International Trade/Offshore Manufacturing/Sourcing/Export/Import/Consulting Trouble in the Pacific: Picking Up the Pieces By Mark Towery "October is one of the singularly most dangerous months to speculate in the stock market, the others being November, December, January, February, March, April, May, June, July, August and September." - Mark Twain "Because no one can resist a speculative market." - Sir Isaac Newton, when asked why he invested in the overvalued Dutch East Indies Company when the fundamentals were not in keeping with the rising stock price. Pat Choate, author of "Agents of Influence," once wrote that you should leave Adam Smith at the airport when you arrive in Japan and pick him up again on the way out, since the invisible hand of market forces is not present in the Japanese system. The same is often said of most other economies in Asia. There is certainly some truth to the fact that due to the uniquely collusive political and economic structure of many countries in the region, normal assumptions that support tactical business decisions in a freewheeling capitalistic democracy do not apply. This attitude, if accepted without contemplation, equates to "checking your brains at customs." Unfortunately, this is often the mindset of Western business persons who learn to succeed by going with the flow, encouraged by Eastern business persons who like to talk of Asian values and perpetuate the myth that natural laws do not apply in the Eastern hemisphere. Well, the reckoning is here and the frequently asked question is what effect will the current economic turmoil in Asia have on U.S. companies trying to do business there. The short answer is that it depends on what kind of business you are in, where you plan to do business, and what your business objectives are. The longer answer requires, well, longer. First of all, Asia is not a homogeneous market. The cultural, political and economic characteristics are quite varied, and have evolved differently. Very simply, there is a great difference in the work ethic and economic structure in North Asia and South Asia. More precisely, I would suggest that five basic socio-economic models have evolved in the region over the past three decades: The Socialist-Mercantile Model This is the model on which the Japanese system is based. A highly educated and disciplined, homogeneous work force labors loyally under the security of an implied social contract that is basically egalitarian and held in check by social mores. The mercantilist banks and trading companies share equity and minimize risk; capital is patient and mostly held by institutions and partner companies; and financial leverage is utilized to support long-term, export-driven strategies that require constant market share growth to sustain. Money politics supports an inefficient domestic market that is protected by formal and informal barriers, but global competitors are supported rather than hindered by the government. In an expanding, stable, global manufacturing environment, this system thrives. In a dynamic and technology-driven global economy, it is sluggish and unresponsive. The Command and Control Model This system is similar to the Japanese model, with the primary distinction being the much more authoritarian role of government. Whereas, in Japan, large trading companies received some guidance and support from the government, in Korea, the military governments showed unabashed favoritism to founders of leading chaebols and tightly controlled investment and lending, directing capital and resources toward selected strategic industries. The domestic market was more overtly protected and the mostly privately held chaebols took advantage of their cozy monopolies and diversified into absolutely everything. Highly leveraged aggressive strategic investment for market dominance, without regard for short-term market fundamentals, requires even more constant growth than the Japanese model to sustain. The system works well as long as wages are competitive, but is more vulnerable than the Japanese system to economic fluctuations. The Cheap Economies of Scale Model This system, primarily Chinese, requires little explanation. When you have a population in excess of one billion, state-controlled technology, and some of the lowest wages in the world, it doesn't take much liberalization to start an avalanche of exports. But it is an unsophisticated model that will require adjustment to sustain. Its biggest competitive threat is internal. The Clannish Entrepreneurs Model This is the most entrepreneurial and capitalistic of the models. The overseas Chinese blend a Confucianist work ethic, the cunning survivalist instincts of economic refugees, and guanxi that stretches from Taipei to Jakarta. Their ability to move money around invisibly and adapt to local political realities has sustained small family-run manufacturing that is flexible and responsive to the market. Their biggest vulnerability is dependency on the political whims and fortunes of host and neighboring countries. Crony Capitalism The least noble of all the systems is the one that permeates much of Southeast Asia. While it is dangerous to generalize, for the most part, ruling families have controlled the political and economic agenda and protected the local markets, while courting foreign investment to build export platforms to exploit cheap labor and natural resources. Much of the foreign exchange is directed toward family and cronies, and mega-infrastructure investments are hastily planned to keep up with growth and to spread the wealth to the right people. The region thrives when there is a shortage of labor-intensive manufacturing capacity, but suffers from lack of market discipline and skilled labor, and is most dependent upon foreign benefactors. The flaw with all these models is that they are dependent upon the fortunes of their trading partners, and have been historically insulated from the positive rationalization of competitive market forces. In other words, Mr. Smith should have been allowed through customs before he got so upset at the stultifying bureaucracy and corruption, and rammed the gate. The first two models of North Asia (Japan and Korea) suffer primarily from too much debt, too much diversification, and financial systems that loaned money based on relationships, inflated earnings and mutual financial guarantees within conglomerates, and government "suggestions," without regard to such details as cash flow projection. The middle two (overseas Chinese and China) are currently more in a reactionary mode and not as directly affected by the current situation, although they will both suffer effects. The final model of Southeast Asia suffers from lack of political leadership, transparency and basic integrity in capital markets. Bursting Bubbles Sir Isaac Newton was one of the world's greatest thinkers and even he could not resist a speculative market. Starting with Japan, most Asian economies developed from a foundation of low wages, guided export policies that initially targeted the large and open U.S. market, and the favorable politics of the Cold War. Their momentum hit the apex of growth as the U.S. economy regained competitiveness, the Cold War ended, and technology helped globalize intellectual and financial capital. Unfortunately, what had been a true "Asian Miracle" began to take on mythical unreality and Westerners and Easterners alike began to believe in an Asian century of perpetual growth that was invulnerable to economic realities. Lending and investment practices became irresponsible. The rising prices of assets were considered a constant that belied economic fundamentals. The tide of prosperity precluded any incentive for healthy rationalization and regulatory reform. There is an oriental mindset against selling short. Japan first experienced sluggish growth in 1991 when its "bubble" burst. Even then, real estate prices were held artificially high long after market realities proved them to be over-valued. Thinking people began to recommend a restructuring of the banking system five years ago, but business and government have just begun to come to terms with this reality. Fundamental structural problems with the economies in Korea, Thailand, Indonesia and Malaysia have also been apparent for four or five years. But with booming economies and rising asset values, no one could resist the temptation to profit from the economic momentum and admit the emperor's attire might be threadbare. When Thailand's currency devaluation hit, there came a gradual realization in the region that everyone might get caught with their pants down, and panic set in. The Outlook Dividing the economic crises in Asia into northern and southern regions, it is helpful to use Indonesia and Korea as benchmarks, since their economies have suffered as much as any. Sustained economic prosperity requires democracy to check the excesses of capitalism and transparency to throttle the tendency towards mercantilism. Countries like Indonesia (and to some degree others in Southeast Asia) have neither, and the outlook is bleak. They also suffer from a lack of skilled labor, a large impoverished population and a small industrial base. Many of these economies were built on foreign investment, and as this capital gets nervous, there is little left to prop them up. The key to economic recovery is political reform and it is uncertain, at best, and volatile at worst. Domestic demand for consumer goods is likely to be low for sometime to come. The countries that can maintain political and monetary stability may present bargain investment opportunities that will pay off, as the region once again becomes a cheap export platform. It is no game for the timid, however, and recovery looks to be a long way off. Korea (and other fundamentally strong economies of northern Asia) presents quite a different story. Companies are strong in terms of fundamentals of skilled labor, access to technology, and market position. They are simply over-leveraged and over-diversified. There will be acute pain over the next year or two, but the current crises could be just the impetus needed to precipitate a rationalization and restructuring required for the new economic realities. There is a large middle class that has developed a taste for the good life and they will not retreat from it easily. Korea became a full democracy in 1992 and just elected its first opposition candidate. Infrastructure is developed, and the work ethic is one of the most intense in the world. If business and government react appropriately, the current crisis could have a number of positive effects. Over-diversified chaebols will be forced to divest non-performing subsidiaries, and incorporate more transparent accounting practices. Since a handful of privately held conglomerates control about half of the economy, this will make them more focused and competitive globally, and open the market to entrepreneurial domestic and foreign competitors. The government has already begun removing legislative barriers to foreign entry. Korea's rising wages have made many of its products non-competitive. The currency devaluation and competitive realities will restore its competitive position in the world market. Korea imports mostly industrial products. The unfavorable exchange rate will force companies to source many of these products locally, thus stimulating the domestic economy. Almost all major Korean conglomerates are privately held and managed by the founder or close relatives because of presumed loyalty. The concept of professional management has been virtually non-existent in Korea in the past. To propose the purchase of a Korean company was tantamount to suggesting that it was bankrupt, that its management was a failure, and all would be fired after the acquisition was concluded. To put it mildly, an entirely different mindset toward mergers and acquisitions is present for the first time. Korea now presents unprecedented opportunities for U.S. companies to make strategic acquisitions. The devalued currency simply offers the bonus of fire sale prices. The companies are over-leveraged, but not necessarily mismanaged. Consumer demand will certainly be low for a while, and the market doesn't offer a quick return. But the economy will recover in a couple of years, and companies that go in now will benefit from a once-in-a-half-a-century opportunity. The financial crisis definitely means slow demand in consumer goods and industrial products for a while to come. Countries with less progressive politics like Indonesia and Malaysia will suffer most and offer the greatest risk. Fundamentally strong economies like Korea and Japan offer a tremendous opportunity for strategic entry, although investors will have to patiently wait out the recovery period. Asia still presents the most economic promise of any region on Earth and will benefit greatly from the rude arrival of Adam Smith. Mark Towery is managing director of GeoStrategy Partners, an Atlanta-based firm with affiliate offices in the Pacific Rim, Europe and elsewhere that assist companies in developing overseas sales and marketing strategies. E-mail Advertise on this site Put your company on this site!