keynes and the asia crisis

8/3/2019 Keynes and the Asia Crisis

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The Asia Crisis

• Who are the AsianTigers?

• In the mid-1990s wespoke of the “AsianTigers” with awe.Heavy savings and

investment, rapiddevelopment. Activist,statist economicplanning

• Singapore



Countries Affected in the Contagion

• Thailand, July, 1997

• Indonesia, June to August, 1997

• Korea, July, 1997

• Japan had already been through its own crisisearlier and was in an economic depression

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



The Asian Crisis: BOOM ANDBUST

• First Phase: Currency undervalued topromote exports. Government picksand promotes “winners” (major projectsand firms).




• Second Phase:Export successes produce large

earnings.Heavy investment inflows by the early1990s.

Available – a plethora of capital.




• Inflation should have produced somecurrency devaluations in these

countries, but currencies were tied toUS Dollar, which was appreciating atthe time. Currencies were thenovervalued..

• A bubble starts to develop – Banks not monitored.



The Asian Crisis: Financeand the Bubble

• Japanese rice subsidies inflate thevalue of land to promote the realestate bubble. Huge real estateinflation and subsequent collapse.

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




• Only modest returnsneeded with interest

rates very low.Emphasis on marketshare and growth, noton profits in Japan.

• Japan was thegovernance model for“statist” Asian

economies.

Bangkok, Thailand

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• Bad debts accrue.Investors look for

larger returns, butthese have higherrisks.

• “Keep the FinanceMinistry off our case.”

• Non-FunctioningLoans fill bank

portfolios.

Bangkok, Thailand

A i C i i Th Fi

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Asian Crisis: The FinanceProblem

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

• With capital mobile, flight can occurwith any provocation. (Modern versionof a run on the bank.)

A i C i i Th Fi




• Stock values plummet as they are soldoff.

• Currency values?

• They drop precipitously as funds are

sold off then the yield is exchanged forthe investors’ currencies.

A i C i i Th Fi




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

• Severe recession begins as consumptionand production expenditures falter andprompt layoffs.Foreign exchange is now so costly thatneeded production inputs and consumergoods cannot be afforded.



Three mistakes of Asian Lenders

• The countries involved usually hadsome 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 andloaned in local currency. No hedging tocounter foreign exchange risk.



Three mistakes of Asian Lenders

Asian bankers often did not ask to seeconsolidated balance sheets. They

didn’t monitor the total assets andliabilities of the borrowers.

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



Keynes and the CorporateGovernance Problem

• What is Keynes mostnoted for?

The General Theory of Employment, Interest,and Money ,

Chapter 12, “The Stateof Long-termExpectation.”

Lord Keynes



Keynes and the CorporateGovernance Problem

What did this chapteraddress?

Written to solve theproblem of the greatdepression, thischapter turns out to

be the intellectualfoundation of postwarthought on economicgrowth and planning.

Lord Keynes



The Investment Problem: Choosing theRight Projects under Uncertainty

• Personally acquainted with theuncertainties of investment prospects

and market performance, Keynesnoted:

• “the extreme precariousness of the

basis of knowledge on which ourestimates of prospective yield have tobe made,”



The Investment Problem: Choosing theRight Projects under Uncertainty

• What is precarious here?

Our ability to deal with the future’suncertainty.

• What are investors engaged in“enterprise”?

• Those who will “purchase investmentson the best genuine long-termexpectations he can frame.”



America’s Wall Street: Speculation

There are also the “game-players” whoare involved in the speculation that

seeks for capital appreciation ratherthan income. Such speculation hefound to be particularly common

among Americans.




What did he believe they were interestedin?

“unduly interested in discovering whataverage opinion believes averageopinion to be.” This “nationalweakness finds its nemesis in the stock

market.”




Keynes believed investment outcomeswere“a result of animal spirits -- of aspontaneous urge to action rather thaninaction, and not as the outcome of aweighted average of quantitative

benefits multiplied by quantitativeprobabilities.”



The Keynesian Conclusion

• Due to the difficulties ofinvestment uncertainty,

“I expect to see the state,

which is in a position tocalculate the marginalefficiency of capital-goods onlong views and on the basis ofthe general social advantage,…

.



The Keynesian Conclusion

…taking an ever greater

responsibility for directly

organizing investment.”

After WWII, economic

planning was adopted bymost nations.



National economic plans

• What would be the objective of anational economic plan?

• Plans enunciated the aims and guidingprinciples of development policy,




• described the desired development ofthe country as a whole,

• described development of the

economy’s principal sectors, • provided estimates on production and

investment figures.

Often a plan was “consideredsynonymous with a program ofinvestment projects.”




• Most plans were relatively innocuousas compared to the comprehensive

and authoritarian planning of the Sovietbloc countries.



Planning Results

• Over the next few years, few positiveresults recommended continued

planning, so most nations downsizedtheir planning experiments into variousforms of “structural policies.”



Planning Results

• In Japan, the model Asian developmentcountry, postwar MITI was to “target a

potentially growing industry andimplement an industrial policy that wouldenhance productivity in that industry andultimately improve its competitiveness in

the global market through coordinatedefforts by the government and businessleaders.”



Planning Results

• Targeted industries were plied with capitalfrom the local bank, as directed by the

Ministry of Finance. Japanese industrialpower was perceived as a function of itsability to administer “guided capitalism.”



How successful was the Japanesedevelopment model?

-- Japanese savings are immense.

The Japanese Model of Economic Development



-- The American market is an openexport target for Japan,

• -- Deming’s Quality Control and

world class manufacturing,




-- Large NetExport Earnings,

• -- Japan seen asthe world’s first

economic

superpower.


Tokyo Stock Exchange



“Insurmountable” US Problems

• For whom does U.S. industry produceits fruits?

• What is corporate governance?

• The U.S. system of corporategovernance is designed to assureshareholder earnings.




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

• Critique: “Preoccupation with thebottom line is hostile to long-termprojects which might generate returnslater but which may not be profitable at

the present.”




• Selecting projects without regard totheir short-term profitability is viewedas a disadvantage to their strategicperformance.

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



Michael Porter on Government Policy

• “Government is prominentlydiscussed in treatments ofinternational competitiveness. Manysee it as a vital, if not the mostimportant, influence on moderninternational competition.



Michael Porter on Government Policy

• Government policy inJapan and Korea isparticularlyassociated with thesuccess thesenations’ firms have

enjoyed.”

The Competitive Advantage of Nations The Free Press,

1990), p. 126

ester urow: ea to ea



ester urow: ea to eaStrategy

• Early 1990's: there is no way tocompete against Japan and Europe,Thurow said, without restructured

antitrust laws. Larger units must becapable of competing with the morelong-term oriented keiretsu of Japan.

L t Th A H d t H d



Lester Thurow: A Head to HeadStrategy

• Implement measures that makeinvestments in American corporationsmore long-term.

ester urow: ea to ea



ester urow: ea to eaStrategy

• A national strategy ornational industrialpolicy essential tosurvival as a competitorin world markets.

• See Head to Head: The

Coming Economic Battle Among Japan,Europe, and America, New York: WarnerBooks, 1993.



Investment processes became globalized.

• By the early nineties, a net transfer offinancial resources flowed into Asia. Itsupplemented gross domestic savingsin the Asian countries.

• Capital poured in from the West, but aconsiderable share also came fromJapan, and other Asian countries

investing in their less developedneighbors.



Investment processes became globalized

• The United States also became amajor supplier of funds to Asia and the

rest of the world, both through directand portfolio investment, the sum ofthese being $178 billion in 1993 and

$119 billion in 1994.

When the Bubble Burst




• What happened when the bubble

burst?• Worldwide, foreign direct investment isfar and away the largest part of netfinancial flows to the developing

economies.

When the B bble B rst




• These are highly concentrated andnearly 75% flowed to the ten largestrecipients in Asia and Latin America

• The onset of the crisis for 22 countriesof South and East Asia in 1997 madeitself manifest with an outflow ofapproximately $92 billion in short-termborrowing, stock market net flows, andnet outflows of funds from domesticresidents.





• Stock markets crashed, nationalcurrencies collapsed, and imports andproduction shriveled up miserably.

keynes and the asia crisis

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