The Falling Dollar : America’s Industry Is Being ‘Hollowed Out’

Initially dismissed as unimportant, the dollar’s prolonged free fall against the Japanese yen and German mark now raises the more sobering possibility that American economic thinking is ill-adapted to the modern economy.

The first sign of trouble has been the nation’s stunning trade reversals after both the Bush and Clinton Administrations tried to increase exports--and lift domestic living standards--by letting the dollar slide. In the last year alone, as the dollar dropped to postwar lows, U.S. merchandise exports climbed 10.1%, to $502 billion, but imports rose at an even faster 13.5% clip, reaching an all-time high of $669 billion.

The combined goods and services deficit, normally more positive than the merchandise figures alone, increased by 43%, to $108 billion, the second-highest level ever. Even in trade with Asian nations, where the dollar has taken its biggest beating, the deficit skyrocketed.

Clearly, global investment decisions, and purchases of goods and services, are not simply driven by exchange rates, as U.S. policies have long assumed. Rather, the way that competing countries encourage--or fail to sustain--regional sup- pliers that offer premium goods and services throughout the world is an increasingly important factor.

Countries that moderate the risks of regional supply and investment disruptions are more likely to foster the highly adaptive, technically capable, small and mid-scale firms that enjoy a competitive advantage in the global economy. Unlike the United States, for example, both Japan and Germany have long provided extensive political and industrial support for local and regional firms.

When two countries profoundly differ in the extent to which they encourage broad-based domestic-supplier development, and they then compete head to head, one nation’s supply base, over time, can be “hollowed out� by imports from the country more supportive of local industry. As the foreign content of “domestic� goods steadily rises in the disadvantaged nation, bilateral trade flows will not respond to currency devaluations, because domestic producers have no choice but to import key components. Under such conditions, a falling currency can amplify trade deficits by driving up the price of indispensable imports faster than the nation’s export gains.

This is precisely the problem America now faces in global competition.

America’s commercial-aircraft exports, for example, are frequently cited as a great competitive success. But to offset U.S. advantages in the industry, foreign manufacturers, especially in Asia, are insisting that they supply a growing share of the parts used in the aircraft they buy.

During 1987-91, after the yen began its sharp appreciation in 1985, Japanese aerospace exports--largely to the United States--grew by more than 200%. One Japanese expert claims that, despite the yen’s rising value, as much as 70% of all foreign procurement for Boeing’s 767 airliner now comes from Japan. Japanese designers and suppliers are more fully integrated than ever into Boeing’s 777 aircraft-production team.

These Japanese and other overseas suppliers, meanwhile, are displacing America’s comparatively fragmented aerospace firms, cutting the net benefits of aircraft trade to the domestic economy and contributing to the nation’s huge job losses in the industry.

Similarly, since 1990, America’s electrical-component and semiconductor industries, which supply the computer and other high-tech sectors, have grown by a healthy 54%, to $134 billion. Even as the dollar plummeted, however, component imports, mostly from Japanese and Asian producers, used by U.S. suppliers rose by 58%, to $50 billion. With American firms increasingly compelled to buy these high-priced imports, total U.S. employment in the electronics-supply sectors fell by nearly 12%, or about 90,000 jobs, even as statistics suggested robust growth.

Although the value of foreign-vehicle imports into the United States remained steady during 1992-94, and the number of imported cars actually fell, foreign-parts purchases by U.S. manufacturers increased by 29% despite the dollar’s rapid slide. Imports from Japan alone rose an astonishing 33%.

While the U.S. automobile industry has enjoyed banner years since 1990, and the value of domestic auto parts and automobile shipments rose an impressive 23%, the volume of imported parts grew nearly twice as fast. This helps explain why the United States lost nearly 9% of its automotive work force--close to 80,000 jobs--even with rising sales figures.

All this illustrates the new logic of international competition. Most of the world’s employment, production and service-industry growth is occurring in smaller firms, often concentrated in well-defined regions like Southern California, Shizuoka or Baden-Wurttemburg. These companies, and the regional networks they form, compete to sell complex products to multinational distribution and assembly firms and to end-users in world markets.

Japan and many Asian nations, because they actively support regional supply-base development, can more nimbly respond to major competitive challenges, like the rapid appreciation of their currencies. One option is to reduce the price vulnerability of their domestic industries by becoming indispensable suppliers of critical products everyone must buy, irrespective of cost.

The United States has developed no comparable supply-base strategy. Instead, U.S. policy-makers have tried to deal with Japan and similar competitors by such means as technology subsidies paid to national research labs or universities in the hope of ensuring that the nation retain “critical technology� leadership. But rather than stimulate domestic job growth, the knowledge they generate frequently finds practical commercial applications only with overseas suppliers. During Commerce Secretary Ronald H. Brown’s celebrated “let’s make a deal� trip to China last year, for example, blue-chip U.S. companies sold their patents and production rights to Chinese manufacturers. This may have improved their profits, but hardly helped U.S. employment and suppliers.

America’s rare attempts to construct policies remotely similar to the supply- base initiatives common elsewhere, such as the Clinton Administration’s “regional technology alliances� for defense conversion, inevitably degenerate into pork-barrel subsidies largely wasted on politically savvy, but non-competitive firms. Even the simplest measures, such as small-business loan programs, have been loaded up with burdensome regulatory and social mandates.

There is little reason to think that the Intermountain Western and Southern Republican leaders and the moderate Southern Democrats that now run Washington can reverse these trends. By and large, they hail from states that host few fully integrated supply networks--and thus lack instincts for spurring such an economy--and which grew by luring away companies from urban areas.

Amid a consensus favoring free trade, the United States remains dangerously unprepared to meet its novel challenges. The country’s multinational firms have quickly learned the intricacies of world-wide sourcing, and many have boosted their profits and Wall Street values. In an era of supply-base competition, however, such achievements no longer guarantee domestic job and skill development. Increasingly, only regional supplier expansion can generate such results.

In no small measure, investors are discounting the dollar because they are skeptical that the United States can effectively address such problems. They are looking for the comprehension and political will to tackle productive urban economic development, and stimulate regional industrial centers, in the manner now second nature in most Asian capitals, much of Europe and parts of Latin America and other “developing� regions.

The dollar’s decline is thus not “Japan’s problem,� a temporary technical anomaly, or some strange aberration on the part of world currency traders, as some have suggested. Rather, it offers a profound warning about our future that we ignore at our own peril.