According to Levy Institute Distinguished Scholar Wynne Godley, the significance of the deficit in the U.S. balance of payments has been underestimated in both public policy and academic discussions. This underestimation has occurred despite the fact that U.S. markets are increasingly dominated by foreign manufacturers--the main cause of the 20-year deterioration in the U.S. balance of trade. In this Brief, Godley analyzes the problem posed by the U.S. balance of payments deficit. Breaking down the current account into its component parts, he traces the cause of the deficit. He also refutes the arguments made by other economists that the balance of payments deficit is self-correcting, unimportant or the result of other domestic forces (namely, too low a level of national saving) and outlines the policy approaches to solving the problem. Godley notes that the deficit in the balance of trade has turned the United States from the world's largest (international) creditor into the world's largest debtor. He contends that if the United States continues to run current account deficits, even for only a few more years, its foreign debt and payments of interest on it will rise to an unacceptable level that would demand corrective action if the debt is not to explode. There are two general approaches that policy might take to improve the balance of payments, each with different consequences for inflation, output and employment levels. The first path, the deflationary approach, would be to impose restrictive fiscal and monetary policy. Such an action would reduce production and income, thereby reducing imports. However, the costs of such a policy in terms of lost output and high unemployment would be severe and not confined to the U.S. economy. The second approach would be to attempt to switch domestic spending away from imports to domestically produced goods and services. Improving the trade balance inthis manner need not cause output to fall or unemployment to rise. Expenditure switching could be achieved by currency devaluation. A large enough fall in the dollar rate of exchange could bring about the needed switch in spending away from imports but would carry a risk of inflation. However, under the present system of floating exchange rates and unregulated international capital flows, devaluation no longer exists for the United States as a viable instrument of policy. According to Godley, there is no reason to suppose that market forces will cause the dollar to move to the level that would achieve the required change in a timely fashion. Godley proposes consideration of another expenditure-switching solution, the use of temporary, nonselective import restrictions to achieve the required switch in favor of domestic output. Such restrictions may legitimately be made in accordance with relevant provisions of the General Agreement on Tariffs and Trade (GATT) as adopted and modified by the new World Trade Organization. Godley disavows the use of illegal, protectionist measures used selectively to protect sectoral interests, such as the recent imposition of restrictions levied against Japan by the United States. If imports were restricted by tariffs, taxes could be reduced without increasing the federal budget deficit. Godley notes in concluding that although the strategic problems posed in this Brief are specific to this country and the United States may have to take unilateral action to solve them, "at a more fundamental level these are problems that have arisen because there is no significant international regulation of the system as a whole." Inherent flaws have developed in the system of international production, trade and payments as that system has expanded and become increasingly deregulated. "All the difficulties that exist, or that are foreshadowed in this Brief, would be best resolved by energetic international cooperation, of which there is at present little sign."
