Problems and Prospects of the Pacific Economies


Paper presented at Brigham Young University, November 14, 1986.


               This afternoon I want to talk about the direction in which the world economy is evolving. For purposes of this discussion, I will leave to one side the strategic and geopolitical context of global economic developments, important though that is. As you know, my training and background are those of a professional economist and economic policy maker. And while I agree with Clemenceau that politics is too important to be left to the politicians, I also believe that economists are well advised not to stray too far beyond the limits of their professional competence.

First, then, I would like to briefly review the short-term prospects for the world economy before looking at the intermediate to long-term future.

On the positive side, we seem to have at last escaped the vicious cycle of escalating oil prices and rising inflation. Most observers are now convinced the oil price stabilization of the past year is a secular rather than temporary phenomenon, likely to persist until the close of this century. Except for Indonesia and Brunei, the East Asian nations are all net beneficiaries of lower oil prices. In Korea, for example, this has been a major factor in converting our chronic balance-of-payments deficit into a surplus in 1986 for the first time in many years. Declining oil prices have also, of course, contributed significantly to overall price stabilization.

Within this environment of relative price stability, advances in high technology and bioscience will underpin rising prosperity over the next several decades. The advanced industrial countries will continue to set the pace in these areas, but the so-called newly industrializing countries, or NICs, will emerge as leading exporters of high-technology products. In Korea, we refer to this shift in the export pattern from labor-intensive to technology-intensive goods as our "second economic takeoff."

The role of China in this scenario remains uncertain. However, if China is not sidetracked politically from its current economic course, the growing Chinese presence in global commerce is likely to have a massive-though incalculable-expansionary impact on world trade by the year 2000.

But in the meantime, the Asia-Pacific economy, as an integral part of the world economy, will continue to be deeply influenced by problems of global concern. Perhaps the most troubling of these is the trillion-dollar foreign debt burden of the developing countries. To be sure, this is a much less pressing problem in East Asia than in other regions such as South America. Although Korea is the fourth-largest debtor nation among the developing countries, Korea's debt-servicing capability has seldom been questioned. Indeed, as a result of our current account surplus this year, the Korean government has advanced its debt repayment schedule by four years. However, a major default elsewhere would quickly spill over to East Asia, not to mention the impact on the American banking system on the other side of the Pacific.

A second and related area of deep concern is that of monetary instability-more specifically, the continuing wide fluctuations in foreign exchange rates. The uncertainty caused by such instability acts as a powerful deterrent to trade expansion and dangerously complicates economic and financial planning by national governments. I need hardly emphasize to an educated American audience the importance of reducing U.S. budgetary deficits as a vital component of any exchange-rate stabilization program.

An even greater deterrent to trade expansion is the rising tide of protectionism among the advanced industrial countries since the late 1970s. At the present time, some 30 percent of world commodity trade is subject to some form of nontariff import restriction, compared with 17 percent in 1981. In the 1950s and 1960s, trade was the "engine" of world economic growth. But by the early 1980s, that engine was suffering so badly from wear and tear caused by protectionism that a complete breakdown was widely feared. Certainly, the protracted trade crisis was a major factor behind the sharp decline in the real growth rate of the world economy from an average annual 4.4 percent during 1970-1975 to 3 percent in the first half of this decade.

Thus, revitalization of the world trading system may well be the key to achieving rapid growth of the world economy for many years to come. Such revitalization presupposes an end to protectionism, which in turn requires that the United States, Japan, and the NICs resolve their differences on trade-related issues.

The U.S. Congress and public are rightly concerned about America's mushrooming trade deficits with Japan and the NICs. However, the principal causes of those deficits are complex and often improperly understood. Certainly there is a market access problem for the United States that some U.S. trading partners have been slow to address. However, the East Asian NICs such as Korea have generally been quite responsive to American requests that they open their domestic markets more widely to American goods. In Korea, for example, some 91 percent of the items listed in a standard index of trade commodities can be freely imported, and it is a determined policy of the government to make the Korean market more open and reduce tariff rates in the next few years.

The root cause of the American trade deficit is to be found not so much in foreign import restrictions as in the long-standing overvaluation of the dollar from 1981 to 1985. During that period, U.S. goods were priced out of many of America's traditional markets. And, despite the steady weakening of the dollar since early 1985, reclaiming those markets has proven more difficult than anticipated.

Take, for instance, U.S. trade with Korea. As recently as 1981, the United States sold more to Korea than it bought, a pattern that has prevailed for 18 of the last 26 years. Only when the U.S. budget deficit rose to unprecedented heights, pulling the dollar up with it, did American products begin to lose their price competitiveness in the Korean market. As a result, Korean importers were often forced to turn to Japanese substitutes. For the first time, Korea began to run consecutive annual trade surpluses with United States, while our trade account with Japan, always in the red, further deteriorated.

The point I want to emphasize is that trade deficits have both microeconomic causes such as trade restrictions and macroeconomic causes such as fiscal and monetary imbalances. In the present situation in the United States, the latter are, I believe, more important than the former.

America may have lost its comparative advantage in certain traditional fields of manufacture like textiles and automobiles, but in such high-tech areas as advanced electronics, bioengineering, and avionics, along with the financial services sector, the United States commands a strong competitive position. In the next decade or so, demand for these goods and services is expected to grow rapidly, especially among the NICs. Eventually, this should result in the establishment of a new and more dynamic trade equilibrium between the United States and its East Asian partners. By then, the U.S. trade deficits of the 1980s will probably be seen as a short-term phenomenon in a long-term process of industrial readjustment.

This long-term process has a number of aspects, but its central line of development can be summarized as a fundamental change in the pattern of international specialization. Since the Industrial Revolution, the exchange of raw materials for finished products has dominated most international trade relationships. This so-called vertical division of labor is now being replaced by a horizonal division of labor-the exchange of manufactured products within particular industrial sectors.

Reflective of this trend, direct investments are increasingly becoming a two-way street, like trade, between the North American countries and the Asian developing countries. For example, Korean companies have been setting up manufacturing plants in America in order to spread the benefits of production and employment to the countries where the end products will be marketed. Conversely, increasing numbers of American companies continue to invest in Korea jointly with Korean companies to produce not only for the Korean market, but also for their home markets, as well as for the large markets of Korea's populous neighbors. These companies are taking advantage of geographical proximity to other Asian markets including China, highly competitive wage rates, and a relatively good economic and social environment, all of which are found in Korea today.

The emerging world economic structure will obviously be a more interdependent one, in which capital and technology flows will be much more widely diffused. It will probably also be a more egalitarian one, since terms of trade tend to be more stable between different kinds of industrial components than between raw materials and manufactured goods.

This trend, to reiterate, is potentially global in scope. But it is prefigured most clearly in the pattern of interdependency now taking shape among the nations of the Pacific Rim-specifically, advanced industrial nations such as the United States and newly industrializing countries like Korea.

If, as this scenario suggests, the twenty-first century is indeed to be the "Age of the Pacific," the United States and its East Asian partners have the most to gain from-as well as contribute to-this historic development.