The Changing Structure of World Trade : Implications for Pacific Basin Countries


Paper prepared for the Twenty-Second International General Meeting of the Pacific Basin Economic Council (PBEC), Taipei, Taiwan, May 18, 1989.

Changing Position of Major Players

               As we are all aware, the center of gravity of world trade and production has been shifting to the Asia-Pacific region over the last two decades or so, and this process is accelerating. In the last ten years (1975-1985), for example, the region's total trade volume increased at an average annual rate of 13.1 percent, compared with 8.4 percent for world trade as a whole.

Within the region, the position of the major "players" has likewise been shifting in response to changing patterns of comparative advantage. Japan and the United States have moved into high-tech production and export, while the East Asian NIEs have gained export dominance in many less technology-intensive production lines. Yet no sooner had the NIEs gained such dominance than rising labor costs and currency appreciation have forced them to move up to the next rung of the technological ladder. Meanwhile, other Asia-Pacific countries, particularly ASEAN members, are reducing their dependence on raw materials exports by expanding production of labor-intensive exports. China, which has become a full-fledged participant in world trade in the last ten years, is following a similar trajectory.

The change in the relative position of these players in the world trading system has been especially striking. In 1957, the United States accounted for 21 percent of world exports, while Japan's share was only 2.1 percent in 1955. By 1988, however, the U.S. share had fallen to 11.3 percent, while that of Japan had increased more than four-fold to 9.3 percent. As for the NIEs, from 1970 to 1987 their aggregate share of world trade nearly doubled, reaching 8 percent.

Both regionally and globally, the United States and Japan play the leading economic roles. But in the area of trade, their respective roles are quite distinct. The large and relatively open U.S. domestic market has been an important contributing factor to the export success of Japan and the East Asian NIEs. Although that market is not as open as it once was, the United States continues to absorb around 30 to 40 percent of the exports of many Pacific Basin countries, accumulating huge trade deficits in the process. By contrast, the volume of manufactured goods imported by Japan remains disproportionately modest. According to Clyde Prestowitz in his book Trading Places, Japan imports about the same amount of manufactured goods as Switzerland, even though there are twenty times more Japanese than Swiss. As a result, Japan maintains large trade surpluses with most other nations both within and outside the region.

The emergence of the NIEs onto the world trading scene is a more recent phenomenon, dating from the 1970s. Added together, the economies of the four East Asian NIEs-Korea, Taiwan, Hong Kong, and Singapore-are only a quarter as large as Japan's, but they are collectively involved in about the same amount of external trade. In the 1980s, the NIEs' trade surpluses with the United States increased to the point where they now exceed the U.S. trade deficit with the EC. These surpluses have focused international attention on the NIEs and have come to be viewed as a problem in restoring world trade equilibrium.

Trade Imbalances

Indeed, the restoration of international trade equilibrium is now widely regarded as the most important challenge confronting both the Asia-Pacific and world economies. In practical terms, the issue is largely reducible to the trade imbalance between the United States, Japan, and the NIEs.

In seeking to reduce its trade deficit, the United States is severely constrained by the gap between domestic savings and investment within the country. To the extent that domestic savings fall short of domestic investment, that shortfall must be made up through foreign borrowings.

A significant implication of the growing dependence of the United States on foreign creditors is that it limits the scope of U.S. monetary policy options. For example, the United States needs to keep interest rates high enough to satisfy foreign creditors who demand a higher return and cheaper dollars-a policy response that will dampen domestic economic activity and quicken inflation.

To reduce its large trade deficit, the United States has relied mainly on exchange rate policy. But there is a limit to the effectiveness of this policy. A weaker dollar will help U.S. exporters only if the U.S. economy has excess capacity and U.S. exporters can quickly recover markets lost to other countries when the dollar was overvalued. Moreover, a weak dollar has not greatly reduced imports because of the strong consumer demand for imported goods, many of which are no longer produced domestically. Also some American imports are intermediate goods produced by U.S. subsidiaries abroad for use by firms in the United States.

Moreover, it is often pointed out that the huge volume of financial flows to the United States to finance its twin deficits increases foreign exchange volatility and renders global financial markets vulnerable to changing expectations of the market participants. In short, the reliance on monetary and exchange rate policies alone will not reduce the current U.S. account deficit significantly unless the savings-investment gap and budgetary deficits, in particular, are drastically reduced.

In the absence of effective measures to achieve this, the United States has been pressuring Japan, the NIEs, and other trade-surplus countries to revalue their currencies. Since the Plaza Accord in September 1985, substantial revaluation has taken place, with the Japanese currency almost doubling in value against the dollar and the Taiwanese and Korean currencies appreciating 43 percent and 30 percent, respectively, as of the end of 1988.

In all three countries, rapid currency appreciation has slowed export growth and hurt labor-intensive industries, but it has not led to a significant reduction of the U.S. trade deficits. Both Hong Kong and Singapore have resisted currency revaluation, contending that their currencies are not overvalued. Korea has substantially revalued, but now argues that further currency appreciation is unnecessary and undesirable given its escalating rates of inflation and wage increases since 1987.

Faced with the failure in reducing its trade deficit-though it decreased somewhat in 1988-the United States, or at least a large number of Americans, have turned to more drastic protectionist alternatives. Just as the Smoot-Hawley Tariff is now seen as the high-water mark of protectionist sentiment in the 1930s, so may the U.S. Omnibus Trade Act of 1988 be regarded as its contemporary equivalent. However, I don't mean to suggest that the United States is mainly or even primarily responsible for the current protectionist climate of world trade. The point, simply, is that because the huge U.S. market has traditionally absorbed such a large proportion of world exports, any reduction in foreign access to that market will have a proportionately large impact on world trade.

The protectionist option is, in any event, a short-run palliative at best, rather than a long-term solution. Even as a palliative it is likely to fail, since uncompetitive "protected" industries handicap the economy and mortgage its future productivity by diverting scarce resources from more productive sectors.

Macroeconomic and Structural Adjustment

But if currency revaluation has failed to restore trade equilibrium and if protectionism is effectively a dead-end policy, then what measures are required to achieve the desired result?

To answer this question, we must first recognize that economic development is essentially a process in which countries move from lower to ever-higher levels of production and export in terms of skilled and technical intensiveness. A typical developing country begins as a producer/exporter of primary products, then shifts to labor-intensive manufactures; if all goes well, it moves on to produce and export more skill-intensive capital and consumer goods and even sophisticated high-tech products.

At each stage of this process, the "advance guard" industries in the developing country pose a formidable challenge to the "rear guard"-that is, uncompetitive-industries in the developed countries. The principle of comparative advantage requires that the latter yield ground to the former, so that the developing country can continue to develop and the developed country can concentrate its resources in the more advanced sectors where its economic future lies. But in reality, vested interests are often able to exert enough political pressure to halt or slow the process through state intervention in the international free trade system.

A more appropriate role for government-and this provides the answer to the question I posed earlier-would be to encourage structural adjustment so as to spread the short-term costs of relinquishing noncompetitive industries over the entire nation. The costs of job training, factory relocation, family assistance, and so on are far less in the long run than the costs of protectionism to the economy as a whole.

By adopting such a policy, the United States could substantially ease its economic strains with the NIEs, to the benefit of all parties concerned. Of course, such actions should be taken in the context of a broad macroeconomic approach designed to increase domestic savings and reduce the budgetary deficit, thus facilitating reduction of the U.S. trade deficit.

But restoration of an international trade equilibrium cannot be accomplished by one nation acting in isolation. It can only be achieved through cooperation and coordination of relevant policies by all the principal international actors. In the case of Japan, this requires a major shift of economic priorities in favor of a more open domestic market and more expansionist fiscal and monetary policies. To some extent, Japan is already moving in this direction, as reflected in its rapidly growing volume of imports from the developing countries. It remains to be seen to what extent such progress can be extended to Japan's trade relations with the developed countries.

As for the NIEs, the two smallest-Hong Kong and Singapore-have traditionally been virtual free trade zones, unlike the two largest-Korea and Taiwan. Yet in the case of Korea, somewhat paradoxically, a relatively closed market until the early 1980s was accompanied by chronic trade deficits. In the past five years, both Korea and Taiwan have substantially opened their home markets to manufactured imports, while revaluing their currencies as noted earlier. Though both continue to record large trade surpluses, those surpluses are now beginning to decline as the growth rate of imports exceeds that of exports for the two countries. It would seem, therefore, that Korea and Taiwan would be well advised to continue their market opening and import expansion policies, which appear to be working.

The role of ASEAN in regional affairs is also of vital importance. The Asia-Pacific nations constitute the major region where intraregional trade between developing countries is increasing. However, high tariff and nontariff barriers remain among the major factors inhibiting such trade. The ASEAN Preferential Tariff Scheme, although quite limited, is one of the few regional arrangements designed to reduce trade barriers among the member countries. We hope that this promising ASEAN initiative leads to further liberalization of trade within and without the region.

At the multilateral level, our top priority must obviously be to ensure the success of the Uruguay Round negotiations in Geneva. Following the Montreal Mid-Term Review last December, the prospects for success looked rather bleak, but recent developments point to a more favorable outcome.

We welcome the creation of free trade zones in North America and Oceania as well as the movement toward a European single market scheduled for 1992. However, we must guard against the possible danger that regionalism may stand in the way of multilateral efforts for strengthening the GATT system.

Let me reiterate that, in any event, the long-term solution to the problem of trade imbalances can only be accomplished by means of fundamental macroeconomic and structural changes among the largest trading nations-mainly, but not exclusively, the United States and Japan. Moreover, these changes need to be coordinated between the countries involved-directly as well as indirectly-in order to maximize their effectiveness.

Need for a Regional Coordinating Body

Despite numerous bilateral channels of communication, at present there does not exist any permanent structure through which such coordination could take place. I believe that the creation of an Asia-Pacific regional coordinating body could carry out this function to a large extent. In addition to macroeconomic policy issues, it could also be an effective vehicle for taking concerted action in other matters of regional concern such as aid to the LDCs, environmental protection, and elimination of the traffic in dangerous drugs. Indeed, such an organization could form the nucleus or embryo for the eventual emergence of a regional economic union along the lines of the EC.

If, indeed, this idea ever becomes reality, it will be owing in large part to the work of Pacific Basin Economic Council (PBEC) and the Pacific Economic Cooperation Conference (PECC) in creating an intellectual climate favorable to such a concept. And so, in closing, I want to commend your organization for a job well done, and offer you the continued support and cooperation of the PECC.