Malaysian Eclipse: Economic Crisis and Recovery

Malaysian Eclipse: Economic Crisis and Recovery – Review

Gerald Epstein


Malaysian Eclipse: Economic Crisis and Recovery. Edited by Jomo K.S. London and New York: Zed Books, 2001. $75.00. 294 pages.

The ideological and political debate over the Asian financial crisis of 1997-1998 continues virtually unabated, now almost four years after the devaluation of the Thai baht on July 2, 1997, which is widely seen as the precipitating event. (1) This battle over the Asian financial crisis continues for good reason. Unlike the Mexican crisis of the early 1990s, or the “third world debt crisis” of the early 1980s, when countries with checkered economic records and obviously questionable macroeconomic policies appeared to many observers be accidents just waiting to happen, the Asian tigers of Korea, Thailand, Malaysia, and Indonesia had been the envy of the developing world. They were virtually the unanimous choice of the world’s economics and financial elite as the miracle economies of the decade. When the financial crisis brought these countries to their knees, it was not as easy as before to simply “blame the victim” for macroeconomic mismanagement. And when some major heavyweights of the economics profession–i ncluding Jeffrey Sachs, Joseph Stiglitz, and, perhaps, most influentially because of his solid conservative credentials, Harvard’s Martin Feldstein–started pointing fingers at the International Monetary Fund (IMF) for its handling of the crisis, a serious debate ensued about the relative responsibilities of the main actors in the etiology of the crisis and its aftermath: the domestic governments, the international financiers, and the key international institutions of governance, especially the IMF and the U.S. Treasury Department.

A great deal of the initial debate concerned the issue of who was to blame for precipitating the crisis. Defenders of the IMF quickly developed a theory that the cause of the crisis was the “crony capitalism” that pervaded these Asian countries. This argument holds that, despite their apparent successes, the Asian Tigers’ growth was built on rotten foundations of inefficient and corrupt financial practices based on political and social connections rather than on sound banking methods. These resulting bad loans and investments were bound to go bust eventually, and the long-term solution to the mess they caused is fundamental structural reform of the Asian Tigers, especially their adoption of Western models of economic governance. It was precisely these structural reforms that the IMF imposed on those countries that turned to them for assistance, most comprehensively in South Korea.

Critics of the IMF and the international financial system pointed out that, while there were certainly problems brewing in many of these countries, they had far from defunct economic systems. These Tigers had among the highest savings rates in the world, and they had achieved rapid economic growth. Indeed, defenders argue, the same critics who were now claiming that “crony capitalism” was a pervasive and fatal characteristic of these regimes had strongly praised the Asian model of capitalism just prior to the onset of the crisis. (2) Critics of neoliberalism, therefore, strongly downplay the role of so-called “cronyism” in the generation of the economic troubles that followed.

Instead, according to these defenders, the precipitating causes of the crisis were, first, unstable international financial markets due to inappropriate financial liberalization, which precipitated a currency crisis; and then, misguided IMF policies, which turned a currency crisis first into a financial crisis and then into a full-blown economic crisis.

The second stage of the debate concerned the neoliberal medicine the IMF prescribed and its effectiveness. One of the central protagonists in this phase concerns Malaysia, the country that is the subject of this fine collection of essays, Malaysian Eclipse, edited by Jomo K.S., an economist from the University of Kuala Lumpur. Malaysia, unlike South Korea, Thailand, and Indonesia, refused to borrow money from the IMF and thereby did not subject itself to the IMF’s structural adjustment medicine. Instead, it adopted an unorthodox policy of capital controls and Keynesian expansionary macroeconomic policy. In short, Malaysia bucked the iron-fisted financial orthodoxy of the late twentieth century, and it did not collapse. Far from it, Malaysia’s economy recovered from the depths of the crisis and continued to grow at a brisk pace, at least prior to the onset of the current world recession.

A Brief Chronology

The basic outlines of the crisis and policy responses in Malaysia are worth recounting here as background. (3) As Malaysian Eclipse emphasizes, Malaysia entered the Asian financial crisis with relatively strong fundamentals, partly because of the early set of regulations and restrictions on capital flows that it had instituted in 1989 and 1994. Malaysia had a much smaller share of short-term external debt then its fellow crisis countries. Most important, Malaysia’s short-term debt was much lower than its foreign exchange reserves, which made the country somewhat less vulnerable to a run on its reserves. However, not all was well with the financial situation of Malaysia. Malaysia was a country with a very high level of general indebtedness, which made it vulnerable to a panic by investors. Part of Malaysia’s problem stemmed from excessive credit creation based partly on very high equity prices. In particular, Malaysia had the world’s highest stock market capitalization ratio (310 percent of GDP, compared to 11 6 percent in the United States and 29 percent in Korea). The result was that Malaysia in mid-1997 had a domestic debt–GDP ratio (170 percent) that was among the highest in the world (Perkins and Woo 2000 [see note 3], 237). As a result, as the authors of Malaysian Eclipse argue, Malaysia was far from an “innocent bystander” in the etiology of the crisis. Instead, they argue, inappropriate financial liberalization and other policies led to a dangerous increase in Malaysia’s vulnerability to a reversal of financial flows.

In response to the Thai crisis in late 1997 and the reversal of capital flows to the region, Malaysian authorities at first bailed out Mahathir’s friends, according to Jomo et al. But then it implemented an orthodox adjustment policy. Interest rates were raised to stem the decline of the ringgit, and in December 1997, the government announced a large reduction in government spending. This package was similar to IMF programs elsewhere and was proposed by Deputy Prime Minister Anwar Ibrahim. Meanwhile Prime Minister Mahathir was criticizing foreign “speculators” and suggesting a different policy.

The authors of Malaysian Eclipse are somewhat unclear about what the impact of these orthodox policies would have been had they been continued. On the one hand, they are anxious to defend Anwar, whom they see as having been unfairly targeted as a scapegoat for the crisis. In particular, they are anxious to show that he was no tool of the IMF. At the same time, though, they argue that Keynesian policy was necessary to bring the Malaysian economy out of recession.

According to many observers, the Malaysian economy deteriorated more rapidly in response to the orthodox policies. Consumption and investment demand fell. This outcome gave the opponents of Anwar’s policies the upper hand, and in early September 1998, Mahathir sacked Anwar and appointed Daim Zainuddin, a former finance minister, as minister in charge of “tasks relating to economic development.” Daim was told to formulate an alternative to Anwar’s policies. Mahathir, apparently, was intent on reinflating the economy through cuts in interest rates and credit expansion, but there was little effective change in monetary policies over the next several months. This result was at least partly due to the fact that the attempt to reduce domestic interest rates was undermined by growing speculation against the ringgit in offshore markets. The economy continued to go down. In September 1998, the government instituted a set of capital controls that they hoped would stop the speculation against the ringgit and would allo w the reflationary monetary policy to take hold.

Evaluation of Malaysian Policy

Precisely because Malaysia did buck orthodoxy, its policies have come under intense scrutiny from neoliberals who want to downplay its achievements, critics of neoliberalism who want to hold up Malyasia as a model, and more or less neutral social scientists and policy-makers who simply want to figure out whether there is an alternative to the neoliberal road.

All of these interested observers would do well to read Malaysian Eclipse. The collection of nine essays and a helpful preface, mostly written by Jomo, and various collaborators, contains a wealth of material about the Malaysian economy, the roots of the crisis, the role of Malaysia’s heterodox policies in its recovery, and the important political context within which all of these critical economic events have occurred. Jomo is a long-time observer of the Malaysian economy, the author and editor of numerous books and articles about the Malaysian economy during the last several decades or so, and a well-trained economist. (4) Most important, and most refreshing, Jomo and his colleagues are not tied to preordained battle lines between neoliberals and their critics. For example, one will read in these pages that crony capitalism is important in the Malaysian context, and that the capital controls imposed in September 1998 might not have been necessary or helpful to the Malaysian economy’s recovery. At the same time, neoliberal advocates will find little comfort in this book. Jomo and colleagues blame the vagaries of the international financial markets and inappropriate financial liberalization for the economic crisis, criticize the IME’s “solutions,” such as the emphasis on austerity and “improved corporate governance,” as misguided, and attribute Malaysia’s and South Korea’s economic recoveries not to IMF-inspired austerity measures and structural reforms but rather to their opposite: Keynesian-inspired expansionary policy.

Equally interesting and important, Malaysian Eclipse discusses the longer-term structural problems of the Malaysian economy that created the context for the financial crisis of 1997 as well as possible longer-term solutions. In this vein, while Malaysian Eclipse recognizes the importance of what the authors call “failed industrial policies” and “cronyism” in the long-term weakening of the Malaysian economy, they place the blame for the immediate financial crisis squarely on inappropriate financial liberalization, the flight of portfolio capital, and inappropriate policy responses by the Malaysian government. For example, the authors are especially critical of the government policy that allowed the “internationalization” of the ringgit, that is, the widespread use of the ringgit in offshore markets in Singapore and elsewhere. But they do not stop here. The authors suggest that two intriguing, underlying political economy factors account for these precipitating factors: (1) The inappropriate industrial policie s are due, in no small part, to the fact that these policies were compromised by an official focus on interethnic redistribution, a focus that has become too important in recent Malaysian politics. More novel is (2), their argument about the causes of inappropriate financial liberalization, another precipitating element in the crisis. Jomo, in a fascinating and paradoxical claim, argues that the large role played by transnational corporations in the manufacturing sector of Malaysia’s economy has hindered the emergence of a local manufacturing class. This power vacuum, he argues, has allowed both a national and international financial elite (or “rentiers”) to develop significant power in Malaysian politics. This power of local and domestic rentiers accounts for the excessive and inappropriate financial liberalization that has occurred, and, together, these two factors can help account for the “cronyism” that has been a longer-term weakness of Malaysia’s political and economic scene.

This claim is paradoxical because, on the face of it, why would the excessive power of manufacturing transnationals lead to the dominance of finance and rentiers? Why did it not simply lead to the dominance of manufacturing transnational corporations themselves? Did the financial power of rentiers harm the transnational corporations? Would not the latter have opposed the dominance of the rentiers? If so, why did they lose out? If the transnational corporations did not oppose the rentiers, why not? Perhaps MNCs do not concern themselves with such domestic policies. In any case, this provocative thesis should be better developed in future work. One wishes this extremely interesting argument had been developed more carefully and fully.

The authors blame the crisis in the other East Asian economies on inappropriate financial liberalization and fickle investors, as well. They argue that there was a difference in the types of financial problems that different countries experienced, and therefore different countries were made more or less vulnerable to the vagaries of international finance. Crucially, as mentioned before, Malaysia had reserves in excess of its foreign debt, and it did not run up large amounts of short-term bank borrowings, a problem that had brought on the downfall of South Korea, for example. Part of the reason for this difference is that Malaysia had instituted financial regulations earlier in the decade against such short-term foreign bank borrowing. At the same time, Malaysia’s economy was made more vulnerable by trying to develop its equity markets and, as a result, became subject to a quick drop in equity prices when investors pulled out their funds. The authors point out that Malaysia was much more “reliant” on equity in vestments than were their Southeast Asian neighbors.

What can explain this difference in financial regulatory policy? Again the authors turn to their political economy analysis to offer an explanation. They claim that differences in the circumstances, agendas, and relative power of the domestic and international financial elites in the various countries can help account for the differences in financial liberalization that did occur.

This proposition is very intriguing, indeed. Again, one hopes the authors develop this insight further.


The authors do not shy away from controversy in their discussion. Perhaps most controversial in Malaysia itself will be Jomo’s defense of the ousted finance minister Anwar, whom the current premier, Mahathir, fired, and who was then subjected to charges of sexual misconduct and is serving prison time. Jomo argues that, contrary to the claims by the government, Anwar was not doing the bidding of the IMF and, in fact, had earlier accepted capital controls and other financial regulations as a way of dealing with financial crises. That is, Anwar was not a neo-liberal fanatic as Mahathir had portrayed him.

Capital Controls

Jomo et al. argue that, while they support nonorthodox policies and while the capital controls were not the disaster that many neoclassicals predicted and, in retrospect claimed, nor were they clearly successful. The authors of Malaysian Eclipse suggest that the capital controls were too late and probably ineffective. They cite the fact that the South Korean economy also recovered but without capital controls.

While many economists tend to agree with Jomo, there is certainly no shortage of observers who believe that the capital controls in Malaysia were successful. A recent paper by Ethan Kaplan and Dani Rodrik(5) takes a close, empirical look at the question of the impact of Malaysia’s controls. They compare the impact of the controls with the impact of the IMF programs that South Korea, Thailand, and Indonesia experienced. A number of papers have made this comparison, but Kaplan and Rodrik’s innovation was to look at comparative impacts from the time the IMF policy or the capital controls were imposed, not comparing them from the same dates. This way they were looking at the two policies as alternatives. In this comparison (and, of course, holding constant for other important factors), Malaysia fares much better than South Korea, Indonesia, or Thailand. Compared to East Asian countries with IMF programs, these authors find that the Malaysian policies produced faster economic recovery, smaller declines in employm ent and real wages, and more rapid turnaround in the stock market. This result, of course, calls into question Malaysian Eclipse’s claim that the capital controls were not effective.

Certainly this controversy will continue. I am sure that neither Jomo et al.’s work nor that of Kaplan and Rodrik will be the last word on the subject. It is important because it relates to the critical question: Is there an alternative to the neoliberal orthodoxy?

Malaysian Eclipse does briefly discuss alternatives to both “cronyism” and “neoliberalism,” but this is not the main focus of the book, and certainly not its strongest part. And here, of course, is the problem facing all critics of the status quo: to develop coherent and practical alternatives to the neoliberal approach. The Malaysian government’s policy is therefore certainly worthy of dose study as we try to accomplish that task. And, despite some redundancy in the various chapters, Malaysian Eclipse, with its wealth of data, information, and analysis, is an excellent place to start in learning about what can go wrong and what can go right as relatively successful, semi-industrialized countries try to navigate the treacherous waters of global neoliberalism.


(1.) See Nouriel Roubini’s web site for a chronology and a great deal of other material on the crisis:

(2.) See the excellent work of James Crotty on these points. His work can be found on the website of the Political Economy Research Institute (PERI), at

(3.) Joseph Stiglitz and Jason Furman, “Economic Crisis: Evidence and Insight from East Asia,” Brookings Papers on Economic Activity 2(1998): 1-135; S. Radalet and J. Sachs, “The East Asian Financial Crisis: Diagnosis, Remedies, Prospects,” Brookings Papers on Economic Activity 1 (1998): 1-90; Ethan Kaplan and Dani Rodrik, “Did the Malaysian Capital Controls Work?” NBER, Cambridge, MA, February 2001; Dwight Perkins and Wing T. Woo, “Malaysia: Adjusting to Deep Integration,” in The Asian Financial Crisis: Lessons for a Resilient Asia, ed. W.T. Woo, J. D. Sachs, and K. Schwab (Cambridge: MIT Press, 2000); Stephen Haggard and Linda Low, “The Political Economy of Malaysian Capital Controls,” University of California, San Diego, 2000 ( This section draws extensively on Malaysian Eclipse and on Kaplan and Rodrik.

(4.) See, for example, E. T. Gomez and Jomo K.S., Malyasia’s Political Economy: Politics, Patronage and Profits, 2d ed. (Cambridge: Cambridge University Press, 1999); Jomo K.S., ed., Southeast Asia’s Ersatz Industrialization (London: Macmillan, 2001); and Jomo K.S., Growth and Structural Change in the Malaysian Economy (London: Macmillan, 1990).

(5.) Kaplan and Rodrik, “Did the Malaysian Capital Controls Work?”

COPYRIGHT 2001 M.E. Sharpe, Inc.

COPYRIGHT 2001 Gale Group