16 September 2014
Asia’s future challenges -- a geopolitical & economic perspective

Asia’s future challenges -- a geopolitical & economic perspective

Today Asia is facing increasingly complex challenges, economic and above all political, writes Ian Buchanan Senior Executive Adviser, PwC strategy& (formerly Booz & Company), Chairman AusPECC.

Today Asia is facing increasingly complex challenges, economic and above all political, writes Ian Buchanan Senior Executive Adviser, PwC strategy& (formerly Booz & Company), Chairman AusPECC.

The domestic institutions and policies which worked in the past, may not work as well in the future.

To understand these challenges, it is necessary to revisit the geopolitical and economic context for our region’s remarkable post-World War 2 growth.

Before doing so, I must stress that in practice there is no Asia. Our region is a complex portfolio of countries at different stages of development, with diverse political and economic systems.

But these countries share a common geographic location. And this accident of geography, combined with geo-political and strategic decisions in the emerging Cold War, triggered the initial wave of globalisation.

First wave of Asian development -- globalisation

The first wave of Asian development (Wave 1) was an unintended consequence of three key Cold War initiatives which favoured Asia over other regions. This was in part because of post iron curtain concerns in Washington about Japan and its other Asian allies -- and the question of where the bamboo curtain would fall combined with the rapid post WWII decolonisation in the region:

The initiatives were:

-- the US led the creation of new global institutional architectures (eg IMF, World Bank, GATT/WTO) designed to isolate the Soviet Bloc but which ‘enabled’ rapid growth in global trade and investment flows.

-- US investment in dual-use technologies in transport and communications which improved speeds and reduced costs – and therefore enabled separation of production from consumption, and thus trade.

-- US strategies to provide favoured access (through the Generalised System of Preferences) for its emerging market Asian allies to the giant US domestic market, which in the early post-war period accounted for about half of world output.

These initiatives shrank the globe and became the engines of globalisation. Another driver of globalisation was multinational companies like General Electric which developed new ways of organising their activities through supply chains and which embraced a new, global division of tasks, functions and, as a consequence, of labour. This led to a rapid expansion of global trade.

This global realignment of supply chains provided a once off opportunity for countries to align domestic policies with external growth drivers, by opening up to rapidly increasing external trade and investment flows. The Asian tigers of Hong Kong, Korea, Singapore and Taiwan seized this opportunity.

Their political leaders were also willing to educate their people to change their attitudes to foreign investment, often in cultures with traditional beliefs where foreign investment was seen as a form of economic colonialism.

They also partnered with multinationals in developing national skill-building programs, as a means of moving up the value chain.

Second wave of Asian development -- regionalisation

If globalisation was indeed the driver of Wave 1 of Asia’s miracle growth, then this was running out of steam after the second oil price shock, in 1979, and might have died after the end of the Cold War in 1989. However, a new wave of Asian development was to come from an unlikely source.

Deng Xiao Peng’s four modernisations in 1978, combined with the rapid appreciation of the yen following the 1985 Plaza Accord, led to an acceleration of FDI from Northeast Asia into Southeast Asia and then, after some years, to China. This triggered a second wave of Asian development, based on regionalisation.

Some Southeast Asian economies, which had hitherto maintained their import substitution policies, received more FDI from US, Japan and North Asia in the 18 months following the Plaza Accord than in the preceding 18 years. In some countries, this second wave of development fueled arrogance, authoritarianism and ill-informed talk of both an Asian miracle and a unique set of Asian values supposedly responsible for the miracle growth. This was most evident in the case of Malaysia’s long-ruling Prime Minister Dr Mahathir.

China began to become an important destination for FDI after the relaunching of China’s reform process at the time of Deng’s Southern Tour in 1992, and then even more so after China’s membership of the World Trade Organisation in 2001. The rapid growth in China’s economy, together with financial crises in the US and Europe, also encouraged a more strident tone in China.

Asian financial crisis -- a wake-up call

The little understood Asian miracle-bubble led to unsustainable flows of short term money into the region. When confidence faltered – as it began to do in mid 1997 – it ultimately triggered a pan-regional run on Asian banks and currencies. This hit a tipping point in Bangkok in July 1997 and rapidly spread contagion across the region.

The Asian financial crisis provided both a shake up, and a wake up call, for countries throughout the region. While painful, the crisis restored some humility and led to a rethink of development models, including recognition of the importance of sound domestic policies and institutions aligned to the reality of external growth drivers.

Many countries in the region which benefited from Waves 1 and 2, and which survived the crisis, have returned to a growth path. However, many others have failed to make the tough domestic reforms needed to sustain domestic productivity growth and their economic fortunes may be increasingly vulnerable.

The crisis also triggered political change in a number of countries, most notably the 1998 overthrow of President Suharto and the emergence of a series of politically far more complex coalitions and democratically elected leaders. The resulting stakeholder complexity of these more Western democratic models does however have implications for the authority and decision-rights of the next wave of leaders.

Will they be able to rapidly build the political consensus needed to drive much needed policy and institutional reform?

The challenge of Wave 3 development

In the post global financial crisis world, with the risk of secular stagnation, it is necessary to ignite a new wave of development, a Wave 3. This will require not only rebalancing away from excessive emphasis on trade. It will also require developing more evidence-based approaches to enhance behind the border reforms, which will improve total factor productivity.

This is the arena where the lines between economics and politics blur and we – collectively in APEC and PECC - will need courage to take on research in an area which lacks a solid theoretical or econometric foundation. Although most Asian economies are already committed on paper to these so called behind the border reforms, progress has been slow. One reason is that the political economy and institution building are linked.

Some of the many political challenges in pursuing a Wave 3 growth agenda are:

1. Loss of political legitimacy. The post colonial leaders and/or parties such as Sukarno & Golkar in Indonesia, Lee Kuan Yew and PAP in Singapore, UMNO in Malaysia and the Communist Party in China earned their legitimacy as leaders of national liberation movements. However, not all have been able to deliver public services necessary to meet rising voter expectations.

2. Rising expectations: maintaining legitimacy has meant delivering improved economic conditions. Doing so was not very difficult for those leaders who opened their economies to Waves 1 and 2. However tougher Wave 3 conditions, plus the rising expectations of a younger demographic, which in many countries has no personal memory of post-war poverty, will dramatically increase the challenge – and the need to enhance political legitimacy.

3. Digitisation and media liberalisation: with rising economic and educational standards came a desire for greater press freedom. This plus the explosion of digital news/social media has reduced the ruling powers monopoly on information and shifted news from propaganda to analysis – and entertainment! This requires much more sophisticated political leadership and institutional capacity to reach-out to an electorate which increasingly benchmarks itself not against their nation but against their global Facebook friends. Radical – and often painful and politically difficult - domestic change is now needed to engage and communicate with this new digital citizenry.

4. Cronyism and concentration of wealth: as the new Asian democracies evolved from the initial political monopolies to a more contested political system, competition has increased for party-political funding. In many countries in the region this has led to a combination of – politically compliant – SOE’s and/or close links with powerful private business groups offering both formal – and black political donations, often in return for access to monopoly rents. In many countries in the region this has given rise to a class of political blue chips with close access to the ruling party and often committed to maintaining the status quo rather than encouraging economic and institutional reform

5. Political empowerment of rural and urban poor: most of the new Asian development models have led to migration from rural, often subsistence, agriculture to labour intensive industrial and service positions in urban areas. This is happening on a planned basis – and a huge scale – with reports of up to 550 million people being relocated from rural areas into – often newly created – cities. Wealth will become increasingly concentrated not just in rapidly expanding city areas – but in the typically better educated professional and business classes. However as TV and the new digital media have penetrated the villages and made the wealth gap starker to the younger generation, new opposition leaders are emerging who will increasingly challenge the authority of the post war autocrats. The current political crisis in Thailand is an interesting ‘work in progress’ laboratory.

6. Demographics – the militant fecundity effect - Birbeck College demographer & political scientist, Eric Kaufmann, in his book ‘Shall the religious inherit the earth?’ suggests that the higher birth rates of extreme, often religious, groups in most of the world’s democracies – a trend Kaufman refers to as militant fecundity - will by 2050 lead to polarisation of politics as these groups pull political parties towards more extreme positions.

Will the rise of Asian power continue?

The prospects for the continued rise in Asia depend fundamentally on governance. And the work of Michael Porter, and Daron Acemoglu and James A. Robinson have valuable insights to this issue.

In his book, The Competitive Advantage Of Nations, Michael Porter argues for a new growth model, and for new roles for government, most notably in enhancing fair and transparent domestic competition, and not in protecting domestic industry.

In their book, Why Nations Fail, Daron Acemoglu and James A. Robinson argue that the key differentiator between countries is their “institutions”. Their conclusion is that “inclusive economic institutions that enforce property rights, create a level playing field, and encourage investments in new technologies and skills are more conducive to economic growth than extractive economic institutions that are structured to extract resources from the many by the few”.

Inclusive economic institutions are in turn supported by, and support, inclusive political institutions which “distribute political power widely in a pluralistic manner and are able to achieve some amount of political centralization so as to establish law and order, the foundations of secure property rights, and an inclusive market economy.” Conversely, extractive political institutions that concentrate power in the hands of a few reinforce extractive economic institutions to hold power.

As one of their case studies, the authors conclude that China’s remarkable growth will not be sustainable because it results from an “extractive political and economic system where the Communist party’s monopoly on political power mobilised resources at a scale that has allowed for a burst of economic growth starting from a very low base” but “sustained economic growth requires innovation and cannot be decoupled from creative destruction, which replaces the old with the new in the economic realm and also destabilises established power relations in politics and unless China makes the transition to an economy based on creative destruction its growth will not last”.

So where does this lead us?

As I said at the outset, there is no Asia. In this spirit, it is useful to look at clusters of Asian countries, rather than Asia as a whole.

In Cluster 1, there are communist countries like China (until 1978), North Korea, Vietnam, Laos, and Cambodia. They missed out on Wave 1, and other than China, they are still struggling to adapt their political economies, institutions and policies to catch up in a post Cold War, emerging Wave 3 environment.

While centrally planned economies may be good at early stage development, with forced accumulation of capital and rapid infrastructure development – modern economies are complex and require facilitation of restructuring and innovation, not top-down command and control. Over time, the evidence suggests the emerging – market-based – economic systems have eclipsed the Soviet-style command economies with their cumbersome price and allocation rules. China remains a special case, and the analysis of Acemoglu and Robinson is insightful.

In Cluster 2, there are socialist economies which leaned ideologically towards the Soviet Russian economic system but desired greater political independence, adopted socialist models with greater international links and relatively more parallel – albeit heavily regulated - private sector activity. This includes India and the other countries from the sub-continent.

These countries missed the booms and busts of Asia’s Wave 1 – and part of the Wave 2 - growth miracle but have subsequently achieved solid growth. However while most have begun to benefit from high level market liberalisation, in the absence of far reaching institutional and political reforms they are all at risk of missing out on Wave 3.

For example, despite incoming Prime Minister Modi’s huge majority, what may be more insidious for India’s Wave 3 outlook is that at state and local level most leaders remain political appointees and many vestiges of the old Soviet Gosplan-like central planning and resource allocation system still exist.

In Cluster 3, there are the democratic market economies like the four Asian tigers, and most of Southeast Asia. Despite their excellent records and foundations, they also have challenges in aligning domestic policies, institutions – and perhaps political systems – with the drivers of future Wave 3 growth. Singapore, perhaps the least democratic, now faces growing opposition pressures.

Some concluding comments

The post-war Asian miracle was not a miracle. It was the result of alignment of geo-political, technological and institutional factors, with domestic political and policy responses, and the development of related national institutional capacity. The external forces of Waves 1 and 2 which have driven growth so far are now waning.

Today, the immediate critical issue for regional leaders seeking to maintain Asia’s rise going forward is that they now face a combination of a much more challenging external environment – at a time when their domestic authority, their very legitimacy, and freedom of action is being curtailed.

This will require vision, an ability to think strategically and building the necessary domestic case for change with the voting public, their political partners and their financial backers to accelerate national economic, political, institutional and cultural transformation. This path will be very, very challenging.
Tags: asia, regionalism, deng xiaoping, asian financial crisis, governance, democracy, politics

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