The End of the Asian Miracle

The investment guru who coined the term "emerging markets" returns from Asia, finds that the slowdown is real, and offers five game-changing events that are reshaping the global economy.

By Antoine van Agtmael coined the term "emerging markets" while at the International Finance Corp., was the principal founder, chairman, and chief investment officer of Emerging Markets Management, and is the author of "The Emerging Markets Century."

Foreign Policy introduces "Trip Report," a new feature that takes readers behind closed doors with some of the world's sharpest minds for an intimate, unfiltered look at subjects ranging from the European economic crisis to the course of the war in Afghanistan. Think of it as a new kind of intelligence -- a backstage pass to rooms you haven't been cleared into before.

Foreign Policy introduces "Trip Report," a new feature that takes readers behind closed doors with some of the world’s sharpest minds for an intimate, unfiltered look at subjects ranging from the European economic crisis to the course of the war in Afghanistan. Think of it as a new kind of intelligence — a backstage pass to rooms you haven’t been cleared into before.

Where I went: I recently returned from a two-week trip to Asia, visiting India, Thailand, Hong Kong, China, Taiwan, and South Korea. I’ve been to these countries many times over the past 25 years in my capacity as chief investment officer and later chairman of Emerging Markets Management and AshmoreEMM. During my trip I met with a number of high-level policymakers, bankers, company executives, investors, think tanks, and scholars. But where there was once almost universal optimism, this time I came away with a very different sense. A few years ago there was a widespread feeling that the developed world had fallen off its pedestal — that Asia had not only escaped the global financial crisis but that its system was somehow superior. That overconfidence seems gone now. Instead, there is a sense of vulnerability. There is more awareness of the political Achilles’ heel of their own path of development and even new economic concerns about challenges to their newly acquired competitive edge.

The takeaway: Confidence about political stability and effectiveness has been shaken in China, India, and other emerging markets. The Arab Spring was a shock wave that not only brought to light misdeeds of autocratic regimes but also created economic uncertainties for the future. In BRICs at two ends of the political spectrum, political stability has turned out to be more fragile than earlier assumed. The Bo Xilai case in China has raised questions about the legitimacy of the whole political succession process. And Prime Minister Manmohan Singh’s disappointing performance in India (some business leaders even told me he had "lost it") has created gridlock in New Delhi while emboldening states.

At the height of the financial crisis, local elites and the broader population in India and China viewed indecision, stagnation in policymaking, corruptive power of vested interests, and lack of leadership as major problems in the United States, Europe, and Japan — but these same people are now concerned that they face similar problems. On the positive side, turmoil from Tunisia to Myanmar has brought hope and a feeling of empowerment. The sudden transformation now under way in Myanmar has re-energized Southeast Asia and the Association of Southeast Asian Nations as a sizable, relevant, and vital economic entity nestled between the two emerging regional superpowers, China and India.

The other big question involves the economic future of the leading emerging market — China. Who would have thought a decade ago that the United States would lose its unquestioned AAA credit status? Until recently, it would have been equally unthinkable that questions are now being raised about whether China will remain the unquestioned manufacturing champion. Its wages have risen, its currency is more expensive, its labor surplus has evaporated, its population is aging fast, and other emerging markets are emulating its impressive infrastructure. Bangladesh, Vietnam, the Philippines, and Thailand (and one day, perhaps Myanmar) are mentioned more often as places where global manufacturers are looking to set up new plants. Even the United States now is seen as a place that manufacturers are turning to. Slower growth in China and India is becoming accepted as a new reality.

Conventional wisdom debunked: For the past five years or so, the idea had become commonplace that the United States was losing the race for global competitiveness. In my own book, The Emerging Markets Century, I wrote about how the rise of China and India was shifting the competitive edge and how some emerging multinationals (from Samsung Electronics in South Korea to Embraer in Brazil) were becoming world-class companies. All of that remains true; emerging markets remain the place to be for the next decade at least. But, interestingly, the creative, competitive response I had expected seems to be coming even faster than I had thought. In fact, the United States may be doing better than we thought, and China and other rising powers may not be doing quite as well as believed. 

We have all come to assume that the developed world lost its drive or "will to win," ceding manufacturing to emerging markets. China and India built impressive manufacturing platforms or back-office strengths based on a belated unleashing of private-sector initiative, low labor costs, and impressive investment in infrastructure. China and others gained a near monopoly on making cheap goods cheaply. Consumers in the United States began to feel that China had won the battle for shelf space in Walmart. American infrastructure fell way behind in building a 21st-century network of roads, rails, bridges, pipelines, airports, and communications technology. Political antagonism combined with the budget and debt crises had placed the onus on "expense cutting" instead of rebuilding infrastructure to remain export-competitive and promote manufacturing. America’s traditional brands had lost some of their luster: No longer was General Motors the pride of global automaking; iPhones were neat, but made in China. Meanwhile, India’s Tata Corp. bought iconic brands like Jaguar, Land Rover, and Tetley Tea. China’s Geely bought Volvo, while Lenovo purchased IBM’s computer division. In South Korea, Samsung and Hyundai became major players; in Taiwan, HTC came from nowhere to be a recognized and respected brand name. To cap it all off, it seemed an irreversible trend: The United States had missed the boat in becoming a "green" leader in a more environmentally conscious world as it ceded ground to mass production in China and innovation in Europe.

But as I saw on my travels, the story is beginning to change. I now believe the despair and fear felt by many in the United States is misplaced. In fact, there are early signs that the United States may be regaining some of its lost competitiveness in manufacturing and that China is losing some ground, especially against other emerging markets. 

Game-changers in the making: As I see it, there are five game-changers now happening in emerging markets:

1.      The shale gas explosion
2.      The erosion of low-cost advantage
3.      The burden of aging populations
4.      The smartphone revolution
5.      The fighting spirit of smarter competition 

These five game-changers constitute nothing short of quiet revolutions, and they will have a huge impact over the next decade, completely reshaping the competitive landscape. You’ll soon see the effect in earnings, margins, growth, and foreign direct investment. 

1. The shale gas explosion: The United States is becoming a low-cost producer of energy again, as a result of vast new discoveries of natural gas. The glut has made natural gas prices of $2 to $2.50 per 1 million BTU equivalent to oil at about $12 to $15 per barrel, which is quite an incentive to use more gas for electricity, petrochemicals, industrial applications, trucking, and even cars. In contrast, China and Japan are now forced to import gas at much higher prices of $13 to $17 per 1 million BTU. Supercheap gas is also making the United States a great place to invest again for energy-intensive industries. For example, the Canadian company Methanex* recently moved its production of petrochemicals from Chile to Louisiana, and Orascom Construction in Egypt is building a fertilizer plant in the United States. This will be a true game-changer for the next decade and will help make manufacturing more competitive in the United States.

  • In the future, gas will be king rather than oil. In a decade, gas prices may no longer be set by oil prices, but the other way round.
  • As the United States is winning the lower-carbon energy race, it is becoming more energy independent. In fact, the liquid natural gas facilities built to import gas from Russia and Qatar may be used in a few years to export gas to Asia.
  • China has its own shale gas but the United States has a major head start in geology, technology, and pipelines. It will take China several years to catch up. India’s offshore gas production has been disappointing and slow. Thailand will run out of gas in ten years, though Myanmar will bring on line large new supplies. 

2. The erosion of the low-cost advantage: China is no longer the place for manufacturing. Wages in China and India have been rising at 15-20 percent over the past five years. Meanwhile, stagnant wage growth in the United States and the rising Chinese yuan has devalued the dollar on a trade-weighted basis.

  • A large wage gap remains but even narrowing it will have a big impact. In a dinner speech at the Brookings Institution, Jeff Immelt of GE claimed that an American factory worker can be competitive at $15 per hour with a $3 worker in China.
  • Unit labor costs in the United States, according to OECD data, have declined from 100 to 88 since 1995, better than anywhere in the developed world except Sweden (80). For comparison, Spain (135) and Italy (120) are much higher. That’s good news for U.S. global competitiveness.
  • According to several manufacturers I met with who have plants in China, China now suffers from a lack of technologically trained manpower. Bangladesh and Vietnam are now lower-cost manufacturing centers than China — even Thailand, the Philippines, and Mexico are becoming wage competitive.
  • Productivity per manufacturing worker is also better in the United States than widely assumed. Hyundai, for example, has car plants in South Korea, the United States, China, and India and "unit per hour" production is actually highest in Alabama.
  • World-class Indian car axle maker Bharat Forge found that Chinese workers in its plants had only 40 percent of the productivity of other workers. The Pune hub (near Mumbai) has become much more competitive because of trained labor and better transportation (a container trip to the port used to take at least two days but now only four hours and the port is more efficient).
  • Of course, China’s enormous competitive advantage is not just in wages but also in its scale for assembly-type production, infrastructure, internal competition, and growing domestic market. These advantages are not going to disappear overnight but are now being questioned. 

3. The burden of aging populations: This is no longer a theoretical problem, but a very real one, especially in China. Demographics will make their power felt this coming decade as they never have before and change the competitive picture. China and South Korea, along with Europe and Japan, are aging fast. India and Africa still have large untapped labor pools, though they need to be better trained. Consider these statistics about China’s demographics:

  • There were 26 million births in 1987 but only 15 million today.
  • With a fully employed migrant labor pool there are now increasing labor shortages, with 1.08 job opportunities for each job seeker.
  • The increase in China’s working population has shrunk from 10 million to 3 million per year and will be negative by 2018, if not sooner.
  • Within 20 years, its retired (60-plus) population will double from 180 million to 360 million (bigger than the entire U.S. population). A professional family now worries already about having to take care of four elderly parents. The support ratio was 5:1 and will be 2:1 in the not too distant future.
  • The savings rate will drop, and entitlements (now unfunded liabilities) will increase. According to some Chinese economists, the Chinese economy won’t be able to grow more than 6 to 7 percent by the end of this decade without collapsing under the burden of these unfunded liabilities.
  • In the meantime, proposals to reform health care and pensions, an urgent necessity, have gathered dust as vested interests and political indecision have delayed action. 

4. The smartphone revolution: The speed with which everyone in the world — not just the rich, the elites, or developed economies — embraced mobile phones has been astounding. The same is now beginning to happen with smartphones and tablets as prices rapidly drop to an "affordable" level of $120 (without subsidies) thanks to competition from Chinese clones.

  • Within five years, several billion people will be "addicted" to smartphones — emailing, browsing, taking photos and videos, making video calls, using myriad apps, streaming, and playing games.
  • The smart-pad will bring high-quality education to the masses around the globe. Taking classes online or being part of an interactive presentation will be as commonplace as Googling today.
  • Bandwidth, good infrastructure, and monthly costs (which are rivaling the cost of food for poor families) will become increasingly important.
  • Interestingly again, in the speedy world of smartphones, China is falling behind in its telecom infrastructure (despite an otherwise great infrastructure). China was already behind in the past generation (3G) of telecom infrastructure because it unsuccessfully tried to sell the world on its own 3G standard, something the Koreans learned to avoid earlier. It will not issue licenses for its newest version of 4G (TD-LTE) until 2014.
  • Moreover, even though the traditional Internet cafes are increasingly being replaced by more than 1 million hot spots, for home Wi-Fi China has only just started to make a major investment.
  • It is interesting to watch that, despite competition from the clones, in the premium-brand sector, Apple’s iPhone (assembled by a Taiwanese firm in China with key components from Samsung) has become a status symbol in China and elsewhere, even in Seoul’s "Samsung city."

5. The fighting spirit of smarter competition: It seemed for a while that the United States would leave the manufacturing to emerging markets and focus instead on innovation, design, finance, and super-high-value-added manufacturing. It is now widely recognized that this was a losing strategy. As Andy Grove of Intel once observed, for every manufacturing job generated in the United States by the computer industry, 10 are outsourced to emerging markets. For job creation, it is important to realize that there are many more "makers" than "thinkers." While R&D is spreading around the world, a lot of key innovation remains in the United States, Japan, and Europe. Indeed, leading companies there have adjusted to compete in a world with huge markets outside their borders and aggressively competing emerging world class companies. They are competing smarter and are fighting back. For example:

  • Apple, Qualcomm, Google, Amazon, Facebook, YouTube, Twitter, and Bloomberg are just some examples of new "brands" and of companies at the leading edge of innovation which did not exist or were tiny a decade ago. Today’s world could not live without their inventions, used by millions around the world and which are constantly imitated.
  • Not only big companies like Caterpillar but many small companies in the United States have adapted to competition from emerging markets by specializing in technologically advanced, higher value, high-precision manufacturing that integrate electronics and use sophisticated automation. American firms hire hundreds of thousands of software engineers in India (and thus from potential Indian competitors). When smartphone baseband chip designer Qualcomm saw that a Taiwanese competitor became the "go to" source for Chinese clones for low-cost processor chips, it dropped its prices and forced it on the defensive. It could do so because it is a price setter with high margins rather than a price taker.
  • With some jealousy it is said these days in Asia that 90 percent of profits go to Apple and 10 percent to China. This gives these companies enormous pricing power and high margins. What most people don’t realize is how concentrated the key parts of the smartphone industry are. There are less than a handful of companies that design the most expensive chips in the smartphone (based mostly on ARM architecture), and they are mostly made by two fabrication firms (TSMC and Samsung). China is way behind in this area. There are also only a handful of companies that make the touch screens for smartphones.
  • Infrastructure, especially in the United States, fell way behind but, while this remains a political football, more attention is being paid to the importance of infrastructure as a source of competitiveness. There were less "shovel-ready" infrastructure projects than initially believed for the stimulus but the ultimate return on investment may be higher. The United States has regained a bit of ground in the global infrastructure race as new airports, pipelines, and local projects come on stream and shale gas is being developed. 

No more can we maintain a blind reliance on mega-emerging markets to sustain future global growth. After a decade of 10-plus percent growth in China and a shorter period of 8-10 percent growth in India, the remainder of this decade is likely to bring only 6-7 percent growth, a fact to which the rest of the world will have to adjust reluctantly — as it struggles with its own problems and growth of less than half that rate. We all took the rapid growth of China and India for granted too easily. This will be a rude awakening for those who like to project past trends forward.

But there is a new reason for optimism. The shift in China to less dependence on exports and less aggressive investment in fixed assets in favor of higher consumption of anything from food, clothing and smartphones to healthcare, travel and education will gradually dissolve the large export surpluses and create a more balanced and sustainable global economy. 

This will be a different era for Asia. Sure, the region’s emerging markets proved themselves much more resilient in the global financial crisis and came out of it faster and in better shape. China’s fast-acting stimulus, in many ways, was a major turning point and saved the world from deeper problems. But the challenges of the next decade require a more sustained approach: balancing growth with inflation and local consumption with export dependence and relentless investment is critical, particularly if policy makers we want to ensure a smooth path to a future growth model.

*Correction: This article originally identified Methanex as a Chilean company. Methanex is headquartered in Vancouver, Canada, and has operations in Chile. It is moving an idle plant from Chile to Louisiana, not Texas. We regret the errors.

Antoine van Agtmael coined the term "emerging markets" while at the International Finance Corp., was the principal founder, chairman, and chief investment officer of Emerging Markets Management, and is the author of "The Emerging Markets Century." Twitter: @avanagtmael

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