Asia’s Rebalancing Act

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By: Lee Jong-Wha

.Somalilandsun – Rapid economic growth in China undoubtedly benefits the rest of Asia. Indeed, strong Chinese demand has supported its trading partners’ export-led growth for much of the past three decades. But now, faced with a slowdown in China and significant downside risks there, the rest of Asia must abandon over-relianc

e on export-oriented development strategies and strive to ensure stable and sustainable growth domestically and regionally.

China’s vulnerabilities and risks – stemming from property bubbles, shadow banking, and local-government debt – have triggered concerns about a crisis not only there, but also in neighboring Asian countries. Some, indeed, now predict a Chinese banking or fiscal disaster; others predict long-term stagnation equivalent to Japan’s lost decades.

These “hard landing” scenarios are extreme. But the road ahead is bumpy and uncertain. No one can guarantee that Prime Minister Li Keqiang’s attempts to achieve deleveraging and structural reform will succeed. Moreover, external shocks, policy mistakes, and political instability could disrupt even the best-laid plans.

In any case, China’s stellar growth record cannot be sustained. Even if it manages a “soft landing,” annual output growth will slow to 5-6% in the coming decades. Standard growth theory predicts “convergence” of per capita GDP: a fast-growing country will eventually encounter difficulty maintaining high rates of labor mobilization, capital accumulation, and technological progress.

In China, labor inputs have fallen as a result of declining fertility and an aging population. Reduced rates of return will lower investment rates. China may be able to rely on policy reforms to boost productivity growth; but, with relatively low innovative capacity, it will struggle to catch up with frontier technologies.

China’s inevitable growth slowdown, along with a large tail risk, threatens stable growth in Asian economies that have become increasingly interdependent. Trade within Asia now accounts for more than half of the continent’s total trade turnover. Moreover, direct investment and financial flows contribute further to economic interdependence.

The rise in intra-Asian trade reflects China’s central role in East Asia’s production networks. From 2001 to 2011, China’s share of South Korean exports doubled, from 12% to 24%; its share of Japanese exports grew even faster, rising from 8% to 20%. As a result, China has become South Korea’s single largest export market, and Japan’s second largest. It is also the largest trading partner of all ten members of the Association of Southeast Asian Nations (ASEAN).

Asian economies’ deepening trade and financial integration has left them increasingly vulnerable to growth shocks from China, with exporters of commodities and capital goods especially vulnerable. In fact, a study by the Asian Development Bank shows that Chinese shocks have larger and more persistent effects on individual Asian economies’ output than do global shocks, as a 1% increase in China’s GDP raised GDP in emerging East Asia by about 0.6%.

Rapid economic growth in chinaIn terms of investment, the International Monetary Fund predicts that a disruption in China’s investment boom will adversely affect its trading partners. A drop of one percentage point in China’s investment rate is estimated to reduce Taiwan’s GDP growth rate by 0.9 percentage points and Korea’s by 0.6 percentage points.

If China can successfully rebalance its economy and shift to consumption-based growth, its trading partners could benefit enormously from a huge retail market. But as long as China’s import share of final consumption remains low, direct gains for exporters of consumer goods are likely to be small.

As they prepare for the coming Chinese slowdown and seek to minimize the risk of regional destabilization, Asian economies must strengthen domestic demand and reduce excessive reliance on exports to China. In other words, sustainable growth requires all of Asia’s China-dependent economies to rebalance their two main growth engines.

To enhance domestic demand, Asia, including China, must reallocate resources and structurally transform the economy. Reinforcing social safety nets, broadening and deepening financial markets, and supporting small and medium-size enterprises would also strengthen domestic demand. Likewise, service-sector liberalization will be essential to promoting productivity and creating jobs. In short, implementation of fiscal, financial, and structural reforms can mitigate the spillover effects from China’s slowdown.

But a second reform front, aimed at enhancing regional coordination, must also be opened. With economic shocks able to spread more quickly than ever before, owing to broadened trade and financial channels, all Asian countries must maintain a sound macroeconomic environment.

Perhaps most important, deeper regional integration calls for closer cooperation in macroeconomic and financial surveillance, as envisaged by the Chiang Mai Initiative Multilateralization. Asian countries must be able to conduct well-coordinated candid reviews of one another to reduce the likelihood of risks and detect emerging vulnerabilities.

China’s long-term growth potential – and that of the rest of developing Asia – is not pre-defined. Maximizing it requires not only that individual countries address their weaknesses and rebalance their sources of growth, but also that they build and strengthen the regional institutions needed to manage economic integration.

Lee Jong-WhaLee Jong-Wha, Professor of Economics and Director of the Asiatic Research Institute at Korea University, served as Chief Economist and Head of the Office of Regional Economic Integration at the Asian Development Bank and was a senior adviser for international economic affairs to former President Lee Myung-bak of South Korea.

Copyright: Project Syndicate, 2013.

www.project-syndicate.org

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