Vol.1 No.8, 27 August 2001

How Malaysia got away with Heresy

By Margaret Legum

On September 1, 1998, Mahathir Mohamed, Prime Minister of Malaysia, made a very angry broadcast. It was not entirely unexpected: a year earlier when all the Asian currencies were being deserted by international capital, he had used some very undiplomatic language - including 'moron' and 'brigand' - to describe George Soros personally. But the September broadcast was different: the war of words gave way to action.

Dr Mahathir announced that the ringgit (Malaysia's currency) would no longer circulate outside the country - any then in banks abroad would have one month to get home, after which they would be worthless. The government would fix the exchange rate - later set at 3.8 ringgit to one US dollar. He also restricted the repatriation of profits made by foreigners from trading shares. Non-residents would have restricted access to the ringgit. Investments abroad by residents for non-trade purposes would require permission. In other words he put out of bounds speculation in the value of the Malaysian currency. He also reinforced measures to expand the economy by low interest rates, increased government expenditure and help for the banks.

As a solution to Malaysia's problems this was greeted with derision by all Western governments, financial institutions and the pundits. All of Malaysia's equally ravaged neighbours - Japan, Korea, Indonesia, Thailand - were obediently following IMF prescriptions about how to recover: tight fiscal and monetary controls, and free trade and capital flows. Malaysia had done the same for the first year after the crash. The result had been continued depreciation of all their currencies. The ringgit had fallen by 35%, and the Kuala Lumpur Stock Exchange composite index by 52%. Mahathir had had enough. His heresy was heard with disbelief and predicted to lead to disaster.

Take a step back. Before the financial crash in 1997/8 the then-called 'Asian Tiger' states had astonished the world by the rapidity of their economic growth - of the order of 1,500% in four decades. There were several contributing factors. The neo-liberal Washington Consensus put it down entirely to export-led production based on total liberalisation of the economies - labour prepared to work without restriction, privatisation, unregulated capital markets and untrammelled competition through unrestricted trade. Some of that was true but not all of it.

In fact, the 'Tiger' governments had regulated their economies: they invested carefully in those enterprises that they reckoned could make an impact in export markets, and those which were labour intensive. They opened their markets to competition from abroad only when they were good and ready to compete. (Unlike the African countries, including South Africa, who were 'persuaded' to drop tariffs as an apparently vain incentive to foreign investment.) They did, however, open their currency exchanges and were rewarded with floods of both investment and speculative capital. And they kept the activities of trade unions minimal, so that labour was 'flexible' in its demands. Poor people worked long and hard.

The crash came suddenly, following rumours that the financial institutions in some places were 'over-borrowed' and vulnerable to withdrawal. It spread like wildfire, the whole region being tarred with the same brush. It also spread - totally irrationally - to all countries considered to be vaguely in the same 'middle-income developing' category. South Africans, for instance, watched helpless as the rand nose-dived. Why? Because speculative capital is engaged in the business of second-guessing itself rather than understanding economies. The herd instinct is highly sensitive to rumour and associative innuendo. With hindsight the IMF blamed the crash on 'lack of transparency': the suggestion was that not enough information led to mistaken over-investment. Few believe that any more: the fact was that the 'over-borrowing' was plain for all to see. Investors did not want to see it while the going seemed good - just as today they do not want to see the bubble building on the American bourses.

The devastation was enormous in Asia. Before the crash Malaysia's annual growth rate had averaged some 8.7%, inflation was below 4%, the unemployment rate 2.5%. Its external debt was small, with a debt-service ratio of 6.1%. The national savings rate was 38.5%.

As a result of the crash, real GDP growth went into the negative, falling to minus 25.2% in 1998, and struggled up to 1.9% in 1999. Savings and investment nearly halved. Both net domestic assets and the capital account balance went into negative. Literally millions of people became unemployed. The same, or worse, was happening in the other 'Tiger' states.

Following Mahathir's defiance, he set up a National Economic Action Council (NEAC) to make detailed policy for the various sectors of the economy. In principle trade was not affected, but for some months non-essential imports were restricted. The economy is gradually being re-introduced into the globalised market at the pace the government reckons will be best for its citizens. By mid-2000 profits from investment were allowed to be repatriated - provided the capital had been in the country for at least a year, otherwise it would be subject to an export tax.

Three years on what has happened? Perhaps the most convincing evidence comes from the IMF. In July 2000 it concluded an 'Article IV Consultation' with Malaysia. This is a bilateral discussion with a member country to collect information and discuss economic policies. In August and September the IMF published successive 'Public Information Notices' summarising its Board's discussions following the Consultation . This is what it acknowledged.

"The Malaysian economy has recovered from the 'sharp decline' of 1998, 'which had had a more severe impact on economic activity than expected' Domestic demand had fallen by 26%. Real GDP growth is now over 5.5%, the manufacturing sector growth is 13%. Capacity utilisation in many industries has reached pre-crisis levels. Inflation is below 2%. 'Directors broadly agreed that the regime of capital controls - which was intended by the authorities to be temporary - had produced more positive results than many observers had initially expected'. Foreign inward investment has resumed 'aided by the upgrading of Malaysia's ratings and the reinclusion of Malaysia in the Morgan Stanley Capital Index at end-May….The Kuala Lumpur Stock Composite Index recovered by 39% during 1999, and rose further by 10% this year, while most neighbouring countries' indices fell." (my emphasis)

It is worth quoting that sentence in full, because it shows that, in simple terms, Malaysia has fully regained the confidence of the investing fraternity. This is a major lesson of this story. People who want to invest capital on the ground - as opposed to speculatively - are suited by a stable currency and stable government policies. Malaysia's recovery has been led by its domestic investors - they make up some 97% of new investment - and they are pulling in international capital in their wake. There was never any evidence that economic growth was a product of foreign investment - foreign capital goes where the economy is already working and the prospects of profit are good. The measures taken by the Malaysian authorities provided that environment while discouraging speculative capital. That is the best of both worlds.

The result is a stronger balance of payments on capital and current accounts. For the whole of 1999 there was a surplus of RM 42 billion, or 15% of GDP. Export growth is the highest among the crisis-hit countries. The annual rate of inflation is down to 3%. The other 'Tiger' economies have also recovered to some extent, but later and slower and from a deeper depression

What conclusions can be drawn from the Malaysian experience? The IMF fails to draw them, falling back on its old terms of reference for the future. It has 'commended the authorities for the implementation of policies that have placed the economy on a path of recovery.' But it encourages the government to be more transparent about the 'potential liabilities of the public sector' and to give 'explicit recognition' to the 'role of privatised infrastructure projects'. It wants a removal of the ceiling on interest rates and 'greater flexibility' in managing exchange rates to facilitate their 'liberalisation'

The IMF it seems has learnt nothing. By contrast, Malaysia's experience shows:

Finally, Mahathir makes a point often overlooked, but relevant to more than the drama over his own country. 'More than $1 trillion of the purchasing power of the East Asian nations has been destroyed. The political fallout is disastrous, with governments collapsing, law and order breaking down, people raped and killed, property looted and shortages of all kinds of necessities including food and medicine.' (Daily News, Kuala Lumpur, 8 May 1999)

Later, at the Second World Knowledge Conference in 2000, he said: 'There is a great deal of "globaloney" about globalisation….I have no doubt it will be brought to an abrupt end by the multitudes of the world if …unbridled and unconscionable capitalism, bereft of ethics, morality and caring rides roughshod over the welfare of the people…'

Hyperbole apart - and whatever one thinks of Mahathir as a democrat, his words have a prophetic ring in the decade after Seattle. There is a growing tide of understanding that the prescriptions of the IMF, far from useful for all countries, were in fact in service to the rich countries of the North and the West. This is now seen to be unacceptable: it leads not only to grinding poverty for millions in the North as well as the South but also to vast social upheaval. New prescriptions must be found to end the dangers of global footloose capital. What Malaysia shows is that individual countries can contribute to that search: they need permission from no one.

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