MAIN PAGE | SPEECHES & EDITORIALS | 1999 | FROM MIRACLE TO DEBACLE
PACIFIC BASIN ECONOMIC COUNCIL
MAIN PAGE | SPEECHES & EDITORIALS | 1999 | FROM MIRACLE TO DEBACLE
From Miracle to DebacleThe Asian Economic Crisis in PerspectiveProfessor Jagdish Bhagwati Arthur Lehman Professor of Economics and Professor of Political Science, Columbia University Wednesday, May 19, 1999 The Challenges of the Next Century for the Pacific Basin
The author is the Arthur Lehman Professor of Economics and Professor of Political Science at Columbia University. Keynote-speech remarks based on this paper were made at the Pacific Basin Economic Conference in Hong Kong on 19th May, 1999. I. Introduction The Asian economies have historically been a source of surprise to economists. Just consider two telling examples, one going back to the early postwar years which few present today were witness to, and the other from the later, very recent ones we all have lived through. In the 1950s, nearly all economists thought that the two sleeping giants, China and India, would wake up and become the super-achievers in the quarter century after the end of the 2nd World War and with the beginning of the new era in the 1950s of determined national and international efforts at accelerated development. Imagine then our astonishment that the winners in the race turned out instead to be the four little tigers of the Far East: Korea Taiwan, Singapore and our host today, Hong Kong. [Indeed, I might take the occasion to remark that, for those of us who believe in the virtues of open trade, Hong Kong has been a source of inspiration. It is often said that, whereas Europe's empire in the 19th century was one by conquest, America's in the 20th century has been one by invitation. We could readily add that Hong Kong's, and indeed the Far East's, empire has been one by example.] Indeed, these NICs, the Asian Four, grew over a long period of nearly three decades at rates that exceeded the wildest expectations of anyone in the 1950s about the maximum potential growth rates anywhere in the world, no matter how splendid the policy framework. It seemed natural therefore to consider the East Asian performance to be one that should be called a "miracle", not in the sense that it w as beyond explanation but in the sense that it was off the curve. But then came yet another surprise. With the financial collapse of Thailand in mid-1997, and its spread forthwith to Malaysia, Korea and Indonesia (these are the new Asian Four, united by profound distress whereas the old Asian Four were blessed by huge prosperity instead), the Asian miracle turned into an Asian debacle. No one had predicted this, of course. My brilliant MIT student, Paul Krugman, is regarded as having foreseen the reverse because, in a much-cited Foreign Affairs article, he used the econometric work of yet another of my students (at Columbia University), Alwyn Young, to argue (along with Young) that the Asian miracle was a result almost entirely of increased investment. Hence, Krugman drew a parallel with the Soviet Union's decline (a matter which itself is dubious since distinguished experts on Soviet decline such as my colleague Padma Desai, the Harriman Professor of Comparative Economic Systems at Columbia University, have argued convincingly that the Soviet decline is far better seen as resulting instead from a progressive decline in technical progress and in economic efficiency), and argued that increasing accumulation would lead to diminishing returns in Asia and hence to diminished growth rates and the end of the Asian miracle. But it is wrong to assign prescience to Krugman for predicting the Asian debacle because of this prediction by him of how the miracle would end, for two compelling reasons: First, there are strong empirical reasons to reject Young's notion that total factor productivity (TFP) was negligible in the East Asian region as a source of growth. If you periodise the econometrics, it shows that the TFP did in fact increase with time. This is in fact what you would expect: technological maturity increases over time. Japan, for instance, progressed from shoddy manufacture, to quality manufacture, to minor product and process improvements and finally to major ones. Young's work misses this element, I am afraid the diminishing returns theory is therefore not consistent with the situation as we can see it plainly and as later econometrics seems to underline as well. Second and more pertinent, is the fact that Krugman's prediction of diminishing returns to capital accumulation would imply that the growth rate would fall gradually and continuously. Instead, the collapse was sudden, sharp and discontinuous: and its causes were financial (though there is controversy about whether these were endogenous and internal to the Asian economies, taking the form of crony capitalism and weak financial structures or were exogenous to them, and a product of speculative panic). The diminishing returns hypothesis was thus not a plausible prognosis of a diminished Asian future; nor did it have anything robust to do with the grim outcomes since mid-1997. If I may then use a blunt analogy, assigning foresight to Krugman for the Asian debacle is akin to assigning credit to a Jesus freak, who has been walking the streets and declaiming that the end of the world is near because of a Biblical flood, for having forecast the end of the world when the world ends because of nuclear winter! I say all this, not just to chastise my students, no matter how distinguished, when they go wrong -- a habit that dies hard with Professors -- nor to just remind you that economic forecasting, not merely for the short-term, is fraught with hazards -- a lesson that none of you engaged in finance and industry needs to be told -- but because the reasons for the Asian miracle and then for the Asian debacle bear directly on the three questions that I wish to address today: 1. what were the causes, and hence what are the lessons for policy, of the Asian debacle both for the current recovery and for appropriate policies to avoid such shocks in the future;
Since the miracle preceded the debacle, and its explanation has bearing also on the causes of the debacle, it is convenient to begin with the analysis of the last question first. II. The Miracle: Its Causes Asia's miracle was clearly a product of policy choices. The remarkably high investment rates noted by many, and the steady absorption of technical progress, that sustained these phenomenal growth rates, were a product, in my view, of the outward orientation of these economies in their trade, and for some countries (e.g. Taiwan and Singapore, not Korea), of their pro-DFI (direct foreign investment) policies. Hong Kong and Singapore were certainly free traders, pretty close to 19th-century Britain. True, the others used trade barriers. But the results were still close to those promised by free trade because these countries managed, through other policies, to countervail the chief and fatal flaw of trade protection: namely, that your enterprises get addicted to sheltered home markets and then "goof off" into continuing inefficiency. This countervailing policy was the strong commitment to using export promoting measures such as export subsidies to make the external markets important as well, the continuous political emphasis on reaching world class in quality production, and accompanying emphasis on literacy and higher education as supportive policies. The outward trade orientation, furthermore, meant also that the inducement to invest was not limited by the domestic market, as was the case with import-substitution-oriented economies like India. Hence, investment rates could rise to, and be sustained at, much higher levels. With export earnings rising also due to the export-orientation, this also meant that the high investment took the form of imported capital goods that embodied the evolving technologies abroad, thus adding the benefits of technological absorption to those of capital accumulation. The emphasis on education in turn meant that the new technologies could be handled with great efficacy, and that over time there would also be elements of evolving domestic technical change of various kinds, both resulting in yet higher productivity gains (compared to countries where education was lagging behind).(1) In my view, none of these specific factors have changed for the worse as far as the basic Asian fundamentals are concerned. In fact, the reason why one might even be more optimistic about the Asian resumption of high growth in the near future is that a segment of the reforms under way, specifically the introduction of better banking and accounting standards and an enhanced focus on transparency and good governance, should only strengthen the infrastructure within which high growth can proceed in a sustainable fashion. A source of pessimism, on the other hand, is the fact that the world is currently registering excess capacity in some sectors and a slowed growth in trade, so that, for the immediate future, the possibility of outward trade orientation as the key ingredient in Asian growth strategy is somewhat handicapped. But the postwar period has shown that trade is a pretty resilient phenomenon; and the Asian countries, in particular, have demonstrated that markets can be found if there is no defeatism and India has demonstrated by contrast that defeatism, in the form of export pessimism, is almost always a self-fulfilling phenomenon: if you assume you cannot export, you will not export. So, I would not set my sights for resumed growth, provided that the causes of the financial-crisis-caused debacle are set right. The other source of pessimism about Asia's resumption of high growth rate, once the financial crisis is surmounted, comes from the pro-industrial-policy writers such as Robert Wade and Alice Amsden who thought that industrial policy was responsible for the high growth rate and that this will now be eliminated by pressures from the triumphant Americans and the conditionality-driven demands of the IMF. But, paradoxically, it also comes equally from the anti-industrial-policy reformers who feel that these reforms will take a long time to take hold. I believe that both are wrong. As I just argued, the principal driving force behind Asian economic performance lay elsewhere, the role (whether good or bad) of industrial policy, of chaebols, of "administrative guidance", of Japanese keiretsus etc. being seriously exaggerated. Whether these practices stay, whether in an emasculated or robust mould, is therefore a matter of minor consequence in my view. Needless to repeat, I remain unpersuaded by the notion that Asia's growth rate, once resumed, will run rapidly into diminishing returns. I might also remind the economists in that school of thought (or perhaps thoughtlessness): the interesting question you should ask instead is why diminishing returns did not strike these economics for so long as three decades despite their phenomenal capital accumulation and growth! III. The Debacle: Its Causes and Remedial Policies So, I have answered in the optimistic mode the question whether the Asian economies can return to fairly high growth rates, once they get past the current financial-crisis-fueled debacle. But how soon will they? The answer to that depends, of course, on our assessment of the causes of the crisis and therefore of the appropriateness of the remedies currently deployed. And then there is the related pair of questions: can similar, debilitating shocks be avoided in the near future; and if so how? Let me state at the outset that I subscribe to, indeed was among the earliest economists (in December 1997 in interview in The Times of India which was widely circulated by Robert Wade on the Internet), to propose that the chief underlying cause of the Asian crisis starting mid1997 was to be found in the hasty opening to freer capital flows under pressure from what I have christened as the "Wall Street-Treasury Complex" in my much-cited and translated May 1998 Foreign Affair article, provocatively titled "The Capital Myth" by the editors. Wall Street naturally wished to enlarge its sphere of operations; the US Treasury reflected that lobbying pressure while also succumbing to the "ideology" of the market while forgetting that the capital funds market is not as innocuous as goods markets and needs to be monitored and regulated carefully. There has been a tendency in Washington to pretend that there was no such pressure; but just talk to any developing country Finance Ministers in the half decade prior to 1997 and you will get plenty of evidence to the contrary. In fact, Barry Eichengreen, the prolific friend of the IMF and of freer capital flows, has come around finally to much of what I had written about the hasty and imprudent opening of the capital account through financial liberalization and of the Wall Street-Treasury Complex's dominant responsibility for that outcome. Let me just quote some telling sentences:(2) "Only in recent years, in response to pressure from the International Monetary Fund and the United States, have governments (first in Europe and Japan, and later in most emerging markets) abandoned capital controls. The Asian crisis suggests that at least in the case of developing economics, this was a serious mistake." "After Mexico in 1994 and Asia in 1997, do we need a third reminder of the dangers of premature financial liberalization?" "Pragmatism is the order of the day. Developing countries are simply not ready for prime time (in freeing up capital flows)." "The U.S. Treasury needs to overcome the "Wall Street complex."(3) This imprudent financial liberalization led to dangerous levels of short-term borrowing which, in turn, set up the Asian economies for the debacle. When the panic-driven reversals of the inflows came, amounting to historically unprecedented levels of resource outflow for the Asian Four in quick succession, the IMF compounded the problem by imposing an anti-Keynesian prescription of high interest rates and deflation. Finally, in a third mistake, the US and the IMF killed, even at a neonatal stage, the so-called Sakakibara plan to inject up to $100 billion from Japan into the afflicted Asian economies: the reasons were a mix of US hegemonic concerns vis-a-vis Japan, the IMF-Treasury view that the IMF's hegemony to address crises must be left untouched, and the serious misreading of the crisis as one that would be fairly readily fixed anyway (the hubris coming from the success with the Mexican rescue). How wrong all this was! I am of the view that the US administration really blew it. In fact, it is not unfair to say that Messrs. Rubin and Summers may well have presided over the largest manmade disaster in the world economy since Smoot-Hawley! Today, they are applauded for the turnaround that I shall shortly address: but that is a bit like, if you are a liberal Democrat in the US, Mr. Kissinger being awarded the Nobel Peace Prize for the end of the war in Vietnam after having prosecuted it to his countrymen's distraction and rage that is not yet spent. None of this is to say that there were weaknesses in the afflicted countries' economies. True, their banking systems were weaker than ours, though we can overdo this since Malaysia, for instance, had excellent standards and expertise. Again, there was indeed crony capitalism around. But neither cronies nor capitalism are unique to Asia: Washington has plenty of cronies around the White House and not a week goes past without lurid tales of PAC-money corruption of US politics. Besides, few of these critics who are eager to find scapegoats within these countries for errors of their own can tell us why precisely this crony capitalism could produce or be consonant with rapid growth over decades and suddenly became a cause of economic disaster. Again crony capitalism of the Suharto variety is an abomination on grounds of income distribution and democracy; was it really incompatible with economic prosperity? So, while I am quite enthusiastic about improving accounting standards, and the structural reform of banking systems overloaded with bad debts (caused, not necessarily by some failure hitherto endemic to Asia but by the crisis itself), I see little connection between other reforms such as the privatization of public enterprises and the prevention of financial crises or the recovery from the current one. Indeed, the recovery of South Korea, a little ahead of what had been anticipated last year, is consistent with lack of progress for instance on eliminating chaebols, which had been the target of US and IMF criticisms. In fact, here I side totally with Martin Feldstein that the excessive conditionality being imposed by the IMF on all sorts of "reforms" is truly absurd, since it is based on an undefended advocacy of our way of doing many things when three decades of unprecedented growth under their way of doing things ought to make us at least a little more circumspect in these matters. In this context, I recall reading in The Financial Times last year about Larry Summer's caustic remark about Japan, now regarded as a sorry spectacle when in the 1980s it was feared as omnipotent, that (I quote roughly) "the last time Japan invented anything important was the Sony Walkman"! The Financial Times editors had mischievously run alongside that comment a story about how Honda had just announced a new engine that had cut emissions in half! So much for the hasty triumphalism of Washington! And of the resulting IMF's overreach on conditionality. In my view, the only robust policy prescriptions that relate to the emergence from the current crisis are the fortunate reversal of the deflationary policies of the IMF, and the recognition that the use of capital controls in times of crisis is not indefensible. Malaysia has not done dramatically better than, say, Korea with them; but it has not done notably worse either. Besides, Malaysia had to face a hostile IMF and US; and it also shot itself in the foot by undertaking the ill-advised trial against Mr. Anwar which further alienated world opinion; so, we do not have a "controlled" experiment here of the advisability of using capital controls when you have a crisis and you have free capital flows on your books. Also, if you look beyond Asia, just consider the incredible rapidity with which Russia's IMF loan last year simply drained out in totality: could this have happened if the IMF had been wise enough to advocate the use of temporary suspension of capital account convertibility at the same time? IV. Concluding Observations I should then like to end on a positive note.
(1) I have developed these arguments in "The Miracle That Did Happen: Understanding East Asia In Comparative Perspective', May 3, 1996; available on my website: http://www.columbia.edu/~jb38.
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