Increasing Reliance on Domestic Demand

A key component of the trans-Pacific rebalancing strategy is the implementation of structural policies that increase domestic demand and the development of non-tradable sectors in the regional countries. However, as is well recognized, exports have all along played a central role in the growth and development of the Asian tiger economies. In this section, we consider the prospect of adopting a new growth model for the Asian tigers that leverages more on the domestic economy. To this end, we examine the expenditure structure for the characteristics of balance in each country's growth.

We note at the outset that the size of net exports does not indicate the importance of foreign demand relative to domestic demand in an economy, particularly when there is a high propensity to import. Each domestic expenditure category, namely private consumption (C), government consumption (G) and Investment (I)—which comprises fixed capital formation as well as the increase in stocks—has its own import content. These import components are not shown separately but are aggregated and included in total imports (M) which is in turn subtracted from total exports (X) to produce net exports. Therefore, when considering drivers of growth, a better measure of the significance of external demand is the magnitude of total exports (rather than net exports) relative to the levels of domestic demand components.

To gauge the relative importance of foreign demand, we rewrite the standard national income accounting identity:

GDP = C + G + I + X – M (1)

as C + G + I + X = GDP + M (2)

The left and right hand sides of equation (2) represent total demand and total supply in the economy, respectively. We see from equation (2) that an increase in any of the components of total demand could suffer from import leakage. An increase in C, G, I or X would not only lead to higher production in that country but also increase production elsewhere (as reflected by an increase in imports). While imports in themselves do not generate income in an economy, they are necessary to allow the country to export. Of course, imports are also critical for restoring external imbalances.

The relative shares of the components of total demand for the Asian tigers are shown in Figure 10 [ PDF 18.1KB | 1 page ]. The figures imply that these economies are highly dependent on export demand and that the reliance on foreign demand has grown over the past decade in all four countries. In 2008, external demand accounts for 70%, 29%, 76%, and 45%, respectively, of total demand in Hong Kong, China; Korea; Singapore; and Taipei,China, respectively. In the case of Hong Kong, China and Singapore, external demand dominates domestic demand because re-exports account for a significant portion of their total exports, exceeding 90% and 30%, respectively.

The extent to which the drivers of growth can be recalibrated depends on, amongst other things, the leverage each demand component exerts on output growth. For small open economies, a 1% increase in external demand is likely to have a greater impact on GDP than a corresponding 1% increase in say private consumption. After all, an exogenous increase in export demand will not only raise GDP in the current time period, but will also have second round effects of inducing growth in the domestic demand components in future time periods. Moreover, as explained earlier, an increase in any component of domestic demand in such economies would tend to suffer from high import leakage. Osada (1998) provides estimates of the marginal propensity to import for Hong Kong, China; Korea; Singapore; and Taipei,China of 3.1, 0.4, 1.5, and 0.6, respectively.⁴

Figure 11 [ PDF 22.8KB | 2 pages ] depicts the annual % change of total demand and its components. We observe from this figure that, with the exception of Korea, fluctuations in GDP growth are closely associated with changes in external demand rather than changes in domestic demand. For instance, the dip in domestic demand growth in Hong Kong, China in 2005 did not make a significant dent on its GDP growth in that year (see Figure 11a). Similarly, it is clear from Figure 11c that the upsurge in domestic demand in 2008 in Singapore—that is largely due to a jump in government consumption—did not seem to have any discernible effect on its GDP growth in that year. In sharp contrast, Figure 11b reveals that movements in GDP growth in Korea do not closely follow the fluctuations in external demand but are significantly influenced by developments in domestic demand. As for Taipei,China, there is insufficient deviation in the pattern of fluctuations between domestic demand and external demand, so that we are unable to distinguish which is dominating GDP growth.

These findings are not in the least surprising when we consider the population size of the two city states Hong Kong, China and Singapore, which are only 7 million and 4.8 million in 2008, respectively. In other words, added to the problem of high import leakage, domestic demand in both these economies lacks the scale to drive output growth. These observations seem to attest to the fact that a domestic-led growth model is clearly unsuited for ultra small open economies like Hong Kong, China and Singapore. In comparison, the population size in 2008 of Korea and Taipei,China is 48.6 million and 23 million, respectively. Hence, there appears to be more room for policy maneuvering with regard to increasing reliance on domestic demand in the two larger economies of Korea and Taipei,China.

While external demand will in all likelihood continue to be significant, domestic demand could over time play a more dynamic role in the Asian tiger economies. In particular, household consumption in these economies is likely to increase along with the projected shifts in their demographic profiles. With reference to the life cycle hypothesis, an ageing population tends to put downward pressures on the saving rate as there is a tendency for the elderly to consume out of savings upon retirement. The findings of an IMF study (IMF, 2005) that uses panel regression analysis confirm that the old age dependency ratio—which is the ratio of those aged 65 and over to the population aged 15–64—is negatively associated with savings. In the study, each percentage point increase in the elderly dependency ratio is estimated to raise consumption by 3 percentage points of GDP, suggesting life cycle factors do have a significant effect on the savings rate.

Figure 12 [ PDF 16.6KB | 1 page ] depicts the past and projected old age dependency ratio for the Asian Tigers. We observe that, without exception, the elderly dependency ratio has been going up and is likely to climb further.⁵ The hitherto high saving rate in these countries could partly be attributed to higher household saving as people prepare for retirement. Hence, we infer that ongoing changes in the age composition of the population in these countries are likely to increase the consumption to GDP ratio notwithstanding bequest motives. However, such adjustments are likely to be gradual as shifts in demographic profiles occur only slowly (Eichengreen, 2006).

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