The myth of Asia's miracle or the recovery of Asia?

The Past & The Future:

With the recent crisis, the East asserted with increasing confidence that their system was superior than the West: Societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of achieving overall net gain, take charge of their economics, and sacrifice short run consumer interests for the sake of growth would eventually outperform the increasingly chaotic societies of the West.

Before turning to Asian growth, it may be useful to introduce the concept of growth accounting and review some important pieces of economic history. Economic expansion represents the sum of two sources of growth: (1) increase in inputs – growth in employment, in the education level of workers, and in the stock of physical capital (2) increase in productivity – may result from better management or better economic policy, but in the long run, it is primarily due to increase in knowledge. The growth accounting can tell us how much of growth is due to each input – say capital as opposed to labor and how much of it is due to improved efficiency.

Now, let’s turn to the example of rapid Soviet economic growth four to five decades ago. It was one of the wonders of the world. Official soviet growth numbers were consistently being criticized. Nonetheless, Soviet claimed that the astonishing achievement was fully justified: their economy was achieving a rate of growth twice as high as that attained by any important capitalistic country over any considerable number of years and three times as high as the average annual GDP growth rate in the US by the early 1970s. When economists began to study the growth of the Soviet economy by using growth accounting, they actually found that Soviet growth was based on rapid growth inputs, rather than efficiency growth. By some estimates, the efficiency growth was almost nonexistent. The Soviet moved millions of workers from farms to cities, pushed millions of women into the labour force and millions of labours into longer hours, pursued massive programs of education, and plowed the ever-growing industrial output back into the construction of new factories. Soviet rapid expansion did eventually come to an end.

It is hard to see anything in common between the Asian success stories of recent years and the Soviet Union five decades ago. Indeed, it is safe to say that a typical business traveler flying into Singapore’s remarkable harbour with thousands of cargo boats in endless lines off the coast, never even thinks of any parallel to its roach-infested counterpart in Moscow. How is this Soviet example relevant to the modern world? Yet there are surprising similarities. The newly industrializing countries in Asia, like Soviet Union of the 1950, have achieved rapid growth in large part through an astonishing mobilization of resources, rather than by gains in efficiency.

Singapore grew through a mobilization of resources. Some statistics show that its productivity growth has been very much flat in the past few decades. Of course, Singapore today is far more prosperous than the Soviet when it was at its peak, because Singapore is closer to, though still below, the efficiency of Western countries. The point, however, is that Singapore’s economy has always been relatively efficient, it just used to be starved of capital and educated workers.

Singapore’s case is admittedly the most extreme. Other rapidly growing East Asian economies have not increased their labour force participation as much, made such dramatic improvements in education levels, or raised investment rates quite as far. Nonetheless, the basic conclusion is the same – there is little evidence suggesting improvements in efficiency.

What about Japan and China? Japan, unlike the East Asian tigers, seems to have grown both through high rates of input growth and through high rates of efficiency growth. Today’s fast growing economics are nowhere near converging on the US efficiency levels, but Japan is staging an unmistakable technological catch-up. However, for China, it is still a relatively poor country by GDP per capita standard. Its population is so huge that it will become the next economic power if it achieves even a fraction of Western productivity levels. And China, unlike Japan, has in recent years posted truly impressive rates of economic growth. Back to growth accounting, it is unclear what year to use as a baseline for the growth assessment in China. If one measures Chinese growth from the point at which it made a decisive turn toward the market, say 1978 Mao Zedong’s later years, there is little question that there has been dramatic improvement in efficiency as well as rapid growth in inputs. If one measures growth from before the cultural Revolution, say 1964m the picture looks more like the East Asian “tigers” – only modest growth in efficiency, with most growth driven by inputs.

If growth in East Asia is indeed running into diminishing returns, it is likely that growth in East Asia will continue to outpace growth in the West for the next decade and beyond without improving efficiency, but it will not do so at the pace of recent years. Going forward, the next priority on the list for Asian nations is to focus more on the long term sustainability of their economies, rather than the short term gains. To achieve this, investments in education, infrastructure, social benefits, technology and higher-value industries will have to be increased. The good news is, technology now increasingly flows across borders, and that newly industrializing nations are increasingly able to match the productivity of more established economies within a much shorter period of time. Diffusion of technology will place huge strains on Western world as capital flows into the emerging world and imports from these nations undermine the West’s industrial base.

If there is a secret to Asian growth, it is simply deferred gratification, the willingness to sacrifice current satisfaction for future gain.

~ Summary of Paul Krugman's "The Myth of Asia's Miracle" article from MIT

Are you ready for the next bubble in Asia?

Asian central bankers see a ghost from the past in the U.S. Federal Reserve’s plan to pump $600 billion into the banking system. To them it's like the rolling mid-1990s again, except that they know how this party is going to end.

Here's the scenario: This tsunami of cheap dollars would flood Asia's stock, property, commodities and other asset markets, pushing up prices, then forming bubbles that would eventually burst and result in another ruinous recession like the 1997 Asian financial crisis.

Even scarier now than 13 years ago is that options to manage this cash onslaught have come down to a hard dilemma for central bankers in Asia: If they raise interest rates to absorb excess capital, which would almost definitely be higher than the rates in the U.S. and Europe, it would only attract more of that cheap money. If they leave the markets alone, the risk of a severe shock multiplies. Hot money comes in fast, and flees just as easily.

Compounding the situation is that these economies have only just come off their own stimulus in 2008-2009. So the Fed's move is like a double stimulus for them, piling on top of the money still sloshing around.

“The launch of QE2 [this second round of quantitative easing] will definitely add pressure to the asset markets in the emerging market economies such as Hong Kong’s. As far as Hong Kong is concerned, we will take measures that are specific to the housing market,” said Norman Chan, chief executive of the Hong Kong Monetary Authority, the city’s de facto central bank.

Property prices in Hong Kong have risen to their highest since 1997, the peak of the last bubble. The Hang Seng index this week reached a two-year high in anticipation of the Fed's loose money. With a highly liquid market and no capital controls (unlike mainland China), Hong Kong is a natural proxy for investors seeking a China exposure. In the first 10 months of the year, HK$345.9 billion ($44.6 billion) was raised in Hong Kong from initial public offerings. That shows just how much money has been circulating. Hong Kong hardly needs more.

Property speculation is a major concern too in China, Malaysia and Singapore — all three already curbing mortgages. In South Korea, stocks reached their highest level in nearly three years this week. Bailed out by the International Monetary Fund in 1997 — South Korea came out with a combative tone against effect of the stimulus, signaling it will “actively” seek measures to control the flow of capital, which could include taxing foreign investments in government bonds. Thailand — another poster country of the 1997 crisis — already did that last month.

Surely, Asian authorities want to see the U.S. economy pick up – after all they sell a lot of their exports to America? However, the Fed’s intervention, although anticipated, still conjures U.S. unilateralism, an attempt by America to save itself regardless of how it would affect others.

“The main issue here is that the United States conducts monetary policy that has consequences not only on the United States. The U.S. dollar, for better or for worse, is the only serious international reserve currency,” said Uwe Parpart, chief Asia economist and strategist of Cantor Fitzgerald in Hong Kong.

The Fed’s stimulus was a de facto weakening of the dollar. Conversely, it means the Fed has just engineered for the value of Asian currencies to go up.

So how is that different from the Bank of Japan intervening in the foreign exchange market to weaken the yen? Or from China managing its exchange rate?

Whatever happened to global coordination of policies to prevent a currency war? Did the Fed just precipitate that? Only a few weeks ago, Treasury Secretary Tim Geithner said there was “no risk” of a currency war.

This only gives Beijing ammunition to counter the expected clamor at the G20 next week for the yuan’s appreciation and it allows central banks in Asia to justify future foreign exchange interventions.

Already, the currencies of big exporting economies such as Japan, South Korea and Thailand have risen to multi-year highs. This makes their products more expensive abroad and they are unsurprisingly, not happy with that (although a strong currency also makes imported components cheaper.) More foreign capital flows further raise the values of their currencies as foreign investors buy local currencies.

The Japanese yen hovers around a 15-year high against the dollar despite a massive purchase of dollars by the Japanese central bank in September to weaken the yen.

There are indications that Asian central banks may take concerted actions to control the flow of capital into their economies. Capital controls work well when done together, but a robust common policy may be hard to come by because some Asian economy stand differently today, than say, in 2008, when all agreed on stimulus measures.

Japan, for instance, has mirrored the sluggish economic recovery of the United States and may even implement its own quantitative easing (expected Friday).

China, too, attracts foreign capital, perhaps more than others, because of its expected 10-percent growth rate this year. But because the yuan is heavily managed by the central bank and because of existing capital controls and foreign investment restrictions, it has some built-in safeguard against capital inflows.

All told, Asian monetary authorities are probably reaching for their antacids now. Yes, they want the U.S. economy to grow to stabilize the global economy. But they don’t want the imported inflation and the instability risks. They didn’t survive two severe financial crises in less than 15 years to be sitting ducks for another one.

The question now is, how far would Asian leaders assert themselves at the G20 talks in Seoul next week (Nov. 11-12) against the United States and the weak dollar?