Regional President Speech

DEKALB COUNTY ECONOMIC DEVELOPMENT COUNCIL ECONOMIC OUTLOOK BREAKFAST DeKalb, Illinois April 17, 2002 ..................................................................... The Impact of Open Markets and Expanded Trade It’s a pleasure to be here and to have the honor of speaking at your economic outlook breakfast this morning. Traveling here from the Chicago area was a very scenic trip. As we passed through the rolling farmlands, it reminded me of the agrarian beginnings of our American economy. Certainly the roots of the DeKalb County economy were in agriculture, as settlers from the East moved here beginning in the 1830s to farm some of the richest soils in the world. From the invention of barbed wire to the founding of the Farm Bureau to the creation of hybrid corn, DeKalb County has been a leader in agriculture for well over a century. Even today, Roger said that there are three times more pigs in the county than there are people. But just as the rest of the country has evolved, this region also has expanded beyond agriculture to include substantial growth in the manufacturing and services sectors. In all of these businesses, DeKalb County is directly or indirectly connected to markets that reach well beyond the charming small towns of the area. You participate in the national and the global economy. SowhatIwould like to do today is talk about the health of the economy and the impact of open markets and expanded trade on economic development. I’ll cover where we’ve been, as well as where we’re going. 24 Michael Moskow Speeches 2002 Background on Federal Reserve A little background first. At the Federal Reserve, our aim is to help ensure a healthy and growing economy. We carry out this mission through three primary activities. They are: Supervising and regulating banks, Providing financial services to banks and to the U.S. government, and, Conducting monetary policy—which garners the most attention. The Federal Reserve Bank of Chicago is one of 12 regional reserve banks in the Federal Reserve system. Together with the Board of Governors in Washington, D.C., we serve as the nation’s central bank. The Chicago District serves a five-state area that includes all of Iowa and most of Indiana, Illinois, Michigan and Wisconsin. Our head office is in Chicago, but we also have regional offices in Des Moines, Detroit, Indianapolis, Peoria and Milwaukee. As president of the Chicago Fed, I serve on the Fed’s key policymaking group, the Federal Open Market Committee, or FOMC. This is the group chaired by Alan Greenspan that is responsible for determining mon- etary policy. The most visible aspect of this function is setting the short-term federal funds rate. All 12Fedpresidents play an important role in determining FOMC policy. At each meeting, we report on eco- nomicconditions in our respective regions and share our outlook and policy recommendation for the nation- aleconomy. That’s why it’s important to connect with local business leaders such as yourselves, in preparing for our FOMC meetings. Overview of the economy As we look at the overall picture for the country, we are seeing signs of recovery from the recession that the National Bureau of Economic Research said began last March. Analysts are more bullish now; and, on balance, we believe the recovery is underway. The big question is, How will this recovery unfold? Going forward, we expect moderate gains in outlays for most household purchases. Important here, is the fact that real incomes have been supported by three factors: • low overall inflation; • tax cuts; • and, most important, wage increases supported by productivity growth. Michael Moskow Speeches 2002 25 Indeed, productivity growth has remained unusually high during this recession. Typically, productivity falls during contractions, regaining strength only when the economy’s recovery is underway. In part, this is because firms initially retain too many workers in the face of weaker demand for their products. However, in this cycle, firms seem to be taking advantage of increased flexibility in the labor market. One example is the use of temporary workers and outside contractors, whose hours can be cut during slow times to temper or avoid employee layoffs. This adaptability, combined with longer run improvements in technolo- gy and the skills of workers, has helped keep productivity healthier than in past slowdowns. With regard to business investment, many firms remain somewhat cautious. That could continue to weigh on discretionary spending and capital outlays. Nevertheless, recent data suggest that the contraction in busi- ness spending is at least moderating. The fall in capital spending subtracted about a percentage point from real GDP growth last year. So, even if business investment simply stops falling, this would be a significant improvement relative to the large declines of 2001. Real GDP growth last year was reduced by about an additional percentage point as businesses moved from rapid stockbuilding to large inventory liquidations. Inventory levels now are lean enough that firms are rebuilding inventories. Accordingly, inventory investment will likely turn from a negative factor to a signifi- cant source of growth. In addition, government policy is also supporting these changes. On the fiscal policy front, incomes were boosted by last year’s tax law change. Furthermore, bills signed into law after September 11 are increasing government spending. And the recent economic stimulus bill signed in early March increases incentives for business investment. In addition, the Federal Open Market Committee reduced the federal funds rate target from 61⁄ to 13⁄ percent 2 4 last year. Given the usual lags, we probably haven’t seen the full effects of those cuts yet. At its March 19 meeting, the Committee kept the target at 13⁄ percent and noted that the economy is expanding at a signifi- 4 cant pace. We also cautioned that the degree of strengthening in final demand is still uncertain. Although the stance of monetary policy is currently accommodative, the risks are now balanced with respect to the prospects for price stability and sustainable economic growth. Other factors to consider What are some of the other factors to consider as we look ahead at the overall economy? In the household sector, generous retail discounts and low interest rates could boost spending more than expected. On the other hand, if this cycle is like previous ones, unemployment rates will continue to rise for a time even after the recovery has begun to take hold. Resulting income losses would likely hold down spending somewhat. And worry over job prospects could cause households to cut back more dramatically as well. In the business sector, as technology advances, at some point firms will need to upgrade their current equip- ment with more cutting-edge systems. But the timing and ultimate magnitude remain quite uncertain. 26 Michael Moskow Speeches 2002 Indeed, a great deal of capacity was added in the 1990s, which is now unused. This low capacity utilization may weigh on investment for some time. On the international front, many central banks cut their policy interest rates. Long term, these policy moves should help foster growth in aggregate demand abroad, which in turn would help support U.S. exports. Another key factor in economic growth both here and abroad is the long-term process of opening our borders to trade and investment. In recent weeks, these advances have been overshadowed by increases in tariffs. The United States has increased tariffs for steel and lumber. The European Union and Canada have threatened to increase tariffs on a variety of products, including steel, motorcycles and tomatoes. Some commentators have questioned which way the world trading system is moving. Is it towards more open- ness or less? As part of this dialog, it is appropriate to take a step back and consider how open markets and expanded trade affect economic growth in general. Let me turn to that subject. Open markets foster prosperity Despite recent economic uncertainty, the United States and much of the rest of the world have never before been as affluent as they are today. For example, per capita output in the United States in 2001 was about twice the 1966 level and more than four times the 1940 level. We also have seen a dramatic rise in economic open- ness among nations. For the United States, total trade, measured as exports plus imports, has increased from less than 10 percent of GDP in 1940 to nearly 25 percent today. The parallel rise in openness and affluence is no coincidence. Economic studies have repeatedly found that openness promotes prosperity. Looking across the countries of the world, you find that the economies most open to trade and investment are those with higher per capita income. That is because cross-border investment fosters an efficient reallocation of resources that leads to productivity improvements and higher economic growth. Moreover, economies benefit from the real efficiency gains brought about by freer trade. When firms can pur- chase the highest quality and lowest cost materials from anywhere in the world, their production costs fall. These lower costs lead to lower prices, which spread broadly throughout entire societies. But, it’s important to note that the benefits of lower prices are largest for those with low and moderate incomes. Because free trade lowers the price of everything from food and clothing to automobiles, those who spend the largest fraction of their income on these goods reap the largest gains. Domestic and international benefits of openness U.S. firms and workers benefit from producing and selling goods globally, but countries on both sides of the transaction stand to gain — particularly in developing countries. Countries that lack capital can develop more quickly because capital inflows allow them to increase their productive capital stock without foregoing current consumption. When the capital inflow takes the form of foreign direct investment, it improves access to international best practices in accounting, banking, legal and other important standards. Michael Moskow Speeches 2002 27 As a result, developing countries that have opened their borders to trade and investment are better off. In its examination of 84 developing countries, the World Bank reported that those with the largest tariff reductions inthe 1990s also had the most rapid growth in GDP and exports. And American multinationals pay workers in developing nations double the local manufacturing wage. Thus, open markets, from a purely economic per- spective, benefit the consumer, the producer and economic development at home and abroad. Many reasons groups oppose free trade Despite these benefits, there are a number of groups, both here and abroad, who oppose free trade and open markets. Especially in cases regarding displaced workers, their concerns are serious and deserve our atten- tion. I’d like to discuss some of their concerns and what role, if any, the government can play in addressing these issues. As trade barriers fall, some industries and their workers find themselves facing sharp competition from imports. Others gain from expanded trade. This is because increased trade redirects resources toward their most productive uses. In the United States, the result is that production shifts to higher value-added prod- ucts—such as pharmaceuticals, medical equipment and information technology devices — as production of lower value-added goods — such as apparel and consumer electronics — shifts overseas. This dynamic reallocation process is similar to the changes that take place in economies that are growing, and often results in costly adjustments. These reallocations and adjustments take place even when unemploy- ment is low. Overall, economic studies suggest that worker dislocation caused by trade accounts for no more than 10 percent of all displaced workers in the U.S. Nonetheless, there is widespread support in this country for programs that help them. Dealing with arguments against open markets Protectionist policies and high tariffs have their genesis in a variety of groups that oppose open markets for a number of reasons. Let me address a few of their concerns. It is indeed true that inefficient industries will suffer from increased competition. Free trade helps society through lower prices and more choice for consumers. But it does so by promoting the reallocation of resources, such as capital and labor, from less efficient sectors in the economy to the most productive ones. In a market economy, the allocation of resources is guided by profits and costs, including wages. Nevertheless, the reallocations that arise from expanded trade do not reduce the total number of jobs in the United States. Indeed, expanded trade is, overall, good for workers. Because of competitive pressures from imports, some firms may have to reduce their work forces. But other firms will find themselves with new opportunities and will increase hiring. The evidence suggests that the expanded opportunities are likely to be in high productivity industries such as aircraft and pharmaceuticals that pay wages substantially above the average U.S. wage. Conversely, high tariff barriers can reduce employment in relatively efficient industries by directly increas- ing costs of production. Here’s just one example. In the U.S. sugar industry, trade protection has pushed the domestic price of sugar well above the world price. In 1999, we paid almost five times the world price. That 28 Michael Moskow Speeches 2002 is a huge difference, and one of the unintended consequences is that Midwestern candy factories are relocating to countries such as Canada, where the price of sugar is not artificially increased. Thus from a broader perspective, society at large suffers if we choose not to open our borders. While a small number of industries benefit greatly from barriers, a larger number firms, workers and consumers suffer the costs. Another concern expressed by opponents of open markets is that resources and personnel freed by the inef- ficient industries will not be reallocated to more efficient uses and will remain idle for long periods of time instead. This is a difficult and important question to address. The growth process presents ample evidence that resources are surprisingly flexible. They have to be, because technology is constantly changing. For example, 100 years ago, 50 percent of our labor force was engaged in farming. Today, only a little more than 2 percent is. This suggests that, in the long run, resources can reallocate and that the efficiency gains from free trade can indeed be realized. But100years is a long time. Many of us would like to consider the effects of open markets and free trade over a shorter period — say, within our lifetimes. To gain an idea of how flexible resources are in the short run, consider the large number of technological improvements and innovations that lead to new products and production methods every year. These innova- tions reduce the market share of older products and may even drive them out of the market completely. Clearly this type of innovation is highly desirable. Who would question the advantages of using a PC instead of a typewriter, a CD instead of an 8-track, or a DVD instead of a VCR? Moreover, even though they take place continuously, these innovations do not seem to create large amounts of unemployment caused by technological change. Thus, if the transformations introduced by free trade reform were similar to the transformations generated by technological innovations, they would not be a spe- cial concern. The resources displaced by foreign competition would soon find better uses. However, a closer look reveals some important differences. Let me explain. Businesses and workers generally expect technological innovation to change the nature of their enterprises. For example, enhanced information systems and the Internet have dramatically improved how firms make purchases and manage inventories. Moreover, technological innovations usually take place in small steps, allowing workers and firms to find some use for their skills and machinery in the newer technologies. But future free-trade reforms may be unforeseen at the time workers and businesses commit to long-term investments in human and physical capital. In fact, drastic trade reforms can cause entire industries to be unprofitable. In this context, businesses and workers may find it difficult to shift their specialized resources to alternative uses, leading to serious dislocations — and idle resources. Job losses in industries such as steel and textiles, for example, are concentrated geographically. Because those workers have skills that don’t easily shift to other industries, they tend to have a harder time finding good, high-wage jobs in their locales. So, in my view, the crux of the free trade debate is, “How can we cushion short-term dislocations so that we can more quickly achieve the long-term benefits of open markets and expanded trade?” Michael Moskow Speeches 2002 29 Free trade issues over long term There are a number of policy choices that should be considered. First,free trade reforms could be designed to help the trend towards open markets resemble the trend of con- tinuing technological innovation that the economy normally goes through. In particular, policy reforms could take a more gradual approach. If tariffs and non-tariff barriers can be phased out over a considerable period of time, this will give business- es and workers more time to accommodate to the transition — as would be the case with other innovations. In fact, this gradual approach has already been implemented in a number of cases. For example, under NAFTA, the tariff on imports of automobiles from Mexico is gradually being reduced from 10 percent in 1994 to zero by 2004. Second,training programs could be improved to provide dislocated workers with the skills needed to become re-employed in more efficient industries. Third, the government could directly compensate the “losers” from trade reform. Efficiency gains for con- sumers and producers, arising from lower prices and better use of our resources, are large enough that, even after compensating the “losers” for their losses, America would still be better off. The dislocated workers could be given a one-time sum at the time of trade reform, rather than be subsidized for remaining unemployed. This way, they would receive compensation for being dislocated but would be encouraged to become re-employed in a different industry. Time does not permit a more detailed discussion of the advantages and disadvantages of these policy choices. But, in my opinion, they are the types of policies that are important to consider as we move forward to open markets and expand trade. Conclusion In conclusion, let me say that increased cross-border investment and the long-term reduction of tariffs and non-tariff barriers over the past five decades has benefited America and many other countries around the world, including developing nations. Yet even as we actively promote and encourage free trade, we must con- front the very real opposition to expanded trade. Our response must include addressing the short-term dislocations caused by open markets, through policies such as those we have just discussed and other options as well. In this way, we can help expand the long- term benefits of free trade both here and abroad. 30 Michael Moskow Speeches 2002

Michael Moskow (2002, April 16). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20020417_michael_moskow

@misc{wtfs_regional_speeche_20020417_michael_moskow,
  author = {Michael Moskow},
  title = {Regional President Speech},
  year = {2002},
  month = {Apr},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20020417_michael_moskow},
  note = {Retrieved via When the Fed Speaks corpus}
}