The Sunday Times 
January 18 1998 OPINION
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Asia on the run from a ghost called Keynes  
 
In a new book describing his part in Margaret Thatcher's monetarist revolution, Gordon Pepper, the economist, recalls receiving a letter in the 1970s from the nephew of John Maynard Keynes, Britain's greatest 20th-century economist. It said that Keynes's worry, just before he died in 1946, was what his followers would do in his name. If the great man was worried then, he will be turning in his grave now. 

Asia's economic crisis has brought out some unusual sights, from the head of Yamaichi, the failed Japanese investment bank, weeping with contrition, to Koreans queueing up to hand over their gold baubles to help out the government. Perhaps the most alarming aspect of the crisis, however, is that it has brought out of the closet what was once thought to be a dying breed, the unreconstructed Keynesians. 

It is more than 20 years since James Callaghan, in his famous 1976 speech to the Labour party conference, buried the post-war Keynesian consensus with the memorable words, said to have been written by Peter Jay: "We used to think you could spend your way out of a recession by cutting taxes and boosting government spending. I tell you in all candour, that option no longer exists." And it is over 15 years since the Thatcher government, in defiance of the 364 economists who predicted that such a course of action would mean disaster, introduced an austerity budget in the depths of the recession of the early 1980s. It marked, not the onset of a new economic downturn, but the point of a recovery that lasted for most of the decade. 

When it comes to diagnosing and solving the ills of the Far East, however, none of that, or the parallel developments in other western countries, might have happened. Asia, apparently, is different. What it needs, the Keynesians say, is a good old-fashioned dose of 1950s-style fiscal activism. 

"Come back Lord Keynes, all is forgiven", is the title of a report out tomorrow from Professor Douglas McWilliams of the Centre for Economics and Business Research, an economist not normally noted for his Keynesian views. Asian governments, he says, may need to cut taxes and boost public spending to head off a slump. 

The International Monetary Fund has been presented with the begging bowl by economies such as South Korea, Thailand and Indonesia, so recently regarded as among the brightest spots of the world economy. Now the IMF is under attack for imposing on these countries off-the-shelf austerity programmes, of the sort it applied to Britain's basket-case economy in the 1970s and Mexico three years ago. Critics ranging from Jeffrey Sachs, head of the influential Harvard Institute for International Development, to, more surprisingly, Joseph Stiglitz of the World Bank, the IMF's sister organisation in Washington, accuse the fund of risking adding more deflation to an already gloomy deflationary situation in the region. 

In Japan, which has no need of IMF assistance, the plea is more direct. If only, the Keynesians say, the Japanese government, which last year was intent on cutting back its budget deficit, injects big tax cuts and extra government spending into its economy, then it will get back on its feet, pulling the rest of Asia up at the same time. 

Stockbrokers and investment bankers, who would normally regard such talk as dangerously left wing, nod sagely in agreement. For the brokers, anything that helps Asian stock markets will cut their losses. And as for the bankers, anything that keeps businesses in these economies going, whether they deserve to or not, rescues them from some highly dubious lending decisions. 

Not everything the IMF has done in Asia has been right. Back in November, when its team went into Indonesia, it seemed like a good idea to shut down immediately 16 dodgy banks, including one controlled by the son of President Suharto. But its action merely added to the mood of panic in the country and the belief that the financial system was about to collapse. And the Japanese government could have been more astute with its timing when it decided to raise taxes last year. 

The argument that Asian governments should spend their way out of impending recession, and be encouraged by the IMF to do so, should not, however, get beyond first base. For one thing, it assumes that the troubled Asian economies are basically sound, and just need a short-term boost to get them through their difficulties. Gerald Segal, director of the International Institute for Strategic Studies, and one of the few experts not to have been taken in by talk of an Asian economic miracle, argues, correctly, that the opposite is true. 

"What the IMF is doing is based on its discovery that the fundamentals of these economies are not correct," he says. "A degree of austerity is absolutely necessary. You have to close large numbers of institutions, banks and companies which have been built up on a false basis." 

In countries like Indonesia, where much of the economy seems to be under the control of Suharto's relatives and friends, the idea that you should look to even bigger government as a solution is obscene. Throughout the region, the need is for new brooms to sweep away corruption and restrictive practices, not for big budget deficits. 

Japan, while in a different category, is testimony to the ineffectiveness of Keynesian policies when the underlying economy is in trouble. It is a standing joke that, in a habit acquired when the country was under pressure from Washington over the size of its trade surplus with America, no Japanese prime minister can attend an important international meeting without unveiling a new fiscal expansion package. 

From 1989, when Japan had a budget surplus of 3% of gross domestic product, to 1996, when it had a deficit of 4.5%, the medicine was tried repeatedly. Interest rates were cut to record low levels. Yet the economy, hungover after the wild excesses of the 1980s, has remained in the doldrums. 

Allowing Asia a painless escape from its woes would also be a classic case of moral hazard. Unless people learn from their mistakes, and suffer for them, they will repeat them. In case anyone is inclined to forget that, Republicans in the American Congress, who ultimately hold the IMF purse strings and who do not believe the IMF should even be promoting structural reform in economies that may rise again to challenge America, will be quick to remind them. 

Asia will not get through its crisis without suffering. It is bad economics, and a cruel deception, to pretend there is a painless way out. The Keynesians should get back into the closet. And let Keynes rest easy in his grave. 
 
 
 

 
 
 
 
 
 
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