Legal Commentary

Is Asia Becoming the Center of the World Economy? Posner's Comment

By Richard Posner

I am less bold than Becker, and so I will make no predictions about the future of the wo rld economy. I do have some reservations about treating Asia as a unit, however. Even if one stops at the eastern border of Pakistan, the Asian countries are far from uniform in their economic prospects. For they include such politically and economically challenged nations as Pakistan, Bangladesh, and Burma, along with Australia and New Zealand, which are not culturally or ethnically Asian; and Japan, which has a rapidly declining population and is economically stagnant, albeit at a high level. The fact that there is such heterogeneity in the Asian world suggests that individual country factors predominate over factors that distinguish Asia as a whole from the other continents.

What is a common to a number of the Asian countries is mercantilism, which is to say the policy of accumulating large cash balances (in the old days, it was gold) by devaluing the currency, so that exports are cheap and imports dear. The result is an export surplus; and if a country sells more than it buys, it takes in more foreign currency than it spends in its own currency. China, aggressively mercantilist, has accumulated almost two trillion U.S. dollars.

The mercantilist policy of China and other East Asian countries has been attributed to the financial trouble that a number of these countries got into in the late 1990s when their governments were pursuing the opposite policy--that of encouraging imports and, in particular, foreign investment in their countries. As a result (much like the United States in the 2000s!) these countries accumulated large foreign exchange deficits, which ballooned when the investors shifted many of their investments to other parts of the world. The deficits reached a level at which the countries had to push interest rates up to depression-causing levels in order to prevent the flight of capital from reaching a point at which the countries' credit systems would collapse.

Once burned, twice shy; the East Asian countries switched to an export-first policy, which by enabling them to accumulate large dollar balances have prevented a recurrence of capital flight. I am calling it "mercantilist" but in part, perhaps major part, it should be viewed as precautionary--to prevent a repetition of the economic crsis of the 1990s. Yet China had already begun to emphasize exporting. The reason may lie in John Maynard Keynes's analysis of mercantilism. He argued that if domestic demand for goods and services is weak, perhaps because of a low propensity to consume, there is likely to be a lot of unemployment, as otherwise supply would exceed demand. By devaluing the currency and thus making exports cheaper and so increasing the demand for exports, government can increase employment, because the higher output is, whether consumed domestically or abroad, the more workers are needed. The Chinese population was (and is) poor, so domestic demand was weak, and overall demand and therefore output could be increased by pushing exports. The success of such a policy would depend on the foreign demand for goods that Chinese industry was able to produce at reasonable cost, but that demand proved to be strong. The large dollar balances accumulated as a consequence of the export-first policy were available for investment. As a result, China is today the world's largest creditor.

Should the United States and other debtor nations reduce their foreign borrowing, China's (and other East Asian countries') mercantilist policies will become less attractive because interest rates will fall. Moreover, as domestic demand in those countries grows, there will be pressure to make imports cheaper and to divert production from satisfying foreign demand to satisfying domestic demand. On both counts, trade balances will become more even.

But how even? Japan, despite its very high standard of living, had, until the current economic downturn, a strongly positive balance of trade. An unusually high propensity to save, coupled with an inefficient system for distributing consumer goods and services, keeps domestic demand down. It remains to be seen whether, as China's economy grows, it will become more like Japan, or more like the United States.

Full post as published by Becker-Posner Blog on June 01, 2009 (boomark / email).