564564 Chapter 15 | Economic PolicyExchange Rates, Consumer Tastes, and Labor Costs The first factor influencing
trade and the balance of payment is the relative value of currencies. However, there
isn’t much the government can do about the value of the dollar because that value is
determined by international currency markets. When the dollar is strong, imports
are relatively cheap to consumers in the United States and U.S. exports are expensive to
consumers in other countries. Therefore, if the United States is running a trade deficit—
importing more than it is exporting—it would like the value of the dollar to fall in the hopes
that this would increase the sales of U.S. products abroad.
How does the value of the dollar affect the trade deficit? Consider the following
example. As of September 2018, a dollar was worth .86 euro. Therefore, a BMW 320i
that would sell for 40,000 euros in Germany would go for about $46,512 in the United
States, whereas a Cadillac XTS that would retail in America for $46,000 would sell for
39,560 euros in Europe—although this example doesn’t factor in shipping costs, dealer
incentives, higher taxes in Europe, and so on.
Now see what happens if the dollar falls in value: now you can only get .70 euro for a
dollar instead of .86. Now that Cadillac could be purchased in Germany for 32,200 euros
and the BMW would still cost 40,000 euros, while the BMW would cost an American
consumer $57,143 and the Cadillac would still cost $46,000. Nothing has changed except
the value of the dollar, but suddenly the car buyer’s choices have changed dramatically. In
both countries, the Cadillac has become a much better bargain, and therefore, theoretically,
Cadillac sales (and sales of other GM models, as well as those of Chrysler and Ford) should
increase and BMW (and Mercedes, Volkswagen, Fiat, MINI Cooper, etc.) sales should fall.
We say “theoretically” because of the second factor that influences trade—
consumer tastes. If consumers are willing to pay an increasing premium for foreign
goods, then a weaker dollar may not help the trade deficit. There isn’t much policy
makers can do about consumer tastes, despite the ongoing campaign urging citizens to
“buy American.” Even with President Trump’s campaign pledge to “Make American
Great Again” and the focus on restoring American jobs, there is little evidence that this
political talk has influenced consumer tastes or broad market forces.
The low cost of labor is a third factor affecting the trade balance that policy makers
cannot do much to influence. If a foreign firm pays its workers a daily wage that is equal
to what American workers earn in a single hour for the same job, the foreign firm has
a huge competitive advantage. Consequently, the United States has been flooded
with cheap consumer goods from nations where labor is very cheap. Low prices are
good for American consumers, but they come at the price of large trade deficits and
lost American jobs. Furthermore, foreign firms sometimes absorb some currency
fluctuations and do not raise the price of their goods in the United States as the dollar
falls in value relative to their currency. The final factor—the strength of foreign
economies—is also outside the control of American policy makers. If foreign economies
are weak, consumers abroad do not have the income to purchase U.S. exports.Trade Policy and Trade Deficits Although it is difficult to control trade outcomes
because exchange rates, consumer tastes, and labor costs in other countries are all
largely outside the control of policy makers, Congress and the president still try by
altering trade policies. The main target of trade policy is the trade balance, which is
defined as the difference between the total value of our exports and imports. In recent
years, the balances reached record deficits, exceeding $830 billion a year in 2008
before falling back to $491 billion for the 12-month period ending in September 2016
(see Figure 15.9). The current account deficit, the broadest measure of the balance of
payments including investments, has also been running at record levels. Economists
have warned that deficits of this level are not sustainable. There is increasing consensus
that something must change—either we need to stop buying as many imports and sell
more exports or the value of the dollar must fall to help make this happen.The United States exported$341 billion
in goods and services to Canada in
2017 (more than any other country)
and imported the most from China
($523 billion, with Mexico second at
$345 billion).
Source: Bureau of Economic AnalysisDID YOU KNOW?
Full_16_APT_64431_ch15_530-571.indd 564 15/11/18 2:35 PM