Emerging Asia’s Rising Productivity
By Robert Horrocks
November 22, 2012
What do we really mean by "emerging" economies? When you consider global developments today, it is some of the so-called “emerging” economies that have less debt and higher productivity growth compared to more developed economies. Judged through these criteria, they are only emerging in the sense that the West is submerging! Countries are generally classified as emerging based on criteria that measure them against institutions in Western markets. Surely there are some absolutes when it comes to establishing a good environment for investing and institutions are a big part of that. But other factors also matter. In fact, what is key to the emerging opportunities in Asia is productivity. It is productivity growth that creates economic growth, raises living standards, and improves the opportunities for business profits and investment. Productivity improvements lead to opportunities in capital goods sectors as businesses buy items such as machinery to remain competitive, and in the consumer sector where most of the added value is captured by the increasing affordability of the new goods. The process of developing new skills and more efficient production creates wealth and raises the standard of living. In Asia, we believe a sense of optimism about the future, backed by sensible government policies, will keep this process going.
A Difference in Institutions
Productivity grows if you can incentivize people to produce more goods and services. It is a function of people’s ability to acquire new skills and the incentives to enrich themselves. It is also a function of the institutions that economies create—the very institutions that critics of “emerging” markets often say are not Western enough. But let us look at some differences in institutions. For example, look at the vision statement of Singapore’s Department of Manpower, which: “embodies the aspirations of lifelong learning and the need for Singaporeans to adapt, learn and re-learn skills, attitudes and competencies for lifelong competitiveness.” Compare that with the U.S. Department of Labor’s perhaps more distributive mission statement: “To foster, promote and develop the welfare of the wage earners, job seekers, and retirees of the United States; improve working conditions; advance opportunities for profitable employment; and assure work-related benefits and rights.” These seem to be different kinds of institutions. And it is Singapore’s version that is the blueprint for Indonesia’s Ministry of Manpower: “The realisation of productive, competitive and wealthy manpower.” Therefore, I would argue that “emerging” is indeed about different institutions, goals and visions—but not necessarily ones that are less sophisticated or less productive than what we find at home.
In August, Asia’s International Conference on Productivity and Sustainable, Inclusive Development took place in Taipei, organized by the Asian Productivity Organization (APO) in collaboration with the China Productivity Center. During the conference, participants from nearly two dozen countries reviewed the past five decades of productivity improvement efforts in the region in order to identify major innovations and best practices. Ultimately, we believe the long-term outlook for growth in Asia remains optimistic. Why? Asia, as a whole, is still a very unproductive part of the world. Starting from a low base makes it easier to grow faster.
City states like Singapore and Hong Kong have shown per capita GDP that may seem comparable with the U.S. But take a look at productivity per hour per worker and you are likely to see levels that are still some 20% or even 30% below what can be achieved in the U.S. That is to say that even in places like Singapore and Hong Kong, there is increased room for greater productivity, which could lead to higher GDP per capita. It could also lead to just more leisure time for people.
According to an Asia Productivity Organization study of Asian countries against Japan’s historical per capita productivity experience (expressed as relative to Japan’s 2010 level), Vietnam is currently Japan in 1950, India is just a few years later behind that, China is Japan in 1960, and Korea and Taiwan are equivalent to Japan circa the mid to late 1990s. We believe that for those who invest in Asia this means that there should be continued strong economic growth, and that growth will be in different sectors in different parts of the region, offering a diversified exposure to Asia's productivity gains.
Labor, Input and Ingenuity
Productivity growth comes from three general areas: labor, inputs such as capital inputs and the ingenuity with which you put these elements together. Asia is commonly regarded as a low-wage region of the world and, therefore, labor inputs are considered important to productivity growth. But this is a misconception if you consider that even Indonesia, which has probably gained the most from increased labor inputs, has seen less than 2% a year in productivity growth from labor inputs over the last decade. In China, you might be surprised to know that the contribution to growth from increased labor inputs is less than 1 percentage point a year. The majority of improved productivity comes from new capital investment. In Asia this is predominantly non-IT capital spending—building bridges, other infrastructure and factories—rather than using machinery to produce goods more efficiently.
In China, today, many cars are still actually made by hand, and many factories have long assembly lines of workers putting parts together with little automation. The potential to increase the amount of capital machinery used per worker is vast and therein lies a further spurt of growth. IT spending in the U.S. and Japan is about three-quarters of all new capital spending. In Asia, it’s far less than that.
Taking a look at GDP per capita, adjusted for Purchasing Power Parity (PPP), allows us to mull the purchasing power of the consumers in various markets in Asia. Per capita GDP in Singapore, Hong Kong and Taiwan are higher than that of Japan. Korea is doing better than Malaysia. Far to the right of the chart above we have what are considered “frontier markets” such as Laos and Cambodia, which are continuing to open and develop their markets.
For investors, the focus should not only be “where are things growing” the most but “which industries and products are growing” in any particular market. Where disposable income is being spent is one consideration. Some of the emerging opportunities that we see in Asia may also appear quite familiar. Sales of robotics in China grew 51% in 2011 over just the prior year, and China could become the world’s largest consumer market for industrial robots by 2014. In another familiar area, toothpaste is now a growth industry in India and other exciting opportunities abound in such mundane industries as contact lenses and diapers.
GDP per capita in China is currently about US$5,000—an income level that affords some consumers to be able to “trade up” in certain lifestyle areas. This type of consumption is generally not as correlated to the cyclicality of the economy. The contact lens industry in some emerging areas of Asia has grown in recent years. China’s contact lens market is only about US$500 million, and it’s growing at 10% to 12% per year. This compares to high single digits in the global market. Local competition in this market is growing too and the industry has seen as expansion in nationwide distribution channels. Meanwhile on the demand side of the equation, China’s contact lens penetration rate is only at 5%, compared to 25% in some developed countries in Asia. That demonstrates significant headroom for growth.
The disposable baby diaper industry is also an interesting business seeing growth in a small but important area. Disposable diaper usage is a function of income levels. Usage in Japan, Korea, Singapore and Taiwan is not surprisingly much higher than in countries such as Thailand and the Philippines. In China, for example, the average usage is 20 diapers per month per baby—not even one diaper a day. For China to reach the same saturation point in diaper usage as more developed peers in the region may still take over a decade.
“Developed,” “emerging” or “frontier,” categorizations are deeply embedded in general investment frameworks and the stigma of emerging markets continues to weigh on Asia. Emerging markets are regarded by this framework as peripheral and often the target of tactical rather than strategic allocations. In addition, valuations in the region are currently at levels below those in Western markets and well below Asia’s own historical averages—on a price-to-forward earnings basis, and similar to what we saw during the Asian Financial Crisis, the outbreak of SARS and during the more recent global financial crisis. What’s more, expectations for Asia’s growth in the short-term are fairly pessimistic, and are roughly comparable with what they were during the global financial crisis—with nominal sales growth still growing in the mid-to-high single digits.
But at Matthews we prefer the original meaning of “emerging” and its connotations of the optimism and opportunity. Indeed, sentiment among the working population of these “emerging markets” is another area where I believe we see a difference to the West. In our frequent trips to the region, we feel a sense of optimism that pervades Asia—optimism that lives are changing and that the future is going to be wealthier than the past. Per capita GDP in China has tripled in purchasing power parity terms in the last decade and yet Chinese workers still likely have their most productive years ahead of them. Asia as a whole has seen consumption increase by a third since the global financial crisis, even as the West has languished.
At Matthews, when we think about what is “emerging” what we’re really considering are the new investments, the new spending habits, the different uses of technology and the new business models that are appearing in Asia and that, in our judgment, provide an opportunity for profitable growth. And current sentiment seems at odds with what we believe should happen in Asia over the long run.
Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC
(c) Matthews Asia