(FORTUNE Magazine) – ASIA'S FASTEST-GROWING economies, the so-called little dragons of South Korea, Taiwan, Singapore, and Hong Kong, prospered for years with a simple formula: pump out cheap exports to the U.S. and Europe and let Japan take the heat. Inevitably the dragons' success triggered the same kind of protectionist backlash that has buffeted Japan. Their costs kept rising too. Wage increases in Taiwan, Singapore, and South Korea have outstripped productivity growth for several years. Countries with lower labor costs, including the People's Republic of China and India, have flooded export markets with cheaper clothing and shoes. The dragons' high-flying economic growth rates slowed to an average of 2.3% last year, down from nearly 9% a year for two decades. Still, the economic miracle is hardly over. Even with sluggish growth, the four dragons' 1985 exports to the U.S. totaled $41.9 billion, about 58% of Japan's. And they are adjusting their strategies with remarkable speed and effectiveness. Governments that tried to control everything are relying more on market forces. They are getting out of the way of entrepreneurs. Manufacturers are making older factories more efficient and producing more sophisticated products. To fight protectionism they are building plants in the U.S. and Europe and forming joint production deals with American and European companies. The dragons are going all out to develop new export markets, especially in China. The strengthening yen helps. The dragons' currencies have more or less mirrored the drop of the U.S. dollar against the yen. South Korea has received the biggest boost. The Korean won has depreciated some 35% against the yen in little over a year vs. 30% for the dollar, making Korean TVs and videocassette recorders much cheaper in the U.S. than Japanese exports. The drop of the won against major European currencies has given Korean companies an edge there, too. Japanese manufacturers are investing in the dragon lands to take advantage of weaker currencies. Sanyo is shifting production of some car stereos and telephones to Singapore, while Toyota is preparing to make components in Taiwan. Also known in Asia as the little tigers, the four countries have been lumped together because of their rapid growth and because they share Confucian values of diligence, education, and thrift. (China is the big dragon in Oriental tradition.) Still, there are large differences among them. With 41 million people, South Korea has a sizable home market. Tiny Singapore (pop. 2.5 million) must export to survive. Hong Kong, due to be given back to China by its British colonial masters in 11 years, has thrived as a freewheeling financial center for Asia. Taiwan has made it largely with small, family companies turning out cheap goods. Some of the dragons have slowed down more than others. Taiwan grew at a 4.9% rate last year. That was little more than half its 1984 pace but still good by world standards. South Korea's rate eased from 7.5% to 5%. Hong Kong's growth, on the other hand, tumbled from 9.6% to less than 1%. And Singapore's economy shrank 1.7% vs. an 8.2% expansion in 1984. This year Korea should grow about 7% and Taiwan about 5.5%. Hong Kong's rate could exceed 4%. Singapore may not grow at all, but it hopes to snap back in 1987. While economic adjustments are tricky enough, the dragons are also grappling with risky political transitions. Peking says Hong Kong can keep its capitalist system for at least 50 years after 1997. But nobody knows whether Chinese leaders of the future will honor that commitment, or if Hong Kong can retain its dynamism even if they do.

In South Korea and Taiwan, strong man rulers who have provided years of ! political and economic stability will be bowing out in one way or another in the next few years. South Korean President Chun Doo Hwan, 55, the dour general who took power in 1980 after a bloody coup, has promised to step down in 1988. But under present rules, his successor would be picked by electors he essentially controls. Students and other demonstrators have taken to the streets to demand direct elections. Getting the country back on a high-growth track may help Chun keep control. But opposition leaders have been emboldened by the fall of Ferdinand Marcos in the Philippines. In any case, widespread street demonstrations hardly boost productivity. Taiwan must find a successor to ailing President Chiang Ching-kuo, 76, son of Nationalist leader Chiang Kai-shek. The succession marks a generational shift. The new president will almost certainly be from a younger group of leaders who did not flee the mainland Communists with Chiang Kai-shek. Though the new generation has its share of hard-liners, Taiwan's younger politicians, as well as young entrepreneurs, tend to prefer trade with the mainland to conflict. In Singapore, Premier Lee Kuan Yew, 62, has kept a tight lid on the opposition since he led the country to independence two decades ago. Despite occasional grumbling at the government's heavy-handedness, Singaporeans generally went along with Lee's authoritarian rule as the price for the country's remarkable prosperity. As growth slowed, Lee knew he had to move quickly to keep criticism from turning into outright opposition. He not only began to move possible younger successors -- including his son -- into positions of power, he radically shifted economic policy. Singapore is the most striking example of the dragons' shift away from strong centralized economic control. ''Our government has decided to stop playing God,'' says the head of a local company. Instead of singling out industries to promote with tax breaks and low-cost loans, Singapore plans to cut everyone's taxes and rely more on private enterprise to figure out where to invest its money. Singapore is also encouraging workers to curb wage demands and even accept cuts. South Korea and Taiwan are also relaxing economic controls. Hong Kong never tried to direct its economy. More than ever before, the dragons are teaming up with Western companies. As one Korean corporate executive puts it, ''Together we can beat the Japanese.'' General Motors' new Pontiac Le Mans will move into U.S. showrooms next year from Korea, where labor costs are $2.16 per hour vs. $24.40 in the U.S. Ford will soon start making subcompacts for Canada in Taiwan. Inside Germany's Nixdorf computers are electronic components produced in Singapore. COMPANIES ARE investing in the West to leap over trade barriers and improve sales. Singatronics, a small Singapore electronics company, bought a major U.S. customer -- the medical products division of Timex. Eddie C.K. Foo, managing director of Singatronics, says the acquisition not only gives the company Timex's Healthcheck brand name for such Singapore products as digital thermometers, but also provides distribution channels into 20,000 drugstores in the U.S. South Korea's Pohang Iron & Steel has assured itself of a long- term outlet for partially processed products by investing $290 million for a half interest in U.S. Steel's cold-rolled sheet plant in Pittsburg, California. All the dragons are trying to make China a customer rather than an export rival, but it is no easy trick. Only Singapore has what could be considered normal relations with the People's Republic. Taiwan and Peking remain official enemies. As a longtime ally of North Korea, Peking does not recognize South Korea. And Hong Kong's relationship with the People's Republic is hardly relaxed as the clock ticks toward 1997. But China needs much of what the dragons produce for its modernization drive. Peking has been willing to gloss over political inconveniences, and the dragons have jumped at the chance. South Koreans invest in China through Hong Kong holding companies. Daewoo Corp., one of South Korea's most aggressive conglomerates, has quietly set up assembly lines for color television sets and refrigerators in South China. Hong Kong has already become the center for financing such deals. Peking encourages trade with Taiwan in the belief that such ties will eventually bring the adversaries together. For economic reasons, the government of Taiwan looks the other way when Taiwan companies sell huge amounts of goods to China.

The China market looks especially promising to Singapore. Singaporeans speak the Mandarin dialect of Peking, rather than the Cantonese dialect of Hong Kong that is common only in South China. Wearnes Technology, a Singapore computer company, is preparing to assemble floppy-disk drives just across the border from Hong Kong. Hoong Bee Teck, 35, the company's assistant general manager, says, ''Singapore is a logical conduit for transferring American technology to China. We understand both the Western and Chinese mentality.'' South Korea is clearly the strongest dragon, and much of its strength comes from its large conglomerates, called chaebol. Hyundai, one of those giants ($14 billion in sales last year), is squeezing the Japanese on the low end of the U.S. car market with the Excel subcompact. Chung Moon Doh, chairman of Hyundai Corp., the group's trading arm, says: ''There's no reason for losing to Japan in this game.'' Daewoo, the youngest and one of the biggest Korean conglomerates, thrives under all those pressures. Kim Woo Choong, 49, the founder and chairman, spends over half the year roaming the world as his company's highest-powered salesman. ''When times are uncertain, as they are now,'' he says, ''you have to seek out contracts. They won't come to you.'' Daewoo's exports jumped 16.6% to over $3 billion last year. Shipbuilding is a global disaster area. But Kim's persistence, and low prices, have landed $256 million in orders that will keep Daewoo's shipyard going full speed for the next two years. The shipyard lost money last year, but Kim hopes to get it into the black by tightening efficiency. Overseas construction work in the Middle East, another Korean specialty, is fading as oil prices drop. A risk-taker, Kim still has construction crews in Libya and Iran. ''Iran pays on time,'' he says, ''and there's no corruption.'' Linking up with Western companies, another of Kim's growth tactics, provides a steady stream of fresh business. Daewoo makes forklift trucks for Caterpillar and jet-aircraft body structures for Boeing. Next year's new small Pontiac will come from Daewoo Motor, a fifty-fifty joint venture with GM. Kim has three more joint ventures with GM. One will supply auto parts for the Korean operation, and two others will make parts for auto plants in other countries. Last year Daewoo Telecom designed an IBM-compatible personal computer, which Leading Edge sells in the U.S. Consumer Reports has described the machine, priced at under $1,500, as ''the best buy among IBM compatibles.'' The company plans to turn out over 120,000 this year. Daewoo is also acquiring ZyMOS, a U.S. microchip company.

Despite relatively low Korean labor costs, Daewoo Heavy Industries has developed its own industrial robots. Youngkook Kang, 45, senior executive managing director of the subsidiary, says he decided to build robots after Japanese suppliers told him, ''You're not ready for that.'' Daewoo sells some robots, but Kang says he builds them mainly for Daewoo factories. Using homebred robots, Daewoo Heavy has set up an automated line that produces several kinds of diesel engines simultaneously. TAIWAN has long been an export giant with pygmy industries. Thousands of family-owned firms make cheap running shoes, plastic bric-a-brac, and garments. Chao Yao-tung, 70, chairman of Taiwan's Council for Economic Planning and Development, says these companies are afraid to try anything more complex. ''They have no guts,'' he says. ''But our younger businessmen do.'' Government research organizations and private investors are leading Taiwan into new industries. The island's most ambitious project is a $200-million joint venture for making VLSI (Very Large Scale Integrated) semiconductors, which are used in computers. The Taiwan government wants to bring in Texas Instruments and Philips of the Netherlands as majority investors. Says Morris Chang, 54, president of Taiwan's Industrial Technology Research Institute, who is leading the negotiations: ''All the fast-growing Asian countries talk about technology, but Taiwan has the most scientific talent.'' No mere bureaucrat, Chang, a Stanford University Ph.D. in electrical engineering, spent 25 years at Texas Instruments and was president of General Instrument in the U.S. Last year he came home to help Taiwan push into more advanced industries. Chang intends to make chips for major computer and electronics manufacturers, which will supply the chip designs. ''Our strategy is to ally ourselves with international companies, not compete with them,'' he says. Chang figures that Taiwan's VLSI factory can start this year. He has a pilot production line, and his institute has already trained 200 engineers. The government hired Arthur D. Little, the Cambridge, Massachusetts, consulting firm, to help electronics firms diversify into such products as microprocessors that control facsimile machines, computer work stations, and ink-jet printers. Irving Ho, 65, president of the government's Institute for Information Industry, says: ''We'd like to have just 2% of the world market for information products.'' He expresses confidence that Taiwan can get that slice: $4.6 billion in sales of computers, peripherals, and components by 1989 vs. $1.3 billion last year. Automation has created a new business for Formosa Plastics Group, Taiwan's largest nongovernment corporation, with over $3 billion in sales last year. First the company hired Hewlett-Packard to train its engineers. The engineers then designed a computerintegrated manufacturing plant for making printed circuit boards. The resulting computer-controlled factory inspired a joint venture with Hewlett-Packard that helps other Taiwan companies automate. Singapore has an impressive long-term plan for exporting services. Its principal author is Lee Hsien Loong, 34, the Acting Minister of Trade and Industry and the premier's son. The younger Lee, educated in computer science at Cambridge University in England and in government at Harvard, says, ''We can't get out of this recession just with short-term solutions.'' With South Korea and Taiwan becoming more attractive factory sites, he says, Singapore must be ''a total business center,'' where multinationals can develop products and manage regional subsidiaries. Hong Kong, with its low business taxes and minimal regulation, has been a favorite headquarters city. Many U.S. companies, however, are beginning to prefer Singapore. More people speak English there than in Hong Kong, and the place is far more stable politically. Fairchild Semiconductor of Cupertino, California, uses its Singapore plant to develop production machinery for its other factories. Marcel Morrissette, director of Fairchild's Far East operations, says, ''Singapore is becoming the Asian headquarters for electronics companies.'' INCREASINGLY, Hong Kong is the most fragile dragon. It is becoming an economic outpost of China, which propels Hong Kong's growth but also reduces its independence. Hong Kong's 5.5 million people, who are predominantly Chinese, worry that Hong Kong will not be even remotely similar to what it is now after the Chinese take over. Hong Kong Chinese businessmen are reluctant to invest. To pump up business confidence, Peking has invested over $4 billion in Hong Kong over the past five years. China has even bailed out troubled companies, including a local bank, by acquiring them. A Western diplomat warns, ''In the long run, all that Chinese investment may not be in Hong Kong's interests. What overseas Chinese entrepreneurs do here now is world class, but it won't be if they spend most of their time working through their less sophisticated relatives in China.'' For now, Hong Kong's ethnic Chinese manufacturers survive by rapidly adapting to challenges. They cut costs by farming out labor-intensive parts of toys and garments to contractors in China. Last year the U.S. imposed trade restrictions on knitwear assembled from components made in China and labeled ''Made in Hong Kong.'' Undeterred, Hong Kong plants simply installed Japanese computer-controlled machines to do the work more cheaply in Hong Kong. Their contractors in China continue doing piecework for Hong Kong knitwear exported to Europe. Using another tactic to dent protectionism, Yangtzekian Garment Manufacturing is setting up a $12-million plant in Liverpool, England. Agile and adaptable, the four little dragons can still roar through world markets. Boon Yong Koo, an economist and senior counselor to Korea's deputy prime minister, insists the four will continue growing faster than most industrial countries ''because they work harder.'' Now the dragons are starting to work smarter, too.