Danby seminar: Mexico, Malaysia, and the Perils of Liberalization

[Colin Danby <danbyc@xxxxxxx>]

Thanks to all who have posted comments on my
paper.  I need to chew some things over a bit
more, but here is one (long) response.


I don't know enough about Malaysia to offer
advice with much confidence, but I can try to use
the framework I'm discussing in the paper and
discuss how it links up with exchange-rate pegs
and capital inflows, particularly in the presence
of financial liberalization.

If I'm right that there has been a center-
periphery structure to international financial
markets which has made currencies and financial
systems at the center more stable and peripheral
currencies and financial markets less stable
(skipping over the mechanisms for now), then
LDCs have to adapt in some way.

One adaptation that has been reasonably
successful (I think of Mexico in the 50s and 60s)
is a kind of corporatist model in which the state
both to some degree guarantees large firms'
profits and often arranges their financing, often
through its own foreign borrowing.  This can be
seen then as a response to the weakness of
national securities markets and the timidity of
domestic capitalists when they are not
coddled.  (Or think of it as a more extreme
version of the "German-Japanese" bank-firm model
of financial development that is often distinguished
from the "Anglo-Saxon" model with deeper securities
mkts.)  Again with the caveat that I know little
about SE Asia, corporatist systems and crony
capitalisms, often with strong public/private
oligarchies, do seem to characterize a number of
countries in the region.

Comes the call to liberalize, or perhaps just the
lure of foreign short-term money.  With a pegged
exchange rate as a symbol of the state's fiscal
and monetary rectitude, money flows in and there
is a domestic expansion.  Unfortunately the real
exchange rate (RER) appreciates because domestic
inflation remains above foreign inflation, with
Dutch-disease-ish effects of encouraging factors
to move to nontraded goods.

Large firms start using dollar debt to acquire
peso-generating assets.  Especially given RER
appreciation, dollar borrowing is a lot cheaper.
This begins to create pervasive fragility, as
firms and large banks put themselves at greater
and greater risk of bankruptcy from devaluation;
in turn as soon as anything happens to the
currency there is a run on the central bank as
various people try to protect themselves and to
profit from the anticipated large devaluation.
(The "downdraft" from efforts to cover short $
positions once a slide begins is well-analyzed
in a front page article in Monday's WSJ.)

   (Re Warren's query: I think this will work
    even if the central bank is not very actively
    supporting the currency -- one can still have
    a bubble that collapses rapidly.  But it's
    true that my frame of reference is exchange
    -rate-based-stabilization, which may not be
    entirely appropriate in SE Asia.)

So firms' going short in dollars and long in
pesos creates the devaluation-vulnerability
that sooner or later gets you rolled by
speculators (who are often mostly your own
nationals, as in Mexico in 1994).

Large firms take on devaluation risk because they
anticipate post-devaluation bailouts; so do
foreign lenders.  (And indeed the more the state
insists on the fixed exchange rate as a symbol of
its own virtue and rectitude and as a signal of
its "commitment" to neoliberal policy, the easier
it is for firms to argue post-devaluation that it
wasn't their fault, they were just following the
government's signals.)

The bailing out is in fact encouraged by the IMF,
which provides international liquidity to
gvernments in this position to repay foreign
lenders to both public and private borrowers.
The IMF-approved stabilization that follows
socializes the losses.  It was striking, in
the recent Thai case, how quickly the notion
that firms and banks that made bad bets should
suffer consequences gave way to a rhetoric of
"restoring confidence" by bailing out swindles
of every description.

In this context the main flaw in neoliberal
reform may be that it underestimates the
institutional task involved in achieving its
laissez-faire ideal.  In a political economy
of implicit guarantees, capital inflows and
financial liberalization only encourage private
irresponsibility at public expense.

Best, Colin