In responding to a crisis, most of us feel more comfortable employing some sort of action rather than inaction. Their is a call to “Do Something” — even when nothing needs to be done. That is why politicians and sundry financial gurus from around the world have been calling for a complete overhaul of the world financial infrastructure.
Proponents of a “New Financial Architecture” point to the disasters in Asia, Russia and now Brazil as evidence that the post-war capitalist world order is dysfunctional. That the current system has structural flaws which are “unfair” to the “masses” and cause great harm to every day working people. The critics also insist that malevolent currency speculators have the power to manipulate entire markets to enrich themselves while destroying the living standards and quality of life of a good portion of the world’s population. In fact, the president of Malaysia, Dr. Mahatir Mohamed, still derides “Open Society” George Soros as a criminal.
However, the financial crisis that beset Southeast Asia two years ago, Russia in late 1998 and Brazil just one year ago is not indicative of capitalist failings. As a matter of fact, the nature of the financial debacle of 1997/1998 is much more mundane than the grand questions of capitalism versus other economic systems. In a nutshell, the crisis is merely one of banking and finance.
In the late 1980s and early 1990s, investing in emerging markets became in vogue among mutual fund managers and other large institutional investors. Private capital flows to emerging markets increased exponentially. Incidentally, the financial and banking sectors of various emerging market nations were underdeveloped and incapable of absorbing such a sharp rise in supply of investment capital in their home markets. The oversupply of investment capital furnished by global securities investors coupled with a financial/banking infrastructure not entirely prepared for such attention was a shaky combination and this led to myriad malinvestments (such as the Petronas towers in Kuala Lumpur). When the first sign of trouble appeared, investors liquidated their positions and rushed for the exits. And, therein lies the problem. The amount of capital that left was so large in proportion to the market capitalization of the markets in question, that the strain on the currency was unbearable and degenerated into a full blown currency crisis.
So the question is: who’s to blame?
Is it the under-regulated and inadequate financial/banking system of developing nations or the reckless investors who poured in billions upon billions of dollars without properly considering the inherent risks? I would say both are equally to blame. In hindsight, the global investment community is beginning to understand the downside of ignoring the utter lack of transparency, the accounting irregularities and problems of corruption, cronyism and nepotism endemic in certain parts of the world. All of these are features not of a rule of law under capitalism, but of its opposite: statism. And, developing nations are now more aware than ever how their financial markets can be punished when policies, deemed to be unsound by the market, are implemented. Capital, let’s not forget, is a factor of production and has no loyalties. It will go wherever it is treated the best.
Fortunately, the crisis has put the spotlight on both parties. Multilateral organizations and western financial institutions are calling for sweeping structural reforms to the financial/banking framework within emerging markets. And, global equity investors have temporarily slowed (in some cases stopped) the pace of capital flows to certain developing economies. These are positive moves but more can be done. A disproportionate share of the blame has fallen on the shoulders of emerging market financial institutions. Let’s not forget that American financial institutions exercised recklessness as well. I believe just the mention of Long Term Capital Management is sufficient without elaboration.
So calls for radical change are unnecessary. And, many of the solutions to today’s financial problems are no better than the status quo or could even make matters worse. For the time being, the best course of action would be to implement needed modifications such as raising financial accounting standards, improving transparency and reassessing risk management policies.
As for the problems of corruption, cronyism, and nepotism endemic in certain parts of the world, the blame for these lies not in capitalism, but with “political entrepreneurs” whose ability lies not in the ability to create value but to pay off and bribe their cronies in political office. What is needed is not big government that strikes with an arbitrary hand, but good government under a rule of law. What is needed is a government that protects the rights of all equally — anything less is not enough, anything more will only compound the problem.
