The East Asia Crisis, Miranda Nelson

The East Asia Crisis

How IMF Policies Brought the World to the Verge of a Global Meltdown

Miranda Nelson

The East Asia Crisis began on July 2, 1997, when the Thai baht rapidly depreciated. This sudden hit to the currency market affected not only Thailand but its effects were also felt in the rest of East Asia - South Korea, Singapore, Indonesia, Malaysia, the Phillipines, Hong Kong - and spilled over into Russia, Brazil, and even the United States. The East Asia Crisis is an important event to study as it clearly illustrates the interconnectedness of modern economies as well as the need to develop better strategies surrounding economic downturn.

Pre-Crisis

Before the crisis, East Asia had experienced phenomenal growth; indeed, this economic success is often referred to as the East Asia Miracle. Poverty had decreased, and governments were more stable, providing more funding to education, and had strong industrial policies. Governments were vital parts of the economy and privatization was not reasonable. The IMF and the World Bank had not studied the great successes of this region; according to Stiglitz, this may have been due to East Asia's refusals to follow Western policies such as the Washington Consensus in order to achieve success.

Patterns

Stiglitz discusses two patterns that emerged during the crisis. The first was the devaluation of the country's currency; this scenario played out again and again throughout the region. If a trader believes a currency will devalue, he sells his stocks of that currency; this causes the currency to devalue as the supply of money increases but the demand does not. As the currency devalues, more people sell their currency, causing its value to drop more. Or, a government spends its foreign currency reserves to prop up its own currency until it runs out of reserves. Either way, the currency falls in value. This was the case in Thailand. There was a speculative attack on the currency in May 1997 and this caused investors to sell off their baht holdings, thus decreasing its value. By July, the Thai government had run out of foreign currency reserves and couldn't support its exchange rate any longer; the baht dropped 20 per cent on the first day of devaluation. The IMF offered to loan Thailand $17 billion in order to keep the exchange rate stable.

The second pattern Stiglitz discusses is one that occurred in South Korea. The U.S. pressured South Korea to allow domestic firms to borrow from international banks. When the international banks feared that the South Korean firms would be unable to pay back its loans or roll the loans over (essentially taking out new loans to pay old loans), banks stopped lending. As a result, South Korea couldn't roll its loans over and defaulted on its original loans.

Washington Consensus

Written by John Williamson in 1990, the Washington Consensus is a set of economic reforms designed to aid Latin American countries.

According to the Washington Consensus, growth occurs through liberalization, "freeing up" markets. Privatization, liberalization, and macrostability are supposed to create a climate to attract investment, including from abroad. This investment creates growth. Foreign business brings with it technical expertise and access to foreign markets, creating new employment opportunities. Foreign companies also have access to sources of finance, especially important in those developing countries where local financial institutions are weak. (67)

The Washington Consensus is the IMF's standard policy; it is often confused with neoliberalism and carries many negative connotations these days. Instead of detailing it, please check the links at the end of this document.

The IMF and its Contributions to the Crisis

Stiglitz argues that the most important contributing factor to the crisis was capital account liberalization, the removal of restrictions relating to the flow of capital, in this case, currency. The Western world encouraged East Asian countries to allow foreign investors easier access to the Asian markets. Hot money flowed into the region rapidly but many of these countries did not have regulations in place to ensure foreign investment could not be pulled out without penalty. When negative speculation occurred, this money flowed out of the region as fast as it was initially invested.

"... capital flows [are] pro-cyclical.... capital flows out of a country in a recession, precisely when the country needs it most, and flows in during a boom, exacerbating inflationary pressures." (Stiglitz, 100)

The IMF did several things during the crisis that prolonged the situation. For instance, it refused to lend money to East Asian nations unless they undertook certain economic reforms. Among these reforms:

Increased interest rates, sometimes as high as 25 per cent.
Decreased government spending. Indonesia's government had to eliminate food and fuel subsidies in April 1998.
Countries had to close poorly performing domestic banks.
South Korea had to enact financial reforms and allow international firms to participate in its domestic markets.
Mass layoffs were experienced in many countries.

The IMF also demanded political reforms, like increased government transparency and openness. Stiglitz points out that "some of the conditions [demanded by the IMF] had nothing to do with the problem at hand." (96)

Contractionary Policies

According to economist John Maynard Keynes, a key way to get out of a recession is to maintain government spending. People are reluctant to invest when there is a downturn in the economy but investment is still required; governments are the best group to maintain investment as they are generally the only ones with money in a recession. In times of recession, Keynes even felt running a deficit was acceptable as long as the spending was stimulating the economy. This type of policy was part of the IMF's original mandate but during the East Asia Crisis, the IMF pushed for tight monetary and fiscal policies, which only served to encourage recession.

Herbert Hoover, president of the U.S. at the beginning of the Great Depression, acted in a way analogous to the IMF in the East Asia Crisis. Keynes believed that prices should be lowered during a recession in order to stimulate demand; however, Hoover increased tariffs on imported goods and both imports and exports decreased. He would not provide relief to starving and unemployed citizens, as he was of the belief that this would only "corrupt" them. Despite this, he was a proponent of corporate welfare and aided many companies. As well, he didn't understand how bad the crisis was; he saw the Great Depression as part of the regular cycle of the economy and thus didn't address the problem as soon as he needed to or in the appropriate manner.

Globalization, Discontentedly

To me, this chapter illustrates three important facets of globalization.

Different countries require different economic strategies. What works for one country doesn't necessarily work for another. Each country has a different history, climate, social order, government, religion, and culture. All of these factors need to be considered when deciding economic policy. For instance, it is ridiculous to give a corrupt government money, yet that is what the IMF did in 1998 when Russia's economy began to collapse. The Washington Consensus, the standard economic policy followed by the IMF, was originally designed for Latin America; however, the IMF tried to solve the problems of Asia with these policies. It seems obvious to me that the Washington Consensus could not adequately address the problems in such a disparate area.
Nations are very interdependent. According to the World Bank, contagion is "the cross-country transmission of shocks or the general cross-country spillover effects" (World Bank, 2000). In other words, what affects one country will affect others. With trade linking every nation and the increasing interdependence of countries, it is surprising how small events can snowball into crises so quickly. The IMF was sure that it could prevent subsequent recessions after Thailand experienced such a downturn, but it failed. One of the most significant aspects of the East Asia Crisis was its effect on Russia. Once the Asian economies entered into recessions, demand for oil in the area dropped. Russia, a main exporter of oil to the region, lost these markets for its oil and saw its revenues drop. This significantly contributed to the resulting recession in the former superpower.
Macroeconomic solutions are needed in order to reduce the harm of globalization. Right now, multinational corporations have too much influence, especially on developing nations. Governments need to reform their economic policies and corporations need to incorporate social costs when evaluating costs and benefits. Stricter regulations on capital flows would reduce the negative effects of speculation. For instance, Malaysia had a strong central bank which, in September 1998, restricted "transfers of capital abroad by residents of Malaysia," prevented foreign investors from pulling out their money for 12 months, and placed a large exit tax on anyone who wished to take money out of the country. These short term measures were seen as a bad idea to the IMF as they felt this would discouraged long-term investment. However, Malaysia's efforts prevented a mass of capital from leaving the country and it remained more stable than other countries in the region. (Stiglitz 123-24)

Solutions

Stiglitz offers several strategies to combat the effects of recessions and current globalization policies in this chapter (130-131):

"Maintain the economy at as close to full employment as possible."
Have countries follow expansionary monetary and fiscal policies; in other words, get countries to continue to spend money when recession is imminent.
When undertaking financial restructuring, focus on "maintaining the flow of finance" and allow countries to stop payments briefly on debts.
Restructure the current institutions and corporate policies; create bankruptcy policies for use during "macroeconomic disturbances that [are] well beyound the normal."
Allow strong government intervention in the economy and provide incentives for businesses to succeed, instead of allowing owners to strip assets from said businesses.