VII. The Asian Economic Model and the Crisis

It has become customary for US commentators to blame the serious financial crisis in Asia on the dirigiste capitalism that many of these countries traditionally followed. Unfortunately for the crisis-stricken countries, this view is endorsed, as we saw earlier, by Alan Greenspan and other eminent US officials, as well as by the IMF. It is argued that, although the crisis may have been triggered by short-term macro-economic imbalances, its fundamental causes were structural and micro-economic. The close relationship between governments, corporations and banks, it is suggested, led to crony capitalism and a disregard for profits in corporate investment decisions. This resulted in overinvestment, which, together with the high debt-to-equity ratios of Asian corporations, made them highly vulnerable to interest rate or exchange rate shocks. Hence the crisis and the IMF policy recommendations that the affected countries fundamentally change their economic organization, the relationship between government and business and their labour laws so as to alter the micro-economic behaviour of economic agents.

The IMF theory, although plausible, is far from convincing. It has been examined at length in Singh (1998b; 1999a) and in Singh and Weisse (1999). Other studies, notably by Feldstein (1998; 1999), also bear on this thesis. A critical weakness of the theory is that it cannot explain why these countries were so extraordinarily successful during the three decades prior to the crisis.

Singh (1999a) and Singh and Weisse (1999) note that the Bretton Woods institutions’ analysis of the Asian model underwent three major transformations between 1991 and 1997. In a major study intended to represent what Bank economists had learned from four decades of development experience, it was argued that the outstanding economic success of the East Asian countries was due to their “market friendly” approach to development, with only minimal role for the government (World Bank, 1991). Further, it was suggested that these nations owed their success to their close integration with the world economy. This analysis was sharply challenged by a number of independent scholars who pointed out that, contrary to the World Bank’s assertions, the state had played a vigorous role in these economies through industrial policies. Moreover, although these economies had export orientation, they continued to maintain extensive import controls. Thus the critics argued that, instead of close integration, the Asian countries had a strategic integration with the world economy - i.e. they opened up their economies to the point where it was useful for them to do so (Singh, 1995c).

In response to these criticisms, the Bank’s second stage study (World Bank, 1993) fully accepted that the government had a large role in these economies, but insisted that the industrial policies were largely ineffective. At the policy level, the Bank made no concessions at all, emphasizing that the essential lesson of the East Asian experience was to get the prices right and to follow the country’s comparative advantage. However, at the theoretical level, the World Bank represented a major advance in the thinking of its economists. For example, the close business-government relationships of the East Asian economies were rationalized in terms of the so-called deliberation councils, which, it was suggested, in the real world of incomplete and missing markets improve welfare by co-ordinating investment decisions. Similarly, the performance standards imposed by these governments on business were interpreted in terms of export contests and contingent contracts, which were conducive to economic efficiency.³⁶

³⁶ See also Aoki et al. (1997); Singh (1999c).

At the third stage, following economic crisis in East Asia, it is now being suggested by the IMF that the governments of these countries intervened too heavily all along - which, it is also suggested, was the fundamental cause of the crisis. Deliberation councils are now interpreted as crony capitalism. Export contests are, presumably, now regarded as distortions to the market mechanism.

The analysis of the crisis by Singh (1999a) and Singh and Weisse (1999) comes to rather different conclusions concerning the culpability of the East Asian model. These conclusions may be summarized as follows:

· By comparative international standards, the crisis-affected Asian economies all had strong fundamentals, as indicated below:

° High long-term rates of growth of GDP.

° Low, single-digit rates of inflation.

° Very high domestic savings and investment rates.

° Fiscal soundness with low public debt-to-GDP ratios.

° Export orientation and high rates of growth of exports.

· Although the affected Asian countries had strong fundamentals, they suffered to varying degrees from short-term imbalances, such as overvalued exchange rates or low central bank reserves relative to the country’s short-term liabilities. This required some macro-economic adjustments and restructuring of debts. However, these were problems of liquidity rather than solvency. In view of their long record of fast economic growth and export orientation, all these countries had the ability to service their debts in the medium to long term.

· The IMF’s pronouncements that the crisis was structural and required fundamental changes in the organization of these economies were unhelpful. They panicked investors and helped convert a relatively minor liquidity crisis into a crisis of solvency.

· Many of the macro-economic imbalances, as well as other often-cited instances of mis-allocation of resources (e.g. the property bubble in Thailand), were not caused by too much government interference but by too little. In the period preceding the crisis, both the Republic of Korea and Thailand had undertaken extensive financial liberalization with the result that the governments were no longer co-ordinating allocation of resources. This led to overinvestment in certain sectors and the observed fall in the profitability of investment.

· It is generally agreed that the proximate cause of the crisis was the sudden reversal of external capital flows to Asian countries. From 1994 to 1996 net private capital inflows to Asian countries more than doubled, rising from $40.5 billion to $90.3 billion. However, in 1997 there was a net outflow of over $100 billion - equivalent to 10 per cent of the GDP of these countries. The overall evidence supports Radelet and Sachs’ (1998) contention that this was a classic case of a panic run on the bank, where each bank considered only the short-term illiquidity of the countries concerned and consequently withdrew its funds, worsening the crisis for both borrowers and lenders.

· It is significant that, despite some liberalization, both China and India maintained extensive capital controls, and thereby escaped the Asian financial crisis. This is despite the fact that the Indian fundamentals were much weaker than those of the crisis-affected Asian countries. Further, although China had stronger fundamentals, it had nevertheless suffered recent reduced economic growth and considerable slowing export growth.

· On the basis of the above analysis, rather different policy conclusions from those of the IMF (1999) have been drawn here. It is suggested that, in view of the depth of the crisis, the affected countries should not only maintain the close government-business relationships of the Asian model, but, indeed, extend them to involve trade unions and other groups in civil society. The crisis is more likely to be resolved by co-operation and equitable sharing of the burdens of adjustment than by the social conflict that is likely to follow from introducing at external behest deep structural changes in political and economic organization.