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(11/02/1999 - Prestowitz) COMMENT & ANALYSIS - A Malaysian Lesson In Home Remedies

COMMENT & ANALYSIS - A Malaysian Lesson In Home Remedies
By Clyde Prestowitz
844 words
2 November 1999
Financial Times
(c) 1999 Financial Times Limited. All Rights Reserved

There is much to be gained from studying a strategy for recovery that rejected IMF prescriptions.

They said he was crazy, but Mahathir Mohamad, prime minister of Malaysia, is having the last laugh. His government has been criticised in the US for harassing political opponents, but it is hard to dismiss his country's economic achievements.

After the crash of the Thai baht precipitated the Asian economic crisis in July 1997, George Soros, the global investor, called Mr Mahathir "a threat to his own country". And when Mr Mahathir rejected International Monetary Fund policies and imposed capital controls in 1998, critics said Malaysia might never recover.

In fact, not only is Malaysia recovering nicely, it is arguably doing better than any other Asian country, with the possible exceptions of Singapore and Taiwan. Growth forecasts for the year have just been pushed above 4 per cent, and the stock market is up 180 per cent since September 1998. Meanwhile, unemployment is falling and the trade surplus has boosted the country's reserves to $31.7bn - the equivalent of seven months of imports.

Others can point to higher growth rates and bigger trade surpluses. But what sets Malaysia apart is the greater speed and extent of its reforms, and the strength of its economic structure. Before the crisis struck, Malaysia had recognised the risk of a bubble and had taken steps to limit speculative bank lending. In the wake of the crisis, it moved quickly to establish two institutions to dispose of bad loans and recapitalise banks.

Although it implemented some industry-targeting policies such as those for cars and steel, Malaysia had always been open to foreign investment, and thus to a high degree of international competition. Its civil service, which was relatively clean and competent, used the crisis as an opportunity to introduce even greater transparency and market discipline. At the same time, care was taken to maintain key elements of an economic safety net that was lacking in other crisis-hit countries.

The results speak for themselves. More importantly, they suggest that Mr Mahathir's views on future developments in Asia might be instructive. He has long been unpopular in official US circles because of his resistance to US hegemony in Asia. Yet he has been engaged for most of his career in an effort of which many Americans would approve - affirmative action.

Like the US, Malaysia is a multi-ethnic society with a history of racial tension. For 30 years, the country has not only experienced rapid economic growth, it has also distributed the fruits of that growth relatively broadly through affirmative action. That has enabled it to achieve a degree of social harmony not evident in many other parts of Asia.

As a result, the economic crisis not only posed a threat to growth, but menaced the integrity of the country. According to Mr Mahathir in a recent interview, the austerity measures proposed by the IMF had a fundamental flaw. They failed to recognise the potential for social disintegration and ethnic unrest in Malaysia. The example of Indonesia - where a financial crisis eventually led to unrest and political instability - supports Mr Mahathir's scepticism about IMF policies.

When it became clear that austerity could tear apart the social fabric of the country, Malaysia rejected IMF prescriptions. It turned instead to traditional fiscal and monetary stimulus policies to resuscitate the economy. Soon afterwards, capital controls were imposed to prevent currency speculation by hedge funds that could have undermined stimulus efforts.

While these policies initially elicited a storm of criticism, Mr Mahathir notes that they were eventually endorsed and imitated by other crisis-hit countries, helping to renew Asian economic growth. Capital controls were a particular object of criticism, and Malaysia was the only country formally to introduce them.

But Mr Mahathir suggests that Hong Kong's intervention in the domestic stock market and pressure from the US and the IMF on banks not to withdraw capital from Korea were both forms of capital control. Indeed, the IMF has acknowledged the usefulness of controls in some circumstances.

According to Mr Mahathir, the lesson from the episode is the need for a full understanding of a country's circumstances when it is in crisis. It may be wiser to swallow a recommended dose of aspirin, and forsake the risks that attend a bout of radical market surgery.

For the future, Mr Mahathir emphasises the importance of developing human capital to compete on the basis of skills, instead of low labour costs. He says investment in infrastructure - such as Malaysia's multimedia corridor around the new capital of Putrajaya - is important. But it is hollow without the development of human skills.

Mr Mahathir also believes that Asian countries must wean themselves off an over-reliance on exports, and develop stronger internal and intra-regional demand. Everyone in Asia cannot be an exporter indefinitely.

Clyde Prestowitz is president of the Economic Strategy Institute in Washington, DC.

Copyright Financial Times Limited 1999. All Rights Reserved.

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