Comparing SE Asian Crisis in 1997 with Eurozone crisis in 2010

A nice speech by Bank of Thailand Governor Prasarn Trairatvorakul.

He draws similarities and differences between SE Asian crisis and Eurozone crisis.

First similarities:

First, both crises, like most others in the recent economic history of the world, are often associated with the mispricing of risk and distorted incentives structures.

Second, both crises occurred as a result of a failure to fulfill the necessary “pre-conditions”. In Asia, they were preconditions for liberalization, and in Europe they were preconditions for integration.

On the whole, these countries were victims of their own success. The “reckless optimism” prior to both episodes of crisis had ultimately led the countries to face similar consequences of severe market stress and capital flight, albeit with different symptoms: for Asia, losses incurred in the private sector’s balance sheet, for Europe, public sector balance sheet was impaired.

Nice bit on pre-conditions.

Differences. The first is obvious the freedom to devalue:

The first is policy flexibility. The devaluation of the exchange rate helped restore export competitiveness of the Asian economies. However, this freedom of flexibility might not be practical for Europe given its single currency setting and political complexities.

The second is the supportive global economy, which provided the necessary market for Asia and allowed Asia to export our way out of the crisis. Global GDP registered a 4.7% growth in 2000 with advanced economies, the world’s largest consumer, growing at 4.1%. In contrast, the global setting of the current European sovereign debt crisis is not  as favorable. Global and advanced economies growth turned to a negative territory of 0.6% and 3.4% respectively in 2009.

Lessons from SE Asian crisis:

First, conventional policy prescriptions may not be appropriate for unusual circumstances and there is no one-size-fits-all solution. Asia was a case in point of ill-timed austerity measures. Public sector debt in Thailand then was less than 15% of GDP; yet the policy prescription for Thailand was to tighten fiscal policy and maintain tight monetary policy, resulting in (interbank) interest rate rising from 10% at the beginning of 1997 to over 20% at the end of 1997.

The case of Indonesia further led the IMF to reform towards more careful and focused policy prescription. The abrupt close-down of Indonesian commercial banks under the IMF program added to a sense of panic, which led to a broad-based bank run. Moreover, the conditionalities did not focus on the more critical macroeconomic adjustments which were directly related to the problems of the crisis but also included unrelated changes such as requirement to abolish import restrictions on all new and used ships.

Secondly, policymakers must be ready to take away the punch bowl. In the past we used to talk about monetary policy being on the alert to take away the punch bowl. This crisis has proven that public policy in general need to observe this principle as well. Fiscal policy must guard against falling into the populist trap.

Lastly, continuous and collective reforms are vital. Crisis is a recurring phenomenon and no lessons from previous crisis will ever fully prevent the next one. But through the process of reform after each crisis, the market grows and becomes more  efficient.  Crises provide a window or “political feasibility” to undertake needed structural changes that may be hard to sell to the public in normal circumstances, so one should not waste a good crisis.

 

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