"With a little help from our friend". (Focus on the Economy).

The previous three columns in this series looked at the contribution of the consumer, government, and private investment to the growth of the U.S. economy. There is one other very important element to consider, and that is the relation of the domestic economy to the rest of the world. As globalization has become more and more of a force during the past two decades, the linkages between nations has become tighter and, for good or ill, it is virtually impossible to separate any local economy--even down to the level of individual cities--from trends that are afoot on the far side of the world.

Of course, it is quite apposite to treat this subject in an edition of Real Estate Issues that is devoted to Global Cities in an Era of Change. Americans are so used to the international influence in the economy that it is almost totally transparent. We grew up with Bayer aspirin. We drive Toyotas or BMWs. We watched Monty Python on our Sony TVs. We've gotten used to eating Chiquita bananas and other tropical fruit on a year-round basis. At happy hour, there's whisky from Scotland, vodka from Russia or Finland, wine from Italy, France, or even Australia. Shoes from Italy; watches from Switzerland; cheese from Holland; movies from Bollywood. The computer that this article is being composed on came stamped "Made in Malaysia" even though, dude, it's a Dell!

Real estate, though often thought of as the most local of industries, has gone global as well (as the articles throughout this edition of REI amply demonstrate). Investors like Lend Lease, the Grosvenor Estate, TMW, RFR, GSIC, and Henderson Global Investors own substantial holdings of U.S. commercial property More and more, financing is accomplished through entities like HSBC, Hypo-Vereinsbank, ING, and Caisse de Depot de Quebec. Capital, even more than goods, flows freely across borders in the contemporary economy. This affects price and terms, usually by driving the market to the most efficient and lowest cost source of funds.

Conventionally, there is a lot of hand-wringing about the impact of world trade on the U.S. economy. Every quarter the Department of Commerce international trade numbers spark a round of editorializing about the ballooning trade deficit, which was $427 billion in the merchandise sector for 2001 and looks like it will wind up at an even larger number in 2002, based on three quarters of data. The trade deficit, by definition, is a negative influence on GDP since it means we are consuming goods made elsewhere (i.e., not produced here--that's the "DP" in "GDP") and by extension sending U.S. dollars to our trading partners. Commentators keep saying "this can't go on forever" and, of course, they are right. But the ebbs and flows of the trade balance are just part of the picture, and the adjustment in its level depends upon many factors, including growth elsewhere in the world, the value of the dollar, savings rates that vary widely from country to country, and even the age-structure of national populations and oth er demographic features.

A few items seem worth mentioning. First, the trade deficit has to be put into the perspective of a U.S. economy that has grown above $10 trillion in size and that has been sustaining growth--with the exception of the recession period that saw contraction from the second to fourth quarter of 2001--since 1991: the exact period of the weakening trade figures. Second, in many ways the overall trade deficit disguises sectors of comparative strength and weakness that are very important to many U.S. economic regions. For instance, while we run substantial deficits in energy, automobiles, and most consumer goods, we are in trade surplus in agricultural and food products, and in capital goods: chiefly aircraft, semiconductors, industrial machinery, sophisticated instruments, and medical equipment.

Third, from a real estate perspective the usual calculation of the trade deficit (exports minus imports) is fairly irrelevant. Demand for U.S. industrial space is more influenced by a figure rarely publicized: total trade (exports plus imports), because whether goods are coming into or going out of the country, they have to pass through the warehousing and distribution system. As Graph 1 shows, the trend in total trade has been rising steeply for a long time. And fourth, a trade surplus is not a guarantee or even a reliable sign of prosperity. Japan has been running large trade surpluses for the past decade, even as its economy has stagnated and its financial system brought to the brink of collapse.

The other side of the international transaction picture is capital investment. This has also been growing spectacularly for the past two decades, and in both directions. Foreign direct investment in the United States (FDIUS) has grown more than tenfold since 1982, while U.S. direct investment abroad (USDIA) has sextupled over the same period (see Graph 2). Direct investment flows consist of equity capital, debt including loans by parents to affiliate companies (or vice-versa), trade accounts, and reinvested earnings. Especially in the period of exceptional growth enjoyed by the United States in the late 1990s, tremendous volumes of foreign direct investment capital were attracted to the U.S., with Western Europe the principal source of new funds (especially Germany and the Netherlands, with Switzerland also high on the list due to debt structuring by Swiss-based multinational companies).

Perhaps more than any other figure, the capital accounts on direct investment illustrate how tightly bound together the world economy is. Real estate has witnessed the degree to which cross-border investors compare the risk-reward profile of alternative acquisitions. It is not an accident that, as world stock markets have suffered, the volume of capital being directed into U.S. commercial property by foreigners has noticeably increased.

Much more could be said, though the limits of space constrain discussion in this column. For example, deflationary pressures overseas (particularly in Asia) have helped keep U.S. consumer prices down, thus supporting the Fed's efforts to stimulate our domestic economy by dropping interest rates to historically low levels. At the same time, the U.S. dollar has been kept very high (limiting our export potential) and it is likely that we will see downward pressure on the dollar in the coming year or so. This is not such a bad thing, despite the Bush Administration's dogmatic faith in keeping the currency high. After all, it was the G-7 Plaza Accord of 1985 that restored U.S. competitiveness on world markets by lowering the dollar that set the stage for our excellent economic performance thereafter.

In short, we are intimately networked with the rest of the world. U.S. economic policy (to the degree such a thing can be said to exist right now) cannot be set on purely domestic terms, and analyses of our economy must always keep an eye to the international influences on trends and the global ramifications of decisions. Real estate professionals, too, must be acutely aware of what is happening behind changes in the demand for space and in the capital market for our products.

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Hugh F. Kelly, CRE, is the principal of an independent counseling practice, specializing in applied real estate economics for clients with domestic and international commercial property interests. Kelly is based in Brooklyn, NY, and is well known as a writer and public speaker. Formerly, he was chief economist for Landauer Realty Group and author of the Landauer Forecast from 1986 to 2000. Kelly was a 2000 national vice president of The Counselors of Real Estate, chair of its New York Metropolitan Chapter in 1999 and 2000, and editor in chief of "The Counselor" newsletter from 1997-1999. (Email: hughkelly@hotmail.com)