The United States is our biggest market



Thai Competitiveness in US Markets

Thai Farmers Research Center

September 2000

Table of Contents

page

1. Introduction 1

2. Transportation Costs 6

3. Foreign Exchange 10

4. Labor Costs 16

5. Tariffs 23

6. Cost Analysis 30

7. Discussion and Recommendations 36

8. Bibliography 46

9. Tables 48

9.1 US Imports Market, Market Share 48

9.2 Transportation Costs to the United States 50

9.3 Foreign Exchange Rate Changes Relative

to the Dollar Since 1993 54

9.4 Foreign Exchange Rate Changes Relative

to the Baht Since 1993 55

9.5 International Labor Costs by Sector 56

9.6 International Labor Costs as a Percent

of Thai Labor Costs 57

9.7 Tariffs for Important Thai Exports 58

9.8 Market Share for Important Thai Exports 60

9.9 Share of World GDP and Trade 67

danlewis@tfrc.co.th

Thai Competitiveness in US Markets : Introduction

This paper looks at Thai competitiveness in the US market and attempts to determine why Thailand has had such poor performance. Unlike our neighbors in South East Asia, Thai exports to the US have actually experienced a small drop in market share since 1992. Overall, Asia has been losing ground in terms of US share, a fact that has been masked by the huge increase in US imports overall. However, higher income countries (Japan, and the NICs) have shown most of the decrease in market share, with middle income countries such as Thailand mostly showing small increases, and lower income countries such as China and Vietnam showing stronger growth in market share. Thailand is an exception in our group in that we have been losing market share. Our poorer performance can partly be explained by the composition of our exports, with more emphasis on agricultural and labor intensive goods which compete with lower income countries, and less on electronics and consumer goods.

Higher Income Countries-

Japan Singapore

Taiwan Hong Kong

Australia New Zealand

Brunei

Medium Income Countries-

Thailand Malaysia

Philippines South Korea

Fiji

Low Income Countries-

China Indonesia

Vietnam Cambodia

Burma Papua New Guinea

Although our neighbors in ASEAN have mostly been doing better then us in terms of market share, our real competition for the US market comes from elsewhere, from the combined expansion of Chinese and Mexican imports into the US market. These two countries export many products that compete directly with Thai exports, and that are often cheaper. In an effort to better understand this competition, the core of this paper takes a serious look at the factors that determine the cost of Thai products. By looking carefully at transportation costs, foreign exchange rates, labor costs, and tariffs, we can begin to understand what in particular is influencing Thailand's lack of competitiveness.

The US economy is enormous accounting for 27 percent of world GDP. The United States is by far our largest export market, and deserves special attention. Last year, the US accounted for 21 percent of our exports. Furthermore, the US share in our total exports has been steadily rising, increasing our reliance on that market. Exports to the United States are now equal in value to about ten percent of the value of Thai GDP.

The United States is important in another way. As a long term defender of free trade both in principle and in practice, it is the importer of last resort. It has been instrumental in instituting many of the trade policies in effect today. The average tariff on imports to the US is only 2 percent on a trade weighted basis. Nevertheless some sectors are still heavily protected, and we shall see that trade barriers on textiles and agricultural products to most of the world, have had a significant effect on import patterns particularly in shifting production of labor intensive goods to Latin America. These special trade bloc programs of the US are likely to increase in importance in the short term, further reducing our competitiveness.

The importance of the US market and our lackluster performance therein inspires this cost-based analysis. It is only by understanding our competitive strengths and weaknesses that we can ready ourselves for ever increasing competition. As with all our work here at Thai Farmers Research Center, we have tried to include suggestions and opportunities for investors and exporters throughout the paper.

The Current Situation

[pic]

Source: USITC Dataweb Note: these numbers are in terms of value, and are market shares. Falling market share tells us that imports from Thailand are rising slower than US imports overall. Measuring in value terms means that as the baht devalues, export levels fall. For the sake of comparison, all of these countries currencies have experienced similar levels of devaluation since 1992, except Indonesia, which has devalued more.

Relative to our neighbors in ASEAN we are doing poorly, as the only country which has lost market share since 1992.

The dominant features of US imports has been the fall in market share of Japan and the ascendance of Mexico and China.

[pic]

Source: USITC Dataweb

The Asian newly industrialized countries (NICs) as a group have been losing market share in the US, though incidentally, their market share in world exports have not fallen. High costs have prompted them to invest in neighboring countries.

[pic]

Source: USITC Dataweb

Looking at these charts together we can see several things. Although China and Mexico are doing very well in terms of market share, they have not yet had a big impact on ASEAN countries. Market share has grown at the expense of Japan and the higher income NICs. As those higher income countries have suffered market share losses, they have invested in other source countries, following in the footsteps of Japan. Critically, unlike in the late 1980s and early 1990s, much of that investment has gone to other countries, especially China.

Although ASEAN has not yet been strongly affected by the growing dominance of Mexico and China, we predict that those countries will soon have a more direct effect on Thailand. Industries in China and Mexico are growing very rapidly in precisely those exports in which we are doing the best. Therefore it is only a matter of time before they start directly affecting our own market share. Those predictions will also be borne out in a lter section on factor cost analysis.

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Source: USITC Dataweb

The dominant feature of this graph is the astonishing rise in imports of garments from Mexico, from a very low base in 1992. Mexico has benefited from proximity to the US as well as low tariffs and an absence of quotas due to its participation in NAFTA. Many countries (not just the US) have invested in Mexico because of its special privileges under NAFTA.

[pic]

Source: USITC Dataweb

In this graph, both Mexico and China are dominating growth in the import market for computer monitors. China's advantages are low labor costs, and an enormous and dynamic domestic market that makes FDI attractive. Although Thailand is not yet losing much market share, if current trends continue, loss of market share is inevitable.

Focus of Study

This series will focus on:

• Macroeconomic Factors - rather than microeconomic factors. The study is broad and it would be difficult to talk about individual conditions for every product. Nevertheless numerous specific examples are given.

• Foreign Data - rather than Thai data. There are many studies that start from Thai data and work outwards. This study does the opposite. US data is comprehensive and freely available from a variety of sources, many of which are listed in the bibliography.

• Cost-Based Approach - rather than a strategic or marketing approach. This paper tries to look at the costs involved in producing products rather than the strategies of competing nations, or the marketing of particular products.

Chapters

Over the coming weeks, the following topics are scheduled to be addressed. Each chapter is a free standing article, which can be found in its entirety on our English language website.

Transportation Costs discusses the role transportation costs play in restricting low value goods in favor of high value goods, and looks at actual transportation costs for many Thai products. The effect of rising oil prices on transportation costs is also discussed.

Foreign Exchange discusses the gradual depreciation of the currencies of many developing currencies relative to developed countries and the relationship between exchange rate shifts and export performance.

Labor Costs discusses wage rates by sector for many countries around the world. Labor costs, although a surprisingly small part of total costs, play a major role in some industries. Thailand's performance in a number of labor intensive industries is discussed.

Tariffs discusses the three main strands of US trade law: 1) Global free trade, 2) Free Trade Area for the Americas, and 3) Support for least developed nations, and the tensions that arise between them. Also covered - typical tariff rates for Thai products, the effects of changes in trade status for competitors such as China, Caribbean countries, and Vietnam, and non-tariff barriers.

Cost Analysis divides exports into three broad sectors, and gives predictions for each. Then it discusses price sensitivity and the effects different shocks would have on price competitiveness. Finally the different cost factors from this paper are summed together to give a sense of how we compare to China and Mexico.

Conclusions and Recommendations summarizes findings from this paper, and suggests some ways to address our competitive situation in the future.

Finally, the Appendix of Tables is an extensive collection of data related to Thai trade with the US and comparing Thai costs with those of other countries in the world.

Thai Competitiveness in US Markets : Transportation Costs

Transport costs have long played a significant role in determining the flow of imports and exports. A few centuries ago, spices from South East Asia were sold for exorbitant prices in Europe, while tea from India was sold for exorbitant prices in China and America. Spanish galleons carried gold from Latin America, and British brigs carried diamonds from South Africa. In short, the only goods transported internationally were small, valuable, and commanded enormous premiums. Since the advent of modern shipping and air freight transportation costs have diminished in importance, but they still play a significant role in the flow of trade for some of Thailand's most important exports, especially those of lower unit value.

With transportation costs, the most important relationship is of the value of the good relative to the cost of transporting it. So, for example, a valuable good (e.g. frozen shrimp) may be expensive to ship, but compared to its final value the transportation cost is reasonably low. Other valuable goods (e.g. hard drives, jewelry) are so cheap to transport that their final cost is hardly affected by transport costs. Goods that are of low value must be cheap to transport in order to make it economical to ship them. (Shoes and clothing can be transported because they require neither speed nor special care. Fresh jackfruit and rose apples are not transported.) Transportation costs play the least role with goods that are of high value and easily shipped, and play the largest role with goods that have low value and are expensive to ship.

Some Goods are More Economical to Transport Than Others

| |High Transport Cost |Low Transport Cost |

|High Value |Okay |Best |

|Low Value |Cannot Transport |Okay |

The cost of transport something will depend on how it is transported. When transporting by water, bulky goods are expensive, since prices often reflect volume rather than weight. For air transport, weight is the critical factor. When shipping by land, both of these factors can be important. The speed with which the good must be delivered (perishability), and any special conditions the good requires (e.g. keep frozen) also have a large effect on the shipping cost. In terms of competitiveness, generally if a good is expensive to ship from one country, it is also expensive to ship from another. Advantages arise only in being closer to the final market. If the good is expensive to transport distance matters a great deal.

The following table shows actual transport costs for imports to the United States from a variety of different countries. Values shown are the percent of the value of the good that must be added for transport costs, and are calculated by taking the difference between custom value and C.I.F. value in US trade data, and dividing by the custom value. Custom value is the price paid for the good before shipment to the US. C.I.F. value includes all costs including insurance and freight of bringing the good to the customs port in the US. Therefore transportation costs within the US are not included in these numbers. Transportation costs are averaged for the years 1996-1999.

Transportation Costs as a Percent of the Value of the Product of Goods Arriving in the United States From Several Countries, Average for 1996-1999

| |Hard Drives |Shrimp |Garments |Grain |Jewelry |Wooden Frames |Cars and Parts |Plastics |

| | | | |incl. Rice | | | | |

| |8471704065 | | | | |HS4414 |HS87 | |

|HS Code | |160520130 |HS62 |HS10 |HS71 | | |HS39 |

|World |1.0 |2.1 |4.0 |9.2 |0.5 |4.8 |1.8 |5.1 |

|Thailand |0.5 |1.9 |5.0 |14.2 |1.1 |5.7 |5.3 |11.2 |

|Mexico |1.0 |1.7 |0.9 |4.2 |0.4 |1.0 |1.1 |1.9 |

|Canada |0.8 |2.2 |0.7 |6.5 |0.1 |3.0 |0.9 |2.4 |

|Honduras |---- |2.2 |1.9 |----- |----- |----- |----- |----- |

|Mainland China |1.6 |3.5 |4.7 |16.8 |4.3 |7.4 |8.8 |8.6 |

|Philippines |1.0 |12.8 |5.2 |----- |----- |7.5 |5.6 |----- |

|Malaysia |1.5 |----- |4.7 |----- |----- |7.1 |9.2 |10.1 |

|Indonesia |----- |1.8 |5.8 |----- |1.9 |8.1 |6.1 |11.3 |

|Italy |----- |----- |2.8 |8.5 |0.8 |6.6 |3.5 |6.5 |

|India |----- |6.6 |8.5 |8.1 |0.5 |10.7 |7.2 |8.2 |

Source: United States National Trade Data Base, Dataweb, World Trade Analyzer

In this table, some goods, such as hard drives, shrimp, and jewelry, have low transport costs that do not influence Thai competitiveness for US markets. In other categories, such as plastics, grain (rice), wooden articles and garments, there is a clear transportation cost advantage to being close to the US. There is not a clear distance based relationship here because of 1) economies of scale, 2) efficiency in ports and airports, and 3) the composition of goods within a category may vary.

Clearly transportation costs are not prohibitive for any of the above categories, since they are all important Thai exports, but in terms of long term competitiveness Thailand is at a disadvantage. The economic benefit of producing these goods close to the United States might eventually move centers for their production closer to the final market. The location of other goods, such as electronics and jewelry will be influenced by other factors such as tariffs, exchange rates, and conditions in the producing countries.

We can look at a more complete list of Thai exports to discover what other goods might have a long term competitive disadvantage.

Thai Products that have Different Levels of Transportation Costs

|Low Transport Cost |Medium Transport Cost 2-5% [pic] |High Transport Cost |Very High Transport Cost |

| | |5-8% [pic] |[pic] |

|0-2% [pic] | | | |

|Hard Drives |Monitors |Garments |Ceramics 9% |

|Jewelry |Rubber Gloves |Wooden Frames |Plastics 11% |

|Shrimp |Vehicle Wiring Sets |Keyboards |Pineapples 15% |

|Integrated Circuits |Fax Machines |Ceiling Fans |Cement 42% |

|Ink Jet Printers |Footwear |Toys |Rice 14% |

|VCRs |Tuna |Microwaves |Speakers 12% |

|Photocopy Machines |Power Supply Units |Rubber |Furniture 10% |

Based on US merchandise trade data, NTDB

Some products have already shown a marked tendency to shift towards more local production. For example, garments imported into the United States are increasingly coming from a variety of Latin American countries, rather than Asia, although Asia is still the largest source. Garment exports to the United States from Thailand have increased over the past five years, and they have also increased from China, but the largest increases have been from Latin American countries.

US Imports from Several Regions of Articles of Apparel, or Clothing Accessories, Not Knitted or Crocheted (HS62)

[pic][pic]

Based on US merchandise trade data, NTDB

The transportation sector is strongly sensitive to energy costs. Because of this, Thai competitiveness in US markets may be decreased if the oil price rises. The following table gives an idea of the effect on transportation costs of a change in oil price.

Effect of Changes in Energy Prices on the Cost of Transportation

|Sector |Percent Change in Cost for a 1 percent Change in Oil Price |

|Ocean and Coastal Water Transportation |0.306 |

|Road Freight Transport |0.270 |

|Railways |0.183 |

|Air Transport |0.143 |

Source: TDRI, "The economic impact of the liberalization of the oil market," May 1998. Based on data from the 1990 Input-Output Table for Thailand, NESDB

We can calculate the effect the recent rise in oil prices might have on Thai competitiveness via transport costs. The average price of oil (Brent Crude) from 1996 to 1999 was $17.70 dollars a barrel. In the first 10 months of this year, the average price was $28.80, an increase of 63 percent. Ocean transport costs should therefore rise by

.63 * .306 = .193 or 19.3 percent. Then if transport costs are 10 percent of the value of the product, the increase in the final cost of the product, due only to transport costs, would be

.10 * .193 = .0193, or 1.93 percent of the price of the good. Unfortunately, goods that already have high transport costs will show more of an effect than those with low transport costs.

Effect of Higher Oil Prices on Thai competitiveness Through Transport Costs

|Product |Average Transport Cost 1996-1999 |Estimated Transport Cost This Year |

| |(percent added to Thai export price) |(percent added to Thai export price) |

|Ceramics |9 |10.7 |

|Plastics |11 |13.1 |

|Garments |5 |6.0 |

|Shrimp |1.9 |2.3 |

|Cement |42 |50.1 |

|Electronics |1.9 |2.1 |

Source: Thai Farmers Research Center estimates.

Compared to other neighboring countries, such as China, Malaysia, and Indonesia, Thailand seems to have slightly lower transport costs, category by category. Therefore higher energy costs might improve our competitiveness vis-à-vis our closest neighbors, but would surely hurt our competitiveness vis-à-vis the majority of nations that are closer to the United States.

In summary, although transport costs do not matter as much as they once did, nevertheless Thailand's distance from the United States still acts to reduce the competitiveness of many low value, high volume goods. In particular, there is the potential for transportation costs to preclude long term competitiveness in plastics, in ceramics, in wooden products, in basic agricultural commodities, and in garments. Some other goods are not significantly affected by transport costs, such as high value computer parts, shrimp, and jewelry. To reduce the effect of transport costs on competitiveness, Thailand should continue to increase the value-added in its exports. Transport costs are only important as a percentage of the value of a product, and so they diminish in importance as the good becomes more expensive.

Chapter Three Thai Competitiveness in US Markets : Foreign Exchange

Of all the factors that affect Thailand's exports to America, the exchange rate has the largest effect on competitiveness. The devaluation in the baht over the last several years has made Thai goods 40 percent cheaper for Americans (excluding flow-through of goods that must be first imported into Thailand). In comparison, tariffs and transportation costs may give only a few percent price advantage. Our exchange rate relative to our competitors therefore plays a very large role in our international competitiveness.

The exchange rate can be viewed as the price of all our country's goods together. If we take the analogy of Thailand as a business, if we charge a lower price (weaker exchange rate), then more people will buy our goods. However, we will receive less money - less to live on, less to invest in the future, and less to buy the inputs that we need. Also like a business, if we lower our prices/exchange rate there will be great pressure on our competitors (once they see the effect on their sales in terms of trade figures) to lower their prices/exchange rate as well, so that competitive devaluations are likely.

The exchange rate is a price that affects all of the country's exports and imports. Each good also has its own price. Some goods need to have reduced prices, others are competitive at existing price levels. Why then doesn't the price of each of the individual goods change rather than the overall price? One reason is that prices of both goods and factors of production tend to be sticky. A firm does not wish to decrease the price of the goods it sells. Even more so, it cannot reduce the wages of the people it employs. The exchange rate adjusts if other factors cannot.

Often the effect of a devaluation is to reduce the value of Thai labor relative to imported goods, so that for the Thai producer the labor component of locally produced goods becomes cheaper relative to the good component. Overseas, Thai goods are cheaper because in terms of dollars the labor component has become cheaper.

The price that can be charged for Thai goods in the international market depends on what other competitors are charging. Therefore it is important to know about changes in the level of our exchange rate relative to that of other countries. If the productivity and price levels of our competitors are similar to ours ( a big assumption) then our prices will depend on our relative exchange rates.

We compare exchange rates both to the US dollar, and to the Thai baht. Both are important. Comparing to the US dollar tells us about the price of imports relative to locally made goods in the US market. Also, if imports are getting cheaper, probably more of that kind of good will be demanded. Comparing to the Thai baht tells us how our prices are relative to our competitors. Many goods will be too expensive to produce in the US so in that case our prices relative to our competitors is the most important.

The period of comparison is 1993 to 1999, which covers the period just before the most recent Chinese devaluation, to the present. Because we are looking only at competitiveness in the US market we need only look at exchange rates relative to the US dollar, not to other measures such as the real or nominal effective exchange rate.

The Change in Market Share of US General Imports and the Change in Exchange Rates Relative to the Thai Baht and US Dollar over the Six Years from 1993 to 1999.

[pic]Based on Information from the US Department of Commerce as reported in USITC Dataweb, Exchange Rates from US Federal Reserve Bank, and CEIC.

Notes: For Market Share and Exchange Rates - over a six year period, Strong Decline/Rapid Depreciation = 30% or More; Decline/Depreciation = 10 to 30%, Constant/Neutral = -10 to 10%; Growth/Appreciation = 10 to 30%; Rapid Growth/Rapid Appreciation = 30% or More.

This table shows us a number of interesting things.

1) The Thai baht is quite cheap now relative to many other currencies, and should not face strong devaluation pressures.

2) The US dollar is appreciating in value against many currencies. Actually, it is the more developed countries' currencies which are appreciating versus the less developed countries, as currencies of the more economically advanced countries of Asia seem to be moving together with the US dollar.

3) The more economically advanced countries of East Asia are doing poorly in terms of market share, even if their absolute level of exports might be rising. If this holds out in their other export markets, it may put downward pressure on their exchange rates.

4) The strong growth in the region comes from China because of many different kinds of goods (not especially garments though), and from the Philippines and Malaysia, who are apparently exporting electronics that were previously provided by the East Asian countries.

5) There is a clear relationship between exchange rates and export success. Generally if a country's currency is depreciating relative to the Thai baht, it has a good chance of increasing or at least maintaining market share; whereas if a country's currency appreciates versus the Thai Baht, it has a good chance of losing, or at least just maintaining market share.

6) The per unit value of US imports is probably falling as the US dollar appreciates versus many other currencies.

7) If a currency is depreciating, then more exports in terms of volume need to be shipped just to maintain the same level of exports. Therefore, countries in which strong growth in market share is matched by rapid depreciation have exceptionally high levels of export growth in volume terms. (e.g. Mexico) Countries with appreciating currencies may show export growth in value terms, when volume is constant, perhaps because their exports are not price sensitive.

How is the exchange rate determined? How much can we control our exchange rate? How much do we want to control it? The determination of the exchange rate is complicated and is strongly affected by a number of factors:

Interest Rates Interest rates affect the exchange rate through capital flows. As the interest rate in Thailand increases relative to the interest rate in other countries, it means that investors can earn more money in interest if they have their money in Thailand. Having money in Thailand means having Thai baht. As people buy Thai baht they increase demand for it and increase its value.

Interest rates also have a large effect on domestic GDP. Most investment is financed with debt. If the interest rate is low, it encourages people to invest. Therefore policies to expand the economy through investment often weaken the exchange rate as people move money overseas to get higher returns on capital.

Inflation and Price Levels Economic theory predicts that arbitrage will act to make price levels the same in all countries. The law of one price states that absent of transportation costs and barriers to entry, a good in one country should have the same price as in another. A looser version of this rule is absolute price parity. The price level in one country will be the same in every country, even if not for every good. The weakest form, relative price parity, is which is what is used in practice. Because of differences in labor productivity or the labor capital ratio, prices may be different from one country to another. However the relative differences will be maintained over time unless inflation rates are different. Any differences in inflation rates will be reflected in exchange rates. Therefore countries with high inflation rates will have depreciating exchange rates.

Future Expectations The value of a currency reflects not only current conditions, but also expectations about the future. Current demand for currency is a result of the balance of payments. If the number of people wanting to buy baht is more than the number of people wanting to sell baht, then the currency will appreciate. If it is perceived that in the future, fewer people will want to buy baht, that will be factored into the current price of the baht. Since there is a direct link between the economic health of the country, and the number of people who want to buy the baht, the exchange rate is tied to expectations of Thailand's future prospects.

Capital Flows Capital flows could be influenced by number of factors including portfolio investment based on the health of the stock market, foreign direct investment to take advantage of opportunities or because of low valuations, or a number of other factors including debt payments to the IMF, payment of private foreign debt, etc.

Currency as an Asset Currency is itself an asset, and one that can pay very high returns if you can predict what direction an exchange rate will move. The interest per day on 1 million baht is about 100 baht if kept in the bank. The profit on foreign exchange using 1 million baht is 250 baht for each satang move in the exchange rate. Enterprises with access to low spreads, and holding a lot of cash may try to benefit from this market, as evidenced by the enormous amount of currency that trades hands each day.

All of these factors contribute to making it very difficult to have an active foreign exchange policy. However, even if we could control the exchange rate, it would probably not be wise to do so.

Why are the exchange rates of developing countries falling relative to developed countries?

The exchange rate of developing countries may be falling because of competition in the production of commodities and manufactured goods. As more countries develop stable macroeconomic policies and use export led growth strategies, there is more competition for the export markets. A strategy that worked well for some countries has come of age, and now is less effective when used by all. There is also more competition for FDI.

Manufactured goods are becoming commodities that can be produced in many locations, and that do not have a lot of profit margin. Low quality manufactured goods are to developing countries like agricultural commodities were in the 1960s.

There has been enormous excitement about opening the Chinese domestic market, but the average Chinese does not have the income to buy many manufactured goods, and the Chinese government does not want the domestic market dominated by foreigners. In order to get an eventual foothold in this market, many international companies have built export-oriented plants in China to eventually supply local demand. Short-term profitability has not always been the criteria for investment.

Asian countries have practiced an export strategy based on maximizing market share rather than profit, which is useful for opening up markets, but is not sustainable in the long run. The recent recession may have a silver lining in that it cut back investment to Asia, which will eventually make the surviving companies more profitable.

Currencies are strongly linked to each other, especially within a region. The Thai baht moves closely in orchestration with other regional currencies. The following table shows correlations between the baht and some other currencies since 1997.

Correlation Coefficients Between the Thai Baht and Other Currencies for the Period 1997 to June 2000

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Based on Monthly Data From CEIC

Several interesting results can be seen in this table. Clearly Thailand's currency is closely linked with the currency of other countries in the region. The exception is China, whose currency has slowly been appreciating over the period, probably due to capital inflows, and Hong Kong, which has a currency which is essentially pegged to the US dollar, therefore showing little variability.

Currencies from South Asia are also linked to the Thai baht, but to a lesser degree than East and Southeast Asian currencies. European and South American Currencies also have positive correlations with the Thai baht.

Correlations are positive with almost all countries, which is to be expected since one half of the variation should be due to changes in the US market which should affect most countries in the same way. (i.e. if the US increases interest rates it should cause the US dollar to appreciate against almost all currencies.)

Why is geography so important with exchange rates? Why should neighboring countries have similar foreign exchange trends? There are a number of similarities between neighboring countries that can encourage this, such as similar political and institutional structures. Trade flows between the countries can mean that as one does well, so does its neighbors. Significant influences in the region, such as Japan in Asia, or a political conflict can have an effect on all its neighbors. Finally the perceptions of foreigners who aggregate the world in certain ways, may play a role in determining exchange rates as well.

Suggestions for Thai Exporters

The goods Thailand exports are losing value versus the US dollar. The best remedy for this is not just increasing the value added of goods, but also to increase the uniqueness of Thai goods. We need to look for goods that others are not exporting, and we need to build brands. European goods still do well because they rely on goods that are hard to duplicate - antiques, wines and cheeses, and branded fashions. Without brands we cannot build market power. Thai competitiveness does not necessarily have to be built upon high technology, but it does need to be based on uniqueness, be it based on brand, unique products, or provided services.

Furthermore, although it is clear that depreciating currencies increases our competitiveness, but just as a shop that decreases prices must expect others to do so, we also have to expect that competitive devaluations will follow. It also may decrease our income to the point where we cannot expand or compete. It is important to realize that developing nations are in this together, and as a group of exporters we should try to maintain exchange rates just as we do with specific commodities, and minimize the effect of competitive devaluations that have occurred in the past, even if it means fewer exports for each of us. This needs to be kept in mind when considering the seemingly all important export growth figures.

Recent history of competitive devaluations:

|Year |Event |

|1994 |China devaluation |

|1995 |Mexico/Latin American devaluation |

|1997/1998 |Asian devaluation. |

Effect of Flexible versus Fixed Currencies

There is no evidence to suggest that developing countries with flexible exchange rates have depreciated any less than those with fixed exchange rates. Countries that have flexible exchange rates have depreciated just as much as ones that didn't, but since the devaluation occurred over a number of years, it was not so obvious. For instance, all the South Asian currencies have depreciated as much as the baht over the past 6 years, but more gradually.

Chapter Four Thai Competitiveness in US Markets : Labor Costs

The price of labor is a direct measure of the wellbeing of the Thai people. When the World Bank wants to compare the level of development between countries, it looks at per capita income - so that the higher wages are, the better off we are. However, wage rates can also be too high to make us competitive internationally. This can lead to a long term decline in our prosperity.

One of the biggest factors determining our wage competitiveness in the international market is the exchange rate. The wage rate for traded goods essentially falls and rises with the exchange rate. Domestic factors are also very important in that wage rates are mostly set by supply and demand in the domestic market. Supply and demand are in turn influenced by the domestic demand for goods, the supply and demand of the imports and exports of the country, demographics, and the productivity of workers in the country.

When measuring wages we can either consider the wages or earnings that the worker receives (including or not bonuses and fringe benefits), or we can consider the whole cost to the firm of hiring the worker. Clearly the latter is preferable for comparing competitiveness between nations, but obtaining data is difficult because that is not the way data is usually collected. In Thailand, non-wage costs average 30-50 percent of the wage costs, and can range from very low (200 percent) for some tourism facilities.

The productivity of labor is also very important. In the end, it is the amount of product that can be produced for a certain total labor cost that is important, not how many laborers are employed. If it takes 100 workers to cook a pizza, we don't care how cheap each one is to hire. One well paid worker would be better.

In practice productivity is easy to measure, but difficult to interpret and compare. A simple measure of productivity is to divide output in an industry by the labor cost. This, however, does not account for 1) how much capital is used or 2) if business cycles are keeping workers busier or less busy then usual. Although these factors can be taken into account, differences in capital quality and different ways of measurement make international comparisons somewhat suspect. Productivity in Thailand is increasing, but slowly.

Thailand has traditionally been a popular location for foreign investment, in part because of its cheap labor supply. Leading up to the economic crisis of 1997, the conventional wisdom was that wage rates had risen to the extent that Thailand was no longer competitive as a location for labor intensive production. After the crisis and devaluation, despite a 35-40 percent drop in the effective price of labor, it is still believed that labor costs are too high to compete in labor intensive industries such as apparel, wood working, footwear, textiles, leather and rubber goods. Is there truth in this assessment? To help look at this issue, we will look at manufacturing wages relative to our largest competitors for US markets.

[pic]

Source: TFRC database. Derived from UNIDO, ILO, CEIC, and US Fed Data.

Note: All countries, Wages in US dollars in 1998

There is quite a range of wage rates, with some countries much cheaper than us, and some much more expensive. Even the high wage countries are doing well in the world, so we should not be overly discouraged. Rather we need to think of the things that the high wage countries produce that we can produce as well. This is NOT just about technology - many of the exports of these countries are luxury goods, or are scarce for some reason.

Some industries use more labor than others. Clearly an industry that uses a lot of labor (labor intensive) will be more sensitive to labor costs than one that does not (capital intensive). Even for labor intensive industries, labor costs are not typically a large part of the total costs. In labor intensive industries, labor costs are rarely more than 20 percent of total costs, while the overall percent is 7.2 as the following table shows.

Percentage of Labour Cost in Total Cost by Industry, 1998

|ISIC Code |Sector |Percent |

|Rev.3 |LABOR INTENSIVE | |

|361 |Ceramics |28.8 |

|322 |Wearing apparel, except footwear |18.2 |

|362 |Glass products |17.0 |

|332 |Wooden Furniture |15.2 |

|314 |Tobacco |14.9 |

|331 |Wood products, except furniture |14.7 |

|323 |Leather products |13.4 |

|324 |Footwear, except rubber or plastic |13.2 |

| |MIDRANGE | |

|321 |Textiles |10.4 |

|356 |Plastic products |10.4 |

|355 |Rubber products |7.5 |

|311 |Food products |5.6 |

| |CAPITAL INTENSIVE | |

|354 |Misc. petroleum and coal products |3.4 |

|351 |Industrial chemicals |2.3 |

|353 |Petroleum refineries |0.5 |

|300 |TOTAL MANUFACTURING |7.2 |

Source: Employment Survey Report, Ministry of Labour and Social Welfare 1998

One effect of the low share of labor costs in total costs is that wage rate advantages can be dwarfed compared to some other factors. For example, in the apparel industry, wages in China are 27 percent of our wages. Their total costs are therefore .27*.182 + 1*(1-.182) = .867, or 86.7 percent of our costs, a significant cost advantage. The same calculation for food products in which labor is only 5.6 percent of total costs and Chinese wages are 34 percent of our wages, gives us .34*.056 + 1*(1-.056) = .958, or 96.3 percent of our costs, which is not nearly so threatening This cost advantage could be compensated by higher productivity, lower raw material costs, lower transportation costs, etc. Even the apparel cost advantage could be overcome by a 15 percent further depreciation of the exchange rate which given all domestic products, would make our prices cheaper. Unfortunately, this would likely cause China to depreciate in turn, meaning lower income for all of us, and no change in competitive advantage!

Our wage rates are considerably cheaper than wage rates in the United States, so that it is unlikely that we will be competing directly with domestic production. To give a sense of comparison, the average manufacturing wage in the US is 14.84 times greater than in Thailand. Even for the sectors where wage rates are most similar, (apparel: 6.81 times, printing: 7.26 times) US rates are still significantly higher.

Now that we have a sense of general wage levels, it is helpful to see how wages vary in some important export markets. The following table gives the local wage in dollars, the market share, and the growth rate for several labor intensive industries that are important export industries to the United States.

US Imports of Electrical and Non-Electrical Equipment

[pic] Source: TFRC database. Derived from UNIDO, ILO, CEIC, and US Fed Data.

Notes: Wage98 is the wage as a percent of the Thai wage in the same industry in 1998, MS99 is the market share of US imports in 1999, and AGR9699 is the average annual growth rate during the 1996-1999 period.

These two categories include an eclectic mix of machinery, computers, and circuits. Important Thai exports included in these categories are:

HS84: Hard Drives, Monitors, Printers, Keyboards

HS85: IC Circuits, Vehicle Wiring, Fax Machines, Power Supplies, Telephones, VCRs, TVs

Some clear trends are evident in these tables. Countries with wage rates much higher than Thailand's wages (>400 percent), are generally losing market share, while others (900,000 Bits |1.5% |

|8516500030 Microwave Ovens Having Capacity 31.0 Liters |6.9% |

|4001210030 Natural Rubber In Smoked Sheets, Grade 3 |5.7% |

|8519990045 Optical Disc (Incluiding Compact Disc) Players |1.1% |

|4001220025 Technically Specified Natural Rubber, Grade 20 |8.3% |

|8534000020 Printed Circuits Of Plastic/Glass =>3 Layers, Cndt |4.5% |

|6110202075 W/G Other Apparel Of Cotton, Knit |4.7% |

|8708915000 Radiators For Vehicles, Nesoi |3.8% |

|8542138058 Mono Ic,Dig,Sil,Mos,Ex Vol,(Eprom) N/O 80,000 Bits |0.9% |

|8525408085 Still Image Video Camera,Vdeo Camera Recordr,Nesoi |1.7% |

|1605102040 Crabmeat, Prepared, Nesoi, In Airtight Containers |2.8% |

|8527211015 Motor Vehicle Radio-Tape Players, Cassette, Stereo |0.9% |

|7113112000 Slvr Jwlr Etc Nt Ov $18 Per Doz Pcs Or Pts |2.7% |

|6403996040 Ftwr Sol R/P Up Lthr Exc Pigskin Tenis-Gym Shoe Me |4.7% |

|6110202065 M/B Other Apparel Of Cotton, Knit |4.7% |

|8415100040 Air-Conditioners,Wind/Wall,Self-Contain 33.02cm |1.7% |

|9401696010 Hshld Seat W Wooden Frame For Chrs, Exc Uphl Nesoi |11.3% |

|0306130018 Shrimp/Prawn Shell-On Count Size 89-110 Per Kg Frz |2.4% |

|9018907570 Pts & Accessories Of Dialysis Inst & Apparatus |3.7% |

|6212109020 Bras Not Containing Lace Net Or Embroidery Mmf |4.0% |

|8528122420 Tv Rec,Non-Hi Def,Col,Sing Pt Tub,Non-Pro, Ov33.02 |2.5% |

|8471801000 Control Or Adapter Units For Adp Machines |2.5% |

|4001210050 Natural Rubber In Smoked Sheets, Nesoi |4.0% |

|8504406007 Powr Suppls Fr Inc Into Adp Mach/Units, 50w - 150w |3.4% |

|7103991000 Gemstones, Nesoi, Cut But Not Set Suitbl Fr Jewlry |1.2% |

|8516500060 Microwave Ovens Having Capacity >22.5l 400 Mhz |2.4% |

|8504408500 Static Converters For Telecommunication Apparatus |12.9% |

|6202934500 W/G Garm Desgn Rnwr Mmf ................
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