WORKING PAPER NO. 45

CHINESE MERCANTILISM:

CURRENCY WARS AND HOW THE EAST WAS LOST

SURJIT S. BHALLA

JULY, 1998

INDIAN COUNCIL FOR RESEARCH ON INTERNATIONAL ECONOMIC RELATIONS

CORE-6A, 4

FLOOR, INDIA HABITAT CENTRE, LODI ROAD, NEW DLEHI-110 003

TH

Foreword

The Asian financial crisis has generated a lot of research, analysis and debate.

The exact causes of the crisis are not firmly established, although various

hypotheses have been offered. This paper presents one view of the genesis of

the East Asian crisis. Several explanations are examined: managed exchange

rates, over and undervalued currencies, crony capitalism, asset bubbles,

Japanese devaluation, or "too much" capital account liberalization.

A large part of the analysis centers around the proposition that the regime of

managed exchange rates was at the core of the problem. In addition, the paper

offers an additional contributory cause of the crisis - China's mercantilist policy.

The role of the international system in allowing China to devalue its currency (by

over 50 percent), despite burgeoning trade surpluses, is also addressed. The

paper also explores the question of whether the Chinese economy needed any

devaluation in the early nineties.

I have no doubt that this paper will provoke debate and contribute to a better

understanding of an issue which is occupying the minds of most policy makers

around the world.

Isher Judge Ahluwalia

Director & Chief Executive

ICRIER, New Delhi

2

Table Of Contents

Foreword......................................................................................................................... 2

Table Of Contents ........................................................................................................... 3

CHINESE MERCANTILISM : ....................................................................................... 4

CURRENCY WARS AND HOW THE EAST WAS LOST ............................................ 4

1. INTRODUCTION................................................................................................. 4

2. CHINA, DEVALUATION, AND MERCANTILISM - SEEDS OF A CRISIS ...... 6

a. The Data ............................................................................................................ 7

b. The Evidence..................................................................................................... 8

c. Genesis of the Crisis - Did China need to devalue the yuan in 1991-93 ?............ 8

d. The Importance of Chinese Devaluation ............................................................ 9

(i) China vs. Greater China data...................................................................... 10

(ii) Export and Import data............................................................................... 11

(iii) The counter-factual ................................................................................... 12

e. Summarizing the Macro Evidence.................................................................... 13

f. The Micro Evidence ......................................................................................... 13

g. Did Devaluation Hurt Chinese Imports (and Asian Exports) ?.......................... 14

h. Political Economy of Trade Surpluses ............................................................. 14

i. Mercantilism defined ........................................................................................ 14

j. Mercantilism Index says YES ........................................................................... 15

k. Why Can't All Countries be Mercantilist ? ...................................................... 15

3. ALTERNATIVE EXPLANATIONS OF THE CAUSES..................................... 15

a. Did Japan Devaluation Cause the Crisis ? ........................................................ 15

b. Did Capital Account Liberalization cause the problem ? .................................. 16

c. Is Capital Account Liberalization not good for LDCs ? .................................... 17

d. Crony Capitalism and Non-Performing Assets of Banks .................................. 18

e. Equity and Property Markets............................................................................ 19

f. The perverse role of fiscal surpluses ................................................................. 19

4. WHAT DID HAPPEN ? ...................................................................................... 20

a. Capital flows and fixed exchange rates............................................................. 20

b. Zero hedging costs........................................................................................... 20

c. Floating exchange rates would have avoided the crisis ..................................... 21

d. Efficient Excess Capacity Creation .................................................................. 21

e. How to Compete? ............................................................................................ 21

f. Response of East Asia ...................................................................................... 21

g. Plaza is the parallel .......................................................................................... 21

5. CONCLUSIONS ................................................................................................. 22

References .................................................................................................................... 37

3

CHINESE MERCANTILISM :

CURRENCY WARS AND HOW THE EAST WAS LOST

Surjit S. Bhalla

1

1. INTRODUCTION

The world changed on July 2, 1997 when Thailand floated the baht.

Explanations abound on the origins of the crisis - indeed it is a growth industry.

This study is part of that explosion. It has several objectives. Identification of the

causes

of the crisis is the most important goal. Why did it happen ? Why did the

contagion happen ? What went wrong ? Was the East Asian miracle a mirage ? If

causes are correctly identified, the correct policy response is expected to follow.

If not, then developing countries may embark on another lost decade.

A large part of the analysis centers around the proposition that the regime of

fixed, quasi-fixed, managed exchange rates was at the core of the problem. In

addition to managed exchange rates, the paper offers an additional contributory

cause of the crisis - China's mercantilist policy. The role of the international

system in allowing China to devalue its currency (by over 50 percent in the early

nineties), despite burgeoning trade surpluses, is also addressed. This two cause

hypothesis is an

ex-post

one, and one that does not exclude other contributory

factors. Over-investment (actually an outcome of the above two factors) played a

part, as did property price booms.

The analysis suggests a presence of "currency" wars. It is probable that the East

Asian policymakers at least partially

welcomed

the Thai crisis because it allowed

them to get out of the straitjacket of fixed exchange rates - and, like US with

Japan a decade earlier (Plaza agreement), allowed them to be competitive once

again. A twenty something devaluation was common in the previous three

decades and the policymakers probably felt that the devaluation could be

beneficial, and handled without a crisis. Indeed, Taiwan stated as much when

they said that for "competitive" reasons it was going to let the currency

depreciate from its managed level of 28 NT/dollar (and it allowed the Taiwanese

dollar to depreciate by about 25 percent). However, markets are difficult to

control, much more so in today's capital flow world. The situation got out of hand

and a "welcome" devaluation turned into a crisis. The fact that a crisis did occur

does not negate the logic that

a priori

, the devaluation was desired (and

planned?) by countries of East Asia.

President, Oxus Research and Investments, New Delhi. This paper has greatly

1

benefitted from useful comments made at a seminar held at ICRIER, New Delhi on

31.7.98 and is a revised version of the draft presented at that Seminar.

4

The role of China's devaluations (the 1990-93 devaluation was the last salvo -

the yuan had already depreciated by close to 200 percent in nominal terms, and

close to 100 percent in real terms by the time of the "last" 90-93 devaluation) in

"messing" up the East Asian fixed exchange rate "agreement" should not be

underestimated. If most countries have their currencies fixed, and overvalued,

there is a consumer loss all around, but there is little possibility of a crisis - or a

currency war. Several implications for exchange rate policies in developing

countries follow from the analysis of the crisis. First, countries are unlikely to

create the climate for a future currency war. Therefore, less fixed or more

floating exchange rates will be the norm; the latest conversion of Brazil to this

new reality is a confirmation of this trend. This also implies that the movement

towards capital account convertibility in developing countries is inexorable and

inevitable. Most Asian and Latin American and Eastern European nations have

their currencies significantly more convertible today than in June 1997, the date

prior to the onset of the crisis.

Second, that China, having helped to create the "crisis", is unlikely to devalue

anytime soon. This is based on an additional reason - according to calculations

presented in

Developing Trends

(1998) the Chinese yuan is today under-valued

with respect to the dollar by about 10 to 15 percent. This forecast of a "no

devaluation" of the Chinese yuan incorporates political realities. (The Hong Kong

peg is a different issue and the Chinese may under the guise of exchange rate

unification (again!) devalue the Hong Kong dollar to the $-yuan rate of 8.3 from

the 7.75 HKD/US at present). International politics (particularly US) may be an

important force in determining exchange rate policies in developing countries.

And it is precisely an extension of this politics which leads to the conclusion that

China will not devalue as a

quid-pro-quo

to the US for allowing it to pursue a

mercantilist policy in the nineties.

Other implications also follow from this forecast. Without a Chinese devaluation,

the East Asian economies will be able to recover faster, and the world can move

towards a more level playing field. Capital account convertibility will likely

accelerate, and bring with it reduced real interest rates, and higher growth in

developing countries. And all without the imposition of old-new schemes to

control capital flows (Tobin tax) and without new global institutions to supplant or

replace the IMF.

The paper is organized as follows. Section 2 looks in detail at the argument that

the Chinese devaluation was not important in causing Crisis '97. The arguments,

and data, are examined in detail; the conclusion - Chinese devaluation was

critical in reducing the competitiveness of the East Asian economies. Section 2

also documents the mercantilist policies of China. Section 3 looks at other, more

common, explanations of the crisis. Section 4 outlines the development of the

crisis and Section 5 concludes.

5

2. CHINA, DEVALUATION, AND MERCANTILISM - SEEDS OF A CRISIS

Most commentators agree that managed exchange rates were a major cause of

Crisis '97, though the desire by some for a re-imposition of capital controls

suggests that the economic house is still divided. Operation of a managed

exchange rate, is, after all, a form of capital control. A legitimate question arises -

if controls were a major part of the problem, how can they now be a significant

part of the solution?

The earliest commentators (Bergsten (1997), Bhalla(1997), Makin(1977), and the

Economist

(1997)) suggested that China's devaluation of its currency by 50

percent on Jan. 1 1994, was a major contributory cause of the East Asian

devaluations. This view seems to be accepted by most market participants,

though not necessarily by most economists. The market takes it for granted that

an additional Chinese devaluation would deliver a knock-out blow to world

stabilization efforts, and lead to a new currency war. Hence, the market

implicitly

believes that the 90-93 Chinese devaluation caused the 1997 East Asian crisis.

The IMF was among the first to question the China devaluation thesis, and it did

so in a footnote in the

World Economic Outlook

of Dec. 1997.

"It has been argued by some observers that the devaluation of the Chinese yuan

at the beginning of 1994 also had a significant adverse effect on the

competitiveness of Southeast Asian economies. In terms of the U.S. dollar, the

unification of the yuan implied a devaluation of the official rate by 50 percent,

which is comparable to the yen's depreciation between mid-1995 and mid-1997.

However, since by late 1993 a large part (estimated at 80 percent) of foreign

exchange transactions were already essentially carried out at the swap market

rate, the effective depreciation is estimated to have been less than 10

percent....

The yuan's devaluation therefore had a much smaller impact on these

countries international competitiveness than the depreciation of the yen during

1995-1997

. In fact, structural reforms in China may have been a more important

source of improvements in its international cost competitiveness in recent years;

these may be inadequately reflected in real exchange rate data and may have

affected the trade performance of China's Asian competitors significantly" .

(footnote 4, page 7, IMF(1997), italics added).

While rejecting the China devaluation hypothesis, the IMF offered the hypothesis

that the devaluation of the yen, from mid-1995 onwards, may have been

responsible for the East Asian crisis. The

Economist

also echoed the view that

the China devaluation was not relevant.

6

"A misunderstanding of recent history may have caused those worries to be

overdone.. Some commentators (including

The Economist

) have contended that

China's last devaluation, in 1994, hurt its neighbours' exports, which inexorably

led to this years traumatic devaluations. This analysis, however, ignores the fact

that China's devaluation, an impressive 50 % on paper, amounted to less in fact.

Prior to 1994 China operated two exchange rates; while the official rate was

sharply devalued, the rate at which four-fifths of China's foreign trade was

conducted barely changed at all. So South-East Asia's 1996 slump cannot be

blamed on China's 1994 devaluation." (p.83, Dec. 13, 1997, emphasis added).

The World Bank, in its "official" response to the crisis (World Bank, 1998), did not

mention the Chinese devaluation as a possible cause; nor did it contend that the

East Asian currencies were overvalued in 1997.

A detailed analysis of the hypothesis that China's devaluation was unimportant

was offered by three economists at the International Division of the Federal

Reserve Board of the US. In a study entitled "

Was China the First Domino ?

Assessing Links between China and the Rest of Emerging Asia

", (March 1998)

authors Fernald, Edison and Loungani (hereafter referred to as FEL) contend

that "the devaluation was not economically important: the more relevant

exchange rate was a floating rate that was not devalued, and high Chinese

inflation has led to a very sharp real appreciation of the currency". FEL present

evidence on export shares of China and its competitors from 1993-1997 to

support their conclusion. Incidentally, while rejecting the Chinese devaluation

thesis, the authors do not provide an explanation for why the East Asian crisis

occurred.

a. The Data

The debate on the effects of Chinese devaluation has helped to highlight the

large discrepancies in the trade data. Exports and imports data as revealed by

own

) national accounts data of individual countries (and reported in IMF

International Financial Statistics

, (IFS)) differ, sometimes radically, from the data

reported by

recipient

countries, and reported in a sister publication of the IMF,

Direction of Trade Statistics

or (DOTS). Using discrepancies in own and

recipient country data, Bhalla(1995) warned, as early as April 1995, of the

undervaluation of the Chinese yuan and the effects of such undervaluation on

Chinese competitiveness and Chinese trade surpluses.

There are very large differences in trade data as reported by China the exporter

and as reported by recipient countries with recipient country data showing

exports to be about 60 per cent higher. Imports are also higher but by a much

lower percentage (see Table 1). The Chinese data suggests a large deterioration

in the trade account from 1990 to 1993 - the trade account moves from a surplus

of $ 9 billion to a deficit of $ 11.9 bn. Using

recipient

country data, the trend is

opposite - a large trade surplus in 1990, $40 billion, turns even larger in 1993 - $

7

49 billion. Incidentally, China is one of the few countries (detailed investigation is

in progress) to have such large differences between own and recipient country

accounts. Even FEL, whose thesis is that the devaluation was not important,

argue in favor of using recipient country data. Our thesis, that the devaluation

was important, also prefers recipient country data.

b. The Evidence

Background data on the Chinese economy in the nineties is reported in Table 1.

Three

exchange rates are reported - the official exchange rate, the theoretical

parallel exchange rate for exporters, and a weighted exchange rate reflecting the

actual

rate faced by exporters. The differences in the latter two rates reflects the

operation of the dual exchange rate system whereby exporters were allowed to

keep approximately 70-80 percent of export proceeds.

This table substantiates the proposition that the devaluation on Jan. 1 1994 was

not actually equal to the nominal 50 percent devaluation (from 5.8 yuan to 8.7

yuan) but rather a smaller 7 percent (8.1 to 8.7). (Note that the table reports end-

period data while the devaluation took place on Jan 1 1994 when the official

exchange rate changed from 5.8 to 8.7 yuan). However, this valid point is

fundamentally

trivial

and pertains to the specification of the exact date of the

devaluation. In addition, there are major problems with this (trivial but correct)

technical objection. The Chinese devaluation was not a one-off affair but rather a

continuous process over the preceding few years, a point noted by FEL as well

(also see Mehran et. al. (1996)). If the occasion of devaluation is shifted from

Jan. 1, 1994 to just six months earlier i.e. June 1993, then the effective exporter

devaluation was 16 % and if shifted to mid-1992, the devaluation for exporters

was a high 35 percent. Since the discussion is about the loss in competitiveness

of Asian economies post 1993, the exact timing of "when" prior to Jan. 1, 1994 is

of relatively little consequence. In any case, most analysts agree that export

markets react with a lag to exchange rate changes.

While the (ex) free falling Indonesian rupiah made these thirty something

devaluations insignificant, it should be emphasized that historically, such

devaluation magnitudes are high. India devalued by only 20 percent in 1991,

and that was considered far reaching. Further, as shown in Table 2, this Chinese

devaluation was in the context of either stable or

appreciating

exchange rates in

South - East Asia.

c. Genesis of the Crisis - Did China need to devalue the yuan in 1991-93 ?

Before discussing the

consequences

of the Chinese devaluation, an earlier

question needs to be addressed: did the Chinese economy require the stimulus

of a devaluation in 1990 to 1993 ? According to figures reported in Table 1, the

answer seems to be an overwhelming NO. The preceding five years (1985 to

1989) the Chinese economy grew at an

average

growth rate of 9.5 % per annum

8

with inflation at a high 14 percent; inflation then collapsed to a 4 % rate 1991-

1993, and economic growth remained high at 9 percent. Trade surpluses were

most likely reflecting a large under-valuation of the yuan; such surpluses had

exactly doubled from $ 40 billion per year 1985-89 to an average of $ 80 billion

during 1990-1993. With such robust statistics, most economists would not have

advocated an expansionary devaluation policy. However, China continued to

devalue from 1990 to end-1993 and the World Bank had this to say in its glowing

China 2020 report published in mid-1997: "Perhaps most important, the

government maintained a realistic exchange rate policy. It almost halved the

exchange rate at the outset of reforms and devalued the currency on four later

occasions" (World Bank, 1997a, p. 10, emphasis added).

d. The Importance of Chinese Devaluation

Economists make two arguments

against

the hypothesis that the Chinese

devaluation played a contributory role. First, it is pointed out that China did not

devalue, the exchange rate was only

unified, not devalued

. Second, that the 50

percent devaluation that

did

occur from 1990 to 1993 did not hurt East Asia

because all these countries increased their export share in the "nineties". Both

these objections to the "China devaluation is important" thesis are examined in

detail below.

There is a curious aspect to the view that the Chinese mega-devaluation (from

1990-1993) was irrelevant. Most economists recommend devaluation for

redressing trade deficits - it helps increase exports and decrease imports. (As

shown below, not only did China not have trade deficits, it had huge trade

surpluses

to the devaluation.) It is reasonable to expect, therefore, that an

increase in China's "trend" exports, and a decrease in its "trend" imports, would

cut into the export share of its competitors. Hence, if the textbook consequences

of a devaluation were to occur, then it is likely that China's competitors were hurt.

The debate about the importance of Chinese devaluation centers on data, and its

interpretation. There are aspects where there is general agreement i.e. recipient

country trade data should be used rather than national data - this because of

vast differences in the two, especially for China. There are centers of conceptual

agreement as well - the competitors are correctly identified as the East Asian

neighbours, and trade performance (rather than GDP growth, or inflation, or

interest rates etc.) is the correct barometer. But even on agreement, there can be

differences. For example, should the competitors be the Asean4 countries

(Indonesia, Malaysia, Philippines and Thailand) or should they be the Asean7

countries (above four plus Korea, Singapore and Taiwan)? On trade, should only

export data be examined, or both exports and imports? If the latter, then trade

imbalances (surpluses and deficits) become an important criterion.

There are areas of disagreement as well (between economists and between the

analysis contained here and in FEL). Should China be considered as the

9

comparator (this paper), or should it be Greater China i.e. China plus Hong Kong

(as preferred by FEL)?

Yet another important consideration for analysis is the time-period chosen.

China's devaluation for exports was a continuous affair between 1990 and 1993.

When the exchange rate unification occurred on Jan. 1, 1994, importers were

confronted with a 50 percent devaluation. So for exports, the proper time-period

of analysis is 1990 to 1997, and for imports 1993 to 1997. The end-point is

dictated by the onset of the crisis in July 1997; in the data presented in this

paper, the 1997 data are for end-June 1997 i.e. the data has been annualized for

1997 according to data for the first two quarters.

Given the large set of combinations of data possible, Charts 1-3 and Tables 1-8

contain data on all the combinations reported above. This over-presentation of

data is necessary because of the importance of the question, and the differences

in the results. Fernald-Edison-Loungani (and the IMF) conclude that the Chinese

devaluation was unimportant - using the same data, we reach a completely

opposite conclusion - the Chinese devaluation was a critical cause of the East

Asian crisis.

The reader can make up her own mind as to what set of assumptions are

necessary to examine the economic implications of the China devaluation. A

readers guide to the three major differences between the Fernald-Edison-

Loungani and our analysis of China's and East Asia's trade performance is as

follows.

(i) China vs. Greater China data

FEL prefer to use data for Greater China while we advocate a preference for only

mainland China. China devalued its currency by a huge 50 percent between

1990 (the start of the exchange rate unification program) and 1993. The Hong

Kong currency stayed stable. If effects of devaluation on trade performance is the

subject of investigation, then it is inappropriate to combine the trade data for

China and Hong Kong.

In support of their controversial decision, FEL offer the following argument: "it

makes economic sense to combine China and Hong Kong trade data (even

before the handover) because it is conceptually difficult to differentiate between

the contributions of Chinese and Hong Kong firms" (p. 7). FEL cite Krugman

(1997) to support their (questionable) reasoning: "Krugman also argues that we

should combine China and Hong Kong, on the grounds that conceptually, it is like

separating the trade statistics for New York city and the rest of the United

States".

The FEL-Krugman argument is less than convincing. Even for data after the

handover (June 1997) it is not clear that the trade statistics for China and Hong

10

Kong should be combined. The two regions have different exchange rate

regimes, hugely different devaluations (large versus none), different costs,

different tax structures, and different comparative advantages. The data for the

two regions tell a different story. At the margin, it is the case that taking the

extreme step of combining Hong Kong and China data helps the FEL argument

because Hong Kong exports grew at a considerably lower rate than Chinese

exports.

But it could be that the growth rates differ by the extent they do because

China had a large devaluation and Hong Kong did not

. If one is trying to prove

that Chinese devaluation did not have an effect, then it maybe erroneous to base

the analysis only on export data for Greater China, rather than just mainland

China.

China's exports to industrialized countries (IC's) grew at a 17 percent annual

rate in the nineties, more than

double

the rate of the ASEAN7 economies (Table

3). Since world exports to IC's grew at 4.9 percent , it is apparent that the export

share increased for both China and the Asean countries. China, however, shows

a considerably larger increase (Table 4a). While the ASEAN7 increase their

share by barely 1 percent over 7 years - from 6.9 to 7.9 percent - China's share

more than doubles from 1.7 to 3.7 percent. Greater China's share also increases

by more than sixty percent - from 2.7 percent to 4.4 percent. Korea and Taiwan

register a

decline

in market share. Little evidence, therefore, that the "new" and

"cheap" exporter did not hurt East Asian exports.

(ii) Export and Import data

Another major difference between FEL and us is in the use of overalll trade data,

rather than exclusively export data. Concentration on the latter makes one ignore

the reality that devaluation is a double-edged sword - it hurts the competitors in

third markets, and via imports in one's own market.

FEL primarily concentrate on the use of export shares to demonstrate that the

China devaluation was unimportant. Both the IMF and FEL are completely silent

on the effects of the Chinese devaluation on Chinese imports, and China's trade

surplus. For imports the official devaluation of 50 percent was equal to the actual

devaluation, with predictable effects. Proper beggar-thy-neighbor policies entail

an increase in trade surplus which comes about not only through large gains in

exports, but also via smaller growth in imports. Import substitution can be

achieved both with import taxes or with an under-valued exchange rate. This

seems to have happened in China - as shown in Tables 1 and 5, import growth

collapsed, and trade surpluses zoomed in the post 1993 devaluation period. As

shown in Table 6, China averaged a trade surplus of $ 54 billion per year with the

industrialized countries during 1990 to 1997; Greater China averaged $ 40 billion;

Asean4 only $ 13 billion and the Asean7 countries - an average deficit of $4.2

billion per year!

11

(iii) The counter-factual

Even if the extreme assumption of only export shares is accepted, there is still

the problem of the problematic counter-factual. Even if the restrictive FEL criteria

are accepted - export shares of the

Asean4 countries

, with respect to

Greater

China

, in only the

post 1993

period (Tables 3 to 7), one cannot conclude that the

devaluation was unimportant.

Export shares of the competitor Asean4 countries

increased

(with respect to the

rest of the world, but not with respect to China) from 1993 to 1997, so how can

one argue that China devaluation hurt? This line of reasoning is reminiscent of

the arguments made in the early nineties defending the state intervention

practiced in high growth economies of East Asia (see Wade, Petri) i.e. these

countries grew at high rates, so state intervention must have had positive effects.

The response to that argument was that what mattered was not the absolute

level of growth, but rather the potential rate of growth. Phrased differently, what

mattered was the rate of growth of total factor productivity(TFP).

Parenthetically, the World Bank's

World Development Report

(WDR) of 1991

was the

first

to document the low TFP growth achieved by the state managed

East Asian economies - a finding that was elaborated upon by Bhalla (1992) and

Young(1993), and popularized by Krugman (1994) but which two World Bank

studies (the miracle study, World Bank (1993) and the WDR (1997b)) attempted

to reverse.

The relevant question is not whether East Asian economies maintained their

market share, but the counter-factual: what would have happened to their market

share if China had

devalued. Increase in production capacity is usually made

with projections of demand for output, and not with maintenance of market

shares. Consequently, the following assertion by FEL is questionable "What is

striking is the similarity in export growth between Greater China (sic) and the rest

of developing Asia, including in the period 1994 to 1996: both show high growth

in 1994 and 1995, and a slowdown in 1996...Hence, China's robust export

performance in 1994 and 1995 - and the alleged devaluation of 1994 - did not

translate into major gains in market share". (FEL(1998), p. 4 and 5).

What the counter-factual argument incorporates is the reality that crises occur

when production, exports etc. grow significantly less than planned. China, by

stealing the Asian lunch, caused severe indigestion of large scale capital flows

i.e. East Asian exports to industrialized countries

grew at significantly lower rates

than if China had not devalued

. Recall that in 1994, Mexican exports were

growing at double-digit rates yet that was neither necessary, nor sufficient, to

indicate that the peso was extremely overvalued. Similarly, the fact that the East

Asian market share was increasing is not half as important as the fact that

Asean7 exports were growing considerably less than capacity investments had

"planned", and at half the rate of their main competitor, China.

12

e. Summarizing the Macro Evidence

Charts 1 to 3 graphically illustrate the reality of the Chinese devaluation and the

differences between FEL and our analysis. Chart 1a documents the evolution of

China's trade surpluses, an outcome made possible by the devaluation. These

surpluses zoomed from around $ 40 billion in 1990 to more than $ 120 billion in

1997. Chart 3 documents the fact that in 1997, the US had identical problems

with both China and Japan - both countries with surpluses around $ 50 billion.

Chart 2 graphically illustrates that only for the restrictive

Greater China vs.

Asean4 exports

to US comparison, is the performance of Greater China and its

competitors of roughly equal magnitude. For industrialized countries, China

increases its export share (indexed at 100 for 1990) to 250 in 1997 i.e. a 150

percent increase in seven years. For Greater China, the increase is a 100

percent; for Asean4 there is only a 50 percent increase; and for Asean7, an

almost negligible 20 percent increase. This is where competitive China hurt the

fortunes of East Asia.

f. The Micro Evidence

Tables 4b and 4c provide evidence about the increase in China's market share at

the micro level. Data for four industries are presented: toys, electrical machinery,

computers and apparel. Table 4b shows in numbers what is now a well known

reality: in the space of just two years (1994 to 1996) China was able to increase

its share of the toy market in the US from a very high 47 percent to an even

higher 54 percent. The Asean7 show a large decline in these two years - from 21

to 16 percent, and Japan also shows a large decline - from 13 to11 percent.

Both China and Asean7 show an identical 1 percent increase for electrical

machinery with Japan showing a large decline from 28 to 22 percent. (Note that

in growth terms, China's exports grew at a much larger rate).

Table 4c reproduces a table contained in FEL. This table reports export share

data

among

the East Asian economies, including China, for two important

industries - computers and apparel. In the former, China's share goes up from 0

% in 1989 to 3 % in 1993 and 5 % in 1996. For apparel, the share increase is

exponential - from 18 percent in 1989 to 41 percent in 1993 and 47 percent in

1996. The East Asian competitors are left behind - their share in apparel

declines exponentially, from 64 percent in 1989 to 40 percent in 1996. For the

important computers sector, the Asean7 economies are barely able to maintain

their share. Thus, the micro data is consistent with the hypothesis that the

Chinese devaluation from 1990 to 1993 helped Chinese exports

at the expense

of their East Asian neighbors.

As noted above, part of the data is reproduced

from the study by the three US FED economists, FEL(1998), who strangely do

13

not reach the same conclusion i.e. that China's mercantilist trade policy hurt its

neighbors.

g. Did Devaluation Hurt Chinese Imports (and Asian Exports) ?

The flip side of export growth via devaluation is import compression. Import

growth in China collapsed from a 26.4 percent annualized growth 1990-1993 to

only an 8.4 % growth rate during 1993-1997. (Table 5). In contrast, almost all

countries show an acceleration in import growth during these two periods, with

the ASEAN-4 increasing from 12.3 to 14.8 percent and the ASEAN-7 showing an

increase from 11.1 to 12 percent.

h. Political Economy of Trade Surpluses

Since the 1985 Plaza agreement, US policy-makers have been concerned with

the large trade surpluses that mercantilist Japan has been able to enjoy. In the

nineties, a new political economy problem emerged - China's trade surpluses

with the US - surpluses which match those of Japan. China's trade surplus with

the world in 1997 (figures are end June and therefore prior to the crisis -Table 6)

was $ 111 billion in contrast to Japan's $ 150 billion. In striking contrast, China's

trade surplus with the US in 1997 was almost equal to the "horrendous" figure for

Japan - $ 45 billion vs. $ 54 billion.

Chinese trade (imports plus exports), at $ 415 billion, was a little more than

half

of Japan's $ 770 billion. In 1990, China's trade surplus was only $ 40 billion

compared to Japan's $ 100 billion. The Asean7 countries, with almost a third

higher volume of trade, registered only a quarter of the surplus ($32 billion)

enjoyed by China.

i. Mercantilism defined

What China followed, via large devaluations was a policy of systematic

undervaluation of the currency. Given that huge trade surpluses were present

to devaluation, this suggests that a mercantilist trade policy was being

followed. Webster's dictionary defines mercantilism as follows:

"an economic system developing during the decay of feudalism to unify and

increase the power and especially the monetary wealth of a nation by strict

governmental regulation of the entire national economy usually through policies

designed to secure an accumulation of bullion, a favorable balance of trade, the

development of agriculture and manufactures, and the establishment of foreign

trading monopolies".

14

As shown in Table 6, a key feature of mercantilism, accumulation of trade

surpluses, did seem to occur in China. Only China's trade surplus shows a

quantum jump - with respect to the all important market (industrialized countries)

China's trade surplus almost doubles from an

average

level of "only" $ 35 billion

during 1990-93 to an average of $ 66 billion during 1993-1997. No movement of

the surplus is observed for Japan, and the trade surpluses become

deficits

for

the Asean7 (decline is from $ 8 billion, 1990-93 to minus $14 billion, 1993-1997).

j. Mercantilism Index says YES

Table 6 also reports on a mercantilism index for the various regions. This index

attempts to capture "excess exports" and is defined as the ratio of such excess

(X-M) to export levels. Both China and Japan appear as the major mercantilists,

and since 1996, China appears as the most mercantilist in the world, even more

than recession battered Japan. (In a recession economy, or during periods of

stabilization, this index overstates mercantilism). The figures for Japan today

vastly overstate mercantilism because the depression there vastly understates

imports, a problem not present in booming China. The Asean7 countries, at least

during the nineties, do not reveal any mercantilist tendencies.

k. Why Can't All Countries be Mercantilist ?

In a democratic set-up, there will be demands for a revaluation of the currency,

an outlet not available in Communist regimes like China. Workers, and

consumers, lose out with an undervalued currency with the gainer being the

mercantilist state. However, the post-War experience of Japan has shown that a

democratic polity is only a necessary and not sufficient condition for providing a

"checks and balances" to mercantilism. Nor does the international financial

system help. Various mechanisms to identify and punish dumping are in place.

Unfortunately, the structure does not allow vigilance over under-valuation while

over-valuation gets corrected automatically - large current account deficits need

to be financed and lenders are unwilling to lend. Trade surpluses, however, are

self-correcting only if the domestic political system allows representation, or if

IMF plays its appointed role.

3. ALTERNATIVE EXPLANATIONS OF THE CAUSES

Some of the more prominent explanations for the generation of the crisis are

explored below.

a. Did Japan Devaluation Cause the Crisis ?

IMF(1997) contends that the yen devaluation of nearly 40 percent between mid-

June 1995 and end-June 1997 may have been responsible for the financial crisis.

Apparently, the view is that the yen devaluation mattered, but not China's

devaluation - an inconsistency also endorsed by the

Economist

(1998).

15

Japanese exports, and trade surpluses peaked in 1995 and in 1997 were barely

above 1995 levels, even though the yen had devalued. It is interesting to note

that the IMF mentions the yen devaluation as a contributory cause with no

evidence from exports data, and does not acknowledge the possibility of Chinese

devaluation with significant data about Chinese exports and trade surpluses.

Table 7 contains data on the Japanese economy in the nineties. The yen-

devaluation of 1995 is an excellent example of something that superficially

makes sense, but on closer examination fails to fulfill expectations. Several

pieces of evidence are noteworthy. First, the yen devaluation failed to help

Japan's exports - they

peaked

in 1995 and were 5 percent

lower

in 1997. Nor

were Japanese imports severely curtailed - a necessary condition for the Asean

countries to be "hurt". Instead, Japan's imports

increased

from a $ 300 billion

level in 1995 to $ 307 billion in 1997. This occurred at a time when the Japanese

economy was fast approaching a recession. Both China and Asean7 maintained

their market share in Japan from 1995 to 1997. Note however the large increase

in China's share of Japan imports, 1990 to 1997. The share more than

doubles

from 4.4 percent to 9.3 percent; in contrast, the Asean7 economies barely

maintain their share - 22.1 percent vs. 25 percent. Thus, there is little support for

the IMF (and others) hypothesis that the yen devaluation was a contributory

cause to Crisis '97.

b. Did Capital Account Liberalization cause the problem ?

Before evaluating the possibly harmful effects of capital account liberalization it is

important that a definition of capital account convertibility (KAC) be adopted. In

Bhalla(1997f) it is argued that a necessary and sufficient condition for KAC is a

floating exchange rate regime, as well as currency board regimes as in Argentina

and Hong Kong. If this definition is adopted, then it follows that the managed

exchange rate regimes of East Asia were economies

without

KAC; hence, the

presence of KAC cannot be a cause of the crisis. The reason this obvious point is

being made is because there is a popular perception (and a correct one) that

large short-term dollar borrowings were part of the East Asian problem. As

argued by Bhalla (1997b, 1998) ,

lack

of KAC ( a managed exchange rate)

provided no-brainer profits to traders and international bankers which was why

short-term lending to East Asian economies were so high.

Over the last few years, the IMF has published several articles on the benefits of

KAC. (See Mathieson-Suarez-Rojas and Quirk-Evans). The Reserve Bank of

India's report on KAC (RBI (1997)) also documents research on the positive

effects of capital liberalization. Indeed, the trendy research topic over the last few

years has been that pertaining to financial liberalization, and the accumulated

evidence does suggest that even the incomplete managed exchange rate version

of CAL has considerable benefits for growth.

16

Table 8 reports data on real interest rates and output growth for both developed

and developing countries for the period 1981 to 1996. What does jump out from

this aggregate data is that the developing countries (which witnessed the largest

change in CAL since 1981) increase their growth rate from 3.9 to 4.7 percent;

and the volatility (risk) of both short-term and long-term rates has come down

with increased CAL.

Another presumed benefit of CAL is increased capital flows and a

lack

of a

relationship between savings and investment. In two important articles, Feldstein-

Hororika (1980) and Feldstein-Bacchetta (1991) document that the relationship

between saving and investment rates is suggestive of an

absence

of capital

market integration. The Feldstein argument is that one measure of capital

integration across economies is the amount of correlation between domestic

savings and domestic investment. If correlation is large, then the capital account

is relatively closed. If the correlation is small, then the capital account is relatively

open. After controlling for co-integration (see Bhalla(1997f) for details), it is

observed that the Feldstein conclusion of high correlation is rejected. Indeed, the

hypothesis that the correlation became zero in the nineties cannot be rejected.

This means that capital account liberalization allows capital to seek the highest

return - something that is consistent with higher, not lower, growth.

c. Is Capital Account Liberalization not good for LDCs ?

The above data show that CAL has considerable benefits for resource allocation,

and therefore, by implication, in lowering the cost of capital. Further, the

operation of capital markets means a lowering of risk.

Among the more intriguing ? explanations for the East Asian crisis is one offered

by Stiglitz (1998). He makes two points about CAL and its effects. First, that CAL

increases the overall level of risk in an economy. "I think the statement that

capital account liberalization increases risk is uncontroversial" (p. 17). Second,

that CAL does not lead to higher growth.

"A very large literature has documented the positive consequences of trade

liberalization, including faster growth, higher wages in exporting jobs, and lower

prices for consumers. We do not have anything resembling this body of research

establishing the positive effects of capital account liberalization. One of the few

recent studies, a paper by Dani Rodrik (forthcoming) showed that there is no

statistically significant relationship between growth or investment and capital

account liberalization. I do not think that this one study is definitive. What it does

show, however, is that the positive benefits of capital account liberalization do not

jump out from the data" (p. 17).

The econometric evidence cited by Stiglitz is questionable. The Dani Rodrik

cross-country regressions contain regional dummies for East Asia, Latin

America and Sub-Saharan Africa in addition to a variable which captures capital

17

account liberalization. Assume for a moment that East Asian economies had

higher growth and more CAL (something several studies, including the miracle

study (World Bank (1993) have extensively documented). The dummy regional

variable is liable to capture a lot of the effects of CAL rendering it insignificant i.e.

the effects of CAL are captured almost entirely by the hugely significant, and

positive, East Asian dummy.

Besides a problematic dummy, other variables can be used to proxy for CAL.

The World Bank's World Development Report of 1991 reported cross-country

regressions with the black market premium (BMP) on a country's currency as an

independent variable. This study, along with Scully-Slottje, was one of the first to

use this variable in the context of the new growth theory regressions. In

Bhalla(1992) it was argued that BMP captured economic freedom or the

presence/absence of foreign exchange controls. In other words, BMP is almost a

perfect variable to capture capital account liberalization.

What is the empirical evidence relating capital account liberalization (black

market premium) to economic growth? Bhalla (1992, 1997e) reports several

reduced form cross-country regressions relating per capita income growth to

determinants of growth In addition to BMP, other important presumed

determinants of economic growth are also included e.g. economic freedom, fiscal

deficits, etc. The results are robust: one of the consistently significant variables is

the black market premium, as well as economic freedom (a variable which

contains large elements of capital account liberalization). Higher the black market

premium, less the amount of capital account liberalization, and less growth. That

these variables are significant, in the presence of an East Asian dummy variable,

suggests that they are also "robust". The magnitude is not trivial either -

improvements in capital account liberalization can increase the per capita growth

rate (proxy for productivity growth) by 1 to 3 percent per annum.

d. Crony Capitalism and Non-Performing Assets of Banks

Analysts have identified causes of the crisis which are really

subsets

of a

managed exchange rate regime. The example of "crony capitalism" is one such

"derived" primary cause. The access to rents i.e. cheaper foreign credit, is

rationed by the government to preferred customers (cronies). Hence, cronyism

helps obtain rents.

Now consider the example of non-performing assets, or banking sector

problems. Suddenly, in late 1997, it became fashionable to contend that non-

performing assets in East Asia were large and were

the

cause of the crisis. This

was a surprise, since the

earlier

conventional wisdom was that the much more

developed financial sector, and realistic interest rates, were the cause of the East

Asian

miracle

.

18

How do non-performing assets occur ? When bad investments occur. How do

bad investments occur ? When the returns to investments are not high. What

happens if foreign borrowing rates are almost 3 to 5 percent less than risk-free

domestic deposits ? Excess borrowing occurs which results in excess

investments which results in an excess of non-performing assets. In other words,

the banking sector problems in East Asia were an outcome of the managed

exchange rate regime, and therefore should not be construed as a cause of the

crisis.

e. Equity and Property Markets

The leading indicator of the economy in both developed and developing markets

is the stock market. Especially in developing countries where the policy makers

"control" the workings of other financial markets - interest rates and exchange

rates. This makes the stock market the

residual

shock absorber. Perhaps

because of this acknowledged role of the stock market, the first conventional

wisdom culprit cause of the crisis was an "asset bubble". (See Sachs(1998),

Krugman(1998) among various others).

The evidence does not support this conclusion. In end 1996 and/or June 1997,

the dollar based indices with

1990 equal to a 100

were as follows: Indonesia at

135, Korea at 79, Malaysia at 236, Philippines at 397, Singapore at 210, Taiwan

at 195 and Thailand at 111. Excepting the Philippines, the "best" bubble was

Malaysia with stock market prices twice

those six and a half years earlier

. The

Malaysian economy, like the rest of East Asia, was growing at an average of 7+

GDP growth rate during this period. According to "fair" value index reported in

Developing Trends

(1998), the Malaysian stock market was trading at a 17

percent

discount

in June 1997, the Philippines at a premium of 60 percent and

Thailand and Korea both at discounts exceeding 60 percent! Little, rather no

evidence, of a stock market bubble. Indeed, the stock market was giving more

than adequate notice that something was wrong with the investments that were

being undertaken in these economies.

In contrast, however, the

property

market in all the East Asian economies was in

the midst of a property asset bubble. According to So-Kanatunga(1998), in both

Hong Kong and Singapore, property lending (as a percent of total loans) had

zoomed to 35 percent; the "capital value index" of real estate in major cities was

at its peak in all the East Asian economies in June 1997. However, while this

bubble was present, it was so in only the capital cities of these economies, and

could not possibly have absorbed the billions of dollars of excess borrowing.

f. The perverse role of fiscal surpluses

Instead of fiscal deficits, the East Asian economies were running

surpluses

for

several years prior to the crisis in 1997. Bhalla(1997b) makes the point that

possibly the

worst

policy for a developing country is good fiscal policy and

19

managed exchange rates. This occurs because of the signaling effect. Foreign

investors, and yuppie traders, need to make quick, and hopefully not very taxing,

decisions on where to invest. The menu is the world, and the senior management

will not approve of investments in "irresponsible" economies.

The best indicator of an economy's health is the fiscal deficit. How can it be

wrong to invest in a country which has 8 percent growth and fiscal surpluses ?

Nobody has ever lost a job on a lemming investment. Hence, the flood of money

into East Asia, aided and abetted by the "fiscal" guarantee that things could not

go wrong. More the fiscal surplus, better the economy, more capital came in,

and the exchange rate became more over-valued. A virtuous cycle became a

vicious cycle. Hence, the over-capacity, the decline in the rate of return to

investment, and the denouement of the crisis. It is a moot question whether

senior managers know more or less than yuppie traders about what the

determinants of growth are in an emerging economy. What is clear is that both

are heavily influenced by the latest fashion (literally) on Wall Street.

4. WHAT DID HAPPEN ?

In Bhalla(1998a) a detailed analysis of "what and why" of Crisis '97 is presented.

In summary form, the explanations seem to be as follows.

a. Capital flows and fixed exchange rates

The nineties were witness to a boom in private capital flows to emerging markets.

From nascent levels (around $ 25- $ 50 billion) in the early years, such flows

accelerated to around $ 300 billion at the time of the crisis in mid-1997. None of

the East Asian economies had a floating or market determined exchange rate.

Central Banks intervened, and intervened often, to restrict capital movements.

Most, if not all, the Central banks had either an implicit or explicit FX band - lines

in the sand which were not allowed to be crossed. (As events of 1997 showed,

lines in the sand only serve to ensure that the ensuing dust storm can be a

blinding one). All participants - domestic central bankers, international central

bankers, and private bankers - knew about the bands, and their "sanctity".

b. Zero hedging costs

In a managed fixed" exchange rate regime, there is considerable incentive to

indulge in hedging. The currency might appreciate, in nominal terms, as indeed

it did in many developing countries during 1991 to 1996. (Table 2). The exchange

rate might depreciate

less

than interest rate differentials. And the "smart money"

would exit early i.e. most investment bankers felt that they would be able to exit

before any large discrete devaluation, the experience of Mexico 1994

notwithstanding.

20

c. Floating exchange rates would have avoided the crisis

If exchange rates had been floating (as they now are), exchange rates would

have quickly appreciated (or depreciated) in response to profitability perceptions.

For example, as more capital flows in, the more the exchange rate appreciates,

and the less excess returns the last entrant obtains i.e. a self-regulating system

that does not need bureaucratic or central bank control. In contrast, with a

managed exchange rate, the inward capital flows can be limitless.

d. Efficient Excess Capacity Creation

These unhindered capital flows helped generate the creation of a large amount

of capacity in emerging, especially Asian economies. The popularity of economic

reforms everywhere (Argentina, Brazil, China, India, Eastern Europe) meant not

only capacity, but relatively

efficient

capacity was being generated. And the

capacity was similar, if not identical. It was created by similarly educated

domestic manpower in collaboration with world capital, world technology and

world management. This excess efficient capacity and production has likely been

the

reason why the death of inflation occurred - and not because of "tight" and/or

"appropriate" monetary policies in countries as diverse as the US, Germany,

China, or India.

e. How to Compete?

The brave new world required lean and mean competitive machines. Profit

margins were significantly reduced, as the new virtuous cycle was in full

operation. Given this competitive environment, where was the "edge" ? Most

emerging markets, and particularly those in East Asia, could not follow the old

mercantilist model of an under-valued currency. Most of these countries were

relatively open to foreign capital so devaluation could no longer be achieved by

fiat. Further, any such devaluation would have been met by an extremely hostile

response from foreign investors and international banks.

f. Response of East Asia

What are policy makers (especially of export-oriented economies) to do when

they are competed out of markets by their big neighbor ? They can complain to

the international authorities about a genuine non level-playing field, but this for

political reasons (US-China bond) was not possible. The other alternative was to

devalue. But this would have met with wrath from the foreign investors, or from

other neighbors, about not playing by the rules.

g. Plaza is the parallel

While most analyses of the crisis have centered on parallels with the Mexican

devaluation of 1994, it is likely that the closest parallel was the Plaza agreement,

21

an agreement undertaken to stop the undervaluation of the Japanese yen. This

"deal" was hammered out under the leadership of the US government in Sept.

1985; its purpose was to devalue the dollar in general, and revalue the yen, in

particular. The Bretton Woods fixed exchange rate system had been dismantled

more than a decade earlier. Yet, the yen remained strangely fixed, (the yen/$

exchange rate was 260 yen just before Plaza in 1985 - it was the same five years

earlier) and under-valued, in a floating rate world. Japan also continued to run

up huge trade surpluses - a factor which had not gone unnoticed in the American

corporate, and political, circles.

Replace Japan with China in the above paragraph and the parallels become

striking. China was also running huge trade surpluses; also rapidly growing; also

rapidly approaching East Asian productivity levels; and also continuously

operating an under-valued currency. The competitor(s) hurt in this instance by a

mercantilist policy were the East Asian neighbors, the very same set of countries

that took part in the Asian crisis.

5. CONCLUSIONS

This paper has attempted to explain the causes of the East Asian financial crisis

of 1997. What is "new" about this paper is in its attempt to examine the various

hypotheses that have been offered and to provide a consistent explanation to the

various facts. The crisis occurred because of over-investment and over-

production; such over production was caused by planning for a future which had

not correctly anticipated the important role that Chinese production, and low

Chinese costs, would play; comparative costs became important because of the

50 percent Chinese devaluation (in the guise of exchange rate reform) that was

allowed to occur between 1990 and 1993; capital continued to flow to East Asia

because of the promise of high returns (bad anticipation of China's role) and

because of the promise of stable returns (quasi-fixed exchange rates). Once the

trade shares of the East Asian economies were affected, investments became

relatively unprofitable; and once Thailand showed the way, the other East Asian

competitors of China followed.

The role of the Chinese economy in helping make the crisis inevitable is crucial

for this paper. Consequently, detailed data on trade of China, and East Asia, with

the industrialized countries are presented. These data also offer an alternative

interpretation to that presented by Fernald-Edison-Loungani who argue the

opposite case i.e. that the Chinese trade policy (devaluation) was irrelevant.

Differences between the two studies arise primarily because of three factors.

First, FEL look at only the 1993-1997 data for exports despite arguing that

China's devaluation of Jan. 1994 was only a unification of the exchange rates -

hence, it follows that the data for 1990 to 1997 should be used (as argued in this

paper). Second, FEL ignore the role of trade surpluses and imports of China

which were affected by the devaluation. Third, FEL concentrate only on data for

Greater China (China and Hong Kong) rather than the two separately as done in

22

this paper. It seems only logical that if the effects of devaluation are being

studied, then one cannot combine the data of a country with a large devaluation

(China) with a country with zero devaluation (Hong Kong).

If trade shares etc are used then the conclusion is inescapable that China's

devaluation and trade policy, along with managed exchange rates, caused the

East Asian crisis of 1997.

23

Table 1: Chinese Economy at a Glance

Average

1985-89 1990 1991 1992 1993 1994 1995 1996 1997

GDP Growth (%)

9.5 3.7 9.1 13.6 13.0 12.2 10.2 9.7 8.1

Inflation(%)

14.1 2.1 4.0 7.0 29.5 25.5 17.1 8.3 8.3

Exchange Rates(yuan/$)

Official 3.53 5.22 5.43 5.75 5.80 8.45 8.32 8.30 8.29

Parallel 4.53 5.88 6.25 7.69 9.09 8.45 8.32 8.30 8.29

Weighted Parallel 4.23 5.68 6.01 7.11 8.10 8.45 8.32 8.30 8.29

Correct "Fair" Currency O/V 12.4 -7.2 -18.3 -41.1 -31.5 -14.5 -1.9 0.1 -4.0

Correct "Fair" Exchange Rate 4.8 5.3 5.1 5.04 6.2 7.4 8.2 8.3 7.9

Incorrect "Fair" Currency O/V 12.4 -6.2 -11.2 -26.6 -14.5 2.4 15.8 19.9 17.7

Incorrect "Fair" Exchange Rate 4.8 5.3 5.4 5.6 7.1 8.7 9.9 10.4 10.1

Trade (Recipient Country

Data)

Exports 88.7 112.9 137.4 157.7 192.7 234.0 254.5 262.8

Imports 49.1 61.8 82.1 108.3 120.6 146.1 157.6 151.6

Trade Balance 39.7 51.1 55.3 49.4 72.1 87.9 96.9 111.2

Trade (Chinese Data)

Exports 39.6 62.9 71.9 85.5 91.6 120.8 148.9 151.1 162.0

Imports 48.6 53.9 63.9 81.8 103.6 115.6 132.1 138.8 125.6

Trade Balance -9.0 9.0 8.1 3.6 -11.9 5.2 16.8 12.3 36.4

Reserves 35.5 21.7 19.4 21 52 74 105 140

Trade with Industrialised

Countries

Exports 44.7 56.9 70.7 81.8 104.2 125.7 139.2 144.4

Imports 21.1 26.0 23.0 44.3 49.0 58.8 58.6 52.7

Trade Balance 23.6 31.0 47.7 37.6 55.2 66.9 80.6 91.7

Trade with US

Exports 16.3 20.3 27.4 31.2 41.4 48.5 54.4 56.9

Imports 4.8 6.3 7.5 8.8 9.3 11.7 12.0 11.6

Trade Balance 11.5 14.0 19.9 22.4 32.1 36.8 42.4 45.2

Source: 1.) Direction of Trade Statistics (DOTS), IMF, 1997 yearbook; June 1998 quarterly

2.) O[x]us Research & Investments Database

Notes:

Values for 1997 are as of end June,1997. All other figures are end-year figures.

All trade figures are based on recipient country data unless otherwise stated and are in US $ Bn.

Incorrect "Fair" Exchange Rate adjusts for inflation differences while Correct "Fair" Exchange

Rate corrects for both inflation and productivity differences.

24

Table 2: Exchange Rates (vs. US$), 1990-1998

1990 1991 1992 1993 1994 1995 1996 June,

1997 June,

1997

1998

India 18.1 25.8 26.2 31.4 31.4 35.2 35.9 35.8 39.2 42.4

China Off. 5.2 5.4 5.8 5.8 8.5 8.3 8.3 8.3 8.3 8.3

China Parallel 5.9 6.3 7.7 9.1 8.5 8.3 8.3 8.3 8.3 8.3

ChinaWt.Para

5.7 6.0 7.1 8.1 8.5 8.3 8.3 8.3 8.3 8.3

llel

Hong Kong 7.8 7.8 7.7 7.7 7.7 7.7 7.7 7.7 7.8 7.7

Indonesia 1901 1992 2062 2110 2197 2285 2361 2431 5350 14500

Korea 716 761 788 808 788 776 845 886 1430 1373

Malaysia 2.7 2.7 2.6 2.7 2.6 2.5 2.5 2.5 3.9 4.1

Pakistan 21.9 24.7 25.7 30.1 30.8 34.2 40.1 40.4 44.0

Philippines 28.0 26.7 25.1 27.7 24.2 26.2 26.3 26.4 40.2 41.8

Singapore 1.7 1.6 1.6 1.6 1.5 1.4 1.4 1.4 1.7 1.7

Taiwan 27.2 25.8 25.5 26.8 26.3 27.3 27.5 27.8 32.7 34.4

Thailand 25.3 25.3 25.5 25.5 25.1 25.2 25.7 24.9 46.2 42.2

Argentina 0.56 1.00 0.99 1.00 1.00 1.00 1.00 1.00 1.00 1.00

Brazil 0.00 0.00 0.00 0.12 0.85 0.97 1.04 1.08 1.11 1.16

Chile 337 375 382 431 403 406 424 416 439 466

Mexico 2.9 3.1 3.1 3.1 4.7 7.7 7.8 7.9 8.1 9.0

Czech R. . . . 30.0 27.9 26.7 27.3 32.4 34.3 33.4

Hungary 61 76 84 101 113 136 162 187 204 220

Poland 1.0 1.1 1.6 2.1 2.4 2.5 2.9 3.3 3.5 3.9

Australia 1.3 1.3 1.5 1.5 1.3 1.3 1.3 1.3 1.5 1.6

Germany 1.5 1.5 1.6 1.7 1.6 1.4 1.5 1.7 1.8 1.8

Japan 134 125 125 112 100 104 116 114 130 139

New Zealand 1.7 1.8 1.9 1.8 1.6 1.5 1.4 1.5 1.7 1.9

Switzerland 1.3 1.4 1.5 1.5 1.3 1.1 1.3 1.5 1.4 1.5

UK 0.52 0.53 0.66 0.68 0.64 0.65 0.59 0.60 0.60 0.60

Source: O[x]us Research & Investments Database.

Notes:

1)The values for 1998 are for June or the latest available.

2)The exchange rates are end-period values, except where noted.

25

Table 3: Was China the Favored Exporter?

Exports Exports Annualized Growth

Rates(%)

Country In 1990($

in 1997($

1990-

1993-

1990-

Bn)

Bn)

1993

1997

1997

China World 88.7 262.8 19.2 12.8 15.5

Industrialised

44.7 144.4 20.2 14.2 16.8

Countries

USA 16.3 56.9 21.6 15.0 17.9

G.C. World 138.4 321.3 13.6 10.9 12.0

Industrialised

70.0 171.7 14.2 11.8 12.8

Countries

USA 26.2 65.9 15.0 11.8 13.2

ASEAN-

World 94.5 243.3 13.7 13.4 13.5

4

Industrialised

62.3 137.6 11.9 10.9 11.3

Countries

USA 18.4 47.7 17.4 10.8 13.6

ASEAN-

World 270.1 598.0 10.9 11.7 11.4

7

Industrialised

179.0 310.0 5.7 9.4 7.8

Countries

USA 71.7 120.8 5.8 8.7 7.5

Japan World 309.5 459.2 7.5 4.2 5.6

Industrialised

183.4 220.5 2.9 2.4 2.6

Countries

USA 93.1 121.3 5.7 2.4 3.8

IC's World 2577.7 3626.2 -0.6 9.0 4.9

Sourc

:

Direction of Trade Statistics (DOTS),

IMF, 1997

yearbook; June 1998

quarterly.

Notes: 1.) The annualized growth rates are computed as first differences in logs.

2.) ASEAN-4 comprises of Indonesia; Malaysia; Philippines and Thailand.

ASEAN-7 comprises of

the ASEAN-4 countries plus Korea; Taiwan and Singapore.

3) The 1997 figures are approximated from the first two quarters of 1997.

26

Table 4(a): Exports of Asia to Industrialized Countries, 1990-97

1990

1991

1992

1993

1994

1995

1996

1997

Exports to IC's ($

Bn)

China 44.7 56.9 70.7 81.8 104.2 125.7 139.2 144.4

Greater China 70.0 82.6 96.6 107.1 130.2 155.4 169.6 171.7

Asean 4 62.3 70.3 79.8 89.0 103.0 123.0 134.2 137.6

Asean 7 179.0 191.7 203.8 212.5 244.9 294.3 308.6 310.0

Japan 183.4 189.8 198.3 200.2 216.1 229.3 212.8 220.5

USA 267.6 275.1 278.4 280.1 316.7 361.8 384.4 420.5

World 2577.7 2602.

2716.

2528.6 2881.

3386.

3503.9 3626.2

3

0

8

8

Export Shares (%)

China 1.7 2.2 2.6 3.2 3.6 3.7 4.0 3.7

Greater China 2.7 3.2 3.6 4.2 4.5 4.6 4.8 4.4

Asean 4 2.4 2.7 2.9 3.5 3.6 3.6 3.8 3.5

Asean 7 6.9 7.4 7.5 8.4 8.5 8.7 8.8 7.9

Japan 7.1 7.3 7.3 7.9 7.5 6.8 6.1 5.6

USA 10.4 10.6 10.2 11.1 11.0 10.7 11.0 10.7

Sourc

:

Direction of Trade Statistics (DOTS),

IMF, 1997

yearbook; 1997 data are

annualized Jan-June 1997 levels.

27

Table 4 (b): Export Shares Of Asian Countries in the US Market, Selected

Industries, 1994-96.

Industry 95 (Toys and Accessories) Electrical Machinery

($

Share Share ($

Share Shar

Billions)

Billions)

1994 1996 1994 1996 1994 1996 1994 1996

China 5.6 8.0 47 54 6.8 9.2 7 8

Hong Kong 0.2 0.2 2 2 1.5 2.1 2 2

Greater

5.8 8.2 49 56 8.3 11.3 9 10

China

Indonesia 0.1 0.1 1 1 0.8 1.3 1 1

Malaysia 0.3 0.3 2 2 8.2 9.9 9 9

Phillipines 0.1 0.1 1 1 2.4 3.7 2 3

Thailand 0.4 0.3 3 2 2.2 2.6 2 2

ASEAN-4 0.9 0.9 7 6 13.6 17.6 14 15

Korea 0.2 0.2 2 1 7.3 8.9 8 8

Taiwan 1.3 1.2 11 8 5.5 7.2 6 6

Singapore 0.04 0.02 0 0 3.8 4.2 4 4

ASEAN-7 2.4 2.3 21 16 30.2 37.8 32 33

Japan 1.6 1.6 13 11 26.5 25.7 28 22

India 0.01 0.02 0 0 0.1 0.1 0 0

World 11.8 14.7 100 100 96.2 116.4 100 100

Source: National Trade Data Bank, U.S. Department Of Commerce .

28

Table 4 (c): Export Shares of Asian Economies in US Market: Selected

Industries, 1989-1996.

Industry 213 (Computers,Peripher

Industry 400 (Apparel, Footwear

als

and

and Semiconductors)

Household products)

1989 1993 1996 1989 1993 1996

China

0 3 5 18 41 47

Hong Kong

7 4 3 18 14 13

Greater

7 7 8 36 55 60

China

Indonesia

0 0 1 3 6 8

Malaysia

12 15 15 2 3 4

Phillipines

4 4 6 3 5 5

Thailand

5 6 5 4 5 6

ASEAN-4

21 25 27 12 19 23

Korea

21 16 18 27 13 7

Taiwan

20 23 19 22 11 9

Singapore

31 29 28 3 2 1

ASEAN-7

93 93 92 64 45 40

World*

100 100 100 100 100 100

Source: Fernald, John, Hali Edison and Prakash Loungani,1998. pg.36.

Notes: World* comprises of total of ASEAN 7 and Greater China.

29

Table 5: Exports to China, or Chinese Imports - Devaluation Bites

Imports Imports Annualized Growth

Rates

Country in 1990($

in 1997($

1990-

1993-

1990-

Bn)

Bn)

1993

1997

1997

China World 49.1 151.6 26.4 8.4 16.1

Industrialised

21.1 52.7 24.7 4.3 13.1

Countries

USA 4.8 11.6 20.0 7.1 12.6

G.C. World 130.5 331.1 18.0 9.8 13.3

Industrialised

53.4 123.2 19.4 6.3 12.0

Countries

USA 11.6 26.5 15.7 8.8 11.8

ASEAN-4 World 86.5 226.3 12.3 14.8 13.7

Industrialised

52.0 125.4 12.2 12.9 12.6

Countries

USA 10.8 30.0 13.7 15.2 14.6

ASEAN-7 World 250.9 566.0 11.1 12.0 11.6

Industrialised

162.4 325.8 9.6 10.2 9.9

Countries

USA 44.8 93.0 9.2 11.4 10.4

Japan World 207.6 307.2 1.0 9.1 5.6

Industrialised

102.1 133.9 -1.3 7.8 3.9

Countries

USA 48.6 67.2 -0.4 8.4 4.6

Sourc

:

Direction of Trade Statistics (DOTS),

IMF, 1997

yearbook; June 1998

quarterly.

Notes: 1.) The annualized growth rates are computed as first differences in logs.

2.) ASEAN-4 comprises of Indonesia; Malaysia; Philippines and Thailand.

ASEAN-7 comprises of

the ASEAN-4 countries plus Korea; Taiwan and Singapore.

3) The 1997 figures are approximated from the first two quarters of 1997.

30

Table 6: Booming Chinese Trade Surpluses - U.S. says "No Problem"

Trade

Trade

Average Per Year

Balance

Balance

in 1990 in 1997 1990-

1993-

1990-

Country

1993

1997

1997

China World 39.7 111.2 48.9 83.5 70.4

Industrialised

23.6 91.7 35.0 66.4 54.3

Countries

USA 11.5 45.2 17.0 35.8 28.0

Mercantilist Index

44.7 42.3 40.4 37.7 39.2

G.C. World 7.8 -9.8 -1.0 -15.2 -8.1

Industrialised

16.7 48.6 18.6 30.7 27.0

Countries

USA 14.6 39.4 18.5 32.9 27.0

Mercantilist Index

5.7 -3.1 0.2 -6.1 -2.5

ASEAN-

World 8.0 17.1 13.8 13.4 13.1

4

Industrialised

10.3 12.2 13.0 12.7 12.7

Countries

USA 7.6 17.7 10.6 19.0 15.3

Mercantilist Index

-1.1 -1.8 2.1 -1.1 0.7

ASEAN-

World 19.3 32.0 22.6 20.7 21.1

7

Industrialised

16.6 -15.8 7.7 -13.8 -4.2

Countries

USA 26.9 27.8 25.8 31.9 29.6

Mercantilist Index

-0.03 -0.06 1.1 -1.4 0.05

Japan World 101.9 151.9 139.7 166.0 151.8

Industrialised

81.3 86.7 93.4 92.4 91.7

Countries

USA 44.5 54.2 51.4 59.8 55.3

Mercantilist Index

32.9 33.1 39.6 37.0 38.5

Sourc

:

Direction of Trade Statistics (DOTS),

IMF, 1997

yearbook; June 1998

quarterly.

Notes: 1.) Figures represent individual country trade surpluses vs. the

corresponding entity; World represents total exports. In all instances

home country data are not used.

2.) ASEAN-4 comprises of Indonesia; Malaysia; Philippines and

Thailand. ASEAN-7 comprises of the ASEAN-4 countries plus

Korea; Taiwan and Singapore.

3) The 1997 figures are approximated from the first two quarters of

1997

31

Table 7: Japanese Devaluation & the East Asian Crisis

1990

1991

1992

1993

1994

1995

1996

1997

GDP Growth (%) 5.0 3.9 1.0 0.1 0.5 0.9 3.6 -0.2

CPI Inflation (%) 3.8 2.7 1.2 1.0 0.7 -0.1 0.1 0.1

Exchange Rates (vs.$) 134 125 125 112 100 104 116 114

Exports ($ Bn) 309.5 335.8 363.7 388.2 426.7 480.1 457.2 459.2

Imports ($ Bn) 207.6 210.3 207.0 213.7 244.6 299.4 316.6 307.2

Japan Exports ($ Bn)

China 7.7 10.0 13.7 23.3 26.3 29.0 29.2 25.4

Greater China 20.9 26.4 35.2 46.3 51.6 57.6 56.1 52.5

Asean 4 25.1 29.5 31.4 36.8 46.0 59.0 56.6 56.6

Asean 7 70.3 81.9 85.5 96.8 116.7 145.6 135.8 132.2

USA 93.1 95.0 99.5 110.4 122.5 127.2 118.0 121.3

Share of Japan Exports

(%)

China 2.5 3.0 3.8 6.0 6.2 6.0 6.4 5.5

Greater China 6.8 7.9 9.7 11.9 12.1 12.0 12.3 11.4

Asean 4 8.1 8.8 8.6 9.5 10.8 12.3 12.4 12.3

Asean 7 22.7 24.4 23.5 24.9 27.4 30.3 29.7 28.8

USA 30.1 28.3 27.4 28.4 28.7 26.5 25.8 26.4

Japan Imports ($ Bn)

China 9.2 10.3 11.7 15.8 21.5 28.5 30.9 28.6

Greater China 13.9 15.6 18.0 22.7 29.9 39.1 42.7 39.6

Asean 4 21.0 23.1 23.6 25.4 28.2 33.8 37.4 38.1

Asean 7 45.9 50.1 49.5 52.4 59.2 74.6 78.6 76.7

USA 48.6 48.1 47.8 48.0 53.5 64.3 67.5 67.2

Share of Japan Imports

(%)

China 4.4 4.9 5.7 7.4 8.8 9.5 9.8 9.3

Greater China 6.7 7.4 8.7 10.6 12.2 13.0 13.5 12.9

Asean 4 10.1 11.0 11.4 11.9 11.5 11.3 11.8 12.4

Asean 7 22.1 23.8 23.9 24.5 24.2 24.9 24.8 25.0

USA 23.4 22.9 23.1 22.4 21.9 21.5 21.3 21.9

Sourc

:

Direction of Trade Statistics (DOTS),

IMF, 1997

yearbook.

Notes

:

1. All export and import figures are based on recipient country data. In the case of Korea

and Taiwan, data represents host country (Japan) figures. This is reflected in figures for

Asean 7.

2. Data for 1997 reflect figures as of June, 1997, or figures imputed for 1997 based on data

till June 1997.

32

Table 8: Real Interest Rates and Output Growth - 1981-1996

1981-90 1991-95 1996

World Trade Growth

4.1 6.3 5.4

World Output Growth

2.9 2.0 2.9

Output Growth for DCs

2.5 1.4 2.3

Output Growth for LDCs

3.9 4.7 4.9

Avg. Short-Term Real Rates for DCs

3.9 4.8 3.3

Avg. Short-Term Real Rates for LDCs

1.6 1.8 3.8

Avg. Long-Term Real Rates for DCs

5.9 7.5 6.2

Avg. Long-Term Real Rates for LDCs

4.7 5.3 6.9

Volatility of S-T Real Rates for DCs

3.2 2.4 2.2

Volatility of S-T Real Rates for LDCs

9.9 8.8 7.0

Std. Deviation of L-T Real Rates for DCs

2.9 2.9 2.6

Std. Deviation of L-T Real Rates for LDCs

10.9+ 9.0 9.3

Source:

The table is extracted from Bhalla, Surjit S. 1997. "

Eureka : KAC and the Laws of

Flotation

", Draft for

World Bank Conference on "India: A financial Sector for the 21

Century", Goa, India.

December,

1997.

Notes:

Short-term rate is either the rate of overnight money or 3-month T-Bill rate, depending on the

availability of data. Long-term rate is either the prime lending rate or the 10-year bond rate,

depending on the availability of data. Source: IMF, International Financial Statistics

Volatility is measured as the standard deviation of monthly data.

33

Chart 1a: Chinese Trade Surpluses, 1990-1997

140

120

100

China

80

60

40

20

China (Own)

0

-20

Chart 1b: Industrialized Countries' (IC) Imports

from China, 1990-1997

6

Greater China

5

Greater China (Own)

4

China

3

2

China (Own)

1

0

Notes :

1. Greater China is defined as China and Hong Kong.

2. "Own" refers to home country data, i.e., from the country's page in DOTS.

3.

Asean-4 comprises Indonesia, Malaysia, the Philippines, and Thailand

Asean-7 comprises the Asean-4 countries, plus Korea, Singapore, and Taiwan.

Source : O[x]us Research & Investments Database; Direction of Trade Statistics (DOTS).

34

Chart 2a: IC Import Shares, 1990-1997 (1990=100)

250

225

China

200

Greater China

175

Asean 4

150

Asean 7

125

100

Japan

75

50

Chart 2b: US Import Shares, 1990-1997 (1990=100)

250

225

China

200

175

Asean 4

150

Greater China

125

Asean 7

100

Japan

75

50

35

Chart 3a: Trade Surplus with

Industrialized Countries (ICs), 1990-1997

120

100

Japan

80

60

China

40

20

Asean 4

0

Asean 7

-20

-40

Chart 3b: Trade Surplus with the US, 1990-1997

80

70

Japan

60

50

China

40

30

Asean 7 Asean 4

20

10

0

Source: O[x]us Research & Investments Database; Direction of Trade Statistics

(DOTS).

36

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