What Form Should An Asian Economic Union Take? BY WING THYE WOO , THE BROOKINGS INS T I T U T ION AND UNIVERSITY OF CALIFORNIA A T DAVIS The Impetus to Recent Initiatives Translation: Prior to July 2 1997, I might even say domestic for Asian Economic Integration: crony capitalism and economic financial crises, are built into The Asian Financial Crisis mismanagement in these Asian the human genome. When we economies had loaded their map the whole thing, we will A financial typhoon appeared national financial systems with find something there called in the Gulf of Siam on July 2, 1997, weak loans, and hence rendered greed and something called fear first toppling the Baht and the Thai their continued high growth and something called hubris. economy and then sweeping to-and- unsustainable. These Asian That is all you need to produce fro across East Asia for the next eight economies imploded for the international financial crises in months, doing severe economic and same reasons the Soviet bloc the future.” political damage to South Korea, economies had imploded in the Indonesia, and Malaysia. The ripples Finding 3: The victim died not early 1990s. Their industries of the typhoon were felt as far as from the bad cold she caught with the were not viable without various Brazil and Russia, with an equally change in weather but by the mistaken forms of subsidies (e.g. directed disastrous outcome in the latter. Post- administration of nitrogen instead of credit, protection), and the mortems have abounded since; initially oxygen while in the ambulance on the aggregate subsidy had reached a in the form of media and official way to the hospital. level in 1997 that the state could assertions; next in dissertations from Translation: The incompetence no longer provide. academic dissections; and finally in of the IMF turned a downturn Paul Blustein’s excellent book, The Finding 2: The victim died because into a depression with Chastening (Public Affairs, 2001). Each she was crushed in her sleep by the contractionary “rescue” autopsy report typically contained the coconut tree brought down by the gale. packages, and helped to following three findings, with each Translation: International exacerbate (if not initiate) work differing in emphasis on the financial markets, just like the regional panic with dire importance of individual findings in domestic financial markets, are diagnoses of the patient. The each country. susceptible to bouts of mania, Koreans were correct to dub Finding 1: The victim died because panics and crashes, causing them the perfect storm they found she was already so wasted internally to help stoke booms and busts in themselves in “The IMF Crisis.” by self-inflicted wounds that she their clients’ performance (which While the Asian financial crisis keeled over when the wind started in the periods of irrational was most probably the product of blowing. The role of the storm was exuberance are often dignified all these three factors, it would be happenstance because a sneeze later with self-congratulatory honors irresponsible to completely avoid on would also have caused her to like The Asian Miracle, and apportioning blame because this would crumble when her constitution had Japan as No. 1). Paul Volcker deny the importance of accountability. been rendered more fragile by the (1999) has put the matter well: It is convenient to embrace Finding 1 soft rot. “International financial crises, readily because no economy is without No. 67 1 No v e m b e r 2007 flaws. However, the fact that output in Malaysia, South Korea and Thailand rebounded just as quickly as they had fallen falsifies the initial IMF belief that, beside monetary-fiscal tightening, It stretches credibility and the imagination that drastic overhaul of the economic all these governments coincidentally shifted system and incentive structure similar to those undertaken earlier in the to destabilizing policies in the same decade. former Soviet bloc (e.g. immediate increase in the capital adequacy ratio and abrupt large-scale closure of financial institutions) were necessary to restart growth. This initial misjudgment There has long been a tradition in 1992-93, the Mexican and Latin explains why the IMF kept under- of resistance within the economics American financial crisis in 1994-95, predicting until the end of 1998 the profession to acknowledge the the Asian financial crisis in 1997-98, strength of the growth that occurred. phenomenon of disorderly market the conversion of the Russian ruble The many careful studies in the behavior. The most commonly to a rubble in August 1998, and the voluminous literature on the Asian used defense against claims of collapse of the Brazilian real in January financial crisis have produced many speculative bubbles is the alternative 1999. It stretches credibility and the valuable insights on every dimension hypothesis that unstable asset imagination that all these governments of the crisis: the origins, early prices reflect unstable government coincidentally shifted to destabilizing detection, preemptive interventions, policies. The claim (labeled the “peso policies in the same decade. Herein lies emergency-room macroeconomics, problem”) is that observed flip-flop the first lesson insight from the Asian and post-crisis recovery.1 For the movements in asset prices reflected financial crisis: occasional excessive topic of the types of economic policy rational anticipations of changes in price movements in financial markets cooperation that are appropriate for government policies that turned out are normal and should not be labeled Asia, there are two lessons that are not to occur. The truth is that the peso ‘peso problems’ in a knee-jerk fashion. particularly useful. The first lesson problem hypothesis cannot really The second important relevant concerns the natural working of the be disproved—there is just no way lesson from the Asian financial crisis market mechanism, and the second of getting around the sophistry of a is that “the only form of reliable concerns the availability of help during determined peso problem believer. help during an economic emergency a financial crisis. The fact that financial contagion has is self-help.” The IMF could not be been common in the 1990’s cannot counted upon to be always correct in be in serious dispute: the European its diagnosis upon its first reading of 1 See, for example, Wing Thye Woo, Klaus Schwab and Jeffrey Sachs (edited), The Asian Financial Crisis: Exchange Rate Mechanism crisis the situation. Moreover, the United Lessons for a Resilient Asia, MIT Press, 2000. 2 No. 67 No v e m b e r 2007 that they could continue to command a disproportionate influence on world affairs, and China was not prepared to The only country that was willing to commit be rushed by events into supporting a immediate large-scale financial assistance new regional institution without careful to the crashing Asian economies was consideration of all the implications. the neighboring country of Japan, which These two lessons propelled the East Asian countries after their recovery proposed the Asian Monetary Fund (AMF). to go on a reserves accumulation spree to insulate themselves from future speculative attacks (i.e. be independent of the supervision of States could not be expected to be their costly experience with hanging on the IMF). These lessons also led always ready to help out countries in to the Shah of Iran until the bitter end the Asian countries—the 10 ASEAN desperate straits. In the three-decade in 1979) had become more interested countries, China, Japan and South long rule of General Soeharto, he had in who would be replacing him than in Korea, collectively called ASEAN+3— been bailed out several times before by maintaining him in power. to start the process of currency and the US and its allies (notably Australia, The only country that was willing financial cooperation when they met Japan, Holland, and the international to commit immediate large-scale in Chiangmai, Thailand, in 2000. The financial institutions), and it was financial assistance to the crashing resulting Chiangmai Initiative had two thus quite natural for him to expect Asian economies was the neighboring major components: some external aid when things started country of Japan, which proposed 1. The countries agreed to come going awry in the last quarter of 1997. the Asian Monetary Fund (AMF). to each other’s aid if similar Soeharto was mistaken. He did not Japan did not succeed in establishing speculative attacks were realize that with the end of the Cold the AMF, however. Three of the key to reoccur. This pooling of War in 1992, he was dispensable to US reasons for the failure of the AMF reserves to defend the existing security and ideological interests just initiative were that some important values of their exchange rates as his fellow general, Joseph Mobuto of was enabled by each country developed countries believed in the Congo-Leopoville, was; that a newly- entering into a web of bilateral crony capitalism explanation of the impoverished Indonesia, not being an swap arrangements. crisis and concluded that an AMF immediate geographical neighbor to 2. An Asian Bond Market (ABM) would merely mean throwing more the US, could not send a tsunami of would be established to keep unemployed workers into the US as money to the undeserving, corrupt funds within the region. The a newly-impoverished Mexico could; elite of these countries, some other assumption is that if there and that as he neared the end of his developed countries wanted to protect were an unjustified (i.e. panic- natural life-span, the Americans (after the monopoly position of the IMF so stricken) capital flight from one No. 67 3 No v e m b e r 2007 Asian country, the existence of the ABM would channel these funds to the other Asian countries.