MELTDOWN EXPLAINED
Rights and wrongs of the Asian Crisis
By Ricardo Saludo
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HE IS ONE OF the biggest winners in the Asian Economic Crisis. Unlike investor George Soros, however, it was not his bank balance that rocketed when the region's currencies plunged in 1997 - but his reputation. American economist Paul Krugman got vindication big-time after more than two years of being attacked for his late 1994 article, "The Myth of Asia's Miracle." Then with Stanford University and now with MIT, the maverick thinker had questioned the basis of East Asia's phenomenal economic growth since the 1960s and argued that it was bound to slow as the region's capital, human and natural resources got scarcer.
In fact, it was other factors that defanged the region's economic tigers - wasteful investments, badly run banks, the trillion-dollar tides of global capital. And Krugman himself denied predicting the Crisis. But he was the Cassandra who first warned of the end amid all the boomtime bullishness, and that teleported him to guruship in the Crisis-hit world.
Still, his new book on Asia's financial maelstrom and its global prelude and aftermath does not have the c-word anywhere in the title. The Return of Depression Economics (W.W. Norton & Co., 176 pages, hardback; $23.95.) sounds like a turgid academic tome for professors and bankers. In fact, it is one of the best layperson's guides to the Asian Crisis, written in engaging, jargon-free style. More important, it avoids fashionable Western diatribes that portray the debacle as just desserts for the Asian way of business, usually described as shady, corrupt and colluding.
Indeed, the book asserts: "The crisis was not (mainly) a punishment for sins. There were real failings in these economies, but the main one was a vulnerability to self-fulfilling panic." Krugman notes that many ills of Crisis-hit Asia, like corruption, high debt, poor governance and bank regulation, afflict China and India, yet they escaped the regional storm. Why? Because these economies were not as open to the ebb and flow of world money. But the Crisis countries had become "more vulnerable partly because they had opened up their financial markets." (The IMF had promoted such full currency liberalization, which it made a policy objective in April 1997, just when the baht first came under serious attack.)
The investor panic that hit Asia, says Krugman, was not the briefly irrational sort quickly dissipated by a reality check. Rather it was the self-validating kind: "whatever sets it off . . . the panic itself makes panic justified." In a bank run, the rush for withdrawals forces the institution to liquidate assets at fire-sale prices and go bankrupt - giving sound basis for the initial panic. So it was in the Crisis: foreigners and locals dumped Asian currencies, precipitating bank and corporate troubles which in turn justified the stampede. What is worse, the investor exodus in one country spurred a contagion of other self-validating stampedes in nearby emerging economies.
In this panicky climate, managing the Crisis came down to playing to the markets in the hope that they would be impressed enough to stop pulling billions out of Crisis countries - whether or not the measures adopted were correct. "The perceived need to play the confidence game supersedes normal concerns of economic policy," Krugman writes. "It sounds pretty crazy, and it is." The International Monetary Fund, he adds, did much the same thing, giving Asia the Mexico remedy of interest-rate hikes and budget cuts which calmed Latin American markets in 1995 (due largely to luck, says Krugman) - in an all-out drive to boost confidence and stop the plunge of regional currencies.
But in Asia, that formula only exacerbated the recession and collapsed businesses, even well-run ones, under debts bloated by devaluation and high interest rates. "The IMF at best avoided one vicious circle by starting another," Krugman contends. It also demanded sweeping structural reforms that had little impact on the financial crunch and often triggered disputes with governments, particularly Indonesia's, further torpedoing confidence. "One might describe this," says Krugman, "as the view that governments had to show seriousness by inflicting pain on themselves - whether or not that pain had any direct relevance to the immediate problems."
Defenders of the Fund would be quick to point to Asia's steady recovery since August 1998 as evidence that the IMF got it right. But the book cites other factors that may have well done more to help the region climb back. In particular, hedge-fund losses in Russia and Hong Kong and steep U.S. interest-rate cuts lifted the yen, easing pressure on Asian currencies. That in turn allowed Crisis economies to cut domestic interest rates and boost public spending. Moreover, the IMF realized its mistake in imposing excessively tight monetary and fiscal policies, and loosened up. All that helped alleviate the recession and set the stage for recovery.
For Krugman, the top priority in the aftermath of the Crisis should be reviving growth, and the big danger is a deflation spiral of falling demand, prices and earnings. Policymakers, he argues, should be willing to try solutions other than the free-market ones pushed by the IMF and the U.S. Among the unorthodox measures are currency controls, which Malaysia adopted last September days after Krugman advocated them in Fortune magazine. For Japan, he urges a major expansion of money supply, to fight deflation and spur spending. "Economic analysis," Krugman argues, "is not a set of rules to be followed on all occasions [but] a way of thinking . . . that allows you to craft new responses."
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If Depression Economics offers a big-picture sweep of key Crisis issues, Asian Eclipse: Exposing the Dark Side of Business in Asia, by Michael Backman (John Wiley & Sons, 412 pages, cloth; $29.95), a widely published expert on regional enterprises, is a treasure trove of detail about the ills of regional business, which most analysts have blamed for the Crisis. The research and reporting is impressive and up-to-date, including events like Manila's Orient Bank failure and the Sultan of Brunei's financial woes. And it's a pleasure to read, rich in anecdotes and never boring or academic.
Backman's analyses and generalizations can at times be too sweeping, though. And some remarks on Asian firms in fact apply to all business. For instance, he tells Westerners to always confirm agreements with Asians in writing, and never to buy an Asian company without an independent audit. But keep your eye on the facts and figures, and Backman's book, like Krugman's, will prove an invaluable pointer to what the region has to do - or undo - to escape the Crisis and avoid a future one.
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