A Tale of Two Cities

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Bangkok is a crowded city, teeming with vehicles that observe the rules of the road more in the breach than in the practice. Despite this maelstrom, surprisingly, everyone seems to know how to handle the confusion, and even the ubiquitous tuk‐​tuks (three wheeled motorized open‐​air taxis) thrive in this atmosphere. Indeed, trying to impose order on this chaos would only cause more of a mess than it would solve.

Thailand now faces an economic situation similar to the haphazard streets of Bangkok, only the vehicles and all the drivers are making a dash for the road out of town. The epicenter of the Asian crisis of 1997, Thailand is now being confronted with a similar problem, as capital is starting to desert the country in droves and the baht has lost 15 percent of its value since last year.

The mood turned even gloomier last week as Chatu Mongol, the Bank of Thailand’s governor and the man who helped to pull Thailand out of the Asian crisis, was ousted after an argument with the government over interest rate policy. Investors have become unsettled by this change of management, and the question on everyone’s lips is, will Thailand follow Malaysia’s lead in imposing capital controls? And will these restrictions be able to control the flow of capital, or will they merely force a traffic jam and disrupt a functioning system?

The economic arguments against capital controls rest on both efficiency and equity considerations. Capital controls are highly ineffective for myriad reasons, not least of which is that they don’t work. The longer they are in place, the craftier people become in evading them, through methods such as falsification of invoices in trading, leads and lags in paperwork, substitution of exempted flows with restricted flows, and illegal methods (such as bribery and smuggling). Capital controls are the proverbial immovable object that the irresistible force always overwhelms.

More important than the theoretical arguments against capital controls is the instructive experience of Thailand’s neighbor, Malaysia, which imposed them at the end of the Asian crisis in October 1998 after much of the worst damage from the Asian crisis had passed. Ironically enough, Malaysia was well poised to weather the storm, having undergone a major banking crisis in 1986 and having embarked on a fairly successful restructuring immediately afterwards. Moreover, the short‐​term flows that were blamed for the volatility made up a relatively small part of Malaysia’s capital stock–the most portfolio equity ever accounted for was 5.7 percent of gross domestic product in 1993, and this had fallen to 4.38 percent in 1996.

Indeed, Malaysia’s imposition of capital controls seemed to be a nakedly political move by despot Mahathir Mohammed, who sought to consolidate his own grip on power and gave him a pretense to remove (and jail) his main political rival, Finance Minister Anwar Ibrahim. While they may have saved Mahathir’s political position, the arcane array of capital controls didn’t do their highly touted job. The international markets, in particular, were just waiting out the controls: in the first quarter this year, after Malaysia dismantled most of its restrictions, Malaysia’s central bank lost nearly $1 billion a month in foreign reserves, and speculation that the overvalued ringgit may be devalued is prompting more capital flight.

With Mahathir now in charge as the Finance Minister as well as Prime Minister (following the resignation of Daim Zainuddin at the beginning of May), the capital markets are not sanguine about the necessary reforms in Malaysia being pushed through. Thus, the effect of the controls was to poison the investment climate and merely postpone the inevitable. Somehow, this doesn’t appear to be a policy that should be replicated.

But perhaps Thailand has learned some of the lessons of the Asian crisis, as Finance Minister Somkid Jatusriptiak explicitly ruled out controls in an interview with the Financial Times last week. Since the Asian crisis, Thailand has faltered, but has generally remained open to the world and has undergone an extraordinary political shift. Malaysia, on the other hand, remains mired in its authoritarian ways and further estranged from the liberalization that the region needs.

Thailand’s eschewing of capital controls may prove to be the decisive lesson in a region that was once hailed as the new model for economic policy; as Malaysia has demonstrated, any attempts to rollback liberalization can leave a country stranded in an endless roundabout.