Asia, Europe Find Their Supply Chains Yanked. Beware the Backlash.

By Steven Pearlstein
Friday, February 20, 2009

For the past two years, Asians and Europeans have tended to view their own financial and economic problems as largely imported from the United States. The impacts on their own economies, they reasoned smugly, would be modest and short-lived.

Turns out they were wrong.

Over the past two weeks, the bottom has fallen out of Asia's export economy while Europe has come face to face with a financial crisis that is as bad as ours and will probably become even worse without the kind of unified response that individual countries have so far resisted.

And what does that mean for us? Nothing good. It means that our downturn will be longer and deeper than many had hoped and that we can't rely as much on export growth to pull us out of the ditch.

Basically, there are two stories to tell here about the sudden downturn in the global economy.

The easiest to understand is the collapse of industrial production in East Asia, where the supply chain starts in places like Taiwan and Vietnam and moves through places like China and Japan before cars, shoes, computers and flat-panel TVs arrive at stores in the United States, Western Europe and everywhere else.

According to Barry Eichengreen, an economist at the University of California at Berkeley, the 40 percent decline in Taiwan's industrial production at the end of last year was the "canary in the coal mine" of Team Asia's formidable export machine. At about the same time, Japan's exports fell 35 percent, Korea's 17 percent, and China's fourth-quarter gross domestic product was essentially flat -- no economic growth at all.

As did a number of other economists, Eichengreen told me he'd never seen declines this fast and this steep, even during the Asian economic crisis when he was working at the International Monetary Fund's war room here in Washington. It all reflects not only the sharp pullback in discretionary consumer spending around the world but also an equally sharp pullback in the flow of foreign investment that was used to build factories and shopping centers and has been an important driver of growth in the region.

Demand for Asian exports will pick up again before too long, but it will be a long time before they reach the levels attained at the height of the bubble economy. And it will be longer still before foreigners will be eager to invest in expanding capacity again.

Ideally, Asians would respond to this challenge by reducing their heavy reliance on exports and foreign investment and reorienting their economy more toward domestic consumption. But as Raghuram Rajan of the University of Chicago points out, that's not as simple as it sounds.

For starters, the things Asians might want to consume aren't necessarily the things they produce to export, so production would need to be reoriented and workers retrained and redeployed. And to replace the foreign investment, these economies would need to develop financial institutions that can raise and invest risk capital, which right now they don't really have. Most significantly, Asian governments would have to create safety-net programs like Social Security so people don't save so much and spend so little.

In short, the Asian downturn is probably manageable, particularly now that the Chinese government has responded with a massive stimulus package. But it will take time for the region to make the necessary adjustments to get the region humming again.

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