By Ronald Man
For stable demand, turn to emerging Asia. Household consumption growth in the region has been less volatile than in the rest of the world over the past three years, something that hasn’t happened since the early 1980s.
While it is easy to point the finger at China and its increasingly domestic-driven economy, don’t forget the smaller economies. In particular, household consumption growth became markedly smoother in Thailand, Indonesia and Korea.
What does this mean? One way to look at it is through the permanent income hypothesis, which in layman’s terms states that people will consume more today if they expect to earn more later on in life. Conversely, if people expect to earn less in the future, consumption decreases. The underlying message is that sudden changes in expectations of future wealth will be reflected in what people spend today.
Recent evidence also shows that people actually prefer to gradually consume more over time.
So, if households know how wealthy they will become, their consumption will grow at a steady pace.
Stabilizing growth in the daily spending habits of the average Li, Singh and Kim suggests that households have been unfazed by recent external shocks.
Events over the past decade, including the terrorist attacks on September 2001 in New York, the credit-led boom and subsequent global financial crisis, have had a relatively limited effect on emerging Asian households’ long-term growth expectations.
In contrast, the world has become a more dangerous place in the eyes of everyone else outside emerging Asia.
Increasingly volatile spending in other regions showed that households were vigorously revising expectations of future wealth, which in turn started to change the way people were spending their money.
Specifically, the volatility of household spending outside emerging Asia has increased by over five-fold since the end of 2007.
Although it is not surprising that this is most apparent in the U.S. and Europe, similar dynamics exist in Latin America and Africa. While economies in Latin America and Africa are still largely dependent on the U.S. and Europe, emerging Asia has begun to hum its own tune.
Greater intra-regional trade has helped sustain local consumption growth by shielding its economies from some, but not all, of the external shocks.
China has been instrumental in this structural shift as the world’s second largest economy becomes, if it is not already, the biggest export market for most neighbouring economies.
China’s trade with emerging Asia has boomed 560 percent since it gained WTO membership in December 2001.
The region’s strong domestic base and sustained growth will attract more foreign direct investment (FDI) from multinationals.
Overseas companies that diversify into emerging Asia like the fact that the local demand growth is less volatile than at home as it reduces their risks. Indeed, emerging Asia’s share of global FDI has risen from 10 percent to 25 percent over the past decade.
That said, household spending must continue to grow strongly for the regional economies to mature. It currently makes up 45 percent of local GDP, well below the 71 percent reported in the U.S.
In Korea, household spending needs to play a bigger role in driving growth.
Being a trade dependent economy, the country’s higher exposure to external conditions means that the volatility of its consumption growth is higher than in neighbouring countries.
One implication is that full-time employment growth must increase in order to raise job security.
Only then will Korean workers be able to forecast their future wealth with greater confidence and increase today’s spending.
For this to be achieved, however, policy makers must make the bold move of removing rigid labor market regulations.