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This volume helps to foster an open debate on economic policymaking
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Malaysian Eclipse: Economic Crisis and Recovery
Jomo K. S., editor
London and New York: Zed Books, 2001
Joseph Stiglitz, the Nobel-prize-winning former chief economist of the World Bank, calls the 1997 East Asian economic crisis “the most dramatic illustration of the failure of self-regulating markets.” Malaysia’s experience of that crisis and its imposition of capital controls which attacked the myth of self-regulating markets form the core topic of Malaysian Eclipse.
Malaysia is well suited for the study of the effects of financial liberalization and “self-regulating” markets on economic development. First, Malaysia (and Thailand and Indonesia) relied more heavily on markets and less on government intervention than had the first generation of East Asian NICs.
Second, Malaysia was a favorite destination of financial capital, capturing more of the capital that flowed into the newly emerging markets during the 1990s than any other developing economy.
Third, Malaysia managed its post-July 1997 recovery not with International Monetary Fund–administered austerity measures but with its own policies that included a highly controversial experiment with capital controls. That experiment made Malaysia and Dr Mahathir Mohamad objects of derision in orthodox financial circles but a champion for others seeking an alternative to financial-market-dictated economic development.
Independent Analysis
Malaysian Eclipse is critical of the free-market ideology of the IMF, the U.S. Treasury, and the economics profession. Yet the book is also damning of Mahathir’s conspiracy theories and self-serving rhetoric of economic nationalism, frank in assessing the limits of capital controls, and cognizant of the corroding effect of cronyism.
Jomo’s independent path of analysis is clear from his dedication of Malaysian Eclipse to Anwar Ibrahim. The dedication alone challenges the standard reading of Malaysian economic policy debate that pits Anwar’s “neoliberal leanings” against Mahathir’s economic nationalism. Indeed the Mahathir camp branded Anwar an “ill-informed stooge of the IMF and other foreign interests” and made him the scapegoat for the government’s early austerity programmes.
Jomo came away from a meeting with Anwar in May 1998 with quite a different impression: The Anwar he saw was in command of the economic issues and open to criticism. Shortly after, Anwar announced policies intended to reflate the economy, a move that Jomo himself advocated. Anwar, Jomo argues, had been no more an advocate of privatization than Mahathir who had championed privatization since the 1980s. In fact, Anwar had administered Malaysia’s 1994 exercise in capital controls, and when the 1997 crisis began, Anwar had favored smaller cuts in the government budget than those Daim Zainuddin wanted.
Ills of Financial Liberalisation
Malaysian Eclipse challenges the neoliberal agenda of financial liberalization in the developing world. Jomo and his co-authors identify an “ill-timed and ill-sequenced” liberalization of Malaysia’s banking system and financial markets as the “root cause” of Malaysia’s crisis. They recount the transformation of the Thai currency crisis into a regional financial crisis, and then an economic crisis made worse with the IMF austerity policies. They document the breakdown of prudential oversight of the banking sector and the late 1980s rush to liberalize financial markets, and trace the unprecedented inflow of portfolio investment and its reversal during the crisis.
In this way, the authors are able to dispute IMF’s contention that the crisis was “homegrown” and caused by faulty macroeconomic management. Jomo and Rajah Rasiah establish that Malaysia’s pre-crisis “first order macroeconomic conditions” were sound and characterised by sustained rapid growth, relatively mild inflation, and fiscal discipline.
What plagued the Malaysian economy was a persistent current account deficit dangerously financed by short-term capital flows. Unlike Thailand and Indonesia, which relied on borrowing from foreign banks, Malaysia tapped the capital markets to finance its current account deficit because prudential regulation limited bank borrowing from abroad.
When the crisis hit, both types of short-term capital flows – foreign bank lending and stock buying – reversed with little regard for the actual strength of these economies. Malaysia’s closer regulation, however, left its banking sector in better shape and muted the impact of the crisis.
Jomo and his co-authors do not attribute Malaysia’s pre-crisis record of rapid growth to financial liberalization. Although dependent on long-term foreign direct investment (FDI), especially in export-oriented manufacturing, much of the rapid growth predated the 1990s deluge of foreign portfolio investment. The econometric analysis in Malaysian Eclipse fingers portfolio investment, not FDI, as the footloose culprit and found foreign portfolio investment to be more volatile than FDI and even foreign bank borrowing. The precipitious outflow of portfolio investment was significantly not followed by sudden FDI pullouts.
Cronyism and Beyond
Jomo also challenges the international financial establishment’s contention that cronyism, not market failure, caused the East Asian crisis. He notes that cronyistic practices were widespread before the crisis and ironically Western financial analysts regarded them as a source of stability in the economy. Jomo acknowledges that cronyism eroded economic growth and worsened the crisis but he goes beyond a critique of cronyism as an explanation of the crisis.
Cronyism in the award of government contracts to, or the bailout of, politically connected friends according to Jomo, is best understood as “nondevelopmental rent-seeking” that contributes little to productive capacity or economic development. Malaysian crony-ism is often part of government-supported, large-scale infrastructure projects and other ventures that are “sometimes unnecessary and often unviable.”
In Jomo’s estimation the Malaysian government’s economic interventions were far less successful than the practice of industrial policy in South Korea and Taiwan where government support for corporate investors was more often tied to performance standards and potential international competitiveness.
Ambiguities of Capital Controls
On September 1, 1998, Malaysia imposed capital controls which required portfolio investment funds to remain in the country for a year. In Jomo’s view, the capital controls “remind[ed] the world that there are alternatives to capital account liberalization”. However, he is not prepared to declare Malaysia’s experiment a successful example of what developing countries can do to protect themselves against “predatory speculators” and financial volatility.
Jomo regards the Malaysian capital controls as neither the unbridled success proclaimed by the Mahathir administration nor “the unmitigated disaster” predicted by market fundamentalists. Jomo suggests that the contribution of capital controls to Malaysia’s recovery was ambiguous. The Malaysian stock market stabilized but foreign direct investment declined partly due to the “hostile official rhetoric” of the Mahathir government. Still Malaysia’s economy recovered no more slowly than Thailand’s which labored under an IMF-imposed austerity program.
Much of the problem with evaluating Malaysia’s capital controls is their timing. By September 1998, the crisis was 14 months old, and the bulk of foreign portfolio investment had left the country. For Jomo,the capital controls “closed the stable door long after the horses had bolted” and had the perverse effect of restricting the movement of the capital that remained in the country. Hence, capital controls allowed the Malaysian authorities to reduce interest rates, but their measures had only a limited effect because interest rates across the region had fallen by then.
Jomo seems convinced that “there is little to gain from maintaining the current regime of [capital] controls.” He favors a system of closer prudential regulation that would moderate capital inflows, deter speculative surges, and include limits on foreign borrowing and a managed float of the currency with convertibility.
However, such measures, he insists, must be accompanied by greater cooperation among monetary authorities in the region – the first step toward establishing an East Asian monetary facility which, unlike the IMF, would provide needed liquidity to economies experiencing crisis.
For now, abandoning Malaysian capital controls, even allowing that their effectiveness remains a matter of controversy, would be a mistake. If capital controls are abandoned, reinstating them at the start of another financial crisis would face the vehement opposition of the most powerful actors in the international economy—the World Bank and IMF, the governments of the wealthy nations, and the largest financial and nonfinancial corporations.
This volume helps to foster an open debate on economic policymaking which Jomo rightly says Malaysia needs desperately. More than that, Malaysian Eclipse provides strong reasons why emerging economies must avoid the financial liberalization promoted by international organizations, and, instead regulate short-term capital flows and limit bank lending through prudential supervision.
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Abridged from a longer review published in World Policy Journal, Vol. XIX, No. 2 (Summer 2002) and used with permission from the World Policy Institute. John A. Miller is Williams Professor of Economics, Wheaton College, USA. |
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