Ref yours...." To make matters worse her breadmaker is a Sanyo and we don't have a Sanyo bread slicer. So now what?"
I am laughing and have fallen onto the rug. I am now crawling across the room to my own breadmaker to see if it is a Sanyo.
Best to you,
Clark
A very elegant piece written on "the crisis" by Jeffery Sachs
For Private use only
(C) Far Eastern Economic Review
ECONOMIC SURVEY
Missing Pieces
After the deepest recession in memory, what next for Asia? That is the question at the heart of our annual economic survey that begins this week. Economist Jeffrey Sachs leads off with an essay on the need for Asia to invest in "social software" such as education and political institutions to regain its economic competitiveness. Two articles follow on the mixed prospects for foreign investment and exports to fuel recovery. The survey continues the following two weeks with a roundtable discussion by leading regional economists on the outlook for recovery, and forecasts for 10 leading Asian economies.
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By Jeffrey Sachs
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February 25, 1999
A fter a year and a half of economic crisis in East Asia, we can see more clearly the roots of the crisis and the way forward for the region. In the early days of the crisis, each analyst groped for a piece of a larger puzzle, like the proverbial blind men trying to fathom different parts of the elephant. Now it's possible to start assembling these pieces in order to construct a plan of action for policymakers and private investors.
The short-run phase, characterized mainly by financial panic, is coming to an end, and some early signs of recovery are already evident in South Korea and Thailand. The medium-term phase will involve a considerable amount of financial restructuring, as the region digs its way out of a mountain of bad debts. The long-run phase, however, may be the trickiest. Over the next few years, East Asia will need a significant upgrading of a range of social institutions--extending from politics to higher education, to science and technology--if the region is to re-establish rapid growth in the years ahead.
At the epicentre of the crisis, we now know, was a remarkable panic of foreign investors, created in part by a panic of the International Monetary Fund itself. The story can be summarized as follows:
As the world's most successful developing region, East Asia was able to attract several hundred billion dollars of international bank loans in the first half of the 1990s. By mid-1997, there were an estimated $274 billion of international bank loans outstanding to borrowers in five Asian developing countries: Indonesia, South Korea, Malaysia, the Philippines, and Thailand. Of this amount, roughly $175 billion was short-term, that is, with a maturity of under one year. The short-term debts borrowers in these countries owed vastly exceeded the level of liquid foreign-exchange reserves, which stood at about $100 billion.
When the international banks started to sniff trouble in 1996, with overvalued currencies, weakening exports, and overcapacity, these banks began to reduce their lending. After the devaluation of the Thai baht in mid-1997, they started to flee. When the IMF panicked--ostentatiously declaring that Asia needed drastic financial surgery such as immediate and widespread bank closures, astronomical interest rates and drastic fiscal cuts--the investors panicked right alongside.
Taking yet another step back, we see clearly that the financial market liberalization in East Asia in the early 1990s was the trigger for the huge inflows of capital. In the early 1990s, the international investors wanted a way to share in the Asian bounty, so they pressed Thailand, South Korea and other countries to open their capital markets. Yet the markets were opened in just the wrong way. Restrictions were kept on long-term capital inflows (such as foreign ownership of Asia's domestic banks), while short-term inflows were encouraged. Both the lenders and the borrowers dug their own graves.
At an even more general level, the financial institutions were incapable of efficiently channelling the increased inflows into profitable investments. There is plenty of evidence that the accelerated investment spending of the early 1990s was relatively poorly used, with low rates of return and excessive investments in several sectors. At the very core of the problem was the difficulty of achieving efficient GDP growth of 8% per year on a continuing basis.
Time has also shown that the financial crisis and its underlying causes were hardly unique to Asia. Since the outbreak of the Asian panic, Russia and Brazil also succumbed to a massive withdrawal of foreign creditors. Most of South America is likely to be pulled into financial crisis this year. The ingredients were everywhere the same, though with somewhat different proportions in each case: overvalued currencies fixed for too long to the U.S. dollar; heavy short-term borrowing from abroad; and poor advice from Washington, which tended to exacerbate panic and economic contraction.
Successful development takes time and care. Otherwise, capital spending will be directed at wasteful or superfluous purposes. Moreover, investment in the social software--education, public institutions, science and technology, democratization--has to keep pace with the rapid investments in the hardware of plants and equipment. Throughout Asia we can see the mismatches in "hardware" and "software" investments.
Now let's run the clock forward rather than backward. Starting with the proximate cause of the crisis, financial panic, the worst is over. The panicked flight of capital has ended: Short-term debts have been repaid, rescheduled or defaulted upon. This is the secret of the rebound in exchange rates and lowering of interest rates in East Asia in recent months. Without panic, asset prices have returned to reasonable levels. This is also the reason that Malaysian Prime Minister Mahathir Mohamad's currency controls were completely unnecessary and more harmful than helpful. Malaysia's capital controls didn't merely shut the barn door after the horses had bolted, but when the horses were ready to come back into the barn.
The financial wreckage, however, still lies strewn around the region. Bad debts are everywhere, and must be written down. The trick here will be compromise and speed. Most urgently, large numbers of Asian banks should be sold to foreigners, after sufficient public funds are injected to re-establish positive net worth. This would accomplish three things. The banks would be quickly recapitalized with private funds; foreign owners would bring high quality, and less politicized, management; and the banking sector would be less vulnerable to panic in the future, since foreign banks also bring a foreign lender of last resort with them.
With regard to corporate debts, foreign investors are simply going to have to split the difference with Asian enterprises, getting partial repayments rather than holding out for a complete takeover of domestic enterprises.
Longer-term financial management must be corrected, too. Exchange rates should be kept flexible, and with an eye on the yen and the euro as well as the U.S. dollar. There is no simple rule that can guarantee success, but rigid formulas are sure to produce failure. Financial supervision should be tightened to prevent the next generation of banks and corporations from borrowing short-term funds in such large amounts from overseas. (Yes, foreign lenders with very short memories will once again make such loans available in excessive amounts.)
A separate word should be said about Japan. Though obviously not a debtor country, Japan has seemed paralyzed in overcoming its domestic banking and financial woes. The U.S. advice--to expand deficit spending--has probably been more harmful than helpful. Japan now sits with a massive budget deficit and little growth in domestic demand to show for it. What Japan has long needed is a double-barrelled assault on its financial weaknesses: recapitalization of the banks plus a large infusion of money into the economy to boost asset prices and lessen the burden of bad debts. The yen would weaken relative to the dollar, perhaps to a range of ¥140-150, but this is probably a necessity for Japanese recovery.
The greatest challenges to long-term Asian growth, however, probably lie elsewhere. East Asia will restore its competitiveness in world markets only if the investments in social software are now given their due priority. Most of Southeast Asia is deficient in higher education, science and technology, and the quality of political institutions. Most of the universities in Asia are under the auspices of the governments--and that brings political implications which tend to weaken the various programmes of study.
One-party states are coming to an end in all parts of the world; much more open political competition will replace them. Latin America and Central Europe are ahead of much of Asia in this political transformation, and are likely to reap economic benefits from this advantage unless the laggard parts of East Asia make a determined effort to catch up in this respect, also. Fortunately, the experience of democratization in South Korea, Taiwan, and Thailand gives some important regional evidence of vitality and success in this aspect of change.
The annual Global Competitiveness Report of the World Economic Forum, also prepared in collaboration with the Harvard Institute of International Development, gives some clear and quantifiable evidence of these hardware-software mismatches (see chart). While the Asian manufacturing countries (China, Indonesia, Japan, South Korea, Taiwan, Malaysia, Thailand and the Philippines) achieved an average overall ranking of 21 out of 53 countries in the 1998 rankings, and a particularly high ranking of nine on fiscal management, these countries scored a surprisingly low rank of 30 in technology, and 34 in quality of governmental institutions, with the calculations based on a mix of business survey results and objective indicators.
If we delve more deeply into the problem of technology, we find that the Southeast Asian countries rank low on several dimensions of technological capability. In the advanced economies, research collaboration between universities and industry are a major fuel of technological progress. Such university-industry collaboration is evidently missing throughout Southeast Asia, according to the survey responses. At the same time, the business community identified a serious shortage of qualified scientists and engineers. Evidently, the entire nexus of scientific education and high-level R&D is woefully lacking.
There are no easy short cuts to improved science and technology. Foreign direct investments can make a difference, by bringing technology from the advanced economies. But FDI can't substitute for local scientific talent, which must be developed through stronger local universities as well as extensive training of graduate students abroad. Taiwan's illustrious science parks were filled with young Taiwanese scientists trained in the U.S., with early career experience in Silicon Valley and other hi-tech centres. Interestingly, India's long-term investments in the Indian Institutes of Technology are finally coming to fruition with the stunning growth of information-technology exports, which have now surpassed textiles and apparel to become India's leading export area.
Much of the news about public institutions is also discouraging. Indonesia, Malaysia, Thailand, South Korea, China, Taiwan, and the Philippines all ranked poorly on judicial independence in the Global Competitiveness Survey. On the key dimension of corruption, specifically bribes associated with business activities, Malaysia ranked in the middle, while Thailand, the Philippines and Indonesia languished at or near the bottom.
These "social software" problems were not, by themselves, the cause of the current crisis. After all, these problem areas have been rather well understood for years, and did not deter the region's sustained rapid growth over a period of decades. Yet they almost surely played an indirect role in the onset of the crisis, and will be a major drag on growth in future years unless they are more successfully addressed.
Part of the urgency for broader-based reform comes from the simple fact that the world economy is much more competitive today than just a few years earlier. For example, the region is now finding that many of its key export sectors suffer from a glut on world markets. East Asian exporters did well when they were virtually alone among developing countries in promoting manufactured-goods exports. Once the competition from China, India, Latin America, and Eastern Europe intensified in the early 1990s, however, the region's vulnerability to exchange-rate overvaluation, and to terms of trade decline, almost surely increased as well. While the solution to avoiding macroeconomic crises is to avoid overvalued nominal exchange rates, the key to the rapid growth in export earnings must also involve a continual upgrading of export products. In the future, East Asia will therefore have to give even more attention than in the past to improvements in education and scientific capacity.
One can make similar points about the quality of public institutions. Asia's flawed political institutions--that have supported many governments that greatly overstayed their welcome and allowed for too much corruption and mismanagement--are a cause for serious concern, even though they're not the proximate cause of the current crisis. Only Indonesia, arguably, was brought to its knees by cronyism; even there, it was a virulent banking panic, triggered by IMF measures, more than Suharto's corruption that brought the economy to collapse. South Korea and Thailand have made major strides to a more transparent, and probably less corrupt, system.
Indonesia and Malaysia are still in the throes of political instability, and are still in need of basic political reforms. If Indonesia's transition to democracy proceeds peacefully and honestly in the coming months, Indonesia will have won itself a new start in the world system. If the path to democracy is somehow blocked, then the crisis in Indonesia will deepen dramatically. Similarly, Malaysia has taken a pounding internationally from the lack of democratic scruples on display in that country.
In a world of growing international competitiveness, when foreign direct investors are courted not just by Asia but Central Europe and Latin America, the concerns over governance are bound to grow, and to weigh increasingly heavily on the unreformed countries of Asia.
Jeffrey Sachs is a professor of economics at Harvard University and director of the Harvard International Institute of Development.
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