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Send comments to: William Gamble, J.D., LL.M. Tel 401-272-8906 Fax 401-272-8139 |
William Gamble, J.D., LL.M. |
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September 2, 1997 [home] Relationship Protecting Effects of Size on Asian Restructuring Biologists often extol the virtues of biodiversity. It is nature's cushion. It helps protect nature from sudden changes. For example, sudden changes in climate or a new disease might be devastating if the few species could not adapt. The catastrophe of the Irish potato famine occurred because the few varieties of potatoes planted were all susceptible to the same disease. Apparently, there is a similar effect in economics. Certain economic systems, either by chance or design, have created structures that are dependent on a few large enterprises. When these large enterprises experience periodic downturns, the effects can be disastrous for not only the firm, but the country as well. For the past year we have been treated to the spectacular collapse of these dinosaurs. In this millennium extinction it seems that only the smaller more flexible enterprises have a chance to survive. It was not always this way. The industrialization of much of the post war world has been based on the concentration of economic power in a few organizations. Under the communist system in Russia and China, it was felt that industrial behemoths would have the economies of scale to undertake the process of industrialization. South Korea followed a similar path. With the concentration of development by government design in the few huge Chaebols, it was felt that the few resources of a small underdeveloped country could be used efficiently. Japan developed the keiretsu system probably more as a cultural process than government policy. Under this system, groups of companies often from different industries ban together to form large interrelated groups that can, and often do follow a concerted path of action. Encouraged by the Ministry of Industry and Trade (MITI), these organizations seemed unstoppable as they gobbled up one market after the other. In Indonesia, the process was driven by greed and consolidation of power. Suharto's cronies and family eventually had a finger in every pie. Large government subsidies were doled out to monopolies controlled by the favored. Then it collapsed. Janet Yellen, Chair of the Council of Economic Advisers, has referred to one of the fundamental causes of the East Asian crisis as something called "Relationship Lending." Ms. Yellen defines this process as "centralized and behind-the-scenes mechanisms for the allocation of capital." As a result of this process in Russia, China, South Korea, Japan, Indonesia and other countries, large amounts of cheap loans were placed on risky investments or often just squandered. Unfortunately, since these systems encouraged concentration of capital, the failure of these massive interconnected enterprises has had a catastrophic impact. When these enterprises collapse, they take not only their bankers, but often their currencies with them. Worse, "Relationship Lending" has a flip side. In my comparative studies of bankruptcy systems, I have found the process of "Relationship Protecting." Normally, recessions are viewed as the plumbing of economics. They drain out of the system the inefficient and allow for the reallocation of capital and labor to the most efficient enterprises. A bankruptcy system is most successful when it can quickly and cheaply accomplish this reallocation. "Relationship Protecting" is the greasy clog in the system. The bureaucratic, commissar, crony, oligarch, dictator or related firm that helped provide the loan, now protects the insolvent firm when the money is gone. This top down process insures that taxpayer or depositor money is thrown away propping up firms and their banks. Consequently, the global landscape is haunted with monstrous zombies sucking their country's economic life blood. In contrast, Taiwan where over 95% of the companies are small to medium size firms, firms do not have the economic, political or the connections to either secure risky loans or protect themselves from going under. As a result the smaller firms not only are sufficiently flexible to take advantage of changing markets and economic environments, their collapse does not risk any bank's capital, the country's currency or the taxpayer's money. Despite an archaic bankruptcy system, cultural impediments and moderate corruption, Taiwan manages to kill off 4.7% of its businesses, ten times the number in Korea. So flexible is the system that according to a paper by Bee Yan Aw, Xiamen Chen and Mark Roberts, in 1991, 38% of textiles and 54% percent of the fabricated metals in Taiwan were produced by companies that didn't even exist five years before. Taiwan's growth rate is projected to be over 5% this year. In a system that encourages economic diversity (econdiversity?) this should come as no surprise. Nor we be surprised by the continuing problems of the formerly vibrant centralized economies. Like an effective democracy, power should be divided. As long as capital is concentrated and allocated according to the whims of the connected and powerful rather than by the market, the death of the dinosaurs will be protracted and painful. Rather than providing funds to bail them out, their governments should encourage their demise and promote smaller more flexible diverse set of economic mammals instead. By: William Gamble Emerging Market Strategies Company 1990 Pawtucket Avenues, Suite 1D Tel. 401-272-8906 This article can also be found on the University of Virginia Darden School of Business Administration Alumni Forum and in the EMS Newsletter. Some of these articles are referenced in Professor Roubini of New York University Stern School of Business Administration Asia Crises Home Page and in the Providence Journal - Commentary Section. |