By Stephen Lee
Stephen Lee is the chief economist at Meritz Securities, Seoul. Courtesy of Stephen Lee
It’s been 18 months since the COVID-19 pandemic heavily hit the economies of developed nations. In the U.S., the recession lasted for a mere two months, but it turned out to be the deepest one in history. As the economy began to show signs of recovery after the short recession, the demand for services only crumbled before recently recovering. Manufacturing, on the other hand, has enjoyed the fastest recovery ever, as demand for devices and IT investments surged. If we were to set U.S. real retail sales as a proxy for goods demand, and U.S. industrial production as a proxy for supply, the former is above the latter by 11 percent as of July 2021, if we rebase the two indicators to Feb. 2020.
This situation amounts to excess demand vis-a-vis supply, but naming it from the other way around, it’s called “shortages.” The supply has not been able to catch up with the surging demand because of its inelastic nature. Rising commodity prices, global supply-chain disruptions, as well as labor shortages ― in some cases, voluntary unemployment on the back of stimuli, and in others due to difficulties in finding or transitioning to different jobs ― have made the situation even worse.
A gauge for a shortage, measured in the form of the U.S. ISM Manufacturing Supplier Delivery Index, rose to 78.8 in May 2021, the highest since 1974. The gauge came down for three straight months as commodity price pressure eased and workers returned to work. The shortages have not been completely resolved but they are likely passing their peak. What does this mean for production? Previously, production lagged against orders, but it’s now starting to catch up. Wholesalers and retailers will now be able to fill their inventories. As a result, shipments and deliveries will rise and recover ― a good phenomenon for global trade.
Longer capital expenditure growth cycle will follow
In my view, the resumption of shipments and deliveries is not the end of recovery. Beyond that, we will likely get to see a longer capital expenditure growth, or “capex,” cycle. History tells us that whenever the supplier delivery index rose above 60, it was perceived as shortages, or excess demand. Once manufacturers realized that excess demand existed, they got more proactive in substituting old items for new ones, and if needed, built capacities. There were three similar cases before COVID-19: 1995-99, 2003-06 and 2017-18.
One might say that it is premature to directly compare previous episodes with the current one, as past three- to four-year-long capex cycles had special features like the IT boom and the emergence of China. We do not have these new engines now, but supply tends to rise gradually upon the change of corporate policies. I believe that reducing the widening gap between demand and supply created by one of the most severe shortages in history will take two years or more.
History shows that prolonging capex cycles have resulted in continuous rises in global trade volumes. Shortages in the U.S. do not mean that manufacturers there will only be buying equipment made at home. Machines and devices are tradable goods; therefore, those countries with capital goods-based export structures can benefit also. In Asia, these countries include Korea, Japan and Taiwan. During previous capex cycles, the global goods import volume increased at an annual average pace of 7.3 percent and 9.0 percent during the 1995-99 and 2003-06 cycles, respectively.
Global environment in favor of Korean exports
Amid such a global environment demanding capital goods, Korean exports are currently growing, characterized by much better quality than in 2017-18. Korean exports back then were driven by IT, commodities and industrials in the first place. But soon, these exports turned out to be heavily dependent on semiconductor prices. This time, as global macros suggest, Korean export recovery is being driven by both volume and unit price. Greater demand for devices and equipment are leading volume growth, while a greater volume of exports for products with higher ASPs (average selling prices) are driving up unit value as well. These are: 1) MCP (multi-chip package) and System LSI (large-scale integration) semiconductors; 2) OLED (organic light emitting diodes) flat displays; and 3) SUV, luxury car and EV (electric vehicle) automobiles.
Of course, going forward, many forecasters may argue that on-year export growth will slow. Such a slowdown is natural as base effects fade. What is more important is the sustainable growth pace. One simple way of gauging this pace is to reconvert export growth to a 2-year CAGR (compound annual growth rate) basis. The daily average exports growth in August was 29.0 percent, down from 49.0 percent in May. Two-year CAGR growth on the other hand, was 11.2 percent as of August, slightly up from 10.3 percent in May. We should consider near 10 percent growth as the sustainably growing pace of Korean exports.
To sum up, given global manufacturers’ high demand for devices and equipment to meet the balance between demand and supply after shortages peak out, the double-digit growth of Korean exports is likely to continue into next year. This growth will be the main factor sustaining the nation’s GDP growth above 3 percent in 2022.
The writer is the chief economist at Meritz Securities, SeoulInternet Explorer Channel Network