Also In This Issue Related stories: Cover Story • No Hand-Wringing, Please • Instructions Not Included • The Unintended Revolution • Legacy Of Strength, Or Weakness?

By Bruce Stokes, National Journal
© National Journal Group Inc.
Monday, Jan. 28, 2008

America's hegemonic role in the world economy has diminished during the Bush years. American consumers' spending is less critical to global economic well-being. Wall Street faces rivals as the world's premier financial market. And the United States is less attractive to foreigners seeking a better life.

Gulliver has certainly not become a Lilliputian. The U.S. economy is still the world's richest. The dollar remains the world's pre-eminent currency. And nearly 2 million people still immigrate to the United States each year, both legally and illegally.

But the relative strength of the United States in the world economy -- whether measured by the flow of goods, money, or people -- is not what it was. This slide is a product of the economic emergence of Asia and the creation of a single European market and currency. It is also a legacy brought on by years of Americans' living beyond their means and by post-Enron, post-9/11 regulatory changes in the United States.

Because much of this falloff is not the fault of the Bush administration, the next president cannot necessarily be expected to turn these trends around. Americans will need to come to terms with the fact that while the United States is still the Big Foot in the global marketplace, its footprint has diminished.

A Smaller Market
The United States is now the second-largest market in the world -- the European Union is slightly larger -- but Americans are still the richest people. According to newly revised calculations by the World Bank, in 2005 the U.S. economy accounted for 23 percent of the world economy on a purchasing-price-parity basis, which compares consumers' relative buying power. China accounted for less than 10 percent, and Japan only 7 percent. The average American has a per capita income of nearly $42,000, more than a Swiss or a Brit or a German. Only citizens of small, oil-rich countries are better-off.

But Americans' purchases of foreign products are not the driving force behind world economic growth that they once were. U.S. imports of goods as a share of world imports peaked at 18.7 percent in 2000. In 2006, the U.S. market accounted for only 15.5 percent of such trade.

This means that when the U.S. economy catches a cold, as it now seems to be doing, the world will likely come down with a milder case of pneumonia. In the future, the United States will play a smaller role in the investment decisions of foreign conglomerates, such as Japan's Toshiba and South Korea's Hyundai. Foreign companies will build more plants and create more jobs elsewhere. Multinational corporations, including American ones, will increasingly design products with Indian and Arab consumers' tastes in mind. At the margin, companies will be more likely to adopt European or Chinese technical standards for everything from cellphones to automobile engines. This will put U.S. products at a competitive disadvantage and cede to others the global-standard-setting role that Americans have come to believe was a reflection of U.S. values and market sensibilities.

Wall Street's Slide
Americans can also no longer take the dollar's primacy for granted. In the third quarter of 2007, the dollar accounted for 40.5 percent of the foreign-exchange reserves held by central banks, down from 56.4 percent at the end of the third quarter in 2000, according to the International Monetary Fund. Euros, the second-most-popular reserve currency, accounted for 16.7 percent of such holdings in 2007, up from 13.2 percent.

The dollar is still the currency reserve of choice. Thanks to the huge American current-account deficit, more dollars are held abroad, especially by emerging market economies, than ever before. And some of the relative change in the value of currency holdings simply reflects the recent depreciation of the dollar and the appreciation of the euro, rather than central banks' exchanging their dollars for more euros.

"The dollar is no longer the reserve currency of Europe," said Brad Setser, the senior economist at RGE Monitor, an online economic think tank. "And it has become less important in Eastern Europe. But it remains a key currency for the [Persian] Gulf states and Asia." Setser warned, though, that past is not prologue. He predicted that the Gulf states may soon set their exchange rates against a basket of currencies, increasing their demand for the euro, the yen, and the Chinese renminbi.

There has been a similar tailing off of American dominance in world capital markets. In 2001, 47.2 percent of all equities sold were issued in the United States, according to Thomson Financial. In 2007, that proportion had fallen to 24.7 percent. Similarly, Wall Street accounted for 58.5 percent of bond issues in 2001, but only 45.4 percent in 2007. U.S. primacy in mergers and acquisitions is also down -- 44.6 percent of all corporate mergers and acquisitions that took place in 2001 occurred in the United States; in 2007, the U.S. share was only 36.3 percent.

The American equity, bond, and merger and acquisition markets were all at or near record levels in 2007. So the U.S. financial market is not declining. But more and better business opportunities are emerging elsewhere. And the looming U.S. recession is likely to make other markets even more attractive to investors.

Benn Steil, director of international economics at the Council on Foreign Relations, says: "It is irrelevant where business takes place physically. What matters is what rules govern the transactions. And, increasingly, the standards for international financial transactions are being established elsewhere" as the capital market business moves abroad. This rule-making has long-term adverse implications for U.S. influence that may well prove more important than annual changes in the dollar value of transactions.

No Immigration Magnet
Given America's history as a nation of immigrants and the intensity of the current U.S. political debate about illegal immigration, it is not surprising that many Americans take foreigners' desire to come to the United States to work and to study as confirmation of the American economy's relative strength.

But today's immigrants have choices, and often they are choosing to go elsewhere. According to estimates by the Migration Policy Institute in Washington, 1.8 million people who were likely to stay in the United States indefinitely entered the country each year between 2002 and 2006, either legally or illegally. That is the same number of people who entered the European Union in 2005, according to estimates by Rainer Munz, a senior fellow at the Hamburg Institute of International Economics.

Moreover, foreign-born people now make up a larger proportion of the national population in France, Germany, Ireland, the Netherlands, Spain, and Sweden, than in the United States, according to Demetrios Papademetriou, president of the Migration Policy Institute. Today, these countries, not America, are the true immigrant nations.

Unlike in the late 1990s, many of the world's best and brightest are no longer choosing to attend universities in the United States. More Chinese students are at Oxford, Heidelberg, and elsewhere in the European Union than on American campuses. Since 2000, the U.S. market share of students studying outside their own country has fallen from 26 percent to 22 percent.

The United States is not necessarily the country of choice for economic migrants. In 2005, the Pew Global Attitudes survey asked people in 15 countries in Europe, the Middle East, and Asia where they would advise a young person to go to lead a good life. Only Indians cited the United States as their first choice. The most popular destinations were Australia and Canada.

This decline of indicators about U.S. pre-eminence in the world economy is not headlong or dramatic. It reflects the economic success by others around the globe as much as it does U.S. growth rates. It is also, experts say, generally to the benefit of all Americans. And, for the most part, there is nothing the president could or should do about it.

But some of the slippage is a product of economic and regulatory decisions that analysts say could and should be changed. One reason for the diversification of foreign-reserve holdings is the growing belief abroad that the dollar will continue to weaken because the U.S. trade deficit is unsustainably large. Curtailing the deficit would buttress the value of the dollar and its role as a reserve currency.

Steil and other financial experts argue that the Sarbanes-Oxley accounting reforms enacted after the Enron fiasco are driving some capital market business abroad. Reform of such rules to improve Wall Street's competitiveness might gain a foothold in any new administration's agenda.

Recent anti-immigrant sentiment in the United States and the tightening of visa requirements after 9/11 seem to have discouraged some foreigners from studying here. Perhaps some way can be found to ensure that the world's budding engineers and scientists continue to come to the U.S. and contribute to the American economy.

The next administration may first have to cope with a recession. But its long-term economic challenge will be to adapt to the relative decline of U.S. economic influence during the Bush years, to do what can be done to reverse that trend, and to have the grace to accept that the days of American economic hegemony may be over.