The recent upturn in Asian economies is creating a dangerous optimism that almost wilfully ignores the difficulties ahead. Future historians will mark 2008 as the year that the development model that has driven much of Asia’s rapid growth for the past two decades went bankrupt. While the next decade will represent a difficult transition towards a new development model, unfortunately many Asian countries are responding to the economic crisis with policies that may temporarily boost growth but that are only likely to make the transition more difficult.
At the centre of the Asian development model, with China providing a steroid-fuelled example, were policies aimed at mobilising high levels of domestic savings and channelling massive investment into productive capacity. These policies boosted savings by constraining consumption even while they forced rapid growth in domestic production. One of the consequences of the Asian development model has been that production outgrew consumption for decades. When a country produces more than it consumes, it must run a trade surplus to export its excess capacity. The Asian model consequently required high and rising trade surpluses that allowed Asian producers to produce far in excess of what Asian consumers could afford to absorb.
But there cannot be trade surpluses without trade deficits elsewhere. A fundamental requirement for the Asian model was that foreigners were able to run the requisite trade deficits. In practice, only the US economy and financial system were large and flexible enough to play this role. The Asian model, in other words, implicitly involved a massive bet on the willingness and ability of the US to continue to run large and rising trade deficits.
For nearly two decades US households borrowed recklessly to finance the consumption binge that allowed Asian exporters to continue exporting excess capacity but, as household balance sheets in the US became vastly overextended, it was just a question of time before a long deleveraging process would occur. The global financial crisis is part of this very process.
Very thought provoking.