JPRI Critique Vol. V No. 5 (June 1998)
The Asian Crisis and Western Triumphalism
by Robert Wade

Two main interpretations have emerged of the Asian meltdown. One says it is part of the end-game of Asian state-directed capitalism. The other says it is due to a panic-driven investor pullout that has triggered debt deflation.

The most prominent, if not most eloquent, exponent of the first is Alan Greenspan, chairman of the Federal Reserve. "What we have here is a very dramatic event towards a consensus of the type of market system which we have in this country," he said recently. "The current crisis is likely to accelerate the dismantling in many Asian countries of the remnants of a system with large elements of government-directed investment, in which finance has played a key role in carrying out the state's objectives. Such a system inevitably has led to the investment excesses and errors to which all similar endeavors seem prone. In a system of government-directed production gluts and shortages are inevitable." Many of the people now expounding this same line were saying up to as recently as mid-to-late 1997 that East Asia was successful precisely because of its commitment to the principles of free markets. The rewriting-of-history industry has swung into high gear.

The IMF is the champion rewriter of them all. It was still lavishing praise upon most of the governments of the region in September 1997. Now it is using its control of bailout money to insist on not only domestic austerity but also packages of structural and institutional "reform" (i.e., liberalization) on the same sort of scale that it required of its borrowers in the former Soviet Union and its satellites. The underlying assumption is that, contrary to what it was saying a few months ago, the institutional structure of the economies now in crisis is basically unsound, above all because markets for commodities, finance and labor do not work in a wholly arms-length, short-term-contract kind of way.

The second interpretation is that the crisis is the playing out of a financial panic, like a classic run on a bank whose liquidity is in doubt. The conditions for the crisis were created when some Asian governments liberalized their financial systems too fast before building up an infrastructure of bank regulation and supervision, as well as a stock of skills in operating in international financial markets. But the larger national systems were basically sound, just as international financial organizations said they were, until the crisis induced them to change their minds.

Korea and Taiwan

Which interpretation is more accurate? Could the Asian economies have continued--but for the panic--to enjoy reasonably fast growth while retaining quite a large government role in governing markets? It is certainly true that several of them were experiencing problems serious enough to require an adjustment. They ran sizable current account deficits over the 1990s. Thailand's were the biggest, ranging from 5% to 8% of GDP; Malaysia's ranged from 2% to 8%; and Indonesia's from 1.5% to 3.5%. These are not trivial. But inflation was very low, government budget deficits were small, GDP growth rates were very fast, and a high proportion of imports were capital goods and industrial inputs rather than (as in Latin America in the 1980s) consumer goods. All told, it is not clear that current account deficits of these magnitudes were not sustainable.

One also has to distinguish clearly between northeast Asia, in particular Korea, on the one hand, and southeast Asia ( the ASEAN countries) on the other. Korea and Taiwan are perhaps the most successful developing countries of all time, notwithstanding Greenspan's claim that a system of government-influenced investment is inevitably subject to "gluts and errors." Korea and Taiwan are the only two countries in the world (excluding the city states of Hong Kong and Singapore) to have raised real average wages by as much as 300% since 1970; and if one looks not at the average wage but at the average wage of the bottom 20% of the population, the achievement is even more extraordinary.

Sadly, in the West the ideology and interests of the owners and managers of capital have come so to infuse economics that some analysts would regard this rise in real wages as a "problem" in response to which government should act to free up labor markets still more, in the interests of "competitiveness." But by any standard of mass welfare, one has to regard the rise in wages as a resounding success (though achieved at terrible environmental cost).

As a second indicator, take patents. The number of patents taken out each year in the U.S. by residents of other countries gives a measure of the relative technological capacity of those countries. In recent years, Taiwan has taken out the 7th largest number, Korea the 8th largest, ahead of middle-ranking OECD countries such as Italy, Ireland, the Netherlands, and Scandinavia. This and other evidence points to both Korea and Taiwan becoming technological centers of some robustness, an achievement no other developing countries come close to matching.

Southeast Asia's Problems

On the other hand, the prospect of Southeast Asia following the Northeast Asian trajectory was always much more uncertain. The Southeast Asian economies have been caught in a medium technology trap. They remain in a subcontractor role in the world economy, and have seriously under-invested in education, with secondary school enrollments much less than those of Korea and Taiwan at the same per capita income level. They have serious infrastructure congestion. And they have been squeezed in export markets by China, especially after the Chinese devaluations of 1990 and 1994.

On top of these problems came the 1990s financial liberalization. Firms became free to borrow abroad on their own account without government monitoring or coordination. They found they were able to borrow abroad at roughly half the rate of interest that they could borrow domestically. International banks, awash with funds as the central banks of Europe and Japan attempted to stimulate their economies, rushed in to lend. Some U.S. members of Congress as well as quite a few economists believe that the international banks rushed in because of implicit IMF bailout guarantees--with the implication that the banks would have been more sensible had the IMF not existed. This is largely nonsense. The banks rushed to lend because Asia was growing very fast and no one wanted to miss out on the business that their competitors were getting.

Consider the scale of net private flows to and from the five Asian economies (the ASEAN four plus South Korea). Inflows in 1996 were $93 billion, outflows in 1997 were $12 billion. The swing in one year of $105 billion (with most of the outflow concentrated in the last quarter of 1997) equals 11% of the combined GDP of those five countries. Such a whipsaw movement cannot but tear apart the social fabric of countries subjected to it. Asia's experience was worse even than Latin America's in the 1980s. The swing between 1981 inflows and 1982 outflows in the three biggest debtors (Brazil, Mexico, and Argentina) amounted to 8% of their combined GDP.

Clearly, the rapid deregulation of national financial systems and the opening of their capital accounts, without paying attention to both the adequacy of the regulatory regime and the skill base in the financial sector (much thinner than in manufacturing), was an act of gross irresponsibility on the part of both the national governments and the international organizations that championed them. It is also true, though, that the crisis was more than an indicriminating bank run. Thailand, Indonesia, and Korea faced real problems of declining manufacturing profitability, to which financial markets eventually reacted.

Predatory Western Capitalists

The Asian crisis is causing not just fast rising unemployment and poverty, but also a transfer of asset ownership from domestic to foreign firms. Some analysts have argued that the accounting mess in domestic firms will limit foreign takeovers. But the signs are that transfers are beginning on a big scale. However, a nationalistic political reaction is also beginning and will intensify. All kinds of ways will be used to try and squeeze the incoming foreign firms, especially the foreign banks, and initial transfers of ownership may not be the end of the story.

The crisis shows that, Alan Greenspan notwithstanding, financial markets are not particularly efficient. They are subject to irrational, herd-like behavior, whether in an optimistic or a pessimistic direction. It is deeply ironical that at the end of the 20th century we are moving back to the free market financial system that was in place at its beginning and that is directly implicated in the financial crises and depression of the 1920s and the 1930s.

The Bretton Woods system was a carefully designed response to those crises, and it worked. After 25 years or more of great economic success, there has been a movement away from the Bretton Woods since the early 1970s that has accelerated in the last few years. The IMF has been pushing for revision of its articles so that member countries can be required to institute open capital accounts, including full currency convertibility. The WTO has negotiated a financial services agreement that frees up markets in financial services world-wide. The OECD has been negotiating a multilateral agreement on investment that will render illegal differences in the treatment of foreign investors versus domestic investors--differences that were fundamental to the practices of the East Asian developmental state.

Yet the IMF has no empirical evidence that free world capital mobility brings to developing countries benefits greater than its costs. Why is it, at the head of a phalanx of other international organizations, pushing the crisis-affected countries so hard? The answer is that the Fund sees the crisis as a golden opportunity to cajole newly-needy governments into adopting fundamental reforms of a kind it has long wanted, which will indeed move these countries in the direction of an Anglo-American (not Japanese, not European) system.

Where does the IMF get its agenda? The Fund is now, perhaps more than ever before, subject to the influence of the U.S. treasury, which is itself supported in its international agenda by the U.K. treasury. These two treasuries in turn are today unusually responsive (compared to, say, the mid 1980s and before) to the big financial firms of Wall Street and London. These financial firms are keenly seeking capital account convertibility because they are more powerful and perhaps more efficient than competitors in other centers and therefore stand to gain hugely from the opening of other countries' financial markets.

Perhaps the Asian crisis will not be severe enough, in terms of the lenders' profits, to change the mood of Western triumphalism. But with the U.S. economy currently in its biggest financial disequilibrium of the twentieth century, the next major crisis could hit closer to home. If so, we may yet get a Bretton Woods II conference on the issue of capital account convertibility, and on how to reduce the liquidity of capital markets and slow down the enormously destabilizing flows of short-term capital.

ROBERT WADE is a professor of international political economy at Brown University, and visiting scholar at the Russell Sage Foundation, New York. He is the author of Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization and "The Asian Crisis: The High Debt Model Versus the Wall Street-Treasury-IMF Complex," New Left Review 228, 1998.

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