Articles from Martin Khor - Part 1 (fwd)

[Robert Weissman <rob@essential.org>]

Dear Friends,
 
On 16 September 1998, the UNCTAD (UN Conference on Trade and
Development) published its annual Trade and Development Report for
1998.  It contains a comprehensive and incisive analysis of the
Asian crisis, of financial crises in general, provides a critique
of the IMF approach, and gives its own concrete proposals for how
to manage and prevent such crises.  
 
I have written three articles summarising what I considered to be
the most interesting points of this report, which is attached below
for your information.  It seems to me that the proposals (including
a reflationary strategy for affected countries, an international
Chapter 11-type debt standstill mechanism, and national capital
control policies) should be taken up by the NGO community for
advocacy.  The proposals go beyond the wishy-washy "new financial
architecture" rhetoric (which seems to imply that greater IMF
surveillance to ensure disclosure and transparency in developing
countries and better managed banks are the solution).
 
I hope you will find the time to read these articles.  Those who
wish to obtain the full report can send an email to UN Publications
New York at publications@un.org (tel 1-212-9638302) or to UN
Publications Geneva at unpubli@un.org (tel 41-22-9170027).
 
Best wishes,   Martin Khor, director, Third World Network, 228
Macalister Road, Penang, Malaysia (fax 604-2264505, email:
twn@igc.apc.org).
 
 
 
 
 
UNCTAD'S WIDE-RANGING ANALYSIS OF FINANCIAL CRISES
(First of 3 articles on the UNCTAD Report on the Financial Crisis)
 
 
by Martin Khor, Third World Network (twn@igc.apc.org)
 
 
SUMMARY:   A new report by the United nations agency, UNCTAD, says
that despite the current problems, the East Asian development model
is not dead.  It wasn't so much that the Asian economic style
caused the crisis, but more the deviation from its previous
practice.  The report shows that financial crises are very much
part of the global system and the Asian case is only one.  It gives
an incisive critique why the IMF approach converted a liquidity
problem into a solvency crisis.  Finally, UNCTAD also proposes a
range of crisis management measures, including a debt standstill
and capital controls.  (This is the first in a series on the UNCTAD
report). 
--------------------------------
 
 
 
A pathbreaking report on the Asian crisis was released in mid-
September 1998 by the United Nations Conference on Trade and
Development (UNCTAD).
 
Previous UN reports by other agencies had focused more on the
social aspects of the crisis, or were mainly descriptive on the
economic issues.  Thus much of the institutional economic analysis
receiving wide publicity had come from the International Monetary
Fund. 
 
The UNCTAD study (its Trade and Development Report 1998) is unique
in its professional and comprehensive treatment of the crisis.
 
It examines the causes of the crisis, locating these in the very
system of global finance. It criticises the IMF-led international
response to the crisis.  And it provides several proposals for the
appropriate management and prevention of such crises.
 
Among the suggestions are the establishment of a mechanism allowing
countries on the brink of crisis to declare a "debt standstill,"
during which creditors are obliged to give time for a restructuring
of debt repayments, similar to the Chapter 11 procedures in the
United States bankruptcy law.
 
Another proposal is that developing countries make use of capital
controls as part of their "armory" in preventing or helping resolve
financial crises.  The details of this part of the Report will be
of special interest to those grappling with proposals for crisis
prevention and damage control.
 
On the causes of the crisis, UNCTAD presents an economic analysis
that goes beyond the simplistic and superficial to probe into the
root causes.  
 
It argues that the East Asian experience is only one of a series of
many financial crises (for example, in Southern Cone of Latin
America in the late 1970s and early 1980s, Latin America in the
1980s, European countries in 1992, Mexico in 1994) of the past two
decades.  
 
These crises are caused by the intrinsic and volatile nature of the
global financial system, after the closure of the fixed exchange
rate system in the early 1970s.
 
The Asian crisis, says UNCTAD, began with financial liberalisation,
causing a build-up of vulnerability of the countries to external
forces.  When large inflows of short-term capital took place, it
led to an asset price bubble that broke when speculative currency
attacks caused sharp depreciations which then spread via contagion
to other countries.
 
Once the countries fell into crisis, the IMF's response (monetary
and fiscal tightening and high interest rates) made it worse.
 
In one of the deepest critiques of the IMF approach, UNCTAD says:
"The situation was characterised by a stock disequilibrium rather
than a flow imbalance that could be corrected by expenditure
reduction.
 
"Since most of the external borrowing had been undertaken in
foreign currency without adequate hedging, the fall in the currency
created a balance sheet disequilibrium for indebted banks, property
companies and firms.
 
"At the new exchange rates the stock of outstanding foreign debt
became too large to be supported by expected income flows.  The
value of firms, and asset prices more generally,thus declined.
Since these assets had been the collateral for much of the
increased lending, the quality of bank loans automatically
deteriorated.
 
"Rather than ease the burden of refinancing on domestic firms by
granting additional credit, the recommended policy response was to
raise interest rates.  This depressed asset prices further and
increased balance sheet losses of firms and their need to repay or
hedge their foreign indebtedness quickly by liquidating assets and
selling the domestic currency."
 
Moreover, says the Report, instead of the IMF loans going to
support the new exchange rates, in East Asia the exchange rates
were left to float.  
 
"Thus rather than guaranteeing the new exchange rate, the Fund's
lending has been aimed at ensuring the maintenance of the domestic
currency's convertibility and free capital flows, and guaranteeing
repayment to foreign lenders.
"The latter, unlike domestic lenders, emerge from the crisis
without substantial loss, even though they had accepted exposure to
risk just as other lenders had done."
 
According to UNCTAD, the crisis was initially one of liquidity
rather than of solvency.  As long as they were given sufficient
time to realise their investments, the countries would have been
able to generate foreign exchange to repay their external debt with
an exchange rate adjustment needed to restore competitiveness
(which UNCTAD estimates at only 10-15 percent, instead of the very
sharp currency drops that took place).
 
However, "the use of high interest rates, the extent of currency
devaluation and the reduction in growth rates that created
conditions of debt deflation quickly acted on financial
institutions and company balance sheets to create a solvency
crisis."
 
In other words, in this analysis, the crisis-stricken countries
that sought IMF funds were never given a proper chance.  What would
that chance have looked like?
 
UNCTAD says that given the sharp attacks on the currencies, "the
appropriate action  would be to move quickly to solve the
intertemporal problem by introducing a (debt) standstill and
bringing the borrowers and lenders together to reschedule, even
before the commitment of IMF funds."
 
It adds that a combination of rapid debt restructuring and
liquidity injection to support the currency and provide working
capital for the economy would also have made it possible to pursue
the kind of policies that enabled the US to recover quickly from a
situation of debt deflation are recession in the early 1990s.
 
Another part of the Report shows how the US got out of its crisis.
Reacting to the weakness in the financial system and the economy,
short-term interest rates were reduced in the early 1990s almost to
negative levels in real terms, thus providing relief not only for
banks, but also for firms and households, which were able to
refinance debt at substantially lower interest-servicing costs.
 
This eventually produced a boom in the securities market, thereby
lowering long-term interest rates and helping to restore balance
sheet positions, thus providing a strong recovery.
 
"The policies pursued in the early 1990s were exemplary in the way
they addressed debt deflation, making it possible for the US
economy to enjoy one of the longest post-war recoveries."
 
UNCTAD's analysis thus shows the sharp contrast between the IMF's
policy of tight credit and high interest rates, and the United
States' own opposite policy of extremely low interest rates and
provision of liquidity.
 
Reading the Report, one can't help wondering that since the US
policy succeeded, it is curious why the IMF (which is after all so
much influenced by the US Administration) imposed an opposite
policy on the affected Asian countries.
 
The countries that have come under IMF loan conditions have little
room to formulate their own policies.  In this, Malaysia is one
Asian country fortunate for not having to seek IMF aid, although it
does receive IMF advice.  Malaysia has been able to switch policy
track from one which was close to the orthodox IMF line, to one
which is now close to the US domestic line.
 
In another interesting section, the Report considers whether the
Asian development model has been killed by the crisis.
 
It notes the view of some Western commentators that blamed the
crisis on the Asian countries' structural shortcomings (such as the
close government-business relation and market distortions that
insulated business from competitive forces and market discipline).
 
Some commentators say the model is now outdated and overwhelmed by
global market forces, although it had succeeded in the past.
 
UNCTAD however says that whilst the East Asian economies are run
differently from the Western model, its present crisis does not
differ from similar crises experienced by developed and developing
countries, including those operating under the Western Anglo-
American model.
 
The Asian crisis "is yet another episode in a series of crises that
have been occurring with increasing frequency since the breakdown
of the Bretton Woods arrangements, and with the introduction of
floating exchange rates and the unleashing of financial capital."
 
As in the earlier episodes of financial crisis and currency turmoil
in developing countries, the East Asian crisis "was preceded by
financial liberalisation and deregulation which, in some cases,
constituted a major break with past practices.
 
"In this sense the fundamental problem was not that there was too
much government intervention and control, but too little."
 
To support this, the Report also quotes the World Bank chief
economist Joseph Stiglitz: "The heart of the current problem in
most cases is not that the government has done too much, but that
it has done too little...The East Asian crisis is not a refutation
of the East Asian miracle. 
 
"The more dogmatic version of the Washington Consensus does not
provide the right framework for understanding both the success of
the East Asian economies and their current troubles."
 
Citing South Korea as an example, UNCTAD argues that the country
broke away from its past policies and practices.  The government
had been very careful in regulating the private sector's borrowing
from abroad, and had also coordinated the private sector's
investment decisions to avoid excessive competition and excess
capacity.
 
Recently, the South Korean government had abandoned its investment
coordination role (which contributed to misallocation and
overinvestment) and also relinquished its control over the
financial sector (thus, the country became vulnerable to an
external debt run and currency attack).
 
UNCTAD thus concludes that "it is the departure from the 'model'
rather than its pursuit that is the main cause of the crisis in
that country."
 
The Report draws the lesson that successful industrialisation
depends on how profits and integration into the global economy are
managed.
 
The Asian crisis confirms this:  "When policies falter in managing
capital and integration, there is no limit to the damage that
international finance can inflict on an economy."
 
There is certainly considerable scope for national policies in
preventing and better managing crises of this sort, says UNCTAD,
but "these crises are a systemic problem, and action is therefore
needed also at the global level."
 
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