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I. Endogenous Growth and International Transmission

II. The Asian Crisis and Resolution

Lecture 18

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The Dramatic Demographics of the Developing World

0%

20%

40%

60%

80%

100%

2000 2010 0 100 200 300

US & Canada

Asia High

Western Europe

Latin America

Middle East & Africa

Asia Low Income

China

Asia Mid Income

Less than 15% of the World’s Population is in Europe, Japan and North America

Asia dominates the growth

Population by RegionPopulation Growth,

2000-2010, Millions of People

Per

cent

of

Tot

al

Note: Asia High Income includes Singapore, Hong Kong, New Zealand, and Australia; Asia Mid Income includes Korea, Thailand, Indonesia, Malaysia, and the Philippines; Asia Low Income includes India and Pakistan

Japan

Asia HighWestern Europe

North America

Latin America

Middle East & Africa

Asia Mid

Asia Low

China

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0%

2%

4%

6%

8%

10%

US

& C

anad

a

Asi

a: H

igh

Inco

me

Eur

ope

Latin

Am

eric

a

Mid

dle

Eas

t an

dA

frica

Asi

a Lo

w In

com

e

Chi

na

Asi

a: M

id In

com

e

1985-1999

2000-2010

$0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000

North America

Asia: HighIncome

WesternEurope

Latin America

Mid. East &Africa

Asia: LowIncome

China

Asia: MidIncome

Real GDP Average Annual Growth Absolute Increase in Market Size (Real GDP)US$ billions increase, 2000-2010

Gro

wth

Rat

e

Dollars in Billions(Adjusted for Purchasing Power)

Note: Asia High Income includes Japan, Singapore, Hong Kong, New Zealand, and Australia; Asia Mid Income includes Korea, Thailand, Indonesia, Malaysia, Taiwan, and the Philippines; Asia Low Income includes India and Pakistan

Asia Will Have the Largest Absolute Real GDP Gain Through 2010

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The New Economic Order: Open Borders for Goods, Technology and Finance

Increasingly free trade with the developing world creates tremendous stress in the mature industrial economies: the opportunity to move production and assembly technologies abroad removes a previously captive privilege from the workers of the United States, Japan, and Europe. The NAFTA and EC expansions point to extended trends in this direction.

– Semi-skilled labor is now in gross over-supply worldwide.

– Managers and entrepreneurs will benefit.

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The New Economic Order: Open Borders for Goods, Technology and Finance

Unprecedented technology and capital transfers plus political transformations signal high growth for selected developing nations. The earliest and most rapid advancement will occur where:

– the work-force is the best educated and motivated;

– the indigenous entrepreneurial climate is most positive;

– equity investment and trade are encouraged;

– government fiscal and monetary policies are best balanced to keep inflation and exchange risks minimal; and

– the democratic heritage is strongest.

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Returns to Education Have Risen

0

0.2

0.4

0.6

0.8

1

1.2

1.4

College Graduates High SchoolGraduates

High School Drop-outs

1979 1988

(Multiple of average income)

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International Transmission

A country can import a higher level of “technology” to accelerate its growth by:

Copying, licensing or pirating from successful approaches elsewhere Sending students to foreign universities and technical programs Sending business managers and engineers on plant tours Reverse-engineering products All of this tends to create a strong convergence process pulling up nations

with below average productivity This pace of convergence appears to be correlated with the level of

investment in equipment.

– Given the ability to change technology, the new equipment can be logically expected to yield a high rate of return.

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International Transmission

A country can import a higher level of “technology” to accelerate its growth

– Depending on how the official investment series are deflated to account for quality changes, this could include better “machines” and show up as either endogenous (measured) or exogenous (unmeasured) changes in inputs or TFP

– It certainly also includes better work flow and production patterns which will appear to be exogenous

– Access to this may require allowing equity investment and partnerships: the best practices are not for sale to non-partners

A country can also play to global comparative advantage by opening up to trade and so boost its standard of living

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The Most Rapid Growth in Developing NationsHas Occurred for those Having.....High Investment

Shares of GDP,

BottomGrowthQuartile

TopGrowthQuartile

0

0.05

0.1

0.15

0.2

0.25

0.3

BottomGrowthQuartile

TopGrowthQuartile

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BottomGrowthQuartile

TopGrowthQuartile

00.05

0.10.15

0.20.25

0.30.35

BottomGrowthQuartile

TopGrowthQuartile

...High Secondary School Enrollment Rates,

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BottomGrowthQuartile

TopGrowthQuartile

0

0.2

0.4

0.6

0.8

1

BottomGrowthQuartile

TopGrowthQuartile

...and High Trade Shares of GDP

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Markets Outside the United States Still Offer the Greatest Long-Run Growth Potential

LARGE POPULATIONS, WITH HIGHER GROWTH RATES

+ Opening markets for goods, technology, information and capital

+ Productivity rising toward the US standard

+ Transformation toward free enterprise economies = RAPID INCOME GROWTH

+ Rising share of income spent on consumer durables and business capital equipment

= VERY RAPID MARKET GROWTH , IN LOCAL CURRENCIES

+ Currency appreciation relative to $US as development proceeds = EXTRAORDINARY LONG TERM OPPORTUNITY FOR US$

REVENUE GROWTH

The long-run trend remains very positive. However, this trend to higher-valued currencies is

subject to periodic crises

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20.2%

7.7%

-1.0

1.0

3.0

5.0

7.0

9.0

11.0

13.0

15.0

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

Durable Goods

Real GDP

Ind

exe

d t

o 1

98

0=

1

The Market Growth Advantage Exceeds the GDP Growth Advantage Korean Durable Goods vs. GDP

CAGRs: Inflation Adjusted Concepts

Durable Goods :

GDP :

Growth Multiple (Durable Goods/Real GDP): 2.6:1

1980-1995

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A Positive Trend of Currency Appreciation as Development Proceeds, But with Periodic

Major Crises

0.0

0.2

0.4

0.6

0.8

1.0

1.2

0 5,000 10,000 15,000 20,000

Rea

l Exc

han

ge R

ate

(R

XP

PP

/RX

)

Real Per Capita GDP (1995)

Korea: 1960-1998

1997

1998

Crisis

The 1998 Currency Value is Appropriate for a Country with only 1/3 of Korea’s GDP!

Note: The “real” exchange rate depicted here is the ratio of the market exchange rate to the hypothetical exchange ratethat would equate the cost of goods in Korea to the cost of goods in the major industrial nations. For example, a real exchange rate of 0.4 means that the cost of goods in Korea is only 40% of the cost in the major nationsat prevailing market won/$ exchange rates

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The Relationship Between a Country’s Level of Development and an Appreciating Exchange Rate

is Confirmed in Cross-Country Comparisons

0.00.20.40.60.81.0

1.21.41.61.82.0

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000

Re

al E

xch

an

ge

Ra

te

Real Per Capita GDP

Malaysia

Taiwan

SpainSingapore

Japan Switzerland

At any point in time (1996 shown here), the strength of a country’s exchange rate correlates well with its level of development

CanadaBrazil

Mexico

Argentina

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0

0.2

0.4

0.6

0.8

1

1.2

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000

Brazil and Argentina were clearly overvalued until recently

Argentina: 1984-1998

0

0.2

0.4

0.6

0.8

1

1.2

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000

Brazil: 1965-1998

0

0.2

0.4

0.6

0.8

1

1.2

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000

Mexico: 1960-1998

Rea

l Exc

ha

ng

e R

ate

(R

XP

PP

/RX

)

Real Per Capita GDP (in 1995 Dollars)

Rea

l Exc

ha

ng

e R

ate

(R

XP

PP

/RX

)

Real Per Capita GDP (in 1995 Dollars)

Rea

l Exc

ha

ng

e R

ate

(R

XP

PP

/RX

)

Real Per Capita GDP (in 1995 Dollars)

‘89

‘90

‘98

Late‘90s

‘65

‘83‘84 ‘85

‘81

‘82

‘86‘87

‘97

Mexico has only partially recovered, and remains

cheap

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0%

20%

40%

60%

80%

100%

1985 1990 1995 2000

Exc

hang

e R

ate

As

% O

f P

arit

y

Korea

Note: The “real” exchange rate depicted here is the ratio of the market exchange rate to the hypothetical exchange ratethat would equate the cost of goods in Korea to the cost of goods in the major industrial nations. For example, a real exchange rate of 0.4 means that the cost of goods in Korea is only 40% of the cost in the major nationsat prevailing market won/$ exchange rates

Brazil

Mexico

The Cycles Of Crisis Devaluations(Around A Rising Trend?)

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The Competitive Pressure From China:The Chinese Exchange Rate Was Cut Sharply

as China Engaged in More Trade With the West

0%

20%

40%

60%

80%

100%

120%

140%

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

0

1

2

3

4

5

6

7

8

9

10

Exc

hang

e R

ate

as %

of

Par

ity

Exchange Rate: Actual as percent of Parity(left scale)

Purchasing power parity exchange rate (inverted at right)

Exchange rates, Chinese currency per dollar (inverted scale at right)

Actual rate

Chinese currency per U

S D

ollar

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Developing Nations Compete Fiercely:The Chinese Devaluation in 1994 Was a Prime

Force in the Asian Crisis

0

0.2

0.4

0.6

0.8

1

1.2Ja

n-91

May

-91

Sep

-91

Jan-

92

May

-92

Sep

-92

Jan-

93

May

-93

Sep

-93

Jan-

94

May

-94

Sep

-94

Jan-

95

May

-95

Sep

-95

Jan-

96

May

-96

Sep

-96

Jan-

97

May

-97

Sep

-97

Jan-

98

May

-98

Sep

-98

Jan-

99

May

-99

Sep

-99

Exc

hang

e R

ate,

Mar

ch 9

1=1.

0

Mexico

Thailand

Korea

China

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The Chinese Devaluation in 1994 Was a Prime Force in the Asian Crisis

0%

5%

10%

15%

20%

25%

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

Exports

Imports

Impacts of 1994DevaluationP

erce

nt o

f G

DP

Chinese International Trade as Percent of GDP

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1984 1986 1988 1990 1992 1994 1996 1998 2000

Exc

hang

e R

ate

As

% O

f P

arit

y

Korea

Note: The exchange rate percentage depicted here is the ratio of the market exchange rate to the hypothetical exchange ratethat would equate the cost of goods in Korea to the cost of goods in the major industrial nations. For example, a real exchange rate of 0.4 means that the cost of goods in Korea is only 40% of the cost in the major nationsat prevailing market won/$ exchange rates

Brazil

Mexico

China

The Competitive Pressure From China:Costs At Only 20% Of Industrial Nations, And 40% Of

Large Developing Nations

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Will China Destabilize Global Competition for Decades?

• Another Chinese devaluation would be grossly destabilizing

• Chinese leaders largely understand this– They would prefer to increase their global clout – The exchange markets would not tolerate a competitive

shift

• Therefore, two alternate paths exist:– A Chinese economy with a rising currency and massive

scale– A continuing crisis for developing nations and

disruptive job relocation from the US, Europe, Japan

Tectonic Shifts Beyond 2000 : The Global Economic Pressures

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Insights into Asian Recovery Prospects

Long-term opportunities in developing nations

Causes of the immediate currency-financial-

economic crisis, and probable scenarios for

resolution of the crisis

Global competition: labor costs

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The Ingredients of the Crisis in Asia

– The emerging nations are subject to financial crises… for reasons that can be pretty well understood but not entirely eliminated» Changing economic regimes and

pursuing high growth fundamentally risks volatile performance

» Policy mistakes, limited information, and inadequate financial supervision spawn crises

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Pursuing high growth adds risk, but mediocrity is the only other option

– As an individual....» If you’ve never had a speeding ticket, on

average you’re driving too slow» If you’ve never missed a flight, you’re

wasting too much time at the airport

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Pursuing high growth adds risk, but mediocrity is the only other option

– As a nation or a world economy...» If no bank fails in your country,

you’re over-supervised and illiquid» If no currency crises ever occur, there’s

too little cross-border risk investment

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The Specific Ingredients of the Crisis in Thailand, the First Asian Victim in this Cycle

– An economy with many obvious strengths, attracting voracious investment in both industry and, as too often follows, real estate

– Borrowing in dollars, lending in local currency

– A currency that became over-valued

» Fixed nominal value to $U.S., combined with rapid $U.S. appreciation versus Europe and Japan

» 30% Chinese devaluation in 1994, plus tax rebates and aggressive lending to Chinese exporters

» Huge, growing current account deficit

– A banking and financial system with supervision, information and disclosure problems

» Financial deregulation prior to establishing supervision

» Fraud

» Too much speculative real estate lending Spillover Throughout the Region

– Currency devaluations prompted by:

» Competitive need to remain close to Thai and Chinese costs in manufacturing and assembly

» Overseas investor fears of comparable weakness--some flight without knowledge

» Similar banking / borrowing problems when confronted with falling currency

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Will Asia Recover Without Great Delay?

Arguments for:

Financial shock is similar in scale to previously “well-digested” shocks in Asia, Mexico, and Brazil

Asia has huge saving rates to supply much of its own capital

The current drop in Asian production equals only 2 years’ growth, not 5-10 years’ as in Latin America

The region is now even more attractive as low-cost production base

Above- average entrepreneurial mode of the region will be strengthened by IMF reforms

Arguments against:

– The region has no comparable “engine” (like the US helping Mexico) to pull it out

– Indeed, Japan is a heavy “caboose” retarding the region

– The IMF initially forced fiscal austerity

– China could be a de-stabilizing force, again

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The Resolution of the Emerging Nation Crisis

0.00

0.20

0.40

0.60

0.80

1.00

1.20

11

/30

/96

1/3

1/9

7

3/3

1/9

7

5/3

1/9

7

7/3

1/9

7

9/3

0/9

7

11

/30

/97

1/3

1/9

8

3/3

1/9

8

5/3

1/9

8

7/3

1/9

8

9/3

0/9

8

11

/30

/98

1/3

1/9

9

Brazil

Taiwan

Hong Kong

Japan

Malaysia

Thailand

China

Korea

MexicoIndonesia

199

4 =

1.0

0

Exchange Rate Developments in Key Asian and Latin American Nations

THE PARTHENON GROUP

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0.75

1.00

1.25

1.50

1.75

2.00

2.25

7/3

1/9

6

9/3

0/9

6

11

/30

/96

1/3

1/9

7

3/3

1/9

7

5/3

1/9

7

7/3

1/9

7

9/3

0/9

7

11

/30

/97

1/3

1/9

8

3/3

1/9

8

5/3

1/9

8

7/3

1/9

8

9/3

0/9

8

11

/30

/98

1/3

1/9

9

Brazil

Taiwan

Japan

Malaysia

Argentina

Korea

Mexico

19

91

= 1

.00

The Resolution of the Emerging Nation CrisisIndustrial Production in Key Asian

and Latin American Nations

Note the Full Recovery in Korea

THE PARTHENON GROUP

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Long-term opportunities in Asia

Causes of the immediate currency-financial-

economic crisis, and probable scenarios for

resolution of the crisis

Global competition: labor costs

Insights into Asian Recovery Prospects

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Asian Devaluations Have Dramatically Reduced Asia’s Cost of Manufacturing Labor

The dramatic reductions in Asian labor costs will accelerate the migration of manufacturing and assembly to Asia from North

America and Europe.

As Korea developed, the hourly labor cost appropriately rose from $0.32/hour in 1975 to $8.22/hour in 1996

The crisis has cut the cost back down to 1991 levels ($4.81/hour), roughly 1/4 of US labor compensation ($19/hour)

Taiwan, at $6.64/hour, is also competitive

Mexico, at $1.77/hour in the wake of the1995 crisis, is inordinately cheap.

Comparable data is not available for Brazil and Argentina, but the earlier charts of their exchange rates indicate expensive situations.

Europe is very expensive, even after the 1995-1998 depreciation

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Cost of Manufacturing LaborRelative to US

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%1

96

0

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

Co

st a

s %

of

US

Co

st

Germany

France

Japan

Korea

Mexico

Singapore

Spain

Taiwan

UK

Source: US Bureau of Labor Statistics; DRI Forecast