Asia’s rebalancing act
Asia must ditch its dependence on exports and instead create its own sources of demand. The alternative is a prolonged – and potentially destabilizing – period of decline
It wasn’t meant to be like this. When the crisis first erupted in the US financial sector, many looked to Asia to continue its surge forward.
The region, after all, wasn’t heavily exposed to U.S. securitized assets. And many supposed Asia was shielded by improved macroeconomic fundamentals as well as relatively sound bank and corporate balance sheets.
But the received pieties have since been shattered. Asia is being hit –hard. The impact of the crisis has been more brutal than anything since the region’s own financial collapse over a decade ago.
The Asian Development Bank slashed its 2009 growth forecast to 3.4% for the region’s developing countries; it warns that an anticipated rebound in 2010 will depend on a broader recovery of the world economy. By contrast, IMF data show that even during the peak of the 1997 financial crisis, Asia continued to grow by around 3.7%.
ADB president Haruhiko Kuroda tells Emerging Markets that although this year will mark the “severest” period of the global crisis, “next year the impact will continue to be felt and only from 2011 will medium-term sustainable growth will come back.”
While the impact on Asia’ financial stability so far has been limited, the toll on the real economy through the trade channel is profound. Exports are collapsing – on average down 30% since the fourth quarter of last year – and are proving a major drag on income and investment. Domestic demand is also showing signs of slowing down, with retail sales dropping.
Meanwhile the poverty impact will also be severe: by 2009, 60 million more people will fall below the poverty line, says the ADB. That number will swell to 100 million in 2010.
The global crisis has its roots in Asia’s macro-economic imbalances: excess savings in emerging economies allowed the US to maintain its excessive household consumption and high current account deficit. Asia’s surplus – notably China’s – is an integral part of global current account imbalances.
On this account, the massive flow of excess savings from developing Asia to the U.S. helped lower global interest rates, encouraging investors to seek riskier assets for higher yields.
But doubts are growing over whether running sustained current account surpluses has served the region’s own self-interest. And the logic of the flow of capital – from merging economies to advanced economies, from the poor to the rich, and from countries with high investment returns to those with low returns – has long been questioned by economists.
Moreover, Asia’s sharp slowdown highlights the risk of excessive reliance on exports or external demand. The solution is a global economic rebalancing, and, for Asia, a shift in its growth model towards domestic demand through a mix of supply side and demand side policies.
As the severity of the crisis became apparent towards the end of last year, governments across the region embarked on expansionary monetary and fiscal policies. Meanwhile the region’s previously conservative governments – many of which have recently balked at the idea of spending to tackle a crisis that has its roots in US profligacy – are now scrambling to maintain employment and growth through tax breaks, subsidies and other measures.
US president Barack Obama’s top economic adviser Lawrence Summers argued in March that the urgent need for a short term increase in spending by governments around the world overrides all other macroeconomic considerations, including tacking the global imbalances many economists believe contributed to the financial crisis.
“The old global imbalances agenda was more demand in China, less demand in America. Nobody thinks that is the right agenda now,” he said. “There’s no place that should be reducing its contribution to global demand right now. It is really the universal demand agenda.”
The stakes could not be higher. If the world economy is to scrape through the crisis – without deficit countries spending themselves into bankruptcy – surplus countries must expand domestic demand relative to potential output. The stimulus packages that have been announced across the region would need to turn an excess of savers into eager consumers.
A new Asia
As the ADB puts it in its annual report: “The global crisis, as profound as its impact will be on developing Asia, did not create the need for rebalancing. Rather, it introduces an added urgency to rebalance growth.”
Kuroda suggests that the Asia that emerges in the aftermath of the current crisis will look different from the continent that went into the crisis: a greater stress on domestic demand will replace or supplement the previously heavy dependence on external markets, he suggests.
ADB acting chief economist Jong-Wha Lee has pointed out that rebalancing growth demands a “judicious mix of policies” to build strong domestic demand and apply resources more efficiently. They include: a focus on strengthening domestic consumption; improving the investment climate and social infrastructure; accelerating financial development; and strengthening regional integration and cooperation.
It’s increasingly clear that today’s policy decisions will affect social and economic development for years to come. But while talk of such a deeper structural shift is now commonplace, putting theory into practice is less straightforward.
Thailand’s central bank governor Tarisa Watanagase points out that today’s rebalancing agenda is nothing new. “After the 1997 crisis we were talking about the same thing. But because the global economy recovered, people forgot,” she tells Emerging Markets. “But now [Asia] must do it out of necessity and countries will be focusing more on this strategy.”
She notes that while a lack of infrastructure is still a major impediment, “the room is still there to build up productive capacity.”
Pakistan’s central bank chief Salim Raza also points out the urgency of a new growth model. “We went into a decade of globalization thinking exports were the way to go, that the domestic market didn’t have the capacity,” he tells Emerging Markets. “But our businessmen see the sizeable emergence of purchasing power. That basically is the change.”
Yet many Asians save to compensate for poor, or non-existent, social security systems. China’s leadership, for example, has spoken for years of the need to build up a proper safety net, but efforts have not yet persuaded the Chinese people to change their savings habit.
Stephen Roach, chairman of Morgan Stanley Asia says a lack of a social safety net is the “single biggest impediment” to the development of a consumer culture in China.
“The most important thing is to boost the social safety net, provide funding for social security, health, education, insurance and pension reform,” he tells Emerging Markets. “The Chinese government has lagged dramatically in these areas for reasons that are not clear. They need to speed that up.”
The impact of the crisis on China has been severe – growth hit 6.1% in the first quarter, down from a record 13% in 2007 – and is giving a much needed urgency to policy-makers efforts to rebalance growth.
Chinese policy-makers have long talked of the need to rebalance growth away from exports and towards private consumption. But so far the ability of China to increase domestic private demand – and rely less on net exports – has been severely limited. Weakness in net exports at a time when domestic private demand cannot grow fast enough is also likely to limit China’s economic recovery.
The country’s central bank governor Zhou Xiaochuan argued recently that Asia’s high savings rate is endemic and largely a result of cultural factors. “Tradition, cultural, family structure, and demographic structure and stage of economic development are the major reasons for high savings ratio in the East Asia. First, the East Asia countries are influenced by Confucianism, which value thrift, self-discipline, zhong yong or Middle Ground, and anti-extravagancy.”
But he also pointed out the authorities’ “clear policy intention to reduce savings ratio. Since 2005, boosting domestic demand and encouraging consumption have been important components of the national economic policies. These policies would eventually bring down the savings ratio.”
The structural reasons for high Chinese savings rates, however, still persist. And with the Chinese yuan having returned to its implicit peg to the U.S. dollar, Chinese reserve accumulation and the purchase of U.S. assets as yet shows little sign of abating. China is still running a substantial current account surplus – near to 8% of GDP. Despite the crisis, the first-quarter surplus was higher than last year’s. And the IMF reckons China’s stimulus is unlikely to bring down the current account surplus.
As economist Brad Setser points out, China’s $2.3 trillion in claims on the world could double in the next four years, based on its projected surplus. As a result, he says, China’s surplus may continue to fuel its reserve growth and the build-up of Chinese government claims on the US and Europe, turning a global imbalance into a “Sino-American imbalance.”
But with the trade deficit in the US and other countries shrinking, some economists fear China could yet face a devastating adjustment in its external accounts.