A Year Afloat

30 June 1998

Over the year since the floating of the baht, views on the cause of the crisis and on the cure have changed a lot – especially among the US opinion-makers and policy-makers who have been critical in shaping the response.

In retrospect it is obvious that they knew a lot about Latin America and rather little about Asia.

From the start, they argued the cause of the crisis was the same government meddling in the economy which had dumped Latin American economies into debt crises in the 1980s. The ‘Asian model’ of development, which the World Bank had touted as ‘market-friendly’, was now reinterpreted as anti-market. Soros and the hedge funds which triggered the crisis were not demons. They had simply been the markets’ invisible hand, delivering a slap to Thailand and other Asian countries as punishment for bad economics.

The cure – the same as administered in Latin America – would be more liberalisation, especially of capital markets. Alan Greenspan claimed lyrically that free markets were one of the great sources of good in the world.

But as the crisis deepened, spread, and began to impact on US firms, the experts took a closer look. In reality, the Thai government had not meddled too much but had supervised too little. Financial liberalisation had been handled badly. Of course this was Thailand’s fault, and the Nukul commission acknowledged that fact. But this same pattern of financial liberalization leading to foreign exchange crisis and banking crash has been recurring around the world for twenty years. As international finance has gown steadily stronger, the crises have been getting steadily worse. Maybe it was no surprise that a country like Thailand handled liberalisation badly. Maybe the international financial market is not an angelic incarnation of market rationality.

The IMF itself commissioned a survey on the role of the hedge funds in the crisis, and concluded that they clearly magnified the impact. Soros himself announced that the financial markets were a dangerous source of international instability and needed regulation. The IMF and World Bank stopped harassing other countries (like India) to hurry up and liberalise their financial markets. The Tobin tax was brought out again for discussion.

Jagdish Bhagwati, who had written the textbook on free trade theory, questioned whether it could be applied to financial markets. The theory assumes that participants have good access to information and the market clears rationally. But as bankers admit, information in financial markets is very hazy. And as Soros has engagingly explained, he makes his money because the financial markets are not at all rational but driven by fads and panics.

Bhagwati concluded that free trade theory could not be used to justify financial liberalisation. Dani Rodrik confirmed that liberalisation had not had the beneficial results which the theorists claimed. Supachai Panitchapakdi, who had been one of Thailand’s most ardent liberalisers, stated recently: "An effective system of global governance of international money markets…could have mitigated the crisis…the movements of money and capital…cannot be left entirely to market forces without incurring tremendous risks". Even writers for The Economist have muttered in private that they no longer believe in free financial markets.

In sum, of course Thailand had goofed on financial liberalisation, but in the light of history this can now be seen as no surprise. Nor will financial sector reforms guarantee any immunity from future crises. Look at what has been happening to the Australian dollar. Big international finance makes its profits by circulating instability around the world. Compared to the problems of regulation and supervision in little Thailand, consider the same problems on a global scale. After the Mexico crisis, the IMF was tasked to watch out for unusual, destabilising flows of international money. How then had it missed the massive floods into Thailand and other Asian countries in 1994-6? Well, the IMF confessed, their database is lousy and at least 9 months out of date.

What then of the cure? Late last year, the model in everybody’s minds was the Mexico crisis. There, within two months of the IMF entry, the capital flight had stopped, the peso stabilised, and the worst of the crisis had passed. In Thailand, the IMF and their local counterparts hoped for a similar bounce. With 17 billion dollars and the avuncular IMF presence, confidence would return.

But after a few months under the IMF, Thailand’s economy was on a dangerous slide. Still that could be blamed on Thailand’s "state of denial" and Chavalit’s incompetence. So the Democrats were brought into power and promised to be the IMF’s dutiful pupil. Chuan promised "definite improvement in 6 months" and Tarrin talked of a "V-shaped recovery". Still no improvement. So now the problem was blamed on "contagion". The quest for confidence was boosted by shuttle diplomacy between Bangkok and Washington. Photo-ops were arranged. Friendly, upbeat words were spoken. But still no confidence blip. Now the blame was redirected to Japan.

By now the programme of the IMF had become more important than the presence. But the programme had been designed for a Latin American government which borrowed too much, spent too much, and pushed its economy into current account deficit and inflation. The point of the IMF programme was to stamp on the brake, discipline the government, douche the inflation, and create space for the private sector to grow. But apart from the current account deficit, Thailand had nothing in common with this model. The government budget was in surplus, public debt under control, inflation minimal. Most of the external debt was private. Most important, the real economy was not careering out of control, but slumping to the low point of the cycle. Stamping on the brake sent the economy slithering into reverse.

The reasons why confidence had not returned was not "denial", Chavalit, contagion or even the yen. Rather, international financiers could not work out how the IMF programme would create a healthy Thai economy worth investing in. Slowing the economy, choking demand, and throttling liquidity meant that debts rose, and the attraction for investors receded.

The measure of the IMF’s miscalculation is the change in the GDP growth prediction for this year. It has slid from plus 3.5 percent to minus 5.5 percent – a swing of nine points over nine months. Many predict that the swing will continue to minus 8 percent or more.

The IMF and the Thai government still believe that the old economic growth pattern, based on foreign investment and manufactured exports, can somehow be revived. But the World Bank, the World Trade Organization and many economists have pronounced that the age of export-oriented growth is over. And the financiers have lost their enthusiasm for stuffing money into emerging markets and Asian miracles. Besides, the Thai economy will be dragged down by debt repayment for years to come.

In the past, in the face of such dead ends, the Thai economy has changed course quite dramatically. But such transitions take time (the shift from import substitution to export orientation took a decade). Maybe the severity of this crisis will speed things up. But the first step needed is a change of mentality.

The Thai economy will be forced into greater self-reliance – not just at the level of the individual farmer, but also at the level of the macroeconomy. There will be less capital flowing in, and less money to buy imports. The trick will be turning these limitations into advantages. Once the hot money has all gone away, Thailand has a chance to become less vulnerable to the predatory and destabilising flows of international finance. With a large population, self-sufficiency in food, relatively well developed infrastructure, and home-grown entrepreneurship, Thailand has some freedom of choice not available to every country.

The basic reorientation needed was set out in the vision of the Eighth Plan: "shifting from a growth orientation to people-centred development". Although the Plan has been forgotten in the crisis mentality of the year afloat, the vision has become even more relevant now that attention must shift to the development of the home market.

Thailand still needs to grow exports, and must move quickly to follow the shift of market opportunity from Asia to Europe. But Thailand must also think how to develop the domestic market. Investing in agriculture and agro-exports can kill several birds with a single stone. The prospects for growth are good simply because of the extent of past neglect. The value-added is high. The multiplier effect through local incomes is strong. The impact on income distribution and savings can be dramatic.

The Thai economy need not become much more closed to the outside world. Indeed the multinationalisation of the finance industry will prevent this. But Thailand needs a macroeconomic stance which provides some immunity against financial destabilisation, and creates some space for social and economic engineering.

After one year afloat, the easy explanations and the simple cures are at last losing their appeal. The tough task now is to plot a strategy of growth which reaps the advantages of globalisation on one side, and of Thailand’s capacity for self-reliance on the other.