Global Policy Forum

Market Discipline/Fundamentalism Meets
Developmental/Crony Capitalism

By Charles Tanzer

Introduction

The decision by the Thai Government on July 2, 1997 to devalue the baht is widely perceived as the start of the Asian currency and financial crisis. What began as a seemingly minor downward adjustment in the currency peg of a small Southeast Asian economy quickly evolved into a crisis involving emerging markets from Asia to Russia to Latin America. The damage to the real economies of the affected countries, the effects on employment, production and economic and social standards have been nothing less than disastrous. A corollary to the financial crisis has been the "intellectual" crisis taking place within academic and policy circles concerning the causes of the Asian financial crisis and the necessary adjustments needed in the global financial architecture.

What is clear is that a new phenomenon in the financial world had led to rapid growth in several poor countries, and virtually overnight this growth had been reversed and the lives of millions of people adversely affected. The result has been a scramble in intellectual and policy circles to analyze and explain the crisis, as well as a flurry of proposals for how to reform the global financial system currently in place. Institutions such as the IMF, which figured prominently in the crisis response, have been at the center of this debate, as its role as a lender of last resort has been widely questioned. Along with this, many have begun to question the role played by large institutional investors such as hedge funds in the currency crisis, and more generally the effect that unregulated capital flows can have on the stability of the world financial system.

It is equally clear that the outcome of this debate will have far-reaching implications for millions of people around the world, but particularly for those in the developing world and East and Southeast Asia. The numbers here tell the story. The Indonesian Government's Bureau of Public Statistics estimates that as result of the economic crisis, the number of poor people grew from 40 to 50 million people between 1996 and 1998, bringing the percentage of the country living in poverty (defined as earning less than $1 per day) from 19 to 24.2%. The poverty incidence in Thailand, according to World Bank Estimates, grew from 11.4% in 1997 to 12.9% in 1998 (based on $2/day), but more importantly the change in average standards of living in Thailand was -13.6% between 1997 and 1998. In South Korea, the urban poverty rate grew from 8.6% in 1997 to 19.2% in 1998, and the average standard of living declined -21.6%. (World Bank Poverty Update, "Trends in Poverty," p.3).

As the magnitude of the crisis becomes clearer, the world has begun to realize that financial markets and the structure or architecture of the international financial system are of tremendous import to the lives of people across the globe. The decisions made about the new financial architecture, most likely taken in closed sessions among finance ministers in the industrial nations with some input from developing countries, should be of concern to everyone in the developing world, and particularly to the people of East and Southeast Asia (and Latin America and Russia) who have experienced firsthand the "punishment" markets can inflict on small or developing economies. Conferences on the need for greater transparency, enhanced risk- management practices, prudential banking regulations, or the need for controls on the flow of global capital should not remain esoteric topics to be discussed and hashed out by the "experts" in the world of finance and public policy. Rather, as subjects which are of central importance to us all, they should receive the fullest open and participatory debate possible.

As one observer has noted, when financial markets "adjust," the burden of adjustment falls disproportionately on workers in both debtor and creditor countries. (Levinson, p.49) It is not the young Wall Street or City of London currency traders who must shoulder the burden of crises in emerging markets, but the poor of Asia, Latin America and Africa. For this reason the shape the new architecture takes will be of tremendous importance to the world for many years to come.

This paper will attempt to analyze some of the various proposals for a new global financial architecture. There are several key areas that will be examined. One is the initial IMF response to the crises and the motivations behind its policy prescriptions, including what many see a confluence of powerful economic and political interests united in favor of certain policy reforms. A second is the difficulty developing countries face in maintaining the "confidence" of financial markets, and how this led to the abandonment of Keynesianism in the initial stages of the crisis. Exchange rate and capital flow policy will also be briefly examined, with a recommendation for floating exchange rates as generally preferable to fixed rates. However, this is made with the caveat that even floating exchange rates may not be enough to ensure stability in developing economies. This is due to the fact that financial markets and investors view "advanced industrial" versus "developing" countries in different ways, and floating exchange rates may not be sufficient to prevent financial meltdown in emerging markets. Another important proposal that will be considered is that of an Asian Monetary Fund, first put forth by Japan in 1997. This will be given serious consideration, and despite the formidable obstacles to the actualization of such a fund, it is wholeheartedly endorsed by this author as a way for Asian countries to take greater control of their own economic destinies. Capital controls will also be addressed, with the recommendation that they be regarded not as a threat to the financial world, but as a tool that can be useful for countries that have the administrative capacity to implement them and the political will to employ them properly towards the goal of maintaining relatively stable exchange rates. A final subject to be examined is that of hedge funds and their role in the crisis. The recommendation is that there be much greater regulation and supervision of these highly leveraged, opaque institutions due to their capacity to inflict severe shocks not only to emerging market economies but the entire global financial system.

The guiding theme throughout the analyses will be a focus on the long-term implications for development in the South that each of the proposals implies. The role of the new global financial architecture and the expanded role of the IMF are no longer about buffeting short-term exchange rate fluctuations and preserving international macroeconomic stability. They have come to encompass the future prospects for development for a large portion of the world's poor, and as such should not be relegated to obscure discussions on the need for inclusion of non-acceleration clauses or majority-voting in bond and loan contracts. While these are important details, the bigger picture should not be lost behind the economic jargon. And that is that liberalized financial markets in countries with underdeveloped financial sectors or poor technical capacity can be a recipe for disaster. The problem is that there are no easy solutions to the dilemma of global finance, and there is a great danger of thinking in terms of a "one size fits all" solution for how to regulate global finance in the developing world. The capacities of states vary tremendously between countries and regions, and their institutional capacities vary accordingly.

An illustration of the dangers of applying a universal solution to countries with varying economic structures and institutional capacities is the debate over capital controls, a topic which will be examined in greater detail in a later section. Some have proposed capital controls in one form or another as a way to control the risk/volatility of short-term capital flows, and many countries, including Malaysia and Chile in recent years, have instituted these. But as Moises Naim, former Venezuelan Minister of Trade and Industry, said at a recent World Bank Conference on Emerging Markets: …many of these countries that are being advised to set up a bureaucracy to control currency transactions… are countries that have a very hard time collecting their garbage or distributing their mail. So if you have states…that have not figured out how to get organized to collect garbage or deliver the mail, imagine how they are going to get organized to deal with foreign exchange transactions and derivative instruments, forwards, options and all that. (Moises Naim, p. 13)

The greatest mistake would be to hold blindly to the belief that liberalized financial markets, whether done sequentially or rapidly or in any other order, will necessarily lead to greater economic growth and social development. Market "discipline" is a social construct of certain interests, and to apply it unilaterally in binding international laws or institutions would be wrong. Perhaps the Asian brand of "developmental" capitalism as defined by the academic Robert Wade and others is fundamentally incompatible with Anglo-American style capitalism. Whether this is true or not, there are clear differences between the two systems, and we must not resort to neoclassical economic dogma when seeking solutions to the current crises. As widely noted by trade economist Jagdish Bhagwati and others, the empirical evidence for economic growth as a result of liberalized finance, as opposed to trade, is severely lacking. This should be kept in mind before we rush to deregulate, further liberalize, and remold the economies of developing nations on the basis of an Anglo-American model with dubious foundations.

Background to the Asian Crisis and Conflicting Analyses of its Causes

In the late 1980s and early 1990s, many of the crisis-hit countries in Southeast Asia took steps to liberalize their capital account and generally deregulate their financial sectors. As a result, the flow of international capital crossing borders daily increased tremendously, to the extent that over $1.2 trillion dollars crosses the global wires each day. (Martin Wolf, The Financial Times, 3/3/98, p.16) Much of these capital flows were in the form of short-term lending from the advanced industrial nations to the developing world, in recent years particularly to Southeast Asia. For the first time, Western and Japanese banks were allowed to lend heavily to banks and firms in the region, as the stock markets, banking sectors and currency markets of Southeast Asia opened their doors to a flood of global capital.

However, certain countries began to run persistently high current account deficits, particularly Thailand, and this combined with the decreasing competitiveness of Southeast Asian exports due to the Yen depreciation and over-investment in unproductive or non-tradable sectors of the economy led Northern investors to become wary of their exposure in the region. Several preliminary speculative attacks on the Thai currency also contributed to the doubts about the soundness of its currency peg. Regardless of the reasons, and they have been much debated in the last two years (contagion, herd behavior, structural domestic weaknesses, "crony" capitalism), what is clear is that an unprecedented outflow of capital occurred in the primary countries of East and Southeast Asia, leading to severe depreciation of their currencies. What was a net inflow of private capital of $93 billion to East and Southeast Asian economies (Thailand, Malaysia, Indonesia, Philippines, and South Korea) became a net capital outflow of $12 billion in 1997, a swing in the net supply of private capital of $105 billion in only one year. That accounts for 11% of the pre-crisis GDP of the five affected countries, a tremendous change that is three percentage points higher than the corresponding figure for Latin America during the early 1980s. (Robert Wade, World Development, Vol. 26 No. 8, August 1998 p. 1543).

This in turn led to huge increases in the debt obligations of Asian firms that were heavily leveraged with unhedged dollar-denominated debt; many firms were bankrupted, employees laid off, and hundreds of banks quickly approached insolvency. Poverty in the region increased dramatically as a result, the financial crisis quickly spread to the real economy of the countries, and the gains in social development that had been attained in countries such as Indonesia, Thailand, South Korea and Malaysia were set back tremendously, although the incidence of poverty and the figures on employment cited in the introduction are of course somewhat contentious.

Within this context, one can discern two broad schools of thought regarding the causes of the Asian (and later Latin and Russian) financial crises, and these two explanations for the crises also translate roughly into the different proposals put forth for how to restructure the financial architecture. One school of thought, the "micro" school, sees the crises as a result of poor corporate governance and bad macroeconomic policies. The second school of thought, the "flows" school, recognizes the importance of governance issues but sees the real problem as imperfections in capital markets and the herd behavior of portfolio investors. The first school of thought advocates that emerging market governments practice better corporate governance, banking supervision, and create more transparent capital markets. The second school believes that these measures will be useless unless the greater problem of leveraged, short-term flows is not addressed. (Brian Caplan, Euromoney, Feb.1998).

There are as well several other interpretations of the crisis and proposals for the future. Some of these look to the political and economic interests behind the various reform proposals, and see a push by the "Wall Street-US Treasury Complex" (Jagdish Bhagwati, Foreign Affairs, May/June 1998) to open capital markets in Asia for the benefit of institutional investors and large corporations and banks in the West. Others see the crisis fundamentally as one of overproduction in the world economy, and predict a return to depression economics in the future. Still others believe that regional currency blocs and financial institutions are a way to prevent future crises, and Japan at one point proposed the creation of an Asian Monetary Fund so that Asians themselves could deal with future financial/economic crises that may arise in the region. All of these proposals will be examined in the following paper, with emphasis placed on the political economy aspects of the ideas, and the interests that lie behind them.

The Asian/Emerging Markets Crisis and the IMF Response

It follows from the previous analysis that whichever school of thought one belongs to in terms of the reasons for the financial crisis (the "micro" or "flows,") this will translate neatly into the recommendations for action one proposes for crisis hit countries. In the case of the IMF, clearly it is of the belief that the crisis is largely a result of domestic and structural weaknesses in the afflicted economies. The rescue packages of $17 billion (Thailand), $43 billion (Indonesia), and $57 billion (South Korea) came with a string of conditions that reveal the policy biases of the IMF. And when one speaks of the IMF, there can be little disagreement that the predominant influence within the organization is that of the United States, particularly that of the US Treasury and several key players within it.

So what then were the conditions of the IMF-led bailout of the three countries, and the goals behind them? One of the major demands was for greater fiscal austerity, a policy the IMF almost universally calls for in countries hit by short-term balance of payments crises. Austerity in Asia involved the goal of restricting domestic demand through the use of higher interest rates, lower government spending, and increased taxes. The objective was to stabilize the currency, facilitate the repayment of foreign debts, and in the longer-term send a signal to the financial markets that the countries were committed to reducing their current account deficits, and to stem the hemorrhage of capital flight by both domestic and foreign investors. The second objective of IMF policy in Asia to date has been to liberalize the financial, banking, and labor markets in the crisis-hit countries in return for its rescue packages. In particular, there had been for a time an emphasis on full liberalization of the capital account, (Robert Wade, Foreign Policy, Winter 1998-1999), although as mentioned previously this has been tempered recently to allow for "prudential" liberalization of the capital account.

The official rationale behind these objectives, in the policy circles of Washington and elsewhere, is that free markets and the free flow of capital will in the long-run bring benefits to the developing nations that embrace this system, as they can tap the savings of the wealthy to finance their investment. Michel Camdessus, Managing Director of the IMF, has expounded on the theme of free markets as the engines of growth throughout his tenure. Speaking in Seoul, South Korea, on May 20, 1999, in a speech before the 34th South East Asian Central Banks Governor's Conference, he said: …your clear acceptance of open competition as a condition for progress…is impressive… even when faced with such a severe recession, most countries have eschewed protectionist policies. You have recognized, correctly, that the strong growth of the past decade was promoted by the progress of open trade, investment, and payment regimes. This necessary, if not sufficient, condition will need to remain at the heart of your economic thinking and lay the groundwork for future progress. (Michel Camdessus, Speech entitled Sustaining Asia's Recovery from Crisis, Seoul, Korea, May 20,1999 p.4)

Later, in a speech in New York before the Council on Foreign Relations on June 4, 1999, Mr. Camdessus addressed more specifically the question of liberalized capital flows. Capital flows have been central to both the tremendous advances of the past decade as well as the crises. The international community has been considering whether to extend the IMF's mandate to incorporate capital account liberalization in its purposes….indeed, in Hong Kong, at the IMF's Annual Meetings in 1997, the international community acknowledged that "[it] is time to add [this] new chapter to the Bretton Woods agreement." (Camdessus, speech entitled Global Financial Reform: The Evolving Agenda, June 4, 1999 p.3)

In the same speech Mr. Camdessus went on to say that, "the crisis, of course, gave rise to second thoughts on this matter but in fact only one country resorted to capital controls…in this light, as the crisis recedes, it is now time to proceed." He went on to mention that of course liberalization should be done in a orderly, judicious fashion, financial system need better supervision, creditor nations need to pay more attention to risk-managment, and the rest of the by now familiar platitudes concerning adherence to Basle Capital Adequacy ratios, transparency and the like. The message was clear: capital account liberalization is the goal of the IMF, along with provisions to allow foreign ownership of Asian banks, corporations, and general greater market access on Western terms.

A similar theme was echoed by Mr. Alassane D. Ouattara, Deputy Managing Director of the International Monetary Fund, in a speech in Berlin on June 9,1999 before the Foundation for International Development. He said: I think we all agree that there can be no successful development without good economic policies. A broad consensus has developed among policy makers over the past few years on the basic elements of such policies. First, macroeconomic stability (sound fiscal policies, a prudent monetary stance, and appropriate exchange rates) aimed at achieving low inflation and facilitating growth. Second structural reforms to remove bottlenecks and enhance the efficiency of resource allocation, liberalize market access, foster trade and investment and create a propitious environment for private sector development as the principle vehicle for growth. (Alassane D. Ouattara, Speech entitled The Political Dimensions of Economic Reforms-Conditions for Successful Adjustment, Berlin, Germany, June 9, 1999 p.2)

As a specialist and expert on Africa, Mr. Ouattara, acknowledging that Africa had largely been left out of the boom in financial capital flowing to the developing world, spoke of the need for African countries to more fully integrate into the global market place so they could greater enjoy the benefits of exposure to international competition and private capital to finance the investment that "Africa needs so desperately to accelerate growth." But in a departure from typical IMF discourse, he also said that :
since economic policy is not an end to itself…policymakers must always ask themselves whether their decisions advance social development. This question must guide the debate over the objectives of policy, and decision makers must never lose sight of the social dimensions of the policies they advocate. (Ouattara, p.2)

This atypical statement was likely well received by a development foundation in Europe, but unfortunately it does not seem generally reflective of the IMF's policies with regards to the conditionality of its agreements in the wake of the emerging markets crisis. In essence, what may play well in Berlin does not really carry much weight in Washington or at the US Treasury.

Finally, to round out the official consensus by the economic elite, academia, and policy makers on the desirability of further capital account liberalization and the need for rigorous implementation of market "discipline," we have an editorial in the Jakarta Post by Christopher Lingle, a corporate consultant and adjunct scholar at the Centre for Independent Studies in Sydney. Decrying the Malaysian "experiment" with capital controls, he writes: If the government were truly concerned about dealing with exchange rate uncertainty or capital outflows, controls are unnecessary. Markets provide a more efficient way to do the same thing. For example, market competition led to the development of financial derivatives as a mechanism to minimize exposure to financial risks. (Christopher Lingle, Jakarta Post, August 9, 1999)

The statement that markets are more efficient at dealing with exchange rate uncertainty seems baffling in the wake of the Asian currency crisis, yet it reveals the fervor with which many in the economic mainstream and academia believe in the "one size fits all" policy of open markets for all countries across all sectors and industries of an economy. As for the notion that Malaysia's capital controls are an "experiment" or an anachronism, this is rather dubious as well. The industrial nations of the world employed capital controls frequently from the end of World War II until the mid-1960s, and several European nations, including Portugal and Ireland, did not resort to full capital account convertibility until the early 1990s. (Jagdish Bhagwati, "The Capital Myth," Foreign Affairs, May/June 1998, p.10) As the noted economist Paul Krugman, referring to the "first class" industrial nations of which Brazil had aspired to become one, said, "most of those 'first class' nations had capital controls themselves for a generation after World War II; they became prosperous and then opened themselves up to free capital movement." (Krugman, Depression Economics, p.166) Finally, to assert that financial derivatives minimize exposure to financial risk seems to fly in the face of empirical evidence, especially in the wake of the Long -Term Capital Management debacle in the United States. (Wade, Foreign Policy Winter 1998-1999; Henwood, Wall Street, p.41 -42).

The above statements reflect the views of much of the mainstream academic and policy community regarding the IMF's response to the crisis, the proper form of the future economies in Asia, and the slant toward market "fundamentalism." However, there are critics of this model, those who feel the IMF's response to the crisis was misguided, that it's market-based policies to promote growth are often ill-planned and ill-informed, and that there are certain interests behind the models promoted by the IMF and others. They also feel that financial markets are often irrational in their assessment of countries, and that there is a bias towards First World nations. The next sections will deal with some of these themes.

The Abandonment of Keynesianism and the "Confidence" Problem in Financial Markets In the advanced industrial world, including the United States, Europe, and Japan, when an economic crisis or recession hits, a country is quick to deploy the classic tools of Keynesian economic policies. These include lowering interest rates, increasing government (deficit) spending, lowering taxes and increasing the money supply as necessary, despite possible inflationary fears. However, in Asia the situation was reversed. The IMF demanded a reverse of typical Keynesian policies despite their usual effectiveness. These included raising interest rates to astronomical levels, raising taxes, and cutting government spending. All of these measures would seem to guarantee a recession in the countries pursuing these policies, yet one after another they pursued this fiscal austerity. The official reason economists at the IMF demanded such policies was to stabilize the exchange rate, and unofficialy it was also due to "fear of speculators." (Krugman, p.104) The question then that must be asked is why the IMF imposed the inverse of traditional Keynesian policies in Asia. And this leads to what economist Paul Krugman calls the "Confidence Game." With Southeast Asian economies so heavily exposed to short-term, unhedged dollar-denominated debt, the need to "reassure" markets was the most important goal of the IMF. This led it to demand policies that made no sense in terms of traditional economic fundamentals, but were perfectly rational in the sense of trying to win back that mythical "market confidence." In explaining the inverse-Keynesian policies pursued by the IMF, Krugman says:
And that is how the Keynesian compact got broken: international economic policy ended up having very little to do with economics. It became an exercise in amateur psychology, in which the IMF and Treasury Department tried to persuade countries to do things they hoped would be perceived by the markets as favorable. No wonder the economics textbooks went right out the window as soon as the crisis hit. (Krugman, p.114)

The Trilemma of Capital Flows and Exchange Rate Policy

Macroeconomic planners generally have three goals when deciding capital flow and exchange rate policy. One is to preserve discretionary monetary policy, to fight inflation and combat recession. A second is to have fixed, stable exchange rates so that businesses, particularly those that sell in export markets or depend heavily on imports for their exports or domestic products, are not faced with too much uncertainty regarding the costs of foreign exchange. A third goal, if a country hopes to attract international capital and financing, is to allow free capital flows. This is done primarily to reassure businesses and investors, both domestic and international, that they will be able to pull their money out of a country should they begin to doubt the soundness of its economy.

It is generally considered an economic rule that one cannot have all three goals simultaneously; you cannot have fixed exchange rates, free movement of capital, and discretionary monetary policy at the same time. A government can abandon fixed exchange rates, employ a float (or crawling peg, or numerous other variations) and allow free capital movement. The benefits of this are that discretionary monetary policy can be used. The downside is that it may severely decrease the likelihood of attracting international investment and lending, as floating rates imply less security for international investors. In Southeast Asia, prior to the crisis, the general policy was to have stable, fixed exchange rates and free movement of capital, at the expense of discretionary monetary policy. However, as the crisis unfolded, it became clear that free movement of capital could also be a dangerous thing. The immense capital outflows put tremendous downward pressure on the currencies of the region, forcing governments to devote all their monetary resources to maintaining what were ultimately unsustainable exchange rates. This is what prompted Malaysia to impose capital controls, to stem the flow of foreign capital and stabilize the exchange rate. Investors may have been scared off by Malaysia's policies, but the economy of Malaysia as of current writing does not seem to have suffered from these policies, and moderate growth is projected for the next fiscal year. This recalls the point that a rigid economic dogma of "one size fits all" is not the best way to manage an economy, and that in some cases capital controls can be a valuable tool. (This will be dealt with further in a later section.)

In the wake of the Asian crisis, the consensus among most economists is that floating exchange rates are the best option for developing countries. The currency pegs of Southeast Asia were perhaps valuable at one point in preserving a stable business climate and attracting foreign investment. However, by the time of the Thai devaluation many investors had come to feel, for reasons explained earlier, that the currencies of Southeast Asia were highly overvalued and the exchange rates unsustainable. In hindsight, many have said that if the exchange rates were allowed to float earlier, their would have been a slower and gradual adjustment in each economy, and the deep and prolonged length of the crisis would have been averted.

Of course, with a floating exchange rate, some would argue the economies may not have received the immense influx of foreign capital that they did during the 1990s. But as we have seen, these same capital flows were one of the primary causes of the crisis, from which the countries are only now starting to recover from. Overall, therefore, floating exchange rates are probably the best choice for developing nations if they are to be integrated in world financial markets given the constraints they face. While this may not draw in the amount of foreign capital desired, as mentioned previously there is little empirical evidence to show that free capital flows lead to or are necessary for economic growth. It may not be a coincidence that countries such as China, which has capital controls, and Taiwan, which has informal controls, have been relatively unscathed by the crisis. So if a country, having already decided it will allow free capital flows, is forced to choose between fixed and floating exchange rates, it would seem that floating rates are the best choice in the long-run. However, there is a problem even with this, as we shall see in the next section, as floating exchange rates do not always "work" as well for developing nations as they do for advanced industrial ones.

The Problem with Floating Rates and the Financial "Double Standard"

A complement to Krugman's critique and one that this author finds quite convincing is that of the "Double Standard" of financial markets. He cites the example of Australia, which has run persistent current account deficits of over 4% for decades and is highly dependent on foreign capital. When the Australian dollar declined by 20% in 1996, Australia did not attempt to prop up its currency, and in fact investors saw this as an opportunity to invest cheaply in the Australian economy and increased their exposure in the country. This is because they perceived Australia as politically and economically stable. And as we have seen in Asia, perception is all that matters when it comes to market confidence, regardless of the economic fundamentals of the real economy of a country. How else to account for the disastrous capital flight in Indonesia, a still largely poor rural developing nation, being followed by massive capital flight in South Korea, an urban, industrialized nation with the world's 11th largest economy. There are very few similarities between the two countries, they are geographically far apart, and their economies bear very little resemblance to one another. But they are both perceived as Asian and developing, whereas Australia is a solid member of the First World club in the eyes of financial markets. Yet in both countries, the devaluation and float of the exchange rate led to a massive flight of capital out of Asia. Krugman accounts for this in the following way:

…floating exchange rates do work pretty well for First World countries, because markets are prepared to give those countries the benefit of the doubt. But since 1994 one Third World Country after another-Mexico, Thailand, Indonesia, Korea, and, most recently, Brazil-has discovered that it cannot expect the same treatment. Again and again, attempts to engage in moderate devaluations have led to a drastic collapse in confidence…it is this problem of confidence- a problem that Asians used to think did not apply to them, but which now clearly applies to all Third World Countries-that ultimately explains why the Keynesian compact has been broken. (Krugman, p.111)

If one is to take Krugman's analysis as valid, and there are surely many who will disagree, then the issue of a developing nation's integration into world financial markets is one that must be considered seriously by a government before it allows full capital account liberalization. If emerging markets (read developing countries) are all to be grouped together in the minds of investors, the implications are that a country with a fundamentally sound economy may suffer a serious recession because of events over which it has little control and that are unrelated to its own economic situation. This should give pause to those who would advocate that further integration into world financial markets by developing countries is a necessary precondition for growth. In some cases capital flows can be extremely beneficial, but there is no such thing as an axiom for growth in terms of financial market liberalization. Floating exchange rates may be the best option for one country, while capital controls may be necessary for another. If the IMF, US Treasury, or anyone else really had an answer for what works best, then there would be Nobel Prizes all around. In the absence of this, current economic orthodoxy concerning developing nations, capital account liberalization and financial markets should be regarded with a good deal of skepticism.

The Argument for a Wall Street-Treasury-IMF Complex

Some scholars, most notably international trade economist Jagdish Bhagwati of Columbia University and political scientist Robert Wade of Brown University, have argued that there are certain politico-economic interests that coincide to push for capital market opening in Asia, and that they have used the crisis to get a foot in the door. The essence of this argument, as laid out by Wade, is that The United States sees free capital movements as a wedge that will force other economies to move in its direction. Indeed, the Asian crisis is dreadful confirmation that financial liberalization and capital account opening make it more difficult to sustain the long-term relationships and national industrial-policy arrangements that have prevailed in the Asian political economy. In other words, there is a powerful confluence of interests between Wall Street and multinational corporations in favor of open capital accounts worldwide. (Wade, Foreign Policy, p.47)

He goes on to outline the argument in further detail, stating that the US Treasury has led a campaign to pressure the IMF to include capital account convertibility as a condition of Fund membership. Along with this, he includes the World Trade Organization's financial-services agreement, which commits countries to open their banking, insurance, and securities markets to foreign firms. According to Wade's analysis, before the crisis many countries, especially in Asia, had opposed the agreement in negotiations. But after the Thai crisis, Asian leaders felt they had to sign the agreement or US and IMF help in dealing with the crisis would not be as forthcoming. (Wade, Foreign Policy, p.48)

It is an interesting argument, and one that has gained some adherents in Western academic circles. Wade further makes the case for Asian "developmental" capitalism as being fundamentally different than Anglo-American capitalism. Included in this is the fact that Asian corporations tend to operate with much higher debt-equity ratios, and that the closeness between governments, firms and banks is a large reason for the tremendous economic success of the East Asian Newly Industrialized Economies (NICs) [Taiwan, South Korea, Singapore and Hong Kong], and the success of the "New NICs" [Thailand, Indonesia and Malaysia.] All of this is in one way or another based on Japan's model of state-led capitalism, in which the government, particularly the Ministry of International Trade and Investment (MITI) and the Ministry of Finance, played a guiding role in Japan's economic development. This included targeting certain industries and sectors and providing them with subsidized credit and soft loans, tying credit to export quotas, and funding research and development for "rising" industries. It is not a new story, and falls under the familiar heading of Japan, Inc. Only now, in Wade's analysis, what had worked for over 30 years in East Asia has gone from "developmental" to "crony" capitalism in the eyes of Western observers. There is, to use his words, a "Big Push" by Western economic interests to dismantle this system and gain greater market access and control in the region.

Well, it certainly is an interesting argument, and one that at least on the surface appears to have some merit. It is doubtful that there is any "conspiracy" to destroy or recolonize Asia, as Malaysian Prime Minister Mahatir has suggested. More likely what is happening, if this analysis is correct, is economic realpolitik being practiced by the US and other Western powers, and it should come as no surprise to those who follow trade and economic issues closely. However, there are who disagree with this thesis, and who maintain that "crony" capitalism was and is a serious problem in the Asian economies, one that led to inefficiencies and structural weaknesses in the economies that were bound to surface sooner or later in the form of slower growth or recession. The Asian crisis, goes this line of thinking, merely brought to light sooner than expected these problems, and with greater financial liberalization and much-needed economic restructuring occurring in the region, the economies in the end will be better off. They will be able to reap the benefits of Western accounting, banking, managerial and technological practices as more and more Western banks and firms enter the securities, corporate, banking and industrial sectors of Southeast Asian countries. < p align=justify> So, which is the correct argument, and is there a case for a "complex" of any type? It would appear that certainly the US and others are using the crisis to conduct economic realpolitik and reassert control in Asia. Regardless of whether or not the growth that occurred in East Asia over the last 30 years, and over the last decade in Southeast Asia, was based on "crony" or any other type of capitalism, there is no denying the tremendous gains in living standards that were experienced by millions of people in the region. Did corruption exist? Of course it did. There was even outright looting by some political leaders, and bribery, favoritism and preferential treatment were the order of the day. But this does not negate the progress that was made, and certainly does not inherently imply the need for a wholesale restructuring of each economy along Western lines.

An example of the current dogmatic view concerning Asian economic restructuring can be found in one of the proposals by Barry Eichengreen in his new book Toward a New Financial Architecture: A Practical Post-Asian Agenda, written at the Institute for International Economics, a prominent American economic think tank. In the opening salvo of the book, which is extremely broad and diverse in its sweep, he makes the following statement, from which all his other recommendations follow:
…liberalized financial markets have compelling benefits. They encourage savings mobilization and efficient investment allocation while allowing consumption smoothing and portfolio diversification….the days when the East Asian governments could "pick winners" simply by following the Japanese example-allowing them to minimize the role of the market mechanism-are long past. (Eichengreen, p.2)

From this analysis comes what Eichengreen terms a "practical, pragmatic" post-crisis financial architecture. Chilean - style capital inflow taxes are considered as a viable option, outflow taxes are dismissed as damaging and impractical, and the idea of regional monetary funds is dismissed, along with proposals for an international bankruptcy court or the famous "Tobin Tax" on international currency transactions.

What Eichengreen has done is to present what many in the West consider the practical, best option for Asia in the wake of the crisis. The nature of liberalized financial markets and the question of whether they actually contribute to growth is never fundamentally questioned. The more radical proposals are dismissed as impractical or utopian, and in general the US and IMF view is reflected in his writings. However, if one is to consider the view of dissenting scholars such as Wade and others, then some of the "practical" proposals made by Eichengreen do not seem so attractive. For example, one proposal, raising capital adequacy standards for lending to borrower banks in developing countries, appears to have a great deal of support in the West. Eichengreen also urges the IMF to allow private-sector international bodies, such as the Basle Committee on Banking Supervision (made up of supervisors from the leading industrial countries), to develop and promulgate international banking standards. (Eichengreen, p.23) According to Wade and others, however, Asian corporations tended to work on high debt-equity ratios. Concerning Korea, he writes:
Meeting Western standards for the adequacy of banks' capital entails a rapid fall in banks' debt/equity ratios and a sharp cut in their lending, causing more company bankruptcies…whole swathes of the corporate sectors of the region are being offered at fire-sale prices, and only outsiders have the capital to buy them up or to recapitalize existing banks. We may be in the early stages of a massive transfer from domestic to foreign ownership. This is not just a transfer of control and profits; it will affect the basic dynamic of the economy. Foreign banks may not lend to high debt/equity local companies, and may not participate in the kinds of alliances between government, the banks, and companies that a high debt/equity financial structure requires. (Wade, World Development, p.1544)

So in this case, what at first might appear to be practical and pragmatic proposals to restructure banks and banking practices along Western lines becomes problematic if one believes that it is the precise nature of the Asian style of "alliance capitalism" and bank industry cooperation that led to its remarkable growth in the first place. The same can be said for many of the mainstream and IMF proposals concerning the securities, insurance, and corporate sectors of the economies, as well as the proposals to make labor markets more "flexible." It is well know that this is a codeword for facilitating the ability of corporations to fire more workers and set hours, wages, and terms of employment according to "market dynamics," all of which are necessary to compete in the new global marketplace, as we are told again and again by corporations and financial media around the world.

In essence, what has become the mainstream consensus in many Western policy circles is that while financial markets may have their flaws, they are the best way of allocating capital, and with a little adjustment to bring Asian and Latin systems in line with Western standards, everything will work out. But as Jerome Levinson, professor at American University in Washington DC and former Chief Counsel and Staff Director of the U.S. Senate Subcommittee on Multinational Corporations and United States Foreign Policy, states in a recent article:
The uncritical faith in the superiority of the unregulated market in efficiently allocating capital is unmatched by empirical experience. The syndicated bank lending of the 1970s was driven as much by internal bank dynamics-place the money and the repayment prospects be damned approach-as considerations of creditworthiness or efficient use of resources. The emerging market syndrome of the early 1990s, which resulted in the Tesobono fiasco and the Mexican financial rescue, is a tribute to the triumph of greed, ignorance, stupidity and arrogance over common sense. (Levinson, p.39)

If we are to take seriously these critiques of the Western and Wall Street views of the efficacy of financial markets and the interests behind them, then the question naturally becomes, what have been some of the counterproposals? The World Bank, in its controversial 1993 report entitled The East Asian Miracle, praised the economic growth of the crisis-hit Asian economies and acknowledged the role of state intervention in their success. Six years later this growth is being dismissed as a facade. Yet if there was in fact a "miracle" in growth and development in the region, and if this was based in large part on a system of Asian capitalism fundamentally different from the Anglo-American model, then what have been some of the proposals put forth by Asia to deal with the crisis on its own terms? We now turn to the subject of a regional, or in this case Asian, Monetary Fund.

The Proposal for an Asian Monetary Fund

In July 1997, as the Asian crisis began to unfold and the regional currency collapses were threatening to turn into financial and real economy collapses, Japan stepped forward with a proposal for a $100 billion standby reserve fund for Asia, in essence suggesting the creation of an Asian Monetary Fund. As is well known, the US Treasury and the IMF quickly shot down this proposal, insisting that the IMF take the lead role in Asia. China also had objections, and the idea was eventually dismissed by the financial powers that be. However, there is a compelling argument to be made concerning the need for an Asian Monetary Fund, and the subject therefore merits serious attention by those who are truly interested in seeking a solution to Asia's dilemmas.

The original proposal by the Japanese was for:,br> A fund that would function like the IMF, but in a more forceful and rapid manner, without the IMF-type conditionality clauses. This proposed fund was to be a multilateral revolving facility, involving other Asian countries, notably China, Hong Kong, Taiwan, and Singapore as well as Japan. It was to be backed by funds of $100 billion, drawn from the combined reserves of major Asian countries. (Mathews and Weiss, "The Case for an Asian Monetary Fund," Japan Policy Research Institute, March 1999 p.2)

On the surface the proposal would seem to make a great deal of sense. Regional integration in North America (NAFTA) has proceeded apace. The recent creation of the European Monetary Union in Europe and the introduction of the Euro and a single European Central Bank has been greeted with approval by the United States. The logical complement to this would be a regional Asian Monetary Fund to deal with the debt and currency problems in Asia, and which would play the role of coordinator of creditors and debtors for the region. As is well known, the combined foreign reserves of Japan, Taiwan, Singapore, China and Hong Kong are over $400 billion, and it would seem that in this case the Asian countries should be able to deal with their own crises, according to their own internal and regional preferences and arrangements. So why then was there such strenuous objection from the US Treasury and the IMF?

The public arguments by the IMF and the US Treasury against an Asian Monetary Fund (AMF) were that an AMF would in essence duplicate the functions of the IMF, but that without the conditionality clauses, the risk of "moral hazard" would be very high for Asian countries drawing from the Fund. (Mathews and Weiss, p.2) This is presumably because without conditionality on bailout loans, Asian countries, banks and corporations might recklessly invest in unproductive projects with the knowledge that the Fund stood by ready to bail them out without any serious penalties or unwanted restructuring of their economies.

However, other scholars and analysts of Asia see a different motive behind US objections. Indeed, these motives have been stated quite bluntly by C. Fred Bergsten, former US Treasury official and economist: Japan's proposals for an Asia-only "Asian monetary fund"…would exclude us from the most crucial area of cooperation with the world's most dynamic economies…The costs of any such outcome to the broad national security as well as economic interests of the United States, would play out over many years and could be huge. (Francois Godement, The Downsizing of Asia, p.46)

So once again we have what appears to be economic realpolitik being practiced by the US, under the guise of the need to avoid "moral hazard" in Asia. Chalmers Johnson, the widely noted analyst of Japan, has characterized the US reaction to the proposal in even greater detail, again revealing the level of distress and the reasons for it that we saw in the US at the time:
The Japanese…proposed a new multinational financial institution led by Japan and instructed to make loans to Asian countries. The Americans instantaneously objected, correctly sensing that Japan was about to try its hand at long promised but never delivered international leadership. If the Japanese had succeeded, they would have slipped the leash of the US Cold War system. Moreover, they would have started using their surplus capital to help countries in Asia rather than continuing to send it to the world's number-one debtor nation, the United States. (Godement, p.47)

As the above passages reveal, the true reasons for the strong US objection to the creation of an AMF are quite clear, and quite logical in terms of geopolitical and economic strategy. US objections aside, is there now a case for an AMF, and would it be able to deal with future crises in Asia better than the IMF as currently constituted? A recent paper by two scholars at the Japan Policy Research Institute makes a strong case for the need for an AMF. Their argument is based on three main points: 1. The European Monetary Union has already been launched, providing a clear precedent for financial cooperation to be undertaken at the regional level, and this has not been seen as a threat to world financial stability. 2. The IMF has failed the countries of Asia in its rescue packages, and according to many its response packages have turned what might have been a severe financial jolt into a protracted slump with lingering long-term implications for the real economies of the affected nations. 3. An AMF would provide an "effective remedy for Asian nations threatened with currency collapse or sudden financial dislocation through external forces. It would provide a collective financial security umbrella, through its provision of standby credits and its credible threat of intervening in currency or other markets to ward off speculative attacks." (Mathews and Weiss, p.2)

The three points made by the scholars are extremely strong, in this author's view. First, as mentioned previously, the European Monetary Union was launched successfully last year, and as the authors of the article note, it was even welcomed by the United States on the grounds that a "stable and prosperous Europe is good for America." (Mathews and Weiss, p.3) This begs the question that if a stable and prosperous Europe is good for America, why not a stable and prosperous Asia? As Chalmers Johnson correctly noted, the US is still largely able to call the shots in Asia, whereas Europe long ago, not without much difficulty and inter-country wrangling, decided to take control of its own economic destiny. Perhaps it is time that Asia also do the same.

The second point made by the authors of the above-mentioned article, that the IMF largely failed Asia and may have exacerbated the crisis, has already been discussed in this paper. Some believe the IMF initially misread the crisis and sent the wrong signals to financial markets by imposing austerity in Asia, thereby announcing that there was in fact a serious crisis and possibly contributing to a "self-fulfilling" or "self-validating" panic on the part of investors. Others, as noted previously, conclude that the IMF acted responsibly and made the right policy prescriptions in the face of a difficult situation. This author personally believes that the wholesale restructuring of East and Southeast Asia, based on IMF and US Treasury recommendations, often reffered to as the "Washington Consensus," is not the best route for Asia in terms of long-term development, and contradicts the policies employed in the region to achieve high growth in the first place. Regardless of this, the IMF was the one calling the shots during the crisis, and the full outcome of economic restructuring and its implications for growth and development is not yet clear, and probably will not be for several more years.

It is the two scholars' third point which is most interesting, and which seems the most powerful argument for an Asian Monetary Fund. Empirical evidence that direct, centralized intervention in currency or other markets can ward off speculative attacks and prevent severe and destabilizing currency depreciation already exists if one looks at the case of Hong Kong in August and September 1998. Paul Krugman, in his new book The Return of Depression Economics, details the story of how several large hedge funds, including George Soros' Quantam Fund, mounted an attack on the Hong Kong currency and stock markets, betting that either the Hong Kong dollar would be devalued, and they would make money on the currency speculation, or that the Hong Kong Monetary Authority would be forced to raise interest rates to defend the currency, which would drive down local stock market prices and they would make money off their short position in Hong Kong stocks.

However, the Hong Kong Monetary Authority, in a departure from its traditionally hands-off free market policies, responded deliberately on a massive scale by drawing on its huge foreign reserves to buy up a sizable portion of the local stock market, estimated to be between 6 and 10% of the total market. This forced up stock prices, and thereby caused the hedge funds, which had sold short, to lose a great deal of money. The hedge funds had reportedly raised somewhere on the order of $15 billion, and had assumed that Hong Kong had neither the political will nor the economic resources to fight off the attack. On that score they were wrong. (Krugman, p.128)

What this case illustrates is that it is possible for Asian economies to fight off currency or stock market speculative attacks, but that it was only possible for Hong Kong because of its huge amount of foreign reserves (nearly $100 billion) and its coordinated, centralized intervention in the stock market. A country such as Thailand or Malaysia, with much smaller foreign reserves, would normally be unable to do this. But if the East and Southeast Asian economies pooled their resources in an Asian Monetary Fund, there would be more than enough money to defend against any type of speculation, as well as the ability to work out debt restructuring arrangements on their own terms. Timely responses would be possible, and in this case the amount of foreign reserves available will ensure its viability, as opposed to other regional forums such as APEC or ASEAN, which were unable to effectively respond to the crisis in part due to their lack of economic resources. As the authors of the article note, an AMF would be able to act with "greater promptness and better scale intervention, so that a potential panic might be nipped in the bud."

This is not to say that there would not be coordination problems, as Mathews and Weiss point out in their article, and certain countries that are in competition with each other, and that have been traditionally hostile to each other (Japan, South Korea, China) would have much to smooth over to make such an arrangement economically and politically viable. But if it were achieved, the AMF would likely go a long way towards ensuring regional economic stability and autonomy in setting their own economic and developmental agendas for the countries of East and Southeast Asia.

An alternative proposal to the Asian Monetary Fund is C. Fred Bergsten's Asia Pacific Monetary Fund. (APMF) As Bergsten explains it, if the idea of an Asian Monetary Fund were elaborated upon to include the United States and several other countries, then an APMF "could provide a valuable regional complement for the International Monetary Fund in the same way that the Asian Development Bank …complements the World Bank." (Bergsten, "Reviving the 'Asian Monetary Fund," International Economics Policy Briefs, December 1998.) However, he makes clear that while APMF programs would respond to the desire of many Asians "for their own institution," an APMF would grant credits "only in conjunction with IMF programs, to maintain the primacy of IMF adjustment requirements."

Bergsten reasons that a regional AMF will not work without the US for three reasons. One is that no Asian country would accept any hint of Japanese domination, and the only other candidate for leadership, China, is not yet ready to play such a role. However, according to French scholar Francois Godement, this is untrue. He states that "several meetings in Asia had positively endorsed the idea, and several ASEAN countries clung to it even after Japan had stopped voicing the proposition publicly. (Godement, p.46)

Bergsten's second objection is that an "Asia only" grouping would "risk dividing rather than uniting the two sides of the Pacific." (Bergsten, p.2) Yet he voices no similar concern about "division of the Atlantic" when it comes to the European Monetary Union. And the third objection is that the United States could play a decisive role in making an APMF work because of its "willingness to speak much more frankly than most Asians, including to other Asians, at this time in history." (Bergsten, p.2) Aside from the condescending tone and the assumption that the US could act as a father figure or big brother to the quiet Asians, it is clear that what is really meant is that the Asians cannot, and should not, go it alone. Not only is this dismissive and ignorant of Asian capabilities, it also reveals the true motives of an APMF, which would be to ensure that the US maintains its leading role in the region.

As quoted previously, Bergsten has plainly stated the true reasons for opposition to an AMF, which are that it would exclude the US from the most dynamic economic region in the world and be detrimental to US economic and national security interests in the long-run. The proposed APMF would therefore do nothing to increase the autonomy of Asian countries to determine their own economic destinies, it would merely be an appendage of the IMF. It appears that the proposal is simply appeasement by the West to grant Asian nations some degree of control over their regional financial policies, while still being held to the conditionality imposed by the IMF. In this case, an APMF would be scarcely different from the IMF. If an Asian Monetary Fund is to work at all and function in a way that ensures a degree of financial and economic autonomy for the countries of Asia, then it must be composed of Asian countries only. Whether the political will and consensus exists in Asia to achieve this goal remains to be seen, but it would be a step in the right direction towards ensuring future financial and economic stability in the region.

The Dilemma of Capital Controls

Much has been said and written in the past two years about the benefits or dangers of the use of capital controls by a country to regulate international capital flows. As noted previously, capital controls are nothing new. Most nations in Europe and North America employed them until the mid-1960s, by which time they had achieved an advanced degree of industrialization. They then had the political, technical, and institutional capacity necessary, for the most part, to allow the free convertibility of their currency and liberalization of their capital markets. Even as late as 1992, several European nations had not fully liberalized their capital account, and restrictions remained on the convertibility of their currencies. Yet if one listens to the current rhetoric concerning capital controls, and the IMF's vehement opposition to them, one would think that capital controls are something from the 18th century, a form of feudal or mercantilist economics long since discredited. When Malaysia decided to impose controls on the outflow of capital in 1998, a firestorm of debate and protest was set off in economic policy circles. It is therefore instructive to examine more closely this debate, in part to demystify capital controls, and also to determine whether a case can be made for the use of capital controls by nations not only to stem rapid capital flight when faced with a panicked run on their currencies, but as a longer-term macroeconomic policy as well.

To begin with, there are several ways to implement capital controls. One is a tax on capital inflows, as Chile has used most recently. Another is a tax or control on capital outflows, what Malaysia has attempted to do in the last year. There are also other models as well, including the well-known "Tobin Tax," a tax to be levied on all short-term international currency transactions. The model that has received the most attention and met with the most approval in international financial circles of late is the Chilean-style inflows tax. This will therefore be examined in somewhat more detail.

International investors have long been attracted by the high interest rates offered by banks in emerging markets, and this has been the primary reason for their copious lending to developing countries considered to be rapidly growing economically. Many have said that a precondition for international investors' willingness to lend to developing countries is the knowledge that they will be able to "pull out" their money whenever they desire. Accordingly, a tax on capital flows of any type will deter international investors and result in less capital for promising developing countries to finance their development. So goes the typical economic-speak.

However, according to Eichengreen of the Institute for International Economics, a country should and can adopt Chilean-style capital inflows taxes if it meets four conditions. One is that the capacity of bank owners and managers to manage risk is underdeveloped, and the narrowness of domestic financial markets means that their mistakes can have severe systemic repercussions. A second condition is that inadequate auditing and accounting standards exist, and political pressure prevents bank capital from being written down. A third is that supervision and regulation of the banking system is weak. And finally, there exists a "culture of implicit guarantees." Under these circumstances, he notes, banks will tend to fund themselves excessively abroad, and foreigners will tend to readily lend to them. He suggests that capital-inflow taxes are the only effective way of containing this problem. (Eichengreen, p.50)

The conditions described above would certainly seem to apply to many of the Asian countries hit by the economic crisis. Had they had a capital inflows tax in place, perhaps their unhedged foreign exposure would not have been as large, and the crisis may not have been as severe as it turned out to be. Eichengreen believes that as emerging market financial systems mature, they can eventually abolish a capital inflows tax, as evidenced by the fact that none of today's advanced industrial economies employ such a tax. He goes on to note that because economic conditions in emerging markets are fundamentally different than those in advanced nations, it follows logically that they may need to follow fundamentally different policies. (Eichengreen, p.50) This argument seems quite rational, and the fact that it is being made by someone from a generally moderate, mainstream American think tank illustrates that at least in this arena, the wall of orthodoxy that enshrines the idea of full and free capital account convertibility as an axiom for growth in all countries may be starting to crumble, if only at the edges.

Another objection by financial interests, corporations, the IMF, Wall Street and mainstream academia to capital inflow taxes has been that it will raise the cost of short-term borrowing for emerging markets. This is precisely what it is intended to do. If distortions exist such as implicit guarantees for banks, excessive foreign lending will be encouraged, and a tax would limit this lending, thereby narrowing the gap between the private and social cost of foreign borrowing. (Eichengreen, p.51)

Naturally, any inflows tax creates incentives for evasion by both lenders and borrowers, and over time a tax may be more difficult to sustain. But the example of Chile shows that it is possible to achieve successful results without discouraging foreign lending. A study by Salvador Valdes-Prieto and Marcelo Soto (1997) of Chile's inflows tax found no impact on the level of capital inflows, but a significant impact on the maturities of the loans. This is precisely the goal, a lengthening of the maturity structure of foreign debt without a diminishment in the total amount of credit being supplied. (Eichengreen, p.51) (For a more in-depth discussion of the specifics of Chile's inflows tax, see Eichengreen, Towards a New International Financial Architecture.) The general mechanism was a deposit requirement such that all non-equity foreign capital inflows had to be accompanied by a one-year, non-interest bearing deposit. Between 1992 and 1998, the deposit requirement was 30% of the capital inflow. Since 1998, in response to a decline in world copper prices, one of Chile's major exports, the requirement has been progressively lowered. But the general goal, according to most observers, has been or was accomplished. And that is to reduce banks' excessive dependence on short-term foreign borrowing.

So, it appears that there is a case to be made for a Chilean-style capital-inflows tax. What about a tax on capital outflows or a Tobin Tax on all short-term international currency transactions? The idea of the Tobin Tax has been around for over 20 years, at various times in and out of vogue in academic circles. Some have called for the proceeds from a Tobin Tax to be used to provide debt relief to the most highly-indebted poor countries, and have claimed that within several years Third World Debt could be virtually erased. While the idea is inspiring, as a tool to control currency speculation and exchange rate instability the Tobin Tax is difficult to gauge. In theory it could provide a useful "slowdown" in destabilizing flows, particularly outflows in times of crisis, but to do this it would have to be significantly high enough to discourage those investors who want to "pull out at all costs." The existence of such a high tax might then discourage investment in countries that are financially sound and able to deal with large inflows or outflows. The more pragmatic argument against a Tobin Tax is that it is easily evaded (a charge also levied on outflow taxes). Some maintain that currency traders would simply shift their transactions to offshore tax havens, or find other ways of subverting the tax. (Eichengreen, p.89) While this may be true, the conclusion of rational people who wish to preserve financial stability and prevent destabilizing crises in developing countries should be that perhaps these offshore tax havens and other instruments of financial evasion should be regulated more thoroughly. Regardless of this, it appears that at least for the foreseeable future, there does not exist the international will or desire to implement, or for that matter discuss, a tax of this type.

What about a tax or control of some type on capital outflows? This has been implemented by Malaysia, and some have argued that is has been successful to date in stemming the outflow of foreign capital and stabilizing the currency. One of the arguments against outflow controls (similar to that against the Tobin Tax), on practical grounds, is that they are very difficult to enforce and require a large administrative bureaucracy on the part of governments if they are to be successfully enforced. Inflow taxes are more feasible, many argue, because major inflows do not generally take place when there are expectations of a large change in the value of a currency. Outflow controls, by contrast, attempt to stem a financial panic by requiring capital to be kept in a country for a given length of time, and putting limits on its removal. The problem with this is that if everyone is trying to pull out their money at once, governments will virtually have to "check people at the airport" to make sure they are not repatriating capital or sending it to safer havens abroad. (Eichengreen, p.56) Many countries do not have the resources to do this, goes this line of thinking. For example, according to Robert Aiten, Chief Economist at the USAID mission in Jakarta, while inflow taxes may be possible, outflow taxes are not a viable option for Indonesia, as there is "no navy," and simply not the administrative and governmental capacity to enforce such a measure throughout the country. (Robert Aiten, interview conducted July 15, 1999 at USAID, Jakarta).

However, despite this caveat, there are those who would argue that an outflows tax or some form of control on outflows is necessary to stabilize a nation's currency in times of crisis. The Malaysian Second Finance Minister, Dato' Mustapa Mohamed, stated his country's views on the issue at the annual meeting of the IMF/World Bank on October 7, 1998. …the belief that globalization and the unfettered workings of the market, especially the financial market, can only bring benefits is flawed. In the haste to liberalize, the downside risks have been downplayed…Unbridled capital flows, including speculative capital, have wrought havoc on economies that have relatively under-developed and thin capital markets…the changes in the exchange control rules are directed at containing speculation on the ringgit and at minimizing the impact of short-term flows on the domestic economy. (Statement by Dato' Mustapa Mohamed, Second Finance Minister of Malaysia, 10/7/98, p.3)

While many have decried Malaysia's claims of a foreign conspiracy to destroy the Malaysian economy, at the meeting last October the finance minister went out of his way to ensure the audience that Malaysia remained committed to an open economy, and that the controls imposed were a practical and necessary measure. Conspiracy theories aside, there does seem to be a case, at least in conceptual terms, for countries' employing outflow controls in times of crisis, at least in the short-term so that they may undertake whatever financial sector or regulatory reforms necessary to prevent a future crisis, without having to suffer during the retrenchment period. As for capital controls as a longer-term economic strategy, there is also evidence that they can be successful in shielding an economy from an international financial panic (China, Taiwan), and that foreign short-term portfolio investment is not a precondition for economic growth (China, South Korea, Japan, Taiwan.)

The attitude of investors and the economic policy elite to the notion of outflow controls has, not surprisingly, been one of fear and outrage, as the following quote illustrates: Many free market advocates…believe that the right to put their money where they see fit is a sacrosanct principle. But just as the right to free speech does not necessarily include the right to shout "Fire" in a crowded theater, the principle of free markets does not necessarily mean that investors must be allowed to trample each other in a stampede. For that is what happens in a runaway crisis. (Krugman, p.164)

If we take seriously the notion that markets are imperfect, that externalities, public goods, asymmetric information and coordination failures all imply the need for government intervention, then we should not fear the idea of outflow controls in times of crisis. While they may not be viable for all countries at all periods in time, they should be considered at least as a legitimate short-term tool for containing a financial panic when all else fails, and in some cases as a possible longer-term development strategy if other necessary conditions exist. What they are not is the threat to world order, freedom, and stability by which they have been largely portrayed.

Hedge Funds and the Regulation of Large Institutional Investors

One final element to be examined in the discussion concerning global finance and the shape of a new financial architecture is the rapid rise in the number and economic power of hedge funds in the last 15 years. Many have called for increased regulation of hedge funds in the wake of the Asian crisis and the Long-Term Capital collapse in the United States. This is a topic which has been extensively dealt with in academic and policy circles of late, and has even splashed the pages of the major news media. I will therefore briefly summarize the main arguments in favor of greater regulation of hedge funds, as well as the origins and nature of these financial entities.

The first hedge fund was set up in 1949 by a Wall Street investment manager whose goal was to "hedge" his clients' risk by buying stocks that were considered cheap ("going long") and selling stocks that were considered overvalued ("going short.") By 1969, there were over 140 hedge funds, and today it is estimated that there are approximately three thousand hedge funds in operation with assets under their control totaling around $1 trillion. Because of their secretive nature and the lack of regulatory law concerning hedge funds, the actual figure is not accurately known. Measured in assets, hedge funds are now around ¼ the size of US commercial banks and 1/5 the size of US mutual funds. (John Cassidy, "Time Bomb," The New Yorker, July 1, 1999, p.29)

But what exactly are hedge funds? A simple definition is:
…the pooled capital of usually 100 or fewer partners (rich individuals or institutions), led by a single manager or a small team. They're barely regulated if at all; many are registered in offshore havens…and can do pretty much whatever they like with their money, from U.S. bonds to Turkish stocks to silver futures to Moscow real estate…since they borrow so heavily from banks, a really disastrous year for the speculators could do serious damage to the broad financial system--meaning that central banks may face the choice of a bailout or systemic collapse. There is also the worry that they increase the volatility of markets…(Henwood, p.84-85)

So here we have a simple definition of hedge funds. Generally they are highly leveraged, severely underregulated, and secretively managed. And what is the main activity of hedge funds? The original concept of "hedging" conjures up folksy notions of farmers locking in a price for their future harvest to guard against poor weather or natural disasters through the futures market, for example. These and other tools are in theory supposed to provide stability to a market, be it in commodities, the financial sector, or any other good, and to ensure that market fluctuations do not adversely affect one's wealth. And what do hedge funds actually do? Here another simple, if biased, definition: What hedge funds do, by contrast, is precisely to try to make the most of market fluctuations. The way they do this is typically to go short in some assets…and go long in others. Profits come if the shorted assets fall in price…or the purchased assets rise, or both. (Krugman, p.119)

The story of the hedge funds' attacks on the Hong Kong markets has already been detailed. They have also been implicated in the attacks on the Malaysian ringgit and other currencies, including the British pound in 1992. And then there is the case of Long-Term Capital Management, in which a highly leveraged hedge fund run by Nobel Laureate physicists and mathematicians ended up losing around $4 billion and had to be bailed out by a consortium of major banks and investment companies at the behest of the United States Federal Reserve Bank of New York. The bailout of Long-Term capital was organized because its collapse, according to William McDonough, president of the New York Federal Reserve Bank, would have posed "unacceptable risks to the American economy." (Cassidy, p.28)

In the wake of these developments, there seems to be a consensus that there is a need for greater regulation and supervision of these highly-leveraged institutions. From Japan we have : "In order to prevent excessive risk-taking, industrial countries should strengthen the supervision on financial institutions, especially 'highly leveraged institutions (HLI)'." (Masayuki Kichikawa, "Regional Policy Options: An Agenda for Action," Singapore, June 1999). From Malaysia, there is the statement: "There are also rising concerns on the destabilizing activities of hedge funds and other institutional investors and the lack of regulation over their activities." (Mohamed, p.2) From Indonesia, "…large market participants, such as highly leveraged institutions which have systemic significance, should be subject to regular and timely transparency and disclosure requirements." (Hadi Soeasastro, "Creating a New Economic Environment: How Bold Can ASEAN Be?" CSIS, Jakarta, July 1999, Draft, p.13) And in the United States, there is the statement by the President's Working Group on Financial Markets: "The central public policy issue raised by the Long-Term Capital episode is how to constrain excessive leverage more effectively. The near collapse of LTCM…illustrates the need for … hedge funds, to face constraints in the amount of leverage they assume." (Cassidy, p.4)

So it appears that their is a great deal of consensus on this issue, with officials at the IMF even speaking of the need for greater regulation of institution investors. The question is how to accomplish this, and to be sure it is not an easy task. The most practical answer so far seems to come from Eichengreen, who notes that the Basle Standards say nothing about capital requirements for nonbank financial institutions, such as hedge funds. And since hedge funds, as noted previously, are often based in offshore tax havens, he has two recommendations. On the creditor/industrial nation side, he suggests strengthening the regulation of commercial banks that provide the bulk of the credit to hedge funds. On the debtor/developing country side, the proposal is to use Chilean-style inflow taxes to make it more difficult for hedge funds to get in and out of emerging markets. (Eichengreen, p.25)

The above suggestions appear to be quite rational and the easiest to implement. However, there is no mention of amending the Basle Standards to raise minimum capital requirements for hedge funds. This would seem to be an even better, or at least complementary, way of ensuring transparency in hedge funds and guarding against excessive leverage and systemic risk. Yet it would require a consensus among top finance officials in the industrialized nations on precise standards/requirements, and this has yet to occur.

Another alternative would be to amend the securities laws in the United States, so that hedge funds fall under the jurisdiction of either the Securities Exchange Commission (like securities firms) or the Federal Reserve (like commercial banks.) (Cassidy, p.2) However, this would require a large amount of political clout, and the political and economic interests lining up against such a move would surely be formidable. In the meantime, hedge funds remain largely unregulated, beholden to no one, and a persistent danger to economic stability around the world, particularly to small emerging markets without the resources to deal with or counter them.

Conclusion

This paper has attempted to shed some light on the current debate concerning the causes of the Asian and emerging market financial crises, and in particular to analyze the proposals for a new global financial architecture. It has not addressed every proposal, but rather has highlighted some of the major proposals that have been made to date from a political economy perspective. The overarching focus of the analyses have been to discern the implications for long-term development in East and Southeast Asia of the current reform proposals to date. The tremendous economic growth that has taken place in East Asia over the past thirty years, and in Southeast Asia over the past fifteen years, has changed the lives of millions of people and brought employment creation, increased living standards and higher levels of health and education to previously neglected populations in these countries.

While not erasing these gains, the Asian financial crisis that ensued and its spread to Latin America and Russia has dealt a serious setback to the development achievements and future hopes of the peoples of these nations. As policymakers and pundits hold conferences and debates about how to reform the current financial architecture, one thing is patently clear: liberalized financial markets, while offering low-cost finance to the countries of Asia, have also brought with them serious drawbacks, and there is a greater need for regulation of finance in many of these countries. The implications for long-term development should always be foremost in policymakers' minds when examining a proposal to reform the financial architecture. As noted previously, when short-term investors flee an economy en masse, it is generally the poor of the affected country that suffer most. As the former Finance Minister of Venezuela noted, "every time the GDP, the total economic output of Brazil drops one percent, two million people fall under the poverty line. That means, more or less, that they don't have enough money to buy the food that provides the calories needed not to go hungry." (Naim, p.8) Accordingly, when considering how to regulate global finance, the implications for the standards of living of those at the lowest rungs of society should be of utmost concern.

The central recommendations of this paper have been several. First and foremost is the need to disregard dogma and "accepted wisdom" concerning the benefits of free currency convertibility and of financial liberalization more broadly. With a lack of empirical evidence to support the link between liberalized finance and growth, each country should consider its own economic and developmental needs, capacities, and goals, and then choose its financial sector policies accordingly. Financial sector liberalization should not be an end in itself, it should be seen only as a means to the end of economic and social development; the potential benefits and costs should be weighed carefully before a government rushes to open up its banking, insurance, securities and currency markets.

Second, although exchange rate policy and capital flow policy often involves a difficult decision, the general consensus is that floating exchange rates are the best way to avoid the dangers of perceived overvaluation by financial markets and the severe depreciation and collapse which can ensue when market confidence is lost. However, as noted in this paper, even with floating exchange rates, devaluations in "Third World" or developing countries are often perceived as a sign of underlying structural weakness, while in advanced industrial nations they are more likely greeted as an opportunity to invest cheaply. This is yet another reason to keep in mind that liberalizing finance in developing countries has quite different implications for these countries than in advance industrial nations, and should therefore be evaluated according to separate and more stringent criteria before blanket across the board financial liberalization.

A third point, which is actually included within the first, is that their are always interests behind the proposals for reform. Certain people, groups, countries or corporations (generally in the West) stand to benefit greatly from the opening of financial markets in Asia, and at the same time the Asian countries in question risk losing economic autonomy and decisionmaking capacities in key sectors of their economies. If the requirements of the IMF as currently constituted are fully implemented, the consequences for Asian economies could be serious. Therefore, the case for an Asian Monetary Fund as an institution to provide quick and large injections of capital into countries experiencing financial crises should be seriously considered. This would help contribute immensely to the ability of Asian policymakers to determine the future structure of their economies without deferring to IMF conditionality or Western concepts of the beneficence of liberalized finance that rest on shaky empirical foundations.

A corollary to this point is that capital controls, whether in the form of inflows taxes, outflows taxes or controls, deposit requirements or international currency taxes should be seriously considered as an option. They should be considered not only in countries experiencing financial crises due to excessive exposure to short-term foreign debt, but in some cases as a longer-term component of general macroeconomic policy that would shield countries from financial market panics while still allowing for longer-term, foreign direct investment. Capital controls are not new, and they have been used effectively in many countries for a very long time. To claim now that they are outdated or impractical, as the IMF and other international financial institutions maintain, is to be hypocritical in the face of the historical record. There is nothing holy about liberalized finance, and it is not a precondition for economic growth. The rapid economic growth of Japan, South Korea, Taiwan, and China attests to this fact.

Finally, there is a need for greater regulation of hedge funds and other large institutional investors. Either the Basle Standards of capital adequacy should be amended to include hedge funds as well, or US and European banking and securities laws should be changed to include hedge funds in their regulatory frameworks. The risks these funds pose to both emerging markets and to world financial stability are too great to be ignored.

This paper has not been a purely economic analysis of the proposals for the new global financial architecture. It has attempted to consider mainly the political and social aspects of the proposals, and to make recommendations based on these analyses. Topics such as bank recapitilization, creditor-debtor workout negotiations, amendments of bondholder clauses to include majority voting and other economic issues related to debt and finance, while important, have not been examined in great detail. It is my belief that all of these questions come down to political decisions, and that the architecture that emerges from current negotiations will be based o n political calculations, however well clothed in economic theory they may be.

A final note is merely to state that there is not now, and never has been, a universal or even majority consensus on the prerequisites for economic growth. Many countries have grown rapidly in the past without liberalized financial sectors or fully open capital accounts. In a world of integrated financial markets, confidence in an economy one day can turn to panic and crisis the next, often based merely on "herd behavior" and not the fundamentals of the economy. The amount of confusion in current economic circles attests to the profound nature of the intellectual crisis concerning global finance. The fact that economists cannot have a consensus about what sort of exchange rate regime should apply to a sick country is akin to physicists debating the laws of gravity. That is the kind of science we are dealing with at this point. (Naim, p.10)

In this context, there is a great need for caution and skepticism concerning the proposals to liberalize finance even more extensively. As this paper attempts to make clear, the opposite is in fact true; there may be a need for greater regulation, not less. The worst prescription is to apply the "one size fits all" Anglo-American model to economies that differ vastly from the ones they are being modeled after. The above quote illustrates that it is not for nothing that economics is known as "the dismal science." When someone claims to have discovered a knew economic axiom, in this case that liberalized finance equals growth, it is likely that they have strong motivations, but little evidence, for making this claim.

We should beware fundamentalism in all its forms, including the current market fundamentalism concerning global finance that we hear from so many in the policy community. The shape of the new global financial architecture will have a profound impact on future prospects for world development, and it must therefore be based on a rational consideration of all the options available. The alternative, to continue holding to the misguided belief that unfettered financial markets will always allocate savings and investment in the most efficient manner, is to condemn ourselves to a theory that has been disproved time and again.

Charles Tanzer, GPF Associate, is a graduate student at Columbia University in the School of International and Public Affairs. This essay was written while a Visiting Researcher at The Centre for Strategic and International Studies, Jakarta

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