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Coping With the Crisis

Asia’s remedy to the end of US consumption excess

Photo by AFP

The financial crisis in the West presents Asia with many challenges, but also some opportunities. It opens a door for the region to take a lead in ensuring that this crisis does not lead to a retreat toward global protectionism.

It is a chance to reaffirm that the financial sector exists to serve the real sector, not be the tail that wags the dog. It presented an opportunity for the region to demonstrate how much it had learned from its own crisis a decade ago. In their different ways, all these opportunities are also ways to curtail the growth of the income and wealth gaps that have emerged in many parts of developing and developed Asia.

The financial crisis has brought the world, and especially Asia, face to face with the economic reality that had been too long delayed—the end of the consumption excess of the United States (US). The condition, which had been prolonged by easy credit and asset price inflation, was suddenly reversed. The global slowdown and recession in the West have curbed not only exports but also remittances that are especially important for South Asia, Philippines, and Viet Nam.

There is a very real danger that the recession—which is certain in the US and probable in Europe—will lead to a surge of protectionist sentiment in the West. This would follow 50 years of the West mostly— with the big exception of agriculture— pushing for freer trade and movement of capital, a process of which East Asia has been the major beneficiary. However, a resurgence of the kind of protectionism seen in the 1930s is not inevitable if Asian countries, which have enjoyed large trade surpluses for most of the past decade, recognize that the process must now go into reverse.

At the time of the Asian crisis, a surge in protectionist sentiment in the region would have been a natural, if dangerous, reaction to sharp falls in output. But this did not occur, partly because of the influences of multilateral institutions, such as the Asian Development Bank, the World Bank, and the International Monetary Fund, which linked new funding to reform and liberalization. Trade barriers actually fell and the Association of Southeast Asian Nations brought forward its free-trade timetable. All this was helped along by the stimulus provided by devalued currencies that spurred exports and curbed imports.

Unfortunately, Asia’s economies are not in a position to pressure the US and the European Union in the way they did then. As the only reserve currency economies, barring the minor role of the yen, they can in theory print their way out of financial problems. However, Asia must do certain things if it were to help moderate pressures for a new protectionism.

These include: First, Asia must continue moves toward currency flexibility. In most cases, this will likely lead to appreciation against the currencies of the recession-hit West. Reliance on currency undervaluation to boost exports in a beggar-thy-neighbor fashion will only invite protectionism in the West. In most cases, too, currency appreciation would boost real incomes of workers at the expense of corporate profits, which in most of East Asia have been gaining increasing shares of national income.

Second, fiscal measures must be used to boost spending, whether on consumption or investment. Some countries need consumption rather than investment and export-led growth. The People’s Republic China (PRC), in particular, has huge scope to increase the consumption share of gross domestic product. Others, particularly in ASEAN, need a pickup in investment.

Fiscal stimulus and currency appreciation, together with export stagnation, will cause some substantial trade deficits to reemerge. But, with reserves high almost everywhere in Asia, room for deficits is ample. Lots of room exist for the big surplus countries of Northeast Asia to buy the local currency public-sector debt of countries needing to borrow to finance infrastructure requirements. This would help cement regional cooperation and provide new avenues for surplus countries to invest in growing Asian economies rather than stagnant western ones.

Market Crash A danger exists that recession will lead to a source of protectionist sentiment
Photo by AFP

Several formerly crisis-stricken countries are now in a position to sustain larger fiscal deficits. Others have room for more effective tax collection that would enable more spending on education, health, and infrastructure, which in turn would tend to reduce inequalities in standards of living. Fiscal deficits are also less likely to run out of control than an excessive easing of monetary policy and the buildup of private sector debt. It should not be forgotten that several countries hit by the Asian crisis were running fiscal surpluses while allowing credit to explode. Likewise, the US fiscal deficit is a minor problem compared with excessive credit growth combined with increasing leverage in the financial system.

Apart from the chaos they can create, financial and asset price bubbles redistribute income in mostly undesirable ways. And they mostly benefit the few at the expense of the many. The many pay for them in public sector bailouts and higher taxes, and in the heightened inflation that accompanies them. It is not coincidental that the US crisis has followed a sustained period of negative real interest rates that undermined the incentive to save, and benefited stock market punters at the expense of small savers.

Asian countries, long takers rather than makers of international trade policy, may well need to take the lead in protecting the status quo at the World Trade Organization from being undermined. Revival of Doha may be very difficult under present circumstances, but the region should make every effort both to keep discussions going and avoid any measures that could be considered backsliding. It is particularly important that farm product markets do not become more distorted than they are already. Southeast Asia, PRC, and India all need to ensure that the food price spike earlier this year does not lead to restrictions and costly attempts at self-sufficiency that result in high prices for consumers without benefiting farmers at large.

Overall, Asia must escape from the temptation to see the current crisis as a failure of free trade and free movement of capital. Like the Asian crisis, it has showed on an even bigger scale the need for financial regulation and sound money policies. There is little to suggest that free trade is part of the problem or that flows of nonfinancial capital are to blame.

That may be a hard case to argue, given the extent to which the US has simultaneously pushed free trade and open, deregulated financial markets onto the world. But trade in goods (which are tangible) and trade in money (which is based on trust) are conceptually different and need to be treated differently. Keeping a grip on that distinction is vital for Asia. •