What a difference six months can make. As recently as last December, experts were calling the economic crisis in Asia a containable, manageable “correction.” Since then, the problems in the area have deepened and spread. Over the past few months, its financial markets have been subjected to continuous bouts of volatility.
That volatility, exacerbated by political upheaval in Indonesia and labor unrest in South Korea, has triggered a significant flight of capital from Asia to North American and European markets. Japanese investors bought a record $30.5 billion worth of foreign bonds and equities during the first 10 days of April. In the first five months of
this year, about $70 billion sluiced out of Indonesia. And analysts think Asian cash represents a major chunk of the $5.8 billion that has been pouring into American mutual funds every week recently.
This exodus of capital has had three potentially farreaching consequences.
First, it has added ftiel to the fires of North American equity markets. The injection
of “hot money” has helped to keep share prices aloft, even as corporate earnings show signs of losing altitude. But it has also added a heightened element of uncertainty to the market, because Asian capital could leave town as quickly as it arrived.
The second consequence of the Asian capital drain is that it has deepened the region’s economic recession and delayed its recovery. In the last half of 1997, about $17 billion in private capital flooded out of Asia. And last week, despite government efforts to prop it up, the Japanese yen fell to a seven-year low against the U.S. dollar. That happened in part because Japanese financial institutions have become net sellers of their own currency.
But perhaps the most enduring fallout from the Asian downturn is the increasing pressure to limit the free flow of capital among countries. Until recently, it was generally accepted that free movement of capital—like free trade in goods and services— is the best way to ensure that markets function at optimum efficiency. In other
words, capital will reward those who foster the best environment for it.
That assumption is now being challenged by a number of high-profile economists. Most of them focus their arguments on the existence of market imperfections—for example, unequal access to information— which distort capital flows and can cause severe damage in unsettled situations, such as the one in Asia.
Proponents of limiting capital flow also use the example of Chile to bolster their case. Since 1991, Chile has required that foreign investment remain in the country for a minimum period of one year. Furthermore, foreigners who invest in Chile must deposit 30 per cent of the money with the central bank for one year, without interest.
The exodus of capital from Asia has added fuel to the fires of North American equity markets
Although the costs of capital in Chile are high—about twice the cost in neighboring Argentina—the country has produced the most stable economic growth record in Latin America. Chile has also been singled out as a free trade partner by Canada and is a member-in-waiting of the North American Free Trade Agreement.
Another element of the
push to contain disruptive capital shifts comes, albeit indirectly, from
Canada. At recent meetings of the International Monetary Fund and the Asia-Pacific Economic Co-operation forum, Finance Minister Paul Martin advanced the idea of an international watchdog to act as an early warning system for weak financial systems. As with the call for capital flow limits, that proposal is part of a broader ideological trend: the resurgence of central government influence and intervention as merged corporations expand their grasp and global markets mature.
Of course, curtailing capital movement is not a new idea. Economist James Tobin, for one, has long advocated a tax on “hot money” that would retard the speed at which it moves, and frequently disrupts, fragile economies. The debate may now be worth having, but Asia is a bad case upon which to base any thesis in favor of limits. That is because free-flowing capital is at its most destructive when, as in Asia, information is unavailable or incomplete, domestic banks are weak and government corruption distorts economic reality.
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