East Asia: After the Crisis

Keynote Presentation to the Berne Union, Annual General Meeting
Seoul, Korea, October 14, 2009

East Asia: After the Crisis
Jim Adams
Vice President, East Asia and Pacific Region, World Bank

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Chairman Ryu
President Konno
Members of the Berne Union
Distinguished Guests:

It is a great honor for me to be invited to speak at your Annual General Meeting this year, particularly at a pivotal point for East Asia and in the aftermath of the past years’ financial turbulence and economic turmoil.

I must begin by reciprocating my appreciation for being asked to speak along with Dr Jun, a long-time colleague from the World Bank who has successfully returned to Seoul to play a key role in Korean economic policy.

Colleagues - the trade and investment issues you are discussing today have seldom been of such critical importance, especially in East Asia where trade accounts for two-thirds of GDP, a larger share than in other developing regions. 

We are all too aware that the financial crisis engulfed all economies over the last year with a substantial shrinking of trade, accompanied with large declines in investment, output and employment. 

Where is East Asia now? That is the first issue I want to address today. Unlike six months ago, we are no longer in an unpredictable downward spiral - and although the turbulence is not yet over, this region is leading the way to a global recovery.

East Asia is Leading the Global Recovery

Indeed, the global economy is now recovering from the worst economic since the World War II, thanks to extraordinary fiscal and monetary stimulus and the upturn in inventory cycles.  Global financial conditions have also improved markedly and contributed to the positive economic sentiment.

East Asia, led by China, has been at the forefront of the recovery because of its own timely and decisive policy responses with robust economic frameworks and well-capitalized banks and governments that had taken to heart the lessons of the crisis a decade ago.  In the region today, there is a marked and cautious sense of optimism, including in Korea, as the global center of economic gravity is shifting forcefully to the East.  Signs of broader global recovery have also begun to emerge, with Japan and Germany exiting strongly from recession in the second quarter, and the U.S. likely to follow in the third quarter of this year.   

Even with this emerging recovery, the sharp decline in activity earlier this year will leave global output 2.3 percent lower in 2009 than last year, with sizable declines in most developed economies and the weakest pace of expansion among developing countries since 1982.  In the East Asia and the Pacific Region, the recovery in activity that began in the second quarter in almost all countries should limit the slowdown in regional growth to 6.7 percent this year from 8 percent in 2008 and the impressive 11.4 percent pace in 2007. 

While current economic projections are revised substantially up from our forecasts earlier in the year, and this year’s pace of expansion will keep East Asia at the top among the world’s developing regions, the bulk of growth will again be contributed by China.  Indeed, in China, we project output to expand 8.3 percent in 2009.  In fact by taking China out of the regional averages, however, the rest of the region is projected to grow at a slower pace than the Middle East and North Africa, South Asia and even Sub-Saharan Africa.  Indeed, several countries in the region will see contractions in 2009 as a whole, notably Thailand, Malaysia and Cambodia.

Next I would like to address the challenges to governments in the region to ensure that the recovery is sustained.

Sustaining the Recovery in the Near Term

Although there is now a discernable V-shaped increase in industrial production and exports in virtually every country in the region this year, the recovery is still fragile and policymakers need to avoid complacency.  The fiscal and monetary stimulus now in place and the rapid re-stocking of inventory will help propel activity through mid 2010.  But as these temporary factors recede, so will their effect on activity, risking a slowdown in growth in late 2010 and early 2011 unless private investment and private consumption begin to pick up. 

A sustainable recovery in private investment and in private consumption not related to the stimulus, however, is likely to be held back by exceptionally large excess capacity, restricted credit availability due to ongoing deleveraging among banks and households in advanced economies, and a combination of higher unemployment and weak household incomes.  Consumption will be particularly weak in the U.S. and other advanced economies, with the consequence that household saving rates will rise and imports stagnate compared with the levels observed before the crisis.  Continued banking problems in the U.S. and Europe, or new waves of tension in financial markets, could dampen the recovery, or even trigger another contraction in activity. 

Concerns about premature withdrawal of stimulus or relaxing efforts to support domestic demand through expansionary fiscal and monetary policies, as a result, rightly preoccupy policymakers and were at the top of the agenda during the recent G20 Summit in Pittsburg and the IMF-World Bank meetings held last week in Istanbul. 

There is even discussion of additional stimulus in some developed countries, and policymakers have debated the possibility of extending extraordinary fiscal support after the current stimulus begins to wane.  Most governments plan to sustain the fiscal stimulus until recovery is on a firmer footing, but they recognize that the limits of what fiscal policy could accomplish will be reached faster unless private investors and consumers are reassured that governments have viable exit strategies in place to unwind the stimulus and reduce the debt burden over the medium term. 

In East Asia, the fiscal stimulus announced late last year, and in early 2009, amounted to about 9 percent of regional GDP, including the full size of the stimulus in China of 12 percent of GDP.  The government portion of the stimulus to be implemented in 2009 amounts to about 1.8 percent of GDP for the region on average, with a similar amount utilized in late 2008 and in 2010.  The region, as a result, compares favorably with the G-20, the U.S. and the EU separately.  Only Japan is implementing a larger stimulus in 2009 of about 3.5 percent of GDP. 

Even some of the low income countries in Asia that at the start of the year were considered by us as less likely to have fiscal space to implement fiscal stimulus have secured such space through a combination of increased lending from international donors and drawdowns of government deposits.  In Lao PDR, for example, government implemented a fiscal stimulus of about 3 percent of GDP, an effort that has helped limit the slowdown of growth there to 5 percent from 7 percent. 

Coping with the Social Impacts of the Crisis

While a global recovery is now in progress, the impact of East Asia’s slowdown in growth in has been disproportionate across countries - ultimately affecting low-income countries more heavily - and within countries - where it is those close to the poverty line or those losing jobs that are suffering most.  Globally, we estimate that because of the growth slowdown, 89 million more people will be living in extreme poverty on less than $1.25 a day by the end of 2010.  The corresponding figure on a $2 a day basis is as high as 120 million.  In the East Asia region, about 10 million more people will be unable to escape poverty as a result of the crisis.

While those in poverty are the most destitute, hardship has also spread to those that have lost jobs during the crisis.  Unemployment rates in most countries rose in late 2008 and early 2009 when exports and production hit their nadir, but increases have been modest in most countries in the region as most people in developing countries without adequate social safety nets cannot afford to stay unemployed.  Instead, people have either returned to the countryside or, to a much larger extent during the current crisis, found jobs in the informal sector, typically marginal urban service employment or government jobs created through fiscal stimulus packages. 

In China, for example, we estimate about a million formal sector jobs in manufacturing were lost early this year – together with perhaps 20 million or more manufacturing jobs held by migrants not counted in unemployment statistics were also lost.  At the same time, about half a million jobs in construction – related to the infrastructure component of the stimulus package were created, together with nearly a million public sector jobs.  In Thailand, a large part of the million formal sector workers that lost job have found employment in the service sector. 

We have evidence from past crises that shows that situations where growth collapses usually have serious effects on school enrollment, nutrition, and healthcare, especially of girls―effects that can cause irreversible damage to human development outcomes.  This underscores the importance of support to protect critical spending in poor countries.  A recent World Bank paper on low-income countries estimates that close to $12 billion of core public spending in these countries, including key programs in education, health, and social protection, is at risk as a result of the crisis.  Governments in East Asia have worked hard to protect such key programs and the amounts at risk in the region are limited.  Nonetheless, challenges for the authorities in the low-income countries are numerous and sustained support from international and bilateral donors will be needed. 

Prospects for the Medium Term

Policymakers and analysts are rightly preoccupied with developments in the near term.  But the outlook in the medium term is as important and poses just as large policy challenges.  Analysis carried out recently demonstrates that a substantial output gap – the difference between potential and actual GDP – will remain in both high-income and developing countries for five or even more years to come.  This sizable excess capacity will constrain investment, limiting scope for unemployment to decline and job opportunities for those in the informal sector to emerge.  The medium-term recovery in developed countries will remain moderate, even if ultimately the pace of growth picks up to the historical average. 

In this scenario, economic developments will create political pressures in developed and developing countries, and populist or protectionist temptations will likely increase.  Dealing with such temptations will remain critical in ensuring an open international and financial trade system.

As you all are aware, private capital flows to developing countries fell sharply last year.  Renewed investor appetite for emerging market assets has in recent months supported a recovery in emerging market sovereign bond issuance and purchases of emerging market equities, but foreign bank lending has continued to drop.  Inflows of foreign direct investment, meanwhile, set to remain constrained.  Overall, prospects for private capital flows to developing countries remain weak, and we estimate that total net private flows likely to drop in 2009 to one-third their peak of $1.2 trillion in 2007.  While East Asia has fared better than other developing regions, it has not emerged unscathed from the tight international credit markets, as balance of payments gaps in the few deficit countries, such as Vietnam, Lao PDR and many of the Pacific islands remain large. 

Given prospects for slower global recovery and slower growth in potential output among developed countries, it is important to ask whether the countries in East Asia can grow as fast as before the crisis.  This question is intimately linked to ongoing discussions whether the export-oriented model countries in the region have pursued needs to be changed, and if so in what manner. 

Before addressing this issue, it is important to note that openness and globalization have benefitted East Asia tremendously in the past, helping lift living standards at much faster pace than in other developing regions.  Countries will not be able to prosper without access to foreign export markets, foreign machinery and foreign capital.  Ensuring a strong pace of convergence to developed countries will increasingly require attention to developing a thriving domestic market, however. 

In China, for example, rebalancing growth to allow for robust expansion in domestic consumption will be a big challenge and but also an opportunity.  The government has focused reforms in two complimentary directions.  First, reducing the under-pricing of raw materials, energy, credit and labor will be crucial for success in these efforts in China, as will be proper land titling to enable farmers to pledge land as collateral for loans.  Second, introducing more comprehensive and better funded safety nets and education should help households over the medium- to longer-term to reduce large precautionary savings. 

Reforms to enable the domestic service sector to thrive are considered in other countries as well.  In Korea, for example, government is considering reducing tax incentives for exporters and opening up the service sector to competition, including from abroad.  The Malaysian government has moved forcefully in liberalizing the service sector by eliminating local-equity requirements for investment in 27 subsectors, including health, business services, tourism and transport, and by allowing foreign institutions to increase equity holdings in Malaysian financial institutions. 

While these efforts will be crucial for supporting stronger growth, ensuring sustained convergence will require a boost to innovation to lift companies from East Asia closer to the technological frontier.  Innovative companies need different institutions than companies that imitate, including more – rather than less – openness to trade and finance, enhanced flexibility of labor, product and financial markets, and better educated labor force. 

None of these components of a more dynamic societies and economies negates the need to ensure that financial markets are properly regulated to help limit the excesses that led to the global financial crisis.   

The Role of the World Bank Group

Let me turn to the role of the World Bank Group in helping developing countries tackle the global economic and financial crisis.  In response to the crisis, the World Bank Group in total delivered a record $59 billion of financial assistance during the fiscal year that ended in June 2009.  More than half of the total was accounted for by IBRD commitments that rose three-fold from the previous fiscal year. 

Our commitments to our poorest county members - - International Development Association - - were also at a record, and half of the projects from our private sector arm - - International Finance Corporation - - were also for the poorest countries.  You will also be aware of the critical role of our Multilateral Investment Guarantee Corporation – ably represented at this meeting by Executive Vice President Kobayashi.

In the current fiscal year, we expect to increase lending beyond last year’s totals.
As this crisis subsides, the Bank intends to play an even more active role in helping developing countries secure support to boost growth, accelerate progress toward poverty reduction and meeting the other Millennium Development Goals.  It will be important to ensure that the international financial institutions like the World Bank Group have adequate resources and instruments to play their part. 

Conclusion

Ladies and gentlemen: your Annual General Meeting takes place at a remarkable time in our region and globally.  As the world economy recovers from this severe economic and financial crisis, East Asia is emerging faster and stronger than other regions.  The effects of this recent crisis will last for an extended period of time, however.  Your Annual Meeting presents an excellent opportunity to share experiences and information, consider improved coordination within the group, and understand better the challenges lying ahead to ensure a sustained global recovery, so that they can be used effectively for improved trade and investment in your countries. The catalytic role your agencies perform in this regard will be critical.

Thank you again for inviting me to participate in this important event.

I wish you the best of success in your discussions.