Time For A Reality Check In Asia

As the miracle economies slow down, their hidden problems start to appear

For decades, they've been known as the "flying geese." At the head of the flock was Japan, blazing new routes and passing its wealth, industries, and experience on to the new East Asian "miracle economies" that followed in its tailwind. Those included South Korea and Taiwan, which at first made shoes and garments, then graduated to heavy industry and electronics. Close behind were Thailand, Malaysia, China, and the other nations of the region. East Asia seemed impervious to recession, producing strong growth rates by focusing on manufacturing exports and mobilizing their immense pools of savings and cheap labor.

Today, this simple model isn't working so neatly. Japan is struggling to emerge from four years of stagnation. South Korea, beset by a slump in key exports, is questioning whether its days as an industrial powerhouse are fading. In Singapore and Thailand, where stock markets have been pummeled and growth forecasts slashed, planners wonder whether they have the workers and managers required to make the next leap into knowledge-intensive industries. In almost every country, trade balances have deteriorated and growth forecasts have been shaved by as much as two percentage points. In China, there's even debate that its average 10% annual growth rate has been way overstated.

Two decades into one of history's greatest economic booms, the region is getting a reality check. The problems that have long been obscured by go-go growth are suddenly smack in everyone's face. Labor costs are rising much faster than the region's productivity. Many of the best-known private corporations are generating huge sales but little or no profits. The race for manufacturing dominance has led to overbuilding in almost every key industry, including autos and semiconductors. School systems aren't producing enough innovative technicians and managers needed for the push into higher-value-added industries. A sophisticated middle class is growing fed up with pollution, bad housing, poor infrastructure, and corruption.

THORNY ISSUES. A few years ago, some economists such as Stanford University's Paul Krugman argued that East Asia was good at mobilizing cheap labor and foreign capital but lacked the productivity and innovation to guarantee continued growth. As the region exhausted these "inputs," Krugman asserted, growth would hit a wall and the Asian miracle would vanish.

Such naysayers were shouted down. But now, prominent Asians are voicing the same fears, and policymakers are starting to tackle these thorny issues. As a result, a rethinking is under way of many of the policies, strategies, and even values that have been at the core of East Asia's rise. Schools stressing rote memorization, rigid curriculums, and obedience to authority have produced disciplined and politically docile workers. Now, they are seen as inadequate. Financial systems that guide savings to powerful corporations, rather than dynamic new entrepreneurs, need an overhaul.

How different countries handle the new challenges could well determine the winners and losers of East Asia's next stage of development. The winners will no longer gauge success exclusively by the growth of GDP but will also take into account their development of human capital. The losers will keep going for the easy gains--and be stuck in low-tech industries with truncated growth prospects.

Multinationals from outside the region will feel the shakeout as well. Many U.S. and European corporations have staked their plans for future profits on Asia's insatiable appetite for autos, telecom equipment, and power plants. Slow growth means more competition and lower profits. Latecomers to the Asian game are finding fewer chances for huge returns.

Asian governments do have time to initiate the reforms needed to coax more wealth from their maturing economies. With savings among the world's highest and an enormous emerging consumer class, East Asian countries will probably keep growing at 5% to 8% for another decade, double the rate of the West. And there are signs of a rebound from this summer's deep, regionwide plunge in export growth, which was worsened by a global electronics slump and currency fluctuations.

But no one should expect a return of the almost limitless optimism about Asia that existed just three years ago. Back then, the exhilaration of boom times was hard to miss. Entire cities were rising out of rice fields up and down China's coast. Rough-and-tumble ethnic Chinese tycoons were building sprawling corporate empires. Big markets such as Vietnam were just opening up.

For investors, there were almost too many opportunities to choose from. General Electric, AT&T, and Royal Dutch/Shell Group mapped multibillion-dollar strategies to tap a market that had an insatiable demand for everything. Foreign capital flowed into bull markets from Bangkok to Jakarta. "Anywhere you dipped your oars," recalls George Baeder, president of Hong Kong-based Pacific Rim Consulting Ltd., which advises numerous multinationals, "you got growth of 30%."

MAJOR HEADACHES. Now, with a few exceptions such as Hong Kong, most of those bourses are still trading near or far below their highs of 1993, and the Dow Jones industrial average has risen by more than 50% in the same period. Granted, investment rates are still impressively high, but it's also clear as you cruise sprawling new districts outside Shanghai, Bangkok, and Guangzhou that much of the newfound wealth has been wasted on glistening office towers, industrial estates, and high-rise condominiums that are barely occupied. Foreign companies are also feeling the squeeze in Beijing, Hong Kong, Seoul, Singapore, and Taipei, which are now more expensive places to do business than New York.

For ordinary Asians, rising incomes represent well-earned progress. Their interests, after all, were long ignored in the single-minded pursuit of growth. But for the manufacturers that generate most of Asia's export wealth, the changes pose major headaches.

The experience of disk-drive maker Seagate Technology Inc. provides a vivid illustration of the new realities. A decade ago, the industrial estates in Penang, Malaysia, became a manufacturing mecca for Seagate and other high-tech giants, thanks to superattentive local officials, unbeatable tax breaks, subsidized training institutes, and an abundance of fast-learning workers making less than $1 an hour. Today, hundreds of thousands of Malaysians assemble everything from Intel microprocessors to Dell computers.

Now, with unemployment around 2% in Malaysia, wages overall are growing twice as fast as productivity. To staff its seven futuristic Malaysian plants, Seagate has 100 buses shipping in young women from villages as far as two hours away each day. Managers scour rural Indonesia for recruits. To boost productivity without adding staff, Seagate actually flies Malaysian workers earning $10 a day all the way to Bloomington, Minn., to learn to how to run the latest robots. "We are growing as fast as the labor market will allow, but that isn't enough," says Penang Seagate Industries Managing Director Timothy Harris.

As they race to develop their industrial clout, these nations are creating other problems. Overcapacity looms in such key areas as petrochemicals, consumer appliances, passenger cars, and chips. The region has based its strategy on the experience of Japan, South Korea, and Taiwan, which graduated to higher value-added industries through skillful use of protection and subsidy after losing competitiveness in garments, shoes, and toys. East Asia doesn't need all these refineries and car plants. But policymakers seem oblivious to what their neighbors have been building so furiously.

A CARMAKER "BLOODBATH." In petrochemicals, Indonesia, Thailand, China, Taiwan, and South Korea all are sinking billions into sprawling complexes. This year, a chemicals glut pushed prices down by 36%, walloping Asian producers. Yet the building binge rages on. South Korea, already accused by its neighbors of dumping, has three huge petrochemical plants under development and three more on the drawing board. They include plants by giants Hyundai Corp. and Samsung Group. "Once Samsung and Hyundai get into petrochemicals, they will overbuild like they do in autos," says McKinsey & Co. chemical consultant Steve Tagtmeier. "They're going to crash the world market." Kim Tae Han, strategic planning manager for Samsung's chemical group, is unfazed: "To compete with European and U.S. companies, we need to expand."

A similar situation is shaping up in autos, another export status symbol for aspiring Tigers. Malaysia already has a protected national carmaker that wants to churn out 500,000 of its Proton sedans by 2000. Thailand's capacity is expected to more than double, to 1.5 million, in five years. Indonesia recently announced its own "national car" program, between South Korea's Kia Motors Corp. and one of President Suharto's sons, that will receive special breaks on fees and tariffs.

China, with a domestic market of 370,000 cars, already has five major auto ventures, and Beijing may still develop an all-Chinese "people's car." Even Vietnam, whose domestic market has less than 10,000 cars, authorized 11 assembly plants. In India, where more than 15 foreign ventures have been approved, Chrysler CEO Robert J. Eaton predicts a "bloodbath." Says Volkswagen Asia President Martin Posth, who runs a successful VW venture in Shanghai: "I can't believe all these projects will fly." The rational thing would be for different Asian countries to specialize in certain vehicles and components, and trade these with one another. But most neighbors, determined to protect their industries, drag their heels on market access.

An edifice complex also afflicts Asia's semiconductor industry, where manufacturers are scrambling to find the talent to staff their plants. South Korea has emerged as a giant in memory chips, Taiwan and Singapore in silicon-wafer foundries, and Malaysia in semiconductor packaging for the likes of Intel, Motorola, Texas Instruments, and Western Digital. Yet despite this year's 82% crash in prices for dynamic random-access memory chips (DRAMs), Taiwan is building a dozen new $1 billion silicon-wafer plants. Many of the entrants are giant, cash-rich companies such as Formosa Plastic Group and Hualon Textile that made their billions in old-line industries. Singapore wants to lure 20 wafer fabs. Malaysia is even building wafer fabs at a site cleared from jungle on the remote island of Borneo.

LOWER-WAGE HAVENS. The world cannot absorb this much capacity. What's more, operating skills are wanting at some of these ventures. "A lot of these companies are growing fast, but they don't seem to be doing enough to put management in place," says Ron Jones, a Taiwan-based semiconductor consultant. "Even if you emptied the Bay Area of engineers, you would have a hard time staffing all the wafer fabs going up in Asia." Jones predicts a shakeout soon, with players such as Taiwan Semiconductor Manufacturing, Singapore's Chartered Semiconductor Manufacturing, and South Korean packaging giant Anam Industrial Co. taking over the losers.

The growing skill shortage raises the prospect of a widening gap between the region's economies. In Southeast Asia, schooling is far below the standards of first-wave Tigers such as Hong Kong, Singapore, South Korea, and Taiwan. The impact is being felt in Thailand, the world's fastest-growing economy over the past three decades. Behind the plunge in export growth, expected to be a meager 3% this year, vs. 23% in 1995, is an exodus of garment, shoe, and toy plants to lower-wage havens such as China, Vietnam, and Burma. But Thailand has an acute and growing shortage of engineers. It needs more of them to stay competitive in industries such as electronics, machinery, and specialty steel. Says Thailand Development Research Institute economist Wisarn Pupphavesa: "We haven't done the groundwork to upgrade our industries to the next level."

Poor use of resources is largely to blame. Bangkok has slews of shopping malls and luxury condos, yet primary schools in rural areas, where most of the population lives, are pathetically poor. Only 60% of Thai workers have more than the compulsory six years of education. Universities also are strapped for funds.

RED TAPE AND CRONYISM. Other Southeast Asian countries are even less conducive to high-tech industry. In Indonesia, where education standards are worse than in Thailand, investors face the added headaches of pervasive corruption, red tape, and the cronyism of the Suharto family. While literacy and primary education are good in impoverished Vietnam, most serious investors have written it off for now because of its dismal universities and Hanoi's failure to enact critical legal, financial, and bureaucratic reforms.

Government institutions are not alone in needing reform. Dealing with growing pains is a daunting challenge for Asia's corporations, too. Management strains are severest in conglomerates run by the ethnic Chinese tycoons who dominate business in every Asian country outside Japan and South Korea. In the early 1990s, Asia was their oyster. Relying on their unparalleled connections and ability to invest or raise millions of dollars with a few phone calls, magnates such as Hong Kong's Gordon Y.S. Wu, Li Ka-Shing, and Peter Woo, Malaysia's Robert Kuok, and Thailand's Dhanin Chiaravanont crisscrossed the region, landing megadeals in property, telecom, infrastructure, and broadcasting. Others took advantage of China's opening to snap up factories producing everything from beer and paper to electrical machinery.

UNDER THE HOOD. Today, many of their business groups rank among the world's biggest in terms of market capitalization and growth. But look under the hood, and management often is a mess. "On the one hand, they have the entrepreneurialism and drive," says McKinsey's Hong Kong-based director, Trevor MacMurray. "But they've gone too far too fast and haven't really invested in management systems required to understand those businesses." Many of the first wave of pioneers are likely to get pushed aside by multinationals. In October, Hong Kong's beleaguered Gordon Wu, who has troubled mass-transit and highway projects in Thailand and China, announced plans to sell 80% of his Asian power-plant business to Atlanta-based Southern Co.

A dearth of management skills is also an obstacle for East Asian companies that attempt to globalize. Acer Inc., Taiwan's $6 billion computer and semiconductor giant, has no problem finding managers for its factories at home. But with 35 overseas factories and a major push under way to diversify into such "information appliances" as Internet television, set-top boxes and digital cameras, local talent is thin. "Taiwan's consumer-appliance companies do not have the capability to run global operations," says Simon Lin, CEO of Acer's information-products unit. So, Acer is handing ever more managerial, financial, and marketing autonomy to locals in its foreign units.

Another surprising problem is how parochial some Asian managers are. Singapore companies--pushed by the government, which fears growth on the island of 3 million will stall unless its corporations globalize--have pumped more than $16 billion into markets such as China, Vietnam, Burma, and India. But an acute scarcity of Singaporean managers willing to live overseas puts these investments at serious risk. "Singaporeans are used to following the straight and narrow path at home," says Arun Mahizhnan of Singapore's Institute of Policy Studies. "When they go abroad, they find a labyrinth." So now, the push is on to find local managers overseas and even draw them from places such as the Philippines and India.

Nowhere is the management crisis more serious than among China's 100,000 state enterprises. Despite numerous reform crusades and 10% average GDP growth for the past four years, losses and bad debts are reaching staggering new levels. Some 40% are spilling red ink, whether they make paper, chemicals, steel, or TVs. In most cases, the problems relate to overproduction and inefficiencies. Even the wild enthusiasm over China's infant stock markets in the early 1990s didn't help, since dozens of companies that went public wasted their new funds on misguided property and financial investments. Says Li Jiahao, president of the China Europe International Business School in Shanghai: "We have squandered a decade of opportunity."

Meanwhile, unproductive state enterprises lap up 70% of all bank lending. More nimble state and village enterprises and new, privately owned factories contribute most of China's growth. But they are forced to raise funds from local governments, friends, or foreigners.

Reform of financial markets is urgently needed throughout the region, since the inflow of foreign money may slow. Previous waves of investment were driven by rises in the U.S. dollar, and then the yen, as U.S. and Japanese manufacturers scrambled into cheaper export bases in China and Southeast Asia. Some 70% of Japan's $11.7 billion in investment last year in Asia went into manufacturing.

Even though Asia will probably draw more Japanese money when the yen strengthens, this time around the "wave into export-related industries will be much smaller," predicts Tetsusaburo Hayashi, vice-president of the Japanese External Trade Relations Organization in Bangkok. Costs are not as attractive as they were, and many factories in Japan are now operating profitably at 110 yen to the dollar. "There will be a pause in manufacturing investment," says Taizo Nishimuro, president of Toshiba Corp. "This slowdown of Japan's expansion will have a very strong effect on Asia."

Warnings like Nishimuro's are getting more attention as the realization is sinking in that being the world's workshop cannot propel growth forever. Economists now argue that it would make more sense for East Asia to ease its fixation on exports and capital-intensive industries. Manufacturing accounts for 28% of the U.S. economy, but it reaches 43% in Indonesia, 45% in South Korea and Malaysia, and a full 55% in China. These countries could unlock new reservoirs of growth if they unleashed private enterprise in such barely tapped sectors as private health care, media, and consumer finance.

"THINKING" CONFERENCE. Switching economic gears requires an overhaul of education and training. In Penang, the government is beefing up tech training programs for workers in everything from factory automation to computer-automated design. Penang figures it has little choice. "No multinationals owe us a living," says Boonler Somchit, executive director of the Penang Skills Development Center. In Singapore, top officials vow to reform the education system to promote critical discussion and individual initiative. The government will even host a conference on "thinking" next June for 2,000 academics, executives, and creativity gurus. In the future, declared Singapore Prime Minister Goh Chok Tong in a recent speech, "what will matter will be the ability to think creatively and generate new ideas." Trouble is, Goh admitted, Singaporeans "are not strong on innovative thinking."

The most enlightened governments are also preparing for the impact of free trade on the region. Indonesia, the Philippines, and Thailand have been strident backers of the Asia Pacific Economic Cooperation forum, which aims to dismantle trade barriers in the Pacific Rim by 2020. Singapore will host the next meeting of the World Trade Organization. True free trade would correct the overexpansion in autos and semiconductors and other industries by exposing manufacturers to open markets.

Letting go of industrial policies entails wrenching choices. As East Asians weigh the probable consequences of free trade, domestic industries are exerting pressure on leaders in Beijing, Jakarta, and Bangkok not to open the competitive floodgates too early. "The problem with having a global economy is that nobody knows the costs and benefits for individual societies," says economist Chira Hongladarom of Bangkok's Thammasat University. "How do you decide which industries will survive when they all have strong political ties?"

Until now, the autocrats who have dominated East Asia have not had to make these difficult decisions. By fostering low-cost manufacturing and keeping a tight grip on their markets and financial systems, they have been able both to produce brilliant economic statistics and to keep themselves at the helm. At the same time, China's Communist Party, Malaysia's United Malays National Organization, the regime of Indonesian President Suharto, and successive governments in Thailand and South Korea still dole out choice franchises and contracts to local businesses based on connections and patronage, thereby thwarting the emergence of dynamic new entrepreneurs.

Tackling reform is especially hard while current-account deficits widen and anxiety runs high. But Asians have already shown enormous resilience in building their economies. Asian policymakers should also learn from the case of Japan, which never dealt properly with similar structural problems and is now paying the price. Although their economies are still expanding, they cannot take continued growth for granted. It is time for East Asians to chart a new course.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE