Residential buildings under construction at Tianjin eco-city in China. As the largest Asian economy starts to decelerate, other countries in the region can no longer rely on China for a stimulus, and already their growth has fallen back to where it was for much of the 1990s. The next boost will come from internal reforms, argues the writer. Photo: Bloomberg.

If China’s growth permanently slows in the coming years, as George Magnus anticipated in Part I of this series, Chinese foreign investment and trade is likely to decline somewhat as well. What will happen to other developing Asian economies as China pulls back on trade and direct investments in the region? What political and economic reforms must be made to cushion the transition?

What follows is Part II of our three-part series on China’s economic outlook and its impact on the world:

The slowdown in China’s sustainable growth rate may be only half-completed. From growth of between 7.5 percent and 8 percent currently, it will most likely decelerate further to between 4 percent and 5 percent over the coming decade.

As this happens, and as the commodity intensity of China’s growth model declines, there will be profound implications for commodity producers. This also applies to the complex manufacturing supply chains that run throughout Asia.

But growth in emerging Asia is already slowing down. This corroborates the view that if there was anything miraculous about Asia’s economic performance from the 1990s to the 2000s it is now history. How should we assess Asia’s prospects now?

In spite of the financial crisis in Asia in the late 1990s, growth in developing Asia recovered strongly, reaching a peak of over 11 percent in 2007. Subsequently, it has slipped to between 6 percent and 7 percent. That is roughly where it was for much of the 1990s.

Asia, excluding China, has now returned to growth of about 5.5 percent. The International Monetary Fund (IMF) predicts more or less stable growth around this level for the next several years.

However, in my view, there are six reasons why Asia will have to look to reform, rather than miracles:

1. China’s own economic performance may be less robust than is widely assumed.

If China’s investment share in gross domestic product (GDP) slides back to “only” 40 percent by 2020 from the current 50 percent share, this will have very direct consequences for the rest of Asia.

The cost to growth, according to the IMF, could be between 1 percent and 2 percent of GDP in the Philippines and Indonesia, between 4 percent and 6 percent of GDP in Malaysia, South Korea and Thailand, and 10 percent in Taiwan. Inevitably, there would be additional multiplier and spillover effects.

2. The export-centric models of countries belonging to the Association of South-East Asian Nations (Asean) and, to a degree, of larger nations, such as China, South Korea and Taiwan, have become flawed in the wake of the Western financial crisis. Prominent Asean members include Indonesia, Malaysia, Thailand, Vietnam and the Philippines.

It is often suggested that South-South trade, or trade between developing countries, will substitute for weaker trade with the West. But even though developing countries now buy more than half of one another’s exports, a lot of this trade is with China, is commodity-related and is the product of deeper supply chains.

According to the Asian Development Bank, roughly three-quarters of Asian exports end up outside the region, predominantly in Europe and the US.

3. Asia’s financial indicators are flashing warning signs, even if there does not appear to be any immediate threat of instability. Excluding China, the ratio of credit to GDP has risen above 100 percent – higher than it was in 1997. Also, land loan to deposit ratios in Asian banking systems are rising significantly again.

4. Asian countries, including China, are now richer and more complex. Their prospects will depend more on total factor productivity, or the immeasurable phenomenon that boosts GDP through technological and organisational efficiencies, and through the effects of robust institutions.

Total factor productivity rose to nearly 2.5 percent in the 2000s but has since slowed. To strengthen it, Asian governments will need to spur innovation and other new ways of replicating the benefits of the past decade or so, when growth was achieved by educational attainments, electrical power consumption, air transport, telecommunications and internet usage, and higher value-added exports.

5. What about India? Asia’s soon-to-be most populous nation has yet to harvest its so-called demographic dividend. India’s working age population is predicted to grow by 350 million by 2050. That increase is larger than the stock of working-age people in western Europe today.

But, as things stand, India isn’t going to be a game-changer for Asia. After a short-lived 10 percent growth burst in 2010 and 2011, India’s growth has halved.

The demographic dividend will accrue only if India can raise its game significantly on job creation. That is a big challenge given that about a quarter of all people deemed to be employed are also deemed to be at or below the poverty line.

This is a failure of labour market governance. There are other failures, notably with regard to India’s construction programmes and adequate infrastructure, as well as export growth and diversity.

There are also the twin deficits, with external and public budget deficits of between 9 percent and 10 percent of GDP. These important economic deficiencies can be remedied only by significant political and institutional reforms. Moreover, India’s fragility is attributable in large measure to the degradation of state institutions.

6. Not only is income inequality rising in Asia, but it is constraining growth.

Low levels of income inequality empower a broader society, which keeps the political system open. Both are considered important characteristics of sustainable, inclusive growth.

Extremes of inequality are widespread in Asia, and in most cases they are at levels higher than in any of the countries that have succeeded over the past 50 years in graduating out of the middle-income group to the high-income universe.

It has been argued that Asia’s miracle occurred because Asians came to understand, absorb and implement Western best practices – free market economics, modern science and technology, meritocracy and the rule of law. For some countries, more or less, this assertion is unquestionably true, complementing vigorous resource mobilisation. But the latter has now been exploited or is more difficult. In addition, Asians face a less benign global trade and economic environment, as well as heightened economic and political security risks.

Without strong reform initiatives to sustain high domestic growth, many Asian miracle countries could get stuck in a middle-income trap.

George Magnus is an independent economist and an adviser to UBS and other investment banks. This is the second of a three-part series. Read Part III next week. This article is provided as a courtesy by The Globalist (, the daily online magazine on the global economy, politics and culture.

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