A Tale of Two Cities

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

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

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

The economic arguments against capital controls rest on both efficiency andequity considerations. Capital controls are highly ineffective for myriadreasons, not least of which is that they don’t work. The longer they are inplace, the craftier people become in evading them, through methods such asfalsification 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 proverbialimmovable object that the irresistible force always overwhelms.

More important than the theoretical arguments against capital controls isthe instructive experience of Thailand’s neighbor, Malaysia, which imposedthem at the end of the Asian crisis in October 1998 after much of the worstdamage from the Asian crisis had passed. Ironically enough, Malaysia waswell poised to weather the storm, having undergone a major banking crisis in1986 and having embarked on a fairly successful restructuring immediatelyafterwards. Moreover, the short-term flows that were blamed for thevolatility made up a relatively small part of Malaysia’s capital stock--themost portfolio equity ever accounted for was 5.7 percent of gross domesticproduct in 1993, and this had fallen to 4.38 percent in 1996.

Indeed, Malaysia’s imposition of capital controls seemed to be a nakedlypolitical move by despot Mahathir Mohammed, who sought to consolidate hisown grip on power and gave him a pretense to remove (and jail) his mainpolitical rival, Finance Minister Anwar Ibrahim. While they may have savedMahathir’s political position, the arcane array of capital controls didn’tdo their highly touted job. The international markets, in particular, werejust waiting out the controls: in the first quarter this year, afterMalaysia dismantled most of its restrictions, Malaysia’s central bank lostnearly $1 billion a month in foreign reserves, and speculation that theovervalued ringgit may be devalued is prompting more capital flight.

With Mahathir now in charge as the Finance Minister as well as PrimeMinister (following the resignation of Daim Zainuddin at the beginning ofMay), the capital markets are not sanguine about the necessary reforms inMalaysia being pushed through. Thus, the effect of the controls was topoison 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, asFinance Minister Somkid Jatusriptiak explicitly ruled out controls in aninterview with the Financial Times last week. Since the Asian crisis,Thailand has faltered, but has generally remained open to the world and hasundergone an extraordinary political shift. Malaysia, on the other hand,remains mired in its authoritarian ways and further estranged from theliberalization that the region needs.

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