United States Can Learn Much from Faltering Asian Markets

Steven Hayward

December 19, 1997

Traders in the financial markets are ordering Rolaids by the case these days, as each morning begins with a look over our shoulder to see how the fragile Asian markets behaved overnight. The Asian economies, thought invincible just a few years ago, now teeter on the brink of a prolonged depression. Meanwhile, one of the most important lessons of the Asian crisis has been overlooked, namely, the fact that the political economy of the U.S. is still the best in the world.

It was just a few years ago, after all, that we were subjected to a drumbeat of criticism from the Deep Thinkers about how the U.S. was going to fall hopelessly behind the Japanese and other Asian tigers unless we emulated their style of government-directed economics. We would end up “trading places,” in the title of Clyde Prestowitz’s best-selling book, unless we adopted Japanese-style “industrial policy.” Lester Thurow, Chalmers Johnson, and James Fallows, among other “experts,” all swooned before the altar of Japan’s Ministry of International Trade and Industry (MITI), which “picked winners” and directed “strategic” investment in Japanese industry. It makes a difference, these alarmists soundbited, whether the United States makes potato chips or microchips.

Well, the U.S. today makes the best of both kind of chips, while the Asian tigers seem to be producing only cow chips. How have they managed to step in it so badly? And why has the U.S. avoided, for the time being anyway, the same fate?

There is probably a Chinese proverb somewhere reminding us that water only runs downhill, but the Asian planners got in trouble for ignoring the financial equivalent of this common sense. Everyone is now saying, “the bubble burst,” but few have shown a real grasp of how bubbles grow too big or how they finally come apart. The only people who have ever understood this clearly are the so-called “Austrian” economists (such as Ludwig Von Mises and F.A. Hayek) who long ago noted that high growth economies are prone to overinvestment.

What happens is that investment capital flows to where there are high returns, but tends to keep flowing there even after the rates of return begin to decline because of natural competitive pressures. Just as water flows downhill and seeks its own level, the rates of return on investment will decline to above average level as first two new factories are built, then three, and so forth. The periodic real estate crashes we experience here in the U.S. are classic “Austrian cycles,” but the same thing has happened in Asia on an economy-wide scale. Money kept flowing to Asia even though they were overbuilding everything and not returning the same high rate on capital as a few years ago.

The U.S. had the same problem in the late 1980s and early 1990s. The result was a sharp and painful recession–but a short one, because we took our hits right away and adjusted quickly. Our banks had to write off or write down billions of dollars in bad loans, which plunged the value of bank stocks into the basement. The savings and loan bailout cost taxpayers $500 billion, but the result of these sharp pains is that we set the stage for the sustained boom we have experienced since 1992. And our banking system has recovered smartly. The stock market value of Citibank, for example, has gone up more than tenfold since 1991.

By contrast, the Asians looked the other way as their overinvestment and misinvestment began to drag down their economic growth. Instead of writing off bad loans and liquidating bad investments, they papered over their troubles and continued making bad loans. Japan’s “amen chorus” here in the U.S. was in denial as well. In 1989, when Japan’s stock market was peaking at about 38,000, James Fallows wrote: “No symptom of slowdown can yet be observed. By every measurable indication–corporate profit, personal savings, industrial productivity–Japan is distinctly on the rise.” Today Japan’s stock market struggles to reach 18,000, and its emulators in the region are sinking into the same swamp. Most Japanese banks would be insolvent by American standards.

The lesson is clear. The U.S. allowed the markets to work to clear out bad investment. The Asian tigers didn’t. We didn’t let our government control “strategic” investment. They did, and got increasingly poor results. The Asian countries are like a person with a bad tooth, who puts off the sharp pain of having it removed right away. The result is much more pain over the long run.

But the U.S. shouldn’t get too smug. Don’t believe all this talk about a “new era” economy here. The last time such a phrase was popular was in the late 1920s. No economy is immune from the tendency to overinvest when times are good, leading to a bust. Last time we handled it generally right (a thank you is owed to President Bush, who refused to panic, even though it cost him re-election), but with so many people having racked up huge paper profits in the stock market in the 1990s, there could be strong political pressure to preserve these “gains” if a swift collapse happens here. Let’s not make the same mistake the Asians did.

Steven Hayward is an Adjunct Fellow at the Ashbrook Center for Public Affairs at Ashland University.