Wall Street Journal
February 19, 1999
Economists Extend Finger-PointingBy EDUARDO LACHICA
To Include Markets and Investors
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- The search for the real villains behind Asia's financial crisis is turning up a broad list of suspects. While Asian economies' own shortcomings took the brunt of initial blame, the net is now being cast wider to include volatile markets and herding investors.
The debate is more than academic; it affects how Asian economies and international investors seek to adjust to their changed circumstances. This weekend's meeting of top officials from major industrial countries, for instance, faces a rift between those who want to contain markets and those who argue markets should simply be helped to work better.
Most economists still believe that the Asian countries for the most part brought the trouble upon themselves. Indeed, the International Monetary Fund's bitter medicine for Thailand, Indonesia and South Korea is based on the assumption that rising current-account deficits, poor bank supervision, crony capitalism and other internal faults were what brought them to grief. Another culprit fingered by many market-oriented economists: "moral hazard," or the inclination of lenders and borrowers to accept more risk than they should because of implicit guarantees of rescue should their business turn sour.
But the debate is heating up with the counterargument of Harvard University economists Jeffrey Sachs and Steven Radelet that the Asian economies may be less to blame than the inherently volatile nature of financial markets. They explain the crisis as a "self-fulfilling panic" that seized foreign and domestic investors alike.
The Harvard scholars allow that the affected countries exposed themselves to financial turmoil by overborrowing and allowing asset prices to reach bubbly heights while keeping their currencies pegged to a rising U.S. dollar. But they argue that these and other shortcomings don't add up to a full explanation of why the five Asian countries, including Malaysia and the Philippines, were overcome by the crisis almost at the same time.
"A lot of good things happened in Asia before the crisis. It didn't necessarily have to happen," says Mr. Radelet.
What did happen, they argue, was the equivalent of a bank run of massive proportions. When investors and lenders yanked $105 billion in net capital outflows from those five Asian economies mostly in just the last half of 1997, the Harvard team argues, individual creditors were just acting rationally. They hurried to get their money out first before the cash was all gone.
The Radelet-Sachs theory has been criticized for letting Asian governments and borrowers off too easily, but it's taken seriously by other noted crisis watchers including Joseph Stiglitz, the World Bank's chief economist.
In the current issue of Foreign Affairs magazine, Massachusetts Institute of Technology economist Paul Krugman comes close to endorsing their theory that panic-prone financial markets rather than the borrowers are mostly at fault. "The idea that economies are being punished for their weaknesses is ultimately unconvincing on at least two grounds," Mr. Krugman writes. "For one thing, the scale of the punishment is wholly disproportionate to the crime. Furthermore, if the fault lies with the countries, why have so many of them gotten into trouble at the same time?"
The Harvard team tested a number of possible crisis signals and found corruption to be less a harbinger of financial trouble than other factors such as high ratios of short-term debt to foreign-exchange reserves. "There is extensive corruption in East Asia, but so too in other emerging markets that did not fall prey to financial crisis," the duo says in a recent paper.
Other economists aren't persuaded. Charles Calomiris, a Columbia University professor, says that if his Harvard colleagues look hard enough they'd find "fundamental" macroeconomic weaknesses that would be sufficient to explain the East Asian crisis. Some vital signs might have made those economies look healthy -- government borrowing was low, unlike before the Latin American debt crisis of the 1980s; and personal savings were high, unlike before Mexico's 1994-95 peso crisis. But, Mr. Calomiris asserts, investors' nervousness could very well have been triggered by the expectation of creditors that Asian governments were accumulating insupportable fiscal and trade deficits.
To damp the volatility of capital flows, the Harvard team prescribes the use of Chile-style "speed bumps" such as reserve requirements on dollar deposits or even outright taxes on such deposits. Instead of IMF-organized bailouts of crisis-hit economies, the two prefer private-sector workouts such as the arrangement that Western and Japanese lenders came up with that helped South Korean banks avert default in early 1998.