Quotes of the Day
Asia appears to be recovering from the global recession faster than the West. But the financial imbalances that triggered the worst economic crisis in memory could still put the brakes on the world's fastest-growing economies. So warns economist and Morgan Stanley Asia chairman Stephen Roach in his new book, The Next Asia, a collection of his essays and analysis from the past several years that foreshadowed the meltdown. The following is an exclusive excerpt from the book's introduction.
As the most dynamic and rapidly growing region in the world over the past decade, developing Asia has attained a new level of prosperity. From China to India, the region's per capita income has more than doubled since the wrenching Asian financial crisis of 1997-98. Since 1990, over 400 million fewer Asians are living in poverty on incomes of less than $2 per day. On the surface, the region has much to celebrate on the long and arduous road to economic development. Many believe the Asia Century is now at hand.
Such celebration may be premature. As 2008 came to an end, every economy in the region had either slowed sharply or tumbled into outright recession. Far from having the autonomous capacity to decouple from weakness elsewhere in the world, export-led developing Asia had become even more tightly tethered to foreign markets than was the case a decade earlier. The export share of panregional gross domestic product (GDP) hit a record 47% in 2007, fully 10 percentage points higher than the portion in the late 1990s. With approximately 50% of those exports earmarked for the rich countries of the developed world, a rare and sharp synchronous downturn in the U.S., Europe and Japan undermined an increasingly important source of Asia's seemingly invincible growth dynamic. Far from celebrating a newfound resilience, the region was reeling from a severe external shock. Like it or not, Asia's newfound ascendancy remains precarious.
Ironically, this very outcome was predicted by China's Premier, Wen Jiabao. In a statement following the conclusion of the National People's Congress in March 2007, Premier Wen acknowledged that the Chinese economy looked extremely strong on the surface, especially in terms of GDP and employment growth. Yet, beneath the surface, he cautioned, such strength was far more questionable. In the case of China, he warned of an economy that was increasingly "unbalanced, unstable, uncoordinated and unsustainable." Little did he realize at the time how those "four uns," as they were later to become known, would pose an immediate and tough challenge to China's growth imperatives. Nor did he or other Asian leaders appreciate the broader implications of those insights for the region as a whole.
In warning of the precarious state of the Chinese economy, Wen was expressing concerns about the nation's very risky macro bet. With nearly 80% of its GDP going to exports and fixed investment, China had become overly reliant on cross-border trade and on the investments required to support the logistics and capacity of its increasingly powerful export machine. Not only has China slowed dramatically — with export growth turning sharply negative in late 2008 and industrial output growth slipping into the low single digits — but the rest of an increasingly China-centric Asian economy has been quick to follow.
China's export dependency went far beyond the unbalanced structure of its real economy. Its financial and currency policies were also aimed at deriving maximum support from external demand. A closed capital account and an undervalued renminbi (RMB) were icing on the cake for China's powerful strain of export-led growth. Moreover, to the extent that its currency-management objectives required ongoing recycling of a massive reservoir of foreign-exchange reserves into U.S. dollar – based assets, such capital inflows helped keep longer-term U.S. interest rates at exceptionally low levels. In effect, China's implicit interest-rate subsidy ended up becoming an important prop to bubble-prone U.S. asset markets and, ultimately, for the asset-dependent American consumer.
The linkage between Asian growth and the American consumer bears special mention. The U.S. consumer is still the dominant consumer in the global economy. Although America accounts for only about 4.5% of the world's population, its consumers spent about $10 trillion in 2008. By contrast, although China and India collectively account for nearly 40% of the world's population, their combined consumption was only about $2.5 trillion in 2008. During the boom, China and the rest of Asia reaped enormous benefits from a mercantilist growth model that was tied increasingly to the voracious appetite of the American consumer. Unfortunately, Asia did not do a good job in hedging that bet. The U.S. could now be in the early stages of a multiyear consumption retrenchment, making the problems of an unbalanced, export-dependent Asian economy even more acute.
But that's not the only challenge that Asia faces. Significantly, Wen's warning was not just about the imbalances of an economic and financial structure that had become overly reliant on exports. By raising concerns over instability, he was also cautioning of the perils of overreliance on energy, industrial materials and base metals. In an era of booming global growth, the threat of the so-called commodity supercycle and its ever higher price structure was a crushing burden on resource-intensive developing nations. The Premier urged China to focus more on what he called a "scientific development" strategy that would be based on improved efficiencies of resource consumption. Similarly, by warning of a lack of coordination, Wen was highlighting the fragmentation of the Chinese system — not just its banks and companies but also a system of governance that was still heavily dominated by power blocs at the provincial and local level. And his concerns over sustainability were specifically aimed at pollution and environmental degradation — unmistakably negative externalities of China's fixation on open-ended, manufacturing-led economic growth. To the extent that the Chinese experience is a microcosm of the broader Asian development model, Wen's "four uns" are very much a blueprint of what it will take to realize the aspirations of the Asian Century. Just as the financial crisis of the late 1990s was a wake-up call for the region to put its financial house in order, the global crisis and recession of 2008-09 is a strong signal for Asia to refocus the basic structure of its economic-development model.
From a macroeconomic point of view, better balance is Asia's most urgent priority. Central to that rebalancing will be the long-awaited emergence of the Asian consumer. For a region steeped in a culture of saving, this will not be an easy transformation. Here again, China undoubtedly holds the key. Its legendary excesses of precautionary savings are traceable to two major developments: massive layoffs associated with over 15 years of state-owned enterprise (SOE) reforms and the lack of an institutionalized social safety net. With SOE reforms likely to be ongoing — albeit probably at a slower pace in the years ahead — China needs more aggressive initiatives in the areas of social security, pensions, medical care and unemployment insurance.
Heightened efforts in the area of resource efficiency are also an urgent priority. A shift from manufacturing-led export growth to more of a services-based consumption model will relieve some of the inherent biases of energy- and resource-intensive growth. But Asia must do more in the way of investing in alternative energy technologies, retrofitting existing production platforms and moving to lighter construction and production techniques. Air and water pollution have become endemic to Asia's hypergrowth. That's especially true in China, home to seven of the 10 most polluted cities in the world and whose level of organic water pollutants is, by far, the worst in the world — more than three times the emissions rate of the No. 2 polluter, the U.S. Asia has attempted to explain away its poor track record, arguing that when scaled by its enormous population, its pollution problem still falls well short of developed countries'. Asian leaders have also argued that since economic development, itself, is a resource-burning and pollution-intensive endeavor, the delayed onset of the region's economic takeoff casts it unfairly as the villain in an era of global warming. Although both of these claims have considerable merit, a damaged planet engenders little sympathy for the Asian excuse. On an absolute basis, Asia now makes the largest contribution to total growth in global pollutants — a trend that must be arrested, regardless of the size of its population or the state of its economic development.
The Next Asia will also have to come to grips with its inherent lack of coordination by exerting greater control over its fragmented economies, markets and political systems. China's four largest banks, for example, still have over 50,000 branches between them — branches that in many cases function autonomously with respect to deposit-gathering and lending policies. Such a fragmented banking system has long been a major complication for China's central bank and its execution of a coherent monetary policy. Asia's rural-urban dichotomy also creates a natural fragmentation to its social and economic fabric — underscoring ever widening income and educational disparities that remain a major source of instability in the region. Widespread corruption further complicates the macro implementation of Asia's development imperatives. The more the region matures and makes further progress on the road to economic development, the greater the need for improved macro coordination.
Wen's "four uns" largely offer inward-looking prescriptions. But the Next Asia has much to gain from its external linkages — especially by focusing more on the benefits of cross-border economic integration. Perhaps the greatest opportunity in that regard could come from closer ties between the two greatest powers in the region: Japan and China. Despite a long and difficult history between them, these two nations are natural complements in many key respects. Japan, with its declining population and high-cost workforce, has much to gain from Chinese outsourcing and efficiency solutions. China, with its need for new technologies and pollution abatement, has just as much to gain from Japan's leadership position in both areas. And the rest of an increasingly integrated Asian economy would be well positioned to realize the benefits of supply-chain externalities that could be important by-products of greater integration between China and Japan.
Change and growth have been the mantra for Asia for the past quarter-century. But the endgame of sustained economic development and rising prosperity continues to be a moving target. Developing Asia has enjoyed spectacular success in the decade after the wrenching financial crisis of the late 1990s. But, as they say in the investment business, a track record of success is no guarantee of future performance. The current global recession is an important wake-up call for Asia — a not-so-subtle hint to find a new recipe for its growth model. The Next Asia that emerges from this transition will need to be all about a shift in focus from the quantity to the quality of the growth experience. Although the quality of economic growth is something of an amorphous construct, its attributes are undoubtedly steeped in better balance, stability, coordination, sustainability and integration. This is the essence of a critical transformation that could well usher in more of a pro-consumption, lighter and greener Asian economy than is the case today. The Next Asia will need to measure its success increasingly on those counts.
Change is never easy — especially on a scale that the Next Asia requires. But change has been at the core of all the Asian miracles of the post – World War II era. Once again, circumstances require this dynamic region to look inside itself and reinvent the model that will take it to the next phase of its remarkable journey. I remain confident that Asia will be able to pull it off. At the same time, I don't underestimate the risks that the Next Asia will face as it once again moves out of its comfort zone. That's something we all have in common in looking to the postcrisis era.
- Why the region's continuing economic progress depends upon new policies for a postcrisis world