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.