Global Economic Effects of the Asian Currency Devaluations (Policy Analyses in International Economics)

1 Introduction and Overview

Introduction On 11 May 1997 the Asian Development Bank released Emerging Asia: Changes and Challenges, a study extolling the virtues of the developing countries in Asia and predicting their continued ‘‘robust economic growth.’’ Less than two months later, on 2 July, Thailand abandoned its exchange rate peg to the dollar, igniting a financial turmoil that quickly spread throughout Southeast Asia. The following month the crisis hit South Korea, where on 27 August a high-ranking official of the Ministry of Finance and Economy (MFE) stated, at a Seoul press conference, that the Bank of Korea would defend its ‘‘Maginot Line’’ of 900 won to the US dollar. The Bank had the same success as the French army in 1940, and the level was soon breached. A wise man once observed that history repeats itself—appearing first as tragedy, then as farce—and on 17 November MFE officials solemnly announced that they would defend their new ‘‘Maginot Line’’ of 1,000 won to the US dollar. They spent billions of dollars trying, but the following day the level was once again breached as the Bank of Korea announced it was ‘‘temporarily’’ suspending its defense operations. During the final week of December, the won hit 1,950 to the dollar. By then stock markets throughout developing Asia had lost nearly half of their value within a year. During the 1990s, Asia has accounted for more than half of world growth, and an Asian slowdown arising from the financial crisis represents a major shock to the global economy, affecting both the global financial system and, through trade links, the performance of countries 1

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inside and outside the region. In this study we analyze the real adjustment induced by the real exchange rate and supply-side shocks arising from the financial turmoil of 1997-98. Our results indicate that the Asian financial crisis will significantly reduce real absorption throughout developing Asia and generate shifts in trade balances on the order of tens of billions of dollars as these countries attempt to export their way out of their crisis. This increase in net exports will be insufficient to offset fully the decline in absorption, and national incomes throughout developing Asia will fall.1 China thus far has remained relatively immune to the crisis according to our central estimate. It has had a real appreciation that could reduce its trade surplus by more than $12 billion, thereby complicating its process of economic restructuring. In this case we estimate that a real depreciation of 6 percent would be sufficient for China to reattain its precrisis competitiveness as defined by its precrisis trade balance.2 However, given the possibility that such a devaluation could ignite another round of financial turmoil, we recommend other policy responses. The changes in trade balances will reverberate across the world trading system. For the United States, the increase of the trade deficit associated with the crisis could be on the order of $40-50 billion—and even more in real terms.3 In absolute terms, the impact could be even larger in Western Europe, and, in percentage terms, Oceania could be hit even harder.4 Yet the consequences could be quite subtle: while net exports will fall in the developed countries, this decline will be offset by an income effect induced by the terms of trade improvement and increased capital inflow depressing domestic interest rates. While the traded-goods sector contracts, the nontraded sector will actually expand, and thus the overall consequence could be a wash. In the United States, the rise in trade imbalances will increase trade tensions with Asia, thereby increasing the likelihood of formal trade

1. In the interests of brevity we will paint with a broad brush: for our purposes ‘‘developing Asia’’ consists of South Korea, Malaysia, Thailand, Indonesia, and the Philippines. Singapore, Taiwan, Japan, and China have been affected by the crisis to a lesser extent and will appear in this narrative separately as relevant. Malaysia, Thailand, Indonesia, and the Philippines will often be referred to as the ASEAN-4. 2. Considerable uncertainty remains as to the ultimate magnitude and persistence of the financial shocks in Asia; in appendix C we present estimates based on alternative assumptions regarding developments elsewhere in Asia. Estimates of the impact on China’s trade balance range from $4 billion to $20 billion, and the associated real depreciations necessary to reestablish the status quo range from 2 to 10 percent. 3. Again, this is our central estimate. The sensitivity analyses reported in appendix C indicate that the effects of the crisis on the US trade balance could range from $15 billion to $75 billion. 4. These results contrast with statements made by EU monetary affairs officials who have discounted the effects of the Asian financial crisis. See the Financial Times (6 January 1998 and 8 January 1998). 2 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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actions against Asian countries. At the same time, the growing dependency of these Asian economies on the US market will increase the likelihood that they will comply with US demands.

Origins and Nature of the Crisis In this chapter, we make the following argument: 䡲 The Asian ‘‘miracle’’ was and is real. These are strong economies that have performed well—indeed, spectacularly—in the past, and there is every reason to expect them to perform well in the future. 䡲 The financial sectors in the Asian economies, however, did not evolve in parallel with economic performance. In most of these countries, the financial systems have major structural weaknesses—banks that are ‘‘captives’’ of major industries; extensive government involvement in investment allocation decisions; underdeveloped and underregulated stock markets; ‘‘crony capitalism’’ and corruption in bank operations; and a general lack of oversight and transparency in the workings of the financial system. These weaknesses are fundamental and would have, at some point, caused major problems, since they interfere with the ability of the financial system to serve its role as an effective intermediary between savers/investors and producers with profitable investment opportunities and needs for working capital. 䡲 The world capital markets overinvested in the Asian economies for a number of reasons. There were serious domestic problems in Japan, which led to major capital outflows. At the same time, US interest rates fell, making foreign investment more attractive. Exchange rates were favorable for investors. There is also a well-known herd mentality among institutional investors that leads them to behave similarly. Finally, the nature of the investment changed, moving to more shortterm, portfolio investments and away from long-term investments in productive capacity. 䡲 The financial institutions in Asia were not capable of effectively and productively intermediating this increased inflow of foreign investment. The increased flows served only to exacerbate the underlying structural weaknesses of these systems. 䡲 A crisis was inevitable. There was panic, and it was not just any panic. Although increasing liquidity is undoubtedly required, reestablishing confidence will require more than that. The Asian crisis is thus different from the Mexican crisis of 1994-95, which was largely a liquidity crisis. 䡲 Adjustment to the crisis will require significant changes over the medium to long run. Major reforms of the financial systems in most INTRODUCTION AND OVERVIEW 3

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of these countries must occur. There have been, and will continue to be, significant realignments of real exchange rates, which will persist. There have been, and there will be more, changes in real trade balances in these countries, which will affect their trading partners. All these changes will require years of adjustment, and these adjustments will reverberate throughout the world trading system. They will have significant consequences on the developed countries and will affect trade relations, and trade disputes, around the world. The Asian financial crisis took most observers by surprise, by its virulence, if not by its timing. A variety of explanations have been offered for the crisis after the fact. Our focus is on the impact of the crisis on real exchange rates, trade balances, and changes in the structure of production and trade in the medium run. We distinguish two views.5 The ‘‘fundamentalist’’ view of the crisis, most commonly associated with Krugman (1997, 1998a); Corsetti, Pesenti, and Roubini (1998); and Goldstein (1998), among others, holds that its origins lie in structural weaknesses in domestic financial institutions in the Asian countries. An alternative perspective, most often associated with Sachs (1997a, 1997b, 1997c) and Stiglitz (1997, 1998a, 1998b), stresses the expectational, ‘‘confidence,’’ or ‘‘panic’’ origins of the crisis. In fairness, for most observers this distinction is a matter of emphasis; few would completely discount the relevance of both ‘‘fundamentalist’’ and ‘‘panic’’ considerations.6 This distinction is important for our analysis of the real consequences of the crisis. If the crisis is essentially expectational in nature—a shortterm panic—then restoring confidence could lead to a reversal of the asset market declines and a relatively quick and painless return to the previous status quo, with only transitory implications for trade and production for either Asia or the rest of the world.7 If, however, the origins of the crisis lie more in flawed ‘‘fundamentalist’’ considerations then the shocks to 5. While Radelet and Sachs (1998) distinguish five intellectual perspectives on the crisis, for our purposes it is sufficient to consider only fundamentalist and panic explanations. 6. Sachs (1997c) probably comes the closest to purity, asserting that ‘‘There is no ‘fundamental’ reason for Asia’s financial calamity except financial panic itself.’’ Krugman (1998b), in contrast, states that ‘‘I believe that crony capitalism in general, and moral hazard in [domestic] banking in particular, created a ‘bubble economy’ that had to burst sooner or later. Yet it is hard to deny that there is a strong element of self-fulfilling panic in the Asian crisis.’’ 7. For example, Stiglitz (1998a) has written, ‘‘Restoring growth in East Asia requires restoring confidence. This is as much a matter of perception as of reality. . . .’’ Sachs (1997a) argued: ‘‘Fortunately, in Thailand and elsewhere, little real damage has yet occurred. With prudent adjustments, the large benefits of capital flows to the emerging markets can still be secured without the costs of unnecessary crises.’’ Writing about South Korea, he (Sachs 1997c) opines, ‘‘With appropriate confidence-building measures, [South] Korea could have probably got by with a modest slowdown in growth, no credit crunch, and a realistic time horizon of a few years to complete its needed financial reforms.’’ 4 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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these economies will be more persistent and have greater implications for economic adjustment over the medium to long run.8 While both sets of explanations certainly contain elements of truth, we believe that the existing evidence lends considerable credence to the ‘‘fundamentalist’’ view, suggesting that the crisis will have persistent real effects.

The Fundamentalist Story The starting point of this argument is that the crises that emerged in Asia, while originating in flawed financial systems, were unlike previous currency crises.9 Like the French generals of the 1930s preparing to refight World War I, observers tracked the predictors of the last crisis and missed the indicators of the one to come. For the most part, large budget and current account deficits that were central to most previous developingcountry currency crises were not in evidence. Nor was there widespread unemployment, which could have tempted monetary authorities to abandon an exchange rate peg or, alternatively, could have induced speculation in anticipation of such abandonment—as occurred in Europe. These were the ‘‘miracle’’ economies that had exhibited stellar performance for decades (World Bank 1993), though even as the miracle unfolded some of their financial practices were disconcerting to the cognoscenti. Some of the Asian countries were running sizable current account deficits, but they had been running deficits of similar magnitude for much of the 1980s (table 1.1) Below the surface, however, things had begun to change in 1995. Because the exchange rates of most developing Asian currencies were pegged—to a greater or lesser extent—to the US dollar, the dollar’s rise against the yen and major European currencies meant that the Asians were losing competitiveness in what were major export markets.10 Moreover, the Asian countries’ inflation rates, while low by developing-country standards, were higher than those of most developed countries. These two effects generated modest real effective exchange 8. McKibbin (1998) explores the empirical importance of this distinction, to which we will return in chapter 2. 9. See Krugman (1979), Flood and Garber (1984), and Obstfeld (1994). Corsetti, Pesenti, and Roubini (1998) have additional references. 10. During the 1990s, the Thai baht was fixed in a narrow range of 25.2 to 25.6 to the US dollar. The Malaysian ringgit was allowed a bit more flexibility, staying within a 10 percent band of 2.5 to 2.7 ringgit to the US dollar. The Philippine peso moved within a 15 percent band of 24 to 28 to the US dollar until 1995 when it was fixed at 26.2. Indonesia maintained a crawling peg, and the currency was allowed to depreciate in nominal terms from 1,900 rupiah to the US dollar in 1990 to 2,400 rupiah to the US dollar at the beginning of 1997. The South Korean won followed a controlled float, but was held within a narrow range of 770 to 800 won to the US dollar from early 1993 to mid-1996, when it was allowed to depreciate by about 10 percent. INTRODUCTION AND OVERVIEW 5

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Table 1.1 Current account deficits as a share of GDP, 1975-97 (percentages) China Hong Kong Indonesia Japan South Korea Malaysia Philippines Singapore Taiwan Thailand

1975-82

1983-89

1990

1991

1992

1993

1994

0.7 1.9 –1.2 0.4 –4.6 –2.0 –6.5 –8.8 1.6 –5.6

–1.0 8.3 –3.5 3.0 2.5 –0.7 –0.3 1.8 12.9 –3.2

3.4 8.9 –2.8 1.5 –0.9 –2.1 –6.1 8.3 6.7 –8.3

3.5 7.1 –3.4 2.0 –3.0 –8.8 –2.3 11.2 6.7 –7.7

1.5 5.7 –2.2 3.0 –1.5 –3.8 –1.6 11.3 3.8 –5.6

–2.7 7.4 –1.5 3.1 0.1 –4.8 –5.5 7.4 3.0 –5.0

1.4 1.6 –1.7 2.8 –1.2 –7.8 –4.6 17.1 2.6 –5.6

1995 0.2 –3.9 –3.3 2.2 –2.0 –10.0 –4.4 16.9 1.9 –8.0

Sources: International Financial Statistics, IMF; Taiwan Statistical Data Book, Taiwan, Republic of China (various issues).

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1996

1997

0.9 –1.3 –3.3 1.4 –4.9 –4.9 –4.7 15.0 5.2 –7.9

2.5 –1.5 –2.9 2.2 –2.9 –5.8 –4.5 14.0 4.2 –3.9

Figure 1.1A Thailand’s real exchange rate, January 1995January 1998

120

100

80

60

40

20

0 5/95 9/95 1/96 5/96 9/96 1/97 1/95 Source: JP Morgan real broad effective exchange rate indices.

5/97

9/97

1/98

Figure 1.1B Malaysia’s real exchange rate, January 1995January 1998 120

100

80

60

40

20

0 5/95 9/95 1/96 5/96 9/96 1/95 Source: JP Morgan real broad effective exchange rate indices.

1/97

5/97

9/97

1/98

rate appreciation (figures 1.1a-e). In 1996 export growth began to slow significantly. As competitiveness in the traded-goods sector eroded, the composition of capital inflows began to change. While much of the inflow in the 1980s had taken the form of foreign direct investment, the composition of the INTRODUCTION AND OVERVIEW 7

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Figure 1.1C The Philippines’ real exchange rate, January 1995January 1998

120

100

80

60

40

20

0 5/95 9/95 1/96 5/96 9/96 1/97 1/95 Source: JP Morgan real broad effective exchange rate indices.

5/97

9/97

1/98

Figure 1.1D Indonesia’s real exchange rate, January 1995January 1998 120

100

80

60

40

20

0 5/95 9/95 1/96 5/96 9/96 1/97 1/95 Source: JP Morgan real broad effective exchange rate indices.

5/97

9/97

1/98

capital inflow began shifting toward more liquid portfolio investment in the 1990s. The saving-investment balance corollary to the widening current account deficits was investment booms—with much of the investment concentrated in the nontraded sector. Indeed, much of it was concentrated in assets of relatively fixed supply such as land and real estate (table 1.2). 8 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure 1.1E South Korea’s real exchange rate, January 1995January 1998 120

100

80

60

40

20

0 5/95 9/95 1/96 5/96 9/96 1/97 1/95 Source: JP Morgan real broad effective exchange rate indices.

5/97

9/97

1/98

These investments were intermediated by local banks and nonbank financial institutions, in the widely held belief that governments would not allow these institutions to fail.11 Often using the very same land, real estate, and financial assets as collateral, financial institutions lent for property and stock market investments. This set up a self-reinforcing upward spiral—as financial institutions lent into these markets, the value of existing collateral increased, thereby permitting greater lending, which in turn drove asset prices higher. The existence of lower interest rates internationally, together with the existence of long-standing exchange rate pegs, encouraged financial institutions to borrow foreign exchange abroad, convert it into domestic currency, and lend it domestically— assuming the exchange risk. These reckless practices were facilitated by weak prudential supervision and a culture of cronyism. Such conditions are not indefinitely sustainable. Indeed, the list of real and financial shocks that could reverse such a process is nearly endless, with many possibilities evident from history. Once in reverse, the process feeds on itself: asset prices begin to fall, creating nonperforming loans and eroding the value of collateral. Lending then contracts, which reduces asset prices, creates more bad loans, and destroys more collateral. Foreign 11. For example, it was widely believed that no South Korean bank would be allowed to fail due to the state’s intimate involvement with the financial system; indeed, in October 1997, the Korean government nationalized a small bank rather than closing it. A similar argument could be made with respect to the ASEAN-4. This is an area in which ‘‘crony capitalism’’ may well have played an important role in certain economies. INTRODUCTION AND OVERVIEW 9

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Table 1.2 Banking system exposure to risk

South Korea Indonesia Malaysia Philippines Singapore Thailand Hong Kong

Property exposure

Collateral valuation

Nonperforming loans in 1997

Nonperforming loans in 1998

Capital ratio

15-25 25-30 30-40 15-20 34-40 30-40 40-55

80-100 80-100 80-100 70-80 70-80 80-100 50-70

16.0 11.0 7.5 5.5 2.0 15.0 1.5

22.5 20.0 15.0 7.0 3.5 25.0 3.0

6-10 8-10 8-14 15-18 18-22 6-10 15-20

na = not available. Note: Data for the first five columns are as a percentage of assets at the end of 1997. Data for the last column are as a percentage of deposits or assets for 1996. Sources: Data for the first five columns are from JP Morgan, Asia Financial Markets, January 1998 and Corsetti, Pesenti, and Roubini (1998, table 25). Data for the last column are from Goldstein and Turner (1996, table 5) .

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Five largest banks’ share of deposits or assets (percentage) 38 na 35 na 39 60 40

lending dries up, and as stock markets fall, net capital inflow turns negative as both residents and foreigners rush for the exits. This rush, in turn, puts pressure on the exchange rate peg. The conventional remedy is to raise interest rates, but given the fragile state of the domestic financial system, monetary authorities are forced to choose between maintaining the peg or maintaining the solvency of the domestic financial system. Paradoxically, a rise in the interest rate may well be seen as an indication of financial weakness, which would worsen rather than reduce capital flight. Inevitably, the peg is abandoned, and the currency collapses. For firms with significantly unhedged foreign currency debt, the exchange rate depreciation means insolvency, as the domestic resource cost of debt service skyrockets. Bankruptcies cascade through the financial system. The real and financial sectors contract, and inflation accelerates as the prices of imports increase.12 Eventually, resources shift into the exports sector as domestic producers respond to the depreciation (although the structural adjustment is hindered by lack of credit, which, in turn, has real effects on costs and production). The economy begins to export its way back to full employment, suitably defined, recognizing that part of the prior capital investment has been ‘‘wasted’’ and is unlikely ever to achieve expected returns on its installed value. The Asian financial crisis was a product of large capital inflows into deeply flawed financial sectors. Although the currency crises that occurred in the second half of 1997 were a by-product of domestic financial turbulence rather than a principal cause of the crisis, exchange rate misalignment played an important role in the story.

The Exchange Rate as a Transmission Mechanism Without going back to Genesis, one can trace the origins of the crisis to the exchange rate misalignments of the mid-1980s. In February 1985, the Japanese yen began a rapid appreciation against other currencies, particularly the US dollar. As the relative cost of production in Japan rose, Japanese firms responded by moving production offshore, mainly to Taiwan and South Korea, which raised concerns of a ‘‘hollowing out’’ of the Japanese industrial base. Economic growth slowed and the term endaka, or high-yen recession, entered the Japanese lexicon. To counteract this phenomenon, Japanese monetary authorities pursued a policy of aggressive monetary expansion, cutting the official discount rate to its then-historical low.13 12. The extent to which this inflation erodes the boost to competitiveness arising from the nominal exchange rate depreciation is an important issue that is discussed in chapter 2. 13. See Balassa and Noland (1988) for a more complete description of Japanese macroeconomic policy during this period. INTRODUCTION AND OVERVIEW 11

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Rapid monetary growth and low interest rates, together with a still appreciating currency, facilitated the creation of an asset market bubble and an outflow of capital. Between 1985 and 1989, the Japanese money supply grew by 48 percent, the price level fell by 11 percent, and the stock market rose by 158 percent. (Indeed, in the late 1980s, the Tokyo stock market had the largest capitalization of any market in the world.) Even larger price increases were experienced in land and real estate markets: Boone and Sachs (1989) calculated that in the late 1980s, the land under the Imperial Palace in Tokyo was worth as much as all of the land in California, all of the land in Canada, or all of the land, factories, and houses in Australia! At this time the currencies of Taiwan and South Korea were pegged to the US dollar. The real depreciation caused by yen appreciation, combined with the inflow of investment and technology from Japan, created ‘‘hypercompetitiveness’’ and emergent macroeconomic imbalances.14 Soon, Taiwan and South Korea were experiencing asset bubbles similar to Japan’s: between 1985 and 1989 in Taiwan the money supply increased 117 percent, the price level again fell by 9 percent, and the stock market rose a whopping 1,053 percent. During the same period in South Korea, the money supply increased by 105 percent, the price level rose by 3 percent, and the stock market went up by 458 percent. By 1989, the Taiwanese and Korean stock markets were sixth and ninth largest in the world, respectively. Eventually these economies came under both market and political pressure to revalue. As they did, this sparked a second iteration of the process, this time with billions of US dollars of capital flowing from Northeast Asia into Southeast Asia (Noland 1989, table 1.7). During this period China was making its transition from a centrally planned economy to a market economy, and emerging as a significant participant in regional and global markets. One of China’s policy goals was to develop the institutional mechanisms to reduce macroeconomic instability despite the relative dearth of tools for macroeconomic management. Another key characteristic of the Chinese economy was the growing importance of external trade and financial flows. Beginning in the early 1990s China began to slowly liberalize its foreign exchange regime to accommodate the needs of the increasing number of participants in foreign exchange transactions by establishing a swap market that operated in parallel to the central bank’s foreign exchange window. As the Chinese rate of inflation had been consistently higher than that of the United States (and its regional neighbors), China could either maintain its nominal peg to the US dollar and accept real exchange rate appreciation, or allow the nominal rate to depreciate to maintain real exchange

14. See Balassa and Williamson (1990) for details of Korean and Taiwanese macroeconomic performance during this period. 12 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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rate stability. In the absence of sufficient nominal depreciation, the official and swap market exchange rates increasingly diverged. On 1 January 1994 China unified its exchange rate by bringing the official rate into line with the swap market rate, and, indeed, some trace the origins of the current crisis to this action.15 At the time, the official rate of the renminbi (RMB) was at 5.8 RMB per US dollar versus the 8.7 RMB per dollar at the swap center. The official rate devaluation was nearly 50 percent. The conventional wisdom is that the fall of the renminbi implied a real exchange appreciation for the dollar pegged currencies in Southeast Asia, undercutting their export competitiveness both among themselves and in third markets. However, reality is a bit more complicated for at least three reasons. First, while it is true that the renminbi depreciated in nominal terms, China experienced higher inflation than its trade partners, thereby eroding its real depreciation.16 Second, these calculations are normally done with respect to the renminbi’s value against the US dollar. But for the most part, Chinese exports do not compete against US exports in third markets nor even with US domestic production in the US market.17 The relevant measure of export competitiveness is the real exchange rate defined relative to China’s export competitors and weighted by trade shares. Lastly, most analysts implicitly assume that all transactions occurred at the official rate. Yet there is evidence that prior to the unification of the exchange rate in 1994, a considerable share of transactions occurred at the swap rate.18 Depending on the relative weights one gives official and swap rate

15. For example, on 17 September 1997 the Financial Times editorialized that ‘‘A large part of China’s recent export success reflects the devaluation that occurred in January 1994,’’ that China continued to pursue ‘‘a cheap currency policy,’’ and that this was ‘‘one of the factors provoking the crisis in Southeast Asia.’’ Makin (1997, 2) wrote that ‘‘China’s preemptive devaluation in 1994 was the first of a number of events leading to acute problems in Asian countries that surfaced this year.’’ (In fairness, it should be added that Makin also mentions the reintroduction of fiscal incentives for exporters.) According to the 22 November 1997 issue of The Economist (p. 41), the Chinese devaluation of 1994 created an export boom that ‘‘may have laid the ground for some of Southeast Asia’s woes.’’ Corsetti, Pesenti, and Roubini (1998, 31) write that ‘‘The 50% nominal depreciation of the Chinese currency in 1994 led to a significant loss of competitiveness in the rest of the Asian countries.’’ Huh and Kasa (1997) provide evidence that average dollar wages in China declined in 1994 (but presumably rose thereafter). 16. China’s macroeconomic data, particularly its inflation data, are subject to considerable uncertainty. In the analysis below we accept the figures reported in the IMF International Financial Statistics at face value. See Noland (1997a) for a discussion of this issue. 17. See Noland (1998a) for an analysis of this issue. 18. According to IMF studies by Tseng et al. (1994) and Mehran et al. (1996), roughly 20 percent of the transactions took place at the official rate and 80 percent of the transactions took place in the swap market prior to the exchange rate unification. Although this is the conventional wisdom, we are unaware of any estimates derived from transaction volume INTRODUCTION AND OVERVIEW 13

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transactions, one can obtain considerably different indications of the path of the exchange rate. Table 1.3 reports export share weighted nominal and real effective exchange rates constructed from the export data of China’s major trading partners. Two things are immediately apparent: there are significant differences in the paths of the nominal and real exchange rate, and the relative weights assigned to the official and swap rates are important in assessing cumulative exchange rate movements since the early 1990s. If one assumes that all transactions occurred at the official rate, then both the nominal and real effective exchange rates have depreciated since the early 1990s (although the nominal rate has depreciated far more, much of the real depreciation has been eroded by China’s relatively high rate of inflation since 1995). As one increases the importance accorded to transactions at the swap rate prior to 1994, a very different story emerges, which suggests that there has been cumulative appreciation of the real exchange rate since the early 1990s. Indeed, there may even have been cumulative effective nominal appreciation over this period as well. Another study done by Fernald, Edison, and Loungani (1997) also reaches similar conclusions. This fact, together with tremendous uncertainty about the extent of relative productivity increases in China, makes it difficult to ascertain how close China’s current exchange rate is to a fundamental equilibrium rate. The bottom line is that although China has emerged as a major competitor in many of the specialized product markets to Southeast Asia, which may have put downward pressure on the relative prices of these goods to the detriment of the region, it is hard to argue that the 1994 unification of exchange markets was a decisive blow.19

Capital Inflows and Financial Fragility In the mid-1980s, the macroeconomic adjustment to the rapid real appreciation of the Japanese yen generated asset bubbles domestically and largescale capital outflows principally into South Korea and Taiwan. These large capital inflows contributed to a similar pattern of domestic asset bubbles, followed by large capital outflows, mostly destined for China and Southeast Asia.20 In Southeast Asia these inflows contributed to an data, and even such estimates would not necessarily indicate the correct marginal weights. The poor quality and unavailability of China’s data remain impediments to comprehensive understanding. 19. Noland (1998a) and Huh and Kasa (1997) provide some evidence on this point. Fernald, Edison, and Loungani (1997) show that the export growth rates of the ASEAN-4 did not slow after 1994 relative to their performance earlier in the decade. The argument that the Chinese exchange market unification was the trigger is even less plausible in the case of South Korea, where the product composition of output differs significantly from China’s. 20. These exchange rate issues are discussed more fully in chapter 2 in the context of modeling real exchange rate changes. 14 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table 1.3 China’s nominal and real effective exchange rate, 1990-97 1990 Assumption 1: 100 percent of transaction at official rate NEER REER Percentage of NEER depreciation (if minus, appreciation) Percentage of REER depreciation (if minus, appreciation)

100.05 100.05

Cumulative change from 1990

1991

1992

1993

1994

1995

1996

1997

112.79 117.72 12.74

119.21 124.23 5.69

126.83 118.96 6.39

194.70 153.71 53.51

194.64 136.62 –0.03

185.49 125.46 –4.70

171.45 115.89 –7.57

66.03

17.67

5.53

–4.24

29.21

–11.12

–8.17

–7.63

21.25

112.02 88.44 5.19

111.98 78.60 –0.03

106.72 72.18 –4.70

98.65 66.67 –7.57

–0.80

–11.46

–11.12

–8.17

–7.63

–37.99

117.57 92.82 9.00

117.53 82.50 –0.03

112.01 75.76 –4.70

103.53 69.98 –7.57

4.32

–8.26

–11.12

–8.17

–7.63

–33.48

130.49 103.02 17.52

130.45 91.57 –0.03

124.32 84.08 –4.70

114.91 77.67 –7.57

15.83

–1.09

–11.12

–8.17

–7.63

–23.31

Assumption 2: 10 percent of transaction at official rate and 90 percent at the swap rate NEER 100.05 102.00 104.15 106.49 REER 100.05 106.46 108.54 99.89 Percentage of NEER depreciation 1.96 2.10 2.25 (if minus, appreciation) Percentage of REER depreciation 6.41 1.95 –7.97 (if minus, appreciation) Assumption 3: 20 percent of transaction at official rate and 80 percent at the swap rate NEER 100.05 102.73 105.16 107.86 REER 100.05 107.22 109.59 101.17 Percentage of NEER depreciation 2.68 2.37 2.57 (if minus, appreciation) Percentage of REER depreciation 7.17 2.21 –7.69 (if minus, appreciation) Assumption 4: 40 percent of transaction at official rate and 60 percent at the swap rate 100.05 104.41 107.51 111.04 NEER REER 100.05 108.98 112.04 104.15 Percentage of NEER depreciation 4.37 2.97 3.28 (if minus, appreciation) 8.93 2.82 –7.05 Percentage of REER depreciation (if minus, appreciation) NEER = nominal effective exchange rate. REER = real effective exchange rate.

Note: Trade weights for 1996 and 1997 are from the year 1995 when data are available. Exchange rates are from the International Monetary Fund’s International Financial Statistics and the Financial Times (various issues).

Source: Authors’ calculation.

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Figure 1.2 Stock market capitalization, 1985-1996 Billions of US dollars 300

250

200

150 Thailand 100 Malaysia Philippines 50 Indonesia 0 1985 1986 1987 1988 1989 1990 Source: International Finance Corporation (IFC).

1991

1992

1993

1994

1995

1996

investment boom and widening current account deficits, but these were not alarming given the presumably productive and relatively illiquid nature of the investments. This investment boom represented a significant positive shock to these economies, contributing to asset price increases. This boom was also facilitated by liberalization of internal and external financial controls undertaken during this period.21 Stock markets rose (figure 1.2), and similar booms occurred in land and real estate. Increases in asset prices facilitated rapid expansion of domestic credit, as banks lent on the basis of rapidly appreciating stock, real estate, and land as collateral. However, as this process evolved, the composition of the capital inflows began to change, with financial capital (portfolio investment) accounting for an increasing share of capital inflow (table 1.4). Reliance on highly liquid ‘‘hot money’’ inflows leaves the domestic financial system vulnerable to either foreign interest rate spikes or domestic currency depreciation. This vulnerability may be particularly problematic if the domestic currency is pegged to a foreign currency such as the dollar, but in a crisis the peg is abandoned and the domestic currency depreciates. Such problems are exacerbated if there are mismatches in the term structure of borrowing and lending. In Asia, the scale of these mismatches was spectacular, with local institutions intermediating huge 21. See Noland (1989) and Dobson and Jacquet (1998) for a more detailed description of the liberalizations undertaken during this period. 16 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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foreign inflows, borrowing short and lending long (Corsetti, Pesenti, and Roubini 1998). Such a system is fragile and susceptible to a negative monetary shock. Once thrown into reverse, the economy will go into a self-reinforcing downward spiral as asset values, domestic lending, and real domestic activity contract.

The Trigger Having established the conditions for a financial meltdown, one still needs a triggering event. McKibbin (1998) argues that this was an increase in US interest rates in the spring of 1997. However, examination of the data INTRODUCTION AND OVERVIEW

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17

suggests that conditions in Asia were deteriorating before then. Export growth slowed dramatically in 1996 in part due to real exchange rate appreciation and as the growth rate of domestic absorption slowed in Japan. The result was widening current account deficits, which were financed by increasingly liquid forms of short-term capital inflow. At the same time, the Asian developing countries experienced significant negative terms-of-trade shocks as world prices of key exports began to fall. Among export commodities, tropical oils, rice, wood, and rubber all experienced significant US dollar price declines of about 20-40 percent in 1997. Prices also weakened for manufactured exports. The price of a 16MB dynamic random access memory (DRAM) chip fell from more than US$40 in January 1996 to less than US$10 by the end of 1997. The dollar export price index for South Korea’s electronic components fell by nearly 50 percent over the same period. Anecdotal evidence suggests significant price weakening for other key manufactured exports such as automobiles and ships, though the nature of these markets makes documentation difficult.22 As these terms-of-trade shocks hit, expectations of corporate earnings were downwardly revised, and stock markets began to fall. Nearly all of the stock markets in developing Asia fell by 50 percent in 1997, with the markets of Thailand, Malaysia, and the Philippines falling more or less steadily through 1997, while the markets of Indonesia and South Korea peaked in the first half of the year and fell dramatically through the second half. As can be seen in figures 1.3a-e, which plot stock market indices and indices of the nominal exchange rate, the declines in the stock market significantly preceded the depreciation of the currency in all cases. As the markets declined, investors in Southeast Asia began moving funds offshore in search of higher returns. Although foreign speculators are often blamed for the net capital outflow, anecdotal evidence suggests that in these crises (and in most currency crises) domestic residents led the way for the exits—they had better appreciation of domestic conditions, and with a greater share of their portfolios in domestic assets they had greater incentive to flee. In South Korea, capital controls prevented domestic investors from moving their money offshore, and the net capital outflow was manifested by reduced rollover rates by foreign banks’ creditors. Many of these were Japanese banks that had their own domestic problems. This net capital outflow drained official reserves in the countries with strictly pegged exchange rates and put downward pressure on the countries with limited floating, ultimately with the same result. Fixed exchange rates are important to the Asian story because nominal exchange rate 22. Price changes for both automobiles and ships are difficult to document because of the differentiated nature of the products. Moreover, industry sources indicate that measured prices may not accurately reflect actual transaction prices due to rebates and other sales incentives, which reportedly were aggressively employed during this period. 18 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure 1.3A Thailand’s nominal exchange rate and stock market changes

120

100

Nominal exchange rate

80 Stock market 60

40

20

0 1/96 3/96 5/96 7/96 9/96 Source: International Financial Statistics.

11/96

1/97

3/97

5/97

7/97

9/97

11/97

Figure 1.3B Malaysia’s nominal exchange rate and stock market changes 140

Stock market

120 100 Nominal exchange rate 80 60 40 20 0 1/96 3/96 5/96 7/96 9/96 Source: International Financial Statistics.

11/96

1/97

3/97

5/97

7/97

9/97

11/97

rigidity impeded adjustment of the real exchange rate to these terms of trade shocks, and, hence, supported increasingly inappropriate sectoral structures of trade and production. There was feedback between the foreign exchange market and the domestic financial system. As the exchange rates collapsed, financial and nonfinancial firms with unhedged foreign denominated debt found themINTRODUCTION AND OVERVIEW 19

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Figure 1.3C The Philippines’ nominal exchange rate and stock market changes 140 120

Stock market

100 Nominal exchange rate 80 60 40 20 0 1/96 3/96 5/96 7/96 9/96 Source: International Financial Statistics.

11/96

1/97

3/97

5/97

7/97

9/97

11/97

Figure 1.3D Indonesia’s nominal exchange rate and stock market changes 140 120

Stock market

100 Nominal exchange rate

80 60 40 20 0 1/96 3/96 5/96 7/96 9/96 Source: International Financial Statistics.

11/96

1/97

3/97

5/97

7/97

9/97

11/97

selves crushed by a mounting debt burden in terms of domestic resources. This debt burden was the justification for subsequent IMF policy recommendations to raise interest rates to stabilize exchange rates in order to stabilize the domestic resource burden of outstanding foreign debt—a recommendation that may have backfired as investors correctly saw the policy as a futile attempt to plug the hole in the dike. 20 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure 1.3E South Korea’s nominal exchange rate and stock market changes 120

100

Nominal exchange rates

80

Stock market

60

40

20

0 1/96 3/96 5/96 7/96 9/96 Source: International Financial Statistics.

11/96

1/97

3/97

5/97

7/97

9/97

11/97

The Panic Story The discussion thus far has focused on the policies and practices of the borrowing countries and institutions. Yet for every borrower there is a lender, and the question could rightly be asked: ‘‘Why were foreigners lending into such environments?’’ Moreover, the ‘‘fundamentalist’’ explanation for a financial meltdown in a single country seems less persuasive for a regional domino-like pattern of crises in successive countries. Expectational issues are central to both issues. The ‘‘panic’’ view posits that in mid-1997 the economic ‘‘fundamentals’’ in Asia were essentially sound and that the crisis was largely a product of abrupt expectational changes by domestic and foreign economic agents. A relatively minor disturbance in Thailand was turned into a regional financial panic by international investors’ irrational behavior on the one hand and hamfisted policies by the IMF on the other. The result was to increase the risk premium associated with investment in these countries, and reverse international capital flows. A variant of this view places moral hazard considerations associated with previous international rescues—most notably the Mexican bailout of 1995—at the center of the story.

Lender Behavior Oceans of ink have been spilled over the issue of moral hazard and its relevance to the Asian financial crisis.23 The argument is typically made 23. See, for example, Calomis (1998), Lindsey (1998), and Meltzer (1998). INTRODUCTION AND OVERVIEW 21

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that the Mexican bailout reduced international investors’ appraisal of the riskiness of lending in emerging markets—if conditions turned sour, international financial institutions such as the IMF together with national governments would act to forestall a default or other crisis. The result was capital inflows on terms that did not reflect true underlying risk. The logic of this argument is unassailable. What is questionable is its relevance. First, the class of investors subject to such moral hazard appears to be relatively narrow. Equity investors, foreign and domestic, have taken enormous hits, as documented in figures 1.3a-e. Similar arguments could be made for investors in fixed income assets. With respect to direct lending, bank managers have probably been harmed professionally, if not financially, by their role in the debacle. That leaves equity investors and bond holders in foreign banks. Presumably these are the beneficiaries of bailouts. It is hard, though not impossible, to imagine that these investors were swayed by moral hazard considerations when making their investment decisions.24 Even so, one must still link the decisions of these principals and the behavior of their agents, the managers. On this point, one can examine three sorts of evidence, none of which appears to support the significance of moral hazard considerations. The first is that economic forecasters did not appear to have had an inkling that an upheaval was imminent. To illustrate, the forecast of the 1998 change in the US-South Korean bilateral real exchange rate of the Blue Chip consensus is shown in figure 1.4. As late as November 1997, the Blue Chip consensus was for the 1998 real appreciation of the won. By January 1998, the consensus was for a 35 percent depreciation—a 36 percent forecast revision in two months. As for GDP growth, from February until November 1997, the consensus forecast for South Korean growth remained between 5.8 percent and 6.3 percent. Significant downward revisions were made in the December 1997 and January 1998 forecasts. Many forecasters made similar abrupt, across-the-board revisions for other Asian countries.25 These revisions do not establish that agents were not subject to moral hazard considerations, just that the forecasters in retrospect appear to have been incredibly myopic. They would probably argue that the Asian crisis was a ‘‘peso problem’’-phenomenon—an important though unlikely event—and that their forecasts were accurate in discounting its likelihood in any particular forecast period. But moving closer to the markets does not appear to strengthen the moral hazard case. If moral hazard considerations were motivating risk assessments, one would expect to see this reflected in the ratings of international private 24. Tesebono investors in Mexico probably did know, and certainly should have known, the risks of their investment. They may well have expected, correctly as it turns out, to benefit from the bailout loan guarantees (DeLong, DeLong, and Robinson 1996). 25. This point is discussed further in chapter 2 in the context of modeling the crisis. 22 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure 1.4 South Korea’s real GDP growth and real exchange rate change forecasts Real exchange rate change

GDP growth

20.0

7.0 GDP growth 6.0 5.0

10.0 Real exchange rate

0.0

4.0 -10.0 3.0 -20.0 2.0 -30.0

1.0

-40.0

0.0 2/97 3/97 4/97 5/97 6/97 7/97 8/97 9/97 10/97 11/97 12/97 Source: Blue Chip Economic Indicators (February 1997-January 1998).

1/98

ratings agencies such as Moody’s, Standard and Poor’s, and Fitch IBCA. However, these firms’ ratings of Asian debt did not improve after the Mexican bailout, as one would expect if there had been a systemic reduction in risk faced by private investors. Rather, these firms’ ratings did not change in 1996 and were lagging indicators of the unfolding crisis in 1997. Presumably the difficulty the ratings agencies encountered spotting the emerging crises was partially due to the lack of transparency noted earlier.26 What about actual market transactions? If the moral hazard hypothesis was motivating behavior, one would expect to observe a decline in spreads after the Mexican bailout in 1995. Instead, the spreads show little trend at all even controlling for underlying fundamentals (Cline and Barnes 1997, appendix table D-1).27 While the logic of the moral hazard argument is valid, the evidence suggests that it was not empirically significant. However, while rejecting the moral hazard view, the same evidence just cited—lack of forecasts of 26. However, one study found that ratings agencies generally are lagging indicators of developments (Larrain, Reisen, and von Maltzan 1997). 27. Cline and Barnes (1997) analyzed changes in spreads and concluded that the general narrowing of emerging market spreads between 1995 and 1997 could not be fully explained by economic fundamentals, which would be consistent with either moral hazard or ‘‘irrational exuberance.’’ These results are completely conditional on their statistical model (it is possible that one could specify an econometric model in which the fundamentals could more than explain the narrowing of spreads), and this analysis does not provide compelling evidence on the source of the divergence between fundamentals and spreads. INTRODUCTION AND OVERVIEW 23

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a crisis, lack of warning signals from the ratings agencies, and lack of movement in market spreads—could be used to argue that the crisis was a product of simple panic.28

Transmission Rejecting the moral hazard argument, one still has to address the issue of why the crisis took on regional rather than country dimensions. Direct links among the Southeast Asian countries do not appear particularly strong. Thailand absorbs less than 4 percent of the exports of any of the other Asian countries, and with the exception of Japan, and possibly South Korea, the financial links (as distinct from product market links) among the affected Asian countries are not large either (table 1.5). So the scope for direct macroeconomic spillovers does not appear to be large. These countries could be indirectly linked through their competition in third country markets. So, for example, when Thailand devalued by 35 percent, this put pressure on countries in the region since they export similar products to third markets such as the United States, Japan, and the European Union. Even so, such effects could not cause depreciations of the magnitude actually observed—the real linkages are simply not that strong. Some have attributed the Asian financial crisis to contagion—spillovers not associated with direct or indirect product or financial market links. One explanation is herd behavior, which argues that as global investment opportunities increase, investors’ direct knowledge of local situations decreases. As a consequence, investors are forced to rely more on their observations of other investors (who may have better or inside knowledge of local conditions) rather than on their own observation of local fundamentals. Hence, once an investor follows a particular path, the ‘‘herd’’ will follow (Calvo and Mendoza 1998). Another contagion scenario is that investors consider members of a group of imperfectly observed countries similar. Events in one are attributed to all, transmitting a shock throughout the group, independent of their economic linkages (Drazen 1997). Krugman (1997) argues that agents such as pension fund managers are risk averse with respect to their own income. Since their compensation is often determined relative to the performance of others, they tend to follow the herd.29 Then, of course, there is also pure irrational panic. Lastly, it is possible that the markets are being manipulated. According to Krugman (1997) this transmission mechanism could be motivated by 28. Stiglitz (1998b) and Radelet and Sachs (1998) review evidence similar to what has been cited and make precisely this argument. 29. Krugman argues that asymmetries also affect managers: they may face greater scrutiny for staying in markets when others are fleeing even if they are right, while their rewards are less lucrative for being right than are the penalties for being distinctively wrong. 24 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table 1.5 Export markets for Asian competitors, 1995 (percentage of each country’s exports) USA

WEU

Japan

China

South Korea

Taiwan

Indonesia

Thailand

Philippines

Malaysia

China South Korea Taiwan Indonesia Thailand Philippines

24.74 18.41 23.45 14.12 17.61 28.14

23.81 12.99 14.18 16.51 18.14 21.12

19.14 19.67 13.26 26.69 20.43 20.58

13.20 24.10 6.54 6.60 4.31

3.52 2.17 6.28 1.72 2.71

2.61 3.00 3.50 2.32 1.52

0.96 2.25 1.46 1.46 0.95

1.30 1.92 2.73 1.45 2.51

0.84 1.12 1.03 1.28 0.73 -

1.06 1.97 3.01 2.05 2.48 1.83

Malaysia

20.77

14.57

13.75

6.48

2.99

2.89

1.01

3.66

0.89

-

WEU = Western Europe. Source: GTAP-4 Prerelease (Hertel 1997).

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investor George Soros’s 1992 attack on the British pound: if a currency peg appears vulnerable, an investor—in this case it is essential that it be a very large investor—could take a short position in the currency and then through some public action trigger a crisis.30 Paradoxically, a currency should collapse as soon as this possibility appears.31 However, if the currency has collapsed, then it cannot be manipulated. Perhaps this is why we do not often observe these types of manipulations.

Credibility Beyond the issue of whether real or expectational factors were the principal drivers behind the crises, the final factors affecting the depth and spread of the crisis have been political uncertainty and lack of credibility (often associated with a lack of transparency). When the crisis broke, Thailand had a weak and corrupt government and was in the midst of revising its constitution. In Indonesia, questions arose as to whether aging President Suharto would seek another term in office—which he did. With Suharto apparently unwilling or unable to come to grips with the crisis, two IMF agreements collapsed, high-ranking economic technocrats were purged, and an economic nationalist was appointed vice president. The president carried out an on-again off-again romance with the notion of establishing a currency board, which under the conditions of the time would have amounted to a mechanism for capital flight for the politically connected and exacerbated the country’s economic ills. Suharto was later forced to resign in the midst of a political crisis. In both South Korea and the Philippines, the crisis became entangled with electoral cycles.32 And in Malaysia, there was no election, but political factors, this time in the form of the public rants of Prime Minister Mahathir Mohamad, exacerbated the economic problems.33 30. On 24 July, 10 days after the central bank had abandoned the defense of the currency, Malaysian Prime Minister Mahathir Mohamad blamed ‘‘rogue speculators’’ for the ringgit’s problems. Two days later he publicly fingered investor George Soros, whom he was later to brand a ‘‘moron,’’ as the source of Malaysia’s difficulties, and would subsequently expand his circle of conspirators to include an international Jewish cabal. (Soros, not without reason, would eventually describe Mahathir as ‘‘a menace to his own country’’ and assert that ‘‘[Mahathir] couldn’t get away with it if he and his ideas were subject to the discipline of an independent media inside Malaysia.’’) 31. This is analogous to the argument that if the takeover and breakup of a firm is profitable then it should have already occurred. 32. See Noland (1998b) for a more detailed discussion of the role of politics in the South Korean financial crisis. 33. The Mahathir-Soros war of words took a turn for the worse at the joint World BankIMF meetings held in Hong Kong, when Prime Minister Mahathir, on 20 September, stated that ‘‘currency trading is unnecessary, unproductive, and immoral’’ and should be ‘‘stopped’’ and ‘‘made illegal.’’ He reaffirmed these views in an opinion piece in the South China Morning 26 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Beyond these political developments, the Asian governments initially released inaccurate data, though it is unclear whether this was the result of incompetence or malevolence. For example, South Korea constantly revised its foreign debt figures upward; the Bank of Thailand did not indicate that a substantial share of its foreign reserves were committed to forward market transactions. Lack of transparency in financial reporting coupled with lack of confidence in the quality of policymaking exacerbated the crisis.

Summary The Asian financial crisis has proved to be a major shock to the world economy. There were, and still are, major structural weaknesses in the financial systems of many of these countries—with implications for their abilities to adjust their structures of production. Whatever its origins, the crisis revealed these structural problems, and simply restoring market confidence will not lead to a quick rebound. While expectational factors have surely been important in determining how events have unfolded, the evidence reviewed in this chapter suggests that the crisis had its origins in bad policy decisions over an extended period and in the structural weaknesses of many Asian financial institutions. Restructuring takes time, and the crisis will have significant, persistent effects in the Asian countries, and these effects will be transmitted to others outside the region. This study uses a computable general equilibrium (CGE) model to analyze the global pattern of real adjustment implied by this episode. Considerable uncertainty exists regarding how much of the nominal exchange depreciations that have occurred since July 1997 will translate into real exchange rate depreciation. Likewise, it is unclear how large a real-side supply shock has been caused by the financial turmoil. In light of these uncertainties, we present alternative scenarios regarding the magnitude of these shocks in our work. For the ASEAN-4 and South Korea, our qualitative results are robust. All of these countries have experienced considerable real exchange rate depreciations that will be accompanied by significant supply-side contractions. Our results indicate that these five countries experience a large fall in domestic absorption. Net exports increase primarily through a compression of imports and only secondarily through an expansion of exports. All five experience a positive increase in their bilateral balances with the United States. Post the following day. These remarks sparked a financial panic, pushing the ringgit to a new low—an event that was repeated on 30 September when Mahathir called for tighter regulation or a total ban on foreign exchange trading. INTRODUCTION AND OVERVIEW 27

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For Singapore, Taiwan, and Japan, the results are more subtle because, though they have experienced nominal and real depreciations vis-a`-vis the United States and Western Europe, they have appreciated against the ASEAN-4 and South Korea. The three countries tend to increase their trade surpluses with the United States and Western Europe but this is offset by decreases in trade balances with the ASEAN-4 and South Korea. Which effect will predominate depends critically on the size of real depreciations and supply-side contractions in the ASEAN-4 and South Korea. It is certainly questionable whether all three countries, which were in surplus at the time of the crisis, should increase their external balances further. Thus far China has been relatively immune to the crisis, though it also faces significant financial and real adjustment problems. The obvious temptation would be for China to devalue in an attempt to maintain aggregate demand while restructuring its economy. Our results indicate, however, that the direct impact of the crisis on China will be relatively modest. Given the likelihood that a significant Chinese devaluation would spark another round of competitive devaluations, caution is warranted. Rather than devalue, China should develop better alternative tools of macroeconomic management. In Western Europe, Oceania, and the United States, the most notable characteristic of the crisis is how it will differentially affect the tradedand nontraded-goods sectors. In the United States, we estimate that the crisis will mean an increase of $40-50 billion in the US trade balance. This result is relatively invariant to Chinese actions—a Chinese devaluation would in part merely reallocate the pattern of US bilateral balances across trade partners. At the same time, the income effect of the real appreciation and the terms-of-trade improvement should boost the nontraded-goods sector, and we estimate that the net impact on gross domestic product (GDP) is a wash.34 Similar adjustments occur in Western Europe and Oceania—with the impact on Western Europe larger in absolute terms, and the impact on Oceania larger in relative terms. The negative impact of the crisis on bilateral trade balances of the United States with its Asian partners will likely increase trade tensions and increase the likelihood of formal trade actions (see chapter 3). At the same time, the increased dependence of the Asian countries on the US market will probably increase US negotiating leverage. However, the US policy response is likely to be mitigated by two considerations. First, these trade disputes will arise in the context of financial crises. Agencies concerned with financial, political, and security issues may fear that trade frictions could be destabilizing and mobilize bureau34. McKibbin (1998) obtains similar results in which the capital inflow associated with the increase of the trade deficit puts downward pressure on domestic interest rates that lead to the same sectoral pattern of adjustment and slight increase in GDP. 28 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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cratically to temper US trade pressure. Second, the formation of the World Trade Organization (WTO) and its dispute settlement mechanism (DSM) significantly constrains US unilateralism. On the import side, the prognosis is for an increase in antidumping cases that are WTO-consistent and more immune to bureaucratic politics. On the export side, the United States may find itself in the position of making even greater use of the WTO and its improved DSM to forestall trade policy backsliding by Asian countries as they adjust. How this plays out may ultimately depend on the cyclical state of the US economy. The United States entered the Asian financial crisis in the midst of an unprecedented economic expansion. If the US economy remains healthy, the pressure on trade policy may not be great. However, if the US economy were to weaken, a backlash on trade policy could occur. Were this to happen, US actions would likely be emulated around the world.

INTRODUCTION AND OVERVIEW 29

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2 Global Economic Effects

Structure of the World Model In this chapter we present a model of the global economy that we use to quantify the implications of the Asian crisis over the medium term for production and trade—both sectoral and aggregate—by major countries and regions. The model is a multisectoral, multicountry, computable general equilibrium (CGE) model and is part of a family of models that have been used widely to analyze the impact of global trade liberalization and structural adjustment programs.1 Our model focuses on real trade flows, trade balances, world prices, and real exchange rates. It incorporates considerable detail on sectoral output, consumption, and trade flows— both bilateral and global. However, the cost of this structural detail is that it does not consider financial markets, interest rates, or inflation; so it cannot be used to analyze the impact of the crisis on asset and money markets.2 Similarly, the model is comparative statics in nature—given the pattern of world output and trade at one moment of time, it generates what that pattern of output and trade would be after the world economy adjusted to the shocks specified in the model scenario. The model is not 1. The model and its lineage are described in appendix A. 2. McKibbin (1998) reports a model that explicitly models financial markets in an intertemporal context, at the cost of ignoring much of the underlying structural changes that our model captures. 31

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designed to generate quarterly macroeconomic forecasts. In principle it could be linked to a macro model that includes asset flows and could determine the set of real exchange rates resulting from a macro shock. Given a macro scenario, this model could then be used to determine the resulting real trade flows and regional sectoral structural adjustments in a comparative-statics framework. The model includes 17 regions,3 each with 14 sectors4 and 5 primary factors of production: agricultural land, natural resources, capital, unskilled labor, and skilled labor.5 The regions are linked by commodity trade. Within each region, the model solves for domestic commodity and factor prices that equate supply and demand in all goods and factor markets. The model also solves for world prices, equating supply and demand for sectoral exports and imports across the world economy. In addition, for each region, the model specifies an equilibrium relationship between the balance of trade (in goods and nonfactor services, or the current account balance) and the real exchange rate (which measures the average price of traded goods—exports and imports—relative to the average price of domestically produced goods sold on the domestic market). Any change in a particular region’s exchange rate will reverberate across the world economy, affecting the aggregate trade balances and/ or real exchange rates of all 17 regions as they adjust their trade flows and structures of production to achieve a new equilibrium. Each regional economy includes a number of economic actors. Producers are assumed to maximize profits—purchasing inputs and supplying output to both domestic and world markets (exports) in response to market prices in commodity and factor markets. Consumers receive income from firms and demand goods (and save)—responding to prices and incomes. The government collects taxes, buys goods and services, and saves (government surplus or deficit). An aggregate savings-investment account serves the function of financial markets, collecting all savings 3. The regions in the model are the United States (USA), Canada (CAN), Mexico (MEX), Western Europe (WEU), Australia and New Zealand (OCN), Japan (JPN), South Korea (KOR), Taiwan (TWN), China and Hong Kong (CHN), Indonesia (IDN), Thailand (THA), the Philippines (PHL), Singapore (SGP), Malaysia (MYS), South Asia (SAS), Latin America and the Caribbean countries (LTA), and the rest of the world (ROW). 4. The sectors are agricultural products, processed food and beverages, forestry and fishery, mining, energy, textile and apparel, light manufactures, industrial intermediates, motor vehicles and parts, other transportation equipment, electronics, machinery, housing and construction, and services. 5. Skilled workers are defined as International Labor Office (ILO) International Standard Classification of Occupations (ISCO) occupation groups 0-2 (Professional; Technical and related workers; Administrative and managerial workers). The remainder—ISCO 3-5 (Clerical and related workers; Sales workers; Service workers), ISCO 6 (Agricultural workers), and ISCO 7-9 (Production and related workers; Transport equipment operators; Laborers)— are classified as unskilled. 32 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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(private, government, and foreign) and allocating them for the purchase of investment goods. It is reasonable to wonder if an equilibrium model is sufficient for analyzing adjustment to a crisis such as the one at hand. In normal operation, the regional models all assume perfect competition and complete adjustment in all markets, and, hence, solve for a new full-employment equilibrium after any shock. However, the Asian financial crisis is causing disruptions in the affected economies that are having serious effects on aggregate employment of resources. Many firms throughout the region are going bankrupt, and the rate of labor unemployment is rising. We simulate these effects by introducing negative ‘‘supply-side’’ shocks, reducing total factor productivity across all sectors in the affected regions. In other words, for convenience, instead of specifying increased unemployment or shutting down factories, we allow all resources to remain employed but reduce their efficiency in the model—thereby generating the same fall in output. The magnitudes of these shocks are described in more detail below as part of the scenarios we analyze. The model determines relative prices within each region and on world markets. Traded and nontraded goods are assumed to be distinct (and imperfect substitutes) by sector, so changes in relative world market prices are only partially transmitted to domestic markets. The model thus incorporates a realistic degree of insulation of domestic commodity markets from world markets. The links are still important and provide the major mechanism by which the crisis is transmitted across regions. Since the model cannot determine inflation, only relative prices change. The United States is specified as the ‘‘reference’’ economy, with both its aggregate price level and exchange rate fixed. That is, all relative world prices and trade balances are measured in terms of real US dollars. In addition, the aggregate consumer price index is fixed in each region, which defines a regional ‘‘no inflation’’ benchmark.6 The equilibrium exchange rate determined by the model for each region can be interpreted as the real effective exchange rate (REER) deflating by the ratio of the regional consumer price index and the US index.7 It is important to emphasize that the exchange rate variable in the model is not the nominal exchange rate that one reads in the newspaper. The REER differs from the nominal rate because it takes the price level of the two countries into account. So, for example, if the Korean REER depreciates by 25 percent, this could reflect a 25 percent nominal depreciation of the won against the US dollar and no change in relative price levels or inflation rates, or it might reflect a 35 percent nominal depreciation of the won

6. Formally, the consumer price index is the ‘‘numeraire’’ price index for each region, and the US exchange rate is selected as the ‘‘numeraire’’ for world prices. 7. See Wren-Lewis and Driver (1998) and Devarajan, Lewis, and Robinson (1993). GLOBAL ECONOMIC EFFECTS 33

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against the US dollar combined with a 10 percent increase in the Korean price level. In other words, movements in the REER reflect changes in both nominal exchange rates and relative price levels, and any particular change in the REER is consistent with an infinite number of combinations of those variables. In this model, the REER is not a financial exchange rate, since the model has no assets or asset markets. The model specifies an equilibrium relationship between the real exchange rate and the trade balance, given world prices and regional export supply and import demand functions. For each region, the model includes the three macro balances: savingsinvestment, balance of trade (in goods and nonfactor services), and government expenditure-receipts (government deficit). The three balances are not independent—if two of the balances are determined, the third follows from the fact that the three must always sum to zero. The determination of these macro balances is the subject of traditional macroeconomic models. In terms of our real trade model, which does not include financial markets or variables typical of macro models, the determination of these macro aggregates is specified by simple rules. The macro adjustment mechanism constitutes the macro ‘‘closure’’ of the model. In the absence of any convincing analysis of the quantitative impact of the macro adjustment on different components of national income, we specify a macro closure that assumes any adjustment in aggregate absorption is spread in a neutral manner across aggregate consumption, investment, and government expenditure. Aggregate investment and government expenditure are simply specified as fixed shares of total absorption in each region (or aggregate regional expenditure, which equals gross domestic product [GDP] plus imports minus exports). Aggregate private savings in each region are assumed to adjust endogenously to match aggregate investment, thus achieving savings-investment equilibrium even with endogenous changes in the government deficit and the balance of trade. In the aggregate, as noted above, there is a functional relationship between the balance of trade (in goods and nonfactor services, or the current account balance) in each region and the real exchange rate. If the real exchange rate depreciates, the price of traded goods increases relative to the price of domestically produced goods sold on the domestic market. Exports increase, imports decrease, and the trade balance will improve. Given our assumption that aggregate investment is determined as a share of aggregate absorption, changes in the trade balance, which directly affect foreign savings, are assumed to have only a partial effect on aggregate investment in the region. Instead, they lead to an equilibrium adjustment in the domestic savings rate, which partially offsets the change in foreign savings. In the model, we specify a fixed real exchange rate for each region. In the base solution, calibrated to 1995 (the most recent year for which a 34 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Chinese social accounting matrix can be constructed), the initial trade balance and exchange rate are assumed to be in equilibrium for each region—that is, the initial trade balance is assumed to be ‘‘sustainable’’ and consistent with the initial real exchange rate. In simulation experiments, we change the exchange rate for a particular region, which changes the equilibrium trade balance both in aggregate and bilaterally. In the multiregion model, there is a ripple effect, since, as noted in the previous chapter, a depreciation in one region’s real exchange rate implies a relative appreciation for its trading partners, which also leads to changes in their equilibrium trade balances. The world model is closed in the sense that the sum of all regional trade balances must equal zero. Thus, we can use the model to see how real exchange rate shocks lead to adjustments in country trade balances worldwide in a consistent framework. In the simulations, we change the real exchange rate of one region at a time, keeping all other regional real exchange rates fixed. We cumulate the exchange rate changes over a series of experiments, simulating the domino effect of cascading changes. We use the model to isolate the exchange rate transmission effect. We do not attempt to model a mix of exchange rate and trade balance adjustments or to forecast what might actually happen. This real model, with no money or asset markets, simply cannot be used for such forecasting. However, the model does allow us to explore structural adjustment effects such as changes in sectoral production, exports, and imports in a comparative-statics framework.

Defining Modeling Scenarios To use the model for analysis, we specify a series of simulation experiments or scenarios. The real exchange rate depends on the future levels of nominal exchange rates and prices. There are then three major sources of uncertainty in designing realistic scenarios: specifying future levels of nominal exchange rates, future levels of prices, and effects on the supply side. We characterize the Asian financial crisis as a real exchange rate shock and a negative supply-side shock. As of May 1998, with the exception of Indonesia, the nominal exchange rates in the region have more or less stabilized. The extent to which the nominal devaluations will be offset by higher rates of inflation is a more open question. One would expect that relatively small, open economies subject to large nominal depreciations would exhibit an acceleration of inflation as import prices rise in domestic currency terms. Oddly, however, a number of major forecasters do not appear to have incorporated this effect in their real exchange rate forecasts (table 2.1). The data for late 1997 and early 1998 indicate that this process is under way: for most countries real exchange rates appear to have begun appreciating from GLOBAL ECONOMIC EFFECTS 35

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their trough (table 2.2).8 Nevertheless, the ultimate magnitude and persistence of this shock is highly uncertain. To get some notion of the sensitivity of our results to the magnitude of these shocks, for each country we specify low-, ‘‘best guess’’ medium-, and high-shock scenarios (table 2.4).9 For the remainder of the chapter we base our discussion on the ‘‘best guess’’ medium-shock scenario; additional material on the low- and highshock scenarios is included in appendix C. This approach, while adequate for normal situations, may inadequately capture the crisis aspects of the current situation. The precipitous nominal exchange rate depreciations have been accompanied by significant disruptions of domestic financial markets and institutions. Firms may suddenly find themselves liquidity-constrained, unable to finance purchases of intermediate inputs, and many have been forced into bankruptcy.10 We model this financial disruption to the economy as a series of negative supply-side shocks to total factor productivity, in effect shifting the pro8. For some specifics on the inflationary response, see Goad (1998) and Choi (1998). 9. For the low-, medium-, and high-shock scenarios, we assume that all countries experience low, medium, or high shocks. More extreme outcomes could be obtained if, for example, one country experienced a high shock while the others experienced low shocks. We regard the possibility of this occurrence as unlikely so we do not report these results. 10. See, for example, 26 January 1998 issue of the Financial Times. 36 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table 2.2 Real effective exchange rates since July 1997 Hong Kong Indonesia July 1997 August 1997 September 1997 October 1997 November 1997 December 1997 January 1998 February 1998 March 1998 Percentage change since July 1997

131.2 131.7 131.2 134.8 136.2 138.0 138.2 136.7 137.7 5.0

103.7 96.9 90.2 76.8 82.9 61.9 32.9 39.7 34.3 –66.9

Japan

South Korea

Malaysia

109.9 109.0 106.1 106.0 103.0 103.7 107.6 108.6 105.3 –4.2

85.8 86.7 85.9 84.4 77.0 59.0 54.8 58.1 63.7 –25.8

115.3 110.3 100.7 92.3 91.3 84.5 74.5 84.7 86.1 –25.3

Philippines Singapore 110.2 106.3 98.2 95.1 95.0 90.5 83.3 87.2 91.8 –16.7

117.4 115.9 114.8 112.9 113.1 114.1 112.5 114.6 117.2 –0.2

Note: 1990 is 100. An upward movement is an appreciation. Source: JP Morgan Broad Real Effective Exchange Rate Indices.

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Taiwan 91.5 91.4 91.4 89.6 87.7 88.9 85.2 87.4 88.4 –3.4

Thailand 92.9 92.8 85.0 84.0 79.8 72.0 62.0 70.5 78.9 –15.1

United States 104.9 106.6 107.0 106.8 108.1 111.9 114.4 112.3 112.0 6.8

duction possibility frontier inward (or alternatively, allowing for less than full employment of resources). In the baseline scenario, the countries experiencing 20-25 percent depreciations (Thailand, Indonesia, and South Korea) also experience a 5 percent negative supply shock. These are in line with the downward forecast revisions of GDP growth (table 2.3). In our experiments, we attempt to follow the historical evolution of the crisis, beginning in Southeast Asia, and move northward to Northeast 38 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Asia in experiments 1 through 8. We then consider a competitive devaluation by China to reattain its precrisis external balance as the final experiment. The results generated by the model should be interpreted as annualized flows after adjustment to the shock has occurred. Adjustment here is defined as redeployment of factors of production in response to the new set of relative prices. In this kind of model, the time needed for adjustment is typically thought of as 18 months to 2 years; the actual time needed for adjustment will be influenced by many institutional details including policy. There is no reason to suppose that adjustment will be equally rapid in all countries.

Results For each country we graphically depict the adjustment of aggregate exports and imports to each of the eight exchange rate shocks, and in tabular form report changes in GDP, domestic absorption (GDP plus imports less exports), and the change in trade balance. We also report the bilateral matrix of trade balance adjustments for experiment 8 (the historical evolution of these changes) and experiment 9 (the prospective devaluation of the RMB), the changes in sectoral output, and the changes in sectoral trade balances. Occasionally, we also make reference to other results obtained from the model, which are not reported in tabular form. In qualitative terms, the results are similar for four groups of countries: the ASEAN-4 and South Korea; Singapore, Taiwan, and Japan; and Western Europe, Oceania, and the United States. The case of China is distinguished by the focus on its prospective devaluation. We organize the discussion in this chapter along these lines (with the exception of the results for the United States, which are discussed in chapter 3).

ASEAN-4 and South Korea As a result of the crisis, the ASEAN-4 and South Korea all experience falls in domestic absorption that are only partly compensated by increases in net exports of merchandise trade and services. The decline in domestic activity and the rise in the price of imports relative to domestically produced substitutes reduces imports, and most of the change in trade balance is due to this fall in imports, not the increase in exports. As we will see later, the counterpart adjustment for the developed countries is a decline in their exports, as demand for imports falls in developing Asia. Figures 2.1 through 2.9 summarize the impact of the nine experiments on aggregate trade for the nine Asian countries. As illustrated in figure 2.1, Thailand initially receives a big boost in competitiveness as the first counGLOBAL ECONOMIC EFFECTS 39

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Figure 2.1 Impact of Asian cumulative devaluations on Thailand’s exports and imports Billions of dollars 15.0 10.0 Change in exports 5.0 0.0 -5.0 -10.0 -15.0 -20.0 -25.0 Change in imports -30.0 -35.0 Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

try to devalue.11 However, as others follow suit, Thailand’s initial real exchange rate depreciation is gradually eroded. In the final experiment Thailand’s external trade balance has increased by approximately $34 billion, with the largest share of this improvement coming with Western Europe (table 2.5).12 (These figures are annualized changes from the base after an adjustment period of perhaps 18 months to 2 years beginning July 1997.) As illustrated in table 1.5, Thailand ships more exports to Western Europe than it does to the United States. It also ships more to Japan than to Western Europe, but in these experiments Japan, unlike Western Europe or the United States, experiences some real depreciation, though not bilaterally vis-a`-vis Thailand. The increase in net exports only partially offsets the nearly 40 percent decline in real absorption as the economy contracts and consumption, investment, government expenditure, and imports are squeezed to accommodate the increase in net exports (table 2.6).13 (Note that the GDP figure in table 2.6 is the change relative 11. The cited figures are all in final-price observed terms. The changes in base price values could differ significantly. 12. As shown in appendix C, the range of outcomes is large—if Thailand and the other countries experience high shocks, the improvement of the trade balance is nearly $60 billion, while in the low-shock scenario the trade balance improves by less than $30 billion. 13. By way of comparison, McKibbin (1998) obtains an even larger fall in Thai consumption for 1998. As shown in appendix C, the magnitude of the swings in domestic absorption and net exports obtained from our model are significantly affected by the magnitude of the 40 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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to the base—it does not indicate that the Thai economy experiences a negative 8 percent growth rate.) With respect to the sectoral composition of output, Thailand experiences a collapse in the construction sector as a result of the crisis (table 2.7). In international trade terms, Thailand’s largest export increases are in services (which includes tourism) and light manufactures.14 The largest percentage increase in exports is in motor vehicles and parts. The increase in net exports is largest for the services where exports rise and imports fall, and for machinery, which is driven by a decline in imports of capital goods as investment falls (table 2.8). In figure 2.2, the same set of experiments is run for Malaysia. The country initially suffers a decline in competitiveness associated with Thailand’s devaluation, which is then more than compensated by its own devaluation. This effect is subsequently eroded as other countries’ currencies depreciate; in the final medium-shock scenario, Malaysia experiences a trade balance improvement of roughly $18 billion. 15 As shown in figure 2.2, most of this difference is on the import side, reflecting the extent of contraction of overall activity. Real GDP in the ‘‘best guess’’ medium-shock scenario falls by more than 7 percent, and real domestic absorption declines almost 35 percent.16 The large impact on Malaysia is due to its relative openness and exposure to international trade and its export concentration in relatively low price sensitive or elastic manufactures. Like Thailand, Malaysia experiences a collapse in the construction industry and the biggest increase in net exports is in machinery where imports fall in response to the decline in investment and overall economic activity. The response of Indonesia’s aggregate exports and imports is shown in figure 2.3.17 In the medium-shock scenario, Indonesia’s trade balance real exchange rate and supply shock: for smaller depreciations and smaller reductions in total factor productivity (TFP), the increase in net exports is smaller on a larger GDP base, generating a smaller swing in the trade balance as a share of GDP. 14. Tourism arrivals for Thailand were up 13 percent in January 1998, relative to their level a year earlier (Priscilla Cheung, Associated Press, 14 May 1998). 15. In the low-shock scenario the trade balance improvement is roughly $5 billion, and in the high-shock scenario it is roughly $27 billion. See appendix C. 16. McKibbin (1998) distinguishes two scenarios in his model: one in which the impact of the crisis is essentially temporary (the ‘‘panic’’ scenario) and one in which it is more permanent (the ‘‘fundamentalist’’ situation). For Malaysia, he obtains a fall in GDP in 1998 of about 5 percent in the ‘‘temporary’’ or ‘‘panic’’ scenario and about 8 percent in the ‘‘permanent’’ or ‘‘fundamentalist’’ scenario. 17. Given the extreme uncertainty about developments in Indonesia, we ran a series of experiments in which we increased the magnitude of the real exchange rate shock. For real depreciations of more than roughly 50 percent the model collapses, indicating adjustment would come through another mechanism such as hyperinflation. GLOBAL ECONOMIC EFFECTS 41

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Table 2.5 Change of bilateral trade flows from the base (current price, with productivity shock, Chinese devaluation excluded, medium-shock scenario) (billions of dollars) USA CAN MEX WEU OCN JPN KOR TWN CHN IDN THA PHL SGP MYS SAS LTA ROW

USA CAN MEX WEU OCN JPN KOR TWN CHN 0 0 2 0 –14 –13 –3 0 0 0 0 0 –2 –1 0 0 0 0 0 0 0 0 0 0 –2 0 0 –1 –11 –8 –2 –1 0 0 0 1 –2 –2 0 0 14 2 0 11 2 –9 0 5 13 1 0 8 2 9 1 4 3 0 0 2 0 0 –1 0 0 0 0 1 0 –5 –4 0 2 0 0 5 1 3 0 0 1 5 0 0 9 1 8 0 1 2 2 0 0 2 0 1 0 0 0 2 0 0 3 0 1 –1 0 1 4 0 0 5 1 3 0 1 1 0 0 0 0 0 –1 –1 0 0 0 0 0 2 0 –3 –4 0 0 1 0 0 5 0 –6 –5 0 0

IDN –2 0 0 –5 –1 –3 0 0 –1 0 0 –1 0 0 –1 –1

THA PHL SGP MYS SAS LTA ROW TOT –5 –2 –2 –4 0 0 –1 –43 0 0 0 0 0 0 0 –4 0 0 0 0 0 0 0 –1 –9 –2 –3 –5 0 –2 –5 –55 –1 0 0 –1 0 0 0 –5 –8 –1 –1 –3 1 3 6 19 0 0 1 0 1 4 5 47 –1 0 0 –1 0 0 0 3 –2 0 –1 –1 0 0 0 –12 0 0 1 0 0 1 1 15 0 2 1 0 2 4 34 0 0 0 0 0 1 6 –2 0 –2 0 0 2 4 –1 0 2 0 1 1 18 0 0 0 0 0 0 –2 –2 0 0 –1 0 0 –9 –4 –1 –2 –1 0 0 - –15

Note: USA = United States, CAN = Canada, MEX = Mexico, WEU = Western Europe, OCN = Australia and New Zealand, JPN = Japan, KOR = South Korea, TWN = Taiwan, CHN = China and Hong Kong, IDN = Indonesia, THA = Thailand, PHL = Philippines, SGP = Singapore, MYS = Malaysia, SAS = South Asia, LTA = Latin American and Caribbean nations, ROW = rest of world, and TOT = total.

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Table 2.7 Sectoral change of production from the base (Chinese devaluation excluded) (percentages) United States Agriculture Processed food Forestry and fishery Mining Energy Textile and apparel Light manufactures Intermediate goods Motor vehicles and parts Other transportation equipment Electronics Machinery Housing and construction Services Total

–0.89 0.02 –1.39 –0.49 –0.01 –0.63 –0.82 –0.71 –1.21 –1.13 –2.38 –2.63 0.71 0.39 –0.07

Western Europe –0.16 0.04 –0.46 –0.55 –0.05 –0.84 –0.42 –0.58 –1.09 –3.01 –1.95 –1.87 0.70 0.32 –0.05

Japan 0.45 –0.04 –0.04 –0.13 0.46 0.43 0.25 0.43 3.30 3.58 0.86 0.87 –0.55 –0.27 0.10

South Korea –6.01 –10.10 –4.06 –9.44 –2.15 12.34 9.13 4.06 7.85 21.16 4.37 12.23 –21.47 –10.14 –4.33

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Taiwan

China

Indonesia

Thailand

–0.02 –0.83 –0.65 –0.21 –0.16 0.98 2.31 1.52 1.78 7.68 2.76 1.62 –2.14 –0.85 0.35

0.71 0.53 0.24 0.58 –0.23 –2.17 –1.90 –0.90 –0.15 –1.06 –1.04 –0.88 2.59 0.71 0.05

–3.95 –8.23 –1.48 0.46 0.87 17.32 12.94 2.69 4.90 1.75 –0.05 –3.27 –18.01 –11.96 –6.03

5.04 2.71 0.18 –3.60 –1.51 7.46 7.03 0.00 –3.74 9.03 2.78 1.27 –35.16 –7.37 –3.60

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Philippines Singap –5.56 –7.29 –6.88 –4.74 –6.45 9.77 8.01 –4.54 –10.20 4.73 1.86 3.94 –15.84 –6.65 –5.56

0.7 –0.0 0.2 –5.5 –3.0 2.6 2.8 –0.3 –0.7 4.6 3.0 –1.1 –6.5 –0.6 –0.3

Table 2.8 Sectoral change of trade balance from the base (Chinese devaluation excluded) (billions of dollars) United States Agriculture Processed food Forestry and fishery Mining Energy Textile and apparel Light manufactures Intermediate goods Motor vehicles and parts Other transportation equipment Electronics Machinery Housing and construction Services Total

–1.7 –1.3 –0.2 –0.5 –1.1 –1.0 –2.2 –4.5 –5.1 –3.2 –4.5 –10.0 0.0 –7.5 –43.0

Western Europe

Japan

–0.4 –1.5 –0.1 –1.4 –1.4 –2.4 –3.2 –5.9 –7.7 –3.2 –3.4 –12.0 –1.2 –11.4 –55.2

0.6 1.1 0.8 0.3 2.7 1.3 1.5 0.6 5.0 1.3 1.9 –1.6 0.1 3.4 19.1

South Korea

Taiwan

1.8 1.2 0.5 1.2 2.7 2.6 2.5 6.0 3.6 2.9 3.0 9.2 0.0 9.9 47.2

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0.2 0.1 0.0 0.1 0.2 –0.3 0.1 0.2 0.4 0.3 0.2 0.6 0.0 0.9 3.0

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China

Indonesia Thailand Philippines Singapore

–0.6 –0.7 –0.3 –0.4 –0.5 –1.8 –1.7 –1.3 –0.2 –0.3 –0.5 –1.8 0.0 –2.1 –12.0

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1.2 1.0 0.0 0.5 0.7 0.8 1.3 2.2 0.6 0.3 0.7 2.4 1.5 2.0 15.2

0.4 0.8 0.8 1.4 1.9 1.5 2.0 5.1 2.8 1.0 1.7 6.9 0.0 8.0 34.2

0.3 0.5 0.1 0.2 0.4 0.3 0.3 0.7 0.2 0.2 0.2 1.1 0.1 1.9 6.3

0.2 0.1 0.0 0.1 0.1 0.2 0.6 0.1 0.1 0.2 0.2 1.3 0.0 0.4 3.7

Ma

Figure 2.2 Impact of Asian cumulative devaluations on Malaysia’s exports and imports Billions of dollars 10.0

5.0 Change in exports 0.0

-5.0

-10.0

-15.0

Change in imports

-20.0 Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

Figure 2.3 Impact of Asian cumulative devaluations on Indonesia’s exports and imports Billions of dollars 10.0

5.0

Change in exports

0.0

-5.0

-10.0

Change in imports

-15.0 Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

46 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure 2.4 Impact of Asian cumulative devaluations on the Philippines’ exports and imports Billions of dollars 2.0 1.0

Change in exports

0.0 -1.0 -2.0 -3.0 -4.0 -5.0

Change in imports

-6.0 -7.0

Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

mediates as a result of a decline in imports from the fall in investment and domestic absorption. The results for the Philippines are displayed in figure 2.4. In the medium-shock scenario, the external balance of the Philippines increases by approximately $6 billion, less than $2 billion in the low-shock scenario, and nearly $9 billion in the final high-shock scenario as shown in appendix C. Most of the trade balance increase occurs in trade with Western Europe and the United States. The largest export increases are in services, textiles and apparel, and light manufactures. Exports of electrical equipment, motor vehicles and parts, and industrial intermediates actually fall due to heightened competition from other suppliers and substitution of domestic production of these products for imports. In the ‘‘best guess’’ medium-shock scenario, real GDP falls by around 7 percent and real absorption by nearly 20 percent. Figure 2.5 reports the aggregate trade results for South Korea. Under the medium-shock scenario, Korean trade balance increases by more than $47 billion, GDP falls by about 7 percent, and domestic absorption falls by more than 22 percent. 21 (By way of comparison, McKibbin [1998] obtains falls in domestic absorption of 30-40 percent and declines of GDP 21. In the low-shock scenario the trade balance improves by nearly $36 billion, while in the high-shock scenario it increases to a whopping $73 billion. Given the recent real appreciation of the Korean won, it is unlikely that an increase of this magnitude will occur. GLOBAL ECONOMIC EFFECTS 47

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Figure 2.5 Impact of Asian cumulative devaluations on South Korea’s exports and imports Billions of dollars 30.0

20.0 Change in exports 10.0

0.0

-10.0

-20.0

-30.0

Change in imports

-40.0 Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

on the order of 12-16 percent in his various scenarios.) The largest absorber of the increase in net exports is the United States (an issue that we will return to in chapter 3), though Japan, Western Europe, and China all absorb some of the Korean trade balance improvement. (Indeed, the only country in the model with which South Korea experiences a decrease in net exports is Thailand.) Sectorally, the largest percentage change in production is in ‘‘other transportation equipment,’’ which includes shipbuilding and repairing. The largest export increases are in machinery and motor vehicles and parts. The largest net export increases are in services, machinery, and industrial intermediates. These increases are primarily due to reduced imports as aggregate demand reduction is reinforced by the substitution of domestically produced goods for imports.

Singapore, Taiwan, and Japan The countries modeled thus far have experienced unambiguous depreciations of their real exchange rates. Characterizing the exchange rate shocks experienced by Singapore, Taiwan, and Japan is a more subtle and ambiguous exercise. Since the crisis broke in July 1997, Taiwan’s currency has experienced a nominal depreciation against the US dollar of about 15 percent, while the currencies of Singapore and Japan have fallen by about 10 percent. However, in terms of real effective exchange rates (taking into account inflation differentials and the pattern of trade), Singapore, 48 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure 2.6 Impact of Asian cumulative devaluations on Taiwan’s exports and imports Billions of dollars 1.0 Change in exports 0.0

-1.0

-2.0

-3.0

-4.0

-5.0

-6.0

Change in imports

Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

Taiwan, and Japan have experienced real depreciations of less than 5 percent (table 2.2). That is to say, the real effective depreciations of these three currencies are considerably less than the nominal depreciation of their currencies against the US dollar. For this reason, in the low-shock scenario, reported in appendix C, we assume that they experience no real depreciation relative to the base. With the depreciation of other countries’ currencies in the low-shock scenario, Singapore, Taiwan, and Japan experience a real effective appreciation. For this reason, the results for these three economies will exhibit greater ambiguity compared to the previous five cases—i.e., the qualitative results are scenario-specific, depending critically on the relative magnitude of the exchange rate and supply-side shocks across the region. Taiwan exports capital equipment and intermediates to Southeast Asia in competition with Japan and the other newly industrialized countries. Figure 2.6 illustrates how exports decline as the Southeast Asian countries and South Korea experience their devaluations and associated supplyside shocks, recover when Taiwan devalues, and then begin to fall again as Singapore and Japan devalue. In the medium-shock scenario, Taiwan’s aggregate exports fall by nearly $3 billion, but imports fall even more, and the overall trade balance increases by around $2 billion.22 (It increases 22. This is consistent with the forecast by the Taiwanese government, which predicted that both aggregate imports and aggregate exports would fall in 1998. See Laura Tyson (Taiwan Economy Achieves Growth Rate of 5.92 Percent, Financial Times, 22 May 1998). GLOBAL ECONOMIC EFFECTS 49

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Figure 2.7 Impact of Asian cumulative devaluations on Singapore’s exports and imports Billions of dollars 8.0 6.0 Change in imports

4.0 2.0 0.0 -2.0 -4.0 -6.0

Change in exports

-8.0 -10.0 -12.0

Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

by about $6 billion in the high-shock scenario. In the low-shock scenario it actually falls by about $2 billion as exports fall and imports remain largely unchanged. In macroeconomic terms, real GDP remains roughly constant and domestic absorption increases—as one would expect in response to a real appreciation of the currency.) With respect to its trade partners, Taiwan experiences, in the medium-shock scenario, an increase in its bilateral balance of more than $2 billion with both Western Europe and the United States, while its bilateral balances decline with the Southeast Asian countries and South Korea. In the medium-shock experiments, the biggest export declines are in machinery and industrial intermediates, which it ships to Southeast Asia, while the ‘‘other transportation equipment’’ and motor vehicle and parts sectors show increases. Net exports fall in textiles and apparel but rise in services and machinery (as domestically produced goods are substituted for imports). Figure 2.7 illustrates the results for Singapore. Because of its small size and entrepoˆt status, modeling the effects of the Asian financial crisis on Singapore is difficult. In this model we held the sectoral composition of Singapore’s output constant and allowed all adjustment to come through trade flows. According to this analysis, in the medium-shock scenario Singapore’s trade balance increases by nearly $4 billion (it increases even more in the high-shock scenario). In the low-shock final experiment, as reported in appendix C, Singapore, like Taiwan, experiences a slight increase in real GDP and domestic absorption, and its trade balance 50 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure 2.8 Impact of Asian cumulative devaluations on Japan’s exports and imports Billions of dollars 15.0 10.0 Change in imports

5.0 0.0 -5.0 -10.0 -15.0 -20.0

Change in exports -25.0 -30.0 -35.0

Thailand

Malaysia

Indonesia Philippines

S. Korea

Taiwan

Singapore

Japan

Cumulative devaluations

decreases by more than US$6 billion. Again, like Taiwan, its bilateral balances with Western Europe and the United States increase, while those with the Southeast Asian countries decline. The aggregate trade results for Japan are shown in Figure 2.8. These are the obverse of those for Thailand: starting with the Thai depreciation, Japan’s competitiveness erodes as its real exchange rate appreciates until experiment 8, when it devalues. In the medium-shock scenario, Japan’s overall trade balance increases by more than $19 billion, including $14 billion of increased net exports to the United States (table 2.5). Added to a slight decline in GDP, the result is a significant decline in absorption (table 2.6).23 Exports in two of Japan’s key sectors are affected differently by the crisis, underlining the merits of using a multisectoral approach. Exports of motor vehicles and parts increase in response to Japan’s enhanced price competitiveness in key markets, but exports of machinery and industrial intermediates actually fall in response to lower economic activity in the rest of Asia, and to intensified competition from South Korea and Taiwan. The result is that net exports of motor vehicles and parts increase, but net exports of machinery decline (table 2.7). 23. This result is scenario-specific. Like the other developed countries, in the low-shock scenario reported in appendix C, Japan experiences a real appreciation, a decline in its trade balance, and a slight increase in GDP. GLOBAL ECONOMIC EFFECTS 51

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Unlike the ASEAN-4 and South Korea, which were running trade deficits at the outset of the crisis and whose increases in net exports could be viewed as reestablishing sustainable external balances, Singapore, Taiwan, and Japan were all running trade surpluses at the beginning of the crisis. The results presented here suggest that they will increase their surpluses even more. Traditional balance-of-payments adjustment analysis holds that countries should adjust by lowering the size of their imbalances—deficit countries should narrow their deficits and surplus countries should reduce their surpluses. While one can criticize this approach on many grounds, to the extent that the ASEAN-4 and South Korea will need a significant swing in their external positions to recover from the crisis, adjustments in Singapore, Taiwan, and Japan appear to be hindering this effort. Rather than maintaining aggregate demand through an increase in external surpluses, these countries should be increasing domestic demand and easing their neighbors’ adjustment burden.

Western Europe and Oceania Beyond Asia, the region most affected by the crisis in absolute terms is Western Europe, which experiences a $55 billion decline in net exports globally. Much of this takes the form of decreased exports to Asia as a consequence of reduced economic activity, with the machinery sector taking a particularly large hit. However, the shock to Europe’s trade balance plus its terms-of-trade improvement, yield an increase in real absorption of nearly 1 percent of GDP. In percentage terms, the most affected region is Oceania. Australia and New Zealand experience a deterioration in their aggregate trade balance of nearly 2 percent of GDP, most of which comes from trade with Japan and South Korea. But as in the case of Europe, the macroeconomic impact of the trade balance change and the income effect (through the terms of trade improvement) increases in real domestic absorption. In terms of the McKibbin (1998) model, which explicitly models the capital account, the capital inflow contributes to lower interest rates that partially offset the fall in exports with an induced increase in investment. Australian gross domestic production (GDP) falls in the short run by 0.05 to 0.25 percent, depending on whether the crisis reflects ‘‘temporary’’ or ‘‘permanent’’ shocks (our estimate in table 2.6 is 0.15 percent), but rises in the long run, reflecting a reallocation of world production. However, national income, measured in terms of GNP, does the opposite—it rises in the short run and then falls in the long run as capital owned by Australian residents earns a lower return in Australia than it would have if invested in Asia.24 24. A similar argument could be applied to the case of Western Europe, and, in the lowshock scenario, to the case of Japan reported in appendix C. 52 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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China This leaves China—the shoe that has not dropped. Conventional wisdom has it that China, thanks to its capital controls, has remained largely immune to the contagion that swept Asia. Makin (1997), for example, has argued that not only have the capital controls prevented the kind of turmoil in the foreign exchange markets experienced elsewhere in Asia, but the state’s strong influence over the economy through its control of decision making by state-owned enterprises (SOEs) and the banking system essentially allows it to keep output high despite market pressure for a contraction. The problem is that much of this output (in manufactures, at least) appears to be accumulating as inventory in warehouses, and much of it may be worthless on world markets. Unable to sell their output, these SOEs must rely on loans to maintain production. Ultimately these SOEs must be restructured and many, if not most, will either be downsized or shut down completely. The magnitude of labor shedding associated with this process could be vast—up to one-third of the 100 million SOE workers could be displaced. It is unlikely that many of the loans to these SOEs will ever be repaid. Lardy (1997) quotes an official statement to the effect that 22 percent of loans made by China’s largest banks are nonperforming; he argues that this statement probably understates the true magnitude of the problem.25 This means that China’s nonperforming loan problem would easily put it in the same league as the other Asian countries (table 1.2). Similarly, the BIS figures on bank indebtedness suggest that the foreign debt exposure of China’s banks is on a scale roughly comparable to that of the other Asian countries (Corsetti, Pesenti, and Roubini 1998). Despite its huge foreign exchange reserves and its nonconvertible currency, China appears to be susceptible to the same kind of financial turbulence that has affected the rest of Asia. Moreover, China appears to be coming under the same kind of deflationary pressures as the other Asian countries. With aggregate demand weakening, the government is embarking on large-scale public works projects. Facing incipient deflation and falling aggregate demand, one textbook solution for China would be to devalue its currency, the renminbi. Although this would increase the domestic resource cost of servicing the outstanding foreign debt, devaluation would represent a boost to competitiveness in the traded-goods sector, which could be particularly important in industrial restructuring. As shown in figure 2.9, under the medium-shock scenario, the Asian financial crisis reduces China’s global trade balance by $12 billion. Most of this reduction comes from changes 25. An even higher figure of 25 percent for the share of nonperforming loans was cited in the 8 December 1997 issue of the Financial Times, while Steinfeld (1998) calls ‘‘conservative’’ an estimate that puts nonperforming loans as a share of GDP at 25 percent. GLOBAL ECONOMIC EFFECTS 53

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Figure 2.9 Impact of Asian cumulative devaluations on China’s exports and imports Billions of dollars 2 0

Change in imports

-2 -4 -6

Change in exports

-8 -10 -12 -14 -16 Thailand

Malaysia Indonesia Philippines S. Korea

Taiwan

Singapore

Japan

China

Cumulative devaluations

in trade with Japan and South Korea.26 This is due to the direct effects on China’s trade with its Asian partners, as well as indirect effects through the loss of competitiveness in third markets. The question naturally arises: What would be the magnitude of the real depreciation necessary to reestablish the status quo defined in terms of China’s precrisis trade balance? Our simulations show that in the mediumshock scenario a 6 percent real devaluation on the Chinese side is sufficient for it to reattain its initial position.27 The bilateral trade matrix for the medium-shock scenario is reported in table 2.9. Relative to the base, China’s bilateral balance with the United States increases by $5 billion. However, the incremental impact of China’s 6 percent devaluation on the US global trade balance is only about $4 billion, which increases the accumulated impact on the US external balance to $47 billion dollars—i.e., China competes in the US market with other Asian countries, and the direct impact of a Chinese devaluation on

26. As reported in appendix C, China’s trade balance falls by $4 billion in the low-shock scenario and more than $20 billion in the high-shock scenario. 27. In the low-shock scenario a real devaluation of only 2 percent would be needed to reestablish the status quo ante, while in the high-shock scenario a devaluation of 10 percent would be necessary. 54 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table 2.9

Change of bilateral trade flows from the base (current price, with productivity shock, Chinese devaluation included) (billions of dollars)

USA CAN MEX WEU OCN JPN KOR TWN CHN USA CAN MEX WEU OCN JPN KOR TWN CHN IDN THA PHL SGP MYS SAS LTA ROW

0 0 –2 0 14 13 3 5 2 5 2 2 4 0 0 1

0 0 0 0 2 1 0 1 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

2 0 0 1 11 8 2 7 5 9 2 2 5 0 2 5

0 0 0 –1 2 2 0 1 1 1 0 0 1 0 0 0

–14 –2 0 –11 –2 9 0 0 3 8 1 1 3 –1 –3 –6

–13 –1 0 –8 –2 –9 –1 –2 0 0 0 –1 0 –1 –4 –5

–3 0 0 –2 0 0 1 1 0 1 0 0 1 0 0 0

–5 –1 0 –7 –1 0 2 –1 1 1 0 0 0 0 –1 –2

IDN –2 0 0 –5 –1 –3 0 0 –1 0 0 –1 0 0 –1 –1

THA PHL SGP MYS SAS LTA ROW TOT –5 0 0 –9 –1 –8 0 –1 –1 0 0 –2 –1 0 –1 –4

–2 0 0 –2 0 –1 0 0 0 0 0 0 0 0 0 –1

–2 0 0 –2 0 –1 1 0 0 1 2 0 2 0 0 –2

–4 0 0 –5 –1 –3 0 –1 0 0 1 0 –2 0 –1 –1

Note: USA = United States, CAN = Canada, MEX = Mexico, WEU = Western Europe, OCN = Australia and New Zealand, JPN = Japan, KOR = South Korea, TWN = Taiwan, CHN = China and Hong Kong, IDN = Indonesia, THA = Thailand, PHL = Philippines, SGP = Singapore, MYS = Malaysia, SAS = South Asia, LTA = Latin American and Caribbean nations, ROW = rest of world, and TOT = total.

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0 0 0 0 0 1 1 0 0 0 0 0 0 0 0 0

0 0 0 –2 0 3 4 0 1 1 1 0 0 1 0 0

–1 0 0 –5 0 6 5 0 2 1 4 1 2 1 0 0 -

–47 –4 –1 –61 –6 14 46 2 13 15 33 6 2 17 –3 –11 –16

the United States is reduced in part (by roughly $1 billion) by offsetting decreases in the US trade deficit with other Asian countries.28 With respect to other countries, such a devaluation brings China’s bilateral balance with Japan back to the precrisis level—that is, completely offsetting the Japanese devaluation. In the case of South Korea, the Chinese devaluation partly offsets the impact of the earlier Korean devaluation. Sectorally, relative to the base, China’s net exports fall in services, textile and apparel, light manufactures, and machinery. This is largely driven by declines in exports, as China loses competitiveness relative to the rest of developing Asia. With the devaluation, however, net exports improve significantly in machinery, industrial intermediates, and light manufactures, largely due to import substitution. Overall, these figures suggest that the impact of the Asian financial crisis on China, though considerable, might be relatively small compared to the magnitude of the problems that China confronts. Given the unsettled situation in the region (in which financial markets remain skittish and the wrenching process of real adjustment is only beginning), our results—that the crisis should have only a relatively modest impact on China—strongly argue for restraint on China’s part. A devaluation could amount to smashing a lot of crockery for relatively minor gains. Indeed, if a Chinese devaluation sparked another round of financial turbulence, China could end up even worse off. In this situation, a more sophisticated textbook is required. Nevertheless, the Asian financial crisis is not beneficial in light of the tasks that China faces. Exports account for about 30 percent of the Chinese GDP and contribute roughly 3 to 4 percentage points to China’s GDP growth. A slowdown in the export sector will surely cause job losses and exacerbate an already severe unemployment problem.29 For a society without a well-developed social safety net, massive unemployment could lead to social unrest. Chinese officials, including Premier Zhu Rongi, have repeatedly declared that, for the sake of regional stability, China will not devalue its currency, earning the Chinese leadership both international praise and credibility. Although regional stability may be one of China’s concerns, maintaining stability in Hong Kong is another.30 A Chinese devaluation 28. Noland (1998a), using a different modeling approach and a far more disaggregated set of sectors, obtained a much greater degree of apparent substitutability between Chinese exports to the United States and those of other suppliers, suggesting that the impact on the US market might be smaller than indicated in table 2.9. 29. The official unemployment rate is 3.1 percent, but if unregistered unemployed workers are included, this estimate rises at the high end: 7.5 percent of the urban workforce might already be out of work (China News Digest, 22 February 1998). Also, if migrants from rural areas are included in the calculation, the number could be even higher. 30. Although Hong Kong has successfully defended its peg, the costs have been significant— high interest rates have put a heavy toll on the banking and real estate sectors, the core of 56 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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could lead to increased trade tensions with the United States and impede China’s entry into the WTO. By demonstrating that it can act responsibly, China may seek to dispel doubts about whether or not it would be a constructive force as a member of the WTO. Still, China faces the task of maintaining aggregate demand in an economically rational way. The problem is its lack of macroeconomic policy tools. To offset the potential reduction in external demand, one option would be to use fiscal stimulus by spending funds on infrastructure and residential housing to revive domestic demand and soak up unemployment. But it is unclear from whence the necessary funds would come.31 The development of an efficient government bond market would be highly useful in this regard: it could finance China’s huge long-run infrastructural needs; it could help satisfy the country’s pension fund investment needs; it would promote banking sector reform and financial market development; and it would contribute to macroeconomic management and control. Indeed, development of an efficient bond market could even promote China’s entry into the WTO (Graham and Liu 1998). Obviously, without a set of well-defined commercial laws and regulations, a consistent accounting system, or proper disclosure, an efficient and deep bond market simply will not develop. However, by tackling these problems now, especially with the government as a major player in the initial stage of the bond market development, China could benefit immensely from such an important capital market in the long run.

Conclusion In this chapter a multicountry CGE model has been used to analyze the implications of the Asian financial crisis for the global economy. Several key points stand out. First, there is considerable uncertainty as to how much of recent movements in nominal exchange rates will ultimately be translated into real exchange rate changes. The nominal changes could reverse themselves, and increases in inflation in the affected countries could erode the real depreciation associated with a particular nominal depreciation. the economy. The conventional wisdom is that if China ever devalues its currency, it will invite speculators to attack Hong Kong’s currency again and undermine the stability of Hong Kong’s economy. Not all observers agree with this view, however: Hong Kong is mainly a service center for southern China, and a devaluation that boosts the competitiveness of the export industries of southern China would increase demand for Hong Kong’s services. 31. Since reforms were inaugurated, central government revenue as a share of the GDP has decreased: budgetary revenues dropped from 35 percent of GDP in 1978 to 11 percent in 1995 (and have since stabilized at around 12 percent). It is estimated that 15 of the 24 percentage points that dropped were directly attributable to lower tax collections from SOEs (World Bank 1997). Also, see Ma (1997) for a detailed analysis on this issue. GLOBAL ECONOMIC EFFECTS 57

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To address this uncertainty we have computed three sets of results, each associated with a different pattern of real exchange rate and supplyside shocks. In the cases of the ASEAN-4, South Korea, Western Europe, Oceania, and China, the qualitative results obtained from the simulations are largely robust across the three sets of experiments: the ASEAN-4 and South Korea experience significant declines in domestic absorption, increases in net exports, and an overall decline in domestic output. The greater part of external adjustment comes from declines in imports rather than increases in exports. The sectoral composition of the increase in net exports tends to be concentrated in labor-intensive manufactures, though there are considerable differences across countries in this regard as previously discussed. All of them experience increases in their bilateral balances with the United States and Western Europe. In the cases of Singapore, Taiwan, and Japan, where there is more uncertainty about the ultimate direction of the real exchange rate changes emerging from the crisis, the results are more ambiguous. Their trade partners in developing Asia are experiencing both real significant depreciations and considerable compressions of domestic absorption. Absent sufficient real exchange rate depreciations of their own, Singapore, Taiwan, and Japan experience net declines in output driven by falling exports to, and rising imports from, developing Asia. However, if their own exchange rates are allowed to depreciate sufficiently, then some of the negative spillover from developing Asia can be offset by an increase in net exports to the United States and Western Europe. In the mediumshock scenario this is indeed what happens: Singapore, Taiwan, and Japan increase their global surpluses despite falling surpluses with the rest of Asia. That is to say, under the ‘‘best guess’’ scenario, these three off-load adjustment to the crisis onto the rest of the developed world. Given that developing Asia must increase its net exports to recover from the crisis, the response of three surplus countries in the region to increase their surpluses even further would appear to hinder the adjustment process. To a significant extent, China competes against the ASEAN-4 in third country markets. As developing Asia depreciates, Chinese exports to developed-country markets fall. The impact on China is not particularly large, though. China could recoup the loss in competitiveness with relatively small real devaluations—on the order of 2-10 percent in real terms, depending on the magnitude of the real depreciations experienced elsewhere in Asia. However, given the relatively small direct impact of the crisis on China, and the possibility of a Chinese devaluation igniting another round of financial turbulence and competitive devaluations throughout the region, the use of other tools of macroeconomic management by China would be preferable. Lastly, developed economies such as Western Europe and Oceania are affected in subtle ways by the crisis. They experience a real appreciation, 58 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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and their traded-goods sectors are hit by falling demand in Asia for exports and rising competition from Asia for their domestic-import competing sectors. At the same time, the real appreciation generates positive terms-of-trade and income effects. The reduced demand for capital in Asia contributes to capital inflow and lower interest rates at home. As a result of these effects, the nontraded-goods sector experiences an expansion. Overall, this model indicates that these regions experience an increase in domestic output.32 The same story holds for the United States. We now turn to the crisis’ impact on the United States and its possible policy ramifications.

32. McKibbin (1998) argues that national income could fall if the rate of return on domestic investment is significantly lower than what could have been obtained overseas in different circumstances. GLOBAL ECONOMIC EFFECTS 59

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3 Impact on the United States

Since many Asian goods are exported to the United States (in David Hale’s words, the world’s ‘‘consumer of last resort’’), the consequences of Asian competitive devaluation on the US trade balance are enormous. In the medium-shock scenario, defined in table 2.4, US exports decline, imports rise steadily through the 8 experiments, and the trade deficit grows to $43 billion. If China devalues to reestablish its precrisis trade balance, this figure rises to more than $47 billion (figure 3.1).1 These figures are in terms of nominal current prices—what would actually be observed. In base prices (those that do not take into account relative price and terms-of-trade effects used in computing the national accounts), the increase in the US deficit would be bigger—nearly $65 billion for the shocks that have occurred thus far, and close to $70 billion if China experiences a 6 percent real devaluation. Moreover, the model is calibrated for 1995. If accumulated inflation in wholesale prices is taken into account, the figures rise to $67 billion and $73 billion, respectively. The biggest increases in the deficit are generated by trade with Japan and South Korea. These countries are large exporters, have large bilateral trade flows with the United States, and experience large real exchange rate depreciations. Trade with China, which does not experience

1. These are our central estimates: Without Chinese devaluation, the US deficit increases by $76 billion in the high-shock scenario and by less than $15 billion in the low-shock scenario. McKibbin (1998) obtains a reduction in the US current account balance of roughly 1 percent of GDP for 1998, which is toward the higher end of our estimates. 61

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Figure 3.1 Impact of Asian cumulative devaluations on United States exports and imports Billions of dollars 20

10 Change in imports 0

-10

-20 Change in exports -30

-40 Thailand

Malaysia Indonesia Philippines S. Korea

Taiwan

Singapore

Japan

China

Cumulative devaluations

a devaluation in the initial experiments, accounts for a relatively small share of the increase (table 2.6). Sectorally, the increase in the US deficit is generated mainly by decreases in exports to Asia of machinery, services, and industrial intermediates, and by increases in imports from Asia of motor vehicles and parts, electronics, and machinery.2 In percentage changes, the fall in exports is greatest for other transportation equipment, which includes aircraft, and forestry and fisheries (see table 3.1).3 Production falls throughout the traded-goods sector (with the possible exception of the energy sector)— with the machinery and electronics industries hit particularly hard— reflecting an increase in imports and a decrease in exports (table 3.1).4 2. These results can be contrasted with those obtained by Scott and Rothstein (1998) who posit a $200 billion increase in the trade deficit and then simply assume that the sectoral distribution of the trade impact would be the same as in 1981-85, though the source of the shock to the trade account is entirely different. (Of course the trade balance is simply the obverse of the savings-investment balance, and Scott and Rothstein do not address the issue of whether an increase in the trade balance of this magnitude is even plausible, given basic macroeconomic constraints.) Using this methodology they obtain the outlandish result that the Asian financial crisis would cause a 22 percent fall in US domestic output of industrial machinery. Similarly bizarre results are obtained for other sectors. 3. Similar tables could be constructed for all other regions in the model but are omitted for the sake of brevity. 4. In one scenario, the energy sector slightly increases output. See appendix C. 62 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table 3.1 Impact of Asian cumulative devaluations on US trade and sectoral production (medium-shock scenarios, with and without 6 percent Chinese devaluation) (percentages) Change in exports Without China Agriculture Processed food Forestry and fishery Mining Energy Textile and apparel Light manufactures Intermediate goods Motor vehicles and parts Other transportation equipment Electronics Machinery Housing and construction Services Total

–5.42 –4.33 –7.25 –5.06 –3.54 –3.56 –5.96 –3.24 –2.94 –8.74 –4.59 –4.86 –5.86 –3.90 –4.38

With China

Change in imports Without China

–6.47 –5.12 –8.19 –5.60 –3.64 –4.83 –6.90 –3.56 –2.93 –9.21 –4.85 –5.13 –5.76 –3.96 –4.70

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–0.44 0.74 –2.43 0.48 1.31 0.92 1.18 0.57 3.77 5.96 2.40 1.12 1.40 0.95 1.49

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With China –0.62 0.79 –3.03 0.60 1.45 1.18 1.48 0.75 3.84 6.85 2.62 1.31 1.56 1.19 1.67

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Change in production Without China –0.89 0.02 –1.39 –0.49 –0.01 –0.63 –0.82 –0.71 –1.21 –1.13 –2.38 –2.63 0.71 0.39 –0.07

With China –1.06 0.00 –1.68 –0.57 0.01 –0.99 –1.24 –0.79 –1.10 –1.20 –2.50 –2.82 0.79 0.44 –0.07

However, the impact on the traded-goods sector is more than offset by an increase in output in the largely nontraded housing and construction and services sectors due to the real income increase associated with the real exchange rate appreciation. In terms of macroeconomic aggregates, the terms-of-trade effect generates an increase in consumption, and with government expenditure and investment relatively stable, the result is a fall in savings. This outcome resembles the US experience in the first half of the 1980s—a decline in savings, an increase in investment, and a shift in the composition of output toward nontradables. In the medium-shock scenario the effect is only about one-half to one-third as large (relative to national income) as experienced in the early 1980s. Similar results for the United States are obtained by McKibbin (1998) (who explicitly models the capital account) for his ‘‘permanent’’ shock case (equivalent to our ‘‘fundamentalist’’ story). In McKibbin’s model, the capital inflow associated with the increase in the trade deficit depresses domestic interest rates and induces an increase in investment. As in our model, gross domestic production (GDP) increases.5 (In the short run, less than 0.1 percent, as in our model.) However, as McKibbin points out, though domestic production has increased in the short run, national income may actually be lower in the long run, especially if the rate of return on the induced domestic investment is lower than the rate of return on foreign investment, had the crisis not occurred.6

Trade Policy Response The Asian financial crisis could be expected to influence US economic policies in a variety of ways. In the short run the inflow of capital and the weakening of export demand that has occurred in the wake of the crisis has reduced some of the pressure on the Federal Reserve to tighten monetary policy in light of the cyclical position of the US economy. In the long run, as real adjustment occurs in the United States, there could be increased attention to distributive or adjustment policies to assist workers adversely affected by the impact of the crisis. Although the Asian financial crisis may not have a significant effect on the United States in macroeconomic terms, it is of obvious importance to the affected Asian countries, and, given their need to increase net exports to recover, US trade policy is critical. The results reported in the previous section indicate that the changes in trade flows are expected to substantially increase US bilateral trade deficits with a number of its Asian trade 5. In McKibbin’s ‘‘temporary’’ shock case (the ‘‘panic’’ or loss of confidence story), US GDP actually falls initially. 6. This could occur if the long-run rate of return on capital were lower in capital-abundant countries (such as the United States) than in capital-scarce regions (like developing Asia). 64 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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partners. The pattern of bilateral trade conflict (and its resolution) between the United States and its trade partners has been a topic of recent research (Noland 1996b, 1997c). Significantly, the most striking result is that trade conflicts are linked to the magnitude of bilateral imbalances. In other words, the projected pattern of Asian adjustment is on a collision course with the history of US trade policy response. A fundamental problem faced by analysts of trade policy is that the United States takes relatively few formal actions against its trade partners—most trade disputes are resolved before formal actions or sanctions are applied. To understand the degree of interaction prior to the formal dispute stage, the number of pages devoted to the analysis of trade issues with partner countries in the US Trade Representative’s (USTR) annual National Trade Estimate Report on Foreign Trade Barriers has been taken as an indicator of attention while the initiation of legal processes that could lead to sanctions has been used as a proxy for action. As can be seen in table 3.2, Asian countries appear to get more than their share of attention from the USTR. Some simple correlations between these trade conflict variables and a number of other variables are reported in table 3.3.7 Note the strong correlation between trade conflict and the magnitude of bilateral imbalances. 7. The correlations were calculated with respect to the United States’ 36 largest non-oil trade partners, together accounting for more than 95 percent of US trade and investment. The correlations were calculated from the beginning of the publication of the annual in 1984 until the merger of several of the sample countries into the European Union in 1993. See Noland (1997c) for details. IMPACT ON THE UNITED STATES

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65

As shown in table 3.4, the simple correlation is further substantiated by multivariate regressions. The degree of trade conflict between the United States and its partners is highly correlated with the magnitude of bilateral trade imbalances and other variables.8 The question immediately arises as to whether this trade pressure is successful—that is, has it eliminated access barriers encountered by US firms? On this point the evidence is weak. There is evidence, however, that the United States has tended to be the most successful in resolving issues such as export subsidies 8. In the cross-section regression (4.1), seven countries are omitted from the regression due to lack of data on intrafirm trade; in the panel regressions (4.2 and 4.3), the intrafirm export variable is omitted due to lack of time-series data for this regressand. In addition to the tariff variables reported in table 3.3, estimates of nontariff barriers were also included but are not reported here for brevity’s sake. Regional dummy variables were also included to test whether US trade policy had a particular regional bias, but these variables were seldom significant. There was no evidence that Asia or China were singled out for particular scrutiny, though there was some evidence that Japan received more attention than its economic characteristics would warrant. See Noland (1996b, 1997c) for these results and a description of the instrumental variable estimator employed. 66 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table 3.4 Bilateral trade conflict SAMPLE DEPENDENT VARIABLE CONSTANT GDP GDPGROWTH

4.1

4.2

4.3

N ⳱ 28, 1993

N ⳱ 360, 1984-93

N ⳱ 360, 1984-93

Attention

Attention

Action

5.63 (2.46)b

—

—

3.44E-6 (1.38)

0.01 (3.65)a

ⳮ0.00 (ⳮ0.29)

0.32 (1.42)

4.56 (2.04)b

1.83 (0.83)

ⳮ2.74E-4 (ⳮ1.89)c

TBAL

ⳮ0.30 (ⳮ4.60)a

IIT

ⳮ6.99 (1.98)b

2.09 (1.58)

EXPORT

3.92E-4 (2.52)b

ⳮ0.08 (1.56)

ⳮ0.02 (ⳮ0.61) 2.32 (2.83)a 0.02 (0.63)

INFEXP

ⳮ7.41E-4 (ⳮ1.84)c

—

FDI

ⳮ2.31E-5 (ⳮ0.27)

0.07 (2.29)b

TARIFF

ⳮ0.08 (ⳮ0.64)

1.20 (0.25)

1.89 (4.01)a

STNDTAR

2.15 (ⳮ0.62)

ⳮ3.55 (ⳮ0.09)

4.57 (2.83)a

R2

0.90

— ⳮ1.54 (ⳮ0.09)

0.21 ⳮ117.02

log likelihood Cases correct (percentage)

0.88

Note: INFEXP ⳱ intrafirm exports (millions of dollars). See table 3.3 for definitions of other variables. a. Significant at the 1 percent level. b. Significant at the 5 percent level. c. Significant at the 10 percent level. Sources: For column 4.1, Noland (1996b, table 11); for 4.2, Noland (1997b, table 4); and for 4.3, Noland (1997b, table 5).

or countertrade where well-specified international norms exist, and less successful on issues such as intellectual property rights or government procurement for which rules were less well established during the period under analysis. (Success here is defined as the disappearance of an issue from the bilateral negotiating agenda—there is little evidence of an impact of these actions at the level of aggregate bilateral trade or investment.) IMPACT ON THE UNITED STATES 67

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Success rates can also be analyzed by partner country characteristics. In table 3.5, the sample consists of all (1,508) trade issues raised by the United States with its partner countries during the sample period. The results indicate that the greater the dependence on the US market (measured in terms of the shares of exports to and imports and investment from the United States in partner country national income), the greater the likelihood that the United States successfully pursued its complaints. The figures representing the change in US bilateral exports and trade balances from table 2.5 have been inserted into the 4.2 and 4.3 regression results to generate projections of US trade attention and action. As shown in table 3.6, these results indicate that there would be a 14 percent increase in attention devoted to trade problems in Asia—with Japan and South Korea taking the most prominent roles. The medium-shock scenario changes in bilateral balances do not imply large changes in the probability of formal actions, except for South Korea, for which the increased likelihood of formal trade action is considerable. If the 50 percent level is interpreted as the threshold where one moves from a projection of inaction to action, South Korea would be the additional country where one would project formal US trade action based on the projected trade changes. Finally, the simulation results imply that Asian countries increasingly depend on the US market. Combining table 2.5 results with table 3.5 regression results (and ignoring the crises’ impact on foreign direct investment flows, for which we do not have projections), we see that this increased dependence is indeed translated into a greater probability of resolving disputes to the satisfaction of the United States—with increases 68 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table 3.6 Impact on US trade relations

Indonesia Japan Malaysia Philippines Singapore South Korea Taiwan Thailand TOTAL

Attention (actual pages) 8 46 5 8 4 20 11 7

Attention (projected, medium shock, no Chinese devaluation) 10 51 6 9 4 23 12 9

109

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Probability of action (percentage) 8 94 41 26 0 45 20 12

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Probability of action (projected, medium shock, no Chinese devaluation) 9 96 44 27 0 51 24 13

Increased likelihood of success (percentage) 55 22 120 48 25 65 16 63

ranging from 16 percent in Taiwan to 120 percent (i.e., more than doubling the likelihood of success) in Malaysia.9 However, two considerations suggest that US policy may not follow these model results. First, the sample period of the underlying model was not a financial crisis period. It may well be that, during a financial crisis, concerns about financial stability would mitigate against trade actions. One might expect agencies such as the Treasury Department, the State Department, the Department of Defense, and the National Security Council to mobilize bureaucratically to temper trade disputes to a greater degree than if these developments occurred during more ‘‘normal’’ times. Second, the underlying regression model was estimated for a sample period prior to the formation of the World Trade Organization (WTO), whose existence, along with its more effective dispute settlement mechanism (DSM), may alter the way that trade disputes are resolved in the future. In particular, it would appear that the WTO and its DSM significantly constrain the United States’ ability to unilaterally use actions under Section 301 of the Trade Act of 1974 in the absence of DSM panel decisions authorizing retaliation. As a consequence, political pressure for action may manifest itself in terms of different policy tools. One possibility would be through Section 201 ‘‘escape clause’’ petitions, though these have only been used sporadically since the early 1980s. A more likely avenue would be through antidumping actions. In contrast to Section 301 cases, these are explicitly WTO-consistent and are less subject to interagency politics. Empirical research indicates that the number of antidumping cases is positively correlated with import penetration and bilateral imbalances—both of which would increase according to our model.10 Studies of the direct impact of real exchange rate appreciation in the United States have obtained mixed results, though more recent studies support the hypothesis that real exchange rate appreciation increases the number of cases.11 The nominal appreciation of the US dollar may make it harder to prove dumping, but an affirmative injury finding would be more likely. Given the elasticity of the Commerce Department’s

9. Malaysia’s significant increase is due to the relatively large size of its trade sector and its relative dependence on the United States as a trade partner. 10. See Salvatore (1989), Tharakan (1991), Tan and Lichtenberg (1994), and Tharakan and Waelbroeck (1994). 11. Salvatore (1989), using annual data from 1954 to 1986, found that the real exchange rate operates only indirectly through the impact on bilateral balances. Feinberg (1989) examined actual filings between 1982 and 1987 and found that the real exchange rate was negatively correlated with both filings and positive determinations. Stallings (1993) estimated a variety of econometric models using quarterly data for 1980-88 and found that real exchange rate appreciation was positively associated with antidumping and countervailing duty filings with an elasticity on the order of 3-5. That is, for every 1 percent of real exchange rate appreciation, there was a 3 to 5 percent increase in cases. 70 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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definition of dumping, the injury test is the only real constraint on the imposition of antidumping duties. These remedies would only be available to importers, however, and our results indicate that the crisis will significantly affect US exporters. In this regard, the IMF programs successfully negotiated with several Asian countries contain trade liberalization provisions, as well as the WTO’s DSM—which may be useful in impeding potential backsliding on the part of the affected economies.12 In the end, the virulence of the possible trade policy backlash could be strongly affected by the macroeconomic environment in which this adjustment occurs. As previously noted, the projected adjustment pattern for the United States is similar to its experience in the mid-1980s, though on a smaller scale. This earlier period was a time of growing trade policy activism on the part of both the Congress and the Reagan administration (Destler 1995). A major difference between the US economy in the mid1980s and the current situation is that earlier the United States was emerging from a deep recession and, more generally, an extended period of lackluster economic performance. Unemployment was relatively high. In contrast, going into the Asian financial crisis the United States was experiencing an unprecedented expansion, and, indeed, many have argued that the crisis actually helped the economy from overheating. As long as the overall economic environment remains robust, the swings in the trade deficit may not have a major impact on policy. If the US economy weakens significantly and unemployment rises, then a significant backlash on trade policy could be a result. If this were to occur in the United States, it would surely be emulated elsewhere in the world.

Conclusion As a result of the Asian financial crisis, the United States will experience a negative shock to its external position regardless of the scenario. Our central estimate is that the US deficit increases by approximately $43 billion, with most of this coming from Japan and South Korea. (The direct impact of a Chinese devaluation on the United States would not be particularly great, in part just reallocating the US trade deficit across partners.) The consequences to the US economy vary across sectors. The traded-goods sectors experience a decrease in output, and the nontradedgoods sectors (housing and construction, and services) increase. Indeed, 12. The best known of these was the commitment to open the Korean automobile market and greatly increase the access of foreign financial services firms to the Korean market as part of its IMF package. However, these commitments are not legally ‘‘bound’’ in terms of the WTO and would not be actionable there. Indeed, the creation of a new trade agreement compliance and monitoring program by the United States may actually contribute to frictions. IMPACT ON THE UNITED STATES 71

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the impact of the income effect associated with the real appreciation and the improvement in the US terms of trade are such that gross domestic product (GDP) actually rises slightly.13 In this regard, the impact of the Asian financial crisis on the United States is similar to that which occurred in the mid-1980s, when the traded-goods sector was adversely affected by the US dollar’s real appreciation while the nontraded-goods sector boomed. We estimate the impact of the current episode would be about one-third to one-half as large as the effect felt in the 1980s. When the United States experienced significant real appreciation and growing trade deficits in the mid-1980s, the government responded by increasing trade pressure on partner countries. If history is a guide, the United States is likely to increase the attention it pays to trade problems and it may well undertake a greater number of formal actions in an attempt to resolve them. Indeed, the increased dependence of the Asian countries on the US market will increase the likelihood that the United States will resolve the disputes to its satisfaction. For several reasons, the present situation differs significantly from the pattern set in earlier years. First, the current situation arises in the context of financial crises, not normal macroeconomic adjustment. It may well be the case that agencies of the US government concerned with financial, political, and military issues will mobilize to a greater degree to forestall trade disputes. Second, the existence of the WTO significantly reduces the possibility that the United States will use Section 301, its primary tool of trade policy—unilateralism. As a consequence, disputes on the import side are likely to be manifested as antidumping cases brought by US firms against foreign competitors. Ironically, US exporters may make greater use of the WTO to oppose backsliding by Asian countries as they attempt to deal with their own adjustment. Finally, the earlier episode occurred during a period of weak macroeconomic performance in the United States. The present crisis occurred during an unprecedented US expansion. If the US economy remains robust, then trade policy pressure may not be significant. However, if the US economy weakens, there could be a significant backlash on the trade policy front, and were this to occur, it is likely that US actions would be emulated abroad.

13. A similar result is obtained by McKibbin (1998), who examined the impact of the crisis on US interest rates. In the long run, however, he argues that US national income measured in GNP terms might be lower if the rate of return on domestic investment were significantly lower than the returns that would have been obtained on foreign investment in the absence of the crisis. 72 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Appendix A Algebraic Description of the Model

This appendix provides a detailed description of the 17-region, 14-sector model for world production and trade used in this analysis. The model is neoclassical in spirit and is part of a long tradition of multicountry, multisector, computable general equilibrium (CGE) models. The earliest world CGE models were developed by Whalley (1985) and Deardorff and Stern (1990) to analyze the impact of the Tokyo Round of GATT negotiations. Our model is based on the WALRAS world model developed at the OECD (Burniaux et al. 1990) and is similar to the models of ASEAN and APEC developed by Lewis, Robinson, and Wang (1995) and Lewis and Robinson (1996). Our particular China-focused model was developed by Wang (1994, 1997). We apply the Whalley (1985) approach to endogenize all regions (including the rest of the world) and incorporate the macroeconomic specifications from Devarajan, Lewis, and Robinson (1990). We also include an international shipping sector similar to the global trade analysis project (GTAP) model (Hertel 1997). However, in this application, the commonly used Leontief supply-side technology (cf. de Melo and Tarr 1992) is replaced by a more flexible constant elasticity of substitution (CES) production function, which allows substitution between valueadded and aggregate inputs in the upper level of the production tree. On the demand side, the standard LES demand system has been extended to an extended linear expenditure system (ELES), allowing endogenous household saving decisions in the model. Because duality is used throughout the specification, the model is relatively simple and transparent in structure. 73

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The model includes 17 regions1, each with 14 sectors2 and 5 primary factors: agricultural land, natural resources, capital, unskilled labor, and skilled labor.3 The regions are linked by commodity trade, with world commodity prices determined endogenously to clear world markets. Primary factors are mobile across regional sectors (except agricultural land and natural resources, which are sector-specific), but internationally immobile. Prices and wages (including the rental rate of capital) are determined to clear regional commodity and factor markets. However, the financial crises could be expected to cause a variety of disruptions in the economy that would move it from a full employment equilibrium. We model this by introducing negative supply-side shocks as described in the next section.

Economic Agents and Factor Endowments Three demand-side agents are assumed for each region: a single aggregate private household that buys consumer goods, the government that buys the goods and the services of public administration, and an aggregate capital account or an aggregated investor that purchases capital goods. Factor endowments are owned by households and set exogenously. Households sell the two categories of labor and rent capital to firms, and allocate their income from factor returns to savings and expenditures. The capital account collects savings from households, government, and firms, thereby accounting for foreign capital inflows or outflows. Investors can use total regional savings to purchase capital goods for gross investment.

Production There is only one competitive firm in each sector of each region, which produces only one product. Production is characterized by two-level 1. The 17 regions used in the model are the United States, Canada, Mexico, Western Europe, Oceania (Australia and New Zealand), Japan, South Korea, Taiwan, China (including Hong Kong), Indonesia, Thailand, the Philippines, Singapore, Malaysia, South Asia, Latin America and the Caribbean nations, and the rest of the world. 2. The 14 sectors are agricultural products, processed food and beverages, forestry and fisheries, mining, energy, textile and apparel, light manufactures, industrial intermediates, motor vehicles and parts, other transportation equipment, electronics, machinery, housing and construction, and services. 3. Skilled labor is defined as International Labor Office (ILO) International Standard Classification of Occupations (ISCO) occupation groups 0-2 (Professional; Technical and related workers; Administrative and managerial workers). The remainder—ISCO 3-5 (Clerical and related workers; Sales workers; Service workers), ISCO 6 (Agricultural workers), and ISCO 7-9 (Production and related workers; Transport equipment operators; and Laborers)—are classified as unskilled. 74 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Figure A.1 Structure of production

SECTOR OUTPUT

Constant elasticity of transformation

Constant elasticity of substitution

DOMESTIC SUPPLY

EXPORTS

Cost-minimizing input bundle

COMPOSITE PRIMARY FACTOR Constant elasticity of substitution

AGGREGATE INTERMEDIATE INPUTS Fixed proportion input requirements

Cost-minimizing input bundle

Composite good 1

Composite Composite good 2 . . . . good n

Agricultural Natural Unskilled Skilled Capital land resources labor labor Domestic Imported . . . . Domestic Imported product 1 product 1 product n product n

interlinked CES functions. At the first level, firms optimize over two inputs: a composite primary factor and an aggregate intermediate input. At the second level, firms can substitute among the five primary factors (again, according to a CES cost function), but the demand for produced intermediate inputs must follow the Leontief specification that forecloses substitution among them. The degree of substitutability between the composite primary factor and the aggregate intermediate, as well as among the five primary factors, depends on their base year share in production and the elasticity of substitution that is assumed to be constant. Technologies in all sectors exhibit constant return to scale implying constant average and marginal cost. Firms’ output is sold on the domestic market or exported to other regions through a constant elasticity of transformation (CET) function. The structure of production is illustrated in figure A.1. The CET function can be partially or entirely turned off in the model. In this case, domestic sales and exports become perfect substitutes.

Demands Agents in each region value products from other regions as imperfect substitutes (the Armington assumption). The private household in each APPENDIX A 75

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Figure A.2 Structure of demand HOUSEHOLD GOVERNMENT CONSUMPTION SPENDING Fixed share EL ES

INVESTMENT DEMAND

INTERMEDIATE INPUT

f

ntie

Leo

TOTAL DEMAND

Level 1 Substitution among categories and commodities

14 COMPOSITE GOODS CES Cost-minimizing commodity bundle DOMESTIC DEMAND

IMPORT DEMAND

Level 2 Substitution between domestic and import composite goods

CES

Imports from region 1

Imports from region 2

Imports Imports ... from region n

Level 3 Substitution among imports from different sources

region maximizes a Stone-Geary utility function over the 14 composite goods, subject to their budget constraints, which leads to the ELES of household demand functions. Household savings are treated as demand for future consumption goods (Howe 1975). Thus, an economywide consumer price index is specified as the price of savings. It represents the opportunity cost of giving up current consumption in exchange for future consumption (Wang and Kinsey 1994). Government spending and investment decisions in each region are based on Cobb-Douglas utility functions, which generate constant expenditure shares for each composite commodity. In each region, firms’ intermediate inputs, household consumption, government spending, and investment demand constitute total demand for the same Armington composite of domestic products and imported goods from different sources. A two-level interlinked CES aggregational function is specified for each composite commodity in each region. The total demand is first divided between domestically produced and imported goods; then the expenditure on imports is further divided according to geographical origin under the assumption of cost minimization. Sectoral import-demand functions for each region are derived from the corresponding cost function according to Shephard’s lemma. Complete trade flow matrices for all trade partners are part of the model solution. The structure of demand is depicted in figure A.2.

International Shipping An international shipping industry is used in the model to transport products from one region to another. Each region is assumed to allocate 76 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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a fraction of its transportation and service-sector output to satisfy the shipping demand that is generated by interregional trade. The global shipping industry is assumed to have a unit elasticity of substitution among supplier sources. The margins associated with this activity are commodity/route specific. At the equilibrium, total value of international transportation service at world price equals the sum of each region’s export-related transportation costs.

Trade-Distorting Policy Each regional government imposes import tariffs, export subsidies, and indirect taxes—all in ad valorem terms. Tariff and tax (subsidy) rates vary by sector and by destination. Nontariff barriers are applied in terms of their tariff equivalents, with the caveat that this treatment is inadequate with respect to the quantitative restrictions that create them.

Price System There are 10 types of prices for each good with the same sector classification in each region: value-added prices, aggregate intermediate prices, average output prices, composite good prices, consumer prices, producer prices, export prices, import prices, f.o.b. prices, and c.i.f. prices. The valueadded price equals the unit cost of primary factor inputs. The aggregate intermediate price is a fixed-proportion (IO coefficients) weighted average of composite good prices. A CES aggregation of the two equals the average output prices. Adding the production taxes to it yields the producer prices that are the tax-inclusive CET aggregation of domestic and export prices. (Sellers receive this price.) The composite good price is the tax-inclusive CES aggregation of domestic and import price, which in turn is an aggregation of tariff-inclusive import prices from different sources. The consumer price is the composite good price plus sales tax. (Buyers pay this price.) The f.o.b. price of each Armington good is the firm’s export price plus the export taxes or minus export subsidies. Adding to it, the international transportation margins yields the c.i.f. price. The relationship among the 10 categories of prices in the model is illustrated in figure A.3. An exchange rate, as a conversion factor, translates world market prices into domestic prices. It is important to emphasize that the ‘‘nominal’’ exchange rate variable in the model is not a financial exchange rate but measures the ‘‘parity’’ that translates international prices—measured in US dollars—into domestic prices (de Melo and Robinson 1989; de Melo and Tarr 1992; Devarajan, Lewis, and Robinson 1990). In the model, all prices are relative ones, including the exchange rate, since the model includes no money or assets APPENDIX A 77

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Figure A.3 Price system Value-added price

Aggregate intermediate input price

CES function

Consumer price

Fi

xe d

Sales tax

pr

op

Average output price

or

tio

n

Production tax

Producer price CET function

Composite good prices CES function

Domestic price

Export price

Import price

Export tax exchange rate

Tariff exchange rate

f.o.b. price of region r

CES function

c.i.f. price of region r

Sh

ipp

ing

t

cos

c.i.f. price of region s

t

f.o.b. price of region s

ing

cos

ipp

Sh

and thus cannot determine the aggregate price level endogenously. ‘‘Relative to what’’ is determined by choice of numeraire. Devarajan, Lewis, and Robinson (1993) sort out the relationship between the exchange rate variable in a CGE model and various measures of the ‘‘real’’ and/or purchasing power parity exchange rate. De Melo and Tarr (1992) and de Melo and Robinson (1989) show that, in a single-country model, when the price index of ‘‘home’’ goods is chosen as numeraire, the ‘‘nominal’’ exchange rate in the model is equivalent to the real exchange rate of trade theory—that is, it measures the relative price of traded goods sold on world markets to the prices of ‘‘semitradable,’’ domestically produced goods sold on domestic markets.4 In a multiregional model, where world 4. Based on the definitions in the model, the real exchange rate in region r (RERr) is: RERr ⳱

兺 兺 (␩ i⑀I

irs

PWEir ⳯ ER r Ⳮ ␯ isr PWMisr ⳯ ERr)

s⑀R

兺 ␲ PD ir

ir

i⑀I

where 兺I兺s(␩irs Ⳮ ␯isr) ⳱ 兺i␲ir ⳱ 1, and all the index weights in the sums are nonnegative. Rearranging terms, RER r ⳱

共兺 兲 ER r ␲ ir PD ir

⳯

共兺 兺 i⑀I

兲

(␩ irs PWE irs Ⳮ ␯ isr PWMisr) .

s⑀R

i⑀I

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prices are endogenous, measuring the appropriate real exchange rate requires consideration of both international terms of trade effects (the relative price of exports and imports on world markets) as well as domestic terms of trade effects (relative price of traded and domestically produced goods sold on domestic markets).

Equilibrium The equilibrium in each country’s product and factor markets determines a set of relative product and factor prices so that supply equals demand for all goods and factors—subject to the negative supply-side shocks described below. The world market equilibrium determines a set of relative world prices so that desired sectoral supply of goods (exports) equals desired demand (imports) across all countries. Relative world prices are all measured in terms of US exports and imports, whose exchange rate is set to one.

Choice of Numeraire In this model, we specify the aggregate consumer price index (CPI) in each region as the numeraire price index. This choice implies that, in model solutions, factor returns and household income measure real returns in terms of welfare. For this choice, the exchange rate variables by region are defined as price-level-deflated (PLD) real exchange rates, deflated by regional CPI. In addition, a numeraire is required for aggregate world prices, which is given by setting the US exchange rate to one.

Choice of Macro Closure For each region, the model includes the three macro balances: savingsinvestment, balance of trade (in goods and nonfactor services), and government expenditure-receipts (government deficit). Since each regional model satisfies Walras’s Law, the three balances are not independent; only two need to be determined by means of a specified macro adjustment mechanism, or macro ‘‘closure’’ of the model. When 兺i␲irPDir is chosen as numeraire and set to unity, the percentage change in the real exchange rate equals the percentage change in the parity variable ERr plus the percentage change in the price index of all tradables. That is: ⌬RER r ⳱ ⌬ERr Ⳮ ⌬price index of all tradables. It is clear that only when all international prices (the f.o.b. and c.i.f. prices in the current model) are constant does the percentage change in RERr equal the percentage change in ERr. Otherwise, they are not the same. APPENDIX A 79

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In this model the real exchange rate is set exogenously, and the trade balances adjust to changes in private savings and investment. We specify a macro closure that spreads the adjustment equiproportionately across each component of domestic absorption (consumption, investment, and government expenditure) in response to the change in total absorption. Aggregate investment and government expenditure are specified as fixed shares of total absorption in each region. The government deficit is endogenous—direct and indirect tax rates (including tariffs) are fixed, so total tax receipts are a function of the level and distribution of economic activity. Aggregate private savings in each region are assumed to adjust endogenously to match aggregate investment (through changes in the rate of retained earnings by producers), thus achieving savings-investment equilibrium. The model specifies sectoral export supply and import demand functions that depend on sectoral relative prices of goods sold on international and domestic markets. With imperfect substitutability between imports and domestically produced goods within the same sector and imperfect ‘‘transformability’’ between sectoral supply to world markets (exports) and domestic markets, each sector has distinct prices for exports, imports, and domestic sales. In the aggregate, there is a functional relationship between the balance of trade (in goods and nonfactor services, or the current account balance) in each region and the real exchange rate. If the real exchange rate depreciates, the price of traded goods increases relative to the price of domestically produced goods sold on the domestic market. Exports increase, imports decrease, and the trade balance will improve. Our macro closure forces a proportional adjustment in each component of domestic absorption, and domestic saving adjusts endogenously. In the model, we specify a fixed real exchange rate for each region. In the base solution, the initial trade balance and exchange rate are assumed to be in equilibrium—that is, the initial trade balance is assumed to be ‘‘sustainable’’ and consistent with the initial real exchange rate. In simulation experiments, we change that rate for a particular region, which changes the equilibrium trade balance both aggregatively and bilaterally. In the multiregion model, there is a ripple effect since, as noted in chapter 2, a depreciation in one region’s real exchange rate implies a relative appreciation for its trading partners—which leads to changes in their equilibrium trade balances as well. The world model is closed in the sense that the sum of all regional trade balances must be zero. Thus, we can use the model to see how real exchange rate shocks lead to adjustments in worldwide trade balances in a consistent framework. In the simulations, we change the real exchange rate of one region at a time, keeping all other regional real exchange rates fixed. We use the model as a simulated laboratory to isolate the exchange rate transmission effect. We do not attempt to model a mix of exchange rate and trade 80 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Box A.1 Notation Region name: USA (the United States), CAN (Canada), OCN (Australia and New Zealand), WEU (Western Europe), JPN (Japan), TWN (Taiwan), CHN (China and Hong Kong), KOR (South Korea), SGP (Singapore), IDN (Indonesia), MYS (Malaysia), PHL (Philippines), THA (Thailand), MEX (Mexico), SAS (South Asia), LTA (Latin American and Caribbean countries), and ROW (rest of the world). Sector name: AGR (agriculture goods), PFD (processed food), FAF (forestry and fisheries), MINES (mining products), ENRGY (energy), TEXT (textile and wearing apparel), LMNF (other light manufactures), INTER (manufactured intermediates), MVH (motor vehicles and parts), OTN (other transport equipment), ELEC (electronics), MACH (other machinery), HOSC (housing and contruction), and SERV (services). Factor name: LND (arable land), NRS (natural resources), NLB (unskilled labor), SLB (skilled labor), and CAP (capital). Subscripts and set definition: *Regions are defined in set R and indexed by r or s. r, s ⑀ R ⳱ {USA, CAN, OCN, WEU, JPN, TWN, CHN, KOR, SGP, IDN, MYS, PHL, THA, MEX, SAS, LTA, ROW}; *Sectors are defined in set I and indexed by i or j. i and j ⑀ I ⳱ {AGR, PFD, FAF, MINES, ENRGY, TEXT, LMNF, INTER, MVH, OTN, ELEC, MACH, HOSC, SERV}; *Agricultural sectors are defined as a subset of I: IAG(I) ⳱ {AGR}; *Primary factors are defined in set F and indexed by f. f ⑀ F ⳱ {LND, NRS, NLB, SLB, CAP}; Conventions: Uppercase English letters indicate variables. A variable with a bar on top is usually set exogenously. Greek letters or lowercase English letters refer to parameters, which need to be calibrated or supplied from exogenous sources. When multiple subscripts of a variable or parameter come from the same set, the first one represents the region or sector supplying the goods and the next one represents the region or sector purchasing the goods.

balance adjustments or to forecast what might actually occur. This real model, with no money or asset markets, simply cannot be used for such forecasts. Our model is calibrated around a 17-region, 14-sector, social accounting matrix (SAM) estimated for 1995 based on the GTAP database (Hertel 1997). Details of this type of multiregional SAM and its construction from the GTAP database are described in Wang (1997). A concordance between the model and GTAP sectors as well as the International Standard Industry Classification (ISIC) system is given in appendix B, and the model’s parameters are reported in appendix D. Notations used in this book are explained in box A.1. APPENDIX A 81

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Table A.1 Price equations PWEisr ⳱ (1 Ⳮ teisr) ⳯

共 兲

1 ⳯ PE ir ER r

PWM isr ⳱ (1 Ⳮ trs isr ) ⳯ PWE isr PM ir ⳱

for s ⳱ / r

(1)

for s ⳱ / r

(2)

1 1 1ⳮ␴t i 1ⳮ␴ti i ⳯{ ␰ ␴t } irs ⳯ [(1 Ⳮ tm irs ) ⳯ ER r ⳯ PWM irs ] ␮ ir s⑀R

兺

(3)

PX ir ⳱

1 1 1ⳮ␴mi i i 1ⳮ␴m i ⳯ {␣ ␴m Ⳮ (1 ⳮ ␣ir ) ␴mi ⳯ PM 1ⳮ␴m } ir ⳯ PD ir ir ⌫ir

(4)

PN jr ⳱

兺 io

(5)

ijr

⳯ PX ir

i⑀I

PVir ⳱

1 1 1ⳮ␴␯ i 1ⳮ␴␯ i i ⳯{ ␦ ␴␯ } fir ⳯ PF fr ⌳ ir f⑀F

(6)

PPir ⳱

1 1 1ⳮ␴pi i ⳯ {␭␴p Ⳮ (1 ⳮ ␭ir) ␴pi ⳯ PV ir1ⳮ␴pi } 1ⳮ␴pi ir ⳯ PN ir Air

(7)

Pir ⳱

兺

1 1 i i 1ⳮ␴e i ⳯ {␬ ir␴eir ⳯ PD 1ⳮ␴e Ⳮ (1 ⳮ ␬ir )␴ei ⳯ PE 1ⳮ␴e } ir ir ␹ ir

PC ir ⳱ (1 Ⳮ tc ir ) ⳯ PX ir

CPI r ⳱

兺 PC

ir

(9)

⳯ C ir

i⑀I

兺

(8)

(10) PC0ir ⳯ C ir

i⑀I

PID r ⳱

⌸ PC i⑀I

␤ir ir

⳯ CPI rmpsr

(11)

Price Equations Table A.1 lists price equations in the model. Equations 1 and 2 define the relationship between border (world) prices and internal prices, while equations 3, 4, 6, 7, and 8 define price indices for aggregate imported goods, Armington goods, composite value added, and the firm’s output with and without production taxes, respectively. In equations 3, 4, 6, and 7, the price indices are the unit cost functions, while in equation 8 they are unit revenue functions, all of which are dual to the corresponding 82 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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unit quantity aggregator functions. For example, equation 7 is the result of cost minimization by the representative firm in each sector with respect to its aggregate factor and inputs, subject to a CES production function. Since CES functions are used as the building blocks of the basic model, and this quantity aggregator function is homogeneous of degree one, the total costs can be written as total quantity multiplied by unit cost (Varian 1984, 28). This implies that the average cost, under cost minimization, is independent of the number of units produced or purchased. Thus, the unit cost function also stands for the price of the composed commodity. Equation 5 defines the unit price for aggregate inputs, which is the IO coefficient-weighted sum of all the value of its contents. Equation 9 states the domestic consumer price is the Armington goods price plus sales taxes. Equation 10 specifies an economywide consumer price index, which is used as price of household savings. Equation 11 defines the numeraire in the model.

Factor Demand and Export Supply Equations In table A.2, equations 12 and 13 specify the demand functions for aggregate factor and intermediate inputs, while equation 14 specifies demand functions for each primary factor. They equal unit demand function multiplied by the quantities of total output, and the unit demand functions are obtained by taking partial derivatives of the unit cost functions (equations 6 and 7) with respect to the relevant factor prices, according to Shephard’s lemma. Equations 15-18 are the domestic and export supply functions corresponding to the CET function commonly used in most CGE models. They are derived from revenue maximization subject to the CET function in a way similar to the derivation of factor demand functions. Equation 19 aggregates exports by the representative firm in each region, which implies that producers only differentiate output sold in domestic and foreign markets, but do not differentiate exports by destination (foreign markets are perfect substitutes). Equations 15-18 can be partially or entirely turned off in the model, in which case PDir ⳱ PEir ⳱ Pir will be enforced, and exports and domestic sales become perfect substitutes in the model.

Trade and Final Demand Equations Trade and final demand equations are shown in table A.3. Equation 20 is the consumer demand function, which is the Extended Linear Expenditure System derived from maximizing a Stone-Geary utility function subject to household disposable income, which is specified in equation 31. Equation 21 defines household supernumerary income, which is disposable income less total expenditure on the subsistence minima. Equations 22 APPENDIX A 83

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Table A.2 Factor demand and export supply equations

共 兲 1 A ir

NX ir ⳱

VA ir ⳱

DFfir ⳱

共 兲

DX ir ⳱

DX s␯,r ⳱

EX ir ⳱

EX s␯,r ⳱

1ⳮ␴pi

⳯ ␦ fir ⳯

共 兲 1 ␹ ir

共 兲 1 ␹ ir

共

1ⳮ␴es␯

EX ir ⳱

Pir PD ir

兲

冥

fir

⳯ Q ir

⳱1

(13)

for ᭙ ir (14)

␴e i

⳯ Q ir

Ps␯,r PDs␯,r

兵

Pir PE ir

⳯ (1 ⳮ ␬ s␯,r ) ⳯

兺 (1 Ⳮ te

兲

irs )

for i ⳱ / s␯

(15)

␴e s␯

⳯ (Q s␯,r ⳮ TRQS r )

(16)

␴e i

其

Ps␯,r PE s␯,r

ER r

s⑀R

␴pi

(12)

f⑀F

兵

1 ⳯ PE ir

⳯ Q ir

兺␦

⳯ VA ir

⳯ (1 ⳮ ␬ ir ) ⳯ 1ⳮ␴e s␯

PVir

␴␯i

⳯ ␬ s␯,r ⳯

1ⳮ␴e i

共 兲 1 ␹ s␯,r

兲

PVir PFfr

⳯ ␬ ir ⳯

共 兲 1 ␹ s␯,r

共

1ⳮ␴e i

冤

兲

␴pi

PPir

⳯ (1 ⳮ ␭ ir) ⳯

共

1ⳮ␴␯i

1 ⌳ ir

PPir PN ir

⳯ ␭ ir ⳯

共 兲 1 A ir

共

1ⳮ␴p i

⳯ Q ir

其

for i ⳱ / s␯

(17)

␴e s␯

⳯ (Q s␯,r ⳮ TRQS r)

⳯ PWE irs ⳯ X irs

(18)

(19)

and 23 give government and investment demands. Equations 24-26 are demand functions for domestic goods, aggregate imported goods, and imported goods by source, respectively. They describe the cost-minimizing choice of domestic and import purchases as well as import sources. They are derived from corresponding cost functions using Shephard’s lemma, which is rather similar to the derivation of factor-demand functions (taking partial derivatives of the cost function with respect to the relevant component prices). Because of the linear homogeneity of the CES function, the cost function that is dual to the commodity aggregator can be represented by its unit cost function (equations 3 and 4) multiplied by total quantity demanded.

International Shipping Equations Table A.4 lists the equations describing international shipping industry in the model. Equations 27 and 28 describe the supply side of the interna84 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table A.3 Trade and final demand equations C ir ⳱ ␥ir Ⳮ

␤ir ⳯ SYr PC ir

SYr ⳱ HDI r ⳮ

兺 PC

(20) ⳯ ␥jr

jr

(21)

j⑀I

GC ir ⳱

␪ ir ⳯ GSPr PC ir

(22)

ID ir ⳱

kio ir ⳯ INVr PC ir

(23)

DX ir ⳱

共 兲

MX ir ⳱

共 兲

X isr ⳱

共 兲

PXir PD ir

⳯ ␣ ir ⳯

1ⳮ␴t i

兲

␴mi

兵

1ⳮ␴m i

1 ⌫ir

1 ␮ ir

共

1ⳮ␴mi

1 ⌫ir

⳯ (1 ⳮ ␣ ir ) ⳯

兵

⳯ ␰ isr ⳯

⳯ TX ir

PX ir PM ir

其

(24)

␴m i

⳯ TX ir

共

(25)

兲其

PM ir (1 Ⳮ tm isr) ⳯ ER r ⳯ PWM isr

兺␰

isr

␴t i

⳯ MX ir for s ⳱ / r (26)

⳱1᭙i⌳r

s⑀R

Table A.4 International shipping equations TRQ ⳱

1 ⳯ PTR

TRQS r ⳱

TRQD ir ⳱

兺 ER

Ps␯,r

r⑀R

r

⳯ TRQS r

(27)

␶r ⳯ ER r ⳯ PTR ⳯ TRQ Ps␯,r

(28)

兺

1 ⳯( trs isr ⳯ PWE isr ⳯ X isr ) PRT s⑀R TRQ ⳱

兺 兺 TRQD

(29)

(30)

ir

r⑀R i⑀I

APPENDIX A 85

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Table A.5 Income and savings equations HDI r ⳱

兺 PF

fr

⳯ FSfr ⳮ drr ⳯ FSk,r Ⳮ GTRANS r

(31)

f⑀FC

兺 PC

HDI r ⳯ ⳮ

ir

⳯ C ir

i⑀I

SAVr ⳱

(32)

CPI r

GR r ⳱ PTAX r Ⳮ CTAX r Ⳮ TARRIFr Ⳮ ETAX r PTAX r ⳱

兺 tp

(33)

⳯ Pir ⳯ Q ir

(34)

⳯ PX ir (C ir Ⳮ GC ir Ⳮ ID ir )

(35)

ir

i⑀I

CTAX r ⳱

兺 tc

ir

i⑀I

TARRIFr ⳱

兺 兺 tm

isr

⳯ ER r ⳯ PWM isr ⳯ X isr

(36)

s⑀R i⑀I

ETAX s ⳱

兺 兺 te

⳯ PE is ⳯ X isr

(37)

GTRANS r ⳱ GR r ⳮ GSPr ⳮ GSVA r

(38)

isr

r⑀R i⑀I

BOTr ⳱

兺 兺 PWE s⑀R i⑀I

irs

X irs Ⳮ

Ps␯,r ⳯ TRQS r ⳮ ER r

兺 兺 PWM

isr

⳯ X isr (39)

s⑀R i⑀I

tional shipping industry. Equation 27 states that at equilibrium, the returns from shipping activity must cover its cost. Like other industries in the model, it also earns zero profit. Equation 28 describes the demand for each region’s service-sector exports to the international shipping industry, which is generated by the assumed Cobb-Douglas technology. The next two equations, 29 and 30, refer to the demand side of the international shipping industry. The demand for shipping services associated with commodity i in region r is generated by a fixed proportion input requirement (Leontief) coefficient trsisr, which is routine/commodity specific (equation 29). In equilibrium, the total demand of shipping service must equal its total supply (equation 30).

Income and Savings Equations Table A.5 summarizes all income and savings equations in the model. Equations 31 and 32 define household disposable income and savings. Equations 33-37 determine government revenue from production taxes, consumption taxes, tariffs and export taxes (a negative number equals a 86 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Table A.6 General equilibrium conditions TX ir ⳱ C ir Ⳮ GC ir Ⳮ ID ir Ⳮ

兺 io

ijr

⳯ NX jr

(40)

j⑀I

兺 DF

fir

⳱ FS fr

(41)

i⑀I

Pir ⳱

PN ir ⳯ NX ir Ⳮ PVir ⳯ VA ir Ⳮ tpir ⳯ Pir ⳯ Q ir Q ir

INVr ⳱ drr ⳯ FS k,r Ⳮ CPI r ⳯ SAVr Ⳮ GSAVr ⳮ ER r ⳯ BOTr

(42) (43)

total number of equations: 14 ⳯ R Ⳮ 20 ⳯ I ⳯ R Ⳮ 3 ⳯ I ⳯ R(R ⳮ 1) Ⳮ (F ⳮ 1) ⳯ I ⳯ R Ⳮ (IAG Ⳮ F) ⳯ R Ⳮ 2 (17,478)

subsidy), respectively, while equations 38 and 39 define government transfer to household and the balance of trade (foreign savings) in each region.

General Equilibrium Conditions Equations defining the general equilibrium conditions are given in table A.6. Equations 40-43 are system constraints that the model economy must satisfy. For each sector in each region, the supply of the composite goods must equal total demand (equation 40), which is the sum of household consumption (Cir), government purchases (GCir), investment (IDir), and the firm’s intermediate demand. Similarly, the demand for each factor in each region must equal the exogenously fixed supply (equation 41). In this dual formulation, output in each region is determined by demand. Sectoral equilibrium is determined in equation 42: unit output price equals average cost, which is also the zero profit condition. Equation 43 describes the macroeconomic equilibrium identity in each region, which is also the budget constraint for the investor. Since all agents in each region (households, government, investors, and firms) satisfy their respective budget constraints, it is well known that the sum of the excess demand for all goods is zero—that is, Walras’s law holds for each region. Therefore, there is a functional dependence among the equations of the model. One equation is redundant in each region and thus can be dropped. There are 17,478 equations and 17,614 variables in the static version of the model. Since the 85-factor endowment variables (FSr) are usually set exogenously, 3 additional sets of variables have to be set exogenously as macro closures in order to make the model fully determinate. They are chosen from the following variables: (1) government spending or gross APPENDIX A 87

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Table A.7 Definitions of variables Variable

PWEisr

Definition

Number of variables

ER r PIDr

World f.o.b. price for goods from region s to region r s ⳱ / r World c.i.f. price for goods from region s to region r s ⳱ / r Price of aggregate imported goods in region r Price of composite goods in region r Price of domestic products sold at domestic market in region r Price of domestic goods for exports in region r Domestic consumer price in region r Average output price before production tax in region r Average output price after production tax in region r Factor price in region r Price of value added in region r Price of aggregate intermediate inputs in region r Price of savings in region r (consumer price index) Exchange rate of region r Price index in region r

Qir VAir NX ir DFfir

Sector output in region r Variable sector production cost in region r Aggregate sector intermediate input in region r Sector factor demand in region r

DX ir EX ir

Sector domestic sales in region r Domestic goods for exports in region r

PWM isr PM ir PXir PDir PEir PCir PPir Pir PFfr PVir PN ir CPIr

I ⳯ R(Rⳮ1) (3,808) I ⳯ R(Rⳮ1) (3,808) I ⳯ R (238) I ⳯ R (238) I ⳯ R (238) I ⳯ R (238) I ⳯ R (238) I ⳯ R (238) I ⳯ R (238) F ⳯ R (85) I ⳯ R (238) I ⳯ R (238) R (17) R (17) R (17) I ⳯ R (238) I ⳯ R (238) I ⳯ R (238) (Fⳮ1) ⳯ I ⳯ R Ⳮ IAG ⳯ R (969) I ⳯ R (238) I ⳯ R (238)

investment (GSPr or INVr), (2) balance of trade or exchange rate (BOTr or ERr), and (3) government savings or transfer (GSAVr or GTRANSr). The model is implemented in the General Algebraic Modeling System (GAMS) (Brooke, Kendrick, and Meeraus 1988). The definitions of variables and parameters are listed in tables A.7 and A.8.

88 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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(table continued) ⳯ ⳯ ⳯ ⳯ ⳯ ⳯

Cir GC ir ID ir TX ir MX ir X isr

Household consumption in region r Government spending in region r Investment demand in region r Composite goods demand (supply) in region r Sector composite goods imports in region r Trade flows from region s to region r s ⳱ / r

I I I I I I

TRQ PTR TRQDir TRQSr

Total international transportation supply Price of international shipping service International shipping demand by region r International shipping service supply by region r

1 1 I ⳯ R (238) R (17)

HDIr SYr GRr GSPr TARRIFr ETAXr

Household disposable income in region r Household supernumerary income in region r Total government revenue in region r Total government spending in region r Total tariff revenue in region r Total export tax revenue (subsidy expenditure) in region r Total production tax revenue in region r Total consumer sale tax in region r Household savings in region r Government savings (deficit) in region r Government transfer in region r Balance of trade in region r (net capital inflow) Gross investment by region r

R R R R R R

(17) (17) (17) (17) (17) (17)

R R R R R R R

(17) (17) (17) (17) (17) (17) (17)

PTAXr CTAXr SAVr GSAVr GTRANSr BOTr INVr FSr

Factor endowment by region r Total number of variables: 17 ⳯ R Ⳮ (2 ⳯ F Ⳮ IAG) ⳯ R Ⳮ 20 ⳯ I ⳯ R Ⳮ 3 ⳯ I ⳯ R(Rⳮ1) Ⳮ (Fⳮ1) ⳯ I ⳯ R Ⳮ 2 (17,614)

R (238) R (238) R (238) R (238) R (238) R(Rⳮ1) (3,808)

F ⳯ R (85)

APPENDIX A 89

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Table A.8 Definitions of parameters Parameter

Definition

te isr tmisr tpir tcir

Sector export tax (subsidy) rate for goods to region r from region s Sector tariff rate for goods from region s in region r Sector indirect tax rate in region r Consumer sale tax rate in region r

trcisr ioijr kioir drr

International transportation cost margin as percent value of f.o.b. Input/output coefficients for region r Sector share of total investment in region r Depreciation rate of capital stock in region r

⌫ir ␮ir ␣ir ␰ ir ␴mi ␴t i

Unit coefficients in first-level Armington aggregation function Unit coefficients in second-level Armington aggregation function of region r Share parameters in first-level Armington aggregation function of region r Share parameters in second-level Armington aggregation function of region r Substitution elasticities between domestic and import goods Substitution elasticities among import goods from different regions

␹ir

␴e i

Unit coefficients in constant elasticity of transformation (CET) function of region r Share parameters in constant elasticity of transformation (CET) function of region r Elasticities of transformation between domestic sales and exports

Air ␭ir ␴pir

Unit parameter in aggregate cost function Intermediate input share in aggregate cost function Elasticities of substitution between aggregate factor and intermediate input

⌳ir ␦fir ␴vir

Unit parameter in value-added function Factor share in value-added function Elasticities of substitution among primary factors in value added

␥ir ␤ir mps r ␪ir

Sector minimum subsistence requirements for private households in region r Marginal propensity to consume for private households in region r Marginal propensity to save for private households in region r Sector share of government spending in region r

␶r

Regional share of international shipping service supply

␬ir

90 ECONOMIC EFFECTS OF THE ASIAN CURRENCY DEVALUATIONS

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Appendix B Sectoral Definitions and Their GTAP-ISIC Concordance

91

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Appendix B Sectoral definitions and their GTAP-ISIC concordance Sectors in the model

a

GTAP 4-sector number and description

ISIC

b

revised 3 code

(1) Agriculture

(1) Paddy rice, (2 )Wheat, (3) Cereal grains, n.e.c., (4) Vegetables, fruit, nuts, (5) Oil seeds, (6) Sugar cane, sugar beet, (7) Plant-based fibers, (8) Crop, n.e.c., (9 )Bovine cattle, sheep and goats, houses, (10) Animal products, n.e.c., (11) Raw milk, (12) Wool, silk-worm cocoons

0111-13, 0121-22, 0130, 0140

(2) Forestry and fishery (3) Processed food

(13) Forestry, (14) Fishing

0150, 0200, 0500

(19) Bovine cattle, sheep and goats, houses meat products, (20) Meat products, n.e.c., (21) Vegetable oils and fats, (22) Dairy products, (23) Processed rice, (24) Sugar, (25) Food products, n.e.c., (26) Beverages and tobacco (18) Minerals, n.e.c., (34) mineral products, n.e.c.

1511-14, 1520, 1531-33, 1541-44,1549, 1551-54, 1600

(4) Mining (5) Energy (6) Textile and apparel (7) Other light manufactures (8) Manufacture intermediates

(9) Motor vehicle and parts

(15) Coal, (16) Oil, (17) Gas, (32) Petroleum, coal products, (43) Electricity, (44) gas manufacture, distribution (27) Textiles, (28) Wearing apparel (29) Leather products, (30) Wood products, (42) Manufactures, n.e.c. (31) Paper products, publishing, (33) Chemicals, rubber and plastic products, (35) Ferrous metals, (36) Metals, n.e.c., (37) Metal products (38) Motor vehicles and parts

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1030, 1200, 1310, 1320, 1410, 1421-22, 1429, 2610, 2691-96, 2699 1010, 1020, 1110, 1120, 2310, 2320, 4010, 4020, 4030 1711-12, 1721-23, 1729-30, 1810, 1820, 2430 1911-12, 1920, 2010, 2021-23, 2029, 3610, 3691-94, 3699 2101-02, 2109, 2211-13, 2219, 2221-22, 2330, 2411-13, 2421-24, 2429, 2511, 2519-20, 2710, 2720, 2731-32, 2811-13, 2891-93, 2899 3410, 3420, 3430

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(10) Other transport equipment (11) Electronic (12) Machinery

(39) Transport equipment, n.e.c.

3511-12, 3520, 3530, 3591-92, 3599

(40) Electronic equipment (41) Machinery and equipment, n.e.c.

(13) Housing and construction (14) Services

(46) Construction, (50) dwellings

3000, 3210, 3220, 3230 2213, 2230, 2911-15, 2919, 2921-27, 2929-30, 3110, 3120, 3130, 3140, 3150, 3190, 3311-13, 3320, 3330 4510, 4520, 4530, 4540, 4550

(45) Water, (47) Trade, transport, (48) Financial, business, recreational services, (49) Public administration and defense, education, health services

3710, 3720, 4100, 4510, 5010, 5020, 5030, 5040, 5050, 5110, 5121-22, 5131, 5139, 5141-43, 5149-50, 5190, 5220, 5231-34, 5239-40, 5251-52, 5259-60, 5510, 5520, 6010, 6021-23, 6030, 6110, 6120, 6210, 6220, 6301-04, 6309, 641112, 6420, 6511, 6519, 6591-92, 6599, 6601-03, 6711-12, 6719-20, 7010, 7020, 7111-13, 7121-23, 7129-30, 7210, 7220, 7230, 7240, 7250, 7290, 7310, 7320, 7411-14, 7421-22, 7430, 7491-95, 7499, 7511-14, 7521-23, 7530, 8010, 8021-22, 8030, 8090, 8511-12, 8519-20, 8531-32, 9000, 9111-12, 9120, 9191-92, 9199, 9211-14, 9219-20, 9231-33, 9241, 9249, 9301-03, 9309, 9500, 9900

n.e.c. = not classified elsewhere. a. Global Trade Analysis Project, version 4 pre-release(Hertel, 1997). b. International Standard Industry Classification.

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Appendix C Sensitivity Analyses

As indicated in chapters 1 and 2, considerable uncertainty exists about the ultimate magnitude of the real exchange rate and supply-side shocks for the Asian countries. In this appendix we report summary information for the low-shock and high-shock scenarios summarized in table 2.4. The qualitative results are generally invariant for all regions of the model (except Singapore, Taiwan, and Japan as discussed below), indicating the robustness of the results reported in the main text. The low-shock scenario is summarized in table C.1. The main difference between this scenario and the results reported for the medium-shock scenario in table 2.5 is the smaller magnitudes for each region—except in the cases of Singapore, Taiwan, and Japan. These three economies, in the low-shock scenario, experience real appreciations vis-a`-vis the ASEAN-4 and South Korea, and their trade balances remain largely unchanged. (In contrast they actually increase their external surpluses in the mediumshock scenario discussed in the text.) A second observation about the low-shock scenario is that with the Asian countries’ lack of negative supply-side shocks, the magnitude of change in domestic absorption and net exports as a share of GDP is much smaller: absorption and net exports are not changing as much in absolute terms, and the GDP denominator is not significantly declining. The high-shock scenario is summarized in table C.2. In this scenario the main qualitative results are the same as reported in the main text, only the magnitudes of the effects are larger. In this situation, the ASEAN4 and South Korea experience large increases in net exports and large declines in domestic absorption, driven by large real exchange rate depreciations and significant supply-side contractions. The declines in consumption and investment in these scenarios are closer in magnitude to those reported by McKibbin (1998). 95

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Table C.1 Change of bilateral trade matrix from the base (current price with productivity shock, Chinese devaluation excluded, low-shock scenario) (billions of dollars) USA CAN MEX WEU OCN JPN KOR TWN CHN IDN THA PHL SGP MYS SAS LTA ROW

USA

CAN

MEX

WEU

OCN

JPN

KOR

TWN

CHN

IDN

THA

PHL

SGP

MYS

SAS

LTA

ROW

TOT

0.0 –0.1 –0.4 0.1 –0.1 8.9 0.0 –0.1 1.3 3.6 0.4 –0.3 1.2 –0.1 0.1 0.3

0.0 0.0 0.0 0.0 0.1 0.7 0.0 0.0 0.1 0.3 0.0 0.0 0.1 0.0 0.0 0.0

0.1 0.0 0.0 0.0 0.0 0.2 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0

0.4 0.0 0.0 0.1 0.3 5.6 0.1 0.4 2.7 7.4 0.5 –0.4 1.5 0.1 1.0 2.1

–0.1 0.0 0.0 –0.1 0.0 1.2 0.0 0.0 0.3 0.4 0.1 0.0 0.2 0.0 0.0 0.0

0.1 –0.1 0.0 –0.3 0.0 8.4 0.2 0.4 2.1 7.4 0.4 –0.4 1.5 0.0 –0.1 0.1

–8.9 –0.7 –0.2 –5.6 –1.2 –8.4 –0.8 –2.8 –0.2 0.4 –0.2 –1.3 –0.4 –0.4 –2.6 –3.5

0.0 0.0 0.0 –0.1 0.0 –0.2 0.8 0.5 0.3 1.0 0.1 –0.1 0.2 0.0 0.0 0.0

0.1 0.0 0.0 –0.4 0.0 –0.4 2.8 –0.5 0.5 1.3 0.1 –0.2 0.3 0.0 –0.1 0.0

–1.3 –0.1 0.0 –2.7 –0.3 –2.1 0.2 –0.3 –0.5 0.1 –0.1 –0.6 –0.1 –0.2 –0.6 –0.7

–3.6 –0.3 –0.1 –7.4 –0.4 –7.4 –0.4 –1.0 –1.3 –0.1 –0.2 –1.8 –0.8 –0.4 –1.2 –3.0

–0.4 0.0 0.0 –0.5 –0.1 –0.4 0.2 –0.1 –0.1 0.1 0.2 –0.1 0.0 0.0 –0.1 –0.2

0.3 0.0 0.0 0.4 0.0 0.4 1.3 0.1 0.2 0.6 1.8 0.1 1.3 0.0 0.1 0.1

–1.2 –0.1 0.0 –1.5 –0.2 –1.5 0.4 –0.2 –0.3 0.1 0.8 0.0 –1.3 –0.1 –0.2 –0.3

0.1 0.0 0.0 –0.1 0.0 0.0 0.4 0.0 0.0 0.2 0.4 0.0 0.0 0.1 0.0 0.0

–0.1 0.0 0.0 –1.0 0.0 0.1 2.6 0.0 0.1 0.6 1.2 0.1 –0.1 0.2 0.0 0.1

–0.3 0.0 0.0 –2.1 0.0 –0.1 3.5 0.0 0.0 0.7 3.0 0.2 –0.1 0.3 0.0 –0.1 -

–14.8 –1.4 –0.5 –21.7 –1.9 –19.8 37.0 –2.3 –3.5 9.2 29.2 1.7 –6.8 5.5 –1.0 –3.7 –5.2

Note: USA = United States, CAN = Canada, MEX = Mexico, WEU = Western Europe, OCN = Australia and New Zealand, JPN = Japan, KOR = South Korea, TWN = Taiwan, CHN = China and Hong Kong, IDN = Indonesia, THA = Thailand, PHL = Philippines, SGP = Singapore, MYS = Malaysia, SAS = South Asia, LTA = Latin American and Caribbean nations, ROW = rest of world, and TOT= total.

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Table C.2 Change of bilateral trade matrix from the base (current price with productivity shock, Chinese devaluation excluded, high–shock scenario) (billions of dollars) USA CAN MEX WEU OCN JPN KOR TWN CHN IDN THA PHL SGP MYS SAS LTA ROW

USA

CAN

MEX

WEU

OCN

JPN

KOR

TWN

CHN

IDN

THA

PHL

SGP

MYS

SAS

LTA

ROW

TOT

0.0 –0.3 –2.8 0.5 27.1 20.0 4.9 0.5 2.9 7.9 2.3 4.6 6.4 0.0 0.5 1.5

0.0 0.0 –0.3 0.0 3.2 1.7 0.3 0.1 0.3 0.6 0.1 0.2 0.3 0.0 0.1 0.2

0.3 0.0 –0.2 0.0 0.7 0.3 0.0 0.0 0.1 0.3 0.1 0.1 0.1 0.0 0.1 0.0

2.8 0.3 0.2 0.9 21.4 13.4 3.9 3.0 7.0 16.2 2.7 5.1 7.6 0.6 3.9 9.4

–0.5 0.0 0.0 –0.9 4.0 2.6 0.5 0.0 0.8 0.9 0.3 0.6 0.9 0.0 0.0 –0.2

–27.1 –3.2 –0.7 –21.4 –4.0 13.3 0.3 –8.1 2.8 13.8 1.1 1.8 5.2 –1.0 –5.5 –11.0

–20.0 –1.7 –0.3 –13.4 –2.6 –13.3 –1.1 –5.1 –0.3 1.0 –0.1 –1.3 –0.1 –0.8 –5.7 –8.3

–4.9 –0.3 0.0 –3.9 –0.5 –0.3 1.1 –0.2 0.5 2.0 0.2 0.2 1.0 –0.1 –0.5 –0.6

–0.5 –0.1 0.0 –3.0 0.0 8.1 5.1 0.2 1.1 2.6 0.6 1.5 1.3 0.0 –0.4 –0.3

–2.9 –0.3 –0.1 –7.0 –0.8 –2.8 0.3 –0.5 –1.1 0.2 0.0 –0.5 0.0 –0.4 –1.5 –1.9

–7.9 –0.6 –0.3 –16.2 –0.9 –13.8 –1.0 –2.0 –2.6 –0.2 –0.3 –2.7 –1.4 –0.8 –2.6 –6.3

–2.3 –0.1 –0.1 –2.7 –0.3 –1.1 0.1 –0.2 –0.6 0.0 0.3 –0.2 0.0 –0.1 –0.5 –1.0

–4.6 –0.2 –0.1 –5.1 –0.6 –1.8 1.3 –0.2 –1.5 0.5 2.7 0.2 2.6 –0.4 –0.6 –3.1

–6.4 –0.3 –0.1 –7.6 –0.9 –5.2 0.1 –1.0 –1.3 0.0 1.4 0.0 –2.6 –0.4 –0.9 –1.6

0.0 0.0 0.0 –0.6 0.0 1.0 0.8 0.1 0.0 0.4 0.8 0.1 0.4 0.4 –0.1 –0.2

–0.5 –0.1 –0.1 –3.9 0.0 5.5 5.7 0.5 0.4 1.5 2.6 0.5 0.6 0.9 0.1 0.2

–1.5 –0.2 0.0 –9.4 0.2 11.0 8.3 0.6 0.3 1.9 6.3 1.0 3.1 1.6 0.2 –0.2 -

–76.1 –6.7 –2.0 –98.6 –8.7 43.6 73.3 6.3 –16.2 19.1 59.5 8.8 10.8 27.0 –3.0 –14.0 –23.3

Note: USA = United States, CAN = Canada, MEX = Mexico, WEU = Western Europe, OCN = Australia and New Zealand, JPN = Japan, KOR = South Korea, TWN = Taiwan, CHN = China and Hong Kong, IDN = Indonesia, THA = Thailand, PHL = Philippines, SGP = Singapore, MYS = Malaysia, SAS = South Asia, LTA = Latin American and Caribbean nations, ROW = rest of world, and TOT = total.

Institute for International Economics

|

http://www.iie.com

Institute for International Economics

|

http://www.iie.com