International Herald Tribune
Asia braces as Americans consume less
Monday, March 12, 2007

HONG KONG: Keep your eyes closed and hope for the best. That seems to be the general reaction in Asia to the recent global financial-market shiver and talk of an impending U.S. recession.

Markets have recovered some composure, but they cannot hide the lack of preparation for the consequences of Asian currency appreciation at a time when Americans start to consume less and save more. There is a reasonable debate on the extent to which a U.S. recession, and accompanying exchange-rate realignments, would hurt a trade-dependent Asia. For sure, direct dependence on the U.S. market has been falling steadily for several years, and for most economies in the region it is under 25 percent of exports. China's economy is set to keep growing fast — even if the U.S. driver is no long there — and the country will continue to spur many of its neighbors.

Trade dependence is often not as great as the raw data suggest. Because of the importance of regional manufacturing networks, much trade is in components for electronics and garment industries. But the actual contribution to the local economies where the work takes place is quite small.

In principle too, the high-saving economies of the region should be able to continue to feed off one another. Demographic trends and urbanization are still strong enough in China and Southeast Asia to drive growth, and, almost everywhere, investment is raising productivity in manufacturing and services. The potential for high-saving, rich Northeast Asia to spur growth in Southeast Asia and China remains.

With almost every country having excess foreign exchange reserves, low inflation, liquid banking systems and government debt at comfortable levels, East Asia would seem to be in a position to shrug off a U.S. recession, just as the West generally shrugged off the Asian crisis of a decade ago.

But there are some disturbing features that need to change. Most obvious is that, almost everywhere, domestic demand remains relatively weak, which accounts for the high level of external surpluses. In some economies, the problem is weak investment, in others, notably Japan and Taiwan, weak consumer spending. But everywhere, wages have been lagging gross domestic product.

In Japan, the huge gains made by exporters as a result of the weak yen have not been passed on to workers. Indeed, profits in Japan generally have been booming, but wages have not. No wonder consumers are reluctant. The same is true of Taiwan, where politics and a lack of reform of the service sector means that export successes are not mirrored by domestic demand.

The story in China is one of high household savings and rising profits adding to an already rampant investment boom. But again, incomes are lagging while the low productivity of much of the investment acts as a drag on consumption and means that China is not making the best use of its most abundant resources — labor — while capital is under-priced. Beijing's new budget plans will not help. Spending, which could spur consumption and reduce the pressure for savings, remains cautious.

The problem in Southeast Asia is one of inadequate private investment. This was long driven by export expectations. Now, the region has been unable to adjust to a situation in which China attracts more exporter investment. Legal and implementation issues remain a drag on badly needed infrastructure investment in Indonesia and the Philippines and politics is a dampener in Thailand and Malaysia, both countries with the capital and capitalists who could spur investment-driven demand.

As for the impact of China on the rest of the region, few seem to consider the consequences if a U.S. recession hits China's export-driven economy at the same time as a mix of domestic credit tightening and falling profits brings the investment boom to a halt.

Some economies, like Korea and Thailand, look like they will be able to ride out a storm, despite their high export dependence and currencies that have appreciated steeply.

Malaysia will prosper unless commodity prices slump dramatically. And Japan may take confidence and currencies in the region sharply higher, bringing money back to Asia for consumption and investment.

But unless governments and central banks assume that the U.S. import boom is on its last legs, their responses will be ineffective. The American consumer has lulled East Asia into a false sense of security.