Keynote address on US financial turmoil and the future prospects for Asean economies

Speech by Anwar Ibrahim delivered at the CLSA Investor Forum in Hong Kong on Friday 26th September, 2008

What do you do when a financial behemoth implodes?

What can you say about free market capitalism when the world’s leading liberal democracy dumps nearly a trillion dollars in private debt onto taxpayers? Are Freddie Mac and Fannie May along with Lehman Brothers, Merrill Lynch, and AIG totally unforeseen victims of systemic once in a lifetime financial meltdowns or are they not really victims of their own greed? When you allow the “mushrooming of weapons of financial mass destruction,” to borrow a phrase from Warren Buffet then isn’t it written that you shall reap what you sow?

The question is who should pay the price of Wall Street’s excesses. I learned in Economics 101 that those who live by the market must also die by the market. But with this gargantuan bailout it looks like the only thing that is dead is raw capitalism. Not that I’m complaining or that I ever subscribed to this thing called a totally free market. Some will recall that in my address in Bangkok last year I repeated my mantra that the free market is well and good but Adam Smith’s invisible hand may sometimes continue to be invisible if not altogether paralysed when the time for action draws nigh. Sometimes as it is in times like these, Uncle Sam’s hand may prove to be far quicker on the draw. Otherwise spontaneous order may well turn out to be spontaneous chaos.

Hayek is history, so they claimed.

Speaking of history, it would appear that the powers that be have learned some lessons. We know what happened in the 1930s when, adhering strictly to free market principles, the Federal Reserve folded its arms and did absolutely nothing even as the financial system was cracking under the weight of massive defaults that eventually caused the collapse of the American economy and the contagion spread to Europe. There would have been lessons learned too from the October 87 crash, and the savings and loans scandal. Then of course, there was the 1997 Asian financial crisis.

As for the latter, Asian countries having experienced the pains of the financial meltdown which saw their currencies plunging to the depths, are now having generally stronger balance sheets. Regardless whether or not they swallowed the bitter pill of IMF prescriptions, they now have better current accounts than they had ten years ago. But what exactly were the lessons learnt? Is it that we can snicker at the U.S. and tell ourselves that we don’t need to listen to you, because we are far better off now? Is it that we don’t need market economy and the related principles?

Why talk about the sanctity of free markets and the importance of non-interference by governments when the bastion of free market itself is now engaged in the biggest bail out exercise?

Some leaders are now gloating over their so called successes in resorting to bailouts even much earlier and retrospectively sanitising their remedies of capital controls and the policy of currency. This is a false premise. Bailouts cannot be used as a veneer for crony capitalism. It appears rather foolhardy for certain leaders in the region to start thumping their chests over their relatively wealthier positions and that they have strong fundamentals.

Are the fundamentals that strong?

To get the analogy of true strength let me relate some lines from Tu Fu (Du Foo) one of the greatest Chinese poets and contemporary of Confucius; also a well known sage of the Tang Dynasty:

And so firm is the deep root, So established underground, That its lone lofty boughs Can dare the weight of winds, Its only protection the Heavenly Power, Its only endurance the art of its Creator

The convulsions that began the last summer arising from the subprime crisis have morphed into a full blown seizure the implications of which have left us still groping in the dark. Aggravated no doubt by record breaking inflationary pressure, the current crisis has reached such a level that the threat of a worldwide recession looms. The hysteria, irrational as it is, is real. We saw the run on the U.S. financial institutions and the consequences unleashed. And as we all know, even Hong Kong hasn’t been spared—this week two typhoons scored near misses on the city, one a torrent of rain that passed to the south, and the other entailed a long line of depositors lined up outside the Bank of East Asia. With emotions running tense, we could certainly benefit from a return to sanity.

Even though the locus of the slaughter is the United States, the bastion of free ‘market’ democracy, yet, in many ways the current upheaval bears some similarities to the Asian crisis. We would think that the lessons learnt from the Asian crisis, in particular the Asean region, could help us navigate the treacherous waters that we may be heading towards.

At the end of the day, we are looking at a credit fiasco gone haywire. Both concern loan defaults which trigger a chain of consequences ending in massive losses for financial institutions. Like the crisis in the Asean region, there are without a doubt serious issues of governance, transparency and accountability at stake.

As I said back in 1998 at a forum in New York chaired by Maurice Greenberg, who was the AIG chief, I had likened the Asian crisis to the sinking of the Titanic. (I am talking about the AIG then, the financial Rock of Gibraltar, solid and unshakable, not the fallen giant of today.) Prior to the meltdown, there was the euphoria among the Asian leaders about the so-called East Asian miracle and all skeptics were dismissed as naysayers and those calling for fiscal restraint, including myself, were branded as doomsday prophets. Then the crash came. But the question is who the real victims were. Undoubtedly they were the ordinary people while cronies and family members of political leaders were given the life boats and the first to be bailed out.

In this regard, social justice must remain one of the main purposes of government. The proponents of free market may not want to admit it let alone utter the dirty word because the mantra is that state intervention should be avoided like the plague. But it is once again all too apparent that, left unchecked and unregulated, the consequence of markets running amok is not just gross inequalities of income distribution but systemic failure altogether.

We are looking at foundational weaknesses. Apart from the obvious issue of risks management, I believe that the global financial architecture and the institutions need structural reform. Make no mistake. We are not here to advocate command economies of the Orwellian kind but we can no longer be in a state of denial as to efficacy of a common sense approach to managing the economy. This is also very much in line with the demands of social cohesion and political stability.

Though we believe in a well-regulated market, where contracts should be honoured and the principles of fair dealing applied, we also know that a heavily-regulated market, coupled with highly opaque government operations cripples the economy and discourages investment. And it would be a grave error to think that governments have a duty to bail out badly run institutions and companies. Moral hazard cannot be simply dismissed as just another Bretton Woods construct. Among the most important lessons appears to be if you keep on spending money which is not yours, sooner or later it will take its toll.

In this regard, we view with great consternation the path that Malaysia has been taking in the last five years. Public-sector spending rose to RM200 billion annually from RM160 billion in 2004. That of course doesn’t include the slush funds in excess of RM30 billion used at the discretion of the Prime Minister. The national debt has gone up by another RM100 billion and as more money is being spent, the fiscal deficit has risen to 4.8% of GDP this year.

With capital flight at a record high since the 1997 crisis, RM125 million in 2008 already, Malaysian investment abroad now exceeds inward foreign investment. We are facing a double barrel onslaught of our own doing with the Ringgit hitting all time lows since 2005 and inflation a record high of 8.5%, the worst in 27 years.

Issues of governance and corruption are yet unresolved. The latest corruption perception index from Transparency International speaks for itself. In almost a decade Malaysia has hardly improved its position in the ranking while our would-be peers are making substantial improvements.

Our agenda for Malaysia is clear. Revive the lagging economy by adopting market friendly policies and take decisive action to cure the festering sore of corruption and cronyism that has decimated the judiciary, rendered the anti-corruption impotent and leeched billions of dollars from the state coffers – by Morgan Stanley’s account in the amount of at least $10 billion per year. Restore faith in the institutions of governance both domestically and internationally so that investors will once again find the country an attractive destination for their long-term investments. Among other things, this means strict adherence to the rule of law and an immediate end to draconian statutes that would allow the powers that be to detain their adversaries willy-nilly and without due process.

The issue of regime change is central to the current political scenario. The ability to handle a transition is a measure of the strength of the country’s democratic institutions. It can, and ought to be done, peacefully and orderly. Stability cannot be sacrificed on the altar of freedom no matter how intense the desire for change has become.

Weathering the storm of its own internal strife, it is apparent that populist spending is the easy way out for governments hell bent on clinging to power. On the contrary we would introduce structural reforms in public procurement programmes and the management of State companies while ensuring that adequate social safety nets are in place.

With the political will to combat corruption, wastage and mismanagement an 8% per annum growth rate is not unrealistic. Petronas should be made accountable to Parliament and not remain the private piggy-bank of the Executive Branch. We will remove restrictions on foreign capital inflows and outflows and revamp government protection of monopolies in industries like telecommunications and banking.

If our markets are strong and unfettered, and if our laws are transparent and enforced by impartial judges, we will not need special development corridors or regions to attract investment. A stable and clean business environment is far more important than special tax breaks and quotas handed out by a corrupt and opaque government.

With compassionate policies in place, the rifts caused by unequal development will finally begin to heal. Just as importantly, poor bumiputeras will finally be able to access economic aid that trickles all the way down instead of disappearing long before it reaches them.

The central principle of these economic policies is that the right opportunities must be made available to every single Malaysian –to learn, to earn an honest living, and to realise their dreams.

Ladies and Gentlemen,

When the Asian Crisis struck ten years ago, the decisions I made as Finance Minister were not populist nor were they popular. On principle, I felt they were the right moves even though it was at the expense of my personal freedom. Yet in my darkest hours of solitary confinement I had never given up hope that something good was to come of the ordeal. And now after more than a decade of struggle and profound challenges we are on the threshold of a new beginning.

Thank you.