Correcting the original problem may involve structural change, the extent and direction of which is an empirical question, but hardly a paradigm shift.
The issues are:
● The nature of the inefficiency in current policy set-up and the extent of the adjustment that is likely to occur if that is corrected
● The policy issues in any transformation which occurs, which are not receiving sufficient attention and to which research across the region can make a contribution.
Scenario – a reorientation of output
Growth since the earlier Asian financial crisis (and earlier) is sometimes characterised as ‘export-led’. The growth strategy involved the accumulation of international reserves. Not only were exports growing quickly, but import growth was also slower, and domestic savings rates were high relative to domestic investment.
‘Export-led’ is a misnomer. An export-led strategy could be associated with similar growth of imports and higher levels of consumption which embody the gains from trade.
The concern in the current environment is the ‘excess’ level of net exports, mirrored by the excess of savings over investment. This led to the accumulation of reserves in East Asia, which were reinvested across the Pacific and which became part of the context in which the financial crisis in the United States became so large.
The proposal is to remove this excess, and to turn to domestic consumption and investment while domestic saving decreases, so that net exports would also fall with falling exports and rising imports.
The adjustment can be driven by changes of some form in the real exchange rate (including the removal of subsidies for exports as well as appreciation of the exchange rates which leads to a reallocation of resources to sectors not directly involved in world markets).
This is the normal process associated with growth leading to a real appreciation of the currency, which has not occurred so far.
An Asian adjustment implies a change in consumption patterns. Not only are more imports consumed relative to exports but also the relative size of the tradeables sector shrinks.
Economic aggregates, and also other indicators of the quality of life, would also be expected to change – such as the quality of health care and the provision of social security systems. This is associated with rising government expenditure.
Adjustment in the rest of the world has to make the changes in Asia ‘add up’ to meet the global constraint on the balance between savings and investment. At the same time as surpluses fall in Asia, they are expected to rise in the United States, where the pattern of adjustment is exactly the opposite – falling consumption, rising savings and a lower external deficit. Whether the US government is also going to play its part in this process remains to be seen.
How big?
The extent of the adjustment that would be required in this scenario is an important empirical question.
It may not be quite so big as to qualify for a paradigmatic shift status.
What might occur is a correction only of the part that refers to ‘excess’ saving. In that case, the actual outcome will be a combination of adjustment in these external positions but still with export (now equal to import) led growth which continues to capture the gains from trade.
To advocate more than this could very costly indeed, running real risks of losing significant gains from trade and the benefits of openness.
An adjustment in net exports will be associated with shifts in patterns of trade, within the region and across the Pacific, the detail of which is also a topic for empirical work.
It might involve for instance more rapid growth in trade in services as that sector expands, attracts capital inflow and in a second round of adjustments exports the outputs of the foreign-invested activities.
The adjustment will also vary between economies.
The consequence would not be a ‘decoupling’ of Asia from markets in the rest of the world.
How to adjust?
Arranging the correction even of ‘the tip’ may not be easy without other action. The ‘excess’ of saving is a response to the absence of other risk shifting devices. It reflects two things.
The first is household preferences over long term saving and the accumulation of reserves at household level to manage the chance of losing a job or other costs of shocks. In the absence of other forms of social security these incentives remain.
Second, it reflects national concern about exposure to risks of swings in capital flows. The experience of the Asian financial crisis, in the absence of other forms of risk management, encourages economies to accumulate reserves.
In the absence of other institutional arrangements at the national, regional or global level these incentives remain firmly in place.
Challenges in adjustment
Even with a low level of structural change, there are significant challenges in adjustment in the direction of rising consumption plus a shift out of traditional tradeables.
As already evident in recent experience, the ramping up of government expenditure is not straightforward. Cash transfers may be possible to increase but a long term manageable fiscal position depends on making investments which meet rate of return targets.
In many developing economies, while good projects exist in principle (in the infrastructure sector), their implementation is often more difficult.
This may be the case especially in emerging democracies. At a local level, with distribution of autonomy, government projects may be easier to implement. At a national level, with new channels of appeal against costs of adjustment to this structural change, there are often inhibitions to implementation. Indonesia provides examples of these processes.
This same challenge of finding efficient investment applies in the so-called non-tradeable sector, which is often characterised by lack of competition, regulatory issues and variety of distortions, including barriers to international investment and trade in many sub-sectors.
Larger changes in relative prices are required to shift resources. Large scale investment in distorted sectors is ‘immiserising’. Plans to reallocate resources should therefore be undertaken with care.
Meeting this challenge requires at least a policy stocktake, to capture the likely distortions to investment decisions, followed by a significant reform program. The best focus is one on introducing competition (including from but not only from foreign providers). This involves both trade and investment policy reform but also domestic regulatory reform.
The focus on the rebalancing is risky and needs to go exactly right. Otherwise we’ll open the gates to a debate that leads to a loss of the benefits of openness. But there is also the opportunity to use this context to reinvigorate interest in services sector reform.
Kuroda’s idea needs rigorous scrutiny in regional and international forums. What is risky becomes an opportunity if the debate is embedded in a discussion about principles for and commitments to policy reform.
Bottom line
There might be a wish to search for new sources of growth but the extent to which that needs to occur is an empirical question. Decoupling Asia from world markets is not plausible and to some extent genuine export (equal to import) led growth remains.
Correcting even ‘the tip’ exposes the challenges of domestic regulatory reform and in reform of trade and investment policy in the service sector.
There remains significant scope for gains from cooperation in the design and implementation of the relevant policy settings and institutions – domestic and international – as well as in research on the emerging scenarios and the extent of structural change that is actually involved.
The research support for this includes policy benchmarking in the service sector and suggestions on the design of and implementation of reform programs.
If this is what the ‘new paradigm’ is about, then it’s pointed in right direction.
But I’m afraid the new paradigm that is out there now hints of a return to the failed and inward-looking regionalist paradigm that has left Asia thinking about the wrong set of problems as the crisis unfolded.
The 18th General Meeting of the Pacific Economic Cooperation Council took place in Washington DC, May 12-13, 2009.
Paradox of Exports and policy overshooting by overreaction
Findlay’s article causes me to recall two well known phenomena: the paradox of thrift and exchange rates overshooting. Both have remarkable relevance to this topic. However, they have different implications.
Let me talk about the paradox of thrift first. It is generally there are many virtual merits for individuals to make some savings out of their earnings for future use in terms of retirement, emergencies and illnesses, or even to bequest their offsprings. It is even more so when hard times are expected ahead from every individual’s point of view. Here comes the paradox of thrift: when everyone is doing the same to increase their savings at the time of an economic downturn, the aggregate demand will fall even more, more people will be out of their jobs, and the economy will be depressed more severely. So it goes down the spiral and everything gets from bad to worse. Apparently virtuous behaviour at the individual level is aggregated and transformed to unexpected vicious thing!
That is the familiar story with the paradox of thrift. Krugman has talked about a number of paradoxes in the US existing during the current great recession (See “Falling Wage Syndrome”, http://www.nytimes.com/2009/05/04/opinion/04krugman.html?_r=1&em). It seems that we have got another paradox at the international/world level with individual countries in the place of individuals. This paradox is export paradox.
Over the decades, most main stream economists have advocated export orientation or export led growth as a recipe for success of developing economies. Many studies have also proven empirically that export is conducive to domestic growth, the higher the share of exports the higher the economic growth of the country. Governments from more advanced industrialised economies often called for the opening of developing economies and for them to look at the more broad international markets for development. Alas, we seemed finally to have got the success formula, or the holy grail of economic growth. Countries after countries have embarked on this road to success. To tell the truth, most of them including the more dynamic East Asian economies, have produced different degrees of success and some have almost caught up with their industrialised counterparts. That is a fact beyond questioning.
It has been said again and again that there are many advantages for export orientation. I will focus on only one aspect of them here. That is, the use of the much larger external markets as a reservoir to absorb the excess supply/outputs for an economy especially a developing one and to balance its domestic savings and investment “imbalance”.
It is obviously true that the world market at large has much larger capacity to absorb the excess of outputs of an individual economy. Even though there is a long lag of consumer recognition of the quality and value of the goods and services from a developing economy, it nevertheless can take the advantage of international trade and to specialise more on its comparative advantages to promote relatively rapid growth, higher than that in most industrialised economies. However, if such strategies are pursued by all developing countries and they all exhibit higher growth, collectively it will test the capacity of absorption from the industrialised countries for the excess supply in the developing economies. It may even get to a stage that external reservoir is full and has little extra capacity to absorb the excess supply of outputs from the developing economies hence including all individual ones.
So far that paradox has not really eventuated yet, though the actual situation may have approached very close to that point. Now the situation has, however, suddenly changed now. The world economy is in a great recession. Demand in some of the most advanced and largest economies has declined. International trade almost collapsed, with some countries’ exports in some months fell by almost 50 per cent. Countries that have relied more on export (more export oriented ones) are being hit especially hard. Japan, for example, has almost reached the degree of a depression in that its annualised growth of the past two quarters was more than negative 15 per cent. The recession has brought the paradox of exports into a reality.
One implication of this export paradox is that some of the thinking in the realm of export led growth may need to be recast a little. Rather than relying on industrialised countries as the main reservoir, other developing countries collectively can also be a reservoir, if many of the developing economies are having simultaneous rapid growth. Accompanied with this is likely the requirement of more explicit international cooperation and coordination to accommodate such growth and the need to “balance” the different savings and consumption/investment needs from different countries, developing and developed alike.
So much for the paradox of exports for now. Now let me talk a little about another rapidly emerging phenomenon, likely policy overshooting in addressing or over reactions to the current financial and economic problems. Findlay has just mentioned that Mr Haruhiko Kuroda, the president of the Asia Development Bank, called recently for a shift in development/growth paradigm. We have also heard many calls, including strong voices from some governments for much stronger regulations in banking and finance, derivatives and etc. This makes me to recall Rudi Dornbusch’s famous overshooting theory of exchange rates.
I will not indulge here into how the overshooting works, but only say that Dornbusch proved that it is that volatility in some markets was in fact a far more fundamental property than merely a consequence of imperfect information or market obstacles. Due to the sluggishness in the prices and adjustments in some markets, some other markets would have larger volatility, so in the currency markets, foreign exchange rates are likely to overshoot its equilibrium value in the initial processes.
What is the relevance of that overshooting to today’s topic here? While, I think it has enormous relevance, related to the general phenomenon that when one is faced with a deviation of something from its normal course or from its correct places, he/she tends to over correct it in his/her reactions desires to solve that first/initial problem, in the initial stage. This is exactly what many people have been saying and possibly doing over the past many months during the current world-wide financial crisis and the great recession. What frightens me the most is that the world authorities are likely to really overreact and over-tighten regulations to such a degree that it will be detrimental to the health of the world economy and welfare.
In that light, the calls for reduced reliance on exports, the call for balance of savings and consumptions between countries are some of such examples. Yes, there may be a need to adjust a little to address some of the long term problems. Yes, we have seen the pains of countries when their exports faltered as a result of shrinking external demand. But do we need to require that trade must be balanced year in and year out? Do we really need to balance savings country by country at every time? Do we really need to give up the benefit of trade to just avoid another possible down turn in external demand for our exports?
We need to take actions and to react to lift the world economy out of this great recession. We need to tighten some regulations or practices to prevent irresponsible behaviors in the context of externality. We need to consider how the international banking and financial system can be made more robust to withstand temporary difficulties. But we need and must do them in a very careful way. As Findlay argued, we should not “throw the baby out with the bathwater”, because there are some problems with the water.
It seems to me that many of the calls reflect the tendency to over react, some driven by ideologies as a revenge for other and opposing ideologies, some purely inexperience or immaturity.
We don’t need those. What we need is rationality, creativity and practical strategies and effective actions. We can’t afford to act blindly in solving current problems. We can’t be emotional. We need to be cool.
Haruhiko Kuroda is an interesting fellow. I was reading his reflections on his time at the Ministry of Finance recently (tsuka gaiko), which was published in 2003. In it he lays out his ideas, or thinking, about how the world economy works and, importantly, how he thinks the regional economy ought to work. The ideas that he is espousing as the President of the Asian Development Bank (ADB), such as about the importance of intra-regional trade to substitute for extra-regional exports, are very much based on his personal experiences at the Ministry, especially during the Asian Financial Crisis of 1997-8. While it is well enough known that Kuroda, as the protégée of Eisaku Sakakibara (aka Mr Yen, designer of failed Asian Monetary Fund) believes the yen is somehow under represented in the world/region, less well known is that his ideas about trade also possess an equally ‘regional’ flavoring. President Kuroda’s ideas, at least those that he presents in his reflections, are not merely reflected in this speech, but in his championing of FTAs at the ADB since becoming President. Anyhow, the book can now be bought second hand for 2 yen online, and there is at least 2 yen’s worth of value in the last section alone in which Kuroda attacks Moody’s for reducing Japan’s AAA rating.
Joel, your comments caused me to reflect on the term “interest groups”. It may appear to be a remote link, but I can’t help to see a shadow there. Intraregional or extra-regional trade, it should all be based on comparative advantages and changes in those advantages overtime. They should not be regulated or forced by some authorities according to their will, such as the ADB with little real accountability.
The blunders that the IMF made during the Asian financial crisis in the second half of the 1990s have been well known. Few people from IMF back then have been held accountable for the huge costs their mistakes caused to some Asian countries. One would hope that the ADB would learn from the IMF experience and avoid making similar mistakes.
This is a useful overview of the issues by Christopher, warning against a naive tendency to think that goverments can have a significant influence on the directions of trade.
International economic integration continues to be market driven.
While not disagreeing with the main thrust of these various comments, it also needs to be noted that there appears to be a serious problem of “domestic absorption” in quite a few developing countries in Asia. And it is unlikely that these problems will be solved by a readjustment of prices through forex movements alone.
Clearly, as Chris Findlay mentions, many poor countries need huge increases in investment in infrastructure. In PNG, for example, 90% of the households do not have access to electricity in their homes. Millions of people across the region lack access to basic water and sanitation supplies. And yet billions of dollars have been put into US Treasuries in recent years rather than into roads, power plants, and schools and hospitals in the region.
There appear be structural problems (legal, administrative, political) in spending money because government officials across the region routinely say that they have “difficulies in spending money.” Governments seem to find it very hard to prepare bankable projects in the infrastructure sector.
Whatever the precise structural problems involved in spending money are, it seems remarkable that governments in poor countries cannot work out ways to actually spend annual budgets.
It seems almost ridiculous that spending agencies across the region are having trouble spending money but apparently it is true. In recent years this has apparently become a signficiant bottleneck to development. Technical assistance — both to Treasury departments in the region and to spending agencies — is needed to unplug this particular bottle. And it would also help if the main multilateral development banks (MDBs) begain focusing on their traditional area of infrastructure again. The neglect by the MDBs of infrastructure since the early 1990s has done much harm. It is time for the MDBs to change their approach.