Challenges and Opportunities in a Global Economy: Perspectives on Outsourcing, Exchange Rates, and Free Trade: A Summary of the 2004 Philadelphia Fed Policy Forum

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"Challenges and Opportunities in a Global Economy: Perspectives on Outsourcing, Exchange Rates, and Free Trade" was the topic of our fourth annual Philadelphia Fed Policy Forum held on December 3, 2004. This event, sponsored by the Bank's Research Department, brought together a group of highly respected academics, policymakers, and market economists, for discussion and debate about the macroeconomic impact of developments in the global economy. Our hope is that the 2004 Policy Forum serves as a catalyst for both greater understanding and further research on policymaking in an increasingly global economy.

Over the past couple of years, the widening U.S. trade deficit and rising oil prices became front page news in discussions of U.S. economic performance. The longer-term impact of globalization on our labor markets and economic well-being became a discussion topic at cocktail parties and around dinner tables. The feeling that globalization was leading to the loss of U.S. jobs made some people even question whether free trade was as positive for the U.S. economy as economists know it to be. As world economies become more integrated, topics such as the macroeconomic effects of outsourcing, exchange rate policies and the flow of financial capital, and free trade and the cross-border flow of goods and services are garnering increased attention from policymakers and researchers. How best to seize the opportunities and meet the challenges of the global economy was the focus of the 2004 Philadelphia Fed Policy Forum.

Anthony M. Santomero, president of the Federal Reserve Bank of Philadelphia, began the day discussing the breadth and depth of the global economy's influence. The international marketplace is widening geographically, and the U.S.'s relationships with its traditional trading partners in North America and Europe, with Japan, and with the emerging markets of Asia are evolving.

In Santomero's view, developments in the global economy are transforming the basic structure of the economy, the issues policymakers need to address, and the questions researchers are studying. The revolution in information technology and the emergence of new market economies are opening up opportunities to reallocate production and distribution around the globe.

Yet, so far, the potential effects of this outsourcing on the U.S. economy have been difficult to quantify. Similarly, there is still much to learn about the distribution of the costs and benefits of free trade. An examination of the sharp decline in the value of the dollar during the mid-1980s suggests that a substantial relative price change causes an expansion or contraction of economic activity in well-established sectors but does not open up brand new areas of international trade. Declining trade barriers, however, bring more fundamental change to the economies affected. For example, as Timothy Kehoe discussed later in the day, the North American Free Trade Agreement (NAFTA) led to an increase in trade in goods and services that were traded only in limited quantities previously and accelerated the transfer of new technologies across borders. Santomero conjectures that one possible explanation for the difference in effects is that a change in tariffs is perceived as being more permanent than a change in exchange rates; hence, it elicits a larger response. He also posits another possible explanation: that changes in exchange rates affect relative prices across a broader array of goods and services and so evoke smaller adjustments across that broad array, while changes in tariffs affect a smaller number of goods and services and so have narrower but larger effects.

While opening up free trade brings participants an improved standard of living, it also creates dislocations and imposes cost on individual sectors within nations. As Santomero points out, free trade is beneficial provided the people and firms who gain from it are able to compensate the losers. …