THE BACKGROUND TO THE ASIAN FINANCIAL CRISIS

Ben Stavis
Director, Asian Studies Program
and
Associate Prof., Political Science Department
Temple University
Philadelphia PA 19122
send comments to bstavis@temple.edu
 

The financial collapse in East Asia in 1997 and 1998 has changed the image of Asia and has also changed our ideas of development strategy. It is clear that the crisis is embedded in the Asian "developmental state" (superficially called "crony capitalism" in today's press). The problem, ironically, is that the Asian developmental state was so successful that it led to over-production and sharp competition and price cutting, undermining everyone's ability to repay loans, which had been made recklessly. Dialectically, what had been the solution to the problem under-development became a problem of over-development. This paper will outline the evolution and structure of the Asian developmental state, its inherent problems, and the way it came to crisis. Clearly, in the new environment, the countries that have been following this model need to undertake important reforms.

THE JAPANESE DEVELOPMENTAL STATE

The Asian developmental state started in Japan in the late 1860s and has been evolving for more than a century. In this model, the state plays a critical role, helping to mobilize human resources to develop export earnings. The group basis of society and authoritarian politics are retained. These features will be reviewed here:

1. The state plays a critical role in mobilizing society to develop rapidly. In Japan in the 1860s, the impetus came from fear of Western colonialism. When China lost the Opium War to Britain in 1840 and was forced to open economic and cultural exchanges with the west. When Admiral Perry sailed into Tokyo Bay in 1854, the Japanese leaders recognized their serious risks and felt the urgent need to modernize, industrialize, and develop a creditable military capability.

The state played a direct role in developing modern industry. The state brought in the western technology, made the initial investments in enterprises, appointed managers, and coordinated the development. It gave the corporations a good deal of autonomy, but it retained leadership. After a few decades the state-owned enterprises went bankrupt and were privatized, but still, the state continued its leadership role in economic planning. It continued treating the now-private enterprises as virtual extensions of the state bureaucracy, and business owners and managers continued acting as obedient bureaucrats.

The state also leveled and integrated society. It ended privileges of the traditional military class (samurai) and enabled ordinary peasants to have all privileges of citizenship (including the right to serve in the military). It expanded education and made it compulsory, so that all members in society could contribute to development. When the privileged classes rebelled militarily, they were suppressed in a bloody civil war.

The virtual merger of state and economy providing both central leadership and decentralized management should not be surprising. It had twin roots: Traditional Chinese statecraft formed one model. In the traditional Chinese state, the state had the responsibility for major flood control and irrigation projects, for the development of critical industries (esp. salt and iron), for much science and technology (astronomy-calendar, metallurgy, chemistry, etc.), and for organizing and managing trade and labor associations to stabilize markets. Second, the traditional Japanese state had a distinctive blend of a centralized state coupled with feudal decentralization.

2. In terms of economic strategy, the East Asian model is based on using East Asia's one plentiful resource, namely human resources. The simple phrase to describe resources has been, "lots of people, little land." How to convert rich human resources into national wealth has been the fundamental challenge in Asian development.

Historically, human resources were used in labor-intensive rice cultivation and silk making. Rice is a crop that responds well to garden-style management. If the land is leveled carefully; if it is irrigated and drained carefully through carefully maintained canal systems; if seeds are planted early in protected beds so that seedlings can be transplanted when the weather is warm enough; if it is fertilized (largely by recycling of animal manures and human excrement); if it is weeded maticulously; if seeds are selected for resistance to diseases; if locusts and other insects do not swarm; if people are mobilized to harvest, thresh, plow, and transplant in the middle of summer to plant a second crop -- in short, if people work very hard for the year, rice offers the most caloric value per acre of land in traditional agriculture.

The traditional supplemental use of labor has been to produce silk for export. A lot of labor is utilized to grow and collect mulberry leaves to feed silk worms, to manage the reproduction and growth of silk worms, to unravel the cocoons into thread, to process and dye the thread, and to weave a cloth. The result, of course has been a highly prized commodity that provided the foundation of trade between Asia and Europe two thousand years ago, across the "Silk Road."

Japan certainly utilized the rice-silk strategy in the early stages of its development, but its leaders at the turn of the century had another idea as well. They noticed that European states had conquered other countries and established empires to ensure access to raw materials and markets. They emulated this strategy from 1895 to 1940. First they conquered the Chinese province of Taiwan, to expand their agricultural base into southern latitudes that could prove both rice and semi-tropical fruits and vegetables. Next they took over Korea, with its agricultural and mineral resources. During the first part of this century, Japan expanded its influence and control in China to provide access to the iron and coal of the northeast China, as well as its rich agricultural resources that provided protein-rich soy beans as well as other crops. Imperial conquests extended to Southeast Asia, including oil-rich Indonesia. The expansion of Japan's empire and resistance to it led to the Asian part of World War II, with its enormous human costs.

With Japan's loss in World War II, its colonial empire collapsed. For that matter, all the other colonial powers (England, France, Holland, The United States, Italy) discovered they could not hold their colonial possessions. Independence movements swept virtually all colonies in South Asia (India, Pakistan, Sri Lanka), Southeast Asia (Indonesia, Indo China, Philippines), and Africa, replicating the independence movements in North and Latin America, a century or two earlier.

Without an empire, Japan's leaders came up with a profoundly simple but revolutionary strategy to develop on the basis of human resources. They discovered that they could embody human resources in labor intensive products for export. At first, they focused on hand labor. Hands could sew clothing, shoes, pocketbooks, etc. They could assemble toys, solder electrical devices, grind fine optical lenses for cameras and binoculars. Later they realized that labor could be used extensively in metal fabrication industries, making simple tools, and building ships.

As this trade evolved, the economic strategists realized that it would be more profitable to make more specialized, expensive, high-technology products that incorporated brain power more than hand labor. Japan started designing the electronic devices they assembled, and took over the stereo industry. Later they developed VCRs, telephone answering machines, cell phones, and who knows what next. Similarly, the fine machinery skills developed in optics and cameras were matched with superior engineering, and Japan's motorcycle industry took over the world. Engineering brain power was applied to the automotive industry, and Japan was soon a major producer and competitor in this industry. Similarly, Japan's engineering talents went into machine tools and robotics, with very positive results.

In applying brain power, Japan's economic strategy went beyond engineering component. They developed highly efficient methods of industrial production, so that they could produce at a low cost. They developed special methods of management, to minimize defects. Their marketing system was able to identify, open, and nurse emergent markets throughout the world. One of the greatest indicators of Japan's marketing, management, and manufacturing strengths has been their ability to identify and satisfy markets in the United States, before domestic companies understood what was happening. By developing products that could be sold globally, they could further reduce costs of production and improve their competitive position.

Ultimately, Japan accumulated another resource with which they could make money: capital. They were able to invest capital in a wide range of assets to generate long-term income flows. U.S. Treasury Notes, stocks, bonds, etc. They invested in real estate, including both office buildings and farm land. They invested in manufacturing facilities abroad, closer to markets, able to utilize lower cost labor, in areas with fewer environmental controls, and in countries which insisted on local investment as a precondition for trade.

3. While competing vigorously in global markets, Japan shielded its domestic economy and society from much of the roughness of a free market place. Japan did this within the context of a traditional culture with a Confucian foundation that emphasized collective group identify, hierarchy, and personal relations. Remarkably, Japan's capitalist taming of the market place had some similarities with (as well as important differences from) both Fabian and Stalinist socialist systems in western Europe and the communist bloc.

Within the work unit, great emphasis was placed on stability. In many cases, employment was for life. Workers would not seek jobs elsewhere, and employers would protect workers' livelihood, even in periods of economic downturn. Employers were asked to make a full commitment to the corporation; labor unions were weak. Salaries and status was linked to seniority, thereby minimizing other forms of intra-group conflicts. Management was expected to work closely with workers and minimize social distance. Japanese management style included similar uniforms for everyone (no "blue collar" and "white collar" dressing and status). Management and workers would share the same dining facilities, and interior space was arranged to emphasize openness and sharing, rather than privacy and power. In short, the market did not threaten workers with unemployment or sharpen social or economic differentiation.

However, in sharp contrast to the various forms of socialism, the Japanese system did not provide cradle-to-grave social welfare. People had to save and invest for their own retirement funds, and this has created a very high savings rate, abundant supply of investment capital, and low interest rates. With a low interest rate, it has been easier for investors to think about productive investments with long-term payoffs. (Higher interest rates require faster payoffs of investments.)

In relations between enterprises, market forces were also muted. Corporations functioned within groups or networks of corporations. Before World War II, these were formal holding companies, known as zaibatsu. Within one group, there might be a wide range of complementary enterprises -- coal mine, steel mill, machine tools plant, ship building, auto/truck manufacture, auto/truck parts factories, electronics, communications, insurance, banking, retail sales, import-export trade, etc. Typically, the bank within each zaibatsu played a critical role in financing the various enterprises. The bank owned shares in the companies and had a strong voice in their boards of directors. While the bank certainly wanted each company to be profitable, it took a long-term view of profitability and was equally concerned with maintaining and expanding market share, because each company was also, hopefully, contributing to the profits of other companies in the group.

After World War II, the U.S. military occupation leaders gauged that these industrial concentrations were too large and powerful, were monopolistic, and had contributed to Japan's militarism. The zaibatsu were dissolved and banned. But the notion of group organization fitted Japan's culture. The groupings reappeared, renamed "keiretsu." In the new form, they lacked the formal holding company structure but they remained groupings of corporations with long-term, stable relations. Banks continued to be linked to corporations within the keiretsu. All companies were reluctant to do business outside of these relations.

Relations with investors has been long-term as well. Banks have owned substantial portions of corporate assets. They have stressed long-term development and market share, rather than quarter-by-quarter profits. They are not expected to invest outside of their keiretsus, so they have little choice but to assist their corporations grow and develop.

Finally, as suggested above, corporations accept a leading role of the government. The Ministry of International Trade and Industry (MITI) has played a critical role in developing a strategy for overall economic development and for guiding companies to function within this strategy. MITI can encourage investments into new areas with loans, subsidies for job training, etc., and can also encourage termination of production activities or closing of facilities. In cooperation with various other ministries of the Japanese government, even if formal tariffs are fixed by law and international treaty, a wide range of informal administrative decisions can be made under the guise of health and safety that can protect domestic markets from foreign competition for many years.

These long term relations between suppliers, banks, politicians, and government administrators are also expressed as personal relations. They may have started among classmates at college, typically the Law Department of the University of Tokyo. They have been cemented by after-hour socializing as well as gifts. These gifts may be small and symbolic, but sometimes, especially those given to politicians, are of considerable value and play a critical role in funding campaign expenditures and patrimonial linkages.

4. Authoritarian Politics

In the 1880s, the Japanese leaders decided they needed a western-style constitutional system. Although they studied the American, British, and French systems, they decided that Bismark's system was most suitable to them. Bismark had just unified a loose confederation of feudal domains, he had developed industry, developed military power, and created a centralized system. This was exactly what Japan's reformers were seeking.

In adopting Bismark's system, they established a constitution in 1890 that was highly authoritarian. The Prime Minister was a virtual dictator. The parliament was little more than a debating society, lacking the power to withhold money from the government. During the early decades of the Twentieth Century, Japanese demanded more democratic rights. Suffrage did expand, but instead of democracy, they got military dictatorship in the 1930s. Democracy eventually did come after 1945, but it was imposed on Japan by a military occupation, not as a result of domestic political dynamics.

The historical model of Japan is clearly that for several decades, industrialization and social transformation are created under an autocratic government. As the economy becomes very complex, as workers organize and demand their rights, as business requires a stable legal environment and pressures grow for a more democratic form. However, the political dynamics of transformation of the autocratic Bismarkian system into democracy is something the Japanese did not learn and is not part of their model. The Japanese experience of democratic transition imposed by a military occupation is hardly an attractive model to anyone.

On balance, the Japanese system as worked brilliantly. Japan has become one of the very rich countries of the world. While growth has been stagnant this decade, and while living conditions are still cramped, Japan is living proof that non-western countries can become rich. It is the envy of much of the world.
 

REPLICATING THE JAPANESE STRATEGY

The Japanese developmental state has been the model for development in East Asia precisely because it has been successful, it seems congruent with Asiatic culture, and it stabilizes and enriches the political-business elites. The model is certainly no secret and is not patented; every country can copy it. Its key element, human resources, is everywhere in abundance. Every country in Asia has a large, lowly paid labor pool that can be employed making low-cost labor intensive exports. Every country in Asia has bright young children, eager to be educated in science, technology, and computers and ready to enter high-technology competition. Moreover, as more countries are drawn into this strategy, owners of factories are eager to invest in new countries, because they can have their products made by lower-priced labor. Thus it is not surprising that the Japanese model spread throughout Asia.

Logically enough, the strategy was first emulated by the states which knew it best, the former colonies of Japan, namely Taiwan and South Korea. Just as Japan in the 1800's was trying to strengthen and protect itself against European colonialism, Taiwan and South Korea, as portions of larger, divided states, were engaged in fierce struggles for autonomy, legitimacy, and survival. The elites in these two former colonies may have hated and opposed the Japanese exploitation, but they fully understood the power and structure of the Japanese developmental model.

They both quickly centralized power, established authoritarian states in which the military played a key role, and expanded the role of the state in creating and shaping modern industry. In Taiwan there was much U.S. influence and willingness to dilute the Japanese model somewhat, but in South Korea, the similarity to Japan was striking. The state played a key role in structuring the economy. The Korean government has government agencies and ministries modeled after Japan's, including a Ministry for International Trade and Industry (MITI). The concept Japanese zaibatsu was replicated in Korea, as the chaebol. (While "zaibatsu" and "chaebol" sound different, both phrases utilize the identical original Chinese characters.) The same concept of banks playing a key role in industrial development was maintained. Lifetime employment in factories was copied. The close network between state and economy, integrated by gifts and financial payments, was copied and perhaps "improved." (A former Prime Minister was eventually convicted of accepting bribes. Over US $600 million had gone through his bank account!)

In terms of economic strategy, both followed the path of developing labor-intensive exports and then converting to brain-intensive industries. They initially competed vigorously in the area of sewing clothing, shoes, etc. Taiwan moved strongly into textiles and electrical and electronic devices. Eventually it focused on the personal computer industry, and developed its own brain power in this field, so that it could sell engineering as well as hand labor. Taiwan has become the major supplier in the world of the critical components of personal computers.

Korea, a much larger economy, developed a more diversified economy. A critical element in its strategy was to create ultra-modern steel mills. With low cost steel available, Korea moved into ship building and automobiles. These male dominated industries developed strong labor unions, unlike the sewing and electronic soldering industries which use female labor and are less likely to unionize. The trade union movement in Korea played a large political role in the 1980s. Korea also competed in the electronic-computer markets.

In both Taiwan and Korea, after two or three decades of rapid development, pressures towards democracy increased. In Taiwan, especially as the United States recognized the communist government in the mainland, it became increasingly absurd for the Taiwan government to base its legitimacy on its claim to be the government of all of China. It needed democratic elections to provide political stability. In the late 1980s, the political leadership moved boldly to terminate martial law, to allow political parties to function, and to have free elections. Taiwan went through a remarkable political transformation.

In South Korea, the legitimacy of the military governments, installed by coups and assassinations, grew increasingly thin. Especially after the bloody repression in Kwangju in 1980 (in which around 2,000 students were thought to have been killed), students and trade unions waged relentless demonstrations until the political elite realized that constitutional reform and elections were needed to provide political stability. Governments were elected in 1988, 1992, and 1996, moving progressively from leadership of the old military group to leadership by former political dissidents, political prisoners, and poets. Again, this has been a breathtaking political transformation.

Two other places in Asia, the city states of Hong Kong and Singapore, drew on the same model, although they too implemented it in distinctive ways. As city states, with negligible rural hinterlands, there was no need to consider agricultural or rural development. Like any city, to eat, they had to export industrial goods. However, they were unusual in that they are disembodied cities, unattached to a large country. With no national market, they took the whole world market as their hinterland.

Hong Kong and Singapore, although ethnically Chinese, had been British, not Japanese colonies. In some ways, they reflected opposite ends of the British political spectrum. Hong Kong followed a Tory approach to development. The role of the state was minimized, and free markets ruled. The state provided minimal guidance and minimal health and education services. In contrast, Singapore seemed to reflect the Labour Party's Fabian socialism. Its long-term leader Lee Kwan-yu was, in fact, associated with the Democratic Socialist movement. Singapore has public housing, public health services, and governmental steering of the economy. It has emphasized attracting investments in factories of large, high-tech multi-national corporations, which have provided good wages for much of the population. Singapore is now developing a high-speed data network so that everyone can use computers in new ways. It is becoming the world's first "smart city."

Both Hong Kong and Singapore retain their authoritarian politics. Singapore has a parliamentary skeleton, but its politics have been dominated by a single party, dominant leader Lee Kwan-yu, and strong doses of coercion. In Hong Kong, the colonial administration was not interested in democracy, and as time came to return Hong Kong to China, the Chinese vigorously opposed democracy in China, fearing it would set a model for political development on the mainland.

As the success of these emulations became evident, the idea of utilizing the Japanese model spread to China. As early as 1980, China started to show interest in the idea of cultivating labor-intensive exports. They developed the city of Shen Zhen, adjacent to Hong Kong, to utilize Hong Kong's capital and entrepreneurship and to provide land and low-priced labor, both in short supply in Hong Kong. These strategic ideas quickly spread throughout the cities and towns in south China, and spread to other major cities that historically had been linked to world markets, such as Shanghai. By the mid 1980's China was courting investments from major multi-nationals to set up joint ventures in a wide range of modern technology. While multi-nationals were hoping for access to China's vast markets, the Chinese government wanted the multi-nationals to provide capital, technology, management sills, and international marketing capabilities to earn export dollars.

Needless to say, the Chinese were perfectly comfortable with the notions of a strong state steering the economy and resisting democratic urges of the citizens. They had that already. In fact, the new model required a somewhat reduced role of the state in the economy to leave more room for market interactions. Chinese have been moving slowly in this direction, gradually privatizing some sectors of the state economy.

Bureaucrats have not resisted giving up economic power in China. Instead, they have capitalized personally from the process, selling state assets to their children, relatives, or friends, at very favorable prices. A new ruling elite is being constructed, linking together former communist leaders and bureaucrats with upstart entrepreneurs and international corporations.

Elements of the Japanese model have been copied elsewhere as well. Thailand has also been seeking investments from aboard and has been developing its labor intensive export industries. Indonesia is a little different. While it has vast supplies of labor to produce labor intensive exports, unlike other regions of Asia, it also has natural resources that can be exported, principally petroleum and lumber. To some extent, Malaysia also has resources, historically rubber, palm oil, and tin. Vietnam is trying to get onto the lower rung of this pattern of development as we.
 

PROBLEMS WITH THIS STRATEGY

The strategy of the Asian developmental state is powerful and attractive. It also has some very important problems. The first clear manifestation of problems was the collapse of Japan's "bubble economy" in 1991 and continued stagnation for the 1990s, as Japan hoped that minor fiscal and monetary reforms would restore growth. The financial collapses in Thailand, Indonesia, and South Korea, with spill-overs into other Asian countries in 1997 and 1998, show the pervasiveness of these problems that are inherent to the strategy.

1. Overproduction and downward pressures on prices

The most obvious problem with the Asia strategy is that it relies on earnings in export markets, and export markets are limited in size and growth. When we think back to the early 1980s, it seemed that already Hong Kong, Taiwan, and Korea had fully saturated our ability to buy clothing and shoes. At that time, these three entities had a total population of around 65 million people. Then more countries leaped on the bandwagon, especially China, with its roughly 1,000 million people. Even if one thinks "only" of coastal China, there were probably roughly 300 million people. Roughly five times the previous number of workers were ready to make products for export. Of course this put downward pressure on textiles, toys, anything that Chinese labor could make.

As prices went down and profits were squeezed, businessmen were even more interested in investing in factories in new locations, with lower labor costs. In particular, Chinese businessmen in Hong Kong, and Singapore, with ample capital but very restricted building space and labor supplies, circulated throughout China, looking for new investment possibilities. By around 1990, Taiwan businessmen went to China too, despite the political crevasse between these two regions of China.

At the same time, not wanting to be dependent on China, wanting to hedge their bets and diversify, and to engender competition between different potential suppliers, they went to Thailand and Indonesia to invest in productive facilities. This competition, in turn, put pressure on China.

As vigorously expanding production for export faced modestly expanding demand for imports, prices fell. In this type of international strategy, the obvious, simple way to have an across-the-boards price cut is to devalue the currency. China took a critical step in 1997, when it reduced the price of the Chinese yuan by one-third, from $.16 to $.10.

Obviously, this put great pressure on all the other countries to cut their prices (devalue their currency) too, unless they had special products that were in higher priced, less competitive markets. A great international price war was started by countries to retain some foothold in saturated markets.

2. Corruption

A second inherent problem with this strategy has been corruption. The confluence of government power over the economy, a society based on personal relations instead of law, and primacy to familial obligations results in extensive corruption and nepotism. The western observer might criticize corrupt behavior from a moralistic perspective, but in other cultural systems, moral behavior requires favoritism to family and friends. This issue is embedded very deeply in history, culture, and social structure.

Although China created the concept of bureaucracy thousands of years ago, it also retained the primacy of personal relations. Confucius directly argued that filial piety trumped following the law. Historically, the Chinese bureaucracy was never funded adequately from public funds; bureaucrats were expected to charge for their "services."

Over a century ago, Karl Marx recognized that Asia did not fit into his model of the transition of feudalism into capitalism. He guessed that there was an "Asiatic Mode of Production," in which the traditional state played a special role in managing the economy, unlike western patterns. Later, German sociologist Max Weber reached a similar insight from a different theoretical perspective. He argued that "traditional" societies were very different from "modern societies." In traditional societies, personal relations counted far more than law. A person's family and social position counted for more than his actual ability and accomplishments. Weber suggested that a "patrimonial state" could provide transition from one social form to another, and that his system was characterized by personalized patron-client relations, in which bureaucratic power was intertwined with the personal relations.

Confucius's primacy of personal values over bureaucratic or legal principle, Marx's "Asiatic Mode of Production," Weber's "patrimonial state," and the current phrase "crony capitalism" all point towards the same phenomena, the intertwining of bureaucracy and personal relations, resulting in corruption and nepotism. Needless to say, the concept of the "patrimonial state" is not congruent with China or Asia. It exists everywhere, to a greater or lesser degree. Systematic attempts to compare the levels of corruption in various countries show both the prevalence and the tremendous structural differences between European systems and many third world systems. A convenient access to comparative analysis has been done in a joint project of Transparency International and the University of Goettingen. (http://www.gwdg.de/~uwvw>

Japan seems to have less corruption than most other Asian countries, but since the mid 1970's Japan has had one scandal after another, starting with the Lockheed scandal, continuing through the Cosmos Recruit scandal, and now centering on the banking scandal. It used to be thought that these financial scandals were anomalies in an otherwise healthy environment of government leadership. However, the persistence of scandal in Japan and the discovery of the magnitude of financial payoffs in South Korea make it clear that these types of relations are an inherent part of the model of development. Similarly, in China corruption is a manifestation of the conversion of the old communist elite into a new business elite, and of the intergenerational transfer of fungible political assets to the next generation.

Corruption has serious economic and political consequences:

From an economic point of view, if government policies are shaped by financial contributions and political considerations, there is a high likelihood of adopting policies, corporate structures, and corporate leaders which are, to put it charitably, inefficient. In Japan, the over-representation of the rural sector has led to the maintenance and protection of a very high priced agricultural sector. Japan has risked major trade confrontations with the United States to protect small, inefficient producers of oranges and apples for political reasons. In the urban sector, the real estate market has been static. Low-rise buildings are protected, so it is very difficult to convert land to more intense, efficient use. As a result, the land prices are astronomical.

The structural aspects of corruption are even more obvious in Indonesia. General Suharto is simply setting up his children as the business tycoons of the future. They lack business acumen, and the result is massive waste and little economic performance.

Another problem with corruption is that it becomes an obstacle to developing effective interactions with many of the leading multi-national corporations. The United States has laws prohibiting bribing of foreign officials. While U.S. corporations presumably have enough lawyers and creativity to figure out how to circumvent the law (probably using foreign subsidiaries), the fact remains that most western businessmen are more comfortable in the realm of product, price, and service, and are uncomfortable in the realm of bribe and gift. They often shun Asian business because they lack and do not want to develop such business skills.

During periods of rapid economic growth, minor inefficiencies have only marginal significance. But as markets saturate and profit margins go down, these inefficiencies can make the difference between profit and loss. And, as we will see, the narrow difference between profit and loss means the critical difference between paying off loans or defaulting.

Corruption also has political consequences. In Japan, with each new scandal, the political legitimacy of the dominant party, the Liberal Democratic Party (LDP) eroded. Finally the LDP lost its parliamentary majority in 1993. Whether it will be able to re-establish is stable majority position is far from clear. Japan may finally be entering a period of competitive, multi-party politics.

Analogously in China, anger about endemic bribery and corruption sparked the Tiananmen Square demonstration in 1989. Similar forces were at work in the political demonstrations in Burma and Thailand, and could easily explode in Indonesia.

Corruption is a double edged sword. To some extent, it can integrate political elites (if spread out broadly enough), perhaps improving political stability. At the same time, it engenders popular anger and cynicism, leading to potential civil uprisings.

3. Breaking Iron Ricebowls

One of the distinctive aspects of the Asian Developmental strategy has been the way it has shielded many people from the vagaries of market relations. The principal way has been to offer life-time employment in the industrial sector and subsided, assured food. The importance of this can not be underestimated. The Asian culture originated from an environment in which life was not assured. Periodically famine would come and large portions of the population would die. Families would be torn apart or terminated. People were not concerned about getting rich. Instead, they were concerned about survival in bad years. An employment system that guaranteed them food, regardless of any circumstance (an iron rice bowl, that could not break), was a wonderful gift.

Permanent employment was characteristic of the Japanese industry under the rubric of traditional group-oriented values. It was also characteristic of China, under the language of proletarian control of society. Korea copied the system also.

The problem with this system, of course, is that it adds a great deal of difficulty in adjusting economic patterns to change conditions. Demand may change for a product; technology always changes. How is it possible to have a static labor force? Efficiency would seem to require a system in which workers leave jobs (voluntary or forced) and seek new positions in sectors of new need.

Again, as profit margins decline in Asian economies and efficiencies are needed, economists and managers disparately want to end the system of permanent employment (iron rice bowl) and introduce a system of flexible labor markets. Workers resist. In China, as much as the governments wants to introduce flexibility to the labor market, workers fear unemployment. They threaten demonstrations, which the government fears. Similarly, in Korea new laws were passed to allow workers to be fired. They have struck and demonstrated to protest such laws.

Similarly, the whole system of keiretsu/chaebol creates sort of an "iron rice bowl" for small suppliers within these groupings. To a certain extent, these make it difficult for corporations to develop lower-cost providers of some components. They also may contradict the spirit and rules of the World Trade Organization. Similarly, these arrangements will probably be revised as competitive pressures intensify.

4. Changing International Conditions

Changing international conditions have also created problems for the East Asian developmental state. The major problem has been the collapse of the Soviet Union and the end of the cold war. To have vigorous growth through exports, it was necessary to have large, rich export markets. In the post World War II years, the United States was the most important market. It opened its borders to vast imports form Japan, Taiwan, and South Korea. The United States had security interests in helping these countries export and develop their economies. It felt that that would be stable, secure allies in the cold war. Japan provided military bases, from which U.S. military forces could reach Soviet military assets in Vladivostok. Taiwan constrained China. South Korea was the front line in the cold war. Free access to the rich U.S. market was the quid, in exchange for the quo of strategic assistance in the cold war.

When the Soviet Union disintegrated and ceased being a strategic threat, the quo was no longer worth the quid. The United States pushed harder on its trade partners in Asia, demanding that they open their borders, reduce their informal obstacles to imports from the United States, and in general, move towards a more balanced trade with the United States.

At the same time, the United States emphasized its relations with its Latin American neighbors. The North American Free Trade Association provided opportunities for Mexico to compete effectively with East Asia as the origin of low cost labor-intensive exports to the United States, and other countries in Latin America started to take on the same role.

Less enthusiasm from the United States and more competition from other countries in Latin America combined to add to the pressures on the East Asian developmental states.
 

THE BURSTING OF THE BUBBLE ECONOMY

These problems first came together in Japan. As late as the 1980s, Japan had vigorous economic growth. This drove up the price of land and properties. Overvalued land was used to secure more loans to buy more assets at prices not supported by cash flow analysis.

Some of the investments were made abroad. Japanese analysts (as others throughout Asia) understood that the vast supplies of very poor but potentially very skilled human resources in Asia (China, Vietnam, Indonesia, India, Bangladesh, Pakistan) could put enormous downward pressures on all efforts to capitalize on human resources. The alternative was to take profits that had been earned already and invest them in other types of assets that could give virtually perpetual, stable returns, uninfluenced by Asian labor dynamics.

Fortunately for Japanese, foreign demand for their products pushed up the value of their currency. Foreign assets became bargains. Rather than buy oversized American cars or washing machines, as U.S. business interests and the government had hoped, Japanese bought U.S. assets, such as U.S. Treasury notes, with stable interest income. They bought U.S. farm land, thinking that farmland would maintain value. They bought office buildings, with seemingly stable rental incomes. They bought art works, entertainment companies, golf courses, baseball teams, etc., hoping to establish secure future income flows uninfluenced by more Chinese workers entering global competition. In many cases they paid very high premiums to buy these assets, and in many cases the assets did not return anywhere near the level or stability of income flows they had hoped for.

Japan's bubble broke in the early 1990s. Japan's economy showed virtually no growth in 1993. The stock market crashed, loosing half its value. Land and property values similarly plummeted.

The combination of economic stagnation and corruption led to a political crisis as well. In 1993 the Liberal Democratic Party lost its control of the Japanese political system. Since then Japan has had multi-party coalition governments. They have tried to make systemic reforms, but have not had the political strength and stability to make long-term structural changes.

The bursting of the Japanese bubble economy was self contained. Japan had financed its own growth and its own bubble. As the bubble was bursting, Japan did not have to pay back international banks with deflating currency. There was no international financial crisis, but there was anxiety, as financiers wondered if Japanese investors would withdraw funds from foreign markets to cover paper losses in Japan's internal market.

In fact, the Japanese government let banks keep assets on the books at purchase prices, so that technically the Japanese banks remained solvent, even though everyone knew that they were skating on very thin ice, improbably supported by unrealistic accounting procedures and very "friendly" government rules and regulators. Instead of a crisis and a shakeout (along the lines of the U.S. savings and loans mess), Japan has had stagnation.
 

THE ASIAN BANKING CRISIS

The bursting of Japan's bubble reflected underlying dynamics which affect all of the countries that followed Japan's model. The competitive pressures resulting from more and more countries adopting the strategy cause constant stress. Changes in the the international situation have added to the problems. Like a bicyclist coming to a hill, the Asian economies had to keep peddling harder and harder to maintain stability and to prevent falling over. However, even the IMF and the World Bank, in their analyses of the East Asian economy just months prior to the financial collapse, were optimistic.

So the question is: what forces transform a problem into a crisis? To answer this, we have to understand the dynamics of banking.

The banking industry must loan money to make money. No loans, no profits. So when it identifies an area/sector that seems profitable, bankers flood in, offering bigger loans at lower rates. Everyone wants to have a significant share of a presumably expanding market. The fact that other banks enter the market is sufficient proof of the inherent profitability of making loans to that market. Global banks competed with each other to loan to the "emerging Asian markets.

As bankers competed to make loans, they make them more and more recklessly, with less attention the the likely future cash flows under less favorable assumptions. Looking at the prospects of a single company, they do not fully appreciate that many other companies will be adding to the supply of the product and providing competition. This will put downward pressure on prices and profits. If common natural resources are involved, they overlook the possibility of aggregate actions of the industry might deplete the resource. They do not think clearly what will happen to the market value of assets that are securing the loan in the event of an economic downturn. They tolerate components of cost structure that essentially are corrupt payoffs to officials, friends, and themselves.

When these problems begin to accumulate, they can quickly get out of control. When people have trouble paying their loans, they may sell products or assets at reduced prices. This pushes down prices and profitability, so others in the industry have trouble paying off their loans. In international economics, the way to reduce prices is through devaluation of currency. As currency is devalued, profits drop too low to repay the loans. As profits fall and currency cheapens, the asset value no longer can match the mortgage. All the Asian countries are trapped in a downward spiral.

Ultimately, bankers brush the crisis under the rug with the graceful phrase, "un-performing loans." They threaten economic chaos unless some government's program can be manipulated to subsidize this combination of foolishness and corruption.

This general pattern holds in a wide range of situations.

- loans to fishermen in New England and Canada.
- loans to real estate developers in Texas/Oklahoma.
- loans to farmers in Iowa.
- loans to third world countries to support petroleum development.

The banking crisis in East Asia is roughly the same type of crisis.
 

REFORM AND ADJUSTMENT

The international banking system has extensive experience with debt and debt crisis, going back to the 1970s, as countries borrowed for investment and to cover the increasing costs of petroleum imports. By the 1980s, the World Bank and the International Monetary Fund had worked out fairly standard method of managing the debt crisis. The made loans conditional on countries adopting "structural adjustments." This meant that countries would have to open up their economies to market forces. This included privatization of government-owned companies, reduction in government rules, regulations, and permits that restricted market responses, opening up the economy to foreign trade and investment, greater transparency in accounting procedures, reductions in government corruption, reductions in government subsidies for food, fuel, health, etc.

The international banking system is, not surprisingly, trying to impose this set of solutions on those countries in East Asian that are unable to pay their loans. South Korea and Indonesia are resisting vigorously the pressures of the IMF to adopt such reforms. They want to retain their indigenous approaches. Indonesia's aging leader Suharto does not want international interference in his family zaibatsu. Korean financial and political leaders do not want to surrender power over their economy for foreign bankers.

Whether they will manage to retain more autonomy than Latin American and African leaders did during the 1980s and 1990s is not clear. In those regions, leaders had little choice but to adopt these structural adjustment programs to remain financially afloat. In Asia, subsidies and easy access to international markets are no longer likely. Government leadership and shielding of society will decline, and markets will play a larger role. The iron rice bowl must go, and mobility in the labor market established. Economic leadership must shift to those with business acumen, and corruption and nepotism need to be restricted. Crony capitalism can not continue to be subsidized, either by the poor or by the rich countries. However, these changes will not be easy.

There is no doubt that these changes have caused enormous pain in the short term. Investors loose assets into the vastness of banks' cyberspace. Businessmen loose their businesses. Workers loose jobs, wives loose husbands. Food prices go up, medical services disappear. Families are torn apart as people migrate to find some new source of sustenance. Governments can fall, if they fail to get foreign aid. One way or other, the Asian countries will go through such pains.

Whether these structural adjustments actually contribute to long-term economic growth is not yet clear. The actual economic data are far more ambiguous than the economic theory and ideology. Eventually, a new equilibrium is established, based more directly on realistic evaluations of peoples' resources and abilities. Many old lives were "ruined" and lives start over again, but the world does not come to an end.

These dynamics will have spill-over effects on countries that do not have these debt problems. Investment funds from Asia will decline, and this will reduce China's efforts to attract and utilize foreign capital. They will also impact U.S. financial markets. Also, as Asian countries keep their foreign exchange valued very lowly, this will present China with serious competition. It will also benefit importers of these products in rich countries, but complicate competition against these imports from other manufactures.

As we have seen, these elements in the Asian developmental state are deeply embedded in culture and history. In China, there has been a fairly clear understanding for over a decade that market reforms are needed, that the iron rice bowl has to go, and that corruption is dangerous. The forces of resistance are strong, and these reforms still have been adopted only on a limited scale. Perhaps it needs a crisis atmosphere to get reforms actually implemented.

While the Asian model still has validity, the notion that Asia can provide all the labor-intensive products for the whole world may need re-thinking. Long-term, stable development will ultimately require more inward direction, more supplying of the domestic markets, and more expansion of wages that can make domestic markets more profitable to satisfy. In the long run, however, Asia's comparative advantage will be more in the area of human resources than natural resources, and some specialization and trade will always be sensible.