from Follow the Money

Asia’s two recessions

February 1, 2009

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During the good times, both exports and investment boomed. Indeed, the fact that China ran a large current account surplus even as Chinese domestic investment soared -- something only possible because of a large increase in China’s national savings rate -- was one of the global economy’s core puzzles. Investment booms generally lead to current account deficits (setting aside investment booms financed by spare petrodollars) not large surpluses.

The risk always was that exports and investment might turn down at the same time. And, alas, that indeed is what seems to be happening. The Economists’ analysis this week was spot on:

many of Asia’s tiger economies seem to have been hit harder than their spendthrift Western counterparts. In the fourth quarter of 2008, GDP probably fell by an average annualised rate of around 15% in Hong Kong, Singapore, South Korea and Taiwan; their exports slumped more than 50% at an annualised rate ... .

In the fourth quarter of 2008, real GDP fell by an annualised rate of 21% in South Korea and 17% in Singapore, leaving output in both countries 3-4% lower than a year earlier. Singapore’s government has admitted the economy may contract by as much as 5% this year, its deepest recession since independence in 1965. In comparison, China’s growth of 6.8% in the year to the fourth quarter sounds robust, but seasonally adjusted estimates suggest output stagnated during the last three months.

Asia’s richer giant, Japan, has yet to report its GDP figures, but exports fell by 35% in the 12 months to December. In the same period, Taiwan’s dropped by 42% and industrial production was down by a stunning 32%, worse than the biggest annual fall in America during the Depression.

Note the scale of the fall in Taiwanese production. There is a big difference between "worse since the Depression" and "worse than the Depression." Hopefully the fall in Taiwanese production reflects a one-off inventory adjustment in the global electronics supply chain. Japanese industrial production is also down significantly.

Asia’s slowdown isn’t just a magnified reflection of the fall in US (and European) consumption. The Economist notes in its leader: "Most of the slowdown in regional economic growth so far stems not from a fall in net exports but from weaker domestic demand."

More details are provided in the longer analysis piece:

Asia’s export-driven economies had benefited more than any other region from America’s consumer boom, so its manufacturers were bound to be hit hard by the sudden downward lurch .... Shocking as the export figures are, they are not entirely to blame for Asia’s woes. A closer look at the numbers reveals that in most countries imports have fallen by even more than exports, and that weaker domestic demand explains a larger part of the slump.

In China, for example, weaker domestic spending—mainly the result of a collapse in housing construction—accounted for more than half of the country’s slowdown in 2008. In South Korea, net exports actually made a positive contribution to GDP growth in the fourth quarter, while consumer spending and fixed investment fell at annualised rates of 18% and 31% respectively. ... Domestic spending has collapsed elsewhere. Over the past 12 months, retail sales have fallen by 11% in Taiwan, 6% in Singapore and 3% in Hong Kong. ...

A recent report by Frederic Neumann and Robert Prior-Wandesforde, two economists at HSBC, a large bank, argues that Asia is suffering two recessions: a domestic one as well as an external one. Domestic demand had been expected to cushion the blow of weaker exports, but instead it was hit by two forces. First, the surge in food and energy prices in the first half of 2008 squeezed companies’ profits and consumers’ purchasing power. Food and energy account for a larger portion of household budgets in Asia than in most other regions. Second, in several countries, including China, South Korea and Taiwan, tighter monetary policy intended to curb inflation choked domestic spending further. With hindsight, it appears that China’s credit restrictions to cool its property sector worked rather too well.

The two recessions reinforced one another. Part of the slump in domestic spending is attributable to falling exports, which force firms to cut investment and lay off workers.

The fact that China’s imports are falling more than its exports may not be an accident; China’s domestic economy has slowed alongside its export sector. That is a problem for China -- but also the world. China would find it far easier to transition away from export-led growth if investment was soaring even as trade contracted.

That is, incidentally, what happened in the US in the late 1990s: a boom in investment (think .coms) offset the impact of the Asian crisis on US trade. And US demand, in turn, helped pull Asia out of its crisis.

The Economist argues that Asia cannot continue to rely on foreign demand to pull Asian economies out of their cyclical downturn -- or as a future source of growth.

Asian governments have more than this year’s growth rate to worry about. Beyond the immediate crisis, where will growth come from? America’s consumer boom and widening trade deficit, which powered much of Asia’s growth over the past decade, has come to an end. America’s return to thrift is unlikely to prove a cyclical blip. For years to come, Americans will have to save more and import less. Asia’s export-led growth therefore seems to have reached its limits.

It needs a new engine of growth: in future it must rely more on domestic demand, especially consumption. In recent years, it has been doing the opposite: consumer spending has fallen as a share of GDP, while the share of exports and investment has climbed (see chart 4). Two decades ago, consumer spending accounted for 58% of Asia’s GDP. By 2007 it had fallen to 47%. Consumer spending in China is just 36% of GDP, half the American share.

The fall in China’s ratio of consumer spending to GDP largely reflects a fall in wage income to GDP, not a rise in household savings. The Economist notes, correctly:

"The popular explanation [for the fall in consumption] is that it is all because frugal households have been saving a bigger slice of their income in response to uncertainty over pensions and social welfare—uncertainty that will presumably increase in a recession. But this doesn’t quite fit the facts. In many countries, notably South Korea and Taiwan, household savings have fallen relative to income in the past decade; in China they have been broadly flat. (The rise in China’s savings rate comes from firms and the government, not households.)

The core goal of Chinese policy over the next few years, it seems to me, should be to raise the ratio of consumer spending to GDP. China’s exports aren’t going to increase by factor of five over the next eight years; mechanically, exports simply can not provide the boost they did in the past. And investment is already very very high relative to GDP. That leaves only one potential engine that could propel China’s future growth ...

UPDATE: Korea’s January trade data was terrible. Exports to China are down more than total exports. And Korea is now running a trade deficit despite the huge fall in commodity prices because exports have fallen more. Japan is in a similar position. That suggests a huge fall in the global current account surplus, as the fall in the oil exporters surplus doesn’t seem to be offset by a rise in Asia’s surplus.

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