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p. 11 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world Overview of economic highlights and prospects Export or domestic demand-led growth in developing Asia? Introduction Export-led growth strategy Definition of domestic demand- and export-led growth strategies Demand-side growth-accounting exercise Decomposition analysis of stances in the private, government, and trade sectors Comparison of expenditure shares of open European countries and selected countries in the Asia-Pacific region Summary and conclusions Endnotes and references II. Economic trends and prospects in developing Asia III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : I. Developing Asia and the world

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Export-led growth strategy

Overview

Export-led growth is a term used loosely to refer to a strategy comprising the encouragement of and support for production for exports. The rationale lies in the belief of many economists that trade is the engine of growth, in the sense that it can contribute to a more efficient allocation of resources within countries as well as transmit growth across countries and regions. Exports, and export policies in particular, are regarded as crucial growth stimulators. Exporting is an efficient means of introducing new technologies, both to the exporting firms in particular and to the rest of the economy, and exports are a channel for learning and technological advancement. Moreover, the growth of exports plays a major part in the growth process by stimulating demand and encouraging savings and capital accumulation, and, because exports increase the supply potential of the economy, by raising the capacity to import.

Mercantilist economists believed that the wealth of a country should be measured by the extent of the accumulation of precious metals and placed a great emphasis on achieving trade surpluses. Classical economists, on the other hand, argued that trade was welfare improving because it led to an efficient use of resources in each country, in the sense that countries would produce and export the products in which they have a comparative advantage, and import the products in which they have a comparative disadvantage. It could even be said that the purpose of trade, from a classical point of view, is imports. Exports are simply the way to pay for imports. In this sense, there is also an emphasis on the importance of exports, although of different nature.

As a development strategy, the classical belief was that development could be transmitted through trade. Classical economists justified the benefits of exports with the traditional argument of comparative advantage. Accordingly, opening up a country's market to the international markets allows a country more efficient production and allocation of resources as the country can concentrate on the production of goods in which it has a comparative advantage based on its factor endowments. Thus, world trade markets allow producers and consumers of the participating countries to benefit from lower prices, higher-quality products, more diverse supply of goods, and higher growth. The export-led growth model seemed initially to have been vindicated with the success of Asia's miracle countries, which achieved extraordinarily high growth between the 1970s and mid-1990s, supposedly through export promotion. Since the eruption of the Asian crisis, however, some sectors have expressed increasing doubts as to the feasibility of export-led growth for many developing countries (Felipe 2003).

Recent decades have brought about other important justifications for export promotion. Some of these are:

• Participating in trade, especially export production and promotion, exposes a country to the latest and most advanced production and marketing techniques, and a "learning-by-doing" process that brings about dynamic innovation and technological diffusion into the economy. It also drives a country to higher production and to economies of scale, which lead to increasing returns (Felipe 2003).
• Many development economists use the "two-gap or three-gap" models of Taylor (1993) to justify the need to earn foreign exchange via exports. According to these models, the investment-savings gap and the foreign exchange gap are major obstacles to the growth and development of many developing countries. Since countries need precious foreign exchange for their development needs (capital goods, industrial raw materials, oil, and food), export earnings are a more efficient means to finance these needs than foreign debt since the latter is vulnerable to adverse exogenous shocks and currency risks that may lead to debt defaults.
• A similar argument (McCombie and Thirlwall 1994) claims that large balance-of-payment deficits, spurred by large import propensities or elasticities, may be a hindrance to growth for many developing countries. Thus, moderate trade deficits, or trade surpluses, are more desired. This, of course, implies that export growth should be in pace with, or ahead of, import growth.
• Felipe (2003) also argues that export-led strategies allow an expansion of aggregate demand without much inflationary pressure and without the danger of a wage-price spiral, compared with strong domestic demand injections. This partly stems from the real appreciation of the currency that results from large export earnings, which tame inflation and allow real wages to rise.

A rationale for domestic demand-led growth?

It is important to mention that while the literature on growth and development considers the export-led growth strategy, the "domestic demand-led growth strategy" is not a term defined and used (hence it has to be defined here, in particular for purposes of empirical implementation--see "Definition of domestic demand- and export-led strategies," below).³ Therefore, it is not straightforward to place the "debate" between export-led and domestic demand-led growth strategies in a theoretical context.

In recent years, however, a series of economists have hypothesized that, the Asian crisis had very different roots and that after several decades of being presented as the optimal growth strategy, the export-led growth model that the Asian countries followed ultimately gave in and even harmed the growth prospects of developing countries. These economists have put together a critique of the export-led growth model and proposed a shift toward domestic demand-led growth.

Palley (2002), for example, has argued that the emphasis on export-led growth of most Asian countries had a series of negative effects. First, it prevented the development of domestic market growth. Second, it put developing countries in a "race to the bottom" among themselves. Third, it placed workers in developing countries in conflict with workers in industrial countries. Fourth, there is a relationship between export-led growth and financial instability through the creation of overinvestment booms. Fifth, due to the emphasis placed on global goods and commodity markets, this model has aggravated the long-trend deterioration in developing-country terms of trade. And finally, and most important, export-led growth has reinforced the dependency of developing countries on industrial countries, thus rendering them vulnerable to slowdowns in industrial-country markets (e.g., as in the slowdown of the semiconductor world market in 1996-97 right before the Asian crisis). Export-oriented economies are dependent on foreign (mostly Western) demand. The problem is that recessions in Europe, US, or Japan translate into slow growth in the developing world. Summing up, Palley (2002) argued that the export-led growth model that the Asian countries followed for several decades is no longer an optimal strategy.

Blecker (2002, 2003) has also contended that the adoption of a development strategy that relied on high rates of growth of manufactured exports is the root cause of the problems that led to the crisis, for such a strategy led to growing excess capacity, intensified competitive pressures, and disappointing growth performance. In a similar vein, Kaplinsky (2000) and Erturk (2001-2002) have suggested the possibility of immiserizing growth as a result of the creation of excess capacity in export-oriented manufacturing industries. During the 1990s, too many developing countries entered the more advanced product categories, thus creating excess capacity and fostering falling prices.

Blecker (2002, 2003) has also argued that reliance on export growth suffers from a "fallacy of composition." The reason is that, if too many countries try simultaneously to rely on export-led growth policies to stimulate growth in a given set of global demand conditions, the market for developing countries' exports is limited by the capacity of the industrial nations. If demand in the industrial countries stagnates, it translates into overinvestment and excess capacity in developing countries. As Asian countries plunged into the crisis, the first policy option they all considered as a means of resuming growth was the export-led strategy. However, the difficulty with this strategy is that the fallacy of composition problem has been exacerbated, since during the last decade the PRC has been added into the equation. Export-led growth operates through a hierarchical process with less-developed newcomers replacing more maturing export economies as their wages grow. The PRC poses an entirely different problem for it has a fairly large supply of labor so that it can keep wages very low and, seemingly, for a long time.

Blecker summarizes his views as follows: "the current emphasis on export-led growth in developing countries is not a viable basis on which all countries can grow together under present structural conditions and macroeconomic policies" (Blecker 2003). Palley (2002) has gone further and contends that the export-led growth model followed by many developing countries during the last few decades was part of the "Washington consensus" emphasis on trade liberalization.⁴ As a solution, Palley proposes a new development paradigm based on domestic demand-led growth.⁵

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