The Asia Crisis

• Who are the Asian Tigers?

• In the mid-1990s we spoke of the “Asian Tigers” with awe. Heavy savings and investment, rapid development. Activist, statist economic planning

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• Singapore

Countries Affected in the Contagion

• Thailand, July, 1997• Indonesia, June to August, 1997• Korea, July, 1997• Japan had already been through its own crisis

earlier and was in an economic depression

• Russia and Mexico followed a little later with crises of their own.

The Asian Crisis: BOOM AND BUST

• First Phase: Currency undervalued to promote exports. Government picks and promotes “winners” (major projects and firms).

The Asian Crisis: BOOM AND BUST

• Second Phase:Export successes produce large earnings. Heavy investment inflows by the early 1990s. Available – a plethora of capital.

The Asian Crisis: BOOM AND BUST

• Inflation should have produced some currency devaluations in these countries, but currencies were tied to US Dollar, which was appreciating at the time. Currencies were then overvalued..

• A bubble starts to develop– Banks not monitored.

The Asian Crisis: Finance and the Bubble

• Japanese rice subsidies inflate the value of land to promote the real estate bubble. Huge real estate inflation and subsequent collapse.

• Japan trying to fight a depression so Japanese interest rates were at zero.

The Asian Crisis: Finance and the Bubble

• Only modest returns needed with interest rates very low. Emphasis on market share and growth, not on profits in Japan.

• Japan was the governance model for “statist” Asian economies.

Bangkok, Thailand

The Asian Crisis: Finance and the Bubble

• Bad debts accrue. Investors look for larger returns, but these have higher risks.

• “Keep the Finance Ministry off our case.”

• Non-Functioning Loans fill bank portfolios.

Bangkok, Thailand

Asian Crisis: The Finance Problem

• Ultimately, long- and short-term investors notice the lack of returns. Then the crisis begins. How?

• With capital mobile, flight can occur with any provocation. (Modern version of a run on the bank.)

Asian Crisis: The Finance Problem

• Stock values plummet as they are sold off.

• Currency values?

• They drop precipitously as funds are sold off then the yield is exchanged for the investors’ currencies.

Asian Crisis: The Finance Problem

• Import prices (for productive materials and parts and for consumption goods) skyrocket.

• Severe recession begins as consumption and production expenditures falter and prompt layoffs.Foreign exchange is now so costly that needed production inputs and consumer goods cannot be afforded.

Three mistakes of Asian Lenders

• The countries involved usually had some international indebtedness, and Asian banks and borrowers used short-term credits to finance long-term loans.

• Asian borrowers (banks and firms) borrowed in foreign currencies and loaned in local currency. No hedging to counter foreign exchange risk.

Three mistakes of Asian Lenders

Asian bankers often did not ask to see consolidated balance sheets. They didn’t monitor the total assets and liabilities of the borrowers.

The IMF paid the bills for such banks, finance ministries and countries. Moral hazard problems! Investors should pay for bad decisions.

Keynes and the Corporate Governance Problem

• What is Keynes most noted for?

The General Theory of Employment, Interest, and Money,

Chapter 12, “The State of Long-term Expectation.”

Lord Keynes

Keynes and the Corporate Governance Problem

What did this chapter address?

Written to solve the problem of the great depression, this chapter turns out to be the intellectual foundation of postwar thought on economic growth and planning.

Lord Keynes

The Investment Problem: Choosing the Right Projects under Uncertainty

• Personally acquainted with the uncertainties of investment prospects and market performance, Keynes noted:

• “the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made,”

The Investment Problem: Choosing the Right Projects under Uncertainty

• What is precarious here?Our ability to deal with the future’s uncertainty.

• What are investors engaged in “enterprise”?

• Those who will “purchase investments on the best genuine long-term expectations he can frame.”

America’s Wall Street: Speculation

There are also the “game-players” who are involved in the speculation that seeks for capital appreciation rather than income. Such speculation he found to be particularly common among Americans.

America’s Wall Street: Speculation

What did he believe they were interested in?

“unduly interested in discovering what average opinion believes average opinion to be.” This “national weakness finds its nemesis in the stock market.”

America’s Wall Street: Speculation

Keynes believed investment outcomes were “a result of animal spirits -- of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

The Keynesian Conclusion

• Due to the difficulties of investment uncertainty,

“I expect to see the state, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, …

.

The Keynesian Conclusion

…taking an ever greater responsibility for directly organizing investment.”

After WWII, economic planning was adopted by most nations.

National economic plans

• What would be the objective of a national economic plan?

• Plans enunciated the aims and guiding principles of development policy,

National economic plans

• described the desired development of the country as a whole,

• described development of the economy’s principal sectors,

• provided estimates on production and investment figures.Often a plan was “considered synonymous with a program of investment projects.”

National economic plans

• Most plans were relatively innocuous as compared to the comprehensive and authoritarian planning of the Soviet bloc countries.

Planning Results

• Over the next few years, few positive results recommended continued planning, so most nations downsized their planning experiments into various forms of “structural policies.”

Planning Results

• In Japan, the model Asian development country, postwar MITI was to “target a potentially growing industry and implement an industrial policy that would enhance productivity in that industry and ultimately improve its competitiveness in the global market through coordinated efforts by the government and business leaders.”

Planning Results

• Targeted industries were plied with capital from the local bank, as directed by the Ministry of Finance. Japanese industrial power was perceived as a function of its ability to administer “guided capitalism.”

Development

How successful was the Japanese development model?

-- Japanese savings are immense.

The Japanese Model of Economic Development

Development

-- The American market is an open export target for Japan,

• -- Deming’s Quality Control and world class manufacturing,

The Japanese Model of Economic Development

Development

-- Large Net Export Earnings,

• -- Japan seen as the world’s first economic superpower.

The Japanese Model of Economic Development

Tokyo Stock Exchange

“Insurmountable” US Problems

• For whom does U.S. industry produce its fruits?

• What is corporate governance?• The U.S. system of corporate

governance is designed to assure shareholder earnings.

“Insurmountable” US Problems

• Corporations secure strong, short-term returns or stockholders will walk.

• Critique: “Preoccupation with the bottom line is hostile to long-term projects which might generate returns later but which may not be profitable at the present.”

“Insurmountable” US Problems

• Selecting projects without regard to their short-term profitability is viewed as a disadvantage to their strategic performance.

• C. 1993: “The U.S. is finished as an economic power.”

Michael Porter on Government Policy

• “Government is prominently discussed in treatments of international competitiveness. Many see it as a vital, if not the most important, influence on modern international competition.

Michael Porter on Government Policy

• Government policy in Japan and Korea is particularly associated with the success these nations’ firms have enjoyed.”

The Competitive Advantage of Nations The Free Press, 1990), p. 126  

                                                      

Lester Thurow: A Head to Head Strategy

• Early 1990's: there is no way to compete against Japan and Europe, Thurow said, without restructured antitrust laws. Larger units must be capable of competing with the more long-term oriented keiretsu of Japan.

Lester Thurow: A Head to Head Strategy

• Implement measures that make investments in American corporations more long-term.

Lester Thurow: A Head to Head Strategy

• A national strategy or national industrial policy essential to survival as a competitor in world markets.

• See Head to Head: The Coming Economic Battle Among Japan, Europe, and America, New York: Warner Books, 1993.

Investment processes became globalized.

• By the early nineties, a net transfer of financial resources flowed into Asia. It supplemented gross domestic savings in the Asian countries.

• Capital poured in from the West, but a considerable share also came from Japan, and other Asian countries investing in their less developed neighbors.

Investment processes became globalized.

• The United States also became a major supplier of funds to Asia and the rest of the world, both through direct and portfolio investment, the sum of these being $178 billion in 1993 and $119 billion in 1994.

When the Bubble Burst

• What happened when the bubble burst?

• Worldwide, foreign direct investment is far and away the largest part of net financial flows to the developing economies.

When the Bubble Burst

• These are highly concentrated and nearly 75% flowed to the ten largest recipients in Asia and Latin America

• The onset of the crisis for 22 countries of South and East Asia in 1997 made itself manifest with an outflow of approximately $92 billion in short-term borrowing, stock market net flows, and net outflows of funds from domestic residents.

When the Bubble Burst

• Stock markets crashed, national currencies collapsed, and imports and production shriveled up miserably.