Why Asia has been missing out on the global value chain

Of course, forward-looking government policies to open up to foreign manufacturing, and attention to social infrastructure and education, helped to equip Asian economies. They learned and slowly moved up the value chain.

The Japanese export-led manufacturing strategy was successfully imitated throughout East Asia. In the famous flying geese formation, the four "Dragon" economies - Taiwan, Korea, Hong Kong and Singapore - were followed by four "Tigers" - Malaysia, Thailand, the Philippines and Indonesia. These countries rapidly formed a global supply chain. China did not emerge as an export giant until the early 1990s, but today forms the core of the supply chain through its sheer size and market capacity. No regional corporation with global ambitions can ignore its China strategy.

South Asia took a slightly different path. Heavily influenced by Fabian socialist philosophy, the region adopted a protected import-substitution strategy, so that its manufacturing prowess could not compete with East Asia.

But India was able to find a market niche in IT services, exploiting its human talent in science and mathematics and in knowledge based work. Nevertheless, Indian manufacturers, particularly the family companies, have become formidable competitors globally in steel and other areas.

But the Asian corporate and economic strategy had a fundamental flaw. In mobilising savings to invest in manufacturing, East Asian governments typically protected the services and distribution sectors, so that the financial sectors were not well developed. The result is that trade surpluses generated from manufacturing exports remain largely utilised via Western banks and the financial centres of London, New York, Hong Kong and Singapore, rather than through domestic capital markets.

Ultimately, this dualistic strategy - strong in manufacturing, weak in financial services - led to the Asian crisis and also the global imbalance. Of course, the Western banks also failed because they did not utilise their savings in a prudent manner. But Asians must understand where they failed before we can avoid the same mistakes.

As my forthcoming book - "From Asian to Global Financial Crisis" to be published by Cambridge University Press in the autumn - will demonstrate, the global supply chain is a network and the Asian and current financial crises are, in effect, network crises. First of all, Asian manufacturers learnt that Metcalfe's Law works through the cluster and economies of scale effect.

Metcalfe's Law states that the value of the network is exponentially related to the number of users. In their search for scale, Japanese, Korean, and now Chinese, firms have expanded at almost any cost, very often through high leverage, incurring huge risks.

But if you look at value chains, you discover three key parts - manufacturing, distribution and trading. A T-shirt could cost less than US$1(Bt34) to manufacture, but the distribution, marketing and trading costs will take more of the margin, so that the final product could be sold for $20-$100 depending on the design, branding and quality. You can imagine how much profit the cotton farmer gets from his sale of raw cotton.

East Asian corporations are waking up to the fact that as their production becomes commoditised, and even high-value items such as mobile phones and computers have become commodities, the value chain, or profit, lies more in the trading and distribution side. The key question is whether these corporations have the skills and ability to exploit value in this part of the game, which is currently dominated by Western firms. This is not for want of trying.

Japanese manufacturers initially used trading houses (sogoshoshas) such as Mitsubishi and Mitsui to source their raw materials, and in-house banks to finance their trade.

Gradually, as the manufacturers gained confidence, they established their own distribution chains, so that you can now find Sony and Toyota manufacturing and distribution companies throughout the world. The relative role of the trading houses diminished, but not before a few, like Sumitomo, lost money by trading in commodities.

In my experience, one thing is remarkable - that Asian corporations have not yet established world-class trading companies. The reason is that the trading side is the most knowledge intensive and individualistic part of business. This is not to say that a few, like Li and Fung, have not been pioneers in the distribution and services sides of the export supply chain.

But it is obvious that despite the efforts of, particularly, the Japanese and Singaporeans, no Asian houses have successfully established investment banks or made consistent large profits in proprietary trading on a global scale. Hong Kong's home grown investment bank, Peregrine, imploded in 1998. You only have to read the autobiography of Robert Rubin - "In an Uncertain Age", 2003 - in which he describes how he grew up under the tutelage of traders and bankers, before you realise the specialist and deep knowledge embedded in old houses like Rothschild, Morgan and Goldman. It takes a lot to breed a great trader; so much easier being a property developer.