READING THE ASIAN AUSPICES

Europe shouldn't be smug about Asia's

financial troubles, says Francis Pike.

It could meet the same fate

I WAS recently commiserating with one of my Asian colleagues who had just Laid off 20 per cent of his employees. 'Don't worry about them,' he said. 'They have only just left the swamp — going back is quite easy.' He might have added that they will remember how to get out of the 'swamp': by hard work and not, one imagines, by clamouring for a Jospin-style 36-hour week, a policy that in Asia would be con- sidered an outrage to human liberty and an act of totalitarian thuggery.

Predictably, Europe's ruling establish- ment has barely reflected on the wider implications of Asia's financial crash. Recently an Italian diplomat gleefully assured me that the collapse of the Thai bhat and other Asian currencies demon- strated that Asia's economic miracle was over; Europe had nothing to fear from that quarter.

This sense of Schadenfreude has not been unfamiliar in Europe over the past few months. Many commentators have rather enjoyed the crises in economies that have been held up as models of growth. Indeed it was hard not to be entertained by the spectacle of Malaysia's Prime Minister, the acerbic and anti-West- ern Dr Mahathir, making a fool of himself by flailing wildly at foreign 'speculators', the media and multinational agencies. Korean commentators have also hinted darkly at a plot by the Americans and the International Monetary Fund to impose a humiliating settlement on their country. However, if we look at the reasons behind Asia's current problems, there are few straws of comfort for Europe's govern- ments.

Fixed parity currency systems, much loved by Europhiles with their ERM and EMU obsessions, lay at the heart of Asia's recent woes. As I toured Asia during the 1980s I would always stop in at the respec- tive central banks to quiz bureaucrats. There were notable differences: in the poorer countries the central banks nearly always had smarter offices than the richer countries. The Central Bank of the 'Mar- cos-hobbled' Philippines was particularly notable not only for its opulence but also for the notice in the lobby requiring visitors to leave their handguns at reception. I was also entertained by the Filipino bureau- crats who plied me with beer, cakes and sandwiches while clerks brought in hand- written ledgers and mechanical adding machines to calculate aggregate investment flows and other basic tallies.

When it came to currency policy, howev- er, the story from the central banks was vir- tually identical throughout Asia: 'We operate our currency adjusted to a basket of international currencies of which the US dollar is the major component.' Adjust- ment' to a bureaucrat, however, is a dirty word; it smacks of being led by the market rather than controlling events. As for politicians, currency parities become totems for themselves and their electorates. Over time, adjustable parity systems, like the supposedly adjustable ERM, become set in concrete. Asian currencies settled into a fixed lock with the US dollar.

For Asia this worked marvellously for the decade following the 1984 Plaza agree- ment; during this time the United States pursued a weak currency strategy which helped to price American workers back into employment. The free ride for Asia with its dollar-linked currencies only began to falter when the US economy began to improve in 1995. From this point the rapid appreciation of the dollar against the yen and the deutschmark began to undermine the competitive positions of the dollar- linked Asian economies.

The fixed exchange rate parities had other even more serious consequences. Over time Asian industrialists became used to the idea that a Thai bhat or an Indonesian rupiah had a fixed value against the US dollar, so they preferred to borrow low interest dollars rather than high interest rate local currencies. As a consequence their dollar debt grew rapid- ly. Between 1980 and 1996 Indonesian external dollar debt rose from $18 billion to $85 billion and increased from 22 per cent to 42 per cent of gross domestic prod- uct. The fixed parity systems led to massive over-borrowing and over-investment which, with hindsight, was the root cause of the financial crashes now afflicting Asia. When their currencies were finally deval- ued against the dollar, Asian businessmen were unable to repay their dollar-denomi- nated loans.

A second criticism launched at the Asian economies is that while superficially pursu- ing a course of free-market capitalism, the politicians and bureaucrats colluded at economic 'cronyism' through directed loans by banks to favoured customers. It is clear that this contributed not only to the Over-investment pattern in Asia but also to the crippling low return on capital evident in the banking sector. The corrupt nexus between political funding and directed bank loans was perhaps most extreme in Korea; a reality that became apparent to me in 1984 when I was a junior member of a team charged with preparing a report on behalf of the Asia Development Bank to advise the Korean government on financial and capital market deregulation. Not sur- prisingly, in the absence of any financial crisis, the Korean political and bureaucrat- ic elite shelved our suggestions to intro- duce transparency into the banking industry.

It is difficult, however, to see what com- fort my Italian diplomat or any such Europhile could draw from the origins of Asia's financial crash. Firstly, the Asian debacle adds another name to that list of 20th-century financial panics caused by fixed parity systems; the collapse of the gold standard, the failure of Bretton Woods, the 1992 ERM fiasco, the collapse of the Soviet 'rouble' bloc, and the Mexi- can peso crisis. In the face of such spectac- ular evidence, increasing in frequency as a result of the economic globalisation of the last decade, the Europhiles' continued belief in the virtues of fixed parity systems seems staggering. Rather than draw the conclusion that the organic pricing and fluctuations of the market are preferable to rigid currency systems, one fears that the Eurocrats will turn logic on its head and argue that the Asian crisis confirms the need for rapid monetary and political union. They should note, however, that when a currency parity system fails within a political union, the outcome is not just a financial crash, as in Asia's case, but a revolution, as in the case of Russia and the former Soviet republics.

As for 'cronyism' and politically directed lending, can we be certain that Europe is safe? Surely these were the very same sins that caused a $20 billion taxpayer bail-out of Credit Lyonnais. Why is it that the French banking sector achieves a 3 per cent return on capital compared to the United Kingdom's 20 per cent plus? In Germany the major commercial banks also achieve just an 8 per cent return on capital.

Although such comparisons with Asia should stymie any tendency to gloat over the Asian financial crash, we should also have real fears about what the crash means for European competitiveness. Exports from Malaysia, Indonesia, the Philippines and Korea are now 30 to 50 per cent cheaper for European consumers. Also, unlike the Latin-American debt cri- sis of the early Eighties, where the debt liabilities were largely used to sponsor government's 'white elephant' infrastruc- ture projects, Asia's private sector has accumulated high-quality industrial capac- ity. That capacity will he put to use by whoever ends up owning it. Far from reducing the threat of Asia, the region's financial crash will increase the competi- tive pressures on Europe while at the same time reducing the demand for luxury products from Europe. In anticipation of this downturn, the luggage-to-champagne luxury goods conglomerate LVMH (Louis Vuitton Moat Hennessy) has seen a 30 per cent fall in its share price over the last six Months.

While the scale of the structural prob- lems of the Asian economies should not be underrated, and it remains to be seen whether the politicians of the region have the political will to effect lasting change, nevertheless the reasons for Asia's vigorous growth over the past 20 years remain large- ly intact: young population structures with a high ratio of workers to non-workers, low government spending as a proportion of GDP (typically less than 25 per cent com- pared with over 50 per cent in Western Europe), competitive wage prices and a savings rates above 30 per cent compared to less than 10 per cent in most of Europe. By comparison with the 2,200 to 2,400 hours per year worked by an Asian, his European counterpart, even pre-Jospin, works just 1,700 hours.

A financial crash is not necessarily the same thing as economic failure. The Unit- ed Kingdom's 1992 'White Wednesday' departure from the ERM is an obvious example of how the financial markets can force politicians into beneficial policies which they have not the wit to follow of their own accord. Rather than gloating, Europeans should be wondering whether it will take a devastating financial crash to force their political and bureaucratic elite to dismantle the barriers to efficient alloca- tion of human and capital resources. With none of Asia's growth advantages but with many of its structural deficiencies, Europe's politicians should be quaking in their boots as they look out over the finan- cial wreckage in Asia.

The author is a specialist in Far Eastern affairs and works for an Asian investment bank `That's my a-wife in front of my ex-house with my ex-car . . . '