Is East Asia Decoupling or Can It Decouple?

There have been a lot of talks as to whether the East Asian economies have decoupled from the Western economies since their stock markets have rallied significantly this year despite downward trend of their exports. Has their decoupling happened or would it happen?

The East Asian economies are closely interwoven with the Western larger economies, especially the U.S. economy. China has jumped into the global economic scene by exporting its goods to the U.S. and pegging the yuan to the dollar. The U.S. dollar hegemony and its status as importer country have made it possible for the States to sell its treasuries to the East Asian countries. All three countries, Japan, Korea, and China, seem to be fully aware that if they stop buying dollars, their export economies might be ruined due to their currency appreciation, although they have attempted to reduce their holding of U.S. treasuries.

We are in a global economy. Many consumer electronics goods made in China to export to the U.S. are assembled in China with chips produced in Japan and Korea. A lot of manufacturing jobs not only in the U.S. but in Japan and Korea have been outsourced to China. Corporatism would perpetually move for cheaper labor around the globe. Technology transfer from the advanced countries to the developing ones has occurred through various modes such as reverse brain drain, acquisition, and strategic alliance. Capital has also been flown across the border.

The East Asia’s economic contraction is in large part derived from faltering demand from their trading partners in the Western economies. Given several indicators such as a sharp fall in their exports and the unemployment, the East Asian economies are falling, not decoupled from the Western economies. We may be entering a new phase of demand-constrained economies due to various factors such as structural unemployment and aging demographics. How can the East Asia economies decouple from the Western economies and pull out of this crisis first? Again, resetting the system for decoupling would involve the confluence of many factors.

The East Asian countries have had the very low domestic consumption levels. Given the small size of their domestic market, their overcapacity problem won’t go away soon. This brings the need for boosting their domestic demand for their goods, as discussed in the previous post. In order to boost domestic consumption, income should be leveled up through increased corporate earnings or job growth.

Businesses are central to a sound recovery. The East Asian countries may have to replace the imported goods with locally-produced goods by raising the ratio of domestic components and capital goods. So as not to heavily depend on Western demand for their goods, the East Asian companies may need to expand their geographically diverse product portfolio, which some Korean firms have successfully done. In Korea’s case, foreign shareholders who own the shares of the Korean corporations have been the major movers of Korean stock market uptick and can easily shake the Korean economy. Hence, their economic performance – especially chaebols’ -, which is heavily dependent on exports, would be one of the key indicators of decoupling scenario.
This global recession may provide some rare opportunities for the East Asian companies to leap if they are able to foresee the future outlook and prepare themselves for it. It is interesting to point out that Korean chaebols were able to enter the high tech businesses such as semiconductor and flat panel by utilizing the global recession wisely as explained in the previous posts.

Some pivotal issues around economic fundamentals remain unresolved. As in the West, the banking sector holds the lion’s share of financial assets in East Asia. Nurturing the healthy financial sector may be an imminent issue for the East Asian countries. The collusion between the government and big businesses has been fueled by the state’s control of the financial system. The financial markets of Japan and Korea have been liberalized. And yet they have learned that the easing of regulations and the liberalization of markets for free trade and capital influx can cause the adverse consequences such as a widening gap between classes. Since the East Asian countries can’t compete with the foreign financial institutions on a level playing field, they may have to be cautious about further opening their markets up to global capitalism until they have proper infrastructure put into the system. Their recent policies such as low interest rates, fiscal stimulus, and bailouts are worrisome, as Japan’s case demonstrates that it didn’t do a whole a lot to revive the ailing economy.

How the various policy approaches in East Asia pan out would be paramount to true decoupling. Policy initiatives need to be crafted in a way that prepares for the global economy and protects its people, considering the dynamic patterns of the macro-economic effects. Although it would not be easy to conjecture how each country would decouple, the one who takes a hard look at the real fabric of the economy and prepare for the next economic upturn in a global economy would get out of the mess first in which we are mired today.

The East Asian countries have histories of excessive or mismanaged government interventions including interfering in financial markets, policing mergers, and creating conglomerates. Although big businesses (in China’s case, SOEs) in the East Asia have been the locomotive for their economic development, their excessive reliance on them has hindered the proper functioning of market economies. The government’s criteria used to determine the bailouts has been dubious on many occasions. In order to move up the economic food chain, ventures should be nurtured in accordance with market mechanism since they can grow jobs in emerging industries. Monopolistic and anti-competitive practices by big businesses should be banned through proper regulations. A level playing field should be guaranteed to small businesses.

More robust infrastructure critical to further enhance indigenous innovation capacity such as higher education and national innovation system should be built. For example, the U.S. still has the best engineering schools in the world, and many engineers who were sent to attend those schools from Korean chaebols hardly return to Korea due to the better educational system and working conditions. Resources including financial and human capital should be better reallocated throughout the economy accordingly. Whichever country with this infrastructure being in place would have much more recovery potential.

True decoupling may require something deeper than mere economic transformation. It may entail social transformation and political will since economic factors are compounded by its internal social and political concerns. Decoupling may require a fundamental reset of an economy that will operate in the interests of the society.

In addition, to make matters more complicated, geopolitical dynamics can be a defining factor in determining if the East can actually decouple from the U.S. There are also geo-political issues among the East Asian countries themselves. For instance, China has a lot of geopolitical upside in East Asia.

All these factors would play a part in decoupling. Reshaping the society and retooling the economy is a painful process. They know it from their prior experience during a financial crisis. Japan has been in deflation even when global bubble economy was booming. How they can decouple from the Western economic contraction seems to be a matter of survival, not an option they can take, given the speed and degree of downward trend of their exports.

We may see there would be some actual East Asian decoupling from the West if the East Asian economies still show strong sign of recovery after being hit by the initial ripple effect of faltering Western economies. If they don’t, they may risk a Japan-style lost decade of growth.