Implications of Globalisation on Industrial Diversification

Process and Improved Competitiveness of Manufacturing

in ESCAP countries
_____________________________________________________
_

DR. TARUN DAS

Economic Adviser
Ministry of Finance, Government of India, and
Consultant, UN-ESCAP, Bangkok, Thailand.

December 15, 2001

_______________________________________________________________________
_

• Prepared for the International Trade and Industry (ITD) Division, ESCAP, United
Nations, Bangkok as a part of their Project on Implications of Globalisation on the
Industrial and Technological Development Process in Developing Countries.

• The author would like to express his gratitude to ESCAP, particularly to the Director
and Chief of the ITD Division for providing an opportunity to prepare this report and
the Ministry of Finance, Government of India for granting necessary permission for
writing this report. However, the paper expresses personal views of the author and
should not be attributed to the views of the Government of India.

1
 Implications of Globalisation on Industrial Diversification
Process and Improved Competitiveness of Manufacturing
in ESCAP countries

CONTENTS

1 Introduction and Overview

1.1 Objectives and Scope of the Study

1.2 An Overview of the Study
1.3 Profile of Regions and Sample Countries
(a) General economic profile
(b) South Asia and SAARC
(c) East and South East Asia
1.4 Overall growth and industrial progress in Asia and Pacific in 1990s
(a) Overall economic growth
(b) Industrial progress
(c) Trend of sectoral shares
(d) Impact of crisis on manufacturing
1.5 Policy reforms for industrial diversification and improved competitiveness

2 Implications of Globalisation and Regional Integration on Industrial Progress

2.1 Challenges and Prospects of Globalisation

(a) Globalisation and its impact on international trade
 Share in world exports
 Growth rates of merchandise exports and its share in GDP
 Japan's economic slowdown and linkages with Asia
 Agricultural exports
 Services exports
 Direction of trade
(b) Developments in investment
(c) Backward linkages of TNCs for parts and components
(d) ICT revolution and new economy
2.2 Regional Integration and Industrial Development
(a) ASEAN and AFTA
(b) SAARC and SAFTA
(c) APEC
(d) ESCAP
(e) Multilateral Agreement on Investment (MAI)

2
3: East Asian Economic Crisis During 1997-1999:
Origins, Onset, Spread, Measures and Lessons of the Crisis

3.1 Anatomy of the Crisis

3.2 Origins of the Crisis
(a) Victims of their own economic success
(b) Changes in External Environment
(c) Macroeconomic Management and Exchange Rate Arrangements
(d) Financial Sector and other Structural Weaknesses
3.3 Onset and Spread of the crisis
3.4 Role of multilateral financial institutions
3.5 Summary of Structural Reforms in Crisis Countries
(a) Financial and Corporate Sector Reforms
(b) Competition and Governance Policies
(c) Trade Reforms
(d) Social Policies
(e) Stabilisation Policies
3.6 Lessons from the Asian Crisis for Macro-economic management
(a) General policies
(b) Financial sector reforms
(c) Monetary policies
(d) Fiscal policies
(e) Sequencing capital account convertibility
(f) International co-operation
(g) External Debt Management Strategy

4 Role of Foreign Capital in Industrial and Infrastructure Development

4.1 Private capital flows to developing countries

4.2 Relation between capital flows and economic growth
4.3 FDI - Technology - Growth Nexus
4.4 Regional distribution of FDI
4.5 Sectoral Distribution of FDI
4.6 Modes of Foreign Capital

3
4. Foreign Capital for industrial and Infrastructure Development
5 Role of Privatisation for Development of Industry and Infrastructure

6 Policies and Strategies for Promoting Globalisation

6.1 Macro-economic policies

6.2 The Export-Push Strategy and Role of Export Processing Zones
6.3 Promoting industrial linkages
6.4 Role of Small and Medium-Sized Industries (SMIs)
6.5 Role of information technology
6.6 Technological capacity building
6.7 Role of Natural and Human Resources
6.8 Regional and sub-regional co-operation
 ASEAN Experience
 SAARC Experience
 ESCAP experience

7 Concluding observations and recommendations

7.1 Policy areas

7.2 Industrial capacity building
7.3 Facilitating private sector growth
7.4 Industrial investment promotion
7.5 Technological capacity building
7.6 Application of information technology
7.7 Strengthening capacities for SMEs
7.8 Human resource development
7.9 Promoting regional co-operation

Selected Bibliography

4
ACRONYMS

ADB Asian Development Bank

ADR American Depository Receipts
AFTA ASEAN Free Trade Area
APEC Asia Pacific Economic Cooperation (presently comprises 21 countries including
Australia, Brunei Darussalam, Canada, Chile, China PR, Hong Kong, Indonesia,
Japan, Korea Republic, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru,
the Philippines, Russia, Singapore, Chinese Taipei, Thailand and the United States).
ASEAN Association of South-East Asian Nations (comprises Brunei, Indonesia,
Malaysia, Philippines, Singapore, Thailand, Vietnam, Lao PDR, Myanmer, Cambodia.
BOL Build, Operate and Lease
BOLT Build, Operate, Lease and Transfer
BOO Build, Operate and Own
BOOT Build, Operate, Own and Transfer
BOT Build, Operate and Transfer
CIS Commonwealth of Independent States
ECB External Commercial Borrowing
EEC European Economic Community
EHTP Electronic Hardware Technology Park
EOU Export Oriented Unit
EPZ Export Processing Zone
ESCAP Economic and Social Commission for Asia and the Pacific
ESTP Electronics Software Technology Park
FCCB Foreign Currency Convertible Bond
FDI Foreign Direct Investment
FERA Foreign Exchange Regulation Act
FIIs Foreign Institutional Investors
FTZ Free Trade Zone
GATT General Agreement on Tariffs and Trade
GDP Gross Domestic Product
GDRM Global Depository Receipt Mechanism
GNP Gross National Product
GSP Generalised System of Preferences
ICOR Incremental Capital-Output Ratio
ILO International Labour Office
IMF International Monetary Fund
IPR Intellectual Property Rights
M&A Mergers and acquisitions
MFN Most Favoured Nation
MIGA Multilateral Investment Guarantee Agency
NIEs Newly Industrializing Economies
OCBs Overseas Corporate Bodies

5
OECD Organisation for Economic Co-operation and Development, comprise
Australia, Austria, Belgium, Canada, and Czech Republic, Denmark, Finland,
France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Rep. of Korea,
Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Spain,
Sweden, Switzerland, Turkey, United Kingdom, United States of America.

ODM Own - Design - Manufacture

OEM Original Equipment Manufacture
OPEC Organisation of Petroleum Exporting Countries
PPP Purchasing Power Parity
R&D Research and Development
SAARC South Asian Association for Regional Cooperation comprises Bangladesh,
Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka.
SMIs Small and Medium-Sized Industries
SOEs State Owned Enterprises
STP Software Technology Park
TNCs Transnational Corporations
UN United Nations
UNCTAD United Nations Conference on Trade and Development
UNDP United Nations Development Programme
UNIDO United Nations Industrial Development Organisation
WB World Bank
WTO World Trade Organisation

Notes on Units

Million = 1000 thousand

Billion = 1000 million
Trillion = 1000 billion
Tons = 1000 kilograms
Dollar $ = US dollars, unless otherwise specified

6
 INTRODUCTION AND OVERVIEW

1.1 Objectives and Scope of the Study

The present study is a part of a larger project for analysing the implications of
globalisation on the industrial and technological development process of developing
countries in the ESCAP region. The basic objective of the present study is to critically
analyse the trend and pattern of globalisation in Asian developing economies and to
examine its impact on the industrial progress and diversification and competitiveness of
manufacturing industries.

As the study is concerned with the impact of globalisation in the past and future issues,
the time frame of the study is confined mainly to 1990s. For analytical purpose, Asian
economies considered in the study have been grouped into the following regions:

South Asia comprising Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri
Lanka.

The Newly Industrializing Economies (NIEs) comprising Hong Kong, China; the
Republic of Korea; Singapore; and Taiwan, China.

Developing Economies in the Southeast Asia comprising Cambodia, Indonesia, Lao PDR,
Malaysia, Myanmar, the Philippines, Thailand and Vietnam. These countries alongwith
Brunei and Singapore now constitute the Association of Southeast Asian Nations
(ASEAN) and ASEAN Free Trade Area (AFTA).

Three other economies in East Asia comprising Japan, Mongolia and People’s Republic
of China.

1.2 An Overview of the Study

This report is divided into seven chapters including this introduction which describes
objectives and scope of the study, and provides general economic profiles and policies of
Asian economies. The chapter also discusses the extent of industrialisation of sample
countries and regions in pre-crisis and post-crisis period in 1990s.

Chapter 2 provides a critical analysis of the challenges and prospects of globalisation of

industrial progress in Asian developing countries with particular emphasis on
developments in trade, investment and information technology affecting competitiveness
of manufacturing industries. The chapter focuses on need for integration of industrial
activities at regional and global levels, capacity building improvement of

7
competitiveness, international linkages for markets, with special reference to developed
countries and economies in transition.

Chapter 3 makes a review of the origins, onset and spread of financial crisis in the East
Asian economies. The Chapter also discusses the measures taken by the East Asian
economies with the help of multilateral funding agencies to tackle the crisis, and lessons
from the economic crisis for developing countries.

Chapter 4 deals with role of foreign capital including foreign investment for industrial
and technology development in Asian economies.

Chapter 5 makes a critical review of the role of privatisation for development of industry,
infrastructure and services in Asian economies.

Chapter 6 deals with broad policies, reforms and strategies for promoting greater
liberalisation and globalisation. It particularly discusses the role of the following policies:

• Alignment of industrial policies with trade, investment, fiscal, monetary, financial

and overall macro-economic policies,
• Exploiting the potential for promoting complementarities, backward linkages for parts
and components, and forward linkages with value added products and services,
• SMEs development, business incubation and entrepreneurship.
• Utilisation of information technology and other knowledge bases industries to access
and retain competitiveness in global markets.
• Other technology capacity building and adaptations,
• Role of human resource and skill development,
• And regional and subregional co-operation for promoting industrialisation.

Chapter 7 summarises the basic issues and problems for promoting greater industrial
diversification and makes recommendations on the following issues:

• Policy areas.
• Institutional capacity building,
• Facilitating private sector growth,
• Industrial investment promotion.
• Technological capacity building,
• Applications of information technologies.
• Strengthening capacities for SME growth and development, and
• Human resource development for industry.

The report ends with a list of selected bibliography on the subject.

8
 1.3 Profile of Regions and Sample Countries

(a) General Economic Profile

Selected countries for this study covering 55 per cent of the world population and 15 per
cent of area display a number of contrasts (see Tables 1.1 and 1.2 for general economic
profiles of the sample countries). The sample includes two most populous countries of the
world viz. China and India, and also small economies like Bhutan and Maldives with
population less than a million and a city-state Singapore. The sample includes the world’s
second largest economy Japan with per capita GNP of $34210 in 2000, and some of the
poorest countries of the world– Bangladesh, Cambodia, Mongolia, Nepal and Vietnam
(Table 1.2). Levels of social indicators also differ widely among the regions. While East
Asian countries generally have higher degree of adult literacy and life expectation, South
Asian countries except Sri Lanka, Maldives and Myanmar lag far behind.

In 1990s, despite serious foreign exchange and financial crisis in some of the East Asian
countries during 1997-1999, Asian developing economies had shown remarkable
economic vigor and dynamism by outperforming by a wide margin other developing
regions and industrial countries as a group. As regards industrial growth, performance by
the developing countries of Asia continued to outpace that in every other developing
region and even the industrialised countries by about 5 percentage points. The continued
robust growth in Asia was attributable to a number of factors such as widespread and
sustained policy reforms in industry, trade and financial sectors and continued surge of
foreign capital flows to these countries.

The best performers have been in Asia. China’s growth has been particularly spectacular,
with real GDP growing at 10.3 percent a year and real per capita income at 9.2 percent
during 1990-2000. Building on past investments in human, physical, and institutional
capital, continual high growth was the result of an ambitious, comprehensive, and
sustained reforms programme. Economic reforms liberalised agriculture, redirected a
large part of savings to the provinces, removed price controls, gradually liberalised trade,
revamped the tax and financial systems, and converted economic zones into attractive
manufacturing platforms for export.

The mechanism that contributed the high growth of the Asian economies in these years
can be summarised as export-oriented investment-led growth supported by extremely low
production costs. As judged by ratios to GDP, investments and exports made a much
higher contribution to growth in Asia than in the other regions. Asian economies achieved
high economic growth by introducing capital and technology from advanced countries,
while enjoying the benefits of the huge markets that these advanced countries offer. In
other words, the Asian economies are typical examples of “catch-up type” economic
growth.

9
 Table-1.1 Basic Indicators of Selected Asian Countries in 1995 and 2000

Country Area Population GR of Pop. Adult Adult Life Exp. Life Exp.
in 2000 Mid-2000 percent literacy(%) Literacy(%) years years
000 sq.km (million) 1990-2000 1995 1999 1995 1999
NIEs
Hong Kong 1 7 1.8 92 93 79 80
Korea,Republic 99 47 1.0 99 98 72 73
Singapore 1 4 2.8 91 92 76 78
Taiwan,China 36 22 1.1 92 93 75 76
China & Mongolia
China 9597 1261 1.1 81 83 69 70
Mongolia 1567 2 1.3 n.a. 62 64 67
South-East
Cambodia 181 12 2.7 n.a. 49 53 54
Indonesia 1905 210 1.7 84 86 64 66
Lao, PDR 237 5 2.6 57 47 52 54
Malaysia 330 23 2.5 83 87 71 72
Myanmar 677 46 1.2 83 84 59 60
Philippines 300 76 2.2 95 95 66 69
Thailand 513 61 0.9 94 95 69 69
Vietnam 332 79 1.7 94 93 68 69
South Asia
Bangladesh 144 130 1.6 38 41 58 61
Bhutan 47 0.8 2.9 42 43 48 61
India 3288 1016 1.8 52 56 62 63
Maldives 0.3 0.3 2.6 93 96 63 68
Nepal 147 24 2.4 27 40 55 58
Pakistan 796 138 2.5 38 45 60 63
Sri Lanka 66 19 1.3 90 91 72 73
East Asia
Japan 378 127 0.3 99 99 80 81
Low & middle income 101487 5152 1.6 70 75 65 64
East Asia & Pacific 16385 1853 1.2 83 85 68 69
Europe & Central Asia 24209 475 0.2 95 97 68 69
Latin America & Carib. 20461 516 1.6 87 88 69 70
Mid. East & N.Africa 11024 296 2.2 61 64 66 68
South Asia 5140 1355 1.9 49 54 61 63
Sub-Saharan Africa 24267 569 2.6 57 61 52 47
High Income 32087 903 0.7 n.a. n.a. 77 78
World 133572 6054 1.4 n.a. n.a. 67 66
n.a. Data not available
Sources : (1) World Development Report 1997, World Bank.
(2) World Development Report 2002, World Bank.

10
 Table-1.2 Per capita GNP and GDP Growth Rates of Selected Asian Countries in 1995 and 2000

Country Per capita Per capita GR of GR of GDP GDP PPP GNP

GNP GNP PC GNP PC GNP $ billion $ billion Per capita
(US$) (US$) 1985-1995 1995-2000 1995 2000 US$
1995 2000 2000
NIEs
Hong Kong 22990 25950 4.8 2.5 144 163 25660
Korea,Republic 9700 8910 7.7 -1.7 456 457 17340
Singapore 26730 24740 6.2 -1.5 84 92 24970
Taiwan,China 10011 12670 6.5 4.8 225 279 n.a.
China & Mongolia
China 620 840 8.3 6.3 698 1080 3594
Mongolia 310 390 -3.8 4.7 1 1 1660
South-East
Cambodia n.a. 260 n.a. n.a. 3 3.2 1410
Indonesia 980 570 6.0 -10.3 198 153 2840
Lao, PDR 350 290 2.7 -3.7 2 1.7 1530
Malaysia 3890 3380 5.7 -2.8 85 89 8360
Myanmar n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Philippines 1050 1040 1.5 -0.2 74 75 4220
Thailand 2740 2010 8.4 -6.0 167 122 6330
Vietnam 240 390 n.a. 10.2 20 31 2030
South Asia
Bangladesh 240 380 2.1 9.6 29 48 1650
Bhutan 420 550 4.9 5.5 0.3 0.4 1350
India 340 460 3.2 6.2 324 479 2390
Maldives 990 1460 5.9 8.1 0.3 0.4 4880
Nepal 200 220 2.4 1.9 4 5 1360
Pakistan 460 470 1.2 0.4 61 62 1960
Sri Lanka 700 870 2.6 4.4 13 16 3470
East Asia
Japan 39640 34210 2.9 -2.9 5109 4677 26460
Low & middle income 1090 1230 0.4 2.4 5393 6568 3890
East Asia & Pacific 800 1060 7.2 5.8 1341 2059 4120
Europe & Central Asia 2220 2010 -3.5 -2.0 1103 961 6620
Latin America & Carib. 3320 3680 0.3 2.1 1688 1995 7030
Mid. East & N.Africa 1780 2040 -0.3 2.8 524 592 5170
South Asia 350 460 2.9 5.6 439 620 2260
Sub-Saharan Africa 490 480 -1.1 -0.4 297 322 1560
High Income 24930 27510 1.9 2.0 22486 24772 27450
World 4880 5150 0.8 1.1 27846 31337 7350
n.a. Data not available
Sources : (1) World Development Report 1997, World Bank.
(2) World Development Report 2002, World Bank.

11
Rapid growth in intra-Asian trade has been accompanied by rising foreign direct
investment. The traditional focus of overseas investment by Asian companies in financial
and real estate markets of industrial countries has been augmented by rapid growth in
investment in manufacturing, primarily in South-east Asia. The changing pattern of
capital flows is, to some extent, a reflection of the changing cost structure in the Asian
economies as wages and other costs have risen rapidly in Japan and the NIEs. It is also
indicative of the movement towards higher value added and more technologically
intensive activities in these economies.

The process of rapid growth in output and intraregional trade and investment in Asia is
sometimes referred to as a “virtuous circle” of economic development. Foreign capital
inflows have combined with a favourable policy environment, industrialisation and trade
expansion to achieve a sustained acceleration in economic growth. The efficient use of
resources, increased trade and rapid growth have, in turn, stimulated an increase in the
flow of intraregional foreign investment. This process is gradually helping to internalise
Asian growth and to reduce Asia’s vulnerability to external shocks.

During 1990s, the “virtuous circle” evolved rapidly primarily due to the structural adjustment process in

Japan subsequent to the sharp appreciation of the yen following the Plaza Accord. Japan’s growth became

increasingly “domestic demand led” and it had been sustaining rapid export growth of other Asian

countries. More recently, such a process has occurred in the NIEs as well, fueling further intra-regional

trade and investment. Rapid structural adjustment and shifting comparative advantage from Japan to the

NIEs and further to the Southeast Asian countries due to rising wages and factor prices have contributed

significantly to Asia’s dynamism. South Asia, which depends more on the agriculture sector, was by and

large left out of this process. But the situation is changing, albeit slowly, as these countries globalise

gradually and cautiously.

(b) South Asia and SAARC

South Asia is a region full of contrasts. On the one hand, it has vast economic potential.
During 1990s it achieved an average growth rate of 5.6 per cent a year compared with 3.6
per cent by all low-and middle-income countries. Its growth was exceeded only by that
in East Asia and Pacific. Progress in reducing fertility led to annual growth in per capital
income by 3.7 per cent during 1990s which was regarded as a “lost decade” for many
other regions of the world. In fact, Sub Saharan Africa and Europe and Central Asia
witnessed a decline of per capita income in 1990s (Table 1.3).

12
Fueling the growth in 1990s in South Asia were savings and investment rates of around
20-25 percent, mainly from domestic sources building on strong legal and political
traditions and a growing pool of technical manpower. Deregulation and trade reforms
increased internal competition, reduced transactions costs, and improved product range
and quality. The increased private activity in Asia stimulated the financial sector and is
beginning to attract substantial foreign investment, particularly in infrastructure and the
stock market.

On the other hand, South Asia is characterised by widespread poverty and low levels of
living. While accounting for a fifth of the world’s population, South Asia is also home to
nearly half the world’s poor. It has lower life expectancy than in any other region except
Africa, high infant mortality rates, high rates of malnutrition and low levels of literacy
(except Maldives and Sri Lanka).

Table 1.3 Average Annual Growth rates of GDP and per capita GNP
in different regions (per cent)

Country GR of GR of GR of GR of Percaput GR of GR of
GDP GDP GDP GDP GDP PC GNP PC GNP
GNP
percent percent percent Percent US$ Bln US $ percent percent
1980-1990 1990-1995 1996-2000 1990-2000 2000 2000 1985-1995 1995-2000
Low & middle 2.8 2.1 5.1 3.6 6568 1230 0.4 2.4
income
East Asia & Pacific 7.6 10.3 4.1 7.2 2059 1060 7.2 5.8
Europe & Central Asia 2.3 -6.5 3.3 -1.6 961 2010 -3.5 -2.0
Latin America & 1.7 3.2 3.4 3.3 1995 3680 0.3 2.1
Carib.
Mid. East & N.Africa 0.2 2.3 3.7 3.0 592 2040 -0.3 2.8
South Asia 5.7 4.6 6.6 5.6 620 460 2.9 5.6
Sub-Saharan Africa 1.7 1.4 3.4 2.4 322 480 -1.1 -0.4
High Income 3.2 2.0 2.8 2.4 24772 27510 1.9 2.0
World 3.1 2.0 3.2 2.6 31337 5150 0.8 1.1

Two themes have characterised recently the development approach of most South Asian
economies: a strong economic role for the private sector and relatively outward-looking
development policy. The broad lessons of development during the past decade are that
countries with more market-friendly policies and outward-looking strategies do better
both in generating growth and reducing poverty. While there is general agreement in
South Asia about the need of reforms, the pace has been uneven due to mainly political
economy issues. Recent progress is most visible in reforms in privatisation, industrial,
trade, external, fiscal and financial sectors.

Both the direct and indirect taxes were reduced in many countries to encourage private
investment and savings. Progress continued in India, Nepal, Pakistan, and Sri Lanka

13
towards moving to a full-fledged value-added tax, and Pakistan made important progress
in broadening the tax base by introducing an agricultural income and wealth tax.

SAARC has completed more than fifteen years of its existence, but the process of
economic cooperation in the region had been slow. Nevertheless, SAARC has established
itself as an important regional grouping due to its large market space measured by the
size of its population and its potential purchasing power. The ongoing economic reforms
and globalisation by the SAARC economies have also made the region an attractive
destination for foreign direct investment and other capital flows.

The SAARC is rich in natural resources, which are not fully utilised. Its bio-diversity is
an immense wealth, and mineral and water resources are plenty. The region is endowed
with a large pool of skilled and semi-skilled manpower. Despite these advantages, the
region faces common problems of poverty and unemployment. Economic cooperation in
the region would be an effective instrument for improving the welfare of the people.

As compared to the world and other developing countries, the contribution of the
industrial sector to GDP in South Asia is rather small. During 1990s, the service sector
grew at a faster rate than the industrial sector in South Asia. Within the service sector,
major contribution came from the financial and trade sectors, and contribution of the
transport and communications also improved rapidly in recent years.

The share of South Asia in world trade is negligible being less than one per cent. The
intra-regional trade of South Asian countries is also insignificant, being 3.5 per cent of
total trade, compared to the intra-regional trade of all developing countries at around 40
percent of their total trade. This implies that there is significant potential for increasing
intra-regional trade among the SAARC economies. About 35 per cent of South Asia’s
exports are destined towards other developing countries, while dependence of South Asia
on other developing countries for imports is to the extent of 46 percent. The composition
of South Asian trade reveals concentration of exports in labour-intensive products like
textiles, clothing, gems and jewellery, while imports consist of mostly crude oil,
petroleum products and capital goods.

Most of the exports in intra-regional trade originate from India, followed by Pakistan,
while Bangladesh and Sri Lanka are major importers in intra-regional market. In recent
years, the combined share of imports of Bangladesh and Sri Lanka was about 70 percent
in total intra-regional trade, while the share of India’s exports in intra-South Asian trade
was 60 per cent.

The challenge facing South Asia in the new millennium is how to continue the high
economic growth of the 1990s with rapid reductions in poverty and unemployment and
improvement in social indicators. A sustainable growth path for the 2000s must be based
on continued economic reforms, lower fiscal deficits, dynamic capital market, sustainable
balance-of-payments, and improvement in environment.

14
 (c) East Asia and South-East Asia

Over the past three decades, the economies of East Asia made remarkable economic
progress and grew faster than all other regions of the world. Following on the heels of
Japan’s double-digit growth in the 1960s, Korea, Taiwan Province of China, Hong Kong
SAR, and Singapore grew at very rapid rates from the mid-1960s with their per capita
incomes rising to match those in a number of advanced economies in western Europe.
They were followed in the 1980s and the 1990s by the Southeast Asian economies
(especially Indonesia, Malaysia, and Thailand) which also grew at exceptionally fast rate.
All these countries experienced sustained economic growth with some attaining an
average growth rate of 8-10 percent a year for a decade, except for the crisis period. In
East Asia and Pacific, GDP grew at average annual rate of 7.2 percent in 1990s, while
annual population growth averaged 1.2 percent.

Savings and investment rates of the South East Asian economies were generally higher
than those in other regions (Table 1.4). Governments boosted savings through a
combination of fundamental and interventionist policies. The former included
maintaining macro-economic stability – primarily controlling inflation, and ensuring the
security of banks. Low to moderate inflation rates and largely positive real interest rates
lowered the risk of holding financial assets, and hence encouraged financial savings.
While nominal interest rates were low and were frequently controlled by the
governments, these rates still assured positive real returns in the range of 3-6 percent per
annum for the investors and moderate yields to the commercial banks and financial
institutions because of low transactions cost.

Table-1.4 Gross domestic savings as % of GDP in Asia and Africa (%)

Region 1967-1973 1974-1980 1981-1990 1990-1997 1998-1999

Gross Domestic Savings

Sub-Saharan Africa 15.7 20.7 12.6 15.9 15
East Asia 21.1 28.4 33.2 33.5 37
Southeast Asia 18.9 28.1 31.9 32.0 36
South Asia 14.4 17.1 19.1 22.0 18

Gross Domestic Investment

Sub-Saharan Africa 17.3 17.9 19.1 16.6 18
East Asia 25.4 27.0 27.7 31.6 35
Southeast Asia 20.1 21.0 22.1 27.5 33
South Asia 16.2 16.5 17.0 21.0 22
Source: Bank Economic and Social Data base, The World Bank, 1998, 2000.

East and South East Asian countries relied heavily on export-push strategy and were
generally open to foreign investment and technology transfer although they adopted
different strategies regarding industrial promotion and foreign technology. Some
depended on FDI by TNCs, others on licensing and imports of capital goods. All the

15
countries were successful in expanding industrial base and exports, but they adopted
different industrial structures, export specialisation and technological capabilities
(Dasgupta 1996).

The rapid growth of the East Asian economies was accompanied by impressive advances
in social development indicators. Poverty, infant mortality, and adult illiteracy declined
significantly, while life expectancy at birth rose considerably. Also, contrary to the earlier
conventional wisdom, rapid economic growth was achieved with significant reduction in
poverty ratios (Table 1.5) and without increases in income inequality.

Table-1.5: Poverty incidence and growth rates in India

and selected Asian countries (in per cent)
Country Poverty Poverty Annual Average Average
ratios Ratios Reduction GDP growth GDP
1975 1995 In 1975-95 1970-1980 Growth
Percentage 1980-1995
Point
India 54.9 36.0 0.9 3.2 5.6
China 59.5 22.2 1.9 5.0 11.1
Indonesia 64.3 11.4 2.6 7.8 6.6
Korea 23.0 5.0 0.9 9.0 8.7
Malaysia 17.4 4.3 0.7 7.8 6.4
Philippines 35.7 25.5 0.5 6.2 1.4
Thailand 8.1 0.9 0.4 7.2 7.9
Source of data: For India, Planning Commission, Government of India; and for others
World Bank Report on Social Consequences of the East Asian Financial Crisis,
September, 1998.
Note: For India, poverty ratios refer to the years 1973 and 1993 respectively.

During 1997-1999, however, a number of Southeast Asian economies and Korea had
been in the grip of severe financial crises that had thrown the region into deep recession.
Economic activity in Japan, after languishing since the busting of the asset price bubble
in 1990, also contracted sharply since spring 1997. Unemployment rates increased to 3
percent in Malaysia, 6 percent in Korea and 15 percent in Indonesia in 1998. Poverty,
therefore, increased at an alarming rate. Indonesia, which had an impressive record of
poverty reduction, experienced a rise in the poverty ratio from 11 per cent to about 16 per
cent within a year (World Bank 1998). The severity of the “Asian crisis” raised questions
about the durability of the region’s rapid growth and the factors that underlay it.

Although the region recovered quickly following the structural reforms and adjustment
programs supported by the IMF and other funding agencies, recent crisis had highlighted
that there remain serious obstacles to sustained development for many countries in the
region. Despite recent gains, the countries of the region had an average income of

16
US$4120 in 2000, which is much below that of US$27450 in the developed countries.
Serious environmental damages associated with rapid urbanisation, inadequate regulation
and planning, and incorrect pricing of resources, continues to impose major costs.

Another serious problem is the historical inadequacy of infrastructure investment relative

to rapidly growing demand. As the region’s infrastructure needs are large, the private
sector themselves and foreign direct investment (FDI) will have to play an increasingly
critical role in developing and modernising East Asia’s infrastructure base. In turn,
governments of the region will need to strengthen the regulatory and legal frameworks to
attract and secure such investment. The need for expanding competent management
across most areas of development is emerging as a major issue in East Asia. Effective
institutions are essential in pollution monitoring and control, design and implementation
of monetary and fiscal policies, traffic-management planning and deregulation.
1.4 Overall Growth and Industrial Progress in Asia and Pacific in 1990s

(a) Overall Economic Growth

As a consequence of East Asian economic crisis in 1997-1998, GDP growth rate turned
negative in 1998 in Hong Kong (-5.3 per cent), Republic of Korea (-6.7 per cent),
Indonesia (-13.1 per cent), Malaysia (-7.4 per cent), Philippines (-0.4 per cent) and
Thailand (-10.8 per cent) (Table 1.6). Consequently, there was a significant fall of
overall growth rates in most of the countries in East and South East Asia in the second
half of 1990s compared with those in the first half of 1990s (Table 1.8).

Average annual growth rate of real GDP for East Asia and Pacific declined from 10.3 per
cent in 1990-1995 to 4.1 per cent in 1996-2000. There was a decline of average growth
from 5.6 per cent in the first half of 1990s to 3.6 per cent in the second half of 1990s in
Hong Kong, from 7.2 per cent to only 5 per cent in Korean republic, from 8.7 per cent to
6.4 per cent in Singapore, from 6.5 to 5.8 per cent in Taiwan, from 8.7 to only 4.8 per
cent in Malaysia, from 8.4 per cent to only 0.4 per cent in Thailand, and from 7.6 per cent
to only 1 per cent in Indonesia. Although China was relatively unaffected from the
contagion effect, its average growth rate also declined from 12.8 per cent in the first half
to 8.3 per cent in the second half of 1990s.

The South Asian countries in general were insulated from the East Asian contagion effect
because of their less dependence on global trade and restrictions on convertibility of
domestic currency. As a whole, the average growth rate of the South Asian countries
increased from 4.6 per cent in the first half to 5,9 per cent in the second half of 1990s.
There was significant improvement of growth rates in the second half of 1990s in India,
Maldives and Bangladesh due to sound macro-economic management and continuance of
structural reforms in industry and trade. There was marginal improvement of growth rates
in the second half of 1990s in Bhutan and Sri Lanka, while Pakistan and Nepal witnessed
some decline of growth rates due to socio-political problems.

The sources of East Asia’s rapid and sustained economic growth have been the focus of
extensive research. Central to much of this research have been attempts to measure the

17
relative contributions of factor inputs – physical and human capital – and technological
progress to the persistently high rates of growth. A commonly used approach is to
estimate the total factor productivity (TFP) growth as the residual of the growth in output
per worker over a weighted average of the accumulation of physical and human capital
per worker. TFP growth basically measures the increase in productivity brought about by
technological advances and greater organisational efficiency.

Empirical estimates of the contributions of factor inputs and TFP growth to east Asian
economies’ output growth fall in a wide range, with capital accumulation generally found
to have made the largest contribution. Productivity growth is found to have made smaller
but still significant contributions. A World Bank study found that over 1960-94, in all
four of the Asian newly industralised economies and the three fast grown ASEAN
economies – Indonesia, Malaysia, and Thailand – the contribution of capital per worker
dominated growth in factor productivity in explaining growth in output per worker. Since
the early 1980s, however, TFP growth appears to have played a larger role.

Taking into consideration international differences in productivity levels, abundant

opportunity exists for further technological catch-up in the East Asian economies. Real
output per worker in Korea, one of the most advanced of the east Asian economies, is
only about one-half of the level in the United States, and labour productivity in other east
Asian economies represents s fractions of the U.S. level. Therefore, much of the catch-up
in real GDP per capita in east Asia has occurred through increased capital intensity rather
than growth in TFP, so that productivity gaps remain wide.

Table 1.6: Trend of Growth Rates in Selected Asian Countries in 1996-2000

Country GDP growth rate GDP growth rate GDP growth rate
1996 1997 1998 1999 2000 1996-2000
NIEs 6.3 5.8 -2.9 7.9 8.4 5.1
Hong Kong 4.5 5.0 -5.3 3.1 10.5 3.6
Korea, Rep 6.8 5.0 -6.7 10.9 8.8 5.0
Singapore 7.5 8.5 0.1 5.9 9.9 6.4
Taiwan,China 6.1 6.7 4.6 5.4 6.0 5.8
China and Mongolia
China 9.6 8.8 7.8 7.1 8.0 8.3
Mangolia 2.4 4.0 3.5 3.2 0.5 2.7
South-East 7.4 3.5 -9.0 3.1 5.1 2.0
Cambodia 5.5 3.7 1.8 5.0 4.5 4.1
Indonesia 7.8 4.7 -13.1 0.8 4.8 1.0
Lao, PDR 6.9 6.9 4.0 5.2 5.5 5.7
Malaysia 10.0 7.3 -7.4 5.8 8.5 4.8
Myanmar 6.4 5.7 5.8 10.9 9.0 7.6
Philippines 5.8 5.2 -0.6 3.3 3.9 3.5
Thailand 5.9 -1.4 -10.8 4.2 4.2 0.4
Vietnam 9.3 8.2 4.4 4.7 6.1 6.5
South Asia 7.0 4.7 6.1 5.8 5.8 5.9

18
Bangladesh 4.6 5.4 5.2 4.9 5.5 5.1
Bhutan 6.0 7.3 5.5 5.9 6.1 6.2
India 7.5 5.0 6.6 6.4 5.2 6.1
Maldives 8.3 7.8 8.9 8.8 4.2 7.6
Nepal 2.9 4.9 3.3 4.4 6.4 4.4
Pakistan 6.8 1.9 4.3 3.1 4.8 4.2
Sri Lanka 3.8 6.3 4.7 4.3 6.0 5.0
East Asia
Japan 3.5 1.4 -2.0 -0.5 1.7 0.6
Sources: Asian Development Outlook 2001, Asian Development Bank, Manila.

19
Table 1.7 Trend of Industry Growth Rates in Selected Asian Countries in 1996-2000
Country Industry growth rate Industry growth rate Industry growth rate
1996 1997 1998 1999 2000 1996-
2000
NIEs
Hong Kong n.a. n.a. n.a. n.a. n.a. n.a.
Korea,Rep n.a. n.a. n.a. n.a. n.a. n.a.
Singapore 7.2 7.4 1.0 6.5 10.3 6.5
Taiwan,China 4.2 6.1 2.7 4.7 6.0 4.7
China and Mongolia
China 12.1 10.5 8.9 8.1 9.6 9.8
Mangolia -3.2 -3.3 3.8 3.2 1.0 0.3
South-East
Cambodia 11.7 20.4 8.6 11.4 16.0 13.6
Indonesia 10.7 5.2 -14.0 1.9 5.5 1.9
Lao, PDR 17.3 8.1 8.5 7.5 7.3 9.7
Malaysia 14.4 7.5 -10.9 8.0 14.7 6.7
Myanmar 10.7 8.9 6.1 13.7 9.0 9.7
Philippines 6.4 6.1 -2.1 0.9 3.6 3.0
Thailand 6.9 -1.9 -13.3 9.5 5.2 1.3
Vietnam 14.5 12.6 7.3 7.6 9.7 10.3
South Asia
Bangladesh 7.0 5.8 8.3 4.9 5.6 6.3
Bhutan 8.4 3.8 7.7 12.4 10.3 8.5
India 6.0 5.9 3.6 6.4 6.6 5.7
Maldives 3.9 11.6 21.1 17.5 5.8 12.0
Nepal 8.3 6.4 2.3 6.0 8.7 6.3
Pakistan 5.4 1.0 6.8 2.5 3.0 3.7
Sri Lanka 5.6 7.7 5.9 4.8 6.4 6.1
Sources : (1) Asian Development Outlook 2001, Asian Development Bank, Manila.

20
Table-1.8 Growth Rates of GDP and Industry of Selected Asian Countries in 1995 and 2000

Country GR of GR of GR of GR of Growth rate in Industry

GDP GDP GDP GDP
percent percent percent percent Percent percent percent
1980-1990 1990-1995 1996-2000 1990-2000 1980-1990 1990-1995 1996-2000
NIEs
Hong Kong 6.9 5.6 3.6 4.0 n.a. n.a. n.a.
Korea,Republic 9.1 7.2 5.0 5.7 14.7 7.8 n.a.
Singapore 7.3 8.7 6.4 7.8 6.1 8.7 6.5
Taiwan,China 8.8 6.5 5.8 6.1 8.1 6.0 4.7
China & Mongolia
China 10.3 12.8 8.3 10.3 11.7 16.5 9.8
Mongolia 5.4 -3.3 2.7 1.0 5.8 -2.8 0.3
South-East
Cambodia 5.4 6.4 4.1 4.6 n.a. 11.4 13.6
Indonesia 6.4 7.6 1.0 4.2 5.9 10.3 1.9
Lao, PDR n.a. 6.5 5.7 6.5 n.a. 12.5 9.7
Malaysia 5.2 8.7 4.8 7.0 7.4 11.2 6.7
Myanmar -0.1 5.9 7.6 6.8 -0.2 9.5 9.7
Philippines 1.0 2.3 3.5 3.2 -0.9 3.0 3.0
Thailand 7.9 8.4 0.4 4.2 10.3 10.5 1.3
Vietnam 8.1 8.3 6.5 7.9 7.7 12.9 10.3
South Asia
Bangladesh 4.1 4.1 5.1 4.8 5.6 6.9 6.3
Bhutan 7.5 5.8 6.2 6.2 12.3 11.9 8.5
India 5.8 4.6 6.1 6.0 7.1 6.6 5.7
Maldives 12.1 6.5 7.6 6.6 9.0 8.6 12.0
Nepal 4.7 5.1 4.4 4.8 6.2 8.6 6.3
Pakistan 6.2 4.6 4.2 3.7 7.6 5.7 3.7
Sri Lanka 3.8 4.8 5.0 5.3 4.9 7.3 6.1
East Asia
Japan 4.0 1.0 0.6 1.3 4.9 0.7 n.a.
Low & middle income 2.8 2.1 5.1 3.6 3.9 4.9 n.a.
East Asia & Pacific 7.6 10.3 4.1 7.2 8.9 15.0 n.a.
Europe & Central Asia 2.3 -6.5 3.3 -1.6 n.a. n.a. n.a.
Latin America & Carib. 1.7 3.2 3.4 3.3 1.4 2.5 n.a.
Mid. East & N.Africa 0.2 2.3 3.7 3.0 1.1 n.a. n.a.
South Asia 5.7 4.6 5.9 5.6 6.9 5.3 n.a.
Sub-Saharan Africa 1.7 1.4 3.4 2.4 0.6 0.2 n.a.
High Income 3.2 2.0 2.8 2.4 3.2 0.7 n.a.
World 3.1 2.0 3.2 2.6 3.3 1.4 n.a.
n.a. Data not available
Sources : (1) World Development Report 1997, World Bank.
(2) World Development Report 2002, World Bank.

21
Table-1.9 Growth Rates of agriculture and Service Sector of Selected Asian Countries in 1995 and 2000

Country Growth Rate in agriculture Growth Rate in services

1981-90 1991-1996 1999-2000 1980-1990 1991-1996 1999-2000

NIEs
Hong Kong 0.8 n.a. n.a. 9.6 n.a. n.a.
Korea,Republic 8.1 1.0 n.a. 15.4 8.1 n.a.
Singapore -6.9 1.6 -1.3 8.2 8.1 6.7
Taiwan,China 1.9 0.4 0.7 10.1 7.9 6.2
China & Mongolia
China 5.5 4.2 2.6 12.4 9.3 7.7
Mongolia 3.1 0.3 n.a. 5.1 -4.3 n.a.
South-East
Cambodia n.a. 2.3 0.5 n.a. 8.3 4.9
Indonesia 3.1 2.9 2.2 7.6 7.6 2.1
Lao, PDR n.a. 4.0 4.7 n.a. 7.4 6.1
Malaysia 3.9 1.8 2.1 4.3 9.2 4.2
Myanmar -0.3 5.2 8.0 0.2 5.5 8.1
Philippines 1.0 1.7 4.7 2.9 3.1 4.3
Thailand 3.8 3.5 2.0 7.7 7.4 1.9
Vietnam 7.4 4.4 4.4 9.3 9.5 3.3
South Asia
Bangladesh 2.4 1.1 5.6 5.2 5.6 5.0
Bhutan 4.9 2.3 2.7 8.1 6.4 5.0
India 3.1 2.6 0.8 6.8 6.9 9.0
Maldives 6.9 2.3 2.5 16.6 8.2 6.1
Nepal 2.7 2.2 3.8 5.4 7.5 6.0
Pakistan 4.1 4.5 4.6 6.7 5.1 4.3
Sri Lanka 1.0 1.8 3.5 4.3 5.3 5.6
East Asia
Japan 1.2 -2.8 -1.5 3.7 2.6 n.a.
Low & middle income 3.1 2.0 n.a. 3.6 4.5 n.a.
East Asia & Pacific 4.8 3.9 n.a. 9.0 8.4 n.a.
Europe & Central Asia n.a. n.a. n.a. n.a. n.a. n.a.
Latin America & Carib. 2.0 2.3 n.a. 1.9 3.8 n.a.
Mid. East & N.Africa 4.5 3.3 n.a. 1.2 n.a. n.a.
South Asia 3.2 3.0 n.a. 6.6 6.0 n.a.
Sub-Saharan Africa 1.9 1.5 n.a. 2.5 1.5 n.a.
High Income 2.3 0.6 n.a. 3.4 2.3 n.a.
World 2.8 1.3 n.a. 3.4 2.6 n.a.
n.a. Data not available
Sources : (1) World Development Report 1997, World Bank.
(2) World Development Report 2002, World Bank.

22
Table-1.10 Distribution of GDP for Agriculture, Industry and Services in 1995 and 2000 (per cent)

Country Share of Agricultur Share of Industry Share of Services

e
1995 2000 1995 2000 1995 2000
NIEs
Hong Kong 0 0 18 15 82 85
Korea, Rep. of 7 5 31 44 63 51
Singapore 0 0 43 34 57 66
Chinese Taipei 3 2 39 35 58 63
China & Mongolia
China, Peo.Rep 19 16 53 49 28 34
Mongolia 23 32 42 30 35 39
Southeast Asia
Cambodia 45 44 19 19 37 38
Indonesia 16 17 42 47 42 36
Lao PDR 57 53 19 22 25 25
Malaysia 14 12 47 40 39 48
Myanmar 46 60 15 9 39 31
Philippines 22 17 36 30 43 53
Thailand 11 10 42 40 47 50
Vietnam 34 25 28 34 38 40
South Asia
Bangladesh 33 26 20 25 48 49
Bhutan 38 33 28 32 34 35
India 28 27 31 27 41 46
Maldives n.a. 10 n.a. 15 n.a. 75
Nepal 42 39 19 20 39 41
Pakistan 24 26 27 23 49 50
Sri Lanka 20 21 31 27 49 52
East Asia
Japan 2 2 40 36 58 62
Low & middle income 14 13 36 35 48 52
East Asia & Pacific 18 15 44 46 38 38
Europe & Central Asia 11 10 n.a. 33 n.a. 57
Latin America & Carib. 10 8 33 31 55 61
Mid. East & N.Africa 11 14 58 38 31 48
South Asia 30 27 27 26 41 47
Sub-Saharan Africa 20 15 30 28 48 57
High Income 2 2 32 32 66 66
World 5 5 33 31 63 63
n.a. Data not available
Sources : (1) World Development Report 1997, World Bank.
(2) World Development Report 2002, World Bank.

23
Table-1.11: Share and Structure of Manufacturing in Asian Countries in 1990s:

Country Share of Manufacturing in GDP Structure of Manufacturing (% )

percent Food, beverage,tobacco Textiles & Clothing
1970 1995 1999 1970 1992 1970 1992
NIEs
Hong Kong 29 9 6 4 11 41 35
Korea, Rep. of 21 27 32 26 10 17 12
Singapore 20 27 26 10 10 13 14
Chinese Taipei n.a. 30 24 n.a. n.a. n.a. n.a.
China & Mongolia
China, Peo.Rep 30 38 24 n.a. 13 .. 13
Mongolia n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Southeast Asia
Cambodia n.a. 6 6 n.a. n.a. n.a. n.a.
Indonesia 16 24 25 65 23 14 16
Lao PDR n.a. 14 17 n.a. n.a. n.a. n.a.
Malaysia 12 33 35 26 10 3 6
Myanmar 10 10 6 n.a. n.a. n.a. n.a.
Philippines 25 23 20 39 37 8 13
Thailand 16 29 32 23 16 14 16
Vietnam n.a. 22 21 n.a. n.a. n.a. n.a.
South Asia
Bangladesh 6 10 17 30 24 47 38
Bhutan n.a. 20 20 n.a. n.a. .. n.a.
India 15 19 16 13 12 21 15
Maldives n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Nepal 4 10 9 n.a. 31 .. 39
Pakistan 16 17 17 24 23 n.a. n.a.
Sri Lanka 17 16 17 26 40 19 29
East Asia
Japan 36 24 24 8 10 8 5
Low & middle income 21 20 22
East Asia & Pacific 27 32 28
Europe & Central Asia n.a. n.a. n.a.
Latin America & Carib. 25 21 21
Mid. East & N.Africa 7 n.a. n.a.
South Asia 15 17 16
Sub-Saharan Africa 12 15 17
High Income 24 21 21
World 23 21 21
n.a. Not available.
Sources : (1) World Development Report 1995, World Bank, 1995.
(2) World Development Report 1997, World Bank, 1997.

24
Table-1.11 Share and Structure of Manufacturing in Asian Countries 1995: Completed

Country Machinery ,transport Chemicals Others

equipment
1970 1992 1970 1992 1970 1992
NIEs
Hong Kong 16 21 2 2 36 32
Korea, Rep. of 11 30 11 10 36 37
Singapore 24 33 13 6 40 38
Chinese Taipei n.a. n.a. n.a. n.a. n.a. n.a.
China & Mongolia
China, Peo.Rep n.a. 27 n.a. 12 n.a. 35
Mongolia n.a. n.a. n.a. n.a. n.a. n.a.
Southeast Asia
Cambodia n.a. n.a. n.a. n.a. n.a. n.a.
Indonesia 2 14 6 7 13 40
Lao PDR n.a. n.a. n.a. n.a. n.a. n.a.
Malaysia 8 34 9 11 54 39
Myanmar n.a. n.a. n.a. n.a. n.a. n.a.
Philippines 8 11 13 12 32 27
Thailand 4 40 25 5 34 23
Vietnam n.a. n.a. n.a. n.a. n.a. n.a.
South Asia
Bangladesh 3 7 11 17 10 15
Bhutan n.a. n.a. n.a. n.a. n.a. n.a.
India 30 25 14 14 32 35
Maldives n.a. n.a. n.a. n.a. n.a. n.a.
Nepal n.a. 1 n.a. 4 n.a. 25
Pakistan 6 5 9 10 23 24
Sri Lanka 10 4 11 5 33 22
East Asia
Japan 34 38 11 10 40 38
n.a. Not available.
Sources : (1) World Development Report 1995, World Bank, 1995.
(2) World Development Report 1997, World Bank, 1997.

25
 (b) Industrial progress

Industrial growth was severely affected in the second half in most of East Asian
countries. In 1998 industrial growth decelerated to 1 per cent in Singapore, 2.7 per cent in
Taiwan, and the actual industrial value added declined in Indonesia (-14 per cent),
Malaysia (-10.9 per cent), Philippines (-2.1 per cent) and Thailand (-13.3 per cent) (Table
1.7). However, all the countries were able to recover quickly due to structural adjustment
programs and achieved positive growth rates in industry in 1999-2000. In all these
countries, average industrial growth was significantly lower in the second half of 1990s
than that in the first half.

Average annual growth rate of industrial value added decelerated from 8.7 per cent in
1990-1995 to 6.5 per cent in 1996-2000 in Singapore, from 6 per cent to 4.7 per cent in
Taiwan, China, from 16.5 per cent to 9.8 per cent in China, from 10.3 per cent to only 1.9
per cent in Indonesia, from 11.2 per cent to 6.7 per cent in Malaysia, and from 10.5 per
cent to 1.3 per cent in Thailand (Table 1.8). As with overall economic growth, industrial
growth was most adversely affected in Thailand and Indonesia.

Within South Asia, except Maldives, all the countries also achieved lower growth rates of
industrial production in the second half than in the first half due to lower external demand
for their traditional and other exports.

Lower industrial growth in the second half of 1990s also affected the growth of service
sectors in the second half in most of the countries. Services growth was most adversely
affected in the second half in Thailand, Indonesia and Malaysia. Average growth rate of
services declined from 8.1 per cent in 1991-1996 to 6.2 per cent in 1999-2000 in
Singapore, from 7.9 per cent to 6.2 per cent in Taiwan, China, from 9.3 per cent to 7.7 per
cent in China, from 7.6 per cent to 2.1 per cent in Indonesia, from 9.2 per cent to 4.2 per
cent in Malaysia, and from 7.4 per cent to 1.9 per cent in Thailand over the same period
(Table 1.9).

Within South Asia, except India and Sri Lanka, all the countries experienced deceleration of growth rates in

the services sector in the second half of 1990s. In India, average growth rate of services accelerated

significantly from 6.9 per cent in 1990-1996 to 9 per cent in 1999-2000 due to substantial progress of

financial services, personal and community services, telecommunications and computer software’s.

(c ) Trend of Sectoral Shares

Sectoral shares in GDP indicate mixed trends over time among regions and countries
(Table 1.10). For newly industrialised countries (NIEs), which have dominant share of
the services sector in GDP, share of industry declined and shares of services increased
further during 1995-2000 in Hong Kong, Singapore and Taiwan. Only in Korean

26
republic, share of industry in GDP increased from 31 per cent in 1995 to 44 per cent in
2000 and that of services declined from 63 per cent to 51 per cent over the same period.

In East Asia and Pacific as a whole, the share of services remained unchanged at 38 per
cent, share of industry increased by 2 percentage points from 44 to 46 per cent during
1995-2000 and that of agriculture declined by the corresponding percentage point. As
regards individual countries in the Southeast Asia, only Indonesia, Lao PDR and Vietnam
experienced increased share of industry in 1995-2000. In Malaysia, Philippines and
Thailand, while the share of industry in overall GDP declined, there was substantial
increase of the share of services sector in 1995-2000 (Table 1.10).

For South Asia as a whole, the share of agriculture declined from 30 per cent in 1995 to
27 per cent in 2000, that of industry also declined from 27 to 26 per cent and the share of
services increased from 41 to 47 per cent. In Bangladesh, Bhutan and Nepal, share of
agriculture declined while shares of both industry and services increased during 1995-
2000. In India, there was decline of shares in both agriculture and industry and
corresponding increase of share of services sector.
An analysis of the trends of Shares of manufacturing given in Table 1.11 indicates that
except for Sub-Saharan Africa, all the regional groups experienced either a decline of the
share of manufacturing in overall GDP during 1995-2000 (South Asia, East Asia and
Pacific) or invariant share of manufacturing (Latin America and Caribbean, High income
countries and the World as a whole).

An analysis of the structure of manufacturing given in Table 1.11 indicates that in

general the shares of agriculture and primary sector based traditional goods (such as
food, beverages, tobacco and textiles) in overall manufacturing production have declining
trends over time, while the shares of machinery, transport and equipment, chemicals or
other products have increasing trends over time.

(d) Impact of Crisis on Manufacturing

The crisis emphasised weaknesses in the competitive ability of the traditional

manufacturing and had disproportionate effects on small and medium-size enterprises
(SMEs). Although East Asian firms, including those in crisis countries, were adept in
adopting new manufacturing techniques, they faced continual challenges from low wage
developing countries and from China and Japan. As in the case of Mexican crisis, the
East Asian crisis led to a sharp fall of production and investment in non-traded sectors.
This is expected because currency depreciations, which favour traded goods, reduce
incentive to invest in non-tradable sectors.

In general, non-tradable sectors faced high levels of non-performing assets. In Malaysia

about three-fourths of the non-performing loans were to enterprises in nontradable
sectors. Even in the pre-crisis period the nontradable sectors such as real estate, retail
trade and distribution had been characterised by overcapacity and low productivity.
Corporate distress, measured by percentage of firms unable to meet current debt
obligations, was highest in Indonesia and lowest Malaysia. Among the sectors, in general,

27
corporate distress was highest in real estate followed by services and manufacturing
(Table 1.12).

Table 1.12 Corporate Distress in Crisis Countries in 1995-2000

(Percentage of firms unable to meet current debt obligation)

Country 1995 1996 1997 1998 1999 1999 1995

Total Total Total Total Total Manufa Service Real Total
cturing estate
Indonesia 12.6 17.9 40.3 58.2 63.8 41.8 66.8 86.9 52.9
Korea, rep. 8.5 11.2 24.3 33.8 26.7 19.8 28.1 43.9 17.2
Malaysia 3.4 5.6 17.1 34.3 26.3 39.3 33.3 52.8 13.8
Thailand 6.7 10.4 32.6 30.4 28.3 21.8 29.4 46.9 22.3
Source: Global Economic Prospects and the Developing Countries, World Bank, 2000.

Of all the crisis economies, Korea’s industrial production recovered the fastest rising
above the pre-crisis levels within two years, whereas the levels of industrial production in
Malaysia, Thailand and Indonesia remained below the pre-crisis level even after two
years (World Bank 2000). The more rapid recovery in Korea reflects partly its greater
strengths in sectors such as electronics, computers and telecommunications. Korean firms
also performed well in transport equipment, whereas Malaysian and Thai firms suffered
in these sectors. Korea had poor performance in traditional and resource-based sectors
such as food, chemicals, base metals, paper and pulp products.

Traditional manufacturing sectors were expected to lead the way to recovery in the crisis
countries having lower wages. In Thailand the textiles sector grew rapidly following the
depreciation of Baht, but output fell back to precrisis level as the currency appreciated
and Thai products faced steep competition in export markets. Traditional manufacturing
in Korea rebounded only slightly after the crisis reinforcing a secular decline.

Small and medium sized firms were adversely affected in all crisis countries. While
aggregate Korean industrial output started to increase in late 1998, production by SMEs
continued to fall in absolute terms until July 1999, resulting in a decline by one-third
from precrisis production levels. In other countries, where SMEs had larger proportion in
industrial production, poor performance by SMEs intensified overall industrial set back.
For example, more than 50,000 small firms and 400,000 households throughout Thailand
accounted for about 50 per cent of non-performing loans in 1999. The inability to
restructure these debts effectively contributes to financial sector problems, which feed
back into continued financial difficulties of SMEs.

Although large firms were drivers in recovery, they also posed systemic risks. In Korea,
the onset of the crisis was associated with the collapse of two conglomerates, Hanbo steel
and Kia. Subsequently, there was collapse of Daewoo in 1999 due to delays in its
restructuring. In Thailand the financial problems of Thai petrochemicals were the result
of over investment in capacity and excessive reliance on external debt. Throughout the
region, diversified conglomerates were initially regarded as “too big to fail” as
demonstrated by early efforts of the Korean and Malaysian governments to bail out

28
largest business groups. The takeover of chaebol Daewoo by its creditors was an
important break from this perception.

1.5 Policy Reforms for Industrial Diversification and Improved Competitiveness

All the crisis affected countries viz. Thailand, Indonesia, Korea, Malaysia and Philippines
intensified their structural reforms and stabilisation programs with the help of multilateral
funding agencies like the IMF, World bank and the Asian Development Bank. Chapter 3
deals with detailed scope of these reforms. Here we summarise the basic strategy and the
general policies adopted by these countries.

The root cause of the East Asian crisis, unlike some earlier crisis episodes in Latin
America, were not in macro-economic imbalances, rather stems from structural
weaknesses (Neiss 1999). These weaknesses manifested themselves in progressively
weaker banking and financial sectors and heavily leveraged corporate sectors. So the
reforms program emphasised banking sector reforms, corporate restructuring and
improving corporate governance. All these countries were convinced that returning to the
normal growth path and sustained industrial progress requires not only reflationary
policies but also major corporate restructuring.

The vast bulk of measures taken by the countries involved financial sector restructuring
which was seen as essential to restore market confidence, overcome the crisis and lessen
vulnerability to future crisis. Corporate sector restructuring, a critical counterpart to the
reforms in the financial sector, was a vital part of the IMF supported program. However,
as the Fund was not well equipped to deal with corporate sector issues, which were
beyond its areas of expertise, close collaboration with the World Bank was necessary for
design of measures in this area. Due to the complexity of the needed restructuring of the
financial and corporate sectors, the policy matrices expanded substantially as the
programs evolved during 1997-1999.

The policy matrices went beyond the core areas of financial and corporate restructuring.
Some of the additional areas covered such as capital account liberalisation, strengthening
the social safety nets, labour market reforms, and systematic reforms (e.g. institution
building, the legal and regulatory framework) were essential to support the core areas.
Other areas of reforms included trade and financial services liberalisation, privatisation of
public enterprises, and tax reforms. Table 1.13 presents illustrative postcrisis policy
reforms in selected crisis affected countries.

On corporate debt restructuring, the countries followed the so-called London Approach
practiced in England under the guidance of the Bank of England in which Government
provides only the necessary legal set up and framework for voluntary negotiations
between debtors and creditors, but donot play an active role for complete debt workouts.
These workouts are complex and involve not only debt restructuring and debt write off
but also debt-equity swaps and operational restructuring such as management contract,
sale or closure of affiliates. Such corporate restructuring was much less advanced than the
financial restructuring followed by most countries as an element of recovery.

29
 Table 1.13 Illustrative Postcrisis Policy Reforms in Crisis Countries
Country Corporate governance
Indonesia • Corporate Secretary made
compulsory to improve
disclosure,
• Bankruptcy Law updated
(Aug.1998),
• Code of best practices for
corporate governance.
Korea, • Restrictions on cross-debt
Republic guarantees (1998),
• Introduction of
international accounting
standards (Aug.1999)
• Lowering the minimum
equity holding require-
ment to exercise share-
holder’s rights (1999)
Malaysia • Creation of High Level
Finance Committee on
Corporate Governance
Code on takeovers and
mergers with stricter
disclosure standards (Jan.
1999)
Thailand • Financial statements of
public companies and
financial institutions to be
as per international best
practices (1999),
• Requirement of Board
Audit Committee (1999),
• Bankruptcy and fore-
closure laws amended
(March 1999)
Source: Global Economic Prospects and the Developing Countries, World Bank, 2000.
Loss allocation Factor mobility
and transfer
• Tax exemptions for • Relaxation of foreign
loan-loss reserves held ownership limits
by Banks (March (Sept.1997),
1998). • Tax holidays up to 8
years for new
investments in 22
industries (Jan.1999)
• Revaluation and • Introduction of Foreign
adjustment of capital Investment Promotion
and foreign exchange Act (Nov. 1998)
losses (Aug. 1999)
• Reduction of corporate • Reduction of property
tax rate from 30 per gains tax rate from 30%
cent to 28 per cent (Oct to 5% for nonresidents
1997), on the sale of property
• Tax exemption on held for minimum five
interest from NPLs for years (October 1997),
the years 1999-2000. • Exemption of real
property gains tax on
mergers of financial
institutions (Jan 1999)
• Elimination/ deferral of • Alien Business Law
income tax and taxes on (enacted in Aug 1998,
asset transfer and revised in Oct 1999),
unpaid interest (Jan • Tax free mergers and
1999), acquisitions for 100%
• Introduction of new mergers (Jan 1999),
asset depreciation • Introduction of Equity
method (March 1999) Fund, Thailand
Recovery Fund for large
and medium scale
companies, and Venture
Capital Fund for small
and medium size
enterprises (Mar 1999),
• Reduction of real estate
transfer fee from 2 to
0.01% of the appraised
value (March 1999).
30
The crisis provided good opportunities for corporate and industrial restructuring. As too
much diversification does not add to resilience in times of crisis, very diversified
conglomerates had to redefine their core business and important locations. They had to
sell some of their businesses to reduce exposure. This is particularly true for
multinationals in the field of automobiles and electronics.

Toyota’s operations in the Southeast region during the crisis period provides a good
example how a multinational affected by global slowdown coped up with the crisis. At
the beginning of the crisis in 1998, Toyota was the third largest automaker in the world
after General Motors and Ford, exported cars to 160 countries, and had had 34
manufacturing units in 24 countries (Takemoto 1999). It had seven marketing
organisations and nine manufacturing units in ASEAN countries, one manufacturing and
marketing company in Taiwan and several operations including production of engines
and semi-finished cast iron and aluminum in China. In addition Toyota has a management
service company in ASEAN, Toyota Motor Management Services Singapore (TMSS).

Toyota’s ASEAN exports include both complete built units (CBU) and a wide variety of
parts including jigs, dies, equipment, and machine tools. Toyota’s engine exports have
recently been enlarged to Japan, ASEAN, India and South Africa. During crisis period
Toyota expanded its operations in Asia and established a factory in India for production
of family-type multipurpose vehicles designed for the Indian market, and another factory
in China for production of a coaster-class bus for the Chinese market.

Excluding Taiwan where Toyota did relatively well, the overall production of Toyota in
big-4 ASEAN markets in Thailand, Indonesia, Malaysia and Philippines dropped by 65
per cent in 1998. Toyota factory in Thailand was closed for two months, and the factory
in Indonesia for domestic production was closed for some days, although production of
export vehicles in Indonesia continued with full capacity.

The crisis affected technological advancement in Asian countries most directly by

reducing financial support for technology sector. As the major concern of the private
sector ad the government was to solve the financial crisis, the budgets were under
pressure to address unemployment, inflation and social concerns. So the focus was
shifted from the long-term payback period required for technology investment
(Butsuntorn 1999).

The crisis changed the traditional resistance to cross-border mergers and acquisitions in
East Asia. For example, in the cement industry, the British Company Blue Circle acquired
58 per cent of Malayan Cement in Malaysia, while Holderbank, which is the largest
cement producer in the world, bought 33 per cent share of the Republic Cement and 70
per cent share of Tenggara Cement. In the Philippines, Holderbank bought 40 per cent
stake in Union Cement, while British Blue Circle became a partner in Mindanao Cement
and Fortune Cement. In Thailand, also the French Company Ciment Franche acquired 49
per cent stake of Jalaprathan Cement, while Holderbank bought 25 per cent share of Siam
City Cement. All these mergers and acquisitions in the region strengthened global
networking in marketing and manufacturing.

31
In Korea, foreign ownership in listed companies jumped from 13 per cent in 1996 to over
30 per cent at the end of 2000 (Chopra et al 2001). Many of the Korea’s leading
companies are now majority foreign owned including Samsung Electronics (57 per cent),
POSCO (56 per cent) and Hyundai Motors (50 per cent), though the foreign stakeholders
are mainly portfolio and institutional investors and may not have interest in management.
In addition, Renault has taken over Samsung Motors, and Daimler Chrysler now owns 15
per cent stake in Hyundai Motors.

To help eliminate overcapacity in key manufacturing industries, the Korean government

called for a number of mergers and swaps the so-called “Big Deals”. In September 1998,
the top-5 chaebols (Hyundai, Daewoo, Samsung, SK and LG), which accounted for a
large share of the country’s resources and exports, agreed on the general terms for
merging and swapping 17 companies in seven core industries covering aircraft, autos,
petrochemicals, power generation, rolling stock, semiconductors and ship engines. As a
result of these restructuring, the average debt-to-equity ratio for the non-financial
corporate sector declined from 425 per cent in 1997 to 235 per cent in 1999. For the
manufacturing sector, which accounts for over half of the nonfinancial corporate sector
the average debt-to-equity declined from 396 per cent in 1997 to 215 per cent at end-
1999 and further to 193 per cent at end-June 2000.

The countries continued to review the rigid and outdated laws, rules and regulations
particularly in services, finance, labour, technology and all production inputs. As SMEs
account for almost 80 per cent of industrial establishments in Asia, and these SMEs faced
serious shortage of capital, markets and professional management, all the countries
continued to have special programs for the development and technology upgradation of
the SMEs. They also emphasised the development of both physical and social
infrastructure, especially public utilities, research and development and technical-oriented
infrastructure, which are particularly needed by the small and medium enterprises.

The countries continued to move from resource based and labour intensive types of
industries to skill and knowledge based and medium and high technology industries.
They also liberalised further foreign investment policies to attract more of the widely
accepted foreign direct investment and portfolio investment.

The multinational corporations operating in the region are trying to establish cooperation
and partnership among manufacturing sectors. The alliance partners are fighting the crisis
together, supplementing and reinforcing each other and responding successfully to
opportunities and constraints of new environment. The following are the best examples in
this regard. Sony and Microsoft have introduced new products for interactive cable
television and have become leaders in global digital home-electronics market by
combining their computer software and audiovisual technologies. Matsushita has also
formed tie-up with Northern Telecom of Canada to develop new cellular phone system
using wide-band code-division multiple access technology.

32
2 IMPLICATIONS OF GLOBALISATION AND REGIONAL INTEGRATION
ON INDUSTRIAL PROGRESS

2.1 Challenges and Prospects of Globalisation

(a) Globalisation and its Impact on International Trade

Globalisation can be defined as the ongoing economic, technological,

social and political integration of the world that began after the Second
World War (ADB 2001). There are several dimensions to this dynamic
process such as increased internationalisation of economic markets as
reflected by movements of goods, persons, capital and various services
across countries. There are also institutional and social changes that are
taking place within geographical boundaries of different states. There
are also changes in international economic and political relations.
Globalisation has helped rising world economic growth and reduction
of poverty through increased flows of goods, services and investment.

Globalisation has helped world trade to surge from 23 per cent of world
GDP in 1960 to 32.5 per cent in 1991 and further to 41 per cent in 2000
(Table 2.1). The major contributing factors for this growth are
summarised below:

(i) Effective tariff rates and non-tariff barriers (NTBs) have been reduced
significantly during 1990s (Table 2.2) and by 80-90 per cent since the
Second World War.
(ii) Costs of ocean shipping, air transport and telecommunications have
dropped significantly in last 50 years (Table 2.3).
(iii) Outsourcing has increased substantially in automobiles and
electronics. However, in 1990s foreign affiliates are being established
to have the advantage of domestic sourcing and backward linkages in
automobiles, IT and food processing.
(iv) There had been significant advancement is research and technology
leading to explosive growth in knowledge-based industries.

Table-2.1 Total Merchandise trade (percent of world GDP)

1 1 1 1 1 1 1 1 2
9 9 9 9 9 9 9 9 0

33
 6 7 8 9 9 9 9 9 0
0 0 0 1 6 7 8 9 0
World 2 2 4 3 3 3 3 3 4
3 5 1 2 7 8 8 8 1
. . . . . . . . .
1 2 9 5 2 9 8 8 2
Industrial 1 1 2 2 2 2 2 2 3
countries
5 8 8 3 4 5 6 6 0
. . . . . . . . .
7 7 5 2 7 5 2 2 4
Developing 7 6 1 9 1 1 1 1 1
countries
. . 3 . 2 3 2 2 0
5 5 . 3 . . . . .
4 5 4 6 6 7
Source: Asian Development outlook 2001, ADB, manila.

34
 Table 2.2 Mean tariff rates and non-tariff barriers in selected countries
Country Mean tariff rate World import- % of
(%) weighted tariff lines
Mean tariff (per under
cent) NTBs
1990 1999 1990 1999 Recent
year
India 84.1 34.3 93.6 28.0 5.2
Banglades 123.2 22.4 125.5 18.5 n.a.
h
China 44.9 33.4 46.5 18.5 11.2
Indonesia 27.1 11.8 27.4 14.3 2
S. Korea 18.6 7.8 17.8 7.0 n.a.
Malaysia 17.6 12.0 14.4 9.4 2.4
Nepal 18.3 13.5 21 17.8 0.5
Pakistan 53 50.0 n.a. n.a. 17.3
Philippines 28 9.3 28.8 8.5 n.a.
Sri Lanka 27.5 19.1 22.2 19.8 4
Taiwan 10.9 6.7 12.2 6.5 n.a.
Thailand 41.7 47.3 42,4 43.7 4.2
Source: World Development Indicators 1997, 1999, 2000, 2001/02.

Table 2.3 Trend of transport, communications and computers cost in 1960-2000

Ye Ocean Average Cost of 3- Price of
ar freight revenue per minute computers
1920=100 PKM on air telephone relative to
(in 1990 call, GDP
US$) New York (2000=100)
-London
(in 2000
US$)
19 28 0.24 60.42 186,900
60
19 29 0.16 41.61 19,998
70
19 25 0.10 6.32 2,794
80
19 30 0.11 4.37 728
90
20 27 0.08 0.40 100
00
Source: World Economic Outlook, May 1997, World Bank, updated to 2000, U.S.
Commerce Department, Bureau of Economic Analysis.

Table 2.4 Share of manufacture exports in total exports in Asian countries (percent)
Country 1975 1985 1990 1995 2000
Hong Kong, 98 98 99 95 95
China

35
Korea 82 92 94 93 91
Singapore 52 54 74 80 86
Taipei, China 81 91 94 93 95
China, PR n.a. 49 74 81 88
Indonesia n.a. 14 38 53 54
Malaysia 31 32 56 65 80
Philippines 22 62 73 76 41
Thailand 24 43 65 73 74
India 51 58 75 75 76
Pakistan 52 67 77 85 84
Sri Lanka 11 34 62 73 75

As most of the East and Southeast countries adopted export-oriented

strategy, share of exports in their GDP recorded substantial increase.
Share of inter-regional trade also accelerated significantly during 1990s.
In both Hong Kong, China and Taipei, China trade with Mainland
China increased while China's trade with the region fell as OECD
markets became more important. Korea began to export more
manufactured goods such as automobiles and electronics to the rest of
Asia. Singapore increased its trade with Indonesia and Malaysia in
electrical products. In India, opening up of the economy in 1990s
helped the country integrate more with its Asian neighbours. In
Indonesia, the increased trade within the region has been in the exports
of primary products particularly palm oil and crude oil, and of labour-
intensive products.

After the second world, Asian countries began exporting primary

products to the industrial countries. In the 1960s, the NIEs started to
export labour-intensive manufacture products to Europe, Japan and the
USA. Subsequently, ASEAN countries and China joined them as
exporters of labour-intensive manufactured goods. Over time, these
countries upgraded their technology and gradually moved to higher
value added and capital-intensive exports such as automobiles, and
subsequently to skill- and knowledge-intensive products, such as
electronics, computers and pharmaceuticals. Asian exporters increased
their market shares in traditional manufactured exports through
improved quality and competitive prices.

Countries in East Asia had, in general, large shares of manufacturing

exports in total merchandised exports (Table 2.4). Consequently, these

36
countries were the first to be adversely affected by the global slowdown
and collapse of import demand in the United States and Japan. East
Asia’s high-tech laden exports (about one third of total shipments from
the region) were adversely affected as demand for computers,
telecommunications equipment and other semiconductor-based capital
goods dissipated. However, even after the crisis, the share of
manufacturing exports was highest in East Asia (Table 2.5). In fact, the
share of manufacturing export in total exports increased during 1995-
2000 in almost all countries in East and Southeast Asia except
Philippines (Table 2.6). The share of high-tech exports in total
manufacturing exports was high in Korea, Singapore, Chinese Taipei,
Malaysia, Thailand and Philippines (Table 2.6). The share of
manufacturing imports also increased in almost all countries in 1990-
1999 (Table 2.7).

Table 2.5 Composition of developing country exports (per cent) in

1998-2000

Regions Percentage Share in total exports

Ma Oil Non- Se T
oil
nuf comm rvi otal
actu odities ces
ring
All developing 56 13 16 15 100
countries
East Asia 72 3 12 13 100
South Asia 60 0 20 20 100

37
 Table-2.6: Exports of Selected Asian Countries in 1995 and 2000

Country Merchandise Exports Share in World Export Manufact. Exports Hightec

h
Billions of US$ % % % in total exports Exports :
% in
manf.
1995 2000 1995 2000 1995 2000 Exports
NIEs
Hong Kong 174 202 3.4 3.2 95 95 21
Korea, Rep. of 125 173 2.4 2.7 93 91 32
Singapore 118 138 2.3 2.2 80 86 61
Chinese Taipei 112 148 2.2 2.3 93 95 40
China & Mongolia
China, Peo.Rep 149 249 2.9 3.9 81 88 17
Mongolia 0.3 0.4 0.0 0.0 n.a. 10 n.a.
Southeast Asia
Cambodia 0.9 0.6 0.0 0.0 n.a. n.a. n.a.
Indonesia 45 62 0.9 1.0 53 54 10
Lao PDR 0.4 0.3 0.0 0.0 15 n.a. n.a.
Malaysia 74 98 1.4 1.5 65 80 59
Myanmar 1 1.3 0.0 0.0 n.a. n.a. n.a.
Philippines 18 40 0.3 0.6 76 41 59
Thailand 57 69 1.1 1.1 73 74 32
Viet Nam 5 14 0.1 0.2 n.a. n.a. n.a.
South Asia
Bangladesh 3 6 0.1 0.1 81 91 0
Bhutan n.a. n.a. 0.0 0.0 n.a. n.a. n.a.
India 31 42 0.6 0.7 75 76 10
Maldives n.a. n.a. 0.0 0.0 n.a. n.a. n.a.
Nepal 0.3 0.8 0.0 0.0 84 69 0
Pakistan 8 9 0.2 0.1 85 84 0
Sri Lanka 4 5 0.1 0.1 73 75 3
East Asia
Japan 443 479 8.6 7.5 97 94 27
Low & middle income 1152 1747 22.4 27.5 n.a. 64 20
East Asia & Pacific 359 712 7.0 11.2 n.a. 81 31
Europe & Central Asia 346 307 6.7 4.8 n.a. 56 10
Latin America & Carib. 221 358 4.3 5.6 n.a. 48 14
Mid. East & N.Africa 106 214 2.1 3.4 n.a. 17 1
South Asia 47 64 0.9 1.0 n.a. 79 4
Sub-Saharan Africa 73 93 1.4 1.5 n.a. 39 9
High Income 3997 4603 77.7 72.5 n.a. 82 22
World 5145 6350 100.0 100.0 n.a. 79 21
n.a. Data not available
Sources : (1) World Development Report 1997, World Bank.
(2) World Development Report 2002, World Bank.

38
Table-2.7 : Average Annual Growth Rates of Exports and Imports in 1990-99 (per cent)

Country Merchan- Merchan- Exports of goods Share in GDP Manf.

Imp
dised exp. dised imp. and services in 2000 % in total
GR (%) GR (%) GR (%) GR (%) Merchand. Merchand. imports
1990-1999 1990-1999 1980-1990 1990-1999 exports imports 1990 1998
NIEs
Hong Kong 8.3 9.2 14.4 9.5 124 114 85 89
Korea, Rep. of 12.3 8.1 12.0 15.7 38 30 63 61
Singapore 5.7 7.3 10.8 13.3 149 123 73 84
Chinese Taipei 5.3 8.6 n.a. n.a. 53 39 69 73
China & Mongolia
China, Peo.Rep 16.0 10.5 11.5 14.5 23 17 80 81
Mongolia n.a. n.a. n.a. n.a. 41 n.a. 62 65
Southeast Asia
Cambodia n.a. n.a. n.a. n.a. 18 n.a. n.a. n.a.
Indonesia 8.4 5.0 2.9 8.6 41 17 77 69
Lao PDR n.a. n.a. n.a. n.a. 18 n.a. n.a. n.a.
Malaysia 10.8 9.7 10.9 13.2 110 78 82 85
Myanmar 15.5 19.6 1.9 7.5 6 81 83
Philippines 12.4 9.4 3.5 9.6 53 30 53 80
Thailand 9.1 4.8 14.1 9.4 56 39 75 78
Viet Nam 23.4 16.0 n.a. 27.7 46 42 n.a. n.a.
South Asia
Bangladesh 14.6 7.2 7.7 13.7 12 16 56 69
Bhutan n.a. n.a. n.a. n.a. 0 0 n.a. n.a.
India 9.8 6.0 5.9 12.4 9 10 51 55
Maldives n.a. n.a. n.a. n.a. 0 0 n.a. n.a.
Nepal 13.7 8.9 3.9 14.3 15 35 67 42
Pakistan 4.8 1.2 8.4 2.7 15 16 54 55
Sri Lanka 9.0 8.6 4.9 8.4 34 34 65 67
East Asia
Japan 2.7 4.9 4.5 3.9 10 6 44 58
Low & middle income 7.1 6.2 6.6 8.2 27 20 70 74
East Asia & Pacific 12.3 8.6 11.1 12.6 35 21 73 75
Europe & Central Asia 2.6 2.5 n.a. 4.4 32 31 n.a. 67
Latin America & Carib. 5.5 10.8 5.4 8.7 18 15 69 80
Mid. East & N.Africa 3.9 1.8 n.a. n.a. 36 19 69 69
South Asia 9.2 5.5 6.5 9.6 10 12 54 56
Sub-Saharan Africa 2.7 3.5 2.4 4.4 29 24 n.a. 71
High Income 5.6 6.2 5.0 6.5 19 18 71 78
World 5.9 6.2 5.2 6.9 20 18 71 77
n.a. Data not available Sources : (1) Global Economic Prospects 2002, World Bank.
(2) World Development Report 2002, World Bank.

39
Share in World exports

During 2000 among the developing countries, East Asia and Pacific had the highest share
in world exports (11.2 per cent) followed by Latin America and Caribbean (5.6 per cent)
and Europe and Central Asia (4.8 per cent). South Asia had the lowest share at 1 per cent.
Despite economic crisis, almost all the countries in East and South East Asia and South
Asia either maintained their share in world trade or achieved some increase in shares in
1995-2000 except marginal decline of shares by Hong Kong, Singapore and Pakistan and
significant fall in Japan (Table 2.6). Developing countries as a group increased their
share in world trade from 22.4 per cent in 1995 to 27.5 per cent in 2000.

Growth rates of merchandise exports and its share in

GDP

During 1990-1999 East Asia and the Pacific had the highest growth rate of merchandise
exports (12.3%) followed by South Asia (9.2%) and Latin America and Caribbean
(5.5%). As regards average growth of merchandise imports, Latin America and the
Caribbean achieved the highest growth (10.8%) followed by East Asia and Pacific (8.6%)
and South Asia (5.5%) (Table 2.7). In 2000 the share of merchandise exports in GDP
was the highest in Middle East and North Africa (36%) closely followed by East Asia and
Pacific (35%) and Europe and Central Asia (32%) (Table 2.7). Among the countries,
Singapore had the highest share of exports in GDP (149%) followed by Hong Kong
(124%) and Malaysia (110%).

Japan’s economic slowdown and linkages with East

Asia

During 1970s and 1980s East Asia’s developing and newly industrialised countries
found that links with Japan’s goods trade, banking flows, direct investment and
official assistance helped in boosting trade, financial integration and growth within
the region. However, in 1990s Japan experienced economic slowdown with meager
output growth of 1.4 per cent per annum and the problem of significant non-
performing loans in its banking system. While the region has become relatively less
dependent on trade with Japan, the linkages with Japan remain significant with
around 12 per cent of East Asian exports being sold to Japan and 20 per cent of
imports coming from Japan (Table 2.8).

Japanese lending to East Asia doubled between 1990 and 1996 rising to 4.4 per cent
of GDP and as high as 21 per cent of GDP in Thailand. The financial crisis of 1997-
1998 yielded a swift decline in Japanese bank loans on the crisis-5 countries
(Indonesia, Republic of Korea, Malaysia, the Philippines and Thailand) dropping
by 30 per cent in 1996-1998. From 1998 through 2000, Japanese claim on developing
countries fell by 53 per cent for Asia Pacific region and 12 per cent for other
developing regions.

40
While Japanese FDI has declined and its banks have
reduced lending to many East Asian countries since the
Asian crisis, Japan nonetheless remains an important
source of capital. There are also strong linkages between
stock markets in Japan and a number of countries in East
Asia, particularly with Hong Kong, Korea and Singapore.

41
 Table 2.8 Linkages between Japan and East Asia in 2000 (per cent)

Country Share of Exports to External Share of Stock Share of bank Share of

exports to Japan as Debt/ GDP Debt in market lending from FDI from
Japan % of GDP Yen correlation Japanese banks Japan
Indonesia 22 8 97 21 0.03 25 13
Thailand 16 9 66 32 0.21 37 25
Korea 11 4 28 17 0.32 18 16
Hong Kong 6 7 . . 0.40 32 .
Malaysia 13 13 48 30 0.12 27 14
Philippines 14 7 76 27 0.09 18 7
Singapore 7 11 . . 0.30 27 23
China 16 4 14 16 0.00 18 7
Source: Global Economic Prospects 2001, World Bank.

Agriculture exports

Restrictions on trade of agriculture and labour intensive manufactures, notably textiles

and clothing, are damaging to the developing countries. Virtually all major agricultural
commodities face trade barriers such as steeply rising non-transparent tariffs, quotas on
non-tariff imports, domestic and export subsidies in high-income countries, and state
enterprise trading in many developing countries. About one third of exports of the
developing countries face tariff peaks in one of four major markets, the United States,
Japan, Europe or Canada (World Bank 2001). Developing countries can have
substantial gains from reducing protection in these sectors as part of negotiated reciprocal
reduction in high-income countries for agriculture and labour intensive manufactures.

Services exports

Services are the fastest growing component of the global economy, and trade and foreign
investment in services had grown at a faster speed than that in goods in the last decade.
More efficient services in finance, telecommunications, transportation and professional
services improve the overall performance of the economy with their broad linkage
effects. Developing countries can gain significantly from further liberalisation of trade
and foreign investment in services.

In 1997 global service sector output was valued at $6.6 trillion or 61 per cent of global
output of goods and services. Although the developed countries accounted for three-
fourths of world services output, the contribution of services also increased significantly
in developing countries. The growth of service sector output and employment has been
accompanied by increased globalisation. Both foreign direct investment and trade in
services have grown considerably. Today, service sector accounts for 40 per cent of the
global FDI stock estimated at $30 billion, and 50 per cent of the world FDI flows, the
bulk of which is concentrated in developed countries. Service exports have been the

42
fastest growing components of world trade over the last 15 years. During 1985-1999 the
compound annual growth rate for services exports on the basis of balance of payments,
which covers primarily cross-border supply and consumption abroad, was over 9 per cent
per annum, compared with 8.2 per cent per annum for merchandised exports. As a result,
services trade more than trebled in volume in 15 years to $1.4 trillion in 2000 and
accounts for 25 per cent of all cross border trade.

Developing countries have witnessed the fastest increase (about four folds) in service
exports and consequently have increased their share in world service trade from 14 per
cent in 1985-89 to 18 per cent in 1995-98. Europe and Central Asia and East Asia and the
Pacific increased their service exports six times, South Asia and Latin America and
Caribbean kept up with the world growth, and Sub Saharan Africa and Middle East and
North America lagged behind.

During last two decades, there has been significant decline in the share of transport
services in total services exports from around one third to one fifth which may partly
reflect a decline in the relative prices of transport services. While the 1980s witnessed the
relative importance of travel from 25 per cent in service exports in 1980 to 33 per cent in
1990, the 1990s witnessed a significant increase in the share of other services. Among
the other services, royalties and license fees account for 12%, financial services 10%,
construction 7%, insurance 5%, communications 5%, computer and information 5%,
personal, cultural and recreational services 3%, and other businesses 53%.

Box 2.1

India’s Software Exports

One of the striking examples of a developing country service export success story is the
Indian software industry. Indian software exports increased from $225 million in 1992 to
$1.75 billion in 1997 and further to $4 billion in 2000. A recent report projects annual
revenues of $87 billion, 2.2 million jobs and market capitalisation of $225 billion for the
Indian information technology (IT) sector by the year 2008. By that year the IT sectors
could account for 35 per cent of India’s exports and can attract $5 billion of FDI per year.

These forecasts are feasible considering that India now accounts for only half a per cent
of the world software market and it has substantial comparative advantage in IT industry.
The average cost per line of code at $22 in Germany (the most expensive country) is
more than four times of that at $5 in India (the cheapest country) compared with $18 in
the USA, and $10 in Ireland and Italy. On considering that the total market for software
services amounts to $58 billion in the USA, $42 billion in Europe, $10 billion in Japan,
cost savings could be substantial. Other gains from trade liberalisation include a more
competitive market structure, wider choice and greater diffusion of knowledge.

The movement of service-supplying personnel remains a crucial means of delivery.

Although the share of on-shore services in total Indian software exports has a declining

43
trend, about 60 per cent of Indian exports are still supplied through the temporary
movement of programmers to the client’s site overseas, compared with 90 per cent share
of on-shore services in 1998.

Table 2.9 Direction of Exports of Developing Asian Countries in 1994-2000 (% Distribution)

Destination 1994 1995 1996 1997 1998 1999 2000

Industrial countries 51.5 50.3 49.8 49.3 52.9 53.5 52.5
Developing Countries 47.3 48.5 48.9 49.6 46.8 46.2 47.1
Africa 1.4 1.3 1.2 1.3 1.5 1.4 1.3
Asia 39.4 40.6 40.9 41.5 37.5 37.9 39.0
Europe 1.5 1.7 1.8 1.8 1.9 1.7 1.6
Middle East 2.6 2.6 2.6 2.5 2.9 2.7 2.6
Western Hemisphere 2.4 2.3 2.3 2.5 2.8 2.5 2.6
Other Countries n.i.e. 1.2 1.2 1.3 1.1 0.3 0.3 0.4
World 100 100 100 100 100 100 100
Memorandum Items
Total exports (billion) 475 590 619 668 629 662 792
World exports (billion) 2949 3595 3738 3882 3785 3917 4353
% share in world exports 16.1 16.4 16.6 17.2 16.6 16.9 18.2
Annual percentage change
Industrial countries 14.9 18.8 3.4 5.5 2.1 7.9 17.3
Developing Countries 21.5 24.6 5.5 7.9 -10.1 5.4 22
Africa 13.5 17.5 -1.1 7.9 13.7 -2.4 10
Asia 25.4 25.2 5.4 7.9 -13.8 7.9 22.9
Europe -8.7 38 9.4 7.7 2.3 -9.2 19
Middle East -0.1 20 5.4 2.5 10.6 -1.3 16.4
Western Hemisphere 18.1 16.7 7.6 13.2 8.5 -5.3 23.4
Other Countries n.i.e. -23.2 23 -6.2 1.2 -19 17.9 75.9
World 18.1 21.5 4.5 6.5 -4.7 6.8 19.5

Direction of trade

Tables 2.9 and 2.10 indicate that intra-regional trade in Asian developing countries
remained quite high in 1990s. Asian developing countries account for almost 40 per cent
of total exports and 41 per cent of total imports. While during the crisis period 1998-
1999, share of intra-regional exports showed some decline, the share has improved to 39
per cent in 2000. However the share on intra-regional imports in total Asian imports has
shown continuous increase throughout 1990s.

During 1994-2000 the share of developed countries in Asian exports had increased by
one percentage points from 51.5 per cent to 52.5 per cent, while their share in Asian
imports had declined significantly from 55 per cent in 1994 to 46.6 per cent in 2000.
Consequently, the share of developing countries in Asia’s exports remained more or less
invariant, while their share in Asian imports increased substantially from 43.6 per cent in
1994 to 52.4 per cent in 2000. Among developing countries, the share of intra-Asian

44
imports increased from 35 per cent in 1994 to 41 per cent in 2000, while Africa and
Middle East also recorded modest increase in share of Asian imports.

Within Asian developing countries there had been

significant diversification of trade in 1990s, particularly
after the financial crisis. While intra-regional trade among
developing countries has increased, with a few exceptions
(such as Hong Kong and Thailand), the share of exports
to Japan declined, sometimes quite substantially (as for
Indonesia, Malaysia and Pakistan). For Malaysia and
Indonesia, the decline of trade with Japan is due to
decline of primary products such as crude oil, rubber and
palm oil. For the China, Korea and Philippines, the decline
reflects the deceleration of demand in Japan due to its
slowdown, while USA became a more important export
market for many developing countries during the long US
expansion in 1990s.

Table 2.10 Origin of Imports of Developing Asian Countries in 1994-2000 (% Distribution)

Destination 1994 1995 1996 1997 1998 1999 2000

Industrial countries 55.0 54.9 53.4 52.0 50.6 48.9 46.6
Developing Countries 43.6 43.8 45.4 46.8 48.6 50.3 52.4
Africa 0.9 0.9 1.1 1.3 1.3 1.4 1.5
Asia 34.9 34.9 35.5 36.6 39.8 40.2 40.8
Europe 1.9 1.8 1.9 1.6 1.5 1.9 1.7
Middle East 4.3 4.6 5.3 5.7 4.6 5.3 6.9
Western Hemisphere 1.5 1.6 1.6 1.6 1.5 1.5 1.4
Other Countries n.i.e. 1.4 1.3 1.2 1.2 0.8 0.8 1.0
World 100 100 100 100 100 100 100
Memorandum Items
Total imports (billion) 464 577 622 645 550 604 760
World imports (billion) 2926 3555 3747 3870 3866 4103 4674
% share in world imports 15.9 16.2 16.6 16.7 14.2 14.7 16.3
Annual percentage
change
Industrial countries 13.0 18.2 3.1 2.5 0.6 4.3 7.6
Developing Countries 15.5 21.7 8.1 6.6 -4.0 8.0 24.7
Africa 7.8 17.2 13.4 3.8 -10.7 7.5 25.7
Asia 15.4 21.5 6.9 6.1 -1.6 9.2 21.9
Europe 33.2 31.9 3.4 4.4 -0.4 0.9 21.7
Middle East 0.8 15.2 13.8 6.6 -22.4 17.4 50.1
Western Hemisphere 17.0 19.5 11.3 11.5 -0.4 5.7 22.1
Other Countries n.i.e. 10.2 5.2 25.4 -12.7 -13.2 -3.5 13.0
World 13.8 19.0 4.8 3.9 -1.1 5.4 13.5

45
 (b) Developments in Investment

Notwithstanding the East Asian economies’ outstanding record of economic growth and
their potential for continued productivity gains, the recent economic crisis has cast
considerable doubt on their ability to sustain the very high rates of capital accumulation
they experienced in the pre-crisis period. Investment rates in Korea, Malaysia, China and
Thailand were exceptionally high at around 40 percent GDP in the first half of 1990s
(Table 2.9). Investment rates in Singapore and Indonesia were also high around 35 per
cent of GDP in 1990-1995. But there is a variety of evidence that suggests that the East
Asian economies may have been over-investing and that both the investment and the
efficiency of investment had declined in the second half.

As compared with the average rate in the first half of 1990s, gross domestic investment as
percentage of GDP declined by more than 9 percentage points to 28 per cent in the post-
crisis period 1999-2000 in Korea, by 20 percentage points to 15 per cent in Indonesia, by
15 percentage points to 25 per cent in Malaysia, and by 22 percentage points to 21 per
cent in Thailand in 1999-2000. Singapore, Hong Kong, China, Philippines and Viet Nam
also experienced decline in GDI but by lower percentage points in the range of 2 to 3 per
cent. Taiwan and Myanmar maintained more or less the same level of GDI, while
Mongolia and Cambodia achieved higher rates of GDI in the post-crisis period.

Countries in South Asia had mixed trends with higher rates of GDI in Bangladesh and Sri
Lanka and lower rates in all other countries in the post crisis period.

A measure of changes in the efficiency of overall investment is provided by the

incremental capital-output ratio (ICOR), which measures the ratio of the rate of change of
investment in any period to the period’s change in output. A rising ICOR may be
interpreted as a declining output response to investment and thus a falling efficiency of
investment. It could also indicate, however, that output is decelerating, relative to capital,
for other reasons: for example, the economy may be shifting to a production structure
with a higher capital intensity, which is a normal feature of Industrialisation.

In Korea and Thailand, (and also in Hong Kong SAR), ICORs approximately doubled
between 1990 and 1995, suggesting that investment became less efficient in generating
growth. In Indonesia (and also Singapore), in contrast, ICORs remained roughly constant.

Inflows of foreign capital, particularly direct foreign investment and portfolio investment
facilitated investment growth. Overall, within Asia, there has been greater financial
integration over time and the pattern of financial integration has generally followed
pattern of trade. Generally, dollar denominated assets had recorded the highest growth as
in Hong Kong and Singapore. Because of liberalisation in financial and capital markets,
many more regional banks and foreign institutional investors are competing for business
throughout Asia.

Much of the support for augmenting capital formation in East Asia came from Japan and
USA following the Korean War. The USA made substantial infrastructure investments in

46
Taipei and Korea. Both these Asian economies enjoyed technology transfers from joint
ventures with Japanese companies adopting Japanese systems of industrial policy,
techniques of production, inventory control and distribution. FDI began to flow to labour-
intensive industries to take advantage of low wages. These sunset industries became
unviable in Japan due to high wages and strong yen. The flow of FDI from Japan helped
develop manufacturing industries across the region and accelerating technology transfer.

In the post crisis period 1999-2000 there was significant decline of ICORs in Hong
Kong, Korea, Malaysia, Myanmar, Philippines, India and Pakistan due to financial and
industrial restructuring and better utilisation of non-performing assets. However, there
was some increase of ICOR in Taiwan, Mongolia, China, Cambodia, Indonesia, Vietnam,
Bangladesh and Sri Lanka, while ICOR remained more or less invariant in Singapore,
Lao PDR, and Thailand. The increase in ICORs in several of the East Asian economies
need not necessarily imply a declining efficiency of investment. It could be an indication
that these economies are shifting to a more capital-intensive production structure.

Table-2.11 Growth Rates of GDP, Gross Domestic Investment & Incremental Capital/Output ratio (ICOR)
in selected countries in 1990-1995 and 1999-2000

Country GR of GDP GDI as % of GDP ICOR ICOR GR of GDI

1990-1995 1999-2000 1990-1995 1999-2000 1990-1995 1999-2000 1990-1999
NIEs
Hong Kong 5.6 6.8 30.0 26.3 5.4 3.9 8.9
Korea, Rep. of 7.2 9.9 37.0 27.7 5.1 2.8 6.3
Singapore 8.7 7.9 35.0 31.8 4.0 4.0 8.5
Chinese Taipei 6.5 5.4 23.0 23.1 3.5 4.3 n.a.
China & Mongolia
China, Peo.Rep 12.8 7.6 39.0 37.0 3.0 4.9 13.4
Mongolia -3.3 1.9 22.3 26.5 -6.8 13.9 n.a.
Southeast Asia
Cambodia 6.4 4.8 16.3 18.6 2.5 3.9 n.a.
Indonesia 7.6 2.8 34.7 15.1 4.6 5.4 4.4
Lao PDR 6.5 5.4 26.2 21.6 4.0 4.0 n.a.
Malaysia 8.7 7.2 41.5 24.7 4.8 3.4 10.8
Myanmar 5.9 9.7 13.2 13.2 2.2 1.4 14.7
Philippines 2.3 3.6 22.2 18.1 9.7 5.0 4.1
Thailand 8.4 4.2 42.6 21.0 5.1 5.0 -2.9
Vietnam 8.3 5.4 23.9 21.5 2.9 4.0 25.5
South Asia
Bangladesh 4.1 5.2 14.0 22.3 3.4 4.3 7.0
Bhutan 5.8 6.0 52.0 41.8 9.0 7.0 n.a.
India 4.6 5.9 25.0 23.4 5.4 4.0 5.9
Maldives 6.5 6.5 n.a. n.a. 0.0 0.0 n.a.
Nepal 5.1 5.4 23.0 22.1 4.5 4.1 5.7
Pakistan 4.6 4.0 19.0 15.0 4.1 3.8 2.1
Sri Lanka 4.8 5.2 25.0 28.0 5.2 5.4 6.2

47
East Asia
Japan 1.0 1.0 31.0 26.0 31.0 26.0 0.2
Low & middle 2.1 5.5 n.a. 24.0 n.a. 4.4 3.0
income
East Asia & Pacific 10.3 7.5 n.a. 31.0 n.a. 4.1 7.0
Europe & Central Asia -6.5 6.3 n.a. 19.0 n.a. 3.0 -7.0
Latin America & 3.2 3.8 n.a. 21.0 n.a. 5.5 4.9
Carib.
Mid. East & N.Africa 2.3 3.9 n.a. 21.0 n.a. 5.4 n.a.
South Asia 4.6 4.9 n.a. 23.0 n.a. 4.7 6.8
Sub-Saharan Africa 1.4 3.0 n.a. 16.0 n.a. 5.3 3.6
High Income 2.0 3.4 n.a. 22.0 n.a. 6.5 2.6
World 2.0 3.8 n.a. 23.0 n.a. 6.1 2.9

Table-2.12 Shares of Manufacturing, Exports and Investment in GDP in 1995 & 2000 (per cent)

Country Manufacturing Share of Exports Share of Investment

1995 2000 1995 2000 1995 2000
NIEs
Hong Kong 9 6 139 124 33 27
Korea, Rep. of 27 32 28 39 37 29
Singapore 27 26 177 150 34 31
Chinese Taipei 30 24 38 53 25 23
China & Mongolia
China, Peo.Rep 38 24 26 23 40 38
Mongolia n.a. n.a. 56 41 24 26
Southeast Asia
Cambodia 6 6 20 18 22 19
Indonesia 24 25 25 40 38 18
Lao PDR 14 17 21 18 n.a. 25
Malaysia 33 35 90 110 41 26
Myanmar 10 6 2 5 13 11
Philippines 23 20 35 53 22 20
Thailand 29 32 39 57 40 22
Viet Nam 22 21 23 46 28 25
South Asia
Bangladesh 10 17 12 12 15 23
Bhutan 20 20 35 35 55 42
India 19 16 12 9 24 25
Maldives n.a. n.a. n.a. n.a. n.a. n.a.
Nepal 10 9 18 15 20 21
Pakistan 17 17 16 15 19 15
Sri Lanka 16 17 34 33 26 27
East Asia
Japan 24 24 9 10 30 26
Low & middle income 20 22 22 27 27 24
East Asia & Pacific 32 28 29 35 39 31
Europe & Central Asia n.a. n.a. n.a. 32 n.a. 19
Latin America & Carib. 21 21 17 18 20 21
Mid. East & N.Africa 7 7 47 36 26 21
South Asia 17 16 14 10 23 23

48
Sub-Saharan Africa 15 17 28 29 19 16
High Income 21 21 22 19 21 22
World 21 21 22 20 23 23
n.a. Data not available
Sources : (1) World Development Report 1997, World Bank.
(2) World Development Report 2002, World Bank.

49
Table-2.13 Gross Domestic Savings,Gross Domestic Investment, Exports and
Current Account Balance (as percent of GDP at market prices)

Country Average GDS Average GDI

1981-1990 1991-1996 1999-2000 1981-1990 1991-1996 1999-2000

NIEs
Hongkong 34 33 31 27 30 26
Korea,Rep 31 45 32 31 37 28
Singapore 42 48 51 42 35 32
Taiwan,China 34 27 26 23 23 23
China and Mongolia
China 34 40 38 33 39 37
Mangolia n.a. 15 18 n.a. 22 27
South-East
Cambodia n.a. 6 7 n.a. 16 19
Indonesia 32 32 21 30 35 15
Lao, PDR n.a. n.a. 16 n.a. 26 21
Malaysia 29 35 47 32 42 25
Myanmar 11 12 13 15 13 13
Philippines 22 19 16 22 22 18
Thailand 26 35 30 31 43 21
Vietnam n.a. 14 25 n.a. 24 22
South Asia
Bangladesh 2 14 21 13 14 22
Bhutan 10 22 21 36 52 42
India 21 24 23 23 25 24
Maldives n.a. n.a. n.a. n.a. n.a. n.a.
Nepal 12 12 14 19 23 23
Pakistan 16 16 13 18 19 15
Sri Lanka 13 13 19 25 25 28
East Asia
Japan 33 32 30 32 31 29
1990 1995 1999 1990 1995 1999
Low & middle income 26 22 25 26 27 24
East Asia & Pacific 35 38 37 35 39 33
Europe & Central Asia 26 n.a. 23 28 24 20
Latin America & Carib. 22 19 20 19 20 21
Mid. East & N.Africa 22 20 19 24 23 22
South Asia 19 20 19 23 22 22
Sub-Saharan Africa 16 16 14 15 19 17
High Income 23 21 22 23 21 21
World 23 21 23 24 23 22
Sources : (1) World Development Indicators 1997, World Bank.
(2) World Development Indicators 2000/2001, World Bank.
(3) Asian Development Outlook 2001, Asian Development Bank, Manila.

50
Table 2.14 Role of Private Sector in Selected Asian Countries in 1990s

Country Private Stock market Listed Domestic

Investment
as % of GDI companies
Capitalisation
US$ billion
1990 1997 1990 1999 1990 1999
NIEs
Hongkong n.a. n.a. 83 609 264 695
Korea,Rep 80 73 111 309 669 725
Singapore n.a. n.a. 34 198 150 355
Taiwan,China n.a. n.a. n.a. n.a. n.a. n.a.
China and Mongolia
China 34 48 2 331 14 950
Mangolia n.a. n.a. n.a. n.a. n.a. 418
South-East
Cambodia 86 74 n.a. n.a. n.a. n.a.
Indonesia 68 77 8 64 125 277
Lao, PDR n.a. n.a. n.a. n.a. n.a. n.a.
Malaysia 65 73 49 145 282 757
Myanmar n.a. n.a. n.a. n.a. n.a. 108
Philippines 82 80 6 48 153 226
Thailand 85 66 24 58 214 392
Vietnam n.a. n.a. n.a. n.a. n.a. n.a.
South Asia
Bangladesh 50 67 0 1 134 211
Bhutan n.a. n.a. n.a. n.a. n.a. n.a.
India 57 70 39 185 2435 5863
Maldives n.a. n.a. n.a. n.a. n.a. n.a.
Nepal n.a. n.a. n.a. 0.4 n.a. 108
Pakistan 52 58 3 7 487 765
Sri Lanka n.a. n.a. 1 2 175 239
East Asia
Japan 79 71 2918 4547 2071 2470
Low & middle income 65 67 485 2427 8360 24892
East Asia & Pacific 63 57 197 955 1443 3754
Europe & Central Asia n.a. n.a. 19 265 110 9000
Latin America & Carib. 74 80 78 585 1748 1938
Mid. East & N.Africa n.a. n.a. 5265 152 817 1863
South Asia 56 69 43 194 3231 7199
Sub-Saharan Africa n.a. n.a. 143 276 1011 1138
High Income 82 79 8913 33603 17064 24748
World 78 76 9398 36031 25424 49640
Sources : (1) World Development Indicators 1997, World Bank.
(2) World Development Indicators 2000/2001, World Bank.

51
Table 2.15 Role of Private Sector in Selected Asian Countries in 1990s
Country Domestic credit Highest Tax Rate Interest rate spread
provided by banks Individual Corporate
% of GDP incometax incometax
1990 2000 1999 1999 1990 1999
NIEs
Hongkong 156 141 17 16 3.3 4.0
Korea,Rep 57 104 40 28 0.0 1.4
Singapore 62 90 28 26 2.7 4.1
Taiwan,China n.a. n.a. n.a. n.a. n.a. n.a.
China and Mongolia
China 90 133 45 30 0.7 3.6
Mangolia 69 7 n.a. n.a. n.a. 17.9
South-East
Cambodia n.a. 7 20 20 n.a. 10.2
Indonesia 46 66 30 30 n.a. n.a.
Lao, PDR 5 11 40 40 2.3 18.6
Malaysia 78 144 30 28 1.3 3.2
Myanmar 33 27 30 30 2.1 5.1
Philippines 23 63 33 33 4.6 3.6
Thailand 91 122 37 30 2.2 4.3
Vietnam 16 35 32 32 n.a. 5.3
South Asia
Bangladesh 24 35 n.a. n.a. 4.0 5.4
Bhutan n.a. n.a. n.a. n.a. n.a. n.a.
India 51 48 30 35 8.0 2.5
Maldives n.a. n.a. n.a. n.a. n.a. n.a.
Nepal 29 44 n.a. n.a. 2.5 4.0
Pakistan 51 49 n.a. n.a. n.a. n.a.
Sri Lanka 43 38 35 35 -6.4 -4.8
East Asia
Japan 269 144 50 35 3.4 2.0
Low & middle income 58 65 n.a. n.a. n.a. n.a.
East Asia & Pacific 71 116 n.a. n.a. n.a. n.a.
Europe & Central Asia n.a. 24 n.a. n.a. n.a. n.a.
Latin America & Carib. 59 38 n.a. n.a. n.a. n.a.
Mid. East & N.Africa 54 79 n.a. n.a. n.a. n.a.
South Asia 48 47 n.a. n.a. n.a. n.a.
Sub-Saharan Africa 56 43 n.a. n.a. n.a. n.a.
High Income 140 147 n.a. n.a. n.a. n.a.
World 125 127 n.a. n.a. n.a. n.a.
Sources : (1) World Development Indicators 1997, World Bank.
(2) World Development Indicators 2000/2001, World Bank.

52
 (c ) Backward Linkages of TNCs for parts and
components

Over the years FDI has promoted backward linkages between foreign affiliates and
domestic firms. These linkages provide the strongest channel for diffusing skills,
knowledge and technology. For foreign affiliates, the local procurement can lower
production costs and allow more specialisation and flexibility. For domestic suppliers, the
direct effect of linkages is generally a rise in suppliers’ output and employment. Linkages
also transmit knowledge and skills, promote efficiency, productivity growth and
increased market diversification. There had been significant production backward
linkages in a number of countries including China, India, Malaysia and Singapore,
particularly in the fields of automobiles, electronics, consumer durable, food processing,
and information technology.

Knowledge diffusion through linkages with foreign affiliates can offer long-term
benefits to host developing countries. Linkages also increase the local integration
and rooting of TNCs and make them less footloose. Moreover, TNC linkages with
SMEs can promote the formation and upgrading of industrial sectors in host
countries.

Local sourcing and local content are the most commonly used proxies for backward
linkages. Local sourcing is very common in electronics and automobile industry.
Locally procured components by foreign affiliates in electronics and electrical
industries comprised 62 per cent of exports in Malaysia in 1994 and 40 per cent in
Thailand. In the hard disk drive industry, the level of local content provided by
affiliates and domestic firms in Thailand was estimated at 30 to 40 per cent of total
production cost in 2001.

In automobile industry, local content is estimated to be 19 per cent for passenger

and heavy commercial vehicles and 25 per cent for pick-up trucks in Thailand, and
30 to 40 per cent in Malaysian automobile industry. In China, a policy of localisation
stipulated that foreign affiliates in automobile industry had to source 40 to 50 per
cent of inputs locally. Several foreign affiliates such as Shanghai Volkswagen
Company reached this target by inducing their foreign suppliers to invest in China.

The use of the “brand to brand complementation” (BBC) scheme of the ASEAN helps in
establishing affiliates to produce parts and components. The BBC scheme waives some
duties for automotive parts produced within the ASEAN region and considers them as
domestically produced. If each country tried to produce a full complement of auto parts,
an unavoidable limit would be placed on lot sizes, even as production volumes increased.
The basic idea behind the BBC scheme is therefore to secure economies of scale by
allowing the production of specific parts to concentrate in specific countries and then

53
sharing them with each other. This scheme took effect in 1994 and most Japanese
manufacturers have qualified for it.
The local content rates are rising in ASEAN as the influx of parts makers continues
and ASEAN countries gain the ability to produce higher value added parts. For
example, Aisin Seiki Co. Ltd., an auto parts maker with ties to the Toyota group, has
set up its first ASEAN operations in 1996 in Indonesia, where produces clutch
covers, clutch disks, and other parts for transmission systems. Zexel, a Nissan-
affiliated parts company, is also producing the air-conditioner compressors for its
cars locally. From the US side, GM-affiliated Delphi had a local factory for steering
parts. These companies and others like them have enabled ASEAN countries to
establish the parts industries that are at the core of the automotive sector.

Toyota Motor Thailand has established an extensive network of linkages with

supplier firms. In January 2001 TMT’s first tier suppliers comprised 575 firms of
which 134 supplied core auto parts and 441 supplied other materials. The second
through fourth tier suppliers of TMT’s supply chain comprise around 1500 Thai
owned firms. During the economic crisis period in 1997-1998, TMT provided
significant financial support to the first tier suppliers. The following table indicates
the extent of backward linkages of the Toyota Motor Thailand Local procurement
by Toyota Motor Thailand in 2001 by type of supplier and type of inputs. Toyota has
already established a wide range of supporting industries in Thailand for key
components such as engines and major body parts. These key components are
generally produced by Toyota’s affiliates operating in Thailand and not by domestic
firms. The remaining parts procured locally include precision transmission parts
and electronic controls.

2.16 Local procurement by Toyota Motor Thailand 2001

by type of supplier and type of input

Type of supplier Purchasing of key parts Purchase of other

and components materials and facilities
Number of % Distribution Number of % Distribution
suppliers of purchases supplies of purchases
Toyota owned firms in 4 37 0 0
Thailand
Japanese joint ventures 69 42 103 72

Thai firms with Japanese 17 7 3 2

technical assistance
Non-Japanese joint ventures 6 2 71 6

Pure Thai firms 19 1 264 14

Firms in ASEAN under 19 11 0 0

ASEAN BBC programme

54
Total 134 100 441 100

Source: UNCTAD (2001) World Investment Report 2001.

Food processing is another linkage-intensive industry. It generates extensive and strong

local linkages as a result of the use of perishable agricultural inputs such as milk and
other dairy products, fruits and vegetables. Difficulties in imports and storage of the
required inputs coupled with restrictions on land ownership in many countries can force
the foreign affiliates in food processing to rely on domestic sources and to engage in
efforts to develop new and upgrade existing suppliers. In India, leading foreign affiliates
of TNCs in the food processing industry such as Nestle India Ltd., Cadbury India Ltd.,
Pepsi Foods Ltd. and GlaxoSmithKline Beecham Ltd. sourced locally on an average 93
per cent of their basic raw material (tomato, potato, basmati rice, groundnut, cocoa, fresh
milk, sugar, wheat flour etc.) and 74 per cent of other inputs (plastic crates, glass bottles,
refrigerators, ice chests, corrugated boxes, craft paper etc.).

Similar arrangements for local sourcing exist for Nestle in China, Unilever in Vietnam,
and thousands of fast food restaurants like McDonalds, Wimpy, Pizza Hut, Pizza Corner,
Kentucky Chicken etc, in India, Thailand, Singapore, Japan, Philippines and many other
countries in Asia.

(d) ICT Revolution and New Economy

The process of globalisation, which has been facilitated greatly by the development in
information and communications technology (ICT) has reinforced the growth of ICT and
is leading to the growth of new economy called knowledge based economy. Prompt and
decisive economic reform could maximise IT's effectiveness in boosting productivity
throughout the economy and raising the GDP growth, exports, employment and living
standards. The IT sector has tremendous potential to lower the cost of business, create
new products, deliver services more quickly and increase transparency and efficiency of
public institutions.

The ICT revolution is multifaceted encompassing a wide range of areas such as computer
hardware and software, high speed transmission of information by relay stations,
satellites and fibre optical cable, and digitisation of information not only by words and
data but also by sound and video, and generating new business applications such as
computer aided designs (CAD) and teleworking. These technological advances resulted
in explosive growth of the use of mobile phones, fax machines, Internet and E-mail, E-
commerce and business. The US economy is the leading exponent of these trends.

The ICT has revolutionalised the whole economy with innovations in products in
financial and other services, shorter product cycles, improved business environment and
greater competition through reduction of distance, time and cost. It is often argued that
the advancement of ICT has created the so-called “digital divide” wherein benefits reach

55
only rich households. This criticism may not be true as the advancement of ICT has led to
significant fall in transactions cost and tariff rates for telephones, fax, E-mail etc. in many
developing countries as in India and thereby has enhanced accession by people in large.

Combined with growth of Internet, ICT has the potential to reduce costs and increase
efficiency. Retailing over the Internet known as business to consumer (B2C), business to
business (B2B) and consumer to consumer (C2C) has led to significant reduction of
transaction cost and improvement in quality of products. Although presently only a small
fraction of B2B and C2C transactions take place on Internet, there is tremendous scope
for potential savings and cost reductions through B2B and C2C operations on Internet.

ICT has revolutionalised operations in banking, finance and industry in USA and
Singapore and is being increasingly used by many developing countries in Asia such as
Hong Kong, Taipei and Korea. In Europe, the use of the Internet is not as widespread as
in the USA, but Europe is well developed in ICT use for banking and other financial
services. In varying degrees, China, India and ASEAN-4 have experience in production
and exports of electronics in which they have comparative advantage.

The rate of diffusion of ICT to the developing countries has been rapid compared to
earlier all purpose technological change. Just after a decade of the start of IT revolution,
developing countries (with 85 per cent of the world’s population) account for 10 per cent
of world Internet connections in 2000. Though from a low base, IT expenditure increased
throughout 1990s for all developing countries and for many of them at a faster rate than
that for developed economies (Table 2.17). Investment spending slowed when economic
conditions were unfavourable as in Indonesia in late 1990s, but expenditures continued to
grow resulting in a substantial increase of personal computers and telephone lines per
capita which in turn led to widespread use of Internet.

Strong growth and investment friendly policies enhance the rate of IT adoption, which in
turn has long-term beneficial effects on growth. There exists a “vicious circle” among
growth, urbanisation, education, favourable policies and information technology
reinforcing each other. In general, countries with relatively high growth rates, greater
urbanisation and conducive policy environment have expanded their use of cell phones
and Internet connections at a faster pace than others. High levels of human capital are
strongly correlated with the adoption of IT. Since new technology is embodied in new
equipment, high investment rates speed up adoption as in the case of Korea and Malaysia.
A policy regime opens to imports and foreign direct investment also induces adoption of
new technologies in general and computers in particular.

However, some of the poorest countries have also achieved higher ratios of Internet users
to telephone than advanced economies implying that the latent demand for access to IT is
even strong in poor countries. The critical issue for these countries is how to use IT more
productively for accelerating the pace of development.

Information technology presents the attractive possibility of “leapfrogging in technology

advancement”. For example, countries with old-fashioned mechanical telephone systems

56
can bypass the analog electronic era and go straight to advanced digital technologies.
Leapfrogging leads to better IT system with lower transaction cost. Bangladesh’s
Grameen Bank, pioneer in the area of micro-finance, has provided cell phones and
Internet access in the rural areas.
Table 2.17 Indicators of Information technology Use in Selected Countries

Country IT/ GDP ratio (%) IT per capita (US$) Personal computers Telephone lines
per 100 people Per100 people
Change 1999 Growth 1999 Change 2000 Change 2000
1992-99 1992-99 1990-00 1990-00
Developing countries
Argentina 1.0 3.4 78.0 294.3 4.4 5.1 12.0 21.3
Brazil 2.3 5.8 199.4 267.4 4.1 4.4 8.4 14.9
Chile 1.1 5.7 121.8 321.0 7.5 8.6 15.5 22.1
China 3.0 4.9 465.7 37.9 1.6 1.6 8.0 8.6
India 1.8 3.5 220.8 15.4 0.5 0.5 2.6 3.2
Indonesia -0.3 1.4 7.0 13.7 0.9 1.0 2.5 3.1
Korea -0.5 4.4 53.8 521.5 15.3 19.0 15.4 46.4
Malaysia 2.1 5.5 61.8 168.4 9.7 10.5 12.2 21.1
Mexico 5.2 1.0 30.6 231.8 4.3 5.1 6.0 12.5
Philippines 0.9 2.7 82.6 33.6 1.6 1.9 2.9 3.9
South Africa 1.8 7.2 49.5 240.6 5.5 6.2 3.2 12.5
Advanced countries
Canada 1.6 5.3 31.6 1808.7 28.3 39.0 11.1 67.6
Denmark 1.0 4.5 45.3 2540.3 31.6 43.1 13.8 70.5
France 0.8 3.8 27.5 1706.6 23.4 30.5 8.5 58.0
Germany 0.9 4.1 29.4 1699.9 23.4 33.6 16.0 60.1
U.K. 0.7 4.7 52.0 1979.5 23.0 33.8 12.6 56.7
U.S.A. 0.9 5.2 57.9 2792.1 36.8 58.5 12.8 67.3
Source: World Economic Outlook , International Monetary Fund, October 2001.

The ICT sector has made increasing contribution to world trade growth during 1990s
(Table 2.18). The share of ICT exports in total exports more than doubled in East Asia
from 14 per cent in 1990 to 32 per cent in 1999. The contribution of ICT exports to
export value growth in 1998-99 in USA was as high as 98 per cent, followed by East Asia
(85 per cent). With the growing importance of the ICT sector in economic output and
international trade, the characteristics of business cycle has changed. For example, in the
semiconductor sector, recoveries in the 1990s occurred within six to nine months.

Table 2.18: Contribution of ICT exports to total exports and exports value growth

in selected countries and regions 1990-1999 (per cent)

57
 Country or Share of ICT export in total Contribution of ICT exports

Region merchandise exports

to export value growth
1990 1999 1990-1999 1998-1999
Europe 4.7 8.1 14.2 n.m.
United States 11.0 16.0 22.7 97.7
Japan 14.0 17.0 23.5 15.6
East Asia 14.0 31.7 49.3 84.6
n.m. stands for not meaningful. European merchandise export growth in 1999 was negative, but ICT

exports grew by 5.6 per cent in value terms.

Source: The Global Development Finance 2001, World Bank.

At the core of ICT revolution are advances in material science leading to increases
in the power of semiconductors resulting in rapid decline of semiconductor prices.
In recent years, East and Southeast Asian countries have made significant progress
in production and exports of electronics. Electronics products can be broadly
divided into three broad groups viz. industrial electronics (mainly microchip testing
equipment), electronics component and parts (mainly semiconductors and
microprocessors) and consumer electronics (predominantly computers).

Table 2.19 presents the shares of electronics in total exports in selected countries in
East and Southeast Asia. It is observed that in these countries, except for China and
Indonesia, electronics account for one third of total exports (in Thailand, Hong
Kong and Korea) to two thirds of total exports (in Singapore and Philippines) with
Malaysia and Taipei in the middle range. In seven out of nine countries, at least two-
thirds of electronics exports comprise electronic components and parts. Only China
and Indonesia have high share (85 per cent) of consumer electronics, while Hong
Kong, Korea, Singapore and Taipei have 10 to 18 per cent shares in industrial
electronics. Thailand is roughly split between consumer electronics and electronics
components.

The electronics industry has been hard hit by the recent global slowdown with
semiconductor prices falling sharply in all major markets. ASEAN members and the
NIEs have been heavily exposed to recent fluctuations in electronics industry.
Indeed, industrial production in these economies had been more volatile than in the
large industrial economies in the past decade due to fluctuations of world
semiconductor prices and sales and the increasing concentration of Asian
production in electronics.

58
 Table 2.19 Sectoral distribution of electronics exports in 1999-2000 (per cent)

Economy Share of Share in electronics exports

electronics Industrial Electronics Consumer
exports in total electronics Components Electronics
exports And parts
Singapore 64 10 89 1
Philippines 61 0 66 33
Malaysia 58 2 70 28
Taipei, China 46 15 80 5
Korea 38 18 78 4
Thailand 36 0 43 57
Hong Kong 33 12 70 18
China 24 0 15 85
Indonesia 14 0 15 85
Source: Asian Development Outlook 2001, Asian Development Bank, and Manila.

The IMF has begun cross-country study on the impact of IT-related capital deepening on
labour productivity growth in China, Hong Kong, Indonesia, Korea, Malaysia,
Philippines, Singapore, Taiwan and Thailand. Estimates of IT capital stocks indicate that
the ratios of IT capital stocks to GDP are largest in the USA and NIEs followed by
ASEAN-4 countries and then China. Within IT, the stock of telecommunications capital
is the largest, followed by IT hardware and then IT software. Results also show that the
contribution of IT-related capital deepening to labour productivity growth increased
significantly in emerging Asia during 1990s.

IT sector exports now account for 30 per cent of total exports equivalent to 10 per cent of
GDP for the Asian region as a whole, and to 20 per cent of GDP in the smaller regional
economies. For most countries in the region, however, electronics production and exports
include a high proportion ranging between 50 to 75 per cent of imported intermediate
inputs, mainly sourced from the region. The size of IT sectors exports relative to GDP
varies from 25 per cent of GDP in Malaysia to 1 per cent of GDP for Hong Kong
(excluding re-exports).

59
 Box 2.2
Information Technology in India

From humble beginning a few yeas ago, India's software and related service
companies now comprise 20 to 25 per cent of India's total stock market capitalisation.
The sector's revenue has grown by about 60 per cent per annum since 1992 to reach $6
billion in 2000 about two thirds of which comprise exports. During 2001 export
earnings from IT and related service sector, mainly firms providing back-office and
data services, amounted to $6 billion enough to pay almost half the import bill for
crude oil and petroleum products imported by India.

The IT sector in India now employs about 300,000 software developers by about 1000
companies. India has the potential to become a major base of outsourcing data
management, customer services, e-commerce, e-business and computer applications
for entertainment, scientific research, media work, transport and communications,
health, financial and banking services. The ITC sector is setting new standards of
corporate governance and transparency due to largely overseas listings. Leading
Indian software firms such as Satyam Infoway, Infosys, and Silverline Technologies
are listed on U.S. stock exchanges, and more are likely to follow.

The sector is projected to generate exports of $20 billion by 2003 (about 4 per cent of
current GDP or half of current merchandise exports) and more than ten-fold increase
in jobs by 2008. During the last decade FDI inflows into export-oriented production
contributed to much of the 250 per cent growth in Chinese exports and to over 200 per
cent growth in Philippine exports. If properly promoted, the IT sector could have a
similar impact on Indian economy as in the case of East Asian economies in 1990s.

2.2 Regional Integration and Industrial Development

Regional economic cooperation facilitates the free flow of goods, services, capital and
labor across national boundaries and acts as an effective instrument for securing
efficiency in the use of resources and thereby enhancing growth of all member countries.
Intraregional capital flows, particularly FDI, have grown very rapidly over the past
decade. They also entailed an increasing flow of technology associated with individual
projects and embodied in the flow of capital equipment and intermediate inputs arising
from projects. Japan and the NIEs are the source of much of this intraregional FDI.

(a) ASEAN and AFTA

60
 The Association of Southeast Asian Nations (ASEAN) consisting of Brunei, Indonesia,
Malaysia, Philippines, Singapore and Thailand was formed in 1967. ASEAN Free Trade
Area (AFTA) began in 1992 with the then six members. When Vietnam, Lao PDR,
Myanmar and Cambodia subsequently acceded to both ASEAN and AFTA the objective
of incorporating all Southeast Asian nations in ASEAN was finally achieved.

AFTA has evolved a comprehensive regional trading arrangement with an explicit time
table for eliminating tariffs within the group by the year 2002 and for introducing its
Common Effective Preferential Tariff (CEPT). Members have agreed to eliminate
quantitative restrictions and nontariff barriers on trade in products in the CEPT. They
have also agreed to cooperate in some areas of service trade and to explore cooperation in
some non-border issues such as harmonisation of standards, reciprocal recognition of
tests and certification of products, and removal of barriers to FDI. An important feature of
this Agreement is the intent to free the movement of capital and to increase investment,
industrial linkages and complementation among members.

As regards industrial cooperation, some positive results have been achieved in the
ASEAN Brand-to-Brand complementation (BBC) in the automotive industry, which
envisage manufacturing different components of a vehicle in different countries. ASEAN
Industrial Cooperation (AICO) Scheme is the latest industrial cooperation program in the
ASEAN, under which two participating companies from two different ASEAN countries
should involve not only in the physical movements of goods but also in resource sharing
and industrial complementation. Outputs of these companies enjoy a preferential tariff
rate in the range of 0-5%.

To promote and protect intra-ASEAN investment, the ASEAN countries since 1976 have
an Agreement providing most-favoured nation treatment to intra-ASEAN investment.
Other important ASEAN integration efforts related to their efforts towards joint resource
mobilisation and intra-ASEAN infrastructures. For example, the “ASEAN Minerals
Cooperation Plan” was designed to develop downstream industries. Similarly, different
ASEAN subsectoral programmes in energy cooperation promoted efficient use of coal in
the subregion. The gas pipeline projects across the member States also proved useful for
the subregion.

A recent development with AFTA's widening is the attempt to link up with other
"Regional Trading Arrangements (RTAs)". AFTA has closest link with Australia-New
Zealand Closer Economic Relations Agreement. There is also a link between AFTA and
the North American Free Trade Agreement (NAFTA). This is an informal arrangement
involving discussions and exchanges between officials over trade issues. The initial
ASEAN six members are also members of Asia Pacific Economic Cooperation (APEC).

There are two other recent and important developments in the region. First, the
ASEAN+3 idea, comprising the China, Japan and Republic of Korea. ASEAN+3 has
announced a region-wise system of currency swaps to help members deal with future
crises, and three bilateral agreements were signed in May 2001. China has signed an
agreement with ASEAN in November 2001 to create a free trade area between the two

61
within 10 years with differential treatment to newer and less developed members like
Cambodia, Myanmar, Las PDR and Vietnam. The two identified agriculture, information
and communications technology, human resources development, investment and Mekong
river basin development as five priority areas of cooperation.

The second important development is the growth in bilateralism in the region. From
ASEAN, Singapore has been active in pursuing such arrangements and has already
concluded a free trade agreement with Japan. Singapore has also plans for bilateral
arrangements with Canada and Mexico. These agreements are intended to be WTO-Plus.
Within ASEAN+3, a bilateral free trade agreement between Japan and Korea is under
negotiation. Japan is also pursuing agreements with Canada and Mexico, while Korea is
negotiating with Chile and New Zealand.

There is little evidence to support the view that crisis has hastened the process of
deepening within ASEAN. On contrary, the first round of crisis-induced reforms in most
of the ASEAN countries, some of which were reinforced by IMF supported programs,
suggests that the prospects of regional deepening had been hampered. Most of the
reforms were unilateral in nature and not regional. The contagion effect of the crisis has
however put pressure on the ASEAN to pursue further widening and deepening. If that
happens there would be substantial impact on intra and inter-regional trade and
investment, and so on economic growth of the respective countries.

Even though the provisions of AFTA are yet to be implemented fully, there is some
evidence that it has helped to increase intra-ASEAN trade, which as a percentage of total
ASEAN trade increased from 17.6 per cent in 1992 to 21.2 per cent in 1997. Intra-
ASEAN export share increased from 21.4 per cent in 1993 to 25.4 per cent in 1997.
However it declined to 22.7 per cent in 1998 due to shrinking demand in the region
caused by economic crisis. Notable sectors contributing to the intra-ASEAN trade include
machinery and electrical appliances, chemicals, mineral products, base metal and plastics.
To some extent intra-ASEAN trade represents entreport trade between Singapore and her
neighbouring countries particularly Malaysia, and partly mutual trade in mineral oil.

The average ASEAN CEPT rates of the widely traded sectors have fallen in the range of
0-5 per cent by 2000. In fact, only five sectors viz. prepared foodstuff, woods, foot ware,
arms and miscellaneous manufactured articles presently have tariff rates higher than the
range of 0-5. As the tariff rates have been reduced drastically, all the member countries
are now shifting their attention towards elimination of non-tariff barriers (NTBs).

Besides improving intra-regional trade, AFTA and complementary investment policies

such as AICO have facilitated the process of efficiency seeking industrial restructuring in
the region. Intra-regional investments in the ASEAN increased both in numbers and
volume except some decline since 1998 due to economic crisis. AICO arrangements have
already attracted many Japanese automotive manufacturers in the region. As many as 63
AICO arrangements generating more than $700 million in trade transactions per year are
already operational in the region.

62
 (b) SAARC and SAFTA

South Asian Association for regional Cooperation (SAARC) was established in 1985 and
is the counterpart of ASEAN for the South Asian countries comprising India, Bangladesh,
Bhutan, Maldives, Nepal, Pakistan and Sri Lanka. ASEAN is far more open than
SAARC due to long-followed policies of export promotion and foreign investment. FDI
inflows into ASEAN have been far more significant and instrumental in raising the
industrial linkages and complementarities in the region. SAARC, on the other hand, has
so far made little contribution to either regionalism or globalisation. Only recently
SAARC has included activities on trade and investment as a part of its regional
cooperation. There is, however, hope that as a first step SAARC members, having agreed
on a free trade area, will promote regional trade cooperation as a building block towards
globalisation. For its success, SAARC will need to agree on a clear policy towards
foreign investment as a vehicle of technology upgradation and overall growth.

The regional economic integration in South Asia received fresh impetus with bilateral
trade agreements between India and Sri Lanka in December 1998, which became
functional in March 2000. India has also bilateral trade agreement with Nepal and has
proposed one with Bangladesh. India allows automatic approval of outward investment
by Indian companies up to a limit of $50 million to SAARC member countries. Treaty of
Transit and Trade between India and Nepal was amended in 1996 and allows imports of
goods manufactured in Nepal to India free of customs duties and quantitative restrictions
except for alcohol, tobacco and cosmetics. This system of investment regime and “tariff
jumping” have facilitated restructuring of production by certain companies by shifting
production bases to Nepal for serving Indian and other markets. Indian companies run 72
of 214 foreign ventures in Nepal accounting for 53 per cent of capital of all foreign
ventures (Kumar 2001).

The share of intra-SAARC exports in total SAARC exports increased from 3.2 per cent in
1990 to 4.7 per cent in 1999. The intra SSARC imports as a proportion of total SSARC
imports increased from 1.91 per cent in 1990 to 4.12 percent in 1999. Given the fact that
at present the intra –regional economic integration is limited to only a preferential trade
agreement for select commodities; it is not expected to unleash a widespread industrial
restructuring. However the India Nepal free Trade Agreement and India Sri Lanka Free
Trade Agreements seem to have ignited a modest trend of industrial restructuring. Sri
Lanka hosts about 90 Indian ventures in light engineering goods, automobiles and hotels
etc. which is basically domestic market seeking.

While there are only two formal regional trading arrangements in Asia - ASEAN Free
Trade Area (AFTA) and SAARC Preferential trading Arrangements (SAPTA), there are
various economic cooperation of a more informal nature among countries in the region.
These sub-regional economic zones (SREZs) are popularly referred to as growth
triangles, growth polygons, or simply growth areas. The main focus of the SREZs is on
the transnational movement of capital, labour, technology, and information and on the
inter-country provision of infrastructure rather than on trade in goods and services. India,
Thailand, Bangladesh and Sri Lanka, having a coastline on the Bay of Bengal, have

63
formed a regional trade group on June 6, 1997, called the Bangladesh, India, Sri Lanka,
Thailand Economic Cooperation (BIST-EC). Trade between these countries currently
totals only $1 billion and is expected to improve substantially in the next decade due to
predicted economic boom in South Asian economies. Attempts are also being made to
form a sub-regional economic group through the Bangladesh, Bhutan, Nepal and India
“growth quadrangle” (BBNI-GQ).

(c) APEC

The most comprehensive form of multi-government cooperation in terms of both

countries and the scope of issues addressed are the Asia Pacific Economic Cooperation
(APEC). This Organisation was established in 1989 and currently has 21 member
countries in Asia and the Pacific including the Unites States, Japan, China, Russia,
Australia, Canada, Chile, Mexico and New Zealand. The APEC forum is of special
significance, as it is not founded on a formal agreement in accordance with the GATT.
The member countries have agreed by consensus on a program of action to achieve a
state of “free and open trade and investment” the so-called “open regionalism” by the
year 2010 for industrial country members and 2020 for developing country members.
Many of the members have already made significant unilateral tariff reductions before the
target date. There is an agreement on a set of APEC Nonbinding Investment Principles
for investment flows in the region. These are intended to reduce restrictions on the
international flow of portfolio investments.

The APEC has emerged as a powerful building block of the World Trade Organisation
and offers solutions to a wide array of problems in international business and trade. The
greatest potential of this forum lies in its strength to bring several economically diverse
and geographically dispersed countries together to address issues and problems in
international trade and investment. However, it is argued that APEC is not the only policy
track that is being used by the member countries to protect and promote their interests.
For example, the ASEAN Free Trade Area (AFTA) and the North American Free Trade
Area (NAFTA) also provide legal frameworks for many of the APEC members to iron
out tariffs and non-tariff barriers to promote international trade.

Nevertheless, the APEC is a formidable grouping including some of the most buoyant
and dynamic economies of the world. APEC member countries have a combined share of
55 per cent of global output and 50 per cent of global trade. Intra-APEC exports and
imports and investments are also considerably high. USA and Japanese firms are major
investors in the region, while China and Hong Kong are major host countries. APEC
includes some of the most populous and fastest growing economies like China and
Indonesia. It also includes three largest economies of the world viz. USA, Japan and
China in terms of PPP adjusted GDP.

Over the years APEC has widened its agenda. In Osaka in 1995 APEC leaders unveiled
action plans on trade and investment liberalization, business facilitation and economic
and technical cooperation. In the following year the Manila Action Plan for APEC
included the following items on priority agenda:

64
• Developing human capital,
• Fostering efficient and safe capital markets,
• Strengthening economic infrastructure,
• Harnessing technologies for future,
• Promoting environmentally sustainable growth,
• Encouraging the growth of SMEs.
In subsequent post-crisis summits in 1998 in Kuala Lumpur, in 1999 in Auckland
and in 2000 in Brunei, member countries stressed on the importance of sound
economic management with the help of reform programs, strengthening markets,
trade and investment liberalisation, and the importance of globalisation, openness
and inter-dependence for achieving growth and prosperity.

(d) ESCAP

From its inception ESCAP has promoted economic co-operation in the Asian and Pacific
region. ESCAP conceived the integrated communications infrastructure for the Asia and
promoted regional cooperation in shipping, ports and technology transfer. Financial and
developmental institutions like the Asian Development Bank, Asian Clearing House, The
Asian and Pacific Centre for the Transfer of Technology, the Asian Reinsurance
Corporation etc. were established at the initiative of ESCAP in order to promote
economic co-operation in Asia.

Increasing levels of intraregional trade and investment are gradually shaping a truly
interdependent regional economy in the Asia-Pacific region, based on the linkages of
production structure and regional division of labour. They succeeded significantly in
utilizing the technological revolution to enhance their national comparative and
competitive advantages. First, Japan and then the advanced countries of the region have
become critical growth centres supplying foreign investment and technology to other
economies of the region.

Although regional economic cooperation in ESCAP is being worked out at various levels,
actual progress is limited due to a number of reasons: (a) All the subregional groups
except ASEAN and the South Pacific Forum are about a decade old and it takes much
time to build up confidence and trust among the members. (b) Asian regional groupings
are only intercountry institutions and donot have supernational powers like the EC. (c)
There is hardly any linkage or dialogue among the regional or subregional groups.

The opportunities for regional cooperation in the endogenous technological capability

building of ESCAP member countries are enormous. While advanced developing
countries such as the NIEs have adequate domestic resources to attract technology and
capital and to expand their technological capacity, a number of developing countries in
the region (LDCs, island developing countries and disadvantaged traditional economies)
remain outside the mainstream of economic development primarily because of poor,
inappropriate or unfavourable local conditions in terms of skills, market size,
technological and physical infrastructure.

65
 (e) Multilateral Agreement on Investment (MAI)

The vigorous growth of bilateral and regional investment agreements, the inclusion of
certain FDI-related issues in the Uruguay Round agreements and the beginning of
negotiations on a Multilateral Agreement on Investment in the OECD clearly indicate that
both the developed and developing countries are moving towards liberalised trade and
investment regime.

At the regional level, the mix of investment issues covered is broader than that found at
the bilateral level, and the operational approaches to deal with them are less uniform.
Most regional instruments are legally binding. Issues typically dealt with at the regional
level include the liberalisation of investment measures; standards of treatment; protection
of investments and disputes settlement; and issues related to the conduct of foreign
investors (e.g. illicit payments, restrictive business practices, disclosure of information,
environmental protection, and labour relations).

At the multilateral level, most agreements relate to sectoral or to specific issues.

Particularly important among them are services, performance requirements, intellectual
property rights, insurance, settlement of disputes, employment and labour relations,
restrictive business practices, competition policy, incentives and consumer protection. It
is at the multilateral level that concern for development is most apparent. This is
particularly so in the case of the GATS, TRIPS and TRIMs agreements, as well as the
(non-binding) Restrictive Business Practices Set, where special provisions are made that
explicitly recognise the needs of developing countries.

66
 Chapter-3: East Asian Economic Crisis During 1997-1999
Origins, Onset, Spread, Measures and Lessons of the Crisis

3.1 Anatomy of the Crisis

The crisis unfolded against the backdrop of three decades of outstanding economic
performance in East Asia. These economies, particularly Indonesia, Malaysia,
Philippines, South Korea and Thailand recorded very high growth rates during 1980s and
early 1990s. However, most of the countries had recently large current account deficit,
financed by capital flows attracted by the region’s economic boom, macro-economic
stability, interest rate differentials and stable exchange rate. East Asia became the darling
of international investors since the 1980s and the advancement of computer and
information technology speeded up capital movements from one market to another for
higher returns. A part of the impetus for the increased capital flows to the East and South
East Asia also originated from the crisis of commercial banking in major industrial
countries to find alternative sources of business and to enhance returns of capital
(UNCTAD, 1998).

Private sector companies were the main borrowers abetted by an euphoric

environment created by liberalisation of financial markets without strengthening the
regulatory and supervisory systems. There was close links between government, business
and banks. Companies borrowed easily foreign currency on short terms and lent too
rapidly for use in unproductive sectors. Lending was based not on feasibility of projects
but on personal relations or “crony capitalism”. The chaebols in Korea, the politically
well-connected monopolies in Indonesia and the influential private corporations in
Malaysia are examples of such links (Kochhar et. Al. 1998).

Surge of foreign capital inflows led to an over-extension of lending, a decline in the

quality of assets and laxity in risk evaluation and portfolio management by the financial
sector. Capital inflows financed investment booms in:

• protected or illiquid sectors having low return and long gestation period (real estate
and petrochemicals in Indonesia, Thailand, Malaysia) causing maturity mismatch
between assets and liabilities of the financial intermediaries,
• sectors with high or excess capacity having low or negative returns (steel, ships,
semiconductors, automobiles in Korea),
• non-tradable (such as land, office blocks and condominiums in Thailand) that
generate return in domestic currency and did not generate foreign exchange;
• directed lending by chaebols in Korea to maintain their market shares in automobiles
and electronics with inadequate attention to profitability, and
• Speculative and unproductive lending in share markets.

The whole system set the stage for a classic boom-bust cycle in asset markets. Stock
and property prices soared initially, then plunged leading to the currency and financial
crisis. These prices plunged even more after the crisis, and led to deep and wide spread
economic crisis and social chaos. The financial intermediaries, both banks and non-bank,

67
were the creators of this asset cycle. Liabilities of these financial intermediaries were
perceived as having an implicit government guarantee, but they were essentially
unregulated. They borrowed large amounts of international capital, much of which was
on short-term maturity, denominated in US dollars and not hedged against currency risks.
They lent money to highly leveraged speculative investors, mostly in real estate.

The excessive risky lending by these institutions created inflation of asset prices. The
overpricing of assets and over-investment were sustained by a sort of circular process, in
which proliferation of risky lending led to an increase in prices of risky assets. There was
a serious mismatch of assets/ liabilities of banks and their financial intermediaries. Their
financial conditions seemed sounder than the real balance sheet position. It led a fragile
financial system with illiquid and undercapitalised assets.

Finally, there was a burst of price-bubbles in the middle of 1997 leading to a

significant fall of asset prices in all the crisis economies. As the asset prices fell further, it
became increasingly doubtful whether governments would really stand behind the
deposits and loans that remained. Both the depositors and lenders rushed to withdraw
their money. Foreign investors stampeded to recall their loans and investments, forcing
currency devaluation. It worsened the crisis even further as banks and companies found
them stuck with illiquid assets in devalued Baht or Rupiah, but with liabilities in US
dollars. Finally, the financial crisis was converted into wider economic disruption and
social chaos.
3.2 Origins of the Crisis

The difficulties that the East Asian countries face are not primarily the result of
macroeconomic imbalances. Rather, they stem from weaknesses in financial systems
and, to a lesser extent, governance. Although private sector expenditure and financing
decisions led to the crisis, it was exacerbated by governance issues, notably government
involvement in the private sector and lack of transparency in corporate and fiscal
accounting and the provision of financial and economic data. Thus, the build-up to the
difficulties in east Asia, which eventually lead to the present economic and financial
crisis in these economies and elsewhere can be traced in four major factors:

(a) Victims of their own economic success

These countries were, to some extent, victims of their own economic success: High
growth and commendable economic success resulted in underestimation of risk combined
with inadequate financial sector supervision. During 1992-95, the group of countries
known as the ASEAN-4 (Indonesia, Malaysia, Thailand and Philippines), Singapore and
Korea experienced unparalleled impressive GDP growth rates. Inflation was moderate, at
least by developing country standards. The absence of significant fiscal imbalances in
most cases confirmed the automatic discipline of macroeconomic policies. Rapid,
outward-oriented growth attracted large foreign investment. With healthy fiscal positions
in most cases and a sizable current account deficit being run up persistently in some cases
- most notably in Malaysia and Thailand - reflected shortfall of private saving relative to
private investment. A significant part of domestic investment was being financed by

68
foreign capital attracted by relatively high return. This brought mixed blessings.
Absorption of the capital inflows posed challenges in terms of their productive
deployment and their prudent intermediation through financial systems that were not well
developed. These challenges were more severe with short-term flows, especially flows
into banks and other financial institutions. The scale of difficulties that arose therefore
depended on macroeconomic policies and the soundness of financial system.

(b) Changes in External Environment

Various positive features of their external economic environment (such as dependence on

exports of automobiles and electronics), that at first were favourable turned sour in
several respects in 1996 and 1997. The surge in capital inflows to emerging markets in
the early 1990s was contributed by the decline in asset yields in the industrial economies.
There was also sharp narrowing of asset yields. Apart from contributing to the surge in
inflows and associated challenges, these developments magnified the potential reversal
when yields turned upward in the industrial countries in early 1997. Movements in
exchange rates among the major currencies in recent years have been another significant
external factor. When the US dollar weakened during 1994 and 1995, especially against
the Japanese Yen, these economies generally gained competitiveness as their currencies
depreciated in trade weighted terms. Conversely, when this decline in dollar was
reversed over the two years beginning in mid-1995, these countries suffered substantial
losses in competitiveness with adverse effects on net exports and growth. These swings
in competitiveness have tended to affect the current and capital accounts of BOP and
investors’ expectations of future exchange rate changes. Besides, a number of
developments contributed to the slowing in export markets. Among them, a widespread
deceleration of imports by the industrial countries, a glut in the global electronic markets
that resulted in a sharp fall in prices, and a slow down of growth in much of the Asian
region itself.

(c) Macroeconomic Management and Exchange Rate Arrangements

There were some sshortcomings and inconsistencies in domestic macroeconomic and

exchange rate policies; many countries in the region maintained a policy of stable
exchange rate for a long period despite deceleration of exports, and pursued a policy of
relatively high interest rates in order to maintain a stable exchange rate. The
macroeconomic performance of the Southeast Asian economies raised common concern
about the risk of overheating, which in turn raised questions about the sustainability of
exchange rate policy. There were signs of higher inflation in output prices, substantial
and growing external current account deficits. These indicated that the growth of demand
was indeed pressing on resources, and possibly also the competitiveness problems were
building. But a more important source of demand pressure was the growth of financial
system credit to the private sector. The increasing growth of private sector credit was
largely attributable, in turn, to burgeoning capital inflows, including directly into the
banking system, which were reflected in rising official foreign exchange reserves,
increasing commercial bank liquidity and expanding foreign liabilities of commercial
banks. Among the incentives encouraging borrowing from abroad were the relatively

69
high domestic interest rates by international standards and exchange rate policies that
appeared to provide assurance that the price of foreign currency would not increase to
outweigh the interest differential.

(d) Financial Sector and other Structural Weaknesses

There were also various structural weaknesses, particularly in the financial sector that
made these economies and especially their financial systems increasingly fragile and
vulnerable to adverse developments. As events unfolded, weaknesses of the financial
sector became particularly stark in Thailand, Indonesia, and Korea, although lack of
transparency delayed public realisation of the scale of the problems. Inadequacies in the
regulation and supervision of financial institutions as well as limited experience among
financial institutions in the pricing and managing of risk, lack of commercial orientation,
poor corporate governance, and lax internal controls- all these factors in the regime of
continual movements toward liberalisation and increased competitive pressures, had
contributed to imprudent lending, including lending associated with relationship banking
and corrupt practices. Non-performing loans, relative to equity were very high.

Another source of vulnerability was the investment of banks in non-bank financial

institutions with large-scale exposure to the domestic property market. Encouraged by the
relatively fixed exchange rate system, the financial intermediaries borrowed on a large
scale from the international capital market in order to extend credit to domestic
borrowers. Thus, there was serious problem of currency mismatch in the asset-liability
structure, in that a substantial fraction of liabilities of these companies was denominated
in US dollars, while their assets consisted of loans in terms of local currency. The
borrowers from the international market did not hedge themselves by entering into
forward contract or ensuring future flow of earnings in terms of foreign currency.
Besides, the structure of foreign debt had become highly unbalanced with a
preponderance of short-term borrowing.

It may be observed from the Table-3.1 that there were serious macro-economic
imbalances on the eve of the crisis in all the crisis economies. They became increasingly
vulnerable in 1997 to external shocks for the following reasons:

• The current account deficit as a percentage of GDP ranged between 2 per cent in
Korea to 5.2 per cent in Philippines.
• External debt as a percentage of GDP ranged from 34 per cent in Korea to 76 per cent
in Indonesia.
• Share of unconcessional debt to total debt ranged from 77 per cent in Philippines to
94 per cent in Malaysia.
• Share of short-term debt in total debt ranged from 19 per cent in Philippines to 62 per
cent in Korea.
• Share of short-term debt in total foreign exchange reserves ranged from 47 per cent in
Malaysia to 75 per cent in Korea.
• Although foreign exchange cover of imports ranged from 0.6 months in Korea to 4.7
months in Indonesia, practically all foreign exchange reserves were sold off in large

70
 forward contracts on the foreign exchange markets particularly in Thailand (Karin
Lissakers 1998).

Banking sector was subject to high risk and vulnerability to adverse shocks for the
following reasons:

• Ratio of domestic credit to GDP rose to 165 per cent in Korea, 160 per cent in
Malaysia and 157 per cent in Thailand.
• Interest expenses as a percentage of GDP ranged from 14 per cent in Philippines to 25
per cent in Thailand.
• Debt to equity ratio reached nearly 400 per cent in Korea compared with 85 per cent
in Taiwan, 144 per cent in Germany, 160 per cent in Malaysia, 154 per cent in
Sweden, 200 per cent in Japan and 150 per cent in USA.
• On the eve of the crisis, short-term interest rates rose to more than 16 per cent in
Korea and 22 per cent in Thailand.
• In 1997, banks’ exposure to property sector was 34 per cent in Indonesia, 26 per cent
in Malaysia and 13 per cent in Thailand.
• Non-performing loans of commercial banks reached 19 per cent of total credits in
Thailand, 16 per cent in Korea and Malaysia, and 17 per cent in Indonesia compared
with 1 per cent in the USA (IMF 1988).

The situation was exacerbated by the weakness in corporate and public sector
governance. Total (domestic and foreign) debt of private and private sectors amounted to
190 per cent in Indonesia, and exceeded 225 per cent of GDP in Korea, Malaysia and
Thailand. In Korea and Thailand, incremental capital output ratios (ICORs) doubled in
1990-1995. Debt to equity ratio increased to nearly 400 per cent in Korea in 1997. In
Korea, the net profits of 30 largest chaebols were close to zero, with six chaebols filing
for bankruptcy in early 1997.

3.3 Onset and Spread of the crisis

World was astonished with the speed and extent to which the crisis spread from
Thailand to other countries in the region. The financial and exchange rate crisis, that
began in Thailand in mid 1997, spread to many countries of East Asia, Russia, parts of
Latin America and also affected the economic health of major industrial economies like
Japan, North America and Europe. Contagion or the Wake up call effect and slipover
effects through intraregional trade and investment linkages have been felt by many
emerging market countries in other region in the form of declining stock prices and
intense pressures on exchange rates, It has adversely affected their economic growth
prospects in 1998 and outlook for future.

The crisis has led to dramatic depreciation of the nominal exchange rates. The sharp
movement of the exchange rate has greatly complicated the macroeconomic policy
choices by raising the cost of repaying foreign debt, weakening the financial and
corporate sectors. Remarkably, the CPI inflation rate since June 1997 has been in the
range of 5-12 per cent with the exception of Indonesia, where the current inflation is

71
running around 80 per cent. Mexico, by way of comparison, experienced a 40 per cent
surge in inflation during first ten months of its crisis in 1995. Despite large increases in
nominal interest rates in some countries, only Korea and Thailand have been able to
maintain real interest rates as significantly higher levels than those before the crisis have.

For the crisis-hit East Asian economies real GDP growth rates in 1998 were negative,
ranging from -5.3 per cent for Hong Kong, –6.7 per cent for Korea and –7.4 per cent to
Malaysia to –10.8 per cent for Thailand and –13.1 per cent for Indonesia. These countries
continued to incur massive social and economic costs in terms of loss of output,
acceleration of inflation, rising unemployment, and growing poverty in 1998-1999.

Main causes of economic recession:

Four main factors as indicated below are responsible for the current recession:

(a) Lack of external demand as a result of several factors such as:

• An effective collapse of the regional market as a result of decline of imports by 4 to

13 percent in volume. The crisis countries (and these including Japan) accounted for
45 per cent (and 55 percent) of the exports to the region. This explains that the
performance in volume (between negative 0.6 percent for Indonesia, 5 percent
Malaysia and 24 percent for Korea) is much lower than the pre-crisis level.

• Prices of exports also declined significantly leading to very low performance in value,
given the decline in exchange rates. Export value declined in Malaysia and Indonesia,
and increased by only 1.4 percent in Thailand and by 5 percent in Korea.

(b) Lack of internal demand as a result of several factors such as:

• Loss of wealth (market capitalisation down by 16 percent in Indonesia, to 145 percent

in Malaysia);
• Capital flight equivalent to about 10 percent of GDP;
• Increase in unemployment and number of people below the poverty line, and loss of
revenues by the working population.
• None of this has been compensated so far by sharp increases in public demand, either
in terms of investment or current expenditures on social sectors.

(c) Problems on the supply side: The corporate sector face considerable difficulties in
responding to demand, mainly due to collapse of financial sector. There is also the
problem of trade finance and internal credit crunch due to various factors such as:

• Lack of competitiveness, and industrial restructuring taking time (Korea, Thailand);

• Corporate distress due to sharp increase of foreign debt (Indonesia) or high real
interest rates (everywhere except in Indonesia);

72
• Decline in bank credits as banks reduce their exposure because of capital adequacy
requirements, and not enough capital to lend;
• No credit available for specific categories of enterprises such as SMEs because banks
supporting them collapsed. In general SMEs were hit more than large exporting
corporate houses.
• Each country was, in effect, exporting its recession to its neighbours and there was no
obvious engine of growth to pull the region from recession.

(d) Low return of investment: In 1990s, in many East Asian economies, major portions
of investment went into non-traded or protected sectors (such as real estate or
petrochemicals in Indonesia, Malaysia, and Thailand), which generated low returns, or in
sectors with high or excess capacity (such as semiconductors, steel, ships, and
automobiles in Korea) which also yielded low or even negative returns. In Thailand, for
example, value added in the construction and real estate sector grew by over 11 percent
annually in real terms between 1992 and 1996, rising from 12 percent to 14 percent of
GDP. In 1990s office vacancy rates increased, reaching 15 percent by the end of 1996.
Similarly, in Indonesia, the construction and real estate sector grew by 13 percent
annually in 1991-1996, rising from 9.5 to 10.5 percent of GDP, while in Malaysia, the
construction sector grew by over 14 percent annually between 1993 and 1997.

(e) Political and social factors: Political and social events also played a significant part
in the crisis. While political changes in Thailand and Korea assisted in stabilising of the
exchange rate, with the establishment of a clearly understood and supported reform
programme, political uncertainty in Indonesia played an important role in the opposite
direction. There were signs of social unrest almost everywhere, although by different
degrees. Unemployment rates were 3 percent in Malaysia, 6 percent in Korea and 15
percent in Indonesia. Poverty, therefore, increased at an alarming rate. Indonesia, which
had an impressive record of poverty reduction, experienced a rise in the poverty ratio from
11 per cent to about 16 per cent within a year (World Bank 1998). The poor were being
severely hurt during the crisis as demand for their labour fell, prices of essential
commodities rose, social services were cut, and crop failures occurred due to weather
shocks. Social areas, including ensuring food and medicine supplies, keeping children in
school, and protecting women’s health were key targets for interventions by the
government and multilateral funding agencies.

3.4 Role of multilateral financial institutions

The IMF is charged with safeguarding the stability of the international monetary system.
Thus, a central role for the IMF in resolving the Asian financial crisis was clear, and has
been reaffirmed by the international community in various multilateral forums. The
IMF’s priority was also clear to restore confidence to the economies affected by the crisis.
In pursuit of its immediate goal of restoring confidence in the region, the IMF responded
quickly by:

• helping the three countries most affected by the crisis Indonesia, Korea, and
Thailand to formulate and implement programs of economic reforms that could

73
 restore confidence. The Philippines extended and augmented its existing IMF
supported program in 1997, and arranged a stand by facility in 1998;

• approving in 1997 about US$35 billion of IMF financial support 1 for reform
programs in Indonesia, Korea, and Thailand, and spearheading the mobilization of
some US$77 billion of additional financing from multilateral and bilateral sources
in support of these reform programs. In July 1998, committed assistance for
Indonesia was augmented by an additional US$ 1.3 billion from the IMF and an
estimated US$5 billion from multilateral and bilateral sources.

The reform efforts have been invaluably aided by the World Bank, with its focus on the
structural and sectoral issues that underpin the macroeconomic, and the Asian
Development Bank (ADB), with its regional specialization.

The IMF’s immediate effort to reestablish confidence in the affected countries entailed:

• the introduction of flexibility to exchange rates, where it did not already exist;
• a temporary tightening of monetary policy to stem pressures on the balance of
payments;
• concerted action to correct the obvious weaknesses in the financial system, which
constituted the major element in the crisis;
• structural reforms to remove impediments to growth (such as monopolies, trade
barriers, and non-transparent corporate practices) and to improve the efficiency of
financial intermediation and the future soundness of financial systems.
• efforts to assist in reopening or maintaining lines of external financing; and
• the maintenance of a sound fiscal policy, including provision for rising budgetary
costs of financial sectors restructuring, while protecting social spending.

Forceful, far-reaching structural reforms were at the heart of all the programs. As
financial sector problems were a major cause of the crisis, the centerpiece of the Asian
programs had been the comprehensive reform of financial systems. While tailored to the
needs of individual countries, in all cases the programs arranged for:

• the closure of unviable financial institutions, with the associated write down of
shareholders’ capital;
• the recapitalization of undercapitalized institutions;
• close supervision of weak institutions; and
• increased potential for foreign participation in domestic financial system.

To address the governance issues that also contributed to the crisis, the reform of the
financial systems was buttressed by measures designed to improve the efficiency of
markets, break the close links between business and governments, and prudently
liberalize capital markets. Transparency was increased, both as regards economic data
(on external reserves and liabilities in particular) and in the fiscal and corporate sectors,
as well as in the banking sector.

74
 3.5 Summary of Structural Reforms in Crisis Countries

The IMF supported programs and policy advice to the crisis countries have placed
particular emphasis on broad ranging structural reforms of the financial and corporate
sectors, competition and governance policies, and trade regimes. In broad terms the
suggested reforms may be summarized as follows:

(a) Financial and Corporate Sector Reforms

• Closure of insolvent financial institutions, with their assets transferred to a resolution

or restructuring agency (Korea, Indonesia and Thailand); together with
recapitalization and mergers of other (all countries). The reform programs in
Malaysia and Thailand place particular importance on the finance company sector.
• Announcement of limited use of public funds for bank restructuring actual funds used
to be made explicit in the budget (all countries)
• Measures to significantly strengthen prudential regulation, including loan
classification and provisioning requirements, and capital adequacy standards (all
countries).
• Measures to strengthen disclosure, accounting and auditing standards, and the legal
and supervisory frameworks (all countries).
• Liberalization of foreign investment in domestic banks (Korea, Indonesia and
Thailand)
• The introduction of more stringent conditions for official liquidity support (Indonesia,
Malaysia and Thailand).
• Strengthening of prudential regulations on loan exposure (all countries).
• Introductions of funded deposit insurance scheme (planned in Indonesia and
Thailand; under consideration in Malaysia, already in place in Korea and the
Philippines)
• Restructuring of domestic and external corporate debt (Indonesia, Korea, Thailand)
and closure of nonviable firms (Korea).

(b) Competition and Governance Policies

• Liberalization of restrictive marketing arrangements for a variety of key commodities

(Indonesia)
• Establishment of competitive procedures for privatization of government assets and
for procurement (Indonesia, planned in Malaysia and Thailand)
• Announcement of bans on limits to the use of public funds to bail our private
corporation ( Indonesia, Korea, Malaysia and Thailand)
• Introduction or strengthening of bankruptcy laws and exit policies (Indonesia, Korea,
and Thailand)
• Acceleration of privatization or closure of non-viable public enterprises (Indonesia)

75
• Strengthening of corporate disclosure standards (Korea)
• Liberalization of foreign investment in ownership/management in sectors other than
the financial sector (Korea, Indonesia, Malaysia and Thailand)

(c) Trade Reforms

• Reduction of import tariffs and export taxes (Indonesia).

• Easing of quantitative imports and or export restriction (Indonesia and Korea).

(d) Social Policies

• Labour intensive public works programs (Indonesia, Thailand), and expansion of

unemployment insurance system (Korea).
• Protection of low income groups from increases in prices of food and other essential
(Indonesia, Malaysia, the Philippines, Thailand).
• Provision of higher spending for health and education (Indonesia) and reallocation of
budgetary expenditures to health programs for the poor (Thailand).
• Expansion of scholarship and loan programs to minimize number of student dropouts
(Thailand, Malaysia)
• Provision of subsidized credit for small and medium size enterprises (Indonesia,
Malaysia).

(e) Stabilisation Policies

In early 1998 the markets began to distinguish better economies among the different
country situations, with progress in implementing economic reforms being seen by the
markets as less steady in Indonesia than in Korea and Thailand. In the latter two
countries, exchange rates stabilized and the external financing situation improved. In
Indonesia, the social disturbances and political uncertainty in May 1998 further worsened
economic conditions and delayed desired economic reforms.

The IMF World Bank, ADB and bilateral donors augmented, in July 1998, the financing
for Indonesia’s revised program of economic reform. It took into account the need to
urgently repair the country’s distribution system and strengthen the social safety net, as
well as to act quickly to stabilize the economy and restructure the banking system. While
the global effects of the East Asian crisis appeared to have been contained by 1999,
devaluation of the Russian Ruble, the recession in Japan and the weakness of the yen
introduced some new uncertainties.

Additional measures were undertaken in the affected countries in 1999-2000 in terms off
economic restructuring to mitigate the adverse effects on output and employment. These
measures included the following:

• budgetary flexibility so as not to worsen the output loss;

76
• mitigating the effect of credit tightness and reductions in trade financing on
exporters and small and medium enterprises; and
• alleviating the social costs of adjustment, including through strengthening the
social safety net and encouraging a social dialogue among employers, employees,
and government.

Targeted fiscal positions were eased over time to allow for greater social spending in all
three affected countries. In Indonesia, for example, the overall budgetary cost of social
safety net programs increased to 7.5 per cent of GDP in 1999. It included funding of
food, fuel, and medicine subsidies; employment-generating programs targeted to poor
and vulnerable regions and households; health expenditure on village health centers and
immunization programs, and student aid to minimize the decline in school enrollment.

3.7 Lessons from the Asian Crisis for Macro-economic management

In a comprehensive study of the East Asian crisis, Kochhar, Loungani and Stone
(1988) have grouped policy lessons into two categories: policy lessons for crisis
resolution and those for crisis prevention. The lessons for crisis resolution include the
importance of tight monetary policy early for exchange rate stabilisation, flexible fiscal
policy, and comprehensive structural reform. Crises are avoided by prudent macro-
economic policies, diligent bank supervision, transparent data dissemination, strong
governance, and forward-looking policy, even in good times. Broad policy lessons for
macro-economic management that emerge from this paper and other studies by the World
Bank (1998), IMF (1998) and UNCTAD (1998) are summarised below:

(a) General policies

• The Asian crisis has highlighted the importance of a sound macroeconomic policy
framework, and the dangers of unsustainable large current account deficits. An
analysis of Table-3.2 indicates that India was insulated from the contagion effects of
the East Asian crisis and sustained high growth with stability in prices and exchange
rate during 1997-2000. Sound macro economic policies and reforms taken by India
during 1990s and its relatively less integration with the global economy helped India
to avoid the effects of the East Asian crisis.

• Basic lesson from the crisis is that the sooner the problems are identified and properly
treated, the better the chances for being successful, and the smaller the economic and
social costs. The odds for the occurrence of a financial crisis can be reduced by better
macroeconomic management, complemented by appropriate legal, regulatory and
institutional set-up for effective prudential regulation, monitoring, surveillance and
supervision of the financial system and improved corporate governance.

(b) Financial sector reforms

77
• The linchpin of the crisis was the weak banking and financial system, which
constrained the monetary for appropriate banking supervision. A few lessons for the
financial sector reforms are now evident. First, worst time to reform a financial
system is in the middle of a crisis. Second, when currency turmoil is associated with
financial difficulties, raising interest rates over an extended period may simply
worsen the situation by bringing about widespread corporate and bank insolvency.
Third, currencies should not be left to sink while funds are used to bail out the
international creditors.

• The Indonesian experience teaches that when public expectation is fragile, the closure
of insolvent banks even though a must for creating a sound banking system, could
have an adverse result. Closure of weak banks precipitated the translation of what was
initially a liquidity crisis into a solvency crisis, leaving behind a large stock of unpaid
debt. It may not be realistic, but the liquidation of weak banks should be done when
the economy is not fragile. And, in general, the sooner the better.

• Banking reforms need to be co-ordinated with monetary reforms. Conflicts between

the aims of price stability and bank soundness entail an inter-temporal trade-off.

• Disclosure of key information on performance, credits, profitability etc. of both

financial and corporate entities is essential for creating investors’ confidence.

(c) Monetary policies

• Monetary policies need to be kept sufficiently firm to resist excessive exchange rate
depreciation through adequate increase in interest rates. For economies with large
amounts of short-term external debt, it is particularly important that monetary
conditions provide adequate incentives for the private sector to roll over short-term
foreign loans in the face of the increase in risk premium.

• Monetary policies can be used for changing the composition of capital inflows in
favour of long-term flows. There can be an explicit tax on inflows of foreign capital.
It is also possible to impose quantitative controls on capital such as fixation of
prudential limits on or prohibitions of non-trade related swap activities, offshore
borrowing, ceilings on banks’ foreign currency liability or sale of short term money
market instruments to foreign residents (Islam 1998).

• Generally, a tight monetary policy is required to defend a currency, which is under

severe downward pressure. Higher interest rates not only raise return on financial
assets and thus encourage inflows of foreign currency deposits, but also reduce
speculative demand for foreign currency by making it more expensive.

• However, tight monetary policies increase the debt burden in domestic currency and
the fiscal deficit, which may put downward pressure on the exchange rate when
foreign lenders and investors perceive greater credit risks. Therefore, a tight monetary

78
 policy may be avoided as far as possible or may be used only temporarily in an
economy with relatively large domestic debt burden.

(d) Fiscal policies

• Fiscal policies need to contribute to the mobilisation of domestic savings and to

encourage the flow of non-debt creating financial flows and thereby reducing the
country’s excessive reliance on foreign debt.

• Fiscal policy needs to strike a balance between different objectives such as growth
with stability, equity and economic justice. Fiscal deficits were allowed to increase
considerably in all crisis countries, alleviating the effects of the crisis on real activity.

• Objections that no fiscal tightening was needed because the crises were made by the
private sector and not the result of “government profligacy” is valid: even if fiscal
policy was not part of the initial problem, it was a useful part of the solution.

(e) Sequencing capital account convertibility

• The capital account convertibility should be done in an orderly and sequenced manner
in line with strengthening of domestic financial systems through adequate prudential
and supervisory regulations in order to maximise the benefits and minimise the risks
of free capital movements (Goldsbrough 1998). The golden rule is to encourage
initially non-debt creating financial flows such as FDI and portfolio equity investment
followed by long term capital flows. Short term or volatile capital flows may be
liberalised only at the end of capital account convertibility.

• Most of the affected countries imposed capital controls in response to the financial
market pressures. If retained beyond the short term, the costs of unilateral controls are
likely to outweigh the benefits and can impose significant risks to other members of
the international community. A strategy of integration, rather than isolation, clearly
offers more benefits in the long run.

(f) International co-operation

• International economic and financial co-operation was essential to contain the crisis.
The major advanced economies should seek to maintain supportive conditions in
international financial markets.

• Collaboration and consultation at the regional and bilateral level are also capable of
contributing to the prevention of financial crisis. Their potential role is particularly
important with respect to the prevention of currency disorders and contagion effects.

• Changes are needed to the global economic and financial architecture in view of
the excessive volatility of short-term debt flows, strong contagion effects of crisis,
and increased moral hazard in international financial markets.

79
 (g) External Debt Management Strategy

• As mentioned earlier, in all the East Asian crisis economies, weaknesses in financial
systems as a result of weak regulation and supervision and a long tradition of a heavy
government role in credit allocation led to misallocation of credits and inflated asset
prices. Another vital weakness of all countries was associated with large unhedged
private short-term foreign currency debt in a setting where the private corporate
sector was highly leveraged.

• The management of debt crisis faced by the East Asian countries is not without
precedence. Following the inception of the Latin American debt crisis in 1982, and on
the presumption that the debt problem was one of liquidity and not solvency, the
initial debt management strategy aimed at normalising the relationship between the
debtors and creditors through a combination of economic adjustment by debtor
countries and negotiations on financial relief. The financing modalities provided
debtor countries with some financial relief through interest rate spreads, reduced fees,
and extension of maturities and provision of new finances. The negotiations
conducted on a case by case approach for debtor countries were co-ordinated by the
private bank steering committees in consultation with the IMF, World Bank and
governments of the creditor banks’ home countries (Islam 1998).

• So long as free movement of international capital is allowed, there is no guarantee

that the debt crisis will not recur in future. Whenever such a financial crisis occurs in
future, it is necessary to formulate an international debt management strategy on the
basis of negotiations among international private lenders, investors and borrowers for
sharing the responsibility for debt relief or rescheduling debt and repayment.

• More effective structures for orderly debt workouts, including better bankruptcy laws
at the national level and better ways at the international level of associating private
sector creditors and investors with official efforts are needed to help resolve
sovereign and private debt problems.

• A range of options are available to tackle a debt crisis viz. (a) to contract credit and
swap facilities with groups of foreign banks, to be activised in the event of liquidity
pressures, such as those contracted by Argentina and Mexico; (b) embedding call
options in certain short-term credit instruments to provide for an automatic extension
of maturities in times of crises; (c) feasible modifications of terms of sovereign bond
contracts to include sharing clauses; and (d) a possible role for creditor councils for
discussion between debtors and creditors. However, these are complex issues and
need to be designed carefully so that there are no perverse incentives.

• Developing countries need to strengthen their debt management strategy by

developing comprehensive debt sustainability models which will integrate external
sector, particularly the flows of external debt, with broad macro-economic variables
and provide early warning regarding any possible debt trap.

80
• All countries need to monitor very carefully short-term debt, long-term debt by
residual maturity, all guarantees and all contractual contingent liabilities arising out
of both dent and non-debt creating financial flows.

81
 Table-3.1: Major macro-economic variables in India and East Asian countries
in 1997 (in percentage, unless mentioned otherwise)

Items India Indone Korea Malay- Philipp Thai-

sia sia ines land
1. GDP growth in 1997 4.8 4.6 5.5 7.8 5.1 - 0.4
2. GDP growth in 1998 6.6 -12.0 -5.0 -4.0 0.5 -6.5
3. GDI to GDP ratio 25.0 29.5 36.8 42.8 23.9 35.0
4. GDS to GDP ratio 23.5 27.1 34.8 38.0 18.7 32.9
5. Current a/c deficit to GDP 1.4 2.4 2.0 4.8 5.2 2.2
6. External debt to GDP ratio 24 76 34 44 57 59
7. Concessional debt as a ratio to 41 20 … 6 23 8
total external debt
8. Short-term debt as a ratio to 5 25 62 28 19 41
total external debt
9. Debt-service ratio 19 31 9 6.3 11 15
10. Short-term debt as a ratio to 17 103 751 47 134 112
foreign exchange reserves
11. Foreign currency assets 6.9 4.7 0.6 3.5 1.7 4
(months of imports)
12. Exports of goods & non-factor 16 30 37 94 40 48
services as a ratio to GDP
13.Banks exposure to real estate Negligi 34 16 26 27 13
ble
14. NPAs of banks 9 17 16 16 13 19
15. Short term interest rates 9.5 48.9 7.7 6.6 13.4 7.5
as on 2nd December, 1998
16. Domestic credit to GDP ratio 21 63 165 160 90 157
17. Bank credit to public sector as 3 5 10 10 25 2
percent to GDP
18. Debt/equity ratio 100 250 400 . . .
19. Interest expenses to GDP 3 19 21 15 14 25
20. Currency depreciation since 15.5 70 32 34 34 30
July 1997 until Nov.98
21. Fall in REER since June 1997 3 57 31 29 25 29
22. Fall of stock prices since July 34 58 48 62 38 37
1997
23. CPI inflation rate as in 16.3 79.3 6.8 5.2 10.2 4.1
October 1998
24. Central government balance -5.5 0.8 0.0 2.6 -1.0 -1.0
25. Internal debt at the end 1997 49 46 … 32 85 19
as percentage of GDP

82
Table-3.2: Basic Indicators of the Indian Economy 1991-2000
(in per cent)
Variables 1990- 1991- 1994- 1995- 1996- 1997- 1998- 1999- 2000-
1991 1992 1995 1996 1997 1998 1999 2000 2001
5.4 0.8 7.8 7.6 7.8 4.8 6.6 6.4 5.2
GDP growth
rate
3.7 -2.0 5.4 0.2 9.4 -5.7 7.9 -0.7 -6.5
Agricultural
growth
8.2 0.6 9.3 12.2 6.1 6.6 4.1 6.7 5.1
Industrial
growth rate
Infrastructure 4.8 6.1 9.1 7.9 2.6 4.8 2.5 6.5 7.2
growth rate
Savings/GDP ratio 22.3 21.0 24.2 24.1 23.2 23.5 22.0 22.3 23.0

Investment/GDP 25.5 21.5 25.4 25.8 24.5 25.0 23.0 23.3 23.9
ratio
Fiscal deficit/GDP 7.7 5.4 5.6 4.9 4.9 5.8 6.4 5.4 5.1
ratio (Central govt)
Internal debt/GDP 48.6 47.4 47.0 45.6 44.5 47.5 47.5 49.2 50.6
ratio (Central govt.)
CPI inflation rate 11.6 13.5 10.3 10.0 9.4 6.8 13.1 3.4 3.8

Exports growth rate 9.2 -1.1 18.4 20.3 5.6 4.5 -3.9 11.6 20.4

Current A/C as % of -2.9 -0.3 -1.0 -1.6 -1.2 -1.4 -1.0 -0.9 -0.5
GDP
Forex currency 2.2 5.6 20.8 17.0 22.4 26.0 29.5 35.1 39.6
assets($ bn)
FER cover (no. of 2.5 5.3 8.4 6.0 6.5 6.9 8.2 8.2 9.0
months)
External debt/GDP 27.3 37.7 30.0 26.3 24.5 24.3 23.4 21.9 21.4
ratio
Non-debt capital as 1.2 2.9 60.0 155.4 56.6 139 62 84 88
ratio total cap. flow
Debt-service ratio 35.2 30.2 26.2 24.3 21.2 19.5 17.8 16.2 17.1

Short-term debt as % 10.2 8.3 4.3 5.4 7.2 5.4 4.4 4.0 3.5
of total external debt
Short-term debt as % 147 77 17 23 25 17 12 10 9
of FE assets
Foreign invest ($ bn) 0.1 0.1 4.8 4.6 5.8 5.0 2.4 5.2 5.1
Foreign direct inv. 0.1 0.1 1.2 1.9 2.5 3.2 2.5 2.2 2.3
Portfolio investment 0 0 3.6 2.7 3.3 1.8 -0.1 3.0 2.8

83
 CHAPTER-4 ROLE OF FOREIGN CAPITAL IN INDUSTRIAL
AND INFRASTRUCTURE DEVELOPMENT

4.1 Private capital flows to developing countries

Developing countries account for 85 per cent of the world’s population but only 7.6 per
cent of global private capital flows, 1.8 per cent of global capital market flows, 19 per
cent of global Foreign Direct Investment, 22.5 per cent of global output and one third of
global trade. These shares had generally increasing trends until the East Asian crisis in
1997, followed by declining trends in 1998-99 and modest increase in 2000 (Table 4.1).

Aggregate net capital flows to developing countries increased about three-fold during
1990s from $123 billion in 1991 to $358 billion in 2000 (Table 4.1). During 1990s the
continuous fall of official development finance was over compensated by an increasing
trend of private capital flows including foreign investment. Long term private capital
flows to developing countries increased almost five times from $62 billion in 1991 to
$300 billion in 1997 and the share of developing countries in global private capital flows
increased from 11.8 per cent to 14.4 per cent during the same period. However, since the
financial crises triggered in some of East Asian countries in 1997, developing countries'
use of external private capital declined as a consequence of reduced demand for external
capital in some countries and constrained supply for other countries due to uncertainty
and risk. Following their collapse during financial crisis period of 1998-1999, private
capital flows to developing countries resumed growth in 2000 and reached $319 billion
(amounting to 7.6 per cent of global private capital flows) in the wake of strong economic
recovery in crisis affected countries. But these capital flows failed to keep up with global
output and trade and constituted a significantly lower share of developing countries' gross
domestic product and exports than those in 1996-1997.

During 1990s there was a significant change in the composition of external financial
flows to the developing countries. There was an increasing share of private capital from
50 percent in 1991 to 89 per cent in 2000, and a corresponding declining share of official
development finance from 50 percent to only 11 percent over the period (Table 4.1).
Within private capital, flows of foreign investment comprising foreign direct investment
(FDI) and portfolio investment increased by more than six-and-half times surpassing
other types of capital flows and constituting more than 80 percent of total private capital
flows to developing countries in 2000 compared with 35 per cent in 1991. In fact, FDI
was often the only source of international private capital to most least developed
countries which failed to receive the investment-grade ratings required for borrowing
from abroad or tapping international capital markets.

As regards regional distribution, South Asia had a share of 9 per cent and East Asia and
Pacific had a share of 28 percent of total private finance to the developing economies in
1990 (Table-4.2). While Latin America and Caribbean had a share of 22 per cent, Europe
and Central Asia had a share of 13 per cent, Sub-Saharan Africa had a share of 18 per

84
cent and Middle East and North Africa only 10 per cent in total capital flows to the
developing countries in 1990. During financial crisis the share of East Asia and Pacific in
private capital flows dropped to 25 per cent in 1999 but recovered quickly and improved
to 32 per cent in 2000. Shares of Europe and Central Asia and Latin America and
Caribbean also increased during the period 1990-2000, while South Asia and Sub-
Saharan Africa received reduced shares.

Table 4.1 Total net long-term capital flows to developing countries in 1990s (Billion US$)

Type of flow 1991 1995 1996 1997 1998 1999 2000

Aggregate net capital flows 122.9 261.2 311.2 342.5 346.1 301.0 357.8
Official development finance 60.9 55.1 31.9 42.8 54.6 45.3 38.6
Total private flows 62.0 206.1 279.3 299.7 291.5 255.7 319.2
Capital markets 26.3 99.1 147.8 127.1 103.5 33.7 79.2
Debt flows 18.7 63.0 98.6 96.9 87.9 -0.8 31.3
Commercial banks 5.0 30.5 33.7 45.2 50.0 -24.6 0.7
Bonds 10.9 30.8 62.5 49.0 40.9 25.4 30.3
Others 2.8 1.7 2.4 2.7 -3.0 -1.6 0.3
Equity flows 7.6 36.1 49.2 30.2 15.6 34.5 47.9
Foreign direct investment 35.7 107.0 131.5 172.6 188.0 222.0 240.0
Ratios to total capital flows: in per cent
Aggregate net capital flows 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Official develop.finance 49.6 21.1 10.3 12.5 15.8 15.0 10.8
Total private flows 50.4 78.9 89.7 87.5 84.2 85.0 89.2
Capital markets 21.4 37.9 47.5 37.1 29.9 11.2 22.1
Debt flows 15.2 24.1 31.7 28.3 25.4 -0.3 8.7
Commercial banks 4.1 11.7 10.8 13.2 14.4 -8.2 0.2
Bonds 8.9 11.8 20.1 14.3 11.8 8.4 8.5
Others 2.3 0.7 0.8 0.8 -0.9 -0.5 0.1
Equity flows 6.2 13.8 15.8 8.8 4.5 11.5 13.4
Foreign direct investment 29.0 41.0 42.3 50.4 54.3 73.8 67.1
Developing country shares: in per cent
In global private capital flows 11.8 12.4 13.2 14.4 9.9 7.6 7.6
In global capital market flows 3.3 5.1 6.2 4.3 3.4 0.9 1.8
In global FDI flows 22.3 32.3 34.9 36.5 27.1 20.7 18.9
In global output 19.8 20.7 22.1 23.2 21.6 21.7 22.5
In global trade 26.5 29.5 31.3 32.4 30.7 30.7 33.4
In global population 84.0 84.6 84.7 84.9 85.0 85.1 85.2
Memo Items: Billions of US$
Global capital market flows 794 1928 2403 2929 3033 3910 4324
Global FDI 160 331 377 473 693 1075 1271
Share in total developing country FDI flows: in per cent
Middle income countries 87.3 87.0 86.5 88.8 92.4 94.7 93.2
Low income countries 12.7 13.0 13.5 11.2 7.6 5.3 6.8
Ratio of FDI inflows to GDP
Middle income countries 0.9 1.9 2.1 2.7 3.1 3.2 2.8
Low income countries 0.5 1.4 1.7 1.8 1.4 0.9 1.1
* Developing countries are defined as low-income countries with GNP per capita no more than $755 $755
in 1999 and middle income countries with per capita income in between $756 and $9265 in 1999.

Source: (1) Global Development Finance 2001, World Bank, 2001.

(2) World Investment Report 2001, UNCTAD, Geneva, 2001.

85
Table 4.2 Private capital flows to developing countries by country groups in 1970-2000

Country group or country 1970 1980 1990 1999 2000

Net private capital flows (US$ billion)
All developing countries 10.8 74.5 99.3 264.9 294.8
East Asia & Pacific 2.2 11.2 27.7 65.3 92.9
Europe & Central Asia 0.6 7.1 12.5 52.5 54.9
Latin America & Caribbean 4.2 29.9 21.8 116.5 102.4
Mid. East & N.Africa 1.1 8.6 10.1 2.5 9.3
South Asia 1.4 6.5 9.2 7.2 16.5
Sub-Saharan Africa 1.3 11.4 18.0 21.0 19.1
% shares in total private capital flows
All developing countries 100 100 100 100 100
East Asia & Pacific 20 15 28 25 32
Europe & Central Asia 6 10 13 20 19
Latin America & Caribbean 39 40 22 44 35
Mid. East & N.Africa 10 12 10 1 3
South Asia 13 9 9 3 6
Sub-Saharan Africa 12 15 18 2 6
FDI inflows (US$ billion)
All developing countries 2.0 4.4 24.3 222.0 240.0
East Asia & Pacific 0.3 1.3 11.1 92.0 120.2
Europe & Central Asia 0.1 0.0 1.1 26.5 28.8
Latin America & Caribbean 1.1 6.1 8.2 91.0 76.0
Mid. East & N.Africa 0.3 -3.3 2.5 1.5 4.5
South Asia 0.1 0.2 0.5 3.1 3.2
Sub-Saharan Africa 0.1 0.1 0.9 7.9 7.3
Percentage shares in total FDI flows
All developing countries 100 100 100 100 100
East Asia & Pacific 15 30 46 41 50
Europe & Central Asia 5 0 5 12 12
Latin America & Caribbean 55 139 34 41 32
Mid. East & N.Africa 15 -75 10 1 2
South Asia 5 5 2 1 1
Sub-Saharan Africa 5 2 4 4 3
Portfolio inflows (US$ billion)
All developing countries 0.0 0.0 3.7 34.5 47.8
East Asia & Pacific 0.0 0.0 2.3 21.1 28.6
Europe & Central Asia 0.0 0.0 0.2 3.5 5.5
Latin America & Caribbean 0.0 0.0 1.1 3.9 9.9
Mid. East & N.Africa 0.0 0.0 0.0 0.7 0.9
South Asia 0.0 0.0 0.1 1.3 2.1
Sub-Saharan Africa 0.0 0.0 0.0 3.9 0.8
Percentage shares in total portfolio flows
All developing countries 100 100 100
East Asia & Pacific 62 61 60
Europe & Central Asia 5 10 12
Latin America & Caribbean 30 11 21
Mid. East & N.Africa 0 2 2
South Asia 3 4 4
Sub-Saharan Africa 0 11 2
Footnote as in Table 4.1.
Source: Global Development Finance 2001, World Bank, 2001.

86
Table 4.3 Composition of net resource flows to developing countries by regions in 1972-1998
(in percentage)

Sources of flows All East Latin Europe South Sub Middle

deve- Asia America and Asia Saharan East
loping And and Central Africa And
coun- Pacific Cari- Asia North
tries bbean Africa

Net long term resource flows 89 88 92 94 98 90 89

Private flows 55 60 70 55 29 27 42
FDI 20 31 29 15 9 15 15
Bank loans 20 15 28 22 10 4 6
Portfolio flows 8 10 8 10 9 2 9
Other flows 7 4 5 8 1 6 12
Official flows 34 28 22 39 69 63 47
Net short term flows 11 12 8 6 2 10 11
Uses of net flows
Net external finance 54 45 66 67 74 68 25
Current account deficit 34 22 47 66 65 67 -27
Change in reserves 20 23 19 1 9 1 52
Capital outflows and E&O 46 55 34 33 26 32 75
Footnote as in Table 4.1.
Source: Global Development Finance 2001, World Bank, 2001.

An analysis of composition of external capital in different regions for a long period

during 1972-1998 (given in Table 4.3) indicates the following main observations:

 Long term capital flows constituted almost 90 per cent or more of total capital flows
in all regions.
 The share of short-term capital was highest at 12 per cent in East Asia, which was
affected most by the financial crisis in late 1990s. The share of long term capital was
highest at 98 per cent in South Asia which was relatively unaffected by the contagion
effects of the East Asian crisis in 1997-1999.
 The share of private capital flows was highest at 70 per cent in Latin America and
Caribbean followed by East Asia and Pacific (60 per cent) and Europe and Central
Asia (55 per cent).
 The share of FDI was highest at 31 per cent in East Asia and Pacific closely followed
by Latin America and Caribbean (29 per cent) and distant third positions (15 per cent)
held by Europe and Central Asia, Sub Saharan Africa, Middle East and North Africa.
 The share of commercial bank loans was highest at 28 per cent in Latin America and
Caribbean followed by Europe and Central Asia (22 per cent) and East Asia and
Pacific (15 per cent).
 The share of portfolio investment was highest at 10 per cent in East Asia and Pacific
and Europe and Central Asia closely followed by South Asia and Middle East and
North Africa (9 per cent).
 The share of official flows was highest at 69 per cent in South Asia closely followed
by Sub Saharan Africa (63 per cent) and Middle East and North Africa (47 per cent).

87
An analysis of trends of private capital flows to developing countries and to Asian region
in 1990s leads to the following key conclusions:

• Alongwith rise of capital inflows to developing countries, capital outflows also

increased during the period. Thus, despite substantial increase in capital inflows, the
contribution of foreign capital to consumption and investment fell sharply.

• Capital outflows from developing countries have different causes and implications.
They are a matter of concern where they represent capital flight because of a weak
investment climate or where tax incentives induce “round tripping” of capital.
However, outflows also represent integration with the global economy and hedging of
risks of investment.

• The worldwide boom in cross-border capital flows has been directed toward
industrial economies, particularly the United States, reflecting optimism about
technological progress. The share of developing countries declined sharply in these
flows after the crises. The increased concentration of flows within a few developing
countries emphasises the importance of hospitable environment climate to attract
foreign investment.

• In fact, countries with sound macro-economic management and well-organised

money and capital markets received large private capital inflows.

• There is reduced market liquidity since the crises and continued investor aversion to
risk. Demand for external capital remains limited in the East Asian crisis countries,
where unutilised industrial capacity and the slow pace of corporate restructuring put
constraints on investment.

• The private capital flows are likely to be more beneficial since they are generally
accompanied by technology transfer and market access in the case of FDI; diversified
investor base in the case of bonds; and a reduction in the domestic cost of capital in
the case of equity portfolio flows.

• Capital market finance for privatisation and infrastructure projects is an important

component of international flows.

• Among categories of private flows, commercial bank lending has shown deckling
trend, while bond issues increased significantly during 1990s.

• FDI flows to developing countries remained resilient throughout the financial crisis
and reached a broader range of countries although they have started to level off after
their rapid growth in the first half of 1990s.

88
 5.2 Relation between capital flows and economic growth

Private capital was implicated in the severe crisis of the late 1990s and some critics
have raised questions about its efficacy for stimulating long-term growth. Global
Development Finance 2001 published by the World Bank critically examines how
private capital flows contribute to domestic investment and productivity. The study
concludes that private capital flows bear a significant positive correlation with long-
term growth and in general tends to reinforce an existing growth dynamics
generated by domestic efforts and initiatives. Main observations of the study are
summarised below:

• On average, private capital inflows raise domestic investment almost one for
one. The impact is strongest for those countries, which are least, integrated with
international financial markets, where FDI augments domestic savings and
finances new investment opportunities. The association between greater FDI and
domestic investment is thus strong in Africa, even stronger than that in East Asia
and Pacific or in Latin America and Caribbean. For developing countries in
general, however, the relationship has weakened since 1980s because of greater
increase of mergers and acquisitions relative to green-field investment.

• The potential for productivity growth through private capital flows has probably
increased because of the growing importance of knowledge as production input.
Both the benefits are available mainly to countries that have a strong capacity to
absorb flows. In East Asia, especially in Malaysia, the absorptive capacity is high
with consequent positive relationship with productivity and growth. In Taiwan,
China FDI has been associated with higher productivity in foreign-owned firms
and with positive slipovers to domestically owned firms (Chuang and Lin 1999).
In Mainland China, benefits of FDI are amplified under conditions of good
infrastructure and superior human capital (Mody and Wang 1997).

• Capital flow volatility significantly dampens economic growth. Indeed, the crisis-
ridden years of 1990s were associated with enormous shocks to output and
consumption in some countries in East Asia. Even so, many countries appear to
be increasingly able to manage volatility and in the aftermath of the crises,
growth rates have rebounded quickly in many affected countries. Adjustment
was promoted by greater exchange rate flexibility, more diversified industrial
structure and better risk-management techniques.

• There has been “no environmental race to the bottom”. FDI to developing
countries is not attracted by lower environmental standards. Countries
experiencing rapid growth of FDI have also steadily improved their
environment, because communities in these countries place increasing value on
protection of environment and foreign investors have also reputation to maintain
it.

89
 5.3 FDI - Technology - Growth Nexus

Among private capital flows, FDI has emerged as the most important source of
external finance and its share in total private capital flows to developing countries
increased from 29 per cent in 1991 to 60 per cent in 2000 with a peak level of 70 per
cent in 1999. Like trade, FDI is an important channel of globalisation and
technology transfer. FDI adds to the capital stock of the host country in many ways
viz. Green-field investment establishing a new business, an ownership switching
through mergers and acquisitions, or raising equity in joint ventures. In most of the
developed countries, FDI is ownership switching, whereas it is mostly green-field
FDI or joint ventures in Asian developing countries. However, privatisation related
FDI has also recently become an important form of ownership switching FDI for
Asian countries, although FDI to Asian developing countries accounted for about
one-third of total FDI flows to developing countries in recent years (Table 4.2).

Many developing countries liberalilsed their industrial, trade and investment

regimes by adopting most-favoured nation treatment, and level playing field for the
foreign investors. Unlike other capital flows, FDI is a “package” which contains not
only capital but also “management, technology, technical skill and marketing network
in international trade and commerce”. Experience in developing countries suggests
that “unbundling of the FDI package” by borrowing capital from the international
banks, purchasing technology through licenses and negotiating management
agreements, is less efficient in terms of productivity than the FDI package which
brings capital, technology, management and international marketing together.

There are different types of FDI such as “natural-resource seeking, market-seeking,

technology seeking, cost-reducing, risk avoiding, export-oriented and defensive
competitive FDI”. Natural resource seeking FDI, which consists of investment in mining,
processing, textiles, oil and gas is the earliest type of foreign investment. Until 1980s
market-seeking FDI was largely confined to the manufacturing sector motivated by “tariff
jumping” to take advantage of the regulated market, but due to the recent trends of
economic reforms and privatisation of infrastructure, sectors such as power,
telecommunications and financial services are attracting increasing amounts of foreign
investment. Industrial restructuring through mergers and acquisitions (M&As) have
emerged as a favourite route to FDI. Export-oriented FDI is guided by the “product life
cycle” theory of FDI, which postulates that as real wages increase due to economic
growth in a country, labour-intensive industries will relocate to countries at a lower level
of economic development. Regional groups (such as the European Union, NAFTA,
MERCOSUR, APEC, ASEAN and SAARC) also facilitate regionally integrated
production networks. Geographical distribution of direct foreign investment also favours
neighbouring and ethnically related countries.

90
Host countries can be classified according to four stages of development viz. factor-
driven (attracting FDI in processing, textiles and minerals exploitation), investment
driven (heavy and chemical industries, power, construction, transport and tele-
communications), innovation-driven (electronics, information technology, bio-
technology) and wealth-driven (attracting FDI to meet domestic demand in construction,
real estate, urban development and share markets and outward FDI flows).

The pattern of investment and production in ASEAN followed the “flying geese pattern”
of evolving comparative advantage, and promoted regional integration through
“production sharing” which involved the setting up of multiplant production in different
countries. Technological advances lowered transportation costs and improved
telecommunications networks, which made location of production more sensitive to cost
differentials such as lower wages. ASEAN countries particularly attracted foreign
automobile manufacturers through the Brand-to-Brand Complementation scheme, which
provides for a diverse production base.

Trade and FDI go hand in hand. FDI has grown fastest among the countries, which
participated fully in the multilateral trade negotiations. Within the traditional structures of
manufacturing Trasnational Corporations (TNCs) generating FDI-trade linkages, intra-
firm sales tend to comprise mainly flows of equipment and services from parent firms to
their affiliates. If foreign affiliates are located downstream, intra-firm trade consists
mainly of parent firms’ exports to affiliates; if they are upstream suppliers, they generate
intra-firm imports for parent companies.

FDI has made significant contribution to economic growth in developing countries by

promoting exports and providing access to export markets. The export propensities
(measured by the ratio of exports to output) of U.S. foreign affiliates nearly tripled in the
past two decades. This ratio more than doubled and reached 39 percent in Latin America,
while the ratio remained high in Asia, ranging from 30 percent in the Republic of Korea
to more than 80 percent in Malaysia. The export propensities of Japanese affiliates also
have been increasing, most notably in East Asia, where their exports accounted for 34
percent of total sales in 1995. Japanese affiliates in China exported 53 percent of their
sales in 1995, up from less than 10 percent in 1986, directing 43 percent of their sales to
home markets in Japan.

The significance of FDI in domestic capital formation can be judged from the ratio of
inward FDI flows in the gross fixed capital formation which reached the peak level of
24.5 per cent in China in 1994, 26 per cent in Malaysia in 1992, 47.1 per cent in
Singapore in 1990, 37% in Fiji in 1990, 61.3% in Vanuatu in 1994 and 96% in the Pacific
least developed countries in 1994. Share of FDI stock in GDP was as high as 98 per cent
in Singapore, 65 per cent in Malaysia, 46 per cent in Indonesia, 31 per cent in China, 256
per cent in Hong Kong and 30 per cent in Asia and Pacific in 2000 (Table 4.8).

FDI flows as a share of GDP also indicates the importance of FDI in overall economic
development. The ratio of FDI inflows to GDP for middle income countries increased
continuously from 0.9 per cent in 1991 to 3.2 per cent in 1999 before declining to 2.8 per

91
cent in 2000, and that for low income countries increased from 0.5 per cent in 1990 to 1.8
per cent in 1997 after which it showed a declining trend and reached 1.1 per cent in 2000
(Table 4.1).

These figures do not capture the full role of FDI as an agent for growth and structural
transformation. In many countries FDI was instrumental in shaping industrial structure,
technological base and trade orientation. Perhaps the most significant contribution of
FDI is qualitative in nature. FDI embodies a package of growth and efficiency-enhancing
attributes. TNCs are important sources of capital, technology, marketing networks, and
managerial and technical skills. Their presence promotes greater efficiency and
dynamism in the domestic economy. The training gained by workers and local managers
and their exposure to modern organisational system and methods are valuable assets.

5.4 Regional distribution of FDI

Global inflows of FDI increased by 18 percent in 2000 to reach record level at $1271
billion mainly due to a significant increase in cross-border mergers and acquisitions
(M&As) by almost 50 per cent to $1100 billion in 2000. The rapid expansion of FDI
makes it the main force in globalisation. A total of 63,000 transnational corporations with
over 800,000 foreign affiliates drive FDI and increasingly shape trade patterns accounting
for two-thirds of world trade. But, FDI is unevenly distributed. The 30 largest host
countries account for 95 per cent of global FDI flows and 90 per cent of FDI stocks,
while 30 home countries, mainly industrialised countries, generate around 99 per cent of
outward FDI flows and stocks.

Nearly all of the 10 largest home and host countries were developed countries except
China and Hong Kong SAR. The developed countries accounted for more than three-
fourths of global FDI in 2000 with over $1000 billion recording an increase by 21 per
cent over 1999. FDI flows to least developed countries increased somewhat, but they
constituted only 0.3 per cent of global FDI flows.

Table-4.4 FDI Inflows by regions in 1998-2001 (US$

billion)
FDI Inflows ($ billion) Percentage share
Regions 1998 1999 2000 1998 1999 2000

World 693 1075 1271 100.0 100.0 100.0

Developed countries 483 830 1005 69.7 77.2 79.1
Developing countries 188 222 240 27.1 20.7 18.9
Africa 8 9 8 1.2 0.8 0.6
Latin America and the Caribbean 83 110 86 12.0 10.2 6.8
Asia and the pacific 96 100 144 13.9 9.3 11.3
South, East and South East Asia 21 96 137 3.0 8.9 10.8
Central and Eastern Europe 22 25 27 3.2 2.3 2.1
Source: The World Investment Report 2001: Promising Linkages, UNCTAD.

92
The FDI flows to developing countries have grown rapidly in 1990s and reached $173
billion in 1997 compared with $36 billion in 1991. The share of developing countries in
global FDI flows increased from 22.3 per cent in 1991 to 36.5 per cent in 1997.
Thereafter, FDI flows to developing countries showed some deceleration during 1998-
1999 due to financial crisis in East Asia, and reached $240 billion in 2000 accounting for
19 per cent of global FDI flows.

As regards sources, more than 80 percent of global FDI inflows originate in OECD
countries and the major home countries are the United States, United Kingdom,
Germany, Japan and France which accounted for two-thirds of global FDI outflows
in 1990s. The main suppliers of FDI to Latin America remain United States and
Europe, while Japan has emerged as the predominant partner in Asia. The
dominant role of FDI from the United States in Latin America and the Caribbean,
from Japan in Asia and from Europe in Africa underline the tendency of the TNCs
from the “Triad” in building up regionally integrated networks of affiliates. In 2000
the triad of the European Union, USA and Japan accounted for 71 per cent of
inward flows and 82 per cent of outward flows mainly because of cross-border
M&A. The United Kingdom and France have now replaced the United States as the
principal outward investors. The United States is still the leading recipient of FDI,
although its inflows and outflows dropped by 5 per cent and 2 percent respectively
in 2000.

Table-4.5: 10 largest home and host countries of FDI in 2000

10 largest home countries 10 largest host countries

Country US$ % in Country US$ % in
billion global billion global
FDI FDI
1. United Kingdom 250 19.7 1. United States 281 22.1
2. France 173 13.6 2. Germany 176 13.9
3. United States 139 10.9 3. United Kingdom 130 10.2
4. BelgiumLuxembourg 83 6.5 4. Belgium-Luxembourg 87 6.8
5. Netherlands 73 5.7 5. Hong Kong SAR 64 5.0
6. Hong Kong SAR 63 5.0 6. Canada 63 5.0
7. Spain 54 4.3 7. Netherlands 55 4.3
8. Germany 49 3.9 8. France 44 3.5
9. Canada 44 3.5 9. China 41 3.2
10. Switzerland 40 3.1 10. Spain 37 2.9
968 76.2 Total 978 76.9
Total
Source: The World Investment Report 2001: Promising Linkages, UNCTAD.

The Asia and the Pacific is the new growth centre of the global economy with China,
Hong Kong, Republic of Korea and Taiwan, China as “the brightest spot of FDI in the
developing world”. FDI flows to and from the developing countries of Asia were at

93
record levels in 2000 as the region recovered from the crisis in 1998-1999. Inflows to the
region increased by 44 per cent and reached $144 billion in 2000 accounting for 21 per
cent of global FDI flows and 60 per cent of FDI flows to the developing countries,
compared with $20 billion in 1990 accounting for only 10 per cent of global FDI flows.
Outflows of the Asian region increased by 140 per cent to $85 billion in 2000. East and
South East Asia alone received $134 billion in 2000, while South Asia received only $3
billion in 2000 mainly due to sustained inflows into India. The overwhelming majority of
inflows were to Hong Kong rising 160 per cent to $64.4 billion, and China $40.8 billion.
One of the reasons for Hong Kong SAR overtaking China as the single largest recipient
of inflows in Asia was that FDI flows entered Hong Kong as “parking funds” for the
purpose of being invested in the mainland China, in anticipation of China’s expected
entry into the WTO. The increase of FDI inflows to China partly reflects major cross-
border merger and acquisitions in telecommunications, which alone accounted for nearly
one-third of total FDI inflows to Hong Kong. There is also an element of “transit FDI or
round-trip FDI” into Hong Kong. Other large recipients of FDI in Asia in 2000 were
Korean republic ($10.2 billion), Singapore ($6.4 billion) and Malaysia ($5.5 billion).

Table-4.6 Ratio of FDI inflows to World FDI in selected Asian countries (per cent)

1990 1994 1995 1996 1997 1998 1999 2000

Country
India 0.08 0.52 0.65 0.79 0.77 0.38 0.20 0.24
China 1.71 13.33 10.91 11.37 9.53 7.06 3.60 3.21
Hong Kong 0.85 0.67 2.71 3.00 2.31 1.57 1.52 5.07
Korea, Rep. 0.39 0.32 0.54 0.65 0.61 0.80 0.87 0.80
Malaysia 1.14 1.71 1.27 1.42 1.10 0.58 0.14 0.43
Philippines 0.26 0.63 0.45 0.43 0.19 0.27 0.05 0.12
Singapore 2.74 1.68 2.17 2.38 1.71 0.79 0.65 0.35
Thailand 1.20 0.53 0.63 0.66 0.80 1.08 0.58 0.38

Table 4.7: FDI Inflows as percentage of fixed capital

formation in 1985-1999

1984- 1990 1994 1997 1998 1999

Regions/ Country 1989
South, East, South-East Asia 2.6 3.7 8.2 10.1 10.4 11.2
Asia and the Pacific 2.3 3.1 7.2 9.3 9.5 9.6
Developing countries 2.8 3.2 7.5 10.9 11.7 13.8
World 3.0 4.0 3.9 7.5 10.9 16.3
China 1.8 2.6 24.5 14.6 12.9 11.3
Hong Kong SAR 12.2 8.5 8.2 19.8 29.9 60.2
India 0.2 0.2 1.1
Indonesia 1.6 2.8 3.6 7.7 -1.6 -11.0

94
Korea, Republic of 1.4 0.8 0.6 1.7 5.7 9.3
Malaysia 8.8 23.8 16.1 15.1 13.9 20.1
Philippines 5.1 5.2 9.6
Singapore 28.3 47.1 23.5 35.3 20.6 26.1
Taiwan 3.3 3.8 3.5 3.4 0.4 4.4
Thailand 4.4 7.1 4.9

Sources: (1) World Investment Report 1996, UNCTAD, United Nations, Geneva.
(2) World Investment Report 2001, UNCTAD, United Nations, Geneva.

95
Table 4.8: FDI Stock as percentage of gross domestic product in 1985-1999

1980 1985 1990 1995 1999

Regions/ Country
South, East, South-East Asia 3.8 21.2 18.4 19.7 34.4
Asia and the Pacific 2.9 17.5 15.5 17.3 30.2
Developing countries 4.3 14.1 13.4 15.6 28.0
World 4.6 7.8 9.2 10.3 17.3
China 0 3.4 7.0 19.6 30.9
Hong Kong SAR 6.3 413.6 217.5 135.4 255.6
India 0.7 0.5 0.5
Indonesia 14.2 28.6 34.0 25.0 46.2
Korea, Republic of 0 2.3 2.0 2.1 7.9
Malaysia 24.8 23.7 24.1 32.9 65.3
Philippines 3.8 4.2 4.7
Singapore 52.9 73.6 76.6 70.0 97.5
Taiwan 5.8 4.7 6.1 6.0 8.0
Thailand 3.0 5.1 9.3
Sources: (1) World Investment Report 1996, UNCTAD, United Nations, Geneva.
(2) World Investment Report 2001, UNCTAD, United Nations, Geneva.

Asian developing economies themselves are increasingly becoming outward investors,

reflected in the liberalisation of their outward FDI regimes and provision of incentives for
such investments. In 2000, the region with $85 billion FDI outflows accounted for 86 per
cent of all developing country outflows with Hong Kong as the largest outward investor
with FDI outflows of $64 billion. Most outward FDI is going in the region to take
advantage of cost differentials, liberal trade and FDI regimes and to allow export-oriented
FDI to flourish. Malaysian and Thai TNCs directed 60% of their FDI outflows to Asia;
some four-fifths of Hong Kong’s outward FDI went to China; a good part of Singapore’s
outward FDI is distributed to other ASEAN countries and China; and 60% of China’s
outward FDI remained in the region.

Surveys of FDI in Asian developing countries highlight the following general features:

(a) The geographic distribution of FDI favours neighbouring and ethnically and
culturally related countries.
(b) FDI tends to concentrate in industries using standardised technology and management
skills or industries based on natural resources (processing, textiles and minerals) or
export-oriented industries (food processing, automobiles, and electronics).
(c) Most TNCs are involved in joint ventures to limit their capital commitments, and to
obtain local managerial and organisational skills or access to markets of their
partners.

96
 4.5 Sectoral Distribution of FDI

In recent years services have increased their share to more than one third in total FDI
flows, while share of manufacturing declined to one-half, with the remainder accounted
for by agriculture and mining. Within services financial services, information technology
and telecommunications are emerging as major FDI recipients, with trade, construction,
and tourism also becoming important. Within manufacturing the trend was to move from
lower-technology or labour-intensive industries (food, textiles, paper and printing, rubber,
plastics) to knowledge-based and higher-technology industries (such as electronics
including computer hardware, chemicals, and pharmaceuticals).

Sectoral distribution differs among regions depending on their level of development. In

most countries in Asia, FDI went primarily to the secondary sector (mainly
manufacturing), although investment in the tertiary sectors was of major importance for
some Asian countries. Some resource-rich countries like Indonesia and Vietnam also
attracted FDI into the primary sector (mainly oil production). In Latin America, new
investment flows to the natural resources and services sectors have now surpassed that in
the manufacturing sector. In Africa, the bulk of FDI went to primary sector.

The size and dynamism of developing Asia made it a favourable base for TNCs to service
rapidly expanding markets or to tap the tangible and intangible resources for their global
production networks. In addition, the region’s infrastructure financing for the next decade
will play a role in sustaining FDI flows to Asia. Countries are dismantling barriers to
FDI in infrastructure sectors, giving rise to large investment opportunities for TNCs.
Privatisation, although lagging behind other regions, is showing signs of taking off
particularly in manufacturing, mining, power, telecommunications, petroleum and
financial sectors. European union TNCs that neglected Asia in the 1980s is making large-
scale investment in Asian developing economies to take advantage of new opportunities
in power, petrochemicals and automobiles.

Transnational corporations in retailing, and other trading firms also played an

important role in the building up of export capabilities of several Asian economies.
In addition to linking local producers to foreign customers, they deepened the ties of
those economies to the international market place. Asian experiences also indicate
that contributions to international competitiveness and export performance are
particularly high in developing economies that are open to both trade and FDI.

The sectoral composition of FDI has changed significantly in China during 1990s.
Inflows in 1990s were mostly concentrated in capital-intensive and technology-intensive
productive compared with dominance of labour-intensive sectors in 1980s. Today,
world’s leading manufacturers of computers, electronics, telecommunications equipment,
pharmaceuticals, petrochemicals and power generating equipment have extended their
production networks in China. Most recently R&D activities have also expanded. The
trend is giving way to the so-called “flying-geese formation” with China at the low end

97
of the value chain comprising technology transfer from newly industrializing economies
to China (UNCTAD 2001).

The prominence of FDI in technology intensive industries is also manifested in China’s

foreign trade. Foreign affiliates’ exports of new and high-tech products increased from
$4.5 billion in 1996 to $29.8 billion in 2000, accounting for one-fourth of all exports by
foreign affiliates and 81 per cent of China’s total high-tech exports. In parallel with these
trends, the share of FDI flows to the traditional industries like footwear, travel goods,
toys, bicycles and electrical appliances etc. has been declining. Driven by the country’s
excess productive capacity and encouraged by their increased export competitiveness,
Chinese firms in these industries are now expanding to set up processing or assembly
plants overseas.

4.6 Modes of Foreign Capital

The major alternatives to syndicated bank lending are bonds, financing through
new instruments, foreign direct investment, foreign portfolio equity investment, and
foreign quasi-equity investments (such as joint ventures, licensing agreements,
franchising, management contracts, turnkey contracts, production sharing and
international subcontracting). Out of these the most popular modes are FDI,
portfolio investment and foreign quasi-equity investment as they involve risk
sharing, sharing of managerial responsibilities and the promotion of a more efficient
use of resources. Foreign portfolio investment, in addition, has a favourable impact
on local capital markets. The disadvantages are that there might be misuse of
control and foreign direct investment might introduce inappropriate technology.

Empirical evidence indicates that private capital contributed more to economic growth of
the Asian developing countries than official aid, the relative importance of which in total
resource inflows declined since 1980s. There was also a change in the structure of private
flows. Until the crisis year 1997, bank lending was a major mode of foreign private flow
to the Asian developing countries. Subsequently, the relative significance of bank
lending has declined and that of other modalities has increased. The share of foreign
direct investment has increased the most followed by portfolio equity flows and bonds.

Country experiences also indicate that the majority ownership was preferred mode of FDI
in capital intensive industries like chemicals, equipment, electronics and automobiles,
whereas joint ventures were preferred in traditional and primary industries like textiles,
food processing, paper products and metals.

Foreign Portfolio Investment in the emerging markets can be channeled through three
main mechanisms: direct purchases on local stock markets, country or regional funds;
and issues of depository receipts on foreign stock exchanges by the domestic companies.
The size of direct purchases in local markets depends on market developments that
facilitate and encourage such trading. In recent years, the opening of the local brokerage
and investment banking business to foreigners has facilitated such purchases. Developing
countries have also enhanced the limits of foreign equity, which can be held by the

98
foreign institutional investors (FIIs). In India FIIs and non-resident Indians are permitted
to hold up to 49 percent of total paid up capital of any listed or unlisted companies.

Mergers and Acquisitions (M&A) activity has increased substantially in recent years in
developing countries. The number of cross-border M&A increased by 50 per cent in
1995-1999. M&A transactions account for a large share of total FDI flows to developing
countries and reached $75 billion in 1998 but fell to $67 billion in 1999 (World Bank
2001). Virtually all these transactions have been concentrated in middle income countries
largely reflecting privatisation transactions in Latin America and post-crisis asset sales in
East Asia. M&A activities in East Asia increased by 34 per cent in 1998 and further by 45
per cent in 1999 owing to easing of government barriers to such transactions and the fall
in the foreign currency value of assets with the currency depreciatins induced by the
crisis. About half of M&A activity in East Asia have been in non-tradable industries such
as wholesale and retail trade, real estate, and financial industry. The stepped-up M&A
activities in East Asia partly reflect “fire sales or distress sales” of assets as the excessive
depreciation of the local currency and contagion of financial crisis forced domestic firms
to liquidate their assets in a thin market for paying of short term currency debt.

99
 Chapter-5: Role of Privatisation for Development of industry and
Infrastructure in Asian Economies

5.1 Role of Privatisation

Privatisation implies transfer of productive assets from the state to the private sector.
Privatisation transactions in the developing countries increased more than five times from
$12.7 billion in 1990 to $66.6 billion in 1997, but thereafter slowed down significantly
and reached $44.1 billion in 1999 partly reflecting the postponement of deals because of
the collapse of aggregate demand and increased uncertainty induced by the East Asian
and Russian crises and partly reflecting the decline of the Brazilian program.

(a) Modes of Privatisation

Privatisation occurs through such method as auctions, stock offers, stock

distributions, negotiated sales, management-employee buyouts, and voucher or
coupon exchanges. Other methods include leasing, joint ventures, management
contracts, concessions, and different forms of build-operate-transfer (BOT)
arrangements. Sales methods have varied across regions for various reasons,
including privatisation strategy, market conditions and political economy. In 1999,
direct sales accounted for over 70 per cent of privatisation revenues and public offer
contributed to most of the remaining sales. Equity linked privatisation started
rebounding in 1999 and 2000 after a considerable slowdown in 1998 with the East
Asia and Pacific region (in particular China) accounting for the major share in both
cases.
(b) Regional distribution

During 1990-1999, in the developing world, the bulk (56% by value) of privatisation took
place in the Latin America and Caribbean region, followed by Europe and Central Asia
(21 per cent) and East Asia and pacific with 14% of the share as against a minimal (3 to 4
percent) proportion in South Asia, Sub-Saharan Africa and the Middle East and North
Africa (Table 5.1). During 1990s the share of East Asia and Pacific in privation revenues
increased from 3 per cent in 1990 to 14 per cent, that of Europe and central Asia
increased from 10 to 21 per cent with fluctuating trend, while that of Latin America and
Caribbean declined from 86 to 56 per cent.

Privatisation in 1999 was more evenly distributed over regions than in 1998. In
1998, privatisation activity declined considerably in the Asia and the Pacific region
(only 2 per cent of total revenues) due to financial crisis and was mainly
concentrated in Latin America and Caribbean (77 per cent of total revenues) and
Eastern Europe and Central Asia (16 per cent). In 1999 by contrast, the share of
Latin America and Caribbean fell to 54 per cent while that of Europe and Central
Asia increased to 23 per cent and that of East Asia and Pacific increased to 12 per
cent.

100
Table 5.1: Privatisation revenues in different regions in 1990-1999 (millions of US$)

Regions 1990 1995 1996 1997 1998 1999 1990-

1999
All developing countries 12658 21903 25400 66573 49308 44076 315722
East Asia & Pacific 376 5410 2680 10385 1091 5500 44100
Europe & Central Asia 1262 9742 5466 16537 8002 10335 65466
Latin America & Caribbean 10915 4616 14142 33897 37685 23614 177839
Mid. East & N.Africa 2 746 1478 1612 1000 2074 8198
South Asia 29 916 889 1794 174 1859 11854
Sub-Saharan Africa 74 473 745 2348 1356 694 8265
Percentage shares
All developing countries 100 100 100 100 100 100 100
East Asia & Pacific 3 25 11 16 2 12 14
Europe & Central Asia 10 44 22 25 16 23 21
Latin America & Caribbean 86 21 56 51 76 54 56
Mid. East & N.Africa 0 3 6 2 2 5 3
South Asia 0 4 4 3 0 4 4
Sub-Saharan Africa 1 2 3 4 3 2 3

Source: Global Development Finance 2001, World Bank, 2001.

East Asia and Pacific

After the financial crisis led to a collapse in privation activity in 1998, divestitures
rebounded in East Asia and Pacific in 1999 with revenues reaching $5.5 billion
(Table 5.2). Key sectors for privatisation in 1999 included power in China, telecom,
food processing and international container terminal in Indonesia, financial services
in Thailand and Philippines and Airport holding in Malaysia.

Preliminary estimates for 2000 show that privation proceeds increased significantly
in the region as a result of Chinese divestitures in the oil and gas,
telecommunications and power sectors. Divestitures in banking, power and oil and
gas will remain strong in the coming years as countries in the region are preparing
these sectors for privatisation.

South Asia

Despite an increase in total proceeds in 1999, progress in privatisation has been

modest in the South Asia (Table 5.3). Total revenues amounted to $1.9 billion in 1999
with India virtually accounting for all revenues in the region. Privation in India
picked up in banking, oil and gas, telecommunications, and power. Since 1995, Sri
Lanka divested an important share of its economy in various sectors such as
plantations, telecommunications, banking and steel that encouraged private
participation in infrastructure development. While Pakistan privatised a large share
of its economy in the first half of 1990s, divestitures slowed in recent years.

101
Bangladesh did not meet its privatisation targets in 1999 indicating slow progress
for political reasons. Privation revenues remained low in the South Asia in 2000 due
to slow implementation in most countries except Sri Lanka because of sluggish stock
markets and lack of interest by foreign institutional investors.
Table 5.2 Privatisation revenues in East Asia and Pacific in 1990-1999 (million US dollars)

Countries 1990 1995 1996 1997 1998 1999 1990-

1999
Millions of US dollar
China 0 649 919 9120 611 2946 20594
Indonesia 0 2031 1008 141 122 850 6135
Malaysia 375 2519 214 704 0 130 10158
Philippines 0 207 22 371 0 230 3960
Thailand 0 0 291 48 353 1344 2987
Others 1 4 226 0 5 0 266
Total 376 5410 2680 10384 1091 5500 44100
Percentage shares
China 0 12 34 88 56 54 47
Indonesia 0 38 38 1 11 15 14
Malaysia 100 47 8 7 0 2 23
Philippines 0 4 1 4 0 4 9
Thailand 0 0 11 0 32 24 7
Others 0 0 8 0 0 0 1
Total 100 100 100 100 100 100 100
Footnote as in Table 4.1.
Source: Global Development Finance 2001, World Bank, 2001.

Table 5.3 Privatisation revenues in South Asia in 1990-1999 (million US dollars)

Countries 1990 1995 1996 1997 1998 1999 1990-

1999
Millions of US dollar
Bangladesh 0 5 0 0 0 0 60
India 0 810 495 1373 52 1858 8983
Pakistan 11 36 317 58 41 0 1992
Sri Lanka 18 65 77 361 81 1 803
Others 0 0 0 2 0 0 15
Total 29 916 889 1794 174 1859 11853
Percentage shares
Bangladesh 0 1 0 0 0 0 1
India 0 88 56 77 30 100 76
Pakistan 38 4 36 3 24 0 17
Sri Lanka 62 7 9 20 47 0 7
Others 0 0 0 0 0 0 0
Total 100 100 100 100 100 100 100
Source: Global Development Finance 2001, World Bank, 2001.

102
 (c) Sectoral distribution

Infrastructure sector has been dominant accounting for 49% of total revenue for the
developing world in 1990-1999 followed by primary sector (19%), manufacturing (16%)
and financial services (12 per cent) (Table-5.4). While divestitures in large infrastructure,
particularly in telecommunications, accounted for 80 per cent of privatisation revenues in
1998, privatisation in the oil and gas sector had the dominant share (40 per cent) in 1999
followed by infrastructure (27 per cent) and financial services (21 per cent).

Table 5.4: Sectoral distribution of privatisation revenues raised in 1990-1999 ( US$ million)

1990 1995 1996 1997 1998 1999 1990-99

Sectoral distribution Millions of US$

Infrastructure 9704 9240 15063 37370 39964 11669 154347
Telecommunications 7643 3691 3814 12863 26619 5340 76110
Power 59 4523 6156 17979 9994 5545 53427
Manufacturing 1402 5787 3546 7795 2167 3127 50152
Steel 185 135 193 916 3 303 9613
Chemicals 156 291 488 1222 514 908 6060
Construction 196 592 745 318 718 746 5812
Other manufacturing 864 4769 2120 3743 932 1169 27071
Primary sector 1367 4336 2787 12932 3125 18085 59917
Oil and gas 568 2781 1687 7956 1975 17985 45074
Mining 485 618 468 4418 971 17 9001
Financial services 47 1933 2895 3445 3149 9007 38008
Banking 47 1853 2646 3055 2471 8244 34164
Other services 138 607 1109 5031 903 2188 13298
Total 12658 21903 25400 66573 49308 44076 315722
Sectoral distribution Percentage shares
Infrastructure 77 42 59 56 81 26 49
Telecommunications 60 17 15 19 54 12 24
Power 0 21 24 27 20 13 17
Manufacturing 11 26 14 12 4 7 16
Steel 1 1 1 1 0 1 3
Chemicals 1 1 2 2 1 2 2
Construction 2 3 3 0 1 2 2
Other manufacturing 7 22 8 6 2 3 9
Primary sector 11 20 11 19 6 41 19
Oil and gas 4 13 7 12 4 41 14
Mining 4 3 2 7 2 0 3
Financial services 0 9 11 5 6 20 12
Banking 0 8 10 5 5 19 11
Other services 1 3 4 8 2 5 4
Total 100 100 100 100 100 100 100

103
Infrastructure, including energy, tele-communications, water and transportation played an
important role in Latin America, the Caribbean, South Asia, East Asia and the Pacific;
while industrial enterprises (which include steel, chemicals, construction) accounted for
major sales through divestitures in Eastern Europe and Central Asia, the Middle East and
Latin America. In recent years, financial sector, which includes banks, insurance, real
estate and other financial services, have emerged an important source for privatisation
revenues mainly through divestitures of the banking sector in Eastern Europe, East Asia
and Pacific, and South Asia. Initial estimates for 2000 show significant transactions in
East Asia particularly in Indonesia and the Philippines.

(d) Role of foreign capital

Over the period, foreign direct investment was the main source of foreign revenues raised
through privatisation, accounting for 72 per cent of the total foreign exchange raised
during 1990-1999, while portfolio accounted for the rest (Table-5.5). The extent of
foreign participation in privatization varied across regions. In 1999, Latin America and
the Caribbean, Eastern and central Europe, East Asia and Pacific attracted largest shares
of foreign investment as a result of sales of oil and gas related industries and
telecommunications and banking services. China was the main recipient of foreign
investment in East Asia and Pacific followed by Thailand, Indonesia, and Malaysia.

5.2 Development of Infrastructure and Services

Rapid technological developments in telecommunications and computers in the 1990s

have made some services, especially information-intensive ones, more tradable. The
“long-distance” type of service does not necessarily require physical proximity between
the provider and the user. Live broadcasts, trans-border data transmissions, and traditional
bank and insurance services fall under this category. The scope of long-distance service
transactions has greatly increased with the advance of technology. In “long-distance”
services, there is no need for movement of labour.

In 1990s there has been an increasing interest on the part of both governments and private
sector to enhance the role of foreign investment in infrastructure development in East
Asia and Pacific, and the Latin American countries. However, there is a basic difference
of experiences between Latin America and East Asia. Most countries in Latin America
encouraged outright sale or transfer of management/ majority share of public enterprises,
while East Asian countries encouraged private investment for creating new capacities.
Most of the South Asian countries have also followed the path of East Asian countries.

Because of lumpiness of huge capital, high risk involved and the budgetary constraints,
developing countries are increasingly financing their infrastructure projects by external
commercial borrowing and increased use of bond and equity markets. Finance for
infrastructure typically comes in a package with equity, debt, commercial bank loans,

104
export credit guarantees, and contingent liabilities of the host government ranging from
“full faith and credit guarantees” to “comfort letters”.

Table 5.5 Foreign exchange raised through privatisation in developing regions 1990-1999
(Millions of US$)

Regions 1990 1995 1996 1997 1998 1999 1990-

1999
All developing countries 6994 9339 11271 28770 28555 32321 127107
East Asia & Pacific 1 2026 1990 3775 1082 4982 18724
Europe & Central Asia 586 4778 1880 8874 5190 6503 30789
Latin America & Caribbean 6358 2206 6448 12486 21535 19567 69277
Mid. East & N.Africa 0 16 126 623 43 747 1260
South Asia 11 38 528 1043 11 104 2693
Sub-Saharan Africa 38 275 299 1969 694 418 4364
Percentage shares
All developing countries 100 100 100 100 100 100 100
East Asia & Pacific 0 22 18 13 4 15 15
Europe & Central Asia 8 51 17 31 18 20 24
Latin America & Caribbean 91 24 57 43 75 61 55
Mid. East & N.Africa 0 0 1 2 0 2 1
South Asia 0 0 5 4 0 0 2
Sub-Saharan Africa 1 3 3 7 2 1 3
Sources
Foreign direct investment 6888 6380 5644 21094 26505 27919 90910
Portfolio investment 106 2959 5627 7676 2050 4402 36197
Percentage shares
Foreign direct investment 98 68 50 73 93 86 72
Portfolio investment 2 32 50 27 7 14 28

Footnote as in Table 4.1.

Source: Global Development Finance 2001, World Bank, 2001.

The private sector outpaced the public sector in external infrastructure finance although
with the help of substantial government guarantees. Compared to the public sector, the
private sector relied more on loans than on bonds or equity. But the growth has been
uneven across the regions, countries and sectors. East Asia raised the most finance (led by
China, Indonesia, South Korea, Malaysia, Philippines, Thailand) followed by Latin
America. Power generation, telecommunications and transport attracted the most external
finance, while power transmission and distribution and water supply lagged behind.

TNCs invest in infrastructure projects in the form of FDI (Greenfield investments or

acquisitions through privatisation), BOT, BOO, BOOT, BOLT, BTO or variants of these
schemes. There are various forms of BOO and BOT schemes in the region such as those
for toll roads, annuity schemes for construction of roads, sea ports and Airports in India,
toll roads in China, India, Malaysia, and Thailand; telephone facilities in Indonesia, Sri

105
Lanka and Thailand; power generation in India, China, Pakistan and Indonesia; and
energy, transportation and water resources in India, China and the Philippines.

Various constraints such as high fixed or sunk costs, long gestation periods, price ceilings
and other regulations on the operations of an infrastructure facility in host countries, and
political risk (expropriation or nationalisation) have induced foreign investors to
minimise equity commitments to such projects and to rely on debt (commercial loans and
bonds) and non-equity financing (technical know-how, expertise, R&D cost sharing,
trade credits and supply of capital goods).

There are constraints that arise out of the very nature of some of the ways in which
infrastructure projects are financed. Given the perceived risk, investors require high rates
of return. This necessarily requires user fees commensurate with the rate of return, which,
in many developing countries, are too high to be sustainable. There are also
environmental issues associated with infrastructure projects. Consequently, negotiations
of BOT/BOO and similar schemes - in developing and developed countries - are typically
very complex and take long drawn for final agreements and financial closure.

In recent years, a number of Asian investment funds have been created to mobilise
international capital to finance Asia’s infrastructure. These funds provide medium and
long-term finance (5-10 years) for infrastructure projects through equity (usually 10% or
more) or convertible debt. Funds are raised from a diverse group such as institutional and
private investors, TNCs, regional banks and multilateral organisations. The Asian
Infrastructure Fund (AIF), in which the Asian Development Bank was an initial investor,
was the first infrastructure investment fund in the region. The AIF is investing in utility,
transportation and communications projects in China, Indonesia, Malaysia, Thailand,
Philippines and Taiwan. Since then, several infrastructure investment funds, similar to
international mutual funds, or unit trusts, have been set up.

5.3 Lessons for Privatisation in Asia

To speed the reform process for privatisation, successful governments in East and South
East Asian countries, and India, Pakistan and Sri Lanka in South Asia have taken the
following actions:

• They persisted with and deepened macro-economic reforms for establishing new
relative prices and creating opportunities for job and income generation.

• They have made efforts to inform their citizens, legislators, journalists, and
academicians of the high costs of inaction in public enterprises reforms and potentials
of divestiture. These efforts have often mobilised popular support in favour of
privatisation and broken the opposition of vested interests.

• They have used methods of direct sale combining with such broad ownership vehicles
as trust funds and employee ownership options to ensure widespread participation in

106
 and approval for the privatization process. These methods address fears that only
foreigners, the elite, or particular groups benefit from privatization.

• They have streamlined – indeed privatized – the privatization process, by keeping the
public agency lean and agile and by contracting out the details of implementation to
private lawyers, accountants and investment bankers, both local and foreign.

• Where privatization is difficult or not yet feasible, particularly for infrastructure

firms, they have made greater use of methods for privatising management – such as
asset leasing, franchising, concessions, and management contracts.

• Recognising the importance and difficulty of establishing good regulatory systems in

place, they have adapted regulatory structures to fit market conditions and existing
legal and institutional capabilities.

• They have begun to unbundle ancillary or social assets from enterprises and to
transfer them to the private sector.

• They have established severance funds, insurance and security schemes, training
programmes, and other elements of social safety net to assist those laid off or
adversely affected in the reform process.

• With donors and the international financial community, they are trying, selectively, to
give limited comfort to investors through guarantees particularly in infrastructure.

The least developed and developing countries in Asia, which have lagged behind
privatisation, can learn from these experiences. However, economic conditions for
privatisation in these countries may be difficult, as their product markets are less
competitive and capital markets are thin. Investors perceive high risks. Public enterprises
in infrastructure have a lower net worth and are less attractive to foreign buyers, except
perhaps in telecommunications. Government resists selling to foreigners because of
political ideology, and investors are reluctant to take an equity position in infrastructure
firms before governments have established consistent policies and pricing practices.
These serious obstacles delay or dilute reforms for privatisation.

Development of efficient capital and money markets is essential for implementing

successful privatisation programme. Attracting reputable private banks will be difficult,
unless government reduces the dominant position of public enterprises and develops an
attractive environment to stimulate private investment and participation. A good part of
the banking development in China, India, Pakistan, and Sri Lanka has been stimulated by
the growth of a competitive private sector that demands a wider range of efficiently
delivered services. In turn competitive banking system helps foster a competitive private
sector, since borrowers are not limited to a few banks that service only selected and well-
connected clients. The presence of foreign banks also help to promote and facilitate FDI.

107
 POLICIES AND STRATEGIES FOR PROMOTING
GLOBALISATION
AND LIBERALISATION IN ASIAN COUNTRIES

6.1 Development Models in East Asian Countries

While there is no uniform model of development that was applied throughout East Asia,
central to the performance of the successful East Asian economies was an emphasis on
stability-oriented macroeconomic policies. The basic objectives of these policies were
relatively low inflation and the avoidance of overvalued exchange rates; high rates of
physical and human capital accumulation; and export-oriented production, which, among
other things, encouraged the adoption of advanced technology. Favourable initial
conditions also played a part in rapid economic progress. However, more differentiated
across countries, and more controversial in their effects, were industrial policies and
government intervention, particularly in financial and capital markets, aimed at
mobilising and allocating savings.

A major study entitled “The East Asian Miracle: Economic Growth and Public Policy’’
made by the World Bank (1994) concluded that “exports push” and a combination of
fundamentally sound development policy and selective interventions had been crucial to
East Asia’s success. Developing countries, which want to follow the footsteps of East
Asia, must limit policy interventions and focus on fundamentals. The study further
concluded, “Of the many interventions tried in East Asia, those associated with export
push hold the most promise for other developing countries”. The fundamentals focused
by the East Asian economies included the following:

• Managing monetary and fiscal policy to ensure low inflation and competitive
exchange rate.
• Concentrating public investment on education in primary and secondary levels of
schooling,
• Fostering effective and secure financial systems to encourage savings and investment.
• Limiting protection so those domestic prices are close to international prices.
• Supporting agriculture by assisting the adoption of green revolution, technologies,
and investment in rural infrastructure and limiting taxation on agricultural goods.

Success of countries in participating in globalisation and liberalisation, therefore, depends

on their ability to maintain a stable macro economic system and to take proper safety nets
for the vulnerable sections of the society. Other developing countries in Asia can learn a
lot from the experience of the East and Southeast Asian countries in this respect.

Low-income countries are also adapting elements of the globalisation and liberalisation
to their cultural, social, political, economic and institutional conditions. The lessons from
the experience of the East Asian countries can contribute significantly to the learning
process. But the task of globalisation and liberalisation is not purely technical. A broad

108
consensus for reforms and full government support for the difficult long-term agenda is
essential for success. When governments do adopt comprehensive and consistent reforms,
donors must be ready to help with the necessary support to sustain their implementation.

It is necessary that the governments refrain from changing the direction of their reform
policies once they are set in motion. If the authorities consider that economic
fundamentals are such that they make reversal unavoidable, they should, from the start,
introduce reforms in discrete steps so that they would stay put even if economic situation
changes for worse.

6.2 Macroeconomic policies

The five major factors for high growth in the East Asia in the pre-crisis period were pro-
savings policies, maintenance of sustainable fiscal position, investment on human capital
and physical infrastructure, greater outward orientation and rapid corrective responses to
macroeconomic disequilibrium situations. Clearly, these factors are mutually reinforcing,
and their importance has increased further in the post crisis period.

(a) Pro-Savings Policies

The keys to accelerated growth are much higher investments and domestic savings,
combined with systematic structural reforms – necessary to maintain macroeconomic
stability and significantly improve productivity. A critical factor in achieving
macroeconomic stability in East Asia has been the early focus on improved revenue
efforts and, perhaps more important, curbs on government consumption. Several East
Asian economies also ran budget surpluses for long periods.

The declining trend of savings and investment in some of the East Asian countries in post
crisis period needs to be reversed through pro-active policies for savings and reforms in
insurance, provident and pension funds.

Almost all low-income countries need urgently to reduce the budgetary drain of public
enterprises and to put their physical and human resources to more efficient use. Major
changes will have to be made in the size and structure of government revenues and
expenditures. Raising revenue calls for measures to broaden the tax base by simplifying
tax regimes, abolishing exemptions, reducing the discretionary authority of tax
administrators and improving collection capacity. But the biggest impact will come from
reducing the budget support for public enterprises and stopping the leakage from the
banking system, which eat up most domestic savings in many developing countries.

(b) Sustainable Fiscal Positions

Although it is not practicable to determine an absolute standard for the appropriate size of
fiscal deficit, the sum of taxation, seigniorage transfers, and domestic borrowing by the
governments of the East Asian economies has been significantly large as proportion of
output. However, the sustainability of a fiscal position was a key determinant of

109
 macroeconomic stability in East Asia. The evidence of both central government and
public sector budget deficits in the East Asian economies shows that, except for brief
period when budget deficits became excessively large, they were generally managed at
sustainable levels.

All the developing countries must pay greater attention for maintaining sustainable levels
of fiscal deficit and public debt. Large levels of government borrowing not only lead to
crowding out of private investment for productive sectors, but also put pressures on
interest rates and thereby on inflation and exchange rates.

(c) Greater outward orientation

In both the NIEs and the fast-growing economies of Southeast Asia, exports had grown
fast, and export intensity had a strong positive correlation with income growth. The share
of imports in total domestic demand was also highly correlated with the growth rate.
Openness of trade and emphasis on competitiveness of the manufacturing sector were
important factors contributing growth. Economic policies did not penalise the traded
goods sector, and market forces were allowed to determine the real exchange rate. This
facilitated an efficient allocation of resources.

Initially endowed with abundant labour resources, they expanded their exports of low
value-added and labor-intensive manufactured goods. Subsequently, as labor costs
increased, they shifted the structure of manufacturing production and exports towards
more sophisticated and higher valued-added products. A comparatively “level playing
field” allowed both the traded and non-traded goods sectors to grow vigorously,
complementing and supplementing each other in investment, production and trade.

Economic growth in Asia correlates strongly not only with export growth but also with high savings and

investment rates. A trinity of openness to trade, high investment and high savings rates coexist in the fast-

growing economies of Asia, and it is important to stress the presence of all these three factors to achieve

higher growth.

Trade has been pivotal to the economic success of the NIEs and the fast-growing
economies of Southeast Asia. The benefits of a more liberal trading environment reached
beyond the narrow efficiency gains highlighted by the theory of comparative advantage.
Other benefits include more competitive goods and factor markets, increased investment
including foreign investment, and the associated transfer of knowledge and technology.

The prospect for an improved world-trading environment has been enhanced with the
formation of the World Trade Organisation (WTO). But there are still legitimate concerns
in a number of areas. There is a view that the gradual nature of some of the reforms did

110
not adequately cover investment; and much remains to be done to reduce barriers to trade
in both services and agriculture. Some countries also fear that new obstacles to trade in
the name of “social conditionalities” and “environmental protection” will take the place
of old ones. There is also evidence that some industralised countries have bound
themselves to maximum tariffs on many commodities such as textiles and agricultural
commodities in which the Asian developing countries have the comparative advantages.
“Dirty tariffication”, as this practice is called, opens the way to reducing the potential
gains from the WTO agreement.

(d) Investment on human capital development

In nearly all the East Asian high performers, the growth and transformation of
educational and training systems during the past three decades has been dramatic. The
quantity and quality of schooling and training in the home improved simultaneously.
However, higher shares of national income devoted to education cannot fully explain the
larger accumulation of human capital in the high-performing Asian economies. In both
1960 and 1989, public expenditures on education as a percentage of GNP was not much
higher in East Asia than elsewhere. In 1960, the share was 2.2 percent for all developing
countries, 2.4 percent for Sub-Saharan Africa, and 2.5 percent for East Asia.

During the three decades that followed, governments in other regions as well as in East
Asia increased the share of national output they invested in formal education. In fact,
Sub-Saharan Africa’s share of 4.1 percent was higher than East Asian’s 3.7 percent, and
the rest of the developing world’s 3.6 percent. High-income growth, early demographic
transitions, and more equal income distribution were all enabling factors. However, the
decision factor in East Asia’s success was the allocation of public expenditure between
basic and higher education. East Asia consistently allocated a higher share of public
expenditure on education to basic education than elsewhere. Because of the existence of a
large pool of skilled and educated manpower, East Asian countries were able to carry out
in a short period the desired restructuring of the financial and corporate sectors and to
recover from the severe financial and economic crisis in 1997-1998.

(e) Selective state interventions

The success of East Asia has been attributed to some extent to the selective strategic
interventions that were undertaken by them to speed up Industrialisation. However, many
low-income countries such as South Asian countries were characterised by long periods
of extensive state intervention, with a significantly wider ambit than in any of the East
Asian successes. Such interventions were justified by a multiplicity of objectives such as
nationalisation of public utilities or enterprises of strategic importance, correction of
rural-urban imbalance, food security, generation of employment and rapid
Industrialisation. Public policy was expected to serve a number of goals simultaneously,
but adequate attention was not made to match instruments to objectives. It is also not
evident that the “rules of the game” were always transparent and arbitrated impartially.
Most economies followed often-contradictory policies and programmes, each offering
high rents to selected segments of their populations. State interventions need to be made

111
when these are absolutely necessary for public interest and overall economic welfare.
There is need for greater clarity of objectives, and a fuller understanding of the effects of
particular instruments on specific and economy-wide outcomes.

6.3 Foreign Investment Policies

(a) Host country policies for FDI

The substantial increase in FDI flows to Asian developing countries in recent years is
attributable to a large number of factors, including:

* A change of attitude in the host countries, which had welcomed FDI as an engine of
growth and a factor contributing to the transfer of technology, upgradation of skills and
overall efficiency and competitiveness.

* Ongoing economic reforms in almost all the countries in Asia. Favourable policies
ranged from general economic policies leading to a stable macroeconomic framework
and liberalization of industrial, trade, financial and public sector to specific FDI-related
measures such as transparent and non-discriminatory legal and regulatory systems.

* A change of attitude by multinational companies to work more closely with host

countries on a partnership basis; and an increase in global competition reinforced by the
close linkage between FDI and trade, increased intra-firm trade and trade within regional
groupings.

* Among the traditional factors influencing FDI, most important factors are domestic
market potentials and low cost of labour.

* Governments of home and host countries have adopted various measures to

encourage FDI. Widely used instruments were bilateral investment protection agreements
containing rules on fair and equitable treatment, repatriation of equity and dividends, and
international arbitration in the case of disputes.

Impediments to FDI include sectoral protection, ceilings on foreign ownership,

licensing and approval procedures, performance requirements and restrictions on
employment of foreign staff. The formation of regional trading groupings (such as
NAFTA, ASEAN, SAARC etc.) would have an important impact on the FDI pattern. In
the foreseeable future, countries outside the regional groupings might be at a
disadvantage in attracting FDI.

The diversity of experiences in Asia with respect of FDI requires different policy
approaches on the part of host countries. Those countries that have only recently been
open to FDI need to ensure that the “open door policy” is maintained and remains stable.
They should examine the possibility of a further liberalisation of FDI regimes; the
harmonisation of FDI and related policies on industry, trade and technology; and

112
improving the efficiency of their administrative set-up for investment approvals. In doing
so, all countries in the region should pay particular attention to the firms from
neighbouring countries, so as to capitalise the growing intra-regional investment. Special
attention needs to be given to small and medium-sized enterprises whose special needs -
dictated by their limited financial and managerial resources and insufficient information -
may call for incentives for the joint ventures. The Asian market has high potentials for
small and medium-sized TNCs.

(b) Host Country Policies for Portfolio Investment

The upsurge in the flows of FPEI to emerging markets has been driven by liberalisation
of these markets and the global factors such as low interest rates. International investors,
aiming to maximise returns and minimise risk, have found that emerging markets offer
attractive risk-adjusted returns and opportunities for diversifying portfolios. Host country
factors which have attracted portfolio investments fall into three groups: (a) the degree of
political and macroeconomic stability; (b) the commitment to the process of economic
and financial liberalisation and reforms; and (c) the state of development of the stock
markets and the institutional and regulatory framework. The size of the local stock
market, number of listed companies, liquidity, number of participants, investor protection
(such as insider trading regulations), enforcement of regulations and volatility etc. are
particularly important to influence the inflow of foreign portfolio investment.

In order to sustain the inflow of FPEI, many of the Asian developing countries have
taken a number of steps including transparent economic policies and commitment to a
longer-term package of regulatory and market reforms; taxation policies which are
nondiscriminatory for foreign investors; appropriate investors protection; improvement of
the settlement system; encouraging periodic disclosure of financial information; and
improvement of accounting and auditing practices.

Most of the South Asian and East Asian countries are liberalising foreign exchange
regimes, and domestic financial sector and capital markets. Consequently, the stocks
markets in the emerging markets are expanding rapidly with increasing number and
volumes of stocks traded and higher market capitalisation.

In many countries of Asia, massive infrastructure investment requirements, coupled

with government fiscal constraints, have led to a strong interest in private financing of
infrastructure projects with special emphasis on build-operate-transfer (BOT) financing
schemes. The BOT schemes have generally been applied in the transport,
telecommunications, energy, water-treatment and waste-management sectors. Among the
main issues to be tackled is the need to restructure some utility sectors, the need for an
improved regulatory environment, and problems associated with demand risks and
foreign exchange risks.

(c) Sectoral Policies and Regulation

113
 Locational, safety and environmental regulations are necessary for the efficient
functioning of industry, but these are a relatively small component of sectoral regulation.
India’s complicated regulations, as in most countries, have their origins to offset market
failures. The financial sector, transport and telecommunications, professional services and
media all have special regulatory requirements, but most of these regulations are
excessively detailed and outdated. The reduction, simplification and greater transparency
to reduce the need for bureaucratic intervention are needed to ensure that a country can
obtain benefits from foreign investment quickly.

Mineral industries, including petroleum and gas, create particular problems for
investment because resource rents have to be divided between local landowners, the
States and the central governments. Private firms also seek a share of such rents to
compensate them for the riskiness of mineral exploration and subsequent mine
development. The efficient and equitable apportioning of mineral rents is thus an
important aspect of the economic policy framework.

Indonesia and Malaysia have been among world leaders in dealing with foreign
investment in petroleum, gas and other minerals. Papua New Guinea developed mineral
resource taxes to tax mineral rents. With such policies in place, project by project
negotiation can be avoided or minimised. Forestry, fisheries and hydroelectricity also
generate rents that require special consideration. All these industries have environmental
aspects that should be taken into account on a nationwide basis rather than project by
project.

Agriculture and real estate present difficulties for foreign investment because of
complexities of landownership, and rules and taxes regarding tenancy, sale, purchase,
transfer, lease or mortgage. Because of these problems, many countries like India donot
allow foreign investment in agriculture and real estate. In the case of plantation, foreign
investment in nucleus estates and processing facilities can provide a market for farmers
and at the same time enable them to improve their productivity.

Investment in minerals, including petroleum, has retained its share of total foreign
investment. Indonesia led the way in devising agreements that gave an equitable share in
mineral “rents” to the host country while satisfying investors. Forestry has attracted
investors, mainly within the region, but with growing policy difficulties as the socio-
economic costs of forestry become evident and had to be funded. The mainstream of
investment has been in manufacturing, (in protected markets and for export), and in
service industries such as tourism, financial sectors and, on a smaller scale, in
professional services. Investment in infrastructure is now beginning to take place.

(d) Miscellaneous factors affecting foreign investment

Fiscal incentives and investment environment

In 1960s the International Chambers of Commerce argued strongly that developing

countries should attract foreign investment with tax ‘holidays’ and other incentives such

114
as subsidised credit and privileged access to protect domestic markets. The International
Monetary Fund (IMF) favoured the suggestions, but advised that incentives should be
extended to all investors. Many developing countries began to compete for foreign
investment with various incentives. But, a considerable body of evidence showed that
these incentives failed to attract foreign investment. Only those ‘fly-by-night’ firms that
move from country to country, exploiting tax holidays, are attracted by these incentives,
but they exit as soon as fiscal incentives expire or are withdrawn. An efficient and
equitable tax system with internationally competitive taxes and duties is far more
conducive to long run investment inflows than incentives.

Inflows of foreign direct investment are determined by a complex set of economic,

political and social factors and that investors look beyond the array of investment
incentives (in particular fiscal incentives) offered. Performance requirements and various
restrictions and regulations act as disincentives to foreign direct investment and often
serve to offset the positive effects of investment incentives. What should be determined
in evaluating the policy impact of foreign direct investment is the net incentive effect,
taking into account all policies, which directly indirectly affect business risk, profitability
and ability to repatriate capital and investment income.

Foreign investors are also attracted by market opportunities (domestic and

international), a clear legal and institutional set up, administrative speed and efficiency,
efficient infrastructure services and above all by liberal economic policies and stable
economic situation.

Although some transnational firms prefer wholly or majority owned branches or

subsidiaries in their foreign operations, it is widely held that some form of joint venture
with a host country partner is advisable because of the experience and insights local
partners bring. Local partners are particularly effective in managing labour and dealing
with regulatory issues. Some form of joint venture investment is becoming increasingly
prevalent.

Foreign investors are also moving into joint ventures with public enterprises, preferring
corporatised ones. Foreign investment with its capital, technology and management
package can make a considerable contribution to the vast investment required in
infrastructure in developing countries like India. Existing plants can be made more
productive and new facilities can be provided, often on the BOT/ BOO principles, but
governments and investors are still at the process of learning and experimenting.

Low wage rates and low production costs

From the viewpoint of the advanced countries, Asia is still an extremely attractive place
for estabilishing production bases because of its extremely low production costs. China,
India and countries of ASEAN have large, low-income farming populations, implying the
existence of a potentially huge supply of labour for the manufacturing sector. This reserve
should enable manufacturers to secure an adequate labour force. Moreover, since younger
people make up a larger proportion of the population of Asia, they can be expected to

115
play a major role in ensuring a smooth supply of labour in the future. Besides low labour
costs, various other production costs such as real estate rents, transport, communications
and electricity charges are all substantially lower in Asia than in the advanced countries.

Higher Rates of Return

An important factor that determines the influx of direct investment into Asia is the
ongoing globalisation of companies from the advanced countries to take advantage of low
costs in the developing countries. Another factor that encourages Japanese companies to
continue shifting their production bases into Asia is the generally high profitability of
their overseas affiliates in the region. Compared with production bases in North America
and Europe, production bases in Asia are far more profitable.

Huge domestic market

Furthermore, in addition to their original role in producing goods for export, these
production bases are now expected to play a growing role in producing goods for rapidly
expanding consumer markets within the region. In a recent survey conducted by the
export-import Bank of Japan in 1995, Japanese manufacturers were asked their reasons
for investing overseas. In the case of China, the NIEs and ASEAN, a great deal of
importance was attached to investments designed to ‘maintain and expand local markets”.
In fact, overseas Japanese affiliates substantially increased their sales within the Asian
region.

Expanding regional consumer markets are expected to provide an impetus for further
economic growth. Consumption of Asia continues to expand at a healthy rate. Compared
with the developed countries in the world, the relative share of labour in GDP is still low
in Asia. Even in more advanced economies in Asia such as South Korea and Hongkong,
labour relative share is almost 10 percentage points lower than in Japan, the United States
and Germany. This suggests that there is ample scope for an expansion in consumption as
labor relative share rises.

Labour mobility

Labour reform is another area of concern, particularly in large organised sectors.

Though detailed information on labour markets is not available for many low-income
countries, government regulation generally reduces labour mobility. Large firms bear the
brunt of rigid labour laws that constrain them from restructuring their operations, force
smaller capacity expansions than otherwise, and reduce employment creation by
encouraging capital-intensive modes of production.
‘
Rigid labour laws have slowed the pace of economic reforms, privatisation, and state
enterprise reforms. In India, where the organised industrial sector accounts for 80 percent
of industrial value added, constraints on rationalizing the labour force act as the heavy
drag on industrial growth. In China, the competitiveness of a the state-owned sector has
been adversely affected by the need to maintain high employment and provide workers

116
with housing, medical care, schools, transport, and other social services not usually
provided by other firms. Their labour costs are more than twice those of collectively
owned enterprises are. The challenge is to unbundle these services and transfer them to
municipalities or commercial entities so that firms can operate on a commercial basis and
labour is free to seek opportunities elsewhere.

6.4 The Export-Push Strategy and Role of Export Processing Zones

Of the many policies tried by the East Asian countries for accelerating growth, those
associated with their export push hold the most promise for other developing economies.
The export-push approach provided a mechanism by which industry moved rapidly
toward international best practice and technology. Export-push strategies were, however,
implemented in different ways by the High Performing East Asian countries (World Bank
1994).

(a) Hong Kong and Singapore established free trade regimes, linking their domestic
prices to international prices; the export push was an outcome of the limited size of their
domestic markets alongwith neutral incentives for domestic and external markets. Both
economies made export credits available, although they did not subsidise it, and
Singapore focused its efforts on attracting foreign investment in exporting firms.

(b) In Japan, Korea, and Taiwan, China, incentives were essentially neutral between
import substitutes and exports. Export incentives, however, were not neutral among
industries or firms. There was an effort in Japan, Korea, Singapore, and Taiwan China, to
promote specific exporting industries. In Korea, firm-specific exports targets were
employed; in Japan and Taiwan, China access to subsidised export credit and
undervaluation of the currency acted as an offset to the protection of the local market.

One of the major factors for success of the export push in some countries like Japan and
Korea, was the government’s ability to combine cooperation with competition. Export
targets provided a consistent yardstick to measure the success of market interventions.
The more recent export-push efforts of the Southeast Asian newly industrializing
economies (NIEs) relied less on specific incentives and more on gradual reductions in
import protection, coupled with institutional support to exporters and a duty-free regime
for inputs into exports. Recent strategies to attract direct foreign investment in Indonesia,
Malaysia, and Thailand have also been explicitly export-oriented.

The rapid expansion of export processing zones (Apses) in developing countries during
the last two decades represents a significant development in the world economy. Ireland
is credited with establishing the first modern EPZ in the world with the establishment of
the Shannon Export Free Zone in 1955. The success of the Shannon experiment led to the
rapid growth of Apses in developing countries. The first developing country to set up an
EPZ was India with the creation of the Candela Free Trade Zone in 1965. Today there are
more than 200 Apses in 60 developing countries compared with just eight Apses in 1970
and 55 Apses in 1980. Nearly half of Apses is located in Asia.

117
 The emergence of Apses reflects a shift in the Industrialisation strategy of developing
countries, which in the 1950s and 1960s favoured import substitution policies to reduce
dependence on the outside world. The inward-looking policies were supported with high
tariff rates, generous subsidies and foreign exchange restrictions. Since the late 1960s,
there has been a gradual shift in emphasis towards an outward-looking Industrialisation
strategy through the promotion of non-traditional exports. This was accompanied by a
more liberal attitude towards FDI in an effort to attract it not only to acquire much needed
capital but also to promote the transfer of new technologies, upgrade skills and acquire
access to markets and distribution channels. EPZs were a means of fostering export-
oriented Industrialisation, and in some countries, they assumed a prominent role in the
strategy.

There is undeniable evidence that the EPZ sector, although still small, has been among
the most dynamic sectors in attracting FDI. EPZs accounted for more than 85 percent of
FDI in Mauritius and over 70 percent in Mexico. FDI inflows to the oldest four special
economic zones in China amounted to more than 30 percent of FDI inflows in 1989.
Foreign investors account for a major portion of investment and employment in EPZs,
which are characterised by the dominance of the textiles, garments or the electronics
industry. There is also evidence that EPZs were successful in promoting exports of
manufactures and in generating foreign exchange earnings.

One of the striking features of EPZs is the tendency to breed a distinct type of industrial
monoculture, either in textiles and garments or in the electronics industry. An analysis of
the structure of employment by product group in EPZs of selected countries indicate that
there is one dominant industry in each country: textiles and garments industry in
Bangladesh, China, Dominican Republic, Egypt, Jamaica, Mauritius and Sri Lanka; and
the electronics industry in Barbados, Brazil, Republic of Korea, Malaysia, Mexico and
Taiwan, China. Concentration rates vary among countries and zones. In Jamaica,
Mauritius and Sri Lanka, the leading industry, textiles and garments, accounts for almost
90 percent of total employment, whereas for the electronics industry, EPZs in Malaysia
have the highest concentration rate of over 74 percent.

EPZ’s effectiveness as an instrument for the long-term development of industries

depends on the degree of linkages created with the domestic industries and on the extent
to which they provide avenues for the transfer of technology and the upgrading of skills.
In this regard, EPZs seem to have fallen short of expectations. A major limiting factor to
the transfer of technology and skills is the nature of the production processes typically
undertaken in EPZs, which involve low technology and/or simple skills (UNCTAD
1993).

Success of EPZs depends on a favourable investment climate, skilled labour force and
an active local business community and government’s support for the EPZs, while
failures may be attributable to poor locations, inadequate infrastructure, insufficient
promotion, excessive costs and mismanagement. The long-term viability of EPZs also
requires that their operations should be properly integrated with the overall economic and
industrial development strategy of the country.

118
 Results of a cost-benefit analyses of a few Asian EPZs have shown that incentives,
subsidies and infrastructure expenditures entail considerable costs for the host countries.
These costs are sometimes difficult to justify, from both the financial and economic
viewpoints. However, stiff competition among EPZs of developing countries to attract
investors has exerted pressure to offer increasingly generous incentives, thus eroding
their net benefits (UNCTAD 1993).

6.5 Role of Small and Medium Sized Industries (SMIs)

Small and medium industries predominate output in a number of industrial sectors in

many Asian countries such as Bangladesh, India, Pakistan, China, Korea, Indonesia and
Philippines. Even they played a significant role in the economic development in Japan
and Singapore (Chowdhury 1990). They are mainly in the textiles, garments, wood and
furniture, food processing, leather products, fabricated metals, machinery and
equipments, rubber and plastic products, pottery, printing and publishing. In 1990 they
accounted for 95 per cent of establishments in Bangladesh, 70 per cent in Indonesia and
80 per cent in the Philippines.

The importance of these industries in India may be gauged from the fact that the SSI
sector accounts for 40 per cent of the total turnover in manufacturing and 35 per cent of
total exports. It is the second largest employer after agriculture, providing employment
opportunities to 15 million persons.

Many East Asian economies supported small and medium enterprises (SMEs) with
preferential credits and specific support services. Rapid growth of labour-intensive
manufacturing in these firms absorbed large numbers of workers reducing unemployment
and attracting rural labour. As firms shifted to more sophisticated production, efficiency
rose and workers’ real incomes increased.

Support for SMEs has been most explicit and successful in Taiwan, China. SMEs
comprise at least 90 percent of enterprises in each sector and also dominate the export
sector, producing about 60 percent of the total value of exports. Japan directed enormous
financial resources towards developing SMEs. Public financial institutions have allocated
an average of 10 percent of lending towards SMEs. During the rapid growth period of the
1950s, about 30 percent of their total lending for fixed investments went to SMEs. The
SME sector has become a cornerstone of Japan’s economy. In 1989, SMEs accounted for
about 52 percent of both manufacturing value added and sales, and their share of
employment in various manufacturing subsectors ranged from 41 percent in transport
machinery to 100 percent in silverware.

Korean development has been largely driven by the expansion of conglomerates. But in
the 1980s, the SME sector began to grow rapidly. SMEs share in total manufacturing
employment rose from 37.6 percent in 1976 to 51.2 percent in 1988, while that in
manufacturing value added rose from 23.7 percent to 34.9 percent.

119
 Like Japan, Korea established an expensive support system for SMEs such as export
financing system and credit guarantee programmes.

In China, rural industries dominated production in cement, iron and steel, fertiliser,
hydropower and agri-machinery and contributed about 25 per cent of total industrial
output in China and 20 per cent of rural employment in 1990. Initial focus of rural
industry in China was on primary processing of farm produce, handicrafts, manufacturing
and repairing of simple farm tools, developing and processing local industrial resources.
The industries were small and used primitive techniques. Reforms in China have
encouraged rural Industrialisation alongwith entry of multinationals in export-oriented
sectors.

The SPARK programme on rural Industrialisation approved by the Chinese Government

in 1986 aims at vitalising and modernising the rural economy of China through Science
and Technology. The SPARK programme works at three levels - county, province and
central government. In general, units under SPARK include (i) village and township
enterprises having R&D units in cooperation, (ii) R&D units which have village or
township units for cooperation and (iii) scientific and production consortium. SPARK has
adopted a mechanism of setting up technology development and extension network that
interlinks local sectors and central departments and institutions for continuous flow of
technology.

China’s experience in providing 100 million jobs in rural enterprises under non-farm
sector during 1986-1993 and plan to provide similar number of employment
opportunities by the end of this century, reveals that its rural non-agricultural enterprises
owe their success to a market-orientation, availability of infrastructure, stress on higher
technology, incentive-linked wages, competitiveness, diversity in products and
community cooperation.

Sub-contracting and ancillarisation have helped the dispersal of industry and growth of
the small and medium industries and rural non-farm sector in many countries. The most
successful example of sub-contracting from large urban areas to small rural entrepreneurs
is Japan. The division of responsibility and resources, in keeping with its economic
propensity, has given Japan an unparalleled global edge. Its success is attributed to
expanding demand, limited capital of large companies, low basic skills required by small
units and paternalistic relationships. Big business houses share the production process,
technology and innovation with small/medium industries.

Thailand, Malaysia and Indonesia have adopted Japanese model with variations to suit
each nation’s cultural and social environment. In Thailand large companies are allowed to
develop ancillaries, which can operate within the same factory premises and yet entitled
to have independent recruitment, wage structure and service conditions.

In Pakistan, sub-contracting has been in practice over a long period in traditional

products such as carpets, garments and footwear. Sub-contracting is also strong in the
labour intensive activities of rattan in Indonesia and for garments in Philippines.

120
“Bapakangkat” (parent Unit) and “Anakangkat” (related units) of Indonesia are good
examples of networking. Under the scheme, in addition to contractual networking, the
Bapakangkat provides technical and financial assistance, leases plant and equipment and
trains people who leads to higher employment and lowering of cost of production.

In India, Indonesia and Philippines, about 50 per cent of the small enterprises now in
existence were established within the past decade. Most of these began as household
industries, but subsequently grew into the small and medium categories, and into larger
enterprises in a number of cases. The experiences of Japan, Republic of Korea and
Singapore suggest that given appropriate program and policy assistance, small and
medium industries can make substantial contributions not only to output and employment
but also to exports. In all these countries, small and medium units received a number of
fiscal and monetary benefits such as tax holidays, concessional excise duty and lending
rate, priority lending, purchase and price preference by the public sector and reservation
of items for exclusive production by them.

In brief, a dynamic small and medium industries sector serves not only to generate
employment but also to earn foreign exchange, upgrade the quality of the labour force,
expand the base for indigenous entrepreneurs, help in dispersal of industries, and diffuse
technological know-how throughout the economy. The location of small and medium
enterprises in rural areas helps to utilise rural savings, surplus labour and local raw
materials that may otherwise remain idle and unutilised. It helps to reduce the migration
to urban areas by providing livelihood opportunities to rural labour. Small enterprises
also provide a source and training ground for the development of entrepreneurship and
business management skills for medium and large undertakings.

Against these positive aspects, there have been criticisms regarding the ability of small
industries to realise economies of scale in production, procurement and marketing.
Consequently, they may experience larger unit costs despite low labour costs and other
advantages due to their proximity to the local markets. In many branches of
manufacturing, small units exist on the strength of the costly government support
programmes in terms of reservation, price and purchase preference, priority lending and
fiscal concessions.

A wide range of opportunities can be seized by small-scale, labor-intensive industries in

the Asian region where horizontal division of labor through trade and joint venture
projects has been increasing sharply in recent years. The following issues need to be
given due consideration while formulating policies for the SSI sector:

* Adequate backward and forward linkages need to be established between small and
large units in terms of sub-contracting, manufacture of components etc.
* Suitable measures may be taken to enhance the access of the SSI sector to
information particularly relating to external markets, foreign investment and better
technology.
* Vertical expansion of the small-scale industries may be limited due to reservation of
items for the small scale. A review of the reservation policy is necessary.

121
 6.6 Utilizing information technology to achieve international competitiveness

Developing countries must put special emphasis on ICT development for the following
reasons:

• The ICT sector has become an important for an economy’s ability to capitalize on
globalisation. The ICT is an important factor for rapid productivity gains. The ICT
development has helped further expansion of trade and flow of capital which in turn
have facilitated the spread of ICT.

• The ICT revolution could create opportunities for developing countries to export skill
intensive services. India, Philippines, and Singapore have already developed
substantial software and data entry platforms.

• Growth in Internet may create more level playing fields through dissemination of
information, announcing global tenders and subcontracting jobs through Internet etc.

• Developing countries will receive greater dividends from improving education and
skill. ICT revolution will also help to reduce brain drain. Since ICT applications are
not location specific, the ICT revolution has reduced the tendency for highly skilled
professionals to emigrate. Numerous ICT professionals have emigrated and then
returned to their home countries to start up new companies, particularly in India.

• As ICT revolution allows increased modulation of product delivery, there would be

more opportunities to develop market networks through foreign partnerships,
outsourcing and strategic alliances. The Internet B2B and B2C transactions have
helped many small and medium sized industries in Taipei to compete internationally.
Hong Kong and Singapore are aggressively expanding their ICT infrastructure to
improve their ability to take advantage of the Internet and globalisation.

All the developing and developed countries are now attaching special importance for the
development of ICT infrastructure through formulation of national policies on ICT and
related sectors. Indian government has introduced in Parliament a Convergence Bill to
cover telecommunications, information technology (IT) and broadcasting under the same
act. Under the framework of WTO, there is a special international agreement on IT under
which all participating countries have agreed for duty free entry for all IT products and
components.

6.7 Other Technology Capacity Building and Adaptations

(a)Role of Legal and Institutional Set up

Many of the difficulties faced by governments in handling foreign investment, and by

the foreign investors setting up in a host country, derive from the absence of a clear civil,
commercial and criminal legal system. Given a set of laws, it is esential that foreign

122
investors are treated equally with domestic investors. Not only is this a moral issue, but
there are strong practical arguments against giving foreign investors privileges that
domestic firms do not enjoy (and vice versa). Domestic firms will launder money to
become foreign investors if this will give them subsidies that they cannot otherwise
receive. Chinese publicly owned enterprises use transfer pricing at other than arms’
length to become foreign investors in China, or they form joint ventures within foreign
firms to benefit from subsidies to foreign investors. Giving entrepreneurs of Indian origin
special privileges by India are also inequitable and inefficient. Continued reforms will
attract the worthwhile investors among them without incentives.

In open economies, such as Singapore, Hong Kong or Mauritius, only minimal special
foreign investment laws and regulations are necessary and administrative costs are
negligible. Most developing countries like India are faced with a transition period. The
experience of countries such as Indonesia, Malaysia, Taiwan and Thailand suggests that
the transition can be managed well. The faster an economy is reformed, the easier the
management of foreign investment. Regulations can be simple and their administration
transparent.

(b) Role of Natural and Human Resources

Many studies have found an inverse relationship between natural resource endowment
and the level of industrial technology (Kakazu 1990) for the following reasons :

(a) The first is the “Dutch Disease” hypothesis which maintains that overconcentration
on resource-based production and exports may create an adverse environment for the
introduction and diffusion of advanced technology. For example, rich mineral and forest
resources for exports in Indonesia seem to have adversely affected its technological
assimilation and improvement.

(b) Second, India and Indonesia, relatively resource-rich countries in terms of the size
of land and population, have been tempted to adopt more inward or domestic market-
oriented policies compared with the Republic of Korea and Thailand. Import-substituting
industrialisation has discouraged the adoption and dissemination of industrial
technologies appropriate for labor surplus economies such as India and Indonesia.

(c) The third explanation is that a resource-rich economy can sustain its growing
populatin by exploiting extensively its natural resources and may not feel the pressure or
need to adopt advanced technology to utilise given resources more efficiently.

The availability of well-educated human resources is more important than the

availability of natural resources in industrial technology development. Various case
studies made recently by the Asian Productivity Organisation (APO) also found that a
shortage of skilled and technical manpower is the major constraint to the digestion of new
technologies in Asian developing countries.

123
 Indonesia’s institutional capability for technology development is limited due to several
cultural and policy factors. The diversified geography with more than 6,000 inhabited
islands and 2,000 ethno-cultural groups creates problems for institutional development in
education, communications and administration. Recently Indonesia is attaching special
importance for the development of basic infrastructure including human resources.

In the Republic of Korea, scientists, engineers and skilled workers are the main actors
who made it possible for the country to achieve such a remarkable progress. Korea
broadened its educational base to increase technical manpower and thereby trained the
required manpower within a relatively short span of time. Even the poorest of the Korean
families do not spare any efforts to provide the kind of education which the economy
would consider necessary. Formal education is important to all Koreans. The
government’s investment in education has expanded several times. But, the government
expenditure on education represents only 30 percent of the total expenditure on
education; the remaining being borne by the private sector.

(c) Role of Research and Development (R&D) Expenditures

There is a high correlation between R&D expenditure and technological capability

because a new technology, which depends upon R&D activities, must be developed
domestically as a country attains technological maturity. The NIEs spent more and more
on their own technology development as imported technologies became more costly and
increasingly difficult to obtain from developed countries due to growing technology
protectionalism. The R & D expediture in India at 0.9 percent of GNP and in Thailand at
0.5 percent of GNP in 1992 were considerably lower than that in U.S.A. (2.7%), Japan
(3%), Germany (2.9%), and South Korea (2.8%). In USA the Federal government
provided 43% of total R & D funds in 1992 and the remaining 57% was provided by the
industry, state governments, Universities and other non-profit institu-tions. In Japan,
while the government provided only 16% of R & D expenditure, the rest was provided by
industry. In Germany, 35% came from government sources and the remaining 65% was
borne by the industry. In South Korea, the ratio of govwernment and private investment
in R & D changed significantly from 97:3 in 1963 to 15:85 in 1992. In contrast R&D
expenditures are mostly funded by the public sector in Thailand, Indonesia and India.

India has built a wide array of institutions to support the development and diffusion of
industrial technologies since the inception of planning in 1951. It has virtually all basic,
applied, hardware and software and R&D institutions, some of which have world-class
standards. But, these institutions have failed to commercialise R&D activities as these are
virtually financed and controlled by the public sector without any linkage with the private
sector. Since 1993 Government had encouraged private sector funding of research
institutions by providing tax reliefs on R&D expenditure.

The Indian government adopted a progressively more restrictive policy of technology

imports from the mid-1960s due mainly to foreign exchange constraints. Imports of
capital goods were liberalised to some extent during 1980s, but the import duties were
high and irrational. Since July 1991 as a part of structural reforms in industry and trade,

124
India has liberalised completely the import of capital goods and technology transfer with
significant reduction of import duties on capital goods.

6.8 Regional integration

(a) Regional integration and co-operation

There are strong aspirations for regional integration in South Asia as well as East and
Southeast Asia. Indeed, many countries are starting to coordinate and harmonize policies
for tariffs, taxation, investment, and business regulations. But the biggest and most
productive impetus to regional integration would come from removing the restrictions on
movements of goods, capital, and people. These restrictions have severely limited trade
and encouraged smuggling. In addition, there is considerable untapped potential for
regional cooperation in power, transport, telecommunications and tourism.

Regional integration is also likely to get a boost from strengthening the regional growth
centres in South Asia and Southeast Asia. These could produce important pull effects on
growth throughout the continent if the limitations and impediments on local and foreign
investors and movements of goods, people, and capital are removed. They would also
help promote FDI by enlarging markets. But regional integration should not be a
substitute for opening up to the global economy. It should be seen as the way to help
firms connect to global markets at lower cost.

(b) Regionalisation and FDI complementarities

Three lessons can be drawn from past developments on FDI policies. First is that
progress in the development of international investment rules is linked to the convergence
of rules adopted by individual countries. Second is that an approach to FDI issues that
takes into account the common advantage of all countries, is more likely to gain
widespread acceptance and to be more effective. Third is that in a rapidly globalising
world economy, the list of substantive issues entering international FDI discussions is
becoming increasingly broader and complex and include the entire range of questions
concerning factor mobility.

(c ) Technical Assistance

Industrial and technology development depends crucially on the development of basic

infrastructure. Multilateral agencies including the International Development Association
(IDA) can help the developing countries by providing financial and technical support and
investment guarantees for the development of infrastructure and human resources. They
can also play a more catalytic role in mobilising funds from a wide range of private
sources using all the available means.

Multilateral financial and development institutions and bilateral donors have played an
important role by providing financial and technical assistance to the countries of South
Asia and the least developed countries in the areas of improved education, health services

125
and family planning. External assistance should further be increased and continued to be
provided on concessional terms, given the long-term nature of investment in human
capital and its link to poverty alleviation, skill formation and enhancement of industrial
productivity and efficiency.

The international community like the World Bank, IFC, Asian Development Bank,
UNDP, UNICEF, UNIDO and UNCTAD are engaged in the provision of technical
assistance, consultancy and advisory services with regard to the development of the
private sector, human resource development, and promotion of non-debt-creating
financial flows, and FDI in particular. The regional organisations can spur institutional
progress by providing forum for high level discussions on Asian solutions to Asian
problems and by providing a framework for concerted and collective policy actions in
response to problems of globalisation.

Although the experience with technical assistance received from these institutions have
been found to be very valuable, there is scope for improvement in the following fields:

• Promotion of regional cooperation in human resource development, R&D, S&T

development, technology blending, use of information technology, and computer
training and facilities.
• Studies on public sector enterprise reforms, privatisation and industrial restructuring.
• Consultancy and training aimed at technology upgrading and skill improvement for
the growth and globalisation of SMEs with special attention to entrepreneurs from
rural areas, ethnic and backward classes, and women and young entrepreneurs.
• Regional technical assistance programmes on harmonisation of national and regional
policies and plans for private sector development and foreign investment.
• Promotion of technology management, evaluation, assessment and enterprises
cooperation for the blending of indigenous technology and imported technology.
• Improvement of the institutional machinery, administrative and legal framework with
a view to facilitating foreign investment flows and improving the database on FDI
and portfolio flows.
• Advisory services for developing countries to strengthen capital markets and to attract
foreign portfolio investment.
• Technical support for developing countries and countries in transition to upgrade their
institutional capacity to identify, design, negotiate, and implement schemes on
BOT/BOO/BOLT.

126
 CHAPTER 7 CONCLUDING OBSERVATIONS AND
RECOMMENDATIONS FOR PROMOTING GLOBALISATION AND
LIBERALISATION IN ASIAN ECONOMIES

7.1 Policy Issues

East Asia has emerged again as the world's fastest growing region as a result of sound
macroeconomic management in a difficult economic situation followed by harsh and
quick adjustment process, progressive implementation of structural reforms in financial
and corporate sectors. Recovery was also helped by impressive physical and social
infrastructure built over the years in all countries in East Asia and turnaround in regional
and global trade. Increased demand has improved enterprise cash flows, reduced non-
performing loans in banks and allowed some bank recapitalisation. In all countries,
economic recovery has created new jobs and permitted poverty reduction to resume.

However, growth prospects of the hardest-hit countries - Indonesia, Korean republic,

Malaysia, Philippines and Thailand- are constrained by corporate debt overhang, rising
public debt and fall of savings and investment rates. For achieving sustained high growth,
East Asian countries need to strengthen institutions and improve policies in three broad
areas:

 Managing globalisation in financial, trade and investment,

 Revitalising business environment, and
 Forging a new social order and role of government.

(a) Managing globalisation in financial, trade and investment

Countries have responded to the crisis not by retreating from globalisation but by
attempting to manage it more effectively to their advantage. Rather than backtracking
from liberalisations on trade and investment, they have opened new sectors for foreign
investment and liberalised further trade regime but with better regulation. Although
Malaysia and Thailand introduced some restrictions on capital flows in the wake of the
crisis, the controls were either short lived or scaled down quickly. The accession of China
and Taipei to WTO have indicated their determination to deepen globalisation and to
adhere to the discipline of global rules, which is bound to enhance global trade and
economic cooperation.

However, the small and least developed economies in the region lagged behind in
structural reforms and integration with the global economy. Removal of distortions and
reductions of restrictions on trade, services, investment and information can generate
substantial productivity gains for these countries.

(b) Revitalising business environment

127
In the three years since the crisis hit, there had been significant progress in financial and
corporate restructuring in most of the crisis countries. However, there are still areas of
concern. First, many banks remain undercapitalised, which could put constraints on
renewed lending as the recovery gets momentum. Second, the debt-equity ratios for the
corporate sector still remain high with unpaid interests for loans. This situation would
affect adversely the credit rating of these corporates and their ability to expand when
market demand picks up. Third, the crisis has led to an increase in government ownership
of many banks and corporates when government wants to do exactly the reverse and to
play a more aggressive role as regulator.

In China and Vietnam, due attention needs to be given for corporate governance,
management of corporate debt and reduction of non-performing assets. Solution lies in
intensifying reforms in state enterprises which started since 1993 in China and only
recently in Vietnam.

(c) Forging a new social order and role of government.

Effective management of globalisation requires government to be more efficient in

management of public expenditure, use of human resources and delivery of public
services. Governments in the crisis economies need to improve their social safety nets for
the poor, elderly and other vulnerable sections of the society. The crisis revealed that
growth by itself is not substitute for an effective social security and insurance policy.

In China and Vietnam, social support mechanisms have not kept pace with the expanding
domain of markets. East Asia has also lagged other developing regions for providing
necessary protection to the elderly and families. All these countries need to have more
active participation by the government for development of social security systems.

7.2 Institution Capacity Building for Supporting implementation

The strategy outlined here implies a major change in the role of the government – from
an owner and operator to a policy maker and regulator that works closely with the private
sector in developing a competitive, outward-looking economy. Fundamental to the
success of this orientation is to accelerate government efforts to build competent and
agile institutions that can help enterprises respond quickly to changing market conditions.

(a) Infrastructure and Human Resource Development

Efficient physical infrastructure and human capital are critical overheads that investors
seek. For the more dynamic traded goods and services, telecommunications are the most
important facilitator of investment, and technological and organisational innovations
drive foreign investment into those countries which have trained and skilled workforce
and fairly high educational standards. This points to the overriding importance of
developing countries to invest more in the development of human resources,
infrastructure and services. It also highlights the risk of being marginalised for the least

128
developed countries with a low level of skilled labour force and infrastructure constraints.
The existence of a dynamic local business sector creates a supportive environment
through efficient networks of local suppliers, service firms, consultants, partners or
competitors. It is, therefore, necessary to concentrate efforts on the development of local
entrepreneurship. Equally important is the availability of high quality
telecommunications and transport systems, energy supply and other utilities.

(b) Legal and Institutional Set-up

Many of the difficulties faced by governments in handling foreign investment, and by the
foreign investors setting up in a host country, derive from the absence of a clear civil,
commercial and criminal legal system. Given a set of laws, it is essential that foreign
investors be treated equally with domestic investors. Not only is this a moral issue, but
there are strong practical arguments against giving foreign investors privileges that
domestic firms do not enjoy (and vice versa). Domestic firms will launder money to
become foreign investors if this will give them subsidies that they cannot otherwise
receive. Chinese publicly owned enterprises use transfer pricing at other than arms’
length to become foreign investors in China, or they form joint ventures within foreign
firms to benefit from subsidies to foreign investors. Giving entrepreneurs of Indian origin
special privileges by India are also inequitable and inefficient. Continued reforms will
attract the worthwhile investors among them without incentives.

In open economies, such as Singapore, Hong Kong or Mauritius, only minimal special
foreign investment laws and regulations are necessary and administrative costs are
negligible. Most developing countries like India are faced with a transition period. The
experience of Indonesia, Malaysia, Taiwan and Thailand suggests that the transition can
be managed well. The faster an economy is reformed the easier the management of
foreign investment. Regulations can be simple and their administration transparent.

(c) Competent economic bureaucracy

The experience of the economies of Japan, Korea, and Taiwan, China, suggests that the
first prerequisite for the proper conduct of targeted industrial policy is a stable
macroeconomic environment. In essence, prudent macroeconomic management is needed
to prevent inefficiencies, which generally impinge on macroeconomic variables such as
the budget deficit and inflation, e.g., subsidies become burdensome. Unless there are
institutional constraints that keep the deficit and inflation from exploding, the
inefficiencies would continue and ultimately cause considerable harm to the economy.

An important institutional prerequisite appears to be the establishment of a competent

economic bureaucracy. The complexity and difficulty of managing targeted industrial
policies places high demands on the economic bureaucracy, which must be able to
balance financial support for targeted industries with penalties for non-performance. The
economies of Japan, Korea, and Taiwan, China all had economic bureaucracies capable
of imposing discipline on private industry. In short, running a set of successful industrial
policies of the East Asian type requires a deep commitment to a stable macroeconomic

129
framework, and an economic bureaucracy capable of running complex pricing policies,
and objectively running public subsidy schemes.

(d) Regulatory system

As regards the limits and nature of government intervention in private sector activity, it is
necessary to devise optimal rules for operating regulatory system, which while servicing
its legitimate purpose will not transcend its limits to the disadvantage of the private sector
development. First, any policy affecting allocation of resources, and regulation of private
sector needs to be pursued if and only if there is a specified set of procedures. Second,
even when there is strong presumption in favor of government intervention, it is
imperative to limit it to minimum necessary scale, as efficiency of regulation is scale-
determined. Three, from amongst the available alternative regulatory sets, it is necessary
to go in for one which will provide the least scope for rent seeking.

Alongwith with deregulation, more important measures are needed to be directed towards
creating a legal and institutional infrastructure for the smooth functioning of the private
sector. This has been well illustrated by the Indonesian experience. Though Indonesia’s
industrial policy, trade and financial sector reforms were deep and sweeping, they failed
to get a full pay-off as Indonesia lagged in changing its corporate law and other laws vital
to trade and industry. Similar was the case with issues of land and property rights.

An important lesson from the East Asian development experience is that a holistic
approach to deregulation is more productive than a partial deregulation in any one sphere
say in industrial policy which is divorced from any reform in other areas. Domestic
deregulation should proceed pari pasu with liberalisation of trade and tariffs in order to
ensure optimal allocation of resources between traded and no-traded goods.

(e) Restructuring the financial sector

For the five most affected East Asian economies viz. Indonesia, Malaysia, Philippines,
South Korea and Thailand, the average total debt to GDP ratio increased to 230 per cent
and debt service ratio to 27 per cent in 1997. While much is made of external debt
overhang, the real problem is with domestic debt to GDP. After many years of excessive
credit growth, over-investment (i.e. on the basis of price appreciation rather than yield)
and inadequate banking supervision, domestic debt to GDP was 116 per cent on an
average in 2000. The capital flight from foreign banks, residents and domestic
corporations triggered a massive credit squeeze forcing real interest rates to soar and
triggering nation-wide recession. Financial stabilization to foster the initial turnaround in
economic activity was the first order of business. To build the basis for a sustained and
strong recovery of activity over the next several years, major efforts are needed, and are
under way, to restructure the financial and corporate sectors.

In conjunction with bank restructuring and recapitalisation there is a need for financial
reconstruction of the corporate sector. The crises have led to large increases in domestic
and foreign debt burdens of both the private and public sectors. At the end of 1997, total

130
(domestic and foreign) debt of private and public sectors in Korea, Malaysia, and
Thailand exceeded 225 percent of GDP, while in Indonesia it stood at around 190 percent
of GDP. Unlike in the Latin American debt crisis of the 1980s, most of the debt was
private rather than sovereign. In Korea, Malaysia and Thailand, private sector debt
accounted for over 85 percent of total debt at end –1997 while in Indonesia and the
Philippines private debt amounted to 70 and 60 percent, respectively, of total debt.

Besides the needed restructuring and recapitalization of the banking system and the non-
financial corporate sector, financial reforms are required to prevent a recurrence of
similar crises. There is a clear need for stronger prudential, supervisory, accounting, and
legal standards, as well as improved corporate governance and the establishment of more
transparent relations between government, banks, and corporations.

From a long-term perspective, a fundamental question facing the East Asian economies is
whether they can gradually shift from mainly input-driven growth to growth based more
on stronger gains in efficiency. That will depend on continuing improvements in the
institutional infrastructure to provide a supportive climate for investment and the supply
of finance, risk-taking and innovation, and the efficient allocation of investment.

(f) Role of R&D Expenditures

The R&D expenditure in many developing countries like India (0.9% of GNP), Pakistan
(0.6%), Philippines (0.7%) and Thailand (0.5% of GNP) are considerably lower than that
in USA (2.7%), United Kingdom (2.3%), Japan (3%), Germany (2.9%) and South Korea
(2.8%). The situation may not be very much different for the African developing
countries. Developing countries in Asia and Africa must allocate more resources on R&D
and encourage private sector funding of research institutions engaged in R&D. For
effective role of R&D in the generation, development, adaptation, assimilation and
diffusion of industrial technologies, public research institutions must try to commercialise
R&D activities with necessary linkages with the private sector and production activities.

7.3 Facilitating Private Sector Growth

In terms of the role of the private sector, East Asian governments have explicitly taken
the attitude that what is good for the private sector is also good for them (in terms of
taxes, public welfare, economic growth etc.). Therefore, the role of the state with respect
to the private sector is to do everything necessary to ensure the sector’s success, and to
work with the representatives of the private sector to design government policies
accordingly. In terms of export development strategy, it is not simply a question of
reluctantly removing barriers to trade, or grudgingly handing over tax rebates. The East
Asian countries put the development of exports as the central economic strategy, in the
belief that this would be the source of economic success in other spheres.

(a) Private sector development strategy

131
Though pivotal, private sector development must be a part of an overall strategy for
sustainable development that embraces such other elements as health, education,
infrastructure, and environmental protection. East Asian governments developed a long-
term vision for their economies and societies and set out with determination to design and
implement policies to realise this vision.

For private sector development to promote accelerated growth, progress on the

macroeconomic front has to be buttressed with structural and institutional reforms to:

• Improve business environments

• Reduce the drain of public enterprises
• Build robust financial systems
• Increase the supply and quality of human resources and physical infrastructure.

Specifically, the strategy requires the developing countries:

• Must sustain sound macroeconomic management as indicated by sustainable balance

of payments deficit, minimization of external debt-overhang, declining fiscal deficit
and reasonably stable inflation rates.

• Must establish a more favourable business environment to promote competition and

reduce risk and high cost particularly for the firms in the informal sector and small
and medium-size enterprises. This means pressing ahead on an array of legal,
regulatory, and institutional reforms in partnership with business and labour.

• Go further and faster on public sector reform by privatising the utilities and public
monopolies, and by liquidating major loss-making enterprises.

• Accelerate financial reform by restructuring and privatising banks, allowing private

entry, strengthening prudential norms for capital adequacy, regulation and
supervision, and developing basic financial infrastructure.

Many low- and middle-income countries have implemented elements of the complex
mosaic of private sector development, and the private sector response has been
impressive. But even in countries with well-established institutions and legal systems –
and the human resources to translate commitment into action – systemic reform has been
a long process (often exceeding 15-20 years) subject to reversal and fragility. Moreover,
the poorest countries lack many of the prerequisites. The challenges are particularly
daunting in the Least Developed Countries (LDCs), where the environment for
entrepreneurs is highly uncertain, markets are smaller, skills are shallower, the supporting
infrastructure is weaker, and the legal and regulatory environment is very restricted. The
LDCs thus need financial and technical assistance from multilateral and bilateral sources
in designing and implementing their reform programmes.

132
The economies which strive to grow rapidly through a medium of private sector
have to maintain macroeconomic balances. In absence of this, regulatory reforms
would not yield optimal results, and would weaken the economic system. Real
incentives for the private sector is generated from a stable economic situation, which
assures growing markets, scope for enterprise, and innate urge for seeking profit
opportunities. These incentives are stronger than the disincentives stemming from
regulatory system per se.

(b) Privatisation programmes and strategy

The efforts of many developing countries at public sector reforms without complete
privatization of non-core public enterprises rarely produced the desired results. Many of
them turned to partial privatization, but almost none has divested an economically
significant portion of its public enterprise sector. Yet, in the few instances where large
private investors have been attracted (roads, power and telecommunications in India and
Pakistan, for example), there has been significant impact on macro-economic aggregates.

Stronger actions are needed to reform public enterprises and faster and deeper
programmes of privatization – to produce macroeconomic improvement through major
reductions in fiscal deficits and general improvements in business conditions.
Simultaneous action is needed on both fronts – public enterprise reform and privatization
are not “either-or” propositions.

Countries succeeding in this process have avoided investments in the public sector that
could better be handled by the private sector – and imposed a hard budget constraint on
the remaining public enterprises. Experience reveals that the way forward is to:

• Sell public enterprises producing tradables and operating in competitive markets. If

they cannot be sold, they should be liquidated. Prime candidates are the largest public
enterprises having adverse impacts on the budget and the economy – the loss making
banks and financial institutions, the large manufacturing enterprises, the marketing
boards, and the procurement, refining, and distribution of petroleum products. Even
where proceeds might be modest, as in much of Africa, ending the financial drain can
generate substantial public savings.

• Involve the private sector in the commercialization, management, financing, and as

much as possible in the ownership of infrastructure – as in China, India, and Pakistan.

• Divestiture is neither a panacea nor an end in itself. But, it is a powerful tool that not
only brings better performance at the firm level, but also helps repatriate flight
capital, attract foreign direct investment, and broadens and deepens access to
international capital markets.

• These positive macroeconomic effects are enhanced when privatization’s proceeds are
devoted to retire the high-cost government debt that is crowding out the private sector
and increasing real interest rates.

133
• Infrastructure utilities are attractive candidates for divestiture. The financial,
economic, and psychological impact of increased private involvement is generally
large. The need for improved services is incontestable – consumers always applaud
increases in the quality or reliability of services, and investors are willing to act.

• Moreover, privatising infrastructure services facing growing demand such as

telecommunications or power typically results in little loss of employment. And
efficiency still rises because of increased investment and proper pricing.

(c ) Private-Public sector partnership

Cooperation and close collaboration between business and government has been one of
the hallmarks of the East Asia’s success in industrialisation. Formal institutions, called
deliberation councils, have facilitated the policymaking process in Japan, Korea,
Malaysia, Singapore, and Thailand. These councils generally consist of high-ranking
government officials, representatives of the business community, academia, consumer
groups and labour. A council serves as a forum through which government officials and
private sector groups can interact repeatedly in the formulation of policies. It creates a
basis for nurturing trust and for developing cooperative relations.

Making a council system work has several requisites:

• First, the government must have a reasonably competent economic bureaucracy.

• Second, there should be participation of equally competent individuals from the
private sector who have the requisite skills to run a business enterprise.
• Third, it is important for the (current) political regime to have some reasonable degree
of longevity.
• Finally, for cooperation to emerge, there has to be a minimum level of mutual trust
and confidence between the government and the private sector.

Given these requisites, full-blown East Asian type government-business partnership may
not be feasible immediately in the least developed countries (LDCs), but steps can be
taken to move in this direction. Joint Councils may be created and charged with initially
more straightforward tasks such as FDI promotion strategies, legal and institutional set-
up etc. before moving on to more complex and sector specific strategies or more sensitive
issues such as privatisation and tariff reforms. This requires a careful approach to terms
of references and selection of council members, but a modest attempt seems preferable to
a “hands-off” approach.

(d) Development of infrastructure and services

The private sector participation in management, financing or ownership will in most

cases be needed to ensure a commercial orientation in infrastructure. Public-private
partnership has promise in financing new capacity. Guarantees from host governments,
multilateral institutions and export credit agencies play an important and legal role to

134
 mitigate the policy uncertainties and commercial and foreign exchange risks inherent in
large-scale infrastructure financing. But, these should not be taken as substitutes for
correcting sectoral distortions or removal of market imperfections.

The lessons of experience in East Asia indicate that developing countries are required to
have priority attention in the following five areas while formulating country strategies to
enhance private participation in the provision of infrastructure:

* Overall country objectives, strategy and priorities;

* Reform of policy, legal and regulatory framework;
* Facilitation and increased transparency of government decisions
* Unbundling and mitigation of risks; and
* Mobilisation of private terms lending.

(e) Fiscal and monetary incentives

Although all the countries under examination had introduced a variety of incentive
schemes– fiscal, credit, marketing and technical, they were either inadequate or
overborne by a set of direct regulations. If the emphasis were mainly on the former, the
rent seeking could have been much less and industrial growth would have been higher.

The promotional policy particularly in regard to small-scale industry through reservation

of products tends to discourage capacity creation and competition from large-scale
industry whether or not. Therefore, the focus of promotional activities should be on
access issue and not on subsidies, tax holidays or reservation.

7.4 Export development policies

Of the many policies tried by the East Asian countries for accelerating growth, those associated with their
export push hold the most promise for other developing economies. Export development policies such as
duty draw-back/ duty exemption schemes and development of free trade zones (FTZs) and 100% export
oriented units (EOUs) have been a critical part of East Asia’s success and merit consideration.

(a) Duty Drawback Schemes

Duty exemption and duty drawback systems have failed in many developing countries for
reasons of cumbersome procedures, and because the costs from delays and paperwork
outweigh the reductions in duty. In the case of drawback schemes, administrations are
often unable to repay duties prepaid by exporters. In order to improve Africa’s
competitiveness in manufactured exports, governments must take a new initiative to
widen the use of these schemes and assure speedy access to exemptions and drawbacks
for all exporters, through modernised administrative mechanisms..

One of the key elements of a modernised duty drawback scheme should be the
development of a system of pre-tabulated and published input-output coefficients and
band rates or industry rates for drawback on the basis of experiences drawn from Korean

135
republic, Taiwan, China, India and Bangladesh. The new GATT rules on export subsidies
also require the systematic documentation of the input-output coefficients. Another key
element of export support is the assurance of export credit supply for exporters,
especially for pre-shipment finance.

Another major problem for the least developing countries is the weakness of Customs
Administrations, which contributes to the difficulties facing exports. Not only does this
come in the form of slow or nonexistent rebates, but also in negative effective protection
as exporter face duties on inputs while final goods are smuggled.

(b) Free Trade Zones

The free trade status for export activities can be achieved through: (I) fenced private or public free trade
zones (FTZs); (ii) nonfenced FTZs, (iii) bonded drawbacks/ rebates. These specialised schemes have been
widely and effectively used in countries at the early stages of development. The fundamental feature of
Korea’s pioneering export promotion drive was the duty drawback scheme implemented through the
domestic letter of credit (DLC) and the export finance system. In Korea, the Input Coefficient
Administration, which estimates and publishes detailed input-output coefficients, band and individual
commodity drawback rates, and the back-to-back credit system offered through Domestic Letters of Credit
(DLCs), has efficiently provided tax free inputs and ready access to working capital finance to direct and
indirect exporters. India, Taiwan, China, Indonesia, Malaysia and Thailand also have export support
instruments including tax incentives, duty drawbacks and exemptions, and export and investment finance
for exporters.

Four broad conclusions can be drawn from the Asian experience for development of
export promotion zones:

• Where the general economic climate is reasonable, or becoming so, the development
of FTZs can be a useful instrument to the development of export-oriented industry, as
it can lower initial investment costs for investors, and encourage economies of
agglomeration.

• FTZs should be a component of a broader outward-oriented development strategy,

rather than a substitute for such a strategy, or an excuse to delay much needed
economy-wide trade reforms.

• FTZs should have proper infrastructure and linkages with the other parts of the
country through proper hinterland development.

• The benefits from FTZs in terms of foreign exchange earnings, employment,

technology transfer and linkages with domestic markets may be limited, unless
accompanied by an appropriate policy framework and human capital development for
sustained export development.

• While accepting that sometimes market failure justifies a potential role for the public
sector in the development of free trade zones, the pricing of land in such zones should
not be subsidized. Similarly, as part of a general programme to promote foreign

136
 investment, governments should be sure to remain open to the private development of
such industrial estates, as in being done in China.

7.5 Foreign investment policy

Foreign direct investment (FDI) can be critical in introducing widespread technological

change, improving the agility and competitiveness of firms, and providing access to skills
and global markets. This is evident in China, and to a lesser extent in Bangladesh, India,
and Kenya, where FDI is increasingly generating spillover effects in many sectors.
Successful cases show the importance of having governments promote and welcome FDI,
particularly in infrastructure such as communications and energy. They also show the
importance of true such as communications and energy. They also show the importance
of avoiding excessive regulation and restrictions on expatriates and financial flows and
the business activities of firms.

The need for FDI is greatest in South Asia and the least developed countries, but they
have attracted relatively less inflows of foreign investment due to mainly socio political
reasons. Indeed, international credit rating for these countries had been low due to
uncertain political and economic environment, high cost of doing business, and the fears
that policies and regulations discriminate against foreign investors, who have many other
opportunities all over the world. FDI inflows and FDI stock already in the country would
benefit from a more stable and dynamic economic and political environment.

(a) Host Country Policies for FDI

For host countries, the policy agenda for increasing FDI inflows and for drawing
maximum benefits from them must include the following priorities:

• ensuring a stable economic environment conducive to sustained economic growth;

• encouraging the development and upgrading of local industrial and technological
capabilities;
• strengthening infrastructure and human resource development,
• and providing requisite legal, regulatory and institutional set up.

Those countries that have already been open to FDI need to ensure that the “open door
policy” is maintained and remains stable. They should examine the possibility of further
liberalisation of FDI regimes; the harmonisation of FDI and related policies on industry,
trade and technology; and improving the efficiency of their administrative set-up for
investment approvals.

In recent years, the competition among the host countries to attract FDI has intensified
the use of incentives to such an extent that the situation is often referred as an
“investment war”. Host countries get trapped in the “prisoner’s dilemma” leading to
competitive attitudes in providing fiscal incentives in which all participants are left worse
off than the situation of no fiscal concessions. It will be beneficial for the host countries
to arrive at harmonisation of policies, to ensure more transparency on FDI regime, to

137
exchange information about their regulatory regime and other FDI-related policies and to
share their experiences on the impact of FDI on the costs and benefits to the economy. All
these measures are likely to reduce unnecessary transaction costs.

All countries in the region should pay particular attention to the firms from neighbouring
countries, so as to capitalise the growing intra-regional investment. Special attention
needs to be given to small and medium-sized enterprises whose special needs - dictated
by their limited financial and managerial resources and insufficient information - may
call for incentives for the joint ventures among the small and medium-sized TNCs.

Successfully enticing one important TNC to locate in a country can trigger a chain
reaction that leads to substantial sequential and associated investment. The most obvious
targets are firms already established in a country. Governments can strive to encourage
sequential investment (including reinvested earnings),, which can provide positive
demonstration effects for potential new investors. A satisfied foreign investor is the best
commercial ambassador a country can have.

Policy makers should be concerned when foreign investors leave the host country due to
deteriorating local conditions. Emphasis on after-investment and investment-facilitation
services for current investors is therefore crucial.

Free, prompt and unrestricted transfers in any freely usable currency should be permitted
for all funds related to an investment. The bottom line to a business is the ability to make
profits and to distribute funds to partners and shareholders. Expropriations should only
occur in accordance with international law standards and be subject to due process. An
expropriation should be for public purpose and nondiscriminatory, and prompt, adequate
and effective compensation must be paid.

Firms must be confident that they can obtain a fair hearing in the event of a dispute, and
must have reciprocal ability to seek international arbitration. Investors should have full
access to the local court system, but also have the choice to take the host parties directly
to third party international binding arbitration to settle investment disputes.

The legal framework governing labor markets must be reformed to institute a market-
based bargaining process that is free from interference by the government or trade unions,
and a system of severance liabilities that conform free market conditions and developing
country norms.

Facilitation of exist is as much crucial as entry which is addressed by deregulation. In

addition to this, employment schemes paid for with wage goods, tried in countries like
India can be implemented. In short, labour market reforms should be considered as a sine
qua non of the industrial policy reforms.

(b) Host Country Policies for Portfolio Investment

138
The strengthening of local capital and stock markets is essential for the development and
broadening of the domestic investor base and the establishment of a healthy private
sector. In this respect, privatization has a role to play in broadening the investment base.
A prudent regulatory framework alongwith transparency and efficiency of price
dissemination are also necessary to ensure investors’ confidence in the stock market.

Among the main issues to be tackled for BOT financing schemes in infrastructure are
the need to restructure some utility sectors, the need for an improved regulatory
environment, and measures to reduce demand risks and foreign exchange risks.

(c) Home Country Policies

With domestic outward FDI policies liberalised, developed home countries must
supplement their domestic policies with international instruments aimed at protecting and
facilitating outward FDI. They should improve FDI liberalisation standards generally and
encourage level playing field among themselves. Few developing countries and
economies in transition have paid due attention to outward FDI policies; typically these
are subsumed under general capital-control policies which, in turn, are quite restrictive.
There is a need to liberalise furthers capital markets and foreign exchange rules and
regulations so as to move towards full convertibility on capital account.

As regards portfolio investment, the enormous potential represented by the pool of

savings held by institutional investors in the OECD countries may increasingly seek
investment outlets other than those offered by the mature markets. However, home
country regulations concerning outward portfolio investments can be a major constraint
on outward portfolio investment. In most developed countries, savings institutions such
as insurance companies and pension funds face ceilings on the share of foreign assets in
their portfolio and are usually subject to prudent investment and diversification norms. As
the investment managers become more familiar with emerging markets, a relaxation of
home country policies concerning portfolios of institutional investors could lead to a
multiple increase of portfolio investment to developing countries.

7.6 Application of Information Technology

For the development of ICT sector, developing countries in Asia need to take a number of
policy measures:

• Structural policies should encourage the widespread adoption and effective use of
ITC including flexible labour markets and efficient service sectors.

• ICT has to be supported by a vibrant telecommunications sector. This will require

large investment in Southeast Asia and South Asia to enhance the teledensity at par
with the level in NIEs. As there are constraints on public investment, it will require
partnership between public and private sectors and further liberalisation of foreign
investment policy for telecommunication and other IT related sectors.

139
• Human resource development for computer literacy, skill formation and upgradation
of science and mathematics training are also equally important.

• Policy support for private sector ICT development, including standards for hardware
and software to ensure compatibility of systems is justified by positive slipovers of
ICT to the rest of the economy.

• Intellectual property rights also need to be safeguarded by strengthening laws on

copyright, patent rights and trademarks.

7.7 Role of Small and Medium Sized Industries (SMIs)

A wide range of opportunities can be seized by small-scale, labour-intensive industries. It

is particularly so in the Asian and African region where horizontal division of labour
through trade and joint venture projects are increasing sharply..

The following measures need to be given priority for strengthening the SMI sector :

• It is necessary to facilitate the transfer of technology to the SMEs by suitable

arrangements such as regional information networks and provision of timely and
adequate finance to SMEs.

• Adequate backward and forward linkages need to be established between small and
large units in terms of sub-contracting, production sharing and manufacture of parts.

• Suitable measures may be taken to enhance the access of the SMI sector to
information particularly relating to external markets and foreign investment.

• Vertical expansion of the SMEs may be limited due to reservation of items and limits
on investment. A review of the reservation policy and investment limits is necessary
to facilitate capacity expansion, technology upgradation and economies of scale.

• Much of the existing growth of SMEs has taken place in and around the metropolitan
areas, but the balanced regional growth requires that the process of industrialisation
needs to be extended to the countryside. In this respect, the experience of China in
setting up Township Enterprises on a large scale may be particularly relevant for other
developing countries.

• SMEs are most vulnerable to trade protectionism and exchange rate fluctuations.
Undesirable tariffs and non-tariff restrictions on their products must be removed to
enhance the export potentials of SMEs.

7.8 Strengthening regional cooperation in ASIA

140
Developing countries in Asia are going through a phase of economic liberalisation, which
provides a solid foundation for the success of intra- and inter-regional cooperation. They
need to make greater efforts to create a more liberal trading and investment environment
for reduction of wide disparities in the levels of income and market size, and to have cost
sharing and distribution of benefits. The economic exchange and cooperation among the
economies can be strengthened by the following measures:

• At the regional level, host countries can increase their locational attraction for foreign
investment if closer linkages are established with neighbouring countries in order to
generate larger markets and complementary locational advantages.

• Since almost all countries in the region are trying to attract foreign direct investment,
a lot of competitive overbidding and unnecessary loss of resources could be avoided
through some harmonization of policies of different economies at national, bilateral,
regional and global levels.

• Instead of competing for foreign capital, the countries should undertake appropriate
policy reforms, which will not only encourage more savings and investment internally
but also help the return of flight capital to the region.

• At the regional level, countries should cooperate with one another to modernise their
financial systems to cope with the increase in trade and cross-border capital flows.

• Another aspect of regional cooperation that is of growing importance is the sharing of

information. Regional cooperation can reduce the transaction costs of gathering
information can reduce the research and development costs. The sheer magnitude for
investment required for technological R&D needs subregional pooling of limited
resources (financial, physical and human) to obtain the best possible leverage.

• National governments as well as regional trade, industry and business organisations

must facilitate contacts, cooperation and mutually business relations among
enterprises and entrepreneurs for building up internal strength of industries.

• It may be desirable to establish a regional investment guarantee facility. A major

problem in attracting investment funds to the developing countries is the perceived
risk of confiscation, civil strife, and political turmoil.

• For the least developed countries, which lack the capacity to undertake
comprehensive efforts for development of local capacity, there is an urgent need for
more active support by the donor community in such areas as strengthening the
private sector and local entrepreneurship, building institutional capacity, improving
physical infrastructure and enhancing human resource development.

• At a broader level, the Asian Development Bank (ADB), can play a complementary
role in enhancing regional cooperation to attract more private capital into Asia and

141
 pacific. ADB can also expand its catalytic role in private sector financing and
augment its resources for infrastructure development.

• Other multilateral financial institutions will also have to strengthen their catalytic role
through co-financing and guarantee with a view to encouraging participation of
private capital in the development process, particularly in Africa.

East Asia- Conclusions

East Asia has emerged again as the world's fastest growing region as a result of sound
macroeconomic management in a difficult economic situation followed by harsh and
quick adjustment process, progressive implementation of structural reforms in financial
and corporate sectors. Recovery was also helped by impressive physical and social
infrastructure built over the years in all countries in East Asia and turnaround in regional
and global trade. Increased demand has improved enterprise cash flows, reduced non-
performing loans in banks and allowed some bank recapitalisation. In all countries,
economic recovery has created new jobs and permitted poverty reduction to resume.

However, growth prospects of the hardest-hit countries - Indonesia, Korean republic,

Malaysia, Philippines and Thailand- are constrained by corporate debt overhang, rising
public debt and fall of savings and investment rates. For achieving sustained high
growth, East Asian countries need to strengthen institutions and improve policies in three
broad areas:

 Managing globalisation in financial, trade and investment,

 Revitalising business environment, and
 Forging a new social order and role of government.

Managing globalisation in financial, trade and investment

Countries have responded to the crisis not by retreating from globalisation but by
attempting to manage it more effectively to their advantage. Rather than backtracking
from liberalisations on trade and investment, they have opened new sectors for foreign
investment and liberalised further trade regime but with better regulation. Although
Malaysia and Thailand introduced some restrictions on capital flows in the wake of the
crisis, the controls were either short lived or scaled down quickly. The accession of China
and Taipei to WTO have indicated their determination to deepen globalisation and to
adhere to the discipline of global rules, which is bound to enhance global trade and
economic cooperation.

However, the small and least developed economies in the region lagged behind in
structural reforms and integration with the global economy. Removal of distortions and
reductions of restrictions on trade, services, investment and information can generate
substantial productivity gains for these countries.

142
 Revitalising business environment

In the three years since the crisis hit, there had been significant progress in financial and
corporate restructuring in most of the crisis countries. However, there are still areas of
concern. First, many banks remain undercapitalised, which could put constraints on
renenued lending as the recovery gets momemtum. Second, the debt-equity ratios for the
corporate sector still remain high with unpaid interests for loans. This situation would
affect adversely the credit rating of these corporates and their ability to expand when
market demand picks up. Third, the crisis has led to an increase in government ownership
of many banks and corporates when government wants to do exactly the reverse and to
play a more aggressive role as regulator.

In China and Vietnam, due attention needs to be given for corporate governance,
management of corporate debt and reduction of non-performing assets. Solution lies in
intensifying reforms in state enterprises which started since 1993 in China and only
recently in Vietnam.

Forging a new social order and role of government.

Effective management of globalisation requires government to be more efficient in

management of public expenditure, use of human resources and delivery of public
services. Governments in the crisis economies need to improve their social safety nets for
the poor, elderly and other vulnerable sections of the society. The crisis revealed that
growth by itself is not substitute for an effective social security and insurance policy.

In China and Vietnam, social support mechanisms have not kept pace with the expanding
domain of markets. East Asia has also lagged other developing regions for providing
necessary protection to the elderly and families. All these countries need to have more
active participation by the government for development of social sectors.

143
 Selected Bibliography

Asian Development Bank (1997) Emerging Asia-Changes and Challenges, ADB,

Manila.

_______ (2001) Asian Development Outlook 2001, ADB, Manila.

Asian Productivity Organisation (1999) Asia Economic Crisis: in Search

of Higher Competitiveness in Global Markets, APO, Tokyo.

Atkinson, Caroline (1998) Persistence of Asia crisis underlines need for

reforms, Economic Perspectives, Sept. 1998, United States Information
Service, New Delhi.

Brooks, D.H. and Leuterio, E.E. (1997). Natural resources, economic structure and Asian
infrastructure, in Investing in Asia, ed. C.P. Oman et. el. 1997, OECD.

Butsuntorn, Tawee (1999) The future direction of manufacturing

industries in Asia after economic crisis, pp.67-74, in Asian Economic
Crisis: In Search of Higher Competitiveness in Global Markets, Asian
Productivity Organisation, Tokyo, 1999.

Chopra, Ajai and Kenneth Kang, Meral Karasulu, Hong Liang, Henry Ma and Anthony
Richards (2001) From crisis to recovery in Korea: strategy, achievements and lessons,
International Monetary Fund Working Paper no. WP/01/154, Oct. 2001, Washington.

Das, Tarun (1996) Policies and Strategies for Promoting Private Sector’s Role in
Industrial and Technological Development Including Privatisation in the Asian
Economies, pp.1-171, ST/ESCAP/1696, United Nations, New York.

______ (1997) Technology Transfer- Growth Nexus Towards Greater

Regionalisation And Complementation of Manufacturing Production and
Technology Upgrading, pp.1-258, Report prepared for ESCAP, United Nations,
Bangkok, October 1997.

______ (1998) Private Sector Development Programmes in Selected Countries in

Asia and Lessons for Africa, pp.1-165, Report prepared for Economic Commission
for Africa, United Nations, Addis Ababa, Nov. 1998.

______ (1999) East Asian Economic Crisis and Lessons for External Debt Management,
pp.77-95, in External Debt Management- Issues, Lessons and Preventive Measures,
edited by A. Vasudevan, Reserve Bank of India, Mumbai, April 1999.

_______ (2000) Role of Fiscal Policies for Management of External Capital Flows, in
Corporate External Debt Management, published by CRISIL, Mumbai.

144
Dasgupta, Biplab (1996). New Political Economy and the East Asian Development
Experience, mimeo, December 1996, New Delhi.

ESCAP (1992). Economic and Social Survey of Asia and Pacific 1991, Part 2, Challenges
of Macroeconomic Management in the Developing ESCAP Region, United Nations, New
York.

______(1993). Economic and Social Survey of Asia and Pacific 1992, Part 2, Expansion
of Investment and Intraregional Trade as a vehicle for Enhancing Regional Economic Co-
operation and Development in Asia and Pacific, United Nations, New York.

Fischer, Stanley (1998) Reforming world finance- lessons from a crisis,

IMF Survey, Special Supplement, October 19, 1998; reprinted from the
October 3, 1998 issue of the Economist, London.

International Monetary Fund (1997) World Economic Outlook- Globalisation,

Opportunities and Challenges, May 1997, IMF, Washington, D.C.

________(1998a) World Economic Outlook - Financial Crises, Causes and

Indicators, May 1998, Washington D.C.

_______ (1998b) Mitigating the social costs of the Asian crisis, Finance
and Development, Volume 35, Number 3, September 1998,
Washington D.C.

______ (2001a) World Economic Outlook, October 2001, Washington

D.C.

______ (2001b) International Capital Markets- Developments, Prospects

and Key Policy Issues, August 2001, IMF, Washington D.C.

______ (2001c) Direction of Trade Statistics Yearbook, 1996, Washington, D.C.

Islam, Azizul (1998) The dynamics of the Asian economic crisis and
selected policy implications, paper presented at the Expert Group
Meeting on “What have we learned one year into the emerging market
countries financial crisis?” 21-23 July 1998, United Nations, New York.

Kochhar, Kalpana; Loungani, Prakash, and Stone, Mark R. (1998) The

East Asian Crisis: macroeconomic developments and policy lessons,
IMF Working Paper.WP/98/128, August 1998, International Monetary
Fund, Washington, D.C.

Kumar, Nagesh (2001) Globalisation and Quality of Foreign Direct Investment, London
and New York: Routledge.

145
Neiss, Hubert (1999) IMF in Asian monetary crisis: current and future,
pp.1-17, in Asian Economic Crisis: In Search of Higher Competitiveness
in Global Markets, Asian Productivity Organisation, Tokyo, 1999.

Oman, C.P., Brooks, D.H. and Foy, C. (1997). Investing in Asia, Development Centre,
The Organisation for Economic Co-operation and Development (OECD).

Sadli, M (1999) The Asian crisis and the way to recovery, pp.25-35, in
Asian Economic Crisis: In Search of Higher Competitiveness in Global
Markets, Asian Productivity Organisation, Tokyo, 1999.

Stiglitz, J.E. (1998) South Asia beyond 2000: lessons from East Asia and
elsewhere, Keynote Address to South Asia Beyond 2000, Colombo, Sri
Lanka, 19 March 1998.

Takemoto, Motonobu (1999) Toyota’s commitment and challenges in

Southeast Asia, pp.67-74, in Asian Economic Crisis: In Search of Higher
Competitiveness in Global Markets, Asian Productivity Organisation,
Tokyo, 1999.

United Nations Conference on Trade and Development (UNCTAD) (1997) World

Investment Report 1997, United Nations, Geneva.

______ (2001) World Investment Report 2001, United Nations, Geneva.

Wei, Shang-jin (1997). Foreign direct investment in China: sources and consequences, in
Takatoshi Ito and Anne O. Kruger. ed., Financial Deregulation and Integration in East
Asia, Chicago University Press, Chicago.

World Bank (1997). World Development Report 1997, June 1997, Washington, D.C.

_____ (1998) Social Consequences of the East Asian Crisis, 1998,

Washington D.C.

_____ (1999) World Development Report 1999, Washington, D.C.

_____ (2000a) World Development Report 2000-2001, Washington, D.C.

_____ (2000b) Global Economic Prospects and the Developing Countries, Wash. D.C.

_____ (2000c) East Asia: Recovery and Beyond, Washington D.C.

_____ (2001a) Global Development Finance, May 2001, Washington D.C.

_____ (2001b) World Development Report 2003, Washington, D.C.

146
_____ (2001c) Global Economic Prospects and the developing Countries 2002, October
2001, Washington, D.C.

Yamazama, Ippie (1997). APEC and investment, in Investing in Asia, ed. C.P. Oman et.
el. 1997, OECD.

147
148