September 2 1997: Martin Wolf: The real lesson from Asia

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Martin Wolf: The real lesson from Asia
TUESDAY SEPTEMBER 2 1997
wolf Is the Asian "miracle" over? Despite the turmoil in the region's stock markets, which has driven the FT/S&P Pacific Basin (ex-Japan) index down 9 per cent in the past week, the short answer is no. That reply will disappoint many in Europe and North America - all those, that is, who dislike boasts of "Asian values", fear Asian competition or detest the triumph of these outward-looking market economies.

Yet disappointed they will almost certainly be. Their only hope is for the governments of the countries concerned to lose their heads, as did the Brazilians after the first oil shock in the 1970s. Mistaken policies then ended a period of growth that had been comparable to that of the Asian tigers.

What happened in east Asia over the past few decades was never a miracle and, for that reason, is unlikely to vanish overnight. The present upheaval may be painful, not least to the amour propre of such leaders as Mahathir Mohamad, Malaysia's prime minister. But it will pass.

The starting point for any understanding of Asian success is the gap between the output per person in the tiger economies and that in the most advanced economies in the world. This gap defines the opportunity for catching up.

Catching up is precisely what east Asian economies have been doing. Between 1970 and 1995, the gross national product per head of South Korea rose almost eleven-fold, of Hong Kong four-fold and of Thailand three-and-a-half-fold. In 1970, Korea's real income per head (at purchasing power parity) was some 15 per cent of that level. By 1995 it was over 40 per cent of the US level. Thailand's income per head has risen from some 11 per cent to 28 per cent of US levels over the same quarter of a century. This is convergence at work. Japan, Hong Kong and Singapore have already caught up.

Inevitably, the opportunity for rapid growth is a function of the size of the remaining gap. On average, argues Jeffrey Sachs of Harvard University, a doubling of real income per head reduces the underlying growth rate by 1.4 percentage points. If US real income per head will grow sustainably at 1½ per cent a year, Japan's would be expected to grow about as fast, South Korea's at a little over 3 per cent and Thailand's at about 4 per cent.

Yet these are merely tendencies. Individual countries can do better. Hong Kong, South Korea, Singapore and Taiwan have done so. As if to prove there is nothing geographically determined about east Asian performance, the Philippines has, until quite recently, done far worse.

What is striking about the region, however, is how many countries have managed to seize available opportunities to import modern technology and managerial skills and converge on the incomes enjoyed by advanced countries. They have done so because of their imitation of one another. This is neither a miracle nor the fruit of uniquely Asian virtues: Chile has already demonstrated that it is possible to learn from east Asian countries, despite being an ocean away.

Policy is what matters: successful countries have made economic growth a priority; they have followed prudent macroeconomic policies; they have generated extraordinarily high savings rates; they have removed obstacles to trade, particularly to exports; they have kept real exchange rates at competitive levels; they have intervened so in directions encouraged by the market; and they have promoted mass literacy.

The question raised by the present turmoil is whether such fundamental forces for rapid growth have become irrelevant. There are three arguments:

That the opportunities for catch up are rapidly diminishing;

That even though these opportunities are not diminishing quickly, east Asian countries have lost the capacity to exploit them;

That a hostile world environment will prevent the countries from exploiting their potential, as happened in the 1930s. Take these three arguments in turn. In the first place, the countries most affected by the market turbulence - Thailand, Malaysia, Indonesia and the Philippines - still possess substantial room for catching up. Maybe the exceptionally rapid growth of the first half of the 1990s will not be sustained. But sharp reductions in past rates of growth seem far more plausible for Singapore or Hong Kong, which have been relatively untroubled by the markets, than for Indonesia, Malaysia or Thailand.

In the second place, those worried about the loss of the capacity to deliver fast growth can point to clear signs of hubris in Mahathir's Malaysia, the late-regime decay of Suharto's rule over Indonesia or the declining authority of the technocrats in Thailand. Yet, except conceivably for Thailand, it is far from evident that the others have lost the policy threads binding them to past successes.

Finally, there is nothing in the global environment to suggest continued rapid growth is infeasible. True, east Asian countries have to adjust to the rising competition of China, but the latter's growth also creates opportunities for them, as the US has done for Canada. On balance, the underlying global environment is more liberal than at any time since the early part of the century and more stable than since the 1960s.

If there is no reason to believe rapid growth is at an end, how does one explain what is happening? Part of the answer is that market economies never proceed in straight lines. Before the first world war, the US economy was notoriously unstable, which hardly prevented it from growing explosively. The chances of failing to match capacity with output, or demands for loans with the ability of financial institutions to lend sensibly, are particularly high in dynamic but immature economies.

Fortunately, in the case of the east Asian countries, there is also a perfectly good short- to medium-term explanation for the turmoil. It lies in the gyrations of the dollar, particularly against the yen, set against the background of heavily managed exchange rates and immature and inefficient financial systems.

The story can be told most easily of Thailand - the epicentre of the earthquake. During the dollar weakness up to spring 1995, east Asian economies with currencies closely linked to the dollar enjoyed superb competitiveness, not least against producers based in Japan. This helped trigger exceptional growth: the Thai economy expanded at an average rate of 8.4 per cent a year between 1990 and 1995.

Rapid growth, combined with the emerging market euphoria, stimulated huge capital flows. Thailand was able to run a current account deficit averaging close to 7 per cent of GDP between 1990 and 1995. If the exchange rate had been floating, such capital flows would have driven up the currency. Under Thailand's fixed rate, they helped stimulate inflationary excess demand. They did so by keeping interest rates low and stimulating borrowing, particularly for investment in property. Monetary policy could do little about this, given the commitment to the fixed exchange rate.

Things as good as this have to come to an end. With the appreciation of the dollar, they did. The effects on Thailand's exports were exacerbated by the global slowdown in electronics. Also important was the emergence of supply constraints in an economy that had been running flat out for years.

A great deal of what then happened was the result of a foolish resistance to overwhelming market pressure for devaluation. Even now, the decline in east Asian exchange rates against the resurgent dollar is not extraordinary by global standards. Over the past 12 months, the depreciation of the D-Mark has been bigger than that of the Malaysian dollar and not all that much smaller than of the Thai baht.

So would all have been well if the baht had been allowed to float fairly freely throughout? The answer is that things would have been far better. At the least the transmission of external pressures on to the domestic economy would have had far milder effects.

Should all be well now that the baht is floating? Alas no. Policy errors leave long shadows. In this case Thailand's mistakes have hurt its neighbours, partly because they must be concerned about their competitive position and partly because of the contagion that is now infecting the region.

Yet the deepest shadows are always at home. In the defence of the exchange rate the central bank has laid out over $23bn of Thailand's reserves, while high interest rates (to defend the currency) have damaged the solvency of the private sector. Still more seriously, the fixed exchange rate encouraged the private sector to run up short-term foreign debts of around $50bn. An exchange-rate commitment that fails is, in short, a machine for destroying a private sector's solvency.

The legacy of the episode is serious. The current consensus is that the Thai economy will grow by less than 2 per cent this year and by not much more in 1998. This is disappointing. But after years of growth at 8 per cent, it is hardly a catastrophe.

In the region as a whole, the devaluations will be helpful. For the rest, what matters is to take advantage of the opportunity to put their houses in order. It is precisely because the performance of the region has not been a miracle that this is possible. But, for the same reason, growth does depend on sustaining the right policies. Opportunities can be thrown away, as the history of Latin America repeatedly shows.

The east Asian model has not collapsed. Rather, the combination of fixed exchange rates with distorted financial systems is inconsistent with stable growth. That is the true lesson of the Asian turmoil.

© Copyright the Financial Times Limited 1997
"FT" and "Financial Times" are trademarks of The Financial Times Limited.

		Martin Wolf: The real lesson from Asia TUESDAY SEPTEMBER 2 1997 Is the Asian "miracle" over? Despite the turmoil in the region's stock markets, which has driven the FT/S&P Pacific Basin (ex-Japan) index down 9 per cent in the past week, the short answer is no. That reply will disappoint many in Europe and North America - all those, that is, who dislike boasts of "Asian values", fear Asian competition or detest the triumph of these outward-looking market economies. Yet disappointed they will almost certainly be. Their only hope is for the governments of the countries concerned to lose their heads, as did the Brazilians after the first oil shock in the 1970s. Mistaken policies then ended a period of growth that had been comparable to that of the Asian tigers. What happened in east Asia over the past few decades was never a miracle and, for that reason, is unlikely to vanish overnight. The present upheaval may be painful, not least to the amour propre of such leaders as Mahathir Mohamad, Malaysia's prime minister. But it will pass. The starting point for any understanding of Asian success is the gap between the output per person in the tiger economies and that in the most advanced economies in the world. This gap defines the opportunity for catching up. Catching up is precisely what east Asian economies have been doing. Between 1970 and 1995, the gross national product per head of South Korea rose almost eleven-fold, of Hong Kong four-fold and of Thailand three-and-a-half-fold. In 1970, Korea's real income per head (at purchasing power parity) was some 15 per cent of that level. By 1995 it was over 40 per cent of the US level. Thailand's income per head has risen from some 11 per cent to 28 per cent of US levels over the same quarter of a century. This is convergence at work. Japan, Hong Kong and Singapore have already caught up. Inevitably, the opportunity for rapid growth is a function of the size of the remaining gap. On average, argues Jeffrey Sachs of Harvard University, a doubling of real income per head reduces the underlying growth rate by 1.4 percentage points. If US real income per head will grow sustainably at 1½ per cent a year, Japan's would be expected to grow about as fast, South Korea's at a little over 3 per cent and Thailand's at about 4 per cent. Yet these are merely tendencies. Individual countries can do better. Hong Kong, South Korea, Singapore and Taiwan have done so. As if to prove there is nothing geographically determined about east Asian performance, the Philippines has, until quite recently, done far worse. What is striking about the region, however, is how many countries have managed to seize available opportunities to import modern technology and managerial skills and converge on the incomes enjoyed by advanced countries. They have done so because of their imitation of one another. This is neither a miracle nor the fruit of uniquely Asian virtues: Chile has already demonstrated that it is possible to learn from east Asian countries, despite being an ocean away. Policy is what matters: successful countries have made economic growth a priority; they have followed prudent macroeconomic policies; they have generated extraordinarily high savings rates; they have removed obstacles to trade, particularly to exports; they have kept real exchange rates at competitive levels; they have intervened so in directions encouraged by the market; and they have promoted mass literacy. The question raised by the present turmoil is whether such fundamental forces for rapid growth have become irrelevant. There are three arguments: That the opportunities for catch up are rapidly diminishing; That even though these opportunities are not diminishing quickly, east Asian countries have lost the capacity to exploit them; That a hostile world environment will prevent the countries from exploiting their potential, as happened in the 1930s. Take these three arguments in turn. In the first place, the countries most affected by the market turbulence - Thailand, Malaysia, Indonesia and the Philippines - still possess substantial room for catching up. Maybe the exceptionally rapid growth of the first half of the 1990s will not be sustained. But sharp reductions in past rates of growth seem far more plausible for Singapore or Hong Kong, which have been relatively untroubled by the markets, than for Indonesia, Malaysia or Thailand. In the second place, those worried about the loss of the capacity to deliver fast growth can point to clear signs of hubris in Mahathir's Malaysia, the late-regime decay of Suharto's rule over Indonesia or the declining authority of the technocrats in Thailand. Yet, except conceivably for Thailand, it is far from evident that the others have lost the policy threads binding them to past successes. Finally, there is nothing in the global environment to suggest continued rapid growth is infeasible. True, east Asian countries have to adjust to the rising competition of China, but the latter's growth also creates opportunities for them, as the US has done for Canada. On balance, the underlying global environment is more liberal than at any time since the early part of the century and more stable than since the 1960s. If there is no reason to believe rapid growth is at an end, how does one explain what is happening? Part of the answer is that market economies never proceed in straight lines. Before the first world war, the US economy was notoriously unstable, which hardly prevented it from growing explosively. The chances of failing to match capacity with output, or demands for loans with the ability of financial institutions to lend sensibly, are particularly high in dynamic but immature economies. Fortunately, in the case of the east Asian countries, there is also a perfectly good short- to medium-term explanation for the turmoil. It lies in the gyrations of the dollar, particularly against the yen, set against the background of heavily managed exchange rates and immature and inefficient financial systems. The story can be told most easily of Thailand - the epicentre of the earthquake. During the dollar weakness up to spring 1995, east Asian economies with currencies closely linked to the dollar enjoyed superb competitiveness, not least against producers based in Japan. This helped trigger exceptional growth: the Thai economy expanded at an average rate of 8.4 per cent a year between 1990 and 1995. Rapid growth, combined with the emerging market euphoria, stimulated huge capital flows. Thailand was able to run a current account deficit averaging close to 7 per cent of GDP between 1990 and 1995. If the exchange rate had been floating, such capital flows would have driven up the currency. Under Thailand's fixed rate, they helped stimulate inflationary excess demand. They did so by keeping interest rates low and stimulating borrowing, particularly for investment in property. Monetary policy could do little about this, given the commitment to the fixed exchange rate. Things as good as this have to come to an end. With the appreciation of the dollar, they did. The effects on Thailand's exports were exacerbated by the global slowdown in electronics. Also important was the emergence of supply constraints in an economy that had been running flat out for years. A great deal of what then happened was the result of a foolish resistance to overwhelming market pressure for devaluation. Even now, the decline in east Asian exchange rates against the resurgent dollar is not extraordinary by global standards. Over the past 12 months, the depreciation of the D-Mark has been bigger than that of the Malaysian dollar and not all that much smaller than of the Thai baht. So would all have been well if the baht had been allowed to float fairly freely throughout? The answer is that things would have been far better. At the least the transmission of external pressures on to the domestic economy would have had far milder effects. Should all be well now that the baht is floating? Alas no. Policy errors leave long shadows. In this case Thailand's mistakes have hurt its neighbours, partly because they must be concerned about their competitive position and partly because of the contagion that is now infecting the region. Yet the deepest shadows are always at home. In the defence of the exchange rate the central bank has laid out over $23bn of Thailand's reserves, while high interest rates (to defend the currency) have damaged the solvency of the private sector. Still more seriously, the fixed exchange rate encouraged the private sector to run up short-term foreign debts of around $50bn. An exchange-rate commitment that fails is, in short, a machine for destroying a private sector's solvency. The legacy of the episode is serious. The current consensus is that the Thai economy will grow by less than 2 per cent this year and by not much more in 1998. This is disappointing. But after years of growth at 8 per cent, it is hardly a catastrophe. In the region as a whole, the devaluations will be helpful. For the rest, what matters is to take advantage of the opportunity to put their houses in order. It is precisely because the performance of the region has not been a miracle that this is possible. But, for the same reason, growth does depend on sustaining the right policies. Opportunities can be thrown away, as the history of Latin America repeatedly shows. The east Asian model has not collapsed. Rather, the combination of fixed exchange rates with distorted financial systems is inconsistent with stable growth. That is the true lesson of the Asian turmoil.


		© Copyright the Financial Times Limited 1997 "FT" and "Financial Times" are trademarks of The Financial Times Limited.