This is frightening stuff. But in the fog of panic that can surround the discussion of financial markets, it is easy to miss several important distinctions. For instance, it is misleading to treat all the money flowing in and out of emerging markets in the same way. “Foreign direct investment” (i.e., people building new factories) undoubtedly helped to contribute to Asia’s economic overexpansion, and the resulting overcapacity is the underlying reason for the deflation that haunts the region. It is also true that “foreign portfolio investment” (i.e., buying shares) helped blow up the Asian bubble by inflating local stock-market prices. But the chief cause of Asia’s woes was the third source of capital: debt.
Asian companies borrowed too much short-term money, most of it denominated in foreign currency, in financing their various long-term projects. When banks got nervous about declining foreign-exchange reserves in the lending countries and refused to roll over the loans, the crisis began. Equity investors, by contrast, could not ask for their money back; all they could do was sell, which many did at a loss. The people who actually turned off the tap were bankers, who did so in much the same boring way that they have for p. 58 centuries: writing letters and serving notices about clauses in their contracts. With both South Korea and Long-Term Capital Management, banks’ credit-control systems tended to be based on the bear-outside-your-tent strategy (derived from an old joke: Two people are inside a tent when a bear begins to shake it. One of them starts putting on his sneakers. “You can’t outrun a bear!” observes the other. “I don’t need to,” the first replies. “I just need to outrun you”). Each bank thought that it could get its money out faster than its rivals could.
Do open capital markets encourage imprudent lending? In essence, there are two opposing views. One school thinks that capital has become more dangerous because it has been overprotected. The assumption that the IMF would bail them out encouraged banks to lend to South Korean companies; and the U.S. government’s deposit insurance encouraged American consumers to deposit their money without checking whether a bank was lending to South Korea. This approach has the advantage of intellectual purity, but it seems both ill suited to the real world (why should Aunt Agatha with her savings account know about South Korea?) and slightly blasé about the prospect of systemic failure.
On the other hand, there is plainly a temptation to go too far in the opposite direction and start constructing all sorts of new financial orders. Many of the problems with imprudent lending could be solved if, rather than regulating different risk levels, governments embraced the concept of narrow banking and forced banks to separate the insurable deposit-taking part of their business from the riskier things that they do. In many cases, a decent set of accounts would have alerted them to the danger. Long before Enron, a devastating report on auditing practices in Asia by UNCTAD criticized Arthur Andersen and other big accounting firms for putting their names to audit reports that clearly failed to meet international standards. One badly burned banker in Russia puts it simply: “No Western audited accounts; no Western money.” But this presumes the audits will be accurate.
For many developing countries, better banking and accounting standards would be very helpful, but they are not enough. First, such concern shows that the rich West is preoccupied with hanging on to its dirty dollar (and rightly so: a banking collapse in California, let alone Japan, is much more dangerous to the global financial system than the disintegration of the entire Malaysian economy). Second, standards alone do not answer developing countries’ fundamental grievance: that they opened up their markets and got slapped in the face for their efforts.
This second point is as mistaken as it is emotionally appealing. Rather p. 59 than surrendering to the rule of the market, most of the countries were engaged in elaborate attempts to buck it: sticking to unsustainable exchange-rate policies; borrowing too much; refusing to change inadequate standards of accounting and supervision; and, crucially, not opening up their local financial systems to outsiders. Markets need openness, and too much went on behind closed doors. Markets need competition, and too much was decided by collusive cliques. Above all, markets need information, and too little of it was available. Would Thailand or Argentina have collapsed if it had not stuck to its exchange-rate policy? Would South Korea be in such a mess if it had not (staggeringly) discriminated against long-term foreign capital? Would Russia have hit the rocks if it had not handed its government to kleptocrats? We think not.
The travails of 1997-1999 do not invalidate the claim that the most open countries have usually been the most successful. India and China are often cited as successes because they avoided the Asian flu, but they have suffered from much more debilitating diseases instead. As Alan Greenspan pointed out to Congress in September 1998, even the most badly savaged East Asian economies only lost about a sixth of their per-capita growth over the past decade, and their average incomes were still two and a half times those in China and India. Without foreign money and foreign know-how, economies grow more slowly. Chile has always coupled its capital controls with openness to foreign financiers and a transparency in its financial sector that contrasts strongly with the situation in the Asian countries. More than half of Chile’s banks are foreign owned.
That still leaves the question of whether temporary capital controls can work in a crisis. The answer is that they can. But a lot depends both on how cleverly the policy is enforced and what exactly the word temporary means. It is noticeable that Chile lowered its controls when the Asian contagion was whistling around the world. When Malaysia decided to put Krugman’s thesis into action, the economist, far from celebrating this rare triumph for the dismal science, promptly distanced himself from the decision, arguing that controls must be “an aid to reform not an alternative.”[11] Not only is there a great danger of cronyism in the short term (if people cannot take their money out legally, they will do so illegally), there is the problem of the long-term impact on foreign investors. Even now that Malaysia has lifted its controls, few investors of any sort are likely to forget that they were trapped—and there are plenty of other places to invest.
In Defense of the Gunslinger
p. 60 This leaves the argument that capital markets are generally a force for openness. Open markets go hand in hand with open governments and open societies. That does not mean that capitalism automatically favors democracy: Given a choice between a stable authoritarian regime and a crisis-racked liberal one, those greedy young men at the trading terminals would probably put their money on authoritarianism. The same markets that punished President Suharto in 1997 had showered him with gold for years. But in general, as Suharto found out, openness and political stability tend to go together. Open systems of corporate governance discourage managers from making foolish decisions. Open systems of politics prevent a ruling clique from amassing too large a share of the nation’s resources. Above all, open systems generate the one thing that markets require to work properly: information.
The capital markets can take some of the credit for several blessings that are now common in most developed countries: low inflation, low interest rates, and (notwithstanding George W. Bush’s huge tax cut) shrinking government budget deficits. As well as punishing governments that stray off course, the capital markets also reward the ones that stay on the straight and narrow. For instance, when Sweden’s budget deficit reached almost 13 percent of its GDP in 1994, yields on government bonds rose to almost 12 percent. When the government attacked the deficit, the interest rate demanded dropped by about half. Asia shows not only that the capital markets are becoming ever quicker to turn against people but also that they are quicker to forgive. Latin America spent most of the 1980s trying to recover its reputation. By contrast, South Korea was able to issue bonds worth billions of dollars within months of going to the IMF.
More generally, when people think about the capital markets, they usually focus on dealing rooms. But much of their magic is worked in boardrooms. Corporate governance provides the best method we have f
or holding bosses accountable for their actions. It makes it easier to sack the real duds. It prevents managers from treating a company’s money as their own. (Pay may still be out of control in the United States, but the good ol’ boys of the boardroom are awarding themselves fewer perks.) In general, it lets a little daylight into what could easily be a completely secret world.
Demands for accountability have even more explosive implications outside the United States. Even in relatively advanced markets, such as France and Germany, old elites have suddenly had to explain what they are doing with other people’s money. Nearly two out of three German investors would p. 61 prefer to have global (i.e., American) corporate governance standards.[12] In France, thousands of ordinary investors have signed up to take courses at a traveling “École de la Bourse” to find out more about their money. In places such as South Korea, the idea of asking the chaebol or their equivalents to justify their performance remains a revolutionary concept. To see this struggle at work, let us return to Seoul.
Sweet Seoul Music
Even by the dismal standards of economics departments, Korea University’s concrete bunker stands out in its ugliness. Jang Ha Sung, a preppie-looking figure in blue blazer, club tie, and button-down shirt, seems out of place—like a classicist who has been forced to join the squalid world of numbers as part of a bizarre academic experiment. As he works, opera burbles in the background; The New Harvard Dictionary of Music nestles next to Financial Theory and Corporate Policy on his shelves.
If Jang makes an unlikely economics professor, he makes an even less likely agitator. Yet that is what he is. At shareholder meeting after shareholder meeting, Jang gets up and shouts questions at the chaebol chiefs, while supporters from his People’s Solidarity Movement taunt the corporate leaders from behind him. Jang also has to put up with boos and hisses from the chaebol’s henchmen, but that seems a small price to pay. Not long ago, shareholder meetings were about as rowdy as a party congress in the communist North; often the entire agenda was wrapped up in only a few minutes. Now Jang and his allies regularly keep the business elite onstage for hours on end.
For Jang, the movement to open up Korea’s businesses is part of a broader movement to open up its political life. Company chairmen, he complains, act like kings, plundering company property to enrich their families, transferring resources from one company to another, and making idiotic decisions without fear of reprimand. Many suspect that Jang has long-term political ambitions: He comes from a family of politicians, and People’s Solidarity is backed by several leading reformers. But Jang thinks that political reform is impossible without corporate reform.
As a student of finance at the Wharton School, Jang learned that the purpose of public companies is to increase shareholders’ return on their capital and that the purpose of corporate governance is to hold managers accountable. In 1994, he helped to form People’s Solidarity, a group two hundred strong that campaigns for liberal reform. At the time, this seemed an impossible cause. Corporate law required that shareholders own 3 percent of a p. 62 company before they could bring a motion at a shareholders’ meeting—a huge hurdle in a country dominated by giant conglomerates. The chaebol tried to intimidate Jang, spreading the rumor that he was bent on selling the country’s assets to foreigners. People’s Solidarity found it so hard to track down shareholders of one of its first targets, the Korea First Bank, that members took to walking the streets with placards asking shareholders to come forward.
Helped by foreign investors, Jang won a few early skirmishes, notably a struggle to force SK Telecom to appoint an independent auditor. But the arrival of the Asian crisis gave him a welcome burst of publicity. The World Bank invited him to speak at its annual meeting; professional shareholder activists started asking him to their conferences; Bill Clinton even invited him to join a discussion group when he visited South Korea in November 1997. Meanwhile, President Kim changed the law, making it easier for foreign shareholders to invest in South Korea; he also changed the regulatory environment. Now Jang needs a stake of just 0.01 percent to bring a motion, and public companies must appoint one quarter of their directors from the outside.
In one way, Jang has already won the war. “Punish conglomerate chiefs!” has become the rallying cry for the huge crowds of Koreans that regularly gather outside the chaebol-dominated Federation of Korean Industries. The chiefs themselves have become symbols of profligacy, inefficiency, and nepotism. Capital markets are now open to foreigners. More than a dozen chaebol have gone bankrupt. Mighty Daewoo, the second biggest of them all, has been broken up.
Yet the forces ranged against reform are huge. There is no shortage of bureaucrats who think that the creation of what Kim calls a “democratic free-market system” will deprive them of not just their power but also their job security. The big trade unions are nostalgic for the old world. Both trade unionists and bureaucrats are suspicious of the foreigners in whom Kim puts such faith. Kim’s government, South Korea’s first experiment in coalition rule, is a fragile affair.
Worse, many reforms have proved to be either synthetic or counterproductive. Foreign financial institutions have often been frustrated in their attempts to buy Korean firms. For instance, HSBC’s attempt to take over Seoulbank, nationalized in 1998, ran aground because Kim’s government refused to have the bank’s loans assessed according to international standards. Meanwhile, the attempts to force banks to tighten up their credit control have paradoxically helped the chaebol. The banks concentrated their p. 63 resources on their best-connected clients, convinced that the government would never allow them to go under, while small and medium-sized businesses went bankrupt by the thousands. And, wily as ever, the chaebol moved to defend themselves by buying stakes in life insurers, asset managers, and a new class of “merchant banks,” which specialize in short-term corporate loans (of just the sort that you might need if you had a slightly dodgy subsidiary that needed cash fast).
All this leaves the visitor to Jang Ha Sung’s office with a worrying conclusion for the new century: From a long-term perspective, South Korea—and Asia in general—may have bounced back too quickly. Far from suffering from years of depression and stagnation, the region’s stricken economies recovered at a remarkable pace, none more so than South Korea’s; indeed, South Korea’s GDP in 2001 was nearly a quarter bigger than in 1996. Some of this recovery was due to reforms pushed by people such as Jang, but the biggest contribution came from that buyer of last resort, the American consumer—who cannot buy forever. Even today, South Korea seems to be trying to buck the capital market, welcoming money but still insisting that it plays by the rules of the chaebol. Unless that changes, there is always a risk that the crisis that almost sank the country in 1997-1998 will repeat itself, and the national schizophrenia will never go away.
4 – The Visible Hand
p. 64 IN THE LATE 1970s, the General Motors plant in Fremont, near the southern tip of San Francisco Bay, was a symbol of everything that was wrong with the American car industry; it was a perennial victim of slowdowns, sickouts, and strikes. The workers hated the bosses, the bosses despised the workers, and the two had as little to do with each other as possible. Absenteeism ran at 20 percent. The company’s parking lot became a bazaar, featuring hookers, drugs, and barbecued food; the factory was so full of marijuana smoke that you could get high just by doing your job. One GM worker recalled,
There was shit all over the place. The parking lot was covered with broken glass. It looked like a diamond field in the morning sunlight. Busted beer and whiskey bottles all over the place! It looked like pigs lived [t]here. People would sit wherever they wanted and read books, eat, and play radios. I remember working on a car that was full of chicken bones left over from a guy’s lunch. Nobody cared.[1]
In 1982, GM’s managers finally gave up the struggle, closing down the four-million-square-foot plant and throwing its employees on the dole. Yet two years later, the plant was back in business with a new name—New United Motor Manufacturing,
Inc. (NUMMI)—and a new ethos. General Motors had decided to use the plant as a laboratory for the introduction of Japanese manufacturing techniques into the United States. It formed a joint venture with Toyota and gave the Japanese company a free hand to introduce the same “lean production” methods that it had used to such astonishp. 65ing effect at home. Toyota divided the workers up into teams, requiring them to check their own work rather than leaving oversight to the quality department; it forced managers to work on the floor; it cut back the huge inventory of parts, switching to suppliers that delivered just in time.
The result was a dramatic increase in productivity. By 1994, the plant was producing the same number of cars that it had produced in 1982 but with just 65 percent of the workforce. And this time the cars worked. J. D. Power rated the factory’s Geo Prism as one of the best American cars ever built. NUMMI exported more than four hundred million dollars’ worth of cars, including twenty-six thousand Corollas to Taiwan, as well as seventy-eight million dollars’ worth of car parts to Japan. It acted as a magnet for dozens of parts suppliers, anxious not only to get its business but also to learn “lean production.” As Detroit began to restructure (Ford and Chrysler each closed roughly 40 percent of their American capacity in the 1980s; General Motors axed 25 percent), surviving factories copied Toyota’s ideas. Nowadays, every car factory carries NUMMI’s imprint in one way or another—so much so that when you visit Fremont, it no longer feels particularly special.
A Future Perfect: The Challenge and Promise of Globalization Page 11
