At the 2017 Regional meeting of the Mont Pelerin Society in Seoul I gave a short paper where I turned a critical eye on some of the policies applied by Asian, African, and Latin-American “Tigers.” It was invidious of me to disagree with measures that in the opinion of many have led to fast growth in some parts of those regions, especially so in Korea, where years of extraordinary growth had been attained up to four years ago. In rewriting this paper I insist on the advice I gave the very attentive and polite audience: for the Korean economy and other developing nations to sail out of the economic doldrums in which they are caught, they could do worse than attend to the following three objectives:

  • Creating reliable monetary arrangements
  • Moving away from export led development
  • Resisting the temptations of the welfare state and turning a kinder eye on private education


In the 19th century, large and prosperous nations adopted the gold standard, which by definition is a fixed exchange rate regime, while poorer and smaller countries tended not to fix their exchange rates, whether by design or by force of circumstance.1 The movable exchanges of developing countries took two forms: one was a proper float against gold, because the national currency was fixed to silver when all their big trading partners were fixed to gold, as was the case with Spain; the other was repeated exchange failure, when imprudently issued gold denominated bonds turned out to be impossible to service, as was the case with Argentina. At the present time the regime is the reverse: large advanced countries or blocs, like the United States, Japan, the United Kingdom, and the European Union, float and manage their exchanges, while small open countries either set up a currency board or directly make the U.S. dollar, the French franc, or the euro their legal tender. The reason for this inversion of policies is that large advanced countries now feel confident they can use the exchange rate as a monetary and commercial tool; while small countries with a large foreign sector fear forex volatility and the financial crises it could bring in its train. However, the 1997 Asian crisis showed that not even pegging their money to a world currency was a fool-proof protection from sudden monetary typhoons. So then, what is the choice for small emerging countries?

There are three possible exchange regimes for them: (a) running two different currencies, both freely accepted in payment of debts; (b) setting up a currency board, with a fixed exchange rate between the national and a world currency; or (c) dollarizing (or eurolizing) the country.

Two currencies

The most revealing case for me is that of Peru after the drastic reforms undertaken by Alberto Fujimori when first elected President in 1990. Among Fujimori’s reforms was the issuing of a new currency (nuevo sol), abolishing exchange controls, and lifting controls on foreign investment and dividend remittances. Though dollars are not legal tender, individuals and corporations, whether national or foreign, can freely open accounts, write contracts, and make and receive payments in dollars or soles, as they wish. The use of dollars is convenient for international companies in the large mining and oil sectors. The Reserve Bank of Peru keeps a large balance in dollars to maintain confidence in the payments system. It is, however, slowly trying to reduce the weight of the dollar in the monetary system, by deftly managing the exchanges and by setting lower interest rates in its loans of soles to commercial banks, compared with dollars. It does this with two aims: insulating the country from the vagaries of the U.S. Federal Reserve and increasing seignorage income. However, the exchange rate acts as a brake on possible imprudent issues of soles. Indeed, the officials of the Bank told me that they appreciated the advantages of having to deal with an important dollar sector, as this reinforced the independence and prudent monetary policy of their central bank.

Legalising the use of two currencies in developing countries is not such an outlandish idea as central bankers steeped in the lore of monetary sovereignty tend to think. Parallel currencies can help ease monetary reform or alleviate the harshness of orthodox monetary policies. John Major, the British Prime Minister, proposed that the euro (then called ecu) be issued in parallel with the national currencies of the European Union members, with a floating exchange rate between the two and for the use of tourists and foreign investors. Jacques Delors, then President of the European Commission, rejected this idea because he wanted a single currency that would act as a flag for the future European Federation. Double circulation would have made the European currency much more acceptable generally, while keeping the national currency as a cushion in times of emergency.

The unending plight of Greece seems to call for the double circulation of euros and drachmas. The necessary condition is a fully flexible exchange rate between the two. Using new drachmas for internal transactions could have alleviated three problems: (1) the sudden lack of euros as means of payment when the crisis struck; (2) the wide protests when state services and pensions had to be cut to reduce the budget deficit; and (3) the pain of internal devaluation to correct the balance of payments deficit. Drachmas would be used as ready money while euros were being hoarded. Pensions and welfare could be discharged in drachmas. And by reducing the euro costs of exports it would help rebalance foreign payments. The consequent fall in the value of new drachmas in terms of euros would in time act as a brake on excessive issue of the national currency, for fear of a steep devaluation that would lead to the disappearance of the drachma from circulation. This idea could be applied in Zimbabwe or other African economies where parallel currencies exist de facto.

Currency Boards

Leaving aside the temporary arrangements for European countries aspiring to join the euro and the currency board in the two economic unions in French Africa, the outstanding example of success of a currency board is Hong Kong, and of failure, Argentina.

The main advantage of a currency board is that it aligns the domestic inflation rate to that of the anchor currency. However, it imposes a harsh discipline. The nation’s monetary authority has to focus only on keeping the exchange rate at the announced price (in the case of Hong Kong, 7.80 ? 0.05 HK$ = 1 US$). A currency board is always open to speculative attacks to try to force the local currency off its peg. This means that the monetary authority and the issuing banks must keep a reserve of dollars equal to or greater than the total high-powered money of the country.2

The monetary authority cannot act as a traditional central bank trying to manage credit or act as a lender of last resort. The government must avoid running a budget deficit, or at least must keep a reserve that will answer any unexpected fall in tax revenue. Ministers should be very prudent in their plans for long term investments financed by debt.3 The reason is that, as is well known, a continued budget shortfall will lead to a balance of payments deficit of similar size. A country with a currency board will be forced to abandon it if the government falls into continuous debt. This was the trouble in Argentina during its period of fixed exchanges, when it set the rate at $1 to 1 peso; the central government could not bring the provincial governments back to a zero budget deficit.

Also, the country and the government must be ready to ride over recessions caused by regional financial crises or large and sudden appreciations of the anchor currency, and credibly so, because its wages and other prices are known to be fully flexible. Thus, during the 1997 Asian crisis, Hong Kong saw its GDP fall by more than 20 percent, a situation that was eased by the fact that in Hong Kong trade unions are forbidden by law.


Three counties in Latin America (apart from some island states) have dollarised their economies: Ecuador, El Salvador, and Panama. Ecuador dollarised to try to stabilise an ailing economy in the midst of the financial and banking crisis of the year of 2000, when the sucre was showing a CPI inflation rate of 96.2%. Now it lies at around 1%, with a tendency to rise a little with U.S. inflation. El Salvador did so in 2001 for the inverse reason, to reinforce the stabilisation already carried out after the end of their civil war.

Giving up the national currency is in principle a more credible regime than pegging the exchange rate. It more directly imports the inflation rate of the anchor currency.4
Other advantages are that the savings of residents are less liable to melt, that remittances become more secure, and foreign investors have a greater degree of confidence in the country. Also, there is no central bank to act as lender of last resort, which makes depositors look much more closely at their bankers. But the main advantage is that there is no monetary policy to please (leftist) Governments. Alleged disadvantages are that any sustained rise in the value of the dollar makes exports more expensive in the short run, and that in times of high oil or coffee prices there could be bouts of over-spending. I say ‘alleged’ because in the long run it is not the market exchange rate that governs export prices but the real rate of both exports and imports, and this rate lies beyond the grasp of governments. Also, bonanzas could be corrected with the creation of a sovereign fund to invest surplus foreign money abroad, along Norwegian lines.

The case of Panama adds an interesting note to this analysis. Panama dollarised in 1904 and has stuck to dollarisation through thick and thin, even when the Canal was nationalised. This means markets fully expect dollarisation to be maintained for a long time to come, a credibility that has allowed Panama to borrow itself out of crises caused by the vagaries of the U.S. dollar, be they sudden revaluations and interest rate hikes.

The lesson of all these attempts by developing countries to create a stable monetary environment is a demanding one. A good name is not acquired overnight. A responsible public opinion must be shown to exist in election after election. Governments need to be trusted to apply predictable macroeconomic policies, year in, year out. It is only slowly that a country can achieve monetary stability.

Export-led growth

The world is a different place after the 2007 crash. Though the emerging markets of Latin America, East and South Asia, and Africa have not suffered as much as those of the developed world, the ground on which to build a prosperous future has shifted markedly even for them. This means that the economic policy of the 80s and 90s of artificially engaging in export-led growth should be re-examined and perhaps given up, just as import substitution policies of the 1950s were.

An export-led growth policy, as applied by the East Asian Tigers, has been was based on the following four elements:

  • An abundant and well-trained labour force
  • The institutional environment needed to attract foreign direct investment, to incorporate quality foreign technology, and to apply well-tried management techniques
  • Company strategies for succeeding in foreign markets
  • Government protection through tariffs, abundant finance, and acceptance of private oligopolies

Government intervention is what has attracted special attention because it seems to go counter the classical theory of international trade. There certainly is an element of protectionism in export-led growth, in that governments tend to reserve the domestic market to companies which later take the jump to sell abroad. Also so is the insistence that foreign corporations wanting to access the domestic market should form partnerships and share technology with local firms are clearly forms of protection. But this is not all.

There was more resentment in the developed world at what were seen as unfair practises of Third World exporting countries. One was state aid received by exporters. Second was the large proportion of nationalised companies among exporters that made people suspect a continued tolerance of hidden losses. Third was crony capitalism, in Korea, tolerating chaebols. Finally, there was the general category of practices condemned as ‘dumping’. All four practices are not in any case very efficient for the exporting countries since at bottom they are gifts to foreign clients or harms to local residents.

But the main accusation of unfair practices has centred on artificially low exchange rates. I am highly sceptical of the effectiveness of under-pricing the national currency to foster exports and make imports more expensive. Politicians, journalists, and pressure groups tend to focus on nominal rather than real exchange rates. Sustained depreciation of the national currency, either by excessive printing of money or by artificial devaluation, is soon reflected in the prices of the exporting country, be they at factory gates or in consumer baskets. Such policies are only sustainable if there is a large supply of labourers ready to enter export sectors and so keep real costs down. So, it is the number and quality of wage-earners and their productivity that explains low export prices, not the nominal exchange.

More generally, I think that attributing Asian progress from 1980 simply to state sponsorship of exports is an over-simplification. Professor Razeen Sally wrote some four years ago a Policy Analysis pamphlet of the Cato Institute titled Asia’s Story of Growing Economic Freedom5 that should be read by all who are mystified by the up to date success story of South and East Asian. Dr. Sally accepts that, for a time, developing nations can grow fast by throwing everything at exports, including government aid and indulgent finance. This is what he calls “catch-up growth”, based on a high rate of investment, on imitation of advanced nations’ technology, and on the low wages of the hidden unemployed. Even so, he questions the belief that catch-up growth could be helped by the Government picking winners. He says,

“Vertical” policies of selective intervention promoted targeted industrial sectors, restricted imports and foreign direct investment, and directed the financial system to channel cheap credit to favoured sectors… However, there is scant hard evidence—only assertion—that industrial policies worked. At best, they altered the sectoral composition of output and exports and did not seriously impair growth.

For Professor Sally, government programmes to foster export-led growth are simply old-fashioned industrial policy writ large. He rather maintains that catch-up growth comes when the developing country starts freeing markets and moves towards a capitalist economy. Says Sally,

The lesson from the [East Asian] “miracle” economies is for governments to provide for economic stability, to expand economic freedom, and to open up to the world economy—not to “guide the market” with dirigiste policies.

Old and new tigers need to get on the globalisation bandwagon with no after-thoughts or holdbacks. Simply continuing with the same blanket development policies will lead to a waste of resources. When capital, specialist labour, and finance become scarcer, growth demands that opportunity costs be taken into account. The misspecification of the reasons for the success of export-led policies tends to stop further progress.

“If we follow the theory that enhanced economic freedom is what promotes growth, the first steps to be taken by the expanding nations of Asia are what Dr. Sally calls “first generation reform:” Macroeconomic stabilisation and market liberalisation.”

If we follow the theory that enhanced economic freedom is what promotes growth, the first steps to be taken by the expanding nations of Asia are what Dr. Sally calls “first generation reform:” macroeconomic stabilisation and market liberalisation. As for the already advanced tigers, much more difficult “second generation reforms” are needed, to wit, structural reforms to boost innovation and competition. He classifies these structural reforms under three headings:

  • Freeing financial market from the grip of politics
  • Opening trade not only to partners of regional accords but unilaterally to the whole world, after the fashion of Chile in the 1970s.
  • Avoiding the trap set by enemies of free energy markets in the name of climate change.

This goes counter the typical Keynesian reaction of governments when fostered export policies come to a dead-end and the rate of growth starts falling. Thus, orthodox opinion holds it that the way forward for China is politically imposed redirection of the national economy towards consumption and public welfare. The socialists of all parties expect China to develop generous social services, control working hours and labour conditions, and in general drastically regulate industry and markets. Also, they recommend increasing home consumption and reducing the rate of investment. Consumption and investment can look after themselves if the credit market is not interfered with. What is needed is further privatisation of national corporations and doing away with obstacles to free competition and free trade: in sum, more economic and personal freedom, not liberal-socialism.

The lure of the Welfare State

This brings me to the danger that developing countries goi down the primrose path of a full-blown welfare state: labour regulation, minimum wages, unfunded health systems, pay-as-you-go pensions, state education, and so on. This message is timely in many countries, but especially in Korea. Mr. Moon Jae-in, the new President, calls himself a progressive but really is a socialist; he wants to “democratise the economy”, which means that he sees inequality as the main problem. He wants to make entitlements more generous for the poor; to make housing more affordable, and so on. We in Europe know the lyrics of this song, especially now that Theresa May, the British Prime Minister, is singing it with gusto.

The protectionists in the advanced countries are much to blame. They demand an ‘even playing field’. They complain of the unfairness of competition from countries where the cost of labour is not increased by welfare contributions. They think that wages are determined by bargaining between business and trade unions or by political fiat, not by the value of the marginal product of labour. They also see social security contributions as an inevitable tax on labour because families cannot be trusted to save for a rainy day or educate their children or treat their employees properly and competitively. Neither do they think that private charity and trade union cooperation can look after the needy when in trouble, as was the case in the Britain before the 1942 Beveridge Report.

An easily avoidable mistake in countries with a very young population is that of going for pay-as-you-go pension systems. José Piñera well explains the advantages of capitalised pensions. Individuals have property rights over what they have saved for their pension. Those funds are invested in and outside the country for the benefit of future pensioners rather than applied to defray current pensions. This creates the right kind of incentives, so that frictions between generations disappear. The aging of the population ceases to be a problem. Investment of the pension funds markedly contributes to economic growth. However, the main question is how to deal with current pensions when individuals at work start saving for their own benefit rather than financing current pensions. A youthful population alleviates but does not do away with this conflict. The reality is that the obligation to retirees was there before but hidden from sight, so that recognising it with a special issue of public debt would be a move for democratic transparency. Many countries round the world now have capitalised pensions of different kinds. A discussion of what the best scheme could be for each would be a useful way of moving forward towards a sustainable pension system.

For more on these topics, see the EconTalk podcast episodes Autor on Trade, China, and US Labor Markets, March 2016, Burgin on Hayek, Friedman, and the Great Persuasion March, 2013, and James Tooley on Private Schools for the Poor and the Beautiful Tree, Dec. 2014.

See also “The Erosion of Political Economy and the Retreat from Freedom”, by Pedro Schartz, Library of Economics and Liberty, April 4, 2016; and Gold Standard, by Michael D. Bordo in the Concise Encyclopedia of Economics.

There are many dangers for developing countries when they try to imitate the welfare and social policies of the advanced world. But before I end this column I must allude to one singularly mistaken policy, that of overlooking the shortcomings of state education, both foreign funded or paid out of taxes. In fact, in East and Southeast Asia, school education is customarily supplemented by high cost private tutoring within the family. The combination has made for education of high quality. A great part of the four Tigers’ economic miracle is due to the human capital accumulated over the years by the young in Asia. This is so even in China, where literacy has made huge advances. As a parting shot, may I ask my readers to see what James Tooley has to say in The Beautiful Tree (2009). One of the great slurs on the very poor is to say that they do not really care for the education of their children. John Stuart Mill was one of the first to allege that one could not expect the uncultured to understand the use of schooling and he therefore demanded that elementary education be made compulsory. When Tooley recounts droves of poor parents in Zimbabwe, Ghana, India or even rural China, paying what little they can afford to send their offspring to private schools, while rejecting the free education offered by the State, one’s confidence in liberty is reaffirmed and multiplied.


The choice faced by the advanced countries was well analysed by John Maynard Keynes’ 1924 Tract on Monetary Reform. Keynes there showed that if the United Kingdom fixed the exchange rate to the dollar (and thus indirectly to gold) the price level in Britain would in fact be governed by the Fed in Washington; and that only if the Bank of England allowed the pound to float would she be able to steady the domestic price level. This was before the United Kingdom rejoined the gold standard for a brief period, from 1925 to 1931, only to give it up gave it up finally in 1931. Now that the gold standard has been abandoned by all and sundry, countries with a large economy that can be to some extent be isolated from the rest of the world prefer Keynes’s second policy and manage their exchange rate so as to conduct a national monetary policy—God bless them! In 1931, by giving up gold, devaluing, and floating, the United Kingdom made an early recovery from the Great Depression. But over the years this policy of managing the currency politically has led to a huge loss of value of the pound—some 93% from 1931 to 2017.

In very difficult times there may be need for the monetary authority to fight the hedge funds that shorten the currency or the stock exchange as a whole, by purchasing futures and securities on the local stock exchange, but this has to be a very short term intervention (as happened in Hong Kong in 1998). See the very revealing letter of Joseph Yam to Alan Greenspan, of September 17, 1998.

This the Hong Kong government has tried to avoid doing by creating a “Future Fund” in the 2016-17 budget under the previous Financial Secretary, John Chang Chun-wah). See the 2016-2017 Budget Speech, at

The risk premium will tend to set domestic rates of interest higher in the small country. Also, there may be temporary differences in price levels depending on expectations and the tariff regime and on how oligopolistic the small economy is.

Available online at “Asia’s Story of Growing Economic Freedom”, by Razeen Sally. Cato Institute, June 5, 2013.


*Pedro Schwartz is “Rafael del Pino” Research Professor of economics at Universidad Camilo José in Madrid. A member of the Royal Academy of Moral and Political Sciences in Madrid, he is a frequent contributor to the European media on the current financial and social scene. He currently serves as President of the Mont Pelerin Society.

For more articles by Pedro Schwartz, see the Archive.