Why Adam Smith Would Love Asia

Only a few years ago many pundits--Western as well as Asian--were claiming that Asian nations had developed a new paradigm of economics, a superior alternative to Adam Smith's capitalism. With the 1997 economic crisis, this view was stood on its head: it turned out that Asian values, a.k.a. crony capitalism, had made the region uniquely vulnerable to financial disaster. Now that some of the dust has settled, it seems clear that both views were utterly wrong. Instead of being some kind of alternative, Asia has been the proving ground for global capitalism, the place where both the potentials and the risks of the New World Order have been most fully revealed. True, the Asian Miracle of the 1980s was less miraculous than it may have seemed, but it did show that rapid economic development was possible, that you didn't have to be of European descent to join the modern world and that the global economy offered huge possibilities for export-led growth. To put it another way, the global economy was not, as so many dependency theorists had claimed, rigged against latecomers. On the contrary, it offered the opportunity for countries like South Korea to achieve two centuries' worth of economic progress in little more than a generation. And that discovery energized not only the Asians but capitalism in general. But while Asia's growth has restored capitalism's luster, its instability has revealed that capitalism has not lost its old self-destructive tendencies either. Leaving aside the dress rehearsal in Mexico two years earlier, in 1997-98 Asia experienced the first postmodern financial crisis: a high-tech, globalized version of the Great Depression. Many investors and officials are now declaring it a one-time event. I think they are whistling past the graveyard. The truth is that through a combination of globalization and technological innovation, markets have outflanked the defenses put in place 60 years ago. Bank regulators and central bankers still have no good answer to liquidity crises that crucially involve non-bank institutions, such as hedge funds, that transcend national borders. And there is a strong case to be made that this particular crisis ended too soon. Few of the factors that made the crisis possible--high leverage, herd behavior by investors, the whole problem of a global financial system without global regulators--have been addressed. So now what? Here's a parallel. Suppose that a thoughtful observer had looked at the United States in the early 20th century. An optimist would have been impressed by the dynamism of the economy, concluding that it represented a vindication of the capitalist system and that the world's economic center of gravity was headed for a major shift away from Europe to this new powerhouse. A pessimist would instead have focused on the observation that financial instability was even more conspicuous on this new frontier than in older industrial economies, and that it seemed to be getting worse over time; he might have worried that this instability could shake the world economy so severely as to threaten capitalism itself. Both the optimist and the pessimist would have been right: American dynamism saved capitalism, but first, in the 1930s, American instability very nearly destroyed it. It seems to me that the parallel works pretty well. However you look at it, Asia represents the future of capitalism--whether that future consists of unprecedented progress, financial instability on a scale not seen since the 1930s, or both. And nobody knows how it will turn out. Paul Krugman is a professor of economics at the Massachusetts Institute of Technology