EAI Fellows Program Working Paper Series No.26


Barbara Stallings is the William R. Rhodes Research Professor at the Institute, codirector of Brown’s Graduate Program in Development, and editor of Studies in Comparative International Development, a leading journal that is housed at the Institute. She is past director of the Watson Institute and of its Political and Economic Development Program.


Stallings has a PhD in economics from the University of Cambridge and a PhD in political science from Stanford University. Her work has focused on economic reform and development, particularly in Latin America and East Asia; finance for development; development strategy; and international political economy.


Prior to joining the Institute in 2002, she was director of the Economic Development Division of the United Nations Economic Commission for Latin America and the Caribbean in Santiago, Chile. She was previously professor of political science at the University of Wisconsin at Madison, where she also served as director of the Global Studies Research Program, director of the Latin American Studies Program, and associate dean of the graduate school.


Stallings has lectured around the world and acted as adviser to several governments and international agencies. She is author or editor of 11 books and numerous book chapters and articles. Most recently, she co-authored a book titled Finance for Development: Latin America in Comparative Perspective (Brookings Institution, 2006). She has also served on the editorial boards of several journals, including Studies in Comparative International Development, Oxford Development Studies, Competition and Change, Oxford Companion to Politics of the World, International Studies Quarterly, American Journal of Political Science, and Latin American Research Review.

본 working paper는 "EAI Fellows Program on Peace, Governance, and Development in East Asia"에 제출된 논문이며, 온라인 버전으로만 배포됩니다. EAI Fellows Program은 대만 장경국 재단, 미국 헨리루스 재단의 후원으로 진행됩니다.





The crises of 1997-98 and 2008-09 are watersheds that had a profound impact on East Asian economies and polities, but they did so in different ways that are important to understand. In the 1990s, the financial systems of the region itself played a major role in detonating and propagating the crisis. In the 2000s, by contrast, the principal problems in East Asia came from the outside, mainly via the disruption of world export markets. How do we account for the minor role that East Asian financial institutions played in the current crisis, especially since banks and related institutions were at the center of the economic distress in other parts of the world? This is the main puzzle addressed in this paper.


In offering an explanation for the different characteristics of the two crises in East Asia, the first hypothesis is that financial systems across the region were strengthened considerably in the intervening decade. This process typically involved the capitalization and privatization of banks, the elimination of non-performing loans, the growth of capital markets, and the creation or improvement of regulatory agencies. Regulators, in turn, insisted that banks act cautiously with respect to participation in international markets for new and complex financial instruments ― unlike the situation in the industrial countries. Of course an element of luck may have been involved. If the recent crisis had occurred a few years later, more Asian financial institutions might have moved into new instruments. Beyond these similarities, a second hypothesis is that countries differed in terms of the actors and processes that were involved in the policy changes, based on variations in their historical and structural characteristics.


The paper examines changes in East Asian financial systems since 1990 through a two-part analysis. The first part provides an overview of the region as a whole. It presents macroeconomic and financial indicators over the two decades to analyze changes in the performance of the financial systems in the leading countries of the region. The main focus is on the banking sector, but emerging bond and equity markets are also taken into account. Indicators of interest include: GDP growth rates, inflation rates, current account balances, international reserves, bank capitalization, non-performing loans, credit ratios, and the size of the capital markets. This section tests the first hypothesis mentioned above: that East Asian financial systems are now stronger and more diversified and thus better able to withstand global financial pressures. As a follow-up, we ask whether the current crisis ― even if it originated outside the financial sector ― may nonetheless have a negative impact on banks and other financial institutions at a later point in time.


The second part of the paper focuses on two countries in the region ― Korea and China ― to ask how the changes in their financial systems came about. While these two economies are arguably the most successful in the region, they differ in several ways that are important to the paper. Most notably, Korea was a major crisis country in the 1990s, while China was much less affected. Examination of a crisis and a non-crisis country from the earlier period can provide a useful perspective on the causal dynamics of the two crises and policies relating to the financial sector in the intervening period. In terms of mechanisms, the hypothesis is that in the crisis case of Korea, external actors were especially influential in bringing about change, while in a non-crisis case like China, the changes resulted mainly from domestic decisions. The rest of the paper is organized as follows. Section 2 discusses the literature on financial crises and our hypotheses. Section 3 provides a brief look at the 1997-98 crisis. Section 4 presents the regional analysis of changes between 1998 and 2008. Section 5 consists of the two case studies. Section 6 concludes.


Financial Crises in the Literature


The 1997-98 crisis served as a catalyst for the development of an extensive new theoretical literature on financial crises. The analysis of new causes began with the argument that the Asian crisis was not an example of the old macroeconomic syndrome seen throughout the postwar period, whereby a large fiscal deficit and loose monetary policy led to a devaluation that had negative impacts on the economy and thus on banks’ loan portfolios. Nor was it the result of microeconomic problems in particular banks, leading to panics that spread to the banking system as a whole and sometimes undermined the currency as a result of rescue policies. Rather, new interpretations had to be sought. Two sets of explanations were initially proposed ― one focused on internal imbalances, the other on external relationships. Eventually some degree of convergence emerged around the idea that both domestic and international factors were involved, perhaps in a necessary and sufficient relationship.


The domestically oriented (“fundamentalist”) approach argued that structural and policy distortions in the countries concerned were the main causes of the crisis. An early version of this approach, put forth by the International Monetary Fund (IMF), focused on four alleged problems. First was over-investment relative to domestic savings, which ― given the lack of fiscal deficits ― was the counterpart of large current account deficits and increasing (short-term) foreign capital inflows. Second were deficiencies in macroeconomic management, mainly pegging exchange rates to the dollar but also ignoring underlying demand pressures. Third were financial sector weaknesses, including inadequate regulation and supervision, poor corporate governance, lack of transparency, and imprudent lending. Fourth was the international environment, but the focus was on declining competitiveness rather than financial flows and contagion. Others added a stress on “moral hazard,” or the expectation that governments would come to the rescue if problems arose (e.g., Corsetti, Pesenti, and Roubini 1998a, 1998b).


The other approach to explaining the crisis agreed that these domestic weaknesses were present, but pointed out that they had existed for a long time while the crisis countries had been highly successful. Understanding the reasons for the crisis was argued to require a focus on new relationships with the international financial markets. In particular, the liberalization of the capital account of the balance of payments in developing countries had enabled banks and corporations to borrow large amounts of capital from abroad, but these same flows could easily be reversed if a political, economic, or even psychological shock occurred. These outflows, or “sudden stops,” were the main source of the crisis.


One of the problems with both approaches ― in addition to the tendency to focus on one explanation or the other, rather than the relationship between them ― was the blurring of banking and currency crises. The literature on so-called twin crises addressed this distinction. Kaminsky and Reinhart (1999), together with others who built on their path-breaking work, stressed the need to separate the two types of crisis since they are related, but different. In historical terms, Kaminsky and Reinhart found many currency crises but few banking crises before financial liberalization ended the tightly controlled financial systems in developing countries. In the 1980s and 1990s, by contrast, both were frequent. The general pattern was for banking crises to precede currency crises, being set off by financial liberalization, credit booms, and excess liquidity. Banking crises undermined the currency, leading to devaluations that, in turn, exacerbated the banking problems. As will be seen, twin crises are central to our analysis of Asian crises.


If we focus on the four internal factors discussed above, substantial overlap exists with analyses of the current crisis in the United States. Large current account deficits were typical of the U.S. economy ― though due to over-consumption rather than over-investment. Macroeconomic management was deficient in many ways, and lack of competitiveness was becoming more evident. Financial factors also showed great similarity and are generally agreed to have played a central role in fomenting the crisis: 1) low interest rates, easy credit, imprudent lending, and excessive leverage; 2) lack of transparency, complex instruments, and opaque, off-balance sheet activities; and 3) the wave of deregulation that occurred over several decades...(Continued)