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Creating the right conditions for growth

Update: September, 12/2013 - 08:25

by Dennis C. McCornac, Ph.D, Lyola University Maryland

Economics by nature is not a generous science. The best of all world scenarios, high growth with price stability being one such example, are usually exceptions to the rule, with a trade-off between inflation and growth one of the foremost dilemmas. A rapidly expanding economy can also mean high inflation rates, and its accompanying evils.

This phenomenon is certainly not limited to developing nations as evidenced by the asset price bubble in Japan in the late 1980s and the housing bubble experienced by the United States during the last decade. These episodes were fueled by overheated economic activity as well as uncontrolled money supply and credit expansion.

Nevertheless, emerging economies are more susceptible to these forces given the fragile nature of their economies and the fact they are often characterized by an undeveloped financial sector that places limits on carrying out monetary and fiscal policies.

Quite often, usually in the short-run, the high levels of economic growth are often deemed desirable. However, the inflationary pressures eventually must be contained with heavy economic costs on the economy as monetary authorities are forced to raise interest rates to halt excessive credit expansion. Reducing inflation by creating a recession may not be the most desirable tool, but often is one of the most effective.

A good example of this phenomenon is Viet Nam's recent experience with double digit inflation rates and the subsequent negative consequences of slower growth that resulted from the contractionary fiscal and monetary policies implemented to reduce the inflationary pressures.

The spiraling levels of bankruptcies and higher unemployment that are a byproduct of the slowdown are still fresh in the minds of consumers and investors. And a return to such a scenario would be a devastating blow to Viet Nam's economic potential.

While recent economic statistics coming out of Viet Nam are promising, the situation remains fragile. The economy, for example, has shown signs of stabilizing with gross domestic product growing by 5 per cent in the second quarter of this year, an improvement from the previous year's 4.8 per cent expansion. The VN index is up over 25 per cent year-to-date and unemployment is slowly drifting downward.

These positive developments notwithstanding, policy makers must be careful to not let down their guard on prices, particularly via excessive credit expansion. The banking sector continues to be burdened with bad debt, which the central bank estimated at 7.8 per cent of outstanding loans at the end of last year, and efforts to return to the heyday of the beginning of early 2000s could portend economic hardships in the future.

Two important indicators to which attention must be paid are the current account and government budget deficits. Viet Nam's economic development to date cannot be characterized as one that has primarily depended on export-led growth. Although trade surpluses were reported in June and July, Viet Nam once again recorded a deficit in its trade position, a return to past trends.

Only in 2012, for example, did Viet Nam have its first annual trade surplus in two decades, mainly due to weak imports as the slowing economy hit consumer demand. Too ambitious expansionary policies could signal a return to continuing trade deficits which would put downward pressure on the dong and further add to inflationary pressures.

Paralleling the rise in the current account deficit is Viet Nam's ever-expanding government deficit, estimated at just slight below 4.8 per cent of GDP. Policymakers, however, have recommended unblocking credit channels to pump capital into the economy. While such strong measures may be necessary to achieve economic growth goals, again the Government must resist resorting to excessive monetary expansion as a fund-raising tool.

Thus, prudent monetary and fiscal policy will play an all-important role in determining a successful and sustainable rate of economic development. Failure to exercise the necessary controls may expose the country's macroeconomic stability to substantial risks that, if not properly addressed, could erode many of the gains of the past.

The government must realize that a growth rate that is sustainable over time is preferable to excessive growth rates in the short-term that create inflationary pressures and subsequent lower growth rates in the future.

Viet Nam's policy makers may be best advised to concentrate their efforts on speeding up the pace of economic reforms and implementing the rules and regulations necessary for the operation of a market economy. Setting the proper conditions for a sustainable level of development will do much to alleviate many of the growing pains suffered by emerging economies. — VNS

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