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Is Asia poised for a sharp slowdown?

Tuesday, 30 Jul 2013 | 3:53 AM ET
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Pessimism about China's economy, question marks about Japan's attempts to end two decades of economic stagnation, and the U.S. Vice President Joe Biden proffering his mother's advice to India "to take medicine … to be healthy" are reflecting growing concerns about these three Asian countries representing 26 percent of the world economy.

I shall take a closer look at some of these issues. To complete the picture, I shall also add South Korea and Indonesia. That will give a group of countries accounting for nearly one-third of the global demand and output.

China. A growing legion of China watchers are making light of Beijing's commitment to keep the country's economic growth between 7 and 8 percent. This year's official growth target of 7.5 percent is often ridiculed as wishful thinking, and the IMF's forecast of 7.75 percent is totally ignored, implying that analysts have better knowledge and information about the Middle Kingdom than Washington experts.

(Read more: China risks following Japan into economic coma)

And when the actual numbers on the Chinese economy come in stronger than the bets placed by China watchers, the usual response is to cast serious doubts about the accuracy of Beijing's economic and financial statistics.

Here are some examples of the dire forecasts of China's economic future: China watchers are telling us that Chinese money lending is out of control. Once that is reined in, they forecast cascading bankruptcies – including those of local authorities – followed by bank failures. They then conclude that China's whole financial system will implode, leading to the crashing economy and social unrest.

Heavy stuff, indeed. It shows that these forecasts must be based on assumptions that Chinese authorities have no idea of (a) what they are doing, (b) what is going on in their economy and (c) how to recalibrate their policies to make sure that no systemic risks are caused by policy adjustments.

To drive their argument home, these China economists are also saying that Beijing's attempt to boost household consumption, while shifting resources away from exports and investments, will inevitably lead to a sharp economic downturn. Again, the assumption here is that Chinese leaders are so inept that they have no sense of measure and timing in their policy actions.

90 Seconds with Art Cashin: Watch Japan & China
CNBC's Bob Pisani and Art Cashin, of UBS, discuss the mini-crash in Japan. That's only a minimum impact, he says. He also says keep an eye on the relationship between China and Japan and a potential dispute over sea lanes.

The reality, of course, is quite different. China has no intention of closing down its vast export-oriented industries that were built, and continue to operate, on imported technology acquired through joint-ventures with foreign firms. These joint ventures are estimated to generate three-quarters of Chinese exports.

The same can be said about investments. China is a country that needs to build roads, railroads, airports, water systems, decent housing, health care facilities and educational institutions of all academic levels. Providing these basic elements of social infrastructure can keep the investment-driven economy growing at 7-8 percent as far as the eye can see.

And China has ample means to finance all that from internal sources.

What can be said about the shift to a more vigorous household consumption? A better and a more comprehensive social welfare system – one of Beijing's current priorities – would help households to set aside more income for discretionary spending, but, other than that, no special measures are needed when the personal disposable income is growing at an inflation-adjusted rate of 7 percent.

My take on China is this: To be sure, this vast economy has structural and cyclical problems. But its record of economic management shows that these issues had been successfully addressed ever since the reforms of a hopelessly collectivist, desperately impoverished and backward Chinese economy began 35 years ago. I, therefore, have no reason to think, as most China watchers do, that – all of a sudden – Beijing is being seized by terminal bouts of stupidity and ignorance. On present evidence, I believe that China has the means and the know-how to keep its economy at, or near, its potential growth rate of 7-8 percent.

(Read more: Albert Edwards: Chinese deflation may be biggest risk to markets)

Japan is a very different story. Its money printing presses have led to soaring stock prices, but the wealth effect from portfolio investments has yet to trickle down to the (private) consumption-driven economic growth. The fact that businesses -- full of cash and enjoying the real cost of capital of only 0.8 percent -- are not investing in Japan simply means that they don't expect sales volumes that would warrant new, or bigger, factory floors and/or additional machinery to satisfy anticipated demand for their goods and services.

Printing money and public spending largesse was the easy part. It no doubt helped the governing party to win recent elections by crushing the opposition and regaining total control of the parliament. But Japan has yet to address structural changes, an unsustainable fiscal position and the opening up of its economy. All that will hurt. Reforms of the labor markets (essentially a more liberal hiring and firing), growing competition from abroad (if that ever comes) and inevitable higher taxes will dent output and employment.

So, what is Japan's way out? What it has always been: push the yen down to boost exports, assuming that Tokyo's major trading partners will tolerate such freeloading. Germany is already robustly on record that it won't, and it is a safe bet that the rest of the E.U. won't either.

India is struggling with declining growth, consumer price inflation of 9.3 percent, the total public sector budget deficit of about 10 percent of gross domestic product (GDP) and the trade deficit of 4.5 percent of GDP. Capital flight and a weak currency are signs of investors' serious concerns about the economy. There also seems to be an exodus of disappointed foreign direct investors, led by ArcelorMittal and Posco.

In view of that, Mr. Biden's advice to India to "take the medicine" by opening up its economy to foreign companies may not be helpful. Foreign investors are leaving as a result of bad regulatory treatment once they get in. Apart from that, the advice is ill-timed in the run-up to general elections 10 months from now in a country traditionally hostile to outside players.

Given the high inflation rate and large domestic and external deficits, there is no room for "safe" monetary and fiscal easing to rev up demand and employment in time for next elections. Political pressures may still tempt India to cut interest rates. But that would be much too late to make a difference, and it could also trigger a new round of capital outflows and declining currency.

South Korea is arguably the healthiest Asian economy. It recorded a strong growth rebound in the first quarter of this year in an environment of perfect price stability, soaring currency, balanced public sector accounts and a large trade surplus.

(Read more: South Korea Q2 growth hits 2-year high, but China risks cloud outlook)

China and South Korea are the only major economies in the region having plenty of room to support demand and employment with looser monetary and fiscal policies.

Indonesia experienced a mild growth slowdown since the middle of 2012 to 6 percent in the first quarter of this year. In spite of that, inflation accelerated considerably over that period to 5.9 percent (from 4.5 percent), the trade deficit doubled to 2.6 percent of GDP and the budget deficit edged up to 3 percent of GDP.

A weak currency (down 9 percent against the dollar over the last twelve months), negative real short-term interest rates, rising inflation and increasing domestic and external deficits leave no room for monetary and fiscal easing to support growth and job creation.

Conclusion

Major Asian economies are no longer the proverbial growth tigers of the world economy. Only China and South Korea are poised for sustainable growth. They also have ample room to support demand and employment. Japan remains a worryingly big question mark.

With the exception of Philippines, smaller East Asian economies have shown very weak growth in the first three months of this year. Some, like Thailand and Taiwan, have even recorded a sharp drop in economic activity.

(Read more: Fuzzy numbers? Real China growth only half: Expert)

As much as I would like to suspend judgment, these are ominous signs for export-driven East Asian economies at a time when modest U.S. growth, upward pressures on U.S. long-term interest rates and euro area's continuing recession offer little, if any, hope of expanding global demand. East Asians should perhaps follow China's example by (a) generating more growth from household consumption, (b) building better and more comprehensive welfare systems and (c) investing more to modernize their economies.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

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