Global Trends by Martin Khor

Monday, 12 September 2011

Asia needs to confront new global crisis

The renewed global economic slowdown is putting pressure on Asian countries to review their export-based growth model and their vulnerabilities to the inflows and outflows of capital.


Amid more and more signs that the global economy is slowing, possibly towards a new recession, Asian countries facing the adverse effects will have to consider their policy responses.

Last week, finance ministry and central bank officials and economic experts from Asian countries gathered in Manila for a workshop on Asia and the global crisis.  It was organized by the UN Economic and Social Commission for Asia-Pacific and hosted by the Philippines Central Bank.

It was a timely meeting, especially since the near-term economic prospects in the United States, Europe and Japan have worsened so significantly in recent weeks.

In the 2008-2009 “great recession”, the region was affected by a sharp drop in exports which caused a dip in the Gross National Product.

But the economic stimulus policies in the advanced developed countries and many Asian countries (including Malaysia, China and India) led to a quick recovery.

A switch in policies from fiscal stimulus to austerity in the developed countries is a major reason for the recent slowdown, which is likely to last longer.

Asia is vulnerable to a new downturn, because of its high reliance on exports.  A South Centre paper estimates that exports contribute about 50% of China’s recent pre-crisis growth.  China is already preparing for reduced export and GNP growth.

The shared wisdom is that China has to increase domestic consumer spending as its future growth engine. But that is easier said than done.

In recent years the share of consumption in GDP has gone down from 55% in late 1990s to 36% in 2008.  A main reason is that wage increases lagged behind productivity increases. As a result the share of wages in GDP fell to about 40% at present from 50-55% in the 1990s.

China is now taking measures to raise workers’ wages, which can then spur domestic demand. But there is also a fear that higher wage rates may make Chinese firms uncompetitive as they have low profit margins.

Many other Asian countries are even more export dependent.  In Indonesia, Korea, Taiwan and Thailand exports contributed over 60% to growth, compared to 40-50% in China.  The export dependence of Malaysia, Singapore and Vietnam is even higher.

They are very vulnerable to a slowdown in exports to developed countries as well as to China.  For every $100 worth of processed manufacturing exports of China to the US and EU, about $35-$40 go to East Asian developing countries. They export a lot of the components that China uses to make its exported products.

Thus a slowdown of Chinese exports to the US and EU will also have a strong impact on Asian countries.

In many Southeast Asian countries, a major problem is the seeming lack of investment opportunities, since investment is lagging behind savings.

In Malaysia, Singapore, Philippines, Taiwan and Indonesia, investment rates have been around 20 per cent of GDP in recent years, less than half the rate in China.

Their investment rates not recovered to the levels attained before the 1997 Asian crisis.  They are too low to generate a rapid growth of effective demand.

These countries need to plan for new sources of growth based on higher domestic demand, as well as expanded trade among the countries in the region and in other developing regions.

A key lesson learnt by many Asian countries from the 1997-99 Asian crisis is that they should not be caught in a vulnerable situation having their foreign reserves drawn down to the point of facing a debt default.

Thus the high current account surpluses and significant accumulation of foreign reserves have cushioned many countries during the 2008-2009 global crisis.

However, the region also faces a number of financial vulnerabilities that the new global turmoil may make more evident.

First, some countries in the region have significant current account deficits and rely on inflows of foreign capital to meet the deficits.  They could face balance of payments problems should exports deteriorate, or if there is a reversal of capital flows.

Second, many Asian countries have been liberalizing their capital flows in the past decade. They opened up to foreign capital inflows, including direct investment, portfolio investment and loans.  They also allowed capital outflows by resident individuals, banks and companies.

Thus they are now more susceptible to surges of both capital inflows and outflows of funds by local companies and individuals.

In periods where capital inflows are large, they balance out or exceed resident outflows.  However, when a country faces a reversal of foreign capital flows, it would be difficult to bring back the local capital that went abroad.

As a result, the country is exposed to the risks of significant net outflows. If this is not adequately matched by a surplus in the trade and current accounts, its balance of payments position could deteriorate.

Third, Asian countries are exposed to surges of international funds searching for higher yield.  The recent wave of capital inflows has caused problems such as currency appreciation (resulting in exports being less competitive), excess liquidity, inflationary pressures, and bubbles in equity and housing prices.

They are also vulnerable to a sudden reversal of capital flows, which can have devastating effects. Some Asian countries like Thailand and Korea have used capital controls to reduce inflows, but the pressures continue.

Fourth, many Asian countries have made losses due to the fall in value of their foreign reserves, much of which are held in US treasuries and bonds, as a result of the dollar’s depreciation. The present lack of alternative to the dollar as a global reserve currency makes this problem more acute.

While Asian countries can take national policy measures to control or reduce the vulnerabilities above, these may not be effective unless there is collective action at the global level.

Thus, policy makers in the region should be more active in pushing for global financial reforms.  This was one of the conclusions of last week’s Manila meeting.

The new global slowdown has made it all the more urgent to rethink the national and regional growth models, and to have a strong regional voice in global economic policies and financial reforms.