III. Economic Developments and Adjustment, 1970–93
- Erik Offerdal, Kalpana Kochhar, Louis Dicks-Mireaux, Jianping Zhou, Mauro Mecagni, and Balázs Horváth
- Published Date:
- December 1996
The analysis in this section focuses on the shocks of the late 1970s and 1980s. The section also provides an overview of Thailand’s economic policy responses to the shocks.
During the second half of the 1970s in Thailand, in an attempt to revitalize the economy after the effects of the first oil shock, there was a rapid expansion of public expenditures, and industrial protection and incentives for private investment were increased substantially. Growth and investment picked up, but the public sector deficit widened, in part because prices of energy and other public services were not adjusted in line with costs. The external current account deficit widened dramatically to over 7 percent of GDP in the late 1970s, and external indebtedness rose from below 15 percent of GDP in the mid-1970s to about 35 percent by 1982-83 (Table 4). Thus, the Thai economy was already in a vulnerable position when it was hit with the adverse external shocks of the late 1970s and early 1980s.
|Real GDP growth||6.5||4.6||8.0||5.5||11.7||7.8|
|Real per capita GDP growth||3.4||1.9||5.7||3.4||9.3||6.3|
|Current account balance/GDP||-1.7||-2.4||-5.4||-4.3||-3.8||-6.3|
|Total factor productivity3||-0.2||-0.8||2.6||-0.6||6.5||1.6|
|Debt-service ratio (in percent of exports of goods and nonfactor services)||7.4||7.8||14.4||23.4||17.7||11.8|
|Memorandum: Real GDP growth valued at PPP4||5.9||3.9||7.9||4.5||11.1||6.5|
Shocks and Responses
During the 1980s the Thai economy faced two sets of macroeconomic shocks. The first set consisted of the second oil price shock in 1979 and the global recession, a decline in commodity prices, and the interest rate hikes of the early 1980s. The second shock was the surge in capital inflows that Thailand has experienced since 1987—in the forms of foreign direct investment from Japan and the Asian newly industrializing economies (NIEs: Hong Kong, Korea, Singapore, and Taiwan Province of China), portfolio capital, and commercial borrowing.
Between 1979 and 1982, the impact of the unfavorable external shocks amounted to a remarkable 11 percentage points of GDP, dominated by the effect of the terms of trade deterioration (equivalent to almost 8 percentage points of GDP).8 This deterioration arose largely because of the increase in oil prices in 1979-80 and the decline in commodity export prices (primarily of rice) in 1981-82 (Figure 3).
Figure 3.Terms of Trade Movements
Source: International Monetary Fund, International Financial Statistics (various issues).
How did the Thai economy respond to these adverse shocks? A useful approach to organizing the discussion of this question has been developed by McCarthy, Neary, and Zanalda (1994). In essence, the methodology involves estimating the impact effects on the balance of payments of the major shocks (changes in the terms of trade, fluctuations in world interest rates, and changes in global demand conditions),9 and then decomposing the economy’s response to these shocks into various measures of adjustment—through changes in export performance and the degree of import intensity or through a demand squeeze affecting the level of economic activity—and changes in the level of external financing.10 These responses are measured in terms of deviations from historical trends and obviously cannot be attributed simply to changes in policies, since many other factors could have been at work (including the lagged responses of the private sector to the exogenous shocks). However, the responses do give a broad indication of how the external sector adjustment was achieved.
Table 5 shows the magnitude of the shocks in percent of GDP and the responses of the economy, also as a ratio to GDP. Three distinct phases are discernible. First, between 1980 and 1982 the most significant outcome was a major reduction in import intensity, along with a modest improvement in export market shares. That real GDP growth was below trend during these years contributed to the decline in imports and to the improvement in the external current account, but this was much less important than the change in import intensity. Second, in 1983–86 the declining trend of import intensity was reversed. Third, during 1987–93 there were large increases in both export and import market shares.
|Phase of Adjustment||Total Shocks1||Change in Export Market Share2||Change in Import Intensity3||Change in Imports Attributed to Deviations of Output from Trend4||Average Growth in Import Volume (in percent)||Average Growth in Export Volume (in percent)|
|1987–93||2.7||17.5||–7.0||–1.9||19.6||18.3|Figure 4.Growth of Expenditure and Output
Sources: International Monetary Fund, International Financial Statistics (various issues);Thai authorities; and IMF staff estimates.
Notable points are the following. First, in the five years before the adjustment programs, consumption and investment by the public sector grew considerably more rapidly than that of their private sector counterparts. Second, during the adjustment period, there was a significant reduction in the growth of consumption and investment (especially public investment). Third, the growth in net exports during the adjustment period indicates that expenditure and production switching—primarily through a sharp reduction in imports and moderate growth in exports—played an important role in Thailand’s adjustment. Fourth, the growth in real absorption in the postadjustment phase was unprecedented, with the largest contribution being made by private investment. Gross investment as a share of GDP rose by over 15 percentage points between 1986 and 1993; indeed, national saving also rose during this period, and the share of consumption in GDP declined markedly. Fifth, the output gap measure suggests that output was significantly below potential during the entire adjustment period and that it was not until 1987 that output growth recovered to potential.
Linking Outcomes to Policies
What role did macroeconomic and structural policies play in generating the outcomes described above? With regard to responses to the first set of shocks, how was the decline in import intensity in the 1980–82 period achieved? Despite a nominal devaluation of about 9 percent in 1981, the real effective exchange rate (Figure 5) steadily appreciated between 1979 and 1984 as the U.S. dollar strengthened against other currencies. Movements in the real effective exchange rate thus do not appear to be consistent with a decline in import intensity. The answer appears to lie in three factors. First, despite the real appreciation of the baht, competitiveness as measured by relative unit labor costs was broadly unchanged during this period (see Figure 5).12 Closer examination of underlying trends reveals that although unit labor costs rose in Thailand, the increases were much smaller than in some of its major trading partners, particularly in the United States.
Figure 5.Exchange Rate Indices
Sources: International Monetary Fund, World Economic Outlook (various issues); IMF Information Notice System; and IMF staff estimates.
1Unit labor cost in Thailand relative to a trade-weighted average of unit labor costs in the United States, the United Kingdom, France, Germany, the Netherlands, Japan, Hong Kong, Singapore, Malaysia, Korea, and Taiwan Province of China.
Second, a change in the orientation of trade and industrial policy in favor of less import-intensive sectors occurred, despite the stated objective of trade reforms in this period to move away from the previous emphasis on import substitution. At first, in addition to the devaluation in 1981, export taxes were reduced, and an attempt was made to rationalize tariffs. However, budgetary problems quickly led to the imposition of import surcharges. Less import-intensive sectors such as agriculture and agroprocessing experienced an increase in the effective rate of protection (see Section VII). Third, expenditure reduction during this period was concentrated mainly in the import-intensive categories, primarily capital expenditures of the government and public enterprises. Thus, the appreciation of the baht combined with the increase in protection led to “inward-oriented” adjustment during this period. This mix of policies, which contributed to the tapering off of the export expansion, appears to have been detrimental to the recovery in growth, which remained below trend until 1986–87.
What factors accounted for the shift, in 1986–87, in the pattern of external adjustment to one driven almost entirely by increases in export market shares? A significant change in the policy mix occurred, starting with the nominal devaluation of the baht vis-à-vis the U.S. dollar in late 1984. The baht was devalued by nearly 15 percent in nominal terms just ahead of the Plaza Accord, and it subsequently was pegged to an undisclosed basket of currencies. As the dollar fell against the yen in the second half of the 1980s, the weight of the dollar in the basket was raised so that a significant nominal devaluation took place vis-à-vis the yen and some other East Asian currencies.
A dramatic reversal took place in the trend in the real effective exchange rate as the nominal devaluation was translated into a significant and sustained real effective depreciation, owing mainly to the support of conservative financial policies that kept inflation in check. The other important element of the shift in the policy mix was the massive tightening of fiscal policy, which served to accommodate the surge in export-oriented domestic and foreign-financed private investment. Also, export taxation was eliminated, and industrial policies were reoriented to take a proactive approach to export promotion, mainly through the provision of various tax incentives. The presence of generally flexible labor markets and the absence of systematic wage-price inertia were instrumental in generating the resource shifts necessary to produce the impressive supply response of the second half of the 1980s.
Although there was a marked slowdown in output growth in the immediate aftermath of the devaluation, in part owing to a decline in business confidence as banks and firms that had borrowed heavily from abroad suffered large losses when the currency was devalued, output growth rebounded sharply and relatively quickly. By 1987, the output gap had turned positive again. After a short lag following the devaluation, exports responded vigorously; since 1986, export volume growth averaged almost 18 percent annually.
The second shock that Thailand faced was the sharp increase in capital inflows beginning in 1987–88.13 Most of these inflows were attributable to foreign direct investment. The major causes for the inflows were the sharp depreciation of the baht vis-à-vis the currencies of several large East Asian economies and rising labor costs in these economies, which led, in turn, to considerable relocation of production to Thailand.14 For the most part, the surge in capital inflows was perceived by the authorities as a response to fundamental changes in the attractiveness of Thailand to foreign investors. However, the threat of overheating was also a major concern. The policy responses of the Thai authorities to these inflows reflected these concerns.
The first line of defense was the tightening of fiscal policy, a policy choice that was reinforced as the durability of the inflows and their impact on investment and growth became clear. Other policy responses included effective sterilization of monetary impulses and the maintenance of a generally tight monetary policy stance; selective reduction of trade barriers, especially beginning in 1991; liberalization of capital outflows, also since 1991; reductions of direct controls on interest rates and credit, since 1990; and the reimposition of a withholding tax on foreign borrowing. Together, these measures helped the authorities to accommodate the surge in capital inflows without a significant acceleration in inflation, and the increase in the investment rate contributed to the marked acceleration in growth.15
Investment and Saving
Figure 6 outlines the evolution of saving-investment balances since the early 1970s. Consumption smoothing in response to the first oil price shock led to a decline in saving while investment levels were maintained virtually unchanged. Widening current account imbalances mirrored the resulting saving-investment gap. The response to the second oil price shock was similar—investment rates were maintained largely unchanged in the early 1980s, and the saving rate, especially that of the private sector, again declined. The resulting external imbalances increasingly became a concern to the authorities. In response, the renewed macroeconomic adjustment efforts of 1984/85 had fiscal consolidation as their centerpiece. Public sector saving began its striking growth, and, with the marked increase in output growth that also occurred during this period, private saving and investment rates rose dramatically—reaching 25 percent and 32 percent of GDP, respectively, by the early 1990s.
Figure 6.Saving and Investment
Sources: International Monetary Fund, International Financial Statistics (various issues); and IMF staff estimates.
The behavior of private investment in Thailand since the mid-1980s prompts two questions. First, why was the initial decline in investment in the poststabilization period so short-lived, in contrast to the experience of many developing countries? Second, what factors accounted for the remarkable surge in investment in the second half of the 1980s?
Econometric evidence presented in the appendix suggests that the decline in private investment in the mid-1980s was attributable to high real interest rates and tight credit conditions. As regards the surge in private investment in the second half of the 1980s, although it can be ascribed in part to fortuitous exogenous developments—such as the currency realignments and rising labor costs in several East Asian countries—policy-related factors contributed significantly. The devaluation of the baht, buttressed by the conservative monetary policy stance, resulted in a marked improvement in competitiveness. Moreover, flexible labor markets (judged in terms of real wage flexibility and labor mobility) were an important factor underlying the developments in relative unit labor costs and, in turn, the favorable path of investment in both the stabilization period and beyond. The data also suggest that there is substitutability between public and private investment in Thailand, at least in the short term. A key implication of this result is that the surge in private investment could be accommodated without a significant acceleration in inflation because of the simultaneous rationalization and reduction of public expenditure, including on investment, that began in the late 1980s. However, the costs of this conservative public investment policy stance became increasingly apparent in the early 1990s, when severe infrastructure bottlenecks emerged.
Finally and crucially, overall macroeconomic stability, combined with the consistently pro-business orientation of the government, resulted in relatively low policy uncertainty and has proven to be conducive to private investment, both domestic and foreign. The absence of a significant and prolonged decline in investment during and after the stabilization phase is, in large part, attributable to these characteristics of economic policies as well as to the existence of a well-developed and dynamic private sector.
As regards the behavior of saving, it is clear that the increase in national saving (as well as the large private capital inflows) played a key role by providing noninflationary financing for the investment boom. Econometric evidence on the determinants of saving in Thailand, from internal IMF staff studies, suggests that three factors account for the bulk of the increase in the saving rate. First, the strong increase in public saving that accompanied the fiscal consolidation of the late 1980s is estimated to have increased the gross national saving rate by over 6 percentage points. The evidence also indicates that, contrary to the general experience in most developing countries, changes in public saving did not have a significant offsetting impact on private saving. Second, the sustained rapid growth in private disposable incomes was instrumental in raising the rate of private saving. Finally, substantial demographic changes, reflected in the increase in the working-age population, contributed in important ways to the sharp rise in saving.