It's been a rocky year for Asia. China's economy lost steam as infrastructure spending fizzled. A strong dollar and higher U.S. interest rates have weighed on exchange rates and investor nerves alike. And trade tensions between the U.S. and China raise the specter of weaker exports across the region as their effects ripple through supply chains.
Some of this, too, shall pass. After all, China has already started to address the weakness in its construction sector, helping local governments to issue more bonds in recent months to finance new projects. Meanwhile, the greenback seems to be pausing for a little breath of late, and one can even begin to make out, ever so faintly, the end of the current Fed tightening cycle at some point next year.
That leaves tariffs. It's tempting to shrug them off as a temporary distraction in Asia's continued march to prosperity. After all, if a deal can be struck between China and the U.S., wouldn't the region's export engine simply rev up again?
Well, it would certainly help. And, it should be noted, it would benefit the entire region given how intricately woven Asia's supply chains are. However, Asia's export malaise runs a lot deeper than the tariffs currently imposed on China by the U.S. (and vice versa).
The region must confront the fact that exports are unlikely ever again to be an all-embracing economic driver and that governments must do more to encourage domestic growth sources through liberalization.
Asia's export engine has been sputtering for a while. After expanding at nearly 15% annually in the decade before the Global Financial Crisis, export volume growth for emerging Asia since 2011 has averaged less than 4%. Granted, in 2016 and 2017 things looked a lot better: But the export rebound was narrowly focused on electronics, instead of the broad-based boom of earlier years. And the latest tech recovery seems to be fading as well: the consumer electronics cycle is slowing and semiconductor prices are softening.
A number of trends have been under way for a while. Supply chain integration, which saw components increasingly shipped to and fro before final assembly, often in China, started to mature perhaps ten years ago. The process propelled regional trade and unlocked tremendous efficiencies, drawing in more and more investment and thus boosting overall growth. And yet, the process inevitably started to reach its natural end as a further dissection of production between factories became uneconomical.
In addition, the lift to Asian trade in the 2000s was to a large extent the result of liberalization: the implementation of the Uruguay Round the decade before and China's subsequent accession to the World Trade Organization. Since the 2008 Global Financial Crisis, however, no such treaties, at least of equal scale, have been implemented. If anything, the global trade system has since started to "gum up," with restrictions added here and there, especially in the wake of the Great Recession.
From this perspective, it's unlikely that Asia will deliver the same rates of export growth as in the last decade, or even before. Something would need to change structurally: either a major breakthrough on trade liberalization or a revolutionary production process that would intensify supply chain processing. Ideally, you'd need both to happen simultaneously, as it so fortuitously did before.
That seems unlikely. Even if trade tensions between the U.S. and China can quickly be ironed out, Asia is stuck with a much deeper problem: The trade boom of years past may be hard to replicate in years to come. If anything, the sputtering export engine will continuously lose torque.
How then to sustain growth? At heart, that's a productivity issue. Exports, traditionally, were a powerful driver of efficiency: a steady stream of multinational investment and fierce global competition ensured that the latest production techniques were applied and efficiency enhanced. Both eventually spilled over into the local economy, too.
Now, however, productivity will need to come mostly from domestic sources. And this is where Asia has traditionally lagged: with easy growth to be obtained from revving up exports, local drivers of efficiency were often woefully neglected. This was true decades ago with Japan and remains true today.
Instead of the fierce competition of the global market place, which maintains pressure on exporters to continuously raise efficiency, domestic companies often operate in a more sheltered market. Productivity, as a result, doesn't advance as quickly in local sectors. Stronger competition policies are thus needed, and the scope of some state-owned enterprises may need to be pruned to streamline activity and raise efficiency for public and private companies alike.
In a sense, therefore, Asia's economies, whether developed or emerging, remain dual in nature: efficient, competitive, and disciplined externally, but not always so domestically. Yet, to sustain productivity gains, and therefore the rates of growth experienced in the past, local sources of efficiency gains will need to be unleashed.
The good news is that there is plenty of low hanging fruit to makes this happen. The bad news is that this often entails courageous political decisions, painful reforms that are unpalatable for a while but all the more rewarding in the end.
For example, state-owned companies still occupy prominent positions in most economies, and even expanded their share of gross domestic product in China of late. While full-scale privatization may not always be the most practicable option, a partial listing and corporate governance reform would still help to raise efficiency. Vietnam, for example, last year has laid out a clear road map toward reducing government ownership, thus helping to strengthen managerial focus on operational and financial goals. Elsewhere, however, such reforms have often fallen short of government goals, including in India.
The latest trade tensions, in short, only mask a deeper challenge for Asian economies. The export engine has been sputtering for a while. For growth to be sustained there is but one choice: let domestic vitality have freer rein.
Frederic Neumann is co-head of Asia Economics Research at HSBC.
