198S). U.S. assembly plants have

since improved, according to the International Motor Vehicle Program of the Massachusetts Institute of Technology cited above. The

Program’s recent suwey showed that the average Japanese assembly plant now has a 40 percent advantage in productivity over the average

U.S. plant.
52 ● Paying the Bill

rising productivity-economic growth and

rising standards of living — their growth rates

must be higher, at least for a time. Indeed, it

has been suggested that convergence of

productivity levels among industrialized nations is all but inevitable, due to the diffusion

of technical knowledge all over the world

and to the application of that knowledge by This idea con- those striving to catch up.81

tains some truth but it does not justify complacency. If U.S. productivity growth were to

lag behind that of its trade competitors for

long, the consequences would be serious.

The example of Great Britain, the former

world leader, is cautionary. The U.K.

productivity growth rate averaged less than

one percentage point below that of the

United States from 1870 to 1950, but during

that time the output per capita of the British

economy dropped to 60 percent, and

America eclipsed Britain in standard of

living and industrial might.82

61 For an e

F

ition of this point of view, see William J. Baumol. “Productivity Grow-th, Convergence, and Welfare: What the Long-Run

Data Show,” e American Economic Review, vol. 76, no. 5, December 1986.

w Angus Maddison, “Growth and Slowdown in Advanced Capitalist Fxonomies: Techniques of Quantitative Assessment,” Journal of

Economic Literature, vol. xxv, June 1987.
Why Manufacturing Matters

The evidence is substantial that U.S. performance in manufacturing has weakened,

that several important American industries

do not measure up to the competition, and

that the trouble cannot all be laid at the door

of the high dollar. The next question to ask

is whether it matters. Does the Nation really need a strong manufacturing sector? Or

has the time come to gradually cede production of goods to other countries while in this

country manufacturing gives way, in a

natural and desirable progression, to performance of services?

The answer, for now and the foreseeable

future, is that there is no choice to made between manufacturing and services. The nation needs both. As we have seen,

manufactured goods are indispensable for

trade with other nations. It is also clear that

America has not entered a post-industrial

stage; the demand for manufactured goods

by consumers, businesses, and government is

greater than ever. Moreover, to speak of services as taking the place of manufacturing in

the economy is to overlook the strong interdependence of the two kinds of activities and

the blurring of distinctions between them.

Many manufacturing industries could hardly

exist without allied services; the manufacture of computers and design of software

(often by an independent firm) are an obvious example. It works the other way as well.

For instance, manufactured hardware makes

it possible for hospitals to offer highly

sophisticated radiology services such as magnetic resonance imaging and computerized

tomography.

There are worrisome aspects to this interdependence. With the great rise in imports

of manufactured goods in the 1980s, a large

number of jobs were lost in manufacturing,

and with them went some closely associated

jobs in the service sector. OTA’s analysis

suggests that about 6.5 million service sector

jobs were tightly linked to manufacturing in

1984. Altogether, some 27.7 million U.S.

jobs were involved in manufacturing, either

directly or indirectly (i.e., producing services

or material inputs for manufacturing). Jobs

associated with manufacturing are generally

good ones. Manufacturing wages, overall,

are higher than wages in the service sector.

Most of the jobs in producer services that are

closely tied in with manufacturing are also

better than average. To keep these good

jobs, as well as good jobs in the manufacturing sector itself, America must compete effectively in the production of goods.

Links Between Manufacturing and

Services

It is hardly novel to observe that manufacturing and services are interdependent.

When Adam Smith remarked in 1776 that

“the labour . . . of artifices, manufacturers

and merchants naturally does fix and realise

itself in some such vendible commodity” he

was noting that merchants, although in a service occupation, are among the workers involved in bringing goods to the final

83 There are many other sorts ‘ f

purchaser.

connections as well. Before reaching the

merchant who sells it, the vendible comm Adam Smith, The Wealth of Nations, Book IV, chapter IX, cited in J.I. Gershuny and I.D. Miles, The New Sewices Economy The

Transformation of Employment in Industrial .Societies (New York, NY: Praeger, 1983).

53
54 ● Paying the Bill

modity must first pass through the hands of

truckers and warehousers who provide

transportation and storage services. Farther

upstream, bankers and venture capitalists,

insurance companies, lawyers, engineering

consultants, temporary help agencies, and

computer specialists all contribute to the

production of commodities. The service industries, in turn, are important customers of

the manufacturing sector. For example, according to one study, 80 percent of the computing, communications, and related

information processing equipment sold in

the United States in 1982 was purchased by

the service sector.84

Specialized technical skills are particularly

in demand for the manufacture of innovative, high technology products. In

microelectronics the links between

manufacturing and services are exceptionally close. The highly successful U.S. computer

manufacture industry could not have

developed without constant interaction between hardware engineers and software

designers. Software itself is an excellent example of the marriage of manufacture and

services, since it has the character of both a

good (it can be stored and shipped) and a service (computer programs are not immutably

fixed).

Some kind of services, however, are not

very closely tied to the location of goods

production. In general, the service activities

downstream of manufacturing–trucking,

warehousing, and wholesale and retail sales

of the final product –are not tightly linked

 Most Of these with domestic manufacture.85

services can just as well take place with goods

shipped halfway across the world.86 On the

other hand, upstream services —those that

manufacturing firms use as inputs in producing goods —tend to be linked much more

closely to the place where the goods are

made. These upstream services include such

things as process engineering, machinery

repair, trucking of goods between related industries, janitorial services, testing and lab

work, payroll and accounting services. So

long as manufacturing stays home, so will

these services and the jobs and national income they generate. If domestic goods are

displaced by imported ones, or if U.S.-owned

manufacturing operations are moved offshore, then many of the tightly linked

upstream services will go with them.

Not all upstream services are so tightly

bound. An obvious case is advertising;

American agencies, for example, create

television ads for Japanese cars. Thanks to

telecommunication, some software design

has now migrated overseas, e.g., to India,

where salaries for engineers are much lower

than for their American counterparts. And it

is quite possible for foreign banks to lend

money to U.S. manufacturing enterprises.

By and large, however, upstream services

that are inputs to manufacturing stay or go

with the manufacturing activity itself, for the

simple reason that most services are not very

transportable, and are produced near the

place where they are consumed.

u Cited in: James Brian Quinn and Christopher E. Gagnon, “Will services follow manufacturing into decline, ’’Harvard Business Review,

November-December 1986, p.96).

as For a detailed discussion of Iinka es, not only of services and manufactunn but also of the reduction of various kinds of oods with

each other, see Stephen S. Cohen and ohn 5 Z~man, Manufacturing Matters: A ? %

Basic Books, Inc., 1987), ch. 2.

e Myth of the ost-Industnal Economy (New ork, NY:

aa It should be noted that foreign manufacturers selling in the United States do often set up their own wholesale distribution centem.; an

example is Japanese multinational investment in the United States, which is heavily weighted to wholesale establishments. Many of the jobs,

and a good deal of the income, generated by these establishments go to Americans.
Why Manufacturing Matters ● 55

So long as the upstream services are

provided by employees of manufacturing

firms, they are apportioned in the national

accounts to manufacturing output and

employment. Often, however, they are

provided by outside firms, in which case the

national accounts attribute to the service

sector activities that are really a part of the

fabric of manufacturing. Among the fastest

growing sectors in the U.S. economy are

those that provide services to companies,

rather than consumers. While total employment in all the private service sectors grew at

an average rate of 2.6 percent between 1973

and 1986, the number of jobs in business services — which includes advertising, computer

software and data processing, temporary

help agencies, management services, and research and development laboratories — grew

by 7.5 percent a year. Likewise, miscellaneous professional services (including architectural and engineering services and

accounting, auditing and bookkeeping) increased at the rate of 5.2 percent per year.

Some of this great expansion in business

and professional services in recent years was

tied to manufacturing. To get a quantitative

idea of the connections between manufacturing and services, an input-output model is

helpful. The model can provide estimates of

how much the manufacturing sector buys

from service industries in the process of

making goods and how many jobs are involved, and vice versa. In 1984, private service industries supplied 17 cents of inputs

toward each dollar of manufacturing output.

Manufacturing in turn contributed 12 cents

worth of inputs toward each dollar of output

of the private service industries.87

The same kind of exchange held for

employment. Many of the jobs counted in

the service sector are really closely involved

in manufacturing. Estimates based on

OTA’s input-output model indicate the jobs

involved in producing services that are inputs to manufacturing numbered about 6.5

million in 1984.88 In addition, 1.8 million

jobs in agriculture, mining, and construction

were linked to manufacturing in the same

way (table 8). There were 19.4 manufacturing jobs in 1984. Add to that the 6.5 million

jobs in service industries and 1.8 million in

natural resources producing inputs for

manufacturing, for a total of 27.7 million jobs

involved, directly or indirectly, in manufacturing. In turn, some 6.5 million manufacturing jobs were devoted to making inputs for

the service and natural resource sectors,

Workers in these jobs produce goods ranging from tractors to sewer pipes to computers

to CAT scanners to paper clips, needed for

the conduct of business by enterprises as

diverse as farms, sanitary services, banks,

hospitals, and insurance offices.89

At a finer level, the service industries that

are most closely involved with manufacturing are wholesale trade, transportation and

warehousing, business services, gas, electric

and sanitary utilities, and radio and

67 This exchange is on the basis of gross out ut of the manufacturing and private service sectors. The figures do not include purchases of

capital equipment or structures needed to pJuce industry output.

aa The OTA model was developed for the asse=ment Technology and the American Ikonomic Transition (op. cit.). OTA’S model is based

on the 1980 input-output tables and is updated to 1984 for employment and sectoral demand. It includes capital flows.

m 13stmates of setices jobs closely linked to manufacturing, manufacturing jobs to services, and links of both these sectors wth natural

resources are adapted from the OTA model.
56 ● Paying the Bill

television broadcasting. Each contributes

more than 20 percent of its employment to

meeting manufacturing demand (table 8). In

numbers of jobs, wholesale trade and business services are most prominent, together

accounting for about 2.6 million of the 6.5

million jobs involved in service sector inputs

to manufacturing in 1984.90

The picture emerging from this analysis is

interdependence — not primacy of manufacturing as a solid base on which a rather

flimsy superstructure of services is erected,

nor on the other hand a succession in which

services are ousting manufacturing from a

place of economic importance. One can also

conclude that if manufacturing production

and employment is lost, services cannot

Table 8.–Workforce Involved In Manufacturing and Average Full-Time Equivalent Compensation, 1984

Average annual

Percent of full-time

Wage and sector equivalent

salary workers employment compensation

involved in involved in (thousands of

manufacturing manufacturing dollars)

Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . . . . 792 50,4% $11,3

Mining ., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45.5 37,0

Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . 575 13.3 26,8

Manufacturing . . . . . . . . . . . . ., . . 19,396 1000 287

All public and private services ., .

All private services .,

Wholesale trade . . . . . . . . . . . . .

Transportation and warehousin g

Business services . . . . . . . .

Radio and IV broadcasting . . .

Electric, gas, water and sanitary services

Communications, except radio and television . . . .

Automobile repair and services . . . . . . . . . . . . .

Retail, except eating and drinking . . . . . .

Finance and insurance . . . . . . . ... . . .

Hotels, personal and repair services (exe. auto) . . . .

Eating and drinking place s

Real estate and rental* ... .,

Amusements . .

Health, educ. & social serv. and nonprofit org.

6,492

6,343

1,501

704

1,276

50

171

129

79

1,176

413

207

428

72

46

89

9.4

11.9

26.3

242

22.8

218

214

116

116

103

9 0

8 5

7 9

6 7

4.5

0.9

246

244

27,6

303

24,7

29,6

37.5

397

178

171

27.4

157

110

21 1

19.9

20.2

Government ., ., ., ., ., ... 149 0.9 31,1

Total ., 27,697 29.0% $274

SOURCE. ‘Workers involved in manufacturing data derived from OTA Input-Output Model (1980 technical coefficients, 1984 estimated demand, 1984 BLS employment, adjusted

for capital flows, imports and duties) Compensation data dewed from Bureau of Economic Analysis, National Income and Product Accounts, electronic data, mapped to

Input-output industry classifications

m The 1980 input-output tables, on which OTA’S model is based, cover only 8S industries, with wholesale and retail trade lumped together.

A much finer mesh, covering 537 industries and posting wholesale and retail trade separately, was published for 1977, the benchmark year.

For this report, OTA used the 19?7 in ut-output tables to separate wholesale from retail trade, and thus to derive estimates of employment

associated with manufacturing for eac[ separately.
simply and directly replace them. A substantial number of service jobs depend directly

on the presence of manufacturing. Manufacturing and services are strongly enough

linked that they will prosper together or

decline together.

Links between suppliers and customers

may also be quite close among different

manufacturing industries. Of course this is

not always the case, since goods can be

stored and shipped much more readily than

services. For example, U.S. automakers buy

components and parts, from engines to

windshield wipers, all over the world. At the

same time, some major automakers, and

other manufacturers as well, are developing

stronger bonds with local suppliers. Having

suppliers close by enables companies to use

just-in-time deliveries, and helps in developing long-term, cooperative relations with the

suppliers–both key elements in Japanese

manufacturing strategy. In the textile/apparel business, for example, a leading U.S.

maker of jeans has completely changed its

relations with denim suppliers in the past few

years. Instead of driving the hardest possible

bargain on price with competing suppliers,

the company now buys most of its denim in

long-term arrangements from two or three

textile manufacturers, gaining the advantages of consistent high quality and justin-time delivery. In fact, the jeans

manufacturer now keeps virtually no inventory and has turned an entire warehouse into

sewing space.

Different segments of whole industry complexes may depend on each other to a greater

degree than one might suppose, if relations

between supplier and manufacturing purchaser were governed only by technical possibilities and not at all by spatial bonds.

Cohen and Zysman draw examples from

agriculture; they say:92

It is technically possible, but

economically improbable to mill

sugar cane in a country far from

the sugar fields, or to process

tomatoes far from the tomato

patch, or to dry grapes into raisins

or crush them for wine far from the

vineyard. It is a forward linkage

starting with farming; food

processing is downstream in the

production chain . . . In agriculture,

both in theory and in what is too

often dismissed as mere realworld examples, tight linkages

bind in both directions. There are

many activities tightly bound to

farming that are backward

linkages: crop dusters, animal

vets, harvesters, tractor repairers,

mortgage appraisers, fertilizer

salesmen, blight insurers,

agronomists, chemists, truckers,

shuckers.

The fiber/textile/apparel complex provides

another example. It is conceivable that

American textiles could be sold to Hong

Kong apparel makers, but the U.S. chemical

companies that make fibers and the textile

companies that spin and weave the fibers are

not counting on it. Both are taking a leading

role in strategies to strengthen the U.S. apparel industry, partly by forging stronger

links among all segments of the industry,

from textiles to apparel to designers and

retailers. (Some of the chemical companies

91 OTA intetiew with Thomas O“Gorman, President, Greenwood Mills,

w Ckhen and 7,ysman, op. clt,
58 ● Paying the Bill

are also hedging their bets by producing fiber

in Southeast Asia, near textile and apparel

manufacturing centers.)

An input-output model is not much help in

showing the strength of the ties between

manufacturing companies. It can show what

materials or intermediate goods one industry buys from another, but not whether

one depends on the presence of another in

the same national economy. For an accurate

view of the strength of these spatial bonds,

empirical studies of individual manufacturing industries are needed; OTA’s full assessment of Technology, Innovation, and U.S.

Trade will discuss these kinds of connections

in several manufacturing complexes.

Manufacturing and the Quality of

Jobs

The kinds of jobs associated with manufacturing are important as well as the number.

Pay is better in manufacturing than in the

private services overall, and has consistently

been so for many years. Moreover, the services jobs most closely connected with

manufacturing tend to pay better than services in general.

Total compensation –wages, salaries and

benefits –of people employed in manufacturing in 1984 was $28,700; for all workers in

the services, it was $22,900, and in the

economy overall, $24,300 (see table 8).93

Jobs in transportation and warehousing,

radio and TV broadcasting, and utilities paid

as much or more than the manufacturing sector itself, and they are closely linked to it.

Over 20 percent of their output goes into

manufacturing as inputs, compared to less

than 12 percent in private services as a

whole. Business, legal, and professional services, a category that includes everything

from janitors to corporate tax lawyers, is also

closely tied to manufacturing; jobs in this

group of industries paid above average for

the services, but below manufacturing.

Wholesale trade, which has a higher proportion and larger number of jobs (1.4 million)

associated with manufacturing than any

other service industry, paid nearly as well as

manufacturing.

Some service industry groups that do not

sell a large share of their output to manufacturing still devote a large number of jobs to

manufacturing input. The most important of

these is retail trade, which had 1 million jobs

associated with manufacturing in 1984, and

retail pay is low; Yearly compensation (per

full-time worker) averages $17,100. Others

with fairly large numbers of jobs linked to

manufacturing but low pay are eating and

drinking places ($11,000) and hotels and

personal services ($15,700). These three

low-paying industry groups employed onequarter of the U.S. service sector workers

making inputs for manufacturing in 1984.

OTA has calculated the average compensation for jobs in all the service sectors tightly

linked to manufacturing at $24,600, compared to $22,900 in the services as a whole,

in 1984.94 The difference in pay between

private (non-government) services linked to

83 All compensation figures are given on a full-time worker basis; this eliminates a downward bias in compensation for the sexv-ice industries,

which have a greater share of part-time jobs than manufacturing. h’umbers of workers are also given as full-time equivalents. The reason for

choosing 1984 as the year for comparing compensation in different sectors is that OTA’S input-output analysis showing relations between

service and manufacturing jobs was done for that year. Pay in manufacturing jobs and in service jobs associated with manufacturing remained

better than in setice jobs generally in 1986.

w This is a weighted average, based on the data in table 8.
Why Manufacturing Matters ● 59

manufacturing and all private service industries is even more pronounced – $24,400

versus $21,900.

What is the basis for the longstanding superiority of wages in manufacturing, and in services closely related to manufacturing, over

the rest of the economy? Possibly, higher

output per employee hour. It has long been

considered a truism that productivity is better in manufacturing than in services. This is

not entirely true. What does seem to be true

is that manufacturing and the distribution

and producer services with closer than

average links to manufacturing have higher

than average productivity as well as higher

than average pay. The obverse does not hold,

however. Finance, insurance, and communications have high productivity and pay

well, even though they have only an average,

or below average, degree of association with

manufactur ing.

According to official figures compiled by

the Bureau of Labor Statistics (BLS),

productivity growth in manufacturing has

been higher than in private business as a

whole for many years, since 1960 at least

(table 9). The discrepancy appears especially remarkable in recent years. From 1979 to

1987, manufacturing productivity rose at an

annual rate of 3.4 percent, while for private

business as a whole (including manufacturing), the yearly growth rate was 1.3 percent.

Leaving out agriculture, the growth rate for

all private business was only 1.1 percent.

These figures seem to mean that manufacturing has carried the whole economy on its

back in raising productivity, especially since

the 1970s. Recall, however, that the producTable 9. – Productivity in Manufacturing and

All Business, 1980-87

(1977 = 100)

Year All business Manufacturing

1960 . . 67.3

1961 : : : : : : . . . . . 69.7

1962 ., 72.3

1963 : . . 75.2

1964 . . : 78.4

1965 ., ., : : : : 80.8

196 6 . . .. , 82.9

1967 . 85.2

1968 : : : 87.6

196 9 87.7

1970 . 88.4

197 1 91.3

1972 94.0

197 3 95.9

1974 . 93.8

1975 95.7

197 6 98.4

1977 100.0

1978 100.8

1979 99.5

198 0 99.2

198 1 100.6

1982 100.3

198 3 103.0

1984 105.6

1985 107.5

1986 109.5

198 7 110.5

Annual average growth rates

1960 73 2 8

1973 7 9 0 6

1979 87 13

62.2

64.0

66.7

71.2

74.6

76.6

774

77.4

79.8

80.8

8 0 8

85.3

89.0

9 3 4

906

9 2 9

971

100.0

1015

1014

1014

1036

1059

1120

1181

1242

1288

1330

3 2

1 4

3 4

SOURCE. U S Department of Labor, Bureau of Labor Statistics, electronic data,

Monthly Labor Review, various Issues, table 44
60 ● Paying the Bill

tivity figures are based on a constant-dollar

series for gross national product that may

substantially understate the share of

manufacturing in GNP for earlier years —

and thus overstate its growth in real output,

value added, and productivity.95

Another way to compare productivity of

manufacturing and various service industries

is to look at their respective levels (not

growth rates) in one recent year, thus avoiding the problems of using a constant dollar

series over time. For this purpose, productivity can be calculated as value added in an

industry or sector, divided by the number of

hours worked in that industry.% On this

basis, manufacturing productivity in 1986

was $20.27 an hour, compared to $18.08 for

all private services averaged together (see

table 10).97 The average conceals a more interesting story. Business and professional

services and the transportation and

warehousing industry, all of which devote

over 20 percent of their output to manufacturing, are virtually the same as manufacturing in productivity. Public utilities, another

industry with close links to manufacturing,

has exceptionally high productivity–over

$65 of value added per hour. Wholesale

trade, with its high proportion and large

number of jobs involved with manufacturing,

has productivity well above average.

Table 10.-Value-Added per Hour, by

Industry, 1986

Percent of

Value sector

added employment

involved in

hour manufacturing

Agriculture . . . . . . . . . . . . . . . . . . $12.68

Mining . . . . . . . . . . . . . . . . . . . . 54.55

Construction . . . . 1563

Manufacturing . . . . . . . . . . . . . . . 20.27

Public and private services . . . . . . . 20.21

All private services . . . . . . . . . . . . . 21.86

Wholesale trade . . . . . . . . . . . . . . 24.31

Transportation and warehousing 21,25

Business services . . . . . . 19,60

Radio and TV broadcasting . 27.49

Electric, gas, water and

sanitary service s 65.31

Communications, except radio

and television . . . . 45,93

Automobile repair and services 15.16

Retail, except eating and drinking 12.62

Finance and insurance . . 20.58

Hotels, personal and repair

services (exe. auto ) 10.63

Eating and drinking places 1541

Real estate and rental* 161.28

Amusements . ., . 14,51

Health, educ. & social serv. and

nonprofit org . 1323

Government . 14.57

Private services excluding

real estat e 18.08

Total . . . $1777

50.4%

45.5

13.3

100.0

9.4

11,9

26.3

24.2

22.8

21,8

21.4

11,6

11,6

10.3

9.0

8.5

7.9

6 7

4 5

0.9

0.9

12.0

22 .1%

Value-added includes inputed rent from other sectors of the economy

SOURCE: Value-added by industry from U S Department of Commerce, Bureau of

Economic Analysis, National Income and Product Accounts, Gross

Product Originating by Sector, electronic data, hours of all persons engaged from U S Department of Labor, Bureau of Labor Statistics, Office

of Economic Growth, Hours of All Persons, unpublished data, workers

involved in manufacturing dewed from OTA Input-Output Model (1980

technical coefficients, 1984 dewed demand, 1984 BLS employment,

adjusted for capital flows, imports and duties)

m If the constantdollar value added figures are taken literally, the level of roductivity in manufactunn was much lower than in services,

and in the economy as a whole, until quite recently. For example, using the B {‘A series on value added in 1 2 dollars, manufacturing output %

per full-time e uivdent employee in manufacturing appears to have been $20,900 in 1960, compared to $2S,700 for rivate services (excluding

real estate),an $29,200 for the economy as a whole; for 1986 the comparable figures are S44,000 for manufacturing, 32,800 for private services ! f

except real estate, and $38,700 for the whole economy. A series calculated on the basis of constant 1982 dollars shows the level of productivity

in manufacturing lower than that of the economy as a whole from 1960 through 1982. In fact, since the figures are still relatively close together,

the only way productivity could have grown so much faster in manufacturing than in the rest of the economy for such a long time is to have

started at a much lower level.

EM Value added is the difference between the cost of materials, parts, and services that an industry buys to produce an item or semice, and

the sales revenues the industxy collects. The constituents of value added, as usually calculated, are wages, interest, rent, profit, depreciation,

and indirect taxes.

97 As noted in table 8, real estate is excluded from this calculation, because in the national income and product accounts, real estate value

added includes not only agency fees but also all rents and all imputed rents for owner-occupied dwellings. By this definition, value added in

real estate is not really equivalent to value added in other sectors, but is more like gross output, and is inconsistently high.
Why Manufacturing Matters ● 61

Highly productive enterprises and good

jobs certainly exist in service industries other

than those closely linked to manufacturing.

The communications industry, including

telephone and telecommunication services

but excluding radio and TV broadcasting, is

near the top in productivity, but has no more

than average links with manufacturing.

Finance and insurance, a very large sector

with employment of 4.9 million in 1986, has

productivity equal to that of manufacturing,

but is not at all strongly linked. It is also true

that none of the service industry groups at

the bottom of the heap in productivity – consumer, social, and retail services — is very

closely tied to manufacturing (11 percent or

less of their output goes into manufacturing).98 Value added per hour in these industry groups is down in the range of $12 to

$13.

All this said, it must be recognized that

there is something quite unsatisfactory

about comparing productivity from one sector to another. Ideally, productivity would be

calculated on the basis of how many manhours it takes to produce a physical quantity

of a good or standard unit of service. The

BLS does produce productivity studies of

this sort for specific industries. But goods are

unlike each other, and services are more different still. To look at productivity in the

economy as a whole, or across sectors, the

only common unit of measurement is dollars.

It may seem straightforward enough to

figure productivity in both goods and services as value added per hour. But what is

value added? By definition, it is the sum of

wages, interest, rent, profit, depreciation,

and indirect business taxes in the sector or

industry under consideration. A large

proportion of value added, varying by industry but generally about one-half to twothirds, is wages and salaries plus corporate

profits. Thus, if wages and profits are relatively high in an industry, its value added, and

therefore its productivity, will show up as

high. This may reflect genuinely high

productivity-that is, high physical output

per hour worked; indeed, the economic

foundation for good wages and living standards is high productivity. But within an

economy, one sector’s wages may be higher

than another for reasons other than productivity.

An industry with a lot of market power, i.e.,

in a near-monopolistic position, can often

extract higher prices, and therefore pay

higher wages and profits, than one that is

more competitive but equally efficient in

using labor. Consider steel up until the late

1970s, before international competition and

declining demand destroyed the industry’s

market power. The steel industry paid

premium wages, and on the basis of value

added, had above average productivity

growth in the 1970s. But on the basis of physical output per hour (as calculated by the

Bureau of Labor Statistics), steel’s productivity growth was below the all manufacturing average for most of the decade.l00 By

contrast, agriculture, which has shown strong

productivity growth in physical measureea Note, however, that a ve~ large number of retail trade jobs is associated with manufacturing, even though the proportion of linked jobs

in this veV large sector is only 11 percent.

w Other factom alw affect the ability of near-monopolistic industries to set prices above a competitive level, and thus pay higher wages

and profits than they otherwise could. ‘1’hese factors include the degree of elasticity of demand for labor, the elasticity of substit ution between

labor and capital, and the elasticity of demand for the Industries’ output,

leoU.S. Con ress, Office of Technology Assessment, U.S. Industrial Corn

4 T

titiveness: A Comparison of Steel, Electronics, and

Automobiles ( ashington, DC: US, Government Printing Office, 1981), pp. 56-
ments of output (such as bushels of wheat

per hour worked), is highly competitive, pays

low wages, and has low value added in dollar

terms. Also, strong unions can raise wages;

and social practices such as paying nurses

(female) less than truck drivers (male) can

lower pay. Because of these other influences

on wages and profits, value added (divided

by employee hours) is no more than a rough

guide to levels of productivity indifferent industries.

The fact remains that manufacturing pays

better than services, and so do linked services. This at least suggests that manufacturing is able to pay both its employees and its

service suppliers relatively well because of

superior productivity. This does not mean

that other services cannot provide good jobs.

Within the designation of “services’’ are very

different kinds of activities; all they have in

common is that they do not produce tangible

goods, and even that distinction is blurred in

some industries, such as software. Some industries in this disparate collection do indeed have low productivity and pay, and

employment in these industries (e.g., retail

trade) is so large that they pull down the

average pay for services in general. Of the

service industries that are better paid and

more highly productive, several have in common a substantial dependence on advanced

technology (e.g., computers in banking, insurance, and telephone communications), or

high capital investment per worker (e.g.,

public utilities), or both.101 These features

are also found in the services most closely

linked to manufacturing.

High Technology Industries

Manufacturing industries at the cutting

edge of technology, in products or processes,

help to buoy the economy, provide new jobs,

improve the trade balance, and advance

technology outside their own industry as well

as within it. Traditionally, whatever industries were at the technological forefront

for their time have helped to give the United

States a competitive edge. The criteria widely used to define high technology industries

are higher than average ratios of technologyoriented workers, and average or higher than

average research and development spending.102 A list of 26 manufacturing industries

based on these two criteria includes most of

the ones that people intuitively select as high

tech (table 11). Among them are computers,

electronic equipment and components,

communication equipment, precision instruments, specialized engineering products,

aerospace, chemicals, and drugs.

Clearly, high tech industries are vital to the

nation’s future. The development of

knowledge-intensive, technologically advanced products and methods of manufacture, from supercomputers to robotics to

biotechnology, is indispensable for a better

quality of life and rising incomes. The question, however, is whether high tech industries can fill the gaps left by the decline

of traditional manufacturing industries,

creating high wage jobs and making goods

for export to offset imports of standard

products made by lower wage workers in

lol For an indepth discussion of different kinds of service industries and a classification based on knowledge-intensiveness, see U.S.

Congress, Office of Technology Assessment, International Competition in Services, OTA-lTE-328 (Washington, DC: U.S. Government

Printing Office, Juty 1987).

I@This is the definition of Grou 111 high technolo

E. Hecker, and John U. Burgan, “ f F

industries developed by the Bureau of I,abor Statistics; see Richard W. Riche, Daniel

{igh Technology oday and Tomorrow. A Small Slice of the Employment Pie,’’ Monthly bbor Review),

November 1983.
Why Manufacturing Matters ● 63

Table 11. - U.S. High Technology

Manufacturing Industries

Electrical components and accessories

Office computing and accounting machines

Communication equipment

Aircraft and parts

Measuring and controlling instruments

Surgical, medical, and dental instruments

Guided missiles and space vehicles

Drugs

Miscellaneous electrical machinery

Soaps, cleaners and toilet preparations

Industrial organic chemicals

Optical instruments and lenses

Engineering, laboratory, scientific and research instruments

Photographic equipment and supplies

Agricultural chemicals

Miscellaneous chemical products

Industrial inorganic chemicals

Engines and turbines

Petroleum refining

Electrical industrial apparatus

Ordnance and accessories

Paints and allied products

Special industry machinery

Electrical, transmission and distribution equipment

Radio and IV receiving equipment

Plastic materials and synthetics

NOTE. High technology manufacturing industries are defined as those with a proportion of technology -oriented workers (engineers, Iife and physical scientists, mathematical specialists, engineering and science technicians and

computer specialists) equal to or greater than the average for all manufacturing industries, and a ratio of R&D expanditures to sales close to or above the

average for all Industries

SOURCE Richard W Riche, et al , "High Technology Today and Tomorrow a

Small Slice of the Employment Pie,” Monthly Labor Review, November

1983

other countries, as some have suggested.103

The answer is no. High tech industries do

not stand alone, any more than services.

Though they are necessary to the generation

of jobs, wealth, and exports, they cannot do

the job alone.

A great many of the products of high tech

industries are intermediate goods used by

other industries, both other high tech industries downstream (e.g., computers) and

more traditional industries (e.g., autos).

There is little consumer demand for semiconductor chips, lasers, or programmable

machine tools. The big consumer demand is

for goods such as cars, compact disk players,

microwave ovens, and washing machines

which, increasingly, contain advanced technology products or are made by advanced

manufacturing methods. For example, the

auto industry is one of the largest users of

computer aided design and computer assisted manufacturing equipment (CADCAM), robots, and sophisticated machining

centers, and is also one of the largest purchasers of semiconductor chips.

Semiconductors illustrate the point that

high tech industries depend on other industries to buy their wares. Excluding captive producers (e.g., IBM and AT&T) who

make chips mostly for their own use, 85 percent of the 1986 output of the U.S. industry

went to non-military industrial customers,

who use semiconductors in the process of

manufacture or embed them in autos or

other consumer goods. About 40 percent of

the chipmakers’ output went to manufacturers of data processing equipment (including computers), and another 15 percent to

producers of communications equipment.

Sixteen percent went to industrial machinery

and equipment, 7 percent to consumer

electronic goods and 8 percent to transportation equipment.104 Strong demand from

the semiconductor-using industries, both

traditional and high tech, is fundamental to

the strength of the semiconductor industry

itself.

Of course, that demand need not all be

domestic demand. The United States does

IcMSee, for example, Robert Z. Lavrence, Can America Cmmpcte? (Washington, DC: The 13rookings Institution, 1984), ch. 4,

l~National .Seience Foundation, The Semiconductor Industry, report of a I:ederal Interagency Staff Working Group (Washington, DC:

National Science Foundation, 1987), p. 6, chart 2, based on in format Ion from I)ataquest.
have a large share of the world market, but

that share is declining, while the Japanese

portion is rapidly increasing. Considering

only sales of merchant producers, excluding

captive consumption in both countries, U. S.-

based companies had 40 percent of global

semiconductor revenues in 1986 compared

 U.S. trad e

to 48 percent for the Japanese.105

in semiconductors has been in deficit since

1982.

The Japanese semiconductor industry has

benefited from strong demand from

Japanese manufacturers of consumer

products. According to one source, 40 percent of Japan’s semiconductors went into

consumer products in 1986; the industries included consumer electronics such as

television sets, VCRs, compact disc players,

and audio equipment. The consumer

electronics industry has almost vanished

from America (except for Japanese and

Korean owned plants that assemble parts imported from the home country); consumer

products took only 7 percent of the U.S.

semiconductor industry’s output in 1986.106

The demand from consumer products in

Japan is not only large; a goodly share of it is

reliable, owing to vertical integration that

fosters close links between production of

semiconductors and end uses. This strong,

steady demand provides the wherewithal to

pay for successive generations of new equipment. It is one of the factors enabling the

Japanese semiconductor industry to develop

advanced manufacturing technology that improves yields and cuts manufacturing

costs.107

Another kind of link is the pool of skills

available from traditional manufacturing to

further innovation in high tech manufacturing. Invention of new products is often not

enough by itself to confer a competitive advantage; the inventor needs manufacturing

know-how and other supporting technologies to capitalize on the invention.

For example, underneath the creative ferment of new inventions in microelectronics

in Silicon Valley is the presence of scores of

metalworking job shops with skilled

machinists on hand.

Limits on traditional manufacturing skills

may limit the possibilities of high tech innovation. The VCR story supplies an example. One reason RCA chose to go with its

ill-fated videodisc system (which was unable

to record) instead of cassette tape, was that

the complex and precise assembly required

for the tape player proved to be extraordinarily difficult and expensive; the company

thought manufacturing costs would put too

high a price tag on the equipment.109 Although it took years to accomplish, the

Japanese producers did eventually achieve

ImIbid, p. 10. According to this source, shipments from U.S. based plants, including captives, were 52 percent of the world total in 1985,

but had slipped from 61 percent in the 3 years since 1982.

~odbid., p. 6, chart 2.

~oTMichael Borrus, James E. Millstein and John Zysman, “Trade and Development in the Semiconductor Industqc Japanese Challenge

and American Response,”in John Zysman and Laura Tyson, eds., American Indust~ in International Competition (Ithaca, NY: Cornell

University Press, 1983).

loaDavid Teece, “Profiting from Technolo “cal Innovation, ’’Research Poli ,

+’ ‘?’

1986, vol. 15, no. 6; Nathan Rosenberg, “Technological

Interdependence in the American Economy,’ echnology and Culture, January 979, pp. 25-50.

Idle projected hi

r

cost and difficulties of making cassette tapes, plus severe standardization problems, were other hurdles, probably

even more important t an the cost of machining and assembling the player. }{owever, the rising cost estimates for the player (up from $450

to $750 as of early 1971) and continuing difficulties in manufacture were central factors in RCA’s decision to give up the videocassette recorder

and go with the Videodisc. See Margaret B. W. Graham, RCA and the VideoDisc: The Business of Research (C~mbridge, F.ngland and New

York, NY: Cambridge University Press, 1986), especially pp. 128-1.38 and 148-150.
Why Manufacturing Matters ● 65

the necessary precision economically, both

for VCRs and for miniaturized products

such as Sony’s Walkman.

None of this is to underrate the past contributions of high technology industries in

America and the importance of their continued development. Several of these industries have expanded much more strongly

than manufacturing in general in recent

years, and have added jobs even as their

productivity soared. For example, employment in computer and semiconductor

manufacture combined grew from 520,000 in

1979 to 679,000 near the end of 1987.110 In

the 26 high tech manufacturing industries altogether, employment also rose, but more

modestly, from 5.1 million to 5.3 million.

As discussed below, the surpluses of past

years in hightech trade have nearly vanished.

High technology industries face increasingly

stiff competition, both from lower wage but

rapidly industrializing Asian countries, and

from the higher wage but highly competitive

Japanese. World demand for goods related

to microelectronics is expected to go on

rising strongly, but American manufacturers

will have to scramble to keep their share of

demand and their output growing. One ingredient in success has to be reliable demand

for high tech goods by a strong American

manufacturing sector.

1 I oThe composition of employment changed in computer manufact ure, howeveq while total employment rose from 320,(MI0 to 406,000 from

1979 to 1987, jobs for blue<ollar production workers dropped from 131,0CKI to 128,000.
The Anatomy of Trade

In thinking about different ways in which

the United States might turn the trade deficit

around, it is useful to consider first what U.S.

trade consists of–what we trade, what are

the biggest items in the deficit, who are our

most important trading partners, and which

of them run the biggest surpluses with the

United States. These facts about the

anatomy of trade as it is now point to the adjustments that will have to be made when

U.S. trade comes back into balance.

Products

Manufactured goods account for most of

the merchandise trade deficit. Among

manufactured goods, by far the most important deficit item is motor vehicles, parts and

engines. The deficit in automotive imports

alone was over $53 billion in 1987, having

risen more than tenfold since 1976 (figure

26); it now amounts to about one-third of the

entire deficit in merchandise trade. When

U.S. trade deficits fall, it is clear that much

of the reduction must be in automotive

products — either through importing less or

exporting more or both.

Other industrial sectors are also running

sizable deficits, and also face pressures for

adjustment (table 12). Of course, it is not

necessary to reach a balance in every industry; some with surpluses can compensate

for others that are in deficit. But the deficits

are so great in a few industries that it is hard

to see what others could generate high

enough surpluses to offset these deficits. As

table 12 shows, electronic equipment, including items ranging from semiconductors

to television and radio sets, ran a $23 billion

deficit in 1987, mitigated only slightly by a $1

billion surplus in computers and automatic

data processing equipment. The textile and

apparel industry complex hit an all-time high

(or low) of $21 billion in deficit. The industry

groups with the strongest trade performance

were aircraft and other transportation

Figure 26

Balance Of Trade in Automotive Products,

1976-8 5

_ Billions of dollars

o

-lo -

-20 -

-30 -

-40 

-50

-60

t

-70 L

 1976 1977 1978 1979 1980 19611962196319641965 19681967

SOURCE: U.S. Department of Commerce, Bureau of Economic

Analysis, Business Statistics, 1986, p. 80-81, Foreign

Trade of the U.S. - Value of Exports and Imports

equipment (excluding autos) with a surplus

of over $12 billion, and chemicals, with a

healthy and rising surplus of nearly $10 billion.

It is noteworthy that the worsening trade

balances in manufacturing have not spared

high technology products.111 Between 1985

11 I For international trade, the Department of Commerce defines high technology products as those embodying high levels of research and

development expenditures

~

r unit of output; the set of industries producing these ~oods is similar to the list based on the Bureau of Labor

Statistics criteria. See U.S. epartment of Commerce, International Trade Administration, United States Trade Performance in 198.S and

Outlcmk (Washington, DC: U.S. Government Printing Office, 1986).

66
The Anatomy of Trade ● 67

and 1987, for example, the positive trade billion in 1986. The improvement in 1987

balance in computers and automatic data was due mostly to rising surpluses in the

processing machinery dropped by $2.8 bil- aircraft and chemical industries.112

lion, to about $1 billion (table 12). Overall,

the trade balance in high technology The record still illustrates something funproducts shrank from a surplus of $27 billion damental: high technology industries have

in 1980 to a surplus of only $600 million in come under many of the same pressures af1987, having gone through a deficit of $2.6 fecting other manufacturing industries.

Table 12.–Trade Balance In Selected Manufacturing Industries

(billions of dollars)

Industry 1985 1986 1987

Total manufacturing

Durable goods

Wood and cork manufactures

Furniture and parts

Nonmetallic mineral manufactures

Iron and steel

Nonferrous metals

Misc. metal manufactures*

Industrial machinery

Power generating machinery

Special industrial machinery

Metalworking machinery

Other industrial machinery

Electronic, computing, and office machinery

Office and ADP machinery

Telecomm and sound reproducing equip

Semiconductors and other electrical equip

Motor vehicles

Aircraft and other transport equipment

Prof. , scientific and control inst

Photo equip , optical goods and timing equip

Misc. manufacturing**

Military arms, ammo, vehicles

Non durable goods

Textiles and apparel

Yarns, fabrics and textile articles

Wearing apparel and accessories

Footwear

Paper, paperboard and manufactures

Chemicals

Organic chemicals and related products

Medicine and Pharmaceuticals

Fertilizers

Synthetic resins, rubbers and plastics

Other chemical materials and products

Tires and tire tubes

Luggage, handbags, and similar articles

$101.6

$1.4

3.1

5.8

9.9

5.3

3.7

0.1

0.4

2.2

1.6

0.9

15.3

3.8

14.4

4.7

39.8

11.2

3.4

2.4

10.3

2.7

153

2 8

124

6 0

3 9

6 7

13

16

11

2.1

0 6

17

15

$1289

$1.4

3 9

6 7

8 4

-63

4 5

5 4

0 5

0 2

1.9

2 8

208

14

162

5 9

516

108

3 0

2 9

119

2.0

17.6

3 5

141

6 7

4 0

7 2

14

19

10

2 4

0 6

18

16

$137.7

-$1.6

-4.4

-6,8

-8.5

-6,0

4 9

-6,7

-0.6

-1.6

-1,4

--3.1 

21.6

1.0

156

- 7 0

53.3

12.5

3,0

3.1

12.8

2.0

208

- 3 9

169

7 4

-44

9 6

1 9

1.7

1.4

3.4

11

1 9

2.0

* Not specified elsewhere

** Not specified

SOURCES: U S Department of Commerce, Mice of Trade and Investment Analysis, unpublished data

1121nformation prcwldcd t~> the L’ S, Ikpartmcnt of (bmmc rce, ( )fflcc of “1’radc and Invest mcnt Analysis,
68 ● Paying the Bill

Trade in high technology products is substantial, with imports and exports both

reaching just over $80 billion in 1987; high

tech imports were almost one fourth of all

manufactured imports, and high tech exports

were 42 percent of all manufactured exports.

While American high tech companies are

still quite competitive, it is unlikely that they

can regain the kind of dominance they had

just a decade ago, relative to producers in

Europe, Japan, and a few developing Asian

nations. It is therefore unlikely that hightech

trade can generate a large enough surplus to

offset substantial deficits in traditional sectors.

Countries

The United States trades mostly with other

developed nations, although trade with

several developing nations has expanded

greatly in recent years. The top ten suppliers

of U.S. imports in 1987, in descending order,

were Japan, Canada, West Germany,

Taiwan, Mexico, the United Kingdom, South

Korea, Italy, France, and Hong Kong.113

When the trade deficit is reduced, most of

the adjustment will fall on these countries

(figure 3). The impact of the adjustment will

vary by nation and by region, depending on

how important trade with the United States

is to our trading partners. It will also depend

on how fast the economies of other countries

are growing; the more other markets expand,

the easier will be the adjustment to reduced

sales (or slower growth in sales) to the

United States.

The developed nations that are our largest

trading partners will probably have to bear

most of the adjustment costs. Six of the top

ten suppliers of U.S. imports are developed

nations: Japan, Canada, West Germany, the

United Kingdom, Italy, and France. Their

merchandise trade surpluses with the United

States totaled nearly $96 billion–about 60

percent of the U.S. merchandise trade

deficit. Figures 27 and 28 show, in percentages, the part played in U.S. trade by our

leading trading partners from 1950 to 1986.

Adjustment costs will mean different things

to different nations. If American exports are

to grow faster than imports, nations that export to the United States can maintain export

levels only if worldwide economic growth,

including U.S. growth, is substantially

greater than it has been in recent years.

Faster growth” in the American economy–

the world’s largest — is not likely, since we

cannot continue to maintain consumption,

investment, and government deficits at current levels indefinitely. Under these circumstances, it will be difficult for foreign

producers to maintain their levels of exports

to the United States, and many will find that

they must replace U.S. customers with others

or produce in the United States instead of in

the home country. The alternative to

these cutbacks would be rapid economic

growth rates in the exporting countries, thus

enabling them to substitute their own

markets as well as others for the U.S. market.

Except for Japan these countries have so far

shown little evidence of being able or willing

to do SO.

113U.S. Department of Commeree, International Trade Administration, U.S. Merchandise Trade Position at Midyear 1987, (Washington,

D. C.: U.S. Government Printing Office, October 1987).

I IdUntil 198S, however, investment by foreign countries in the United States had done nothing to improve the U.S. merchandise trade

balance, in fact quite the contrmy. This situation may already have begun to change with the falling dollar, but whether or how soon foreign

direct investment in American producion replaces imports is uncertain..
The Anatomy of Trade ● 69

Figure 27

Volume of U.S. Exports, 1978-8 6

Percent of total U S merch. exports 100% ----- -

80%

60%

40%

20%

0%

1978 1979 1980 1981 1982 1983 1084 1985 1986 1987

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, table 3, June 1987 and March

1988.

Figure 28

Volume of U. . S Imports, 1978-86

Percent of total U.S. merch. imports 100%

8 0 %

60%

4 0 %

20%

0%V

1978 1979 1980 1981 1982 1983 1984 1985 1988 1987

SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business, table 3, June 1987 and March

1988,
70 ● Paying the Bill

The greatest bilateral merchandise deficit

of the United States – $57 billion in 1987, or

about 36 percent– is with Japan. Twentyone percent of U.S. merchandise imports, or

$85 billion, were from Japan, and about 11

percent of our exports ($28 billion) are sent

there. The deficit with Japan has been onethird to one-half of the U.S. merchandise

trade deficit for about the last decade, growing during that time approximately tenfold.

In 1986, the leading import by far from Japan

was passenger motor vehicles (table 13).115

This item accounted for $23 billion, or over

one-fourth of all imports from Japan, and

nearly half the U.S. deficit in motor vehicle

trade. Besides motor vehicles, other major

imports from Japan include consumer

electronics, telecommunications equipment, automatic data processing and office

machinery, and electronic components.

Some adjustment has already taken place.

For example, even before the fall of the dollar against the yen, beginning in early 1985,

there were pressures on and within Japan to

change its postwar policies of export-led

development. 116 Many nations were exhorting Japan to reduce its trade surplus, and increasing saturation of some export markets

was apparent. The Japanese government has

announced an official policy of lesser

reliance on exports. But shifting to an

economy more dependent on growth of

domestic consumption is not simple; export

growth accounted for almost 40 percent of

Japan’s economic growth between 1980 and

1985.117 As exports slackened in 1986,

Japanese GNP growth faltered somewhat,

rising only 2.4 percent compared to 4 and 5

percent in the earlier 1980s. Capital-investment plans were revised downward.118

Japanese firms and industries that were particularly hurt by stagnating demand, like the

steel industry, began to diversify, entering

high technology fields like special chemicals,

new materials and biotechnology.119 At the

same time, there were layoffs, especially in

the steel industry. Nippon Steel, for exTable 13.-Major U.S. Imports From and Exports to

Japan, 1986

Compound

C i f value* annual

(millions of growth rate

dollars) 1982-86

Import category

Passenger motor vehicles $22.8 21 .2%

Phonographs, IV image &

sound reproducing equipment . 6.0 371

Special purpose motor vehicles 51 316

Telecommunications equipment,

nspf** 4.0 239

Parts of motor vehicles, nspf** 3.1 508

Automatic data processing machines 2.9 64.1

Export category

Gold (nonmonetary, except ores) 3.3

Air and spacecraft, etc. 1.8

Corn or maize, unmilled 0.9

Oilseed and oleag. fruit ., 0.8

Wood (rough cut) ., ., 0.8

Meat (fresh, chilled, frozen) 0.7

ADP machines 0.7

Parts for office machines 0.7

Radioactive and assoc. material 0.6

Organic chemicals and products 0 6

Medicinal and pharmaceutical prod O 6

Fish (fresh, chilled, frozen) 0 6

Measuring and checking instruments O 6

Coal and lignite 0 6

Petroleum products (refined) 0 4

695

189

6 9

3 7

17

9 7

169

131

8 8

3 9

6 6

123

7 4

408

2 7

“C I f value of imports includes cost, insurance and freight

● *Not specified

SOURCE U S Department of Commerce, International Trade Administration,

1986 U S foreign Trade Highlights, Office of Trade and Investment

Analysis, March 1987

I IsDetailed figures on trade by product and by country were not yet available for 1987 when this report was written.

I la.lon Woronoff, “Japan’s Structural Shift from 13qmrts to Domestic Demand, ”in Japan’s F~onomy and Trade wilh the United States:

selected Papers, Subcommittee on Ronomic Goals and Intergovernmental Policy of t he Joint IZonomic Committee. Congress of the United

States (Washington, D. C.: U.S. Government Printing Office, December 1985).

1 ITRobert J. Samuelson, “Japan’s Case of Malaise, ’’Newsweek, May 4, 1987.

I laNo Big Deal,’ The Economist, November 8, 1986.

I IiJapan: Steelmaker are Vigorously Restructuring, ’’Foreign Broadcast Information Setice, 2.5 l:ebrua~ 1987.
The Anatomy of Trade ● 71

ample, announced a temporary layoff of

3,000 of its workers in October 1986.120

After this rather rough year, the Japanese

economy bounded back in 1987, with a GNP

growth rate of 4.2 percent. The revival was

fueled by a housing boom, an increase in

consumer spending (spurred by a tax cut),

and a $46 billion government spending package, including a 20 percent increase in the

public works budget. A tax deduction on

mortgage loans and a cut in interest rates encouraged the housing boom; housing starts

rose over 18 percent in the first half of

1987. 121 The construction activity spilled

over into greater demand for steel, which

staged a substantial recovery, and a whole

range of consumer and household goods.122

Whether domestic demand will continue to

rise at the 1987 rate, compensating for slowing or declining external demand and a

shrinking trade surplus, is yet to be seen. The

Japanese economy has proven extraordinarily resilient in difficult circumstances

before, notably after the oil shock of the

early 1970s. And Japanese manufacturers

are responding to the high yen by paring

profit margins and redoubling efforts to raise

productivity.123 At the same time, Japanese

companies are beginning to move some

manufacturing operations offshore, in

response to the high yen, and these moves

are bound to have some dislocating effects

on employment and the economy. The adjustment to a higher yen is not yet over.

While the coming changes are not simple

and easy for Japan, they could be harder for

some of our other trading partners. Among

developed nations, Canada and the United

Kingdom – our second and fifth largest suppliers of imports, respectively–are in the

most difficult positions; both countries run

trade surpluses with the United States, but

sustain overall trade deficits and relatively

shaky economies. Canada, whose economy is

heavily dependent on the American market,

may face great difficulty — even if the newly

established free trade agreement is effective

in further liberalizing trade between the two

countries.

Between 1976 and 1987, the U.S. merchandise trade deficit with Canada increased

from $316 million to $11.9 billion. The 1982

recession and the rise in the value of the dollar were clearly the major factors accounting

for the change in trade deficits with Canada.

Canada’s share of the U.S. merchandise

trade deficit rose from its normal 5 or 10 percent to 25 percent in 1982. In absolute terms,

the U.S. merchandise trade deficit with

Canada increased over 4000 percent, peaking at $15 billion in 1985. The leading import

from Canada in 1986 was passenger motor

vehicles ($11.9 billion). Canada’s top five exports to the U.S. consist of motor vehicles

and parts and wood products (table 14).

It could be very costly to Canada to reduce

exports to the United States. Nearly fourfifths of Canada’s manufactured products

are sent here.124 Finding other markets to

ldapanese Steelmaker, Blasted,’The Economist, Janua~ 3, 1987.

121”A Shopping Spree Starts Turning Japan Around, ’’Business Week, August 17, 1987, p. 50.

lzKharles Smith, “Under Its Own Steam, ’’Far Eastern Economic Review, Feb. 4, 1988.

l-e, for example, John Burgess and Fred Hiatt, “Toyota Finds Ways to Hold Down Prices,’ The Washington Post, Feb. 16, 1988,

t pdMarc Levinson, “More Bucks Out of the Maple haf?’’Dun’s Business Month, July 1986, p. 45.
72 ● Paying the Bill

replace lost opportunities will be difficult,

particularly if other U.S. trade partners are

trying to do the same thing. Past Canadian

efforts to diversify exports, and reduce the

heavy reliance on the United States, have

125 Moreover, failed. Canada has begun to

run current account deficits: about $7 billion

in 1987 down from a surplus of $2 billion in

1984.126 If exports to the United States are

curtailed, Canada’s trade deficit could increase, putting further downward pressure

on an already low Canadian dollar and on

Canadian living standards. Canadian unTable 14.--Major U.S. Imports From and Exports to

Canada, 1986

Compound

C.i.f. vaIue* annual

(millions of growth rate

dollars) 1982-86

Import category

Passenger motor vehicles

Parts of motor vehicles, nspf**

Paper and paperboard (not cut)

Wood (shaped or simply worked

Special purpose motor vehicles

Crude petroleum

Gas (natural and manufactured)

Gold (nonmonetary, except ores)

Export category

$11.9

. . 4.9

. 4 5

. . 3.1

3.1

. 2 9

. 2.5

2.4

19.4%

21.3

8.1

16.2

4.5

7,2

-15.1

21.5

Parts of r&d- vehicles and tractors 63 7.6

Passenger motor vehicles . 5.9 25.2

General merchandise, low-value . . . 3.2 41.4

Internal combustion & piston engines 1.8 3.0

Trucks & special purpose motors 1.7 4 1 6

Parts for office and ADP machines 1.2 17.1

Gold (nonmonetary, except ores) 1.1 14.2

Coal and lignite . . . . . . . . . . . 0.7 -8.2

● C. i. f value of imports includes cost, insurance and freight

**Not Specified

SOURCE: U S Department of Commerce, International Trade Administration, Office of Trade and Investment Analysis, 1986 U.S. Foreign Trade HIghlights, Much 1987

employment has been higher than that of the

United States and many other industrialised

countries in the 1980s, though it had declined

to 7.8 percent in early 1988. This compares

to the current rate of 5.6 percent in the

United States, 2.7 percent in Japan, and historical rates in Canada of 3 to 6 percent in

the 1960s and early 1970s.127

In another break with the past, the United

States is running large deficits with Western

European countries. Our merchandise trade

with Western Europe fell from a surplus of

$20 billion in 1980 to a deficit of $27 billion

in 1987. Over one-half of the European

deficit – $15.3 billion – was with West Germany; Italy accounted for $5.5 billion, or 20

percent, and the United Kingdom for $3.4

billion. Again, as with Japan and Canada,

the largest import item from Western

Europe is passenger motor vehicles –$11.7

billion in 1986–with West Germany the

major supplier. Motor vehicle imports dwarf

the next most important European import,

organic chemicals (table 15).

The cost of adjustments will vary among

European countries. Unemployment is high

in France, the United Kingdom, West Germany and Italy, relative to historical standards. The worst off is France with an

unemployment rate of nearly 11 percent in

early 1988. The United Kingdom is recovering from a prolonged bout of unemployment

at around 12 percent; the rate is currently 9

percent and declining. West Germany’s unemployment rate, over 7 percent, is lower,

but high by historical standards; the rate

throughout most of the 1960s and early 1970s

l~Alan M. Rugman, “U.S. Protectionism and Canadian Trade Policy, ’’Journal of World Trade I~w, July-August, 1986.

nization for Economic Co-Operation and Development, OECD Economic Outlook, (Paris: O~,CD-Publications, May 1986 and

Ju;~WY , p. 58.

tmU.S.-~psrtment of Labor, Bureau of Labor Statistics.
The Anatomy of Trade ● 73

was less than 1 percent. In Italy the current

unemployment rate of about 7 percent, is

more than double the levels of the 1960s and

1970s. In terms of trade balance, Germany’s

merchandise trade surplus —exceeding $20

billion in the mid-1980s–puts that country

in better shape to handle a diminishing

American export market than Italy or the

United Kingdom, both of which were in

deficit in 1983.128 These deficits were small:

Table 15.– Major U.S. Imports From and Exports to

Western Europe, 1986

Compound

C.i.f. value* annual

(millions of growth rate

dollars) 1982-86

Import category

Passenger motor vehicles . . . . . . . . $11.7

Organic and related chemicals . . . . 2.8

Beverages, alcoholic . , 2.7

Air and spacecraft, etc . 2.6

Crude petroleum . . . . . . 2.3

Motor vehicle parts, nspf** ... 2.2

Special transactions, nspf** 2.2

Gold (nonmonetary except ores) 2,2

Petroleum products . . . . . 21

Specialized industrial machinery 1.9

Export category

Air and spacecraft, etc. ., 5.1

Office and ADP machine parts ., ., 4.0

ADP machines 4.0

Measuring and checking instruments 2.3

Internal combustion engines ., . . . 2.2

Oilseed and oleag. fruit . . . . . 2.2

Coal and lignite ... . . . . . . . . . . 1.8

23.7%

12.0

5.1

17.4

-237

23,2

7.1

90.0

9.0

24.9

12.7

14,2

8 9

2.6

8.9

-14.5

-10,0

● C I f value of imports includes cost, insurance and freight

● *Not specified

SOURCE: U S Department of Commerce, International Trade Administration, Office of Trade and Investment Analysis, 1986 U.S. Foreign Trade Highlights, March 1987

$1.7 billion for Italy, and $0.8 for the United

Kingdom. Nonetheless, since both countries

ran substantial merchandise trade surpluses

with the United States, any loss of U.S.

markets would almost certainly mean

deeper deficits, and downward pressure on

living standards and currency values.

Certain developing nations are important

suppliers of imports to the United States and

major factors in the U.S. merchandise trade

deficit. Those facing the largest adjustment

costs are the East Asian newly industrializing countries (NICs) — Taiwan, South Korea,

Hong Kong, and Singapore –and two Latin

American NICs, Mexico and Brazil. Like the

developed nations, different developing

countries vary in their abilities to cope with

the adjustments.

About one-quarter of the U.S. merchandise trade deficit in 1987–$47.2 billion–

was with Asian countries, excluding Japan;

the four East Asian NICs accounted for

three-quarters of this. The deficit with

Taiwan was much the largest: $17.4 billion,

compared with $9.4 billion with the Republic

of Korea, $5.6 billion with Hong Kong, and

$2.1 billion with Singapore. Table 16 lists the

most important imports from and exports to

the Asian NICs in 1986. If all the separate

categories of apparel and footwear are aggregated, this is by far the largest category of

imports, amounting to at least $14 billion.129

Apparel and footwear top the list of imports

from three of the Asian NICs (Hong Kong,

12aU.S. Department of Commerce, International Trade Administration, International Eronomic Indicators, op. cit.

lmTrade data are ublished in ways that make it difficult to sum u

?

Iar e categories of imports, such as apparel, so this estimate is onl

approximate. Eight o the 35 leading Imports fmm the East Asian N]&fin 986 were apparel and footwear; they added up to $13.8 billion. t{

is likely that more articles of apparel were imported, but were not among the leading 35. In addition, detailed data on imports and e

T

rts by

countxy and by region are pubhshed by the International Trade Administration (ITA), U.S. Department of Commerce, and are on a ifferent

basis from the more general trade figures published by the Department’s Bureau of Economic Analysis (BEA). In the BEA data, both imports

and exports are reported on a free alongwde ship (f.a.s.) basis, which means the price of the item as it is loaded for shipment. In the ITS data,

exports are f.a.s., but im rts are reported on a cost, insurance, and freight (c.i.f.) basis, which adds the cost of insurance and frei t to the

original cost of the item.%us, in the ITA accounts, imports appear to be greater than in the BEA accounts. Where possible, the B& figures

have been used, because they present imports and exports on the same basis. }Iowever, some of the detailed data are available only from ITA.
74 ● Paying the Bill

Table 16.-Major U.S. Imports From and Exports to

East Asian NICs, 1986

Compound

C.i.f. value* annual

(millions of growth rate

dollars) 1982-86

Import category

Footwear (new, exe. military) $39

Toys and baby carriages, etc. . 3.0

Sweaters and other outerwear . . . 2.9

Outerwear apparel, (cotton & wool) 2.6

Office and ADP machine parts . . . 2.2

Telecommunications

equipment, nspf** . . . . . . . . . . . . 2.2

Electronic components and parts 1.7

ADP machinery . . . . . . . . . . . . . . 1.4

Furniture and parts . . . 1.3

Television receivers, etc. 1.2

Undergarments ., . . . . . . . . . 12

Rubber and plastic articles . . 1.1

Export category

Electronic components and parts . 1.5

Air and spacecraft, etc . 1.2

Office and ADP machine parts 0.9

Organic chemicals and products 08

Hides and skins (except fur) 06

Oilseed and oleag. fruit . 0.6

Rubber, plastic and syn. resin 05

ADP machines . . . 0.5

Measuring and checking instruments 05

Telecommunication equipment 04

Corn or maize (unmilled) . . . . 0.4

Pulp and waste paper . . 0.4

Wheat (unmilled) ., . . . . . . 0.4

20.5%

13.0

26.2

14.4

44.7

23.8

8.3

128,4

34.3

20.2

12,6

30.4

10,6

9.5

23.9

14,9

32,2

7.1

10.2

18.1

4.6

- 4 5

-8.5

19.1

4.3

● C I f value of imports Includes cost, insurance and freight

● *Not specified

SOURCE: U S Department of Commerce, International Trade Administration, Of

fice of Trade and Investment Analysis, 1986 U.S. Foreign Trade Highlights, March 1967

Korea, and Taiwan) and place in the top ten

from Singapore. The fastest-growing imports are passenger motor vehicles, which

rose from $10 million to $854 million in one

year, 1985-86, and automatic data processing

machines (including computers and calculators), which increased from $53 million

to $1.4 billion in the 4 years 1982-86. Almost

all automobile imports from the Asian NICs

are from Korea, while automatic data

processing machinery exports are from all

four nations, with Taiwan accounting for 52

percent, Korea for 26 percent, Singapore for

16 percent, and Hong Kong for 6 percent.

In general, developing nations are less able

to cope with a diminishing American market

for their exports than developed nations.

Even Taiwan, with a healthy and growing

trade surplus and massive reserves of foreign

exchange, could have problems with adjustment.130 Like many other developing nations, it is highly dependent on export-led

growth, particularly in exports to the United

States. America is the market for half of

Taiwan’s exports, and over half of Taiwan’s

GNP depends on exports.131

South Korea’s economy may be more vulnerable, as Korea is only just beginning to

reverse chronic trade deficits, and is still

.

pursued a strategy of export-led growth,

which is successful as long as exports are able

to expand fairly rapidly. In 1987, for example,

Korean GNP rose 24 percent, pulled by a 36

percent expansion in exports. Korea was

able to run a current account surplus in 1986,

for the first time in modern history, mainly

130Carl Goldstein, “Economic Monitor Taiwan: Exports Hit New Peaks,’’ Far Eastern Economic Review, 9 April 1987, p. 137.

lsl Robert G. Sutter, ‘Taiwan: Recent Developments and Their Implications for the United States, ’’Congressional Researeh Sexvice Issue

Brief IB87092, Updated June 16, 1987; information provided by the Cm-ordination Council for North American Affairs.

ldavrence A. Veit, “Time of the New Asian Tigers, ’’Challenge, July-August 1987. Korea’s international debt totaled $45 billion in

1986 –45 percent of Korea’s $100 billion GNP.
The Anatomy of Trade ● 75

due to its increasing import penetration of

U.S. markets. Lower oil prices, the appreciation of the yen, and falling interest rates

helped, but Korea’s $9.4 billion trade surplus

with the United States in 1987 offset its $5.2

billion deficit with Japan. However, Korea’s

dependence on exports could backfire when

the U.S. merchandise trade deficit shrinks.

Exports account for 40 percent of Korean

GNP, and 39 percent of Korea’s exports go

to the United States – up from 30 percent a

decade ago.133 Reducing the U.S. trade

deficit might cause political as well as

economic trouble in Korea.

The U.S. merchandise trade deficit with

Latin America was $12.2 billion in 1987,

amounting to only 8 percent of the total. This

represented a steep deterioration for the

United States, however, with U.S. merchandise trade having descended from a surplus

with Latin America of $1.3 billion 1981.

Most of the deficit is with just three

countries: Mexico ($5.7 billion), Brazil ($4.1

billion), and Venezuela ($2.0 billion) as

shown in table 17. In contrast to imports

from Asian developing countries, or

developed countries, imports from Latin

America are tilted heavily towards natural

resource commodities: petroleum and

agriculture and fishery products account for

40 percent. However, imports of internal

combustion piston engines have been growing very rapidly in the 1980s, from $362 million in 1982 to $1.1 billion in 1986, mostly an

indicator of the importance of Mexican

production. The trade deficit with Latin

America peaked in 1984, declining since

then as a result of both modest increases in

exports and contractions in imports. A part

Table 17.– Major U.S. Imports From and Exports to

Latin America, 1986

Compound

C.i.f. value* annual

(millions of growth rate

dollars) 1982-86

Import category

Crude petroleum . . . . . . .,

Petroleum products . . . . . . . . . . .

Coffee . . . . . . . . . . . . . . . . . . . .,

Fruits and nuts (prepared), nspf** .,

Shellfish (fresh, frozen, salted) . .

Internal combustion engines . . . . . . .

Footwear (new, exe, military) .,

Electrical distributing equipment .,

Special transactions, nspf** .

Motor vehicle parts, nspf**

Export Category

Road vehicles and tractor parts

Organic chemicals and products

Air and spacecraft, etc .

Telecommunication equipment .,

Civil engineer and contractors

General merchandise, low value

Rubber plastic and syn. resins .,

Internal combustion engines . .

Petroleum products (refined) .,

Office and ADP machine parts

Electronic components and parts

Electrical appar. (current carrying)

Wheat, unmilled

ADP machine s

Measuring and checking instruments

Electrical machiner y

Specialized industrial machinery

Electrical distributing equipment

Fertilizers and materials .,

Misc. chemical products .,

Paper and paperboar d

Non-electric parts, nspf**

$6.9

4 8

3 4

16

12

1.1

10

0 8

0 8

0 8

1,7

11

0 9

10

0 9

0 9

0 8

0.8

0.8

0 7

0 7

0 6

0 5

0 5

0 5

0 5

0 5

0 4

0 4

0 4

0 4

0 4

-11 .9%

-12.0

13.1

9.0

7 0

31.1

20.4

336

0.6

284

0 8

4.1

3.1

9.2

13,8

28.4

3,2

4 6

139

13,3

150

6 5

193

5 0

-2.7

0 0

2 3

276

6 4

- 1 9

- 4 3

0 5

 *C I f value of imports Includes cost, insurance and freight

* Not specified

SOURCE U S Department of Commerce, International Trade Administration, Offlee of Trade and Investment Analysis, 1986 U S Foreign Trade High

hights, March 1987

of the drop in value of imports is due to the

sharp drop in oil prices in 1986.

Much of the deterioration in our merchandise trade balance with Latin America in the

1980s has to do with indebtedness. Brazil,

the largest Latin American debtor, owed

nearly $107 billion to foreign creditors in

lxXhristopher Madison, “Korea: A New Interest, ’’National Journal, April 5, 1986; information provided by the Korean Embassy
1985; Brazil’s foreign debt was equal to 51

percent of its GNP. Mexico owed $97 billion,

with debt at over 58 percent of GNP;

Venezuela’s debt was $32 billion, or 66 percent of GNP. Nations facing heavy international debt burdens have been forced by

their major creditors (the International

Monetary Fund and U. S., European, and

Japanese banks) to devalue their currencies

and institute austerity programs —which

boost exports and curtail imports–before

their creditors would refinance their debts.

So far, these countries have made little

progress in reducing their debt levels; one

result is a conflict between the needs of the

United States to curb its merchandise trade

surplus and needs of Latin American debtors

to run trade surpluses to pay off their debts.

Many proposals have been made to deal with

the Latin American debt crisis, but whatever

the outcome, the difficulties of managing

these debts are sure to intensify as U.S. trade

deficits fall.

The U.S. trade deficits of the 1980s not only

enabled Americans to consume beyond the

nation’s means –for the time being. They

also helped to fuel the economic growth of a

number of countries that based their growth

on rising exports to the world’s largest

market. Leaving aside the costs that went

along with the benefits of America’s buying

spree (e.g., job losses of American factory

workers), the situation cannot last. As noted

earlier, foreign capital will not indefinitely

make up a widening difference between

what we buy from other nations and what we

sell. The burdens of the inevitable adjustment, when it comes, will fall both on

American consumers and on foreign exporters. The adjustment might take a number of different forms, some easier than

others, but none painless.

International Companies

American companies with affiliates in

other countries, and foreign companies with

affiliates in the United States, are important

players in international trade. Their trade effects (at least through 1985, the last year for

which data are available) are not entirely

what might be expected. From 1982 to

1985 –years of large and growing national

trade deficits – all American companies with

affiliates abroad showed consistent merchandise trade surpluses of $3 billion to $5

billion with their affiliates (see table 18).134

Foreign affiliates of U.S. manufacturing

companies accounted for 43 percent of the

total $898 billion sales of the foreign affiliates of all American companies in 1985.

Trade surpluses of manufacturing parents

and their affiliates amounted to $11 billion

to $15 billion in 1977 and 1982-85. For the

U.S. parent companies overall, trade in

petroleum inflated imports, resulting in a

small deficit in 1977, and in the 1980s

diminishing to some extent the surpluses due

to trade between U.S.-based manufacturing

companies and their affiliates.

Since World War II, many U.S.-owned

companies have engaged in large scale

IWle data in table 18 are for U.S. parent companies in the manufacturing indust V and foreign affiliates in which they hold a majority

interest.
The Anatomy of Trade ● 77

Table 18.–Balance of Merchandise Trade, U.S.

Parent Companies and Majority-Owned

Foreign Affiliates, 1977 and 1982-85

(billions of U.S. dollars)

All U.S. U.S. manufacturing

companies companies

1977 . . ., $-1.6 $12.3

1982 . . . . . . 5.8 14.7

1983 ., . . . . 3.6 11.2

1984 . . . . . . . . . . 3.4 11.7

1985 ... , ... 5.7 14.4

NOTE: Majority-owned foreign affiliates are those in which the U S parent company holds a mqo~-ownership

SOURCES U S Department of Commerce, Bureau of Economic Analysis, U.S.

Direct Investment Abroad, 1977 (Alexandria, VA: National Technical

Information Service, April 1981 ) tables Ill T 1 and Ill T 4, U.S. Direct In -

vestment Abroad: 1982 Survey (Washington, DC: U S

Government Printing Offfice, December 1985), tables Ill P 1 and Ill P 4,

U.S. Direct Investment Abroad: Operations of Parent Companies and

Their Foreign Affiliates, 1983-85, available from the Bureau of Economic Analysis, tables 57 and 58

manufacturing operations overseas, mostly

in the developed world. About threequarters of the sales by foreign manufacturing affiliates of U.S. companies are in

developed countries — nearly 50 percent in

Europe and another 20 percent in Canada. It

is generally accepted that the main reason

American companies produce goods in

Europe is to sell the goods there; and these

operations are associated with trade

surpluses for the U.S. parent companies.135

Some production by affiliates of U.S. companies in developing and newly industrializing countries is for the same purpose, but

another important reason is to reduce costs

of producing goods to be sold back in the

United States and in other markets. While

manufacture by U.S.-affiliated companies in

less developed countries is still on a much

smaller scale than activities in the industrialized world, there is evidence of change in

regional patterns. Manufacturing by and for

American companies in Korea, Southeast

Asia, and Mexico is growing fast–much

faster than production by U.S. affiliates in

developed countries. These are the most

favored locations for going offshore to lower

labor costs. And these operations are

generally associated with trade deficits for

the U.S. parent company. However, the

amounts involved were not yet large enough

in 1985 to make much of a dent in the

surpluses from operations in Europe and

Canada. The large and growing national

trade deficits of the 1980s were reduced, not

aggravated, by operations of U.S.-based

companies abroad.

The opposite has been true of foreign companies and their affiliates in the United

States. The deficit arises chiefly from

wholesale trade — evidence that the main

reason for foreign companies to operate in

the United States is to sell here, just as U.S.

companies operate in other industrialized

countries principally in order to sell there.

Merchandise trade between foreign parents

and U.S. affiliates showed sizable and growing deficits on the U.S. side, from 1977 to

1985 (table 19). Most of the deficit is due to

sales of foreign goods – cars, VCRs, compact

disk players– through local wholesale outlets of foreign companies. For example, in

1985,$45 billion of the $54 billion deficit associated with trade between U.S. affiliates

and their foreign parents was in wholesale

trade –$22 billion in motor vehicles and

equipment and another $21 billion in other

durable goods.

l~Data published by the U.S. Department of Commeree, Bureau of Economic Analysis on U.S. Direct Investment Abroad, Operations

of U.S. Parent Companies and Their Foreign Affiliates, show that nearly half of all sales by foreign manufacturing affiliates of U.S. companies

are in Europe; that most goods produced by these European affiliates are sold in Europe; and that exports from the U.S. parents to their

manufacturing affiliates in Europe are substantially greater than imports.
78 ● Paying the Bill

Table 19.-Balance of Merchandise Trade, Foreign

Companies and U.S. Affiliates, 1977-85

(billions of U.S. dollars)

All U.S. U.S. manufacturing

affiliates affiliates

1977 . . . . . . . . . . . . . . . . . $ -19.2

1978 . . . . . . . . . . . . . . . . -22.7

1979 . . . . . . . . . . . . . -23.2

1980 . . . . . . . . . . . . . . . . . -26.0

1981 . . . . . . . . . . . . . . . . . -25.3

1982 . . . . . . . . . . . . . . . . . -26.9

1983 . . . . . . . . . . . . . . . . . -32.2

1984 . . . . . . . . . . . . . . . . . -43.4

1985 . . . . . . . . . . . . . . . . . -54.1

$ -3.1

-4.2

-6.1

-5.2

-5.1

-4,6

-6.1

-7.7

8.4

NOTE: US affiliates are those in which a single foreign person owns or controls

directly or in directly a 10 percent or greater share

SOURCES: US Department of Commerce, Bureau of Economic Analysis, Foreign Direct Investment in United States, Operations of U.S. Affiliates, 1977-60, table G-3; Foreign Direct Investment in the United

States, 1980, table G-3, Foreign Direct Investment in the United

States, Opereations of U.S. Affiliates of Foreign Companies, 1981-85,

table G-3, all available from the Bureau of Economic Analysts

U.S. manufacturing affiliates of foreign

parents have also had persistent and growing

deficits in merchandise trade, but on a much

smaller scale. Considering only trade between the affiliates and their parents, the

deficit rose from $3.1 billion in 1977 to $8.4

billion in 1985; if trade with unaffiliated foreigners (on both the import and export sides)

is added in, the deficits were smaller, rising

from $2.1 billion to $5.6 billion. These

deficits are more or less comparable with the

surpluses associated with trade between

foreign affiliates of U.S. manufacturing companies and their parents. One way that these

deficits could arise in the affiliate’s country

is that the parent company exports parts and

materials to its affiliate abroad, where more

value is added – but not enough to offset the

import of parts and materials. If the item is

sold in the affiliate’s country, then the sale

helps the home country’s trade; if it is sold

back in the parent country or in a third

country it has a negative effect on the home

country’s trade balance.

The idea that foreign investment in the

United States–specifically, investment in

manufacturing plants –will reduce merchandise imports very substantially is not

necessarily or always true. To the extent

items made in the foreign investor’s plant

replace imported goods, they do reduce imports, and improve the trade deficit. But if

they replace goods made by a domestic

manufacturer, then they could increase imports and worsen the deficit.

The persistently low dollar may stimulate

production of goods in foreign-owned plants

in the United States at the expense of imports. There was some evidence by mid-1988

that higher prices, reflecting the high value

of the yen, was finally beginning to stem imports of Japanese cars. It would not be

surprising if Honda, Toyota, and Mazda

were to switch as much production as possible for the U.S. market (and possibly some

production for other countries as well) to

their American plants. This would help to

reduce the trade deficit--and the more U.S.

suppliers replace Japanese suppliers, the

greater the effect.
Climbing Out: How To Reduce the Trade Deficit

It will be difficult to stop living beyond our

means. It will not be painless. But some ways

will be more painful than others.

First, the United States could reduce its

Federal budget deficit. Some deficit reduction was achieved in 1987: the deficit fell to

$150.4 billion, down from $221.2 billion in

1986.137 The Council on Economic Advisers

forecasts further reductions to less than $130

se billion in 1989.138 To reduce the deficit

substantially requires either reduced outlays

or higher Federal revenues, and either might

also reverse some other trends, including the

rising share of consumption in GNP. Higher

taxes would also tend to restrict private investment (with harmful repercussions on the

performance of manufacturers). Despite

some success in cutting the Federal deficit in

1987, the deficit remains very large; further

budget cuts will be more difficult to accomplish and raising taxes is unpopular. If

there is an economic recession – which some

analysts are predicting for 1989 – it is likely

that the budget deficit will quickly balloon. 139

Curtailing the growth of consumption and

increasing personal saving (which has fallen

to record low levels)140 means living less

well, for most Americans. If investment were

dampened, efforts to improve competitiveness could be thwarted. Moreover, some

foreign governments have been reluctant to

spur economic growth and risk inflation, and

their disinclination is magnified by

America’s failure to make more progress in

deficit reduction. In short, even reversing the

reversible could prove elusive.

Added to this is the fact that there are some

things that the United States cannot affect

directly, if at all. The prime example is the

improved manufacturing and export performance of other nations. The improved performance of many nations results both from

improved manufacturing productivity and

quality, and from national industrial policies

and a world trade regime designed to stimulate development. It would be foolish to expect foreign companies to stop learning how

to improve productivity and quality in

manufacturing; it is foolish to expect foreign

governments to stop promoting their own

economic development and exports. We

might be able to impose barriers to the continued access of foreign producers to the

U.S. market, but we can hardly expect our

trading partners to accept such handicaps

willingly. Moreover, while there may be

cases where such barriers are prudent, a

wholesale resort to trade barriers to improve

our trade performance could be ruinous, and

136An excellent discussion of some of the choices confronting the United States and its tradin

w

rtners can be found in I,ester C. Tlurow

and Laura D’Andrea Tyson, “The Economic Black Hole, ’’Foreqq Policy, Summer 1987; and in arris, op. cit.

lwllonornic Re rt of the President, Transmitted to the Congress February 1988 (Washington, D. C.: U. S. Government Printing Office,

February 1988), p. 37. r

13aThis, of course, assumes that there will be no recession through 1989.

~wFor example, the Federal budget deficit more than doubled during the 1982-3 recession, increasing from $79 billion in 1981 to $208

billion in 1983. Source, Economic Report of the President, op. cit.

I@The personal saving rate, which fluctuated between 6 and 10

E 1?

rcent throu out the 1960s and 1970s (dipping below 6 percent in only

5 quartem since 1%2) fell, b 1987, to between 3 and 4 percent. . urce:

1’

U.S. epartment of Commerce, Bureau of Elconomic Analysis,

Business Conditions Digest, anuaxy 1988, p. 83.

79
80 ● Paying the Bill

could undo the progress made in the postwar

period toward more open international trading.

The path of relying on further currency adjustments to achieve trade balance could

cause considerable pain. It is already apparent, both from research and from the performance of U.S. imports and exports, that

the dollar is far from low enough to bring the

current account back to historical levels

(within a range of $10 billion or so, deficit or

surplus). The dollar’s value, as of February

1988, had fallen nearly 37 percent from its

peak in the second quarter of 1985, on a

trade-weighted basis.141 This has helped to

bring U.S. monthly merchandise trade

deficits down to $10-14 billion in the first

four months of 1988, largely by stimulating

exports. It has only recently begun to reduce

manufactured imports, although some

products — notably, Japanese motor

vehicles — have begun to show lagging sales

and rising inventoried, a result of price increases induced by the change in dollar-yen

values.

Bringing the dollar down further would

mean that more imports would move beyond

the means of more Americans. By the end of

1987, the unit value index for all U.S.

manufactured imports had risen 12 percent

from its 1985 level (table 20).142 Items that

are major purchases for most households –

notably, motor vehicles — have become

much more expensive, rising 30 percent in

price above 1985 levels by 1987 (figure 29).

While consumers might be expected to

switch to domestically produced vehicles,

they apparently have not: imported

automobiles were expected to account for

nearly 30 percent of American sales in 1987,

up from 28 percent in 1986.143 In part, this is

because domestic automakers raised prices

too, sometimes in response to the rising costs

of imported vehicles. Less costly items like

VCRs, televisions, and CDs have also become more expensive, although many of

these items come from countries like Taiwan

and Korea whose currencies have not risen

very much relative to the dollar (although

there is a great deal of pressure on these nations to raise their currency values). The

prices of imported office machines and

automatic data processing equipment increased 45 percent between the first quarter

of 1985 and the last quarter of 1987, and imported telecommunications equipment

prices rose 8 percent. Imported sound and

image tape recorders and players (including

VCRs) went up by 16 percent. Interestingly,

the prices of imported television receivers

dropped 2.5 percent. This shows the effects of substituting imports from Korea, and

from other nations whose currencies have

risen less against the dollar, for more expensive exports from Japan.

Consumers are not the only ones to suffer

“as import prices rise. Imported capital goods

have become more expensive too, and many

producers are finding it more difficult to afford imported machinery and equipment as

a result. Imported capital goods cost almost

9 percent more in 1987 than in 1985. The

price of imported textile industry machinery

ldl International Monetaxy Fund, International Financial Statistics, April 1988, count~ pages.

l@Jnit Value Index numbem are from the Department of Commerce, Office of Tmde and Investment Analpis.

l@J.S. Department of Commerce, 1988 U.S. Industrial Outlook, (Washington, D. C.: U.S. Government Printing Office, Janua~ 1988), p.

38-3.

1441mport price data for office and ADP machines, telecommunications equipment, televisions, and sound and image tape recorders and

playm are from the Bureau of bbor Statistics,
Climbing Out: How To Reduce the Trade Deficit ● 81

Table 20.-Average Prices, Imports to the United States (1977= 100)

1980 1981 1982 1983 1984 1985 1986 1987

All commodities . . . ............161.4 170,3 167.5 160.6 163.5 159.4 154.0 164.6

Manufactured goods . .. ..140.6 145.5 148.1 143.6

Consumer goods, non-food, non-auto 131.1 137,1 141.0 133.5

Autos ., ., . . 139.8 163.5 177.2 186.5

Autos from West Germany . . 160.8 178.2 198.9 225.6

Autos from Canada . . . . . . .129.3 153.3 166.8 176.0

Autos from Japan .. ..143.6 172.6 185.4 199.2

Nondurable goods . ......1410 1428 156.1 120.5

Woven cotton fabrics ., ... ., 126.4 143.5 147.9 144.4

capital goods 126.7 123.1 126,4 122.0

Industrial supplies and materials 192.1 2066 195,3 180.6

Textile machinery except weaving .. .2155 2182 204,9 220.2

148.0

134.8

200.3

220.2

189.8

220.1

115.5

156.0

128.6

178.1

246.1

148.1

128.9

206.0

215.1

197,5

223.2

104.5

144.4

131.0

167.2

247.4

153.0

130.1

236.9

200.8

205.9

279.5

103,9

140,2

136.2

129,5

283,6

163,2

133.9

264.2

361.4

222.6

306.3

99.2

163.0

142.4

143,1

356.2

NOTE: Average prices for imported items are expressed as unit value indexes

SOURCE: United States Department of Commerce, Bureau of the Census, unpublished data

rose 44 percent over the same period. 145 Because most textile industry machinery is imported, textile makers are, in most cases,

unable to switch to cheaper domesticallymade machines. This could handicap the efforts of the industry to improve product

quality, raise productivity, and compete with

less expensive, imported textiles.

Another danger of relying only on further

devaluation of the dollar to reduce the trade

deficit is the risk of a severe recession. If we

take no other action to reduce imports, increase world demand, reduce the budget

deficit, and raise exports, foreign governments and private investors will force a solution by curtailing investment in American

assets and securities. If that happens, we face

a period of rising real interest rates as consumers, investors and the U.S. treasury compete for an increasingly limited supply of

capital. Exchange rate markets would also be

in turmoil, as the dollar, no longer supported

by foreign demands for dollars, declines further, and sharply. These developments could

Figure 29

Average Price, Imported Motor

Vehicles and Parts

1 977=100

370

320

270

220

170

120 1 1 I 1 t 1 J

1980 1981 1062 1983 1084 1085 1066 1987

— All motor vehicles and parts — Motor vehicles from Germany

Motor vehicles from Canada --- Motor vehicles from Japan

NOTE: Average Prices for imported commodities are reported

as Unit Value Indices,

SOURCE: U.S. Department of Commerce, Bureau of the Census, various years, unpublished data.

force the U.S. economy into a recession,

which would almost certainly engulf other

nations whose welfare depends substantially

on the American economy. According to

l&50urcc: Department of Commerce, unpublished data on Unit Value Indexes for Imports.
82 ● Paying the Bill

some analysts, such a recession would include increasing inflation as well as rising interest rates–both of which would depress

consumption (and thereby, standards of

living). Rising interest rates also choke off

investment, which would hamper the ability

of American firms to improve their competitiveness. In short, a recession generated by a

cutoff in foreign capital inflows would be a

setback to our efforts to balance trade in

manufacturing by means other than protection from imports.

Finally, relying on currency adjustments for

further improvement in trade performance

is undependable at best. Many businesses

that are beginning to boom as export orders

rise are reluctant to add capacity or make significant long-term investments in plant and

equipment solely on the strength of a currency-induced upturn, since currency adjustments are beyond the direct control of

manufacturers. According to one article,

manufacturers still are unconvinced of the

durability of the dollar’s drop, and even

those that are reaching production limits are

reluctant to expand capacity. Some companies are even passing up export business,

preferring to serve domestic customers instead as they push production closer to

capacity. Many manufacturers see the

dollar’s fall as a windfall, offsetting its disastrous rise — much as farmers welcome rain

after a drought. Long-term improvement in

our trade picture cannot be based on such

windfalls. Sustained improvement must be

based on something more reliable: improved

competitiveness.

In terms of the macroeconomic adjustments, the least painful course would be

steady and substantial progress by the

United States in reducing government

deficits, reducing the growth of consumption

and increasing savings; more expansionary

policies and stimulatation of demand in

major developed nations; efforts to find ways

for developing nations to reduce their debt

burdens and begin to open their markets.

This is a tall order. At best, such changes

will take years, and an extraordinary degree

of cooperation between nations. But

progress must be made if we are to restore

some degree of predictability and stability to

international markets.

Besides these changes, prompt and comprehensive efforts to improve U.S. manufacturing performance are needed.

Technology-broadly defined–has been a

source of strength. Promoting development,

acquisition and diffusion of new product and

process technologies will help to improve

competitiveness. Other actions that government might undertake include improving

education and training workers and

managers in new skills, helping firms to export, encouraging investment in productivity-enhancing machinery and qualified

people, and providing information about effective ways of organizing production and

developing new markets. The government

could also evaluate how other policies encourage longer term investments in product

and process improvement. This is not a

catalogue of government policy options to

146Alan Murray, “Aided by Wc.ak Dollar, Facto~ Output Lzads Economy Once Again, ’’Wall Street Journal, Jan. 26, 1988.

1471bid.
foster improved manufacturing performance; it is only a short list drawn from past

work. 148

The trade patterns of the 1980s are a significant departure from any past experience,

and the enormous current account deficits of

the United States have changed economic

relationships throughout the world. While

some remedies will make more of a difference than others, solutions that aim at

Climbing Out: How To Reduce the Trade Deficit ● 83

only one area — such as promoting competitiveness or reducing federal spending or further devaluing the dollar or opening foreign

markets – cannot achieve more than limited

success. We must make progress in many

areas to overcome the trade deficit while

minimizing the impact on standards of living.

Whatever solutions we adopt, we are in uncharted waters: we have never had such

problems to solve before.

l-e, for example, U.S. Congress, Office of Technology Assessment, International Competitivenw in Electronics, OTA-ISC-2(M,

(Washin on, D. C.: U.S. GPO, November 1983); U.S. Congress, Office of Technology Assessment, International Competition in Services, o’rA-n%-3~ (Washin on, D. C.: USGPO, July 198

& 7

U.S. Congress, Office of Technology Assessment, Technology and Structural

Unempl~ent, OTA- -2S0 (Washington, D. C.: USC ‘O, February, 1986); The President’s Council on Industrial Gmpetitivenesa, Global

Competition: The New Reality, op. cit.; and Thurow and Tyson, op. cit.