Foreign Relations of the United States, 1981–1988, Volume I, Foundations of Foreign Policy

322. Address by Secretary of State Shultz¹

Washington, April 23, 1988

The Winning Hand: American Leadership and the Global Economy

Some years ago, I wrote a book about my government experience called Economic Policy Beyond the Headlines.² It was not a best seller. That was a little surprising to me because it must have been the last hardcover book on economics—or any other subject—that sold for $8.95.

But there was one principle in those pages that expressed my philosophy of government. The key to effective public policy is to interpret the public interest-—as it is usually shaped, in the midst of controversy—through an informed and objective understanding of the issues.

Today we are in the midst of a great controversy over our role in a world of rapidly changing technology. Some have even suggested that America is a nation in decline, that we are no longer competitive.

Have we still got what it takes? My answer is a resounding yes. An informed and objective understanding of the issues yields only one conclusion: we bring to the table a winning hand. But to play that winning hand, we must be fully engaged in the shaping of the new global economy. And “full engagement,” in my dictionary, means the will and the resources to do the job—to lead the world toward greater economic growth, more coordinated international economic policies, and, above all, openness. These are the keys which unlock the door to a better future for all of us.

America in a Global Economy

Let me begin with the facts about America’s relationship to the global economy.

Fact number one: the American economy is increasingly part of the world economy, not an isolated national economy. A long-term process of economic integration and convergence, made possible by postwar trade liberalization, has sharply reduced the importance of national borders in economic affairs. The evidence is all around us, not only in economics but in science and culture as well. And most Americans have begun to understand this fact and adapt to it—not just bankers and economists and public officials but the proverbial man and woman in the street.

A few months ago, I saw a striking sign of economic integration: a headline announcing that “European Central Banks Cut Interest Rates.”³ Of course, I was happy to read that story, but the striking thing was its location—on the front page not only of the Washington Post but also of other major newspapers around the country. This was not “inside-the-beltway” news. You didn’t have to search through the middle of the business section to find it. Today the average newspaper reader realizes that his economic prospects depend on developments abroad as well as at home.

Now, fact number two: the very process of production crosses national boundaries. Economic integration has not been restricted to the exchange of goods across borders. Today’s market for inputs and output is the world. Here, too, Americans have understood the reality. Our business leaders have grasped the opportunities presented by such integration. Firms are establishing a wide variety of international linkages to take advantage of the new technologies and markets around the globe.

In much of contemporary international trade, one branch of a firm is selling to another branch of the same firm located in a different country. According to some estimates, as much as 40% of total U.S. trade may be of this nature. A recent survey indicates that 88% of U.S. manufacturers use foreign components in their products.

It is often difficult to identify what is “national” and what is “foreign.” My favorite example is a shipping label for integrated circuits fabricated by an American firm. It said, “Made in one or more of the following countries: Korea, Hong Kong, Malaysia, Singapore, Taiwan, Mauritius, Thailand, Indonesia, Mexico, Philippines. The exact country of origin is unknown.”

Fact number three: the globalization of production has been accompanied by the globalization of finance. For example, U.S. income from international assets has increased by $40 to $60 billion every 5 years since 1967. The size of international financial markets strains the imagination. The New York Federal Reserve Bank estimates that the daily volume of international financial flows is over $1 trillion, or about the same as annual U.S. Government expenditures. And by now, everyone is aware of how stock exchanges around the world react to each other with unprecedented speed.

Fact number four: the world as a whole and America in particular have benefited from the emergence of the new global economy. Trade accounts for a growing share of the national economic activity of every country. The most rapid economic growth in recent history occurred in the years between 1950 and 1973, when trade was growing most briskly.

What was true for the world was true for America. Our markets abroad and America’s per capita income grew faster in the decades of most rapid international economic integration than they have in the more recent past, when the growth of world trade slowed appreciably.

All these facts suggest to me that we are at a turning point. We can play to our strengths. We can catch the curve of the future by recognizing global economic realities, by continuing to reap the benefits of integration and growth. Or we can descend the curve and get off of it by building new and more disruptive barriers between ourselves and the rest of the world, condemning us—and everyone else—to eventual stagnation.

A Cycle of Inflation and Disinflation

Why is it so difficult to make this choice? Why are we reluctant to play the winning hand? Instead of speculating about some mysterious change in our national character, I prefer to look again at the facts. We are beset today by the legacy of a severe cycle of inflation and then disinflation that has troubled the world for nearly two decades.

Accelerating inflation in the 1970s drove real interest rates down to unsustainably low—often negative—levels, providing a powerful incentive to incur debt. Then disinflation in the 1980s pushed real interest rates to unsustainably high levels, producing a sharper-than-expected rise in the real debt-service burdens of borrowers.

This roller-coaster ride badly hurt commodity producers who were caught between rising debt burdens and declining prices for their products. The resulting Third World debt problem continues to exact real hardship from those least able to bear it. And the stagnating economies of the highly indebted developing countries have reduced America’s exports.

American farmers also suffered severely from the cycle. By now, we are all too familiar with the story: land values skyrocketed as crop prices rose, and farmers borrowed heavily as the value of their assets increased. But, as inflation was wrung out of the economy and crop prices dropped, disaster struck many farm families. It also encouraged massive agricultural subsidies, here and abroad, that have distorted international trade.

On the industrial side, the rising unemployment rates that accompanied inflation in the 1970s convinced most economists that inflation—a little or a lot—is not the way to reduce unemployment. But the inflation/unemployment experiences of Japan, the United States, and Europe from 1970 to 1985 proved to be quite different. In Japan, there was little or no relationship between unemployment and either the inflation rate or overall economic activity. In the United States, we moved in the 1980s toward the lower inflation and lower unemployment patterns of the pre-1970s. In Europe, however, unemployment increased steadily, seemingly unresponsive to the rate of inflation or to economic activity.

So, if we review the legacy of the period 1970–85, we find heavily indebted developing countries, low commodity prices, and high unemployment, especially in Europe. Added to these trends were wide swings in inflation-adjusted exchange rates, bloated government spending, and large trading imbalances among the industrialized countries.

American Leadership

This legacy goes far to explain some of the debate about our future leadership. The vision of a new global economy, with all of its opportunities, is sometimes overshadowed by the old problems, with all of their pain.

As Secretary of State, I know the costs of engagement are considerable. The foreign affairs budget, which is crucial to our engagement abroad, will never be popular. But that budget is used to defend America’s interests—our security, our economy, our political strength. It fights the drug traffickers and the terrorists. Yet in terms of real dollars, the resources we are committing to these activities have fallen since fiscal year (FY) 1985 by almost a third.

Let me repeat: we must do what is necessary to serve the public interest, through an informed and objective understanding of the issues. Now let’s take this test of the public interest and grade the alternatives to full American engagement.

Let me start with the idea we are overextended abroad and, therefore, headed for irrevocable decline unless we cut our security commitments, i.e., the defense budget. Of course, it is true the United States is no longer the preeminent power it was in 1945, when much of the world lay in ruins. But the recovery of our allies in Europe and Asia under the American security umbrella must be reckoned as one of the greatest success stories of all times. It will be a sorry day in America when we regard the good fortune of our friends as detrimental to our interests, especially since we have benefited mightily as a result of their success.

I also reject the argument that our defense effort “robs” our industry of its future competitiveness because so much of our research and development effort is defense related. Clearly, there are economies where such things happen—the Soviet Union, which spends an estimated 15% to 17% of its GNP [gross national product] on defense, is a good example—but that is not true of the American economy. Our high-technology sectors are strong, and our pattern of economic growth simply does not support the argument of a long-term, defense-related decline.

In fact, we enjoyed our highest economic growth in the 1950s and 1960s when our military expenditures averaged 9.2% of GNP, a much higher proportion than the 6.7% we spend today. Over the past 10 years, we have had a slightly higher rate of growth than that of Western Europe and Japan, if you average them together, although their military expenditures take a much lower proportion of their GNP than ours.

Now, I am not saying there is a correlation between higher defense spending and growth or lower defense spending and stagnation. I am only saying whatever the reasons for our economic difficulties, our military and political commitments are not among them. The facts are quite different. We certainly have the means—and our allies also have the means—to defend ourselves and our interests abroad. Whatever our constraints may be, they are not imposed by our economy.

Now, let’s examine for a moment another popular argument, that protectionist legislation will cure our trade troubles, a little or a lot. Here history teaches a strong lesson. Every Member of Congress ought to reread the record of the 1920s and 1930s before voting on trade legislation. It is a sad story that cannot be retold often enough. International trade collapsed, not mainly because of the 1929 stock market crash but in considerable part because of protectionist policies of the 1930s which were intended to preserve domestic jobs.

Have we forgotten, too, the political counterpart of this economic disaster? The age of democracy was succeeded by the age of the dictators and then by world war. The enlightened alliances and the open international economic system established in the postwar era nourished our freedom and planted the seeds for the spread of democracy. Now, four decades later, we are witnessing a remarkable global resurgence of democracy, thanks to the universal attractiveness of the democratic ideal. From Central America to the Philippines and Korea, from Africa to Eastern Europe, people want freedom: freedom for themselves, freedom at home, freedom in the workplace, freedom to choose their leaders.

Are we going to throw away this renaissance of free markets, free economies, free societies, and free nations in order to prove we cannot learn from history? Or are we going to reject protection, procedural or otherwise, for what it is—not an insurance policy against the fire of unfair competition but an act of economic arson that eventually burns down everyone’s house.

Finally, we ought to take on those who say Americans can no longer compete. What are the signs of such fundamental weakness? The often-cited trade deficit, for example, tells us a lot about the relative rates of growth, macroeconomic policies, and exchange rates that existed between the United States and the rest of the world earlier in this decade. But it says nothing that supports the view U.S. manufacturing is in decline. Far from it—U.S. manufacturing output accounts for just as large a share of our GNP as in the past. Productivity growth in manufacturing has been strong in recent years. The boom in U.S. manufacturing exports now in progress shows how competitive American factories have become once again.

So, instead of abusing our self-esteem, let’s not lose sight of the reality. As Herb Stein says, “The basic fact about the American economy is that it is very rich. It is not rich enough to do everything, but it is rich enough to do everything important. The only problem is deciding what is important.” And the first thing of importance is to look out for our security.

Sometimes, our friends from abroad may see our choices for the future more clearly than we do ourselves. I think the Prime Minister of Singapore, Mr. Lee Kwan Yew, put it best before a joint session of Congress when he said:

There are two scenarios for the 21st century. The first is bleak: If, because of domestic problems, the United States loses the will to maintain open and fair trade, protectionism and retaliation will shrink trade and so reduce jobs. Is America willing to write off the peaceful and constructive developments of the last 40 years that she made possible?

Does America wish to abandon this contest between democracy and the free market on the one hand, and communism and the controlled economy on the other—and this at a time when she has very nearly won this contest for the hearts and minds of the people of the Third World?

Ask the Prime Minister of Singapore. The answer to those questions must be: we are not going to throw away our winning hand just because the game gets challenging.

Directions for the Future

A transition to new relationships among the major economic powers is clearly underway. In this transition, the United States is showing the way and we must remain the leader, both economically and politically. Who else can do it? But ours must be a leadership suited to the times. The economic achievements of Europe and Japan now qualify them for much greater responsibility in the global economy. Their productivity, their income, their share of world output and trade admit no other conclusion. Clearly, they must share a commensurate responsibility for maintaining and expanding the openness of the world economy.

Let me be more specific about the directions I would like to see us all take in today’s global economy:

First, the role of government in promoting more vigorous growth around the world. Every sensible person favors more economic growth. The issue, however, is the role to be played by government in promoting such growth. That role is limited but very important. Government’s responsibility is to provide a stable fiscal, monetary, and legal environment, and then let markets work freely. Such an environment is critical if private entrepreneurship and innovation are to flourish.

Our recent experience has shown this concept works well. President Reagan’s insistence that the market, rather than the government, should be the principal force in economic policy has paid off. The so-called misery index, the sum of the inflation rate and the unemployment rate, is down to single digits after more than a decade in double digits. Employment in the United States is at an all-time high—and that’s also in terms of the percentage of the population 16 years of age and older. It’s at an all-time high, not just numbers. And the largest employment gains have been in higher paying and higher skilled occupations. Nearly two-thirds of the new jobs—some 15 million in the last 5 years—are to be found in managerial, professional, technical, sales, or precision production operations.

So, the idea that governments can dictate all positive economic results should be defunct—though it lingers on in political nostalgia. Government programs did not produce the 15 million new jobs added to the U.S. economy since 1983. Entrepreneurship did it, and mostly small enterprises.

That brings me to the second direction we should all take: I call it constructive international coordination. In a world of interdependent economies, no nation can pursue policies successfully that are widely at variance with the realities of the global marketplace. The political reality, however, is that many nations have been tempted to defy this convergence. None has succeeded. That is why we are faced today with very large international economic imbalances that must be rectified.

Many have looked to the process of international coordination to ease the transition from these imbalances to a more stable world economy. This is a complex undertaking which can succeed if we keep two things in mind:

• First, we and our trading partners must pursue the correct economic policies at home. That means we should work on root causes that interfere with the market, such as overspending, over-regulation and overtaxation by governments. I’ll have something more specific to say about those policies in a moment.
• Second, coordinated international action should serve to strengthen the market, and encourage those domestic policies that do the same. Coordination, after all, is a process, not a panacea. Through it, we can move in the right direction or in the wrong direction. It would be counterproductive, indeed, if the process of international coordination reinforced wrong-headed protectionism—as will happen; if we protect, they’ll protect, and so on, so you have a convergence of policies of the wrong sort—or preserved agricultural subsidies, which in part are kind of a competitive explosion of convergence in the wrong direction, thereby trying to repeal once more the realities of the marketplace.

Now what does constructive coordination require today? All participants in the global economy have roles to play so adjustment of the current imbalances takes place in a climate of growth, not recession. In the United States, our Federal Government spending absorbs savings that otherwise would be available for investment in the private sector. We must bring government spending under control, and the deficit will take care of itself. The budget agreement in the summit was a good first step. Now we need the discipline to hold that agreement in place, and it isn’t easy.

Despite the occasional monthly fluctuations, to which we pay too much attention, the fact is the U.S. trade deficit is shrinking—perhaps even more rapidly than many people realize. It has already shrunk about 18% in terms of volume since the third quarter of 1986, and the dollar figures are beginning to follow. This will have a major impact, not only on us but on our trading partners as well. Other countries will face great strains unless their economies and world trade continue to grow as our trade deficit—and their trade surpluses—are reduced.

That is why we have emphasized structural reform and growth in our economic consultations with Germany and the other EC [European Community] countries, Japan, and all our major trading partners. Japan, Germany, and the other OECD [Organization for Economic Cooperation and Development] countries must increasingly look to their domestic economies, rather than just exports, for growth. This change of direction is in their interest, not just in our interest.

Some years ago I pointed out the propensity of the Japanese to save more than they invest, with the excess appearing as the net exports needed to maintain high domestic employment. Recently, the Japanese have begun to make significant adjustments, driven by the realignment of exchange rates and a new commitment to domestic growth. These steps are welcome. We need more of them. They need more of them, too.

Among the anomalies of our times is a Europe that seems content to live with unemployment rates above 10%—even higher among the young—because European social welfare systems have made unemployment almost as desirable as working. But there are very high costs for such policies—costs that go beyond excessive public spending and unproductive use of resources. Above all, there is the human tragedy. When competition in the global economy increasingly demands skill and training, no nation, including ours, can neglect its youth or condemn its next generation to idleness.

Changes in policies that stunt growth are even more crucial for the developing countries with heavy debt burdens. Many debtor countries have run large trade surpluses by cutting investment and imports to the bone, not by creating the market-oriented environment that will allow exports to expand. The austerity required by such a strategy strains their political and social fabric. And as the U.S. trade balance rights itself, debtor countries will face new challenges exporting to the United States.

There, too, we face a very complex process. One side of the coin is that economic growth requires increased investment—investment which can only come largely from private sources. The only way ever invented to attract equity capital—not just debt rollover—is to assure an attractive investment climate. And that means structural reforms to free up markets, promote trade, and encourage private entrepreneurship.

The other side of the coin is the debt problem itself. It is now clear that large increases of official foreign assistance cannot be expected. Further exposure by commercial banks under current circumstances is not in the cards. I am convinced the most creative and least costly solutions will emerge when the debtors and their private lenders work out a solution directly. Let the government not get involved.

Third, and finally, we must all go on the offense for openness—in trade, in investment, in ideas. I want to put it bluntly. Over the last 15 years, we have found it difficult to do more than fight off destructive protectionism. That’s not good enough to meet the challenges of tomorrow. We have got to open markets further, lower trade barriers, and spur on the process of global economic integration.

That is why the U.S.-Canada Free Trade Agreement is so important. This historic accord establishes the world’s largest international free trade area, affecting trade of about $125 billion per year. It will strengthen the economies of both countries, and it will create better jobs in both countries. While the centerpiece of this agreement is the elimination of tariffs on all goods within 10 years, one of the best things about it is the new set of opportunities it provides for the rapidly expanding services sectors of both countries. The agreement also liberalizes trade in agriculture, autos, energy, and government procurement. It sets up an effective mechanism for settling disputes. The benefits for both countries will be the most powerful inducements in our ongoing multilateral and bilateral efforts to liberalize trade.

We also have before us today a tremendous opportunity to open up the global marketplace through the Uruguay Round of multilateral trade negotiations. There are several crucial areas for reform here, including the extension of international rules to promote the free flow of services and investment and the protection of intellectual property. But I want to focus on one area, which can be the stepping stone to a better future for all mankind.

I’ll put it simply: the need for major structural reform in agriculture is overwhelming. Farm programs around the world have become ever more costly to governments and consumers. The OECD estimates the budget costs of support systems and higher prices to consumers in member countries—just the OECD—now approach $150 billion annually. That is, the subsidy costs plus the higher-than-necessary prices consumers, added up, it’s $150-billion-a-year tag.

This cost far exceeds the benefits being transferred to farmers. Farm programs have become increasingly wasteful of resources which could be more productively employed elsewhere. It’s a shame, because farmers are about the most hard-working portion of our population, and from the standpoint of the United States, our farmers are inherently very competitive. But they’re caught up in this crazy process of competitive subsidies, and here we are with a $150-billion-a-year price tag.

In the GATT [General Agreement on Tariffs and Trade] negotiations on agriculture we should address the root causes of such distortions: government supports and export subsidies. To achieve equilibrium in global supply and demand, the negotiations must reach agreement to reduce and eventually eliminate these distorting government policies—and that is the U.S. position on the table. We must not be satisfied with patchwork solutions such as market-sharing arrangements. That’s bad convergence.

America’s Spirit

Let me close on this note. I have spoken of America’s winning hand—of growth, of coordination, and of openness—as the keys to the future. Whether we play that winning hand, however, depends not only on our wisdom but also on our zest for the game. So in a larger sense, what I propose here goes beyond economic policy. It goes to the spirit of America itself.

Now, 150 years ago, Alexis de Tocqueville detected that spirit when he described Americans as eager for change and self-confident in their ability to master the future. That spirit of adventure—not only our material resources—has brought us into the front rank of nations. Our universities—including MIT—our industry, our farmers, our workers have set world standards. The common thread tying together these achievements is a sense of adventure, of experiment, of anticipation of the future.

And that’s my message. Let’s embrace that future with the zest that makes us great. Let’s play the winning hand that we hold.

1. Source: Department of State Bulletin, June 1988, pp. 18–22. All brackets are in the original. Shultz spoke before the annual dinner of the Massachusetts Institute of Technology (MIT).
2. Shultz, George P. and Kenneth W. Dam, Economic Policy Beyond the Headlines (Stanford, CA: Stanford Alumni Association, 1977).
3. Possible reference to Paul Blustein, “European Central Banks Cut Key Rates: Move Shows Support for U.S. Policies,” Washington Post, November 25, 1987, pp. A1, A12.