Renew corporate, political governance

By Christopher Lingle

SYDNEY (JP): Asian stock markets have made a dramatic comeback from their lows of 1998 due mostly to an inflow of funds from offshore investors. Optimism about recovery has sparked an impressive run-up of share indices across the region. At the beginning of May, the Japanese Nikkei had gained nearly 27 percent, the Hang Seng almost 33 percent, the Malaysian Composite about 16 percent and the Singapore Times Index around 35 percent. Despite a few hiccups, these rises have continued.

Along with large increases in the value of stock market indexes, there has been a strengthening of many of the region's currencies while interest rates have fallen and trade surpluses are rising (at least in terms of local, devalued currencies). But the evidence suggests that this is another bubble rather than the beginning of a sustained recovery.

While financial sectors are experiencing seemingly impressive rebounds, there are few changes in the economic fundamentals on the real side of these economies. Restored growth and rising employment will only come after there is a substantial reduction in excess productive capacity and removal of nonperforming debts. Like the "miracle" boom of the past that collapsed under a minor reality check, the current euphoria is based more upon external conditions than internal realities.

Trade and current account deficits posted in the precrisis era have recently been transformed into surpluses. Changes in trade patterns have also enabled these countries to work toward stabilizing battered currencies while restoring depleted foreign reserves. As domestic interest rates have come off their peaks, emerging-market credit spreads have narrowed.

In turn, Asian governments and private enterprises are beginning to reenter international debt markets. Malaysia, despite being shunned by investors due its imposition of capital controls, will test the waters with a US$2 billion bond issue. And China will return to the market after the closure of on-going bankruptcy proceedings by a variety of provincial financial institutions.

In many instances, public sector budget deficits are rising as governments try to buy their way out of the economic gloom. The bad news is that growth inspired through throwing money at public projects combined with easy credit will not spark sustainable growth. Once the funds dry up due to ballooning debts and deficits, the folly of government-led growth will become clear.

Reliance upon deficit spending to boost Gross Domestic Product (GDP) like in China and Japan may work in the short term, but such expenditures are unlikely to underpin sustainable growth. In China, too much of the spending has gone into shoddy public works or into household savings. Japan's experiment with large public spending programs has resulted in repetitive and abject failure.

Part of what is missing in the optimism behind East Asia's encouraging numbers is that quality of growth is more important than measured quantities. One of the key lessons from East Asia's economic crises is that high growth of GDP may be illusory. Dramatic drops in the valuations of enterprises could indicate that capital assets do not have objective value.

Even physical capital can have a zero or negative value when there is excess capacity among producers of a similar product or if technological change renders it out-of-date.

Another element is necessary to understand what is happening in East Asia's economies. It is useful to think of the crises as arising from a mixture of cyclical and structural influences. The cyclical component is the boom and bust influence of easy access to credit. Prior to 1997, many of East Asia's banks relied upon fixed exchange rates to borrow heavily at low rates on the international market and lend at higher rates on the domestic market. Lenders who miscalculated the nature of commercial and political risks facilitated this process. Consequently, the normal cyclical process was exaggerated by government policies.

The structural influences that contributed to the crises relate to the institutional infrastructure and industrial mix of their economies arising from the ingrained corporate culture. This includes qualitative aspects of the body of law, the nature of the judicial system, political involvement with market processes, accountability of corporate and political leaders and so on. Investors began to realize that the existing institutions offered fewer protections for their investments than originally thought. As they exited these markets, the cyclical downturn was amplified.

At the same time, many of the largest companies substituted market share and growth for profitability, leading to heavy debt ratios. With ready access to cheap financing, there was substantial overbuilding in property development and industrial capacity. This was the structural basis of the regional bubble that burst beginning in July 1997.

Just as these combined pressures contributed to the downfall of these economies, their long-term recovery requires a resolution of both.

Ironically, the significant advances in the region's stock indices reflect a new source of cyclical exaggeration. In this case, the primary source of rising valuations is the inflow of foreign portfolio investments. In turn, this has inspired a renewal of domestic commitments to these markets. For example, many small investors in Korea are buying into stocks for the first time. When the inevitable market correction comes, the pain is likely to be inflicted more widely and suffered disproportionately by novice investors.

Structural change requires an introduction of new attitudes about corporate and political governance. Modern management will arise from fresh, new faces in boardrooms, parliaments and presidential palaces. This new cyclical bubble that is forming in East Asia should not distract leaders from the fundamental transformations required by the realities of the global economy.

The writer is an independent corporate consultant and adjunct scholar at the Centre for Independent Studies in Sydney, Australia. He is also the author of The Rise and Decline of the Asian Century (Hong Kong: Asia 2000, 1998). His e-mail address is: CRL@po.cwru.edu.