How will Asia’s financial crisis affect the world economy? The conventional wisdom is that nations outside Asia will see their gross domestic products shrink as exports to hobbled Asian markets decline. Some project that the U.S. gross domestic product could be as much as 1% below what it would have been otherwise. But conventional wisdom only captures part of the story.
A new type of global economic modeling developed at the Brookings Institution by myself and Peter Wilcoxen suggests that U.S. GDP may actually rise slightly because of the Asian turmoil. What distinguishes these new economic models is their explicit use of international capital flows.
While unexpected growth of U.S. GDP sounds like good news at first glance, it has some alarming ramifications for the International Monetary Fund’s policies toward Asia—and for the political stability of that region’s troubled nations.
Asia’s real economic crisis is a disastrous financial and economic contraction. We project a significant collapse in private consumption and investment in several of these economies because, for several reasons, foreign capital has been pulled out of the region, starting in Thailand and accelerating regionally through 1997.
This financial capital did not evaporate but has relocated to the industrialized economies, particularly the United States. Our research suggests that this U.S. capital inflows have pushed down long-term real interest rates and stimulated private investment—while increasing demand for non-traded goods and services like real estate, construction and financial services.
That’s not to say U.S. exports won’t suffer a direct hit in terms of demand. They will. They’ll also become less competitive in other markets against relatively cheap exports coming from troubled Asian economies. To that extent, the traditional models tell part of the story.
But the stimulus to the non-traded part of the economy that comes from stronger investment and more consumption spending should outweigh this negative impact. Our research, soon to be published by Brookings, suggests that U.S. GDP in 1998 could be 0.1% higher than it would have been without the crisis. Our models indicate that U.S. consumption and investment is far more important for U.S. economic growth than net exports.
The flow of capital out of Asia into the United States and the resulting drop in interest rates are more important for the U.S. economy than the loss of competitiveness.
Even in a country like Australia that is more highly integrated with Asia than the United States, the overall losses are far less than most pessimists believe, and for the same reasons. Looking at the Asia crisis in this way, we must rethink a number of assumptions. First, the capital inflow that is stimulating the U.S. economy through lower real interest rates implies a significant increase in the U.S. current account deficit—by up to $80 billion through 1998, we estimate. With President Clinton and Congress in ecstasy over expected overall budget surpluses, this widening in the deficit over a number of years must be understood as a crucial part of a successful global adjustment.
While this is bad news for export- and import-competing industries, a rising current account deficit keeps U.S. interest rates down and the economy strong.
More important, this rise allows American industry to sustain the current boom with a bolstered supply side. And through strong exports to non-Asian consumers, Asian GDPs are buffered against a collapse in consumption and investment.
An additional safeguard for the Asian economies would be allowing standard fiscal stabilizers. These are automatic changes in fiscal policies that counteract changes in economic activity.
For example, when economic activity slows, a wider fiscal deficit helps maintain demand. The problem for economies such as Thailand, South Korea and Indonesia is that the IMF programs in place in these economies remove this stabilizing factor by contracting fiscal policy even as economic activity declines.
The only safety valve remaining is the strong export surge caused by the exchange rate depreciation.
Without overseas markets, the productive capacity of a number of these economies could collapse, and that would have serious ramifications for U.S. political interests in Asia for years to come.
Warwick J. McKibbin is a Senior Fellow at the Brookings Institution in Washington, D.C., and economics department chairman in the Research School of Pacific and Asian Studies at the Australian National University.