6a. SE Asian boom and bust 1986-99

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Overview

Global economic shocks and national responses, 1973-85

Global trade boom and Asian FDIThailand’s manufacturing export boom

Structure of production and the labor forceDiscussion: vulnerability?

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Four defining events

First oil price shock (1973-5). Recycling of “petrodollars” in global markets --> cheap credit for developing countries.

Second oil price shock 1979-80. Global recession; high real interest rates on new and existing debt

Global commodity price slump mid-1980s. Export revenues collapse for resource-dependent economies. Debt servicing crises and recessions (1985). Collapse of inward-oriented strategies.

Plaza Accord 1985. Recovery in US and world economies (--> boom in global manuf. trade) and “hollowing-out” of Japanese economy (--> SE Asian FDI boom)

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After the oil shocks: recession and recoveryAfter 1973 oil price shock, period of “cheap and easy capital” for

developing country borrowersVery low (or negative world real interest rates encouraged

borrowing to maintain growth momentumAfter 1979 shock, world recession with high real int. rates

Commodity price crash accompanied interest rate hikeGov’ts which accommodated these negative shocks through

credit creation experienced high inflation or hyper-inflation “Lost decade” (1980s) for heavily indebted econs, e.g. Lat.

AmOther gov’ts chose earlier adjustment, with lower growth but

greater stability of prices and macro aggregates (debt, etc) Mid-1980s: recession everywhere, but varying severity E/SE Asian economies showed generally high growth

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Governments vs markets in 1970s-80sDuring period of ‘cheap and easy credit’, many gov’ts

attempted large-scale industization via public projects Philippines, “11 major industrial projects” (all failed) Indonesia: Pertamina (national oil company) borrowing

spree for development, mid-1970s (ended in bankruptcy & default)

Malaysia, HICOM heavy & chemical industry initiative 1982-85 (expensive flop)

Malaysia,1982 attempt to corner world tin market (disaster)

Speed with which K-intensive ‘showcase’ projects were abandoned helped determine adjustment and recoveryDivergence once again: Philippines adjusts slowly, falls

behind neighbors in growth7

Elements of SE Asian adjustment & recovery

Fiscal conservatism: low deficits, low public sector debtThus relatively low inflation in most of SE AsiaGov’t debt used more for investment than for consumption

Price and exchange rate stabilityPolitical aversion to high inflation in Indonesia, Thailand, …Conservative fiscal policies underpinned exch. rate stability

‘Fixed but adjustable’ exch. rate pegsRelatively friendly investment climate

Few fears of nationalization/expropriationExch. rate stability helped guarantee returns to FDIOutward-oriented industries promised sustained returns on K

Complementary resources: labor, skills, natural resources

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The global trade and investment boom

Global trade liberalization, lower transport costs, more open capital markets from mid-1980s1985: World oil prices collapse to mid-1970s levelsRecovery and boom in West; world trade grows by

much more than income More open economies poised to capture gains

Major realignment of JP Yen-US $ (Plaza Accord), Sept. 1985Japanese manufacturers seek offshore basesSE Asian economies are close, relatively open,

politically & economically stable, with cheap and ‘docile’ labor forces

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Thailand’s policy shift, and its rewardSince 1960s, strongly ISI-oriented

1971 ERPs ranged from -20 to 236 1982 ERPs ranged from -21 to 1693

Trade liberalization begins mid-1980s 1988 reform reduced tariffs and tariff dispersion on many

products More reforms in 1990s

Macro stability: Baht/US$ exch rate = 25 from 1984 to 1997

Openness & stability attracts FDI and domestic investment:

ΔGDP = 8.60 + 1.43*L + 0.3*K – 0.15*FDI + 0.62*OPEN*FDI(data for 1970-99; source Kohpaiboon 2002)

- Strong support for Bhagwati hypothesis

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GFCF: Gross fixed capital formation (i.e. new investment before depreciation)

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Cumulative FDI ($m) FDI From Indonesia Malaysia Philippines Thailand

To 1976 Japan

USA

2,044

1,000

255

108

134

175

75

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To 1980 Japan

USA

3,372

575

226

80

299

752

77

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To 1983 Japan

USA

7,268 764 721 521

To 1993 Japan

USA

13,366 4,585 1,904 5,476

Bowie and Unger Table 2.1

Effects of the investment boom

Transformation of agricultural to industrial economySee earlier data on GDP shares by sectorThailand emerges as leading regional exporter in key

product areas, e.g. motorcycles, automobiles These are primary areas of investment by E. Asian

capital-- complementary with the post-Plaza Accord “hollowing-out”

Effects on total growth: ThailandReal GDP per capita growth, 1951-86 average: 3.9% 1987-96 average: 8.0%

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Year Poverty (%) Inequality

Total Rural Urban (Gini)

1969 63.1 69.6 53.7 0.43

1975 48.6 57.2 25.8 0.43

1981 35.5 43.1 15.5 0.43

1986 44.9 56.3 12.1 0.48

1988 32.6 40.3 12.6 0.48

1992 23.2 29.7 6.6 0.52

1994 16.3 21.2 4.8 0.54

1996 11.4 14.9 3.0 0.52

1998 12.9 17.2 3.4 0.52

2001 13.0 16.6 5.1 0.52Source: Warr 2005

Consequences of post-Plaza growth

Comparative advantage and EOI mean:Potential for sustained growth by exporting into world mktIncreasing integration with global capital markets

Gains: rapid, labor-intensive growthImmediate impacts on wages, employment, poverty

CostsInequality? Rising returns to skilled L relative to unskilled

L; pressure to maintain competitive labor costsGreater vulnerability to shocks from international economyLimits on domestic policies

Foreign capital owners “vote” on domestic policy choices

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Break time!

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Overview

Thailand’s boomMacroeconomics of a boom Sources of vulnerability: Thailand and Indonesia

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Boom, bubble and bustBoom: “E. Asian Miracle” in early 1990s: Thailand, Singapore, Malaysia,

Indonesia grow at record ratesBased on rising exports of low-end manufacturesFinanced largely by foreign fixed capital investments

Bubble: overoptimism about continued growth; speculative booms in property, construction, stocksFinanced increasingly by short-term borrowing from foreign banks

Bust: loss of export competitiveness, financial crisisChinese competition; labor costs; human capital constraints Inability to earn enough to service foreign debts

Recession and recovery: slow for some; permanent reduction in growth rate?

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Thailand’s boom and bubble economyDouble-digit growth 1989-91, concentrated in Bangkok

Non-ag GDP growth rate 2–3 times faster than ag.See labor force transition data (class 14)

Sources of rapid growth? Not TFPTotal factor productivity (TFP) growth is supposed to be the

biggest contributor to long-run growth (Solow; Radelet et al)But pre-boom growth in ‘new tiger’ economies due to factor

accumulation, not productivity increases (Krugman: “Myth of Asia’s Miracle”, 1994)

In Thailand. apparently large ‘Solow residual’ during boom years But: underinvestment in education TFP was due to foreign K inflows (Warr, “Boom, bubble,

bust”)

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Thailand’s boom and bubble economy A key point: domestic and foreign capital are not perfect substitutes in

Thailand One consequence: FDI raises the productivity of domestic capital,

stimulating dom. investment Another consequence: limited success of demand-constraining

‘sterilization’ attempts by central bank Mundell-Fleming: sale of bonds to raise interest rates, with fixed exch. rate

and open capital account, stimulates short-term K inflow that drives int. rates down again; reserves rise but no domestic effects

When dom. & for. K are imperfect substitutes, rate rise can persist, attracting additional foreign K inflows

Foreign reserves will increase, raising investor confidence

Inflows will also contribute to growth in dom. demand, and thus cause a real appreciation (rise in relative prices of nontraded goods)

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Opening the capital accountHospitable environment for FDI

Stable price level and baht-dollar exchange rate since 1984

Capital account liberalization 1993: Bangkok Int’l Banking Facility (BIBF) created to

facilitate foreign borrowing for domestic investmentFixed exch. rate and Bank of Thailand guarantees on

solvency of financial institutions reduce risks of borrowing by private sector

Result: boom in K inflows, with short-term debt dominating

Changing contributions (%) to total savings:

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Foreign investment Total

Period H’holds Gov’t Total

Long term

Short term

1973-86 112.9 –16.7 3.8 5.1 2.1 100

1987-96 93.1 –11.4 18.2 4.1 22.8 100

Source: Warr 2005: Boom, bust and beyond. Note: discrepancy = decline in reserves

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BIBF

The confidence game

Price and policy stabilityInterest rates above world benchmarkRising foreign reserves following liberalization“Implicit guarantee” of exch rate stability“East Asian Miracle” tag… future rapid growth seems

assured“Investing in Thailand seemed both safe and profitable.

Not to participate was to miss out.” (Warr, p.640)Result: accelerating capital inflows, increasingly in

form of int’l borrowing by Thai banks to satisfy demand by domestic borrowers

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BIBF

Banks’ loan stock

Real appreciation Increasing demand for non-traded services and assets

(housing, offices) fuels speculative investmentsThe crane becomes Thailand’s national bird:

construction sector employment increases from 6% – 10% of labor force btwn 1985 and 1995.

Debt-fueled speculation in stock market, property development, and other non-tradable activities

Extent of real appreciation: RER index = 100 in 1973; =70 in 1988, = 40 in 1997.

Real appreciation also undermines profitability of traded goods industriesThey pay more for non-traded inputs, compete with

speculative investors for capital

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Figure 2 Thailand : Agricultural and non-agricultural wage, 1961-

1995 (baht/day)

0

50

100

150

200

250

300

1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995

average agriculture wage average non-agriculture wage BMR non-agriculture wage

Signs of vulnerability

Rising domestic inflation (see: real appreciation)In mid-90s, Thai inflation rose to 5-6%; US inflation

fell to about 2%Indicators of excess supply in speculative mkts

(property etc)Declining profitability and export revenues in

‘boom’ industriesImplicit bank failures (actual failures prevented by

official interventions)Non-objective appraisals of the above by regulators

(Bank of Thailand “blustering” -- Siamwalla)

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As wages rose, exports from the most labor-intensive industries shrank fastest

37Foreign reserves of BoT:

Why does investor sentiment change, and why so quickly?

Private sector failures: e.g. Bangkok Bank of Commerce1994-96: Evidence of malpractice & politically motivated

lending1996: Run on BBC; BoT supports it with $US 7 billion

injectionNumerous other “failures” through 1996-97, all bailed out

by BoTGovernment failure: democratization reduced influence

of military and technocrats (fiscally conservative forces)Local money politics, esp. in provinces, busts national

budgetReluctance to cut spending projects even as banking

system began to collapsePolitically-connected banks & companies receive GOT

protectionInstitutional failure: decline of the technocrats

In BOT, loss of independence and competence, esp. as private sector outbid public sector salaries for well-trained economists

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Thailand: Level and growth rate of GDP per capita

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

198819891990199119921993199419951996199719981999200020012002

Source: WDI

-15

-10

-5

0

5

10

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GDP per capita, PPP(current international $)GDP per capita growth(annual %)

Indonesia: a healthy economy? Indonesia’s economy seemed in good shape prior to 1997

Currency stable against US $; current account deficit relatively small and stable Open capital account since 1971 Financial liberalization since 1988

Budget broadly balanced; inflation low and stableWages and other business costs fairly stable; no big export

slowdowns in 1995-96Speculative activity in property markets, but “bubble” small

Signs of economic vulnerability -- pre crisisBank collapses (1993) underline inst’l weaknesses in private

sector Short-term debt very high in relation to international

reserves; big private capital inflows raise short-term debt to about twice the value of international reserves

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Constitutional weaknesses“Year of Living Dangerously” (1965): hyperinflation, civil war

(1966): aversion to instabilityUnder Suharto (1967-99), economic policy made under guidance

of “technocrats” -- until 1993After 1993, influence passed to “technologs” associated with Dr.

Habibie (Minister for Science & Technology)Habibie: “you can’t build ships by selling fish”. Major

industrial projects (aircraft, biotech, ship-building… ) launched.

Decline of technocrats coincided with period of rapid capital inflows with liberalized capital market

Pinnacle of powerNo institutional checks on presidency, or safeguards against

failureConcentration of econ. power, poor governance (“KKN”)

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Vulnerability: who/what to blame?

Stiglitz, Globalization and its Discontents, p. 99: “I believe that capital account liberalization was the single most important factor leading to the crisis” in Asia …

… It has become increasingly clear that all too often capital account liberalization represents risk without a reward… Probably no country could have withstood the sudden change in investor sentiment… inevitably, such reversals would precipitate a crisis, a recession, or worse.

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Vulnerability: who/what to blame?

Siamwalla, “Can a developing country manage its macroeconomy?”“Although the root cause for the crisis lies in

excessive borrowing by the private sector, its effect has been multiplied by misguided policies, especially those emanating from the Bank of Thailand.

“Since failure of technocracy could in principle be corrected by political leadership, it has to be explained why the Thai political system failed to deliver that leadership.”

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