Economic Development in Asia  The result was a sharp decline in aggregate

economic activity in late 1997 and in 1998.

Explanations for the Asian Crisis

 There are three broad explanations, none of them

alone completely satisfactory.
 First, a speculative bubble in the housing and equity
markets arose which was funded and sustained by
excessive lending by the banking system.
 Second, external sector difficulties emerged
Chapter 4 – The Asian Crisis and Recent Developments including slow export growth, loss of external
competitiveness and rapid growth in current
Start of the Asian Crisis account deficits.
 June 1997, after a sustained attack on the currency  Third, capital flight and investor panic spread across
led by currency hedge funds, the Thai baht the region through a contagion mechanism as a
sustained a large devaluation. result of globalization.
 Currency devaluations in Malaysia, Indonesia and The Asian Crisis –
the Philippines followed in July. The Bubble Economy (1)
 The currency weakness extended to Australia, Hong
Kong and Korea currencies in October.  First, the bubble economy was the result of
 Malaysian ringgit, the Indonesian rupiah, and the interaction between lenders (mostly banks) that
Philippine peso. borrowed offshore at high interest rates and relend
 While the currency parity with the u.s. dollar was at higher rates to domestic investors.
maintained, the stock market fell by about 30  The domestic investors borrowed extensively to
percent of its value in a week. finance speculative investments in the housing and
equity markets.
The Asian Crisis  This created a speculative bubble that depended on
a stable exchange rate and high profits.
 By early 1998, currencies fell by 35% to 55% for
 High profits became more improbable as the boom
Korea, Philippines, Malaysia and Thailand, and more
reached its peak, which was further undermined by
than 15% for Singapore and Taiwan.
the successive devaluations in all the economies as
 Indonesia suffered greatest fall of 80%.
the crisis unfolded.
 Equity prices also fell as a result of investor
 Banking weakness was reinforced by a lack of
uncertainty and currency volatility (Table 3.1).
competition and unsound lending practices.
 These included risky long term lending in local
currency using short term dollar loans from
overseas lenders.
 When these borrowers defaulted it resulted in the
inability of the banks to repay these short term
dollar obligations.
 This banking crisis was also influenced by moral
hazard
 Moral hazard occurs when an agent takes more risk
 Thin and restricted equity markets exaggerated the because they are insured against the negative
decline. consequence of such actions.
 Lack of hedging facilities forced investors to reduce  In the case of the Asian financial crisis banks
holdings dramatically. thoughts that governments would insure a stable
 Interest rates were raised to help stabilize exchange rate.
currencies and liquidity was reduced.
  They also might have thought that the government “competitive devaluations” as investment funds left
would bail them out if they found themselves in the region.
financial trouble
Post-Crisis Experience

 The impact of the crisis was fully felt in 1998 when

The Asian Crisis – all the crisis countries and most other countries had
External Sector Difficulties (2) negative or very small rates of positive growth.

 Second, as the bubble of the early 1990s

progressed, current account deficits also grew as
 PRC and Taiwan were the only exceptions.
offshore borrowing increased.
 Equity prices also fell across the region in 1998.
 While exports were growing rapidly, this was
viewed as a sign of strong investment and growth
enhancing capital expansion.
 However, when export growth began to sag in 1996
this large current account deficits became a growing
liability and worry for international investors.
 Exchange rates were tied to the dollar and exports
were hurt in international markets as the dollar
appreciated in the mid 1990s.

The Asian Crisis –

Contagion Effects (3)

 Third, there was a strong contagion effect as the

financial crisis spread across the region.  Beginning in 1999, there has been a recovery in
 Countries that had strong currencies and growth and equity markets.
economies, such as Hong Kong, Singapore and  This recovery has been accompanied by a
Taiwan were also adversely affected. significant amount of industrial and financial
 As the foreign exchange crisis unfolded, there was a restructuring.
dramatic turn around in net private capital flows to  Many countries suffered from a high level of Non-
the region – from a $97 billion inflow in 1996 to a Performing Loans (NPLs).
$12 billion outflow in 1997.  To deal with these NPLs, the most affected
 This $109 billion reversal was about 10% of the GDP countries created separate agencies to deal with
of the five most affected economies – Indonesia, them. These Asset Management Companies (AMCs)
Korea, Malaysia, Philippines, and Thailand. have taken many of the bad loans and negotiated
 There was also a dramatic reversal in bank credit their liquidation.
which also amounted to about 10 percent of GDP.  Korea and Malaysia have been particularly
 Together, the reversal of capital flows and bank successful in reducing NPLs, enabling the banking
credit created a liquidity crisis that led to a sharp system to begin to extend new loans.
fall in income and output.  Thailand and Indonesia have been only moderately
 Indonesia, which had been a model of probity and successful while in the Philippines, the level of
sensible policies was hardest hit by the crisis as its NPLs, though small during the crisis, has crept up in
exchange rate fell by over 50 percent and aggregate recent years.
incomes fell dramatically. Social Impact of the Crisis
 This contagion effect was the result of investors
pulling out of many economies simultaneously.  The fall in output and employment created
 The pressure that arose on all the currencies of the hardships for many segments of the society in the
region could have been a combination of this affected countries.
contagion effect as well as a process of  There was significant reverse migration to rural
from urban areas as job opportunities dried up.
 Poverty levels increased between 1997 and 1998.
  Disadvantaged groups such as the poor, women,  China joined WTO several years ago.
children and the elderly were the worse hit by the  Import GDP ratio is 34% in China versus 9% for
crisis. Japan.
 Some adverse affects on school enrollment and on  Shows Japan is still somewhat protectionist.
health indicators were observed.  Middle income countries are being squeezed by
China.
 In Southeast Asia in particular.
 China competes in many different international
markets from labor intensive to skill intensive.
The Recovery Part 1
 Innovation and new products are drivers of trade in
Asia now.
 60% of export growth in Asia is in new varieties and
products not more of the same products.
 Geography and outsourcing are important and
locational advantages are shaped by various
factors.
 History, availability of manpower, availability of
capital, cost of shipping and agglomeration
economies all play a role.
 Shenzen in China and Bangalore in India are
examples of agglomeration economies.
 Export processing zones help create incentives for
high growth export development and innovation.
The Recovery Part 2 Recovery Part 3
 Between 2002 and 2007 economic growth in the  As the global economic crisis unfolds in 2009 Asia is
Asian region accelerated, led by India and China. being adversely affected.
Living standards increased and poverty fell.  Slower growth in Asia in 2009 and perhaps 2010 is
 Domestic demand and foreign trade were both anticipated.
important factors in the resumption of growth.  There will be a slowdown in export demand from
 As the recover progressed financial restructuring Europe, Japan and the United States.
proceeded and the financial systems strengthened.  Asia is in good shape to offset these anticipated
weaknesses in the foreign sector with monetary
and fiscal stimulus.
 Most countries cut interest rates in last four
months of 2008.
 Falling energy and food prices should ameliorate
any tendencies toward inflation.
 There has been general fiscal stimulus.
 China’s projected $850 billion additional spending
on infrastructure in next few years.
 East Asia and Southeast Asia have current account
 The region has grown much richer in the decade surpluses.
since the Asian crisis.  All countries in the region have ample foreign
 China has emerged as a regional economic exchange reserves.
powerhouse.  India could have a more difficult time than the rest
 Half the GDP of the region and one third of exports of the region.
originates in China  It has a large fiscal deficit which limits fiscal
 China is now the largest trader in Asia overtaking stimulus.
Japan.
  Lack of willingness of overseas lenders to  Arrangements of credit lines with the private
investment. sector.
 As the global recession deepens greater cuts in  Reform of exchange rate regimes to reduce the
employment and exports in Asia. chance of abrupt currency devaluation.
 Could create greater social tension.  The movement of hot money that takes advantage
 Exacerbate poverty with reverse migration. of large short term interest differentials was
 Singapore, Hong Kong and Malaysia most exposed discouraged or made illegal.
to foreign trade.  Consideration of capital account reforms to include
 Both Hong Kong and Singapore adversely affected possible taxes on short term capital but where not
in Asian crisis of 1997. approved.
 Thailand’s prospects will also be adversely affected  Possible controls on international portfolio
by political uncertainty. movements were also considered but not
 Taiwan will have to fight its way through a recession implemented.
that has already begun.  Minimum international standards of financial
 Korea has a lot of household debt which could slow practice were implemented.
the economy further.  Accountability and transparency of business
 But a big fiscal stimulus and currency depreciation practices strengthened.
of around 30 percent in 2008 which should boost  Increased international surveillance to detect
exports. possible future financial crises have been
 Volatility in many markets will restrain risk taking considered but not implemented.
and investment.  Basle accords used to strengthen supervision and
 Volatility causes sharp changes in balance of regulation of banking systems.
payments  Introduce greater competition in financial markets
 Puts pressure on governments to adjust their while strengthening prudential regulations.
budgets to reflect these shifts.  Improve accounting and disclosure standards.
 It creates uncertainty in the business community  Introduce greater flexibility and depth into financial
 Has a dampening impact on investment. markets including greater hedging and providing
 The economic recovery continued into the second greater access for foreign investors.
and third quarter of 2009.  Maintain open trading environments in keeping
 Industrial countries and developing countries in with WTO and regional trading arrangements.
Asia all benefited.  Look into ways of restraining FDI concessions that
 Stimulus packages were adopted by many countries distort incentives and distort the flow of
including fiscal and monetary measures. investment.
 Enhance the flow of technical expertise, innovation
and human capital flows and exchanges.
 Continue to undertake research into the process of
financial and economic crises.

Growth projections

 In this section we explore prospect for future

growth and structural change.
 We begin with a simple growth model
 y = (ls) h + (1- ls) k + a
Agenda for Reform  where y is growth income h is the rate of change in
education adjusted labor input, k is the rate of
 In the wake of the Asian crisis, there were a number growth in capital, ls is labors share in income, (1- ls )
of reforms is capital’s share in income and a is total factor
 Continuation of the debt restructuring process with productivity.
help of AMCs.
  If we assume that the capital to output ratio is fixed
in the short run then we can substitute y for k on
the right hand side of this equation and rearrange
 y = h + a/ ls
 income growth (y) is a function of the growth of
the labor force adjusted for improved quality by
higher education and better health (h), the share of
labor in total income (ls) and TFP (a).
 The rest of the section looks at various assumptions
about these factors and projects growth into the
future.

 The main conclusion is that estimates for TFP (a) in

South Asia using the past tend to underestimate the
rate of growth.
 We have also oversimplified because we haven’t
looked at saving potential.
 You can read about this on pages 46 and 47.
 By considering the factors in these simple growth
models we can get some insights into what causes
rapid growth.
 Investment
 TFP (a)
 Labor force growth (ls)
 Education and health (h)
 Governance, corruption, foreign investment also
important as indirect determinants of TFP

Summary

 Causes of the Asian financial crisis.

 Analysis of the impact and severity of the financial
crisis in affected countries.
 Policy implications gained.

Supplementary Resources

 The Asian Crisis Four Years On by IMF

 The Asian Crisis: Cause & Cures by IMF
Economic Development in Asia crisis and the region, as a whole, will play a major
Chapter 2 – Introduction and Overview role in the global, high tech world economy that we
are moving towards in this new millennium.
Economic Development in Asia
 In South Asia, where the impact of the financial
 East Asian miracle, a showcase of development up crisis on the region was not as severe, economic
until the Asian crisis. progress has accelerated following a shift in policy
 Asian crisis created a number of questions about in the late 1980s and early 1990s . Nevertheless,
the continued viability of a rapid growth profile for this region faces a number of challenges, including
the region. further progress in reducing poverty and the
 Economies have begun to rebound. resolution of political disputes that have drawn
 The enormous interest in the economic resources away from economic development.
development of postwar East Asia has continued Difference between development economics and other
into the new millennium. The regions recent branches of economics
economic history has been marked by an
“economic miracle” that spanned several decades  It looks at all of the other branches of economics
followed by a severe financial and economic crisis. within the context of economic development.
Problems of widespread poverty and economic  It uses the tools developed in other branches of
inequality remain despite significant economic economics to analyze the problems and challenges
progress. of economic development.
 The development process began in Japan when it
Measuring Growth & Development
opened its economy to increased trade and
investment. The rapid industrialization that  Use of GDP and GNP and exchange rate
followed quickly spread to the neighboring comparisons lead to patterns of growth over time.
economies of South Korea, Singapore, Taiwan and  Other methods such as purchasing power parity can
Hong Kong. Economic growth in these newly also be used to compare standards of living.
industrialized economies (NIEs), sometimes called  Using measure of the amount of goods and services
the Asian “tigers” , averaged 8 percent per year in produced in an economy in a year, we can get some
the three decades prior to Asian financial crisis in idea about the standard of living in that economy.
1997. When the value of these goods increases over time,
 After the sharp economic contraction in 1998, the there is economic growth.
region rebounded rapidly. In south korea, for  Gross Domestic Product (the total value of
example year-on-year industrial production and production in an economy) or gross national
gross domestic product (GDP) increased product (GNP – which is GDP plus net factor income
dramatically in 1999 while stock market value from abroad) is used a measure of the nation’s
doubled in Thailand and Malaysia. income or production. The size of the total
 Social impact of the crisis has been substantial. population can be used to deflate it to per-capita
 Future development will depend upon many terms.
factors, including public policy and developments in
Other Measures
industrial countries.
 This course looks at both the history and the future  Human development index (HDI)
outlook for the region.  Healthy life expectancy
 The financial crisis also hampered progress in  Green GNP
reducing poverty and addressing other social issues. - assesses the impact of environmental
The human development gains in health, education, degradation in the development experience.
poverty and equality and the distribution of income
achieved by East Asia in the two decades prior to Human Development Index (HDI)
the crises was eroded to some degree resulting in  The United Nations Development Program (UNDP)
slower growth. developed the HDI in the late 1980s and has been
 There is no doubt, however, that the economies of publishing it since 1990. This index has three
East Asia are in the process of recovering from the components: per-capita income and two additional
 measures-life expectancy at birth, and level of PPP METHOD
educational attainment that combines adult literacy
 The purchasing power parity method develops a cost
and educational enrolment rates. These are added
index for comparable baskets of consumption goods
to per-capita income, which is adjusted to reflect
in the local currency and then compares this with
the diminishing marginal use of money to obtain
prices in the United States for the same set of
HDI.
commodities. A country’s PPP is defined as the
HEALTHY LIFE EXPENTANCY number of units of the country’s currency required
to buy the same amount of goods and services that
Number of Years
a dollar would buy in the United States.
Male Female
Summary
Japan 72 78
 Uniqueness of the Asian development progress
Singapore 69 71 (Asian Miracle Economies).
 Indicators of economic growth and development.
Kuwait 67 67

Korea 65 71

China 63 65

Malaysia 62 65

Vietnam 60 63

Thailand 58 62

Indonesia 57 59

Philippines 57 62

 A measure used by the WHO summarizes the

expected number of years to be lived in “full
health”.

GREEN GNP

 One of the more recent approaches developed to

address the inherent shortcomings of GDP and GNP
as growth and development measures is based on
what is known as the “green” system of national
accounting. Green GNP is the informal name given to
national income measures that are adjusted to take
into account the depletion of natural resources
(both renewable and non-renewable) and
environmental degradation.

EXCHANGE RATE METHOD

 The exchange rate method between the local

currency and the U.S. dollar to convert the currency
into its U.S. dollar equivalent. A country’s GDP and
GDP per capital would then be valued accordingly, in
U.S. dollars.