Death of the Asian Development Model: Exporters Chasing a Failing Strategy?

China Financial Markets which is written by Michael Pettis has an intriguing post on the death of the Asian development model.

Here is how Pettis describes the model:

As I see it the Asian development model involves polices that aim directly or indirectly at boosting savings and channeling huge amounts of subsidized resources (usually subsidized by savers, and so constraining consumption) into investment and manufacturing capacity.Some people call this mercantilism, and in many ways it does correspond to certain classic mercantilist policies, but I am wary of defining it this way because “mercantilism” is such a loaded word.

China, Japan, Korea and many other countries have successfully employed this model over the past several decades and have seen their economies grow exponentially. Mr. Pettis is of the opinion that the current fiscal policies in China are pushing the country towards ever greater reliance on the model at the expense of developing domestic consumption.

So why does he think the Asian development model is a goner? His thesis, and it’s pretty obvious, is that without external demand the model doesn’t work since production of goods in a country with an underdeveloped consumer sector either has to export or produce increasing quantities of inventory. Assuming there are foreign takers for their goods, they will run a trade surplus which means someone else has to run a trade deficit.

He goes a bit further and suggests that the entire model was based on the existence of an “importer of last resort.” If you are ahead of me and have already labeled the U.S. as that importer, congratulations. But as Mr. Pettis points out, the danger, largely ignored or considered implausible, was that consumption patterns in America would always remain the same. His belief that indeed those patterns are going to change is the reason that the model is broken.

He cites two reasons for the likely change in consumerism in the U.S. One, the Obama administration is trying to turn the country towards less consumption and towards more savings and two, the high debt accumulated as a result of excess consumption necessitates a change. I agree with his second idea. I also don’t deny the intentions of the Obama administration, I just question their ability to manage the economy that directly.

All of this is a rather lengthy way of getting to a point that I’ve made here often and that Pettis seems to share. Put simply, the Asian countries and China in particular are losing their main customer and there isn’t anyone to step into the breach. That’s bad enough, but like many they proceed on the belief that circumstances will revert to the norm that prevailed prior to the crisis.

One could add that seems to be the general approach of governments around the globe. Witness the attempts on the part of the administration to resurrect the securitization market via TALF and the obsession with bank lending and reinflating consumption. Viewed from that perspective, the idea that the administration truly wants to change the base of the economy is called into question.

Pettis argues as do so many that the only way out for China and others is to grow their domestic economies. Paradoxically, he thinks that the steps that China is taking right now are going to make that a more difficult path to follow once the country comes to the realization that it needs to go that direction.

Briefly, he argues that by pouring so much bank lending into more production geared to the production of goods for the export market they are sowing the seeds of a banking crisis. He expects non-performing loans to rise as the borrowers find few takers for their goods. A compromised financial system then retards the development of a consumer society.

There is a lot of noise about China’s growth exceeding expectations and the potential for that country to help lead the world out of this funk. If Pettis is right, I’m in his corner, it signifies a lot less than one might think. And if he is right, then the next few years are going to be pretty wrenching for everyone.

Comments

[Glen88:]

Another reason to believe that the 'model' is broken is that China's experiences with it occurred during a period of low US unemployment. The loss in manufacturing and other jobs was tolerable as the displaced Americans could find other employment. Now, with unemployment rapidly increasing, the willingness of the US to overlook distortions trade will fall under tremendous pressure be addressed.

Apr 27 12:52 PM

[Chris B:]

The historical average consumer savings rate is 10%. Since the 1980's this rate has declined rapidly. In 2005, we hit negative one percent as consumers took out credit card and home equity debt to buy merchandise - much of it made in China. That was obviously unsustainable. Now the savings rate is back up to 4% and rising.

The baby boomers who were driving so much of that spending find themselves just a few years away from retirement with their 401(k) savings slashed in half (not that they were saving enough even before this crisis!). They face 20-30 years of poverty if they don't save every last penny during their few remaining working years.

The rise of the savings rate from -1% to +4% over the past 3 years was associated with a decline in Asian exports, despite rapidly rising Chinese supply. I suspect that 10% marks the sustainablility point for the consumer savings rate, because savings rates around this number persisted for several decades before the 1980's. At 10%, people are saving just enough for a modest retirement and to handle life's emergencies without going into debt. Consumer savings rates below that point will eventually result in an inability to retire.

Consumers from the baby boomer generation now have a savings and debt emergency on their hands. To an extent, so does generation X. They'll have to kick their savings into high gear to undo the damage of a decade building up debt while saving next to nothing.

The first things on the chopping block will be Asian exports, which tend to be entertainment, electronics, toys, and other discretionary purchases. Food, rent, utilities, clothing, communications, and healthcare, in that order, will be the new priorities. 50" LCD televisions will not.

South Korea and Australia might be OK. South Korea (EWY) exports less discretionary items like cars, ships, and steel. Australia (EWA) exports minerals.

Apr 27 04:37 PM

[bricki:]

Japan has proven that this strategy can only take you so far. Once your economy develops to a western standard of living additional growth by this mechanism cannot take place because you have no cost advantage over locally produced goods. Worse yet we are heading to an era where transportation costs are a significant fraction of the price of the imported good. Now Japan is in a bind because of its aging workforce and low birth rate.

China is unlucky to have this economic environment; demographics and accumulated debt are the immediate reasons why the US will not act as an effective sink for their exports to the degree needed. But more fundamental are the relative sizes of the populations. The US bore a lot of the cost of developing Japan with its population of 100 million. Bearing the cost of developing China with a population 13 times larger to western standards is not possible. Mercantilism or whatever you wish to call has its limits. If China wishes to achieve a western standard of living for its population it will have to find a new model.

Apr 27 08:09 PM

[M.R. Henderson:]

If he is wrong, and now jobs are created, while consumption levels return in a year to levels that allow factories to turn a profit running under capacity, and as just happened (largely unreported) the government quietly pays off the bad loans of its banks allowing them to continue with little adverse affect, then China will have in place a more efficient infrastructure with which to develop the internal economy that it also knows is strategically necessary in the case of a war. Most of China's stimulus projects have been on the books for years. They are being accelerated, with 1/3 of the stimulus leaking, which arguably isn't that bad a thing right now in the face of declining domestic demand for goods and property. We call this corruption, Keynes would call it demand. It doesn't really matter where it comes from, if it takes cars off the lot and liquefies overbuilt apartments. And that's not even considering the deflationary effects of increased savings amidst over capacity. So this first salvo of stimulus is not necessarily a mistake for China.

But if demand from the world for China's goods does not come back to a certain level, if as Soros and others suspect, we are at a paradigm shift, and savings rates around the world increase, then China will need to rapidly increase long term employment, possibly through health and other public safety initiatives to help control things at a simmer for awhile. However, the Chinese consumer, fed by Hollywood, may need little stimulus to increasingly recycle its earnings, the Chinese multi-child boomers (1970-1981) are now coming into peak profit earning age. They do not save like their parents, indeed they spend their parents savings.

Apr 27 10:20 PM

[Tom Lindmark:]

You make some interesting points. I don't think that stimulus is bad for China but there are indications that a lot of it may be just recycled into the equity markets. I'm not sure that they will be able to ramp up domestic demand to the extent they may need to in order to plug the hole in their future exports. At any rate it's going to be interesting to watch.


On Apr 27 10:20 PM M.R. Henderson wrote:

> If he is wrong, and now jobs are created, while consumption levels
> return in a year to levels that allow factories to turn a profit
> running under capacity, and as just happened (largely unreported)
> the government quietly pays off the bad loans of its banks allowing
> them to continue with little adverse affect, then China will have
> in place a more efficient infrastructure with which to develop the
> internal economy that it also knows is strategically necessary in
> the case of a war. Most of China's stimulus projects have been on
> the books for years. They are being accelerated, with 1/3 of the
> stimulus leaking, which arguably isn't that bad a thing right now
> in the face of declining domestic demand for goods and property.
> We call this corruption, Keynes would call it demand. It doesn't
> really matter where it comes from, if it takes cars off the lot and
> liquefies overbuilt apartments. And that's not even considering
> the deflationary effects of increased savings amidst over capacity.
> So this first salvo of stimulus is not necessarily a mistake for
> China.
>
> But if demand from the world for China's goods does not come back
> to a certain level, if as Soros and others suspect, we are at a paradigm
> shift, and savings rates around the world increase, then China will
> need to rapidly increase long term employment, possibly through health
> and other public safety initiatives to help control things at a simmer
> for awhile. However, the Chinese consumer, fed by Hollywood, may
> need little stimulus to increasingly recycle its earnings, the Chinese
> multi-child boomers (1970-1981) are now coming into peak profit earning
> age. They do not save like their parents, indeed they spend their
> parents savings.

Apr 28 12:22 AM

[Plant the s...:]

What is difficult to understand, chinese population and growth in demand obviates the need for such an export focused strategy. Japan, Korea and other smaller countries had smaller markets that sought scale outside their borders.

Sep 15 06:15 PM