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 .
In some ways, growth has been imbalanced. But it’s important to think of this concept in a broad sense. It is true that growth has relied on exports, and constraints to domestic investment and consumption may be reducing the potential of local demand for Thai goods and services to pull the economy along. But growth has also been concentrated in certain sectors (manufacturing) and regions (Bangkok). So a strategy for growth that is more sustained and resilient to shocks will need to do more than just boosting domestic demand:
- To boost domestic investment: Lowering the costs of doing business by complementing investments in “hardware” (infrastructure) with a renewed focus on the “software” (improved regulations).
- To boost domestic consumption: Building social safety nets to allow individuals to reduce precautionary savings and to undertake more productive (but riskier) activities.
- To boost the services sector: Enhancing the productivity of the services sector by increased competition and modern regulations, including more trade in services.
- To boost the economy outside Bangkok: Even if growth may naturally be geographically concentrated, government services need to be more evenly delivered across different regions in the country.
In some ways, however, growth needs to be less balanced. Over the past 20 years, the incomes of all income groups have grown at about the same pace (about 9 percent per year in nominal terms). This has meant that inequality remained persistently high  during that period (indeed, inequality in Thailand is one of the highest in East Asia). High inequality is associated with a greater probability of conflicts  (pdf), and Thailand’s current political crisis is in some ways related to high levels of income and geographic inequality.
Reducing inequality requires that the incomes of the poor grow faster than the incomes of the rich. This actually has happened in Brazil (where this current blog entry is being written) over the past decade, and Brazil’s notoriously high income inequality has been steadily declining for the past seven years and it’s now close to Thai levels (pdf - only in Portuguese, but take a look at the charts. See also this pdf .).
How did Brazil do it? Transfers clearly helped – the government here pays low-income families a stipend to boost their income and allow them to keep children in school. An uneven increase in labor incomes (i.e., the incomes of the poor have grown more quickly than those of the rich) has been equally critical to the reduction of inequality. This likely reflects the fact that the productivity of low-income individuals has increased more quickly than that of higher-income workers. While the causes of this unbalanced growth in labor incomes are not fully understood, a possible explanation is that educational reforms implemented in the 1990s (which greatly expanded access to basic education and incentives to conclude primary education) are currently bearing fruit.
There are two possible lessons for Thailand. First, although straight “cash handouts” are likely to be quite unpopular in Thailand (indeed, there have been studies which show that Thais are generally culturally against cash handouts), transfer policies should not be dismissed outright . Indeed, the government’s new pension to elderly individuals not covered under the social security scheme provides one example of a transfer policy that targets a group that is over-represented among the poor. Other similar social insurance schemes may be feasible – and desirable.
Second, Thailand needs to make it a top priority to upgrade the skills of its workers, especially among the most vulnerable. Unlike Brazil, access to education in Thailand has been quite ample, and ‘bricks and mortar’ are likely not the main obstacle. Rather, a focus on reforming curricula to foster creative minds and research skills – and other educational policies – is likely to yield the greater payoffs.