THE Brexit vote is having a worldwide economic effect, and Asian countries, though detached from the political negotiations in Europe, are bracing themselves against the uncertainty. The South Korean finance ministry announced Tuesday a 20 trillion-won ($17.1 billion) stimulus package and a cut to its internal growth forecast. In Japan, the government has already held one emergency meeting this week with the Bank of Japan to discuss market conditions and will hold another the morning of June 29. China, for now, seems more worried about the long-term implications of Brexit and particularly about the impact it might have on global trade.
The concern is warranted: Asian countries will certainly feel the secondary effects of Brexit. As a region, Asia had already been dealing with massive structural shifts that will take place over the next five years, and the biggest economic contributors to the region—China, Japan and South Korea—are all working to redefine their growth strategies. Brexit’s effects, both short-term and long-term, will make the process only more difficult.
China is at the center of Asia’s impending economic transformation. China’s shift from an export-based growth model to a consumption-led one has not gone as planned. The growth of Chinese consumption expenditure per capita has declined from 8.9 percent year-on-year in the first quarter of 2014 to an average of 7 percent for the past three quarters. China’s exports have suffered as well. Every major industrial sector in China, including steel and shipbuilding, suffers from overcapacity, and China’s efforts to consolidate these sectors have been limited at best. Global growth has faltered, and two of the world’s major export destinations—Europe and Japan—have had problems generating consumption growth as their populations contend with long-term demographic decline. As a result, China has had only two months of positive export numbers year-on-year since the beginning of 2015. Adding Brexit to this mix will only complicate China’s reform efforts and hurt Chinese exporters even more.
Furthermore, Beijing has been hesitant to enact any kind of immediate financial reform, which would help buffer the impact of global market forces as it manages its economic transition. For China, domestic stability is a key geopolitical imperative. Already looser capital controls have made China more susceptible to capital flight, hitting outflows of portfolio investment and lowering the value of the yuan. Though the People’s Bank of China has managed to cope with these shifts thus far, Brexit has added downward pressure on the yuan as investors have moved to safer assets. At the same time, Beijing knows that financial reform and liberalization are critical for generating a consumption-led economic model and a more vibrant private-sector economy. Therein lies the paradoxical challenge for Beijing: The pressure from Brexit will make the need to shift away from the old industrial, export-oriented economic model more pressing for China, but at the same time it will make China even more susceptible to the Brexit-induced financial volatility that it wants to avoid by delaying its economic reforms.
Any structural shift in the Chinese economy will affect South Korea immediately, given that in 2015 South Korean exports to China accounted for a whopping 15 percent of South Korea’s gross domestic product. (Exports are 50 percent of South Korea’s GDP overall.) Chinese economic growth is slowing down, but what is even more alarming for South Korea is that China is moving toward producing similar products as Korean exporters: electronics, ships, refined products and petrochemicals and, likely soon, cars. Samsung, the South Korean electronics giant, has already seen its global market share of smartphone shipments decline from 31.1 percent in 2013 to 22.3 percent in 2015. The main beneficiaries are China’s Xiaomi, OPPO and Huawei, which have seen their market share increase from 8.8 percent to 15.3 percent. These are also fundamentally different corporations than China’s old, industrial state-owned enterprises; they are new companies that are market-driven. Not only is China’s economy slowing overall, which affects South Korea, but China is also becoming more of a direct competitor to South Korea. Any global uncertainty created by Brexit will only hurt South Korea’s exports to Europe, even though trade between the two is protected by a free trade agreement.
On Tuesday, South Korea announced a fiscal stimulus package that highlights the sluggishness of its export sector. The increasing political clout of South Korea’s conglomerates, known as chaebols, has helped bring about robust corporate reform, though strict labor laws remain in place, undermining potential efficiency. For South Korea, moving away from exports to consumption is an even a bigger challenge than for China, given how reliant the country is on exports to begin with. These challenges are of course not new, and South Korea’s over-reliance on the export sector has always made the country susceptible to fluctuations in global trade. Since the 1990s, however, globalization has enabled South Korea’s economy to coast along, but now that its export sector is under increased pressure from emerging technologies, it is unclear how much longer South Korea can maintain its good economic fortune.
Finally, Japan’s economic predicament is perhaps the direst. Japan has struggled to generate consistent economic growth for two decades, and Abenomics—with its “three arrows” of fiscal stimulus, monetary policy and structural reform—has failed to interrupt that pattern. The monetary policy approach to generate inflation has continued to push interest rates lower, and an International Monetary Fund working paper from August 2015 found that the Bank of Japan may need to slow, or significantly change, its quantitative easing program by 2017 or 2018, as it reaches the limit it can buy of Japanese government bonds. Brexit has sent the yen’s value up to 102 to the dollar, which puts the yen’s value back at where it was just before the Bank of Japan doubled down on its quantitative easing program in October 2014. The bank is expected to push interest rates even further into negative territory soon, possibly at its next policy meeting at the end of July, if not before then.
The other area of Abenomics affected by Brexit is structural reform. Although Japanese Prime Minister Shinzo Abe has had some success in areas such as power sector reform, his progress in other areas has been glacial. Abe has already delayed the next income tax hike until October 2019. Progress on solving the country’s rigid labor structures, increasing labor flexibility and real wages has been slow as well. This of course all comes at the time when Japan is also going through a demographic decline that will be among the first felt globally—and that will contribute to an even larger drag on consumption-led growth.
Japan, South Korea and China are all in the middle of significant shifts that will shape the way the global economy behaves over the next decade. Though Brexit will mostly affect the European project, and its direct effects on the Asian economy will be muted in comparison, it is important not to overlook how the resulting global macroeconomic uncertainty and changes in global financial flows will challenge what is collectively the world’s largest economy: Asia and the Pacific.
– © STRATFOR GLOBAL INTELLIGENCE