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Curbs on Capital Flows Gain New Respectability

September 16, 1998|ART PINE | TIMES STAFF WRITER

WASHINGTON — When the Asian financial crisis broke out in 1997, Malaysian Prime Minister Mahathir Mohamad accused Western investors of using global financial markets to bring Malaysia to its knees. Few listened.

This month, after a year's worth of further economic deterioration, Mahathir abruptly prohibited the trading of Malaysia's currency, the ringgit, outside the country. This time, the concept of limits won grudging endorsement from some Western economists.

Between then and now, the world changed. The currency collapse that began in Thailand has now engulfed Asia, Latin America and Russia. In self-defense, some free-marketeers are beginning to change their stripes.

Malaysia is not the only country imposing more restrictions on markets. Hong Kong is pouring billions of dollars into its stock market in a duel with speculators. Russia unilaterally decided not to pay some of its foreign debt. Some right-wing political leaders in Mexico want to put a 12-month leash on foreign investment.

And political leaders protecting their flanks aren't alone in rethinking the virtues of the unfettered movement of capital.

Robert A. Litan, a Brookings Institution analyst, says the idea that emerging-market countries should seek to control capital flows at their borders--at least in a limited fashion--has gained new respectability among Western strategists as a way smaller economies can protect themselves from increasingly large speculative flows.

"It's wise for countries to at least slow down their foreign currency borrowing. That's the main lesson of this crisis," Litan said. "There's been a tremendous sea change on this issue, and there's a major rethinking going on."

Similar endorsements have come from such diverse free-market advocates as Joseph Stiglitz, the World Bank's chief economist, and Massachusetts Institute of Technology economist Paul Krugman, who argued in a recent Fortune magazine article that imposing limits on currency trading might give hard-hit countries some breathing room to tackle their other problems.

The admittedly modest shift in thinking nevertheless constitutes a conspicuous departure from the rigid free-market doctrine that Western policymakers and economists have been preaching. For months, both U.S. and International Monetary Fund officials have been telling governments of severely affected countries that the best way to overcome the Asian crisis is to open their markets further.

But now, Krugman argues that while currency controls inevitably cause distortions and work badly if kept in place too long, "when you face the kind of disaster now occurring in Asia, the question has to be: badly compared with what?"

By any standard, global capital markets have swelled to enormous proportions. World currency markets alone handle more than $1.5 trillion worth of transactions a day--up from only $190 billion a decade ago. Analysts say that figure is a reasonable proxy for all financial markets because cross-border stock trades involve currency trading.

But the huge flows into emerging markets are a relatively recent phenomenon. As late as 1991, most developing countries were getting most of their money from abroad via so-called official capital flows, such as foreign aid and World Bank loans. Private foreign investment was relatively minimal--about $44 billion, according to the Institute of International Finance, a Washington think tank created by international banks.

During the following years, however, that figure soared. By 1996, private investors were pumping a net $304.5 billion into poorer countries through global financial markets, while net official flows had shrunk to $1.4 billion. (Private flows fell to a net $232.6 billion in 1997, thanks largely to the Asian crisis, and are expected to slide to $221.3 billion in 1998.)

The last year's tsunami in global financial markets has severely damaged Asian economies. South Korea's stock market has plunged a staggering 73%, in U.S. dollar terms, since the start of the crisis. Indonesia's has fallen 90%, Thailand's 75% and Malaysia's 83%. Their currencies have suffered similar declines.

Moreover, the deluge has spread to other countries--Russia and South Africa, to name just two--and moved on to several nations in Latin America and elsewhere that had followed sound economic policies.

Mexican Finance Minister Jose Angel Gurria complained this month that "markets are overreacting and not discriminating" among countries that are following sound principles and those that are not. "You can't put all of us in the same bag," he said angrily after a conference of Latin American economic officials at the IMF.

Economists are increasingly sympathetic.

"The Asian crisis [showed] that capital movements can generate major crises that these countries just aren't equipped to deal with," said Jagdish Bhagwati, an international economics expert at Columbia University. Bhagwati calls "the pretty face" of unfettered capital flows "a mask that hides the warts and wrinkles underneath."

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