A More Diversified and Flexible Economy
Globalization is not the only possible cause behind the moderation of the business cycle. Improved monetary policy, fewer external shocks (what some economists call “good luck”), and other structural changes in the economy may have all played a role. For example, the decline in unionization and the resulting increase in labor‐market flexibility have allowed wages and employment patterns to adjust more readily to changing market conditions, mitigating spikes in unemployment. Better inventory management through just‐in‐time delivery has reduced the cyclical overhangs that can disrupt production. Lifting the ceiling on deposit interest rates has helped lending institutions weather downturns, while more access to consumer credit and home equity loans have helped families smooth their consumption patterns over time when incomes temporarily fall.
Combined with those other factors, expanding trade and globalization have helped to moderate swings in national output by blessing us with a more diversified and flexible economy. Exports can take up slack when domestic demand sags, and imports can satisfy demand when domestic productive capacity is reaching its short‐term limits. Access to foreign capital markets can allow domestic producers and consumers alike to more easily borrow to tide themselves over during difficult times.
During the current economic turmoil, as the housing and mortgage markets have turned downward, many U.S. companies have maintained or expanded production by serving growing global markets. In 2007, U.S. exports of goods and services rose a brisk 12.6 percent from the year before, more than double the growth rate of imports. Meanwhile, U.S. companies and investors saw their earnings on foreign assets grow an even faster 20.3 percent.8
A weakening dollar has helped to boost exports and earnings abroad, but the main driver of success overseas has been strong growth and lower trade barriers outside the United States. As The Wall Street Journal summarized in a front‐page story: “Economies in most other parts of the world–including China, Latin America and Europe–have grown faster than the U.S. over the past 18 months, providing a countercyclical balance for multinational companies. Overseas growth could provide further support for companies and investors if parts of the U.S. economy continue to worsen.“9
American companies have been earning a larger and larger share of their profits overseas for decades now. According to economist Ed Yardeni, the share of profits that U.S. companies earn abroad has increased steadily from about 5 percent in the 1960s to about a quarter of all profits today.10
Even the American icon Harley‐Davidson motorcycle company in Milwaukee, Wisconsin, has become a multinational enterprise. The company that once came begging to Washington for protection from foreign competition is enjoying robust sales and profits abroad even as its domestic sales slump. In the second quarter of 2007, the company saw its profits jump by 19 percent–fueled by the double‐digit growth in sales in Europe, Japan, and Canada–while its domestic sales fell 5.5 percent.11
Earning a larger share of profits abroad allows Harley‐Davidson and other U.S. companies to better weather downturns at home, reducing the need for drastic cost cutting and layoffs when recessions hit.
If the U.S. economy does tip into recession this year, free trade and globalization will be among the likely scapegoats. The pain of recession will be real for millions of American households, but raising barriers to foreign trade and investment will provide no relief for most affected workers. In fact, reverting to protectionism would only reduce the capacity of our economy to regain its footing and resume its long‐term pattern of growth.
For the U.S. economy as a whole, the era of globalization has brought healthy long‐term growth and a moderation of the business cycle. Expansions are longer if less spectacular than in eras past, and downturns are mercifully shorter, shallower, and less frequent. Moderation of the business cycle in recent decades is something to be thankful for, and expanding trade and globalization deserve a share of the credit.
1National Bureau of Economic Research, “The NBER’s Recession Dating Procedure,” www.nber.org/cycles/recessions. html.
2NBER, “Business Cycle Expansions and Contractions,” www.nber.org/cycles.html.
3Evan F. Koenig and Nicole Ball, “The ‘Great Moderation’ in Output and Employment Volatility: An Update,” Economic Letter, Federal Reserve Bank of Dallas 2, no. 9 (September 2007).
4NBER, “Business Cycle Expansions and Contractions.”
5Bureau of Economic Analysis, National Economic Accounts, “Gross Domestic Product (GDP): Percent Change from Preceding Period,” U.S. Department of Commerce, www.bea.gov/national/index.htm#gdp.
6NBER, “Business Cycle Expansions and Contractions.”
7Jeffrey Frankel and Eduardo Cavallo, “Does Openness to Trade Make Countries More Vulnerable to Sudden Stops or Less? Using Gravity to Establish Causality,” NBER Working Paper no. 10957, December 2004.
8Bureau of Economic Analysis, “U.S. International Transactions: Fourth Quarter and Year 2007,” U.S. Department of Commerce, News Release, table 1, March 17, 2008.
9Timothy Aeppel, “Overseas Profits Provide Shelter for U.S. Firms,” The Wall Street Journal, August 9, 2007, p. A1.