Asia’s collapse at the end of 2008 stunned a region which had begun to consider itself largely immune to another economic upheaval.
But the speed of its upturn following the global financial crisis similarly caught many unawares. Two years into its recovery emerging Asia continues to roar ahead with unprecedented vigour, spurred on in part by intense demand from China, abundant global liquidity and, on the face of it, relentless capital inflows.
The ADB predicts the region will grow at 7.8% this year and 7.7% in 2012, following a 9% expansion from the depths of the crisis. Such continued high growth is all the more stark when compared to the leaden fortunes of industrial economies, which are set to expand as a group by a meagre 2.1% this year and next.
“Asia’s recovery is on firmer ground, unlike the last two years when the growth prospects were not very secure,” ADB chief economist Changyong Rhee tells Emerging Markets.
But far from the heady optimism of a year ago, authorities are now grappling with a range of challenges – both domestic and external. How they respond will decide the region’s fate for years to come.
TOO HOT TO HANDLE
Most pressing among these in the short term is inflation. Authorities are scrambling to prevent their economies becoming victims of their own success amid intense demand pressures and shrinking output gaps. But the picture has been made worse by food and energy price shocks, which, combined with domestic pressures, could push inflation to 5.3% in 2011, on ADB estimates.
Such pressures may now force a change in the policy logic across much of the region which has long plumped for growth at all costs. Today, faced with the dilemma of sustaining high growth or tackling inflation, Rhee says policymakers should focus principally on price stability. “When looking at the trade-off between growth and inflation, we’re [urging policymakers] to focus more on inflation because growth prospects are brighter today,” he says.
While authorities have begun tightening monetary policy, inflation – both headline and core measures – continues to rise across the region; the worry is that the policy response was – and still is – behind the curve. And this has raised fears that upward pressure on prices could be here to stay.
The combination of price rises and, in particular, the shock from food inflation could in turn sow the seeds of social unrest, given high levels of poverty across the region, Rhee says. But he adds that Asian authorities are showing a renewed willingness “to sacrifice the speed of growth” to maintain social stability and so “will now spend effort in tackling inflation.”
Still, he says the risk of a continued upsurge in food and oil prices could threaten the balance even further, lopping as much as 1.5% off regional growth – and pushing 64 million people into extreme poverty with just a 10% rise in food prices.
Rhee also warns that, given ongoing instability in the oil-producing Middle East, “there’s a good probability that oil prices will continue to increase. If that happens, countries will face a harder trade off. If oil prices increase it could cause recession. If inflation is increasing at the same time, this could lead to stagflation.”
AVOIDING THE TRAP
Notwithstanding such alarming prospects – the majority of analysts expect commodity inflation will moderate in the second half of the year – conventional wisdom in policy circles and financial markets alike is that Asia’s rise over the longer term is inevitable.
But an increasing number of experts are sounding the alarm over the dangers of such thinking. A new ADB study warns that Asia faces the prospect of falling into a middle-income trap within a decade without urgent policy action to address inequality, boost governance and step up efforts in both regional and global economic cooperation.
The Bank’s managing director Rajat Nag noted last week that a middle income trap scenario would see per capita income for Asia peak at only $20,000, in purchasing power parity terms, by 2050, instead of $39,000 per head – on par with Europe today – a level which the region could reach if it undertakes the right measures.
Such dramatically divergent outcomes would also become evident in Asia’s share of global output. The region could account for half of world GDP four decades from now, up from 27% today, if politicians focus on rebalancing the region’s economy toward productivity-led growth. Such a result would see Asia regain its dominant global economic position of 250 years ago – a tantalising prospect some have dubbed the “Asian Century”.
GREAT EXPECTATIONS
Achieving such a goal calls for new sources of growth – grand national and regional initiatives that can propel the region up the value chain and, the hope is, towards a brighter future. But putting theory into practice is another matter.
According to UC Berkeley economist Brad DeLong, today’s consensus expectations for Asia’s growth are likely to be proven wrong because they are based on false assumptions about the nature of that growth.
“Asia is now riding high. Growth is now rapid. Asian expectations are now extravagant. Everyone buying assets in Asia expects the current growth pattern to continue, and they all price that continuation of rapid growth into asset prices,” he said at a recent policy gathering in Bretton Woods, New Hampshire. But Asian output today represents “catch up growth” which “inevitably slows as you reach the limits of capital accumulation” and technology transfer, he points out.
“There will be a slowdown in Asia,” DeLong said. “When it comes, whenever it comes, it will hit Asian economies that will then be expecting and will be pricing an extra five to ten years of growth just as rapid as the past generation – and growth during the past generation has been phenomenal – into asset prices. And when the slowdown comes asset prices will then move far and fast.”
THE CHINA FACTOR
The worry is increasingly that China could precipitate that fall: it may be the country that helped pull the Asian and global economies back from the abyss following the global crisis, but equally, the worry is, it could send the world hurtling back again if its growth falters.
DeLong’s colleague at Berkeley, economist Barry Eichengreen, set out in a recent study to identify the per capita income threshold at which fast-growing economies slow down. In the case of China, he reckons the ceiling will be reached in “five to seven years”.
“Catch-up economies can’t stay in catch-up mode forever,” he says, pointing out that for China, slower growth will come “sooner rather than later” – driven by an ageing population, entrenched inflation and a chronically undervalued currency. The latter, he says, makes a slowdown more likely “because it encourages unproductive investments when a country holds on for too long”.
Such an “incontrovertible” trajectory, says Eichengreen, will mean vast changes in Asia’s economic landscape, as countries reorient their strategies to keep pace.
But this also raises the stakes for Beijing to manage its growth transition smoothly – a policy goal to which the nation’s leadership has, in theory, long been committed. It’s also widely accepted that a sustainable recovery of the global economy more fundamentally requires a rebalancing – a reduction of current account surpluses in creditor nations and a corresponding decrease in the deficits of big debtor nations.
China’s surplus fell from a peak of 10.6% in 2007 to 4.9% in 2010; Germany’s fell from 7.6% to 5.4%. Meanwhile the US current account deficit fell from 5.1% in 2007 to 3.0% in 2010.The state’s reserves, he notes, have in effect been borrowed from China’s wealthy savers. “When the slowdown comes and they want [their money] back, asset prices will move far and fast – and asset prices that move far and fast are recipes for financial crisis,” he said.
Says Eichengreen: “The Chinese understand the need to move away from a tried and true development model. They’ll have to adjust their exchange rate. I do hope we can get there without a crisis, but I wouldn’t guarantee it.”
“Back in 2005 we were discussing what the next financial crisis was going to be,” DeLong said last month in Bretton Woods. “Back then those discussions were highly theoretical and they focused on a crisis that might come some day if global imbalances were not dealt with. You could call it a dollar crisis or a reorientation of Asian development crisis – that crisis is still out there; it’s still possible.”
He added: “The fact of Asia surmounting this last crisis says little about its ability to surmount the next one. And that potential crisis is now six years closer.”