the asian recession and northern labour markets

58 ECONOMIC RECORD MARCH

58

copy 2004 The Economic Society of Australia ISSN 0013ndash0249

THE ECONOMIC RECORD VOL 80 NO 248 MARCH 2004 58ndash 75

The Asian Recession and Northern Labour Markets

ROD TYERSFaculty of Economics and Commerce Australian

National University Canberra Australia

YONGZHENG YANGInternational Monetary Fund Washington

DC USA

The Asian recession saw an increase in the volume of mainlymanufactured Asian exports Other things equal this would have dis-advantaged the labour intensive end of northern (mainly USA andEU) manufacturing and hence the northern manufacturing workforceCentral to the crisis however was a redirection of investment awayfrom Asia to the north raising northern aggregate demand and henceemployment in northern services This paper examines the magnitudesof these two effects in a broader analysis of the real impacts of theAsian recession that is grounded in a global general equilibriumframework Northern workers are found to be net beneficiaries in boththe short and medium run

I IntroductionWidening wage differentials in the USA and

increasing unemployment in Europe attracted a sub-stantial literature in the 1990s the thrust of whichwas to seek explanations for the poor labour marketperformance by low-skill or production (as distinctfrom professional) workers1 Although workplaceautomation is widely seen as the generic factorinfluencing labour market change throughout thelsquonorthrsquo2 it is conceded that at least part of the decline

in the performance of northern production workershas been attributable to expanded international com-merce particularly with developing countries Indeedthe long boom in Asian developing countries duringthe past two decades is seen by some as a majorfactor in the slower low-skill job growth in the north(Wood 1994) In 1997 however this long boomended following the lsquoAsian financial crisisrsquo3 Whileoverall economic growth slowed throughout East andSouth-east Asia several of the developing econ-omies that had earlier been major contributors toAsian growth slid into deep recession4 The questionarises then if the long boom hurt northern workersmight the Asian recession have helped them

Militating against possible benefit to northernworkers was the contraction in Asian domesticdemand and the surge in the volume of (mainly manu-factured) exports that followed as Asian currentaccount balances moved from deficit to substantial

3 A lsquocrisisrsquo of more modest overall economic impact tookplace in some Latin American East European and formerSoviet economies at about the same time Although thatevent may prove comparatively important in Europe it isnot addressed in this paper

4 For details about the genesis of the financial crisis seeCorbett and Vines (1999) McLeod and Garnaut (1998)and Radelet and Sachs (1998)

For useful discussions in the formative stages thanksare due Robert McDougall Tom Hertel and Simon GrantValued comments on earlier drafts have also been receivedfrom Peter Dixon George Fane Ross Garnaut WarwickMcKibbin and Kar-yiu Wong and an anonymous refereealong with participants in two seminars at the AustralianNational University at the Second Global Trade AnalysisConference in Copenhagen June 1999 and at the AsianCrisis II conference at the University of Washington inSeattle January 2000 The views expressed in this paperare those of the authors and do not necessarily representthose of the IMF or IMF policy

Correspondence Professor Rod Tyers Faculty of Econ-omics and Commerce Australian National UniversityACT 0200 Australia Email rodtyersanueduau

1 Several surveys of this recent research are availableincluding those by Burtless (1995) and Tyers et al (1999)

2 For our purpose the north comprises the older industrialeconomies of North America Western Europe and Australasia

2004 THE ASIAN RECESSION AND NORTHERN LABOUR MARKETS 59

surplus between 1997 and 1998 Other things beingequal this would have reduced the relative prices oflabour intensive manufactures on world markets andso reduced the demand for low-skill or productionlabour in the north But other things were not equalThe primary effect of the Asian financial crisis wasa flight of savings from Asia leading to increasedinvestment in the north By itself this new invest-ment would have raised aggregate demand and henceemployment in some northern manufacturing indus-tries and in northern services sectors These twoconsequences of the Asian recession are associatedwith a real appreciation in the northern economiesagainst Asia and other regions not receiving the newinvestment Accordingly northern employment wouldhave expanded particularly in the non-tradablessectors and it would have tended to contract in atleast some tradables sectors Clearly some tradablessectors would be hurt by the Asian export expansionbut helped by the boost in local investment demandAt issue then is the magnitude and direction of thenet effects on northern labour demand

We address this issue by taking as our startingpoint the real effects of the Asian financial crisisNo attempt is made to address the genesis of thecrisis or to simulate its short-run dynamics The nowrecorded real short-run shocks to Asian aggregatedemand comprise contractions in investment (ashome savings fled abroad and foreign savings in Asiawere withdrawn) and consumption demand (as Asianwealth fell due to currency depreciations and in-creased debt service costs) Output also contractedas firms carrying US$ denominated debt were ren-dered illiquid or insolvent by the depreciations andthe credit crunch that followed These firms eitherclosed their doors or contracted their output pend-ing the resolution of rights to ownership over theircapital In estimating the effects of this recessionon trading partners in the north we have sought tocharacterise these changes in production explicitlyrather than to adopt the common practice of sub-suming them in a generic lsquoproductivity shockrsquo

To link the Asian recession with economies in thenorth we employ global general equilibrium analysisin a short-run counterpart of numerous general equi-librium studies of the preceding Asian lsquolong boomrsquo5

Some early studies of the Asian recession have alsoemployed such models6 A growing number haveused fully dynamic models some with financial

markets represented7 The behaviour that precipitatedthe crisis in Asia is still not fully captured in suchmodels however and the associated studies tend toemphasise implications for prudential regulation andmacroeconomic policy in the affected countries ratherthan real effects outside Asia

In examining the real effects of the Asian re-cession comparative static analysis allows us theluxury of more detailed microeconomics and greaterdisaggregation than is available in most fully dynamicmodels We construct short and medium-run com-parative static characterisations of the recessionand apply them to a suitably modified version ofan established global general equilibrium modelThe results offer a useful qualitative picture of therecession-affected regions as well as estimates of itseffects abroad The expansion of investment in thenorthern economies and the associated increase inservices output and employment prove dominantEven though real appreciations relative to Asia causenorthern tradeable goods sectors to contract the neteffect on northern output and labour demand is posi-tive even for production workers

In Section II a brief review of the Asian recessionis offered and our choice of model explainedSection III then provides a summary of the structureand behaviour of the model Our construction ofexperiments with it is detailed in Section IV and theresults summarised in Section V Section VI thenoffers conclusions

II The Asian recessionThe bursting of Japanrsquos 1980s asset bubble caused

a decline in investment that accelerated in 1997 inspite of a macroeconomic policy that maintained verylow short-term interest rates8 Private consumptionin Japan remained comparatively stable during the1990s but it declined during the crisis periodimports fell and there was a further expansion ofJapanrsquos current account surplus In addition a trendtoward lower working hours combined with therecent implementation of a standard 40-h week causeda decline in total labour hours and an associated

5 See Krugman (1995) and Tyers and Yang (1997 1999)6 See for example Adams (1998) and Duncan and Yang

(2000)

7 Although the events in the lead-up to the crisis are nowbetter understood the best dynamic global macroeconomicmodels to date still retain fully informed risk-neutralfinancial agents with perfect foresight or model-consistentexpectations and so cannot fully endogenise the capitalflight of 1997 They do however precipitate valuableinsights into the onset and management of such recessionsSee for example McKibbin (1998a 1998b)

8 The financial origins of the Japanese recession are dis-cussed in Horiuchi et al (1998)


reduction in output per worker9 Thus Japanrsquos tradesurplus rose while its GDP fell10

In the most affected countries of developing Asiathe genesis of the crisis differed from that in Japanand the scale of the contractions was proportionallylarger11 Worst hit were Indonesia and Thailand butthe economies of Malaysia and Korea also contractedsubstantially The crisis in these countries beganin Thailand in mid-1997 following a period duringwhich export performance had begun to falter andforeign currency denominated debt to accumulateAs doubts arose about the governmentrsquos commit-ment to honour implicit guarantees to maintain thenominal exchange rate a capital flight ensued result-ing eventually in a substantial nominal depreciationThe sharp rise in domestic debt and debt servicecosts that followed precipitated the associatedfinancial crisis Fear of similar developments appearsthen to have been self-fulfilling in near neighboursIndonesia and Malaysia As savings were with-drawn from these economies and their currenciesdepreciated asset prices fell considerable wealthwas lost and private consumption collapsed The verylarge declines in domestic investment relative tosavings caused these countries to switch from surplusto deficit on their capital accounts On the currentaccount side these changes were counterbalanced bycollapses in imports

Although the US$ value of exports from develop-ing East Asia changed little in the first year after thecrisis the nominal depreciations meant that exportvolumes were rising Moreover the collapse ofJapanese imports from elsewhere in Asia meant thatholding the line on export values required not onlyan expansion in export volumes but also a consider-able redirection of exports from Japan toward theUSA and the European Union (EU)

The primary real shocks were as follows First assavings fled domestic investment declined In Japanwhere the process was more gradual investment fellby about a tenth in the 2 years from late 199712 In

the most affected economies of developing Asiahowever the initial panic of 1997 was so great thatdomestic investment declined by as much as halfDomestic capital goods and construction demandcollapsed The contractionary impact on output wasfurther exacerbated by a collapse in private consump-tion driven by the associated wealth effects of assetprice declines Imports therefore fell dramatically

The second of the real shocks was a short-rundecline in domestic production in the affected econ-omies In Japan banks that had been burdened withincreasing bad debts since the property bust earlierin the decade were forced to allow some client firmsto go insolvent and many of those to cease pro-duction In developing East Asia equity marketswere comparatively underdeveloped and investmentduring the prior decade had been financed primarilyby debt In that period private sector credit as a pro-portion of GDP tripled in Indonesia and doubled inThailand13 Debtndashequity ratios of Korean domesticmanufacturing firms in the mid-1990s were doublethose of manufacturing firms in the USA Althoughcentral bank responses to the crisis differed in allthe affected developing countries the high level ofprivate sector US$ denominated debt meant that thecurrency crisis caused a blowing out of debt servicecosts and hence a high incidence of illiquidity andinsolvency

This is borne out in a World Bank survey of 3 700companies in the worst affected economies14 Fully15 per cent of these companies reported insolvencyIn Indonesia the number rises to 51 per cent Inaddition across the five most affected economies28 per cent of surveyed companies were thus fartechnically solvent but illiquid Although post-crisisassets still exceeded the liabilities of these firmsdebt service costs exceeded operating surplus Theywere therefore in imminent danger of becominginsolvent In the short run with ownership issuesunresolved many insolvent and near-insolvent firmsshut down At the very least and particularly forsmall firms the prospect of new ownership ormanagement and the necessary commitment of allnew operating surpluses to creditors would have sub-stantially reduced incentives to maintain productionThis is also borne out by the World Bank surveywhich highlighted production contractions in allaffected countries

An important exception to this pattern of supply-side shocks was China Although the currency

9 See Bayoumi and Towe (1998)10 See IMF (1998) Chapter IV11 However their contributions to global GDP are smaller

in magnitude than that of Japan The 1998 contraction ofthe Japanese economy by 28 per cent took US$114 billionoff global output This compares with a total of US$83billion from the combined contractions in the affecteddeveloping Asian countries Although purchasing powerparity (PPP)-based comparisons would enhance the latterfigure they would not nullify the point of the comparison

12 According to the IMF (1998 table 3) gross fixed capitalformation in Japan declined by 35 per cent in 1997 andwas forecast to decline by 72 per cent in 1998

13 See IMF 1998 chapter 3 table 3814 The World Bank (1999a) study is reported in Asiaweek

16 April 1999


depreciations stopped at Chinarsquos doorstep it was notfree from the effects of the financial crisis Between1996 and 1998 Chinarsquos capital account turned fromsurplus to deficit through an estimated magnitude ofUS$60 billion financed largely by a rise in domesticsavings15 Fixed parity was maintained against the US$but the real appreciation against its crisis-affectedAsian trading partners and export competitors wasconstrained by tight domestic monetary policy aslowdown in aggregate demand and hence domesticdeflation Both private and state-owned firms facedhigher debt service costs and higher real wages Somepreviously state-owned enterprises were allowed toclose and economic growth slowed Although thissupply-side pattern differs from those of the otheraffected countries of developing Asia China was asubstantial contributor to the reallocation of invest-ment away from Asia and toward the north

In summary then the prevailing pattern of pro-duction declines in the affected Asian economiesstemmed from declines in domestic investment andprivate consumption expenditure Other things equalassociated real depreciations would have brought anoffsetting surge in export demand Although exportvolumes did increase in the short run they wererestrained primarily by the second cause of outputcontraction insolvencies and shutdowns In Japanshutdowns also occurred in larger numbers thanpreviously and in China growth slowed as real wagegrowth accelerated

III The ModelThe analysis of these combined shocks and their

effects on northern economies requires a global modelcapable of representing an open capital accountin each region and for which a closure can beconstructed that will allow the idling of industry-specific capital in the short run We use an adap-tation of the GTAP global general equilibrium model16

The analytics of our adapted version are summarisedin Appendix I As a starting point it offers thefollowing useful generalisations (i) a capital goodssector in each region to service investment (ii) ex-plicit savings in each region combined with openregional capital accounts that permit savings in oneregion to finance investment in others (iii) multipletrading regions goods and primary factors (iv) non-traded goods (v) product differentiation by countryof origin (vi) empirically based differences in tastes

and technology across regions (vii) non-homotheticpreferences and (viii) explicit allowance for trans-portation costs and policy distortions17

For the corresponding database we use the GTAPVersion 4 data aggregated into the regions listed inAppendix II1819 To preserve the diversity of factorproportions across industries and so reflect trade com-position effects of shocks as accurately as possible20

we use the full list of 50 sectors available in thedatabase Once each solution is complete the resultsare aggregated for purposes of presentation to sixsectors as indicated in Appendix II This aggre-gation is based on factor proportions in the EU21 Whengrouped in this way the differences between the fac-tor shares of each industry group are not stark par-ticularly in manufacturing and services as indicatedin Table 1 Skill-intensive manufacturing for examplehas a skilled labour share that is only slightly largerthan low-skill-labour-intensive manufacturing Indeedthe starkness of this contrast is further reduced whenthe factor content of intermediate inputs is taken intoaccount Broadly however agriculture and manu-facturing are comparatively intensive in low-skilllabour and mining is capital intensive Typical ofall the northern industrial economies the dominantservices sector is capital intensive relative to manu-facturing and it comprises two subsectors one ofwhich is intensive in production or low-skill labourwhile the other combines relatively balanced sharesof the three mobile factors

15 See Yang and Tyers (2000 2001)16 For a detailed description of the standard version of

this model see Hertel and Tsigas (1997)

17 These generalisations mean that the conditions essen-tial to factor price equalisation no longer exist and hencetransmitted factor market effects are muted relative tosimple HeckscherndashOhlinndashSamuelson formulations SeeFrancois and Nelson (1998)

18 For a detailed description of the database seeMcDougall et al (1998b)

19 Note that we use the rather large aggregate lsquorecesseddeveloping Asiarsquo (RDA) to represent the smaller econ-omies of the affected region We have however taken painsto separate the large and particularly important economiesof Japan and China Since our emphasis is on the effects inthe north further disaggregation is not justified

20 The importance of accurately representing the diversityof factor proportions across industries in any analysis offactor market effects transmitted by trade is emphasisedby Falvey and Tyers (2004)

21 The 50 industries are grouped in broad sectors thenranked according to their labour intensity on the one handand their skill intensity on the other If an industry rankshigher on labour intensity than it does on skill intensity itis placed in the labour-intensive sector in Appendix II If itranks higher by the skill intensity criterion it is placed inthe skill-intensive subcategory even though its skill sharemay be smaller than its labour share


Table 1Factor Proportions in the EU per cent (Source GTAP Database Version 41 see McDougall et al 1998b)dagger

Low-Skill Skilled NaturalSector Share of GDP Land Labour Labour Capital Resources Total

Agriculture 3 10 (7) 58 (53) 4 (11) 24 (26) 4 (3) 100Mining 1 0 (0) 17 (24) 9 (14) 38 (37) 36 (25) 100Manufacturing Intensive in

Production Labour 7 0 (1) 57 (50) 20 (21) 23 (27) 0 (1) 100Skilled Labour 18 0 (0) 48 (45) 26 (26) 26 (29) 0 (0) 100

Services Intensive inProduction Labour 32 0 (0) 41 (41) 17 (20) 42 (39) 0 (0) 100Skilled Labour 39 0 (0) 34 (36) 36 (33) 30 (31) 0 (0) 100

dagger Listed are value added shares with in parentheses total factor proportions (including the factor content of intermediate inputs)

22 The early literature on real exchange rate changes tendedto focus on associated relative price changes where trade-able goods prices retained parity with international tradingprices More recently it has become certain that short-rundepartures from the law of one price occur across all trade-able goods sectors See Engel (1999)

23 These elasticities emerge from a calibration exercise onthe short-run recession shock the objective of which is toachieve real effective exchange rate changes similar to thoseobserved over the year between mid-1997 and mid-1998

24 Hamermeshrsquos (1993 Ch3 part IV) survey of the evi-dence on skill-capital complementarity suggests that thereis at least some supporting evidence Although we omitthis complementarity here its implications are explored ina separate analysis using an otherwise similar model Yangand Tyers (2000)

Households and firms in the model consume acomposite of goods and services that is a blend ofhome products and imports The composition of thisblend depends on relative prices and an elasticity ofsubstitution In turn imports are a blend of the prod-ucts of all regions and the composition of importsdepends on regional trading prices and a furtherelasticity of substitution This structure facilitatesthe departures from the law of one price that tend tooccur even in tradeable goods sectors in the short andmedium run22 On the supply side the derived demandfor primary factors stems from the nest of constantelasticity of substitution (CES) functions illustrated inFigure 1 Because the length of run is short we usethe smaller-than-standard elasticities of substitutionin both demand and supply listed in Table 223

Our adaptation of the standard model involveschanges to its intermediate input and labour demandstructure and to the sector specificity of factors Asto factor demand the standard GTAP formulationhas intermediate goods and factors used in fixed pro-portions by volume in all industries This restrictssubstitution by firms in the face of factor and prod-uct price changes so we have made output a CEScomposite of intermediate products and primaryfactors In addition to more accurately reflect fac-tor market impacts of external shocks we haverecomposed the demand structure for low-skill or

production labour skilled or professional labour andcapital This allows the two types of labour to bedifferently substitutable for each other rather thaneach is substitutable for the third mobile factorcapital24 Finally because of the short-run nature ofthe experiments we have changed the model so thatcapital is sector-specific in all experiments Returnsto capital therefore vary across industries

IV The Construction of Asian Recession Shocks

(i) The short run 1997ndash98In the short run as discussed in Section II the set

of real shocks comprises changes in the internationaldistribution of investment changes in savings ratesand changes in trade balances Indeed since the short-run effects on both investment levels and currentaccount deficits are known we set these asexogenous rendering the rate of savings in recesseddeveloping Asia China and Japan endogenous tomaintain their current account positions Rates ofsavings in the other regions remain exogenous how-ever while the other elements of their capital andcurrent accounts are endogenous Since the globaldistribution of investment is exogenous and theinstalled (productive) capital stock is fixed thelsquoexpectedrsquo rate of return on capital must be endogen-ous and allowed to vary across regions Recall fromAppendix I that the equality of global savings withglobal investment defines a global average lsquoexpectedrsquorate of return rw In most applications investment in


Figure 1Structure of Intermediate and Primary Factor Demand A Constant Elasticity of Substitution Nest

each region would be endogenous and this expectedrate of return would apply everywhere Here how-ever we introduce the region-specific risk premiumπi When the level of investment in any regionis exogenous the corresponding premium isendogenous

To capture the effects on output of insolvenciesand illiquidity in developing Asia and Japan pro-duction levels are made exogenous In sectors wherethis occurs capital use is then made endogenous sothat some capital is left idle Labour markets in theseaffected regions are assumed to remain flexible and


both skilled and low-skill labour to remain mobilebetween industries25 The implications of theseelements of the short-run closure are discussed inthe following subsection Finally to reflect the anec-dotal evidence of a substantial retreat by workers toagriculture in recessed developing Asia (production)labour productivity there is reduced and land pro-ductivity raised

(ii) Capital Idling in Recessed DevelopingAsia and Japan

Given that capital is industry specific and that dataare already available on the extent of short-run out-put contractions we can make output in each indus-try exogenous and reduce it to a known extent settingindustry level capital use as endogenous26 To seehow such an imposed reduction in output at theindustry level brings about a reduction in capitaluse in the model and on what the extent of thisreduction depends consider the following illus-tration The standard formulation in models such asours represents each industry as comprising atomisticprice-taking firms with identical technology and feeentry and exit Such industries exhibit constant costsand so can be represented as single firms withconstant returns to scale Our illustrative industryemploys only labour L and capital K which it com-bines according to the CES production function

y L K [ ]= +minus minus minusα βρ ρ ρ1

(1)

In the short run K is industry specific and its rentalrate or gross rate of return r is endogenous to theindustry27 Labour is mobile however and its wagew is determined in the wider economy as is theindustryrsquos product price p As do all industries inthe model this one makes zero collective econ-

omic profits Set the elasticity of substitution toσ = 1(1 + ρ) = 12 and hence ρ = 1 and simplifyfurther by setting α = β = 1 Minimising the cost ofachieving output y then yields conditional capitaldemand to be

K yw

r

= +

11 2

(2)

Marginal and average cost equal the price

MC = AC = [w12 + r12]2 = p (3)

As indicated earlier the product price and the wageare determined in the wider economy and so areparametric to the firm The above condition then fixesthe rate of return on capital in the focus industryirrespective of the quantity of capital employed Onlyone rate of return is consistent with zero profit price-taking behaviour no matter what the level of outputor capital use in the industry Once the rate of returnon the industryrsquos capital is known from equation 3there remains the one to one relationship in equa-tion 2 between output y and capital use K

To construct a standard short-run closure designedfor example to investigate effects of a change in atax or tariff rate one would normally make the fullemployment assumption and set K exogenous and yendogenous In our case we know that many com-ponent firms shut down during the crisis idling theircapital and we know the effects of this on industrylevel output We therefore reverse this closure andset output exogenous shocking it by the observedproportion The levels of capital use in each industrythen emerge from the model as they do fromequation 2 above The shortfall between capital useand the capital stock then indicates the extent ofidled capital28

It is useful to know however what the effect ofthe factor substitution elasticity σ is on the extentof capital unemployment This can be seen fromFigure 2 There the exogenous contraction in outputis from y0 to y1 Were the technology to be Leontief(σ = 0) the quantity of capital employed would de-cline equiproportionally (from K0 to K1 in the figure)This is true even if factor substitution is elasticso long as the product price and the wage remain

25 Despite official statistics indicating increased unemploy-ment in recessed developing Asia we believe it is appro-priate to assume that aggregate employment remainsunchanged following the crisis Evidence from socialimpact studies suggests that workers displaced from manu-facturing moved to (possibly informal) services sectorsor retreated to agriculture taking a cut in wages SeeWorld Bank (1999b) Tambunlertchai (1998) Siamwallaand Sophchokchai (1998) Anecdotal evidence is also sup-portive of this assumption See Vatikiotis (1998) Crispin(1998) and Cohen (1999)

26 The magnitudes of the output contractions imposed inthe short run in developing Asia and Japan appear later inTable 5

27 When the capital stock is defined in terms of its moneyvalue the rental rate is the same as the rate of return oninstalled capital gross of depreciation Sector specificity ofcapital yields variation in r between industries

28 In some industries the contraction may be sufficientin spite of the general recession and associated demandcontraction to drive the industryrsquos product price up Insuch a case the rate of return on the industryrsquos capital mustrise and the owners of capital still in production wouldearn rents


unchanged For a constant wage (w) however ifthere is a rise in the product price there will be a risein the return on the industryrsquos capital (r) This willresult in a larger decline in capital use the moreelastic is the substitution between capital and labour(say to K2 in the figure) If on the other hand theproduct price should fall the decline in capital usewill be smaller the greater is the factor substitutionelasticity (say to K3 in the figure) These two resultsalso apply if the product price is unchanged andthere is a fall (rise) in the wage In sum the moreelastic is factor substitution the larger will be thedeviation from equiproportionality when the productprice changes substantially relative to the wage

(iii) China in the Short RunAs explained earlier the treatment of the supply

side in China is different There were no large-scaleshutdowns like those in the directly affected Asiancountries but there was a rise in private outflows onthe capital account This negative balance of pay-ments shock caused a real depreciation that com-bined with the macroeconomic policy of the periodled to a substantial deflation The labour market inChina is the most regulated amongst the crisis-affected countries and there is clear evidence ofdownward wage rigidity across the state-ownedand part of the non-state sectors29 Our treatment

embodies the assumption that there is downwardrigidity of the nominal wage over the length of runconsidered and that the nominal exchange rate isfixed against the US dollar To incorporate thesenominal rigidities in our real model we take advan-tage of the definitions of the real wage and the realexchange rate and the fact that data are now availableon changes in price levels during and since the crisisEliminating the home price level P from thedefinitions of the real wage w = WP and the realeffective exchange rate eR = (EP)P we have that

wWE

P eR

=

1(4)

where W is the nominal wage E the nominalexchange rate and P a trade weighted index offoreign price levels In proportional change formwhen the nominal wage is fixed this implies

= minusD = Ecirc minus D minus ecircR (5)

This equation is incorporated in the model in whicheR is already an endogenous variable and henceit renders the real wage w endogenous also Theobserved proportional change in EP is introducedas an exogenous shock Thus while the conventionalclosure would either require an exogenous real wageor exogenous (full) employment by adding equation5 we are able to make both the real wage and thelevel of employment endogenous To construct theexogenous shock to EP we use the trade weightedaverage of this ratio for the five regions trading withChina Over the first four quarters following theonset of the financial crisis this rose 35 per centThe complete set of shocks and the closures adoptedin the short run are detailed in Appendix III

(iv) The Medium RunOur medium-run analysis requires a new set of

comparative static shocks At this length of run weassume that debt workouts have resolved propertyrights issues and that capital is no longer idled indeveloping Asia and Japan In those economies out-put in each sector is therefore no longer exogenousCapital remains immobile between industries how-ever As capital utilisation rates return to benchmarklevels the retreat of labour to agriculture is reversedand factor productivity in agriculture returns to itsreference levels In China the nominal wage isassumed flexible in all sectors in the medium runThus in all the affected regions the supply-sideshocks of the short run are lifted in the medium run

On the demand side the global distribution ofinvestment is retained as in the short run This time

Figure 2Capital use Reductions Implied by a Given Output

Contraction (K capital L labour r rate of returny output w wage)

29 For more detail as to this and our treatment of theChinese supply side see Yang and Tyers (2000) and Tyersand Yang (2001)


Table 2Elasticities of Substitution In Intermediate and Primary Factor Demand (Source GTAP Database Version 41

see McDougall et al 1998b)dagger

In product demand In import demand between domestic between regions In factor demand

and imported of origin primary factor groupsDaggerSectorbetween Short run Medium run Short run Medium run Short run Medium run

Agriculture 12 23 24 47 01 02Mining 15 28 30 56 01 02Manufacturing Intensive in

Production Labour 23 30 46 59 06 12Skilled Labour 08 30 15 59 06 13

Services Intensive inProduction Labour 05 19 10 38 08 16Skilled Labour 05 19 10 38 06 13

dagger These are group-specific weighted averages across the 50 industries defined in the database The structure of intermediate and primaryfactor demand is indicated in Figure 1 The CDE (constant difference of elasticities of substitution) parameters governing substitution in finaldemand are discussed in McDougall et al (1998a) Substitution elasticities in intermediate product demand and between intermediates andprimary factors are set to unity (CobbndashDouglas) in this analysisDagger The complete set of GTAP factor substitution elasticities are listed in table 192 of McDougall et al (1998b) The elasticity of substitutionwithin the labour group between skilled and low-skill production labour is set at unity Householdsrsquo corresponding elasticity of transfor-mation between these types of labour is set arbitrarily small for this analysis

however it is achieved by allowing the model todetermine investment levels and by making ex-ogenous the risk premia on regional expected ratesof return πi These premia are then retained at thelevels they took in the short-run experiment Alsoin the three Asian regions average savings ratessi = Si Yi are made exogenous and fixed at the ratesachieved in the short run Other components of thebalance of payments are now endogenous Thisallows any recovery in national incomes in recesseddeveloping Asia China and Japan (due to the removalof supply-side shocks) to further raise total savingsand hence for the capital account deficit (S minus I) torise The trade imbalance (X minus M ) then widens furtheras growth in exports leads their recoveries

Finally the medium-run analysis uses larger elas-ticities than the short run Elasticities of substitutionbetween home goods and imports on the demandside and between factors and inputs on the supplyside take on the standard values from the Version IVDatabase as summarised in Table 2

V The Results

(i) The Short RunThe simulated changes in the balance of payments

real exchange rate and terms of trade in each regionare displayed in Table 3 The (exogenous) falls ininvestment prove larger than the (endogenous) de-clines in domestic savings in all three Asian regions

and the balance of payments implications of thesechanges are matched by substantial declines inimports relative to exports In the case of recesseddeveloping Asia a small decline in the US$ value ofexports is indicated in the table As discussed earlierhowever the corresponding volume actually rose Inthis simulation the short-run rise in export volumefrom recessed developing Asia is 4 per cent

The USA and the EU experience enlarged invest-ment Although the US$ value of (fixed rate) savingsrises slightly with national income in each case themajority of the new investment is from abroad Theresulting shifts in their capital accounts towardsurplus are then matched by shifts in their currentaccounts toward deficit that take the form of rises inimports and smaller falls in exports Integral withthese changes are real depreciations in the affectedAsian regions Against all other trading partners theeconomies of the north suffer real appreciations thatare largest for the USA At the same time cheaperAsian exports dominate the terms of trade changes andboth the USA and the EU enjoy substantial gains30

30 These effects are comparatively small in Australasiabecause it is a major exporter to Asia of natural resource-based goods whose prices fall substantially OverallAustralasiarsquos terms of trade gain relative to developing Asiais therefore smaller and hence it suffers a deterioration inits terms of trade and a real depreciation relative to the EUand the USA


Table 3Short-Run Changes in the Balance of Payments and Real Exchange Rate Following the Recession in Developing Asia

and Japan 1995 US$ Billion (Source Model Simulations Described in the Text)dagger

Sector RDADagger Japan China USA EU A amp NZsect

Capital Account Surplus (I minus S) = (MI minus X) minus146 minus36 minus30 137 82 3Investment I minus192 minus193 minus17 171 94 2Saving S minus46 minus157 13 34 12 minus1Imports M minus171 minus51 minus20 82 55 minus2Exports X minus26 minus15 10 minus55 minus27 minus5

Change in Real Effective Ratepara () minus121 minus48 minus43 118 39 06Real Appreciation Against USAdaggerdagger () minus190 minus140 minus143 00 minus52 minus101Terms of TradeDaggerDagger () minus47 minus53 minus24 89 12 minus19

dagger Short-run closure details are indicated in Appendix IIIDagger Recessed developing Asia excluding Chinasect Australia and New Zealandpara The ratio of the home GDP deflator to a trade-weighted average of the GDP deflators of other regionsdaggerdagger The ratio of the home GDP deflator to that of the USADaggerDagger Change in the value of exports at endogenous prices weighted by fixed 1995 (base period) export volumes divided by the value ofimports weighted by fixed 1995 import volumes

Table 4Short-Run Changes in Gross Sectoral Output and GDP per cent (Source Model Simulations Described in the Text)dagger

Sector RDADagger Japan Chinasect USA EU A amp NZpara

Agriculture minus16 minus12 minus78 minus18 minus06 minus08Mining minus109 minus53 minus23 minus04 minus07 minus12Manufacturing Intensive in

Production Labour minus45 minus39 43 minus14 minus07 06Skilled Labour minus105 minus41 minus35 07 01 minus05

Services Intensive inProduction Labour minus154 minus64 minus38 18 09 05Skilled Labour minus98 minus52 minus24 05 02 minus04

GDPsect minus94 minus48 minus36 01 01 00

dagger Short-run closure details are indicated in Appendix III Sectoral production changes in RDA and Japan are exogenousDagger Recessed developing Asia excluding Chinasect In China the current account and investment are exogenous leaving the domestic saving rate and GDP endogenous Unlike the other crisis-affected regions the Chinese labour market is considered to exhibit nominal wage rigidity Its real depreciation when combined with theobserved (hence exogenous) change in its effective nominal exchange rate is associated with domestic deflation and hence a real wageincrease that contributes to Chinarsquos GDP decline as in Yang and Tyers (2000) The associated decline in employment is about 8 of thelabour forcepara Australia and New Zealand

Worst hit in the USA and EU are the tradeablegoods sectors The real appreciations experiencedrelative to Asia have made Asian goods and servicescomparatively cheap Output in agriculture miningand the (low-skill or production) labour-intensive endof the manufacturing sector contracts for this reasonthough the skill-intensive end of manufacturing inboth the USA and the EU holds up The reasons forthis different outcome in the northern skill-intensivemanufacturing sectors are threefold First to facili-tate the expansion of manufactured exports from Asia

The exogenous output contractions in developingAsia and Japan are substantial as indicated in thefirst two columns of Table 4 Those in China are theresult of nominal wage rigidity in the face of deflationand its associated unemployment They should be seenas a slowdown in Chinarsquos considerable rate of econ-omic expansion In the north however there are nodirect shocks affecting output We observe the effectsof the Asian shocks transmitted through trade andcapital flows For this reason the magnitudes ofoutput changes are substantially smaller


Table 5Short-Run Changes in Product Prices Capital Returns and Capital Utilisation in Developing Asia and Japan per cent

(Source Model simulations Described in the Text)dagger

Sector Recessed Developing Asia (RDA)Dagger Japan

Pricesect Capital Returnpara Capital Use Pricesect Capital Returnpara Capital Use

Agriculture minus5 minus2 0 minus1 1 0Mining 4 63 minus14 minus1 11 minus4Manufacturing Intensive in

Production Labour 9 56 minus26 2 22 minus14Skilled Labour 6 27 minus20 0 5 minus6

Services Intensive inparaProduction Labour minus1 2 minus14 0 24 minus19Skilled Labour minus2 7 minus14 1 8 minus9

dagger Short-run closure details are indicated in Appendix IIIDagger Recessed developing Asia excluding Chinasect Producer price relative to the regionrsquos GDP deflatorpara Unit reward of each sectoral capital stock relative to the regionrsquos GDP deflator

Asian imports of mainly skill-intensive manufacturedinputs also rise This is against the trend of totalAsian imports and these manufactures come in partfrom the north31 Second the USA and EU haveexpanding services sectors that are intensive in theuse of skill-intensive manufactures as intermediateinputs Third the supply-side contractions due toinsolvencies in the recessed Asian economies reduceAsian output of all manufactures In these econ-omies skill-intensive manufactures are import com-peting and so this militates in favour of increasedimports from the USA and the EU

The corresponding northern contractions inagriculture and mining are also associated with thereal appreciations but these sectors are more directlyaffected by the short-run collapse in Asian importsof agricultural and mineral products Overall thereare small net enlargements of GDP in the north Thedriving force behind these is the services sectorIn all three northern regions output in the (low-skillor production) labour-intensive services sectors ex-pands strongly There is also expansion in the skill-intensive services sectors in the USA and the EUThis expansion is the result of increased investmentthe domestic content of which is very intensive inservices and particularly production-labour-intensiveservices like construction and transport32

Back in Asia recall that the output declines resultfrom both changes in investment and insolvenciesAssociated with the latter is the idling of capitalin the short run The extent of implied idling ofcapital depends as discussed in Section IV(ii) uponassociated changes in product prices wage ratesand capital returns in each affected sector Thesechanges are shown in Table 5 In some sectors par-ticularly mining and production labour-intensivemanufacturing in developing Asia and skill-intensivemanufacturing in Japan the contractions in productionare very much larger than can be explained by reducedinvestment alone Indeed they are so large that theproduct price rises at least relative to the regionrsquosGDP price (which falls relative to external pricesconsistent with these regionsrsquo real depreciations) Inthese cases the substantial output reductions there-fore imply a high rate of capital idling that confersrents on the owners of the remaining sector-specificcapital still in use33

The overall pattern of changes in unit factorrewards is indicated in Table 6 Most striking are the

31 For a more detailed examination of this issue see Tyersand Yang (2002)

32 For sources related to the content of capital goodssectors in each region see McDougall et al (1998b)

33 Whether the sectoral detail offered here accuratelyreflects the behaviour encountered during the crisis awaitsmore detailed empirical assessment It is possible that someof the rises in capital returns are due to an underestimationof the associated contraction in demand We have assumedthat the RDA labour market is flexible If substantial idlingof workers occurred then these high capital returns mightnot emerge from the simulation In any case our focus inthis paper is on the external effects of the crisis in northerneconomies and this is driven primarily by the exogenousinvestment and output shocks


Table 6Short-Run Changes in Real Factor Rewards per cent (Source Model Simulations Described in the Text)dagger

Primary Factor RDADagger Japan China USA EU A amp NZsect

Production Labour minus151 minus80 101 14 05 01Skilled Labour minus152 minus82 108 13 05 minus02Capitalpara 134 103 minus18 10 05 minus04Land minus78 12 minus300 minus76 minus39 minus28Natural Resources minus419 minus43 minus101 minus21 minus15 minus37

dagger Short-run closure details are indicated in Appendix III All entries are unit rewards relative to the regionrsquos consumer price indexDagger Recessed developing Asia excluding Chinasect Australia and New Zealandpara Capital is sector specific and hence has returns that differ by sector Here the change in the regionrsquos total payment to capital is given

declines in the returns to land and natural resourcesworldwide This is because the now recessed Asianeconomies are major importers of agricultural andresource based goods The returns to capital riseworldwide as capital is idled in Asia34 The excep-tions are China where the return on installed capitalfalls due to a rise in the real wage and a fall inemployment and Australasia where an unusuallylarge share of the installed capital is assigned tosectors affected by the drop in exports to Asia

Turning to production and skilled labour withinregions there is no substantial difference in theeffects on these two factor markets There is howevera stark dichotomy between production labour rewardchanges in recessed developing Asia and Japan onthe one hand and the northern regions on the otherProduction labour skilled labour land and resourcesare big losers in Asia35 Even in China where realwages rise this is at the cost of a considerabledrop in employment relative to trend The principalbeneficiaries are production and skilled labour inthe north That northern workers gain in this waysuggests that the crisis-driven capital flows and theredistribution of investment that followed them havebenefited northern workers to an extent outweighingthe associated surge in exports from developingcountries and the cheapening of production-labour-intensive goods on world markets

In the north even though the new investmenthas no impact on the productive capital stock at thelengths of run simulated here it increases the demand

for capital goods at the regional level and leads toreal appreciations The former raises regional labourdemand but the latter reduces competitiveness intradeable goods sectors Since most employment isin little traded services and since the services sectorin the north is ultimately the major beneficiary ofthe investment redistribution there is a net increasein both production labour and skill demand in thenorthern regions

Even so the similarity of the effects on pro-duction and skilled labour in the north is surpris-ing Superficially one would expect inferior labourmarket performance from low-skill labour since itstraditional employers have been in agriculture andmanufacturing and these sectors contract and shedworkers in the short run And northern manufacturingsuffers most at the low-skill end In northern labourmarkets however the main counterbalancing forceis the expansion of services and particularly theproduction-labour-intensive services sector Demandgrowth there is sufficient to raise the real unitrewards of production workers throughout theeconomy in each region

(ii) The Medium RunIn this case the supply-side shocks that had lim-

ited output in the short run are removed as are theexogenous shocks to the balance of payments in eachregion All that remains are the risk premia impliedby the levels of expected return on investment ineach region that emerged from the short-run results36

The removal of supply-side shocks allows Asian34 Recall that capital remains industry-specific in these

solutions and the numbers shown are changes in totalregional returns

35 The rise in return to land in Japan occurs in spite ofthe decline in Japanese agricultural output Land-intensivecrop output in Japan actually expands while other moreincome-elastic agriculture contracts substantially

36 The short-run changes in expected rates of return oninvestment retained here as exogenous shocks are RDA60 per cent Japan 11 per cent China 10 per cent USA6 per cent EU 3 per cent Australia and New Zealand4 per cent and lsquorest of the worldrsquo 0 per cent


Table 7Medium-Run Changes in the Balance of Payments and the Real Exchange Rate 1995 US$ Billion (Source Model

Simulations Described in the Text)dagger


Capital Account Surplus (I minus S) = (M minus X) minus188 minus85 minus40 142 130 8Investment I minus193 minus180 minus11 154 140 9Saving S minus5 minus95 29 12 10 0Imports M minus113 minus32 minus13 73 67 4Exports X 75 53 27 minus69 minus63 minus5Change in Real Effective Ratepara () minus68 minus25 minus37 42 24 33Real Appreciation Against USAdaggerdagger () minus97 minus66 minus80 00 minus10 minus16Terms of TradeDaggerDagger () minus29 minus26 minus20 32 08 10

dagger The medium-run closure imposes the regional risk premia on expected rates of return that emerge as endogenous from the short-run resultsThis maintains approximately the short-run global redistribution of investment associated with the Asian recession Capital is still not mobilebetween sectors but all the components of the balance of payments all output levels and all product and factor prices in all regions are nowendogenousDagger Recessed developing Asia excluding Chinasect Australia and New Zealandpara The ratio of the home GDP deflator to a trade-weighted average of the GDP deflators of other regionsdaggerdagger The ratio of the home GDP deflator to that of the USADaggerDagger Change in the value of exports at endogenous prices weighted by fixed 1995 (base period) export volumes divided by the value ofimports weighted by fixed 1995 import volumes

37 In the medium run equilibrium the global expectedrate of return is lower than in the short run by 2 percentagepoints

output to recover and this increases the level of (nowfixed rate) Asian saving In turn this further increasesAsian capital account deficits as indicated in Table 7Relative to the short run these changes are offsetmainly by substantial increases in Asian exports Theassociated real exchange rate changes run in the samedirections as in the short run but their magnitudesare smaller in the medium run because householdand firm responses are more elastic at this length ofrun worldwide

There is an apparent redistribution of globalinvestment away from the USA toward the EU andto a small extent Australasia Recall that investmentdepends elastically on the global expected rate ofreturn on investment rw the regional risk premiumπ i and the regional rate of return on installed capi-tal ri

c (Appendix I) In the medium run the globalexpected rate of return rw declines as Asian outputrecovers and global savings increase37 This reducesthe magnitude of the wedges driven by risk premiabetween regional rates of return so that the expectedrates of return in the USA and the EU now differ byless than in the short run

At the same time the northern gains in ratesof return on installed capital ri

c are smaller in the

medium run because the full capital stock is backon line in Asia The proportion by which this gaindiminishes is greater in the USA however than inthe EU (compare Tables 7 and 12) In Australasiathe change is from a fall in the short run to a rise inthe medium run These changes in rates of return arerelated to corresponding changes in these regionsrsquoterms of trade From Tables 6 and 10 the USA con-tinues to enjoy a terms of trade gain but this gainhas diminished relative to the short run by a greaterproportion than that of the EU In Australasia bycomparison the change is from a terms of trade lossto a gain In turn these terms of trade changes stemfrom the recovery of production in Asia between theshort and medium runs In particular the Asianindustrial recovery raises global output of skill-intensive manufactures reducing USA and EUexport prices and volumes (compare Tables 7 and 11)The change in USA output in this sector relative tothe short run is substantially larger than that for theEU Clearly compared with that of the EU USAindustrial output is more directly competitive withthat of Asia and particularly that of Japan Thoughboth regions gain overall Asiarsquos medium-run indus-trial recovery appears to advantage the EU relativeto the USA

In Asia the production recovery is incompletewhile ever investment is redirected to the north Asin the short run the production-labour-intensive ser-vices sector contracts in all three Asian regions and


Table 8Medium-Run Changes in Gross Sectoral Output and GDP per cent (Source Model Simulations Described in the Text)dagger


Agriculture 00 01 minus50 minus10 minus06 minus17Mining minus09 minus29 00 minus04 minus07 minus12Manufacturing Intensive in

Production Labour 45 minus05 54 minus06 minus04 minus06Skilled Labour 11 01 07 minus10 minus09 minus02

Services Intensive inProduction Labour minus88 minus23 minus08 17 13 14Skilled Labour minus09 06 16 02 01 01

GDP minus07 00 minus03 01 01 02

dagger The medium-run closure imposes the regional risk premia on expected rates of return that emerge as endogenous from the short-run resultsThis maintains approximately the short-run global redistribution of investment associated with the Asian recession Capital is still not mobilebetween sectors but all the components of the balance of payments all output levels and all product and factor prices in all regions are nowendogenousDagger Recessed developing Asia excluding Chinasect At this length of run the Chinese labour market is considered to exhibit nominal wage flexibility so that nominal wage changes do notresult in additional unemploymentpara Australia and New Zealand

Table 9Medium-Run Changes in Real Factor Rewards per cent (Source Model Simulations Described in the Text)dagger

Primary factor RDADagger Japan China USA EU A amp NZsect

Production Labour minus32 minus06 13 07 04 08Skilled Labour minus20 minus08 52 04 03 06Capitalpara minus24 minus03 19 04 04 03Land 17 15 minus160 minus36 minus24 minus54Natural resources 15 minus04 minus18 minus13 minus12 minus35

dagger The medium-run closure imposes the regional risk premia on expected rates of return that emerge as endogenous from the short-run resultsThis maintains approximately the short-run global redistribution of investment associated with the Asian recession Capital is still not mobilebetween sectors but all the components of the balance of payments all output levels and all product and factor prices in all regions are nowendogenous Here all entries are per cent changes in unit rewards relative to each regionrsquos consumer price indexDagger Recessed developing Asia excluding Chinasect Australia and New Zealandpara Capital is sector specific and hence has returns that differ by sector Here the change in the regionrsquos total payment to capital is given

offsetting The medium-run pattern of changes inunit factor rewards is indicated in Table 8 Eventhough Asian output shocks are smaller the patternof the effects on real unit factor rewards is similar tothe short run Land and resources continue to be theprincipal losers in the north and both production andskilled labour enjoy real gains

Clearly northern labour gains from the Asianrecession both in the short and medium run Asproperty rights issues are resolved in Asia andindustrial capital comes back on line there the netgain to northern workers remains but with reducedmagnitude In this medium run Asian exports arelarger and the effect of trade competition is largerrelative to that of redistributed investment

these contractions are offset in part by substantialexpansions in the export-manufacturing sector in eachcase In recessed developing Asia and China it islow-skill-labour-intensive manufacturing that expandswhile the skill-intensive manufacturing sector expandsin Japan In essence whereas the short run sawdeclines in their levels of manufacturing productionin the medium run these two regions pump out theirmanufactured exports at rates above those of theprerecession period

In the north the general pattern is similar to thatof the short run results ndash expansion in services andcontraction in the more tradeable agricultural andindustrial sectors Once again therefore the effectson employment in the north can be expected to be


VI ConclusionSuperficially one might think of the Asian re-

cession as the reverse of the long Asian boom thatpreceded it Much has been said about how thisboom was export driven and how the exports causedsubstantial structural change in the north shiftingthe demand for labour toward increased skill andfinally about how this hurt northern productionworkers Although new research has cast doubt onthis thesis it remains of interest to ask whether pro-duction workers might indeed be advantaged by theAsian demise From our analysis the Asian recessiondoes appear to advantage workers in the northMoreover it advantages all northern workers bothskilled (professional) and low-skill (production) bysimilar proportions

In the short run imbalances between investmentand saving at the regional level are important Thesharp decline in investment in Asia is associatedwith increased investment in other regions and par-ticularly the USA and the EU The associated rise inthe demand for capital goods there stimulates thenorthern economies raising overall labour demandAgainst this however are substantial real appreci-ations relative to developing Asia and Japan Thesereduce the competitiveness of the northern tradeablegoods sectors and tend to contract employmentparticularly in agriculture and manufacturing But theeffect of enhanced investment spending (the capitalaccount effect discussed earlier) is dominant par-ticularly in the low-skill-labour-intensive servicessector Overall there is a net increase in the demandfor both production and skilled labour in the north

Unlike the long boom in reverse the Asian re-cession extends to Japan a larger economy than thatof developing Asia and one specialised in skill-intensive goods This tends to offset any bias infavour of northern professional or skilled workersThe recessed Asian economies do expand exportsbut this expansion is largely low-skill-labour-intensive from developing Asia and skill-intensivefrom Japan In the end it is the expansion in theservices sectors of the northern economies thatdetermines the distribution of real wage effects

Also unlike the long boom in reverse the shocksassociated with the Asian recession are short-runin nature and readily reversible Superficially we areimplying that the Asian recovery if it reverses theshocks of the recession must hurt northern workersWhether this turns out to be true depends on twomatters that go beyond the scope of this studyFirst short-run shocks such as those simulated hereare substantially affected by macroeconomic policyMonetary policy appropriately coordinated in the

north can and probably has helped mitigate thesudden changes in the real exchange rate that areso important in the foregoing analysis Second thenew investment now taking place in the north willaffect the postrecession pattern of production costsIf as a consequence the north enjoys a productivitygain relative to Asia the Asian recovery will notfully reverse the shocks considered here

REFERENCES

Adams PD (1998) Computable General EquilibriumAnalysis of the Consequences for Australia of the AsianCrisis Centre of Policy Studies Monash University

Bayoumi T and Towe C (1998) lsquoMacroeconomicDevelopments and Prospects (Staff Country Report)rsquo inIMF Japan ndash Selected Issues IMF Washington DC

Burtless G (1995) International trade and the rise inearnings inequality Journal of Economic LiteratureXXXIII 800ndash16

Cohen M (1999) Back to Basics Far Eastern EconomicReview October 7 pp 80ndash1

Corbett J and Vines D (1999) Asian Currency andFinancial Crises Lessons From Vulnerability Crisis andCollapse The World Economy 22(2) 155ndash178

Crispin SW (1998) Without a Net Far Eastern EconomicReview July 9 69

Duncan R and Yang Y (2000) The Impact of the AsianCrisis on Australiarsquos Primary Exports Why it has notBeen so Bad Australian Journal of Agricultural andResource Economics 44 36ndash91

Engel CM (1999) Exchange Rates and Prices NBERReporter Winter 1998ndash99 13ndash7

Falvey R and Tyers R (2004) Sectoral similarity andStolper-Samuelson effects in the H-O-S model WorkingPapers in Economics and Econometrics forthcomingAustralian National University

Francois JF and Nelson D (1998) Trade Technologyand Wages General Equilibrium Mechanics EconomicJournal 108 1483ndash99

Hamermesh DS (1993) Labor Demand PrincetonUniversity Press New Jersey

Hertel TW and Tsigas M (1997) Structure of GTAP inHertel TW (ed) Global Trade Analysis Using theGTAP Model Cambridge University Press New YorkChapter 2 pp 13ndash73

Horiuchi A (1998) Japan in McLeod R and GarnautR (eds) East Asia in Crisis from Being a Miracle toNeeding One Routledge London Chapter 12 pp 189ndash206

Huff KM Hanslow K Hertel TW and Tsigas ME(1997) GTAP behavioural parameters in Hertel TW(ed) Global Trade Analysis Using the GTAP ModelCambridge University Press New York pp 124ndash148

IMF (October 1998) World Economic Outlook InternationalMonetary Fund Washington DC

IMF (May 1999) World Economic Outlook InternationalMonetary Fund Washington DC


Krugman P (1995) Growing World Trade Causes andConsequences Brookings Papers on Economic Activity1 327ndash77

Lane T Ghosh AR Hamann J Phillips S Schulze-Ghattas M and Tsikata T (January 1999) IMF-supported programs in Indonesia Korea and Thailanda preliminary assessment IMF paper Washington DC

McDougall RA Dimaranan B and Hertel TW (1998a)Behavioural parameters in McDougall RA Elbehri Aand Truong TP (eds) Global Trade Assistance andProtection The GTAP 4 Database Center for Global TradeAnalysis Purdue University December Chapter 19

McDougall RA Elbehri A and Truong TP (eds)(1998b) Global Trade Assistance and Protection TheGTAP 4 Database Center for Global Trade AnalysisPurdue University December

McKibbin WJ (1998a) The Crisis in Asia an EmpiricalAssessment Brookings Discussion Paper in InternationalEconomics 136 The Brookings Institution WashingtonDC

McKibbin W (1998b) Internationally Mobile Capital andthe Global Economy in McLeod RH and Garnaut R(eds) East Asia in Crisis from Being a Miracle to NeedingOne Routledge London 227ndash44 (Chapter 14)

McLeod RH and Garnaut R (eds) East Asia in Crisisfrom Being a Miracle to Needing One RoutledgeLondon

Radelet S and Sachs J (1998) The Onset of the EastAsian Financial Crisis Harvard Institute for InternationalDevelopment Cambridge MC

Siamwalla A and Sophchokchai O (1998) Respondingto the Thai Economic Crisis in UNDP Social Impli-cations of the Asian Financial Crisis Korea DevelopmentInstitute Seoul 427ndash65

Tambunlertchai S (1998) The Social Impact of theFinancial Crisis in Thailand and Policy Responsesin UNDP Social Implications of the Asian FinancialCrisis Korea Development Institute Seoul 115ndash38

Tyers R and Yang Y (1999) lsquoEuropean Unemploymentand the Asian Emergencersquo Working Papers in Econom-ics and Econometrics No 369 Australian NationalUniversity Canberra Available from URL httpecocommanueduauecopapers

Tyers R and Yang Y (2000) CapitalndashSkill Complemen-tarity and Wage Outcomes Following Technical Changein a Global Model Oxford Review of Economic Policy16 23ndash41

Tyers R and Yang Y (2001a) China after the Crisis TheElemental Macroeconomics Asian Economic Journal 15173ndash99

Tyers R and Yang Y (2001b) The Asian Crisis andEconomic Change in China Japanese Economic Review52 492ndash511

Tyers R Duncan R and Martin W (1999) Trade Tech-nology and Labor Markets General Equilibrium Perspec-tives Journal of Economic Integration 14 226ndash64

Tyers R and Yang Y (1997) Trade with Asia and skillupgrading effects on labor markets in the older indus-trial countries Weltwirtshaftliches Archiv Band 133 Heft3 383ndash418

Tyers R and Yang Y (2002) Agricultural trade reformafter the Asian recession a bridge too far in Milner Cand Read R (eds) Trade Liberalisation Competitionand the WTO Edward Elgar London pp 59ndash91

Vatikiotis M (1998) No safety net Far Eastern EconomicReview October 8 pp 10ndash3

Wood A (1994) NorthndashSouth Trade Employment andInequality Clarendon Press Oxford

World Bank (1999a) The crisis pictured Asiaweek(April 16)

World Bank (1999b) Global Economic Prospects andthe Developing Countries 199899 Beyond FinancialCrisis World Bank Washington DC

Yang Y and Tyers R (2000) Weathering the crisis the roleof China Pacific Economic Papers no 308 October

APPENDIX I Model AnalyticsSingle household in each regionUtility CobbndashDouglas between

bull private household expenditurebull government expenditurebull savings (the share and marginal propensity of

which can be modified exogenously)

Government consumption CobbndashDouglascomposite of all goodsPrivate household consumption CDE38 expenditurefunction (non-homothetic)

bull Decomposition between home goods and importsArmington

bull Decomposition of imports by region of originArmington

Firms are perfectly competitive with constant returnsto scaleTechnology is a CES combination of intermediateinputs with a CES composite of primary factorsIntermediate demand is decomposed to home goodsand imports as for household final consumptionPrimary factor demand is split according to the nestedCES system in Figure 1Land and natural resources are specific to agri-culture and mining respectively All other factorsare perfectly mobile between industriesPrimary factor supply all factors are inelastic insupply39

38 Constant Difference of Elasticities of substitution whichallows elasticities of substitution to be pair-wise distinctand the system therefore to be non-homothetic while main-taining parameter economy See Huff et al (1997 pp 133ndash47)

39 Households can transform labour between skilled andlow-skill types However this capability is made negligiblein the applications discussed in this paper


Capital returns are intra-regionalInvestment worldwide is the sum across regionsrsquosavings

When investment is made endogenous it is allo-cated across regions so that its proportional changeis larger in regions i with high values of the aver-age rate of return on installed capital r i

c40 In thisprocess a global lsquoexpected returnrsquo rw is calculatedsuch that ΣiSi = ΣisiYi = ΣiIi(r

w ric πi) where si

is the domestic saving rate in region i Yi is totalincome Ii is (net) investment and π i is a region-specific risk premium The investment demandequation for region i takes the form41

K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1

where Ki is the (exogenous) installed capital stock βis a positive constant and εi is a positive elasticity

Investment does not affect the current installedcapital stock but it does consume capital goods and itspattern of regional allocation has a significant influ-ence on the capital account of each regionrsquos balanceof payments and hence on the real exchange rate

Primary Factors

1 Agricultural land2 Natural resources3 Skilled or professional labour42

4 Low-skill or production labour42

4 Physical capital

Sectors

Full 50 goods and services defined in the GTAPdatabase43 Aggregated to six after model solutionsfor ease of presentation only The six aggregates are

1 All agriculture2 Mining and energy (coal oil gas and other

minerals)3 Skill-intensive manufacturing (petroleum paper

chemicals processed minerals metals motorvehicles and other transport equipment electronicequipment and other machinery and equipment)

4 Low-skill labour-intensive manufacturing (textilesapparel leather and wood products metal productsother manufactures)

5 Skill-intensive services (electricity gas waterfinancial services and public administration)

6 Low-skill labour-intensive services (constructionretail and wholesale trade dwellings)

APPENDIX III Reference Shocks and Closures44

Recessed Developing Asia

bull Regional investment is exogenous and reducedfrom 1995 to 1998 levels

bull Regional expected rate of return on currentinvestment is endogenous45

40 This is the rental rate on physical capital (which whenphysical capital is sector-specific varies across sectors)adjusted for depreciation and divided by the price ofcapital goods to yield a unitless net rate of return

41 The formulation of expected returns in the standardmodel along with some alternative investment allocationrules is discussed in Hertel and Tsigas (1997 pp 54ndash60)

APPENDIX II Model Structure

Table IShare of World GDP of Each Region

Regions Share of World GDPdagger

1 Recessed developing AsiaDagger 512 Japan 1803 Chinasect 254 European Unionpara 2905 USA 2526 Australasia 147 Rest of world 188

Dagger Korea (Rep) Indonesia Philippines Malaysia SingaporeThailand Vietnam Hong Kong and Taiwansect China excludes Hong Kongpara The European Union of 15dagger Share of 1995 GDP in US$ measured at market prices andexchange rates

42 The labour disaggregation is based on the ILO Classi-fication of Occupations Skilled or professional workersare defined as including managers and administratorsprofessionals and para-professionals Low-skill or pro-duction workers are plant and machine operators and driverstradespersons clerks labourers and related workers sales-persons and personal service workers

43 GTAP Version 4 database See McDougall et al (1998b)44 Sources Trade balance shocks are from IMF (1998

1999) Statistics from web sites for countries concerned assummarised in Duncan and Yang (2000) The sourcesfor China are indicated in Yang and Tyers (2000) In allscenarios capital is completely sector-specific in allregions so that the rate of return differs across sectors

45 In the subsequent scenarios regional investment isendogenous to equalise regional average lsquoexpected returnsrsquoadjusted for risk premia The trade balance is endogenous


bull The average regional saving rate SY is madeendogenous46

bull The trade balance X minus M is exogenous andchanges as observed

bull Sectoral production volumes are exogenous andshocked as observed

bull Sectoral capital use is endogenous so that capitalis idled in contracting sectors

bull Labour productivity in agriculture is reduced by5 per cent while land productivity is raised by2 per cent

bull Labour (low-skill and skilled) remains sectorallymobile and is fully employed

Japan








China

bull Regional investment as a percentage of GDP isexogenous and is increased by 3 per cent


bull Government spending as a percentage of GDP isexogenous and increases as observed



bull Sectoral production volumes are endogenouswhile sectoral capital use is exogenous

bull Labour (low-skill and skilled) remains sectorallymobile

bull Nominal wage is rigid downward so that the realwage depends on the endogenous real exchangerate and an observation-based exogenous nominalprice shock Full employment is therefore notensured

The lsquoNorthrsquo USA EU Australasia (and the Restof World)bull Regional investment is endogenousbull Regional current account X minus M is exogenous

and changes as observed (except for lsquothe rest ofthe worldrsquo)

bull Regional expected return on current investmentis endogenous45


bull Labour (low-skill and skilled) remains sectorallymobile and the real wage of production labour isflexible upward only47

47 In the end this constraint does not bind since the realwages of low-skill and skilled labour both rise

while the average savings rate is retained exogenous andthe observed reference scenario shock to it imposed Riskpremia on the expected rates of return on current invest-ment are then exogenous and also shocked as indicated inthe reference scenario

46 Since the capital account and current account must beequal in magnitude and opposite in sign I minus S = M minus X Forrecessed developing Asia Japan and China the shocksimpose exogenous changes in investment and in importsrelative to exports In all three regions the volume and rateof saving then follow endogenously


surplus between 1997 and 1998 Other things beingequal this would have reduced the relative prices oflabour intensive manufactures on world markets andso reduced the demand for low-skill or productionlabour in the north But other things were not equalThe primary effect of the Asian financial crisis wasa flight of savings from Asia leading to increasedinvestment in the north By itself this new invest-ment would have raised aggregate demand and henceemployment in some northern manufacturing indus-tries and in northern services sectors These twoconsequences of the Asian recession are associatedwith a real appreciation in the northern economiesagainst Asia and other regions not receiving the newinvestment Accordingly northern employment wouldhave expanded particularly in the non-tradablessectors and it would have tended to contract in atleast some tradables sectors Clearly some tradablessectors would be hurt by the Asian export expansionbut helped by the boost in local investment demandAt issue then is the magnitude and direction of thenet effects on northern labour demand

We address this issue by taking as our startingpoint the real effects of the Asian financial crisisNo attempt is made to address the genesis of thecrisis or to simulate its short-run dynamics The nowrecorded real short-run shocks to Asian aggregatedemand comprise contractions in investment (ashome savings fled abroad and foreign savings in Asiawere withdrawn) and consumption demand (as Asianwealth fell due to currency depreciations and in-creased debt service costs) Output also contractedas firms carrying US$ denominated debt were ren-dered illiquid or insolvent by the depreciations andthe credit crunch that followed These firms eitherclosed their doors or contracted their output pend-ing the resolution of rights to ownership over theircapital In estimating the effects of this recessionon trading partners in the north we have sought tocharacterise these changes in production explicitlyrather than to adopt the common practice of sub-suming them in a generic lsquoproductivity shockrsquo

To link the Asian recession with economies in thenorth we employ global general equilibrium analysisin a short-run counterpart of numerous general equi-librium studies of the preceding Asian lsquolong boomrsquo5

Some early studies of the Asian recession have alsoemployed such models6 A growing number haveused fully dynamic models some with financial

markets represented7 The behaviour that precipitatedthe crisis in Asia is still not fully captured in suchmodels however and the associated studies tend toemphasise implications for prudential regulation andmacroeconomic policy in the affected countries ratherthan real effects outside Asia

In examining the real effects of the Asian re-cession comparative static analysis allows us theluxury of more detailed microeconomics and greaterdisaggregation than is available in most fully dynamicmodels We construct short and medium-run com-parative static characterisations of the recessionand apply them to a suitably modified version ofan established global general equilibrium modelThe results offer a useful qualitative picture of therecession-affected regions as well as estimates of itseffects abroad The expansion of investment in thenorthern economies and the associated increase inservices output and employment prove dominantEven though real appreciations relative to Asia causenorthern tradeable goods sectors to contract the neteffect on northern output and labour demand is posi-tive even for production workers

In Section II a brief review of the Asian recessionis offered and our choice of model explainedSection III then provides a summary of the structureand behaviour of the model Our construction ofexperiments with it is detailed in Section IV and theresults summarised in Section V Section VI thenoffers conclusions

II The Asian recessionThe bursting of Japanrsquos 1980s asset bubble caused

a decline in investment that accelerated in 1997 inspite of a macroeconomic policy that maintained verylow short-term interest rates8 Private consumptionin Japan remained comparatively stable during the1990s but it declined during the crisis periodimports fell and there was a further expansion ofJapanrsquos current account surplus In addition a trendtoward lower working hours combined with therecent implementation of a standard 40-h week causeda decline in total labour hours and an associated

5 See Krugman (1995) and Tyers and Yang (1997 1999)6 See for example Adams (1998) and Duncan and Yang

(2000)

7 Although the events in the lead-up to the crisis are nowbetter understood the best dynamic global macroeconomicmodels to date still retain fully informed risk-neutralfinancial agents with perfect foresight or model-consistentexpectations and so cannot fully endogenise the capitalflight of 1997 They do however precipitate valuableinsights into the onset and management of such recessionsSee for example McKibbin (1998a 1998b)

8 The financial origins of the Japanese recession are dis-cussed in Horiuchi et al (1998)














16 April 1999










































(1)



K yw

r

= +

11 2

(2)


MC = AC = [w12 + r12]2 = p (3)













wWE

P eR

=

1(4)





















V The Results



























































































REFERENCES





















































w ric πi) where si


K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1



Primary Factors



4 Physical capital

Sectors






























Japan








China






























16 April 1999










































(1)



K yw

r

= +

11 2

(2)


MC = AC = [w12 + r12]2 = p (3)













wWE

P eR

=

1(4)





















V The Results



























































































REFERENCES





















































w ric πi) where si


K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1



Primary Factors



4 Physical capital

Sectors






























Japan








China


























































(1)



K yw

r

= +

11 2

(2)


MC = AC = [w12 + r12]2 = p (3)













wWE

P eR

=

1(4)





















V The Results



























































































REFERENCES





















































w ric πi) where si


K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1



Primary Factors



4 Physical capital

Sectors






























Japan








China






















wWE

P eR

=

1(4)





















V The Results



























































































REFERENCES





















































w ric πi) where si


K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1



Primary Factors



4 Physical capital

Sectors






























Japan








China




























V The Results



























































































REFERENCES





















































w ric πi) where si


K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1



Primary Factors



4 Physical capital

Sectors






























Japan








China






































































































REFERENCES





















































w ric πi) where si


K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1



Primary Factors



4 Physical capital

Sectors






























Japan








China





















































w ric πi) where si


K I

K

r

ri i

i

wi

ic

i

( )

+=

+

minus

β πε

1



Primary Factors



4 Physical capital

Sectors






























Japan








China
























Japan








China

















the asian recession and northern labour markets

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