FRBSF Economic Letter
1998-10 | March 27, 1998
Pacific Basin Notes. This series appears on an occasional basis. It is prepared under the auspices of the Center for Pacific Basin Monetary and Economic Studies within the FRBSF’s Economic Research Department.
Since July 2, 1997, when the fall of the Thai baht against the U.S. dollar rang the first alarm about problems in East Asia, numerous economists have forecast the effect of those developments on growth in the United States. Current consensus estimates suggest that the Asian turmoil likely will reduce real GDP growth in the nation by ½ to 1 percentage point in 1998. Since the Twelfth District ships about twice as much of its gross product to East Asia as the nation does, some observers have speculated that District growth could decline by twice this much, or by a full percentage point or more during the year. However, as noted in a recent Economic Letter by the President of the San Francisco Fed, Robert T. Parry, there are reasons to be cautious about using this simple metric to estimate the relative impact of East Asia on District growth. This Economic Letter reviews some of these reasons.
Estimates of the impact of East Asia on U.S. growth over the next year assume that developments in East Asia will affect the U.S. economy primarily through two trade-related channels. First, reductions in the value of East Asian currencies will increase the relative prices of goods and services produced in the U.S., slowing U.S. exports to East Asia and the world and accelerating East Asian imports to the U.S. Second, underlying economic weakness in many East Asian nations will slow economic growth there, further depressing demand for U.S. exports. Such changes in the terms and patterns of trade as well as significant weakening among some of our primary East Asian trade partners worsen the U.S. trade balance, ultimately damping growth. Accounting for effects through both of these channels and for the fact that exports to and imports from East Asia amount to roughly 3% and 5% of U.S. GDP, respectively, most estimates suggest that the Asian turmoil is likely to reduce real U.S. GDP growth in 1998 by between ½ and 1 percentage point. (For the purposes of this analysis, East Asia includes Malaysia, Thailand, Indonesia, the Philippines, South Korea, Taiwan, Singapore, Hong Kong, Japan, and China.)
Ideally, estimates of the impact of the East Asian financial crisis on District growth should account for import and export effects through both of these channels, as they do for the U.S. However, data constraints relating to imports make a complete analysis at the state and regional level significantly more difficult. Therefore, many studies of the effects of East Asia on District growth are based on examinations of District export exposure to East Asia. Under the assumption that the effects of import substitution are similar across states in the U.S., the export component of District trade can provide a basis for judging the relative exposure of the District economy to developments in East Asia.
The figure displays merchandise and service exports to the world and to countries in East Asia as a share of GDP for the Twelfth District and the U.S. Merchandise exports include manufactured and non-manufactured commodities and reflect Department of Commerce data on origin-of-movement of goods; service exports include business and personal services, passenger fares, royalties and licensing fees, and freight and port services and must be estimated for the District. District service exports were computed based on the assumption that the relationship of service exports to merchandise exports for District states is similar to that for the U.S. Two relevant observations for the U.S. regarding service exports are: (1) service exports are half the value of merchandise exports or about one-third of total exports, and (2) the most common services exported are business and consulting services, which include engineering and management services, packaged software products, and telecommunications support. An additional observation at the District level is that business and consulting services represent a larger fraction of the economy in western states than in the U.S. Based on this information, District service exports were estimated by multiplying the value of merchandise exports by a weighted merchandise to service export ratio, where the weighted ratio equals ½ times the ratio of the value of business services in District states to the value of business services in the average state in the U.S.
The estimates shown in the figure indicate that the Twelfth District exports a larger fraction of its GDP than the U.S. The U.S. exports about 11.4% of GDP compared to about 13.4% exported by District states. Moreover, when exports to East Asia are compared, the District’s dependence relative to the U.S. grows. The average District state exports more than 50% of its total exports to destinations in East Asia, compared to about 30% exported to East Asia by the average U.S. state. In GDP terms (as shown in the figure), District states export approximately 7% of GDP to East Asia, or more than twice the 3.3% of GDP exported to East Asia by the average U.S. state. Thus, other things equal across the U.S. and the District, an equal percent decline in East Asian exports in the District and the U.S. might be expected to reduce District growth by about twice as much as it reduces U.S. growth.
However, a number of factors suggest caution is warranted when using this estimate. First, such a calculation assumes that any decline in East Asian demand for exports affects the U.S. and the District equivalently, or more simply, that the product mixes of District and U.S. exports to East Asia are similar. Second, it assumes that the total value of exports shipped from the District is created in the District and that District industries are not affected by reductions in exports from other areas of the U.S. The remainder of this Letter reviews why these assumptions may not hold.
Differences in the composition of exports between the U.S. and the District (detailed in the December 1997 issue of Western Economic Developments) suggest that the District-U.S. export exposure ratio may not accurately characterize the vulnerability of the Twelfth District relative to the U.S. In particular, relative to the U.S., District exports to East Asia are more concentrated in high-tech products, aircraft production, and business services, and less concentrated in heavy machinery, primary metals, and agricultural commodities. Anecdotal reports and preliminary data from coastal ports indicate that, thus far, the composition of District exports has worked to temper the disproportionate impact of East Asia on District growth suggested by the 2 to 1 export exposure ratio between the District and the U.S.
In the case of high-tech manufacturers in the District, who provide nearly 25% of District exports to East Asia, reports indicate only slight declines in export demand since the East Asian currency crisis began. Industry experts attribute part of the current resiliency of this sector to the fact that many high-tech exports to East Asian nations are intermediate goods used to create final demand products, such as computers, for reexport. The future stability of this component of East Asia’s demand for high-tech products will depend on the continued ability of East Asian businesses to secure financing for production. Scattered reports of declines in export demand, primarily in the semiconductor manufacturing equipment sector, have been associated in part with disruptions in financing arrangements.
In the transportation sector, shipments of aircraft dominate the District’s exports to East Asia. Boeing currently has a backlog of orders and is running operations at full capacity. Thus, outstanding orders from customers in the U.S. and countries outside of East Asia could substitute for any near-term slowdown in demand from East Asia.
The sectors where the slowdown in District exports has been most evident are agricultural commodities, processed foods, and products related to natural resources. Producers in these sectors have reported order cancellations, buyer financing problems, and significant declines in demand for future deliveries. While such declines likely will have a noticeable impact in certain areas of the District, exports to East Asia from these sectors combined account for just 15% of District exports to East Asia and less than 1% of District GDP.
These findings suggest that while District exports have been affected by developments in East Asia, the composition of District exports has served to mitigate some of the disproportionate effect predicted by the District’s large East Asian export exposure relative to the rest of the U.S.
Another concern with using the District’s relative East Asian export exposure to characterize the impact on District growth is that the total value of exports shipped from the District is not created in the District. The total value of exports represents a collection of value-added components, many of which are produced outside of the District. Thus, the effect of a given reduction in demand for District exports may not be borne entirely by the District. Rather, it will be distributed throughout the U.S. in proportion to the value-added inputs to the final good. However, on the other side of the coin, District manufacturers of intermediate and capital goods used in non-District exports to East Asia also will be affected. The net effect of these two factors must be considered in any calculation of the effect of East Asian developments on District growth.
Estimating the net effect on District growth is not an easy task. Research on production linkages across the United States is scarce, and studies that are available focus on all products, not just those traded with East Asia. Still, assuming that production linkages across states are equivalent for total exports and for the subset of products shipped to East Asia, this research provides some statistical basis for estimating the net effect of a decline in export demand on District growth. In one such study, Shao and Miller (1990) suggest that, in general, regions of the U.S. included in the Twelfth District are net demanders of production inputs from other regions of the U.S. This implies that a given dollar reduction in demand for U.S. exports may have a smaller effect on District growth than the impact on total District exports would imply. More precisely, the impact on the District’s value-added component of products is likely to be less than the measured reduction in District exports. Under these circumstances, the net effect of District production linkages serves to mitigate, rather than to enhance, the impact implied by the 2 to 1 export exposure ratio.
In summary, although Twelfth District states are about twice as dependent on exports to East Asia as the U.S., this does not necessarily imply that the East Asian impact on District growth will be twice as large. Other factors, including the District’s product mix and the value-added component of exports relative to the U.S., in principle, could serve to mitigate or magnify the District’s vulnerability to East Asia as measured by export exposure ratios. Thus far, these factors appear to be tempering the East Asian impact on District growth, bringing it closer to that estimated for the total U.S.
Parry, Robert T. 1998. “Prospects for the U.S. and California Economies.” FRBSF Economic Letter 98-06 (February).
Shao, Gang, and Ronald Miller. 1990. “Demand-Side and Supply-Side Commodity-Industry Multiregional Input-Output Models and Spatial Linkages in the U.S. Regional Economy.” Economic Systems Research 2, pp. 385-420.
Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita Todd. Permission to reprint must be obtained in writing.
Please send editorial comments and requests for reprint permission to
Attn: Research publications, MS 1140
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120