Self-Inflicted Wounds.

• Author: Root, Hilton

THE GLOBAL financial crisis that began with the collapse of the Thai baht in mid-1997 was fundamentally one of information mismanagement--that is, banks failed and markets collapsed mainly because crucial information was not collected and distributed to investors. Once burned, those same investors have understandably proved reluctant to return to markets where they mistrust the available financial data and, more generally, the credibility of host governments. To lure back investment, armies of financial specialists have been dispatched to Asia by the International Monetary Fund (IMF) and other multilateral institutions to establish basic standards of accounting and disclosure requirements for banks and firms.

But what these specialists have discovered is that the mismanagement they seek to remedy is often the product not of inefficiency but of direct and willful government action. More precisely, governments in Asia routinely misuse financial information for corrupt purposes or unreasonable taxation. Firms then respond by withholding this information, thereby reducing potential trade and investment. If a firm in China, for example, were to maintain the same standards of accounting as its counterparts in the United States, it would soon find itself subjected to a wide range of capricious interventions by state officials.

By contrast, the transformation of the U.S. economy made possible by the emergence of the public corporation in the late nineteenth century depended upon protection from arbitrary government. Without government financing, managers turned to the public and issued stock, the sale of which required the release of vital information. Because governmental opportunism did not jeopardize firms that accurately disclosed information, American businesses were able to create a thriving equity market. As firms grew by drawing capital from dispersed shareholders, enormous economies of scale developed. Municipalities learned that responsible public accounting permitted the financing of infrastructure by issuing bonds.

Private sector initiatives have not emerged, however, in present-day China, India, Russia and a host of smaller countries having their first serious encounter with a market system. This is not surprising: information about a firm's assets or ownership structure is simply not available in these places. Fearing confiscation of their assets, firms disguise their holdings as well as their management structure, which in turn constrains their ability to access capital...