The USD Strength and Economic Growth: An Empirical Study in Asia Pacific Countries

550 | Policies and Sustainable Economic Development The USD Strength and Economic Growth: An Empirical Study in Asia Pacific Countries NGUYEN PHUC CANH University of Economics HCMC - canhnguyen@ueh.edu.vn Abstract The USD strength has strong impacts on trade activities, investment flows, and also consumption in opened countries through income effects and substitution effects, which are now stronger due to the higher integrations around the world Asia Pacific is one of the major economic areas in terms of population, economic scale, and their openness, which are also impacted by the USD strength This paper investigates the impacts of USD strength on real economic growth of 39 Asia Pacific countries (excluding China) using the panel data from 2000 to 2013 By recruiting the fixed effects and random effects models for panel data estimators, it is found that the income effects are strong and stronger in developing countries, but the 2008 global financial crisis has reduced them Furthermore, the Chinese economy is confirmed to have an important role in real economic growth of both developed and developing Asia Pacific countries Keywords: USD strength; economic growth; Asia Pacific; income effects Policies and Sustainable Economic Development | 551 Introduction The USD is in the downward trend from 2000 until the slightly recovery in the 2008 global financial crisis, meanwhile the world economy, the US economy and also the Asia Pacific economy sharply fallen in 2008 and 2009 after a long increased trend beginning from 2001 Economic growth and USD index 4.0 140.0 3.0 120.0 2.0 100.0 1.0 80.0 0.0 -1.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 60.0 -2.0 40.0 -3.0 20.0 -4.0 0.0 US Real GDP growth rate East Asia real GDP growth rate Central Asia and Europe real GDP growth rate World real GDP growth rate USD index Figure USD strength and real economic growth The Asia Pacific countries are majorly the small open developing economies except some large economies such as Australia, Japan, Korea, and China Excluding China, almost large developed economies in Asia Pacific such as Australia, Japan, and Korea have lower real economic growth rates in the sample of 40 countries, while other small developing countries have higher growth rates than the world rate which prove a fact that Asia Pacific area is a dynamic area with high economic development Table Real economic growth at Asia Pacific Mean Rank Mean before 2008 Rank Mean after 2008 Rank Min Max Std Dev Afghanistan 3.56 3.30 3.77 0.46 8.29 2.26 Armenia 3.01 11 4.81 0.62 36 -6.63 5.71 3.11 Australia 1.31 30 1.43 31 1.14 29 0.75 1.77 0.34 Azerbaijan 4.89 6.83 2.30 16 0.03 12.87 3.49 Bangladesh 2.48 16 2.47 18 2.50 12 1.88 2.96 0.28 Bhutan 3.25 3.69 2.66 11 0.88 7.16 1.43 Cambodia 3.30 3.96 2.42 15 0.04 5.40 1.18 China 4.08 4.33 3.74 3.20 5.75 0.70 Fiji 0.67 36 0.61 38 0.76 32 -0.74 2.24 0.81 Georgia 2.44 17 3.14 10 1.50 24 -1.67 5.05 1.67 Economic growth 552 | Policies and Sustainable Economic Development Mean before 2008 Rank Mean after 2008 Rank Min 26 2.23 13 2.96 21 1.10 30 -1.08 3.62 1.33 11 2.88 1.62 4.24 0.92 2.29 20 2.14 22 2.49 13 1.55 2.73 0.34 Japan 0.39 40 0.65 37 0.05 39 -2.47 1.97 0.98 Kazakhstan 3.31 4.20 2.13 18 0.52 5.50 1.26 Kiribati 0.93 35 1.08 34 0.72 34 -2.00 3.94 1.42 Korea 1.88 24 2.28 20 1.35 25 0.31 3.68 0.86 Kyrgyz Republic 1.90 23 1.91 28 1.89 21 -0.21 4.35 1.48 Laos 3.04 10 2.80 13 3.37 2.43 3.59 0.42 Malaysia 2.13 21 2.34 19 1.85 23 -0.66 3.69 1.07 Maldives 2.74 14 3.60 1.87 22 -3.94 7.77 3.13 Marshall Islands 0.99 34 1.19 33 0.71 35 -0.89 2.59 1.11 Mongolia 3.19 2.74 15 3.79 -0.55 7.01 1.90 Nepal 1.74 28 1.59 29 1.95 20 0.05 2.61 0.60 New Zealand 1.08 33 1.45 30 0.59 37 -0.82 2.13 0.68 Pakistan 1.73 29 2.13 24 1.20 27 0.69 3.21 0.78 Palau 0.44 39 0.95 35 -0.25 40 -4.94 3.37 2.05 Papua New Guinea 1.87 25 0.94 36 3.12 -1.10 4.40 1.52 Phillipines 2.11 22 2.08 27 2.15 17 0.50 3.19 0.74 Samoa 1.26 31 2.10 26 0.14 38 -2.14 2.91 1.38 Singapore 2.39 19 2.69 16 1.99 19 -0.42 6.16 1.75 Sri Lanka 2.40 18 2.13 25 2.75 10 -0.68 3.44 1.01 Tajikistan 3.35 3.74 2.83 1.62 4.53 0.77 Thailand 1.74 27 2.14 23 1.22 26 -1.02 3.27 1.20 Tonga 0.66 37 0.53 39 0.84 31 -1.84 1.54 0.93 Turkmenistan 3.52 2.77 14 4.52 0.11 5.96 1.73 Tuvalu 0.55 38 0.43 40 0.72 33 -1.97 3.52 1.88 Uzbekistan 2.93 12 2.51 17 3.48 1.62 3.94 0.80 Vanuatu 1.22 32 1.27 32 1.16 28 -2.28 3.53 1.53 Vietnam 2.70 15 2.91 12 2.42 14 2.22 3.16 0.30 Economic growth Mean Rank Hong kong 1.75 India 2.92 Indonesia Max Std Dev Therefore, the fluctuations in USD strength may have important roles in Asia Pacific economic activities such as trade and investment through the income effects and the substitution effects In the light of the 2008 global financial crisis, the studies of economic growth are focused again in more concentration on international integration, cross – country’s economic contagion and the fluctuations in exchange rate which have strong impacts on trade activities and investment flows (Brooks et al., 2004; Ilzetzki et al., 2004; Magud & Vesperoni, 2015; Ng et al., 2008; Reinhart, 2012; Xiangqian & Guoqiang, 2005; Zhang et al., 2008) Still, these studies usually investigate the real exchange rate between one economy with one economy which of course has direct impact on the trade and investment activities between two of these countries, but they not study the impact of an Policies and Sustainable Economic Development | 553 increasing or a decreasing in the most important currency, USD, for overall economic activities While, almost of the trade and investment activities around the world are done under the USD for transacting, investing, paying, thus this study emphasizes on the effects of USD strength on economic growth at the most dynamic economic area, Asia Pacific Moreover, the USD has fluctuated more and more in recent years, especial in the 2008 global financial crisis This fact puts to the question on the field of USD strength and the real economic growth at Asia Pacific area This paper investigates the impacts of USD strength on real economic growth at Asia Pacific economies from 2000 to 2013 in the relationship with the higher role of Chinese economy in this area and the world So, this study goes to contribute to the literature under three aspects Firstly, this study investigates the impact of USD strength which presents for the overall effects of change in exchange rate to the real economic growth at Asia Pacific which are going to become the important area in the world Secondly, this study contributes new evidence of the influence of the 2008 global financial crisis on real economic growth through the exchange rate channel Thirdly, this study also considers the influence of Chinese economy on the neighbor countries which is now got more attention from both academic and practical eyes This study is divided into five sections The introduction presents the significant of this study, the literature review presents the literature on economic growth in the relationship with the effects of exchange rate, the third section is methodology and data which presents the estimation method and data, then the results and discussions present the findings of this study, and at last the conclusion section presents some main points which are draw from this study Next section presents the literature review Literature review From 19th century, the economic growth theories have been developed and they are one of the most active areas of empirical studies (Rebelo, 1992) In the studies of economic growth, the production function is the root that every economists go to build the growth model, it was firstly built in work of Cobb and Douglas (1928): 𝑌 = 𝐴𝐿𝛽 𝐾 𝛼 (1) where Y is total production, L is labor input, K is capital input, A is total factor productivity, α and β are the output elasticity of capital and labor, respectively In the neoclassical growth model of Solow (1956) and Cass (1965), low economic growth rates are the results of low real rates of investment return by private agents The countries with low ratios of capital to labor will have high marginal products of capital and thereby they tend to grow at higher rates than rich countries (Barro, 1991a) In the 1950's and 1960's, capital fundamentalism theory argues that national stock of capital determines the national product (King & Levine, 1993) In the neoclassical growth model, population growth is not affected by GDP per capita thus population is endogenous, meanwhile the technological progress only effects on the GDP per capita through the increase in labor productivity Until 1980s, Paul Romer develops the Endogenous growth theory in 554 | Policies and Sustainable Economic Development his studies such as Romer (1986), Romer (1989), Romer (1990), and Romer (1994), which explains technological progress as an exogenous variable He explains that the technological progress may have many explanations as technological development is seen as a public goods, the development in human capital, etc In the light of these theories, many researches go to investigate the determinants of economic growth such as monetary policy, fiscal policy, capital flows, trade activities, law system, financial development, stock market, banking system, economic integrations, etc around the world (Afonso & Furceri, 2010; Allen et al., 2005; Altunc & Aydın, 2013; Arestis & Demetriades, 1997; Demetriades, & Luintel, 2001; Barro, 1990a, 1991b; Barro & Sala-i-Martin, 1992; Beck & Levine, 2001, 2004; Becker et al., 1994; Bencivenga & Smith, 1991; Cavenaile et al., 2014; Chibba, 2007; Cooray, 2009; Galor & Tsiddon, 1997; Haq & Zia, 2009; Kaufmann & Kraay, 2002; Khan, 2007; Knack, 2002; Kneller et al., 1999; Kurtz & Schrank, 2007; Levine, 1996, 1997, 2001, 2005; Patrick, 1966; Prasad et al., 2007; Rajan & Zingales, 1996, 2001; Rebelo, 1992; Stiglitz, 2000; Stulz, 2002) In the line with analysis of Druck et al (2015), we assume that the economy produces two kinds of goods which include non-tradable goods (N) and tradable goods (T) with prices as 𝑝𝑁 , and 𝑝𝑇 which are determined in perfect competition market The Cobb – Douglas of N is the function of labor (L) and capital (K): 𝑌𝑡𝑁 = 𝑔(𝐿𝑁𝑡 ; 𝐾𝑡𝑁 );g’L > and g”LL g”KK 0, and ∆𝑝𝑇 = 0, then (12) can be expressed as = 𝑎 𝑇𝐿 𝑤 + 𝑎 𝑇𝑀𝐼 𝑝𝑀𝐼 , which results as ∆𝑤 = − 𝑎𝑇𝑀𝐼 𝑎𝑇𝐿 ∆𝑝𝑀𝐼 , so ∆𝑤 < Thus, in this first dimension, we see that if USD strength increases, the labor income will be reduced and then people has lower income, while they face to the budget constraint thus they cut expenditures that leads to lower total aggregate demand and of course which is harmful for economic growth This is called as the income effect In the second dimension, USD strength also impacts on economic growth through the trade activities The production and the equilibrium of domestic tradable goods is the function of domestic production, export and import (equation 11) The export demand is function of international demand and exchange rate, meanwhile import demand is function of international price of import goods and exchange rate, in the case of increase in USD strength, the price of domestic export on international market will be relative cheaper, while domestic price of import goods will be relative expensive If domestic production can produce products to replace for import goods or domestic citizens can substitute other goods for import goods, import will be decreased Meanwhile, if international demand increases with the decrease in export price, the export will be increase As sum up, trade balance is increased and then simulate the aggregate demand and boost the economic growth That effect is called as substitution effects So, as the theory stated, the USD strength may have either negative impact or positive impact on the real economic growth As the case of Asia Pacific countries which are almost the open developing countries with the high labor force and low labour productivity so the income effects may be strong since the producers can reduce the labor cost without fearing a lack of labor While, the exporting products from Asia Pacific almost are the agricultural products that are a suitable international demand for it thus the higher USD strength may not benefit for them, meanwhile the importing products at there are usually higher technologies products and the raw material such as iron or steel, therefore the higher USD strength will increase the input cost of production, so adding both of these reasons we see that the strengthen of USD may not have strong substitution effects In order to test these ideas, next section presents the methodology and data Methodology and data 3.1 Methodology To shed some light on the theoretical ambiguity presented above and base on the baseline specification following the study of Druck et al (2015) to test the impact of USD strength on the real economic growth at Asia Pacific through the model: Policies and Sustainable Economic Development | 557 𝑖 𝑦𝑡𝑖 = 𝑎 + 𝛽𝑋𝑡 + 𝜕𝑍𝑡−1 + ∅𝑉𝐼𝑋𝑡 + 𝑢𝑠𝑑𝑖𝑛𝑑𝑒𝑥𝑡 ∗ 𝑉𝐼𝑋𝑡 + 𝜀𝑡𝑖 (12) in which 𝑦𝑡𝑖 is real GDP growth rate of country i in year t (realgdpg), 𝑋𝑡 is vector of main explanatory variables including USD strength (proxy by USD index - usdindex), Chinese real GDP growth rate which proxy for influence of Chinese economy on neighbor economies (Chinarealgdpg), but before testing the influence of Chinese economy, we test the base model with the real US 𝑖 economic growth rate which proxy for the international economic growth (usrealgdpg); 𝑍𝑡−1 is vector of control variables including the ratio of net financial account on GDP of each country (financialacc), the logarithm of GDP per capita of each country (loggdppc), in which they are lagged to avoid the endogeneity problem in panel data; and the implied volatility of S&P 500 (VIX), 𝜀𝑡𝑖 is residual term Meanwhile, the interaction term between USD strength and the VIX is used to evaluate the difference in the impact of USD strength on Asia Pacific economic growth in the 2008 global financial crisis In order to investigate the impacts of USD strength on real economic growth, the real GDP growth rate is seen as the best measurement which help us to exclude inflation The rates are calculated from the real GDP value of each country from the World Development Indicator of Worldbank While, the USD strength is proxied by the USD index which are calculated by the FED Meanwhile, the real GDP growth rate of US is used to proxy for the international economic growth The lagged real GDP per capita of each country is used to factor in income differences across countries The ratio of net financial account on GDP to control for the effects of international fund to the domestic economic growth Next section presents the source and the description of data 3.2 Data This study collects data from 2000 to 2013 period of 39 Asia Pacific countries (excluding China) which are named in Table The data sources are presented in Table Table Variables and sources Variable Definition Sources Realgdpg Real GDP growth rate Calculate from data of Worldbank Usdindex Trade weighted USD index FED Usrealgdpg Real GDP growth rate of US Calculate from data of Worldbank Chinarealgdpg Real GDP growth rate of China Calculate from data of Worldbank Loggdppc Logarithm of GDP per capita Calculate from data of Worldbank financialacc Ratio of net financial account on GDP Calculate from data of ADB Vix Implied volatility index of S&P 500 Yahoo finance Data description in Table shows that the Chinese real economic growth is over 4% in period from 2000 to 2013, while the overall economic growth rates of all Asia Pacific countries in our sample are just around 2.1%, moreover the US real economic growth rate is just around 0.8% Whereas, the USD is seemly in strength stage since 2000 to 2013 with the average point at 109.5 558 | Policies and Sustainable Economic Development Table 10 Data description Variable Obs Mean Std Dev Min Max Realgdpg 541 2.146 1.807 -6.626 12.872 Usdindex 546 109.552 9.693 97.107 126.809 Usrealgdpg 546 0.819 0.732 -1.235 1.740 Loggdppc 543 3.334 0.594 2.365 4.575 Chinarealgdpg 546 4.077 0.700 3.202 5.752 Financialacc 515 2.936 9.327 -28.387 56.768 Vix 546 21.373 6.147 12.550 31.793 The correlations between variables in Table show that real economic growth rates in Asia Pacific countries have significant positive correlations with both US and Chinese real economic growth, which indicates the positive effects of both US and Chinese economic growth on the Asia Pacific area They also have positive correlation with financial account that indicates the significant role of external capital flows with the Asia Pacific countries Table 11 Correlation matrix Correlation realgdpg realgdpg 1.000 usdindex -0.029 usdindex usrealgdpg loggdppc chinarealgdpg financialacc vix 1.000 0.503 usrealgdpg loggdppc chinarealgdpg financialacc vix 0.232*** 0.237*** 1.000 0.000 0.000 -0.245*** -0.099** -0.033 0.000 0.021 0.450 0.195*** -0.122*** 0.121*** -0.009 0.000 0.004 0.005 0.831 0.089** 0.047 0.069 -0.119*** 0.072 0.044 0.290 0.117 0.007 0.103 -0.207*** 0.091** -0.711*** -0.008 -0.352*** -0.034 0.000 0.033 0.000 0.854 0.000 0.440 1.000 1.000 1.000 1.000 Note: *, **, and *** denote significance levels of 10%, 5%, and 1% respectively Meanwhile, The Asia Pacific real economic growth rates have negative correlation with Vix that means the 2008 global financial crisis may have negative effects on Asia Pacific economies The next section presents the estimation results and discussions Policies and Sustainable Economic Development | 559 Results and discussions The panel data estimations from pool least square (PLS) to fixed effects (FEM) and random effects (REM) are recruited respectively Due to the limitations of pool OLS in estimating the panel data (Kiviet, 1995), therefore FEM and REM are more preferred in panel data estimations (Ahn & Schmidt, 1995) In addition, we step by step put the control variables into model to test the consistence of our results, the results are presented in Table from model (1) to model (5) show very strong consistence of our results Table 12 USD strength and economic growth at Asia Pacific countries (REM) (REM) (FEM) (FEM) (FEM) Usdindex -0.015** -0.011* -0.051*** -0.052*** -0.169*** Usrealgdpg 0.623*** 0.561*** 0.548*** 0.571*** 0.655*** 0.404*** 0.234** 0.243** 0.330*** -6.683*** -6.833*** -7.578*** 0.023*** 0.024*** Realgdpg Chinarealgdpg Loggdppc(-1) Financialacc(-1) Vix -0.477** Usdindex*Vix 0.005** C 3.339*** 1.255 28.549*** 29.164*** 43.450*** 0.090 0.125 0.178 0.205 0.216 0.055 0.057 0.216 0.232 0.231 R -overall 0.061 0.086 0.102 0.118 0.116 Wall-chi2 49.61*** 71.53*** 24.99*** 22.52*** 17.06*** N 541 541 480 480 480 No of countries 39 39 39 39 39 Hausman test 2.71 1.80 19.09*** 21.31*** 26.31*** R -within R -between Note: *, **, and *** denote significance levels of 10%, 5%, and 1% respectively The significant negative coefficients of USD index indicate a stronger income effect at Asia Pacific countries which the higher USD strength harms to the real economic growth We can understand that the domestic production of almost Asia Pacific countries are developing that are on the way of innovating, and they import material for their products therefore the production will be impacted strongly by the strengthen of USD Besides, the Asia Pacific area is the area with the high dollarization situation (see Larraín & Tavares, 2003; Menon, 2007; Katada, 2008) which make the USD not only becomes a currency for transaction but also becomes a saving asset, thus people will keep saving more money into USD which are presented as the USD deposit at commercial banks or keep at their home when its strength goes up thus the consumption and private investment will be reduced and that distorts the economic growth The negative effects of USD strength on real economic growth at Asia Pacific countries also indicate that the substitution effects are weak at this area In fact, almost 560 | Policies and Sustainable Economic Development Asia Pacific economies are developing with low competitiveness products thus the increase in USD strength does not have strong effects on the export activities, meanwhile their importing price is increased thus the economic growth is harmed Meanwhile, the significant positive coefficients of US real economic growth, especially Chinese real economic growth on the real economic growth indicate the positive effects of the world, especial Chinese economy with the countries in this areas Moreover, the Chinese economy is now day by day going to have more important role with the growth motivation of other Asia Pacific economies through their trade activities, especially through their outflow capital to other countries in area Besides, the financial capital flow also has significant positive effects on the real economic growth, which usually emerges through the spillover effects of foreign direct investment flows Of course, our results show the consistence evidences with many studies about the impact of the 2008 global financial crisis on the economic growth of Asia Pacific area since the higher integration of this area with the world Which is presented through the significant negative coefficient of VIX However, we find an interesting evidence that in the crisis the higher USD strength helps reducing the negative effects of crisis on real economic growth at Asia Pacific which is showed in the coefficient of interaction term between VIX and USD index This shows the fact that in crisis the substitution effect is stronger at Asia Pacific area, and so, the 2008 global financial crisis may be a chance for Asia Pacific countries to improve their competitiveness on the international markets In our sample, we collect data from 39 Asia Pacific countries including developed and developing countries which may be differences in income effects and substitution effects due to their differences in economic structures, competitiveness and the products thus we divide our sample into subsamples including developed countries and 33 developing countries to test the differences between groups Table 13 USD strength and economic growth in two groups of Asia Pacific countries developed countries Realgdpg 33 remained countries (REM) (REM) (FEM) (FEM) -0.016 -0.088 -0.062*** -0.190*** Usrealgdpg 0.792*** 1.020*** 0.528*** 0.562*** Chinarealgdpg 0.408*** 0.503*** 0.209* 0.286** Loggdppc(-1) -3.575 -3.535 -7.587*** -8.526*** Financialacc(-1) -0.023 -0.017 0.025*** 0.026*** Usdindex Vix -0.268 -0.528** Usdindex*Vix 0.003 0.005** C R -within 16.814 23.073 31.388*** 47.505*** 0.431 0.447 0.196 0.207 Policies and Sustainable Economic Development | 561 developed countries Realgdpg 33 remained countries (REM) (REM) (FEM) (FEM) R2-between 0.383 0.346 0.161 0.159 R2-overall 0.419 0.423 0.095 0.093 Wall-chi2 54.01*** 55.53*** 17.72*** 13.50*** N 78 78 402 402 No of countries 6 33 33 Hausman test 0.56 0.80 17.20*** 22.12*** Note: *, **, and *** denote significance levels of 10%, 5%, and 1% respectively The estimation results are presented in Table show some interesting findings First, we find that the negative effects of USD strength on the real economic are significant at developing countries, while it does not have statistical evidences at developed countries, which indicate the stronger income effects at Asia Pacific developing countries That can be understood as in the labor at developing countries are huge and they are at low productivity so that the income effect is stronger Second, the external flows have positive effects on real economic growth at the developing countries, but it has negative effects at developed countries Thus, the positive spillover effects of FDI just exist at Asia Pacific developing countries While, the negative spillover effects exist at developed countries Third, one of our target, the strengthen of USD helps reducing the impact of the 2008 global financial crisis with the statistical evidences only at developing countries Which indicates that the substitution effects are stronger at developing countries than developed countries At last, the Chinese economy also has strong effects on both group which reconfirms the important role of China in this area Conclusion This study uses the panel data of 39 Asia Pacific including developed and 33 developing countries to examine the effects of USD strength on the real economic growth We find that the income effects of USD strength are stronger at areas, especial at developing countries We also find that the crisis had reduced this income effects of USD strength at this area and helps increasing the substitution effects which increase the competitiveness of Asia Pacific product, and so, that effects are stronger at developing countries We also contribute to the literature about the important role of Chinese economy at this area for both developed and developing countries 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