Finance and the real economy: theoretical implications of the financial crisis in Asia

Abstract

This paper offers a preliminary assessment of some implications of the Asian financial crisis for theories about the development of a global economy. The paper (i) draws together some of the available evidence about the history of the crisis, and (ii) identifies some current diagnoses of its cause before (iii) arguing that the central implication of the crisis is that it enables us to identify the manner in which the financial and real economies are linked. While the evidence about the chain of events and causes in this crisis still remains scattered, most diagnoses point to the particular economic and political characteristics of the specific countries involved: the financial crisis reflected real conditions. By contrast, it is argued that the crisis was driven by financial considerations, that reflect the mode of operation of the global financial system not the characteristics of east Asia.

Introduction

Between mid-1997 and mid-1998, the currencies of Indonesia, South Korea and Thailand each lost over a third of their value; the currencies of virtually all other countries in the Asia-Pacific region lost over 20% of their value. Some South American currencies were falling and Russia was about to default on its loans. European banks, currencies, and stock markets were badly affected. The sharp decline in worldwide economic growth brought commodity prices to a historical low. As the Asian Development Bank (1999) observed a year later, the threat of a global recession loomed over the world economy in mid-1998. Yet at the end of 1999, European and North American economies and financial markets seemed unaffected by this crisis in Asia; and within the Asian-Pacific region itself, recovery is underway (World Bank, 1999) – the ADB expects Korea's GDP to have grown by over 8% in 1999, a lead followed by Taiwan, Singapore, Malaysia, Philippines and Thailand (though Hong Kong and Indonesia remain in the doldrums).

Despite the speed of this apparent recovery, despite too the manner in which the crisis has been confined spatially, the financial crisis in Asia is one of the key events of our time.¹ The crisis is so important for three main reasons.

First, for many people in east and Southeast Asia, the crisis is likely to be a defining event of their lives (Lee and Rhee, 1999). Throughout the region the incidence of poverty has increased significantly, with some countries experiencing significant declines in households' access to both health and education services for the poor (World Bank, 1999; Levinsohn et al., 1999). Divorce and suicide rates in Thailand skyrocketed after the crisis; the number of infants abandoned after birth or placed in orphanages increased; there has been a rise in the number of arrests for drug-related criminal activity and property crimes (World Bank Office Thailand, 1999). Within Indonesia people are continuing to be killed in riots triggered by economic collapse. If this started as a financial crisis, then it is clearly now real: social and economic spaces are being redefined.

Governments have been ejected and political power within the region has also been substantially realigned as the crisis has forced changes to the political economy of the Asia-Pacific region. The IMF has become a dominant force in world politics: the $US110 billion financial assistance to Indonesia, Korea and Thailand that the IMF brokered has enabled it to demand a variety of reforms in those countries. The ADB, by contrast, has been virtually ignored and the World Bank's concern about poverty and sustainable development (Wolfensohn, 1998) has carried little weight against the demands for market reform. Similarly, despite the magnitude of its assistance to the region, Japan has lost authority in comparison to the USA and China: Japan remains mired in recession even as the USA booms; the market that draws forth exports from east Asia is the US market and not the Japanese; the Japanese government appears in 1997 to have rejected an approach from Thailand for assistance; and then Japan's proposal for a regionally oriented approach to the crisis, an Asian Monetary Fund, was derided by the IMF and the USA.

Finally, ideologies have gained and lost too. By the argument that the cause of the crisis is local, the entire idea of a miracle system has been dismantled (see Greenspan's statement of this interpretation in Sanger, 1998). By Japan's own inept management, the whole idea of state-led development is ridiculed. To the IMF, to most of the western world's economists and press, the crash in east Asia was not simply a change in the rates of growth, but was equally the signifier of the failure of a development model. The localisation of the social and political institutions that sustain markets by regulating, stabilising and legitimising them is ignored under the rush to impose American styles of economic governance. And yet the world's institutions of economic governance sadly misread the future of the countries in this region: both the World Bank's The East Asian Miracle (World Bank, 1993) and the Asian Development Bank's even more recent Emerging Asia (Asian Development Bank, 1997) were full of praise for the development model followed by countries in the region and projected rapid and continuing increases in living standards. And at last, after decades of radical criticism of IMF Structural Adjustment Policies for countries in Africa and Latin America, some mainstream economists have begun to question the relationship between IMF intervention and the subsequent collapse of the Indonesian economy and much of its social structure (see Radelet and Sachs, 1998). The crisis seems to have reinforced once more the fact that the existence of money at a world scale needs also government of money at a world scale.

It is clearly important that we understand this crisis. In this paper, I seek to accomplish three tasks. First, I remind ourselves of the key events in the chronology of the crisis, illuminating the sequence of countries involved and the manner of that involvement. The chronology involves data on exchange and interest rates, for these are the prices that have been most dramatically affected and that are empirically most robust.² It also traces some of the central political events of the crisis, including the manoeuvring of the IMF, national governments and banks. Secondly, the paper identifies the central explanations that have been advanced for the crisis, and elucidates some of their characteristics. These explanations focus on the immediate, medium-term and longer-term causes of the crisis. However, these explanations all focus on the characteristics of east Asian countries themselves rather than on the characteristics of the financial system. So finally, I seek to draw special attention to the growing independence of financial markets from real economic and social conditions. This I take to be the central theoretical implication of the crisis: that the financial events have come to dominate the real.