Do Investors and Policy Makers Misunderstand Asia?

by: Daniel Moser
Economists often use large and growing current account surpluses to attempt to spot imbalances that might be building up somewhere in the global economy. In fact, according to The Economist, “Asia’s current account surpluses have been widely (if unfairly) blamed for causing the global financial crisis.” Granted there is plenty of blame to go around for the causes of the financial crisis and quite frankly rehashing it again would serve the best interests of no one.
A significant amount of policy makers, economists, and T.V. pundits argue that the global economy needs to be reshaped into a more balanced place in terms of global trading patterns. They tend to argue that China specifically, and in general Asia, need to expand their consumer base thus balancing out their own economies thereby creating a more stable global economy. But is this the right solution? Could it be that policy makers, investors, and T.V. pundits actually have a rather large misunderstanding with respect to the balances among the Asian economies?
In a thought provoking article by The Economist titled “Invested Interests”, some basic statistics are explored around the argument positing that expanding the consumer base in Asia is the best policy for rebalancing the global economy. As it turns out, Asia excluding China primarily relies on consumption for the majority of their GDP. The article states,

According to a study by Eswar Prasad of Cornell University, private consumption accounts, on average, for 58% of GDP in emerging Asia outside China. That is lower than in America, which has been over consuming for years, but it is slightly higher than in Japan or the European Union. In the eight years to 2008, investment accounted for half of China’s GDP growth and private consumption for less than one-third. But in most other Asian economies the relative shares were almost exactly the reverse, with consumption the dominant source of growth.

The article goes on to cite a Barclays report which argues,

To reduce their excess saving, most Asian economies need to invest more rather than consume more. Higher investment, especially in infrastructure, they argue, would not only reduce current-account surpluses but also boost growth and living standards. Better roads and railways would help farmers get their produce to cities and enable manufacturers to export their goods abroad. Clean water and sanitation could raise the quality of human capital, thereby lifting labour productivity.

When evaluating the global capital markets in a very broad sense, it seems fair to suggest that capital moves where it is treated the best. Personally, I think this is why capital has been flowing at an increasing pace to Canada and Australia. Economic policy, as well as political rhetoric, out of Canada and Australia has been far superior to that of the United States (in recent times anyways), and as such, capital has been moving to those locations at an increasing rate.

This notion is further developed by The Economist's argument that

by investing (and saving), a country sacrifices current consumption but future output and consumption will be higher. The optimal level of investment is the rate that generates the highest sustainable level of consumption over time. That, in turn, depends on a country’s “marginal product of capital”, or how much output is produced by new investment. The higher this measure, the more it should invest.

Combining these arguments momentarily, it seems clear to me that capital will flow where it is treated best and can earn the highest level of growth.

Estimates by Yuwa Hedrick-Wong, an economic adviser at MasterCard, suggest that in China, India, Indonesia and Thailand capital per person is only 2-6% of that in America. This means there is huge scope to boost productivity by giving workers new machines and better infrastructure. The optimal rate of investment will therefore be much higher than in developed economies, and may even justify the pace of China’s investment of more than 45% of GDP.

Yet in Taiwan, Malaysia, the Philippines and Thailand investment is no higher (and in some cases lower) as a share of GDP than in Japan or the euro area. This helps explain why these countries’ growth rates have slowed over the past decade. Mr. Hedrick-Wong finds that among emerging economies, those that invest a bigger share of GDP tend to enjoy faster growth.

So what are the implications of this whole discussion? Investment, as a share of GDP, in Asia as well as other emerging markets should expand relative to savings/consumption to achieve superior growth over time. This suggests that investing in infrastructure as well as other productivity enhancing investments in emerging markets will actually serve a greater benefit to these nations than increasing their reliance on domestic consumption.
This seems bullish for copper, machinery makers, tractor suppliers, even tech companies that enhance productivity such as Baidu (NASDAQ:BIDU). Of course this is contingent upon policy makers sharing the same view.

Disclosure: Long FCX PCU

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