A New Strategy for the Global Crisis
A shorter version of this brief appeared in The Washington Post, Outlook Section, September 20, 1998.
© Institute for International Economics. All rights reserved.
The "Asian economic crisis" is much deeper, much more pervasive and likely to last much longer than anyone imagined. Economies that had grown 6-8 percent annually for two decades are declining by like or greater amounts, a swing of depression-era magnitude with incalculable political and social consequences. The contagion has already spread far beyond Asia, engulfing Russia and much of Latin America, and could do so even more violently in the days ahead. We now face a truly global crisis, which has already hit the United States hard and will do so with increasing force.
Recovery from the crisis will clearly take several years. The afflicted countries (Thailand, Indonesia, Malaysia, Korea, Russia and, to some extent, China and Hong Kong) need fundamental reform of their banking and corporate governance systems. These structural changes are far more difficult and socially disruptive than cutting budget deficits, money growth and overvalued exchange rates, the central responses to most previous crises. Even the most committed reformers, as in Korea and Thailand, are only beginning to make real progress and will be hard pressed to sustain political support for the needed changes in their domestic societies and power structures.
Moreover, Japan, which accounts for three quarters of the Asian economy, has plunged into recession and is already close to a "lost decade" of growth à la Latin America in the 1980s. The crisis countries must put their own houses in order but, even if they do everything right, they cannot resume satisfactory growth until Japan does so. The "flying geese" formation, whereby the rest of Asia follows the lead of Japan, may become a flock of dead ducks for a prolonged period-whereas rapid growth and open markets in the United States enabled Mexico to bounce back from its 1995 crisis after only one bad year. A renewed plunge of the yen and/or implosion of the Japanese banking system are among the most likely triggers of the next spike of the global crisis.
the rest of Asia follows the lead of Japan,
may become a flock of dead ducks
for a prolonged period
Four new policy strategies are needed to stop the downward spiral and provide a foundation for recovery. All require effective international cooperation and strong leadership from the United States.
First, the crisis countries should launch a concerted program of domestic expansion through sizable fiscal and monetary stimulus. Export-led recovery will not work because the countries rely too heavily on each others' markets and that of stagnant Japan, and because the US trade deficit has already hit $250 billion and will trigger protectionist reactions as soon as our unemployment starts to rise. The essential structural reforms will become more palatable in a climate of resumed growth. The International Monetary Fund will surely bless such a strategy, which would help refurbish its own image as well as get the region growing again.
a concerted program of domestic expansion
through sizable fiscal and monetary stimulus.
Fortunately, fiscal stimulus is eminently feasible because all the countries entered the crisis with solid budget positions. The stimulus can be financed partly from domestic sources and partly from activation of the "second lines of defense" which Japan, the United States and other foreign creditors have pledged to the crisis countries. Interest rates have already come down considerably but currencies have largely stabilized and thus further cuts, especially if done in concert to avoid capital shifts from one crisis country to another, are also quite doable.
The Concerted Asian Recovery Program should be launched at this year's summit of the Asia Pacific Economic Cooperation (APEC) forum in mid-November, which will be attended by the President and the leaders of every country on the Pacific rim (including Russia). Host Malaysia is desperately seeking domestic expansion and should strongly support the effort. China has already begun to stimulate domestic demand and would welcome company. Japan could perhaps be persuaded by such a regional initiative to enact the large tax cuts and fundamental bank reforms that are required to reinvigorate its economy (and the entire region), which would enable it to switch dramatically from goat to hero.
Second, the United States and European Union should globalize the strategy by cutting their own interest rates. This would encourage capital reflows to the crisis countries, reduce their debt burdens and improve their competitive position by promoting a stronger yen. It would also ensure continued world growth and help prevent further stock market declines.
Union should globalize the strategy
by cutting their own interest rates.
In the United States, real short-term interest rates (adjusted for inflation) are historically quite high. The Federal Reserve's overnight lending rate is higher than the yield on thirty-year Treasury bonds. In light of the slowdown in the American economy and the continued absence of inflation, the Fed should emulate the sharp decline that has already occurred in market rates and cut by a full percentage point. The Europeans, who have played very little role in responding to the crisis to date, are moving toward a single interest rate as they prepare to create their common currency (the euro) in January; they should converge their national interest rates at the lowest current (German) level and then follow any Fed cut at least halfway.
Third, it is time to recognize the long-term nature of the crisis and extend meaningful debt relief to the crisis countries. The world waited seven years to provide real relief for the Latin Americans via Brady bonds in the late 1980s, substantially prolonging their agony. The current debt is largely owed by banks and companies in crisis countries to a wide array of private lenders in the industrial world, which complicates its management but can be handled through consolidating each debtor country's overall position and then having the individual debtors and creditors implement the rescheduled conventions.
As with Brady bonds, the IMF should help determine the magnitude of relief needed for each country, e.g., less for Korea and more for Indonesia. Only countries complying fully with IMF programs, reoriented as described above, would qualify for negotiated relief that would maintain their standing in the capital markets. In addition to easing the crisis, the substantial burdensharing thus required from private creditors would deal with the issue of "moral hazard," under which the availability of IMF support supposedly induces reckless behavior by foreign lenders, the only serious critique of current IMF procedures.
Finally, the Congress should step into the current global leadership vacuum by passing both full funding for the IMF and new "fast track" trade negotiating authority for the President. The former is essential so that the IMF can help Argentina, Brazil, Hong Kong, Malaysia, Mexico or any of the numerous other countries that could be hit hard by the next waves of contagion.
On trade, the Republicans plan to bring "fast track" to a vote next week. A negative vote would imply that the United States, the world's strongest economy and most vocal advocate of liberalization, might close its own markets. This would send a devastating signal to the crisis countries, encouraging them to seek refuge behind new barriers as Russia and Malaysia have already done with respect to capital flows. Markets would tumble around the world and the United States, far from exercising leadership, would correctly be blamed for deepening the crisis. (Controls over capital inflows à la Chile can help prevent crises but controls over outflows, especially adopted in the midst of crisis à la Malaysia, will deter foreign investment just when it is needed and cannot promote recovery.)
President Clinton pointed in most of the correct directions in his comprehensive statement on the crisis on September 14. However, he failed to specify how to renew growth in either the crisis countries or the world economy. He called for debt restructuring but not for meaningful debt relief. He continued to pander to narrow interests in the Democratic Party by opposing early passage of his own trade legislation.
nature of the crisis and extend meaningful
debt relief to the crisis countries.
The President took a very important step, however, by asking the finance ministers and central bank governors of the "G-7 and key emerging economies," the new G-22, to report to their heads of state on all these issues by the end of the year. Financial crises and the financial system are far too important to be left to financial officials. Only the engagement of G-7 summits produced the modest systemic improvements adopted by the IMF and G-7 itself after the Mexican crisis in 1995. Engagement of political leaders is essential to counter the leadership crisis that is adding so greatly to market uncertainties and global economic deterioration. The crisis countries of course bear primary responsibility for restoring their own economic health but the ability of the global community to deliver a program along the lines suggested here will go far to determine the course of the world economy for years to come.