Speculation is growing that the U.S. economy may have alreadyslipped into recession. If the past is any guide, politicians onthe campaign trail will be tempted to blame trade and globalizationfor the passing pain of the business cycle. Rising unemployment andfalling output can provide fertile ground for attacks on importsand foreign investment by
U.S. multinational companies. But an analysis of previousrecessions and expansions shows that international trade andinvestment are not to blame for downturns in the economy and may infact be moderating the business cycle.
Economic downturns have occurred periodically throughout U.S.history. The popular definition of a recession is two consecutivequarters of negative growth in the nation's gross domestic product(GDP). The National Bureau of Economic Research in Cambridge,Massachusetts, which has become the official bookkeeper of thebusiness cycle, offers a more refined definition: "A recession is asignificant decline in activity spread across the economy, lastingmore than a few months, visible in industrial production,employment, real income, and wholesale-retail trade."1
By NBER's accounting, the nation has suffered through 11recessions since the end of World War II, not including the currentpossible downturn.2 All recessions produce, to one degree or another,falling industrial output, lower real wages and household income,higher rates of unemployment, increased foreclosures andbankruptcies, and growing self-doubt about our economy and ourcountry's future. In the political arena, recessions often spur abacklash against incumbent office holders, especially those of thepresident's party, and against foreign producers and foreign tradein general.
The supposed link between trade and recessions is superficiallyappealing. During any recession, critics can point to imports thatdisplace domestic production, putting some U.S. workers out oftheir jobs and supposedly reducing domestic demand for goods andservices. They can more easily blame U.S. multinationalcorporations for "shipping our jobs overseas" by locatingproduction facilities in countries where labor and other costs arelower. But like so much of the conventional wisdom about trade andthe economy, the alleged link between rising levels of trade andrecessions simply does not exist.
"The Great Moderation"
In recent decades, as foreign trade and investment have beenrising as a share of the U.S. economy, recessions have actuallybecome milder and less frequent. The softening of the businesscycle has become so striking that economists now refer to it as"The Great Moderation." The more benign trend appears to date fromthe mid-1980s. As a recent study from the Federal Reserve Bank ofDallas found:
On average, the five recessions from 1959 to 1983 were47 months apart, lingered 12 months and were associated with a 2.17percent peak-to-trough decline in real gross domestic product. Bycontrast, the 1990 downturn came after 92 months of expansion,lasted eight months and involved a 1.26 percent decline in GDP. The2001 slump ended a record 120 months of uninterrupted growth,lasted eight months and involved a GDP decline of only 0.35percent. More generally, quarterly growth in both real GDP and jobsbecame markedly less volatile after 1983.3
The Great Moderation means that Americans are spending more oftheir time earning a living in a growing economy and less in acontracting economy. According to the NBER, our economy has been inrecession a total of 16 months in the past 25 years, or 5.3 percentof the time. In comparison, between 1945 and 1983, the nationsuffered through nine recessions totaling 96 months, or 21.1percent of that time period.4 (See table 1.) In any given month, the country wasfour times more likely to be in recession in the post-war decadesbefore 1983 than since then. And even if the U.S. economy hasalready entered a recession in 2008, the expansion that began afterthe 2001 recession would have lasted six years--making it thefourth-longest expansion since 1945.
|Table 1Economic Contractions Are Becoming Less Common|
|Time Period||Number of Contractions||Contractions||Expansions||% of time in contraction|
|1855-1944||21||21 months||29 months||41|
|1945-1982||9||11 months||45 months||21|
|1983-2007||2||8 months||95 months||5|
|Source: National Bureau of Economic Research.|
Moderation of the business cycle has not come at the expense ofoverall growth. In the past 25 years (1983-2007), annual real GDPgrowth has averaged 3.3 percent. That is virtually the same averageannual growth rate as occurred during the previous 25 years(1958-1982).5 Likea superior investment, our more globalized economy has deliveredthe same rate of return in the form of real GDP growth but withmuch less volatility than in the past.
The more recent globalized growth also compares favorably withthe supposed Golden Age of the late 19th and early 20th centuries,when U.S. manufacturers were protected by high tariffs. The era ofprotection so admired by skeptics of trade was also a time ofdramatic boom and bust cycles. From 1854 to 1944, according to theNBER, the U.S. economy suffered 21 recessions averaging 21 monthsin length. During that time, despite tremendous growth, the U.S.economy was contracting 41 percent of the time. A depression in the1870s lasted more than five years. The "Gay Nineties" (1890-99) andthe "Roaring Twenties" (1920-29) each witnessed all or parts offour recessions.6And we should always remember that the Great Depression of the1930s occurred on the protectionists' watch.
America's recent experience of a more globalized and lessvolatile economy has not been unique in the world. Other countriesthat have opened themselves to global markets have been lessvulnerable to financial and economic shocks. Countries that put alltheir economic eggs in the domestic basket lack the diversificationthat a more globally integrated economy can fall back on to weathera slowdown. A study by Jeffrey Frankel and Eduardo Cavallo for NBERfound that a country that increases trade as a share of its grossdomestic product by 10 percentage points is actually aboutone-third less likely to suffer sudden economic slowdowns or othercrises than if it were less open to trade. As the authorsconclude:
Some may find this counterintuitive: tradeprotectionism does not "shield" countries from the volatility ofworld markets as proponents might hope. On the contrary...economies that trade less with other countries are more prone tosudden stops and to currency crises.7
A More Diversified and Flexible Economy
Globalization is not the only possible cause behind themoderation of the business cycle. Improved monetary policy, fewerexternal shocks (what some economists call "good luck"), and otherstructural changes in the economy may have all played a role. Forexample, the decline in unionization and the resulting increase inlabor-market flexibility have allowed wages and employment patternsto adjust more readily to changing market conditions, mitigatingspikes in unemployment. Better inventory management throughjust-in-time delivery has reduced the cyclical overhangs that candisrupt production. Lifting the ceiling on deposit interest rateshas helped lending institutions weather downturns, while moreaccess to consumer credit and home equity loans have helpedfamilies smooth their consumption patterns over time when incomestemporarily fall.
Combined with those other factors, expanding trade andglobalization have helped to moderate swings in national output byblessing us with a more diversified and flexible economy. Exportscan take up slack when domestic demand sags, and imports cansatisfy demand when domestic productive capacity is reaching itsshort-term limits. Access to foreign capital markets can allowdomestic producers and consumers alike to more easily borrow totide themselves over during difficult times.
During the current economic turmoil, as the housing and mortgagemarkets have turned downward, many U.S. companies have maintainedor expanded production by serving growing global markets. In 2007,U.S. exports of goods and services rose a brisk 12.6 percent fromthe year before, more than double the growth rate of imports.Meanwhile, U.S. companies and investors saw their earnings onforeign assets grow an even faster 20.3 percent.8
A weakening dollar has helped to boost exports and earningsabroad, but the main driver of success overseas has been stronggrowth and lower trade barriers outside the United States. AsThe Wall Street Journal summarized in a front-page story:"Economies in most other parts of the world--including China, LatinAmerica and Europe--have grown faster than the U.S. over the past18 months, providing a countercyclical balance for multinationalcompanies. Overseas growth could provide further support forcompanies and investors if parts of the U.S. economy continue toworsen."9
American companies have been earning a larger and larger shareof their profits overseas for decades now. According to economistEd Yardeni, the share of profits that U.S. companies earn abroadhas increased steadily from about 5 percent in the 1960s to about aquarter of all profits today.10
Even the American icon Harley-Davidson motorcycle company inMilwaukee, Wisconsin, has become a multinational enterprise. Thecompany that once came begging to Washington for protection fromforeign competition is enjoying robust sales and profits abroadeven as its domestic sales slump. In the second quarter of 2007,the company saw its profits jump by 19 percent--fueled by thedouble-digit growth in sales in Europe, Japan, and Canada--whileits domestic sales fell 5.5 percent.11
Earning a larger share of profits abroad allows Harley-Davidsonand other U.S. companies to better weather downturns at home,reducing the need for drastic cost cutting and layoffs whenrecessions hit.
If the U.S. economy does tip into recession this year, freetrade and globalization will be among the likely scapegoats. Thepain of recession will be real for millions of American households,but raising barriers to foreign trade and investment will provideno relief for most affected workers. In fact, reverting toprotectionism would only reduce the capacity of our economy toregain its footing and resume its long-term pattern of growth.
For the U.S. economy as a whole, the era of globalization hasbrought healthy long-term growth and a moderation of the businesscycle. 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 tobe thankful for, and expanding trade and globalization deserve ashare of the credit.
3Evan F. Koenigand Nicole Ball, "The 'Great Moderation' in Output and EmploymentVolatility: An Update," Economic Letter, Federal Reserve Bankof Dallas 2, no. 9 (September 2007).
4NBER, "BusinessCycle Expansions and Contractions."
6NBER, "BusinessCycle Expansions and Contractions."
7Jeffrey Frankeland Eduardo Cavallo, "Does Openness to Trade Make Countries MoreVulnerable to Sudden Stops or Less? Using Gravity to EstablishCausality," NBER Working Paper no. 10957, December 2004.
8Bureau ofEconomic Analysis, "U.S. International Transactions: Fourth Quarterand 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 WallStreet Journal, August 9, 2007, p. A1.