The Shift to the East and Implications for the West

Abstract

East Asian countries seem to be weathering the global economic crisis much better than the US and Europe. Western countries have been burdened by fiscal deficits and incoherent monetary policies. Asian triumphalism is unfounded, but the fact remains that Asia has a much more dynamic outlook. Especially China is rising again and driving the economic recovery of the rest of the region. But structural political and economic factors still impede China and other Asian countries from rising to the status of real global powers. The US remains the indispensable global leader. What really separates Asia from the West, and especially Europe, is a continental awakening, a striving for progress and advancement that contrasts with a new Eurosclerosis.

The global economic crisis has narrowed the gap between the West and emerging markets. An anaemic recovery and pervasive gloom cloud the West; talk of American decline and Eurosclerosis is back in fashion. Roaring growth and sunny optimism brighten emerging-market skies, especially in Asia; China and India shine brightest of all. What sense can we make of this ‘shift to the East’? And what does it mean for the West?

Crisis effects: short-term divergence, long-term convergence

In retrospect, it is evident that the globalisation boom in the quarter-century leading up to the crisis enabled faster ‘catch-up growth’ outside the West. This period saw the greatest increase in economic growth, globalisation and prosperity in history. The West benefited; much of the rest of the world benefited even more. Technological innovation and liberalisation of markets were the twin engines of late twentieth-century and early twenty-first-century globalisation.

The crisis has induced both divergence and convergence. Post-crisis economic performance has markedly diverged; but this has accelerated the long-run catching up or convergence of emerging markets with the West.

Diverging economic performance has its roots in the crisis itself. The West had a financial crisis. That translates into a deeper than normal recession and a slower than average recovery. The picture looks very different in emerging markets, particularly in Asia. Unlike the West, Asia did not suffer a financial crisis; its banks and balance sheets (household, corporate, government and external) were reasonably solid. Rather, it suffered a trade or ‘de-globalisation’ crisis as the financial crisis, originating in the West, spread to the real economy and demand for exports collapsed. But Asia rebounded quickly—much more so than the West. China led the Asian bounce back, helping to lift other East Asian countries out of the crisis, and India recovered quickly as well. In 2010 China and India are expected to grow at more than 10% and more than 9%, respectively, and developing Asia at more than 9%. Advanced economies are projected to grow at only 2.6%. Trade volumes for emerging and developing economies are expected to increase by 9% in 2010, compared with an estimated 6% increase for advanced economies. Foreign direct investment (FDI) in developing countries continued to increase through the crisis, while it shrank in the West. Inward and outward FDI for China, India and other key emerging markets remained buoyant in 2009 and is projected to increase significantly in 2010.

The policy outlook: bad news for the West

What about post-crisis economic policies in Asia and the West? How do they compare?

The crisis has triggered a big shift in ideas and policies against free markets and in favour of government interventionism. It marked the close of a thirty-year chapter of freer markets and more limits on government intervention; a new chapter of bigger government has begun.

So far, government intervention has been more evident in domestic economic policy than in trade policy. Domestic ‘crisis interventions’ are grouped in two key areas: huge bailouts and the associated subsidies, especially but not confined to financial services; and fiscal stimulus packages, usually combined with loose and unorthodox monetary policies. The former are concentrated in the West; the latter spread across the OECD and developing countries.

The post-crisis effects of these policies are likely to be far worse in the West than in emerging markets. Financial bailouts in high-income countries cost 28% of GDP in 2008—equivalent to the public financing of a large-scale war. US and EU public debt is projected to rise to about 70% and 120% of GDP, respectively, over the next decade. Financial-sector bailouts may have been unavoidable, but Keynesian macroeconomic policies have not worked—at least not so far. Both sets of policies leave oceans of public debt that point to higher taxes and real interest rates, in addition to inflationary threats (given governments’ temptation to inflate their way out of debt repayments).

The microeconomics and politics of financial bailouts and profligate macroeconomic policies are equally vexing. Intrusive financial regulation and bigger public expenditure portend arbitrary interventions by politicians and bureaucrats, wasteful pork-barrel spending, indiscriminate subsidies, long-term entitlements and rent-seeking. This heralds a partial reversal of the product- and factor-market liberalisation that was the hallmark of the Reagan revolution in the US, the Thatcher revolution in the UK, and the single market revolution in the EU. It will stifle private-sector incentives to save, invest and innovate; and it will restrict competition and raise costs for businesses and consumers. These could be the medium-term consequences of short-term crisis interventions and the return to Big Government.

The news is much better on international trade: the world has not hurtled into tit-for-tat protectionism. As the WTO notes, obvious protectionism—mainly border measures such as tariffs, quotas, import licenses and anti-dumping duties—have hardly increased; they affect less than 1% of international trade. But this does not take account of non-traditional, non-border protectionism—mainly complex domestic regulations that spill over the border and discriminate against international trade. Many crisis interventions fall into this category: intrusive new financial regulations that affect cross-border finance; public-procurement restrictions; industrial subsidies; and onerous product and process standards (including environmental standards to promote renewable energy and combat climate change).

Non-traditional regulatory protectionism in the wake of the crisis, especially in the form of subsidies and standards, is worrisome. It is more opaque than traditional protectionism and much less constrained by WTO rules. The danger is that if not contained, it will spread gradually to cover bigger swathes of international trade. That is what happened in the 1970s and early 1980s: rampant domestic interventions to combat external shocks led to creeping protectionism. The result: industrial overcapacity and the delay of a global recovery and globalisation.

To sum up the global policy outlook: The medium-term consequences of domestic crisis interventions are likely to be far worse in the West than in emerging markets. The prevention of traditional protectionism is good news all-round. At the same time, creeping non-traditional protectionism is worrisome.

The US and EU: sclerosis at home, defensiveness abroad

To turn now to the US and EU, still the two leading players in the world economy.

America is down and diminished, though not out. On foreign policy, President Obama's rhetoric on soft power and multilateralism has not translated into effective American leadership abroad, on either the security or the economic agenda. Economic woes at home are clearly constraining the US's ability to lead abroad; weakness at home translates into weakness on the global stage.

Also regrettable is the Obama administration's defensive approach to international trade, which is very low on its list of priorities. President Obama is not an instinctive free trader; indeed, he seems to be ambivalent on the subject. Above all, the administration is not leading with open-market initiatives, and the President seems extremely disinclined to face down his union supporters and the protectionists in Congress. This is no surprise: a left-liberal administration given to wide-ranging domestic intervention is not the sort of administration to take the fight to protectionists at home and lead international cooperation to open markets worldwide.

This is bad news. The United States is abrogating its traditional leadership role in world trade. It leaves a global vacuum, for there is no substitute leader to forge international cooperation to contain protectionism, open up markets and strengthen multilateral rules—not the EU, not China nor anyone else.

The picture in the EU is similar to the US situation: internal weakness and external defensiveness. True, some European economies show signs of healthy recovery. But that is not the overall picture. Symptoms of malaise abound: sovereign-debt crises, still-malfunctioning banking systems, industrial strife, sclerotic labour markets, bloated welfare states, intergovernmental squabbling and weak EU institutions.

Generally, when the single market is opening up to and integrating new members, EU trade policy—its de facto foreign policy—is more outward looking and proactive. That was the case in the 1990s. When the single market is under stress from internal protectionism, EU trade policy turns to navel-gazing and gives way to protectionism against outsiders. That happened in the 1970s and 1980s, and that is the risk today.

Perhaps the biggest casualty of the crisis was the abandonment of the Lisbon Agenda of market reforms to boost EU competitiveness. The EU's post-crisis blueprint for competitiveness, the ‘2020 Strategy’, is a half-hearted measure: difficult market liberalisation and concrete structural reforms are missing. Externally, trade policy is defensive; trade negotiations, with few exceptions, are not advancing or are stuck. And the EU's vaunted soft power, outside its immediate neighbourhood, is hardly taken seriously—when not dismissed as a joke.

Rising Asia: still a mixed picture

The shift of economic gravity to the East will have profound political and economic ramifications. This prompts Asian hyper-optimists to proclaim the demise of the West: it—including the US—can no longer lead the world. The new era belongs to other regions, especially Asia. Within Asia, China is rising to global leadership.

This Asian triumphalism is overdone; it is Asia hype. And notions of ‘China ruling the world’ anytime soon are rubbish. But one should equally recoil from the other extreme, that of Asian doomsterism. Cassandras predict that the Chinese political and economic systems will crash, and that Asia's governments and institutions are too hidebound to cope successfully with a turbulent post-crisis global economy. Where does this leave post-crisis Asian reality? Let us begin with Asia's Big Three: China, India and Japan.

China

China powered through the crisis with a turbo-charged fiscal and monetary stimulus package equivalent to almost 45% of GDP in 2009. It is the leading contributor to post-crisis global growth. Other countries around the world export raw materials and capital goods to power China's continuing industrial revolution. That is also true of other East Asian economies, which, in addition, export parts and components to China for assembly and export elsewhere. Increasingly, they are also gearing up to export finished goods to a booming Chinese consumer market. More than ever, the rest of Asia revolves around China. Gradually, China is asserting itself in international organisations. And its footprint is ever more visible elsewhere in the non-Western world—in its East Asian backyard and in South Asia, Africa and South America.

China is now one of the Big Three in the global economy. Until recently, it imported ‘global order’: it absorbed policies, rules and institutions that materialised from decisions made elsewhere. China still imports global order; but, given its market size, it, like the US and EU, now exports global order as well. Decisions made in China reverberate around the world. And they do so to a much, much greater extent than decisions made in the other BRIC countries (Brazil, Russia, India and China). China accounts for about 60% of the BRICs’ output, two-thirds of its foreign-exchange reserves and exports, and one-third of its inward investment. China plays in its own league among emerging markets. The other BRICs play in an inferior league; they are still much bigger net importers of global order.

But that is still a far cry from Chinese ‘leadership’. To assert the contrary is China hype. While China has just overtaken Japan to become Asia's largest economy, it is still far behind the US (at market exchange rates), and its living standards are barely a tenth of the Western average (at purchasing-power parity). China's military spending, while growing at double-digit rates, is still only a tenth of US military spending.

China also has entrenched domestic weaknesses. Its external liberalisation has stalled. Factor markets (for land, capital, water and energy) remain tightly controlled. That and other industrial policy and protectionist measures prop up public-sector national champions. Domestic consumption is repressed. Excess savings, plus an undervalued currency, spill over the border, inflate ‘global imbalances’ and add to international trade tensions. Last year's stimulus has created property and stock market bubbles and raised the spectre of inflation. It also exacerbates the economy's structural fault lines by boosting the public sector at the expense of the unsubsidised, far more productive private sector. And there is no sign that the Beijing leadership will reverse course and proceed with necessary pro-market structural reforms.

The good news is that China's pragmatic leadership will not go too far in a dirigiste and protectionist direction; it will not ‘rock the boat’ too much. It is well aware of the retaliation that this would invite, and the damage it would do to ordinary Chinese. Still, China's domestic weaknesses will cramp its ability and will to lead externally. Its leaders will remain too preoccupied with China's myriad economic, political and social problems to switch to external leadership mode. Besides, China has no tradition of regional or global leadership.

China enthusiasts would have us believe that China will be taken over by ‘state capitalism’; that it will decouple from the West and switch to domestic consumption; that it will be militarily aggressive and dominate Asia; and that it will exercise global leadership. None of the above is likely to happen anytime soon. China remains a complex hybrid; it still presents a very mixed political and economic picture.

India

India has weathered the crisis well, buoyed by exuberant domestic consumption. Previous market reforms have liberated domestic producers and consumers and opened India to the world. This has transformed the business landscape and spawned an aspiring, vibrant urban middle class. India boosters go further: India will exceed 8–10% growth rates; the catalysts for this will be high-value services and manufacturing niches, and this can happen without a new wave of policy reforms (which have eluded the Congress government since 2004). At the same time, they argue, India is rising to be a regional and global power.

This is India hype—even more ridiculous than China hype. It defies belief that India can boost growth above an annual 10% without further structural reforms. In terms of market reforms, India lags behind China and other parts of East Asia. It has higher protection against imports and inward investment. Its public finances, infrastructure and primary education system are much weaker. It has more damaging restrictions that stymie domestic markets in agriculture, manufacturing and services—and especially, draconian employment laws that prevent firms from employing unskilled workers in large numbers. Government subsidies are more wasteful. Worst of all, India's unreformed, dysfunctional state—the Union government in Delhi, the state governments and other levels of government—is the biggest obstacle to faster growth. Absent further market reforms, India will not have what it desperately needs: East Asian–style agricultural, service and—above all—industrial revolutions that are labour intensive and will put its poor into productive work. Moreover, the combination of a barely reforming government in Delhi and worse global economic conditions after the crisis might make it difficult to maintain current levels of growth.

No one can deny that India is a bigger player on the global stage. But economically and militarily, it is still too small to be a regional, let alone a global leader. It pales in comparison with China. Even within South Asia its leadership is diminished by testy relations with most of its neighbours and disastrous relations with its biggest neighbour, Pakistan.

Japan

Japan is still about as large as China in absolute market size and is still Asia's richest economy (in terms of per capita income). But it is stuck in a political and economic quagmire that has lasted two decades. The Japanese political system is blocked; it seems hopelessly incapable of delivering clear policy choices, including economic reforms. The economy has sputtered along a low-growth track, now with astronomically high public debt. The crisis seems to have made Japan even more averse to reform. Exceptionally in Asia, Japan has had a Western-style crisis: Keynesian macroeconomic policies alongside escalating public debt and growth contraction followed by anaemic recovery. Conditions would be much worse if not for roaring growth in its neighbourhood, especially in China.

All these factors condemn Japan to be a dwarf on the global stage. That and historical baggage prevent it from becoming a regional leader. Now, China's political and economic ascent casts an ever longer shadow over Japan. At best it can be a second-rank or upper-middle power in Asia, perhaps alongside India.

Asian economic integration

One key factor that prevents Asia from rising faster is regional markets that are very badly integrated. Cross-border economic integration has increased in East Asia, but it is mostly limited to manufacturing supply chains in information and communication technology products linked to final markets in the West. In other words, greater regional trade integration is a product of increasing dependence on the West. National policy barriers and a lack of infrastructure prevent regional integration in agriculture, services and other parts of manufacturing. As for South Asia, it is the least integrated region in the world economy, with very low intra-regional trade, and it is not yet plugged into East Asian and global supply chains.

Asia boosters argue that region-wide free trade agreements (FTAs), monetary and financial cooperation, cross-border infrastructure and growing domestic consumption (especially in China and India) will knit together regional markets, creating Asian supply chains for Asian consumption—and lessen dependence on the West. These arguments are either wrong or highly premature.

First, Asian FTAs are ‘trade-lite’: they barely liberalise trade or improve upon WTO rules. Asian monetary and financial cooperation is much weaker; it is embryonic, very ‘soft’ and limited to East Asia.

Second, some commentators argue that the crisis has shifted trade patterns. Consumption is increasing among Asia's rising middle classes, especially in China. This, they say, is creating Asian supply chains for Asian consumption. There are several holes in this argument. Even the latest hard data do not reveal decreasing dependence on extra-regional markets for Asian exports. Also, Asian consumption is still small in comparison with consumption in the West: it is about a fifth of global private consumption, well behind that in the US. Hence it will be some time before Asian consumption acquires the critical mass to substantially lessen dependence on final markets outside the region. Perhaps this will happen a decade from now, when Chinese GDP will be closer to 20% of world output. Finally, the lack of deep structural reforms across Asia is the biggest short-term drag on domestic consumption—and not only in China.

Third, there are several regional-integration initiatives on the table, centred on regional institutions such as APEC (Asia-Pacific Economic Cooperation), ASEAN (Association of Southeast Asian Nations) and SAFTA (South Asian Free Trade Area). At the top of the list are ideas for East Asian and pan-Asian FTAs. For the foreseeable future, however, these institutions will likely remain quite weak, and regional-integration initiatives are unlikely to go beyond ‘soft cooperation’. At best they can be chat forums to gradually build confidence and trust, exchange information and ideas, improve transparency and promote trade facilitation and other ‘best practice’ measures. But this is unlikely to be transformed into ‘hard cooperation’ with binding, enforceable rules. Intra-Asian divisions—countries at widely different stages of development, competing producer interests, significant intra-regional trade barriers, rivalry among Asia's Big Three (China, India and Japan) and, not least, a history of bitter nationalist rivalries and lack of cross-border cooperation—will continue to stymie Asian regional integration for a long time to come.

Geopolitics, global governance and other factors

Other factors also inhibit Asia's collective rise. Let me mention three.

First, weak domestic political and economic systems: Most of Asia's political systems, ranging from democracy to authoritarianism, can at best react to changing global conditions, but they lack the capacity and flexibility to be proactive in the region and around the world. Economic institutions—public administration, enforcement of property rights, diverse regulatory authorities—remain relatively weak and keep business costs high, repressing entrepreneurship, innovation and consumption.

Second, huge geopolitical obstacles: None of Asia's Big Three powers is in a position to exercise outright regional leadership. This is not simply a matter of domestic constraints or the lack of a tradition of external leadership. Most countries in Asia do not want Chinese hegemony, just as they are wary of a resurgent Japan. Rather, they prefer a multipolar regional balance of power, with a vital role for the US as the region's balancing power. Also, it is true that stronger economic links among the Big Three help to contain their political tensions and conflicts. But security flashpoints remain, and they will present enduring threats, not least over competition for natural resources in Asia and elsewhere.

And third, limits to Asia's role in global economic governance: China and India have greater power in international institutions such as the WTO, World Bank, IMF and now the G-20 than they had before. They are stronger in bilateral relations with other powers, notably the US. Japan should be in the same category, but it is constrained by its post-war geopolitical settlement and internal sclerosis. Asia's middle powers, especially South Korea, Indonesia and Australia, have important niches to fill. But none of them are willing to exercise onerous global—or even regional—responsibilities. Not one of the Big Three—not even China—is remotely close to assuming the kind of responsibilities the US has undertaken around the globe since the Second World War.

Conclusion

‘Asia’ was invented by the ancient Greeks—yet another Western mental and geographical construct. The Asia of today still defies hard, credible generalisations that apply to all its diverse countries and regions. That is why such sweeping generalisations about Asia are generally wrong.

With that caveat in mind, the shift to the East is undeniable. It creates very different economic and geopolitical conditions from those that prevailed under US leadership and a transatlantic-centred world economy in the second half of the last century. Western and Asian elites are only just beginning to recognise this shift, but they still have few ideas for how to deal with it.

Asia's prime advantage is social and cultural. That is true of East and South Asia—‘globalising Asia’; it is much less the case in North and West Asia, which are less globalised. Across much of East and South Asia, technology and markets have unleashed ‘animal spirits’, particularly among the hungry, aspiring, hard-working younger generation. Their commitment to education, work and self-improvement is everywhere in view. These are the most uplifting sights in Asia; it is a huge continental awakening. What a contrast with much of the West today, particularly in Europe. The parts of Asia that are awakening to vast new opportunities cannot be accused of a lack of individual responsibility, over-dependence on the state, laziness, sloth, decadence and degeneracy—all features of the Old Continent, especially galling when one sees them among the young.

But Asia's political and economic institutions and its intra-regional divisions continue to hold back its rise. This means the shift to the East will not translate into Chinese or wider Asian leadership for a long time to come—if ever. The US is still the fulcrum of international relations, and the world is far from being ‘post-American’. But the US is diminished; it is less capable and less willing to exercise global leadership—clearly evident under the Obama administration.

Europe is no substitute for US leadership. The EU has the world's biggest unified market. But that is the extent of the EU's global power. Its hybrid nature, internal divisions and absence of ‘hard power’ (a unified military capacity) will always prevent it from having a serious, coherent foreign policy. Its ‘soft power’, outside the greater European neighbourhood, is mostly postmodern hot air. That leaves its big three national powers, the UK, France and Germany, which are declining middle powers on the world stage. The EU is also one of the least dynamic parts of the world, weighed down by over-regulation, ageing and shrinking populations and wrecked public finances. Globally, the EU risks being squeezed and sidelined by the US on the one side and by emerging non-Western powers elsewhere.

Europe has reversed Eurosclerosis and global marginalisation once before, aided by Margaret Thatcher, the single market, the fall of the Berlin Wall and the collapse of the Soviet Union. It must regenerate internally if it is to do it again. Engaging Asia fully, starting with commerce, and harnessing some of Asia's new energy will aid European regeneration.