Asia Pacific: Coping With the Chinese Decade
Daniel Lian (Singapore)
morganstanley.com
As our chief economist for the region, Andy Xie, pointed out in his recent report titled “Asia/Pacific Economics: The Chinese Decade” of February 10, 2003, the “Chinese decade” is not necessarily all gloom and doom for ex-Singapore Southeast Asia despite the likely acceleration in China’s industrialization in the coming decade. He pointed to two favorable trends for Southeast Asia:
· First, a rich natural resource endowment means that Indonesia, Thailand and Malaysia should do quite well in complementing China’s industrialization as the massive capacity expansion in the Middle Kingdom provides a structural lift to commodity prices.
· Second, the strong income spillover from China also suggests lower wage economies in Southeast Asia should be able to make a decent living by providing services (specifically through tourism) to China.
We broadly agree with Andy’s analysis but we are more guarded in our optimism. There are two reasons: First, we believe that the decline in mass manufacturing in Southeast Asia will be quite significant. Second, firmer commodity prices and rising tourism receipts from China may not be sufficient to offset the decline in manufacturing export income.
The region’s rich resource endowment at present is not properly leveraged as policy makers have indulged in the pursuit of single-track development policies. We believe that in the long run the development potential of the renewable resource endowment of the region is significantly more important than of its non-renewable resources. In our view, to cope with the inevitable Chinese decade, the region must effectively capitalize on its natural resource wealth by re-deploying labor and capital that previously serviced MNC-owned mass manufacturing and inefficient, rent-dominated domestic conglomerates to the rural economy, which is best positioned to exploit the region’s natural resources. The leveraging of capital, labor and natural resources in a rural economic setting constitutes the core of the second track of the dual-track strategy -- to attain pricing power through small but numerous successful enterprises -- that we think is most appropriate for Southeast Asia.
The reward of coping or the price of not being able to cope with the Chinese decade is likely to be substantial. At the end of 2002, the manufactured exports of the ASEAN-five (Singapore, Malaysia, Thailand, Indonesia and the Philippines) totaled some US$306 billion, or 54% of the combined US$566 billion GDP. The value added generated by the manufacturing sector was 27% of GDP. We estimate that in 10 years, in present-day dollar terms, 30%, or more than US$90 billion worth, of manufactured exports will be lost to China. The preserving or even augmenting of living standards in Southeast Asia clearly depends on the success in identifying a new development anchor, i.e., better deployment of capital and labor to leverage the natural resource endowment to compensate for the expected manufacturing losses.
Nuts and Bolts of Responding to the Chinese Decade
In his article, Andy -- outlined several important ideas relating to the phenomenal emergence of China’s economy. We discuss in detail his three key observations on Southeast Asia (italicized points 1-3 below) and provide our analysis on the policy reformulation that we think is needed by policy makers in Southeast Asia to drive the region towards a more complementary growth path with China.
(1) “China reduces the prices for labor and capital. Its impact on labor is most pronounced. As China’s labor force is huge, it can permanently devalue the value of labor against scarce resources.”
This is significant for the direction of Southeast Asia’s economic development. The region has largely relied on mass-manufacturing-driven industrialization and mass-manufactured export income as the primary apparatus for lifting real wages and standards of living. We have long argued that mass manufacturing cannot be the sole engine of growth for Southeast Asia, i.e., the single-track EAEM (East-Asia Economic Model) as a growth strategy.
What attracted FDI by MNCs to Southeast Asia was primarily the low-cost labor coupled with a favorable investment climate fostered by preferential tax treatment, good infrastructure, and a stable social-political environment. Labor and market potential, in our view, were the overriding factors influencing MNCs’ investment decisions as the other policy-driven incentives for MNCs (tax, infrastructure, stable environment) could be readily duplicated in China and elsewhere. (And they are in fact being duplicated quite effectively elsewhere.)
The difference in market potential between China and Southeast Asia is obvious. Labor endowment, from the aspects of both supply and prospects for labor productivity growth, is also far superior in China. At sometime in the future, when China has made substantial inroads into manufacturing and real wages have risen over those of Southeast Asia, then the latter region may be able to find some breathing space in the shift of manufacturing to China. However, we do not expect such a pause for at least another 10 years. And if Southeast Asia stubbornly sticks to the single-track EAEM path, it is likely to see a substantial relative, if not absolute, decline in the standard of living over this period.
In summary, China’s domination in the global factory space means that Southeast Asia, with its vast population and predominantly low-skilled and low-wage labor pool, must find a new development anchor to preserve and perhaps even augment its standard of living. We believe that new anchor lies in proactive leveraging of the region’s resource endowment.
(2) “There are five major factors in production: intellectual property, labor, capital, land and natural resources. The development of China unambiguously presents a bullish story for natural resource suppliers. In this regard, Indonesia is the major beneficiary, and both Thailand and Malaysia will benefit as well.”
We broadly concur with Andy’s view. The benefits of firmer commodity export prices accruing to Southeast Asia can be readily observed in the past few years. And given that the firmer natural resource price trend is likely to be structural because of the tidal-wave shift in China, many policymakers and analysts could think that the region is in for an easy ride alongside China’s ascent. However, we believe natural resource complementarity with China is not yet a savior for the region. Southeast Asia is not well positioned to truly leverage its resource endowment. This should come as no surprise given that the rural and natural resource sectors are the most ignored in the region.
We should clearly define here what we mean by natural resource endowment and its relationship to the rural economy. The word “natural” conveys the idea that these resources are “commodity-like” and “exhaustible”. This is a narrow and mistaken perception. Natural resource endowment refers to a much larger area of endowment. Very roughly, natural resource endowment in Southeast Asia consists of two types:
Non-renewable natural resources
These include energy (chiefly oil and gas) and mineral deposits (tin, copper, to name a few). While export earnings from these areas at present are good for Indonesia and Malaysia, the non-renewable nature -- oil and gas are estimated to be exhausted in 15-20 years -- and concession aspect -- in Indonesia the exploration and extraction rights of most mineral deposits have already largely been conceded to foreign companies in arrangements that will not augment future export earnings much -- do not augur well for Southeast Asian countries that are counting on non-renewable commodity exports for growth.
Renewable resources
These are largely divided into three categories. (1) Commercial crops and other agro-based resources -- for example, natural rubber, timber, palm oil, as well as the whole agro-food-based industry that is based on adding value to the basic food staple and fishery sectors. (2) Tourism-related attributes that are linked to the rich physical and geographical features as well as the hospitality of the populace. (3) Indigenous skills embedded in the non-mass-manufactured products made by local SMEs and the rural economy -- handicrafts and local art are two examples. All four major Southeast Asian countries -- Malaysia, Thailand, Indonesia and the Philippines -- are rich in renewable resources.
Renewable resources development is sustainable whereas non-renewable resources by definition are exhaustible. In the renewable resources sector, commercial crops, the agro-food-based industry and tourism are probably better understood and hence better developed. However, there is still plenty of scope for further value-added development as these sectors are generally deprived of government policy and banking system support. The more acute underdevelopment is in the rural sector in general where there is a huge pool of under- and untapped indigenous skills and resources in this diverse and culturally rich region. (Many indigenous skills are linked to the cultural heritage.)
The leveraging of natural resource endowment is closely linked to the development of the rural economy. We loosely refer to the SME, rural and resource-based “local” economic activities as rural economy, as opposed to urban economy, which is driven largely by MNC-led and urban-centered mass-manufacturing activities. (We recognize that the definition and distinction are not perfect.) Together they constitute the second track of the dual-track development strategy that we have advocated for the region for more than two years. Southeast Asia must truly “leverage” its rural economy and natural resources by combining them effectively with the region’s capital and labor through a conducive policy framework. This dual-track strategy is essentially an economic development strategy aimed at the mobilization of domestic savings as capital and surplus labor to fund the development of local enterprises that can leverage the resource endowment of the country.
A successful dual-track strategy -- and each Southeast Asian country, because of the uniqueness of its respective rural economy and natural resource endowment, must formulate its own version of the dual-track strategy -- requires each country to re-assess its competitive landscape through carefully examining its five major factors of production: intellectual property, labor, capital, land and natural resources. We have already discussed the issue of natural resource endowment. Of the remaining four, the region clearly has poor intellectual property resources and has little prospect of leveraging intellectual property for future growth. But the remaining three factors deserve analysis.
Land
The nature of this particular endowment is often misunderstood as agriculture and natural resource capacity is tied to land. Land as a whole cannot be treated as a strong resource endowment because population density, after taking into account inhabitable land, non-cultivable land, and land that is tied up in renewable resource development and exploration and extraction of non-renewable resources, is already quite high. The region can only aim for longer term self-sufficiency in basic food staples, and cannot count on land for economic growth and export earnings.
Labor
The relative decline in mass manufacturing and the concomitant inability to create employment in manufacturing suggest that the development of the rural economy and natural resource sector is the only viable way to absorb surplus labor. For some countries like the Philippines and Indonesia, an increase in the export of labor is almost inevitable.
A plentiful supply of labor and natural resources may combine to conjure up a bleak picture of low-skilled workers laboring in a palm oil plantation or down a copper mine. But instead, we could shift the projector to an image of well-heeled foreign tourists patronizing a pricey spa service on a beach resort or buying a brand-name handicraft produced in the rural economy. Manifested in these economic activities is pricing power, i.e., product pricing and wage earning ability that Southeast Asian enterprises and labor cannot earn from a foreign-owned manufacturing plant. It is therefore important to recognize that, while the opportunity to augment real wages from the factory floor may have been lost to Chinese labor, the region can still thrive through higher value-added activities encouraged by a policy of proactive rural and resource-based development.
Capital
Mass-manufacturing industrialization results in the region being dependent on foreign capital, i.e., FDI by MNCs. This has developed, not because Southeast Asia has insufficient saving (saving rates, though run down somewhat since the Asian Crisis, are still among the highest in the world) but because MNCs’ modus operandi is to own the industrial capacity it creates in developing economies. A sizeable part of savings, prior to the Asian Crisis, was, in turn, channeled into domestic infrastructure -- some clearly wasteful projects facilitated by the rent-based system of political patronage -- and inefficient capacity expansion largely in unproductive assets by large rent-seeking local enterprises. The surplus saving, in turn, was passively parked in the form of US dollars and Treasuries (i.e., foreign reserves).
Effective capital deployment means mobilizing savings to facilitate the development of the rural and natural resources sector. For the first time in 30 years, Southeast Asia must proactively (through government policy) deploy domestic savings to aid the development of its rural economy and resources sector. Thailand’s proactive policy of encouraging lending to SMEs and rural sectors, and the recently introduced “capital creation” scheme are examples. (See “Capital Creation -- Another Step Up for Thailand” dated January 16, 2003.)
(3) “China will enjoy a spectacular rise in income and wealth. The income spillover from the rise of China will benefit those that can provide services (tourism is a good example) to China at affordable rates. Countries with similar wage rates, i.e., Malaysia and Thailand, or lower wage rates, i.e., Indonesia and the Philippines, will benefit as Chinese spending can create jobs in these countries at a wage that will help maintain their standard of living.”
We agree with this view but our optimism on the positive impact of a Chinese-fueled tourism boom is much more cautious. First, tourism cannot replace manufacturing. The annual tourism receipts likely to be earned by Southeast Asia from China, measured in 2002 dollars, cannot realistically exceed US$20 to $25 billion in a decade --- this would represent only a fraction of the US$90 billion we estimate the region will lose in terms of annual manufactured export income over the next ten years.
Second, while we recognize that tourism is a resource endowment and the promotion of tourism is thus an integral part of a resource-based development strategy, our main worry is that it is such an obvious development that too many Southeast Asian countries are focusing on tourism and ignoring other more important but difficult areas of resource-driven development. Overemphasis on tourism also carries the risk of wasteful and indiscriminate expansion in transport (too much airport capacity) and hospitality (too many hotel rooms) capacity.
Bottom Line: Tailor-Made Dual-Track Strategy Key
to Coping with the Chinese Decade
In his recent article, Andy -- painted a rather rosy picture for resource-rich ex-Singapore Southeast Asia despite the inevitable “Chinese Decade”. We believe that the reward of coping or the price of not being able to respond positively to the Chinese decade is likely to be substantial.
At the end of 2002, the manufactured exports of Singapore, Malaysia, Thailand, Indonesia and the Philippines totaled US$306 billion, or 54% of the combined US$566 billion GDP. The value added generated by the manufacturing sector was 27% of GDP. We estimate that in 10 years, in current dollar terms, 30%, or more than US$90 billion worth, of manufactured exports will be lost to China and the value added of the manufacturing sector could shrink to just 20% of GDP. Firmer commodity prices and rising tourism receipts from China may not be sufficient to compensate for the decline in manufacturing export income.
The preserving or even augmenting of living standards clearly depends on the ability to find a new development anchor, i.e., better leverage the natural resource endowment through more effective capital and labor deployment, to make up for manufacturing losses.
Important Disclosure Information at the end of this Forum |
