The New Economy’s Troubling Trade Gap

While Americans celebrate the spectacular growth of the so-called new economy, one chronically troubling economic indicator threatens to spoil the party: the balance of payments. The country’s shift in the 1990s toward information-based, postindustrial businesses has been accompanied by a dramatic widening of its trade gap. The U.S. deficit this year could reach a record $300 billion, according to Goldman Sachs. That represents a 188% increase from the already huge $104 billion deficit recorded in 1989, and it does not bode well for America’s future.

It’s no coincidence that the U.S. economy’s growing reliance on information industries like software, Internet commerce, and financial services has been accompanied by a sharp deterioration in its trade position. Like most other service businesses, information industries are poor export earners.

Even mighty Microsoft, the colossus of the new economy, is a disappointing player in world markets. Its exports totaled only $2.9 billion in 1998—just 20% of its total sales of $14.5 billion. By comparison, traditional manufacturing powerhouses like Boeing routinely derive close to half their revenues from exports. And in key areas of the electronic components industry, which is increasingly dominated by Asian companies, export ratios are even higher. It is estimated, for example, that the Japanese liquid crystal display industry exports more than 70% of its entire output.

The Microsoft story is a classic illustration of the intrinsic weaknesses of postindustrial businesses in foreign markets. For a start, software and other information-based products are easily pirated—a practice that’s endemic to many foreign markets. More important are the language and cultural barriers that inhibit the cross-border flow of information goods. Microsoft’s word processing programs, for instance, must be heavily rewritten to sell in key markets like Japan or China. Since the adaptation of the software is usually done in the local market, its cost eats severely into the revenues remitted to the parent company in the United States.

If Microsoft’s export performance seems disappointing, that of most of the vaunted Internet players in the United States is abysmal. Take the leader of the pack, America Online. As of 1998, only 2.3 million—less than 16%—of AOL’s 14.6 million subscribers lived outside the United States. And even that ratio greatly overstates the company’s true export performance. In reality, America Online does virtually no direct business with overseas subscribers. Rather, it serves them through overseas subsidiaries and affiliates. The foreign partners in these ventures, such as Germany’s Bertelsmann group and Japan’s Mitsui & Co., typically own at least 50% of the shares. Most of the value-added therefore accrues not to the United States but to the local economies. By America Online’s own admission, foreign ventures do not contribute significantly to its operations or its financial position.

Perhaps most surprising is the weak performance of America’s great financial services companies. Some of these businesses have been serving foreign markets for more than a century and, as such, count as the new economy’s most experienced exporters. And certainly they never tire of bragging about their international reach. Merrill Lynch, for example, trumpets its “global leadership” in the front of its 1998 annual report. But the fine print in the back tells a different story: the company still generates 74% of its revenues within the United States.

Of course, the 26% garnered abroad seems impressive compared with Microsoft’s or AOL’s export ratio. But again, appearances are deceiving. Only a small fraction of Merrill Lynch’s foreign revenues actually count as exports for the United States. Because the company serves most of its foreign customers from offices in the local markets, its salaries and other expenses in those markets count as deductions from its foreign revenues. When those costs are taken into account, it appears that even in a good year less than 5% of the company’s revenues contribute to the plus side of the U.S. balance of payments.

One thing is clear: America’s current account deficits are rapidly approaching dangerous levels, and they will continue on that track as long as the country’s reliance on postindustrial businesses grows. The question for policy makers and corporate executives alike is, How much longer can the U.S. dollar take the strain without experiencing a massive devaluation similar to the ones it suffered in the mid-1980s and early 1990s?