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.

The relations of interdependency concerning investment and

intra-regional trade formed during the process of high-speed
economic growth caused the East Asian currencies to follow each
other down. As the region is now in recession, the high ratio of
intra-regional exports is hurting overall export performance, and
there is little prospect of an export-led recovery in the near term.

ccording to the Asian Development Bank (ADB), real economic growth in Asia in
1997 slowed to 6.1%, below the 8.2% for 1995 and 7.5% for 1996, due to the
effects of the Asian currency and economic crisis. The economies of South Korea
and the ASEAN4 were particularly hard hit, and growth rates in all five countries
were below 1996 levels. Economic activity has also dropped dramatically, and
South Korea, Indonesia, Thailand and Malaysia all posted negative economic
growth rates for the first quarter of 1998. With production adjustments,
bankruptcies and increasing unemployment, East Asia has entered a deep
recession. Inflation in the Asian region, on the other hand, fell from 9.4% in 1995
to 6.1% in 1996 due to anti-inflationary policies of financial and monetary restraint
in countries in the region, and despite the devaluation of East Asian currencies in
the second half of 1997, inflation declined again in 1997 to 5.6%. However, ADB
forecasts that it will rise to 12.9% in 1998 due to the deepening of economic crisis.

According to the ADB, exports of manufactured goods in the Asian region grew an
extremely strong 18.3% in 1994 in terms of value and 22.1% in 1995. The rate of
growth in exports then slumped to 6.8% in 1996 and 7.2% in 1997. An
examination of exports by country and region in 1997 shows that while exports
registered strong growth of over 20% in China, the Philippines and Vietnam, there
was a year-on-year decline in countries such as Singapore, Malaysia and Pakistan,
where trends of sluggishness in exports sharpened. The reasons for the slump in
exports include (1) the slowdown in exports bound for East Asia where the
currency and economic crisis occurred, and (2) the fact that the sudden fall in the
value of local currencies did not lead directly to an increase in exports in those
countries as production activities were hindered by the difficulty of raising funds
due to the credit squeeze and the soaring cost of imported materials.