Asian Tiger's New Path: Blocking the Flow of Capital

Malaysia challenged the 'Washington consensus' on the free flow of capital this month. Is it leading a path for others?

A feisty, brilliant man named Mahathir bin Mohamad has led Malaysia for nearly two decades, deftly taking advantage of foreign capital and markets to turn this Southeast Asian mighty mouse of 22 million people into America's 11th biggest trading partner.

Mr. Mahathir has understood the dominant ideology of the second half of this century: that governments should let the free market guide their economies and forsake state control for liberalization.

But early this month, Mr. Mahathir pretty much kissed globalization goodbye, declaring Malaysia's currency worthless overseas, fixing its value to the dollar, and making it impossible for foreigners to yank their money quickly out of Malaysian investments.

In the aftermath of East Asia's economic crisis, which has begun to buffet the rest of the world, the managers of the global economy are deciding that free markets can be a little too free. Economists, officials, and political leaders are concluding, in the words of British Premier Tony Blair, that there is a need for "a new international financial system for a new international financial age."

The recognition is growing that there is simply too much money circulating the globe in search of profit.

In the mid-1990s, for instance, foreign banks and mutual-fund managers were making annual investments in Thailand worth nearly 10 percent of the country's entire economy. When confidence in those investments sagged last summer, the investors pulled their money out, collapsing the Thai economy and setting off a chain reaction throughout the region.

Just what sort of new system could prevent a recurrence remains unclear - except in Malaysia. Mahathir insists that countries can and should protect themselves from shocks caused by sudden changes in the international flow of capital. His is a controversial policy, since countries have been moving away from currency controls since the 1970s on the theory that free-flowing money helps trade and investment.

American Federal Reserve Chairman Alan Greenspan warned last week that "the obvious consequence of confiscating part, or all, of foreign investors' capital and/or income, is to ensure a sharp reduction in the availability of new foreign investment." The World Bank, worried about Malaysia's controls, announced this week it would postpone consideration of a $700 million loan Malaysia requested.

Malaysians seem ready to take the risk of alienating outsiders. "Right or wrong, let history be the judge," says investment banker David Chua, of the currency-control policy. "If it is wrong, then people will spit on Mahathir for a decade. If it is right, then we have an alternative."

Alternative to what? To the conventional wisdom, to the International Monetary Fund's ideas on how to help countries in crisis, to what some call the "Washington consensus." Mahathir's willingness to go it alone is part trademark boldness and partly the response of a leader whose economy is in a desperate situation.

Just a year ago, Malaysians were worried about the economy overheating, labor shortages, and inflation. Today there is recession, rising unemployment, and the perception - before the controls were announced - that there was no way out.

In South Korea and Thailand, nations more severely affected by the crisis, the IMF is insisting that governments maintain high interest rates in order to lure investments from overseas that could revive the economy. The problem is that this process takes time - and while everyone waits for confidence to reappear, businesses fail because they can't afford the high rates, creating unemployment, suffering, and instability.

Malaysia was less exposed to short-term portfolio investments and so could afford to stay away from the IMF. Its new policy is designed not to win foreign confidence but to restart the economy.

Fixing the exchange rate, for instance, makes it easier for businesses to plan for the future, since they know the value of the goods they import or export won't be subject to exchange-rate fluctuations. Declaring the Malaysian ringgit worthless overseas is designed to ensure that deposits in that currency in Singapore, Hong Kong and other countries come back to Malaysia, giving banks here some money to lend.

And telling foreign portfolio investors that they must wait a year to repatriate their funds is intended to discourage speculation and shocks to Malaysia's financial system. One ultimate aim of the entire package is to bring down interest rates, which have fallen to about 8 percent from roughly twice that four months ago.

It is true that these policies have all but stopped portfolio investment from overseas, but Malaysians are struggling to convince outsiders who want to build factories or maintain their existing projects that nothing has changed. Companies with tangible investments here - rather than shares of stock - seem willing to hope for the best. "There is a certain sympathy for Malaysia trying to do something to get its house in order," says a diplomat who watches the economy. Like many other observers, he insists that Malaysia must use the breathing space afforded by the currency controls to make the financial industry more open and to improve corporate governance.

That is a fancy way of expressing concern about corruption and a fear that easing of liquidity will be used to rescue bad companies - ones that may have good political connections - rather than give needed cash to viable enterprises.

Economics does not take place in a vacuum and recent political developments have given outsiders other reasons to worry. "[T]he big worry for Malaysia is that currency controls do tend, over time, to breed distortions and corruption," says Paul Krugman, an economist at the Massachusetts Institute of Technology in Cambridge.

Mahathir's dismissal of former Deputy Prime Minister Anwar Ibrahim amid accusations of sexual misconduct is troubling, Mr. Krugman adds. "It's creating an environment in which corruption can flourish - after all, who will blow the whistle on cronies of the prime minister , if telling the truth lands you in prison on sodomy charges?"

Politics aside, however, the general feeling here is that the economy now has a chance. Mr. Chua, the investment banker, advises Malaysians on where to put their money, as well as institutional investors. He recognizes that the foreigners may not be back, perhaps not for a long while, but at least Malaysian investors are now perking up.

But given the recession, it's not as if foreigners were very interested before the controls were imposed. "If there's no growth," he says, "people will not invest."

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