Journal of International Economics 52 (2000) 405–407www.elsevier.nl / locate /econbase

Book review

Is the U.S. Trade Deficit Sustainable?Catherine L. Mann, Institute for International Economics, 1999 pp. xii 1 191,$17.00.

If timing is everything, Mann’s book could have not timed it better: the UStrade deficit is at historical heights and the question of sustainability is, again, thesubject of attention. Indeed, understanding the factors responsible for movementsin this deficit and relating those factors to the conduct of macroeconomic policy,though straightforward in theory, is complicated in practice. Mann’s book is aboutthat practice: relating numbers to policy conclusions and questioning the wisdomof other established views. Indeed she offers a clear discussion on how to relatemovements in key components of the U.S. external sector to recurring policyquestions. The material is useful to students of applied international economicsand to policymakers who, while not experts in economics, are interested in theU.S. role in the world economy.

Chapter 1 provides a historical perspective to the sustainability question byrecalling that the U.S. current account reached nearly four percent of U.S. GDP in1986, unprecedented by the standards of that time (page 19). By relying on thesavings-investment identity, chapter 2 explains why federal and external deficitsmoved in tandem during the 1980s and why they have not since 1991. Chapter 3notes that the share of services in U.S. exports has increased, that the U.S. servicesector is more productive than the service sectors of other countries, and thatmaintaining a comparative advantage in services will contribute positively to theU.S. trade balance.

Chapter 4 examines whether the U.S. trade deficit is responsible for job lossesand Mann argues that it is not – just the opposite: cyclical expansions areaccompanied by lower unemployment rates and declines in the balance of trade(her figure 4.1 is rather telling in this regard). She also studies the wage gapbetween skilled and unskilled workers and argues that the increase in this gapstems not from competition of imports in the U.S. market lowering the wages ofunskilled workers but, rather, the competition of US exports in foreign marketsthat raises the wages of skilled workers (page 58).

0022-1996/00/$ – see front matter 2000 Elsevier Science B.V. All rights reserved.PI I : S0022-1996( 00 )00051-9

406 Book review / Journal of International Economics 52 (2000) 405 –407

Chapter 5 covers briefly the trade-off between inflation and unemployment andhow globalization might affect this trade-off (pages 66–71). Chapter 6 examineswhether the U.S. external deficit is caused by unfair trade practices abroad. Thefocus is on whether the removal of trade barriers on a bilateral basis can reduce theU.S. trade deficit. Mann offers two reasons for a negative answer. First, bilateraltrade balances are determined by differences in endowments, preferences,business-cycle phases, and lastly trade barriers. Second, a multilateral reduction oftrade barriers has a greater chance of affecting the savings-investment balance thana reduction of trade barriers at the bilateral level (pages 84–87). The strength ofthe second argument rests on the assumption that barriers and price responsivenessare distributed uniformly across markets, for which some evidence is presented.

Chapter 7 studies two measures of competitiveness: shares in world trade andlabor costs after adjusting for productivity and currency denomination. The chapterhas clear presentations on the pass through of exchange rates to prices and on themeasurement of trade on an ownership basis (page 107). Chapter 8 asks whetherthe United States is living beyond its means. Mann’s answer involves differentiat-ing between secular and cyclical perspectives. A secular decline in the U.S.savings rate is interpreted as living beyond one’s means (page 129). A cyclicalacceleration of U.S. growth relative to foreign growth that worsens the externalbalance need not be interpreted as living beyond one’s means (page 126). Thisuseful differentiation introduces, however, a tension with her earlier view in whichthe external balance ‘‘is determined by the difference between aggregate domesticproduction and aggregate domestic spending (page 96).’’ This earlier viewindicates that the United States is living beyond its means, irrespective of cyclicaland secular perspectives.

Chapter 9 reviews how the forces determining global capital flows affect theeconomic channels that equilibrate the current and capital accounts (page 134).There is a discussion of how financial deregulation has resulted in a diversificationof portfolios (page 139) and a brief reference to the home-bias of U.S. residentsfor U.S. assets. The chief observations are that trade and capital flows respond todifferent factors, that capital flows are much larger than trade flows, and that tradeflows respond slower than capital flows (pages 144–45).

Chapter 10 starts the discussion on sustainability by differentiating betweendebtor and creditor viewpoints, an important and useful distinction. Then Mannoutlines her five-equation model (pages 158–60): a behavioral equation for growthin nominal exports depending on exogenously given growth rates of world incomeand the dollar (a weighted average of bilateral exchange rates); a behavioralequation for growth in nominal imports depending on exogenously given growthrates for U.S. nominal GDP and the dollar; and three identities (balance of trade,current account, net investment position). The model’s exclusion of the savings-investment identity, even though it is used throughout the book, means that onecannot examine how changes in fiscal policy affect current-account sustainability.

For parameter values, Mann assumes a full exchange-rate pass through and uses

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estimated trade elasticities from econometric studies: unitary price elasticities, anincome elasticity for imports of 1.7, and a unitary income elasticity for exports;there are no dynamic adjustments. For extrapolating the exogenous variables,Mann assumes a fixed, nominal dollar and two alternative growth paths: ‘‘businessas usual’’ or ‘‘high performance.’’ Under ‘‘business as usual,’’ the ratio of the U.S.current-account to GDP reaches eight percent by the year 2010, an unprecedentedlevel. Combining a high-growth path with either a dollar depreciation or anincrease in the income elasticity of U.S. exports from 1.0 to 1.3 (chapter 3) bringsthis ratio to historical levels.

Overall, Mann concludes ‘‘that the U.S. current account is sustainable for atleast two or three more years, or even longer as judged by the investors’ constraint(page 163).’’ In the meantime, judging the usefulness of this conclusion involvestrading off accuracy against transparency. Mann does not evaluate the accuracy ofthe model’s extrapolations which tends to undermine, in my view, the usefulnessof the conclusion. On the other hand, the transparency of the model and the ease ofboth replication and portability means that virtually anyone can take her frame-work as a starting point and introduce modeling refinements and additionalevaluation criteria to address whether the U.S. trade deficit is sustainable.

1Jaime MarquezBoard of Governors of the Federal Reserve System

20th & C., N.W.Washington, DC 20551

USA

1Federal Reserve Board. I have benefited from comments from Linda Goldberg, William Helkie, andCatherine Mann. The views in this paper are solely the responsibility of the author and should not beinterpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of anyother person associated with the Federal Reserve System.