Markets and the Power Shift to the Emerging Economies

The weight of economic activity is shifting from the US & Europe to Asia & Iberoamérica

Energy squeeze – higher prices

The longer-term energy story is complex. The developed world is now barely increasing its use of energy and energy demand is projected to remain stable for the forseeable future, at least for the next couple of decades. Energy use in the emerging world, by contrast, continues to grow relentlessly every year.

The emerging world now uses more energy than the old developed world. This is what you would expect to happen, for as the weight of economic activity shifts from the US and Europe to Asia and Iberoamérica, so too will demand for energy. But it means the price paid by the developed world will be increasingly determined by the emerging world. The so called “West” (the US and Europe) has never been in this position since industrialisation. There is a weak parallel with the rise of Opec in the 1970s when the oil producers cut supply and quadrupled the price. At that time, the US and Europe found other sources of oil and reduced their dependence on Opec. But this time the squeeze comes from the demand side, not the supply, and there is not much the US and Europe can do about it.

And what next for the commodities markets 

The Chart below provides an overview contrasting developed countries with emerging economies' share of GDP and their world share of some of the most important commodity markets and other indicators:

Source: The Economist Daily Charts

Many analysts believe that the long-running boom in commodity prices (for some of the world's most important raw materials) has been driven up by financial speculation as much as physical need. Hence the commodities market may be heading for a massive crash on the scale of sub-prime. The commodity boom has not reached the excess so evident in the subprime era but it is pretty big nevertheless. Recently, some analysts have speculated that the gigantic merger between the mining company Xstrata and the commodity trading house Glencore is a signal of the prospect of a looming crash in the commodities markets. Just before the subprime crash, many massive subprime acquisitions came at the end of a massive boom in the securities markets and those doing the deals appeared to have sensed that the party was coming to an end and that they had to do something spectacular to be able to reap the super profits to be had in the final stages of the blowout. The Geo-Trade Blog believes it is possible that this deal may be the signal that the commodity markets are today where debt markets were on the eve of the credit crunch.

Printing Money and Bubbles in Markets

In the immediate aftermath of the subprime crash, printing money or quantitative easing (QE) as it is also known helped a wide variety of financial institutions to avoid facing up to their losses, covertly recapitalising US and European banks that were, to all intents and purposes, insolvent. Over the last few years protests from countries including Thailand, Australia, South Africa and China have been heard complaining that the US' unprecedented monetary expansion was responsible for causing dangerous bubbles in commodity markets going way beyond US equities. The US government also knows, although it denies it, that the more money it prints, the more speculative pressures push up global food prices. 

While the causes behind the Arab Spring unrest in 2011 are complex, it must be noted that it was surging food price that provided the spark. Hence the large emerging economies view "quantitative easing" as a developed country policy aberration, dressed up as a "legitimate technical solution" that they do not agree with at all. Brazil's finance minister has described it as "throwing dollars out of a helicopter and the Russian PM has described it as "economic hooliganism". The emerging economies clearly perceive the current trials and tribulations of the developed countries very differently to the conventional wisdom that underpins the policy decisions and assumptions that justify QE in the developed world. Emerging Economies are aghast that the US is now shouldering declared federal liabilities of $9,100bn - making it by a long way the world's largest debtor. Furthermore US Government debt is set to reach 42pc of GDP by 2015 according to official estimates. And more and more interest is being shown in the fact that the US' total sovereign liabilities including off-balance sheet items such as Medicare and Mediaid amount to $75,000bn - no less than five times annual GDP.

 

South Korea - the Asian "France" or "Germany" of the 21st Century

 K-POP Video on YouTube

 

Overseas trade and the industrial revolution of 19th and 20th centuries

As overseas shipping costs fell during the industrial revolution, it became possible for massive industrial cities to specialise in large-scale production and ship their goods to customers all over the world. The concentration of industry in cities, however, was still largely a product of the fact that it was costly to move goods over land. In a port city, you could bring in inputs, process them into outputs, and ship them back out. If it had been necessary to move intermediate goods well inland for manufacture at any point, costs would have soared, making profitable production impossible.

But transport costs continued falling. Shipping became much cheaper and more efficient. Air freight became an economic possibility. And improvements in trucking and freight rail led to stunning drops in the cost of moving goods over land. And so where once producers had crowded on top of each other in cities to take advantage of specialisation without blowing their budget on transport costs, they now began to spread out: first into the suburbs, then into cheaper regions of the same economy, and then, finally, into vastly cheaper economies abroad. This process facilitated the rapid industrialisation of Asian giants firstly Japan and then South Korea.

South Korea's 20th century economic success
 

In 1960, in the aftermath of a devastating war in the Korean peninsula, the exhausted south was one of the poorest countries in the world, with an income per head on a par with the poorest parts of Africa. At the beginning of 2012 it is richer than the European Union average, with a gross domestic product per person in US dollars of $31,750, calculated on a basis of purchasing-power parity (PPP), compared with $31,550 for the EU. The below graph shows GDP per capita levels projected to 2050.

Goldman Sachs - IPPR: Third Wave of Globalisation Report

 

 

 

Much of South Korea’s economic miracle has been the work of big family run conglomerates, or chaebol. Samsung Electronics, for instance, one of 83 constituent parts of the Samsung empire, has become the market leader with its smartphones overtaking Apple. Korea’s shipyards have just started work on a new class of container ships called the triple E-class which are the largest container ships ever built. Korea’s large companies employ slightly less than a quarter of the workforce and produce more than half the country’s output. 

The chaebol system as with any family business, the moment of greatest danger is when the leadership passes to the next generation. Samsung passed this test in 1987 when the founder handed over to his son, Lee Kun-hee. Now Mr Lee’s son, Jay Y. Lee, has been appointed chief operating officer of Samsung Electronics and a new transition looms. 

The South Korean model of heavy state intervention combined with an aspirational and entrepreneurial culture has brought it huge economic success. The model is being studied closely by Vietnam, Indonesia, Cambodia, Bangladesh and Mongolia as well as the Central Asian republics of Uzbekistan, Kazakhstan and Kyrgyzstan. But aside from the economic success, South Korea dominates the cultural sphere too through the immense popularity of Korean pop (K-pop) (see above video) and television dramas and soap operas in the rest of Asia, as part of the "Korean wave" phenomenon washing across Asia.

Challenges ahead for 21st century

To some extent South Korea’s economic success is dependent on China. South Korea exports more capital goods to China relative to the size of its economy than anyone else, even Germany. 

 

But, there are signs that the chaebol may be stifling innovation and entrepreneurship. They have proved expert at applying and improving existing technology, even the high technology of touch-screen smartphones. But except in some internet businesses and computer gaming, South Korea has few start-ups or cutting-edge technology firms.

South Korea lacks nationwide venture-capital businesses because each chaebol has one of its own. The firms snap up the best and brightest graduates and turn them into company men. In this way the conglomerates act like light-hogging trees in a forest: their canopy may be impressive, but it is hard for anything to grow underneath. As South Korea moves towards the technological frontier, such attitudes will have to change. Innovation is not going to come if everyone shelters from risk in the chaebol.

Furthermore, there is a huge productivity gap between South Korea’s export-oriented chaebol and small and medium-sized firms (SMEs) which dominate services. Value added per worker in small firms is less than half that in large ones. SMEs’ operating profits were 4.5% of sales in 2007, compared with about 7% for large firms. Small firms spend about half as much on research and development as large ones per unit of sales and borrow far more relative to assets. Over time, their performance seems to be getting worse. South Korea, in other words, has first-world manufacturing exporters but currently has third-world services.

Nuclear powered aircrafts, could they become a reality?

Artist's impression of a nuclear powered aircraft

A recent work by Cranfield University's Bhupendra Khandelwal on an air transport model that combines nuclear-powered cruisers with chemical-powered short-range transports considers this possibility. As these long-range cruisers continually fly looping tracks that cross oceans and take them over major population centres, shorter-range aircraft would bring up passengers and cargo that would ride on the cruiser until they reach their destinations, where they would transfer to other short-range aircraft and fly down to land.

He has developed an air transport model (below) that combines nuclear-powered cruisers with chemical-powered short-range aircraft.

Graphic courtesy of Cranfield University Study, UK.

Taking off from conventional airports, flying to and landing on the cruiser, the chemical-powered transport would be optimised for take-off, climb and landing, with no need to cruise. This would reduce emissions, says Khandelwal, as the nuclear-powered transport would carry the aircraft to its destination, where it would detach from the cruiser to descend and land normally.

The cruiser, meanwhile, would have taken off from a remote site. This and its extreme endurance, which significantly reduces the number of take-offs and landings, would minimise the risk of a crash leading to a nuclear incident. Also the cruiser would be unmanned, he says, improving safety and avoiding the risk to a crew of prolonged radiation exposure during the cruiser's extended voyage. For further safety, the cruiser would have back-up chemical propulsion.

Khandelwal calculates this air-transport model could produce a fuel saving over conventional point-to-point flights of 40% for a 1,000km mission, rising to 85-90% for a 10,000km mission, where the chemical-fuelled flights to and from the cruiser would be a smaller fraction of the total.

Nuclear propulsion could be either direct or indirect cycle. In direct cycle, air flows through the compressor, into the reactor where it is heated, and out through the turbine. The risk here is radiation in the exhaust gases. In an indirect cycle a heat exchanger transfers energy from the reactor to the airflow. The radiation risk is reduced, but so too is thrust. 

Khandelwal's work provides much food for thought on new models of air travel in the 21st Century. The Geo-Trade Blog will continue to follow new innovative models for air transport with the potential to reshape travel and trade.