Warning Hymn of the Tiger Economies

stephen clarke, 6 October 2011

It is not clear if David Cameron was really planning on telling ‘households – all of us’ to pay off ‘credit card and store card bills’ or whether he really just meant that in general ‘the only way out of a debt crisis is to deal with your debts’. Whatever Mr Cameron’s original intention, it would be worth politicians, at home and in Europe, thinking about the relationship between debt, spending and austerity.

Yesterday saw the ONS revise down the country’s growth between April and June to just 0.1 per cent. Despite this dismal figure the Government is keen to emphasize there will be no concessions made on its plan for cutting the budget deficit. Despite this reassurance, the Government is clearly concerned about the meagre growth prospects of the British economy, previous predictions that private sector growth will fill the gap left by public sector cut-backs look overly optimistic.

The Government and the country need growth, yet for such growth to occur there must be people willing to consume. Businesses won’t invest unless they believe there will be demand for whatever they produce. Clearly the Government doesn’t want public demand to play as large a role in the economy as it did before the crisis. What about private demand? British households are indebted and clearly spending has been constrained recently, balancing the need to pay-down debt without destroying demand is difficult – as Cameron’s speech flip-flopping demonstrates.

What about demand abroad? The Government is keen on increasing exports and ‘rebalancing’ the British economy so that exports, in particular manufacturing exports, form a greater part of national output. A look at the East Asian economic crisis of the late 1990’s however illustrates the possible problems with this strategy at present.

The East Asian crisis which began in 1997 was exacerbated by the interlinked nature of the affected economies. Although the crisis began as a result of severe currency devaluations and a loss of investor confidence leading to massive outflows of money, the problems were perpetuated by the failure of the countries to increase output after the initial crash.

One of the reasons for the stagnation in output was the lack of demand in other countries. Taking one country particularly affected by the crisis, Thailand, it is clear that Thailand relied on exports to other East Asian countries to sustain output. Even in 1999, after the worst of the crisis was over, exports to other East Asian countries accounted for 46.1 per cent of Thailand’s exports. Thailand’s reliance was reflected by a similar situation in the other countries affected by the crisis. As made clear in a House of Commons Research Paper in 1999:

With exports to Japan and to each other accounting for about one-quarter to one-third of total exports in Indonesia, Korea, Malaysia and Thailand, exporters have faced particularly depressed markets in which to compete…Moreover, given the prevalence of processing activity in several Asian countries, export industries are highly dependent on intermediate inputs imported from elsewhere in the region. Thus, weakening imports and exports have been feeding upon each other.

Joseph Stiglitz described the situation as ‘beggar-thyself’, instead of erecting tariff barriers to imports, as countries did after the 1930’s crash, countries were erecting self-imposed barriers to trade by cutting back on consumption of imports, in effect limiting the exports of other countries. When all countries did this in unison the effect was just as damaging as if all countries had stopped exports through import tariffs.

Without attempting to suggest that Britain’s current plight perfectly mirrors that of the East Asian economies in the late 1990’s, their experience is illustrative. The trade of European countries is similarly interlinked:

• 39.6 per cent of Britain’s trade is with: Germany (11.2), Netherlands (8.5), France (7.7), Irish Republic (6.8), Belgium (5.4).
• 40.5 per cent of Germany’s trade is with: France (10.1), U.K. (6.6), Netherlands (6.6), Italy (6.3), Austria (5.7), Belgium (5.2).
• 50.9 per cent of France’s trade is with: Germany (16.4), Italy (8.2), Belgium (7.7), Spain (7.6), U.K. (6.8), Netherlands (4.2).
• 36.2 per cent of Italy’s trade is with: Germany (13.2), France (11.7), Spain (5.9), U.K. (5.4).
• 53.8 per cent of Spain’s trade is with: France (18.7), Germany (10.7), Portugal (9.1), Italy (9.0), U.K. (6.3).

The upshot of all this is that with consumption depressed across many European countries, Britain’s exports are suffering.

Although Britain’s economy is not as reliant on exports as that of the Asian economies in the 1990’s, it is worth reflecting on the wider effects of depressed demand across heavily inter-linked economies. There is no easy way out of the current problems, and Britain is perhaps in a better position than its European peers due to its independent monetary policy, and the fact that it is less reliant on European trade than some other countries. Nevertheless politicians need to be aware that with consumption in Europe depressed, Britain’s output may struggle to grow as quickly as previously forecast.

One final lesson may be learnt from the East Asian crisis. The IMF was heavily criticised for its handling of the crisis, in particular its imposition of higher interest rates to prevent the currencies of the East Asian countries depreciating further. Many analysts argued that depreciation was unavoidable, and necessary for the countries to regain competitiveness. Something Greece might reflect on now.