What’s Dragging Down the Asian Economy? A New Look at Determinants of Growth

Following several decades of remarkable growth, many Asian countries, notably China, are facing a possible economic slowdown. For instance, China averaged 10 percent growth per year for the three decades preceding 2010 but managed only 7.4 percent growth last year. The International Monetary Fund (IMF) predicts China’s economic growth will continue to slow to 6.8 percent this year and 6.3 percent in 2016.

It is, therefore, interesting to ask the question: What led to the decline of many Asian countries? As one of the traditional pillars of growth, the significance of investment has been broadly recognized. However, the effect of exchange rate policy on macroeconomic performance remains a subject of debate. Asian countries practice a changing and diverse range of exchange rate regimes, from fixed to free-floating, making it difficult to control for their effects in empirical studies over a longer period of time.

In “A New Look at the Determinants of Growth in Asian Countries,” Manuk Ghazanchyan, Janet G. Stotsky, and Qianqian Zhang creatively examine the drivers of growth in Asian countries, with a focus on the role of investment, the exchange rate regime, financial risk, and capital account openness. Ghazanchyan et al. consider a longer time frame (1980-2012) than is typical in the literature on South and East Asian economies. This allows them to look at both the 1997 Asian Financial Crisis and the recent 2008-2009 global financial crisis in their studies.

The study finds that, before 2010, Asian countries tended to have high levels of private investment and more modest levels of public investment. In some, the majority of investment was funded by internal sources, while, elsewhere, foreign direct investment was more significant. The study finds that private and public investments are both strong drivers of growth, and the marginal impact of public investment is consistently larger than that of private investment.

The researchers proceed to classify Asian exchange rate regimes into three schemes, namely pegged, intermediate, and floating. They find that the exchange rate regime does not appear to be a significant determinant of growth—however, more flexible regimes are slightly associated with stronger growth. In fact, the majority of Asian countries have some form of intermediate flexible, or “managed,” exchange rate regime. One theory is that the managed, floating regime leads to better economic performance by enabling stronger resilience to external, real shocks without sacrificing the stability that a credible peg may entail—a lesson learned in the 1997 Asian financial crisis.

Although many of the Asian countries considered are relatively open to capital flows, there has been reluctance among a number of them to fully open capital markets because of the concern that doing so may prove challenging to macroeconomic management and exchange rate policy. The study did not find that either the fear of floating or real exchange rate volatility limits growth, but the data did show that a more open capital account in the face of financial turbulence may reduce growth, albeit only marginally. The results also confirm that the recent crisis had little impact on Asian growth.

Article Source: “A New Look at the Determinants of Growth in Asian Countries,” Manuk Ghazanchyan, Janet G. Stotsky, and Qianqian Zhang, IMF Working Paper, 2015 August.

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