Over-Capacity Stalks The Asian Tigers

Chen Zhao, managing editor of the prestigious monthly economic review, The China Analyst, is a gloomy man.

On a recent visit to north-east China he says he found factories which had stopped production entirely, while the price of goods was falling in the shops.

It is evidence, he says, for his theory that China and many other countries in Asia are suffering from a serious over-capacity problem, not only in property but also in manufacturing. This is going to hold back the recovery from last years export slowdown.

Somewhere down the road, he adds, there is going to be a massive deflationary shock. Such views put him well on the pessimistic end of the spectrum of expectations for Asias economic development.

However, while they think his fears are overdone, other economists agree that Asia has built up excess capacity in some industries in its headlong rush to invest. As a result the coming recovery is likely to be muted. In the next pickup you wont see the 10 per cent growth rates we saw in the past, though that in itself is not necessarily a bad thing. Growth will be more in the range of 5 to 7 per cent, says Neil Saker of Crosby Securities in Singapore.

Chen, whose review is published by the Montreal-based Bank Credit Analyst Research Group, rests his case on the high level of investment in emerging Asia so far this decade. At an average annual growth rate of over 20 per cent this decade, investment has been rising about three times as fast as growth in gross domestic product, suggesting Asia has been suffering from a serious case of over-investment.

Now, he says, capacity use is running at very low levels in countries such as China (below 60 per cent), South Korea (below 70 per cent) and Taiwan (72 per cent). China and Korea are both suffering from very high inventories.

In Koreas case these have been growing in spite of a rebound in electronics exports this spring. Regional export prices, which were rising by around 10 per cent a year at their peak, were falling by around 4 per cent annually by late last year.

Still, in many countries the foreign investment continues to flow in, creating yet more capacity that has to be absorbed in the future. The trouble is that the real state of affairs is very difficult to measure and is confused by the state of the cycle, says Andrew Freris of BA Asia in Hong Kong.

Very few countries in Asia in fact produce figures for capacity use, and reliable unemployment figures are hard to come by. There is anecdotal evidence of an excess build-up of capacity in some areas, notably in the automotive sector where aspiring producers have been flooding markets in China and south-east Asia.

Similarly there are concerns about excess capacity in traditional industries such as textiles in the Philippines, even though the overall impact on exports is masked by a strong growth in electronics products. William Overholt, regional economist at Bankers Trust says he thinks the problem is worst in countries such as China, Korea and Japan which employ dirigiste economic management. In Thailand, there is a problem because its government encouraged industries such as steel and petrochemicals that were not strictly needed.

But the problem of surplus inventories is not a general one, says Annabel Betz of ING Barings. Taiwan has really pared down on inventories, similarly Hong Kong last year, and Singapore. In theory these economies are better positioned.

The picture that emerges is one of a fragmented regional economy in which performance varies not only from country to country, but also from industry to industry within countries. Overall, says Betz, Asia will again rely on exports as a source of growth this year.

According to ING Barings, Asia outside Japan saw growth of 7.5 per cent last year compared with 8.4 per cent in 1995. Export growth slumped to 5 per cent from 20.4 per cent, while consumption and investment were steady at 7 and 12 per cent respectively. This year overall growth will be around 7 to 7.5 per cent, with export growth picking up to around 10 per cent.

Consumption and investment may weaken as bank lending is reined in, so exports will again take the lead. One solution might be for Asian countries to focus more on consumption-led growth and less on saving and investing, less, but ensuring through reform of their financial systems that investment was more productive. But says Ms Betz, a switch to more consumption would boost imports when incomes are already rising strongly. Asian governments are in a bit of a bind. They have to keep that export machine going. Much depends, adds Mr Chen, on what happens to Japan. The best hope for Asia is that the Japanese economy starts growing strongly again and sucks in imports. But no matter what Japan is doing, recovery in the rest of Asia is going to be very different from what we found in the early 1990s. Mr Saker agrees. What were seeing is the emergence of a more cyclical environment over the next ten years rather than straight line growth. Asian countries must invest continuously to upgrade capacity and keep themselves competitive in a global market, he says. As for falling export prices, they too reflect global competition, but that does not matter if productivity gains exceed the price falls. Nowadays Asia must run fast to stand still. Copyright Financial Times Limited 1997. All Rights Reserved