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. Last Updated: 07/27/2016

East Asian Recovery




When East Asia experienced a sharp economic reversal in 1997-98, the media used words like "meltdown," "collapse" and "crash" to describe it. The region's recovery in 1999-2000 has been no less dramatic, but media rhetoric has been anything but robust.


An obvious explanation is the media's predilection for bad news over good. Or uncertainty over the strength of the recovery might make commentators hedge their bets, lest the Asian turnaround might again turn around. The explanation could also be technical in nature. The 1997-98 economic shocks jeopardized the balance sheets of money-center banks in the United States, Europe and Japan, which had made billions of dollars in short-term loans from 1995 to 1997 without adequate attention to their "due diligence" standards. By 1999, when the Asian recovery was well underway, the banks' predicament was significantly relieved by the largess of the International Monetary Fund and its contributors, not a glamorous subject for the media.


In any case, there's no question that the economic turmoil in East Asia was severe. Four Asian economies f those of Thailand, South Korea, Malaysia and Indonesia f that realized high growth rates in gross domestic product in 1996 sustained negative rates between 5 percent and 12 percent in 1997-98. On average, asset values in these countries plummeted by about 75 percent.


That makes Asia's turnaround all the more extraordinary. South Korea, Thailand and Malaysia currently have annual growth rates about equal to those of 1996. Indonesia's growth, about 3 percent to 4 percent, is surprisingly high, though it's shaky because of problems unrelated to the 1997-98 economic crisis: civil and military unrest in Timor, Aceh and the Moluccas and the continuing, ambiguous role of the military establishment in the country's politics.


Other indicators of the recovery's surprising strength abound. Capital inflows have resumed, mainly in the form of direct investment rather than debt. South Korea, almost closed to foreign direct investment before the turmoil of 1997, received $15.5 billion in outside investment last year, five times the 1996 inflow. The current accounts of the four economies are positive, and, with the exception of Indonesia, their foreign-exchange reserves are above 1996 levels. Their currencies have regained about 50 percent of their pre-crisis values, and foreign debt has been substantially restructured to favor long-term rather than short-term obligations.


The evidence of recovery is all the more impressive because the Japanese economy, long viewed by conventional wisdom as the engine of East Asia's recovery, continues to stagnate for reasons unrelated to Asia's financial crisis. Asia's other major economy, China, continues to register significant growth, although it is still beset by problems largely independent of the 1997-98 crisis: the continuing, heavy burden of its subsidized state-owned enterprises, a poorly managed and vulnerable banking sector and widespread corruption.


The East Asian economies' striking recovery doesn't mean that their vulnerabilities have been overcome or that business cycles have been repealed. South Korea's large and amorphous chaebols, or conglomerates, still require reform. In Thailand, one-third of the banking system's loans are nonperforming. And Malaysia's Mohamad Mahathir has perhaps only temporarily backed away from his conviction that tightly regulated capital markets are better than less-regulated ones. Moreover, doubts have been expressed about the sustainability of the Asian recovery because of its reputed overdependence on exports to the United States and uncertainty about whether the U.S. market will maintain its momentum.


Nevertheless, the upward trajectory of the Asian economies is likely to endure because of five lessons learned from the debacles of 1997-98.


? As a form of foreign capital inflow, direct investment is far preferable to debt.


? When emerging-market governments or corporations borrow abroad, they should not borrow short-term and invest or relend long-term, a pervasive practice leading up to and precipitating the 1997 Asian crisis.


? Borrowing in foreign ("hard") currency and re-lending or investing for purposes that do not generate foreign-currency earnings should be avoided unless ample foreign-exchange reserves are available to cover a possible currency squeeze.


? Domestic currency shouldn't be pegged to the U.S. dollar unless fiscal and monetary policies and institutions are strong enough to support the connection.


? In charting development strategy, what used to be known as the "Japan development model" should be eschewed. Much-extolled in the 1970s and 1980s, the model based resource allocations on nonmarket industrial policies favoring particular companies or industries rather than on market criteria of costs and profitability.


While these lessons provide grounds for optimism, there is also a perverse lesson that, unfortunately, might be gleaned from yesteryear's financial turmoil and the quick fixes adopted to remedy it. If events turn sour f whether as a consequence of mistaken public policies in emerging-market countries or misguided lending practices of banking institutions in wealthy countries f a belief has been nurtured that IMF or other government bailouts will charge to the rescue. The result of this "moral hazard" might be to encourage irresponsible behavior and subsequent crises. Notwithstanding the hoped-for reform of the IMF, its increased financial resources and heightened aspirations might actually intensify the dangers of financial irresponsibility in the future.


Charles Wolf Jr., senior economic adviser and corporate fellow in international economics at Rand, is a research fellow at the Hoover Institution. He contributed this comment to the Los Angeles Times.