Asian downturn

DELEGATES to the World Economic Forum at Davos this year came despondent and left in despair. Both the discussions and the new evidence released at the Forum indicated that the global crisis was not just bad but worse than originally anticipated. One damaging projection came from the International Monetary Fund (IMF) in its Update to the World Economic Outlook, released in January 2009. It declared: Global growth in 2009 is expected to fall to half per cent when measured in terms of purchasing power parity and to turn negative when measured in terms of market exchange rates. This represents a downward revision of about 1 percentage point from the November 2008 WEO Update.

Fear stems not just from these distressing figures. It is also triggered by evidence that the recessionary trend is affecting Asia as well. Developing economies in Asia, which as a group grew at 10.6 per cent and 7.8 per cent in 2007 and 2008, are now expected to grow at just 5.5 per cent or 1.6 percentage points lower than projected as recently as November last year. Japan was already contracting by 0.3 per cent in 2008 and is projected to see that figure becoming 2.6 per cent in 2009.

But the three growth engines in Asia the ASEAN-5 (the five original members of the Association of Southeast Asian Nations, namely, Indonesia, Malaysia, the Philippines, Singapore and Thailand), China and India also now seem to be badly affected by the crisis. The ASEAN-5 economies, which grew at 6.3 and 5.4 per cent in 2007 and 2008, are now projected to grow at 2.7 per cent in 2009 (down 1.5 percentage points from the November 2008 estimates). The corresponding figures for China are 13.0, 9.0 and 6.7 per cent (1.8 percentage points) and for India are 9.3, 7.3 and 5.1 per cent (1.2 percentage points). Moreover, the IMF has predicted a damaging immediate future for South Korea, with its economy projected to contract by 4 per cent this year.

Estimates from national sources and elsewhere are less pessimistic than the IMFs, but there is consensus that outside the United States it is Asia where the recession is biting most. This is of significance because when the crisis was just beginning to unfold, optimists pointed to Asia as the shock absorber of the global downturn. It was argued that a decoupled Asia would, through its own growth and the demands that it would make on the worlds output, ensure that the financial crisis, which was largely a phenomenon restricted to the developed countries, would not have as damaging an effect on global growth as the pessimists, then in a minority, were predicting.

Implicit in this confidence was the view that Asia was a region where the turn to market-friendly policies was undertaken in a form and at a pace that had strengthened these economies and delivered an Asian century. When sceptics pointed to the East Asian financial crisis, they were countered with the view that 1997 was an aberration that resulted from cronyism or some such intangible, and not from liberalisation and global integration. This privileging of Asia was ideologically important since neoliberal policies were fast losing their credibility in Latin America and Africa.

Integration and the neocolonial exploitation of the continents resources had not only left much of Africa severely damaged but had undermined the nation state in many countries to a degree where reconstruction required not just radical economic realignment but also major political ones. And in Latin America, with its geographical proximity to the U.S., the early shift to more liberal, open-door strategies had not just made it the original site of modern-day financial and currency crises but delivered two lost decades when assessed in terms of economic growth.

It needs noting that the fruitlessness of neoliberal strategies forced many Latin American countries, exhausted with seeking foreign capital that triggered a net drain of foreign exchange rather than growth, to search for alternative strategies. In time, that enforced search had political repercussions, strengthening democracy and bringing to power in many countries left-of-centre forces, which were voted to power because of their promise to reverse neoliberal policies. The resulting turn in economic policymaking in Latin America has had positive consequences.

In the past, a crisis in the U.S. and other developed countries proved damaging for Latin American countries, dragging them down to degrees far greater than the crisis in the developed countries itself. However, this time around, growth in the developing countries of the Western hemisphere, which was estimated at 5.7 and 4.6 per cent in 2007 and 2008, is expected to fall to a positive 1.1 per cent in 2009. That is, the continent seems to have escaped the kind of contraction it was prone to in the past when the global economy faced crises of even lesser intensities.

It was the failure of neoliberalism in the rest of the world that resulted in Asia emerging as its showcase, with global capital talking up these economies and attempting to garner the support of domestic elites for neoliberal policies. As success accompanied each turn in policy, the shift to a regime that opened these economies to trade, foreign direct investment and purely financial flows intensified. Asia came to symbolise the benefits to be derived from liberalisation and global integration and epitomise the view that the world is flat with no walls to climb.

Over the last two decades and more, this shift towards neoliberal strategies has indeed transformed Asias relationship with the rest of the world. While the region was earlier home to a few mercantilist, export-oriented economies such as Japan, South Korea and Taiwan, in time every Asian economy, including the biggest, was looking for a market abroad, with some like China proving extremely successful in manufacturing and others like India in services.

Moreover, while Asia could be proud of a high degree of regional integration through trade and investment flows, this integration reflected not the decoupling of Asia from the rest of the world but the creation of an export platform in which multi-country production networks created products that were targeted at world markets. Production processes were segmented, and these segments, each located at an appropriate site that generated intermediate products, were combined at a final location (such as China) to be shipped abroad.

The other impact of the process of liberalisation and integration was a sharp increase in foreign investment flows to the region, including large inflows of portfolio capital. A concomitant of this inflow was the liberalisation of rules regarding the presence and operation of foreign firms, including financial firms such as banks, merchant banks, insurance companies, hedge funds and private equity firms. Capital inflows in many countries in the region were far in excess of that needed to finance their current account deficits. In fact, some countries with current account surpluses were also recipients of large capital inflows.

If capital inflows were not needed to finance net current foreign exchange expenditures, and the exchange rate regime was liberal, central banks had to intervene in the market for foreign exchange to stabilise appreciating currencies since such appreciation would subvert the process of export-led growth. A consequence was the accumulation of large foreign exchange reserves in the vaults of the central banks in a number of Asian economies. These reserves, as is now well known, were invested in safe and liquid assets such as U.S. Treasury bills and other forms of agency bonds denominated in dollars. That is, foreign savings flowing to Asian emerging markets were not needed to finance domestic investment because domestic savings rates were adequate to sustain the relatively high rates of investment in these economies. The idea that there was a savings glut in these countries that accounted for capital outflows from them was a misconception.

This did not mean that foreign exchange inflows were not important for growth. The liquidity overhang generated by these flows and the change in financial behaviour brought about by financial liberalisation broadened the market for housing investments and purchases of automobiles and consumer durables since even those with relatively insecure jobs were provided access to credit to finance those expenditures. This did expand demand and spur growth. In sum, the macroeconomic scenario in which current account deficits were small or current account surpluses were significant, where credit financed consumption and housing investments were on the increase, where investment and growth were high and where foreign exchange reserves were large, was a result of the successful shift to a neoliberal regime.

Given these forms of integration, it is not surprising that an Asia that was experiencing robust growth until recently has been affected quite adversely by the global financial and economic crisis. As the financial crisis unfolded, foreign financial investors in need of capital to cover losses and meet margin calls at home unwound their positions in Asia, resulting in a collapse in stock markets in many Asian economies. Countries such as China, India and Vietnam, which had seen their stock markets outperforming those of their global competitors, were the ones that recorded the steepest falls.

The outflow of capital put pressure on many currencies, forcing central banks to unwind a part of their reserves. A liquidity and credit contraction ensued. Foreign financial institutions that were located in these countries and were facing difficulties in global markets had to downsize or close, leading to ripple effects in domestic economies. Domestic financial institutions exposed to sub-prime mortgage-related assets recorded large losses. Finally, the global economic recession slowed export growth in these increasingly export-driven economies. All this generated an Asian version of the global financial and economic crisis, which is what the collapse in aggregate growth figures reflects.

The intensity of this Asian crisis sends out a larger message. Neoliberalism had failed in Africa and Latin America but had earned a new lease of life in Asia, where it was not imposed on many national governments but owned by them. The first challenge to the regime came in 1997 when the financial crisis broke in some of the strongest economies in the region. But the forces advocating neoliberal ideology survived that challenge and intensified the process of liberalisation and integration. The current crisis poses a second and stronger challenge because finance capital that advocates neoliberalism is seen as responsible for it. It is to be seen whether the advocates of neoliberalism will overcome this challenge as well or whether the ideology will be fundamentally discredited.