(continued from previous entry – Part 2 of 2,  Asia’s Economy: Challenge and Opportunity for the Obama Administration)

Renewing and Rebalancing Our Global Commitment to Free Trade

In the coming months, the new administration will be closely watched in two
of the preeminent arenas governing world trade.

The labored and precarious Doha Round of WTO talks largely stalled during the
second half of 2008 as the world waited for results of the U.S. presidential
election. When trade ministers convened unofficially in Davos in late January
2009, it was clear that prospects had not improved. While the financial crisis
has underscored the urgency to complete this round, it also reduced the room for
maneuver and compromise. Newly empowered Democratic constituencies in the U.S.
are now looking to strengthen labor and environmental safeguards in these
negotiations, while India and other standard bearers of the developing world are
stiffening their defenses in response to the subsistence risk posed by rising
prices for rice and other basic commodities. The United States’ moral authority
in these trade talks has been further weakened by the collapse of Wall Street
and its global consequences. A clear statement of the new administration’s
commitment to longstanding principles of free and balanced trade is a necessary
precondition to completing what WTO director-general Pascal Lamy figures to be
the remaining 20 percent of this process. The U.S. also must articulate a
creative win-win proposition to align the new administration’s vision of a
changed and changing world with legitimate demands from the developing
world.

A nearer-term traction point is the upcoming cycle of G8/G20 meetings.
Tremors signaling a shift in global power were already felt during the G20
Summit held in New York last November. Occurring in the aftermath of Lehman
Brothers’ collapse, this meeting effectively upstaged the G8 process and
signaled a shift of influence from the advanced economies to the emerging
economies led by BRIC (Brazil, Russia, India, and China). Change in the balance
of influence between the G8 and G20 is natural, and to be encouraged. According
to IMF statistics, the developed world in aggregate is estimated to see growth
fall to -2 percent at the anticipated trough of the world economic crisis, while
the BRICs and emerging/developing economies will see their growth fall from
previously much higher levels to an average of +3.3 percent.

The consequences of this disparity cut two ways . Despite higher overall
growth rates in the developing economies, the narrow diversification and limited
trickle-down of their economies will likely lead to greater political and social
dislocation than experienced by negative-growth advanced economies. By the same
token, however, the positive contribution to world growth through the crisis
will doubtless translate into expectations of an amplified voice in the future
for managing the world’s financial system. President Obama will have the
opportunity to recognize that a greater role for these economies is inevitable
and beneficial during his first overseas travel to the G20 meeting in London
this spring.

Stabilizing the Regional Economy, Limiting Political Fallout

President Obama must also attend to the risks of political and social fallout
in the home markets of major trade partners in Asia.

At the onset of the financial crisis, there was hope that Japan’s economy
might be a bright spot. With no housing bubble and with the positive experience
of painful reform instituted during and after its “lost decade” (a period from
roughly 1991 to 2003), there was some basis for optimism. However, Japan’s
contraction in the fourth quarter of 2008 was 12.7 percent, far steeper than in
the U.S. The reason appears to be structural over-reliance on exports. Despite
some notable headway in diversifying its economy in the wake of the Asian
Financial Crisis, Japan reverted to dependence on exports for growth following
the dot.com meltdown. From 2002-07, annual exports jumped by 74 percent while
household spending rose by less than 7 percent. The result has been a negative
cycle, with stagnation of reform and leadership crisis reinforcing one another.
With December 2008 exports down by 35 percent from the prior year, the
manufacturing sector now finds itself hobbled with too many workers in factories
operating at excess capacity . Even Toyota is being forced to reengineer its
celebrated employment model.

Meanwhile, export-reliant South Korea’s economy appears headed for a 2
percent contraction this year. Following average GDP growth rates of 5-6 percent
in recent years, this represents a wrenching downward adjustment. Likely
repercussions are mounting pressure for protecting key sectors of the domestic
economy and an erosion of popular support for trade multilateralism as well as
political efforts to unify the Korean Peninsula. A critical issue will the fate
of the U.S.-Korea Free Trade Agreement (FTA) signed on June 30, 2007 but not yet
approved due to expiry of the Bush presidency’s fast-track trade negotiating
authority. Should this FTA finally be approved by the Obama administration and
the National Assembly of South Korea, it would lift approximately 85 percent of
duties assessed on each country’s imports of industrial goods from the other.
More broadly, concluding this FTA would represent the United States’ first FTA
with a major Asian trading partner. In order to achieve this, however, the Obama
administration must deal with longstanding concerns over environmental and labor
standards as reflected in this and other, already concluded FTAs. It must also
resolve deep-seated ambivalence within the Democratic party over the benefits of
FTAs in general.

Taiwan, with an economy structurally similar to that of South Korea though
somewhat smaller, has been exceptionally buffeted by the downturn. January’s 44
percent drop in exports relative to the prior year is unprecedented in Taiwan’s
post-1949 experience. This economic loss has taken wind out of popular support
for the newly elected KMT party’s program of commercial and trade link
normalization with the mainland.

Like South Korea, Taiwan pins its hopes on concluding an FTA with the U.S.
While there are solid economic arguments in favor of this possibility, the
prospects, both procedurally and politically, are much dimmer than in South
Korea’s case. Procedurally, Taiwan will need to demonstrate substantial progress
under the existing Trade and Investment Framework Agreement (TIFA) process as a
prerequisite for the U.S. Trade Representative to be willing to take up
consideration of a U.S.-Taiwan FTA. Also, Congress will need to re-extend
fast-track authority to the new President. Beyond those procedural hurdles, any
possible U.S.-Taiwan FTA would be sure to face a political firestorm of
criticism from Beijing and its supporters. Active cross-strait comanagement with
China of fallout from the financial crisis may provide a practical parallel
track for keeping relations with China moving in a positive direction.

Indonesia, with a large domestic economy and some sectoral insulation from
the global economy, may be less affected by the financial crisis than its
smaller, more globally integrated neighbors such as Thailand, with its high
dependence on tourism and the global automotive supply chain. A forecast by
Consensus Economics for Indonesia’s 2009 GDP growth shows a still healthy 4
percent gain, though this is down by almost one-third from its 5.8 percent
growth rate in 2008. Similarly, resource-rich Australia is forecast to register
0.9 percent growth in 2009, down from 2.8 percent in 2008. While limping forward
rather than sprinting, these economies are at least moving ahead. This gives
them a leg up on much of the developing and developed world. Against this
background, the real immediate challenge for this region will be to maintain
momentum toward ASEAN economic integration and some semblance of political
relevance amid the global slump.

India, which was even later than China to plug back into the global grid
following its failed experiment with socialism, is now enjoying some of the
benefits this relative insulation has conferred in the current crisis.
Additionally–and uncharacteristically for Asian economies–it has a relatively
highly developed service economy, which lessens its economy’s weighting toward
manufactured exports. Due to these and other factors, India appears positioned
to withstand the financial turbulence in 2009 with its growth momentum
reasonably intact. Having registered approximately 8 percent growth in 2008, it
appears on track to achieve close to 6 percent growth in 2009.

Pakistan, on the other hand, presents an alarming case study of a downward
spiral, with economic and political instability feeding off one another. On the
brink of insolvency, Pakistan has been forced into the role of global financial
supplicant, increasingly dependent on the strained resources of the
international financial community. The horizons of its politics have largely
collapsed to moment-by-moment imperatives of survival. Neither of these
conditions strengthen its government’s popular support. The global financial
crisis amplifies all of these pressures. Whether through loss of government sway
in its own territories or through misguided adventurism aimed at India as a
means to offset internal loss of control, security challenges will be
exacerbated in 2009 by the financial turmoil.

Rebalancing Our Economic Relationship with China

Key to helping stabilize the Asian regional economy in the years ahead will
be putting our bilateral relations with China on a sounder economic footing.
Like the U.S. in 1929, China stands in the middle of the current crisis.
Currently the world’s most dynamic economy, it is also generating the largest
balance-of-trade surplus. It therefore stands to be hurt the most if other
nations step back from an open trading system.

A snapshot of the current condition of China’s economy provides at best a
mixed picture for the near- to mid-term. Agriculture is the crux of China’s
social engineering experimentation and a primary cause for anxiety over social
stability and the continuity of CCP rule. Given the inefficiency of small-scale
farming landholding and the disproportionate population in under-productive
rural areas, China has an imperative to move 15 million rural inhabitants into
more productive urban settings each year. The minimum 8 percent which is often
cited as Beijing’s minimum GDP growth target is, in a more practical and
existential sense, the level of annual growth required to attract this number of
new arrivals to urban factories each year and absorb them. The recent volatility
in world food pricing, the current impasse of the Doha round trade talks, and a
large-scale flow of migrant workers back to their home villages over the Chinese
Lunar New Year all bode poorly for China’s near-term agricultural outlook.
Consumer-related sectors (which include a broad range of consumer goods and
services, real estate, and the steel and cement industries which provide raw
material inputs to the housing sector) are also down sharply now that China’s
real estate bubble has burst. The technology sector is reeling from the same
drop in worldwide demand that has caused Taiwan’s exports to plummet, reflecting
not only the global economic downturn but also commoditization pressures on core
product lines. Ironically, banking and financial services provide one of the few
bright spots in the Chinese economy. This reflects the fact the Chinese
regulators have kept China’s banking system relatively insulated from the world
marketplace.

Despite the dire outlook at a sectoral level, recent statistical data for
freight bookings and factory purchase plans provide grounds for hope that
China’s could be among the first of the world’s hard-hit economies to pull out
of the current downward spiral. If so, it would be a notable achievement
because, as a result of its export dependence, China is among the three groups
of countries identified by the Council on Foreign Relations’ Sebastian Mallaby
as most challenged by the current financial crisis–the others being
high-spending oil producers like Dubai, Iraq and Venezuela and smaller
finance-dependent economies such as the U.K. But whatever the short-term
outcome, China still faces clear forks in the road for the longer-term
development path it follows from this point on.

Essentially, there are three directions Beijing’s policy response might take.
First, it could pursue a neo-mercantilist approach and wait as a free-rider for
other countries to take steps to stimulate and stabilize the global economy.
Second, it could continue in the direction of its announced stimulus plan of
last November and conduct more pump-priming for the build-out of hard
infrastructure. Finally, it could redirect spending in such a way as to
transform and modernize the economy, focusing on “soft infrastructure” to put in
place a social safety net that is now largely absent, to spur commercial
innovation, and to put spending power in the pockets of its citizenry.

These three pathways for Beijing’s policy response lead directly to three
different outcome scenarios for China’s economy. In the first case, China would
likely encounter the same outcome experienced by OPEC producers as a result of
the 1970s oil shock. They would find that the world recession is not good for
their economy and that people get angry in response to “beggar thy neighbor”
approaches. In the second case, China would simply be increasing the capacity of
its export machine, with all the attendant risks of a policy approach that
depends upon the goodwill and deep pockets of consumers in the West under
present circumstances. In a strictly economic sense, this approach also risks
diminishing returns. As Japan experienced in the 1990s when faced with a
structurally similar situation, there are only so many roads and dams that can
be built without further encouraging corruption and economic inefficiency. The
third approach is in line with what Robert Zoellick termed the responsible
“stakeholder” approach for China’s involvement in the global community. It would
entail a structural transformation of the current export orientation of China’s
economy in order to integrate more fully and sustainably with the world economy.
Notwithstanding considerable enthusiasm for this approach in Chinese think tanks
and progressive policy circles, this pathway of transformation represents an
arduous and long-lasting undertaking, one which would encounter–and need to
overcome–deeply entrenched interests. Basic building blocks of this approach
would need to include: boosting household incomes to better match the nation’s
GDP growth; building out educational and health care systems to provide
fundamental security for population undergoing stresses of rapid “graying” and
demographic imbalance; and top-to-bottom reorientation of the business
environment to foster a more services-oriented economy protective of innovation
and promoting domestic consumption.

No one wants to see China burrow deeper into a neo-mercantilist mindset. But
fundamental trade-offs and contradictions must be recognized as the Obama
administration begins to advocate specific policy prescriptions prompting
Beijing toward one or the other of these scenario-pathways. To the extent that
the Obama administration looks to Beijing for immediate, synchronized stimulus
to help alleviate the current crisis, they will try to push Beijing down the
more traditional pathway of “hard infrastructure.” “Available bandwidth” and
“potential carrying-speed” for government investment in “soft infrastructure”
are simply too limited to allow for large-scale and immediate stimulus. For
instance, large-scale investment in the build-out of heathcare and pension
systems will not be efficient or successful unless China’s citizens overcome
traditional barriers of distrust and come to see the state as a more reliable
partner for assuring their long-term livelihood and security needs. Likewise,
the state needs to further develop intermediate market mechanisms before it can
reduce its reliance on state-owned enterprises and begin channeling more of its
resources through consumer discretionary spending. The catch-22 here is that
immediate pressure by the Obama administration to enlist China’s support in
synchronizing global stimulus will tend to further rev exactly the same Chinese
“export machine” engine that was responsible for powering the current crisis.
Conversely, a stalled export machine could lead to massive unemployment and the
Chinese Communist Party’s nightmare scenario of widespread social unrest.

The Obama administration has indicated a new policy direction that holds
better promise of underpinning a structural transformation of China’s economy
over a longer-range timeframe: a proposed agenda for mobilizing the two
economies to assume joint leadership in helping the world counter the effects of
climate change. As the world’s two largest contributors to the emissions that
are driving climate change, the complementary economies of the U.S. and China
could each realize structural benefits by working together toward this common
goal.

By highlighting this initiative during her February 13 speech at the Asia
Society and by tapping Todd Stern, her new special envoy for climate change, to
accompany her to Beijing, Secretary Clinton appears to be clearing the way for
this strategic reorientation. To progress in this direction, the Obama
administration will need to update some traditional instruments of policy
guidance, but the administration has already shown itself adept in this regard.
More generally, today’s multipolar world of challenge and opportunity realizes
in many respects the vision of shared responsibility that postwar U.S. policy
sought to create.
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