Skip to main content

Remarks on the Current Account Deficit

Playwrights Horizons Current Events Breakfast

It is good to be here and I very much agree with the tone of Bob Rubin’s questions. But I would begin by saying that, for all our problems, which are very serious – and Bob touched on those that I think are some of the main ones – as an economic policy maker, I would rather have America’s hand to play than the hand of any other country in the world. And it is a good thing that our problems are problems of political paralysis rather than problems of deep, substantive impossibility, or deep substantive difficulty, which is the case for many other countries in the world. Let me take the three questions that Bob asked and answer them in reverse order.

First, science and technology. Economists debate why industrial countries grow, and there are three basic reasons: they grow because they have more physical capital; they grow because they have a more educated populace; and they grow because of technological advance. The debate is whether technological advance accounts for two-thirds of the growth or whether it accounts for 90 percent of the growth. No one argues that technological advance is not the principal engine of growth.

If you think about the progress that our country makes, or that other countries have made, there is a good case to be made if you ask yourself which you would rather have, a 2005 level of income and 1952 standard of health care, or a 1952 income and 2005 standard of health care. Most people think about that question for a while and can’t quite decide, or they decide that they would rather have 2005 health care. What that is telling you is that the progress we have made in medical and health research has contributed about as much in human well-being as all the rest of the prosperity and growth that has taken place in our country over the last 50 years.

How do we keep it going? It’s a matter of drawing the most talented people into the field. We are now badly under-investing and, in particular, badly under-investing at a young age. I don’t know whether it is a good thing for society or a bad thing for society, but the taxpayers of the United States convinced me to become an economist rather than a lawyer by offering me a $300 per month fellowship when I was 22 years old and studying for a PhD in economics. We now offer fewer of those fellowships today, and fewer of those fellowships in the natural sciences, than we did when I was making that decision in 1975. The average age of people who win grants for the first time at the NIH has crept up from the mid-30s to the early to mid-40s and the difficulty of starting a scientific career is greater than it ever was before. And that is why, now, 60 percent of our PhDs in natural sciences are coming from abroad.

What do we do as a country? We need to make the sciences more attractive, starting in the schools, and carrying through with respect to all college students and then in the support we provide to people who want to go into science at an early stage of their career. That is where a substantial part of future prosperity and leadership is going to come from. They felt terrific in England in the 1950s because, though there were very few British students entering the sciences, not to worry, there were a lot of foreigners coming to Oxford, and many of them were staying in England. It didn’t work out terrifically in that case, and I don’t think that is a strategy you can rely on.

India and China and the world. There has never been a time, in all of economic history, when there were vast volumes of trade between countries where average wage levels differed by a factor of 10. So this is something that is quite new and quite fundamental. And it is going to be with us for a long time. As long as there are hundreds of millions of people living not that far from subsistence in both India and China, no matter what kind of progress they make, that progress is going to take the form of drawing more people from subsistence into the modern sector, not in the form of wage rates reaching the levels of those in the United States. And this is going to place all kinds of pressure on anybody who does things that are competitive with what they are able to do. It already has in physical manufacturing processes. Increasingly it is in a range of other activities from making travel reservations, to reading X-rays, to doing some of the work of investment analysts. There is really no alternative to the broad economic strategy of staying ahead intellectually – going back to the questions of education – and creating clusters of excellence that are very hard to replicate in a different place, whether it is the kind of cluster of excellence that we have now in New York City, with its financial community, whether it takes place in Palo Alto and Silicon Valley, whether it is some of the things we are trying to do in Boston around the life sciences. Clusters that people want to come to – and that they pay a premium to come to because of their strength – have to be an increasingly prominent part of our strategy.

The shorter-term outlook. Bob said that the personal savings rate was basically zero, and he is right. It is also the case if you take the national savings rate. That is, the personal savings rate plus the corporate savings less the government’s borrowing. That is very close to zero as well. If you have a national savings rate of zero, you have a problem. Very simply, how much you invest is equal to how much you save plus how much you borrow. So if you do not save, you either do not invest, or you can be very heavily dependent on foreign capital.

It is a complex phenomenon. There are those who say we should not worry about it because after all, wouldn’t you rather live in a country that capital is trying to get into than a country that capital is trying to get out of? And aren’t these capital flows just a reflection of our strength? I do think this does have something to do with others’ weaknesses. But if you look at those capital flows, 1) they are debt capital flows, not equity, 2) they are short-term capital flows, not long-term capital flows, 3) they are coming heavily from central banks and governments, and not from private investment, 4) they are financing consumption, not investment, and 5) insofar as there is financing of investment, it is going into the production of non-tradeables, like real estate, rather than into the exports that will ultimately be necessary to service the debt. All of that suggests an issue of questionable sustainability.

So, what is the right metaphor? What is the right historical analogy? If you are an optimist you say the dollar was way over-valued in the mid 1980s, and we had a big current account deficit, and life went on. If you are a pessimist, you say look what happened to Mexico, look what happened to South Korea, and look what happened to the vast majority of countries that found themselves with very large current account deficits. I think the balance of probability is more on the pessimistic side. People who are optimistic think of the 1980s as a benign adjustment period. There was a little interruption in October of 1987 that had something to do with international investments and the falling dollar. That adjustment period involved the Japanese monetary policy, which created bubbles that set the stage for 15 years of stagnation in Japan. The current account deficit then was half as large as the current account deficit is now. The health of the European economy since its spurt of growth was very different then than it is now. The capital markets move much less rapidly then than they do now. So, I think we are taking a substantial unnecessary risk and I think that policies, particularly at the level of government and fiscal policy – most far and away, most crucially, those that raise our national savings rate – would reduce risks to our economy and improve long-term effects.

Thank you.