Why the Asian model has gone off the road

Diane Coyle on Yamaichi securities
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The collapse of Yamaichi Securities, one of Japan's biggest stockbrokers, is anything but a surprise. Seriously ailing for at least three years and loss-making since 1991, its official bankruptcy is a merciful release. The Japanese authorities should have put it out of its misery long ago. The fact that they did not, and indeed allowed it to disguise the extent of its financial difficulties for so long, justifies a damning verdict of Asian-style capitalism.

The same verdict applies to South Korea, now reluctantly applying to the International Monetary Fund for an emergency loan because the majority of its big banks are technically bankrupt. The government has used the financial system to channel funds to the huge industrial conglomerates, the chaebol, which used the apparently limitless supply of cheap funds to expand into frankly unprofitable activities.

Throughout much of Asia, banks and finance houses have over the decades provided the ammunition for big companies' conquest of an ever-increasing share of world markets. It has long been fashionable in some quarters in the West to praise extravagantly the long-termism of the Japanese financial system, in contrast to the disloyalty and greed supposedly displayed by shareholders in Western companies in their hunt for a quick profit. After all, the financial support from banks that have made long-term loans and bought shares in their client companies accounts, for example, for the dominant Japanese and, lately, Korean position in the manufacture of cars and consumer electronics. This achievement, the argument goes, could never have been achieved if the corporations had been forced to deliver a short- term profit to shareholders.

But the new crisis should finally lay to rest this unquestioning worship of Asian values. The long-term relationships between banks and corporate borrowers have turned out to be a cover for cronyism at best, crime and corruption at worst. These evils have been a common factor in each of the countries afflicted by financial crisis this year: from tiger cubs Malaysia and Thailand, through Indonesia, to industrial giants Korea and Japan.

Anglo-Saxon market values make for a more resilient economy. To see this, go back to the roots of Japan's troubles in the late 1980s. The boom in property and share prices gave Yamaichi and other financial institutions record profits in 1989. The bursting of the bubble plunged them into loss within a couple of years as the massive loans they had made, secured on shares and real estate, turned bad.

A swathe of lenders specialising in property should have gone under almost immediately, but it was not until the end of 1994 that two credit unions collapsed. Only a handful of other small banks and brokers have been closed and taken over since. It is only now that analysts see in yesterday's announcement about Yamaichi Securities a signal that Japan's Ministry of Finance will undertake brutal surgery to restore the financial system to health.

Contrast the much tougher approach the American authorities took to the "savings and loan" crisis. This too had its roots in excessive lending secured on the fragile base of soaring property prices in the late Eighties. It also involved widespread fraud and cover-ups by these local banks. The US banking regulators were not in a position to resist market pressures, and promptly set up the Resolution Trust Company, a taxpayer-funded body, to cover the bad debts and swiftly closed the duff savings and loans. In the end it cost under $20bn in tax dollars, far less than initial fears. And the US economy has being going from strength to strength for at least the past four years.

By preserving the network of long-term financial relationships, rather than taking similar brutal and early action, the Japanese government is going to have to ask its taxpayers for a much larger amount to rescue the country's financial system. According to Steven Bell, head of research at the investment bank Deutsche Morgan Grenfell: "The US institutions and the US economy are now very healthy, whereas the Japanese economy has been the most disappointing performer during the 1990s." And Keith Skeoch, director of research at HSBC Investment Bank, says: "The Japanese model has very little to recommend it."

Although there is no sign of an end to its recession, it would be a mistake to overdo the gloom about Japan. While the financial system has not reformed during the past decade, the big corporations have steadily extricated themselves from the banks' fatal embrace. Japanese multinationals, like their American or European counterparts, now meet their financial needs from the global capital markets. Japan is still a powerful and rich economy with a huge industrial base, and the future of companies such as Nissan and Sony is not under threat.

The outlook for South Korean industry is bleaker. Its conglomerates are likely to be severely damaged by the withdrawal of bank credit, as the IMF restructures the country's financial system. Korean companies will have to pull in their horns. The same goes for the smaller East Asian countries, where business activity is similarly dependent on having contacts in the banks. But whatever the various prospects, the real lesson of the Asian crisis is that the vaunted system of long-term links between banks and business, so much admired by Western critics of home-grown capitalism, has failed.

It is a lesson that applies to another system much admired for its long- termism. German banks are also famed for backing the companies which they support financially through thick and thin. Like their Japanese equivalents, they too have been able to exploit unpublished hidden financial reserves to disguise the true costs of doing so.

This has been fine as long as good times have followed bad. But rigid long-term structures are a burden, not a benefit, at times of fundamental economic change. And change, above all, characterises the late 20th century. Free markets, despite their warts and imperfections, make wiser investments. Bankers spend years playing golf, having dinner and exchanging presents with company executives they might have known since their schooldays. The virtue of markets is that their judgements are not distorted by personal sentiment - or bribery. In the face of today's huge technical, demographic and social changes, capitalism in its flexible, free-wheeling Anglo-Saxon variety is coming into its own.