Chapter 22 Chapter 22 Developing Countries: Developing Countries: Growth, Crisis, and Reform Growth, Crisis, and Reform Prepared by Iordanis Petsas To Accompany International Economics: Theory and Policy International Economics: Theory and Policy , Sixth Edition by Paul R. Krugman and Maurice Obstfeld
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Reforming the World’s Financial “Architecture” Summary
Introduction The macroeconomic problems of the world’s
developing countries affect the stability of the entireinternational economy.• There has been greater economic dependency between
developing and industrial countries since WWII.
This chapter examines the macroeconomic problemsof developing countries and the repercussions ofthose problems on the developed countries.• Example: Causes and effects of the East Asian
The macroeconomic problems of the world’sdeveloping countries affect the stability of the entireinternational economy.• There has been greater economic dependency between
developing and industrial countries since WWII.
This chapter examines the macroeconomic problemsof developing countries and the repercussions ofthose problems on the developed countries.• Example: Causes and effects of the East Asian
financial crisis in 1997
The Gap Between Rich and Poor• The world's economies can be divided into four main
categories according to their annual per-capita incomelevels:
Inflation and the 1980s Debt Crisis in Latin America• In the 1970s, as the Bretton Woods system collapsed,
countries in Latin America entered an era of inferiormacroeconomic performance.
• Unsuccessful Assaults on Inflation: The Tablitas ofthe 1970s
– 1978– Argentina, Chile, and Uruguay all turned to a new exchange-
rate-based strategy in the hope of taming inflation.
– Tablita– It is a preannounced schedule of declining rates of domestic
currency depreciation against the U.S. dollar.
– It is a type of exchange rate regime known as a crawling peg.
– It declined the rate of currency depreciation against the dollarby reducing the rate of increase in the prices of internationallytradable goods to force overall inflation down.
• Unsuccessful Assaults on Inflation: The Tablitas ofthe 1970s
– 1978– Argentina, Chile, and Uruguay all turned to a new exchange-
rate-based strategy in the hope of taming inflation.
– Tablita– It is a preannounced schedule of declining rates of domestic
currency depreciation against the U.S. dollar.
– It is a type of exchange rate regime known as a crawling peg.
– It declined the rate of currency depreciation against the dollarby reducing the rate of increase in the prices of internationallytradable goods to force overall inflation down.
Figure 22-3: Current Account Deficits and Real Currency Appreciationin Four Stabilizing Economies, 1976-1997
• Mexico– 1987 – It introduced a broad stabilization and reform
program and fixed its peso’s exchange rate against theU.S. dollar.
– 1989-1991 – It moved to a crawling peg and crawlingband.
– 1994 – It joined the North American Free Trade Areaand achieved 7% inflation.
East Asia: Success and Crisis
The East Asian Economic Miracle• Until 1997 the countries of East Asia were having very
high growth rates.• What are the ingredients for the success of the East
Asian Miracle?– High saving and investment rates– Strong emphasis on education– Stable macroeconomic environment– Free from high inflation or major economic slumps– High share of trade in GDP
The East Asian Economic Miracle• Until 1997 the countries of East Asia were having very
high growth rates.• What are the ingredients for the success of the East
Asian Miracle?– High saving and investment rates– Strong emphasis on education– Stable macroeconomic environment– Free from high inflation or major economic slumps– High share of trade in GDP
East Asia: Success and CrisisTable 22-4: East Asian CA/GDP
Asian Weaknesses• Three weaknesses in the Asian economies’ structures
became apparent with the 1997 financial crisis:– Productivity
– Rapid growth of production inputs but little increase in theoutput per unit of input
– Banking regulation– Poor state of banking regulation
– Legal framework– Lack of a good legal framework for dealing with companies in
trouble
The Asian Financial Crisis• It stared on July 2, 1997 with the devaluation of the
Thai baht.
• The sharp drop in the Thai currency was followed byspeculation against the currencies of: Malaysia,Indonesia, and South Korea.
– All of the afflicted countries except Malaysia turned tothe IMF for assistance.
• The downturn in East Asia was “V-shaped”: after thesharp output contraction in 1998, growth returned in1999 as depreciated currencies spurred higher exports.
The Asian Financial Crisis• It stared on July 2, 1997 with the devaluation of the
Thai baht.
• The sharp drop in the Thai currency was followed byspeculation against the currencies of: Malaysia,Indonesia, and South Korea.
– All of the afflicted countries except Malaysia turned tothe IMF for assistance.
• The downturn in East Asia was “V-shaped”: after thesharp output contraction in 1998, growth returned in1999 as depreciated currencies spurred higher exports.
East Asia: Success and CrisisTable 22-5: Growth and the Current Account,
The lessons from developing country crises aresummarized as:• Choosing the right exchange rate regime
• The central importance of banking
• The proper sequence of reform measures
• The importance of contagion
Reforming the World’sFinancial “Architecture”
The Asian crisis convinced nearly everyone of anurgent need for rethinking international monetaryrelations because of two reasons:• The fact that the East Asian countries had few apparent
problems before their crisis struck
• The apparent strength of contagion through theinternational capital markets
The Asian crisis convinced nearly everyone of anurgent need for rethinking international monetaryrelations because of two reasons:• The fact that the East Asian countries had few apparent
problems before their crisis struck
• The apparent strength of contagion through theinternational capital markets
Capital Mobility and the Trilemma of the ExchangeRate Regime• The macroeconomic policy trilemma for open
economies:– Independence in monetary policy
– Stability in the exchange rate
– Free movement of capital
• Only two of the three goals can be reachedsimultaneously.
• Exchange rate stability is more important fordeveloping than developed countries.
A Confused Future• In the years to come, developing countries will
experiment with:– Floating exchange rates
– Capital controls
– Currency boards
– Abolition of national currencies and adoption of thedollar or euro for domestic transactions
Summary
There are vast differences in per-capita incomebetween countries at different stages of economicdevelopment.
Because many developing economies offerpotentially rich opportunities for investment, it isnatural that they have current account deficits andborrow from richer countries.
In the 1970s countries in Latin America entered anera of distinctly inferior macroeconomicperformance.
There are vast differences in per-capita incomebetween countries at different stages of economicdevelopment.
Because many developing economies offerpotentially rich opportunities for investment, it isnatural that they have current account deficits andborrow from richer countries.
In the 1970s countries in Latin America entered anera of distinctly inferior macroeconomicperformance.
Summary
Despite their excellent records of high output growthand low inflation, key developing countries in EastAsia were hit by currency depreciation in 1997.
Proposals to reform the international architecture canbe grouped as preventive measures or as ex-postmeasures.• The architecture that will ultimately emerge is not at
Despite their excellent records of high output growthand low inflation, key developing countries in EastAsia were hit by currency depreciation in 1997.
Proposals to reform the international architecture canbe grouped as preventive measures or as ex-postmeasures.• The architecture that will ultimately emerge is not at