Book Reviews

A blueprint for a benevolent hegemon

3. Fred Bergsten and others

The United States and the World Economy Foreign Economic Policy for the Next Decade

Institute for International Economics, Washington, D.C., 2005, 488 pp., $26.95 (cloth).

In these days of flourishing anti-globalization propaganda, it is heartening to read a book resolutely committed to multilateralism and free trade. In contrast with the protectionist opposition, the authors rely on serious analysis and persuasive empirical evidence. Their advice focuses on the national interest of the United States, but also gives warranted consideration to the needs and concerns of other countries. The title promises a blueprint for U.S. foreign economic policy for the next decade. And this it fully delivers.

Fred Bergsten identifies three important challenges in the short run: the large current account deficit, the energy problem, and trade liberalization. The preoccupation with the current account imbalance centers on the possibility of a "hard landing" adjustment involving rising U.S. inflation and interest rates and a precipitous decline in the dollar. A similar warning was issued in the first half of the 1990s, but the dangers predicted at that time did not materialize. The appreciation of the dollar was reversed later in the decade, the U.S. external position improved, and the feared "disorderly crash of the dollar" never happened. To some extent this mirrored the reduction of the U.S. budget deficit. As Bergsten and Michael Mussa rightly observe, fiscal deficits absorb national saving, boost U.S. interest rates, and attract foreign saving. This was true in the 1980s and is even more true today. Nevertheless, the argument that foreign capital inflows reflect the U.S. position as an attractive haven for foreign investors may still be relevant.

The solutions recommended by Mussa are inescapable. The United States must cut its budget deficit, and its major partners must increase domestic demand relative to output. Moreover, China and other Asian countries must stop intervention to maintain overvalued exchange rates-which is in violation of their international obligations-and contribute to the international adjustment process. Somewhat less convincing are Bergsten's calls for "exchange rate action," including coordinated intervention and possibly "target zones." Earlier attempts to fix exchange rates have been costly, and it does not seem logical to advocate nominal exchange rate rigidities for the now-floating advanced countries while condemning them in the case of China and other emerging market countries.

The second issue is the threat of rising fuel prices. Philip Verleger warns that current strains in world energy markets signal a "gathering storm" and require urgent action. The sources of these strains include the expansion of world demand stemming from the emergence of China and India as major importers, political instability in several producing countries, insufficient inventories, bottlenecks in transportation and refining, and insufficient conservation by consumers. The steep rise in fuel prices predicted by the author has already materialized and models project that further increases could seriously damage the U.S. economy.

Verleger supports the idea of a U.S. gasoline tax, matched by a cut in other domestic taxes, to achieve a substantial...