“Italy’s economic miracle” sounds like a cruel joke today, but the Italian economy was once the envy of Europe. A spectacular burst of post-war growth culminated in the ‘sorpasso’ of 1987, when the government trumpeted the fact that GDP had finally passed Britain’s to rank Italy as the world number five.
Now though Italy is the sick man of Europe. And at least part of the blame lies with Asia. That’s because Italy’s small, family-owned firms once thrived in industries such as textiles and furniture, until their low labour costs were undercut by even lower Asian ones.
There’s a hard lesson here for fast-growing economies. If you don’t keep moving up the ladder, the country on the next rung down will knock you off it. And it’s a lesson that some parts of Asia need to absorb very soon, as China threatens to do to them what it’s already done to Italy. Fortunately, most seem to be taking the right steps – and that should mean new opportunities for investors …
China threatens its suppliers
The rise of China is, overall, a big positive for Asia. Its robust growth should help offset sluggish Western economies and give a boost to export-dependent neighbours over the next few years. But at the same time, it’s a real threat to Malaysia and Taiwan.
These economies are major players in niches such as electronics manufacturing, and specialise in the more high-tech end of the industry. Once the skilled work is done, their products are often exported to China, where less-skilled, but lower-cost, workers put the various components together to make your PC or iPod.
This business model worked well while Chinese factories lacked the ability to make these complex components at home. But now Chinese manufacturers are muscling into this part of the value chain as well. And lower costs mean they can take on, and beat, foreign plants.
Since there’s no way of holding back this tide, Malaysia and Taiwan have two choices. They can follow Italy into a long decline. Or they can evolve. And as you’d expect from countries that have already come so far in the last fifty years, they’re choosing option two.
Malaysia is fighting back
Last week, Malaysian Prime Minister Najib Razak announced his second round of liberalisation measures in two months. By sweeping away many restrictions on foreign investment and reducing some of the bumiputra (‘sons of the soil’) measures that discriminate in favour of ethnic Malays, the government hopes to guide the economy further away from manufacturing and towards services.
Many of the changes are aimed at making Malaysia competitive in financial services and in particular Islamic finance, where banking, insurance and investment services must be compliant with Sharia (Islamic religious law). Islamic finance has grown rapidly around the world in the last decade (see charts below). Malaysia – where the state religion is moderate Islam – hopes to make Kuala Lumpur a leading hub as the industry matures.
In addition, there are signs that the oft-strained relations between Malaysia and neighbouring city-state Singapore – which was part of Malaysia until 1965 – could take a turn for the better with top politicians paying exchange visits over the last few weeks. Closer co-operation and better transport links between the two should pay dividends for both Singapore – which is rich, but short of land for new development – and Malaysia, which could use Singaporean investment and expertise.
These measures certainly aren’t going to solve all Malaysia’s problems overnight. But they are encouraging for the longer term. Many of these measures have been in the planning stages for a long time. With the economy hard-hit by the global recession, the government has finally been prodded into doing rather than talking. Hopefully this trend will continue.
Can Taiwan escape China’s shadow?
Meanwhile, changes in Taiwan are more even more drastic. The government is set on sweeping away 60 years of history and patching up relations with Mainland China.
You may already know the troubled history of Taiwanese and Chinese relations, but here’s a brief recap. When Mao’s communists defeated the nationalist government of Chiang Kai-shek in 1949, the nationalists fled to Taiwan. They set up a military dictatorship and continued to claim to be the rightful government of the mainland. Meanwhile, the communists regarded Taiwan as a renegade province that should be brought back under their control.
However, at first, the mainland government lacked the military strength to topple Taiwan’s ruling elite; later as Chinese forces grew in strength, the American government made it clear that they would defend Taiwan from invasion. So until recently, the situation has been an uneasy stalemate.
Taiwan is effectively independent, but is not legally recognised as an independent country (it doesn’t have a seat at the UN, for example). China has long tolerated this on the proviso that Taiwan doesn’t formally declare independence, which would be humiliating for Beijing. But there have always been intermittent spats and sabre-rattling. And relations worsened significantly between 2000 and 2008 when Chen Shui-bian – who supported a (never held) referendum on explicit independence – was president.
Taiwan needs more investment – China can supply it
However, since Ma Ying-jeou took over as president last year with a more pro-China policy, things have improved. Chinese firms are to be allowed to invest in Taiwan for the first time, while limits on how much Taiwanese businesses can invest in the mainland will be increased. And there are now regular direct flights between Taiwan and the mainland, making travel substantially quicker.
With travel, trade and political relations much improved, investment should start to flow back into Taiwan to take advantage of the island’s skilled workforce, and build Taiwan up as a research and development centre serving manufacturing on the mainland. This will make a huge difference to the local economy, which has suffered large capital outflows in recent years.
We’re also likely to see Taiwanese businesses that have already profited in China returning some of their money to the island, plus a further boost from Chinese investors and tourists, as happened in Hong Kong. Back in the 1980s, there were similar fears that that city would be ‘hollowed out’ as manufacturing shifted to the lower-cost mainland. But in the long run, the profits were routed back into the Hong Kong economy, particularly via financial services and property. With cross-strait relations improving, the same can now happen for Taiwan
Great opportunities all over Asia
All this suggests that Malaysia and Taiwan will avoid Italy’s fate. And it’s a timely reminder that investing in Asia is not just about China and India. The next few years will see plenty of changes and opportunities all over the region.
Malaysian financial services and Taiwanese technology will be among them, while domestic sectors such as retail and real estate should benefit from a stronger economy. And other niches will emerge; for example, Taiwan’s higher standard of healthcare could make it a popular destination for Chinese medical tourism, while the government also hopes to develop the local biotechnology industry.
The good news is that many of these developments can be played through stocks listed in London, Hong Kong or Singapore. Meanwhile the Malaysian and Taiwanese markets are both open to foreign investors willing to make the effort. I’ll be looking at some specific ways to invest in these themes over the next few months as Asia’s recovery gets underway.
In other news this week …
| Market | Close | 5-day change |
|---|---|---|
| China (CSI 300) | 3,327 | +6.4% |
| Hong Kong (Hang Seng) | 18,203 | -2.1% |
| India (Sensex) | 14,913 | +1.0% |
| Indonesia (JCI) | 2,075 | +1.7% |
| Japan (Topix) | 921 | -0.7% |
| Malaysia (KLCI) | 1,073 | -0.3% |
| Philippines (PSEi) | 2,431 | -1.9% |
| Singapore (Straits Times) | 2,300 | -0.8% |
| South Korea (KOSPI) | 1,420 | +1.8% |
| Taiwan (Taiex) | 6,665 | +3.1% |
| Thailand (SET) | 583 | -2.1% |
| Vietnam (VN Index) | 435 | -5.6% |
| MSCI Asia | 94 | -0.5% |
| MSCI Asia ex-Japan | 391 | +0.6% |
The Indian government’s pre-budget economic survey outlined a number of encouraging reforms, including allowing more foreign investment in retail and financial services. Taxes, price controls and subsidies should also be improved, while the central government deficit will be cut from around 6% last year to 3% as soon as possible (local government borrowing adds a further 3-4% to the deficit). The chances of these measures being implemented are much improved following the Congress party’s very strong performance in the May elections, although another large deficit is certain for this year.
In Thailand, parliament approved plans for a THB600bn (US$17bn) of infrastructure investments from 2010-2012 (about 2.3% of GDP per year). This is positive for Thailand’s economy in the longer run; however, the political stability to implement such a plan may be missing. Disagreements within Prime Minister Abhisit Vejjajiva’s government seem to be growing, while a party loyal to exiled former Prime Minister Thaksin Shinawatra won two by-elections in his former stronghold of the northeast, defeating candidates from the ruling coalition.
Chinese electricity production was up 3.6% year-on-year in June, the first year-on-year growth since October. That probably partly reflects rising production in the energy-intensive metals sector; steel output hit a new record at an annualised rate of 555m tones per year in mid June, according to the China Iron & Steel Association. Suppliers are restocking too – perhaps too optimistically – in expectation of strong demand later this year as a backlog of investment kicks off.
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