Oh why the Asians can't just be more like "us"?

Martin Wolf (and Nouriel Roubini) chide China and the rest of East and Southeast Asia for not listening to Western economists:

The Asian financial crisis of 10 years ago taught two contrasting lessons: the one the majority of western economists thought the Asians should learn; and the one Asians did learn.

The western economists concluded that emerging economies should adopt flexible exchange rates and modern, well-regulated and competitive financial markets. The Asians decided to choose competitive exchange rates, export-led growth and huge accumulations of foreign currency reserves. The question is whether the Asians need to change their choice. The answer, I believe, is “yes”.

I will leave the obvious irony in complaining about the high-performing Asians not listening to Western economic advice aside (look at the wonderful results such advice has yielded elsewhere!), but are Wolf and Roubini correct in arguing that China and the others should alter their strategies?

I think Wolf's and Roubini's concern for global imbalances are justified: China's current account surpluses have to be matched by equally large deficits elsewhere (and in the U.S. in particular). This not only raises the specter of financial turbulence down the road, it also raises trade frictions.

But these authors overstate the advantages of free floating and underestimate the benefits of undervalued currencies as a "growth strategy." Regarding the former, Asian countries rightly feel that leaving what is one of the most important prices in the country entirely to market sentiment leads to excessive volatility and unpredictability, which in turn depresses investment. Anyone who focuses on the real economy as opposed to the financial one has got to be skeptical about floating for low and middle-income countries.

An even more important consideration is the role that an undervalued currency plays in stimulating tradables output in developing nations. This is good for growth because tradables suffer disproportionately (compared to non-tradables) from the market and institutional failures that stifle growth. In economists' language, an undervalued currency (and a high domestic price for tradables relative to non-tradables) is a second-best mechanism for overcoming developmental bottlenecks. Hence the empirical regularity that real exchange rate undervaluation is strongly associated with economic growth in developing nations.

If forced to choose between a world in which developing countries are growing rapidly but there are global macro imbalances associated with it, and one in which current account imbalances are smaller but there is less growth in poor nations--which one would you pick? I would go for the first.

Of course, the essential point is that we have to get the right mix between these two objectives. Arguably, we have sacrificed macro balances too much in the last few years. But as we go about redressing this, we better not forget the role that the level of the real exchange rate plays in developing nations, and not become too enamored of floating.

Comments

[Justin Rietz]

"Of course, the essential point is that we have to get the right mix between these two objectives"

There's the rub. This policy of balancing requires that some "elite" group (i.e. a cadre of government officials and economists) steps in and moderates the economy. Such a group, no matter how skilled, cannot effectively predict and manage something as dynamic as a national economy that represents the thoughts and actions of millions, if not billions, of people. Unintended consequence abound. Either some segment of the population is unjustly burdened (the rural poor in China) or the market kicks back against imbalances and crisis occurs (Asian currency crisis).

Slow, solid growth will beat engineered booms in the long run every time. The irony is that the "slow" path, by creating a solid economic foundation and building confidence in the inherent strength of an economy, may end up being faster than government-fostered booms.

If being more like "us" means that my children will have larger real incomes, longer life spans, a higher quality of life, and more freedom from government constraints, I would like to be more like us too...

[Butter]

The growth stemming from the undervalued exchange rate is likley because undervalued exchange rates, in a sense, force people to save.

[fadi]

Professor Rodrik,

I do agree with your position.

Just some comment/question:

Why do you say that the global macro imbalance raises the spectrum of financial turbulence? Actually U.S. current account deficit is matched by Asian (mainly China) reserves. These are the potential speculators against the US$, but in the short-medium run it sounds implausible that China speculate against US$ since it would reduce its export competitiveness. I guess investment fund would speculate neither against the dollar nor against economic giants with so many reserves.
I agree about potential trade frictions.

I saw your graphs about China and India, that’s true for other countries! A competitive real exchange rate not only foster growth, but it makes it more sustainable in terms of national macro balance and production structure diversification. This point is terrifically clear by looking at Argentina’s current growth and at that of the ‘90s.

We passed from the ‘90s where hard currency peg was advocated (or imposed) to recent claims for pure floating. Global macro imbalance is a matter of industrialized countries (mainly US).
If sometimes it happens that developing countries are gaining something from globalization is it fair to blame them?

I pick up your first choice too.

Great Blog! I found it out recently. Very good and balanced debates, Thanx!

[Daniel Dreymann]

Justin wrote:

If being more like "us" means that my children will have larger real incomes, longer life spans, a higher quality of life, and more freedom from government constraints, I would like to be more like us too...

OK, but I'm not sure how that's gonna happen if you keep posting stuff during work hours;-)

Daniel (Justin's boss)

PS: just kidding, I like your posts.

[Justin Rietz]

Ahhh, perhaps you failed to notice that dates on the comments are central time, not pacific. So my post was actually at 9:09am while I was driving 70mph on the freeway headed to work ;-)