[Viewpoint] Asia’s take on austerityThe austerity debate was, with good reason, the topic du jour at this year’s World Economic Forum in Davos, Switzerland. Europe is slipping back into a recession just when recovery in the U.S. is finally getting some traction, undermining the case for fiscal consolidation which is so heavily favored in Europe.
Yet I took away a different conclusion from Davos. I moderated a session on “The New Context in East Asia,” addressed by a panel of senior representatives from Thailand, Korea, Malaysia, Singapore and Japan. With the exception of the Japanese participant, all had first-hand experience with the devastating Asian financial crisis of the late 1990s.
I couldn’t resist the temptation to draw Asia into the debate between Europe and the U.S. Rather than ask the Asian panelists to theorize about the impact of austerity in the overly indebted West, I asked them to assess their own experiences during and after the crisis of the late 1990s.
Frankly, I was surprised by what I heard. The panelists agreed on two points: First, they initially detested the wrenching adjustment programs dictated by the terms of the International Monetary Fund’s so-called conditional bailouts (the Koreans still scornfully refer to the crisis as the “IMF crisis”). Second - and this was the real surprise - they agreed that with the benefit of hindsight, these excruciating adjustments were worth it because their crisis-torn economies were forced to embrace structural reforms that led to their spectacular economic performances today.
On the surface, the numbers speak for themselves. In 1998, during the depths of the Asian crisis, aggregate output in the so-called Asean-5 - Indonesia, Malaysia, the Philippines, Thailand and Vietnam - plunged by 8.3 percent. Real GDP in Korea, long considered the darling of Asia’s newly industrialized economies, contracted by 5.7 percent that year. But then the tough conditionality of IMF bailouts and adjustment programs kicked in.
In response, current account balances went from deficit to surplus. For the Asean-5, current account deficits averaging 4 percent of GDP in 1996-97 swung dramatically into surpluses of 6.8 percent of GDP in 1998-99. A similar transformation occurred in Korea, where a 2.8 percent current account deficit in 1996-97 became an 8.6 percent surplus in 1998-99.
Since then, the region has never looked back. Within two years, most of Asia’s crisis-ridden economies had regained their precrisis peaks. Nor was this a temporary rebound. Beginning in 1999, the Asean-5 began a ten-year spurt of 5 percent average annual GDP growth. In short, there were no lasting negative effects from the dose of austerity, and the long-term benefits have proven to be both enduring and astounding.
Three lessons for the rest of us come to mind. First, there is no gain without pain. Few in the developed world can fathom aggregate output contractions on the scale that Asia suffered in the late 90s, let alone muster the political will to impose them on our economies. The economic dislocations and the humiliation of proud nations were indeed devastating (as Greeks today can attest). But once the excesses were purged, Asia’s post-crisis rebounds were both strong and sustainable.
Second, currencies played an important role as an escape valve in the early days of Asia’s post-crisis adjustment process. As the region moved from hard exchange rate pegs to floating rates, Asian currencies plunged, with drops against the dollar ranging from 28 percent in Korea, roughly 37 percent in Thailand, Malaysia and the Philippines to almost 80 percent in Indonesia.
Finally, there is no substitute for restructuring. In Asia, measures aimed at the financial sector dominated IMF-imposed structural adjustment programs, but there were also programs that focused on tax and expenditure reforms, corporate governance, privatization and business debt restructuring. Not all of these programs were implemented in strict compliance with IMF conditionality, but they played a key role in promoting significant improvements in Asian competitiveness.
None of these lessons should be lost on Europe or the U.S. While individual countries lack currency flexibility in a monetary union - one of Europe’s most obvious and important differences from Asia in the late 1990s - there is nothing to prevent a depreciation of the euro from boosting pan-regional competitiveness. The same, of course, is true of the U.S. dollar.
But no country has ever devalued its way back to prosperity, so Asia’s structural lessons are equally important to the developed world. Germany’s economy is outcompeting and outgrowing the rest of Europe, largely owing to labor market reforms and deregulation. The same might prove beneficial to the rest of Europe - to say nothing of the U.S., which faces a major competition challenge of its own.
In the end, Asia’s developing economies had no choice but to accept draconian measures as the price of bailouts. It remains to be seen if rich and developed countries are willing to take the same route. Two decades ago, in their book “Changing Fortunes,” Paul Volcker and Toyo Gyohten underscored the glaring double standard of crisis resolution: “When the [International Monetary] Fund consults with a poor and weak country, the country gets in line. When it consults with a strong country, the Fund gets in line.” Perhaps that is the key lesson from the Asian crisis: Austerity can work. But its success or failure ultimately boils down to power politics - namely, a resolution of the tension between short-term palliatives and the commitment to a long-term strategy. That’s where the battle still rages in the West.
Copyright: Project Syndicate, 2012.
by Stephen S. Roach
* The author, former chairman of Morgan Stanley Asia, is a member of the faculty at Yale University and the author of “The Next Asia.”