February 1999

Crisis, What Crisis?

by Gerald Segal



The Asian crisis has not brought down global capitalism. Most of the affected countries are now recovering strongly and some have more liberal regimes. But while the world's attention has been diverted eastwards, western corporations have been quietly rewriting the rules of global trade.



CAPITALISM HAS JUST had its worst crisis for a generation, and guess what happened? Nothing! No red flags flew, no communist guerrillas took to the hills of Asia and the most radical proposal to have come from the west involved tinkering with the international financial institutions. The only ideas that in a few countries provided a rallying point to victims of the economic crisis were the very old ones of ethnicity and religion. Francis Fukuyama has been proved right: if you want to grow rich, there is no alternative to an essentially liberal political economy.

While supporters of the Fukuyama view of history have no reason to be complacent, they have always understood that you must read the fine print in the advertising brochures for liberal economies--markets may rise and fall. But the essential formula for success, with all its flaws and variations, remains untouched by recent events.

Those who are sceptical about the superiority of a liberal political economy have wanted to have it both ways on Pacific Asia. First they focused on the region's success-which seemed to be based on a most illiberal political economy--and then on its economic failure since 1997. But Asia has done so well out of the global market, even taking into account recent setbacks, that most countries in the region have remained supporters of the existing order.

ASSESSING THE LESSONS of the crisis in Pacific Asia depends on whether you think recent events are, as they are usually described, an "economic crisis," or a crisis with political and social roots. Although it is clear that all the countries affected remain far better off after a generation of early-stage capitalism, it is less clear where they go from here. If you believe, along with Harvard economist Jeffrey Sachs, that the economic fundamentals in Pacific Asia are sound, then it is possible to blame the IMF for turning a blip into a slump. But the fundamentals were not sound in many parts of Asia and where the IMF proposals and the broader liberal prescription have been followed there are already signs of success.

The first group of countries in Pacific Asia are those which have more or less taken their IMF medicine and are now showing signs of recovery. The IMF was criticised for having deepened the crisis unnecessarily in places such as Thailand, South Korea and Indonesia because of an early insistence on measures designed to stop currency depreciation. But currencies did stabilise and interest rates did come down. The devaluations were deep at the start, but two out of three of those countries are now recovering. In dollar terms (as of late December 1998) the Thai baht is 29 per cent higher than a year ago and the Thai stockmarket is up 40 per cent since 1st January 1998. The South Korean won is almost back to where it was before the crisis and the country's stockmarket is 67 per cent higher than on 1st January 1998. The Indonesian rupiah is about half its dollar value a year ago and Indonesia's stockmarket is still 29 per cent lower (but we will come to this story in a moment). In the short term, the decline in growth in Thailand of 7 per cent in 1998 is set to become a growth rate of 0.5 per cent in 1999 and South Korea's loss of 5 per cent of GDP in 1998 will improve to about minus I per cent in 1999. Even Indonesia is projected to see a 16 per cent fall in GDP become a "mere" 3 percent fall in 1999.

This is not to say that reforms are not needed. Stable growth in the future depends on deep and difficult reforms. South Korea's Chaebol--the dozen or so large companies which dominate the economy-have to be broken up, and the economy as a whole needs to be liberalised. All three countries need to become more financially transparent. They also face the challenge of creating a proper welfare net after the poverty and destitution left in the wake of the crisis revealed that Asian family values no longer sufficed.

Perhaps the best news from these three countries is that all have taken important steps towards a more pluralist political system. In the midst of the crisis Thailand chose its cleanest government ever (although there are still serious problems), South Korea experienced the first democratic election of an opposition president, and Indonesia replaced the authoritarian President Suharto-albeit with a still very uncertain mix of democratic forces.

In the long term, the emergence of more pluralist governments will be helpful for economic reform, but in the meantime the lure of populist politics may make some economic reforms more difficult to achieve. These uncertainties are most obvious in Indonesia-a country still in the midst of a political and social crisis triggered by the economic collapse. Critics of the tough conditions imposed by the IMF before dispensing money to the Suharto regime must now recognise that the fund's robust line was crucial to helping the Indonesian people overthrow their dictator. Future reform must be achieved at home, but Indonesia's social and political fabric is too complex to allow reliable guesses about how it will progress.

The second cluster of states are those which have done quite well considering the storm around them. Taiwan is the greatest success story-having sustained a growth rate of more than 5 per cent in 1998 with the same predicted for 1999. Singapore's GDP dropped by about 1 per cent and is set to grow by 1 per cent in 1999-a remarkable story considering how far its Southeast Asian neighbours have fallen. The Philippines achieved a 1 per cent growth in 1998 and will do a bit better in 1999.

The causes of these relative successes are varied. Taiwan prospered by keeping its enterprises small with low debt. Its new and raucous democracy helps eliminate corruption and its fear of China forces it to maintain huge currency reserves. Singapore is not as undemocratic as its critics suggest, but its success is built on a ruthlessly honest civil service and providing a constantly upgraded and welcoming environment for foreign investment. The Philippines is too unstable to provide the basis for far-reaching conclusions, but optimists will argue that having been through its phase of kleptocratic capitalism under Marcos, its lively democracy is committed to open government. But taken together, these three countries demonstrate that you can resist the powerful winds of crisis if your economic fundamentals are sound. Once again, a liberal political system-or a clear move towards it-seems to help.

A third, and contrasting, category includes the dissenters from liberal orthodoxy, most notably in Malaysia and to some extent in Hong Kong. It is difficult to avoid feeling a little sorry for Prime Minister Mahathir (and his people) for having decided to peg his currency and impose capital controls just when the rest of the region was beginning to recover. The result is a currency still down 8 per cent from the start of 1998 and GDP growth which fell by 6 per cent and will fall again by 2 per cent in 1999. The longer-term worry is that by having tried to check out of the global economy without being followed by anyone else, foreign capital will be loathe to flow back to Malaysia when it eventually returns. Long-term growth will be stunted unless the breathing space provided by capital controls is used to reform crony capitalism. So far there are no signs that the brief respite is being well used and the brutal treatment of Anwar Ibrahim-a more liberal economic strategist who was deposed as deputy prime minister and put on trial 'for "deviant" sexual practices-suggests that Mahathir has engineered a self-fulfilling prophecy of western hostility.

Hong Kong is not yet in the Malaysia class, but the fact that it used its reserves to prop up the stock market has been rightly seen as a retreat from its earlier liberal orthodoxy. Hong Kong's defence of its currency peg to the US dollar at all costs has also meant a dismal GDP record and a growth forecast similar to Malaysia's. Hong Kong was such a liberal capitalist economy before the crisis that even its recent retreat leaves it safely in the liberal camp for the time being, but it may be sliding.

The fourth and final category includes the lumbering giants of Asia, Japan and China. Despite the western attention lavished upon Southeast Asia and China, it is Japan-and Japan alone which can have a real impact on other Asian economies and the developed west. Non-Japan Asia (including China) accounts for less than 7 per cent of the trade of the developed world. Japan accounts for more than two thirds of GDP in Pacific Asia and accounts for twice the trade of the EU and US with non-Japan Asia. Non-Japan Asia could disappear from the world's economic map and we would hardly notice it. If there is anything more than minimal damage to Atlantic economies from the Asia crisis (one half of one per cent of the GDP of Atlantic countries), then more than half of it is due to Japan's shrinking GDP.

Understanding the difficulties of Japan's transition to a post-industrial age is the key to understanding the "crisis" of international capitalism. Yet the west has been paying more attention to China, which is said to have had a "good crisis" because its GDP seems to be still growing at about 6 per cent. But it was, in fact, China which helped tip the Southeast Asians into crisis in the first place when it hit the region's export surge by devaluing in 1995.

Moreover, China is in poor shape to ease the crisis by stepping up its imports again because it has failed to reform its state-owned industries or bankrupt banking system. China's economy has been effectively in recession: some 3 per cent of its notional GDP growth is the useless product of industry which goes straight into storage to rust. Another 3 per cent growth is the result of merely adding a rapidly growing population to the labour force. China may have huge foreign capital reserves, but capital flight has exceeded in-flows for a number of years now

WHAT DID NOT happen in Pacific Asia is nearly as important as what did. There have been no wars. The pre-crisis orthodoxy in the region was that economic growth would keep the region at peace, but economic crisis has not meant military crisis. Francois Godement, in his new book The Downsizing of Asia notes that in South Korea there is a liberal President Kim Dae Jung committed to a "sunshine policy' designed to entice North Korea into detente; there is also a drop in military spending in Southeast Asia as a whole; and, above all, there is far less ethnic tension than expected. Indonesia is the notable exception.

Another scenario which has not materialised is an Asian economic solution to Asian economic problems. The expositors of Asian values in the region before the crisis, and their western counterparts, expected to see the newly confident Asians rejecting western solutions. But an early attempt by Japan in September 1997 to put together an Asian Monetary Fund (AMF) instead of accepting the conditions set down by the IMF, was swiftly knocked back by Americans and Europeans who refused to provide funds for an effort which would fail to deal with the causes of the crisis while undermining global norms and institutions.

The idea of an AMF is now resurfacing. After all, if Asian economies have financial surpluses and are more sensitive to local needs, why don't they take charge of their own future instead of having the rules set by the Atlantic-dominated IMF? Are not the Europeans using their new single currency to create European solutions that allow them to stand up to global market forces?

The flaw in this argument is that unlike the European single currency which is a post-national project of political integration, AMF proponents are still looking to strengthen nation states in Asia. In practice, Asians would rather have the more distant US hegemon telling them what to do than their local hegemons in Tokyo or Beijing. Asian regionalism is about strengthening the nation state while European regionalism is about transcending it.

In global terms the most striking thing not to have happened is the creation of a "new global economic architecture." The post-second world war Bretton Woods institutions-the IMF and the World Bank-may at most be subject to minor tinkering. Bill Clinton and Gordon Brown were among the loudest advocates of a "new architecture," but no more than a mouse has emerged from G-7 deliberations.

The cooling of reformist passions owes something to the plain fact that although there is a reduction in global growth rates, there is emphatically no recession in the Atlantic world. EU growth of about 3 per cent in 1999 will be almost the same as in 1998. US growth at similar levels continues to confound the pessimists. The contrast between Atlantic success and Pacific predicaments reminds just how much globalisation was really about the spreading out of the western system rather than creating a single global entity. The fact that the Asian crisis did not engulf the rest of us suggests that we do not live in a single, wholly interdependent, economic system in which we all rise and fall together.

The absence of a radical reform agenda for the Bretton Woods institutions also owes something to calm reflection. IMF transparency might be welcome but if, for example, the fund had shouted louder and earlier about Thai corruption, does anyone think Thai markets would have done anything but collapse earlier? While there is a good case to be made that the IMF should avoid the problems of moral hazard by not bailing out foolish western investors before they help people in emerging markets, reforming hedge funds is fading from the agenda. These funds are essentially conservative operations-they spend most of their time insuring against market gyrations and closing them down might actually increase market volatility.

Even the creation of a single European currency is a less radical reform of the global system than many imagine. Once proudly independent countries surrendering control of monetary policy with the strong prospect of fiscal policy following not long after, is certainly a step towards a post-modern state. But the inhabitants of Euroland are not about to find a way to buck the global market economy. By surrendering sovereignty to Frankfurt, they hope to have a stronger voice in the existing system. The ability of the Atlantic powers to manage the global market will almost certainly be strengthened. But this will not be the result of detailed intervention in markets as proponents of exchange rate target zones would like.

So if the Asians are not re-making the liberal, western-designed order, and the Atlantic powers are merely fine-tuning their invention, then how are the rules to be made for the coming information and innovation age? Barry Buzan and I argued in Prospect (February 1998) that the existing and future international system is best described as "westernistic"--meaning that the basic rules are set by westerners and their liberal political and economic ideology, but these rules are adapted to the history and culture of different countries and regions. Although there are notable variations in liberal orders even within the west, no one can hope to prosper without adopting a market economy and pluralist political system. Western success depends on learning from mistakes and from contacts with others-hence Japan's earlier challenge and contribution to the making of the western success story- Creative incoherence and destruction is the mechanism that constantly remakes the westernistic world.

This pragmatic view of the progress of the western project is essential to understanding how the people of the emerging markets can recover from their current problems. Countries such as Taiwan, Singapore or Poland, demonstrate that small countries can make themselves less vulnerable while even large powers suffering from hubris (Japan, China, Russia) are likely to be helpless. A well-run Canada need not surrender all sovereignty and become a colder California, just as Switzerland need not join the EU.

When we begin to think about how to prosper in an economy which will be increasingly dependent on knowledge and innovation, Europeans and Americans run the risk of their own kinds of hubris. The European and American tendency to unilateralism on trade policy, for example, is the biggest single threat to a liberal trading system. The current dispute over bananas is merely the most ludicrous example of how the struggle against protectionism is barely being won.

While Asians are debating the false prospects of an AMF and trans-Atlantic trade officials are engaged in their monkey business with bananas, the real liberal political economy is being shaped by the corporate sector. The post-industrial economy based on information is being created almost free of government rules, and almost entirely within the Atlantic world. But public authorities need to help shape the ground rules. We need to have much more debate, for example, about the rules of biotechnology in international trade. Currently, standards and procedures for biotech trade are being set by the large western chemical companies (with a smattering of Japanese), because governments cannot agree on what to do about it. Western companies are also setting the rules on encryption and taxation in the global information economy because the US and the EU cannot reach agreement on global management of the internet. While governments dither, companies act and set standards which will probably stick. The real worry about the misreading of the current economic woes in Asia and other emerging markets, and the futile debates about "new architecture," is that the public authorities are being distracted from these far more important issues.