Japan's unemployment continues to rise to historic highs. One of South Korea's largest conglomerates is teetering on the brink of collapse. And Thailand's bad debts keep rising.

So why have foreign investors--who fled the region in a panic two years ago at far less grim news--been returning in droves over the past eight months?

For starters, lower interest rates, increased government spending and stable currencies have helped restore growth to much of the region.

But while these indicators are welcome news, many foreign investors say their big financial bets are grounded in something deeper--a belief that Asia's two largest economies, Japan and South Korea, are moving toward more free-market systems.

They see a shift from a "Japan Inc." or "Korea Inc." economy, in which government officials protect key industries and decide which companies prosper, to one in which financial outcomes are determined by the markets. Many economists and investors believe such movement, if real and long-lasting, could provide the foundation for a sustained regional economic recovery and stronger global growth.

In Japan, for example, new accounting and disclosure rules are forcing companies to cut spending and employees--a radical change in a country where lifetime corporate employment had long been guaranteed. New laws making it easier to spin off, split up or reorganize bankrupt companies are helping to bring in new sources of capital.

In South Korea, foreign money began pouring back in after the government agreed to remove barriers to foreign investment, deregulate markets and force companies to disclose far more about their financial condition.

Some experts say these changes and others are the first steps in an economic restructuring that will take years, and that the region's economies have a long way to go before they become healthy.

But others, especially many Western money managers and consultants who spend long hours with Japanese and South Korean executives, insist they see an unmistakable change in thinking. These days Japanese executives constantly talk about returns on equity and returns on assets, terms rarely heard in Asia before the crisis. Western fund managers said they used to be ignored by Asian companies, but now they get frequent calls asking for advice.

"Two years ago, Korean managers weren't familiar with the idea of operating a company to increase shareholders' value," said Michael ByungJu Kim, head of Asian operations for the Carlyle Group, the Washington-based investment firm, which has raised $1 billion to buy companies in Asia, largely in South Korea and Thailand. "That's changed significantly."

In the past, Asian governments often tilted laws against outside investors and protected domestic companies by allowing them to hide their problems. Now, numerous American executives in Japan say they are struck by the new attitude toward foreign investors.

Charles Schwab Corp., the largest U.S discount brokerage firm, is planning a push into the Japanese market this fall. In the past, the Japanese government might have tried to slow Schwab's entry, to give a head start to Japanese competitors. But on the contrary, a Schwab spokesman said, "the Finance Ministry people are almost like missionaries these days. They are looking for people to come in, and they are trying to do everything in their power to smooth the way. They're like bush clearers."

This year a number of private equity and venture-capital firms, such as Patricof & Co. and Rothchild, have come here looking for investment opportunities.

"This is a relatively new phenomenon. Several of these groups have recently moved into Tokyo, set up shop and have good pools of money, and are ready to invest in ideas," said Timothy McCarthy, a former president of Charles Schwab, who has spent years doing business in Asia.

"So now, if you have a really good idea, know how to put it together, you can get the money. That's a huge change for Japan," said McCarthy, whose information technology company sells software and systems to Japanese firms that want to provide Internet stock-trading services.

More fundamentally, the Japanese government is forcing companies to change the way they do business, for example by requiring that companies report consolidated earnings, disclose massive pension liabilities and value assets more accurately.

In addition, the unexpectedly tough stance of the Financial Supervisory Agency, an independent regulatory agency, has shocked financial institutions into realizing that cooking the books, as they did in the past, could now put them in legal hot water.

Global financial markets also are making it tough for banks to continue to supply loans to money-losing companies because of "long-term relationships" or cronyism.

Because the banks are so weak, companies are turning more to stock and bond markets to raise money, forcing them to pay more attention to shareholders. In the past two years, companies abruptly learned that a downgrading from such bond rating agencies as Standard & Poor's Corp. or Moody's Investors Services Inc. meant "their financing costs increased, and in some cases it was almost impossible for them to finance in the markets," said Tadashi Nakamae, head of a research institute here.

To try to improve their ratings, companies began shutting down unprofitable businesses, selling off subsidiaries, shedding employees and cutting capital investment sharply to become more profitable.

As a result, some analysts are predicting that Japanese corporations will register a growth in profits this year, a reversal after last year's sharp drop in earnings. And the Nikkei 225 stock index is expected to climb toward the 19,000 mark, a level not seen since before the Asian financial crisis began two years ago.

"I think that earnings hit bottom in the fiscal year ending in March. Companies are clearly focusing on maximizing profits rather than on maximizing employment," said Garry Evans, chief strategist in Japan for HSBC Securities. "And government reforms are putting pressure on companies to continue to restructure."

This transition to a more market-based economy has forced Nissan Motor Co. into a merger with France's Renault SA; Japan's banking system could no longer prop up the debt-ridden Nissan, despite its status as Japan's second-largest automaker. It also meant that Japanese authorities did not intervene to block Britain's Cable and Wireless PLC's recent hostile takeover of a Japanese telecommunications company, something that probably would not have been permitted two years ago.

McCarthy also wears another hat. He is chairman of a Korean firm recently renamed Good Morning Securities, which is one small example of why South Korea is bouncing back faster than expected.

Good Morning Securities used to be called Ssangyong Securities, part of the Ssangyong Group, a debt-ridden conglomerate of family-run companies. Last year, the Ssangyong Group sold its securities firm to an investor group lead by Hambrecht & Quist Inc., the California-based investment bank.

To run the company, Hambrecht & Quist recruited Ki-Kwon Doh, a U.S.-educated Korean who had worked for Citibank for 15 years in Seoul and Bangkok. Doh has done some things that Asians fear from Western-trained presidents. For instance, he hired a U.S. human resources consultant to transform the firm's personnel system from one based on seniority to one based on merit.

Doh did not, however, display the slash-and-burn instincts that Asians associate with U.S. management styles. Instead, he persuaded the board to hire 200 new sales and marketing people, and to increase the marketing and information technology budgets, providing a tiny boost to the economy.

Meanwhile, South Korea's second-largest conglomerate, Daewoo Group, is being dismantled by creditors in a process being closely watched by international investors as a test of the country's commitment to financial restructuring.

Before the Asian financial crisis, such conglomerates, called chaebol, dominated the economy, in part because of their close relationships with the government and the banks. But South Korean President Kim Dae Jung, who has invited foreign investment and pressed for financial reforms, said in a speech Sunday, "The concentration of economic power in the chaebol is no longer accepted by the market."

Skeptics continue to question whether the changes underway in Japan and South Korea represent long-lasting, fundamental reform. But in both countries, many Asian analysts and fund managers say they are betting that the new laws and regulatory agencies will make it harder to pursue the old practices.

In Shibuya, a busy section of Tokyo, a wide range of respondents agreed that the shift to a market-based economy was inevitable.

"The old system wasn't good," said Tomoya Oji, 32. Oji added that he was a bit apprehensive about the unfamiliar world of free markets. "Since we haven't experienced the new system yet," he said, "it's hard to tell if I will like it."

Others, however, said they expected the change to be liberating. Hiromi Akiba, a 49-year-old manager at a computer company, said that Japanese have become too passive under the old system, where the government decided everything.

Koji Keira, 27, a travel agency staffer, agreed: "The direction is good, because now individuals will have to take more responsibility for their own actions and their own future."

While Japan's high unemployment rate has persisted ...

... joblessness has started to ease in such Asian countries as South Korea and Hong Kong ...

...and the markets of many Asian countries have rebounded this year:

Percent change

Year to date

South Korea (Korea composite) 49%

Indonesia (Jakarta composite) 42

Singapore (SES all share) 39

Malaysia (Kuala Lumpur composite) 33

Japan (Nikkei 225) 33

Hong Kong (Hang Seng) 27

Thailand (SET) 15


S&P 500: 9%

SOURCE: Bloomberg News