>> MIM Speaks
FOUNDATION FOR LONG-TERM GROWTH
JUNE 17, 2001 -
THE STAR
THE millennium opened with a tech bubble and almost euphoria
over the triumph of technology. I suspect that when we look
back into the end of the 20th Century, historians would
identify three inter-related trends: the triumphalism of
technology; globalisation; and the rise of the market as a
social institution.
These trends will have profound impact on the world, with
implications that we have not yet fully understood. Technology
and global markets have transformed our lives and the way we
look at the world.
Today, we take for granted that an investor can buy through the
Web almost any product from the rest of the world. It means
that a US company can outsource its manufacturing from
Malaysia, Mexico or Madagascar, and control its inventory on a
just-in-time basis, with real-time knowledge of consumer
patterns.
We even take for granted that the market is the accepted social
organisation to distribute goods and services, when not more
than 10 years ago, before the fall of the Berlin Wall, central
or social planning to allocate resources was still fashionable.
But if we drill down into these three trends, we Discover that
the reason why some companies and economies are more successful
than others is not that they have better technology, not that
they have superior resources or global reach, but because they
have better management or governance.
In the 21st Century, the competition between the Americas,
Europe and Asia will intensify. Asia accounts for more than 55%
of world population and one quarter of market exchange rate
weighted global world income and world exports.
In purchasing power parity terms, Asia would account for just
under one-third of world income. It also accounts for more than
half of total official foreign exchange reserves.
But in the financial sector, despite huge domestic savings and
almost no overall balance of payments deficits, the financial
markets in Asia are still small compared to the huge equity and
pension markets of Europe and the Americas. In the Morgan
Stanley Capital Global Index, Asia accounts for only 16%, while
the US accounts for just under 50% and EU just under 30%.
Despite such strong growth, hard work and high savings, Asia
still ended up with a financial crisis.
Cliches such as crony capitalism and poor corporate governance
have been thrown in as explanations. But we need to go deeper
into the role of high quality information and the proper
functioning of financial markets to have an appreciation of why
well-functioning and complete financial markets matter.
So, my key propositions are: First, reliable, accurate and
timely information is a market fundamental;
Second, the production of good quality information, requires
good governance;
Third, in globalised markets, the markets punish policy and
governance mistakes very brutally;
Fourth, while the need for good governance is universal, the
ability to achieve good governance is constrained by local
information, institutions, and the legal framework; and
Finally, good governance is like a Swiss watch - it is not made
overnight - it takes a whole infrastructure of checks and
balances to produce. We need to understand how governance and
process are inter-related in order to produce high quality
governance.
In this globalised world where everything is being benchmarked
to international standards, relying solely on "Asian values"
will not be sufficient to propel Asian economies successfully
into the 21st Century.
Markets and governance
Financial markets have five factors and four key functions.
The five key factors are what I call the five P's: People
trading Products, under a Policy and Prudential framework,
using certain Process or technology Platform to trade, clear,
settle and pay.
The four functions of financial markets are: resource
allocation, price discovery, risk management and corporate
governance.
People trade in markets under certain rules. All financial
contracts are property rights protected by the rules of the
game. These rules are shaped by the policies, regulatory
framework and the trading, clearing, settlement and payment
processes.
If investors feel that their property rights are not protected,
that transaction costs are very high, and that it is not a
level playing field, they will simply avoid that particular
market.
Traditional economic theory emphasised the role of financial
markets in resource allocation and price discovery. But
markets have very major roles in risk management and corporate
governance.
For example, if macro-economic policies are bad, they add
policy risks which markets have to factor in. If the regulatory
framework is weak, and enforcement poor, then markets must
price in the risks of corruption, sudden regulatory changes and
costs of regulatory delays.
Moreover, if trading, clearing, settlement and payment Systems
are antiquated, obsolete and costly to run, they add costs to
transactions.
In sum, markets help in risk management and also price in risks
in key market factors. Once the risk is properly priced in, the
forces of supply and demand work to deliver a market price. If
not, liquidity simply dries up as buyers avoid the market.
Take the information cycle as a market process. We need quality
information to make good market decisions. Companies and
governments collect, collate, classify and disclose information
to the public to help the market function. The information is
analysed and important market decisions to buy, sell, hold or
invest are made.
Such decisions create new trades and generate new price
information. All these processes used to be manual and paper
based. The arrival of digital technology and telecommunications
reduced the costs of information collection, analysis and
dissemination, so that the markets became wider, involving more
market participants.
Taken to its logical conclusion, good information depends on
good processes, which require good governance or management to
produce. Conversely, bad management leads to the production of
bad information, which leads to market distortion.
Good governance is a foundation to long-term growth and
stability. A recent World Bank study across 150 countries, for
example, found evidence of a strong causal relationship between
better governance and better development outcomes.
Companies are now larger than economics. Microsoft, with a
market capitalisation of more US$600bil at its peak, qualifies
to join G-7. Fidelity has US$1tril under management, slightly
less than three times the foreign exchange reserves of Japan.
Global companies have become global investors, and their
movement of capital flows action to bad news can bring about
market panic and crises. Markets hate surprises, and react
poorly to countries with major governance issues. In market
parlance, when in doubt, sell out.
Corporate governance in Asia
Any discussion of corporate governance in Asia cannot avoid the
fact that the majority owners of listed companies in Asia are
either family-led or state-led. Indeed, significant parts he
Asian banking system is also heavily cross-linked with family
groups or state-owner. In Asia (ex-Japan), roughly 60% of the
total market value of the equity market is held in the
proportion of 20% or more of the equity the company, by
family-led companies. Compare this with US at 18.3%; Australia
at 12.2%; zero in the case of the UK.
In the banking sector, family-owned banks account for more than
one-third of the banking systems in Thailand and Indonesia.
Unfortunately, the state has had to intervene more in ownership
of banks through bank restructuring in the wake of the Asian
crisis.
Various studies argue that the close relationship between the
state and holy groups create conflicts of interest that put
minority interests at a huge disadvantage. They suggest that
these relationships could involve excessive or imprudent
risk-taking at the expense of the public.
How family and state-led companies can evolve to meet ruthless
competition from multinationals with global reach and superior
technology is obviously the key question facing all smaller
economies.
Old habits die hard. The Asian Miracle was built on a
mercantilist model of self-help in the face of adversity.
Asian corporate and social governance have always been
paternalistic in behaviour. From the Japanese Meiji reform
onwards, father-figure governments helped hard working family
groups to export as the way to gain foreign technology and
markets. Domestic banking systems helped finance such
industrialisation, which worked brilliantly until the 1990s.
But the Asian crisis demonstrated that the chaebols, keiretsus
and kongloms, which rose in prominence through political
connection, market protection and huge banking support, could
impose large costs on society through their failure from
excessive risk-taking, leverage, and inefficiencies.
Paternalistic values are having a hard time competing against
changing technology and global markets. Local companies wishing
to be global can no longer rely on family members or local
talent to take them to new heights.
Local management talent is less and less bound by family,
corporate or national values, when they feel that their career
is constrained by an incompetent superior appointed for family,
political or whatever reason.
There are global headhunters willing to offer them global pay
and global career prospects. Increasingly, companies that want
to go global must adopt global standards of behaviour and use
global management talent.
(Next: Three disciplines of corporate governance)
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