Asia Pacific: Asia's Economic Sovereignty
Daniel Lian (Morgan Stanley)
Two recent events led me to ponder the subject of Asian economic sovereignty. The IMF (International Monetary Fund), after acknowledging last September that Malaysia has done the right thing in imposing exchange rate controls and installing a fixed currency peg, has further acknowledged in recent weeks that it has miscalculated the economic consequences of its tough Ã¢ÂÂcredit shrinkingÃ¢ÂÂ policy in Indonesia. It is clear that Western expertise does not always benefit Asia.
Second, in India, the Congress Party scored an unexpected victory over the incumbent BJP in May, despite the latterÃ¢ÂÂs sound record in economic restructuring and growth. Market participants were starkly reminded that rural development matters to economics and investment. It is clear that there are critical flaws in the standard outward-oriented economic development model embraced by Emerging Asia.
Shallow Economic Growth versus Economic Development with Sovereignty
The issue of AsiaÃ¢ÂÂs economic sovereignty appears to be a taboo subject that few people want to discuss.
Yes, there is no doubt that Western-style economic development has benefited Asia. Japan is a full-fledged developed economy. Hong Kong and Singapore enjoy living standards to rival the West. Korea and Taiwan are successful, high-income industrialized economies.
But first, Japan is not Asia (see discussion later). Second, the spectacular rise of Hong Kong and Singapore is largely due to these economiesÃ¢ÂÂ efficient intermediary role servicing inefficient hinterlands and their lack of a rural sector. As their neighborsÃ¢ÂÂ efficiency improves, living standards in these merchant city states may deflate. The rest of Emerging East Asia cannot duplicate the economic models of Hong Kong and Singapore. Third, it is too early to call the successful economic stories of Korea and Taiwan Ã¢ÂÂpermanentÃ¢ÂÂ as their ownership of intellectual property and their pricing power in the global market is at best tenuous.
The rest of East Asia is far from attaining economic prosperity. In China and India, a combined 1.5 billion rural dwellers Ã¢ÂÂ or close to a quarter of the worldÃ¢ÂÂs population Ã¢ÂÂ have not benefited much from economic development. At least 500 million Chinese and Indians live on family income of less than US$1 a day. In Thailand, 40% of the population is rural and accounts for less than 11% of GDP. In Indonesia and the Philippines, respectively, 20 million and 10 million people earn less than US$1 a day.
The reality is that these independent East Asian states have enjoyed political sovereignty and have embraced Western economic development models for several decades. In my view, one needs to examine economic development in the context of economic sovereignty.
Political sovereignty and nationhood arrived in developing Asia starting in the 1950s after the end of the Second World War. This also marks the beginning of a rapid end to Western Imperialism and colonization. The end of colonization meant Asia now has a wide-open platform to pursue economic development. After a brief flirtation with import substitution in the 1950s and 1960s by some Asian countries, most Northeast and Southeast Asian economies joined the bandwagon of export-orientation. China started to embrace some aspects of market economics in the late 1970s, and India started to experiment with economic liberalization and outward orientation a decade ago. So what is wrong with this seemingly Ã¢ÂÂprogressiveÃ¢ÂÂ path for Asia? The trouble is that it has been an extremely imbalanced development model.
The global economy has suffered massive global imbalance for the last several decades. This global imbalance has centered on saving, i.e., AsiaÃ¢ÂÂs excessive saving compared with inadequate saving in the US and parts of the West. From another macro perspective, the imbalance is characterized by AsiaÃ¢ÂÂs gigantic export machine and the US and parts of the WestÃ¢ÂÂs appetite for Asian goods. In some sense, AsiaÃ¢ÂÂs export machine has ensured that its current account surpluses have been finely balanced against the global imbalance in savings.
In 2003, Japan and Non-Japan East AsiaÃ¢ÂÂs (NJEA consists of China, Korea, Taiwan, Hong Kong, the ASEAN-Five and India) gross national savings rates were, respectively, 26% and 36% relative to the USÃ¢ÂÂs 14%, the EUÃ¢ÂÂs (ex-UK) 21%, and non-US Anglo Saxon countriesÃ¢ÂÂ (UK, Australia, Canada and New Zealand) 18%. In fact, Japan and NJEA had combined gross national saving of some US$2.4 trillion (Japan: US$1.1 trillion and NJEA: US$1.3 trillion) on combined GDP of US$8 trillion (Japan: US$4.3 trillion and NJEA: US$3.7 trillion), whereas the US generated only US$1.5 trillion of saving from GDP of almost US$11 trillion.
Concomitantly, Japan and NJEA generate current account surplus to GDP ratios to the tune of 3.2% and 5%, whereas US and non-US Anglo-Saxon countries have suffered current account deficits in the region of more than 5% and 3%, respectively. The US and Asia are the root cause of macro imbalance as Japan and non-Japan East AsiaÃ¢ÂÂs combined current account surpluses totaled US$320 billion whereas the USÃ¢ÂÂs current account deficit alone was US$550 billion.
Western Upper Hand and Welfare Transfer
While in terms of macro imbalance, Japan and developing Asia have been on the same side, in terms of economic power and ownership, Japan has been squarely in the Western camp. Developing AsiaÃ¢ÂÂs export and growth success over the last few decades did not translate into economic advantage or power. The West and Japan have a gridlock on intellectual property Ã¢ÂÂ they probably deserve it as they were hundreds of years ahead of developing Asia in industrialization Ã¢ÂÂ and they dominate developing Asia either through economic ownership of their export and resource sectors or by dictating the terms of their global trade.
Japanese and Western multinationals (MNCs) have played a key role in such economic dominance. As well as benefiting from developing AsiaÃ¢ÂÂs institutionalized Ã¢ÂÂsuppressedÃ¢ÂÂ exchange rates and real wages, subsidized infrastructure and tax concessions, many MNCs pay only Ã¢ÂÂcost plusÃ¢ÂÂ prices to secure manufacturing or service outsourcing contracts in emerging Asia for Ã¢ÂÂbrand-lessÃ¢ÂÂ manufactured goods or services (many Asian companies make Ã¢ÂÂbrand-lessÃ¢ÂÂ goods that subsequently bear Western labels). Moreover, in certain industrial sub-sectors where indigenous Asian companies control production, lack of market access means marketing and distribution are left to Western Ã¢ÂÂseniorÃ¢ÂÂ partners, who charge Western consumers and end-users several times the price they pay to Asian producers. Evidence is abundant that Emerging Asia sweats and the West enjoys the fruits.
Japanese and Western dominance extends far beyond industrial sectors and terms of trade. Despite AsiaÃ¢ÂÂs massive savings, international financial systems dominated by the West and the Ã¢ÂÂinstitutionalizedÃ¢ÂÂ saving and investment behavior of the West ensures global financial flows and investment decisions are largely controlled by the West. Financial MNCs of the West are every bit as powerful as their real sector counterparts.
In my view, the world is experiencing the greatest welfare transfer ever seen across geographical regions and across generations. Such transfers are embodied in the macro imbalance characterized by AsiaÃ¢ÂÂs aggressive exports but passive savings in US Treasuries and other foreign assets. AsiaÃ¢ÂÂs obsession with exports and savings has enabled present generations of the US and some parts of the developed world to sustain an unusually high present rate of consumption, at the expense of present generations in Asia. This is because Asian exchange rates are artificially low and exports are artificially cheap, and Asia has suppressed its present consumption to subsidize buyers of its exports. It also comes at the expense of future generations of the US economy and some parts of the developed world. At some point, present consumption in these countries would have to give way to saving to restore macro imbalances. Future generations would have to bear the economic burden of an aging population, as well as the devaluation of their currencies and retirement of their public and private debt.
One would think future generations in Asia are the obvious winners as they inherit vast savings accumulated by their hardworking parents. However, their world is extremely uncertain and they face three major risks. First, wealth distribution has been heavily skewed and benefits only the few. Poor governance means there is a good chance their wealth will be squandered by the collective bad deeds of rent-seekers through systemic risk in AsiaÃ¢ÂÂs financial systems and asset markets. Second, it is hard to believe the unfortunate future generations of the US and other parts of the developed world would work doubly hard in their lifetimes to retire debt accumulated by their parents. They will simply raise inflation to reduce their debt burden at the expense of the future generations of Asia who inherit those excess savings. Third, with a probable deteriorating demography (Asia would grow older then), lack of intellectual property, and economic ownership, and without the excessive consumption behavior of the West, Asia has insufficient economic means to accumulate wealth.
Asia Shooting Itself in the Foot
If Emerging Asia invested its economic growth and saving wisely, this might help change its economic fortune. However, the fact is that a big part of its saving is controlled by AsiaÃ¢ÂÂs crony capitalists and wasted on relatively unproductive investment. The bulk of its foreign savings are invested in US Treasuries.
Relative economic success has camouflaged the rent-seeking culture that permeates most of Asia, and which typically favors politicians, government insiders, and large local corporate owners. Political patronage and rent-seeking create tremendous government inefficiencies and protect the monopoly power of large local corporate owners.
Substantial parts of the Ã¢ÂÂsuperÃ¢ÂÂ corporate profits, regular government spending, and government concessions and contracts constitute the Ã¢ÂÂAsian pork barrel.Ã¢ÂÂ This pork barrel is created at the expense of many constituencies: minority shareholders Ã¢ÂÂ whose rights often are not respected; urban workers Ã¢ÂÂ whose real purchasing power is artificially suppressed by a vastly undervalued exchange rate and a lack of wage bargaining power; rural dwellers and farmers Ã¢ÂÂ who tend farmland that is heavily taxed and low yielding as rural and agricultural development gets left behind; and indigenous SMEs Ã¢ÂÂ who do not receive the subsidies through infrastructure, protracted tax holidays, or tax incentives that are enjoyed by rent-seeking local large corporates and by MNCs.
It is thus not a surprise to find that the biggest and most successful Asian companies in developing Asia are not competitive global firms but tend to be companies that either enjoy special privileges or grew out of government protection Ã¢ÂÂ banks, telecoms, utilities, infrastructure and property, and transport and logistics. They are insiders (appropriating rents) and builders (scraping the pork barrel) but they are far from securing global pricing power.
Japan Is Not Asia
Despite its macro malaise over the past 15 years, Japan has always provided a great deal of inspiration to Asia enthusiasts. Some Asia enthusiasts believed in the late-1970s that the rise of Japanese economic might signalled the arrival of the Ã¢ÂÂPacific CenturyÃ¢ÂÂ in which Japan would lead Asia into economic dominance. This also marked the time when Japanese MNCs started to relocate some of their production sites in East Asia and the Ã¢ÂÂflying geeseÃ¢ÂÂ East Asia economic development theory was born: economists and policy makers envisioned that poorer, developing Asian countries would move up the value-chain and prosper alongside JapanÃ¢ÂÂs economic ascent.
In my view, Japan is not destined to help Asia prosper. Japan is part of the Western development complex. While the Meiji Restoration (1868) was more than 100 years after the Western Industrial Revolution (1760), it was not a gradual economic development process that Emerging Asia embraced another 100 years later. The outward orientation of Korea, Taiwan, Hong Kong, and SingaporeÃ¢ÂÂs development dates to the late 1960s/early 1970s. The Meiji Restoration represents a big bang, wholesale installation of the Western complex (initially mainly modeled after Prussia) where whole systems of Western institutions and development were emulated. Japan hence operates the Western model Ã¢ÂÂ its MNCs exploit cheap labor and resources and open markets in developing Asia while at the same time guarding intellectual property, pricing power, and distribution channels.
China and India Will Entrench Western Dominance
Just like the Japan enthusiasts two decades ago, some new Asia enthusiasts believe the rapid rise of ChinaÃ¢ÂÂs economy coupled with a probable new Indian economic powerhouse will help usher in a Pacific-centric economic century centered on two new Asian economic giants. I see the opposite. A rapidly developing China and India based on the same Ã¢ÂÂcheapÃ¢ÂÂ manufacturing and service outsourcing model will facilitate and prolong Western economic dominance for reasons outlined above.
Bottom Line: Installing Emerging Asia Economic Sovereignty Is About Correcting Past Mistakes
When Europe started emerging out of the Middle Ages 500 years ago and Christopher Columbus set sail to the West, the two most established economic powers and advanced civilizations were the Islamic Ottoman Empire and the Ming Dynasty of China. At that point, Western economic power was puny relative to these advanced civilizations. The subsequent conquering of the Americas (post 1500 AD) and the industrial revolution (1760 AD) laid the stage for absolute global domination by the West. Despite the end of Western Imperialism and colonization several decades ago, Western economic dominance continues today.
Installing economic sovereignty for Emerging Asia is not about rejecting global trade, MNCs, or Western economic systems. It is about creating genuine Asian economic powers and correcting past macro and development malaises and excesses. A detailed discussion is beyond the scope of this note. However, I suggest the following roadmap.
First, leverage vast savings to buy and then build economic power. The vast savings of Emerging Asia (NJA generates US$1.3 trillion gross national savings a year, runs current account surpluses to the tune of US$181 billion a year, and has accumulated a stock of foreign reserves worth some US$1.3 trillion) should be used actively to buy Western intellectual property and Western companies with pricing power. The current model represents passive investment that subsidizes the consumption of current generations of Americans and Anglo-Saxons.
Second, Emerging AsiaÃ¢ÂÂs policy makers must tolerate the exchange rate appreciation and real wage increases that accompany genuine economic development. These represent the correct barometers for a sustained rise in standards of living for the masses.
Third, developing Asia must dismantle its rent-based complex. This would ensure a more equitable and efficient allocation of economic fruits and resources.
Fourth, the present development platform that puts excessive emphasis on excess saving, external demand, and FDI-dependent mass manufacturing or service-outsourcing sacrifices social equity and harmony, as well as proper development of rural-resource-SME sectors, for the sake of faster industrial growth. Such an imbalance must give way to a more balanced platform that addresses the long-term development needs of the urban poor, rural, resource, SME, government, and big local corporate sectors.