NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Growth and Recovery in East Asia

"In the long-term East Asian countries will go from a pre-crisis average annual growth rate of 7 percent to around 5 percent."

In the modern history of economic upheavals, the East Asian financial crisis that began in 1997 with the fall of the Thai baht surprised economists in two ways: first, for the massive damage it inflicted upon Indonesia, Korea, Thailand, Malaysia, and the Philippines, and, second, for how quickly these countries bounced back from the battering.

In Recovery and Sustainability in East Asia (NBER Working Paper No. 8373), Yung Chul Park and Jong-Wha Lee assert that the reason the so-called "Asian Tigers" went down so hard yet came up fighting so fiercely is that the crisis was relatively brief and the effected economies were fundamentally healthy. "Although the financial crisis of 1997 abruptly brought a halt to Asia's period of robust growth, there was little in Asia's fundamentals that inevitably led to the crisis," the authors state.

The main reason the crisis erupted with such severity, Park and Lee argue, is that East Asian countries had "too much short-term capital flowing into weak and under-supervised financial systems," and thus set themselves up for a sudden and sharp upheaval that was "in large measure a liquidity crisis caused by investor panic." But the authors contend that once the panic ended and a measure of stability (that is, liquidity) returned, the crisis countries were able to quickly recover, aided by "a large real (currency) depreciation, expansionary monetary and fiscal policy, and an improvement in the global economic environment." But more fundamentally, note Park and Lee, the countries were still in possession of the same qualities that earned many of them double-digit growth rates pre-crisis: "high rates of saving, good human resources, trade openness, and maintenance of good institutions."

Park and Lee observe that an analysis of other countries that have undergone currency crises shows a pattern in which an initial drop in growth is followed by a return, after about three years, to "pre-crisis or non-crisis growth rates." They note that East Asian countries appear to be following a similar pattern, albeit in a more dramatic fashion on both ends. Thus, they predict that in the long-term East Asian countries will go from a pre-crisis average annual growth rate of 7 percent to around 5 percent. However, the authors point out that the lower growth is attributable not to the crisis but to the fact that some of the high growth in the past came as East Asian countries made improvements to put themselves on par with their more industrialized peers. Now that they've narrowed the gap, Park and Lee believe, there will be less growth realized simply as a result of "catching up."

Ultimately, they remain convinced that "there is no evidence for a direct impact of a currency crisis on long-term growth...This suggests that with a return to the core policies that resulted in rapid growth, the East Asian economies can again returned to sustained growth," the authors state.

NBER Research Associate Robert Barro agrees that there is "broad evidence" to be gleaned from other crises bolstering the notion that East Asian countries will return to growth rates "that would have prevailed" without crisis. But in his study, Economic Growth in East Asia Before and After the Financial Crisis (NBER Working Paper No. 8330), he looks at investment rates and stock market prices post-crisis and finds reasons to be concerned that the five East Asian crisis countries could become the exception to the rule.

"The failure of investment ratios to rebound significantly in the crisis countries suggests that the crisis had a long-term adverse effect," writes Barro. "This conclusion is reinforced by the observation that real stock market prices in the crisis countries have failed to re-attain their pre-crisis values."

Barro finds that in four of the five countries that suffered the sharpest contractions in the crisis--Indonesia, South Korea, Malaysia, and Thailand--investment as a share of GDP dropped by more than 10 percent in 1998 and did not recover substantially in either 1999 or 2000. (The fifth country, the Philippines, already had a low investment ratio and the reduction post-crisis was relatively small.)

As for stock prices, Barro notes that in the crisis countries, stock valuations at the end of 2000 fall far short of those from early 1997. And he views the lack of anything approaching a recovery as a clear signal from the financial markets that investors are bearish on long-term growth prospects. "From the perspective of the financial markets, events from 1997 through 2000 had permanent negative consequences for the economic outlook of the five Asian-crisis countries," he writes.

Barro agrees that the "recoveries in the five countries in 1999-2000 were strong in most cases" but concludes that it is "unclear whether" the wounds inflicted by the crisis will quickly heal or continue to fester for sometime to come.

-- Matthew Davis


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