Monday September 14, 2009

Look East no more?

Hock's Viewpoint - By Cheong Khuat Hock

We should look everywhere for relevant lessons but stay nimble enough to change directions

IN the late 1980s, Japan, at the height of its economic prowess, could do no wrong. Malaysia and even the West were emulating the Japanese way of doing things. Our then prime minister Tun Mahathir Mohamad even instituted the “Look East” policy where Japanese business practices and policies were encouraged.

It is true that Japan under the Liberal Democratic Party (LDP) enjoyed one of the strongest growth rates in the 1960s until the 1980s and the Japanese manufacturing sector introduced revolutionary concepts like “just-in-time” manufacturing that improved productivity and reduced inventory levels. Japanese innovativeness and focus on research and development (R&D) propelled the country into an exporter of high-tech products resulting in Japanese companies dominating the motor and many electronics industries.

Just as we learn from Japan’s successes, we have just as much to learn from its failures, especially when some parallels can be drawn between Japan and Malaysia.

First, Japan’s growth in the late 1980s was largely due to private sector speculation on real estate. The Keiretsu system, where Japanese conglomerates, often including a bank, were supporting each other, meant that restructuring was slow as banks were reluctant to call in loans of affiliates.

Unfortunately, the United States did not learn the dangers of an asset and debt bubble from Japan and low US interest rates and lax controls resulted in a massive housing and debt bubble in the United States, which resulted in a global recession when the bubble burst. Chart 1 shows the subsequent private sector deleveraging in Japan lasted over 10 years and a similar deleveraging in the United States points to a slow recovery in the real economy.

Second, using fiscal stimulus as a means to revive the economy can be ineffective as was the case in Japan. Many governments use fiscal stimulus as a means of rewarding cronies and the LDP in Japan was no different.

The LDP government used fiscal stimulus to benefit allies in the construction and rural sectors. Contracts were given to build bridges-to- nowhere, resulting in money being wasted on projects with little economic returns. As a result, government debt to gross domestic product (GDP) in Japan rose from 60% in 1990 to 182% in 2008 (see Chart 1), representing a huge financial burden to future generations.

Malaysia’s Government debt to GDP is still manageable at around 50% but relatively high budget deficits since 1998 (see Chart 2) from expenditures rising faster than revenues has resulted in a steady rise in government debt. Malaysia’s fiscal stimulus is expected to result in a large budget deficit estimated at 7.6% of GDP in 2009 (the highest since 1987) and like Japan, the bulk of the funding will be financed by domestic savings.

Are we spending the fiscal stimulus on projects that result in economic returns? We have to ask hard questions like whether a double-tracking railway from Ipoh to the Thai border costing RM12bil will result in the same economic return as a similarly priced fast speed railway from KL to Singapore.

Third, the LDP government, which successfully guided Japan to First World status in the first 30 years in power, failed to reform the factional and patronage system within the party. Ultimately, its failure to extricate Japan from economic stagnation since 1990s and the current recession caused by a collapse of Japanese exports resulted in the LDP losing power after being in power for 50 years.

This is indeed a warning to all long-serving governments including that of Malaysia that past performance alone is not enough to guarantee re-election as voters with a short memory expect an effective government that can deliver economic growth.

Lastly, Japan could be suffering from a long-term decline due to demographics. Unlike the United States, which is a more open society with a rising population due to immigration, Japan seems keener to maintain its homogeneity at a time when its population is declining because of a low fertility rate.

Japan’s population peaked at 127.8 million in 2004 and is expected to fall by 25.5% to 95.2 million in 2050. With the percentage of Japan’s population aged above 65 expected to increase from 22% to almost 40% by 2020, productivity improvement is difficult.

Unless the earnings of intelligent Japanese robots can be included in its GDP calculation, China is expected to overtake Japan next year as the world’s second largest economy. Fortunately, fertile Malaysians are preventing a demographic problem in the country for now.

Look East we still should but not to blindly follow Japan’s policies. Japan’s lean manufacturing processes, R&D commitment, branding and nurturing of local companies are still relevant today.

At the same time, we should also learn from its mistakes like the dangers of an asset and real estate bubble, ineffective use of fiscal spending and a government paralysed by factional fighting and patronage.

Look East also at emerging China to see how we can position ourselves to complement rather than compete directly with the emerging giant. In fact, we should look everywhere for relevant lessons and be nimble enough to change policies as policies that worked in the past may not work now.

Choong Khuat Hock is head of research at Kumpulan Sentiasa Cemerlang Sdn Bhd.

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