External shocks and macroeconomic adjustments in the Philippines and Thailand : a comparative study

Abstract

The Philippines and Thailand are the two countries in the Southeast Asian region that share the most similar economic characteristics. In the 1950s and the 1960s, the growth performance of both countries was similar. However, in the 1970s, when both countries faced similar kinds of external shocks, growth performance began to differ. By the mid 1980s, comparative economic performance became clear: Thailand was growing at a rate of more than 10 per cent per year in real terms while the Philippines experienced a negative real growth rate. The adjustment in response to the changing external environment in Thailand also led to a favourable economic transformation. Many preconditions for take off were seen and the country was destined to become another member of the Newly Industrialised Economies (NIEs). On the other hand, the Philippine economy was still shaky and vulnerable to any shock that may arise. The question is why, despite the similarity in economic characteristics and exposure to the same kind of external shocks, Thailand has been able to perform relatively better than the Philippines? The difference in economic performance could be the result of differences in political and economic structure, the magnitude of external shocks, and policy adjustments in response to the shocks. This Thesis investigates how these three factors can help to explain the difference in economic performance between the two countries. The differences in economic structure and the magnitude of the shocks were found to be minimal. It was the difference in economic policy response to the external shocks that mattered and largely explains the relatively poor economic performance in the Philippines. Four approaches were used to investigate the differences in economic policy responses. The first is to use a simple macroeconomic model with one final good to analyse the effects of external shocks and how an economy can respond to them. The external shocks analysed were the volume of trade shock (a fall in export demand) and the oil terms of trade shocks (a rise in the relative prices of oil to home goods). Because the terms of trade shock may have different effects on different sectors in the economy, the Australian model of traded/non-traded goods is also applied. This explains the effect of the oil terms of trade shock (the relative prices of oil input to the final traded goods) on the real exchange rate (the relative prices of traded to non-traded goods) which affects the allocation of resources between the traded and non-traded sectors. These two approaches deal with the case of a fully anticipated shock, whether temporary or permanent. The third approach attempted to explain adjustments in the event that the shock is not anticipated, and so there could be a cost associated with the incorrect expectation. The model being used is a simple dynamic model with two periods of adjustment. The final approach is a decomposition of the current account and policy responses of a country. This approach was developed by Bela Balassa, EdmarBacha and Gerald Helleiner in the early 1980s. The approach was a rough and ready tool to analyse the effects of external shocks and domestic policy responses such as export promotion policy, import substitution policy, etc.. However, it did not have an explicit linkage between the changes in the current account and domestic macroeconomic response in terms of consumption, savings and investment. Therefore, this approach was reviewed and another decomposition method proposed. The essence of macroeconomic adjustment in response to external shocks is the skilful use of fiscal, monetary and exchange rate policies. The thesis also investigates the conduct of these policies and identifies the major differences in policy conduct that led to macroeconomic policy being a more effective instrument in Thailand than in the Philippines. The concluding chapter of the thesis also suggests some lessons for other developing countries to learn from the comparative study of the Philippines and Thailand in response to external shocks.