How this global recession can help Asia in the long run

Key word: can

I read this great article on the current economic state of Asia by Brian Klein and Kenneth Neil Cukier in Foreign Affairs that talked about how this recent economic downtown has affected Asia and what steps they should take to emerge stronger from it.

For the most part, all of the coverage and blame for this recent recession has been directed at Western economies—their consumption binge, the dramatic collapse of the real estate bubble, the lax issuances of risky assets (i.e. subprime mortgages), over-levered banks, etc. And more or less this is all pretty much correct. What has become apparent, however, is that as the recession unfolded, it was more than just the Western economies that suffered. As a result of increased globalization, many other regions of the world suffered—and suffered tremendously indeed. Asia, for example, was hit exceptionally hard. According to this article, Taiwan’s exports and industrial production shrank by a percentage larger than the United States experienced during the Great Depression. In addition, Japan is showing its first trade deficit in 30 years and Singapore’s economy is expected to contract by almost 10 percent, which is the largest decrease since 1965.

Now compared to the contraction seen in many Western economies, this may not seem overly excessive. Yet what is so surprising about these numbers is that this was not supposed to happen! Many of Asia’s financial institutions avoided much of the risky assets that plagued their Western counterparts. In fact, as a result of the lessons learned during the recent 1997-98 Asian financial crisis, most of the governments in the region displayed fiscal integrity and many corporations kept healthy balance sheets. Now add the region’s traditionally high individual savings rate, and this should all be a recipe for economic stability—especially given the circumstances that led to this downturn.

So why was Asia hit so badly? This is why: this recession showed, if anything, how overly dependent these Asian countries are to their export driven economies. Even amidst such aforementioned fiscal prudence, Asia suffered simply because their economies are skewed too much towards exports. To hear this is definitely no surprise. For the last 60+ years, Asia has developed into the export powerhouse of the world. Starting from Japan’s success story, then emulated by the Asian “Tigers” of Hong Kong, South Korea, and Singapore, and now with the awakening of the “Sleeping Dragon” (aka China), Asia has developed a very strong export-driven economic culture. Don’t get me wrong, Asia’s export-led growth is still an incredible success story. It has lifted billions of individuals from the lowest of poverty levels to (in some cases) living standards that now rival the West. Except now it has become apparent that this model needs to change.

It is never good for an economy to be as heavily skewed towards one element. When this happens, as with the case of Asia’s export-led growth, it significantly affects incentives—which then lead to huge economic distortions. An unbalanced focus on exports means that corporate investment, government spending, and foreign direct investment all flow right into exports and not into other industries that may benefit the domestic economy as a whole. For example, programs that would increase social welfare, such as education, healthcare, unemployment benefits, and social security will get overlooked. As a result, the infrastructure for these social programs is not existent, and as a result, recessions are significantly exacerbated. Many will point at the traditionally high household savings rate of the region and attribute that to a cultural norm. This may be true, but another reason why Asians need to save so much is that because of a lack of social programs such as education, health and social security, there is more of a necessity to “save away for a rainy day.”

Not only do social programs suffer, but skewed incentives in this case lead to a huge income disparity between the rich (those involved in export-industries) and the poor. This in turn has significantly affected domestic demand, which is practically nonexistent in Asia. Although Asia is now a manufacturing powerhouse, the majority of the population cannot even afford the goods that it produces. Now couple that with the high household savings rate, and you begin to see why domestic demand is so low in the region.

This global recession can help Asia in the long run simply because it has exposed much of the region’s economic weaknesses. As the West struggles to emerge out of this recession, it will continue to de-lever itself for years to come. In fact, household savings has already reached record highs. In other words, the West will be in no position to continue its spending binge, and the East will certainly suffer. I think this can be good though. If Asia’s governments recognize this and begin to take steps towards increasing domestic demand and improving social services, this may be the push that the region needs to rebalance its economy. It won’t be easy or painless for the region to apply the brakes and shift away from the model that has provided it with unbelievable growth in the last half-century, but I believe that this is an absolutely necessary step for future of the region.