May 13, 2003
Severe acute respiratory syndrome is wreaking havoc in Asia. This is nowhere truer than in China. Should the Chinese economy lose steam and its factories suspend operations as a result of the epidemic, it would likely affect other Asian nations, such as Japan, whose economies are closely linked to that of China. The negative impact of this scenario would be greater for Japan and the newly industrialized economies, which have a complementary relationship with China, than for the members of the Association of Southeast Asian Nations, which are in competition with China.
If a decline in production in China can be compensated through increasing production in Japan, it would help support the Japanese economy. But when we consider the fact that few products made by Japan and China compete with each other, the effects of such a production shift would be limited. (The demand curve will shift to the right, but only slightly. Diagrams below.) In contrast, should the Chinese economy slow down as a result of SARS, Japan's exports to China will likely decrease. (The demand curve will shift sharply to the left.)
Much of Japan's exports to China are in the form of machinery and parts, and effects on the demand side of the equation will probably be most concentrated in these industries. When we combine these two effects on the demand side, Japan's overall output will no doubt decrease. Likewise, service-related industries, such as tourism and airlines, have been dealt a serious blow by the sharp decline in the passenger traffic between Japan and China, even though a portion of the overseas travel demand has been partly compensated for by the increase in domestic travel.
Furthermore, supply-side factors will also work to the disadvantage of Japan's output. In many industries, especially those where modularization has progressed such as electrical appliances and personal computers, there is a division of labor among production processes between Japan and China. Should the supply of order-made parts from China be cut off, its effects would be far-reaching due to input-output linkages. Even in cases where substitute products can be found for those made in China, prices will rise if there is a shortfall in supply. For Japanese firms, this signifies a rise in production costs, and becomes a factor that dampens output. (The supply curve shifts sharply to the left.)
The conclusion that both demand and supply factors will have a negative effect also applies to the NIEs, which, like Japan, are in a complementary relationship with China. That said, Hong Kong, Taiwan and Singapore are directly affected by the SARS epidemic and it is clear that the situation in those economies is more serious than in Japan.
In contrast, the industrial structures of the ASEAN nations are similar to that of China, and they are in a competitive relationship with China. On the demand front, their dependence on exports to China is low, and so even if China-bound exports were to fall due to the slowdown of the Chinese economy, the impact on total exports--and thus the total economy--would be relatively small. (The leftward shift of the demand curve would be small.)
On the contrary, ASEAN countries will probably enter the spotlight and take China's place as a recipient of orders placed by transnational corporations. (The demand curve will shift sharply to the right.) Meanwhile, on the supply side, their dependency on intermediate input such as Chinese parts is low, and impact will be limited. (The supply curve will shift to the left, but only slightly.) When all of these effects are taken into account, we can see that ASEAN's output will not shrink, but in fact may even expand.
The fact that ASEAN and China are in a competitive relationship also means that they are close substitutes for each other not just as recipients of production orders but also of direct investment. In recent years, Japanese investment in China has been booming, but the recent turn of events will likely lead many firms to review their investment strategies. In fact, the idea that overseas investments should not be excessively concentrated in China from the viewpoint of risk diversification was floated among Japanese firms even before this epidemic. With the specific appearance of risk in the form of SARS, the brakes will probably be put on the shift of direct investment from ASEAN to China.
Just as in the case of the Asian financial crisis of 1997, the effects of SARS are not only limited to the country of origin but affect all neighboring countries. This is not only evidence that Asian economies are closely linked through the flows of people, goods and capital, but also underscores the need for economic cooperation among all the countries in the region - not just in battling disease but on the trade, finance and monetary fronts - so as to achieve regional stability and prosperity.
Diagram The effects of SARS on Asian economies
a) Japan
b) ASEAN
Author, C.H. Kwan
Senior Fellow
Research Institute of Economy, Trade and Industry (RIETI)
Editor-in-Chief, Ichiro Araki
Director of Research
Research Institute of Economy, Trade and Industry (RIETI)
e-mail: araki-ichiro@rieti.go.jp
tel: 03-3501-8248 fax: 03-3501-8416
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[http://www.rieti.go.jp/en/index.html].
The opinions expressed or implied in this paper are solely those of the author, and do not necessarily represent the views of the Ministry of Economy, Trade and Industry (METI), or of the Research Institute of Economy, Trade and Industry (RIETI).
