Moody’s “Who’s hurt worse by U.S. recession?”

November 24, 2008
Singapore Democrats

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Alaistair Chan
Korea Newswire

Conditions across Asia continue to worsen. Japan and Singapore are ‘officially’ in recession, and growth in most other countries is slowing. Exports are slowing sharply, and investment is also weak. There is a growing realisation that problems in the U.S. are more protracted than first thought and that conditions will not return to the way they were a few years ago any time soon, if ever.

Falling output

For the second successive quarter, Japanese output contracted, thereby satisfying the technical definition of recession. For the world’s second-largest economy, the sun has officially set on its longest post-World War II expansion.

Exports, which have been decimated by declining demand from the U.S. and Europe, weakened further during the third quarter. Net exports subtracted from GDP during the third quarter—a stark turnaround from the large contributions made as recently as the first quarter. Export-oriented businesses have responded to declining sales by cutting back on investment in plants and equipment, causing capital expenditure to decline for a second successive quarter. This has deprived the economy of the twin engines of economic growth it has relied on for most of the past decade.

Exports in Taiwan were similarly weak in the third quarter, falling 0.6% y/y. The outlook for economic growth in Taiwan is dismal, tracking the outlook for the world economy. Net exports constituted 17% of GDP in 2007. All components of Taiwan’s national accounts except government spending contracted during the third quarter.

The global downturn has hit Singapore hard. Output has now fallen quarter on quarter for two consecutive quarters, placing the economy in a technical recession, with output in the third quarter lower than it was a year ago. It seems that most of the sectors that Singapore’s economy is built around have been hurt in some way by the global financial crisis and subsequent downturn.

Singapore is heavily dependent on external demand, and the drop in nonoil domestic exports such as electronics and pharmaceuticals is hurting manufacturing. Part of this is due to weak demand in Western countries, but part of this is the rise of competitive producers elsewhere. Mobile phone production has been shifting to other countries such as China and Taiwan. Domestic producers may have been handicapped by the rising currency, which the Monetary Authority instituted to dampen inflation. It stopped currency appreciation after its October meeting, and could switch to depreciation at its next meeting in April.

The financial industry has been threatened in many ways. The falling stock market and financial volatility have hurt profits from trading, sales and wealth management. Meanwhile, the property market is facing a slump, and prices for apartments and housing are falling. This hurts construction mostly, but also reduces the demand for loans. Tight, or barely functioning, credit markets are also impeding trade by making it difficult to secure letters of credit for shipments.

Could Asia be hurt more than the U.S.?

There is a case to be made that a global downturn will hurt Asia more than it will the United States. The reason is that Asian countries run current account surpluses, while the U.S. runs a current account deficit. This seems counterintuitive. But it matters because it means Asian countries are mostly net producers, while the U.S. is a net consumer. A reduction in global demand means a reduction in global supply, so although the U.S. downturn will trigger this reduced global demand, Asia could bear the brunt of the problem through reduced global supply.

The Great Depression and Smoot-Hawley

Much research has been done on the Great Depression. One overlooked reason for why the United States was so badly hurt during the Great Depression was that in the 1930s, the U.S. was the world’s largest exporter and ran the world’s largest current account surplus. Europe had the place of the U.S. today, running a trade deficit and consuming American goods.

So when demand collapsed, there was overcapacity, mostly in the United States. Rather than boost domestic demand to absorb the excess production, the government imposed import tariffs, notably the Smoot-Hawley Act. This led other countries to retaliate, further blocking off markets for American goods. This resulted in a painful adjustment period, when production had to fall to the level of consumption, which was ultimately corrected with the onset of government spending for World War II.

The U.S. is now undergoing another period of adjustment in which consumption and investment relative to GDP fall while saving increases. Among other things, this implies a reduction in the U.S. current account deficit and hence a reduction in Asian current account and trade surpluses. Given that China is its second biggest import supplier and the country with which it has the largest bilateral trade deficit, it is likely to bear a large part of the adjustment.

The coming adjustment

Many commentators claim to know the solution for Asia—stimulate domestic demand! But if the process were straightforward, governments would likely have done so already. The flip side is that they have no other choice. With little demand in Western markets, either domestic demand must compensate, or supply must shrink.

If the adjustment in consumption and saving in the U.S. is part of a long-term correction, there will be major implications for Asia. For one thing, entire export industries will have to be retooled to serve domestic sectors. Retooling, say, factories in Shenzhen from assembling iPods and mobile phones towards products that Chinese consumers would buy would require a long process of reconfiguring supply chains across Asia, affecting, among other things, semiconductor production in Taiwan, memory production in Korea, and hard drive production in Singapore.

The process is likely to take decades. In terms of government policy, to boost domestic consumption, saving will have to be discouraged. Governments may have to ramp up deficit spending and improve social safety nets such as unemployment benefits and healthcare.

Repeating mistakes?

China, however, is in danger of repeating some of the mistakes of the U.S. The Chinese government earlier announced tax rebates for a range of goods. In an economic sense, there is little difference between import tariffs and export subsidies. There is also speculation the government may begin to depreciate the yuan, which would have a similar effect. The announcement of the 4 trillion yuan fiscal stimulus also seemed designed partly to encourage American policymakers to come up with a larger package.

But there is a deeper reason why governments are reluctant to abandon the export-led model—namely, their economies will grow more slowly. Selling products to Western consumers does wonders for productivity, accelerating growth in capital-to-labour ratios and helping to create world-class infrastructure and workforces. Reduced import demand from the U.S. could halt this process.