26 Dec 2011

The economic model invented and refined by the West and used by the rest of the world does not function anymore. The so-called Washington Consensus, the plinth of economic globalisation, has effectively gone with the wind.

The economic model invented and refined by the West and used by the rest of the world does not function anymore. The so-called Washington Consensus, the plinth of economic globalisation, has effectively gone with the wind.

The global financial crisis exacerbates the ongoing shift in global economic and financial power from the West to Asia. It does not change the prediction that the Asian economies will gradually take over from the West, but tells another and perhaps more fundamental story. The economic model invented and refined by the West and used by the rest of the world does not function anymore. The so-called Washington Consensus, the plinth of economic globalisation, has effectively gone with the wind.

Asia has one trump card: it sits on the world’s savings and will continue to do so for some time. This is likely to trigger a shift in policymaking, and concomitantly, global investment flows to serve Asia’s interests over that of the West. On the flip side, there is a lack of sufficiently strong financial institutions in Asia. The world’s financial powerhouses are still to be found in Europe and the United States. Asian banks also need to build up strong reserves and reduce their exposure to the contagion from the West.

The global financial crisis is an opportune moment for Asia to start thinking ahead about the kind of international monetary system it would like to lead and fashion. Asia needs to step up and assume more responsibility in the global system, but it is not enough just to seek influence in international institutions. More fundamentally, Asia needs to decide what it wants to do with its growing influence. To do this, Asia needs to distil the correct lessons from the current economic crisis.

First, any durable financial system must be part of the productive. Its function is basically simple: to channel savings into investment. To serve the economy properly, the system needs to be able to screen investment projects to determine which ones are profitable and which ones to skip. The more complicated and sophisticated the financial system becomes, the more likely it is that the basic function fades away to be replaced by self-serving operations that shuffle savings around financial instruments instead of channelling them into investments.

The Asian financial crisis of 1997/98, the IT bubble of 2000 and the global financial crisis of 2008 have in common one shortcoming: the financial system did not do its homework. These could all be foreseen but were not, because the lure of short-term profit overshadowed long-term prudence. What were the highly paid rating agencies doing?

Research and development is vital for the dynamism of an economy, but it is also risky. As seen in the United States, venture capital is necessary, but a right balance has to be struck. It is not a good idea to jump into whatever R&D project is put on the table. A good financial system rewards bold entrepreneurs and punishes foolhardy ones.

Asia is going to be the home of the major capital-seeking multinational companies (MNCs) of the future. The financial system must therefore provide the capital needed for investment and overseas expansion, which calls for an ability to judge overseas operations and understand what is going on in the world.

Second, corporate governance is defined by the strongest economies, so in due course it will be up to Asia, Asian MNCs and Asian banks to sketch a new model for corporate governance. Thought must be given to this now, and if Asia acts wisely, it will achieve a win-win situation whereby governments, corporations and society interact – contributing to the wider development of society – instead of the quest for short-term profit which has only encouraged irresponsible behaviour.

Politically, Asia must play its cards right to maximise its influence. Many observers ponder over the likelihood of China coming to the rescue of the euro zone. China will decide whether to do so according to its own interests, not to save the euro zone per se. From a Chinese perspective, this may be the price worth paying to avoid the U.S. dollar being the only major international currency and to stop China from being boxed in to acquire US treasury bonds as the only financial instrument available.

The three global institutions – the International Monetary Fund, World Bank and World Trade Organisation – are all controlled by the West, with an American at the helm of the World Bank and Frenchmen sitting atop the two other institutions. Many view this as an anomaly, but it should be remembered that Europe and the United States still account for almost half of the global economy. The financial expertise, regardless of the flaws demonstrated when the global financial crisis broke, is still predominantly found there. Over many decades they have amassed tremendous experience in fielding candidates, getting them elected and thereafter running these organisations.

Eventually this will change. How fast it does rests on two issues. First, how good Asia will be in finding and putting qualified candidates on the table to garner global support. Europe and the United States did not just put their people into the director’s chair, their candidates were elected. Second, will Asia be able to formulate a coherent policy about what it wants to do with these institutions? If Asia is content to be a bit player, it is insignificant whether the top person is Asian, European, or American. But Asia is now at an important crossroad: if it wants to transform the global system, it needs political will and courage to come up with a new paradigm and set of rules to organise the world financial system.

Joergen Oerstroem Moeller is Visiting Senior Research Fellow at the Institute of Southeast Asian Studies. He is also Adjunct Professor at Singapore Management University and Copenhagen Business School.