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posted on 01 December 2015

Great Asian Slowdown

by John West, Asian Century Institute

We are now in the midst of the "Great Asian Slowdown", driven by aging populations and the failure to undertake to take structural reforms to boost productivity, argues John West.

East Asia's leading economies of China, Japan, and Korea are slowing down. This is due in part to a number of short-term factors like the weak global economy, and rising wage costs and excess capacity in China.

But there are more fundamental factors at work. Aging populations in these and some other East Asian economies is a secular trend dragging down potential growth, and which will keep economic growth on a weaker trajectory for the foreseeable future. This adverse trend is being exacerbated by a failure of governments to seriously implement structural reforms to turn up productivity as a growth driver.

These countries benefited from demographic dividends during their high-growth periods, thanks to their large youthful populations. But as populations age, and working age populations decline, demography becomes a "tax" rather than a dividend.

Neither advanced Western countries, nor commodity exporters from the emerging world, will be able to rely on Asia as a big source of growth, as they have in the past few decades. In fact, many emerging economies and advanced countries will suffer from dumping from China's excess capacity in many industries.

Japan -- East Asia's first slowdown economy

Japan was of course the country that led Asia's development. It was also the first to be hit by the adverse demography of aging populations, due to low fertility and rising life expectancy. Japan's working-age population started declining in 1995, and has been falling ever since.

As a result, Japan's annual potential economic growth rate fell from over 3% in the early 1990s, to less than 1%. Today, the Bank of Japan puts Japan's potential growth rate at just 0.5%. Japan shifted from being a demographic dividend to a demographic tax country. Its aging population is pulling its potential growth down.

The Japanese government could have responded by launching structural reforms to boost productivity. But it didn't. Productivity remains chronically low in the country's services and agricultural sectors. Today, Japan's labor productivity is a mere 70% of the US level.

Japan could also have made serious efforts to offer more economic opportunity to women and youth. But it hasn't.

There has been lots of huffing and puffing over Abenomics and "womenomics". But this is a case of too little, too late. There is very little sign of serious structural reforms being undertaken, other than perhaps the Trans Pacific Partnership. And the financial implications of supporting Japan's aging has been major factor driving Japan's national public debt to close to 250%, a world record among advanced countries.

China -- East Asia's next slowdown economy.

China seems to be heading down the same track. In part due to the one-child policy, China's working age population peaked in 2012 and has since been declining.

This is reducing China's potential growth rate. In contrast to Japan, China faces the risk of becoming old before it becomes rich. Its GDP per capita is only one-fifth of the US level.

There has been much noise about China's recent decision to transform its one-child policy into a two-child policy. But this is also a case of "too little, too late", which is unlikely to have much impact on China's economy, at least for another two decades. Indeed, the effect could be more negative than positive, as additional children impose a burden on the public purse.

China has of course much potential to lift its productivity towards that of global leaders, especially in its backward services and agricultural sectors. But since 2007, China's productivity growth has slowed down sharply as a growth driver. Recent growth has been largely driven by capital investment, much of it due to the government's fiscal stimulus to keep the economy afloat. And much of this has been inefficient leading to excess capacity in a wide array of industries.

Despite the Communist Party's commitment to allow market forces to play a decisive role in the economy, structural reform is very much in the slow lane. Indeed, with the Chinese economy in the midst of a big slowdown, the government is now reluctant to take the risk of launching much needed structural reforms. And the Chinese government's public finances will also be hit faces more pressure to improve support for its aging population.

Some commentators argue that China's slowdown is a natural part of the economic convergence process (ala conditional convergence theory).

It is true that growth slows as the low-hanging fruit of economic catchup are exhausted. But China could do much more to revive productivity growth, especially by reforming its inefficient and debt-ridden financial sector. It is dominated by state-owned banks, which lend much of their finance to state-owned enterprises and large politically connected enterprises, rather than dynamic SMEs.

Korea -- another Asian slowdown economy.

Korea is also heading in the same direction. Population aging in Korea is the fastest of any OECD country, as fertility rates are even lower than in Japan and China. And its working age population will start falling in a few years time.

Korea is being struck by population aging at a much more advanced stage of economic development than China. But its GDP per capita is still only about half that of the US. And despite the global prominence of companies like Samsung, productivity in Korea's services sector is only 40% of that of the manufacturing sector, while Korea's massively protected agricultural sector also has a very low productivity.

Could Korea reform itself to lift productivity? Unfortunately, the answer is no.

The reality is that Korea is increasingly known as a "chaebol republic", as the nation's conglomerates like Samsung and LG have a stranglehold on both the nation's economy and politics. They are blocking the necessary opening of the economy to more competition, and to reform of corporate governance.

Thailand is another case of an Asian country suffering from poor demographics due to very low fertility rates at an early stage in the development process. And Taiwan, which has in recent times held the world record for low fertility, is another case.

Cases of Hong Kong and Singapore

The contrast with Asia's most advanced economies of Hong Kong and Singapore is stark. They both face the challenge of aging populations, and low fertility, indeed lower than Japan and China.

But both are very open to migration, with around 40% of their residents being foreign-born, whereas the foreign born populations in Japan, Korea and China are trivial and there is little sign of this changing. And both Hong Kong and Singapore have open economies, with business-friendly policies. Not surprisingly, their productivity and GDP per capita are among the highest in the world, and much higher than in Japan, China and Korea.

Asia's new demographic surplus countries

Countries like India, Bangladesh, Indonesia, and the Philippines are at a different phase in their demographic transitions. They all have large youth bulges now entering the labor market.

These youth bulges have the potential to generate demographic dividends, as in the earlier cases Japan, China, Korea, and other East Asian economies. But to capture these demographic dividends requires two things.

First, it is necessary to educate their youth populations, especially providing vocational education and training. But in all these labor bulge countries, education and training is very poor for much of the youth population. For example, in India half the population is functionally illiterate!

Second, it requires a dynamic economy which generates job opportunities. But again, all these labor bulge economies are in desperate need of structural reforms to stimulate foreign and local investment. But progress on structural reform has been woefully inadequate. All of these economies are also in desperate need to improve their infrastructure.

The risk in all cases is that potential demographic dividends could become demographic time bombs, with large numbers of unemployed, and frustrated youth. The potential for growing social and political unrest is great. Already, India is bristling with religious and gender violence. And the risk is that this will only get worse.

Concluding comments.

We may be coming to the end of Asia's high growth period. Potential economic growth is being dragged down aging populations in countries like Japan, China, Korea, Thailand and Taiwan. And governments do not have the courage to implement deep structural reforms and open up to immigration.

Demographic surplus countries like India, Bangladesh, Indonesia and the Philippines have the potential to enjoy demographic dividends, and provide an impulse to the Asian Century. But there is a greater risk of demographic time bombs, as these countries do not provide adequate education and training to their youth, and do not generate sufficient job opportunities.

Adjusting to the Great Asian Slowdown will present many challenges to both Asia and the rest of the world.


This article is based on a presentation made by John West, Executive Director, Asian Century Institute, to a conference organized by the Official Monetary and Financial Institutions Forum at the Federal Reserve Bank of Atlanta, US.


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