More crises to come in Southeast Asia

Lax regulation and easy access to foreign capital produced an over-leveraged banking sector, both in US dollar and local currency terms. Heavy exposure to a patently frothy property market aggravated the problem.

Prolonged dependence on low value-added manufactured goods for export made economic growth dangerously vulnerable to a downturn in foreign demand that now looks to be more secular than cyclical. Finally, the inherent rigidity of a pegged exchange rate regime made adequate, rapid response impossible.

In response to the ensuing mass exodus of international investors from the Asia-Pacific markets, regional policy-makers and other interested parties have painted an optimistic picture about the future of the Tiger economies, seeing the crisis as a mere "correction." Nothing could be further from the truth.

To be successful in export-led growth, Asia must diversify its export base to include a much higher proportion of value-added products and services. This would allow them to compete with vast new export capacity coming on line in China, Eastern Europe and Latin America.

Unfortunately, there is little evidence that Southeast Asia is either upgrading or diversifying its exports. For example, despite overwhelming evidence of global overcapacity, the Singapore government has committed billions of dollars to assist the development of indigenous electronics firms and to finance ventures in capital intensive sectors such as semiconductors.

The trust in the region's high rate of savings and low tax rates is also misplaced. Even the casual visitor can easily see that more tax revenue will be needed by governments to fund badly needed infrastructure and other public spending projects.

Furthermore, translating high savings rates into economic growth through domestic investment only works as long as demand from Western consumers remains strong. With an ever-increasing proportion of Western demand being satisfied by China or the emerging economies of Central Europe and Latin America, Asia's Tigers will necessarily become more dependent on internal demand to fuel growth.

Unfortunately, Asia's leaders continue to encourage oversaving by extolling thrift as the quintessential Asian value. They further exacerbate the problem by irrationally allocating resources to protected domestic industries that cannot compete globally, but that are favoured by the bureaucrats (like automobiles in Indonesia).

Sanguine sentiments about Asia's future are also bolstered by the region's ostensible commitment to education. However, Southeast Asian school systems historically have been unable to turn out skilled workers in sufficient numbers to support the region's need to shift into more sophisticated manufacturing. Worse, it is highly unlikely that they will be able to any time soon, given the need for fiscal austerity precipitated by the current currency crisis.

Up until the recent currency crisis, investors could reasonably assume that Asia's financial planners were committed to encouraging foreign investment by adhering to sound economic and regulatory policies.

Investors are no longer safe in that assumption, given the deliberate failure of Thailand's Finance Ministry to respond to the International Monetary Fund's June 1996 warning on the need for a more flexible exchange rate policy.

When crisis hit, Thailand depleted its foreign exchange reserves in a futile effort to prop up its overvalued baht. Equally ill-conceived was Malaysia's attempt to stabilize its reeling stock market by regulating short-selling by foreign investors. Both missteps have dealt a serious and lasting blow to investor confidence.

It is doubtful that Asia's institutional rigidity can be sufficiently overcome to prevent further crises. While pervasive corruption blocks rapid adjustment in many East Asian economies, an inherent conservatism also impedes necessary responses. For example, despite a pressing economic need to reform lending and disclosure practices, Japan's banking sector remains enmeshed in the bureaucratic snares that contributed to the property and asset bubble that burst in the late 1980s.

Financial institutions in Korea, Thailand and Malaysia are in the midst of a similar upheaval owing to the outmoded practice of lending against asset values (mostly property), instead of on a cash-flow basis.

No one can deny that the Tiger economies have been successful at narrowing the gap in per capita output and income with the most advanced economies in the world. But that was yesterday. The current upheaval has exposed the fault lines of property overhang, inappropriate government policy, and the specter of shifting comparative advantage.

Teresa Wyszomierski is an attorney and Christopher Lingle is visiting associate professor of economics at Case Western Reserve University and author of "The Rise and Decline of the Asian Century" (1997).

• Teresa Wyszomierski is an attorney and Christopher Lingle is visiting associate professor of economics at Case Western Reserve University and author of "The Rise and Decline of the Asian Century" (1997).