What are the big changes that demand a strategy shift?
Let’s take a step back and look beyond the current focus on trade wars. Events since the beginning of this year have helped to crystallise several troubling trends.
First, expect more frequent shocks
The world was already getting more insecure for small nations, but that trend has accelerated in the past few weeks. America’s attack on Iraq in 2003, China’s occupation of disputed reefs in the South China Sea in the 2000s and the Russian invasion of Ukraine in 2022 chipped away at a world order that was designed to limit big power aggression. But now we have the super-power that once underpinned that world order, openly declaring its intention to take over Greenland and the Panama Canal — while also demanding control over resources in Ukraine and Congo in return for security assistance.
That is a signal to bullies to push their agendas against their weaker neighbours more aggressively. Consequently, there will be lots of mini-explosions of conflict around the globe, making for a higher frequency of conflicts.
The new administration in the US has also pulled out of global efforts to forestall climate change. Other countries have taken that as an excuse to weaken their commitments to international cooperation to reduce carbon emissions. That can only mean a faster route to more extreme weather events like far more damaging and less predictable hurricanes, floods and droughts.
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Second, it will be harder to grow exports
President Trump’s trade war against almost every other country in the world has shredded the agreements and organisations that allowed world trade to function smoothly. Tariffs have been imposed even on countries that had free trade agreements with the US, and even on Canada and Mexico, despite having negotiated those agreements himself.
The World Trade Organization (WTO) is now incapable of organising and bringing to a conclusion complex negotiations over new multilateral trade treaties. Its dispute settlement function had already been crippled by previous American administrations’ vetoing of judges to the WTO Appellate Body. There is now little to prevent aggressive trading nations with strong leverage to strong arm weaker partners into trading arrangements that are disproportionately beneficial to the larger nation.
Compounding this is the inward turn in policy making. Countries all over the world are more prepared for an inward-looking economic development approach that favours local producers rather than turning to imported goods and services — even where it would have been more efficient to import.
See also: Southeast Asia rushes to avert tariff pain by enticing Trump
A final challenge to incumbent exporters comes from rapid technological changes, which can upend existing structures of competitiveness. Look at how Chinese electric vehicles have overwhelmed incumbent automobile manufacturers just within the space of a few years — and completely out of the blue. We expect accelerating technological progress to produce more such shocks to existing producers by, for example, automating what is now labour-intensive production or by aiding the development of new products in sectors such as pharmaceuticals, bio-medical equipment, renewable energy and material sciences.
One particular challenge is that many new technologies seem to favour nations which can offer better opportunities to scale up. Notice how it is in the US and China, two huge and well-integrated markets, where we see a proliferation of unicorns that go on to become dominant. Even Europe and India struggle to compete — their markets are large but fragmented.
Third, we will get a redirection of capital flows
We are likely to see more competition for savings and changes in the way surplus savings are allocated. First, we are likely to see governments absorb more of national savings. The more troubled geo-political setting means a big increase in defence spending. Basically, relatively more funds will be flowing into unproductive defence activities than into growth-enhancing areas such as infrastructure or boosting human capital through education and healthcare programmes.
Higher defence spending is just one of many additional demands on government budgets. Ageing populations will require more spending on elder care and healthcare. As more countries embrace industrial policies to promote domestic production, money will be needed to fund these investments. And, even if some countries are trying to pull out of climate agreements, the hard reality of more frequent climate-related shocks will force them into spending more on mitigating and adapting to climate change.
If higher demands for fiscal spending are not matched by a stronger tax revenue base, deficits will rise, which could mean that the bonds governments issue will have to offer higher yields.
A second big change will be in where foreign direct investment flows because supply chains will now be reconfigured more extensively. This will benefit China’s competitors, who in Asia will be India and Asean:
Even with negotiations and exemptions, tariff rates around the world will be higher by year-end than before, led by the US. China is likely to suffer more from tariffs and other trade restrictions than others, given America’s geopolitical leanings. Moreover, China’s industrial policies have led to a massive build-up of production capacity, which cannot be absorbed by domestic consumption. The resulting surplus production is being exported abroad. These surges in exports are overwhelming domestic producers in those importing countries, triggering backlashes. If America’s restrictions on Chinese exports lead to China diverting its exports to other markets, this backlash can only get worse.
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Expect even more trade restrictions on China from a wider range of countries.
Despite all the challenges, the Chinese economy will continue to expand, albeit at a slower pace. Rising Chinese per capita incomes and a contracting workforce will likely lead to a sharper increase in Chinese labour costs than in Southeast Asia.
India and the Asean economies are likely to benefit from continuing infrastructure improvements, urbanisation, rising middle-class spending, and synergies from trade agreements that will promote their ability to attract foreign investment and replace China in some areas of manufacturing.
There is thus a good chance that India and Asean economies will improve their share of global foreign investment flows.
Recalibrate economic strategies
Given the changing power dynamics against less powerful nations and the rougher global environment described above, collective action is preferred to individual ones. But Asean has struggled of late to deliver collective initiatives that achieve meaningful results. Asean needs to rediscover its capacity for generating consensus around new initiatives if it is to be more effective in getting its voice heard in global forums and in terms of implementing trade and other integration initiatives that actually move the needle. Realistically, the track record of failure in recent years does not give us much reason to be helpful.
In the meantime, individual Southeast Asian countries will have to do most of the heavy lifting of adjusting to this new world.
Further strengthen resilience against the greater volatility
To do so, it has to:
Strengthen the capacity for quick, effective and credible fiscal and monetary policy responses to shocks. By tackling inflation well and communicating better with financial markets, central banks in this region have become more adept at monetary policy. However, there are signs that political elites in some countries are trying to dilute central bank independence by pressuring them to loosen monetary conditions. Such changes will undermine policy credibility and open those economies to financial market pressures.
Improve the diversification of economies by creating new growth engines and finding new markets to grow exports.
The other area of policy attention will be to address the longer-term challenges that arise from new trends in geopolitics, technology and climate change that can upend existing structures of competitiveness.
In doing so, a big question is how to maintain export-led growth
This will be much harder than before, but Asean countries have little choice but to keep trying. Industrialisation is a vital pathway to economic development, but most of the countries in the region are too small to industrialise without the benefit of exports since their domestic markets are small. Also, it is when local companies are forced to compete internationally that they hone their skills and keep upgrading their workers’ productivity and their own innovation capacity.
All is not lost, however. While the US might be turning inwards, it only accounts for around 13% of world imports. Asean still has markets accounting for 87% of world imports to access. Even the US may be willing to cut Asean some slack since the region is a key battleground in the contestation between the US and China. When the dust settles after the current period of trade wars, there will be opportunities to cut deals that give the regional countries market access in return for opening up their economies in mutually beneficial ways.
The region has existing agreements, such as the Comprehensive and Progressive Trans-Pacific Partnership and the Regional Comprehensive Economic Partnership, that it can build on to improve its trading capacity. Europe and China are also looking for trade opportunities now that the US has turned inward. They, too, appreciate Southeast Asia’s strategic value and would be open to agreements to enhance trade.
More efforts can be undertaken to enhance cross-border economic cooperation of the sort that has been so successful in the Greater Mekong Sub-Region integration project. Coalitions of the willing to promote economic integration among two or three countries will be easier to organise than Asean-wide integration. For example, the Johor-Singapore Special Economic Zone can be expanded in time to include Indonesia’s Riau Islands Province.
The state plays a crucial role in these areas, so strengthening its capacity is essential
In a world of greater trade distortions and industrial policies, the region cannot leave as much to the free market as before. The state will have to play a bigger role in economic development.
Many things need to be done to ensure the state is able to play this role, too many to discuss here. But the key starting point is to ensure that the state has the resources to do what it needs to do. Too many countries in the region have limited tax bases. More needs to be done to raise the tax revenue to GDP ratio to at least 15% or more.
Changing times call for new thinking. Although the region confronts a more challenging world, there are still opportunities that Southeast Asia can take advantage of in order to maintain decent rates of economic growth. With the right policies, the region can adapt successfully and continue to prosper.
Manu Bhaskaran is CEO of Centennial Asia Advisors
