ALL POLITICS ARE LOCAL,ALL POLITICS ARE LOCAL,MOST ECONOMIC CRISES MOST ECONOMIC CRISES

ARE LOCAL:ARE LOCAL:LESSONS FROM THE LOWER LESSONS FROM THE LOWER

LATITUDESLATITUDESPaul McNelis, S.J.

Gasson Lecture

March 19, 2002

Keynes, Policy Makers and Academic Scribblers

"The ideas of economists and political philosophers, both

when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back... Sooner or later, it is ideas, not vested interests, which are dangerous for good or evil." — John Maynard Keynes

Escaping Old Ideas

"The real difficulty in changing any enterprise lies not in developing new ideas, but in escaping from the old ones." — John Maynard Keynes

• Strong charismatic leaders after World War II• Attempt to be “non-aligned”, find a “third way”

between communism and capitalism• Highly centralized countries, with long years of

military rule• Technocratic economic policy: “Chicago Boys” in

Argentina, “Berkeley Mafia” in Indonesia• Argentina typifies the “old style” crisis, Indonesia

the “new style” crisis

Argentina and Indonesia: Similarities

Political Triangles:Non-Cooperative GamesNon-Cooperative Games &

Nash VulnerabilityNash Vulnerability

Military

MuslimChinese

INDONESIA

Military (till ‘90)Corporate Elite (after ’90)

AgricultureOligarchy

PeronistUnions

ARGENTINANash

Crises and the Global System

• Origin of both types of crises is local, rooted in the political history of each country

• Integrated world financial system can certainly magnify the effects of a crisis

• Each country is caught in a political triangle, with government debt expansion representing a non-cooperative outcome

• Continuing “Nash” vulnerability: how to escape it?

Old and New Style Crises

• Old style crisis is about fiscal and current account balances, and “sustainability” of the exchange rate. If the deficits are too high, sooner or later the exchange rate will “crack”

• Old Style crisis is there for everyone to see; crisis “event” often anti-climatic, a “slow motion” process

• New style is about balance sheets: government incurring liabilities of the private sector which it cannot hope to cover, or cover at high costs. “Fast action” process

New Style Crisis: Vulnerability

• If something goes wrong, suddenly a lot goes wrong. Very shaky and non-transparent banking system

• “Until you step in, you do not know how deep the puddle is”.

• Japanese banks have lent money to almost every losing proposition of the last 15 years. Little desire to ask hard questions with their Asian clients, especially in South East Asia

Argentina

Birth: 1793 Death: 1877 Argentine Dictator. Burial: Southampton Cemetery (Also known as 'Old Cemetery' Hill Lane, Southampton, England

Juan Manuel de Rosas

HIPOLITO YRIGOYEN

• Founder of the UCR (Radical Party)

• Implemented democratic and labor reforms

• Identified a sense of “argentinidad”

• "No he venido a castigar ni a perseguir, sino a reparar". Rights for labor unions

• Overthrown by military in 1930

Eva Duarte Peron

• Born 1919 in interior of Buenos Aires Province• By 15, moved to capital city, became a radio and

movie actress• Met Juan Domingo Peron, Labor Minister, at a

rally for earth quake victims in 1944• Led the “labor fusion” for Peron, head of

Fundacion Eva Peron, de facto labor minster• Died in 1952

Juan Domingo Peron-Part I

• Born in 1895• Educated in military schools• Participated in coup against Yrigoyen, became labor

minister in “neutral” military government during WWII, married Eva Duarte, Oct. 22, 1945

• Elected president in 1944 and 1948.• We are “neither Yankees nor Marxists”, but “Justicialistas”: the “third way” • Ousted in coup after Eva’s death, excommunicated

from Catholic Church

Peron’s Journey, Part II

• Met Maria Estella MartinezMaria Estella Martinez, “Isabelita”, an Argentine nightclub dancer, in Panama

• Fled to Spain and Franco, after time in Dominican Republic with Trujillo.

• Eva’s body sent to Rome • Excommunicated lifted, Peron marries “Isabelita” with blessing

of John XXIII• Eva’s body found by Peron and taken to his house in Madrid• Lopez-Rega, Argentine magician, becomes Isabelita’s advisor

and body guard in Madrid.

back in Argentina…

• Military government continues, with only a short-lived democracy in late 1950’s

• Peronists divide between “left” and “right”, each group visits Peron in Madrid regularly

• Perons made several attempts to return• Finally Perons return in 1973.• Peron elected President, Isabelita vice president, 1974• Peron dies in 1975, Isabelita becomes president• Lopez-Rega becomes advisor, arms “right-wing” Peronists with uzi machine guns

Lopez-Rega

Dirty War, Technocrats

• Coup against Isabelita Peron by military, “dirty war” begins in 1976

• Martinez-de-Hoz becomes finance minister, implements New Orthodoxy with “Chicago Boys”

• Exchange-rate based stabilization policy:tablita• Fast liberalization of current account: shock treatment.• Slow fiscal adjustment, high prices, a majorCrash in 1982, Malvinas war ends military rule .

Martinez-de-Hoz

Heterodox Shocks, and Convertibility Plan

• With new democratic government of UCR Alphonsin, “heterodox” stabilization plan

• Switch to new currency, exchange rate & wage/price freeze, intended to make inflation more responsive to cuts in demand

• Early success led to lax fiscal stabilization• Plans crash, Menem assumes office early,• Cavallo implements “convertibility plan”

MenemMenem

AlphonsinAlphonsin

CavalloCavallo

Collapse of Plan

• Recession after the dollar appreciates in world markets after 1995

• Radical de la Rua elected President, continues with convertibility, recalls Cavallo as Finance minister

• Recessions becomes more severe, de la Rua resigns, Peronist opponent Duhalde becomes president

• Menem waits in the wings to run again

Argentina: Real GDP Per Capita

FIGURE 1

DETRENDED Real GDP per capita 1979 = 100

60

65

70

75

80

85

90

95

100

105

110

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995

Argentine Annual Inflation

-500

0

500

1000

1500

2000

2500

3000

3500

1940 1950 1960 1970 1980 1990 2000 2010

Convertibility

Fall of Military

Heterodox Plan

Return of Peron

Argentine Fiscal Deficit (% GDP)

0

1

2

3

4

5

6

7

8

9

1975 1980 1985 1990 1995 2000

Indonesia

Dutch Colonialism

• Differences with English and “Mediterranean” Colonialism: Dutch just wanted to make money!

• In 1938 one school of tertiary education for every 62,000 Indonesians, in Philippines, ratio was 1 to 1500;

• Divide and conquer approach: segregation of ethnic Chinese, pribumi, and bules

• Only a small fraction of population literate after 300 years of rule: 10% literacy rate.

Independence: Aug. 17, 1945

• Ambiguity of President Roosevelt: proud of Dutch ancestry, admirer of Queen

• General Marshall encouraged a peace process when Independence declared

• Republic forces in Yogyakarta, Dutch in Batavia, now Jakarta

• Dutch overplay: attack on Republic, but their weapons bought with Marshall plan money.

• US embargo till 1949 against Holland• Dutch kept New Guinea

Indonesian Leaders, 1945-2002Sukarno

WidjojoLeader ofBerkeleyMafia

Megawati

Pancasila:

• One God Almighty (not Allah)

• Human Dignity

• Unity of the Republic

• Democracy

• Equal justice for all -- neither Islamic Law nor separate Islamic courts for Muslim offenders

Sukarno and Hatta

Political Dynamics in Indonesia under Bapak Bangsa Sukarno

• Three “players” : nationalists (PNI), Islamic parties (NU) and communists (PKI)

• Military PNI, but Air Force had PKI sympathy

• Tensions toward separatism by oil and resource risk outer islands ( Shiite Aceh in Sumatra traditionally wanted independence and nationhood)

Sukarno US Visit in 1956

• Televised speech to US Congress, great rhetoric, charmed nation and US press

• Kept waiting by Ike at White House because Sukaro had PKK members in his delegation

• Upset at American hospitality in final interview: not “Acehenese”, not “provided a woman and accepted as a relative”.

• After US visit, declared a state of “guided democracy” in Indonesia

Political Undercurrents:Bandung Conference of 1956

NAM: Non-Aligned MovementNAM: Non-Aligned Movement

NehruNasser

Tito

(Egypt first country to recognize Indonesia,Nationalized Suez in 1956)

Dulles Brothers and Sukarno

• To be neutral was “immoral” to Dulles brothers and US administration

• Indonesia recognized “Red” China, took aid from USSR, said no to SEATO

• CIA Plan to “Balkanize” Indonesia thwarted by Filippina “bar girls” network

• American bomber pilot, Alan Pope, released in ’61, after capture in 1957, to new President Kennedy, with a request for a good will visit by Marilyn Monroe

John Foster Dulles Allan Dulles

Dutch New Guinea Crisis

• Visited JFK in 1962, warmly received• Near war over Dutch New Guinea• Bobby Kennedy visited Sukarno to resolve

situation, and send Peace Corps to Indonesia• Sec. State Rusk supported Dutch, Bundy at NSC

supported Indonesia on New Guinea• Ellsworth Bunker mediated transfer of Dutch

New Guinea in Middleberry, Virgina

New Crises: Viet Nam and Malaysia

• Sukarno came out against LBJ on Viet Nam• Opposed formation of Malaysian Federation by

British, wanted small independent states; quits United Nations

• Looked to a wider “republic” including Indonesia, Malaysia, and Philippines

• Maxwell Taylor visited Sukarno to cool off a war over Malaysia

Internal Crises, Growing PKI Strength

• Formed NECO --alliance with China, N. Viet Nam, N. Korea

• Purge of US-trained academics at universities (Berkeley Ph.D’s.), AFS students at universities

• “Land Reform” led to confiscation of land from village Islamic schools, called pesantren

• Formation of a 5th Armed Force, Air Force ranger batallion, sympathetic to PKI

• Nationalization of more foreign firms

Falling into Chaos: 1965

• By now, Indonesia is ranked the lowest in per capita income of all Asia

• Inflation reaches 650%

• Suharno goes to Japan, returns with 18 year old Geisha as his latest wife, Dewi.

• Many old friends are accused of being CIA.

• Sukarno withdraws Indonesia from the UN

Sept 30, 1965

• Assassination of 5 generals, escape of Suharto and Nasution, whose wife and daughter killed

• Suharto rallies loyal troops, PKK 5th Force surrenders, General Dani of PKK still in prison

• After burial of Nasution’s daughter, “purge” of PKK begins by student groups armed by Suharto. Estimates still vary of numbers killed during Year of Living Dangerously, 1965-66

New Order: BeginningBapak Pembangunan Suharto

• Sukarno under house arrest at Presidential Palace in Bogor, gradual “Javanese” transfer to power, Sukarno dies in 1970

• Suharto is de facto President in 1966.• Berkeley Mafia installed in ministries• Debt forgiveness cheerfully accepted by US,

since Soviet Union was largest creditor!• Pro foreign investment: Freeport comes to Irian

Jaya (formerly Dutch New Guinea)

New Order: Growth and KKN

• Success in terms of inflation and growth: 5-10 solution

• KKN and Ibu Tin: the other 10% solution• Massive capital inflows• Deregulation of banking, no separation of bank and

firm ownership• Diversification away from oil to manufacturing

exports: NIKE footwear• Ethnic Chinese-Military bargain: “triangle” of

Muslims-Chinese corporatists-Military

New Order Foreign Policy

• Ford/Kissinger approve annexation of East Timor at end of Viet Nam war

• Continues with NAM, but starts APEC and ASEAN, economic cooperation instead of military alliance, accepts World Bank aid

• Criticism of Carter administration over human rights, low tolerance of dissent.

• Anger at Reagan over Law of the Sea reversal, works out “special understanding”

Kris Mon of 1997 and End of New Order

• Monetary crisis exposes “rot” of the domestic banking system

• Protests by students against Suharto lead to his resignation in 1998

• Habibe becomes president, calls for plebiscite in East Timor, massive slaughter

• Habibe defeated by Gus Dur, Dur soon impeached and Megawati becomes President

• Tommy Suharto jailed for corruption

Javanese Wayang:Wayang:Hukum Karma

• Student groups, which protested and purged PKI, led to Suharto’s own undoing

• Suharto kept under house arrest at end by Sukarno’s daughter, Javanese Hukum Karma

• Recovery is fragile, but under IMF “guidance”, bank deposits are guaranteed 100% but there is still little supervision

• Zombie banks are a ticking time bomb• Decentralization issue for fiscal reform

ICMI: Growing Islamic Pressure

Indonesian Center forMuslim Intellectuals

Muhammadyah movement

“Technology and the Koran”

Amien Reis, Speaker of Parliament

ISLAMIC LAW imposed in Aceh, creation of religious police,Departure from the Pancacilla.

Major religious warfare in Ambon

Indonesia Per-Capita GDP

0

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3500

1970 1975 1980 1985 1990 1995 2000

Indonesian Illiteracy Rates

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5

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30

35

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45

50

1965 1970 1975 1980 1985 1990 1995 2000

Indonesian Fiscal Deficit% GDP

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

1970 1975 1980 1985 1990 1995 2000

Monetary Policy and Exchange Rates: Pre and Post Kris MonKris Mon

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2000

4000

6000

8000

10000

12000

14000

16000

87 88 89 90 91 92 93 94 95 96 97 98 99

ER

Exchange Rates Pre Kris MonKris Mon

1600

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2000

2200

2400

2600

87 88 89 90 91 92 93 94 95 96 97

ER

Interest Rate Adjustment

0.0

0.2

0.4

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87 88 89 90 91 92 93 94 95 96 97 98 99

SBIRATE

Annual Inflation

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87 88 89 90 91 92 93 94 95 96 97 98 99

INFLATIONA

How to Escape Nash Vulnerability?

• Asian way is evolutionary, with consensus, except when things get bad!

• Western way is legalistic, institutional• Traditional IMF/World Bank “Agreements” with

unenforceable conditions will not work in this culture

• Nor will external “criticism” lead to cooperative outcomes

• Early warning signals from external creditors on “vulnerability” may help, if done diplomatically