Conventional investment wisdom since the mid-1980s suggests fund managers should pack their portfolios with a bit of Asia-Pacific equity to gain exposure to its high-growth economies. With average real economic growth of 8 per cent a year in the region, and most Western economies struggling at 2 to 3 per cent, there appears to be a no-brainer investment opportunity at stake. The global equity fund manager looking for superior returns bought this story and many piled into the region, especially in the early 1990s. Things did not work out the way these fund managers had hoped. The good, the bad and the ugly illustration explains what happened. On the good side, fund-manager expectations of regional economic growth were met. Nominal gross national product growth, Asia versus the United States, saw Asia outperform the US by a big margin from 1990. The bad side shows, however, there was a problem in terms of profitability. Relative regional profitability, Asia versus the US, slumped. And the ugly part of this story is the relative under-performance of the region's stock markets against those in the US since 1990. A fund manager who over-weighted the Asia-Pacific in this period and under-weighted North America would be worrying about keeping his or her job. The problem for the fund manager is that Asia-Pacific earnings have failed to reflect economic growth in full. While in North America, returns on equity of the Dow Jones Industrial Average and the Standard & Poor's 500 have been running between 17 per cent and 22 per cent in the past two years, Asia-Pacific markets have seen moribund return on equity. If the benefit of all this regional economic growth did not show up in equity returns or returns on equity, where did all this money go? According to economist Simon Ogus, a lot of this money went into the pockets of the domestic consumer and this was reflected in the high savings ratio associated with these economies. 'Savings should be considered as the retained profits of an economy,' Mr Ogus said. An economy's savings can either accrue to the corporate, the household or the government sector. A rise in the share of a sector's savings in total savings is equivalent to a rise in that sector's profit share in gross national product. 'Savings shifts should be proxied by relative factor price movements in the economy,' Mr Ogus said. This means more economic growth went on the wages of the region's labour force than appeared in the profits of its listed corporates. During this same period, while Asia went through a boom, North America hit recession in 1990 to 1992. When the US economy finally woke up, equity was able to power away with strong earnings and returns, because wages were held at historically low levels. In short, the US economy became more productive, while liquidity going into Asia-Pacific economies increased the size of the overall economic pot, but efficiency was not improved. Mr Ogus said some economies had tackled this problem. In Japan during the 1970s, and South Korea and Taiwan in the 1980s, crises of competitiveness were faced. These economies had championed the industrial sector at the expense of labour and banking, with fixed exchange rates. The capital accounts of these economies were firmly closed. Greater competition from more competitive regional counterparts forced domestic industry to make efficiency gains by moving into higher technology production and by shifting a huge amount of capacity offshore. In the 1980s, the Hong Kong Government managed to change by pushing up wages and forcing a change in the domestic economy to improve efficiency. Hong Kong shifted its labour offshore and its economy became efficient by becoming a good middleman to the global economy with a growing service sector. The territory, however, has probably reached the limit of its ability to tap southern China for cheap labour, as Guangdong province is facing its own rising labour costs. So what of the rest of the region? Mr Ogus said members of the Association of Southeast Asian Nations (excluding Singapore) and China probably faced the greatest challenge. Most are choosing to maintain cheap currency policies. The ability of their industries to deliver the productivity gains required by a strong currency appears limited. In addition, the political environment does not lend itself to allow the economies involved to enter the weaker growth period required to make the transition to more efficient productivity. Mr Ogus said for these economies, consumer prices and wages were rising, fed by a tight labour market. This meant the corporate profit share of gross national product was probably falling and could hamper the ability of the corporate sector to deliver profit growth in line with economic growth.
