JOINT SERIES OF COMPETITIVENESS NUMBER 21 MARCH 2 IMPACT OF ASIAN FLU ON CANADIAN EXPORTS, WITH SPECIAL REFERENCE TO WESTERN CANADA Dick Beason, PhD Abstract: In this paper it is found that the overall impact of the Asian financial and economic crisis on Canadian exports was largely mitigated by robust exports to the rest of the world, especially the US. Unfortunately, Western Canadian exports are far more exposed to Asia than is the case in Central Canada. Notwithstanding this, the Asian crisis has had far less negative impact on Western Canada than was originally feared, and the region has recovered fairly quickly. As well as benefiting from rising resource prices, Western Canada should see growth in both the volume and value of exports. The author gratefully acknowledges the support of the Centre for International Business Studies and the Western Centre for Economic Research, University of Alberta. Visit our web site at www.bus.ualberta.ca/cibs-wcer/
Canadian Cataloguing in Publication Data Beason, Richard. Impact of Asian flu on Canadian exports, with special reference to Western Canada (Joint series of competitiveness ; 21) Includes bibliographical references. ISBN 1-55195-59-6 1. Exports--Canada. 2. Canada, Western--Commerce--Asia. 3. Asia-- Commerce--Canada, Western. I. University of Alberta. Centre for International Business Studies. II. Title. III. Series: Joint series on competitiveness ; 21. HF3229.W57B42 2 382.6 971 C-91413-5 Joint Series of Competitiveness No. 21, May 2 Page ii
MOTIVATION It is typically taken for granted that the factors which led to the meltdown of Asian financial markets during the period July- November 1997 were pure contagion effects. Indeed, so widespread were the fears that the crisis had de-linked from fundamentals and might threaten world financial markets that then Treasury Secretary Rubin began immediate work on emergency financial rescue packages. These have now all been largely implemented, and a consensus has emerged that the response amounted to overkill. The exceptions are the basket cases, countries such as Malaysia and Indonesia, with deep fundamental economic and political problems. In earlier work on this issue, Beason and Hsin (1999) found that there was never compelling evidence of pure contagion effects after the initial Asian collapse. That is, as is well known, all markets tend to be highly correlated with one another in the very short run, and this correlation tends to match very strongly the correlation between markets in the rest of the world with respect to the US. Even in this case, however, experience has shown us that the pure contagion element tends to be short lived, with most financial markets quickly returning to being driven by their own fundamentals. The best example of this is Black Monday in 1987, when most world markets were back on track within a few short weeks. The same sorts of dire consequences came to be expected for world trade as for financial markets after the Asian crisis began. Despite the fact that the US export ratio is only in the 12-13% range, and the same is true of Japan s, many US policy makers were predicting the collapse of the American and Japanese economies on the back of the Asian crisis. Eventually, this twisted logic even blamed Japan for the Asian collapse, especially the collapse of Asian exports to Japan. While it is certainly the case that Asian exports to Japan had seen weakness, this was in result to increasing weakness in the Japanese economy during the entire period 199-1998, and was certainly not a new factor that dramatically appeared in the summer of 1997. Clearly, the crisis in Asia during 1997 was homegrown, and not a response to weakness in the Japanese economy. In this paper, the impact of the Asian Flu experience on Canadian exports is summarized, and the stylized facts are clarified. It was found that Canadian exports as a whole were remarkably robust during the Asian crisis, and this robustness is attributed to the geographical diversity with respect to trade partners. Unfortunately, this diversity has tended to work against Western Canada, with its closer ties to Asia. This work is framed in the context of earlier work on contagion effects in world financial markets during the Asian Flu episode. That is, the temporary linking of markets very quickly gives way to markets being driven in accordance with their own fundamentals. Here, one expects to find geographic diversity which will have mitigated to some extent the initial negative impact on exports. That is, while the events of mid-late 1997 certainly had an impact on Canadian exports, it is argued that the diversity of that impact makes it inaccurate to characterize the episode as one of contagion. Just as world financial markets survived the Asian crisis, so has world trade. STYLIZED FACTS First of all, while there can be little doubt that the crash in Asia caused Canadian exports to flatten, there is certainly no evidence of a collapse in Canadian exports in response to these events (Figure 1). This should not be surprising. Canada s largest trade partner by far is the United States, and the US economy has continued to be robust, driving rapid import growth and the current account deficit. As such, the detrimental impact of the Asian crisis was mitigated to some extent by the robust US economy. Joint Series of Competitiveness No. 21, May 2 Page 1
Figure 1: Canada s Exports 1988-1998* (millions of dollars) 1,4 1,2 1, 8 6 4 2 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). Indeed, this is precisely the pattern that is obtained, with Canadian exports to Asia collapsing with virtually no time lag from July 1997 onward. The sharp collapse was exacerbated by the phenomenal growth in exports to Asia from the early to mid-199s, and public policy had changed dramatically since then to reflect that growth (Figure 2). Thus, it was all the more devastating when the crash came, and that it came so suddenly. This also did much to destroy the credibility of those who had argued that such trade with Asia represented a healthy diversification away from the dependence upon the US. Indeed, it was trade with the US which rescued Canada from disastrous consequences of the collapse in Asian trade. Figure 2: Canada s Exports to Asia: 1988 1998* (millions of dollars) 12 1 8 6 4 2 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). Joint Series of Competitiveness No. 21, May 2 Page 2
Exports to the US remained very robust just as exports to Asia were collapsing (Figure 3). Indeed, since 1997, the US economy has continued along a growth trend which is accelerating without significant evidence of inflation. Very recently, US imports have been surging, as domestic production is simply not capable of satisfying domestic demand. Canadian policy makers had made essentially the same mistakes as their American counterparts in assuming that the Asian crisis would have dire consequences, but perhaps even more serious mistakes in having pursued aggressive diversification strategies over the previous years. One can be thankful that they did not work for the most part. Figure 3: Canada s Exports to the US: 1988-1998* (millions of dollars) 1,2 1, 8 6 4 2 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). Some other interesting stylized facts emerge as well. Japan was largely lumped together with the rest of Asia after the 1997 crash. Indeed, there was even a tendency to pin much of the blame for the Asian crisis on Japan. In fact, exports to Japan were on a strong recovery trend after 1995 until the period of the Asian crisis, after which time they leveled off (Figure 4). This leveling off, while not a collapse, did represent a break in the earlier positive trend. Of course, this is almost certainly the result of third country effects. Ceteris paribus, exports to Japan would probably have continued to grow, but because of the crisis in Asia, Japanese importers decided to play cautiously until the dust had settled. Simultaneously, Japan s economy slowed during 1997 in response to ill-timed fiscal tightening, and this weakness was entirely independent of events in the rest of Asia. As a consequence, exports to Japan did not see a sharp collapse, but neither did they resume their growth trajectory. Joint Series of Competitiveness No. 21, May 2 Page 3
Figure 4: Canada s Export to Japan: 1988-1998* (millions of dollars) 5 4 3 2 1 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). While somewhat unrelated to the topic of this paper, the chart for Canadian exports to Japan demonstrates something else of interest. For the most part, a chart of the rest of world exports to Japan would look very similar to this chart, and shows that from early 1995 until early 1997, Japanese imports from the rest of the world were recovering. This is not surprising. The yen had strengthened dramatically from the period 1994-96, and the economy had begun to improve during 1995-1996. From 1997, the collapse of demand in Asia and the ill-timed fiscal policy moves worked to send the Japanese economy reeling again. However, imports simply remained flat rather than showing any signs of collapsing. On this basis, what can be said is that arguments that Japan was bringing the rest of Asia down, as former Treasury Secretary Rubin used to insist, were patently false. Japan, if anything, was giving the rest of Asia a boost prior to the events of 1997, and it would be a stretch to place blame for the events of July-October 1997 on Japan. WESTERN CANADA Unfortunately, the Western Canadian experience was a bit different from that of the rest of Canada, in the sense that more of the bad and less of the good passed through to our economies than to the country as a whole. Our focus will be on Alberta, but much of what can be said here can be generalized for all of Western Canada. First and foremost, Western Canada saw the same essential decline in exports to Asia, but at the same time saw exports to the US weaken. There are likely a number of explanations for this, but among them would be that US imports came to be more heavily manufacturing-focused as the US economy continued along its robust growth path. This meant that manufacturing exporters like Ontario benefited from growth in exports to the US, but Western Canada failed to reap the same benefits. Also, resource prices began to soften from 1997 until mid 1999. While this coincided with a weaker Canadian dollar, so that the real Canadian dollar value of exports did not contract as much as they might otherwise have, there can be no doubt that this resource price weakness adversely affected Western Canada. Joint Series of Competitiveness No. 21, May 2 Page 4
Figure 5: Alberta s Exports: 1988-1998* (millions of dollars) 14 12 1 6 4 2 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). Indeed, Alberta s world exports began a declining trend almost identically timed to the Asian crisis (Figure 5 above). The interesting fact is that in stark contrast to the figures for all of Canada, Alberta s exports to both Asia and the US weaken at roughly the same time (Figures 6 and 7 below), so that Alberta absorbed the double burden of declining exports to Asia and the US. It will be recalled that commodity prices were generally weak during the period of the Asian crisis and did not strengthen significantly until 1999. British Columbia suffered a significant meltdown in tourism income as a result of the Asian crisis. As such Western Canada suffered the brunt of the Asian crisis while missing most of the benefits of the manufacturing boom in Central Canada. Figure 6: Alberta s Exports to Asia: 1988-98* (millions of dollars) 2 15 1 5 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). Joint Series of Competitiveness No. 21, May 2 Page 5
In fact, Alberta s exports to Asia had already entered a downward trend in 1995. There are a number of reasons for this, but two of them focus on Japan. First, the boom in housing, especially in lower end housing, which had been barreling ahead since 1993 began to slow into 1995-96. This was partly policy driven, but related more to saturation of the low end of the Japanese housing market. Many Alberta manufacturers are directly tied into the Japanese low end housing market. The other factor is that the strong Alberta focus on Japan within Asia meant it was quite exposed to weak Japanese demand well before the Asian crash of 1997 (Figure 8 below). The later crash simply added to Alberta s woes over Asian exports. Figure 7: Alberta s Exports to the US: 1988-98* (millions of dollars) 12 1 8 6 4 2 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). Unfortunately Alberta, along with much of Western Canada, could not seek respite in boosting exports to the US, though this certainly occurred at the level of the economy as a whole. This result should not be unexpected. Many of the goods which Alberta ships directly to Asia are also the types of goods shipped to US manufacturers, who in turn export to Asia. Again, examples might be housing-related products and agricultural commodities. Many housing producers in the US import lumber and other goods from Canada, and it is well known that the housing market in Japan and the rest of Asia did poorly after the crash. Also, agricultural forage, some of which is exported to the US for production of value added forage products, became particularly vulnerable after the crash. Thus, it is not completely surprising that some of the support that Western Canada might have enjoyed by being able to offset declining Asian exports by growing US exports was simply not available. Joint Series of Competitiveness No. 21, May 2 Page 6
Figure 8: Alberta s Exports to Japan: 1988-98* (millions of dollars) 8 7 6 5 4 3 2 1 *Values are in Canadian dollars deflated by Canadian export price index, based on 1975=1 (seasonally adjusted). LESSONS LEARNED As obvious as the findings may seem, there is room for disagreement on whether the Asian crash actually contributed to a fundamental change in Canadian export behavior. Perhaps the most important issues surround the adjustment of trade flows to exchange rate changes. These would have both positive and negative impact upon Canadian exports in value terms. For example, on the positive front, the weak Canadian dollar presumably promoted exports to the US (for the country as a whole, at least), thereby mitigating the impact of the Asian crisis. On the other hand, the collapse of the Asian currencies presumably harmed Canadian exports, especially Western Canadian exports to Asia. Overall, how do the combined effects of currency values, Asian economic collapse, and US robustness combine to explain Canadian trade patterns after the Asian crash? It is to these issues that we presently turn. While a formal analysis is somewhat beyond the scope of this paper, it is nevertheless worthwhile describing some of the general findings of such an exercise. This can be explored by means of a simple model of export performance, where exports measured in local currency terms are a function of the exchange rate and economic performance of our trade partner. Using such a model and including a time trend, it is found that the model performs reasonably well as an indicator of Canadian export performance. Using Alberta as a proxy for all of Western Canada, it is found that the model performs less well, given the even greater dependence and correlation to Asian exports as a whole. Again, one can attribute this to the greater Canada-wide dependence upon exports to the US, and the impact of the Canada-US exchange rate. Not withstanding this, it is interesting to question whether there was indeed any pure contagion effect attributable to Asian Flu on exports, either at the national or provincial level. In order to answer this, it was necessary to examine whether export behaviour could be explained by factors external to partner performance or exchange rates. Evidence to support any pure contagion effects on levels of Canadian or Alberta exports after the Asian crash were not found. That is, once fundamental factors, including economic performance of trading partners is included, there are no significant effects which one could identify as pure contagion. This is reassuring, and allows some conclusions to be drawn. First, it can be concluded that for Canadian exports as a whole, the Asian crisis did little more than contribute to a slowing of what was otherwise robust growth. No fundamental break was detected. For Western Canada, on the Joint Series of Competitiveness No. 21, May 2 Page 7
other hand, the decline in Asian exports produced a significant negative impact on overall exports. That this came at a time of weak commodity prices did not help matters. In terms of policy, there has been a significant push for diversification of trade to Asia, and it might be argued that this policy was ill-conceived. Indeed, most of the rhetoric surrounding the diversification policies took it for granted that Asia would remain a high growth region. Now that Asia is on the rebound, we may be able to enjoy the benefits of these policies. Still, a clear lesson has emerged: policy formation on the basis of extrapolation of past trends is a dangerous business. REFERENCES Beason, D. and Chinwen Hsin, Contagion Effects and Asian Flu, Asia Pacific Journal of Finance., Vol.2, pp. 21-37, May 1999. Joint Series of Competitiveness No. 21, May 2 Page 8