Flaws of export-led Asia growth model surface

Flaws of export-led Asia growth model surface

BEIJING

Tuesday, September 30, 2008

THE deepest financial crisis since the Great Depression is likely to do more than years of international prodding to wean China and its Asian neighbours off their export-led model of economic growth.

Washington's US$700 billion mortgage bailout will reshape the US financial industry, perhaps for a generation or two, in ways that are not yet clear. The fallout for the rest of the world will be far-reaching.

But for Asia, one consequence of the turmoil is already inescapable. After living beyond its means for many years, America will have to rebuild its savings, so consumption will fall. Exports to the US from China, Taiwan, Hong Kong and now South Korea are already weakening. The need to take up the slack is urgent.

"I think this is a wake-up call for China," said Stephen Roach, the chairman of Morgan Stanley in Asia.

Roach expects US growth to slow from an average of 3.2 per cent over the past 13 years to no more than two per cent over the next two to three years. Consumption growth is likely to halve to around two per cent as debt burdens are pared back.

As economic weakness spreads to Europe and Japan, the hit to China's exports could cut its growth rate from around 10 per cent now already down from 11.9 per cent in 2007 to about eight per cent, in Roach's view.

"It just underscores the fact that when you have a vibrant but very large export sector, when you have an external shock and you don't have a lot of dynamism on the internal demand side, you have greater risks to growth," he said at the weekend during a meeting of the World Economic Forum in Tianjin, northern China.

Central banks in the region are already responding. Taiwan, China, Australia and New Zealand have all cut interest rates.

Easing monetary policy is all well and good, especially as inflationary risks are receding. Many countries can also afford to resort to fiscal stimulus.

But stoking domestic demand also requires long-haul reforms that sometimes shake the very foundations of an economy such as scrapping deterrents to foreign investment in Japan, ending protection for favoured groups in Malaysia or subjecting dominant firms to more competition in the Philippines and Hong Kong.

These are politically arduous tasks at the best of times. That's why economists wanted governments to get cracking on them while the going was good.

Countries instead largely shirked the challenge, content to rely on export-led growth by holding down their exchange rates.

Quite apart from hindering the needed rebalancing of the global economy, an undervalued currency acts as a tax on domestic demand, Hong Liang and Yu Song, economists who follow China for Goldman Sachs in Hong Kong, noted in a report. The result is evident in the case of China, where household consumption last year came to just 35.3 per cent of gross domestic product an unprecedented low in peacetime for a major country.

This means that a lopsided economy has scant domestic demand to fall back on as the global downturn deepens. "The real costs of China's resistance to yuan appreciation are now becoming more apparent," Liang and Song wrote.

So what is to be done?

For the region more broadly, a precondition of stronger domestic demand is a more efficient financial system. For too long, Asia has in effect contracted out to Wall Street the job of managing its excess savings.

If Asia's surpluses now shrink and it keeps more money at home, the region will have to deepen its bond markets at last and, ironically, promote more financial innovation so capital can be invested productively.

With complex, new-fangled debt instruments now discredited, making the case for financial liberalisation will be tough.

Regulators in Asia will now be extremely cautious about approving any new forms of securitisation, said James Seward, a financial sector specialist at the World Bank.

Reuters