External shocks and structural adjustments in east Asian newly industrializing economies

Abstract

AbstractThe two oil price increases and the subsequent recessions in the industrial countries in the 1970s constituted large external shocks for the trade‐dependent East Asian newly industrializing economies (NIEs). The effects of these external shocks on their balance of payments were two‐fold. First, the higher price of oil meant deteriorations of terms of trade and hence increases in import bills. The second impact was recession‐induced declines in the volume of exports. The recession also added to the protectionist pressures, especially against labour‐intensive exports of the NIEs. Therefore, there was a secondary decline in the demand for the NIE's exports. Unlike many other developing countries, however, the East Asian NIEs have coped with such large external shocks quite remarkably. In less than a decade they have been able to turn their current account deficits into surpluses. By using a framework developed by Salter and Corden, this paper seeks to examine the nature of the East Asian NIEs adjustment experience. The East Asian NIEs responded to external shocks with a policy package which included downward adjustments in exchange rates and reductions in absorption, especially public consumption. In the short run the depreciation of their currencies improved competitiveness and discouraged imports. It also switched expenditure away from tradables freeing goods for exports. While these short‐run adjustments improved their current accounts, the long‐run adjustments were crucial in sustaining these improvements and eventually producing surpluses in current accounts. In the longer run, depreciations of their currencies switched the production structure of Korea — and to some extent that of Taiwan — towards tradables. Hong Kong and Singapore were relatively less successful in restructuring their economy towards the traded sector. In the case of Singapore it was perhaps due to an excessive emphasis on the home‐ownership scheme. In Hong Kong the tying of Hong Kong dollar to that of the US led to a substantial appreciation of the currency when the US dollar rose in the early 1980s. Nevertheless, they were relatively more successful than most other developing countries. This paper suggests that this was due to their ability to regulate the labour market which, in turn, enhanced the switching effect of devaluation.