International Trade, Capital Flows and Economic Development in East Asia

The Challenge in the 21st Century

Anthony Bende-Nabende, Anthony Bende-Nabende

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351926508
• Edition: 1
• Topic: Economics
• Subtopic: International Economics
• Index: Economics

The book provides an understanding of how international trade and capital flows have engineered the development process in East Asia, and examines the real and potential challenges that the region is expect to encounter in the twenty-first century. It integrates four topics (i.e. capital flows, East Asia, globalization and economic development) that are at the centre of the social, political and economic debate. The text highlights the region's growing strategic importance in the twenty-first century globalizing world, where transnational corporations are playing an increasingly decisive role in the global distribution of production and trade. It blends generalised regional analyses with country-specific case studies in the world's most dynamic region. It is so well designed that each of the seventeen countries that comprise the region gets some space for discussion. Thus, the text is a valuable contribution to the social science and business literature, with a special focus on the now strategic region of East Asia.

Chapter 1

Introduction

Anthony Bende-Nabende

International Trade, Capital Flows and Economic Growth

During the last two decades, world economic growth has been relatively high, fuelled by spectacular growth rates in Pacific Asia and creditable performances in both the European Union (EU) and the United States of America (US). At the same time, there have been huge increases in international trade and global financial flows, and a rapid rise in the size of the international financial sector. This has been facilitated by general liberalization, which has allowed foreign participation in previously domestically oriented economies. It has also been driven by technological advancements, particularly, information technology which enables instantaneous remittance of funds between different locations. Consequently, there has been a trend towards the now renowned globalization process.

The globalization of the world economy entails a growing inter-penetration among economies in which the role of international trade and foreign capital has become increasingly important. Specifically, the dramatic growth of foreign capital flows in the 1990s, and over time since the 1970s has brought about a greater degree of integration of the world economy than could have been achieved by trade alone. For instance, in recent years, world foreign direct investment (FDI) has grown more rapidly than world exports. There is no doubt that the ongoing global integration is making it not only easier for international capital to flow across borders, but also to do so at a faster rate.

International capital flows typically fall into the three major categories of, portfolio flows, loans and FDI. The management dimension is what distinguishes FDI from portfolio investment in foreign stocks, bonds and other financial instruments. For instance, FDI involves active control of part or the whole of the investment, while portfolio investors are passive investors, motivated only by the rate of return on the asset. Thus, FDI is not only an exchange of the ownership of domestic investment sites from domestic residents to foreign residents, but also a corporate governance mechanism in which the foreign investor exercises management and control over the un-informed domestic savers. In addition, FDI has more commitment to the long-run than either portfolio investment or loans. Therefore, it is more resilient to any economic shocks that may arise. For instance, FDI flows to East Asian countries were comparatively remarkably stable during the 1997/98 Asian financial crisis. Similarly, the resilience of FDI to financial crises was also evident during the 1994 Mexican financial crisis, and the Latin American debt crisis of the early-1980s. In sharp contrast, portfolio equity and debt flows, as well as bank loans, dried up almost completely during the same periods. In situations of international iliquidity, a country’s consolidated financial system has short-term obligations in foreign currency in excess of foreign currency that the country has access on short notice. Under, such circumstances, FDI flows provide the only direct link between the domestic capital market in the host country and the world capital market at large. From this point of view then, the recent trends of FDI are encouraging, particularly from the developing countries’ perspective. For instance, FDI was third placed among capital flows during the 1960s, 1970s and early-1980s, when aid and commercial bank loans were larger. However, recent trends show that global flows of FDI have reached record levels in recent years, growing faster than merchandise trade, and representing the most important form of capital inflows for many developing countries. Nonetheless, this should not underscore the importance of portfolio investment and loans, which can be very handy particularly for the short- to medium-run.

The existing literature (Barro, 1991, 1997; and Levin and Renelt, 1992) has explored many determinants of output growth and concluded that international trade is one of the engines of economic growth. Economists have long established that a liberal and outward-oriented trade regime is an optimal strategy for a small open economy that takes international prices as given. Such a regime increases welfare and income by engineering an optimum allocation of resources in production (re-orienting resources to areas of comparative advantage) and consumption, and by minimizing the incentive for engaging in income-generating but unproductive activities associated with protection, such as smuggling, lobbying and tariff evasion. From a general standpoint, in addition to its beneficial impact on foreign exchange (exports), and on resource allocation resulting from specialization, trade also induces growth by offering greater opportunities for economies of scale owing to an enlargement of the effective market and greater capacity utilization due to additional external demand. Furthermore, the competition faced in the international markets for exports and in home markets through imports tends to force domestic producers to become more efficient, learn new technology and improve the skills of their employees. Therefore, it provides incentives for fostering more rapid technological change and better management in both tradable and non-tradable sectors, thus raising overall productivity and economic growth (Bende-Nabende, 2002). This is how Western Europe, the US, Canada, Australia, and New Zealand managed to derive their economic growths from international trade during the nineteenth century and the first half of the twentieth century.

Notwithstanding, international capital flows also have a paramount role they play in the growth process. Although they perform a variety of functions in the world economy, their common traditional role lies in the blending of foreign savings with domestic savings to finance domestic investment. Therefore, they have direct implications for domestic capital formation. For countries generating large amounts of savings, international capital flows provide a means to invest where returns are higher than at home. Consequently, they permit levels of domestic investment in a country to exceed the country’s level of savings. For rapid growing countries, inflows of foreign investment permit faster growth, and/or growth with less sacrifice of current consumption, than could otherwise take place. In the absence of domestic distortions, foreign capital flows can augment domestic resources available for capital formation and hence can accelerate economic growth. Furthermore, international capital flows facilitate international integration, which is particularly good for the diffusion of technology.

While FDI represents investment in production facilities, its significance for developing countries is much greater. Not only can it add to investible resources and capital formation, but, perhaps more important, it is also a means of transferring production technology, skills, innovative capacity, and organizational and managerial practices between locations, as well as of accessing international marketing networks. On the importance of these factors in this context see for instance, UNCTAD (1997, 1999), and Bende-Nabende (1999, 2002). The awareness of the link between FDI and economic growth in host developing countries has been propelled by the unprecedented and sustained high growth rates (for almost 30 years) most notably experienced by the Asian newly industrializing economies (NIEs), and the Southeast Asian economies in general, with substantial involvement of FDI (Bende-Nabende, 2002). Moreover, many of the growth promoting factors identified by the endogenous growth theory have been hypothesized to form the foundation of the now renowned key positive spillover effects of FDI. For instance, FDI is said to stimulate economic growth through the creation of dynamic comparative advantages that lead to new technology transfers, capital formation, human resources development (i.e. spillover effects on domestic suppliers, research institutes, employment and training of more skilled personnel, and the introduction of new managerial and organizational techniques), expanded international trade, and modern environmental management systems (see UNCTAD, 1997, 1999, 2000; and Bende-Nabende, 1999, 2002). Nonetheless, the empirical investigations on the link between FDI and growth are still inconclusive. For instance, the results for Gupta (1983), UNCTMD (1992), Borensztein et al (1995), and Bende-Nabende and Ford (1998) demonstrate a positive direct link between FDI and growth. However, Bende-Nabende et al (2001) found FDI for some countries to be positively related to growth, while that for others was negatively related. Likewise, UNCTAD (1999) found FDI to exhibit either a positive or negative relationship with output depending on the variables it was entered with in the equation.

Official Development Assistance (ODA) is expected to support the developing countries’ initiative to develop and is based on the understanding that economic development be promoted by self-help efforts. ODA loans tend not to be abused because they have to be repaid in the future. Therefore, they enhance the growth process if targeted at the proper projects.

Private external debts can be detrimental to the current account. For instance, they can fuel trade deficits or the savings-investment gap, and are worsened by the increasing debt servicing. High fiscal deficits push interest rates up or reduce the availability of credit to the private sector, or both, crowding-out private investment. The external debt burden can hamper investment through each of the three channels. First, debt service requires an external transfer that under conditions of external financing reduces investible resources. Second, the anticipated tax associated with future debt service reduces the anticipated return on investment. In particular, high fiscal deficits push interest rates up or reduce the availability of credit to the private sector, or both, crowding-out private investment. Third, uncertainty about policies needed in the future to meet an equally uncertain debt service also tends to depress investment (Serven and Solimano, 1993). Nonetheless, loans used for infrastructure and basic industry investments, i.e. used indirectly for industrialization through the provision of public goods can prompt growth in the short-run.

Notwithstanding, foreign capital may impose threats (associated with financial integration) on an economy. For instance, foreign financing may stimulate domestic banks to incur excessive lending if moral hazard problems are present (McKinnon and Pill, 1997). The consequences may be widespread loan default that requires a costly bailout, or that leads to a disruption of the banking system. In addition, short-term flows may impart negative effects on an economy (Rodrik and Velasco, 1999). In their models, McKinnon and Pill (1997) and Rodrik and Velasco (1999) illustrate that domestic banks may face liquidity problems and suffer runs if they incur excessive short-term debt. The consequences are costly asset liquidations and hence a reduction in income and welfare. The Mexican (1994) and the 1997/98 Asian financial crises, which in part involved the fleeing of foreign capital have brought an awareness of the dynamic impact foreign capital can have on a given economy.

Likewise, FDI can impact negatively on the development process of a country. This is partly because the objectives of transnational corporations (TNCs) may differ from those of host governments. For instance, whereas governments seek to spur national development, TNCs seek to enhance their own competitiveness moreover, in the international context. Thus, their strategies are not devoted to the development of the host country. Subsequently, their needs and strategies may differ from the needs and objectives of the host country. Consequently, although there may be considerable overlaps, there are also significant differences. For this reason, not all FDI is always and automatically in the best interests of the host country.

Purpose of the Book

East Asia can be divided into two geographic sub-regions, the Southeast and the Northeast. The Southeast comprises ten countries namely, Brunei, Cambodia, Indonesia, Lao Democratic Republic, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. These countries now constitute the renowned Association of South East Asian Nations (ASEAN), or rather the ASEAN-10. The Northeast on the other hand consists of China (Peoples’ Republic), Taipei China (Taiwan), Hong Kong (province of China), Mongolia, North Korea (Democratic Peoples’ Republic), South Korea (Republic) and Japan.

The belief that closer integration into the world trading system would create more favorable conditions for growth in developing countries and allow them to close the income gap with industrial countries has dominated commercial policy in most developing countries in recent years. Rapid liberalization of trade and FDI has been the policy approach, and in many cases, this has been accompanied by increased participation of developing countries in world trade, including a rapid expansion of their exports. Among the developing countries, it was the East Asian economies that improved their share in world manufacturing income (value added). Their success in combining expansion in trade with growth in income enabled them to continue to close the gap with the richer industrialized countries.

Not unexpectedly, East Asia’s strong growth performance unleashed a major debate about the factor inputs that were responsible for this growth. The general point was that factor inputs of labor and capital (as opposed to new technology) accounted for much of the growth in East Asia over the past three decades. The disproportionate dependence of growth on factor (capital) accumulation was, particularly, in the initial stages of industrialization. During this transition, the economies exhibited relatively high levels of investment and correspondingly high rates of growth, subject to the availability of savings. The foreign technologies developed by previous industrialists were embodied in the imported capital equipment. Absolute, as well as relative, rates of total factor productivity growth were low at this early stage of economic development either because the capacity to innovate was particularly late to develop, or because the processes of importing technology and of innovating at home competed for the same limited domestic resources. However, as the economies developed, they were able to utilize modern industrial technologies. This is exemplified by recent research (i.e. Bende-Nabende et al, 2002), which demonstrates that total factor productivity is picking-up, and increasingly accounting for economic growth in the more dynamic economies in the region.

East Asian development dynamism is mostly derived from international trade and capital flows, particularly (but not exclusively) in the form of FDI. Yet, as exemplified by the 1997/98 Asian financial crisis, it is arguable that the region’s success in these factors has also been a source of weakness. Moreover, the globalization process, which intensified during the end of the twentieth century, has now introduced a new dimension to the understanding of the dynamics of the aforementioned factors. For that matter, the regional financial crisis compounded with an escalation of the globalization process has changed the course of Asia’s emergence and introduced inherent future challenges. This implies that there is for instance, a need for re-evaluation of the so-called ‘East Asian Development Model’ by economists, business analysts and policy-makers alike. This is more so, particularly, in relation to international trade and capital flows, which have been unprecedented engines of economic growth in the region. But, such re-evaluation is made more difficult by the diverse and hence, heterogeneous nature of the economies comprising the region.

Nevertheless, the region remains the most dynamic in the world, and will be for the foreseeable future. Some economic analysts estimate that by the year 2020, five (China, Japan, Indonesia, South Korea and Thailand) of the eight (including the US, Germany and India) largest economies in the world will be in the East Asian region. Although this might not happen as early as it has been predicted, the question now is more of when, and not if, the aforementioned countries will indeed join the ranks of the world’s economic powers. For that matter, the sub-title of the book is based on an expectation that since in development terms, the nineteenth century was favorable to the United Kingdom (UK) and the twentieth century beneficial to the US, then given the current trends, there is reason to believe that the twenty-first century will be favorable to Asia in general, and to East Asia in particular.

As the title clearly illustrates, the prime theme of the text is to evaluate the roles played by international trade and capital flows, particularly in the form of FDI in the economic development process of the East Asian region. Therefore, the main thrust of the book is to provide an understanding of how international trade and capital flows have engineered the development process in East Asia, and to examine the real and potential challenges that the region is expected to encounter in the twenty-first century. Needless to say, the text also highlights the region’s growing strategic importance in the twenty-first century globalizing world where TNCs are playing an increasingly decisive role in the global distribution of production and trade. Unsurprisingly, all topics make some link with the on-going changes in the global economy, particularly, the globalization process. Thus, the text is a valuable contribution to the social science and business literature, with a special focus on the now strategic region of East Asia.

Plan of the Book

The book is structured along the ‘general to specific’ format. For instance, the earlier chapters focus on topical issues that relate to the East Asian region as a whole, or as a group of selected countries. The later chapters are on the other hand country-specific, in the sense that they focus on individual countries and for that matter are country-specific case studies. Yet, even within this general to specific format, the discussions flow from international trade, to FDI and then to other capital flows.

As a good starting point of examining the role both international trade and capital flows play in engendering the development process, Bende-Nabende examines the trade-investment nexus in Chapter 2. Special attention is given to the literature relating to whether investment and trade are substitutes or whether they are complements of each other. It is also extended further to explore the role FDI can play in export promotion and export competitiveness in host countries, and the growing importance of international production sharing in the globalizing economy, with special reference to East Asia.

In Chapter 3, Grimwade explores multilateralism, minilateralism and regionalism in East Asia, and examines how they have influenced the nature of trade policies of different East Asian economies, and consequently their patterns of trade and FDI. Particular attention is given to the effects of liberalization on competitiveness within the region, and the evaluation of the extent to which trade liberalization through Asia Pacific Economic Corporation has worked in parallel, rather than in conflict, with the World Trade Organization liberalization framework.

Osaka’s investigation of whether the adverse impacts of the financial crisis are short- or long-run is the theme of Chapter 4. The chapter not only examines the role of investment, but also whether there has been productivity growth in the Asian-crisis countries’ economic growth experiences. Two estimation techniques, i.e. growth accounting and regression analysis are employed to generate the results upon which inference is based. The empirical results suggest that the negative influence of the financial crisis on TFP growth was short-lived. While capital factor contribution to growth declined after the financial crisis, TFP contribution surged. The importance of investment for economic growth is captured in the error correction specifications whilst the Granger causality test exposes the close association between investment and net resource inflows. These empirical examinations suggest a need of a favorable macroeconomic environment to sustain stable net resource flows for investment, and hence economic growth.

Ford...