The Asian Crisis: a perspective after ten years

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<ul><li><p> 1</p><p> 2007 The Author Journal compilation 2007 Crawford School of Economics and Government, The Australian National University and Blackwell Publishing Asia Pty Ltd.</p><p>doi: 10.1111/j.1467-8411.2007.00199.x</p><p>Blackwell Publishing AsiaMelbourne, AustraliaAPELAsian-Pacific Economic Literature0818-9935 2007 Asia Pacific School of Economics and Government, The Australian National University and Blackwell Publishing Asia Pty LtdXXX</p><p>ORIGINAL ARTICLES</p><p>SHORT TITLE RUNNING HEAD</p><p>: CORDEN </p><p>THE ASIAN CRISIS: A PERSPECTIVE AFTER TEN YEARS</p><p>ASIAN-PACIFIC ECONOMIC LITERATURE</p><p>The Asian Crisis: a perspective after ten years</p><p>W. Max Corden</p><p>*</p><p>Heinz W. Arndt Memorial Lecture, Canberra, 22 March 2007</p><p>1</p><p>My self-imposed task here is limited. I want topresent a simplified overview of the causes ofthe East Asian financial crisis and the mainpolicy actions taken against it. I have not triedto make a grand assessment of causes andpolicies, of how something similar might beavoided, and what policy faults were committed,though there are various hints. Many countrieswere affected by the crisis that burst upon anunsuspecting world in 1997, but here I focusonly on the four principal countries involved,namely, Thailand, Indonesia, Malaysia andKorea. I shall note some special features of thecrisis in each of these countries. Usually thePhilippines is included in the list, but thiscountry was actually affected much less,mainly because it had only recently recoveredfrom an earlier crisis and thus its boom wasmuch smaller. Many other countries wereactually or potentially affected, but I do notdiscuss them.</p><p>While there are plenty of references to theInternational Monetary Fund (IMF), I do notdiscuss systematically the role of the IMF inthe East Asian crisis, or make an assessmentof its activities. This is a popular subject onwhich there has been a considerable literatureand strong views are held. It would take a fulllecture to deal with it. I reviewed it all conciselyin Corden (1999) and my views have not changedsince. Recent and valuable assessments are inthe report of the IMFs Independent EvaluationOffice (2003) and in Ito (2007).</p><p>I have drawn extensively on the publicationsof present or former members of the Departmentof Economics in the Research School of Pacificand Asian Studies of the ANU, of which HeinzArndt was head for many years, namely Hill(2000) on Indonesia, Athukorala (2001) onMalaysia and Warr (1999, 2002, 2005) onThailand, as well as Corden (2002) on exchangerate policies and experiences. In addition, Ihave benefited from Lee and Rhee (2007) onKorea, and Siamwalla (2005) on Thailand.</p><p>The Boom</p><p>In the four countries, Thailand, Indonesia,Malaysia and Korea, there was an investmentboom financed both by local savings and byforeign capital inflow. This was a familiarstorysuch booms have happened, evenwhen capital markets are closed to capitalinflow or outflow. But this one was truly inter-national. Significant capital account opening inthe early 1990s in Thailand, Korea and Malaysiaplayed a key role in the story. The explana-tion for the boom was simple: the countriesmacroeconomic policies and outcomes werevery favourable when compared with those ofother developing countries; budget deficitswere low and, in some cases, there were sur-pluses; and inflation was low and growthrates were high. These countries were the starsof the developing world.</p><p>* University of Melbourne, Australia.</p><p>1 This is an expanded version of the H.W. Arndt Memorial Lecture given at The Australian National University on22 March 2007. I am indebted to valuable comments on drafts of this paper from Robert Z. Aliber, Prema-ChandraAthukorala, Stephen Grenville, Hal Hill and Peter Warr.</p></li><li><p> ASIAN-PACIFIC ECONOMIC LITERATURE</p><p>2</p><p> 2007 The AuthorJournal compilation 2007 Crawford School of Economics and Government, The Australian National University</p><p>and Blackwell Publishing Asia Pty Ltd.</p><p>In Thailand and Malaysia, new industriesfor exporting manufactures were establishedor further expanded as a result of FDI aswell as local investment financed in Thailand,in part, by foreign borrowing. In Korea, inter-nationally successful conglomerates (</p><p>chaebols</p><p>)were financed to enable further internationalexpansion. Stock market values rose. Thesecountries indeed looked good. They werepart of the Asian miracle. I have the impres-sion that much of the investment, especiallyin the early part of the period, was sound.This was probably true, especially in the caseof investment in Thai and Malaysian exportindustries.</p><p>As usual, the booms went too far. Therewas irrational exuberance not just in thecountries themselves but also in the worldcapital market. In Thailand and Malaysia,where the funds initially went into developingmanufacturing industries, real estate boomsdeveloped and got out of hand. Investmentshifted from manufacturing to construction.In both countries, there was a huge stockmarket boom. All of this was bound to cometo an end. The four countries had been verysuccessful, but they were not perfect. Therewas a lack of transparency in investmentallocation, and excessive political influenceon bank lending.</p><p>The various crises earlier in Latin Americaother than the 199495 Mexican crisishadoriginated in excessive borrowing by the publicsector, including parastatal enterprises. Bycontrast, the Mexican crisis was the first post-World War II crisis originating in the privatesector. This East Asian crisis was also a privatesector crisis. Indeed, one reason why the flowof international capital to these countriesaccelerated after 1994 was the rebound fromthe Mexican crisis. For some years Mexico hadbeen the largest recipient of private fundsflowing to emerging markets.</p><p>While inflation was generally low whencompared with Latin America, there was realappreciation with nominal exchange rates moreor less fixed to the US dollar (or movingclosely with it), and domestic prices andwages rising somewhat faster than in the USand other trading partners. In some cases,</p><p>notably Thailand and Malaysia, there werelarge current account deficits, this being theway in which capital inflow was transferredinto the economy. These deficits were notreally a separate phenomenon but were a partof the capital inflow story.</p><p>During the boom, capital inflow took essen-tially three forms. First, there was FDI, whichwas important in Malaysia, but to a lesserextent in Thailand and Indonesia and restrictedin Korea. Flows of such investment seemed tohave been fairly stable, and not changing inresponse to herd effects (investor sentimentmoving </p><p>en masse</p><p>). Nevertheless, the flowswould in time have surely responded some-what to changes in expectations about exchangerates and investment profitability. Second,there were inflows of portfolio capital intolocal stock markets. This was particularlyimportant in Malaysia. Finally, there wasshort-term borrowing from the world capitalmarket by local banks and other financialintermediaries, and also by corporations, all inthe form of debt-creating instruments. Thelenders were international banks and alsomutual funds, pension funds, and so on. Thedebts were (almost) all denominated in USdollars. Both portfolio capital and short-termborrowing were highly responsive to changesin expectations and lacked the relative stabilityof FDI. It was a feature of the boom that somuch of it was financed by highly mobilecapital in the form of short-term borrowingand, to a somewhat lesser extent, in the formof portfolio capital.</p><p>The bust and the trigger</p><p>It may be inevitable that a boom comes to anend some time, but not necessarily a suddenend. There could be a soft landing, with agradual decline in investment and capitalinflow. But the herd effect in the internationalcapital market may lead to a sudden end inthe form of a crisis, which would be a hardlanding. Usually it is not possible to predictwhether there will be a soft or a hard landingand, if the latter, when it will take place. Onecan see the possibility of a crisis but cannot</p></li><li><p> CORDEN </p><p>THE ASIAN CRISIS: A PERSPECTIVE AFTER TEN YEARS</p><p>3</p><p> 2007 The Author Journal compilation 2007 Crawford School of Economics and Government, The Australian National University and Blackwell Publishing Asia Pty Ltd.</p><p>predict it. This applied as much to the EastAsian crisis as it does now to a frequentlypredicted dollar crisis, or indeed a housingcrisis in various countries.</p><p>A hard landing usually has to have atrigger of some kind. But the trigger is notthe fundamental cause of a crisis. In thesefour Asian countries, the fundamental causewas the inevitable ending of the investmentboom owing to eventual over-investment,and the financial difficulties that an excessiveboom was causing. In the case of Thailand,the trigger was a combination of domestic andexternal factors that led to a drastic collapsein the growth rate of exports (from over20 per cent a year to about zero) in 1996, andthus to an increase in the current accountdeficit. I shall come back to that later. Thisexport growth collapse led in 1997 to anexchange rate crisis in Thailand, with theThai currency (the</p><p> baht</p><p>) depreciating from26 </p><p>baht</p><p> to the US dollar to 47</p><p> baht</p><p>. In the caseof the other three countries, the trigger wasthe </p><p>baht</p><p> depreciation.Suppose there had not been a sudden and</p><p>sharp depreciation of the </p><p>baht</p><p>, would therestill have been crises in the other three coun-tries? This is a relevant question because it isoften argued that international action is neededto avoid contagion. And when an event inThailand set off crises in Malaysia, Indonesiaand (after some lag) Korea, for example, it isindeed a case of contagion. The answer has tobe that, for fundamental reasons, the booms inthe latter three countries had to come to anend; but if there were no trigger there wouldbe a soft rather than a hard landing, and henceno crisis. Yet it is also possible that, in theabsence of the Thai exchange rate crisis,eventually there would have been some othertrigger.</p><p>My general conclusion, at this point, is thatthe fundamental cause of the crisis was thatthere had been investment booms that endedin a period of irrational exuberance. Bothlenders and borrowers, as well as financialintermediaries, should be blamed for this. Itwas not predictable that the boom wouldend in a crisis, but it was certainly a possibility.The sharp decline in investment caused</p><p>recessions in all countries, with a multipliereffect literally multiplying the effect of theinvestment slump as reflected in a decline inconsumption. As shown in Table 1 below,the recessions were deepest in Indonesia andThailand.</p><p>Table 1</p><p>Real growth rates</p><p>(% of GDP)</p><p>The international nature of the boom andsubsequent slump clearly depended on theability of capital to move freely, or relativelyfreely, internationally. Thus the liberalisationsof international capital movements that hadtaken place earlier were crucial, especially inallowing contagion to take place. India andChina, which had strict capital controls, didnot have crises. But with regard to the fourcountries on which I focus here, one should bemore precise. For Thailand, a crucial policyfeature was the gradual liberalisation, espe-cially of short-term capital movements, thattook place principally in 1993 (Siamwalla2005). Indonesia had fully liberalised in the1970s, and in practice enforceable controlswere hardly feasible anyway. Malaysia wasvery liberal about FDI and also portfolio capi-tal, but not short-term, debt-creating borrow-ing. I shall come back to this important featurelater. Finally, Korea had controlled and dis-couraged FDI inflow, but had liberalisedshort-term, debt-creating borrowing, leadingto massive short-term, interbank inflows. Itsliberalisation was associated with its member-ship of the OECD.</p><p>At this point, let me mention that, aftergiving this lecture, I looked at Kindleberger</p><p>Country 198895* 1996 1997 1998 1999 2000</p><p>Indonesia 7.9 7.8 4.7</p><p>13.1 0.8 4.9Malaysia 9.4 10.0 7.3</p><p>7.4 6.1 8.9South Korea 8.1 7.0 4.7</p><p>6.9 9.5 8.5Thailand 10.0 5.9</p><p>1.4</p><p>10.5 4.4 4.8</p><p>* Average growth rate.</p><p>Source</p><p>: Asian Development Bank at , accessed on 8 May 2007.</p></li><li><p> ASIAN-PACIFIC ECONOMIC LITERATURE</p><p>4</p><p> 2007 The AuthorJournal compilation 2007 Crawford School of Economics and Government, The Australian National University</p><p>and Blackwell Publishing Asia Pty Ltd.</p><p>and Aliber (2005) on Manias, Panics andCrashes. This is the fifth edition of a classic byCharles Kindleberger, first published in 1978.It tells the story of numerous booms thatended in crises. Financial crises, or bubbles asthey are addressed, are hardy perennials.The authors list (p. 8) the big ten financialbubbles, beginning with the Dutch Tulip BulbBubble of 1636, and including the late 1920sstock price bubble which preceded the GreatDepression. One of these ten is the East Asianbubble, which they regard as beginning in1992 and, of course, ending in 1997. This putsthe topic of this lecture in perspective. Onechapter of the book discusses internationalcontagion, another the domestic lender oflast resort, and all issues that arise in any dis-cussion of the East Asian crisis are covered.</p><p>The exchange rate regime and </p><p>exchange rate crises</p><p>It may seem surprising that I have hardlyreferred to exchange rates so far, other thanthe brief reference to the Thai </p><p>baht</p><p>. The EastAsian crisis is often thought of as a currencyor exchange rate crisis. And, it is true that,in Indonesia, Malaysia and Korea, it wastriggered by the depreciation of the </p><p>baht</p><p>.What then is the relationship between theexchange rate regimes and the investmentbooms and slumps? Before the crisis, threeof the countries had (more or less) fixedexchange rates to the US dollar. The Indonesiantarget zone regime was somewhat (and notvery much) more flexible. The first point isthat, if the exchange rates had floated and ifthe underlying changing expectations aboutinvestment profitability had been the sameas they actually were, then there would stillhave been a boom followed eventually by asoft or a hard landing.</p><p>During an investment boom, nominalexchange rates would have appreciated, sothere would have been less inflation than thereactually was with a fixed exchange rate, butthere would still have been current accountdeficits (real appreciation might have beensomewhat greater, and this might have</p><p>moderated the boom). When investment eventu-ally declined, there would have been nominaldepreciation, possibly very sharpthat is, ahard landing. After a lag, the depreciationwould probably have stimulated export andimport-competing sectors, and thus wouldhave moderated, or even ended, the recessioncaused by the investment slump. One mightcompare this with what actually happened.The various crises ended the fixed rateregimes, and this was followed by substantial(in the case of Indonesia, vast) depreciations,which eventually stimulated exports. With afloating rate initially, this stimulus to exportswould have happened earlier.</p><p>I have focused on the underlying funda-mentals, namely the investment booms andslumps, which were somewhat similar...</p></li></ul>


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