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Economic Crisis and Recovery in Asia and its Implications for the International Financial System - Address by Shigemitsu Sugisaki
March 5, 1999
I. Introduction
The economic record of East Asia over the past three decades is impressive by any measure. As a result of policies favoring outward-oriented growth, high savings and investment, and sound fiscal positions, per capita incomes in the region are, on average, 10 times higher than 30 years ago. Rapid growth has been the basis for equally impressive improvements in social indicators: reductions in poverty, increased investment in human capital, improved health care, and lower incidence of disease. Since the 1960s, life expectancy in the region has risen, on average, from 60 years to 70 years. Recent events aside, the socio-economic performance of the region has been called a "miracle," and rightly so.
Against this backdrop, the scale of the crisis in East Asia took most observers, the IMF included, by surprise. The severity of the crisis and the difficulties of the recovery process raise many important questions. I would like to focus on three of these:
II. Basic Strategy of IMF-Supported Programs
As a broad generalization, the crisis in Asia was the result of the interaction among fundamental structural problems, in a few cases macroeconomic imbalances, and shortcomings in the international financial system. What made the crisis so different from previous ones and so difficult to tackle once it started were the financial vulnerabilities in the banking and corporate sectors, and the speed and size of capital flow reversals that occurred once those vulnerabilities were revealed. The buildup of these problems reflected deep-seated weaknesses in corporate governance; ineffective bank supervision; nontransparent relationships among government, banks and corporations; and macroeconomic imbalances evidenced by rising current account deficits and short-term external debt. And the counterpart of this buildup of financial vulnerabilities was considerable deficiency in creditors’ risk assessment.
Given the nature of the crisis, and the need to restore confidence as soon as possible, the basic strategy of the IMF-supported programs has had three elements:
As with all IMF-supported reform programs, these programs were flexible and adapted as circumstances changed. In particular, with recessions in these economies turning much deeper than initially expected, the adaptations in the IMF-supported programs included:
The IMF recently concluded a preliminary review of the programs in three Asian crisis countries: Thailand, Indonesia and Korea. Our conclusions were that, despite occasionalsetbacks, the basic strategy was sound and is working: financial stability has been restored; a recovery is imminent or already under way in all crisis countries; and a good start has been made with structural reforms.
By the same token, much remains to be done to restore East Asian growth to its potential. A clear lesson from the crisis is that when growth is accompanied by asset price bubbles, excessive and inefficient investment, and implicit public guarantees, the foundation for sustained growth is shaky. Hence, a revitalized East Asia will require a sound financial system, an independent and competitive private sector, and high standards of public sector governance. While a good start has been made, there is still much to be done in each of these areas.
III. Social Dimensions of the Asian Crisis
The IMF has long recognized that the programs it supports have far-reaching consequences in the economies and societies of its members, and that the IMF has an obligation to ensure that adverse social consequences are minimized. Thus, securing macroeconomic stability including containing inflation is fundamental to reducing the costs of the crisis on the poor. The IMF-supported programs during the Asian crisis also included a number of other measures to contain the social costs of the crisis; these measures were strengthened during the course of the program as it became apparent that the economic downturn was going to be deeper than initially expected.
Broadly speaking, the strategy was to include measures to provide income support for the unemployed, to raise targeted income transfers, and to broaden the coverage of social safety nets, which were often rudimentary. Fiscal policy was adapted to accommodate increased social expenditure. In implementing this strategy—in close collaboration with the World Bank and the Asian Development Bank—program design took account of the particular social problems each country faces. For instance:
Implementing these policies has not been easy. Monitoring the social impact of the crisis on different parts of the population, designing well-targeted social programs, and implementing them under conditions of economic instability and a severe recession has been difficult. A particular challenge has been to formulate a relatively simple, cost-effective, and sustainable social programs that do not create large labor market disincentives or discourage job creation. Timely mobilization of external financing is also critical to allow for increased social expenditures and the provision of adequate social safety nets.
While these programs have certainly helped to mitigate the social costs of the crisis, the sharp downturn in economic activity is clearly having serious adverse effects on the poor.
Without attempting to minimize the impact of these costs, indications are that the social impact of the crisis may be less drastic than initially feared. This appears to be the message, for instance, of some of the evidence presented at a recent World Bank Regional Conference on Social Issues in Bangkok. While it is too early to reach definitive conclusions, there is reason to hope that while the social gains achieved during the decades of fast growth in East Asia have suffered a setback, the original gains remain largely intact.
The recent experience with social programs in Asia has served to highlight some basic policy imperatives to strengthen the prospects for equitable growth:
IV. Implications for the International Financial System
The IMF is pleased that significant progress is being made in dealing with the crisis: Asia has stabilized and is turning toward recovery, and contagion from the recent crisis in Brazil has been relatively contained. Nonetheless, there is no denying that we live in a new world where globalized financial markets offer tremendous opportunities but also pose the risk of disruptive capital flow reversals. Work is under way, inside and outside the IMF, to adapt the international financial system to the realities of global markets, in order to reduce the frequency and size of future crises and to mitigate the impact on the most vulnerable when one occurs.
For individual countries, crisis prevention in the new global market requires an uncompromising effort to avoid the build-up of imbalances and disruptive capital flows and to make domestic systems more robust in the face of shocks. In turn, this requires not only appropriate macroeconomic policies, but also close attention to structural and social issues. Individual countries’ efforts are essential, but the current crisis has demonstrated the need for significant systemic improvements, that is, improvements in the "architecture" of the international financial system. The goal is to adapt the current system to the new realities of the global financial marketplace, by focusing on five main areas: development of internationally accepted standards; increased transparency; orderly integration of international financial markets; involvement of the private sector in the prevention and resolution offinancial crises; and adding a "social building block" to the edifice of the new international architecture.
The development, dissemination, and adoption of internationally accepted standards or codes of good practice contributes to a stronger financial architecture by allowing market participants to compare information on country practices against internationally agreed benchmarks of good practice and to make more sound investment decisions. The IMF's role here is both to help develop or refine standards in its core areas of expertise (data dissemination, monetary and financial policies, and fiscal transparency), and more generally to assist in the dissemination of standards and to encourage members to adopt them.
Transparency on the part of individual countries provides a means to foster better economic performance, in part by encouraging more widespread discussion and analysis of a country’s policies. Transparency on the part of the IMF (greater openness and clarity on our policies and advice) can also contribute to a better understanding of our role and operations and of our views on the policies of member countries.
Integrated international capital markets bring substantial benefits, but carry risks and need to be managed carefully. Consequently, with respect to capital account liberalization, the emphasis should be on an orderly and well-sequenced liberalization process, especially the prior need for a sound banking system. Effective international coordination and supervision of such liberalization is at the heart of ongoing efforts to enhance the IMF’s role in this area.
The international community is examining measures that can involve the private sector more systematically in preventing and resolving financial crises. This is one of the most difficult and complex issues being considered in the continuing discussions of the new financial architecture, and a consensus has yet to emerge. Moral hazard issues are at the forefront of this debate, and the challenge is not to protect unduly risky investor behavior or inappropriate government policies, while ensuring that new crisis management mechanisms do not drive investors away as soon as a crisis looms.
Finally, the new architecture could well include a "social building block" which would seek an international commitment to appropriate social safety nets, core labor standards, consensus-building in countries, and common social goals.
The task of redesigning the architecture is challenging. While progress is being made, there is much to be done, and an internationally coordinated and sustained effort is needed to complete the task. The IMF will continue to be a focal point of the policy debate, coordination, and implementation, but the major contribution must come from member countries and other international organizations. The IMF will play its part with the support of the membership.
1 Presented at the Meeting on Development Cooperation: Responding to the Asia Crisis, Sydney, Australia (March 5, 1999).
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