1999 Reports

The Asian Financial Crisis: What Happened, and What Is to Be Done

Sachs, Jeffrey D.; Woo, Wing Thye

We identify the Asian financial crisis to be the result of the instabilities of short-term capital flows, inadequate prudential supervision in the financial markets of the developing countries, mistaken commitments to the fixed exchange rate regime, lack of international coordination in the regulation of international financial markets, absence of an international mechanism for the orderly working out of international debt, and inappropriate "rescue" packages imposed by the IMF. We recommend 30 policy reforms to make the international economy more resilient to financial turmoil, and to reduce the costs of such turmoil. We conclude that there is little particularly "Asian" about the Asian financial crisis. Even though official Washington, led by the IMF, proclaimed the crisis to be one of Asian capitalism, the more generic character of the crisis became all too clear during 1998, as the crisis spread to Russia, South Africa, and Brazil. Rather than an Asian crisis, the world is experiencing a type of global crisis that reflects the rapid arrival of global capitalism, in a world economy not yet used to the integration of the advanced and developing countries. Because we see no justification for the monopoly position of the IMF as the sole international institution on monetary affairs, we advocate the formation of regional monetary bodies to provide mutual support in the event of a financial crisis hitting one or another member country. We also advocate that an international bankruptcy system be established in order to accelerate an orderly workout of international debts when a developing country falls into an extreme indebtedness crisis. Existing key international organisations like the IMF have performed poorly, and they must be reformed to render them more transparent in their operations, and more democratic in their governance. Developing countries must have a greater role in designing future rescue packages extended to financially distressed countries so that rescue packages will no longer be biased toward the interests of the creditor countries. The new global financial architecture should have generalised floating of currencies as its mainstay. The bad debts of the financial and corporate sectors in Pacific Asia to be quickly resolved by the infusion of public money, and the takeover of some large domestic banks by foreign banks. Furthermore, the revival of the corporate sectors in Asia requires international creditors to write-down the value of their loans, and to convert part of their loans into equity participation. There is a serious mismatch in Pacific Asia, particularly in most of southeast Asia, between investment in physical hardware - factories and machinery - and investment in the social software - scientific research centers, administrative and judiciary systems, and growth of civil society. In a world of growing international competitiveness, when foreign direct investors are courted not just by Asia but Central Europe and Latin America, the concerns over governance are bound to grow, and to weigh increasingly heavily on the unreformed countries of Asia. The long-term competitiveness of Asia rests as much on "getting its institutions right" as on "getting the prices right."