Global Instability

The Political Economy of World Economic Governance

John Grieve-Smith, Jonathan Michie

• Publisher: Routledge
• Year: 1999
• eBook ISBN: 9781134633326
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

In Global Instability, internationally renowned contributors examine the key problems besetting the world economy in the era of globalisation and outline possible solutions. They reject the current orthodoxy in mainstream economics, challenging the fatalistic belief that the new globalised economy resists any change of course. The book reviews · international economic institutions, · the linked crises which recently hit Asian economies · the implications of globalisation, the role of multinational investment, the IMF and the World Bank. Global Instability is a comprehensive and much-needed analysis of the contemporary economy written by leading authorities in the field, and will be vital reading for anyone in management, business, or economics.

Part I
The 1997–1998 Asian crises

1
‘Asian capitalism’ and the financial crisis

Ajit Singh

I
Introduction

With the economic crisis in East Asia and a continuing boom in the US, American triumphalism is in the air. The latter is perhaps not unexpected and probably does no harm. But what is more questionable is the view held in the highest circles in the US Government and international financial organisations in Washington which causally links the so-called Asian model of capitalism to the economic and financial crisis which is currently engulfing the hitherto highly successful economies of East and South East Asia.

Thus, Mr Greenspan, the respected chairman of the US Federal Reserve, in his testimony before the Senate Foreign Relations Committee suggested that, in the last decade or so, the world has observed ‘a consensus towards, for want of a better term, the Western form of free-market capitalism as the model which should govern how each individual country should run its economy… We saw the breakdown of the Berlin wall in 1989 and the massive shift away from central planning towards free market capitalist types of structures. Concurrent to that was the really quite dramatic, very strong growth in what appeared to be a competing capitalist-type system in Asia. And as a consequence of that, you had developments of types of structures which I believe at the end of the day were faulty, but you could not demonstrate that so long as growth was going at 10 per cent a year.’¹ Mr Larry Summers, the US Treasury Under Secretary, puts the matter in slightly different terms. The Financial Times (20 February 1998) reports him as arguing that the roots of the Asian financial crisis lie not in bad policy management but in the nature of the economies themselves. Summers states: ‘[this crisis] is profoundly different because it has its roots not in improvidence but in economic structures. The problems that must be fixed are much more microeconomic than macroeconomic, and involve the private sector more and the public sector less.’ Similar views have been expressed perhaps in more measured terms by the Managing Director of the IMF, Mr Michel Camdessus.²

A central aim of this chapter³ is to systematically assess the validity of this influential and important thesis, i.e., the chapter will explore to what extent, if any, the so-called ‘Asian model’ is responsible for the present crisis in countries like Thailand, Indonesia, Malaysia and Korea. This question is also important in part because in economic terms until very recently this model seems to have been exceptionally successful. It is no exaggeration to say that the industrialisation and economic development of the Asian newly industrialising countries (NICs), as well as Japan in the post-World War II period, has been the most successful example of fast economic growth in history. Moreover, the ‘Asian model’, in addition to its economic merits, has also had a number of attractive qualities from a social point of view, e.g. poverty reduction, lifetime employment in large corporations and relatively equal income distribution. In contrast, the alternative Western or American model has acquired some unappealing social characteristics as it is increasingly based on the doctrine of promoting labour market flexibility. Social protection which hitherto workers enjoyed is being greatly diminished and a growing number of jobs are being ‘informalised’.⁴

In view of the economic and social merits of the Asian model, it is important to ask whether the model also entailed some long-run hidden costs. Was it for example likely to lead to the kind of crisis which descended suddenly and almost simultaneously on several of the hitherto highly successful economies. Such an analysis will obviously involve, inter alia, an assessment of other factors which may have been responsible for the crisis.

From the practical policy perspective, the central issues for the affected East Asian countries are the appropriateness and the effectiveness of the IMF remedies. Will these measures enable these economies to adjust quickly so that they can go back to their long-term trend growth path? Or will the world witness another ‘lost decade’ of the kind experienced by Latin America in the 1980s under IMF tutelage following the debt crisis.

The chapter is organised as follows. Section II reports on the economic and social achievements of the leading East Asian NICs and of the Asian model over the last three to four decades. As we shall see, Joseph Stiglitz, former Chairman of the US Council of Economic Advisers and now Chief Economist at the World Bank, and an eminent but dissident member of the Washington Establishment, is quite right to observe that ‘no other economic model has delivered so much, to so many, in so short a span of time’. Section III outlines the essential characteristics of the Asian model. These have been the subject of an intense debate in the past, but as will be shown below, current events appear to be leading to a consensus on the broad contours of the system. Section IV examines alternative theories of the current financial crisis, paying particular attention to the idea that the Asian economic system itself is the main cause of the financial turmoil. Section V reviews the evidence bearing on these issues. Section VI analyses the IMF policy programmes in East Asia including, inter alia, the extent, if any, to which these may have contributed to the crisis. Section VII sums up the analytical conclusions of the chapter and comments on their policy implications.

II
Industrialisation and catch-up in Asia, 1955–1995

The Asian model of ‘guided’ capitalist development originated.in and is epitomised by the post-World War II experience of Japan, especially in the high growth period between 1950 and 1973. In the early 1950s, after the economy had recovered from the war and at the end of the period of US occupation, the Japanese economic situation was not much different from that of a developing country. The total value of Japanese exports in 1952 was less than that of India’s (Krueger, 1995); exports consisted mainly of textiles and other labour intensive products. In 1955, Japan produced only 5 million tons of steel and 30,000 automobiles. US production at that time was 90 million tons of steel and nearly 7 million cars. Japan possessed few natural resources for producing steel or other heavy industrial products, and indeed the Japanese costs of producing steel were at that time considerably greater than the prevailing world prices. Nevertheless, disregarding short term comparative advantage and against almost all economic advice, the Ministry of International Trade and Industry (MITI) deliberately encouraged and orchestrated the development of heavy industry in Japan. The rest is history. By the mid-1960s, Japan emerged as the lowest cost steel producer in the world and was outselling the US steel industry in the US itself. By early 1970, it was producing as much steel as the US. By 1975, Japan had overtaken Germany as the largest exporter of automobiles in the world. By 1980, Japan produced more automobiles than the US. Looking back on this phenomenal growth, this incredible catch-up occurred over the relatively short space of 30 years.

One might argue that Japan was a special case because it had been undergoing industrialisation since the Meiji Restoration in 1870. However, Korea, which consciously followed the Japanese economic strategy was unequivocally backward in industrial development in the 1950s. In 1955 Korea’s per capita manufacturing output was only $US 8 compared with $US 7 in India and $US 60 in Mexico.⁵ Less than four decades later, Korea has become an industrially developed economy. It competes with advanced economies in a wide range of industrial products. Next to the US, it is the second most important country in the world in electronic memory chip technology (DRAM). By the year 2000, Korea was expected to become the fourth largest producer of automobiles in the world.

The Japanese and Korean development models have been followed to varying degrees in Taiwan and Singapore but, more significantly, also in Malaysia, Indonesia, and Thailand. There are important differences in aspects of industrial strategy followed by these five countries compared with that of Japan and Korea. The second group of countries have, for example, relied much more on FDI compared with the first group. Nevertheless, all these countries have followed the basic model of guided capitalist development rather than relying on free competitive markets.

Table 1.1 Trends in GDP growth: selected developing regions and industrial countries, 1965–1996 (average annual % growth)

Table 1.2 GDP growth: East and South East Asian NICs, 1970–1996 (average annual % growth)

The outstanding economic success of this group of East and South East Asian countries, together with Hong Kong, is widely acknowledged. These countries have been able to industrialise quickly and grow very fast over the last three decades (see Tables 1.1 and 1.2). Indeed, since 1980, this part of the world has emerged as the most dynamic region in the world economy (Table 1.1). Between 1980 and 1995, developing East Asia was growing at three times the rate of growth of the world economy.

Significantly, fast growth was accompanied by low inflation as is indicated by the data for the affected Asian countries in Table 1.3. Moreover, World Bank (1993) notes ‘For the eight HPAEs [high performing Asian economies], rapid growth and declining inequality [in income distribution] have been shared virtues, as comparisons over time of equality and growth using Gini coefficients illustrate.’⁶ In addition, as Stiglitz rightly emphasises, one of the most important achievements of Asian countries during this period was an enormous reduction in poverty. Stiglitz (1998a) observes: ‘In 1975, 6 out of 10 Asians lived on less than $1 a day. In Indonesia, the absolute poverty rate was even higher. Today, 2 out of 10 East Asians are living in absolute poverty. Korea, Thailand and Malaysia have eliminated poverty and Indonesia is within striking distance of that goal. The USA and other western countries, which have also seen solid growth over the last 20 years but with little reduction in their poverty rates, could well learn from the East Asian experience.’⁷ Indonesia’s success in reducing poverty is particularly remarkable. In 1970, 60 per cent of the population was living below the official poverty line. By 1996, the proportion had fallen to 12 per cent, while during this period the population had increased from 117 to 200 million (IMF Survey 16 August 1997). Table 1.4 shows changes in social indicators of development for selected ASEAN countries between 1970 and 1994.

There is still further evidence which suggests that these high performing economies, most of which were working under some version of the Asian model, not only achieved fast growth for the last three decades, but that this growth was widely shared. Between 1980 and 1992, real wages in the fast growing Asian NICs rose at a rate of 5 per cent a year, whilst at the same time employment in manufacturing increased by 6 per cent a year. Some of these hitherto labour surplus economies began to experience a labour shortage and imported labour from neighbouring countries. Overall, in South East and East Asia, there was a vast improvement in the standards of living of literally hundreds of millions of people, especially if China is also included in this group of countries.⁸

The above highly positive East Asian record stands in striking contrast to that of large parts of the developing world in the recent period. In relation to Latin America, for example, ILO (1995) reports that during the 1980s and the early 1990s there was a steady fall in modern sector employment, with paid employment falling at a rate of 0.1 per cent a year. This reversed the trend of the previous three decades, when steady economic growth had led to a significant expansion of modern-sector employment. Tokman (1997) reports that there has been a huge ‘informalization’ of the labour force in Latin America since the debt crisis of the early 1980s, that is, four out of five new jobs that have been created during the last fifteen years are low quality, informal jobs paying low wages. The average real wage in Latin American manufacturing in 1995 was still below its pre-debt crisis level.

Table 1.3 Key indicators for Asian crisis economies: Malaysia, Indonesia, Thailand and Korea (% of GDP unless otherwise noted)

Table 1.4 Selected ASEAN countries: social indicators of development, 1970–1994

III
The East Asian model

Before any causal connection can be established between the Asian model of capitalism and the current financial crisis in the South East and the East Asian countries, it is important to be clear about the precise nature of this model of development. In this connection it is interesting to observe that, in the 1990s, the international financial institutions’ (IFIs) theses—specifically the World Bank’s —concerning (a) the basic characteristics and (b) the effectiveness of the Asian model have undergone a number of distinct changes.

At the first stage, in a seminal contribution,⁹ World Bank (1991) claimed the East Asian countries were successful because they followed a ‘market-friendly’ strategy of development and integrated their economies closely with that of the world economy. In order for the term not to be a mere tautology, the Bank’s economists to their credit defined ‘market-friendly’ in a fairly precise way as follows:

1. ‘intervene reluctantly’, i.e. the government should intervene in economic activity only if the private sector is unable to do the tasks required
2. interventions should be subject to checks and balances
3. interventions should be transparent. This characterisation essentially suggested a ‘night watchman’ state, the main task of which was to provide the legal framework and the infrastructure necessary for private enterprise to flourish.

These propositions concerning the East Asian economies could not however be sustained as they were greatly at variance with facts. Critics pointed out that all the evidence suggested that the governments in countries like Japan and Korea did not ‘intervene reluctantly’. Rather, they pursued a vigorous industrial policy, the basic purpose of which was to change the matrix of prices and incentives facing private enterprise in the direction preferred by the planners. Similarly students of the subject pointed out that neither Japan nor Korea for instance closely integrated their economies with the rest of the world. Although both countries were export-oriented, both of them made extensive use of selected import controls to protect specific industries.¹⁰ Moreover, both countries discouraged rather than promoted inward foreign investment.

At the second stage, in response to these criticisms, in another seminal publication in 1993 (The East Asian Miracle), World Bank economists significantly changed their characterisation of the East Asian model. The fact of enormous government interventions in these economies was now fully acknowledged. The World Bank (1993) stated:

Policy interventions took many forms—targeted and subsidised credit to selected industries, low deposit rates and ceilings on borrowing rates to increase profits and retained earnings, protection of domestic import industries, the establishment and financial support of government banks, public investment in applied research, firm- and industry-specific export targets, development of export marketing institutions, and wide sharing of information between public and private sectors. Some industries were promoted while others were not.

Nevertheless, the Bank argued that, although the government intervened heavily, these interventions were neither necessary nor sufficient for the extraordinary success of the East Asian countries. The World Bank (1993) concludes:

What are the main factors that contributed to the HPAE’s superior allocation of physical and human capital to high yielding investments and their ability to catch up technologically? Mainly, the answer lies in fundamentally sound, market-oriented policies. Labour markets were allowed to work. Financial markets…generally had low distortions and limited subsidies compared with other developing economies. Import substitution was…quickly accompanied by the promotion of exports…the result was limited differences between international relative prices and domestic relative prices in the HPAE’s. Market forces and competitive pressures guided resources into activities that were consistent with comparative advantage…

In other words it was suggested that, notwithstanding the facts of heavy government intervention in East Asian economies, the Bank’s traditional policy conclusions—that countries should seek their comparative advantage, get the prices right, have free markets as far as possible—are still valid.

Now, in the wake of the current financial crisis in South East Asia, the IMF in particular is suggesting that important characteristics of the East Asian model are dysfunctional.¹¹ Especially singled out for criticism are: (a) the close relationship between government and business, and (b) various distortions to competitive markets. The relationships under (a) are regarded as creating crony-capitalism, leading to corruption and a myriad inefficiencies in resource allocation. The inference is that these countries should go back to the World Bank (1991) prescription of a ‘night watchman’ state and an economy which is closely integrated with the world economy.

The Bank’s critics vigorously ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Figures and tables
• Contributors
• Preface and acknowledgements
• Introduction
• Part I The 1997–1998 Asian crises
• Part II Global instability
• Part III A new structure for international payments