Frederico Gil Sander's blog

Umbrella factory in Chiang Mai (courtesy of rustybadger under a Creative Commons license). Thailand's workers need to contribute more complex tasks to the supply chain.

The complexity of the products made in Thailand has increased drastically over the past 30 years (see the Thailand Economic Monitor, April 2011 (pdf)– especially section 3.2). Thailand went from exporting primarily raw commodities such as rice and rubber to becoming one of the world’s largest exporters of hard disk drives, integrated circuit packages, cars, and auto parts. Electrical, electronic and automotive products now comprise about 40 percent of Thailand’s exports.

But it is the sophistication of tasks, not products, that is important. Making a new laptop or car involves a large number of tasks. The product needs to be conceived, thousands (or millions) of individual parts need to be designed and engineered, then a process must be put in place to churn out each part. The final product then needs to be tested, packaged, and marketed (…and this is far from an exhaustive list of tasks!).

Price increases continue to make headlines in Thailand. Inflation in April was the highest in 15 months and, despite some respite from oil markets, the worst may not be over since many prices remain controlled to some extent. In my last entry, I discussed why inflation has been hard to tackle: it comes mostly from external sources, it doesn’t hurt everyone and it may be driven by long-term trends. So what can be done about the inflation challenge?

Higher prices have been making headlines in Thailand. Although wages and farm incomes are up, so are the prices of eggs, milk and fried rice. I am definitely feeling the pinch: the price of my favorite beverage—coconut water—has surged following a beetle infestation.

As prices go up, so does the pressure on the government to reign in the spiraling cost of living. But as we discussed in the recently released Thailand Economic Monitor - April 2011, the current inflation challenge is especially tough to tackle.

Image courtesy of Caitfoto through a Creative Commons license

(Available in: ภาษาไทย)

Following the very successful earlier engagements of a Khmer palm reader and a celebrity turtle-shell fortune teller, the Thailand economic team has recently hired the forecasting star of the moment to divine the future of the economy. I am not talking about Professor Nouriel “Dr. Doom” Roubini, but Octopus Paul, who had to escape Germany in a hurry to avoid becoming “pulpo a la Gallega”. For a hefty fee of a five shrimps, the wise cephalopod spent a few hours in our offices sharing his prognosis for the Thai economy.

In the years since the 1997/1998 Asian financial crisis, the Bank of Thailand (BoT) worked hard to build a heavy fortress around the nation’s financial sector. As a result, at a time when credit markets froze in developed countries and investors “fled to quality,” large amounts of capital still flowed into Thailand, where banks remained solid and well capitalized. Despite the financial strength brought by prudent policies, for the first time since the financial crisis, Thailand will see GDP and household consumption drop, and poverty could even increase in 2009. It is clear that the financial armor was insufficient to protect the economy from another crisis.

The culprit has been identified as Thailand’s excessive reliance on external demand, and talk of “rebalancing” growth towards domestic consumption and investment has become quite common (pdf). The idea of rebalancing makes some sense – but it can also be misleading. Let me explain.

As part of its regular monitoring of the corporate sector in Southeast Asia, the World Bank economic team I am part of in Thailand has been working on a short case study of supply chains of Japanese multinational companies (MNCs) in the electrical and electronics (E&E) industry. We wanted to hear directly from firms about how the crisis affected them, how they were able to adjust so quickly to the drop in demand, what the rebound looked like, and what were the prospects going forward to upgrade along the value chain. I have learned a great deal from these interviews, and have become convinced that supply chains are central to understanding the current crisis in Thailand and East Asia more generally.

Some facts: the crisis had a disproportionate impact on manufacturing. In Thailand, manufacturing represents about 40 percent of GDP, but contractions in manufacturing value added have accounted for about 75 percent of the contraction of headline GDP. Within manufacturing, the auto and E&E industries account for the bulk of the contraction. Most of the output in those industries is exported, and more than three-fourths of the decline in Thai exports during the crisis was due to falls in shipments from the auto and E&E industries. My conclusion is that the magnitude of the crisis in Thailand has been driven primarily by these two industries.

In Laos, the government has reportedly already healed the economy from the economic flu. But in Thailand, there seems to be more uncertainty about the health of the economy, and some commentators are not ready to call the recession over. The Thai economy contracted by 4.9 percent from the previous year in the second quarter of 2009, better than the 7.1 contraction posted in the first quarter. What can we expect for the rest of 2009 and 2010?
 
This is very timely question for all World Bank economists in East Asia, who are currently finalizing their forecasts for the upcoming East Asia and Pacific Update economic report, to be launched in November. On my end, I am writing this post from Cambodia, where I am meeting with palm readers, fortune tellers and other economic healers to ensure highly accurate forecasts. Let me offer a preview of what the soothsayers are saying.

When the capacity of the economy to supply goods and services (given by its factories, workers, etc.) exceeds demand, as happens in a crisis, there is pressure for prices to fall. A continued decline in prices (deflation) can in turn aggravate the economic crisis, because consumers expect prices will be lower in the future and so have an incentive to postpone purchases. They also fear that their wages (the price of labor) may decline along with other prices, and tend to save more. These factors further reduce demand and may create a vicious cycle, such as the one that happened in Japan in the 1990s.

But not all changes in prices are related to the underlying domestic economy. If price changes are expected to be "one-off" then the expectations of consumers about future prices do not change, and the logic above does not apply.

Are these green shoots? This question, usually the primary concern of pandas (or panda look-alikes), is now on everyone’s mind as observers try to identify the early signs of recovery out of the global financial crisis, which, like a forest fire, spread rapidly and caused great damage to the world’s economies and the Thai economy in particular. It now appears that the fire has been put out (with much liquidity…), but the green shoots emerging in the burned forest remain very fragile as hot spots remain and the risks of the fire re-igniting are not negligible.