A shifting growth strategy for Asia

Much of Asia is still delivering stellar rates of growth, comfortably beating other parts of the world. But the growth process that has long underpinned much of the region's prosperity is becoming unstuck. It’s time to ask, therefore, what will drive Asian economies in years to come?

Since the Global Financial Crisis, tired markets in the US and Europe have offered far less enticing prospects for Asian manufacturers. Moreover, successive waves of outsourcing – starting with apparel in the early years, then shifting to things like furniture and other household items, and culminating in a wholesale shift of electronics assembly to the East – have started to ebb. Few major industries are now left to be offshored into Asia, thus curtailing local opportunities for growth by increasing export manufacturing for developed markets. Such structural shifts are worth keeping in mind amid the current trade frictions. Even a swift resolution might not prompt a sudden renaissance in Asian export-led growth. The world has moved on and the region's traditional growth model has largely run its course. Hence the question: what else is there that might keep growth at such a lofty pace as in recent decades? Two pillars come to mind, regionalization and reforms, each reinforcing the other, yet both requiring courageous policy choices.

First, regionalization. Despite the traditional importance of exports in Asia, the region is in many ways 'punching below its weight' when it comes to trade. Although roughly half its shipments end up in neighboring economies, most of these are components for goods ultimately intended for exports to the West. In part, that's because the region still maintains relatively high import and investment restrictions. Tariff rates, for example, are still above the world average, and despite some open sectors and the ubiquity of liberal export processing zones, many barriers remain for foreign companies to access local markets. Intra-Asian trade liberalization would thus present a major avenue for further growth. The IMF calculates that if Asian economies lowered their trade barriers to the world average, the resulting benefits would be enormous – nearly 12 percent of GDP for the region overall, with some seeing gains of nearly 20 percent.

Efforts at more rapid integration are already under way. The Regional Comprehensive Economic Partnership, potentially by quite some distance the biggest trade bloc on earth, is currently being negotiated. To be sure, talks have ground on for a number of years now, marked more by vacillation than alacrity. But there is now a palpable sense of greater urgency among all participants to get over the finish line, not least because of the risks posed by ongoing US-China trade tensions, which due to the region's integrated production networks, worries all participants

Regional integration, however, isn't entirely dependent on free trade agreements as well as a whole range of smaller multilateral and bilateral deals. Physical connectivity matters equally: as much as the region has lagged in genuine trade integration in recent decades, this was reflected in the poor transport links connecting individual economies. This is starting to change, rapidly. China's Belt and Road Initiative is merely the most prominent example. Yet other projects are making a huge difference as well: Japan, for instance, still finances more infrastructure in ASEAN than China does.

The first pillar, in short, is tying the region more closely together.
This will require courageous policy choices, especially the reduction of import barriers and investment restrictions, to pry open hitherto comfortably sheltered markets.

All this, however, may not be enough. For a second pillar is needed to secure growth for generations to come. Trade, after all, is a powerful driver of growth and prompts efficiency gains that would otherwise be harder to attain. But it will not be sufficient nor sustainable unless local demand keeps pace, providing the necessary ballast for economies that might otherwise become too reliant on exports alone. Over the past decade, however, the momentum of local reforms has also dissipated. Low interest rates and the easy availability of credit were partly to blame. The ability to leverage up swiftly blunted the need to make tougher choices, ones that would have spurred productivity gains but involve difficult political decisions.

As debt has now soared in many places, this comfortable avenue of prosperity is also becoming ever more congested. Household debt has reached such lofty levels in some places that consumers will be unable, or at least unwilling, to splurge much further. Many companies and governments, too, will become more constrained in raising their debt loads, even if interest rates may fall over the coming quarters. What's required, then, is a more determined stab at reforms. It is not that the region's economies have entirely stood still: from Korea to India, and China to Indonesia, important reforms are underway, but these will need to gather pace and often cut much deeper if productivity growth is to make the necessary gains.

The precise agenda varies from one economy to the next. But common threads are present nonetheless. One runs through state-owned enterprises. These still retain a prominent role in much of the region, not just in China where their role is most frequently discussed. On the whole, such companies tend to curtail economy-wide efficiency in two ways. First, they often deploy capital less efficiency, frequently hemmed in by conflicting or inflated mandates that stretch well beyond the profit-maximizing goals of their private sector counterparts. While understandable, a balance needs to be struck between commercial viability and the provision of public goods. The second drawback is that public firms may curtail competition, itself among the most powerful drivers of efficiency. This may be simply because they deprive others of necessary investment capital, or because of their privileged positions within the marketplace. Pruning such privileges, therefore, might not only entice greater competition but also prompt greater efficiency among public enterprises themselves.

Another crucial reform, and one arguably more urgent now than in the past, relates to improvements in human capital. For all the vaunted educational attainments in Asia, there are still many pockets in the region, including in countries that have reached already admirable standards, where better access to, and better quality, education is required. Meanwhile, public health demands a lot more investment as well: as populations age, and environmental degradation takes its quiet toll elsewhere, a dynamic workforce will require greater ready and affordable access to quality healthcare. But neither argument holds: as income levels rise, and job opportunities progress from simply assembly to ever more complex manufacturing and service provision, only a highly trained workforce, through all layers of society, will be able to guarantee that productivity advances at the required speed. For political leaders, moreover, in Asia as elsewhere, considerable courage is required to mobilize scarce public resources to what amounts to such less flashy, yet highly worthwhile, causes that will show their benefits only quietly, if powerfully, over time.

For all those headlines and fretting about trade frictions between the US and China, the episode thus offers a chance at deeper changes. Asia's traditional growth model, reliant on exports to the West, had long looked tired anyways. The recent trade tiff only raises the urgency to find a new pathway to sustained prosperity. This will be built on two pillars: regional integration and vibrant, productivity- driven local demand. It'll take courage to achieve this, but there's hardly any choice.

Frederic Neumann

Co-head of Asian Economics Research, HSBC