The worst is yet to come

Economic predictions have seldom been more difficult as the world has gone from a long- lived boom to an almost unprecedentedly severe bust in less than half a year. But it is at least possible to moderate both excessive pessimism and false hope by thinking through the processes of transmission from one country to another, one industry to another and how crude data can be misleading.

China provides several guides to what’s happening elsewhere – and vice versa.

At one level, China’s exports in December could be seen as reflecting the nation’s still very strong trading strength. For sure, to be down 2% on a year earlier was a blow after years of double digit increases. But China’s export decline was tiny compared with neighbors experiencing falls of 20-30%. 

The statistics do not lie even though they may be at odds with reports of huge layoffs of migrant workers, and closures of many factories, particularly in the Pearl River delta. The most revealing data was not exports but imports – down 23%. The figures were even worse for the export processing trade, as excluding them limited the decline in imports to 16%, much of which could be explained by falls in oil and other commodity prices.

The knock-on effect

China’s processing factories mostly sit at the end of cross-border manufacturing chains controlled by either brand-name manufacturers or large scale retailers. Exports in December were the product of orders placed weeks earlier. Now new orders have slumped, component imports from the likes of Japan and Taiwan have also declined. This means the worst is yet to come for China’s exporters, the last link in the chain.

Some of this lost demand may never come back as factories close permanently or production shifts to cheaper locations in Asia, or ones closer to North American and European markets.

However, before assuming that the export production model is dying, it is worth asking how much the slump has been caused by falling in consumption in the West and how much by inventory adjustment. Consumer spending in the US was down 9% year-on-year in December and fell a cumulative 12% over the previous six months. But inventory contraction, caused in part by the global flight to cash and interruptions to normal trade credit, has been just as significant. This cannot be permanent.

Looking forward, inventories must stabilize and may begin to rise again. Even a surge in the US household saving rate need not be catastrophic for China’s exporters if they can match it with savings on energy costs. Furthermore, the brunt of consumer caution is likely to fall more on autos and high-end electronics than on clothing and cheap consumer durables.

Struggles to come

Over the next few months, China’s trade surplus will contract, but not necessarily very rapidly, as import costs, at least for raw materials, fall as fast as manufactured exports. China’s Southeast Asian neighbors – many of whom are economically dependent on commodities – will experience tougher times. Countries such as Indonesia, which had had several years of current account surplus, will go into deficit.

These nations can only be cushioned against a global slowdown if they have the external resources to avoid drastic spending cutbacks. For that, much depends on the speed of response by rich countries, and those with massive reserves, such as China.

So far those needs have been largely forgotten. The West has noted China’s efforts to stimulate domestic demand, but obstacles to stimulus in most of the rest of the developing world have gone largely unnoticed. The rich world has focused on its own woes rather than those of nations which could collectively help sustain global demand.

China can play an important role in helping global institutions like the IMF perform their role by adding to their resources. This can only work if the West and Japan – which dominate these institutions – are prepared both to take initiatives and allow China a larger say in decisions.

If not, China and the region’s other big foreign reserve holders will focus more on regional initiatives, lending to Southeast and maybe South Asia. Their intentions may be laudable enough, but the actions carry the longer term danger of trade regionalism. This would disrupt the globalization from which most of Asia has benefited.