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Risky but rewarding

Two years ago, when most Asian economies were in financial turmoil, I heard many Indians praising the wisdom of our bureaucrats for carrying out half-hearted economic reforms. The emphasis, in case you are wondering, was on 'half-hearted' and not on 'economic reforms.'

India escaped almost unscathed from the Asian crisis while most countries of the region suffered from hyper- inflation, huge unemployment and multiple bankruptcies. Many attributed India's insulation from the Asian contagion to the slow pace of Indian reforms which kept the economy largely closed to the outside world. Economic reforms, they concluded, were risky. These would expose the Indian economy to the vicissitudes of the global market. Hence, they recommended: halt the process of reforms. And the government obliged.

Is globalisation really risky? Does it make economies more vulnerable? The answer, believe it or not, is not always yes. Economies can enjoy the fruits of globalisation while adequately safeguarding themselves from the associated risks.

Take, for instance, the US economy. It is one of the most open economies in the world. Yet, if the events of the past couple of years are an indication, it is also highly protected from the vagaries of the global economy. Oil prices recently touched $25 a barrel from $11.37 a barrel in February, the highest in almost a decade. In 1973, 1980 and 1990, such hikes led to recessions mixed with high inflation or what economists call stagflation.

But this time around, economic indices stubbornly refuse to respond to oil price hikes. There is neither inflation nor stagnation. US inflation rose by a mere 0.1 per cent last month. The economy has not seen such rapid continuous GDP growth in several years. Despite globalisation, the largest consumer of oil in the world is unaffected by the doubling of its price!

When the East Asian crisis was spreading there were fears that it would soon engulf the world's largest economy. But neither the Asian currency debacle, nor the Russian financial crisis, affected Wall Street exuberance. Neither world recession nor financial turmoil lowered the growth of the US economy. The US attracts the largest amount of capital from all over the world; but it is still unaffected by bad news from outside.

So, what is the secret of this relative insulation? Firstly, a plethora of financial instruments which enable investors in the US hedge against unexpected risks. A large number of US companies, for instance, have hedged a substantial proportion of their oil requirements for next year at prices much below the spot rates. They are not in the spot market to buy oil at the present exorbitant rates. So even if oil prices touch $30 a barrel, as many oil expert predict, the US economy may remain unaffected.

Secondly, technological progress has substantially changed the structure of the US economy. This along with increased productivity and high GDP growth has made the economy far more secure from the ups and downs of the world economy.

Most economic activities involve risk. The higher the risk, the greater the chances of earning a high profit. Globalisation is risky, but the rewards are also high. Economies equipped with modern financial instruments can insure against these risks to a large extent.

Piece-meal globalisation is even riskier. It hinders the development of financial market instruments that can provide safeguards against market risks. If real estate companies in Thailand had hedged their investments against foreign exchange risk, there would not have been a South Asian currency crises. If there were enough financial instruments to insure investment in real estate, there may not have been so many bankruptcies. The solution to lessen the risks of globalisation is to quicken, not reduce, the pace of reforms.

(Neeraj Kaushal is a financial journalist who lives in New York and is a former senior editor of The Economic Times)

Neeraj Kaushal

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