A crash course in globalisation

What has happened in East Asia is almost a true copy of what had happened in Latin America in the eighties, the only difference being that the inflow of foreign funds in East Asia was almost totally in the form of FI while in Latin America it consisted of debt and FI. The common pattern was that in both cases the inflows of foreign funds created an initial period of high growth. There was a genuine improvement in the living conditions. As these flows became large the service burden on the existing stock also increased. The situation thereafter tends to deteriorate.

For example, a 30 billion-a-year inflow of FI, as is presently occurring in China, turns into a 300 billion stock in 10 years. This requires servicing, say 10 per cent, or a repatriation of 30 billion every year. As long as fresh FI inflows are equal to this outflow, there is no visible problem.

The problem arises as soon as investors perceive that fresh inflows may slow down. If that happens, the supply of dollars would slow down while the demand for dollars for repatriations will continue to increase as more of the FDI projects come on line. The result is that there will be a tendency for the Yuan to depreciate. That becomes a cause of concern to the portfolio investors. Their investments are denominated in Yuan. The value of their investment measured in dollars depreciates along with the Yuan. They find that their gains over the last few years can be eroded by a relatively small fall in the value of the Yuan. This leads them to try to divest their portfolios and down goes the stock market. As the earnings of the foreign investors take a nosedive, so does the value of their own stocks on the New York stock exchange and we have a global crisis on our hands.

After a series of bailout packages the situation stabilises. Now the host economy, China, finds that it has to service the remaining stock of FI, say down to 200 billion now. It has to use its current export earnings to service this debt8217;. Now the past FI turns into a burden. The country has to slog to earn to meet its repatriation obligations.

The present crisis indicates that foreign investors no longer consider East Asia as safe havens. It is significant that, as the Hong Kong crisis unrolled itself, China announced new measures to attract fresh FI. According to the Wall Street Journal the Chinese government announced 8220;new incentives for foreign investors this year in an attempt to reverse a sharp decline in planned US investment. According to Beijing8217;s data, contracts for new foreign investment were down 50 per cent in 19978217;s first half from the year before; US commitments fell 63 per cent8221; might the Chinese not be happy enjoying the fruits of the existing stock of FI of many hundred billion dollars?

No. They cannot quite enjoy the fruits of existing FI because only fresh inflows can provide the dollars for the profit repatriations. If these fresh inflows do not materialise, they are in for trouble. That is exactly what had happened in Latin America. As soon as fresh flows of capital and debt had slowed down, it lapsed into the lost decade8217;.

The world markets have recovered. We may see a few months of stability. But it would be safe to predict that there will continue to be one crisis after the other in East Asia as fresh FI flows fall. In the end we may find East Asia having followed Latin America in losing decades.

Perhaps we need to redefine globalisation in terms of free trade rather than free capital flows. Free trade does not bring with it long term problems of profit repatriations. What needs to be opposed is a desire for quick growth by foreign investment.