In Search of the Virtuous Cycle

by Eddie Lee: Singapore

The question of whether the world has decoupled from the US economy never really mattered that much for Tiger economies. During the 1990/91 US recession for example, the South Korean Tiger economy continued to sprint at a rate of 9% GDP growth, easing only slightly to 6% in 1992.

However there is visibly much more anxiety in Korea these days. As a recent report from the Samsung Economic Research Institute lamented, “There used to be a virtuous circle ..in which growing exports increase investment .. leading to a consumption boost. The link has weakened considerably ..”

The problem in Korea today is that weak domestic spending has left the economy vulnerable to a downturn in its booming export sector.

Industrial output almost came to a screeching halt last December, expanding a mere 2.3% year-on-year, a sharp slowdown from 10.6% in the third quarter of 2006. All it took was a moderate cooling of demand in the US and China to have an outsized effect on Korea’s economy.

Korea’s outlook is decidedly shaky.The Export-Import Bank of Korea’s export sentiment indicator just fell below 100 in the first quarter of this year, suggesting that there are now more pessimistic exporters than there are optimists.

The Council for Economic Planning and Development’s leading indicator is flashing a blue light – warning that a recession is looming.

The striking characteristic of the current economic cycle in the East Asian Tiger economies is their subdued domestic economy. After snapping back from a sharp contraction during the Asian Economic Crisis, the share of domestic spending in total demand has steadily shrunk, to below even the Asian crisis low.

Domestic spending now accounts for 66% of total demand in Korea, down from 73% in 2002 and a high of 79% back in 1993. In Taiwan, the share of domestic demand has shrunk to 58% from 67% 4 years ago.

One reason for the shrinking share of domestic demand is the protracted post-Asian Crisis decline in investment. It may be, as the IMF argues in their September 2006 Asia Pacific Regional Economic Outlook, that the weakness in investment is due to producers of non-tradable goods being constrained by a credit crunch.

Yet weak private consumption growth in Korea and Taiwan suggests that a lack of consumer demand may have more to do with constraining investments than a credit crunch. A recent survey by the Taiwanese Ministry of Economic Affairs found that not only retail and restaurant businesses have been growing at a slower pace, "preferential loans for government employees and office workers, credit cycle surpluses and car loans are all on the decline, indicating a conservative trend among private consumers."

Private consumption growth in Taiwan averaged just 2% in the past 4 years; in Korea, it is only marginally higher at 3%. That’s a long way below the 8.5% average of the late 1980s and early 1990s.

Even in the case of fellow East Asian Tiger Singapore, whose economy is out-pacing it’s northern neighbours due to a strong inflow of foreign direct investments, private consumption remains lackluster - up just 2.6% despite 7.7% GDP growth last year. Domestic demand in Singapore now accounts for less than a quarter of total demand, down from a third 5 years ago.

One can’t help but notice some similarity with the situation in Japan. To be sure, household spending among the East Asian Tigers isn’t declining. But, it’s clear that a bifurcated economy is developing – lackluster consumption contrasting with booming exports; the traditional link between export-led growth and domestic demand apparently broken.

There is widespread agreement that the East Asian Tigers are feeling the weight of the global labour arbitrage – it is a reason why median real income growth is modest at best. What about the demographic factors that Edward Hugh and Claus Vistessen have written so much about?

Here it is interesting to compare the East Asia Tigers with the US. Both have a median age of around 36 years. Yet the relative restraint of East Asian consumers stands in contrast to their US counterparts.Why is the global labour arbitrage having a larger impact on the East Asian Tigers?

One argument is that there is a greater sense of economic uncertainty in the wake of the Asian Crisis and the technology bust of 2001. For consumers used to uninterrupted fast growth, these were very rude shocks, particularly in a region with a relative lack of social security.

Now with old age dependency ratios projected to increase at more than twice the rate in the US over the next 2 decades, my guess is that it'll likely get harder for East Asian consumers to shake off their new found restraint. All this is likely to mean that the East Asian Tigers search for the lost virtuous cycle will remain elusive. Instead, they will increasingly rely on their export prowess for growth. Certainly, something to watch in the years ahead.