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DOWNSIDE OF OPEN FINANCIAL MARKETS: There is a price to be paid for G7 policies of liberalization

Roy Culpeper

(Ed. note) Roy Culpeper is president of the North-South Institute, an Ottawa-based foreign policy research institute.

Financial Post, Daily edition, Tuesday, November 18, 1997

Top billing in the upcoming Asia-Pacific Economic Co-operation forum in Vancouver is likely to go to the economic crisis that has rocked Southeast Asia since the summer. Certainly, the recent financial turmoil has spread to stock markets and currencies around the world. Many Asians believe financial speculators such as George Soros are responsible for the possible demise of their ``economic miracle,'' with its stunning double-digit growth rates and historically unprecedented pace of development. Are they right? And what are we learning, if anything, from the international financial crises that seem to erupt every few years?

The last bout of financial turbulence was centred in Mexico in 1994-95. It demonstrated that financial markets are eventually able to shrug off such episodes. But it is a different story for vulnerable people -- particularly the poor.

History is about to repeat itself in Southeast Asia. Thailand has had to accept an economic reform program from the International Monetary Fund in return for US$17-billion emergency financing. In Indonesia, the IMF program is almost twice as large, at US$33 billion. In both countries, several commercial banks will close and financial supervision will be tightened. Many will agree such reforms are overdue. But remember these countries have performed extremely well despite these ``policy distortions.''

And then there is the price to pay: In Thailand, for example, there will be an enormous fiscal crunch -- a budget deficit of 20% of gross domestic product must be eliminated within a year. Three million people may be unemployed as a direct result.

At the root of the periodic financial instability that is becoming a regular feature of the global economy is a deliberate push by the Group of Seven industrialized countries to liberalize financial markets. That is, policy makers in the rich countries have decided open financial markets are like free trade in goods and services, bringing economic growth and prosperity to all involved.

What's wrong with open financial markets? Would they not bring savings from those with money and allocate them to investments with the highest returns? Yes, if financial markets made only long-term commitments. The problem is that communications technology has made financial markets extremely fixated on short-term profits, and hence very volatile. A single report by Morgan Stanley in Asia led to the run against the HK$. Such events are typical in financial crises and they indicate that, far from being the rational, well-informed agents of economic textbooks, market operators often fall prey to groundless rumors and the herd instinct.

There is also a deeper problem of policy incompatibility. Economists have known for some time that unrestricted financial mobility undermines the ability of countries to manage stable exchange rates and pursue the monetary and fiscal policies suited to domestic needs. One or more of these domestic economic policy objectives must be surrendered in the face of financial liberalization.

For example, money flooding into a country causes the value of local currency to rise, undercutting trade competitiveness and jobs in the export sector.

And to prevent money flooding out, central banks must swiftly raise interest rates, crippling investment and economic growth.

In the latter case, currency devaluation is also a policy option -- one that Mexico and the Southeast Asian countries have chosen. But devaluation is unwelcome to foreign investors and may stimulate further capital flight. Furthermore, trading partners often resent competition from cheaper imports and threaten to close their markets. Stay tuned for growing trade frictions between Southeast Asia and the U.S.

Asians are right to be upset about the toll of the financial crisis on their economic prospects. Perhaps they are wrong to pin all the blame on financial speculators. Rather, the problem stems from the wrong-headed determination of G7 policy makers to open financial markets at all costs.

In the face of this most recent international financial crisis, G7 leaders would do well to heed a warning from none other than Soros, the consummate speculator, who recently said the greatest threat confronting world stability comes from unrestricted free markets. He should know.

Source: This information is provided by the Financial Post.

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