The Trade Implications of the Asian Financial Crisis
Testimony before the Committee on Finance
United States Senate
The Asian financial crisis will have a series of important implications for trade flows and trade policy, both globally and for the United States. The immediate, medium-term and long-run implications may differ substantially.
Continued Liberalization in the Short Run
It is still too early for the crisis and policy responses to it to have had much impact on trade flows. Korea has already shifted into current account surplus. There are a few early indications of deterioration in our trade balance. But major changes in our position will probably not show up until later this year, so I will deal with them below.
There have been some effects on trade policy, however, and to date they have been largely positive. Despite concerns in some quarters that liberalization of national financial markets was a cause of the crisis itself, the members of the World Trade Organization—including all of the crisis countries in Asia—agreed in early December to further opening of that key sector. The crisis in fact seems to have had a favorable impact. Weaknesses in financial sectors were a central cause of the difficulties in every Asian country. It was universally recognized that further reforms, including opening to foreign institutions, was a necessary component of adjustment programs that would restore confidence in the countries' currencies and economies.
The crisis promoted financial liberalization in two very direct ways. The heightened need for foreign investment, to finance continuing current account deficits in a sustainable manner and to recapitalize weak banking systems, added powerfully to the case for liberalization. And the International Monetary Fund strongly reinforced the WTO agreement, and in a number of instances required reforms, that went well beyond it in its support packages for the troubled countries.
A second positive development was the decision of the 18 APEC countries, at their annual summit in Vancouver in November, to designate 15 major sectors—including automobiles, chemicals, energy goods and services, environmental goods and services, and medical equipment—for early liberalization. They also agreed that detailed plans for eliminating barriers in nine of these sectors, totaling over $1.5 trillion of global trade, should be agreed by the middle of 1998 and implemented in early 1999. Some of the Asian members of APEC are of course the countries hit most directly by the crisis and it is extremely encouraging that they were willing to continue, and even accelerate, their progress toward achieving the agreed APEC goal of "free and open trade and investment in the region" by 2010/2020.
To be sure, there has been some modest increase in trade barriers as well. Most notably, Mercosur increased its common external tariff by 25 percent—from 12 to 15 percent—as part of its effort to avoid greater contagion from Asia. The failure of the United States to pass fast track legislation last year was also a negative development (to which I return later).
On balance, however, the bicycle of trade liberalization has continued to move forward over the past six to eight months despite the Asian crisis. The bottom line is "so far, so good."
A Better Policy Framework in the Long Run
The trade implications for the longer run are also favorable. As the Chairman and I pointed out in our recent op-ed in the Washington Post1, the potential silver lining on the cloud is the considerable further liberalization that countries will have to adopt to restore their economic prospects and thus to overcome the crisis.
It is noteworthy that every problem country in Asia has clearly indicated its intention to move in this direction, whether with the IMF (Indonesia, Korea, Philippines, Thailand) or to avoid it (Malaysia, perhaps China). The reforms will include increased transparency and accountability of financial systems and corporate governance, reduction of impediments to trade and investment, and corresponding domestic measures.
At the end of the day, the trade and investment climate should be considerably stronger throughout Asia as a result of the crisis and policy responses to it. As the Chairman and I concluded in our op-ed, "the crisis will accomplish enormously more for trade expansion than decades of effort by US negotiators."
Trouble in the Medium Term
There may be major problems in the medium run, however, both in the crisis countries themselves and in the rest of the world as a result of impact of the crisis on trade flows. Over the next one to three years, the huge currency depreciations in Asia will sharply improve the competitive position of virtually every country in the region— starting with Japan and Korea. These exchange rate swings, along with their plunging economies, will produce very large changes in national trade balances.
A new study by my Institute colleagues Marcus Noland and Ligang Liu, along with Sherman Robinson and Zhi Wang, uses a computable general equilibrium (CGE) model to assess the prospects for trade even if the Asian currencies rebound to some extent from their present levels. Their results include:
- an increase of almost $100 billion in the United States deficit in real terms;2
- a similar reduction in the surplus of the European Union;
- an increase of about $50 billion in the surplus of Japan; and
- a similar swing of almost $50 billion in the position of Korea, converting it from large deficit to large surplus.
These swings will occur at a time when trade policy is already under substantial pressure in many countries. The US Congress failed to approve new "fast track" negotiating authority for the President in 1997 despite the stellar performance of the American economy, and the prospects for resurrecting the legislation this year are highly uncertain. Europe continues to face very high unemployment and is preoccupied with the creation of the euro and the expansion of its membership. As noted, Brazil and its Mercosur partners raised their common external tariff by a quarter as part of their effort to avoid contagion from Asia.
The largest problem is Japan. As the world's largest surplus and creditor country, it should be reducing its trade surplus sharply rather than increasing it. Instead of proposing new funds that would make $100 billion of capital available for the rest of Asia, it should be importing an additional $100 billion worth of products from the region. China and Taiwan could also afford to run modest deficits, rather than their current sizable surpluses, to help with the regional adjustment processes.
The first trade policy casualty of this process could be the Second Summit of the America, in Chile in April. Negotiations to create a Free Trade Area of the Americas could still be launched but nothing serious will happen until the United States obtains fast track authority and Mercosur decides to extend its liberalization beyond the grouping itself. A second casualty could be the WTO Ministerial Conference in Geneva in May; the fiftieth anniversary celebration of the GATT/WTO could be reduced to nostalgic platitudes rather than commencing serious planning for Sir Leon Brittan's Millennium Round. A third casualty could be the APEC liberalization program cited above because the United States needs new negotiating authority to pursue a number of the sectoral initiatives and the Asians may retreat from the process if the United States is unable to pursue them effectively.
The United States and European Union will have to accept temporary deteriorations in their trade balances to enable the emerging marker economies in Asia to successfully engineer the needed adjustments. Congressional rejection of fast track authority would signal that the United States may not be prepared to do so, however, and this could induce Asian policymakers to reconsider their commitment to market-oriented strategies—jeopardizing both their prospects for resolving the current crisis and the favorable long-term outlook cited above.
The World Trade Organization will also be severely challenged by the new trade policy threat. It has completed the carryover business from the Uruguay Round with its sectoral agreements on telecommunications, information technology and financial services. Wholly new initiatives will be needed to keep the bicycle moving forward and the still-new institution from becoming moribund for a prolonged period, as its predecessor GATT did after completion of the Kennedy and Tokyo Rounds.
At a minimum, the major industrial countries—the United States, the European Union, Japan and Canada—should agree to avoid adopting any new trade restrictions in the wake of the Asian crisis. The OECD members took a similar "standstill" pledge after the oil shock of 1973 when they realized that it would be foolish to try to pass around the resulting deficits among themselves. The impact of the Asian crisis could be at least as sizable as that initial oil shock and the OECD membership should resolve to avoid beggar-thy-neighbor trade responses.
All this also implies a major challenge to the continued march of globalization. Anti-globalization forces are mounting in both the industrial countries, where they are celebrating the defeat of fast track negotiating authority in the United States as a "historic turnaround in attitudes toward international integration," and in many emerging market economies due to the onslaught of yet another financial crisis. Both the intellectual underpinnings of globalization, and the policies to implement it, are likely to be questioned more severely than at any other time in the past two decades. The global outcome for several decades ahead will turn on the outcome.
There are thus a number of potentially significant trade implications from the Asian crisis. We will shortly be moving into the period where countries both inside and outside the region may be tempted to turn to trade restrictions, or at least to avoid new trade liberalization, to help them through the difficult adjustment period.
In such a situation, the best defense is a good offense. The crisis countries need to liberalize further, to restore market confidence in their economies and to fulfill their IMF programs. The industrial countries need to do so too, to make clear that they will accept increased Asian exports and to encourage the Asians to maintain their market-oriented adjustment strategies. New initiatives to maintain the momentum of liberalization are acutely needed, particularly in the WTO but in regional contexts such as APEC and the FTAA as well.
The United States must lead this process. For all our problems, including our excessive trade deficit, we have by far the strongest economy in the world. Indeed, some of our major competitors (including Japan) have now been weakened substantially by the crisis. Hence further trade liberalization is highly desirable from our standpoint because it will enable us to fully exploit our strong competitive position. Any US backing away from our previous commitments, such as the pursuit of free trade in the Asia Pacific region and the Western Hemisphere, would send an enormously counterproductive signal to weaker economies that they too could—and even should—backslide.
Hence the coming year or two will present both major challenges to, and major opportunities for, the trade policy of the United States. I urge this Committee to continue its strong leadership of a constructive approach that will enable the world, as well as the United States itself, to emerge from this period in an even stronger position. Rapid passage of fast track authority, along with the provision of resources for the International Monetary Fund, is the place to start.
2. The nominal impact will be less because of large favorable changes in the US terms of trade. Changes in the real impact are what count for GDP growth, however, and probably for trade policy sentiments as well.