The long-heralded ‘Asian growth story’ is rapidly becoming an ‘Asian collapse story’ in 2009. Perhaps ‘collapse’ is too strong a word, but Business Monitor International (BMI) has recently revised or is currently in the process of revising down its GDP growth forecasts for several Asian economies, including South Korea, Taiwan, Thailand, Singapore, and Hong Kong. Minus three percent generally seems realistic in my view.

On an ‘extreme’ note, CLSA is even more downbeat, predicting contractions ranging from 7% to 11% in South Korea, Singapore, and Taiwan.

BMI’s forecasts would represent the worst performances since 1998, when the financial meltdown crippled Asian economies. In fact, an 11% contraction in Taiwan would probably match the effect of a major war!

So, what’s all gone wrong?
Quite a few things, actually.

The Folly Of The Export Model
For a start, Asia’s economies remain driven by exports. Although many have pointed out that net exports (that is, exports minus imports) contribute far less to GDP than is commonly believed, this does not change the fact that the overall structure of many Asian economies is very much geared towards exports. My opinion is that while exports-to-GDP ratios may overstate exports’ importance, focusing on net exports understates their importance.

The folly of the export model is that it leaves Asia horribly vulnerable to the recession in the major markets, namely the US, European Union/Eurozone, and Japan. This is why we are seeing double-digit y-o-y contractions in Asian exports, and why countries such as Singapore and South Korea have seen double-digit annualised contractions in their Q4 2008 GDP figures.

But this begs the question of why Asia is so export-focused. I think there are several reasons:

Starting with Japan in the aftermath of World War II, reindustrialisation and manufacturing, boosted by US demand in the Korean War (1950-53), catapulted Japan to major economic power status by the 1970s. Because Japan was so successful, this model was subsequently adopted by South Korea and Taiwan, and also Hong Kong and Singapore. It’s also worth remembering that Japan, Korea, and Taiwan were (and are) close US allies and thus have traditionally enjoyed easy access to US consumer markets, as well as American investment. In other words, the US made a political commitment to these countries.

And because Korea, Taiwan, et al were so successful, it was natural for China (from the 1980s), Thailand, and eventually Vietnam, to follow the export model.

Another reason why the export model was useful for Asia is that its traditional low per capita GDPs and small populations meant that domestic markets were insufficient to boost growth.

Asia’s economies collapsed in 1997-98, when they were hit by severe capital flight. But that only encouraged Asia to become more export-focused. Firstly, the collapse of Asian currencies made exports much more competitive. Secondly, governments resolved that in order to avoid future financial crises, they would have to build up current account surpluses and foreign reserves. The quickest route to this was via exports. The paradox is that the solution to the last crisis has become the cause of the present one.

What Happened To Decoupling?
During the global boom years of 2003-07, there was much talk of Asia (and emerging markets in general) ‘decoupling’ from the US and Europe, thanks to strong growth in China and to a lesser extent India. China was very much seen as an alternative anchor to the US, and statistics showing a rising proportion of individual Asian countries’ exports to China seemed to corroborate this view.

However, the decoupling argument had several flaws. Firstly, in an increasingly globalised world, it doesn’t make sense for Asia (or emerging markets) to decouple from its main trading partners. So, Asia couldn’t decouple from the US by coupling to China, because China was itself coupled to the US.

This leads to my second point, namely that a key factor behind increased intra-Asian trade was final demand from the US and EU. In other words, much of intra-Asian trade is intermediate goods that are assembled as final products in China, not necessarily for the Chinese market, but for re-export to the Western world.

A third point is that although incomes are rising in China, Chinese private consumption (i.e. for final products, not components) has been shrinking as a percentage of GDP to less than 40%. With US consumption comprising 70% of a US$14 trillion GDP (US$9.8 trillion), and Chinese consumption at 40% of a US$4.0 trillion GDP (US$1.6 trillion), there is no contest which ultimately exerts greater global weight. In fact, it will probably be decades before Chinese consumers are able to match their American counterparts.

What About Domestic Demand?
The first thing to say about domestic demand is that it does not exist separately to external demand. If you work in an export-oriented factory in China, and you lose your job as a result of collapsing demand for your product in the US or Europe, then of course you will spend less. Thus, even those Asian economies with a high proportion of private consumption to GDP (e.g. India, Indonesia, Philippines, Vietnam) will be hurt by a global recession. In fact, Indonesia and the Philippines are vulnerable because the former exports a lot of commodities, and because the latter’s consumption is reliant on workers’ remittances from… the US!

Secondly, private consumption as a percentage of GDP is weaker in many Asian countries than in the West because saving rates are high and wages are still low. Saving rates are high because of inadequate social security systems, and because of a greater preponderance for frugality (at least theoretically). Given that these factors are structural, I see no quick fix solution. Some governments will spend more on health and pensions, while others will encourage spending through financial system reform (by making borrowing easier). Nonetheless, even in Japan, the most developed country in Asia, private consumption is still ‘only’ 55% of GDP.

Beyond Manufacturing
Are there options beyond manufacturing? Japan, South Korea, Taiwan, and Singapore are all seeking to turn themselves into financial powerhouses, following the example of Britain, post-industrialisation, in the late 1970s. However, even if those four were global financial powerhouses today, they would still be suffering heavily from the present recession, just as Britain is at present (BMI predicts a 3.5% contraction of GDP in the UK in 2009).

Innovation in areas such as biotechnology and nanotechnology offers new growth drivers for Asia. But then again, these too are dependent on adequate financing, and new products still have to be manufactured, marketed, and sold. In other words, they are vulnerable to demand!

I will say this in praise of Asia’s export model. It has generally brought prosperity to the region over the past generation or two. South Korea and Taiwan in recession are still more stable and comfortable places to live than many Latin American and African countries on a good day.