UNIVERSITY OF SAINT LOUIS

Tuguegarao City

SCHOOL OF ACCOUNTANCY, BUSINESS and HOSPITALITY

First Semester
A.Y. 2023-2024

COURSE LEARNING MODULE

ECON 1023 – Economic Development

Prepared by:

GLADYS T. TUMBALI, MBA

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 COURSE LEARNING MODULE
ECON 1023 (Economic Development)
AY 2023-2024

Lesson 10: Asian Crisis and Recent Developments

Topic: Post-Crisis experience

Lessons and Prospects for the Future

Learning Outcomes: At the end of this module, you are expected to:

- Identify the post-crisis experiences;

- Describe the different agenda for reform.

LEARNING CONTENT

Introduction:

Commentators from international institutions were initially quick to discount the impact of the current crisis
on the world economy. However, weaknesses in Korea and Japan surfaced toward the end of1997 and these
tended to have wider implications. However, when all was said and done, the Organization for Economic
Cooperation and Development (OECD) countries, with the exception of Japan and Korea, were not appreciably
affected by the crisis. World output growth in 1998 did fall, but this was primarily the result of a slowdown in the
growth of the US economy Asia as a whole, including India and China, which both grew rapidly, registered growth
of between 1 and 2 percent (Asian Development Bank, 2002b). This was much lower than the 1997 figure, but
it did not drag world growth down too much. More importantly, it did not precipitate into a worldwide recession.
In 2001, the US economy suffered a short and shallow recession from which it recovered only slowly in 2002.
This reduced the demand for US imports and probably also slowed the growth of the Asian economies as they
continued to recover from the 1997 financial crisis. However, as the United States and other industrial countries
recovered, there was a salutary impact on growth in the Asian economies.

Lesson Proper:

POST-CRISIS EXPERIENCE

Economic Growth

The overall economic growth in the Asian economies did not immediately reflect events in the financial
sector and in foreign exchange markets. However, 1998 was a bad year for most countries in the Asian region.
Growth was negative in all the five crisis countries, as well as Hong Kong. Singapore grew by only 0.1 percent,
compared with 8.5 percent growth in 1997. There was, however, a strong recovery in 1999, which strengthened
in 2000, particularly in East Asia and Malaysia (see Table 4.5). The recovery of Korea was particularly significant.
Nevertheless, the slowdown in growth in the United States and other industrial countries had a negative impact
on economic growth in East and Southeast Asia in 2002. The effect of this slowdown in the industrial countries
was particularly severe in those countries that had strong trade linkages with the United States, and where
international trade in electronics was high. This group of countries included Malaysia, Singapore, and Taiwan,
among others.

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During the following five years, the global economy recovered and so did the Asian economies. Between 2002
and 2007, economic growth in the Asian region accelerated, led by India and China. Living standards rose and
poverty fell (see Table 4.5). Domestic demand and foreign trade were both important factors in the resumption
of growth.

EXCHANGE RATES Exchange rates have strengthened from their lows in the first part of 1998 (see Figure 4.1).
This extends to all currencies, even the Indonesian rupiah, the most adversely affected currency. Depreciation
vis-a-vis pre-crisis levels was between 15 and 30 percent as of July 2002. In subsequent years, between 2003
and 2007, there was an appreciation of some Asian currencies, particularly in 2006 and 2007-about 6 percent
for China relative to 2005, 9 percent for Korea, 12 percent for Thailand, and 16 percent for the Philippines. Other
currencies depreciated slightly.

EQUITY PRICES Stock prices also rebounded. In Korea, they had risen above pre-crisis levels by the middle of
1999. Stock markets elsewhere in Asia also rebounded as funds from the rest of the world started to return. This
served to reinforce the optimistic feeling that was spreading throughout the region (see Table 4.6).

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From 2002 to 2007, stock markets in Asia generally increased, often dramatically. The Bombay stock market in
India increased ninefold, the Jakarta index around sixfold, Korea fourfold, the Shanghai and Hong Kong indices
tripled, and the Taiwan stock market index more than doubled. Since the beginning of 2008, however, growth in
the industrial countries has faltered, and all the Asian markets have weakened. The extent of this weakness is
displayed in Table 4.7. The fall in stock market values since the beginning of 2008 is largely due to weakness in
the global markets, particularly for Asian exports as a result of a recession in the industrialized countries.
Consequently, this is expected to result in much slower growth throughout the Asian region in 2009.

RESTRUCTURING Many weaker firms throughout the region went out of business during the Asian financial
crisis. Those that survived were Operating more efficiently. Banks started to become more stringent about
lending and took greater care to evaluate borrowers. Thailand is a case in point. There was also more
transparency and ongoing attempts to deal with corruption and shady business practices. Even as the Asian
economies recovered, they put in more efforts to avoid the potential bubble that had resulted in the previous
crisis.

Economic Recovery

As we have seen above, the downturn in most economies was not caused by a dramatic fall in exports.
Rather, it was a result of a combination of the withdrawal of funds by short-term lenders, a collapse in currency
exchange rates, and bankruptcies caused by the burden of un-hedged foreign debt.

Indeed evidence suggests that currency depreciation inflicted much less damage on firms than the rise in interest
rates and cut-backs in domestic credit lines because many firms with large foreign indebtedness were export-
oriented. If credit lines had been maintained greater competitiveness and growing export revenues would have
provided a cushion against rising liabilities in domestic currency as a result of depreciation. . . . In a sense,
orthodox policies succeeded in stabilizing exchange rates not by restoring confidence through high interest rates
as intended but by creating a deep recession. . . . (UNCTAD, 2000, p. 53).

The report goes on to say that the recession may have been avoided if a temporary debt standstill (their words
for moratorium) had been put into effect and borrowers and lenders brought together to reschedule short-term
debt. This would have avoided high interest rates and the subsequent reduction in domestic lending and the
contraction in aggregate demand. Furthermore, the Malaysian and Chinese experience of fixing the nominal
exchange rate did not necessarily lead to currency appreciation since there were effective controls over capital
flows.

Recovery came through a revival of domestic demand supported by exports and a restoration of investor
confidence. Softer budget deficits and lower interest rates also underpinned the recovery. The slowdown in the
growth of the industrial countries in 2001 initially served to moderate the recovery in Asia. However, sustained
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growth in these countries later helped to reinforce the subsequent recovery of Asia in 2002 until 2007. In addition,
as noted below, there was a very strong turnaround in the current account balances (see Table 4.7). Export
performance also recovered significantly.

A dramatic turnaround in the external balance was experienced by many countries, especially the trigger
economies (see Table 4.8), which saw huge surpluses, compared with the large deficits in 1996, as can be seen
in Table 4.4.

These surpluses have grown even more in the past five years, particularly in Malaysia, China: Hong Kong, and
Singapore. The primary reason for the quick turnaround in the external balance lies in the collapse in imports in
the early years of the recovery, while exports remained relatively strong. This turnaround in the net export
balance had a significant stimulating effect on overall GDP and GDP growth (with net exports increasing from a
large negative to a large positive figure.) This reinforces the conclusion drawn earlier that the recession in Asia
was primarily a failure of domestic demand. The collapse of domestic income resulted in a commensurate fall in
imports, which was compounded by the rise in the cost of imports following the currency devaluation. In countries
that were less affected by the recession (China, Taiwan, and Singapore to some extent), the change in the
current account was much less dramatic, although there were subsequent further improvements in the current
account and trade balance in all the countries in the region.

All the crisis economies have made a recovery, although there are still difficulties in resolving nonperforming
loans and weaknesses in the financial sectors of several crisis economies, particularly Thailand and Indonesia,
which retarded further recovery in 2003 and 2004. However, by 2007, all the trigger economies were in good
financial shape.

Social Impact of the Economic Crisis

The crisis put extreme pressure on many sectors of the economies of the five crisis countries. The credit
crunch made banks reluctant to lend and firms were starved of working capital; currency depreciation made it
difficult for firms to service external debt; inflation accelerated and purchasing power fell as the price of imports
increased and government revenues came under strain when the tax base contracted and incomes fell. The
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price of providing public services also increased, while the ability to undertake compensatory spending was
constrained by the crisis itself. As a result, there was a fall in output, an increase in unemployment, and the
incidence of poverty.

As the crisis deepened and economic conditions worsened, there was an increase in reverse migration as urban
residents moved back to the province. Fortunately, the agricultural sectors of the affected countries were not as
hard hit as the urban sectors, and the rural areas were able to absorb these returning workers without much
trouble. At least, they could provide subsistence levels of food and housing.

The formal rate of unemployment increased dramatically in all four of the crisis countries (excluding the
Philippines), as reflected in the estimates made by ESCAP, shown in Table 4.14.

These figures do not tell the entire story as the unemployment rate is compiled mostly from urban employment
figures, which exclude the large rural sector where the impact of the crisis was less dramatic. Moreover, self-
employment opportunities sometimes provided work for those laid off. However, wages also fell for those already
employed.

Estimates of poverty reported by ESCAP show increases from 6.8 percent to 8 percent in Malaysia between
1997 and 1998, while in Thailand, the rate rose from 11.4 percent in 1997 to 15.3 percent in 1998. The estimate
of poverty increasing from 11 percent to 40 percent in Indonesia seems improbable.

Budget cuts and reduced incomes had an adverse effect on expenditures on health and education during the
crisis. Health budgets were cut by more than 5 percent in Thailand and 4 percent in Indonesia, and consumers
also shifted away from expensive health care services to lower quality and cheaper services. The impact on
infant mortality and malnutrition has not been estimated but was probably quite substantial.

There was also a higher incidence of mental health problems as unemployment grew, and tighter household
budgets increased mental stress, family violence, and the crime rate.

The rates of school dropouts rose as many families found it difficult to afford even the minimal costs of sending
their children to school. Instead, they were either put to work in the informal sector or forced to stay at home. In
Indonesia, as many as 25 percent of children dropped out of school. The highest rate being for high school
students whose school fees were more unaffordable (Knowles, Pernia, and Racelis, 1999). There was greater
discrimination against girls, who were often forced to stay at home while limited resources were used to educate
the boys in the family.

A detailed and in depth study of the impact of the crisis by the Asian Development Bank (Knowles, Pernia, and
Racelis, 1999) suggests that the impact of the crisis varied significantly from economy to economy and one
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should be careful about making blanket judgments. For example, they found no consistent evidence that children
had been taken out of schools in large numbers as a result of the crisis, nor was there any evidence of significant
adverse health effects on children. At the same time, there was a sharp decline in real per-capita income between
1997 and 1998-20 percent in Korea, 12 percent in the Philippines, and by about 24 percent in Indonesia.

They found that households used a number of coping mechanisms to deal with the crisis. Some of them helped
to smooth consumption and made adjustments to minimize the impact by working longer hours, delaying
purchases of durable goods, and substituting cheaper foods. Others involved postponing or shifting the impact
of the crisis to the future, by borrowing or taking children Out of school. Since the income constraint was more
binding on the poor and institutionalized populations, such as the disabled, the elderly and children in
orphanages, these methods were used more often and imply intergenerational loss of welfare as a result of lost
schooling. Their study concluded that certain disadvantaged groups, such as the poor, women, children, and the
elderly were particularly hard hit by the crisis.

Their study also suggests that better targeting mechanisms have to be developed together with better social
safety nets. Monitoring systems also need to be set up to keep track of target populations in situations of crisis.
This includes poverty monitoring together with the delivery of public services.

As the Asian economies recovered from the crisis, the unemployment rate fell and growth accelerated.
Significant progress was also made in reducing poverty further. Between 1998 and 2002, the percentage of
people below the poverty line fell from 13.3 percent to 11.5 percent in the Philippines, from 5.2 percent to 2.4
percent in Thailand, and from 15.4 percent to 12.7 percent in China (Dowling, 2007). Poverty rates also fell in
other Asian economies (Dowling, 2008).

LESSONS AND PROSPECTS FOR THE FUTURE

An Agenda for Reform

Based on the reform agenda prescribed by international banks and aid agencies after the crisis, we list
the following items that could be helpful in speeding up reform in the crisis-affected countries of Asia. This list
makes much sense and can be easily extended, with some modifications, to global structural reform.

DEBT RESTRUCTURING Great emphasis is placed on an orderly restructuring of debt. This will be more difficult
than in the Latin American case because there are more lenders and borrowers, and the private sector is heavily
involved. However, the process has already started and will be made easier as balance sheets improve in 2000
and beyond.

PRIVATE-SECTOR CREDIT LINES Given the limited resources of the IMF and the conceptual difficulties with
the notion of an international lender of last resort, it may be useful for governments to establish credit lines with
the private sector. Argentina entered into such arrangements with foreign banks before the Mexican crisis, and
they did supply credit to the country. These facilities could be strengthened by multilateral guarantees from the
World Bank or the IMF.

REFORM EXCHANGE-RATE REGIMES Many of the problems faced by developing countries in Asia were the
result of “hot” money outflows during the crisis that resulted in abrupt currency devaluations. Many businesses
and banks borrowed in foreign currencies and held large un-hedged positions. As currencies devalued, they had
great difficulty in meeting their foreign obligations. Some went bankrupt governments also lost substantial
reserves in trying to defend fixed exchange rates.

A pure, flexible floating exchange rate allows continuous adjustment to accommodate changes in relative price
movements or commodity markets. Those who advocate such a system argue that a flexible exchange rate
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provides a clear signal of the effects of government policies. In any event, whether a peg against a basket or a
free float is adopted, the new exchange-rate regimes in this region will have much greater flexibility than they
had before and this will help to prevent repeat episodes of macroeconomic disequilibrium. By moving to a flexible
exchange-rate regime, the chances of such defaults occurring would be minimized since the costs of not hedging
would be more apparent. Furthermore, the exchange rate would automatically move in response to capital
inflows and outflows, thus reducing the chances of an inflationary bubble arising.

CAPITAL ACCOUNT REFORM The regulation of short-term capital movements, such as through the imposition
of taxes, can be considered. The experience of Chile is useful to study in this regard. It is also important to
carefully consider further capital market deregulation. This is particularly true when domestic capital markets are
underdeveloped or where it is difficult to control excessive risk-taking by domestic banks and businesses.

INTERNATIONAL PORTFOLIO CONTROLS UNCTAD also suggests in its report that controls on international
portfolio investment at the source of the lending should be explored. This would be in addition to measures taken
by developing country governments to impose capital controls. These controls would involve monitoring and
supervision of international financial firms (banks, insurance companies, pension funds, financial
conglomerates). Another proposal is to focus on international bank-lending practices by putting a ceiling on
lending which would be insured through a new sister institution to the IMF, called the International Credit
Insurance Corporation (ICIC).

ESTABLISH MINIMUM INTERNATIONAL STANDARDS OF FINANCIAL PRACTICE Auditing and accounting

practices still vary considerably across countries. This makes it difficult for lenders to gauge the financial
conditions of borrowing banks and business firms. Differences in corporate governance practices, investor
protection, and insider trading also reduce transparency and increase risk. The establishment of minimum
international standards would create a floor of credibility which would also help to prevent national problems from
spilling over into international markets.

ACCOUNTING AND DISCLOSURE Tougher accounting and disclosure rules will help to expose weaknesses
before they can fester. Greater transparency and higher standards are needed, particularly where the rules are
woefully deficient. In Korea, for example, banks do not have to disclose, let alone make provision for all of their
suspect loans.

STOCK MARKETS A major reform would be the introduction and development of the derivatives market,
particularly in Thailand, Malaysia, and Indonesia, especially those permitting better hedging of equities
exposures. Access by foreign investors should be significantly liberalized (elimination of B shares where they
still exist) and the imposition of price limits to trade, such as those adopted by the New York Stock Exchange,
should be reviewed.

TRADE POLICIES Further reforms of trade policies are desirable. However, Thailand and Malaysia have raised
tariff rates after the crisis and this could be harmful and unnecessary, particularly given the large exchange-rate
devaluations. Countries in Asia have an exceptional record of unilateral reductions in tariff and other border
restrictions on trade in goods. Trade liberalization should be continued. In the case of Indonesia, the IMF package
requires them to remove the international trading monopolies for some commodities, but others remain. These
are particularly objectionable because they combine the monopoly powers of single traders (as with the statutory
monopolies in Australia) with the transfer of these valuable implicit property rights to the individuals who were
granted the monopolies. These countries have been much less active in reducing restrictions on service trade
in general. The current WTO negotiations on an Agreement on Financial Services provide an opportunity for the
developing countries to join the industrialized countries in liberalizing trade in these services.

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FOREIGN DIRECT INVESTMENT Another critical area is FDI incentives. These incentives were a factor in the
rapid expansion of FDI and capital formation, as a result of which the East Asian developments in other
developing countries, such as Argentina and Chile In Chile, the central bank regularly visits banks and classifies
them based on the quality of their loan portfolios and then publishes the results. In Argentina, regulation is shared
between the state and the market. Banks are required to issue bonds linked to the value of their deposits. The
price of the bonds indicates the strength of the bank in the eyes of the market. While new methods of regulation
such as these would have to be reviewed, a different pattern of regulation with tighter controls in some areas
and weaker controls in others is required, rather than a blanket deregulation.

HUMAN CAPITAL Finally, more long-term measures need to be taken to address the shortage of human capital
required to upgrade the productivity capacity in skilled and knowledge-intensive industries. The pattern of
international trade is shifting more and more toward these areas. Nearly all of the industries that have increased
their share of international trade in the past two decades have been in these industries, particularly computers
and electronics. The countries in East Asia have generally taken advantage of this trend and have increased
their share of manufactured exports in these industries. However, additional efforts will have to be made to
continue the process of technological transfer into these industries and to deepen the product mix of exports.
Thailand and Indonesia are particularly at risk if they fail to address these issues, since they have noticeable
deficiencies in knowledge and technology-intensive industries.

*** END of LESSON ***

REFERENCE

Dowling, J.Malcolm, Valenzuela, Ma.R.,Brux, J. (2019) Economic Development Philippine Edition. Cengage
learning Asia Pte Ltd.

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