SINGAPORE (July 3): Two decades ago, several Asian economies were shattered by a series of financial, economic and political crises that set the region back badly.
Indonesia, Thailand, Malaysia, South Korea and the Philippines bore the brunt of this crisis, while Singapore also took a brief hit. Today, these countries face a world in which great dangers loom, but also one that could generate huge opportunities.
Have these countries learnt enough lessons so that they can avoid another crisis of the same scale? Do they have what it takes to seize the new, emerging opportunities?
Our view is that the region has emerged from the Asian crisis with much greater resilience to external shocks than before. So, while there could well be external shocks, especially financial ones, the region is probably better positioned to absorb these shocks and mitigate their downsides. But, resilience to sharp shocks such as a global financial upset is one thing, the ability to adjust to longer-term geopolitical, competitive and technological disruptions is quite another — and here, we do face challenges.
Improved resilience to one-off shocks
We must not underestimate the possibility of a major global financial shock. Years of ultra-low interest rates and the quantitative easing of major central banks have unleashed a tidal wave of money that has inflated the value of a range of assets.
At the same time, low rates tend to cause investors to underestimate the price of risk as well as the cost of capital. This underestimation often leads to capital misallocation and excessive risk-taking, creating bubbles and imbalances that can end in crisis.
However, even if we do get such a global shock, the chances of any of these countries experiencing a thoroughgoing political, economic and financial crash similar to 1997 are remote. Since 1997, policymakers have executed a series of reforms that has improved their resilience:
• External sectors are better managed. In most Asian countries, the buffer provided by foreign exchange reserves is huge. The balance of payments is less marked by unsustainable deficits, as was the case in 1997. Currencies are now managed in a more flexible manner so that the abrupt devaluations that caused so much damage in the past are unlikely;
• Better supervision has ensured that financial vulnerabilities have been reduced. Banks are strongly capitalised and their governance improved to prevent the kind of cronyist lending that was a major source of the 1997 crisis. Macroprudential measures have targeted the build-up of imbalances such as real estate bubbles or excessive debt burdens on household or corporate balance sheets. These measures have not been entirely successful, as household debt levels have risen across the region. So, there are some potential pitfalls. However, there are enough capital buffers to take care of problems that might arise;
• Fiscal and monetary policies have improved and central banks in the region command much more credibility than in 1997. There is considerable scope for policy actions to counter any shock that hits the economy; and
• Economies are now more diversified — few of these countries depend excessively on just one or two drivers of growth.
With multiple sources of growth, economies are less likely to be thrown off balance by a shock in one or two areas. In fact, the experience in recent years is comforting. Economies that were hit by the Asian crisis have largely overcome the many crises and episodes of stress since 2007 — the most severe global crisis since the 1930s, a eurozone sovereign debt crisis, the taper tantrums of 2013 and the China- related financial turbulence in August 2015 and early 2016.
Malaysia suffered a massive devaluation of its ringgit in 2015 to 2016, but its economy is still growing reasonably strongly and there is no sign of any major downturn. Thailand has been cursed with unending travails — two military coups, severe flooding followed by the worst drought in decades, and the death of the revered King Bhumibol.
Yet, the Thai baht has been steady and while growth has slowed, the economy did not crash. In Indonesia’s case, there have been occasions, such as in 2008 and 2013, when its rupiah weakened sharply, but in each case, the currency regained its footing while the economic and financial systems held up rather well. In other words, the region’s resilience has been tested and found to be in good condition.
But can these countries prosper in a world of great disruptions?
The world has become a volatile place in recent years and it can only get worse. The global economy is on the cusp of changes that will be transformational, carrying the risk of great disruptions while also promising huge rewards to those who are able to take advantage of these new developments.
What are these immense changes? We list here just a few of the major ones:
• A much more competitive world: China is moving up the value chain and will now compete in many of the niches occupied by South Korean, Singaporean, Thai and Malaysian companies. At the same time, many emerging economies are mimicking the economic models employed by East Asian ones to surge ahead. As they reform their economies, these countries — such as Mexico, Peru and several in central and eastern Europe — will compete head-on with East Asian economies for export markets and to attract foreign investment and talent;
• Populist policies include more protectionism that could limit the trade, foreign investment and business process outsourcing that have boosted growth across Asia;
• Geopolitical stresses are building in areas such as the Middle East and the Korean peninsula, which could lead to earth-shaking dislocations with direct impact on Asia; and
• Multiple technologies are reaching their take-off points and these will transform the world economy. Renewable energy, especially solar and wind, is now taking off and is likely to reduce demand for fossil fuels faster than anyone had thought possible.
Artificial intelligence and robotics will change the dynamics of the manufacturing sector. The invention of new materials such as composites will reinforce this change in manufacturing, as will the advent of 3D printing. In the biomedical area, new therapies and methods of delivering drugs into the body more precisely could extend lifespans and create whole new industries.
Then, there is big data as well as cloud computing and all the possibilities they present. All these changes will alter the cost structure of many industries and shift competitive advantage in some cases. It could mean, for example, that global corporations no longer need to move production to cheaper locations in the developing world as much as they did before.
Dramatic changes such as these always come with upsides as well as downsides. Which countries end up as losers or winners depends on whether they have the flexibility to adjust and adapt successfully in the face of such transformations.
This is where we may face some problems: If one looks at the prerequisites for successful adjustment, many of the countries in the region are wanting in some respects.
First, there should be political capacity to allow reforms that will enable economies to adapt to these challenges. But in many countries, vested interests take advantage of corrupt political leaders to distort policies in their favour, throttling the possibility of dynamic adjustments and the emergence of new players.
In addition, because there will be much dislocation as new technologies burst forth, we need better social safety nets to ensure that the initial dislocations do not produce political instability. These social safety nets are still limited in scope, even in the more developed economies such as South Korea and Singapore. Second, many of these technological changes give an edge to large economies that allow innovating companies to scale up and become dominant. Most of the economies, including Indonesia, could be sub-scale.
It is not a coincidence that the big success stories in technology have been companies such as Google, Apple, Alibaba Group Holding and Baidu, which all hail from large economies. Yet, there is little political will to make the short-term sacrifices that would enable the economic integration that would allow regional countries to gain scale.
Third, a much bigger commitment to education and training is needed. Some of the smaller countries that have done well in the new economy, such as Israel and the northern European countries, have overcome the disadvantages of being small through the right investments in education while also pursuing links to large economies — Israel, for example, has tremendous integration with the US. But education systems across the region appear to be woefully inadequate — too few students make it beyond lower secondary levels and there is not enough vocational training.
Even in South Korea, with its outstanding academic achievements, there are probably too many university graduates and too few with the right vocational skills. Singapore’s commitment to lifelong learning could be the way forward.
Fourth, innovation is a key part of adjusting to this new world, but it is a tough business that goes beyond just finding cash for R&D and training high-quality human capital. It is proving to be a real challenge to convert inputs such as government cash and the establishment of universities and research centres into desired outcomes in innovation.
The latest Global Innovation Index shows that Singapore is ranked a miserable 63rd in the world in terms of innovation efficiency (how effectively inputs are converted to outcomes) and Malaysia is a little better at 46th, Indonesia at 42nd and the Philippines at 55th. However, Thailand does reasonably well with a 24th ranking and South Korea is very good at 14th.
Fifth, what this suggests is that giving scope for spontaneous bottom- up entrepreneurial activity is key. In many Asian countries, the regulatory and financing obstacles to such entrepreneurial-led dynamism are considerable. We need to see comprehensive efforts to deregulate the economy in this region. New financing mechanisms need to be put in place as well. But even that may not be enough.
In Singapore’s case, it has done well in eliminating such obstacles, but it may be the dominance of MNCs and large government enterprises that limits the scope for such bottom-up enterprises.
Conclusion: No repetition of crisis, but can the region be a winner in the new economy?
The good news is that enough has been done to allow us to deflect potential big shocks emanating in the world economy. Bad things may happen, but most of the region can probably contain the damage.
The bad news is that adjusting to the longer-term trends in the world economy could prove more difficult. Unless ways are found to overcome some of the challenges listed above, the region could end up being losers in the brave new world that is emerging.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy.