Miracle, Financial Crisis, & Recovery in SE Asia Politics of Southeast Asia Prof. Edmund Malesky, Ph.D. UCSD A Short Course on Miracles • Think quickly! You just told that cute somebody at the cocktail party that you are a student of the political economy of Southeast Asia and they actually seemed interested. Now, you have to back up your bold claim with a little…you know… knowledge - but not too much!! Any more than a sentence, and the buffet table at the far end of the room will start to look a lot more interesting than you. What is your one sentence/cocktail-safe definition of the East Asian Miracle? Maybe a few images might help… (Paste Link into Browser) Income/Life Expectancy http://graphs.gapminder.org/world/#$majorMode=chart$is;shi=t;ly=2003;lb=f;il=t;fs=11;al=30;stl=t;st=t;nsl=t;se=t$wst;tts=C$ts;sp=6;ti=2006$zpv;v=1$inc_x; mmid=XCOORDS;iid=phAwcNAVuyj1jiMAkmq1iMg;by=ind$inc_y;mmid=YCOORDS;iid=phAwcNAVuyj2tPLxKvvnNPA;by=ind$inc_s;uniValue=20;iid=phAw cNAVuyj0NpF2PTov2Cw;by=ind$inc_c;uniValue=255;gid=CATID0;iid=phAwcNAVuyj1jiMAkmq1iMg;by=grp$map_x;scale=log;dataMin=212;dataMax=2612 3$map_y;scale=lin;dataMin=26;dataMax=88$map_s;sma=20;smi=1.2$cd;bd=0$inds=i10_d001950bNbI;i29_d001960aXa5;i163_h001960aIbd;i143_d00196 0bkbM;i220_p001950aqbk;i249_p001960aUao;i223_p001960beas;i203_p001950aob7;i134_l001960abbL;i176_p001950bcaB;i209_h001980bwcq;i114_d0 01960axcx GDP Growth – ASEAN 5 http://graphs.gapminder.org/world/#$majorMode=chart$is;shi=t;ly=2003;lb=f;il=t;fs=11;al=30;stl=t;st=t;nsl=t;se=t$wst;tts=C$ts;sp=6;ti=2006$zpv;v=1$inc_x;mmid=XC OORDS;iid=ti;by=ind$inc_y;mmid=YCOORDS;iid=phAwcNAVuyj1jiMAkmq1iMg;by=ind$inc_s;uniValue=20;iid=phAwcNAVuyj0NpF2PTov2Cw;by=ind$inc_c;uniValu e=255;gid=CATID0;iid=phAwcNAVuyj1jiMAkmq1iMg;by=grp$map_x;scale=lin;dataMin=1900;dataMax=2010$map_y;scale=lin;dataMin=- 1415.3205;dataMax=21743$map_s;sma=20;smi=1.2$cd;bd=0$inds=i102_p001960cHcg;i176_l001903beaS;i134_p001960cVcK;i203_p001930aNa6;i223_p001960c YbI Life Expectancy – ASEAN 5 http://graphs.gapminder.org/world/#$majorMode=chart$is;shi=t;ly=2003;lb=f;il=t;fs=11;al=30;stl=t;st=t;nsl=t;se=t$wst;tts=C$ts;sp=6;ti=2006$zpv;v=1$inc_x;mmid= XCOORDS;iid=ti;by=ind$inc_y;mmid=YCOORDS;iid=phAwcNAVuyj2tPLxKvvnNPA;by=ind$inc_s;uniValue=20;iid=phAwcNAVuyj0NpF2PTov2Cw;by=ind$inc_c;u niValue=255;gid=CATID0;iid=phAwcNAVuyj1jiMAkmq1iMg;by=grp$map_x;scale=lin;dataMin=1900;dataMax=2010$map_y;scale=lin;dataMin=18;dataMax=83$m ap_s;sma=20;smi=1.2$cd;bd=0$inds=i102_p001960bYbg;i176_h001950aJaL;i134_p001960cAbC;i203_h001950a4ab;i223_p001960cta1 Life Expectancy – All SEA http://graphs.gapminder.org/world/#$majorMode=chart$is;shi=t;ly=2003;lb=f;il=t;fs=11;al=30;stl=t;st=t;nsl=t;se=t$wst;tts=C$ts;sp=6;ti=2005$zpv;v=1$inc_x ;mmid=XCOORDS;iid=ti;by=ind$inc_y;mmid=YCOORDS;iid=phAwcNAVuyj2tPLxKvvnNPA;by=ind$inc_s;uniValue=20;iid=pyj6tScZqmEcjeKHnZq6RIg;by =ind$inc_c;uniValue=255;gid=CATID1;iid=phAwcNAVuyj1jiMAkmq1iMg;by=grp$map_x;scale=lin;dataMin=1900;dataMax=2010$map_y;scale=lin;dataMin =18;dataMax=83$map_s;sma=27;smi=1.2$cd;bd=0$inds=i102_p002005bYbg;i176_h002005aJaL;i134_p002005cAbC;i203_h002005a4ab;i223_p002005c ta1;i249_p002005ayaN;i35_t002005,,,,;i121_t002005,,,, http://graphs.gapminder.org/world/#$majorMode=chart$is;shi=t;ly=2003;lb=f;il=t;fs=11;al =30;stl=t;st=f;nsl=t;se=t$wst;tts=C$ts;sp=6;ti=2005$zpv;v=1$inc_x;mmid=XCOORDS;iid =ti;by=ind$inc_y;mmid=YCOORDS;iid=pyj6tScZqmEcjeKHnZq6RIg;by=ind$inc_s;uniVal ue=20;iid=phAwcNAVuyj3WKLh6zjDsBQ;by=ind$inc_c;uniValue=255;gid=CATID0;iid=ph AwcNAVuyj1jiMAkmq1iMg;by=grp$map_x;scale=lin;dataMin=1979;dataMax=2005$map_ y;scale=lin;dataMin=19;dataMax=74$map_s;sma=15;smi=7.45$cd;bd=0$inds=i102_n,,b Ybg;i176_f,,aWaR;i134_j,,bXay;i203_n,,awaJ;i223_n,,akaQ;i249_f,,auat;i35_b,,cxaw;i12 1_f,,aOay;i44_r,,,,,,;i29_r,,,,,,;i10_r,,,,,,;i143_r,,,,,,;i209_b,,ana4;i114_r,,,,,,;i163_r,,,,,, Here is the World Bank’s Definition • Sustained high economic growth over many years with limited inequality. But why were they able to achieve it? Economic Explanations – Market Friendly: “…the appropriate role of government is to ensure adequate investments in people, provide a competitive climate for private enterprise, keep the economy open to international trade, and maintain a stable economy.” – Export Orientation: “This is primarily a story about moving away from Import Substituting Industrialization and embracing the fruits of an open economy.” – Institutions: The secret to East Asian development was their construction of an incorruptible (and highly paid) civil service, strong governance, and fair and equitable dispute resolution channels in the court system. – Flying Geese: Development in Asia looks a bit like the arrow-shaped pattern of flying geese with Japan in the point position. Japanese companies invested in South Korea, Taiwan, and Hong Kong until they developed large and strong enough multinationals on their own to invest in the other countries of Southeast Asia. To join this club, a Southeast Asian country need only open its doors to Foreign Direct Investment and liberalize exporting. Total Factor Productivity • In our reading for this week, Krugman takes issue with many explanations for the miracle, citing Young’s “Tyranny of Numbers.” • Krugman (1994): “Their rise was fueled by mobilizing resources – increasing inputs of machinery, infrastructure, and education – just like that of the now-derided Soviet Economy…If there is a secret to Asian growth, it is simply deferred gratification, the willingness to sacrifice current satisfaction for future gain.” • Bottom line is that East Asian Economies did not improve productivity, the efficiency of labor and capital usage over the time period studied. • Krugman’s beef with the explanations of the Asian Miracle draws on one of the most important theories in macro-economics…. Solow Growth Model (Review of Samphantharak Notes) • MIT Macro-Economist in the 50s and 60s • Developed a theory of economic growth, whether growth is derived from exogenous technological progress • We won’t derive the formula, but here are the implications of the model: Two sources of economic growth: 1. Input accumulation • Capital accumulation (through higher savings) • Higher labor market participation, Lower unemployment rate & Longer work hours 2. Technological progress • Micro productivity growth • Macro efficient allocation Input driven growth is transitory and cannot be sustained in the long run due to the diminishing marginal product of capital and labor. Long run growth must come from technological progress Where does technological progress come from? Micro technological progress • R&D is an important source of technological progress • “Learning” or “Technology Adoption” Macro (aggregate) technological progress • More efficient resource allocation Accounting for TFP Input Accumulation Solow Residual Technological Progress gY = (1 – α) gK + α gN + α gA Our Dependent Variable is the Growth in Capital Growth in Labor Growth of Total Accumulation Market Output (y) Participation Model assumes capital (K) and labor (N) are paid according to their marginal products, so α = (labor income/gdp) So TFP is in the Residual gY -α gY = (1 – α) gK + α gN + α gA A α gA = gY - (1 – α) gK - α gN TFP Using this, we can decompose the growth of the SEA Tigers over the Miracle Period. Alternative Calculations of TFP Bottom Line for Young and Krugman • SEA wasn’t doing anything special, it was just mobilizing resources. • Eventually this strategy would run into diminishing marginal returns. • Economies only grow when they increase productivity. Critiques of Young • Severe Measurement Errors in the calculation of capital stock – This is critical because TFP is in the residual. Any measurement error will also show up in the residual. If we overestimate, the capital stock we under-estimate TFP. • Naïve Assumptions – Cobb-Douglas function assumes constant returns to scale. – Perfect competition, which was not the case in SEA. Stiglitz (2001) famously argued that inputs do not get paid their marginal product. • Micro-logic of the Theory – The Young assessment should find little evidence of innovation within SEA countries. Other studies have found examples of assembly-line and management innovations. – There appears to be evidence that SEA economies skipped whole generations of technological development. (The technology gap is decreasing). Stiglitz Contribution to the Debate • “The undeniable miracle was the high savings rates of the SEA economies.” • Savings increases fuel the investment growth and workforce improvement. • He argued that there is some lag between income increases and consumption. In these cases, economies can gravitate toward 1 of 2 equilibriums. – High growth with high savings. – Low growth with low savings • Why did East Asia gravitate toward the high growth-high savings equilibrium, when the rest of the world did not? Summary of the Economic Explanations for SEA Growth What under-girds input accumulation, and/or technological progress? 1. High savings in physical capital - Domestic - (FDI) 2. Financial development (i.e. physical capital allocation) 3. Human capital accumulation and allocation 4. Openness in international trade - Export oriented industrialization - Free trade 5. Role of government policies Other Political Economy Explanations • Revisionists – Selective Interventions/The Developmental State: “Industrial policy and interventions in financial markets are not easily reconciled within the neoclassical framework. Some policies are more in accord with models of state-led development. Moreover, while the neoclassical model would explain growth with a standard set of relatively constant policies, the policy mixes used by East Asian governments “led the market” in critical ways.” “Not only has Korea not gotten relative prices right, it has deliberately gotten them wrong.” (Alice Amsden and Robert Wade). – Relationship Networks: Close connections between government, business, and finance allow the government to direct development choices and pick winners. Moreover, strong social bonds allow for external enforcement of contracts. But why were they able to achieve it? • Hybrid Theories – Critical Juncture: For the most part East Asia followed a neo-classical approach, but did diverge from it critical junctures in order to right the course. – Unsuccessful Interventions: East Asian economies did try to engage in selective interventions across a number of industries, but these interventions were generally successful. What worked was economic orthodoxy. On-Going Debates 1. Miracle or not, why did such a large period of high growth with relatively low inequality occur in East and Southeast Asia? • Explanations from some scholars: – 1. Cultural (Confucianism, "The Internal Dynamism of the Asian Man." Lee Kwan Yiew) – 2. Security (Doner, Ritchier, Slater….) – 3. Diffusion – 4. Networks and community ties On-Going Debates 2. Is the East Asian Experience unique? - Other economies have experienced faster growth with different policies. - Clear evidence of diminishing marginal returns to inputs. - Inequality eventually began to increase along with growth. - With so many developing countries, export orientation may not be the path to glory it once was. On-Going Debates 3. Did the Asian Financial crisis signal the end of the East Asian Miracle or was it just a blip on the overall growth trajectory? On to the Crisis – What Happened? http://graphs.gapminder.org/world/#$majorMode=chart$is;shi=t;ly=2003;lb=f;il=t;fs=11;al=30;stl =t;st=t;nsl=t;se=t$wst;tts=C$ts;sp=6;ti=2005$zpv;v=1$inc_x;mmid=XCOORDS;iid=ti;by=ind$in c_y;mmid=YCOORDS;iid=phAwcNAVuyj3WKLh6zjDsBQ;by=ind$inc_s;uniValue=2;iid=phAwc NAVuyj0NpF2PTov2Cw;by=ind$inc_c;uniValue=255;gid=CATID1;iid=phAwcNAVuyj1jiMAkmq1i Mg;by=grp$map_x;scale=lin;dataMin=1991;dataMax=2004$map_y;scale=lin;dataMin=- 27.1177;dataMax=31$map_s;sma=50;smi=1.2$cd;bd=0$inds=i249_d001985bLc1;i223_l0019 61sDbH;i203_l001961sMbd;i176_d001961gdcw;i134_l001961sBa5;i102_l001961sNcb;i35_p0 01994akak The Financial Crisis – Abridged • Western investors loaned money to banks in East Asia. • Those banks funneled the loans to investment projects at low rates of interest and took very little in collateral. • When these investments did not perform, currency speculators bet that the baht was overvalued and began to sell baht on the open market. • The value of the baht fell causing other investors to worry about currencies in the rest of Asia. • Pandemonium struck. • I was one year out of college, spending my summer in Thailand, and getting paid in $. Life was good for me. I now feel very guilty about this. The Players 4 Groups of Countries a) Countries whose actions set the stage for the crisis. • China – Devaluation of the Yuan in 1994 lowered the effective price of Chinese products in areas where many SEA companies competed. • Japan – Economic stagnation throughout the 1990s slowed FDI into region and limited exports. b) Countries who were hammered by the crisis. • Thailand, Indonesia, Malaysia, S. Korea, and to a lesser extent the Philippines. • Currencies dropped roughly 50% and GDP growth slowed or in the case of T, I (by 15%) and S. K (by 2.8%) reversed. The worst US recession was 2.1 % in 1987 The Playahs 4 Groups of Countries c) Countries who survived due to high foreign reserves and/or economic fundamentals. d) Countries who escaped because their currencies were not convertible (Vietnam, China, Laos), or who were otherwise not highly exposed to foreign portfolio flows (Cambodia, Burma). Da Playuzz • 4 Groups of Investors – 2 from Developed Countries • Institutional Investors (Banks, Pension Funds) • Currency Speculators – 2 from Southeast Asia • Domestic Banks and Financial Corporations • Domestic Long-Term Investors (factories, real estate) The Players • International Organizations – Many were involved but the one we will be most concerned about today is the role of the IMF both before and after the crisis. De facto this means the US, and Robert Rubin, Secretary of the Treasury were also involved. Economics Primer 1 • The Balance of Payments always balances. – There is a direct connection between current account deficit and foreign investment. – A purchase is always accompanied by an equal sale. Purchase of a good requires the sale of an asset and vice versa. – Trade deficit is paid for by inflows of foreign capital. Countries use foreign inflows to buy imports abroad. – Economists believe that countries current account deficits should equal their capital account surplus. – Countries with current account surpluses accumulate high levels of foreign reserves, as countries buy their products in foreign currency. – As Prof. Samphantharak reminds us, a short-term current account deficit is not by itself problematic; the problem is when expected future capital inflows may not be enough to balance the deficit. Deep Level Explanations • The Asian economic miracle led to a situation where institutional investors felt confident loaning money to banks in Asian developing countries for two reasons: – They expected Asian economic growth to continue indefinitely and wanted to take advantage of that growth. – Felt if there was a bad turn and Asian banks (and Thai finance companies) defaulted on the loans that the IMF would bail out those banks and thus indirectly the institutional investors. • There was now a problem of Moral Hazard- The IMF previous bail-outs of Mexico and Argentina led institutional investors to believe that they had a one-way bet (i.e. they couldn't lose). Net Private Capita Flows/GDP Balance of Payments Balance of Payments Economics Primer 2 • The domestic Asian bank or finance company was essential acting as a conveyor bet for foreign funds. – It receives loans in dollars or yen, but it wants to invest domestically in Thailand, so it goes to the foreign exchange (forex) Market and exchanges western currencies for baht. – The demand for baht has increased, so the value of the baht should rise…. – but the Thai government was maintaining a fixed exchange rate; it would respond to the rise in the baht by selling baht and buying foreign currencies. – This kept the price of the baht stable but had two other effects: • Thai Central Bank exposure to Foreign Currencies Increases. • Domestic money supply increases. • As a result, there was more money in the economy to invest. Could have let the baht just rise. Soon the increased investment started to fuel more imports and lead to a current account deficit. Foreign Exchange Exposure Domestic Financial Sector (Haggard 2001) • Moral Hazard 2: The close connection between government, investors/bankers in S. E. Asia. – Governments were interested in directing investment into profitable sectors and would coerce banks through tax breaks, subsidies, and direct coercion to invest in businesses that they normally would not have at very low rates of interest.. – This appeared to be positive when these countries were trying to develop exporting industries, but it quickly became corrupted when banks started to loan to favored government companies (holding very little collateral as security) An Example from Indonesia • In Indonesia, 6 of the top 15 banks had the government as the largest shareholder and Suharto family members tended to receive the vast majority of the loans. – Bank of Duta- lost $500,000,000 but was bailed out by two other conglomerates Government Lending Policies in Other Countries • Malaysia was trying to direct investment to help out ethnic Malays or bumiputras. • Thailand was directing investment. through the bank of commerce (BBC). • In Korea, government connections fueled lending to the Chaebol. Non-Performing Loans • Because the lending was based on political connections, banks funneled loans from international institutional investors to private companies with little concern for the profitability/risk ratio of the investment or the assets they would receive as collateral. 15 – 15% of the loans in Indonesia were non-performing (meaning that investment was not growing enough to pay back interest payments and the collateral held was less than the value of the investments) – In Thailand, 24.4% of BOC's loans alone were non- performing, but was kept afloat with a 7 billion dollars from the Thai Government. According to the government resolution justifying the bail-out, the Central Bank of Thailand was inclined toward political interests. In short, several politicians were beneficiaries of BBC loans. Total Non-Performing Loans Lack of Transparency • Overall, it was very difficult for any of these connections to be observed or corrected, because financial records were poor, manipulated, and often did not list non-performing loans. Bottom-Line on Local Finance • Another one way bet for local investors: Heads the investor wins, tails the taxpayer loses. Government was highly unlikely to let insolvent banks sink. Here come the speculators… • Currency speculators in developing countries began to notice Thailand was running a massive current account deficit - 8.4% of GDP in 1996. – This was the result of the Chinese 1994 devaluation and the decline of the Japanese Yen against the dollar by 35%. – Thai goods were becoming relatively more expensive abroad relative to Chinese goods and very expensive in Japan (Thailand's most important market) where consumers could now afford much less. – As word started to leak that many investment in these markets were non-performing and many investments went sour, institutional investors became less likely to lend money to banks or finance corporations. Here come the speculators… • Lack of foreign investment should have led naturally to a decline in the baht on foreign exchange markets. – After all, there was less demand for it. • But the Bank of Thailand needed to maintain the value of the baht, so it started to sell foreign currency to prop up the baht. • This action was causing Thailand to deplete its foreign reserves. • Thailand could have raised interest rates to raise the currency value, but this would have made it expensive to invest in Thailand -- just as Thailand was entering a recession. • Notice: It was not just the current account deficit, it was the fact that currency speculators did not believe Thailand could attract enough investment to maintain it. Here come the speculators… • Currency speculators began to bet that the government would rather let the value of the currency decline rather than turn the screws on the domestic economy. • A devaluation of the baht would hurt the government's reputation, but also hurt Thai banks and businesses who held their savings in baht or were owed money in baht. • Speculators began to sell short: They borrowed baht on the international market, expecting the value to decline, and promised to sell them for dollars at the current rate. After the baht fell, they could pay back that baht loan at a substantial profit. Inside Thailand…. • But it wasn't just speculators: Local businessmen borrowed baht to pay of loans that were denominated in dollars. Middle class Thais sold their holdings of Thai government bonds and began to buy US Treasury bills denominated in dollars. • The baht's value began to fall and the Government now had two choices. – Let the value of the baht fall all the way to its natural level – Or defend it all costs by selling foreign reserves. – Instead, Thailand hedged as long as it could. Its President Chavilit pledged to defend the peg and on the July 1, 1997 made a formal statement that Thailand would not abandon the peg. An Investment Tip • Whenever you hear a national leader formally pledge to defend a currency as long as possible…. sell! • The very next day Thailand devalued, but readjusted to a new peg. They did not let their currency float. • Speculators thought they could invest more, local Thais began to pull out their savings, and I was able to eat out at fancy restaurants every night. • By the end of the summer, the Thai baht would drop from 25 baht to the dollar to 63 baht to the dollar. Finance models tell us that a normal devaluation to make Thai companies cost competitive would have been 15%. • But loss of confidence caused it to drop farther ---a loss of confidence caused by the Thai President's decision. So that explains Thailand • But how do we explain the spread from one economy to the next over the next year?? Contagion • "Excess variability and co-movement of portfolio flows and asset prices that is not explained by economic fundamentals.“ • 3 Explanations for Contagion – Brute Force Economics – Emerging Market Portfolios – Cascading Information Flows Contagion: Brute Forces Economics • Two Variants 1. Similar fundamental economic problems. Large current account deficit and non-transparent financial rules. Malaysia, and the Philippines were in similar situations. But what about Indonesia its trade deficit was less than 4% of GDP - less than Australia's. 2. Linkages through trade or FDI --Indonesia can be explained because it was a trade competitor to Thailand and a devaluation would make its goods relatively more expensive. It would need to devalue as well. But how do we explain why South Korea was taken down by the crisis. It was one of the world's most powerful economies and its economic problems were not nearly so severe. A devaluation in Thailand was no threat to Korea, Nor was a Korea a large market for Thai products, which could be eliminated from Korean books by "Just a rounding error." Contagion: Emerging Market Portfolios • 2 Variants 1. Samphantharak’s “Common Banker Puzzle.” • When two country’s borrow from the same banks, a crisis in one will trigger a squeeze in the other regardless of underlying fundamentals. 2. Actions of International Investors • Big western investors were holding all of their developing country bets in umbrella “Emerging Market Portfolios.” When one country ended up in crisis, they dumped their entire portfolios and fled to safer ground. The tech boom beginning immediately after the crisis may have been impart fueled by this exodus. • Less drastic version: Once an investor faces a loss in one emerging market, she may sell other emerging market assets to shore up her overall position Contagion: Cascading Information Flows (Banarjee 1992; Mendoza 1994) • Explanation by Example Huyen, Prof. Only Prof. Malesky’s RA is Malesky knows interested in Thuba and the question for decentralization. Mike,Huyen’s the Politics of She checks out a teammates, see SEA Final number of books her check out the The rest of the SEA class sees Thuba and Mike at the library from the library on books and assume checkout counter. Knowing their proximity to Huyen, they decentralization. she knows assume she knows something. Pandemonium strikes, the something about library is emptied of books on decentralization, and on the the final. They also day of the final, everyone receives a question about ……. begin researching colonial influence. decentralization. Contagion: Cascading Information Flows • Cascading information is extremely helpful explaining what happened in 1997. • There were only a few truly knowledgeable investors in the region. Others simply watched their actions carefully and imitated. • When they re-adjusted their portfolios, the others followed suit. Contagion: Cascading Information Flows • A few things to keep in mind about the theory. – This is entirely rational behavior (bounded rationality). People have limited time and calculating ability to study every country all the time. – As a result, it is rational to rely on clues or signaling devices like more informed investors. – An entirely rational process led to an irrational over-reaction by a large group. Responses to Crisis: The International Monetary Fund Enters the Fray • A Joke: What does the IMF stand for? –I – aM – F (In really really really big trouble)! Responses to Crisis: The International Monetary Fund Enters the Fray • Nobody who needs help likes the IMF much. If anyone did, it would be a bad sign. • The IMF is the lender of last resort; it is the place you go when you have no other options. • Lenders of last resort practice tough love, to give you what you need rather than what you want, and to force you to pull yourself together and make changes for the better. • "A cute and cuddly IMF wouldn't be doing its job." • But the converse isn't true, just because people hate the IMF doesn't mean it is doing its job well. These days most people and the IMF staff themselves have questions about the response. Let's probe to see what they did. The Basic IMF Formula • money so bad, LendNot reallyin the short term to get them over the crisis Think of right? • parents for the In exchange bailing amoney, ask officials to reform their economies to get over the worst college student out of of crony capitalism excesses a credit card And Robert • fiasco. maintain high interest rates to Require them to Rubin, U.S. the country entice capital into staying inSecretary of the • Treasury, as Ask for prudential fiscal reforms such had balanced budget, paying back loans, and successfully committing to inflation. employed the • strategy in Wait for investor confidence to return and the Mexico viscous circle to turn into a virtuous 1995. circle. But there were problems… 1. Medicine worse than the disease • The IMF demanded that the countries practice fiscal austerity-- that they raise taxes in order to avoid large budget deficits? • Why budget deficits? This wasn't the problem at all ; trade deficits were the problem. • The idea was to restore investor confidence, but it caused a two-edged problem 1. If countries could achieve a surplus, the recession was worsened because demand was reduced. 2. If they didn't , it sent the message that the country was in chaos and fed the electronic herd's panic. But there were problems… 2. Structural reform: • Bank reform just fine, but what did reducing special perks for Suharto cronies do? • Korea just needed short term creditors and encouragement to rollover loans, but the IMF bailout of $57 billion insisted on fundamental overhaul of Korean economy. – easing purchases of Korean businesses – easing imports – breaking up Chaebols. • The reforms made the short term transition painful, and made firms that were survivable in the long run insolvent in the short run. • The proper institutional foundations may not have been in place for such a drastic shock. But there were problems… 3. A new type of moral hazard • Reform was so painful (to avoid investors losing confidence), countries now have an incentive to wait too long to seek modest help. • Perhaps, they will just hoard foreign reserves. But this is money that could go for modernization? But there were problems… 4. Martin Feldstein: Why did they have the right? • A major portion of US debt (in the form of T-bills) is held by Japan and China. Can they impose changes on us? The Alternative Solution: Malaysia • Malaysia’s logic after attempting orthodoxy under Anwar Ibrahim. – Currency crises are self-fulfilling. – If investors think that the currency will depreciate in the future, they will sell the currency now– causing the depreciation (or devaluation) of the currency now (This has certainly happened with bank crises. – The solution: Stop the outflow. Impose capital controls • Investors needed to sell foreign exchange to government at a fixed rate. • Short-term investment was limited. – Investors were upset and sharply criticized the actions 10 Years Later: What do we know? • The East Asian Economies have recovered and are growing again at rapid rates. But Growth Has Settled on a Lower Trajectory than Before Why is growth not at the same high rates? • Labor growth has not declined • Education rates have not declined either • Total Factor Productivity was hurt by the crisis, but is back to pre-crisis levels. But fixed Investment declined after the crisis On the other hand, FDI is now starting to pick-up (Despite significant FDI heading to VN and China) Poverty is also declining • 228 million people raised above $2 a day. Reserves Under Pressure in Some Countries due to Today’s Crisis Never Again: No more BOP exposure, impacted SEA economies have become creditor nations. Running Positive Current Account Balances Never Again: Flexible and Strong Exchange Rates Not struggling to balance in current crisis On the downside, inequality may be increasing in some countries. Improvements in the Business Environment? Concluding Thoughts • How have different regime types fared over the past twenty years in SEA? • Was the crisis just a blip and is SEA back on the road to recovery? • Have changes in political institutions helped or hurt the recovery?
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