Asian View

Ten years ago, the Asian financial crisis ravaged south-east Asia. The IMF prescribed severe austerity and economic shrinkage. You chaps have been living beyond your means for years, it said, and have severe structural problems that cannot be reflated away. So, you need bitter monetary medicine (sky-high interest rates) and fiscal medicine (slashing government spending and fiscal deficits). Yes, the shrinkage of GDP will be painful, but will cure your structural ailments and improve your long-term health.

Ten years later we have another financial crisis, originating this time in the US. But the IMF, which prescribed austerity for Asia in 1997, is prescribing fiscal and monetary stimulation in the US, to save it from the consequences of its own follies. This is not only bad economics but also outrageous politics. It looks like a double standard that discriminates against the poor.

The US has for a decade indulged in chronic overspending, reflected in gargantuan trade deficits, financed by borrowing overseas. This has eerie similarities with south-east Asia's over-borrowing in the 1990s. The Asian financial crisis began with the bursting of a housing bubble in Thailand, caused by imprudent lending. The current crisis has begun with the bursting of a housing bubble in the US, also caused by imprudent lending (sub-prime mortgages).

Conditions in the US are in most ways better but in some ways worse than in Asia in 1997. The US is immensely creditworthy, and can borrow trillions with minimal effects on the dollar. By contrast, south-east Asian economies in 1997 had low forex reserves and eroding credibility, leading to a panicky flight of investors. The US has huge foreign assets to offset its rising debt, so its net debt is modest. The quality of US institutions, financial markets, corporate governance and accounting standards is infinitely higher than in Asia in 1997. So, we don't see any panicky exit of investors from the US.

Yet, in some ways the US is structurally worse off than Asia in 1997. Asian economies always had high savings rates. But US households have for years had a negative savings rate - that is, they spend more than their disposable income, taking advantage of cheap, easy credit. The US trade deficit of around $700 billion per year is mind-boggling, far higher than the combined deficits of the Asian countries that sank in 1997. A country as rich as the US can afford to overspend on this scale for years. But not even the US can do this forever.

The US has a deep structural problem - grossly inadequate savings. Its politicians are as spendthrift as households. They have committed themselves to high welfare spending on social security (for retirees), Medicare (for the aged) and Medicaid (for the poor). Some projections suggest that such spending could triple from 7% of GDP today to 20% by 2030.

So, both US households and the government are on an unsustainable spending spree. This cries out for structural adjustment. Huge US imbalances, in its balance of payments as well as savings, have to be pruned. This painful structural adjustment is not urgent, given US riches. But it is inescapable in the long run, and remedial action is overdue.

The adjustment can take place either through a huge depression, as in the 1930s, or through a series of slowdowns-cum-mild recessions. Many economists, including me, would regard a string of mild recessions as less damaging for the US and world economy than another Great Depression.

Seen in this light, a US recession is a solution to its structural imbalances, not a problem. A recession will reduce the US trade deficit, and drive home to US households the need to save more and borrow less. It will entail some pain. But, as the IMF is fond of saying, no pain means no gain.

Global imbalances are evident in huge Chinese and OPEC surpluses, no less than in US deficits. All three require adjustment. But the US is currently in crisis, and needs adjustment foremost.

You might think that the IMF today would be urging austerity and structural adjustment on the US, as it did on Asia in 1997. In fact, it is doing the very opposite. It has applauded the fiscal stimulus legislation and slashing of interest rates there. The IMF can argue, rightly, that the two situations are different. Yet, there are enough similarities to warrant complaints that it has one rule for the rich and another for the poor.

I raised this issue of double standards when Dominique Strauss-Kahn, managing director of the IMF, gave a talk in New Delhi last week. If austerity was good for imprudent Asians in 1997, i asked, isn't it also good for the imprudent US right now? Should you not welcome a recession as a form of adjustment? Should you not burst asset bubbles in the US rather than reflate them?

Strauss-Kahn waffled and refused to give a straight answer. Instead, he talked of the need to reform the IMF, by giving a bigger say to developing countries. However, his double standards suggest that the reform has to go deeper.