The 1930s Great Depression changed the nature of capitalism by bringing in New Deal-type policies and establishing US hegemony in global finance. We have now had the sequel, the Great Recession of 2008-09. A fresh set of players has emerged more or less unscathed, this time concentrated in Asia, apparently ready to provide leadership. The West should get used to the consequences. This is epoch-changing stuff. The world?s future financial and economic architecture will carry the hallmark of the international creditor nations.
These circumstances may cause disturbance and soul-searching, yet we should see them as an opportunity. Before we resume the bad old ways of highly leveraged banks and highly indebted consumers, it is time for fundamental reflection and fundamental action. The entire system of global economic governance needs refashioning. This will require renewing the institutions of world financial and economic power, and remodelling them in line with Asia?s own approach to fiscal and financial responsibility.
Asia must be fully co-opted into efforts to create and supervise the new structures?a condition that the G20 process, though welcome, only partly fulfils. Global governance has been one of the major culprits of the crisis. Imbalances need repairing, not just in finance but also in the political sphere. The leadership of the Bretton Woods institutions can no longer be left as a US-EU duopoly. The field must be thrown wide open. The West can no longer hide behind veto power.
Asian countries will be the powerhouse of the global economy for the next 50 years. China and India are now the engines of growth, as Germany and Japan were in the late 1970s. China has earned its place as a member of the G2 tandem with the US. Asia has responded well to a recession it did not cause, preventing the feared ?double-dip?. China led the way with one of the largest reflationary packages. India?s package was inclusive of its rural hinterland as well as its urban industries.
Asia?s rise is not just an upheaval. It is a renaissance. It marks Asia?s return to the top table after an absence of half a millennium. The Classical Age saw the Empires of Rome, Persia and China. India never had a single imperial authority for any length of time, but it was a thriving society. Trade flourished between these areas in silk, textiles, spices, horses and gold. Europe ran a balance of trade deficit vis-?-vis Asia. From the decline of Rome until around the 15th century, Islamic armies rode high. Across North Africa and Southern Europe, there was a thriving Muslim Empire. Trade flourished across the Indian and Mediterranean oceans?and by land across Central Asia all the way to Italy, as Marco Polo demonstrated.
In the late 15th century, the world turned on its axis and tilted towards the West. The Iberian powers were first off the block, as the advance guard of maritime Empires. China gave up on its Imperial Navy for reasons that are a mystery. The development of manoeuvrable ships carrying light artillery was the crucial innovation that gave the West its decisive advantage. The maritime link with Asia around the Cape of Good Hope spurred expansion of trade. The hoards of gold and silver taken by Spain and Portugal from South America went to Asia to pay for the spices and textiles and silks. In the 100 years between 1750 and 1850, the West secured its military domination over Asia. Its armies were smaller but better trained and organised?and were often manned by the Asians themselves. Even before the Industrial Revolution gave further advantage, the West had secured an Empire. Asia lost. Europe won.
The balance began to change in the late 20th century. After 25 years of growth and mass consumerism, the West began to lose its competitive advantage as full employment and inflation eroded industry?s profitability. Asian Tigers were waiting in the wings. They used western technology to win markets abroad. By the 1980s, China had joined the Tigers?Taiwan, Hong Kong, Singapore and South Korea. Soon Malaysia, Indonesia, Thailand and the Philippines took their place among high-growth Asian economies. In the 1990s, India entered the club, too.
The fall of the Berlin Wall and the death of the Soviet Union stemmed from, and also accelerated, globalisation. Many emerging economies embraced fully-fledged financial markets and free trade under the auspices of the World Trade Organisation. Asia was ready to take advantage. Manufacturing exports from Asia poured into Europe and the US. Everyone benefited: Asian economies had surplus labour while western capital was looking for higher returns. Low tech and medium tech left western shores and settled in Asia. And, in the West, financial services and IT companies grew up in the gap left by industry.
Asia had its harsh lesson in globalisation during the 1997-98 financial crisis. Asian countries realised the fragility of their banking structures and regulatory systems. These lessons led Asia to accumulate large foreign exchange reserves in the next 10 years. Asia under-consumed and over-saved, mainly via exports. The West over-consumed?especially the US and the UK. The West borrowed from Asia but did not invest the money productively. The real estate boom did not last long enough to valorise all the debt incurred. The Great Recession of 2008-09 brought the coup de gr?ce.
Now we face many challenges. The fragile international payments system needs repair so that financial imbalances can be managed without causing another recession. The damaged parts are in the West, not in resurgent Asia. Yet the structures of global governance?the G20, the G8, the IMF and so on?do not give Asia its due place. Voting power in the Bretton Woods institutions does not pay sufficient regard to the new creditor countries.
The old post-Second World War structures?the gold/dollar exchange standard, the formation of Special Drawing Rights, today?s IMF voting system?have all failed to serve their original purpose. We need a multilateral exchange rate and reserve asset regime to replace a de facto dollar standard that gives little incentive to Washington to be fiscally responsible. One of the lessons of the crisis is that US seigniorage gains are as unhealthy for the US as for the rest of the world. But one of the unfortunate side-effects of the current euro upheaval is that it may perpetuate the dollar system that many believed has had its day.
There is a similar situation with regulatory reform. Much of Basel II had problems in its design. As reform discussions proliferate?with various suggestions such as returning to the Glass-Steagall system, improving host country/home country co-ordination, higher capital adequacy, living wills?it is beneficial to study how Asia got it right. The western regulatory authorities failed to see the crisis building up. They did not only fail to prick the asset bubbles; they positively fed them. These authorities cannot be the best agents for designing the new system. The over-representation of OECD countries at all levels of reform discussions is a scandal.
Asia as a region did not have a deep recession, only a growth correction. Its banks remained solvent. Asia learnt its lessons from 1997. Asian countries reformed their structures and did not fall for the siren voices lulling them in the West?s direction. Asia has large pools of saving and it has invested in productive assets. It has taken advantage of international market access, showing that, in quality and price, it can compete on equal terms. Asia can outline the route to a balanced multilateral set-up in which the burden of adjustment will be shared by the deficit countries as well as the surplus nations, but where there can be no single currency dominance. Asia can help remodel the IMF and World Bank to maintain the global system in expansionary mode without restrictions on trade and capital flows.
Asia can help fashion structures that encourage savings more than indebtedness as the path to growth. Asia can point to its own example of harnessing market forces without being overwhelmed by them. It can remind the West about its own old habits of thrift and sensible banking that many forgot. Asia has a voice. In the highest echelons of world governance, on reforming, regulating and remodelling the global economy, it should make this voice heard. Asia has arrived. It is here. This is Asia?s millennium.
The author is a prominent economist and Labour peer