Causes of the Financial Collapse in Asian Economies - Essay Example

of the of the number Asian economic and financial crisis Introduction Asia had been recognized, in the twentieth century, as an economic zone that is capable of depicting miraculous growth rate. The “real per capita income” (Wong 391) in the countries of Asia have increased on an average at the rate of 4 percent to 6 percent each year, since the mid 1900s. It has been affirmed by analysts that this growth rate of the Asian countries is not an outcome of any anomaly in national income accounting of these countries but reflected the rising consumption rates prevailing in these economies. The enormous improvements in life expectancy, overall health status and level of education accessible to the average Asian population are the different aspects that reflected this economic growth. “The 1993 World Bank policy research report” (Ryan 802) named The East Asian Miracle, identified eight “high-performing Asian economies (HPAEs)” (Ryan 802) and classified them into three distinct groups according to the duration of uninterrupted “positive real economic growth rates between 1960 and 1990” (Ryan 802). Japan alone occupied the first group. By the 1960s, Japan had already become matured as an economy by maintaining a remarkably high focus on economic development. Hence it had become a leader with an enviable record showing sustained economic growth for thirty consecutive years. The second group consisted of four countries recognized as ‘four Asian tigers’; namely, Singapore, Hong Kong, Taiwan and South Korea. All these four economies had witnessed soaring economic growth rates consistently since the mid-1960s until the mid 1990s. Three other countries, Thailand, Malaysia and Indonesia, were referred to as “newly industrializing economies (NIEs)” (Ryan 802) by the World Bank. These countries that made the third group of HPAEs had been included in the list of the HPAEs in the beginning of 1970s. The outstanding growth rates and economic performances reflected by the eight nations had one thing in common. Excepting Japan, which had been categorized as a developed country by the 1960s, all the other seven countries had adopted strategic macroeconomic policies and implemented them to manage their economic activities, coupled with carefully selected policy interventions by their individual governments. Research reveals that in all these cases, the government played a decisive role in mobilization of resources. Government policies were assisted by foreign direct investment (FDI) and technological transfer from other industrialized nations of the world, particularly Japan and the USA (Ryan 802). Causes of the financial collapse in Asian economies Heavy dependence on cheap labor input Initially, competitive advantage of these countries was founded on their endowment of abundant labor. Since supply of labor was abundant in these countries, labor input was cheap, which created competitive advantage for these countries in adopting labor intensive technologies of production. However, as the knowledge intensity increased in the exports made by these countries they increasingly started to rely on highly skilled labor force that was more productive than low skilled laborers and was also more disciplined. Krugman had made a controversial contention on the phenomenon of economic growth of the Asian economies (65). The renowned economist had put that these countries would inevitably face a downfall in their economic growth. Since the lofty growth rates of these countries were achieved principally through incorporation of higher amounts of labor input along with capital input into the production process of these economies. This led to higher output and hence higher GDP, but, did not increase the net level of productivity. This was a stage when the economies were moving along the revenue curve in the zone of increasing returns. According to Krugman, it could be anticipated that these economies would reach the range of diminishing returns (Krugman 65) that would ultimately cause the economic growth of the HPAEs to slow down. In the early part of July 1997 the myth of the Asian economic miracle abruptly came to an end when Thailand faced a dramatic financial collapse. It was apparently unpredictable. Thailand was speedily followed in succession by financial crises in other economies in Asia; “Indonesia, Malaysia, South Korea and the Philippines” (Ryan 803). These financial crunches arrived one after the other and spread rapidly, hitting few of the rapidly growing economies, taking the form of economic crisis in Asia (Radelet and Sachs 105). The fall of Japan in 1991: Weakening of Yen Japan was considered a developed country until the 1990s. In 1973 Japan reported a very high average real growth rate of per capita GDP; it reached almost 10 percent per annum (Araki 32). The average growth rate between the years of 1973 and 1991 was approximately 4 percent (Araki 32). Japan gained the name “bubble economy” in the period between the years 1985 and 1991. It was marked by high price levels of assets in real market, soaring expectations of growth and rapid expansion of credit. An abrupt drop was found in the growth rates of the country’s GDP after 1991. From 5.6 percent in 1991 it dropped to 2.4 percent in 1992 and it further declined to 0.5 percent in the following year. In 1999, the growth rate was measured at – 0.7 percent (Araki 32). Collapse of real estate market in the country was followed by exposure of corruption in the top-notch levels of government service corruption in the public front. Rate of bankruptcies had swollen. After collapse of the real estate market, incidences of corruption emerged to the surface in the top-notch levels of government service in the country. All these led to weakening of the Yen. As mentioned above, Japan was one of the primary sources of foreign direct investment in the economies of East Asia. It was also a big importer of the electronic components exported by these countries (Ryan 805). The financial crush of Japan adverse affected the trade condition of all these countries since their imports fell with Japan entering a worse situation of recession. The cause of the fall: real estate bubble Hoshi has pointed out that previously, in Japan, it were the big corporate firms that received loans from the banks (15). They were well established and belonged to the well known keiretsu groups. They shared long standing relationship with the banks; which also had opportunities to obtain sufficient relevant information that helped them to judge the credibility of these banks and they could monitor the activities of their clients. However, later on the banks also started to offer loans to the small and medium sized enterprises in the country. This gave rise to the issue of unavailability of information and required data to assess their credibility. The banks in Japan considered the rising prices of lands and accepted land as collateral while giving loans to their clients as a measure against bankruptcy. Thus, investment activities in the real estate industry and the construction businesses looked particularly safe. However, expectations of these banks failed and price of land declined miserably. The Japanese firms started to accumulate huge amounts of debt and their balance sheets were negatively affected. In many cases, under pressure, these firms sold inventory goods at a price much lower than the cost of production. Cutting prices under pressure reveals that the financial condition of the firm is not healthy; thus it reduces their credibility. The problem is aggravated since banks refuse to lend them money. When the relative price of the product of indebted firm versus the price of the same products of other firms drops” (Araki 39) it indicates the fact that the borrower firm is not performing well. Stiglitz and Weiss have also supported this statement explaining that the reputation or credit worthiness of the firm gets ruined (400). Effect on international trade International trade plays a significant role in spreading the contagious effect of financial crisis. The Asian financial crisis sets a blaring example of this phenomenon. Countries that take part in international trade are linked together by way of trading with one another. Therefore crisis development in one country led to development of fresh crisis in another country with which the former country trades. Most economists are of the view that international trade can explain financial crises and it is an important factor that gets affected through these crises. Devaluation of the currency of a country would lead to an increase in the export volume of the country while reducing the import volume for the country. When Japan faced the financial crisis it there was “a devaluation of its national currency” (Ma and Cheng 255); the import level in Japan declined but there was an increase in their exports level. The position of US as a result of the Asian financial crisis is unclear. As the US dollar strengthened against the currencies of the Asian countries, volume of exports to the Asian countries fell and US faced higher amounts of imports from these countries. Import of goods and services from these markets might have risen both due to relatively high rates of growth in the US and comparatively cheaper import. The financial crisis started in July in the year 1997 when the government of Thailand discarded its efforts to uphold a fixed exchange rate of its currency, the ‘baht’. With this the baht depreciated quickly by almost greater than 20 percent. As a consequence, most of the neighboring nations had been required to dump their policy of fixed exchange rate. Massive speculation took place against the price of baht and the other currencies of the countries in Asia, which forced Thailand, along with some other countries to “devalue their currencies” (Youssef). A major fraction of the reserves of foreign exchange in Thailand was consumed in speculative activity that took place in the next several months. In general, investors “flee a currency” (Youssef) when they have the strong expectation about the currency’s devaluation owing to continual imbalances existing in the economic situation of the concerned country. Such imbalances include hefty and “persistent deficits in the current account” (Youssef), rapid declines in the foreign reserves of the country, budget deficits as well as debts (both foreign and domestic). Lack of confidence on part of the investors of an economic was fundamentally one of the main reasons that triggered the Asian currency crises. Conclusion Currency crises, in general, have “destabilizing effects on trade and investment” (Youssef), however, also depends to a large extent on how big the economy is in terms of trade with the other countries involved on the crises. The effect of the Asian financial and economic imbalances is debated. This is because, despite the severe economic downturn, economic activity in China continued to expand. In other countries in East Asia, the crisis casted strong negative effect, due to which currency traders readjusted their positions. Foreign investors that had made short-term investment in these countries withdrew their funds. “A massive flight of foreign capital” (Youssef) had been registered, that pushed several banks in the area into default. However, the Japanese government took tax cut policies to stimulate consumption activities in the economy. It expectedly also pulled other economies of Asia out of the financial slump. References Araki, Haruka. “The Causes of the Japanese Lost Decade: An Extension of Graduate Thesis.” Economic Activity 2. 37 (1998): 31-43. Hoshi, Takeo. “What Happened to Japanese Banks?” Monetary and Economic Studies 19.1 (2001): 1-29. Krugman, Paul. “The myth of Asia's miracle.” Foreign Affairs 73.6 (1994): 62-79. Ryan, Liam. “The ``Asian economic miracle'' unmasked: The political economy of the reality.” International Journal of Social Economics 27.7/8/9/10 (2000): 802-815. Radelet, Steven and Jeffrey Sachs. “The Onset of the East Asian Financial Crisis.” NBER. NBER. 2000. Web. 1 Jun. 2013. Stiglitz, Joseph E. and Andrew Murray Weiss. “Credit rationing in markets with imperfect information.” American Economic Review 71.3 (1981): 393-410. Wong, Y. C. Richard. “Lessons from the Asian financial crisis.” Cato Journal 18.3 (1999): 391-398. Youssef, Michael. "The Impact of the Asian Financial Crisis on the World Economy." Sam Houston State University. Sam Houston State University. January/February 1998. Web. 1 Jun. 2013. Read More