April 2012

The Emerging ASEAN Economic Community (AEC 2015) in the Wider Regional and Global Economy A Macro View (Part 1) 1
By George Abonyi
Introduction
Assessment of the present and likely characteristics of the nascent ASEAN Economic Community as a single market targeted for 2015 (often referred to as AEC 2015), suggests the following conclusions: (1) Developed economies (e.g. US, EU) are likely to remain key markets for the regions manufactured exports over the medium term; and although buying behavior is likely to be more cautious and changing, consumers in these markets will continue to have substantially higher disposable incomes than consumers in emerging markets, including in ASEAN. In this context, ASEAN, and more broadly East Asia, is likely to retain its present characteristic of significant intra-regional manufactures trade in parts and components for final products aimed primarily at (albeit slowing) developed markets outside the region. (2) At the same time, Asian emerging markets in general, and ASEAN in particular, present significant growth opportunities over the longer term. However, consumers in these markets are likely to look different from those in developed economies. Innovation of new types of products, services, and business systems will be needed to serve consumers whose buying patterns are likely to be different than those of consumers in developed economies; and this in turn can also be an important source of reverse innovation of new types of products for global markets. This Brief develops the first of the above conclusions; a subsequent Brief focuses on the second conclusion. Given the key role and nature of intraregional trade in East Asia in general, the ASEAN economy (AEC 2015) has to be considered within the broader framework of East Asian regional integration, with particular attention to the key role of China; and where East Asia refers to both Southeast Asia (ASEAN) and Northeast Asia.

George Abonyi is Visiting Professor in the Department of Public Administration and International Affairs, Executive Education Program, Maxwell School, Syracuse University, and Senior Advisor, Fiscal Policy Research Institute (FPRI), Bangkok.

Asia Policy Briefs April 2012

ASEAN economy has to be considered within the broader framework of East Asian regional integration, with particular attention to the key role of China

What type of market is ASEAN (and East Asia) now? ASEAN exports
and imports have shifted from natural resource-intensive goods to electronics and other relatively sophisticated manufactures such as machinery. Manufacturing exports now account for approximately three quarters of total ASEAN exports, up from two thirds in 1990; with machinery and transport equipment constituting about half of both exports and imports 2 . In East Asia in general, intra-regional trade has increased in importance (Fig. 1). East Asias pattern of trade has changed from capital goods and final products, to parts and components, which now have the largest share of intra-regional trade (Fig. 2). The growth in intra-regional trade reflects increasing cross-border production integration in manufactures, and the role of the regions firms in production networks within the framework of global value chains in key industries such as electronics and IT. However, more than 71% of Asias final manufactured exports are to developed economies outside Asia, particularly the US and EU (Fig. 3). China has become the largest single export market for an increasing number of the regions economies, for example Thailand 3 . However, this is misleading in that it reflects primarily Chinas key role as the destination for the intra-regional parts and components trade for final assembly of products for external markets (referred to as Chinas processing exports). As will be discussed, a significant share of Chinese imports from the regions economies is used as inputs into exports for final goods destined for the US and EU markets. Its useful to consider briefly, developments in the region since the onset of the global economic crisis in 2008. East Asian growth recovered quickly in 2009. This fueled discussion of possible decoupling of East Asia from dependence on developed economies as final markets. However, closer examination of the regions recovery suggests that it was driven to a large extent by temporary fiscal and monetary stimulus of governments, and related expansion of investment and final demand 4 . The region continues to be closely tied to final markets outside Asia 5 . That is, ASEANs

traditional export markets for final manufactures, e.g. US and EU, have continued to be the primary contributors to the regions investment-driven growth, even though these economies growth slowed recently as a consequence of the Global Crisis. This is also reflected in the regions recent slowing exports to traditional developed markets, and the related impact on the growth of East Asian economies. Therefore it is not clear at this stage to what extent and how quickly the region is shifting toward domestic demand-led growth, i.e. as its own final market. At the same time, there is evidence to suggest that domestic demand will continue to become an ever more important source of growth in East Asia in coming years. For example, in all East Asian economies, except Korea, the ratio of exports to GDP has been declining since 2005 (World Bank Database 2011); and current account surplus as a proportion of GDP of the ASEAN+3 has also been declining since 2007. In addition, the expectation is that China will undergo structural changes that will bring about growth in the demand for consumer manufactures, including imports from within East Asia. Similarly, a number of ASEAN economies including Indonesia, Malaysia, Philippines, and Thailand are attempting to move toward a more balanced growth strategy, with a focus on expanding domestic demand. Chinas emergence as the leading single export destination for many of the regions economies is seen as particularly important in an expected shift toward the region becoming its own final market in the future. However, as will be discussed in the next section, at this stage China still remains largely a conduit for importing parts and components from other East Asian economies and assembling them into final goods for export; and this is not likely to change significantly over the medium term.

East Asia refers to both Southeast Asia (ASEAN) and Northeast Asia

Asia Policy Briefs April 2012

More than 71% of Asias final manufactured exports are to developed economies outside Asia, particularly the US and EU

Medium Term: continued dependence on developed markets

The international economy is characterized by basic changes in the pattern of global growth over the medium term, referred to as the new normal (Table 1). ASEANs traditional markets, the developed economies, are settling into slower growth as they recover from the Global Crisis; while emerging economies, particularly in Asia, are expected to continue to grow at a faster pace. Partly in response to this new normal in global growth, ASEAN economies and China are attempting to rebalance by focusing on increasing domestic demand. However, expanding domestic demand in the region is likely to take time. Private consumption has been relatively weak in most East Asian economies. For example, in Malaysia, Thailand, Singapore, as well as Korea and Taiwan, its share in GDP is under 55% (in the case of Singapore below 40%), well below rates in more affluent economies such as the US (over 70%) and the EU (over 60%). Therefore raising the relative share of consumption in the regions economies over the medium term is likely to be a challenge. Given China as a key (leading) market for the regions exports, it is important to take a closer look at its role as potential future consumer. The share of domestic household consumption in Chinas GDP has been falling since the late 1990s from over 55% to around 35% in 2011 6 , as the relative share (and value) of investment has increased. This low level of consumption seems to be due less to very large household savings, and more to the low share of household income in GDP 7 . That is, the disparity between domestic consumption and investment, and related dependence on exports, is largely the outcome of an imbalance between wages the dominant share of household income -- and profits, particularly of state-owned enterprises (SOEs), which have been a key source of investment-drive growth. Although wages in China have been rising, driving up production costs, they have lagged behind productivity growth and their share in value-added has been declining. The downward trend in the share of wages in GDP has been mirrored by the declining share of private consumption in Chinas GDP. Therefore the gap between consumption and

investment, and the resulting dependence on foreign markets, reflects an imbalance between wages and profits, between household and corporate incomes, in effect representing a transfer from households to firms (e.g. SOEs). Therefore increasing consumption in China suggests challenging fundamental reforms not only in the basic structure of the economy, but also in key political power relations (e.g. SOEs vs. households and smaller firms (SMEs)). In other words, the transition to a domestic consumption-driven growth in China is more a challenge of political economy, than economics 8 . Beyond the challenge of lagging domestic consumption, the import-intensity of domestic demand in most East Asian economies, including (particularly) China, is generally much lower than that of exports. This is the result of the close linkage of the regions manufactured exports to production networks in global value chains aimed primarily at developed markets, and the related dominance of parts and components in intra-regional trade, as well as the large share of nontradable services in private consumption. Similarly, the import-intensity of investment is also greater than that of domestic consumption, particularly in economies with underdeveloped capital goods industries. Therefore expanding domestic consumption of final goods within the region, and particularly their import content, presents challenges beyond increasing aggregate demand, given the regions existing production and trade structure. Given Chinas central role in the regions present manufactures trade, and expectations with respect to its key future role as a final consumer of the regions exports, it is important to take a closer look at its import patterns 9 . For processing (manufactured) exports, the share of developing Asia in Chinese exports is in the range of 75-80% of total value. Since, processing exports

China still remains largely a conduit for importing parts and components from other East Asian economies and assembling them into final goods for import

Asia Policy Briefs April 2012

ASEANs traditional markets, the developed economies, are settling into slower growth; while emerging economies, particularly in Asia, are expected to continue to grow at a faster pace

are a very large share of Chinese exports to the US (close to 80%), and parts and components account for a large share of total manufactured exports of the regions economies to China, a slowdown of Chinese exports to the US and EU is likely to have a strong impact on the regions economies. This is particularly the case as the US and EU account for much higher proportion of exports of China (around 25% each) than for the exports of countries such as Thailand (e.g. together 20%) 10 . That is, since an important part of the exports of the regions economies to China are linked via production networks to Chinas exports of final goods to the US and the EU, the overall exposure of these economies to a sustained slowdown in the US and the EU is much greater than is suggested by their direct exports to these markets 11 . Furthermore, while China is a major importer from East Asian economies through regional production networks within the framework of global value chains, it is not a major market for their final products. A significant share of these Chinese imports is for exports to developed markets rather than used internally. For example, one estimate is that around 60% of imports are used, directly and indirectly, for exports, less than 15% for consumption, and some 2025% for investment 12 . Thus, the Chinese economy plays an important role in importing for exports and for exportoriented investment, but much less for domestic consumption. At this stage, domestic consumption and investment in China generates proportionately much less demand for imports from East Asia than its exports to the US and the EU. While the share of final goods in Chinas imports from the region has been increasing in recent years 13 , parts and components continue to dominate intra-regional manufactures trade. Consequently, a shift by China from export- and investment-led, to a consumption-led growth, and a simultaneous reduction of imports by the US and EU, is likely to result in a significant slowdown of imports from the regions economies, particularly those closely participating in the regional production networks. For China to become a regional growth locomotive, it would need to raise not only its domestic

consumption as a proportion of GDP, but also its import content and, in particular, its imports of final goods from the region 14 . Conclusion: The implication is that over the medium term, developed economies (i.e. US, EU) are likely to remain key markets directly and indirectly for the regions firms. In this context, the AEC (2015) single market is likely to retain over the medium term its present characteristic of significant Chinacentered intra-regional manufactures trade in parts and components for final goods aimed at (albeit slowing) developed markets outside the region. Therefore the continuing challenge to policy makers in the region is to ensure effective participation of the regions firms, particularly SMEs, in global value chains. Over the longer term, relatively faster growth in emerging economies, particularly in East Asia, means these economies will play an increasingly important role in driving both regional and global growth. The regions consumers will have higher incomes and growing discretionary spending. However, most Asian emerging economies including China, and emerging markets in general, will remain over the medium term relatively poor as compared with developed economies such as the US and EU. Therefore consumers in emerging Asia and their product preferences, are likely to have different characteristics than the regions traditional customers in the US and EU. This, in turn, will require an increased emphasis by firms (and in the supporting role of governments) on innovation in products, production processes and business systems, which however, can also become the basis of innovation for global markets -- the focus of the second Brief.

Expanding domestic consumption of final goods within the region, and particularly their import content, presents challenges beyond increasing aggregate demand, given the regions existing production and trade structure

Asia Policy Briefs April 2012

Fig. 1 Intraregional trade shares in East Asia, EU-27, and NAFTA: 1980-2009
Source: Kawai (2011) 15

Fig. 2 Share of products in intraregional trade of East India

Source Fig. 2, p.3, Lim and Kimura (2011) 16

Asia Policy Briefs April 2012

Fig. 3 Final demand composition of Asias exports (2006) Source: ADB (2010) 17

Table 1: The new normal pattern of global growth Source: Table 1.1, p. 2, IMF World Economic Outlook (January 24, 2012)

18

2010 World Output United States Euro Area Japan Developing Asia China India ASEAN 5 5.2 3.0 1.9 4.4 9.5 10.4 9.9 6.9

2011 3.8 1.8 1.6 -0.9 7.9 9.2 7.4 4.8

Year on year change (%); P = Projected 2012 (P) 2013 (P) 3.3 1.8 -0.5 1.7 7.3 8.2 7.0 5.2 3.9 2.2 0.8 1.6 7.8 8.8 7.3 5.6

Asia Policy Briefs April 2012

Endnotes This Brief is based on Abonyi, G., 2011. Private Sector Development Strategy for Thailand. ADB Thailand Resident Mission, Bangkok, June; and Abonyi, George and Atipol Bhanich Supapol, 2012. Getting More Out of the ASEAN Economic Community (AEC) Single Market: Developing Small and Medium Enterprises (SME) Policy Index for ASEAN. Economics and Research Institute for ASEAN and East Asia (ERIA), Jakarta. 2 See for example Table 2, p. 2, Petri, Peter, A., Michael G. Plummer and Fan Zhai, 2010. The Economics of the ASEAN Economic Community. Brandeis University, Dept. of Economics and International Business School Working Paper No. 13, September. 3 See for example Abonyi, G., 2011, op cit. 4 IMF, 2011. Asia and Pacific: Managing the Next Phase of Growth. Regional Economic Outlook, International Monetary Fund, Washington D.C. 5 ADB (2010), op cit 6 See for example World Bank data base at http://data.worldbank.org/indicator/NE.CON.PETC.ZS 7 Pettis, M., 2011. The Contentious Debate Over Chinas Economic Transition. Policy Outlook, Carnegie Endowment for International Peace, March 25; and Pettis, M. Surveying Chinas Rebalancing Options. 2012, at http://www.mpettis.com/ 8 For a discussion of the political economy of policy reform see for example Abonyi, George, 2005. Policy Reform in Viet Nam and the Asian Development Banks State-Owned Enterprise Reform and Corporate Governance Program Loan, ERD Working Paper No. 70, Asian Development Bank, Manila, August. 9 This section draws on Akyuz, Yilmaz, 2011. The Global Economic Crisis and Trade and Growth Prospects in East Asia. ADB Economics Working Paper Series No. 242, January; and Akyuz, Yilmaz, 2010. Export Dependence and Sustainability of Growth in China and the East Asian Production Networks. The South Centre, Research Papers 27, April. (2011, 2010); and Pettis (2011) and (2012), op cit. 10 See for example Abonyi (2011), op cit. 11 It is argued that the conventional growth accounting based on the national income identity underestimates the contribution of exports and overestimates the contribution of domestic demand to GDP. In order to assess importance of exports in the income generating process, it is necessary to identify direct and indirect import contents of consumption, investment and exports, using inputoutput linkages. (see Akyuz, 2010, op cit) 12 Akyuz (2010), op cit. 13 See for example Athukorala, Prema-Chandra, 2011. Asian Trade Flows: Trends, Patterns and Projections. Working Paper No. 2011/05 Arndt-Corden Department of Economics Crawford School of Economics and Government, ANU College of Asia and the Pacific, March.; and Kim, Soyoung, Jong-Wha Lee, and Cyn-Young, 2010. The Ties that Bind Asia, Europe, and United States. ADB Economics Working Paper Series No. 192, Asian Development Bank, Manila, February. 14 Akyuz (2011), op cit. 15 Kawai, Masahiro, 2011. Regional Economic Integration: Engine of Asias Growth and Development. Presented at Conference on East Asian Development 2011 World Bank, Singapore, 21-22 March 2011 16 Lim, H., and F. Kimura, 2010. The Internationalization of Small and Medium Enterprises in Regional and Global Value Chains. ADBI Working Paper 231, Asian Development Bank Institute, Tokyo. 17 Asian Development Bank, 2010. Institutions for Regional Integration: Toward and Asian Economic Community. Asian Development Bank, Manila. 18 IMF World Economic Outlook Update, January 24, 2012
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Asia Policy Briefs April 2012