In analysing the European financial crisis, Asia’s experience with the 1997 Asian financial crisis is a useful point of reference. After the forced devaluation of the Thai baht, encouraged by the People’s Republic of China (PRC) and Japan, Thailand was compelled to accept the IMF-imposed austerity programs. As part of the contagion that followed the baht crisis, Indonesia and the Republic of Korea also accepted the IMF program. As the IMF’s prescriptions reduced aggregate demand and contained no “pro-growth” elements, they worsened the crisis in these Asian countries. In contrast, Malaysia rejected the IMF’s prescriptions. The different experiences of these crisis-hit Asian economies led to a change in thinking on the productiveness of “straight” austerity programs as a response to the financial crises. Austerity policies were relaxed and pro-growth policies introduced, which in combination, helped Asia to recover from its financial crisis.
Will the same austerity policies work for Greece? If Greece was not a member of the European common currency area and only a party to the European Union like the United Kingdom, then through a massive devaluation of the Greek currency, the IMF “pain for gain” austerity solution might work. However, drawing from the experience of the Asian financial crisis, even if Greece had its own currency regime, without the introduction of pro-growth policies, Greece’s financial problems may ultimately not be resolved and recovery would prove difficult. Nevertheless, because Greece is a eurozone member, the Greek currency cannot be devalued. Currency depreciation would only occur eurozone-wide via deposit runs from Greek banks to the rest of Europe, subsequently leading to a flight of capital from the eurozone to “safe havens” like Japan. The massive inflow of “hot money” from the eurozone to Japan has already caused the yen to appreciate substantially, which has created fresh problems for Japan.
How then should Europe and the rest of the world respond to the European financial crisis? The eurozone nations cannot escape from the crisis unless the countries in the eurozone collectively adopt a more pro-growth policy stance. This means that all member countries, rather than just Greece, would have to switch to pro-growth policies. Even then, to solve the crisis, not only must the eurozone countries pursue pro-growth policies, the rest of the world and Asia, including the PRC and Japan, must switch from austerity or anti-inflationary stances to pro-growth policies.
It might be cautioned that the pursuit of pro-growth policies without a long-term concern for inflationary threats will ultimately be detrimental to the economies that pursue such policies. However, inflation would be more of a concern if the pro-growth policies that are adopted are of the traditional demand-side variety, meaning stimulating aggregate demand to raise consumption, but not investment. Instead, as demonstrated in recent decades by the Asian new growth paradigm, pro-growth policies need to be supply-side oriented. This entails mobilizing public and private sector funds, as well as credit facilities to invest in improving the productivity of workers and industries, introducing new technology, and enhancing real value creation by improving the quality of products and services as opposed to only increasing quantity or branding. It should also involve ensuring that various sectors are open to new entrants and fair competition. The pursuit of pro-growth policies means that governments inevitably have to enter into deficit spending. It is worth noting that Asian countries have generally accumulated substantial surpluses and savings that could be directed to finance such endeavors.
The switch to pro-growth policies cannot only be symbolic. With the stakes increasingly high for all parties concerned, rhetoric alone will not stabilize the financial markets. A concerted and substantive global response is needed to resolve the eurozone crisis.