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East Asia in Crisis: The Security Implications of the Collapse of Economic Institutions

Authored by Dr. Stephen J. Blank. | February 1999

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Introduction

Contrary to earlier reports and hopes at the time of the conference, East Asia?s financial and economic crisis is spreading abroad and worsening. It has become a global crisis embracing Latin America and Russia and the Middle East oil states. Many analysts now believe and publicly state that it might last at least into the year 2000 or 2001. It already has toppled several governments, devastated virtually all of East Asia?s economies, and threatens to cut an even deeper swath through the world economy. By August 1998 Russia had to devalue its ruble, Brazil and Venezuela were rumored to be in line for devaluation. And China had pledged not to devalue and took strong measures in support of its currency.

One sign of the crisis? global impact is the effect it has had on global commodity prices, e.g. energy. Those prices have tumbled as a direct result of the dramatic fall in Asian aggregate demand. Thus states that depend on commodity products for foreign exchange, e.g. Russia, which rely on oil and gas revenues, are undergoing severe economic crises as well.1 History shows that crises of this magnitude generally lead to major international crises that have a great effect on U.S. security policy and upon our allies. For example, Indonesia is on the brink of chaos and widespread internal violence and famine.2 Social unrest there has already toppled the Suharto regime and could undermine its successor as well. Likewise, Japan?s prolonged structural crisis has profound implications for Asia and the global economy. The consequences of that development or of similar catastrophes in other states are incalculable for both regional and global security.

For that reason the Strategic Studies Institute, together with The National Bureau of Asian Research and The Reserve Officers Association of the U.S. armed forces, organized a conference in Seattle, Washington, on June 9-10, 1998, to assess the crisis? direction and impact. This conference focused on the crisis? domestic and international causes, its current and foreseeable directions, and its implications for international security. The conference brought together a distinguished international group of academic and governmental experts, policymakers, business leaders, and military officers who represented a unique mix of inter-group cooperation and expertise. This report presents a summary of the main points and ideas discussed at the conference.

In general, anxiety and sobriety marked the conference?s tone, particularly when discussing Indonesia. There also was considerable general pessimism about Japan?s readiness and ability to reform its own system and help pull Asia out of the crisis. Everything that has happened since the conference, especially the newly-elected Japanese government?s continuing failure to launch adequate reforms, seems to confirm that negative assessment.3 Japan?s centrality to Asia and its long-term stagnation are major reasons for concern over Asia?s future. For instance, any significant depreciation of the yen will instantly undermine China and South Korea?s efforts to hold the line on their currency and their ability to export enough goods to keep growing. Beijing has already intimated that in the event of a devaluation of the yen it would then have to devalue the Reminbi, stimulating further distress all across Asia. Foreign observers also well understand the pressure on China?s currency.4 And Seoul is likely to experience the same pressure and follow the same course.

Likewise, there were few signs of optimism for the near term, although most speakers reiterated their conviction that, given proper policy changes, Asia would reform and return to economic health. Only in the case of Russia, one of the many casualties of this crisis and its fallout, did Herbert Ellison voice optimism, mainly on the basis of the installation of the Kiriyenko government and its pledges to carry out a vigorous reform program. Since then, as well, the IMF has come to Russia?s rescue by lending it some $22 billion on the promise of vigorous implementation of a new reform plan. But even the IMF?s rescue efforts could not prevent a full-scale collapse of the Russian government, which, as of November 1998, still had no credible economic recovery plan. At the conference there was some debate over whether this optimism was justified. In the end it is clear that it was not warranted and that Russia?s crisis is only in its inception as its leaders now admit. Russia appears to be something of a black hole and nobody really can say with certainty how it can be saved.

Accordingly, financial and presumably political crises may spread throughout the Commonwealth of Independent States (CIS). If that is coupled with a major crisis in Asia, it is not clear whether the international community can cope with such large interactive and simultaneous crises. Finally all the participants clearly understood that however individual governments and states contributed to the crisis and were then affected by it, there is a strong international dimension to its causes and any future resolution.

These features of the conference and the general concern for the future emerged at the outset of the program. Keynote speaker George Russell, CEO of the Frank Russell Company, one of the U.S.? leading institutional investment firms, voiced his fears that the Asian crisis was slipping from recession to depression. This foreboding has also begun to enter into foreign discussions of the crisis as Japan?s stagnation and recession betoken a protracted regional crisis and loss of its former preeminence in Asia.5 Naturally, the word depression evokes memories of the Great Depression, 1929-41 , which was instrumental in providing the stage for the crises that led to World War II. Here Russell clearly sought to alert the audience to both the international scale and scope of the challenges now confronting Asia and the world economy. Russell and the other speakers all agreed that efforts at recovery must not assume only a narrow national dimension. Rather those efforts must be international in scale and led by the United States, due to its leadership in world affairs and its own strong economy. Trends since the conference appear tobear out the rightness of this assertion since no one else has taken or appears ready to take the lead in addressing the crisis in practical fashion.6 Those U.S.-led international efforts must combine coordinated private and public institutions? activities.

Another theme that emerged from Russell?s speech and from the conference in general was considerable skepticism about the IMF?s role. There was a feeling that the IMF had placed too much pressure on weak states and undermined them once the crisis began. It failed to foresee the crisis and responded relatively slowly to it. Furthermore, the IMF is vulnerable to charges of defending the big banks that invested abroad rashly. This means it supported the moral hazard of defending unsound lending and investment practices. The IMF is also accused of usurping legitimate state functions, and of imposing an unmerited policy of austerity. While certainly many of the conditions it is imposing for transparency of financial and corporate sectors are needed, it is also the case that the IMF is now seriously compromised as an impartial player and its resources are quite strained should further crises develop. Should that occur, the IMF cannot automatically count on U.S. political support since the last Congress showed itself to be highly reluctant to fund further ?bailouts of the IMF.? Thus, one of the cornerstones of American international policy since 1945 is steadily being eroded at a time when it is most needed. Because so much of our worldwide security policy rests on the foundation of liberal and flourishing international economic policies and institutions, this development, in itself, may yet have ominous repercussions whether or not one approves of the IMF?s policies.

Furthermore, due to the freedom for ?hot money? to move in and out of currencies, there is a need, as Russell stated, to examine with an open mind the question of regulating international financial flows. Russell?s observation accords with a growing debate over the wisdom of unrestricted global flows of financial credits and instruments. Unregulated flows of money are clearly coming under attack although it is not clear whether that attack will succeed in restricting the freedom of money to move around the world.

Thus this crisis is already shaking the financial pillars of the current status quo as embodied in the IMF and its more or less uniform approach to such crises. It also is shaking individual governments and the hierarchy of power in Asia because it has transformed the standing of China and Japan vis-à-vis Asia and the United States. Presently, a continuing strong Sino-American relationship has risen in importance relative to the existing U.S.-Japan connection. That development causes some nations to perceive a potential for a tectonic shift in Asian security agendas. China?s rise to great power status, some believe, could even eclipse Japan?s standing in Asia and may prove to be the most consequential aspect of this crisis. While other participants in the conference acknowledged these trends, they were less sanguine about China?s economic future. They cited the fragility of China?s banking system and state-owned enterprises. Therefore it is absolutely necessary for the U.S. Government to take a broad strategic leadership role in attacking the crisis and formulating long-term solutions for it. In the financial domain these solutions necessarily involve greater disclosure, transparency, and financial and corporate reforms in Asia. They also should help restrain what might have been called the ?irrational exuberance? of lenders and financial institutions here and elsewhere who willingly abetted the Asian boom that went out of control.

Subsequent speakers addressed many of the themes raised by Russell and, in many cases, spoke with regard to specific states and governments. They noted that by the time of the conference South Korea and the most affected Southeast Asian states had suffered an annualized income loss of $50 billion/year and lost over $500 billion in market capitalization. Total unemployment will reach at least 20 million people in Indonesia, which must add 3 million people annually to the labor force to prevent an increase in unemployment. Indonesia also faces an imminent famine due to ecological devastation from last year?s fires, the enormous devaluation of its currency and the ensuing price rises and the forced ending of subsidies of basic commodities.7 And since the conference, conditions there have not appreciably improved, and may have worsened. Therefore one major outcome of this crisis, which will be pervasive but particularly powerful in Indonesia, is the widespread immiseration of large sectors of the Asian population. In the absence of a viable ?safety net? in Indonesia and elsewhere, there is a severe risk of widespread social unrest, not to mention humanitarian emergencies that require large-scale, urgent, external intervention, in many countries. For example, labor unrest and labor-management struggles are already daily occurrences in South Korea and Russia.8 To the extent that austerity must spread, it is quite likely that labor-management strife will intensify. Inasmuch as labor movements historically have been powerful forces for democratic reform or for pushing the establishment over into Fascism as a reaction to pressures for democratization, the prospect of further strife within several unsteady states demands our careful and ongoing scrutiny.

Accordingly, many speakers emphasized that recovery must take place on an international basis and is directly tied to the capacity of governments to implement needed reforms and undertake innovative policies. To the degree that governments fail to do so, stagnation may be the best of several bad alternatives in the afflicted countries. Here there was widespread concern that Japan shows signs of denial, and an inability or unwillingness to reform itself let alone be an engine of recovery for Asia. Unless Japan moves forward quickly, the global economy will undergo further traumatic shocks and a more protracted crisis. China, on the other hand, has played a major constructive role by embarking on a major program of domestic reform and investment and by keeping its currency stable. But for the crisis to end, the industrialized world must here follow the United States and open their markets to Asian exports so that afflicted states can obtain sufficient short-term working capital to revive their economies. Right now we see stagnation and a decline in imports for lack of capital and a concurrent decline in the internal Asian markets because of the liquidity crisis affecting all sectors of the most seriously afflicted economies.

Paradoxically states must take the lead to strengthen their ability to create a framework for their economies yet must retreat from their efforts to protect individual sectors and cronies from competition. Globalization, in the context of a retreat of the state from economic sectors that it cannot effectively control, must be allowed to take place across Asia to a hitherto unprecedented degree in order for those governments to control what they can and must regulate. To the extent that Asian economies have followed the Japanese model (and there is some debate as to whether they have actually imitated Japan?s example) they and Japan must now leave that model behind and find a new paradigm of political economy. That does not necessarily mean, as many Americans have written, that they must adopt our model. In many ways they cannot and will not and it is quixotic to hope for that.

Nevertheless they must move in a new direction. Japan, due to its enormous economic power, wealth, and involvement in the Asian economies, must itself overcome the structural barriers to reform at home, including opening the economy to a greater penetration from abroad and moving to a less regulated model of the economy?s actual operation. This would entail removing the state from its central role as an actor in the economy to a hitherto unprecedented degree. It also means shattering the cozy ties between the ruling Liberal Democratic Party and the banks, and opening up the political system to more democratic and less bureaucratic forms of control and the representation of economic and political interests. A pro-consumer, rather than the traditional national state perspective of production must come to dominate Japanese economic policy. And it is the magnitude of both political and economic reforms, including much more economic democracy and weakening of the Keiretsu, the Liberal Democratic Party, and the bureaucracy that has led to these sectors? entrenched opposition to such reforms.

Although the acute symptoms of Japan?s enduring crisis manifest themselves most strongly in economic recession and stagnation, unpaid bad debts, banks? reluctance to loan capital and a preference for devaluation rather than opening the market to imports, the real illness lies in the realm of political economy. To most observers, the system is bankrupt but it is precisely that bankruptcy and the novel phenomenon of attacks upon the bureaucracy for corruption, misguided policy, etc. that prevent the bureaucrats and other leading sectors from taking on a new paradigm. It is possible, as Kenneth Pyle thought, that once the Japanese Establishment fastens on that new paradigm that it will move with tremendous speed to institute it.9

However, the prevailing sentiment at the conference was that Japan?s political system and its major components, parties, bureaucracy, and banks are either in denial, or simply cannot grasp the magnitude of what must be done. Hence the most we can hope for from Japan is muddling along. Unfortunately that is not enough for Asia. Hence Japan?s reputation for economic leadership and its actual ability to offer and provide it either in economics or in politics is evaporating almost on a daily basis. Nor is the long-term prognosis for Japan as a leader in Asian economics and politics a particularly optimistic one. Steven Rosefielde?s paper pointed to negative trends of decline for Japan in the years to come, a warning that, if heeded in Japan should awake the regime from its torpor. But there is no sign of that happening yet.10

Conclusion

Zoellick made the point that this crisis highlights the fragility of the previous Asian order and represents a crisis of transition to an as yet undefined order. In the future we may encounter a China that will play a greater role, a Japan that remains unable and unready to act, and a U.S. whose policy is adrift. Obviously, if that is the future, it will not suffice to meet any or all of Asia?s concurrent security challenges. The economic or financial crisis is not an isolated event. The Indo-Pakistani nuclear challenge, China?s rise as Russia collapses, the lack of money to support the 1994 deal on North Korean proliferation, like the economic crisis, all betoken a structural crisis of the old order. Indeed, Pyongyang already has threatened to revoke the 1994 agreement unless it gets its money soon and Washington will have to find a solution to that crisis, too.34 Meanwhile, North Korea shoots missiles over Japan, upping the ante in the security arena.

Drift is not the answer. Past history and much current writing on world affairs tell us that economic-political failure and a resort to violence are generally related. Worse yet, if that failure is due to liberalism, then liberalism will be repudiated and anti-liberal forms of political order will emerge. In this connection, it is noteworthy and worth remembering that much writing on Japan points out that Japan?s economic organizations and ideology derive from authoritarian, nationalist, Listian, and even Marxian ideas, not Adam Smith?s liberalism as in the United States.35 Given the popularity of such non-liberal, or even anti-liberal ideas in Asia over many years, continued liberal failure will give them a new respectability among a new generation of disaffected Asian elites. Therefore a prompt and comprehensive solution to the economic and financial crisis is essential. Economic challenges to security cannot be isolated from political andultimately military ones. As Australian scholar Andrew Butfoy wrote in 1997,

In the Asia-Pacific moves towards cooperative security gathered considerable, if patchy, momentum in a manner which suggested a growing sense of regionalism, and in ways that cut across the divide between strategy and economics. Indeed, in places like the Asia-Pacific it was difficult to disentangle efforts to build cooperative security from the parallel evolution of international capitalism. Here attempts to explore the potential for security regimes need to be seen within a complex context. This context was dominated by inter-locking patterns of world trade and investment, the burgeoning of global communications networks, a dawning (though incomplete) appreciation of the security dilemma, and an unfolding (but contested) sense of Asian identity.36

The challenges to the United States and to its armed forces are numerous and highly significant. Moreover, we must begin to address them now even if other institutions cannot or will not do so with us. Those crises comprise ASEAN?s decline as a meaningful security provider, Russia?s collapse, Japan?s stagnation, South Korea?s unresolved democratic transition in economics and politics, Seoul?s and Tokyo?s inability or growing reluctance to support the 1994 nuclear accord with North Korea, the danger of an unforeseeable crisis emerging in North Korea, and most of all the rise of China with nobody but the United States to counter or balance it. The challenge confronting the United States and its allies involves nothing less then the creation of a new, legitimate order in Asia. That order must be shaped and created very much by the leadership of the United States in all fields of national power:diplomacy, economics, trade, investment, finance, defense, and culture. But doing so requires a strong U.S. leadership that will tie all these elements of power together in a comprehensive, politically persuasive vision, and the fortitude to implement them at home and abroad.

Absent that response, drift, stagnation, enduring crisis, and probably violence will mark Asia?s alternative reply. Perhaps these crisis phenomena will occur to varying extents and not in all states or not to an irretrievable degree in any one state. But unless our firm leadership manifests itself soon, it is almost certain that we will see a crisis-ridden Asia and maybe other areas as well for some time to come. But from today?s vantage point can we truly say that we see the strong American leadership that Asia and we need to move to a new international order there?

Endnotes

1. Moscow, ITAR-TASS, in English, October 16, 1998, Foreign Broadcast Information Service, Central Eurasia, October 16, 1998, Breffni O?Rourke, ?Mideast: Oil Price Decline Hits Hard,? Radio Free Europe, Radio Liberty Magazine, October 1, 1998.

2. Robert B. Zoellick, ?The Political and Security Implications of the East Asian Crisis,? The East Asian Crisis: Implications of the East Asian Crisis, N BR Analysis (Henceforth East Asian Crisis), IX, No. 4, 1998, pp. 12-13; Sandra Sugawara, ?In Japan, Ties Meant to Bind Now Strangle," Washington Post, October 16, 1998, pp. A1, 34-35; Keith B. Richburg, ?After Suharto?s Fall: Indonesia Is Near Chaos,? Washington Post, March 22, 1998, pp. A1, 20; Theodore Friend, ?Indonesia in Flames, Orbis, XLII, No. 3, Summer, 1998, pp. 387-407.

3. Tokyo, Kyodo, in English, August 26, 1998, Foreign Broadcast Information Service, East Asia, (Henceforth FBIS-EAS) August 26, 1998; Robert Alan Feldman, ?Sputter, Choke, Cough: Japan Misfires as the Engine of Asia,? Brookings Review, Summer, 1998, pp. 18-21; Kenneth Pyle, ?Japan?s Immobilism,? East Asian Crisis, pp. 21-29; Seoul, Sindong-A, in Korean, July, 1998, FBIS-EAS-98-187,July 7, 1998.

4. Beijing, Quishi, in Chinese, March 1, 1998, No. 5, Foreign Broadcast Information Service-China-98-138,May 18, 1998; Paul Dibb, David D. Hale, and Peter Prince, ?The Strategic Implications of Asia?s Economic Crisis,? Survival, XL, No. 2, Summer, 1998, pp. 19-20.

5. See the sources in Note 3.

6. Paul Lewis, ?U.S. Said to Face Brunt of Economic Crisis,? New York Times, October 9, 1998, p. A8; Zoellick, pp. 14-18.

7. Richburg; Friend.

8. Russian miners sat in front of the Kremlin for over a month as of August 1998 to demand payment of their back wages, which are in massive arrears. See also, ?Government Wins One Battle in Miners ?RailWar?,? Current Digest of the Post-Soviet Press, L, No. 31, September 2, 1998, pp. 1-4.

9.Pyle, pp. 21-29.

10.See the other sources cited in Note 3.

34. Thomas Lipman, ?N. Korea-U.S. Nuclear Pact Threatened: Funding Holds up Promised Oil,? Washington Post, July 6, 1998, pp. A1, 13.

35.Bai Gao, Economic Ideology and Japanese Industrial Policy: Developmentalism From 1931 to 1965, Cambridge: Cambridge University Press, 1997.

36.Andrew Butfoy, Common Security and Strategic Reform: A Critical Analysis, New York: St. Martin?s Press, 1997, p. 125.