Productivity boost

Asian countries need a major turnaround to revive its lost dynamism in order to keep up with the rapid recovery of more advanced economies

PUBLISHED : Tuesday, 13 May, 2014, 1:13am
UPDATED : Friday, 16 May, 2014, 7:10pm

There are plenty of signs that growth prospects in the world's advanced economies are rebounding fast - and the nature of those recoveries are such that they pile the pressure on Asia to turn around falling productivity to rekindle the dynamism it has lost.

There are four reasons why growth prospects in this region remain subdued.

First is the relatively soft support coming from export growth.

Yes, improving performance in developed economies should provide a cyclical uplift to Asian exports, but the still substantial overhang of deleveraging that remains in the wake of the financial crisis means consumer demand growth in the US and Europe will be below trend.

Developed nations are making a transition towards stronger, sounder and more sustainable expansion that is driven by capital spending, not the final consumer demand that export-oriented economies thrive on.

Productivity dynamic in the region has been extremely weak over the past six years

Meanwhile, Asia ex-Japan economies have also lost export competitiveness as their currencies have appreciated in real terms, so while exports growth for the region should improve in the next 12 months, it is likely to be in the range of 5 per cent to 10 per cent year on year, versus the 21 per cent rate during 2003-07.

The second drag on regional economic performance comes from demographics.

A number of economies are fast approaching an inflection point. In China, Hong Kong, South Korea, Taiwan, and Thailand, the working-age population aged 15-64 will begin to decline in two to three years.

Age dependency ratios - the proportion of the non-working age population versus the working age population - have risen since 2010 in all of these economies, plus Singapore.

The weakening demographic trend clearly poses a challenge for economic growth.

A slower growth rate, or outright decline in the working-age population, implies less labour availability and, hence, slower labour input growth.

Rising age dependency ratios mean that consumers - typically defined as people in the non-working age groups - will comprise a growing share of the overall population. Such an increase implies a natural drawdown on the level of overall saving in the economy, which in turn would constrain investment levels.

As demographic trends weaken, firms tend to substitute labour with capital. However, as the capital to labour ratio increases, the marginal product of capital or capital productivity tends to deteriorate, and this would weigh on total factor productivity growth.

The third problem is that aggregate leverage, or debt to GDP, has picked up sharply.

Debt had risen to 208 per cent of GDP by the end of 2013 from 148 per cent in 2007, after remaining broadly steady in 2003-07.

This pick-up in leverage was driven by policymakers' intent to push domestic demand to offset the collapse in external demand in late 2008 and was supported by low global real interest rates courtesy of aggressive monetary easing by major central banks.

The region's leverage already looks overextended in its per capita incomes. As signs of misallocation are now visible, policymakers are beginning to slow debt growth. In addition, declining excess saving in the region and rising real interest rates are also causing a slowdown in loan growth and domestic demand.

The recent emergence of disinflationary pressures only adds to the challenge of managing debt dynamics, as it will likely weigh on nominal GDP growth and push up real interest rates.

What is most concerning is the risk of a vicious circle forming - slower domestic demand growth, weaker inflation, higher real interest rates and debt servicing burdens, downward pressures on asset prices, and a faster pace of non-performing loan accumulation leading to risk aversion in the banking system and, further pressures on growth.

Fourth - and arguably most important - is that the productivity dynamic in the region has been extremely weak over the past six years.

The region's incremental capital output ratio, which measures the units of capital required to generate a unit of GDP growth, has risen sharply since 2007 to hit a two-decade high. That is the clearest indication of the rapid deterioration of productivity growth. This is now being reflected in elevated price, financial and external stability risks.

Clearly the region is in the adjustment phase and policymakers will have to focus on correcting macro imbalances and regaining productivity growth.

Considering the challenges posed by weakening demographics, high levels of debt and the emergence of disinflationary pressures, productivity have to do the heavy lifting in this cycle to boost growth. The region's performance will likely depend on how quickly policymakers move to lift productivity from here.

Chetan Ahya is chief Asia economist at Morgan Stanley