All the pieces are in place for the 21st century to be the Asia-Pacific century. But the boom – led by China – will be driven by consumers and by markets, not by governments. Asia (excluding Japan) will be the driver of growth in the US and Europe, rather than the other way round. And, Jim Walker predicts, the upswing will spread cheer throughout the emerging market universe. –
During the mid-1990s it was common to hear the claim that the 21st century would belong to Asia-Pacific. This was based on the evidence of rapid growth in southeast Asia as well as in China.
But the term quickly fell out of use following the Asian crisis in 1997. That crisis, we felt, was highly predictable given the imbalances that had grown up in the region as a result of currency pegs and credit explosions.
For the past five years the region has been in a state of repair and regeneration. It is only now that we can see domestic demand beginning to build a new momentum in the region. China forms the pivot for that new momentum and for the real “Pacific Century”.
With the revolution that has occurred in the Chinese private sector – underlined by the emphasis placed on private property rights during last November’s 16th Communist Party Congress – it is clear that the axis of global growth is swinging eastwards in a way hitherto unimagined.
This is despite the fact that the world’s second largest economy, Japan, will remain moribund – apart from short bursts of muted cyclical upswings. Nor will it be because of yet another export-led boom emanating from the US.
This particular Asian upswing will be effected without great support from western economies. In fact, the coming Asian up cycle will be a driver of growth for the US and Europe, rather than the other way round. It will also be a major source of support for other emerging markets, especially commodity producers.
This leads to two questions. First, where will the growth come from? Secondly, which countries will be the leading lights in that growth? On the first question, there are four sources of domestic demand growth reinforcing each other in Asia:
- For the first time in three decades Asian consumers are being encouraged – rather than actively discouraged – to dip into their accumulated savings and spend. Interest rates are at generational lows and, given muted inflationary pressures, are not going to rise fast. High savings rates will not disappear overnight but there is likely to be a moderation in savings rates and, more important, consumers are beginning to borrow more against realistically priced collateral. In other words, net savings will fall. This process has already begun in many countries in the region, including China.
- Producers will react to growing domestic demand signals. The next investment upswing in Asia – and there are early signs that it is already beginning, with capital goods imports on the increase – will be market-led rather than government-led. It will also be concentrated on producing goods and services for domestic and regional consumption. This is hugely significant for the sustainability of the upcycle and the returns on investment that it will produce.
- Banks across the region have now had five years to repair their balance sheets following the Asian financial crisis. Some countries have been more successful and active than others but, by and large, financial institutions are in much better shape today than they were three years ago. Loan-deposit ratios suggest there is scope for significant credit expansion without the need to attract new deposits. This is another reason for believing that interest rates will stay low and that competition between the private and public sectors for funds will not cause crowding out.
- Perhaps most important, there is increasing confidence. This has been shown in surveys such as the biannual MasterCard consumer confidence index and various official business and consumer confidence reports. Moreover, individuals are heavily influenced by what is going on around them. This is particularly true in today’s age of the internet and digital communications. The signals are clear – from car sales to concert tickets – that consumption demand in many Asian economies is on the up. As sentiment and confidence improve they will spread like wildfire through economies that have been relatively depressed, especially in domestic demand terms, since 1997.
- The motive force in this new upswing is the realization by Asian governments that their ability to control and influence their respective economies is much more limited than they had previously thought.
After years of praise – from analysts, businessmen and the World Bank in particular – the 1997 crisis demonstrated that Asia’s cosy government-business complex was flawed. Government direction of investment resulted in poor returns – lots of GDP growth as measured conventionally, but not much profit.
Nowhere was this more the case than in China where the “Deng boom” of the early 1990s led to more bad debt overhang for the state banking system than any previous episode in the opening and reform process. But Beijing has learnt its lesson, it is no longer directing and controlling investment. That mantle has passed firmly to China’s resurgent private sector.
The Asian financial crisis achieved two things over and above the obvious recessions and bankruptcies. First, it demonstrated to Asian electorates (the population, in China’s case) that their governments were not omnipotent after all.
Secondly, it shifted a huge proportion of private debt onto the state’s shoulders (CLSA Emerging Markets’ May 2002 special report, Unravelling Public Finances: Gordian Debt, shows how Asian public debt-GDP ratios have grown in the last decade).
While this might not seem like a good thing at first sight, it has positive consequences – and, as with so many aspects of economics, unintended ones. With most Asian governments now facing severe public debt burdens, the pressure is on to minimize public involvement in the private economy and to privatize and or rationalize old (and new) state assets.
Whether they like it or not, Asian governments are being forced to withdraw from the government-business complex. This is ultimately good news for both growth and return on investments.
With this in mind we can also draw conclusions for our second question, as to which countries will be leading lights. First and foremost, there is China. Growth at the margin in China has passed firmly to the private sector. The state-owned banking system and state-owned enterprises are no longer the main drivers or mechanisms of growth.
This means that China’s growth quality is improving and becoming more sustainable. This is good news for demand throughout the region. Elsewhere, the countries that are demonstrating the greatest increase in domestic private sector activity are Korea, Thailand, Malaysia, Indonesia and (tentatively) India. This group makes up the vast bulk of the Asian population.
Already the influence of China is becoming apparent in terms of intra-regional trade. Although regarded as a threat in some quarters of the Association of South East Asian Nations (Asean), China has become the rest of the region’s fastest-growing export market.
Year-on-year export growth rates to China of 50% to 100% were common in 2002. In some countries, the absolute increase in exports to China compensated for the declines to the US and Europe.
Of course, many manufacturers around the region and elsewhere will fail to compete with cheap products from China. But that is the nature of capitalism’s creative-destructive process. In their place will grow companies and industries that supply the goods and services China does not produce. That is the beauty of international specialization and exchange. Consumers globally will benefit from this continuing tension.
But back to the region: why can one be so confident of Asia’s growth prospects over the next three to five years? The four sources of growth that are driving domestic demand have already been mentioned. In addition, the economic environment has changed. It has become much more conducive to market-driven growth (what can be termed “consumer sovereignty”).
Furthermore, despite their complex character, economies display some long-term regularities. One of these is the tendency for economic systems to grow naturally. Endogenous growth comes from a combination of specialization and expansion of factors such as labour and capital.
Even after a period of recession or pessimism about growth prospects, these natural tendencies come to the surface. The recent strength in consumer spending patterns in various countries across the region is a good indication that the growth tendency is resurfacing. Lastly, financial systems have been partly repaired and are in good enough shape to begin their intermediation process once again. This is in marked contrast to the malaise that bedevils Japan still.
The conditions and timing are right for a cyclical upswing in domestic demand in Asia. Clearly the region cannot fully compensate for a weak US economy, a sclerotic Europe and a sick Japan.
But, when the underground component of GDP is taken into account, Asia ex-Japan probably represent around a $4 trillion to $5 trillion annual market (on official GDP numbers Asia ex-Japan amounts to a $3 trillion economy, but we estimate unofficial activity at around one half of this total, if not more). This is half the size of the US, but just as large as Japan.
In its own right Asia is a sizable engine of growth in world terms. Commodity producers will be particularly glad to hear this. Asians are still “goods poor” by international standards. This means that, as Asian income levels rise, more of each incremental dollar is spent on goods than would be the case were incomes rising in the US, Europe and Japan.
In the rich countries people tend to spend more on services with each marginal increase in income. Since goods are commodity intensive, an upswing in Asian economic fortunes will underpin demand for commodities and, thus, commodity prices. The turn in the Asian cycle will spread cheer throughout the emerging market universe.
Jim Walker is chief economist of CLSA Emerging Markets, a Hong Kong-based securities firm.