Until very recently, I had been declining the request to give a talk about Asia for various reasons. Sometimes the schedule simply didn't work out. Sometimes I had absolutely no idea about the topic. But then I felt pretty bad about refusing to go all this time and finally accepted participate in a student-organized project.
I still don't know what I will be talking about. but this is the slides (will be revised a lot, probably). I really don't think there has been any `pivot'. But the underlying conditions suggest that Asian countries will have to make some choices pretty soon. And the data suggests that keeping status quo (not really using more RMB) would be the right choice.
Wednesday, April 13, 2016
In Demanding Revolution, David Steinberg proposes a convincing theoretical framework, namely,``conditional preference theory'', to answer the question, `why undervaluation is so rare despite its unequivocal economic benefit?'. He suggests that strong manufacturing sectors support undervaluation when and only when the cost the policy incurs to them is reduced by the government. These costs, including increasing wage levels and imported input costs as well as decreasing access to credits, can be reduced when 1) financial institutions are controlled by governments (such that banks are forced to provide cheap credits -- ``financial repression'') and/or 2) labor rights are limited (such that upward wage pressures are suppressed).
The empirical evidence he presents lends strong support to this framework. Using a mixture of quantitative and qualitative evidence, he shows that undervaluation is most likely in countries where 1) manufacturing sector accounts for large parts of the national economy, 2) labor rights are limited, and 3) banks are, at least partially, nationalized. While the quantitative evidence neatly illustrates this evidence in a cross-sectional time-series manner (although I believe Figure 2.3 can be drawn better), the beauty of the empirical analysis of the book is in the case studies. Of the five country cases studied, China and Korea confirms one side of the story, namely that sustained (though intermittently interrupted) periods of undervaluation was made possible by strictly controlled labor and banks combined with large manufacturing sectors. The cases of Argentina and Mexico, on the other hand, illustrate the prevalence of overvaluation when the condition present in China and Korea are absent (and the policy debates were overwhelmed by extraordinary levels of inflations) even though manufacturing sectors were fairly strong. The Iranian case represents a rather odd scenario where manufacturing sector is weak and commodity export is dominant in the national economy.
While I thoroughly enjoyed the book, a few aspects of it struck me as unclear, asking for further investigations. First, what was the role of the state, particularly in the cases of China and Korea? The conditional preference theory essentially is interest group theory, assuming that the strong interest groups' preference translates into policies without much interference of the state. But the very conditions that enabled undervaluation in these cases--nationalized banks and controlled labor--is the products of strong, autonomous states. Indeed manufacturing sectors were nurtured by states in its infant stages and elevated to the `strong' status through deliberate government actions; undervaluation was one of those. Granted, in the later stages, that is the 1990s for Korea and 2000s for China, industrialists outgrew the influence of the state and rather dictated exchange rate policies in some ways. This was not true, however, for the majority of the times that the book covers. (To be fair, the author does address this issue here and there, but I think this state-society(business) issue needs to be more seriously handled, preferably in the theory section)
Second, in a similar vein, the external factors are not modeled in the conditional preference theory. The big difference between China/Korea and Argentina/Mexico, however, is their industrialists' access to foreign credits. In the former, individual firms' foreign borrowing had been substantially limited until financial liberalization (which really hasn't come to China even these days) and the degree to which the global interests rates influenced domestic markets was much narrower in these countries than in Argentina and Mexico. Again, the book does explain this part in the empirical section, but more as a sideway show that occasionally conditions each state's policy choices, not as a main independent variable.
Overall, the book significantly extends our understanding of monetary policies of developing countries. The literature does not really go beyond ``competent Asian states = undervaluation / incompetent Latin American-African states = overvaluation''. The book provides much more in-depth theorizing with convincing empirical evidence. I would use this for my graduate seminar.