By Kanes
There are many policy makers and economists who argue that South Asia has failed to achieve high growth rates of East and South-East Asia because it has not liberalized, deregulated and privatized enough to integrate with the world economy or to globa-lize. It is a fact that South Asia has liberalized less than East Asia, attracted less foreign capital investment, achieved lower growth and has lower income and living standards. The GDP per capita in East Asia (including South-East) was $740 or more than double that of South Asia - $360 in 1995. The average economic growth per year in East Asia in 1991-95 was 10.5 per cent or more than double South Asia's 4.6 per cent. Net long-term resource inflow in 1995 for East Asia was $84.1 billion or 7.6 per cent of GDP while it was $5.1 billion for South Asia or 1.9 per cent of GDP.

Let us compare South Asian countries with the rapidly growing East Asian ones. GNP per capita in Malaysia was $4370 in 1996 as compared to $740 in Sri Lanka and to $380 in India. Average annual growth rate of GDP in 1990-1996 in Malaysia was 8.7 per cent while it was 5.8 per cent in India and 4.8 per cent in Sri Lanka. Malaysia attracted $40.2 billion in foreign direct investment in the eight years 1990-1997, Indonesia $26.5 billion, and Thailand $17.1 billion whereas India received only $9.1 billion. As mentioned, last week, India had only 926 affiliates of transnational corporations whereas South Korea had 3671, Singapore 10,709 and China 15,966. The greater part of foreign direct investment in East Asia was in export-oriented industries and its economic growth was thus export-based. Rapid economic growth based on exports enabled East Asia to reduce the proportion of people being below the poverty line ($1 at 1985 prices per day) from 57.6 per cent in 1975 to 21.2 per cent in 1995. The proportion of absolutely poor in South Asia by contrast in 1995 was about 43 per cent.

East Asia Was Not Fully Liberalized
Is the high level of foreign investment in East Asia the result of liberalization? It appears as if the importance of liberalization has been exaggerated when we consider the following facts. The first is that while East Asian countries have liberalized their financial sector, they have not fully liberalized the other sectors. Some of them maintain high tariffs and import restrictions. The weighted mean tariff on all imported products in Thailand for instance was 41.5 per cent in 1993 which was even higher than that of Sri Lanka - 23.0 per cent. Further, countries like South Korea had rigid import restrictions on goods which competed with their industries.

The East Asian countries are also well known for the important role played by the State in guiding, supporting and protecting indigenous enterprises and actively participating in economic activity. In Malaysia for instance, State owned enterprises accounted for 26 per cent of total investment in the country in 1990-1995; the proportion in Indonesia and South Korea was about 15 per cent. In Indonesia State-owned BULOG has monopoly in the import of basic foods - rice, wheat, corn, sugar, soyabean and fishmeal. The government of Singapore owns the greater part of Singapore Airlines - the most efficient airline in the world - and the Development Bank of Singapore - the largest bank in South-East Asia and is a shareholder of most of the leading firms. Few are aware of the fact that the government and government linked businesses create about 60 per cent of Singapore's GDP.

Some of our political leaders and policy makers have taken Singapore as a model for Sri Lanka mistakenly assuming it to be a free market economy. Further, most of the East Asian countries have restrictions on foreign ownership of property. In South Korea foreign ownership for land is severely restricted only for business purposes; thus, only 0.039 per cent of national land belong to foreigners. Malaysia has limited foreign ownership of local banks to 30 per cent. In Thailand, overseas firms cannot purchase property directly; they must form joint ventures with Thai parties who must hold the controlling stakes. Alternatively, a foreign company can own 100 per cent of a property by entering into a 30-year lease arrangement. Further, there are limitations imposed on foreigners in the stock exchanges of both Korea and Taiwan.

These restrictions on foreign ownership, tariff, import restrictions and State intervention apparently have not discouraged foreign investment in these countries. In fact over the past 20 years, some 80 per cent of the manufacturing investment in Singapore has come from transna-tional corporations.

The second and the more puzzling fact is that China which maintains a dirigiste or centrally controlled economy and is far from liberalized, attracts more foreign direct investment than any other developing country. In 1990-1997, it attracted $199 billion in foreign direct investment while India received only $9 billion. Further, as mentioned earlier there were 15,966 affiliates of transnational corporations in China and only 926 in India. Similarly, Vietnam, another centrally controlled economy where liberalization is virtually unknown, attracted $11 billion in foreign direct investment in 1990-1997 or higher than India. This seems to indicate that foreign investors do not regard lack of liberalization as a deterrent to investment.

The third is the case of Sri Lanka which has liberalized the economy since 1977 to makes it the most liberalized economy in South Asia. It is, however, significant that despite this liberalization, it has failed to attract foreign investments as it had hoped. In the eight years 1990-1997 it received only $0.8 billion when Malaysia attracted $40.2 billion. In the year 1996, foreign direct investment was 0.9 per cent of GDP in Sri Lanka as compared to 4.5 per cent in Malaysia and 10.0 per cent in Singapore. Hong Kong which is a free port attracted only $2.6 billion in foreign direct investment in 1990-1997 whereas Singapore, another free port, attracted $52.4 billion in the same period. Clearly, there are factors other than liberalization which induce foreign investors to invest in a particular country.

Risks of Financial Liberalization

It has been argued that the liberalization of the financial sector in East Asia was the main factor responsible for the inflow of foreign capital and high economic growth. If financial sector liberalization caused the economic boom, it was also responsible for the bust - the current economic crisis and negative growth. Financial sector liberalizations in East Asia opened the door not only for foreign direct investment in development projects but also for speculative short-term capital flows to the stock markets and liberal foreign bank loans to domestic banks and forms. In 1995 for instance, portfolio equity flows to East Asia amounted to $14.7 billion compared to $2.3 billion to South Asian and net debt flows to East Asia amounted to $17.6 billion as compared to $1.1 billion to South Asia.

It was the heavy presence short-term capital an large foreign debts of banks and firms which fuelled speculation to cause the currency crisis. The sudden flight of short-term capital from East Asia, estimated at $203 billion, and the consequent depreciation of currency and the collapse of the stock market led to bankruptcy of firms, default of loans, bank failures, restriction of credit and economic depression.

East Asian economies which achieved very high growth rates of 8-10 per cent a year are now experiencing negative growth: Indonesia - 15 per cent, Thailand - 8 per cent, South Korea-7 per cent Malaysia-2 per cent and Hong Kong-2 per cent with no prospect of early economic recovery. Unemployment is estimated at 22 per cent or 20 million in Indonesia, 10 per cent or 2 million in South Korea, 5.6 per cent or 3 million in Thailand, 3.5 per cent in Malaysia and 4.2 per cent in Hong Kong. These countries had near full employment before the crisis. A substantial part of the progress made by these countries in the last 30 years is being wiped out by the current crisis, and the people are facing a bleak future. In Indonesia, for example, people living below the poverty line were reduced from 64.3 per cent in 1975 to 11.4 per cent in 1995, but the prevailing crisis has increased it to 40 per cent now.

Speculative Capital Movements
If slow liberali-zations was responsible for the trickle in foreign investment to South Asia, it was the same slow liberalization that saved South Asia from the Asian financial crisis. South Asia, unlike East Asia, has not liberalized its financial sector, and it maintains control over capital movements; such controls enabled her to prevent excessive inflows of speculative capital and excessive foreign bank borrowings by domestic banks and firms and maintain stability (like China). A distinction should be made between longterm foreign investment in industrial and other projects which are of a durable character and short-term speculative capital and foreign borrowings. While long-term foreign direct investment for national priority sectors should be encouraged, short-term capital and borrowings should be regulated to reduce the risks to the country's economic stability from the volatile nature of short-term funds.

The hazards of short-term capital movements are well known. They tend to exert pressure on the exchange rate when they exceed the current account deficit and create an overvalued currency which may reduce the international competitiveness of the country's exports. They tend to increase the liquidity of the banking system which could stimulate excessive credit expansion. They tend to hide the underlying structural deficiencies of the domestic economy and lull policy makers into the belief that they have more time to make the necessary structural adjustments.

They destabilize the domestic financial system and reduce the reliability of conventional indicators such as money supply, short-term interest rates and the yield curve as a basis for monetary policy decisions. The volatility can hurt the process for capital market development; excessive dependence on portfolio investment tends to artificially heat the market and push up prices to abnormal levels. Financial structure of companies tend to get distorted with too much dependence on equity financing even for working capital purposes. Detailed studies of the experience of different countries show stock market booms do not generate additional saving or more efficient allocation of investment or disciplined corporate management.

On the contrary, excessive stock market activity encourage corporate bodies to expand or diversify through take-overs rather than through organic growth. That liberalization or globalizatin has risks which a developing country must guard against is the lesson that South Asia can learn from the Asian currency crisis. It is difficult to understand why the IMF is pressing East Asian countries to eliminate all controls over cross-border money movements when it had previously approved Chile's tight regulation of short-term foreign borrowing.