Global Conference 1998
Thursday, March 12, 1998 / 8:45 am - 10:15 am
For example, we can expect Korea to see a downturn of at least 5 percent in its economy this year. Indonesia′s future loss is anybody′s guess, but it could be easily 10 percent or more. And we should expect zero or negative growth in most of the other problem countries—Thailand, the Philippines, Malaysia, and others. Indeed, many in Southeast Asia see their current situation as equivalent to our Great Depression of the 1930s, and they may turn out not to be wrong. Beyond that, and critically important for the world, the other end of Asia—Japan—is also in recession and is likely to experience zero or potentially negative growth this year as well. When I look at the effect on Asia, I include Japan and Korea, and that is why I think the effects are so large.
Japan is in fact two-thirds of the Asian economy, at least if we make comparisons based on market exchange rates rather than purchasing power parity. How Japan will do, therefore, will go far in determining how Asia will do. Japan also is in recession; its outlook is grim. That makes it much more difficult for the rest of Asia to recover. China, Hong Kong, and Taiwan, what I think of as the strong center (as opposed to the structurally weak Northeast Asia and the cyclically weak Southeast Asia), will do better. They will certainly continue to grow; but even in this region, growth rates will be substantially lower—as a result of both the external crisis and of internal reforms in the case of China, by far the biggest other actor in the drama.
These effects are just starting. During the course of this year we will see millions of unemployed in all of the problem countries and even in the fast growers like China. Unemployment rates will double in Indonesia, Thailand, and other countries throughout the region. There will be tens of thousands of bankruptcies; there will literally be blood in the streets in many of the countries.
We at the Institute for International Economics have analyzed all 125 major financial crises that the world has seen since 1970. One thing we found is that the average period to recover a growth rate equal to the average of the two pre-crisis years is two to two and a half years. Some suggest Asia might do better because of underlying strength, but others suggest Asia might take longer because of the difficult structural nature of the reforms and changes that are required, which are much more difficult than simply bringing money supply growth under control or even bringing budgets into line. So we don′t know how long it will take, but we can be sure that it will be deep and intense. That means it will be extremely difficult in political terms to maintain stability in some of the countries and to sustain reform programs, even in countries that now seem committed to them, such as Korea.
Asia has been providing fully half the growth in the world economy in the 1990s. Thus, the kind of slowdown we envisage in Asia will have a major dampening effect on the world as a whole. However, we also could get another severe market disruption that would worsen the picture already described: It now seems clear that Indonesia will break with the IMF (International Monetary Fund), perhaps as we speak, or some time in the near future.
President Suharto has repudiated the IMF (International Monetary Fund)program on three different occasions. And there is simply no way that market confidence can be restored in Indonesia without prolonged faithful adherence to the IMF program or some alternative adjustment program, which seems extremely unlikely. Korea and Thailand only began to restore a degree of market confidence and credibility after political change took place: New governments came in and committed themselves to correct the situation. That has not yet happened in Indonesia, and until it does, the prospect for recovery is quite grim. Indeed, President Suharto said to his people in November, after the first IMF program, that he regarded the IMF as the enemy and that any of his cabinet who were with the IMF were against him—not an auspicious beginning to an effort to comply with the program. Instead, Indonesia has been groping for some silver bullet.
The last notion they had was the currency board idea. We did an extensive study of currency boards three years ago. It shows they do work in two kinds of cases. One is in very small, open economies heavily dependent on the world system that essentially have no exchange rate autonomy. That is the situation in Hong Kong, Estonia, and others. The second case is a country coming out of hyperinflation that desperately needs a nominal anchor and whose population is so shellshocked by the events of the past that they′re ready to take anything—20 percent unemployment, as in Argentina; sky-high interest rates, as in other countries—in order to wring inflation out of the system.
Indonesia, at least at this point, obviously qualifies under neither of those terms. I′m afraid President Suharto sees a currency board as an alternative to discipline, which it most certainly would not be. I fear that a currency board, with its aftermath, would lead to riots in the streets. Barring any action, we have to expect a renewed sharp decline in the Indonesian markets, including its exchange rate. The systemic and global question is whether that will lead to renewed contagion or whether Indonesia can be cordoned off from the rest of the world.
There is a significant risk, maybe one in three, of a renewed bout of contagion once Indonesia tanks substantially again. Some of the neighboring countries are still quite vulnerable: Malaysia, and maybe Hong Kong, whose economy has weakened substantially over the last 6 months. A renewed bout of exchange rate declines elsewhere could trigger the much-feared devaluation of China. China, of course, cannot be forced to devalue because its currency rate is not convertible on capital account. China does not need to devalue, though; it has only lost about 10 percent in terms of price competitiveness vis-à-vis its position at the outset of the crisis. Indeed, if it devalued, it could accelerate or trigger further currency declines elsewhere, after which it might wind up no better off, or even worse off.
On the other hand, if there are a series of renewed depreciations in competitor countries, if China slows substantially in the implementation of its accelerated reform program, then it is quite possible that China, too, would join the crowd. That event would seriously add to the world disruption. Countries outside the region could easily be hit. Brazil remains extremely vulnerable, and Argentina could be tugged down with it. There are lots of vulnerabilities; and there′s one more problem, what I call the "rogue devaluer," the country that you don′t expect to devalue, and indeed has no reason or justification for doing it, but does it anyway.
Taiwan did just this in October and brought on the second phase of the crisis. Taiwan had rapid economic growth, a large external surplus, huge reserves, and could easily have defended its exchange rate, but it chose to let its rate be driven down sharply. And that was what triggered the next market day, the 14 percent decline of the Hong Kong index, which triggered the 500-point dip in our index. More important, it put enormous competitive pressure on its main rival, Korea, and triggered the Korean phase of the crisis, which then escalated the problem throughout Asia and the world. Another rogue devaluer of that type could cause additional problems.
Finally, the IMF is not in a position to deal with additional crises. The usable resources in the IMF are down to $15 billion, not even half or a third enough to take care of a new program in, say, Brazil, or two or three other major countries, if there was a new bout of contagion. So the possibility that we have not yet seen the end of the crisis in market terms compounds the risks that we see on the real side, and suggests that the crisis may be only beginning.
What will be the outcome of all this on the world economy? The United States will probably lose a little more than $100 billion, or a little more than 1 percent of GDP in real terms—less than that in nominal terms because of the improvement in terms of trade, with the strengthening of the dollar and the sharp weakening of the other currencies—even if we do not get another market disruption of the type I described. Our model suggests that Europe would be hit a little harder. This is logical, as they export more to the problem countries of Asia than does the United States.
With the U.S. economy in such good shape, you would think we could absorb a disruption easily. But U.S. trade and current account deficits are already at record annual rates of $200 billion. They could be pushed to between $250 and $300 billion, approaching the share of GDP they hit in the mid-1980s, which triggered the dollar crisis of that period.
In Europe, the sharp decline in the external balance will worsen their unemployment problems, already at extremely worrisome levels and exacerbated by their move to economic and monetary union. So the global effects should not be underestimated in terms of their real potential for renewed difficulty.
What to do about it? The right strategy is straightforward intellectually, if difficult politically: The problem countries simply have to implement effective adjustment programs with or without the IMF. We know that the adjustment programs in most of the countries have a macroeconomic component, but they are primarily structural, focused on their financial sectors, and to some extent, their corporate government structures. That probably does make them harder to adjust. Nevertheless, that is the only likely answer to restoring both economic activity and market confidence.
Some countries have chosen to do so with the IMF, and others, such as Malaysia and China, have decided to reform without the IMF. Indeed, they have put programs in place in an effort to avoid going to the IMF. The IMF is not perfect, but it has shown a great deal of flexibility in altering the terms of its requirements, and its basic strategy is fundamentally right.
The second component of recovery is for Japan to get its economy going. The Japanese problem, of course, far antedated the Asian crisis; but as long as it persists, it will make recovery from the Asian crisis extremely difficult.
The third element is that the strong center—China, Taiwan, Hong Kong, Singapore—has to continue to hold in terms of exchange rates, growth rates, and output expansion. Taiwan flunked that test back in October. We have to hope and work hard to see that this doesn′t occur again, particularly in China, the biggest country and now the most pivotal actor in the whole drama.
The fourth key element is for the rest of the world, especially the United States as the strongest economy in the world, to do its part. That means providing financing, including new financing to the International Monetary Fund, an issue now being hotly debated in our own Congress. If we fail to contribute, the quota increase will not go through; the auxiliary financing and the new arrangements to borrow will not take place; and the IMF will be unable to deal with any additional crisis. But even more important, we in the industrial world have to provide the continued open and growing markets that permit the Asian countries to improve their current account positions and get back on the macro side of their adjustment packages.
In the long run, the most profound question arising from the Asian crisis is not so much whether it will lead to a change in the Asian miracle but whether it will produce a substantial backlash against the globalization trend of the last three decades. We already see a disturbing backlash of that type within our own country, despite the nirvana state of our economy. Congress has been unwilling to pass legislation granting fast-track trade negotiation authority to the President and unwilling, so far, to renew funding of the IMF. The multilateral arrangement on investment of the OECD (Organization for Economic Cooperation and Development) has failed for similar reasons. And the protectionists and antiglobalizationists believe that they are in ascendency. If all this can happen during good times, it is a major worry.
We know that as the blood begins flowing in the streets of Asia over the next year or two, as the unemployment rates and bankruptcies rapidly increase, there will be an enormous backlash against the open market model—whether it be called the Washington consensus, the IMF strategy, or the American approach. If that interacts with a seeming failure or withdrawal on the part of the United States itself despite its strong economic position, then I believe we will face a real risk to the world economy for at least three decades.
GARY BECKER: Is the glass half-empty or half-full? If Asia recovered to its previous growth rates in two to three years, that would be a great achievement. I think it is very possible it will happen, and I am glad to hear that studies show this is the norm—since that has been my forecast. I think the recovery will be good and that the long-term growth will make this time look like a minor dip on the growth rate.
A point often overlooked is that there was and is indeed an Asian miracle. The growth rates experienced by the seven or eight countries involved were fantastic. Korea went from a per capita real income in 1960 of roughly $300 to more than $10,000 today. That is a miracle by any definition. Most other countries of the world would love to have such a miracle, even with the current crisis; they would be a heck of a lot better off even so than they are now.
Furthering the miracle is not based on any sort of trick or house of mirrors. There are a lot of strong fundamentals in Asia that will remain. They have high savings rates, hard-working labor forces, and very high human capital. On almost any set of indices of economic freedom, virtually all of them (with the exception of Indonesia) rank very high. And some of them, like Taiwan, Singapore, and Hong Kong, rank in the top ten; Japan is not too far below; and Malaysia, Korea, and Thailand are somewhat low, but are still quite high by world standards. These strong fundamentals have not been destroyed by the current crisis.
Therefore, I've been a little disturbed by some of the specific reforms advocated by many commentators, in particular by the IMF. What does the Korean labor market have to do with the current crisis? Possibly it should be changed, but it served Korea very well for 30 years. I'd like to see more turnover; I'm a free labor market man. But it's a mistake to say that this is somehow a necessary ingredient to get out of the crisis or to reform an economy, when that economy has performed so spectacularly.
This is true for a lot of other recommendations that have been made. I think it is very presumptuous, based on no economic evidence, that these are the reforms that would be necessary to help resume strong economic growth in this region. I think many of the IMF's proposals have been misplaced and inadequate and haven't really appreciated the enormous achievements of these economies or the strong fundamentals that persist.
That doesn't mean I'm like Voltaire's Dr. Pangloss who believes everything is for the best. There obviously have been problems in Asia, and some of them have been of their own making. In the financial markets, the problems that I see as most fundamental are basically three. One, heavy government subsidies, sometimes to some favorite companies, favorite banks, and other financial intermediaries. Directed loans from government to favorite companies, in effect subsidies from the government, is unattractive in any industry, and it is particularly bad in the financial sector. This practice is common not only in Indonesia but in Thailand, Malaysia, and several others, including Korea.
The second difficulty I see in the financial market is what I call a double moral hazard issue. By moral hazard we mean providing incentives for people through insurance and the like to take risky actions because they anticipate that their losses will be covered through various forms of help. This is the phenomenon that we find in many of the Asian countries. Larger companies were favored and worked under the supposition that they would be helped through government support if they got into any serious difficulty. It encourages excess risks, and you find that in Korea, Indonesia, and Malaysia, as well as in other countries.
The doubling of the moral hazard is introduced by the IMF. The IMF showed in the Mexican bailout that they're ready to help both private banks and others if they get into trouble. My fear is they are doing that to some extent in this situation as well. If you have a domestic company, the government is saying, "We're going to help you out if you get into trouble," and the IMF doubles that by saying to the country as a whole, "We're going to help you out if you get into trouble." Nobody should be very much surprised when you see both companies and countries getting into trouble.
Some have claimed that this current situation suggests a number of problems that need radical surgery, but their solutions deviate from the multilateralism that many of us are trying to push. Some very intelligent economists and others have been suggesting that we have to introduce taxes and other controls over the movement of capital from country to country. I think that would be a serious mistake. The world tried capital controls for most of the postwar period and they were a dismal failure.
We've been unfortunate to move in only the last 10 or 15 years to a much more open capital market. On the whole, I think it has had a great record. It has brought resources to countries that need it, and it would be a terrible mistake to begin to deviate from that. If we believe that either international organizations or countries were like surgeons who could wield a scalpel and cut out those types of capital movements that were undesirable and leave all the others, I'd say, sure, let's do it; but we well know that neither international organizations nor countries are surgeons. I fear if we move down this path that we are going to move in the direction of the 1950s, the 1960s, and the 1970s, when many countries had major and serious restrictions on the movement of capital. That would be a disaster, particularly for the developing countries, which would not be able to develop without access to the international capital market.
I am also disturbed by the great emphasis on the governance of banks and the like in some of the Asian countries. There has been weak governance and weak control, but we should not forget, particularly at the international level, that the loans were made by European banks, Japanese banks, and U.S. banks, all of which have all this governance; yet, they still made a lot of short-term loans and dollar-denominated or marked-denominated debt. So it's not an issue of governance.
I cannot explain why these banks engaged in this sort of large-scale lending activity except by means of the moral hazard argument. They assumed if there was general difficulty the IMF and others would come riding to their rescue. Blaming this behavior on the short-sightedness of or the lack of governance in these Asian countries forgets the other side of the equation, the behavior of the lenders.
Finally, we have learned from the Mexican and other situations that have arisen, including the current Asian situation, that there are really only two (quite different and extreme) viable and efficient exchange-rate policies in the long run: fully floating exchange rates and rigidly fixed rates. By "fully floating" I mean clean floats and not government-dictated floats, where exchange rates adjust in response to changes in supply and demand for currencies, either from the capital or the current account, for merchandise or capital movements. The advantages of that are well known. They are probably the best instrument for allowing flexibility to a particular country for idiosyncratic shocks—that is, shocks that impact that country but are not regional or more general shocks. In nations that have responsible, well-functioning governments, flexible exchange rates are probably the best system.
Unfortunately, only a small fraction of governments fit into that category. Most governments, and particularly many of the Asian governments, have used the power of the government to help out in various ways, subsidizing particular companies, particular banks, and the like, which is true to some extent in Mexico. It was certainly true in Argentina before they went to change their system, and it has been true in many countries of the world. The best antidote that I know of, other than domestic reform, is a rigidly fixed system of exchange rates.
There are various ways to move to a rigidly fixed exchange rate: through a monetary union, currency boards, and other methods. I distinguish a rigidly fixed rate from the pegged rates found in some Asian countries, since they did not have a commitment to maintain in the event of a crisis. You need a rigidly fixed system to limit the ability of government to rate currency and other resources, through a central bank and other ways, in order to finance very dubious projects.
A rigidly fixed system controls government at the expense of less flexibility in adjusting to idiosyncratic shocks. A flexible exchange rate system allows great flexibility but imposes relatively few controls over government. Which is more important really depends on the situation. For a country like Indonesia, some form of rigidly fixed system that the government is committed to is probably best. For countries like Hong Kong, Taiwan, and Singapore, who have managed very well, a more flexible system may be more desirable. Hong Kong has done very well with its currency board.
SALVADOR ENRIQUEZ: What follows are observations, or perhaps confessions, of one from an Asian country afflicted by the currency turmoil that hopefully can contribute to the global overview.
Number one: It's too much too soon. The Asian crisis occurred after years of phenomenal growth. From 1993 to 1995, world GNP (gross national product) was growing at just a little more than 2 percent per year. Asian GNP grew at a yearly average of 8 percent in the same years. Such growth can be attributed to exports and investments. Most Asian countries enjoyed the benefits of their liberalization policies in trade, finance, and investments. But as we all know, as sure as a bust follows a boom, the Asian bubble burst.
Number two: It has been growth without development. I'm not particularly referring to Korea, but to the Asian four: Malaysia, the Philippines, Thailand, and Indonesia. Growth was fueled mostly by speculative investments in property and in services. The industrial sector did not grow as fast. The sequencing of trade liberalization, which was followed closely by the premature liberalization of the capital accounts, caused a massive influx of portfolio investments and short-term foreign funds. High trade and current account deficits peaked to as high as 9 percent of GDP (gross domestic product).
The third observation, or confession: Trade imbalances and comparative disadvantages persisted. For the period 1990-1995, the value of exports of developing Asian and Pacific economies grew by 14.6 percent, while that of imports grew at 15 percent. This implies increased integration into the global economy, but also an inherent structural trade imbalance in the developing economies.
Asian export products consist mainly of electronics, garments, footwear, and the like. Asian imports are mostly manufactured goods, intermediate products, and—a good part of them—capital goods. From the Asian viewpoint, this has implications as to how competitive Asian economies can be, even under (or perhaps despite) the WTO (World Trade Organization) regime.
The rigors of the global market, keen competition, changing preferences, technology advancements, and price fluctuations, demand continued upgrading of product and skills and ingenious product differentiation, the modernization of business practices, and so on. This may not be readily attainable in developing economies. Transnational companies have taken advantage of liberalized trade and investments, and have benefited from them. During 1990—95, the number of transnational companies increased from 37,000 to 39,000. However, foreign affiliates and subsidiaries grew quickly, from 170,000 to 270,000, controlling an investment stock of 2.7 trillion. Some 40 percent of world trade was actually done by companies trading with themselves through their subsidiaries and affiliates. So I suggest that a new international economic order may have to be studied—one that identifies the real needs of nations in the world; one that is sensitive to the aspirations of developing countries as they coexist with industrialized countries.
The terms of reference may have to be reviewed and improved. The developing countries have opened up wide. Have the developed countries opened likewise? I hope to see an international economic order where competition can be transformed into complementarity. I wonder if this is possible. I hope it is. Where before there were underlying imbalances and inequities in the relationships between developed and developing countries, the new order should enable both to give as much as they take; to mutually benefit, rather than force; to serve each other; and to distribute the gains equitably.
JAMES GLASSMAN: In a way I see the crisis in Asia not so much as a terrible event—although certainly it is serious and will create a lot of pain for people there and throughout the world—but as an opportunity. Perhaps it is an opportunity to bring down a second Berlin Wall. I am borrowing that phrase from my friend, Jose Pinera of Chile.
For years many American journalists, academics, and politicians were enamored of the Japanese system, of what I would call "command and control capitalism," the idea of the government playing a major role in the allocation of capital, and also a kind of neomercantilism. Now that model has been adopted by many countries throughout Asia. The stagnation of the Japanese economy over the last five, six, or seven years certainly has made this system a lot less attractive than it was in the past. There is a good chance for these countries to change their systems not only to the benefit of their own nations but also to the rest of the world.
For this conversion, or this revolution, to take place, for the second Berlin Wall to fall, the International Monetary Fund is going to have to step aside. That is really my main message. Though protectionist views do pose problems in Washington, those who oppose IMF bailouts are not necessarily all "protectionists." My colleague at AEI, Larry Lindsay, former governor of the Federal Reserve, is certainly not; George Schultz is not; Walter Wristen is not; Gary Becker is not; and I am not.
What are my problems with the IMF? First, it represents the diversion of capital from its best uses. When we take $100 billion or $200 billion out of the world economy and specify that it must be used to repay banks that made bad loans, that's a diversion of capital from its best uses.
Second, we are not really sure the IMF is doing the right thing. (The IMF has not done the right thing in many cases.) And what it does is not transparent. It doesn't tell us what it's going to do; it seems to change its mind a lot. But let's assume that in this case the IMF is doing the right thing. That its conditionalities, as they are called, are correct or will be beneficial. It wants transparency; it wants the affected countries to allow ownership of assets by foreigners; it wants to get the government out of running the banks and corporations and allocating capital. Those are, I think, the right goals. But can the IMF actually enforce those goals? The IMF's bureaucratic imperative is to give out money. That's what its business is and that's what it does despite the bad faith of several nations. The more money it gives out, the stronger the positions of the people who are there.
Fourth, and probably most important, is this problem of moral hazard raised by Gary Becker. Certainly there is a single moral hazard with the IMF. There is no doubt that the bailout in Mexico set the stage for what is happening in Asia. And we'll certainly get through this Asian crisis. But the third crisis, the one down the road and that may be encouraged by the moral hazard problem could be far, far more serious. There is no other explanation for the terrible loans that were made by U.S., German, Japanese, and French banks to corporations in Asia, Thailand, Indonesia, and Korea, except that they knew that they were backstopped in some way.
Finally, let me say that by focusing on the IMF bailout, we may be ignoring the most important problem in Asia, and that is Japan. Quite clearly the current crisis in Asia could be ameliorated to a great extent if the Japanese would change their fiscal policies. They just had a tax increase—an incredibly dull-witted way to approach the particular problem that Japan has, which is a lack of demand. Sales of automobiles in Japan over the past 11 months are now down 22 percent, the decline dating almost precisely from the increase in the tax. Many of my colleagues believe that what Japan should be doing is reflating.
If the IMF can step out of the way and act as a lender of last resort, not first resort, it may have a role. In the present case it is only delaying the potential fall of a second Berlin Wall.
BARRY HERMAN: If you look at the world as a whole, it doesn't seem to be in crisis. There is certainly a difficult situation in Asia, and this will have important social as well as economic and political dimensions. But the world as a whole has been on what we call a cruising speed of about 3 percent growth since 1994. Now, this hasn't occurred in each and every year. It did in 1994, 1996, and 1997. We believe the world economy in 1999 will also grow at this rate. 1995 and 1998 should have similar world output growth rates of about 2.5 percent. The main reason is a slower growth in industrial countries.
Three percent is not bad. It's better than it was in the 1980s. Moreover, it seems to be sustainable. It is accompanied by unusually low inflation. 1998 will be the fifth consecutive year for about a 2 percent rate of increase in consumer prices in the industrialized countries, and we expect that to continue. It has been super for fiscal positions, and budget deficits are coming down virtually everywhere. It has been lousy for unemployment if you're European, but unemployment correction was really not the highest item on their agenda. It was the forming of a single currency area in the economic and monetary union, and they are going to get it. So in that sense, for the world as a whole and for the developed countries particularly, economic activity has been progressing in a rather positive way.
You can also be encouraged by what is happening in the transition economies. In 1989 the Berlin Wall fell, beginning the fall in other things as well. Output has been falling every year from 1990 until 1996. Output in the transition economies—which is to say Central and Eastern Europe, the Baltics, and the rest of the former Soviet Union—will have risen in 1997 for the first time since the fall of the Berlin Wall. In 1998 we'll see output rise in more countries. The only country that will still see a fall in measured output is Ukraine, and in 1999 we expect output to begin to rise even there. In addition, several of the Central and East European countries are about to begin negotiations to join the European Union. So, from that perspective, there's a lot to be encouraged by.
I'd like to turn for a minute to Africa. There is a lot of conflict in Africa, and there is no point in talking about development while there are wars going on. Output is rising, though, and it has been rising by 3 to 4 percent since 1996. The population is growing by less than 3 percent a year, so for the last couple of years, output per capita has stopped falling in Africa. That's a major achievement, in light of the fact that it was falling for 20 years.
In some countries, like Uganda and Ethiopia, output is rising at 6 percent. They are still very poor countries, but the direction is up. In 1996 and 1997, there were about 15 countries that had per capita income rising 3 percent or more in Africa. And policy has changed in Africa. There is a new generation of people coming into policymaking roles, and I think there are new opportunities. To quote something the Secretary-General of the UN said last week: "Last month after meeting with representatives of the International Chamber of Commerce, we issued a joint statement emphasizing that the goals of the United Nations promoting peace and development, and the goals of business creating wealth and prosperity, can be mutually supportive. We agreed to join forces with a particular focus on Africa and the least developed countries. In this spirit, collaboration should help promote greater investment flows into the continent." I don't know if you would have seen a statement or a meeting of that sort 10 years ago.
In Asia, we expect growth of more than 6 percent this year; it has been growing at that rate since 1995. China's growth rate has slowed down every year since 1992, but the forecast is that it will still be 8 percent in 1998. At the end of last year there was some monetary easing because indeed China has been adversely affected by the Asian crisis. There is also a new fiscal stimulus, an agreement to expand infrastructure investment in China. Thus, China is still managing to grow rather significantly.
What we have seen in the Republic of Korea, Thailand, Indonesia, and so on is a confidence shock followed by a liquidity squeeze. I think we have seen a microeconomic, that is a sectoral, problem, that has been treated in such a way as to have major macroeconomic consequences. I think we have to do some rethinking about what is necessary for adjustments to what kinds of problems. This yields questions about the architecture of international cooperation, both cooperation for development and cooperation in international financial affairs. The World Bank is changing what it does: It is becoming much less a bank and much more a development institution. The IMF is also facing a tremendous challenge. I think we are going to go through a period of reform and discussion of the international financial architecture, which will make the next couple of years quite exciting.
GUILLERMO LE FORT VARELA: Regional financial crises like the current one in Asia are not unprecedented. Latin America suffered a severe financial crisis not long ago, in the early 1980s, with serious effects for all countries in the area. The 1980s was the lost decade in terms of economic growth in Latin America.
The global conditions under which the Latin-American crisis developed were much worse than the conditions we see today for the world economy. In recent years, world output has been growing at a rate on the order of 4 percent per year. In the early 1980s, world GDP was almost stagnant, with expansion rates of 0.5 to 1.5 percent per year. The same is true about the conditions of the region most directly affected by the crisis. While Latin American countries had an average current account deficit of about 6 percent of GDP just before the crisis erupted, the current account deficit for Asian countries as a whole is about 2 percent of GDP. Of course, there are particular Asian countries with larger current account deficits than average, such as Thailand and Malaysia—deficits on the order of 7 percent of GDP. But in the 1980s, some Latin American countries also had current account deficits much larger than the regional average. My country in particular, Chile, registered in 1981 a current account deficit in excess of 10 percent of GDP.
External debt in the Asian countries today is on the order of 100 percent of exports, while in Latin America, just before the crisis erupted, that percentage was twice as high; debt was 200 percent of exports. So we have certain elements to be optimistic about, in the sense that the conditions in this present crisis are a bit better than those that existed before the Latin American crisis. That doesn't mean, however, that solving this crisis is going to be any easier than it was to solve the Latin American crisis, but it does mean that there is a solution.
Some of the countries in Latin America during the 1980 crisis were affected by particularly bad fiscal policies. For them the solution was basically in a macroeconomic correction: adjusting the expansion in domestic demand through the use of corrective fiscal and monetary policies. In the context of the Asian crisis, there is a need for structural rather than macroeconomic adjustment. Although there are elements of macroeconomic imbalance, the problem seems to lie in rotten financial systems. The lack of prudential regulations and rules of financial transparency have seriously affected their performance and helped to distort the decision-making process. Financial institutions have been affected by moral hazard problems that distort their capability to adequately select investment projects. Government intervention is in some cases also at fault, creating hidden incentives and directions that also distort the project selection process.
The solution is deep structural reform in those financial systems: modifying rules and operating procedures to ensure transparency and limit excessive risk and government intervention so that these financial institutions can effectively select investment projects. Eliminating of distortions that affect the investment decision process is the key for success.
Something similar happened in Chile in the crisis of the 1980s. Chile got into that crisis after having a fiscal surplus. The macroeconomic imbalance that was present was created particularly by private spending and spending related to excessive financing provided by a not-very-well regulated financial system and massive international capital inflows. From that crisis, some lessons were learned. A completely new system for regulating the financial system was developed, letting the market work under conditions of ample information and transparency of the financial conditions of each institution, making risks clearly known when they are taken and limiting those risks to the strength of each institution.
During today's discussion a second type of moral hazard was mentioned—one that refers to the intervention of the International Monetary Fund. I am no longer an IMF staff member, so I am not going to take on defending the IMF in this discussion, but some points need clarification. Personally, I agree that financial help from the IMF, or bailouts, for countries in trouble may encourage foreign lending to those countries beyond what is reasonable, because those foreign lenders consider that in the end they will be repaid anyway, and that if needed the IMF will step in to provide the financing. However, I do not agree that the same argument applies to the governments involved in the process. The governments and populations of countries that have undergone that process of IMF programs do not feel as if they really have been bailed out from the troubles that they suffer. We have seen output falling by more than 10 percent in certain cases—15 percent in 1982 in Chile. Latin America took a full decade to recover the level of output that it had before the crisis; unemployment went up to double digits, even up to 20 percent. Inflation erupted when certain countries went to hyperinflation, like in Argentina. These countries have no incentive to adopt the wrong policies simply because the IMF is there to bail them out. IMF medicine is not sweet. And, among those who have taken it, the last thing that they want to do is take it again.
The lesson learned by many economists in Chile during the 1980s was that we should never again accept all the external financing that was offered to us. During periods of bonanza, capital inflows can go up to 10 percent of GDP and stay there for a while; but just as easily, everything can turn around. Financing can disappear and the country can be forced into recession and crisis.
One of the targets that has been followed is to keep the current account deficit at levels that are sustainable: limited in relation to GDP, and limited in relation to exports. To do so it is necessary to limit the impact of capital flows. The policies in Chile have been geared in that direction. We have a system of reserve requirements applied to some capital inflows, particularly to short-term debt. The reserve requirement consists of a dollar-denominated deposit in the central bank for the equivalent of 30 percent of the inflow, to be kept for one year with no interest paid. The requirement has a cost of about 300 basis points if the loan has a maturity of one year; but if the maturity is shorter, the financial cost would be much higher. Short-term financing or the succession of inflows and outflows is possible; but if you move in and out very fast, you will have to pay the price. We do not consider that reserve requirement to be a cure for all, but we think that it is an important part of our macroeconomic policy architecture, without which our monetary policy would not be as strong.
Even while we have restrictions to capital inflows, direct foreign investment is free of the reserve requirement; capital outflows are not restricted. Domestic residents have completely free access to foreign exchange, and the same is true for those who would like to repatriate their previous investments. We have learned from experience that a good and open capital account is good for the country, but that the use of external financing should be subject to limitations.
JAY PELOSKY: I just returned from a trip through Asia. I went there, notwithstanding our concerns about the Asian crisis, to get a sense of why the Asian markets have been the world's best performing markets year-to-date, and also to see if our global emerging markets model portfolio strategy is correct. That strategy has been to hold a fair amount of cash, because we are cautious; to be overweight in Latin America, because we do think that region is much further along in the restructuring process; and to be underweight in Asia, and particularly underweight in ASEAN, because we are quite bearish on the region. The strategy obviously hasn't worked so far this year.
My conclusion is that we should not give up on our strategy. In fact, what we need now in Asia is more bad news. Bad news is needed to keep stimulating the adjustment process, which is at risk of backsliding, because the money to a large extent has already been given out.
Let's spend a few minutes on two key markets: Korea and Malaysia. Korea is a very important market in terms of being a big industrialized country with lots of companies. It can be characterized as a country that's enjoyed excess investment financed by excess leverage and is now confronted with collapsing . We are now in the very early stages of working that back. Korean companies are now cutting capital expenditures. But this is just the first step. I'd like to see closure of companies and asset sales. Something like 11 of the top 25 companies in Korea filed for bankruptcy in 1997, yet virtually all of them are still operating, still producing product, and making it very difficult for those companies that are not yet in bankruptcy proceedings to make a profit.
My sense is that the targeted macroeconomic numbers, as indicated by the IMF, are way too optimistic. The IMF forecasts 10 percent inflation and -1 percent growth for Korea for 1998. Since the new government seems to be targeting inflation, growth will be significantly lower than projected. One of our economists estimates 1998 growth at -4 percent.
The government has got a good point and a bad point going for it. The good point of the government of Kim Dae Jung is that it's new, and therefore can use the time-honored tradition of blaming the old government for what's gone wrong in Korea. The bad point is that it is a minority government, a tough position to be in when having to put through aggressive adjustment policies. Therefore, it needs more bad news to push the adjustment process.
Malaysia is also a key country and market to focus on for the next six to twelve months. It is a symbol of excess property development, again financed by excess leverage. The Malaysian stock market last year peaked with market capitalization as a percentage of GDP of 350 percent. The U.S. market, at this point in a world-record bull market run, is around 130 percent of GDP in market capitalization terms. In Malaysia that 350 percent has come down to about 150 percent with the market correction, but it's still extremely high. The lending boom that has taken place in Malaysia is yet to be adjusted: Loans to GDP in Malaysia are at 160 percent. In 1994—95, loans to GDP in Mexico were 60 percent. The banking system in Malaysia is under huge strain, and it's just beginning to undergo an adjustment process. We have already seen some of the leading banks in the country fail. Unfortunately for Malaysia, it looks as if that country is going to continue this process as the real estate bubble bursts. Eventually they will run out of funding sources for failing companies, and they will have to ask for multilateral assistance. Malaysia is also the most exposed in terms of Indonesia. There are already reports of thousands of Indonesian refugees washing ashore in Malaysia.
Shanghai, China, is the single biggest property development in modern history. Unfortunately, the buildings are still going up, even though the ones that were put up last year are virtually empty. China is trying to do a really tough thing in completely adjusting its state-owned sector and its bureaucracy while stimulating its domestic demand profile. All to be done while the export engine of growth, which has led the country over the last few years, seems to be pretty much dead in the water. The economic forecast of 8 percent growth in China is going to be found to be extremely optimistic.
In sum, Asia can be characterized at this point as a region of excess capital investment that has been financed by much-too-readily-available debt leverage. It is now being confronted by a collapse in demand, and it does not take much to think about what that means for profits. Also, Asian governments seem to continue to want to bail out dead companies. This greatly retards the adjustment process. This is the case today in Korea (where the chaebols that went bankrupt last year are still operating), in Thailand (where the government spent about $25 billion trying to keep ailing banks—that later closed—afloat), in Indonesia (where the central bank is printing money at will), and in Malaysia (where the government is encouraging private businesses to take over failed institutions).
Finally, foreign direct investment in Asia will be, by definition, asset sales rather than greenfield investment. Asset sales are very difficult; typically owners don't want to sell unless they're forced to. Therefore, we need more bad news to continue to put the pressure on these corporates to sell their companies that aren't performing well and to focus on the companies where they have competitive advantage.
Where will demand come from? Mexico was able to recover from its crisis very quickly, in part because it lived right next to the United States. Exports in Mexico in 1995 grew over 30 percent in U.S. dollar terms. Although much has been said about the adjustment in Asia on the trade and current account sides, not enough attention is being paid to the fact that this adjustment is coming about because of import compression as capital investment collapses and not because of export growth. Part of the problem with export growth in Asia is that no single regional entity is able to take that export demand, particularly given the weakness in Japan.
The silver lining in all of this is the acceleration of the adjustment process in many of these countries and companies, particularly in Brazil, Russia, and China. All these countries are using external threats to make domestic political adjustments that would otherwise be tough to do. And that's all very positive.
On the corporate side, a lot of work is yet to be done. Asian companies are going to have to go to international markets to finance themselves to develop further. This will be a very good thing because it's going to subject them to comparative analysis on both a sectoral and stock level and thus accelerate the restructuring process. Our focus is increasingly on comparing companies across borders on a sectoral and stock basis. That is what is done in the United States, and clearly that has been very successful in terms of the stock market in this country. While I am not sure that the complete model of stock market investing should be exported wholesale to Asia, I think that comparative sector and stock analysis will a key part of the successful adjustment of the Asian economies and financial markets.
RICHARD TAN: From my perspective of managing an international company, I believe that the 21st century is here. The momentum is huge. It has challenged the old system, and made room for the new to be built. What happened in Asia? The new is challenging the old and destroying it. Globalization is in progress, with the financial services industry leading the way. Governments are trying to slow it down or prevent it because they believe they have to protect their own interests for their people. The turbulence of globalization will continue and probably not peak soon. It will be a bumpy and painful road.
Money is now flowing everywhere without boundaries, seeking the highest return. No single country or regional market can prevent it. The capital market is correcting what it thinks is not reasonable or proper. The U.S. dollar will become more and more international and more important. The United States is a safe port and has a stable economy. It represents a large share of export trade. The currency markets and securities will offer a lot of opportunities for at least five or ten years. These opportunities will come with high risk, but also high return.
Undervalued assets also will continue to surface in the world. Today they are in Asia. Later, they may be in another region. These represent the lowest risk with the highest return. So, I believe we are facing a lifetime opportunity in the business world.
C. FRED BERGSTEN: To the extent that there is consensus on this panel, we had four: (1) We are in the early stages of the crisis. It will last at least two or three years, maybe a little more. (2) However, it is unlikely to bring down the world economy, which is strong. (3) But we are likely to see some future deterioration in some quarters. (4) There is also some long-term opportunity and prospects that could well come out of the crisis. There is a risk of anti-globalization backlash as all this evolves, but there are some very different views on the role of the IMF.