Economic Report of the President

arily reduced the international competitiveness of U.S. industry dramatically.Other U.S. exporting and import-competing sectors, especiallyagriculture, have also been squeezed.Despite this deterioration in competitive position, it was only in thethird quarter of 1982 that the U.S. trade deficit began to show a significantincrease. This delay was in line with previous experience ofthe effect of exchange rates on trade. The full effect of changes inexchange rates on the volume of exports and imports is felt onlyafter some time has passed, because some trade takes place undercontracts signed in advance and because customers do not alwayschange suppliers immediately when relative prices change. The shorttermeffect of a rise in the dollar is to reduce import prices, whichactually tends to improve the trade balance. Although the negative effectseventually dominate, some econometric estimates suggest thatthe full negative effect is not felt for more than 2 years.As the effects of the strong dollar are increasingly reflected in U.S.trade, the trade deficit will widen. Economic developments elsewherein the world will also contribute to a widening trade deficit. The recessionin other industrial countries will depress the demand for U.S.exports, and financial constraints in developing countries will leadthem to import less. Both developments will have negative consequencesfor U.S. exports. Record trade and current account deficitsin 1983 will almost surely result.Whether the trade and current account deficits persist will largelydepend on U.S. macroeconomic policies, particularly on the fiscalside. If large budget deficits are allowed to continue to depress theU.S. national saving rate, real interest rates may rise again, sustainingor even increasing the high real exchange rate of the dollar. In thiscase the trade deficit could remain high for several years.A large and sustained trade deficit would result in an economic recoverywhich would be "lopsided" in the sense that exporting andimport-competing sectors would not share in the gains. Should thisoccur, government, business, and labor officials must bear in mindthat even though protectionist foreign trade practices distort thecomposition of world trade and reduce economic efficiency both inthe United States and abroad, large trade deficits are not the resultof unfair foreign competition. Large projected U.S. trade deficits area result of macroeconomic forces, particularly large budget deficits.The main sources of the U.S. trade deficit are to be found not inParis or in Tokyo, but in Washington.RESPONSES TO THE STRONG DOLLARThe temporary adverse effects of a strong dollar create pressure todo something for the exporting and import-competing sectors. Three67