Cambridge: The Asian crisis has now passed more than one half year. We can better see what caused the crisis, what has worked in responding to the crisis, what has not worked, and what now needs to be done.

The immediate cause of the crisis is clear: a sudden, unexpected, and large-scale reversal of international capital flows into Asia. During 1996, foreign investors put $93 billion into the five Asian countries now in crisis (Indonesia, Korea, Malaysia, Philippines, and Thailand). This followed new inflows of $47 billion in 1994, and $70 billion in 1995. In 1997, the investors panicked, withdrawing $12 billion instead of making new investments. The swing of $105 billion (from inflow of $93 billion to outflow of $12 billion) equaled about 11 percent of the pre-crisis national incomes of these countries. A collapse of 11 percent of national income in investment finance is catastrophic: it has thrown these countries into deep recession.

Pundits like to blame "Asian capitalism" for the crisis — an alleged orgy of corruption, nepotism, government meddling, and poor financial supervision. This explanation is convenient to European and U.S. banks because it gets them off the hook. But it is not exactly true. If Asian capitalism is so bad, why did foreign investors put so much money into Asia in the first place? A better explanation for the crisis is that investors panicked. They were perhaps too euphoric in 1996, but then wildly pessimistic in 1997. But once the investors started to flee from Asia, it became individually rational for each particular investor to get out, even if the result was a ruinous stampede which hurt both the investors and the Asian economies.

For the first six months of the crisis, the IMF prescribed tough austerity measures to limit the crisis — bank closures, high interest rates, budget surpluses. These measures were misguided, and they failed. Rather than calming the foreign investors, they contributed to the very panic that the IMF was trying to address. Nobody wanted to keep money in a region that suddenly looked like it was heading for disaster. Every IMF forecast therefore failed. The currencies collapsed, and the banking sectors collapsed. The IMF predicted that Thailand and the others would achieve positive growth in 1998 (3 percent in the case of Thailand, for example). Now, the IMF acknowledges that Thailand will shrink by around 3 percent. Its medicine did little to save the economy.

The IMF mobilized massive amounts of money ($118 billion in all) for Indonesia, Korea, and Thailand, so that they would pay back the foreign creditors trying to withdraw their funds. But even these massive loans were insufficient. By the end of December, a substantial proportion of the loans were in default in Korea and Indonesia. In fact, the panicked selling of Asian currencies only began to subside when the Asian debtors (mainly private banks and corporations) actually suspended debt payments, and began to negotiate a formal roll over of these loans. Korean banks and international banks agreed to postpone Korea’s debt payments falling due in the first quarter of 1998. This has, at least temporarily, put a halt to the collapse of the Korean Won.

The solutions going forward include the following measures. First, the timing of debt payments will need to be stretched out even further in all countries, so that the panic finally comes to an end. Direct negotiations between creditors and debtors, rather than IMF bailouts, is the most effective approach to this. Second, Asia’s banks need to be re-started. Otherwise the economies will starve for lack of working capital. The IMF-imposed monetary austerity must be eased, or the collapse will deepen even further. Third, in the longer term, new capital investments will be needed to re-establish an adequate capital base in Asia’s banks. Fourth, Japan should be called upon to play a much larger role in giving aid to its neighbors. Japan’s stakes are largest, and as the world’s major creditor country, it has the resources to help its neighbors overcome the immediate crisis. Since its own economy is in the doldrums, monetary support from Japan to its neighbors will also give an important boost to Japan’s own economic performance.

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