C World Trade Organization (WTO) and Its Predecessors

As World War II drew to a close, leaders in the United States and other
Western nations began working to promote freer trade for the post-war world. They set up the International Monetary Fund (IMF) in 1944 to stabilize exchange rates across member nations. The Marshall Plan, developed by U.S. general and economist George Marshall, promoted free trade. It gave U.S. aid to European nations rebuilding after the war, provided those nations reduced tariffs and other trade barriers.

In 1947 the United States and many of its allies signed the General
Agreement on Tariffs and Trade (GATT), which was especially successful in reducing tariffs over the next five decades. In 1995 the member nations of the GATT founded the World Trade Organization (WTO), which set even greater obligations on member countries to follow the rules established under GATT. It also established procedures and organizations to deal with disputes among member nations about the trading policies adopted by individual nations.

In 1992 the United States also signed the North American Free Trade
Agreement (NAFTA) with its closest neighbors and major trading partners,
Canada and Mexico. The provisions of this agreement took effect in 1994.
Since then, studies by economists have found that NAFTA has benefited all three nations, although greater competition has resulted in some factories closing. As a percentage of national income, the benefits from
NAFTA have been greater in Canada and Mexico than in the United States, because international trade represents a larger part of those economies.
While the United States is the largest trading nation in the world, it has a very large and prosperous domestic economy; therefore international trade is a much smaller percentage of the U.S. economy than it is in many countries with much smaller domestic economies.

D Exchange Rates and the Balance of Payments

Currencies from different nations are traded in the foreign exchange market, where the price of the U.S. dollar, for instance, rises and falls against other currencies with changes in supply and demand. When firms in the United States want to buy goods and services made in France, or when
U.S. tourists visit France, they have to trade dollars for French francs.
That creates a demand for French francs and a supply of dollars in the foreign exchange market. When people or firms in France want to buy goods and services made in the United States they supply French francs to the foreign exchange market and create a demand for U.S. dollars.

Changes in people’s preferences for goods and services from other countries result in changes in the supply and demand for different national currencies. Other factors also affect the supply and demand for a national currency. These include the prices of goods and services in a country, the country’s national inflation rate, its interest rates, and its investment opportunities. If people in other countries want to make investments in the United States, they will demand more dollars. When the demand for dollars increases faster than the supply of dollars on the exchange markets, the price of the dollar will rise against other national currencies. The dollar will fall, or depreciate, against other currencies when the supply of dollars on the exchange market increases faster than the demand.

All international transactions made by U.S. citizens, firms, and the government are recorded in the U.S. annual balance of payments account.
This account has two basic sections. The first is the current account, which records transactions involving the purchase (imports) and sale
(exports) of goods and services, interest payments paid to and received from people and firms in other nations, and net transfers (gifts and aid) paid to other nations. The second section is the capital account, which records investments in the United States made by people and firms from other countries, and investments that U.S. citizens and firms make in other nations.

These two accounts must balance. When the United States runs a deficit on its current account, often because it imports more that it exports, that deficit must be offset by a surplus on its capital account. If foreign investments in the United States do not create a large enough surplus to cover the deficit on the current account, the U.S. government must transfer currency and other financial reserves to the governments of the countries that have the current account surplus. In recent decades, the
United States has usually had annual deficits in its current account, with most of that deficit offset by a surplus of foreign investments in the U.S. economy.

Economists offer divergent views on the persistent surpluses in the U.S. capital account. Some analysts view these surpluses as evidence that the
United States must borrow from foreigners to pay for importing more than it exports. Other analysts attribute the surpluses to a strong desire by foreigners to invest their funds in the U.S. economy. Both interpretations have some validity. But either way, it is clear that foreign investors have a claim on future production and income generated in the U.S. economy. Whether that situation is good or bad depends how the foreign funds are used. If they are used mainly to finance current consumption, they will prove detrimental to the long-term health of the
U.S. economy. On the other hand, their effect will be positive if they are used primarily to fund investments that increase future levels of
U.S. output and income.

X CURRENT TRENDS AND ISSUES

In the early decades of the 21st century, many different social, economic and technological changes in the United States and around the world will affect the U.S. economy. The population of the United States will become older and more racially and ethnically diverse. The world population is expected to continue to grow at a rapid rate, while the U.S. population will likely grow much more slowly. World trade will almost certainly continue to expand rapidly if current trade policies and rates of economic growth are maintained, which in turn will make competition in the production of many goods and services increasingly global in scope.
Technological progress is likely to continue at least at current rates, and perhaps faster. How will all of this affect U.S. consumers, businesses, and government?

Over the next century, average standards of living in the United States will almost certainly rise, so that on average, people living at the end of the century are likely to be better off in material terms than people are today. During the past century, the primary reasons for the increase in living standards in the United States were technological progress, business investments in capital goods, and people’s investments in greater education and training (which were often subsidized by government programs). There is no evident reason why these same factors will not continue to be the most important reasons underlying changes in the standard of living in the United States and other industrialized economies. A comparatively small number of economists and scientists from other fields argue that limited supplies of energy or of other natural resources will eventually slow or stop economic growth. Most, however, expect those limits to be offset by discoveries of new deposits or new types of resources, by other technological breakthroughs, and by greater substitution of other products for the increasingly scarce resources.

Although the U.S. economy will likely remain the world’s largest national economy for many decades, it is far less certain that U.S. households will continue to enjoy the highest average standard of living among industrialized nations. A number of other nations have rapidly caught up to U.S. levels of income and per capita output over the last five decades of the 20th century. They did this partly by adopting technologies and business practices that were first developed in the United States, or by developing their own technological and managerial innovations. But in large part, these nations have caught up with the United States because of their higher rates of savings and investment, and in some cases, because of their stronger systems for elementary and secondary education and for training of workers.

Most U.S. workers and families will still be better off as the U.S. economy grows, even if some other economies are growing faster and becoming somewhat more prosperous, as measured per capita. Certainly families in Britain today are far better off materially than they were
150 to 200 years ago, when Britain was the largest and wealthiest economy in the world, despite the fact that many other nations have since surpassed the British economy in size and affluence.

A more important problem for the U.S. economy in the next few decades is the unequal distribution of gains from growth in the economy. In recent decades, the wealth created by economic growth has not been as evenly distributed as was the wealth created in earlier periods. Incomes for highly educated and trained workers have risen faster than average, while incomes for workers with low levels of education and training have not increased and have even fallen for some groups of workers, after adjusting for inflation. Other industrialized market economies have also experienced rising disparity between high-income and low-income families, but wages of low-income workers have not actually fallen in real terms in those countries as they have in the United States.

In most industrialized nations, the demand for highly educated and trained workers has risen sharply in recent decades. That happened in part because many kinds of jobs now require higher skill levels, but other factors were also important. New production methods require workers to frequently and rapidly change what they do on the job. They also increase the need for quality products and customer service and the ability of employees to work in teams. Increased levels of competition, including competition from foreign producers, have put a higher premium on producing high quality products.

Several other factors help explain why the relative position of low- income workers has fallen more in the United States than in other industrialized Western nations. The growth of college graduates has slowed in the United States but not in other nations. United States immigration policies have not been as closely tied to job-market requirements as immigration policies in many other nations have been.
Also, government assistance programs for low-income families are usually not as generous in the United States as they are in other industrialized nations.

Changes in the make-up of the U.S. population are likely to cause income disparity to grow, at least through the first half of the 21st century.
The U.S. population is growing most rapidly among the groups that are most likely to have low incomes and experience some form of discrimination. Children in these groups are less likely to attend college or to receive other educational opportunities that might help them acquire higher-paying jobs.

The U.S. population will also be aging during this period. As people born during the baby boom of 1946 to 1964 reach retirement age, the percentage of the population that is retired will increase sharply, while the percentage that is working will fall. The demand for medical care and long-term care facilities will increase, and the number of people drawing
Social Security benefits will rise sharply. That will increase pressure on government budgets. Eventually, taxes to pay for these services will have to be increased, or the level of these services provided by the government will have to be cut back. Neither of those approaches will be politically popular.

A few economists have called for radical changes in the Social Security system to deal with these problems. One suggestion has been to allow workers to save and invest in private retirement accounts rather than pay into Social Security. Thus far, those approaches have not been considered politically feasible or equitable. Current retirees strongly oppose changing the system, as do people who fear that they will lose future benefits from a program they have paid taxes to support all their working lives. Others worry that private accounts will not provide adequate retirement income for low-income workers, or that the government will still be called on to support those who make bad investment choices in their private retirement accounts.

Political and economic events that occur in other parts of the world are felt sooner and more strongly in the United States than ever before, as a result of rising levels of international trade and the unique U.S. position as an economic, military, and political superpower. The 1991 breakup of the Union of Soviet Socialist Republics (USSR)—perhaps the most dramatic international event to unfold since World War II—has presented new opportunities for economic trade and cooperation. But it also has posed new challenges in dealing with the turbulent political and economic situations that exist in many of the independent nations that emerged from the breakup . Some fledgling democracies in Africa are similarly volatile.

Many U.S. firms are eager to sell their products to consumers and firms in these nations, and U.S. banks and other financial institutions are eager to lend funds to support investments in these countries, if they can be reasonably sure that these loans will be repaid. But there are economic risks to doing business in these countries, including inflation, low income levels, high crime rates, and frequent government and company defaults on loans. Also, political upheavals sometimes bring to power leaders who oppose market reforms.

The greater political and economic unification of nations in the European
Union (EU) offers different kinds of issues. There is much less risk of inflation, crime, and political upheaval to contend with in this area. On the other hand, there is more competition to face from well-established and technologically sophisticated firms, and more concern that the EU will put trade barriers on products produced in the United States and in other countries that are not members of the Union. Clearly, the United
States will be concerned with maintaining its trading position with those nations. It will also look to the EU to act as an ally in settling international policies in political and economic arenas, such as a peace initiative in the Middle East and treaties on international trade and environmental issues.

The United States has other major economic and political interests in the
Middle East, Asia, and around the world. China is likely to become an even larger trading partner and an increasingly important political power in the world. Other Asian nations, including Japan, Korea, Indonesia, and the Philippines, are also important trading partners, and in some cases strong political and national security allies, too. The same can be said for Australia and for Canada, which has long been the largest single trading partner for the United States. Mexico and the other nations of
Central and South America are, similarly, natural trading partners for the United States, and likely to play an even larger role over the next century in both economic and political affairs.

It may once have been possible for the United States to practice an isolationist policy by developing an economy largely cut off from foreign trade and international relations, but that possibility is no longer feasible, nor is it advisable. Economic and technological developments have made the world’s nations increasingly interdependent.

Greater world trade and cooperation offer an enormous range of mutually beneficial activities. Trading with other countries inevitably increases opportunities for travel and cultural exchange, as well as business opportunities. In a very broad sense, nations that buy and sell goods and services with each other also have a greater stake in other forms of peaceful cooperation, and in seeing other countries prosper and grow.

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