Malaysia's opportunity?


Did I personally destroy the world capital market by arguing in Fortune that Asian countries need a temporary period of currency controls? Surely not. Prime Minister Mahathir Mohamad must already have been close to making such a decision. Anyway, the first economy to stray off the reservation-to shift from a strategy of trying to placate international investors to one of confronting them-was, to everyone's surprise, not Malaysia but Hong Kong. And ultimately the real reason why the International Monetary Fund's strategy for Asia is now so close to unraveling is not what anyone says, but the sheer depth of the region's slump and its receding hopes for recovery.

Still, I probably need to offer some further explanation of why I thought, and still think, that temporary currency controls are a necessary component of a recovery strategy for Asia and also a very preliminary reading of Malaysia's moves.

You might think that proposing currency controls represents a radical departure from orthodox economics. But the ideas that underpin the IMF strategy are really bankers' orthodoxy, not textbook economics. To the extent that standard economic analysis says anything about how to cope with a sudden loss of investors' confidence in your country, it suggests that you should use monetary policy to maintain more or less full employment and let the exchange rate fall where it may. The United States itself practices a policy of benign neglect towards the dollar, even while advising other countries to defend their own currencies. There are reasons for this difference: Countries that are very open to international trade cannot be as cavalier about their exchange rates as huge, relatively closed economies; and there are special problems when a country has large debts denominated in foreign currency. But if a country is in a severe slump, yet feels that it cannot freely use conventional policies to engineer a recovery from that slump, it is squarely in the world of what economists call the "second best"-a world in which policies that one would normally abhor may be better than adhering to free-market principles and waiting for something good to happen. Bankers may tell you that any deviation from the principles of sound money and free financial markets will lead to disaster; but then that is what they would say, isn't it?

Let's be concrete: I am very concerned that Dr. Mahathir will get things wrong. I also think that even if he does get things wrong, it is quite possible that over the next year Malaysia's economy will grow while those of other Asian nations continue to shrink. It will be, as some commentators have pointed out, "low quality" growth but given the desperate straits of the region, how much does that really matter?

That said, preliminary indications from Malaysia are not encouraging. The Canadian economist Harry Johnson once said that the problem with second-best policies is that they tend to be implemented by third-best officials in the service of fourth-best politicians. Currency controls can all too easily be used to avoid problems rather than solve them; they are also subject to corruption, as those with political connections find it mysteriously easy to get foreign exchange while those without cannot. Such political-economy considerations, rather than the strict economics of the case, explain why many economists subscribe to the bankers' orthodoxy-indeed, why I myself accept that orthodoxy for normal times. A country that proposes to use currency controls to gain some economic breathing room must be especially careful to limit such abuses, bending over backwards in its efforts to do the right thing on other fronts. In the 1980s, Jeffrey Sachs used to urge troubled Latin American economies to combine "external heterodoxy" with "internal orthodoxy"; that is excellent advice here. And the ultimate goal of the external heterodoxy should be to be able to return to world capital markets after a fairly brief interval, much as Latin American countries returned to those markets after the Brady debt reductions.

At least so far, however, the signals from Malaysia suggest that Dr. Mahathir has not got this message. He has suggested that the controls will be permanent, when they should be a temporary measure to deal with the crisis; early information indicates that he intends to slacken off on financial reform, when he should be accelerating it.

The most disturbing news, however, is on the political front. Precisely because currency controls are inherently subject to abuse, they have to be administered with the maximum possible fairness and objectivity. One of the best ways to do this is to allow free discussion and criticism, so that in resisting the temptation to relax the rules when it comes to people with the right connections the authorities are given an external backbone. In this light, Anwar Ibrahim's sacking for disagreeing with the policy is dismaying. This is not only politically unforgivable, but can also doom the economic plan itself.

Originally published, 9.17.98