Asian Financial Crisis
Many economists have said that the growth experienced by Southeastern Asian countries during the 1980s and early 1990s was a miracle. Japan, Malaysia, South Korea, Indonesia and other countries in the region experienced annual growth rates of over 7 percent. Along with this rapid growth, these countries also saw very little unemployment and an almost invisible wealth gap between the different social and economic classes of citizens.
Circumstances have dramatically changed, however. In the summer of 1997, Southeast Asia experienced a time of great financial and economic turmoil. At first, the economic crisis was isolated in Thailand’s financial sector, but it quickly spread to Malaysia, Indonesia and South Korea as well.
The Prosperous Times
It seems that Southeast Asia has always been able to turn bad times around and recover to end up as some of the strongest economies in the world. South Korea, for instance, was very weak and vulnerable after fighting a civil war with North Korea in 1953. However, between 1960 and 1990, the country experienced remarkable economic growth and recovery, and soon the world’s 11th most powerful economy.
Many other Southeast Asian countries had similar experiences. South Korea, Hong Kong, Taiwan and Singapore were previously known as the Four Tigers because of their fast and aggressive entry into the global marketplace. Other examples include Japan, Malaysia, Indonesia and Thailand, each of which experienced rapid growth and prosperity in relatively short periods of time.
In the U.S., the Asian miracle stirred up both awe and fear. This was especially so in the 1980s when Asian products became fierce competition for American products. Japan’s automobiles and electronics were rivaled U.S. products and caused much fear among producers in these U.S. markets. This competition, in part, led to a U.S. trade deficit. U.S. congress reacted by passing a number of trade regulations aimed at protecting U.S. industries.
Southeast Asian governments engaged in acts that promoted certain industries and businesses. They provided them with tax credits or subsidies. These policies allowed Asian government leaders to pick the leading industries and helped to ensure their success rather than allow the free trade market to dictate such decisions. Thus, these countries had a power to control and dictate the market, much more so than other Western powers.
Supporters of the Asian system argued that such government intervention in the marketplace was necessary to ensure economic stability. They argued that policy makers could focus on industries with high growth potential. Many of these industries would have otherwise had great difficulty raising capital to start operations. Asian political leaders also implemented tariffs and other protection measures to protect their domestic industries from international competition. The result was the growth of large corporations that became powerful competitors in international markets.
In late June of 1997 sixteen Asian financial companies collapsed which alerted investors to the stresses the economy was currently facing. . By July money market traders believed the government could be forced to abandon its pledge to link the currency unit of Thailand, the Baht, to the US dollar. They felt that the dollar was much stronger than the Baht, and thus pegging the value of the Baht to the value of the dollar greatly overestimated the value of the Baht. On the second of July the Thai government announced a managed float of the Baht. They then called on the International Monetary Fund (IMF) for technical assistance. That day the value of the Baht fell approximately 20 percent in comparison to the US dollar.
Many investors were concerned that the baht would become unstable and suddenly decline in value. So, large numbers of investors exchanged the currency for dollars. They felt the value of the dollar on the international currency exchange was more certain, thus making that investment less risky. As more and more investors became concerned with the future of the baht there was an increase in the number of bahts being exchanged for other currency units. Thailand’s central bank was hoping that the large number of investors selling the baht would slow as confidence was restored in the currency. The baht experienced devaluation, which essentially lowered the price of Thai goods in dollar terms. This made Thai products more attractive to foreign consumers, as they appeared cheaper than domestic goods.
Although devaluation theoretically can help a weak currency, it had other effects on the Thai economy. A large portion of the money used by Thai banks and businesses to invest in the country was borrowed from foreign financial institutions. It became increasingly difficult for these banks and businesses to repay these foreign debts, as the dollar was much stronger than the baht. Many businesses were unable to raise enough baht to cover their debts and defaulted on their loans. The large number of loan defaults caused even more problems for Thai banks, which were already close to filing bankruptcy. The Thai government tried to control the crisis, but the devaluation of the baht impaired their ability to save their banks.
Thai government officials realized the need for help and began to look internationally for assistance. In August 1997, the International Monetary Fund (IMF) and several Asian countries pledged to provide a total of $16 billion in an attempt to save Thailand’s financial system. In return for the loans, the government agreed to improve business practices in the country. The government had to agree to specific tax increases, implementing policies to discourage banks from making risky loans, and close more than 40 financial firms that were on the verge of bankruptcy that the government initially wanted to bail out.
One of the immediate goals of the IMF bailout package to Thailand was to prevent further currency instability in the region. Yet much of the damage had already been done. Following the devaluation of the baht, other currencies in Southeast Asia plunged. Most governments in the region were able to prevent their currencies from tumbling through a variety of monetary policies.
Some of the hardest hit countries included Malaysia, Indonesia and South Korea. Each of their currencies lost nearly 40% of their value by the end of 1997. In Japan and Hong Kong stock markets experienced a drastic drop in October 1997. This was especially alarming, as these were two of the strongest economies in Asia. This stock market crisis set off a panic in many international markets as well. For example, the Dow Jones Industrial Average experienced its largest one-day point drops ever on October 27. Japan and Hong Kong slowly regained strength, Their economies have been relatively stable since the beginning of 1998.
In addition to Thailand, Indonesia and South Korea also sought international assistance in attempts to save their economies. Indonesian President Suharto turned to the IMF for help in October 1997. In January 1998 they agreed to a plan that entitled Indonesia to receive $43 billion in loans from the IMF and from other nations.
South Korea was very reluctant in seeking assistance, but eventually realized the dire need for help. They asked the IMF for aid in November 1997. Even though the country was experiencing extremely difficult times, many top Korean officials considered it humiliating to ask for help. Hesitation was also due to fear that the IMF would order harsh reforms in return for aid. Nonetheless, the government agreed in December 1997 to a $57 billion package coordinated by the IMF. This was the largest package the IMF had ever coordinated.
There is general consensus that Asia’s crisis was mainly caused by an excess amount of domestic investment. Many of Southeast Asia’s banks and businesses were very optimistic that the rapid economic growth would continue. The result was huge amounts of money being borrowed by Southeast Asia’s investors. They then invested in domestic ventures, such as real estate. When those investments did not make a profit, companies simply borrowed more money or extended their loans to cover outstanding debt. Often times, banks were pressured to make loans at the request of the government. The government felt if this cycle of borrowing and reinvesting in domestic industries continued, so would the economic growth.
By 1997, many Asian businesses had debts valued at between three and six times the total amount of cash invested in their companies. These massive debts quickly led to bankruptcy when currencies fell and no one was willing to extend any more loans in Asian countries.
Corruption was also rampant in this region, causing further problems in Southeast Asia. In June 1997, 11 prominent businessmen, bankers and politicians were convicted of embezzling funds and pressuring banks to make illegal loans to a South Korean corporation. The firm’s executives had bribed politicians for special government assistance to keep their firm, which had large amounts of debt, afloat. It was said that this type of scandal was typical of the corrupt business practices in many Asian countries.
Pressure for Change
Many argue that by manipulating the financial sector and coddling business conglomerates with special assistance, Southeast Asian governments promoted risky and foolish business practices that have imperiled the economy. They blame the governments carelessness for the Asian Financial Crisis. They say that the extreme growth in the 1980’s and 1990’s was due to a large accumulation of bad debt and excessive government intervention in their economies. This is demonstrated in Richard Hornik, European business editor for Time magazine, words:
“The financial crisis facing Asia today is merely a symptom of a much deeper problem. The social and political assumptions on which the Asian model was founded are terribly outdated. The global economy is far too complex and fast paced for any bureaucrats to control. The only miracle in Asia is that this approach worked as long as it did.
Some analysts have criticized Japan’s economic system, since it has been the economic model for other nations in the region. Japan is the villain, according to James Glassman, a fellow at the American Enterprise Institute, a conservative think tank in Washington, D.C. Glassman says that Japan’s command-and-control capitalism is a disaster since investment decisions are determined by government officials rather than by the free market. If the normal mechanisms of a free market had been allowed to operate in Southeast Asia, he says, the region’s current problems could have been avoided.”
The deals the IMF struck with Southeast Asia largely supported the view that the region needed to strengthen its free-market system in order to avoid similar crises in the future. In return for IMF financial support, South Korea, Indonesia and Thailand were forced to agree to reform their financial systems. They pledged to eliminate government influence over private-sector borrowing and to open their domestic markets to more foreign competition.
South Korea also made a number of pledges to the IMF. First, they agreed to reduce public spending and to raise interest rates to discourage an over abundance of domestic investment. They also agreed to decrease the number of protectionist trade policies in order to allow an increased free market system.
These reforms the IMF demanded were aimed at opening up Asian markets to more foreign competition and force corporations to make investment decisions based on market forces instead of on political influences. Many Western economists applauded the terms of the IMF deals. They feel these changes may help the world move toward the Western form of free-market capitalism. Under this system, market forces alone would determine the successes and failures of economies, as well as prices for goods and services. Other forces would have little or no effect.
Criticisms of Reform
The push to reform Southeast Asia’s economic model has met with some resistance, particularly within the region itself. There seems to be a general consensus that some reforms are needed to improve Asia’s financial system, but many Asians are very hesitant to support the demands placed upon them by the IMF. They fear that many of these changes will reduce Asia’s power to determine its own economic policies and could result in severe financial hardship. Many economists agree with these fears in the short-term. They have stated that that IMF reforms in Asia will mean increased bankruptcies, more bank closures and higher prices for consumer goods. Many say, however, the long-term result will justify these short-lived effects.
On the other hand, some analysts also caution about trying to impose Western-style capitalism in Asia. They argue that Southeast Asia’s economic model has created several decades of remarkable economic growth. Further, Asia has been able to generate fast economic and industrial growth without experiencing a great wage gap. In addition, unemployment in Asia has been negligible by U.S. standards. Thus, there has not been a need to spend large amounts of public funds to create a system of support for the poor and unemployed.
Further concerns are that free-market reforms could jeopardize the successes previously seen in Southeastern Asian countries. Walden Bello, co-author of Dragons in Distress: Asia’s Miracle Economies in Crisis, warns radical free-market reforms may lead not to the transformation of Asian capitalism but to its unraveling. According to Bello, Asia’s government-led economic system has been a key ingredient in the region’s success. He says that reforms in the region should build on the strengths of that economic model rather than dismantle it altogether.
Bello believes that the fundamental lesson of the Asian crisis is that there was not too much state intervention but too little. He says that deregulation of the banking and financial sectors in some Asian economies during the 1980s led to increased corruption.
Affects on the U.S.
The U.S. was largely unaffected by Asia’s simmering crisis until October 1997, Hong Kong, a key investment center for U.S. business, faced economic risk. The Hang Seng index on the Hong Kong Stock Exchange fell more than 23% over a four-day period, which caused great concern among many foreign investors. As stated earlier, on October 27, U.S. stock markets reacted by falling as well. They quickly rebounded, but their decline foreshadowed the impact that Asia’s economic troubles could continue to have on the U.S. Asia’s increased globalization has helped boost U.S. trade, but many economists say that it has also made the world economy more vulnerable to regional economic crises.
The main concern among U.S. investors is the possible long-term impact of the Asian crisis. Weaker Asian currencies will likely mean that Asian goods will drop in price, making them appear cheaper to foreign consumers. These products will then be more attractive, thus making the previously attractive domestic products less attractive. As cheap Asian-made goods flood the U.S. market, domestic industries could lose some business. Job losses might result. At the same time, Asian countries may be less willing to buy U.S.-made goods because a strong dollar would make them appear more expensive to U.S. producers. That could lead to a larger U.S. trade deficit. On the other hand, consumers might benefit from the Asian crisis since imported goods–electronic imports in particular–would become cheaper. That may force U.S. businesses to cut their prices and improve productivity in order to be more competitive. The overall effect is likely to be a positive one, that is a positive overall increase of net welfare.
While it is still unclear as to the long-term affects the Asian Financial Crisis will have on Asia, and the rest of the world, it is clear that this crisis served as an eye-opener for many parties involved. Many negative results were experienced. It is likely that these results will only be experienced for a short time. If free market policies are followed, the long-term effects are likely to be positive, at least when society as a whole is considered. As with all things, there will be winners and there will be losers. The hope of society is that the losers lose less than the winners win, and that the winner’s gains can be reciprocated to all involved.