Lecture 7--Asian Debt Crisis

1. Today's Questions:
   1. How interconnected are the world's economies?
   2. Does increasing interconnection lead to economic growth or decline in the non-Western World?
   3. What role do local barriers to capital flow play in stabilizing or destabilizing the global economy?

    

    

2. Concepts:
   1. Washington consensus and structural adjustment
   2. Developmental State
   3. Network ("Crony") capitalism
   4. Local legal environments

    

3. Background: Global Economies in the 1990's
   1. Internationalization of Finance Capitalism
      1. Investment capital worldwide expands dramatically
         1. By 1995, $20 trillion
         2. Ten times the 1980 figure
         3. Spending on overseas investments increases dramatically: 197 TIMES more between 1970-1997.
         4. More wealth is stateless
         5. 1.5 trillion PER DAY changes hands in foreign markets.
      2. Leveraging
         1. Much of this money is borrowed and used for speculation
         2. Have a million, borrow five million (explain leveraging)
         3. Used for speculation rather than concrete FDI
      3. Apparent risk reduction
         1. Public monies used to bail out losers
         2. Mexico, 1995
         3. Sends message that investment in emerging markets is risk free
   2. Asian Tigers
      1. Primed with money from international investors, business in East Asia is booming 1992-1997
         1. World Bank Report 1993: the East Asian Miracle
         2. Dramatic increases in the economies of Japan, Thailand, Malaysia, China, Singapore, Indonesia, S. Korea
4. Explanations for the Boom
   1. Washington Consensus argument (the Economists' argument)
      1. IMF/WB/WTO policies (structural adjustment)
      2. Principles include:
         1. External openness to trade and foreign investment
            1. Reduction of trade barriers like tariffs
            2. Repatriation of profits with full currency convertibility
         2. Good government
            1. Small balanced or surplus government budgets (achieved largely by reducing social spending)
            2. Conservative monetary policy leading to low inflation and high savings rates
         3. Emphasis on export processing
            1. Exposure to discipline of international markets.
   2. The Developmental State argument (the Political Scientists' argument)
      1. The "developmental state"
         1. Focuses on promoting economic development in national interest
         2. Government protection of industry, promotion by creating a regulatory environment that allows huge cross-enterprise ties (Japanese keiretsu) and cross-investment.
         3. Values order over freedom
         4. Patriarchal-authoritarian or semiauthoritarian states (China, Malaysia, Singapore, Indonesia)
      2. Asian values (the local intellectuals' argument)
         1. Rooted in Confucianism, a hierarchical order
         2. Asian values favor:
            1. primacy of order over freedom
            2. family and community interests over individual choice
            3. economic progress over political expression
            4. thrift, ambition, hard work, value of education
      3. Network Capitalism (the anthropologists' argument)
         1. guanxi: a political economy based on reciprocal and enduring exchange of favors
         2. enduring kin and ethnic ties maintained in diaspora
         3. "crony capitalism"

    

5. The 1997 crisis
   1. Large institutional investors are pouring money into "emerging economies"
   2. Excess capital leads to "bubble market," in which more capital is going to overvalued and risky investments.
   3. Bubble market began to burst in 1996, when a New York Hedge Fund sold $400 million of the Thai currency, the bath
   4. Loss of investor confidence made Thai stock market drop 75% in 1997.
   5. The effects of the collapsing Thai market led to investor flight

    

6. Which model failed?
   1. The economists say it was the culturalists' models that failed
      1. Asian values of thrift and hard work weren't the source of economic upswing: crony capitalism or "network capitalism" was, and it caused bad investments in both public and private sectors.
      2. Investors gave money to people they knew, not the ones who had the best business plans.
      3. Crony capitalism caused over-valuation of assets.

       

   2. The political scientists say it was the economists' models that failed
      1. Crony capitalism may have contributed, but it couldn't have caused the bubble
         1. Openness was not just the essential ingredient of the economic miracle, but too much openness too fast was responsible for collapse.
         2. High domestic growth and investment led to current account deficits
         3. Open capital accounts and capital-account convertibility made a sudden massive exit of foreign funds possible.

       

   3. The culturalists say it was the political scientists' model that failed
      1. New democracies caused loss of control over macroeconomy
      2. Business people gained control over elected legislatures and enacted legislation which
         1. lowered taxation
         2. reduced interest and the ability to raise interest rates
         3. reduced the ability of already weak financial monitoring and regulatory agencies to control the superheating economy.
      3. Thailand
         1. Frequent elections and widespread vote buying made monetary contraction impossible.
         2. Comparison with Singapore and Hong Kong: authoritarian regimes weathered crisis better because they could respond.
         3. Lack of govt. regulation led to an information shortage: low monitoring and disclosure requirements kept financial markets in the dark.

       

   4. Some answers, some confusion
      1. Lydia Lim (economist from U. Mich) says "the Asian economic crisis does not provide unqualified support for either the Western open markets and democracy model, or the Asian strong government and cultural values model. Both need some adjustment for global and national capitalisms to work smoothly."
      2. The balance between openness and embeddedness, global and local, free flows and barriers must not only be balanced, but timed
         1. Capital market liberalization and democracy have to grow along with (not ahead of or behind) the growth of supportive state and civil institutions.
         2. Governments need to have the strength to resist pressures of network capitalists who wish to interfere with fiscal, monetary, and regulatory autonomy
         3. Private sector networks need to be able to adequately account for risk.
      3. Lim argues that the Asian crisis has taught us to beware of simple, monocausal, one-size fits all models of global/local economic growth.
         1. We need to move away from universalizing theories, like the Washington consensus, and return to a complex knowledge of local economies, politics, and cultures.

    

7. Return to today's questions:
   1. How interconnected are today's economies? More, and growing.
   2. Does interconnection lead to growth or decline? Both, in cyclical waves.
   3. Reducing global economic volatility depends on balancing global flow with local barriers, including thoughtful and well managed regulatory environments.
   4. Local difference still matters, and can be the most important factor in keeping the global economy stable.