Rebalancing Growth in Asia Masahiro Kawai Dean and CEO Asian Development Bank Institute The World Economy Asia Lecture University of Nottingham Kuala Lumpur, 14 January 2010
Outline 1. Introduction 2. The Global Imbalance and Crisis 3. Economic Analysis of Growth Rebalancing 4. Policies to Rebalance Growth 5. Conclusions
1. Introduction What is the rebalancing of growth? Is it needed? Has the pattern of Asian growth been out of balance? Was the pre-crisis global imbalance an important cause of the global financial crisis? What does growth rebalancing achieve? Are policies effective in inducing growth rebalancing?
Why rebalancing is important The global imbalance may have been a factor behind the development of the global financial crisis US and European demand for Asian export products is likely to remain subdued Asia needs to rely more on domestic and regional demand for growth
2. The Global G Imbalance and Crisis (1) The global payments imbalance (2) The imbalance and the crisis: A causal link? (3) The US and European economies in crisis (4) Impact of the crisis on Asian economies
(1) The global g payments imbalance What is the global payments imbalance? Large current account deficits in the U.S. financed by capital inflows Large current account surpluses in East Asia (Japan, China, NIEs and ASEAN) Large surpluses by oil producing countries Europe as a whole has a relatively balanced current account (though there are intra-regional imbalances) Many emerging East Asian economies are rapidly accumulating foreign exchange reserves
Global current account imbalance 2.5 2.0 Percent of World GDP 1.5 1.0 0.5 0.0-0.5-1.0-1.5-2.0 1980 1985 1990 1995 2000 2005 2010 Rest of the world Other industrial countries Other emerging Asia Middle East China Russia Japan United States Note: (1) Data for 2009 and beyond are IMF projections (2) Unlike the original IMF data, other emerging Asia includes Asian NIEs Source: IMF, WEO October 2009
Current accounts of the US, Japan, China and oil exporting countries 500 400 300 200 100 0-100 -200-300 -400-500 -600-700 -800-900 Billion US dollars 1990 1995 2000 2005 US Japan China Oil Exporting Countries Source: IMF, International Financial Statistics
Current accounts of the US, Japan, China, Asian NIEs, ASEAN, Euro area 25 20 Current Account/GDP (%) 15 10 5 0-5 -10-15 -20 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 United States Euro area Japan China Asian NIEs ASEAN-5 Middle East Source: IMF, International Financial Statistics
Savings-investment imbalances, or income-expenditure gaps US spends more than it earns low household savings and large fiscal deficits Japan spends less than it earns high corporate sector savings (despite large fiscal deficits and declining household savings) China s surge of savings (and investment, but to a lesser extent) by both corporate and household sectors ASEAN s sharp drop in investment in the post 1997-98 crisis Oil producing countries sharp rise of savings (oil revenues) due to oil price hikes
Savings and investment in the US 22 20 18 16 14 12 Percent of GDP (%) 10 1980 1985 1990 1995 2000 2005 Gross Domestic Capital Formation Gross Domestic Saving Source: IMF, World Economic Outlook, October 2009
Savings and investment in Japan 34 32 Percent of GDP (%) 30 28 26 24 22 20 1980 1985 1990 1995 2000 2005 Gross Domestic Capital Formation Gross Domestic Saving Source: IMF, World Economic Outlook, October 2009
Savings and investment in China 50 48 46 44 42 40 38 36 34 32 Percent of GDP (%) 1980 1985 1990 1995 2000 2005 Gross Domestic Capital Formation Gross Domestic Saving Source: ADB, Key Indicators, various issues
Savings and investment in Asian NIEs 38 36 Percent of GDP (%) 34 32 30 28 26 24 22 1980 1985 1990 1995 2000 2005 Gross Domestic Capital Formation Gross Domestic Saving Source: IMF, World Economic Outlook, October 2009
Savings and investment in ASEAN-4 35 30 25 20 15 Percent of GDP (%) 1980 1985 1990 1995 2000 2005 Gross Domestic Capital Formation Gross Domestic Saving Source: ADB, Key Indicators, various issues
Savings and investment in Asian NIEs 45 40 Percent of GDP (%) 35 30 25 20 15 10 5 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Gross Domestic Capital Formation Gross Domestic Saving Source: IMF, World Economic Outlook, October 2009
Savings and investment in EU 26 25 Percent of GDP (%) 24 23 22 21 20 19 18 1980 1985 1990 1995 2000 2005 Gross Domestic Capital Formation Gross Domestic Saving Source: IMF, World Economic Outlook, October 2009
Why was the imbalance considered undesirable? The large, persistent imbalance was deemed to be unsustainable due to the risk of: (1) rising protectionism in the US and (2) eventual loss of confidence on the US ability to repay external debt, leading to a collapse of the value of the US dollar The second risk above is still small because of the near-zero balance of interest income payments, but will be serious over time If left unaddressed, there could be a disorderly unwinding of the imbalance, with a sharp decline in the US dollar, negatively affecting East Asian economies
(2) The imbalancei and the crisis: A causal link? Two views of the causesc of the crisis: Policy mistakes in crisis countries (US, Europe) Failure of macroeconomic policy, particularly monetary policy, to contain a buildup of domestic financial vulnerabilities and systemic risk Flaws in financial regulation and supervision Weak global financial architecture * IMF, Initial Lessons of the Crisis for the Global Architecture and the IMF (February 2009). Global payments imbalance The arguments by Greenspan ( conundrum ) and Bernanke ( savings glut ) suggest that East Asia supplied ample liquidity to the US and kept the US long-term interest rate too low
US policy rates rose but not the housing mortgage rates in 2004-2006 9 8 US Interest Rates 7 6 5 4 3 2 1 0 2000M1 2000M6 2000M1 2001M4 2001M9 2002M2 2002M7 2002M1 2003M5 2003M1 2004M3 2004M8 2005M1 2005M6 2005M1 2006M4 2006M9 2007M2 2007M7 2007M1 2008M5 2008M1 2009M3 FEDERAL FUNDS RATE GOVT BOND YIELD: 3 YEAR GOVT BOND YIELD: 10 YEAR MORTGAGE RATE
The validity of the 2 nd view is weaker: The deficit was concentrated in the US while there were many surplus countries Concentration of the crisis in the US and Europe Not all countries had housing bubbles (eg, Australia and Canada managed well)
(3) The US and European economies in crisis Severe economic recession Bursting of the housing bubble and excess household debt Loss of household assets Rising unemployment Consumption and imports of the US likely to return to long-term trend This suggests sluggish recovery and lower potential growth in the post-crisis period
US household debt (total, mortgage) 140 130 120 110 100 90 80 70 60 50 40 30 20 Ratio to Disposable Income, % 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Total debt Trend Mortgage Trend 140 130 120 110 100 90 80 70 60 50 40 30 20 Source: FRB Flow of Funds, US BEA
US households suffered a massive loss of wealth, and need to rebuild balance sheets 800 Ratio to Disposable Income, % 800 700 700 600 600 500 500 400 400 300 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Total assets Trend Net total assets Trend 300 Source: US Bureau of Economic Analysis
US and EU unemployment rates rising 12 11 10 9 8 7 6 5 4 3 Unemployment Rate, % 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 US EU 12 11 10 9 8 7 6 5 4 3 Source: CEIC Note: EU15 before 2000: EU27 from 2000.
Share of consumption & imports in US GDP likely to return to LT trend 72 70 68 66 64 62 60 58 Share of real GDP, % 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 18 16 14 12 10 8 6 4 Consumption Imports (RHS) Source: CEIC
Consequently, US households savings rate needs to rise, and spending slow Y/y% % 14 12 10 8 6 4 2 0 14 12 10 8 6 4 2 0-2 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Disposable income (LHS) Consumption (LHS) Savings rate (RHS) -2 Source: US Bureau of Economic Analysis
(4) Impact on Asia Export collapse due to excessive dependence on the US and European markets for exports, particularly Japan, Asian NIEs, and export dependent middle-income ASEAN countries (like Malaysia and Thailand) Some limited financial contagion, particularly in Korea which almost had a currency crisis Loss of business and consumer confidence GDP contraction or slowdown But quick reaction with countercyclical fiscal and monetary policy
Final demand for Asian exports still comes from the advanced economies Final demand composition of Asia s export in 2006 Source: ADB, Asian Development Outlook
Japan s s industrial structure recently 160 shifted to the tradables sector 150 140 130 120 110 100 90 1980 1985 1990 1995 2000 2005 non-tradables/tradables (nominal) non-tradables/tradables (real) trend (nominal) trend (real) Source: Cabinet Office, National Income Account
China s s industrial structure has also shifted to the tradables sector 260 240 220 200 180 160 140 120 100 1980 1985 1990 1995 2000 2005 non-tradables/tradables (nominal) non-tradables/tradables (real) trend (nominal) trend (real) Source: World Bank, World Development Indicators
while the US industrial structure has shifted to the nontradables sector 210 200 190 180 170 160 150 140 130 120 110 100 90 1980 1985 1990 1995 2000 2005 non-tradables/tradables (nominal) non-tradables/tradables (real) trend (nominal) trend (real) Source: Council of Economic Advisors, Economic Report of the President
Asian policy responses to the crisis Aggressive easing of monetary and fiscal policy, made possible because of ample policy room due to earlier prudent management Supported by strong fundamentals - Improved monetary policy frameworks - Strengthened balance sheets and reduced currency risk - High foreign exchange reserve levels
3. Economics of Growth Rebalancing (1) Current account adjustment (2) A CGE simulation analysis (3) Demand side factors, and inclusiveness and sustainability of growth
(1) Current account adjustment The tradables and nontradables model An intertemporal optimizing model of consumers (Figures 1-4) Firm behavior of investment can be easily incorporated, but not essential in this analysis There are no distortions that impede resource shifts between tradable and nontradable production Important role of the relative price of nontradable to tradable goods
Tradables US CA deficit in period 1 Current account Deficit in period 1 C 1 T T T Y 1 C 1 Q 1 p 1 N N N 0 C 1, Y 1 N Nontradables p 1 N
To be matched by a US CA surplus Tradables in period 2 Current account surplus in period 2 Q 2 T Y 2 T C C 2 2 p 2 N N N p 2 N 0 C 2, Y 2 N Nontradables
CA in balance Tradables T E 0 N p N Nontradables
CA adjustment in periods 1 & 2 Tradables Current account surplus in period 2 Current account Deficit in period 1 C 1 T T Y 2 T T Y 1 T C 2 Q 2 C 2 E C 1 Q 1 p 1 N p 2 N 0 N N C 2, Y 2 p 2 N N N C 1, Y 1 N p 1 N Nontradables
(2) A CGE simulation study Model assumptions Reduction of US consumption by 5% of GDP, which will induce US current account adjustment through real depreciation of the US dollar against the rest of the world US GDP potential growth declines by 1% point Exchange rate adjustment by non-us economies with constant bilateral real exchange rates among them, or exchange rate adjustment by East Asian economies only Current accounts endogenously adjusted Long-run full employment Kawai and Zhai (2009)
Evaporation of US consumption (together with US growth slowdown) induces trans-pacific adjustment CA (change as % of GDP) Terms of trade (% change) Real private absorption (change as % of GDP) China -2.7 [-8.8] 1.2 [4.0] 3.6 [10.9] Japan -1.1 [-3.6] 1.8 [5.7] 1.7 [5.3] Korea -2.0 [-5.8] 1.1 [3.1] 2.5 [7.2] Taipei,China -2.6 [-7.9] 1.0 [2.7] 3.8 [10.8] Indonesia -1.8 [-7.5] 0.9 [3.8] 2.3 [9.3] MYS&SGP -2.1 [-12.2] 0.4 [1.6] 4.7 [22.1] Philippines -2.6 [-7.6] 0.7 [2.5] 3.5 [9.9] Thailand -2.5 [-8.0] 0.5 [2.0] 3.2 [10.4] Vietnam -5.4 [-15.5] 0.8 [2.8] 4.9 [15.5] USA 4.0 [4.0] -6.4 [-6.4] -6.9 [-6.9] Note: Numbers in [ ] are the case of Asia-only adjustment. Source: Kawai and Zhai (2009)
Asia s s output adjustment differs across countries and sectors Percentage change in output East Asia China Japan Korea Taipei, China ASEAN6 Agriculture 1.2 [3.7] 1.0 [ 3.0] 1.9 [6.2] 1.1 [2.9] 3.1 [8.4] 0.6 Manufacturing -1.8 [-4.9] -2.2 [-6.0] -1.8 [-5.2] -1.4 [-4.2] -1.7 [-4.5] -1.0 [2.2] [-2.0] Textile -2.7 [-9.4] -3.6 [-12.7] 0.1 [-1.6] -2.2 [-7.7] -2.0 [-6.6] -3.0 [-7.9] Apparel -3.0 [-7.6] -3.9 [-11.9] 2.5 [5.7] -0.1 [1.4] -2.4 [-3.9] -6.3 [-11.7] Vehicles -2.9 [-7.4] -0.7 [-1.6] -4.2 [-10.7] -2.2 [-6.7] -0.8 [-1.7] 0.9 [3.3] Electronics -1.9 [-5.0] -2.9 [-6.9] -1.8 [-5.4] -1.5 [-5.0] -1.9 [-5.6] -1.0 [-1.1] Machinery -2.3 [-5.9] -2.1 [-5.1] -2.9 [-8.1] -1.7 [-5.3] -0.7 [-4.1] -1.0 [-0.8] Services 0.2 [0.6] 0.6 [1.5] 0.2 [0.4] 0.2 [0.6] 0.3 [ 0.6] 0.4 [0.9] Note: Numbers in [ ] are the case of Asia-only adjustment. Source: Kawai and Zhai (2009)
Findings of the CGE model simulation There will be a switch away from domestic demand-led growth to export-led growth in the US, and a switch away from export-led growth to domestic demand-led growth in non-us (particularly East Asian) economies A decline in US demand leads to structural adjustment in production and trade in East Asia East Asia s manufacturing sectors such as vehicles, electronics and machinery are major losers in the adjustment process, while its agricultural and services sectors are likely to gain from the expanded domestic demand
(3) Demand side factors, and inclusiveness and sustainability Demand side factors Household consumption Level of household income (or discounted sum of life time income) Propensity to consume (the rate of time preference) Corporate investment Retained earnings (or saving) to be used for investment Investment climate
Asia s s consumption/gdp ratios are low 100 90 Consumption/GDP (%) 80 70 60 50 40 30 1990 1995 2000 2005 Bangladesh Cambodia China India Indonesia Korea Malaysia Philippines Singapore Thailand Vietnam Hong Kong Japan Pakistan Sri Lanka Taipei, China Source: ADB, Key Indicators, 2009
Social spending in Japan and Korea Social spending in Japan and Korea are low among OECD countries 30 25 Percent of GDP, 2005 20 15 10 5 0 Sweden France Austria Denmark Germany Belgium Finland Italy Luxembourg Portugal Hungary Norway United Kingdom Spain Poland Netherlands OECD - Total Greece Switzerland Czech Republic Japan New Zealand Australia Iceland Ireland Slovak Republic Canada United States Turkey Mexico Korea Old age Survivors Incapacity related Health Family Active labour market programmes Unemployment Housing Other social policy areas Source: OECD
Social protection expenditure as % of GDP Japan Marshall Islands Uzbekistan Kyrgyz Republic Mongolia Korea Tuvalu Nauru Sri Lanka Bangladesh Azerbaijan ASIA PRC Kazakhstan Armenia Viet Nam India Malaysia Cook Islands Fiji Islands Nepal Philippines Indonesia Pakistan Maldives Cambodia Bhutan Tonga Lao PDR Vanuatu Tajikistan Papua New Guinea 7.5% 6.9% 6.5% 5.7% 5.3% 5.3% 4.8% 4.6% 4.6% 4.5% 4.1% 4.0% 3.9% 3.6% 2.9% 2.3% 2.2% 1.9% 1.6% 1.5% 1.4% 1.4% 1.3% 1.3% 1.1% 1.0% 0.3% 13.5% 11.1% 11.0% 9.8% 16.0% Source: ADB, Social Protection Index for Committed Poverty Reduction, Volume 2: Asia, 2008
Inclusive growth, environmentally sustainable growth Inclusive growth Inclusive growth promotes access to opportunities for growth and spreads the benefits of growth more equitably among all people and businesses Social sector protection Support for SMEs Environmentally sustainable growth Anti-polution, anti-climate change Energy efficiency and conservation
4.. Policies to Rebalance Growth (1) Supply side policy (2) Demand side policy (3) Regional cooperation and integration
Rebalancing growth Stimulate demand for Asia s adjustment Large economies (Japan and China) must focus on domestic-demand driven growth Japan must develop its growth strategy by addressing the challenge of population aging and public debt, and focusing on green growth and cooperation with emerging Asia China needs to focus on social sectors (education, health and pension), rural sectors, the environment and energy efficiency India and ASEAN need to focus on investment through better investment climate and infrastructure investments
(1) Supply side policy Deregulation of the nontradables sector (health care, education, social services as well as new services with IT) to promote productivity growth Reduction of domestic distortions in factor markets (energy, resources, labor, land, credit, etc) particularly in China Improvement of financial systems for better financial intermediation Promotion of the green industry (energy efficiency, clean energy, environment) Investment in human resource development and knowledge
(2) Demand side policy Household consumption - Redistribution of income towards low-income households whose propensity to consume is high - Strengthen social sector protection to provide greater security thereby stimulating propensity to consume Investment strategy - Infrastructure investment with public sector support (enhancing physical connectivity) - Improvement of investment climate - Support of SME development & investment
(3) Regional cooperation & integration A region-wide FTA ASEAN+3 or +6 FTA and investment area Liberalization and harmonization of investment rules Financial market integration More efficient financial intermediation at the national level Regional financial intermediation through financial market integration (Asian Bond Markets Initiatives and Asian Bond Funds, including credit guarantee and investment mechanism) Macroprudential supervision and regulation
Financial safeguards East Asian economies are reluctant to go to the IMF because of the bad experiences during the 1997-98 crisis A credible CMIM needed to convince East Asian economies to accept growth rebalancing Flexibility in CMIM use needed particularly at the time of the type of the crisis observed in Korea in Oct.-Nov. 2008 in line with IMF FCL Need to strengthen Chiang Mai Initiative (full multilateralization, IMF delinking, surveillance unit, and eventual creation of an Asian Monetary Fund) For this purpose, enhance regional surveillance - Involve central bank governors in the ASEAN+3 process - Establish an independent, professional secretariat - Seriously take up the exchange rate issue (ACU)
Exchange rate policy coordination An important mechanism of growth rebalancing through current account adjustment is a change in the relative price of nontradable goods Such a change can be achieved without significant economic costs by nominal exchange rate adjustment As many Asian economies will have to see real exchange rate appreciation to facilitate growth rebalancing, exchange rate policy coordination will be increasingly needed because of the heightened economic interdependence in the region This is particularly the case given the rising inflows of capital into the region
A case for collective currency appreciation To maintain domestic macroeconomic and financial sector stability in the face of rapid capital inflows, and to facilitate growth rebalancing, a collective currency appreciation vs. the US dollar is desirable. This policy maintains both the relative currency stability within the region and national financial and macroeconomic stability while minimizing the loss of price competitiveness This requires exchange rate policy coordination, and it can be facilitated by the use of ACU as a monitoring devise
Developing/emerging Asia has built $ billion 4000 3500 3000 2500 2000 1500 1000 500 sizable foreign exchange reserves 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Central Asia East Asia South Asia Southeast Asia The Pacific Sources: IMF, International Financial Statistics; CEIC Data Company, Ltd.
REER trends: US rate was not exceptionally high until after 2005 130 120 110 China 100 Index 90 80 United States 70 60 1990:1 1995:1 2000:1 2005:1 Year/Quarter
5. Conclusion In the short run, Asia must shift away from public demand-driven growth to private sectorled growth In the longer run, Asia needs to develop a new growth paradigm: (1) to shift away from external (US&EU)- demand driven growth to domestic and regional demand led growth (2) A greater focus on inclusive growth (equity, access to opportunities) (3) A greater focus on environmentally sustainable growth: a shift from a high- to low-carbon economy
5. Conclusion (cont d) The global imbalance was a factor behind, even though not a dominant cause of, the global financial crisis External rebalancing requires closer policy cooperation in Asia: structural adjustment, regional market integration, regional infrastructure investment, stronger social sector protection, green growth, regional financial cooperation, and exchange rate policy coordination East Asia can seize this opportunity by focusing on inclusive growth: allow both poor and middleincome people to cope with economic risks, uncertainty and contingencies; empower SMEs East Asia s exchange rate management will be key to not only growth rebalancing but also macroeconomic and financial system stability
Thank you For more information: Dr. Masahiro Kawai Dean& CEO Asian Development Bank Institute mkawai@adbi.org +81 3 3593 5527 www.adbi.org