Prospects for the North American Economy: 1985 and Beyond

C.R. Charlton

Honoured guests, ladies and gentleman: From what I have learned about Maurice Raymond Greenberg, I conclude that the greatest understatement I could make in introducing him would be to say that: "Mr. Greenberg believes in free enterprise". How could he NOT believe in it? He is free enterprise; the type of free enterprise that thrives within a civilized, law-abiding democracy. Just a few years ago he received "The Free Enterprise Award" from the Insurance Federation of New York.

He has been referred to as "the toughest guy in Insuranceland," and he does not deny the Tough Guy image he projects. "I expect people", he says, "to be prepared.". "Be Prepared." But is that not the motto, used world-wide, by the Boy Scouts?

However, tough guy or Boy Scout, as President and Chief Executive Officer he has led the vast American International Group to phenomenal success in the world of insurance. The AIG is the largest American multinational insurance holding company, with more than 250 subsidiaries active in 136 foreign countries and territories.

When he assumed the top position in this giant operation in 1967 he announced a goal which seemed to some to be overly ambitious at that time - no less than a twenty per cent increase in earnings annually. Since 1970 AIG's earnings have grown at a compound rate of twenty-five per cent annually!

When Maurice Greenberg left high school in the year of Pearl Harbour, to join the U.S. Army, his plans for a career were unformed. When he was demobilized with a captain's rank, his plans were still not firm. But in the interval between the end of World War II and the Korean War, he had earned a law degree from New York University, and had been called to the bar. Recalled to the army, he won the Bronze Star for his service in Korea.

Demobilized again, young Mr. Greenberg started looking for a job, and more or less stumbled into the insurance business. He had wandered into the offices of Continental Casualty Company in New York. His interview with the personnel office upset him so much that he went directly to the senior executive office to protest his treatment. The story goes that he was hired on the spot, and in just eight years became Vice President of the company.

In 1961, at the age of thirty-six, he accepted the presidency of the C.V Starr Organization and in 1967 moved to AIG as President and Chief Executive Officer, with the dramatic earnings results I have mentioned.

We welcome the man who epitomizes "free enterprise", Mr. Maurice Raymond Greenberg.

Maurice Greenberg

The North American economy is undergoing a transition from an inflation born of the 1960s and carried to excess during the 1970s. The current decade is struggling with an unfortunate legacy of distortions in the financial system, excessive debt, high real interest rates and instability created by falling commodity prices, particularly energy. This struggle will dominate the 1980s and seems certain to serve up some unsettling episodes. If successful, it may also pave the way for a more enduring and non-inflationary prosperity than we have enjoyed in many years.

Runaway inflation was finally brought to heel at the beginning of this decade when interest rates were decontrolled and allowed to seek their own level. The result was a twenty per cent prime rate in the United States which precipitated a liquidity crisis and brought on a rather serious recession. And bitter as this medicine was, it did break inflation's fever. However, by the spring of 1982 recession was in full swing with high unemployment and declining business activity. The Mexican debt crisis that summer served as a catalyst for a change in monetary policy and in the period that followed money and credit grew at a very rapid rate for a brief period. Interest rates declined and the beginning of an economic recovery soon became evident.

That recovery has now entered its third year, and its character has been different from other economic rebounds in the post-war period. The Federal Reserve, fearful of losing its earlier headway against inflation, became restrictive much earlier than in prior cycles. This policy kept interest rates higher than normal during the recovery, and shifted the burden to fiscal measures to strengthen and sustain expansion. To say that fiscal policy these last few years has been excessive is more than a modest understatement. Annual budget deficits on the order of $200 billion were the result, and while they did indeed nurture the economic recovery, they are now creating some alarming side effects. An expanding economy and the huge budget deficit created an enormous demand for credit in the United States and the combination of high U.S. interest rates and lagging recoveries abroad has brought a flood-tide of foreign capital to the United States which has accommodated a significant portion of our credit needs. But this capital flow has also had a major impact on foreign exchange - the U.S. dollar has appreciated on the order of fifty per cent since 1980. Consequently, economic activity is now being redistributed away from North America in favour of the rest of the world. The U.S. trade deficit has soared and rising imports are now threatening the prosperity of many of our industries. Indeed, the trade deficit is now neutralizing the stimulative impact of the budget deficit.

The 1982-84 economic recovery has lost much of its momentum. Real GNP in the United States was up 10.1 per cent in the first quarter; 7.1 per cent in the second; and a scant 1.9 per cent in the most recent period. Moreover, high interest rates and the strong dollar are now impacting corporate profits which, after a dramatic rise early in the recovery, showed a decline of 7.3 per cent during the most recent quarter. The message from these recent readings of the economy is clear - new policy initiatives are necessary to sustain the economic expansion.

... new policy initiatives are necessary to sustain the economic expansion ...

This brings us to the present and describes conditions facing a new Reagan administration which is attempting to forge appropriate economic policy directions for the period ahead.

What are the most pressing objectives and what are the policy options?

Heading the list of objectives is the need to bring the budget deficit under control. The U.S. government's debt service burden is expanding faster than the economy. This condition must be reversed, and quickly. Delay will only make the solution more difficult and could deny some of the policy options which might now be possible. Progress on this front will require a combination of spending cuts which must encroach upon the "sacred cows". Revenue enhancing tax measures, and incentives to encourage economic growth are needed. Moreover, policy actions on each of these fronts must be taken with a view to what is perhaps an equally important objective - that of avoiding a near-term recession in the United States.

This latter objective is far more important than was the case when President Reagan took office four years ago. Consider, for example, the implications of a nearterm recession on the LDC debt problem. A strong U.S. economy has led the global recovery these past few years, but not everyone has enjoyed the rebound equally. While unemployment in the United States went from seven per cent in 1980 to eleven per cent in 1982 and then back to seven per cent or so currently, unemployment in a sampling of other industrialized countries has doubled since the beginning of this decade and has only recently begun to plateau. Most of those who have studied the LDC debt predicament concur that the less developed nations need real economic growth on the order of three to four per cent to have any hope of servicing their onerous debt burdens. Most are export-based economies and are only recently beginning to benefit from the economic rebound in North America. A downturn at this juncture would surely revive the LDC debt crisis whose current tranquillity is fragile at best and is predicated upon both the bankers' willingness to extend new loans and the LDC's ability to service them. This tenuous balance would not likely survive a nearterm recession.

Additionally, an early recession in the United States would exacerbate the budget deficit and could easily offset other corrective actions. U.S. industries which are now being hurt by rising imports could be crippled by a downturn in the economy, and the prospect of a recession could also reverse the massive flow of foreign capital making it a great deal more difficult to finance the deficit. Clearly, the implications of a near-term recession in North America are not very pleasant and must be avoided.

... the implications of a near-term recession in North America are not very pleasant and must be avoided ...

One policy option which would serve to reduce the deficit and avoid recession at least in the short run is to lower interest rates. Progress in reducing inflation is perhaps the brightest spot on the current economic landscape, and is affording an opportunity to induce lower interest rates without immediate fear of rising prices. Monetary growth has been contained for most of this year and could be increased without violating the longer term anti-inflation policy. The Federal Reserve Board's action in cutting the discount rate to eight and a half per cent last week is most encouraging, and may signal further cuts in shortterm interest rates in the period just ahead. This trend will hopefully avert a downturn in the U.S. economy, and will buy some, but not much, time to properly address the budget deficit. However, interest rates must also be orchestrated in such a way as to avoid a collapse in the dollar or a loss of credibility in the central bank's resolve to stand up to inflation.

If this is accomplished, the second Reagan administration must seize the opportunity to address the deficit by taking decisive action. The President emphasized spending cuts during his first term and is now armed with a landslide re-election victory and billions of dollars in cost-cutting recommedations from the Grace Commission. It is likely that efforts to control the deficit will again focus on the spending side of the budget. Tax reform and simplification are also on the agenda. But the President has strong feelings against raising taxes and has pledged to do so only as a last resort. Changes in the tax code are coming, and will no doubt provide some measure of revenue enhancement. On balance, however, the President is not likely to alter the pattern established over the past four years, and the success of these efforts is critical to an enduring prosperity.

The legacy of the past two decades has left us with a distorted and threatened financial system and an inherent instability throughout the world. The temptation to address these problems with protectionist measures is rising and is in itself a danger. Our greatest hope is in recognizing these problems, and having the courage and enlightenment to work toward their solution before they reach crisis proportions. To a large measure economic progress in North America will depend on progress in tearing down barriers to trade. No place is this more important than in services trade. Less than a year ago, your Mr. Regan - Gerald Regan - floated the idea of bilateral sectoral free trade in the areas of steel and urban mass transit equipment. Basically, he proposed an extension of the automotive free trade agreement that has worked so well in recent years. At the same time, Roland F razee, Chairman of the Royal Bank of Canada, suggested that we try for an agreement on something he called "traded computer services."

... economic progress in North America will depend on progress in tearing down barriers to trade ...

On the U.S. side, there has been progress as well, in the form of the trade bill that Congress passed last month - an unusually liberal document that is all the more remarkable because it came in an election year filled with protectionist rhetoric. From the perspective of services, this bill does three very significant things. First, it opens the way for bilateral and multilateral trade agreements in services and investment. Second, it strengthens the power of the President to impose sanctions on countries that engage in unfair trade practices in services, as well as goods. Third, it mandates needed and long-overdue changes in the way the U.S. government collects and reports service sector data.

Why this focus in both countries on services trade? We - the United States and Canada - are the biggest bilateral trading partnership in the world. Last year, we did more than $120 billion in business. Automotive and transportation trade made up a fourth of the total. Service trade accounted for a fifth. Both our economies are service-driven. Service activities generate about two-thirds of your GNP and two-thirds of ours. Service activities employ 68 out of every 100 Canadians - only slightly less than the U.S. figure of 74 out of every 100 Americans. Services also generate jobs. Over the past decade, the service sector accounted for eight out of ten new jobs in both Canada and the United States. Even in times of recession, service sector employment grew in both our countries - and showed dramatic productivity gains to boot.

But what are services? The modern service sector is not so much fast-food and video arcades as it is financial; services insurance, brokerage and banking, and professional services such as engineering, law and health care.

In recent years demand for services in many countries has grown faster than goods and commodities. The United States, the world's leading exporter of services, has benefited from this increased demand. Since 1977, U.S. trade in services has grown by sixty-three per cent. As a result, for the three years between 1979 and 1981, the U.S. services trade surplus more than offset our deficit in the merchandise account.

But the service boom is not limited to the United States. Since 1977, Canada's service trade has doubled. By 1982, it represented more than a fifth of your total trade. Many people know that the United States is the world's largest producer and trader in services. Not many know that Canada is the sixth largest producer of services as a percentage of GNP, and ranks fifteenth among the world's services traders. Furtber, the volume of service transactions in our two countries has been growing at the same rate internationally as domestically. In fact, service trade would have probably outstripped domestic service growth if it were not for protectionist barriers overseas.

Protectionism in services has exploded in recent years, in large part because services have remained outside the multilateral trading system institutionalized in GATT. Barriers to service come in all shapes and sizes. They can be overt such as subsidized loans to national shipping firms and import quotas on foreign films. They can be less obvious - as when government prohibits a foreign accounting firm from using its international name. They can be blatantly protectionist - like the discriminatory and punitive landing fees that some governments impose on foreign air carriers.

Today, thanks to your initiatives and ours, we have an unprecedented opportunity to change this trend. Our joint commitment to liberal trade makes it possible for our two nations to do something that no two nations have ever done - reach a meaningful agreement on trade services.

... Our joint commitment to liberal trade makes it possible for our two nations to ... reach a meaningful agreement on trade services ...

As Mr. F razee has suggested, traded computer services are a logical and important place to start. Just about every nation has identified the new information technologies as the key to long-term economic growth. But there has been a growing tendency to impose barriers to trade in computer-related goods and services. I also share Mr. Frazee's view that traded computer service is a relatively known quantity in the murky world of services, and that the chances for some kind of workable agreement are better than average.

However, I also believe that such an agreement - precedent-shattering though it may be - is only a beginning in solving the broader and more serious problems that beset trade in services. For this reason, I urge that any negotiations also touch on areas where the issues are more difficult, but where the need for agreement is equally great.

... two areas deserve particular attention ... First is the right to market access ... second is the right of foreign firms to receive the same treatment as their domestic competitors ...

In my view, two areas deserve particular attention. The first is the right to market access. This closely relates to the right of establishment and the impediments to foreign investment. The second is the right of foreign firms to receive the same treatment as their domestic competitors once they enter a market. Infringement on the right of a business to open its doors in a foreign market is the biggest barrier to the growth of a healthy world service economy. In the name of selfinterest, any number of countries have adopted a wide range of exclusionary policies. Your government has moved quickly and forcefully to address this issue. We applaud the recent loosening up of the Foreign Investment Review Agency, and its rechristening as Investment Canada. It reflects your goal of closer economic relations with the United States and other nations and a commitment to a more open marketplace.

... governments can discriminate against service businesses in ways that are clearlyprohibited ...

The second major problem area is national treatment - the right of foreign businesses to compete in a market on the same basis as local firms. Right now, in the absence of any international agreement, governments can discriminate against service businesses in ways that are clearly prohibited in the agreements that govern trade in goods. For example, consider my own industry, insurance. In many countries foreign insurers must make deposits of assets that are not required of domestic insurers - in institutions that the government specifies. In others, foreign insurers pay taxes on premium income, while domestic companies pay their taxes on profits.

The problem is big and growing. In 1977, one out of every seven U.S. non-bank overseas affiliates faced barriers of one kind or another. Nor is the United States alone. Overseas affiliates from other developed countries face similar obstacles as well. Unless something changes, these barriers can only widen the gulf between rich and poor nations, and add to the frictions that already are straining international relationships in trade.

That is why I urge our two nations to start laying the groundwork for a broader agreement on services. It is fitting that the world's two great trading partners should be the first to conclude such an agreement. The United States has argued in favour of negotiated rules on services for years. Future economic growth between our countries, and indeed the world, will in great part be fueled by service economies. We need international rules now.

The appreciation of the audience was expressed by Col. R.H. Hilborn, a Past President of the Club.