PACIFIC BASIN ECONOMIC COUNCIL
MAIN PAGE | SPEECHES & EDITORIALS | 1999 | BUSINESS DRIVES THE PACIFIC

Business Drives the Pacific Dr. Helmut Sohmen Chairman, Pacific Basin Economic Council PBEC Malaysia Committee Dinner, Kuala Lumpur Thursday, September 3, 1998 It is nice to be back in Kuala Lumpur after the very successful PBEC International General Meeting we had here four years ago. Thank you very much for the invitation to come and speak. And congratulations on your impressive new airport! This is not a good time to be going around in South East Asia - in fact, it is not a good time to go around anywhere. According to Barclays Capital, there are 31 economic, political, and financial crisis in the world today. In Asia, we have domestic banking crises, a pan-East Asian economic slump, a Yen crisis, a speculative crisis affecting the Hong Kong dollar, a collapse in most Asian equity markets, a serious loss in the value of both the Australian/NZ dollars, and a liquidity crunch in many countries. In Europe, the Russian Prime Minister-designate has to worry about confirmation by Parliament, and there may well be default on Russian debt on top of the collapse of the Ruble. We can see a sell-off in Eastern European bonds and currencies, the possible removal of Chancellor Kohl in Germany, a weaker UK economy, and weakening Scandinavian currencies. Even rich Norway is worried about inflation, with high interest rates and falling oil prices impacting on confidence. In the Americas, we have wobbly Latin American currencies and a probable recession in some of the South American countries, and further north a very weak Canadian dollar. There is an explosion in spreads for commercial credit, a crash in many commodity prices and in basic goods. There are more corporate bankruptcies every month, more lay-offs, and in some countries more suicides. There is fear that the political stability in Indonesia is short-lived, that the country could in fact get fragmented as a consequence of regional turmoil. In Japan governments change but everything remains the same, except that the problems get worse from week to week. Taiwan seems to be doing reasonably well up to now and domestic demand is still strong although falling exports are starting to be a worry. Exports are forecast to contract by about 10% this year. GDP growth in 1998 however is still expected to be 5.1%. The scene in China has been more tranquil than in most other Far Eastern countries: with a non-convertible currency, a strong political leadership, substantial foreign exchange reserves of some US$150 billion, a trade surplus last year and (likely) this year of some US$40 billion, low inflation and a reasonable chance to reach the growth target of 8% for the current year, China has a good base. The recent floods in the country may dent growth to some extent, perhaps by some 0.7%, but the overall damage situation is still difficult to judge. Foreign direct investment into China is down somewhat but at contracted US$35 billion still quite respectable. There are other difficulties on the horizon. The long-overdue reform of the state-owned enterprises is going ahead but at a slower pace than originally planned. The pursuit of high investment growth (expected to be at 17% for all of 1998) in an effort to counter deflationary forces may lead to some inefficient projects being undertaken, although the government is trying hard to promote infrastructure projects. The Chinese banking system is still not very strong, despite the reforms of the past few years. There are worries that a further depreciation of the Japanese Yen could put additional pressures on China's external competitive position. I am fairly confident that the People's Republic will not be forced into a devaluation soon, even though President Jiang Zemin was quoted as saying yesterday that the Renminbi's value could not be guaranteed in "all future." There seems to be no immediate pressure to devalue, and there also seems to be few benefits in doing so. Hong Kong has come through the transition to Chinese sovereignty with flying colours, and politically at least developments have turned out to be better than expected. However, the serious economic downturn of the past year throughout the region has impacted on Hong Kong as well, and has hit the Special Administrative Region (SAR) harder than many observers had believed. The Hong Kong economy is now forecast to contract by 4% during 1998. Consumer confidence is at a low ebb, probably the worst in two decades. Tourist arrivals are substantially down, and unemployment is pushing up towards 5%. We are seeing high interest rates in Hong Kong as a result of the currency link to the US dollar. High interest rates in turn impact on asset values, particularly in the important property sector, where values have fallen by some 40% already. The volatility in local interest rates and the correction in asset prices have led to a reduction in lending activity by the financial institutions and has created a credit crunch. A number of foreign banks have withdrawn altogether because of problems in their home countries. Government efforts to produce more liquidity (e.g. through the removal of profits tax on interest) has only had a limited impact. Measures to stabilise property prices (e.g. by the suspension of government land sales till March 1999, and the lifting of quotas on some home-purchase schemes) can only partially be successful in light of the new supply coming onto the market. New demand is naturally affected by the worsening unemployment situation. Although there is some evidence that the strong HK dollar and Renminbi have eroded Hong Kong's export competitiveness, there is evidence that foreign buyers are still placing orders with Hong Kong firms on the strength of product quality and reliability in deliveries. Of course lower rents and labour costs also compensate for the strong dollar and higher finance costs, perhaps over time capable of helping to change Hong Kong's image as being the world's most expensive business location. Hong Kong is officially in recession but is working hard on producing a correction; the SAR has proven in the past that it is highly adaptable and resilient. Despite repeated attacks on the currency, the Hong Kong government seems committed to defend the currency board arrangements. It is of course another question whether the methods employed in this defense, and which have been well publicised this week, are the best strategy. We might discuss the pros and cons further: generally, more negative than positive comments are heard about the measures employed. Economists are still somewhat undecided what the remedies should be to turn the current situation in East Asia around, although they are slowly coming closer to an agreement what the causes for the Asian crises were: a perception of "guaranteed" exchange rates, cheap overseas borrowing, unwise investments, weak financial structures, and too much euphoria that Asia had found a new way for ever-ongoing high cumulative growth. Some economists support the IMF actions and prescriptions, others attack them as ill-advised, ill-suited, or not sufficiently differentiated in the circumstances. One or two economists have argued that there is only one way out of the problem, namely domestic reflation and less reliance on exports, and the protection of currency stability -- not through high interest rates but through the introduction of foreign exchange controls. They argue that this would remove government worries about foreign investor confidence while allowing the stimulation of domestic demand. Malaysia of course decided this Tuesday where and how it wants to go by introducing capital controls. We can only wait and see what happens from now on: I think nobody will disagree with the statement that it is a high-risk gamble, if one defines gamble as a strategy with multiple possible outcomes. So far the measures have not caused any serious disturbances. That is a good sign. However, capital controls do constitute strong treatment: they remind me of chemotherapy in that they are really medicines from the poison cupboard. They should therefore be applied carefully and for limited periods only. The world has struggled hard during the past thirty years to get rid of foreign exchange controls, and their abolition has helped to liberalise trade and encourage investment flows, thereby facilitating the process we call globalisation. With exchange controls, powerful influences over trade and cross-border investments are handed back to government bureaucracies. Exchange controls can undermine investor confidence, stifle new investments, re-direct trade flows, increase transaction costs, create black markets and, if applied on a wider scale, can reduce the potential for economic growth world-wide. And a return to protectionist attitudes will accompany such measures. This will possibly jeopardize the good work that has been undertaken in the framework of the GATT, and now the World Trade Organisation (WTO) by way of convincing nations to regard a scheme of multilateral rules as a better way to achieve their respective strategic interests, than going it alone. Speaking as PBEC Chairman, and hopefully reflecting what I believe is the PBEC credo, let me say that we see any trend towards protectionism as a very worrying retrograde step. Exchange controls are in the final analysis an admission of defeat: things have gotten very serious and no other remedies are seen able to achieve results. But controls alone will not be sufficient; they need to be underpinned by active reforms of whatever has caused the ailment in the economy. The IMF recommendations after the beginning of the crisis (with their emphasis on fiscal austerity), may not have been totally correct or adequate to suit the particular circumstance of each of the East Asian countries. The problems were not the same everywhere. On the other hand, when bottomless pits seemed to open up in Thailand, Indonesia, and Korea last year, the IMF support probably did forestall a total collapse then. It is always easier, in retrospect, to make good assessments of what the perfect solution should have been, but when the house burns you first call the fire-brigade and not the lawyers. Clearly many of the Asian governments did not engage in irresponsible monetary expansion, nor created uncontrollable budget deficits by printing new money, as had other nations at other times. But they allowed weaknesses in corporate finance and in the banking systems to camouflage the true financial position of many enterprises; and they encouraged bad lending and bad investments through implicit guarantees. That systemic or institutional deficiencies were not confined to one or the other country, but general throughout the region, allowed the crisis to reach such proportions so quickly. The resulting loss of public confidence was rapid and wide-spread, assisted by fast communications and instant information flows on the one hand, and by the given interdependence of the economies on the other hand. This was compounded by the urgent need to get hold of foreign exchange, and no doubt by the effects of decisions made by large investment funds, overseas financial institutions, and investors at large. The behaviour of the hedge funds has become a subject of intense discussion lately, not only in Malaysia. Without wanting to take sides in a particular domestic political debate, let me just make the following observations to stimulate the discussion. The hedge funds (and their managers) normally do what their name implies: they try to hedge risks -- and when they smell that things are not going in the right direction in any one place, they look for more attractive opportunities elsewhere. The hedge funds are thus not the root of the problem but its consequence. Because of their size they can indeed have a very profound impact on currencies and national economies since they often move precipitously; and when exiting in a hurry frequently prompt additional anxiety among long-term investors as well. We have to keep in mind also that these funds are not somebody's individual property, but the sum total of many different investors (governments, other public bodies, pension funds, insurance companies, as well as a multitude of private investors). The principal characteristics of hedge funds are that they are truly mobile and truly ruthless. But they are not necessarily immoral. And they can also lose, as recent experiences particularly in Russia have demonstrated. There appears to be no real solution in sight to regulate or adequately control the behaviour of these funds: regulation which by definition would have to be international. The reality is that we live in a world of differing national interests, and that there is no regulatory regime in sight at supra-national level together with an appropriate enforcement machinery; so it will be difficult if not impossible to come to grips with them. That leaves either exchange control mechanisms to be used (as mentioned earlier) in individual jurisdictions, or a resort to the sort of battle of giants which the Hong Kong government decided to engage in recently, the latter with a very questionable chance of a successful outcome. Unlike Malaysia, the Hong Kong government probably still had a few other options open to it before deciding on last week's serious stock market intervention, in the process risking Hong Kong's credibility as a free market place and international financial centre. Possible efforts to restrain international mobile capital also have their downsides: they will impact on foreign direct investment generally, and they can reduce the availability of critical review and an evaluation of the adequacy or rationality of macro-economic policies and management. They will thus tend to help keeping problems hidden for longer than is healthy -- exactly the situation that the current crisis is exposing. The hedge funds as critical investors, rather than as conspirators or saboteurs is the analogy I would prefer to use in this debate. Let us also not forget that private investors in publicly-quoted companies can be fickle, and do not normally have to prove good intent, long possession, or loyalty before being allowed to buy and sell, or vote, their shares. I believe the current crisis is as much a currency and liquidity crisis as it is an adjustment crisis -- an adjustment to a new (and tougher) set of standards that is introduced and moulded by the globalisation process. Mobile international capital is spearheading the need for reforms where they have to be made, and is punishing the laggards. And we have to accept, whether we like it or not, that the world is getting more competitive every day, simply because the number of capable competitors is growing all the time in the global context. If East Asia can adjust -- and over time I have no doubt it will (except I would not like to be pinned down on exact dates) -- then the Far Eastern economies will emerge stronger from the present crisis. The fundamentals are still there: motivation and hardworking people, high savings rates, huge needs for infrastructure development and improvement, the aspiration among (literally) billions of people to achieve a higher standard of living for themselves and their offspring. Asia has had a good long bull run with tremendous cumulative growth. It had to come to an end sometime, since Asia had not invented a new paradigm but simply been able to build on a number of positive factors which fortuitously came together during quite a long period. People like me who work in shipping are quite used to business cycles and market ups and downs: other industrial or commercial sectors will just have to be better prepared for them also, and perhaps be more cautious and a little less exuberant in future. But what has all this to do with PBEC? After all, we in PBEC cannot claim in good conscience that we saw the crisis coming any better than the IMF did or the rating agencies, the academics, and the financial community. Many PBEC members were just as surprised as everybody else by what has happened in East Asia. Many of our PBEC colleagues have in fact also been hard hit in both their corporate and private lives. I must also honestly admit that at this stage PBEC has no ready-made solutions to offer on how to end the crisis. PBEC has no rainmaker's license. All we can individually and collectively do in PBEC, as an organisation of and for business people, in helping to regenerate confidence in the affected economies are the following suggestions. They may sound simplistic but are quite fundamental: One, to encourage each other and all those we deal with to keep calm and not panic in the light ot adversity or greater uncertainty, and to provide positive comment whenever possible rather than idle criticism; Two, to encourage governments -- both in our home economies as well as in the regional groupings to which we belong -- to show leadership: leadership that does not shy away from addressing the problems, does not hesitate in identifying existing structural or institutional weaknesses and applying remedies even when they are painful. We need to ask for leadership that produces and implements consistent and progressive policies within each community. But we also want leadership that is cognizant and fully accepts that market forces do not conform to the rules of wishful thinking. What is important also is that in a time of crisis leaders concentrate on essentials, and do not get sidetracked into minor issues or get lost in technical or bureaucratic niceties. For example, if the Yen is regarded as too weak and prone to create the most immediate risk to East Asian economies or even to other regions, let the concerned statesmen get together to help Japan solve her problems first and foremost: not in an antagonistic but in a cooperative manner. Japan's Finance Minister Miyazawa is to meet US Secretary of the Treasury Rubin shortly: such a meeting should be an occasion to focus on the core issues and put all else aside for the time being. It will be interesting to find out what really happens at that get-together. If the HK currency board is seen as important for confidence and stability in the region, the we should have more leaders speak up in defense of the linked currency rather than engaging in public or private speculation about its imminent demise. If the moral authority of the Indonesian President to govern appears important to us all for the sake of his country and the region overall, let us not have too many voices publicly criticising or belittling him in this difficult period. I hope you get my point. Like in a bank run, we need to recreate a sense of security among the public at large, reduce anxiety, eliminate cynicism, and find a way to retreat from excessive emotional reactions so as to allow a return to rational analysis. This is never easy when things look bleak. And here actions count more than words: and decisive actions count for even more. Surgical cuts can often save the patient more assuredly than prolonged attempts at gentle treatment. Decisions made even at the risk of being wrong are preferable to no action. And any admission of past errors should be seen as a sign of strength, not of weakness. Not everyone agrees with the Malaysian Prime Minister and his stated policies. Nevertheless he has the courage to act and is trying to find solutions while many of his counterparts spend a lot of time deliberating or just talking. Perhaps also because of the high-profile APEC process, there has been a tendency in recent years to believe that macroeconomic policies (involving such things as prudent public finances, a manageable debt, openness to international markets, a limited role for government), together with a stable political environment and sound legal institutions, are sufficient to promote and maintain national prosperity. As long as these factors are in place, so the theory goes, everything else will take care of itself and an economy's competitiveness and development is pretty well assured. We in PBEC beg to differ. It is business that drives economies and moves them towards greater prosperity, not merely the bureaucratic order and the institutional framework guaranteeing stability and predictability. These latter factors establish the potential but do not give the assurance of necessary growth in productivity that makes economies more competitive and the countries and their peoples wealthier. The microeconomic input is thus just as important, if not more important. It is the strategies and operating decisions of individual enterprises, as well as the collective business environment in the national or regional contexts which business creates and of which is a part, that determine ultimate success. Of course these three facets are inter-linked and are contingent on each other. It is for this very reason that an independent business voice such as PBEC's is important and should be listened to carefully in government circles. Here I would like to stress the word "independent": the members of PBEC are self-selected, not appointed or elected. We live, as always, in interesting times. Today we are struggling with new parameters imposed by globalisation. We face new competition and more volatility. New yardsticks are applied to measure the performance of both governments and of the business community. Modern information flows are both a blessing and a curse. A changing political landscape provides more opportunities but also creates more threats. Against this background, and more than ever before, the working together and the sharing of experiences that an organisation such as PBEC facilitates, must be a win-win situation. PBEC has been around for over 30 years. I have no doubt that it will be around for another 30 years or more -- and in the process outlive the nation state and perhaps even the supra-national organisations created in recent times. In fact, as we go forward, the move from government functions to private-sector services offered on a competitive basis, is probably as unstoppable as the globalising process itself. There is much still to be built. Thank you for your support of PBEC here in Malaysia, and thank you very much again for your hospitality.