Malaysia's Third Way

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JEFFREY A. WINTERSFor many countries in Asia and beyond, the current economic crisis is like being plugged into a huge and unstable electrical grid without a surge protector. Convinced that Malaysia had been jolted enough by its exposure to wild swings in cross-national money flows, Prime Minister Mahathir Mohamad pulled the plug and imposed capital controls. Although it was a defensive move driven primarily by domestic political calculations, his decision will have an impact well beyond Malaysia's borders.The widening crisis that started in Asia is rewriting the rules of the international economy. By taking Malaysia off-line, Mahathir has made his most important contribution to that process. A new and significant political-economic space has been carved open for government leaders eager to reclaim some control over their economies. All will study how Malaysia fares. With Kuala Lumpur opting to limit its external financial links, even if only for a few years, the world now has evidence that the range of responses to gyrations of capital in today's international economy is wider than the free marketeers would suggest. It is neither technology nor some abstraction called globalization that determines the huge daily movements of investment funds into and out of countries and the trade in national currencies. Government decisions and policies set the terms of capital movement. And they, in turn, are the result of power relations and political struggles that are as much between groupings of people (those controlling capital and the rest of us) as they are between groupings of nations.You don't have to be a Mahathir fan to acknowledge that his move was shrewd and his timing impeccable. No one can credibly complain that he and other Asian nations failed to give markets and the International Monetary Fund's orthodox medicine a chance to yield results. With the IMF and World Bank damaged and in disarray, with establishment economists more confused and contentious than at any time in the past half-century, and with Japan, Russia, China and even the United States facing escalating economic danger, Mahathir saw he could act with impunity.Stanley Fischer, the IMF's deputy managing director, calls Mahathir's move retrograde, but he can only bark and not bite. Controllers of private capital also are powerless to unleash their standard barrage of punishments. They cannot threaten to withdraw resources because they have already done that. Nor can they credibly threaten to withhold new investments or claim that capital will now go to emerging markets with more attractive investment climates: institutional investors in those markets have been badly burned, and net flows are negative across all countries. Joyce Cornell, the lead portfolio manager of Scudder's Emerging Markets Growth Fund, summed it up this way: Asia is not worthy of much serious investment for some time. And I mean a long time.PAGE 1|
The dire warnings that Malaysia has seriously damaged its reputation among global investors also ring empty. By the time this economic crisis subsides and capital starts flowing again in earnest to emerging markets, Mahathir will likely be at the end of his political career. Malaysia will still be an inviting place to invest. As the country gradually re-engages, the new government can blame the old one for any sins, and investors, assuming their memories are that long or that they even care, will come back with enthusiasm.Southeast Asia today provides three distinct case studies reflecting the full range of responses to the crisis. At one extreme is Indonesia. Thoroughly plugged into cross-border capital flows and hooked up to a slow-drip IV from the IMF, the country has thrown off a dictator and is still riding a roller-coaster of economic default and currency instability as it tries to follow the IMF's prescriptions. It's not working.In the middle is Thailand, which has had one change of government, may soon have another and is on a slightly faster IMF drip. But the Thais are discreetly abandoning the letter and the spirit of the IMF cure and trying economic stimulation instead. It is too early to tell if that new approach will yield results.At the other extreme is Malaysia. Now unplugged from easy capital flows, it has a status quo regime arresting dissidents and digging in more deeply than ever. Malaysia is receiving nothing from the IMF and has decided that a strong dose of Keynesian stimulation in an economic environment less exposed to the vicissitudes of cross-border capital movements is the way to go.Mahathir knows he has to act quickly in this time of crisis. The vulnerability of his governing coalition was made clear in a July by-election when the ruling United Malays National Organization lost a seat it had held for 34 years. Even if he cannot deliver a rapid economic recovery, he must at least restore some semblance of stability to an economy whose currency lost 60% of its value after the crisis began. Mahathir is betting that limiting capital transactions will buy that stability, while Indonesia and Thailand continue to endure jolts and surges across their borders. Mahathir knows all eyes are on him. We are trying to manage a country in deep crisis, he said recently. Whether we fail or we pull through, we will definitely be providing lessons in governance for everyone.|PAGE 2