ADB Economics

Working Paper Series

Trade Structure and the Transmission

of Economic Distress in the High-Income
OECD Countries to Developing Asia
Juthathip Jongwanich, William E. James, Peter J. Minor,
and Alexander Greenbaum
No. 161 | May 2009
ADB Economics Working Paper Series No. 161

Trade Structure and the Transmission

of Economic Distress in the High-Income
OECD Countries to Developing Asia

Juthathip Jongwanich, William E. James, Peter J. Minor,

and Alexander Greenbaum
May 2009

Juthathip Jongwanich is Economist, William E. James is Principal Economist, and Peter J. Minor and
Alexander Greenbaum are Consultants in the Macroeconomics and Finance Research Division, Economics
and Research Department, Asian Development Bank (ADB). This report was prepared as a background
paper for ADB’s Asian Development Outlook 2009. The paper represents the view of the authors and
does not represent those of ADB, its Executive Directors, or the countries they represent.
Asian Development Bank
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May 2009
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Contents

Abstract v

I. Introduction 1

II. Structure and Direction of Developing Asia’s Trade 3

A. Structure of Trade in Parts and Components 8

B. Direction of Trade in Parts and Components versus Final Goods 13

III. Factors Leading to Changes in Developing Asia’s Trade Patterns 18

A. Fundamental Factors 18
B. The Role of the Real Exchange Rate 22

IV. Impacts of the Global Economic Slowdown on Developing Asia 25

V. Impacts of Proposed Fiscal Stimulus Packages on Developing Asia 31

VI. Impacts of the Protectionist Threat on Developing Asia 34

VII. Conclusions and Policy Inferences 38

Appendix: The Global Trade Analysis Program (GTAP) 40

References 42
Abstract

This paper examines the structure and direction of developing Asia’s trade
over the past two decades. The impacts on developing Asia of the economic
slowdown in 2009–2010 in high-income countries of the Organization for
Economic Cooperation and Development (OECD), which includes the European
Union (EU), Japan, and United States (US) are projected through a computable
general equilibrium model (CGE) of world trade and production. In addition,
the impacts of fiscal stimulus and the rise of protectionist sentiments within
developing Asia are examined. The expansion of intraregional trade in Asia
reflects the role of the People’s Republic of China (PRC) as an assembly point
and its reliance on demand from outside the region, the EU and the US in
particular. The trade channel is crucial in transmitting economic distress from the
OECD countries to developing Asia. The projection shows that developing Asia
will continue to suffer from demand decline in OECD countries, with the PRC and
India being the most impacted. Though Southeast Asia faces reduced exports
to the OECD countries, its exports are reduced significantly to other Asian
exporters, demonstrating the indirect trade linkages that now exist in the global
economy. Fiscal stimulus from the largest economies (including PRC, EU, Japan,
and US) could help boost trade and gross domestic product growth in developing
Asia but it is not projected to offset entirely the negative impact from the global
economic downturn. Protectionism has a negative impact on the countries and
regions that take that course. Southeast Asia would be the most impacted by
protectionism. If Southeast Asian countries were to raise their applied tariffs
to the maximum most-favored nation bound rates under the World Trade
Organization, the impact would be negative on real gross domestic product.
Heavy manufactures followed by light manufactures, electronics, and textiles are
most impacted.
I. Introduction
The global economic slowdown is having pronounced adverse impacts on developing
Asian economies. The slowdown stemmed from the United States (US) subprime
mortgage crisis and rapidly spread to European countries and Japan. There are two
key channels through which recession in the high-income Organization for Economic
Cooperation and Development (OECD) has been transmitted to developing Asia,
namely the trade and financial channels (James et al. 2008). So far, the impacts on
developing Asia have been felt primarily through the trade channel rather than through
the meltdown of financial institutions. By the fourth quarter of 2008, exports in developing
Asia had noticeably contracted. The drop of export growth averaged nearly 30% in East
and Southeast Asia and approached double digits in South Asia. As a result, real gross
domestic product (GDP) growth decelerated throughout the region while unemployment
increased significantly, especially in East Asia.

As the crisis has deepened, governments in both developed and developing countries
have authorized economic stimulus packages to counter the impacts of declining
consumption and investment with increased government expenditures. The price tags on
stimulus packages range from less than 1% of GDP to several percentage points of GDP
in developed countries. These are far more circumspect in their magnitude in developing
countries, with People’s Republic of China (PRC), Malaysia, and Singapore leading the
way in Asia. Stimulus packages could help offset the contraction in trade volumes in
developing Asia as domestic demand increases in these countries, pulling in imports from
neighboring countries.

In addition, there is a growing wave of protectionist actions as economies around the

world suffer from lower economic growth rates and rising levels of unemployment. The
US has included “buy America” provisions in its economic stimulus legislation. Meanwhile,
developing economies from Asia to Africa have only reluctantly embraced lower tariffs
in the last 10 years and protectionist sentiments are rising. For example, Indonesia

 The high-income OECD countries include advanced western European countries, defined here as EU-15 unless
otherwise specified, as well as Japan and the United States (US). The members of the EU-15 include Austria,
Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain,
Sweden, and United Kingdom.
 | ADB Economics Working Paper Series No. 161

has restricted the import of certain goods to just a few ports and airports, while India
has increased tax rebates for exporters. Although protectionist moves are viewed by
proponents as a means to boost employment in their own economies, they discount the
fact that economies are now highly globalized and that the production of local goods
depends heavily on global supply chains. For example, automobile manufacturers
in Indonesia depend upon component parts from Japan, and apparel producers in
Cambodia import most of their fabric and materials from the PRC. Since few economies
have completely integrated domestic supply chains, protectionism perhaps threatens more
than it promises in terms of higher prices for intermediate goods (parts and components).

To date, there are limited empirical studies to investigate impacts of the above issues
on trade and growth prospects in developing Asia. In addition, most projections relating
to these issues have been derived using macroeconomic models of consumption
and investment. While these models are appropriate for broad economic predictions,
especially in terms of the ways in which they model money and finance, they lack crucial
information on global industry structure and trade—the exact mechanisms by which
developing Asia is likely to be impacted by the current crisis.

Thus, this study aims to examine impacts of OECD demand slowdown, fiscal stimulus
packages from both OECD and developing countries, and a rise of protectionism on
prospects of trade and real GDP growth in developing Asia in 2009–2010. A computable
general equilibrium model (CGE) of world trade and production is employed instead of a
macroeconomic model. The next section of the paper discusses structure and direction
of Asia’s trade over the past two decades, particularly the increasing importance of
global supply chains, to provide background information on how developing Asia has
become more integrated and how the OECD markets are linked to developing Asia.
This section also shows how the trade channel is crucial for developing Asia and how
the slowdown in global demand is negatively affecting developing Asia, especially as a
result of lower demand from OECD markets. Factors driving changes in trade structures
through global supply chains are provided in Section III. Section IV examines impacts of
the global economic slowdown, driven by the global financial crisis, on developing Asia.
The impacts of fiscal stimulus packages are examined in Section V. In particular, we
address the question, “What is the potential for fiscal stimulus packages in the largest
economies (PRC, Europe, Japan, US) to impact trade and real GDP in developing Asian
economies?” Section VI examines impacts of a rise in protectionist moves in developing
Asia. The final section (Section VII) provides conclusions and policy inferences.

 The Global Trade Analysis Program (GTAP) based at Purdue University maintains a standard CGE model including
global trade and production structures. The most current model is based on global trade, production, and prices in
2004. Since trade and production structure matter most in the following analysis, we updated the structure of trade
shares to reflect a major shift in global textile and apparel trade precipitated by the elimination of global textile
and apparel quotas in 2005.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 

II. Structure and Direction of Developing Asia’s Trade

The emergence of Asian trade over the past four decades as the third hub of world
trade next to Europe and North America has followed a distinctive pattern. Following
Japan’s export success in the 1950s and 1960s, the newly industrialized economies
(NIEs), namely, Hong Kong, China; Republic of Korea (henceforth Korea); Singapore; and
Taipei,China, began to enter export markets as Japan’s industrial structure shifted away
from labor-intensive to more sophisticated products. The 1985 Plaza Accord, which saw
a sharp revaluation of the yen, also supported the NIEs in expanding their exports in the
labor-intensive activities in which Japan was losing advantage (Figure 1). However, by
the late 1980s, these economies were losing their edge in labor-intensive activities as
a result of rising wage costs and attendant real currency appreciation. In addition, the
imposition and gradual tightening of quantitative restrictions by industrial countries blunted
penetration in textiles, garments, and footwear markets (Wells 1986).

Figure 1: Real Exchange Rates, 1980−1990

200

180

160

140

120

100

80

60

40
Jan 80 Jan 81 Jan 82 Jan 83 Jan 84 Jan 85 Jan 86 Jan 87 Jan 88 Jan 89 Jan 90

Hong Kong, China Japan

Korea, Rep. of Singapore
Taipei,China
Note: An increase in the indexes reflects real depreciation (2000=100).
Source: Bank for International Settlements database, available: www.bis.org, downloaded 12 March 2009.

As profitability fell at home, producers from Japan and the NIEs began to move their
production platforms to Southeast Asia. These countries were attractive to investors
because of their relatively favorable macroeconomic conditions, trade, and investment
policies. On the heels of direct inward investment, an export boom followed in labor-
intensive manufacturing. At the same time, rapid advances in production technology
 | ADB Economics Working Paper Series No. 161

created the opportunity for investors to redesign production processes in ways that
accentuated task specialization, i.e., splitting up fabrication and assembly processes and
reducing production costs (Krugman 1995). This process occurred extensively in the
electronics industry so that by the mid-1980s, Southeast Asian countries started exporting
electronics and other more technologically sophisticated products. Later, in the early
1990s, the PRC emerged as a fast-growing exporter of labor-intensive manufacturers.
Product lines “migrated” to the PRC from other countries in East and Southeast Asia,
attracted by its large pool of cheap labor, rapidly improving infrastructure, and policies
favoring exporters.

The evolution of trade patterns shows that rapid export growth in developing Asia
has been underpinned by a pronounced shift in export structures away from primary
commodities toward manufactures. Given the nature of their resource endowments,
NIEs relied heavily on manufacturing for export expansion. Yet, beginning in the 1970s,
a notable shift toward manufacturing has been observed across all countries at varying
speed and intensity. Since the early 1990s, the share of manufactured exports to total
exports in Southeast Asia (except in Indonesia and the Philippines) has exceeded
70%. In the Philippines, the share of manufactured exports to total exports increased
significantly from 50% during 1991–1995 to more than 90% during 1996–2006. In
Indonesia and Viet Nam, the share of manufactures in total exports is significantly lower
at about 50%, reflecting both their comparative advantage, resource endowments, and
their later adoption of export-oriented industrialization strategies.

Within manufacturing, machinery and transport equipment (SITC 7) has become the key
export component in developing Asia. Table 1 shows that in 1992, the share of SITC 7
exports in total manufacturing exports in developing Asia was around 36%, and increased
to 55% in 2006. Within SITC 7, information and communication technology (ICT) products
(SITC 75, 76, 772, and 776) have been the most important, accounting for more than
70% of SITC 7 exports. The share of developing Asia in world ICT exports increased
from 25% in 1992 to 50% in 2006 (Table 2). Electrical goods (SITC 77-772-776) comprise
another major category of manufacturing exports. The level and the change over time of
world market share in this product category among the developing Asian countries are
strikingly similar to that of ICT products. The share of developing Asia in world electrical
goods exports recorded an impressive increase to 36% in 2006, from 16% in 1992
(Table 2).
 The evolution of exports (and trade patterns) in the region is traced using detailed trade data, specifically the
United Nations Commodity Statistics Database (UNCOMTRADE), based on Revision 3 of the Standard International
Trade Classification (SITC, Rev. 3), and Bureau of Foreign Trade for Taipei,China. It is important that the data are
tabulated using importer country records, which are considered more accurate compared to the corresponding
exporter records for analyzing trade patterns for a number of reasons (Ng and Yeats 2003, Feenstra et al. 2005,
Athukorala and Kohpaiboon, 2008). Partner-country records are admittedly less susceptible to double counting
and erroneous identification of the source/destination country in the presence of entrepot trade, compared to
data based upon reporting country records (e.g., the PRC’s trade through Hong Kong, China). In addition, some
countries fail to properly report goods shipped from their own export processing zones. These exports are simply
lumped into “special transactions” (SITC 9). Unless otherwise specified, trade data shown in this paper refer to
manufacturing trade.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 

Table 1: Commodity Composition of Manufacturing Exports in Developing Asia

(percent of manufacturing exports)
Chemicals Resource Textiles Machinery ICT Electrical Miscellaneous Footwear
(SITC 5) Based and Transport Products Products Manufacturing and
Products Equipment (SITC 8) Clothing
  (SITC 6 ) (SITC 7)
Developing Asia            
1992 5.2 20.5 9.5 36.4 24.2 4.4 37.9 16.0
2006 7.3 14.0 3.7 54.8 38.5 6.2 24.0 7.8
East Asia                
1992 5.2 20.6 10.5 31.8 18.4 4.7 42.4 16.5
2006 6.1 14.1 3.7 54.2 36.5 7.0 25.7 7.2
PRC
1992 4.2 16.6 9.2 19.4 10.3 4.6 59.7 24.4
2006 3.9 13.9 3.7 51.5 36.5 7.4 30.7 9.5
Hong Kong, China
1992 6.1 20.9 13.2 30.7 19.4 4.5 42.3 21.3
2006 4.5 15.4 4.6 45.3 34.2 6.2 34.8 15.2
Korea
1992 6.5 26.2 11.2 39.8 24.7 4.5 27.5 11.7
2006 10.3 12.3 2.8 67.6 39.3 4.5 9.8 0.8
Taipei,China
1992 5.1 22.0 10.0 44.1 24.7 5.4 28.8 5.4
2006 13.4 17.7 5.1 53.1 32.9 8.8 16.1 0.7
Southeast Asia                
1992 5.1 14.3 3.5 56.2 45.2 4.4 24.5 10.8
2006 10.0 8.8 1.6 66.0 53.1 4.4 15.1 4.9
Indonesia
1992 4.4 46.2 11.4 8.0 4.4 1.2 41.4 20.7
2006 9.6 23.7 6.1 38.4 23.4 6.7 28.2 13.4
Malaysia
1992 3.6 10.4 2.0 67.7 57.3 4.3 18.3 9.4
2006 5.9 6.8 0.8 77.8 70.2 3.5 9.6 2.3
Philippines
1992 3.4 7.3 1.8 45.7 37.4 6.3 43.6 25.8
2006 1.4 3.2 0.6 85.1 74.9 6.4 10.3 4.9
Singapore
1992 7.8 5.6 0.9 75.1 60.5 5.2 11.5 3.1
2006 21.3 3.6 0.3 67.0 55.1 2.8 8.1 0.3

continued.
 | ADB Economics Working Paper Series No. 161

Table 1: continued.
Thailand
1992 3.3 17.5 5.5 42.2 30.9 4.7 36.9 13.3
2006 9.5 12.9 2.2 62.4 39.8 5.2 15.2 4.7
Viet Nam
1992 2.3 14.8 5.7 3.2 0.4 0.6 79.7 63.9
2006 2.6 10.6 3.5 18.5 8.8 4.4 68.3 26.2
South                
1992 4.9 48.2 25.2 5.3 0.9 0.6 41.6 33.2
2006 13.4 38.1 14.2 12.3 2.1 2.2 36.2 26.5
India
1992 7.4 50.6 17.9 7.4 1.2 0.7 34.6 24.4
2006 17.6 40.7 10.1 16.1 2.8 2.8 25.6 14.0
Sri Lanka
1992 1.4 20.2 4.9 3.1 1.5 1.1 75.3 67.6
2006 1.4 20.4 2.7 7.0 1.5 2.0 71.2 65.8
Bangladesh
1992 1.9 18.0 11.5 3.9 0.2 0.2 76.2 74.4
2006 1.4 8.7 6.1 1.1 0.2 0.1 88.8 87.0
Pakistan
1992 0.5 63.8 57.3 1.2 0.1 0.2 34.5 27.7
2006 2.7 58.9 54.5 1.4 0.3 0.1 37.0 29.5
Nepal
1992 0.7 67.1 62.7 1.3 0.2 0.3 30.9 28.8
2006 14.6 46.8 34.8 3.2 0.4 1.3 35.4 24.7
Note: The corresponding code of textiles is SITC 64; ICT products is SITC 75+76+772+776; Electrical products is SITC 77-772-776
and footwear and clothing is SITC 84+85.
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.

Within developing Asia, the share of SITC 7 exports has increased significantly in East
and Southeast Asia (Table 1). The share of SITC 7 in total manufacturing exports in
these countries was more than 50% in 2006. In Malaysia and the Philippines, the share
of this component in their manufacturing exports was about 80% in 2006 while it was
around 70% in Korea and Singapore. Indonesia and Viet Nam, where SITC 7 accounted
only for 38% and 18% of total manufacturing exports in 2006, were exceptions. In South
Asia the share of SITC 7 showed an increasing trend, but accounted for just 12% of total
manufacturing exports in 2006.

For ICT products, the key component in SITC 7 exports, East and Southeast Asia,
account for more than 80% of the growth in developing Asian exports. In particular, in
2006, the PRC alone accounted for 24% of total world ICT exports, increasing from 3% in
1992, while exports from Malaysia and Korea accounted for 6–7% in 2006, respectively
(Table 2). The share of the PRC in world electronic goods also increased noticeably
from 4% in 1992 to 21% in 2006, while the shares of Korea and Taipei,China in world
electronic goods were stable at around 4% apiece in 1992–2006. This trend reinforces
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 

the view that international trade is facilitating industrialization and structural change in
the region as these countries are evolving in line with the previously observed pattern of
industrial development of developed countries such as Japan by moving into higher skill
and technology exports.

SITC 7 has dwarfed the traditional labor-intensive manufacturing exports of textiles (SITC
64) and clothing (SITC 84) and footwear (SITC 85) in the mid-1980s. In 2006, the share
of these products in developing Asia had declined to 11% of total manufacturing exports,
from 25% in 1992 (Table 1). This pattern is found in almost all Asian countries, except
Bangladesh and Pakistan. In Bangladesh, the share of these items accounted for 93% of
total manufacturing exports in 2006, increasing from 86% in 1992 while in Pakistan, the
share was relatively stable at around 84% during this period (Table 1). In India, Sri Lanka,
and Viet Nam, although the share of these two items declined continuously, they still
accounted for a high proportion of total manufacturing exports. In Sri Lanka, the share of
these products was 68% of total manufacturing exports in 2006, down from 72% in 1992.

However, these labor-intensive products from developing Asia are still important in
the world market. The share of developing Asia in total world clothing and footwear
exports increased to almost 52% in 2006, from 41% in 1992 (Table 2). The PRC has
accounted for much of this increase in world market share, but in contrast to ICT exports,
the geographic participation has been broader. A number of low-income countries in
Southeast and South Asia, including Bangladesh, India, Indonesia, Sri Lanka, and Viet
Nam have all recorded impressive gains in the world market share of these products.

Table 2: World Export Shares of Selected Manufacturing Products (percent)

  Machinery ICT Products Electrical Textiles, Clothing
and Transport Products and Footwear
(SITC 7) (SITC 64, 84, 85)
  1992 2006 1992 2006 1992 2006 1992 2006

Developing Asia 11.9 29.1 25.2 50.5 16.5 35.8 40.7 52.4
PRC 1.6 13.7 2.8 23.9 4.4 21.4 13.9 30.0
Hong Kong, China 1.2 0.6 2.5 1.1 2.1 0.9 6.7 2.3
Korea 1.8 4.5 3.6 6.5 2.3 3.3 5.1 2.1
Taipei,China 2.6 2.2 4.6 3.4 3.5 4.0 4.4 2.1
Indonesia 0.1 0.5 0.1 0.7 0.1 0.9 1.6 2.1
Malaysia 1.4 2.7 3.8 5.9 1.0 1.3 1.2 0.9
Philippines 0.3 1.1 0.7 2.5 0.4 0.9 0.8 0.6
Singapore 2.1 1.9 5.5 3.8 1.7 0.8 0.6 0.1
Thailand 0.7 1.5 1.5 2.4 0.8 1.4 1.4 1.4
Viet Nam 0.0 0.1 0.0 0.1 0.0 0.3 0.1 1.4
India 0.1 0.3 0.0 0.1 0.1 0.5 2.2 3.7
Sri Lanka 0.0 0.0 0.0 0.0 0.0 0.0 0.5 0.7
Bangladesh 0.0 0.0 0.0 0.0 0.0 0.0 0.7 2.2
Pakistan 0.0 0.0 0.0 0.0 0.0 0.0 1.5 1.9
Nepal 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.
 | ADB Economics Working Paper Series No. 161

In terms of imports, the share of manufactures was around 80% of total imports in 1992–
2000. SITC 7 accounted for the highest proportion of manufacturing imports and the
share has increased continuously to 60% of total manufacturing imports in 2006 (Table 3).
While the share of chemical products (SITC 5) has been relatively stable at around 15%,
resource base (SITC 6) and miscellaneous manufacturing (SITC 8), particularly textiles
(SITC64) and footwear and clothing (SITC 84 and 85), have become less important in
manufacturing imports. Among SITC 7 imports, ICT products recorded a notable rise.
The share of this product in developing Asia increased to 36% of total SITC 7 imports in
2006 from 20% in 1992. The significant rise of ICT products in import baskets is found in
almost all Asian countries. Other than Bangladesh and Viet Nam, the rising importance
of ICT and electronic goods has replaced imports of machinery, including both general
(SITC 74) and specialized (SITC 72) industrial machinery.

Table 3: Commodity Composition of Manufacturing Imports in Developing Asia (percent)

  Developing Asia East Asia Southeast Asia South Asia
  1992 2006 1992 2006 1992 2006 1992 2006
Chemicals (SITC 5) 12.5 13.2 12.8 13.3 10.9 12.1 20.8 16.7
Resource based products
(SITC 6 ) 21.6 14.8 22.7 13.6 18.1 13.9 30.6 27.6
Textiles 7.3 3.5 8.6 3.4 4.8 2.7 8.1 6.5
Machinery and transport
equipment (SITC 7) 51.6 60.6 47.1 60.5 61.7 64.7 41.7 47.6
ICT products 20.6 35.9 18.3 37.4 27.7 38.0 6.5 16.0
Electrical products 4.2 5.4 4.3 5.8 4.3 5.0 3.1 3.5
Specialized industrial
machinery 6.5 4.3 6.3 4.1 6.4 4.1 10.0 7.2
General industrial
machinery 6.0 4.6 5.5 4.1 7.1 5.2 6.2 6.2
Miscellaneous
manufacturing (SITC 8) 14.2 11.4 17.5 12.6 9.3 9.3 6.9 8.1
Apparel and footwear 2.9 1.5 4.3 1.8 0.9 1.1 0.4 0.5
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.

A. Structure of Trade in Parts and Components

The ongoing process of global production sharing—in which developing Asia economies
are increasingly integrated into international production networks (global supply
chains)—lies behind Asia’s rapid growth in the trade of manufactured products such as
machinery and transport equipment (SITC 7). The proportion of parts and components
in developing Asia has increased continuously since the early 1990s. In terms of
exports, it increased from 16% of total manufacturing exports in 1992 to 25% in 2006
(Table 4). Countries in East and Southeast Asia stand out in developing Asia for their

 Parts and components are separable from final goods within the UNCOMTRADE at the 5-digit level of the SITC.
The lists of parts and components are extended from Athukorala (2006). There are 269 items classified as parts and
components in which 221 products are in SITC 7 and 59 products are in SITC 8.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 

heavy dependence on parts and components for export dynamism. The share of parts
and components in total manufacturing exports of Southeast Asia increased to 40% in
2006, from 26% in 1992 while in East Asia, the share reached 26% in 2006, from 16%
in 1992. In the Philippines, the share of parts and components doubled to almost 70% in
2006. Also, in the PRC, parts and components accounted for 19% of total manufacturing
exports, rising from 4% in 1992. In Korea and Taipei,China, the relative importance of
components in total manufacturing exports has increased, contradicting the popular
belief that these economies had shifted palpably from assembly activities to final goods
production. Parts and components exports are mostly concentrated in ICT products and
electrical machinery.

In contrast, parts and components exports are limited in South Asia. Among these
countries, India has great potential to benefit from this new form of international
specialization, given its relatively low cost and trainable labor and its location in the
region. However, India remains a tiny participant in global production networks. The
share of parts and components in total manufacturing exports was only 7% in 2006,
increasing from 3% in 1992. Sri Lanka also saw a small but notable increase in parts
and components exports. The share of these products doubled to 4% in 2006. Apart from
these two countries, the share of parts and components was very small, i.e., less than
1% in 2006. A number of supply-side factors such as quality and quantity of infrastructure,
investment climate, including political instability in the region, could constrain the region’s
participation in the global production network.

Parts and components also are an increasing proportion of developing Asia’s import
basket (Table 4). The share of parts and components imports in manufacturing
imports increased to 36% in 2006 from 22% in 1992, and more than 96% of parts and
components imports are in SITC 7. Parts and components imports are limited in South
Asia, compared to East and Southeast Asia. Parts and components imports in South Asia
accounted for 17% of total manufacturing imports, and they were around 37% and 42% in
East and Southeast Asia. The share of parts and components in the PRC rose from only
19% of total manufacturing imports in 1992 to 42% in 2006.
10 | ADB Economics Working Paper Series No. 161

Table 4: Share of Parts and Components in Manufacturing Trade (percent)

  Exports Imports
  Total P&C ICT products Total P&C ICT products
  1992 2006 1992 2006 1992 2006 1992 2006
Developing Asia 15.6 25.4 11.9 20.5 23.2 36.0 14.4 26.7
East Asia 13.0 22.7 9.1 17.6 19.8 36.5 11.8 28.0
PRC 4.3 18.5 2.4 14.1 18.6 41.5 7.8 30.6
Hong Kong, China 17.3 24.1 12.9 19.6 17.3 36.5 9.9 29.2
Korea 16.7 32.7 13.5 26.6 25.7 28.9 14.1 19.4
Taipei,China 19.8 32.6 11.9 24.7 25.7 33.5 18.0 27.1
Southeast Asia 25.9 40.2 22.2 35.5 31.9 42.1 22.2 30.9
Indonesia 3.0 18.2 1.4 11.1 20.6 28.4 6.2 13.6
Malaysia 32.9 46.7 30.1 44.1 38.2 49.9 28.7 40.8
Philippines 32.7 66.5 26.4 61.3 31.4 48.7 21.5 40.1
Singapore 31.3 42.3 26.8 38.1 35.8 43.5 27.6 32.4
Thailand 18.7 25.4 15.0 19.0 25.9 35.5 14.0 22.9
Viet Nam 0.8 8.4 0.3 3.1 7.1 16.3 2.3 7.4
South Asia 2.3 5.5 0.5 1.3 15.0 17.0 4.3 6.8
India 3.3 7.1 0.6 1.6 17.2 18.6 5.2 7.7
Sri Lanka 2.7 4.0 1.4 1.6 9.3 10.1 2.7 3.9
Bangladesh 0.2 0.8 0.1 0.1 7.4 10.6 2.1 5.1
Pakistan 0.4 0.7 0.1 0.2 15.6 16.0 3.9 4.7
Nepal 1.2 1.0 0.2 0.1 13.2 8.9 4.1 2.7
P&C = parts and components, ICT = information and communications technology.
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.

Developing Asia’s share in world trade in parts and components increased from 16% in
1992 to 31% in 2006 (Figure 2). This resulted from a significant increase in the share of
developing East Asia, especially the PRC followed by Korea and Hong Kong, China. In
Southeast Asia, all countries, except Singapore, have recorded increases in world market
shares. In Singapore, the global production networks in high-tech industries have clearly
shifted from standard assembly and testing activities to product design, capital- and
technology-intensive tasks in the production process, and providing headquarter services.
Some of these activities are not captured in the data on merchandise trade (Athukorala
and Kohpaiboon 2008) thereby underestimating the share of Singapore’s parts and
components trade in the world market. In South Asia, although the share of parts and
components in world trade rose, it was less than 1% of total world parts and components
trade.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 11

Figure 2: Share of Developing Asia’s Parts and Components in World Trade (percent)
35
31.3
30
25
20.6
20
15
10.9 10.0
10
5 3.0 3.8 2.9 3.2 3.0
0.7 1.6 1.4 0.2
0
Developing East PRC HKG KOR TAP Southeast INO MAL PHI SIN THA VIE
Asia Asia Asia
PRC = People’s Rep. of; HKG = Hong Kong, China; INO = Indonesia; MAL = Malaysia, PHI = Philippines,
KOR = Korea, Rep. of; TAP = Taipei,China SIN = Singapore, VIE = Viet Nam

35
30
25
20
15
10
5
0.7 0.6 0.0 0.0 0.1 0.0
0
South IND SRI BAN PAK NEP
Asia

BAN = Bangladesh, IND = India, NEP = Nepal

PAK = Pakistan, SRI = Sri Lanka

1992 2006
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.

A comparison of the data on the share of parts and components in total exports and
imports points to an important difference between the PRC and other developing Asian
countries. In the PRC, parts and components account for a much larger share of imports
compared to the share in exports. In other developing Asian countries the percentage
share of parts and components exports tends to be higher than imports. These different
patterns imply the increasingly important role played by the PRC as a final product
assembler using parts and components procured from countries in the region, with
Southeast Asian countries among them playing an increasingly important role.

In addition, the increasing importance of parts and components trade results in a rise of
intra-industry trade—trade in which a country simultaneously imports and exports similar
products, defined here as belonging to the same SITC 5 product group. Intra-industry
12 | ADB Economics Working Paper Series No. 161

trade in developing Asia, measured by the Grubel-Lloyd index (see Box 1), has risen
significantly over the past 15 years, from less than 0.35 in 1992 to more than 0.50 in
2006, and parts and components trade has contributed noticeably to the increase (Figure
3). Although intra-industry trade was more pronounced in East Asia, it sharply increased
in Southeast Asia, particularly in Malaysia and Thailand.

Within East Asia, the most notable rise in intra-industry trade (IIT) was found in the PRC
where the overall IIT index increased by 13 percentage points and the IIT index of parts
and components rose by 14 percentage points. Intra-industry trade was less significant
in South Asia, although the IIT index showed an increasing trend. Excluding India, the
IIT index in this region was only around 0.10 in 2006. In India, the overall IIT index rose
to 0.32 in 2006, from 0.14 in 1992. In contrast to other countries in East and Southeast
Asia, finished products tended to contribute the most to the increase in intra-industry
trade in South Asia.

Figure 3: Intra-industry Trade Index

1.0 1.0
0.9
0.80
0.9 0.84 0.88 0.81
0.8 0.73 0.8
0.7 0.67 0.68 0.7
0.65 0.64
0.6 0.53 0.56 0.6 0.58
0.50 0.47 0.46
0.5 0.46 0.5
0.40 0.38
0.4 0.32 0.4 0.32
0.30
0.3 0.3
0.2 0.2
0.1 0.1
0.0 0.0
Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish
Developing East Asia Southeast Asia South Asia PRC Hong Kong, China Korea, Rep. of
Asia

0.81
0.74 0.71
0.64 0.63
0.54
0.46 0.46 0.48
0.43
0.33 0.34 0.32 0.33
0.28 0.28 0.29
0.25
0.17 0.14 0.11 0.12 0.070.08 0.13 0.11
0.07 0.07 0.07
0.02
Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish Total P&C Finish
Indonesia Malaysia Philippines Singapore Thailand Bangladesh* India Nepal* Pakistan Sri Lanka*

1992 2006

P&C = parts and components, ICT = information and communications technology.

Note: Because of data limitation, the end period of Bangladesh, Nepal, and Sri Lanka is 2004, 2003, and 2005, respectively.
Source: Author estimates.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 13

Box 1: The Grubel-Lloyd Index

Intra-industry trade is the value of exports of goods from an industry matched by the value of imports
of goods to the same industry. The Grubel-Lloyd index is a common measure of intra-industry trade
(Grubel and Lloyd 1975).
For a given industry i in an economy, let Xi denote the value of exports and Mi the value of imports at
some point in time (t). The value of Intra-industry (Ii,t) is then as
I i ,t = ( X i ,t + M i ,t ) − X i ,t − M i ,t (1)
The value of intra-industry trade in equation (1) is then normalized by total trade ( X i + Mi ) to give

 X i ,t − M i ,t 
IIT =  1 − 
 ( X i ,t + Mit )  (2)
 
The index ranges between zero and one. If the country simultaneously imports and exports the same
amount of products in industry i, X i ,t − Mi ,t is equal to zero and the index of intra-industry trade is
equal to one, signifying pure intra-industry trade. By contrast, if the country only imports or exports
products in industry i, X i ,t − Mi ,t is equal to total trade, ( X i ,t + Mi ,t ) , then the intra-industry trade index
is equal to zero, signifying pure inter-industry trade.

B. Direction of Trade in Parts and Components versus Final Goods

The data on the direction of trade are generally consistent with the view that Asia has
become increasingly integrated through merchandise trade (Table 5). The share of
intraregional trade in total trade of developing Asia increased to 48% in 2005–2006,
from 40% in 1994–1995. Intraregional trade was far higher than extraregional trade with
North American Free Trade Agreement (NAFTA), EU-15, and Japan individually, where
the share of manufacturing trade in total trade was 18%, 16%, and 13%, respectively,
in 2005–2006. The increasing importance of intraregional trade mainly came from East
and Southeast Asian countries. There are, however, notable differences in the degree of
regional integration in exports and imports within Asian trade and all regional subgroups
of countries, with export trade showing a lesser degree of regional integration than on the
import side.

The decomposition of manufacturing trade into final products and parts and components
shows that intraregional trade in Asia is mostly concentrated on parts and components
trade. Compared to only an 8 percentage point increase in total manufacturing trade, the
intraregional share of Asian parts and component trade rose by almost 20 percentage
points, increasing to 62% in 2005–2006 (Table 6). The difference is consistently large
across the subgroups of countries within the Asian region (except South Asia). In contrast
to other countries, an increase in intraregional trade in the PRC came only from the
import side while for the other countries, exports also contributed to the increase. While
14 | ADB Economics Working Paper Series No. 161

the share of PRC’s intraregional exports in parts and components has been relatively
stable over the past decade, intraregional imports in parts and components rose to 73%
in 2005–2006, from only 56% in 1994–1995. For other Asian countries, the PRC has
become a key export destination of their parts and components. These differences in the
geographic patterns of imports and exports also reflect the increasingly important role
played by the PRC as a final product assembler for advanced country markets using
components procured in countries within the region.

In contrast to other countries, the share of manufacturing exports from the PRC to
developing Asia dropped noticeably during 1994–2006 while NAFTA and EU-15 have
become increasingly important export markets. The share of NAFTA increased to 31%
in 2005–2006 from 26% in 1994–1995, while that of the EU increased to 20% from 15%
during the same period. In contrast to the PRC, for the other developing Asian countries,
NAFTA and EU shares in manufacturing exports have declined. The PRC share in other
Asian developing countries’ manufacturing exports has risen but this is almost entirely
due to parts and components exports. The geographic patterns of manufacturing and
parts and components exports and imports confirm that the rise of the PRC as the final
assembler has contributed to reliance on extraregional demand, especially for final
products. The lower level of intraregional integration from the export side mentioned
earlier also reflects the dependence of Asia on extraregional markets for export-led
growth.

For labor-intensive products such as textiles and clothing, NAFTA and the EU-15 have become
even more crucial as developing Asia’s main export destinations (Table 7). In East Asia, NAFTA
and EU-15 accounted for 42% of total textile and clothing exports in 2005–2006, increasing
from 35% in 1994–2095. This increase was mainly due to an increase in exports from the
PRC, where the share of exports to NAFTA and the EU-15 increased by 10 percentage points,
reaching 42% of the PRC’s total textile and clothing exports in 2000–2006. In Southeast
Asia, more than 70% of total textile and clothing products were exported to NAFTA and the
EU-15 in 2005–2006, up from 65% in 1994–1995. This reveals that any exogenous decline
of developed countries’ demand could significantly affect export performance of developing
Asia, not only through technology-intensive products, which rely on extraregional demand
for final products, but also through final demand for labor-intensive products.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 15

Table 5: Direction of Developing Asia’s Manufacturing Trade (percent)

  NAFTA EU-15 Japan Developing East PRC Southeast South
Asia Asia Asia Asia
Developing Asia                
Exports
1994–95 28.1 17.9 10.8 37.6 24.3 3.3 12.5 0.8
2005–06 25.8 18.5 8.4 38.4 26.6 11.3 10.2 1.5
Imports    
1994–95 13.8 17.1 26.8 43.0 28.5 7.1 13.6 0.9
2005–06 10.4 13.7 19.3 57.8 40.5 15.2 16.2 1.2
East Asia                
Exports
1994–95 26.8 15.8 11.2 39.3 29.7 4.1 8.9 0.7
2005–06 26.8 18.0 8.8 37.1 28.5 11.7 7.3 1.3
Imports    
1994–95 14.2 15.6 27.0 45.0 36.6 10.0 7.7 0.7
2005–06 9.9 12.6 21.2 59.5 48.1 17.0 10.5 0.9
PRC    
Exports
1994–95 26.1 15.2 12.9 41.5 37.4 3.5 0.5
2000–05 30.5 19.5 10.0 30.9 19.0 5.3 1.2
Imports    
1994–95 8.6 15.0 18.4 55.5 52.2 3.1 0.1
2000–05 8.1 14.2 18.7 64.3 55.0 8.7 0.6
Southeast Asia                
Exports
1994–95 30.9 19.0 10.8 37.5 14.9 2.0 21.8 0.8
2005–06 22.4 17.1 8.5 46.6 24.6 12.0 20.1 1.8
Imports    
1994–95 13.9 16.1 28.8 42.1 18.1 2.8 23.3 0.7
2005–06 11.9 12.4 18.1 58.3 26.4 11.4 30.3 1.5
Exports    
1994–95 28.2 38.0 6.2 17.0 9.4 0.9 5.5 2.1
2005–06 28.4 31.6 1.9 17.6 9.7 3.5 5.3 2.5
Imports    
1994–95 9.4 39.6 11.9 28.6 15.6 4.7 9.5 3.5
2005–06 9.1 29.8 6.0 39.8 23.9 13.9 12.4 3.6
Note: NAFTA: The North American Free Trade Agreement comprises Canada, Mexico, and US.
EU-15 comprises Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands,
Portugal, Spain, Sweden, United Kingdom.
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.
16 | ADB Economics Working Paper Series No. 161

Table 6: Direction of Developing Asia’s Parts and Components Trade (percent)

  NAFTA EU-15 Japan Developing East PRC Southeast South
Asia Asia Asia Asia
Developing Asia                
Exports
1994–95 29.8 15.1 9.0 44.8 20.9 2.8 23.4 0.5
2005–06 17.4 12.6 8.7 59.3 40.6 18.9 17.8 0.9
Imports    
1994–95 18.1 12.6 31.4 41.5 22.6 2.3 18.7 0.2
2005–06 11.7 10.2 18.3 64.4 41.6 10.9 22.6 0.2
East Asia    
Exports
1994–95 29.5 15.1 10.1 41.9 25.0 4.1 16.5 0.4
2005–06 18.1 11.9 9.2 57.9 44.0 20.3 13.1 0.8
Imports    
1994–95 18.0 12.6 32.8 41.8 31.2 3.7 10.5 0.1
2005–06 9.7 9.1 19.0 67.9 51.8 12.4 16.1 0.1
PRC    
Exports
1994–95 22.5 14.2 11.2 50.7 42.7 7.2 0.8
2000–05 20.8 12.9 9.7 52.9 41.3 10.7 0.9
Imports    
1994–95 9.4 16.1 16.6 56.4 53.7 2.6 0.0
2000–05 6.3 10.1 16.1 72.7 62.1 10.5 0.1
Southeast Asia                
Exports
1994–95 30.4 14.9 7.7 48.8 15.8 1.3 32.4 0.5
2005–06 16.1 13.3 7.8 62.8 35.6 16.8 26.2 1.0
Imports    
1994–95 18.3 11.1 30.8 42.4 15.2 0.9 27.0 0.2
2005–06 16.0 10.8 17.5 59.3 23.1 8.2 35.9 0.3
South Asia    
Exports
1994–95 16.4 34.6 2.8 28.8 5.9 0.5 19.5 3.3
2005–06 24.0 32.9 3.7 18.7 6.9 4.1 9.8 1.9
Imports    
1994–95 16.4 39.1 18.0 21.5 9.9 3.8 10.5 1.1
2005–06 11.1 31.0 9.9 40.1 18.4 9.0 20.6 1.1
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 17

Table 7: Direction of Developing Asia’s Textile Trade (percent)

  NAFTA EU-15 Japan Developing East PRC Southeast South
Asia Asia Asia Asia
Developing Asia                
Exports
1994−95 24.8 20.6 13.5 33.2 27.0 3.3 5.2 1.0
2005−06 27.9 23.9 10.6 25.4 19.6 4.4 4.2 1.5
Imports    
1994−95 13.8 17.1 26.8 43.0 28.5 7.1 13.6 0.9
2005−06 10.4 13.7 19.3 57.8 40.5 15.2 16.2 1.2
East Asia    
Exports
1994−95 21.3 14.2 15.9 40.4 34.4 4.2 5.0 1.0
2005−06 22.4 19.3 13.7 31.8 25.8 5.5 4.5 1.5
Imports    
1994−95 14.2 15.6 27.0 45.0 36.6 10.0 7.7 0.7
2005−06 9.9 12.6 21.2 59.5 48.1 17.0 10.5 0.9
PRC    
Exports
1994−95 16.8 14.0 22.8 40.1 37.7 2.0 0.3
2000−05 21.4 20.9 16.8 28.5 24.8 2.5 1.1
Imports    
1994−95 8.6 15.0 18.4 55.5 52.2 3.1 0.1
2000−05 8.1 14.2 18.7 64.3 55.0 8.7 0.6
Southeast                
Asia Exports
1994−95 36.0 29.1 10.3 19.8 9.7 1.2 9.2 0.9
2005−06 46.3 23.9 6.3 14.6 6.5 2.0 6.5 1.5
Imports    
1994−95 13.9 16.1 28.8 42.1 18.1 2.8 23.3 0.7
2005−06 11.9 12.4 18.1 58.3 26.4 11.4 30.3 1.5
South Asia    
Exports
1994−95 31.7 44.6 4.5 9.9 6.5 0.9 2.1 1.2
2005−06 35.7 43.3 1.2 7.5 4.8 1.8 1.2 1.5
Imports    
1994−95 1.8 6.5 4.0 86.1 54.6 10.3 16.3 15.2
2005−06 1.5 6.4 1.6 87.0 62.7 43.4 12.0 12.4
Source: Compiled from UNCOMTRADE Database, downloaded October 2008.
18 | ADB Economics Working Paper Series No. 161

III. Factors Leading to Changes in Developing Asia’s

Trade Patterns
A. Fundamental Factors

The structural shift of trade toward machinery and transport equipment (SITC 7),
particularly trade in parts and components, has been largely underpinned by three
mutually reinforcing developments over the past few decades. The first factor is related
to rapid advancement in production technology that has allowed companies to “unbundle”
the stages of production into finer, portable components so that different tasks can be
performed in different places. Second, technological innovations in transportation and
communications have improved the speed, efficiency, and economy of coordinating
geographically dispersed production processes. This has facilitated establishment of
“service links” to combine various fragments of the production process in a timely and
cost-efficient manner (Jones and Kierzkowski 2001). Third, liberalization policy reforms
in both home and host countries have considerably lowered barriers to trade and
investment (Athukorala 2006). Tariff and nontariff barriers in manufacturing have declined
continuously over the past few decades, resulting in a reduction in costs of production,
thus spurring manufacturing trade. Trade expansion helps attract foreign direct
investment (FDI), especially efficiency-seeking FDI. Trade liberalization in the information
communication and technology (ICT) industry has helped to reduce costs of production
and spur trade in machinery and transport equipment (see Box 2 for detailed information
of trade liberalization in the ICT industry). Under international product fragmentation,
where production/assembly in each country is linked through vertically integrated
production processes, even small reductions of tariffs significantly reduce production
costs through the so called “magnification effects” (Yi 2003).

In terms of the ICT industry, two successful landmark agreements (see Box 2) have been
completed in the World Trade Organization (WTO). First is the Information Technology
Agreement (ITA), reached at the WTO’s inaugural Ministerial gathering in December
1996 providing for the elimination of tariffs on a range of ICT products in both developed
and developing member-countries. The decline in tariffs on ICT products in developed
countries helps to stimulate extraregional demand for developing Asia. The ITA cut tariffs
on computers in the EU and the US to 2% or less, and cut tariffs in East and Southeast
Asia to less than 10% (Fliess and Sauvé 1997). Second is the agreement liberalizing
the provision of basic telecommunication services within the General Agreement on
Trade in Services. There is little doubt that ITA-related liberalization will serve to
reinforce the procompetitive gains flowing from the ongoing deregulation in national
telecommunications markets.

In addition to trade liberalization, reform of investment policy regimes contributed to a

 This is referred to as the FDI-led export-oriented paradigm.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 19

surge of establishment of multinational enterprises (MNEs) in developing Asia and a

shift of trade patterns to machinery and transport equipment. The upsurge in FDI to
developing countries in the 1990s was caused by the unilateral liberalization of their FDI
policies and regulatory regimes (Brooks et al. 2004). Most countries offer incentives to
attract FDI, especially efficiency-seeking FDI that helps to promote exports in developing
countries. These often include tax concessions, tax holidays, tax credits, accelerated
depreciation on plant and machinery and export subsidies and import entitlements. The
investment promotion regimes may, in fact, influence investment location decisions only
at the margin. More important to most potential investors is the overall investment climate
in a country including: the size and expected growth rate of the market to be served, the
long-term macroeconomic and political stability of the host country, the supply of skilled
or trainable workers, and the presence of modern transportation and communication
infrastructure. Once these criteria are satisfied, financial incentives may then influence
investor choice at the margin.

It is noteworthy that the preeminence of East and Southeast Asia as locations of global
production sharing, compared to other subregions and countries, is underpinned by the
following additional factors. As the firstcomers in this area of international specialization,
countries in these subregions tend to offer considerable agglomeration advantages
for companies that are already located there (Athukorala and Kohpaiboon, 2008) Site
selection decisions of MNEs operating in assembly activities are strongly influenced by
the presence of other key market players in a given country or neighboring countries.
Against the backdrop of a long period of successful operation in the region, many MNEs,
particularly US-based MNEs, have significantly upgraded technical activities of production
networks in the region and assigned global production responsibilities to affiliates located
in these subregions. In other words, the Asian experience is consistent with the view that
MNE affiliates have a tendency to become increasingly embedded in host countries the
longer they are present there and the more conducive the overall investment climate of
the host country becomes over time.

In addition, despite rapid growth, manufacturing wages in countries in these regions still
remain lower than or comparable to those in the European periphery and Latin American
countries. Significant differences in wages among the countries within these regions have
provided the basis for rapid expansion of an intraregional production sharing system,
giving rise to increased cross-border trade in parts and components. The emergence
of the PRC as the prime low-cost assembly center of a wide range of electrical and
electronics products has boosted component production and assembly activities in other
Asian countries.

However, there are concerns that some incentives provided by governments could result
in distortions favoring export markets over the domestic market or manufacturing over the
services sector, or both. In fact, the objective of, for example, export processing zones
is to promote manufacturing exports through MNE investment in order to directly provide
20 | ADB Economics Working Paper Series No. 161

jobs and alleviate unemployment, and obtain foreign exchange earnings. In addition, such
zones are aimed at providing indirect effects in terms of knowledge spillovers that can
take place in many ways and backward linkages when companies begin to buy more
inputs from host countries.

Both direct and indirect effects could further generate domestic consumption and
investment in host countries. Nevertheless, some empirical studies (e.g., Furby 2005,
Rondinelli 2006) show limited positive impacts from these zones since the zones primarily
employ low-wage, unskilled workers; create employment that can only be maintained
if demand for exports holds up; transfer little modern technology or know-how; and
have weak links to domestic manufacturers. In addition, governments in many countries
deliberately provide preferential tax treatment and other incentives to export-oriented
manufacturers, limiting knowledge spillovers and backward linkages. Thus, benefits to
host countries, especially in promoting domestic consumption and investment, are limited.

Box 2: The Information Technology Agreement and the Basic Telecommunication

Service Agreement in the WTO

The Information Technology Agreement (ITA) had its genesis in late 1994 and early 1995 when the
US-based Information Technology Industry Council (ITI), the European Association of Manufacturers
of Business Machines and Information Technology Industry, and the Japanese Electronic Industry
Development Association jointly developed recommendations for the G-7 Ministerial Conference
on the Global Information Society that took place in February 1995. The complete elimination of
customs duties on products that formed an essential basis for the realization of the Global Information
Infrastructure had been negotiated in the conference. The initiative was taken up next by the “Quad”
group of leading trading nations—Canada, EU, Japan, and US—that began to explore the potential
content and modalities of an ITA in early 1996 to enlist other WTO members to join an agreement. The
ITA became a central issue at the WTO’s first Ministerial meeting in Singapore on 9–13 December 1996
and was finalized in March 1997 in Geneva where the formal ITA had been launched. Under this accord,
tariffs on most industrial ICT products would be eliminated and almost 40 countries, accounting
for over 90% of world trade in the ICT sector, signed on. Tariff cuts started in July 1997 and were
completed in four stages up to January 2000. The ICT product and country coverage are presented
in Box Table 2.1. It is important to note that consumer electronics products—one of the three main
segments of the electronics industry alongside industrial electronics equipment and electronic
components and devices—are exempted. This means that more than 10% of total worldwide ICT
production remains outside the scope of the ITA. Not surprisingly, Japan and other Asian members of
the Asia-Pacific Economic Cooperation favored the inclusion of consumer electronics products, while
the US and the EU prefer to exclude these products and focus instead on products in the industrial
equipment and components segments.

continued.

 For example, local firms may improve productivity by adopting technology from MNEs or through former
employees who start their own factories.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 21

Box 2: continued.

Box Table 2.1: Product and Country Coverage under the ITA

Main Products Covered by the ITA Coverage

• Computers, e.g., supercomputers, mainframe computers, work stations, Albania; Australia; Bahrain;
personal computers, laptops, computer peripheral devices Bulgaria; Canada; PRC; Costa
Rica; Croatia; Dominican
• Telecommunication equipment, e.g., telephone sets, cordless phones,
Republic; Egypt; El Salvador;
video phones, cellular phones, computer network equipment
European Communities; Georgia;
• Semiconductors, e.g., all semiconductors including memory chips, Guatemala; Honduras; Hong
microprocessors Kong, China; Iceland; India;
Indonesia; Israel; Japan; Jordan;
• Semiconductor manufacturing equipment, e.g., vapor deposition Korea; Kyrgyz Republic; Macao,
apparatus, spin dryers, handling and transport apparatus. China; Malaysia; Mauritius;
• Software, e.g., application-type software, multimedia software products, Moldova; Morocco; New Zealand;
unrecorded floppy disks and other software media. Nicaragua; Norway; Oman;
Panama; Philippines; Romania;
• Scientific instruments and other products, e.g., measuring and checking Saudi Arabia; Singapore;
devices, chromatographs, spectrometers, optical radiation devices, Switzerland; Taipei,China;
electrophorensic equipment, passive and active components (capacitors, Thailand; Turkey; Ukraine; United
resistors, certain electronics switches, certain connection devices, certain Arab Emirates; United States;
electric conductors), automatic teller machines (cash registers, calculators, Viet Nam
electronic translator, digital still cameras and certain photocopiers)
Source: Fliess and Sauve (1997).

Telecommunication services can be divided into two categories, namely basic telecommunications
and value-added services. The former includes all telecommunication services that involve end-to-
end transmission of customer supplier information, e.g., voice telephone services, packet-switched
data transmission services, telex services, mobile data services, teleconferencing, and satellite-based
mobile services. Such basic telecommunication services are provided through cross-border supply and
through establishment of foreign firms or commercial presence. The value-added telecommunication
services are telecommunications for which suppliers “add value” to the customer’s information by
enhancing its form or content or by providing for its storage and retrieval, e.g., online data processing,
online database storage and retrieval, electronic data interchange, email and voice mail.
The telecommunications negotiations lasted from 1986 to 1997. Commitments in telecommunications
services were first made during the Uruguay Round (1986–1994), mostly in value-added services.
In 1994–1997, members negotiated on basic telecommunication services. On 15 February 1997, an
agreement among 69 member countries was reached and on 5 February 1998, the Fourth Protocol
entered into force. Since then, new commitments have been made either by new members upon
accession or in a unilateral fashion by an existing member. The key market access and national
treatment commitments and country coverage are summarized in Box Table 2.2.

continued.
22 | ADB Economics Working Paper Series No. 161

Box 2: continued.

Box Table 2.2: Key Market Access and National Treatment Commitments and Country Coverage
under the Telecommunication Services Agreement

Key Market Access and National Treatment Commitment Country Coverage

The key area of deregulation and liberalization in the Antigua & Barbuda; Argentina; Australia;
telecommunication service agreement is as follows: Bangladesh; Barbados; Belize; Bolivia; Brazil;
Brunei Darussalam; Bulgaria; Canada; Chile;
• Commitments to liberalize at least partially the provision
Colombia; Côte D’ivoire; Cyprus; Czech
of voice telephony, including international voice services,
Republic; Dominica; Dominican Republic;
national long-distance services, and local services
Ecuador; El Salvador; European Communities;
• Commitments on data transmission services Ghana; Grenada; Guatemala; Hong Kong,
China; Hungary; Iceland; India; Indonesia;
• Commitments on leased lines Israel; Jamaica; Japan; Republic of Korea;
• Commitments on cellular/mobile telephony services and Malaysia; Mauritius; Mexico; Morocco; New
other types of mobile services Zealand; Norway; Pakistan; Papua New
Guinea; Peru; Philippines; Poland; Romania;
• Commitments on cellular/mobile telephony services and Senegal; Singapore; Slovak Rep; South Africa;
other types of mobile services Sri Lanka; Suriname; Switzerland; Thailand;
• Commitments on mobile satellite services or transport Trinidad & Tobago; Tunisia; Turkey; United
capacity and on fixed satellite services States; Venezuela

• Commitments to permit foreign ownership or control of all

telecommunications services and facilities. According to
the US trade representative, liberalization of these countries
accounted for 97% of total basic telecommunication services
revenue of WTO members.
Note: Some countries, notably India, South Africa, Turkey, Indonesia, Malaysia, Philippines, and Thailand retained a foreign
investment limit while others such as Canada, France, Israel, Mexico, and Portugal left foreign investment limits on
certain services. In addition, certain countries retained limits on foreign participation in the local incumbents, including
Australia, Japan and New Zealand.
Source: Bronckers and Larouche (2005).

B. The Role of the Real Exchange Rate

Movements of the real exchange rate (RER) have tended to play a minor role in
influencing the structural shift of trade toward machinery and transport equipment
(SITC 7). The importance of RERs seem to be diluted for machinery and transport
equipment that contains a high proportion of parts and components trade (Jones and
Kierzkowski 2001, Arndt and Huemer 2004, Athukorala 2004, Jongwanich 2009),
since parts and components exports involve a high proportion of imported parts and
components. The depreciation of a currency lowers the foreign currency price of exports
but also increases the home currency prices of component imports.

 The real exchange rate is a broad summary measure of the prices of one country relative to the prices of another
country or group of countries, both expressed in a common currency. That is RER = eP*/Pd, where e is the nominal
exchange rate defined as a unit of home currency equivalent to a unit of a foreign currency, P* denotes the foreign
(world market) price level, and P is the domestic price level.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 23

To the extent that import content costs rise, this will offset any expansion in demand
induced by depreciation. In addition, it has been argued that international product
fragmentation requires the establishment of “service links” in order to connect the various
fragments of a production process in a seamless, rapid, and cost-efficient manner. Thus,
the locational decisions of MNEs conducting assembly activities within an international
production network are strongly influenced by the presence of other key variables such
as infrastructure, logistic capabilities, availability of skilled workers, and modern technical
and managerial skills as mentioned earlier. In these circumstances, RER changes are but
one part of a far wider set of considerations about where to locate production facilities.

However, the RER by itself could still influence a country’s export and trade performance.
RER appreciation deteriorates a country’s cost competitiveness, potentially reducing
exports and the country’s trade surplus (or increasing the country’s trade deficit),
especially for labor-intensive products. See Box 3 for the relationship between the RER
and real exports.

All in all, the structure and direction of developing Asia’s trade shows that the trade
channel can be effective in transmitting the slowdown of OECD countries to developing
Asia. Although intra-industry trade has increased over the past two decades, its increase
has been mainly contributed to parts and components trade. The PRC emerged as
the assembly location for the final goods produced in developing Asia. The region
still has to rely on extraregional demand, especially in the EU and the US, through its
forward linkages to the PRC. To estimate the impacts of OECD demand contraction
on developing Asia through the trade channel, a CGE model is applied in Section IV.
While macroeconomic models are appropriate for projection of aggregate economic
performance, especially the way in which they model money and finance, they lack a full
complement of information on global industry and trade—the exact mechanisms through
which developing Asia is likely to be hit by the current crisis. In addition to the global
economic slowdown scenario, impacts of fiscal stimulus and a rise of protectionism are
examined in Sections V and VI, respectively. Projections of trade and GDP growth in
2009–2010 are provided in these three sections.
24 | ADB Economics Working Paper Series No. 161

Box 3: Exports and the Real Exchange Rate in East and Southeast Asia

This box shows the relationship between the RER and real exports in eight East and Southeast
Asian countries, namely PRC; Korea; Malaysia; Philippines; Singapore; Taipei,China; and Thailand. To
emphasize the increasing importance of parts and components trade, export equations are estimated
for three different export categories—total merchandise exports, manufacturing exports, and exports
of machinery and transport equipment (SITC 7). The analysis is based on data during 1993–2008, a
period over which parts and components trade burgeoned.
To examine the role of the RER, “reduced form” export equations derived from both demand for
and supply of exports are estimated for total merchandise, total manufacturing, and SITC 7 exports.
According to this reduced form, real exports are set as a function of the RER, world demand,
production capacity and FDI. Under the different order of integration, the fashionable cointegration
econometric procedures, such as the two-step residual-based procedure adopted by Engle-Granger
(1987), and the system-based reduced rank regression approach due to Johansen (1988) for modeling
nonstationary data are inappropriate. The econometric analysis in this study is based on the General to
Specific Model procedure (Wickens and Breusch 1988, Hendry 1995).
In general, the long-run RER coefficients of machinery and transport equipment (SITC 7) exports
are the lowest (or insignificant) while the coefficients of total merchandise exports are the highest,
with those of manufacturing exports coming in between. These results indicate that exports of
manufactured final products, especially labor-intensive products, are more responsive to changes in
the RER than are exports of SITC 7 products, which have to rely to a greater extent on imported parts
and components. RER coefficients vary across the eight economies. In general, the RER has the least
impact on the Philippines’s exports while the impact is the greatest in Indonesia. In the Philippines,
the long-run coefficients of the RER in all three categories are statistically insignificant while in the
short run, the coefficients are equal to 0.2 for total merchandise exports. In the case of Indonesia,
by contrast, they are greater than one in total merchandise and manufacturing exports (both in the
short and long run) and less than one in SITC 7 exports, i.e., 0.72 in the short run and 0.97 in the long
run. This is consistent with the fact that exports and imports in the Philippines have been dominated
by parts and components over the past decade. In contrast, Indonesia has much greater product
diversification in its export basket.
The coefficient on manufacturing export volume with respect to changes in the RER in Korea;
Singapore; and Taipei,China are all relatively low in both the short and long run. In the long run, the
RER coefficient corresponding to SITC 7 in these economies is insignificantly different from zero. In
the short run, it is statistically insignificant in the case of Korea and Taipei,China while it is around
0.5 in Singapore. In addition to the high degree to which parts and components are represented in
the export basket, RER coefficients will also be influenced by the technological sophistication and
complexity of exports. More advanced and sophisticated products may offer fewer opportunities
for substitution, resulting in the lower response of exports to changes in the RER. In Malaysia and
Thailand, the long-run RER coefficients of total exports are comparatively high. This may reflect a more
diversified export structure.

continued.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 25

Box 3: continued.

Box Table 3.1: RER Coefficients in Eight East and Southeast Asian Countries

Short-run Coefficient Long-run Coefficient

Total Merchandise Manufacturing SITC 7 Total Merchandise Manufacturing SITC 7
(TE) (ME) (SITC7) (TE) (ME) (SITC 7)
PRC 0.60* 0.69* 0.61* 0.50** 0.50** -
Indonesia 1.17* 1.44** 0.72* 4.52* 2.15* 0.97*
Malaysia 0.64* 0.65* 0.48* 1.48* 1.37* 1.06*
Philippines 0.20** n.a. n.a. n.a. n.a. n.a.
Korea 1.12* n.a. n.a. 1.17* 0.14*** n.a
Singapore n.a. 0.89(−2)*** 0.53 (-2)** n.a. n.a. n.a
Thailand 0.34* 0.18* 0.14* 0.70* 0.39*** n.a
Taipei,China 0.38 (−3)** 0.33 (−3)*** n.a. n.a. n.a. n.a
* Significant at the 5% level; ** significant at the 10% level; *** significant at the 15% level.
Note: The values in the parentheses show the lag period of the significance. See details of export equations in Jongwanich
(2009).

IV. Impacts of the Global Economic Slowdown

on Developing Asia
This section examines impacts of the global economic slowdown, driven by the
unfolding global financial crisis, on developing Asian countries. Table 8 provides baseline
assumptions of real GDP growth (or contraction) of OECD countries in 2009 and 2010
based on macroeconomic projections contained in the Asian Development Outlook
2009 (ADB 2009). The consensus in the Outlook is of a deepening of the crisis through
2009 with recovery taking hold in 2010. The projected GDP growth in these countries
is lower than the average growth rate for the 5-year period 2002–2007. In order to
simplify the analysis, all industries used in the Global Trade Analysis Program (GTAP) are
aggregated into 11 groups and the world is split into 13 country groupings. A summary of
these groupings can be found in Table 9. Details of the GTAP model are provided in the
Appendix.

OECD countries import heavily from Asia. Based on GTAP model simulations, it is
projected that had the global financial crisis not taken hold, OECD countries would have
generated annual GDP growth in Asia between 2.3% and 4.0% through demand for
 We note that the financial crisis affected GDP growth estimates as early as February 2007 when HSBC’s mortgage
unit issued a staggering writedown of subprime mortgage assets valued at over US$10 billion. By the end of
2007, over 100 mortgage banks in the US had filed for bankruptcy and the chief executive officers of Citigroup and
Merrill Lynch resigned after massive writedowns. At the same time, the commodities bubble swelled as investors
sought safety in these assets. Although the depths of the crisis were not felt on main street until 2008, GDP
forecasts were already being downgraded for 2009 and 2010 as of early 2007.
26 | ADB Economics Working Paper Series No. 161

Asian imports in the OECD in 2009 and 2010. We call this the potential growth baseline
(see Table 10, columns A and B). The PRC and India would have been the biggest
beneficiaries of trade with the high-income markets, but other developing Asia, South
Asia, and Southeast Asia, which also rely on OECD countries’ consumption to boost their
GDP, would have also experienced significant positive impacts. As a result of the global
financial crisis, for 2009, the contraction of OECD GDP is projected to lower GDP growth
in Asian countries by between 2.8% and 4.1% in 2009 (Table 10, column C). Projections
for 2010 are positive (Table 10, column D), but are still significantly below the potential
growth baseline. It is important to note that these estimates are not based on a country
by country evaluation of financial and political conditions but rather they are the result
of linkages revealed in trade flows. Many countries will experience impacts resulting
from the crisis, depending on factors such as total debt, political stability, and fiscal
and monetary policies of the country being considered. Estimates in Table 10 are those
that would be experienced primarily through trade channels, all other conditions held
constant.

Table 8: Projected GDP Estimates for OECD Countries, 2009 and 2010
Country Region Baseline Average 2009 2010
2002–2007
North America OECD 3.0 −2.4 1.6
European OECD 1.8 −2.6 0.5
Japan 2.2 −3.5 1.1
Source: ADB (2009).

The final column in Table 10 (column G) provides the real impacts of the financial crisis
and recession in the OECD on GDP growth of developing Asian economies. By the end
of 2010, most Asian economies are projected to have real GDP levels that are between
6.3% and 10.2% lower than if the financial crisis had not occurred. The PRC and India
will be impacted most heavily by the end of 2010 with their real GDP reduced by 9.0%
and 10.2%, respectively from their baseline potential. Although the PRC and India are
similarly impacted, the source and structure of impacts are different. The impacts on
India result from its export relationship with the EU, where EU exports make up a high
percentage of total exports. The impacts on the PRC, on the other hand, arise principally
from its reliance on the United States as an export market. Furthermore, the impacts
on India are transmitted largely through a mix of exports of services, manufactures, and
agricultural products while the impacts on the PRC are transmitted principally through
the export of manufactured products (Table 11). In contrast to the PRC where its exports
rely on imported components for a third of their value, India’s supply chains are reliant on
domestic sources for components and materials. The impact on India’s GDP is, therefore,
marginally worse than the impact on the PRC’s GDP (Table 10).
 The model has been modified to reduce shifts in investment between countries to a minimum, but not all
investment effects can be eliminated as the model requires a complete accounting of savings and investment.
Additionally, for the short-run projections, most factor prices are held constant, in contrast to medium- and longer-
run models (2–3 year projections) where factor prices are considered flexible.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 27

Table 9: Sectors and Regions

Sectors Countries/Regions
Agriculture Asia
Raw Agricultural Products Japan (OECD)
Processed Food PRC
Nonagricultural Products (NAMA) East Asia (Hong Kong, China; Republic of Korea; Macau, Mongolia;
North Korea; Taipei,China)
Mining and Extractive Industries Singapore
Textiles and Clothing Malaysia
Motor Vehicles, Parts, and other Transport South East Asia (Brunei Darussalam, Cambodia, Indonesia, Lao,
Equipment Myanmar, Philippines, Thailand, Timor-Leste, Viet Nam)
Light Manufacturing India
Electronics Other South Asia (Bangladesh, Bhutan, Nepal, Sri Lanka, Rest of
South Asia)
Heavy Manufacturing Other Developing Asia (Armenia, Azerbaijan, Kazakhstan, Kyrgyzstan,
Georgia, Oceania, Pakistan, Other Asia)
Services Non-Asia
Amenities and Communications Services Oceania (Australia, New Zealand)
Recreation Services North America (Canada, México, US) — OECD
Other Services Europe OECD (Austria, Belgium, Denmark, Finland, France, Germany,
Greece, Hungary, Ireland, Italy, Luxembourg, Netherlands, Poland,
Portugal, Slovakia, Spain, Sweden, United Kingdom, Switzerland,
Norway, Turkey )
Rest of World
Source: The GTAP Model and database.

Table 10: Impacts of High-Income OECD Countries Growth on Asia

(percent of Real GDP)
 Country/Region Potential Projections (%)2 GDP GAP (%)3
Contribution of
OECD Countries to
Growth (potential
growth baseline)1
(A) (B) (C) (D) (E) (F) (G)
2009 2010 2009 2010 2009 2010 Cummulative
Gap in GDP
(%)3
PRC 3.5 3.5 −3.9 1.4 −7.1 −2.0 −9.0
Other Developing Asia 2.3 2.3 −2.8 0.9 −4.9 −1.4 −6.3
East Asia 3.3 3.4 −3.8 1.4 −6.9 −1.9 −8.7
India 4.0 4.0 −4.1 1.3 −7.8 −2.6 −10.2
Malaysia 3.0 3.0 −3.4 1.2 −6.2 −1.8 −7.9
Singapore 2.8 2.9 −3.3 1.1 −6.0 −1.7 −7.6
South Asia 3.3 3.4 −3.6 1.2 −6.7 −2.2 −8.8
South East Asia 2.9 3.0 −3.4 1.2 −6.2 −1.7 −7.8
1 The potential contribution to growth is estimated from historical growth and assumes the financial crisis had not occurred (see
Table 8).
2 Projected GDP is the impact on Asian countries of lower growth in the OECD countries: actual growth may be greater or less
depending on the policies of individual countries, such as fiscal stimulus or protectionism.
3 The GDP gap is the difference between potential or precrisis growth and current projections. Cumulative growth is the loss
in real economic output for the 2- year period when compared with the historical (baseline) growth in the OECD countries.
Cumulative numbers are not the simple addition of the two years, but reflect compounding.
Source: Estimates based on data in table 9 projected using the GTAP model and database.
28 | ADB Economics Working Paper Series No. 161

Table 11 illustrates projected changes in real exports, by region and commodity. The
simulation results project a drop in exports in all commodities, underscoring the trade
linkages between OECD countries and Asia. Impacts of export reduction differ across
commodities; basic agricultural goods (necessary goods) being least impacted, as
opposed to luxury or normal goods such as electronics and heavy manufacturing being
impacted severely. In absolute terms, exports of agriculture products for developing
Asia drop by US$1.4 billion, compared to over US$20.7 billion for electronics and heavy
manufacturing. The next largest projected impacts are for light manufactures and textiles,
apparel, and leather products, each with Asian export declines of between US$8.1 billion
to US$9.2 billion.

In absolute terms, the PRC’s exports are projected to be impacted most negatively due
to lower economic growth in OECD countries, with a projected drop of over US$27.7
billion in exports to the world. The PRC is followed by East Asia with a loss of exports of
US$24.3 billion and Southeast Asia (excluding Malaysia and Singapore) of over US$11.2
billion in exports.

As was mentioned earlier, international trade has evolved into complex global supply
chains, with many interdependent countries and regions and industries. Table 12
illustrates these linkages: exporting countries or regions are shown as row headings on
the left, and importing regions are shown in columns along the top. Column D shows
the total decline in exports. Columns A, B, and C show the total exports to East and
Southeast Asia, South and Central Asia, and the OECD countries, respectively. Over
two thirds of the PRC’s export declines are directly attributable to the decline in demand
in the OECD countries for imports from the PRC (column C/D). Though we also project
a decline in the demand for East Asian and Southeast Asian exports, the major source
of the decline is different from that of the PRC. The majority of the trade impacts of the
financial crisis are channeled indirectly through third countries, most notably the PRC,
demonstrating the strong regional trade linkages between the PRC and the rest of East
and Southeast Asia.

In contrast, South Asia and India have much weaker regional trade linkages. The majority
of impacts for South Asia and India are projected to be channeled through direct drops in
demand by OECD countries, much in the same way that the PRC’s exports are projected
to be impacted. However, in contrast to the PRC, these regions do not import enough
intermediate goods to drive strong knock-on effects to other regions. There are benefits
and costs to this structure. While South Asia and India likely retain most of the gains from
trade and value-added to their exports to OECD countries, it also means they are likely
to experience more of the direct impacts of a reduction in OECD demand for their exports
as lower demand for exports is transmitted more strongly through the local supply chains.
Table 11: Projected 2009 Change in Real Exports by Region and Commodity
(millions of US dollars, 2004 prices and percent change)
Australia/ PRC Other East India Malaysia Singapore South Southeast Total*
New Developing Asia Asia Asia
Zealand Asia
Agriculture −365 −233 −56 −57 −341 −17 −12 −42 −347 −1,470
(−1.7) (−2.0) (−1.1) (−2.5) (−5.4) (−1.6) (−2.3) (−3.2) (−2.3)
Electronics −48 −7,018 −4 −6,683 −34 −2,578 −1,799 −2 −2,535 −20,700
(−2.9) (−3.8) (−3.2) (−3.7) (−3.1) (−3.4) (−3.3) (−3.6) (−3.5)
Extraction −709 −516 −702 −336 −302 −356 −328 −7 −1,094 −4,351
(−2.6) (−2.9) (−2.6) (−3.3) (−3.2) (−3.1) (−3.3) (−1.4) (−3.4)
Heavy Manufacturing −1,024 −7,774 −344 −7,594 −870 −1,136 −1,478 −68 −2,588 −22,874
(−3.1) (−4.1) (−3.3) (−3.9) (−3.4) (−3.6) (−3.4) (−4.0) (−3.7)
Light Manufacturing −216 −4,984 −63 −1,235 −622 −424 −171 −47 −1,405 −9,166
(−2.9) (−4.0) (−3.3) (−3.7) (−3.0) (−3.5) (−3.3) (−4.3) (−3.6)
Motor and Transport Equipment −143 −1,003 −38 −1,912 −105 −80 −111 −6 −420 −3,818
(−3.1) (−4.0) (−3.3) (−3.7) (−3.2) (−3.6) (−3.4) (−3.9) (−3.7)
Other Services −326 −435 −126 −1,440 −410 −115 −618 −61 −237 −3,768
(−3.2) (−3.8) (−3.3) (−3.6) (−3.1) (−3.5) (−3.3) (−3.7) (−3.1)
Processed Foods −339 −628 −80 −189 −117 −306 −78 −53 −818 −2,609
(−2.4) (−4.0) (−3.0) (−3.5) (−2.8) (−3.2) (−2.7) (−4.4) (−3.6)
Textile, Apparel, Leather −61 −3,895 −328 −1,711 −449 −101 −50 −473 −1,043 −8,110
(−2.4) (−3.6) (−2.9) (−3.4) (−2.6) (−3.1) (−2.8) (−3.8) (−3.4)
Transport and Construction −553 −1,111 −183 −3,008 −151 −187 −443 −75 −636 −6,346
(−3.1) (−3.6) (−3.3) (−3.5) (−3.1) (−3.2) (−3.2) (−4.0) (−3.4)
Travel, Recreation and Tourism −107 −127 −8 −156 −10 −76 −20 −8 −91 −602
(−3.2) (−3.9) (−2.4) (−3.8) (−3.3) (−3.5) (−3.2) (−4.6) (−3.7)
Total −3,889 −27,725 −1,932 −24,320 −3,411 −5,375 −5,107 −843 −11,212 −83,814
(−2.7) (−3.8) (−2.8) (−3.7) (−3.2) (−3.4) (−3.3) (−3.8) (−3.5)
*Totals are for countries and regions listed and differs from the global total.
Note: Numbers in parentheses show declines of exports in terms of percentage changes.
Source: Authors’ estimates from GTAP model.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 29
Table 12: Regional Trade Volume Impacts 2009 (millions of constant 2004 dollars)
Exporter Importer
East And Southeast Asia South Asia and Central Asia
PRC East Southeast Singapore Malaysia (A) India South Other (B) ( C) Rest of (D)
Asia Asia Total Asia Developing Total High World Total
East and Asia South and Income
Southeast Central OECD
Asia Asia
PRC - −2,858 −1,079 −517 −383 −4,837 −299 −104 −211 −613 −17,841 −2,849 −26,140
East Asia −7,083 −1,642 −1,143 −531 −428 −10,827 −262 −84 −116 −462 −10,014 −2,252 −23,554
Southeast Asia −1,255 −1,007 −658 −593 −444 −3,957 −134 −50 −50 −234 −5,301 −976 −10,468
Singapore −622 −521 −728 - −448 −2,319 −113 −44 −47 −204 −2,008 −435 −4,966
Malaysia −876 −413 −411 −540 - −2,240 −110 −26 −30 −166 −2,269 −474 −5,148
India −249 −206 −183 −95 −60 −794 - −168 −37 −206 −2,513 −1,031 −4,543
South Asia −7 −17 −9 −9 −2 −44 −46 −6 −7 −59 −600 −73 −776
Other
30 | ADB Economics Working Paper Series No. 161

Developing
Asia −107 −60 −36 −8 −6 −217 −13 −35 −78 −125 −892 −580 −1,814
Note: When a region is listed as exporting or importing from itself, the values represent intraregional trade among countries in the given region.
Source: Authors’ estimates derived from GTAP model.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 31

V. Impacts of Proposed Fiscal Stimulus Packages

on Developing Asia
As the global financial crisis has deepened, governments around the world have
responded by announcing large fiscal stimulus packages to counter decreases in
demand. The goal of these programs is to increase local demand for goods and services
and put people and capital back to work and back on track for long-term growth. To
support these programs, governments either have to be able to raise large sums of
money or they have to have large reserves to call on. At the same time, fiscal packages
have to be substantial to maintain the credibility of having the potential to broadly impact
the economy. Table 13 lists four of the largest country/region stimulus packages as a
percentage of GDP: Japan, PRC, North America, and European OECD, respectively.
Numerous sources were called upon in compiling these estimates. Where possible, we
used actual government estimates; however, it was often imperative to use other sources
such as financial analysts’ estimates of “double counting” provided by the Institute for
International Finance (IIF 2008) and news reports to try and verify that those numbers are
correct and current. Unfortunately, verification was not always possible. We then used the
estimates in Table 13 to shock the GTAP model to project the impacts of proposed fiscal
stimulus packages on developing Asia’s real GDP growth and trade.

Table 13: Fiscal Stimulus Packages, Percent GDP Estimates for Japan, PRC, North America,
and OECD Europe, 2009 and 2010
Country/Region 2009 2010
Japan 1.0 0.9
PRC 6.1 5.5
North America OECD* 1.9 2.1
European OECD 0.9 0.2
*Analysis of US fiscal stimulus package by year can be found in the Congressional Budget Office Letter to the Speaker of the House
of Representatives on the Investment and Economic Recovery Act of 2009, 13 February 2009. Available: cbo.gov/doc.
cfm?index=9989. Twenty-five percent of the US fiscal package will be expended in 2009. This estimate does not include US
programs to assist banks and insurers dispose of subprime assets from balance sheets.
Note: GDP estimates based on IMF World Economic Outlook Database October 2008 projections for 2009 and 2010.
Source: Authors’ estimates.

Table 14 illustrates the impacts on developing Asia’s economies of the fiscal stimulus in
the four countries/regions above. For convenience, columns A and B have been carried
over from Table 10. These columns show the projected impacts on growth from reduced
demand in the OECD resulting from the crisis. Columns C and D show the impacts
of the fiscal stimulus packages on Asian growth. Finally, columns E and F show the
gap between projected GDP impacts resulting from the crisis and the growth projected
from the fiscal packages. The projected impacts of the stimulus packages modeled add
between 0.2% and 6% to GDP growth in 2009 and between 0.9% and 5.5% in 2010.
Even though the stimulus packages are large, and the impacts on growth are positive,
32 | ADB Economics Working Paper Series No. 161

the stimulus packages will not reverse the impacts of the crisis in 2009. The exception is
the PRC, which benefits from its own large stimulus package. Our projections show that
with the stimulus in Table 13, the PRC’s growth will be boosted by more than the amount
the financial crisis would take away. All countries and regions, except other developing
Asia, will experience positive growth at the end of 2010 despite the financial crisis. Other
developing Asia has a small decline of 0.3% of GDP by the end of 2010, despite the
fiscal stimulus packages.

Note that while sources of funds for stimulus packages are crucial, we assume that
for PRC, Europe, and Japan where saving rates are positive and large, their stimulus
packages are financed by their domestic savings. By contrast, as the US has been a
net debtor nation, the increase in US government expenditure modeled here assumes
that the stimulus package will come from an increase in foreign debt, not from increased
taxes in the US. As a result, government expenditure is found to “crowd out” investment
elsewhere in the world. Other developing Asia and South Asia are found to experience
slight negative impacts on their 2009 and 2010 GDP due to the US stimulus package
and the crowding out of investment. Lower investment will also have negative impacts on
long-term growth, as the capital stock of these nations will be lower as a result of the US
stimulus package.

Table 14: Impacts of Stimulus Packages on Asian GDP Growth, 2009 and 2010
(percent of real GDP)
  Projected GDP Impacts Projected Fiscal Gap (c)
from Economic Stimulus Impacts
Slowdown in OECD (a) (b)
Country/Region (A) (B) (C) (D) (E) (F) (G)
2009 2010 2009 2010 2009 2010 Cumm. Gap
PRC −3.9 1.4 6.0 5.5 2.1 6.9 9.1
Other Developing Asia −2.8 0.9 0.2 1.5 −2.6 2.4 −0.3
East Asia −3.8 1.4 3.5 3.0 −0.3 4.4 4.1
India −4.1 1.3 3.2 2.4 −0.9 3.7 2.8
Malaysia −3.4 1.2 0.9 0.9 −0.7 3.7 3.0
Singapore −3.3 1.1 2.7 2.5 −1.0 3.3 2.3
South Asia −3.6 1.2 2.3 2.2 −2.0 3.3 1.2
South East Asia −3.4 1.2 1.6 2.1 −1.2 3.4 2.2
(a) From Table 10 columns C and D.
(b) Projected GDP is the static impact on the Asian countries of fiscal stimulus packages where actual growth may be greater or
less depending on the policies of individual countries, such as fiscal stimulus or protectionism.
(c) The potential gap is the difference between the impacts from the economic slowdown and the impacts from the projected
fiscal stimulus packages. Cumulative numbers are not the simple addition of the two years but are compound growth rates.
Source: Estimates based on data in table 14 projected using the GTAP database.
Table 15: Projected 2009 Change in Real Exports by Region and Commodity
(millions of US dollars, 2004 prices and percent changes)
Other
Australia/ Developing East South Southeast
New Zealand PRC Asia Asia India Malaysia Singapore Asia Asia Total*
Agriculture −397 2,391 −127 −41 113 −5 2 −7 −124 1,806
(−1.9) (21.3) (−2.6) (−1.8) (1.8) (−0.5) (0.3) (−0.5) (−0.8)
Extraction 17 1,468 −48 173 174 253 195 −2 632 2,861
(0.1) (8.3) (−0.2) (1.7) (1.9) (2.2) (2.0) (−0.5) (2.0)
Processed Foods −24 1,621 −1 72 132 180 29 19 340 2,368
(−0.2) (10.4) (0.0) (1.3) (3.2) (1.9) (1.0) (1.6) (1.5)
Textile, Apparel −16 5,910 13 993 392 42 10 157 429 7,931
(−0.7) (4.6) (0.1) (2.0) (2.2) (1.4) (0.6) (1.3) (1.5)
Motor and Transport Equipment 72 959 15 1,709 138 61 79 3 294 3,331
(1.5) (3.9) (1.3) (3.3) (4.2) (2.8) (2.4) (2.1) (2.6)
Light Manufacturing 54 6,754 20 968 669 257 95 27 862 9,707
(0.7) (5.5) (1.1) (2.9) (3.3) (2.1) (1.9) (2.4) (2.2)
Heavy Manufacturing 635 9,386 175 8,074 937 991 1,130 50 2,060 23,438
(1.9) (5.1) (1.7) (4.1) (3.7) (3.1) (2.6) (2.9) (3.0)
Electronics 24 8,251 2 6,564 39 2,246 1,316 2 1,775 20,218
(1.4) (4.5) (1.6) (3.6) (3.6) (3.0) (2.4) (2.3) (2.5)
Transport and Construction 258 932 83 2,309 132 112 242 46 392 4,506
(1.4) (3.1) (1.5) (2.7) (2.7) (1.9) (1.7) (2.4) (2.1)
Other Services 326 −726 123 1,652 588 119 540 65 278 2,966
(3.2) (−6.5) (3.2) (4.1) (4.5) (3.6) (2.9) (3.8) (3.6)
Travel and Tourism 47 70 5 93 9 46 8 5 59 342
(1.4) (2.2) (1.4) (2.3) (2.9) (2.1) (1.4) (2.6) (2.4)
Total 997 37,015 260 22,565 3,324 4,302 3,647 365 6,998 79,475
(0.7) (5.1) (0.4) (3.4) (3.1) (2.7) (2.4) (1.7) (2.2)
*Totals are for countries and regions listed and differ from the global total
Note: Numbers in parentheses show declines of exports in terms of percentage changes.
Source: Authors’ estimates from GTAP model.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 33
34 | ADB Economics Working Paper Series No. 161

Table 15 illustrates the changes in trade flows resulting from the stimulus packages.
Most countries/regions are projected to experience a significant boost in their exports,
especially for manufacturing products such as heavy manufacturing, electronics, light
manufacturing, and textiles and apparel. Services and agriculture exports are also
projected to increase. Surprisingly, the PRC is projected to see a significant rise in
agriculture and processed food exports but a reduction in services exports. These
results flow from the same source, which is the composition of consumption by the PRC
government represented in the GTAP model (over 90% of government consumption is
in the services industries). Therefore, the projected shift in consumption represented by
the fiscal stimulus package decreases the demand for agricultural and processed food
products relative to other products, freeing them up for export. The opposite is the case
for services, which the PRC government is projected to consume in great quantities as a
result of the stimulus package, leaving fewer available services for export. This analysis
underscores the importance of improved data on exactly what the PRC stimulus package
will be spent on.

VI. Impacts of the Protectionist Threat

on Developing Asia
When economic growth is slow or negative, public opinion often moves toward
protectionism and a reduction in imports as a way of boosting local demand and
preserving local jobs. The WTO sought to limit these types of risks in the Uruguay Round
(UR) of tariff negotiations, which concluded in 1995. A major goal of the UR was to “bind”
tariff levels worldwide, so that waves of protectionism would not threaten the trading
system from time to time. Before 1995, most developing country WTO members had a
substantial number of tariff lines “unbound” and hence outside WTO rules and without
commitment to limit tariffs to a ceiling level. During the UR, developing countries were
asked to “bind” nearly all of their tariff levels with ceiling rates, even if the rate was higher
than their current applied most favored nation (MFN) tariff. The result of this process
has been that many developing countries have what is referred to as “binding overhang”
(Bchir, Jean, and Laborde 2005 ), a situation where the applied tariffs are significantly
below their WTO bound (ceiling) rates. In recent Doha negotiations, this binding overhang
was the focus of negotiations, with many developed countries seeking to lock in applied
tariff rates, rather than accept the high binding tariffs. However, the Doha Round failed
and many countries are still capable of increasing their tariff rates to binding levels while
maintaining their WTO commitments.

Table 16 illustrates the degree of binding overhang for selected countries in the Asia
region and for selected OECD countries. While Bangladesh and the PRC have MFN
tariffs at their bound rates, most Asian countries have a significant number of tariff
lines for which the applied MFN tariff is below the WTO bound rate to which they are
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 35

committed. Therefore, many countries in Asia could raise their tariffs and still maintain
their WTO commitments, relieving other WTO members of the right to retaliate.

Table 16: Bound Tariff Rates within the Asia Region

Country MFN* Tariff Lines Below Country MFN* Tariff Lines Below
Bound Rates (%) Bound Rates (%)
US 2 India 49
United Kingdom 3 Indonesia 94
Japan 2 Kyrgyzstan 17
Malaysia 61
Bangladesh 4 Pakistan 28
PRC 4 Papua New Guinea 95
Hong Kong, China 0 Philippines 61
Singapore 46
Sri Lanka 7
Thailand 51
*Most Favored Nation Tariffs (MFN) are those offered to all WTO members.
Source: WTO CTS database and MacMap. Based on HS6 tariff line counts.

Although the WTO permits these countries to raise their most favored tariff rate to the
bound level, free trade agreements have trumped WTO commitments on binding rates—
taking their place in situations where they exist. Preferential trade agreements (PTAs),
such as the ASEAN Free Trade Area and the South Asia Free Trade Area, and bilateral
agreements such as the Singapore–Japan, and Singapore–India PTAs, now govern
the ability of countries party to these agreements to raise their tariffs between each
other. The result is that the rising protectionism will be restrained by these agreements;
nonetheless, these restraints will increase the regionalism they promote by raising tariffs
to non-PTA parties, while maintaining current tariffs for PTA partners. Using a database of
worldwide applied, MFN, and WTO bound rates, we estimate the potential impacts of a
new protectionist wave throughout the developing world.

Table 17 illustrates the potential impacts of increasing tariffs from WTO MFN-applied rates
to WTO binding rates for all countries, subject to the limitations from PTAs. The countries
being impacted are listed in the rows and the contribution of increased protectionism
in other countries is listed in the columns. The impacts sum to the total impacts as a
percent of GDP. The principal diagonal is the impact of a country’s or region’s increased
protectionism on itself. For example, Southeast Asia/Southeast Asia, which equals –1.0,
show that if this region increased its tariffs, it would reduce its own real GDP by 1%
in the medium run.10 In general, protectionism has a negative impact on the countries
and regions that take that course. India and Southeast Asia stand out for the fact that
they could impact other regions should they raise their tariffs to binding levels. The PRC
stands out for its lack of protectionist potential from increasing applied tariffs to binding
rates in the Asia region.

10 The
trade protectionism scenario is not modeled year by year as in the earlier fiscal and crisis impacts. Instead, the
impacts are measured as medium run, which would take place in 2–3 years or at the end of 2010 at the earliest.
Table 17: Impacts of Increased Protectionism in Developing Countries on Real GDP
(millions of dollars and percent change)
Sources of GDP Impacts
Percent Millions Australia/ Other
Change in of US$ New Developing East South Southeast Rest of
Real GDP Dollars* Zealand PRC Asia Asia India Malaysia Singapore Asia Asia World
Australia/
New Zealand −0.5 −3,790 −0.4 - - - −0.1 - - - - -
PRC 0.0 706 - - - - - - - - - 0.2
Other
Developing
Asia −0.5 −1,009 - - −0.5 - - - - - - 0.1
East Asia −0.3 −3,808 - - - −0.2 - - - - - -
India −0.4 −2,476 - - - - −0.4 - - - - -
Malaysia −0.4 −494 −0.1 - - - - −0.6 0.1 - 0.2 -
Singapore −0.1 −129 - - - - 0.1 - −0.4 - 0.3 −0.1
South Asia −0.1 −97 - - - - 0.1 - - −0.3 - 0.2
36 | ADB Economics Working Paper Series No. 161

Southeast
Asia −0.9 −5,050 - - - - - - - - −1.0 0.1
*Millions of dollars at 2004 prices.
Note: Numbers may not add due to rounding.
Source: Authors’ analysis with GTAP model.
Table 18: Change in Country/Regional Exports Due to Increased Protectionism
(millions of US dollars and percent changes)
Agricul- Extrac- Processed Textile, Vehicles Light Heavy Electronics Transport Other Travel Total
ture tion Foods Apparel, and Transport Manu- Manu- and Services and
Leather Equipment factury facturing Construction Tourism
Australia/
New Zealand −341 49 −294 −72 −776 −629 −3,826 −119 −641 −322 −114 −7,086
(−1.8) (0.2) (−2.3) (−3.1) (−17.0) (−9.5) (−12.1) (−7.2) (−3.2) (−3.2) (−3.5)
PRC 227 −26 −87 −723 −35 −526 −2,101 −142 39 205 19 −3,149
(2.3) (−0.2) (−0.6) (−0.6) (−0.2) (−0.5) (−1.2) (−0.1) (0.1) (1.8) (0.6)
Other
Developing
Asia −66 30 −37 −422 52 −257 −591 −35 −210 −100 −9 −1,645
(−1.6) (0.1) (−1.6) (−4.2) (4.7) (−14.4) (−6.0) (−27.9) (−2.8) (−2.6) (−2.8)
East Asia 7 74 8 −2,519 −2,604 −1,037 −3,311 −621 −491 371 −17 −10,140
(0.3) (0.8) (0.2) (−5.5) (−5.2) (−3.3) (−1.8) (−0.4) (−0.4) (0.9) (−0.4)
India 72 2 −9 −693 −245 −2,252 −3,604 −77 −152 −44 −11 −7,012
(1.3) (0.0) (−0.2) (−4.2) (−7.8) (−11.3) (−15.0) (−7.4) (−1.7) (−0.3) (−3.6)
Malaysia 3 66 −7 38 16 −402 −15 −823 −119 −26 −18 −1,287
(0.3) (0.6) (−0.1) (1.3) (0.8) (−3.7) (−0.1) (−1.1) (−1.4) (−0.8) (−0.8)
Singapore −3 −34 −14 −64 −42 210 976 −631 −472 −288 −12 −375
(−0.6) (−0.4) (−0.5) (−4.1) (−1.3) (4.3) (2.4) (−1.2) (−1.6) (−1.5) (-2.0)
South Asia 7 −2 −9 −111 −28 −50 124 −17 −35 −17 −4 −145
(0.6) (−0.5) (−0.8) (−1.0) (−18.2) (−4.8) (7.8) (−26.0) (−1.7) (−1.0) (−2.5)
Southeast Asia −54 187 −322 −2,456 −315 −3,199 −4,772 −1,706 −298 −58 −69 −13,062
(−0.4) (0.6) (−1.6) (−9.1) (−2.9) (−9.0) (−7.4) (−2.4) (−1.4) (−0.8) (−2.8)
Total −149 345 −772 −7,022 −3,977 −8,143 −17,119 −4,172 −2,378 −279 −236 −43,901
*Totals are for countries and regions listed and differ from global total
Note: Numbers in parentheses show declines of exports in terms of percentage changes.
Source: Authors’ estimates from GTAP model.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 37
38 | ADB Economics Working Paper Series No. 161

Table 18 shows the impacts on exports by product and region. Although some countries
and regions experience a rise in exports, resulting from trade diversion created by
accentuating tariff preferences for regional trade partners, the overwhelming effect is
to reduce trade. In absolute value, exports in developing Asia drop by US$36.8 billion.
Heavy manufactures followed by light manufactures, electronics, and textiles are most
impacted. Southeast Asia’s exports decrease the most, followed by East Asia.

VII. Conclusions and Policy Inferences

The importance of international trade to developing Asia has grown tremendously over
the last few decades. The expansion of intraregional trade in Asia reflects the PRC’s role
as an assembly point and its greater reliance on demand from outside the region, the US
and the EU in particular. Through its forward linkages to the PRC, the rest of the region
also remains dependent on external sources of final demand. The expansion of trade
in parts and components (intermediate goods) tends to dilute the importance of RERs
since parts and components exports involve a high proportion of imported parts and
components. It also makes developing Asia more vulnerable to the effects of the global
financial crisis, through its trade links with OECD countries.

The projections/simulations in this paper also support the view that trade links can be
effective for transmitting lower growth in OECD countries to developing Asia. Asia will
continue to suffer lower growth rates due to lower trade with the OECD countries. The
PRC and India will be most impacted. Though Southeast Asia faces reduced exports
to the OECD countries, its exports are reduced significantly to other Asian exporters,
demonstrating the indirect trade linkages that now exist in the global economy. Overall,
we project Asian economic growth to be between 6% and 10% lower at the end of 2010
than it would have been had the OECD countries continued to grow at the same rate as
the average for 2002–2007.

Fiscal stimulus packages now being considered or implemented in the major markets
hold the potential to put Asia back on an improved growth path. However, growth is
projected to be less than historical averages, with the exception of the PRC. The current
fiscal stimulus package announced in the PRC is sufficient to reverse the impacts of
lower growth due to lower exports to the OECD countries. However, the impacts of
these stimulus packages should be considered carefully, since they may not actually
represent additions to government expenditure, but rather a “double counting” of existing
expenditures. If this is found to be the fact, the projected impacts would be lower. Our
analysis also finds that on what governments spend their fiscal stimulus packages is
important to determining trade and income transmission.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 39

Protectionism through the world is growing and there is considerable room for many
developing countries to increase their tariffs to non-PTA partners and still maintain their
WTO commitments. Our projections show that countries that resort to protectionism
will suffer negative impacts to GDP growth. Notably, Southeast Asia would be the most
impacted by protectionism. If Southeast Asian countries were to raise their tariffs to WTO
MFN-bound rates, the impact would be negative on real GDP.

The simulation results imply that a protectionist spiral should be avoided to ensure that
the fiscal stimulus packages can work well to cushion the impacts of the global economic
slowdown in the short run and to rebalance Asia’s growth pattern in the medium to long
run. To promote economic recovery, a “stand-still” on new protectionist measures should
be agreed upon. In cases where temporary measures discriminating against foreign
products have been imposed, the appropriate review mechanism should be conducted
to ensure the orderly unwinding of such measures after the crisis. In addition, the WTO
Doha round should also be resumed to resist protectionist tendencies and liberalize
global trade.
40 | ADB Economics Working Paper Series No. 161

Appendix: The Global Trade Analysis Program (GTAP)

The GTAP computable general equilibrium (CGE) model is in wide use throughout the world
in government and nongovernment institutions. A CGE model combines data on world trade
and production with economic demand and production theory to simulate the workings of an
economy.11 In this analysis, the global economy is modeled as 13 regions and 11 sectors
(Table 9). The analysis for our purposes makes projections of 1–2 years (2009 or 2010), unless
otherwise noted. This period of projection is referred to by economists as the “short term”. In
practice, the short-term is reflected in a CGE model in three ways:

(i) inflexibility of factor prices;

(ii) unemployment of resources (labor and capital); and

(iii) limits on the growth of capital stocks resulting from investment.

Regarding the first point, our analysis starts from the observation of falling factor utilization
(unemployment) modeled by fixing factor prices. Fully flexible factor prices, in contrast, imply
full utilization of resources. Capital stocks, the other determinant of the short term in the model,
are not permitted to expand in response to investment.12 At the same time capital stocks do not
adjust, investment is permitted to vary. What does it mean for investment to occur without capital
stocks changing? The difference can be viewed as construction on a building (investment), which
contributes to economic activities (through carpenters and engineers), but the construction does
not yet provide rental incomes (capital stocks) through stores or factory space.

Modeling the current economic crisis requires careful consideration of conventional short-term
assumptions used in CGE modeling. What is under way is not simply an economic slowdown
in a single country, or average expansion, it is a worldwide recession, where most economies
are contracting in real terms. Under the more limited scope of an economic downturn, CGE
economists often allow capital prices to remain flexible, despite the short-term nature of the
analysis. Capital resources, therefore, are fully employed, as a matter of convention, even in
the short run. The reasoning is simple, owners of capital will forego profits to maintain output,
and by reducing profits, they reduce the rental price of capital. So, in the short run, convention
has dictated capital prices to be flexible, reflecting the marginal ebb and flow of profits through
economic upturns and downturns. The current crisis, in contrast, is without many precedents, and
capacity utilization rates are falling as businesses are going bankrupt on a wide scale. Moreover,
banks are reluctant to renegotiate loans or provide working capital to distressed businesses. We,
therefore, model capital rental rates with fixed prices, allowing for unemployment of this resource
(reduced capacity utilization). Permitting capital rental rates to decline would reduce the projected
impacts, but then so would allowing other factor prices to fall; however, it would then be hard to
justify unemployment of labor or capital. In the short run, rapid declines in factor prices are not
likely to occur unless from nominal currency depreciations, a factor not modeled here.

11 The current GTAP model is benchmarked to 2004 prices, trade, and production. Our analysis includes an
adjustment to the base 2004 data structure to account for changes to textile and apparel trade resulting from the
phase-out of WTO quotas on these products in 2005. We adjusted market shares for these products to reflect 2008
trade shares.
12 The ability for investment to impact capital stock is also a characteristic of the fact that the model is comparative
static.
Trade Structure and the Transmission of Economic Distress in the High-Income OECD Countries to Developing Asia | 41

Finally, an assumption must be made about the movement of investment between countries. In
the current crisis, investment capital has largely “frozen”. If there has been a tendency for capital
to move, it has been led by demand for security, found in the form of government guarantees
and insured deposits. Despite the fact that the US mortgage sector is recognized as the source
of the financial crisis, this fact has not resulted in widespread capital flight from the US. In fact,
the US dollar has returned as the “reserve” currency of the world, reflecting investors’ confidence
in the US government’s guarantee to pay debts. The net effect on investment flows has been to
maintain the status quo, with significant investment being channeled to the US. We, therefore, limit
investment flows in the model, to reflect the “freezing of capital markets”. By generally accepted
macroeconomic accounting, trade balances are fixed (relative to real income) to reflect limited
international investment flows.13,14

13 The accounting equation referred to is the familiar (S-I) = (X-M) in macro accounting. Investment levels that exceed
savings can only be financed through a current account deficit.
14 The analysis in this paper was not found to be sensitive to the fixed trade balance assumption, and the conclusions
hold, even if trade balances are allowed to vary. This results from our practice of holding factor and capital rental
rates constant in the short term, limiting the change in relative returns between countries.
42 | ADB Economics Working Paper Series No. 161

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About the Paper

Juthathip Jongwanich, William E. James, Peter J. Minor, and Alexander Greenbaum examine
changes in the structure of international trade in developing Asia over the past two decades
and find that, despite a sharp increase in intraregional trade, developing Asia continues
to be vulnerable to a demand collapse in the G3 countries. The rise in intraregional trade
largely reflects increasing fragmentation of production with trade in intermediate goods
and assembly of final products in the People’s Republic of China, leaving the region
still dependent on external demand in the European Union, Japan, and United States.
Simulations indicate the crisis may decrease real income in the region by 6–10% over the
next two years largely as a result of a fall in exports. Although fiscal stimulus may mitigate
these losses, a resurgence of protectionism would work in the opposite direction.

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