The Asian Crisis Proves Industrial Policy Doesn't Pay

Who can forget the numerous economists and pundits who assured us throughout the 12 years of the Reagan and Bush Administrations that Reagan's "politics of greed" had ruined the U.S. economy? The legacy of greed was said to be "twin deficits" of trade and the budget. And these deficits were supposed to have deindustrialized our economy and guaranteed that what remained would be owned by the Japanese. To his critics, President Reagan's wrongheadedness did not stop with tax reductions. He trusted too much in markets and refused to acknowledge that capitalism was fatally flawed when it came to trade, investment, and currency.

The model of success was alleged to be the industrial policy and managed capitalism of Japan and the Asian Tigers. Industrial policy was believed to be superior to capitalism, because it took into account the social aspects of investment. A greater good for a greater number would prevail over individual interests. Instead of businesses making investments based on anticipated profits (greed), government wise men would consider society's wider interests. Only investments that best served national interests would be approved for an allocation of scarce capital.

The protagonists of industrial policy are chastened to find that the Asian countries that they expected to own the U.S. economy by 1997 are instead looking to Washington for a bailout. From Japan and South Korea to the Philippines and Thailand, industrial policy fostered appalling investment, banking, and monetary practices.

COZY RELATIONSHIPS. Reagan's critics thought that capitalism fostered greed and, therefore, was corrupt. They did not understand that the political allocation of capital was the real source of corruption. Industrial policy replaces the impartial market with crony capitalism, in which cozy relationships to government determine financing. Since these cozy ties are kept cemented with payoffs and kickbacks, the result is corruption in politics as well as capital markets.

Industrial policy prevents capitalism from weeding out failures. Banks unprotected by cozy relationships cannot keep bad loans on their books. Under capitalism, crises are resolved daily on an individual basis. Under industrial policy, crises are papered over. They mount until the currency itself cracks. Then all the bad loans come home simultaneously. The U.S. government and the International Monetary Fund have to step in with bailouts to provide the liquidity that places a floor under the downward adjustments.

It has to be galling to Reagan's critics that amid the financial rubble of Asia, only Hong Kong--with no industrial policy, no managed trade policy, and no fine-tuned currency--is still standing. How can an economy so devoid of the discretionary judgment of wise men be the only survivor of the financial tsunami? Why were speculators able to bring down every Asian currency except the Hong Kong dollar?

WINNING THE DEBATE. We have seen it all before--in the Latin American crisis set off by Mexico's peso devaluation. The speculators ran through the currencies until they hit Argentina. There they floundered. Hong Kong and Argentina decided to forgo the vaunted flexibility of a managed currency and an active monetary policy for an inflexible currency board and an exchange rate fixed to the U.S. dollar. Their currencies are backed by 100% U.S. dollar reserves, which protects them from speculative attacks.

Johns Hopkins University guru Steve H. Hanke is the victor in the currency debate of the 1990s. Other economists thought that emerging economies would be strengthened by the flexibility of a managed monetary system. Hanke, however, predicted that these attributes would be an Achilles' heel. Discretion creates vast room for human error and cozy dealings.

The 20th century's naive faith in the ability of government to manage the economy and the wider society can no longer be justified. It is past time for the lessons of public-sector failure to be learned. Effective economic institutions minimize the scope for political decisions that determine the allocation of resources and economic rewards.

Economists know this, but a conflict of interest prevents many from acknowledging it. For the past half century, they have pocketed large fees from devising policies for activist governments and predicting the consequences for private businesses. Although not as corrupt as the plaintiffs' bar, economists have a vested interest in emphasizing the shortcomings of markets and the benefits of discretionary policy. This makes them unreliable arbiters of policy debates.

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