By Michael Heller, The Asian Financial Crisis and the nature of East Asian political economies
Chapter Two
The incomplete transition
by Michael G. Heller [I have added some italics as highlighters]
Joseph Schumpeter once complained that ‘historians of crises primarily talk about stock exchange events, banking, price level, failures, unemployment, total production and so on—all of which are readily recognised as surface phenomena or as compounds which sum up underlying processes in such a way as to hide their real features’. Asia’s financial crisis is no exception: rather than the result of isolated errors and the faulty working of credit mechanisms, it stems from more deep-rooted, structural weaknesses. The crisis has revealed an underlying ‘crisis of disproportionality’ between the slow pace of institutional development at home, and the fast-changing process of global economic integration.
Asian governments fell victim to a series of errors in the way they perceived the region’s political economy: a nostalgic faith in economic planning and interventionism; premature confidence that Asian high-performers were rapidly evolving into modern capitalist societies; and a naive emphasis on capital accumulation at the expense of qualitative appraisals of real market transactions. Prolonged statism, secrecy and monopolistic behaviour meant that, by the 1990s, Asia’s crisis-prone high performers had lost the flexibility to adapt to changing economic conditions. Failure to safeguard legitimate entrepreneurial activity made several economies vulnerable to booty-seekers long before the crisis broke.
While there is no panacea, it is doubtful whether technical ‘fixes’ can be meaningfully implemented without broader domestic institutional reform. There is a long-term relationship between political pluralism and economic pluralism. Governments have numerous options for regulating capital flows and other economic activity as a basis for sustainable growth and development, but the ability to use these tools well depends on a commitment to uniform ownership rights, and to a mobile social order.
Dirigiste fantasies
The financial crisis should have dispelled a few myths about Asian banking institutions. In 1993, the World Bank argued that the region’s high-performing economies had attached importance to promoting stable and well-regulated financial institutions, with depositors protected from bank defaults. There was a widespread perception that close contact between government and business in the region had helped to enable monitoring and sharing of information. Thus, the World Bank pronounced that ‘routine, often daily interaction enables regulators personally to assess the riskiness of a bank’s portfolio’ (World Bank 1993). Despite reservations about moral suasion, restricted market entry, weak disclosure rules and interlinked ownership between banks and firms, the World Bank concluded that the region’s governments could respond rapidly and effectively to periodic crises caused by insufficient supervision or speculative lending. It gave cautious praise to government-directed credit programmes in Japan and South Korea, arguing that credit appeared to have been allocated according to commercial rates of return and ‘objective lending standards, rather than on the basis of political considerations’ (World Bank 1993).
Supporters of a dirigiste approach to development policy were wholehearted in their commendation of Asia’s government-directed credit programmes. Successful late development, as in South Korea and Taiwan, could not be achieved without ‘financial repression’ (Amsden 1989). A crucial element in this strategy was government allocation of credit as a political device to encourage industrialisation. The superficially plausible advantages of a credit-based system in developing countries are fourfold: it allows for faster investment ‘than would be possible if investment depended on the growth of firm’s profits or on the inevitably slow development of securities markets’; it permits the ‘selective fostering of key sectors’; it ‘helps avoid the bias towards short-term company decision-making inherent in a stock market system’; and leverage over firms enables governments to build ‘social coalitions’ to support national industrial strategy (Wade 1988). Companies are less likely to oppose the government when it has the power to cut a firm’s credit lines. As well as a lender of last resort, government is justified in supporting banks imperilled by loan losses. In the event of solvency problems, there is an obligation on governments in developing countries to help ‘socialise’ the risk, otherwise ‘firms are likely to borrow less, and banks to lend less’. The system can also encourage banks to become shareholders in companies, and governments to become shareholders in banks, since it is ‘imperative … for the supplier of credit to become intimate with company management’. The system requires government and banks to develop an ‘institutional capacity to discriminate between responsible and irresponsible borrowing, and to penalise the latter’. Finally, government must be able to control financial flows in and out of the country, otherwise it will be unable to guide investment allocation.
It is difficult to imagine a general prescription more calculated to lead to financial crises. The assumption on which this whole thesis rests is tenuous at best: that government can or will evolve and then sustain indefinitely the capacity to monitor performance and to penalise irrational credit allocation. But as economies grow larger and more complex, so allocating credit rationally becomes proportionally more difficult. Moreover, the more regulatory, allocative and productive functions a government has, the more likely it is that monitoring and compliance will be relaxed, as links of interest develop between officials and non-state players. Asian bank monitoring tended to degenerate into relationships that weakened credit-risk assessment. Statism, even if temporarily effective, self-destructs once interest groups consolidate within and around unaccountable government policy institutions. The technical aspects of planning become too demanding, and create opportunities for corruption and abuse of power. Thus, the state loses the ability or willingness to be selective, responsive and flexible in the face of changing social and economic conditions.
Errors of foresight; lessons of hindsight
The favourable and influential dirigiste analyses of East Asian financial instruments were clearly wrong. They called for great faith in human nature or in Asian cultural values, and did not foresee that deliberately fostering ‘intimate’ relations between regulators, banks and firms would lead to rent-seeking, or that the principle of ‘socialised risk’ would make companies inefficient. Socialised risk allowed firms to borrow, and banks to lend, far more than a market-based credit system would have permitted.
This system worked in the 1970s, when governments in countries like South Korea focused only on maintaining incentives to spur export growth. By the 1990s, however, its consequences had become disastrous; dirigiste discipline had declined into something akin to institutional rigor mortis. Controlling capital flows in and out of the country had not improved the judgement of government bureaucrats. Had banks and firms borrowed internationally at their own risk, it is doubtful whether South Korea would have accumulated the large short-term foreign debt in the mid-1990s that helped precipitate crisis in late 1997. Exposure to international credit-risk standards in the 1980s could have encouraged greater discipline in domestic lending more generally. Subsidised finance to heavily protected firms was the central element in the South Korean model of industrialisation. According to one estimate, the average cost of loans throughout the 1970s was -6.7%, encouraging the worst kind of speculative activity as ‘relatives in government lent money to relatives in business, piling money upon growth expectations and growth upon money expectations, somewhat like a chain letter or a crap game that worked year in and year out as long as the pie kept expanding’ (Cummings 1997).
Any advantages in being able to foster ‘key’ sectors through directed credit are just as likely to be outweighed by social and economic costs. Decision-making in this area is too subjective to withstand the influence of interest groups. Capital markets might perhaps be less inclined to encourage long-term company strategy than Asia’s state-centred credit systems, yet if they are run with adequate disclosure rules, enforceable regulations to minimise insider trading and carefully delimited controls on short-term capital mobility, stock markets can be excellent market-information systems, and are not so easily distorted by personal influence and graft. Indonesia’s stock market did not achieve these regulatory standards in the early 1990s, so companies could not use it to full advantage in developing long-range strategies. Finally, the supposition that government-directed credit will generate a bias towards long-term economic strategy conveniently ignores the tendencies of governments to make short-term decisions in pursuit of political survival and alliances which rely on dipping into the public purse.
In the wake of the Asian crisis, it became evident that most East Asian political economies had not institutionalised another of the basic tenets of a functioning market society: the universal expectation that business failure can lead to bankruptcy.
Despite evidence that loans were often geared to performance, and that export firms would be exposed to global markets, the policy mechanisms and relations between government and business which sustained financial repression also encouraged piecemeal discretion and incentives which could protect firms from the consequences of failure. After the crisis broke, it became clear that companies in the worst-affected countries could default without great risk of being held to account to their creditors under the law. Western investors had little chance of foreclosing on money owed to them by private or public companies. Implicit government guarantees to firms and banks could have significantly contributed to over-lending, over-borrowing and speculation. Bankruptcy proceedings after the crisis could have devastated young industries, but had rules been in place before the crisis, incentives for profligacy would have been fewer and disaster might have been avoided.
A question remains about why Taiwan fared better than its neighbours during the meltdown. Taiwan’s political economy, like South Korea’s, has been dirigiste, and for many years guided by a competent and meritocratic bureaucracy. As in South Korea, Taiwan’s banking sector was state-owned for much of the period in which growth took off. However, the state has tended to keep the private sector at arm’s length. Public-private networks in Taiwan are apparently less ‘dense’, less informal and less institutionalised than they are in Japan and South Korea, and business does not participate in economic policy fora (Evans 1992). The Taiwanese state has thus been unusually ‘autonomous’. The Kuomintang (KMT) regime ‘progressively exposed its “greenhouse capitalists” to the rigours of the market ... diminishing protection over time. Thus the state was able to enforce the emergence of a free market rather than allowing the creation of rental havens’ (Evans 1992). This pattern is more pronounced and enduring in Taiwan than in the East Asian countries which performed badly during the financial crisis. Taiwan’s microeconomic environment may also be unusually fluid and flexible (Economist 3 January 1998). It is as easy to start up new firms as it is for them to fail. The business sector has experienced ongoing ‘creative destruction’; state decisions alone cannot account for the flood of firms into new profit niches. Competition and fear of bankruptcy spurred productivity growth. Taiwanese companies are smaller, more responsive and lighter footed than those of most neighbouring countries. Gradually diminishing government-directed credit and infant-industry protection, combined with capital controls to prevent companies from taking on foreign loans for speculative projects, produced a more sustainable debt structure. The knowledge that the legal system upholds bankruptcy laws also encouraged prudent use of capital resources (Economist 24 January 1998).
Since Taiwan cannot gain recognition as a sovereign entity in international fora, external security priorities drive it to maintain a virtual ‘war economy’ capable of riding out crises. This may partly explain why technocratic decision-making was not dragged down by rent-seeking. Huge foreign-exchange reserves, together with limits on short-term foreign borrowing, protected Taiwan from the worst effects of the crisis. Together with the distinctive nature of Taiwan’s state autonomy, this produced a quasi-dirigiste polity which remained adaptable and flexible for longer than would usually be the case.
The rise and fall of South-east Asian capitalism
When Asia’s high-performing economies were expanding faster than any others in history, it was tempting to revise earlier analyses emphasising the traditional patron-client characteristics of the region’s political culture. Conventional wisdom since the 1960s had it that South-east Asian countries such as Thailand and Indonesia were patrimonial ‘bureaucratic polities’, whose élites were cut off from the societies which surrounded them. The system of parasitic office-holding was seen as a hindrance to modernisation because only ‘pariah entrepreneurs’ with good connections prospered. By contrast, economic growth and the increasing size and dynamism of the business sector suggested that the isolation of the bureaucracy and polity could itself be the source of state strength and developmental success (McVey 1992). This view chimed neatly with the plausible theory that ‘relative state autonomy’ is necessary during early stages of capitalist development, when the business classes were weak.
Ruth McVey’s 1992 analysis, Southeast Asian Capitalists, typifies a theoretically diverse pre-crisis literature which searched for signs of dynamic capitalist development in South-east Asia. Her starting point—ridiculing critics who believed that South-east Asian capitalism might be ‘ersatz’, or qualitatively second-rate—is especially pertinent: ‘The spectre of capitalism is haunting Southeast Asia. A most concrete ghost, it has revealed itself in office blocks towering above Kuala Lumpur, in banking palaces glittering amidst Thai district towns, and in the whitewashed mansions of an Indonesian elite whose wealth comes neither from land-holding nor bureaucratic position’ (McVey 1992).
It is unfortunate that McVey chose triumphal physical edifices, especially the ‘glittering banking palaces’, as emblems of South-east Asian capitalism. Within five years, the crash of the financial sector had pulled the veil from a construction boom which had become a speculative bubble of catastrophic proportions. Charles Kindelberger has described the ‘euphoria’ that precedes a crash, when the objects of speculation are, as they were in several Asian countries during the 1990s, visible real estate, golf courses, shopping centres and condominiums, and when the psychological stimulus to ‘overtrade’ is heightened (Kindelberger 1996).
In 1997, up to 35% of bank loans in Asia were committed to property, which had soared artificially in value until overcapacity set in and prices fell dramatically. Too much investment in construction is typical in countries which have over-guaranteed and under- regulated banks, and when there is complacency about future growth prospects (Economist 10 January 1998). The bubble bursts at the first signs of trouble, and there is a stampede out of speculative assets and into money, causing a sharp drop in the price of property (Kindelberger 1996). Owners default on their loans, and banks are no longer willing to accept property as collateral.
McVey’s analysis stressed the development of the manufacturing industry, and the growth of large-scale indigenous business corporations. She did not ‘read off’ capitalist progress from superficial manifestations of flaunted mercantile wealth, technology and middle-class consumption patterns. … Nonetheless, McVey’s concept of capitalism is representative of the bulk of the literature of this type. It is confined to ‘a system in which the means of production, in private hands, are employed to create a profit, some of which is reinvested to increase profit-generating capacity’. Sectors of the economy are thereby capitalist only ‘provided they are carried on in a capitalist manner and involve domestic capital’ (McVey 1992). Under this definition, McVey reaches the hasty conclusion that the growth of domestic capital that emerged from ‘the nexus of business, politics, and the state... has been central to the Southeast Asian capitalist upsurge’ (McVey 1992). Richard Robison has suggested that rent-seeking and clientism in Indonesia were absolutely necessary, or at least inevitable, when the emerging domestic bourgeoisie ‘rely upon privileged access to licenses, concessions, credit and contracts achieved through special relationships with the politico-bureaucrat appropriators’ (Robison 1986).
These approaches neglect important social and institutional features of long-term capitalist development. In particular, greater emphasis is given to the quantitative increase of ‘capitalists’ or ‘capital’ —almost always ‘domestic’ or ‘indigenous’ —than to the legal and civic environment in which business operates, or to qualitative measures of how markets actually function. It is clear that, in South-east Asia’s financial sectors, the state was more protective than catalytic, and that its actions were compromised by the economic interests of its officials. The state encouraged the private sector to make inappropriate or over-ambitious investments, and it helped to hide the extent of bad debt from foreign investors and international institutions.
In so often and actively taking the role of ‘guarantor’ of loans, the state also more or less nationalised private-sector debt. Supporters of dirigisme and state autonomy seemed not to recognise that effective autonomy required strong meritocratic institutions and a political commitment to building a post-patrimonial market society. These simply did not exist in countries like Indonesia. The alternative view—that states which limit themselves to ‘parametric’ policing functions will be more capable market regulators than ones that become overloaded by strategies of ‘pervasive’ economic intervention(White 1984)— was barely heard.
Thai finance: state autonomy and the autonomy of firms
The history of the Thai banking sector does not support the theory that patrimonial polities were rapidly becoming effective modern states. The major Thai banks began as associations of Chinese trading groups formed before and immediately after the Second World War. As in Indonesia, military leaders and ‘political bureaucrats’ found it expedient to utilise Chinese capital and entrepreneurial skills. Unlike Indonesia, where state banks remained dominant in the financial sector, this ‘alliance of convenience’ encouraged the rapid growth of a small number of large commercial banking conglomerates dominated by Chinese families which shared the same clan or dialect. These families invited leading Thai army or police officers and bureaucrats to become board members and shareholders. By the early 1980s, four families of Chinese origin controlled 62% of total bank deposits (Christensen et al. 1993; Suehiro 1992). Thai commercial banks operate a virtual cartel, collectively setting service-charge and loan rates (Warr 1993). While the government protected these banks from foreign competition, these conglomerates were attractive partners for incoming foreign investors.
In contrast to other Asian newly industrialising countries, the Thai government’s autonomy in the domestic financial sector was limited mainly to controlling the money supply (Laothamatas 1992). Regulations encouraged the close clustering of industrial groups around a few giant commercial banks, adopting a role which was functionally equivalent to the South Korean or Indonesian government-directed credit programmes: ‘Banks gathered the savings which financed expansion and made scale possible... identifying opportunities, smoothing relations with government, broking partnerships, setting up links overseas...[they] looked around for the best opportunities for growth, urged their business friends to pick these “winners”, supplied them with the capital’ (Pasuk and Baker 1996).
Nevertheless, there were sharp contests between state agencies and the banking sector once commercial banks had become relatively autonomous quasi-monopolies. By the 1970s, government technocrats worried that banks were becoming a source of economic distortion and financial instability. In the 1980s, the unusually independent Finance Ministry attempted to put some distance between banks and industrial firms, including efforts to diversify banks’ shareholdings. However, a World Bank-sponsored study in 1993 observed that ‘these regulatory efforts have failed. The big banks are typically family-controlled and closely linked to industrial firms owned by the same families … it becomes difficult to sort out who owns what, which complicates the efforts of the Bank of Thailand to assess the quality and riskiness of bank portfolios’ (Christensen et al. 1993). During the export take-off of the 1980s, the Central Bank provided guarantees to large commercial banks threatened by debt defaults in the industrial sector and soft low-interest loans to help them stay afloat, and continued to protect them from competition.
The transformation of the banking sector did not begin until the early 1990s, when competitive pressures were introduced through a rapidly growing stock market, the liberalisation of foreign exchange and an offshore banking scheme which allowed foreign banks to open branches in Thailand and capture a large portion of the foreign lending market. Thailand quickly became a ‘haven of financial freedom’ —requiring regulators to come of age at ‘breakneck speed’ (Financial Times 5 December 1994). New finance and securities companies played risky, complex and illegal games. In the past, the big banks had lent only to those they knew, and patterns of insider-dealing had been relatively predictable. By the 1990s, however, Thailand’s financial authorities needed a degree of policy flexibility and supervisory stringency that they did not have. Analysts such as McVey, who had detected the metamorphosis of the patrimonial polity into a modernising state, and Suehiro, who spoke of the creation of a world-class banking sector, were premature.
The weakness of the judiciary is one of the main reasons why Thai social relations remain shaped by authoritarianism and patronage (Girling 1990). Parliament gives a low priority to the legislative process and does not uniformly protect the rights of individuals in their dealings with the state. The antiquated civil-law code devolves significant legal power to administrative agencies (Christensen et al. 1993:19). Officials decide who wins and who loses from the regulation of business activity. Bureaucracy has such broad legal authority that deregulation could not be undertaken without the acquiescence of agencies which had in the past supervised the sector. Under these conditions, much-needed economic liberalisation only produced new forms of corruption.
Thailand was warned repeatedly by outside analysts in the years leading up to the crisis that ballooning current-account deficits, overheating and high levels of foreign debt risked major financial-sector problems in the event of any shift in the market mood. Once these problems peaked, foreign creditors felt little commitment to an economy where investor security was so unpredictable.
A closed community: financial sector rent-seeking in Malaysia
The Malaysian banking sector presents a mixed picture of limited dirigiste state autonomy undermined by patronage networks and a weak legal framework. Since the 1970s, the dominant players have been required to assume an overtly political role within an institutionalised financial ‘holding’ framework designed to promote the growth of an ethnic-Malay business class. According to James Jesudason, ‘two mechanisms were critical for the rapid ascent of the Malay bourgeoisie. The first was its access, from strong connections and political links, to enormous funds from...state-controlled and state-owned banks.’ The other mechanism was the ‘state’s regulatory power in opening up ownership opportunities for Malays in local and foreign companies ... It is hard to think of a country where the rich have burgeoned so quickly’ (Jesudason 1989:105).
The state’s commitment to augmenting Malay (bumiputera) ownership dramatically increased the government’s shareholding in commercial banks. As early as 1975, government patronage enabled three Malay banks to replace British houses as the country’s largest financial institutions (Crouch 1996). By advancing loans to business groups closely allied to the government, by 1982 bumiputera equity stakes represented 77% of the entire banking system, up from 3.3% in 1970 (Salleh and Meyanathan 1993; Gomez and Jomo 1997). In the 1990s, the government further consolidated the banking sector by restricting foreign ownership, limiting new licences and encouraging mergers.
The re-routing of resource flows brought benefits to some social sectors, but was detrimental to overall economic performance. It cultivated a ‘subsidy mentality’, with a middle class that clung to the state for employment, and a parasitic, rent-seeking and speculative business sector (Gomez and Jomo 1997). It also meant that the latent entrepreneurial energy of domestic ethnic-Chinese capitalists was diverted away from key export industries (Lubeck 1992).
In the banking sector, three problems stood out. First, ‘because the path to wealth has come so easily and without many risks, it is very tempting [for Malay entrepreneurs] to over-stretch and expand at a frantic pace, piling up dangerous levels of debt’ (Jesudason 1989). This left banks exposed to the possibility of major defaults. Second, since ‘business size and political influence have interacted as part of the new idiom of power in contemporary Malaysia … commercial banks [have] been more inclined to provide credit to larger establishments’ (Gomez and Jomo 1997). Third, reliance on an oligopolistic banking sector and directed-credit mechanisms to manipulate the flow of large-scale investment brought abuses of power: the ‘greatest corruption was in the banking system, especially in the state-owned banks where state managers oversaw enormous funds and could hide behind secrecy laws protecting depositors and borrowers’ (Jesudason 1989).
The legal aspects of these issues are crucial. One observer notes that ‘speculation and peculation’ discredited Malay enterprise because it allowed businesses to avoid market discipline and seek government intervention. Legal regulation offers little promise in contemporary Malaysia because ‘lawmakers have become too involved in the game themselves, and few officials have the courage and independence to enforce the controls that do exist’ (Sieh 1992). The independence of the judiciary is limited: ‘When court decisions have threatened fundamental government interests, the government has taken whatever action necessary to defend its position... the judges continue to be essentially conservative custodians of a political system dominated by the Malay elite’ (Crouch 1996).
Manipulating the legal system is one way in which Malay élites limit pluralism and control the flow of information. These are not conditions that foster confidence in property rights or the predictability of the investment environment. They tarnished Malaysia’s image in the eyes of the world, and contributed to the country’s vulnerability during the financial crisis.
Indonesia’s financial deregulation
Did liberalisation attack the foundations of Indonesia’s patrimonialism as it should, or did it simply encourage monopolistic rent-seeking? For a quarter of a century, President Suharto astutely managed the division of power between conservative technocrats and nationalist bureaucrats. The relative influence of these groups depended on the perceived policy needs of the day. The fall in oil prices in the mid-1980s sparked a series of structural adjustments. Technocrats saw the decline in oil revenue as an opportunity to liberalise an over-regulated and over-subsidised economy with vested interests in recycled oil wealth (Hill 1996). Assisted by overseas advisers, they introduced bold reforms in the late 1980s to restructure the economy and stimulate manufacturing and non-oil exports. In 1988, sweeping deregulation of the banking sector allowed more private national and foreign banks to enter a financial market previously dominated by state houses.
Reform was rapid and unbalanced as liberalisation outstripped the introduction of new regulations. In just 18 months, 40 new private banks had received licences (Schwarz 1991). Sudden financial liberalisation spawned near-boom conditions in the private sector, but new banks introduced gimmicky and risky schemes to attract savers, and few had experience of loan assessment or project appraisal. Liberalisation was taking place within the traditional patrimonial rent-seeking relations of government-business ‘cronyism’.
Credit analysis remained a matter of procedure rather than analysis; bankers relied on the name of the borrower more than assessments of the project’s feasibility. There are ‘no generally accepted accounting principles for measuring a bank’s health and the professionalism of many accounting firms is questionable. The absence of reliable financial reports makes the central bank’s monitoring responsibilities that much more difficult to fulfil ... Provisions for collateral enforcement are vague and many banks do not even bother trying to collect non-performing debt through the judicial system’ (Schwarz 1991). The Central Bank’s supervisory capacity was limited; there were no accurate data on loans which were in arrears or default.
The collapse of several major private and state banks in the early 1990s confirmed the financial chicanery of the political élite and the secretive and interlocked nature of government-business relations. It also reduced the pressure for reform. Nationalists claimed that financial deregulation had helped to send the country’s external debt spiralling out of control. However, official figures probably considerably understated total external debt even before deregulation (Hill 1996). Technocrats continued to defend the principle of reforms; what really mattered, they claimed, was how the borrowed funds were used (Schwarz 1994). Foreign loans had often been used unproductively because of corruption and political favouritism, while foreign banks were prepared to overlook the poor prospects of repayment as long as a state bank was involved in the project, thereby providing a de facto government guarantee.
These guarantees contributed to the sharp increase in Indonesia’s foreign debt from the late 1980s. After a ‘quarter century of … making ill-advised loans to privileged borrowers, the state banks entered the 1990s saddled with mammoth un-collectable debts’ (Schwarz 1994). Technocrats worried by the lax credit analysis of state banks formed a team to monitor all overseas borrowing for any project connected with the government. However, loan screening struck at the heart of cronyism, and its proponents were soon forced to waive some of these borrowing restrictions (Schwarz 1994).
Hall Hill concludes that Indonesia’s poorly developed regulatory regime survived relatively unchanged after the economic reforms of the late 1980s. Indonesia remained ‘a rather lawless society’ (Hill 1996). The severity of Indonesia’s financial crisis cannot be understood in isolation from the untrustworthiness of certified financial data, and the inability of the courts to protect investors and creditors.
Promising waves; dangerous undertows
East Asian financial repression invited rent-seeking. Accumulating state and private-sector capital did not significantly diminish patrimonialism in Indonesia. Banking-sector policies in Indonesia, Malaysia and Thailand remained guided more by the principles of bureaucratic polity than by state autonomy and market rationality. Financial-sector regulatory frameworks in South-east Asia did not help to establish arm’s-length relationships between government, judiciary and business. Asian financial institutions hid the true state of affairs from overseas investors and international institutions. Financial liberalisation was implemented in ways that would reproduce, rather than reduce, cronyism.
Arguing that countries should not have liberalised financial markets during the last ten years, that they liberalised too fast, or that they were somehow tricked into debt crisis, ignores the wider process which culminated in rapid financial liberalisation. Bad debt had accumulated for many years before deregulation, and East Asia’s financial institutions were in poor shape long before the crisis. A desperate need for new capital to roll over maturing debts or support clientist ‘mega-projects’ may have been behind the panicky way in which the financial sector opened up in countries like Thailand and Indonesia. Reforms are only as good as the mentalities, motives and institutions which shape them, which in turn partly reflect deep-seated patterns of economic culture.
Analysts failed to predict the Asian crisis in part because they tended to see the region’s development prospects in terms of policy dogmas, usually choices between state-centred and market-centred economic paths. Insufficient attention was given to the core institutional edifices which supported Asia’s emerging-market economies. In several respects, these remained incompatible with regulations on social and economic relations which, regardless of cultural difference, are universal elements of a functioning capitalist market society.
Financial institutions can least afford to be exceptions to these basic rules. Capitalism is, by definition, ‘enterprise carried out with borrowed money’. The fundamental impulse that sets and keeps the capitalist economy in motion comes from innovation (Schumpeter 1950). To innovate, an entrepreneur (or a developing country’s government and firms) must assemble the necessary financial resources. Economic development requires constant innovation. Bankers are thus a necessary evil because they fuel the engine of capitalist innovation. They are also easily blamed for widespread misery if they choose to call in debt from countries and firms which have failed to ‘realise’ their investments, to maintain a sustainable debt-equity ratio, or to accumulate sufficient reserves and investor confidence to see them through downturns. Bankers assess entrepreneurs largely on trust. It is rational that they should share a common ‘culture’ or outlook.
When different cultural understandings of what trust means come together in a bank manager’s office, adequate disclosure rules, standard accounting procedures and bankruptcy laws which carry a credible threat of being applied are the best ways to avoid misunderstanding.
Asia’s economic success depended on participating effectively in world markets. Restoring that potential will mean leaving behind the institutions and ideologies which eventually fettered the ability of Asian states to be flexible, responsive and selective. This means moving into a post-dirigiste era, a shift which implies greater pluralism, both political and economic. It also means restoring investor confidence and capital flows. Concepts such as ‘transparency’, ‘market-friendliness’, and ‘the rule of law’ may be hackneyed, but they are at the core of improvements in financial sectors—without them recovery is inconceivable. Policies will be thoroughly debated by economists, but the job will be easier if they also convey an understanding of the relationship between capitalist modernisation and the development of rational law. As long as state officials and enterprises operate without reference to these laws, and there is no credible threat that they will be implemented, politics and economies will remain patrimonial.
Once systematised and formal law replaces the arbitrary law-finding of patriarchal or autocratic administrations, safeguards will exist to encourage people to challenge monopolies and to question economic conspiracy. Countries may appear to be moving towards international legal standards, and might feel forced to adapt to rules required by foreigners in order to do business, but the real test is in the objectivity of adjudication and the consistency of implementation (Segal 1997). …
East Asia’s cultures of trust were temporarily effective in domestic business terms, but became irreconcilable with the assumptions and expectations present in fast-moving global markets. Debates in international fora about how to police cross-border financial dealings are a natural and healthy sign of the process by which regulatory change will be brought about. Yet we should not be shy of expecting players to conform to tried and tested operating norms which, though far from perfect, are already broadly successful and deep-rooted.
For a decade or more, investors and scholars were swept credulously along by the spell-binding claim that unique ‘Asian ways’ to economic growth did not need the institutional paraphernalia and normative expectations which governed economic transactions in the West. Now it is clear that rediscovering the route to an ‘Asian Century’ will require more than International Monetary Fund recipes for stabilisation, more than the perspiration and deferred gratification which had helped the earlier take-off, and more than simply recalibrating the central-planning tools which may have helped to kick-start industrialisation in an earlier epoch.
With increasing globalisation, Asia has little choice but to fall into line with the dominant norms of economic and political behaviour. Self-consciously ‘Asian’ leaderships which sought to carve out a distinct economic and cultural identity are now even more unlikely to be able to teach the rest of the world to adopt nationalist development discipline and unwritten codes of trust and consensus. Their own societies have in any case changed over recent decades in ways that make these codes seem antiquated. In response to internationalisation and the increasing size and complexity of national political economies, new middle classes are demanding greater ‘transparency’ and are more assertive about their political and economic rights. Outsiders have ample evidence that both the ‘unwritten codes’ and the ‘discipline’ were either ephemeral or double-edged. These countries can instead look to the cross-cultural institutional changes which characterise modern capitalism. Even if they do not always evolve at speeds that best match the economic moment, they at least work tolerably well.
Notable contributors to this volume include:
François Godement is Senior Associate, French Institute of International Relations (IFRI), and Professor, National Institute of Oriental Studies, Paris, France.
Michael Heller works at the Institute for International Studies, University of Technology, Sydney, Australia.
Michael Hobday is Professor of Innovation, Science and Technology Policy Research Institute (SPRU), University of Sussex, Falmer, UK.
Tim Huxley is Director, Institute of Pacific Asia Studies, University of Hull, UK.
Jean-Pierre Lehmann is Professor of International Political Economy, International Institute for Management Development (IMD), Lausanne, Switzerland.
Michael Leifer is Director of the Asia Research Centre, London School of Economics and Political Science (LSE), UK.
Anthony Milner is Professor of Asian History, Australian National University (ANU), Canberra, Australia.
Gerald Segal was Director of the Economic and Social Research Council (ESRC)’s Pacific Asia Programme, and is Director of Studies, International Institute for Strategic Studies, London, UK.
Michael Yahuda is Professor, Department of International Relations, London School of Economics and Political Science (LSE), UK.
[Michael Yahuda has been Social Science Files subscriber and regular reader since June 2022.]
Editor’s foreword, by Gerald Segal [d.1999]
This book is, in the jargon of the UK’s Economic and Social Research Council (ESRC), an ‘end of award’ volume. It is an attempt to bring together some of the best expertise that was supported by the ESRC’s Pacific Asia Programme, a £2.2 million research effort that included nineteen projects assessing various dimensions of success and failure in Pacific Asia. The programme, the largest single European research effort in the social sciences concerning Pacific Asia, began in 1994 and ended in March 1999, thereby encompassing both pre-crisis euphoria about Pacific Asia’s prospects, and post-crisis gloom. While several of its nineteen projects were badly surprised by the crisis, a pleasing number were warning of the problems that were to come. Incisive scepticism had been voiced especially clearly regarding Pacific Asia’s lack of welfare provision, the risks of ‘Asian-Values’ hubris, the failure to lay the basis for a post-industrial economy, the dangers inherent in neglecting political reform, and the difficulty in finding effective regional solutions to regional problems.
To reflect on what we have learned, and on what we believe is emerging in Pacific Asia, the Pacific Asia Programme invited colleagues from Australia to join the ESRC in evaluating the causes and consequences of the crisis, not least because Australia’s interests have become increasingly focused on Pacific Asia. This book is the result of that collaboration, and more specifically of a conference held at the British Foreign and Commonwealth Office in November 1998. The choice of venue in no way suggests that the product of the meeting constituted official UK government policy, but the connection with the concerns of policy-makers is evidence of the extent to which the ESRC’s Pacific Asia Programme took seriously its mandate to undertake policy-relevant work in close collaboration with government, business and the media.
This mandate was often pursued in the teeth of strong opposition from the British academic community. Throughout the Programme, and certainly in the production of the studies in this volume, the organisers ensured that the work of specialists was tested by regular constructive criticism from officials in the UK, Europe, Australia and further afield.
Partly for these reasons, the papers in this book may sometimes seem more like essays than was initially intended; those wanting more orthodox academic analyses will find them in the major book-length studies these authors have written, or are completing, on their chosen subjects.
[You have now reached the end of this Social Science Files exhibit.]
MGH retrospective 2nd April 2023
Indeed, see my book on Capitalism published ten years after this ESRC conference. The initial rationale for the book was that having spent many years studying Latin America and Southeast Asia I knew their underdevelopment commonality compared with The West was not cultural or a consequence of Machiavellian core-periphery inequalities but rather was their deficit of ‘capitalism’. Ten years after this ESRC conference The West itself erupted in financial crisis and, very unfortunately, did not manage the crisis in a ‘capitalist’ manner. The end result, building on earlier welfare state distortions, is that our own economies and institutions have transitioned to ‘fake capitalism’. My loud warnings at Project Syndicate about the dire consequences that would befall us all if The West did not follow Schumpeter’s creative destruction precepts and Weber’s depersonalisation precepts were not heeded by the mainstream. But anyone who is interested can read them by googling ‘michael g heller schumpeter financial crisis project syndicate’ or ‘michael g heller capitalism impersonal project syndicate’. I think they are still not gated or paywalled, and they probably remain relevant for understanding the causes and consequences of banking bailouts in 2023. I am really rather relieved to have moved on to study deep roots of Western governance with confidence that a hope for the future lies in discoveries about the past.
The Source of today’s exhibit has been:
Michael Heller, ‘Financial reform: the incomplete transition’, in Towards Recovery in Pacific Asia, edited by Gerald Segal (Series: ESRC Pacific Asia Programme), Routledge 2000
Social Science Files displays multidisciplinary writings on a great variety of topics relating to evolutions of social order from the earliest humans to the present day and future machine age.
‘The Heller Files’, quality tools for Social Science.