East Asia and more recently India have been making the most of globalization.  Export-driven development strategies have led to unprecedented rises in prosperity and reductions in poverty.  Societies are becoming more free and open, and politics more pluralistic and democratic.

However, the current economic and financial crisis has led some observers to question the continued viability of export-led growth. 

East Asia's exports may have been one of the causes of the crisis, as they contributed to the large current account surpluses and savings glut.  And as we recover from the crisis, export markets will grow more slowly, especially as US consumers rebuild their savings.

So the argument goes that East Asia should rebalance its growth by shifting away from export-led strategies towards promoting domestic demand and also regional demand.  Sounds nice, but does the argument make any sense?  Let's look at the details.

The countries that have taken the biggest hit on their exports in the wake of the crisis are the smaller ones like Singapore, Taiwan, Hong Kong and Malaysia.  But small open economies everywhere, like Luxemburg and the Netherlands, must rely on exports to drive their growth.  As they are so small, there is no alternative.  Also, these economies benefited most on the upswing, and became the richest countries in the region.  Even if, as predicted, Singapore loses 10% of its GDP this year, it will still remain one of the world's richest countries.  Indonesia and Vietnam are taking less of a hit on their exports, but they have less well developed manufacturing export sectors, and are much poorer.  While China has become one of the world's biggest exporters, exports represent a smaller share of GDP.  So, it will be less affected by the crisis and is expected to record respectable growth, in part because its government responded quickly with a massive fiscal stimulus.

As we question export-led strategies, it is important to recognise that there is more to exports than exports.  In East Asia, much of the regions manufactured exports are produced by vast foreign investment production systems.  If we seek to tilt growth away from exports to domestic demand, we might lose some of that foreign investment.  Hardly a wise thing to do!  Such investment would likely shift to a neighbouring country as East Asia's developing countries have a comparative advantage in labour intensive manufactures.

Sure, most countries have policies that favour exports, and these need to be looked at.  But these exports and foreign investment bring many extra benefits ("externatilities") through technology transfer and learning.  Workers improve their human capital by working in internationally competitive operations, and enterprises learn to make products of an international standard.  Export industries have much higher levels of productivity than domestic service sectors.

What seems clear is that the boom-bust nature of the world economy is becoming a source of volatility.  But those economies most open to the world economy need to manage volatility in much the same way that commodity exporters have always done.

The export hawks are arguing that East Asia needs to stimulate domestic demand as an alternative to exports.  It is true that the domestic service sectors in most economies call for massive deregulation.  Crisis or no crisis, this would be a good idea.  However, experience shows that local vested interests are most strong in this area (witness the barriers to entry for international retail firms), but we should indeed try.  If we succeeded, the first effects would however be high numbers of jobs losses and enterprises closures, so inefficient are these service sectors, including in Japan. 

Infrastructure is another suggestion for boosting domestic demand.  Singapore, which has built its success on first-rate infrastructure, probably does not need much more.  And countries like Japan and to a lesser extent China, which have had massive fiscal stimulus programs in recent years, are overloaded with infrastructure, a good part of which is of questionable value.  Infrastructure programs often end up in pork barrel by financing roads and bridges that do nothing than collecting votes for favoured politicians.  And countries which desperately need more infrastructure, like Indonesia and the Philippines, can barely afford to borrow more money to finance it.

Another hobby horse of the export hawks is to boost regional demand inside the East Asia region.  Greater trade and investment liberalization would certainly help, again, crisis or no crisis.  The present noodle bowl of free trade agreements should be replaced as soon as possible by a regional free trade agreement, but a real one that includes free trade in agriculture.

Once again we have to be realistic about the scope for boosting intra-regional trade and investment.  Intra-regional trade has indeed been growing, but mainly for components and intermediate goods.  East Asia is becoming even more dependent on the US and Europe for exports of final consumer and capital goods.  Intra-industry trade, as is widespread in Europe has been slower to develop, in light of the vast different levels of development of East Asia's economies.  Existing production structures are not set up for intra-regional trade.

Overall, it is clear that some rebalancing away from export-led to domestic demand-led growth seems inevitable.  But we should never underestimate the importance of export-led strategies to successful economic development, even in a post-crisis world. 

In a recent interview with the Vietnamese blog "SGT Weekly" Paul Krugman said the following:

"I still favour the export-led model -- it's the only strategy that has led to rapid development.  What hasn't worked well is close integration with world capital markets; I think countries want to be very cautious about liberalizing the capital account.  Even so, countries with strong export orientation are exposed to global shocks, but I don't think that there's anything to be done about that.

Vietnam is a small country which means there is limited room for manouver.  But you can certainly mitigate the slump by acting to sustain domestic demand demand.  You can keep an eye on your own financial system to make sure that it doesn't have the problems that have affected so many others.  Vietnam has the virtue of not being caught in the extreme financial crunch.  But this is a situation in which small, export-dependent economies don't have a whole lot of independent room.  They can do some things, but to a large extent they really have to rely on the world -- larger economies getting their act together to engineer a world recovery.

But I would say that when we emerge from this, it's not going to be the same world that we had on the eve of the crisis.  At the beginning of the crisis, we had a world where there were a few countries that were consuming a lot more than they produce, the United States chief among them, and a number of other countries that were  very much export-oriented without very much focus on their own domestic markets.  The world that is going to emerge at the end of this is going to be more balanced.  The combination of large deficits and large surpluses will not be as dramatic as it was just two years ago, which means that I believe the domestic markets will grow in the exporting countries.  There will be more opportunities at home and while obviously exporting will continue."  

As usual, Paul Krugman's words are very wise words!

References:

Asian Development Outlook 2009 -- www.adb.org

SGT Weekly -- http://nguyenvanphu.blogspot.com/2009/05/phong-van-gs-krugman.html