The Hindu Business Line : China's growth model slows Asia's rise

The biggest drawback of China's growth model on the rest of Asia is the perpetuation of the export dependent approach. It has postponed Asia's nascent search for an indigenous or domestic demand-led growth model. China has condemned East Asia to s tatus quo. To that extent, it prevents or delays the emergence of Asia as a global economic locomotive, says V. Anantha Nageswaran.

THE REST of the world is watching China's rise with trepidation. Crude oil is reaching $50 per barrel and China's demand is cited as the cause. America attributes its lacklustre job market and high trade deficit to China's exchange rate. Closer home, conventional wisdom approaches the question of whether China is a threat or an opportunity from the angles of international trade and investment diversion to that country at the expense of the rest of Asia, in particular, East Asia. On the investment side, the data are inconclusive. Investment into the rest of Asia has picked up in recent years even as inflows into China have continued to climb.

It is always an interesting but hypothetical exercise to argue if the rest of Asia would have received more investment in the absence of China. But a counterfactual scenario would be hard to establish and hence the debate is more academic.

On the trade side, there has been a clear beneficial effect, on surface, of China's growth on the rest of Asia. A closer look at the data shows that the end-demand originates mostly outside of China. Regardless of these issues and their resolution, this article argues that the biggest drawback of China's growth or, more precisely, its growth model on the rest of Asia, has been the perpetuation of the external demand-led or export dependent growth model. It has postponed (East) Asia's nascent search for a domestic demand-led growth model. China has condemned East Asia to status quo. To that extent, it prevents or delays the emergence of Asia as a global economic locomotive.

I shall start with a comment from Goldman Sachs:

We had termed this year `Asia Becoming Confident'. In particular, we expected the Asian nations to allow their currencies more flexibility. However it is becoming increasingly likely that the optimal window for this to take place was in 2003 and the failure of Asian policy makers to leverage the strong external recovery over the last few years into a stronger domestic demand recovery via currency revaluation is starting to look like a missed opportunity. (Source: Global Markets Research Daily of Goldman Sachs dated September 15, 2004.)

Goldman calls it a missed opportunity to revalue currencies and rely on domestic recovery. Asian central banks and their governments did not do so because they lack the confidence to do the painstaking task of building domestic economic pillars. They still consider or would like to consider themselves as developing nations riding freely on global growth momentum, attracting FDI and producing for exports markets, by and large.

Data show that post-crisis recovery in Asia is still built on the foundations of exchange rate weakness that was a part of the crisis. Investment spending has declined and share of private consumption remains static. Of course, if the experiment with private consumption growth in Thailand and Korea in the last few years is anything to go by, it is perhaps a good thing. East Asia still lacks institutional strength to handle the transition from managed, hybrid economies to purely market economies. Public sector consumption has not picked up anywhere except in Malaysia. This just leaves the external sector as the engine of growth. Given this, it is but natural that they wish to keep their exchange rates weak. Asian currencies, against the US dollar, remain well below their 1997 nominal values.

Where does China figure in this?

To a large extent, it was China's devaluation of its currency that set the stage for Asian currencies to become overvalued in relative terms, in the course of the mid-1990s. From the spring of 1995, the US dollar found a spring in its step and it led to the overvaluation of their currencies and erosion of Asian competitiveness. Coupled with Chinese yuan devaluation, the erosion of exchange rate competitiveness, among other things, contributed to the economic crisis.

Fast forward to the present. China is in the same stage as the rest of East Asia was in the 1990s. It has a high investment ratio, improving but low productivity, high FDI and high degree of export reliance for a large economy. Its combined FDI and export-led growth make it far more open that conventional wisdom would suggest.

Despite a vast economy of its own, why did China choose the FDI, high domestic savings and export-led growth model? A closed Communist and authoritarian society did not have really a blooming domestic entrepreneurial class. The public sector occupied the commanding heights in terms of sheer muscle power and the plumbing depths in terms of quality and value addition. Private household consumption is only now emerging as a powerful growth engine. Further, the role model in East Asia from Japan and other tiger economies was a combination of this: High domestic savings, investment, exports and weak currency.

Further, the dysfunctional financial system in China means that its currency could depreciate significantly once floated. As the world came to know of the deficiencies in the banking system in other Asian countries in the wake of the economic crisis, their currency values plummeted. A similar outcome could be in store for the yuan.

Therefore, for other export-led Asian nations, there is no choice. China is following an externally dependent growth model. So, they have had no time to contemplate a different economic regime after the Asian crisis. In addition, the uncertain future trajectory of the Chinese Yuan exchange rate is another risk to keep in mind.

Intra-regional trade is global demand by proxy

Indeed, the fact that they do exposes the limitations of the argument that intra-regional trade in Asia has grown strong fast enough for Asia to be its own growth locomotive. There is a very high correlation (0.8) between intra-regional exports to China and that of China's exports to the EU, Japan and America.

This high intra-regional trade is apparently intra-industry trade, particularly electronic manufacturing. Countries such as Korea and Taiwan export semi-finished and/or high value-added components to China to be assembled there with low-cost labour for onward export to third-country markets. Now, imagine that East Asian governments, excluding China, decide to let their currencies appreciate. This would simply mean more FDI into China from other East Asian nations and a corresponding fall in intra-regional trade, as all stages of manufacturing would move to China.

To conclude,

East Asia has relied on exports post-crisis, as they are not confident of their domestic economic institutions and management.

China partially contributed to the crisis in the 1990s with its own yuan devaluation. Further, China is continuing to rely on its competitive exchange rate to attract FDI and maintain high export growth. It may be due to relatively low productivity growth or that the economy's deficiencies would be cruelly exposed if the exchange rate appreciates. Given this policy stance, other East Asian countries have decided that a competitive exchange rate is an indispensable and, perhaps, the only economic policy tool.

This external reliance — FDI plus exports — is crucially delaying the maturing of Asian economic skills, management and institutions. The longer the delay, the more painful the later transition. In that sense, China is helping to perpetuate the existing world order and not dismantle it.

In the short-term, it means that there is no alternative to America. If the US economy suffers an economic slowdown, do not look to either China or the larger Asia to step in, to fill the void. They would be hurt first and the most. Further, with the price of crude oil flirting with $50, it would be difficult not to contemplate the coming fight over resources. Former Asian tigers might appear to be benefiting from China's growth by moving on to higher value added production and assembling lower value production in China. But they compete with China for raw material such as oil.

Finally, China remains a country where capital allocation is not market-determined but state driven. Such an economy can never be a market economy but only a political economy. A large state whose underlying economic structure is political would remain more of a threat to others than an opportunity, as long as its structure is unchanged.

(The author is founder-director of Libran Asset Management (Pte) Ltd, Singapore. The views are personal. Address feedback to anantha.nageswaran@libranfund.com)

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