Vorläufige Fassung / Preliminary version

Most Asian states are now past the worst of the crisis. They had only a limited hand in its management: The IMF prevailed in its attempt to use its conventional strategy, designed for current account crises cum public sector debt, to overcome an unconventional crisis, i.e. a capital account crisis cum private sector debt. In doing so it probably increased the costs of the crisis in terms of growth and employment. Yet it is the Asian states who now face the question of how to rekindle growth and development.

The response to the crisis will depend on how the crisis itself is interpreted. Superficially, it was a currency crisis sparked by excessive private sector borrowing abroad. This in turn was caused by high-risk borrowing and lending strategies. Investors, blinded by the outstanding performance of the East and South-East Asian economies, overestimated future earnings and underestimated the risks. The background was a collusion of firms and banks with governments often paraphrased as golf-course or crony capitalism and seen as a survival guarantee for large firms and banks: The latter took such high risks because they felt sure the state would bail them out if worse came to worst. The appropriate response, prominent among the IMF's demands, is to abolish tacit government guarantees for banks and to reform local financial systems, creating transparency (among other things, by adopting internationally accepted accounting standards), introducing private loan and deposit insurance, and establishing credible bank supervision. If the local financial systems - so the reasoning goes - supply domestic and foreign investors with reliable information on risks and earnings, the bubbles in the financial and real estate sectors that triggered the crisis will be a thing of the past.

However, the currency crises of 1997 reflected two other, deeper-seated problems. Firstly, the devaluations of the local currencies point at structural deficiencies that restrict the continuation of high-speed growth. Secondly, the currency crises indicated that dollar-pegged local currencies are no longer compatible with the region's real international ties.

Structural Problems of Asian Economies

Structural bottlenecks had been identified as potential growth checks long before the crisis broke. Infrastructure (transport systems and energy supply), education systems (in South-East Asia) and the high concentration of economic activity in a few large firms (Korea) have frequently been singled out. In slightly more general terms, the structural problems are as follows:

• export-oriented yet import-intensive economies reliant on foreign direct investment;

• growth based primarily on additional factor input and less on increasing productivity of the combined input;

• governments collaborating with large firms and large banks, but failing to provide services at a level insufficient to raise efficiency in the economy as a whole.

Away From Simple Export Orientation

The export-oriented industrialization strategy in South-East Asia - less so in Korea - was based on processing components with domestic labor that was cheap in international terms. The components and the required capital goods had to be imported, making export-oriented industrialization import intensive. While exporting locally processed industrial goods (in 1996, 80% of Thailand's and 83% of Malaysia's exports were industrial goods) generated hard-currency reserves, the balance of trade either stayed in deficit or the surpluses remained too small to compensate for the outflows as foreign firms repatriated profits. Malaysia, for example, has almost always had a trade surplus, but profit outflows regularly pushed the current account into deficit. In addition, South-East Asia's and to a large extent Korea's industrial exports concentrated on a few product groups (notably electronics), where:

• demand is subject to large fluctuations;
• there is fierce price competition;
• Japan being the main competitor, the exchange rate between the dollar and the yen is a particularly critical variable.

The South-East Asian economies cannot and should not replace their export-oriented industrialization strategy with an import substitution strategy on the Latin American model, but they must step it up by extending their industrial base and manufacturing more input products at home, and must boost domestic demand to gradually reduce their reliance on international markets.

Regarding the dominance of foreign direct investment (and outflows of repatriated profits), the South-East Asian countries have no option but to continue attracting foreign firms onto their territory. The situation is different in Korea, where foreign firms have a less important role. True, the IMF has decreed that existing restrictions on foreign investment must be lifted to attract capital. But the positive, one-time effect on the capital account may well be more than compensated by longer-term negative effects on the current account. Also, the indirect effects of foreign direct investment that are otherwise considered more positive - technology transfer, skills and learning processes - are weaker in Korea than in South-East Asia.

Increasing Efficiency

The past boom was largely based on increasing input of labor, capital and land. In the future, efficiently combining these factors will be more important. This means:

Labor Market and Social Security. Future growth will be less based on cheap labor. Firms must be forced to increase labor productivity instead of being subsidized by low wages. Restrictive government labor market policies that limit worker mobility and freedom to unionize must be eased or relinquished altogether. This may require rethinking disincentives to mobility that are perceived as social provision by firms (such as 'life-long employment' in Korea). In addition, workers´ capability of being mobile must be increased. Education and training must be improved and expanded, and the focus of social security provision must pass from firms to the state. Provision for unemployment is a key factor here. There was no urgent need for a national unemployment insurance in the past, because high economic growth guaranteed full employment and in some cases made it necessary to import labor.Firms generally never fired employees and the family provided or at least seemed to provide adequate security in the remote event of unemployment. These conditions no longer apply.

Small and Medium-sized Enterprises (SMEs). Against a background of falling growth rates and harder-to-obtain credit, many SMEs will disappear from the market - unless special programs are developed to help them survive the competition under tighter conditions. Any government enterprise promotion policy will emphasize finance for such firms. Care must be taken here that the expansive credit policies of the past, which artificially sustained a whole range of inefficient economic activities, and in some cases were the only thing that made them viable (as in the financial and real estate sector) are not replaced by state subsidies that do not entail incentives to raise efficiency. The costs of subsidies must be visible, their duration limited and their results measurable.

The reforms of the financial system demanded by the IMF, which target efficient use of capital as an input factor, must be supplemented by more efficient use of land (the bubbles in the financial sector resulted to a large extent from the financing of real estate investment). As a consequence of rapid economic growth, a special political economy of land has evolved, which was characterized by artificially engineered land shortages and skyrocketing property prices. Land shortage resulted from

• economic policies that tolerated or systematically promoted an extreme spatial concentration of growth and thus of 'valuable' land;

• a 'political economy of land' in the narrower sense, that is, collusion between politicians, landowners and the construction industry.

Improving the Supply of Public Goods

Higher efficiency partly depends on an improved supply of public goods. In the long term, restrictive fiscal policies as demanded by the IMF (despite the fact that almost all government budgets in the region were balanced or in surplus) would do great harm. Of course, there are a few prestige projects which ought to be abandoned. But policies that automatically equate public expenditure with profligacy overlook the fact that much government spending is and will remain necessary for projects that cannot be funded privately.

Towards an Asian Currency System

The crisis was caused and triggered by the dollar's appreciation and speculative attacks on several Asian currencies. This points to the problem that governments in the region kept their currencies pegged to the dollar while trade and investment flows became increasingly regionalized. From 1985 to 1996, the US share of South-East Asian imports fell from 16% to 14%, while Japan's share rose from 23% to 27% and that of the East Asian "tiger" states from 16% to 21%. This is shown even more clearly by intra-regional investment flows: since 1985, Japan has been the largest investor in South-East Asia, and in 1995 the "tiger" states drew level with it. In 1995, Japan and the "tiger" states invested $22.2 billion, compared with $6.7 billion by the US. Accordingly, a growing share of South-East Asian exports goes to Japan and the "tiger" states. In addition, other forms of economic ties between countries like Japan and Korea are far more important than direct investment - for example, original equipment manufacturing (OEM), licensing, joint ventures and alliances. Moreover, Japan has long been the largest donor of development aid in the whole of Asia. In other words, an informal, common Asian production zone has emerged between Japan, the "tiger" states, South-East Asia and China (some observers speak of a Japanese-dominated Asian production zone). But the reality of this zone is not mirrored by the currency arrangements. The developing and newly industrialized countries of the region have remained under the umbrella of the dollar and thus reliant on extraregional developments, while to a great extent the real economy has regionalized.

Enabling local currency systems to adapt to the reality of a regional production zone, and to reduce reliance on the dollar requires a phased approach:

In the first phase, local currencies should be pegged to a basket of reference currencies, in which the dollar is accompanied above all by the yen, but also by strong European currencies or the euro.

South-East Asian countries that already have a regional cooperation platform in ASEAN could form a currency system. For the time being, they will be unable to enter monetary union on the EU model, but they could create a common fund to support local currencies. In the medium term, they could develop a regional reference currency on the pattern of the ecu, and set fluctuation bands for local currencies against the reference currency. On the model of the European Monetary System, their central banks could be obliged to intervene if a currency oversteps the upper or lower limit. This strategy is only realistic, though, if trade and investment barriers between the South-East Asian countries are removed at the same time.

In the long term, the emergence of an Asian production zone dominated by Japanese firms must also be reflected in the currency arrangements. That is, a regional monetary system must also include the yen. In view of Japan's overwhelming economic power - it accounts for more than 70% of the region's national product - an Asian currency community would automatically be a yen block. However, two things would stand in the way of fast-track monetary union:

• Although Japan continues to absorb more and more imports of industrial goods from its neighbors, these mostly represent intracompany trade by Japanese firms. The Japanese market is still too closed for "independent" trade of East Asian countries, so they keep relying on the more open American market.

• A currency system for the entire region presupposes liberalization of the financial sector at its center, Japan. Today, only 1% of transactions on Japanese financial markets are done by foreign banks. The Big Bang - complete deregulation of the financial system by 2001 - aims to change this fundamentally, but the question is naturally whether this ambitious goal will be achieved.

The initiative to revitalize the region must come from Japan. Yet there is doubt that Japan is ready to take on responsibility for the entire region. Not only is Japan now in the throes of a severe economic crisis itself; there is also its isolationist political tradition. On the other hand, if Japan is precluded from bearing regional responsibility, sooner or later another power will emerge as the protagonist of a regional economic community: the People's Republic of China. China is already considered a stability factor, and the crisis hit the Chinese economies (the People's Republic itself plus Hong Kong and Taiwan) less severely than Korea or South-East Asia. In summer 1997, China, Hong Kong and Taiwan together had $285 billion in foreign currency reserves, compared with Japan's $211 billion. If the yen does not take on greater regional importance soon, it may be replaced by the Chinese yuan in the not all too distant future. In the long term, a regional shift in power at the expense of Japan and in favor of China could be the most important outcome of the Asian crisis.