India’s Exports Vital For The US.

The US economy grew at an annual rate of 0.8 per cent in the first half of 2011, well below its potential growth rate of 2.5 per cent. While the prospects for the second half of the year are somewhat better, no one anticipates a strong rebound. There are a number of factors that will be a drag on growth for much of the decade. These factors are also likely to bring an end to the era in which US trade deficit was a major engine for the growth of the world economy.

Most immediately, the bubbles in residential and non-residential construction have left an enormous oversupply of structures of all types. This will gradually be eliminated over the next three-four years, but construction will remain at below normal levels at least through 2014.

Similarly, consumption will remain weak as savings rate rises to more normal levels. Through most of the half century following World War II, savings rate hovered near 8 per cent of disposable income. It fell sharply in the ’90s as the wealth created by the stock bubble sparked a consumption boom. The wealth created by the housing bubble led to a further decline in savings rate, pushing it to near zero at the peak of the bubble.

The bubble wealth has largely disappeared with house prices returning to trend levels. This is likely to mean that savings rate will again rise to near 8 per cent. The demographics of the huge baby bo­om cohort at the edge of retirement could be a factor causing the saving rate to even rise above its long-run trend.

At the same time, the private sector is moving towards increased savings and the public sector seems destined to move in the same direction. State and local governments, which account for more than half of government spending in the United States, are almost all cutting spending and raising taxes to eliminate budget shortfalls. Similarly, politics at the federal level have resulted in a situation where the leadership of both parties is committed to reducing deficit.

In short, both private and public sectors in the US are moving towards a path of increased savings. If net saving in the US increases, then trade deficit must fall. This is a simple matter of accounting. A country’s deficit is equal to the gap between its investment and its savings, both public and private. As that gap falls, as is happening now in the US, trade deficit must fall with it. There is no possible way around this identity.

This means trading partners will no longer be able to run large trade surpluses with the US. There remains an important question for the US -- whether this surplus is reduced by a fall in gross domestic product (GDP) slowing import growth or a reduction in the value of the dollar changing relative prices of foreign and domestic goods -- but in either case, trade will be less unbalanced in the future.

The better path for both the US and its trading partners would be that the adjustment be made through a lower value of the dollar. This would allow the economy to return to its potential and sustain healthy growth. This would mean, in the long run, the US would be a much bigger export market for Asia than if its trade deficit was reduced through a period of prolonged stagnation.

There is also an interesting shift in composition that is likely to come about with a substantial decline in the value of the dollar. Exports from China to the US have been primarily manufactured goods. By contrast, India has been much more involved in high value-added services. If the dollar declines substantially against the yuan, some of the cost advantage of Chinese goods will be eliminated, especially if transportation costs increase due to higher oil prices and/or taxes associated with restrictions on greenhouse gas emissions.

On the other hand, a falling dollar is likely to have less impact on high value-added services exported from India. There will still be enormous cost advantages associated with hiring Indian software designers, legal researchers, architects and engineers. The dollar could fall 20-30 per cent against the rupee and still leave India with enormous cost advantages in these areas. Furthermore, since it is essentially costless to transport the output in these sectors, India’s exports will not be affected at all by increases in transportation costs. While US imports from China are likely to continue to grow rapidly for the immediate future, it is likely that, over the longer term, India’s exports to the US will prove to be more important to the US economy.

India’s exports could be especially important in the context of US politics. Thus far, trade has been an important factor leading to greater inequality in the US, as less educated workers have been displaced by imports from relatively high-paying jobs in manufacturing.

However, if the most highly educated workers end up being displaced by their professional counterparts in India, then trade can be an important force equalising the distribution of income. If trade with India continues along its present path, then alliances in the US on trade may flip, with unions and less educated workers being the biggest supporters of more open trade, while professionals would end up as the major proponents of protectionism.

Source : mydigitalfc.com