How international economic links affect East Asia

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized CollcyRosearch WORKlNG PAPERS Internatlonal EconomicAnalysis andProspects Ofice of the RegionalVice President EastAsia and PacificRegion The World Bank April 1993 WPS 1127 How International EconomicLinks Affect EastAsia VikramNehru An anatomyof economiclinksbetweenEast Asiaandthe global ec4nomy- and a descriptionof how those links shape the region's exposureto nsks from the global economy. PolicyReicrWo*ingPpdsmdinatflndinpofwoxkinpoand encmgetheemgchapfideamongBakstaffsnd nUothesinuatcdmdevelopmeWoiduz Ib.epaps,difibutedbycttRcisAdvmyStaff,cathenm1 s ofthey as¢wbms onlythirvico andshoddbeusedantdcitedaccordngly.11efindiegs.interprttions, ndcaiondmsartheautholeown.Iheyshouldd notbe *tttiuted to tbecWodd Ba&. its Boardof Dirs, its management,or anyof its maember comunca. 1127 PolicyResearch InternationalEoonomicAnalysis and Prospects WPS 1127 This paper-prepared by the Office of the Regional Vice President, East Asia and Pacific Region-was written as a background study for the East Asia and the Pacific Regional Development Review. It reflects the Bank's recent emphasis on analyzing the effect of the external economic environment on developing country prospects and policies. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Moira Coleridge-Taylor, room S8-049, extension 33704 (April 1993, 21 pages). Nehru applies the theme of the last two papers in the Global Economic Prospects series, written by the Intemational Economics Department, to the case of one developing region: East Asia. He documents the rapid integration of the East Asian economies into the world economy tlrough trade and foreign direct investment, and suggests that this has helped create a relatively well-diversified structure of production and of external markets. As a result, East Asia was relatively unaffected by the great terms-of-trade shocks experience& ry other developing countries in the 1980s. East Asia's creditworthiness in international financial markets meant that (except for the Philippines) it could maintain access to extemal capital flows during the world years of the debt crisis. East Asia's close economic links with the rest of the world makes the region particularly vulnerable to shocks originating extemally. Simulations suggest that its growth rate is closely related to the growth rate of the OECD economies, even if its export markets are more diversified than those of other developing regions. Similarly, given the strength of its export drive to the industrial economies in the last two decades, especially in labor-intensive products, East Asia would stand to gain the most from a successful Uruguay Round. By the same token, it would also be hurt the most were the Uruguay Round to fail and were industrial protection to increase as a result. So, East Asia must closely watch developments involving the North America Free Trade Agrement (NAFTA). Although preliminary analysis suggests that the immediate trade consequences of NAFTA would be negligible for East Asia, the longer-run consequences for foreign direct investment and trade flows are more difficult to predict. Finally, the region's strong physical and institutional infrastructure, its outwardly oriented trade policies, and its well-developed human resource base, have attracted a large share of incremental private capital flows to developing countries. But such flows are volatile and sensitive to macroeconomic conditions and the regulatory environment in host countries. Were these conditions to change in East Asia and inhibit foreign direct investment and private portfolio flows, the region's rapid transformation into a competitive producer of manufactures would be affected adversely. l Anobjecdveof the senes eteBr in 'Me Policy ResearchWorkingPapSeriesdissebhinates the facdingsof workunderway is to get these findings out quickly, even if presentationsare less than fully polished. The fndings, interpretations,and conclusions in these papersdo not necessarilyrepresentof ficial Bank policy. Producedby the Policy ResearchDisseminationCenter How International Economic Links Affect East Asia by VikramNehru Table of Contents PMg No. Integration and Diversification Through Trade 2 Promoting Links Through Foreign Direct Investment 9 Maintaining Access to Capital Markets 11 Continued access t0 debt financing Shift to non-debt financing External debt management 11 13 13 The External Environment and Economic Performance in East Asia 14 Conclusion 19 Bibliography 20 lNERNAIIONAL ECONOMICLINKAGES:The Case of East Asia1 1. In the 1980s,13crcapita incomes in East Asia grew twice as fast as in SouthAsia and fivc times as fast as the average for the developingworld. East Asia's export volume has grownthreefold since 1965 and more than doubled in the last decade alone. Its share of industrialcountry importsof labor intensivemanufactureshas grown ninefold in two and a half decades. Overa thIrd of the rcgion's outputis saved and invested,far higherthan in any other developing region. And its indicators of external indebtednessare, on average, the healthiest in the developingworld. Moreover,East Asia's rapid economicdevelopmenthas been matched by equally impressive progress on other devclopmentfronts: poverty has been reduced substantially,primary education is almost universal,life expectancyat birth for males andfemaleshas improvedsharply,the infant mortalityra'.eis a third of what it was in 1965,and its populationgrowth rate is the lowestamongdevelopingrcgions(apart from developing Europe). 2. Of course,economicperformanceand socialprogresshas not beenuniform. Indeed,it woulkibe surprising if it had been. Probablymore so than any other developingregion, the countries of East Asia present a strildng study in contrasts: in terms of economic size, land area, population level, naturai resource endowments, and economicand politicalsystems. 3. Nevertheless,by virtually any measure, East Asia's economicperformance in the 1980eis impressive, especiallywhen set against the experience of other developingregions. For example,the 1980shas often been called a "lost" decade for Latin America and Sub-SaharanAfrica: per capita incomes declined in these regions, several countriesdefaultedon their large external debt obligations,savingsand investmentfell as a share of GDP, and social progressslowed. 4. Differencesin economicpolicies explain much of the differencein the economicperformancebetween East Asia and othcr developingregions duringthe 1980s. When the debt crisis broke,there were fears that East Asia would go the way of Latin America. But adjustmentprogramsin Indonesia,Korea, Malaysia,and Thailand were timely and successful. The earlier emphasison macroeconomicstabilityand prudent externalborrowingpaid rich dividends:the adjustmentsrequired were not as deep or painful as in Latin Americaand Sub-SaharanAfrica; and the relatively well developedphysical,social, und institutionalinfrastructurehelped stimulatea quick supply response. 5. The pattern of economiclinks betweenEast Asia and the globaleconomyhas helped as well. Whilethese links have exposedEast Asia to risks emanatingfrom the world economy,they have also worked to the region's benefit. This paper studies the anatomyof these links and asks how they have influencedthe region's economic performance. It does so for two reasons: to identify the channels through which the economiesof East Asia are likely to be influencedby economictrends and events in the rcst of the world, and to examinethe policy options availableto respondto unanticipateddevelopmentsin the world economywithout jeopardizingthe objectives of sustainablegrowth and welfare. The bulk of the evidence nowavailableshowsthat economiesthat have nurtured internationallinks throughtrade and financialflows have improvedresourceallocation,increasedcompetitionand product specialization,andbenefittedfromtechnologytransfer.2 Economiesthat havestrong internationallinkages are naturallymore exposedto risks emanatingfrom the world economy.However,the economicstructure resulting from these linkages also appearsto makethese economiesmore resilient in absorbingthese risks and, togetherwith I East Asia in this paper refers to all low and middleincomecountriesin the region. The term, therefore, excludesJapan, Hong Kong, Singapore,and Taiwan, China. 2 See World Bank. 199lb. Chapter5. -2 judicious policy, appears to have made them better able to adapt to changes in tih. external environmentand sustain growthmomentum.3 Inteuration and DiversificationThrough Trade 6. Over the last two decades, East Asia's integration with the world economythrough trade has progressed more rapidly than for any other developingregion. The differencebetweenthe rates of growthof trade and output was higher for East Asia than it was for the world economyduring the 1970s and 1980s(Table 1), although the pace of integrationin the 1980sdeceleratedfor East Asiajust as it did in the rest of the world. The dechne in the growth rate of trade in the 1960-70periodwas due to China's stagnant exportperformancein that period; trd4e in the rest of the regionoutpacedproduction. Table1: East Asia's integrationwith the worldeconomyacceleratedonly after the 1960s Growth of exiorts and GDP: East Asia and the Wor:d. 1950-90 (averageannual percentagechange) 1980-90 1970-80 1960-70 1950-60 World~~~~~~~""3 ..T 01* ., -.... . -4D. .. E - * a. iffere B - ..........-. B e. Tr~~~~~~de $3~~~~~~ * aa . a . -: S' .. . E E .5-- aR- 'R B - B . ... ... .. A Su n trade d in te a . ~~ ~ ~ ~ ~ . f R -$ . 98 EaE' s i :.: B 1. th f of p ' E -E .:'i.... . . . ..E.. . .. .ffR-. . E. . R t t E a....-. ' ' 2- ' B . .: . iR ........ -............. ...... R ... B... .. . l c . 8... ...... -. -R. . . . . .B5'f w a ............... ......... 7.~~~~~~~ P.196inI. . ... M. ~~~~ .... .sa ...... acelrae 3~~~~~~~~~~~~~~. Mira P. ....... th aeo *.. .... . s ............... SS . .... ... .S .... RR and'''' SocialDatab WorldBank'sEconomic So.. ce:R~~~~~~~~~~~~~~~ YE ....... . . Et 8 S01 ' E3' 34 ,3 E rtcinsrnsinutilcutiswic ..... ..... ..... 3 developingcountries),most OECD economiesare, on balance, more protectionistnow than they were ten years ago. While taiffs continued to fall steadily in these countries, non-tariffbarriers grew in significance. Such barriers include antidumpingmeasures,countervailingduties,voluntaryexport restraints, and domesticsubsidies. Where non-tariffbarriers have been lowered,it has usuallybeen in the contextof a bilateral or a regionaltrading arrangement. 8. It is difficult to assess whether trade barriers in indusial country markets affect East Asia more than other developingregions. Some indicators,however,tend to point to this conclusion. One measureof the extent of protect.-.nis the trade coverageratio, that is the share of imports affectedby non-tariffbarriers. 4 The share of OECD imports from developingcountees subjectto non-tariffbarriers climbed marginally from 20.5 percent in 1981to 21.8 percent in 1990. In the case of East Asia,the trade coverageratio is higher, although it declinedfrom 30.2 percent in 1981to 26.2 percent in 1990. Table 2: Trade coverageratios of industrialcountryNTBs are generallymore extensivefor importsffromEast Asia thanfor other developingregions Tradecoveraie ratios of industrial country NTBs on imnorts from develonine countries. 1990 (in percent) U.S.A lAgric. Manfg ... China~~ ~ 8. .. dornela..~. 01 Korea IA Total I Agric. ,-.2 9.6>S %47.1): 17.3 -405 3. 34,1) 33.2 12,0 33.0 18. ....... South82Asia 45.7 Sourel Cpesimaes based .. 321 9. TheattmoIloetoainniida2t. ismatesbased: Sppouite-aric:stu , Total Agric. JAPAN Manfg Total 4.. 46....... . ...... ''a;... . . l .>,t-^.-........ .-....... ... , ..,-. a. .,. . -. . . . .. ... . .. iR . R' .......... 27.4 EC Manfg 42 .,- 504 29>j.|5 34.1: ... .1.,...- ,. .. , .... ... .. ..... ... 233 2 C 2.- 3.!411725 data and CO 28.0d ~~~ 7.6/NCA41AR9 ~~~~~ ... RD ~~~~~~~~. . datbas .... ED 7Tabl akt te2d4 di7.6 . I h 2)21. AsandCports World tban NCTaSMART database ... n h C dlatilab intensivemanufactrestendto facethe stiffestnon-tariffbarriers. Forexample,the NTBtradecoverageratiofor EastAsianexportshasgrownsharplyfor exportsof iron and steeland hasbeen highand risingfor textilesand clothing. restrictions,voluntaryexportrestraints, quantitative 4 Non-tariffbarriersincludeimportprohibitions, andantidumping measures. licensing, and countervailing MPA restrictions, nonautomatic variablelevies, -4 - 10. The trade coverageratio, however, is an unreliableguide to the level and pattern of protection. It may systematicallyunderestimateor overestimatethe protective effect of non-tariff barriers. Estimates of import penetratitw(imports as a share of total domesticdemand) tell a differentstory. They indicate that protection in industrial zounty marketsseem not to have deterredEast Asian exporters(Table 3). East Asia accountedfor all the incrementalpenetration of the Japanese market for manufacturesby developingcountries between 1968 and 1988;in the caseof t}e EC market,East Asia accountedfor fow-fiths, and in the U.S. market, abouttwo-thirds. Table 3: EastAsia has been more successul than other developingregionsin penetrating industrialcountry markets Imnorts from DevelooineRegions as a Share of ('qnsumtlion in Industrial Countries: All Manufactures (in percent) 1968 ...... . .. . .. 1974 -ECC: . ................. 1~~ 0.4 0* 0- .-BC ..... ..... .. eric.a ~ .==. .. ...... ~~ V. - ......... 0.4... WO:'ST:E'-e,!: :4. 0 ~ Membership . 41 ~~~.7 1.1f 0.9 77[ -,019 16 024 ; :-- ~~~~~tw; 01 . -... ; 1 017 14 X 0. 043 .... ....-.'...'''... '''": ''-, 0. 03::-S fa- :- . 0.. OA ! Note: 1988 3.1 - t-Jp' -$ *pa 2m 1984 ......... 'WrhAme~ 08182.4 4apan 0.9 =.-Nor 1980 of the EC grew from 6 to 12 during -. - .... ... :--:: .... ;.:. ... f 0 '; . - ' '. 0 0, 0 - . .f -........... ,..... 0,.... + ........ -....... ... ... .. , this period. Source:UNCTAD,1991 11L East Asiahas beenparticularlysuccessfulin penetratingindustrialcountrymarketsfor laborintensive manufactures(garments,textiles,leathergoods,fur-niture,iron and steel productsetc.). East Asia'sshare of industia countryimportsof laborintensivemanufactures gre-wninefoldin twoand a halfdecadesrisingfrom1.4 percentin 1965to 12.4percentin 1989(Figur 1). This spectacular growthoccurreddespitethefactthat themost extensivecoverageof non-tariffbarriersin industrialcountriesis of laborintensivemanufacture. Figure 1: East Asia'sshare ofindustrialcountryImportsof labor Intensivemanufactures has grown rapidlysince the mid-I 960s Developing countries'shareof laborIntensive manufactures Imported by Industralcountries 30 ~ ~ Percent reouun ~S dbphr s t E , B| l,,Eat As ~~~I. r 12. East Asia'ssuccessin exportingmanufactures has notjust beenin laborintensivemanufactures.The regionhas also emergedas an exporterof technologyjutensivcmanufactures.5 Of the fivelargestdeveloping countryexportersof technology intensivemanufactures, thxee(Korea,Malaysia,aridChina)belongto EastAsia.b Mlaysia, forexample,barelyexportedUS$3milli'bnof technology inte.nsive manufactures in 1968,or 0.2 percent of its total exports;by 1988,it exportedUSS1.4billion(at 1%3constantprices). This rapidgrowthwaslargely becauseseveralhightechnologyfirmsin Japan,pressuredb3the appreciating yen,relocatedtheirlaborintensive stagesof productionin developmng countries,especiallyEastAsia. By 1989,Thailandand Malaysiaaccountedfor almostthree-quarters of theJapaneseforeigndirectinvestmentin Asia(seepara.24). 13. EastAsia'simpressivesuccessin exportmarketswasaccompanied by suostantialliberalization of trade policiesat home. KCorea eliminatedits quantitativerestrictionson importedmanufacturesand raw materialsby 1991and introduceda phasedreductionof tariffsthat will see them averaging7.9 percentby 1993. Malaysia beganreplacingits QRs with tariffsin 1986,and reducedits averagetariff levelson manufacturesand non. agriculturalraw materialsto 10 percent. In programsbeginningin the first half of the 198Oa,Indonesia,the Philippines,and Thailand,also reducedthe numberof non-tariffbarrierson importsof manufactures, simplified theirtariffstructures,and reducedthe averagetarifflevel. In China,however,importscontinueto be controlledto a significant degree, although some reforms have been implemented in the foreign exchange retention system. 14. Increasedopennessand integrationwiththeworldeconomythroughtradehasfostereda morediversified productionand exportbasein East Asia. In this regard.East Asiahas movedfurtheraheadthan either Latin Americaor SubSaharanAfrica. East Asia'sdependenceon primarycommodities has diminishedsteadily,and now roughly 69 percent of the region's exports are manufactures compared to 13 percent in 1965. Manufactures constitute the bulk of Korea's merchandise exports (90 percent) and of China's (70 percent); andeomprise an important sharert of th o ins he Philippines (62 percent), Thailand (4 percent), Malaysia (44 percent), and even Indonesia (32 percent). In contrast, primaly commodities account for 66 percent of Latin America's merchandise exports and 91 percent of Sub-Saharan Africa's. cS The definitions of labor- intensive and technology-intensive manufactures are the same as tbat used in World Bank, 1992, Global Economic Prospects and the Developin,e Countries. 1992, Appendix B. 6 the other two are Mexico andfBrazil. -6 is. Reflecting this export diversification,the five most important (5-digit SITC) products in East Asia account for orly 14 percent of total exports, comparedto 38 percent for Latin Americaand 61 percent for SubSaharan Africa (Table 4). Moreover,only two of the five most Importantexport items are primary commodities (crudeoil and natural rubber);ip the caseof Latin Americaand Sub Saharan Africaall flve are. Table 4: EastAsian exportsare more diversifiedthan other developingregions Ploduet Concentration Ratios. 1988 (in percent) Product Region Concentration Productdescription Ratioa/ Crudeoil, clectronics,natural rubber,footwear,passengervebicles 14.4 East Asia. Crudeoil, gas oil, coffee,copper,bananas Latin Amerca 38.0 26.5 Cut diamonds,tea, raw cotton,shell fish, nilled rice. SouthAsia 60.9 Crudeoil, coffee,cocoa,copper,diamonds Sub.Saharan Afrca a/ Definedas the share of the five most important5-digit SITCitemsin total exports. Source:IECIT Table 5: EastAsia's exports are relatively well diversiLiedacrossmarkets. East Asia: Exnort share and rorwthrate of all merchandise Loodsand manufactures by market (shares in percent; growthin annual averagepercentagechangeper year) Manufact-res Growth 1980-90 Share 1990 All merchandisegoods Growth 1980-90 Share 1990 HghinoeS 8.~ 10.0 . X0: .A. :0:U.S;Af . . 12;1. . .: . .24 Japaii . ::0 29 6.8: 10,9 ..::: ::3 . ... . : 10:::00:21&= 000::: .:S~~~~~~.... 0..d2S.0 :: ;00 -0.... ;... -34 -. lO,900000.09. . .... 34j114 18 8.7- 7 11.7' 2 1.3. 3 8.1 Other Devloping: countries East'Asia SouthAsia .u . : MENA . -NA~~ Sub-Saharan 2 ~ All developing countries Soure: COMTRADEdata. .. :: K6L 2. - ~~~~ 4.41 ~ ~ 2 :g>.3~~~~~~~~~~~~~~~~. .2S........ .: :.:: 1.3 ...... t. :-: ia :: ::::1-: th ... 83g~ 00 - . . ...... = ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ i...i.. 2 6,6 -2 2 4.3 2 100 9.8 100 .2 Africa Latin America .19 124 -7. East Asia's import sources and export markets are also relativelywell diversified. Japan contributesa 16. quarter of the region's importsand absorbsa fifth of its exports. The U.S. is f:Imostas importanta trading partner, supplying 16 percent of the region's imports and buying 19 percentof its exports. The EC is more importantas a supplierof goodsto East Asia(20 percent of East Asia's imports)than it is as a market for East Asian products(13 percent of exports). Latin America,in contrast,is closelyintegratedwith the U.S. economy,relyingon the U.S. for two-fifthsof its trade. Sub-SaharanAfrica's trade is even more concentratedgeograpalc.;wy;the region sources almost half Its importsfrom the EC and sells 42 percent of its exportsto the Community. East Asia's export markets for manufacturesare even more diversifiedthan for total exports (Table 5). 17. The U.S. emeiges as the single largest market for East Asian manufactures,7 and the importanceof Hong Kong, Taiwan (China), and Australia (all included under the rubric of "other high income economies"in Table 5) becomes apparent. Much of this ref.ectsChina's use of Hong Kong as a transhipmentport for its trade with the rest of the world. In comparisonto East Asia,the concentrationof Latin America'sexport is greater in the caseof manufactures,as is the case of Sub-SaharanAfrica'sexport: to the EC. Intra-regionaltrade within developingEast Asia is a small share of total East Asian trade, but is growing 18. rapidly. The rapid growth of manufacturingin thc large East Asian economies,together with high levels of foreigndirect investment,has spurred the growthof intra-industrytrade within the region (Forstnerand Ballance, 1989). The most dynamiccomponentof East Asia's total trade, however,is not with Japan but with the U.S. and the EC. This is surprising,given that Japan is geographicallyproximateto developingEast Asia and grew faster than both the EC and tt,c J.S. during the 1980s. The diversificationof marketsand exportproductshas helpedEast Asia manageexternal risks better than 19. other developingregions. In recent years,the asynchronouscyclicalpattern of economicactivity in the industrial countries has, in aggregate, had little effect on East Asian export performance. Japan's strong growth in 1991 helped alleviate the dampening effects of the U.S. recession; and the U.S. recovery in 1992 has helped counterbalancethe slowdownin Japan. The importanceof market diversificationis highlightedby the recentexperienceof the socialisteconomies 20. of Mongoliaand, to a lesser extent, Viet Nam and th: Lao People'sDemocraticRepublic. The external trade of these economies was oriented toward the former Soviet Union and Eastern Europe (Table 6).8 They have consequentlybeen affectedby the collapseof the CMEAin 1991 and the contractionin outvut of Eastern Europe and the FSU. Although complete data for 1991 have not been released, the fall in FSU external trade vwas dramatic;partial estimnatessuggestthat exportsdeclinedby between 30 and 40 percent and imports by between 40 and 50 percent. The fail in FSU trade with formerCMEA memberswas exacerbatedby an agreementto settle payments in hard currencies and at world prices. Mongolia, almost totally dependent on tmudewith CMEA members,was hit the hardest. By 1991,the country'sexports were almost a half of their 1989value and their imports almost a third. Productionwas disrupted because of severe shortages of raw materials, intermediate inputs, and petroleumproducts. Viet Nam's losses,a combinationof lowertrade with the FSU and Eastem Europe and lost concessionalfinance from CMEA members,could reach as high as 7 percent of GDP; actual losses would,of course,be higher given the disruptioncausedto domesticproduction. East Asia's diversificationof its product base has helped dampen the volatilityof the region's external 21. terms of trade (Figure 2). With the sharp downtrendin real commodityprices during the 1980s,Latin America and Sub Saharan Africa faced a relativelylarge decline in their terms of trade; for East Asia, the decline was moderate,and for countriessuch as Korea, the external terms of trade actualy improvedduringthis period. What 7 SinceIndonesia'scrude and LNG exports are exc.PidA. a Mongoliaand Viet Nam were membersof the CMEA. -8- is more, "'orld trade in manufacturesgrewfaster than for commodities(5 percent a year in the 1980scomparedto less than 2 percent a year). The dual advantagesof a relativelystable terms of trade and rapidly growing export voljmes meant that export earnings remainedbuoyant throughout the 1980s. Neither Latin America nor Sub Saharan Africa enjoyedeither of these benefits and export earnings remained stagnant. Together with sharp increasesin external interest paymentsin the same period (Latin America'sinterest paymentsgrew by 50 percen in 1980.83),this meant rapid import compressionin both regions and, in turn, a sharp downturn in private and public investment. Table6: SomeEastAsian countrieshave been affectedsevere:yby the economicchangesin Eastern Europe and thef ?rmerSoviet Union TradeBetween Selected East Asian Countries and Eastern Europe and the FSU. 1987-89 Averageshare (% of total) Exportsfrom Importsfrom Averageannual growth rate Exports Imports China 6.0 5.9 15.8 12.9 Lao PDR at 14.9 23.1 -23.9 -23.1 Mal -y.i. 0.9 0.4 28.9 68.1 onXDgol . -92.1 94.6 -1.1 .6.M-aninar 3.0 1.6 -3,7 -13.8 Thailad . 0.9 1.1 93.2 .549 Viet Na*n. 30.7 53.0 38.4 -1.4 IY Refersto trade with the non-convertiblecurrencyarea using the exchangerate Rubles 2.4-$1. h/ Annualgrowth rate for 1989 . Source: Asian DevelopmentBank, 1992. 22. East Asia's openness to trade and its reiiance on industrial country markets do make it vulnerable to downturnsin the world economyor to sharp changesin relativeprices in internationalmarkets. But the flexibility in its industrial structure has turned this into a strength. Opennessin trade has meant that international price signals transmitquick!vto the domesticeconomyand trigger adjustmentsin input and outputmix. Severalstudies haveconcludedthat during the 1970sand ,980s, economieswith relativelyopen trading systemsexperiencedlarge terms of trade shocks,but these economierwere also the fastest to adjust and resumegrowth. Korea and Thailand are two such examplesin East Asia. E..onomieswith inhibitedtrading systems,controlledby restrictivetrade and pricing policies, encounteredsubstantialbudget and balance of paymentsdifficultiesthat were financedthrough external borrowing. Those followingsuch a route includedArgentina,Mexico,and Venezela in Latin America, and Nigeria, Coted'Ivoireand Zaire in Sub-SaharanAfrica;the only exampleof this strategyin East Asia was the Philippines,whichalso ran into severeexternal paymentsdifficulties. PromotingLinks Throuih Forein Direct Investment 23. East Asia's international economic linkages through trade have been shaped in part by substantial increasesin foreigndirect investment(FDI) inflowsfrom abroad. In the 1970s,East Asia accountedfor about 16 percent of total FDI flows to developingcountries. In the 1980sit had more than doubledthis share (Figure 3). Part of the reason was China's emergenceas an attractive destinationfor foreigncapital, particularlyfrom Hong Kong, which contributesover 60 percent of total FDI to China (Table7). Attractedby low wages in the coastal economiczones of China where wagesare only a fifth of the averagewage in Hong Kong and 70 percent of that in Malaysia,most FDI in China is involvedin labor-intensive,export-orientedproduction. In 1990,these enterprises -9are estimatedto haveexportedgoodsworth $6 billion. 9 Recentstudiesalso show that the averagecost of standard factoryconstructionin Hnng Kong is more than five times the cost in Zhuhai, a special economiczone locatedin Guangdong,China, and that production costs in Taiwan, China are at least 25 percent higher than in Fujian province. Figure 2: East Asia's terms of trade have been less volatilethan Latn AmeraIa'sor Sub4SaharanAfrica's Terms of Trade, 1975-90 East Asia, Latin America,and Sub-SaharanAfrica 160 ^/\ 150 Sub-Saharan 140 rmet Latin America 130 O Ind= 110 100 I. 60 1975 1980 1985 1990 Figure3: EastAsia's share of total FDI to developingcountries doubled In the 1980s Shares of Foreign Direct Investment to DevelopingCountries, 1970-90 1970-79 LatinAmerica 53.7% <6A 14.7% Sub-aharanAfica 1980-90 EastAsia 1% other 15.5% ~ ~ ~ 42.0% LatinAmerica U ~~ EastAsia 33.2% ~~~~~~Other 18.1% 6.7% Sub-Saharan Afrca 24. Korea, Thailand, and the Philippinesincreased their share of FDI as well. For a country of its relatively small size, Malaysiahas maintaineda remarkablyhigh share of FDI flows over the two decades 1970-89. FDI in Indonesia,on the other hand, rose in the late 1970sbecauseof high rates of return in the oil sector,only to subside in the first half of the 1980swhen oil prices declined. In recentyears, however,foreigninvestorshavebeen taking 9 Asian DevelopmentBank, 1991. - 10- a renewedinterest in Indonesiaafter trade and regulatoryreformshave increasedthe attractivenessof investments in the non-oilsector. Table 7: The newly industrializingeconomiesof EastAsia are becominginportantforeign investorsin developingEastAsia Share of Inward Net Flowsof ForeiLn Direct Investment: Selected East Asian Countries (in percent) Thailand Philippines Korea Malaysia Indonesia China 1988 1988 1989 1990 1990 1987 EC North America Japan Other HongKong Taiwan,China Korea Singapore LWCs(xck Komea) 9.1 1.9 25.6 20.1 38.0 6.4 3.7 23.9 4.0 9 10.8 34.6 25.5 8.5 0.8 29.8 11.4 71 8.3 3,0 46.9 2.1 36.0: 3.7 5,1 17.9 7.7 7.2 0.6' 2.4 3.7 13.5 15.1 2.7 3.6 100.0- 100.0 1J000 1 09 4,6 7.6 16.1 1.6 66.4 65.5 - - - 10.02 Total Source: UNCTC, 1992. , .785 8.0 11.5 HA.6 2.4 13.6 26.7 48.9 4.5 284 _2. 10.8 11.2 1.1 5,4 2.10.1 0.5 ;-19 .0 1000 JapaneseFDI grew sharply in the 1980s(Table 8). So even though a smaller share went to East Asian 25. countries,the absoluteamounts increasedsharplyenough to make Japan one of the most importantsour,-s of FDI in East Asia, contributingbetweena third to a half of all FDI flows to the region. 10 (For Japan, however,the North American continentremainsthe most importantdestinationfor investmentcapital, followedby Europe and Latin America). But in more recentyears,the newlyindustrializingeconomiesof Hong Kong, Korea, Singapore, and Taiwan (China), have, as a group, becomethe largest foreign investorsin China, Indonesia, and Malaysia. Part of the reasonfor Japan's lowerFDI flowsto East Asia lies in its owneconomicproblemsand the strainsbeing experiencedin its financial sector. In addition, rising real wages in the NIEs is encouraginga structural shift towardmore technologyintensiveindustrial productionand the relocationof labor intensiveactivityto China and the ASEANeconomies.Reflectingdemandpressureson the labor market in these economies,Hong Kong, Taiwan (China),and Singaporehavealso partly relaxed controlson the use of foreignlabor. The proximityof labor-scarceand labor-abundanteconomiesin the East Asia region has given rise to the 26. spontaneouscreation of "growthtriangles" that exploit the complementaritiesof adjoining regions. One of these comprisesSingapore,the southernsection of the Malaysianstate of Johore,and the islands of Riau Provinceof Indonesia. Another includes Hong Kong, southern China, and Taiwan, China. In both, capital, technology, designs,management,and marketing servicesin the NIE are harnessed to relatively cheap land and labor in the A preciseestimate is difficultbecausea breakdownof FDI by destinationis providedby Ministryof 10 Financestatisticswhich, however, cover only "intentions"to investabroad. Balanceof paymentsstatistics includeactual gross FDI flows, but a breakdownby destinationis not available. - 11- adjoining region. Such combinations permit the rapid transmission of new technologies and management practices.It has helped make China the largest exporter of shoes in the world in less than a decade. It also now providesIndonesiawith potential to becomean evenmore successfulexporterof labor intensivemanufactures. Table8: The share of JapaneseFDI going to developingEast Asia has been declininggradually, but the level has been increasing Japan's ForeiLn Direct Investment Abroad (percentageshare) North America Europe Latin America East Mia Developing High.income Other - 1971-75 1976-80 1981-85 1986-89 24 15 19 29 9 16 36 14 20 48 20 13 22 6 14 20 7 19 13 8 9 6 6 7 !100 100 100 100 21 47 170 Memoitem -12 Total FDI *(USS$billion). a/ HongKong, Singapore,and Taiwan (China). Source: Hanazaki,M. 1990;JETRO,1991. Maintair..ne Accessto Capital Markets 27. East Asia's accessto foreigndirect investmentbears testimonyto the creditworthinessof the region as a result of its stable and prudent macroeconomicmanagement,relativelyliberal trade policies,and flexibleexchange rate management.External debt grew more rapidlyin East Asia than Latin Americaduringthe 1970s(Table9). Yet most East Asian economiesescapedthe debt crisis that eruptedin the early 1980s. The region's creditworthinessmeant continuedaccessto the world'scapital marketsthroughthe troubled '80s, a time when severalmiddleincomeLatin Americaneconomiesdefaultedon their debt-servicepayments. Onlythe Philippines experiencedseveredifficultiesin its externalpaymentsposition,and eventuallynegotiateda Brady-typedebt reductionagreementwith its commercialcreditors. By 1990,East Asia's total externaldebt had grownalmost threefoldfrom its level in 1980,far faster than in Latin Americaand at about the same pace as SouthAsia. Yet, East Asia's externaldebt indicatorsremainedlargelyunchanged,evenas those of Latin Americaand SouthAsia worsened(Table10). 29 That East Asiawould manage its externaldebt relativelysuccessfullythroughthe 1980swas not a foregoneconclusionat the beginningof the decade. When the debtcrisis was reachingits crescendo,it was feared that somecountriesin East Asia could go the wayof Latin America. Korea, for example,faceda seriousdebt crisis in 1980. Indonesiafaceddifficultproblemswhen oil pricesfell in 1983. Malaysiawas confrontedwith an externalcurrent accountdeficitequivalentto 14 percentof GNP in 1982. Three factorsset these countriesapart from those in Latin America. First, not only did theyenter the 1980sless burdenedwith externaldebt,but a relativelysmall proportionof this was at variable rates (comparedto Latin America); this partially protectedthe .12East Asian economiesfrom the sudden risein real interestrates in the first half of the 1980s. Second,East Asia was less reliant on primarycommodityexports(40 percentof total exports in 1980)than the economiesof Latin America(83 percent)and Sub-SaharanAfrica(98 percent). Thus, the sharp downtrendin commodityprices during the 1980saffectedthem less than it did the other two regions. And last, and perhaps most importantly,the quality and speedof their policy responsesto the suddendeteriorationin economiccircumstancesled to much more rapid adjustment. With a few exceptions,these adjustmentsincludedexpenditurereductionand switching, expansionof exportsthrough aggressivetrade policyreforms,and the encouragmentof domesticsavings. Pnrdent and crediblemacroeconomicmanagement,togetherwith flexibleexchangerate management, helped to maintain relativeprice stabilityand extemalcompetitiveness,strengtheninvestorconfidence,and discouragecapital flight. Table 9: Long term debt of"selecteddevelopingregions (USS billions) 1970 .E..As. t . LatinAmerica 27.1 .South l114 Ai 1980 .. Growth rate 1970-80 1990 . 7 . .172.8 . . . . .. 3~~~~43.8 21 1019 -11.a4 32.5S Growthrate 1980-90 7 Source:WorldDebt Tables, 1991-92 30. The Philippineswas the only largecountry in East Asia whichfailed to adjustadequatelyand quicklyto the shift in the globaleconomicenvironmentin the early 1980s. The economywas alreadyfacing largefiscal and extenal current accountdeficits in the latter yearsof the 1970s. In the early 1980s,rather than cut government expendituresand sacrificesome growthin the short term, the governmentexpectedthat export growthwould accelerate. Expansionaryfiscalpolicieswere financedby externalborrowing. The Philippinepeso appreciatedin Table 10: Selected externaldebt indicators,1980and 1990 (inpercent) Indicators EastAsia ~EDT/XGS EDT/GNP : 0-.TDS)XGS LtiAniAmeric EDT(XGS -EDT/GNP TDS/XGS South Asia- - - 1990 9. 2, 14:6 197.1 26:.4 40-; 35.1 37.4'2. REDTIXGS -EDT/GNP 17J3 - :Ds/Xos 12.2 EDT: Total extemal debt XGS:Exportsof goodsand services PDS:Total debt service Source:WorldDebt Tables - 1980 8. 16.8 13.5 283.0 30.8. 23.2 -:129-2:9 - 13 real terms, loweringexport competitivenessand uiggeringcapital flight. The economy'sgrowthrate declined Table 11: Private creditorsare retreating;official creditorshave increasedtheirexposure Compositionof External Debt b" Source, 1980-90 (in percent) Official 28.3 East Asia 12.6 Lati A ine ca78.7 SouthAsIa gSti-Saharan 43.0 1980 Private Other 29.3 42.4 28.6 58.6 9.0: 34.5 12.4 22.5 Total 100.0 100.0 Official 44.5 27.2 Private 37.4 S3.0 100.0 100.0 63.660.6 24.7 23.6 1990 Total Other 100.0 18.2 100.0 19.8 .4 1'.7 1000 11.7 i5.S *10.0 ' Africa L IMTcredit and short term financing. b/ Totals include data for Kampuchea,Mongolia,and VietNam. Source:EECDIand OECDdata. sharply,so much so that per capita incomein 1990was lowerthan it had been in 1980. The country is now only one of two highly indebtedeconomiesto have debtand debtservicereductionagreementswith its commercial creditors. 31. Three featureshave markedEast Asia's continuedintegrationwith global capital markets:continued accessto debt finance,increasesin non-debtcapital inflows,and prudent externaldebt management. Total debt stocks of developingcountriespeaked in 1987; it Continued access to debt financin . 32. has declinedever since becauseof the slow down in commercialbank financing, particularlyto severelyindebted middle incomecountriesin Latin America. This declinein commercialbank lendingwas less drastic in East Asia and Sub-SaharanAfrica. East Asia's external debt stock reached a plateau after 1987; so too did Sub-Saharan Africa's. Nevertheless,with private creditors pulling out, officialcreditors increased their exposurein all three regions (Table 11). 33. The average terms of new commitmentsto East Asia during the 1980s comparefavorablywith those for Latin America(Table 12). Sub-SaharanAfrica,on the other hand, benefittedfrom a higher proportionof official assistancewhich was also provided on more concessionalterms; consequently,the average maturity and grant elementof these new commitmentswere significantlyhigher than in the case of East Asia or Latin America. The average interest rate on new commitmentsto East Asia dipped between 1982 and 1987, but increased in the followingyears as a result of a world-widerise in interestrates. However,East Asia has consistentlyobtainednew credit at lower interest rates than Latin America,where the average interest rate has been one to two percentage points higher. The lower interestrate terms for Sub-SaharanAfricareflects a larger elementof concessionalityon its official debt. The average grant element in new commitmentsto East Asia was much higher than in Latin America,but not as high as in Sub-SaharanAfrica. The region's shrinking grant element after 1987 reflects the steady "graduation" of its more successfil economies - Korea, Malaysia, and Thailand - from official developmentassistance. - 1434. East Asia's mix of creditorshas also differedfrom that of Latin Americaand Sub-SaharanAfrica. But one feature is common to all three regions; the countriesbelongingto the European Economic Communityare the largest sourceof finance,and their sharegrew in the secondhalf of the 1980s. Japan, the secondlargest creditor to East Asia, expandedits lendingrapidlyto the regionand is nowchallengingthe EC countriesfor first place. From 1985to 1989,five East Asian countriesbecame more dependenton Japanesecredit; the sole exceptionwas China, wherethe virtual halvingof Japan's share was mirroredby a doublingof the EC's. The U.S. share has declinedfor all regionsand for developingcountriesas a whole. Table 12: The averageterms of newcommitmentsforEastAsia comparefavorablywithLatin America, but not withSouthAsia Average Terms of New Commitments Interest(!/Jo Grant element(%0 1980 1990 1980 1990 East Asia Latin 9.4 6.8 11.6 8,0 SuhAsiaWi 4.5 VSub j 7.1 8.8 4.4 3.9 - : . -: -. Maturity (vrs) Graceperiod(yrs) 1980 1990 1980 1990 22,1 12.1 15.6 ma. 49.9 21,7 44.77 466 3:2.9.- 0 XC: - 11.1 f: - - . -4 418.: :soX 28 -6,-174 . 0--: 4.6 - 7,8 7 5X. : . ., -47 4S - ~~~~~~~~. ...... Source:IECDI 35. Shift to non-debt financing. Commercialbanks have been hesitant to advance large new loans to developing countries since the 1982 debt crisis, and have forced developing countries to look beyond debt financing. In this regard,East Asia has achievedsome success. Foreign direct investment(FDI) inflowsreached $11.1 billion in 1990, rising from $1.3 billion in 1980 (Table 13). To a certain degree, Latin America also achieved some successin attracting foreign direct investmentvia debt-equityswap programs. But it was more successfulin attracting portfolio investment,which increased from 6 percent of total capital inflows to Latin America in 1980 to 46 percent in 1989. East Asia has been less successfl in attracting large flows of foreign portfolioinvestment,which accountedfor only 9% of the region'scapital inflowsin 1989. 36. External debt management. East Asia managedits external debt relativelywell, employinga judicious mix of variable-rateand fixed-ratedebts to hedge against internationalinterest rate risk, and ensuringa relatively stable paymentcurrencymix to hedgeagainst exchangerate risk. To assessthe effectof internationalinterest rate variability on external payments, the difference between the peak and the trough aaverage interest rate was calculated for the entire decade of the 1980sin each major financial market. The effect on interest paymentson the outstandingstock of debt in 1990was estimatedas an incrementto the debt serviceof the order of 1 percent of export earnings for East Asia, 11 percentfor Latin Americaand 4 percent for Sub-SaharanAfrica (Table 14). The relativelylow variabilityin interest paymentsin the case of Sub-SaharanAfricastemmedfrom its lack of access to internationalfinancialmarkets, whichpreventedthe regionfrom accumulatingvariablerate debt. In the eventof a downturnin international interest rates, as occurredduring 1991,countries and regions with the higher stock of variable rate debt (suchas Latin America)will benefitmore from lowerinterestpayments. - 15- Table 13: Total resource inflows increased in EastAsia during the 1990s, largely due toforeign direct investment Breakdown of debt and non-debt financin! (US$ billions) Sub-Saharan East Asia Latn America South Asia Afri TO resorce 1980 1990 1980 1990 1980 1990 1980 1990 12.4 24.6 29.4 18.7 11.0 16.8 5.8 8.4 10.4 114 22.9 8.1 1.9 4.9 3,2 5.2 -:0.6-.: ...-.-- 2.1. 0.4 2.5 3.1 1.1 2.4 2.9 1.:3= 11.1 .:6.1 8.1 04.0 0.8 0.1. .03 flows Not disbursemens of Iongterndebt. :Grants .- .ore. direc FSource_: IECDI.. Table 14: EastAsia is relatively well insulatedfrom interest rate fluctuations in international markets The _nactof Interest ate Changes on External Interest Payments. 1990 a/ (as a percent of exports) USS East Asia of wich: China Indonesia Korea Malaysia Thailand Phiippines FF DM LSTG YEN TOTAL Memo item: Interest payment to export ratio -::1.22.. 0.0 0.1 0.0 0.0 -1.4 5.9 -0.1 0.0 0.0 0.0 0.0 0.31 0.0 0.0 0.0 0.0 0.0 -0.2 -0.1 .0.1 '-O. -0.1 -0.1 -0. 1 1.5 -1.9 0.0 -2.2-0.1 -6.2 4,6 3.. 4.0 6.0. 13.0.. -3.8 9.0 -11.0 13.6 -.1.2 -0iJ.I -0.3 -1.8 406 -5.3 0.0 0.0 0.0 0.0 0.0 -0.2 -0.4 0.0 Sub-Saharan -2.3 -0.9 -0.3 Africa -0.2 -0.2 Latin America -9.3 -0.2. -0.3 a/ See text for explanation on method of estimation. Source: IECDI . : - 16 - 37. A similar simulationexercisewas done to gauge the impactof exchangerate changes on the dollar value of external debt. From 1985 to 1989,all major currenciesappreciatedagainst the dollar. The depreciationof the dollar translated into a higher dollar value of debt denominatedin other currencies. The upper bound of the exchange rate effect on this value is calculated by taking the differencebetween the peak and trough exchange rates of the Deutsche Mark, Japanese Yen, Pound Sterling and French Franc, and applying it to the value of outstanding debt in these currencies (Table 15). For East Asia, which had a substantialproportion of its debt denominatedin JapaneseYen, the incrementaleffect on the dollar value of external debt amounted to about 12 percent of exports. Countriessuch as Indonesiaand the Philippineswere affectedby changes in both exchange rates and commodityprices. Indonesia'sdebt-serviceratio, for example, rose from 10 percent in 1980 to 37 percent in 1986largely as a result of the appreciationof the JapaneseYen and the fall in international oil prices. While developingcountriescan hedge against future exchange rate changes by purchasing currency futures or other hedging instruments,most (includingIndonesia)have not done so due to institutionaland credit constraints. The least difficult avenue open to these countries is to adjust the currency compositionof their debt portfolios through swaps or by altering borrowing patterns, to achieve a desirable balance of currencies in their debt obligations. Table 1: The appreciationof the Japaneseyen raised the dollarvalue of cxternaldebt in severalEastAsian countries The Imnact of Exchange Rate Changes on the Dollar Value of External Debt. 1990 a/ (as a percent of exports) FF DM LSTG YEN Toa Memoitem: Debt to export ratio EastAi 10 1. chna 02 11 .. .o....F IndonesIa34 -otea -2-0V5- E - :I Mala: ;406 Thailand 0.2 Phiippn- 16 .:...A.. 40 Sub-Sahax~ -X::-V238 Africa } 0.4 43 0.1 5 99 : 11 1.7 9.2 11. 8-.X 3064 3: 103 9.7 440 582.0 1 ~~~~~1.4' 3,09 - -.......... X 0.1 :-:R-.3 0i0 0.8 12 11i.8- 0 - 42 X 88 9.3 ' 29 X31. . 5.9 95 56 - ........'..?, '~~~~~~......... ''"'' ''''' ''"' ........... '''': ;''"''' '''' ;':"' bl:i::: ':l .0:''" 2. X 3-95 a/ Exchangerate movementis estimatedas peak-to-troughchangesduring theperiod 1985-89. Source:IECDI The External Environment and EconomicPerformance in East Asia 38. East Asia's linkageswith the global economythroughtrade, investment,and finance,determinethe pattem of exposureto risks that may originate outsidethe region. These risks could include changes in the growth of industrial country markets, the international cost of capital, the terms of trade, and the availability of external capital, notablyforeigndirect investment. 39. Growth in industrial countriesaffectsgrowthin developingcountries,and this is particularlytrue in the case of East Asia (Table 16). A one percentagepoint per year declinein OECD growth in the 1990scould lower the - 17 - growthof all developingcountriesby 0.7 percentagepoints per year (Table15). 11 The primarychannel through which lower OECD growth translates into lower developingcountry growth is through demand for exports. A decrease in OECD growth of one percentage point a year sustained over three years would lower developing countryexportsby US$60billion a year. East Asia, however,couldbe expectedto experiencea lowerGDP growth rate by a full percentage point a year. In fact, a one percentage point decline in industrial country growth is estimated to engender more than a one percentage point deteriorationin the growth rate of Indonesia, Korea, Malaysia,and Thailand. This amplifiedtransfer of a slowdownfrom industrial countriesto the East Asia region is a measure of the integrationthat these countrieshave achievedwith the world economy,their industrialbase, and the rising share of capital goods in their exports. Other regions are neither so well linked nor possesssuch a large manufacturingbase. Sub-SaharanAfrica, for example,would be affected relatively little from lower growth in industrial countries because the income elasticities of demand for its exports are low. Latin America is also relativelydependenton commodityexports,and a slowdown in OECD growthwould have a significanteffecton GDP growthonly in Mexicoand Chile, and to someextent Argentina. Table i6: East Asia stands to benefit mostfrom increasedglobal growthand integration Estimated Effect of Chanees in the External Environment on GDP Growth of DevelonineCountries (percentagepoint deviationper year) OECDgrowth decreases RealLIBORincreasesby Trade and private finance by one percentagepoint 100basis points decreasesa/ Alldeveloping .0.7 EastA~~~~~~~~~~~a 10 ------ -Asia-07 :... ...... ... ,. .O....... ~~~~~MENA .08 LatinAmerica. ..... ... . .... , .. : -0.1 13~~~~~~~~~~~~~~~~~ . .0.2 ~~~~~~~~~~~~~~.. ........ -. .0.1 ..................................... . . . ..................... .................. ....... ........ Ii~~~~~~~~~~~~~~~~~ ...... .... .- .- Note: Data do not incorporatefeedbackto industrialcountriesor any indirect effectsthroughlinkages among the developingcountries. Policyresponsesof the developingcountriesto the given external changesare limitedto managementof the externalfinance constraint. a/ The level of foreigndirect investmentin developingcountriesis doublethat of the baseline(an averageof about $27 billiona year more than in the baseline),and a combinationof favorabletrade-relatedsupply effectsand a more liberaltrading systemadds two percentagepointsto the rate of growthof exportsof developingcountries. Source: WorldBank 1991a 40. The impact of higher international real interest rates on growth in East Asia would be in line with most other developingregions (exceptLat i. America). A one percentagepoint increasein LIBORover the 1990scould be expectedto slowgrowthby about 0.2 percentagepoints a year. This is despitethe fact that East Asia's variable rate debt is over 40 percentof its total dit, and reflectsthe strong externalpaymentspositionof most of the large East Asian economies(exceptthe Philippines). The growthimpact in Sub-SaharanAfrica wouldbe as high een though it holds a smaUershare of variable rate debt, and this is becauseits externalpaymentsposition is relatively weak. 11 These simulationsare cast over a ten year period. Thus, the rate of growth of developingcountriesand regions are based on ten-yearaverages. .; - 18- Table 17: EastAsia's biggestexportgainsfrom industrialcountrytrade liberalizationwouldarise in clothing andfootwear. Estimated Effect of a 50 percent Liberalization in Trade Barriers by Japan, the EC. and the U.S. n Imnorts from East Asia Japan EC U.S. 1988level export 1988level ex:ort 1988level export (US$ expansion(in (US$ expansion(in (USS expansion billion) percent) billion) percent) billion) (in percent) FOod Beveragesand tobacco Crde materials (exceptfuels. Minerli fas Arimatlad vegetableoils ChCm -Bas-: : , . hinryad i-M iscellanes 6.2 0.1 36.8 13.7 3.1 0.1 13.7 4.2 2.3 0.1 6.4 2.6 2.8 0.3 1.3 .9 10.5 0.2 8.2 12.5 0.2 0.6 2.4 6 --1.4 6.8 3.5 16.1 0.8 22 1.9 -10..0 6-C--:-:.9- .10.0 : -.114 : Clothing -oot-.aE.. ''lgooda W .i-o 06 1-3 6 1.. 721 | : .. .... .... .. E -. ,.::'.:.-.,.-,, E ..... .:---0-' :0'-'.'.' w-' '-0 ';. .::' :'.;-. . . . . . . . .. . :':,. . .. . .aB man:u - 0.5 7' 44.6 - `40.3 -- .2-010 03 :,. 4.0 : 21,6 3.3 ..... A''. ......0.~.. ^'4;. 16.0 fu ' .',560." 0 .4.4 178 ~~~24.4 ' - 'V 4.-'."'., 0 62 62 3 19.2 277........ '''S .. . i-; .. .. 36. 0 433 . :... -. ... . . ... :>:.:-:... .. :.:-.:.:..-... .:.:.:.:.:: .....- Source: WorldBank 1992. 41. East Asia wouldalso be the regionmost likelyto be hurt if foreigndirect investmentdecreasesgenerallyand is accompaniedby a worseningin the internationaltrading system. The region's strong physical and institutional infrastrcture, its outward-orientedtrade policies, and its well-developedhuman resource base, has attracted a large share of incrementalprivate capital flowsto developingcountries. Werethis flow to dry up, East Asia's rapid transformationinto a competitiveproducerof manufacum wouldprobablyslow. 42. The region's close links to industrial country markets and its comparativeadvantage in labor intensive manufactureswould make it especiallysensitive to changes in the level of industrial country protection. For example,if protectionlevels in the EC, the United States,and Japan were to be halved,developingcountry exports could rise by 15 percent or US$50 billion in 1988 prices. East Asia would be the region to benefit the most, accountingfor more than half of the increase. Sixtypercentof East Asia's incrementalexportswould be in textiles and clothin& although the rise in exports of transport and equipment as well as food and feeds would also be significant(Table 17). East Asian exportswouldtend to grow in all three major markets - Japan, the EC, and the S;.. -19 U.S. Clothing exports to both the EC and the U.S. would more than double. Exports of footwearwould also be expectedto rise sharply in all three markets. 43. By the same token, East Asia wouldbe the most seriouslyaffecteddevelopingregionwere industrialcountry protectionto rise rather than fall. The stalling of the GATr negotiationsunder the Uruguay Round, increased trade friction between the EC, the U.S., and Japan, and the accelerating trend toward regional trading arrangementsmakes this a possibilitythat cannot be dismissedlightly. The creation of the EC single market by the end of 1992,for example,will probablyhavean adverseimpacton the larger exportersof manufacturesin East Asia - even if the EC's commonexternaltrade barriers did not rise. This is becausetrade creationin the EC post92, although high (assuminghigher EC growth and high incomeelasticityfor manufactures)would be eclipsedby even higher trade diversion. The EC's estimatesindicatethat importswould fall by about 10percent as a result of the reforms - 2.5 percent from removinginternal barriers to trade and a further 7.5 percent from removingcostraising regulatory barriers. The g!eatest trade diversion would be in services and technology intensive manufactures,and in these areas the immediateeffecton East Asia would not be significant. But trade diversion would also be large in the case of labor intensivemanufactures. The removal of internal trade and regulatory barriers within the EC would increasethe competitivenessof exportersof labor intensivemanufactureswithin the EC - particularlyin Portugal, Spain,and Greece. And this could have a substantialadverseconsequencefor East Asian exports in the short term. 44. Anotherless well advertisedeffectof EC92 will be the diversionof investmentflows away from developing countriesand toward the EC. Japan's large foreigndirect investmentin the EC (and in the U.S.) has been driven, in part, by the concem that the regionalizationof trading arrangementsmay lead to higher trade barriers vis-a-vis third countries. Similarly,EC member countries'foreign direct investmentin developingcountries will likelybe affected as a result of new investment opportunitieswithin the enlarged common market. The East Asian economies,traditionally important recipients of FDI (among developingcountries), could expect to find FDI inflowsfrom these sourcesto grow less swifllythan in the past. 45. The effect of EC92 on East Asia is likelyto be amplifiedby the EC's recent associationarrangementswith Czechoslovakia,Hungary, and Poland. These agreements,which establisha free trade area between the EC and each of these three countries,are likelyto lead to substantialincreasesin foreigndirect investmentby EC member countriesonce the uncertaintiesin the region dirninish. These countries,with their plentiful skilled and educated labor and their proximity to the EC market, could competesuccessfullywith the East Asian economiesfor FDI flows and productionof labor intensivemanufactures.Moreover,the reformsin the FSU, Romania,and Bulgaria, if successful,could add to the growing number of East Asia's competitorsin Eastern Europe and Central Asia. Offsettingthe adverse effectsof these trends on the exportprospectsfor East Asia is the possibilityof faster growth in the economiesof Eastern Europe and of the Asian FSU Republics,which make them potentially important marketsfor East Asian exporters. 46. East Asia would also need to keep a close watch on developmentsin the North American continent. The NAFTA agreementbetween Canada, the U.S. and Mexico has yet to be approvedby the U.S. Congress,but an initial assessmentof the proposed agreement'ssalient featues suggests that the immediateeffect on East Asian exporterswould be minimal. For example,in the textile and clothing sector,current quota and tariff restrictions on U.S. imports from Mexico will be replacedby rules of origin designedto maintain the protectiveeffectof the current trade regime (Bannisterand Low, 1992). Mexicanexportswill enjoy improvedaccess to the U.S. market under the NAFTAin exchangefer sourcingcommitmentswhichensure that most inputs into textilesand clothing originatewithin North America. Rulesof origin achieve this through a multipletransformationrequirementthat identifiesthe origin of intermediateinputs. Under triple transformation,for example,a cotton shirt would have to be made in the NAFTA region from yarn and fabric also of NAFTA origin. In the case of Mexico, however, proximity to the U.S. market and long-standingproduction agreements have already created a high level of dupendenceon inputs of U.S. origin. Only7 percent of Mexico'sexportsto the U.S. uses importedinputs (outside -20productionarrangements),and only 8 percent of this (or 0.6 percentof apparel exports)uses inputs importedfrom non-NAFrAcountries. 47. The longerterm effectof the formationof regionaltrading arrangementson East Asia's trade prospectswill dependon whetherregionaltrade blocs help or hinder global multilateraltrade liberalization. Were trade barriers to rise or trade frictions escalateto the point of a trade war, oneof the principal casualtiesin terms of lowergrowth and lost opportunitieswould be the relatively open economiesof East Asia. As important, the trend toward regionalizationis being accompaniedby increased constraints on foreign direct investment. For example, the output of Japaneseautomobileproductionunits in the EC is limitedto establishedproductionceilings,and in some casesvoluntaryexport restraintsagreedwith the U.S. restrictthe option of relocatingproductionin other countries for final export to the U.S. market. Similarly,East Asian FDI in Mexico to take advantageof accessto the U.S. nrket under the NAFTA would most probablybe curtailed. These restrictionswould limit the flexibilityof all economies,including the East Asian ones, to adjust to changing market constraints and opportunities,and to promotegrowththrough increasedtrade and technologytransfer. Conclusion 48. East Asia's impressiveeconornicperformancecan be explained, in part, by its ra,nidintegration with the world economy,the diversificationof its marketsand productionbase, its ability to absorb new technologiesand gain increasedmarket accessthrough the promotionof foreign direct investment,and its prudent handling of its external finances. The relative openness of East Asia's economies,the recent trend toward more liberalized policies,stable macroeconomicmanagement,and a well-developedsocial and physical infrastructurehave helped its economiesto adjust rapidly to external shocks. At the same time, East Asia's strong trade and financial links with the global economy have closely aligned its economic fortunes with the performance of the industrial countries. This has made it more vulnerableto external economicrisks arising from changes in the international trading system than other developing regions, though it is in a better position to adjust to changes in global economicconditions. kI the coming decade, the East Asian economieswould need to be watchfil of the trend toward regionalization around the world, especially in Europe and North America. If multilateral trade liberalizationwere to slow or be reversedas a result of this trend, the consequencesfor East Asia could be more serious than for other developingregions. As far as external financial shocks are concemed, East Asia is less vulnerable than other developingregions because of the higher state of developmentof its capital market, the prudent share of variable rate debt in its overall debt portfolio, and its strong creditworthinessin international capital markets. - 21Biblioaranbv Asian DevelopmentBank. 1991.Asian DevelopmentOutlook 1991,(Manila:ADB). 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Does JaDanes'Direct Foreign InvestmentPromoteJapanese Imports from Developing Countries? World Bank PRE Staff WorlungPaper SeriesNo. 458. UNCTAD.1991. Handbookof InternationalTrade and DevelopmentStatistics(newYork: UnitedNations). UNCTC.1992. WorldInvestmentDirectory1992,Volume 1: Asia and the Pacific).(NewYork: UnitedNations). UNIDO.1989. Industryand Development:GlobalReport 1989/90.(Vienna:UNIDO). Urata, Shujiro. 1991.JapaneseForeignDirect Investmentand its Impact on Foreign Trade in Asia Draft Paperfor the SecondAnnual East Asian Seminaron Economics. WorldBank. 1990.The WorldBank Atlas 1990.(WashingtonD.C.: WorldBank) World Bank. 1991a. GlobalEconomicProspectsand the DeveloRingCountries. 1991.(WashingtonD.C.: World Bank). World Bank. 1991b. World DevelopmentReport 1991: The Challenge of DeveloRment.(New York: Oxford UniversityPress). World Bank. 1992. Global EconomicProspectsand the DeveloningCountries. 1992. (WashingtonD.C.: World Bank). Yeats, A. 1991. "Implicationsof ChangingNational ComparativeAdvantagefor Future Investment, Structural AdjustmentPoliciesand GlobalTrade Paterns", draft nime, InternationalEconomicsDepartment,WorldBank. Policy Research Working Paper Series Title Author Date Contact for paper AndrewM.Warner Oil WPS1102 DidtheDebtCrisisor Declining PricesCauseMexico'sInvestment Collapse? February 1993 M. Divino 33739 PeterJ. Montiel WPS1103 CapitalMobilityin Developing Countries: SomeMeasurement Issues Estimates andEmpirical February 1993 R.Vo 31047 WPSI104 TradePolicyReformin LatinAmerica AsadAlam SarathRajapatirana in the 1980s andtheCaribbean February 1993 J. Troncoso 37826 LeHouerou Deficitsin Philippe Quasi-Fiscal WPSIIO5Estimating Framework: TheCase HectorSierra a Consistency of Madagascar 1993 February N. Velasco 34346 HalilDundar Women'sAccessto WPS1106 Improving A Reviewof World : innferHaworth HigherEducation: BankProjectExperience 1993 February S. David 33752 GerardCaprio,Jr. [zakAtiyas JamesHanson February 1993 W. Pitayatonakarn 37664 1993 February A. Correa 38549 March1993 M.Raggambi 37664 March1993 D. Gustafson 33714 and WPS1107 Financial ReformLessons Strategies WPS1108 PublicOutputandPrivateDecisions:Th. los Catsambas Conceptual Issuesin the Evaluation ActivitiesandTheir of Government for FiscalPolicy Implications andStable WPS1109 RiskManagement FinancialStructures AndrewSheng YoonJe Cho WPS1110WhatWouldHappenIf AllDevelopingWillMartin TheirManufactured CountriesExpanded Exports? Lawin Central WPS1111 ForeignInvestment andEasternEurope CherylW.Gray WilliamJarosz March1993 M.Berg 31450 and Concentration, WPSI1112Privatization, Pressurefor Protection: A Steel SectorStudy YingQian RonaldC.Duncan March1993 S. Lipscomb 33718 March1993 E. Vitanov 38400 March1993 D.Bievenour 37899 Grootaert WPS1113 TheLuckyFewAmidstEconomic Christiaan RaviKanbur Changein Decline:Distributional Coted'lvoireAsSeenThroughPanel DataSets,1985-88 Really WPSI1114DoesPriceUncertainty ReducePrivateInvestment? A SmallModelApplied to Chile AnitaGeorge JacquesMorisset Policy Research Working Paper Serles Title Author WPS1115Lookingat theFacts:WhatWe Know RossLevine aboutPolicyandGrowthfromCross- SaraZervos CountryAnalysis Date March1993 Contact for paper D. Evans 38526 WPS1116 Implications of Agricultural Trade Liberalization fortheDeveloping Countries AntonioSalazarBrandao March1993 WillMartin D. Gustafson 33714 WPS1117 PortfolioInvestment Flowsto Emerging Markets Sudarshan Gooptu March1993 R.Vo 31047 WPS1118Trendsin Retirement Systems and Lessonsfor Reform OliviaS. Mitchell March1993 ESP 33680 WPS1119TheNorthAmerican FreeTrade RaedSafadi Agreement: Its Effecton SouthAsia Alexander Yeats March1993 J. Jacobson 33710 WPS1120 PoliciesforCopingwithPrice Uncertainty for MexicanMaize DonaldF.Larson March1993 D. Gustafson 33714 WPS1121 Measuring CapitalFlight:A Case Studyof Mexico HaraldEggerstedt March1993 Rebecca BrideauHall SwedervanWijnbergen H.Abbey 80512 WPS1122 FiscalDecentralization inTransitionalRichardBird Economies: Towarda Systemic Christine Wallich Analysis March1993 B. Pacheco 37033 WPS1123 SocialDevelopment is Economic Development April1993 S. Rothschild 37460 WPS1124 A NewDatabase onHumanCapital VikramNehru Stock:Sources,Methodology, and EricSwanson Results AshutoshDubey April1993 M.ColeridgeTaylor 33704 WPS1125 Industrial Development andthe Environment in Mexico AdriaanTenKate April1993 C.Jones 37699 WPS1126 TheCostsandBenefits of Slover,an MilanCvikl Independence EvanKraft MilanVodopivec April1993 S. Moussa 39019 WPS1127 HowInternational Economic Links AffectEastAsia April1993 M. ColeridgeTaylor 33704 April1993 J. LucasWalker 31078 NancyBirdsall VikramNehru WPS1128 TheInternational OceanTransport HansJurgenPeters Industryin Crisis:Assessing the ReasonsandOutlook