The ICAS Lectures

No. 98-511-LRK

 Has the East Asian
Financial Crisis


Lawrence R. Klein

ICAS Spring Symposium
Asia's Challenges Ahead
University of Pennsylvania
May 11, 1998

Institute for Corean-American Studies, Inc.

965 Clover Court, Blue Bell, PA 19422




Biographic Sketch

Lawrence R. Klein


 Has the East Asian Financial Crisis Bottomed-Out?

Lawrence R. Klein

The previous presentations by Sung Kwack and Robert Dekle covered the situation very well; I shall simply interpret events in my own framework and try to add a few new observations. I want to emphasize the role of speculation, especially in disturbing market conditions and in causing contagion. The speculation was not benign, did not bring order to markets, and did not bring markets to equilibrium. They caused much "overshooting". The interest rate levels reached in some markets imposed heavy burdens on ordinary people. Re-structuring is called for, but the time table is important and has been neglected. First, the appropriate institutional framework must be put into place (bankruptcy law, work out techniques, financial market regulation, accounting standards, treatment of sovereign debt, etc.) before markets can be opened. It is not satisfactory to call simply for liberalization. It must be liberalization after institutional change, step-by-step, with individual sectors, and not all at once.

Estimates of elasticity of substitution between exports of individual East Asian countries and China, with very long lags (24 mos.), based on monthly data since Jan. 1, 1994, indicate that it was a misguided policy of individual small economies to tie their exchange rates to the US dollar. This cost them market share, as the dollar gained strength.

The East Asian Crisis should be examined in the context of other crises, especially the Mexican Crisis of December 1994. Mexico, after one year's deep recession, started to recover. The current account deficit was reduced. Gradually unemployment stabilized or fell, and production picked up. Inflation was reduced.

Some of the same patterns can be seen in Korea and other East Asian economies. Korea has had increasing current account surpluses in the 4 mos. leading up to February, 1998. The economy shows many of the same dynamic features as Mexico but has not yet stopped the rise in unemployment or the fall in industrial production.

Basically, Korea has a strong economy and an industrious population. The recession now is very sharp, but should start to recover in one or two years. A likely pattern is: a cessation of decline in 1998, followed by a recovery of production in late 1998 or early 1999. At the end of 1999, there will not yet be a full return to the old growth line, but a start should have been made.

In the past, Korea had experienced rapid GDP growth, at rates above 8%, but the recovery is not likely to reach such high levels. Korea, as was true of Japan much earlier, will probably settle down to an expansion path that is 2 or more percentage points lower.

Korea's ability to borrow on the world capital market now is a good sign that the crisis atmosphere is being held in check.

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