EconSouth (Second Quarter 2007)

During the past four decades, international trade has grown from a relatively insignificant slice to nearly a third of U.S. domestic economic activity. To cater to the global economy's palate, U.S. manufacturers and service industries have specialized and become more efficient in producing goods and services that suit the international menu.

Most goods today are not entirely produced domestically; instead, production has been scattered around the world to gain maximum efficiency.

From T-shirts and sneakers to cars and computers, many of the everyday goods that Americans consume are no longer "made in the USA" but are imported. In 2006 alone, the United States imported $2.2 trillion worth of goods and services.

The U.S. external sector—the sum of all imported and exported goods and services—is currently equivalent to 30 percent of overall domestic economic activity, or gross domestic product (GDP). Just four decades ago, however, the share of foreign trade represented a mere 10 percent of GDP. To grow as a share of GDP during the past 40 years of significant U.S. economic prosperity, the external sector had to expand more than the overall economy did. Imports, increasing at an average rate of nearly 11 percent each year, led the external-sector expansion, while exports grew at an average rate of more than 9 percent per year.

In addition, U.S. goods-producing industries have become increasingly more dependent on international markets. Almost two-fifth of the revenues earned by U.S. manufacturers now come from sales abroad compared with less than 15 percent 40 years ago.

How did international trade become such a large, important component of the U.S. economy? The answer is straightforward: As the world became much more integrated through commerce and finance, the U.S. economy adapted and specialized in the production of certain goods and services. In turn, the economic forces that prompted the expansion of the external sector also changed the country's underlying production and consumption patterns.

To understand these changes, it helps to divide imports and exports of goods and services into categories and study the categories' evolution (see the sidebar). Understanding this evolution illustrates how the U.S. economy has allocated its resources, and these allocation patterns, in turn, demonstrate how the U.S. economy has become more specialized during the past 40 years.

The recipe for export growth
From 1967 to 2006, the export of services, expanding at an average pace of 10 percent per year, has led U.S. export growth. As table 1 shows, nearly a third of U.S. total export revenues now come from the export of services, such as financial services, telecommunications, and management and consulting services.

The United States has an especially large trade surplus in financial services because U.S. firms are major providers of banking, investment, and insurance services to the world. This trend is not surprising since, over the past several decades, the world's most developed economies (and the biggest U.S. trading partners) have increased their consumption of services while spending a smaller share of their income on physical goods. To meet this rising demand, the United States has become a major supplier of high value-added services.

At the same time, the United States has significantly increased its exports of capital goods, becoming increasingly efficient at producing these goods and allocating a greater share of resources to that production. During the second half of the 1990s, when massive investments were made in technological equipment and scientific innovations, capital goods exports reached a record high, representing nearly a third of all U.S. export revenues (see table 1). Over the past 15 years, semiconductors, computers, telecommunication equipment, and industrial machines have been the main drivers of U.S. capital goods export growth. Much of the demand for these items has come from developing economies. Since 1990, China has moved from 20th to third place, behind only Canada and Mexico, as a major importer of U.S. machinery and transport equipment.

Consumer goods have also been a consistent contributor to growth in U.S. export revenues. Table 1 shows that, as a share of total exports, consumer goods doubled from less than 5 percent four decades ago to almost 9 percent in 2006. More recently, U.S. exporters have enjoyed strong global demand for toys (including game software) and pharmaceutical goods. U.S. revenues from pharmaceutical exports increased fivefold since 1991 to almost $31 billion in 2006.

Stocking up on imports
Consumer goods and capital goods categories have also significantly increased their shares as a percentage of total U.S. imports since 1967. Currently, the two categories each account for approximately 20 percent of all U.S. import payments (see table 2). As with exports, most of the growth in capital goods imports has come from high-tech products, with one-third of them being purchased from China and another 30 percent from Mexico, Malaysia, and Japan.

The fact that the United States both exports and imports substantial amounts of capital goods (equipment used for production purposes) points to the degree of specialization that has occurred in the United States and the rest of the world's economies. Very often these capital goods sales are part of intrafirm trade, managed almost entirely within a single multinational corporation. According to recent Federal Reserve estimates, intrafirm trade accounts for 40 percent of total U.S. international merchandise trade.

Most goods today are not entirely produced domestically; instead, production has been scattered around the world to gain maximum efficiency. U.S. exports thus have some foreign components, and some components of goods the United States imports have been produced domestically. The International Monetary Fund estimates that the share of U.S.-made components making up U.S. imports is approximately 30 percent. On the export side, in many U.S.-made capital goods, such as electrical industrial equipment, machinery, and computers, imported components are estimated to make up at least 20 percent of the final goods.

Among consumer goods imports, pharmaceuticals has been the fastest-growing category. Imports of pharmaceuticals, which now represent about 3.5 percent of all U.S. goods imports, increased by more than 1,500 percent in the past 15 years and amounted to almost $65 billion in 2006—more than the total value of U.S. agricultural imports. A quarter of those imports come from Ireland, which is the top overseas location for U.S. pharmaceutical companies.

In addition to consumer and capital goods, petroleum products have always represented a considerable dollar portion of U.S. imports. In the 1970s, U.S. import payments to foreigners jumped 20 percent, with petroleum imports accounting for more than two-fifths of that growth. This surge was the result of the oil shocks of 1973 and 1979, when geopolitical crises in the Middle East pushed oil prices higher. Both prices and imports of crude oil stabilized in the mid-1980s through the 1990s, but spending on oil has increased considerably in the past four years. Petroleum products now account for about 15 percent of total U.S. import costs, with Canada, Mexico, and Saudi Arabia being the biggest U.S. suppliers.

Made to order
Not surprisingly, since international trade has become an increasingly important component of the U.S. economy, much of what is produced nowadays in the United States is targeted for sale outside the country. As the chart shows, while exported goods as a share of GDP nearly doubled in the past four decades to over 7 percent, exports of goods as a share of goods production more than tripled to almost 40 percent.

U.S Goods Exports as a Percentage of GDP and Private Goods Production Source: U.S. Bureau of Economic Analysis data from Haver Analytics

Exports' share of domestic production varies by category. For instance, the United States exports approximately 60 percent of civilian aircraft, 40 percent of telecommunication equipment, 25 percent of household appliances, and 20 percent of motor vehicles and parts. The value of exports relative to overall domestic production may be somewhat overestimated, however, because some exported goods are made with imported components.

Exports of services as a share of private services production have nearly doubled in the past 40 years but remain relatively low at less than 5 percent. While the service sector has expanded rapidly in the United States, significant regulatory barriers abroad limit U.S. companies' ability to compete with domestic firms overseas even though the United States has a global competitive advantage in many service industries.

Growing global
Most of the growth in U.S. export revenues in the past 40 years has come from exports of services, capital goods, and consumer goods, while imports of petroleum products as well as consumer and capital goods have driven increases in U.S. import payments. By increasingly specializing in producing goods and services in which it has a comparative advantage, the U.S. economy has increased its commerce with foreign nations and redirected part of its production efforts to service overseas demand. In doing so, the United States has become a much more integrated constituent of today's world economy.

This article was written by Galina Alexeenko, a senior economic analyst, and Diego Vilán, an economist, both in the regional section of the Atlanta Fed's research department.