A Critical Review of the Intellectual Dispute on the Asian Financial Crisis of 1997

As a student of International Relations, I observe the Asian financial tragedy not much as anomaly, but unwanted, inevitable product of economic globalization. The international economic liberal order designed in the aftermath of World War II ushered in an era of interdependence, it is this phenomenon that account for opportunities, sharp contradictions, and exceptionally volatile dynamics leading to execrable outcomes. Therefore, the 1990s witnessed several episodes of currency turmoil, most notably the near-breakdown of the European Exchange Rate Mechanism in 1992-93, the Latin American Tequila Crisis following Mexico’s peso devaluation in 1994-95, and the severe crisis that swept through Asia in 1997-98 (Radelet and Sachs 1998). However, the crisis was exceptionally devastating in Asia. Following years of stellar performances, the crisis hit countries of Thailand, Malaysia, Indonesia, the Philippines, and South Korea, they experienced a plunge in the external value of their currencies and a sudden reversal of private capital flows from June 1997 onward. The tragedy has born massive volumes of literature which I will try to sort out in this short essay.
First and foremost, the paper presents a summary of arguments on the origin of the 1997 Asian financial crisis. Second, present and assess major arguments, controversies and consensus surrounding the Asian financial crisis. Third, I will examine closely the claims by Jagdish Bhagwati (2004); Robert Wade, (2000) Stephen Haggard, (2000) and Ha-Joon Chang, (1998) in defense of their respective positions of the genesis of the financial crisis in early 1997. Finally, a conclusion of where we go from here.
There are two major speculations on the origin of the Asian crisis. First, that the crisis was a failure of Asian capitalism and the second, the failures of Western capitalism. Both theories tend to treat Asia as a chunk, only paying lip service to the different economies, cultures, religions and political structures of the countries within the region and ignoring the fact that not all countries in Asia were hit by the crisis at the same time or in the same way or even that some were in fact either hit by different crises or were not hit at all.
In brief, those subscribing to the theory that the crisis was a failure of Asian capitalism - point to massive misallocation of funds through what has become known as "crony capitalism", coupled with inadequate laws relating to accounting standards and regulation of financial institutions (Krugman 1998; Green Span1998 & Bagwati 2004 Ch. 13). These scholars argue that because of the symbiotic relationship between government, industry and banking, funds were not necessarily directed to the most productive areas and were also directed without adequate assessment of risk. Adequate assessment of risk would in any event have been impossible as information was murky due to inadequate accounting standards and the general secrecy surrounding many businesses.
Because of the relationship of financiers and industry with government, there was a feeling, it is argued, that governments would not let either banks or industry fail and thus lenders acted as if there was an implicit government guarantee (World Bank Report 1998). This further reduced their concern about risk. In addition, the maintenance for too long of pegged exchange rates added a further dimension of risk as it encouraged foreign exchange borrowing without adequate realization of foreign exchange risk on either side (Chang 1998, pp1558) Offshore lenders compensated for the lack of information and risk by lending on a short-term basis (Chang 1998, also see Bagwati 2004, Ch. 13) This meant that when the bubble of confidence burst, there was capital flight and a consequent currency crisis (Chang 1998, pp1556; Sachs, 1997 & Radelet and Sachs 1998). These monetary difficulties were not causes, but symptoms, of an underlying crisis with much deeper roots (Chang 1998, pp1557-9; Joseph Stiglitz 1997; Stanley Fisher 1997; Marshall 1998; and Chang and Velasco 1999).
The proponents of the first theory tend to come from the West. There is a certain amount of self-satisfaction inherent in their comments. They claim that the high savings rates, the, the hard work, the importance of the community as against the individual and the symbiotic relationship between government and industry can no longer be regarded as the cause of a miracle, rather they were the cause of a crisis. The West no longer has to feel defensive about its low savings rates, the less ingrained work ethic and a greater emphasis on individualism (Krugman 1998). It can confidently trumpet the superiority of a free market and preach the necessity for the adoption of Western systems in Asian countries. This overlooks, however, that they often work imperfectly even in the West.
What is clear for proponents of the first theory is that, there is a necessity for free market policies backed up by democracy, proper internal bank regulation, proper financial reporting processes, the adherence to prudential lending standards and floating exchange rates. Barriers to recovery such as antiquated or unusable insolvency laws and laws restricting foreign investment or the free movement of labor must be reformed (See Kim Dae-Jung, Joseph Stiglitz and Amartya Sen in Farrukh Iqbal and Jong-II You 20001; Chang 1998, pp1559-60; Haggard 2000, pp224-6 & Krugman 1998).
Those subscribing to the second theory argue that the crisis is rooted in the failure of Western Capitalism- cite the premature opening-up of the capital accounts in fragile, growing economies, as the central cause of the crisis (Sachs 1998; Bagweti 2004, Ch. 13 and Wade 2000, pp.101). The proponents of this theory say that opening-up of the capital accounts was premature because the institutions and businesses in the relevant countries were not ready for liberalization (Wade 2000).The crisis is blamed on the panicked withdrawal of short-term capital (the latter just as exaggerated as the lending had been in the first place) (Bagwati 2004, and Wade 2000). The view is that Asian capitalism worked well before the influx of outside capital. Indeed, it had created a decade of growth unprecedented in the history of capitalism. The advocates of this theory thus argue for more state intervention rather than less, so that there can be a return to the earlier stability (Wade 2000 and also Chang 1998, agree in this regard).
In essence, the first theory blames the borrower and the second the lender. Whichever theory, if either, is correct it is clear that to some extent, a lack of adequate laws or a lack of adequate enforcement of those laws, takes some blame for the crisis. There is a remarkable consensus that there needs to be legal change, especially in the areas of regulation of financial institutions and accounting standards. Of course, this may be because these are the, seemingly, relatively easy reforms to achieve or at least these are areas where it is relatively easy to formulate what should be done. There is, a divergence of view as to what should happen in the macroeconomic field and this will have an effect on the type of regulation which is wished for there. The supporters of the first theory consider that Asia should embrace the free market and the supporters of the second support greater regulation, and intervention especially of international capital flows. Whatever the outcome of the debate, there is no doubt that the crisis has highlighted gaps in laws or gaps in the usage of laws in certain areas. Whether or not such inadequacies caused the crisis, the fact that inadequacies have been identified means that the correction of these is necessary in the future. As the Asian crisis can be seen to be in large measure a crisis of confidence all that can be done to ensure the return of confidence must be done and this must mean correcting the problems that have been identified with the law.
PLAUSABLE CONSENSUS
First and foremost, close business-government had proven an asset during the period of high economic growth generated moral hazard, distorted liberal process, increased vulnerability to shocks and complicated the adjustment process once the crisis hit. Indeed, the nature of government relationship was so close in the most seriously affected countries. Close interaction between public and private sector is a hallmark of the region and the feature of government that contributed to its high levels of investment and economic growth in the past ( Jones 1998, pp147-50; Komiya 1990, pp220-224; Aoki 1997, pp.233-37;O’malley 1998, pp325-41; Wade 2000, pp.86-7,1998, 271-3; Amsden 1998, pp379; Haggard 1990, pp276, 2000, pp217-9; Chalmers 1987, pp.136-41 and Krugman 1994, pp. 72-3).
Further more, there is amazing harmony between the camps on the sudden u-turn from massive capital inflows to brisk outflow ahead of a monumental collapse in 1997. Robert Wade characterized the boom of inflow as “overcapacity” (Wade 2000, pp100), as a result of huge “outpouring of capital in form of foreign direct investment, portfolio investment and bank lending” (Wade 2000, pp.100-1). Chang argue that in case of south Korea, the country had substantial debt , the debt was so huge that it made devaluation for example impractical “whatever the causes…the Korean government feared that significant depreciation would make the foreign debt repayment burden unbearable” (Chang 1998, pp.1558). Although Bhagwati’s narrative accuses the international capital inflow, he also admits “this crisis, precipitated by panic-fueled outflow of capital…” (Bhagwati1998, pp8-9 & 2004, Ch.13). Overall the verdict was rendered on international capital exodus, though with certainly different opinions to the causes.
Critical to elaborate, is the shaky understanding of the so called “Fundamental,” on surface they all agree, deeply, their serious and statistically irreconcilable arguments leading to contrasting conclusions about the state of regional economic health at the dawn of the crisis. A dramatic example here is Wade and Chang, Wade bluntly claims, “...their economic growth was one of the certainties of our age” (Wade 2000, pp 85). Mr. Chang systematically dismantles the above assertion by engaging in a well balanced analysis, “...looking at the more recent period, current account deficit was $8.7 billion in 1991, which, as a proportion of GNP…was bigger than $8.9 billion in 1995…whereas the case of (earlier) quickly fell back…(the latter)…continues to grow” (Chang 1998, pp .1558). The core here is that despite statistical comparisons, by 1997 the perceived account deficit was comparatively, and substantially higher than in 1995. In short, the agreement on “Fundamental” is brittle; more so when one subject the notion to intellectual logic and economic principles.
More still, the crisis generated pressures for financial and corporate restructuring, but the process faced substantial political resistance and the reform movement is quite slow. However, long-run institutional, legal and policy charges put in place in the awake of the crisis gradually transforming financial systems, corporate governance and business government-relations in important ways, making them more accountable and transparent.
Important also, is the economic health of the states in the region, governments were poorly positioned both politically and administratively, to respond to social dimensions of the crisis. Their interventions did not always reach the most seriously affected groups, which tended to be in the urban middle, working, and marginal classes. This is a challenge all Asian countries face now, and certainly is bound to linger around for decades to come. Chang 1998 and Haggard 2000), seem to cut through the ideological divide, Chang, argues that, although the governments were to blame, the causes were deeply rooted in the liberalization process before the crisis (Chang 1998, pp.1560 also see Haggard 2000).
Finally, despite understandable skirmishes over the types of governments, it is my understanding that a substantial agreement exists on the resilience of democratic governments. With exception of Indonesia, the crisis showed the democracies in the long-run are more resilient and has advanced the cause of reform in the region. In essence, the deepening financial, corporate, and social reforms will also require a parallel process of deepening democracy by enhancing accountability and transparency of government and by reducing the influence of particularistic interests (Chang 1998 and Haggard 2000;
MAJOR CONSTROVESIES
Three schools dominate the debate: “fundamentalists,” who emphasized macroeconomics and particularly exchange rate mismanagement (Chang 1998, pp. 1555; Haggard 2000, pp. 219-20; Bhagwati (2004 Ch. 13) and Furman and Stiglitz 1998); “internationalist s”, who focus on the inherent volatility of international markets and self-fulfilling speculative attacks and contagion (Wade 2000, pp. 84 and Bhagwati 2004, Ch. 13); “new fundamentalists,” who underlined regulatory and structural issues, particularly in the financial sector. Below is a detailed discussion of these points of disagreement.
The foremost heated intellectual struggle revolves on the content of IMF supported programs, but why? The critics contend that fiscal and monetary policy tightening had perverse ramifications (Radelet & Sachs 1998; Furman and Stiglitz 1999, and Krugman 1999). Rather than stabilizing the exchange rate, they sent markets the signal that further decline in store, contributed to the overshooting of exchange rate adjustments and severely compounded the problem in the financial and corporate sectors. Feldstein (1998) argued that the IMF’s efforts at financial market reforms were also overly ambitious and intrusive and had similar adverse consequences (Evans 1997, pp. 62-87 & Wade 2000). According to Stiglitz, the seeds of the Asian crisis were planted in the early 1990s when, under pressure from the IMF and the US Treasury, countries in the region opened their capital markets leading to a flood of short-term capital and the creation of a real estate bubble followed by a rapid capital outflow when the bubble eventually burst (Haggard and Maxfield 1993, pp6-91 & Stiglitz 2000).
They argue that the United States has a powerful interest in maintaining and expanding the free worldwide movement of capital.... Moreover, Wall Street banks and brokerage firms want to expand their sales by doing business in emerging markets.... [Hence] there is a powerful confluence of interests between Wall Street and multinational corporations in favor of open capital accounts worldwide. In response, the U.S. Treasury has been leading a campaign.... to promote capital liberalization (Wade 1998-99: 45-47). Elsewhere, Wade calls this the "Wall Street-Treasury complex" (Wade 1999). Such a formidable coalition of forces is undoubtedly difficult to resist and is directly responsible for the sudden economic crisis in 1997.
However, although the IMF cannot be entirely off the hook, any assessment hinges on some counterfactuals and a weighing of unpleasant tradeoffs (Corden 1998 and 2001; World Bank). For example critics of the IMF and the so called “Wall Street-Treasury Complex” (Bhagwati 2000 Ch.13), tend to discount the risk of even further currency depreciation and its effect on the servicing costs of foreign debt (Fischer 1998). The evidence for perverse exchange rate effects is mixed at best (Goldfajn and Baig 1998: Wang 1998 & Dooley 1999), and the IMF did in fact move albeit perhaps too slow to reverse its initial monetary prescriptions (Noble and John Ravenhill 2000).
My impression is, given the extent of the collapse, it was impossible to avoid reform of financial and corporate sectors. Democracy and reforms go hand in hand, so I will not engage that debate here. Moreover, any assessment requires attention to how actions and inactions of governments affected markets, and that brings us right back to the central role of politics. As Chang eloquently articulates, “…more than 100 firms were going bankrupt per day---this mean that the initial debate on the IMF program regarding Korea have been settled in favor of its critics …to be fair of these things were already contemplated by the Kim Young government..” (Chang 1998, pp.1560). In a nutshell, you cannot squarely apportion blame without being simplistic. In Alan Greenspan's words: "We cannot turn back the clock on technology -- and we should not try to do so" (Greenspan 1998: 249). Any government that still preferred controls was, or is in effect, simply living in the past.
The “fundamentalist contend the problem was primarily domestic, for instance Chang insists that the problem was “home-grown”. In his article “The Misunderstood Crisis” Chang outlines “the deeper causes of the crisis as policy specific failures (1) financial regulation, (2) exchange rate management and (3) investment coordination, (1557). As Amsden and Euh (1990) argued the government departed from her “traditional model” (Chang 2000 and Amsden & Euh, 1990). Scholars in this camp argue that regardless of the international pressure, Asian countries had a choice, but they never acted, when they did they were short, “…it would be incorrect to say, that policy shifts are simply reflection of structural forces beyond Korean policy maker ….the demise of five-year plans and industrial policy …were deliberate strategic choice by the government, rather than something imposed by the a dominant private sector or by overwhelming external force” and that Kim’s merger of planning and ministerial offices resulted in “…demise of planning in Korea” (Chang 1998, pp.1559). The above, coupled with the dismantling of the selective industrial policy this specific policy denied the government the ability to supervise greedy firms. The net effect here is overcapacity, which resulted in falling; export prices, profitability due to low capacity utilization, and the accumulation of nonperforming in leading industries, chemical and automobile (Chang 2000, pp.1558 and Haggard 2000, pp.219).
However, Bhagwati, Wade and others could not disagree more, “…[The] crisis of 1997-1999 had its causes not mainly in the “East Asian Model” nor departure from the model, but in international capital markets and the governments of core economies, especially the United States and Japan” (Wade 2000, pp85). Bhagwati, I contend is a closet anti-free market, he rejects economically plausible theory of diminishing return in an export led investment, “even if the Asian miracle had been based on investment rather than technical progress, it is hardly plausible that the miracle would vanish precipitously” ( Bhagwati 2004). The logic here is at least the events could have been manifested in a gradual decline rather than a “crash”. Indeed both Wade and Bhagwati, like Chang and other fundamentalist pose fundamentally valid but disputable conclusions. At a micro level, Bhagwati’s assertion that the crash was a vindication the inherent laws of economics is a wild card, because he base his reasoning centrally planned Russian economy. The European financial Exchange Rate Mechanism in 1992-93 turmoil and the Wall Street crash could have solved the puzzle somewhat. I take another issue with Bagwati on failing to understand the spirit of transparency in any capitalist economy, albeit weak as it was in East Asian after structural adjustments. He points out panic and lack of baking and financial control, all of which debunks his logical constancy, while the comparisons of cronyism and Enron scandal and Vice President Cheney in the United States sounds attractive, it’s a classic cheap short, like a high school dropout laboring to win a college statistical puzzle. Yes, there is visible sign of economic collusion in the US economic policy, however, the fact remains these policies never directly caused exposure and they never precipitated capital flight.
Regardless of the above attack on the US and the World Bank, Wade and Bhagwati, Chang and Stiglitz's, are not immune, the fact remains, non of these arguments is overwhelming, what I’ve leant from the debate is that there is a complex overlap and interact multiple variables, political and economic and international and domestic. It is not economic development alone that trigger sudden turn of economic fortune, but choices and priorities of the government too, its ability to take action or not to.
From the ‘new fundamentalist” view the problem on the eve of the crisis could be traced back to lapses in regulatory and structural especially in the financial sector. Liberalization and structural adjustment s cannot be solely condemned for massive inflow of foreign capital. Haggard spells out this problem “despite the purported financial liberalization, politician in Indonesia, Malaysia and South Korea still used the backing system as an instrument not only of policy but of politics…in all cases, these arrangements generated both high social costs and perverse incentives for the managers of financial institutions” (Haggard 2000, pp.219). Chang also mentions that “it is fair to say, however, that the Kim government relaxed controls on foreign borrowing more than was needed, and more importantly, failed to supervise the financial institutions involved borrowings adequately” ( Chang 1998, pp1558). Compounding the problem was a poor or unreliable decision making process, Haggard describe it as “stalemate in South Korea,” “weak coalition in Thailand” and Malaysia struggling with a divided decision making authority (Haggard 2000, pp220). Further complicating this fragile state of affairs, was the inability of these governments to ruin in on business based of priory cordial relationship: “…reducing East Asian’s vulnerability is therefore not simply a question of changing policies, but of reconsidering the privileged political domestic business had enjoyed during the high-growth period, and subject business to greater regulatory restraint and accountability (Haggard 2000, pp220 & Berger 2000, pp.48-49). The evidence above shows a weak and disabled state unable to capitalize on new opportunities afforded by capital inflow, with fatal consequences (Evans 1997; Berger 2000, pp.52-3 & Rodrik 1997, pp62-64).
Surprisingly, Bhagwati disagrees, “…hasty and imprudent financial liberalization, almost always under pressure, allowing free international flow of short-term capital without adequate attention on the potentially potent downside of such globalization” (Bagwati 2004, Ch. 13). Important about this discussion is even Wade, strong critic of the liberalization agrees that the government did not do what they out to have done. Why? The Asian state did the minimum when the crunch ensued, “little attention to strengthening impersonal or arms-length methods of bank regulation and supervision----which had previously…” (Wade 1998, pp101). In short, in all four countries that were had-hit by the crisis government’s intervention in and through the financial sector created perverse incentives with respect to the ability of banks to monitor their clients and politicized both lending decisions and subsequent looses. On the other hand, it is important to underline that equal if not greater risks were associated with poorly conceived and regulated liberalization and privatization, what happened in this countries is that the process was either hijacked or captured by businesses and politician and distorted in ways shifts the risk back to the government and increase the vulnerability to shocks typically by diminishing the regulatory process (Evans 1997: Wade 1998).
In a general conclusive, whatever the cause of the crisis were, the impetus of internationalization has set a process of endogenous political and institutional changes both domestically and internationally. The international financial system remain the only theater where Asian economics will prosper, and they cannot avoid the transition to a more transparent and democratic society. They have to institute a financial sector based on rules which replaces relation based operations with an arms length operation of allocation of investable funds. The increased globalization has coincided with information revolution. The populace is now more aware of what is happening around them. As growth falters there will be more demand for a change. This will also become louder as impacts of future crisis’s on poverty and inequality deepen with the demise of neoclassical orthodoxy and some possible control on international capital mobility there may remerge the post Word War II Keynesian consensus with government assuming its traditional role of stabilization.
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