Lawrence R. Klein
ICAS Winter Symposium
965 Clover Court, Blue Bell, PA 19422
Tel : (610) 277-9989; (610) 277-0149
Lawrence R. Klein
The Asian financial crises had not yet become apparent, and I am not sure how he would have responded, had I said that the then visible slowing down of Asian growth would be a serious adverse factor for our economy, but he would not have attached much importance to the kinds of slowdowns that were being forecasted for Asia at that time, i.e. general slippages of growth rates by one or two percentage points from average experience of 7-10% growth in the leading economies of the region (East Asia, excluding Japan).
The Mexican crisis of December, 1994, did not cause a great set back for US performance in 1995. It was only a contributing factor to a slowing down. It was different from the Asian crises in that it did not spread very much - mainly to Argentina - and the recession in Mexico lasted only for one year. It was a very deep but short recession, and Mexico was able to refinance its debt in the private market, thus paying back the US loan in a short period, with interest.
There was, however, a very significant aspect of the Mexican adjustment, namely that the current account deficit, which had peaked at the large sum of about $30 billion in 1994, was rapidly reduced to $1.6 billion in 1995 and held to $1.9 billion in 1996.
It is early to draw conclusions about Asian countries now, but the trade and payments figures seem to be following the Mexican adjustment pattern. South Korea has just reported a third successive month of improvement in net exports. The current account deficit for 1996 is estimated at $23 billion, when there was already a faint sign of economic problems, and was quickly reduced to $8.8 billion in 1997. The projections for 1998 and 1999 are for Korea to be in surplus on current account. The pattern is similar for Thailand - a deficit of $15 billion in 1996, followed by a deficit of $3 billion in 1997 and expecting to reach a small surplus in 1998 and 1999. The same time pattern holds for Indonesia.
When Mexico got into financial trouble, bordering on national bankruptcy, imports were severely restricted, and exports were expanded. That is what produced the time sequence of large deficits, followed by smaller deficits, and eventually near balance or surplus.
At the same time, the home currency falls in exchange value; interest rates go up; and inflation does, as well. The economy slows, probably into a recessionary phase; unemployment rises; debts are re-negotiated; and the process of recovery starts fairly soon. In Mexico, there was only one "down" year, but in 1982-83, responding to the effects of the world debt crisis, Mexico had two years of recession, followed by modest recovery.
There are reasons for believing that more flexibility has been introduced into many economies, many broad markets, while domestic policies put austerity into place. The impact on the afflicted countries is well known. There is significant unemployment, lower consumption levels, high interest rates, a good deal of bankruptcy, projects brought to a standstill and generally miserable economic conditions. This situation does not last indefinitely, and I shall come back to consideration of the duration of poor economic conditions and strength of the recovery.
First we should take up another consequence, namely, the effect of the crisis on the World Economy. It was already noted that the Mexican crisis of 1994 did not send the United States into recession. We were affected but not to the point of falling into recession. The main effects were on selected industries, such as apparel manufacturing, for example, where we were noncompetitive, but US labor markets remained strong and displaced workers found jobs elsewhere. Under the NAFTA Agreement and general adjustment to market conditions, other sectors fared well.
It is interesting to note, however, that in the previous Mexican financial crisis, we suddenly faced a new experience and the cutback in Mexican imports from the United States was so sharp that our recovery from the 1981-82 business-cycle recession was frustrated in spring 1982 and postponed until autumn, 1982.
In the present situation we can see effects on our credit markets, not at all bad from our own point of view; lower import prices; and just hints of adverse effects on our net trade position, which is already very unfavorable. As Chairman Greenspan of the Federal Reserve has testified, the full effects are yet to be felt.
In the case of financial market developments, the "flight-to-quality" (and safety) has led to increased demand for Treasury and other high grade bonds, bringing down long term interest rates by about 25-50 basis points. Part of the drop in bond yields may even be attributed to accommodation (by inaction) of the Federal Reserve, where some members of the Open Market Committee have wanted for some months to raise interest rates, but were restrained for fear of incitement of trouble in a precarious market situation.
A more telling and more objective way of determining the impact on the world economy is to examine the time pattern of international economic forecasts. The IMF, the United Nations, econometric service companies, and many other forecasters, who periodically make projections have nearly all marked down their forecasts for production, profits, price level and other well-known magnitudes.
In Tables 2, and 3, I present the IMF Interim Assessment, prepared in December 1997, and the special slower growth scenario issued by the United Nations, December 10, 1997. Ordinarily, these two organizations make projections and analyses of the World economy in Spring and Autumn, each year. In both cases there are preliminary and final semiannual forecasts, but 1997 events that took place after July so disturbed the entire world economy, that these two organizations (and many others, too) had to issue special December forecasts in order to be realistic in the current context.
Almost the entire reason for this procedural change was attributed to the Asian crises. This is indicative of the seriousness of the situation and shows the quantitative magnitudes of change involved. In both sets of tables a fresh forecast has been made in December, 1997, and show either a new projection, side-by-side, or tabulation of deviations from previous forecasts for the same period.
In these tables, the Asian economic performance still stands out, although not as markedly as before; a world recession is not generated; the changes to Asian performance are still quite moderate; the current account balances change significantly in the direction stated above for Mexico and for Asian countries in terms of their wanting to correct large imbalances. A major adjustment is taking place, but not large enough to send the World economy into a major recession.
The technical economists in charge of this work at the IMF and at the UN realize that these are only first reactions to the measurement of the crisis and are prepared to acknowledge that further adjustments during 1998 are taking place.
The interim forecast for the IMF shows only a modest change for World output in 1997 (only 0.1 off the growth rate in the October forecast). The deviation, however, is quite large for 1998, at 0.8%. The changes for Asia and the Asean-4 (Thailand, Malaysia, Indonesia, the Philippines) are much bigger than for the world, amounting to
-1.7 for Asia, as a whole, and to -3.7% for the Asean-4.
Developing country exports are projected higher for 1997 and 1998, and the current account balances are considerably stronger for all the Asian countries that are severely affected by the financial troubles.
The UN-LINK forecasts are much lower in 1998 and 1999 for GDP. This can be seen for the region as a whole, and for leading cases, such as Korea and Thailand. Exports are projected to be higher for the World as a whole. Most individual countries have stronger forecasts of current account balances 1998, 1999, and 2000.
The main East Asian economies are expected to be strong again, with impressive growth rates for GDP by 2000, but some degree of improvement takes place in 1999, according to these forecasts. As in the case of Mexico's adjustments, major effects are being felt by domestic residents, bringing them to much reduced levels of living, but only modest effects are presently visible in statistics of global projections.
The Mexican data show two patterns of adjustment: (1) a sharp decline with fast recovery, but very big impacts on the population at large, (2) a more moderate, stretched-out decline with more modest recovery and possibly a gentler impact on the population. The choice is not with the victim, but is, to some extent, that of the "Washington Consensus".
A principal motivation for the policy action of 1994-1996 in the case of Mexico was to prevent a spreading financial panic through contagion. Econometric analyses of cross-market responses to the Mexican crisis, indicate that the "tequila" effect did not occur, probably because of swift remedial action. The equity markets of other Latin countries reacted for a few days and then resumed more normal patterns.
In East Asia, however, the cross-country effects have been more lasting. The process started with the July floating of the baht, followed by equally large (or larger) depreciation of many other Asian currencies and stock market declines. The January pictures show at least 6 months of decline in markets throughout the area. This picture is one of a much more pervasive movement than in Latin America.
Although the event is generally considered to have been triggered by events in Thailand, there are grounds for tracing the beginnings to events in South Korea. Korean production started to fall during 1996, and particularly in early 1997. Unemployment started to grow in late 1996. The current account was strongly negative in 1996; problems in the semiconductor industry took place as early as 1996; and some major industrial bankruptcies occurred in South Korea before the Thai baht collapsed. The setting was ripe for spreading of financial troubles as soon as the baht collapsed. Since 1995, the W/$ rate had been rising on a gentle gradient before the break came in late 1997. This, by itself, was apparently inadequate in a short time period.
If the major Asian economies that have participated in this financial decline, with associated bankruptcies, credit squeezes, unemployment, output declines, and halting of social programs, are to start rebuilding again, what are some constructive policy lines to be followed?
The "Washington Consensus" of severe macroeconomic restraint through fiscal and financial austerity, will eventually wear off. Plausible projections are for recovery in 1999 or 2000, at the latest. Many of the good features of Asian economics will still prevail. They are
Institution building should be promoted right away and put into place as soon as possible. This calls for infrastructural investment to facilitate and enhance transportation, communication, sanitation, education, energy supply, modern agricultural practices, and public health.
Markets should be liberalized and opened to competition on a gradual, step-by-step basis, with testing at each stage. Appropriate institutions to regulate, oversee, and implement the workings of markets must be created immediately. This calls for rule of law, bankruptcy proceedings, market regulation for fairness and stability, standards for accounting, anti trust rules.
To a large extent, these and other institutions have not been in place. The push towards liberalization has overtaken events and helped to create crisis situations. Once the crises are contained, it is important to return to placement of the building blocks for entering the global marketplace in competition with players from advanced countries where the necessary institutional foundation was built over several decades, even centuries.
To return to my opening remarks concerning the stability of China, permit me to note that their economy has been liberalized on a cautious path for almost two decades, and markets are not yet fully opened to free competition. The step-by-step pattern of Chinese economic development is still in process, and it is important for China, for Asia, and for the world economy that this process go forward.
There was an interruption in 1989-90, but the economy recovered nicely and moves forward with great strength. All the projections point to a continuation of growth between 5 and 10% annually for some time to come. If the present Asian crisis allows the other economies to get back to growth paths at a somewhat reduced rate of expansion, China is likely to move down from rates near 10% annually to a pace that averages between 7 and 8%, but extreme years will undoubtedly widen the interval, and that is why I put it at 5-10% annually.
Financial markets, new infrastructure, necessary institutions, and full membership in global organizations, will help to maintain a stable economy in the world's largest country in a way that contributes to Asian stability.