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Working Paper Series
Challenges and Choices In Post-Crisis
East-Asia: Simulations of Investment
Policy Reform in an Intertemporal,
Global Model
WP 98-07
Xinshen Diao
University of Minnesota
Wenli Li
Federal Reserve Bank of Richmond
Erinc Yeldan
Bilkent University
This paper can be downloaded without charge from:
http://www.richmondfed.org/publications/
CHALLENGES AND CHOICES IN POST-CRISIS EAST-ASIA:
Simulations of Investment Policy Reform in an Intertemporal, Global Model
Xinshen Diao*
University of Minnesota, Minneapolis-St. Paul
Wenli Li
Federal Reserve Bank of Richmond, Virginia
and
Erinc Yeldan
Bilkent University, Ankara
July 1998
ABSTRACT
The East Asian financial crisis exposed the problems of excessive government intervention in credit
allocation and poor supervision of the banking system. We argue that the crisis is an opportunity to
reformulate the strategies of growth by way of eliminating politicized intervention on investment.
In an intertemporal general equilibrium model, we examine the adjustment processes of the crisis-hit
region and the world economies, and investigate the removal of the investment subsidies. Our
results suggest that the immediate impact of the crisis on the Asian economies is a contraction of
GDP and investment. We also find significant welfare gains in the crisis-hit economies in response
to elimination of the subsidies to firm’s investment.
J.E.L Classification: C68, F11, O41, O53
Key Word: East Asian Crisis, Dynamic GE, Investment Policy
Corresponding author: Dr. Xinshen Diao, USDA/ERS, N5142, 1800 M street. N.W.
Washington DC 20036. Phone: 202-694-5219; Fax: 202-694-5793; E-Mail: xdiao@econ.ag.gov
1
I. Introduction
The East Asian financial crisis is currently cited as a central uncertainty confronting the
global economy and the international commodity and capital markets. Growth is expected to be
slower, risks are higher, and the flows of capital have been dislocated.2 The crisis erupted in
July, 1997 when the Thai Baht was left to float and depreciated by 15 percent, giving way to a
wave of contagion to Indonesia, Malaysia, Philippines, and South Korea. In Indonesia, the
financial problems were compounded by a political crisis along with sharp increases in the price
of basic consumer goods and rise in the rate of unemployment. In Korea as well, bankruptcies
and unemployment rate were on the rise, where eight of the thirty largest industrial-trade
conglomerates (Chaebols) filed bankruptcies in 1997. In Thailand, despite a bumper harvest and
rising export prices, the severe contraction in industrial output led to a sharp rise in the
unemployment rate to 6 percent.
No doubt, external adjustments in the region will necessitate significantly financial restructuring to accommodate the hostile conditions of a new environment with higher interest
rates, depreciation of real exchange rates, and lower domestic absorption.3 Our main objective in
this paper, however, is not limited to an anecdotal narration of the crisis, nor conjectures on its
possible effects on the global world economy at large. We extensively focus on the challenges
and possible strategic reform choices faced by the crisis-hit governments. Our main motivation
2 See, e.g., IMF (1997) World Economic Outlook, Interim Assessment, December. The Economist, April 11, 1998;
and more recently, May 16, 1998.
3 World Bank’s projections report an expected fall of about 7 percentage points in the overall GDP growth for 1998,
in comparison to its projections in mid-1997. Accordingly, full recovery is expected to require two to three years.
2
is that the outbreak of the crisis can as well be perceived as an opportunity by the respective
governments to reformulate their patterns of growth and accumulation by way of eliminating
inefficient (and often politicized) interventions in the allocation of investment credit.
The “East Asian Model of Industrialization” is traditionally associated with strategic
export promotion policies and heavy reliance on government’s selective instruments towards
setting well-defined guidelines for growth and export targets. The selected massive industrialcum-trade conglomerates have served as the principal agents of this mission. Meanwhile, the
banking system served, to a certain extent, as instruments of industrial promotion responding to
the government’s strategic directives, rather than financial intermediaries in charge of allocating
resources to most efficient uses. In this process, the governments have used selective strategic
instruments such as cheap credit provision, tax breaks, and discriminatory entry and exit barriers
in the credit markets.
In this process, both the banks and the industrial conglomerates had intimate connections
with each other, as well as with the government. Overall, the system was observed to suffer from
inadequate supervision and a lax attitude over banks’ internal control; and in many cases there
was no clear commercial assessment in granting loans. It was natural to believe that the
respective governments would not allow the banks to fail, and that there was full guarantee on
deposits.
In the 1990s, however, the world capital markets have become increasingly integrated and
the foreign capital transactions became sufficiently liberalized, as the interest ceilings in most of
the countries in the region were removed and entry restrictions were relaxed. However,
prudential regulation lagged behind, and the governments failed to implement the necessary
3
structural reforms on the banking system. The banks found themselves in a heaven of easy
access to foreign funds which enabled them to incur short term foreign debt very rapidly without
properly evaluating the exchange risk. Thus, a major problem was that the newly liberalized
banking system was operating under highly distorted incentives, and was far from responding to
the signals of the resulting deterioration in the macroeconomic fundamentals.
On the other hand, government guarantees against default were maintained not only for
the banks but also for the firms. In this manner, firms in many instances have provided the main
impetus for exacerbating the excess demand for investment. Consequently, the internal logic of
the East Asian model had witnessed a problem of moral hazard in that the banks and the new
financial institutions borrowed excessively from abroad and financed unprofitable projects with
an excessively high exchange risk.4
The crisis openly exposed the long time problems of the banking system in financing
firms’ investment strategies, and we argue that it can also be regarded as an opportunity to reformulate the prospective growth strategies of the region under the new set of conditions of a
globalized commodity and financial market. One of the major elements in post-crisis reform is
how to reduce government intervention in the firm or bank investment decision processes. It is
clear that such a reform as well as reforms of credit allocation and investment management
would further encourage international and domestic competition, and hence, will affect economic
growth path of the region, as well as the world economy.
To analyze the possible general equilibrium outcomes of such a policy reform, we
4 See, in particular, Krugman (1998) for an analytical exposure of the moral hazard motives behind the crisis.
Krugman (1996) has also argued long before the outbreak of the Thai crisis that the Asian economies had no
immunity against financial breakdowns.
4
develop an inter-temporal (dynamic) multi-sector, multi-region (global) general equilibrium (GE)
model. We primarily focus on the effects of extending the investment policy reform initiatives
over the crisis region, as well as their repercussions on the global economy at large. The
prevalence and nature of the linkages between globalization of the financial markets and regional
capital accumulation patterns, and their effects on production, employment and income
distribution can be easily captured by a such model and hence constitute the main indicators of
our analytical focus.
The plan of the paper is as follows: In the next section, we provide a brief overview on
the deteriorating macro economic conditions which eventually led to the outbreak of the crisis in
1997. Here we primarily focus on the culmination of the so-called problem of moral hazard, and
the strategic role played by a poorly regulated and supervised banking system. In Section III, we
introduce the main elements of our analytical model, and discuss its distinguishing properties.
We use the laboratory characteristics of the model in Section IV to simulate two sets of policy
scenarios: first, on the evaluation of the general equilibrium effects of the crisis on the East Asian
Economies; and second, on the investigation of the second best policy of removal of investment
subsidies in the crisis hit region. We reserve Section V for concluding comments.
II. An Overview of the Macroeconomic Conditions Leading to the Crisis
While there is no consensus on the definite causes of the crisis,5 there is now mounting
evidence that the region’s economies have been confronting a deteriorating macroeconomic
environment since the early 1990s. We summarize some of the salient features of this episode in
5 For a thorough review of the sources of the crisis, see Corsetti et. al. (1998), Radeli and Sachs (1998); Krugman
(1998). The celebrated web sites of Roubini (www.stern.nyu.edu/~nroubini/asia/AsiaHomepage.html), and of
Krugman (http://web.mit.edu/krugman/www/disinter.html) are also excellent sources of reference.
5
Table 1. Tables 2.1 and 2.2, on the other hand, quantify much of this deterioration.
<Insert Table 1 here> and <Insert Table 2.1-2.2 here>
First, several countries in the region experienced a real appreciation in their currencies
over the 1990s, and by 1997 had sizable current account deficits (see Table 2.1). The mode of
financing of these deficits was mostly through short term foreign borrowing with a consequent
rise in their stock of foreign liabilities. Concomitant with this appreciation and foreign debt built
up, there was an autonomous rapid inflow of foreign capital into the region. The history of
sustained economic growth for more than two decades had attracted foreign portfolio and direct
investment. However, in the face of shallow and underdeveloped financial systems, this had put
significant strain on the intermediation and productive use of these funds in the indigenous
economies of the region.
Second, there was a marked slowdown in the rate of growth of exports and industrial
output. This was mainly the combined result of the slow import demand of the developed
countries –mainly of Japan; a recession in the global markets for electronics and semiconductors; and policy shifts in most Asian economies imposing contractionary demand policies
to contain inflationary pressures.
Third, the rapid inflow of capital and slowing of growth in the region unveiled a host of
inherent structural problems in the financial systems. Specifically, there are three sets of
problems: one regards the ownership structure of the financial intermediaries. In all of the crisis
affected Asian countries, until very recently most of the banks are publicly-owned. Entry is
restricted, and in some it is practically nonexistent. Consequently, there was virtually no
provision for bankruptcies or default. Another is the lack of supervision and regulation of the
6
financial sector. Bank examinations are rare and often corrupt. There is either explicit or
implicit government guarantees on all bank deposits. Finally, there is heavy government
intervention in credit allocation. In most of these countries, special banks (such as development
banks of Korea) are set up whose sole purpose is to lend policy loans to sectors viewed as
capable of “maximizing” economic growth, with no regard being paid to the expected rate of
return. In Korea, for example, the banks were required to grant “policy loans” to specific sectors:
heavy and chemical industries, shipping companies, and overseas construction firms in the
1970s, and small- and medium-sized firms since then. Policy loans historically have constituted
between 40 and 50 percent of bank portfolios. At the end of 1996, commercial banks were said
to have 4.5 trillions won of policy loans on their books, of which 56 percent were nonperforming (Lacker and Li, 1998). Such vast government intervention led to cronyism, hence
the Suharto family in Indonesia, the Keietsu in Japan, and the Chaebol in Korea.
Under these conditions, the financial intermediaries whose liabilities are guaranteed by
the respective governments naturally posed a serious problem of “moral hazard” mentioned
above. This resulted in excessive borrowing and lending, mostly borrowing from abroad by the
banking system without proper evaluation of the exchange risk.
In retrospect, existing data reflect that the rate of growth of bank lending to the private
sector was well in excess of the rate of growth of GDP throughout the 1990s. Consequently, the
ratio of bank lending to GDP grew more than 50 percent in Thailand and Philippines, by 27
percent in Malaysia, 15 percent in Korea and Indonesia. Furthermore, given the implicit public
guarantees on the foreign liabilities of the banking system, the interest charges at home could
have been kept low, the interest rate at which domestic banks could borrow abroad and lend at
7
home was low, so that the domestic firms invested too much in projects that were marginal if not
outright unprofitable. Hence, the percentage of non-performing loans rose rapidly to reach 16
percent in Korea and Malaysia, 17 percent in Indonesia, and 19 percent in Thailand.
Given this background, we first introduce the foundations of our analytical GE model in
the next section.
III. The model
III-1. Overview
The model is based on the intertemporal general equilibrium theory with multi-region and
multi-sector specification, and draws in many ways upon the recent contributions of dynamic
applied GE modeling by McKibbin (1993), Mercenier and Sampaïo de Souza (1994), Mercenier
and Yeldan (1997), and Diao and Somwaru (1997). The world economy is aggregated into three
regions: the developing economy (LDR), the developed economy (DR) and the crisis hit Asian
economy (CAR). In each region, there are four production sectors each of which produces a
single commodity. The four aggregate production sectors are: (1) agriculture and food processes
(AGS), (2) mineral and materials (MNS), (3) other manufacturing (MFS), and (4) services (SRS).
All the three regions are fully endogenous in terms of their producers and consumers’ economic
behavior. Furthermore, we keep track of commodity trade flows by their geographical and
sectoral origin and destination. Countries are further linked by an Armington system so that
sectoral commodities are differentiated in demand and supply by their geographical origin.
Firms in each region produce goods and conduct capital investment so as to maximize
firm’s valuation. Infinitely-lived households consume home produced and imported goods to
maximize an intertemporal utility function. Household income is consumed or saved in the form
8
of equity in domestic firms or foreign bonds. Home firm equities and foreign bonds are assumed
to be perfect substitutes. Through equity purchases by households, the world “pool” of savings is
channeled to profitable investment projects without regard to the national origin of savings.
Technological change and population growth are exogenous and hence are assumed to be zero in
the model.6 The detailed description of the model is as follows:
III-2. Firms and investment
We assume that firms within each sector of every region can be aggregated into a
representative firm. The representative firm operates with constant returns to scale technology.
The value added production function for labor and capital is Cobb-Douglas, while the intensities
of intermediate goods are fixed. The representative firm chooses, at each time period, the input
levels of labor and intermediate goods and makes investment decision to maximize the value of
the firm. With constant returns to scale technology, the number of firms does not matter. Hence,
we assume that the firm finances all its investment outlays by retaining profits so that the number
of firm equities within each sector of a region remains unchanged.
A starting point for specifying the firm’s optimizing behavior is the condition of asset
market equilibrium, i.e., the expected returns from holding the equity in the firms must be in line
r=
∆
+ Vi ,
Vi
Vi
d ivi
with those from holding a ‘safe’ asset, such as foreign bonds, at any time period:
6 This specification has no real effects on the model, since, alternatively, we could normalize all variables in per
capita terms.
9
where r is the world interest rate, Vi is the market value of firm i, divi is the current dividend
payments, and 9i = Vi,t+1 - Vi,t is the expected annual capital gain on the firm equity. Assuming
an efficient world financial capital market, each region faces the same world interest rate.
Firm’s intertemporal decision problem can be restated more rigorously as follows: in each
region’s sector i, i = 1, 2,..., 4, the representative firm chooses the optimal investment and labor
employment strategies, {Ii,t, L,ti}t=1,..,∞, to maximize the present value of all future dividend
payments, taking into account expected future price of output, unit value of sectoral specific
capital equipment, and labor wage, {Pi,t, PIi,t, wt}t=1,..,∞, and the capital accumulation constraint.
Max V i, 1 = ∑t∞= 1 Rt d ivi, t ≡ ∑t∞= 1 Rt [ Pi, t f i ( Li, t , K i, t ) - wt Li, t - ai, t - P I i, t I i, t ]
Formally:
K i, t+1 = ( 1 - δ i ) K i, t + I i, t
subject to:
where Rt
t
s=11/(1+rs),
represents the discount factor; Ii,t is quantity of the new capital
equipment built by investment at time period t;
i
is a positive capital depreciation rate; and ai
2
I i, t
ai, t = φ i Pi, t
K i, t
represents the capital adjustment costs and has the following functional form:
Because of the presence of adjustment costs on capital, marginal products of capital differ
across sectors, resulting in unequal although optimal rates of investments. We assume that labor
10
is perfectly mobile across sectors (but immobile internationally), and firms never face any
quantity constraints. Also, the structure of newly produced capital equipment in terms of forgone
sectoral goods is of Cobb-Douglas form. The forgone sectoral goods used to invest can be
purchased in domestic market or imported. Hence, PIi is a function of Armington composite
P I i = ∏4j PC dj j , i = 1 , 2 , . . . , 4 .
good prices:
where PCi is the price for the composite good I, 0 < di < 1, and Σidi = 1.
III-3. The households and consumption/savings
In each region the representative household owns labor and all financial assets, namely,
the equity in domestic firms and foreign bonds, and allocates income to consumption and savings
Max ∑t∞= 0 (
1 t
) u ( TC t )
1+ ρ
to maximize an intertemporal utility function over an infinite horizon:
SAV t = wt Lt + TI t + d ivt + r t Bt -1 - Ptct TC t
subject to the following current budget constraint:
ZKHUH LVWKHSRVLWLYHUDWHRIWLPHSUHIHUHQFHTCt is the aggregate consumption, SAVt is
household savings, Bt-1 is foreign assets and rrBt-1 is interest earnings from foreign bond, Ptct is
the consumer price index, and TInt is the lump sum transfer of government revenues. We assume
no independent government saving - investment behavior. “Government” spends all its tax
11
revenues on consumption or transfer to households and, hence, public sector borrowing
requirement is not explicitly modeled. TCt, the instantaneous aggregate consumption, is
TC t = ∏i C bi,it
generated from the consumption of final goods by maximizing a Cobb-Douglas function:
4
∑i = 1 PC i, t C i, t = Ptct TC t .
subject to
where Ci,t is the final consumption for good I, 0 < bi < 1, and Σibi = 1.
The flow of savings, SAVt, is the demand for foreign new bonds issued by the other
SAV t ≡ Bt - Bt -1 = r t Bt -1 + FBORt
regions7, which, in the equilibrium, reflects current account imbalance of this region:
where a positive FBORt implies a surplus in this region’s foreign trade.
III-4. The government policies
The government policy instruments include import tariffs, export taxes net of subsidies,
indirect taxes imposed on production processes, and sales taxes on final consumption.8 Our main
purpose here is to capture the effects of the government interventions leading to over-investment
7 Since we assume that the number of equities of the firms in each region remains constant.
8 Further information about these instruments along with their initial levels are included in the database used for
conducting the calibration and “base-run” of the model. See, Global Trade Analysis Project (GTAP) database,
version 3, in McDougall (1997).
12
in financially-dubious projects within the crisis hit Asian economy. However, such information
is not available in a quantified form in the original database. As discussed earlier, such
government intervention has often taken the form of implicit insurance which is equivalent to a
stock of contingent public liabilities that are not reflected by data on debt nor the deficit until the
crisis occurs. Even though there were differences in the specifics of the policies pursued by the
governments to enable the firms to expand their investments, they all led to the same outcome:
excessive concentration of investments in certain key sectors of the economy. For these
reasons, we introduce an “investment subsidy policy” to capture the basic features of the
government interventions in firms’ investment strategies. The subsidy is thought to be granted
only for the firms in the manufacturing sector (MFS), with no comparable provisions for the
other three sectors.9 To reduce the firms’ risk caused by investment in MFS, the subsidy is
designed to lower firms’ capital installation (adjustment) costs in their investment process. More
formally, let si be the subsidy rate on capital installation cost, then Eq. (1) is redefined for the
2
I i, t
ai, t = ( 1 - si, t ) φ i Pi, t
K i, t
region of CAR:
where si is positive for MFS and zero for the other three sectors in CAR. The investment subsidy
is financed by a lump sum tax on (or a lowered government transfer to) the households.
III-5. Equilibrium
9 In Korea, excess investment and associated profitability problem was concentrated in the manufacturing sector, in
other countries such as Thailand, the focus was on the real estate sector (Huh, 1997)
13
Intra temporal equilibrium requires that at each time period, (i) in each region, demand
for production factors equals supply; (ii) in the world, total demand for each sectoral good equals
total supply; (iii) in the world, aggregate household savings equals zero. In the steady state
equilibrium, the following constraints must also be satisfied for each region:
r ss =
d iv ss
V ss
I ss = δ K ss
FBOR ss + r ss B ss = 0 .
IV. Analysis of Alternative Simulations
We focus on two sets of issues and conduct two scenarios. The first scenario (EXP-1) is
used to evaluate the general equilibrium effects of the crisis on the world economy. The EXP-1
later is served as a “base” in the second scenario (EXP-2) which is designed to investigate the
possible effects of eliminating government investment subsidy in the crisis hit economy. That is,
in EXP-2, in addition to what we will do for EXP-1, the investment subsidy in CAR will be
removed.
IV-1. EXP-1: General equilibrium outcomes of the crisis
In their recent paper, Corsetti, Pesenti and Roubini (1998) undertake an extensive
analysis of the crisis hit Asian economies’ macro economic environment and financial system
before and throughout the financial crisis, and conclude that common domestic and international
shocks hit several East Asian economies in the 1996-1997 period rather than a pure financial
panic story. Our first policy experiment pursues along this line of argument. However, in the
14
absence of a full-fledged theory on financial-real economy linkages, we directly implement the
real side consequences of the crisis on investment patterns, and shock the model to simulate the
investment contraction. The East Asian financial crisis resulted in currency depreciation,
increases in domestic interest rate and prices, more unemployment and high bankruptcy rate
among the crisis hit Asian countries. All these will likely to cause investment to fall, and hence
economic growth to slow down. Since the intertemporal GE is a real economy apparatus in
which monetary terms and many financial assets are not explicitly recognized, it cannot capture
the effects of currency depreciation on the world financial and asset markets directly.10 Instead,
we focus on the effects of the crisis on domestic investment in the region of CAR by increasing
the difficulty in capital investment in this region.
Technically, we exogenously shock the technological coefficient in the investment
function for the MFS (manufacturing) sector in the CAR, such that the productivity of capital
investment in the regional MFS sector falls temporally in the first 5 years, and then slowly
recovers to the original level in the following 5 years. By so doing, investment falls in the CAR,
which sets out diverse changes in other economic indicators, both for the CAR region and for the
world (Table 3).
Outcomes of the first simulation are comparable with the World Bank’s projections in
that CAR’s GDP falls with a fall in its investment (the World Bank, 1998). With improvements
in its terms of trade, CAR’s exports rise and imports fall. A trade surplus, together with a low
level of investment, results in current account surpluses in the CAR.
10 However, the apparatus allows us to introduce the concept of real exchange rate as the ratio of domestic versus
foreign commodity baskets. See, Obstfeld and Rogoff (1996, Chp. 4) for an analytical exposition.
15
The effects on the world economy as well as on the other countries are also captured by
the model. The world GDP falls by 0.021 percent in the first year of the simulation. GDP in the
developing economy (LDR) falls but slightly rises in the developed economy (DR) in the early
period in the model (Table 3). Such results are also consistent with the World Bank’s
projections, where it was argued that the crisis would affect developing countries more than the
high-income countries. A fall in LDR’s GDP is mainly caused by a slight depreciation of its real
exchange rate, measured by its domestic price index in terms of DR’s price index. With world
merchandise price falling by about 0.31 percent, exports fall and imports rise in both LDR and
DR regions during early period in the model. These cause LDR’s current account deficit to
increase. For the DR region, change in trade flows, together with less demand for foreign capital
inflows by the crisis hit economy (CAR), lead to a fall in the current account surplus of the DR
region in the early period of the model (Table 3).
<Insert Table 3 here>
With its intertemporal optimization feature, the model traces the entire transitional path
until a new steady state is approached sufficiently. Without further shock and any risk caused by
uncertainty in the future, the model shows that world economy will eventually recover from the
shock of the Asian crisis, and the steady state level of world GDP will be slightly higher than its
base level (a less than 0.02 percent increase, see Table 4). This result, of course, depends on the
assumption that productivity loss in the crisis hit region’s capital investment will regain in the
following 10 years. While for the other two regions, the shock is temporal in terms of their
levels of GDP or investment, the shock on the CAR region is sort of “permanent”, i.e., the level
16
of CAR’s GDP never recovers its base status even in the new steady state equilibrium.11 On the
other hand, changes in trade flows are permanent for all the three regions. In the new steady
state, exports rise and imports fall in the region of CAR, while exports fall and imports rise
slightly in the other two regions (Table 4).
<Insert Table 4 here>
IV-2. EXP-2: Effects of government investment policy on the economic recovery
In the second scenario, to study the possible effects of a change in government’s
investment policy, we eliminate government’s investment subsidy in the manufacturing sector.
Of course, without an explicit banking sector, the model cannot capture all effects of a change in
the government’s investment policy, especially the intervention in banking system and banks’
businesses. Note, however, that even though the model lacks an explicit banking system, it
maintains an effective financial capital market and accommodates the main attributes of financial
intermediation of a market economy in a theoretically consistent framework.
In the model, the investment subsidy is employed to reduce the capital adjustment cost in
the manufacturing investment. The subsidy rate is chosen such that the total subsidy is
equivalent to 2.2 percent of total investment in the region of CAR. The subsidy is received only
by firms investing in the MFS sector, and it is set equivalent to 40 percent of capital adjustment
costs of this sector.12
It is obvious that such a policy will distort firms’ investment decisions, leading to
11 Exogenous productivity growth and population growth are not central to our discussion and thus are all ignored in
the model.
12 According to Dalla and Khatkhate (1995)’s calculation, the interest subsidy involved in policy loans in Korea
amounted to about 1 percent of GNP and 6.2 percent of government expenditure in 1991; the cumulative subsidy
17
overinvestment in the MFS, and possibly under-investing in other sectors, such as services and
agriculture. Hence, intuitively, removing such a subsidy would lower MFS’s investment and rise
investment allocated in the other sectors. The simulation results of EXP-2 show that investment
in MFS does fall significantly, and rises in all other sectors. In Table 5, we document such
sectoral investment changes in selected years, while full size transition paths for sectoral
investment, together with change in sectoral output are presented in Figures 1 - 4. In the last row
of Table 5, we also report change in the steady state levels of sector capital stock due to the
elimination of investment subsidy.
<Insert Table 5 here>
We observe that with a fall in MFS’s investment after eliminating the investment subsidy,
the size of MFS, in terms of its capital stock, contracts more than a quarter in the new steady
state, while the size of other three sectors extends 1 - 2.5 percent, compared with those in the
EXP-1. The fall in MFS’s investment magnifies while the rise in the other three sectors’
investment slows down over time along the transition. This causes that total investment in the
region of CAR to rise more in the early years and then less rapidly in the future as compared with
those in the EXP-1 environment (Table 7, row 1 and Figure 5). Thus, the effect of eliminating
sectoral (MFS’s) investment subsidy on the economy-wide capital stock is positive, that is, total
capital stock increases in the new steady state (Figure 6).
We observe that, in terms of production level, the size of MFS does not contract as much
as its capital stock. Comparing with that in EXP-1, output of MFS only falls by 12 percent in the
new steady state when the investment subsidy on this sector is eliminated (Table 6 and Figure 3).
during 1981-1991 amounted to 2 trillion won per annum.
18
The major reason is that, with less capital supply, the marginal product of capital in MFS rises.
This causes the MFS sector to employ more labor to substitute for capital in the production
process. The simulation results show that relative to the other sectors, the marginal product of
capital in MFS rises by 15 percent in the first 10 years, and by 25 percent in the new steady state.
<Insert Table 6 here>
Simulation results further show that even though MFS’s capital stock level falls due to
slowing down of the investment allocated to this sector, increases in the marginal product of
capital play a dominant role in determing its sectoral dividends. Hence, comparing with that in
EXP-1, the MFS’s dividends (i.e., sectoral revenue minus labor and investment costs) rise along
the transition path. This implies that the MFS sector becomes more “efficient” or profitable in
the long-run after eliminating investment subsidy. Furthermore, with a more profitable MFS
sector, the value of its firm’s equity rises.13
Eliminating MFS’s investment subsidy also affects CAR’s trade structure. As shown in
Table 6, comparing with those in EXP-1, exports rise and imports fall for the other three sectors,
while for the MFS sector, exports and imports both rise in the short run but exports then fall
along the transition to the new steady state. While the falling magnitude of the MFS’s exports in
the steady state is quite close to that of the decline in its output, the scale of the rise in MFS’s
imports is smaller. For the other sectors, on the other hand, the range of the fall in their imports
is greater than that of the rise in their exports.
Change in the bilateral trade flows between CAR and the other two regions are presented
13 Value of firm’s equity depends on the expected stream of firm’s dividends, including dividends earned along the
transition path as well as in the steady state, putting more weight on the current and less on the future.
19
in Table 7. Eliminating investment subsidy in CAR allows this region to rise exports of
commodities for which it has a comparative advantage in trade. Furthermore, its exports to the
region with whom it is a net exporter rise more. For example, CAR is a net exporter for AGS in
the DR’s market but a net importer for the same aggregate good in the LDR’s market. When
CAR’s exports of AGS rise due to the elimination of the investment subsidy, its exports of AGS to
DR rise more than that to LDR. On the other hand, CAR is a net importer for MFS in the DR
market but a net exporter for the same aggregate good in the LDR market. When CAR’s exports
of MFS fall, its exports of MFS to LDR fall more than that to DR (Table 7).
The discussion about the sectoral effects on CAR’s economy due to the elimination of the
investment subsidy already tells us that the CAR’s economy would become more efficient after
such policy change. To see it more clearly, we report selected aggregate economic indicators in
Table 8, together with the indirect effects on the other two regions caused by the policy change in
the CAR region.
Effects of removal of the investment subsidy on the CAR’s real GDP vary according to
the time frame considered. In the immediate short-run and then in the very long-run they are
negative; but positive in the medium-run (i.e., the first 5 - 20 years). In comparing with that in
EXP-1, the short- and long-run negative changes in the level of CAR’s GDP are in the range of
less than 0.1 percent, while the medium-run’s positive gains in GDP are more than 0.1 percent
(e.g., 0.18 percent at the 10-th year).
We decompose changes in the regional GDP at a given year by the following:
20
∆GDP
∆
∆
= Σi ( X i + PVAi ) S i
GDP
PVAi
Xi
where PVAi is value-added price for output Xi and Si is sectoral share in GDP. This equation
implies that given sectoral contribution shares, total net change in a region’s GDP is equivalent
to the summation of changes in sectoral outputs and relative value-added prices. It is obvious
that a fall in MFS’ output (about -12 percent in the steady state) is a major factor causing CAR’s
GDP to fall. However, as the marginal product of its sectoral capital rises, the value-added price
for MFS rises by 15 percent (in the steady state) relatively to the other sectors’ prices. This
allows the MFS’s share in CAR’s GDP to rise about 0.18 percent. On the other hands, even
though outputs of the other three sectors rise in CAR, their relative prices fall, which also
contributes to a contracted GDP level. For example, a significant fall (-3 percent) in the valueadded price for the SRS (services) relatively to the other sectors’ prices causes the share of SRS in
GDP to fall by 0.3 percent, even though the output of SRS rises.
The social welfare gain for CAR from eliminating investment subsidy is captured by a
positive change in the equivalent variation index. This index is calculated from the intertemporal
utility function for the consumers and takes into account both the transitional and steady state
effects of the policy change, putting more weight on the current consumption and less on the
future. The equation which is used to calculate the welfare gain/loss is borrowed from Mercenier
and Yeldan (1997) and can be found in the Appendix.
Change in CAR’s investment subsidy policy also affects the other regions’ economy, as
well as the world economy. Such effects are summarized in Table 8, column 2 - 4, while full
size transition path for each region’s total investment and capital stock are in Figure 5 - 6. In
21
comparison with the simulation results of EXP-1, the effects on the developing economies are
mainly negative, yet positive on the developed economies. Taking the comparison of the steady
state equilibria as an example, DR’s total exports increases and imports fall. This allows DR’s
consumers to enjoy a slight welfare gain. On the other hand, LDR’s capital stock contracts, total
exports and imports both fall. LDR’s consumers have to face a 0.04 percent of welfare loss
caused by the policy change in CAR. These results are best understood when account is given to
the fact that current data suggest that DR has a comparative advantage in MFS’s production and
hence is a net exporter of MFS goods. The investment subsidy on the manufacturing sector in
CAR is equivalent to an implicit export subsidy for MFS. This allows CAR to compete with DR
for the exports of MFS. Once CAR’s investment subsidy in MFS is eliminated, both regions can
fully exploit their comparative advantage, and hence DR’s manufacturing exports rise, leading to
welfare improvements. On the other hand, LDR has comparative advantage on the exports of
AGS and MNS. When CAR increases its exports and reduces imports of these two sectoral
commodities, it has to compete with LDR, and hence LDR is likely to be hurt from such
competition.
<Insert Table 8 here>
Compared with the effects of the crisis shock, the simulated investment policy reform
conducted by CAR generates relatively modest aggregate effects in the short- and medium-run,
especially on trade flows for both the crisis-hit economy, and on the other regions. The major
reason is that the expected gains from the investment policy reform should mainly be a result of
improving the economy’s efficiency, i.e., gains in productivity growth. The model cannot
capture such a gain, however, as it is based on the neoclassic growth theory in which productivity
22
growth is regarded as exogenous. Even taking into account such a limitation, the long-term
effects of the investment policy reform conducted by CAR in the model are quite impressive, for
all regions. In a real-life policy setting, one may encounter many other forms of distortions in the
crisis hit Asian economies in their industrial policies, banking systems, or capital markets. It can
be expected that once such essential reforms are implemented by the countries of the region,
adjustments in their economies as well as in the world will be much larger than what we simulate
here.
V. Concluding Comments
In this paper we have investigated the analytics of post-crisis adjustments of the East
Asian crisis with the aid of an intertemporal general equilibrium model. In the absence of a full
fledged model of real-financial links, we tried to capture the real side effects of the crisis by way
of examining its consequences on the investment demand. Our results revealed that in short-run
the crisis hit Asian region would suffer a loss of GDP of 1.24 percent, and a decline in total
investment of 6.4 percent.
Next we analyzed the general equilibrium results of possible policy reform on investment
allocations conducted by the crisis hit economy. By eliminating the implicit investment subsidy
in manufacturing, we tried to capture the efficiency gains associated with the removal of
distortions to the firms’ intertemporal decisions on capital accumulation. Since the investment
subsidy is not explicitly observed in data, the direct income effects caused by eliminating the
subsidy cannot be obtained. However, we still can obtain numerical inferences about the welfare
consequences from the possible reform: in terms of equivalent variation, the reform strategy
23
results in welfare gains of 0.12 percent over the crisis environment (EXP-1).
Steven and Sachs (1998) note that the East and Southeast Asian crisis is actually a “crisis
of economic success.” It is expected that the crisis-hit countries will be able to recover and
reinvigorate their growth patterns, even though this may take time. On the other hand, the crisis
may as well be read as an opportunity for these economies to re-examine the growth strategies
that they pursued in their early economic development process, and enable them to conduct the
necessary policy reforms to reduce and eliminate the inefficient and often politicized
interventions in the economy. Given the new constraints set by a more integrated world
economy and a mobile international financial market, some policies which might have played an
important role in stimulating growth thus far are facing a new challenge. For instance, the
triumvirate of government-banking system-industrial conglomerates, was designed initially to
stimulate investment in certain strategic industries --such as telecommunications and vehicles.
In an economic environment in which the capital market was relatively closed and the banks’
lending ability was effectively constrained by domestic savings, close government-bank-firms
linkages may have been vital for mobilizing resources to allocate to a few priority infant
industries and allowing these industries to grow rapidly and be able to compete in international
markets.14 However, once the country’s financial capital market is opened to the world capital
market, financial resource limitations are virtually removed. Under such an environment,
however, the current international financial system can openly expose and almost simultaneously
punish the countries’ economic weaknesses. It is (therefore essential, under the conditions of a
14 See Amsden (1989), Bardhan (1990), and Westphal (1990) for a thorough overview of the Korean strategy of
export-led growth. Diao, Roe and Yeldan (1998), in turn provide an endogenous growth modeling perspective to the
“Asian model”.
24
financially globalized world economy, for countries to maintain consistent and coherent
economic policies.
It is clear that understanding this macroeconomic phenomena with its microeconomic
foundations within the context of a model with general equilibrium outcomes based on rational
behavior and optimization is no easy task, and the current state of our knowledge is not yet
developed to capture all this detail in a unified framework. However, we believe that the
intertemporal framework within an applied GE setting is a good head start to enhance our
understanding on what is to be done given the macroeconomic fundamentals emerging from the
crisis.
25
References
Amsden, A. (1989) Asia’s Next Giant: South Korea and Late Industrialization, Oxford New
York: University Press.
Bardhan, P. (1990) "Symposium on the State and Economic Development," Journal of Economic
Perspectives 4(3): 3-7.
Brooke, A., D. Kendrick and A. Meeraus (1988) GAMS: A User's Guide, Scientific Press, San
Francisco, CA.
Corsetti, G., P. Pesenti and N. Roubini (1998) “What Caused the East Asian Currency and
Financial Crisis?” mimeo, Princeton University.
Dalla Ismail and Khatkhate (1995) “Regulated Deregulation of the Financial System in Korea”,
World Bank Discussion papers 292.
Diao, X. and A. Somwaru (1997) “An Inquiry on General Equilibrium Effects of MERCOSUR An Intertemporal World Model,” Journal of Policy Modeling, forthcoming.
Diao, X., T. Roe, and E. Yeldan (1998) “Strategic Policies and Growth: An Applied Model of
R&D-Driven Endogenous Growth” Bilkent University Department of Economics, Discussion
Paper, No. 98-1, January.
Huh, C. (1997) “Banking Crisis in Emerging Economies: Origins and Policy Options” BIS
Economic papers, No. 96.
Krugman, P. (1998) “What Happened to Asia?” mimeo, MIT.
Krugman, P. (1996) “Are currency crises self-fulfilling?” NBER Macroeconomics Annual, 345377.
Lacker, J. and W. Li (1998) “Asian banks: Dead Men Walking”, mimeo, Federal Reserve Bank
of Richmond, Virginia.
MacDougall, R. (1997) Global Trade, Assistance, and Protection: The GTAP 3 Data Base,
Center for Global Trade Analysis, Purdue University.
McKibbin, W.J. (1993) “Integrating macroeconometric and multi-sector computable general
equilibrium models”, Brookings Discussion Papers in International Economics, No. 100.
26
Mercenier, J. and E. Yeldan (1997) “On Turkey’s trade policy. Is a customs union with EU
enough?” European Economic Review, April 1997: 871-880.
Mercenier J. and M. Sampaïo de Souza (1994) “Structural adjustment and growth in a highly
indebted market economy: Brazil”, in J. Mercenier and T. Srinivasan (eds.) Applied General
Equilibrium Analysis and Economic Development, Ann Arbor: University of Michigan Press.
Obstfeld, M. and K. Rogoff (1996) Foundations of International Macroeconomics, Cambridge,
Mass. And London: The MIT Press.
Radelet, Steven and Jeffrey D. Sachs (1998) Understanding the East Asian Financial Crisis, a
seminar given at U.S. A.I.D., January 29, 1998.
Westphal, L. (1990) “ Policy in an Export-Propelled Economy: Lessons from South Korea's
Experience" Journal of Economic Perspectives, 4(3): 41-59.
World Bank (1998) “What Effect Will East Asia’s Crisis Have on Developing Countries?”
PREM Notes, March 1998, Number 1.
27
Table 1. Macroeconomic Fundamentals and the Banking System of East Asian Countries
Macroeconomic Indicators
(1) on the good side...
-- strong GDP growth
Average growth rate of 7% in the 1990s, slight slowdown in 1996.
-- high investment rate
Above 30% of GDP throughout the 1990s (except the Philippines), however most in nontraded sector.
-- balanced government budget
Fiscal balance of the central government in surplus or a small deficit as a share of GDP.
-- low inflation
Single-digit inflation rates throughout the 1990s for all the countries.
(2) on the bad side...
-- marked slowdown in exports
Increasing trade imbalance for most countries especially since 1995.
-- increasing current account imbalances
Large and increasing current account deficits for most countries, Thailand and Malaysia
largest and most persistent.
-- appreciating real exchange rates
A real appreciation of the pegged Asian currencies since 1995.
-- accumulating short term foreign currency dominated debt
The ratio of short-term external liabilities to foreign reserves over 100% in many countries.
Banking System
-- virtually no competition in business lending
The majority of the banks government owned except in Thailand.
-- widespread of policy loans
Policy loans a big part of bank loan portfolios (averaging 30-40% in Korea and Indonesia)
-- explicit and implicit government guarantee
Traditionally bad loans consistently bailed out by the government.
-- lack of bankruptcy law or lack of its enforcement
Bankruptcy law nonexistent or not enforced in most of the countries.
-- nontransparent accounting rules
Largely inconsistent with international standards, loose definition of nonperforming loans.
28
Table 2.1 Selected Macroeconomic Indicators of Some Asian Economies
GDP Growth
1991
1992
1993
1994
1995
1996
Korea
9.13
5.06
5.75
8.58
8.94
7.13
Indonesia
6.95
6.46
6.50
7.54
8.22
7.98
Thailand
8.41
7.77
8.27
8.85
8.68
6.66
Current Account (% of GDP), NIA definition
1990
1991
1992
1993
1994
1995
1996
Korea
-1.24
-3.16
-1.70
-0.16
-1.45
-1.91
-4.89
Indonesia
-4.40
4.40
-2.46
-0.82
-1.54
-4.25
-3.41
Thailand
-8.74
-8.61
-6.28
-6.50
-7.16
-9.00
-9.18
Real Exchange Rate, end of year data
1990
1991
1992
1993
1994
1995
1996
Korea
97.1
91.5
87.8
85.2
84.7
87.8
86.8
Indonesia
97.4
99.6
100.8
103.8
101.0
100.5
105.1
98.3
101.7
107.6
Thailand
102.2
99.0
99.7
101.9
Data Source: IMF and Corsetti, Pesenti and Roubini (1998)
29
Table 2.2 Selected Measurement of the Banking System of Some Asian Countries
Market Shares, Korea, 1996
deposits
loans and discounts
Commercial Banks
23.3
27.4
Specialized Banks
9.0
14.5
Non-bank financial Intermediaries
67.7
Number and Market Shares of Total Banking Assets, Indonesia
1982
58.1
1991
share
number
share
number
State Banks
73.7
5
45.2
5
Private Banks
11.3
70
37.7
119
Foreign and Joint-venture banks
7.0
11
7.7
29
development banks
8.0
9.3
Total
100
Market Shares, Thailand, 1980 and 1992
86
100
153
1980
1992
Commercial Banks
82.0
87.0
Agricultural Cooperatives
1.6
0.6
Savings Cooperatives
1.2
2.6
Government Savings Bank
7.7
5.2
Bank for Agricultural and Agricultural Cooperatives
4.7
2.6
2.8
2.0
Government Housing Bank
Source: Lacker and Li (1998)
Nonperforming Loans
1997
Korea
16%
Indonesia
17%
Thailand
Source: BIS; Jardine Fleming.
19%
30
Appendix I: Equations and Variables in the Model
A.1. List of equations
The time-discrete intertemporal utility
(1 + ρ )
1 t
) ln(TC n, t ) + ln(TCn,T )
ρ
1+ ρ
1-T
T
Un, 1 = ∑ t = 1 (
TCn, t = ∏i CDn,b n,i,i t
Intertemporal value of firms
1-T
V n, i, 1
= ∑Tt = 1
(1 + r T )
1
di vn, i, t + di vn, i, T
t
_ s = t ( 1 + rs )
rT
di vn, i, t = PVA n,i, t Lαn,n,i,it K1n,-αi, tn,i - wln, t Ln,i, t - PVA n, i, t ( 1 - sn, i, t ) φ n, i
2
In, i, t
- P In, i, t In, i, t
K n, i, t
Within period equations (time subscript t is skipped)
A.1.1 Armington functions
PMM n, i =
PCn, i =
1
Λ n, i
1
Υ n, i
[∑s θ σs, mn,n,i i (
1
1 + tms, n, i
1-σ m n, i
](1 - σ m n, i )
PXs, i )
1 - tes, n, i
1
σ mm n, i
1-σ
1-σ
n, i
[ β σn,mm
PMM n, i mm n, i + ( 1 - β n, i )
PX n, i mm n, i ](1 - σ mm n, i )
i
1 + σ m n, i
Ms, n, i = Υ n, i
[
θ s, n, i PMM n, i
σ
] m n, i MM n, i
1 + tms, n, i
) PX s, i
(
1 - tes, n, i
1+σ mm n, i
MM n, i = Λ n, i
1+σ mm n, i
Dn, i = Λ n, i
[ β n, i
PCn, i σ mm n, i
]
Cn, i
PMM n, i
[ ( 1 - β n, i )
31
PCn, i σ mm, n i
]
Cn, i
PX n, i
A.1.2 Value added and output prices
1
1α n, i
wk n, iα n, i
1 - α n, i wln
Αn, i α ( 1 - α n, i )
PX n, i = PVA n, i + ∑ j PCn, j IOn, i, j
PVA n, i =
α n, i
n, i
A.1.3. Factor market equilibrium
∑i α n, i PVA n, i X n, i = wln LBn
( 1 - α n, i ) PVA n, i X n, i = wk n, i K n, i
A.1.4. Demand system
bn, i ( Y n - SAVn )
PCn, i
INTDn, j, i = IOn, j, i Xn, i
CDn, i =
INVDn, i, j =
d n, i, j P In, j In, j
PCn, i
A.1.5. Household income
Y n = wln LBn + ∑i di vn, i + TI n + r Bn
A.1.6. Commodity market equilibrium
Cn, i = CDn, i + GDn, i + ∑ j INVDn, i, j + ∑ j INTDn, i, j
A.1.7. Trade surplus
FBn = ∑i ∑s ( PWM n, s, i M n, s, i - PWMs, n, i Ms, n, i )
Dynamic difference equations
A.1.8. Euler equation for consumption
32
Y n, t+1 - SAVn, t+1 1 + r t+1
=
1+ ρ
Y n, t - SAVn, t
A.1.9. No-arbitrage condition for investment
qn, i, t = P In, i, t + 2 PVA n, i, t ( 1 - sn, i ) φ n, i
In, i, t
K n, i, t
( 1 + r t ) q n, i, t-1 = wk n, i, t + PVA n, i, t ( 1 - sn, i ) φ n, i (
In, i, t
)
K n, i, t
2
+ ( 1 - δ n, i ) q n,i t
A.1.10. Capital accumulation
K n, i, t+1 = ( 1 - δ n, i ) K n, i, t + In, i, t
A.1.11. Foreign assets
Bn, t+1 = ( 1 + r t ) Bn, t + FBn, t
A.1.12. Terminal conditions (steady state constraints)
δ n, i K n, i, T = In, i, T
r T V n, i, T = di vn, i, T
r T Bn, T + FBn, T = 0
rT = ρ
A.1.13. Welfare criterion (Equivalent variation index)
∞
∑t = 0 (
1 t
1 t
) ln ( T̂Cn ( 1 + ϕ n ) ) = ∑∞t = 0 (
) ln ( TCnt )
1+ ρ
1+ ρ
where TˆC n is base year’s total consumption. That is, welfare gain resulting from the policy
change is equivalent from the perspective of the representative household to increasing the
reference consumption profile by ϕn percent.
33
A.2. Glossary
A.2.1 Parameters
ni
shift parameter in Armington import function for good i in region n
ni
shift parameter in Armington composite function for good i in region n
Ani
shift parameter in value added function for sector i in region n
Anik
shift parameter in capital good production function for sector i in region n
bni
share parameter in household demand function for good i in region n
cni
share parameter in government demand function for good i in region n
ni
share parameter in value added function of sector i for labor in region n
sni
share parameter in Armington import function for good i in region n imported from s
ni
share parameter in Armington function for composite good i imported by region n
dnij
mni
share parameter in capital good production function for input i in sector j and region n
elasticity of substitution in Armington import function for good i in region n
mmni elasticity of substitution in Armington composite function for good i in region n
IOnij
input-output coefficient for good i used in sector j and region n
rate of consumer time preference
ni
capital depreciation rate in sector i region n
ni
a constant in capital adjustment function in sector i
A.2.2. Exogenous variables
LBn
fixed labor supply in region n
snit
investment subsidy tax rate for sector i in region n
A.2.3. Endogenous variables
PWMnsit world price for good i from region n to s
PMMnit composite import price for good i in region n
PXnit
producer price for good i in region n
PCnit
composite good price for good i in region n
PVAnit
price of value added for good i in region n
PInit
unit price of investment quantity in sector i region n
qnit
shadow price of capital in sector i region n
34
divnit
dividend in sector i region n
wlnt
wage in region n
wknit
marginal product of capital in sector i region n
rt
world interest rate
Xnit
output of good i in region n
Cnit
total absorption of composite good i in region n
Dnit
own good i in region n
Mnsit
trade flow of good i exported from region n to the destination region s
MMnit
composite import good i in region n
TCnt
household aggregate consumption in region n
CDnit
household demand for composite good i in region n
TInt
government transfer in region n
INVDnjit investment demand for composite good j in sector i region n
INTDnjit intermediate demand for composite good j in sector i region n
Ynt
household income in region n
SAVnt
household savings in region n
Lnit
labor employed in sector i region n
Knit
capital stock in sector i region n
Init
investment quantity in sector i region n
FBnt
trade surplus of region n
Bnt
foreign assets in region n
35
Change in Crisis Hit Asian Economy’s Sectoral Investment
and Output after Eliminating Investment Subsidy
% change from the first scenario
Figure 3
AGR
Figure 1
MFS
5
4
Inv’t
0
output
3
-5
Investment
Output
-10
2
-15
1
Output
-20
Investment
0
-25
-30
-1
1
1
5
10
20
30
40
5
10
20
Figure 4
Figure 2
40
50
SRS
2.5
MNS
5
30
50
2
4
Investment
1.5
3
Investment
1
2
0.5
Output
Output
1
0
-0.5
0
1
5
10
20
30
40
50
1
5
10
20
30
40
50
Change in Total Investment and Capital Stock after
Eliminating Investment Subsidy in Crisis Hit Asian Economy
% change from the first scenario
Figure 5
Crisis Economy
3
Figure 7
Developed Economy
0.1
2
0.05
Real investment
1
0
0
-0.05
Value of investment
Real investment
Value of investment
-1
1
5
10
20
30
40
50
-0.1
1
5
10
20
Figure 8
Figure 6
Total Capital Stock
1
-0.1
30
Developing Economy
0.8
Crisis Economy
0.6
-0.2
0.4
0.2
Real investment
-0.3
0
-0.4
Developed Economy
-0.2
Value of investment
-0.4
-0.5
1
5
10
20
30
40
50
Developing Economy
-0.6
1
5
10
20
30
40
50
40
50
Table 3. General Equilibrium Outcomes Caused by a Fall in Investment
% change from the base
Crisis Hit Asian Economy
Developing Economy
Developed Economy
Year 1
Year 5
Year 10
Year 1
Year 5
Year 10
Year 1
Year 5
Year 10
Total Investment
-6.36
-2.29
0.37
0.50
0.30
0.12
0.26
0.18
0.10
GDP
-1.24
-0.77
-0.46
-0.01
0.15
0.23
0.01
0.12
0.16
Current Account
(change in $billion)
23.33
7.19
-5.55
-1.45
-0.39
0.41
-21.89
-6.80
5.14
Total Exports
1.27
-0.16
-1.14
-0.58
0.03
0.47
-1.48
-0.35
0.32
Total Imports
-6.49
-5.51
-4.61
0.43
0.09
-0.07
8.65
7.22
6.38
Real exchange rate(1)
-1.21
0.54
1.13
-0.04
0.01
0.03
(1) The price index of Developed Economy as a numeraire
Table 4. Change in the Steady State’s Equilibrium Caused by the Crisis
% change from the base
World
Total Investment
CAR
DR
LDR
-0.160
0.058
0.044
GDP
0.018
-0.297
0.067
0.073
Total Exports
-0.026
0.388
-0.367
-0.115
-0.436
0.158
0.135
Total Imports
Table 5. Change in Crisis Hit Asian Economy’s Sectoral Investment after Eliminating Investment Subsidy
(% change from the first scenario)
AGR
MNS
MFS
SRS
year 1
3.81
3.92
-21.31
1.90
year 5
3.31
2.30
-23.15
1.90
year 10
3.02
2.51
-24.64
2.04
Steady State
2.49
1.76
-27.00
1.17
2.49
1.76
-27.00
1.17
Stock of capital in
the Steady States
Table 6. Sectoral Effects on the Crisis Hit Asian Economy after Eliminating Investment Subsidy
(% change from the first scenario)
AGR
MNS
MFS
SRS
Year 1
SS
Year 1
SS
Year 1
SS
Year 1
SS
Outputs
-0.06
1.22
1.93
1.14
0.97
-12.13
-0.16
0.30
Exports
0.84
3.11
0.52
3.52
0.50
-11.87
0.47
1.74
Imports
-1.61
-3.60
-1.61
-4.82
0.50
7.61
-1.32
-3.14
Table 7. Change in Crisis Hit Asian Economy’s Trade Flows after Eliminating Investment Subsidy
% change from the first scenario
Exports to:
Developing Economy
Developed Economy
Year 1
Year 10
SS
Year 1
Year 10
SS
AGR
0.31
1.96
2.72
0.85
2.41
3.13
MNS
0.13
2.31
3.00
0.54
2.89
3.54
MFS
0.21
-9.47
-1.51
0.52
-7.18
-1.17
SRS
-0.14
0.83
1.26
0.50
1.39
1.77
Imports from:
Developing Economy
Developed Economy
Year 1
Year 10
SS
Year 1
Year 10
SS
AGR
-1.28
-2.47
-3.08
-1.64
-2.98
-3.64
MNS
-0.54
-3.46
-4.77
-0.88
-3.80
-4.82
MFS
0.94
5.68
8.47
0.49
5.01
7.60
SRS
-1.36
-2.76
-3.53
-1.32
-2.53
-3.13
Table 8. General Equilibrium Outcomes Caused by Eliminating Investment Subsidy in Crisis Hit Asian Economy
% change from the first scenario
Crisis Hit Asian Economy
Developing Economy
Developed Economy
World
Year 1
Year 10
SS
Year 1
Year 10
SS
Year 1
Year 10
SS
0.30
-0.15
-0.46
-0.39
-0.48
-0.37
0.06
0.03
0.09
GDP
-0.04
0.18
-0.07
-0.01
-0.08
-0.22
0.01
0.01
-0.03
Terms of Trade
-0.07
0.05
0.28
0.00
-0.16
-0.24
0.07
-0.02
-0.22
(change in $billion)
7.80
4.25
0.59
0.22
-8.39
-4.47
Total Exports
0.53
0.22
-0.35
0.04
-0.41
-0.60
-0.47
0.16
Total Imports
-0.47
0.15
0.75
-0.34
-0.35
-0.32
0.57
0.23
Value of Total Investment
Total Capital Stock
0.46
-0.37
Year 1
Year 10
SS
-0.09
-0.12
-0.12
0.00
0.14
0.20
-0.09
Current Account (1)
Welfare Index (2)
0.11
-0.04
0.76
-0.28
0.003
(1) In the steady state, current account has to be balanced. Number for Developed Economy indicate current account surpluses fall.
(2) See Appedix for the defition of welfare index.
@FedFRASER