Global Market Commentary

June 19, 2014

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Asian Firms Preparing to Take the World Stage

The development of Asian capitalism over the past several decades has been robust. According to data from the International Monetary Fund (IMF), the proportion of world GDP generated by the advanced G7 economies peaked in 1988 at 69 percent. In that year, developing Asian economies accounted for just 5 percent of world GDP. IMF forecasts suggest that a generation later, in 2018, the G7’s contribution to global production will be down to 45 percent, and emerging Asia will contribute 21 percent.

 

G7 & Emerging Asia

Based on Nominal GDP in 2014 U.S. Dollars
Data Source: International Monetary Fund

 

Much of the heavy lifting in that increased share has come from China, of course.  However, developing Asia has largely deserved its reputation as the world’s factory. As the Economist recently noted, Asia as a whole “smelts 76 percent of the world’s iron and emits 44 percent of its pollution, but hosts only a tenth of its most valuable brands and venture capital activity.” Despite the presence of a few global brands such as Sony, Toyota, Hyundai, and Samsung, Asian firms as a whole lag in global presence and multinational status. Asian multinationals own just 17 percent of the world’s foreign direct investment (FDI). In sum, while they have been productive powerhouses, Asian companies have thus far not risen to prominence on the global stage or in their presence and influence in global capital markets.

Why Asian Firms Are Still “Junior Partners”

Three broad patterns of development in Asian economic and corporate structures have caused Asian firms as a
whole to lag behind companies in the developed west.

First, many firms have had too close a relationship to the state. Since the reforms of Chairman Deng Xiaoping, China has shifted dramatically from the dysfunctional centrally planned train wreck of the Mao era. It has developed a unique model, with most economic sectors more or less privatized, but with the state still exercising stringent top-down control. That control is enacted through a tight macro policy grip, and expressed both through policy and through giant state-owned enterprises that still occupy the “commanding heights” of the economy.

Examples are China’s energy titans — PetroChina, CNOOC, and Sinopec. In China, direct state ownership of these firms has made them inefficient capital sinks for the Chinese economy — with abundant access to credit.  Meanwhile, while smaller private firms that could deploy it more efficiently for value-creation are left starved.  The state banking system has had a similar effect, channeling capital to increasingly inefficient recipients, and driving firms that need credit into China’s unstable shadow banking sector. It is a recipe that is unable to deliver continuing growth — and one that prevents the rise of Chinese firms that can compete on a world stage.

In other Asian economies, the equivalent giants may not be state-owned, but it isn’t necessary for them to be formally state-owned for many of the same troubling patterns to emerge, especially in an environment of endemic corruption. South Korea’s chaebols prospered in such an environment, as did Indian firms such as Mahindra & Mahindra. Large firms, often family-owned, have maintained comfortably close relationships to government, in an atmosphere of corruption, and in sectors especially close to corruption (such as real estate). The results are similar to that of China’s forthrightly state-owned firms. These firms don’t rise to global prominence — and they choke off the flow of capital that might invigorate the smaller competitors who could. Even Japan, although it has more internationally prominent firms than other Asian economies, has not been immune — though for a much more subtle reason. Japan is a genuinely free-market economy, and its political and economic culture is unquestionably dedicated to the rule of law. But corporate culture is relatively rigid, and management feels much more free to work without giving great weight to the expressed desires and interests of shareholders. We suspect that “shareholder activism” is very unlikely to take root in Japan. So although Japan has produced more high-profile international companies than many of its neighbors, it still lags the developed west.

But Changes Are Afoot

We believe that forces are at work that may force Asian capitalism to change its complexion — forces that may bring Asian firms more onto the world stage, and provoke them to challenge the western firms that have so far been dominant. The imminent IPO of Jack Ma’s internet juggernaut Alibaba — and the likelihood that it will soon be challenging western internet incumbents on their own turf — is a symbol of this potentially transformative shift.

Several large trends are driving this process.

First, Asian firms which were born and grew from a low base in the 1970s were used to boom times, with cheap credit, cheap labor, and new domestic markets ripe for growth. Now some of those conditions have changed.  Domestic markets have matured — and most notably, western companies have made inroads into those markets. Asian consumers are often intensely brand-conscious, and in an era of global social media, are turning to western brands. In short, domestic Asian firms are facing intense competition from western firms in their domestic markets — western firms who generally far outspend them in research and development. This competition will be a powerful impetus for innovation — which may ultimately result in more firms like Alibaba that can give western companies a challenge on their own ground.

A second factor is China’s epochal shift from an economy led by heavy capital spending to one led by consumer spending. Already, the success of China’s model has been such that rising Chinese wages are driving low-cost manufacturing into new Asian countries, and driving Chinese firms up the value chain. That’s a significant challenge for other Asian economies, namely South Korea and Japan. With Chinese producers increasingly ready to eat Japan’s and South Korea’s lunch, firms in those countries will be forced to grow in order to survive. That will mean a concerted push to expand their footprint as global competitors. And even in economies that will benefit from taking China’s cheap-labor mantle — perhaps India and Indonesia — there will be widening opportunities in labor-intensive industries.

Third, the emergence of the Chinese middle class will propel the development of firms able to appeal to a vast and growing new group of consumers who have come to expect robustly rising living standards. The Chinese firms that rise to the occasion and meet those demands with better products and brands will also be more fit to succeed outside the People’s Republic.

Caution: Reformers At Work

With the accession of Narendra Modi to India’s top post, he joins a class of Asian leaders all bent on reform, most notably China’s Xi Jinping and Japan’s Shinzo Abe. The reforms these leaders are spearheading are uniquely tailored to the challenges their nations face. We are encouraged that each is trying, on the most basic level, to strengthen the vitality of the free market against the forces that have sapped that vitality in their economic history thus far. Beyond the immediate vicissitudes of policy and performance, we see the possibility of an Asian axis of growth emerging, focused on the strengthening of the private sector, the strengthening of the rule of law, and the encouragement of innovation and engagement in the broader world economy.

That’s the Strategy… But Watch the Tactics

In the meantime, of course, while aware of this larger picture, we remain tactical and opportunistic in our exposure to Asian economies. Particularly, at the moment, we see the potential for higher oil prices as a result of unexpectedly tight global supply meeting strong emerging-market demand growth– for which producer half-truths and geopolitical instability may be to blame. Should oil prices tick higher, many Asian markets may suffer as a consequence — so in the near term we are cautious.

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