Capitalism in Crisis

Western capitalism has much to learn from Asia

Kishore Mahbubani

February 7, 2012

Capitalism itself is not in crisis, but western capitalism is. This is a result of three strategic mistakes.

The first error was to regard capitalism as an ideological good, not as a pragmatic instrument to improve human welfare. Alan Greenspan was probably the greatest victim of this ideological conviction that markets always knew best. The former chairman of the Federal Reserve fully agreed with the Reagan-Thatcher thesis that governments should step aside and let the markets roll. As Mr Greenspan also believed that market traders were smarter than government regulation, and he failed to regulate them vigorously. This has wreaked havoc on the world. But no Asian society, not even Japan, fell prey to this ideological conviction.

Instead, Asians believe that no society can prosper without good governance. Indeed, in a way many of them have understood Adam Smith’s message better. As he wrote in The Wealth of Nations, “the interest of the dealers, however, in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public.”

For capitalism to work well, governments have to play an essential regulatory and supervisory role. This was forgotten by many western governments. To make matters worse, the west spawned a huge new financial services industry that was widely perceived to have added a lot of “value”. For a while, like all good Ponzi schemes, the industry seemed to create a lot of new wealth. Yet it is now clear that it added no real new value.

Andrew Sheng, former Hong Kong central banker, has said, “how do financial engineers make five to ten times more salary than physical engineers year after year? Is there magic in the financial institutions’ ability to create return on equity that is significantly higher than real-sector companies like automobiles or energy? The answer is that they create risks through leverage and interconnectivity which, every ten years or so, become realised losses that are fully underwritten by the public sector through tax bail-outs. The financial sector is being subsidised by all the holders of financial paper through zero interest rate policies. Their liabilities are still guaranteed by central banks. Finance has become the biggest free rider of all time.”

This huge industry was allowed to “capture” the regulators whose duty it was to control and supervise its activities. AIG, which could have single-handedly destroyed the global economy, was allowed to choose a small regulator in Delaware to regulate its trillion-dollar operations. No one in Washington batted an eyelid.

The second strategic error was to forget the lessons that European capitalists learnt from the Marxist threat of the early 20th century. For capitalism to survive, all classes had to benefit from it. Social democracy was the European response to the threat of communism. Wages and welfare benefits of workers were increased. The capitalists became rich but the workers also gained. Even American capitalists, who were clearly not enamoured with the social democracy experiment, saw the value of increasing wages.

According to Lee Iacocca, Henry Fordshocked the world with what probably stands as his greatest contribution ever: the $5-a-day minimum-wage scheme. The average wage in the auto industry then was $2.34 for a 9-hour shift. Ford not only doubled that, he also shaved an hour off the workday.”

Sadly, all the lessons that the west learnt then have been forgotten. Chief executives at some of America’s largest companies earned an average of $11.4m in total pay343 times more than a typical US worker, according to a report by AFL-CIO, the labour federation. This rising inequality was a big challenge.

Rising unemployment was an even bigger challenge. Asian governments fought off unemployment by creating incentive schemes to promote investment and employment. Western governments dismissed this as “industrial policy”, an ideological heresy.

And when western workers suffered, the capitalists retorted, “markets know best.” Perhaps the time has come to for the west to learn from Asia how to manage the existential challenges of the capitalist system.

The third error made by the west was to aggressively promote the virtues of capitalism to the third world, including Asia, without realising that it had to educate its own populations on the critical concept of “creative destruction”. Economics textbooks correctly pointed out that when the automobile was invented, the horse and buggy industry had to disappear. And when digital cameras emerged, Kodak film had to go. Yet, the masses were never told that they would have to learn new trades and skills as new competitors emerged from China and India.

Hence, when manufacturing declined from 27 per cent of US gross domestic product in 1950 to 11 per cent in 2009, no policymaker took note or corrective action. Nor did American leaders warn that workers would have to be helped to find new skills and jobs.

For all its flaws and defects, capitalism remains the best system to improve human welfare. This is why the whole world (barring North Korea) has accepted it, in one form or another. But it is also an inherently imperfect system, as Adam Smith warned us from day one.

It requires careful government regulation and supervision. Asians never forgot this. The west did.

Hence, the time may have come for Asians to reciprocate the generosity of the west in sharing capitalism with Asia. Western policymakers and thought leaders should be invited to visit the industrial complexes and service industries of Japan and Korea, Taiwan and China, Hong Kong and Singapore. There may be a few valuable lessons to be learnt.

The writer is dean of the Lee Kuan Yew School of Public Policy at the National University of Singapore, and author of ‘The New Asian Hemisphere’

Tomorrow’s Pax Pacifica

Kevin Rudd


CANBERRA – Although the relationship between China and the United States is critical to Asia’s future, this does not mean that the region will become a Sino-American duopoly. The concept of a “G-2” is never going to fly in Asia.

To begin with, excluding China, Asia’s combined GDP is roughly equivalent to that of the US, and it vastly exceeds that of China. Furthermore, Japan remains the world’s third-largest economy, while economies like India, South Korea, Indonesia, and Australia are growing rapidly.

Under President Susilo Bambang Yudhoyono’s direction, Indonesia is on the cusp of becoming a $1 trillion economy. With a population approaching 250 million, the country’s annual GDP growth has been consistently above 6%. At this rate, Indonesia is likely to emerge as one of the world’s top six economies by 2030.

Moreover, most of these dynamic emerging economies are also robust democracies and are committed to open economic policies. Indeed, free-trade agreements (FTAs) are expanding across the region.
Australia and New Zealand’s FTA with South East Asia, for example, which is now in force for all 12 signatories, creates a free-trade area embracing more than $3 trillion of regional economic activity.

Australia is also concluding an FTA with South Korea, and is involved in similar negotiations with China, India, and Japan. Negotiations on a Trans-Pacific Strategic Economic Partnership at the 2011 Asia-Pacific Economic Cooperation Summit in Hawaii reflected the pursuit of such opportunities by other countries in the region.

From a global perspective, Asia’s economic dynamism is impressive: Asia accounted for less than 20% of global GDP 30 years ago, whereas the US represented 30%. But, within the next five years, Asia will constitute nearly one-third of global GDP, with the US share falling to less than one-fifth.

Nonetheless, both continental and archipelagic Asia remain beset by unresolved territorial disputes over areas such as the Korean Peninsula, the East and South China Seas, the Taiwan Straits, the Thai-Cambodian border, and Burma’s restive border regions. Each of these conflicts could undermine the prosperity that the region has built so far.

Indeed, while Asia is home to all of the world’s hopes for the twenty-first-century global economy, it is handicapped by all of the rigidities of an almost nineteenth-century set of territorial and security disagreements. Although some of these disputes are intrinsically internal, there is an interest across Asia in collectively charting a common course on some of the region’s seemingly intractable problems, lest they spiral out of control.

Moreover, Asia has been demonstrating democratic progress, as well as a strong interest in expanding its economic openness (both internally and externally). The region is also acknowledging the need for national sovereignty, whereby countries do not have to fear outside interference with domestic politics. Finally, across the region, there is a pervasive desire to avoid polarization into Chinese and American blocs. Instead, countries in the Pacific region are attempting to build the institutions and the habits of cooperation that will enable all of us to collaborate in addressing individual security challenges as they arise.

But can the dissonant values, aspirations, and interests of the US, China, and the rest of Asia be reconciled in the decade ahead? Or do we face a future defined by strategic drift, ideological conflict, and irreconcilable interests? I firmly believe that Sino-American conflict is not inevitable, and that it would undermine the interests of all parties, as well as their fundamental values.

A step in the right direction, albeit an imperfect one, was taken with the establishment of the G20. China, India, Korea, Indonesia, and Australia, along with Japan, now sit at the same table to deliberate on global financial regulation, financial imbalances, and the global recession. So far, China has played a significant and constructive role in this forum. In fact, without China, the global economy would not have recovered as rapidly as it did from the most recent crisis.

As China seeks to take its place in the global order, it has increasingly sought to enhance its global leverage by cooperating with other emerging economies – the otherBRICS” (Brazil, Russia, India, China, and South Africa) – in major global negotiations. The BRICS’ regular meetings and cooperation at multiple levels are likely to be a continuing feature of the international system. But, with the exclusion of the US, this does not provide a common platform to deal with shared policy challenges in Asia (or, for that matter, elsewhere).

.In his recent book On China, former US Secretary of State Henry Kissinger argues for the development of a Pacific Community. In 2011, a good start at following through on this vision was realized at the East Asia Summit in Bali, where, for the first time, China, the US, and the region’s other principal players gathered around a table to deliberate their interests. It was a historic opportunity to begin forging a common vision for Asia’s future.

The task today is to craft what future historians might call a Pax Pacifica – a peace that will ultimately be anchored in the principles of common security, and that recognizes the realities of US and Chinese power, without turning the rest of the region into collateral damage should the Sino-American relationship deteriorate.


Kevin Rudd is Australia’s Minister for Foreign Affairs.
Copyright: Project Syndicate, 2012.

Markets Insight

February 7, 2012 1:17 pm

Avoiding EM economies is the biggest gamble of all

Volatility looks likely to continue across equity markets in 2012. But the risks we typically care about most are large permanent losses, not volatility. 

There is a strong case that we do not face a plethora of potential large permanent losses from multi-country investing in emerging markets in 2012. We do from investing in the developed world.

The world this year will continue to be divided into deleveraging developed economies and emerging market economies without excessive debt. The US and Europe will continue to experience sub-trend growth, with the main risk still a return to recession or even depression. Many of the emerging economies will grow close to trend, with the main risks being country specific, most commonly inflation. Developed and emerging economies will continue to experience broadly synchronised intra-year inventory cycles due to the increasingly globalised nature of the manufacturing supply chain, but the underlying growth stories and the demand side conditions in particular will continue to differ markedly.


Emerging countries are highly heterogeneous and they no longer share the common feature of potential default should they be cut off from foreign capital for the simple reason that they are now often the net creditors. All their major risk scenarios are either country specific, or emanate from the mess in the developed world. The former can be avoided by a portfolio investor, the latter scenarios all pose much greater risks for those invested in the developed than in the emerging world.

Markets though are mainly driven by risk perception, not risk directly. Markets are likely to see more confusion in 2012 as previously stable mental constructs and views of the world are found lacking, and then gradually replaced. Shifts in perception can be radical for the individual, yet the overall cumulative effect is gradual.

Greatest actual risk – that is, the risk of not being repaid on an invested amount – is in those asset classes where a triple cocktail exists: a homogenous investor base; a major under-perception of risk, which is likely to reverse; and leverage. All the main candidates are in the developed world.

Until a year ago there was little inflation in the emerging markets, hence no urgent need to appreciate currencies. There followed a period of central bank inertia as uncertainty in Europe trumped the desire to diversify from the dollar. At the end of 2011 inflation pressure has again subsided. In 2012, we expect the drift in events in Europe to lead to a more definitive resumption of confidence, or crisis followed by recovery. This should lead in due course to dollar weakness (including probably but not necessarily against the euro). A sudden yen appreciation, an announcement by a major central bank of substantial dollar holding reduction, or an oil price shock could all precipitate more acute dollar weakness. Most likely though is a more gradual diversification and reduction of emerging market central bank reserves.

The most likely path for unwinding global imbalances over the medium term is through appreciation of emerging market currencies. We expect this process to be only temporarily interrupted by bouts of risk aversion. Over the medium term as their currencies appreciate, emerging economies will gradually come to rely more on domestic demand. In order for this shift to be non-inflationary, there will be a greater focus on addressing supply-side constraints, particularly through reforms, the development of corporate bond markets, and major pushes into infrastructure investment.

Protracted weakness in developed world demand will also spur south-south investment and trade. Countries will make further efforts to shift trade patterns more to emerging markets. Emerging market banks will take more market share from developed market peers, possibly including through acquisitions. Policymakers may take the initiative in persuading more companies to invoice in non-dollar currencies. We will also likely see further diversification into emerging assets by emerging central banks, a process which is still in its infancy.

Not investing significantly in emerging markets is a form of gambling. Yet denial of this reality is strong: people believe what they want to believe. The argument for hanging on to outdated and simplistic concepts of risk and to prejudices about emerging markets is driven by hope more than rationality. We fear to question our assumptions too closely. The gambler on a losing streak may shut off reality to feed the addiction.

How long should we stay at the roulette wheel when we know our returns are likely to be low even if we don’t lose everything? Do we think the status quo can last indefinitely and that the odds will continue to be rigged? Or do we just think we are lucky? Arguably, the more prudent are investing in emerging market asset classes to reduce risk – in cash markets, sovereign debt, corporate debt and, of course, equities for those with more of a stomach for short term volatility.

Jerome Booth is head of research at Ashmore Investment Management

Copyright The Financial Times Limited 2012.

02/07/2012 06:06 PM


It's Time To End the Greek Rescue Farce

Commentary By Stefan Kaiser

Whether it be an escrow account or a budget commissioner, the latest demands by Germany show just how absurd negotiations over Greece's future have become. It is high time to bring an end to this tragicomedy.

For the past two years, Greece has wrangled with the euro-zone states and the International Monetary Fund (IMF) over its so-called "rescue." Austerity measures have been agreed to, aid has been paid and private creditors have been forced to accept "voluntary" debt haircuts. Despite all this, Greece is in even worse shape today than it was then. Its economy is shrinking, the debt ratio is rising and the country and its banks have been cut off from capital markets. There isn't even the slightest sign that the situation might improve. Something has gone very wrong with this rescue.

But none of the protagonists seem to have grasped this. They continue to negotiate as if things are business as usual, they let one "final ultimatum" after the other pass and they persistently fail to realize that their discussions have started to verge on the absurd. It would be a lot better to end this farce.

For weeks now, the Greek government has been negotiating with private creditors and the troika comprised of the IMF, European Union and European Central Bank (ECB) over a second bailout package. But it is already clear that this aid package will not save the country. It appears it will only delay a Greek insolvency -- and it will serve to create new hardships for the country's population.

It is time for politicians to admit that their carrot and stick strategy has failed. The idea that the country can be freed from its debt quagmire though austerity programs and aid pledges tied to conditions just isn't going to work. It won't even work if private creditors forgive part of the country's debt.


Broken Promises

.For months, Greek government politicians as well as the so-called rescuers in Berlin, Paris and Brussels have all been deceiving themselves. Each supposedly final rescue package is followed by yet another, and austerity pledges aren't being adhered to.

.That has a lot to do with domestic political considerations. German Chancellor Angela Merkel and French President Nicolas Sarkozy must convey to their voters that they have the situation and, especially the Greeks, under control. Meanwhile, the government in Athens must, out of self-preservation, limit the burdens to its own people as much as possible.

.That's why both sides repeatedly agree to promises that everyone knows they will not be able to keep. The current rescue package, for example, officially agreed at the euro summit at the end of October, already has to be improved because it has become too small.

.The Greek economy is shrinking faster than assumed. And the austerity plan Greece approved last summer under pressure from its euro-zone partners is also failing to live up to expectations. That's no wonder, either, because €50 billion of the €78 billion in total savings pledged was tied to proceeds from privatizations that, not surprisingly, have failed to generate the profits expected.


Out of Thin Air

.The truth is that it must have been obvious to all parties concerned, including the Germans, that the figures were pulled out of thin air. What kind of investor would invest so much money in a country that, for the foreseeable future, will be stuck in a serious economic depression?

The supposed rescue efforts have culminated in the latest German proposals. The German government would like to send a "budget commissioner" to Athens to keep an eye on the Greeks. If that doesn't work, then the Germans also want, at the very least, to be able to impound Greek accounts if they don't pay back their debts through an escrow account.

The suggestions have justifiably provoked outrage. Quite apart from the humiliation these measures would entail for the Greeks, Athens would almost certainly find a way to circumvent them. In the end, Germany would wind up turning an entire nation into its enemy without even gaining anything.

Greece Must Go Bankrupt

.Perhaps, the Greece rescuers on both sides of the negotiating table should try being honest for a change. Here's the truth: If the country is to lastingly reduce its mountain of debt and, at some point, be able to borrow money on the capital markets again, then it needs a comprehensive debt haircut. In other words, it needs to go bankrupt.

And it's not just private creditors who will have to forego a large part of their outstanding Greek debts. It is also other European countries and the European Central Bank. That would be expensive for taxpayers across Europe, and it would also be economically risky. Indeed, no one knows what consequences a Greek bankruptcy would have for other crisis-ridden countries like Portugal, Ireland or Italy. But at least it would be an honest solution.

Of course, things wouldn't stop there. The euro-zone states would also have to build a bigger firewall around the remaining crisis countries in order to prevent contagion. They would have to help some banks that get into trouble as a result of a debt cut. And they would have to provide Greece with a real opportunity to get back on its feet and start growing under its own steam -- in other words, a kind of Marshall Plan.

All this would be very expensive, and German taxpayers would also be forced to do what they have feared from Day One -- which is to pay for Greece. But this solution has two major advantages. The payments would be limited, and they would actually help Greece.

And unlike everything that has been negotiated up until now, the solution would also be worthy of being called a rescue package.