1. Barbara Stallings International Studies Assn March 2011

2.  Introduction  Literature and hypotheses  Financial policy changes after 1997  Outcomes of policy changes  Korea case study  China case study  Conclusions

3.  Crises of 1990s and 2000s were both crucial for East Asia, but their origins and consequences were different  Why no financial crises in EA in 2000s, when finance was main source of crises there in 1990s and elsewhere today?  Two-part study: regional economic analysis and country political economy analysis

4.  The 1997 crisis stimulated a new theoretical literature on financial crisis  Previous view: crises caused by loose macroeconomic policy or banking panics that spread  Neither fit the situation in EA in 1990s  New approaches came in two versions

5.  Internal explanations for crises -- Macroeconomic policy errors (over- investment, fixed exchange rates) -- Financial sector weaknesses (poor regulation and supervision, lack of transparency, imprudent lending) -- Political improprieties (“crony capitalism,” moral hazard)

6.  External explanations for crises -- Internal issues had existed for a long time without hindering success in EA -- Real changes were external, following liberalization of capital account -- Resulting large capital inflows and “sudden stops” led to crisis

7.  Hypothesis 1: East Asia suffered both internal and external problems in 1990s; policy changes corrected problems, thus avoiding financial crises in 2008-09  Hypothesis 2: Policy changes came about in different ways in different countries, depending on whether they suffered crises in 1990s or not

8.  Banking sector -- Eliminate NPLs from balance sheets -- Recapitalize banks, sometimes nationalizing them in the process -- Privatization (or re-privatization) of banks, sometimes to foreign capital -- Improvement of regulation/supervision

9.  Capital markets -- Main focus: promoting bond markets to provide alternative source of finance -- Various economic reforms were important: financial liberalization, opening capital account, pension reform -- Institutional reforms: better regulation and supervision, corporate governance

12.  East Asian economies slowed, but recovered quickly through stimulus  Feedback of economic crisis to financial sector? Still early, but some indicators -- No bank failures -- Indicators deteriorated, but still strong -- Stimulus may lead to more NPLs in the future

13.  Korea’s 1997 crisis resulted from a poorly executed financial liberalization, which led to heavy borrowing, especially short-term  Cutoff of access to international financial markets triggered crisis  Government requested IMF loan in Dec. 1997; it was large but not large enough and poorly designed

14.  After crisis, many banks were closed or taken over by the government and later reprivatized  An asset management company (KAMCO) purchased most NPLs  Regulation and supervision were consolidated; forward-looking approach was adopted

15.  Deposit insurance limits were made clear to avoid moral hazard, and corporate governance and transparency were strengthened  Complete foreign ownership was permitted  Capital markets were a lower priority; similar reforms introduced

16.  Indicators of banking sector strength rose substantially  Both banks and capital markets increased finance to Korean economy, in part as result of policy changes  Economy was hit hard by fall in trade and withdrawal of international finance in 2008, but no crisis like 1997

18.  Several approaches 1) Domination by foreign actors -- IMF imposed macroeconomic and structural reforms (especially financial opening) on an unwilling Korean government -- US government was partner, perhaps acting on behalf of US firms

19. 2) Domination by domestic actors -- Democratization was key factor, which changed the relative power of political actors in Korea -- This weakened the executive and led to “western style” reforms -- IMF as scapegoat, not main actor

20. 3) Interaction of foreign and domestic actors -- Role of political leadership (President Kim Dae-Jung) in mediating domestic and external pressures -- Kim persuaded labor to accept reforms -- Foreign actors played specific roles: pressed for recognition of NPLs, financial institution reforms, corporate reforms

21.  China escaped crisis in 1997 because financial sector was still largely closed; no international borrowing binge as in other East Asian countries  Growth slowed, which was met with stimulus but no devaluation  Saw neighbors’ crisis as a call for reform in China itself

22.  Reforms moved in similar direction as Korea’s, but did not go as far  AMCs were created to clean up problem loans in major banks  Major banks were recapitalized several times  Improved regulation/supervision (CBRC)

23.  Increased role of foreign capital -- Foreign banks purchased small shares of several Chinese banks -- IPOs in Hong Kong by largest state- owned banks -- “Strategic investors” -- But significant barriers remain for foreign ownership

24.  Like Korea, banking strength indicators in China rose significantly  China’s banks became increasingly oriented toward the corporate sector, although bond markets used mainly by government  Stimulus funneled through banks was key to quick recovery in China in 2009

26.  Dominance by domestic actors is usually assumed by China scholars  CCP as ultimate source of decisions  Political leadership seen as important, especially role of Premier Zhu Rongji, but several variants re financial reform -- Zhu pursuing ideological agenda -- Zhu fighting for political survival

27.  New literature suggests that external forces are also important in Chinese policy making -- International structural constraints -- Internalization of international norms  Case study of international role – explaining WTO accession, which is important for financial sector

28.  Support found for both hypotheses about political economy of finance in East Asia  Region did not have financial crises in 2008-09 (as opposed to serious economic problems) because of strengthening of financial sector after 1997 crisis  Different processes of policy change in crisis and non-crisis countries in 1997

29.  Despite support for the two hypotheses, there are some interesting caveats  Problems were created, as well as resolved, in cleaning up banks  Government role seems to have increased because of crisis  Both foreign and domestic actors can play a significant role; interaction is important