East Asia's Crises: Toward a New Growth Paradigm?

Christopher Lingle, an independent economist and consultant, is the author of The Rise and Decline of the Asian Century (University of Washington Press, 1998).

The current crises affecting much of Southeast and East Asia are rooted in the failures of political and corporate governance in the region. While this observation may point to a simple truth, the solutions will not be easy to implement. This is because the financial and currency crises reflect deeply rooted institutions that themselves reflect local cultural conditions. In turn, there can be little hope for speedy implementation of the fundamental changes that will be necessary to make operation of the economies of the region compatible with the requirements of a free and open international marketplace. Consequently, restoration of stability to the region’s economies will not come quickly, while recovery may be many years off and is likely to result in much slower growth.

The recent turbulence in regional markets sharply contradicts the World Bank’s report on East Asia’s “miracle” economies suggesting that their governments “got the basics right.” If economic and political fundamentals had been sound for the countries in the region, there would be no discussion about financial and currency crises there.

One likely casualty of these crises is the myth that interventionist or authoritarian governments can effectively shepherd economic development. Until recently, advocates of “Asian values” insisted that the rapid growth in the region was evidence of a superior political system. Another related notion was also fatally damaged by the turmoil that began with the devaluation of the Thai baht in July 1997. In the future, suggestions that political connections can substitute for commercial risk analysis or can inoculate investments against market realities will have little credibility. Just ask anyone with business dealings in Indonesia who sought partnerships with the Suharto clan.

A Common Thread

While there may be no single “Asian model” associated with the rise of East Asia’s economies, a common thread in the political culture in these diverse countries can offer insights into their recent problems. Specifically, the economic and political institutions throughout the region are insufficiently responsive to the demanding climate of the global economy. The dominant political culture that guided economic and administrative structures reflected the specific agenda of a given ruling party or regime and was rooted in conservative local traditions.

To generalize the ungeneralizable, political arrangements in most of East Asia relied on a collectivist, or communitarian, approach to governance. As such, the interests of the greater community, mostly as interpreted by some elite, were placed above individual rights and freedoms. In turn, expressions of individualism were deterred by such admonitions as “the exposed nail is hammered down” and “society above self.”

The dominant sense of the collective is seen in assertions that Asian governments and regional institutions rely on principles of consensus-building and a strong preference for harmony. At the same time, success in life or commerce depends on personal and political connections rather than commercial viability or economic rationality. These relationships readily give way to corruption and cronyism. Indeed, surveys of business leaders involved in global commerce by Transparency International indicate that the most corrupt regimes are in Asia.

Out of Sync with Global Capitalism

Some of the political and economic arrangements in East Asia have a venerable history and may have served noble purposes in the past. Like institutions in other parts of the world, they emerged out of local conditions and were appropriate for the times. Unfortunately, the current crises imply that those institutions do not mesh well with the requirements of global markets. Such markets work best in the presence of individualist-based institutions that operate in conditions of greater corporate accountability and political openness. Even in a market-based society, reliance on personal relationships limits the extent of economic exchange and opportunities. In a modern political context, dependence on political connections invites endemic corruption and may allow for extensive nepotism. At the same time, authoritarian regimes attempt to justify repression on the basis of enforcing cultural traditions of harmony and respect for authority.

The most demanding components of the ongoing globalization of the economy are free and generally unfettered international capital flows and competitive markets. These are the outgrowth of the Thatcher Revolution and the “Big Bang” reform of London’s financial markets in 1982. Unfortunately, the political and corporate culture in most East Asian countries militated against the development of domestic capital markets that might have allowed their economies to weather the competitive storms that have washed over the region. Most governments purposely sought to control credit allocation, which was principally directed through banks. Restraints on the emergence of free and open capital markets better fit the policies of directed development.

Financial markets in most of the region were underdeveloped, inefficient, and weak because the visible hand of government pre-empted the invisible hand of market forces. Consequently, there was little disclosure and almost no scrutiny of institutions that were under the protection of the ruling governments. The real cost of non-economic transactions or unsound loans could be more readily concealed.

Government’s Misleading Signals

There were several operational consequences of East Asia’s underdeveloped domestic financial markets. One consequence was that much of the internal financing of commercial and development projects was channeled through the domestic banking system. Another was the greater dependency on foreign capital to provide liquidity to the domestic financial system.

Government-directed investment misleadingly signaled domestic financial institutions that the projects involved low-risk or no-risk commitments of capital since they would bear the imprimatur of ranking officials. A heavy reliance on bank lending instead of capital markets is problematic since bank managers or directors can be more easily swayed by political pressure. In contrast, large numbers of independent private investors in capital markets demand greater access to information and require greater accountability before offering up funds. In essence, financial markets in most of East Asia were politicized and so commercial risks were ignored because of a promise of protection by political connections. This may have worked while growth rates were high over past decades, but it is now painfully clear that political connections cannot protect investors from downside risk.

As suggested, the inhibitions of capital markets were consistent with the political culture of the region. Authoritarian governments sought to exercise tight control over the flow of economic information. Most countries in the region followed or enforced traditions of collectivist institutions; governance by consensus often created an illusion of harmony. In these settings, criticisms of economic conditions or policies tend to be suppressed, and independent corroboration of government data was unlikely or impossible. When investors and traders have difficulty getting information, markets are more prone to rumors and misinformation. Greater volatility results.

Tough Battle Ahead

Faced with deep and intractable problems in putting their economic and financial houses in order, East Asian economies have a difficult uphill battle. Most will seek to cut prices to export their way out of their predicaments, but other producers both in and outside of the region will contest their traditional markets. Meanwhile, foreign investors will impose higher standards before committing funds to East Asia.

The shared aspects of East Asia’s political culture created flaws in the institutional infrastructure of the “miracle” economies. Consequently, they were ill prepared to withstand the external shocks generated by inevitable global capital flows. The rigidity of conservative political institutions led to policies that interfered with the self-adjusting mechanisms of local economies. While restoration of stability in the East Asian economies will be difficult, the slow pace of institutional change will make recovery an even longer process. Indeed, it may take a generation before some East Asian economies can achieve the institutions required for the sustainable economic growth demanded by the increasingly efficient global capital market.