Source: Carnegie
Prepared February 5, 1999
The crisis in Asia provides a fertile setting for the upcoming meeting of CERN. Asian leaders face the difficult task of securing political support for needed economic reforms while balancing competing demands for relief from adversely affected sectors of the population and the economy. In this context, three topics for consideration are:
1. the obstacles to reform before crisis conditions built up (with the aim of preventing a repetition)
2. the politics of structural change, especially the restructuring of financial and non-financial corporations; and
3. distributive politics and the social strains of recession.
This note explores the economic and political dimensions of these three topics, briefly discusses how these topics could be incorporated into the agenda for the next meeting, and proposes a set of papers to be commissioned to facilitate the discussion.
One of the most puzzling aspects of the crisis in Asia is that so little was done to prevent it. The crisis was caused by both international and domestic factors. On the domestic front, many countries allowed economic weaknesses to go unaddressed until their vulnerability to crisis became extreme. Some weaknesses had been identified before crisis struck--both by governments within those countries and by the international financial community--and were not acted upon. Other weaknesses went undiagnosed or at least unemphasized. While there are many technical, economic issues surrounding these failures, it is important to identify the political obstacles that contributed to the lack of diagnosis and action. Those presumably included the difficulties of undertaking reforms amidst growth and prosperity, vested interests in the political order, inability to reform when competing nations did not, and enabling behavior rather than pressure from neighboring countries. Examination of the record in Asia could be important to draw lessons for the prevention of future crises.
The restructuring challenge
Economists differ in their assessments of the origins of Asia?s crisis: one camp emphasizes the emergence of macroeconomic and structural weaknesses in "crony capitalism," and a second camp stresses the self-fulfilling panic of global capital markets. These two assessments lead to different prescriptions. The first suggests a program to redress structural weaknesses through legal, institutional, and policy changes. The second leads to a policy of reflation to break the financial panic and restore depressed economic activity. Of course, each camp admits the relevance of some aspects of the arguments of the other; but, at the same time, each believes that undue emphasis on the other by policymakers could actually worsen the economic situation. The "structural camp" argues that aggressive reflation could undermine currency stability or at least distract attention from needed structural reforms, and "the panic camp" argues that a preoccupation with structural flaws will impede the restoration of confidence.
This economic dispute needs to be settled on its merits, but it is also important to recognize and reckon with the political dimensions of the policy prescriptions. Reflation is likely to appeal to owners and managers of corporations and financial companies, who hope that expansion of money and credit and a resumption of demand could possibly save their troubled enterprises. Labor is also likely to be attracted to reflation by the hope it would raise employment levels and labor compensation. Restructuring has much less inherent political appeal: it offers little short-run gain, involves significant dislocation, and threatens vested interests. In particular, owners of companies and banks stand to lose control if financial restructuring proceeds. They may block such steps--even when their companies and banks would be saved (although probably in different hands) over the long run. Despite these pressures for reflation and against restructuring, Asian leaders may decide that structural problems pose an obstacle to a resumption of sustained growth. If so, they will need to build a political basis for successfully tackling the structural reform agenda.
Across Asia leaders differ in their assessments of the situation and their prescriptions for macroeconomic and structural policy management. Kim Dae Jung has for the past year dedicated his government to achieving structural change, as has the Chuan government in Thailand. Both governments are finding the resistance of vested interests to be obstacles. Kim is publicly jockeying with the chaebols, but bank owners and labor are also engaged in the battle. The Chuan government is fighting for legislation that is key to restructuring efforts and battling with some owners of conglomerates. In contrast, Mahatir in Malaysia has embraced reflation behind the wall of capital controls. China has virtually abandoned efforts to shut off bank credits to state enterprises in an effort to sustain GDP growth.
In the coming months prior to the CERN meeting, there will be some greater experience with reflation and restructuring efforts. The process, however, is likely to be protracted and to require much ongoing assessment. CERN members may wish to draw lessons regarding unresolved issues surrounding the complicated politics of restructuring.
Distributive politics and the social strains of recession
Coping with the social strains of recession also involves several economic and political dimensions. First, the recessions associated with the Asian crisis have led to a renewed debate about the optimal mix of macroeconomic policies during shock-induced downturns. Particular attention is given to the social and political consequences as well as economic costs of high interest rates to defend currencies. Second, in considering countercyclical fiscal policies, there is debate about the appropriate mix of public works spending versus spending on the so-called social safety net. Third, the feasibility of increases in social spending in the short run is being questioned for two reasons: sudden increases may reinforce traditional modes of clientelistic spending in social areas; and, since social programs have not yet been thoroughly modernized, sudden increases are likely to be prey to new corruption. Fourth, the financing of increased spending on social programs raises technical as well as political problems. In Asia, Keynesian automatic stabilizers--unemployment insurance and welfare entitlements that protect from public spending cuts during a recession but are clearly temporary--do not yet exist. Should such spending be financed from outside, and what would be the implications? Is it politically feasible to ensure that such spending is temporary?
Moreover, the hardships during the present crisis are exposing a broader set of concerns about increases in the inequality of wealth and income associated with the most recent stages of market reform in East Asia. The recession is undermining the typically Asian form of social compact between government and citizens. Under this compact governments delivered fast growth as a substitute for Western-style social welfare insurance, and social programs were politically and socially defined as investments in future growth rather than as redistributive. If this compact breaks down, concerns about inequality will likely become politically important.
The Proposed Agenda
The agenda for the meeting would be based on these three topics. A fourth, concluding session would address the related question of how officials in emerging market countries find a voice in the ongoing debate about the modernization of the international financial architecture. Any such modernization of the international financial architecture would affect individual countries' reform efforts, and thus should take account of emerging market countries' interests, including political dimensions. The concluding session will give CERN members a chance to review both those interests and the possible fora for their expression.
Discussion objectives
These topics should have a fairly broad appeal to CERN members. Many of the issues being considered in Asia have been debated in other regions and other contexts. Non-regional members may not have a familiarity with particular structural challenges, political alignments, social institutions, etc. But most have grappled with the trade-offs between macroeconomic stimulus and structural agendas and have confronted political obstacles to changes that promise only long-run payoffs. As for the social policy issues, many have had the experience of facing crisis with inadequate safety net institutions and budgetary allocations and have confronted in one form or another the question of the appropriate role of social spending in shaping political consensus.
As in past meetings, success will depend upon promoting discussion that draws upon members? individual experiences while also contributing to some general conclusions. In this case, it may be helpful to attempt to draw conclusions that could be directly relevant to Asian countries at present, rather than strictly general conclusions.
Supporting papers
The discussion will be supported by a small set of papers. We want papers that will frame the political issues in Asia without lengthy economic analysis. The papers would be available to CERN members in advance of the meeting and would not be presented during the meeting.
Likely paper topics would include:
* Obstacles to crisis prevention
* The politics of reflation and restructuring
* The social strains of recession
* Inequality and the Asian crisis
We would also aim to produce pairs of papers--one on macroeconomic and structural issues and the other on social policy issues--on the specific country experiences in Korea, Indonesia, Thailand, China, and Malaysia.
