Jan 29th 2009 | HONG KONG
Asia needs a new engine of growth
IT SEEMS so unfair. Most Asian economies have been models of prudence. While American and European households were borrowing up to the hilt, Asian ones were tucking away their savings. While rich-country banks were piling into ever-riskier assets, Asian banks kept their holdings of such assets small. And while America and Britain were sucking up the world’s savings, Asian governments piled up vast stocks of foreign reserves.
Yet many of Asia’s tiger economies seem to have been hit harder than their spendthrift Western counterparts. In the fourth quarter of 2008, GDP probably fell by an average annualised rate of around 15% in Hong Kong, Singapore, South Korea and Taiwan; their exports slumped more than 50% at an annualised rate. Share prices in emerging Asia have plunged by almost as much as during the Asian financial crisis a decade ago. That crisis was caused by Asia’s excessive dependence on foreign capital. This time the tigers have been tripped up by their excessive dependence on exports.
Asia’s emerging economies have long been the world’s most dynamic, with GDP growing at an annual rate of 7.5% over the past decade, two and a half times as fast as the rest of the world. Only last summer, many of these countries were being warned by foreigners that they were growing too fast and needed to raise interest rates to prevent a surge in inflation. Now, many seem to be in free fall and the news is likely to get grimmer.
In the fourth quarter of 2008, real GDP fell by an annualised rate of 21% in South Korea and 17% in Singapore, leaving output in both countries 3-4% lower than a year earlier. Singapore’s government has admitted the economy may contract by as much as 5% this year, its deepest recession since independence in 1965. In comparison, China’s growth of 6.8% in the year to the fourth quarter sounds robust, but seasonally adjusted estimates suggest output stagnated during the last three months.
Asia’s richer giant, Japan, has yet to report its GDP figures, but exports fell by 35% in the 12 months to December. In the same period, Taiwan’s dropped by 42% and industrial production was down by a stunning 32%, worse than the biggest annual fall in America during the Depression.
Asia’s export-driven economies had benefited more than any other region from America’s consumer boom, so its manufacturers were bound to be hit hard by the sudden downward lurch. Asian exports are volatile anyway (see chart 1). And though the 13% fall in the region’s exports in the 12 months to December was slightly smaller than in 1998 or 2001, those dismal records seem certain to be beaten soon.
The plunge in exports has been exacerbated by the global credit crunch, which made it harder to get trade finance. Destocking on a huge scale has further slashed output. Trade within Asia has dropped by even more than the region’s sales to America or Europe. Exports to China from the rest of Asia were 27% lower in December than a year earlier, partly reflecting weaker demand for components for assembly into goods for re-export.
Shocking as the export figures are, they are not entirely to blame for Asia’s woes. A closer look at the numbers reveals that in most countries imports have fallen by even more than exports, and that weaker domestic demand explains a larger part of the slump.
In China, for example, weaker domestic spending—mainly the result of a collapse in housing construction—accounted for more than half of the country’s slowdown in 2008. In South Korea, net exports actually made a positive contribution to GDP growth in the fourth quarter, while consumer spending and fixed investment fell at annualised rates of 18% and 31% respectively. South Korea is an exception to the rule of Asian prudence. Its households’ debt amounts to 150% of disposable income, even higher than in America. The banking system, which borrowed heavily abroad to finance a surge in domestic lending has also been badly hit by the global credit crunch, making it harder for firms to finance investment.
Domestic spending has collapsed elsewhere. Over the past 12 months, retail sales have fallen by 11% in Taiwan, 6% in Singapore and 3% in Hong Kong. As big financial centres, the two city-states have been battered by the global storm. Both have high levels of share ownership, so tumbling stockmarkets and property prices are depressing consumption. In Hong Kong average house prices have already fallen by almost 20% since the summer and Goldman Sachs, an investment bank, forecasts another 30% drop by the middle of 2010.
A recent report by Frederic Neumann and Robert Prior-Wandesforde, two economists at HSBC, a large bank, argues that Asia is suffering two recessions: a domestic one as well as an external one. Domestic demand had been expected to cushion the blow of weaker exports, but instead it was hit by two forces. First, the surge in food and energy prices in the first half of 2008 squeezed companies’ profits and consumers’ purchasing power. Food and energy account for a larger portion of household budgets in Asia than in most other regions. Second, in several countries, including China, South Korea and Taiwan, tighter monetary policy intended to curb inflation choked domestic spending further. With hindsight, it appears that China’s credit restrictions to cool its property sector worked rather too well.
The two recessions reinforced one another. Part of the slump in domestic spending is attributable to falling exports, which force firms to cut investment and lay off workers. This makes it hard to say whether domestic or external demand is more to blame for Asia’s distress. The importance of exports to the Asian miracle has long been controversial anyway. The crude figures show that, on average, emerging Asia’s exports amount to 47% of their GDP, up from 37% ten years ago. The share varies from 14% in India to 186% in Singapore (see chart 2). In Japan, which is often viewed as an export-driven economy, exports are only 16% of GDP.
But this ratio overstates a country’s dependence on external demand if exports have a high import content. China’s exports account for 36% of GDP, but about half of them are “processing exports”, which contain a lot of imported components. Thus the impact on GDP growth of a fall in exports is partially offset if imports fall too. Estimates suggest that domestic value-added from Chinese exports is a more modest 18% of GDP.
An alternative measure of the importance of exports is the change in net exports in real terms. Between 2002 and 2007 the increase in net exports contributed only 15% of real GDP growth in China. In contrast, net exports accounted for half of all growth in Singapore and Taiwan. This measure understates the total impact, though, because it ignores the spillover effects of exports on business confidence, investment, employment and consumer spending. Either way, the smaller economies, Hong Kong, Singapore and Taiwan, are heavily export-dependent; the giants, China and India, less so.
Asia’s recoveries from previous downturns have been led by a rebound in exports to the rich world. This is unlikely in the near future. The question is, might domestic demand now take up some of the slack? There are reasons to think so. Falling commodity prices are boosting consumers’ purchasing power, just as they squeezed it last year. More important is the impact of monetary and fiscal expansion.
With the exceptions of South Korea and India, Asia has so far been spared the financial dislocations that are plaguing the West. The HSBC economists reckon that the region is more likely to suffer a credit pinch than a full-scale crunch. In contrast to America and Europe, where excessive debt could depress spending for years, most Asian households and firms (except in South Korea) have modest debts. And, because of healthier banking systems, Asian banks are less likely than Western ones to react to the crisis by refusing to lend. Hence interest-rate cuts and the easing of credit controls should be more potent than elsewhere. No less important is Asia’s massive fiscal pump-priming. This is also likely to be more effective than elsewhere because the private sector is in better shape and able to respond by spending more.
Asia has never before deployed its monetary and fiscal weapons with such force. Every country across the region has cut interest rates and announced a fiscal stimulus. In previous downturns, Asian governments were often constrained by dire public finances or the need to support currencies. But most countries entered this downturn with small budget deficits or even surpluses. All the main Asian emerging economies apart from India have relatively low ratios of public debt to GDP.
Though the true size of the fiscal stimulus in some countries, notably China, is probably less than the headline-grabbing figures suggest, they are still impressive. After correcting for double counting and unrealistic measures, China, Singapore, South Korea and Taiwan will all enjoy a fiscal stimulus of at least 3% of GDP in 2009. China has signalled that more measures may follow over the next couple of months; it can certainly afford to spend more. On January 22nd, Singapore’s government announced a package of measures equivalent to 8% of GDP. For the first time, this will be financed partly by dipping into the government’s vast reserves.
The effectiveness of fiscal easing depends on its composition as well as its size. Income-tax cuts planned in South Korea and Taiwan will have only a modest impact if the money is saved not spent. Corporate tax cuts, planned in Singapore, may not spur investment when profits are plunging. Taiwan’s government is attempting to boost consumer spending by issuing shopping vouchers worth NT$3,600 ($107) per person. Economists are sceptical about whether this will produce new spending, but the scheme is being watched closely by other Asian governments.
More promising is the fact that every country is planning to boost infrastructure spending. In the short term, this is probably the best way for governments to boost spending and jobs; in the longer term better roads and railways should boost productivity. Fiscal tightening in emerging Asia after the 1998 crisis caused governments to reduce capital spending; as a result, public infrastructure in some countries, notably Indonesia and Thailand, is probably worse than a decade ago. So there is plenty of room to spend more.
If (still a big if) China and others fully implement their stimulus plans, domestic demand could start to recover in the second half of this year even if exports remain weak. Average growth in emerging Asia might fall to only 4-5% in 2009 as a whole, half its pace in 2007 and the slowest rate since the Asian financial crisis. But it would be well above the trough of 2.4% in 1998 (see chart 3). That average conceals a wide variation. The economies of Hong Kong, Singapore, South Korea and Taiwan will all contract this year, while the bigger, but less open economies of China, India and Indonesia should hold up better.
Shop or drop
However, Asian governments have more than this year’s growth rate to worry about. Beyond the immediate crisis, where will growth come from? America’s consumer boom and widening trade deficit, which powered much of Asia’s growth over the past decade, has come to an end. America’s return to thrift is unlikely to prove a cyclical blip. For years to come, Americans will have to save more and import less. Asia’s export-led growth therefore seems to have reached its limits.
It needs a new engine of growth: in future it must rely more on domestic demand, especially consumption. In recent years, it has been doing the opposite: consumer spending has fallen as a share of GDP, while the share of exports and investment has climbed (see chart 4). Two decades ago, consumer spending accounted for 58% of Asia’s GDP. By 2007 it had fallen to 47%. Consumer spending in China is just 36% of GDP, half the American share. An analysis by CLSA, a broking firm, finds that the weight of exports in GDP now exceeds that of private consumption in six of the 11 Asian countries it tracks.
So how can Asia lift consumption? That depends on why it has been declining in the first place. The popular explanation is that it is all because frugal households have been saving a bigger slice of their income in response to uncertainty over pensions and social welfare—uncertainty that will presumably increase in a recession.
But this doesn’t quite fit the facts. In many countries, notably South Korea and Taiwan, household savings have fallen relative to income in the past decade; in China they have been broadly flat. (The rise in China’s savings rate comes from firms and the government, not households.)
If households are not saving more, why has consumer spending declined as a share of GDP? The answer is that wage incomes have fallen relative to GDP. In China the share of wages dropped from 53% in 1998 to 40% in 2007.
One reason for this is that job creation has slowed as governments have encouraged capital-intensive industries. Across Asia, and particularly in China, low interest rates have encouraged investment and policies such as undervalued exchange rates and subsidies have favoured manufacturing over labour-intensive services.
So if Asia is to shift the mix of growth towards consumption, the usual prescription of urging households to spend more will not be enough. A raft of government policies will have to change to lift households’ share of national income. They include: reducing the bias towards capital-intensive manufacturing; speeding up financial liberalisation to lift the cost of capital; scrapping subsidies and tax breaks which favour manufacturing over services; and attacking monopolies and other barriers to services. Stronger exchange rates would also shift growth away from exports and boost households’ real spending power by reducing the cost of imports in local currency terms.
In contrast, some in China are foolishly calling for a devaluation of the yuan to support the economy. This would do little to bolster exports, which have been hurt by weak external demand rather than declining competitiveness, but would hinder the necessary economic adjustment.
Even if household saving rates have been falling, they are still high, at around 20% in both China and Taiwan. This partly reflects the fact that younger populations tend to save more for retirement. An IMF study estimates that as populations age and retired workers run down their savings, this could push up consumption-to-GDP ratios in some countries by eight percentage points or more in the next decade.
Clawing it back
Policy changes can also help nudge up saving rates. In poorly developed financial systems, households find it hard to borrow and so need to save for a rainy day. Easier access to credit could reduce such saving. But the recent credit boom and bust will make governments even more cautious about financial reform.
Inadequate social-welfare nets do encourage people to save. So higher public spending on health, education and welfare support could encourage households to save less and spend more. The recent news that China plans to spend 850 billion yuan ($125 billion) over the next three years to provide basic health care for at least 90% of the population by 2011 is therefore welcome. But the details are sketchy.
After the Asian crisis, many foreigners were quick—too quick—to pronounce the regional miracle dead. Economies bounced back not just because of the appetite of American consumers, but also because Asia still had the key ingredients of growth: rising productivity; high savings to finance investment; low import barriers to spur competition. These will help Asia remain the fastest growing region in the world. But a bigger share of those gains needs to go to workers and consumers.
Asia’s low rate of consumption and borrowing means that it has huge scope to make consumption the engine of growth over the next decade. In previous downturns, Asians were forced to take nasty medicine. Having to go out and spend would surely make a nice change.