Health restored? Uncertainty in forecasting Thailand's economic outlook

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.
 
First, a technical point. Strictly speaking, "recession" means at least two quarters of negative growth in seasonally adjusted GDP. "Seasonally adjusted" means that to be able to compare GDP from quarter to quarter, we have to take into account seasonal patterns in economic output. The Thai New Year takes place in April, so production is lower in the second quarter every year because people are working fewer days; same for China in the first quarter due to the Chinese New Year. As you can see from the chart below, Thailand is indeed out of recession for now because (seasonally adjusted) GDP in the second quarter was higher than in the first quarter.

Quarterly GDP should continue to increase in the last two quarters of the year. Here's what I think is happening: Back in early October of 2008, it was not clear whether governments were going to act quickly or effectively enough to compensate for the shock spurred by the collapse of Lehman Brothers. Companies slashed forecasts of demand for their products. It takes some time to adjust production: contracts with suppliers and workers may force companies to keep buying supplies or labor beyond their needs; it can also be very costly to resume production quickly if the demand forecasts turn out to be wrong. In the 1997/1998 Asian economic crisis, Thai factories took 15 months to 'shut down' about 20 percent of existing production capacity in this process of adjustment.
 
But something was different this time around. Innovations in information technology and institutional arrangements (e.g. labor and supplier contracts) have allowed for much more rapid production adjustments than was possible before. Companies use a greater percentage of temporary workers, who can be easily dismissed, and supply contracts are very short-term. Meanwhile, the management of inventories has become more efficient because of IT improvements. As a consequence, in this recession Thai factories took only five months to 'shut down' close to 20 percent of their production capacity.

It turns out, governments from the US to Thailand – and especially China – did manage to provide unprecedented levels of fiscal and monetary stimulus (see the charts below), and a worse crisis was averted. Demand projections were revised again, but this time upward, and the same factors that allowed factories to be quickly shut down now allow them to restart production just as quickly. Hence the growth we are currently observing in Thailand and elsewhere. This upward adjustment process is likely not finished since optimism breeds optimism (Keynes' "animal spirits" at work) and demand projections have likely continued to increase as further confirmation that the crisis wasn't that bad continued to emerge.

This begs the question of how sustainable the recovery is, or whether we are going to have a "square-root" recovery. The process of readjusting production to the correct levels and replenishing inventories, as well as the large amount of fiscal and monetary stimulus still making their way through the system, will provide some momentum for economic activity through the second half of 2010. What happens next?
 
The problem with forecasting anything beyond the second half of 2010 is that it will once again depend primarily on the actions of policy makers. Having been forced to ride the tiger of massive fiscal and monetary stimulus, policy makers now must dismount without the tiger eating them alive. Withdraw too early, and the global recovery – and with it Thailand's export-dependent economy – may stall; withdraw too late and a new crisis (caused by high inflation, steep devaluation of the US dollar, solvency concerns in some countries because of high levels of debt, etc.) may be around the corner.
 
Will policy makers around the globe dismount the tiger at the right moment? The Khmer palmist entrusted with that question has unfortunately been laid off due to the crisis, so we’ll have to wait for me to consult with a Brazilian babalorixa on that one.