Decades of onerous government regulation and corruption,
restrictions on foreign capital and competition, a concentration of
power in family-owned business groups with close ties to
government, and closed financial systems have contributed to a
weakening of economies some of whom were thought to be the next
"Asian Tigers." Rather than acknowledge the consequences of their
own actions, however, some of these countries have been quick to
blame foreign causes such as international currency traders, some
of whom determined that the Asian governments had demonstrated no
real desire to correct the underlying causes of the crisis and
therefore targeted their investments elsewhere.
Now these Asian governments are running to the IMF to bail out
their economies. In return for giving these countries billions of
dollars in emergency financial aid, the IMF presumably will require
them to liberalize their closed financial systems while undertaking
other reforms which call for less government spending, slower
economic growth, a pledge not to prop up weak banks and companies,
and acceptance of higher unemployment rates. How these nations will
handle these changes remains to be seen.
Few policymakers in the United States (or, for that matter, the
rest of the world) have paid much attention to the root causes of
this crisis, which include excessive government intervention in the
economy, the lack of free and competitive financial institutions,
close economic relationships between government and business, and
corruption involving both governments and family-owned
conglomerates. Moreover, few have asked whether the IMF is equipped
to help these economies and whether its involvement ultimately will
do more harm than good.
An IMF bailout is not likely to help these countries in the long
term. Although it may provide some short-term relief, history has
shown that countries are more likely to repeat the mistakes that
created a financial crisis if they receive IMF aid.2 Most countries that received IMF aid in the
past have been back in line to receive more aid. The solution to
the Asian financial crisis is not to condemn these troubled
economies to long-term dependence on the IMF. To reach economic
stability, these countries must institute fundamental reforms.
U.S. policymakers should not support the IMF bailout in Asia.
Instead, the United States should move to alleviate the current
crisis in these countries by helping them to lay down a foundation
that will prevent such a crisis from recurring. Specifically, U.S.
policymakers should:
• Seek an international agreement on financial
services. Government restrictions on the financial services
industry in many Asian countries stifle competition and subject
banks and other institutions to undue influence by the state. An
international agreement-perhaps like the one currently being
negotiated by the World Trade Organization (WTO)-could open these
financial systems to competition and reduce the level of government
influence.
• Seek an international agreement to eliminate
government corruption. Corruption in many of these Asian
governments has caused them to exert pressure on banks and
businesses to steer capital toward preferential business deals. The
United States is working through the international forum of the
Organization for Economic Cooperation and Development (OECD) to
finalize an international agreement to curtail government
corruption. This agreement is slated to be signed in December 1997,
and the United States should ensure that there are no last-minute
postponements.
• Deny additional funding increases for the IMF. In
order to prevent IMF aid from condemning Asian economies to
long-term dependence, which has happened to countries like Mexico
in the past, the United States should move immediately to withhold
additional funding for the IMF.
• Formulate a strategic withdrawal from the IMF. In
the longer term, the United States should develop a plan to
withdraw all financial support of the IMF. To this date, the U.S.
has pledged some $47 billion to the IMF, approximately $23 billion
of which has gone to the IMF's main account. The U.S. should seek
reimbursement for all the money it has contributed to the
IMF.
Causes of the Economic Crisis
The financial crisis in Asia is the culmination of decades of
hands-on government regulation of the region's economies, distrust
of foreign capital and competition, concentration of power in
family-owned business groups with close ties to government, and
closed financial systems. In the case of South Korea, the
government also followed a policy of funneling capital to some
export industries. This industrial policy of attempting to pick
"winners" backfired as many of these export industries fell victim
to diminishing global demand, leaving South Korea with a
manufacturing over-capacity in some areas. These factors were not
great problems during the 1980s because some of the East Asian
economies kept inflation at bay by pegging their currencies to the
U.S. dollar. In addition, export-driven growth strategies spurred
the highest economic growth rates in the world over the past
decade.
The prevalent view among Western economists is that this "Asian
miracle" occurred because the region was positioned during the past
decade to capitalize on increasing direct investment from Japan and
other countries.3 As foreign investment
capital flooded the Asian economies in the 1990s, the value of
their currencies increased relative to the dollar. In order to
maintain their currencies' peg to the U.S. dollar, the central
banks of these countries needed to remove some of their currency
from circulation. Normally, a government does this by raising
interest rates, which has the effect of reducing the circulation of
currency and bringing the currency's peg into balance with the U.S.
dollar. The central banks of these countries, however, accelerated
domestic monetary supply in an attempt to make exports cheaper on
the world market. This has had a very destabilizing effect by
causing the recent major currency devaluations in many Asian
countries.
The financial crisis assailing the economies of Thailand,
Indonesia, the Philippines, and South Korea, as an analysis for The
Heritage Foundation/Wall Street Journal Index of Economic
Freedom has shown, is rooted in the fact that economic reform
in various sectors has been uneven.4
Although these countries have reduced trade barriers and tax rates,
and although they have made progress in scaling back government
regulations in some sectors, very little progress has been made in
attacking widespread corruption and reforming the over-regulated
and heavily protected financial services industries. Thus, the
problem is not that these economies are too free; it is that they
are not free enough. Indeed, the four annual surveys of the
Index of Economic Freedom show that none of the
economies currently under siege can be classified as "free" because
they still maintain restrictions on economic freedom.
Effects of the Economic Crisis
As loans made by inefficient Asian banks insulated from
competition increased throughout the past decade, many borrowers
defaulted on their payments, prompting poorly managed banks
repeatedly to roll over bad loans. This amounted to piling new bad
loans on top of older bad ones. The banks chose this route because
many of these loans were the result of deals between bankers,
governments, and family-owned conglomerates to finance over-valued
industrial projects and real estate development. Moreover, some of
the loans made to build industrial projects in South Korea under
the government's industrial policy caused some companies to default
on their loans as global demand decreased.
The East Asian governments initially denied the severity of
their problems. They conveniently blamed others, such as
international currency traders who were simply reacting to the poor
economic practice of inflating currency. Following Japan's pattern
of financial collapse in 1991, the East Asian bubble finally burst
in Thailand in mid-1997, after which the trend rolled swiftly
across the rest of the region.
Both the severity of this financial crisis and the extent to
which it could undermine the financial stability of countries like
Japan, Malaysia, and Brazil are largely misunderstood by U.S.
policymakers. At the end of 1996, East Asia's outstanding
international debt was $752 billion, making this region the
international banking system's biggest potential liability. The bad
loans made by East Asian banks account for 10 percent to 20 percent
of their loan portfolios today. Even if the region's financial woes
do not worsen, the total cost of the bailout of Thailand,
Indonesia, the Philippines, and South Korea already amounts to more
than 14 percent of East Asia's gross domestic product (GDP).
This figure could increase quickly if South Korea asks for and
receives a larger bailout amount, and if Malaysia and Japan are
swept up by the financial turmoil. Japan, in particular, is
especially vulnerable to the financial turmoil in East Asia since
one-third of its imports originate there, 37 percent of its exports
go to East Asian countries, and its banks hold more than $250
billion in outstanding loans to East Asian economies. By contrast,
the banking crisis in Mexico during 1995 cost the equivalent of 12
percent of that country's GDP, and the savings and loan crisis in
the United States during the 1980s cost between 2 percent and 3
percent of U.S. GDP.
The Counterproductive Response
In the past, the IMF provided financial assistance in exchange
for macro-economic policy changes-such as raising taxes and
devaluing currencies to gain a temporary export advantage-which
were often counterproductive. More recently, it has been paying
greater attention to the policy changes that are needed to revive
and sustain long-term economic growth, such as lowering tariffs,
reducing barriers to foreign investment, eliminating unnecessary
regulations, and privatizing state-owned enterprises. This emphasis
on free-market policy reforms is a commendable change, and is
partly the result of decades of criticism of the IMF for engaging
in counterproductive economic meddling.
However, the fact that the IMF has included requirements in its
austerity package to force productive economic policies does not
offset its past advocacy of unwise economic policies. In addition,
there are indications that the IMF is now asking some recipients to
raise taxes, mainly their value-added taxes. But higher taxes are
precisely what these economies do not need: They will only
hinder long-term economic growth. Instead of increasing taxes,
Asian governments should reduce their level of government
spending.
Mexican Bailout Lessons
Since 1976, the United States has bailed out the Mexican
economy four times, and each bailout has been more costly to
American taxpayers. Instead of increasing pressure on the Mexican
government to reform weak financial institutions and the monetary
policies responsible for the country's economic crises, these
bailouts created incentives for government officials and foreign
investors to continue policies and investment practices that led to
new financial crises-on an ever larger scale.
The bailouts of Mexico offer policymakers two important
lessons:
• First, IMF loans, usually with U.S. government
backing, create a moral hazard: IMF bailouts of countries
experiencing financial difficulty underwrite otherwise
unsustainable policies and reduce the pressure on governments to
implement needed institutional and policy reforms. In Mexico,
successive bailouts have encouraged the ruling bureaucracy and
business to avoid vital institutional reforms for two decades.
• Second, IMF loans allow the political and business
interests responsible for causing financial crises to circumvent
less expensive market solutions in which creditors and governments
(in the absence of a bailout) would have an incentive to
renegotiate their debts. Although investors would suffer some
losses without an IMF bailout, IMF involvement places the burden of
loans on U.S. taxpayers and the citizens of other countries who
bear no responsibility for the unwise monetary policies which are
the true cause of these financial crises.
The IMF's Dismal Record
Mexico is not the only example of the IMF's faulty bailouts.
In fact, the evidence shows that, instead of putting recipient
economies on solid financial ground, IMF aid to less-developed
countries has created further dependence on the IMF.5 Between 1965 and 1995, for example, 137
countries received loans from the IMF. The number of times 81 of
these countries borrowed from the IMF between 1981 and 1995
increased an average of nearly 50 percent over the number of times
they borrowed between 1965 and 1980. Only 44 countries reduced the
number of times they borrowed during these same periods.
Not only does the IMF have a poor record of guiding countries
onto the right economic track, but it also has not helped
struggling economies grow. For example, of the 89 less-developed
countries that received IMF loans between 1965 and 1995, 48 are no
better off economically today than they were before receiving the
IMF loans. Moreover, of these 48, 32 are poorer than they were
before receiving IMF loans.6 Thus,
there is no evidence that IMF aid helps countries achieve long-term
economic prosperity.
The evidence shows instead that no amount of IMF aid is likely
to force governments to make the changes needed to put their
economies back on track. Such aid is likely to remove the economic
consequences of their past actions and allow these governments to
put off the hard choices they would have had to make without IMF
aid.
How the U.S. Can Help the Asian Economies
An IMF aid package could well create a Mexico-like scenario in
which the Asian economies need financial assistance repeatedly in
the future. If a country with a struggling economy knows it will be
bailed out by the IMF, it has little incentive to change its unwise
policies and investment practices. The solution to the Asian
financial crisis, then, is not to condemn these countries to
long-term dependence on the IMF. Rather, it is to encourage them to
institute necessary and fundamental reforms in their financial
systems.
Rather than rely on the IMF, the United States should use this
opportunity to help Asian countries by pursuing steps that will
help steer their economies toward greater stability. Specifically,
the U.S. government should:
1. Seek an international agreement on financial
services
A major problem underlying the current economic crisis in
these Asian countries is the lack of competitive financial services
that are free from government influence. Governments can influence
lending decisions when banks are protected from competition,
whether foreign or domestic. Foreign investment in banking services
is often curtailed and sometimes prohibited. In addition to
restrictions and regulations on foreign banks, governments restrict
the kinds of financial services in which banks may engage, such as
selling investments and real estate and providing insurance
policies. The lack of competition in financial services and the
presence of onerous government regulations, coupled with government
corruption, have resulted in a system in which the government
influences the allocation of credit, mainly to unsound and unwise
construction and real estate projects.
Although some progress has been made in the World Trade
Organization toward an effective international financial services
agreement, no international agreement at this point has been
far-reaching enough to deal with the kinds of reforms necessary to
abate the financial crisis now occurring in Asia. The United States
should direct all efforts to reach a financial services agreement
that includes provisions to increase competition in all sectors of
financial services. Specifically, the United States should insist
on the following competition-broadening policies:
• Elimination of regulations preventing the full
establishment of foreign banking operations in all signing
countries. Foreign banks should be free to establish wholly
owned branches and subsidiaries in other countries, with few
regulations on their operations. This policy would attract more
foreign banks and increase private-sector competition. Such
competition would also make it harder for governments to influence
lending decisions.
• Legal treatment of foreign banks equal to domestic
banks. Many developing countries, while partially welcoming
foreign banks, tend to treat them differently than they treat
domestic banks. For example, certain government regulations may
apply only to foreign banks. These regulations often are
established to make foreign banks less competitive than domestic
banks. Equal treatment would attract foreign banks to these
countries and thereby increase competition.
• Elimination of laws differentiating investment banking
from commercial banking. Even laws in the United States prevent
banks from offering a host of financial services, such as savings
accounts, loans, real estate, insurance policies, and investments.
Many European governments, however, have removed some regulations
that impose such barriers. The United States and other countries
should follow suit. This would increase competition among all
banks.
2. Seek an international agreement to eliminate government
corruption
The United States, working through the Organization for
Economic Cooperation and Development, is trying to reach an
international agreement to curtail government corruption.
Corruption often takes the form of government direction of credit
to political friends and allies. An international agreement to end
these practices would go a long way toward reducing the ability of
governments to affect the lending decisions of their banking
institutions-and this, in turn, would reduce the likelihood of
banks' funding over-valued projects. This agreement is slated to be
signed in December 1997, and the United States should ensure that
there are no last-minute postponements.
3. Deny additional funding increases for the IMF
Before Congress recessed in November 1997, it rejected the
Clinton Administration's request for a $3.5 billion increase in
funding for the IMF. The President is expected to try again when
Congress reconvenes in January, presumably by arguing that more
taxpayer money should be granted to the IMF to avoid a global
financial meltdown.
Currently, the IMF does not have enough funds to borrow the
billions of dollars the East Asian governments are seeking.
Increasing IMF funding would permit the IMF to borrow more
internationally in order to transfer these borrowings to troubled
economies. Essentially, the IMF has reached its financial ceiling;
it cannot expand its emergency aid to East Asia unless funding by
member governments increases by many billions of dollars. The first
step Congress should take to rein in an ineffective IMF should be
to reject all Administration requests for further funding
increases.
4. Formulate a strategic withdrawal from the IMF
The United States is the IMF's largest donor. The U.S.
taxpayer is liable for some $47 billion in IMF contributions.
Moreover, the IMF, with the Clinton Administration's blessing, has
decided to increase its total capital resources (referred to as
quota subscriptions) by 40 percent over current levels. Under this
plan, the U.S. would be obligated to contribute an additional $15
billion over its current obligations.7
Instead of supporting a search for additional funds that will
increase American taxpayers' indebtedness to the IMF, the U.S.
government should formulate a strategic plan to withdraw all
financial assistance from this institution and seek reimbursement
for the money it already has contributed.
CONCLUSION
It is estimated that the International Monetary Fund's bailout
of Indonesia, Thailand, the Philippines, and South Korea will cost
$118 billion-an amount that will grow if South Korea asks for and
receives a larger bailout and if the region's financial earthquake
spreads to Malaysia and Japan. Many Asian leaders have tried to
blame foreigners for their own financial crisis, including
international currency traders who generated the capital flows
which fueled Asia's spectacular growth rates in the past. These
leaders are wrong. The true causes of the crisis in Asia are
domestic, including decades of hands-on government regulation of
the region's economies, a distrust of foreign capital and
competition, the concentration of power in family-owned
conglomerates with close ties to government, and closed financial
systems.
International bailouts engineered by the IMF may improve the
cash flow of these Asian economies, buying time for these countries
to export their way of out their financial crisis. But without
major domestic reforms, the structural and institutional causes of
the Asian financial crisis will not be corrected, and new and much
larger crises eventually will occur. An IMF bailout is no guarantee
of a better tomorrow. In fact, the historical record shows that
wasteful IMF bailouts have never worked.
Since the Asian financial crisis was caused by the poor economic
and financial policies of East Asian governments, no amount of IMF
and U.S. financial aid will compel them to make the fundamental
reforms in their economic and financial institutions that would
enable them to avoid financial crisis in the future. All an IMF
bailout backed by the U.S. government will do is to give these
governments a cushion on which to postpone true reform.
Instead of relying on an IMF bailout, the United States should
help these countries by insisting on market-driven, private
solutions. By removing the IMF from the equation, the United States
would help create incentives for these governments to implement
effective reforms in their economic institutions, and for foreign
investors to renegotiate privately their outstanding loans with
these governments. This is a far better strategy than placing the
burden on the backs of American taxpayers and Asian consumers who
were not responsible for causing this crisis.
In the near term, such an approach undoubtedly would cause a
slowdown in Asian growth, and foreign investors would suffer losses
on their investments. Over the longer term, however, U.S. advocacy
of market-driven solutions to the Asian crisis would increase the
pressure on these Asian governments to implement domestic
institutional reforms which they have managed to avoid for more
than two decades.
Endnotes