Chapter 42 Lessons from the Crisis
- International Monetary Fund
- Published Date:
- January 2001
There is a saying that not so long ago, an important Chinese official arrived in Paris and a reporter asked him his opinion about the French Revolution. The diplomat answered: “It is too soon to tell.”
The Asian crisis has not been solved yet so it may be premature to draw “lessons” from it for the international financial system. Indeed, “it is too soon to tell.”
However, what we have observed as of today, could be sufficient to derive some good advice. Manuel Guitián has already presented an excellent exercise in this respect.
I think that a comparison between the Mexican and Asian crises, in a couple of aspects, could be of some interest.
First, we have to recall that the Mexican economy suffered a severe depression in 1995, but then starting the following year it recovered at a speed that surprised all analysts (see Figure 1).
Figure 1.GDP Growth: Mexico and U.S
This recovery was undoubtedly related to two important factors: a vigorous American economy, and capital inflows from abroad.
Indeed, aggregate demand expansion in the United States allowed for an acceleration in the growth of Mexican exports, particularly in manufactured goods. This factor was the main engine of initial recovery. It is worth mentioning that in spite of the crisis, external credit lines for Mexican exporters continued to be available throughout this period.
Afterwards, domestic demand took over the role of impelling growth—stimulated, among other things, by the easing of the financial burden on debtors, due to the implementation of specific support programs. Recovery was also favored by the creation of new financial circuits; for instance, the granting of credit for the acquisition of durable consumption goods (i.e. automobiles) by foreign manufacturing firms. The evolution of the Mexican economy exhibited a “V”-shaped path.
Additionally, it is clear that the most difficult period of the depression was associated with a heavy fall in total foreign investment, although direct investment (almost) maintained its level. By contrast, portfolio investment registered notable declines from the fourth quarter of 1994 to the end of 1995. However, it showed a rapid and strong comeback. There is a clear association between the path of the flow of external resources and the evolution of GDP.
The mix of these favorable factors has been absent in the case of the Asian crisis. Specifically, since some time ago, the Japanese economy shows recessive conditions. And, in general, capital inflows have not resumed. Consequently, the usual evolution of the affected economies looks like an “L”-shaped path. The prolonged deterioration has hurt the financial system through several channels, which in turn has translated itself into an additional contraction of capital flows. The result has been a crisis without precedent for the last fifty years, as it was recently and appropriately defined by the president of the Federal Reserve Bank of New York.
From these differences, two very simple “lessons” can be derived: i) the “exit” of the Asian crisis goes, of course, through the reanimation of the Japanese economy, the region’s “locomotive;” and ii) the abrupt contraction of the flow of external resources is a perfect recipe for a generalized disaster.
Would it be too much to say that “without a Japanese recovery, non-Japan Asia will not recover at all ?”
Another distinct aspect of the Mexican crisis, the fragility of the banking system, was repeated in the Asian case, with some variations in appearance but not in essence. As causal factors of the crisis (among others), one usually accepts the following list: the inadequate condition of prudential regulation; the weakness of official supervision; and the existence of government guarantees—implicit and explicit—for banking activities. This combination, among other things, explains the excessive risk-taking by credit managers.
This diagnosis is commonplace among analysts. However, recent difficulties in various financial institutions in developed countries proves that deficient regulation and supervision are not features only of developing nations. It also shows that the existence of moral hazard conditions is also not a peculiarity of premodern countries.
Moreover, these incidents have another common characteristic: they reveal a worrisome over-leveraged condition, or to say it in other words, an evident insufficiency of capital in diverse financial institutions.
So, another “lesson” to be drawn from the current crisis is that structural reforms are a pending task in all latitudes. As long as this process is not fully carried out, we will continue to hear calls in favor of controls of capital movements across boundaries. If such calls are heeded—and the foreseeable economic and political circumstances favor such attitude—we would be facing a regrettable step backwards.