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McKinsey Global Institute

The future of Asia: Asian flows and networks are defining the next phase of globalization

The Asian Century has begun. Asia is the world’s largest regional economy and, as its economies integrate further, it has the potential to fuel and shape the next phase of globalization.

Asia is increasingly the center of the world economy. By 2040, the region could account for more than half of global GDP and about 40 percent of global consumption. Global cross-border flows are shifting towards Asia on seven of eight dimensions, and the region’s growth is becoming more broad-based and sustainable as its constituent economies increasingly integrate with each other.

This is a diverse region, but its different parts have complementary characteristics, and powerful networks are developing within Asia. Patterns of globalization are shifting, and these shifts are occurring faster in Asia than elsewhere, suggesting that more than any other region, Asia could shape the way globalization unfolds in the years to come.

This new paper builds on the McKinsey Global Institute’s research on globalization in January 2019 by examining Asia’s rise on eight dimensions incorporating 16 types of flow, looking at the increasing integration of the economies of the region, and highlighting the development of three powerful new Asian networks: industrialization, innovation, and culture and mobility, and the rising cities that are pivotal components of those networks. The paper is one of a series on the Future of Asia, a multi-phase research project that aims to decipher the many facets of Asia.

Part 1

Asia—the world’s largest regional economy—matters

Although doubtless there will be challenges ahead including the potential for financial risk, growing inequality, and institutional gaps relating to the rule of law and corruption, Asia’s rise looks set to continue. Despite short-term concerns about trade tensions and the deceleration in China’s growth rate, Asia’s medium- and long-term prospects appear robust.

Asia’s rise to global significance is apparent in major macroeconomic indicators including GDP and consumption. In 2000, Asia accounted for 32 percent of global GDP in terms of purchasing power parity. This share increased to 42 percent in 2017 and is on course for a share of about 52 percent by 2040. In contrast, Europe’s share declined from 26 to 22 percent, and North America from 25 to 18 percent from 2000 to 2017. In real GDP terms, Asia’s share was 34 percent in 2017, and is expected to hit 46 percent by 2040. On consumption, in 2000 Asia accounted for 23 percent of the global total, rising to 28 percent in 2017. By 2040, Asia could account for 39 percent of global consumption.

Global cross-border flows are shifting toward Asia on seven of eight dimensions—trade, capital, people, knowledge, transport, culture, resources, and the environment (Exhibit 1). The only flow that has declined is waste (environment).

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Asia’s share of global goods trade has risen from 25 percent in 2000–02 to 33 percent in 2015–17.

To give just a few examples, Asia’s share of global goods trade has risen from 25 percent in 2000–02 to 33 percent in 2015–17. Asia now accounts for 23 percent of capital flows, compared with 13 percent ten years ago. The region is responsible for 48 percent of international students, up from 43 percent in the past decade. Its share of corporate revenue in the global media and hospitality industries has also been increasing, from 17 percent a decade ago to 22 percent today. The region’s share of patents filed worldwide in 2017 was 65 percent, up from 52 percent ten years earlier while its share of IP charges has been constant at around 25 percent. Over the same period, Asia’s share of global container shipping traffic has risen from 59 in 2005–07 to 62 percent in 2015–17. Asia’s share of global energy flows increased from 21 to 29 percent between 2000–02 and 2015–17 while its share of global energy demand increased from 36 to 43 percent during the same period. These flows have strengthened Asia on many dimensions and are the foundation for structural change.

Asia is not only rising in scale but is also integrating rapidly, arguably setting the pace for a new stage of globalization: regionalization. Globally observed shifts toward less trade-intensive goods-producing value chains, and cross-border services trade happening faster than goods trade, for instance, are more obvious in Asia than elsewhere. Asia’s trade intensity dropped from 20 to 14 percent between 2007 and 2017. On all eight dimensions studied, Asia’s integration is increasing and there is an observable shift toward regionalization. For instance, 60 percent of goods traded by Asian economies are within the region, 71 percent of Asian investment in start-ups and 59 percent of foreign direct investment (FDI) is intraregional, and 74 percent of Asian travelers travel within the region.

Part 2

Asia is diverse, but also complementary

Asia is a highly diverse region—there is no single Asia but many. We identified four distinct groups of economies based on scale, economic development, interactions with one another, and connectedness to the world. Each of these “four Asias” has characteristics that complement the other three (Exhibit 2). As they integrate with one another, this may make the region more resilient in the face of any global volatility.

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  • Advanced Asia. The countries of this group (Australia, Japan, New Zealand, Singapore, and South Korea) have all achieved high levels of per capita GDP of between $30,000 and $60,000, are highly urbanized and connected. They provide technology, capital, and a market for more high-end consumption to the rest of Asia. Their outbound FDI was $1 trillion in 2013–17, accounting for 54 percent of total regional FDI outflows.

In 2013–17, China accounted for 35 percent of total Asian outbound FDI.

  • China. China, the second largest economy in the world, is big enough and sufficiently distinct from others in the region to stand in its own category, acts as an anchor economy to the rest of the region and as a connectivity and innovation platform for neighboring countries. In 2013–17, it accounted for 35 percent of total Asian outbound FDI. Having built significant innovation capacity, China accounted for 40 percent of the world’s patent applications in 2017.
  • Emerging Asia. These countries (Bhutan, Brunei, Cambodia, Indonesia, Laos, Malaysia, Mongolia, Myanmar, Nepal, the Philippines, Thailand, and Vietnam) are relatively diverse but tend to have small, highly intraregionally connected economies. The average share of intraregional flows in these economies is 79 percent, the highest of the four Asias. Around 72 percent of trade, 80 percent of capital flows, and 85 percent of people flows in this group are intraregional. These economies provide labor and growth to the rest of Asia while being highly culturally diverse.
  • Frontier Asia and India. These economies (Afghanistan, Bangladesh, Fiji, India, Kazakhstan, Kyrgyzstan, Maldives, Pakistan, Sri Lanka, Tajikistan, Turkmenistan, and Uzbekistan) historically have had low levels of regional integration. The intraregional share of goods, capital, and people is only 31 percent, the lowest in Asia. They have had a broader range of trading relationships historically. In 2017, Europe, the Middle East and Africa, and North America accounted for 45 percent of these economies’ imports and 66 percent of exports, 56 percent of their FDI inflows, and 53 percent of their FDI outflows. They are major producers of services—notably business services in India—but are also moving into manufacturing, as in Bangladesh. They have young labor forces, and offer new markets as they integrate with the rest of Asia.

The economies of each of these Asias is expected to be comparable in size to any of today’s continents by 2040. China may be comparable to the size of North America by then. Advanced Asia and Frontier Asia and India may each be bigger than the Middle East and Africa combined. Emerging Asia may be comparable with Latin America (Exhibit 3).

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Increasing flows between countries in the four Asias are creating powerful new networks. Three in particular—industrialization, innovation, and cultural and mobility—are helping to reinforce those flows and connections.

Part 3

Asia-for-Asia industrial supply-chain networks are emerging

Rising consumption, maturing domestic value chains, and uncertainties around global trade are driving the formation of Asia-for-Asia supply chains. Manufacturing sector employment tends to peak at about 30 percent of total employment, usually after economies reach per capita GDP of between $10,000 and $20,000. Many Asian countries are at 15 to 20 percent in terms of employment in manufacturing, suggesting huge potential for further industrialization. In this developing industrialization network, we discern three major developments:

China is phasing out labor-intensive manufacturing, and Emerging Asia and Frontier Asia and India are picking up share (Exhibit 4). From 2007 to 2017, China’s manufacturing share of GDP increased slightly, from 30 to 34 percent. At the same time, manufacturing became a more prominent activity in other Asian economies. The manufacturing share of GDP in Vietnam increased from 16 percent in 2007 to 22 percent in 2017. Some Frontier Asia and India countries are also industrializing, such as Bangladesh whose manufacturing share of GDP rose from 16 percent to 22 percent between 2007 and 2017.

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Underpinning this growth is Advanced Asia and China, which are investing heavily in Emerging Asia and facilitating their growth. These two Asias account for 43 percent of Emerging Asia’s exports and 61 percent of its imports, and for 47 percent of Emerging Asia’s FDI inflows and outflows. For example, 79 percent of Vietnam’s FDI inflows in the electronics sector between 2013 and 2017 came from South Korea, helping the country to become a hub for electronics manufacturing.

Despite a major influence from Advanced Asia and China, Emerging Asia’s economic ties are still strong within their group. For instance, exports to other economies in Emerging Asia still accounted for 15 percent of the subregion’s exports in 2017. Thirty-one percent of Emerging Asia’s capital flows between 2013 and 2017 remained within the subregion, up from 26 percent in 2008–12.

Exports from Bangladesh, Pakistan, and Sri Lanka to the rest of Asia are now growing at a faster compound annual growth rate than to other regions.

Frontier Asia and India has large potential to grow its industrial base but has found it challenging thus far. Infrastructure is insufficient and lacks quality, and heavy and time-consuming bureaucracy has made decision making slow, deterring investment. However, there is huge potential with large and young populations, and significant capital and investment flowing into these economies. These countries have significant scope to integrate further with other Asian economies. Exports from Bangladesh, Pakistan, and Sri Lanka to the rest of Asia are now growing at a faster compound annual growth rate than to other regions.

New cities across Asia are developing as dynamic industrialization hubs. These “rising cities” on Asia’s industrialization network—among them Jamnagar in India, Phnom Penh in Cambodia, Hai Phong in Vietnam, and Bekasi in Indonesia—tend to have received strategic and investment support from their respective governments including in infrastructure, and incentives to attract large businesses.

Part 4

Asia is leapfrogging through multilocal innovation networks

Asia’s innovation network is much more localized than its industrialization network. We are seeing an innovation network powered with local talent but funded with regional capital that has led to the formation of “multilocal networks”—in other words, the solutions are tailored to local consumers and regulation and usually founded by local entrepreneurs. Multilocal innovation is happening in all four Asias in different ways (Exhibit 5).

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Advanced Asia and China have built strong innovation foundations including a base of large incumbent companies and institutions that are providing capital and knowledge to power innovation in other Asian economies. They have invested—and continue to invest—heavily in innovation and have built up substantial intellectual property.

Emerging Asia and Frontier Asia offer huge opportunities to deploy proven business models, capital, and innovative ideas. Inefficiencies in consumer-facing sectors and industry offer an opportunity to leapfrog in terms of innovation, and the pace of growth of start-ups and funding is much faster in these regions than it is in Advanced Asia. As these start-ups and innovation take off, the soft tissue connecting Asia’s multilocal innovation network starts to form.

Capital flows are often a leading indicator of where innovation is taking root, and these flows are changing dynamically. Asia’s share of global start-up funding increased from 16 percent in 2013 to 47 percent in 2018. About 70 percent of venture capital funding in Asia is intraregional. As companies in Advanced Asia open manufacturing companies in Emerging Asia, local labor and firms can benefit from technology spillovers from these foreign companies. Similarly, as Advanced Asia and China fund start-up and innovation activities in Emerging Asia and Frontier Asia and India, these foreign companies will not only help emerging economies participate in the global value chain, but also help facilitate the sharing of new ideas and foster the next wave of technology breakthroughs.

Asian cities are competing with one another to become innovation hubs—the region’s equivalent of Silicon Valley, but with an Asian twist. Each city has different approaches and offerings based on differing competitive advantage. Beijing and Shenzhen in China are well-established as innovation centers, and there are new players rising on Asia’s innovation network including Wuhan in China, Indonesia’s capital city Jakarta, Yangon in Myanmar, and Hyderabad in India.

Part 5

Asia is a growing hub for people flows and a rising cultural force

Asia is a major hub for people flows, and its importance is rising. Consumption of services, especially tourism, is booming. At the same time, Asia is becoming an increasingly significant cultural force. In contrast to the past when the region was largely a recipient of Western culture with Asian citizens enthusiastic consumers of Hollywood movies and British pop music, for instance, today cultural flows go in both directions. Asia has sufficient scale, cultural content, and diversity to create its own entertainment blockbusters. In addition to viewing and learning about other cultures through digital media, Asians are translating their on-screen curiosity into real-life exploration as the region becomes an increasingly important hub for flows of people, including tourists, and for global transportation networks. We explored three emerging networks—tourism, air traffic, and cultural content.

Asia is redefining global travel standards as both a large outbound market and a growing destination. Over the past decade, travel in Asia has grown at incredible speed. The fastest growth in tourism has been intraregional, growing at 2.7 times over the past decade—faster than the expansion of international travel. Key intraregional corridors for travelers have developed between China and Thailand, South Korea and Japan, and China and Japan. The number of tourists traveling between these pairs of destinations has grown by 29, 8, and 7 percent, respectively, over the past ten years (Exhibit 6).

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Asia is becoming a global interchange and home to the world’s fastest-growing airports. Asia has accounted for more than 50 percent of total growth in air passengers over the past decade. In 2009, Asia had 150 million outbound international passengers; by 2018 that figure had risen to more than 415 million. Today, Asia is home to 11 of the world’s 25 largest airports.

Asia has the scale and influence to create the next entertainment blockbuster. In 2007, Asia generated $6.5 billion in box office revenue, or around 25 percent of the global total. Just ten years later, that number has grown 2.6 times to $16.7 billion—in the same period, US box office revenue increased only 1.2 times—and now accounts for 41 percent of global revenue.

In 2009, Asia had 150 million outbound international airline passengers; by 2018 that figure had risen to more than 415 million.

But Asia is not simply a consumer of media. Increasingly, the region is creating content and using digital channels to share its culture both within the region and with the rest of the world. Chinese internet company Baidu’s video-streaming affiliate iQiyi.com bought the exclusive rights to stream the South Korean TV series Descendants of the Sun in China. The program was viewed more than one billion times on the platform. India is an established powerhouse for movie production, and Bollywood continues to go from strength to strength—well beyond its home country. In 2018, it produced the largest number of films in the world at 1,813, almost double the number made by China, the next largest producer.

Again, a number of cities are becoming prominent hubs for the interchange of people, culture, and ideas. Some, such as Bangkok and Seoul, are well established, while others are becoming considerable cultural hubs including Manila in the Philippines, Hanoi in Vietnam, and Auckland in New Zealand.

Part 6

Four priorities business executives and policy makers need to thrive in the Asian Century

As Asia grows larger in scale, develops stronger intraregional connections, and forms new networks, business executives and policy makers in the region and around the world need to assess how to take advantage. We suggest four priority areas to consider:

1. Be Asia relevant

Firms in Asia and around the world need to consider how to make their business relevant to the world’s largest regional economy, but aspirations and strategy need to be nuanced to reflect different Asian flows, some of which are already global in terms of scale and highly intraregional while others remain relatively underdeveloped.

Aspirations and strategy need to be nuanced to reflect different Asian flows, some of which are already global in terms of scale and highly intraregional while others remain relatively underdeveloped.

Companies that already have a substantial presence in Asia will need to continually revisit and refresh strategy to remain relevant and effective in a highly dynamic environment in Asia. Companies should be part of Asian flows and networks that are already large-scale with a major intraregional element, offer Asia resources and flows on which it remains dependent, and create opportunities for Asia to expand underdeveloped flows in, for instance, services trade, capital flows, data sharing, and culture.

2. Rethink the Asian operating model

Asia is a diverse region with complementary characteristics. Firms need to understand the nuances of differences within the region—even down to the level of individual cities—when developing their Asian operating models. They could consider how to unlock opportunities arising from the complementary characteristics of the four Asias through new partnerships and supply chains and put cities and clusters of cities at the center of their thinking.

3. Protect from and prepare for risks

To make the most of Asia’s growing scale and importance in the world economy, there needs to be a collective effort to sustain growth. Decision makers therefore need to respond to a range of risks including environmental pressures for instance, and fill skills gaps. Asian governments also need to enhance their institutional capabilities.

4. Forge stronger intraregional collaboration

As Asia continues to integrate, the question is how to build collaboration. The region is not without its political and territorial conflicts, and needs to evolve dispute resolution mechanisms to resolve them. Leaders also should consider how to develop stronger relationships beyond trade—in knowledge, data, and people flows, for instance.

About the author(s)

Oliver Tonby is a senior partner in McKinsey’s Singapore office. Jonathan Woetzel is a senior partner and a director of the McKinsey Global Institute, where Jeongmin Seong is a senior fellow. Wonsik Choi, Karel Eloot, and Rajat Dhawan are senior partners in McKinsey’s Seoul, Shanghai, and Gurgaon offices, respectively. Patti Wang is a McKinsey consultant in the Shanghai office.

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