How international economic links affect East Asia

The author applies the theme of the last two papers in the Global Economic Prospects series, written by the International Economics Department, to the case of one developing region: East Asia. He documents the rapid integration of the East Asian economies into the world economy through trade and foreign direct investment, and suggests that this has helped create a relatively well-diversified structure of production and of external markets. As a result, East Asia was relatively unaffected by the great terms-of-trade shocks experienced by other developing countries in the 1980s. East Asia's creditworthiness in international financial markets meant that (except for the Philippines) it could maintain access to external capital flows during the world years of the debt crisis. East Asia's close economic links with the rest of the world makes the region particularly vulnerable to shocks originating externally. Simulations suggest that its growth rate is closely related to the growth rate of the OECD economies, even if its export markets are more diversified than those of other developing regions. Similarly, given the strength of its export drive to the industrial economies in the last two decades, especially in the labor-intensive products, East Asia would stand to gain the most from a successful Uruguay Round. By the same token, it would hurt more if the Uruguay Round failed and industrial protection increased as a result. So, East Asia must closely watch developments involving the North America Free Trade Agreement (NAFTA). Although preliminary analysis suggests that the immediate trade consequences of NAFTA would be negligible for East Asia, the longer-run consequences for foreign direct investment and trade flows are more difficult to predict. Finally, the region's strong physical and institutional infrastructure, its outwardly oriented trade policies, and its well-developed human resource base, have attracted a large share of incremental private capital flows to developing countries. But such flows are volatile and sensitive to macroeconomic conditions and the regulatory environment in host countries. Were these conditions to change in East Asia and inhibit foreign direct investment and private portfolio flows, the region's rapid transformation into a competitive producer of manufactures would be affected adversely.