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Asia: Two Lessons To Learn From Financial Crisis

  • Breffni O'Rourke

Prague, 8 April 1998 (RFE/RL) -- The Asian financial crisis has illustrated dramatically the dangers of vast capital flows, both inward and outward.

For years the high growth economies of Southeast Asia were an irresistible magnet to investment money from around the world. Billions of dollars flowed into the region, heedless to the fact that local banks were beginning to make imprudent decisions about how to invest the money. When the bubble burst, investors stampeded out, leaving behind local banks which were over-exposed to bad debts and leaving many healthy industrial companies starved for capital.

Bewildered governments in the region could only wring their hands as the achievements of decades collapsed around their ears. The crisis provided many lessons. Let's look at two of these, one old but often forgotten lesson, and one new. The old one is that human beings tend to become incautious when they see the chance of profit dangling in front of them. The new one is that in the age of the globalized economy, individual governments are losing part of their sovereignty over economic policy.

Callum Henderson, managing analyst at the MSS investment advisers in Hong Kong, says sound investment requires two types of infrastructure. One is the physical infrastructure of roads, communications and the like which make possible rational economic activity. The other is the institutional infrastructure, which means financial mechanisms which can prudently allocate big inflows of money to the right investment targets. Without a sophisticated financial infrastructure, money is sent on unprofitable adventures, a bubble develops, then there's collapse.

Henderson says that globalization, which is characterized by open capital flows, implies that the markets are empowered ultimately to decide what is acceptable in economic development, thus limiting -- but not eliminating -- the say of governments. The role of international investors takes on social and political dimensions more clearly than before, in that their decisions impact directly on the well-being of national populations.

Henderson says that a properly-functioning financial infrastructure is the crucial element in sustaining beneficial investment, in an atmosphere where risk is properly assessed. But this does not mean leaving markets alone to decide all issues, rather it implies that governments must create the right regulatory framework within which a vigorous market has free play. But what is that framework? Henderson says there is no universal prescription, but rather each country must see what works according to its circumstances.

One model which has aroused much international interest is Chile, a country which has enjoyed steady growth through the 1990s. Chile suffered in Latin America's regional crisis in the 1980s, and the bitter lessons learned have influenced the government's thinking since then.

Chile's strategy rests on several main points. One consists of rigorous rules to discourage inflows of short term capital. In the case of any loan from abroad, a 30 percent deposit must be placed with the Central Bank for one year at zero interest. This rule is designed to discourage so-called "hot money" pushed around the world by speculators seeking quick profit, often at the expense of market stability.

Chile's second rule is strict regulation of the banking and financial system. An independent panel ensures for instance that Chilean banks do not grant credit abroad nor enter deals involving mismatched currencies. These rules are designed to stop the banks making unwise investments which could otherwise go unnoticed for a long period. A third rule is that the government ensures that Chile's public sector consistently runs a fiscal surplus.

These policies have contributed to making Chile a stable economy characterized by steady investment flows. They also serve to illustrate the role government needs to play in the new, globalized era, namely that of a strict referee which ensures that the hard-fought game does not degenerate into chaos.

Brazil, Latin America's major economy, recently introduced with success its own restrictions on short-term capital inflows. In fact Latin America, which underwent its own humiliating crisis in past years, is now a region coping well with the new tensions springing from the Asian meltdown.