Asian Regional Economy
Commodities and Capital Goods Forever
Looking forward, it may be resources, capital and heavy industries, rather than traditional export industries, that drive the Asian regional economy.
Commodities and Capital Goods ForeverBy Jonathan Anderson
From CommonWealth Magazine (vol. 381 )
“When you wake up in the morning, Pooh,” said Piglet at last, “what’s the first thing you say to yourself?”
“What’s for breakfast?” said Pooh. “What do you say, Piglet?”
“I say, I wonder what’s going to happen exciting today?” said Piglet.
Pooh nodded thoughtfully. “It’s the same thing,” he said.
— A. A. Milne
Quick – What Will Asia Be Buying in Ten Years?
Here’s a chance to take your mind off the markets for a moment and consider a quick question: What awaits the rest of the world from a rapidly growing Asia? One way to think about this issue is to look at net trade patterns – what Asia buys from the rest of the world and sells to the rest of the world – and follow the trends over time. We’ve used simple net trade charts in our work on China for a long while now; in Chart 1 we do the same for the entire emerging Asian (ex-Japan) region, from 1960 until the present.
The chart is based on long-term UN trade data, and shows net patterns according to our “standard” four broad categories: raw materials, electronics products, other light industrial goods and heavy industrial products. Bars above the line indicate what emerging Asia exports, and below the line is what emerging Asia imports.
What is the chart telling us? When we look at the figures, our conclusion is that some of the most exciting global growth opportunities over the next decade will be in two areas: (i) commodity resources and (ii) capital goods – as Asian import demand continues to drive markets. By contrast, Asia’s traditional export industries such as light manufacturing and IT may prove to be far less interesting. Let us explain what we mean.
What Asia Sells
If we start from the export side, the first thing to note is that net light manufacturing shipments picked up sharply as a share of emerging Asian GDP from 1970 to 1985, but have been more or less stagnant since. The story here should be pretty clear: Even twenty years ago Asia had already reached mature market penetration, at least in the US economy, across a range of lower-end goods categories including toys, sporting goods and footwear (Chart 2; we show the comparable data for Europe and Japan further below). Since then, most of the action in these sectors has come from reallocation of production within non-Japan Asia, from wealthier economies such as Taiwan, Korea, Singapore and Hong Kong to their poorer neighbors (e.g., China, Thailand, Indonesia and the Philippines).
This doesn’t mean that labor-intensive manufacturing development has fully run its course for the region as a whole; if we look at clothing and apparel, for example, the adoption of formal quotas under the Multifiber Agreement actually led to a sharp drop in emerging Asian market share, and now that quotas are being removed we expect renewed growth over the next five years. However, in broadest terms we aren’t looking for light manufacturing to lead export development for the region as a whole. Asia’s poorest economies still have a bright future ahead in low-end export industries – but most of this growth will inevitably come at the expense of richer next-door neighbors (even China is now starting to feel wage and cost pressures in traditional export industries).
The same is increasingly true for electronics production, which was a relative latecomer to the emerging Asian scene. It wasn’t until 1985 that non-Japan Asia really began to show strong net export gains, and in the past 20 years we have seen a steady and sustained increase in global market share. But here as well the numbers are starting to point to rather mature penetration rates; in computers and data processing hardware the region already accounts for 80 percent of the US import market (similar to the share for toys and sporting goods), and for telecommunications and audio-visual equipment, the share is approaching 65 percent.
Keep in mind also the market share numbers for Europe and Japan look very similar to those in the US. The UN database doesn’t have a long time series for overall European trade, but looking at the 2005 “snapshot” of import market share across categories, the US and European numbers are virtually identical, and for Japan the regional import market share is actually significantly higher .
(This doesn’t automatically mean, of course, that Asia ex-Japan has the same overall market share in those three markets – just that Asia commands the same share in total imports. Most bottom-up evidence suggests that the US economy is still more open to imports in light manufacturing and electronics categories than Europe and Japan, i.e., emerging Asia can still see further growth as Europe and Japan open markets up to outside competition.)
In other words, the size of electronics exports may increase somewhat going forward, but in general we feel it is close to a peak as a share of GDP. Of course, emerging Asia can still see healthy growth in current export industries, as long as the global economy is expanding as well – but we aren’t looking for any further “evolution” in these sectors on a region-wide basis.
What Asia Buys – The Resource Boom
The opposite is true for Asia’s import sectors... and this is where we expect more interesting and exciting changes over the next five to ten years. Start with the blue bars in Chart 6, showing net primary product trade trends in the region.
Analysts love to talk as if Asia always had an “endless thirst” for resources, but in fact the emerging part of the region was actually a net exporter of raw materials and resources right up until 1990. It wasn’t until the last 15 years that non-Japan Asia began to run out of resource supply at home and turned to import markets. Since then the figures have jumped sharply; excluding Japan, Asia now imports primary resources to the tune of nearly 5 percent of GDP, and that number is still growing rapidly.
(Of course, momentum for the most recent three years has been exaggerated by commodity price movements, but then (i) the same trend is very visible even in real terms, and (ii) we don’t expect a significant decline in global commodity prices in the medium-term horizon.)
The key is that looking forward we don’t see any slowdown here. In fact, much of the excitement may still lie ahead. As you can see from Chart 7, China’s net energy and mineral demand has only really come on line in the past five years, and resource supply constraints at home virtually guarantee a growing import profile; in addition, although China has to appear as a large purchaser on global agricultural markets, this should change visibly over the next five years.
And China could be just the beginning. India’s material and commodity import demand has the potential to match China’s current global impact over time – a prospect that is becoming more interesting as India’s structural growth rate accelerates. And when we turn to other populous emerging markets, we also see the possibility of significant upside surprises in the next decade.
What Asia Buys – The Coming Capital Turnaround
Now, in fairness, we’re hardly the first to trumpet Asia’s strong and rising commodity demand; this theme is well recognized and discussed in the market. But there’s still another area which hasn’t received anywhere near the same attention: for the most interesting and least understood trend of all, go back to Chart 6 and take a close look at the behavior of the bars showing net trade in heavy industrial products: capital goods, machinery, chemicals and industrial materials. The story here is that non-Japan Asia used to be an enormous net buyer of capital-intensive products from the rest of the world – and then, about ten years ago, the orders just stopped. They stopped suddenly, and they fell substantially. Since then, emerging Asia has actually turned into a net exporter of capital goods and materials.
Now, for many investors the initial reaction would be: “Aha... it’s all about China.”
Indeed, China has turned the corner from a net buyer to a net seller of steel, other basic materials and a number of machinery categories. There is also an intense and very much unresolved debate as to whether this is a permanent shift driven by long-term productivity gains, or rather a cyclical reflection of excessive investment and overcapacity at home. (We favor the latter argument, and do expect the mainland trade surplus to subside in due course as China returns to its traditional net import position in heavy industry).
But step back. As it turns out, the initial reaction was misplaced to begin with. A closer look at the numbers show that the capital goods turnaround isn’t really driven by China at all. Actually, most of the action has occurred in the rest of Asia. Turn toChart 7 and Chart 8 , which show net trade patterns for China and the rest of non-Japan Asia respectively (the magnitudes in both charts are expressed as a share of total non-Japan Asian GDP).
China has turned from a net importer to net exporter of heavy industrial products, but as a share of the total this effect is very small, just over 1 percent of regional GDP. Instead, the real story is in the rest of the region, which used to import capital goods to the tune of 5 percent of regional GDP. After the Asian crisis those net imports effectively disappeared, and many countries have even moved to a net export position; in total, the size of this turnaround is nearly 6 percent of Asia ex-Japan GDP.
So, to repeat, the real story is not China’s role, but rather the collapse of heavy industrial demand in the rest of Asia. What happened? Was this, as so many have claimed for China, also a reflection of rapid productivity gains? Well, the debate may continue over the mainland, but in our view there can hardly be any argument about what happened in the rest of the region: The culprit was clearly the sharp drop in domestically oriented investment spending in construction and infrastructure sectors after the Asian crisis.
Just look atChart 9, which plots the investment/GDP ratio and the current account balance the smaller Asian export economies (please be careful reading the chart, since the investment/GDP ratio is shown on an inverted scale). As you can see, gross investment spending fell from 33 percent of GDP at the peak in 1996 to only 24 percent of GDP over the past half-decade; as a result, the external current account position rose from a net deficit 2 percent of GDP to a 6 percent of GDP surplus over the same period. And looking back at Chart 8, almost all of that shift came from a decline in heavy industrial goods imports.
In other words, smaller Asian economies stopped investing at home – and stopped buying capital goods from abroad. And despite all the attention on China, this effect has overwhelmed the impact of recent mainland production shifts.
Now, to cut to the chase: Capital goods demand should be coming back – in China too, for separate reasons. But the gradual fading of domestic excess capacity, the turnaround in property and service prices and the return of construction spending in the rest of Asia all point to a turnaround in net heavy industrial goods imports going forward. (Nowhere is this more evident than in Chart 10, for example, which shows the ongoing construction recovery in Asia.) We feel very strongly about this as a medium-term trend.
And the most interesting thing of all, again, is that we don’t hear much about this topic from investors or analysts. So please keep an eye out!
Jonathan Anderson is an economist for UBS Investment Research. This report has been republished with the kind permission of UBS Securities Asia Ltd.
Chinese Version: 未來十年，亞洲買比賣重要