Impacts of the Global Economy on Asia Pacific

December 4, 2009

The question is asked about the impacts of the global economy, and globalization more broadly, on the Asia Pacific region, looking out to 2025. This is curious because it inverts the more conventional problematique of today, which is to ask how developments in the Asia Pacific region, in the aftermath of the world economic crisis, will affect the global economy and other aspects of globalization.

Causality is of course two‐way, and it is in some senses hopeless to try to disentangle regional and global factors. However, it is more helpful to use the Asia Pacific as the starting point, and to think about its impacts on the global economy rather than to start with the global economy. The reason for starting in Asia Pacific is that it is “ground zero” for the reconstruction of the world economy, in the aftermath of the worst economic downturn that we have seen since the Great Depression.

The worst of the global economic downturn which began in late 2008 now appears to be behind us. Yet, the outlook for 2010, and for a sustained recovery in the Asia Pacific region, remains uncertain. While economic growth has returned to most major countries, the rebound has been weak, and there are serious concerns about the ability (and desirability) of governments to continue providing fiscal and monetary stimulus to their economies. In case there is any doubt about how precarious the situation remains, consider that total consumption in the United States is still below where it was at the start of the recession. Indeed on a per capita basis, consumption in the US is about 6% lower today than it was in late 2007. The prospects for a rapid rebound in US consumer spending are, in my view, very dim, given the continued need for deleveraging of household and corporate balance sheets, and – more frighteningly – the dramatic accumulation of debt by the US government. The point is that, for the foreseeable future, the US consumer is not going to be the engine of world growth, and that the reconstruction of the world economy will require the replacement of US demand with other sources of growth that are sustainable. Absent these changes, the downside risks to growth are large and these risks will likely persist for the foreseeable future. The most important of these risks is the problem of so called “global imbalances”, which in practice boils down to an imbalance between on the one hand the United States – which is saving too little and carrying too much debt ‐‐ and on the other hand Asian economies, which have relied too much on US consumer spending and on holdings of US debt. The resolution of the “global imbalance” problem in effect requires the rebalancing of growth in the Asia Pacific region.

The focus of rebalancing has tended to fall on China, not only because it is the largest holder of US debt, but also because it offers tremendous scope for the expansion of domestic demand through investments in social sectors, and the redistribution of national income from corporations to households. Above all, the focus has been on the renminbi, which is pegged to the US dollar, and which has not seen much movement since the start of the economic crisis.

It would be a mistake to focus solely on China, which cannot rebalance the world economy on its own – for both economic and political reasons. Rebalancing fundamentally means a reorientation of the Chinese economy away from exports to domestic demand. In the short run, this will mean job losses in the export sector, especially in coastal cities. If China goes it alone, it will effectively give away market share to competitors in other parts of Asia. We have already seen in recent weeks that Southeast Asian countries have been forced to devalue their currencies in order to maintain competitiveness vis‐à‐vis China. Competitive devaluation is a losing proposition all round, and a recipe for another global crisis. Hence the region has to work together to rebalance the world economy. On the one hand, the US has to increase savings, reduce debt, and reform its financial system. On the other hand,

Asian economies have to find sources of growth other than exporting to the US and Western industrialized countries. Market forces are to a large extent driving the required adjustments in the US savings‐investment balance, but it will take policy action within and coordination among Asian economies to bring about the shift in demand that is needed for global rebalancing. It is in this sense that the central challenge for the world economy today is being worked out in the Asia Pacific region.

I think this is starting to happen. This is demonstrated by the results of this year’s State of the Region report, which I coordinate on behalf of the Pacific Economic Cooperation Council (PECC), and which was launched in Singapore at the APEC Leaders’ Meeting in November. Every year, we send a questionnaire to about 400 opinion leaders from around the Asia Pacific region. When we put forward the proposition that “Slower growth in the Western industrialized economies will encourage a shift to domestic demand growth in Asian economies,” we found that 77% of respondents agreed. And when we suggested that “the global crisis will accelerate the pace of Asian economic integration and cooperation,” we again found a strong majority in support of the statement, at 68% of respondents. The survey results paint a picture of a post‐crisis world where the engines of growth are shifting from the US to Asia; from exports to domestic spending, especially on social priorities; and from production of goods to production of services.

The PECC State of the Region report points out that a rebalancing agenda for the Asia Pacific region should focus on new growth engines in the following four areas:

 Economic integration: efforts to create new types of trade and strategic investments in connectivity;

 Green economy: investments in energy conservation, clean energy research and development, and energy efficient vehicles and transport system;

 Investments in people: programs in education, healthcare, and social safety nets; and

 Knowledge and productivity: investments in technology and reforms to drive gains in productivity.

We are a long way from having rebalanced the world economy and in the meantime, there is a lot that can go wrong. The need for Asia Pacific regional cooperation to rebalance growth is, I believe, the most pressing challenge facing us today. If the “Asia Pacific community” fails to rise to this challenge, the prospects for institutional evolution of the sort that Australian Prime Minister Rudd has advocated are not bright. And yet, it is not clear if the best forum to address the Asia Pacific regional imbalance problem is in fact an existing regional institution such as APEC, APT, and EAS, or the newly‐minted G20.

This brings me back to the original question. I had turned the question on its head and put the focus on the Asia Pacific rather than on the global economy because I believe the central problem facing the world economy has to be resolved first and foremost in this region. But the rest of the world will respond to what happens in this region, and that is where we have to think about intended and unintended consequences. We have recently seen a glimpse of the kind of conflict that will emerge if we don’t get this right. Recently, Chinese Premier Wen Jiabao and European Commission President Jose Barroso were engaged in an exchange of tough words. While Barroso was calling on China to allow the renminbi to appreciate, Wen was accusing the EU of protectionism.

I don’t want to focus inordinately on the Chinese currency, but I think there can be no doubt that a failure to rebalance growth will lead to rising protectionist sentiment in the EU and the US. This is not to excuse protectionism – it is simply to say that major leaders are talking past each other, and that they are backing themselves into corners that will be bad for everyone. A rise in protectionism will lead to inward‐looking strategies in Europe, North America, Latin America and Asia that could break up the world economy into regional blocs. It has often been said that the defining character of Asia Pacific integration is the nondiscriminatory nature of trade and investment liberalization in the region. To use the phrase coined by Australian scholars, the Asia Pacific experience – especially East Asia – is one of “open regionalism.” Since 1998, however, open regionalism has been threatened by the emergence of bilateral and sub‐regional preferential trade agreements in East Asia and across the Pacific. PM Rudd’s vision of an Asia Pacific community is in a sense trying to keep alive the spirit of open regionalism, and to prevent the drawing of a line down the Pacific.

The biggest threat to open regionalism today is not the proliferation of FTAs in the region, but it is the failure to resolve the problem of global imbalances. The Asia Pacific region holds the key to this solution, but success will require a degree of regional cooperation on both sides of the Pacific that we have not yet witnessed. The rest of the world will be watching.