Historical Development of Macroeconomic Policy Paradigms
Some seventy years ago, the Great Depression of the 1930s led to widespread private debt and ample excess industrial capacity in England. To wait for supply to create its own demand in the long run, as Say’s Law would have it, was untenable. John Maynard Keynes, in his General Theory of Employment, Interest and Money, proposed an alternative framework for macroeconomic policy analysis in the context of a closed, single economy. He introduced the active role of the government and the multiplier concept in creating the necessary demand to lift an economy out of depression. After World War II, John Hicks, Paul A. Samuelson, James E. Meade, and Bertil G. Ohlin subsequently popularized Keynes’ approach by introducing international trade among open economies and the discovery of what is known today as macroeconomics. More importantly, the theory was proven successful when put into practice. The New Deal was a prime and well-known example of policy application of Keynesian economics by President Franklin D. Roosevelt of the United States of America.
Around a quarter century ago, a newer concept emerged whereby a multi-country perspective and international trade were added to the understanding of how the world economy functioned. The three major blocs of the world’s foremost economic powers – the United States, western Europe, and Japan – were together regarded as the sole engines of growth for the entire world. Whatever happened to this Group of Three, known as the G-3, would also happen to the dependent, developing world. It was believed that East Asia and the rest of the developing world could not possibly experience economic growth without the required external demand from the G-3 economies.Hence emerged the Locomotive Wagon paradigm of international macroeconomics, which is still widely held today.
A New Macroeconomic Policy Paradigm is Born in Asia
The belief in the combined G-3 engine of growth as the only source and determinant of world prosperity is being undermined by new quantitative evidence coming out of Asia. A major catalyst for the modification of the G-3 Locomotive Wagon paradigm is undeniably the miraculous progress and increasing world presence of the Chinese economy during the last fifteen years. The impact of the People’s Republic of China on world trade in particular will be even stronger in the years to come with China’s accession to the World Trade Organization (WTO). While India’s foreign sector is still not that large, the economic role and influence of India will sooner or later become another important force to be considered and analyzed, at least in the Asian context.
China has resorted to domestic demand stimulation through investment and consumption spendings in parallel with export promotion for at least a decade without articulating the policy approach as “dual track.” The Republic of Korea has been adhering to a similar policy since the 1997 Asian financial crisis. And the same holds true for Malaysia before and after the 1997 crisis. The impact of a domestic demand stimulus package taken in isolation would be limited and fall far short of what could be expected from the cooperative action of a number of economies applying such a policy simultaneously. As it turns out, at least these four countries – China, Malaysia, South Korea, and Thailand – can be clearly identified as having followed a dual track policy.
The current government of Thailand has been able to articulate and popularize this policy practice in East Asia. Reinforcement of this pattern can be expected among member countries of the Thai government-initiated Asia Cooperation Dialogue (ACD), such as the Philippines, Indonesia, and India. Both the ACD and the ASEAN+3 forums, which include Japan, China, and South Korea, have served as venues not only for policy dialogue among Asian leaders, but also platforms to coordinate action plans for the ASEAN+3 currency swap arrangements, the Asian bond, and bilateral free trade agreements.
Empirical Facts Supporting a New Paradigm
Relative to East Asia, the G-3 economies are currently not experiencing high growth. The release of 2002 figures for real GDP year-on-year growth rates of the United States, the European Union, and Japan revealed a range of 0.3 to 2.4 percent, or a weighted average of 1.3 percent. Their USD-value export growth rates ranged between -1.9 and 7.3 percent, or a weighted average of 3.0 percent (with the following weight shares: US = 0.45, EU = 0.23, and JP = 0.32). And their USD-value import growth rates ranged between -3.0 and 4.0 percent, or a weighted average of 2.4 percent.
Meanwhile, the corresponding year-on-year growth rates for the East Asia-9 – China, Hong Kong, Indonesia, South Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand – range between 1.8 and 7.9 percent (weighted average = 5.8 percent) for real GDP, between 2.4 and 18.5 percent (weighted average = 8.6 percent) for USD-value exports, and between 0.1 and 14.6 percent (weighted average = 6.6 percent) for USD-value imports. The relatively high rates of growth for East Asia in both real GDP and USD-value (and real) imports are self-confirming, given the well-established, positive, and empirical relationship between real imports, real output, and real income for practically all countries of the world.
The traditional Locomotive Wagon paradigm cannot explain the fact that currently the economic growth rate of East Asia as a bloc significantly exceeds that of the G-3 bloc. The empirical evidence, however, shows high growth in intra-regional East Asian trade during the last four years (1999-2002). The intra-East Asian (in this case, including Japan) merchandise trade alone has come to account for no less than half the region’s entire foreign merchandise trade worldwide, not to mention the impact of recent interest in intra-regional investment and tourism cooperation.
The case of Thailand illustrates such widely observed, but not yet appreciated, phenomena. The magnitude of Thailand’s foreign trade with East Asia (excluding Japan) has more than doubled that of its foreign trade with Japan. Its export shares to fellow ASEAN countries and four other Northeast Asian economies (China, South Korea, Taiwan, and Hong Kong) increased from 15.7 percent and 13.1 percent in 1998 to 20.3 percent and 15.9 percent in 2002, respectively. The corresponding shares to the United States and the European Union declined from 23.0 percent and 18.4 percent to 20.2 percent and 15.3 percent, respectively, while the export share to Japan rose slightly from 14.1 to 15.0 percent.
Thailand’s import shares from other East Asian countries relative to the G-3 countries have changed even more dramatically as the interdependent nature of the intra-East Asian trade has increased. Ironically, this is due in part to the 1997 financial crisis that resulted in marked declines in the value of most East Asian currencies (except those of China and Hong Kong) relative to the US dollar. Similar studies of other East Asian countries’ trade patterns by many scholars and analysts have arrived at the same conclusion.
Macroeconomic and Microeconomic Reasons for the New Paradigm
While imports into the G-3 economies have not increased much from East Asia lately, both exports and imports of the East Asian economies have leapt during the same period. The trade expansion of the latter has evidently not been at each other’s expense. An important macroeconomic explanation for the phenomenon is the success of the coordinated intra-regional demand stimulation measures undertaken within the dual track policy framework in many East Asian countries. A microeconomic explanation can be found in the nature of the production and exchange that has evolved within the region. A large share of East Asia’s additional exports no longer needs an outlet in G-3 markets. As industries in the region become more and more vertically integrated across countries, the domestic value added in each of the regional economies in a particular line of product manufacturing – such as information and communications technology (ICT) or electrical and automotive goods – is shared and dispersed more equitably. Thus, the value chain involved in such an activity increasingly completes much of its international production and consumption network within the region itself, resulting in a natural enhancement and augmentation of intra-regional trade. Within an environment of overall world slowdown, East Asia has managed to generate sufficient intra-regional demand such that its rate of economic expansion actually outpaces that of the traditional Locomotives by a clear and decisive margin. East Asia has, in other words, developed the capability to sustain its own growth. A new Locomotive, known as East Asia, may have arrived on the world scene.
Modeling the Paradigm Shift
The Fiscal Policy Research Institute (FPRI) of the Thai Ministry of Finance is developing a world macroeconomic model in line with the above paradigm shift and the concerted application of the dual track policy in the context of East Asian regional cooperation and coordination. The new model links domestic economies through international trade flows of goods and services among five major blocs – the United States, European Union, Japan, East Asia-9, and the rest of the world. Forecasting and simulation exercises for the Thai economy (published on the ThailandOutlook.com website) are based on the FPRI Thailand Country Model, which is in turn linked with the FPRI World Model. The new overall conceptual framework is called the Diamond-5 Policy Paradigm to reflect the diamond-shaped structure of the new world economy, made up of five equally important and interacting blocs, a replacement for the outdated, one-way Locomotive Wagon paradigm.
Olarn Chaipravat
The author is Special Adviser on the Asian Bond to Thai Prime Minister Thaksin Shinawatra, Council Chairman of Shinawatra University, and member of the Fiscal Policy Research Institute.
Kyoto Review of Southeast Asia. Issue 4 (October 2003). Regional Economic Integration