COMMERCE DEPT.'S Robert J. SHAPIRO ON RISKS IN GLOBAL ECONOMY

Washington -- Recovery from global economic crisis depends on reforms in
developing countries and leadership by the United States, says Robert
Shapiro, under secretary of commerce for economic affairs.

In a February 18 address to the Society of Government Economists, Shapiro
said the United States has responsibility for leading the world to recovery,
but he noted that the global crisis also poses risks to the U.S. economy.

One risk is falling demand for U.S. exports, he said. A risk related to
decreasing exports is that foreign investors might stop supplying the credit
the United States needs to finance its growing trade deficit, he said.

"A key issue, then, is the strength of the dollar," Shapiro said. "An
important adjustment to the dollar has already taken place in the last six
months .... World markets will judge whether this is sufficient to restore
our export competitiveness."

Shapiro noted four aspects of the global economy that make adjustments more
difficult for developing countries. These are the flow of capital to strong
economies, especially the United States; the overall slowdown in global
growth; the sustained reduction in inflation; and intensified competition
among currencies.

He noted also the resilience of better-integrated economies in North America
and Europe during the crisis to date. Other countries need to carry out
economic reforms; Asian economies need especially to reform their banking
and other financial sectors, he said.

"Our basic responsibility is to bring the world along with us on the road to
prosperity," Shapiro said. "The best ways of achieving this are strong
national savings and strong productivity growth."

Following is the text of Shapiro's address as prepared for delivery:

(begin text)

RISKS AND RESPONSIBILITIES IN A GLOBAL ECONOMY

An Address by Robert J. Shapiro
Under Secretary of Commerce for Economic Affairs

To the Society of Government Economists
Washington, D.C.
February 18, 1999

Introduction

To hear some economists talk about the world these days, you'd think we're
all headed for trouble. But take a look at the American economy. For the
last three years, GDP has grown by 4 percent a year, in an expansion that's
broken all previous peacetime records. Unemployment has stayed below the
level most of us believed would reignite inflation. In fact, for the last
three years, inflation has been falling, to less than 2 percent a year. The
Dow Jones average has reached 9000 and stayed there. And the federal budget
is now promising substantial surpluses -- indefinitely.

Maybe economists are more sensitive to change than most people. Certainly,
they know that economic change carries risk. And there is a great deal of
risk, higher risks and new risks, in today's global economy.

Like yours, my job, as the chief economic adviser at the Commerce
Department, is all about evaluating economic change and risk. I'm just not
allowed to use my evaluations to forecast anything because the job also
includes overseeing the nation's major statistical agencies, the Bureau of
Economic Analysis and the Census Bureau. So, if I get lucky and hit the
mark, I can be accused of cooking the books. And if I miss the mark, I look
like I don't know what I'm talking about. So I leave the forecasting to
those paid to do it.

I still have to understand the forces driving the American economy. And I
have to use that understanding to help inform national policy decisions.

Based on what I understand today about the global economy, I believe that
the new risks associated with globalization carry with them new national
responsibilities for the United States. We bear a new social and economic
burden to lead world economic growth and help pull other countries out of
recession. We also bear a greater social and economic burden to help all
Americans build their human capital.

To understand these new risks and responsibilities, the best place to start
is with the complicated dynamics shaping the current world economy. We
should know why the smaller Asian economies suffered the debacles of 1997
and 1998. We need to understand why, in the midst of this, the large and
economically integrated countries of North America and Europe have been
doing well. And we have to figure out why the large and less integrated
economies of Asia, Russia and South America are struggling. Then we need to
use that understanding to try to build a more secure and prosperous world.

So, I'm going to do a brief survey of global economic conditions, look at
the forces that are driving uneven growth in the world, and offer analysis
of what this means for the American economy today and for the future.

Current Global Conditions: Uneven Growth

One of the most striking aspects of global conditions in 1999 is their
unevenness. Growth is strong in North America and reasonably strong, if
slowing, in Europe. Asia is struggling with serious recession, South America
faces possible recession, and Russia is in economic collapse. What does this
mean?

For one thing, its means that resources -- especially capital -- are
shifting to the strong economies, primarily the United States. Here, with
our export industries weakened by the Asian recession, the capital is
especially flowing to interest-sensitive sectors with high domestic demand.
As a result, the United States has continued to grow strong, even as our
manufacturing exports have taken a large and sustained hit. Business
investment, especially in information technologies, construction and durable
goods, has probably been strengthened by the Asian crisis. And with all that
capital flowing in, the stock market has flourished -- again, especially in
shares of information technology and durable goods firms.

Resources are also shifting in Asia, especially domestic resources shifting
to their exporting sectors. That's because export growth to North America
and Europe has cushioned their recessions a bit. Now, domestic demand in
Asia needs to expand to build a full-fledged recovery. Meanwhile, the
financially stressed service sectors in most Asian countries are being
forced to rapidly reorganize. When eventually the global business cycle
evens out, Asia will be changed, just as the U.S. economy was changed by our
asymmetrical business cycle of the 1980s. It will probably be less dependent
on investment spending to build up capacity, with more attention paid to
productivity and profits.

Another aspect of the current economic picture is the overall slowdown in
global growth. The world economy grew 2 percent in 1998 and, by the IMF
forecast, will grow only another 2 percent this year. That's half the rate
of the 1980s and mid-1990s, and not enough to raise worldwide per-capita
incomes. That tells us that the recession in Asia, and perhaps South
America, cannot turn around by itself. Real changes are needed.

A third important aspect driving the bumpy global economy is the sustained,
worldwide decline in inflation. This has several sources. In part, it
reflects the weakening of global demand arising from Asia's long downturn.
But there is more to it than the business cycle. In fact, the downward
pressures on prices around the world are mainly structural. Perhaps most
important, technological changes have been lowering costs in many
industries, sometimes sharply. In addition, there has been a buildup of
excess capacity in both Asia and commodity industries worldwide because of
too much investment-led growth over the past decade. Also playing a role is
intensified global competition, propelled by the continuing liberalization
of international trade, especially in North America and Europe. Finally, the
deregulation and technological transformation of capital markets has brought
more competition among currencies. That in turn has driven down inflation by
forcing countries around the world to tighten their monetary and fiscal
policies.

The worldwide inflation of the 1970s affected the development and course of
virtually every economy. The current global disinflation has similar broad
and serious implications. It constrains every country's political capacity
to manage its business cycle, just as its opposite did in the 1970s. The
most troubling example of that is Japan -- the powerhouse of the 1980s, now
stagnating. The new pricing dynamic also disciplines the power of business
and labor to affect prices. We see this in the United States and Europe, as
well as Asia. That discipline has shifted the focus of business investment
from building capacity to building productivity. As a result, for example,
45 percent of all fixed U.S. business investment over the last five years
has gone to information technologies. Disinflation also forces labor to
shift its strategy, from seeking higher pay to bolstering job security.

Finally, the current global predicament is affected by an intensified
competition among currencies. This dynamic has led Europe to create the
largest single currency area since the demise of the gold standard. It has
also forced countries as varied as Indonesia, Russia and Brazil to squeeze
their domestic inflation from triple digits to two or even one. Of course,
when pressures build to ease monetary policy, the new competition among
currencies may also trigger economic havoc.

Asia: A Case Study in the Dynamics of Uneven Growth.

To better understand these dynamics, let's look a little closer at Asia.
There, the connections between uneven global growth and the worldwide
disinflation are probably most obvious. In Asia, we have seen how much a
sudden shift in capital flows can traumatize a small, trade-oriented economy
operating in a competitive global market. The extent of the trauma across
most of the continent is well known -- surging unemployment, rising
bankruptcies and the deepest recessions in 50 years.

Geography has also played a part in Asia's current traumas. The continent's
largest customer has been Japan, which has spent the 1990s stumbling in and
out of recession. Meanwhile, China has emerged as a huge, regional
competitor for international investment and export markets.

Some common structural forces have also been hammering Asian economies,
whose political arrangements, balance of payments, reliance on foreign
investment and economic cultures all show so much variation. One such force
is pegged exchange rates, whose pegs become out of date, as they eventually
must. Obviously, pegged exchange rates can help attract foreign investors.
But they also make a country vulnerable, since the dollar and yen to which
they were pegged are themselves subject to sharp swings. Even before the
currency crisis, Asian countries tied to the dollar had a wild ride,
especially those also competing with Japanese manufactures.

Of course, pegged currencies can't by themselves explain the crisis. South
Korea's currency floated down for several years before it hit a serious
crisis. While most Asian currencies now float, two important ones -- Hong
Kong and China -- are still pegged to the dollar -- and therefore to each
other. And Malaysia has reestablished its dollar peg.

Another common factor behind the crisis is the weak domestic banking and
financial systems of most Asian countries. In a global economy, where
currencies compete and foreign investment is channeled through domestic
institutions, any country that lacks a fully developed banking system is at
risk because of the sometimes-volatile movements of international capital.
But here, too, there is the exception. Hong Kong, with fairly sound banks
and very open capital markets, finds itself in a recession as bad as many
others in the region.

Nevertheless, without the integrating force of a sound private banking
system, short-term foreign capital flowing into a country tends to be
distributed haphazardly. Then, when a sudden devaluation looms and capital
flows out, businesses that would never have been financed under sound
banking arrangements fail quickly. In a country like Indonesia, where the
domestic banks have been conduits for politics and cronyism -- or even
Japan, where the flaws of the banking system are more subtle -- the biggest
problem is not the vulnerability to a financial crisis. Rather, it's the
distorted distribution of the country's real resources that precedes a
crisis. And it's also the enormous costs in lost output and unemployment
that come when global competition forces a country to abruptly reallocate
its reduced resources on sounder economic grounds.

The vulnerability of these economies is also aggravated by the current
production process for many sophisticated goods. Part of the East Asia
success story in the early 1990s was the tremendous expansion in exports of
advanced products produced by a number of businesses linked by the
production of the product. When times are good and the currency is stable,
this chain-related production system can create a virtuous circle of broad
investment and economic expansion. When things turn sour, the chain breaks,
and everyone suffers.

Asia's current business downturn will not last forever. In fact, the United
States is an important key to their recovery. Most Asian countries trade
heavily with us, and our strong expansion continues to be the main source of
new demand for their products. Further, the financial conditions in these
countries have been improved by our lower interest rates, as well as by the
stronger yen and weaker dollar we've been seeing since last October.

More important to Asia's long-term recovery, however, are reforms,
especially in the financial and banking sectors. The recent history of most
East Asian economies demonstrates their capacity to adjust quickly to
outside forces. With the exception of perhaps Malaysia, the crisis has
strengthened East Asian support for market-based, trade-oriented economic
policies. Already, U.S. direct investment in Asia is increasing again. We
may also be seeing a real recovery in Korea, where interest rates have
declined, fiscal stimulus has taken some hold, and structural reforms are
proceeding.

Large Integrated Regions Are Prospering

As Asia struggles, most of the world's large and highly integrated economies
have seemed to shrug off the crisis. The United States is, of course, the
leading example. But Mexico and Canada are also doing pretty well, in large
part because of NAFTA and the greater integration it has brought to the
North American regional economy.

Another star performer of 1999 has to be the euro, and its unification of
monetary policies across countries that have not always been good friends.
The euro got a big push in the 1980s, when European governments became
concerned that a two-currency world of the dollar and the yen could hurt
them. These governments further paved the way for the euro in the 1990s by
tightening their fiscal and monetary policies. Today, it is Japan that
worries about a two-currency world, of the dollar and euro.

Ultimately, the euro represents something of the essence of globalization.
It is the clear recognition by some of the world's most highly regulated,
advanced economies that they must intensify their own market forces by
reforms that can help create the conditions -- the capital pool, labor
supply and efficiencies of scale -- to respond effectively to global market
forces.

Of course, Euroland will face serious challenges. If the single currency
produces an even, continental business cycle, as intended, the European
economy could lose one of the advantages of foreign trade. I refer to the
ability of firms in one country to counter a recession by selling more to
neighbors that are still growing. Or conversely, the ability of firms in a
country that's growing to counter rising inflation by importing more from
neighbors in recession. Or the euro may face a different set of problems, if
some of its countries slide into recession while others continue to expand.
Then, the Maastricht Treaty's restrictions on national fiscal and monetary
policy could produce political conflicts that could threaten their common
policies. But these are problems that come with the territory -- and ones
that the United States learned to solve as we moved to a continental-sized
economy.

One of the goals of Euroland is to achieve sufficient economic size and
power to protect its members from strong negative winds from globalization.
But size alone is not enough to protect countries from economic crisis
elsewhere. Just look at Russia and Brazil. They found themselves caught in
the aftershock of the Asian devaluations when international investors moved
to reduce their risk exposures elsewhere. Despite their size, Russia and
Brazil found themselves in much the same box as Thailand and Korea.

This lesson is clearer still in Japan and China. In Japan, highly efficient
export industries have long coexisted with generally protected domestic
service enterprises. China has some of the same characteristics. This lack
of economic integration was exacerbated by their weak banking systems, which
made their economies more vulnerable to recessions when their smaller
trading partners hit their crisis.

Lessons for the United States

What does all this tell us about our own economic prospects? Can the United
States help lead the world to recovery -- as I believe we are doing -- or
will the rest of the world pull us down?

The risks to us are two-fold. One is the falling demand for American
exports. The other is the possibility that as exports fall, global investors
could eventually withhold the credit we need to finance large and growing
current account deficits.

A key issue, then, is the strength of the dollar. An important adjustment to
the dollar has already taken place in the last six months. Now it's back to
roughly its pre-crisis 1997 average value. World markets will judge whether
this is sufficient to restore our export competitiveness.

Another key issue is our return on capital. Once again, we should be
reasonably confident. Returns on capital in the United States continue to be
strong. If we can sustain our recent productivity gains, and if wage
inflation stays moderate, investments in America will remain profitable. And
foreign investment will continue to flow in.

Our basic responsibility is to bring the world along with us on the road to
prosperity. The best ways of achieving this are strong national savings and
strong productivity growth. These should maintain the high return on capital
that attracts foreign capital and that finances strong import growth.

As a matter of basic American economic leadership, it is our responsibility
to maintain and save the budget surplus, rather than squander it on tax cuts
that will only increase consumption, imports and dependence on foreign
investment. This will enable us to provide more of our own resources for
investment here and abroad.

It is also a national responsibility to increase investment in the factors
that will make us more productive. First and foremost, that means
innovation, the predominant factor in growth. And the best ways to promote
innovation is to invest more in research and development, expand open trade,
and reduce unnecessary economic regulation. Second, both government and
business have to prepare American workers to take advantage of innovation,
by investing in education and supporting lifelong training.

American leadership entails a further responsibility. As governments and
nations compete more for global investment, we cannot allow that competition
to dumb down our own standards. Rather, we must help the rest of the world
approach our standards on matters ranging from child labor, and intellectual
property, to antitrust and environmental protection.

We also must promote the integrity of the statistical data that economies
around the world collect. There are many examples of governments trying to
politicize how their statistics are collected. Bad data and faulty
statistics have been an Achilles heel for most of the countries in crisis
today -- not only because they produce bad investment decisions, but also
because funds quickly flow out of a country when investors doubt the
integrity of the economic data. The United States -- led by the Bureau of
Economic Analysis and the Census Bureau -- has long produced the world's
best economic information. It's part of my job to ensure it stays that way.

In this area, the IMF has also played a useful role by forcing more
countries to be transparent and accurate in reporting data. The United
States can act as a useful adviser in this regard.

Conclusion

The world is no longer merely a collection of discrete economies. We are all
in this global economy together. The best news is that, as a result of the
Asian crisis, virtually everyone affected understands that they have to
change their policies and reform their institutions. That adjustment process
is wrenching, but there appears to be surprisingly little denial or
backsliding. South Korea and Thailand are pressing even faster to open their
investment, capital, and production markets. Even Malaysia seems prepared to
loosen the capital controls it put in place in more desperate days.

And throughout the crisis, the basic forces of globalization -- of
production, capital and technology -- have proceeded. Even with the current
slowdown, the volume of world trade continues to grow twice as fast as world
output. As it does, the prices of many traded goods, commodities and even
wages across countries are growing more equal. And as that continues, the
competitive pressures forcing governments to change policies and businesses
to reorganize on more efficient lines, will intensify.

In the long run, as many economists warn, it may not be possible for America
to grow much faster than the rest of the world. But if we meet our
responsibilities to save and to invest in our productivity, we may be able
to approach the long-term world growth rate of 3 to 4 percent. That will be
our reward for meeting our responsibilities in the age of globalization. And
economists, the world's designated worrywarts, should be able to relax a
little.

 risks in globalism