Where Asia Went Wrong

It stuck too long to Old World ways amid rapid global change

Vallobh Vimolvanich could only laugh at his predicament. As he was winding up a depressing interview in September, 1998, atop the imposing Telecom Tower, with its sweeping vista of stalled Bangkok construction projects, the managing director of TelecomAsia Corp. darted to a corner of his office and retrieved an umbrella. It was a gift from the head of one of Europe's biggest banks. "He told me that bankers have a saying: `When the sun is shining, bankers try to sell you an umbrella. When it's raining, they try to take it away from you,"' he said. "I wish I'd heard that earlier." He opened the umbrella and twirled it over his head. "I'm going to keep this," he said giddily. "At least I get a souvenir out of all this."

The climate for corporations across Southeast Asia had indeed turned stormy. A joint venture between Thailand's powerful Charoen Pokphand Group and Nynex, TelecomAsia had been billed as the rising star of Asian telecommunications ever since it landed a government concession in 1991, to install the first privately owned phone network in Bangkok. Back then, success seemed guaranteed. Some 1 million people were on a yearlong waiting list for service; lines were so jammed during weekdays that you needed a cell phone to place a local call. When TelecomAsia went public in 1993, its stock skyrocketed on the first day of trading, giving it a market capitalization of $10 billion.

But TelecomAsia had never lived up to expectations. The company had overstretched its finances to honor its pledge to install 2.6 million phone lines, even though midway through the job it was clear that it was building a network that was in no relation to demand. Signing up subscribers had been harder than expected; many new lines led to unoccupied condominium and office towers. Costly plunges into cable television and wireless telephony also were disappointing.

The crash of the Thai baht the previous July hit just as TelecomAsia's first installment on a $1.9 billion loan came due. Since TelecomAsia hadn't hedged against such a fall, there was no way it could repay foreign creditors. By the fall of 1998, Thailand's economy was severely contracting. The company had sold several big assets, but it wasn't enough. The search for new financing and investors had been fruitless. "Money flows like water to where it is most prosperous," Vallobh said, "and we are stuck on high ground."

The darkest days have passed, and sunlight once again is beaming down on the shattered economies of East Asia, some of which are posting growth rates reminiscent of the boom years. But for thousands of companies like TelecomAsia, the old excitement is gone. The Asian nations entering the 21st century little resemble the Tigers that charged into the 1990s. They still boast high savings rates, young populations, low-wage workers, and talented entrepreneurs and engineers. But with big budget deficits and banks still buried in debt, many resemble the Latin basket cases of the 1980s.

Their old models for growth, which revolved around export manufacturing and banking systems that pumped endless cheap credit into favored conglomerates and projects, have been either fatally wounded or rendered irrelevant by the new global economy. In this tough new era, it will be years before East Asia returns to strong, steady growth, much less recover all that was lost.

SIMPLE RECIPE. The best way to appreciate the magnitude of economic destruction is to take a quick swing through the region's big cities. Jakarta's central business district, the so-called Golden Triangle, is littered with unfinished hotels and office towers, rust stains streaking down from bare metal reinforcing bars with each tropical rain. The abandoned works of fallen master builders--vacant new cities, suspended mass-transit systems, the carcasses of skyscrapers and immense hotels--loom in Kuala Lumpur, Bangkok, and all the way up China's eastern coast. Steel, chemical, and car plants lie dormant or operate at a fraction of capacity. They tell the stories of overambitious tycoons, megalomaniacal dictators, and the financiers who foolishly showered them with money. They are like the archeological remains of a gilded, giddy age.

It's fashionable to say there never was an East Asian miracle. But that belittles three decades of remarkable accomplishments. No other region has reproduced East Asia's growth formula. The period from the mid-1960s, when the Vietnam War, Indonesian massacres, and China's Cultural Revolution defined the Asian landscape, to the crash of 1997 ranks among the longest stretches of regionwide, rapid growth in world history. South Korea, Taiwan, Hong Kong, Singapore, Indonesia, Thailand, and Malaysia averaged growth of 6% to 8%. It took the U.S. 47 years to double its income in the 19th century; many Asian economies did it in a decade--and then did it again and again. East Asia grew three times faster than Latin America and 25 times faster than sub-Saharan Africa. Of 119 countries studied by the World Bank over those three decades, seven achieved both high growth and low income inequality--all in Asia. The number of Asians living in poverty halved from 1970 to 1990, to 220 million, even as the population rose 425 million.

The miracle was that a set of countries with radically different cultures, natural and human resources, ideologies, and historical circumstances emerged from chaos and deployed the right mix of macroeconomic discipline and growth-generating policies, and maintained discipline so long. The recipe was deceptively simple. At its core were restrained public spending and borrowing that helped keep inflation low and currencies stable. This combined with extraordinarily high savings and investment rates, plus heavy spending on education. East Asia also came to account for three-quarters of manufactured exports from developing nations. The momentums seemed unstoppable.

How could it all self-destruct so quickly? Profound changes in global finance and manufacturing competitiveness offer part of the answer. But also, successful economic models were carried to wild excess. Asia was felled by thousands of ill-conceived projects financed by a deluge of cheap money. The damage had been done before the International Monetary Fund arrived. The main causes:

The Rise of Global Hot Money. From 1990 through 1996, some $355 billion in foreign private capital flooded into Thailand, South Korea, Malaysia, Indonesia, and the Philippines. The inflows rose from 1.4% of economic output in these countries to 6.7%. Most of these billions was in short-term instruments that could be jerked from country to country at the press of a button.

Asia's Old World business cultures and financial systems were too entrenched to keep up with the New World of warp-speed capital movements. Regulators lacked the clout to police burgeoning markets; banking supervision was weak. Few Asian loan officers, used to relying on personal ties and government guidance, could analyze credit risk. So they kept steering money to the same overleveraged oligarchs. Most corporations remained steeped in secrecy, nepotism, and handshake dealmaking.

Advocates of rapid liberalization tragically assumed that Western-style institutions and business practices would develop out of necessity. Few knew how long such a transformation would take.

Export Overkill. While Western corporations underwent years of reengineering to boost returns on capital, much of East Asia was fixated on adding production capacity and gross sales. The conglomerates of South Korea, Thailand, Malaysia, and Indonesia piled up debt to build ever-bigger petrochemical, auto, and steel plants. They ended up frantically competing in thin-margin commodities in an age of falling prices, for by the mid-1990s there were gluts in most of the industries they targeted.

What's more, low production costs and material prices no longer guarantee export success in the U.S. and Europe. Now, the premium is on flexibility, minimum inventory, and delivery within days of an order. That's not easy to achieve when plants are half a world away from customers. As a result, production bases are rising fast in Eastern Europe and Mexico. Asian manufacturers, of course, can also learn to provide first-rate logistical services and manage operations around the world. But these are not Asian strengths. And they no longer enjoy virtually limitless access to cheap capital.

Flawed Politics. With rare exceptions, Asia's dynamos were the creations of mercurial dictators who won power as anticolonial firebrands, independence fighters, or coup leaders. Few understood economics. But they had the sense to base their legitimacy on economic advancement, leave space for the private sector, and let technocrats take the wheel when wrongheaded policies imperiled the economy. Asia experts figured pragmatism would prevail in the 1990s.

But authoritarian systems had become a crippling liability. Without rival political parties, a free press, and independent courts, there were no checks against misguided policies and insider abuses. Slowing down became unthinkable, because Asian leaders and overstretched cronies had too much vested in rapid growth. The crisis also exposed the hazards of corruption and business conducted on the basis of guanxi, or connections. From Indonesia to South China, guanxi capitalism led to grotesque misallocations of money. Says the former regional chief of a Wall Street investment bank: "We said to ourselves that corruption just greased the wheels of capitalism. It was `regrettable but necessary.' We were just flat-assed wrong."

Asia is at a pivotal point. If the crisis engenders a radical overhaul of old approaches, it can veer back to strong, sustained growth. The most urgent task is to clear the crushing overhang of bad debt finish reforming financial institutions. Economies must rely less on exporting goods and more on domestic spending, service sectors, and indigenous high-tech startups. Governments must view foreign companies as sources of managerial knowhow, technology, and capital--not necessary evils. The focus also must shift from pumped-up statistics to bettering living standards.

There are signs of progress. But the revolution has hardly begun. As money gushes back, support for reform could dissipate. That would leave Asia vulnerable. Nothing has fundamentally changed in the global economy to keep the disaster of 1997 from occurring all over again.

This adaptation is from the upcoming Prentice Hall book Meltdown: Asia's Boom, Bust, and Beyond, written by Business Week

Asia editors Mark L. Clifford and Peter Engardio.

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