Strategies to Rebalance Growth

For an export dependent economy like Thailand, the current crisis may be harder to deal with than the 1997 crisis. As discussed earlier, Thailand exported her way out of the 1997 crisis, assisted by the depreciation of the baht. This was a natural recovery path for the country, as Thailand, in a similar way to most of the other East Asian economies, is used to the export-led growth path. East Asia has followed the export-led development path for decades, following the successful example set by Japan. This was regarded as a “flying geese” pattern of development (Akamatsu 1962).

During the 1997 crisis, the advanced economies were not affected much (with the exception of Japan which has extensive economic links with other parts of East Asia). Thus, the main export markets for East Asian products could provide the demand for increased exports from East Asia; from both the crisis affected countries as well as from newly emerging production powerhouses, such as the People's Republic of China.

The current situation is very different. The crisis has led to a collapse of world demand for exports, which hits at the very heart of the East Asian model of export-led growth. Exporting their way out of the current crisis is out of the question for East Asian economies. Indeed, many economists view the global imbalance—with East Asia exporting its way to growth, creating a huge balance of payment surpluses, and vast accumulation of reserves, while the US runs bigger and bigger deficits—as being a partial cause of the subprime crisis and subsequent credit crunch. Of course, while the global imbalance may have provided excessive liquidity to the financial markets in the West, a much more fundamental cause of the subprime crisis, however, is the regulatory failure in the West, particularly the US, that allowed a huge explosion of toxic assets, built up from subprime mortgages, throughout the financial system.

It is likely that a sustainable solution to the current crisis will involve not only a strengthening of financial regulations everywhere, but also better mechanisms to prevent a build up of vast global imbalances, as occurred in the past decade. However, correcting such deep-rooted global imbalances takes time, as many major economies or economic groups will have to undergo substantial restructuring. For example, economists know that the US economy must consume and import less and export more, while East Asia and other major trading partners to the US must do the opposite. However, switching from importing to exporting, and vice versa, does not involve just changing numbers on paper, but real adjustments at a firm level and other microeconomic policy changes, such as retraining laborers to be able to shift to new economic sectors, which may require very different skills.

Another important change that is likely to be needed in correcting the global imbalances is a substantial realignment of major currencies. The US dollar certainly needs to be much weaker against its major partners' currencies. Again, this is not an easy adjustment to make. East Asia is certainly facing a huge dilemma on this. On the one hand, not implementing changes that would prevent a reemergence of huge global imbalances in the future runs the risk that a future financial crisis will hit East Asian economies severely, as in the current crisis. On the other hand, working to bring about a realignment of currencies, particularly a significant weakening of the US$, will mean that East Asia will need to accept a book loss on the value of the huge amount of US$ denominated assets that are held by the region.

Whatever might be the solution to preventing a crisis like the subprime crisis in the medium- to long-term, it is clear that East Asia has been forced to make a significant adjustment to its development strategy in the short- to medium-term. In the short-term, countries have been making sizeable fiscal injections to try to shore up the economy, hurt by the collapse of the export engine. The Thai short-term response was discussed earlier. In the medium-term, some form of growth rebalancing will be necessary. This does not mean that exports will no longer be important to East Asia, as it is very unlikely that much of the production base that feeds the global consumer demand for manufactured products can shift back to the advanced economies, or that another region could replace East Asia in this production role. What rebalancing means is that East Asia needs to rely less on the export engine and supplement it with other engines based on domestic demand. This, again, is not that easy to achieve. It will require a significant restructuring of various economies, and also the implementation of appropriate policies to make sure that domestic demand driven growth, such as through investment, does not generate large economic bubbles and current account deficits similar to what occurred prior to the 1997 crisis.

In the case of Thailand, one can say that the economy has not grown in a well-balanced manner since the 1990s. During the economic bubble of the 1990s, growth was driven by excessive and speculative investment. When the 1997 crisis occurred, Thailand then had to rely too much on the export engine to restore growth and overall economic health. The current overreliance on exports makes the country highly vulnerable to the current global recession, as was already seen from recent export and growth figures. There have been discussions in academic and policy circles about rebalancing growth to be more dependent on domestic demand and less on exports. How to achieve these goals, however, is not clear and little serious analysis has been carried out on this issue.

Actually, the issue of Thailand being highly dependent on external trade was discussed seven to eight years ago, when the rapid rise in exports, which enabled Thailand to recover from the crisis, significantly increased exports' share of the economy. Many were already voicing concerns that the increased dependence on exports makes Thailand more vulnerable to the volatilities in both its trading partners' economic conditions and world trade. However, it is difficult to be precise when calculating whether a country depends too much on exports. Certainly, there are countries that have much higher ratio of exports to GDP than Thailand (Malaysia; Singapore; Hong Kong, China; and Japan, to name a few), and the growth experiences in those countries have been very successful. It is true that when external conditions deteriorate, the more open economies experience greater transmission to the domestic economies (see e.g. Rodrik 1996). However, volatilities from short-term external factors does not mean that these export driven economies do not on average perform well over time. Actually, the more open, export led economies tended to perform better than those which were more inward looking (e.g. Sussangkarn 1997). Certainly, having to compete in the export markets can bring about efficiency spillovers. There is also evidence supporting the view that, for Thailand, the degree of openness positively affects the total factor productivity (TFP) (Tinakorn and Sussangkarn 1998; Sussangkarn, Jitsuchon, and Vajragupta 2003).

Irrespective of the impacts of openness on volatilities and growth, it is clear that the fall out from the subprime crisis will mean that Thailand (and other East Asian export led economies) will have to accept a reduced dependence on the export engine over the next several years, and probably over the course of the medium-term. It is therefore of interest to see what might be some of the important strategies to generate sustainable growth given lower export dependence.

One obviously important strategy is increased domestic investment, which will have to be mainly public investment as the private sector has been considerably weakened by the crisis and there is a large amount of excess capacity in the manufacturing and services sectors. It is not entirely clear, however, that an investment led growth strategy can be sustainable. If the investment is not excessive, then it should be sustainable. In that case, however, the growth generated may not be very high. If investment becomes excessive, then there is a danger of large adverse impacts on the current account and external stability. There is also a danger of creating a bubble, as was done just prior to the 1997 crisis. So managing the size of the public investment to ensure that it is at an appropriate level will be important. The quality of these investments will be equally important. Thailand has made wasteful and inefficient investments in megaprojects in the past, including both purely public sector projects and those given out as concessions to the private sector. This is again a very important issue needing careful planning and monitoring.

There are other strategies that will be important parts of a growth rebalancing strategy. In the rest of this paper, we highlight three important strategies from analyses in Sussangkarn, Jitsuchon, and Vajragupta (2003). That paper used a computable general equilibrium (CGE) model of Thailand to carry out policy analyses on how to achieve a moderate average growth path, given an assumed decline in the role of exports in the Thai economy. It was assumed that the ratio of exports to GDP will decline by about 10 percentage points over a five-year time horizon. The paper found that growth would slow down significantly. The paper then analyzes various strategies that could increase growth while ensuring sustainability in the sense of maintaining external stability. In the analyses, the current account was kept fixed for each scenario, with the level of investment being endogenous.

The analyses highlighted three strategies that will be important for growth rebalancing. These are 1) increasing total factor productivity, 2) deepening the production structure of the economy and 3) lowering energy dependence.

6.1 Improving Total Factor Productivity (TFP)

Improving TFP is the best way to make growth more well-balanced. With higher productivity, the country can compete better on a long-term basis. At the same time, higher productivity will translate into higher wage rates and higher real income of the working population, enhancing the purchasing power of the domestic market.

In the past, productivity gains in Thailand came primarily from resource mobilization between economic sectors, and from the accumulation of physical capital, usually in the form of imported technology (Tinakorn and Sussangkarn 1998). Resource mobilization had limits, as the country depleted its natural resources at an alarming rate. The ability for people to move from low-paid agricultural work to higher-paid industry and service jobs is also approaching its limit, as agriculture currently accounts for less than 10% of GDP, and most farmers already have substantial non-farm income. Relying on accumulating imported capital is not a sustainable way of improving productivity either, as the value-added tends to be small.

Real productivity gains should come from improving human capital. In this regard, there is plenty of room for Thailand to make more progress. The education and training system needs to improve a lot. Thailand's international rankings in education and training lag behind its performance in other areas, such as physical infrastructure. Table 6 [ PDF 50.5KB | 1 page ] shows that there are many sub-areas in education and training which are troublesome. For example, although Thailand has made much progress in secondary enrollment since 1990s, its ranking is still low.

Improvement in scientific and technological capabilities is another important area. Investment and expenditures on scientific research and development is low in Thailand compared to more advanced countries, and much of the investments that have been made have not yielded commercial benefits. There has been great difficulty in linking research and development to commercial products.

6.2 Deepening the Production Structure of the Economy

Deepening the production structure means reducing the import content of various sectors in the economy in order to increase domestic demand. The focus here is more on intermediate demand and the stress is not on protectionism, but rather on encouraging a deeper and more diversified production base.

The structural weakness of Thailand's reliance on exports is that most of the leading exports have high import content. As shown in Figure 13 [ PDF 101.6KB | 1 page ] almost half of Thailand's imports are raw materials and intermediate goods. When combined with imports of capital, these two import groups account for two thirds to three quarters of total imports. Thailand is clearly a member of regional production networks that spread the production of parts to many countries. In theory, this international division of labor benefits all member countries. In practice, however, a country will benefit more if more parts are produced within that country, as this lowers the import volume while raising export volume. To increase parts production in Thailand, a highly developed domestic network of industry clusters must be put in place, and logistical arrangements must be efficient.

To reduce intermediate imports, the key issue is to increase the productive capacity of local producers so that they can increase links to the supply chain of various industries. Thailand has seen some successes regarding this in the past for some industries, particularly the auto industry. In its early days in Thailand, most of the auto industry was simply the assembly of completely knocked down parts imported from abroad. Over time, the share of locally produced parts steadily increased. This occurred as local producers improved the quality of their products, up to international standards. More FDI in the parts industry, some as joint ventures with local companies, also helped this process. The auto sector in Thailand is now very competitive with a high local content, and some locally made parts are now exported.

The production deepening will reduce the ratio of imports to GDP. This reduction of import share brings the potential for higher growth. In the CGE analysis, it was found that a reduction of total import share of GDP by five percentage points across all import categories increased economic growth by an average of 1.6% per annum. The auto industry experience is one that Thailand can attempt to emulate in many other industries. This should be an important part of the medium-term growth strategy to craft a rebalanced growth path.

6.3 Lowering Energy Vulnerability

Import dependence is probably most important when it comes to energy imports. As shown in Figure 14 [ PDF 102.1KB | 1 page ], the proportion of imported energy to GDP went up from less than 4% in 1998 to 12–14% in 2006–2008, an increase by three times in less than a decade. As a result, the economy became very vulnerable when energy prices went up, and the vulnerability becomes more and more serious. Not having sufficient domestic energy sources is only a small part of the problem, using energy inefficiently is a much bigger problem.

A policy of lowering energy dependence can also be used to promote new industries and contribute directly to growth. For example, the Thai government initiated the so-called “Eco-car” project in 2007. These eco-cars are small cars (with an engine size, in cubic centimeters, of less than 1,300 for gasoline engines and less than 1,400 for diesel engines) that can achieve a mileage rate of more than 20 kilometers per liter, comply with both the Euro 4 emissions standards and stringent safety standards. The main incentive for the development of eco-cars was a reduction in the excise tax from 30% to 17%. After the project was announced, seven manufacturers applied to the Board of Investment for promotional privileges to carry out an eco-car project. Output was initially due to come to the market in late 2009 or 2010. Unfortunately, with the current crisis, this will be postponed until market conditions get better. Nevertheless, these fuel efficient and environmentally friendly cars should be able to drive a new growth path for the auto industry in Thailand.

6.4 Other Rebalancing Factors

There are obviously many other important aspects of growth rebalancing strategies. For Thailand, income distribution is another important issue. In terms of income distribution, Thailand is among the most unequal countries in the world. The Gini coefficient has remained stubbornly above 0.5 during the past three decades. One of the important consequences of high inequality is the relatively small size of domestic market, as wealth concentrates among only a handful of the rich. A successful redistribution of wealth would therefore increase the domestic market size and make growth better balanced. This is especially true for a country with moderate average income levels like Thailand. Measures to improve income inequality range include fiscal measures, micro credit policies, and equitable enforcement of rules of law, among others. Another important by-product of a more equal income distribution is the reduction in political polarization, which is damaging Thai politics and economy at the moment.

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