Not much to be done

14 February 2000

What Is To Be Done? Under this ringing title, a conference met in Europe last week to discuss the ‘global economic disorder’ of the last two years. The gathering was varied. Banker, technocrat and academic. European, American and Asian. Liberal, social-democrat and conservative. The answer to this big question was: not very much.

The bankers were the most emphatic. They admit their excessive, careless lending helped to create the crisis. "We lent so much to Asian banks, including those in Thailand, because we believed they were protected by the local governments", said one international banker. Many believe moral hazard was behind the crisis. It was nice to hear it from the banker’s mouth.

But the bankers realise the game is up. The crisis overwhelmed the local governments’ capacity to protect their capital. The IMF stepped in to provide a second line of defence. But the series of huge IMF bailouts – Thailand, Indonesia, Korea, Russia – has been ugly. The world is not going to go on and on bailing out bankers.

Still the bankers take heart. They lost some money tied up in non-performing loans in Asia. But they admit they made money out of volatility in exchange and interest rates.

Still, it’s best to lose as little as possible. Among all the crisis countries, Korea offered the best model. Under US guidance, the international bankers sat down with their Korean debtors before the crisis broke and agreed to roll over their loans. As a result, Korea avoided the panicked capital flight which wrecked Thailand and Indonesia. Korea came out of the crisis quicker, stronger, less damaged. Everyone lost less.

The bankers like this model. But they don’t want to see it generalised and formalised. Any such standstill agreement must be "voluntary" and "on a case by case basis" because crisis management is "more of an art than a science". They want "more transparency" in the countries where they lend, and better rules about banking behaviour and bankruptcy. But they are not prepared to be transparent about their own activity. And they don’t want any "rule-based" solutions for managing crisis. They like the word "resilience". This sounds like the possibility to keep having crises without totally wrecking the system.

The technocrats also felt that not too much should be done. It would be foolish, one said, to revise the international financial system in the shadow of the Asian crisis. In particular, any move to increase the power of institutions like the IMF might be regretted later.

But for many academics present, this reluctance to embrace change was deeply frustrating. In the past, finance served the "public good". But now international finance can overthrow governments, impoverish peoples, rearrange economies. One participant talked of "the rise of business feudalism and the destruction of the public realm". It is now up to states and communities to define the public good, to question whether finance serves that goal, and to find better institutional means to enforce it. But this discussion stalled far short of any practical proposal.

Moreover, the demographic reality behind the pre-crisis financial flows has not changed. The developed world has growing numbers of ageing people with high savings. Asia (and other developing areas) has lots of young people ready to work for low wages to create the high profits which those savers want. Before long, the capital will start flowing again. The problem is what channels to use. Asia’s banks are now wrecked. Its stock markets are too unstable. Many financiers look forward hopefully to the development of bond markets to provide a safer way to invest in Asia.

But switching financial flows from bank loans to bonds doesn’t prevent financial crisis. Many felt that the refusal of the banks and the international technocrats to accept any significant change in the policing of international finance meant that debtor countries must look after themselves with capital controls.

Strikingly, nobody at this meeting spoke out against capital controls. Many spoke in favour of them—including European technocrats, Asian central bankers, and American academics. Some of the bankers kept quiet and looked uncomfortable. But nobody spoke against. Even a few months ago, this would not have been so.

The evidence after all is very clear. The Asian countries which controlled their capital accounts (India, China, Taiwan, Singapore) escaped the crisis unscathed, even if they had weak financial systems, bad current account deficits, dodgy politics, and legions of crony capitalists. Those which had liberalised their capital accounts (Thailand, Korea, Indonesia, Malaysia) went down like dominoes.

But on the proper approach to capital controls, there was less agreement. India partially liberalised in the early 1990s, and rapidly slid towards the excess short-term debt which crippled Thailand. India simply reversed out some of the liberalisation, banned short-term inflows, and survived. But for countries which have gone farther along the road of liberalisation, there is no reverse gear.

Most favoured the restrictions on inward short-term capital flows which Chile implemented through the 1990s. Chile struggled with these controls, largely because of evasion. International finance has a unique attitude to regulation. It loves rules applied to everybody else. It will do anything to evade rules applied to itself. As a result, the data on Chile’s experience with capital controls are difficult to interpret. But on balance, the experts believe such controls are worth a try.

Controls on outward flows are still more controversial. Countries like Thailand resisted this option because they worry about being excluded from capital markets in the future. Bankers warn that fears about default could diminish flows of capital to the developing world. Everyone agrees that any provision for restricting outflows in a crisis should be systematic and supervised. But exactly who should supervise and under what conditions is not at all clear.

When you sail out of a storm, it is easy to forget how big the waves were, and to start dreaming of a perfect day. But a wise sailor puts on a better life-jacket.