U.S. Trade Policy and Small Business

Lael Brainard
Lael Brainard National Economic Advisor - National Economic Council

June 13, 2007

Chairwoman Velázquez, Representative Chabot, members of the Committee, I appreciate the opportunity to testify before the House Committee on Small Business today on the subject of U.S. Trade Policy and Small Business.

The New Wave of Globalization

Our economy is undergoing a profound transformation. Although the individual elements feel familiar, the combined contours are unprecedented — in scope, speed and scale.

China is successfully pursuing a growth strategy that is export-led and foreign direct investment fed — at a scale that has never been seen before. As a result, its rise is sending waves to the farthest reaches of the global economy — swelling the coffers of resource producers and becoming deeply embedded in global manufacturing supply chains. No economy has been left untouched.

India’s concurrent economic emergence has greatly added to the scale and scope of the new wave of globalization. While India has pursued a growth strategy more reliant on domestic consumption and investment than China, nonetheless its success in exporting higher skilled “knowledge” services, such as software programming has led to a stunning expansion of the scope of globalization.

Many American businesses large and small are thriving on the new opportunities created by breathtaking growth of more than 9 percent for the two most populous nations in the world — along with strong growth in other developing economies around the world — and the entry of hundreds of millions of consumers into the middle class.

But other American businesses are confronting foreign competition at an intensity and scale they have never experienced before. They are faced with the choice of moving over or moving up the value chain, concentrating on functions such as R&D or marketing that have unique advantages here, or diversifying their geographic base. In addition, many businesses in the services sector are confronting the reality of low wage foreign competition for the first time, and that number will grow substantially over the next decade.

While it may feel familiar, the current episode of global integration dwarfs previous episodes. An economy with a labor force of 1.7 billion has been abruptly confronted with absorbing a labor force of 1.2 billion –with wages as much as 90 percent lower. The entry of India and China amounts to a 70 percent expansion of the global labor force. That is more than three times bigger than the globalization challenge of the 1970s and 80s associated with the sequential advances of Japan, South Korea, and the other Asian tigers.

Textbook economics would predict a squeeze on wage earners until capital and technology investments adjust. Indeed, the data suggests inequality is once again on the rise in many of the world’s richer economies. In the United States, profits are capturing a larger share of income and wages are capturing a lower share than at any time in the last 50 years.

The Role of Small Business in a Global Economy

As the most dynamic and flexible stratum of the economy, small business is on the front lines of this new wave of globalization. As a microcosm of the overall economy, there is enormous diversity within this group of businesses. Many small businesses are encountering unprecedented growth opportunities associated with the new wave of globalization and are rapidly integrating into global supply chains. Meanwhile, others are struggling to compete with low wage foreign competitors for the first time.

The old product life cycle model predicted that businesses would first grow and mature in their own markets before moving overseas. But this linear model no longer fits the high tech, high speed, highly global economy of today. It should come as no surprise that many entrepreneurs are identifying new markets overseas early in their growth and quickly moving to explore them. It is well known to this committee that small businesses account for 97 percent of all exporters and nearly a third of total U.S. export value. In the wake of NAFTA, Mexico and Canada became the top two markets for small business exporters in value terms. Now we are seeing record numbers of U.S. small and medium enterprises (SMEs) making forays into China’s market with the result that China is now the highest growth market for SME export transactions.

Because they are so often on the front lines of globalization — both in taking advantage of opportunities and in facing adjustment pressures — small businesses have a disproportionate stake in the policies affecting globalization. But by the same token, small businesses face higher transactions costs relative to their size as they venture abroad and as they seek to influence the policy environment in comparison with large companies and especially multinationals.

On the export opportunity side, small business has an enormous stake in the establishment of transparent trade and investment rules — and in their enforcement. Most small businesses simply do not have the scale or resources of the major multinationals to spend long months and even years identifying and getting to know the foreign officials who have bureaucratic jurisdiction over their exports and investments. Nor do they have the internal resources to study the minutiae of widely varying trade and investment provisions for each new market. As such, small businesses have a disproportionate interest in the establishment of a clear rules-based system with clear enforcement of intellectual property rights, nondiscriminatory standards, predictable customs procedures, and accessible distribution channels whether direct or electronic. They also benefit from easily accessible export promotion services when contemplating opportunities in unfamiliar markets.

Similarly, when an unanticipated surge of foreign competition causes injury to domestic producers and their employees, small businesses may have less internal wherewithal to cushion the blow, so that government remedies and adjustment programs become all the more important. But it may be difficult for small businesses to secure relief in a timely and effective manner if the eligibility process is time-consuming and daunting and there are high transactions costs to establish industry-wide injury, for example.

Wherever small businesses find themselves on the spectrum of opportunity and adjustment, it is important to emphasize that the vibrancy of our small business sector will remain a key comparative advantage for the United States in the global marketplace. Rates of entrepreneurship remain significantly higher in the United States than in other advanced economies — and this is especially true for so-called “high expectation” entrepreneurship. America’s sophisticated financial markets remain unequalled globally in providing risk capital to high-growth potential entrepreneurs. The ease of starting up and expanding a business are enormous advantages that are now recognized the world over through the annual publication of the World Bank’s Doing Business report. So as we think about how to help America’s small businesses thrive and adapt in an increasingly competitive marketplace, it is important to start from the foundation of ensuring a favorable environment here at home.

Helping Small Business Compete Effectively

Maintaining America’s preeminence in the global economy while supporting rising living standards and easing adjustment to the bracing winds of global commerce requires a seamless web of forward-looking policies — not a patchwork of uncoordinated policies that address yesterday’s challenges. While the key elements of an effective national competitiveness strategy are likely to be the same for businesses of all size, programs within each pillar must be tailored to address the special challenges and strengths of small businesses. A truly effective set of policies would include three pillars:

  1. Investments in Competitiveness

    Investments in 21st century education, innovation, and infrastructure will be critical to ensure that America remains the most attractive economy in the world to produce high-value goods and services. On innovation, this means increasing funding for basic R&D and prizes to reward innovation, sustaining a well-designed tax credit for innovative activity, and allocating research funding against national challenges, such as energy and climate security. It means strengthening programs like the NIST Manufacturing Extension Program, which supports the competitiveness of U.S. based manufacturing by helping small businesses incorporate new technology and best practices. It also means improving broadband access. These measures are particularly critical to those small businesses whose core strength is as innovation incubators.

    On education, it means improving the teaching of science and engineering and making these fields more attractive to students through fellowships and industry linkages. While America will never win at the numbers game, we can do a better job of systematically emphasizing innovation and problem solving in our educational system mdash; skills where America must continue to excel in order to remain at the commanding heights of the world economy. It also means improving America’s attractiveness in an increasingly competitive worldwide market for talent. Finally, attention must extend to lifelong learning so that American workers can upgrade their skills as frequently as they are likely to change jobs.

  2. Strong International Rules

    Small business more than any other segment depends centrally on the negotiation and enforcement of strong, transparent international rules to compete effectively in foreign markets. U.S trade policy can benefit small business not just by securing lower tariff and nondiscriminatory standards across services, agriculture, and manufacturing but also by working towards customs procedures that are predictable, fair, and not unduly burdensome, and improving intellectual property enforcement. It is also critical that the U.S. work actively to prevent sustained exchange rate misalignments, such as the undervaluation of the Chinese yuan.

    While small business as a group may have disproportionately high interests in the enforcement of strong trade rules, it is difficult for small businesses to actively monitor and seek to influence the priorities of our negotiators. The special consideration that this committee has asked the agencies responsible for trade negotiations, export promotion, and trade remedies to give small business is thus entirely appropriate. The special financing provisions that are available to small business through ExIm, OPIC, and SBA are also critical to help small businesses with more limited financing options penetrate foreign markets.

  3. Adjustment Assistance

    For small businesses and their workers who find themselves on the front lines of the new wave of globalization, strong adjustment programs are critical. Improving Trade Adjustment Assistance (TAA) to better meet the needs of small businesses and their employees calls for making the time consuming and excessively burdensome eligibility determinations faster and more automatic — triggered for instance by sector-wide adjustment — and tied to globalization broadly, not just trade agreements. Some of the changes under consideration in the context of TAA reauthorization this year have important implications for small business. Given the importance of small business in the services sector and as suppliers to large companies competing in the global marketplace, it is critical to extend the coverage of TAA to the services sector and make the provisions for secondary impact more effective. Improving TAA for firms so that adjustment policies are proactive and forward-looking is also critical for helping small businesses to adapt and survive, as are rapid response programs for community adjustment. TAA benefits should be flexible so that starting a small business becomes a viable option for more dislocated workers. Finally, TAA should be strengthened to provide for affordable health insurance during transitions and a flexible combination of income support during periods out of work, wage insurance to cushion against significant wage losses during reemployment, and training opportunities that are flexible, accessible and attuned to the marketplace.

    As we navigate the turbulent waters of this new era of intensified globalization, America’s vibrant small business sector will remain a critical comparative advantage. Many of America’s small businesses will thrive as they take advantage of exciting opportunities in foreign markets, while many others will face challenges as they confront competition from lower wage economies. Execution of a strong national competitiveness strategy built on the pillars of innovation investments, trade and currency rules, and adjustment assistance will be critically important for the small business sector. It is important for policymakers to make sure the small business community is heard in the design of these policies and special emphasis is placed on ensuring programs are accessible.