Lessons from the Financial Crisis in Asia

Joseph E. StiglitzUniversity of Macau

March 18th, 2002

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Capital and Financial Market Capital and Financial Market LiberalizationLiberalization THE INTERNATIONAL ARCHITECTURE HAS EXHIBITED ENORMOUS

FRAGILITY OVER THE PAST QUARTER CENTURY.

CAPITAL AND FINANCIAL MARKET LIBERALIZATION ARE SYSTEMATICALLY RELATED TO THIS VULNERABILITY.

ALTHOUGH CAPITAL MARKET LIBERALIZATION CLEARLY PORTENDS GREATER RISKS, IT HAS NOT BROUGHT COMMENSURATE BENEFITS IN TERMS OF ECONOMIC GROWTH.

a. EVIDENCEb. NOT SURPRISING: OPPORTUNITY COST OF RESERVESc. RISK IS BAD FOR GROWTHd. ONE CANNOT BUILD FACTORIES ON MONEY THAT CAN LEAVE

OVERNIGHT

ADVERSE EFFECTS OF FINANCIAL AND CAPITAL MARKET LIBERALIZATION CAN BE RELATED TO MARKED DISCREPANCIES BETWEEN SOCIAL AND PRIVATE RETURNS TO RISK

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Badly Designed Policies (I)Badly Designed Policies (I)

1) BADLY DESIGNED RESPONSES TO CRISES EXACERBATE DISCREPANCIES

2) THERE IS WIDE AGREEMENT THAT IMF POLICIES WERE BADLY DESIGNED

a) EXCESSIVE TIGHTNESS OF FISCAL POLICY

b) HIGH INTEREST RATES, ESPECIALLY WITH HIGH LEVERAGE, LED TO BANKRUPTCY

i) INTERESTS OF THOSE WITH UNCOVERED FOREIGN DEBTS WERE PUT ABOVE THOSE WITH DOMESTIC INDEBTEDNESS

ii) POLICIES DID NOT SUSTAIN EXCHANGE RATE—BASED ON BAD ECONOMIC MODELS

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Badly Designed Policies (II)Badly Designed Policies (II)

iii) LED TO MORAL HAZARD—WEAKENED INCENTIVES FOR LENDERS TO ENGAGE IN DUE DILIGENCE, BORROWERS IN FOREIGN CURRENCY TO OBTAIN COVER

c) LOWERING INTEREST RATES SUBSEQUENTLY DID NOT UNBANKUPT FIRMS

d) CLOSING DOWN BANKS IN WRONG WAY LED TO RUNS

e) SHORTAGE OF FINANCE LED TO SUPPLY DISRUPTIONS, EXACERBATING DEMAND SIDE EFFECTS

f) UNDERESTIMATED REAL CONTAGION—BEGGAR THY SELF POLICIES

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Badly Designed Policies (III)Badly Designed Policies (III)

g) OVERESTIMATED IMPORTANCE OF MARKET PSYCHOLOGY

h) RESTRUCTURING POLICIES ALSO MISGUIDED: KOREA AND MALAYSIA VS. THAILAND

i) CAPITAL CONTROLS DID WORK: MALAYSIA HAD SHORTEST AND SHALLOWEST DOWNTURN, LEFT WITH LEAST LEGACY OF DEBT.

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A Case for InterventionA Case for Intervention

SUCH DISCREPANCIES CREATE A PRIMA FACIE CASE FOR INTERVENTION

IT IS INTELLECTUAL INCOHERENT TO ARGUE FOR BAILOUTS AND HIGHLIGHT THE IMPORTANCE OF CONTAGION AND SYSTEMIC RISK BUT NOT TO TRY TO ADDRESS THE UNDERLYING SOURCE OF THE PROBLEM

THRUST OF INTERVENTIONS SHOULD BE TO STABILIZE CAPITAL FLOWS

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Comprehensive ProgramComprehensive Program

WHAT IS REQUIRED IS A COMPREHENSIVE PROGRAM

a. REFORMS IN DEVELOPED COUNTRIES

b. REFORMS IN DEVELOPING COUNTRIES

c. REFORMS IN INTERNATIONAL ARCHITECTURE

NEEDS TO BE CONGRUENCE BETWEEN COUNTRY’S EXPOSURE TO RISK, ITS ABILITY TO MANAGE THOSE RISKS, AND THE PROVISIONS IT HAS MADE TO INSULATE THE MOST VULNERABLE FROM THOE CONSEQUENCES OF THOSE RISKS

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Final Key IssueFinal Key Issue

KEY ISSUE IS BANKRUPTCY AND STANDSTILLS, INCLUDING DESIGN OF CAPITAL CONTROLS AND EXIT TAXES

– IN PRIVATE BORROWING, SUPER CHAPTER 11– IN PUBLIC ISSUES ARE MORE COMPLICATED

NEED COLLECTIVE ACTION CLAUSES BUT NEED MORE THAN THAT BUT MAJOR CREDITOR CANNOT ALSO BE

JUDGE