Learning from the Southeast Asia Crisis

by John Miller

Dollars and Sense magazine, November/December 1998

It all happened so fast. By year's end, the crisis had spread throughout Southeast Asia and even affected the richer economies to the North, especially South Korea. The value of currencies across the region collapsed-not just the Thai baht but also the Indonesian rupiah and the Malaysian ringgit, Southeast Asian financial markets crashed as well. Plummeting stock prices and plunging currencies combined to slaughter three-quarters of the value of Indonesian and Thai financial assets. Financial capital, unlike the proverbial ocean liner, turned on a dime, withdrawing more funds in less than a year than accumulated in the region over the previous seven years.

The miracle economies of Southeast Asia are in depression. Conditions vary from country to country. Recession prevails in Malaysia, and in Thailand the steep downturn will cause over two million workers their jobs by the end of 1998. In Indonesia, crippling stagflation threatens to double prices at the same time that it pushes nearly one half the population into poverty.

These once high-flying Southeast Asian economies are tending to the wounds from their sudden fall to earth. Thailand and Indonesia are in receivership, undergoing austerity measures administered by the International Monetary Fund (IMF) in return for emergency loans to help repay foreign lenders. Meanwhile Malaysia independently administers similar austerity measures. The $63 billion bailout crafted by the IMF and the U.S. Treasury exceeds the U.S. financed bailout of Mexico in 1995. With South Korea added in, the East Asian bailout package is over $100 billion.

The IMF continues to say that the leading economies in the region-Indonesia, Malaysia, the Philippines, and Thailand-will recover in 1999, if only modestly. But the Thai and Indonesian economies may not have hit bottom yet.

More pessimistic observers fear that the Southeast Asian financial crisis has triggered a deflationary spiral likely to suck all of East Asia, and perhaps the world, into a depression. The threat of economic collapse is real enough, especially if conditions worsen in Japan, the region's most important economy and already suffering a decade-long recession. During most of the 1990s, East Asia accounted for nearly one-half of the expansion of the world economy. In addition, the region's financial crisis has rattled financial markets around the globe in a way the Mexican peso crisis of 1995 never did. Latin American, European, and Russian currencies all have come under attack. Even the booming U.S. economy slowed this summer under the weight of a ballooning trade deficit caused by fewer exports to East Asia (see box on page 14).

For those not blinded by free market faith, the Southeast Asian crisis is a shocking reminder of the failures of markets. Capitalism remains much as Marx and Engels described it one hundred and fifty years ago in the Communist Manifesto - dynamic but unstable and destructive. We need to look more closely at what lessons we can learn from the economic sufferings and financial miseries of Southeast Asia.

A story of market failure

The financial crisis in Southeast Asia differs in important ways from previous crises in the developing world. Unlike the Latin American debt crisis of the 1980s, the roots of the current turmoil are in private sector, not public sector, borrowing. Most of the afflicted countries have run budget surpluses or minimal budget deficits in recent years. At the same time, private sector borrowing increased heavily, especially from abroad and especially _ short-term. For instance, loans to Thai corporations from international banks doubled from 1988 to 1994. By 1997, Thai foreign debt stood at $89 billion - four-fifths of which was owed by private corporations. But most disturbingly, one-half of the debt was short-term, falling due inside a year.

The Southeast Asian miracle economies got into | trouble when their export I boom came to a halt as these short-term loans were due. For instance, stymied by a decline in First World demand, especially from recession-ridden Japan, Thai exports grew not at all in 1996. Also, opening domestic markets to outside money (under an early round of pressure from the IMF) brought a deluge of short term foreign investment and spurred heavy short-term borrowing from abroad, fueling a building boom. By the mid '90s, a speculative binge in everything from high-rise office towers to condos to golf courses accounted for nearly 40% of growth in Thailand.

Now that the bubble has burst, the region endures a horrendous drying out process. Southeast Asian exports from autos to computer chips to steel to textiles now glut international markets, all made worse by intensifying competition from Chinese exports. Foreign financial capital has fled. Domestic spending is collapsing. Banks fail at unprecedented rates. Unemployment mounts, and as more and more people across the region fall into poverty, the Southeast Asian financial crisis has become a story of tremendous human suffering.

In the language of economists, the crisis is also a story of market failure. Southeast Asian capital markets failed in three critical ways. First, too much capital rushed in. Lured by the prospect of continued double digit growth and searching for new places to invest its overflowing coffers, financial capital continued to flow into the real estate sectors of these economies even when financial instability was widespread and obvious to all. Second, the capital markets and the banking system could not channel these - funds into productive uses. Too much money went into real estate and too little went into productive investments likely to sustain the export boom. Third, too much capital rushed out, too quickly. The ~ excessive inflow of l capital reversed itself and fled with little regard for the actual strength of a particular economy.

In their more candid moments, leaders of the financial community have owned up to these market failures. For instance, late in 1997, just a few months into the crisis, Stanley Fischer, economic director of the IMF, confessed at a regional meeting in Hong Kong that: "Markets are not always right. Sometimes inflows are excessive and sometimes they may be sustained too long. Markets tend to react late; by then they tend to overreact."

Where the right went wrong

Despite the doubts of their high priests, most financial conservatives continue to believe that international markets are stable, if subject to periodic excesses, and that whatever their excesses in the East Asian crisis might be, they can be traced back to a misguided interference into those markets. The culprit varies-industrial policy,

crony capitalism, fixed exchange rates or some other shibboleth. But in each case, these conservatives would have it that the economies of Southeast Asia ran into trouble because non-market forces had a hand in allocating credit and economic resources better left entirely up to the financiers.

The conservative solution to the crisis? That is easy, if painful: Put an end to these non-market allocations of resources. Alan Greenspan, the chair of the U.S. Federal Reserve, believes that the current crisis will root out "the last vestiges" of this sort of thing and ultimately will be regarded as a milestone in the triumph of market capitalism.

But none of the leading economies of the region relies on government-managed industrial policies to direct economic growth. One World Bank study placed Malaysian and Thai trade policies as among the most open in developing economies. Since the 1970s, another study reports, the Thai government tended to "allow free markets rather than to intervene with them."

Nor was the crony capitalism which the right derides the cause of the current crisis. This widespread practice-of political connections guiding private sector investment decisions-was a constant, not a new element in the Southeast Asian economic mix, just as present in the boom as in the crisis. And there is no evidence that cronyism is what turned investment in its speculative direction. Nor that the charge of cronyism can't be lodged equally against the first world bankers who financed the "cronies" of the region.

On top of this, there is no reason to believe that greater transparency in financial transactions would have done anything to extinguish the speculative frenzy in Thailand that was in full cry curing the 1990s. "Transparency" refers to the disclosure publicly traded companies are required to make about their operations to their investors. But signs galore of financial instability and overcapacity were there for anyone to see, even first-time visitors to the region. Bangkok alone had over $20 billion of vacant residential and commercial units by 1997. Despite plunging returns, foreign investors pumped more loans into Thailand betting that double-digit growth would continue and make these risks pay off.

In addition, we should remember that this crisis hit first and hardest in Thailand and then Indonesia, the two Asian economies with private domestic banking systems recently deregulated and opened to foreigners. The shortfall of Japanese investment in the early 1990s left Thailand desperate for foreign funds. Under pressure from the IMF and the WTO, Thai authorities moved to further open their economy to foreign investors, allowing foreigners to own stock, real estate and banking operations as well. On top of this, government policies lifted Thai interest rates above those in the West, making Thailand a place where westerners could turn a quick buck.

Tying the value of their currencies to the dollar didn't cause the crisis either. If pegging exchange rates to the dollar was the source of Southeast Asia's problems, these economies surely would have improved by summer's end 1997. By then speculators had forced the Thai, Indonesian, and Malaysian governments to drop the practice. And despite each currency losing over one-half its value with respect to the dollar, the crisis continued. Exports did not recover, even with their lower price tags abroad. Instead, imports needed for manufacturing became more expensive to buy in the local currency, hurting the export sector even more.

Having stable exchange rates was an important building block for the region's trade relations. It allowed manufacturers to import components from Japan and Korea for assembly in Thailand and elsewhere in Southeast Asia, before being sold in the United States and Europe. And pegging the value of their currency to that of the dollar allowed the Thais, for example, to lure capital into their country, fueling investments. But the Thai authorities did not take the next step of regulating the foreign capital that it attracted into its economy this way.

What seems clear now is that the cause of the economic crisis of Southeast Asia was not misaligned exchange rates, or mistaken domestic policy, or even a lack of transparency in the banking sector, although that surely didn't help. Rather the root cause of the crisis now threatening the world with depression is the abrupt reversal of the excessively rapid rise of capital inflows and the falling global demand for the exports from the region that arose from a global economy increasingly turned over to the rule of markets.

By the end of 1997, the Southeast Asian economies suffered "the equivalent of a massive bank run on the region without any lender of last resort," says economist Jan Kregel. In 1996, a net $78 billion flowed into the region from foreign bank loans and short-term portfolio investments like stocks. In 1997, that turned into a $38 billion outflow from the countries most hit by the crisis-Indonesia, Malaysia, South Korea, Thailand and the Philippines. The biggest drop came in short-term portfolio investment, such as stocks, and bank lending.

The IMF, the prime candidate to act as lender of last resort, turned down the role-instead putting in place policies that imposed more austerity and yet tighter credit conditions. Steadfastly insisting that the cause of crisis was "home grown" as Stanley Fischer of the IMF put it, the IMF tightened credit for these countries already suffering from the disappearance of capital.

Even by the IMF's standard, these austerity measures were applied in an arbitrary and disproportionate manner. First world economies facing financial crises came in for far different treatment. The leading industrialized economies (and the IMF) are urging Japan to increase government spending, cut taxes, and keep interest rates low to counteract its continued economic stagnation-just the opposite of the IMF prescription for the rest of East Asia.

In the Southeast Asian crisis, some reckless behavior was punished, while other reckless behavior was forgiven. Surely international investors are just as much or more responsible for the instability of the region as its local capitalist, bankers, governments, and workers. Yet foreign investors are being bailed out by the IMF, not punished. That is, foreign lenders will have their loans repaid. The IMF has not deemed the foreign shareholders ravaged by plummeting stock prices and collapsing currencies worthy of a bailout. Go figure.

Lessons for the Left

Left readings of the crisis originating in Southeast Asia are surely more persuasive than the conservatives' desperate attempts to defend the infallibility of markets. But Left analyses need to guard against two excesses: concluding with too much confidence that the Southeast Asian economies have collapsed with rapid growth never to return, and taking the current depression as proof that the growth that preceded the crisis was artificial.

Depressions happen. Or depressions happen again, as Hyman Minsky, the left-leaning economic theorist of financial fragility, would have put it. Financial crises and economic downturns are the flipside of periods of unbridled capitalist growth. For these rapidly expanding, high debt, and now even less regulated Southeast Asian economies to have fallen into crisis is hardly surprising.

But has the current crisis brought the Asian miracle to an end or unleashed the forces that will bring down the world economy? I am not sure. Whether or not the current crisis is the death knell for rapid growth in the region, or the world economy for that matter, I do know that the growth preceding the crisis was dynamic and unstable- much like the capitalist growth that Marx and Engels observed transforming Europe in the middle of the last century. That the growth was based on brutal super-exploitation and relied more often on capital from the outside does not make it artificial or "ersatz," ready to disappear for that reason, as some might claim. After all, the region sustained growth over a long time, not just for the last decade when Japanese investment was heaviest.

The enhanced mobility of capital-domestic and foreign-during the 1 990s adds to the instability of these economies and reduces the bargaining power of labor. This is a very real concern, especially in economies such as Indonesia and Thailand where a numbing absence of social accountability has left the investors and corporations to operate unchecked. A profoundly flawed economic development has taken hold, both in their earlier period of rapid growth and in the current crisis.

Limited capital mobility, sound economic development

A public policy that regulates capital, whatever its national origins, is called for in Southeast Asia. Only regulation demanding genuine accountability from both the cronies and the capitalists offers the prospect of genuine reform. The crunch of economic losses and slack labor markets makes reform more difficult. But to the extent that the belief in infallible markets is punctured, movements organize, and the opposition to free markets is strengthened, the current crisis brings the potential for regulating capital.

The proposal most favored in the region to limit capital mobility is a transaction tax on all cross-border flows of capital, designed by Nobel prize winning economist James Tobin. Although on its own it could not cool out a speculative fever or capital panic, the Tobin tax would discourage speculation. As a bonus, the tax revenues collected would more than adequately fund an IMF-style agency, freed from the dictates of the United States, that would bail out bankers and capital investors only when they invest long term, pay living wages, and respect international labor standards.

In September, Malaysia took the more immediate action of imposing capital controls-banning the trading of the Malaysian ringgit outside of the country. Malaysia's prime minister Mahathir called the plan, "the only way to isolate the economy from the currency speculators and traders" whom he blames for causing the country's economic crisis. Banning the trading of the ringgit in overseas markets in effect decouples the Malaysian economy from the international currency markets. While Malaysian stock prices plummeted in response, the value of the ringgit remained steady, and Mahathir's move found support from some surprising sources. Maverick mainstream economist, M.I.T.'s Paul Krugman, endorsed the concept of capital controls, for they allowed Malaysian authorities to lower interest rates to counteract Malaysia's recession without causing the ringgit to collapse.

In addition to controlling international capital, whether internationally or domestically, public policy must also compel domestic capital and local elites to accept greater social accountability. Elites seldom pay taxes in these countries. Taxing elites will add to sources of domestic savings and at the same time make more equal the distribution of income. Also giving these governments more money could add to domestic demand-providing a buffer against the shortfall in global demand that had a hand in this crisis. This social accountability must extend to conditions of work as well-notoriously dangerous in Southeast Asia-recognizing the rights of workers to organize, to work in safe conditions, and to earn a living wage.

These forms of social accountability would foster a more sustainable and equitable economic development, and perhaps lay the groundwork for a Southeast Asian economy that does more to relieve human suffering and less to add to it.

John Miller teaches economics at Wheaton College and is a member of the Dollars and Sense collective.

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