July 5, 1999
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ECONOMIC GRAFFITI Supply Laws Demand Flaws Why east Asia couldn't export its way out of trouble By Kaushik Basu In July 1997 when the Thai baht came under attack and rapidly lost value -- causing bankruptcies in Thailand and pulling down other Asian countries such as Malaysia, Indonesia, the Philippines and South Korea in the vortex -- the expectation was that this would be a brief downturn before these economies resumed their normal, high growth. The argument went as follows: with their currencies depreciating sharply, the goods and services from these countries would be in demand all over the world, their exports would pick up and that would create jobs, increase domestic demand and have the economies back on track. The argument is best illustrated with the case of Indonesia, where the crisis was by far the most acute. In June 1997 the exchange rate was around 2,400 Indonesian ruppiahs to a dollar. A year later, and several months into the crisis, the exchange rate had dropped to 14,000 ruppiahs. Suppose in June 1997 an Indonesian shirt cost $10, a year later the same shirt, assuming its price in ruppiahs remained unchanged, would have cost $1.70. It is true that there was inflation in Indonesia during this time and so the cost in ruppiah was not unchanged; but even if we accounted for this, the dollar price of the shirt would have been no more than $3 in June 1998. If the price of this shirt in American stores remained unchanged, the company exporting the shirt would in June 1998 have made an additional $7 profit on each piece. So international buyers should have been falling over one another to buy goods from Indonesia, thereby helping Indonesia recover from the crisis. This did not happen. It is true that the ruppiah has partially recovered since, its exchange rate having risen to around 8,000 to the dollar, but the economy remains in the doldrums. In 1998-99 Indonesia's national income fell by a calamitous 13 per cent. So what went wrong with our reasoning? Till recently the answers were all speculation. But now we have detailed information as results of a massive survey begin to emerge. The governments of Thailand, South Korea, Indonesia, the Philippines and Malaysia, with technical assistance from the World Bank, have surveyed 4,000 firms, interviewing managers and entrepreneurs individually, to find out why the predicted recovery did not occur. Interestingly many of the firms -- some 10 per cent -- that were initially on the list of firms to be surveyed were found not to exist; they had gone bankrupt. This in itself is revealing about the severity of the crisis, but to the statistician it causes another headache. The sample that was surveyed is, because of this, a biased sample. It consists of only the survivors and, therefore, paints a rosier picture of how firms have coped with the crisis. There is now a plan to collect information on the firms that went bankrupt, but even without that the first findings of the survey are revealing. In the absence of information we often attribute a nation's failure to amorphous factors, such as innate business skill or just the people's "attitude", as summed up in the story of the English and Japanese shoe companies that sent salesmen to remote islands in the Pacific. The English salesman wired home: Islanders do not wear shoes, taking return flight tomorrow. And the Japanese salesman wired home: Islanders do not wear shoes, send 100,000 pairs. While such "skills", business acumen and "attitudes" do matter -- fortunately -- when one looks at the evidence closely one can also isolate tangible causes that may shatter myths. This post-crisis survey, for instance, casts doubts on the view that Asian firms faced no dearth of demand, that recovery was held back entirely because of shortage of credit. The data show that the main cause of output decline was diminished demand, followed by high import costs and high interest rates. One reason for the weak demand is the major export destination for these firms has been other Asian countries. Since these nations were all in recession, they were in no position to demand more. Not surprisingly, a third of the firms reported that their export performance had declined by 10-25 per cent. Even when their export volumes were rising, their dollar incomes were not as their currencies had lost so much value. This leaves one question: why didn't new export routes open up, for instance to Europe and the US. The reason must be that export is not just a matter of price but pre-existing institutional arrangements, and these take long to develop. It is not surprising therefore that most of these firms had a lot of unutilised capacity. They had also laid off labour, giving rise to unemployment, though less than what one would expect from the extent of underutilised capacity. The layoffs were the largest in South Korea. On the other hand, the Korean economy seems to be re-starting earlier than others. One reason why credit shortage shows up as less important in this survey, even though the crisis originated in a breakdown of the system of credit, is that the survey was conducted in late 1998. By then the worst was over. The survey seems to confirm that the fiscal tightening the IMF traditionally recommends exacerbated the crisis by dampening an already low demand. Thus the original cause of a crisis may be singular but once a crisis sets in a multiplicity of factors keeps the economy in a low equilibrium trap. The author is C. Marks professor of economics, Cornell University. |
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