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NS4053 Winter Term 2013 Overview of the Asian Eonomies. Outline. Part I – Regional Issues Asian Headwinds – Current Vulnerabilities; the Perfect Storm Structural Change -- Rebalancing/Middle Income Trap Trans-Pacific Partnership Part II – Country Assessments
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Outline • Part I – Regional Issues • Asian Headwinds – Current Vulnerabilities; the Perfect Storm • Structural Change -- Rebalancing/Middle Income Trap • Trans-Pacific Partnership • Part II – Country Assessments • China – Rebalancing/Difficulties in Transition • Japan - Slow Growth Trap • Korea – Causes of Long-run Economic Slowdown • Indonesia – Lagging Manufacturing/Resource Nationalism • Vietnam – End of the Economic Miracle? • Part III -- Final Assessments –
Asian Headwinds I • As export-oriented economies, the Asian economies slowed sharply with the global financial crisis of 2008-09 • However, with notable exception of Japan which suffered its deepest recession of the modern era, the region came through in excellent shape • The region is now being hit with another external demand shock – this time from Europe where the sovereign-debt crisis threatens to bring on a major recession • Financial and trade linkages make Asia highly vulnerable to Europe’s malaise • Lacking well-developed capital markets as an alternative source of credit, bank-funding channels are especially vital in Asia • Asian Development Bank estimates European banks fund about 9% of total domestic credit in developing Asia – three times the share of financing provided by U.S. banks • Means Asia far more exposed to offshore banking crisis than in 2008 with the collapse of Lehman Brothers.
Asian Headwinds II • Transmission effects through trade linkages just as worrying • Historically US was modern Asia’s largest source of external demand • That appears to have changed over the past decade • Due to China’s spectacular growth, the region shifted from US- to China-centric export growth • Combined shipments to the US and Europe fell to 24% of developing Asia’s total exports in 2010 – down from 34% in 1998-1999 • Over the same period, Asia’s dependence on exports within the region expanded sharply from 36% of total exports in 1998 to 44% in 2010 • However, these patterns do not mean that the region is becoming increasingly autonomous from developments in the West
Asian Headwinds III • Beneath the surface 60—65% of all trade in the region is intermediate products – components that are made in countries like Korea and Taiwan, assembled in China and ultimately shipped out as finished goods to the West. • With Europe and the US still accounting for the largest shares of China’s end market exports decoupling has not occurred. • Even worse China itself has tilted increasingly toward Europe as its major source of external demand • In 2007, the EU surpassed the US as China’s largest export market. • By 2010, the EU accounted for 20% of total Chinese exports, while the U.S. share was just 18%. • A China-centric Asian supply chain made a big bet on the EU experiment – a bet that now seems to be backfiring. • Another slowdown in domestic growth stemming from a crisis in advanced countries of the west seems to be playing out in China, and ultimately the rest of an integrated Asia.
Asian Headwinds IV • The good news so far – downside much better contained than in late 2008 or early 2009 • Back then Chinese exports went from 26% annual growth in July 2008 to a 27% decline in February 2009 • This time exports have slowed from 20% in 2011 to 5% in April 2012 • That could change quickly in the event of a disorderly euro breakup • The bad news is that Asia seems to be learning little from repeated external demand shocks • Increased internal demand is the only effective defense against external vulnerability • Yet the region has failed to construct that firewall • Private consumption actually fell to a record-low 45% of developing Asia’s GDP in 2010 down 10% from 2002 • Clearly little decoupling, or immunity from external shocks is taking place. • Rebalancing is the only way out for China and its partners in the Asian supply chain. Until that occurs the vice now gripping Asia will only continue to tighten.
Asian Headwinds V • Summing up: • At present the supercharged rates of emerging market growth recorded in 2003-07 do not look achievable or sustainable • Chronic slow economic activity in rich world presents a serious obstacle to growth • However only incremental rebalancing towards domestically driven growth will make these countries less dependent on advanced country growth – partial decoupling • In addition, to restore high growth most emerging Asian economies will have to undertake economic/governance reforms: • Reduce red tape and corruption, liberalizing investment and labor markets and improving basic infrastructure • If this transformation is successful, instead of looking at rich world growth and estimating the impact on emerging country prospects the tables maybe reversed.
Asia and the Perfect Storm • Many forecasters concerned about the development of a perfect storm in second-half 2012 or early 2013: • A disorderly situation in the eurozone (EZ) with a Greek exit and significant contagion to other fragile periphery members • U.S. Growth that slows to stall speed as a sharp fiscal cliff looms; • Tensions in the Middle East between the U.S./Israel and Iran that reach a boil and trigger a spike in oil prices; • A landing in China that moves from soft to hard • A massive slowdown in other emerging markets. • Focusing on possible risks coming from the EZ, U.S. and China: • Malaysia, Taiwan, South Korea and Vietnam are the most exposed to a perfect storm through their trade and financial linkages • South Korea, Australia, Vietnam and the Philippines have the most policy space to offset such an external shock • Taking trade/finance risk and policy space together • Malaysia Taiwan, Japan and Thailand are the most vulnerable • Australia, India, South Korea and the Philippines are the least
Middle Income/Governance Traps • Compounding the problems of rebalancing and reorienting their economies the larger emerging countries face another obstacle – the middle income trap • Empirical research on growth and governance suggests: • There is a barrier in output per person beyond which countries with poor institutions don’t grow, or slow-down dramatically • Level appears between $10,000 and $15,000 • As of 2009 Russia, Argentina, Libya and Turkey had all hit the wall – China about half way there --Without reform, growth not sustainable • Historical patterns of -- trade – led virtuous circle may not automatically produce process of reform. • These institutions coincide with political freedom which seldom comes without upheaval. • Better governance and economic freedom are necessary to support a more sophisticated economy, transitioning out of old low-tech labor intensive manufacturing industries • To support higher wages, at this stage countries need to move up the value chain and becoming more innovative with much higher levels of productivity
TransPacific Partnership (TTP) I • The changing patterns of trade and structural changes noted above have implications for a major U.S. initiative – the TransPacific Partnership (TTP) • The United States and China are offering competing frameworks for security, trade and economic cooperation in the Asia Pacific Region • In the U.S. case this involves binding traditionally strong bilateral treaty allies and states concerned by China’s rising economic heft and territorial claims into a mutually beneficial multilateral framework • China considers these arrangements as designed to contain that country • More subtly, the approach is centered on regional trading arrangements and strategic plans intended to make it difficult for China to alter the status quo even as its economic power grows.
TransPacific Partnership (TTP) II • Countries currently in negotiations for the TTP are: Australia, Brunei, Chile, Malaysia, New Zealand, Peru, Singapore, the United States and Vietnam. • If signed, it will represent one of the world’s most expansive trade agreements • If Canada, Mexico and especially Japan also sign the agreement will add billions to the U.S. economy and solidify Washington’s political financial and military commitment to the Pacific for decades to come. • China which is the main trading partner for almost all other Asian states has promoted its “Association of Southeast Asian Nations (ASEAN) Plus Three (China, Japan and South Korea) framework • It offers an easily implemented multilateral trade partnership based on a lowest common denominator formula in which countries remove only some trade barriers resulting in rapid, albeit narrow gains
TransPacific Partnership (TPP) III • The US aware that the Chinese framework would marginalize the U.S. -- argues that the TPP would yield superior economic gains. • The TPP requires a greater commitment among members regarding binding rules and standards, but offers the potential for deeper gains through progress on investment, property rights, competition provisions as well as reducing trade barriers. • While the U.S. has not formally excluded China from joining the TPP, the country would need to revalue its currency, reduce subsidies to state-owned companies, provide better protection to intellectual property, as well as reduce trade barriers– all improbable steps • Given the complexity of the TPP, its creation may not be a realistic prospect until early in the next decade – until then it does hold out an alternative to China’s ASEAN Plus Three.
TransPacific Partnership (TPP) IV • One thing is certain: the TPP will not derail Asia’s intra-regional trade integration for a number of reasons: • Asia is likely to be the fastest-growing region in the world for the foreseeable future and to increasingly provide the bulk of incremental global demand. • This means that intra-Asian trade will continue to outpace trade with the rest of the world • Countries in the region have undertaken investments in transport infrastructure connecting the SE-Asian economies with each other and with China • Rising real wages and land prices in China and the country’s appreciating exchange rate will drive labor intensive Chinese firms to eventually relocate in labor-abundant SE-Asian economies further generating trade and investment flows • In sum, trade and investment agreements like the TPP can only facilitate market forces, not fight them. • Several scenarios see an eventual merging of a China-led Asian track and a U.S. led TPP track with the center of the world’s economy in the Pacific basin
Country Analysis • China • Japan • Korea • Indonesia • Vietnam
China’s Rebalancing I Overview: • China’s economy is currently going through a painful transition to a more consumption based economy • The days of double digit economic growth clearly over • In the short run, slower growth is generating concern about the nation’s near-and medium-term prospects • There is an up-side to the gradual slowdown over the past eighteen months • Growth in the coming years will be both robust and more sustainable • The structural reforms that are central to the 12th Five Year Plan (2011-2015) will become somewhat easier to achieve • On balance it appears China’s economy is headed in the right direction, but still worrisome in the short-run • However, key economic and political risks – including corruption, social inequality and lack of progress in governance reforms – must be addressed in order to assure long-term economic growth.
China’s Rebalancing II Sound macroeconomic policy has aided the transition to a slower but more sustainable growth path thus far. • In response to the 2008 financial crisis, China launched the world’s largest stimulus program relative to GDP and arguably the most effective • Production losses as a result of the crisis were recouped in only three months. • Growth remained high – at 9.2% (2009) and 10.4% (2010) • In retrospect the credit expansion that fueled the stimulus was too large • Economy began to overheat in second quarter 2009 setting back 11th Five Year Plan (2006-2010) and rebalancing objectives. • Overheating also fed a dangerous housing bubble in major cities • Government did not overact and a gradual decline in real estate prices appears to have tapered off • The big challenge now is to manage the expected revival of commercial housing markets in big cities without reigniting speculative bubbles.
China’s Rebalancing III • There is considerable controversy over the quality of Chinese economic data, leading to controversies as to how the economy is performing • Regardless of how GDP growth is measured, China’s long-term trend is clearly toward a slower, though still impressive pace • If current trends continue, China’s economy will eventually look more “normal” in its pattern of growth and its GDP growth rate may stabilize around 7 to 8 percent for the next few years • Specifically household consumption growth, a critical rebalancing objective has continued to be brisk – presently exceeding GDP growth • In the first half of 2012 the contribution of consumption to economic growth was almost 60 percent – more than 10% higher than in the first half of 2011
China’s Rebalancing IV • China’s investment/GDP rate remains very high by international standards • However, it has been coming down since 2009 • Reflecting greater reliance on consumption-driven growth as opposed to export-driven growth, China’s current account surplus as a % of GDP which long signaled macroeconomic imbalance has fallen sharply in recent years; in 2011 it was under 3% • As for China’s slowing rate of growth, the country’s overall economic performance since the global financial crisis of 2008 has been remarkable • High rates of overall-growth has occurred despite: • The slowdown in export growth and FDI inflows, and • increased production costs which forced many manufacturing enterprises to close, relocate or change their business model
China’s Rebalancing V China is rebalancing in other ways as well • Since the yuan was first unlinked from the dollar in July 2005, the nominal yuan-dollar exchange rate has appreciated by over 30% and the real rate by over 40% • China has recently widened the yuan’s trading band and has cautiously resumed many financial sector reforms that were stalled since 2004 • The country is also continuing to promote the international use of its currency for trade and investment purposes • China’s traditional east-west development gap is also shrinking as a result of the government’s “Go West” investment policies • In recent years, interior, not coastal provinces have grown most rapidly • Agriculture, main source of income for 30% population continued strong – per capita rural growth has exceeded urban growth • However, income and wealth inequality has increased.
China’s Rebalancing VI • Other changes of importance are in labor markets where there are signs of a maturing: • Wage increases are continuing though at a slower rate than in 2009 and 2010 • The country’s labor-force is close to peaking and the cohort of young workers is already shrinking • Living conditions and job availability have improved in rural areas where most migrant workers originate • Country is at the point were cheap labor dries up, real wages increase and consumer purchasing power rises • The government’s 2010 National Talent Development Plan is a clear sign that it recognizes the shifting economic winds • Indication government committed to upgrading the quality of its labor force and increasing the innovative capacity of the economy • A necessary step in transitioning to the next stage of development • Still, major improvements in governance are necessary to lay an adequate foundation for the next stage of growth – a more innovative, knowledge based economy
China’ Rebalancing VII • Summing Up -- China’s economic adjustment after the 2008 crisis has been impressive but risks may have intensified. These include: • Corruption and social inequality • The possibility of financial instability due to the proliferation of many new, poorly supervised financial products as well as increased corporate leverage • Falling profit margins which have lowered business confidence • Though the housing market in big cities seems to have stabilized a large stock of vacant apartments continues to weigh on prices • Widely reported over investment in basic infrastructure will by contrast probably turn out to be less of a problem than overinvestment in manufacturing and high end real estate • Most of the new infrastructure has been created ahead of needs as part of the government’s strategy to stimulate new development opportunities. • Greatest risk facing China today is stagnant political reform, including promotion of the rule of law • Without progress on this front, social inequality, and perceived unfairness could jeopardize the transition to the next stage of development and with it the country’s long term economic prospects.
Japan: Slow-Growth Trap I Even before the March 2011 crisis, the Japanese economy had been experiencing difficulties: • Investment activity had fallen by more than 15% since late 2008 about 1.5 times more than in other advanced regions • Private consumption had also declined at a faster pace than in comparable countries. • In addition to sluggish domestic demand, slow recovery in Japan primarily the result of unfavorable external conditions: • Yen appreciated by 17 percent – largest appreciation among advanced economies – safe haven, unwinding of Yen carry trade-low interest rates in other advanced countries • Strong yen creating generational friction with strong opposition by the elderly to revaluation • Export demand from main trading partners grew by about 1% compared with 2-5% for Asia’s NIE – due to Japan’s lower export share with China and developing Asia. • Japan’s exports oriented toward high end consumer products.
Japan’s Slow Growth Trap III • High growth (4.1%) in the first quarter of 2012 masked underlying challenges that will keep the economic expansion below 2.0% in 2012 – growth only 1.4% in second quarter. • This is occurring despite support from public-sector reconstruction. • Growth in 2012 and 2013 is also likely to be well below 2.0% due to China’s slow-down and the Euro zone outlook • Downside risks are mainly associated with Yen appreciation. • With a strengthening yen -- fears of industrial hollowing out are returning. • Japanese manufacturers face a strong yen, uncertainty over electricity supply and pressure to diversify supply chains after the Yohoku earthquake revealed hitherto unknown vulnerabilities • Until recently the hollowing out effect of Japanese firms’ outbound FDI has been largely offset by a deepening division of labor between domestic and overseas factories • In coming years the net effect is likely to grow more pronounced
Japan’s Slow Growth Trap IV • The pattern of hollowing out will have profound implications for the future structure of the economy: • Overseas production will displace production inside Japan on a larger scale and at a higher speed • As firms of all sizes move production overseas, domestic manufacturing will shrink at a faster pace squeezing employment and accelerating the shift in the economy toward services • While contributing some to job creation it will make enhancing the global competitiveness of service industries more urgent – currently most service industries have very low productivity compared to manufacturing • The hollowing out may be restrained if Japan is able to expand a cohort of strong, technologically advanced domestic manufacturers with internationally recognizable brands and positioning themselves within global technological chains. • These need not be limited to sectors that now lead the globalization of Japanese manufacturing – autos or electronics • A greater contribution may come from industries such as food production, fashion goods, interior goods, and cosmetics. • Compounding Japan’s problems is the long term-demographic and fiscal patterns likely to drag on the economy
Korea’s Declining Growth I • Korea’s long-term growth which had been nearly 10% in the 1970s and 1980s has been falling continuously since the 1990s. • Korea is facing decreasing labor inputs due to population aging and the introduction of the five-day workweek. • Rapid ageing in the population has slowed growth in the working population (those aged 15-64), and in 2010, for the first time brought about an actual decline of population in the core age group 25-49. • On the capital side investment declined continuously after the 1997 financial crisis, while efforts to improve productivity have not met expectations • Growth in facilities investment averaged more than 15% annually from 1970-1980; falling to 10% in the 1990s and then to 3% after the 1997 crisis • While investments to improve productivity have increased, the scale of such investments has not been sufficient to promote growth of the economy.
Korea’s Declining Growth II • While long term growth has usually been assessed from the perspective of factor inputs, recent research at Samsung Research suggests that Korea’s problem may lie more critically on the demand side. • Korea’s domestic demand is failing to provide a safety net to the economy, and the private consumption to GDP ratio has fallen considerably over time • The share of private consumption in GDP has fallen over time from well over 60 percent in the early 1990s to 53 percent in 2009 – a very low figure for countries in Korea’s income range. • The biggest obstacle to boosting private consumption appears to be variability in income flow • The resulting uncertainty causes families to increase precautionary savings • Reviving domestic demand and increasing its contribution to the economy will be critical to improving Korea’s long term growth potential as well as its short-run recovery.
Korea’s Declining Growth III • To revive growth in the short-term it will be necessary to control inflation and household debt which contribute to the stagnant consumption • In the mid-to long-term it will be necessary to address anxiety about future income by expanding employment opportunities , and better unemployment insurance. • When consumers have weak expectations about their ability to maintain a stable income throughout their lives the have strong incentives to constrain their current consumption • Revival of facilities investment also critical to recover the growth trend. • Korea's weak parts and materials industry does not provide sufficient support for manufacturing • In sum the Korean economy needs to seek balance between exports and domestic demand and to adapt to the changing landscape of the global economy. • Discovering new export growth engines critical as other emerging economies gain in competitiveness
Sustaining Indonesia’s Growth I Indonesia’s economic performance has been impressive: • In recent years the country’s economic growth has been the highest in Southeast Asia • The country’s inflation has been low • Fiscal policy has been prudently managed – the sovereign debt burden as declined • There have been no balance-of-payments crisis • Most importantly, the economy emerged largely unscathed from the global financial crisis in 2009-10 • In recognition of the country’s solid financial situation, two-credit rating agencies upgraded Indonesia’s sovereign credit rating to investment-grade level. • Still, despite these accomplishments, sustained progress and growth is not guaranteed. • Several problem areas are developing that will require attention to assure continued prosperity.
