Comments on Christopher Findlay “Asian Development Bank and the invention of a new Asian growth paradigm”, 19/05/2009, http://www.eastasiaforum.org/2009/05/19/asian-development-bank-and-the-invention-of-a-new-asian-growth-paradigm/#more-4448
Findlay’s article causes me to recall two well known phenomena: the paradox of thrift and exchange rates overshooting. Both have remarkable relevance to this topic. However, they have different implications.
Let me talk about the paradox of thrift first. It is generally there are many virtual merits for individuals to make some savings out of their earnings for future use in terms of retirement, emergencies and illnesses, or even to bequest their offsprings. It is even more so when hard times are expected ahead from every individual’s point of view. Here comes the paradox of thrift: when everyone is doing the same to increase their savings at the time of an economic downturn, the aggregate demand will fall even more, more people will be out of their jobs, and the economy will be depressed more severely. So it goes down the spiral and everything gets from bad to worse. Apparently virtuous behaviour at the individual level is aggregated and transformed to unexpected vicious thing!
That is the familiar story with the paradox of thrift. Krugman has talked about a number of paradoxes in the US existing during the current great recession (See “Falling Wage Syndrome”, http://www.nytimes.com/2009/05/04/opinion/04krugman.html?_r=1&em). It seems that we have got another paradox at the international/world level with individual countries in the place of individuals. This paradox is export paradox.
Over the decades, most main stream economists have advocated export orientation or export led growth as a recipe for success of developing economies. Many studies have also proven empirically that export is conducive to domestic growth, the higher the share of exports the higher the economic growth of the country. Governments from more advanced industrialised economies often called for the opening of developing economies and for them to look at the more broad international markets for development.
Alas, we seemed finally to have got the success formula, or the holy grail of economic growth. Countries after countries have embarked on this road to success. To tell the truth, most of them including the more dynamic East Asian economies, have produced different degrees of success and some have almost caught up with their industrialised counterparts. That is a fact beyond questioning.
It has been said again and again that there are many advantages for export orientation. I will focus on only one aspect of them here. That is, the use of the much larger external markets as a reservoir to absorb the excess supply/outputs for an economy especially a developing one and to balance its domestic savings and investment “imbalance”.
It is obviously true that the world market at large has much larger capacity to absorb the excess of outputs of an individual economy. Even though there is a long lag of consumer recognition of the quality and value of the goods and services from a developing economy, it nevertheless can take the advantage of international trade and to specialise more on its comparative advantages to promote relatively rapid growth, higher than that in most industrialised economies.
However, if such strategies are pursued by all developing countries and they all exhibit higher growth, collectively it will test the capacity of absorption from the industrialised countries for the excess supply in the developing economies. It may even get to a stage that external reservoir is full and has little extra capacity to absorb the excess supply of outputs from the developing economies hence including all individual ones.
So far that paradox has not really eventuated yet, though the actual situation may have approached very close to that point. Now the situation has, however, suddenly changed now. The world economy is in a great recession. Demand in some of the most advanced and largest economies has declined. International trade almost collapsed, with some countries’ exports in some months fell by almost 50 per cent. Countries that have relied more on export (more export oriented ones) are being hit especially hard. Japan, for example, has almost reached the degree of a depression in that its annualised growth of the past two quarters was more than negative 15 per cent. The recession has brought the paradox of exports into a reality.
One implication of this export paradox is that some of the thinking in the realm of export led growth may need to be recast a little. Rather than relying on industrialised countries as the main reservoir, other developing countries collectively can also be a reservoir, if many of the developing economies are having simultaneous rapid growth. Accompanied with this is likely the requirement of more explicit international cooperation and coordination to accommodate such growth and the need to “balance” the different savings and consumption/investment needs from different countries, developing and developed alike.
So much for the paradox of exports for now. Now let me talk a little about another rapidly emerging phenomenon, likely policy overshooting in addressing or over reactions to the current financial and economic problems. Findlay has just mentioned that Mr Haruhiko Kuroda, the president of the Asia Development Bank, called recently for a shift in development/growth paradigm. We have also heard many calls, including strong voices from some governments for much stronger regulations in banking and finance, derivatives and etc. This makes me to recall Rudi Dornbusch’s famous overshooting theory of exchange rates.
I will not indulge here into how the overshooting works, but only say that Dornbusch proved that it is that volatility in some markets was in fact a far more fundamental property than merely a consequence of imperfect information or market obstacles. Due to the sluggishness in the prices and adjustments in some markets, some other markets would have larger volatility, so in the currency markets, foreign exchange rates are likely to overshoot its equilibrium value in the initial processes.
What is the relevance of that overshooting to today’s topic here? While, I think it has enormous relevance, related to the general phenomenon that when one is faced with a deviation of something from its normal course or from its correct places, he/she tends to over correct it in his/her reactions desires to solve that first/initial problem, in the initial stage. This is exactly what many people have been saying and possibly doing over the past many months during the current world-wide financial crisis and the great recession. What frightens me the most is that the world authorities are likely to really overreact and over-tighten regulations to such a degree that it will be detrimental to the health of the world economy and welfare.
In that light, the calls for reduced reliance on exports, the call for balance of savings and consumptions between countries are some of such examples. Yes, there may be a need to adjust a little to address some of the long term problems. Yes, we have seen the pains of countries when their exports faltered as a result of shrinking external demand. But do we need to require that trade must be balanced year in and year out? Do we really need to balance savings country by country at every time? Do we really need to give up the benefit of trade to just avoid another possible down turn in external demand for our exports?
We need to take actions and to react to lift the world economy out of this great recession. We need to tighten some regulations or practices to prevent irresponsible behaviors in the context of externality. We need to consider how the international banking and financial system can be made more robust to withstand temporary difficulties. But we need and must do them in a very careful way. But as Findlay argued, we should not “throw the baby out with the bathwater”, because there are some problems with the water.
It seems to me that many of the calls reflect the tendency to over react, some driven by ideologies as a revenge for other and opposing ideologies, some purely inexperience or immaturity.
We don’t need those. What we need is rationality, creativity and practical strategies and effective actions. We can’t afford to act blindly in solving current problems. We can’t be emotional. We need to be cool.