Restoring growth in Asia after the late 1990s economic crisis: Need for domestic and international economic reforms

Restoring growth in Asia after the late 1990s economic crisis: Need for domestic and international economic reforms

Aggarwal, Raj

This paper finds that the primary causes of the late 1997 Asian economic crises were 1) stronger international competition among Asian countries, 2) high levels of political influence in private economic decisions and poorly developed domestic financial markets, and 3) a weak international financial architecture. Restoring economic growth in Japan and other industrial countries and the avoidance of competitive devaluations are important for Asian economic recovery. In addition, it is important that domestic financial systems in Asia are reformed so they are no longer characterized by low disclosure levels, high debt ratios, positive feedback circles, and high political influence in credit decisions. Finally, the international financial architecture must be strengthened to cope with high levels of cross-border financial flows and financial liberalization.

INTRODUCTION

Asia has been the economic miracle of the last half of the twentieth century having been the region with the highest growth rate until mid1997. In 1997 it experienced a serious economic crisis which expanded in 1998 to exert a significant negative influence on economic growth and financial confidence worldwide. How did this unexpected turn of events come about and what are the fundamental causes and determinants of this Asian economic malaise? More importantly, can this Asian malaise infect other economies and what are the prospects for an economic turn-around in the Asian countries.

These questions are explored here and it is found that the suffering Asian countries share many characteristics. For example, many of these countries have highly developed industrial economies but relatively poorly developed financial markets and institutions. Because of poor financial development, these Asian economies suffered not only from asset bubbles that became unsustainable, but also from banking crises that continues to hamper economic recovery. Further, many economic policies with positive feedback characteristics (virtuous circles) that were used to accelerate economic growth, contributed to and worsened the economic downturn. Thus, sound recovery of the Asian economies will require structural reform and the development of better and more robust financial systems.

THE LATE 1990s ASIAN ECONOMIC AND FINANCIAL CRISES

The 1997-98 economic crises in Asia is well documented not only in the business press, but also in a number of books (e.g., Goldstein, 1998; Henderson, 1998). Three aspects of the late 1990s Asian economic crises make it especially significant and interesting. First, the crisis seemed to have come upon us suddenly in mid1997 and even the major debt rating agencies seemed to have been caught off-guard. Second, the speed with which this crisis escalated from dropping currency values to asset price crashes to declining economic growth rates seemed surprisingly rapid. Third, these Asian crises seemed to have had a disproportional negative impact on major industrial economies.

The 1997 Asian crisis seemingly started with a summer fall in the Thailand Baht that quickly spread to weaknesses in other Southeast Asian currencies. In the second half of 1997, the Indonesian exchange rate fell by over three fourths, while the Thai Baht and the Korean Won had lost half, and the Philippines Peso and the Malaysian Ringgit over 40% of their international values. Markets for financial and other assets in these countries also declined by similar amounts in local currency terms and by even larger amounts in U.S. dollars. Even fundamentally strong Asian economies were affected. For example, between July 1997 and April 1998, Hong Kong experienced drops of between 30 and 40 percent in real estate and stock prices eliminating wealth equivalent to two years of its GDP. As in 1990 in Japan, financial market bubbles also burst in many other Asian countries in 1997. Also, still other Asian countries with overbuilt property markets and overextended banks, presented additional bubbles that could burst making their economies also vulnerable to recessions (e.g., Walker, 1998).

However, the 1997 currency crises in Asia were only symptoms and the real causes of the crises were more structural. The affected Asian countries had some of the most robust industrial and export sectors in the world, but their current accounts had moved from being positive in the 1980s to being negative in the 1990s. Foreign capital was flowing into these Asian countries at an annual rate of about $100 billion in 1996, while it was flowing out at about the same rate in the second half of 1997. Expectations of economic growth over the next few years were slashed not only for these Asian countries, but also for other countries and the world economy. In many of these Asian countries, economic suffering resulted in political unrest and riots with loss of life. In the first half of 1998, while some Asian economies had recovered somewhat from this currency, asset price, and economic carnage of 1997, some countries like Indonesia had not recovered.

International Responses to the Asian Crises: To forestall further deterioration in the rapidly declining Asian economies, teams from the International Monetary Fund (IMF) and the United States Treasury Department (USTD) were sent to the region in late 1997 and early 1998 with offers of financial aid that were packaged with requirements for economic reform. The 1997 and 1998 international rescue programs succeeded in temporarily restoring confidence and in reducing the further spread of default among Asian countries. While, this IMF led rescue reduced the losses suffered by the Japanese, German, and U.S. banks that had made high risk, high margin, loans to Asian countries, it worsened the moral hazard problem in international banking and increased the likelihood of future imprudent bank lending sprees (like those in Latin America in the 1980s and in Asia in the 1990s).

In addition, by insisting on high interest rates and restrictive monetary policies in the affected Asian countries, IMF policies punished many good companies in these countries (along with the many banks and companies that made poor economic decisions). While such restrictive policies may have been appropriate in the Latin American crises of the 1980s, they seemed less suitable for the 1997 Asian crises. As the Asian economies continued to decline, the IMF seemed to adjust its policy prescriptions and change course in a number of cases. The IMF-led Asian rescue plans came under much criticism, with many contending that IMF restrictions led to unnecessary suffering and delays in Asian economic recovery. But it should be noted here that this mixed assessment of IMF policies depends on assumptions of somewhat uncertain validity about the nature and specific determinants of the Asian crises.

Even though international rescue efforts may have limited the damage, the 1997 Asian crisis was not only very significantly negative for some of the fastest growing countries of the region, it also had a significant negative global impact. The Asian economic crisis was not only conveniently blamed for earnings disappointments among U.S. companies with significant (or even insignificant) Asian business, but it was also blamed for much of the 1997 and 1998 instability in U.S. financial markets. The Asian economic crisis certainly spilled over into other countries outside the region to become a negative factor in global growth. Why were otherwise strong economies outside Asia vulnerable to this Asian ‘flu’ especially as nonJapan Asia is not a particularly large proportion of the global economy?

INTERNATIONAL COMPETITIVENESS AND THE ASIAN CRISES

Global economic integration and the rapid emergence of newly developing countries as international competitors posed difficult challenges for the export driven Asian economies in the 1990. Many of these Asian countries, however, faced these external challenges with domestic financial systems that were inadequate and highly under-developed; a combination that led to the 1997 crises in Asia.

Evolving Global Competitive Structure:

With advances in technology and global communications, the speed at which technology flows across borders has accelerated in recent decades. As a result, in the 1980s and 1990s, the rapidly growing heavily export dependent Asian countries faced increasing competition at the top from mature and advanced countries like Japan and at the bottom from emerging economies like China and India. Thus, each of the Asian countries suffering in this crisis has been facing increasing competition simultaneously from economies at lower technological levels that offer lower cost manufacturing bases and from economies at higher technological levels with reputations for higher quality, greater reliability, and long-time customer relationships. For example, as the low cost producers with educated work forces, China and India have taken over much of the low end manufacturing business from many Asian countries forcing these countries to upgrade their technological capabilities rapidly (e.g., Aggarwal, 1999; Drysdale and Huang, 1997).

With the emergence of China as a global economic power with rising exports in the early 1990s and the extended Japanese recession of the 1990s forcing it to export more, each Asian country had to jockey and adjust to a new and more competitive international environment. These competitive pressures from China and Japan on other Asian countries were accentuated by the devaluation of the Chinese currency in 1994 and the decline of the Japanese Yen after April 1995 when it was 80 yen per dollar.

Unsurprisingly, many of these rapidly growing countries that had run current account surpluses started reporting current account deficits in the 1990s as a result of this tougher competitive environment. Thus, while the Asian currency and economic crises may have been a surprise to the rating agencies, clear signs of trouble were evident even in the early 1990s.

Globalization of National Economies

Driven by comparative advantage and risk diversification, advances in telecommunications and information technology, and lower tariffs and declining transportation costs, for the last half a century cross-border trade and investment have risen faster than global economic output (e.g., Aggarwal, 1999). Thus, along with other countries, openness of the U.S. economy, exports and imports as a percent of the economy, has risen steadily from about 6-8% in the early 1970s to about 25-30% in recent years. Financial markets and cross-border financial transactions have also multiplied and grown exponentially in the last few decades. For example, government foreign exchange reserves now amount only to one or two days of transactions in the foreign exchange markets as daily volumes for such trading now exceed annual volumes in stock markets. While this increase in economic globalization has contributed significantly to economic prosperity, we now live in a globally integrated economy with much cross-border trade, lending, and investment activities that transmit economic growth (and decline) across borders.

Further, international trade has grown particularly rapidly as a proportion of economic output for the fastest growing Asian countries. For these Asian countries, an ever increasing proportion of this rising tide of cross-border trade is with other Asian countries. Moreover, cross border economic ties are particularly strong in South East Asia as overseas Chinese business families that extend over many countries play significant roles in each economy in the region. Thus, crossborder economic and financial contagion is likely to be particularly strong for Asian countries.

Thus, because of extensive cross border trade, lending, and investment among Asian countries, financial and economic difficulties in one country have significant potential to ‘infect’ other countries. While this explains how a crisis may deepen and extend to other countries, in order to fully understand the origins of the Asian crises of 1997, it is also necessary to understand the structural changes in the international competitiveness caused by the rapid cross-border flow of technology and the emergence of new competitors in the global economy. While the proximate cause of the 1997 Asian crisis seemed to be a balance of payment based decline in Asian currency values, the currency crises were themselves a reflection of important changes in the structure of international competition in the region.

FINANCIAL CONTAGION, REFORM, AND RECOVERY IN ASIA

Cross-Border Economic and Financial Contagion

The 1997 Asian crises spread surprisingly rapidly to other parts of the world. In 1998, the negative impact of the Asian crisis threatened currencies and financial markets not only of developing countries in Latin America and Eastern Europe, but also of the developed countries of Western Europe and North America. Why do currency and financial market crises and economic downturns spread from one country to another?

Economic slowdowns in one Asian country leads to lower exports for other Asian countries, slowing their economies. These slowing economies in turn further reduce the demand for the first country’s exports exerting further downward pressure on that economy, and so forth, with a cascading effect. Thus, cross-border economic contagion is likely to be stronger for countries that trade a great deal with each other. If a country tries to counteract declining exports with price reductions such as a currency devaluation, its trading partners may do the same to negate its price advantage. Thus, as an economy and the international value of its currency deteriorate, it is no longer a good customer for its neighbor’s exports (in fact, because of the declining value of its currency, it is ready, willing, and able to export more to these neighboring countries). These currency and economic effects interact to reinforce the negative impacts on a country’s trade balances and economic prospects.

Similar arguments can be made regarding the impact of declining cross-border investments and attempts by countries to counter such declines by raising domestic interest rates. Raising domestic interest rates to counter currency declines or foreign investment outflows generally exerts a negative influence on domestic economic activity. Further, each country’s overextended banks and companies also face defaults on their loans and investments in these financially distressed neighboring countries. In early January 1998, Peregrine, a once booming Hong Kong based investment bank, filed for bankruptcy primarily due to losses on its Indonesian loans. Earlier, partly due to their overseas defaults, a number of large Korean and Japanese banks and securities firms had also failed as did Yamiachi, the fourth largest Japanese securities firms.

As could have been expected, the countries that seem to have suffered the most had pegged (semifixed) exchange rates. Such arrangements did not allow these countries to easily adjust to forces of supply and demand in the currency markets especially when these countries started suffering significant current account deficits (e.g., Sender, 1998). This combination put increasing downward pressures on their currencies and led to their continued borrowing of ever larger amounts from international lenders, even though these loans were increasingly short-term in nature. Such a process clearly could not continue for too long as a country’s debt capacity is limited by its export earnings and other sources of foreign income. The ever increasing overhang of shortterm foreign debt would be disastrous for the value of a currency when it eventually (as it must) reverses – a situation faced by many of the countries caught in the 1997 Asian crises.

Further, economic downturns are usually accompanied by declines in the financial, real estate, and currency markets as investors revise downward their expectations. Financial contagion spreads across borders if and when investors revise their expectations downward regarding the future of their own country based on events in a neighboring or another country. In particular, declines in business and economic confidence in one country prompt re-examination and likely downward revisions in business and economic prospects in their trading partners. Unfortunately, it seems that negative news about investor confidence are much more contagious than are positive news. Financial markets are particularly vulnerable to such revisions as financial asset values very much reflect expectations about uncertain future returns. Indeed, financial and economic decline can and does cross borders especially to countries that may already be over-extended and have vulnerable financial systems.

Government Directed Economic Growth, Virtuous Circles, and Capital Markets

Many of the Asian countries could not manage large external capital inflows as they had poorly developed and fragile domestic financial markets. Under-developed domestic financial systems were the norm in Asia because of the importance of government directed financial flows. Rapid economic growth in East and Southeast Asia has been attributed to many factors including demographics (expanding and young workforce), high savings and capital investment ratios, late industrialization and reverse engineering, Asian values of thrift, hard work, and education, and an openness to international trade and investment (e.g., Wee and Tan, 1997). More importantly, it seems that in spite of some differences, most of these fast growing Asian countries also shared important characteristics, 1) the use of virtuous economic circles, 2) under-developed private sector financial systems with heavy government direction of financial flows, and 3) openness to international financial flows. While these characteristics may have been the bases of much of the rapid economic growth in the region, these features were also some of the primary contributors to the Asian crisis of the 1990s.

Virtuous economic circles have been used to accelerate economic growth in much of Asia (e.g., Aggarwal, 1996). As an example of such a circle, consider the positive feedback effects between wages, savings, and capital investments. With high savings rates, a country can have a high rate of investment in productivity enhancing new capital equipment. Such investments can lead to even higher wages and bonuses that can mean even higher savings rates. This virtuous circle can be an important factor in economic growth especially if the government encourages this process with appropriate policies. In these late industrializing Asian countries, since the 1950s, governments directed financial flows to selected industries. The risks inherent in such government direction of funds were reduced by fact that the selected industries were already developed in other countries and could be studied by appropriate government bureaucrats. While these mutually reinforcing virtuous circles between savings and capital investment succeeded in raising economic growth rates in many Asian countries, they also had some unintended and not so desirable side effects.

Government direction of financial flows over a long period means that private sector financial systems tend not to develop very much. In such countries, financial intermediation generally takes place mainly through institutions that can be influenced heavily by governments and financial markets for corporate securities are not likely to develop much. Bank lending is likely to be based on government direction, political connections, and on the use of collateral. In part because of the government’s certification role, companies are likely to have high debt ratios and low disclosure levels. Companies are also likely to be lightly monitored by outsiders and may mis-allocate capital. In general, private sector financial systems are likely to be highly under-developed. But as the gap between an economy and advanced industrial economies becomes smaller and the economy becomes more open to foreign trade and investment, government ability to direct capital successfully is likely to decline. Such a development then leaves a country with poorly developed private sector financial systems vulnerable to asset bubbles based on positive feedback circles.

When bank lending is based more on collateral and less on credit analysis of the borrowers earnings ability, rising asset prices lead to increased borrowing capacity. Further, if funds based on this increased borrowing capacity are widely used to buy more assets that can also be used as collateral, prices of such assets are likely to go up as a result. Such asset price increases would start the circle again and asset prices are likely to go up in a bubble that will eventually burst. As such asset prices decline, the positive feedback effects between prices and collateral would work in reverse and accelerate the decline in asset prices. As asset prices decline, banks and other lenders will face insolvency as asset-based loans lose collateral and go into default. The resulting banking crises will further slow the economy as banks will either be reluctant or be unable to lend (e.g., Barth et al 1998).

Thus, the institutional conditions that are the bases of virtuous positive feedback circles can also be the bases of positive feedback based vicious circles. According to the June 1998 Annual Report of the Basel, Switzerland, based Bank for International Settlements, “the effects of economic slowdowns, asset price collapses, and banking crises tend to be mutually reinforcing as the curtailment of bank credit depresses asset prices and further deepens recessions. This in turn creates additional problems for banks that are forced to retrench still further. The term vicious circle has been an overworked term, but it describes Asia’s crisis too well.” Indeed, the institutional conditions underlying the positive feedback virtuous circles so useful for accelerating economic growth, are also the conditions that make for positive feedback vicious circles that accelerate economic decline. Under these circumstances, any of the many ‘feathers’ that threaten investor confidence, like an episode of domestic financial discord or distress, could break the ‘camels back’ and start the negative chain that led to the Asian crises especially as international regulatory mechanisms have not kept pace with rapidly rising waves of international financial flows.

Variations in Asian Economic Structures

While the Asian countries in the late 1997 crises share many characteristics including high rates of savings, investment, and economic growth, they also differ along many significant dimensions. For example, while Japan is the largest and technologically the lead economy in Asia, it is characterized by an unusually strong group ethos in business and personal life. Its banking and financial systems are shaky and it has been in a prolonged economic slump following the 1990 bursting of its bubble in asset prices. Next come the four ‘Tiger’ economies of Korea, Taiwan, Hong Kong, and Singapore. The Korean economy is dominated by large business groups (Chaebols) who have close connections with the government bureaucracy. In contrast, the Taiwan economy is characterized by numerous small companies many of which are allowed to go bankrupt fairly easily. While Hong Kong and Singapore are both city states, Hong Kong has very little government influence on the economy, while the Singapore economy is characterized by the presence of very large government owned companies. The next tier of countries include Thailand and Malaysia, then Indonesia and Philippines, followed by Vietnam, China, and India. Each of the countries in this tier differ greatly by size, technological sophistication, cost structure, government influence, openness to foreign trade and investment, and competitiveness of the private structure. It is important to note that these differences are likely to lead to differences in these countries’ recovery and growth prospects.

Interestingly, in this crises, China and India, and Taiwan, Hong Kong, and Singapore have been able to avoid as serious a damage to their currencies and economies as suffered by other Asian countries. These differing vulnerabilities mean that some countries are more resistant to foreign economic contagion than others. It seems that countries like Hong Kong, Singapore, and Taiwan avoided excessive debt and asset bubbles, had adequate financial disclosure, well-developed procedures allowing unsuccessful businesses to fail, and had husbanded enough foreign exchange reserves to finance their international trade. Further, the Asian countries that avoided the worse problems either limited cross-border financial flows by placing restrictions on such flows (e.g., China and India), or had foreign exchange reserves consistent with their exchange rate regime (e.g., Hong Kong, Singapore, and Taiwan).

As the limited success of some Asian countries discussed above indicates, economic recovery in Asian countries depends greatly on developing more robust domestic financial systems. The Asian countries affected by the late 1997 economic crises need to restructure their economies and strengthen their domestic financial systems mostly along similar lines to restore long-term economic growth.

Reforming Asian Financial Systems

Both aspects of financial systems, institutions and markets need strengthening. For example, the banking systems of these Asian countries need reform to prevent ‘crony capitalism’ so that lending based on political connections can be replaced with publicly disclosed lending based on credit analysis. Financial sector development did not keep pace with industrial and technological growth in these Asian countries and these Asian countries lacked self correcting market mechanisms that require transparency in business transactions. Consequently, much domestic investment was being made in projects (such as too many urban high rises) that were uneconomic, but were backed by politically well connected domestic investors. Unfortunately, in these Asian countries, overinvestment in uneconomic projects was accompanied by very high corporate debt ratios that were imprudent. Reform efforts also need to focus on restructuring overextended companies and the development of regulations that require better accounting and higher levels of disclosure so that market discipline can supplement or replace government regulation of banks. As in Taiwan, bankruptcy laws should be reformed so it is easier for non-performing companies and banks in other parts of Asia also to fail without great difficulty.

The past two decades have seen more than 90 serious banking crises each of which of resulted in bank losses that were higher as a proportion of GDP than the U.S. banking collapses in the 1930s great depression (Economist, 1999). The 1997 Asian crises were no different and most affected Asian countries face serious problems in their banking systems. Most Asian financial regulators were inadequately prepared to handle the massive reversal of foreign capital inflows and the simultaneous bad loan problems in the deregulating domestic banking sectors that were a hallmark of the 1997 Asian crises.

Similarly, financial markets in most Asian countries also need to be reformed and strengthened. Equity markets in the Asian countries most affected by the 1997 crises generally could benefit from better regulations requiring higher levels of corporate disclosure and having stronger prohibitions against insider trading and other unfair practices. More importantly, the domestic corporate bond markets in most of these Asian countries are not highly developed. Such bond markets are an essential part of robust capital markets and reduce the reliance on foreign currency debt.

Unfortunately, building robust financial markets is not an instantaneous process. It involves the development of an independent accounting profession, appropriate disclosure policies, enforceable property rights, well-regulated brokerage firms and institutions for the analysis of fundamental corporate and economic data, and markets for trading securities and derivatives. As these institutions develop and investors gain investor confidence in their ability and integrity, efficient trading can move progressively from low risk and short-term securities to higher risk and longer-term securities (e.g., from short-term government debt to long-term government and short-term prime corporate debt, to long-term prime and short-term sub-prime corporate debt and prime corporate equity, to sub-prime corporate equity and derivatives). Without the development of this supporting infrastructure, securities markets are likely to remain speculative and unlikely to intermediate significant proportions of national savings and capital.

Longer term, in addition to the reform of business regulations and banking practices along with the development of better accounting and disclosure regulations, most of these Asian countries will also need political reform to reduce the business influence of governments (e.g., Chanda, 1998). However, some of these countries may also need temporary restrictions on the free cross-border flows of “hot capital” (e.g., short-term foreign portfolio investment) while they are developing more robust domestic financial systems that are able to participate in global markets.

International Economic Cooperation and Asian Recovery

Economic recovery of the Asian countries also depends on the continuing health of the world economy, especially European and American economies that are important markets for Asian products. Similarly, restoring economic growth in Japan is even more critical for Asian recovery especially as Japan is not only the second largest economy in the world and larger that the economy of the rest of the Asia, it is a very important trading and investment partner in the rest of Asia. Unfortunately, Japan had already been in a serious economic slowdown since the 1990 bursting of its bubble in asset prices. As the Japanese economy is heavily interdependent with other Asian economies, the continuing weakness of the Japanese economy and banking system means that recovery in other Asian economies is more difficult.

Asian economic recovery also needs international cooperation to avoid 1930s type competitive devaluations. As the Asian countries with devalued currencies try to increase their exports, China and other developing countries with competing exports would face declines in their exports and resulting temptations to devalue their currencies to stay competitive. Similarly, Japan and other industrial countries would face similar pressures from Korean companies. Such devaluations could start additional rounds of competitive devaluations. Somewhat offsetting such devaluation pressures is the fact that China, India, and Japan all have large domestic economies and such devaluation may not be of much use. In most cases, however, in addition to internal reforms in Asian countries, international cooperation is essential to avoid a repeat of cycles of competitive devaluations that would acerbate any economic slowdown and turn it into a 1930s style depression.

Inadequate International Financial Architecture

In recent decades while financial markets have grown greatly due to the fall of communism and widespread securitization, declining barriers and deregulating capital markets have meant that cross-border financial flows have grown at even faster rates. Trading volumes in financial and currency markets have grown so much that they far exceed the ability of individual governments to manage them. International and multilateral institutions to manage these large and surging cross-border capital flows have also not kept pace and considered inadequate in the recent crises (e.g., Kahler, 1998; Soros, 1998).

It is clear that at a minimum, new and stronger international standards for financial disclosure, regulation, supervision, and enforcement are necessary. It is also clear that an international lender of last resort which can distinguish between liquidity and solvency crises would be very useful but much of the enforcement of these new regulations may have to be privatized (e.g., credit rating agencies and investors in subordinated bank debt). However, designing a new international financial architecture is likely to be challenging given the three important but inconsistent objectives of such a system, i.e., continuing national sovereignty, financial systems that are supervised and resilient, and financial markets that are free and globally integrated.

Business Opportunities as a Crises Antidote

It must be noted that the Asian countries currently in crises have been fundamentally very strong economies with excellent work ethics, high educational levels, strong private sectors, and high rates of saving and of growth-generating capital investment. Many Asian countries now present unusually good bargains. For example, sourcing opportunities are especially good with the significant drops in currency values since last summer. Further, as asset prices have sunk to very low levels in local currency terms and even lower in dollar terms, these countries represent excellent opportunities for acquisitions, mergers, and strategic alliances.

As with all cross-border business activity, political and business risks must be assessed and balanced against diversification advantages and the gains associated with these highly discounted prices. This is especially true when investing in Asia. While the worse of the current economic crises in Asia may be mainly over in some Asian countries, there is still the very real prospect of significant downturns in many Asian countries. In such a case, investors with relatively short time horizons, such as portfolio investors, may still want to avoid investing in at least some of the riskier Asian countries. On the other hand, investors with longer investment horizons, such as investors in real assets, may find many bargains in Asia. In fact, many large companies such as General Electric and General Motors are already making new direct investments in Asia and taking advantage of the new sourcing opportunities in Asia. Such sourcing and direct investment activities by western firms are also helping accelerate the economic recovery of these Asian countries.

The widely accepted consensus so far is that the benefits of economic globalization are greater than its occasional costs (e.g., Krugman, 1998), and world economic growth would be much lower if wealth creating international trade and direct investment were reduced or restricted as a result of this Asian crises. International rescue efforts to support the Asian economies will not only limit negative contagion for the world economy, restoring the Asian countries as some of the most productive members of the global economy will be very good for the world economy.

CONCLUSIONS

The economic crises that hit the fast growing Asian countries in 1997 had a serious negative impact not only on these countries, but it also seems to have spilled over into a significant negative economic impact on other regions. The underlying cause of the economic crises in these otherwise strong economies, seems to be a combination of changing international competitive structure, poorly developed domestic financial systems, and an inadequate international financial architecture. Financial systems in the crises hit Asian countries are weak relative to the economic wealth and technological sophistication of these countries and characterized by high reliance on debt, especially on short-term debt, low levels of disclosure, and high influence of politics in capital allocation and other economic decision-making. The Asian countries also suffered because the international financial architecture was unable to manage the crises being inadequate in an era of vastly increased cross-border financial flows.

Economic recovery in the Asian countries will require mostly similar steps to strengthen financial institutions and markets in each affected country, but each of these Asian countries also differ in their economic and political structures and, thus, are likely to follow somewhat different paths to economic recovery. Some Asian countries are likely to recover fairly rapidly as they have either been relatively less affected or have rapidly acknowledged their problems and the need for reform. Other Asian countries are taking longer to recognize or deal with their problems, have suffered major setbacks, and are likely to face a slow and uneven process of economic recovery.

Economic recovery in Asia will also require continuing international cooperation and a stronger international financial architecture to forestall threats of 1930s type competitive devaluations as well as continuing good growth prospects in Europe and America, and economic recovery in Japan. In the meantime, the current depressed levels of exchange rates and asset prices in many Asian countries may represent some of the best sourcing and direct investment opportunities.

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Raj Aggarwal

John Carroll University

Copyright College of Business Administration. University of Detroit Mercy Fall 1999

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