Mutual Interdependence: Asia and the World Economy, Address By Anne O. Krueger, First Deputy Managing Director, IMF
June 30, 2005
Address by Anne O. Krueger
First Deputy Managing Director
International Monetary Fund
To the Institute for Global Economics
Seoul, Korea, June 30, 2005
Thank you Dr SaKong for that very kind introduction. I am very pleased to be in Korea again—it's been too long. And I am especially pleased to be here at the IGE and to see so many old friends.
My focus today is Asia, and its role in the world economy. This is a continent that has been transformed in the past half century, and nowhere has that transformation been greater, or more evident, than in Korea. Rapid economic growth in most parts of Asia has had a dramatic impact on living standards. The reduction in poverty has been remarkable.
Today, Asia is a large part of the world economy, and the most dynamic. It has been an engine of growth for the world economy for the past several decades; and, as it has grown in economic size, so its contribution to world economic growth has increased. Emerging market Asia was the most rapidly growing region in 2004. The world needs Asia, and the contribution that Asian economies make to world economic growth: of that, there can be no doubt.
But Asia needs the world, too. Asian economic success is the result of economic policies that have promoted stability, growth and openness. But the continent's success has also been based on successful integration with the international economy. All rapidly growing Asian economies have used their traded goods sectors as engines of growth and have benefited from the open international economy.
Future economic progress—both for the advanced economies such as Korea and for the developing economies in Asia—depends on a global economic system that continues to expand. More than ever before, we live in an age of mutual economic interdependence.
So this morning, I want to examine how the economic transformation of Asia came about, and then to consider the implications for Asia's future role in the world economy. I will argue that this role is one that permits Asian countries legitimately to make demands on the rest of the world, but it is also one that brings obligations for Asian countries too.
The Asian transformation
The modern Asian economic miracle is a phenomenon of the period since the end of the Second World War. The war itself had left its mark on the region. Figures put together by the economic historian Angus Maddison show that even in 1950 several Asian economies were still worse off than they had been in 1913. Per capita GDP on a purchasing power parity basis had fallen in many Asia countries including China, India, and Indonesia; and those same countries accounted for a smaller share of world GDP in 1950 than they had in 1913.
Estimates by Maddison also indicate that Asia had been in relative economic decline since at least the beginning of the nineteenth century. In 1820, Japan is estimated to have had a per capita GDP marginally above the world average, China slightly below; Asia excluding Japan is estimated to have had a per capita GDP equal to about four fifths of the world average. The same series of figures suggest that by 1950, Japan's per capita income was slightly below the world average; while China's was little more than a fifth of the world average. Asia excluding Japan had a per capita income that was roughly a third of the world average.
All that was to change dramatically, as we know. Japan had joined the ranks of the industrial economies before the First World War. But in the postwar period, it became the first economy to experience the sort of very high growth rates that had no historical parallel. In less than a quarter of a century, Japan grew so rapidly that it had a GDP per capita in 1973 almost three times that of the world average—and had almost caught up with Western Europe.
Japan may have been the first, but it was soon followed by other Asian countries, not least, of course, Korea. Angus Maddison's figures show that in 1998, Korea's per capita GDP [in 1990 purchasing power parity dollars] was almost 16 times what it had been in 1950. Its share of world GDP had risen from 0.3 per cent in 1950 to 1.7 per cent—a more than five fold increase during a period when the country's share of world population had remained constant, at 0.8 per cent.
Data from the World Bank's World Development Indicators enable us to track the comparative progress of Asian countries from 1975. China's real per capita GDP rose almost eightfold between 1975 and 2003—and fourfold from 1985. Indian growth has also begun to accelerate—real per capita GDP rose 2.4 times between 1975 and 2003—with most of that growth coming after the reforms of 1991.
By historical standards, the postwar growth rates were unprecedented. In the period after 1960, the Korean economy recorded growth each decade that exceeded the growth of the British economy during the whole of the nineteenth century. Real per capita GDP in Korea, Thailand and Singapore has grown by more than 5% a year, on average, since 1960. Since 1990, Asian per capita incomes have grown nearly twice as fast as that of the United States.
The domestic policy framework
This remarkable economic performance was no accident. Success reflected a strong commitment from policymakers, sustained over long periods, to bring about the rapid rises in growth rates needed to raise living standards and reduce poverty. It reflected a determination to adopt policies that would foster growth and to stick with these policies with a single-mindedness that policymakers in other parts of the world have viewed with awe. I think it is true to say that nowhere were policies aimed at accelerating growth adopted and implemented with greater determination—tempered by a pragmatic readiness to adjust when circumstances dictated—than here in Korea: and the results are evident. In 1960 this was one of the world's poorest countries, and the third poorest in Asia. Today, as you know, it is one of Asia's richest economies.
Trade has been critical to Asian economic success. As growth accelerated in the postwar era, so did the importance of trade to Asian economies. In Korea, the export to GDP ratio rose from 3 per cent in 1960 to 26 per cent in 1975 and 38 per cent in 2003. In China, the acceleration has been more recent: the export to GDP ratio was 2 per cent in 1970 and rose to 34 per cent in 2003.
The experience of Korea, China and other Asian countries underlines the crucial importance trade plays in fostering rapid economic growth. As every economist knows, an open trading system is crucial for lasting economic success. Closed economies can have temporary spurts of rapid growth although such spurts are often followed by sharp reversals. But no country—either in Asia or anywhere else in the world—has achieved sustained rapid growth without opening its economy to the rest of the world.
Trade brings competition—and this is a powerful force for increased economic productivity and thus higher real wages and employment. Competition helps increase efficiency and ensures that resources are allocated in the best possible way. It helps eliminate domestic monopolies. And so it drives down prices both for domestic consumers—as well as producers in import-consuming industries—and in the international marketplace. Prices fall because trade barriers are removed. Import-competing industries are no longer protected and monopolists are, as a consequence, forced to lower prices and to improve their efficiency.
Trade also helps create employment, especially in emerging market countries. Open, developing, economies have an outlet for large pools of unskilled labor: instead of being a drain on resources, unskilled labor becomes an opportunity to benefit from export markets for goods whose production is labor intensive in the early stages of economic growth. And those jobs enable workers to learn the skills that later permit movement up the value-added chain once most unskilled labor has been absorbed.
Asian policymakers have recognized the importance of trade liberalization, and they have reaped the benefits. Of course, other factors have also been of great importance in determining Asia's success: macroeconomic stability must remain a cornerstone of any strategy aimed at promoting rapid and sustained growth; attention to education, appropriate infrastructure, and a wide variety of other measures is also crucial.
The external environment
The extent to which appropriate policies matter is clear when we look at other parts of the world where Asian-style growth rates have proved elusive. It is worth remembering that Asia's impressive growth performance was often achieved against an unpromising backdrop: countries with few natural resources, or small populations, and that are geographically distant from most of the main industrial country markets, have grown at a pace that apparently more favorably-situated countries elsewhere in the world have failed to achieve.
So the domestic policy framework has a crucial role to play, and it is arguably this that explains a large part of the gap between the rates of growth achieved in emerging Asia and in some other regions of the world. Sound macroeconomic policies; structural reforms that make economies flexible and responsive and that encourage competition and make it possible for markets to flourish; and openness to trade: these, along with improving education, better infrastructure and other measures, are all vital ingredients of lasting economic success and sustained rapid growth.
But the international environment is also important in determining the magnitude of the benefits of sound macroeconomic and structural policies. Without a favorable international environment, the rates of growth that would have been achieved even with an appropriate domestic policy framework would have been significantly lower; although of course countries with inward-oriented trade strategies have fared even worse.
The multilateral trade regime established at the end of the Second World War has played a crucial part in the rapid expansion of global trade in the past five or six decades. The founders of the Bretton Woods system set up in 1944 saw trade as crucial for growth. They were determined to prevent any repetition of the beggar-thy-neighbor policies of the 1930s, and to reduce and eventually eliminate protection in the context of a multilateral trading system.
The progressive elimination of tariff and non-tariff trade barriers has been a persistent feature of the international trading system under the General Agreement on Tariffs and Trade (GATT) and its successor the World Trade Organization. It is no coincidence that the sharp fall in tariff rates and the removal of quantitative and other restrictions that took place in successive rounds of international trade negotiations was matched by an unprecedented expansion in global trade. They were inextricably linked: one would not have been possible without the other, and together they created a virtuous circle, with expanding trade stimulating growth and growth creating a favorable environment for further trade liberalization.
Look at the numbers. In 1947, average tariffs on manufactured imports among the industrial countries were over 40 percent. These tariffs were progressively reduced, so that by the late 1990s they had been lowered to less than 5 percent in the main industrial countries—the European Union, the United States, and Japan. As the newly-industrializing countries (NICs) embarked on successful development strategies, they too began reducing their levels of protection. Today, average protection in most of the developing world is far below what it was a decade or two ago.
At the start of this new century, world trade was worth around $8 trillion—25 per cent of global GDP. That compares with $1.5 trillion, in comparable dollar terms, in 1970, and 13 per cent of world GDP. According to the WTO, the volume of world trade in 2000 was 22 times its level in 1950. Merchandise exports have grown by 6 per cent a year on average for the past 50 years. World trade has consistently grown more rapidly than global GDP, and continues to do so. Last year, global growth was 5%; global trade grew by 8.5%.
Along with many other parts of the world, Asian countries have benefited greatly from this rapid expansion of trade. The more open an economy is, the more it will benefit from expanding global trade, and Asia has clearly demonstrated the truth of this. As a result the Asian continent accounts for the much larger share of world trade and world output that I mentioned earlier. And, as you know, without this rapid growth the enormous gains for Asian citizens in terms of improved living standards, as well as sharp improvements in all the main indicators measuring the quality of life—health, education and life expectancy—would not have been possible.
By harnessing the benefits of multilateral trade liberalization, Asian economies attained their high rates of growth. And Asia has contributed significantly to the rapid expansion of global trade. In doing so, Asian countries have acted as a model for others to follow.
It is clear that the lessons from Asia's experience can be applied in many other parts of the world; and this is especially true of those regions that have yet to attain the sustained rapid growth that Asia has achieved. Rapid sustained growth is essential for poverty reduction: and Asia has blazed a trail for others to follow.
The currently favorable global economic climate is a favorable background for emerging market and low income countries to pursue structural economic reforms that will significantly raise their potential growth rates and make their economies less vulnerable to shocks. It is also an opportunity for Asian economies to build on their success hitherto.
In this context, let me say a word about regional trading arrangements. As economies continue to grow and to benefit from the expansion of trade, it is natural that there should be attempts to foster economic and trade links among neighboring countries. Such groupings have, in the past, brought many benefits as trade barriers have been lowered and trade relationships have strengthened. One has only to look at the experience of the European Union to see what can be achieved.
But it is important that regional trade arrangements should be complements to and not substitutes for multilateral trade liberalization. The EU eliminated trade barriers between its members in the context of rapid multilateral liberalization of trade; tariffs fell by 40 percentage points globally and by 45 percentage points within the Union. European trade with the rest of the world was expanding rapidly even as Europe was integrating.
Neither poorer countries seeking to raise their growth rates significantly, nor Asian countries looking to continuing rapid growth, will be able to realize their ambitions if the multilateral trading system is undermined.
The Doha round of international trade negotiations has reached a critical stage. It is vital that the momentum be maintained if there is to be a successful outcome to the WTO ministerial meeting in December, which in turn will give fresh impetus to further trade expansion.
I believe we have a convergence of interests here, and a chance for Asia to play a leading role in resolving disagreements and breathing new life into the global trading system that has served Asian countries so well in the past. A Doha round agreement will bring huge benefits for developing countries. And by strengthening the multilateral trading system, and opening up global markets still further, an agreement would also strengthen the prospects for continuing rapid growth in Asia.
Asian countries are already prominent in the negotiations, of course. But I think Doha offers a real chance for Asian leadership in the world economy and it is perhaps appropriate that the crucial WTO Ministerial meeting is taking place in Hong Kong. There is scope for Asia to do more to push the Doha negotiators towards the agreement that we all need. The key message to get across in the Doha negotiations is that everyone needs to show a willingness to move. It is—of course—essential that the advanced economies fulfill the promises they have already made to reduce agricultural and other protectionist behavior. But this by itself will not provide the momentum for further multilateral trade liberalization that we all want to see. Developing countries, too, must commit themselves to reducing protectionism and they will gain greatly from so doing.
I argued earlier that opening Asian economies up to trade had been a vital ingredient in raising growth rates. It was—and the same thing was true, earlier, for the industrial countries. Halting the process of liberalization before it is complete would deprive the poorest countries the chance to benefit in the same way, and to begin the process of catching up. It would deprive millions of people of the chance to escape from poverty. The more open economies become, the more they and their citizens can benefit. This is true of unilateral liberalization, of course. But the benefits for all countries of further multilateral liberalization are far greater.
Leadership means more than bold words, though these are certainly needed in the Doha negotiations. Effective leadership also means arguing by example. For the Asian countries to push ahead with commitments to further liberalization now will greatly strengthen their bargaining power and influence in the Doha round—and in the world economy more generally.
And that means being ready to take difficult decisions for many countries in Asia, including Korea, perhaps above all on agriculture. Those countries around the world that restrict access to their agricultural markets and that subsidize farm exports need to show that they are ready to reduce and eliminate such protectionism. This would bring significant benefits to consumers, and raise growth rates, in those countries—whether they be in the European Union, in the United States, or Asia. It would also help developing countries. And the best outcome in terms of increasing global welfare would be if action to liberalize was taken multilaterally, which would also reduce the adjustments that individual liberalizing countries would need to make.
It is right to call on the industrial countries to get serious about agricultural trade reform.
But the liberalization of trade between the developing countries themselves is vital if the full potential benefits of a Doha round agreement are to be realized. We need to see recognition among developing countries that it is not in their own interest to apply protectionist measures against each other. Protectionism simply undermines their growth prospects.
The international financial system
Multilateral trade liberalization has been crucial in enabling Asian economies to experience from rapid sustained growth. But the founders of the postwar economic order recognized that the expansion of global trade required a stable international financial system. Maintaining international financial stability is, of course, the principal task of the IMF. But it is clear from our Articles of Agreement that this is because financial stability is an essential condition for the expansion of trade and economic growth. The founders of Bretton Woods had learned from the bitter experience of the 1930s, when the international financial system had proved so fragile and stability so elusive.
The Bretton Woods system has, I believe, proved to be remarkably durable, adaptable and successful. In the period up to 1971 the system of fixed but adjustable exchange rates established as part of the postwar settlement provided a stable framework that fostered growth. And it did so at a time of considerable change in the international economy as the industrial—and the developing—countries recovered from World War II and experienced the most rapid growth of global GDP in any quarter century in human history. The Fund's ability to provide its member countries with temporary financial support during balance of payments crises proved critical, on more than one occasion, to the maintenance of stability in the system as a whole.
The transition to floating exchange rates in the period 1971-73 was, with hindsight, much smoother than anyone had anticipated. Rapid growth and greater economic integration required economies to be increasingly flexible, and the fixed rate regime that had served the world so well was no longer sustainable. The abandonment of fixed exchange rates was timely, since the greater flexibility that came with floating rates helped the industrial countries cope much better with the oil price shocks of 1973-4 and 1979-80 than would otherwise have been possible.
The switch to floating rates demonstrated the adaptability of the postwar financial system, and the experience of subsequent decades provided further evidence of this. In the early 1980s, the system had to cope with the so-called third world debt crisis when many countries were unable to repay, or service, the large debts they had incurred, mainly from Western banks, in the 1970s. At the time, many observers assumed that developing countries would be forced in the future to rely almost entirely on official capital rather than commercial bank or other private lending to finance development. Once again, the system proved sufficiently adaptable to confound the pessimists, and, with the assistance of the so-called Brady bonds and other market-based approaches developing countries were able, gradually, to recover from the setbacks of the early 1980s and to regain access to private capital, in the form of bond financing directly from the markets as well as from the commercial banks.
The Bretton Woods founders had assumed that the postwar world would be reliant on official capital flows—that private flows would never resume the importance for economic development they had before 1914. The first signs that this might have been a misguided assumption came in the 1960s: Korea, as everyone here knows, was the first emerging market country to borrow on the international capital markets for the purposes of financing long-term investment, back in the 1960s. In the 1970s, the banks acted as a major source of finance. In the 1980s, it was thought that the debt crisis might mark the end of private capital flows, but by the 1990s, private international capital flows were soaring, as investors sought the best return on their capital. Such flows were a force for good, enabling developing countries to benefit from increased access to capital.
By the 1990s, however, the pace of change in the world economy had accelerated further, and the financial system faced new tests. The world was becoming increasingly interdependent; and this brought huge benefits in terms of the expansion of trade and the acceleration of growth for many countries. But as capital moved around the world in search of the most productive home, it became clear that economic rigidities and policy mistakes would be exposed much more rapidly than in earlier times. The series of financial crises, beginning with Mexico in 1994, taught all of us some painful lessons. As all of you here know only too well, the Asian financial crisis of 1997-98 came as a severe, and painful, shock. Decades of rapid growth came to a juddering halt as economies contracted, living standards fell and unemployment rose. The Asian miracle seemed, for a short time, to have ended ignominiously.
That diagnosis was wrong, of course. As we might have anticipated, Asian countries displayed remarkable resilience in the aftermath of the crisis. Confounding all the gloomy predictions, most countries bounced back with remarkable speed. Korean GDP was back to pre-crisis levels within two years, for instance. Indonesia, the last of the crisis countries to complete its Fund-supported program, was able to exit at the end of 2003.
Nevertheless, the Asian crisis, and others in Russia, Argentina, Brazil and Turkey, taught us some valuable lessons. With hindsight, of course, it should have been more evident to many of those involved—including the IMF—that trouble was brewing for some of those countries.
The proximate cause of the crisis in Asia was the sudden sharp reversal of capital flows to the region. Net inflows to the Asian crisis countries were roughly 6.3% of their GDP in 1995, and 5.8% in 1996. In 1997, net outflows were 2% of GDP, a figure which rose to 5.2% the following year. The economic dislocation caused by the sudden reversal was huge, and would have been so for any country.
But, as we now know, the change in investor sentiment was not wholly capricious. There had been a huge expansion of credit over a relatively short period of time. Rapid credit growth is almost always indiscriminate and, in many Asian countries, the result had been a sharp rise in the number of non-performing loans (NPLs). These NPLs had reduced the rate of return on capital, and, in time, they reduced the rate of growth. Once the international capital markets recognized that credit had been misallocated, it was inevitable that they would reassess the risks involved in lending to countries whose fundamentals were less sound than they had previously appeared.
As investor sentiment shifted, several factors conspired to make the situation worse. Fixed exchange rates compounded the problem. Poor regulation of the banking and financial sector in many countries had enabled banks to build up liabilities in one currency and assets in another. Government assurances that exchange rate pegs would be sustained left currency mismatches unrecognized. Devaluation then left financial institutions facing massive losses, or insolvency. Once the cushion of foreign capital was removed, the weaknesses of domestic banking systems were revealed—as was the impact on economic performance.
The contraction in GDP that most crisis countries experienced made things even worse, of course, because the number, and size, of non-performing loans grew rapidly. The further weakening of the financial sector inevitably had adverse consequences for the economy as a whole. In short, the crisis economies found themselves in a vicious downward spiral.
Asia's experience in the late 1990s reminded us of things we already knew, but whose importance we perhaps underestimated. There is no getting away from the need for a sound macroeconomic framework, but the crucial importance of a sound, well-regulated financial sector is now more widely recognized as well. The Asian crisis countries now have better macroeconomic frameworks in place. Monetary policy has become more focused. Fiscal policy reforms are under way in several countries. And flexible exchange rate regimes are now the order of the day in most countries in the region.
The Asian crisis also underlined that the benefits of short-term exchange rate stability are greatly outweighed by the risks that pegged or tightly-managed exchange rate regimes bring—not least from the danger of currency mismatches in the corporate and the banking sectors. Fixed exchange rates can result in very large—and sudden—changes in the rate, thus creating great volatility and lost output over the longer term. The move to flexible exchange rates in most countries has reduced vulnerabilities.
Before the crises of the 1990s, we had perhaps not fully understood quite how important a healthy financial sector is. As economies become more sophisticated, so the role played by a strong, deep, financial sector in allocating resources efficiently becomes ever more critical. We also now appreciate the importance of a healthy corporate sector—and how much this matters for the soundness of the financial sector. A weak financial sector cannot be nursed back to health if corresponding weaknesses in the corporate sector are ignored—any remedy will turn out to be no more than a short-term fix as more corporate loans go bad.
To achieve a strong, well-regulated financial sector means addressing issues such as non-performing loans; capital adequacy; and effective supervision. Financial institutions need the appropriate incentives to develop the skills required to assess and manage credit risk and returns. Effective bankruptcy laws—that strike the right balance between creditors' and debtors' rights—need to be in place. Much has been done in Asian economies to address the weaknesses exposed by the crisis of the late 1990s. And it is no coincidence that those countries that have been more aggressive in the area of financial sector reform have enjoyed better growth performance. And the IMF has been using its bilateral Article IV consultations and other means to take these lessons to all its members.
But there is always more to be done, in part because some countries have yet to complete financial sector and other reforms; and in part because the world economy is always evolving, and economies need to be ready constantly to adapt to new challenges.
A readiness to adapt, a willingness to learn from experience—these are all essential for lasting success, and they are also important characteristics of economic management in many Asian countries. Indeed, one of the most remarkable features of the postwar order has been its adaptability; and this, in turn, has helped the system be a durable one. As the world economy continued to evolve, the international financial system adapted as well. At every stage, national policymakers and the Bretton Woods institutions have sought to learn from experience. The 1990s taught us, for instance, that capital account crises were fundamentally different in nature from current account crises that had initially plagued many countries in the early postwar period.
Asia and the world
The international financial stability that has been characteristic of the postwar period has been an essential underpinning for the rapid growth of the world economy over that period. Asian countries have been major beneficiaries of this stability; and they have been major contributors to it.
This is a continent that has experienced remarkable success—and is continuing to do so. And economic success has brought with it greater influence in the world. Real influence depends on changes in the real world—the larger and more powerful economies become, the more influential they are.
Nevertheless, the pace of change in Asia has been so rapid that it has been argued that Asia's voice in the global economic institutions has not kept pace. Certainly, many of the institutional structures do not yet fully reflect the changes that have been taking place in the world economy. We at the IMF are clear about the strength of Asia's case and Fund management supports the proposals for a rebalancing of voice and representation at the Fund, so that Asia's economic weight is more properly reflected.
That is an issue that will have to be addressed sooner or later. But the Fund operates by consensus and ultimately, as you know, any change will require the agreement of all the Fund's shareholders. Precisely because the Fund is a consensus-based institution, though, Asia's voice carries more weight in our Board discussions—reflecting increased Asian influence in the real world—than the current voting shares might imply.
There are already many ways in which Asia can make its influence felt. This continent has already set an example for others to follow in terms of achieving rapid sustained growth. Asian countries, as I argued earlier, can also take a leading role in furthering the vital cause of trade liberalization.
Let me briefly sum up.
Asia's economic progress in the past half century has been truly remarkable. In no era have more people in the world escaped poverty. Many of those have been in Asia in the past fifty years and, indeed, in the past decade as growth accelerated in India and China. The example of what can be achieved by sound policies, dogged pursuit of economic reforms, and trade liberalization is inspiring.
This is an important moment. We have an opportunity to build on the progress of the past fifty years, and to help those countries still struggling with poverty and slow growth to catch up. A vibrant, healthy world economy is in all our interests. None of us benefits by some being poor—this is not a zero-sum game.
Asia now has a chance to ensure that other countries can follow the Asian path to economic success. Yes, that means policymakers adopting appropriate policies and sticking to them. Here they can learn by the example set by Asian countries.
But rapid growth also depends on a stable international financial system and a multilateral trade system that fosters the progressive liberalization of trade. And here Asian countries can help by doing what they can to preserve the international economic system that served them so well in the past and by working to ensure that regional arrangements complement rather than substitute for the multilateral approach that has brought so much prosperity to so many.
As we approach a critical point in the Doha round of trade negotiations, there is a real chance for Asia to make a difference. Asian leadership at this juncture could help strengthen the multilateral trading system and so ensure that all countries, industrial and developing, can benefit from an expanding, prosperous global economy.