Monday, November 23, 2009

The China Factor

If as in my last post, fiscal stimulus is contraindicated as a way to full recovery for Malaysia, then we need to look at external demand.

The Asian Development Bank has just published research that looks into the impact of China on the rest of the region (Warning, pdf link). Specifically, the research asks the question: Can China pull East Asia out of recession on its own:

"Developing Asia has traditionally relied on exports to the United States (US) and other industrialized countries for demand and growth. As a result, the collapse of exports to the US and other industrialized countries during the global financial and economic crisis has sharply curtailed gross domestic product (GDP) growth across the region. The emergence of the People’s Republic of China (PRC) as a globally influential economic force is fueling hopes that it can supplement the US as an additional source of demand and growth. The central objective of this paper is to use vector autoregression (VAR) models to empirically investigate whether exports to the PRC have a significant and positive effect on the GDP of nine developing Asian countries. The study’s results from a three-variable VAR model indicate that PRC’s imports have a significant positive effect on the GDP of regional countries. However, the study’s results from a four-variable VAR model indicate that the PRC’s apparently positive impact reflects the US’ demand for Asian goods, rather than independent demand from the PRC. Therefore, overall, the study’s evidence suggests that the PRC is not yet an engine of growth for the rest of the region."

The answer is taken as a unit, China does exercise considerable influence over the economies of the region. However, once you add external factors, then we are still looking at final demand from the US underlying even China's import demand.

So looking at current events, I would say that China's stimulus spending has helped support the region during the past year, but full recovery (if it will occur at all) depends on recovery in US consumer demand. With global rebalancing in full swing, that's by no means a given.

I suspect what we'll see going forward is a permanently lower path of global growth, which I referred to here. In other words, there will be no full closure of the global output gap but rather destruction of over-capacity instead, which suggests a slow, hesitant recovery path.

On a side note: as with all VAR studies, we're looking at historical data and the framework used is agnostic of structure. Nothing says that a secular shift towards consumer consumption in China won't change future interrelationships. A global crisis like the one we're experiencing is a natural structural break.

Technical Notes:
D. Park and K. Shin, "The People's Republic of China as an Engine of Growth for Developing Asia?: Evidence from Vector Autoregression Models", ADB Economics Working Paper Series No. 175

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