Y V Reddy: Asia in a post-crisis 'new normalcy'

Public policy support and regional cooperation are vital if Asia is to emerge stronger from the slowdown

There are several reasons for examining the likely consequences for Asia of the global financial crisis and economic slowdown. First, this financial crisis, unlike others in recent decades, originated in developed economies of the “centre”, like the US and the UK, and not in the “periphery”, namely, Latin America, Asia or Eastern Europe. Second, the near collapse of markets happened in countries whose financial sector was considered a model for all others to emulate. Third, the policies and procedures of regulators of financial sectors in these countries were considered to be the best and they set the standards for judging other regulators. Fourth, leading global financial institutions, about 15 that accounted for over 70 per cent of cross-border finance, based in the “centre” suddenly ceased to do business with each other. They were credited with having the best mathematical models for risk management, to be emulated by all others; and it is exactly those that were the most affected. They were also too big to fail. Fifth, multilateral bodies, especially the International Monetary Fund (IMF), pointed to existence of some broad economic imbalances, but were not able to anticipate, let alone prevent or moderate, the crisis that erupted. 

The pre-eminence of the US economy and of economic policies identified with the US and the UK have been challenged by the crisis. On the other hand, Asian economies, even though they are dependent on the US economy, have been less impacted by the crisis. Asia appears to be recovering sooner than the rest, and is maintaining high growth, especially in China and India. Asia has its own unique features of macro-economic management, and these are being favourably assessed. 

Asia’s economies are dominated by banking systems concentrating on traditional retail banking. It does not have dominant derivatives markets that, in a way, caused the crisis. Asia built considerable forex reserves as a self-insurance against global shocks in the real sector through commodity prices or the financial sector through capital flows. Asia had, for most part, surpluses on current account, though a few like India had modest deficits. 

Against this background, it is worth asking what does “return to normalcy” mean for the global economy? Normalcy after a crisis cannot obviously mean return to the old world order. A post-crisis return to normalcy would imply a “new normalcy”. In this “new normalcy” what will Asia’s position be? 

Asia’s growing importance has already been recognised in the ongoing dialogue on reform of the global financial architecture. At the same time, Asia has taken several initiatives for strengthening cooperation within the region. It is critical for Asia to assess its problems, prospects and its role in the process of rebalancing and designing the “new normalcy” in global economic management. To make use of the opportunities, Asian economies must deal with significant challenges in the realm of public policy. 

The yearly addition to the workforce in Asia will be huge and standards of living will keep improving. The culture of savings in Asia will provide capital to match growth in supply of labour. A huge demand will be generated by the growing new middle class of Asia. Urbanisation and concomitant infrastructural demands will be large, spurring massive economic activity. Indonesia and Vietnam are emerging in ways similar to China and India. The region has great diversity in demographic cycles, with Japan at one end and India or Indonesia at the other; China being at the intermediate state. This characteristic could lend considerable stability to demand for and supply of labour, and goods and services. 

Asian multinationals could take centre stage in the world. Intra-regional trade should grow very rapidly, which may warrant re-emergence of the Silk Road and Spice Route. The most defining factor for the re-emergence of Asia as a force to reckon in global economy may be the magnitude, balance and quality of trade between China and India. 

With an annual addition of about 40 million to the workforce, involving rural-to-urban migration, education and skill upgrade will continue to be a major challenge for Asia. Demands on public health and medical care will be huge. Water could prove to be a complex issue, while climate change will be a daunting challenge. Above all, social consequences of growing inequalities and inadequate social security could be serious. 

Most of these challenges are in the domain of public policy, but the private sector cannot prosper if these issues are not resolved satisfactorily. 

Asia has the potential for becoming a hub for global financial activity with the pool of capital that is being supplied and demanded. Human skills in managing finance will be needed. Till now, domestic or regional financial markets have tended to follow rather than lead global finance, though recent initiatives in this regard, particularly by China, are noteworthy. A major issue, however, relates to infrastructural services for economic activity, such as credit-rating services, business news agencies, and standard contracts and dispute-resolution mechanisms. The dominant global financial conglomerates are still based in the US and Europe, but their ownership could, over the years, change hands in favour of Asia, reflecting changing balances in economic activity between Asia and the rest of the world. 

Leadership in the global economy is linked to leadership in thought and innovation. Asia is yet to invest adequately and demonstrate its strengths in this area. Japan has demonstrated significant technological capabilities but Asia as a whole lags behind the West in research and technological innovation. Public policy has a critical role in this regard. 

While the size of economy and financial activity is important, commanding confidence and credibility in global markets over a long period requires better standards of governance. In particular, assured existence of property rights and enforcement of contracts are essential, while social and political system stability also plays a role. 

Intra-regional cooperation is important. The most notable recent development is the multilateralisation of the Chang Mai Initiative, and the agreement to have surveillance at regional level. This initiative does not, as yet, include India. To be effective, Asian regional cooperation must rest on four pillars, namely, Japan, China, India and Asean. 

History shows that major shifts in economic power in the world take place over a period of decades and may not necessarily be smooth. For Asia’s rise to be smooth, major countries in the region must reinforce each other and ensure good relations with the rest of the world. Further, Asia must ensure acceptance of its rise by other regions, especially Latin America and Africa. 

Extracts from Justice K Madhava Reddy 
Memorial Lecture, Hyderabad, November 2009

The full text of 
Yaga Venugopal Reddy’s
S Guhan Memorial Lecture, Chennai, 
October 22, 2009, can be accessed at:
business-standard.com/374311/