World Development Vol. 26, No. 8, pp. 1.

535-1553, 1998
Pergamon 0 1998 Elsevier Science Ltd
All rights reserved. Printed in Great Britain
0305-750X/98 $19.00+0.00
PII:SO305750X(98)00070-9

The Asian Debt-and-development Crisis of 1997-?:

Causes and Consequences
ROBERT WADE*
Brown University, Providence, U S.A.
Summary. - Interpretations of the Asian crisis have coalesced around two rival stories: the
“death throes of Asian state capitalism” story about internal, real economy causes; and the
“panic triggering debt deflation in a basically sound but under-regulated system” story that gives
more role to external and financial system causes. The paper presents the stories and assesses
the evidence. The evidence - in particular, the chronology of the crisis - supports the second
rather better than the first.
The paper discusses the interests driving capital account liberalization without a framework of
regulation, the single most irresponsible act of public authorities in the whole crisis. US and UK
financial firms, allied with their treasuries and with the IMF, the WTO, and the OECD, saw
themselves at a chronic disadvantage in the Asian system of long-term relationships and patient
capital. This alliance, supported by segments of Asian political and financial elites, achieved
dramatic domestic financial sector liberalization and capital account opening in Asia over the
199Os,setting up the conditions for crisis.
Paradoxically, the crisis may be looked back upon not as the triumph of benign globalization
and neoliberal economic doctrine but as the beginning of its end. 0 1998 Elsevier Science Ltd.
All rights reserved.

1. INTRODUCTION 1997,and the Indonesian rupiah has fallen by

How on earth did the Asians get caught in the
debt trap? In the 1980s much of the rest of the
world was caught - not only Latin America and
some African states, but also European social
democratic regimes that faced great pressure to
reduce budget deficits and cut back social
welfare programs. Asia, however, sailed free,
except for Korea. But Korea had very fast
growth of exports from which to service its debt.
The devaluation of the Thai baht in July 1997
precipitated a wave of currency crises or financial
instability from Thailand, to the rest of Southeast
Asia, to Taiwan, to Hong Kong, to Korea, to the
Philippines, to Russia, to Brazil, to Estonia, to
Australia and New Zealand.’
Commodity producers around the world have
suffered. The International Monetary Fund
(IMF) has mounted refinancing efforts on a scale
that makes the Mexican bail-out of 1994-95, the
biggest in the IMF’s history to that date, look
small, yet the run has continued, the panic
feeding upon itself. As of February 1998 the
Thai baht and the Korean won have lost almost
half their value against the US dollar since July
three-quarters.*
The debt crisis has become a full-fledged
development crisis. Output and living standards
plummet as unemployment rises and the effects
of huge devaluations work through into higher
import prices. Many millions of poor people are
at risk, and many millions who were confident of
middle-class status feel robbed of their lifetime
savings and security. It is not a humanitarian
tragedy on the scale of North Korea, but the loss
of security and productivity is a tragedy nonethe-
less, almost as cruel as war.
Interpretations of the crisis in the West have
coalesced around two rival themes. One is the
“death throes of Asian state capitalism”.’ The
other is “panic, triggering debt deflation in a
sound but under-regulated system”.
*Visiting scholar, Russel Sage Foundation, New York.
This paper builds on finance-development arguments
set out in Wade, 1990, especially chapters 6 and 11 (pp.
364-368). Some of its arguments are developed in a
complementary paper by Wade and Veneroso, 1998.
Relevant background, especially on Japan’s role in
Southeast Asia and on the worldwide push for financial
liberalization, is given in Wade, 1996.

1535
1536 WORLD DEVELOPMENT
2. THE DEATH THROES OF ASIAN STATE
CAPITALISM
The crisis, according to the death throes view,
reflects excessive government intervention in
markets, especially financial markets; and it
marks the beginning of the end of the outmoded
state-directed Asian system, opening the way for
a properly modem (read Anglo-American) free
market system. The chairman of the US Federal
Reserve, Alan Greenspan, is the most promi-
nent, if not most eloquent, exponent of this idea.
Talking to the New York Economics Club in
early December 1997, he said,
The current crisis is likely to accelerate the
dismantling in many Asian countries of the remnants
of a system with large elements of government-
directed investment, in which finance played a key
role in carrying out the state’s objectives. Such a
system inevitably has led to the investment excesses
and errors to which all similar endeavors seem
prone... .
Government-directed production, financed with
directed bank loans, cannot readily adjust to the
continuously changing patterns of market demand
for domestically consumed goods or exports. Gluts
and shortages are inevitable.. .
Greenspan warmed to the triumphant America
theme in his testimony to the Senate Foreign
Relations committee in mid February 1998. One
of the most fundamental effects of the Asian
crisis, he said, was a worldwide move toward
“the Western form of free market capitalism,”
instead of the competing Asian approach that
only a few years ago looked like an attractive
model for countries around the world. “What we
have here is a very dramatic event towards a
consensus of the type of market system which we
have in this countly.“4
Steve Hanke, advocate of laissez faire and
currency boards, said much the same thing in an
interview with Forbes magazine at the end of
December 1997.
FORBES: Some say it [the financial crisis] is an
example of free enterprise gone berserk; that we
need more regulation.
HANIU? No. These economies were government
directed. More regulation by government isn’t a
proper solution. Government is the problem.. .’
A correspondent for the International Herald
Ttibune put it this way in late January 1998:
As Asia’s economic crisis has intensified, it has been
widely noted that most of the urgent short-term
remedies prescribed by the international financial
community are labeled “Made in America”. Only
now is another point beginning to sink in: The
upheaval is likely to bolster America’s global influ-
ence over the longer term, too. The sudden collapse
of Asia’s house of cards is beginning to be seen as the
end of an outdated economic and political system-
based largely on the mercantilist, government-run
Japanese model - much as the fall of the Berlin
Wall symbolized the demise of communism.6
George Soros, the international financier,
advised the Korean government what to do on
Korean television. “You must invite foreign
companies to come in and be direct investors
and owners of Korean companies,” he said.
“And companies that can’t meet their obligations
must be allowed to go bankrupt.“’ Korea must
establish a proper market system.
Stanley Fischer, deputy managing director of
the IMF, described the Asian problems as mostly
“homegrown.” He listed as causes such things as:
failure to dampen overheating, maintenance of
pegged exchange rates for too long, lax financial
regulation, and insufficient political commit-
ment.8 The whole IMF strategy assumes that the
crisis reflects basic institutional deficiencies of
Asian markets.
The tone of voice ranges from gloating, to
sanctimonious, to schoolmasterly. It is not hard
to imagine the offense of Japanese, Korean, and
other Asian policy-makers at the triumphalism of
Westerners who picture the Asian political
economy as a system whose movement toward
America-without-the-ghettoes the current crisis
has simply accelerated.
Offense aside, how does this interpretation
square with the facts? In contrast to Latin
America in the 198Os, East and Southeast Asia’s
debt is mostly private; the debt has been incurred
by private borrowers and private lenders, with
little government direction. Prior to 1997 the
macroeconomic “fundamentals” looked fine -
and difficult to reconcile with Greenspan’s
picture of the gluts and shortages inevitably
caused by large elements of government-directed
investment.
Growth was fast. East and Southeast Asia
accounted for a quarter of world output but half
of world growth over the 1990s and almost
two-thirds of world capital spending. Savings
rates were very high. Fiscal accounts were
balanced. Inflation was low. Educational levels
were deepening. Firms throughout the region
make products that sell in the most demanding
markets - if the exchange rate is right. Korea,
by mid-1997 the world’s 11th biggest economy,
was growing at 8% a year over the 199Ck, with
low inflation and low unemployment. Indonesia
was also growing fast, with a balanced budget
and inflation at less than 10%. Its current
account deficit was less than 4% of GDP through
the 1990s. Thailand, at 8.6%, was about the
fastest growing economy in the world over
 ASIAN DEBT-AND-DEVELOPMENT
1985-94, and had one of the highest savings
rates in the world (36% of GDP in 1995). It had
run sizable current account deficits over the
199Os, but most of the corresponding capital
inflow went for investment at a rate even higher
than the high rate of domestic savings. A good
part of it was direct investment by Japanese
manufacturing firms.
There were, however, serious internal obsta-
cles to the continued fast growth and upgrading
of the Southeast Asian economies.’ The econo-
mies have continued to engage in the world
industrial economy largely as subcontractors,
largely for Japanese firms. They have experi-
enced relatively little technology spillover from
the export-oriented subcontractors to the rest of
the economy, so much so that their industrializa-
tion has been characterized as “technology-less,”
in the sense that even adaptive technology
continues to come from abroad. Shortages of
skilled people have grown “from a crisis to a
critical emergency,” according to a Thai analyst.
Thailand’s gross enrollment ratio at secondary
school level languished at only 37% in 1992, less
than half of Taiwan’s in 1978 when Taiwan had
the same per capita income as Thailand in 1992.
In Malaysia, too, the skills shortage has become
so acute that some prominent foreign companies
long operating in the country have moved
production elsewhere, mainly to China and
Indonesia. Throughout the region infrastructure
is chronically congested, attested to by electricity
blackouts, traffic paralysis and rising cost of
water. In short, serious problems in the “real”
economy have been building up, even if they are
problems of success. But the calamity unleashed
on the region is hugely disproportional to the
severity of the problems in the real economy.
There were few signs of impending crisis, such
as rising interest rates in the G-7 countries or a
sudden suspension of capital flows to developing
countries after the baht devaluation. The
Japanese government’s de facto credit rating
agency, the Japan Center for International
Finance, gave Korea one of its highest credit
ratings for any developing country in June 1997
and the World Economic Forum rated Korea the
fifth best investment site in the world. The IMF
and the World Bank lavished praise upon the
governments of the region through 1997. Only
three months before Korea’s December 1997
crisis the IMF annual report said, “Directors
welcomed Korea’s continued impressive macro-
economic performance (and) praised the
authorities for their enviable fiscal record.” The
report called for financial sector reform in
general terms, but gave no hint of alarm, and
CRISIS 1537
made no mention of breaking up the chaebol or
allowing foreign ownership of banks or strength-
ening banking supervision-issues that are now
central to the IMF’s program for Korea. The
same report praised “Thailand’s remarkable
economic performance and the authorities’
consistent record of sound macroeconomic
policies” - shortly before the collapse of the
Thai currency.”
For all its popularity, the death throes inter-
pretation falls down at the second nudge.
3. INVESTOR PULLOUT/DEBT
DEFLATION IN A SOUND BUT
UNDERREGULATED SYSTEM
According to Jeffrey Sachs, director of the
Harvard Institute for International Development
and a prominent exponent of the second view,
There is no ‘fundamental’ reason for Asia’s financial
calamity except financial panic itself. Asia’s need for
significant financial sector reform is real, but not a
sufficient cause for the panic, and not a justification
for harsh macroeconomic policy adjustments. Asia’s
fundamentals are adequate to forestall an economic
contraction: budgets are in balance or surplus, infla-
tion is low, private saving rates are high, economies
are poised for export growth.
Asia is reeling not from a crisis of fundamentals but
a self-fulfilling withdrawal of short-term loans, one
that is fueled by each investor’s recognition that all
other investors are withdrawing their claims. Since
short-term debts exceed foreign exchange reserves, it
is “rational” for each investor to join in the panic.”
Instead of dousing the fire the IMF in effect
screamed fire in the theater.”
Joseph Stiglitz, now chief economist at the
World Bank and winner of the American
Economics Association’s John Bates Clark medal
for outstanding work by an under 40 year old
economist, spells out the argument. The contrast
with the views of Greenspan, Hanke and others
of the first camp could scarcely be sharper.
For the past 25 years East Asian economies [to
include what we describe as Southeast Asian] have
grown more than twice as fast as the average rate for
the rest of the world....These successes have been
fostered by sound fiscal policies, low inflation,
export-driven growth, and effective institutions,
which in turn helped make East Asia the world’s
leading recipient of foreign investment. Moreover,
the region’s high savings rate, more than one third of
gross domestic product, is six times foreign invest-
ment. These savings have made possible a high and
increasing level of investment..
1538 WORLD DEVELOPMENT

Recent developments, however, underscore the more effective regulation, many western analysts
challenges presented by a world of mobile capital- consider this the opposite of what is needed.
even for countries with strong economic fundamen-
tals. The rapid growth and large influx of foreign
investment created economic strain. In addition
heavy foreign investment combined with weak finan-
4. HISTORY OF THE CRISIS
cial regulation to allow lenders in many southeast
Asian countries to rapidly expand credit, often to
risky borrowers, making the financial system more The following history provides an interpreta-
vulnerable. tion consistent with the second theory. It shows
the build up of stocks of mobile capital in East
Inadequate oversight, not over-regulation, caused and Southeast Asia, and then the outflow after
these problems. Consequently, our emphasis should July 1997. The outflow grew into a panic-stricken
not be on deregulation, but on finding the right and regionwide run on a scale that has launched
regulutoly regime to reestablish stability and a debt deflation, that has in turn torn at the
confidence.” fabric of whole societies.
Stiglitz’s statement is remarkable in that it
comes from the chief economist of the World
Bank. It is implicitly a critique of the IMF’s
approach.14
More indirectly still, the Japanese government The starting point is the Plaza Accord of 1985,
has also voiced opposition to IMF and US that caused a rise in the value of the yen against
prescriptions for the Japanese economy. Eisuke the US dollar. Japanese companies sought a new
Sakakibara, Japan’s vice minister for inter- cheaper manufacturing base in a US dollar zone.
national finance, popularly known as “Mr Yen,” Southeast Asia was the obvious choice - close
said on Japanese national television in late to Japan, currencies pegged to the US dollar,
December: cheap and well-educated workers. Very cheap
credit in Japan, and strong Japanese government
We should make clear to the public that we will not
allow banks to fail. [He cited the Hokkaido encouragement helped to stimulate a Japanese-
Takushoku Bank as one the government should not led investment and export boom in Southeast
have allowed to fail, as it did in early December.] Asia. Rising exports supported more borrowing,
We should not let securities companies of consider- more equity issues and more foreign direct
able size fail either. The United States and the investment.
United Kingdom have not done it either. This is the Meanwhile, Japan experienced stock market
global standard. and real estate bubbles in the late 1980s (aggra-
He went on to say that it is up to politicians vated, Western commentators should note, by
not to let banks fail, and up to banks not to let US pressure on Japan to stimulate its domestic
big companies fail.15 demand and act as a locomotive for the world
Sakakibara’s statement can be read as an act economy, thereby mitigating the US’s hemor-
of defiance of the broad IMF approach to the rhaging current account deficit). When the
Asian crisis, that calls for some banks and bubbles burst in 1990 they left a legacy of bad
companies to be let go bankrupt as part of a debts in the banking system, which has been at
comprehensive market liberalization. the root of Japan’s very slow growth. Japanese
The crisis, as this roundup of views shows, has firms and banks have been carrying very high
rekindled fundamental debates about the role of levels of debt, while Japanese households have
governments and markets, both national and been saving a high proportion of household
international. Moreover, it has exposed a basic income. (Japan’s gross domestic savings
incompatibility in the interaction between Asian amounted to 31% of GDP in 1995.) With
and Western financial systems. The difference in consumption depressed, Japan has been running
policy “ethos” between Asia and the West are a large current account surplus - the other side
caught in a minor news item from early January of which is capital export. Capital exports
1998. The Japanese government announced redoubled Japanese loans and foreign direct
plans to rein in stock speculators and punish investment (FDI) in Asia. Of Japanese bank
market manipulation more vigorously, intended lending to developing countries, 84% has gone to
to help halt the fall in the stock market. Western Asia, making the Japanese economy heavily
analysts called the measures “Mickey Mouse,” as exposed there.”
“misguided at best and damaging at worst”.16 Moreover, the central bank of Japan has
The Japanese government thinks of how to get pursued an expansionary monetary policy,
 ASIAN DEBT-AND-DEVELOPMENT
pushing money into the economy in an attempt
to revive the spirits of consumers. But consumers
have been slow to react. The central banks of the
continental European countries have also
pursued monetary expansion and for the same
reason of very low growth in the 1990s; there too
consumers have been slow to react. The result
has been excess liquidity in the world system at
large. The excess liquidity has spilled over into
financial asset markets world-wide, driving up
prices. Much of the money ended up in the
hands of financial institutions in the United
States, Japan and Europe. They invested in the
US stock market, creating the long rise in US
equity prices, and they also scoured the world
looking for higher returns. They invested heavily
in Asia.
In a situation of excess liquidity worldwide and
with very low inflation at home, lenders in the
core countries have been prepared to lend to
East and Southeast Asia at nominal rates even
lower than the cost of domestic borrowing, and
borrowers in East and Southeast Asia have been
prepared to borrow abroad to take advantage of
the lower nominal rates. (With domestic inflation
commonly on the order of 6% a year, nominal
domestic interest rates have been on the order of
lo%, compared to 5% or less for foreign
borrowing.)
Much of this inflow took the form of what is
known as the carry trade. Banks, investment
houses and insurers borrowed in yen and dollars
and invested in short-term notes in Southeast
Asia that were paying far higher rates. These are
the carry trades.” Both domestically-based and
foreign-based companies and banks participated.
Capital flows to developing countries overall
grew from $46 billion in 1990 to $236 billion in
1996. Flows to South Korea, Indonesia,
Malaysia, Thailand and the Philippines rose from
$47 billion in 1994 to $93 billion in 1996. Of this,
the flow of private commercial bank lending
jumped from $24 billion in 1994 to $56 billion in
1996.19The flow of borrowed money had a self-
reinforcing effect on confidence, investment and
economic growth. There was less and less
compulsion on the part of lenders, borrowers or
governments to improve financial supervision or
control bank asset quality.
The foreign borrowing and lending to East
and Southeast Asia was premised on the assump-
tion that the exchange rate would hold. If the
value of domestic currency fell the advantages
might be wiped out as repayments increased in
domestic currency and foreign lenders faced
higher risks of nonrepayment. Similarly if
interest rates for yen or dollars should rise.
CRISIS 1539
(b) Capital liberalization
The Asian countries (excluding Japan and.
partially, Korea) operated fixed-exchange-rate
regimes, their currencies pegged to the US
dollar. It has been a reasonable assumption in
most of East and Southeast Asia that the peg
would hold. Their domestic inflation was
somewhat higher than that in Japan and the
United States, but their productivity growth was
also higher.
At the same time, these countries have under-
gone radical financial deregulation over the
199Os, including near-removal of restrictions on
the inflow and outflow of mobile capital. The
deregulation happened with little attention to
the new kinds of regulation that would be
required and with only a thin base of financial
skills (much thinner than in manufacturing).
Banks and finance companies still operate in
much of East and Southeast Asia as family
businesses, with management structures unable
to cope with the complexity of present-day
finance. The deregulated financial systems
enabled inexperienced private domestic banks
and firms to take out large, dollar-denominated
loans from foreign lenders and on-lend with
generous spreads. High profits for those with
access to much cheaper foreign credit was the
chief reason firms and banks, both national and
international, pressured governments to under-
take financial deregulation, their pressure
converging with that of the IMF and the World
Bank.
Thailand, where the crisis first hit, fueled its
fast expansion over the 1990s with heavy foreign
private borrowing, over half from Japan. The
Bank of Thailand undertook radical capital
liberalization and financial deregulation just as it
was overwhelmed with other complex issues and
political strife.
In Korea the government of President Kim
Young Sam that came to power in 1993 pro-
claimed financial deregulation as an important
policy objective, partly in order to facilitate its
acceptance into the OECD. It marginalized and
then abolished the pilot-agency Economic
Planning Board, and abandoned its traditional
role of coordinating investments in large-scale
industries. This made it easier for market failure
to manifest itself in excess capacity in
automobiles, shipbuilding, petrochemicals, and
semiconductors.20 Also in the name of financial
liberalization, the government relaxed its
monitoring of foreign borrowing activities.
Korea’s external debt ballooned from very little
in 1990 to around $150 billion in 1996.” On top
1540 WORLD DEVELOPMENT
of all this, the government bought the monetarist
view that inflation control should be the
overriding priority of macroeconomic policy and
that the exchange rate should be an “anchor” for
inflation control. This caused a significant
overvaluation of the currency, hurting exports.
(c) High savings and high debt
Meanwhile, well before the huge inflow of
foreign funds and continuing through it, Asian
households saved. Gross domestic savings are
typically one-third of GDP or more, about the
highest in the world, giving East and Southeast
Asia the world’s biggest pool of savings. (Korea’s
gross domestic savings amounted to 36% of
GDP in 1995, as did Thailand’s; China’s equaled
42%. In contrast, US gross domestic savings
amounted to 15% in 1995, down from 19% in
1980; the UK figures are the same.)** We
normally think of high-income countries as
capital-abundant and low-income countries as
capital-short (an assumption at the heart of the
post-WWII international aid regime and the
subdiscipline of development economics). But
East and Southeast Asia is a lower-income
region where capital is in a sense more
“abundant” than in higher-income regions of
North America and Europe.
A large part of the savings come mostly from
households, and thanks to a relatively equal
income distribution a high proportion of house-
holds are net savers. (Compare the United
States, where only the top 10% or so of house-
holds are net savers. The US household sector
overall is a big net borrower.) Asian households’
risk preferences are such that the savings are for
the most part deposited in banks rather than
invested in equities. Banks must therefore inter-
mediate a huge inflow of savings, and these
countries tend to have a high level of bank
deposits to GDP (a “deep” banking system).
Some of the savings are invested abroad, but
most are invested at home. Government is not a
major borrower (in contrast to most of the G-7
countries). Since households and government are
non-borrowers, the borrowers must be firms and
other investors. Hence the system is biased
toward high ratios of debt to equity in the
corporate sector, the other end of their high
savings.
Firms with high levels of debt to equity are
vulnerable to shocks that disturb cash flow or the
supply of (bank or portfolio) capital - for debt
requires a fired level of repayment while equity
requires a share of profits. The higher the debt-
to-equity ratio the more likely that any depres-
sive shock will cause illiquidity, default and
bankruptcy. Therefore banks and firms must
cooperate to buffer systemic shocks, and govern-
ment must support their cooperation. The need
for government support gives the government a
powerful instrument for influencing the behavior
of both firms and banks. This is an economic
rationale for the pattern of “alliance capitalism,”
derogatorily called “crony capitalism,” that is
often said to characterize East and Southeast
Asia and that is usually understood in political
terms, such as corruption and the survival strat-
egies of rulers.
Countries of the region vary in how the
government uses its influence over banks and
firms. At one end are the developmental states
of Japan (1935-80), South Korea and Taiwan,
where the state coordinated, directed, and
collaborated with firms entering major world
industries. In some of the new industries the
state assisted firms with cheap credit, tax breaks
and other forms of subsidy, helping them to
amass resources on the scale needed to under-
take rapid upgrading and disciplining the alloca-
tion of help with criteria related to international
competitiveness, such as export performance. In
some dying industries the state helped firms to
exit or move offshore. At the other end of the
scale are states such as Thailand and Indonesia,
which have made no more than sporadic efforts
at public sector directional thrust or public-
private collaboration in sectoral development.
Much of the directional thrust of their industrial-
ization came from the strategies of Japanese
firms operating in close collaboration with the
Japanese government. In the middle is Malaysia,
which has, in Business Week’s words,
copied Japan’s aggressive partnership between
government and the private sector. In the Malaysian
version of Japan Inc., government officials meet
formally with representatives of industry and
commerce to decide how much funding will go to
each sector before the national budget is drafted.. .
Not surprisingly, Japanese companies, such as
Matsushita Electric and Mitsubishi Motors, have
robust operations in Malaysia, which imports more
from Japan than from anywhere else.”
For all the variation in the role of the state,
relatively deep debt structures, with their vulner-
ability to external shocks, are common to the
region.24
(d) Preconditions for the crisis
These, then, are the preconditions of the
Asian crisis: (i) Very high rates of domestic
savings, intermediated from households to firms
 ASIAN DEBT-AND-DEVELOPMENT
via banks, creating a deep structure of domestic
debt. (ii) Fixed exchange rate regimes, with
currencies pegged to the US dollar (apart from
Japan, and partially, Korea), that created the
perception of little risk in moving funds from
one market to another. (iii) Liberalization of
capital markets in the early to mid-1990s and
deregulation of domestic financial systems at
about the same time, without a compensating
system of regulatory control. (iv) Vast inter-
national inflows of financial assets, coming from
excess liquidity in Japan and Europe being
channeled through financial institutions scouring
Asia for higher returns and lending at even lower
nominal rates than domestic borrowers could
borrow from domestic sources, creating a deep
structure of foreign debt.
(e) Towards the tipping point
The movement towards crisis began with infla-
tionary pressure. The inflow of financial capital
and foreign direct investment to Southeast Asia
in the 199Os, combined with the fixed exchange
rate regime, forced an increase in domestic
money supply (because under the rules of the
fixed rate system the central bank has to buy the
foreign currency and issue domestic money in
exchange). This fueled inflation at around 6% in
the past few years, when inflation in Japan and
the United States had become much less.
Then came major shifts in exchange rates.
First, the US dollar has appreciated against the
yen by 50% in the past two years as the Japanese
economy languished in recession. Second, China
devalued the yuan by 35% in 1994,* while
keeping inflation low and productivity growth
high. The combination of devaluation, low infla-
tion and high productivity growth made the yuan
the most undervalued currency of any major
trading country. For the fixed-exchange-rate
countries of East and Southeast Asia, the
Japanese and Chinese devaluations against the
US dollar were a double blow, squeezing them
from above and from below.
The appreciation of currencies tied to the US
dollar, coupled with domestic inflation at rates
higher than those of trading partners, made for a
squeeze on exports and a cheapening of imports.
Thailand had the biggest problem: its current
account deficit exceeded 4% of GDP every year
since 1990. By 1996 all four Southeast Asian
economies ran current account deficits of
*There is dispute about the real magnitude of the
devaluation. The key point is that it was perceived as
significant and responded to accordingly.
CRISIS 1541
between 4 and 8% of GDP, Thailand’s being the
biggest of all.
Responding to high savings, domestic inflation
higher than trading partners’, and reduced
prospects for export-oriented manufacturing,
investors in Southeast Asia invested in real
estate. Property speculation flourished, and went
on flourishing as foreign currency continued to
pour in and the domestic money supply
continued to expand. As people expected infla-
tion to continue, property investment continued
to appear the best hedge. For several years in
the first half of the 1990s property prices in
Bangkok rose at more than 40% a year. Notice
that excessive real estate investment was under-
taken by private agents, and not with government
encouragement.
(f) Thailand over the brink
Thailand’s private sector-generated property
bubble burst in 1995, and the stock market
crashed in mid-1996. The property market, like
the stock market, is a market where small
withdrawals can have a big effect on prices and
leave the banking system in the sort of danger
that makes depositors withdraw their money.
When the property market crash came, it ripped
through the whole financial sector and on into
the foreign exchange market as foreign investors
saw that domestic borrowers were less able to
meet the now much more expensive debt service
charges on their short-term foreign loans,
Economic growth and export growth slowed
sharply. With the prospect of a baht devaluation
in sight (a breaking of the peg), companies in
Thailand, both foreign and domestic, tried to sell
their baht for dollars. There were runs on the
baht in mid-1996 and again in early 1997. The
Thai central bank tried to buy up baht to prevent
the price drop, but eventually gave up as reserves
fell to dangerously low levels.
Then in early May 1997, Japanese officials:
concerned about the decline of the yen, hinted
that they might raise interest rates. The threat
never materialized. But the combination of the
threat of a rise in Japanese interest rates in
order to defend the yen, plus the worries that
were circulating about Thailand’s currency.
raised fears among commercial bankers, invest-
ment bankers, and others about the safety of big
investment positions throughout the region that
were predicated on currency stability.”
The investors scurried to sell holdings in local
currencies, and especially in Thai baht. In early
July 1997 the Thai baht was floated and sank. In
August 1997, the IMF stepped in with a support
1542 WORLD DEVELOPMENT
package and “conditionality” measures that
included the freezing of many finance
companies. This was the start of what Sachs calls
the IMF’s screaming fire in the theater. The
freezing of finance companies sent uninsured
depositors into a panic.
(g) The contagion
One of the mysteries of the Asian financial
crisis is how the widely acknowledged real estate
problems of Thailand’s banks could have
triggered such far-reaching financial contagion.
The fact that there were few signs of impending
crisis is, it has to be said, par for the normal
course of financial crashes. Historically, financial
crashes have occurred in the industrial econo-
mies not when the economy was in trouble by
the usual measures, but when everything seems
to be going well - when economic growth is
strong, inflation low, and optimism high (to
paraphrase Alan Greenspan’s description of the
current US economy).26
(h) Refocusing of risk
During the boom years of the 1990s inter-
national investors and the international rating
agencies (Moodys, Standard and Poors) focused
on macroeconomic factors such as budget
deficits, debt/GDP ratios, and export growth.
After the shock of the Thai devaluation,
investors suddenly began to reevaluate risk and
focused on different risk factors. They paid much
more attention than before to microeconomic
risks such as the volume of dollar debt maturing
in the next 12 months, the debt/equity ratios of
the corporate sector, and the currency denomi-
nation of external liabilities. In addition, they
had lent to highly indebted Asian firms even
though Western prudential guidelines should
have prohibited such lending, and they now
applied their traditional prudential criteria. The
Japanese banks, struggling with bad debts at
home, especially tried to call in their loans. The
credit problems of Japanese banks weigh on the
Asian financial crisis like the post-WWI repara-
tions weighed on central Europe.”
From this new perspective, ail the Southeast
Asian currencies suddenly looked vulnerable,
since all the economies had a significant
overhang of short-term dollar debt whose repay-
ment looked problematic if exchange rates were
to collapse. Investors and domestic companies
began to sell local currencies in order to hedge
their dollar liabilities. In response to the selling
pressure first Thailand and then Malaysia let
their currencies float.
(i) Indonesia and Thailand
Then Indonesia startled investors by letting its
currency float too, despite the fact that it already
had a much wider target band than the others.
The Indonesian decision confirmed investors and
local companies in thinking that a competitive
devaluation in Southeast Asia was underway, the
rational response to which was to sell as much
local currency as possible - thereby fulfilling the
prophecy. Money managers in the rest of the
world began to think of “southeast Asia” as a
homogeneously dangerous place.
The announcement of the IMF package for
Thailand in August 1997 briefly boosted confi-
dence and slowed the contagion, because it
seemed to indicate a concerted international
effort. But then it became apparent that the US
had contributed virtually nothing to the bail-out
fund because of congressional restrictions on
such help imposed after the Mexican crisis of
1994,2Rand that Japan had contributed only $4
billion despite its heavy exposure in Thailand
and despite its statements in the preceding
months that it would play a big role in promoting
financial stability in the region. Suddenly the
IMF’s Thailand package seemed to show the
limits of international action rather than its
promise. Moreover, the conditions of the IMF
funds required Thailand to undertake structural
and institutional reforms that were not closely
related to restoring Thailand’s ability to repay its
debt, which signaled to international investors
that the whole economy was in a much deeper
mess than they had assumed.
( j) Taiwan, Hong Kong and Korea
Then came Taiwan’s devaluation in
mid-October. Though small in size (about 12%),
it came as a shock because Taiwan is famous for
its towering foreign exchange reserves. That
Taiwan could devalue led the owners of mobile
capital to fear that Hong Kong might do the
same, and Korea too.
Taiwan acted as a fire bridge from Southeast
to East Asia. After Taiwan the conceptual
category of “Asian financial crisis” came into
being.29 Capitalists began to sell the Hong Kong
dollar and the Korean won. Both cases are
surprising. Hong Kong is an autonomous region
of a country, China, running a huge current
account surplus. But on October 23 the Hong
 ASIAN DEBT-AND-DEVELOPMENT CRISIS
Kong stock market fell by more than lo%,
though the peg to the US dollar held. The
Korean economy was performing well, with 8%
growth, low inflation, low unemployment, with a
(published) debt to GDP ratio of only 30%, one
of the lowest of the developing countries, and a
small and shrinking current account deficit.
Meanwhile, Indonesia and the IMF announced
an IMF program of emergency finance, and the
governments of Singapore and Japan also inter-
vened on behalf of the rupiah. The United States
was able to make more of a contribution to the
IMF’s Indonesia program because by this time
the congressional restriction on the post-Mexico
use of US funds for such purposes had lapsed
and Congress had begun to take on board the
threat to US interests posed by the crisis. All this
boosted investor confidence - temporarily.
Then came reports of a sharp deterioration in
the health of Indonesia’s long-time ruler, Presi-
dent Suharto. Indonesia’s wealthy Chinese elite,
that controls much of the business sector, has
long benefited from close ties to the Suharto
family. Reports of his decline induced them to
sell more rupiah and store assets offshore. The
rupiah continued to plunge.
(1) Korea
By this time, around October and November
1997, the whole region was awash with panic.
Investors began to pay attention to the term
structure of Korea’s foreign debt. They estimated
short-term debt at $110 billion, more than three
times Korea’s official foreign exchange reserves.
Rumors circulated that President Kim (like
President Salinas of Mexico before him), not
wanting to finish his term embroiled in crisis,
might be inflating the true level of the exchange
reserves and concealing some of the debt.
Investors scrambled for the exit, accelerating the
fall of the won.
Korean banks had borrowed low-cost foreign
funds and then invested heavily in “junk” bonds,
with high yields and high risks, in an essentially
speculative way, always on the assumption that the
exchange rate would hold. They held large
amounts of Russian bonds and Latin American
“Brady” bonds.“” As the won fell, the banks
began to sell foreign securities in order to boost
liquidity. Their sell-off helped to spread the
financial contagion, as the holders of equivalent
1543
junk bonds saw their value collapse with the
Korean sell-off.
Since Japanese banks, known to be financially
fragile, had lent heavily to Korean companies,
and since Korean companies competed against
Japanese companies in some important indus-
tries, investors saw the Japanese yen as vulner-
able to a won depreciation. Since Korea
competes with Taiwan, Hong Kong, and
southern China in many industries, investors also
saw risks of a further round of competitive,
crisis-driven devaluations of the Hong Kong and
Taiwan dollars.
The scale of the crisis is caught in the figures
on capital movements. A net inflow of private
capital of $93 billion in 1996 (to Southeast Asia
plus Korea) became a net outflow of an
estimated $12 billion in 1997, a swing in the net
supply of private capital of $105 in just one year.
This is 11% of the pre-crisis GDP of the five
economies, a staggering change, and three
percentage points higher than the corresponding
figure for Latin America in the 1980~.~’
(m) The IMF’s Korea strategy
The IMF in December 1997 organized $57
billion from official sources to lend to Korea so
that its private companies could repay US,
Japanese and European banks as the short-term
debt came due. If the Fund’s earlier inter-
ventions in Thailand and Indonesia amounted to
screaming fire in the theater, then its inter-
vention in Korea amounted to screaming even
louder. In Thailand and Indonesia the Fund’s
insistence on far-reaching institutional reforms in
return for loans signaled that it thought these
economies structurally unsound. In Korea the
Fund demanded nothing less than an overhaul of
the Korean economy, beginning with the tinan-
cial system and continuing into corporate
governance, labor markets, and the trade regime;
as well as a contractionary macroeconomic policy
of higher taxes, cuts in government spending,
and much higher real interest rates. The Fund,
talking tough, said it would provide the credit
only as Korea altered these central features of its
economy. The signal of fundamental unsound-
ness was even louder than earlier for Thailand
and Indonesia.
The Fund’s financial restructuring plans aim to
make Korea’s financial system operate like a
Western one, without actually saying so. Trouble
financial institutions are to be closed down or
recapitalized; foreign financial institutions are to
be able freely to buy up domestic ones; banks
are to follow Western (“Basle”) prudential
1544 WORLD DEVELOPMENT
standards; “international” (read “Western”)
accounting standards are to be followed and
international accounting firms to be used for the
auditing of the bigger financial institutions. The
government is required not to intervene in the
lending decisions of commercial banks, and to
eliminate all government-directed lending; also
to give up measures to assist individual corpora-
tions avoid bankruptcy, including subsidized
credit and tax privileges. The Fund also requires
wider opening of Korea’s capital account, to
enable even freer inflow and outflow of capital.
All restrictions on foreign borrowings by
corporations are to be eliminated. The trade
regime, too, will be further liberalized, to remove
trade-related subsidies and restrictive import
licensing. Labor market institutions and legisla-
tion will be reformed “to facilitate redeployment
of labor.““’
These requirements go far beyond what is
necessary to restore Korea’s access to capital
markets.“” Korea’s foreign exchange reserves
continued to worsen after the stand-by agree-
ment with the Fund was announced, partly
because the agreement lacked credibility.
(n) The downward spiral
We now see a huge contractionary wave
propagating itself through the region. Inter-
national banks have slashed credit lines to all
borrowers, including the export-oriented firms
that should be benefiting from currency depre-
ciation. Even the big Korean chaebol, with
worldwide brand names, are finding it difficult to
get even trade credit (letters of credit to cover
the import of inputs into export production).
This did not happen to the same extent in the
Latin American crisis of the 1980s. Latin
American companies did not suffer from the
same withdrawal of credit, though Latin
American countries were far less creditworthy
than Asian ones, because companies had debt/
equity ratios within Western prudential lending
limits.
The much higher real interest rates and cuts in
domestic demand required bv the Fund are
tipping many profitable but -high debt/equity
firms into bankruotcv. Meeting Western stand-
ards for the adequacy of bank? capital entails a
rapid fall in banks’ debt/equity ratios and a sharp
cut in their lending, causing more company
bankruptcies. The resulting financial instability
and unrest may cause net capital outflow instead
of the inflow that the Fund expects. On the other
hand, whole swathes of the corporate sectors of
the region are being offered at fire-sale prices,
and only outsiders have the capital to buy them
up or to recapitalize existing banks. We may be
in the early stages of a massive transfer from
domestic to foreign ownership. This is not just a
transfer of control and profits; it will affect the
basic dynamic of the economy. Foreign banks
may not lend to high debt/equity local com-
panies, and may not participate in the kind of
alliances between government, the banks, and
companies that a high debt/equity financial struc-
ture requires. If Citibank buys up Korean banks
and applies its normal prudential limits (by
which lending to a company with a debt/equity
ratio of 1:l is getting risky), it will not lend to
Daewoo with a debt/equity ratio of 5:l. The
amount of restructuring of Daewoo before its
debt/equity ratio comes close to 1:l is hard to
imagine.
It seems particularly unwise for the IMF to
insist that companies receive even more freedom
than before to borrow on international capital
markets on their own account, without govern-
ment coordination, when it was their uncoordi-
nated borrowing that set up the crisis in the first
place. This will make the country more, not less,
vulnerable to capital flight.
In short, the IMF approach is likely to
generate big social costs long before there is any
significant amount of debt reduction, all because
of a short-term and unforeseeable run by mobile
capital. It aims to dismantle the high debt
system, its developmental advantages notwith-
standing. Moreover, it wants to see a Western-
type financial system in its place that can only
work with a huge reduction in levels of corporate
debt. The Fund has not properly weighed the
economic and social costs of doing this, nor even
the question of whether it has any legitimate
business entering the field of structural and insti-
tutional reform. Eventually Asian economies will
start to grow again, for their “fundamentals” are
strong; but by then their fundamentals will not
be as strong. There will be an inner source of
instability created by the attempt to integrate the
flow of household deposit savings with a financial
structure based on Western norms of prudent
debt/equity ratios. By then they will have a rather
different pattern of ownership, with foreign firms
and banks - in particular, US firms and banks
- having much more control than before. They
will have given up the developmental advantages
of a high debt system based on govemment-
bank-firm collaboration in return for somewhat
lower risks of financial crashes.
Once the crisis is passed, reneging on IMF
agreements may occur. But by that time foreign
banks and other financial institutions may be
 ASIAN DEBT-AND-DEVELOPMENT
well established, making the high debt/equity
system difficult to rebuild.
5. TURNING POINTS
Any coherent account of the crisis runs the
danger of making it look inevitable. In fact,
things could have been different. Halting the
panic would have required something to restore
each lender’s confidence that its own refinancing
would be matched by others.
Had Japan addressed its banking problems
earlier by bolstering bank balance sheets
through a debt reconstruction program or by
preferred stock purchases, Japanese banks
would not have had to slash their refinancing
to Korean and other borrowers in the
autumn of 1997.
Had the Japanese government pledged $10
billion to the IMF package for Thailand in
August 1997, rather than $4 billion, confi-
dence may have been restored.
Had the US congress (supported by majority
US public opinion) had been less isolationist,
less opposed to any government largesse
abroad - had it had not put a restriction in
place after the Mexican crisis on the use of
public resources for such purposes as the
Thai package, had it not objected to
increasing the IMF’s resources (through the
New Agreement to Borrow, announced by
the G-7 countries in January 1997 but not
ratified by the US Congress), had it not
declined to provide more funds to the IMF in
November 1997 because of a dispute about
an abortion-related amendment to the
country’s foreign aid program - the United
States may have been able to pump in more
resources.34
Had developing countries liberalized their
financial systems more slowly (resisting
Western pressure for rapid liberalization),
then the domestic lending excesses and
vulnerability to outflows of hot money would
have been curbed.
Had developing country political leaders been
prepared to check wild real estate investment
and speculation in junk bonds, the vulner-
abilities would also have been less. Taiwan is
a case where these excesses seem to have
been checked.
- Had there had been “sand in the wheels” of
the international financial system (such as a
tax on international currency transactions),
the build-up to crisis may have been slowed.
CRISIS 1545
- Had the IMF stuck to its mandate of helping
countries to cope with temporary foreign
exchange shortages and regaining access to
international capital markets, its prescriptions
might have looked less like screaming fire in
the theater. This would have required the
Fund to focus less on mobilizing a bail out
fund and more on organizing debt resche-
duling negotiations between the debtors and
the banks.
6. CAPITAL OPENING AND THE WALL
STREET-TREASURY-IMF COMPLEX
Perhaps the single most irresponsible action in
the whole crisis was capital account liberalization
without a framework of regulation. This exposed
economies built for patient capital to short-term
financial pressures, and allowed the private
sector to sidestep domestic monetary restrictions
via foreign borrowings, helping to cause currency
overvaluation. The blame is shared between
national governments and international organiza-
tions. But it has to fall disproportionately on the
IMF, that for several years now has been pushing
hard for capital account opening.
Why has the Fund been pushing capital
account opening, and why in the present crisis
has it gone so far beyond its traditional concern
with balance-of-payments adjustments? This has
occurred partly because it had already crossed
the line in dealing with the former Soviet Union
and Eastern Europe, legitimizing an expanded
agenda in that context. Those countries clearly
needed advice about the creation of basic market
institutions, and the Fund was able to get its
advice accepted because it brought vital financial
rewards. In its next great intervention, in Asia,
the Fund has continued to operate over this
much wider jurisdiction, seeking to impose on
Thailand, Indonesia and Korea institutional free-
market reforms as comprehensive as those
imposed on Russia - even though such reforms
in the Asian case are not necessary to restart the
flow of funds.35
The legitimizing precedent of the former
Soviet Union and Eastern Europe is one thing.
But the deeper answer involves the interests of
the owners and managers of international
capital. The reforms sought by the Fund are
connected in one way or another with further
opening up Asian economies to international
capital. Why is the Fund insisting on capital
account opening in countries that are awash with
domestic savings? Why has it done so little to
organize debt rescheduling negotiations, prefer-
ring to seek additional bail-out funds from G-7
1546 WORLD DEVELOPMENT

governments and then give them out in return for responsive to their needs and Jesuistic in their
structural and institutional reforms? The short commitment to the neoclassical “Washington
answer is contained in a remark by James Tobin, Consensus.” The US Congress backs the US
the Nobel laureate in economics. Treasury. The Senate has passed a bill saying
that no US funds may be made available to the
south Koreans and other Asian countries - like
Mexico in 1994-95 - are.. .victims of a flawed IMF until the Treasury Secretary certifies that all
international exchange rate system that, under U.S. the G-7 governments publically agree that they
leadership, gives the mobility of capitalptiority over all will require of its borrowers (a) liberalization of
other considerations.3h trade and investment (no mention of qualifica-
tions to do with environmental protection, labor
Martin Feldstein, professor of economics at
standards and so on), and (b) elimination of
Harvard University and president of the National
“government directed lending on
Bureau of Economic Research, similarly
non-commercial terms or provision of market
observes that
distorting subsidies to favored industries, enter-
Several features of the IMF plan are replays of the prises, parties or institutions” (incuding, presum-
policies that Japan and the United States have long ably, subsidies for energy conservation,
been trying to get Korea to adopt. . . [The IMF] low-income housing and the like).
should strongly resist pressure from the United
The extended complex has over the past year
States, Japan, and other major countries to make
their trade and investment agenda part of the IMF led the process of amending the IMF’s articles of
funding conditions.37 agreement to require member governments to
remove capital controls and adopt full capital
Jagdish Bhagwati, professor of economics at account convertibility.“9 It has likewise worked to
Columbia University and champion of free trade, promote the World Trade Organization’s agree-
takes the argument further. Asked why the IMF ment on liberalizing financial services being
was seeking to open financial markets he replied, hammered out in 1996-97. Many developing
Wall Streeet has become a very powerful influence country governments, including prominently
in terms of seeking markets everywhere. Morgan several Asian ones, opposed the WTO’s efforts
Stanley and all these gigantic firms want to be able to liberalize financial services.4” In response,
to get into other markets and essentially see capital
account convertibility as what will enable them to Executives of groups including Barclays, Germany’s
operate everywhere. Just like in the old days there Dresdner bank, Societe Generale of France and
was this “military-industrial complex”, nowadays Chubb insurance, Citicorp, and Ford Financial
there is a “Wall Street-Treasury complex” because Services of the US, . agreed discreetly to impress
Secretaries of State like Rubin come from Wall on finance ministers around the world the benefits of
Street... So today, Wall Street views are very a WTO dea?’
dominant in terms of the kind of world you want to
see. They want the ability to take capital in and out Then came the financial crisis. By December
freely. It also ties in to the IMF’s own desires, which is 1997 the Asian leaders agreed to drop their
to act as a lender of last resort. They see themselves objections, and on December 12, 1997, more
as the apex body which will manage this whole than 70 countries signed the agreement that
system. So the IMF tinally gets a role for itself, commits them to open banking, insurance and
which is underpinned by maintaining complete securities markets to foreign firms. By then the
freedom on the capital account.
Asian holdouts (including Thailand and
Bhagwati goes on to observe that many Malaysia) saw no choice: either they signed or
countries have grown well without capital their receipt of IMF bail-out funds would be
account convertibility, including China today and complicated. Meanwhile the OECD has been
Japan and Western Europe earlier. “In my pushing ahead with the negotiation of the Multi-
judgement it is a lot of ideological humbug to say lateral Agreement on Investment, that liberalizes
that without free portfolio capital mobility, all direct foreign investment restrictions,
somehow the world cannot function and growth requiring signatory governments to grant equal
rates will collapse.“” Bhagwati’s “Wall Street- treatment to foreign as to domestic companies. It
Treasury complex” is more accurately called the will preclude many of the policies of the develop-
“Wall Street-US Treasury-US Congress-City of mental state.
London-UK Treasury-IMF complex.” US and These events - the revision of the IMF’s
UK financial firms know they can gain hugely articles of agreement, the WTO’s financial
against all comers in an institutional context of services agreement, and the OECD’s Multilateral
arms-length transactions, stock markets, open Agreement on Investment - are the expression
capital accounts and the new financial instru- of a Big Push push from international organiza-
ments. Their respective Treasuries are deeply tions, backed by governments and corporations
 ASIAN DEBT-AND-DEVELOPMENT
in the rich countries, to institute a worldwide
regime of capital mobility that allows easy entry
and exit from any particular place. If the agree-
ments are ratified and enforced, they will ratchet
up the power and legitimacy of the owners and
managers of international capital in the world at
large. This will in turn help secure the predomi-
nance of the Anglo-American system. That
system, based on maximizing returns through the
optimal allocation of the existing stock of capital
and savings, is better suited to maintaining
stability when incomes are high and growth and
inflation low. The Asian system, focused on the
accumulation of capital and deliberate creation
of Schumpeterian rents through the acquisition
of new technology, is better suited to fast growth.
As long as the Asian system operates on the
basis of long-term relationships and patient
capital, Anglo-American capital is at a disadvan-
tage in these markets. Therefore the Asian
system must be changed. What is the point of
being the core, the hegemon, if the periphery
does not do what you want? Yet for all their
implications for sovereignty, democracy, and
social stability the capital favoring agreements
are being negotiated with scarcely any public
debate. They have been protected from public
concern partly because the champions of the
wider movement towards free capital movement
and lifting of government regulations have
managed to harness to their cause the most self-
justifying of slogans, “stopping corruption.”
Capital freedom, we are invited to believe,
checks corruption (as in Asia’s “crony
capitalism”), and is therefore self-evidently a
good thing. The next step will be an international
agreement to deregulate labor markets, intended
to make them more “flexible” (code-speak for
freedom to hire and fire) while stopping short of
open migration. This would further consolidate
the global governance of capital.
There is always a fine line to be trod between
an interest-based theory and a conspiracy theory
(for all that everyone accepts the former and
hardly anyone accepts the latter). It is difficult to
know to what extent and at what point some
events in the Asian crisis were deliberately
encouraged by those who stood to gain from the
sudden loss of resources by Asian governments
and from the opportunities to gain control of
Asian companies at knock-down prices. Certainly
the role of the US Treasury in stiffening the
IMF’s insistence on radical financial opening in
Korea is documented. The Treasury made it
clear that Korean financial opening was a condi-
tion of US contributions to the bail-out, on the
understanding that financial opening would
CRISIS 1547
benefit US firms that would in turn give political
support for US contributions.42
Financial crises have always caused transfers
of ownership and power to those who keep their
own assets intact and who are in a position to
create credit, and the Asian crisis is no excep-
tion. Whatever their degree of intentionality and
their methods of concerting strategy, there is no
doubt that Western and Japanese corporations
are big winners from the Asia crisis. Their
euphoria is nicely caught in the remark by the
head of a UK-based investment bank, “If
something was worth $lbn yesterday, and now
it’s only worth $SOm, it’s quite exciting”.”
Indeed, the combination of massive devaluations,
IMF-pushed financial liberalization, and
IMF-facilitated recovery may even precipitate
the biggest peacetime transfer of assets from
domestic to foreign owners in the past 50 years
anywhere in the world, dwarfing the transfers
from domestic to US owners that occured in
Latin America in the 1980s or in Mexico after
1994. One recalls the statement attributed to
Andrew Mellon, “In a depression, assets return
to their rightful owners.”
The crisis has also been good for the multi-
lateral economic institutions, including the IMF,
the World Bank, and the WTO. Amongst the
owners and managers of capital they gain great
centrality, both as organizations that can get
them out of the crisis without serious losses and
as organizations that can cajole Asian govern-
ments to reshape their domestic economies in
line with Western models. True, the IMF in
particular has attracted much criticism. But
compared to those who see it as the spearhead
of their interests, the critics have little power.
7. THE FUTURE
(a) Asia
We are now seeing the playing out of a
familiar four-step sequence of crisis. Step one is
the exchange rate collapse. Step two is an
upsurge of bank failures and company bankrupt-
cies as a result of the now much higher cost of
servicing unhedged foreign debt. Step three is
domestic recession, with falls in consumption and
investment and rises in unemployment. Step four
is political reaction to the slump, including civil
unrest and anti-foreign sentiment.”
This is the likely sequence in each case, but we
have little idea of how this process will unfold in
the interaction between the countries. We can be
confident that real spending will contract by
more than at any time since the mid-1970s when
1548 WORLD DEVELOPMENT
the first oil shock hit. Much will depend on what
is agreed by way of debt restructuring of
countries’ corporate sectors (whether in the form
of a debt moratorium or government bond
offering). If Korea is unable to regain access to
international credit markets within the next few
months, the degree of disruption and civil unrest
is likely to be high, pushing the government
toward debt default. Ethnic conflict could be
kindled in many countries of the region as
Chinese business elites come to be blamed. How
would China respond?
It will be difficult to repair the relations of
trustworthiness between government, business
and banks, and between foreign (especially
Japanese companies) and domestic companies,
that have underpinned the Asian model. High
debt/equity ratios will be more difficult to
sustain. On the other hand, the crisis means that
savings mobilization through the stock market is
even less likely an option than it was before. It
may take 10 years before the stock market
becomes a serious option for transferring
savings. Yet Asian households are likely to
redouble their savings, putting them into bank
deposits. This in itself gives impetus to restore
the model of guided markets with interfirm
cooperation and government support for deep
structures of bank intermediation.
The crisis will leave a legacy of resentment
towards the West. The Malaysian prime minister
Mahathir Mohamad is quite explicit. At the end
of December 1997 he told Malaysians that they
must be willing to make sacrifices in defending
the country’s currency or risk being “recolo-
nized” by foreign powers.
the fall in our currency’s value has made us
poorer, exposing us to the possibility of being
controlled by foreign powers. If this happens, we will
lose the freedom to run our country’s economy and
with it our political freedom also. In short, we will be
re-colonized indirectly.. . We cannot give up and
surrender. We must be willing to face challenges,
willing to sacrifice in defending our freedom and our
honor!’
Other Asian leaders have been more circumspect
in public but express sympathy in private. Senior
Malaysian and Indonesian leaders have invoked
a Jewish conspiracy as cause of the capital
outflow, perhaps hoping to deflect public anger
away from the local Chinese.&
The Chinese government has also been highly
critical of the IMF and the US. An article in the
Chinese People’s Daily said,
By imposing harsh terms of financial aid to troubled
Asian nations, the United States was forcing into
submission economic rivals in the region. China’s
Communist Party mouthpiece [said the Reuters’
report] portrayed US intervention in the Asian
currency crisis in cynical terms.. . . “By giving help it
is forcing East Asia into submission, promoting the
US economic and political model and easing East
Asia’s threat to the US economy”. The newspaper
said the United States was stressing the authority of
the International Monetary Fund (IMF) during the
crisis to further its own strategic interests4’
Henry Kissinger, former US Secretary of
State, recently warned,
Even [Asian] friends whom I respect for their
moderate views argue that Asia is confronting an
American campaign to stifle Asian competition. “It
is critical that at the end of this crisis”, [he went on
to say], “when Asia will reemerge as a dynamic part
of the world, America be perceived as a friend that
gave constructive advice and assistance in the
common interest, not as a bully determined to
impose bitter social and economic medicine to serve
largely American interests”:’
For all the resentment, Asia’s regional
response to the crisis has been weak, exposing
the thinness of the existing regional structures.
There is an interesting story yet to be told about
the Japanese proposal, in summer 1997, to estab-
lish a largely Japanese-financed Asian bail-out
fund for the purpose of refinancing short-term
debt-an attempt at long-promised but not
delivered international leadership. The US
Treasury, including Secretary Rubin and Deputy
Secretary Summers, reacted to this proposal with
public displeasure and private anger, saying that
the crisis was something for the IMF to manage.
In the event, the Japanese proposal more or less
died. Would the Japanese really have gone
ahead with it had the United States not objected
so strongly? Did they see it as a backdoor route
to doing something the Ministry of Finance had
long wanted to do, namely to establish a public
agency to bail out the Japanese banks similar to
that which the United States established, to good
effect, for the savings and loans institutions in
the 198Os? An earlier Ministry of Finance
proposal to this effect had been torpedoed by
Japanese politicians, responding to strong public
sentiment against the use of public money to bail
out financial institutions. The Ministry of
Finance may have seen the establishment of an
Asia fund as a way to help Japanese banks avoid
exposure to mounting loan losses in their South-
east Asian debt portfolios. On the face of it, one
would expect the United States to welcome such
an initiative since its costs to the US taxpayer
would be negligible, even less than in the case of
an IMF bail-out. Perhaps the Treasury opposed
the idea so strongly out of concern not to see
Japan shore up its weakening politico-economic
position in Southeast Asia and not to see Japan
 ASIAN DEBT-AND-DEVELOPMENT CRISIS
divert its capital from the purchase of US
Treasury bonds. The Japanese agreed to desist in
a November 1997 meeting in Manila (at which
China, as well as the US, was a strong critic of
the Japanese proposal). Japan and some other
Asian countries are continuing to press for the
creation of a contingency fund with which to
support countries in trouble, whereas the United
States continues to want the establishment of
lines of credit rather than pay up front; but this
debate is now being conducted discreetly inside
the IMF, with the Asians in a weak bargaining
position.49
A mini-step toward a regional response was
the special meeting of ASEAN leaders in early
December 1997 in Kuala Lumpur at the invita-
tion of the Malaysian Prime Minister. Signifi-
cantly, it was a meeting of “ASEAN plus other
Asians,” excluding the Americans. The Japanese
Prime Minister, Ryutaro Hashimoto, returned
from the meeting and announced a substantial
fiscal stimulus to the Japanese economy without
prior approval from the governing party. Barely
noticed in the Western press was the fact that
China’s political head attended, President Jiang
Zemin himself. At the conference his govern-
ment negotiated a loan to Indonesia. On the
whole, though, ASEAN has distinguished itself
by sheer impotence?”
China’s leaders now understand more
emphatically than before the need to move
slowly toward a convertible currency and other
financial market openings. The yuan remains
inconvertible, and the banks remain mostly state-
owned. The central bank can protect the state-
owned commercial banks from deposit runs
through domestic monetary policy. If China had
a fully convertible currency it would be difficult
to protect the banks through monetary policy
without encouraging capital flight. China will
now proceed more slowly in abolishing exchange
controls than its policy-makers were talking
about only six months ago.51
China may be looked upon as a model by
other countries, whose governments draw on
China’s experience to justify slowing down finan-
cial liberalization. China’s competition with
Japan for influence in Southeast Asia may
explain why China was unwilling to cooperate
with Japan’s idea of an Asia Fund, which would
seem to require at least tacit Chinese support.
Asked recently about such Chinese support, the
Chinese finance minister, Zhu Ronghi, is
reported to have replied that one co-prosperity
sphere in his lifetime was enough.” This is the
voice of a China that sees itself as the rightful
center of the Asian economy. Japan, on the
1549
other hand, has seen a serious erosion of its
leadership position in the region. In response, it
is covertly helping some ASEAN contries,
notably Indonesia to handle the IMF, seeking to
build up its position in ASEAN in order to
counter the strengthening China-US axis.
European banks have lent more to Asia than
either Japanese or US banks. Yet European
governments and the European Union have been
conspicuously quiet, leaving the Americans and
the Japanese to make the public running.
Collective action theory teaches that a solution
to collective action problems-such as the Asian
crisis of refinancing-is most likely when one or
two players see it as being in their own interests
to act, even if others do not. This is what
happened in the Mexico crisis of 1994: The
United States, seeing great costs to its own inter-
ests, intervened decisively to organize a rescue
package (with concessions about the restruc-
turing of the Mexican economy highly favorable
to the United States). The Asia crisis of 1997
shows only too clearly the power vacuum in Asia,
with none of the major countries-Japan, China,
the United States, Europe-willing or able to act
in the same way, while there is within the region
a swelling tide of antagonism toward the
“foreign” forces that have, apparently, been the
cause of the downfall.
(b) The international financial regime
The IMF has gained centrality but is coming
under renewed scrutiny. It has expended so
much money to Asia that it will need additional
funding to contain contagion effects in other
parts of the world. In addition, the questioning
of its basic prescription for Asia may give
impetus toward reconsidering its whole approach
to financial crises. If the Asian program, with the
Korean program as the acid test, restores private
capital flows as quickly as they were restored to
Mexico in 1995 (within three months), the IMF’s
approach, and the IMF as an institution, will
emerge as a more credible regulator of the world
economy. But even if this happens questions
about the IMF’s role remain, Above all, does the
IMF encourage lenders and borrowers to be
careless, believing that they will be bailed out
with little loss; does it encourage “moral
hazard,” as so many critics claim? Almost
certainly not, although the opponents of the IMF
have managed to convince many US
congressmen that the Mexican bail out in 1995
helped to create the conditions for the Asian
crisis. The opponents assume that the prospect
of IMF support was an important reason for
1.550 WORLD DEVELOPMENT
large-scale lending to Asia. More likely, the
perception of Asia as a growth machine attracted
the funds, not expectations of IMF support.
The crisis should provoke a Bretton Woods II,
a fundamental debate about the character of the
international financial regime in the post-Cold
War world. The debate should focus on
questions such as: Should we make a sharp
distinction between free trade and free capital
movements, seeking to encourage the former
while constraining the latter? Are international
financial markets “efficient,” can they fail, can
speculation be destabilizing? Has the growth of
derivative markets and other forms of leverage
created the preconditions for aggressive inter-
mediaries, such as hedge funds, to disrupt the
financial markets of smaller countries? Does the
growing securitization of credit in response to
the emergence of pension funds and mutual
funds require the development of new forms of
financial supervision comparable to those which
have long existed for banks? How can developing
countries obtain the benefits of international
lending-in terms of investing more than they
save-while limiting their exposure to the costs
of unstable flows? Given that the least affected
Asian countries-china, Hong Kong, Taiwan,
Singapore-all have towering foreign exchange
reserves, should developing countries all try to
raise their reserves? At what cost to their
development? We should keep at the forefront
of the discussion the absence of empirical
evidence that capital account convertibility is
good for developing countries, and
abundance of historical evidence that free inter-
national capital markets are prone to excesses
that result in high social costs.
Indeed, Eisuke Sakakibara, Japan’s top finan-
cial diplomat, has just proposed a new Bretton
Woods agreement, saying that a return to
something like the 1944-71 regime of fixed
exchange rates and temporary financing facilities
should be one of the options. US Treasury and
IMF officials have poured cold water on the
latter idea, making “plain that any ideas being
studied stopped well short of a Bretton Woods-
style fixed exchange rate system”.53 Not surpris-
ingly, given the earlier discussion of the Wall
Street-Treasury-IMF complex. Constraining
financial markets by means of something like a
fixed exchange-rate regime would be deadly for
its power and profit. Vast profit opportunities,
including those of the foreign exchange markets
and the derivatives markets, would shrink,
hundreds of thousands of employees would be
laid off. Moreover, the US government would
lose one of the great assets of hegemonic status:
the ability to create enough credit to sustain
domestic expansion and project military force
abroad at the same time, without raising taxes or
interest rates.
This paper has presented the crisis not as a
symptom of the weakness of “Asian state
capitalism” but as the result, on one level, of a
collective action problem, in which each lender
tries not to refinance for fear that others will not
also refinance. At a deeper level, the crisis is a
symptom of the weakness of a regime of inter-
national credit creation with insufficient limits
and rules, in which such crises are endemic. We
saw the symptoms in Latin America in the 1980s
in Mexico in 1994, and very much in the country
that now lectures Asia on the insufficiency of its
financial regulation, the United States - with its
commercial real estate, junk bond and savings
and loan crises of the 1980s. In each case, exces-
sive debt is created, and the governemnt then
squezzes the “real” economy (some groups more
than others) in order to repay the creditors.
Developing countries should be able to derive
much benefit from large-scale international
lending, because it allows them to invest more
than they save. But the ability to put the inflows
to good use is a function of their stability. When
the swing from net inflows to net outflows equals
11% of pre-crisis GDP, as in Asia during 1996
and 1997, the social fabric is torn asunder.
We must now learn the lesson. The solution
has to involve regulation of international credit
creation and of short-term capital movements
-a new regime of international finance. In the
the
words of Martin Wolf, columnist for 7’he Finan-
cial Times, one of the three main organs of world
capitalist views,
[I] is impossible to pretend that the traditional case
for capital market liberalization remains unscathed.
Either far greater stability than at present is injected
into the international monetary system as a whole or
the unavoidably fragile emerging countries must
protect themselves from the virus of short-term
lending, particularly by-and to-the banks. After
the crisis, the question can no longer be whether
these flows should be regulated in some way. It can
only be how.54
The how question, however, is made doubly
difficult by the growth of private debt tied to
occult derivative contracts that escape estab-
lished methods of bank regulation. The sucesses
of the international regime for tracing drug
money perhaps offer grounds for hope.
It is possible that several years from now the
Asia crisis will be looked back on as “the crouch
before the leap.” We should bear in mind the
history of a decade ago. In the late 1980s Japan
was resurgent, soon to be “number one”, and the
 ASIAN DEBT-AND-DEVELOPMENT CRISIS
United States was in trouble and keen to learn
from the Japanese model. Then the Japanese
stock market and property bubbles burst, the
United States became resurgent, and talk of the
Japanese model faded away. Will the cycle
repeat itself? The US is now probably in the last
stage of its own stock market and currency
bubbles. If they burst and if the Asian liquidity
problems are overcome, the Asian model may
look to have more staying power than most
commentators now think, and be more influen-
tial in setting norms for international economic
and financial regimes. This crisis, far from repre-
senting the triumph of global neoliberalism, may
be looked back on as the beginning of its end.
On the other hand, one has to remember that
world income distribution has been remarkably
stable over the past several decades, both in its
trimodal distribution and in the position within it
of individual countries. Very few countries have
increased their per capita income sufficiently to
move from the lower zone to the middle or from
the middle to the upper.” Several Latin
1. On Wall St., the fall of the Dow Jones industrial
average by a record 554 points on October 27 was a
direct response to the Asian crisis.
2. “4 Asian currencies plunge to record lows,” New
York Times, January 7, 1998, D2. In the first six days of
1998 the Indonesian rupiah lost 26% of its value, after
a 56% decline in 1997 made it the world’s worst-per-
forming currency.
3. The Lex Column, Financial Times, March 3, 1998,
p.18.
4. David Sanger, “Greenspan sees Asian crisis moving
world to western capitalism,” The New York Times,
February 13, 1998, section D, p.1, emphasis added.
One’s interpretation of Greenspan’s remarks to the
Senate must be qualified by the knowledge that he was
appealing for US IMF funding, though he was less
constrained when speaking earlier to the New York
Economics Club.
5. Steve Hanke, interview in Forbes, December
1997.
6. Reginald Dale, “Asia crisis will bolster U.S. pres-
tige,” International Herald Ttibune, January 20, 1998.
7. “Desperate for advice, South Koreans look to the
gloved one,” Wall St Journal, December 16, 1997.
8. From political science the US-based Korean aca-
demic, Meredith Jung-en Woo Cumings, professor
political science at Northwestern University, provides a
corroborating interpretation. “. . .The Korean economic
system has always been intrinsically unstable. and
therefore vulnerable to exactly the sort of financial
calamity that has now befallen it. The only interesting
1.551
American countries looked to be well on the way
into the middle zone in the 1960s and
1970s-until the debt crisis of the early 1980s
pushed them back down. The current Asia crisis,
with its huge devaluations, has pushed Korea
from the lower bound of the upper zone back
into the middle, and pushed Thailand and most
dramatically Indonesia from the middle into the
lower. To what extent is the crisis - beyond a
collective action problem of liquidity and beyond
a symptom of the weakness of the international
financial regime -a reassertion of the stability of
world income distribution? To what extent is it a
structure-restoring adjustment to the seismic
shocks of China’s rise through the lower zone?
The crisis, according to this interpretation, is less
a crouch before the leap than a replay of Latin
America’s nosedive in the early 1980s. A decade
from now we will be able to see whether the Asia
crisis of 1997-? was a blip on an upward Asian
trajectory that changes the structure of world
income distribution, or a restoration of the status
quo.
NOTES
question was when the other shoe was going to drop,
revealing the instability of an obsolescent and increas-
ingly corrupt system.
. ..In the course of this development, the state
created an impressive constellation of mammoth indus-
trial firms, the chaebol, a group of can-do oligopolies
with plenty of entrepreneurial spirit... that founded
one new industry after another. In turn these firms
provided political support for the ruling party, in the
form of floodtides of cash passing between the indus-
trialists and the politicians.
. . . the Korean economy is another kind of leftover
Cold War artifact, good for an era of security threats
and close bilateral relations with Washington, but of
questionable use in the global ‘world without borders’
of the 1990’s. At some point Koreans have to reckon
with a highly-leveraged, highly political, manifestly cor-
rupt nexus between the state and big business.”
Cumings damns Korea by focusing on corruption, as
though a corruption-free system is an end in itself. Her
29, indignation against the wheelers and dealers who
dominate the country might be considered a poor basis
on which to condemn the system (Cumings, 1997).
9. Wade (1997).
10. Jeffrey Sachs, “Power unto itself”: The head of
the Harvard Institute for International Development
explains why the IMF needs reassessment.” Financial
of Times, December 12, 1997.
11. Jeffrey Sachs, “The IMF and the Asian flu,” i’7re
American Prospect, March-April 1998, p.17.
12. Joseph Stiglitz, “How to fix the Asian economies,”
New York Times, October 31, 1997, emphasis added.
15.52 WORLD DEVELOPMENT
See for a similar line of argument Alice Amsden and
Yoon-Dae Euh, “Behind Korea’s plunge,” New York
Times, November 27,199J.
13. For Stiglitz’s explicit criticism of the IMF see
“World Bank questions IMF plan: austerity in Asia
may worsen crisis,” Wall Street Journal, January 8, 1998.
14. Reuters, December 28, 1997.
15. “Japan plans to rein in speculators,” Wall Street
Journal, January J,199J,
p. A16.
16. Hale (1997, p. 8), based on BIS figures.
17. Jonathan Fuerbringer, “Many players, many los-
ers,” New York Times, December 10, 1997, p.Dl ff.
18. Institute for International Finance (1998) and
Martin Wolf, “Flows and blows,” Financial Times,
March 3, 1998, p. 16.
19. Ha-Joon Chang, “Perspective on Korea: A crisis
from underregulation,” Los Angeles Times, December
31, 1997.
20. There has been much uncertainty about how big
Korea’s debt really is. Some estimates say more than
$200 bn.
21. World Bank (1997) Table 13.
22. “Japanese fusion,” Business Week, November 18,
1994, p. 32.
23. See Wade and Veneroso (1998) especially Box:
Shocks and Debt. The inherent vulnerabilities are
spelled out in Wade (1990). “The government must
maintain a cleavage between the domestic economy
and the international economy with respect to financial
flows. Without control of these flows, with firms free to
borrow as they wish on international markets and with
foreign banks free to make domestic loans according to
their own criteria, the government’s own control over
the money supply and cost of capital to domestic bor-
rowers is weakened, as is its ability to guide sectoral
allocation. Speculative inflows seeking exchange rate
gains can precipitate accelerating movements in
exchange rates, with damaging consequences for the
real economy. Uncontrolled outflows can leave the
economy vulnerable to an investment collapse and
make it difficult for government to arrange a sharing of
the burden of adjustment to external shocks between
the owners of capital and others; “the others” are likely
to be made to take the burden, with political unrest,
repression, and interrupted growth as the likely result”
(p. 367).
24. Jonathan Fuerbringer, “Many players, many los-
ers,” New York Times, December 10, 1997, p.Dl ff.
25. Fray Tomas de Mercado, “Global meltdown is
just around the corner,” Asia Times, May 22, 1997.
26. Hale (1997).
27. Restrictions on the use of the Exchange Stabiliza-
tion Fund.
28. For more on Taiwan’s escape from the crisis see
Wade and Veneroso (1998).
29. Brady bonds were issued by Latin American
governments in the 1980s to restructure Latin
American debt, with partial US Treasury backing. Kor-
ean banks invested heavily in them.
30. Martin Wolf, “Flows and blows,” Finuncial Times,
March 3, 1998, p. 16. The Latin American figure is for
Brazil, Mexica and Argentina, comparing 1981 and
1982.
31. The IMF requirements are summarized in IMF
(1997).
32. Feldstein (1998) pp. 20-33.
33. Hale (1997). According to the most recent Wall
Street Journal-NBC News poll, Americans opposed,
51-34%, any US participation in IMF loans to the
beleaguered Asians (Bruce Stokes, “U.S. firms mind
their own business in Asia,” National Journal, Decem-
ber 20, p. 2570).
34. Feldstein (1998).
35. James Tobin, “Why we need sand in the market’s
gears,” Washington Post, December 21, 1997.
36. Feldstein (1998) p.32.
37. Interview in Times of India, December 31, 1997,
emphasis added.
38. The process of modifying the articles of agree-
ment to require countries to adopt capital account
convertibility has been under way since early 1997. At
the Hong Kong Annual Meetings of the Fund and
Bank in September 1997 the Interim Committee
agreed in principle that the Fund should adopt an
aggressive policy to encourage countries to institute full
convertibility.
39. Presumably they distinguished between financial
liberalization that allowed their banks and firms to get
easy access to much cheaper international credit, and a
liberalization of financial services that would expose
their financial firms to full-scale competition from
international ones.
40. Guy de Jonquie’res, “Vision of a global market:
WTO members are hoping to deregulate financial ser-
vices,” The Financial Times, April 10, 1997, p. 28.
41. See Paul Blustein and Clay Chandler, “Behind
the S. Korean bailout: speed, stealth, consensus,” The
Washington Post, December 28, 1998, p.1.
42. Clay Harris and John Ridding, “Asia provides
golden buying opportunities,” Financial Times, Feb-
ruary 26, 1998, p. 16. Also “South Korea: Bargains
galore,” The Economist, February 7, 1998, p. 67-8.
43. Hale (1997).
44. Mahathir Mohamad, Reuters, 31 December, 1997.
Talking of Indonesia, a New York Times report says,
“Signs of an anti-American backlash have emerged
here in statements ranging from newspaper columns to
Government officials to ordinary citizens. “We are now
in a very humiliating position: some foreigners are
coming to dictate to us“, said Adi Sasono, who man-
ages a policy institute headed by Mr. Habibie, the next
 ASIAN DEBT-AND-DEVELOPMENT
vice-president”. (David Sanger, “U.S. is linking aid to
Jakarata to its reforms”, New York Times, March 4,
1998, p.Al and A8.)
45. James Ridding and James Kynge, “Complacency
gives way to contagion,” Special Report: Asia in Crisis,
p. 6, Financial Times, January 13, 1998.
46. Reuters (Beijing), 6 January, 1998.
47. Henry Kissinger, “The Asian collapse: one fix
does not fit all economies,” The Washington Post, Op-
Ed, Februaty 9, 1998, p. A19.
48. See for example, “The Asian crash: beggars and
choosers,” The Economist, December 6, 1997, p. 43-44.
Also Chalmers Johnson, “Cold war economics melt
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