Since the fourth quarter of 2010, the global economy has faced serious uncertainty and a turbulent outlook.

Both the US and Europe have gloomy growth prospects due to a lack of credible medium-term plans for debt reduction in the US and the sovereign debt crisis in southern Europe.

Against the downside risk to growth in the West, Asia’s recovery and growth in the past three years has been exceptional. China and India recorded the highest growth rates in the world with 10.3 and 10.1 per cent in 2010, respectively, while Indonesia, Thailand, Malaysia, the Philippines and Vietnam (ASEAN-5) grew 6.9 per cent. Asia, with a solid global market and a large pool of foreign exchange reserves, has proven to be the shining light of the world economy.

Asia’s future prospects are likely to be affected by the West, yet ‘rising Asia’ also appears able to help save the sinking world economy. Even with weaker demand from the West, Asian growth in 2012 is expected to remain strong on the back of solid domestic demand. But for robust, sustainable and balanced world growth, Asia needs to shift from its conventional extra-regional export orientation to intra-regional demand as a way to help advanced economies recover and to ensure its growth sustainability.

How can Asian governments accomplish these twin objectives amid the current global turbulence? First, they must continue to shift to more domestic demand-based growth in the short and medium term and accelerate ongoing regional economic integration to allow freer intra-regional trade and more cross-border investment. This policy shift will result in two things: greater self-propelled growth and more imports from Western economies, especially the US, which would help correct chronic trade imbalances and raise the growth potential of America and Europe.

Second, Asian governments must minimise external financial contagion and expand intra-regional FTAs to spur sustainable economic growth.

How can they do this? One effective means would be to create a cross-border free trade regime in East Asia. At present, there is a relatively low degree of intra-regional trade share in East Asia. Intra-regional trade among ASEAN+3 countries has increased steadily since 1998, when the Asian financial crisis was subsiding, but slowed a little after 2005. In 2008, the East Asian intra-regional trade ratio, at about 37 per cent, was lower than that of the North American Free Trade Agreement (NAFTA), and far lower than the euro zone’s ratio, with 60 per cent. Considering that the euro zone and NAFTA are free trade blocs, it seems plausible that East Asia could find significant growth sources from its own regional domestic demand if it established an East Asia-wide FTA.

Given the ongoing hub-and-spoke issues around intra-regional FTAs, East Asia should adopt a strategy of ‘doing easy things first’. A good example of such an approach is the Chiang Mai Initiative, which is already under way. The Asian Bond Market Initiative could also be accelerated to provide a viable cross-border financing scheme to small and medium enterprises. In this regard, a cross-border regional cooperation mechanism among sub-regions and mega-cities such as the Pan-Yellow Sea Circle and Greater Mekong Sub-Region could be a starting point.

Northeast Asian integration has great potential to build a robust regional community of peace and prosperity. It is encouraging that China, Japan and Korea in May 2010 agreed to establish a secretariat office in Seoul to address trilateral regional issues. Apart from FTA talks in Northeast Asia, Asian governments in ASEAN+6 need to pay attention to many proposals in cultivating diverse ‘public goods’ such as cross-border oil and gas pipelines and railways to enhance connectivity. Dynamic benefits resulting from a cross-border, bottom-up approach could also be derived from establishing common standards for production technology, product regulations, distribution and after-sales services.

By accumulating success stories for open Asian regionalism, major Asia Pacific economies can work together toward an Asia Pacific Economic Community, which the APEC forum has long addressed. Though it may take time to nurture mutual trust and confidence, Asia should be eager to establish open regionalism which a variety of external stakeholders, including the US, India, Canada, Australia and New Zealand, can join. Asian open regionalism needs to be translated into an Asia Pacific Economic Community to ensure it will be a building block toward viable multilateralism, not a stumbling block.

At this critical juncture of the world economy, East Asian integration must be pursued to increase its own growth momentum internally. Asia must move aggressively to shift its focus to the region’s 3.5 billion consumers so that its intra-regional demand-led growth can contribute to balanced and sustainable global growth. The Greek debt crisis clearly showed that no country can overcome the emerging economic malaise without a strong manufacturing base. Consequently, Asian economies need to strengthen the already existing global ‘manufacturing house’ through intra-regional trading. But Asia is diverse and still not free from historical rivalries. For both its own growth and the good of the global economy, Asia needs visionary political leadership to put historical legacies behind and look toward a long-term vision for an Asia Pacific Economic Community.

Choong Yong Ahn is Distinguished Professor at the Graduate School of International Studies, Chung-Ang University, Seoul.

This is an abridged version of an article that originally appeared here in Global Asia.

1. The DPJ: Sacrificing the economy to ‘save’ agriculture
2. World economy not quite out of the woods yet
3. Economic integration: Will Asia go regional?

The development of Thailand’s financial sector has been a story of restructuring, adjustment and renewal, following the devastating effects of the Asian financial crisis in the late 1990s.

The crisis was very costly to the Thai financial system, with an estimated gross fiscal loss equivalent to about 33 per cent of 2006 GDP. At the peak of the crisis, the Thai banking sector had large net losses, a declining net interest margin, low capital levels and a non-performing loan ratio that peaked at 43 per cent of total loans in 1998.

But the manner in which the Thai banking problem was tackled, beginning in 1998, shows how authorities might successfully overcome a systemic banking crisis. The government embarked on a comprehensive restructuring of the financial sector, intervening in weak banks and focusing on recapitalisation, debt restructuring, reform of the regulatory and supervisory framework, strengthening corporate governance of banks, and introducing initiatives to deepen and broaden the capital market.

Thai authorities then proceeded aggressively with regulatory and supervisory reforms aimed at moving Thailand’s financial regulation and supervision towards a risk-based framework on par with international best practice. Key elements of the reforms centred on risk-based supervision under Basel II (an accord on banking regulations), consolidated supervision and the phased implementation of IAS 39 (a more rigorous method of measuring financial transactions). Financial institutions were also restructured to rationalise and consolidate the financial system under a ‘One Presence’ policy. These reform efforts were coordinated under the broad agenda of the Financial Sector Master Plan Phase I (2004–08) which aimed to improve the financial system’s efficiency, broaden access to finance, and improve consumer protection.

By mid-2007, when the global financial crisis erupted, many weaknesses in Thailand’s regulatory and supervisory framework had been reduced. Consolidation in the financial system brought the number of deposit-taking institutions down to 45 from 124 before the 1997/98 crisis, while the process of deleveraging in the private sector was more or less complete, with the debt-to-equity ratio declining from 1.2 in 1998 to 0.7. The domestic capital market also grew rapidly in response to the funding needs of Thailand’s government and firms, further strengthening the system’s resilience. Importantly, these improvements resulted in much stronger balance sheets for firms and banks.

The immediate impact of the global financial crisis on the Thai economy and the financial sector was limited, due to the funding structure of Thai banks and the low exposure of the Thai banking sector to subprime assets. This structure was based on domestic deposits that helped insulate Thai banks from the tight liquidity conditions abroad. The second-round effects from the decline in economic activity and deleveraging were slightly more pronounced, and a policy response was required at the macroeconomic- and finance-sector levels. The key challenge for Thailand has been to help small and medium enterprises adjust to the impact of the global slowdown while maintaining confidence and ensuring a normally functioning financial sector.

By 2010 the Thai economy was on a firm path to recovery, supported by fiscal stimulus, low interest rates and a fully functioning banking sector. Lessons from the global financial crisis point clearly to the importance of having a sound and resilient financial system to prevent the risk of crisis and help the economy adjust to shocks. Reflecting this, reforms to strengthen the financial sector continue under the broad agenda of the Financial Sector Master Plan Phase II. The plan focuses on improving the financial system’s efficiency through greater competition, reducing the financial system costs, expanding access to financial services, and strengthening banks’ risk-management capacities by developing better and more complex financial markets and infrastructure.

In parallel with domestic reform, the landscape for the global regulatory and supervisory framework is also changing rapidly in the wake of the global financial crisis. The most important item here is the introduction of the Basel III standards, to be implemented in 2013. The aim of Basel III is to make banks resilient to stress through stronger capital bases, better liquidity positions and more comprehensive risk management. Although the capital position of Thai banks is robust, the industry’s longer-term strength will benefit from a continued improvement in capital, liquidity, governance and risk management.

The key future regulatory issue for Thailand, therefore, is how to adapt to the new global regulatory process without harming economic recovery. This must happen while also ensuring the finance industry is contributing to the economy’s efforts to address post-crisis challenges, which are expected to be different and more complex. Important in this context is the role the financial system must play to promote domestic demand as a key engine for growth, and the task of more successfully transforming the country’s high rate of savings into productive investment.

Bandid Nijathaworn is a former Deputy Governor of the Bank of Thailand and is Chairman of the Thai Bond Market Association and President and CEO of the Thai Institute of Directors, Bangkok.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Where is Thailand Headed?‘

1. Financial reforms after crisis
2. The Philippines: resilience from a low base
3. Lessons for the Philippines from the US financial crisis

As Europe continues its desperate struggle to salvage the euro and monetary union, the spotlight of regional cooperation is shifting to Asia.

In December, European leaders retro-fitted the union with fiscal disciplines which impose binding limits on national budgets and borrowing. All but Britain opted in; the UK, Prime Minister David Cameron argued, was not prepared to yield such fiscal sovereignty. Lack of fiscal integration alongside commitment to a common currency was a serious design flaw in the original European enterprise. The new fiscal disciplines will allow more room for the European Central Bank to act as lender of the last resort to European borrowers. Whether these ‘architectural’ arrangements for European cooperation will be sufficient to save the euro will finally depend, of course, on how and whether they encourage the ‘substantial’ structural reforms and adjustments necessary to restore growth momentum in the deeply indebted southern European states.

Faced with shrinking economies and rising unemployment, and lacking exchange rate flexibility to restore price competitiveness in external markets, how can the sick economies of Europe get to grow again? Without the option of deeper currency depreciation, real wage cuts and structural reform are the only way to export-oriented growth — outside the OECD economies — in emerging markets like those in Asia.

As Shinji Takagi argues, the European mess has revealed just how inept Europe’s supra-national institutions were in dealing with a regional problem of the proportion that has emerged there. Inter-governmentalism — that is, a willingness to cede position and sovereignty through decision making in the collective interest — moved centre stage as the instrument of crisis management. French President Nicolas Sarkozy and German Chancellor Angela Merkel had to call the shots for the rest of Europe. France and Germany are providing critical leadership: despite over half a century of regional institution building, the huge Brussels bureaucracy proved little more than a paper tiger. The implications for Asian regional cooperation are profound.

In Asia, a central question is whether strong growth can be maintained despite continuing weakness in the developed world. Success in avoiding that scenario also depends on whether extensive structural reform is put in place to shape the expansion of Asian investment — so that it continues to roll out in ways that ensure it is productive and that economic growth does not run into the sand.

Asia does not need a huge supra-national bureaucracy, but it does need its own measure of inter-governmental cooperation to keep growth on track. It has the architectural frameworks, in APEC and the East Asian arrangements, to give this effect — if it is so minded.

On recent evidence, emerging market economies in Asia and elsewhere might have had some reason to think that there was ‘trend decoupling’ between their growth rates and those in the old G7 economies. But events of the past six months should have dispelled that illusion, as interdependence through expectations and market sentiment, as well as more directly through trade and finance, has ensured that problems in the industrial economies wreak their havoc and uncertainty around the rest of the world. De-coupling Asia from European growth clearly has its limits.

The Asian emerging market economies are, nonetheless, in a stronger position than their industrial country partners, with demographic dividends still to reap, much lower debt ratios, and economies that enjoy the benefit of powerful ‘catch up’ to the industrial-country frontier. The potential rate of growth in emerging economies remains high because the ‘convergence gap’ — the gap between productivity levels in industrial countries and developing economies — remains large even for economies like China and India. This hasn’t changed because the rest of the world has fallen into recession.

With these assets, what’s to stop emerging economies powering the global economy from its industrial-country malaise?

Wendy Dobson in this week’s lead essay suggests that Asia’s focus should be on ‘re-balancing’ and trade liberalisation. Expectations of Asia’s role, Dobson says, are growing much faster than Asia’s capacity to meet them.

In Asia too regional architecture is required for cooperative action. And Asian regional architecture still lacks tight and effective links to emerging global architecture around the G20 process.

‘Yet with some notable exceptions’, Dobson points out, ‘Asia’s focus remains on the architecture rather than the domestic and regional economic adjustments required to sustain growth momentum in the face of potentially serious external shocks from renewed European recession and near-stagnation in the United States’. On trade liberalisation, Dobson puts faith in the recent US Trans-Pacific Partnership (TPP) initiative.

Others would prefer broader regional and continuing global efforts, given that China has not been engaged in the TPP and due to other circumstances in the international economy.

Without Chinese engagement in what is putatively Asia’s primary trade liberalisation enterprise, the TPP is unlikely to give much strength to the heart of Asian integration nor to global trade.

Peter Drysdale is Editor of the East Asia Forum

1. Will Asia step up to the global challenges of 2012?
2. Regional cooperation and national sovereignty: Asia and the euro crisis
3. The East Asia Summit and regional financial cooperation

For the foreseeable future at least, India will meet the majority of its energy demand with fossil fuels.

Renewable energy does not yet offer effective substitutes for oil in transport and power generation, despite marked improvements in hybrid transport technology and the steep decline of photovoltaic panel prices.

And in the current climate, crude oil prices are not likely to head below US$80 a barrel — despite growth impulses in Europe and the US weakening even further. The burgeoning demand for energy from large emerging economies such as China, India and Brazil will likely keep prices from softening any time soon. So India should come to accept the high hydrocarbon prices and focus more on improving power-generation and transport-sector efficiency, and energy conservation measures.

One factor that could change the short-term energy price scenario would be a possible break up of the euro zone. Such an event could sharply bring down commodity prices as demand collapses in Europe and its periphery.

This possibility is becoming stronger, with the markets seriously doubting the ability of European governments to implement effective measures that would reduce debt and re-ignite growth at the same time. As a result there has been unremitting pressure on sovereign bond offerings — with yields of Italian and Spanish bonds hovering dangerously close to the 7 per cent mark.

This issue was discussed at length during the recent International Capital Conference in Paris. French President Nicolas Sarkozy and other senior French leaders addressed the delegates on the evening prior to the conference. They suggested that the markets are acting irrationally, as Europe’s fundamentals are strong — and the markets’ predatory behaviour must be subject to stronger controls and regulations. But the day after President Sarkozy’s speech in defence of the euro, the markets rejected the full offering of German treasury bonds, with a yield of 1.98 per cent — higher than on US treasuries.

This should have caused alarm bells to ring and made Europeans sit up and take notice. But the mood at the dinner that evening was full of bonhomie and good cheer — in total denial of the market sentiment.

There seemed to be no concern at the possibility that markets are beginning to consider German sovereign bonds risky, and thereby perhaps accelerating the move away from the euro. This denial, it seems, reflects an apparent lack of ownership of the euro zone crisis, where every party expects the other to find a solution.

This could well be the bane of the euro zone. Everyone expects France and Germany to lead the fight to save the euro. But the two countries do not fully agree on a common approach, and differ significantly on two important fronts. First, how they view the European Central Bank’s role as the liquidity provider of last resort and second, the extent of fiscal cuts required to restore market confidence.

Germany is in a more dominant position but cannot be seen to exercise its influence to the extent required because of political reasons. While it knows the euro’s demise could also be its own undoing, Germany’s power and influence in such matters can only extend so far; it cannot effectively impose the discipline needed to restore market and investors’ confidence in the euro undertaking, for example.

While other members of the euro zone are not yet prepared to accept the situation, they may have to come around in due course. The markets, for their part, seem set on forcing a more expeditious solution — something neither Germany nor other members of the euro zone are currently prepared for. So, there is a time-sequencing problem that is leading to mounting pressure on the weakest links in the chain, which could snap at any moment.

There could well be a messy breakdown of the euro zone which the world should prepare for. For India, such preparation implies speeding up the stalled structural reform process. The reform measures that can be undertaken as executive action, and which do not require parliamentary approval, should be implemented as soon as possible.

Investor confidence also needs to be restored. India has to present a credible front in order to attract capital flows and prevent capital outflow in the coming period of heightened turmoil and uncertainty. The political class must recognise the dangers facing the economy and not let partisan interests prevent effective action. The lesson from Europe is that these are critical times. India should heed this lesson and prepare itself by pressing ahead with reforms and restoring investor confidence.

Rajiv Kumar is Secretary-General at the Federation of India’s Chambers of Commerce and Industry. A version of this article was first published here on the Hindu Business Line.

1. Coping with unprecedented urbanisation in India
2. The Eurozone crisis and prospects for India
3. Brazil, Russia, India, and China (the BRICs) throw down the gauntlet on monetary system reform

The slow resolution of the European debt crisis has evolved into a liquidity problem which threatens the global financial system.

And these long-drawn-out efforts to address the sovereign debt problems have heightened uncertainties about resolving the crisis and induced speculative activities, threatening the survival of many European banks. In an effort to contain financial disaster, central banks of the world’s major economies have taken a concerted emergency action to provide cheaper dollar funding to these troubled banks at the end of November 2011. Further, the President of the European Central Bank (ECB) recently pledged readiness to act more aggressively in averting a deeper financial crisis.

This serious threat of financial crisis is not new to the global economy. Triggered by different factors, the world has observed two similar crises within the last decade; the burst of the dotcom bubble in the early 2000s and the beginning phase of the global financial crisis through 2007 and 2008, which culminated in the bankruptcy of Lehman Brothers and the freezing up of global finance. In both cases, aggressive policy easing took place in the leading industrial economies, sending real interest rates to a very low level.

The current situation inEurope may still lead to a global economic slowdown if the debt problems are not resolved, propelling the global financial system into another deep crisis comparable to that of 2008. The policy reaction this time should not be much different from 2008. At the very least, the ECB and central banks should relieve pressure on banks and the financial sector by cutting interest rates further to ensure that affordable liquidity is available for the financial sector. As observed in both the burst of the dotcom bubble and the global financial crisis, such action would result in a low international interest rate environment.

Given the integrated global financial system, any such shock would have implications for small, open economies elsewhere. For emerging ASEAN economies (Indonesia, Malaysia, the Philippines and Thailand), the two episodes of internationally originated financial shocks in the past decade seem to have insignificant effects unless coupled with a global recession that pushed their domestic output down at the same time. To better understand the effects of adverse international financial shocks, however, it is useful to isolate these shocks and analyse their impact on the macroeconomic performance of these economies. This type of structural analysis typically suggests the shock’s effects on inflation and output tend to be largely similar and relatively small. An isolated negative shock in international interest rates would tip the ASEAN economies toward an environment with lower inflation and higher output volatility, albeit generally small in magnitude.

Although small, the impacts of purely international financial shocks on ASEAN economies tend to be long lasting, with implications for the management of future macroeconomic stability. It seems the larger the size of the international financial shock, the greater the consequences of maintaining future economic stability for ASEAN countries.

How should emerging ASEAN economies react to an isolated adverse international financial shock? Typically, to counter a drop in the international interest rates, a country may reduce its domestic interest rate. This discretionary policy action may counter the short-run inflation effects from the international financial shock, but would aggravate the short-run impact on the country’s output gap at the same time. Consequently, the country would end up facing greater volatility in its domestic output. In this way, the cure may worsen the illness. Discretionary monetary policy action may only be sensible when the global financial shock is accompanied by a global recession that also reduces domestic output at the same time. In this case, the cure will have the desired short-run impact of limiting the global shock’s effect on both domestic inflation and output.

Yet, confronted with the external shock’s long-lasting effects, the short-lived domestic interest rate shock will only work for containing short-run volatility implications and will leave domestic policy makers with a hanging problem of managing volatility in the medium to longer term. In this regard, efforts to manage the domestic economic implications of a single, large shock in the international financial system would entail not just a simple short-run policy response in emerging ASEAN countries, but more complicated adjustments to their overall economic structure.

To deal with the effect of an adverse international financial shock, individual authorities in emerging ASEAN economies should opt for policies which provide longer-term structural adjustment to their economy. To this end, emerging ASEAN authorities should support the current efforts to restructure the global financial system in order to reduce future risks of more volatility. In addition, the similar pattern of effects on emerging ASEAN countries highlights the need for enhanced policy coordination and cooperation among these countries to better deal with such disturbances.

Arief Ramayandi is an Economist at the Asian Development Bank. The views are solely of the author’s and do not necessarily reflect the views or policies of the Asian Development Bank.

1. ASEAN economies on the slide?
2. An Asian perspective on financial crises
3. An Asian response to international financial reforms

The upcoming G20 Summit in Cannes will undoubtedly attract the world’s attention, as many look to see whether the G20 can play a positive role in the global economic recovery.

And while searching for an effective solution to the crisis, the world will also focus on China, asking whether it might become a responsible ‘leadership state’ in an emerging global governance structure like the G20. The answer, it seems, is that based on its own interests, China is choosing to become a responsible contributor to global governance and wants to become part of the solution to the current global crisis.

China has maintained a rapid growth rate and played a major role in stabilising the global economy since the 2008 global financial crisis — and it wants to remain the biggest engine of growth and the ‘stabiliser’ to the global economy into the future. This could be China’s most important commitment to the world at such a critical time, but Beijing must also be careful not to risk the stability of its own domestic economy. And while becoming a stabiliser for the global economy would clearly increase China’s weight in the G20, the world cannot expect China to assume a particularly substantial leadership role in the G20.

In the eyes of Chinese leaders and the public, China is not ready to take on such a role, as the country is limited in its strength and knowledge, and by its status as a developing nation. China’s economy is in high-speed growth, but it still faces internal social problems and difficulties with efficiency and fair distribution in its economy. Consequently, it is hard to imagine that Chinese leaders would have the legitimacy and support to help finance foreign economies.

China also believes that the global economy is a fundamentally unbalanced system, characterised by the disproportionate and unchecked role of the US dollar as the main reserve currency and the worsening of European sovereign debt. It also views reforms aimed at strengthening the international monetary system and the EU’s internal reform efforts as imperative to establishing conditions for stable, strong and balanced growth. And as for China itself, Beijing must work hard to transition from an export-driven model to one based on domestic demand.

In the meantime, the world should be paying more attention to the development interests of developing countries, in order to increase their representation in international economic institutions and to reduce the risks arising from the global market — especially the volatility of commodity prices. Achieving this goal will benefit China as well, as it is the world’s largest trading nation and needs a stable international market.

Still, China supports the objectives France has set for the upcoming G20 Summit and welcomes the leading role Europe will play. China identifies itself with Europe’s long-term goals of stabilising and reforming the international financial system. China also hopes to stabilise the European economy, which would not only help its own exports to the region, but would also help balance US power and influence in international affairs. Equally, both China and Europe support reforms to the international currency system, stabilising commodity prices and resisting protectionism. But China wants Europe to carry out a more thorough reform to protect the safety of relief funds and to further open its markets — it would be unrealistic to expect China and Europe to be fully consistent on all objectives.

The global economy would undoubtedly benefit from greater consensus building through effective global governance, and the G20 is lagging behind in effectively dealing with these challenges. Consensus is absent among key players, which only further highlights the difficulties of coordination and cooperation within the G20. In the end, China will likely play a ‘balancer’ role between the US and the EU, something which could ensure the protection of China’s own interests. But as its cooperation with France and Europe is strengthening, China does not want to overly complicate its relationship with the US either.

There is little doubt that China hopes to develop a greater platform for contributing to international governance, through which it can safeguard its interests. China would like to see reforms to the current system of global governance, including a reduced dependence on the US dollar as a reserve currency and reforming the IMF to make it more representative. Beijing’s policy is clear: it does not want to overthrow the current system of global governance; it wants to reform it. In this way, China will ultimately play the role of ‘responsible contributor’ — and this role is only set to strengthen as China grows into the future.

Wang Yong is Director at the Centre for International Political Economy, Peking University.

1. Hu visit ends any dream of a US-China duopoly
2. The values dimension of Southeast Asian development and the rise of China
3. Bush, the G20 and China

We live in troubled times. The Dow has taken several multi-hundred point hits as fears rise and fall on Europe’s debt crisis.

The rising debt crisis has left many seriously doubting the United States’ ability to provide global economic leadership. And the news about the global economy’s slowing down is not good.

Over the long term, no other forum but the G20 can continue to represent the shifting locus of economic power away from the developed economies of the West and to the emerging economies of Asia — and no other is likely to emerge.

Even in the short term, following the G20’s successful collective response to the 2008 global financial crisis, the world will look to the G20 again to deal with the renewed threat of a global recession. And with all the domestic constraints that Europe and the US currently face on the third round of quantitative easing and further stimulus, the G20 is bound to focus on the role of Asia.

We should strive for two things in thinking about Asia’s role in the G20. First, handling the short-term problems of global demand and the anxieties about a double-dip recession. Second, and of equal importance, addressing the question of how to rebuild the global economic order in one generation.

A generation might seem a very leisurely pace of change, but it will take time for both the West and the East to adjust to new economic realities. And pretending otherwise will rule out real opportunities for shaping the G20 into the longstanding forum it deserves to become. It must learn from the Asian experience of steady, even if often slow, economic cooperation.

Let’s consider two approaches to addressing these two priorities. First, on the immediate question of sustaining global demand, it now seems clear that the G20 has been able to repeat the success it had in dealing with the 2008 crisis in the much harder task of rebalancing the global economy. That success put the G20 in a somewhat more complacent mood than it can afford. It may also have placed its Asian members in what the Asian Development Bank (ADB) has called the role of ‘a passive onlooker in the debate on global rule-making and a reluctant follower of the rules’. This has to change. The world cannot afford the G20 to lose credibility.

Substantially increasing and advancing investments in productive infrastructure is one way of boosting global demand. The report of the G20 High-Level Panel on Infrastructure on ways to boost and improve infrastructure investments in low-income economies will be timely. This report should catalyse an effort by the Asian G20 members at the 2011 Cannes Summit to address financial and other policy constraints in order to generate accelerated investment in economic infrastructure. We need new ways of raising capital and new ways of sharing the risks that will go with the returns from such infrastructure investments.

Developing economies such as India will need serious policy reforms, including better governance, better land acquisition policies, and overall improvements to the investment climate. This is a win-win strategy, and falling prey to narrow domestic political interests and bureaucratic gridlock will mean passing up on an historical opportunity for many Asian countries.

Second, when it comes to the future of the G20 and its role in bringing about a new economic order, much will depend on whether the organisation remains effective over the long haul. Can the G20 be as effective over a generation as it has been in generating the short-term, collective response to the threat of global recession and of competitive devaluations or protectionism? Much will depend on how the Asian emerging newcomers, including India, take up their responsibilities to shepherd the G20 agenda. There is a lot to lose if the G20 descends into nothing more than the old G7 plus others. ASEAN has had considerable experience in coordinating policy responses and domestic policy choices, both those that have been successful and those that have failed. Asian members should bring this experience to the G20. ASEAN’s durability and openness to change presents an opportunity for the Asian G20 members to bring this ASEAN spirit to the G20. This will equip the G20 to be effective over the generation that will be required to rebuild the global economic order.

Adopting an explicit longer-term framework allows us to think about future developments that need to be shaped now, such as the G3 relationship between the US, China and India, and the shape it will be in 10 years from now. The relationship between these countries will be important in determining future G20 behaviour. India is today by far the poorest member of the G20. But it is nonetheless the fourth biggest economy in the G20, measured at purchasing power parity, and the 11th biggest measured at market exchange rates. Laying the foundations of a more cooperative relationship now will go a long way towards shaping it in productive ways for the future.

Dr Shekhar Shah is Director-General of the National Council of Applied Economic Research, New Delhi.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Asia’s global impact‘.

1. Asia and a new global order
2. East Asia and the new world economic order
3. East Asia, the G20 and global economic governance

The last economic era, roughly from 1980 to 2008, was the most successful combination of globalisation, growth and prosperity in history.

The West benefited, but, more importantly, this was when ‘the Rest’ came on board: ‘underdeveloped countries’ cast off post-colonial isolation and embraced the world economy. But the recent global economic crisis induced sharp divergence of economic performance between the West and emerging markets. The US and most of Europe are stuck with anaemic growth while most emerging markets sailed through the crisis and are booming. This short-term divergence has accelerated the long-term convergence between emerging markets — particularly in Asia — and the West.

There is similar divergence in the global policy outlook. The West’s financial crisis and ‘crisis interventions’ have wrecked public finances. Financial bailouts, fiscal-stimulus packages and extra-loose monetary policy also provided cover for big government micro-interventions that distort competition and restrict economic freedom. Most emerging markets retain healthier balance sheets and have a much more promising outlook.

America is mired in gloom, but I have residual faith in the vitality of American society. I am more pessimistic about Europe. Too many European countries have overlarge public sectors, cosseted public-sector unions, bloated welfare states and an entrenched ‘entitlements’ culture, not to mention unsustainable debt levels. Too many people lack individual responsibility, are over-dependent on the state, lazy and decadent.

In the EU, necessary liberalising reforms have stalled and a Eurozone crisis rages. The European political elite’s response is not to undertake market reforms. Rather, it is a centralising, bureaucratic, almost command-economy-like response: fiscal-policy harmonisation that portends more Brussels bureaucracy, more intrusive regulation, higher taxes and ever-larger transfers to profligate governments in the European periphery. These are symptoms of European decline and the EU may be sleepwalking to disaster.

Asia, in contrast, is an awakening continent whose people are grasping newfound economic freedom with both hands. Market liberalisation over the last few decades, first in East Asia, then in South Asia, and including China and India, has unleashed the ‘animal spirits’ of ordinary people, particularly the young. Their commitment to education, work and self-improvement is seen everywhere. They are exercising their ‘natural liberty’ with gusto, and are transforming the world in the process.

Singapore is where ‘liberty outside the West’ got a massive boost with its founding by colonialist Stamford Raffles in 1819. His vision was of a ‘vast emporium’, fully open to trade and to migrants in search of work and enterprise. Of course Lee Kuan Yew’s Singapore differs from that of Raffles in many ways, but Raffles’ legacy survives: Singapore still practises free trade, open to the world’s goods, services, investment and people.

The last sixty years has seen a remarkable economic renaissance in East and South Asia. Commercial clusters in and around coastal cities are its economic lifeblood. Its networks are complex manufacturing and services supply chains linking them to global markets. It is in these mostly coastal strips — from the south to the west of India, the eastern provinces of China, coastal cities in southeast Asia — that liberalisation of markets, property rights, a burgeoning middle class and other features of commercial society are blossoming most. Hong Kong and Singapore are today’s Malacca and Makassar. They form the core of liberty outside the West today and point the way to its future expansion.

But market reforms have stalled in China, India and elsewhere. Domestic red tape continues to stifle emerging markets’ business climates and repress economic freedom much more than in the West, and all the major global rankings reflect this. Economic institutions and political systems remain relatively weak; they keep business costs high, repressing entrepreneurship and innovation. Emerging-market powers suffer their own divisions, such as the mistrust and rivalry between China, India and Japan. They are still reactive in global economic institutions. And they have high barriers to intra-regional trade, investment and the movement of people — a far cry from the EU and NAFTA. There is huge unfinished business, particularly to expand economic freedom outside the West.

The global economic crisis has ushered in a phase of illiberal ideas and policies, and set back the cause of economic freedom. I have some confidence that the intellectual tide will turn in parts of the West — it already has in the US. But I have greater confidence that the expansion of liberty — especially economic freedom — outside the West, especially in Asia, will provide even more tailwind. The future of liberty is shifting East; more than ever, it lies outside the West.

Razeen Sally is Director of the European Centre of International Political Economy, Brussels. He will soon take up positions at the Lee Kuan Yew School of Public Policy and the Institute of South Asian Studies, both at the National University of Singapore.

1. European debt crisis: European fragmentation?
2. China into the European breach, but not just yet
3. Strengthing the Asian financial system: To look forward, look back

The US debt-ceiling deal at the beginning of last month helped send world financial markets into a round of renewed volatility.

The deal significantly increased the probability of a double dip recession and put on display for all to see the contemporary flaws in the American political system. Rather than restoring confidence in the United States’ setting a course for sustainable recovery from the financial (and policy) failures that precipitated the global financial crisis, it created doubts about whether America was either going to maintain its medium term fiscal expansion or really come to terms with its long term structural over-spending.

In this week’s lead essay Peter Warr exposes the confusion around the problem of dealing with the US debt problem.

The US debt problem is inextricably tied up with the global and trans-Pacific imbalances problem. Current account imbalances are not necessarily a problem, as Warr points out. They reflect what economists call inter-temporal transfers between countries just like there are inter-temporal transfers among people and organisations within countries. These transfers allow higher spending by some when they might need to, using the savings of others who can afford to make them available. As Warr explains, ‘one country (the surplus country) is exchanging current goods and services for financial assets, which are claims on goods and services in the future. The other country (the deficit country) is doing the reverse’. There are gains to both parties through these transactions because ‘the initial circumstances of the countries involved are not the same. For some countries it makes sense to save more now, because they have a younger working age population, for example, in order to consume or invest more later. For others, the reverse applies’.

Why then is there so much focus on East Asia’s current account surpluses and how they need to be cut back?

The overwhelming international consensus is that the present global imbalances are unsustainable, even in the short run. East Asian countries are becoming nervous about continuing to accumulate US debt and may well decide to reduce the stock they hold. Americans are nervous about allowing the accumulation of their indebtedness to continue (though the political nerve to cut spending even over the longer run is in short supply) and they are moving to reduce the stock of debt they currently owe. The two are not mutually exclusive and could happen in tandem. They both rest on the fear that the burden of debt servicing might suddenly become intolerable for the debtors, importantly the US, and that could well result in a large and unexpectedly rapid adjustment, throwing financial and currency markets into a tailspin.

Unless there’s default, all debtors eventually have to pay their creditors, and so too Chinese and other East Asian creditors will have to be paid back by US debtors. This might not be a problem if it happens ‘gradually and predictably’. But if it happens ‘soon’, at an unexpectedly rapid rate, there could be serious adjustment problems involved, especially if current account surpluses have to be cut very quickly. If the problems can be anticipated it might be possible to avoid the large scale unemployment and other social costs that would otherwise result. ‘Growth rebalancing’, Warr points out, is essentially a problem of risk management.

That’s why Warr puzzles at the hue and cry in America that China and the other East Asian surplus economies should cut their surpluses back urgently. What that would do is put more intense adjustment pressure on debtors, including America. Winding back surpluses quickly will siphon off supplies of capital from international markets (to domestic spending in East Asia), putting strong upward pressure on international interest rates, and increasing (through higher interest costs) the burden of being in debt. That’s the last thing, one would have thought, that responsible American leaders would want right now. Keeping interest rates low while the debt burden is lowered seems a much more attractive option. A blinding glimpse of the obvious, maybe, but a point lost in the mad rush to shift the moral blame for one’s own predicament onto others.

Asia has its own problems. Ever since the Asian financial crisis, the Asian economies have, to varying extents, focused their production on exports and away from their domestic markets. If the current account surpluses are to be reduced significantly, or even reversed, they will have to reallocate resources towards production for the domestic market to avoid massive under- or unemployment. Moreover, lifting expenditure and reducing current account surpluses is a desirable objective, both because it increases national welfare and also because it contributes to stimulating a recessed international economy.

For the deficit countries the problem is exactly the reverse. But the objective is exactly the same: avoid large scale unemployment through raising the burdens of adjustment. With its huge stock of debt, the US has strong reason to maintain conditions that keep the cost of debt as low as possible. It should steel up for doing the adjusting it needs to do itself and, Warr suggests, ‘not be berating Asia to reduce its current account surpluses‘ over-soon.

Peter Drysdale

1. The cost of US debt and rebalancing Asian growth
2. The Greek tragedy: Global debt crisis and balance sheets
3. US grand strategy: confronting debt and power

Since the Asian financial crisis of 1997–98, the countries of East Asia have, in aggregate, run huge annual current account surpluses.

The counterparts of these surpluses, including Europe and the US, have been correspondingly huge current account deficits. This process has continued for over a decade and a half, and huge stocks of debt have accumulated. Much of this is US government debt owed to the central banks of the East Asian countries. About half of it is held by China. It is expected that the debt will eventually be repaid and this implies that the surpluses must eventually turn into deficits, and vice versa. Indefinite accumulation of debt is unsustainable.

Current account imbalances are not necessarily a problem. They reflect what international economists call international inter-temporal trade. One country (the surplus country) is exchanging current goods and services for financial assets, which are claims on goods and services in the future. The other country (the deficit country) is doing the reverse. Mutual gains from trade arise from these transactions because the initial circumstances of the countries involved are not the same. For some countries it makes sense to save more now, because they have a younger working age population, for example, in order to consume or invest more later. For others, the reverse applies. In this respect, inter-temporal trade is not fundamentally different from contemporaneous trade in goods and services. But basic differences do exist. The time dimension can mean that the individuals obliged to repay a debt may not be the same as those who incurred it. So the outcomes chosen by this generation of Americans, for example, can create an unwelcome problem for the next generation.

Many observers regard the present global imbalances as unsustainable, even in the short run. First, East Asian countries may be unwilling to continue to accumulate US debt and even wish to reduce the stock they hold. Second, the US may be unwilling to allow this accumulation of indebtedness to continue and seek to reduce the stock of debt they currently owe. The two are not mutually exclusive and could happen at the same time. They both rest on the fear that the burden of debt servicing might suddenly become intolerable for the debtors, notably the US, meaning an unexpectedly rapid adjustment becomes necessary.

East Asia’s current account surpluses may have to decline, and even turn into deficits, very quickly. This must happen eventually — the question is when. It might not be a problem if it happens ‘gradually and predictably’. But if it happens ‘soon’, at an unexpectedly rapid rate, there may be a serious adjustment problem involved. If the problem is anticipated it might be possible to avoid the large-scale unemployment and other social costs that would otherwise result. But these events are uncertain, and ‘growth rebalancing’ is essentially a problem of risk management.

From the perspective of the East Asian countries, the interest in growth rebalancing is motivated by two concerns. First, there is the possibility that current account surpluses (positive flows) will turn into deficits (negative flows) quickly, leading to social disruption and other adjustment costs. Second, there is the fear that the stock of debt owed to them may become so high that it becomes impossible to repay. The first concern is more immediate.

Especially since the Asian financial crisis, the countries of Asia and the Pacific have, to varying extents, focused their production towards exports and away from their domestic markets. But if the current account surpluses are to be reduced significantly, or even reversed, then resources must be reallocated towards production for the domestic market to avoid massive unemployment. For the deficit countries the problem is exactly the reverse. The policy imperative is similar in both cases: avoid the disruption — especially large-scale unemployment — resulting from having to adjust too rapidly.

The issue is not really whether such growth rebalancing will occur, but when, at what rate and by what means. In the current global environment Asia is vulnerable to such an adjustment problem arising at short notice. Some ‘rebalancing’ now — away from reliance on external demand and towards domestic demand — can reduce this vulnerability by reducing Asia’s export dependence.

A simple model of the global demand and supply of loanable funds can be used to bring out a key feature of the adjustment options. Suppose the deficit countries, principally the US, wish to reduce their current account deficits. Is it better for the US to make the adjustment itself or attempt to induce Asia to adjust by reducing its surplus? If the US adjusts, its excess demand for funds declines, the level of its current account deficit declines and world interest rates fall. If Asia contracts its excess supply of funds, the same combination of current account balances may result, but with an increase in world interest rates.

Given the huge level of its stock of debt, the US has a strong interest in low world interest rates. It should therefore do the adjusting itself and not be berating Asia to reduce its current account surpluses.

Peter Warr is John Crawford Professor of Agricultural Economics and Head of the Arndt-Corden Department of Economics in the Crawford School of Economics and Government at ANU.

1. The burden of US debt
2. How should G20 help global rebalancing?
3. Asian Development Bank and the invention of a new Asian growth paradigm