And it's true -- over the past 40 years, we've seen repeated episodes when growth has slowed in the rich world, and collapsed catastrophically in the South. Neoliberalism has meant the tools the North uses to ameliorate slumps have been forbidden to poor countries. As my friend Doug Henwood says, in each of the crises of the past two decades, "the First World banks got a Minsky bailout while the Third World suffered a Fisher deflation." But this time really seems to be different.
It's interesting to compare the last of those episodes, the Asian crisis of 1997, with the most recent crisis.
Whatever you think the underlying causes of the 1997 crisis were (people sure liked saying “crony capitalism”) the basic facts are straightforward. East and Southeast Asia experienced a “sudden stop” of previously large financial inflows, leaving them unable to meet their foreign-currency obligations. As a result they were forced to abandon their currency pegs, abruptly raise interest rates to unheard-of levels, and eliminate their trade deficits with extreme prejudice. The result was severe economic disruption and brutal recessions. Indonesia, for example, didn't regain its pre-crisis level of output for a full five years.
Fast forward ten years, and the same region is a bright spot in the global growth picture. What people don't realize, though, is that many Asian countries experienced a sudden stop of financial inflows in 2007-08 even larger than the one that caused so much destruction in 1997. Add to that a collapse in export earnings as demand in the rich countries fell, and Asian countries faced a substantially larger shock to foreign exchange earnings in 2007-2008 than ten years before.
| Change in Gross Flows as Percent of Peak GDP | ||||
| 1997Q2-1997Q4 | Peak-2008Q4 | |||
| Portfolio Inflows | All Forex Inflows | Portfolio Inflows | All Forex Inflows | |
| Indonesia | -10.6 | -18.5 | -6.1 | -9.7 |
| Korea | -5.9 | -18.0 | -10.1 | -29.5 |
| Phillipines | -5.4 | -15.9 | -9.3 | -30.1 |
| Thailand | -2.5 | -12.4 | -6.2 | -22.4 |
Source: IMF International Financial Statistics.
Notes: [1]
As the table shows, several of the newly industrializing countries of East Asia experienced a shock to their balance of payments in 2007-08 about double that of 1997. So why did the earlier shock have so much larger effects?
“Floating exchange rates” is the wrong answer. (“Fiscal responsibility” is worse, it's not even wrong.) As captured in the well-known J-curve, even when exchange rates move in the right direction, they initially have the wrong effects on trade flows. Even in the most optimistic case it takes at least a year before a depreciation begins to improve the trade balance. Anyway, in the crisis this time, Asian exchange rates didn't fall.
In the short run at least, trade flows respond to movements in incomes, not relative prices. Replacing the trade-price relationship with a trade-income relationship is probably the key contribution of Post Keynesian analysis to the study of international finance and trade. [2] Combined with the notion of liquidity constraints -- despite what the textbook says, the supply of credit is not infinitely elastic at “the” interest rate -- this means there are situations where a country needs to rapidly improve its balance of payments and the only tool available (once direct import restrictions are ruled out) is to reduce income, often by some large multiple of the gap to be closed. [3] In a nutshell, that's what happened in 1997. So why not this time?
The answer is that the Asian countries entered this crisis, unlike the last one, with large current account surpluses and foreign-exchange reserves. Countries that can respond to a negative shock to foreign exchange inflows by reducing their own accumulation of foreign assets or spending down their reserves, don't have to reduce imports by pushing down income and output. Instead, they could and did raise domestic incomes via stimulus programs and interest-rate cuts, to offset the fall in export demand. And this is not only good news for them, it also dampens the process by which trade-induced contractions would otherwise propagate across borders.
Indeed, it's probably precisely to be ready for this contingency that Asian countries committed themselves to running surpluses in the first place. There's an old Martin Wolf column making this argument, which I'll add to this post when/if I find it. It's made more systematically in a couple recent articles by Jorg Bibow. (Bibow's work is about the best I've seen on the whole question of “global imbalances”.) He argues that current account surpluses and reserve accumulation should be seen as a form of “self-insurance” by countries that have become disillusioned with the IMF as a provider of insurance against balance-of-payments shocks (its supposed raison d'etre). Bibow is fairly critical of this approach, which is natural from the point of view of someone steeped in Keynes' ideas of a rational international order. We don't, after all, think it would be such a great thing if people dispensed with health insurance and saved up money for future health expenses instead. But if your insurer insisted that you donate at least a kidney before they'd approve a blood transfusion, self-insurance might look like a better option.
The direct effects of trade flows on aggregate demand are usually dwarfed by the indirect effects, as government spending and investment adjust to accommodate the balance of payments constraint. This is why trade is not, in a Keynesian framework, a zero-sum game, and why the mewling of American economists about Asian "mercantilism" so misses the point. When capital flowed out of Asia in 1997, the whole development process had to be thrown into reverse in order to make up the shortfall in foreign exchange. That's what happens when you're pushed up against your balance of payments constraint. It didn't haVppen this time because of their past ten years of self-insurance. In the US, on the other hand, the external balance doesn't constrain expansionary fiscal policy at all, only the stupidity of our politics does.
Maybe even more important, the political point. How is it that these countries managed to reject the siren song of the Washington Consensus? After all, it promised (1) development would be so much faster with access to the savings of the rich world via unfettered financial flows; (2) if something did go wrong, the IMF loans were always available to bridge short-term foreign-exchange shortfalls; and, implicitly, (3) if things fell apart completely, unrestricted financial flows would ensure that elites could extract their wealth from a wrecked economy.
Around 1990, when I was first becoming aware of politics, we took it for granted that the IMF was one of the great forces for evil in the world. And you know what? I think we were right.
Which makes it all the more remarkable that some substantial fraction of the world has managed to tear itself free of those usurers. In principle, there's the potential for progressive struggle whenever the sociological basis of a form of political consciousness requires it to cohere somewhere beneath the top of a value chain. But in practice, it's hard to do. Much easier for the representatives of a subordinate class or geography to constitute themselves as an agent of the elites above rather than the masses below. So while self-insurance via reserve accumulation might seem like a small step towards socialism, I think it's kind of a big deal. Economically, you have to recognize that Asian economies are not in depression now thanks to prudential state action, not the pseudo-logic of "conditional convergence". And politically it's even more remarkable, in the scale of things, that Asian elites have been able even to this extent to identify themselves with their national economies rather than the global owning class.
[1] "All Forex Inflows" is the sum of gross portfolio inflows, inward FDI, other inward investment and exports. (The gross numbers are conceptually the correct ones, for reasons I can't explain here but hopefully are obvious.) The peak quarter is 1997Q2 for the 1997 crisis. For the recent crisis it is 2008Q2 for Indonesia, 2007Q4 for Korea, 2007Q2 for the Philippines and 2008Q1 for Thailand. The IMF does not have data for Malaysia prior to 1999.
[2] As on so many topics, Joan Robinson's contribution is essential and mostly unacknowledged.
[2] As on so many topics, Joan Robinson's contribution is essential and mostly unacknowledged.
[3] The ratio of the necessary fall in output to the balance of payments gap to be closed is equal to one over the marginal propensity to import. Countries in this situation almost always sharply raise the domestic rate of interest, which theoretically helps attract short-term financial flows to bridge the gap, but in practice is mostly just a mechanism to reduce domestic incomes.
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