Lessons from East Asian Crisis

San Fransisco Fed organised a conference on Asia and the Global Financial Crisis. All biggies – Bernanke, Rogoff, Obstfeld, Eichengreen etc  – discussed on variety of topics – Asian crisis of 1997, Asian economies in this crisis, global imbalances etc.

 

I was reading this paper by Anne Krueger on lessons from East Asian crisis. More specifically, on Korea’s 1997 crisis and Japan’s crisis. The paper is very easy to read and tells you many lessons on the way.

 

Lessons from Japan:

• A first, and perhaps the most important, one is that an undercapitalized banking system can retard, if not entirely stifle, an incipient recovery even when fiscal policy is expansionary.
• Second, efforts by banks (and acquiescence by the government) to hide their difficulties not only delay recovery but create uncertainty about the financial system as a whole
• Third, unless measures to restore healthy banks are sufficiently large, they do not significantly contribute to the resolution of the problem.
• Fourth and finally, when banks continue to roll over NPLs, they are starving the potential new entrants (especially small and medium enterprises) of credit, and hence reducing growth.

 

The same lessons could be drawn from Korean as well:

The Korean experience reinforces the Japanese lessons. Although the crisis was triggered by difficulties within the banks that were intensified by the exchange rate regime, the crisis was financial once the exchange rate had been allowed to depreciate and float. It was already seen that the underlying  problem had been a failure of the financial system to develop commensurately with the needs of an increasingly complex modern economy. This was connected to the problems of the chaebol. They had been heroes of Korea’s hugely successful growth experience, but had accepted government restrictions and had had their own banks each financing much of the needs of the individual groups.

 However, the actions taken by Korean policymakers was faster than Japanese. Krueger points this was also because Japan’s much of the problems was becasue of domestic issues. So Japan just chugged on hoping small policymeasures would be enough. Despite hope, the economy kept slipping.

Whereas in Korea, they owed a large foreign debt and hence there was a lot of attention. The politiicians initially said no to IMF aid but had tioe eventually take it. I had earlier pointed to an interesting angle on why US came forward to help Korea so quickly. But other East- Asian economies also had huge foreign liabilities but were much slower and had much bigger crisis as well.

Lessons for today:

 

 

• Perhaps the most important conclusion that can be drawn from crises in many countries is that delays in recognizing and confronting the difficulties in the financial sector are costly. Denial by officials may be understandable, but when the measures taken are timid relative to the magnitude of the problem, or when they are undertaken after significant delays, the costs of the cleanup mount
• Both the credibility of the authorities and the transparency of both the situation and the measures taken are also crucial.
• Moreover, in almost all crisis situations, the crisis happens because of underlying weaknesses in the economic policy framework and economic  structure.
• It is also notable that growth can resume fairly quickly when strong measures are taken. Most forecasts of post-crisis growth in the Asian countries were unduly pessimistic.
• For emerging markets, further lessons derive from the necessity to maintain consistency between policies toward exchange rates and monetary and fiscal policies.
• But perhaps the strongest lesson from all of the crisis situations is the urgent necessity of restoring the financial system by recapitalizing the banks, removing the NPL from bank portfolios, and enabling the resumption of the flow of credit.

All well known ideas. Nicely put though.