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UBS Investment ResearchEconomic Insights — By George
Asia: is the miracle over?
 
10 September 2012
 
 
George Magnus, Senior Economic Adviser
george.magnus@ubs.comTel. +44 20 7568 3322
 
This report has been prepared by UBS LimitedANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 26.
UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
 
 
 
Economic Insights - By George
10 September 2012UBS
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Asia: is the miracle over?
According to conventional wisdom, Asia, with a rising China at its heart, is thefuture. And since the Western financial crisis, it has become more common toview the rise of China and Asia as a massive change in the structure of the worldsystem, reverting to a type that predates the Industrial Revolution and theascendancy of the West by more than a thousand years, sending the world ‘back-to-the-future’. The popular proliferation of estimates about when China’seconomy will overtake the US, or other Asian economies will rival or overtakethose in Western Europe, adds a certain excitement or frisson to this perspective,depending on one’s point of view.But the Asian miracle, heralded by the World Bank in a major report in 1993,has been the subject of heated debate. Paul Krugman’s infamous article, TheMyth of Asia’s Miracle, published in Foreign Affairs in 1994, suggested that themiracle was more about perspiration than inspiration. In other words,impressive Asian economic development could be fully explained bydemographics, high savings, rising investment, improving education, labourtransfer to the modern sector and other measurable inputs. Sooner or later,growth would become more pedestrian in the absence of strong innovation-ledproductivity growth. In 1997-98, during the Asian crisis, some people wonderedincorrectly whether the Asian miracle was over. Financial and balance sheetexcesses, that precede periodic financial busts, can of course depress potentialoutput growth, as nowadays in Western countries, but they didn’t have apermanent effect on Asia post-1997. When the Western financial crisis erupted,balance sheets were in good shape, the capacity to implement strong stimulusmeasures was high, and Asia came through it with economic guns blazing.Developing Asia’s GDP growth rose from 7% to 9% per year between 1994-2003 and 2004-2011, largely paced by a sharp acceleration in China and India inthe years preceding the financial crisis. In 2008, just as the Western financialcrisis erupted, one of Asia’s most prolific cheerleaders, Kishore Mahbubani,Dean and Professor at the Lee Kuan Yew School of Public Policy at theNational University of Singapore, published a book called ‘The New AsianHemisphere: the irresistible shift of global power to the East’. On cue, so tospeak, Asia weathered the financial crisis and ensuing global recessionsuccessfully, and growth rebounded strongly in 2011 with a near 10% rise inGDP.Since then, however, economic growth has been sliding and is now back toaround 7% or so. A reasonable enough growth rate by any standards, but notnecessarily for investors. Since the start of 2011, for example, developed worldequity market indices have consistently outperformed those for Asia. At firstglance, slightly slower growth and relatively disappointing equity returns overthe last 18 months should be of fleeting concern. Why shouldn’t Asia be able tofind new sources of growth to compensate for its high exposure to world tradeand to Western aggregate demand formed over many years?The answer is it can, but to do so, countries in developing Asia have to addressstructural and political issues that are pulling down total factor productivity, andtherefore, potential growth.
 
 
Economic Insights - By George
10 September 2012UBS
3
 
In China, for example, the faltering property market is the leading edge of abroader investment slowdown and profit squeeze that is reflected in productionand price weaknesses in numerous industries, and rising debt and loan problems.Increasingly, it looks as though the utilisation of copious volumes of capital andlabour inputs, and debt financing to sustain rapid growth is approachingexhaustion. And the more the authorities attempt to offset the current economicslowdown by easing monetary policy or increasing new infrastructure spendingand financing in the face of rising capacity and weakening prices, the moreunstable the economy will likely become. So far, Beijing has been surprisinglyrestrained in trying to offset the economic slowdown - to its huge credit. But arecent editorial in People’s Daily marked a definite change in tone, warning thatChina must plan and be prepared to take new measures to support economicgrowth. As the 18th Party Congress draws nearer, with powerful party positionsin play, this call may well be heeded. The latest macro readings certainly don’tsuggest the slowdown has ended.We should not be fooled into thinking that the summer rally in some residentialinvestment indicators, such as floorspace sold, and sales transactions and pricesin some major cities is the end of the downswing. Unsold inventories amount toperhaps 1-2 years of supply, despite reports of much lower figures in large citiessuch as Beijing and Shanghai. Floorspace under construction in relation to salesis higher than at any time since 2010, and developers are saddled by significantleverage.Yes, you can argue that China’s demand for housing, and the outlook for prices,are strong, bearing in mind that it is still a middle income country in whichurbanisation and modernity are still increasing. However, this structuralperspective isn’t really that helpful because the actual demand for housing thatmatters is the demand that exists at current price and inventory levels. Sinceboth would appear to be too high, we should expect the private housing marketto continue to trend weaker.But the property sector is just one, if very important, part of the picture. Thelabour market and ageing consequences of three decades of the one-child policy,are compromising China’s trend growth rate, along with the complexities of rebalancing the economy, and the uncertainties generated by the leadershipchange. Trend growth in China may already be dropping a couple of percentagepoints to around 6-7%, and a successful rebalancing could even entail growthsliding down to 4-5% in the next few years
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. Citizens care about income growth, jobs and opportunities, not GDP, so this sort of outcome need not be disastrousat all. But it’s different from what most people expect - and a shock forcommodity producers and others that have profited from the working of China’seconomic model to date.
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There’s a lot of argument about the accuracy of Chinese macroeconomic statistics,and about reported GDP growth in particular. See, for example, Janet Koech andJian Wang, China’s slowdown may be worse than official data suggest, FederalReserve Bank of Dallas, Economic Letter Vol 7 No 8, August 2012, or go towww.dallasfed.org/research/eclett/2012/el1208.cfm
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