Service that deficit?

OECD Observer

Why is it that US consumers are willing to spend more of their higher incomes on buying imports than is the case for foreigners on US exports?

In the jargon, US income elasticity for imports is greater than the foreign income elasticity for US exports. The notion, known by economists as the Houthakker-Magee Asymmetry, is reflected in the global trade imbalance today. In short, even if the US economy and the rest of the world grew at the same rate, the US trade deficit would widen as consumers suck in relatively more imports.

One often cited reason for this imbalance is luxury goods. As people get richer, they buy more expensive cars and high fashion. The trouble is, many luxury makes and brands come from outside the US, so demand for them fuels the import bill. But there are other reasons, as a recent study shows.

Take demographics. Younger populations tend to consume a relatively higher proportion of imports and fewer domestic services, such as healthcare, while immigrants tend to keep their tastes for products from their homes abroad. The report finds some evidence that when the age distribution of domestic residents and the proportion of immigrants in the US are taken into account, the incomes skew for imports diminishes.

Supply also counts. There is a tendency for countries with higher growth rates to produce a greater variety and quality of goods for export, which in turn increases the foreign demand for those countries’ products. As the US has some dynamic trading partners, this supply effect, according to the authors, is sufficiently important that it might account for around half the magnitude of the estimated income elasticity of US import demand.

Production relocation and improvements in global and regional market access, as well as vertical integration among firms, also help to explain the asymmetries.

Can anything be done? The authors point to evidence that the asymmetry in US consumer choices and those of Europe and Japan is present only for trade in manufactured goods. For services the effect is even reversed. The US seems to have a comparative advantage in the production of services, particularly those associated with the new economy. Some proponents see further liberalisation of trade in services as an answer, for as investment in new economy services deepens globally, the export performance of services within US trade would rise, so narrowing the overall asymmetry.

But the authors to the OECD paper see risks. In particular, further liberalisation of trade in new economy services could stir up protectionist pressures, and they note that US efforts to restrict international outsourcing of low-skilled services could prompt international retaliation in the new economy.

Reference

OECD (2004), “Channels for narrowing the US current account deficit and implications for other economies” by Anne-Marie Brook, Franck Sédillot and Patrice Ollivaud, Economics Department, working paper 390, available at: www.oecd.org/economics.

©OECD Observer No 246/247, December 2004-January 2005




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