Japan's disease may infect its neighbors

By William Pesek Jr
BLOOMBERG , TOKYO
Wednesday, Aug 22, 2001, Page 19

A Japanese businessman studies a Tokyo brokerage's electric board indicating that the Tokyo stock market's main index dropped to its lowest close in nearly 17 years on Monday. The benchmark 225-issue Nikkei Stock Average fell 187.60 points, or 1.64 percent, to finish at 11,257.94, the lowest close since Dec. 11, 1984, when it closed at 11,250.83. PHOTO: AP

Japan the global economy's equivalent of a terminal patient. Once a strong and vibrant force, it's now bedridden and struggling to survive. So far, conventional cures and even extraordinary measures have failed to stabilize Japan's economy, which continues to flatline.

As this drama unfolds, the rest of Asia is watching with a mixture of wonder and dread. Wonder, because a formerly imposing economic power has fallen and can't get up. Dread, because Japan's failing health is forcing neighbors to look elsewhere to sell their exports. It's the latter emotion -- dread -- that may turn out to be the longer-lived of the two. That's because the rest of Asia may soon develop many of the same problems now plaguing Japan.

Japan's model, after all, is the blueprint followed by many Asian countries. Watching Japan emerge from the ashes of World War II to become an economic superpower was enough to convince Asian leaders to do the same. The success of Japan's style of active government planning and close links between politicians, companies and financial institutions became the standard against which Asian nations measured themselves.

Eleven of malaise has Tokyo dismantling its post-war playbook. Voters recently embraced an unconventional politician, Junichiro Koizumi, to return Japan's ailing economy to the health it enjoyed in the 1980s, when "Japan Inc" was the envy of the world.

Yet are Japan's current problems merely the precursor of Asia's in the years ahead? "In terms of attitude, I'd say yes," says Simon Ogus, chief executive at DSG Asia Ltd. in Hong Kong. "But they have two advantages; they're not as rich as Japan and the demographics are better. Young, poorer, debtor nations have far less scope to [delay reform] for 10 years.

This won't stop many of them trying, though." In many parts of Asia, economies suffer from too much capacity, large public and private debt loads, fragile banking systems, weak domestic demand and low interest rates that aren't doing much good. These Japan-like structural problems mean there's less latitude to increase government spending or loosen monetary policy as growth slows. That's a problem, considering that throughout Asia, gross domestic product is grinding lower at the moment.

Taiwan's for example, shrank for the first time in 26 years during the second quarter. The 2.4 percent slide, which reflected a massive drop in electronics exports, prompted the central bank to cut rates for the eighth time since December. Singapore is in recession for the second time in less than four years; its economy shrank at a 10 percent annual rate in the first half of this year.

Malaysia, which is heavily dependent on US demand for its exports, probably contracted in the second quarter -- the first decline in two years. Gross domestic product fell in Thailand and the Philippines in the first quarter.

Complicating is growing evidence that Asia's snapback from the 1997 to 1998 financial crisis was a mirage. A year ago, the region was congratulating itself for quick recoveries that surprised even the optimists. While it took Latin America a decade to lure back investors after its meltdown in the 1980s, Asia was back in business within a year or two. Leaders and policy makers were quick to take credit for rebounds in their economies, currencies and stock markets.

Now for the reality. At the height of Asia's crisis, officials in Bangkok, Jakarta, Manila and Seoul took important steps toward stabilizing their economies. Foreign debt levels were reduced, banks strengthened, transparency improved and some state-run companies privatized. When investors returned, governments declared victory and decided painful structural change could wait. Now that the global economy is slowing and its two locomotives, the US and Japan, are sputtering, Asia may regret not fixing the problems that caused the crisis.

With the benefit of hindsight, we know that Asia's rebound owed much to buoyant US consumers and bargain-hunting on the part of investors. What's happened since is a virtual writing-off of emerging-market investing.

Thanks more developing-economy crises than financiers care to think about, many are shunning the less industrialized nations. That's decidedly bad news for Asia. The US slowdown already is slamming Asia's export-oriented economies, particularly those dependent on spending on information technology equipment. This is hitting Malaysia, Singapore and Taiwan hard at a time when governments are struggling to boost domestic demand. On top of these challenges, Asian economies may have to do without the foreign capital they used to enjoy.

If they can't rely on exports and foreign capital flows, many Asian economies will have little choice but to boost domestic demand.

Japan's grappling with this transition for 11 years now and tried everything but structural reform. Tokyo issued mountains of government debt to fund economy-boosting public works projects. The spending didn't work and neither have ultra-low interest rates.

Finally, Japan is talking seriously about reform. Koizumi wants to slash public spending and force banks to stop carrying deadbeat companies. He also hopes to privatize many state-run corporations, introduce more competition into the economy and encourage Japan's savers to consume more.

The rest of Asia could learn from Japan's experience. Thanks to politicians dragging their feet, the 1990s were forgettable for the world's second largest economy. Asia has even begun looking to China for the economic strength and leadership Japan had provided in past decades. "The real focus going forward must be on China," argues Mark Mobius, managing director of Templeton Asset Management.

If Tokyo admitted to itself years ago that change was needed, it might not be carrying a debt load a third larger than the economy.

Nor it be relying on the good will of the Bank of Japan, which has driven interest rates to zero percent.

"Reform through Asia is inevitable," says Karen Hawkett, an economist at Stone & McCarthy Research Associates. "It will either happen later than you think if Asian nations can stay afloat, or following a terrible crisis." In the darkest days of 1997 and 1998, analysts and economic policymakers were convinced the "terrible crisis" was upon them. Since then, many Asian countries put structural change on the back burner. Worse, one hears much about reform fatigue in Asia these days. A few years ago, folks in Indonesia, South Korea and Thailand resigned themselves to painful, but necessary, economic-stabilization efforts. Today, their populations are growing weary.

Like Japan, many countries are relying on compliant central banks to keep rates low and economies moving. After World War II, Japan encouraged companies to think very long term. Investing in research and development and winning market share took precedence over short-term profits. Part of the strategy was ensuring cheap bank financing and that meant help from the central bank, which kept borrowing costs low.

Asian like South Korea -- arguably the one that most closely followed the Japanese strategy -- did as much. Nowadays, low interest rates aren't having their intended effect. Borrowers aren't stepping up and banks are getting pickier about who gets loans. The dilemma -- as we've seen in Japan -- demonstrates how loose monetary policy can sometimes be a crutch. If your central bank will bail you out with cheap money, why pursue unpopular reforms? Yet many observers aren't convinced that Asia will soon experience Japan's troubles.

When the Thailands, South Koreas and Indonesias of the world are in recession, social forces demand change. In Japan, however, one senses far less pressure for change from below. "Other Asian countries don't have the money, technology and culture to tolerate the kind of prolonged distress you see in Japan," says Chua Soon Hock, chief executive at Asia Genesis Asset Management Pte in Singapore.

Still, the rest of Asia might be wise to pay attention to Japan's history over the past decade. Surely they don't want to see a repeat of it in their own economies.