< http://www.feer.com > ASIAN ECONOMIC OUTLOOK: OVERVIEW Asia's Red-Queen Economies By Tom Holland/HONG KONG Issue cover-dated September 06, 2001 Asia faces something far more serious than just a cyclical downturn in the global economy. The rise of China as the region's top low-cost manufacturer will compel every country to base future growth on its true comparative advantages "FASTER! FASTER!" cried the Red Queen to Alice. "Here, you see, it takes all the running you can do to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!" To the Red Queen "here" was the chessboard dreamscape of Lewis Carroll's fantastic satire, Through the Looking Glass. But her description could equally well apply to today's East Asia and to the new economic reality now emerging across the region. It's partially obscured by this year's cyclical downswing but a structural shift is taking place in Asia's economies. Gone forever are the fat years of the 1990s, when plentiful capital funded the development of powerful export industries whose success fuelled double-digit growth rates. Tomorrow's environment will be far harsher. In the new era of global economic integration, with China fast emerging as an unbeatable competitor, non-Japan Asia's other economies will have to work hard just to stand still. To achieve their long-term potential growth rate of around 5% each year, like the Red Queen, they will have to run at least twice as fast. If Asia's policy-makers and business leaders have been slow in positioning themselves on this new economic chessboard, they can hardly be blamed. They face a more immediate problem: the wrenching collapse in international demand for their exports, which has halted economic growth in its tracks for many countries in the region. The cause of the slowdown is by now sickeningly familiar. The puncturing last year of the Nasdaq stockmarket bubble exploded once and for all the myth that new technologies were immune to the business cycle. While the U.S. eliminates the over-capacity built up by companies' massive over-investment in technology, business spending has all but dried up. That means little or no U.S. demand for the high-tech hardware that Asia excels in producing. MISPLACED OPTIMISM At first Asian businesses pinned their hopes on European demand, but it is now clear their optimism was badly misplaced. America's new economy did deliver greater efficiency in at least one area: the U.S. has proved remarkably effective at exporting its own slowdown. Falling demand and shrinking corporate profits were soon transmitted across the Atlantic, where Germany's economy lapsed into stagnation in the second quarter. Meanwhile Japan continues to struggle with its own problems of a dysfunctional financial system, mounting public-debt levels and anaemic consumer demand. Prime Minister Junichiro Koizumi has promised radical reforms to eliminate ingrained inefficiencies in the financial and corporate sectors, but real restructuring will be a bitter medicine which will take years to effect its cure. Unable to count on outside assistance, East Asian countries must face the challenges of the current slowdown by themselves. Unsurprisingly, the worst affected are those which invested most heavily in high-technology electronics manufacturing during the late 1990s. Singapore has now endured two successive quarters of economic contraction, and after non-oil exports shrank by 24% in July, the outlook for the third quarter appears no better. Taiwan too has slipped into recession, Malaysia is stagnant while economic growth in Korea has fallen to its lowest level since the depths of the Asian Crisis three years ago. "Electronics contributed enormously to the expansion of East Asian economies, and the technology boom of 1999 and 2000 was a godsend for the region," says Bijan Aghevli, Hong Kong-based director of Asian economic and policy research for JPMorgan Chase. "But over-dependence on electronics exposes the region to huge cyclical swings--Asia is paying for it now." Faced with such a sudden economic slowdown, governments could encourage business investment and domestic demand by cutting interest rates. They could boost their international competitiveness by depreciating their currencies, and they could attempt to prime their economic pumps by raising government spending or by cutting taxes. Of the East Asian economies, Korea gets the top marks from analysts for its policy response to the slowdown. The Bank of Korea moved early to loosen monetary policy in reaction to the approaching slowdown, cutting interest rates and allowing the won to weaken. As a result, relatively robust consumer demand has helped mitigate the impact of the global trade downturn on Korea, which recorded year-on-year economic growth of 2.7% in the second quarter. The region can learn from Korea's example, says Desmond Supple, head of economic research at Barclays Capital in Singapore. "Asia has suffered an unprecedented external shock, but the policy approach in Korea could quite easily be replicated in other countries across the region," he argues. Even so, monetary measures are no cure-all for the region's economic ailments. With Asia's manufacturing economies suffering from over-capacity, low credit demand and depressed external demand, cutting interest rates and depreciating currencies is a classic example of policy-makers pushing on a string. That leaves fiscal measures, but regional governments have found their ability to spend their way out of economic trouble severely constrained. In Taiwan the government of President Chen Shui-bian has whittled its proposed spending package of NT$810 billion ($352 billion) down to just NT$61.6 billion this year. With a fiscal deficit of around 4% of GDP and gross government debt projected by Standard & Poor's to hit 40% of GDP this year, there is little chance of further fiscal measures stimulating the economy to any appreciable degree. In Singapore the government has proved reluctant to initiate new fiscal measures, despite plentiful reserves. Prime Minister Goh Chok Tong has announced a S$2.2 billion ($1.2 billion) stimulus package, but in infrastructure-rich Singapore spending on public works has little effect. Extensive tax cuts would likely be more beneficial, but, as in the past, the government has proved unwilling to cut back its own funding. Part of the reason is that Singapore's leaders have an eye to the longer- term economic future of their tiny island. At the national day rally last month, the prime minister warned of the economic challenges posed by an emergent China, serving notice that Singapore must find its economic niche "as China swamps the world with her high-quality but cheaper products". This is the problem confronting the rest of Asia, and indeed the whole world. China's cost advantages and the diversity of its exports have cushioned it well from the downturn in global trade. Although exports dipped by 0.6% year- on-year in June, they staged a healthy 6.6% bounce in July. Moreover the small size of exports relative to China's GDP--around 20%, compared to 65% in Thailand or 125% in Malaysia--means there has been little impact on overall growth rates. Pumped-up government spending and the inflow of foreign direct investment in advance of China's accession to the World Trade Organization--almost $28 billion in the first seven months of the year--are more than capable of making up for the export slump, and China remains on course to notch up GDP growth of around 8% this year. It's hard to overstate the economic challenge for other Asian countries. While their economies are stalled, China's is racing ahead. "China is the world's lowest-cost producer of everything," says Tim Condon, chief economist at ING Barings in Hong Kong. When export demand finally recovers, it is naturally going to gravitate towards China. Happily though, while China's cost advantages do pose problems for the rest of Asia, they are not insurmountable. The model is Hong Kong. Back in the early 1980s, manufacturing industries constituted around 50% of Hong Kong's economy. Today the proportion is under 10%. That shift might have been expected to trigger a major structural increase in unemployment, but Hong Kong's jobless rate is 4.7%, lower than Taiwan's at 4.92% or Japan's at 5%. Of course Hong Kong's proximity to and links with China are a major advantage, but so too is the territory's economic flexibility, according to Condon. Relative freedom in capital, labour and property markets allowed Hong Kong's businesses to re-engineer themselves to succeed in the new economic environment. Economists believe the rest of Asia can learn from Hong Kong's lesson. Rather than seeking to channel resources into new export sectors, as the Taiwan and Singapore governments are doing by championing their local biotechnology industries, governments should retreat from industry through deregulation. "It is presumptuous of governments to say 'This is where our economy should go'," argues Sun Bae Kim, director of Asia-Pacific economic research at Goldman Sachs in Hong Kong. Instead Asian governments should focus on strengthening their fragile banking systems so the market can allocate credit according to supply and demand. This may be politically unpalatable. Coping with the emergence of China will require Asian countries to be a lot more nimble and to run a great deal faster than they are now. Some may baulk at the challenge. "Countries will have to go back to fundamentals and ask 'What's our comparative advantage?'" says independent economist Simon Ogus, chief executive of Hong Kong based consultancy DSG Group. "If Thailand wants to continue to produce steel and Malaysia wants to go on making cars, they will have to protect these industries behind trade barriers, because they have no comparative advantage. Given the nationalistic tenor in Southeast Asia, that might well happen." If it does it will be a shame for the people of those countries. Retooling economies to face China's competitive challenge will inevitably involve some economic dislocation, and very likely higher rates of unemployment. But erecting trade barriers to protect national industries amounts to opting out of the economic development race. If East Asians want to advance the economic progress made over the last 20 years, they will just have to run faster.
