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Council on Foreign Relations Panel Discussion: American and the World: Challenges Facing the Next Administration -- the Global Economy

Speakers: Jose Mendez, professor of economics and director of the W.P. Carey MBA Mexico City Program, W.P. Carey School of Business, Arizona State University, Carolyn Warner, associate professor of political science, Arizona State University, and Lael Brainard, senior fellow in economic and foreign policy studies, The Brookings Institution
Presider: Michael P. Peters, executive vice president, Council on Foreign Relations
October 13, 2004
Council on Foreign Relations


Tempe Mission Palms Hotel
Tempe, Arizona

MICHAEL PETERS: I'm Mike Peters from the Council on Foreign Relations, and it's my privilege to preside over the conversation about the challenges that the next administration is going to face in the economy. And I was thinking of trying to make a joke with respect to economists as the dismal science, but after listening to the foreign policy guys talk at the first panel, I don't think there's any way this can be a more dismal conversation than theirs! [Laughter.] So maybe we'll redefine economics as a result of this panel.

But I'm really pleased to have with me on the panel today Lael Brainard, to my left, who is senior fellow and director of the Poverty and Global Economy Initiative in the new century chair in international trade and economics at The Brookings Institution. I hope I got that all right. Lael flew in from Washington this morning to be part of this panel, and we're really pleased that she's here.

And next to her is Jose Mendez, whom many of you I think know. He's a professor of economics and director of the W.P. Carey School of Business Administration and the MBA program, Mexico City, of Arizona State. And, Jose, thank you very much. And Jose got pressed into duty at the last minute because, unfortunately, our colleague from the Council, Jagdish Bhagwati, wasn't able to join us today. And so, Jose, we really appreciate your stepping up to the Jagdish Bhagwati chair on the panel.

And Carolyn Warner, who is an associate professor of political science at Arizona State University and also pat of the Global Studies School at Arizona State. And we're pleased that she's here as well.

What I thought we would do is ask each one of the members of the panel just to spend a few minutes telling us what they think are the most urgent and the most important economic issues that they think are going to face the next administration. And I'm using those two terms specifically because I want to differentiate between— as several of the folks in the earlier panel talked about— the things that are in the "in box" that the administration is going to have to deal with regardless, but those issues which perhaps might not be at the top of the in box in terms of urgency, but nonetheless, are particularly important, and are going to need to be dealt with at some point during the course of the next administration.

And I thought I'd first throw that to Lael. Thank you.

LAEL BRAINARD: Thank you. Well, let me must start by saying it's a real pleasure to be here, and thank you to Arizona State and also the Council on Foreign Relations for hosting this. Is my mike on? Is it working? Let's try this. Is that better?

PETERS: There you go.

BRAINARD: Great. Well thank you. And it's also exciting to be here on a pretty momentous day for Arizona State. I think tonight people are going to be watching eagerly to see the last of these three competitions, which have turned out to be more important for the election than I think anybody could have anticipated.

Let me focus a little bit, in terms of Mike's question, on international economic challenges facing the next administration of either stripe, and let me talk about three broad areas— or three broad types— of challenges that I see. The first is that America really needs to restore its competitiveness— its global competitiveness. We've seen a lot of slippage over the last few years on that front. A little-known fact is that exports are actually down in real terms over the last four years. In nominal terms, for the last year, full year, data that we have, exports are also actually down between 2000 and 2003 by about $59 billion for goods overall and $64 billion for manufacturing. That's a pretty stunning reversal compared with the previous period, where we had been seeing 5 percentage growth, percentage points growth each year on our exports.

The second area that we're really flagging is on investment. Foreign investment into the United States has also taken a real beating. It's now one-eighth of the level that it was four years ago— that's investment into America's productive capacity. In fact, for the first time last year we actually received less in terms of foreign investment into this country than China did, which is a remarkable thing, considering that we're actually a much larger economy than China's.

And you know, you will truly hear about the offshoring debate this evening. Well, the counter to that always is in-shoring is so strong. The reality is, in-shoring is actually down as well. If you look at net investment into the U.S., it was actually a big positive— $162 billion— just four years ago. But this past year we're actually investing more abroad than foreigners are investing into our productive capacity, on the order of $134 billion.

And if you look at some of the domestic economic challenges like health care costs, they are not just affordability/accessibility challenges, although those are huge in and of themselves, but they also turn out to be competitiveness challenges. Our employer-based system is much more expensive in terms of the amount of GDP [gross domestic product] that it absorbs than any other country on the planet, and that's a real competitiveness issue as firms are making this choice: Do I expand here, do I expand abroad?

We're falling behind, believe it or not, on broadband deployment. We've slipped to tenth place, and South Korea and Japan are now deploying networks that are 20 times faster. So we actually have to catch up in terms of competitiveness. That's the first order of business.

Secondly, one of the cyclical challenges facing us is what economists like to talk about as the twin deficits. We have run up a rather stunning budget deficit over the last short while, moving from a surplus— a projected 10-year surplus of about $5.6 trillion— to a projected deficit of about $2.8 trillion. That's debt. That's our children's debt, and that's a drag on the economy.

What we don't hear people talking as much about— and my prediction is we won't hear about it tonight— is, what we are doing as we are deficit-spending, is we're actually borrowing a large share of that money from foreigners at this juncture, and guess where in particular— Asia.

And so, if you look at our external deficit— our trade deficit— what we're borrowing from abroad every year, this actually expands to over 5 percent of our income. That means we're borrowing 5 percent per year from foreigners, and it's very different from the '80s when we were actually a net creditor. We're actually already in debt to the rest of the world to the tune of 24 percent of GDP. So running up that kind of a debt when you're the largest economy in the world is a very risky way to run an economy, and something that we are going to have to come to terms with. And that brings in also the issue of oil, which we can talk a little bit more about, but it's another cyclical phenomenon that is going to be a drag on the U.S. economy, a drag on the international economy if we don't get our arms around it.

The third big area, I would say, and this is really that nexus between the domestic economy and our international posture. Americans have a profound, increasing anxiety at the moment about globalization. We can see it in the newspapers, we can see it in the polls. It's going to be very difficult to be an international economic leader, let alone an international foreign policy leader, if we don't have the underlying political support to maintain that openness to the rest of the world.

If you look at the polling on this, it's really quite remarkable how much of a shift we've seen in the last few years. The percentage of Americans who want to actually keep up barriers against foreign trade has risen by fully a third in only five years' time. The poll results compare '99 and 2004. And what's particularly remarkable is that the support has deteriorated most markedly among the higher-skilled, higher-income earners, which is traditionally where support for open borders has been the strongest. And so if you look at those numbers, the people earning over $100,000 a year— support for an active free-trade agenda has slipped by half, from 57 to 28 percent. That is not going to give any leader, of whichever stripe, the political support they need to move forward.

And so we see all of that crystallized in two debates— one really on offshoring, the other specifically on China. But it relates to a much broader set of anxieties about how we're going to be able to compete— how our kids are going to be able to compete. Are we on a downward escalator, as [economist] Paul Craig Roberts has said, of declining living standards?

And let me just conclude and pass over to my colleague by saying that that— part of the reason for that debate is because the overall economy has seen a pattern of increasing distributive pressures. We have seen a big increase already in inequality, just in a very short period of time. And it's been a very lopsided recovery. It's been a recovery in which the corporate profit share of income relative to the wage share is higher than in any previous postwar recovery. And in fact, wages as a share of income are lower than at any time since the statistics were beginning to be kept in 1929. And so that goes directly into these fears that the good jobs are disappearing, that middle-class Americans are not going to be able to educate their children to be able to continue to command this very high standard of living that we have with the integration of China and India, much lower wage-rate workforces, into the world economy.

PETERS: Thanks, Lael.


JOSE MENDEZ: I, too, want to— I want to thank you, Mike, and whoever recommended that I participate in this forum. [Laughter.] I'm very happy to be here. I do have to admit that one of the reasons I was going to be here is that I wanted to see Jagdish Bhagwati. [Laughter.] But in any case, I'm happy to be here.

And let me just say that I don't disagree with the, with the points made by Lael. She's identified the problems of competitiveness, the problems of the twin deficit, the unease we feel with the outsourcing, and also the problems created by a worsening distribution of income. The only area where I would, in a sense, disagree is that I feel that the twin deficits is basically the source of all those difficulties.

I don't think the United States has a competitiveness problem. The competitive problem is derived simply from the twin deficits problem; that is, that we have, we've moved in a, probably historically, at least after World War II, it's the first time that we've ever had such a dramatic movement, going from 2 percent of GDP, having a surplus of 2 percent of GDP to now a projected deficit of, fiscal deficit of four-and-a-half percent of GDP. Never have we had such a rapid movement and deterioration in terms of the fiscal deficit. And for my part, most of the problems, all the problems that Lael, that I agree with, all derive from this fiscal deficit.

And I think that it is— while there is some uncertainty regarding whether or not a current account deficit is tied to the fiscal deficit, I do tend to feel that, in this case, in this period of time, what we have in the United States, unlike the mid-'80s, is a weakness in savings. And so the fiscal deficit, as the government's entering the capital markets or the loan-able funds markets, is pushing up real interest rates, strengthening the dollar, and both of those factors are contributing to the deterioration in the current account. And, of course, the deterioration in the current account means that our industries are less competitive— we tend to import more, we export less, and so on.

For me, looking down medium term and long term, the twin deficit problem— I don't want to sound so pessimistic or so dismal, but it is a serious concern for us, and primarily because looking forward into the future, we do see the problems of the baby boomers both— not just retiring, which I think that is a manageable issue— it's the problem of Medicare. What are we going to do in terms of Medicare? By, I believe, 2012, most of the baby boomers will be eligible for Medicare. And according to some estimates, the deficit on Medicare expenses amounts to 137 percent of today's GDP. And that I think is the critical issue facing us— Medicare expenses.

In terms of Social Security, we do face a deficit, but I think it is more manageable in the sense— although I'm not recommending it— that if we were to raise the payroll tax 2 percent, we would be able to cover the Social Security deficit for another 75 years. So it's the Medicare issue that concerns me most.

And what concerns me about the deficit spending of such a large magnitude historically, we have not seen deficits in absolute terms, postwar, of this size since the mid-'80s with President [Ronald] Reagan. If you remember, in order to correct those, it took some time. We didn't— it took us about seven to eight years before we were able to consolidate the fiscal deficit and move into a surplus. We don't have that time. In 10 years, we're going to have the baby boomers retiring. In 10 years, we're going to have the demands on the health care system. And that's assuming that we do nothing about the 44 million people that have no health care, you know, if we reform the health care system. So that's what concerns me— that if we don't move now in terms of making hard decisions on correcting the federal deficit, our options will be limited 10 years down the road; we won't have the freedom.

And think about how long it takes to get a consensus in the United States to make changes. Back in 1982, I think, we had a panel that reformed the Social Security system. They raised the retirement age from 65 to 67. When was it going to be implemented? In 2002. So reform— building a consensus— takes time, and the policies are phased in usually over a long period of time. And in fact, we're going to move from 65 to 67 over a 25-year period.

So we won't have those options, and that's what concerns me. And it concerns me— so the deficit concerns me, and it also concerns me in the sense that if we do— now talking about internationally— if we don't do anything, capital markets, especially international capital markets, are not going to be willing to lend us the money to fund the deficit as they have in the past. As Lael mentioned, it is true— it is the case that it is not private foreign investors that are paying for our deficit, it is Asian countries; in particular, Japan, China, and India are now funding our deficit. And you have to ask the question why they do it. I suspect that they're doing it to maintain the competitiveness of those products, of their products in the U.S. market or in the world market. But what is going to happen when they decide not to? What's going to happen? I suspect that interest rates are going to go up, the dollar will weaken. And we do know that there's a one-for-one increase in interest rates abroad with the increase in U.S. interest rates. So that's going to slow economic growth over the medium to long term. Our dollar's going to weaken. That's going to make it more expensive— well, it's going to make it more expensive for emerging countries in particular to earn the revenues to pay off their dollar-denominated debt. So I am concerned about the medium to long term.

Now, I'm not quite so dismal in the following sense— it's really not too late. The recession has been relatively mild. It is a jobless recovery. Despite what you may think about the stimulus package, whether it was done correctly, it has helped sustain the economy over the last two years. Its stimulus effects, though, are going to wear down. And— but nonetheless, it appears that, apart from Japan, we're in a situation where we have— the world industrial countries have fiscal strengths. We're not as, the United States has the fiscal difficulties; the rest of the world does not.

So in that sense, that's a good thing. The U.S. economy does seem to be stronger than it did in the mid-'80s, after we were trying to recover from the various oil shocks and inflation. We've had a period of high productivity growth. So in that respect, I mean, we're better positioned. So I'm trying to be like a typical economist: on the one hand, things are dismal, but on the other hand, things are not so bad. [Laughter.]

And now I'll turn to Carolyn.

PETERS: Thanks, Jose.


CAROLYN WARNER: Yes, thank you. I find myself in the odd position— I'm a political scientist. I'm in the odd position of actually agreeing with the economists. [Laughter.] And so I— that's also the danger of going last in a panel.

The twin deficits are the thing that I think is both most important [inaudible]--the twin deficits are both most important and also, I think, most urgent. But I could— my sense, though— and here's where I come in with the political scientist pessimism— is that I'm— I agree with Jose that these problems could be addressed, but I don't know that the political incentives are there to get them addressed in time, whoever wins this next election.

If it's Kerry, he's not going to want to make unpopular decisions because he'll want to be re-elected. If it's Bush, his legacy is going to be Iraq and 9/11. He really couldn't— as a politician, he can't be re-elected. He won't be worried about what happens to the budget 10 years from now in any sense. His personal wealth is secure, so he doesn't have that sort of issue. His daughters' personal wealth is secured.

I'm a little worried about the incentives our democratic system gives to politicians to address critical problems that— you know, critical economic problems. They are also social problems. Social— you know, health care is certainly a big issue. I agree with Lael that that is an area that's been proposed that if we were more like the Europeans, where the state takes over more of the expense of health care, it does not come out so much out of employers' pockets directly, that that might help some of our competitiveness. I'm not saying we should go the full European route, because there are other issues where Europe actually looks less competitive than us in other areas. That's something that would need to be addressed. But, you know, the last time a president tried to provide universal health care, or even broach it, it didn't cost him the next election, but, you know, it went down in flames within a year and was never picked up again— you know, Bill Clinton, by his administration.

So I find it's rather striking. I'm very much in agreement with the economists on what the key issues are. I'm also pessimistic, as I said, about whether or not these will actually be addressed.

The House of Representatives, it's even worse than the presidency. You know, every two years you come up for re-election, so you don't want to have to be telling your constituency, "Yeah, you're not going to be able to retire until you're 70." Or, you know, "Yeah, we raised your Social Security tax so that 70 years from now your kids will have Social Security." You know, that doesn't compute. So I'm quite concerned there.

In terms of more general— the U.S. and the world economy— if I could take it in this direction a little bit, I think aside from all those problems, what the U.S. needs to do is to start to address some of the multilateral international institutions that it has that it's helped create, and use them better for restoring U.S. competitiveness, but also for restoring U.S. credibility in the world as a player that is willing to cooperate at times, and as a player that is willing to open markets at times to other countries.

But I'm not— I would not advise— if I ever could— the next president to, you know, get back on the free-trade bandwagon and say this is the cure for everything. What I would more suggest in terms— is that the U.S. use its leverage, such that it has, to encourage less developed— you know, the countries that are really trying to develop and improve their economies— to make it easier to start businesses, to get loans, to collect debts if people default on loans, having it much easier to open a new business, to provide services. The statistics sometimes are incredible. It can take over three, four years in Bangladesh to open a small business, to get all the proper permits, and that's after you've paid everybody off in a row. And that in itself contributes to sort of a, you know, global poverty.

But I think it also— to the extent that the U.S. has a fairly sophisticated economy— we'd like to sell to, you know, other countries that can afford to buy what we produce— we need to start seeing other countries having greater earning power, greater buying power. And I don't think the way to do that is just to say, well, free trade— we take, you know, textiles from Bangladesh and eventually they'll be able to buy DVDs with an American name on them but made in Taiwan or something, or maybe China. It's more that they need to be able to produce on their own. But to get to that point so that they're more competitive, we need to encourage other countries to reduce regulations that go along with— unfortunately, in many of these countries— that go along with economic activity, in a much greater extent than exists here in the U.S.

And just on a positive note, I think there's one thing the Bush administration started, and that's the Millennium Challenge Corporation, which actually for foreign aid— for part of our foreign aid— looks to assess countries' good governance and good practices of governing business before we give aid. And I think if we do that a little more, we might help the general economic environment of the world. That certainly won't help these other massive problems of the trade deficit, but to the extent that it may address— alleviate— some other people's problems, I think it will be a step in the right direction.

PETERS: Thanks. This evening's debate is, at least in part, supposed to be about economics. And so I guess the question that suggests itself here is you all pretty much agree that— with one another in terms of the importance of trying to restore competitiveness, to deal with the cyclical issues, and to resist anxiety from globalization. But you all seem to agree that these are pretty tough. And Carolyn, you were suggesting that might be politically too difficult to take on.

So assuming that's the case, then what do you expect— what's the economic nature of the debate going to be tonight? What are the differences, as they're going to define themselves, between Bush and Kerry on economic issues? Do you want to start, Carolyn?

WARNER: I think Kerry will speak about fiscal discipline and trying to restore it. I don't know that he has a sure-fire cure, but— or a solution, I should say. But I think he'll talk about if there are going to be tax breaks, giving them to families, middle-income families, lower-income families.

I suspect he'll— he could, you know, pick up on the insecurities that Americans have about globalization and talk about his proposal to facilitate middle-class tax breaks, financing them by eliminating the corporate— apparently corporate— tax breaks for corporations which outsource. I'm not sure that's entirely feasible, but I think that's going to be part of the dialogue tonight. He'll be tapping on the outsourcing issue.

I think health care will come up, and Kerry and Bush seem to have a slightly different approach to health care. I think they're— neither of them are willing to bite the bullet and say we're just going to have to raise taxes, have the government get much more heavily involved.

Bush, rather, it would— seems to rather want it to be a— you know, provide lots of choices, have HMOs [health management organizations]--well, it's the drug cards for seniors and for people on Medicare. I get the impression he would like to extend that to the general population for health care.

Kerry seems to want the more— you might say the traditional Democratic form of more universal health care coverage, [with] a big part of the tab picked up directly by the federal government. I think that's part of where it's going to be going.

I'm not so sure the global economy's really going to come up, except for trade with China, which I think Bush will probably— if he does address it at all, it'll be, well, trade is a good thing. Kerry will be using it to his political advantage to say, Well, but we got to be careful about this, we're losing jobs, you know— so on and so forth.

PETERS: Good. Lael?

BRAINARD: I think you got a taste of it last Friday night. There were both big philosophical differences and then there were programmatic differences that the two candidates wanted to highlight. And I think what we'll probably see tonight is taking those areas that seemed most interesting from Friday and really putting a much finer point on them, because the questioner will again be from the press, as opposed to a town hall kind of setting. So I think there will be some sharper questions, trying to tease out those differences and also raising some of the issues that didn't come up.

On a philosophical basis, you know, the president, I think, does see himself quite differently, and will try to sort of paint himself as somebody that is— really just wants to put dollars back in the pockets of Americans so they can make the decisions themselves. Tax cuts, individual savings accounts for everything— for retirement, for health care, for education— and will try to portray his opponent as a kind of Massachusetts liberal. I doubt very much that the Senator Kennedy reference the other night, which was, interestingly, the only time the president called his opponent by name, was a slip at all. I think that's a very intentional push on the part of the Bush campaign.

I think Senator Kerry, for his part, will lay out a philosophical position that is very akin to the kinds of policies we saw under President Clinton— a real return to fiscal responsibility, and really pointing the finger at President Bush as having just been fiscally reckless, having pushed through tax cuts that have done very little to stimulate the economy or to help the middle class. I think he'll probably try to paint President Bush as somebody who's out of touch with the realities that are faced by the vast majority of working Americans, as opposed to the kinds of special interests— the folks who get the tax cuts at $200,000-plus income every year.

At the programmatic level, Kerry's going to want to talk about health care. He's got a very serious health care proposal, which tries to work within the confines of the current system but takes the catastrophic coverage and puts it on the government's responsibility to reinsure, so taking only that very— the $50,000-plus costs and creating a reinsurance market for health care— and using that to reduce costs to businesses— $1,000 per year— by his campaign's estimates, compared with the $2,600 increase in premium that has happened over the last four years.

Education is going to be another big plank that he's going to want to talk a lot about, and this is going to be really funding [the] No Child Left Behind [program] and funding universal preschool.

I think, as Carolyn said, offshoring has got to come up, one way or the other, because there is a philosophical difference there. The president has kind of shrugged his shoulders on this one. Senator Kerry has said, "No, we need policies," and in particular, has suggested that tax incentives for offshoring should be neutralized.

For his part, I think President Bush is really going to want to come back to the tax cuts agenda, because it's been a very consistent theme; is going to want to talk about the importance to small businesses of continuing on the tax cut front, and that's where his programmatic emphasis is going to be.

Where we won't hear a lot, I think— although I would imagine the questioner will be a little bit more pointed— is on this issue that Jose raised, which is entitlements, which is a really tough area— Social Security less so than Medicare. But that's an area that is absolutely critical to the future fiscal health of the country, not to mention the future actual health of our seniors. And so I wouldn't be surprised if we got a question there as well.

PETERS: Let me change it a little bit. I won't ask you to try to predict what they're going to talk about tonight. But for the most part, the conversation here has been— when you think about the economic challenges, whether they're domestic or international, they're centered here in the United States. I mean, that's the— you know, our current account deficits, other kinds of issues.

What is there outside the U.S.? What is there— are we— do we need to be concerned— does the next administration need to be concerned about currency collapses and shocks in other areas? Is there something else out there, beyond things which are, in a sense, almost U.S.-homegrown, that this administration needs to be particularly, or the next administration needs to be particularly concerned about?

MENDEZ: You're very kind, Mike. [Laughter.] He warned me about 30 minutes ago that he was going to— they were going to ask me a question about what do you think the debate is going to be about. And I told him, "Well, I'm going to give you a big blank, because I don't know." [Laughter.] But I did think about it --


MENDEZ: --so let me say something.

PETERS: You bet. Go ahead.

MENDEZ: I'm going to be a little bit flippant. I do think that the debate is not going to be on the substantive issues, but I think it's going to be on Kerry's Vietnam record— did he deserve the medals; [and] on whether President Bush made a mistake in Iraq. I think every question will eventually go back to those main themes— the wishy-washiness of Senator Kerry, possibly the stance on abortion, that it's not clear-cut. I guess I am very cynical, but I do think that the candidates won't talk about the meat of the issues, but they want to get across their— repeat the same themes, you know. Senator Kerry will be saying, "I have a plan." And President Bush will be saying, "Well, you're wishy-washy." We won't get information about the substantive issues.

PETERS: Do you want to talk about international risks beyond the U.S.?

MENDEZ: OK, now let me get back to your question.

PETERS: Yes, good.

MENDEZ: One of the concerns— and again, I go back to the twin deficits. One of the concerns I do have, is that in trying to understand the cause of the twin deficits, there's always the danger of looking at countries that run current account trade surpluses with us, and in particular, China. And my concern with that, is that usually it leads to protectionist rhetoric. You know, the fundamental problem is our overspending. But it's much easier, I think, for people to understand that, oh well, you know, if China's running a surplus, they must be doing something unfair and we've got to figure out— either we have to put a surcharge on them or we have to pressure them to devalue their currency.

Right now, the big debate among economists is, is the Chinese currency undervalued? As opposed to the U.S., where we're overvalued. Undervalued currency means, what it does is it makes their products cheaper in the U.S. market. And so you'll hear— so the danger is you'll hear the Treasury secretary going to China and trying to lobby them to change their exchange rate policy— that they need to devalue. Or you'll hear protectionism sentiment, and that concerns me.

I myself, being an international economist, and maybe I focus too much on it, but I do think that we need to do a better job of pushing the free trade agenda, and pushing it in a direction of educating Americans that we, too, need to follow sort of the fair trade policies. You know, we expect fairness on the part of foreigners when they're selling their products in the United States. But if you look at the biggest barriers— or the biggest things that we could do as a nation to improve development in poor countries, and that's, of course, to change our agricultural policy, and instead, we're going in the opposite direction. We're giving out— we had the most generous agricultural bill handout in years. But instead, we should be moving back; we should allow— we should open up the markets in— you know, there was the big debate about cotton; there's, of course, the sugar quotas that we have— that would be the first step that I would like us to see.

I do find myself agreeing with the Brazilians, for instance, and the stance that they've been taking in the following sense; that they've decided, Look, we're not willing— we're not willing to make any more commitments on trade and services and other things that are of interest to you, the rich countries, until you abide by the commitments that you've made in the past of opening agricultural markets. You in traditional products open up to free trade. You know, do as you say we should, and then we'll go ahead, and we'll negotiate on trade and services. So, I'm concerned about the danger that the deficit poses in terms of protectionist sentiment.

The issue— I think outsourcing is a good example of the sort of type of things that can occur that create protectionist sentiment. There is absolutely no evidence, except for anecdotes, about outsourcing of jobs. We know that. I mean, people point to the high-tech sector, but what they don't consider is the fact that the high-tech sector was coming off of a bubble. There was too much employment. Everybody was worried about Y2K [year 2000], and everybody was hiring technical people to try to help them solve that problem. And so the high-tech sector was overblown— too much employment. And when it collapsed, naturally there's going to be a decline in the number of jobs in that sector.

Now, some people are saying, well, you know, the reason there's fewer jobs and high-tech jobs is because they're being outsourced. There is no evidence on that. There is absolutely no data. And of course, you might retort and say, well, you know, that the U.S. government, the Bureau of the Census doesn't do a good job of tallying those. But for my part, I don't think it ought to do a good job of tallying those. For the economy to produce— for an economy such as the United States to produce high-wage, good-paying jobs, part of that is having flexibility to destroy jobs, and what we, the government, have to do, is sort of to smooth the transition. There is no doubt that people are hurt. There are many losers from international trade, just as there's many losers from technological progress. We basically don't do anything for the losers from technological progress.

So, for instance, how many of you here are worried about the fact that somebody lost their employment because we don't have CB [citizens band] radio producers? Remember— I mean, I'm old enough to know that that was the rage. You know, everybody had a handle. [Laughter.] Right?

WARNER: Oh, my word.

MENDEZ: Everybody had records or four-track tape players, eight-track tape players. We don't worry about the losers from technological progress. That's what— because we understand that eventually it's technological progress that will raise our standard of living.

Some of you that live here in Arizona, just drive down— drive down [inaudible]. And what you'll see is a lot of carcasses— a lot of empty lots where there were service stations, where there was Mobil. How many of you are lobbying because hey, these people have been put out of work? But in their place, you do see the creation of new employment.

Right now, how many have noticed that there's a CVS Pharmacy on every street corner? OK? And that's— international trade works the same way. It destroys jobs just like technological progress. But the good thing is that it raises standards of living. Now, it is the government's obligation, possibly, to try to figure out how to ameliorate the downside of it. And that's what worries me about outsourcing, is that, you know, it's an easy thing— well, you know, someone's handling my— like Dell, someone's handling my question in India, and for some reason that is a bad thing. So that concerns me.

PETERS: Thanks, Jose. I know there are plenty of things that we haven't touched on up here, but I do want to get to questions from the audience, and so let me turn it to you. There's all sorts of issues out there— and if you will wait for the microphone and identify yourself. Yes, ma'am?

QUESTIONER: My name is Lynn Stoner. I'm in the Department of History. My question is, in the most recent New Yorker magazine, there was an article that said that we shouldn't be worried about the deficit, that the deficit is something that we can sustain perhaps indefinitely. All of you are in agreement that this twin deficit, or the twin tragedy of going from the surplus to the deficit, is the major monster that we face. What do you say, or I'd be very interested in hearing all of you address this disagreement. I am old enough that I think that the deficit is something that is frightening, and I don't understand, really, the argument of economists who say we can just continue running up this deficit. So I'd love to hear you address that.

PETERS: Lael, why don't you handle that one.

BRAINARD: Lynn, I didn't actually read the New Yorker story. Was it referring to the budget deficit or to the trade deficit or both?


BRAINARD: Both. Well, I disagree. And I disagree pretty strongly. Mike asked earlier about what international risks are out there. Well, one of the biggest risks that confronts us today— which we're not very aware of, but people like [former Treasury Secretary] Bob Rubin and financial markets people are acutely aware of— is people could simply decide they don't really want to hold that many more dollar assets because they're already way out of proportion in their portfolios; or they could perceive some risks in the U.S. economy and decide they're going to dump some of these assets. If that were to happen, the mayhem that would ensue in financial markets and the interest rate reaction back here at home could cut off any incipient recovery, even as weak as it's been, and we'd be right back into a recession very quickly.

The only reason we haven't seen as big interest rate increases so far, with the amount of borrowing that the government is doing at home, is because we're simply borrowing from foreigners. And so far, they're happy to lend, but by the way, as Jose was saying, these aren't the same folks lending to us as were lending to us five years ago. These aren't private equity investors in Europe. These are not private folks investing into our stock market, our factories, our offices. These are, by and large, Asian central banks. And they are doing it for complicated reasons, which have to do a lot with their own trade balances and their own desire to keep full employment and to keep their export relationship with us strong.

And Mike also asked: Is this something that's simply homegrown, that we can solve by ourselves? The reality is no. The way that we got out of this box back in the early '90s was a combination of things. The U.S. did a lot on its budget deficit, and we have to do a lot in the coming years.

The reality is, we [inaudible] mainstream economists who are also a little nervous about having China move to a free flow right away. I'm among those people. But China could revalue and do so in a way that's— actually helps solve its own overheating problems and would also help solve the global conundrum of how to rebalance, because right now the only currencies that are really moving vis-à-vis the dollar— and which means that these economies are experiencing more contractual pressures than they need to— are Europe, Canada, Australia.

And the reality is, the China dollar, the China yuan-dollar relationship is not really about the bilateral deficit. A lot of people say that that's why we should care about it. That's not really the reason we should care about it. Most of the Asian currencies are actually similarly pegged. They're all going to move with the Chinese yuan, because that is a tightly linked regional trading system right now. In order to maintain competitiveness, they have to keep in line with the currency. So it unlocks an entire region. And in fact if you talk to Japanese officials, they'd be very happy— it would make their lives a heck of a lot easier than purchasing all these Treasury securities, which they've been doing for the last few quarters at a startlingly scary rate.

And then just one last thought: You know, it may look— it's true for Argentina, for Brazil, for Mexico, and we have these stories and examples. It all looks fine until it isn't fine any longer. And we are so enormous in the world economy, and borrowing at 5 percent of our income every year when we're borrowing in the form of Treasury securities and not in the form of productive investments— it is a risky strategy.

PETERS: Yes, ma'am?

QUESTIONER: My name is Jennifer [inaudible], and this question is for anyone on the panel, as you're all probably equally qualified to answer this. I am a Ph.D. student in political science, and I also teach introductory economics and statistics in the Economics Department. I'm really interested— since hardly anybody's been discussing this— is the implications on labor, immigration, and capital flow from Mexico. And I think that this is a particularly salient issue, given that we're in Arizona. So I guess you could comment both in terms of our state as well as the United States as a whole.

PETERS: Jose, do you want to talk about that?

MENDEZ: Wow. Being in Arizona, you know, it's a politically charged issue. And I'm afraid that, for me, it's also an emotional issue. And I try to be as objective as possible, but I do mix a lot of my own feelings about it.

In the 1980s— when I first— I arrived here in 1980. I wrote a paper on the health care costs of illegal aliens on the Arizona health care system because, you know, one of the big issues at that time was that illegal aliens were placing huge demands on our health care system in Arizona. That changed a lot of my views on immigration. In part, it made me see that this was not an issue, OK? After going through the literature, it made me see that the benefits of immigration, whether legal or illegal, far outweighed the costs. And there are costs.

There are so-called— what I call distributional costs. It is true that over the past 20 years, because of enforcement along the border, the composition and the length of stay of, for example, undocumented workers in the American, in the U.S. economy along the border states has changed. Because of increased enforcement, we no longer have the young males that would come across, relatively healthy, and they didn't place much demand on the health care system. They were relatively healthy. They'd self-medicate. They'd go to the pharmacy. The only times that they needed emergency care, of course, they would go to the emergency room. So it wasn't a concern. But the moment that we stepped up enforcement, it made it much more, riskier for these individuals to want to go back to their families because these individuals generally are not interested in becoming a part of the United States. They're interested in making a lump sum of money and going back and being with the family. But they couldn't do that as frequently, and so the increased enforcement had the ironic effect of making them stay here, not risk going across, and then saying, oh, I miss my family.

So what the, so what has happened over time is that they are risking— you see more anecdotes, and you do see more children, you know, where families are paying for the children to come across, like you know, the ones that were captured in Ciudad Juarez across from El Salvador, I mean from El Paso. So they're staying longer, and of course then the children will be using school and they will be— you know, you're sicker when you're younger, so you will be using more health care.

So there is this distributional impact on the states. They are paying more. But on the other hand, what most studies do document is that illegal aliens or undocumented workers do pay federal taxes. The employers, you know, if they can't determine whether they are illegal aliens, will take money out of their checks. And they also pay sales taxes, which is a very regressive tax. So every time they go in the grocery store or the 7-Eleven, they are paying a sales tax which is used to support local services.

And I was at a conference last year at the Federal Reserve, talking to an economist from UCLA [University of California, Los Angeles] that specializes on these issues of the illegal aliens, and I mentioned to her that I had yet to read a paper from what I consider mainstream economists— and by that I mean academic economists, that you don't have a right-wing or a left-wing sort of agenda— and there has been no paper that I've read from any mainstream or academic economist that say that they're a net burden to the U.S. economy. In fact, every single one says that they're a positive— they increase GNP, not by much, but overall, they are both— they pay more than the services that they use over time; and No. 2, that they expand the U.S. GNP— not by much. So— I forgot what your question was. [Laughter.]

QUESTIONER: [Inaudible.]

MENDEZ: So, for my part— in fact, I've written on this issue. And I would like to see the United States— I don't know if it's politically feasible— to move more towards making NAFTA [North American Free Trade Agreement] a little bit like the European Union system.

I would like to see, for instance, especially with Mexicans, that rather than they're— and they're paying now $1,000, $2,000 or $3,000 to coyotes to get across the border— that they could put a deposit of $1,000 down, and they come in with a— they're permitted to come and work under a temporary worker permit. And they're allowed— they must— they have a five-year sort of period when they're treated like any other worker, except they're not permitted to use social services, except for emergencies. OK? So they couldn't bring their families, and they couldn't have free school, they couldn't have free health care. And then after that— and they would then be— and they'd also be entitled to go back and forth. And if they show that they can be productive, serious citizens, then they would then go into the regular process, if they wanted to— who's to say that they will want to?--go into the regular process of applying for citizenship, et cetera. So that's the kind of program— more of a European-type program of freer flow. But the—

PETERS: I was just going to say, we've got a panel this afternoon, actually, that's probably going to touch on a number of those issues as well, so we should do it.

Yes, sir?

QUESTIONER: My name is Bruce (inaudible. I'm a private sector capitalist; learned my economics back in Maynard Keynes' time. The United States debt, particularly as we're borrowing from these foreign countries, has a unique or at least unusual aspect, and that is that it's denominated in dollars. A, does that present a risk for the lenders? And, b, what's the, how do you spin out that scenario of a post-devaluation scenario where they make the debt meaningless and basically wipe it out by devaluing the dollar?

PETERS: Go ahead.

MENDEZ: You're right that that is a unique feature of the debt in that— I don't know if everybody understands this— that if we do have a financial crisis and interest rates peak upwards, and the dollar falls in value, what happens, is that the debt that foreigners are holding— the dollar-denominated debt— really falls in value. OK?

So we— unlike Argentina— the debt crisis in a sense makes us wealthier. But I think that it doesn't free us from the problems. And, you know, there's going to be the higher interest rates, and it's harming the other countries. OK? So— [inaudible.]

BRAINARD: Yeah, glad you rose those. [Inaudible]--saying it earlier, and I said, Nah, nobody will ever think of that. [Laughter.] But we are. We are incredibly lucky. We get to borrow on own currency. We're the only country in the world that gets to borrow on our own currency, and that means that the folks that are lending to us, they take on not only the risks associated with our economy, but they also take on our currency risk. So you know, the good news here is that we are more insulated from that shock. The bad news is that investors know that. And so when they take on increasing amounts of U.S. assets, they are constantly thinking about the probabilities of the U.S. dollar weakening and how is that going to affect their holdings. And so you can be sure that that kind of calculation has been very much in the mind of investors over the last few years.

What's interesting is that we have seen this willingness to just keep accumulating U.S. assets and only sort of [inaudible] is this massive shift in the composition of those holdings from equities, et cetera, to treasury securities, from Europe to Asian central banks, which means, you know, that the motivations there are not 100 percent sort of market motivation.

We're also lucky, by the way, that we get to import our oil in our currency, and that also insulates us from the kind of currency risks that the whole rest of the world faces in terms of their exposure on their imports, on their debt.

WARNER: I gather from what you are saying, though, that [inaudible] should this scenario occur, we might— it will cause problems in the U.S., but the bigger problems would actually be outside the U.S., which in turn comes back to us because— to the extent that we depend on exports, we can't— other countries would be in such straits that we wouldn't be able to sustain trade with them. [Inaudible.]

BRAINARD: Yeah, I think that's [inaudible] that Carolyn just pointed out is very important. The IMF [International Monetary Fund] actually wrote a very unusual report about a year ago saying, you know [inaudible] the U.S. fiscal deficit, and external deficit more importantly, is a risk not only to the U.S. economy but it's a risk to global interest rates, and it's one of the biggest risks out there [inaudible] precisely that reason.

MENDEZ: To put it in more concrete terms, think about the balance [inaudible] of the central banks of all the other countries. They use the dollar— they don't actually use dollars, they use U.S. treasuries as their reserve. And so what you're doing essentially is wiping out the reserves.

QUESTIONER: Hi, I'm Wendy Plotkin with the Department of History. And I have a question as to what extent the lack of political will to deal with these issues relates to the lack of economic education we have throughout the school system. If you're talking about a very complicated issue, and if you don't have the education and don't understand the issues, then you will listen to rhetoric and slogans rather than dealing with them.

PETERS: Carolyn, do you want to—

WARNER: Yeah. Maybe you're asking if [inaudible] is going to be automatically biased because I'm in the education business, and so I do think education is important in any subject. My colleagues here will say maybe I'm proof of that. I didn't have a formal economics course until I was in graduate school. I just sort of got economics, whatever, from osmosis, from my parents [inaudible] that would enable me to understand a conversation we've been having here. And yes, it was surprising on economics, on other issues when I've talked to— these are very educated, intelligent people in Phoenix and as well as younger people, students— the lack of just basic knowledge, comprehension of, Oh, if this happens, then that's a very likely result.

And I do think that contributes to a sense of irresponsibility or a lack of responsibility; that, Oh, there's got to be an easy answer, and, No, it can't be that complicated, and, No, that wasn't how they said it on Channel 5. And Bush will just stand there and swagger and it will be fine— you know, it's not that big a deal.

So I would agree with you. And it concerns me also that, from what I can tell, I don't know that economics is a formal subject, except in kind of college-prep high schools, until you're in college, and then it's not a requirement. I mean, like I said, I got through a very fine undergraduate institution with no economics. And, yeah.

MENDEZ: Could I—

PETERS: Go ahead. Sure.

MENDEZ: I have to admit that when I heard Monday night that I was going to be on this panel and I was thinking about the deficit, I was sitting down, well, gosh, there's nothing— I mean the deficit, the federal deficit, I mean, the national debt, I mean, how do you put it in sort of conventional terms? I couldn't think of any sort of a nice analogy. You know, like losing jobs is easy to see. And this is a little bit related to Lynn's case about concern about the debt.

And I was thinking that in the past we weren't worried about— and this is the only analogy I could come up with. In the past we didn't worry about the debt so much, during the Keynesian period, because we knew it was a— an intergenerational transfer. It was from Peter to Paul somewhere down the road. But nowadays, since the debt is being financed by foreigners, it's not a Peter to Paul, it's we're taking from Peter and eventually are going to have to pay Pablo. [Laughter.]

PETERS: Back in the back over there. Right there.

And I think this may have to be the last question. I think we're getting pretty close to time. So I apologize ahead of time to those people I didn't call on. Yes, sir?

QUESTIONER: Thank you all for coming to Phoenix. This is wonderful. My name is Chris Miner. I'm an attorney with Squires, Sanders & Dempsey.

I was wondering if the panel could briefly comment on the future of free trade agreements. I know we mentioned NAFTA, Central American free trade, but what's the future?

PETERS: Great. Why don't we just— we'll come this way and start with Carolyn, and address that and any other last thoughts you'd like to leave the group with.

WARNER: On the one hand, there seems to be a big push to extend free trade agreements to try to— you know, with the United States— to try and reach free trade agreements with all of Latin America, say, or North-South American free trade agreement. On the other hand, the collapse of the trade rounds— you know, the Doha trade rounds, the WTO [World Trade Organization], I— with Jose, I thoroughly agree with Brazil of holding things up and saying, Hey, wait a sec, if you're not going to come forward on your agriculture, U.S. and EU, we're not going to come forward on all these other things that you're asking us to do.

There is— there's some very hard-nosed negotiation that goes on in those [negotiations], and there again it takes some stubbornness or political will, but also sophistication and an ability to explain to American farmers that you may be the empty gas stations on rural— the equivalent of the empty gas stations on a rural road. We're going to get our cotton and our sugar and our corn from Mexico, for instance, or you know, India— and that's not politically popular because, you know, that's one of the conundrums of free trade agreements. You have free trade with Brazil, but your leaders are elected by voters back in the United States, and those two don't meet very well.

My other, sort of— my concern about free trade agreements is that they can sometimes get ahead of things in that the enforcement mechanisms tend to be very weak— it's like [Senator] Jon Kyl [R-Ariz.] was saying today with other international organizations— there are real cheating problems, and I don't know— you know, the big countries, the wealthy countries cheat just as much as any other country on these agreements if not more, and getting an arrangement to govern that means you actually have to bring— you take sovereignty away from states and put it at a higher level, which is also not politically popular, and I'm actually kind of uneasy about that trend that I see in that it just moves— I mean, it's already hard enough to think, gee, voting for the president, I'm one of how many people in the United States? Is my vote really going to make any difference? Imagine if the authority is at a yet higher level of a billion people? You know, it— the EU is going in that direction, and I don't think that a lot of Europeans are happy about that.


MENDEZ: I think that the— related to the question about education— economic education— what concerns me about free trade areas is that they're not free, and I dislike free trade areas, and I think that they do drain momentum and energy from the multilateral approach. And, I think that the— the best way to not have distortions— not to create inefficiencies— is to go through the World Trade Organization and its multilateral trade negotiation routes.

PETERS: Lael, last word.

BRAINARD: Last word— well, I'm glad you asked this question and I'll predict it will not be asked this evening [laughter]--

PETERS: So the word Doha will never come up tonight, right? [Laughter.]

BRAINARD: --but I think it's an important point. What we have had, recently, is actually an incredibly— without almost any notice— is a sharp change in American trade policy, an extremely sharp change. If you look up until the end of the '90s, we had negotiated three free trade agreements bilaterally: one in Israel, which was clearly a politically, foreign policy-motivated; and then we did two— one with Canada and then we added on Mexico. Most economists would say those were driven by a natural marketplace, that North America is an economist's definition of where trade should be moving, that the political boundaries are really quite artificial from an economic point of view. Since that time, in four short years, the president's proud to tell you that he's negotiated [inaudible] 12 additional— and he's got another 10 that he'd like to do, good or bad.

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