6a. SE Asian boom and bust 1986-99

1. 6a. SE Asian boom and bust 1986-99

2. Overview • Global economic shocks and national responses, 1973-85 • Global trade boom and Asian FDI • Thailand’s manufacturing export boom • Structure of production and the labor force • Discussion: vulnerability?

3. 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)

4. After the oil shocks: recession and recovery • After 1973 oil price shock, period of “cheap and easy capital” for developing country borrowers • Very low (or negative world real interest rates encouraged borrowing to maintain growth momentum • After 1979 shock, world recession with high real int. rates • Commodity price crash accompanied interest rate hike • Gov’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. Am • Other 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

7. Governments vs markets in 1970s-80s • During 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 recovery • Divergence once again: Philippines adjusts slowly, falls behind neighbors in growth

8. Elements of SE Asian adjustment & recovery • Fiscal conservatism: low deficits, low public sector debt • Thus relatively low inflation in most of SE Asia • Gov’t debt used more for investment than for consumption • Price and exchange rate stability • Political aversion to high inflation in Indonesia, Thailand, … • Conservative fiscal policies underpinned exch. rate stability • ‘Fixed but adjustable’ exch. rate pegs • Relatively friendly investment climate • Few fears of nationalization/expropriation • Exch. rate stability helped guarantee returns to FDI • Outward-oriented industries promised sustained returns on K • Complementary resources: labor, skills, natural resources

9. Price stability

10. Stabilization efforts

11. The global trade and investment boom • Global trade liberalization, lower transport costs, more open capital markets from mid-1980s • 1985: World oil prices collapse to mid-1970s levels • Recovery 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. 1985 • Japanese manufacturers seek offshore bases • SE Asian economies are close, relatively open, politically & economically stable, with cheap and ‘docile’ labor forces

13. Thailand’s policy shift, and its reward • Since 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

14. Foreign investment... and domestic too GFCF: Gross fixed capital formation (i.e. new investment before depreciation)

15. Turning Japanese Bowie and Unger Table 2.1

16. Effects of the investment boom • Transformation of agricultural to industrial economy • See earlier data on GDP shares by sector • Thailand 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: Thailand • Real GDP per capita growth, 1951-86 average: 3.9% • 1987-96 average: 8.0%

19. Economy-wide impacts

20. Economy-wide impacts

21. Thailand: welfare effects of the boom Source: Warr 2005

22. Consequences of post-Plaza growth • Comparative advantage and EOI mean: • Potential for sustained growth by exporting into world mkt • Increasing integration with global capital markets • Gains: rapid, labor-intensive growth • Immediate impacts on wages, employment, poverty • Costs • Inequality? Rising returns to skilled L relative to unskilled L; pressure to maintain competitive labor costs • Greater vulnerability to shocks from international economy • Limits on domestic policies • Foreign capital owners “vote” on domestic policy choices

23. Break time!

24. 6b. Boom, bubble and bust

25. Overview • Thailand’s boom • Macroeconomics of a boom • Sources of vulnerability: Thailand and Indonesia

26. Boom, bubble and bust • Boom: “E. Asian Miracle” in early 1990s: Thailand, Singapore, Malaysia, Indonesia grow at record rates • Based on rising exports of low-end manufactures • Financed largely by foreign fixed capital investments • Bubble: overoptimism about continued growth; speculative booms in property, construction, stocks • Financed increasingly by short-term borrowing from foreign banks • Bust: loss of export competitiveness, financial crisis • Chinese 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?

27. Thailand’s boom and bubble economy • Double-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 TFP • Total 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”)

28. 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)

29. Opening the capital account • Hospitable 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 investment • Fixed 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: Source: Warr 2005: Boom, bust and beyond. Note: discrepancy = decline in reserves

30. Capital inflows and reserves BIBF

31. The confidence game • Price and policy stability • Interest rates above world benchmark • Rising 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

32. Composition of short-term capital stocks BIBF Banks’ loan stock

33. Real appreciation • Increasing demand for non-traded services and assets (housing, offices) fuels speculative investments • The 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 industries • They pay more for non-traded inputs, compete with speculative investors for capital

34. Wage growth = cost increases for L-intensive sectors

35. 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’ industries • Implicit bank failures (actual failures prevented by official interventions) • Non-objective appraisals of the above by regulators (Bank of Thailand “blustering” -- Siamwalla)

36. As wages rose, exports from the most labor-intensive industries shrank fastest Loss of competitiveness in L-intensive inds

37. When the anchor drags Foreign reserves of BoT:

38. Why does investor sentiment change, and why so quickly? • Private sector failures: e.g. Bangkok Bank of Commerce • 1994-96: Evidence of malpractice & politically motivated lending • 1996: Run on BBC; BoT supports it with $US 7 billion injection • Numerous other “failures” through 1996-97, all bailed out by BoT • Government failure: democratization reduced influence of military and technocrats (fiscally conservative forces) • Local money politics, esp. in provinces, busts national budget • Reluctance to cut spending projects even as banking system began to collapse • Politically-connected banks & companies receive GOT protection • Institutional failure: decline of the technocrats • In BOT, loss of independence and competence, esp. as private sector outbid public sector salaries for well-trained economists

39. Income growth forgone

40. 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 stable • Wages and other business costs fairly stable; no big export slowdowns in 1995-96 • Speculative activity in property markets, but “bubble” small • Signs of economic vulnerability -- pre crisis • Bank 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

41. Constitutional weaknesses • “Year of Living Dangerously” (1965): hyperinflation, civil war (1966): aversion to instability • Under Suharto (1967-99), economic policy made under guidance of “technocrats” -- until 1993 • After 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 power • No institutional checks on presidency, or safeguards against failure • Concentration of econ. power, poor governance (“KKN”)

42. 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.

43. 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.”