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China, South Korea, Japan build trade surpluses on ECB, Fed economic stimulus

Tokyo
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Tokyo

The three powerhouses of East Asian economy – China, Japan and South Korea – account for nearly a quarter of global demand and output.

But before you call them – as most people do – the engines of world economic growth, please note that they sold last year an estimated $560 billion worth of goods and services more than they bought from the rest of the world.

Since the balance of payments of the world has to balance, these surpluses are other countries' deficits. And as much as trade surpluses are net contributions to GDP growth, trade deficits are net subtractions from deficit countries' economies. That is why you sometimes hear that countries running systematic trade surpluses live off their trade partners.

It is a small consolation to deficit countries and the industries devastated by their foreign competitors that some of the funds generated by trade surpluses come back to support – temporarily – their consumption. Particularly vexing for deficit countries is when these trade surplus funds come back to take control of their industries.

China's "win-win" ideas

Still, the free trade continues to be considered as an optimal solution for the world as a whole, provided you don't forget the losers – and there are plenty of them. That is the kind of harmless discussion you usually hear during election campaigns in the United States.

But let's go back to East Asia.

Of these three trade-surplus economies, China will probably be the first to begin generating most of its growth from domestic demand rather than exports. That country has a huge internal market and is currently focusing on household spending, residential investments, service sector industries, agriculture, urbanization, regional development, welfare improvements and poverty eradication.

Beijing is also recycling some of its trade surpluses via direct investments abroad. These investments last year amounted to an estimated $120 billion, and the provisional data for January and February suggest that this number could be significantly overshot by the end of this year.

China's urbanization is a process that holds the greatest potential to stimulate internally-generated (rather than export-led) economic growth. With only 56 percent of the country's population currently living in urban areas, there is a long way to go to provide better living conditions for millions of rural dwellers migrating to cities. That will require massive investments in housing, infrastructure, education, healthcare, entertainment and retail services.

Resettling migrant workers (20 percent of the population) and poverty alleviation programs will also direct large resources toward domestic spending. Some 10 million people are expected to be lifted out of poverty in the course of this year, and a faster registration of migrant workers is making it possible for them to set up households and have access to public services in urban centers.

Projects, such as the Yangtze River Economic Belt, are another set of programs that will promote growth and produce a more balanced regional economic development. This particular initiative covers an area of nine provinces that account for 40 percent of the country's population and GDP.

With a savings rate of about 50 percent of GDP, China has ample means to finance these programs, while holding budget deficits and public debt at 3 percent and 41 percent of GDP, respectively.

South Korea's economy needs structural change

Japan is a different story. Its budget deficit of 6.7 percent of GDP and the public debt of 230 percent of GDP leave no room for any meaningful fiscal policy that would support the change of the current structure of the economy.

Last year, for example, there was no growth in domestic demand; the 0.5 percent increase in Japan's GDP all came from net exports (i.e., a trade surplus estimated at $138 billion).

All Japan has left, therefore, are monetary and structural policies. But Tokyo will make it simple. It will again choose to operate via ultra-easy credit conditions, despite evidence that this is doing nothing to prop up the interest-sensitive segments of aggregate demand. Private consumption and residential investments - a total of 64 percent of GDP – declined last year 1.2 percent and 2.1 percent respectively.

This obviously suggests the expectation that the excess yen liquidity will keep the currency within a price range that will stimulate exports. And that's what happened in 2015: export sales grew 2.8 percent, and they were by far the most buoyant GDP component.

Compared to China and Japan, South Korea is showing a very different growth structure. There is an unusual combination here of a strong domestic demand, accelerating imports, tumbling exports and still a large trade surplus equivalent to 7.3 percent of GDP.

The main structural vulnerability is South Korea's excessive dependence on exports; they account for 56 percent of GDP. The fact that China takes a quarter of South Korean exports may also be a cause for concern because Chinese manufacturers are beginning to compete directly, and successfully, in Korean export fields of consumer electronics, housing appliances and high-end IT products.

South Korea, therefore, may wish to reduce the role of exports as a growth driver by increasing the share of domestic demand components. That would make the economy more resilient and less dependent on foreign economic variables Seoul cannot control.

Speaking of control, the intractable crisis in inter-Korean relations makes a policy adjustment toward a greater role of domestic demand eminently advisable. The solution to the crisis is nowhere in sight; it is in the hands of great powers with seemingly irreconcilable strategic interests and no particular sense of urgency.

Investment thoughts

The destabilizing nature of East Asian trade imbalances should give pause for thought to those worrying about the weak growth of output and employment. That may lead them to think about the efforts of the Fed and the ECB to hold one-third of the world economy (i.e., the US and Europe) on a steady growth path, and the fact that this will expand global export markets and fuel further trade surpluses in East Asia.

Given the inter-regnum in the United States and the increasing chaos in European politics, it would be unrealistic to expect any G20 progress on international policy coordination to smooth out the current patterns of global trade flows.

So, don't be down on East Asian economies. They are well positioned to take advantage of the political urge in U.S. and European democracies to stimulate demand and employment.

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