European Affairs

For the United States, one major element in this process has been the North American Free Trade Agreement (NAFTA). In the early 1990s, U.S. exports to Mexico were about nine percent of total exports; in 2000, they were 14 percent. Similarly, U.S. non-oil imports from Mexico have risen from about six percent of the total to about 11 percent.

For Europe, the move to the Single Market at the end of 1992 was a similar milestone that created incentives for economic activity to spill across borders. And the negotiations currently underway for EU accession by 12 more countries should ultimately result in additional investment §ows, wider dispersion of new production locations and increased trade.

U.S. and European companies are also responding to incentives to invest in and trade with other global regions. The high-tech sector has become in many ways a global industry. Global trade is broadly expanding. One consequence of these developments is that the share of U.S. exports going to Europe declined slightly over the 1990s, as did the share of non-oil imports coming from Europe. But the total value of two-way trade between Europe and the United States grew at an average rate of almost nine percent during the same period.

The point is that both these major industrial regions are becoming increasingly integrated with each other and with a range of other countries and regions in the global economy. This integration is leading to complex relationships within the real side of the economy, as well as to rapidly growing and evolving financial relationships that are played out in global financial markets. Companies and trading patterns are multinational in character and respond to developments not just in the "domestic" economy but also in various places around the world.

Secondly, the composition of output and employment in the U.S. and European economies is changing. In the "industrial countries," expanding service sectors are outpacing industry, in the traditional sense of the manufacture of goods from raw materials using labor and capital. The share of goods in U.S. Gross Domestic Product has declined from 45 percent three decades ago to about 35 percent today.

In the euro area, services measured in terms of gross value added grew at an annual rate of nearly 2.5 percent during the 1990s while industry grew by only about 1.5 percent. This shift is even more apparent in the employment data. For non-agricultural payrolls, the share of manufacturing and mining is below 15 percent today, down from nearly 20 percent in 1990 and much higher levels before that.

During the 1990s, employment in services rose at an annual rate of about 1.75 percent in the euro area, while industrial employment contracted at nearly the same rate. The shift from industry to services has been particularly marked in Germany and Ireland.

It is not that manufacturing jobs are moving away, forcing workers to settle for low-skill, low-wage service jobs - although such problems are not entirely absent. The dynamic parts of the services sector are high-skill, high-wage jobs that entail the investment of substantial capital, as well as labor - the so-called "new economy."

Even before that phrase was coined, however, communication services, medical services, education services, financial services and the like were together growing more rapidly than traditional industrial output. And even if the late 1990s will ultimately be judged by history to have produced something of a high-tech bubble, the trends of the past several decades are likely to persist.

One consequence of this is that the cyclical characteristics of our economies will change. Much has been made of the possible effects of changing inventory management on cyclical patterns of output, but perhaps more important is the simple fact that storable output now represents a smaller share of GDP.

Bottlenecks in global raw material supplies and the time required to ship bulky goods may become less important as factors slowing or boosting economic growth. The portion of value created in the economy that is intangible is rising. And this change in turn alters the nature of competition within and between economies. At least some of these services - many in the financial sector - are even more "tradable," at lower delivery costs, than traditional manufactures.

The third feature is the low and stable in§ation of recent years, in contrast to the 1970s and 1980s. The precise numbers depend upon which measures are used. But for the European Union and the United States, the 1970s were clearly a decade of variable in§ation rates that reached double-digit rates toward the end of the decade.

Considerable progress was made in bringing in§ation down in the 1980s, and the last five or six years have confirmed the successes achieved on both sides of the Atlantic in keeping in§ation contained and in§ationary expectations firmly anchored.

This outcome is due partly to the fact that policy officials and the general public have learned from past mistakes; partly to heightened competition resulting from globalization; and partly perhaps to a more favorable run of economic "shocks" than we experienced in earlier decades.

Low in§ation on both sides of the Atlantic contributes to better economic decision-making and, thus, more efficient use of economic resources. And it provides a more favorable climate for monetary policy decisions by the European Central Bank and the U.S. Federal Reserve.

All these economic developments have created a global economy that is more interdependent than ever before, but that is also capable of substantial resilience. The slowdown during 2001 on both sides of the Atlantic, as well as elsewhere in the world, demonstrated that weakness or negative shocks in one country or economic area can cause contractions of economic activity in other regions.

But that same interdependence will enable recovery in one region to support recovery more broadly. And the growing importance of services, particularly in sectors experiencing innovation, should help economies to rebound more rapidly. The low in§ation environment in the United States and in Europe means that monetary policy is not constrained to address medium-term efforts to lower trend in§ation, but can help to promote a recovery in the growth of output.

What are the lessons to be learned for economic policy in the United States and Europe from these developments? What can policy do to promote favorable economic outcomes on both sides of the Atlantic?

I would stress first the need for §exibility. The objective of monetary policy is low and stable in§ation. But the real economy is constantly changing. Financial markets now spread information and conduct transactions very rapidly. So we all need to be §exible in our thinking, in our information gathering, and in our use of policy tools, in order to achieve a stable outcome.

Our policy analysts need to recognize that political borders do not have the same meaning for economic activity as they once did. And at a variety of levels, we need to share information and work together to solve problems, from the supervision of cross-border financial institutions to data-collection on capital §ows and on foreign exchange turnover and to learning from each other's policy successes and mistakes.

Finally, I would point out that in the modern, complex global economy, companies will necessarily expose themselves to a variety of risks - some of them new and not fully understood. We need to work to ensure that these risks are carefully assessed and properly monitored. But at the same time, we must not needlessly hold back economic progress by preventing change and sti§ing this risk-taking.


This article was published in European Affairs: Volume number III, Issue number II in the Spring of 2002.