At last, a credible authority has spoken and laid the blame for most of East Asia’s currency woes not on foreign exchange traders but on the domestic policies of the countries involved.
In an address to the Economic Club of New York, Federal Reserve Board chairman Alan Greenspan repudiated proposals for more stringent controls on capital mobility and pleaded vociferously for more structural adjustment in East Asian economies.
In an unusually blunt diagnosis of East Asian woes, Greenspan blamed the system of government-directed investment in many Asian countries for “investment excesses and errors” leading to “misuse of resources, unprofitable expansions, losses, and eventually loan defaults.”
Greenspan proceeded also to warn the International Monetary Fund and the governments of these countries against any form of “assistance without further reform of financial systems and economic policies as worse than useless since it would foster expectations of being perpetually bailed out.” In other words, domestic policy does matter, and countries cannot blame foreign investors and capital markets for their own largely self-inflicted woes.
Indeed, as these countries ponder the need for reform, especially a much-needed revamping of their banking systems, they will probably require more, not less, foreign capital.
It has become apparent that, in many East Asian countries, banks as well as large industrial concerns are undercapitalized. There is clearly an urgent need for large injections of capital, and it is likely that this capital will have to come from foreign sources. Consequently, it will be imperative for these countries to develop an attractive foreign investment environment with regulations that not only encourage foreign ownership but also create a situation where rule of law and transparency reign.
This will be a challenge in South Korea. Such changes menace the very core of South Korean capitalism, the chaebol or giant conglomerates, and the interlocking deals amongst banks and private industry. In Indonesia, the threat hits directly at the ruling Suharto family and its cronies. In Malaysia, does anyone believe that prime Minister Mahathir Mohamad is ready to welcome more foreign investment? Thailand, as soon as it settles its political and government tensions, might be pushed to open its markets, but in all likelihood this will take time.
Meeting the challenge of attracting long-term foreign capital will also require that all these countries awaken from their state of torpor and denial, and acknowledge that they failed miserably at preempting the looming crisis.
The new global market forces are unforgiving of misguided interventions and policies, and as globalization proceeds, pressures for greater openness and transparency will mount and will not subside.
The IMF can help these countries weather the transition if and only if they tackle serious domestic reforms. The IMF can reassure foreign lenders that they will not be victimized by exchange-rate overshooting. It can also make it clear that private lenders and borrowers will have to bear the brunt of bad decisions. In other words, the IMF can cushion the costs of adjustment and accelerate reform, but East Asian countries must bear the ultimate responsibility for systematically liberalizing their economies.
The era of dirigisme is over. It is clearly incompatible with the freedom to borrow abroad. Global capital markets do not include cronyism, misallocation of resources, discretionary application of laws and regulations, and control of information. Capital flees and confidence dissipates, and only credible reforms will lure it back. East Asia can opt for dirigisme only if it decides to forgo necessary foreign capital. If, on the contrary, it wants to continue modernization, it must shed bad habits.
We should be thankful to Alan Greenspan for reminding East Asia of this rather elementary truth.