With the US seemingly destined for recession, the rest of the world is left to wonder what impact it will have on their economies. For China, a country accustomed to double-digit GDP growth, the prospect of a slowdown must be unnerving.
Just six months ago, Asian economies were in fine fettle, bolstered by the latest economics fad: Decoupling. The idea that the rest of the world could grow without the US taking the lead gained currency when America reeled from the subprime mortgage crisis. Other countries, particularly those in Asia, continued booming.
“[Decoupling] is not that controversial,” said Tim Condon, head of Asia research for ING Financial Markets. “US import demand has been quite low in Asia in 2007, while GDP forecasts for Asia were revised up.”
But recent events are poking holes in the decoupling thesis. The World Bank recently cut its growth forecast for China to below 10%, citing reduced exports as a reason. In late January, China’s stock markets tumbled along with others in the region amid fears for the US economy. Catching the mood, a research note from investment bank UBS pronounced, “the end of the decoupling.”
The decoupling debate shines a light on the trade ties that bind the rich world, emerging Asian nations and China.
Evidence supporting the decoupling argument exists. For example, the portion of Asian exports consumed by the US has dropped from 23.2% in 1985 to 16.7% now. Conversely, Japan and the Eurozone now absorb 24% of regional exports.
Meanwhile, trade within the region has grown too. The Asian Development Bank (ADB) estimates that intraregional trade accounted for 42.7% of total regional exports in 2006. That’s nearly double the figure from 1985.
The G3 economies (the US, Europe and Japan), Southeast Asia and China now represent three points of a trade triangle. But this is a fairly new set of relationships. As recently as four years ago, trade within Southeast Asia was limited to only a few countries. The focus was on pumping out exports to the rich world, particularly the US.
“Intra-ASEAN trade was really a story of Singapore-Malaysia trade – that was virtually all of it,” Condon said.
But China changed things. Since the 1990s, the country became a magnet for foreign cash, distorting investment flows to Asia. According to the ADB, China absorbed more than 40% of foreign direct investment in Asia in 1998.
“Five or even 10 years ago, there were a lot of concerns in Southeast Asia that China was going to grab everything,” said Cheung Tai-Hui, an economist at Standard Chartered in Singapore.
But instead of China gobbling up Southeast Asia’s share of investments and exports to the US, trade within the region increased. According to the International Monetary Fund (IMF), in 1985, 26% of Asian exports went to Asian countries. Twenty years later, is was nearly 40%.
If trade within the region had increased so dramatically, was Asia decoupling from the US? According to Park Cyn-Young, an economist at the ADB, the answer is no.
The decoupling thesis rests on the premise that independent demand in Asian countries has supplanted US demand. But many Asian countries still carry a trade surplus, which indicate that their exports are being sold outside the region. In other words, “final demand” for Asian exports is still being driven by non-Asian countries.
The problem for economists is that import-export data doesn’t distinguish between exports for final demand and exports that are intermediate goods – components that haven’t been built into the end-product yet. These components are often processed in different countries, assembled in China and then the finished goods are shipped to the end-buyer.
By Park’s reckoning, final demand from Asian countries remains low. For example, although China imports a lot from Southeast Asia, Chinese final demand is only about 6%. The G3 countries, by contrast, account for 61% of final demand – about 50% higher than IMF statistics, which don’t factor in how exports are used.
The final demand figures also highlight another point: China’s recent GDP growth hasn’t been driven by trade. The country’s exports are impressive, but it also imports plenty of intermediate goods, so net exports are low. China’s key growth drivers are in fact domestic consumption and investment. This means the decline in exports created by a G3 slowdown will only leave a faint impression.
“All the major economies can slow down without tipping China into a recession,” said Lee Branstetter, an associate professor of economics and public policy at Carnegie Mellon University who researches China.
China and the world
That’s not to say China has broken free of global business cycles. Instead, the converse is true. Although growth is relatively free from external influence, Park’s work at ADB suggests that Chinese cycles are becoming increasingly synchronized with both the region and the G3 economies. This trend was catalyzed by the Asian financial crisis in 1997, which served as a “common shock” for the continent.
Business-cycle correlations both within the region and between Asia and the G3 were low before the meltdown, from 1983 to 1996. But the crisis drew them closer. Park’s correlation coefficient between Asia and the G3 economies, for example, went from 0.06 pre-crisis to 0.62 after the turmoil. China’s link to the G3, however, is still weak, at 0.14 .
These figures portend difficult times ahead for the rest of Asia. Ironically, the region will look to China – once a source of dread – to shore up its accounts.
China’s ongoing infrastructure investment requires vast supplies of commodities, which Southeast Asia is well-placed to provide. Some countries (see box) will prosper by selling China the raw material it needs to continue building its railways, roads and power plants. Others could founder as they are swamped by the ripple effects of a global downturn.
“You have the economies sitting there like a series of boats in a pond,” said Edward Teather, an analyst at UBS in Singapore. “You’re dropping a rock into part of that pond, and those people most closely associated with that part of the pond are going to get a bigger hit.”