Growth After the Asian Crisis: What Remains of the East ...bev.berkeley.edu/ipe/readings/Asian Financial Crisis24-jomo.pdf · The circumstances leading to the onset of the East Asian

G-24 Discussion Paper Series

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

UNITED NATIONS

CENTER FORINTERNATIONALDEVELOPMENTHARVARD UNIVERSITY

Growth After the Asian Crisis:What Remains of the East Asian Model?

Jomo K.S.

No. 10, March 2001

G-24 Discussion Paper Series

Research papers for the Intergovernmental Group of Twenty-Fouron International Monetary Affairs

UNITED NATIONSNew York and Geneva, March 2001

CENTER FOR INTERNATIONAL DEVELOPMENTHARVARD UNIVERSITY

UNITED NATIONS CONFERENCE ONTRADE AND DEVELOPMENT

Note

Symbols of United Nations documents are composed of capitalletters combined with figures. Mention of such a symbol indicates areference to a United Nations document.

*

* *

The views expressed in this Series are those of the authors anddo not necessarily reflect the views of the UNCTAD secretariat. Thedesignations employed and the presentation of the material do notimply the expression of any opinion whatsoever on the part of theSecretariat of the United Nations concerning the legal status of anycountry, territory, city or area, or of its authorities, or concerning thedelimitation of its frontiers or boundaries.

*

* *

Material in this publication may be freely quoted; acknowl-edgement, however, is requested (including reference to the documentnumber). It would be appreciated if a copy of the publicationcontaining the quotation were sent to the Editorial Assistant,Macroeconomic and Development Policies Branch, Division onGlobalization and Development Strategies, UNCTAD, Palais desNations, CH-1211 Geneva 10.

UNCTAD/GDS/MDPB/G24/10

UNITED NATIONS PUBLICATION

Copyright © United Nations, 2001All rights reserved

iiiGrowth After the Asian Crisis: What Remains of the East Asian Model?

PREFACE

The G-24 Discussion Paper Series is a collection of research papers preparedunder the UNCTAD Project of Technical Support to the Intergovernmental Group ofTwenty-Four on International Monetary Affairs (G-24). The G-24 was established in1971 with a view to increasing the analytical capacity and the negotiating strength of thedeveloping countries in discussions and negotiations in the international financialinstitutions. The G-24 is the only formal developing-country grouping within the IMFand the World Bank. Its meetings are open to all developing countries.

The G-24 Project, which is administered by UNCTAD’s Macroeconomic andDevelopment Policies Branch, aims at enhancing the understanding of policy makers indeveloping countries of the complex issues in the international monetary and financialsystem, and at raising awareness outside developing countries of the need to introduce adevelopment dimension into the discussion of international financial and institutionalreform.

The research carried out under the project is coordinated by Professor Dani Rodrik,John F. Kennedy School of Government, Harvard University. The research papers arediscussed among experts and policy makers at the meetings of the G-24 Technical Group,and provide inputs to the meetings of the G-24 Ministers and Deputies in their preparationsfor negotiations and discussions in the framework of the IMF’s International Monetaryand Financial Committee (formerly Interim Committee) and the Joint IMF/IBRDDevelopment Committee, as well as in other forums. Previously, the research papers forthe G-24 were published by UNCTAD in the collection International Monetary andFinancial Issues for the 1990s. Between 1992 and 1999 more than 80 papers werepublished in 11 volumes of this collection, covering a wide range of monetary and financialissues of major interest to developing countries. Since the beginning of 2000 the studiesare published jointly by UNCTAD and the Center for International Development atHarvard University in the G-24 Discussion Paper Series.

The Project of Technical Support to the G-24 receives generous financial supportfrom the International Development Research Centre of Canada and the Governments ofDenmark and the Netherlands, as well as contributions from the countries participatingin the meetings of the G-24.

GROWTH AFTER THE ASIAN CRISIS:WHAT REMAINS OF THE EAST ASIAN MODEL?

Jomo K.S.

University of Malaya, Kuala Lumpur, Malaysia

G-24 Discussion Paper No. 10

March 2001

viiGrowth After the Asian Crisis: What Remains of the East Asian Model?

Abstract

This paper focuses on the prospects for sustained development in the four East Asianeconomies most adversely affected by the crises of 1997/98. These include all three second-tierSouth-East Asian newly industrializing countries (NICs) – Indonesia, Malaysia and Thailand –as well as the Republic of Korea, the most adversely affected of the first-generation newlyindustrialized economies (NIEs). The first section critically examines the East Asian modelpresented by the World Bank’s “East Asian Miracle” (1993). The study emphasizes the varietyof East Asian experiences. The three second-tier South-East Asian experiences are shown to bequite distinct from, and inferior to, those of the first-generation NIEs, especially the Republic ofKorea and Taiwan Province of China.

The circumstances leading to the onset of the East Asian crises of 1997/98 are then reviewedto assess whether and how the East Asian “models” may have contributed to the crises.Macroeconomic indicators in Malaysia and the three most crisis-affected economies – i.e.Indonesia, the Republic of Korea and Thailand – are reviewed to establish that, despite somemisdemeanours, the crises cannot be attributed to macroeconomic profligacy. After reviewingthe causes of these crises, the role of international financial liberalization and the reversal ofcapital inflows are emphasized. Nevertheless, the trend towards further financial liberalizationcontinues. Malaysia is shown to have been less exposed as a result of restrictions on foreignborrowings as well as stricter bank regulations, but more vulnerable owing to the greater roleof capital markets compared to the other three economies in the region. The role of the IMF andfinancial market expectations in exacerbating the crises is also considered.

The emerging discussion begins by asserting that economic recovery in East Asia since1999 – especially in Malaysia and the Republic of Korea – has been principally due to successfulreflationary measures, both fiscal and monetary. The main institutional reforms currently claimedas urgent to protect the four affected economies from future crises and to return them to theirprevious high growth paths are critically assessed. It is argued that the emphasis by the IMFand the financial media on corporate governance reforms has been misguided and that suchreforms are not really necessary for recovery. Instead of the Anglo-American-inspired reformscurrently proposed, reforms should create new conditions for further “catching-up” throughoutthe region. Although the prospects for reform of the international financial system remain dim,a reform agenda in the interests of the South is outlined.

Globalization, including international financial liberalization, has reduced the scope forselective interventions so crucial to the catching-up achieved during the East Asian miracleyears. However, the process has been uneven and far from smooth, leaving considerable roomfor similar initiatives more appropriate to new circumstances. In any case, it is unlikely thatglobalization will ever succeed in fully transforming all other national economic systems alongAnglo-American lines. The emerging hybrid systems have not really advanced late developmentefforts. There is an urgent need to understand better the full implications of globalization andliberalization in different circumstances so as to identify the remaining scope for nationaldevelopmental initiatives.

ixGrowth After the Asian Crisis: What Remains of the East Asian Model?

Table of contents

Page

Preface ........................................................................................................................................... iii

Abstract .......................................................................................................................................... vii

I. Introduction ............................................................................................................................. 1

II. The East Asian Miracle .......................................................................................................... 2

III. East Asian differences ............................................................................................................ 6

A. South East Asia’s ersatzness ............................................................................................... 8B. South-East Asian weaknesses ........................................................................................... 10

IV. The East Asian débâcle ......................................................................................................... 11

A. Crisis and contagion ......................................................................................................... 12B. From miracle to débâcle ................................................................................................... 12C. Consequences of financial liberalization .......................................................................... 14D. Crises of a new type .......................................................................................................... 16E. Reversible capital flows .................................................................................................... 17F. Financial liberalization ..................................................................................................... 21G. The role of IMF ................................................................................................................ 23H. The roots of crises: a summary ......................................................................................... 25

V. Reforms and recovery ........................................................................................................... 26

A. International reform for the better? .................................................................................. 26B. Macroeconomic recovery ................................................................................................. 27C. Reform of corporate governance ...................................................................................... 30D. New international financial architecture .......................................................................... 32

VI. Reforming East Asia for sustainable development ............................................................ 34

A. Exchange rate appreciation and growing imports ............................................................ 34B. FDI slowdown................................................................................................................... 35C. Slow technological progress ............................................................................................. 36D. New investment policies in South East Asia .................................................................... 37

VII. Prospects ................................................................................................................................ 42

VIII. Concluding remarks ............................................................................................................ 43

Notes .......................................................................................................................................... 46

References .......................................................................................................................................... 48

Appendix .......................................................................................................................................... 51

1Growth After the Asian Crisis: What Remains of the East Asian Model?

I. Introduction

From the 1980s, and especially in the early andmid-1990s, there was growing international recog-nition of the sustained rapid economic growth,structural change and industrialization of the EastAsian region. There has also been a tendency to seeEast Asia as much more of an economically inte-grated region than it actually is, and a correspondingtendency to see economic progress in the region asbeing similar in origin and nature. Terms such as the“Far East”, “Asia-Pacific”, “Pacific Asia”, “EastAsia”, “yen bloc”, “flying geese”, “tigers”, “mini-dragons”, and so on, have tended to encourage thisperception of the region as far more economicallyintegrated and similar than it actually is.

The World Bank (1993) argued that of the eighthighly performing (East) Asian economies (HPAEs)identified in its study, The East Asian Miracle,1 threeSouth-East HPAEs – namely Indonesia, Malaysia andThailand – provided the preferred models for emu-lation by other developing countries. Yoshihara

(1988) had earlier argued that South-East Asianeconomies were characterized by ersatz capitalismbecause of the compromised and inferior role of theirstates, their discriminatory treatment of ethnic Chi-nese and their failure to develop better technologicalcapabilities. Jomo et al. (1997) criticized the WorldBank’s claims that the South-East Asian highly per-forming economies were superior models foremulation, pointing to various differences suggest-ing the inferiority of South East Asia’s economicachievements.

The East Asian currency and financial crises of1997/8 radically transformed international percep-tions and opinion about the East Asian experiences,with earlier praise quickly changing into severe con-demnation. This was most obvious with regard tothe issue of business government relations, whichhad previously been characterized as key to the EastAsian success story. Instead, these often intimate re-lations have since been denounced as “crony capi-talism” responsible for the onset as well as theseverity of the crisis (Backman, 1999; Clifford andEngardio, 2000). Various accounts (Jomo, 1998;

GROWTH AFTER THE ASIAN CRISIS: WHATREMAINS OF THE EAST ASIAN MODEL?*

Jomo K.S.

* I am very grateful to Dani Rodrik for his flexible and consultative approach, to Liew San Yee for his research assistance, andto Din Merican for his editorial suggestions, as well as to Chang Ha-Joon, Chin Kok Fay, Joseph Lim, Pasuk Phongpaichit, ShinJang-Sup and You Jong-Il for their help with tracking down references and materials. Needless to say, the usual caveats apply.

2 G-24 Discussion Paper Series, No. 10

Furman and Stiglitz, 1998; Radelet and Sachs, 1998a;Krugman, 1999a; Bhagwati, 1998) have since char-acterized the crises as the consequence of interna-tional financial liberalization and related increasesin easily reversible international capital flows. Theseaccounts have also emphasized the role of the Inter-national Monetary Fund (IMF), particularly its policyprescriptions and conditionalities in exacerbating thecrises.

This paper will focus on the four East Asianeconomies most adversely affected by the crises of1997/98. These include all three second-tier South-East Asian newly industrializing countries (NICs):Indonesia, Malaysia and Thailand, as well as theRepublic of Korea – the most adversely affected first-generation newly industrialized economy. The nextsection of this paper will critically examine the so-called East Asian model, especially as presented bythe World Bank (1993). The third section will thenemphasize the variety of East Asian experiences(Perkins, 1994). The second-tier South-East Asianexperiences will then be shown to be distinct fromand inferior to those of the first-generation newlyindustrialized economies (NIEs), especially the Re-public of Korea and Taiwan Province of China(elaborated in Jomo, 2001b, 2001c). The fourth sec-tion will review the circumstances leading to the onsetof the East Asian crises of 1997/98, and examinewhether and how the East Asian “models” may havecontributed to the crises.

The fifth section will begin with a brief reviewof the reflationary Keynesian policies leading tomacroeconomic recovery since 1999. The section willthen draw on the preceding analyses to critically as-sess the main institutional reforms currently beingclaimed as necessary to protect the four crisis-af-fected economies from future crises and to returnthem to their previous high growth paths. This willmainly dwell on discussions of the need for reformof corporate governance as well as the internationalfinancial architecture. The sixth section considers theimplications of pre-crisis developments and morerecent challenges. In particular, it reviews some ex-change rate dilemmas, the slowdown of regionalforeign direct investment (FDI), limited technologi-cal capabilities and new investment promotionstrategies. The penultimate section reviews the pros-pects for sustainable development in the region inlight of the foregoing, while the concluding remarksconsider the likelihood of convergence – and the vi-ability of distinct development models – in the faceof continued globalization and Anglo-American in-spired liberalization.

II. The East Asian Miracle2

The most important and influential documentwhich attempted to explain the rapid growth, struc-tural change and industrialization of much of EastAsia in the last three decades or more has been TheEast Asian Miracle study (EAM) published by theWorld Bank in 1993. As is now well-known (Wade,1996), the World Bank did not commission the studyon its own volition, and with the East Asian finan-cial crisis since mid-1997 there are many in the Bankwho would now wish to disown the study. In fact, itappears that the study was undertaken by the Bankat the behest of Shiratori, the Japanese ExecutiveDirector or government representative on the Bank’sboard. Shiratori had pointed out the region’s rapidgrowth and structural change in sharp contrast to theBank’s poor experience with structural adjustmentprogrammes (SAPs) in Latin America, Africa andother parts of the world, and with the transitions itwas trying to engineer in Eastern Europe. The SAPsand transitions had generally turned out to be veryproblematic, even causing severe recessions in sev-eral of these economies and, at best, rather slow andunimpressive growth rates elsewhere. Shiratori sug-gested that the Bank should learn and draw lessonsfrom the experiences of East Asia where, by the early1990s, more than half a dozen countries had grownat average rates exceeding 6 per cent per annum forat least a quarter of a century. Shiratori offered theJapanese government funding for such a study, whichthe Bank then undertook.

In EAM, the World Bank identified eight high-performing Asian economies: Japan; the fourfirst-generation NIEs or NICs, dragons or tigers,namely the Republic of Korea, Taiwan Province ofChina, Hong Kong (China) and Singapore; and thethree second-generation South-East Asian NICs,namely Malaysia, Indonesia and Thailand. Interest-ingly, China was left out, perhaps because the Chineseexperience would upset the Bank’s analysis and con-clusions in very fundamental ways. EAM recognizesthat the likelihood of eight relatively contiguouseconomies growing so rapidly for such a sustainedperiod of time is less than one in 60,000. Yet, it doesnot acknowledge the significance of geography –unlike the later 1997 Emerging Asia (EA) study ledby the Harvard Institute of International Develop-ment (HIID) for the Asian Development Bank(ADB).

With the publication and release of EAM, theBank seemed to be shifting its position from the sort


of neo-liberalism, or the extreme economic liberal-ism of the 1980s, to acknowledging an importantdevelopmental role for the state in the 1990s. EAMappeared to have had something to do with this shift.This impression has been reflected in other Bankactivities and publications, especially the 1997 WorldDevelopment Report which seemed to advocate ef-fective, rather than minimalist, states (World Bank,1997).

In EAM, the Bank identified at least six typesof state interventions, which it saw as having beenvery important for East Asian development. It ap-proved of the first four, deemed to be functionalinterventions, but was more sceptical of the last two,deemed to be strategic interventions. Functional in-terventions are said to compensate for marketfailures, and are hence necessary and less distortingof markets, while strategic interventions are consid-ered to be more market-distorting. The two types ofstrategic interventions considered are in the areas offinance, specifically what it calls directed (i.e. sub-sidized) credit, and international trade, while the fourfunctional interventions the Bank approved of are:

(i) Ensuring macroeconomic discipline and macro-economic balances;

(ii) Providing physical and social infrastructure;

(iii) Providing good governance more generally; and

(iv) Raising savings and investment rates.

It is very important to compare what has actu-ally happened in East Asia with the way the WorldBank has presented this. Beginning with the impor-tance of macroeconomic discipline, there is very littledispute that maintaining macroeconomic balanceshas been important in East Asia. But what the Bankconsiders to be the acceptable parameters of macr-oeconomic discipline may be disputed. One finds,for instance, that inflation was generally kept under20 per cent in the HPAEs, but it was certainly notalways kept below 10 per cent in all the economies.In other words, single-digit inflation was neither apolicy priority nor always ensured in some East Asiancountries during their high growth periods.

Similarly, when considering other macroeco-nomic balances such as the fiscal balance and thecurrent account of the balance of payments, one findsthat the balances were not always strictly maintainedin the way the Fund and the Bank now seem to re-quire of much of the developing world. Malaysia andThailand have had relatively high current accountdeficits throughout the 1990s, while other countries

with much lower deficits were not spared the recentcurrency attacks and massive depreciation.

On physical and social infrastructure, until the1980s, the Bank would probably have gone alongwith what the East Asians have done. However, sincethe 1980s, the Bank has increasingly seemed to rec-ommend privatization and private provision ofphysical infrastructure. With the exception of HongKong (China), most physical infrastructure in EastAsia has been provided by governments until fairlyrecently, when there have been the beginnings ofprivatization in the provision of physical infrastruc-ture, which has become the basis for powerful privatemonopolies associated with “crony capitalism”.

The role of government has been extremelyimportant in providing so-called social infrastructureand services in East Asia. In some of its other docu-ments, the Bank seems to acknowledge this, butnonetheless it recommends a more modest role forgovernment in the provision of social infrastructure.For instance, the Bank recommends universal andfree primary education, but does not recommend thesubsidization of education beyond the primary level,when the “user/consumer” (student) should bear thefull costs of education as far as the World Bank isconcerned. This would have had very serious conse-quences in terms of human resource development, ifone contrasts that recommendation with the actualexperience of East Asia. To give some sense of howimportant government support for education has beenbeyond the primary level, in the Republic of Koreatoday over 40 per cent of young people attend uni-versities. Thailand has a percentage of close to 20 percent, Indonesia has 10 per cent, and most of the first-generation East Asian NIEs have well over 25 percent, generally over 30 per cent.

The notion of good governance is somewhatambiguous and often used rather tautologically. Whenthings are going well, it is assumed that there mustbe good governance, and conversely if things are notgoing well. So one does not really have much of anexplanation of good economic performance by sim-ply invoking good governance, although it is widelytouted these days, sometimes ad nauseum. There have,however, been important efforts to try to understandthe factors contributing to good governance. In thisregard, the 1997 World Development Report has beenimportant and useful. It seems from the East Asianexperience that what was called “strong government”(in Gunnar Myrdal’s sense) has been an importantnotion, though one often misunderstood and wronglyassociated with authoritarian government.


What is called “embedded autonomy” has be-come a useful way to try to understand what theconditions of good governance are. Here, embedded-ness refers to the institutional capacity and capabilityof the governments concerned to effectively providethe coordination necessary for rapid capital accumu-lation and economic transformation. Autonomy isprimarily understood to be from “vested interests”,“special interest groups”, “distribution coalitions”and “rent seekers” who, in more favourable or con-ducive circumstances, would be able to influencepublic policy to their own advantage. Embedded au-tonomy is therefore considered to have been verycrucial in ensuring that regimes in East Asia couldeffectively serve as developmental states.

The role of the state in encouraging savings andpromoting investments is also generally accepted.However, much of East Asia’s large savings is actu-ally comprised of corporate or firm savings, ratherthan just household savings. Household savings inEast Asia are not spectacularly higher than in therest of the world, except in Malaysia and Singapore.The difference in Malaysia and Singapore is due tothe mandatory or forced savings schemes introducedin the late colonial period and the relatively high pro-portion of the working class or wage owners as aproportion of the labour force. The latter is particu-larly true in the case of Singapore, but is also notinsignificant in the case of Malaysia. The significanceof coerced savings should be noted because of thepopular view that the high savings and investmentrates in the region exist because East Asians are cul-turally, if not congenitally, thrifty.

The large contribution of high corporate sav-ings implies that firms have often been able to enjoyvery high profit rates due to government interven-tions, subsidies, tax breaks and other incentives forparticular types of investments favoured by the gov-ernments, enabling the firms concerned to enjoyhigher “rents”. But more important is that attractiveconditions (e.g. tax incentives and other induce-ments), largely created by governments, have inducedhigh rates of reinvestment of the huge profits of firms.How have such high rates of reinvestment been se-cured? In some East Asian countries they have beenassured by the very strict controls on foreign ex-change outflows. Capital flight was made verydifficult in certain East Asian economies, especiallyin the Republic of Korea and Taiwan Province ofChina, during their high growth periods. High levelsof reinvestment have also been successfully inducedby structuring laws so that reinvestment of profits is

subject to little or no tax, or by offering other incen-tives to undertake state-favoured investments.

In pursuing these supposedly functional inter-ventions, the East Asian governments were not justmarket-conforming, but instead played importantroles, which have been more than simply market-augmenting, as suggested by EAM. On the morecontroversial, so-called strategic interventions in fi-nance and international trade, the Bank almostgrudgingly concedes that financial interventions havebeen important and successful in East Asia, particu-larly in North East Asia – i.e. in Japan, the Republicof Korea and Taiwan Province of China. However,the Bank implies that nobody else is capable of suc-cessfully pursuing the types of policies that the NorthEast Asians successfully implemented, because statecapabilities in North East Asia have been almostunique and are non-replicable.

Creating the conditions for attracting invest-ment, both domestic private investment as well asforeign investment, has had much more to do withreforming incentives and governance more generallyto attract particular types of investments to generatespecific sources of economic growth, rather than lib-eralizing financial markets as such. South-East Asiangovernments, notably Singapore and Malaysia, haveespecially sought to attract FDI into areas where in-digenous industrial capabilities were not expectedto become internationally competitive. Venture capi-tal markets, rather than the usual stock markets, tendto be more supportive of developing new industrialand technological capabilities.

Attracting FDI should, however, be distin-guished from capital account liberalization. Chile,which has been very FDI-friendly, has imposed fairlyonerous obstacles on easy exit, probably limitingcapital inflows, especially of a short-term nature.Capital account liberalization has come under re-newed consideration, following the East Asianfinancial crisis, since mid-1997, precipitated by aneventually successful currency attack on the over-valued Thai baht, and greatly exacerbated by herd-like panicky withdrawals from the entire South-EastAsian region, inducing currency and stock marketcollapses (Jomo, 1998). Those who control finan-cial assets usually enjoy disproportionate politicalinfluence in most contemporary economies, andespecially in developing ones. Hence, liberalizingfinancial markets alone, without sufficient induce-ments for a not easily reversed and sustained netinflow of portfolio investments, may well causegreater outflows rather than inflows.


Why did the Bank give a positive evaluation offinancial interventions in North East Asia despitetheir clear violation of market norms? A few ana-lysts might suggest that the evidence offers no otherpossible conclusion, but most observers would dis-pute this, especially given the ongoing problems ofthe beleaguered Japanese financial system. Anotherexplanation is the influence and unorthodox neo-classical analysis of Joseph Stiglitz, the principalauthor of this part of EAM. The more cynical mightpoint out that the study was funded by the JapaneseMinistry of Finance, and it is hardly likely that theWorld Bank would bite the hand which feeds it bynegatively evaluating the Ministry’s record. Therehas been significant historical rivalry between theFinance Ministry and the bureaucratically weakerMinistry of International Trade and Industry (MITI).Hence, some observers suggest that it is not surpris-ing that the Bank study did not criticize the role ofthe Ministry of Finance of Japan, but was less sym-pathetic to MITI and international trade-relatedindustrial policy.

The evaluation in EAM of the record of Japan’sMITI and its counterparts elsewhere in the region ismore predictable, arguing that government interven-tions have been trade-distorting and, more impor-tantly, generally unsuccessful in East Asia, with someminor exceptions. However, contrary to the impres-sion given by the study, the governments of Japan,the Republic of Korea and Taiwan Province of Chinadid pursue import substituting industrialization poli-cies from the 1950s, but soon also pursued export-orientation so as to ensure that their industries quicklybecame internationally competitive by requiring arapid switch from import substitution to export-orientation.

In many cases, infant industries were generallyprovided with effective protection conditional onexport promotion, which had the effect of forcingthe firms and industries concerned to quickly becomeinternationally competitive. By giving firms protec-tion for certain periods, depending on the product,and by also requiring that they begin exporting cer-tain shares of output within similarly specifiedperiods, strict discipline was imposed on the firmsin return for the temporary trade protection they en-joyed. Quantitatively, such policies forced firms topush down their own production costs as quickly aspossible, for example by trying to achieve greatereconomies of scale and accelerating progress uplearning curves. Requiring exports has also meantthat producers had to achieve international qualitystandards quickly, which technologically imposed

pressures on progress in terms of products as well asprocesses. With strict discipline imposed, but alsosome flexibility in enforcement, many firms man-aged to rapidly achieve international competitiveness.

Thus, the East Asian miracle was characterizedas principally due to export-led growth. But, whileexports tend to rise with trade liberalization in theshort term, imports also tend to rise strongly, espe-cially if the domestic currency appreciates in realterms. Thus, trade liberalization is inclined to limitor only weakly supplement domestic effective de-mand. Hence, while increased international trade mayenhance growth, the added stimulus tends to be muchless than presumed by proponents of trade liberali-zation. Despite efficiency gains from trade liberali-zation, increased exports do not necessarily ensurestronger domestic economic growth.

EAM and its supporting studies have impliedand argued that South East Asia began to take offafter it reversed such trade interventions. Hence, themid-1980s are portrayed by the Bank as a period ofeconomic liberalization and deregulation leading toeconomic recovery and rapid growth and industri-alization. The facts are more complicated (Jomo etal., 1997; Jomo 2001b). There certainly was somederegulation during this period, but there also wassome new private sector-oriented regulation, moreappropriate to the new industrial policy priorities ofthe governments of Indonesia, Malaysia, Singaporeand Thailand.

Given international trends and pressures inrecent years, trade liberalization has become increas-ingly irresistible, and hence inevitable. But bypro-actively accelerating the apparently inevitable,some advantage may be regained by deliberatesequencing and timing of trade liberalization. Un-fortunately, many trade policy instruments have beenexcluded by recent trends in international trade gov-ernance and are no longer available as options forgovernments. For example, local content require-ments were phased out with the conclusion of theUruguay Round of negotiations under the GeneralAgreement on Tariffs and Trade (GATT). However,despite considerable diminution, there still remainssome scope for trade policy initiatives in support ofindustrial policy.

It is instructive to consider some of the impor-tant differences among the East Asian economies,particularly whether all of East Asia has been pro-ceeding inexorably in the same basic direction in asimilar manner. Although the Bank does not really


extol an East Asian model as such, the Bank studyhas often been read as offering one, or perhaps twovariants. However, more generally, as suggested ear-lier, there has been much talk about East Asia in thesingular, as constituting a flock of “flying geese” oreven a “yen bloc”. Many observers even speak ofgeneric East Asian models, approaches or ways ofdoing things. In response to the financial crisis sincemid-1997, as sentiment on East Asia has turned sour,there have been similar broad-brushed sweeping gen-eralizations about East Asian “crony capitalism”.

III. East Asian differences

While many lessons may certainly be drawnfrom the East Asian experience, they are far fromconstituting a single model. Some of the major dif-ferences in East Asia are themselves very instructive.In the case of the role of FDI, one finds tremendouscontrasts, especially between South East Asia andthe rest of East Asia. In the case of Singapore, FDIhas constituted about a quarter of gross domesticcapital formation. In the case of Malaysia, the pro-portion has been about 15 per cent. At the other endof the spectrum, in the case of Japan and the Repub-lic of Korea, the percentage has long been below 2 percent. Some of the other countries fall between thesetwo extremes, with very few near the mean for de-veloping countries of around 5 per cent. Thosemost successful in developing industrial capacitiesand capabilities in East Asia – namely Japan, theRepublic of Korea and Taiwan Province of China –have hardly depended on FDI, which has only playeda relatively small role.

The far greater importance of FDI in South EastAsia has been due to a variety of reasons, which havenot been entirely economic. One of the reasons forthe major role of FDI in Singapore and Malaysia ispolitical. After Singapore seceded from Malaysia in1965, the Lee Kuan Yew government decided that toensure its own survival, it would be best to attractforeign investment in massive quantities to Singapore,so that the major foreign powers would quickly de-velop a stake in the survival of the Singapore regime.Of course, this preference was subsequently justi-fied in terms of improving access to the technologyfrontier. In other words, political considerations havebeen a very important reason for attracting, evenprivileging, foreign investment in Singapore.

In the case of Malaysia, the country has longhad ethnic rivalries and an ethnic affirmative action

policy. This may have incited some policy makers totry to limit ethnic Chinese control over the economyby encouraging FDI so as to reduce proportionatelysuch control. Again, one finds a political motivationfor the important role of FDI in Malaysia. Singaporeand Malaysia are exceptions, which need to be ex-plained politically, rather than simply by economicconsiderations.

Clearly, there is considerable diversity in therole and performance of public investments, includ-ing state-owned enterprises (SOEs), in East Asia,including within South East Asia. In Japan, HongKong (China) and the Republic of Korea, state-owned enterprises are hardly important today, buthistorically were so in Japan at the end of the nine-teenth century and in the twentieth century beforethe Second World War. Conversely, however, morerecently one finds that state-owned enterprises havebeen extremely important in Singapore and TaiwanProvince of China; this is partly explained by politicalfactors, but there are also economic considerations.Very importantly, the performance of these enter-prises has also been quite impressive.

In the case of Singapore, for instance, the singlelargest foreign investor – i.e. the biggest Singaporeanfirm investing abroad – has been the GovernmentInvestment Corporation. For quite a number of yearsin the 1990s, the average rate of return for its invest-ments was higher than for all major financialinvestment firms in the City of London as well as onWall Street. Such SOE success poses a challenge forthose who insist that state-owned enterprises arebound to fail because of property rights and princi-pal-agent arguments.

There is also tremendous diversity in the roleof industrial and technology policies in East Asia.One extreme, of course, is Hong Kong (China), wherethere is relatively little industrial policy, althoughmore than most opponents of industrial policy careto admit. It is far more detailed and sophisticated inJapan and the Republic of Korea at the other end ofthe spectrum. In the Republic of Korea, industrialpolicy is largely oriented towards the chaebols,whereas in Taiwan Province of China, much moreemphasis is given to medium-sized and relativelysmaller enterprises. There have also been differentorientations, emphases and instruments in industrialpolicy in the region. For example, the role of tradepolicy has been very important in almost all econo-mies in the region except Hong Kong (China) andSingapore, while financial policy has been impor-tant in all the countries, including Singapore, but


again with the exception of Hong Kong (China).Since the latter’s reversion to China in mid-1997,there have been many indications of the possible in-troduction of an industrial policy for the territory,presumably in line with its new status and China’senvisaged role for the de-industrialized financial cen-tre. There have also been very important differencesin the role of technology policy in the region.

As noted earlier, the World Bank recommendsthat the rest of the developing world emulate SouthEast rather than North East Asia. There are very im-portant differences between North East Asia andSouth East Asia underlying the Bank’s recommen-dations. These differences oblige us to recognize theachievement of the first-tier East Asian NIEs (includ-ing Singapore) – rather than the transformation ofthe second-tier South-East Asian NICs – as far moreimpressive and superior in terms of economic per-formance.

Despite the much greater resource wealth ofSouth East Asia, one finds that growth performancehas been superior in North East Asia over the longterm. Over the period studied by the Bank – i.e. fromthe 1960s until the early 1990s – the average growthrate in the former was in the region of about 8 percent, compared to about 6 per cent for the latter. A2 per cent difference, compounded over a period ofa quarter century or more, adds up to a lot. Very im-portantly also, population growth, except in HongKong (China) owing to immigration from China andperhaps Singapore, has been much lower in theformer compared to the latter. The immigration intoHong Kong (China) and Singapore involves a veryhigh proportion of people in the labour force, thusraising the average labour utilization rate. Politicalfactors have also ensured far more equitable distri-bution of economic welfare than would otherwisehave been the case in the first-tier NIEs, whereas suchconsiderations have been less influential in the sec-ond-tier South-East Asian NICs, except perhaps forMalaysia due to its ethnic “social contact”.

Hence, the improvements in per capita incomeand economic welfare have been much more signifi-cant in North East Asia, compared to South East Asia(with the exception of Singapore), despite the rela-tive resource wealth of the latter. In other words, whatSouth East Asia has achieved has been less impres-sive in some critical ways. Drawing from thiscontrast, one could argue that resource wealth is nota blessing but a curse insofar as it postpones the im-perative to industrialize.

As noted earlier, North East Asia has generallyhad a much more sophisticated and effective indus-trial policy compared to South East Asia. Thisaccounts, in no small way, for the very importantdifferences in industrial and technological capabili-ties between North East and South East Asia. Also,industrialization in the latter is still primarily drivenby FDI, whereas industrialization in the former isprimarily an indigenous phenomenon.

It is now generally recognized that Japan andthe first-generation NIEs began to industrialize in thevery specific economic and political conditions of aparticular cold war historical conjuncture. North EastAsia grew rapidly in the immediate post-war periodunder a “security umbrella” provided by the Ameri-cans, especially after the cold war began. Besidessubsidizing military expenditure and providing gen-erous aid, the Americans were anxious for them to“succeed” economically in order to be show-casedas attractive alternatives to those under communistrule or influence. Hence, the Americans were quitehappy to tolerate trade, finance, investment, intel-lectual property and other policies violatinglaissez-faire market or neo-liberal economic normsthat they are now strongly opposed to, especiallyfollowing the end of the cold war. These favourableconditions are simply not available to others, andhence their experiences are said to be almost impos-sible to emulate.

In arguing why other developing countriesshould not imitate the first-generation East AsianNIEs, it is now often argued that their state capabili-ties are almost unique and virtually impossible forany other regimes to emulate. The more cultural ex-planations suggest that this has something to do withthe East Asian Confucian legacy of meritocracy.However, it is important to remember that the sup-posedly Confucian Kuomintang government ofTaiwan was the same regime driven out of mainlandChina by the communists because of its incredibleincompetence and corruption. One could say the sameof the Rhee regime in South Korea in the 1950s, aswell as of the Chun, Roh and Kim Young Sam re-gimes in the 1980s and 1990s. Japan has hardly beenscandal-free in recent years, and most observerswould trace recently disclosed abuses to the natureof post-war Japanese political economy. The supe-rior policy-making and implementation capabilitiesof the North-East Asian decision makers was, at leastuntil recently, widely acknowledged, but this, in it-self, does not prove the existence of thoroughlycompetent and incorruptible policy makers.


There is also the claim that East Asia cannot beemulated owing to its very different initial conditions.Such differences are real, but often exaggerated.There is no doubt that Japan and the first-tier EastAsian NIEs are now distinguished by high levels ofeducation. However, the level of literacy in SouthKorea in 1950 was lower than the literacy rate incontemporary Ethiopia (which has one of the lowestrates in Africa today); thus the level of educationachieved by contemporary Koreans reflects the tre-mendous investments consecrated to developinghuman resources in East Asia in the post-war pe-riod, as the region then was generally not veryadvanced despite, or perhaps even because of, its(elitist) Confucian legacy. But by the end of the1960s, literacy rates had gone up greatly for the first-generation East Asian NIEs after enormous resourceshad been poured into education in the preceding twodecades.

In discussing initial conditions, some fortuitouscircumstances must also be considered. Japan, SouthKorea and Taiwan Province of China all had rela-tively virtuous American-sponsored land reformsshortly after the end of the war (Hsiao, 1996). In Ja-pan, there also was significant redistribution of othernon-land assets, most notably of the pre-war andwartime zaibatsu industrial conglomerates. Much ofthe motivation for such re-distributive reforms was,of course, anti-communist, i.e. to undermine andminimize support for the communists by those de-siring asset redistribution.

The implications of asset redistribution in Ja-pan were considerable. Ironically, the Americanswere not uninfluenced by the left, partly because ofthe nature of the wartime anti-Axis alliance and thenature of the most influential scholarships available(Tsuru, 1993). During the post-war American occu-pation of Japan, it was widely presumed that thezaibatsu “military industrial complex” had been re-sponsible for the militarization of pre-war Japan. Sothe Americans decided to dismantle the zaibatsu, andforcibly broke family control over them, selling offthe assets in interesting ways with important conse-quences. To ensure popular acceptance of this policy,preference was first given to employees, and then tolocal communities – thus developing worker andcommunity stakes in the companies and the basis forwhat is now called a stakeholder economy. Thus, thestakeholder economy was created by deliberatelyre-distributive policies that have had many conse-quences now considered to be peculiarly Japanese.Similarly, many now acknowledge the influence ofthe “human relations” school of industrial relations

on the post-war development of guaranteed life-longemployment and the seniority wage system, both ofwhich have effectively developed a strong employeecommitment to the fate of their firm. There are nu-merous other ostensibly typically Japanese features,many of which were not inherited from the Edo pe-riod or even developed autochthonously during theMeiji period; quite a few are actually relatively re-cent innovations, with rather virtuous consequences.

There are important lessons to be drawn fromEast Asia, but clearly there is no single East Asianmodel as such, and most certainly not one that canaccommodate all the different experiences of SouthEast Asia. Considering the historicity of the devel-opment experiences, it does not make much sensefor any other country to think in terms of trying toemulate any particular economy in the South Eastregion or, for that matter, East Asia more generally.There are many reasons why most will find it impos-sible to imitate any other country even if they wantedto. But even in drawing lessons, it will be importantto recognize the distinctive nature of the South-EastAsian experiences.

A. South East Asia’s ersatzness

There is considerable evidence that the threeSouth-East Asian economies of Indonesia, Malaysiaand Thailand have some common characteristics andpolicies that distinguish them from the other high-growth economies of East Asian (Jomo et al., 1997).Most importantly, the region’s high growth econo-mies have relied heavily on FDI to develop most oftheir internationally competitive industrial capabili-ties; government interventions have also been morecompromised by considerations besides economicgrowth and late industrialization, especially redistri-bution and rent capture. Consequently, industrialpolicy has also varied in nature, quality and effec-tiveness. Yet, it will be shown that the South-EastAsian economies would not have achieved so muchwithout selective government interventions, includ-ing industrial policy.

The conditions contributing to, and the natureof, industrialization in Indonesia, Malaysia, Singa-pore and Thailand have been quite distinct (Jomo. etal, 1997; Jomo, 2001b). The inclusion of these econo-mies as four of the eight HPAEs identified by theWorld Bank (1993) has encouraged comparison withthe record of Japan and the three of the other fourfirst-generation or first-tier East Asian newly indus-


trializing economies (NIEs): Hong Kong (China), theRepublic of Korea and Taiwan Province of China.Comparisons with other countries in South East Asiaand elsewhere are also shown in some chapters below.

South-East Asian industrialization has been farmore dominated by foreign capital (Jomo et al., 1997;Jomo, 2001b), and has, as a consequence, fewer in-dustrial and technological capabilities that may beconsidered indigenous or under national control. Theefficacy of industrial policy has thus emerged as theprimary determinant of the ability of different na-tional economies to take advantage of transnationalcapital’s relocation of productive capacities in theregion. The distinct nature of the South-East Asianeconomies and experiences (Jomo et al., 1997; Jomo,2001b) offers valuable insights into various indus-trial policy instruments, the circumstances in whichthese may work, as well as the importance of relativelyuncompromised, competent and effective state capaci-ties in ensuring desirable industrial policy outcomes.

South-East Asia’s development experienceshave been almost as diverse as those of the otherfour HPAEs identified by the World Bank (1993).South-East Asian high-performing economies havegenerally been less successful in developing indig-enous industrial and technological capabilities forvarious reasons (Jomo et al., 1997); this seems to bepartly due to the greater reliance on FDI in the re-gion for political as well as other reasons. South EastAsia’s industrialization is also less impressive in otherrespects, probably as a result of its greater naturalresource wealth and consequently weaker impera-tive to industrialize (ADB, 1997).

Industrial policy has been less elaborate, effi-cient and effective in the three South-East Asiansecond-tier NICs – Indonesia, Malaysia and Thai-land, as compared to Japan and the first-tier EastAsian NIEs, except for Hong Kong (China) but in-cluding Singapore. This is partly because stateintervention in South East Asia has been far moreabused, and hence, often seriously compromised bypolitically influential business interests. Yet, it wouldbe a mistake to “throw the baby out with the bathwater” by condemning all industrial policy in theregion. Despite various abuses and other weaknessesin implementation, some industrial policy has beencrucial to South East Asia’s rapid economic growth,structural change and late industrialization (Jomo etal., 1997).

Before the currency and financial crises of 1997/98, the South-East Asian second-tier NICs were be-

ing celebrated by the World Bank and others as thenew models for other developing countries to emu-late. In its influential 1993 publication, The EastAsian Miracle, the Bank argued that the eight HPAEs– Hong Kong (China), Japan, Republic of Korea,Singapore, Taiwan Province of China; Indonesia,Malaysia and Thailand – had achieved sustained andequitable export-led high growth and rapid industri-alization.

The Bank and others suggested that owing tothe first five HPAEs’ various exceptional character-istics, the last three South-East HPAEs were the mostappropriate examples for other developing countriesto follow. Implicit in this recommendation was theclaim that the achievements of Indonesia, Malaysiaand Thailand were similar to and comparable withthe other HPAEs in terms of growth, structural changeand industrialization. Their industrialization recordshave been significantly different from and inferiorto those of the other HPAEs, especially Japan, theRepublic of Korea, Singapore and Taiwan Provinceof China (Jomo et al., 1997; Jomo, 2001b).

Closer examination suggests that the experi-ences of Indonesia, Malaysia and Thailand, as wellas Hong Kong (China) and Singapore, more closelyapproximated the neo-classical, export-led, growthmodel than those of Japan, the Republic of Koreaand Taiwan Province of China. The latter appear tohave promoted exports very actively while also pro-tecting domestic markets, at least temporarily, todevelop domestic industrial and technological capa-bilities in order to compete internationally. Thisstrategy of temporary effective protection conditionalupon export promotion (EPconEP) can hardly beequated with trade liberalization. Recent criticisms(Baer et al., 1999) of attempts by an earlier genera-tion (for example, Ian Little, Jagdish Bhagwati, AnneKrueger) to accommodate the North-East AsianEPconEP experience within their fundamentalist freetrade advocacy paradigm, have exposed the intellec-tual sophistry of neo-classical trade economists intrying to explain away the North-East Asian successin requiring export promotion as a condition for tem-porary (national) market protection.

Besides more modest growth as well as indus-trialization, the South-East HPAEs (includingSingapore) were much more reliant upon FDI com-pared to Japan, the Republic of Korea and TaiwanProvince of China. The much greater South-EastAsian dependence on FDI raises disturbing questionsabout the actual nature of industrial and technologi-cal capacities and capabilities in these economies,


especially in their most dynamic and export-orientedsectors. This, in turn, raises concerns about thesustainability of their growth and industrializationprocesses, especially if they are later deemed lessattractive as sites for further FDI, for example as moreattractive alternative locations become available.

B. South-East Asian weaknesses

In recent years, there has been growing recog-nition of major structural and systemic differencesamong the eight HPAEs studied by the World Bank(1993). Of these, Indonesia, Malaysia and Thailandhave been increasingly grouped as second-tier orsecond-generation South-East Asian NICs, with char-acteristics quite different from the others, and ofcourse, even among themselves. It has been arguedthat industrial policy or selective state interventionhas, for various reasons, been of much poorer qual-ity and less effective in these economies. Instead,there have been other state interventions motivatedby less developmental considerations, especially inIndonesia and Malaysia (Jomo et al., 1997). It ap-pears that such interventions bear some of theresponsibility for the vulnerability of the second-tierSouth-East Asian NICs to the factors that precipi-tated the mid-1997 financial crisis in the region.

A longer-term view of the crisis would, ofcourse, have to recognize the vulnerability of exist-ing financial systems to such “exogenous” shocks.The central banks in the region clearly fell short ofthe new challenges faced (Hamilton-Hart and Jomo,2001). National-level central banking faced a newsituation with the new international monetary sys-tem that emerged after abandonment by the UnitedStates of the Bretton Woods framework in 1971.Further international financial liberalization from the1980s on added to the new problems for the nationalmonetary authorities precisely when the role of gov-ernment in economic affairs was coming undergreater pressures for economic liberalization. Thefailure of institutional and regulatory reform to riseto new challenges posed by the changing interna-tional as well as domestic situations has to beacknowledged.

It would be erroneous to view the crises as dueto “crony capitalism” or to some similar failure ofthe policy and institutional framework supporting theaccelerated development of industrial capacities andcapabilities in the region. Yet, it would be equallyfallacious to regard the concerned economies as in-

nocent bystanders bearing no responsibility whatso-ever for what was happening. Instead, the region’svulnerability to crisis was due to inappropriate andeven irresponsible earlier policies, with importantadverse macroeconomic implications.

While official efforts to accelerate industrialtechnological progress in Indonesia, Malaysia andThailand have increased, at least since the late 1980s,the South-East Asian trio remained well behind theRepublic of Korea, Taiwan Province of China andSingapore. Domestic political priorities have oftenneglected technology policies, while policy initia-tives have also been constrained by the weakcommitments of the governments concerned. Thedominant position of foreign firms in the most dy-namic manufacturing sectors has also served as amajor deterrent to more pro-active technology de-velopment efforts. All too often, technology policieshave not been sensitive enough to sector- or indus-try-specific conditions. More worryingly, the scopefor discretionary policies has become more con-strained as global regulatory frameworks areincreasingly defined by international organizationswith enforcement capacities, as well as effectivelycoordinated and articulated investor demands. None-theless, there still is much scope and potential forinformed technology policies in the region.

With accelerated globalization and economicintegration in the past decade, the international in-vestment environment, especially in the East Asianregion, has changed considerably. Taking into con-sideration the fresh constraints imposed by newinternational regulations and commitments, as wellas the more sophisticated industries in some of theseeconomies, investment policy reform was alreadyoccurring before the 1997/98 crises. However, thecrises and its aftermath, including the conditionalitiesimposed by IMF on Indonesia and Thailand for emer-gency credit facilities, have also introduced newconstraints. Attracting new “green-field” investmentsto restore and sustain growth as well as structuralchange is all the more urgent as so much recent FDIin the region has involved mergers and acquisitions.

Most accounts of the East Asian miracle haveemphasized the key contributions of educational ef-forts in raising the quality of human resourcesthroughout the region. However, once again, the ac-tual South-East Asian record in this regard has fallenwell short of the other HPAEs (Booth, 1999). Withthe exception of Singapore, educational achieve-ments in South-East Asia, including in the South-EastAsian trio, have been grossly inferior to those in the


other HPAEs. While the region’s earlier achievementsin extending primary and lower secondary school-ing have probably contributed to rapid its growth andlabour-intensive industrialization, these limited edu-cational gains may well serve as fetters to furtherprogress. (Ironically, the country with the highestshare of tertiary education in the region – the Philip-pines – has not had a particularly impressive economicgrowth record for a complex variety of reasons.)There is now considerable cause for concern thatrapid structural change, industrialization and produc-tivity gains may not be achievable in the future owingto the region’s poor educational efforts. Such find-ings and comparisons compel a reconsideration ofthe facile World Bank policy recommendation thatgovernments should concentrate on enhancing hu-man resources, but only subsidize primary schooling.

Comparing the South-East Asian trio with theRepublic of Korea and Taiwan Province of China, itis now quite clear that the latter two economies notonly achieved far more in terms of growth, industri-alization and structural change, but that incomeinequality in them has been significantly lower aswell (Jomo, 1999). While their better economic per-formance was probably due to more effectivegovernment interventions, especially selective indus-trial policy, lower inequality was probably due tosignificant asset (especially land) redistribution be-fore the high growth period, i.e. more equitable“initial conditions”. However, there is also troublingevidence that economic liberalization in recent yearsmay well have exacerbated inequalities in both EastAsian groups.

Evidence from other developing countries(Ganuza et al., 2000) suggests that more equitablegrowth has been achieved elsewhere with policymixes combining three elements: first, avoiding amacroeconomic mix of real exchange rate apprecia-tion and high domestic interest rates; second, developingand maintaining flexible systems of well targeted ex-port incentives; third, having appropriate prudentialfinancial regulation as well as capital controls to containthe negative consequences of capital flow surges.

IV. The East Asian débâcle

Although there has been considerable workcritical of the East Asian record and potential, noneactually anticipated the East Asian débâcle of 1997/98 (Krugman, 1994). Although some of the weak-nesses identified in the literature did make the region

economically vulnerable, none of the critical writ-ing seriously addressed one crucial implication ofthe greater role of foreign capital in South East Asia,in particular with regard to international financialliberalization, which became more pronounced in the1990s. As previously noted (Jomo, 1998), dominanceof manufacturing activities – especially the most tech-nologically sophisticated and dynamic ones – by foreigntransnationals subordinated domestic industrial capi-tal in the region, allowing finance capital, bothdomestic and foreign, to become more influential.

In fact, financial capital developed a complexsymbiotic relationship with politically influentialrentiers, now dubbed “cronies” in the aftermath of1997/98. Although threatened by the full implica-tions of international financial liberalization, South-East Asian financial interests were quick to identifyand secure new possibilities of capturing rents fromarbitrage as well as other opportunities offered bygradual international financial integration. In theseand other ways (Gomez and Jomo, 1999; Khan,2000), transnational dominance of South-East Asianindustrialization facilitated the ascendance and con-solidation of financial interests and politically influ-ential rentiers.

This increasingly powerful alliance was prima-rily responsible for promoting financial liberalizationin the region, both externally and internally. How-ever, insofar as the interests of domestic financialcapital did not entirely coincide with internationalfinance capital, the process of international finan-cial liberalization was partial. The processes werealso necessarily uneven, considering the variety ofdifferent interests involved and their varying lobby-ing strengths in different parts of the region.

History too was not irrelevant. For example, thebanking crisis in Malaysia in the late 1980s servedto ensure a prudential regulatory framework whichchecked the process from becoming as in Thailand,where caution was thrown to the wind as early ex-ternal liberalization measures succeeded in securingcapital inflows. Yet, in both countries such flows werewanted to finance current account deficits, princi-pally due to service account deficits (mainly forimported financial services as well as investmentincome payments abroad) and growing imports forconsumption, speculative activity in regional stockmarkets, and output of non-tradeables, mainly in theproperty (real estate) sector. There is little evidencethat such capital inflows contributed significantly toaccelerating the pace of economic growth, especiallyof the tradeable sectors of the economy. Instead, it is


likely that they contributed greatly to the asset pricebubbles, whose inevitable deflation was acceleratedby the advent of the crisis, with its devastating eco-nomic, social and political consequences.

A. Crisis and contagion

After months of international speculative at-tacks on the Thai baht, the Bank of Thailand let itscurrency float from 2 July 1997, allowing it to dropsuddenly. By mid-July 1997, the currencies of Indo-nesia, Malaysia and the Philippines had also fallenprecipitously after being floated, with their stockmarket price indices following suit. In the followingmonths, currencies and stock markets throughout theregion came under pressure as easily reversible short-term capital inflows took flight in herd-like fashion.In November 1997, despite the Republic of Korea’srather different economic structure, the won too hadcollapsed after withdrawal of official support. Mostother economies in East Asia were also under con-siderable pressure, either directly (e.g. the attack onthe Hong Kong dollar) or indirectly (e.g. due to thedesire to maintain competitive cost advantage againstthe devalued currencies of South-East Asian export-ers).

Contrary to the impression conveyed mainly bythe business media as well as by IMF, there is stillno consensus on how to understand and characterizethe crisis. One manifestation of this has been thedebates between IMF and its various critics over theappropriateness of its negotiated programmes in In-donesia, the Republic of Korea, and Thailand. Whilepolicy debates have understandably captured the mostattention, especially with the public at large, the EastAsian crises have also challenged previously ac-cepted international economic theories.

However, contrary to the popular impressionpromoted by the Western-dominated financial me-dia of “crony capitalism” as the main culprit, mostserious analysts now agree that the crisis began es-sentially as a currency crisis of a new type, differentfrom those previously identified with either fiscalprofligacy or macroeconomic in-discipline. A grow-ing number also seem to agree that the crisis startedoff as a currency crisis and quickly became a moregeneralized financial crisis, before impacting on thereal economy because of reduced liquidity in the fi-nancial system and the consequences of inappropriateofficial policy and ill-informed herd-like market re-sponses.3

B. From miracle to débâcle

Rapid economic growth and structural change,mainly associated with export-led industrializationin the region, can generally be traced back to the mid-1980s. Then, devaluation of the currencies of all threeSouth-East HPAEs as well as selective deregulationof onerous rules helped to create attractive condi-tions for the relocation of production facilities inthese countries and elsewhere in South East Asia andChina. This was especially attractive for Japan andthe first-tier or first-generation NIEs – Hong Kong(China), the Republic of Korea, Singapore and Tai-wan Province of China – most of which experiencedcurrency appreciations, tight labour markets andhigher production costs. This sustained export-ori-ented industrialization well into the 1990s, and wasaccompanied by the growth of other manufacturing,services and construction activities.

High growth was sustained for about a decade,during much of which fiscal surpluses were main-tained, monetary expansion was not excessive andinflation was generally under control (see Appendixtable 1). Table 1 shows various summary macroeco-nomic indicators for the 1990s, with greater atten-tion to the period from 1996. Prior to 1997, thesavings and investment rates were high and rising inall three South-East Asian economies. Foreign sav-ings supplemented high domestic savings in all foureconomies, especially in Thailand and Malaysia.Unemployment was low, while fiscal balances gen-erally remained positive up to 1997/98.

This is not to suggest, however, that the funda-mentals were all alright in East Asia (Rasiah, 2001).As table 1 shows, the incremental capital-output ratio(ICOR) rose in all three South-East Asian economiesduring the 1990s before 1997, with increase greatestin Thailand and least in Indonesia. The rising ICORsuggests declining returns to new investments be-fore the crisis. Export-led growth had been followedby a construction and property boom, fuelled by fi-nancial systems favouring such “short-termist” in-vestments – involving loans with collateral, whichbankers like – over more productive, but also seem-ingly more risky investments in manufacturing andagriculture. The exaggerated expansion of investmentin such non-tradeables exacerbated their current ac-count deficits. Although widespread in East Asia,for various reasons, the property-finance nexus wasparticularly strong in Thailand, which made it muchmore vulnerable to the inevitable bursting of the bub-ble (Jomo, 1998; Pasuk and Baker, 2000).


Financial liberalization from the 1980s hadmajor ramifications in the region, as foreign savingssupplemented the already high domestic savings ratesin the region to further accelerate the rate of capitalaccumulation, albeit in increasingly unproductiveactivities, owing to the foreign domination of mostinternationally competitive industries in the region.Consequently, several related macroeconomic con-cerns had emerged by the mid-1990s from the rapidgrowth of the previous decade.

First, the savings-investment gap had histori-cally been financed by heavy reliance on FDI as wellas public sector foreign borrowings, with the latterdeclining rapidly from the mid-1980s. Both FDI andforeign debt, in turn, caused investment income out-flows abroad.4 In the 1990s, the current accountdeficit5 was increasingly financed by short-term capi-tal inflows, as in 1993 and 1995/96, with disastrousconsequences later with the subsequent reversal ofsuch flows. Many recent confidence restoration

Table 1

EAST ASIA FOUR: MACROECONOMIC INDICATORS, 1990–1999

Unemployment rate Savings/GDP

1990 1996 1997 1998 1999 1990–95 1996 1997 1998 1999

Indonesia n.a. 4.1 4.6 5.5 6.3 31.0 26.2 26.4 26.1 23.7Malaysia 6.0 2.5 2.4 3.2 3.0 36.6 37.1 37.3 39.6 38.0Rep. of Korea 2.4 3.0 2.6 6.8 6.3 35.6 33.7 33.3 33.8 33.5Thailand 4.9 1.1 0.9 3.5 4.1 34.4 33.0 32.5 34.9 31.0

Investment/GDP (Savings-investment)/GDP

1990–95 1996 1997 1998 1999 1990–95 1996 1997 1998 1999

Indonesia 31.3 29.6 28.7 22.1 19.3 -0.3 -3.4 -2.3 4.0 4.4Malaysia 37.5 42.5 43.1 26.8 22.3 -0.9 -5.4 -5.8 12.8 15.7Rep. of Korea 36.8 36.8 35.1 29.8 28.0 -1.2 -3.1 -1.8 4.1 5.5Thailand 41.0 41.1 33.3 22.2 21.0 -5.6 -8.1 -0.9 12.8 10.0

Incremental capital-output ratios

1987–89 1990–92 1993–95 1997 1998 1999

Indonesia 4.0 3.9 4.4 1.7 0.4 1.8Malaysia 3.6 4.4 5.0 3.9 28.2 4.3Rep. of Korea 3.5 5.1 5.1 4.2 -15.1 3.2Thailand 2.9 4.6 5.2 12.9 -11.5 14.5

Fiscal balance/GDP

1990–95 1996 1997 1998 1999

Indonesia 0.2 1.4 1.3 -2.6 -3.4Malaysia -0.4 0.7 2.4 -1.8 -3.2Rep. of Korea 0.2 0.5 -1.4 -4.2 -2.9Thailand 3.2 2.4 -0.9 -3.4 -3.0

Source: Radelet and Sachs (1998: table 11); ADB (1999); Bank of Thailand, Bank Indonesia, Bank of Korea, Bank NegaraMalaysia.


measures seek to induce such short-term inflows onceagain, but they cannot be relied upon to address theunderlying problem in the medium to long term. Al-though always in the minority, foreign portfolioinvestments increasingly influenced the stock mar-kets in the region in the 1990s. With incompleteinformation exacerbated by limited transparency,their regional presence, the biased nature of fundmanagers’ incentives and remuneration and theshort-termism of their investment horizons, foreignfinancial institutions were much more prone to herdbehaviour, and thus contributed most decisively toregional contagion.

Second, there was an explosion of private sec-tor debt in the 1990s, especially from abroad, notleast because of the efforts of “debt-pushers” keento secure higher returns from the fast-growing re-gion.6 Commercial banks’ foreign liabilities alsoincreased quickly as the ratio of loans to GNP roserapidly during the period.

Overinvestment of investible funds, especiallyfrom abroad, in non-tradeables only made thingsworse, especially on the current account. Only a smallproportion of commercial banks and other lendingagencies went to manufacturing and other productiveactivities. This share is likely to have been even smallerwith foreign borrowings, most of which was collater-alized with assets such as real property and stock.7

Thus, much of the inflow of foreign savingsactually contributed to asset price inflation, mainlyinvolving real estate and share prices. Insofar as suchinvestments did not increase the production of trade-ables, they actually exacerbated the current accountdeficit, rather than alleviated it – as they were thoughtto be doing. This, in turn, worsened the problem of“currency mismatch”, with borrowings in US dol-lars invested in activities not generating foreignexchange.

As a high proportion of these foreign borrow-ings were short-term in nature and deployed tofinance medium- to long-term projects, a “term mis-match” problem also arose. According to the Bankfor International Settlements (BIS) (Asian Wall StreetJournal, 6 January 1998), well over half of the foreignborrowings by commercial banks were short-term innature: in Malaysia 56 per cent, in Thailand 66 percent, in Indonesia 59 per cent, and in the Republic ofKorea 68 per cent.

More generally, the foreign exchange risks ofinvestments generally increased, raising the vulner-

ability of these economies to the maintenance of cur-rency pegs to the US dollar.8 The pegs encouraged agreat deal of un-hedged borrowing by an influentialconstituency with a strong stake in defending the pegsregardless of their adverse consequences for theeconomy. Owing to foreign domination of export-oriented industries in South East Asia, unlike in NorthEast Asia, there was no strong domestic export-ori-ented industrial community to lobby for floating ordepreciation of the South-East Asian currencies de-spite the obvious adverse consequences of the pegsfor international cost competitiveness. Instead, afterpegging their currencies to the US dollar, from theearly 1990s and especially from the mid-1990s, mostSouth-East Asian central banks resisted downwardadjustments to their exchange rates, which wouldhave reduced, if not averted some of the more dis-ruptive consequences of the 1997/98 currency col-lapses.9 Yet, it is also now generally agreed that the1997/98 East Asian crises saw tremendous “over-shooting” in exchange rate adjustments well in ex-cess of expected “corrections”.

It is generally agreed that the affected South-East Asian economies were characterized by thefollowing key fundamentals:

(i) viability of domestic financial systems;10

(ii) domestic output and export responsiveness tonominal devaluations;11

(iii) sustainability of current account deficits;12

(iv) high savings rates and robust public finances.

C. Consequences of financial liberalization

In Kaminsky and Reinhart’s (1996) study of71 balance-of-payments (BoP) crises and 25 bank-ing crises during the period 1970–1995, there wereonly three banking crises associated with the 25 BoPcrises during 1970–1979. However, there were 22banking crises which coincided with 46 BoP crisesover 1980–1995, which the authors attribute to the1980s financial liberalization, with a private lendingboom culminating in a banking crisis, and then acurrency one. Montes (1998) attributes the South-East Asian currency crisis to the “twin liberali-zations” of domestic financial systems and openingof the capital account. Financial liberalization in-duced new behaviour in financial systems, notably:

(i) domestic financial institutions had greater flex-ibility in offering interest rates to secure fundsdomestically and in bidding for foreign funds;


(ii) they became less reliant on lending to the gov-ernment;

(iii) regulations, such as credit allocation rules andceilings, were reduced;

(iv) greater domestic competition meant that ascend-ance depended on expanding lending portfolios,often at the expense of prudence.

Looking at 57 countries during the 1970–1996period, Carleton et al. (2000) find that inflationarymacroeconomic policies and small foreign reservesstocks reliably predicted currency collapses. Theyargue that since the probability of Indonesia, Malay-sia, the Republic of Korea and Thailand experiencinga currency collapse in 1997 was about 20 per cent,and all four currencies (and economies) collapsed –rather than just one, as expected – financial conta-gion is a better explanation than weak domesticfundamentals.

Clearly, investor panic was the principal causeof the Asian financial crisis (McKibbin, 1998;Montes, 1998). The tightening of macroeconomicpolicies in response to the panic served to exacer-bate rather than check the crisis. Economic disastersare not necessarily punishment for economic sins,and while “cronyism” is wrong, it was not the causeof the East Asian crises. And as the recent East Asiancrisis has demonstrated, even sound macroeconomicfundamentals cannot guarantee immunity from con-tagion and crisis.

One of the most cited crisis explanations sug-gests that it stemmed from the banking sector as aresult of imprudent expansion and diversification ofdomestic financial markets, fuelled by short-termprivate borrowings. While this may have been trueof Thailand, it was certainly less so of Indonesia,Malaysia, the Philippines and the Republic of Korea(in order of decreasing relevance). Instead, the sig-nificance of contagion cannot be exaggerated, as “thedifferences raise questions about how sensitive thecurrency knockdowns (and the associated divestmentfrom these economies) are to economic fundamen-tals” (Montes, 1998: 3).

Although financial systems in the region arequite varied and are hardly clones of the Japanese“main bank” system (as is often wrongly alleged),they had nevertheless become prone to similar assetprice “bubbles”, albeit for somewhat different rea-sons. Arguably, the more bank-based systems ofIndonesia, the Republic of Korea and Thailand hada stronger nexus of this kind compared to, say, Ma-

laysia’s much more market-oriented financial sys-tem. Rapid growth, on the basis of export-orientedindustrialization from the late 1980s, gave rise to ac-celerated financial expansion, which contributed toasset price bubbles (including property booms), bothin more market-oriented or “Anglo-American” Ma-laysia as well as in the other more bank-orientedeconomies badly hit by the crises.13

Little has been achieved by insisting that thecrisis should not have happened since East Asianeconomic fundamentals were fine, even if that werecompletely true. In some instances, such official de-nials exacerbated the problem as the authorities didnot seem to be responding to ostensible problems inways deemed appropriate by market opinion mak-ers. Unfortunately, as East Asia has painfully learnt,financial markets are driven by sentiments as muchas by fundamentals. Hence, although much more se-rious current account deficits in 1995, for instance,did not result in a crisis, it does not mean that aneconomy can maintain such deficits indefinitely with-out being vulnerable to speculative attack or loss ofconfidence.

One cannot, for example, liberalize the capitalaccount, and then complain when short-term portfo-lio investors suddenly withdraw following theirwhims and fancies. Capital controls can make it dif-ficult and/or costly to rapidly withdraw capital froman economy. Many governments treat FDI very dif-ferently from portfolio investments. Some authoritiesare trying to distinguish between speculative invest-ments by hedge funds that are clearly short-termistfrom, say, pension funds with more medium-termorientations.

In the early and mid-1990s, some South-EastAsian economies had become excessively reliant onsuch short-term capital inflows to finance their cur-rent account deficits. This problem was exacerbatedby excessive imports to manufactures more non-exportables, such as buildings, infrastructure andheavily protected import substitutes. Ostensibly, pru-dent financial institutions often preferred to lend forreal property and stock purchases, and thus secureassets with rising values as collateral, rather than toprovide credit for more productive ends.

While foreign banks were more than happy tolend US dollars at higher interest rates than avail-able in their home economies, East Asian businesseswere keen to borrow at lower interest rates than wereavailable domestically. The sustained dollar pegs ofthe South-East Asian currencies may have induced


some moral hazard by discouraging borrowers fromhedging their loans, but there is little systematic evi-dence of the extent of this problem. In any case, theexistence of well-developed swap markets allowedSouth-East Asian companies to tap into foreign capi-tal markets, at low cost, by swapping away thecurrency risk.

Hence, many such loans remained unhedged asSouth-East Asian currencies had been pegged to theUS dollar since the 1970s, despite the official fic-tions of exchange rates moving with the baskets ofthe currencies of their major foreign trading part-ners. The growth in foreign banking in the region inthe 1990s led to lending competition reminiscent ofthe loans to third world governments in the late 1970s(which led to the debt crisis of the 1980s). However,the new belief in international policy-making circlesbefore the crisis was that such accumulation of pri-vate sector debt did not matter as long as public sectordebt was reined in.

Meanwhile, portfolio investors moved intonewly emerging stock markets in East Asia with en-couragement from the International FinanceCorporation (IFC), an arm of the World Bank. InMalaysia, for example, they came in a big way in1993, only to withdraw even more suddenly in early1994, leaving most retail stockholders in the lurch.The government introduced some capital controlmeasures, only to withdraw them later in 1994. Un-fortunately, policy makers did not learn the lessonsfrom that experience as the new unsustainable stockmarket build-up from 1995 sent stock prices soaringonce again despite declining price-earnings ratios.

Thus, the East Asian currency and financial cri-ses since mid-1997 have been partly caused byfinancial liberalization and the consequent undermin-ing of monetary and financial governance. The“managed pegs” of the region’s currencies to the USdollar and the encouragement of foreign capital in-flows – into the recently opened-up stock markets aswell as in the form of borrowings, often on a short-term basis14 – financed the current account deficits.They also ensured that foreign savings supplementedthe already high domestic savings rate to raise in-vestment rates in the region, contributing to aspiralling inflationary bubble of share and real prop-erty prices. The peg not only encouraged unhedgedborrowings and portfolio investments from abroad,but also became a target for currency speculators asregional currencies appreciated with the US dollarfrom mid-1995, in spite of declining export competi-tiveness and growth.

Perceiving the East Asian region as much moreintegrated than it actually is, the panicky investmentdecisions of fund managers were typically “herd-like”,15 causing “contagion” throughout the region.The very nature and magnitude of hedge fund opera-tions16 tended to exacerbate these phenomena, withdisastrous snowballing consequences for the region.Other international, regional and, increasingly, localcurrency speculators and hedgers also contributedby reacting in their own perceived self-interest tosupposed market trends, rather than as part of somegrand conspiracy.

With the currency collapses, the assets acquiredby portfolio and other investors in the region depre-ciated correspondingly in value, precipitating an evengreater sell-out and panic, causing herd behaviourand contagion to spread across national borders tothe rest of the region. Meanwhile, liberalizing thecapital account essentially guaranteed residents andnon-residents ease of exit, as well as fewer limita-tions on nationals holding foreign assets, thusinadvertently facilitating capital flight.

Thus, financial liberalization allowed lucrativeopportunities for taking advantage of falling curren-cies, thus accelerating and exacerbating the volatil-ity of regional currency and share markets. All this,together with injudicious official responses, trans-formed the inevitable “correction” of overvalued cur-rencies in the region into collapse of the currenciesand the stock markets of the region as panic set in,aggravated by “herd” behaviour and “contagion”.

D. Crises of a new type

It seems fair to say that no one fully anticipatedthe crisis in East Asia, mainly because it was a crisisof a new type. Some observers argued that there wereimportant parallels with the Mexican tequila crisisof 1995, while others emphasized the differences(Kregel, 1998). There were, of course, sceptics whoregarded the claims of an East Asian economic mira-cle as somewhat exaggerated, albeit for differentreasons: for example, because they had not achievedmuch productivity growth and would eventually runup against diminishing returns (Krugman, 1994). Butthese were different criticisms of the East Asian mira-cle and certainly did not anticipate, let alone predict,the East Asian débâcle of 1997/98.

It is now clear that the East Asian crisis dif-fered from conventional currency crisis scenarios inat least several important ways (Krugman, 1998c):17


(i) the absence of the usual sources of currencystress, whether fiscal deficits or macroeconomicin-discipline;18

(ii) the governments did not have any incentive toabandon their pegged exchange rates, for in-stance to reduce unemployment;

(iii) the pronounced boom-bust cycles in asset prices(real property and stock markets) preceded thecurrency crisis, especially in Thailand, wherethe crisis began;

(iv) financial intermediaries have been key playersin all the economies involved;

(v) the severity of the crisis in the absence of strongadverse shocks;

(vi) the rapid spread of the initial crisis in Thailand,even to economies with few links or similari-ties to the first victims.

Very importantly then, the traditional indicesof vulnerability did not signal a crisis, as the sourceof the problem was not to be found in the govern-ments per se or even in national income accounts.The (mainly private) financial intermediaries were“not part of the governments’ visible liabilities untilafter the fact”. Other issues also need to be takeninto account for an adequate analysis of the EastAsian crisis:

(i) the financial crises had very severe adverse ef-fects on growth by disrupting the productivecontribution of financial intermediation;

(ii) the East Asian crises not only involved exces-sive investments, but also unwise investments;

(iii) the huge real currency depreciations causedlarge declines in output, and seemed to do littleto promote exports;

(iv) other kinds of market failure – for example, herdbehaviour – need to be taken into account.

Furman and Stiglitz (1998: 101) emphasize thateconomic downturns caused by financial crises arefar more severe and have longer lasting effects thanthose caused by inventory cycles. High leveragingby companies and high lending for asset price(stock or property market) booms enhance financialfragility. Increased insolvencies disrupt the creditmechanism. Large unanticipated interest rate in-creases may not only precipitate financial crises, butare also likely to cause economic downturns as thevalue of bank assets and highly indebted firms col-lapse. Also, such adverse effects are likely to persistwell after the interest rate has returned to more nor-mal levels.

Besides asset price bubbles, excessive invest-ments and other problems caused by moral hazarddue to implicit government guarantees for weaklyregulated financial intermediaries as well as the ex-change rate peg, a more comprehensive analysis mustalso consider the following phenomena:

(i) the implications of the growth in currency trad-ing and speculation for the post-Bretton-Woodsinternational monetary system;

(ii) the reasons for the South-East Asian monetaryauthorities to defend their quasi-pegs againstthe strengthening US dollar, despite its obviousadverse consequences for export competitive-ness and hence for growth;

(iii) the consequences of financial liberalization,including the creation of conditions which havecontributed to the magnitude of the crises;

(iv) the role of herd behaviour in exacerbating thecrises;

(v) other factors accounting for the contagion ef-fects.

E. Reversible capital flows

Growing attention has been given to the role ofreversible capital flows into the East Asian region asthe principal cause of the 1997/98 crisis. It is increas-ingly widely accepted that the national financialsystems in the region did not adapt well to interna-tional financial liberalization (Jomo, 1998). Thebank-based financial systems of most of crisis-hitEast Asia were especially vulnerable to the suddendrop in the availability of short-term loans, as inter-national confidence in the region dropped suddenlyduring 1997. Available foreign exchange reserveswere exposed as inadequate to meet financial obli-gations abroad, requiring governments to seektemporary credit facilities to meet such obligationsmainly incurred by their private sectors.

Data from BIS show that the banks were re-sponsible for much of this short-term debt, though,of course, some of it consisted of trade credit andother short-term debt deemed essential to ensuringliquidity in an economy. However, the very rapidgrowth of short-term bank debt during stock marketand property boom periods suggests that much short-term debt was due to factors other than trade creditexpansion. In Malaysia, the temporary capital con-trols introduced in early 1994 by the central bankmomentarily dampened the growth of such debt, but


by 1996 and early 1997 a new short-term borrowingfrenzy was quite evident, involving not only the banksbut also other large private companies with enoughpolitical influence to circumvent central bank guide-lines.

As table 2 shows, in Indonesia, Malaysia andThailand, the non-bank private sector was the majorrecipient of international bank loans, accounting formore than 50 per cent of total foreign borrowings bythe end of June 1997, i.e. well above the developingcountry average of slightly under half. In contrast,65 per cent of borrowing in the Republic of Koreawas by banks, with only 31 per cent by the non-bankprivate sector. Government borrowings were low, andlowest in Malaysia and the Republic of Korea, al-though the data does not allow us to differentiate thestate-owned public companies or partially private,but corporatized former fully state-owned enterprises.

Appendix tables 2a, 2b, 2c and 2d show the re-markable growth of (mainly private) foreign debt inthe early and mid-1990s, especially in the three mostexternally indebted economies of Indonesia, the Re-public of Korea and Thailand. While FDI grew in allfour economies in the 1990s, it was most modest inthe Republic of Korea. Profit remittances on FDIwere least from the Republic of Korea and Thailand,and highest from Malaysia, reflecting its greater rolehistorically, although FDI in Indonesia was actually

Table 2

LENDING BY BIS REPORTING BANKS TO FOUR EAST ASIAN ECONOMIES BY SECTOR,AS OF END-JUNE 1997

(US$ billion)

DevelopingRep. of Korea Thailand Indonesia Malaysia countries

Total Borrowings 103.4 69.4 58.7 28.8 744.6

Banks 67.3 26.1 12.4 10.5 275.3

(per cent) (65.1) (37.6) (21.1) (36.5) (37.0)

Private non-bank 31.7 41.3 39.7 16.5 352.9

(per cent) (30.6) (59.5) (67.6) (57.3) (47.4)

Government 4.4 12.0 6.5 1.9 115.6

(per cent) (4.3) (17.3) (11.1) (6.6) (15.5)

Source: Bank for International Settlements.

higher in 1995/96. Portfolio equity flows into all foureconomies grew greatly in the mid-1990s.

External debt as a share of export earnings rosefrom 112 per cent in 1995 to 120 per cent in 1996 inThailand and from 57 per cent to 74 per cent overthe same year in the Republic of Korea, but actuallydeclined in Indonesia and grew more modestly inMalaysia. By 1996, reserves as a share of externaldebt were only 15 per cent in Indonesia, 30 per centin the Republic of Korea, 43 per cent in Thailandand 70 per cent in Malaysia. By 1997 this ratio haddropped further to 15 per cent in the Republic ofKorea, 29 per cent in Thailand, and 46 per cent inMalaysia, reflecting the reserves lost in futile cur-rency defence efforts. Despite recessions in 1998,reserves picked up in all four economies, mainly dueto the effects of currency devaluations on exportsand imports. The short-term debt share of total ex-ternal debt in 1996 stood at 58 per cent in theRepublic of Korea, 41 per cent in Thailand, 28 percent in Malaysia, and 25 per cent in Indonesia.

Table 3 shows that much of lending to develop-ing countries was done by Japanese, German andFrench BIS-reporting banks, with United States andUnited Kingdom banks being far less significant.This pattern was quite different from that of lendingbefore the 1980s debt crises, and suggests that Anglo-American banks were generally far more reluctant


to lend in the 1990s following their experiences inthe 1980s. There is little evidence to suggest that suchbanks were more averse to lending either to govern-ments or to developing economies. The pattern oflending in the late 1970s and early 1980s suggeststhe contrary.

From the beginning of the decade, Malaysiasustained a current account deficit. Overinvestment

of investible funds in non-tradeables only madethings worse. Insofar as such investments – for ex-ample, in power generations and telecommunications– did not contribute to export earnings, they aggra-vated the problem of currency mismatch, with foreignborrowings invested in activities not generating for-eign exchange. An additional problem of “termmismatch” also arose, as a high proportion of theseforeign borrowings were short-term in nature (ta-ble 4), but were deployed to finance medium- tolong-term projects.

Foreign capital inflows into East Asia aug-mented the high domestic savings rate to raise thedomestic investment rate as well as East Asian in-vestments abroad in the 1990s. Thus, though thereis some evidence that foreign capital inflows mayhave adversely affected the domestic savings rateindirectly, foreign capital inflows generally supple-mented, rather than substituted for, domestic savings(Wong with Jomo, 2001). It is difficult to be conclu-sive on this point as the nature of foreign capitalinflows has changed significantly over time. Hence,even if earlier foreign capital inflows may once haveadversely affected domestic savings, it is also possi-ble that the changed composition of foreign capitalinflows just before the crisis no longer adversely af-fected domestic savings.

Increased foreign capital inflows have reducedforeign exchange constraints, allowing the financ-ing of additional imports, but thus also inadvertently

Table 3

EXPOSURE OF BIS AREA REPORTING BANKSTO NON-BIS BORROWERS, END-JUNE 1997

(US$ billion)

Total 1054.9

Germany 178.2

Japan 172.7

United States 131.0

France 100.2

United Kingdom 77.8

Percentage of private non-bank borrowers 45


Table 4

MATURITY DISTRIBUTION OF LENDING BY BIS REPORTING BANKSTO SELECTED ASIAN ECONOMIES, 1996

(US$ million)

All loans Under 1 year 1–2 years

June Dec. June June Dec. June June Dec. June1996 1996 1997 1996 1996 1997 1996 1996 1997

Rep. of Korea 88,027 99,953 103,432 62,332 67,506 70,182 3,438 4,107 4,139

Thailand 69,409 70,147 69,382 47,834 45,702 45,567 4,083 4,829 4,592

Indonesia 49,306 55,523 58,726 29,587 34,248 34,661 3,473 3,589 3,541

Malaysia 20,100 22,234 28,820 9,991 11,178 16,268 834 721 615



encouraging current account deficits. Finally, foreigncapital inflows have most certainly adversely affectedfactor payment outflows, export and import propen-sities, the terms of trade and capital flight, and thusthe balance of payments. These results suggest cau-tion in determining the extent to which foreign capitalinflows should be encouraged. Furthermore, theSouth-East Asian trio’s heavy dependence on FDI ingross domestic capital formation, especially formanufacturing investments, has probably also lim-ited the development of domestic entrepreneurship,as well as many other indigenous economic capa-bilities, by requiring greater reliance on foreigncapabilities, usually associated with some types ofFDI (Jomo et al., 1997).

After mid-1995 the South-East Asian currencypegs to the US dollar – which had enhanced the re-gion’s competitiveness as the dollar declined for adecade after the 1985 Plaza accord – became a grow-ing liability as the yen began to depreciate once again.The overvalued currencies became attractive targetsfor speculative attacks, resulting in the futile butcostly defence of the Thai baht and Malaysian ringgit,and the rapid regional spread of herd panic, termedcontagion. The resulting precipitous asset price col-lapses – as the share and property market bubblesburst – undermined the East Asian four’s heavilyexposed banking systems, for some (e.g. Malaysia),for the second time in little over a decade, under-

mining financial system liquidity, and causing eco-nomic recession.

Undoubtedly, international financial liberaliza-tion succeeded in temporarily generating massive netcapital inflows into East Asia, unlike many otherdeveloping and transitional economies, some ofwhich experienced net outflows. But it also exacer-bated systemic instability and reduced the scope forthe developmental government interventions respon-sible for the region’s economic miracle. In South EastAsia, FDI domination (well above the average fordeveloping countries) of internationally competitivemanufacturing had weakened domestic industrialists,inadvertently enhancing the dominance of financecapital and its influence over economic policy making.

As noted earlier, three major indicators beganto cause concern from the mid-1990s on. The cur-rent account of the balance of payments and thesavings-investment gap were recording large imbal-ances in the South-East Asian economies, especiallyMalaysia and Thailand. However, as table 5 shows,the short-term foreign debt and current account defi-cits as proportions of international reserves inMalaysia were better than in Indonesia, the Repub-lic of Korea and Thailand, thereby averting the needfor IMF emergency credit. Domestic credit expan-sion had also soared in all four countries by themid-1990s. Prior to the crisis, there had been a steady

Table 5

EAST ASIAN FOUR: DEBT SERVICE AND SHORT-TERM DEBT, 1980–1996

Current account deficit plusDebt service as short-term debt as share

a proportion of exports Short-term debt of international reserves(Per cent) (US$ billion)a (Per cent)b

1980 1992 1995 1992 1994 1995 1996 1992 1994 1995 1996

Indonesia 13.9 32.1 30.9 18.2 14.0 16.2 17.9 191 139 169 138

Malaysia 6.3 6.6 7.8 3.6 7.6 7.5 8.5 29 46 60 55

Rep. of Korea 14.5 6.9 5.8 11.9 31.6 46.6 66.6 133 125 131 127

Thailand 18.9 14.1 10.2 14.7 29.2 41.1 44.0 101 127 152 153

Source: UNCTAD (1997: table 14); World Bank (1994: tables 20 and 23; 1997: table 17).a Year-end figures.b As a percentage of reserves, measured by dividing the current account deficit plus short-term debt by international reserves

(1992 figures computed from World Bank data).


trend towards financial liberalization in East Asia,dating back to the mid-1980s. This had included bankliberalization, considerable promotion of the region’s“newly emerging” stock markets and greater capitalaccount convertibility. Thus, East Asia succeeded inattracting a great deal of capital inflow.19

F. Financial liberalization

An explosion of international financial flowsfollowed the substitution of the Bretton Woods sys-tem of fixed exchange rates with the prevailingsystem of flexible exchange rates. Strong specula-tive motives have been ascribed to most of theinternational capital flow not associated with FDI.Much recent FDI, especially into East Asia in thewake of the crisis, has been for the purpose of merg-ers and acquisitions, rather than to add new economiccapacity through green-field investments.

The demise of fixed exchange rate regimes hasalso encouraged capital account liberalization. Recentfinancial developments have resulted in a prolifera-tion of financial instruments, enabling investors todiversify their financial asset holdings. These trendsgathered steam with international financial liberali-zation in the wake of the international debt crisis ofthe 1980s, and picked up further momentum in the1990s. The volume of foreign exchange spot trans-actions had grown to well over a trillion US dollarsdaily, or more than 67 times the total value of theinternational trade in goods by 1995, or more than40 times the value of all international trade (includ-ing “invisibles” or services). The daily foreignexchange market in 1997 was estimated at US$ 1,250billion. In a world economy where foreign exchangespot transactions are now worth more than 70 timesthe total value of international commodity trade trans-actions, the financial sector has become increasinglydivorced from the real economy.

Viewed from an historical perspective then,such currency trading is hardly natural, inevitable oreven desirable. For most of human history, includ-ing that of capitalism, it has not been “integral toglobal trade in goods and services”, as claimed bythen United States Treasury Secretary Robert Rubin.In fact, as is well known, various critics have offeredvarious alternatives to the present system. With therecent proliferation of new financial instruments andmarkets, the financial sector has an even greater ca-pacity to inflict damage on the real economy. Eversince Keynes advocated “throwing sand” into the

financial system to check the potentially disastrousconsequences of unfettered liberalization, Keynesians,and others, have been wary of the financial liberali-zation advocated by ideological neo-liberals and theiroften naïve allies.

Furthermore, it is important to emphasize thatmany of the promised benefits of international fi-nancial liberalization have not been realized (Eatwell,1997):

(i) First, liberalization was expected to movefinancial resources from capital-rich to capital-poor countries.20 Instead, such net flows offinance – and of real resources – over time havebeen very modest, and if anything, going to thecapital-rich.21 Of course, most net flows to the“capital-poor” were mainly to the most attrac-tive “emerging markets”, especially in East Asiabefore 1998. The rush to convertibility andcapital control deregulation in most transition-al economies has resulted in many (e.g. theRussian Federation) becoming significant netcapital exporters!22 Such flows arguably con-tributed to asset price bubbles and, eventually,to financial panic, and thus to currency and stockmarket collapses.

(ii) Second, while liberalization was expected toenhance options and returns for savers and tolower the cost of funds to borrowers, savers havebenefited most from higher real interest rates.23

Instead, it is claimed that the lower cost of fundsin the late 1970s is attributable to the excep-tional circumstances caused by financial repres-sion, enhanced liquidity due to the availabilityof petroleum revenues and high inflation.

(iii) Third, the new financial derivatives – expectedto improve risk management – have actuallygenerated new systemic risks, especially vul-nerable to sudden changes in sentiment.24 Whilesome of the new instruments have undoubtedlyreduced some of the older sources of volatilityand instability, their creation and operationshave introduced new sources of systemic vul-nerability.

(iv) Fourth, improved macroeconomic performance– with greater investment and growth expectedfrom better allocative efficiency – has not beenrealized. Instead, overall macroeconomic per-formance has been worse than during thepost-war “golden age” before financial liber-alization.25


(v) Fifth, financial liberalization has introduced apersistent deflationary bias in economic policyas governments try to gain credibility in fi-nancial markets to avert destabilizing capitaloutflows, instead of the “healthy discipline” ongovernments expected to improve macroeco-nomic stability.

More generally, financial liberalization has in-troduced further constraints on the role of the state.Governments have reduced options in both monetaryand fiscal policies. Besides such macroeconomicpolicy limitations, the room for discretionary stateinterventions – for example, in the form of selectiveindustrial promotion so crucial to late industrializa-tion – has been much reduced. Thus, financialliberalization has greatly weakened government ca-pacity to become a developmental state. If onerecognizes the desirability of preserving the limitedbut still significant scope for monetary independence,liberalization should not be allowed to frustrate thesound development of the financial system and itseffective deployment for development purposes.26

The scope for monetary independence partly dependson the soundness of macroeconomic management aswell as political will.

Financial markets seem to function in such away as to impose their own “expectations” on thereal economy, thus defining their own “fundamen-tals” and logic, which in turn become self-fulfillingprophecies. In other words, they do not just processinformation in order to efficiently allocate resources.Since financial markets operate like beauty contestsand the real economy has no automatic tendency toconverge to full-employment growth, the presumedanalytical assumptions of other market participantsbecome imposed on the economy.

The threat of instability in the now massive capi-tal market forces both governments and privateinvestors to pursue risk-averse strategies, resultingin low growth and employment creation. A defla-tionary bias in government policy and the privatesector emerges in response to the costly risks of vio-lating the rules of the game. This is exacerbated bythe high costs of debt due to high real interest ratesowing to efforts to maintain financial stability in apotentially volatile world. Thus, “long-term pricestability” supersedes “a high and stable level of em-ployment” as the macroeconomic policy priority.

A successfully liberalized financial system,prioritizing flexibility, or the possibility of easy exittend to become necessarily fragile, as reflected in:

(i) liquidity crises, reducing real output;

(ii) private sector risk aversion, encouraging short-termism;27

(iii) public sector risk aversion, resulting in a defla-tionary policy bias;

(iv) persistent pressure for ever greater flexibility,increasing the ease of exit.

The benefits that the reduction of financial con-trols has brought to “emerging markets” must beweighed against the increased instability resultingfrom enhanced ease and speed of exit. While in-creased flows of (real) FDI generally require agree-ment to unrestricted profit repatriation, this is quitedifferent from the “instant exit” conditions demandedby financial markets.28

There is considerable evidence that in the longerterm economic development has been associated withdevelopmental states. The post-war golden age –which saw high levels of output and employment aswell as short-run efficiency – was based on thepremise of active macroeconomic management un-der the Bretton Woods system. Post-war Europeanreconstruction was achieved with tight capital con-trols. Similarly, Japan, the Republic of Korea andTaiwan Province of China all began late industriali-zation and achieved rapid capital accumulation withthe aid of capital controls.

The adverse consequences of financial dis-intermediation and of grossly undervalued currenciesfor economic development also deserve special at-tention, particularly as the crisis threatens the futureof growth and structural change in the region, notonly directly, but also as a consequence of policyresponses. The typically deflationary policies fa-voured by the international financial community aswell as others may well throw out the baby of eco-nomic development with the bath water of financialcrisis.

Some dangers associated with financial liber-alization have now become quite evident, but mostare not sufficiently recognized, let alone debated andaddressed. Most initiatives in this regard cannot beundertaken unilaterally without great cost, as mar-ket reactions to Malaysian Prime Minister Mahathir’scritical remarks in the second half of 1997 showed.The very few options available for unilateral ini-tiatives need to be carefully considered, and only im-plemented if deemed desirable. Selectively invokinginstances of bad or incompetent policy-making orimplementation does not justify leaving things to lib-


eralized markets that render systematic policy-making impossible. Instead, it emphasizes the im-portance of creating an environment and developingthe capability for good and competent policy to beeffective.

Many policies need to be actively pursuedthrough multilateral initiatives, for which govern-ments need the support of neighbours and others.Given the power of the dominant ideology that in-fuses the prevailing international system, it isvirtually impossible to assert control over the finan-cial system without a fundamental change in prioritiesand thinking by the governments of the major eco-nomic powers. The currencies of a small number ofmajor governments – Germany, Japan, the UnitedKingdom and the United States – were involved inover three quarters of currency transactions in 1995;hence, they have the capacity and capability to moni-tor and control transborder capital flows by acting inconcert.

G. The role of IMF

Critical consideration of the causes and conse-quences of the East Asian crises requires close andcareful attention to the nature and implications ofIMF “rescue” programmes and conditionalities, aswell as policies favoured by the international, as dis-tinct from the domestic, financial communities andothers affected. IMF prescriptions and conventionalpolicy-making wisdom urged bank closures, govern-ment spending cuts and higher interest rates in thewake of the crisis. Such contractionary measurestransformed what had started as a currency crisis,and then become a full-blown financial one, into acrisis of the real economy. Thus, Indonesia, Malay-sia and the Republic of Korea – that had previouslyenjoyed massive capital inflows in the form of short-term bank loans or portfolio investments – went intorecession during 1998, following Thailand, whichwent into recession in 1997.

Not only did IMF underestimate the severity ofthe collapse in all the East Asian economies, it alsounder-estimated the speed and strength of recovery(IMF, 1997, 1998; Lane et al., 1999). This suggeststhat IMF not only did not understand the causes ofthe crisis but was also incapable of designing opti-mal policies in response. There is still considerabledoubt as to whether IMF actually recognized thenovel elements of the crisis and their implications(“old medicines for a new disease”), especially at

the outset. The apparent failure of IMF to anticipatethe current crisis in its generally glowing recent re-ports on the region and also to effectively check, letalone reverse, the situation despite interventions inIndonesia, the Republic of Korea and Thailand –certainly did not inspire much confidence. And al-though the Philippines had long been under IMFprogrammes and supervision, it was not spared thecontagion.29

There is considerable international scepticismabout IMF’s role in, and prescriptions for, the EastAsian crisis. Most economists now agree that theearly IMF programmes for Indonesia, the Republicof Korea and Thailand were ill-conceived, althoughthere is little agreement over why IMF made suchmistakes. Perhaps partly out of force of habit in deal-ing with situations in Latin America, Africa, EasternEurope and elsewhere, where fiscal deficits had beenpart of the problem, IMF insisted on the same pre-scription of deflationary policies in its early policyresponses to the East Asian crisis.

Thus, many of its programmes were effectivelycontractionary in consequence, although this wassometimes disguised by poorly conceived measuresto provide social safety nets for the poor. Hence, whatstarted of as currency and financial crises, led – partlydue to IMF-recommended or imposed policy re-sponses – to economic recessions in much of theregion in 1998. The accounts, of course, vary withthe different countries involved.30

The early IMF policy prescription to raise do-mestic interest rates31 not only failed to stem capitalflight, but instead exacerbated the impact of thecrisis, with financial pain caused by currency depre-ciation, stock market collapse and rising interest rates.But even if higher interest rates succeeded in doingso, such capital flight can only be temporarilychecked, and even so, at great and permanent cost toproductive investments in the real economy. Andwhen inflows are eventually reversed in the precipi-tous manner experienced by East Asia from thesecond half of 1997, much collateral damage is in-evitable.

Despite their sound fiscal balances before thecrisis, the East Asian economies were also asked tocut government spending to restore confidence intheir currencies, despite the ominous implications foreconomic recovery. Although all the affected EastAsian economies had been running fiscal surplusesin the years preceding the crises (except Indonesia,which had a small deficit in 1996), IMF expected


the governments to slash public expenditure. Withthe possible exception of Indonesia (which could notraise the financing required), the other crisis-affectedeconomies eventually ignored this advice and beganto undertake Keynesian-style reflationary counter-cyclical measures from the second half of 1998,which has been primarily responsible for economicrecovery since.

Incredibly, the Fund did not seem to be verycognizant of the subjective elements contributing tothe crises, and seemed to approach the crises as ifthey were solely due to weaknesses in the macr-oeconomic or financial system. Examining thechanging risk premiums on Eurobonds issued by EastAsia, Woo (2000b) found evidence of “irrationalexuberance”, implying that the potential for inves-tor panic also existed. Moreover, although the riskpremiums on Thai Eurobonds increased by 10 basispoints following the July 1997 devaluation, theyjumped by four times as much with the acceptanceof the IMF programme for Thailand in August 1997.This suggests that the latter’s deflationary macroeco-nomic policies and abrupt closure of financialinstitutions had undermined, rather than restored,investor confidence.

Insolvent financial institutions should have beenrestructured in ways so as to avoid the possibility oftriggering bank runs and consequent social instabil-ity. By insisting on closing down banks and otherfinancial institutions in Indonesia, the Republic ofKorea and Thailand, IMF undermined much of theremaining confidence there, inducing further panicin the process. Anwar Nasution (2000) points outthat IMF’s way of taking insolvent banks out of theIndonesian financial system in late 1997 exacerbatedthe country’s economic crisis. He argues that theIndonesian government should have taken over theinsolvent banks temporarily – rather than have themclosed them down suddenly – to sustain credit tosolvent borrowers and to retain depositors’ confi-dence. Also, while IMF insisted on greater transpar-ency by the affected host governments and thoseunder their jurisdiction, it continued to operateunder considerable secrecy itself.

Such IMF double standards, reflected by itspriority in protecting the interests of foreign banksand governments, also compromised its ostensiblerole as an impartial agent working in the interests ofthe host economy. The burden of IMF programmesinvariably fell on the domestic financial sector and,

eventually, on the public at large, which has bornemost of the costs of adjustment and reform. The so-cial costs of the public policy responses have beenvery considerable, usually involving bailouts of muchof the financial sector and the corporate sector moregenerally.

There has been considerable unhappiness inEast Asia about how differently IMF had respondedto the East Asian crises compared to the earlier Mexi-can one. It is widely believed that IMF was far moregenerous in helping Mexico because of the UnitedStates’ interest in ensuring that the tequila crisisshould not be seen as an adverse consequence ofMexico’s joining the North American Free TradeAgreement (NAFTA). In contrast, East Asians sawIMF as far less generous and also more demandingwith all three countries, which had long seen them-selves as allies of the United States and the West.

Liabilities and other commitments to foreignbanks have invariably been given priority by theFund, even though both foreign and domestic banksmay have been equally irresponsible or imprudentin their lending practices. As BIS (1998) noted: “Inspite of growing strains in South East Asia, overallbank lending to Asian developing countries showedno evidence of abating in the first half of 1997”(Raghavan, 1998). In the year from mid-1996 to mid-1997, the Republic of Korea received US$ 15 billionin new loans, while Indonesia received US$ 9 bil-lion from the banks. Short-term lending continuedto dominate, with 70 per cent due within one year,while the share of lending to private non-bank bor-rowers rose to 45 per cent at the end of June 1997.The banks were also actively acquiring “non-tradi-tional assets” in the region, for instance in higheryielding local money markets and other debt securi-ties. Most of this lending was by Japanese andcontinental European banks.

Thus, Western and Japanese banks will emergefrom the crisis relatively unscathed and stronger thanthe domestic financial sectors, which have taken thebrunt of the cost of adjustment. Some merchant banksand other financial institutions will also be able tomake lucrative commissions from marketing sover-eign debt, as the short-term private borrowings –which precipitated the crisis – are converted intolonger-term government-guaranteed bonds under theterms of IMF programmes. Hence, IMF programmeshave been seen as primarily benefiting foreign banks,rather than the East Asian economies or people.


H. The roots of crises: a summary

Financial liberalization reduced monitoring andsupervision of banking operations and transactions,including those of a prudential nature. There was alsoa significant increase in “private banking” as well asincreased banking transactions across borders withthe proliferation of “international off-shore financialcentres” and other international banking facilitiescompeting for business. The growing dollarizationof the world economy, including international finance,has also skewed the nature of these developments inimportant ways.

Liberalization of financial services as well asof investment regulations, including liberalization ofthe capital account, reduced national oversight andmanagement of financial flows, which created con-ditions conducive to the East Asian crises following.The scope for national macroeconomic, includingmonetary, management has been considerably re-duced by various aspects of financial liberalization.Options for rentier as well as developmental initia-tives have also been significantly reduced as aconsequence.

The variety of financial regimes in East Asiado not allow for easy generalizations for the entireregion. Many observers have compared the econo-mies and regimes which have experienced majoreconomic crises since the second half of 1997 (i.e.Indonesia, Malaysia, the Republic of Korea and Thai-land) with the other HPEA economies which havenot been so badly affected – namely Hong Kong(China), Japan, Singapore and Taiwan Province ofChina, as well as China. There is no systematic evi-dence that the difference lies primarily in the extentof corruption, rent-seeking, government intervention,industrial policy, export-orientation, productivitygrowth, FDI, or democracy. Although all the econo-mies affected have liberalized their capital accounts,restrictions remain important, especially in China andTaiwan Province of China. In any case, capital ac-count liberalization may only be a necessary, but notsufficient, condition for the new type of crisis expe-rienced. The big difference seems to have been thatthe East Asian four have had low foreign exchangereserves, unlike the second group of East Asianeconomies, which have the highest reserves in theworld, and hence have been far less vulnerable tocurrency attack. Unlike Malaysia, the external liabili-ties of the three most affected economies were wellin excess of their foreign exchange reserves.

The extent to which macroeconomic fundamen-tals went awry among the affected economies variedconsiderably and, by themselves, cannot explain thefinancial collapses, although they suggest theirgreater vulnerability to currency attack and thegreater likelihood of panic. The crises have under-lined the significance of investor sentiments, andthere can be no convincing explanation for what hap-pened, especially herd behaviour, which does not takeaccount of market psychology. Hence, while confi-dence restoration must necessarily be at the top ofthe agenda for any recovery programme, institutionaland systemic arrangements should also seek to re-duce vulnerability to sudden changes in investorsentiment.

Although there have been important precursorsto the recent crises in East Asia, the market – whichis increasingly being left to its own devices – hasneither a memory nor a capacity to develop naturalimmunity to such cataclysmic shocks. It is thereforeleft to policy makers to build the necessary in-stitutions and to design the needed institutionalframework for sound developmental financialgovernance.

Thus, the recent South-East Asian débâcle canbe traced to poorly conceived and sequenced finan-cial liberalization which resulted in attracting mas-sive, but easily reversible, capital inflows into theregion. As elsewhere in the region, capital inflowsincreased substantially with international financialliberalization, especially just before the crisis. Capi-tal inflows tended to raise foreign reserves, domes-tic credit availability as well as exchange rates.

The combination of increased capital inflows,credit expansion and exchange rate appreciationraised aggregate demand more rapidly than GDP,further increasing the current account deficit. Whileadditional credit availability owing to capital inflowsmay well have stimulated total spending due to in-creased domestic investments, such inflows alsosupported consumption booms (with high importcontents) as well as speculative asset (stock or prop-erty) price bubbles. Such temporary increases indemand could not be sustained as the consequentlygreater external deficit was not sustainable. Worsestill, capital flight ensued as the bubble began to de-flate, and was accelerated by panic induced byregional contagion from the collapse of the Thai baht.Weakened prudential regulation encouraged panic,resulting in massive capital flight.


Increased private sector demand growth result-ing from trade and financial liberalization in theabsence of strong contributions from the public sec-tor or from abroad has often contributed to import-ledconsumption booms, adversely affecting domesticprivate savings rates. Such increased consumptionwas encouraged by cheaper imported goods due toimport liberalization and real exchange rate appre-ciation in the region before the 1997/98 crises. It wasalso enhanced by domestic credit expansion owingto increased capital inflows as well as domestic fi-nancial liberalization.

The currency crisis, which began in Bangkok,rapidly spread to the rest of the region, with devas-tating consequences for financial systems and realeconomies. These external shocks to financialsystems, made vulnerable by inappropriate liberali-zation, in turn precipitated sudden recessions. Theseabrupt downturns were primarily caused by systemicliquidity shocks as earlier asset price inflations weresuddenly reversed and initially gradual reversals rap-idly accelerated. Thus, regional contagion fromThailand’s baht devaluation caused regional currencyand then financial system crises. Panicky investorsand lenders quickly withdrew capital from a regionthat had become reliant on net capital inflows. Theasset price bubbles had been built on a financial houseof cards, that collapsed with devastating effects forthe real economy, not only due to liquidity dryingup, but also because of reverse wealth effects.

V. Reforms and recovery

There is considerable debate about the impli-cations of the crises for economic development,particularly over whether the East Asian experienceof the last three decades offered different lessons andprescriptions for development from those advocatedby the “counter-revolution” against developmenteconomics. As is now well known, this neo-liberalreaction has maintained that development econom-ics and its prescriptions constituted bad economics,based on distortions of neo-classical welfare econom-ics, which exaggerated the extent and implicationsof “market failure” and underestimated the likelihoodof “state failure” and its consequences.

Influential economists at the United StatesTreasury, IMF, the World Bank and elsewhere havecited the East Asian financial crisis to criticize theBank’s 1993 East Asian Miracle volume as flawed.In particular, the critics denounce the study’s ac-

knowledgement of the success of “directed credit”and what has come to be known as “financial re-straint”, authored by Joseph Stiglitz, who laterpublicly dissented on the appropriateness of IMFprescriptions for the East Asian crises, while serv-ing as Chief Economist and Senior Vice-Presidentof the World Bank until late 1999.

The crisis from mid-1997 started not long afterKrugman’s (1994) claims that East Asian growth wasnot sustainable because it was based primarily onfactor accumulation – eventually subject to dimin-ishing returns, rather than productivity growth(“perspiration rather than inspiration”). Many crit-ics, from across the intellectual spectrum, initiallysaw the East Asian currency and financial crises asvindication of Krugman’s argument, or of somevariation thereof. Often, there was more than a touchof neo-liberal triumphalism in hasty pronouncementsof the end of the Asian miracle, or in word playsof “miracle or débâcle”, “tigers or fat cats” and thelike.

A. International reform for the better?

For the first year after the East Asian crisesbegan in mid-1997, there was limited interest in theWest with respect to growing calls from East Asiaand elsewhere for reforms to the international mon-etary and financial systems. An initiative by theJapanese government in the third quarter of 1997 toset up a regional monetary facility with US$ 100 bil-lion to deal with the crisis was opposed by IMF. Theopposition was endorsed by the Western powers aswell as China, which was suspicious of Japanese in-tentions to take advantage of the crisis to secureregional leadership.

However, as noted earlier, the situation changeddramatically a year later as the East Asian crisisseemed to be spreading West, via the Russian Fed-eration and Brazil. In the United States, there was ascare on Wall Street after the collapse of the LTCMhedge fund, subsequently rescued thanks to an ini-tiative of the United States Federal Reserve Bank.The second half of 1998 saw much greater Westernconcern about the international financial system, andthe possible damage its vulnerability might cause.Various government leaders began a briefly animatedinternational discussion concerning the need for anew international financial architecture, leading tosome initiatives to promote greater international fi-nancial stability.


The new challenges at the international levelare formidable, considering the powerful vested in-terests involved, particularly in Europe, Japan andthe United States. There have been many misgivingselsewhere about the nature and volatility of the in-ternational financial system, renewed and enhancedby each new crisis, especially the recent East Asiancrisis, not least because of its new characteristics.Nevertheless, the voice of the developing countrieshas continued to weaken after the debt crisis of the1980s began to reverse the gains of the 1970s, asso-ciated with the New International Economic Orderand related initiatives.

The conditionalities imposed in the aftermathof the debt crisis, the broad range of reforms associ-ated with the World Trade Organization (WTO), andchanging transnational economic and political alli-ances have advanced economic liberalization.Meanwhile, international political developments fol-lowing the end of the cold war as well as the newconstraints on state initiatives have further under-mined the capacity for effective collective action bythe governments of developing countries. Hence, itseems unlikely that much goodwill come out of thetraumatic débâcle of 1997/98.

Contrary to the claim that “the market” willexact swift and painful punishment on governmentsand economies which do not have their macroeco-nomic houses in order, the timing, nature andconsequences of the 1997/98 financial crises in EastAsia underline the imperfect nature of financialmarkets. This was reflected in the long delay in “rec-tification”. For example, although current accountdeficits were more serious in 1995 compared to 1997,there was no rectification then, let alone “punish-ment” of the culprits – i.e. the current account deficitsin Malaysia and Thailand reached all time highs,without any commensurate adverse effect.32

Incredibly, at the September 1997 annual meet-ings of IMF and the World Bank in Hong Kong(China), the IMF policy-making Interim Committee– which represents all 181 IMF member countriesvia 24 ministers – gave the Fund a mandate to alterits Articles of Association. IMF would eventuallyhave “jurisdiction” over the capital account, in addi-tion to the current account of member countries’balance of payments, which it has had for many dec-ades.33 In December 1997, WTO also concluded itsfinancial services agreement, which basically com-mits member countries to a schedule of acceleratedliberalization of trade in financial services. Even theWall Street Journal noted that the agreement would

primarily benefit the United States and Europe, sinceit was most unlikely that the South would be in aposition to export financial services to the North.

It is therefore likely that countries of the Southwill face even greater problems with their balanceof payments as their services, and hence current ac-count deficits worsen. Much of the nascent financialservices that have emerged under protection in thesecountries is unlikely to survive international compe-tition from transnational giants enjoying economiesof scale and other advantages.

B. Macroeconomic recovery

As noted earlier, before the East Asian crisis,there were no clear macroeconomic warnings ofimminent crisis. The countries of the region sustainedhigh growth with low inflation. Their public financeswere sound, and both the external debt and the cur-rent account deficit were manageable. Thus, EastAsian government officials kept reiterating “healthyfundamentals” up to the outbreak of the full-scalecrisis. Many attempts have since been made to ex-plain the causes and consequences of the crisis, butthere has been relatively little attention to the recov-ery.

With the possible exception of Indonesia –largely owing to its complicated political transition– the other three East Asian economies are nowclearly on a path of recovery from financial crisis,the pace of which is far quicker than anticipated bymost early forecasts, including those by IMF. Hence,the speed of the recovery has been as surprising asthe earlier spread and deepening of the crisis (seethe official IMF publications during the period 1997–2000). Initial IMF predictions were that growthwould be stagnant for at least three to four years fol-lowing the crisis (a U-shaped recovery). In late 1997and early 1998, IMF failed to anticipate the sharpdownturns of 1998. Then, once deep recession wasevident, it anticipated continued recession in 1999and very modest recovery from 2000. Instead, theeconomies of Malaysia, the Republic of Korea and,arguably, Thailand have quickly recovered after somesharp drops in 1998 (a V-shaped recovery).

The turnaround in economic performance canmainly be attributed to Keynesian34 macroeconomicmeasures. Both the Malaysian and Korean econo-mies recovered as a result of reflationary macro-economic policies. Also, among financial reform


measures, the swift recapitalization of commercialbanks from mid-1998 in both Malaysia and the Re-public of Korea is now acknowledged as having beencrucial for their recovery.35 However, the restorationof bank liquidity through such measures is not whatis usually meant by the structural reforms desired byIMF. In fact, such measures have been much criti-cized as likely to perpetuate, if not exacerbate theproblem of moral hazard in the economy. After all,as Shin (2000) notes, “the injection of public moneyis necessary to revive its financial sector whether agovernment is committed to reform or not”.

Interest rates were reduced drastically – almostin defiance of IMF prescriptions – to boost corpo-rate recovery. IMF’s initial macroeconomic policyemphasis involved retrenchment. By insisting onsharply higher interest rates, corporate failuressoared, making voluntary corporate reforms evenmore difficult. Figure 1 shows interest rates peakingin Thailand in September 1997, in the Republic ofKorea in January 1998, in Malaysia in April 1998,and in Indonesia in August 1998. Of the East Asianfour, rates had risen least in Malaysia, by less thanthree percentage points. And although capital con-trols introduced in September 1998 succeeded inconsolidating the downward trend in interest rates,Thai rates soon fell below Malaysia’s from their muchhigher earlier levels. Interest rates fell throughout theregion in the second half of 1998; this was helped bychanged monetary policies in the West, and it is notclear whether Malaysia’s capital controls were re-ally necessary for bringing down interest rates bythe third quarter of 1998.

The depreciation of the region’s currenciescaused by the crisis (see table 6 and figure 2) mayalso have helped corporate recovery and contributedto improved trade balances as well as foreign reservesamong the four economies (see Appendix figures1a, 1b, 1c, 1d). Figure 2 also shows that exchangerate volatility declined significantly after mid-1998,except in Indonesia due to political instability. Ap-pendix figures 2a, 2b, 2c and 2d show that interestrates were highest when exchange rates were low-est, indicating that all four governments respondedsimilarly by raising interest rates in response to thecontagion of spreading currency crises and fallingforeign exchange rates. The self-fulfilling nature ofthe crisis suggests that little else could be done inthe face of such capital flight with open capital ac-counts. It is also difficult to determine how futilethese initial monetary policy responses actually were.

The currency depreciations generally more thancompensated for the declining export prices becauseof global price deflation of both primary and manu-factured commodities associated with internationaltrade liberalization. The Malaysian ringgit was fixedto the US dollar from early September 1998 in aneffort originally intended to strengthen its value.Fortuitously, lower US interest rates in the aftermathof the Russian, Brazilian, LTCM and Wall Street cri-ses of August 1998 served to strengthen other EastAsian currencies, causing the ringgit to be underval-ued instead from late 1998. In the Republic of Korea,to ensure exchange rate competitiveness, the authori-ties intervened in the foreign exchange market to slowdown the pace of won appreciation from late 1998.

Table 6

EAST ASIAN FOUR: EXCHANGE RATES AND DEPRECIATION AGAINST US DOLLAR, 1997–2000

Exchange rate Depreciation(Monthly average) (Per cent)

Jan. 1997– Jan. 1997– Jan. 1997–Currency Jan. 1997 Jan. 1998 July 1998 July 2000 Jan. 1998 July 1998 July 2000

Indonesia: rupiah 2,369 9,767 14,233 8,249 312.2 500.7 248.2

Malaysia: ringgit 2.491 4.363 4.151 3.800 75.2 66.7 52.6

Rep. of Korea: won 850.6 1,700 1,294 1,119 99.9 52.1 31.5

Thailand: baht 25.72 53.12 41.22 39.29 106.5 60.3 52.8

Source: Computed from Financial Times, Extel data.


Figure 1

EAST ASIAN FOUR: MONTHLY INTEREST RATES, JANUARY 1997–MAY 2000

0

5

10

15

20

25

30

Jan-

97

Mar

-97

May

-97

Jul-

97

Sep-

97

Nov

-97

Jan-

98

Mar

-98

May

-98

Jul-

98

Sep-

98

Nov

-98

Jan-

99

Mar

-99

May

-99

Jul-

99

Sep-

99

Nov

-99

Jan-

00

Mar

-00

May

-00

Inte

rest

rat

es (

per

cent

)

0

10

20

30

40

50

60

70

80

90

Inte

rest

rat

es (

per

cent

)

Rep. of Korea (LHS) Malaysia (LHS)

Thailand (LHS) Indonesia (RHS)

0

10

20

30

40

50

60

Jan-

96

Mar

-96

May

-96

Jul-

96

Sep-

96

Nov

-96

Jan-

97

Mar

-97

May

-97

Jul-

97

Sep-

97

Nov

-97

Jan-

98

Mar

-98

May

-98

Jul-

98

Sep-

98

Nov

-98

Jan-

99

Mar

-99

May

-99

Jul-

99

Sep-

99

Nov

-99

Jan-

00

Mar

-00

May

-00

Bah

t/US$

, Rin

ggit/

US$

10

0

2000

4000

6000

8000

10000

12000

14000

16000

18000R

upia

h/U

S$, W

on/U

S$10

Baht Ringgit Rupiah Won

Figure 2

EAST ASIAN FOUR: MONTHLY FOREIGN EXCHANGE RATES, JANUARY 1996–JUNE 2000


As figures 3a and 3b show, budget deficits sub-stantially increased in 1998, especially in the secondhalf of the year. While government revenues wereprobably adversely affected by the economic slow-down, government expenditure rose with efforts toreflate the economy from around mid-1998. Govern-ment funds went to recapitalize financial institutionsand for increased spending, especially for publicworks and to provide the “social safety nets” advo-cated by the Fund and the Bank. The recapitalizationof financial institutions36 was crucial for recoveryby taking out inherited systemic risk from the bank-ing system, thus restoring liquidity. The modestbudget surpluses during the early and mid-1990sbefore the crisis were replaced by significant budg-etary deficits to finance counter-cyclical measures.Thus, the balanced budgets of the pre-crisis periodwere crucial to helping overcome the crisis. It shouldbe emphasized that such Keynesian policies were notpart of IMF programmes.

Without capital controls, the East Asian econo-mies could not reverse monetary policy withoutfurther adverse effects due to international exposure.Hence, monetary policy remained cautious until mid-1998. Thus, regional macroeconomic policies couldonly be changed after conducive changes in the in-ternational economic environment. Interest ratescould only be lowered after the G-7 took concertedaction to lower interest rates and increase moneysupply to avoid financial turmoil after the Russiancrisis led to the collapse of the long-Term CapitalManagement (LTCM) hedge fund. In other words,East Asian Keynesian policies were made possibleby international responses to the fear of global fi-nancial collapse from the third quarter of 1998.Ironically, this only became possible over a year af-ter the East Asian crisis began, when it seemed tothreaten the rest of the world, especially Wall Street.

C. Reform of corporate governance37

Many institutional arrangements in the mostaffected economies probably at least once contrib-uted significantly to “catching up” and, while manyfeatures may no longer be desirable or appropriate,corporate reform advocates usually fail to even ac-knowledge that they were at least once conducive torapid accumulation and growth. This is largely dueto ideological presumptions about what constitutesgood corporate governance, usually inspired by whathas often been termed the Anglo-American modelof capitalism. From this perspective, pre-crisis eco-

nomic institutions were undesirable for various rea-sons, especially insofar as they departed from such amodel. Worse still, with minimal evidence and faultyreasoning, the 1997/98 crises in the region have beenblamed on these institutions, as if they were crisesjust waiting to happen. Not surprisingly then, fromthis perspective, thorough-going reforms should bethe top priority and the pre-crisis systems need to beabandoned altogether.

IMF pushed for radical corporate reforms claim-ing that corporate structure was at the root of thecrisis, with some reform-minded East Asian govern-ments agreeing. However, it is doubtful that corporatestructure was a major cause of the crisis, althoughthere were some symptoms of corporate distress inall the crisis-affected economies before the crisis.First, corporate profitability was deteriorating, morerapidly in Thailand but also elsewhere in East Asia.Second, indices of investment efficiency, such as theICOR, were rapidly deteriorating. Some of the econo-mies (especially the Republic of Korea and Thailand)began to experience corporate failures from early 1997.

After Indonesia, the Republic of Korea andThailand went to IMF for emergency credit facili-ties, the Fund kept emphasizing microeconomicreform as central to its recovery programme, espe-cially in the last two countries (Lane et al., 1999).The newly elected reformist governments of Thai-land and the Republic of Korea led by Chuan Leekpaiand Kim Dae Jung, agreed with IMF’s insistence onthe urgency for comprehensive corporate reforms,although there was some dissent over the Fund’spunitive macroeconomic policies. These reformsgenerally sought to transform existing corporatestructures, regarded as having caused overinvestmentand other ills, in line with ostensibly “global” Anglo-American standards. Shin (2000) describes howKorean corporate reforms sought to remould its cor-porate structure along more American lines.

From recent East Asian experiences, it wasclearly better to first improve the macroeconomicenvironment and remove systemic risks in the finan-cial system. There is no evidence whatsoever thatthe simultaneous attempts at radical corporate re-forms helped recovery in any decisive way. Theagenda for corporate reform needs to be determinedafter careful consideration of existing weaknesses,rather than by presumptions about what may be bestaccording to some textbook ideological or policy-driven agenda. An economy’s corporate structure isinevitably the consequence of evolutionary develop-ments, including cultural heritage and colonialinheritance. Most economies accommodate a diver-


-4

-3

-2

-1

0

1

2

3

4

1996 1997 1998 1999

Indonesia Thailand Republic of Korea Malaysia

Figure 3a

INDONESIA, MALAYSIA, REPUBLIC OF KOREA, THAILAND:ANNUAL BUDGET BALANCES, 1996–1999

(Per cent of GDP)

Figure 3b

MALAYSIA, REPUBLIC OF KOREA, THAILAND: QUARTERLY BUDGET BALANCES,1997Q1–1999Q4

(Per cent of GDP)

-15

-10

-5

0

5

10

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

Malaysia Thailand Republic of Korea


sity of corporate structures. Inappropriate arrange-ments would have perished unless propped up bypatrons such as the state. While others may have be-come dysfunctional owing to changing circumstances,there is no universally optimum corporate structure.

The East Asian experiences also suggest thatthe IMF programmes were generally not conduciveto corporate reforms; they tended to exacerbate cor-porate failures sharply, and made corporate as wellas financial adjustments more difficult. The EastAsian experiences, particularly those of Malaysiaand the Republic of Korea, suggest that improve-ments in macroeconomic conditions, especially in-terest rate reductions and appropriate increases ingovernment spending, were necessary to facilitateadjustments and reforms. New stock issues, assetsales and foreign capital investments, all necessaryfor corporate restructuring, only became possible withthe more buoyant economic conditions as of 1999.

It has also been argued that in all the East Asiancases, corporate reform efforts thus far have hardlysucceeded in achieving their objective of correctingthe structure of high debt and low profitability, buthave instead imposed large costs on the economy.This view is seen as self-evident in the case of Ma-laysia, in view of the regime’s approach, and forIndonesia owing to the political uncertainties sincethe crisis, but is also held to be true, albeit to lesserdegrees, for the Republic of Korea (Shin, 2000) andThailand (Pasuk and Baker, 2000).

Enterprises anywhere that are otherwise wellmanaged and profitable may find themselves in seri-ous financial distress because of developmentsbeyond their control. During the East Asian crisis,sudden and steep currency devaluations increasedfirms’ import costs and unhedged external liabilitiesdenominated in foreign currencies, usually the USdollar. As these devaluations were accompanied byfinancial crises, limited access to emergency financethreatened the very survival of firms in the affectedcountries, especially small- and medium-sized en-terprises; they faced insolvency or being taken overat “bargain basement” or “fire sale” prices, usuallyby foreign interests unaffected by the crisis. For awhole variety of microeconomic reasons, such take-overs were unlikely to result in superior management.Such elimination of otherwise viable enterpriseswould most certainly have undermined the processesof capacity and capability-building deemed essen-tial for catching-up development.

Shin (2000) argues for building a second stagecatching-up system for the Republic of Korea, in-

stead of IMF and other proposed transitions on os-tensibly Anglo-American lines. Other similararguments from elsewhere in the region acknowledgethat there were considerable abuses of the pre-crisissystem by politically powerful rentiers, and theseshould, of course, be eliminated (Gomez and Jomo,1999). Nevertheless, the other crisis-affected South-East Asian economies still need reforms to ensuremore appropriate developmental regimes in line withchanging circumstances and challenges. States needto develop a new range of institutions for more ef-fective selective intervention to accelerate thedevelopment of new industrial, technological, organi-zational and managerial capacities to face the variousnew challenges associated with accelerated globali-zation in the past decade and a half.

There are also grave doubts as to whether thereforms have improved corporate resilience in thelong run. Shin (2000) argues that foreign capital re-turned to the Republic of Korea because the economybegan picking up from November 1998, after uncer-tainties had been substantially reduced, rather thanthe return of foreign investment having led the re-covery, as hoped for by IMF. The recovery has beenmainly driven by typically Keynesian policies andcertainly not by reforms in corporate governance.

In light of the basis for and nature of the recentrecovery, the earlier and ongoing emphasis on theurgency of corporate reform was clearly ill-informedand ill-advised. Corporate profitability has undoubt-edly improved. But there is no clear evidence thatcorporate reform was key to bringing about theserecoveries. In fact, it has been noted that many cor-porate reform measures have been intended to preventfuture crises, even at the cost of short-term economicrecovery. With their earlier predictions of imminent“doom without corporate reform” unrealized, thoseinsisting on such reforms as a prerequisite for recov-ery have now switched to warning of a seconddownturn for countries like Malaysia, where resist-ance to reform has been officially articulated.

D. New international financialarchitecture38

As noted earlier, recent trends in IMF and WTOafter the East Asian crises began are unlikely to makeprevention of future crises any easier. By keepingopen the capital account and allowing freedom fortransborder movement of funds, it becomes difficultnot only to introduce measures to prevent financial


crises, but also to introduce effective financial safetynets at the national level. Past IMF consultations withvarious governments have been unable to preventmajor financial turmoil, with the frequency of cur-rency and financial crises increasing, rather than de-creasing, with financial liberalization in the last twodecades. Despite its grudging acceptance of the effi-cacy of capital controls in Chile, Colombia and else-where, the Fund has been reluctant to urge countriesto control short-term inflows before a crisis occurs.

Too little attention is being paid to the policiesof the developed countries, especially the major eco-nomic powers, despite their impact on exchange ratesin the rest of the world, especially in developingcountries. Akyüz (2000a) has noted that all the emerg-ing-market crises of the past two decades have beenassociated with large changes in the exchange ratesof the major industrial economies. Developing coun-tries seem generally incapable of maintainingexchange rate stability, while the major currenciesexperience big fluctuations. Hence, currency coor-dination between Europe, Japan and the United Statesis desperately needed for the stability of their owncurrencies as well as others in the world today. De-spite frequent G-7 meetings, existing arrangementsleave much to be desired. Consequently, there maybe fluctuations of up to 20 per cent within a week.The effects of such huge swings on smaller openeconomies are not well understood, although theyare expected to simply adjust to such changes.

Since the East Asian crisis, the internationaldiscussion on international financial reform to pre-vent future crises has emphasized questions oftransparency and greater supply of information.However, there is no evidence that having more in-formation will be enough to prevent crises. Also,efforts seem to be directed mainly at obtaining moreinformation from governments, especially of the de-veloping countries, with little being done to getinformation on the various financial markets, espe-cially the most volatile and vulnerable ones such asthose involving highly-leveraged institutions andoffshore markets.

A global system of prudential controls shouldaccommodate the existing diversity of national con-ditions as well as regional arrangements. However,the currently favoured approach to prudential regu-lation is to formulate international standards forcountries to implement and enforce. In the recent past,such standards have usually been set by BIS, whichserves banks in the OECD economies. There are sev-eral problems with this approach (Akyüz, 2000a;

2000b). First, such standards do not specifically takeinto account the risks associated with internationallending. Currently, credit rating agencies are reliedupon to fill the vacuum, but they have a tendency tobe pro-cyclical, thus exacerbating, rather than check-ing, fluctuations. Second, the standards have mainlybeen designed to protect creditors, not debtors, andthe countries they belong to. A similar level of expo-sure may imply different risks to different creditorsas well as debtors. Third, the one-size-fits-all ap-proach implicit in setting standards tends to glossover important variations, thus undermining the ef-ficacy of this approach. Although there is currentlyagreement that IMF should not set standards, it islikely to be involved in policing the enforcement ofsuch standards, which would raise similar concerns.

After the East Asian crises, there seemed to beagreement that short-term capital flows required regu-lation. But while developing countries currently havethe right to control short-term capital flows, the lackof international endorsement of such measures servesas a major deterrent for those considering their in-troduction.

Developing countries are currently being encour-aged to either fix (through a currency board systemor even dollarization) or freely float their currencies,but are being discouraged from considering interme-diate alternatives. However, studies have shown thata float system is associated with the same degree ofvolatility as a fixed one (Akyüz, 2000a; 2000b), withthe principal difference between the two being thatof how external shocks work themselves out. It iscrucial to insist that countries should be allowed tochoose their own exchange rate regime, which shouldnot be imposed as an IMF conditionality.

In managing crises, the recent East Asian expe-riences highlight the crucial importance of ensuringinternational liquidity by quickly providing foreignfunds to economies experiencing crisis. Currently,such international liquidity provision is being frus-trated by the following conditions:

(i) Multilateral institutions generally do not havethe necessary finances readily at their disposal.Although IMF nominally has the requisite fa-cilities, it lacks the required funds, which haveto be raised with the approval and active sup-port of its principal shareholders. This de factorequirement subjects the process to undue po-litical influence, as was clear in the internationalfinancial community’s changing responses to theEast Asian crises as it unfolded from mid-1997.


(ii) IMF-imposed policy conditionalities accompa-nying the provision of such emergency liquidityhave also been onerous. The East Asian ex-periences suggest that these conditionalitiesactually exacerbated the macroeconomic crises.

(iii) Such funds should be used to support a currencyagainst speculation, but instead, currencies wereallowed to collapse first, with the emergencyfunds going to pay off creditors.

Recent experiences underline the crucial impor-tance of facilitating fair and orderly debt workoutsto restructure debt payments due. Existing arrange-ments tend to treat debtor counties as if they arebankrupt without providing the protection and facili-ties of normal bankruptcy procedures.39 With such aprocedure, a debtor would have certain rights, in-cluding getting a temporary standstill on debtpayments, continued financing for on-going opera-tions, and orderly debt restructuring. While IMF’sArticles of Agreement allow for such temporarystandstills, this has not actually occurred.

Despite IMF’s Articles of Agreement provid-ing for a temporary standstill, in the recent case ofthe Republic of Korea the creditors got together andstruck an agreement with the government, raisingthree problems:

(i) the government was thus coerced in taking overresponsibility for private debt;

(ii) the creditors thus got better debt restructuringterms, whereas debtors would be more likely toget better terms in a bankruptcy court;

(iii) the new finance went to the creditors, insteadof supporting the debtor.

VI. Reforming East Asia forsustainable development

The currency and financial crises in South EastAsia suggest that the region’s economic miracle hadbeen built on some shaky and unsustainable founda-tions. Growth before the crises in Malaysia and Thai-land had been increasingly heavily reliant on foreignresources, both capital and labour. Limited invest-ments and inappropriate biases in human resourcedevelopment have held back the development ofgreater industrial and technological capabilitiesthroughout the region. South East Asia’s resourcewealth and relatively cheap labour sustained produc-tion enclaves for export of agricultural, forest, min-

eral and, more recently, manufactured products. How-ever, much of the wealth generated was captured byrestricted groups linked to those with political power.They nevertheless contributed to growth by reinvest-ing – albeit mainly in the “protected” national economy– in import-substituting industries commerce, serv-ices and privatized utilities and infrastructure.

Most of East Asia’s macroeconomic fundamen-tals were generally sound at the time of the crash.Low inflation and falling unemployment had char-acterized the economy over the preceding decade.Savings rates continued to rise despite already beingamong the highest in the world. Fundamental weak-nesses in the real economy more generally alsoslowed down growth in the mid-1990s. The growingshift to knowledge- and skill-intensive production andthe emergence of China and India as major low wageproduction sites also threatened export-orientedmanufacturing in the country. Unlike the North-EastAsian economies, the South-East Asian three havenot sufficiently developed the institutions needed togenerate rapid technical change and firm progresstowards the technology frontiers.

A. Exchange rate appreciation andgrowing imports

If falling exchange rates assisted export-com-petitiveness between 1986 and the early 1990s, thereversal from the mid-1990s had the opposite effect.The appreciation of the South-East Asian currencies,with the decline of the yen from mid-1995, was sub-stantial. With the renminbi devaluations of 1990 and1994, their appreciation had especially negative im-pacts on exports, the balance-of-payments currentaccount and FDI inflows. The rising currencies aswell as declining tariffs and other trade controls dueto trade liberalization pushed up imports. There wereno efforts to adjust exchange rates to neutralize theimpact of import liberalization.

Also, their manufacturing export structures hadbecome somewhat rigid and were not sufficientlyexchange rate elastic. Unlike agricultural and finalgoods, which have competitors and substitutes, in-tra-firm trade (especially transnationals directlyexporting assembled and processed items abroad) hasaccounted for much of their exported manufactures.This largely transnational-dominated trade – wheredemand is primarily determined in major marketsabroad – meant that import demand continued to bestrong.


However, the cheaper currencies brought littleimprovement in FDI trends from the mid-1990s, andespecially from 1997. Unlike gradual currency de-preciations, which can attract production fromabroad, especially when accompanied by strongmacroeconomic fundamentals, volatile currencymovements tend to discourage such inflows. The other-wise strong macroeconomic fundamentals tended tostrengthen South-East Asian currency values in theabsence of earlier government devaluation efforts.

The 1997/98 currency devaluations lowereddomestic production costs in South East Asia vis-à-vis North America and Europe. However, the regionalnature of the crises and the preceding Japanese eco-nomic stagnation reduced regional demand forexports, which has become increasingly importantwith growing regional economic integration inrecent decades. Besides, because many foreign sub-sidiaries in South East Asia have low value-addedproduction processes, with strong vertical linkagesto the rest of the firm or industrial group, the devalu-ations neither lowered demand for imports norincreased export demand as much as might be ex-pected from the changes in relative prices. However,the recovery in world demand for electronics sincelate 1998 has contributed a great deal to economicrecovery in the region, especially in Malaysia andthe Republic of Korea. Sticky wage rates are likelyto reduce the additional foreign exchange earningsto be gained with their devalued currencies.

Overexpansion in construction and lending fornon-productive purposes has also limited South-EastAsian financing of manufacturing growth even be-fore the crisis. To make matters worse, the limitedSouth-East Asian capacities to export services andconstruction materials aggravated trade imbalances.Instead, construction and services were responsiblefor massive increases in import bills in the early andmid-1990s. Unproductive investment ventures, in-cluding property and share purchases, attractedfinancing from banks and other financial institutions.The decline in FDI and export growth since the cri-ses has further reduced domestic demand for servicesand construction. To boost their asset markets andreflate their economies, some governments (espe-cially Malaysia) have continued to encourage lendingfor asset purchases, both in the stock and propertymarkets. Before the crisis, some governments (e.g.Indonesia and Malaysia) had launched uneconomicprojects, often at unnecessarily high expense.

Investment in South East Asia expanded fasterthan savings grew in the early and mid-1990s. As a

proportion of GDP, gross fixed capital formation(GFCF) has shown a trend increase, which has in-evitably caused falling capital productivity. Withinvestment rising faster than GDP, incremental capi-tal output ratios (ICORs) for these economies rose.Large injections of capital during early industriali-zation required stable financing, which in South EastAsia traditionally came from high savings rates. Pri-mary exports have enhanced access to foreignexchange, while FDI, much increased since the mid-1980s, has also supplemented national savings.

B. FDI slowdown

FDI as a proportion of gross fixed capital for-mation averaged about 20 per cent for Malaysia inmid-1990s, with lower shares for Indonesia and Thai-land, but still above the developing country averageof around 5 per cent (UNCTAD, 1997: figure II.19).FDI can complement limited domestic capital re-sources to enhance growth, although FDI’s share ofGFCF fell in 1996. However, the South-East Asianshare of total FDI going to South, East and SouthEast Asia fell from 61 per cent in 1990/91 to only 30per cent in 1994–1996. China and India had becomemajor rivals, especially for labour-intensive FDI. Andunlike recovery after the recession of the mid-1980s,largely due to the massive relocation of East Asianinvestments, FDI inflows to South East Asia on acomparable scale seem most unlikely in the foresee-able future.

The fall in FDI to South East Asia from late1996 was a consequence of a number of factors. First,the mid-1990s did not see a further massive exodusof North-East Asian capital seeking new investmentsites in the region, as had happened in the late 1980sand early 1990s. The early massive investments wereneither sustained nor replaced by other sources. Thefalling yen from the mid-1990s also reduced the sig-nificance of the already declining Japanese FDIinflows.

Second, the exhaustion of labour reserves inMalaysia and Thailand – the most attractive of thesecond-tier South-East Asian NIEs for FDI – hadalready started to discourage prospective labour-in-tensive investments. Malaysia had a foreign labourforce exceeding two million in 1996, which ac-counted for 20 to 30 per cent of the country’s labourforce, while Thailand probably had a similar number.The incentives had also changed in the early 1990s,so that labour-intensive firms faced pressure to relo-


cate in less developed locations within the country,or even abroad. The crisis is likely to discourage FDIflows for years. FDI interest in the region has de-clined since 1996, with an increasing proportionconsisting of acquisitions to take advantage of theregional “fire sales” rather than adding new produc-tion capacity through green-field investments.

The early and mid-1990s were also character-ized by increased privatizations. Powerful interestscaptured much of the rents associated with privati-zation. Initially, the abuses did not seem overlydebilitating due to rapid growth. Private interests,working hand in hand with the politically powerful,began dominating financially profitable rentier ac-tivities. Privatizations basically involved the transferof existing assets from public to private hands, withno necessary addition of capacity. Thus, privatiza-tion absorbed scarce private sector financial resourceswithout enhancing economic capacity. With “know-who” becoming more important than “know-how”,“cronyism” undermined the development of entre-preneurship and other capabilities.

External liberalization pressures forced the re-moval of a number of incentives and tariffs, pushingprivate interests into other rentier activities. The es-tablishment in 1995 of WTO and other regional tradederegulation efforts, such as the ASEAN Free TradeArea (AFTA) and Asia-Pacific Economic Co-opera-tion (APEC), accelerated liberalization processes.Incentives used to promote exports (for example, theexport abatement allowance) and tariffs that had shel-tered domestic producers began to fall sharply bythe mid-1990s, forcing rentier activity to shift to othersectors.

C. Slow technological progress

While industrial policy in the Republic of Ko-rea and elsewhere in North East Asia ensured stronginstitutional support driving technical change, thishas generally failed to materialize in most of SouthEast Asia. Singapore has successfully developed andmaintained institutions necessary to sustain its lead-ing role as the South-East Asian regional hub formedium to high technology-intensive production andservices. The Republic of Korea as well as Japanand Taiwan Province of China have successfullydeveloped the necessary institutions to not only speedup the absorption and development of technologies,but also to strengthen their technological capacitiesand capabilities more generally. Such slow techno-

logical deepening in the real sector must have lim-ited the South-East Asian region’s growth potential.Institutional deficiencies in South East Asia can beseen in the institutions supporting technologicaldeepening, human resources, technology diffusionmechanisms, as well as disciplinary mechanisms(Rasiah, 2001; Jomo and Felker, 1999).

Ambitious and expensive technological-deep-ening institutions and mechanisms were introducedin both Malaysia and Indonesia, especially in the1990s, without much concern for ensuring interna-tional competitiveness in the medium term. Whilesuch initiatives had important technological-deepen-ing objectives, serious failures have restricted theirimpact.

Rising production costs and tough externalcompetition forced Malaysia to review its exportstrategies and domestic capabilities. Growth in for-eign-dominated export-processing activities haslargely involved expansion of relatively low value-added production. With labour reserves exhausted,the premium for skilled workers has gone up in Ma-laysia and Thailand. Cheap labour imports fromneighbouring countries have held down unskilledworkers’ wages and slowed down labour-intensivefirm initiatives to upgrade their process technologies(Edwards in Jomo and Felker, 1999).

Achieving higher productivity inevitably re-quires complementary developments in humanresource capabilities. Given the problems of gettingfirms to invest in training workers, there is a strongneed to stimulate state-business collaboration in cre-ating and coordinating institutions to enhance humanresources for technological upgrading. In North EastAsia, the share of engineers and R&D scientists andtechnicians rose quickly with the strong incentivesoffered for increasing their number. South East Asiaoutside of Singapore has lacked comparable humanresource support to facilitate a rapid transition tohigher technology manufacturing (see table 7).

Official measures of technology transfers haveundoubtedly increased in South East Asia. Institu-tion building to facilitate local technology absorptionand development has, however, been weak (Jomo andFelker, 1999). The region does not have enough ef-fective mechanisms to govern and promote effectivetechnology transfer. In North East Asia, governmentsestablished institutions to assist local licensees to getmore favourable bargains from foreign licensers andto speed up absorption and development of desiredtechnological capabilities (Johnson, 1982; Amsden,


1989; Wade, 1990). Weak monitoring and enforce-ment mechanisms have restricted the extent oftechnology transfer and competitive gains in inter-national markets. Until recently, North-East Asiangovernments intervened to support catching-up andfrontier R&D activities. Strict conditions imposedby governments using performance standards ensuredminimal waste of resources.

Limited domestic capabilities have meant thatpayments for imports and profit repatriation havereduced the potential benefits of industrialization tothe region. While transnationals have been reluctantto source more inputs locally, local firms have alsonot adequately developed productive capabilities toincrease their participation in foreign firms’ value-added chains. Industrial policies have not done muchto cultivate and strengthen the capacity of local firmsto take greater advantage of domestic content stipu-lations.

South East Asia’s second-order or deeper eco-nomic fundamentals have generally been weak. The

required mechanisms for effective technology devel-opment to improve competitiveness have been inad-equate. Despite some efforts to address the situation,the region was struggling to sustain competitivenessin international markets before the crash. The regionwas already handicapped by various institutional fail-ures to achieve greater industrial upgrading.

D. New investment policies inSouth East Asia40

The economic crises of 1997/98 have led to sig-nificant changes in economic policy in South-EastAsia (Montes, 1998; Jomo, 1998). Short-term con-siderations (IMF emergency credit conditionalities,efforts to restore market confidence, and the urgentdesire to stimulate recovery) have shaped manyrecent reforms. The seemingly inexorable thrust to-wards economic liberalization has been bolstered byan expanding corpus of multilateral rules and policydirections promoted under the auspices of WTO,

Table 7

SELECTED ECONOMIES: SELECTED HUMAN CAPITAL INDICATORS

Scientists and R&D scientists andtechnologists technologists R&D expenditure as a

per 1000 people per 10,000 people percentage of GNPCountries (1986–1990) (1986–1989) (1987–1992)

Japan 110 60 2.8United States 55 n.a. 2.9Sweden 262 62 2.8Germany 86 47 2.9France 83 51 2.3Canada 174 34 1.4Britain 90 n.a. 2.3Rep. of Korea 46 22 2.1Turkey 26 4 n.a.Brazil 30 n.a. 0.6Malaysia n.a. 4 0.4Thailand 1 2 0.2Indonesia 12 n.a. n.a.Jamaica 6 0 n.a.Kenya 1 n.a. n.a.Bangladesh 1 n.a. n.a.

Source: UNDP (1995); MASTIC (1994, cited in Rasiah, 1998).Key: n.a. – not available.


APEC (Asia Pacific Economic Cooperation), andASEAN. To many observers, these changes signifythe demise of government intervention.

However, such pronouncements may be prema-ture, as there is still considerable evidence thatcrisis-affected governments are continuing to pro-mote and shape economic growth, development andindustrialization. The following brief review of somerecent trends in investment policy suggests thatgovernment interventions continue to be important.Parallel policy adjustments have occurred in the ar-eas of international trade, finance, infrastructure andhuman resource development.

The aftermath of the crisis has seen the reduc-tion, if not the elimination, of barriers to foreigninvestment in previously protected sectors. Havingsurrendered some of their discretionary powers toregulate entry into key economic sectors, South-EastAsian governments must now let global markets re-shape their industrial sectors according to their(inherent) comparative advantages. Although thescope in South East Asia for old-style industrialpolicy has been greatly reduced, the region’s gov-ernments do not necessarily have to stop trying toinfluence investment trends. Governments have beenpaying more attention to the nature and quality ofinvestments, and have been encouraging the devel-opment of domestic technological capabilities andskills.

Seen against the policy priorities of the 1990s,the post-crisis investment policy reforms are lessdrastic than they may seem. The Indonesian,Malaysian, Philippine and Thai governments beganto liberalize investment gradually during the decade-long boom preceding the collapse of 1997/98;arguably, some even developed new approaches toinvestment promotion (UNCTAD, 1998). In this pe-riod, South-East Asian governments balancedinfant-industry policies in certain sectors while pro-moting new export industries, usually with FDI. Theypromoted FDI inflows into export-processing zonesand licensed manufacturing warehouses (Rasiah,1995) by providing special exemptions from tariffprotection for inputs and investment rules for sec-tors not for export. The authorities also tried to fosterlinkages with the domestic economy and to enhancetransfers of technology from transnational corpora-tions to domestic producers.

Undoubtedly, the crises has forced most gov-ernments to put on hold policies to upgrade industrialtechnologies. For the time being, all kinds of invest-

ments are being used to accelerate economic recov-ery. Changes are more evident in some countries thanin others, but adjustments in the aftermath of the cri-ses are likely to give way to further reforms asrecovery is consolidated and governments pay greaterattention to sustaining development in the mediumterm.

To a greater or lesser extent, investment poli-cies before the crisis embraced new priorities,instruments, and institutional frameworks. Invest-ment policies recognized the growing globalizationof production involving international operations bytransnational corporations themselves. Instead ofaiming for nationally integrated and controlled in-dustries, governments sought to position nationaleconomies to a maximum feasible advantage withinthe corporations’ own international divisions of la-bour. Infrastructure and policy support was orientedtowards ensuring location attractiveness, as govern-ments modified their incentives to attract particularactivities, such as management, procurement, logis-tics, R&D and design.

The shift from policies to support infant indus-try towards policies to attract export-orientedtransnational corporations had earlier distinguishedthe South-East HPAEs from the other HPAEs as wellas other developing countries. Acceptance of trans-national corporation-led integration into regionaland global systems of production distinguished thesecond-tier South-East Asian NICs from their late-industrializing predecessors, Japan and the Republicof Korea. Meanwhile, the industrial capabilities ofTaiwan Province of China enabled it to define uniqueterms of engagement with transnational corporations.

Although the other HPAEs in East Asia havealso drawn heavily on foreign technology, they havedone so on terms in line with limiting foreign own-ership of industry to promote domestic industrialcapital. Both the Republic of Korea and Taiwan Prov-ince of China initially invited foreign investment inorder to establish new export-oriented industries suchas electronics, but they restricted FDI over time whileaccessing foreign technology through licensing.

South-East Asian efforts to promote indigenousindustrialization have been more limited and general-ly less successful. Indonesia, Malaysia and Thailandall have resource-based industries that can competeinternationally, while Thailand probably has the mostinternationally competitive light manufacturing in-dustries. But South East Asia’s export-led growthboom before the crisis was driven mainly by mas-


sive foreign investments from Japan and the otherfirst-generation East-Asian NIEs (Jomo et al., 1997:chap. 3), with North American and European inves-tors joining later. Alarmist predictions that footlooseFDI would render the region’s growth ephemeralhave proven to be largely unfounded except in thecase of relatively small Taiwanese investments dur-ing the early 1990s. However, passive reliance onforeign capital and technology inflows will generatelittle more than direct employment.

Consequently, greater attention has been givento the dynamic effects of new investment projects,even extending to matters such as market access, tech-nology transfer and human resource development.Such considerations for evaluating investment per-formance became far more important during thedecade-long boom prior to the 1997/98 crises. Whilecapital formation, employment generation andforeign exchange earnings were not irrelevant,governments did become more selective in theirinvestment promotion efforts, largely with a view tomaximizing value added and positive externalitiesover time. The new emphasis on investment exter-nalities has, in some countries, shifted the objectiveof investment promotion policies from particular in-dustries to industrial clusters of complementaryassembly, component production, and producer-serv-ice activities. Emphasis has shifted from maximizingnew green-field FDI in export-oriented industries toencouraging reinvestment by established producersin deepening their local operations, upgrading skills,forming domestic economy linkages, and gaining alarger share of their parent companies’ global opera-tions.

To varying degrees, the other South-East HPAEshave sought to emulate their regional neighbour,Singapore, which initiated its “second industrial revo-lution” after achieving full employment in the late1970s and, beginning in 1986, sought to establishitself as the best location for the regional headquar-ters of transnational corporations. Unlike theRepublic of Korea and Taiwan Province of China,Singapore adopted an FDI-led path to export-orientedindustrialization in the late 1960s, partly for politi-cal reasons (Rodan, 1989). Yet, despite its desire forforeign investment, Singapore is not opposed to gov-ernment intervention. The Singaporean state hasshaped the investment environment by providing arange of facilities, infrastructure, subsidies and com-plementary public investments (Low, 2001; Chng etal., 2001). Although its circumstances are very dif-ferent from those of its neighbours, Singapore’sexperience clearly demonstrates that the scope for

proactive investment policy in a liberal ownershipregime is much greater than commonly presumed.

As investment policy goals have shifted, policyinstruments have changed accordingly. Negative re-strictions, such as foreign ownership limits and localcontent requirements, have been or are currently be-ing phased out in most sectors, although significantexceptions remain. Tax holidays have also becomeless important insofar as most governments offerthem to varying degrees. Instead, some governmentshave begun providing infrastructure and servicesdesigned to enhance their investment environments,attract desired investments, and induce positive ex-ternalities such as:

(i) one-stop facilitation of administrative approvals;

(ii) provision of specialized physical, customs-re-lated, and technical infrastructure;

(iii) support for labour procurement and skills de-velopment;

(iv) matching of investors with local suppliers;

(v) other services relating to investors’ routine op-erations, such as immigration, customs andother tax services, as well as trouble-shootingadministrative problems with other governmentbureaucracies.

Implementation of these new investment poli-cies has involved daunting political and administra-tive challenges, requiring government investmentagencies to develop greater expertise and flexibilityrather than a sector-neutral and passive policy stance.Reshaping national investment environments in linewith new investor demands requires understandingthe great variation within particular industries, thelogistical needs and strategic concerns of trans-national businesses, and the rapidly changing inter-national investment environment. Changing the maintask of investment policy from regulation to promo-tion, and now services, requires changing oftendeeply entrenched institutions and organizationalcultures within the relevant bureaucracies. Hence,new investment policies have often involved creat-ing new specialized agencies, authorities and admin-istrative zones.

The new investment policy direction has had torespond to and cope with important challenges. Mostimportant, the operations of relatively sophisticatedtransnational corporations have had limited impacton the production linkages, skill formation and otherexternalities of host economies, ostensibly becauseof limited domestic “absorptive capacity”, resulting


in the inadequacy of skills and other technologicalcapabilities. Clearly, FDI alone cannot ensure thedevelopment of capabilities, as is often presumed.Instead, dynamic externalities from foreign invest-ment are more likely in host environments withappropriate skills, infrastructure, and supplier andtechnical capacities. In less conducive investmentenvironments, export-manufacturing FDI may notgenerate the desired consequences, remaining pri-marily low-skill, import-dependent enclaves, as inMexico.

This situation poses difficult challenges forcountries with weak skill endowments, particularlyrelated to engineering. For them, foreign investmentis expected to catalyze industrial development, butthese countries have limited complementary capa-bilities to offer. They have few technologicallyadvanced producers able to integrate easily into theinternational supply chains of transnational cor-porations. Similarly, the efforts of transnationalcorporations to develop internationally integratedproduction specializations may constrain host-coun-try efforts to promote domestic linkages andspillovers. Although some transnational corporationshave begun to devolve functions like procurement,marketing, design, and even R&D to their South-EastAsian operations, certain functions remain central-ized in regional headquarters in Singapore or HongKong (China). Most subsidiaries in other South-EastAsian countries lack the authority to make importantdecisions in close proximity to a regional headquar-ters. As a consequence, they may not even have theindependence to develop new supply sources foranything other than the simplest components. Thesechallenges point to the potential scope for policy ini-tiative by governments and private entrepreneurs inenhancing the gains from FDI under a liberal invest-ment regime. However, government efforts to fosterlinkages, skill formation, and technology spillovershave so far met with considerable difficulties.

Investment policy regimes are usually seen aslying somewhere along a continuum from the restric-tive to the more liberal and incentive-neutral, withthe analytical focus on regulations that shape entrybarriers. From this perspective, the main trend sincethe mid-1980s has been the relaxation of restrictiveregulations on foreign ownership. So-called trade-related investment measures – such as local content,foreign exchange balancing and technology transferrequirements – have also been relaxed. However,three issues have compromised this regional trendtowards open investment regimes.

First, liberalization has occurred unevenly acrosssectors and countries. Although general investmentbarriers have been relaxed, the remaining restrictionshave become more significant, sending clearer sig-nals about policy priorities and concerns. AfterSingapore, Malaysia has the most open investmentregime, allowing wholly foreign-owned firms to op-erate in the export-oriented manufacturing sector withminimal restrictions. However, following the crises,Thailand and Indonesia have opened their financialand other services to foreign mergers and acquisi-tions, while Malaysia has liberalized more cautiouslyin this regard.

Second, exemptions from (national) equityownership requirements in the South-East HPAEshave usually been tied to exports and sometimes othermore specific policy goals. For example, unlimitedforeign ownership was allowed in export-orientedindustries, but not for import-substituting production.Integration into the global economy in the 1980s and1990s did not involve incentive neutrality and mar-ket-determined specialization. Instead, governmentinitiatives responded to fresh opportunities offeredby firms’ new strategies vis-à-vis the globalizationof industrial production.

Third, South-East HPAEs have been using in-vestment subsidies such as tax holidays, exemptionsand deductions, rather than entry restrictions (Felkerand Jomo, 1999). Incentives have been used topromote particular industries or to impose specificperformance requirements. Such subsidies have beenconventionally viewed as due to (socially inefficient)competition among prospective host governments.Nevertheless, they have enabled host economies topromote certain industries to some advantage wheninvestment externalities exceed subsidy costs, forexample owing to scale or agglomeration economies.

It has also been argued that investment incen-tives compensate transnational corporations for theirsearch costs and extra risks involved in transferringadvanced production activities to new locations(UNCTAD, 1998: 97–106). Generally, governmentsin the region have used investment incentives to sig-nal their commitment to attracting and retaininginvestors. Unlike investment restrictions and directexport subsidies, many investment subsidies are notproscribed by existing WTO provisions.

Investment subsidies have been addressed inrecent years by the prospect of a multilateral invest-ment policy regime. First mooted unsuccessfully as


part of the GATT Uruguay Round initiative on trade-related investment measures, another unsuccessfulattempt was made through the OECD’s MultilateralAgreement on Investment. WTO’s Working Groupon the Relationship between Trade and Investmentis drafting a Multilateral Investment Agreement. Ifsuccessful, such discretionary investment subsidiesand other promotional measures will deprive devel-oping countries of crucial policy tools in an increas-ingly challenging globalized investment environment.

Current reform programmes, as prescribed byIMF, exclude a priori the possibility that governmentinvestment policies can encourage technology trans-fer, linkage formation, skill development and otherexternalities. An important requirement for sus-tainable recovery is stronger expertise and moreflexibility in public agencies overseeing industrialdevelopment. In the wake of the East Asian crisis,IMF has urged or even required countries to disman-tle or reduce such subsidies. However, as they losesome policy instruments for promoting and shapingindustrialization, South-East Asian countries willneed to retain and hone the remaining instruments inorder to cope with new challenges.

A country’s comparative advantage as alocation for production linked to transnational cor-porations increasingly depends on factors that affectthose corporations’ costs and competitive advantages.Besides political stability and investment security,transnational corporations are increasingly concernedabout the quality of physical infrastructure andadministrative systems, skill endowments, and prox-imity to quality suppliers. Host governments requireconsiderable public expertise, institutional flexibil-ity, and judicious investments in skill and technicalcapacities to ensure a mutually advantageous invest-ment environment.

Authorities will undoubtedly continue to seeknew ways of encouraging industrial and technologi-cal progress. Overcapacity in several manufacturingsectors and slow recovery in Japan probably meanthat the new manufacturing FDI will not quicklyresume the dizzy rates in the decade preceding thecrisis. More worrying is the shift in FDI flows to-wards mergers and acquisitions and away from newgreen-field investments or even reinvestments ofprofits. Such trends have important implications forthe development of industrial and technological ca-pabilities. While facilitating investments has become

central to recovery throughout the region, the newsituation also poses significant downside risks. Forexample, opportunities for more value-added activi-ties, such as design and R&D, may be constrainedby the new strategies and internal organization oftransnational corporations.

For other reasons too it is unlikely that nuancedproactive investment policies will continue to shapenew investment trends. The region’s opening to ex-port-oriented FDI in the past did not result in thesame sort of industrial linkages and technology de-velopment found in the Republic of Korea andTaiwan Province of China, because of poorer policy,weaker institutional support and fewer capabilities.Whatever the potential advantages of mergers andacquisitions, it is unlikely that these will be fully re-alized without appropriate institutional support,skills, policy incentives, and the ability to extract andcapture rents.

Building new investment-management capa-bilities continues to face formidable difficulties.Assisting governments to regulate foreign investmentis low on the agenda of the powerful internationalfinancial institutions as well as most domestic re-formers. In Indonesia, the desire to restore investorconfidence is likely to constrain government policyactivism for some time. Although there are somesigns of emerging public-private coordination in fos-tering skills and technology development in Thailand,some of the indigenous industrial capacities built upin recent years have been lost with the financial liq-uidation of many manufacturers. Malaysian PrimeMinister Mahathir’s rejection of orthodox prescrip-tions for economic restructuring in Malaysia hasmainly protected financial and other non-manufac-turing interests. Although the government retainsimportant policy instruments, efforts to revive growthin the short term have forced Malaysia to liberalizeits de facto investment policy regime.

Prospects for rebuilding investment-manage-ment capacities have also been clouded by currentmultilateral efforts to proscribe discretionary gov-ernment interventions and regulations affectinginvestment flows. Establishing a multilateral invest-ment regime even more restrictive of nationalgovernment initiative may reduce the potential forabuses of investment policy. The main effect will bethe loss of an important tool for fostering long-termindustrial development.


VII. Prospects

Since mid-1997, the sustainability of the growthand industrialization processes in South East Asiahas been in grave doubt. Unlike the North-East Asianeconomies, the South-East HPAEs have been farmore dependent on foreign investment. Althoughonly Singapore and Malaysia stand out statisticallyin the proportion of FDI in total investment, much ofthe non-resource-based, export-oriented manufactur-ing in all three North-East HPAEs is owned andcontrolled by foreigners; while those of Japan, theRepublic of Korea and Taiwan Province of Chinaalso have foreign investment, their governments havebeen far more selective and restrictive. Their levelsof FDI are well below the average for developingcountries (around 5 per cent). Instead, these econo-mies have emphasized the development of national(not necessarily state-owned, except perhaps in Tai-wan Province of China) industrial, technological,marketing and related capacities. In contrast, mostrentier entrepreneurs in South East Asia have con-tinued to capture rentier opportunities (often basedon political and other connections), rather than de-velop the new capabilities desperately needed toaccelerate late industrialization.

There is a real danger that South-East Asianeconomies will lose their earlier attractiveness as sitesfor FDI, and their indigenous capabilities seem to beinadequate to sustain internationally competitiveexport-oriented industrialization in its absence.Foreign investors can choose among alternativeinvestment sites in line with overall firm strategies,domestic market prospects, infrastructure and othersupport facilities, incentive and tax regimes, relativeresource endowments, comparative production costsin the short and medium term, as well as other con-siderations of likely competitive advantage. Withlimited indigenous capabilities and the irrepressibleindustrialization of China and, more recently, India,the South-East HPAEs, including Malaysia and Thai-land, are less attractive than they used to be.

There is little evidence that the massive de-valuation of the crisis-affected South-East Asianeconomies will support sustained growth. For someanalysts, the crisis was precipitated by the collapseof Thai export growth (and the related slowdown inoutput growth) after the devaluation of the Chineserenminbi in 1994 and appreciation of the US dollarin mid-1995. The crisis beginning in mid-1997 sawthe depreciation of all crisis-affected currencies,leaving South-East Asian economies (including Thai-land’s) a little more cost-competitive, but only in

relation to those economies that did not experiencecurrency depreciations. They did not become morecompetitive in comparison with their neighbours,often their main competitors.

In the immediate aftermath of the crisis, palmoil prices rose, helping to alleviate the worst impactof the crisis. However, vegetable oil prices generallycollapsed with the bumper soybean harvest ofmid-1999. Fortunately for Malaysia and Indonesia,petroleum prices rose strongly in 1999 and into 2000,but again there is no evidence that commodity pricesincreased as a result of the depreciated currencies.The strong upswing in the electronics business cy-cle since 1998 has also helped the region, especiallyMalaysia, with the share of electronics in Malaysianmanufactured exports rising from below 60 per centbefore the crisis to more than 70 per cent. But again,there is little evidence that higher demand for elec-tronics is mainly due to lower production costs owingto the weaker currencies. On the contrary, some ob-servers have argued that increases in Malaysianelectronics output and exports have been below thoseof the industry as a whole, and even below those ofneighbouring Singapore, which experienced lessdrastic currency depreciation.

More worrying, there is considerable evidencethat commodity prices have decreased in recent years,including those of most primary as well as manufac-tured commodities. There is now considerableevidence of significant price deflation for genericmanufactured goods, which are subject to ineffec-tive entry barriers, in contrast to industries that aresubject to effective entry barriers as a result of en-forceable intellectual property rights. This divide ischaracterized by a race to the bottom for the formeras lower prices (and cheaper currencies) transfer eco-nomic gains from the producers (workers and contractsuppliers) to the oligopolies commanding marketshares and to consumers (in the form of lower con-sumer prices) (Kaplinsky, 1999).

Before the 1997/98 crises, Thailand and Ma-laysia were already experiencing full employmentwith significant labour shortages; estimates of for-eign worker presence in both economies in the late1990s ran into the millions. It is widely believed thatthis presence was tolerated, if not encouraged, bythe authorities, especially in Malaysia, as the gov-ernments wanted to remain competitive in low-wageeconomic activities such as plantation agriculture.Thus labour immigration discouraged industrialupgrading and limited indigenous Malaysian tech-nological capabilities, further exacerbating the


problem of inadequate industrial capacity to sustainfurther rapid industrialization and technologicalprogress.

While the first phase of economic recovery inthe region may be rapid as its existing capacity ismore fully utilized, the decline of new, especiallygreen-field, investments in the crisis-affected econo-mies since the mid-1990s is cause for concern.Malaysia, for example, has experienced three con-secutive years of decline in investment approvalssince 1996, although investment approvals have ex-ceeded applications in recent years (Jomo, 2001a).Also of concern is the apparent shift of investmentsfrom manufacturing for export to production for do-mestic consumption, particularly of non-tradeables,contributing to the property price bubble and increas-ing the vulnerability of the financial sector as a whole.Malaysia has successfully held down interest ratessince September 1998, but loan growth has fallenfar short of the central bank’s target of 8 per cent for1998 as well as 1999. The share of bank credit goingto manufacturing, agriculture and mining has alsodeclined significantly, while loans for property andshare purchases have been encouraged once againand now account for even larger shares of new loansthan before the crisis.

There is a real possibility that, while strong eco-nomic recovery during 1999 will continue into 2000and beyond (World Bank, 1998), growth may beginto sputter as existing capacity becomes fully utilizedand new investments are not forthcoming – at leastat the same levels as those preceding the crisis(Rasiah, 2001). The changed international situationdoes not augur well for the South-East HPAEs, whichhave grown rapidly in recent decades but have beenunable to sustain the momentum of manufacturinggrowth.

VIII. Concluding remarks

Finally, to return to the key question of growthprospects for the region after the 1997/98 crisis, onecan reiterate the following.

Although there was no one development modelfor the eight HPAEs, all experienced rapid growthdue to high savings and investment rates as well la-bour utilization and human resource development.Exports were also important in all these economies,although most were far from being open economies.It is now generally agreed that international finan-

cial liberalization was the principal cause of the cri-sis, though those in favour of such liberalizationwould argue that the problems involved impropersequencing and/or inadequate prudential supervisionrather liberalization per se. Such international finan-cial liberalization generally began in the region fromaround the late 1980s, and certainly cannot be con-sidered part and parcel of the development strategiesresponsible for the rapid growth, industrialization andstructural changes before that.

Returning to the various institutional featuresthat made possible the East Asian miracle in the pastis, for several reasons, no longer an option. The in-ternational economic environment has changed quiteradically in the past fifteen years. International eco-nomic governance profoundly altered with IMF’sstabilization programmes and the World Bank’s struc-tural adjustment packages in the wake of the debtcrises of the 1980s. New conditionalities have beenimposed in the region by the Bretton Woods institu-tions, together with the emergency credit facilitiesprovided to Indonesia, the Republic of Korea andThailand during the 1997/98 crises. It is increasinglyrecognized that economic liberalization and suchconditionalities have had adverse consequences forgrowth, let alone distribution. International economicliberalization has been further advanced by otherinstitutions and processes, most notably the conclu-sion of the Uruguay Round of international tradenegotiations with the advent of WTO in the mid-1990s.

Furthermore, the needs and requirements of theHPAEs have changed over time; given their variety,there is no single universal set of institutional re-forms for all these economies. However, bank-basedfinancial systems are still more likely to serve thedevelopmental finance requirements of these econo-mies. But the scope for directed credit (praised inWorld Bank, 1993) and financial restraint has beenconsiderably reduced by internal as well as interna-tional financial liberalization. Instead, with theFinancial Services Agreement under the GeneralAgreement on Trade in Services (GATS) and theimminent broadening of IMF’s mandate to also coverthe capital account, there is likely to be greater pres-sure to promote and open up capital markets in theregion.

As with finance, there is also little conclusiveevidence of the superiority of Anglo-American cor-porate governance. Nevertheless, the Fund and theWorld Bank continue to press for corporate govern-ance reforms and corresponding conditionalities


imposed during the East Asian crises, insisting thatsuch changes are necessary for economic recovery.However, the relatively stronger economic recover-ies in Malaysia and the Republic of Korea have hadlittle to do with such reforms and were primarily dueto successful, Keynesian-style, counter-cyclicalreflationary policies. East Asian business relations –once celebrated as synergistic social capital – hassince come to be denounced as “crony capitalism”ostensibly responsible for the crisis. The family firm,a feature of early capitalist development in much ofthe world, has also been targeted for reform as if itwere responsible for the abuses associated with para-sitic “cronyism”.

Economic liberalization more generally hasgreatly reduced the scope for industrial policy or se-lective government interventions. Yet, the WorldBank’s advocacy of poverty targeting – for example,in connection with its social safety net programmes– has underscored the legitimacy of such selectivity,besides implicitly acknowledging government capac-ity to do so reasonably well. Despite the recent pushfor trade liberalization as well as abandonment ofseveral GATT arrangements that acknowledged andsought to compensate for different national economiccapabilities, UNCTAD’s annual Trade and Devel-opment Reports have continued to affirm theremaining scope for trade-related industrial policy.Similarly, the work of Stiglitz and others have reit-erated not only the need for but also the potential forfinance-related industrial policy.

This paper has considered some recent devel-opments in South-East Asian investment regimes inline with industrial policy despite initiatives such asthe Uruguay Round’s trade-related investment meas-ures (TRIMs), the OECD’s aborted MultilateralAgreement on Investment and WTO’s MultilateralInvestment Agreement. The scope for correspond-ing technology policy has also been identified despitethe strengthening of corporate intellectual propertyrights. Human resource development is probably thearea for industrial policy initiatives least fettered byrecent liberalization trends, despite the World Bank’sadvocacy of non-subsidization of post-primary edu-cation and recent trends in education and health careprivatization.

Ensuring a return to the high productive invest-ment rates of the past is helped by the continued highdomestic savings rates in the region in spite of thedevastating social impacts of the 1997/98 crises inthe East Asian region. It is now generally acknowl-edged that much of the additional funding made

available by foreign bank borrowings as well as port-folio investment inflows into the region helped fuelasset price bubbles, which later burst with such cata-strophic consequences. Yet, financial liberalizationin the region has been furthered – rather than checked– in the aftermath of the crises, mainly due to theconditionalities imposed by the Fund as well as theurgent need for foreign funds to help economic re-covery.

Some popular accounts of the East Asian mira-cle economies portrayed them as geese flying in theslipstream of the lead goose, Japan. Many went fur-ther to imply that they were Japanese clones or atleast “wannabes”. Even serious scholars of the re-gion have written of a yen bloc, for instance, despitethe fact that most Japanese corporations used the USdollar to denominate their internal transactions, andmost monetary authorities in the region, includingJapan, never sought the internationalization of theircurrencies. In short, the picture of East Asian homo-geneity has long been grossly exaggerated.

In the unlikely event that the Europeans and theJapanese do not resist the continued promotion ofthe Anglo-American capitalist norm for the rest ofthe world, it is quite likely that we will witness agreater degree of conformity and uniformity in theformal rules and institutions of the economy. But suchconformity may remain superficial, rather than be-come substantial or, as is perhaps more likely, theAnglo-American forms may take root unevenly indifferent situations depending on changing histori-cal, economic, political, cultural, social and otherenvironmental factors. In the same way that Islamonce spread rapidly across North Africa, providinga common legal and cultural basis for long-distancetrade, the English language and Anglo-Americannorms may well become universal in the forthcom-ing era. But just as the acceptance of Islam has resultedin a great variety of Muslim cultural expression andbehavioural norms, a twenty-first century Anglo-American global capitalism may still be quite diverse.

Neo-liberal globalization of Anglo-Americancapitalism seems likely to continue in the near fu-ture. These trends will probably be led by the twoBretton Woods institutions as well as WTO. Never-theless, there continues to be some diversity ofopinion within as well as among these institutions,which is likely to be reflected in policy prescriptions.WTO’s formal democracy provides some basis forreformist initiatives, while the Fund and World Bankwill continue to be under pressure to become moreaccountable, if not democratic.


As noted earlier, the aftermath of the debt cri-ses of the early and mid-1980s saw stabilizationprogrammes and structural adjustment packages be-gin this process, especially in the most heavilyindebted economies which had to approach theBretton Woods institutions for emergency credit fa-cilities, and were therefore obliged to accept theaccompanying conditionalities. The currency andfinancial crises of the 1990s have seen similar out-comes, with East Asian governments obliged toaccept, implement and enforce conditionalities im-posed by the Fund, the United States Treasury, aswell as other foreign government agencies. But suchcircumstances for the extension of the neo-liberalglobalization agenda underscore the constraints it issubject to. Not only is there growing resentment oversuch impositions within the countries concerned, butthere is also growing international understanding andwariness of the underlying interests and agendas in-volved. In other words, every success also hardensresistance. This alone will ensure that the future ofliberalization is far from assured and unlikely to beeither smooth or even.

Even in the improbable scenario that all devel-oping countries are compelled to subject themselvesto such conditionalities, the outcomes are unlikelyto be the same. Initial conditions can account formany variations, as we have seen from our very lim-ited sample of four East Asian economies. Differenteconomies have developed different capacities andcapabilities, and may therefore be affected ratherdifferently by liberalization and globalization.

Sequencing will also give rise to differences.There are at least several different sequencing issues;that of different aspects of domestic and external lib-eralization may involve many different permutations.Policy makers for those economies that liberalizelater are also in a position to learn from the experi-ences of those before them, and thus to anticipateand prepare themselves better.

The mixed consequences and experiences ofliberalization and globalization thus far have alsogreatly undermined the previously smug self-confi-dence of what has been termed the WashingtonConsensus. With the benefit of hindsight, Stiglitz’s(1998) predictions of a post-Washington Consensusmay well have been premature. The circumstancesof his departure from the World Bank and the morerecent controversy over the contents of the WorldDevelopment Report for the year 2000 on povertyare important reminders of the continued hegemonyof the Washington Consensus, albeit slightly chas-

tened. Hence, it is not a self-confident, unchallengedand unproblematic consensus, but rather one that isincreasingly vulnerable, not least because of devel-opments in East Asia.

The earlier appreciation of the East Asian mira-cle posed an important challenge to the economicneo-liberalism underlying the stabilization pro-grammes and structural adjustment packages of the1980s and 1990s. While the East Asian débâcle of1997/98 has been invoked to negate much of thatearlier analytical challenge, it has also raised trou-bling questions about financial liberalization. Whilemuch of the earlier criticisms of liberalization andeconomic globalization came from outside the main-stream of contemporary economic thinking, much ofthe recent debate and dissent over financial and capi-tal account liberalization, as well as the role of theBretton Woods institutions, has involved orthodoxeconomists, including many who have been strongadvocates of liberalization with regard to interna-tional trade, investment and other economic areas.

And while there is unlikely to be any imminentradical change in the international financial archi-tecture, as the threat posed by and the memory of theEast Asian financial crises recede, it is unlikely thatthere will be a simple return to the smug and simple-minded advocacy of economic liberalization on allfronts, as in the recent past. Much more nuanced andsophisticated understanding of economic liberaliza-tion and its consequences may therefore have agreater intellectual and policy-making impact.

However, while the economic convergencepromised by neo-liberal economic globalization isunlikely – not only because it is mythical, but alsobecause there can never be the truly level playingfield promised by liberalization – one cannot denythat even partial liberalization has limited the rangeof options as well as the variety of possible economicarrangements. The changed institutional or systemicecology permits fewer species to survive. But vari-ety, albeit increasingly limited, there can and willbe.

In these circumstances, it is increasingly prob-able that systemic differences will be less stark andobvious. But this will perhaps compel closer atten-tion to the remaining variety as well as the remainingscope for diversity, which should in turn lead to morecareful attention to detail and to greater appreciationof the sources of efficacy of policy instruments, forexample. Hence, it seems likely that there will beless interest in alternative economic models or sys-


tems, but more consideration of the microeconomicbases for the viability of particular policies and in-stitutions. This could, in turn, lead to a much moreeclectic mixture of policies and institutions, andhence, to a greater variety of systems or models.

Notes

1 Namely: Hong Kong (China), Indonesia, Japan, Malay-sia, the Republic of Korea, Singapore, Taiwan Provinceof China and Thailand.

2 This section and the next draw from the introductions toJomo (2001a) and Jomo (2001b).

3 Many economists have been obliged to reconsider theirearlier assessments of the causes of the Asian crisis, mostnotably Paul Krugman. In the immediate aftermath of itsoutbreak, the crisis was seen by some as vindication ofhis earlier popularization of a critique of the East Asianmiracle as due primarily to massive factor inputs subjectto diminishing returns (Krugman, 1994). In March 1998,Krugman dissented from the view associated with JeffreySachs of the East Asian crisis as due to a “good old-fash-ioned financial panic … a panic need not be a punishmentfor your sins … an economy can be “fundamentally sound”… and yet be subjected to a devastating run started bynothing more than a self-fulfilling rumor”. Instead, he ar-gued “that the preconditions for that panic were createdby bad policies in the years running up to the crisis. Thecrisis, in short, was a punishment for Asian crimes, evenif the punishment was disproportionate to the crime …The specific spirit that pushed Asia to the brink was theproblem of moral hazard in lending – mainly domesticlending” which he associated with “crony capitalism”(Krugman, 1998a). Attributing the crisis to “cronyism”turned on its head one of the main arguments about howintimate business-government relations in East Asianeconomies had helped to create the conditions for the re-gional miracle. However, by October 1998 Krugman(1998b) had completely changed his view: “When theAsian crisis struck … countries were told to raise interestrates, not cut them, in order to persuade some foreign in-vestors to keep their money in place and thereby limit theexchange-rate plunge ... In effect, countries were told toforget about macroeconomic policy; instead of trying toprevent or even alleviate the looming slumps in theireconomies, they were told to follow policies that wouldactually deepen those slumps … But, because crises canbe self-fulfilling, sound economic policy is not sufficientto gain market confidence; one must cater to the percep-tions, the prejudices, and the whims of the market. Or,rather, one must cater to what one hopes will be the per-ceptions of the market … The perceived need to play theconfidence game supersedes the normal concerns of eco-nomic policy.” Later, Krugman (1999b) added: “The scopeof global “contagion” – the rapid spread of the crisis tocountries with no real economic links to the original vic-tim – convinced me that IMF critics such as Jeffrey Sachswere right in insisting that this was less a matter of eco-nomic fundamentals than it was a case of self-fulfillingprophecy, of market panic that, by causing a collapse ofthe real economy, ends up validating itself.”

4 Of course, the availability of cheap foreign funds – forexample, owing to a low real interest rate – can help to

temporarily close both domestic savings-investments aswell as foreign exchange gaps, especially if well investedor deployed.

5 Financial analysts had become fixated with the currentaccount deficit. This indicator, almost alone, had becomethe fetish of financial analysts, especially since the Mexi-can meltdown of early 1995. In earlier, different times,some economies sustained similar deficits for much longer,without comparable consequences. As noted in the im-mediate aftermath of the Mexican crisis of 1995, severalSouth-East Asian economies already had comparable cur-rent account deficits then, despite, or rather because of,rapid economic growth.

6 In some countries, government-owned, non-financial,public enterprises (NFPEs) have been very much part ofthis supposedly private sector, debt growth phenomenon.

7 There is also no evidence that the stock market boom ofthe mid-1990s more effectively raised funds for produc-tive investment; in fact, the converse seems more likely,with financial disintermediation from commercial banksto the stock market.

8 While the United States economy was strengthening, theSouth-East Asian economies were growing even faster.

9 In the mid-1990s, as the US dollar strengthened alongwith the United States economy, both the Japanese andthe Germans allowed their currencies to depreciate againstthe US dollar, with relatively little disruption, in an effortto regain international competitiveness.

10 Montes (1998) emphasizes that sentiments can either fa-vourably or unfavourably influence fundamentals and thehealth of financial systems. In particular, the collapse ofthe South-East Asian currencies due to sentiments wouldadversely affect the viability of investments made in dif-ferent exchange rate conditions, which could in turn fur-ther exacerbate the domestic banking crisis.

11 Montes argues that the rural-based economies of SouthEast Asia have been better able to carry out real devalua-tions from nominal changes in currency value, while theirexport sectors have not been too tied down by supply-side inflexibilities to respond to real devaluations. Afterasserting that stock markets have served to share risksamong asset owners rather than raise financing, he arguesthat, except for financial system weaknesses, South-EastAsian real sectors have been relatively immune from therecent asset market frenzy.

12 Montes points out that equity and portfolio investmentshave overtaken direct investment, loans and trade creditin providing external financing in the 1990s. He citesReisen’s warning (Montes, 1998: 34) that offers of for-eign financing should be resisted if they would “causeunsustainable currency appreciation, excessive risk-tak-ing in the banking system, and a sharp drop in privatesavings”. Hence, in a market-sentiment driven world, cur-rencies become too strong with offers of strong externalfinancing and too weak when capital withdraws.

13 Woo (2000a) has argued that “occasional excessive pricemovements in financial markets” should not be too read-ily attributed to rational anticipation of changes in gov-ernment policies that were not eventually realized – themain argument usually invoked to reject claims of specu-lative bubbles.

14 Short-termism – encouraged by financial liberalization –also accentuated the bias against longer-term productiveinvestments.

15 In the face of limited information and a rapidly changingsituation, such behaviour is often considered rational bymarket players, even if unfortunate.


16 Hedge funds may, however, go in different directions, forinstance, when the currency sell-off of one fund pro-vokes another fund to snap up bargain equities – forinstance, foreigners were often persistent net buyers ofJapanese stocks throughout the bursting of the bubble inJapan in the 1990s.

17 Krugman’s (1998c) attempt at theoretical “catching-up”is particularly worthy of consideration in the light of hisown previous attempts at understanding related interna-tional economic phenomena as well as East Asian eco-nomic growth. As the crisis was still unfolding, such anattempt was hardly definitive, especially without the ben-efit of hindsight. Yet, as policy was very much being madeon the hoof, his attempt to highlight certain relationshipsmay well be illuminating. Hence, Krugman argues that:“It is necessary to adopt an approach quite different fromthat of traditional currency crisis theory. Of course Asianeconomies did experience currency crises, and the usualchannels of speculation were operative here as always.However, the currency crises were only part of a broaderfinancial crisis, which had very little to do with currenciesor even monetary issues per se. Nor did the crisis havemuch to do with traditional fiscal issues. Instead, to makesense of what went wrong, we need to focus on two issuesnormally neglected in currency crisis analysis. These arethe role of financial intermediaries (and of the moral haz-ard associated with such intermediaries when they arepoorly regulated), and the prices of real assets such ascapital and land.”

18 None of the fundamentals usually emphasized seemed tohave been important in the affected economies: all the gov-ernments had fiscal surpluses and none were involved inexcessive monetary expansion, while inflation rates weregenerally low.

19 Whereas the other three crisis-affected East Asian econo-mies succeeded in attracting considerable, mainly short-term, US dollar bank loans into their more bank-basedfinanced systems, Malaysia’s vulnerability was mainly dueto the volatility of international portfolio capital flows intoits stock market. As a consequence, the nature of Malay-sia’s external liabilities at the beginning of the crisis wasquite different from that of the other crisis-stricken EastAsian economies. A greater proportion consisted of eq-uity, rather than debt. Much of the liabilities, includingthe debt, was private – rather than public – compared toMalaysia’s exposure in the mid-1980s. Also, compared tothe others, much of Malaysian debt in the late 1990s waslong- rather than short-term in nature. Monetary policy aswell as banking supervision in Malaysia had generally beenmuch more prudent compared to the other crisis victims.Banks in Malaysia had not been allowed to borrow heav-ily from abroad to lend on the domestic market, as in theother economies. Such practices involved currency andterm mismatches, which increased the vulnerability of thefinancial system to foreign bankers’ confidence, as wellas pressure on the exchange rate pegs. These differenceshave lent support to the claim that Malaysia was an “inno-cent bystander” which fell victim to regional contagionfor being in the wrong part of the world at the wrong time.Such a view takes a benign perspective on portfolio in-vestment inflows, and does not recognize that such in-flows are even more easily reversible and volatile thanbank loan inflows. The magnitude of gross inflows andoutflows reflect the much greater volatility of these flows,often obscured by focusing on net flows (Jomo, 2001a).Contrary to the “innocent bystander” hypothesis, Malay-sia’s experience actually suggests greater vulnerability

owing to its greater reliance on the capital market. As aconsequence, the Malaysian economy became hostage tointernational portfolio investor confidence. Hence, whengovernment leadership engaged in rhetoric and policy ini-tiatives that upset such investment confidence, Malaysiapaid a heavy price as portfolio divestment accelerated.

20 Recent findings suggest that national savings tend to equalnational investment, suggesting that flows of capital to“the best possible use” are far from universal and muchsmaller than simple theories predict. Lack of informationor other risks and uncertainties tend to reduce cross-bor-der capital flows.

21 Eatwell suggests a negative correlation between depend-ence on “foreign savings” and economic performance. Thisis true if we do not break down the nature of foreign sav-ings. The numbers are strongly biased by the inclusion ofshort-term money market flows, which may include ef-forts by governments to prop up their currencies with highinterest rates, which temporarily suck in money from over-seas. Brazil, Mexico and especially Venezuela typified thisa few years ago. If only long-term direct or equity invest-ment were considered, a lot of poorly performing LatinAmerican economies would be screened out. South-EastAsian countries, especially Malaysia and Singapore, wouldthen rank high in both foreign savings (measured “appro-priately”) and economic performance.

22 Of course, capital flight is not an inevitable consequenceof financial liberalization, but may reflect the fears andconsequent hedging behaviour of locals.

23 Currently, high interest rates represent a very unhappy situ-ation for the region. They are intended, in part, to prop thecurrency up to maintain confidence but, perhaps moreimportantly, to allow local companies to pay off their for-eign debts. The cost of this is slower growth. With lowerinterest and exchange rates, which help the economy togrow and help consumers, mismanaged local companieswould have to reorganize themselves, or otherwise losetheir equity (which they deserve, in many cases, to for-feit). Foreign creditors who were stupid enough to lenddollars to mismanaged companies should see their bankloans and bonds defaulted on. Bankrupt local companiescould be bailed out and recapitalized, with 100 per centequity ownership then going into mutual funds or pen-sion funds distributed equally to the masses of ordinarycitizens. Liberalization is generally associated with higherinterest rates. However, lower interest rates could havebeen due to a combination of pegged exchange rates, capi-tal controls, and the deployment of funds inside sucheconomies. Pegged exchange rates are enforced by capi-tal controls which “trap” a pool of savings inside aneconomy. The trapped savings are typically exploited bygovernments or banking cartels that may keep interest ratestoo low, even below inflation rates. The capital controlsmay thus force savers to accept low interest rates and stopthem from getting a fairer return elsewhere. The cheapsavings may get loaned to undeserving corporations orfor other purposes, possibly at the direction of the gov-ernment.

24 One could argue that some of this is the result of greed,stupidity and lack of education or regulation. If used care-fully, derivatives are ultimately insurance contracts.

25 There is evidence of a strong positive correlation betweenfinancial openness, foreign investment, GDP growth andper capita income driven by the performance of the Asiancountries.

26 In more democratic polities, there is also likely to be con-siderable pressure from the citizenry to be more assertive


in international economic affairs and to regain control ofnational economic leadership (Gray, 1998: 7). (I am grate-ful to Din Merican for reminding me of this.)

27 Because of the separation of ownership and managementof portfolio investments, though it may be in the interestof investors to “buy and hold”, it is difficult to write con-tracts to motivate pension managers, mutual funds andother intermediaries to stay put.

28 Of course, liquidity is one of the features which inducesotherwise risk averse investors to buy into a situation. Fur-thermore, in any transaction, there is a buyer for every seller.

29 Arguably, the Philippines currency has not taken quite ashard a hit, in part because their (colonial-inherited) bank-ing and accounting standards are considered relativelybetter, but also because short-term capital inflows havebeen relatively less, given the recentness of its economicrecovery.

30 See Jomo (1998); and Cambridge Journal of Economics(November 1998). See also Jomo (2001a), chap. 1 for anaccount of the Malaysian experience.

31 Furman and Stiglitz (1998) have critically reviewed therelevant literature to argue against raising interest rates toprotect the exchange rate. In particular, where leveragingis high, as in East Asia, high interest rates will take a hugetoll by weakening aggregate demand and increasing thelikelihood and frequency of insolvencies. Unexpected in-terest rate hikes tend to weaken financial institutions, lowerinvestments, and hence output. They offer three main rea-sons why keeping interest rates low while letting the ex-change rate depreciate may be a preferable option in theface of the trade-off involved:(i) To avoid crisis, there should be greater concern about

interest rate increases than about exchange rate de-clines (Demirguc-Kunt and Detragiache, 1998);

(ii) Invoking a moral hazard argument, they suggest thatany government intervention to stabilize the ex-change rate is likely to encourage economic agentsto take positions they would otherwise not take, latercompelling the government to support the exchangerate to avoid the now larger adverse effects;

(iii) Invoking an equity argument, they ask why borrow-ers, workers, firms and others adversely affected byhigher interest rates, should be compelled to pay forspeculators’ profits. When a government defends itscurrency, it is often making a one-way bet, wherethe expected loss is the speculators’ expected gain.In contrast, if the government does not wager anyreserves, the gains of some speculators are simplythe losses of others (Furman and Stiglitz, 1998: foot-note 132).

32 In a telling episode at the beginning of September 1997,IMF deputy head, Stanley Fischer, pointed out that al-though the current account deficits in South East Asia hademerged quite some years ago, markets had failed to ad-just – contrary to the predictions of conventional economictheory. (Instead of recognizing the failure of market mecha-nisms, US Federal Reserve Chair Alan Greenspan gentlychided Fischer in response, as if expecting IMF to “re-mind” Wall Street of what it had forgotten.) Meanwhile,“the market” had become so fixated with the current ac-count deficit that this indicator, almost alone, has becomethe fetish of financial analysts, especially since the Mexi-can meltdown of early 1995. In earlier, different times,some economies sustained similar deficits for much longer,without comparable consequences. As noted in the im-mediate aftermath of the Mexican crisis of 1995, severalSouth-East Asian economies already had comparable cur-

rent account deficits then, despite, or rather because of,rapid economic growth. Yet, as Fischer observed, the cur-rency markets had failed to adjust earlier on in South EastAsia (Fischer, 1997).

33 In the wake of the Mexican crisis in early 1995, the IMFhad stepped back momentarily from its advocacy of virtu-ally unfettered financial, including capital account, liber-alization. Unfortunately, the short-termism of financialmarkets extends to human and institutional memories aswell as to related policy-making and advocacy. (I am grate-ful to Anthony Rowley for confirming these details withKunio Saito, director of the IMF Tokyo regional repre-sentative office, on 17 December 1997.)

34 As Keynes (1936: 322–323) argued, the remedy for crisisis lowering, rather than increasing, interest rates: “The rightremedy for the trade cycle is not to be found in abolishingbooms and thus keeping us permanently in a semi-slump;but in abolishing slumps and thus keeping us permanentlyin a quasi-boom. … [A] rate of interest, high enough toovercome the speculative excitement, would have checked,at the same time, every kind of reasonable new invest-ment. Thus an increase in the rate of interest ... belongs tothe species of remedy which cures the disease by killingthe patient.”

35 However, a much lower share of recent Malaysian bank-lending is going to productive purposes, compared to theother three economies with their more bank-based finan-cial systems. As shown in Appendix tables 3a, 3b, 3c and3d, in 1999 only 19 per cent of commercial bank loansand advances went to manufacturing in Malaysia, com-pared to 35 per cent in the Republic of Korea (in 1998),30 per cent in Thailand, and 36 per cent in Indonesia.

36 For instance, the recapitalization of commercial banks inthe Republic of Korea in September 1998 involved aninjection of 64 trillion won. Similarly, the Malaysian ef-fort involved over RM47 billion to take non-performingloans out of the banking system, and another RM5-7 bil-lion to recapitalize the most distressed banks.

37 This subsection and the next draw heavily on Furman andStiglitz (1998).

38 This section draws heavily on Akyüz (2000a; 2000b).39 Hazel Henderson (1999) argues that rather than invoke

US bankruptcy procedures for private firms (chap. 11),the more relevant and appropriate reference point for de-veloping country governments are the provisions for mu-nicipal authorities (chap. 14).

40 This sub-section draws heavily from Felker and Jomo(1999).

References

ADB (1997). Emerging Asia. Manila, Asian Development Bank.ADB (1999). Asian Development Report, 1999. Manila, Asian

Development Bank.AKYÜZ, Yilmaz (2000a). The debate on the international fi-

nancial architecture: Reforming the reformers. UNCTADDiscussion Paper, No. 148. Geneva, April.

AKYÜZ, Yilmaz (2000b). On financial instability and control.Paper presented at FONDAD Conference on Crisis Pre-vention and Response, The Hague, 26–27 June.

AMSDEN, Alice (1989). Asia’s Next Giant: South Korea andLate Industrialization. Oxford University Press, New York.

BACKMAN, Michael (1999). Asian Eclipse: Exposing the DarkSide of Business in Asia. Wiley, Singapore.


BAER W, MILES WR and MORAN AB (1999). The end of theAsian myth: Why were the experts fooled? World Devel-opment, 27(10): 1735–1747.

BANK NEGARA MALAYSIA (BNM) (various issues). AnnualReport; Monthly Statistical Bulletin; and Quarterly Eco-nomic Bulletin. Bank Negara Malaysia, Kuala Lumpur.

BIS (1998). Report on the Maturity and Nationality of Interna-tional Bank Lending. Basel, Bank for International Set-tlements, January.

BHAGWATI J (1998). The capital myth. Foreign Affairs, 77(3),May/June: 7–12.

BOOTH, Anne (1999). Education in Southeast Asia. Paper pre-sented at the Second Malaysian Studies Conference,Malaysian Social Science Association, Kuala Lumpur. Tobe published in Jomo KS, ed. (2001c), Paper Tigers inSoutheast Asia? Behind Miracle and Debacle. Basingstoke(UK), Macmillan.

CARLETON PD, ROSARIO BP and WOO WT (2000). Theunorthodox origins of the Asian financial crisis: Evidencefrom logit estimations. ASEAN Economic Bulletin, Spe-cial Issue, April.

CHNG MK, PHANG SY, WONG PK and YONG JS (2001).Government policy in Singapore’s manufacturing devel-opment. In: Jomo KS, ed. Southeast Asia’s Ersatz Indus-trialisation. Basingstoke (UK), Macmillan.

CLIFFORD ML and ENGARDIO P (2000). Meltdown: Asia’sBoom, Bust and Beyond. Paramus, NJ, Prentice Hall.

DEMIRGUC-KUNT A and DETRAGIACHE E (1998). Thedeterminants of banking crises in developing and devel-oped countries. IMF Staff Papers, 45(1): 81–109.

EATWELL, John (1997). International financial liberalization:The impact on world development. Discussion Paper Se-ries. New York, United Nations Development Programme,Office of Development Studies, May.

FELKER G and JOMO KS (1999). New approaches toinvestment policy in the ASEAN 4. Paper present at theAsian Development Bank Institute Second AnniversaryWorkshop on Development Paradigms, Tokyo, 10 Decem-ber.

FISCHER S (1997). IMF – The right stuff. Financial Times,17 December.

FURMAN J and STIGLITZ JE (1998). Economic crises: Evi-dence and insights from East Asia. In: Brookings Paperson Economic Activity, no. 2. Washington DC, BrookingsInstitutions: 1–135.

GANUZA E, TAYLOR L and VOS R, eds. (2000). ExternalLiberalization and Economic Performance in LatinAmerica and the Caribbean. New York, United NationsDevelopment Programme.

GOMEZ ET and JOMO KS (1999). Malaysia’s PoliticalEconomy: Politics, Patronage and Profits (second edi-tion). Cambridge, Cambridge University Press.

GRAY J (1998). False Dawn: The Delusions of Global Capital-ism. London, Granta Books.

HAMILTON-HART N and JOMO KS (2001). Financial regula-tion, crisis and policy response. In: Jomo KS, ed.Malaysian Eclipse: Economic Crisis and Recovery. Lon-don, Zed Books: 67–89.

HENDERSON H (1999). Beyond Globalization: Shaping aSustainable Global Economy. West Hartford, CT,Kumarian Press.

HSIAO MHH (1996). Agricultural reforms in Taiwan and SouthKorea. In: Borrego J, Alvarej Bejar A and Jomo KS, eds.Capital, the State and Late Industrialisation. Boulder, CO,Westview: 97–112.

IMF (1997). World Economic Outlook: Interim Assessment.Washington, DC, December.

IMF (1998). World Economic Outlook and International Finan-cial Markets: Interim Assessment. Washington, DC, De-cember.

JOHNSON C (1982). MITI and the Japanese Miracle. Stanford,Stanford University Press.

JOMO KS, ed. (1998). Tigers in Trouble: Financial Govern-ance, Liberalisation and Crises in East Asia. London, ZedBooks.

JOMO KS (1999). Globalization and human development in EastAsia. In: Globalization with a Human Face: Human De-velopment Report 1999. Background Papers, no. 2. NewYork, Human Development Report Office, United NationsDevelopment Programme: 81–123.

JOMO KS, ed. (2001a). Malaysian Eclipse: Economic Crisisand Recovery. London, Zed Books.

JOMO KS, ed. (2001b). Southeast Asia’s Ersatz Industrialisa-tion. Basingstoke (UK), Macmillan.

JOMO KS, ed. (2001c). Paper Tigers in Southeast Asia? Be-hind Miracle And Debacle. Basingstoke (UK), Macmillan.

JOMO KS et al. (1997). Southeast Asia’s Misunderstood Mira-cle: Industrial Policy and Economic Development in Thai-land, Malaysia and Indonesia. Boulder, CO, Westview.

JOMO KS and FELKER G, eds. (1999). Technology, Competi-tiveness and the State: Malaysia’s Industrial TechnologyPolicies. London, Routledge.

KAMINSKY G and REINHART CM (1996). The twin crises:The causes of banking and balance-of-payments problems.Working Paper, No. 17. Baltimore, MA, University ofMaryland at College Park, Centre for International Eco-nomics.

KAPLINSKY R (1999). If you want to get somewhere else, youmust run at least twice as fast as that!: The roots of theEast Asian crisis. Competition and Change: The Journalof Global Business and Political Economy, 4(1).

KEYNES JM (1936). The General Theory of Employment, In-terest and Money. New York, Harcourt Brace and Com-pany.

KHAN M (2000). Rent-seeking as a process. In: Khan M andJomo KS, eds. Rents, Rent-seeking and Economic Devel-opment: Theory and Evidence in Asia. Cambridge, Cam-bridge University Press: 70–144.

KREGEL J (1998). East Asia is not Mexico: The differencesbetween balance of payments crises and debt deflation.In: Jomo KS, ed. Tigers in Trouble: Financial Govern-ance, Liberalisation and Crises in East Asia. London, ZedBooks: 44–62.

KRUGMAN P (1994). The myth of the Asian miracle. ForeignAffairs, November-December.

KRUGMAN P (1998a). Will Asia bounce back? Speech forCredit Suisse First Boston, Hong Kong (China) (http://web.mit.edu/krugman/www).

KRUGMAN P (1998b). The confidence game: How Washing-ton worsened Asia’s crash. The New Republic, 5 October.

KRUGMAN P (1998c). What happened to Asia? Paper preparedfor a conference in Japan, January (www.mit.edu/krugman/www/DISINTER/html).

KRUGMAN P (1999a). The Return of Depression Economics.London, Allen Lane.

KRUGMAN P (1999b). Capital control freaks: How Malaysiagot away with economic heresy. Slate, 27 September (http://web.mit.edu/krugman/www).

LANE T (1999). The Asian financial crisis: What have we learned?Finance & Development, 36(3), September: 44–47.

LANE T, GHROSH A, HAMANN J, PHILLIPS S, SCHULZE-GHATTAS M and TSIKATA T (1999). IMF-SupportedPrograms in Indonesia, Korea and Thailand: A Prelimi-nary Assessment. Washington, DC, IMF, January.


LOW L (2001). The role of the government in Singapore’s in-dustrialisation. In: JOMO KS, ed. Southeast Asia’s ErstazIndustrialisation. London, Macmillan.

MASTIC (1994). Basic Information. Kuala Lumpur, MalaysianScience and Technology Information Centre.

McKIBBIN W (1998). Modelling the crisis in Asia. ASEANEconomic Bulletin, December.

MONTES MF (1998). The Currency Crisis in Southeast Asia.Singapore, Institute of Southeast Asian Studies.

NASUTION A (2000). The meltdown of the Indonesianeconomy: Causes, responses and lessons. ASEAN Eco-nomic Bulletin, Special Issue, April.

PASUK P and BAKER C (2000). Thailand’s Crisis. Chiang Mai,Thailand, Silkworm Books.

PERKINS D (1994). There are at least three models of East Asiandevelopment. World Development, 2(4): 655–661.

RADELET S and SACHS J (1998a). The East Asian financialcrisis: Diagnosis, remedies, prospects. Brookings Paperson Economic Activity, 1998, (1): 1–90.

RADELET S and SACHS J (1998b). The onset of the East Asianfinancial crisis. Paper prepared for the NBER CurrencyCrisis Conference, 6–7 February (www.cid.harvard.edu/cidglobal/asian.htm).

RAGHAVAN C (1998). BIS banks kept shovelling funds to Asiadespite warnings. Third World Economics, 16–31 January.

RASIAH R (1995). Foreign Capital and Industrialisation inMalaysia. Basingstoke (UK), Macmillan Press.

RASIAH R (2001). Pre-crisis economic weaknesses andvulnerabilities. In: Jomo KS, ed. Malaysian Eclipse: Eco-nomic Crisis and Recovery. London, Zed Books: 47–66.

RODAN G (1989). The Political Economy of Singapore’s In-dustrialisation. Kuala Lumpur, Forum.

SHIN JS (2000). Corporate Restructuring after Financial Cri-sis in South Korea: A Critical Appraisal. Singapore, Na-tional University of Singapore, July.

STIGLIT JE (1998). The role of international financial institu-tions in the current global economy. Address to the Chi-

cago Council on Foreign Relations, Chicago, 27 Febru-ary (www.worldbank.org/html.extme/jssp022798.htm).

TSURU S (1993). Japanese Capitalism. Cambridge, CambridgeUniversity Press.

UNCTAD (various years). Trade and Development Report.United Nations sales publication. New York and Geneva,United Nations Conference on Trade and Development.

UNDP (1995). Human Development Report. New York, UnitedNations Development Programme, Oxford UniversityPress.

WADE R (1990). Governing the Market: Economic Theory andthe Role of Government in East Asian Industrialization.Princeton, NJ, Princeton University Press.

WADE R (1996). Japan, the World Bank, and the art of para-digm maintenance: The East Asian miracle in a politicalperspective. New Left Review, 217: 3–36.

WONG HK with JOMO KS (2001). The impact of foreign capi-tal inflows on the Malaysian economy, 1966–96. FEAWorking Paper Series. Kuala Lumpur, University of Ma-laya, Faculty of Economics and Administration.

WOO WT (2000a). Introduction. ASEAN Economic Bulletin,Special Issue, April.

WOO WT (2000b). Coping with accelerated capital flows fromthe globalization of financial markets. ASEAN EconomicBulletin, Special Issue, April.

WORLD BANK (various issues). World Development Report.New York, Oxford University Press.

WORLD BANK (1993). The East Asian Miracle: EconomicGrowth and Public Policy. New York, Oxford UniversityPress.

WORLD BANK (1998). East Asia: The Road to Recovery.Washington, DC.

WORLD BANK (2000). Global Development Finance. Wash-ington, DC.

YOSHIHARA K (1988). The Rise of Ersatz Capitalism in South-east Asia, Singapore, Oxford University Press.


Appendix table 1

EAST ASIAN FOUR: MACROECONOMIC INDICATORS, 1990–1999

(Percentage change over previous year)

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Malaysia

Real GDP 9.7 8.2 7.8 8.4 9.2 9.5 8.6 7.5 -7.5 5.4Private consumption 13.1 9.5 3.0 4.6 9.8 9.4 6.9 4.3 -10.8 2.5M2 12.8 14.5 19.1 22.1 14.7 24.0 21.4 22.6 1.5 11.6M3 18.2 15.3 19.6 23.5 13.1 22.3 21.2 18.5 2.7 8.3Inflation 3.1 4.4 4.8 3.6 3.7 3.4 3.5 2.7 5.3 2.8C.A. deficit/GDP 2.1 8.9 2.8 4.8 6.3 8.5 4.9 -5.0 12.9 14.0Foreign reservesa 9,327 10,421 16,784 26,814 24,888 22,945 26,156 20,013 24,728 30,853

Rep. of Korea

Real GDP 9.0 9.2 5.4 5.5 8.3 8.9 6.8 5.0 -6.7 11.0Private consumption 9.6 8.0 5.5 5.6 8.2 9.6 7.1 3.5 -11.4 10.3M2 17.2 21.9 14.9 16.6 18.7 15.6 15.8 14.1 27.0 27.4M3 28.7 23.6 21.8 19.0 24.7 19.1 16.7 13.9 12.5 8.0Inflation 8.5 9.3 6.3 4.8 6.2 4.5 4.9 4.5 7.5 0.8C.A. deficit/GDP -0.8 -2.8 -1.3 0.3 -1.0 -1.7 -4.4 -1.7 12.8 6.1Foreign reservesa 14,459 13,306 16,640 19,704 25,032 31,928 32,402 19,710 51,963 73,700

Thailand

Real GDP 11.6 8.4 7.8 8.3 8.9 8.7 6.4 -1.8 -10.4 4.1Private consumption 12.8 6.6 7.8 8.7 8.3 8.6 6.6 -1.3 -2.2 n.a.M2 26.7 19.8 15.6 18.4 12.9 17.0 12.6 16.4 9.5 2.1M3 - 19.9 18.5 19.7 17.6 18.7 13.4 3.2 8.9 1.6Inflation 6.0 5.7 4.1 3.3 5.0 5.8 4.8 5.6 8.1 0.3C.A. deficit/GDP 8.3 7.5 5.5 5.5 5.6 8.0 7.9 -2.1 12.7 9.1Foreign reservesa 13,247 17,287 20,012 24,078 28,884 35,463 37,192 25,697 28,434 34,781

Indonesia

Real GDP 7.2 7.0 6.5 6.5 7.7 8.2 7.8 4.7 -13.2 0.2Private consumption 17.2 8.0 3.1 11.8 4.7 9.7 9.2 5.3 -2.1 1.5M2 44.2 17.1 20.2 22.0 20.2 27.6 29.6 23.2 62.3 11.9Inflation 7.4 9.4 7.5 9.7 8.5 9.4 6.5 6.6 58.5 20.5C.A. deficit/GDP 3.4 3.8 2.1 1.6 1.7 3.6 3.3 -2.3 4.1 3.5Foreign reservesa 7,353 9,151 10,181 10,988 11,820 13,306 17,820 16,088 22,401 27,160

Source: Asian Development Bank, Bank Negara Malaysia, Malaysia (Treasury), Economic Report, Bank of Thailand, MonetaryAuthority of Singapore, International Monetary Fund, International Financial Statistics.

a Foreign exchange (IFS line 1d.d), US$ million; current account surplus in US$ million.

APPENDIX

52G

-24 Discussion P

aper Series, No. 10

Appendix table 2a

THAILAND: FOREIGN DEBT INDICATORS, 1970–1998

(US$ million)

1970 1980 1990 1992 1993 1994 1995 1996 1997 1998

Total debt stock (EDT) 8,297 28,165 41,865 52,717 65,597 83,093 90,777 93,731 86,172Long-term debt (LDOD) 726 5,646 19,842 27,138 30,083 36,418 41,998 53,164 56,466 59,410Short-term debt 2,303 8,322 14,727 22,634 29,179 41,095 37,613 34,836 23,523

Net flow on debt 365 1,808 3,534 4,132 11,112 10,474 18,226 6,755 5,796 -10,998of which short-term debt -37 2,210 2,235 7,907 6,545 11,916 -3,482 -2,777 -11,313

Aggregate resource flows and net transfers (long-term)

Net resource flows (long-term) 139 2,087 4,691 4,175 8,226 4,863 10,630 14,220 9,615 8,987Foreign direct investment (net) 43 190 2,444 2,113 1,804 1,366 2,068 2,336 3,746 6,941Portfolio equity flows 0 0 449 4 3,117 -538 2,154 1,551 -308 2,341Profit remittances on FDI 19 38 312 350 420 465 480 510 550 580

Major economic aggregates

Gross national product (GNP) 7,096 32,091 84,272 108,975 122,790 141,500 164,619 176,593 149,257 112,720Exports of goods and services (XGS) 8,575 31,289 42,919 49,596 58,679 74,093 75,385 76,157 69,227International reserves (RES) 911 3,026 14,258 21,183 25,439 30,280 36,939 38,645 26,897 29,537Current account balance -2,076 -7,281 -6,303 -6,364 -8,085 -13,554 -14,691 -3,024 14,241

Debt indicators

EDT/XGS (per cent) 96.8 90.0 97.5 106.3 111.8 112.1 120.4 123.1 124.5EDT/GNP (per cent) 25.9 33.4 38.4 42.9 46.4 50.5 51.4 62.8 76.4RES/EDT (per cent) 36.5 50.6 50.6 48.3 46.2 44.5 42.6 28.7 34.3RES/MGS (months) 3.3 4.4 5.1 5.4 5.4 5.0 5.1 4.1 6.4Short-term/EDT (per cent) 27.8 29.5 35.2 42.9 44.5 49.5 41.4 37.2 27.3

Source: World Bank, Global Development Finance 2000.Key: MGS: Imports of goods and services.

53G

rowth A

fter the Asian C

risis: What R

emains of the E

ast Asian M

odel?

Appendix table 2b

INDONESIA: FOREIGN DEBT INDICATORS, 1970–1998

(US$ million)

1970 1980 1990 1992 1993 1994 1995 1996 1997 1998

Total debt stock (EDT) 20,938 69,872 88,002 89,172 107,824 124,398 128,940 136,173 150,875Long-term debt (LDOD) 2,948 18,163 58,242 69,945 71,185 88,367 98,432 96,710 100,338 121,672Short-term debt 2,775 11,135 18,057 17,987 19,457 25,966 32,230 32,865 20,113

Net flow on debt 890 2,280 7,216 9,331 -1,124 5,066 9,941 12,346 10,087 -4,935of which short-term debt 667 3,160 3,742 -70 1,470 6,509 6,264 635 -9,750


Net resource flows (long-term) 686 1,902 5,901 7,945 3,622 9,594 12,901 15,564 11,592 -808Foreign direct investment (net) 83 180 1,093 1,777 2,004 2,109 4,348 6,194 4,677 -356Portfolio equity flows 0 0 312 119 2,452 3,672 4,873 3,099 298 250Profit remittances on FDI 128 3,234 2,192 2,623 2,577 2,800 3,000 3,400 3,300 2,800


Gross national product (GNP) 9,698 74,806 109,209 132,938 151,992 170,284 192,474 221,277 209,438 85,486Exports of goods and services (XGS) 29,870 38,234 41,940 46,517 54,880 58,793 65,819 57,470International reserves (RES) 160 6,803 8,657 11,482 12,474 13,321 14,908 19,396 17,487 23606Current account balance -2,988 -2,780 -2,106 -2,792 -6,431 -7,663 -4,889 3972

Debt indicators

EDT/XGS (per cent) 233.9 230.2 212.6 231.8 226.7 219.3 206.9 262.5EDT/GNP (per cent) 28.0 64.0 66.2 58.7 63.3 64.6 58.3 65.0 176.5RES/EDT (per cent) 32.5 12.4 13.0 14.0 12.4 12.0 15.0 12.8 15.6RES/MGS (months) 3.1 3.3 3.4 3.2 2.9 3.5 3.0 5.3Short-term/EDT (per cent) 13.3 15.9 20.5 20.2 18.0 20.9 25.0 24.1 13.3


54G

-24 Discussion P

aper Series, No. 10

Appendix table 2c

MALAYSIA: FOREIGN DEBT INDICATORS, 1970–1998

(US$ million)

1970 1980 1990 1992 1993 1994 1995 1996 1997 1998

Total debt stock (EDT) 6,611 15,328 20,018 26,149 30,336 34,343 39,673 47,228 44,773Long-term debt (LDOD) 440 5,256 13,422 16,379 19,197 24,147 27,069 28,605 32,289 36,117Short-term debt 1,355 1,906 3,659 6,951 6,189 7,274 11,068 14,939 8,656

Net flow on debt 63 1,592 -1,851 2,041 5,470 2,220 5,138 6,387 8,397 -3,361of which short-term debt 481 -367 1,565 3,312 -762 1,085 3,974 3,871 -6,283


Net resource flows (long-term) 99 2,052 1,183 6,093 10,923 8,680 10,495 12,031 9,152 8,529Foreign direct investment (net) 94 934 2,333 5,183 5,006 4,342 4,132 5,078 5,106 5,000Portfolio equity flows 0 0 293 385 3,700 1,320 2,299 4,353 -489 592Profit remittances on FDI 166 1,190 1,926 2,713 2,985 3,250 4,000 4,000 4,200 4,500


Gross national product (GNP) 4,089 23,607 40,902 55,166 60,969 68,918 83,101 94,563 94,833 68,581Exports of goods and services (XGS) 14,836 34,514 46,421 54,656 68,526 85,992 94,065 95,387 71,900International reserves (RES) 667 5,755 10,659 18,024 28,183 26,339 24,699 27,892 21,470 26,236Current account balance -266 -870 -2,167 -2,991 -4,520 -8,469 -4,596 -4,792 9,683

Debt indicators



55G

rowth A

fter the Asian C

risis: What R

emains of the E

ast Asian M

odel?

Appendix table 2d

REPUBLIC OF KOREA: FOREIGN DEBT INDICATORS, 1970–1998

(US$ million)

1970 1980 1990 1992 1993 1994 1995 1996 1997 1998

Total debt stock (EDT) 29,480 34,986 44,156 47,202 72,415 85,810 115,803 136,984 139,097Long-term debt (LDOD) 1,991 18,236 24,186 32,236 35,002 40,802 39,197 49,221 72,128 94,062Short-term debt 10,561 10,800 11,920 12,200 31,613 46,613 66,582 53,792 28,139

Net flow on debt 847 6,415 1,058 4,698 2,262 28,321 22,706 33,300 16,774 7,190of which short-term debt 3,396 1,000 720 280 19,412 15,001 19,969 -12,790 -1,653

Aggregate Resource flows and net transfers (long-term)

Net resource flows (long-term) 411 2,440 1,369 7,753 8,603 12,244 13,045 19,358 22,382 13,201Foreign direct investment (net) 66 6 788 727 588 809 1,776 2,325 2,844 5,415Portfolio equity flows 0 0 518 3,045 6,029 2,525 3,559 3,700 1,257 4,096Profit remittances on FDI 5 64 266 247 253 270 295 320 350 375


Gross national product (GNP) 8,997 60,801 252,384 314,337 345,232 401,782 487,918 518,501 473,939 316,195Exports of goods and services (XGS) 22,050 76,679 89,858 97,860 114,850 151,237 157,229 168,928 160,061International reserves (RES) 610 3,101 14,916 17,228 20,355 25,764 32,804 34,158 20,465 52,100Current account balance -5,312 -2,003 -3,944 990 -3,867 -8,507 -23,006 -8,167 40,552

Debt indicators




Appendix table 3a

THAILAND: LOANS AND ADVANCES BY COMMERCIAL BANKS, 1989–1999

(Per cent of total loans)

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Agriculture 6.5 6.6 7.0 6.2 5.5 4.4 3.7 3.4 2.7 2.8 2.6

Manufacturing 25.8 25.1 25.3 23.7 24.0 24.2 25.8 27.1 30.9 30.7 30.1

Construction 3.8 4.0 4.0 4.0 3.8 4.1 4.4 4.9 4.5 4.7 4.3

Trade and transportation 19.5 19.3 19.1 18.9 20.0 18.4 20.3 20.9 20.4 20.2 19.3

Finance and real estate 14.8 17.0 17.0 17.6 17.3 17.6 17.4 15.9 16.1 14.7 17.7

Service industries 5.7 6.1 6.8 7.3 7.7 7.8 7.8 7.8 7.6 8.0 7.5

Households 10.8 10.6 11.2 12.3 12.6 12.7 12.3 12.6 10.8 11.4 11.0

Others 13.0 11.3 9.7 9.9 9.0 10.9 8.2 7.6 7.1 7.6 7.4

Total loans (dom. credit) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Change

(per cent growth p.a.) 29.9 32.7 21.0 20.7 23.5 28.3 22.9 14.2 24.8 -13.6 -2.0

Total loans

(per cent of GDP) 60.6 68.4 72.1 77.1 85.0 95.2 101.5 103.5 125.5 113.0 109.1

Source: Computed from SEACEN Financial Statistics and Bank of Thailand data.

Appendix table 3b

INDONESIA: LOANS AND ADVANCES BY COMMERCIAL BANKS, 1989–1999


1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Agriculture 8.3 7.3 7.5 8.3 8.0 7.3 6.6 6.0 6.9 8.1 8.1

Manufacturing 32.0 31.3 29.2 30.1 34.2 31.9 30.7 26.9 29.5 35.2 36.4

Construction n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.


Finance and real estate n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Service industries 16.4 18.3 18.3 21.5 23.8 26.9 28.4 31.3 30.0 28.5 26.5

Households n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Others 11.7 12.7 16.0 13.4 8.9 10.5 11.2 11.7 11.8 8.4 9.5


Change

(per cent growth p.a.) 38.0 50.0 49.9 47.6 45.6 49.5 51.6 55.0 60.5 49.3

Total loans

(per cent of GDP) 44.6 53.8 16.2 8.9 21.6 25.6 24.2 24.8 29.1 28.9 -24.8

Source: Computed from SEACEN Financial Statistics and Bank of Indonesia data.


Appendix table 3c

MALAYSIA: LOANS AND ADVANCES BY COMMERCIAL BANKS, 1989–1999


1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Agriculture 5.4 5.2 4.8 4.4 3.5 2.6 2.2 2.1 2.0 2.0 2.3

Manufacturing 20.9 23.2 24.2 24.0 23.0 24.0 24.2 22.0 20.1 18.8 18.8

Construction 7.1 6.8 3.8 8.1 7.9 7.7 8.0 8.9 10.1 10.3 9.6



Service industries n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Households n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Others 25.3 26.1 29.7 26.5 28.0 31.9 30.2 29.7 30.5 41.3 42.6


Change

(per cent growth p.a.) 18.1 20.3 20.4 8.8 10.9 14.4 30.5 24.5 32.9 7.2 3.5

Total loans

(per cent of GDP) 65.5 67.8 71.9 70.2 68.1 68.6 78.7 85.8 102.8 109.1 107.4

Source: Computed from Quarterly Economic Bulletin, Bank Negara Malaysia data.

Appendix table 3d

REPUBLIC OF KOREA: LOANS AND ADVANCES BY COMMERCIAL BANKS , 1989–1999


1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Agriculture 9.8 10.0 9.9 8.7 9.0 9.5 10.2 9.7 9.6 9.8 n.a.

Manufacturing 41.4 42.0 46.7 43.8 43.4 42.1 40.9 39.2 37.1 35.3 n.a.

Construction 9.6 8.7 7.5 6.7 6.7 6.6 7.5 7.4 6.9 7.1 5.9

Trade and transportation 7.0 7.2 7.8 7.3 7.5 7.6 8.0 8.8 9.3 9.3 n.a.


Service industries n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Households 2.7 3.1 3.1 2.4 2.2 2.0 2.2 2.3 2.6 2.9 n.a.

Others 22.9 23.4 24.5 24.7 26.6 29.0 29.1 30.5 31.6 30.6 n.a.


Change

(per cent growth p.a.) 28.2 18.4 15.4 20.3 12.0 18.0 12.2 16.2 13.1 -0.1 24.9

Total loans

(per cent of GDP) 41.9 41.4 39.5 41.8 41.5 42.0 40.4 42.3 44.2 44.6 n.a.

Source: Computed from SEACEN Financial Statistics and Bank of Korea data.


0

5

10

15

20

25

30

35

40

45

1996

Q1

1996

Q2

1996

Q3

1996

Q4

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

2000

Q1

US$

bil

lion

Exports Imports Reserves

Appendix figure 1a

THAILAND: QUARTERLY MERCHANDISE TRADE BALANCE AND RESERVES,1996Q1–1999Q4

Appendix figure 1b

INDONESIA: QUARTERLY MERCHANDISE TRADE BALANCE AND RESERVES, 1996Q1–1999Q4

0

5

10

15

20

25

30

1996

Q1

1996

Q2

1996

Q3

1996

Q4

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

US$

bil

lion



Appendix figure 1c

MALAYSIA: QUARTERLY MERCHANDISE TRADE BALANCE AND RESERVES,1996Q1–1999Q4

0

5

10

15

20

25

30

3519

96Q

1

1996

Q2

1996

Q3

1996

Q4

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

US$

bil

lion


Appendix figure 1d

REPUBLIC OF KOREA: QUARTERLY MERCHANDISE TRADE BALANCE AND RESERVES,1996Q1–1999Q4

0

10

20

30

40

50

60

70

80

90

1996

Q1

1996

Q2

1996

Q3

1996

Q4

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

2000

Q1

US$

bil

lion



Appendix figure 2a

THAILAND: GDP GROWTH, FOREIGN EXCHANGE AND INTEREST RATE,1997Q1–2000Q1

-15

-10

-5

0

5

10

15

20

25

30

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

2000

Q1

Per

cen

t

0

10

20

30

40

50

60

Bah

t/U

S$

GDP Interest rates FOREX

Appendix figure 2b

INDONESIA: GDP GROWTH, FOREIGN EXCHANGE AND INTEREST RATE,1997Q1–2000Q1

-20

-10

0

10

20

30

40

50

60

70

80

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

2000

Q1

Per

cen

t

0

2000

4000

6000

8000

10000

12000

14000

16000

Rup

iah/

US$



Appendix figure 2c

MALAYSIA: GDP GROWTH, FOREIGN EXCHANGE AND INTEREST RATE,1997Q1–2000Q1

-15

-10

-5

0

5

10

1519

97Q

1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

2000

Q1

Per

cen

t

0

1

2

3

4

5

6

RM

/US$


Appendix figure 2d

REPUBLIC OF KOREA: GDP GROWTH, FOREIGN EXCHANGE AND INTEREST RATE,1997Q1–2000Q1

-25

-20

-15

-10

-5

0

5

10

15

20

25

1997

Q1

1997

Q2

1997

Q3

1997

Q4

1998

Q1

1998

Q2

1998

Q3

1998

Q4

1999

Q1

1999

Q2

1999

Q3

1999

Q4

2000

Q1

Per

cen

t

0

200

400

600

800

1000

1200

1400

1600

1800

Won

/US$



G-24 Discussion Paper Series*

Research papers for the Intergovernmental Group of Twenty-Four on International Monetary Affairs

No. 1 March 2000 Arvind PANAGARIYA The Millennium Round and Developing Countries: Nego-tiating Strategies and Areas of Benefits

No. 2 May 2000 T. Ademola OYEJIDE Interests and Options of Developing and Least-developedCountries in a New Round of Multilateral Trade Negotia-tions

No. 3 May 2000 Andrew CORNFORD The Basle Committee’s Proposals for Revised CapitalStandards: Rationale, Design and Possible Incidence

No. 4 June 2000 Katharina PISTOR The Standardization of Law and Its Effect on DevelopingEconomies

No. 5 June 2000 Andrés VELASCO Exchange-rate Policies for Developing Countries: WhatHave We Learned? What Do We Still Not Know?

No. 6 August 2000 Devesh KAPUR and Governance-related Conditionalities of the InternationalRichard WEBB Financial Institutions

No. 7 December 2000 Andrew CORNFORD Commentary on the Financial Stability Forum’s Report ofthe Working Group on Capital Flows

No. 8 January 2001 Ilan GOLDFAJN and Can Flexible Exchange Rates Still “Work” in FinanciallyGino OLIVARES Open Economies?

No. 9 February 2001 Gordon H. HANSON Should Countries Promote Foreign Direct Investment?

* G-24 Discussion Paper Series are available on the website at: http://www.unctad.org/en/pub/pubframe.htm. Copies ofG-24 Discussion Paper Series may be obtained from c/o Editorial Assistant, Macroeconomic and Development Policies Branch,Division on Globalization and Development Strategies, United Nations Conference on Trade and Development (UNCTAD), Palaisdes Nations, CH-1211 Geneva 10, Switzerland; Tel. (+41-22) 907.5733; Fax (+41-22) 907.0274; E-mail: [email protected]

Documents

Growth After the Asian Crisis: What Remains of the East ...bev.berkeley.edu/ipe/readings/Asian Financial Crisis24-jomo.pdf · The circumstances leading to the onset of the East Asian