INSIGHT
Will East Asia Export its Deflation Abroad?
THE 1997 crisis in the so-called Asian 'Miracle' economies has sent a quiet shock to the financial capitals of the world's major industrialised countries. This is evident from the highest level meetings of the government officials, bankers, heads of IMF and World Bank and their hurriedly prepared rescue packages for these countries as well as from the deep concerns expressed by eminent academics, professionals and financial wizards in the developed parts of the world over the last few weeks. Trade journals, financial weeklies and highly rated national dailies in the western world are full of articles and commentaries reflecting their anxieties on the subject. However, of all the countries of East and South East Asia, the main worries of the western leaders are about the final resting points of the downward spirals of the economies of Japan and South Korea. Although Japan has been going through a prolonged recession since 1989, it still doesn't need, nor does it want, any financial assistance from the IMF or other countries because it has accummulated a huge external reserve over the last three decades or so through its trade surpluses.
South Korea's precipitous decline in recent months seems to have become the main worry to the world leaders. Witness how even after the IMF's first announcement of $57 billion bailout package another emergency package of $10 billion has been rushed by the leaders of US, Japan, Germany, IMF and World Bank at the end of December to meet its monthly debt repayments obligations, mainly to the American banks and financial institutions. This raises the question as to why the governments of the United States,
Japan and Germany as well as the heads of IMF and World Bank are so keen on giving addition-al help to South Korea? This question will be addressed in this short article. Further, some observations will be made on the widely discussed prospect of a world-wide depression.
Transmission Mechanism of Deflation/Inflation
Before one address the question of importance of South Korea to the US and other economies, a word on the transmission mechanism of one country's deflation/recession or inflation to other countries would be relevant. A country's deflation or inflation is exported to other countries through its (i) trade and (ii) capital flows. To save space, let us concentrate only on the role of trade flows in such transmission. If a major trading country is depressed, the prices of its goods and services go down, and through its export of goods and services to its buying countries, it transmits its low prices. These low priced imported goods compete with domestically produced high priced goods and services in the importing countries. Consumers prefer cheap imported goods and services and hence the domestically produced goods and services remain unsold and piled up. This cannot go on for long. Domestic industries producing such goods and services will have to close down creating unem-ployment and unused industrial capacities.
This is the beginning of a recession in the importing countries if the imports are substantial. The immediate consequence of this situation in the importing countries is that in the face of such a recession, there comes the clamour for tariff protection from both industrialists and trade unions. If protection is given then the world trade is disrupted, the exporting (initially depressed) country has no way of getting out of its recession and the importing country develops inefficiency in its industrial sector. Overall, the volume of world trade and economic growth suffer. However, in the United States, Richard Gephard and his protectionist allies are now raising exactly this protectionist slogan.
Why is South Korea So Important to the United States?
If South Korea (the world's eleventh largest economy) collapses, it will bring down, apart from other East and South East Asian economies, the currently fragile economy of Japan (the world's second largest economy) with which it has deep trade and, financial links. Both South Korea and Japan are major markets for American goods and services and, similarly, the United States in a major market for the South Korean and Japanese products. While referring to the effects of Asian turmoil on the US economy, Arthur B Laffer has reported that "Some 30 per cent of the Standard and Poor's 500 companies' profits are derived from foreign operations. Any impact on these profits will hurt our stock market" (The Wall Street Journal, January 5, 1998, Page-A22). Some other estimates indicate that a collapse of South Korea alone will bring down the US economic growth by at least 1 per cent in 1998. It means that it will have a colossal impact on the US economy. What about the impact of capital flows? South Korea now has $160 billion outstanding debts of which $92 billion is short-term loan. Most of these loans are from the American banks. If South Korea defaults on debt repayments, these major New York banks and financial institutions will almost come to a crashing point. South Korea, therefore, cannot be left in the lurch by the United States. It has to be helped our of the present crisis.
A word on the final incidence of these bailout packages is important. Who bears the cost of such loans to South Korea? There is a lot of cheap sloganeering in the United States saying that this is a plan to bail out the rich New York bankers. This is not wholly true. There are share holders of these banks and financial institutions who will also lose if South Korea defaults. But the ultimate burden of payment will have to be borne by the poor South Koreans. This is inevitable under any one of the plans now discussed between the lenders and the borrowers for rescheduling the outstanding loans and repayment.
South Korea cannot clear its current monthly debt repayments and once the period of its repayments is extended, its interest burden is going to increase. Unless the US banks, i.e. the lenders, forgive some or all of these interests, South Korea will have to pay it. The ultimate payers are the South Koreans. The deeper issues of mismanagement of borrowed money in the name of national development which ultimately has to be borne by ordinary tax payers raises the question of economic and social justice which is violated almost everywhere. In the capitalist lending-borrowing game, the beneficiaries in most cases are the lenders and rarely are the borrowers.
Will There be a 1929-style Depression?
There is a lot of discussions in the western press and among the academics and fund managers about the possibility of a world depression ushered in by the Asian crisis unless it is properly handled by the world leaders. The latter proviso seems to be extremely important at this stage. If Japan sinks further, South Korea defaults, and the United State and Europe adopt protectionist measures, then there is a good chance that the world will sink into a major depression with all its miseries and sufferings.
Since we have witnessed over the last three decades or so a willingness on the part of the leaders of G-7 countries to agree to resolve problems by a co-operative effort, we can expect the same thing this time also.
All world crises are managed at the top, politically. If the major world leaders behave rationally and responsibly, one doesn't see such a prospect of world-wide depression. Otherwise, no one can prevent it.
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