1. International Political Economy Prof. Tyson Roberts
Financial Crises in 1990s
International Political Economy
Prof. Tyson Roberts

2. Lecture Goals
Causes and consequences of 1990s financial crises in Asia and South America
Similarities and differences to the financial crises in the 1980s
Political Trilemma of the World Economy

3. Almost a Decade of Financial Crises in Developing World
1994-5: Mexico
1997-8: Indonesia, Malaysia, South Korea, Thailand
1998: Russia
1999: Brazil
2001: Turkey, Argentina

4. Causes (Oatley)
Liberalization of financial markets => higher volumes of capital flows to developing world in form of “hot money”
Each country had some form of fixed exchange rate
Each country had heavy reliance on short-term foreign private capital inflows

5. Differences from previous international financial crises (Oatley)
Little to do with government borrowing; instead originated in weak domestic banking sectors that had been liberalized
Larger scale of capital outflows
Larger scale of economic contraction (worst since Great Depression)

6. Financial liberalization
Enabled banks to tap low interest loans from foreign commercial banks and lend to domestic borrowers
Borrowed short term loans denominated in foreign currency and lent long term in domestic currency

7. Macroeconomic policy trilemma “The Unholy Trinity”
Fixed exchange rate
Asian currencies
pegged to dollar
Capital controls
Currency board
Capital mobility
Monetary autonomy
Floating exchange rate

8. Asia largest recipient of capital inflows pre Real GDP per capita doubled or tripled in East & Southeast Asian economies in 16 years
Rgdpe in PWT 8.0. Real GDP per capita, PPP adjusted

9. Financial liberalization
How did financial liberalization contribute to each of the following risks, and thereby financial crisis?
Exchange rate risk
Sudden stop or interest rate risk
Moral hazard

11. Trouble Asian currencies pegged to dollar
When dollar appreciated against yen, so did Asian currencies
Real estate prices fell, creating non-performing loans
Thai bank insolvent => panic throughout region

12. East & Southeast Asian economies experienced dramatic declines

13. IMF Conditionality (Oatley)
Macroeconomic stabilization
Tighter monetary policy
Financial sector reform
Close insolvent banks, recapitalize weak banks, improve quality of financial intermediation (including opening to foreign banks)
Structural reform
Trade liberalization, monopoly elimination, state enterprise privatization

14. A positive and negative view of IMF conditionality
The IMF provides necessary technocratic advice, and enables domestic governments to accept that advice by restraining their policy choices
The IMF forces domestic governments to adopt policies that are not necessarily helpful (and sometimes destructive), based on the preferences of policy makers in Washington DC

15. Argentina introduced convertibility (including currency board) to kill inflation
Domingo Cavallo
“a man of action”

16. Macroeconomic policy trilemma “The Unholy Trinity”
Fixed exchange rate
Argentina dollarization
Capital controls
Currency board
Capital mobility
Monetary autonomy
Floating exchange rate

17. Some pros and cons of “dollarization”
Low inflation
Greater savings/investment (if capital believes dollarization is credible)
Cons
Loss of monetary autonomy (interest rates set to maintain peg)
Reduced fiscal autonomy (deficits signal inflation)

18. Out with the old, in with the new

19. One source of foreign exchange was rapid privatization to foreign firms, sometimes using unconstitutional emergency decrees (Saba and Manzetti 1997)

20. Many firms repatriated profits, continuing pressure on the peso
Many firms repatriated profits, continuing pressure on the peso. International crises & strong dollar forced Argentina to raise interest rates to maintain peg, raising the cost of capital

21. The high cost of capital made borrowing expensive The overvalued exchange rate made exports expensive The economy shrank, the government adopted austerity budget Depositors got nervous, began to pull money from banks

22. Democracy, Argentinian sovereignty, & hyperglobalization (e. g
Democracy, Argentinian sovereignty, & hyperglobalization (e.g., total capital mobility) in conflict. Something has to give…
Democratic politics
Global governance
Bretton Woods compromise
Hyperglobalization
Nation state
“Golden Straitjacket”
Argentina dollarization

23. Government limited withdrawals Argentinians were not pleased

24. Dollarization abandoned, peso lost 75% of its value Savings and purchasing power decimated

25. Argentinians were not pleased

26. Argentina’s Economic Collapse

27. Over time, lower borrowing costs & cheaper exports helped the economy (in spite of default reputation costs) until the start of the global financial crisis

28. Return to ISI policies Major oil company (YPF) and Airline (Aerolineas Argentinas) nationalized

29. ISI policies and commodity prices enabled growth for some time but it was unsustainable. Inflation, capital flight, followed by new capital controls

30. Argentinians are not pleased

31. UPDATE: Argentina lost court decision to hedge funds regarding default (Aug. 2013)

32. Argentinians continue to protest inflation, corruption, and “unchecked presidential power” (Aug. 2013)

33. Nov. 22, 2015: Opposition leader Mauricio Macri wins presidency First non-Peronist president since 2001

34. Ability of countries to accept/implement IMF conditions varies
Election timing
Legislative constraint on the executive (institutional veto players)
Fragmented party systems (political veto players)
Party strength
Dependence on foreign private finance markets

35. Results
Severe contraction in Turkey, Argentina, and many Asian countries (but not Malaysia)
High rise in poverty rates
Political unrest
Governments that borrowed from IMF paid the largest political price – had to implement IMF-favored policies that drastically cut government & social spending
E.g., Suharto falls in Indonesia
Eventually robust growth returned

37. Critique of IMF response to Asian crisis
Macroeconomic conditions were inappropriate for Asian crisis
Budget deficits & inflation were not a problem
Austerity created deep recession
Forced bank closures exacerbated fears, precipitated panic
Some structural adjustment moves were unnecessary
“What [do] spice monopolies have to do with restoring financial stability?”
Other critics: IMF financial assistance in crisis creates moral hazard for lending to governments

38. Results of IMF programs generally (i.e., not just in Asia)
No evidence that conditionality increased growth (Stiglitz)
Controlling for who receives IMF loans, IMF loans have had a negative effect on growth (Vreeland)

39. So why do governments accept IMF loans? (Vreeland, Stiglitz)
IMF programs
Decrease GDP growth, and
Decrease labor share of GDP, but
Increase capital share of GDP
Policies that favor capital over labor include
Low inflation (central bank independence with inflation mandate)
Fiscal austerity
Labor market deregulation/liberalization

40. Post-Asian Crisis Policy Recommendations
Capital controls on “hot money” reduce volatility of financial flows with little harm to growth
Banking reform, including transparency, reduces risk
Enhanced Structural Adjustment Facilities (ESAF) replaced with Poverty Reduction and Growth Facilities (PRGF) in 1999
Less austerity, more government control & participation (Poverty Reduction Strategy Papers) – at least in theory

41. 1996: HIPC Participatory process to write PRGF plan
Selectivity (track record implementing plan) instead of conditionality (promised policies)
Debt forgiveness instead of restructuring

42. Changes in IMF policy recommendations
Move away from “one-size-fits-all” approach
Move away from strict neo-liberal policies
Fiscal stimulus recommended for most recent financial crisis
Capital controls can be beneficial (e.g., Iceland case)
Policies that decrease inequality decrease volatility and increase long-term growth

43. Other Asian responses
Chang Mai Initiative: Asian Monetary Fund to replace role of IMF
Bretton Woods II: Asian economies sought to prevent future crises by accumulating large stocks of reserves
Sales to US drives accumulation
New imbalance may have contributed to crises

44. Asian countries made reforms that enabled quick recovery from 2008 crisis
Source: Eder, Grimm, & Steck

45. Conclusions
High financial inflows (often short-term debt) were a foundation for crisis in both 1970/80s & 1990s
1970s/80s: Much was government borrowing
1990s: Much was private investment
Fixed exchange rates lead to sustained international imbalances
1970s/80s: ISI-based overvaluation
1990s: Pegs (crawling or fixed) to dollar

46. Conclusions Crises caused by both domestic and international causes
Domestic: Weak institutions allowing for unproductive state enterprises or private bank loans, etc.
Foreign: Financial liberalization allows for high volume inflows and then outflows/freeze
Prevention of future crises may require both reform (transparency, etc.) and reintroduction of capital controls