|Politik und Gesellschaft Online
International Politics and Society 2/1998
Needed: Domestic Modernization and an Asian Currency System
Vorläufige Fassung / Preliminary version
Most Asian states are now past the worst of the crisis. They had
only a limited hand in its management: The IMF prevailed in its
attempt to use its conventional strategy, designed for current
account crises cum public sector debt, to overcome an unconventional
crisis, i.e. a capital account crisis cum private sector
debt. In doing so it probably increased the costs of the crisis
in terms of growth and employment. Yet it is the Asian states
who now face the question of how to rekindle growth and development.
The response to the crisis will depend on how the crisis itself
is interpreted. Superficially, it was a currency crisis sparked
by excessive private sector borrowing abroad. This in turn was
caused by high-risk borrowing and lending strategies. Investors,
blinded by the outstanding performance of the East and South-East
Asian economies, overestimated future earnings and underestimated
the risks. The background was a collusion of firms and banks with
governments often paraphrased as golf-course or crony capitalism
and seen as a survival guarantee for large firms and banks: The
latter took such high risks because they felt sure the state would
bail them out if worse came to worst. The appropriate response,
prominent among the IMF's demands, is to abolish tacit government
guarantees for banks and to reform local financial systems, creating
transparency (among other things, by adopting internationally
accepted accounting standards), introducing private loan and deposit
insurance, and establishing credible bank supervision. If the
local financial systems - so the reasoning goes - supply domestic
and foreign investors with reliable information on risks and earnings,
the bubbles in the financial and real estate sectors that triggered
the crisis will be a thing of the past.
However, the currency crises of 1997 reflected two other, deeper-seated
problems. Firstly, the devaluations of the local currencies point
at structural deficiencies that restrict the continuation of high-speed
growth. Secondly, the currency crises indicated that dollar-pegged
local currencies are no longer compatible with the region's real
Structural Problems of Asian Economies
Structural bottlenecks had been identified as potential growth
checks long before the crisis broke. Infrastructure (transport
systems and energy supply), education systems (in South-East Asia)
and the high concentration of economic activity in a few large
firms (Korea) have frequently been singled out. In slightly more
general terms, the structural problems are as follows:
Away From Simple Export Orientation
The export-oriented industrialization strategy in South-East Asia - less so in Korea - was based on processing components with domestic labor that was cheap in international terms. The components and the required capital goods had to be imported, making export-oriented industrialization import intensive. While exporting locally processed industrial goods (in 1996, 80% of Thailand's and 83% of Malaysia's exports were industrial goods) generated hard-currency reserves, the balance of trade either stayed in deficit or the surpluses remained too small to compensate for the outflows as foreign firms repatriated profits. Malaysia, for example, has almost always had a trade surplus, but profit outflows regularly pushed the current account into deficit. In addition, South-East Asia's and to a large extent Korea's industrial exports concentrated on a few product groups (notably electronics), where:
The South-East Asian economies cannot and should not replace their
export-oriented industrialization strategy with an import substitution
strategy on the Latin American model, but they must step it up
by extending their industrial base and manufacturing more input
products at home, and must boost domestic demand to gradually
reduce their reliance on international markets.
Regarding the dominance of foreign direct investment (and outflows
of repatriated profits), the South-East Asian countries have no
option but to continue attracting foreign firms onto their territory.
The situation is different in Korea, where foreign firms have
a less important role. True, the IMF has decreed that existing
restrictions on foreign investment must be lifted to attract capital.
But the positive, one-time effect on the capital account may well
be more than compensated by longer-term negative effects on the
current account. Also, the indirect effects of foreign direct
investment that are otherwise considered more positive - technology
transfer, skills and learning processes - are weaker in Korea
than in South-East Asia.
The past boom was largely based on increasing input of labor,
capital and land. In the future, efficiently combining these factors
will be more important. This means:
Labor Market and Social Security. Future growth will be
less based on cheap labor. Firms must be forced to increase labor
productivity instead of being subsidized by low wages. Restrictive
government labor market policies that limit worker mobility and
freedom to unionize must be eased or relinquished altogether.
This may require rethinking disincentives to mobility that are
perceived as social provision by firms (such as 'life-long employment'
in Korea). In addition, workers´ capability of being mobile
must be increased. Education and training must be improved and
expanded, and the focus of social security provision must pass
from firms to the state. Provision for unemployment is a key factor
here. There was no urgent need for a national unemployment insurance
in the past, because high economic growth guaranteed full employment
and in some cases made it necessary to import labor.Firms generally
never fired employees and the family provided or at least seemed
to provide adequate security in the remote event of unemployment.
These conditions no longer apply.
Small and Medium-sized Enterprises (SMEs). Against a background
of falling growth rates and harder-to-obtain credit, many SMEs
will disappear from the market - unless special programs are developed
to help them survive the competition under tighter conditions.
Any government enterprise promotion policy will emphasize finance
for such firms. Care must be taken here that the expansive credit
policies of the past, which artificially sustained a whole range
of inefficient economic activities, and in some cases were the
only thing that made them viable (as in the financial and real
estate sector) are not replaced by state subsidies that do not
entail incentives to raise efficiency. The costs of subsidies
must be visible, their duration limited and their results measurable.
The reforms of the financial system demanded by the IMF, which
target efficient use of capital as an input factor, must be supplemented
by more efficient use of land (the bubbles in the financial sector
resulted to a large extent from the financing of real estate investment).
As a consequence of rapid economic growth, a special political
economy of land has evolved, which was characterized by artificially
engineered land shortages and skyrocketing property prices. Land
shortage resulted from
Improving the Supply of Public Goods
Higher efficiency partly depends on an improved supply of public
goods. In the long term, restrictive fiscal policies as demanded
by the IMF (despite the fact that almost all government budgets
in the region were balanced or in surplus) would do great harm.
Of course, there are a few prestige projects which ought to be
abandoned. But policies that automatically equate public expenditure
with profligacy overlook the fact that much government spending
is and will remain necessary for projects that cannot be funded
Towards an Asian Currency System
The crisis was caused and triggered by the dollar's appreciation
and speculative attacks on several Asian currencies. This points
to the problem that governments in the region kept their currencies
pegged to the dollar while trade and investment flows became increasingly
regionalized. From 1985 to 1996, the US share of South-East Asian
imports fell from 16% to 14%, while Japan's share rose from 23%
to 27% and that of the East Asian "tiger" states from
16% to 21%. This is shown even more clearly by intra-regional
investment flows: since 1985, Japan has been the largest investor
in South-East Asia, and in 1995 the "tiger" states drew
level with it. In 1995, Japan and the "tiger" states
invested $22.2 billion, compared with $6.7 billion by the US.
Accordingly, a growing share of South-East Asian exports goes
to Japan and the "tiger" states. In addition, other
forms of economic ties between countries like Japan and Korea
are far more important than direct investment - for example, original
equipment manufacturing (OEM), licensing, joint ventures and alliances.
Moreover, Japan has long been the largest donor of development
aid in the whole of Asia. In other words, an informal, common
Asian production zone has emerged between Japan, the "tiger"
states, South-East Asia and China (some observers speak of a Japanese-dominated
Asian production zone). But the reality of this zone is not mirrored
by the currency arrangements. The developing and newly industrialized
countries of the region have remained under the umbrella of the
dollar and thus reliant on extraregional developments, while to
a great extent the real economy has regionalized.
Enabling local currency systems to adapt to the reality of a regional
production zone, and to reduce reliance on the dollar requires
a phased approach:
In the first phase, local currencies should be pegged to a basket
of reference currencies, in which the dollar is accompanied above
all by the yen, but also by strong European currencies or the
South-East Asian countries that already have a regional cooperation
platform in ASEAN could form a currency system. For the time being,
they will be unable to enter monetary union on the EU model, but
they could create a common fund to support local currencies. In
the medium term, they could develop a regional reference currency
on the pattern of the ecu, and set fluctuation bands for local
currencies against the reference currency. On the model of the
European Monetary System, their central banks could be obliged
to intervene if a currency oversteps the upper or lower limit.
This strategy is only realistic, though, if trade and investment
barriers between the South-East Asian countries are removed at
the same time.
In the long term, the emergence of an Asian production zone dominated
by Japanese firms must also be reflected in the currency arrangements.
That is, a regional monetary system must also include the yen.
In view of Japan's overwhelming economic power - it accounts for
more than 70% of the region's national product - an Asian currency
community would automatically be a yen block. However, two things
would stand in the way of fast-track monetary union:
The initiative to revitalize the region must come from Japan. Yet there is doubt that Japan is ready to take on responsibility for the entire region. Not only is Japan now in the throes of a severe economic crisis itself; there is also its isolationist political tradition. On the other hand, if Japan is precluded from bearing regional responsibility, sooner or later another power will emerge as the protagonist of a regional economic community: the People's Republic of China. China is already considered a stability factor, and the crisis hit the Chinese economies (the People's Republic itself plus Hong Kong and Taiwan) less severely than Korea or South-East Asia. In summer 1997, China, Hong Kong and Taiwan together had $285 billion in foreign currency reserves, compared with Japan's $211 billion. If the yen does not take on greater regional importance soon, it may be replaced by the Chinese yuan in the not all too distant future. In the long term, a regional shift in power at the expense of Japan and in favor of China could be the most important outcome of the Asian crisis.
© Friedrich Ebert Stiftung | technical support | net edition bb&ola | April 1998