The Hindu Business Line : Growth and adjustment after East Asian crisis

Ten years after the East Asian financial crisis broke out, the economies of the region appear to have recovered, but only through a significant change in economic strategy. In this edition of Macroscan, C. P. Chandrasekhar and Jayati Ghosh examine post-crisis economic growth and macroeconomic performance, and consider the implications of the crisis for the development trajectory.

This July marks ten years since the Asian financial crisis formally broke, beginning with the devaluation of the Thai baht on July 2, 1997. Of course, the intimations of crisis were there for several months beforehand, but July 2007 was a clear watershed in marking a formal break.

The crisis — in the form of capital flight leading to turmoil in the financial markets — rapidly spread to other countries such as Indonesia and the Philippines by September of that year, affecting South Korea and Malaysia by the end of the year.

The turmoil rocked financial markets globally for a short time, and presaged the other financial crises that have hit various parts of the developing world (Russia, Turkey, Argentina) since then. It created huge disruptions in the economies and societies of the region, causing large increases in unemployment, sharp increases in poverty, and even in some cases major political change.

New perspective

However, by now, in mainstream discussion, the Asian crisis is often discussed not in terms of its negative impacts, but rather presented as an example of how economies can recover relatively quickly from crisis and continue on a favourable growth trajectory.

Indeed, there are those who argue that the Asian financial crisis was in general a good thing, since it did not destroy the basic economic growth trajectory of the region and forced the economies in question to intensify liberalising reforms, especially in the financial sector, and thereby reduce “crony capitalism”. In addition, the break up of some of the large South Korean industrial conglomerates (or chaebols) and the collapse of the Suharto dictatorship in Indonesi a are cited as some of the positive by-products of the crisis.

This view is current even among some Indian policymakers, which is of especial concern since it suggests that they may not be sufficiently worried about such an eventuality as to take adequate precautionary measures to avoid such a crisis.

That is why it is particularly important to evaluate the subsequent performance of those economies that were particularly affected by the 1997 financial crisis. Of course, a decade is in any case a useful time to take stock, especially as it is considered sufficiently long for the basic tendencies in the economy to have emerged.

Consider, then, what has happened in the five economies of Thailand, South Korea, Malaysia, Indonesia and the Philippines. It is true that all of the economies have indeed recovered from the most intense effects of the crisis in terms of output and employment declines. Export growth recovered very quickly in these countries, aided by the very major depreciations of currency that were induced by the crisis, but export growth has remained quite strong.

However, both aggregate GDP growth and industrial growth are still substantially below the average rates achieved in the period before the crisis. They have also been more volatile and fluctuating. Charts 1 to 5 provide information on trends in annual real GDP growth rates, savings and investment rates in these five countries.

Perhaps even more important, aggregate employment growth in also much slower than before, and the quality of employment has deteriorated in that there is a greater proportion of insecure casual contracts, low-grade self-employment and part-time work. Even in the sectors where export growth has been buoyant, such as manufacturing, employment has not picked up and in South Korea and Malaysia it has actually fallen in absolute numbers compared to the pre-crisis years. Unemployment rates in the entire region have also been remained at historically high rates, despite the recovery of economic growth in recent years.

Saving-investment gap

But the most startling change that has occurred in these countries is the broad macroeconomic shift in terms of a large divergence between savings and investment rates. The East and South-East Asian region has generally had very high savings rates — between 30 and 45 per cent in the different countries — for some time now.

But the period subsequent to the financial crisis has seen an increase in these already high rates, especially in the “crisis” countries. However, investment rates (that is the share of investment in GDP) have plummeted in all these countries.

Thus, in South Korea the savings rate increased from just under 40 per cent in the three years before the crisis, to more than 42 per cent in 2003-05 (Chart 1). But the investment rate collapsed by almost half over the same period, from 42 per cent to 21 per cent. An almost identical pattern is evident for Malaysia (Chart 2).

In the Philippines, over the same years, the savings rate went up from 26 per cent to 30 per cent, but the investment rate fell from 24 per cent to only 16 per cent (Chart 3). In Indonesia, the savings rate has remained unchanged at around 29 per cent but the investment rate has fallen from 31 per cent to 23 per cent (Chart 5).

Only Thailand shows a slightly different recent trajectory: while the investment rate fell sharply after the crisis, it has recovered somewhat in recent times, although it is still only 28 per cent in the latest period compared to 41 per cent in the pre-crisis period (Chart 4).

In all these countries, the years 1997 and 1998 mark a clear break from the earlier trend, when typically domestic investment rates were higher than saving rates, and the balance was met by an inflow of foreign capital. The latter is in fact what one would expect in a developing country.

Yet, after 1998 all these five countries have shown the opposite tendency, squeezing out savings from the population as a whole but not investing it within the economy to ensure future growth.

This has happened though the development project is still not complete in these countries, especially in Indonesia, Thailand and the Philippines, where poverty and backwardness remain substantial.

Excess caution

This growing “savings surplus” is not only the result of the decisions of private agents in these countries. Of course it is true that stringent monetary conditions and an excess of prudential regulation caused bank credit to be less easily available for investment, and a range of other post-crisis measures dampened private investment by raising the costs of finance.

But it is also true that a very large role in the reduction of aggregate investment was played by governments in these countries, who have increased their savings and cut down on fiscal deficits or increased fiscal surpluses across the region. The aftermath of the financial crises in these Asian countries, which was brought on essentially by private profligacy in a financially liberalised environment, has been to create an excess of caution on the part of governments.

This really means that governments in these countries have not spent as much as could be easily sustained by the economy, to ensure better conditions for the people or to encourage more sustainable growth and generate more employment.

This in turn helps us to understand why growth rates are in general lower, why employment generation has been inadequate and unemployment rates are rising, and why conditions of a large section of the poor do not improve in these countries, despite the apparent aggregate economic “recovery”.

More critically, the project of the developmental state, which was such an essential feature of economic progress in the region in the past, has effectively been abandoned. So financial crises do more than simply create sharp and painful economic shocks for the residents of the country — they also alter longer-term economic trajectories in unfortunate ways.

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