Can the Asian Depression become Global?

Keith Rankin, 16 August 1998


Paul Krugman, in his third lecture on the Asian economic crisis (Robb Lectures, University of Auckland, 13 August 1998), focussed on the issue of global economic interdependence, and on whether there were direct transmission mechanisms in a globalised economy from national depressions in particular regions such as emerging Asia.

Krugman looked back to the 1930s and recognised that Depression as a depression appeared to transmit itself from one country to the next via a sort of domino effect. He was sure that the Gold Standard (of fixed exchange rates) of the late 1920s was the main culprit, especially inasmuch as that standard created a false policy goal: namely the protection of the value of the national currency.

That kind of interdependence doesn't exist today, he noted, given the system of floating exchange rates, and the quite different circumstances of creditor and debtor nations. That is not to say, however, that there are not many lessons that we can draw from the Great Depression.

Krugman failed to note that, in a truly interdependent world economy, under fixed exchange rates (as in the years from the 1870s to World War I) or under floating rates, the normal situation is that, at any point in time, some nations' economies are relatively depressed while others are comparatively buoyant.

It is in the nature of the world's factor markets (the markets that give meaning to the term 'globalisation' in its modern sense: the capital market in particular, but also the labour market and the 'human capital' market) that factors flows to favoured locations and from unfavoured locations. In 1996, emerging Asia was a favoured location. Now it is out of favour. That's what interdependence really means; a rhythmic see-saw type relationship which makes the concept of world depression meaningless, just as both ends of the see-saw cannot be down at the same time.

New Zealand was a favoured location in 1996. Now it falls half-way between favour and unfavour. The USA is flavour of the month this year, and other western nations such as those of the European Union are relatively favoured. As a result of these changes, New Zealand now exports much more to the United States and much less to Asia. Its problem is one of reconfiguring our industry to changes in world demand.

We can see the same up-down forces at work within New Zealand. On Radio New Zealand's Morning Report (14 August) I heard that the Canterbury economy was at its "best since 1991". Now 1991 was, on the whole, a slump year for New Zealand. Canterbury, because of its concentration of export-oriented manufacturing, becomes buoyant when the New Zealand dollar is low. Yet a low dollar is symptomatic of a loss of favour on world capital markets. The Canterbury and the Auckland economies are at the opposite ends of a see-saw.

That's interdependence as it was understood before 1930. And it's the way the 1990s' world economy is, by and large: an inevitable consequence of the mobility of savings; of money; of capital. 100 years ago, capital was also very mobile (as was labour), and countries would lose favour for no more reason than they were seen as similar to or close to another country which had just experienced some spectacular financial crisis. Thus the New Zealand economy crashed in 1879 after a crash of a Scottish bank that had speculative investments in land in many colonies, and the Australian depression of the 1890s was triggered by the collapse of Barings Bank in 1890 on account of the financial failure of the Buenos Aires water supply company.

There are forces at work, however, that do synchronise economic activity. Direct global economic interdependence - the see-saw metaphor - is only a part of the story of the international economy. Crudely put, the other forces relate to fashions of economic policy and economic psychology. Many countries implement the same kinds of economic policies at the same times because they are addressing their domestic problems (real or perceived) with the same fashionable remedies. For example, many countries were simultaneously affected (afflicted?) by the influence of the Chicago School. It is problems of political economy that precipitate global crises.

Fashion is applicable to diagnosis as well as to treatment. Thus the identification of inflation as public enemy number one is as fashionable as is the high interest rate remedy. Global crises are a result of "collective stupidity". An example might be every country trying at the same time to squeeze inflation by raising interest rates. (As long as it is only Dr Brash who was doing that, then it was a comparatively harmless case of individual stupidity.) The result is higher domestic costs worldwide, higher savings, less investment, and no impact on exchange rates. High interest rates worldwide can only mean a world slowdown. Unless the world economy is overheated, that means a world depression, meaning huge numbers of people move from relatively resource-efficient market activity into highly wasteful forms of non-market activity.

Similarly, policies to boost exports while cutting imports, applied everywhere at the same time, generate a world depression.

The particular version of this disease that deeply worries Krugman is what might be called "the Japanese disease". The disease goes much deeper than policy; it reflects practices within firms and households that might be regarded as cultural but are in fact universal. The disease is the propensity to high savings rates. The high savings rate in Japan has been precipitated by both a sense of crisis that has been simmering in Japan throughout the 1990s, and by fears relating to a perceived reproductive crises - too many old Japanese and too few young.

High savings mean low spending which means low investment which means negative economic growth. Savings intended to protect Japanese in retirement in fact create the crisis that the savers were trying to avoid. The Japanese economic cake is shrinking, which means less on average in future for each Japanese, regardless of their savings.

The question we must ask, and that Krugman certainly does ask, is to what extent are other people behaving in the same way as the Japanese. The answer is that many other nations are; in particular those of western Europe which now have both low birth rates and low rates of immigration. Indeed the country most like Japan is Italy, which has very low birth rates and high savings rates. But it's a common and growing pattern in Europe. Furthermore, Europeans have a deeper historical fear of inflation than do Americans. So their central banks are more likely to be more fearful of monetary expansion (a historical problem in Europe) than of the depressive consequences of their own squirrel-like thrift.

Krugman believes that America, with its more expansive central bank culture and more youthful population (thanks to a large extent to its on-going acceptance of immigration), is less at risk than Europe of following Japan over this economic precipice.

In New Zealand, our situation is much like that of America. Despite official attempts to exhort us to save more, we are a people who like to consume new products as if we were richer than we are. We have taken to such innovations as personal computers and the Internet, for example, at a greater rate than any other country except the USA and Canada, despite our being near the bottom of the OECD in per capita incomes. (In the past, it was the same with just about every household appliance.) Our 92% vote against a compulsory savings scheme in 1997 was a very healthy sign, for us, that "saving for a rainy day" is not too high a priority in our lives.

It is this lack of caution in our income disposal habits that will help us to avoid the severe problems that are likely to befall Europe in the second if not the first decade of the next century. We will of course feel the effects of a decline in the demand for our goods in Europe, just as we felt the effects of a fall in Asian demand. But, just as in the early 1980s, we can grow by finding new markets, including a rediscovery of our domestic market. Furthermore, it is likely that many overseas-resident New Zealander's will return, just as they did in 1983 and 1984, and will add to a sense of optimism.

The fly in the ointment is the 1994 Fiscal Responsibility Act. This is a piece of legislation which more or less requires Government to lead the way as a saver, rather than as a spender. Just as in the late 1920s and early 1930s (when William Downie Stewart was Minister of Finance), an obsession with avoiding budget deficits will tilt New Zealand towards self-inflicted depression. Furthermore, an obsession with creating export markets by reducing the costs faced by New Zealand businesses, and reducing imports by reducing wages and corporate tax rates, is another 1920s' recipe for self-inflicted depression. So is a recurring desire to prop up the exchange rate, whether as a means to suppress inflation, or as a means to display creditworthiness to the international financial community.

When the rest of the world is depressed, a country like New Zealand can only operate its economy at full employment if it rations imports through protective tariffs. Otherwise, the balance of payments constraint will become effective despite high unemployment, or a chronically depreciating exchange rate will prevent local producers from being able to afford imported production inputs.

New Zealand is largely exempt from the depressive cultural forces, such as a high propensity to save, that are endemic in both Asia and Europe. But New Zealand governments and businesses are not exempt from the biggest problem of all; the problem that Paul Krugman identifies as "collective stupidity". This is because there are so many situations in which collective stupidity prevails - eg such things as "fiscal responsibility" as defined in the Fiscal Responsibility Act - are things which are intuitively sensible. It makes sense for individuals to make provision for the possibility of an insecure future. But it makes no sense for whole societies to do so. That makes the insecure future self-fulfilling. We need to plant our acorns; not to hoard them.


Krugman's Title and Abstract:

Can it happen to us [eg USA, Europe]?

Many Westerners assume that Asia's crisis is something specifically Asian. If they worry about it, it is only because they fear that Asia can directly drag the rest of the world economy down. This fear is probably misplaced - despite the progress of globalisation, linkages between economies are weak enough that Western economies can ride out the Asian storm without much damage. The deeper question, however, is whether the return of depression economics in Asia is an omen - whether we can suffer the same fate. And the answer is not too encouraging. In particular, it is all too easy to see how Japan's malaise - brought on by a burst speculative bubble, an ageing population, and a monetary policy hobbled by stable-price orthodoxy - could be replicated in Europe.

Lecture 1: Japan: The Future that didn't work.

Lecture 2: Asia's Great Slump.

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