Asian Financial

Liberalization in 1990s:
Rapid Growth Through Crisis
Mehmet Ali KARADEMİR- 2008762180

I. Abstract
1. Introduction 1
2. Decades Before the Crisis 2
3. What Made the Financial Market Inefficiency Hidden? 3
4. The Reasons of the Recession in 1990s: The Crisis 5
4.1. Exchange Rate Problems 5
4.2. Lack of Risk Management- Major Role of Banking Sector
6
4.3. Inadequate Financial Regulations and Wrong Order of Liberalization
6
4.4. Rapid Broadening the Liberalization in 1990s 7
5. Were the Economies of the Region Affected from the Crisis Actually 8
6. Concluding Remarks
10

Abstarct:
7. References
12

In my essay I tried to illuminate the liberalization process of Asian economy not only in 1990s but
before and after that period also. First I defined the undergoing context of liberalization and the
‘miracle’ growth in introduction and next section. In the third section I gave the reasons why the
inefficiencies were not uncovered or showed any negative effect on economic growth. Thereafter I
tried the mention the literature on the reasons that led the region to a crisis in 1997 with basic
reasons in sub-sections. Moreover I discussed the effects of liberalization and crisis on the economy
and financial structure in the fifth section mentioning recent data as well as the information from the
recession period. In the concluding remarks I have mentioned the literature on advices and criticism
on Asian financial and economic situation in period and thereafter and tried to discuss the validity
and possibility of implementation of those advices and the validity of the forecasts made by scholars
in recession period and right after.
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1. Introduction:
In order to be able to discuss about the financial liberalization of Asia in and after 1990s –
and to discuss how much they needed it as well as what are the consequences- I would first
like to focus on the undergoing context in Asian economy before 1990s and the reasons for
the 1997 crisis.

Asia was, compared to Latin America and Sub-Saharan Africa, more protectionist than
other emerging economies, or in other words, the economic policies in the region contained
more government intervention. However it is not appropriate to name the region as a closed
economy even before 1980s. As Eisuke Sakakibra utters in an interview for World Bank (in
2000) ‘‘trade, direct investment and portfolio investment in those countries have taken place
extensively and it is not accurate to call Singapore and Malaysia closed economies’’.
Although just two Asian countries were named the situation for the others did not have any
difference in terms of openness.

However, although the main aim of the structural adjustments was the economic growth,
the context in which the ‘miracle’ occurred was not appropriate for the way that was
proposed and advised by multilateral organizations. The conditionals of loans that were
imposed to developing economies asked to relax the fiscal policies and deteriorate the
restrictions in front of free capital movement. By the way economical circles responded to
the Asian crisis was the suggestion of adapting the structural adjustment programs (SAPs) in
order to recover (Glassman&Carmody-2000) especially by those who were under the shade
of IMF’s patronage.

Despite the problem in the region was the lack of well organized, appropriately
functioning capital markets that has good financial linkages to both developing and
developed financial markets (Glassman&Carmody-2000, Shatz&Tarr-2000). Furthermore the
Asian countries started to liberalize their financial markets before and through 1990s and
that was the reason of the crisis although not directly.

, As those countries didn’t have deep financial infrastructure the liberalization process
brought a conflicting consequences for those developing economies. One of the main
reasons of the crisis, therefore, regarded to be the lack of robust financial market. As the
national financial markets didn’t have necessary linkages to the international capital markets
contrary to some of the corporations which had the opportunity, the short-term investment
in domestic market which was volatile increased and relatively the long-term capital outflow
was also increasing. In other words, debt/equity ratio in domestic financial market was
steadily increasing in 1990s (Schmukler&Vesperoni-2000). Other reasons for the crisis were
regarded to be –some of which are again related to liberalization or globalization- exposition
of unrealistic exchange rates; limitless dollarization etc. Some of the Asian economies
achieved historical success (such as Korea, Indonesia etc) (Shatz&Tarr-2000) while others like
Thailand lost competitiveness in the region by overvaluation of its currency especially
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because of pegging to U.S. dollar which was appreciated against Japanese and other regional
currencies (World Bank 2000, Shatz&Tarr-2000).

2. Decades Before the Crisis

Asian economies since 1960s have never been completely closed or interventionist –though
nor completely open or liberalized- although the progress in integration and joining to the
multilateral agreements on trade was slower than the developed economies (Cohn 2008).
However liberalization in financial markets was not as extensive as the trade liberalization.
Whatsoever the financial liberalization existed in many East Asian (EA) countries since 1960s
when Korea and some other countries liberalized their capital accounts (Ito-2001).

Through 1990s most of the financial markets in the region were liberalized except for
permanent restrictions when necessary. Malaysia, for example, had quite liberalized capital
account although they imposed some restrictions on non-trade and non-investment external
liabilities and prohibited banks from operating swap that are not related to trade in 1994
(Kaminsky&Schmukler 2001). The 1990s were in the mode putting restrictions and taking
back to liberalization rapidly. Portfolio inflows were not restricted in many Asian economies
although it was not approved by economists for developing countries. Attributing the
responsibility of the crisis to the ways led by liberalization those countries imposed severe
controls and restrictions on financial markets during the crisis though.

Furthermore the EA economies succeeded in some aspects more than the developed
countries (DCs). One of them was providing legal protections for the minority shareholders
of broad-based equity markets (Stiglitz-2001). Besides –although the banking sector did not
usually provide long-term loans for investment which had crucial importance for developing
countries- the government of the region encouraged and helped creating financial
institutions that would provide long-term loans for the corporations. That attitude enhanced
the both economic growth and growth of financial sectors. Another success of those Asian
countries was achieving the high saving and high growth equilibrium (Stiglitz-2001) which
brought high savings. The savings of both government and households were channeled to
investment by those banks. By the way the corporations could undertake riskier –as well as
more profitable- projects by the help of low interest rates in domestic financial markets.

However the economic growth was basically attributed to the efficient industrialization in
EA countries in most of the literature on ‘Asian Miracle’ while the down turn trend was
attributed to financial market weakness instead of the financial market closeness. The over
reliance on bank loans on growth and the wrong in liberalization that led the institutional
mismatch (Babb-2005), were regarded as the basic tenants of the deterioration. Thus I will
try to discuss and provide the literature on how those weaknesses were shed and how were
they uncovered in the next sections.
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3. What Made the Financial Market Inefficiency Hidden?

As I mentioned above the industrial ‘miracle’ was so fascinating that the financial sector
weaknesses assumed to be insignificant or never expected to fail. The stable macroeconomic
environment; high rates of savings and reinvestments; the increasing quality human capital;
reducing trend of income inequality; extensive export promotion; successful
industrialization; natural resources; and cheap labor which attracted a great volume of
foreign direct investment (FDI) and, by the way, flow of technological know-how (Ito-2001)
were the basic reasons that made the Asian economies miracle and shaded the capital
market inefficiencies. As it is obviously seen in Table 1 there occurred record

Table 1

World Bank Resources- 2007

growths till the 1997 crisis in most of the Asian economies thanks to the strength of
manufacturing industry especially. The situation savings and investments was no different
than the success of growth as we see in the Figure 1. The data is taken from six Asian
economies which shows record savings and investment GDP ratios. The average is around
25-30% of GDP both for investment and savings. We can easily imply from the date
mentioned above that the export growth was also in extensive amounts. Thus the Asian
economies provided most of the savings from trade surplus (World Bank Report on Asia &
Pacific-2007) which was mentioned as one of basic reasons of not having efficient or fully
developed bond and equity markets ( to be discussed in the reasons of the crisis and risks
faced in 1990s).

Government intervention on exchange rates –in most of the Asian economies- till 1990s
was another factor that enhanced the exports growth. Some of the Asian countries,
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especially Indonesia and Korea, devalued their currencies in order to be competitive in

Figure 1- World Bank Resources 2007

international trade although in short intervals they sometimes controlled the devaluation in
order to reduce inflation. As a consequence the average GDP growth was around 6.9%
between 1960s and 1991 –going up to 7251 U.S. Dollar from 904 Dollar in Korea which was
one of the most successful countries in receiving benefits from the exchange rate controls.
By the time, in the same period, there occurred radical increases in both exports/GNP ratios
and manufactured-goods/exports ratio with the help of rapid and strong industrialization of
the Asian countries.

Besides for Ito’s (2001) and Stiglitz’s (2001) there was another logical clamor for the
robust growth witnessed in Asian countries. For some liberalist that were most usually in
multilateral institutions’ circles, thought that the recession showed the fact that the
bureaucracy in those countries were not a merit-based one. However it was true that the
cheap labor was a competitive feature in the region and the natural resources. But without
capital and technology it was impossible to sustain or even lead a growth. The clamor, came
from Sarah Babb (2005) is that the regional linkages to one of the DCs (Japan) and availability
of funds from U.S. because of the political and security interests in the region and finally the
linkage of the regional small countries to China which is relatively a larger economy provided
growth in the region. When we look through the growth waves and countries they cover it is
possible to see the similar features in those which could managed sustaining growth.
Another support for the idea is that some of the countries in the region were affected from
the crisis harder (Indonesia, Malaysia etc.) than those which were willing to invest on human
capital and technological development such as; China, Singapore and Korea etc. Although
there were various reasoning for the growth, it is certain that there occurred a rapid growth
whatever the reason was.

However the situation has changed through 1990s as the existing regulations and
institutions could not bear the growth. As it is stated in World Bank’s report on EA and
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Pacific ‘‘Many economies can reach middle income status –often quite quickly- few pass
through it because the policy and institutional changes needed are more complex and more
challenging technically , politically and socially’’ (world bank- ten years after the crisis-2007).
The ‘complex’ issue was namely a well functioning and deeply integrated capital market. Of
course there were other problems that those countries came across by getting larger and
larger gradually and rapidly however there was such a panic –inferred from the literature on
the issue- while realizing the fact that, countries in the region had put aside the ‘gradualist
strategy’ (Stiglitz-2001) in the progression period of broader liberalization of financial
markets in order to provide more funds for investment.

4. The Reasons of the Recession in 1990s: The Crisis

Through 1990s more extended liberalization appeared in many Asian countries however it is
ambiguous to define a date or event that brought liberalization into existence but I will try to
mention the process from the literature from which the reasoning ability could be derived.
Therefore I will try to mention the reasons of the recession some of which are pushed
forward by the domestic financial market weaknesses while the others were consequences
of liberalization (some of those included the government responsibility too).lack of an
efficient domestic bond or equity market; by the way over reliance on banking in terms of
investment and growth and by the over and fast liberalization in the lack of money supply
that is enough for the growth pace; can be defined a much simplistic way of describing the
period – to be discussed in detail in the sub sections of this topic.

4.1. Exchange Rate Problems:

Although controls on the exchange rates brought a great competitiveness to Asian

economies till 1990s it was a disaster for them through those years. Their currencies were
floating officially but they used other instrument to provide a stable exchange rate that
would be correlated to U.S. Dollar (Stiglitz-2001, Ito-2001, Sakakibra-2000). The currencies
acted like they were pegged to Dollar –some were in fact- and that provided stable
environment for FDI although it was problematic for portfolio investment.

One of the effects of over dollarization was the extensive capital outflow on long-term
investments and short-term investment in domestic markets. By the way the debt equity
ratio increased dramatically (although another reason for that was the inefficiency of the
existing equity markets). Furthermore both the sudden depreciation of Dollar and the
appreciation caused harm in the domestic economy. To state clearly the depreciation caused
non-performing loans which were great problem for the banking sector who carried the
burden of the risks although the depreciation increased the competitiveness in exporting.
However the appreciation of the currencies in 1990s led many countries in the region lose
competitiveness as most of the countries’ trade partner was Japan basically and their
currencies were appreciated against their trade partner. Therefore they liberalized (or made
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the liberalization more efficient) the exchange rate regime except for China whose major
trade partner was already U.S. and therefore the stability maintained.

Another consequence that was led by dollarization is the ‘currency mismatch’, which
created problem for the banking sector (Ito-2001). The debt market was denominated by
foreign currencies especially with Dollar that exchange rate fluctuations became one of the
basic problems of the domestic financial markets.

4.2. Lack of Risk Management- Major Role of Banking Sector:

Although the EA countries attracted a large amount of FDI they mainly relied on investments
in terms of growth. As their trade surplus was enough for growth for a long time they did not
create efficient equity and bond markets to manage the hidden risks that may occur in
recessions and the burden of the risks were on the shoulders of the financing institutions. It
was thought to be never possible to collapse. However the sudden appreciation of Dollar
against regional currencies led excess supply and therefore production surplus. That led to
great amount of non-performing loans in the capital market. Although those countries could
convert the short-term loans –the debt market- to a partial equity (Stiglitz-2001) that was
out of the manageable area.

4.3. Inadequate Financial Regulations and Wrong Order of Liberalization:

There were two major problems in the financial sectors of those EA countries, those which
were regarded as being responsible for the Asian crisis in 1997. The first one was the
adequacy problem in the financial regulations. By name they were stated by Stiglitz (2001) as
the lack of regulatory and supervisory framework; inadequate bankruptcy laws; inefficient
accounting rules –which became significant for foreign investors after the recession period in
1990s- and the disclosure practice problem. The deregulations that were imposed by the
international monetary institutions was also failed –it coincides the social reactions towards
the failure of structural adjustment programs- and understood that institutional regulation –
in other words having effective and good government- was much more important than
having no government intervention.

Together with the institutional inefficiency and lack of advanced features in the financial
markets, another chronic problem of the region was the order of liberalization. It is also
related with the institutional problem. Liberalizing the financial instruments partially or
wholly without improving the infrastructure to fit this differentiation brought hidden
problems together with them. Korea for example liberalized its capital account in 1980s. the
same problem occurred in Latin America too but they were much more hard hit than Asian
countries, because the liberalization process before 1990s in the region was autonomous
contrary to Americas which were liberalized wholly by the structural adjustment rules
without having the institutional regulations first. The institutional mismatch occurred
because of that problem (Babb-2005). However this problem was faced by Asians through
1990s, although not as much as Americas.
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Those two major financial regulation problems combined with the currency problems
led a double recession –both financial crisis and currency crisis in the same period.

4.4. Rapid Broadening the Liberalization in 1990s:

In addition to the reasons I mentioned above –increasing demand for funds because of the
rapid growth; giving the major role to the banking sector; lacking bond and equity markets;
relying on short-term loans instead of equities; excessive dollarization and lack of
cooperation in exchange rate regime with trade partners etc- willingness to become a
member of OECD in some of large economies in the region, led them to rapid liberalization
in 1990s. Basically, they relaxed the portfolio investment inflow restrictions and eased the
licensing of domestic subsidiaries of foreign banks. Together with the existing foreign owned
banks the new subsidiaries supplied excess lending to the corporations.

However the downturn in the economy, because of the currency problems, was not
solved by the fund supplies. Number of non-performing loans increased in that period. The
accumulated negative consequences led the economy to crisis. In fact not all of the countries
had exactly the same problems or received same effects from the recession but they were all
affected from the process because they were strongly contagion. The countries had both
financial linkages and trade linkages between themselves. And the generalized vantage point
for the whole region provided negative situation for all of the countries in the region, as they
had similar financial structure, although not contraction for all of them.

5. Were the Economies of the Region Affected from the Crisis Actually:
Although orthodox liberals think exactly on the country way, some of the scholars thought
that macroeconomic policies did not have significant direct effect on national economic
growth (Rodrik-2006). Although the institutional conditions in those countries did not meet
the importance given by Dani Rodrik (2006) the rapid growth even through the crisis –just
with a slow down- claims the same aspect to the literature. A considerable amount of the
countries, one of which is China as the largest economy in the region, did not even slow
down in state of growth.

As we see on the table presented in IMF’s ‘World Development Report’ (2009) the
highest average growth in overall output levels is observed in emerging economies,
especially in Asia. The average growth in Asia is 6% between 1991 and 2002 which is the
highest regional growth. Besides the highest individual country growth is again in the same
region, by 10.1% in China. In the following years the situation has no difference in terms of
relative growths.
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Table 2.

Table 2 Taken from the IMF- world development report 2009

The region was even the least affected economy of the world in the current Global
Crisis ( IMF-2009, World Bank-2009, Media news on economy. Contrary to the minus growth
rates forecasted for the end of 2009, Asia shows a relatively great growth rate again for 2009
(3.7%). Those who were hard hit from the crisis were the countries who relied on foreign
capital for growth and whose unique advantage was the cheap labor basically and the
general interest on the region.

However the countries which invested on human capital and development of

technology were not strongly affected from either the 1997 crisis or from the current crisis.
Whatsoever the recession period led them to regulate their financial institutions more
efficiently and liberalize the social and political processes.
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Table 3- Regional Aggregate for Poverty Measures in East Asia

Table 3- derived from World Bank Report on East Asia & Pacific (2007): 10 Years after the Crisis

As we can also see from the aggregate poverty measures, it is obvious that the region
generally didn’t cut human development investments or in other words the social
investments. Although there are high numbers of poor people in those countries we can
observe a rapid and constant improvement in the issue even through crisis. That implies the
fact that that the subject countries didn’t cut budget on social investment which was the
primary expectation of the structural adjustment programs. High domestic savings provided
the ability to maintain investment on health care, education, social services etc. besides
reducing the income inequality.
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As well as the constant growth, the financial structure of the region has not been changed
dramatically although they were more liberalized. However the liberalization did not
affected the deep financial markets (Claessens&Glaessner-1998) and the Asian financial
market was relatively deeper than other developing economies which were exposed to the
effects of liberalization. The liberalization affected the financing choices of firms as I
mentioned above. The leverage ratios decreased for all types of debt however the maturity
structure shifted to short-term (Schmukler&Vesperoni-2000). Correlated with the financial
liberalization the density of internal financing increased in the same direction and
debt/equity ratio went up in late 1990s. Coming across the crisis restrictions took over again
through the end of the decade, and many Asian countries limited the entry of portfolio
investment and foreign financial firms more than DCs (Claessens&Glaessner-1998) along the
crisis period although they eased the restrictions as soon as 1999 or 2000 (Shatz&Tarr-2000)

The liberalization instruments or modes took over the regulations more than
liberalization did in financial sectors after the crisis. The democratic institutions have been
being strengthened so far. More importantly the transparency both in governmental issues
and in corporate laws and operations increased more than it was before the crisis. The
number of people who lived under 2 U.S. Dollars a day after crisis is half as much as it was
before the crisis. Besides they differentiated their foreign currency reserves regime or
enhanced it. Thus a rapid increase in the regional central banks can be observed from the
official data. According to World Bank data in 2006 Asian U.S. Dollar reserves was 2.06
trillion U.S. Dollar –China holding the half. In 2008 it is more than 2 trillion in China and
around 4 trillion totally in Asia.

6. Concluding Remarks
As we infer from the literature and data on Asian liberalization both in trade and financial
markets, it is not easy to say that a complete liberalization or a rigid globalization of capital
markets existed after the 1997 crisis. Moreover there occurred some restrictions after the
crisis although they were removed after the peak of the recession gradually. But it is sure
that the liberalization did not start exactly before or after the crisis. In fact the
manufacturing sector was distinctly more effective in the growth of the regional economy
although much of the reasoning for the crisis were global issues that were hard to control
individually; such as, the depreciation of U.S. Dollar –with respect to the fact that all
countries which pegged their currencies to U.S. Dollar came across similar economic
recession in the same period. However in order to focus on financial issues again I would like
to mention some forecasts made for the future of the Asian economy and some advices on
financial regulations for the region.

Stiglitz (2001) forecasts that the Asian growth would slow down for the reasons that,
basically, diminishing returns will reduce the profitability of the region for new investments;
or the export oriented strategies were being imitated by other developing countries that it
wouldn’t have competitive advantage anymore. Besides he claims that it would be harder
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for those governments to control foreign capital flows in liberalized economy –that they
won’t be able to channel the savings to investment as easily as before(Stiglitz-2001). His
forecasting sounds logical but it has not been actual yet, so far. As we have seen from the
tables (recent data from IMF and World Bank) they are still steadily growing.

Institutional advices in the literature are highly frequent although it has not been possible
for political, economical and especially historical restraints. Some of those were foundation
of an ‘Asian Monetary Fund’ or some kind of regional debt market (World Bank-Sakakibra-
2000). It would be a good development dynamic for the region and provide independence
from the usual lenders, that’s why it sounds good however it does not seem to be possible
for implementation in the near future.

Another advice could be made for the exchange rate regime. In fact there is wide range of
literature on the issue. However I chose the two most frequently mentioned that are related
with each other too. The first one is arranging a common exchange rate regime (Sakakibra-
200) and the other is arranging an exchange rate regime that would take trading partners’
financial and monetary choices into consideration (Stiglitz-2001, Ito-2001).

The social aspects should not be ignored in order to maintain a sustainable growth. The
efficiency of the social public investment should be more efficient. There should be more
budget devoted to the infrastructure improvement,(Stiglitz-2001) as there exists a rapid
urbanization as well as economic growth. Thus social institutions should be created or
regulated if they exist, in order to ensure the social equality and development as the GDP is
not basic measure tool of the development anymore.

One of the crucial factors for Asian economies is financial regulation, in which they are
already progressing, in order to strengthen the financial market and reduce the sensitivity to
global vulnerability. They, owing to the strong manufacturing sector and dynamic economy,
could sustain sharp and fast recovery but it does not ensure the future of the economy.
Therefore they need first of all a risk management strategy and they may provide it by
segmenting the financial institutions and distributing the risks among them as well as
strengthening those institutions. By the time government intervention is not, as we know
from the ‘Monterrey Consensus’, regarded as being the ‘persona non grata’ of the
international economy anymore especially after the Latin American and Sub-Saharan African
failures. Both Ito and Stiglitz imply an optimum government intervention would be useful
instead of market fundamentalism (Stiglitz-2001, Ito-2001).
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References:
Dani Rodrik- Harvard University- Goodbye Washington Consensus, Hello Washington Confusion
(2006)

Garciela Kaminsky & Sergio Schmukler- Short and Long-run Integration: Do Capital Controls Matter?
(2001)

Hower J. Shatz & D. G. Tarr- Exchange Rates and Economic Performance in East Asia, Exchange Rate
Overvaluation and Trade Protection- Harvard University and The World Bank (2000)

IMF- World Development Report (2009)

Jim Glassman & Padraig Carmody- Structural Adjustment in East and Southeast Asia: lessons from
Latin America (revised in July 2000)

Joseph E. Stiglitz- From Miracle to Crisis to Recovery: Lessons from Four Decades East Asian
Experience, Rethinking The Asian Miracle ( the whole book, contains of different articles in each
chapter, is edited by Joseph E. Stiglitz & Shahid Yusuf 2001)

Sarah Babb- Social Consequences of Structural Adjustment 2005

Speech by Eisuke Sakakibra- East Asian Crisis- Two Years Later (at the twelfth annual bank
conference on development economics by The World Bank in Washington D.C., April 2000)

Sergio Schmukler & Esteban Vesperoni- Globalization and Firms’ Financial Choices; EEvidence From
Emerging Economies (World Bank Development Research Group-2000)

Stijn Claessens & Tom Glaessner- The Internationalization of Financial Services in Asia (1998)

Takatashi Ito- Growth, Crisis and Future of Economic Recovery in East Asia, Rethinking The Asian
Miracle ( the whole book, contains of different articles in each chapter, is edited by Joseph E. Stiglitz
& Shahid Yusuf 2001)

Theodore Cohn- Global Political Economy, Ch. 8 Global Trade Relations (2008-Pearson Education,
Inc.)

Theodore Cohn- Global Political Economy, Ch. 11 International Development (2008- Pearson
Education, Inc.)

World Bank- East Asia & Pacific Update- 10 Years After the Crisis (April 2007)