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World: Economists Examine Deflation Consequences

  • Breffni O'Rourke

Prague, 7 January 1998 (RFE/RL) -- The world economic scene presents a panorama of contrasts which is fascinating analysts. On the one hand, the former high-growth economies of East Asia are continuing their dive, and no-one is sure where that will end. On the other hand, the biggest economy in the world, the United States, is enjoying an economic boom which began as far back as 1991 and shows no sign of ending.

What grips the interest of economists and analysts is whether, or for how long, these two apparently contradictory tendencies can co-exist in a world which is supposed to be becoming ever more closely linked through globalisation.

An increasingly voiced fear is that oversupply will unleash deflation -- meaning general falls in prices leading to lower incomes. This could undercut U.S. economic growth.

Oversupply is already emerging from several sources. Firstly, from the sharply lowered consumption of everything from clothes to luxury cars on the big Asian markets. Secondly, from the increase in production capacity in which U.S. firms have recently invested, in the expectation of continuing boom conditions. And thirdly, there's the certainty that as soon as possible Asia will try to export its way back to economic health. But because of the currency crashes, Asian exports could now be up to 50 percent cheaper than before, thus cutting deeply into the sales chances of domestic products.

All these tendencies create pressure for a lessening of prices. Lower prices would squeeze company profits, which eventually would mean incomes would stop growing or even decline, which then mean would mean people would buy less. Then the deflationary circle is complete.

Deflation, with its specter of depression, is one scenario. The other is that the U.S. economy is strong enough to shrug off the negative cycle and continue its growth pattern, something which would help Asia because it would provide an expanding market for Asian products.

The transition economies of Central and East Europe would suffer like the rest of the world if international deflation were to take hold. But the senior analyst for emerging markets at Chase Manhattan Bank in London, Robin Hubbard, says that transition countries can actually benefit from a situation in which there is oversupply in certain commodities.

The transition countries already enjoy a wide price advantage in production costs over West Europe and the USA, and Hubbard says that for instance falling energy and commodity prices would further reduce the cost components of Eastern products, thus increasing their competitiveness.

He says in addition that Asia's cheaper exports will not have the same direct impact on the economies of the transition region as on the developed world. That's because the export product ranges of the two are largely different. Asia's star items are high-tech products, including electronic equipment, and sophisticated machinery, including cars. The transition region however produces mainly intermediate products, including an increasing amount of components for the European Union member states. The two areas are therefore not direct competitors. Hubbard takes the example of a Czech company which might for instance be manufacturing gearbox parts for a German auto maker. The German company will have taken considerable time and effort to establish that the product from the Czech factory is right, that the quality is consistent and the delivery rate is reliable. He says once that business arrangement is running well, the auto maker will not lightly decide to switch suddenly to an Asian supplier just because of the possibility of cheaper prices.

Hubbard says the picture may be different in cases where commodities can be easily substituted, for instance in textiles. In that case, manufacturers of consumer items using textiles can quickly switch their orders from East European to Asian suppliers.

He says however that all things considered, he would not expect a major shift in trade relations between East and West Europe as a result of the Asian developments.