Good News on Trade -- But Beware

By Stephen Koepp

One of President Reagan's best applause lines last week was an economic figure with a lot of punch. "The news is very good," he said, provoking suspense among his audience of 9,000 people at Southeast Missouri State University. His bulletin: the U.S. trade deficit plunged to $9.5 billion during July, down from $13.2 billion in June and the smallest since December 1984. "When America goes into the market to compete," Reagan declared, "we play to win." The trade figures, which reflected a 0.7% boost in U.S. exports and an 8.9% drop in imports, prompted almost giddy reactions within the Administration. Only a day earlier Treasury Secretary Nicholas Brady had predicted during his Senate confirmation hearings that "one of the surprises of the next two or three years will be how fast" the trade gap will shrink.

Yet some economists were murmuring their doubts even as they welcomed the improvement. From January through July, the trade gap was running at an annual average of $137 billion, down from $170.3 billion last year. By historical standards the deficit remains enormous, and further progress may become increasingly difficult. A prime reason is that America's factories, which went through a long period of downsizing for efficiency's sake, no longer produce the diversity or volume of products needed to meet the heavy demands of a healthy U.S. economy.

Now that a scaled-down dollar has made American goods competitively priced, factories have been running at nearly top speed this year to fill orders from customers at home and overseas. During August, U.S. factories, mines and utilities operated at 83.7% of capacity, the highest figure since 1980. A few & industries are approaching their output limits, which means that rising U.S. demand may force buyers to look overseas for their supplies.

In some cases, U.S. companies have abandoned markets in which they lost their competitive edge, so Americans have little choice but to buy foreign. The most hopeless case is consumer electronics, in which Asians control the market not only for established products (videocassette recorders, stereos) but also for new ones (compact-disc players). Only about half the color TVs sold in the U.S. are produced in this country, and most of those are made by foreign-owned factories. Zenith, the sole remaining major U.S. manufacturer of color TVs, controls just 15% of the domestic market.

Asian companies have achieved a similar lock on the office-equipment market. No American company makes facsimile machines, a $914 million business in the U.S. Such Japanese companies as Canon and Sharp produce 94% of the small copiers sold in the U.S. as well.

Through price cutting, the Japanese and Koreans have virtually pushed U.S. semiconductor manufacturers out of the market for the dynamic random-access memory chip, or D-RAM, which serves as the electronic memory in thousands of devices, ranging from personal computers to toasters. Surging production of such products in the U.S. has caused a chip shortage that the Asian manufacturers have been able to exploit. During the first half of this year, Japanese companies shipped $978 million worth of semiconductors to the U.S., a 44% increase over the same period last year.

In some industries, U.S. companies maintain a powerful position but lack the capacity to keep up with roaring demand. America's paper mills, which cut back sharply during a long slump, are running at 97% of capacity. But the U.S. demand for paper so outstrips domestic production that 15% of the business goes to foreign companies, mostly Canadian.

Many products bearing American brand names are really imports or contain a large portion of foreign parts. The Ford Escort uses a Japanese transmission, and 60% of the company's new Probe, to be assembled by Mazda in Flat Rock, Mich., will consist of foreign components. Chrysler's New Yorker and Dodge Dynasty are powered by a Mitsubishi-made V-6 engine.

Many American companies say they are planning to bring manufacturing operations back to the U.S. now that production costs have declined. Spending on new plant and equipment, which stagnated in 1985-86, is finally on the upswing. The Commerce Department estimates a jump of 11% this year, which should help factories meet rising demand and even enable some companies to get back into markets taken over by foreign producers.

Until the U.S. rebuilds its industrial capacity, however, the robust economy and the accompanying demand for imports are going to make the trade deficit difficult to reduce much more. Says Robert Brusca, chief economist at Nikko Securities in Manhattan: "The economy is growing, and that will stop trade progress dead in its tracks." At some point, however, heavy demand for imports may force a solution by aggravating inflation. That would be likely to prompt the Federal Reserve to dampen the consumer appetite for spending with a further increase in interest rates.

With reporting by Jerome Cramer/Washington and Dennis Wyss/San Francisco