The writer is chief economist for Asia at Morgan Stanley
In Asian economies, a powerful momentum is unfolding that will trigger productivity growth and drive outperformance relative to other regions. It’s a trend that has been underestimated by skeptical investors.
Over the next two years, gross domestic product will grow faster in Asia than in the Americas and Europe, cementing its position as the largest and fastest growing economic bloc. Asia’s GDP is expected to grow in nominal terms from $33 billion in 2021 to $39 billion in 2023, surpassing $34 billion for the Americas and $26 billion for Europe. The $5.4 billion increase for Asia compares to $4.8 billion for the Americas and $2.9 billion for Europe.
This dynamic is the interplay of export growth, capital expenditure and productivity. Unlike other economies that have relied heavily on stimulus, Asia’s recovery from the Covid-19 shock has been fueled by a strong recovery in exports. Investors might be tempted to view this as a reflection of a recovery in global growth, but what happens next is arguably far more interesting.
As the world’s largest producer gets back to work, spare capacity will be absorbed and business confidence will rise, boosting demand for capital goods. Rising capital spending should draw more workers into the labor market, setting the stage for a self-perpetuating cycle.
In fact, Asia’s productivity — or the extra GDP generated by new debt — is poised to record the best performance since the 2003-07 cycle. After 2008, global trade volumes grew by an average of just 1.2%, compared to 6% in the 2000s. Without support from external demand, Asian policymakers had to rely on higher leverage to stimulate aggregate demand, which inevitably raised concerns about macroeconomic stability.
Now, supported by strong global trade, Asia’s growth will depend much less on stimulus and leverage, while inflationary pressures and other macroeconomic stability issues will be kept at bay.
However, particular circumstances prevented this productivity dynamic from fully playing out. In general, a strong increase in exports and investment spending translates into stronger growth in income and consumption. This time, the transmission mechanism has been blocked by successive waves of Covid and restrictions mitigating consumption. But Asian economies outside of China are adjusting to life with Covid and following a path to put the woes of the pandemic behind them.
In China, the more transmissible variant of the Omicron coronavirus could test the zero Covid policy and further constrain the recovery of consumption. If the variants of Covid remain mild, however, policymakers could move away from aggressively implementing its zero Covid strategy after the Winter Olympics.
While Covid has dampened China’s growth, the most important factor has been its political cycle. In 2021, macroeconomic policies have tightened excessively and regulatory measures have intensified across a wide range of sectors. The debt-to-GDP ratio was cut by 10 percentage points to 283%, the most aggressive reduction in China since 2003.
The political cycle has clearly shifted from over-tightening to easing, and the economy is expected to move from a slowdown to a recovery. In late December, top policymakers acknowledged that “China’s economic development is facing three pressures: contraction in demand, shock in supply and weakening in expectations”, suggesting that they will continue to relax on all foreheads.
First, the so-called credit impulse – a measure of credit growth relative to GDP – will normalize toward neutral territory, removing a significant impediment to growth.
Second, policymakers are now taking a more structured and institutionalized approach to regulatory tightening, and changes from now on are likely to be incremental.
As governments seek to tackle income inequality, they must not lose sight of the need for continued reforms to encourage a shift to higher value-added activities in order to complete the transition to a high-income society. . This change will not be possible without the participation of the private sector.
Third, measures related to decarbonization and ownership will be less stringent, allowing for a gradual pace of adjustment. That should ease concerns about further action weighing on private business sentiment. As these changes take place in the real economy, we expect a recovery in growth to take hold from the second quarter of 2022.
Across Asia, a virtuous feedback loop is about to unfold, characterized by strong external demand and positive spillover effects on investment spending and consumption.
This cycle will look much like 2003-07, with productivity playing a bigger role in Asia’s growth story, driving its outperformance. The risk is that persistent inflation in the US leads to an aggressive shift in the Fed’s tightening path, which threatens the longevity of this economic cycle.