THE 2008 ECONOMIC RECESSION AND ASIA
THE 2008 ECONOMIC RECESSION AND ASIA
ORIGINS OF THE CRISIS
The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006.High default rates on “subprime” and adjustable rate mortgages (ARM), began to increase quickly thereafter. An increase in loan incentives such as easy initial terms and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 2006–2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher.
GREAT DEPRESSION VS 1997 ASIAN FINANCIAL CRISIS
The financial crisis in the United States weakened the economies of many nations. Investment banks failed. Unemployment rose. Inflation got worse. Poverty expanded. These led to the global economic recession.
To point out the seriousness of the problem, economists and other commentators are comparing the present economic downturn to the Great Depression of the 1930s. The similarities are difficult to ignore: bank failures, a stock market crash, soaring unemployment and homelessness, and the fact that in both periods, it was the decline of the U.S. economy that triggered the global economic crisis.
The Great Depression has always been used as a benchmark to explain and measure economic upheavals. The mere mention of the term creates panic among people, especially Americans. Today, everybody is talking about the Great Depression again. Thanks to the Wall Street crash, everybody is worried that the world will again experience the horrors of the Great Depression era.
Like the rest of the world, most Asians are terrified of the Great Depression. But this fear must be put into context. Asians share the global anxiety about the uncertain future of the U.S. economy and world economy. They dread the possibility of a prolonged economic crisis. But it is not always adequate to invoke the threat of the Great Depression in order to remind Asians about the gravity of U.S. economic woes.
Somehow, Americans and Asians have different memories of the Great Depression. Yes, Asian economies were also down at that time; but most of them were colonial subjects of Western powers. Many Asians blamed their social problems on colonial economic policies. While the West was trying to cope with the depression, Asians were struggling to become free nations. Many Asians remember the Great Depression as the period when independence movements started to expand in their countries. For many Asians, stories about poverty were subsumed in their collective memories of colonial bondage and the struggle to resist the foreign intruders.
It is not the Great Depression of the 1930s, but rather the 1997 Asian financial crisis that is a more appropriate reference point to capture the attention of Asians. Before 1997, many Asian countries were called “tiger” and “dragon” economies because of their amazing economic output. Many Asians thought the positive performance of their economies would continue for a long time. Then the fatal economic crash came in 1997.
The financial crisis spread like wildfire through the region. Suddenly, rising economies like Thailand and Indonesia quickly went down. Confidence in many Asian economies declined. Economic indicators became negative overnight. Asians became poorer, and markets became unstable. Many Asian countries have yet to fully recover from the 1997 downturn.
For many Asians, the Great Depression seems too distant and ancient, while the 1997 Asian crisis is very recent and concrete. Thus, it is not surprising that many Asian commentators are highlighting the 1997 crisis to explain the possible impact of an imminent global financial meltdown. If Asians are worried about the deteriorating condition of the U.S. economy, it has more to do with the fear that their recovering and struggling economies will be unable to withstand the aftershocks of another economic recession, after the last one hit the region only a decade ago.
Remembering Asian countries’ struggles to rebuild their economies after 1997 is relevant too in order to understand Asia’s reactions to the financial bailout program of the U.S. government. On one hand, there is pessimism that the United States will be unable to solve its economic problems. It was the West, led by the United States, that lectured Asia about the need for market reforms in 1997. So far, these neoliberal economic prescriptions have failed to revive the economies of Asian countries.
On the other hand, there is a feeling of contempt for the United States. Former Malaysian Prime Minister Mahathir Mohamad echoes this sentiment in his blog: “We cannot forget how, in 1997-98, American hedge funds destroyed the economies of poor countries by manipulating their national currencies. (Asian) governments were told not to bail out any company or bank that was in deep trouble. The Americans claimed that these companies or banks were inefficient, and they should be allowed to go bankrupt and perish. Better still, they should be sold at fire-sale prices to American investors. Yet today, we see the U.S. government readying 0 billion to brazenly bail out banks, mortgage companies and insurance companies.”
The global economic catastrophe must be viewed from different perspectives. The American worldview is relevant, but it is not applicable nor should it be imposed on the rest of the world. For example, Asia has its own unique historical and social experience, which means it needs a different approach to solve its economic problems.
IMPACT OF THE GLOBAL RECESSION ON ASIA
The prognosis for Asia’s financial sector in 2009 is relatively better compared to other emerging economies and also compared to the region’s own experience in 1997-98. Even so, further GDP contractions and asset market corrections are likely as the external environment continues to deteriorate and domestic demand falters.
Asian economies do have fewer mismatches in external debt, lower imbalances in the government, corporate and banking sector balance sheets than their counterparts in emerging Europe, and as a whole used less leverage. Fortunately, ample foreign exchange reserves held by most countries in the region – even before the introduction of Fed swap lines and the IMF’s short-term liquidity facility – fully cover short-term debt and minimize the threat of a financial crisis. Intra-Asia swap agreements are helping provide liquidity to Asian countries with less ample reserves.
However, given the exposure of Asian economies to exports and to global liquidity, Asia is unlikely to lead the global economic recovery, being reliant instead on resumption of demand from the US. Even so, solid macro fundamentals and a greater capacity to take fiscal and monetary measures will help Asian emerging economies recover faster and stronger, as compared to others. Those countries able to take on more aggressive fiscal and monetary responses, will outperform – but some of the recent responses including those of China risk exacerbating, not reducing overcapacities and domestic imbalances.
LINKAGES BETWEEN US AND ASIAN ECONOMIES
The financial crisis has starkly demonstrated the extent to which the fortunes of the United States, Asia, and the rest of the global economy are intertwined. These powerful economic linkages, as well as the importance of both the United States and Asia in the global economy, underscore the need for consultation and cooperation in addressing common issues and concerns. International coordination is needed to restore confidence of the world economy.
TRANSMISSION CHANNELS : TRADE AND FINANCE
The crisis that began in the West affected Asia through various transmission channels, whose relative importance depended in some degree on the particular characteristics of each economy. However, for virtually all of the Asian economies, international trade appears to have been a critical channel. The severe recession in the advanced economies greatly restrained aggregate spending, including spending on imports, but the decline in international trade appears surprisingly large even when the depth of the recession in the advanced countries is taken into account. One possible explanation for the outsized decline in trade volumes lies in the extreme uncertainty that prevailed in the darkest months of the crisis. Consumers and businesses knew last fall that economic conditions were poor, but, in light of the severity and the global nature of the financial crisis, many feared outcomes that might be much worse. Perhaps to a greater extent than they might have otherwise, households and firms put off purchases of big-ticket items, such as consumer durables and investment goods. Durable goods figure prominently in trade and manufacturing, so these sectors may have been particularly vulnerable to the elevated uncertainty and weakened confidence that prevailed during the height of the crisis.
Credit conditions also likely affected the volume of trade, through several channels. The turmoil in credit markets doubtless exacerbated the sharp decline in demand for durable goods, and thus in trade volumes, as purchases of durable goods typically involve some extension of credit. Manufacturing production, a major component of trade flows, may have been cut back more sharply than would otherwise have been the case as producers, concerned about credit availability, attempted to preserve working capital. Finally, although it is difficult to assess the size of the effect, problems in obtaining trade finance may have also impeded trade for a time. With trade falling sharply around the world, economies particularly dependent on trade were hit especially hard.
Following the reversal in capital flows engendered by the crisis, strains in banking appeared across Asia, leading to severe credit tightening in some countries. Fears of counterparty risk disrupted interbank lending in many countries, intensifying already existing funding difficulties. The drying up of the wholesale funding market hurt Korea’s banking system in particular; prior to the crisis, it had accounted for about one-third of Korean bank funding. In Japan, some banks’ exposures to equity markets damaged their capital positions. With Asian banks experiencing dollar funding pressures similar to those arising elsewhere in the world, the Federal Reserve established 5 of its 14 liquidity swap lines with central banks in the region: Australia, Japan, Korea, New Zealand, and Singapore. The reversal in capital flows also caused rapid exchange rate depreciation in some countries, particularly Korea, Indonesia, and Malaysia. The Korean won depreciated 40 percent against the dollar from the beginning of 2008 through its trough in March of this year, and it has only partially recovered. Over the same period, the Indonesian rupiah fell 22 percent against the dollar.
POLICY RESPONSES
By and large, countries in Asia came into the crisis with fairly strong macroeconomic fundamentals, including low inflation and favorable fiscal and current account positions. Good fundamentals, in turn, provided scope for strong policy responses in many countries. China, Japan, Korea, and Singapore were among those employing relatively aggressive policy strategies; in particular, China undertook a sizable fiscal program, supplemented by accommodative monetary and bank lending policies. The stimulus packages in China and elsewhere have lifted domestic demand throughout the region, boosting intraregional trade.
Not all Asian nations responded so aggressively to the crisis. Some countries with weaker fiscal positions no doubt felt constrained in the extent of fiscal stimulus they provided. Similarly, monetary policies were likely influenced by differences in inflation performance. On the one hand, countries experiencing low inflation or deflation, such as China, Japan, and Thailand, were able to implement expansionary monetary policies without concerns about increasing inflationary pressures. Indeed, Japan used unconventional monetary easing in part to avoid deeper deflation. On the other hand, inflation concerns were more pressing for Indonesia, the Philippines, and Korea, with the result that their monetary policy responses may have been more muted than would otherwise have been the case. The national variation in policy responses likely also reflected differences in the severity of the crisis across countries.
Generally speaking, the Asian response to the crisis appears thus far to have been effective. The revival of demand in Asia has, aided global economic growth.
Despite the initial successes of Asian economic policies, risks remain. As in the advanced economies, unwinding the stimulative policies introduced during the crisis will require careful judgment. Policymakers will have to balance the risks of withdrawing policy support too early, which might cut short a nascent recovery, against the risks of leaving expansionary policies in place for too long, which could overheat the economy or worsen longer-term fiscal imbalances. In Asia, as in the rest of the world, the provision of adequate short-term stimulus must not be allowed to detract from longer-term goals, such as the amelioration of excessive global imbalances or ongoing structural reforms to increase productivity and support balanced and sustainable growth.
LESSONS FROM CRISES AND MEDIUM TERM CHALLENGES
For now, Asian countries look to be weathering the current storm. In part, their successful responses reflect the lessons learned during the Asian financial crisis of the 1990s, including the need for sound macroeconomic fundamentals.
One crucial lesson from both that crisis and the recent one is that financial institutions must be carefully regulated, transparent, and sufficiently well capitalized and liquid to withstand large shocks. In part because of the reforms put in place after the crisis of the 1990s, along with improved macroeconomic policies, Asian banking systems were better positioned to handle the more recent turmoil. With the increased prominence of the Group of Twenty (G-20) as a forum for discussing the global responses to the crisis, emerging market economies, including those in Asia, will play a larger role in the remaking of the international financial system and financial regulation.
Another set of lessons that Asian economies took from the crisis of the 1990s may be more problematic. Because strong export markets helped Asia recover from that crisis, and because many countries in the region were badly hurt by sharp reversals in capital flows, the crisis strengthened Asia’s commitment to export-led growth, backed up with large current account surpluses and mounting foreign exchange reserves. In many respects, that model has served Asia well, contributing to the rapid growth rates in the region over the past decade. In fact, it bears repeating that evidence from the world over shows trade openness to be an important source of economic growth. However, too great a reliance on external demand can also pose problems. In particular, trade surpluses achieved through policies that artificially enhance incentives for domestic saving and the production of export goods distort the mix of domestic industries and the allocation of resources, resulting in an economy that is less able to meet the needs of its own citizens in the longer term.
To achieve more balanced and durable economic growth and to reduce the risks of financial instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital flows. External imbalances have already narrowed substantially as a consequence of the crisis, as reduced income and wealth and tighter credit have led households in the United States and other advanced industrial countries to save more and spend less, including on imported goods. Together with lower oil prices and reduced business investment, these changes in behavior have lowered the U.S. current account deficit from about 5 percent of GDP in 2008 to less than 3 percent in the second quarter of this year. Reflecting in part reduced import demand from the United States, China’s current account surplus fell from about 10 percent of GDP in the first half of 2008 to about 6-1/2 percent of GDP in the first half of this year.
As the global economy recovers and trade volumes rebound, however, global imbalances may reassert themselves. As national leaders have emphasized in recent meetings of the G-20, policymakers around the world must guard against such an outcome. We understand, at least in principle, how to do this. The United States must increase its national saving rate. Although we should deploy, as best we can, tools to increase private saving, the most effective way to accomplish this goal is by establishing a sustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal deficits over time. For their part, to achieve balanced and sustainable growth, the authorities in surplus countries, including most Asian economies, must act to narrow the gap between saving and investment and to raise domestic demand. In large part, such actions should focus on boosting consumption. Admittedly, just as increasing private saving in the United States is challenging, promoting consumption in a high-saving country is not necessarily straightforward. One potentially effective strategy is to reduce households’ precautionary motive for saving by strengthening pension systems and increasing government spending on health care and education. Of course, such measures are likely to improve welfare and productivity as well as to contribute to more balanced, robust, and sustainable economic growth.
CONCLUSION
The United States has benefited significantly from Asia’s rapid development and integration into the global economy, and the payoffs to the Asian economies from global economic integration have been substantial as well. Indeed, the financial crisis has starkly demonstrated the extent to which the fortunes of the United States, Asia, and the rest of the global economy are intertwined. These powerful economic linkages, as well as the importance of both the United States and Asia in the global economy, underscore the need for consultation and cooperation in addressing common issues and concerns. I am optimistic that the United States and Asia will rise to the challenge and address in a mutually beneficial fashion the range of issues confronting the global economy.
I am Anirban Sen.I have done my graduation in Economics and my Masters in South and Southeast Asian Studies.I am interested in current socio-economic and political issues especially international ones.