Remember, Asian flu can strike anywhere
Sunday 14 June 1998
It is a great puzzle, and a puzzle which has taken on new importance with the news of Japan's plunge back into recession on Friday. We all thought the world economy was interdependent. The proportion of world output that is traded internationally is higher than it has ever been in the history of humankind, higher even that at the end of the last century, the previous great global expansion. Buoyant consumers in the US and UK have helped buy the exports of the East Asian emerging economies and of Japan, but they have not bought enough to sustain demand there. Depressed importers in that region have cut their purchases from Europe and North America, but not by enough to damage most of our exporters.
Now you could conclude from this that world trade, though growing, is not yet big enough to transfer the fortunes of one region to another. Domestic demand in most economies is more than 60 per cent of the total, so I suppose what home consumers do will always dominate. But anyone making that point has to explain two other phenomena: the extraordinary contagion of the East Asian disease, and the fact that the developed world's trade cycles have generally moved more or less in time with each other.
The contagion of East Asia has come as a complete surprise. It is a very diverse region both politically and economically: democracies and dictatorships, some of the highest GDP per head in the world and among the lowest. If, as I expect, the fall of the yen triggers a devaluation of the Chinese yuan and the Hong Kong dollar, the currency contagion will be complete. If, as I also expect, there is recession in both mainland China and Hong Kong, the economic contagion will also have spread to the entire region.
Why? This does not happen in the European Union, a much more closely integrated operation, for it is possible for one country to be doing very well while others are in near-recession. It must be partly because of large inter-regional trade, but more because of the inter-regional banking, financial and investment links. It is also partly the result of investor ignorance: the way in which Western investors at least have tended to lump the entire region together.
Ironically, in the downswing ignorance has proved a better guide than knowledge, for the region has behaved as a single economic region, though as recovery begins it will become right to be selective once again.
If the links within the region have proved stronger than expected, the links between the regions have proved weaker. So is it possible for the world's largest economy to continue to boom while the second largest remains in slump?
The experience of the last 30 years suggests that major economic cycles do affect all developed economies to some extent. The oil shock pushed all into recession. There was a marked slowdown in the early 1980s; there was a late 1980s boom just about everywhere; and there was recession again in the early 1990s. True, the amplitude of the swings varied from country to country and the timing of the peak of the booms and the trough of the slumps varied by up to two years. But there was a clear cycle that affected everyone. On this occasion Japan was not pulled up by the boom in the US and UK and the recovery in continental Europe as one might have expected it to be. And so it was uniquely vulnerable to the collapse in East Asia.
The sequence of events is shown in the three charts. Japanese consumer demand was OK-ish in the first part of last year. Then in April came the rise in sales tax which hit things like car and TV sales. They recovered a bit in the second half, but as the full gravity of the regional problem became evident, they plunged again, so that they are way below the levels of early 1997. However strong your exports to Europe and North America, you cannot replace a slump in demand like that.
The result was to give a new push to an already falling yen. Though we think of the yen as exceptionally weak, we tend to forget that it is only weak in relation to its previously absurdly overvalued level. In purchasing power parity terms it is at last about right.
However, this new yen weakness, plus fears of what China might have do to its currencies, has led to a new bout of the glums. Investor sentiment for the region had recovered in the first part of this year; now it is almost as bad as it was last autumn (right-hand chart).
If it is easy to see now the dire story unfolded, it is harder to predict the outcome of the next chapter. There are rather different ways of looking at Japan's new recession, and which you prefer will determine how likely it is that the East Asian time zone will pull down the American and European ones.
Call version one of the next chapter "Don't cover it up". The main reason Japan failed to stage a decent recovery was her failure to make the structural reforms that all the other developed countries have been doing - at least to some extent - following the last recession. We all recapitalised our banks, either by setting low interest rates which allowed them to make large profits (as in the US) or by bailing them out (as in France). We all made our companies restructure and lay off workers where necessary. We all encouraged the growth of service industries by deregulating.
We did this at different speeds. There has been much more reform in the US and the UK than in, say, France or Italy. But there has been much more even in the laggards than there has been in Japan.
By contrast, Japan sought to conceal its problems: it hid unemployment, did not reform taxation, did not change company structures and did not force the banks to disclose the full extent of their bad debts, even though the boom had been more marked in Japan than elsewhere. It looked as though Japan was coming through the recession in better shape than the rest of us, but because the ills were covered up, remedial measures were not taken. Result: Japan needed luck to pull through, and as so often happens, it actually had rather bad luck. It was located in the wrong time zone.
If version one is more or less right, there is no necessary reason why the troubles of East Asia will be visited on the rest of us. Of course there will be some depressing effect on the whole world economy. But there will be pluses for other developed countries. There will be no pressure on commodity prices, for example. You can even argue that recession in Asia comes at rather a good time in that it acts as a counter-balance to possible overheating in the US, UK and fringe Europe. The prospect would be a soft landing for us; softened by the troubles elsewhere. It would be an ill wind...
Unfortunately, there is also version two. Let's call it "What goes up, comes down". This would say that never before has one large part of the world economy been immune from the fortunes of another part. True, the West was immune from the difficulties of the former Soviet Union, but the trade between the two blocks was tiny. Trade with East Asia is big. So if the Asian time zone hits a really prolonged recession, it is inevitable that it will start to pull down demand elsewhere. The lags are long. This process may take two years, maybe even longer. But at some stage, perhaps not until the year 2000, recession in Asia will become recession in Europe and America.
Well, maybe not a full-blown recession. Maybe all we will see is a marked slowdown, a couple of years of below-trend growth; maybe technically a recession (which, by the way, is two consecutive quarters of negative growth) but nothing as bad as the early 1990s version. And that's not quite the brilliant, blazing start to the new millennium that we would all like to see.
Which version of the next chapter is the more likely? It will be a mixture of the two. Japan has made serious policy errors, which are quite difficult to unscramble, because they mean changing a whole system which seemed to work very well. It has to learn from us. But it will; and it will in a year or two's time stage a slow recovery, as eventually the whole time zone will.
We would, however, be quite nuts to think that the rest of us will not experience some sort of slowdown as a result of East Asia. Undoubtedly, we will.
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