Has Asia Recovered?

By Paul Krugman

Two years ago, a nasty virus emerged in Bangkok. It spread rapidly through Asia and beyond, often claiming seemingly robust economies as victims. But no new cases have been reported in the past few months, and most of the original victims seem to be past the worst. Like anyone who has been very sick and starts to feel better, they feel relieved, even euphoric.

But are we celebrating too soon? Pundits who want to sound judicious are fond of warning against generalizing. Each country is different, they say, and no one story fits all of Asia.

This is, of course, silly. All of these economies imploded within a few months of one another, and the logic of catastrophe--a combined banking and currency crisis, as panicked investors tried both to convert long-term assets into cash and to convert baht or rupiah into dollars--was pretty much the same everywhere.

Governments had no good options. If they let their currencies plunge, inflation would soar, and companies that had borrowed in dollars would go bankrupt. If they tried to support their currencies by pushing up interest rates, the same firms would go bust from the combination of debt burden and recession. In practice, countries split the difference--and still paid a heavy price.

In hindsight it is easy to find reasons why the countries deserved their punishment. Like most cliches, the catchphrase crony capitalism has prospered because it gets at something real: excessively cozy relationships between government and business really did lead to a lot of bad investments.

Suppose the U.S., which is pulling in overseas money at the rate of about $300 billion annually, were to see that inflow suddenly become a trillion-dollar outflow--which, on a relative basis, is what happened to Asia's crisis-hit countries. How solid would our financial system look?

Given that there were no good policy options, was the policy response mainly on the right track? There was frantic blame-shifting when everything in Asia seemed to be going wrong; now there is a race to claim credit when some things have started to go right.

The truth is that an observer without an ax to grind would probably conclude that none of the policies adopted either on or in defiance of advice given by the International Monetary Fund--which "suggested" that client countries tighten their belts and raise interest rates--made much difference either way. Whatever countries tried, just about all the capital that could flee, did. And when there was no more money to run, the natural recuperative powers of the economies finally began to prevail. At best, the money doctors who purported to offer cures provided a helpful bedside manner; at worst, they were like medieval physicians who prescribed bleeding as a remedy for all ills.

Will the patients stage a full recovery? As President Bill Clinton might say, it depends on exactly what you mean by "full." If by recovery you mean not just a return to growth, but a recovery that resembles what people used to regard as the Asian norm, the answer is almost surely no.

For one thing, the region's entrepreneurs are not what they used to be. By and large, Asian institutions that looked on paper like modern corporations were really overgrown family firms, whose growth depended on the personal wealth of their owners and their ability to leverage that wealth through bank loans. Well, it will be a long time before Asian banks are able or willing to provide the kind of funding they used to--and, in any case, the entrepreneurs, their fortunes slashed by the crisis, cannot provide the necessary collateral.

Even before the crisis there were indications that Asia was facing diminishing returns--that rapid growth was being sustained only by ever more massive infusions of foreign capital. Foreign investors may have stopped fleeing, but they are not going to pour in funds the way they did a few years ago.

Could the recovery be aborted, with an actual relapse? Not just yet. It would take several years of irresponsible borrowing to create the conditions for a repeat of 1997. Such things can be arranged, but the prospect does not seem imminent.

THE JAPAN SYNDROME

Inevitably, worries about Japan color the prospects of the whole region. And Japan was in trouble long before anyone even imagined that the words Asia and crisis could be used in the same sentence.

If developing Asia suffered from an acute, potentially lethal but short-lived fever, Japan suffers from a slow, wasting disease, the result not of the nation's vices but of its virtues. While there are many things wrong with Japan, the immediate problem is excessive thrift: Japanese households simply save more than the country's businesses can be persuaded to invest, even at a zero interest rate.

The classic response to such a 1930s-type trap is a fiscal jump start: use deficit spending to get the economy moving, and hope that this gets investors investing and consumers consuming. But after years of ever widening deficits--Japan will run far and away the largest peacetime budget deficit in history this year--the economic engine still shows no sign of catching. True, official statistics say the economy grew an astonishing 1.9% in the first quarter, a number that has mystified observers who look at other indicators and see no evidence of a boom. But there is no sign of a genuine, self-sustaining recovery, and it is all too easy to see how things could get considerably worse--indeed, how Japan could plunge into a nasty deflationary spiral if consumers keep their hands in their pockets.

Bizarrely, the Japan syndrome seems to have spread to Asia's other giant. China never caught the Asian flu, because foreign-exchange regulations--though they fostered inefficiency and corruption--prevented hot money from leaving and deterred it from coming in the first place. Instead, the problem is, believe it or not, excessive thrift. Incredibly for a developing country, China is experiencing pronounced deflation. In the end, China, like Japan, may be forced to roll the printing presses--a move that would not be possible without a devaluation of the renminbi, which would make the lives of the country's neighbors considerably more difficult.

In short, Asia will probably not have the same problems over the next two years that it had over the past two, but it is at considerable risk of having different problems. It ain't over until the sumo wrestler sings.

DID THE CRISIS HELP?

Adversity is supposed to come with a silver lining. Has Asia's crisis laid the foundation for sounder economic growth in the future? The answer is a definite maybe. The crisis has curbed some of the worst abuses of crony capitalism, and it has tempered the dangerous belief that "Asian values" somehow made the region's economies bulletproof. The crisis has also probably done some good by softening free-market fundamentalism: countries are less likely to be pressured into throwing their capital markets open to the world before their financial markets are ready, and Washington is less likely to view the main purpose of economic diplomacy as making the world safe for hedge funds. Above all, the crisis has reinforced democratic tendencies and made it much harder for paternalistic strongmen to claim they know best.

Still, it is hard to escape the feeling that a dangerous complacency is setting in. When Mexico started to recover from its 1995 "tequila" crisis, policymakers and investors alike acted as if it had been a one-time event, never to be repeated. But it turned out to be a dress rehearsal for the Asian crisis a year later. Because the world didn't end this time around, everyone is starting to believe that the situation is under control--even though proposals for international reform have been watered down to homeopathic levels. Could investors and countries really be foolish enough to make the same mistakes yet again? Of course they could.

Paul Krugman, a professor of economics at M.I.T., is the author of The Return of Depression Economics (W.W. Norton & Co.; $23.95), which was published in May