On May 15, 1980, foreign bankers in downtown Seoul watched in horror from their high-rise offices as students and riot police clashed in the streets below. Eyes stinging from tear gas, the bankers saw one demonstrator drive a bus through a line of policemen, killing one and injuring several others. "It was like war," recalls one banker. But that was just the start. By the end of the month, bloody uprisings in two provincial cities had claimed an officially reported 189 more lives.

South Korea was living an economic nightmare in 1980, and the social turmoil was partly a reflection. That year, the country experienced its first serious recession since the Korean War, a shattering 5.7 percent decline that wiped out the growth of the entire previous year. The government's powerful economic planners had seriously erred, and the lid had come off the tightly ordered society.

Like several other rapidly developing Asian countries, South Korea had borrowed heavily to fuel its growth and it was an open question that summer how the country's technocrats could possibly approach foreign banks to help cover the balance-of-payments deficit. By the end of 1980, South Korea already owed foreign banks more than $16 billion in short- and long-term debt, on top of more than ten billion dollars in debt to other bodies such as the World Bank and foreign governments. This was money it could not hope to repay for years, if ever.

Many of the large U.S. and European banks did put tight limits on new credit to South Korea, but within weeks the panic was over. The military government reimposed its authority and foreign bankers returned to the fold. By September, four months after the uprisings, banks were competing aggressively for the right to arrange a $600 million eight-year balance-of-payments loan. With the successful marketing of that loan, the worst of South Korea's prolonged economic and political crisis was past, and planners could turn their attention back to the mammoth task of restructuring the economy.

The painful experience was a landmark not only for South Korea, but also for the group of eight countries and city-states that in the 1960s and 1970s had created or tagged along on what came to be called the East Asian Economic Miracle: South Korea, Taiwan, Hong Kong, Singapore, the Philippines, Thailand, Indonesia and Malaysia. All were in their own ways trying to imitate Japan's success through rapid industrial growth and heavy foreign borrowing. They had weathered the quadrupling of oil prices and the world recession of the early 1970s, but since the further doubling of oil prices and the onset of fresh world recession in 1979 and early 1980, many of the high performers have had trouble coping. Several of them-notably South Korea-have had to lower their economic sights and adjust their growth and development plans downward. As the world as a whole has slipped into a disappointingly erratic economic performance, these heavily trade-dependent countries have seen the Japanese ideal fade.

But the experience of South Korea-the most turbulent of any of these East Asian countries-has also demonstrated the broad tenacity of even the most damaged of the East Asian economies. Fears that foreign bankers and investors would pull away from the region have proven particularly unfounded. Senior bankers had warned that the world's banking system might be unable to finance the billowing balance-of-payments deficits of the oil-importing countries. But in 1980 the banks responded to the problem even more smoothly than they had in 1974. Indeed, in East Asia, foreign bankers are among the outside analysts most optimistic about the region's future, especially when they contrast it with the management and inflation problems of Latin America and Africa.

All of East Asia's developing countries face daunting problems in coming years, with no guarantee of a satisfactory solution. But their ability so far to make often painful adjustments indicates that they stand good chances of continuing to perform well by world standards. If they succeed in what they are attempting, their accomplishment may be remembered as a second, albeit less spectacular, economic miracle.

II

The East Asian boom has actually been three booms on different levels. On the highest level is Japan, whose economy for years grew at an annual average of more than ten percent, slowing down only after 1973. Japan's is the world's second largest economy (after the U.S.S.R.), half the size of America's and gaining. Unlike the countries that have tried to imitate its success, however, Japan was already a world power before World War I. Its experience has been very different from that of the eight countries that form the primary subject of this article, and it has remained a superior model, not a colleague or a competitor.

The next level consists of two pairs of countries: the industrial states South Korea and Taiwan, and the bustling city-states of Hong Kong and Singapore. Like Japan, none of these possesses appreciable natural resources. Yet all grew economically from 1960 through 1978 at almost identical average rates of about nine percent a year, outperforming in the process almost every other country except Japan and a few small Middle Eastern oil exporters. Despite still modest gross national products, they joined the world's leading trading countries.

South Korea and Taiwan, formerly agricultural countries that suffered five decades of Japanese colonial rule, transformed themselves into heavy exporters of manufactured goods. The details of their economies have been sharply different, however, and they are also much different in size and geography. Singapore and Hong Kong, dots on the East Asian coast, rode with the region's success to become prosperous and freewheeling financial and service centers of global importance, with some manufacturing as well.

All four of these so-called new industrial countries have experienced qualitative changes in their standards of living in the space of a generation. Despite occasional blowups as in South Korea, social tensions, given the magnitude of the change, have remained quiet. All four have in recent years been trying to make the jump out of labor-intensive industries, such as textiles, footwear and simple electronic gadgets, into higher technology industry. The idea is that each worker in high-technology industry produces more than he would in low-technology industry, which permits higher salaries and prolongs rapid economic growth. They are all trying to follow Japan's lead, but the world has become very different since Japan went into computers, cars and fancy machinery. One big question for the next decade is how far the four new industrial countries will be able to pursue the high technology path.1

The final tier consists of four countries that are trying to move into the labor-intensive industries: the Philippines and Thailand, agricultural countries that do not export oil, and Indonesia and Malaysia, agricultural countries that do.

The Philippines and Thailand, countries of roughly equal size burdened with balance-of-payments deficits and inflation problems, face the most urgent need to make what the World Bank likes to call structural adjustments in their economies. A basic goal is to remove current protection and subsidies for their labor-intensive textile and electronics industries. This would force them to compete in the international market, and reward the strong companies that show the most signs of increasing the country's export earnings. Both countries have been having trouble with this process. Indonesia and Malaysia, countries of vastly different size, are working toward the same kinds of structural adjustments, but their oil and natural gas reserves have given them a bit more breathing space.

TABLE I

1979 GNP 1979

1979 Population (in billions per capita

of dollars) GNP

South Korea 37,265,000 55.9 $1,500

Taiwan 17,250,000 32.6 1,890

Hong Kong 4,671,000 18.7 4,000

Singapore 2,368,000 9.1 3,820

Philippines 46,803,000 28.1 600

Thailand 45,486,000 26.9 590

Indonesia 138,891,000 52.2 380

Malaysia 13,642,000 18.0 1,320

Japan 115,835,000 1,019.5 8,800

China 965,279,000 219.0* 230*

Data from the World Bank, except Taiwan, for which data are based on Asian Development Bank figures. Note that populations of Indonesia, Hong Kong, Singapore and perhaps others may be understated, which means precise comparisons of per capita GNP may be misleading.

* Data from 1978.

All eight of these developing countries will be under pressure to make the right moves in complicated adjustment processes over the next few years. But to some extent, decisions will be out of their hands. All eight are heavily dependent on trade with an outside world that remains economically sick. Even Japan has been tightening up on its imports from Asia in a successful attempt to narrow its own current account deficit, which was more than ten billion dollars in 1980. (Current account measures merchandise trade plus service transactions and some fund transfers.)

Most of the East Asian countries are likely to face a test of how flexible and tenacious they really intend to be. The adjustment will be particularly demanding of South Korea and Taiwan.

III

South Korea is a land of contradictions. The national character, to the extent that one exists, seems at times to be pulling at itself. Some foreigners stereotype the South Koreans as the Germans of developing Asia, hard-working, reliable and stoic; others view them as the Irish of Asia, garrulous and easy going. The economic manifestation of these traits seems to be that South Koreans live in a world of hard work punctuated by big, embarrassing mistakes. That is one way to explain the predicament South Korea currently faces, as well as one of the major stumbling blocks the government must try to avoid in seeking a solution.

In recent years, for example, South Korea has developed one of the world's few healthy shipbuilding industries, in 1980 second only to Japan in new orders, according to Lloyd's Registry of Shipping. The new government-owned integrated steel complex is reputed to be one of the world's most efficient. But an enormous ill-conceived project to build heavy electricity-generating machinery had to be bought up by the government when its private developers could not finish it. Valued at $600 million, it had debts of $800 million, and the government had to pump in $500 million to get construction started again.

One of the country's greatest assets is its government technocrats, the overseas-educated planners and managers who are often given a large share of the credit for South Korea's economic success. President Chun Doo Hwan eased foreign worries after the December 1979 military coup that brought him to power, when he retained some of the most respected government economists as close advisers.

Yet many officials are becoming convinced that in 1973 the technocrats made fundamental errors that led ultimately to the economic and political crisis of 1979-80. The technocrats took an aggressive gamble in 1973: they decided to pursue the high road of rapid economic growth and investment in capital-intensive heavy industry. At first the results were impressive. But the 1980 recession and the return to rapid inflation have provoked "some very serious second thoughts," according to one senior South Korean official. A confidential government study sharply critical of the economic decision-makers of the 1970s says that South Korea should have moved more deliberately, as did Taiwan, focusing less on big industrial projects and more on upgrading labor productivity in less expensive industries, such as the higher technology side of electronics.

South Korean officials trace the fateful 1973 decisions in large part to the Nixon Doctrine of 1971.2 Fears that Richard Nixon, and later Jimmy Carter, were moving to withdraw all U.S. troops from South Korea led the country to invest heavily in defense-related heavy industry and to try to master a wide variety of production processes. The 1973 decision to push further into petrochemicals, steel, ships and heavy machinery was a logical extension of this policy. The country would pull itself out of the oil crisis by importing expensive raw materials and turning them into more sophisticated products, using some at home and exporting the rest at a profit.

But the government tried to do too much at once. It channeled heavily subsidized loans from government-controlled banks into heavy and chemical industries. The cheap money spurred inflation. Efforts to make wages keep pace with inflation simply stimulated more price increases, which in turn reduced the competitiveness of export goods. The government made things worse by initially refusing a currency devaluation, although it later had to accept regular devaluations.

Meanwhile, the government made a second fateful decision: to mount a big push for construction contracts in the Middle East. South Korea earned nothing from Middle East construction in 1973, but by 1978 the country had won almost $15 billion in contracts. As workers went to the Middle East a resulting skilled labor shortage put more pressure on wages. The influx of money sent home by the overseas workers, in turn, helped push up prices, much as Spanish gold helped produce European inflation in the sixteenth century.

Heavy and chemical industry products grew to 25 percent of exports in 1978, up from 16.3 percent in 1972. But South Korea's production costs in these capital-intensive industries-notably petrochemicals-were often higher than those of overseas competitors.

By 1979 the technocrats realized they had gone too far, but it was too late. South Korea's fast-moving corporate groups had raced each other to get into the government-sponsored industries, and had not bothered much with market research. In an effort to avoid favoritism, the government had subsidized the investment. Now the different companies were seriously overextended, each trying to hold on, waiting for the competition to cave in. They were also in need of increasingly large loans.

Under General Chun, the government has announced a tough new policy. It has ordered consolidations of several industries, reducing the number of companies involved. The Bank of Korea, the country's central bank, has said it will no longer grant loans to bail companies out unless they show some sign of being able to survive on their own. Government officials labored this past spring and summer on a new five-year plan which they say will mark a clear change in direction. In line with the new international vogue of supply-side economics, the government insists it will take a more free-market-style approach, ending subsidies and cheap loans, gradually reducing import controls and forcing local business to compete under international standards.

Economic planners say they are placing a new emphasis on "skill-intensive" industry: machinery, textiles, computers and other advanced electronics. Price stability will replace rapid growth as the top priority. The Economic Planning Board has announced that to keep inflation down it will from now on target yearly growth at between seven and eight percent, instead of the nine percent targeted in previous years.

But any effort to bring about fundamental change will suffer from what some economists call the "Queen Mary effect": even if the government tries to push the rudder hard to one side, it will be some time before the ship responds. Many business groups are still overextended, and textile manufacturers in particular have said they cannot afford to switch over to new, high-productivity equipment as fast as the technocrats plan. The country has extensive heavy industrial and chemical plants whose output will remain a fundamental part of the economy. Even the five-year plan calls for heavy and chemical production to continue growing. Locally produced petrochemicals in particular are still more expensive than imports, and South Korean businesses that use the local petrochemicals to make finished goods end up with overly expensive items for local sale and export. This inefficiency filters through the entire economy.

What is more, the country's top economic experts still seem to be privately divided as to goals. Initial outlines of the five-year plan call for postponement of the planned second integrated steel plant and third petrochemical complex, but officials say privately that they still plan to carry out both, at a cost of billions of dollars each. As the decision to invest $500 million more in the heavy machinery complex indicates, the government may find itself in too deep to pull back, even from projects that are white elephants.

There are nevertheless signs of recovery. Exports turned up in the first half of 1981 and the economy is likely to grow back this year to where it was at the end of 1979. Borrowing plans call for more than eight billion dollars in new loan commitments-about half from commercial banks-but banker confidence has returned to a point where this should present no problem. Indeed, many South Koreans and foreigners alike seem to have a visceral faith that, whatever its problems, South Korea will overcome them and prosper again.3

Taiwan is the country many South Korean technocrats wish they could emulate. Largely out of necessity, Taiwan has pursued economic growth cautiously, playing tortoise to South Korea's hare. As the government in Taipei became increasingly isolated from other governments, its leaders knew that Taiwan could not politically afford periods of economic failure, and they have taken steps to promote stability.

Taiwan's policy of slightly less frantic economic stimulation since 1973 seems to have proved the more prudent. In the process, the island has kept inflation, although generally above ten percent in recent years, under better control than South Korea has. Particularly enviable is Taiwan's international financial position: with foreign currency reserves of more than seven billion dollars, Taiwan has more money on deposit with foreign banks than it owes them in loans. That is partly because Taiwan has a higher savings rate than South Korea and has not needed to borrow as much, but it is mostly because Taiwan's more cautious development has not required as much cash.

But Taiwan, like South Korea, is pushing now to transform its economy. Officials like to show off two new government companies: China Shipbuilding, which claims one of the largest drydocks in the world, and China Steel, whose chairman says its steelmaking equipment is the most modern available and operates at 110 percent capacity. But beneath a thin layer of a few big government and private companies, Taiwan's economy is based on a large number of small family companies that can switch into different specialties. Taiwan's biggest exports are not steel or ships, but rather such labor-intensive items as footwear, textiles, electronic goods and other simple industrial products. Although labor costs are somewhat lower than in Hong Kong or Singapore, they are much higher than those of such coming competitors as China and Southeast Asia. Government warnings of the need for change in this area are becoming more shrill.

Premier Y.S. Sun told the legislature earlier this year that the top priority for the 1980s will be development of higher technology machinery and electronics industries, notably automobiles and computer and information services. In both areas Taiwan hopes to maintain a labor-cost advantage over competing producers in more advanced countries.

The government is strongly subsidizing this switch, as it has subsidized other basic industrial moves in the past. It has created a science park, a sort of industrial park for high-technology companies, to train technicians for computer and complex machinery industries. K.T. Li, the former Finance Minister who helped spark economic development in the 1960s and 1970s, has proposed a complicated system of tax incentives for research and development, something the cost-conscious Taiwanese businessmen tend to ignore.

The investment in such a transition represents something of a gamble for Taiwan's cautious government. But although Taiwan's problems are less stark than South Korea's, the Taipei government is under similar pressures. Oil prices pushed the 1980 current account into deficit for the first time in recent years, and another deficit is expected this year. Computers and automobiles are industries that it took Japan years to enter, and Taiwan can expect an uphill battle. It has had trouble attracting foreign investors to the science park, for example. But like South Korea, Taiwan needs to move into industries that will produce higher labor productivity without requiring big capital or raw materials investments.

For Taiwan, the pitfalls of capital-intensive industry were driven home by the problems of its big petrochemical industry. Until recently, petrochemicals were listed by the government as one of the three pillars of Taiwan's industrial future, together with machinery and electronics. But Premier Sun said in February that heavy and petrochemical industries that are big energy users will be expanded only for domestic needs, and no longer to produce exports. (Like South Korea, Taiwan still wants to maintain military-related industries.)

The problem-the same one that plagues the South Korean petrochemical industry-is that the cheapest way to make basic petrochemicals, known as petrochemical intermediates, is from natural gas at the well. Having no wells, Taiwan makes intermediates through an expensive process of refining imported oil. As world demand for petrochemicals has slackened, U.S. petrochemical producers have undersold Taiwan's.

The adjustment is a painful one for Taiwan because its petrochemical industry already makes up a large part of the economy. Taiwan's largest private industrial group, Formosa Plastics Group, saw its profits sag ten percent in 1980, and other companies, less well diversified than Formosa Plastics, were hurt even worse by the high cost of locally produced intermediates. Union Carbide of the United States began quietly looking for a buyer for its 25-percent share in Oriental Union Chemical Corporation, one of Taiwan's government-sponsored petrochemical joint ventures.

The troubles of the petrochemical industry reflect one of the government's most important quandaries. As in most developing countries, major industrial investment in Taiwan has almost always been orchestrated by the government. Although the country went less into heavy industry than did South Korea, Taiwan's government put large amounts of its own funds into steel, shipbuilding, aluminum smelting and, often in conjunction with foreign and local private interests, into a broad intermediate petrochemical industry. Now some of those investments-notably petrochemicals and aluminum-are turning out to be bad competitors by international standards. More so than in South Korea, where many of the heavy industries are privately owned, the government of Taiwan is struggling to resolve its own errors and redirect public money, a difficult process.

The government is itself a curious institution. It is run by so-called mainlanders whose families fled China in 1949. But 15 million of the 17 million people it presides over are Taiwanese, whose families have lived on the island for generations. Senior government officials still tend to see themselves as keepers of the Chinese ideal, rooted in Confucianism, and often see business as an unpleasant necessity. Hence much of the economy seems often to be struggling against government limitations. In spite of government refusal to grant new banking licenses to private business groups, some of the latter have nevertheless managed to establish seven quasi banks called investment and trust companies, several of which have violated government regulations in their aggressive efforts to expand lending. Some Taiwanese business people have found ways to trade with China through Hong Kong, and many wish Taiwan could simply declare itself an independent country, an idea that appalls the government.

Yet this sometimes backward-looking government handled the loss of U.S. diplomatic recognition with great foresight. It moved its reserves held in U.S. banks into accounts in the names of dummy companies, out of China's reach. It courted European powers that had withdrawn recognition in the late 1960s and early 1970s, persuading such countries as France, Britain and West Germany to step up trade. The Netherlands accepted the expulsion of its Peking ambassador in order to sell Taiwan submarines. European banks competed aggressively to open new branches they would not have wanted a few years earlier.

By operating internationally almost like a corporation, Taiwan has diversified somewhat, politically and economically, but it has also developed a new vulnerability. Its new quasi-political relations are dependent on its demand for European goods and on the cheap price of its exports. If it falters economically, it has little to fall back on but the U.S. China lobby and such remaining friends as South Africa and South Korea.

Tensions between mainlanders and Taiwanese seem to be declining, however. As the Chinese ideal fades, some children of mainlanders are emigrating. The expectation is growing that in coming years representatives of Taiwanese businessmen will slowly work their way into government.

Given the tie between economics and politics, the direction of future government investment remains a fundamental question. Up to now the economy's strength has been such that a young person could open a business and be exporting to Bloomingdale's or Sears within five years. Taiwanese businessmen will be trying to do the same now with such goods as computer chips, a complex business in which they will have tough competition from Japan and the West.

Some economists argue that in the race between Taiwan's tortoise and South Korea's hare, South Korea's bigger, broader based economy could prove an asset. The race is not over yet.

IV

The city-states of Hong Kong and Singapore were in some ways the region's best performers in 1980. They showed economic growth rates of about ten percent, with little or no unemployment. Both are tiny trading cities whose imports of consumer goods and raw materials leave them, paradoxically, with large trade deficits. Both cover the deficits more than adequately with service earnings and money from outside investors. Like South Korea and Taiwan, they too are trying to move out of labor-intensive industry, but their success as service centers takes off some of the pressure for industrial performance. Service-related business grew more than manufacturing business in both cities in 1980, yet both economies boomed nevertheless.

Despite the parallels, however, Hong Kong and Singapore are in some ways less alike than South Korea and Taiwan. Both grew up in the British colonial system. But Hong Kong is a city on China's coast, populated mostly by families of refugees who fled across the border after 1949, and the prospect of an eventual restoration of Chinese control hangs over Hong Kong's head. Singapore is an outpost 1,600 miles to the south, between Malaysia and Indonesia. Its future has mostly to do with its immediate neighbors and international trading partners.

The most remarkable difference between Hong Kong and Singapore is in their economic and government structures. Hong Kong is a free market whose colonial government keeps taxes low and practices what former Financial Secretary Sir Philip Haddon-Cave called "positive non-interventionism." Wages, inflation and money supply are left largely to market forces, although a banking cartel sets basic local interest rates. The coming and going of money is only lightly controlled, and the colony is a haven for flight capital from Indonesia, Thailand, the Philippines, Taiwan and Malaysia. Increasing numbers of banks and multinational companies have set up offices in Hong Kong to handle regional lending and trade. China has expanded its own investments in property and local companies, and has increased the activities of 13 China-owned banks in the colony. (One-third of China's foreign-exchange earnings is estimated to come from Hong Kong-related business.) Small textile, electronics and export-import companies abound, adjusting rapidly to shifts in international demand. About 80 percent of manufacturing is exported.4

Hong Kong escapes a heavy oil burden because most of its business is not oil-intensive. Heavier manufacturing as well as labor-intensive business is increasingly migrating to China, whose government is encouraging joint-venture companies with Hong Kong. In some cases, however, Hong Kong investors have complained of problems with unproductive workers and unreliable construction and delivery schedules.

The biggest cloud on Hong Kong's horizon is a political one: the prospect that China, which claims sovereignty over all the colony, will probably one day want some form of political control. Although there is little pressure in Hong Kong for self-government, the British lease on most of the territory runs out in 1997. The date remains a political problem whose dampening psychological effect is beginning to be felt. But although China does not recognize the lease, its pragmatic government finds the free port useful and shows no desire for change at this point. Most analysts expect an eventual accommodation between China and Britain regarding post-1997 government. No one expects the British to remain forever, however, and the uncertainty increases the volatility of the stock and property markets, the latter of which probably includes the highest prices in Asia.

If Hong Kong seems a tribute to the free market, Singapore's success throws that logic on its ear. Here is an authoritarian country where manufacturing companies for two years were virtually required to provide 20 percent wage hikes in order to force productivity increases and drive out labor-intensive industry. (The government dropped the 20 percent guideline this year, when foreign investment showed signs of declining.) The government closely monitors the financial system, unlike Hong Kong, and summons in its foreign and domestic bankers to explain any vagaries in their performance. Prime Minister Lee Kuan Yew keeps an eye on almost everything of economic importance that happens in his little city.

Strong governmental direction, together with Singapore's location between booming Malaysia and Indonesia, which are raw materials producers, has helped spur heavier industry. Singapore is one of the world's largest independent oil-refining centers, refining oil notably for Malaysia and Indonesia, whose own refining capacity is not yet sufficiently developed. Refining income helps shield Singapore from oil price increases. Singapore has also become proficient in constructing such highly technical machinery as big offshore jack-up oil-drilling rigs, which adjust their own height.

Singapore is a very different financial center from Hong Kong. It has created established, government-supervised markets, while Hong Kong is a place for individual deals to be arranged. Singapore, for example, has set up a sizable government-regulated market in which banks lend each other offshore dollars, something Hong Kong's government has not attempted.

For several years now, Mr. Lee has operated like an elected dictator, working with and through a remarkably experienced and tightly knit group of senior advisers. He recently told an interviewer that his decision to emphasize free enterprise over socialism for Singapore was less important than the country's basic need to move up the industrial and financial ladder. His strong leadership has produced lower inflation than in Hong Kong and a higher level of industrial development. (It has also meant the closing of some newspapers that criticized him, and the expulsion of some opposition politicians.)

Singapore's strict immigration restrictions have kept unemployment down, and Hong Kong finally announced last November that it too will close its borders to illegal immigrants. Before that it had tolerated a steady stream of refugees from China. Hong Kong's family-oriented economy and booming free market have prevented any appreciable unemployment.

Given their entrepôt functions in a region that continues to grow rapidly, both Hong Kong and Singapore promise to enjoy bright futures for some time to come, and their growth will probably stimulate trade throughout the region. But since their populations added together barely equal that of metropolitan Seoul, they seem unrealistic models for other Asian countries.

V

Singapore's four partners in the Association of Southeast Asian Nations, the Philippines, Thailand, Indonesia and Malaysia, occupy a very different world from that of the region's four more advanced performers. Theirs is a world of lush agricultural land with extensive natural resources. Except in the case of Malaysia, they also suffer from power blackouts, floods, population problems and rural poverty.

Despite their efforts to diversify their economies, all four of these countries are likely to be dependent for the foreseeable future on their commodity exports. A simple comparison tells a lot. Indonesia's primary exports are oil and natural gas, together a full 73 percent of its exports. One of Malaysia's leading net exports is oil, and natural gas is projected to overtake oil in the coming years. Hence both countries are currently on strong financial footing, with steady, high growth and regular injections of foreign currency income.

The primary Philippine exports are sugar, coconut products and copper concentrates, while Thailand's include rice, rubber, tapioca, tin and maize. All of these are subject to hard-to-predict world price fluctuations. Both countries face serious current account deficits and lower rates of growth than they would like. Their troubles could become serious.

Of the four countries, the Philippines is the one that gets the most international attention. It has borrowed more from foreign banks: according to the Bank for International Settlements it owed the world's leading commercial banks more than nine billion dollars at the end of last year, compared to about four billion dollars for Thailand. (Indonesia owed more than six billion dollars, but had nearly eight billion dollars of its own on deposit with the same banks.)

Bankers have been worrying about the Philippines for years, but so far the country has proved itself reliable and financially responsible. It pays its foreign debts on time. But a recent scandal involving runaway financier and textile magnate Dewey Dee, who left behind 635 million pesos (about $80 million) in personal and corporate debts, exposed some flaws in the business community that ran much deeper than one man's troubles, or even one industry's. Coming at a time of overall economic weakness, the scandal touched off a run on several investment banks. That in turn revealed the heavy debts and serious weakness of a number of leading companies, several of which have close ties to President Ferdinand Marcos.

Officials of Bancom Development Corporation, Southeast Asia's most prestigious indigenous investment bank (not linked to the Marcos family), say the bank was saved from failure by a special bank rescue fund established by the Central Bank, as were several less prestigious investment houses. The government also has begun aiding troubled companies, and among those who have asked for help are Construction & Development Corporation of the Philippines (the largest construction company), the Silverio group (which includes a leading automobile assembly company), and the Herdis group of companies; all three are considered close to the Marcos family. Some economists argue that the major lesson of the financial scandal is that the "new oligarchs," the Marcos associates who built business empires to replace the old families that Mr. Marcos forced out, have become a serious economic burden.

The Dee scandal made it clear that Philippine problems, from shaky finance and government favoritism to weak industries, are broad and intertwined. It is a country that has imported boxes from Taiwan for its bananas and cans for some of its other food products. It has trouble controlling a speculative financial community. In the spring of 1979, for example, the government extended extra credit to stimulate manufactured exports. Somehow, however, much of the money was used for speculative imports of raw materials and consumer goods. The embarrassed Central Bank clamped a lid on credit to counteract the unwanted flow of money into imports. Tight money helped push up interest rates and hurt many of the businesses the Bank wanted to help. Prices went up too and the speculators profited.

The growing power of Marcos-linked companies and the control of the basic commodities by Marcos cronies have long been political issues in the Philippines. Some businessmen complain that if they do well, they have to worry about having their companies absorbed by one of the President's friends. Others worry that if the President is ousted, the demise of some of his friends' many companies will damage the economy.

Basic questions also surround two long-standing pillars of the Marcos government's economic policy: diversification into labor-intensive manufactured exports, and the pursuit of 11 major industrial projects. Many of the latter, which range from copper and aluminum smelting to petrochemicals and an integrated steel complex, are the kinds of projects that have posed problems even for the more advanced countries to the north.

The 1981 financial crisis made it clear that the government has not done a good job of establishing what it calls "non-traditional" industries, essentially labor-intensive textile and electronics manufacturers, which are meant to reduce dependence on agricultural commodities whose prices can fluctuate unpredictably. Although these industries produce 35 percent of exports, planners have found that local parts and fabrics usually are not of high enough quality for export. Export companies usually reprocess expensive imported materials, which means the added value to the country has been low. Most textile companies do not even try to export, and local fabric manufacturers have been protected from foreign competition by tariffs on imported fabric (except that which is to be reprocessed for export), which has permitted them to become inefficient. As the Dee affair revealed, the textile companies are also heavily indebted, at local interest rates that have been above 20 percent for well over two years.

Still, with labor costs rising in Asia's more industrial countries, and with those countries trying to move into high technology, it seems logical that the Philippines should pick up the textile mantle. The government has obtained a World Bank loan to help companies modernize, and under World Bank and International Monetary Fund pressure has begun reducing tariffs and import restrictions. If the program is enforced, it should force some companies to be more competitive, and will probably force others to fail. Philippine wages should not restrict competition, however; many economists believe wages declined in real terms during the 1970s.

Plans for the 11 industrial projects are less clear. Some of the energy-intensive projects, such as petrochemicals, may be delayed. The aluminum project has been plagued by disputes with the foreign partner, although Philippine officials insist they will see it through. The copper smelter, based on the extensive local mining industry and on Japanese investment, is going ahead. Philippine officials say that a good part of the large capital costs of the projects will be provided by foreign investors, and they deny that the projects are too complicated for them to handle. Any projects that divert investment away from projects with a greater chance of success, however, could create problems for the future, as happened in South Korea.

The last two years have been rough on the Philippines, which has missed growth targets and seen growth levels decline steadily (to 5.2 percent in 1980, with 18.8 percent inflation). But the Philippines' bad economic reputation abroad is probably an exaggerated one. Hong Kong and Taiwan have more speculative stock and property markets, and Indonesia's petty corruption and bureaucratic nightmare surpass those of the Philippines.

The Philippines also has human assets. President Marcos has attracted and given broad authority to a variety of respected technocrats. In the private sector, SyCip, Gorres, Velayo & Co. has expanded virtually throughout Southeast Asia to become the most influential indigenous management and accountancy outfit in the region.

The Philippines nevertheless has the highest debt service ratio (yearly interest and principal payments as a percentage of export income) in East Asia: about 19 to 20 percent depending on the level of interest rates. Some foreign bankers fear the debt may eventually have to be restructured and some repayments postponed, which would in effect mean issuing new loans to refinance old ones. Although that would be expensive for the Philippines, it would not be disastrous.

Foreign bankers often seem less worried about the heavy debt than they are about political and economic weaknesses. The political situation, however, has changed little since martial law was declared in 1972. Mr. Marcos has ended martial law in favor of an elected presidency, but he will retain substantial power. His ambitious wife Imelda seems to have lost political ground in the race to succeed her husband, and there is still no clearly chosen successor. Armed rebellions are local, not national problems, and the opposition is disorganized and weak. The biggest political problem is probably the one South Korea solved painfully in 1980: uncertainty about who will follow a man whose name has become synonymous with government.

A more immediate problem is what to do about highly indebted and sometimes badly managed companies that repeatedly turn to the government for loans. The government wants neither failures nor repeated bailouts. Even more than South Korea, it needs to clean up an economy in which well-managed companies (the Soriano family's San Miguel and Atlas Consolidated Mining & Development Corporation are often cited as examples) still mingle with those benefiting from favoritism. That is the real burden that stands between the Philippines and a measure of economic success.

VI

As with the other pairs of countries, Thailand and the Philippines face many of the same basic problems, but within fundamentally different societies. The Philippines has had a strong central government since martial law was declared in 1972, while Thailand has seen a series of revolving-door military and, occasionally, civilian regimes-44 in 48 years. The latest Deputy Prime Minister for Economic Affairs, banker Boonchu Rojanastien, ended certain government energy price subsidies and promised a more open economy, but was pushed out in a cabinet reshuffle after 13 months, shortly before an unsuccessful coup attempt in April. At least three general problems can be singled out: the lack of government direction in a fragmented economy still dependent on price subsidies, the heavy oil demand, and dissatisfaction in rural areas, where people feel they are taxed to support spending in Bangkok.

The dominant economic factor is a group of perhaps 15 leading ethnic Chinese families that control all the leading nongovernment banks and several top companies. Civilian and military government officials, notably the young Turk faction that failed in the recent coup attempt, occasionally threaten measures to control the family dominance of big business, but the families have managed to blunt the effect of one or two laws that have been passed. Laws to restrict Chinese businessmen have not been nearly as forceful as in Malaysia, Indonesia and the Philippines.

Government continuity is maintained by an upper echelon of Western-educated technocrats, but repeated government shakeups have made the bureaucracy as a whole self-protective and resistant to change. Infighting among transitory political parties makes things worse. A proposed increase in oil refinery capacity, for example, became a political issue revolving around foreign oil company profits, and took years to resolve. While the dispute lingered, the country had to increase imports of expensive refined oil products.

A recent World Bank study warned that electricity prices would have to be doubled within four years and petroleum product prices doubled within five years. It noted that chronic government budget deficits forced inflation to 20 percent in 1980, while overconsumption of imported energy has widened the current account deficit. It said that unless the government raises energy prices further, makes government agencies pay for themselves, and initiates an important push toward export industries, Thailand will face mounting current account deficits requiring prohibitively high foreign borrowing. The oil problem is particularly worrisome. A 1979 study of Esso Standard Thailand, Exxon Corporation's local subsidiary, noted that energy demand in Thailand was expected to grow at 8.5 percent per year from 1980 through 1985, slightly down from previous years but "still high by world standards."

Thailand's big hope is offshore natural gas, scheduled to be available for electricity generation later this year. Recently, specialists have said there may be more gas than was originally expected, and that some gas could possibly be sold to Japan to help pay for oil imports. But although oil exploration has stepped up in northern Thailand, the country is likely to remain a major oil importer, and its ability to curb demand will be a big determinant of future economic success.

Thailand's fertile land and heavy food production have been its greatest strength. Until recently there has been enough land that increases in rural population meant increases in production. But the land is filling up and population is growing in Bangkok. Younger, more left-wing planners are becoming more vehement about the need to invest in rural areas, and the issue could lead to tensions between the rural poor and the urban middle class.

If the government takes measures to force industries to become more competitive, Thailand could finish the 1980s with a significant light industrial sector and with oil consumption under control. But it will mean casting aside the established habit of muddling through problems, a habit which has long preserved Thailand from colonization or major war. Past performance has not been strong. For example, efforts to put capital to work through creation of finance companies and an active stock market led to stock speculation and market manipulation by some finance companies. The collapse of Raja Finance Company in 1979 provoked the collapse of stock prices, and neither the market nor the finance companies have recovered yet.

Few political analysts expect the government of Prime Minister Prem Tinsulanonda to be around long enough to free itself of factional rifts. One positive factor, however, is that slowed growth, down to the six to seven percent level, will probably mean fewer imports and less increase in pressure on the deficits in the balance of payments and the government budget.

VII

Indonesia is undoubtedly the East Asian country outside China most blessed with natural riches. Revenue from oil exports is pushing up foreign currency holdings almost faster than the government can keep track, and vast parts of the country, notably offshore waters, still have not been explored. Economists calculate that the country earned almost enough in 1980 from interest on its foreign currency reserves (which currently total more than ten billion dollars by conservative estimate) to pay both the interest and principal it owed last year on its foreign debt.

But Indonesia's wealth is dwarfed by its population. A smile-shaped string of more than 13,000 islands, it is the fifth most populous country in the world, and the largest of the Muslim countries. Despite windfall wealth, it remains a poor, rural, food-importing country.

The 1979 OPEC oil price increase nevertheless helped spark a boom in East Asia's only OPEC member, and foreign oil and gas companies have flocked to invest. It is Indonesia's extensive natural gas deposits, which are just beginning to be developed, that hold the greatest promise for the future.

Current projections call for Indonesia's growing economy to eat up all its oil production by the 1990s, although rising exploration could help extend its life as an exporter. Oil export revenue was up 50 percent in 1980 to $13 billion, the same order of magnitude as that of a small Persian Gulf state. Natural gas, much of which is sold to Japan, earned just $2.3 billion in 1980, but that was double the earnings of the year before. Many economists think gas earnings will grow to more than cover lost oil export revenue.

With numerous large oil, gas and petrochemical projects under way or planned, and with the booming economy generating other industries, foreign investors and contractors often complain of delays, massive corruption and shortages of skilled labor. Indonesia has, however, successfully arranged to repay billions of dollars in loans on which the state oil company Pertamina defaulted in 1975, an incident which exposed one of Asia's most costly government scandals.5 Banks are again eagerly competing to lend in Indonesia.

The World Bank, however, issued a report earlier this year, warning Indonesia that it risks a serious current account deficit by the late 1980s unless it stops relying almost entirely on energy exports for its economic success. The Bank wants Indonesia to stop subsidizing oil prices at home, and to make a more serious effort to develop non-energy-related export industries that can compete internationally. It also wants a major push to improve education and living standards, remove protective tariffs, and reduce obstacles to foreign investment. Many economists feel the World Bank's view is pessimistic, and doubt that the economic pressures will be bad enough to push the slow-moving government into major changes.

But if the World Bank is right, it could mean increasing social and economic problems in the 1990s, though Indonesia today shows few signs of the kind of political instability that produced the bloodletting between communist and anti-communist forces in 1965. That violence led eventually to President Sukarno's departure and brought General Suharto in to replace him. President Suharto, now sixty, is likely to be elected to a fourth five-year term in 1983, and whenever he leaves he is generally considered likely to be succeeded by another conservative general.

Malaysia's position vis-à-vis the other three commodity exporters is similar to the favored position of Singapore vis-à-vis the three other industrial countries. The key to Malaysia's success is a small population and a great diversity of natural wealth. With less than one-tenth Indonesia's population, its per capita GNP is just $200 short of South Korea's. Moreover, Malaysia is not dependent on any single commodity. It is the world's largest rubber and palm oil exporter, and oil is a big export earner. Depending on future discoveries, Malaysia's limited oil supplies could make it a net oil importer by the late 1980s, but like Indonesia it has heavy natural gas reserves to take oil's place.

Manufacturing now accounts for about 20 percent of all exports. The notable success stories are textiles and electronics, the standard ones the economists are pushing. Malaysia is also increasing its capacity to refine its own oil. One of the country's biggest successes has been the conservative economic and monetary management that held inflation to 6.7 percent last year-nearly double the rate of the year before, but unusually low by regional standards.

A major challenge for the 1980s will be development of the states of Sabah and Sarawak on the island of Borneo. Plans have been kicked around for several years to set up energy-intensive industries to use the ready natural gas supplies that lie offshore as well as to exploit the island's timber, but the necessary infrastructure is not in place, and projects have been repeatedly delayed and redesigned. Many economists think Malaysia is not really ready for extensive heavy industrial development, and that the delays are not such a bad idea.

Difficulties seem minor compared to most other Asian countries. Most important is the racial problem. About 53 percent of the population is bumiputra, or what the government considers native races, primarily Malay. About 35 percent is ethnic Chinese, and about ten percent is Indian. Because of the greater business success of the Chinese, a problem that provoked race riots in 1969, the government adopted one of the most blatant policies of racial discrimination in Asia. The New Economic Policy of 1970, together with occasional revisions, set out requirements aimed at increasing the bumiputra shareholdings in companies to 30 percent by 1990, from an estimated 2.4 percent in 1970. Results have been slow and the government has had to buy much of the bumiputra equity itself. The Chinese community remains the driving business force, and racial tensions continue to be a problem.

A related issue is the rising expectations of the population. Although there is a labor shortage in less desirable rural and plantation jobs, urban areas face more than six percent unemployment. Growing demand for imported consumer and capital goods has helped push up inflation this year, and, together with a nasty slump in the prices of Malaysia's commodity exports, has helped throw the current account seriously into deficit.

The government has been tough with foreign investors, notably the oil companies, which since the mid-1970s have had to give the lion's share of production to the government. One, Continental Oil Company, pulled out, but most other foreign investors seem willing to put up with the abrasive government in hopes of a shot at the resources. The country's political problems do not seem to hinder its economic success.

VIII

One of the most troublesome problems facing East Asia's rapidly developing economies is the need for continuing injections of cash to cover large current account deficits and to finance new development. Since 1979, such financial specialists as former Chase Manhattan Bank Chairman David Rockefeller and Federal Reserve Board Chairman Paul Volcker have warned that many banks are reaching prudential limits on international lending, and that big borrowers could begin to have trouble finding sufficient funding.

So far, however, there has been nothing of the sort. Every East Asian borrower, including the much-maligned Philippines, finds it easier to borrow today than it did a year ago. Banks are short of earnings and awash with money to lend, and they are offering attractive terms. Most Asian borrowers are still borrowing more than they need and expanding their reserves, leaving them something to fall back on if borrowing becomes difficult later.

Some bankers worry, however, that the current money glut could be even more transitory than an oil glut. Big borrowers like South Korea and the Philippines are likely to run deficits for the foreseeable future, which means that when foreign loans come due, the governments will not have excess earnings of their own with which to repay. South Korea and the Philippines are already using new loans to cover interest and principal payments on old loans. Morgan Guaranty Trust Co. of New York has forecast that a steadily increasing gap will eventually appear between the needs of the developing countries and the amounts of money the commercial banks can prudently lend.6

Bankers and economists differ widely on how the problem will be resolved. Edward P. Neufeld, chief economist of Royal Bank of Canada, takes what might be called the "closed system" view. So long as oil exporters run balance-of-payments surpluses, he argues, the money will find its way to banks, which will relend it to worthy borrowers. Some very weak economies may have trouble borrowing, he says, but the high growth countries of East Asia should remain attractive places for banks to put money.7

Geoffrey Maynard, Chase Manhattan's director of economics for Europe and the Middle East, argues that the real question is not whether the banks can pass on the cash, but rather what the borrowing countries do with it. In his view, those that manage to create high-productivity industries, expanding the economic base and earning foreign exchange, should have little trouble borrowing, even in large amounts.

Many international bankers are still unhappy with their almost quasi-governmental roles of taking deposits from oil exporters and lending the money to deficit-ridden countries. The International Monetary Fund and the World Bank are stepping up their own roles in this process, notably by borrowing more heavily themselves from such oil exporters as Saudi Arabia and lending the money to developing countries. Arab-owned banks also are becoming more active in the process. But many commercial bankers are beginning to feel, probably rightly, that their banks are becoming so deeply committed to some borrowers that the banks could not withdraw from the process even if they wanted to. Happy or not, the commercial bankers seem to be increasingly resigned to their roles.

What has begun worrying the bankers more immediately is the harsh effect of high U.S. interest rates on developing countries that borrow money. Most international bank loans carry floating interest rates: interest on the loan varies up and down with the interbank rates, the rates that banks charge each other to borrow funds. Most Asian borrowers have succeeded in negotiating terms under which they pay only thin margins in addition to the interbank rate. But in recent months, interbank rates for dollars have averaged well over 15 percent, which represents substantial real interest above U.S. inflation rates. This is a turnaround from the situation during most of the 1970s, when interest rates were often lower than inflation rates and borrowing was cheap.

Heavy borrowers have found themselves with sizable bills to pay. One South Korean official estimates that his country paid as much as one billion dollars more in interest in 1980 than in 1979, and some South Korean companies have seen their interest costs triple or quadruple. For some borrowers, the interest burden has become more severe than the burden of oil prices. In 1970, Morgan Guaranty calculates, the world's 12 largest oil-importing developing countries paid six percent of their export earnings in interest. In 1980, the figure was 16 percent,8 and it has risen since. Many economists consider current interest rates untenable for heavily indebted developing countries such as South Korea and the Philippines. They feel the interest burden is emerging as the primary threat to the success of Asia's more vulnerable economies.

IX

The Korean language has a slang phrase for goodbye that Koreans use much as Americans use the phrase, "take it easy." The Korean version, however, translates as "work hard."

That seems an appropriate phrase for most of the major East Asian developing countries in the next few years. They will probably have to work harder to achieve less remarkable results than before. A certain level of diminishing returns was probably going to hit the four industrial countries anyhow, as they try to make the difficult shift from labor-intensive toward high-technology industry. But a substantial part of the sluggishness they will be fighting will be imported in the form of expensive oil, high interest rates, and depressed demand for Asian exports in Western countries.

Given general international economic performance, what is surprising is not that some of the East Asian countries have had to accept slower growth. It is that four-Hong Kong, Indonesia, Malaysia and Singapore-are still experiencing little or no growth slowdown. Most of the others, notably former fast-growth champion South Korea, have concluded that some slowdown is actually desirable, even if it means giving up the myth of gaining on Japan any time soon.

There is a large crystal ball component to this kind of discussion, however. All eight of the East Asian economies have basic internal weaknesses which they could fail to muster the insight or ability to overcome. High exposure to international trade makes them more vulnerable than most countries to serious disturbances elsewhere in the world. But so long as the world continues to reward productivity and hard work, East Asia is likely to continue as a world center of prosperity and high economic performance.

1 See Willard D. Sharpe, "The Outlook for Asia's Star Performers," The Asian Wall Street Journal, February 14, 1980.

2 For a detailed discussion of this question, see Kim Kihwan, "Current Economic Situation in Korea and the Prospects for U.S.-Korean Cooperation," Economic Bulletin, November 28, 1980, published by the Economic Planning Board of the Government of the Republic of Korea. Dr. Kim is Senior Counselor to the Deputy Prime Minister and Minister of Economic Planning.

3 An executive at Pohang Iron & Steel Company, the government's integrated steel mill, tells a story that helps explain that feeling. When Pohang was still expanding its plant, company president Park Tae-Joon negotiated a long-term contract to buy coal and iron from Australia for a new section of the mill. The strict contract required him to begin paying for the goods even if the construction were delayed. But on his return, he learned the expansion had somehow fallen weeks behind schedule. Rather than stockpile the goods or delay delivery-both expensive propositions-he ordered a double construction schedule. Each day a different executive was assigned to personally lead the workers until the double quota was completed. At the cost of two months of sleepless nights for Mr. Park and his employees, construction was finished and the mill expansion ready when the Australian materials arrived.

4 The experience of a small electrical accessories maker helps illustrate Hong Kong's position. He keeps his main factory in Taiwan, where labor is cheaper. But to avoid Taiwan's currency controls and higher taxes, he sells through his Hong Kong office, realizing profits as much as possible in the colony. He turned his Hong Kong office into a trading company when he saw the 1980 recession coming, but will turn it back into a factory when international demand picks up again.

6 Morgan Guaranty Trust Co. of New York, "World Financial Markets," September 1980.

7 Edward P. Neufeld, "Submission to the Select Committee of the House of Commons on North-South Relations," 1980.

8 Morgan Guaranty Trust Co. of New York, loc. cit., December 1980.

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  • E.S. Browning is The Asian Wall Street Journal's staff correspondent covering banking and finance.
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