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ESSAYS ON ISSUES THE FEDERAL RESERVE BANK OF CHICAGO MARCH 1998 NUMBER 127 Chicago Fed Letter Asia and the Midwest real economy During the sum m er of 1997 the fabric o f the Asian econom ic miracle began to unravel. The outlook for continued high rates o f real gross dom estic prod u ct (GDP) growth, which had averaged 7% to 10% for many co u n tries in the region during the previous decade, turned abruptly less favorable. National currencies, most of which had been p egg ed to the U.S. dollar (o r a basket o f currencies heavily weighted toward the dollar), depreciated sharply. Financial markets and banking systems becam e severely stressed. Several of the Asian “tigers” o f a few years ago were forced to appeal to the international community for financial assistance in ord er to m eet short term international debt obligations. T he im pact o f the recen t develop m ents in Asia will be felt in the U.S. Midwest. Asia is im portan t to this re gio n ’s econom y, as a m arket for locally p rod u ced goo d s an d services, as a source for im ported goo d s and services, and as a competitor in foreign an d dom estic m arkets. This Chicago Fed Letter reviews several key develop m ents in the recent Asian situation an d how these developm ents m ight influence Midwest trade. Asian growth— a m odel fo r the world? By U.S. standards, most east and south east Asian economies have recorded comparatively high levels of econom ic growth since the early 1960s, su p ported by high rates o f investm ent growth, especially in export-oriented industries. Facilitating m uch o f this investm ent were close ties between Asian len d in g institutions an d the dom estic firm s to which they lend. Governm ent-led industrial policies were directed toward stim ulating eco nom ic expan sion an d p rom oted in vestm ent in “targ eted ” industries. Governments sanctioned, even encour aged, close relationships between the financial an d industrial sectors, which som etim es led to investment an d len d ing decisions that did not m eet the rigors o f m arket discipline. This ten dency, in part, un derlies what has h ap p en ed in Asian m arkets during recent m onths. While many date the current econom ic turm oil in Asia to the speculative attacks on T h ailan d ’s currency (the baht) in foreign exchan ge m arkets in Ju n e an d July 1997, a m ore careful read in g o f history places the origins o f the “Asian p rob lem ” m uch earlier. F o r exam ple, in Jap an the close ties underlying the fin a n cial/in d u stria l/ governm ent structure predates W orld War II. T his closely in tegrated struc ture con tin u ed during the postwar reconstruction an d served Jap an and, later, oth er developing Asian econ o m ies well as they focused on b eco m ing leadin g industrial powers during the 1950-80 period. However, in 1990 Jap an ’s financial markets were shocked with a dram atic price decline in the equity an d real estate m arkets. B an ks’ capital, heavily dep en d en t on what had been inflated prices in these m ar kets, suffered. Pressure on the banking system continued, as basic structural ch an ges lagged. Econom ic growth in Jap an has plodded along at an average annual rate o f 1.7% since 1991 (exclud ing a short-lived upturn in 1996, the annual average is only 0.9% ), less than h alf the average rate record ed during the period 1971-90. C on cern abo u t the lackluster p erfor m ance o f the Jap an ese econom y has been renew ed as sim ilar econom ic difficulties have surfaced elsewhere in Asia. In recent weeks the question has often been asked: Will the crisis spread to Jap an ? An equally appropriate question is: Have the econ om ic p rob lem s associated with the structure o f the Japanese economy spread to other countries in Asia that have em braced sim ilar form s o f fin a n cial/in d u stria l/ governm ent integration, but are less well able to deal with potential eco nom ic disturbances? Apparently, the answ er is yes. By late 1995 several Asian econ om ies were experien cin g signs o f distress sim ilar to those in Japan from the late 1980s— in particular, inflated land an d equity values. In mid-1995, the U.S. dollar reversed its depreciatin g tren d from the m id-1980s an d began to appreciate again st the yen (as the prolon ged sluggishness o f the Ja p a nese econom y becom e m ore widely acknow ledged) an d the continental E u ro pean currencies (which faced increased m arket uncertainty with the approach in g deadlin e for m onetary un ion ). Asian currencies (apart from the yen) were generally “m an aged” by their respective governments or pegged to a basket o f currencies; in either case, they were heavily in fluen ced by m ovem ents o f the U.S. dollar. As a result, these currencies also ap p reci ated, reducin g these co u n tries’ com petitiveness in European and Japanese m arkets. This con tributed to a slow ing in their export-led econom ic growth. In m uch o f Asia, GDP had slipped into the 5% to 7% range by 1997 (from the 7% to 10% range during the first h alf o f the 1990s). (See figure 1.) Foreign lenders were becom ing uneasy about the size of cur rent account deficits and the increas ingly overvalued Asian currencies. In late 1996, the T hai govern m en t’s con cern s abo u t the stability o f its econom y led to m ajor ch an ges in the country’s econ om ic leadership. T he 1. GD P growth in Asian countries average annual percent change 0 4 8 12 Sources: Intern a tio n a l M on e ta ry Fund and g o v e rn m e n t o f Taiwan. govern m en t’s ap p aren t inability to im plem ent m ajor reform s an d co n tinued deterioration in econom ic con dition s led to fu rth er ch an ges in the country’s econ om ic lead ersh ip in mid-1997. T he political changes, a disclosure that the banking system held large quantities o f un disclosed n on perform in g loans, an d reports that the International M onetary Fund was pressin g the T hai governm ent to address its financial difficulties quickly translated into speculative attacks on the Thai currency in foreign exchange m arkets. T he m arket’s view that Asian currencies were overvalued sp read to oth er cu r rencies in the region, including those o f Malaysia, Indonesia, an d by late October, South Korea. (See fig ure 2.) T he decline in Asian currencies furth er accen tuated the stress on Asian financial markets, in particular on business es and institutions that faced repaying substan tial short-term foreign debt obligations with dramatically less valu able dom estic currencies. Source: D erived fro m M assachusetts In s titu te fo r Social and E co nom ic Research data. U .S. trade with Asia T he initial real sector im pact o f the Asian situation on the U.S. econom y will be on export industries an d im port com petin g industries. U.S. exporters will find it m ore diffi cult to sell in Asian m arkets. First, the sh arp appreciation o f the dollar again st Asian currencies m eans that the cost o f U.S. goods in Asian dom es tic currencies is higher—a negative for U.S. exporters. C o m pou n din g the direct effect of reduced U.S. exports to Asia is the decline in the ability o f U.S. exporters to com pete with relatively lower priced Asian goo d s in thirdcountry markets, whose hom e curren cies have rem ained relatively stable against the U.S. dollar. Second, econom ic policy adjustm ents to Asian econom ies, either dom esti cally initiated or externally im posed as a con dition fo r financial assistance from abroad, will sharply curtail eco nom ic growth. This will dam pen Asian aggregate dem and, including that for im ported g o o d s— an oth er negative for U.S. exports. T hese negatives are all the m ore im portant given the grow ing im portan ce o f the Asian m arket to the U.S. Nearly 29% o f total U.S. goo d s exports went to Asian m arkets in 1997, co m pared with 22% in 1980. N ote: The in d e x is based on U.S. d o lla r per u n it o f fo re ig n currency. Sources: B oard o f G o ve rn o rs o f the Federal Reserve S ystem and N e w York Times. On the im port side, a reduction in the dollar cost of imports from Asia is clear ly a positive for U.S. consumers and producers who im port com ponents for their dom estic production. However, U.S. industries com peting with im ports in the domestic market will be adversely affected by the Asian currency d e p re ciations, to the degree that lower dol lar im port prices are passed through an d the dollar prices to consum ers for im ported goo d s fall. Currently, 39% o f U.S. goo d s im ports com e from Asian producers, co m p ared with 25% in 1980. Im pact on the M idwest T he direct negative effect on M id west m an ufacturin g exporters, in the aggregate, is expected to be somewhat sm aller than for the U.S. overall. Asia is a com paratively sm all m arket for Midwest m anufacturers, accoun ting for about 12% o f m anufactured goods exports from the region (see figure 3). By contrast, about 25% o f all U.S. m an ufactured exports go to Asian markets. N onetheless, apart from exports to Latin America, the m ost rapid growth in Midwest exports during recent years has been in shipm ents to Asian m ar kets (see figure 4). T hus, a m arked slowdown in exports to Asian markets could dam pen export growth from the Midwest, relative to the first h alf o f the 1990s. (Figure 5 shows M id west exports to Asia by industry.) Asia is an im portan t m arket for U.S. farm com m odities. Two-fifths o f the dollar value o f all U.S. agricultural shipm ents go to Asian m arkets. This is especially im portan t for the M id west, the epicen ter o f the n atio n ’s ap p ea r to have h ad a m ajor im pact on Asian dem an d fo r U.S. farm commodities. Thus, while the current Asian situation can be expected to have a detrim ental im pact on M id west agricultural exports to that re gion, changes in supply conditions abro ad may well overshadow the dem an d effects. Source: D erived fro m M assachusetts In s titu te fo r Social and E co nom ic Research data. soybean an d corn production. For exam ple, in 1996, the Midwest’s share of U.S. soybean exports was nearly 57%. O f that, 45% went to Asian m arkets. T he Midwest accoun ted fo r 53% of U.S. feed grain (mostly corn) exports in 1996 with an equivalent o f 57% o f the total goin g to Asian m arkets.1 H igh er prices for U.S. agricultural exports facing Asian con sum ers an d lower (in some cases declining) income growth in those econ om ies are likely to adversely affect Asian d em an d for U.S. an d Midwest farm com m odities. O n the oth er hand, in recen t years agricultural supply conditions abroad (for exam ple, C hina periodically switching back an d forth from net im porter to net exp o rter o f corn) O n the im port side, a substantial increase in U.S. im ports o f m an u fac tured goods from Asian m arkets may result from reduced dollar prices of such goods. This will cause distribu tional gains or losses across industries an d firms. D om inant Midwest in du s tries, such as autom otive an d steel, will face in creased com petition from lower priced im ports. Relative sensi tivity to price ch an ges between ex ported an d im ported g o o d s will be a key factor in the distributional effects across firms. T he greater the extent to which im ports are substi tutable for dom estic production , the greater the im pact will be on dom es tic industry. T he net im pact o f these distributional effects across sectors is not clear at this point. C onclusion D em an d for U.S. g o o d s from the, until recently, rapidly grow ing econ om ies o f Asia is likely to be sharply curtailed as a result o f th eir current econ om ic difficulties. This will have a negative im pact on Midwest export ers. Midwest m an ufactured goods exporters are likely to be affected relatively less than U.S. m anufactured goo d s exporters. 5. T o p M idwest exp orts to Asia At the sam e time, Midwest an d U.S. Instruments and related equipment con sum ers o f im Chemicals and allied products ported g o o d s will Fabricated and primary metal products clearly ben efit from the Asian shock as Agriculture and food and kindred it contributes to products downward pressure Electronic and on prices o f im port other equipment All other ed as well as dom es tically p rodu ced Transportation im port com petin g equipment goods. T he overall Industrial machinery effect on the in du s and computers trial an d agricultur al sectors o f the Source: D erived fro m M assachusetts In s titu te fo r Social and E conom ic Research data. Midwest econom y, as well as on the U.S., will be negative. T he m agnitude o f the net effect on the Midwest or the U.S. econom y is not yet clear. What is clear is that the negative an d positive effects will be distributed u n evenly across the various sectors o f the economy. T he lo n ger this uneven distribution persists, an d certain industries in creas ingly find them selves at a com petitive disadvantage as a result o f the Asian disturbance, the greater the likelihood that trade policy disputes will arise between Asian exporters and the indus trial countries. In turn, political pres sure within the U nited States and other industrial countries for the im position o f trade restrictions is likely to intensify. T he avoidance o f such a scenario and its atten dan t unfavorable econom ic distortions is potentially a m ajor ch al len ge facing the governm ents o f the industrial countries. —Jack L. Hervey Sen io r econom ist A gricultural export shares by region are based on an allocation of total U.S. agri cultural exports to states (regions) based on the states’ (regions’) share of total U.S. agricultural production for specific commodities. Michael H. Moskow, President; William C. Hunter, Senior Vice President and Director ofResearch; Douglas Evanoff, Assistant Vice President, financial studies; Charles Evans, Assistant Vice President, macroeconomic policy research; Daniel Sullivan, Assistant Vice President, microeconomic policy research; William Testa, Assistant Vice President, regional programs; Vance Lancaster, Administrative Officer; Helen O ’D. Koshy, Editor. Chicago Fed Letter is published monthly by the Research Department o f the Federal Reserve Bank o f Chicago. T h e views expressed are the auth ors’ and are not necessarily those of the Federal Reserve Bank o f Chicago or the Federal Reserve System. Articles may be rep rin ted if the source is credited an d the Research Department is provided with copies o f the reprints. Chicago Fed Letter is available without charge from the Public Inform ation Center, Federal Reserve Bank o f Chicago, P.O. Box 834, Chicago, Illinois 60690-0834, tel. 312-322-5111 or fax 312-322-5515. Chicago Fed Letter and other Bank publications are available on the World Wide Web at http://w w w.frbchi.org. ISSN 0 8 9 5 - 0 1 6 4 Total light vehicle production (seasonally adjusted annual rate) decreased from 12.7 million units in November to 12.2 million units in December. Light truck pro duction decreased from 6.6 million units to 6.4 million units and car production decreased from 6.1 million units to 5.8 million units. Production for cars remained constant with December 1996 levels; however, light truck production increased from 6.0 million units in Decem ber 1996 to 6.4 million units in Decem ber 1997. The CFMMI reached a record high of 125.5 in November. The Federal Reserve Board’s IP index for manufacturing also set a record high of 130.2 in November. The Midwest purchasing m anagers’ composite index for production decreased from 63.7% in November to 58.6% in December. The national purchasing m anagers’ composite index also decreased from 58.62% in November to 55.4% in December. Sources: The Chicago Fed Midwest Manufacturing Index (CFMMI) is a composite index of 16 industries, based on monthly hours worked and kilowatt hours. IP represents the Federal Reserve Board’s Indus trial Production Index for the U.S. manufacturing sector. Autos and light trucks are measured in an nualized units, using seasonal adjustments devel oped by the Board. The purchasing managers’ survey data for the Midwest are weighted averages of the seasonally adjusted production components from the Chicago, Detroit, and Milwaukee Purchas ing Managers’ Association surveys, with assistance from Bishop Associates, Comerica, and the Uni versity of Wisconsin-Milwaukee. peisenboj odiajos TITS ZZE (ZIE) PE8006909 siouini ‘o§ e 3TO z m 'ON HIAIdTd SIONn~lI 'OOV3IH3 P£8 xog'O'd J01U9Quoneuuojuj aijqnj aivd a o v is o d s n aaa o o d va f + diz 1IVIAI SSVIO lSdIJ QTldOSTdd OOVOIHO TO w v a TAHTSTH TVHTQTT J0}}0q p p j o § B 0 iq Q
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