Focus on Trade #30, Part 2 of 3 (fwd)

[Robert Weissman <rob@essential.org>]

FOCUS ON TRADE
Number 30, October 1998
Part 2 of 3

A regular bulletin produced by Focus on the Global South, Bangkok,
Thailand

Focus-on-Trade is a regular electronic bulletin providing updates and
analysis on  regional and global trade and finance.  Although
initially concerned with APEC, the scope of the bulletin now extends
to include the World Trade Organisation (WTO), the ASEAN Free Trade
Area (AFTA), the Multilateral Agreement on Investment (MAI), the
International Monetary Fund (IMF) and any other acronyms that require
critical attention. Focus-on-Trade contains updates on trends in world
trade, with an emphasis on analysis of these trends from an
integrative, interdisciplinary viewpoint that is sensitive not only to
economic issues, but also to ecological, political, gender and social
issues related to developments in world trade.

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Focus on the Global South is an autonomous programme of policy
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IN THIS ISSUE 

Part 1
The Financial Crisis: Deja Vu All Over Again
by Robin Broad

The beginning of the end of the Washington consensus
by Nicola Bullard

Draft Declaration from the participants of the Bank Information Center
Strategy Meeting October 9-10, 1998

Part 2
Another World Depression
By Jayati Gosh

Asia opts for a do-it-yourself solution
by Nicola Bullard

Part 3
Regulation or Barbarism
by Nicola Bullard

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Another World Depression ?
by Jayati Gosh*

Many years ago, the economist Charles Kindleberger had identified the
pattern of a financial crisis in his classic work, Manias, Panics and
Crashes. The crisis is the last phase of a cycle which begins with an
initial boom. The upswing usually starts with some change, such as new
markets, new technologies or political transformations. It proceeds
via credit expansion, rising prices, particularly of assets, and
euphoria. Overtrading and then speculative mania emerge, "as a larger
and larger group of people seeks to become rich without a real
understanding of the processes involved". Ultimately, the markets
cease rising and, as a consequence, some highly borrowed players find
themselves overstretched. This is the "distress" stage. Distress
generates other failures, including some unexpected ones, and this is
followed by a stage of "revulsion" or "discredit". The final phase is
a self-feeding panic, involving a downward free fall.

But then financial markets are notoriously prone to cycles; asset
markets have always tended to go boom and bust. This in itself does
not necessarily make for major real economic depression unless there
are other deflationary forces operating, or unless the effects of the
financial failures on the real economy are not counterbalanced by
increased spending in some other way. Kindleberger recognised that
major economic depressions do not result from credit cycles in
themselves, but from a complex interplay of real and financial factors
that reinforce each other. The central message of Keynes was that such
a downward spiral can be broken by public action. The central message
of Kindleberger's work is that in a global economy, such public action
depends upon institutional arrangements, power configurations and
division of national responsibilities which cannot be taken for
granted to exist.

This is because deflationary tendencies have a tendency to be
transmitted across countries, through trade flows of course, but even
more significantly through the movements of private capital. In the
interwar period which gave rise to the Great Depression, the fears of
capital flight and inflation prevented governments from engaging in
expansionary fiscal and monetary strategies which could have warded
off the crisis. As Kindleberger pointed out, this could happen because
in that period there was no clear leader in the capitalist world,
ready to take on both the power and responsibilities associated with
leadership. 

Such a leader has to operate at both financial and real levels to
prevent economic collapse. In terms of finance, there are three
priorities: first, to prevent failures of highly leveraged speculative
investors from generating systemic financial collapse; second, to meet
the flight of capital from emerging markets with the provision of
liquidity to countries in trouble; third, to respond to any
contraction of credit domestically with determined monetary loosening.
These correspond to the usual lender of last resort functions. In
addition, the leader must also operate on the real economy, to ensure
a continued expansion of demand and economic activity. This means
running large trade deficits, and ensuring continued and expanding
markets for the exports of countries facing economic difficulties.
These have been described as the duties of the buyer of last resort,
and they are as necessary for stable international capitalism. 

It is fairly obvious that the world economy today is desperately in
need of such a world leader, in terms of both buyer and lender of last
resort. The current deflationary pressures - in terms of both
financial and real economic variables - are stronger today than they
have been at any time since the Great Depression. A snapshot view of
the world economy today reveals a picture of stagnation and decline
that would have been simply unbelievable even two years ago. 

Thus, most of the Asian region - including the most dynamic economies
of the previous decade - is already in the midst of a substantial
economic depression. For the crisis-ridden countries of East and
Southeast Asia, GDP forecasts for the current year range from declines
of 6 per cent in South Korea to around 10 per cent in Thailand to as
much as 20 per cent in Indonesia. Even China has not been immune,
despite its attempts to shore up domestic demand, and growth forecasts
there have had to be cut. Meanwhile in Japan, continued attempts at
fiscal expansion and monetary relaxation come to naught, as the
infection from the East Asian depression refuses to go away. 

In Europe, the situation is also bleak. The Russian economy is on the
verge of complete collapse, and national income is expected to fall
again for the ninth consecutive year, resulting in the sharpest
economic decline in modern history, with output around half of the
level of a decade ago. Even formerly socialist countries which have
supposedly "recovered" have barely managed to limp back to national
income levels of the pre-transition period. In western Europe, output
slowdown and high rates of unemployment persist despite all the hype
surrounding the formation of the EU's single market, and
notwithstanding the hopes generated by the future potential of the
euro as one of the world's major currencies. In Africa, already one of
the poorest regions in the world, per capita incomes have been falling
in most countries for nearly three decades now and there are no signs
of a reversal of this disastrous trend.

Latin America was being hailed by market analysts as a region that was
finally coming out of its own crises induced by excesses of external
debt and private capital inflow. Earlier this year it even seemed as
if Latin America would emerge relatively unscathed from the financial
crises besetting Asia and Russia. But the pressures stemming from
lower commodity prices and instability on international markets have
begun to tell in the past two months. In the wake of the Russian debt
default and devaluation, the continent has been buffeted by a wave of
speculative pressure. Stock markets have plunged, currencies have come
under pressure and bond yields have risen to their highest levels
since the Mexican "Tequila" crisis of 1995. Once again, the most
vulnerable economies are those of Brazil and Mexico. Indeed, Brazil is
currently a focal point of the crisis raging through world financial
markets. If Brazil goes, it will drag much of Latin America down with
it. The impact of this on the US economy and financial markets would
be considerable. Some observers have argued that a serious crisis in
Brazil would be the proximate catalyst that could push the already
slowing world economy into recession.

All this year, the US economy seemed to be the great survivor, even
the beneficiary, of the gloom and doom in other markets. The flight to
US assets from other financial markets in decline led to the equity
boom which has in turn led a US consumer boom, driving personal
savings rates in the US close to zero, and creating all the features
of an asset price-led bubble feeding into real economy expansion. Less
than a year ago Alan Greenspan, chairman of the US Federal Reserve,
said it was possible the Asian crisis would have a "salutary" effect
on the US economy. His argument was that the damping effect would slow
the US economy just enough to restrain inflationary pressures, but not
by so much as to prompt a recession.  

Even Mr. Greenspan's tune has changed by now. Last month he admitted
that "it is just not credible that the US economy can remain an oasis
of prosperity unaffected by a world that is experiencing greatly
increased stress." In the past month US equity prices have stumbled
badly as fears mount that the wider depression is coming home to
America. There are at least three reasons for these fears, which
override the effects of the continued consumer boom in the US. 

First, the global financial crisis is expected to bite harder. The
increase in the US trade deficit in the first half of the year is
likely to be the harbinger of more bad news. The Asian region has
turned down further since then and the crisis has spread to Russia,
among other countries. It also looks like causing mayhem in Latin
America, which is even more important for the US. Second, US companies
seem increasingly vulnerable to deflation. Many are being squeezed
between a near inability to raise prices because of weakness in
international markets and rising costs at home. The resulting crunch
on corporate profits is likely to trim investment, which has been a
big contributor to US growth in the past few years, and to weaken
already nervous financial markets. Third, the stock market retreat in
recent months is likely to reduce domestic demand. Since no one really
knows the extent to which the movement of the market has affected
consumer confidence and spending in the US, it is also difficult to
judge the impact of the retreat, but the direction is inevitably
negative in terms of spending and economic activity. 

This explains the gloomy nature of the current forecasts of world
output growth. Mainstream private forecasters like JP Morgan have
predicted US economic growth at a miserable 0.1 per cent next year.
Growth in all emerging economies together, including those that have
escaped contagion, is forecast to be only 1.3 per cent. Quite
optimistically, JP Morgan forecasts Japanese growth at 0.7 per cent
and that of the European Union at 1.7 per cent. But for the world as a
whole, all this means growth of only 0.9 per cent. It should be noted
that all of these forecasts - of the IMF, of the OECD and of private
forecasters, are being continuously revised downwards, which is
another classic indicator of recession. 

If history is any guide, the need for a leader to pull the capitalist
system out of this slump is obvious. It is also clear that the IMF  is
too misguided in its policy responses and too small in terms of its
resources, to play the role of lender of last resort. Indeed, the
Bretton Woods institutions have earned such a bad name in the current
crisis that even the London Financial Times now refers to them as "the
gruesome twosome". But in any case, the amount of resources required
to prevent international financial debacle is certainly beyond their
capacity.  

Similarly the world desperately needs a major buyer of last resort. If
the casualties of the financial meltdown in Asia, the teetering
economies of Latin America, the oppressed primary exporters of Africa,
and the devastated regions of the former Soviet Union are to recover,
they must find markets for their goods in the west. Thus the developed
capitalist countries must increase their imports from such regions
dramatically on order to avoid a more generalised slump. Big trade
deficits in the most prosperous nations are an essential part of a
resolution of the present crisis.

So far, however, the US seems unwilling to take on the duties and
responsibilities associated with leading world capitalism, and the
response of most European leaders has been similarly unimaginative. It
almost seems as if the world economy is condemned to a repetition of
the widely read history of an earlier depression. Of course, that
particular depression did also mark the first systematic attempts at
industrialisation in a range of underdeveloped countries across three
continents. Could the forthcoming depression provide another such
chance ?

* Dr Jayati Gosh is associate professor at the Centre for Economic
Studies and Planning, Jawaharlal Nehru University, New Delhi, India
and a regular commentator for the Indian national newspaper The Hindu.


Asia opts for a do-it-yourself solution
by Nicola Bullard* 

Fifteen months into the economic crisis which has knocked region-wide
growth from annual averages of  5 - 6 % per cent to an estimated
contraction of at least - 10 per cent (estimates for Indonesia vary
from -15 to - 20 per cent for 1998) it seems that Asia has finally
tired of waiting for the US, the IMF and the market to solve the
problems. Even dutiful countries such as Thailand and South Korea,
which have followed carefully the IMF policy advice, are only now
beginning to see some tentative currency stabilisation, but in the
meantime high interest rates and tight monetary policy have strangled
the real sector of cash and urgent intervention is needed to stop the
downward spiral. 

Impatience at  the lack of decisive action from the G7 and the failed
IMF policies may finally push Asia to take matters into its own hands.

Japan’s initiative to establish an Asian Regional Fund – which was
comprehensively blocked last year by the IMF and US – reappeared
through the backdoor at this year’s IMF and World Bank Annual Meeting.
Dubbed the Miyazawa Plan – after Japan’s Minister of Finance – the $30
billion package is earmarked for medium to long term financing and to
bridge short term capital gaps. Mr Miyazawa has indicated that the $30
billion limit is not fixed and that he ‘hopes that the aid package
would lead to wider use of the yen in Asia and perhaps to the creation
of an Asia Crisis Fund.’  

In stark contrast to last year’s black-balling, the IMF and World Bank
supported the proposal, while US Treasury Secretary Robert Rubin gave
the plan a muted reception, adding that  "Japan would be better off
looking after its own problems first." But in fact, by  pumping cash
into the Asian economies and cleaning up bad loans, Japan is looking
after its own problems. Not only are Japanese banks heavily exposed,
but Asian-based Japanese manufacturing has focussed largely on
developing domestic markets with strong import links back to Japan.
Plunging consumer demand has seen local sales drop while currency
devaluations have pushed up the price of imported components and
increased price competition in the region. Growth in consumer demand
and currency stabilisation will be good for Japan.

Ironically,  the US also launched a proposal to establish a
quick-disbursing fund through the IMF which would provide short-term
cash for countries threatened by investor panics, that would be exempt
from usual IMF conditions and avoid time consuming negotiations.
Apparently Japanese Ministry of Finance officials are rather
bewildered as to how this is any different from Japan’s proposal to
establish an Asian Monetary Fund

Apart from the Miyazawa Plan, there was little good news for Asia at
the IMF and World Bank meetings. The next opportunity for Asian
governments to do something about the deepening recession will be at
the November APEC Summit in Kuala Lumpur which, unlike last year’s
whitewash when everyone agreed that things would be fine provided they
kept taking the IMF medicine,  promises to be much more lively.

APEC meeting could be the key
Indonesia’s Foreign Minister Ali Alatas, in a recent newspaper
interview, urged APEC to "adjust" to the reality of the region's
economic crisis by shifting the focus from trade reform to finding
ways of overcoming the damaging side-effects of huge and unpredictable
capital flows. 

"What needs to be done is that we should together study it, (and
consider) whether some regulation is necessary, whether there should
be some form of regulation on monetary and financial markets," he
said. 

This call was echoed by Australian academics and political leaders.
Darby Higgs, deputy director Australia’s National APEC Study Centre,
said ''It's pretty pointless to wander around the region and tell
people who do not have enough to eat that everything is going to be
all right because by 2020 we are going to have free trade.'' 

''The original aim of APEC was to increase the living standards of
people in member countries, and I think that it's got to go back and
put this at the forefront rather than saying APEC is just about
liberalisation trade targets and so on.'' 

''APEC should be doing more in terms of basic humanitarian aid, in
terms of repairing economies in trouble on a social level instead of
waiting for an economic recovery which might not happen in the short
term,'' according to Higgs. 

Former chairman of the APEC eminent persons groups and director of
Washington-based Institute for International Economics, Dr C. Fred
Bergsten, also sees APEC as the only viable forum for dealing with
Asia’s problems.

Speaking at a seminar organised by the IIE during the World Bank and
IMF Annual Meetings in Washington, DC, Bergsten vented his frustration
at the lack of action of the G7. "They have come up with nothing," he
said. " The global economy is in crisis and the world’s economic
leaders have no answers, no vision." 

Bergsten proposed that Asia urgently needs to take matters into its
own hand by launching a region-wide, concerted and coordinated
strategy of stimulating domestic economies by reducing interest rates,
increasing money supply and increasing government expenditure.  

Export-led recovery will not work, he says, because the countries in
crisis depend too much on each other and on the stagnating Japanese
economy.  In addition, the US is reaching its limit for soaking up
excess production without triggering protectionist reactions. The five
countries most effected by the Asian crisis, Thailand, the
Philippines, Malaysia, Indonesia and South Korea are heavily
integrated into the Japanese economy and a slow-down in demand from
the region quickly impacts on Japan: for the first quarter of this
year Japan’s imports from the Asian Five were down 18 per cent, and
its exports down 33 per cent.  The slump in regional trade has been
dramatic and as countries compete with each other for external
markets, they push down prices which in the long term damages their
own earnings. According to Bergsten, only a coordinated effort would
stop the recessionary spiral.  

Bergsten is a die-hard neo-liberal on most counts and doesn’t question
the benefits of free trade and financial liberalisation, however his
suggestion that governments should increase expenditure opens the
possibility for a wideranging debate on how that should be spent, and
how to balance short term measures against long term goals of equity
and environmental sustainability.

Bergsten is floating the idea through the APEC eminent persons group
and will possibly engage in some ‘shuttle diplomacy’ between now and
the APEC Summit due to be held in Kuala Lumpur on 15 and 16 November.

The Summit itself, though, is under a cloud. Breaking with ASEAN’s
long self-interested tradition of non-interference, Indonesia’s
President B.J.Habibie and Philippines President Joseph Estrada, have
spoken out against the sacking and jailing of former Malaysian
Minister of Finance, Anwar Ibrahim, threatening to boycott APEC.  US
President Clinton has also staked his position by announcing that he
will not meet with this year’s APEC host Dr Mahatir Mohamad outside
the formal Summit. Although the stated reason is displeasure at
Mahatir’s treatment of Anwar, one can’t help feeling that it has the
added spin of punishing Dr Mahatir for having the audacity to impose
capital controls. 

Dr Mahatir has been a vocal critic of APEC over the years, seeing it
as a vehicle for promoting the US trade agenda and overriding Asian
interests. Thus far, APEC has made little progress in achieving
effective regional trade liberalisation: although there are some
impressive agreements they are not binding and the targets are
voluntary. In the present climate, there is a fear that countries will
retreat into trade protectionism. At this year’s WTO Ministerial
Meeting in Geneva, US Trade Representative, Charlene Barshefsky
commented that  "we would be learning the wrong lessons from the Asian
crisis if we retreat into protectionism." It will be interesting to
see if the US is so bullish about trade liberalisation at this year’s
APEC given mounting domestic pressure to take action against alleged
dumping of South Korean steel and as the global financial crisis
starts to threaten US growth prospects.

If the APEC agenda consolidates around developing a regional response
for stimulating growth and establishing a regional framework to slow
down speculative money, domestic Malaysian politics may be set aside.
If, on the other hand,  the US decides that it cannot support an
Asia-led initiative for regional economic recovery – which would take
the policy initiative away from the US -- they could well insist on
sticking to APEC’s trade liberalisation schedule or play up the human
rights card as a way of further discrediting Dr Mahatir. By doing this
the US would derail the APEC Summit and reduce the chances of
developing an concerted strategy to address the economic crisis and
control rampant speculators. 

* Nicola Bullard is a senior associate with Focus on the Global South

end Focus on Trade #30, Part 2 of 3



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