Learning from Asia’s unhappy anniversary
This month marks the 20th anniversary of the Asian financial crisis—or, more precisely, of the event that triggered the crisis: the devaluation of Thailand’s baht. While such anniversaries are not exactly cause for celebration, they at least afford an opportunity to look back and examine what has changed—and, no less important, what hasn’t.
The causes of the crisis were contested at the time, and they remain contested to this day. Western observers placed the blame on Asian countries’ lack of transparency and on overly close relations between firms and governments—what they described as “crony capitalism”. Asian commentators, for their part, blamed hedge funds for destabilizing regional financial markets and the International Monetary Fund for prescribing a course of treatment that nearly killed the patient.
There is some validity to both viewpoints. The Bank of Thailand’s published balance sheet wildly exaggerated its available foreign-exchange reserves—hardly a shining example of financial transparency. Foreign speculators actively bet against the baht, and the short sellers included not just hedge funds but also investment banks, including one that was simultaneously advising the Thai government on how to defend its currency. And when counselling Asian countries on how to manage the crisis, the IMF erred—not for the last time, it should be noted—in the direction of too much fiscal austerity.
At a more fundamental level, the crisis reflected the mismatch between Asia’s historic growth model and its current circumstances. That model emphasized stable exchange rates, which were seen as necessary for the expansion of exports. It stressed investment—however much was required for double-digit growth. And it encouraged foreign borrowing as needed to finance the requisite level of capital formation.
But by 1997, the southeast Asian economies had reached a stage of development at which brute-force investment alone was no longer enough to sustain high growth rates. In relying on foreign borrowing, their growth model neglected the risks.
External forces, meanwhile, compounded the problem. South Korea’s admission to the OECD (Organization for Economic Co-operation and Development) required its government to dismantle capital controls, exposing the economy to inflows of short-term “hot money”. More generally, countries felt pressure from the IMF and the US treasury to remove capital-flow restrictions, which magnified the risks and made maintaining pegged exchange rates still more problematic.
This sketch of the crisis highlights how much has changed over the subsequent 20 years.
For starters, the crisis countries have ratcheted down their investment rates and growth expectations to sustainable levels. Asian governments still emphasize growth, but not at any cost.
Second, southeast Asian countries now have more flexible exchange rates. None is perfectly flexible, to be sure, but the region’s governments have at least abandoned the rigid dollar pegs that were the source of such vulnerability in 1997.
Third, countries like Thailand that were running large external deficits, heightening their dependence on foreign finance, are now running surpluses. Running surpluses has helped them accumulate foreign-exchange reserves, which serve as a form of insurance.
Fourth, Asian countries are now working together to ring-fence the region. In 2000, in the wake of the crisis, they created the Chiang Mai Initiative, a regional network of financial credits and swaps. And now they have the Asian Infrastructure Investment Bank to regionalize the provision of development finance as well.
These initiatives can be understood as a reaction to Asia’s unhappy experience with the IMF. More fundamentally, they reflect the emergence of China. In 1997, a China still uncertain of its regional role was not a vocal supporter of the Japanese plan for an Asian Monetary Fund. Its lack of support ultimately sealed the fate of that proposal.
Subsequently, China’s growing self-confidence and leadership helped to spearhead regional institution building and cooperation. This change, occurring against the backdrop of 20 years of robust Chinese growth, is the most consequential change affecting Asia since the crisis.
But if the emergence of China signifies how much has changed, it is also a reminder of how much remains the same. China is still wedded to a model that prioritizes a target rate of growth, and it still relies on high investment to hit that target. The government maintains liquidity provision at whatever levels are needed to keep the economic engine humming, in a manner dangerously reminiscent of what Thailand was doing before its crisis.
Because China’s government relaxed restrictions on offshore borrowing faster than was prudent, Chinese enterprises with links to the government have high levels of foreign debt. And there is still a reluctance to let the currency float, something that would discourage Chinese firms from accumulating such large foreign-currency-denominated obligations.
China is now at the same point as its southeast Asian neighbours 20 years ago: like them, it has outgrown its inherited growth model. We have to hope that Chinese leaders have studied the Asian crisis. Otherwise they are doomed to repeat it.
Barry Eichengreen is a professor at the University of California, Berkeley, and the University of Cambridge.
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