Krugman warns Vietnam against financial sector foibles

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Paul Krugman's advice for Vietnam: don't lose sight of financial regulation as private business takes off and the 'invisible hand" of the market grows stronger.

The Nobel Prize-winning economist said strict regulation of the financial sector and government safety nets would be key to greasing the wheels of Vietnam's transition to a market-based economy.

Speaking at a seminar in Ho Chi Minh City Thursday, The New York Times columnist and Professor at Princeton University said the global economic crisis was 'stabilizing" but that there were no clear signs o a full recovery.

'Things are getting worse, but they're getting worse more slowly," he said, citing less rapid US job losses and a slowdown in the fall of industrial production and exports in key economies.

'I don't think we've hit bottom, but the bottom is not too much further below us," he said. "My big concern is that we don't hit the bottom and bounce, we hit the bottom and stay there. It's not obvious where recovery comes from."

He said there was not much Vietnam could do to help itself recover other than to stay smart, hope and wait.

Shadow banking

Krugman spoke at length of how the deregulation of the US financial sector allowed the shadow banking system to set off the financial crises that transformed into a global economic recession.

Institutions that provide the services of banks without banking regulation, including but not limited to hedge funds, money funds and investment banks, have become notorious for their role in the meltdown.

This system of institutions, known as the shadow banking sector, held trillions of dollars in the US by 2007. With so much money, the vulnerable and unregulated system in which investments are risky and unprotected, became an integral part of US and global finance.

Krugman blamed deregulation that began in the Reagan-Thatcher era for the development.

'We had a whole set of precautionary measures coming out of the great depression that were designed to prevent a recurrence of the banking crisis."

Then the world watched in dismay as the banking crisis of 2008 spawned global panic.

'We were persuaded after about 1980 that we should have the same kind of free market principles for finance that we had for wheat or airline services," said Krugman. 'It turned out that our grandfathers were right and we were wrong."

The Nobel laureate stood by one of his trademark lines about talking to economists:

'Don't trust anyone under 50," he said, explaining that anyone brought up in the new school of economics had not been taught the lessons our grandfathers learned.

He went on to repeat another one of his mantras: 'anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank."

He said the government officials who oversaw this deregulation, not just bankers, have a lot to answer for.

'They liberalized, they deregulated, even as the banking sector was going crazy… in the US, this is bipartisan. The Clinton administration gave the bankers a lot of what they wanted, the Bush administration even more."

Krugman told the mostly-Vietnamese audience to not let the same thing happen here. 'If you let a deregulated financial system run wild, it will do very bad things to your economy."

Slap in the face

In discussing Vietnam's situation, Krugman also warned against some of the market's more exotic trappings.

Asked about whether Vietnam should embrace derivatives, he was clear: 'Don't touch them."

He was skeptical of financial innovation in general. Most innovations - other than ATMs and overdraft protection - were geared toward helping institutions evade regulation, he said.

Turning back to his rules for the financial sector, he suggested that banks be restricted from operating out of their main line of business.

He said any deregulation 'needs to be done with great care because you'll find that when banking system goes wrong it does a lot of damage."

Now that damage has been done, he said the fate of highly trade-dependent, small economies like Vietnam were tightly bound to the world crisis, with their recovery linked directly to a real global recovery.

So, what can Vietnam do toward that recovery?

'Not a lot under the circumstances," said Krugman. 'Pray that the bigger economies get their act together."

He said things would have to change in New York and London before they changed in Vietnam.

Though Vietnam was not responsible for the crisis, Krugman said the country was being 'slapped in the face by the invisible hand."

Wryly, he said: 'I miss that US$3 trillion that we spent on tax cuts and the war," positing that if the US hadn't wasted the funds, the crisis would be less severe.

NO QUICK FIXES

Thanh Nien Daily spoke with leading economists, entrepreneurs and journalists on the sidelines of a seminar presented by Nobel Prize-winning economist Paul Krugman in Ho Chi Minh City Thursday.

Economist Pham Chi Lan

Many reliable international economic magazines are saying the crisis has not hit bottom and nobody knows how large it is… for developing countries like Vietnam, the crisis arrived later but will stay longer.

I personally think official predictions that Vietnam's economy will recover by the end of this year are unrealistic. The Ministry of Labor, Invalids and Social Affairs said 300,000-400,000 people have lost their jobs, while trade associations have reported nearly 5,000,000. As the unemployment rate is a critical criterion in assessing the crisis, transparent information is more essential than ever.

Krugman's careful judgments can help governments and policy makers be more objective. They should keep their eyes on the rough road ahead.

Vietnam's US$8 billion stimulus package accounts for about 10 percent of its GDP. However, several representatives at the current National Assembly session are questioning where this money came from and how it will be used. Here, we [need] a clear target and transparent supervision system for stimulus packages.

Gian Tu Trung, president of the PACE Institute of Directors

This crisis has changed our view of the future… This is a right time for us all to reposition ourselves… I hope Paul Krugman's presentation will bring a new perspective on all this. Understanding the aim of your journey will definitely help you choose the best path to take to get to the destination.

John Yeomans, director of Deloitte Consulting/ICS Pte Ltd.

In terms of the different economic systems around the world, you have some that are more under control than others and some that are more free. What we can learn from the seminar and recent history is that there is no perfect system and so my view is we need to look at different systems around the world and pick the best from each. So the policy makers should adapt in making their policies to best suit their situation.

Vu Thanh Tu Anh, director of research at the Fulbright Economics Teaching Program

I have drawn two important things from the seminar: Firstly, the government's role of ensuring sound regulations for the financial system, especially for an economy like Vietnam's, is crucial.

Secondly, every country under any political system should have an effective social security system, especially during the economic crisis, as the poor are the most vulnerable to unemployment and other consequences.

David Pilling, Asia editor of the Financial Times

The government's role in regulating the economy is crucial and undeniable. However, let's take the example of China. If people's creativity is allowed to flourish, it would usually create better results. In this case, the government should ease regulations for the private sector to fairly compete with the state-owned enterprises in the economy.

Vietnam has allowed room for the private sector to develop and this should be maintained in the future. However, this is not a case for some to take undue advantage and commit corruption. (Interviewed by Vinh Bao)

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