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The following article appeared in Left Business Observer #81, January 1998. It retains its copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.
Just three years after Mexico's disaster, the world is seeing the second great global financial crisis of the 1990s. Mexico was "saved" thanks to a $50 billion bailout and an imposed depression. If the authorities get their way, Asia's crisis will be treated with similar medicine in dramatically larger doses.
Bigtime punters like George Soros didn't create the crisis, but to say that isn't to get foreign capital off the hook. On the contrary, it was the combination of foreign capital and domestic weaknesses that brought about the cataclysm. Since the U.S. press is all too busy listing the local Asian weaknesses -- corruption, cronyism, etc. -- let's look first at the role of foreign capital flows in what might be the final act of the Asian "miracle."
As the nearby chart shows, total capital flows to the so-called developing countries (which exclude the former socialist world, officially "countries in transition") soared in the run-up to the debt crisis. When that melodrama broke out in 1982, capital flows dried up as old loans were restructured and new loans were issued mainly to keep old ones afloat. But as the 1980s debt crisis faded from memory, capital flows more than quadrupled between 1988 and 1996. The falloff in 1997 represents the overture to the Asian crisis.
The composition of those flows also changed enormously over the last two decades. Between 1978 and 1982, nearly half of the flows came from commercial banks and official lenders like the World Bank. Direct investment (foreign investors' purchase of existing firms or plants or the creation of new ones) and portfolio investment (foreigners' purchase of financial assets like stocks) accounted for under 10% of the flow. During the crisis years, official lenders' share increased to 39%, as commercial banks withdrew. But with the "resolution" of the crisis, bank and official finance shrank to just 10% of the total, and direct and portfolio investment increased to 46%. Some "developing" countries found a welcome on global bond markets, which contributed 40% of the total. In other words, the financial markets, which move at lightning speed, replaced the slower-moving commercial and development banks as the major source of foreign capital. (For more, see LBO #77.)
It's amusing to hear U.S. analysts now denouncing the corrupt, inbred, opaque world of Asian capitalism, since it was the injection of foreign capital into these very structures that allowed the region to shift into hyperdrive over the last few years. In Korea, Malaysia, the Philippines, and Thailand, investment ran way ahead of domestic savings, thanks to the extra capital from abroad. Some of this was invested soberly in factories (though lots of these plants are now unable to sell their output) and roads, some of it was squandered on speculative real estate, and some of it no doubt was stolen. World Bank officials reportedly knew that a third of the capital going into Indonesia had been pocketed, just as they knew pretty much the same about Marcos & Co. in the Philippines in the 1970s and early 1980s.
One should never overestimate the sophistication of foreign investors or the IMF, which is supposed to exercise "surveillance." Judgments about countries are formed on the most superficial evidence -- at Wall Street rating agencies by the young and credulous, and at the IMF by small teams of economists who parachute in and talk to a few ministers and central bankers. During Mexico's crisis, the manager of a large emerging market portfolio asked a reporter for a Mexican paper who the vice president of Mexico was, apparently not knowing that Mexico has no vice presidency.
We know where those capital flows ended up; where did they begin? Ultimately from the vast surpluses generated by big business in North America, Japan, and Western Europe. (Europeans like to blame the Americans for financial melodramas, but European banks were the biggest lenders to East Asia.) So, while on first glance it's easy to denounce today's apparent elevation of finance over industry, it's actually impossible to separate the two. All three of the major regions have huge financial reserves that originate ultimately in the past profits of industry; they largely inhabit the financial markets now, but historically they're the monetary residue of past production. Japan's and Europe's economies have been weak, and offer few profit temptations; the U.S. economy is a zippier, but its corporations also throw off vast profits that can't find sufficiently profitable outlet at home. So this capital prowls the globe, looking for the next big thing. A few years ago, it was Latin America, especially Mexico, then Mexico crashed and it was Asia's turn. Who's next?
Distinction should be made between the countries where the crisis broke out -- Indonesia, Malaysia, and Thailand -- and its biggest victim so far, South Korea. The first three derived much of their recent growth from foreign investment, particularly from Japanese multinationals looking for lower labor costs. They were also wide open to foreign goods and capital. Wages were repressed, and technology transfer and social development lagged way behind GDP growth rates.
Korea was another story. Foreign goods and capital were admitted only as needed, protecting industry from competition. Despite vigorous political repression, real wages grew, education levels rose, and Korean firms developed their own technical skills while licensing newer technologies from Japan. But starting in the late 1980s, Japanese multinationals, fearing Korea as a growing rival, cut back on technology licensing, frustrating Korea's upscaling ambitions -- at the same time it faced new rivals (Thailand, Malaysia, China) at the low end. Growth decelerated, and in response to the slowdown, Korean firms and banks borrowed heavily abroad. MIT Korea scholar Alice Amsden rightly blames U.S. pressure on Korea to open up its closed financial markets for contributing to today's crisis -- but a slumping Korea was hoping that foreign borrowing might help turn things around. It didn't.
What's next? Asia may be better-positioned to weather its crisis than Latin America. Unlike Mexico, which had a decade of debt-induced slump before its bubble swelled and burst, today's crisis countries had years of ripping growth before the calamity. Growth and investment levels were high, and Asia used a lot of the capital inflow to boost investment, unlike Mexico, which consumed foreign capital. In theory, this should leave Asia better poised to recover from the shock than Mexico, whose real economy collapsed into a deep depression, throwing millions into unemployment and poverty.
In strictly financial terms, Mexico looked well along the road to recovery in 1997, with strong growth and a 43% gain in stocks for the first nine months of the year (though the bolsa gave back some of these gains as Asia melted). But only glimmers of economic recuperation are visible on the ground, and violence of many kinds, from routine crime to officially sponsored death squads, stalks the landscape. Something similar could be in Asia's future; worker resistance to austerity in Korea or Thailand could inspire bloody crackdowns, and there's great potential for anti-Chinese violence in Indonesia and Malaysia, to list just two possible horrors.
But more than holding up Mexico as a historical precedent for Asia, pundits are holding it up as a model. Stephen Fidler of the Financial Times had a think piece in the paper offering the post-debt crisis restructuring of Latin America as a model for redoing Asia, which would mean cutbacks in investment and public spending, wage cuts, unemployment, and wealth polarization. Days later, Fidler offered Mexico as a model for South Korea. Only someone thoroughly high on stock prices could ever say such a thing.
People unschooled in the higher financial consciousness often express surprise at the destruction of productive assets that comes with the typical austerity program. It looks like superstition, a holdover of bloodletting. But actually there is a perverse logic to the regimen: a big shift in resources away from domestic use and towards the servicing of foreign creditors and markets. A tightening of monetary and fiscal policy produces a sharp recession, which reduces demand for imports (thereby balancing the international accounts), forces down wages, and make exports the most attractive outlet for industrial capacity. Money earned from exports then is recycled to pay foreign bankers and bondholders. Mexico was a "success" because these conditions were largely fulfilled, something you could also say about the management of the 1980s debt crisis.
Turning trade deficits into surpluses is key to an orthodox restructuring -- fewer imports and more exports. This blows back onto the First World countries, which see fewer orders for capital and consumer goods, and a flood of cheapened imports from the countries in crisis. For decades, the U.S. has been the world buyer of last resort, and the Asian melodrama is expected to add as much as $100 billion to the U.S. trade deficit. Such deficits are the reason the U.S. is $1 trillion in net hock to the outside world, a status that undermines U.S. triumphalism just a bit. In fact, that debt, along with large and persistent current account deficits, a stock price bubble fed in important part by foreign capital inflows, and a riotous mood of self-celebration, makes the U.S. look like a country heading for a crack-up.
But there's a bit more to these Asian bailouts than just the off-the-shelf austerity programs. After all, unlike many Latin American countries before their debt crises, Southeast Asia was not known for generous social spending, riotous inflation, or big budget deficits. Still, there will be the usual tightening of fiscal and monetary policy, but on top of that, the IMF and the U.S. government are demanding qualitative changes too. In Indonesia, the Suharto family is expected to surrender some of the state-sponsored monopolies that have made them rich -- not that the IMF much cared about those just a few months ago. And, as political scientist Jeff Winters of Northwestern University points out, there have been several of these crisis-induced promises of reform over the last 25 years, none of which stopped the Suharto family from gathering its $30 billion fortune.
(The development establishment's previous indulgence of Indonesia was boundless. At a press conference in 1995, when WBAI/Pacifica reporter Amy Goodman asked World Bank president James Wolfensohn if the Bank was going to make loans to Indonesia conditional on ending human rights violations, the smart and worldly Wolfensohn said, incredibly, that it was the first he'd heard of them. When Goodman briefed Wolfensohn on Suharto's bloody history, starting with the massacre of hundreds of thousands in East Timor, he said he would have to look into it.)
Korea is another case. There was, and is, plenty of corruption and state-sponsored sweet deals, but it's nowhere near as much a systemic kleptocracy as Indonesia has been. Nor was the repression, even though stiff at times, ever as bloody as Indonesia's. Korea delivered rising incomes and schooling to most of its people, and Indonesia hasn't. It was Korea's state development machinery -- which regulated trade and finance, directed investment according to a plan and subsidized it accordingly, and schemed the technological upscaling of Korean industry -- that helped make this possible.
Now, as a condition of its bailout, Korea is expected to dismantle most of the state, financial, and corporate structures that were responsible for rapid growth. It will open its financial markets to foreign owners and its product markets to foreign manufacturers almost overnight. The foreign buyers will scoop up the sweetest assets and the rest will be left to struggle. Korea may grow strongly again, but it will probably be growth of a more subordinate kind. Its ambitions to join the First World seem dashed for a long while. If Korea can't make it into the imperial inner circle then it seems no one else can. The hierarchies mapped on p. 3 seem as good as fixed unless things change radically.
It may be that as economies mature, throw off their own financial surpluses and get more deeply involved in the global circuit of capital, it becomes impossible to sustain tight structures, whether Korean chaebol, Japanese keiretsu, or German bank-industry links. As the American model is generalized to the world, the transaction comes to reign, and long-term relationships are shed as a sentimental holdover.
Asia -- including Japan -- may also be in the throes of a classic Marxian profitability crisis, as quaint as those seem. After decades of furious accumulation that emphasized growth and market share above all, vast capacity was created -- an "overproduction of capital" in Marx's phrase. Capital, unable to make a sufficient profit, throttles back on production, and the value of everything, from capital goods to financial assets to wages, deflates. Productive capacity is destroyed until profitability turns upward again. There's no doubt that profit rates across Asia were in decline; it was said even back in the 1980s that the rate of return on newly invested capital in Japan was negative, and aggregate profit rates in Japan have only slipped since then. (The OECD estimates the "rate of return in the business sector" as 13% in Japan and 29% in the U.S.) Korean conglomerates were slipping into the red months before the crisis hit.
In this context, the IMF's role can be read as assuring that the costs of the deflation are shifted as much as possible towards the recipients of its largesse, and to limit the blow to creditor nation finances. Bailouts of these sorts are justified as essential to preventing a collapse of the global financial and economic structure like that of 1929-32. This may or may not be true -- who knows? With every crisis, you never know if it's the one that, unchecked, could lead to ruin. Yet every time there's a bailout, temptations to speculate again and generate another, bigger mess down the line are stoked. As a result of the regime of perpetual indulgence towards rentiers, the record on bank failures and other financial crises, measured in both frequency and expense, is actually worse (measured against GDP) than in the 19th century. Indulgence should be coupled with tighter, not looser, regulation, but the opposite has been the case.
We've heard the first whispers of elite worry that maybe this world of free capital flows is just a wee bit out of control, though since that elite's wealth and power is in part constituted through capital flows, the whispers are hushed. Freer capital flows have failed to deliver the promised boost, especially in the so-called developing world; growth rates over the last 20 years are a lot slower than in the previous 20. They've contributed to two stunning disasters in three years, Mexico in 1994-5 and Asia today. If foreign investors are made whole by the latest lifeboat operation, then it's a pretty safe bet that they'll do it again.
Despite the crisis, the IMF -- meaning the U.S. and its pals in the G-7 -- is committed to the further liberalization of capital flows. The Fund is pushing an amendment to the its charter (which doesn't require ratification by national legislatures) that would make currencies as convertible on the capital markets as they are in goods markets. The Fund acknowledged that, given the susceptibility of international capital flows to "turmoil," liberalization would require backing by "a solid multilateral system for surveillance and financial support." Surveillance is a failure; "financial support" is a euphemism for a permanent bailout mechanism to take place of today's custom-cobbled ones.
For that, it would need a cash infusion from member governments even bigger than the 45% capital increase already on the agenda now. Unlike the World Bank, which gets the capital it lends to its clients by floating bonds on international markets, the IMF is less like a bank than a revolving fund, which can only make new loans as old ones are repaid, or when it gets a capital injection. Right now, though it's not out of money, the Fund is stretched, and a crisis in Russia or Brazil or India -- all of which have looked rocky since the Asian crisis broke -- would empty the till.
Pumping more money into the IMF right now would not be an easy sell in any First World parliament, and reportedly only about a third of the U.S. House of Representatives is firmly behind the idea. A "left"-right coalition similar to the one that defeated fast track trade legislation has emerged in opposition to ponying up the U.S. share of the quota increase, $18 billion. It's become clear to a remarkably broad spectrum of opinion around the world that the Asian bailout is fundamentally a bailout of big foreign creditors at the expense of people who work for a living.
Will the authorities pull it off? Can they restructure Southeast Asia into an economic colony like Latin America was in the 1980s? Is the U.S. about to transform a region full of potential rivals into wholly owned subsidiaries, to the profit of the parent country's shareholders? Or is the crisis of what had been capitalism's most dynamic region a symptom of a more generalized overproduction crisis? Will exasperated Indonesians topple Suharto, and Korean workers renounce the IMF program? Is bull market euphoria in its final phases in the U.S.? If the IMF capital increase dies in the U.S. Congress, is it the Smoot-Hawley of the 1990s? No answers yet.
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