EDDY LEE The Debate on the Causes of the Asian Crisis: Crony Capitalism Versus International System Failure S ince July 1997 several South-East and East Asian countries have experienced an economic shock of unprecedented severity after decades of uninter­rupted high growth. The enormity of the shock is captured by the fact that in the worst-affected countries real GDP growth has turned abruptly from over 7 per cent per annum to negative. In Thailand growth fell from 6 per cent in 1996 to almost zero in 1997 , with all the decline con­centrated in the second half of that year, and has fallen by at least a further 5 per cent in 1998 . In Indonesia the corresponding swing is from 8 per cent growth up to the third quarter of 1997 to an absolute decline of 15 per cent in 1998 . Such shifts in GDP in relation to what it would have been according to long-standing trends are very severe indeed. These huge aggregate income shifts were the result of a financial crisis reflected in precipitous currency devaluations and falls in equity prices. Currencies depreciated by up to 80 per cent in the worst case(the Indonesian rupiah) while equity and other asset prices fell by 50 per cent or more in the worst-affected countries. The key factor behind this currency and stock market collapse was a massive reversal of foreign capital flows. It has been estimated that for Indonesia, the Republic of Korea, Thailand, Malaysia and the Philippines net private inflows dropped from US $ 93 billion to 12 billion – a swing of 11 per cent of GDP between the end of 1996 and the end of 1997 . This swing in for­eign capital flows has continued into 1998 . Nature of the Crisis What caused this sudden and massive financial cri­sis in countries that had for decades been heralded as economic miracles? To many observers, there appeared to have been new and unprecedented elements of the crisis which did not fit standard models of currency and financial crises and which could not easily be understood by reference to recent experiences such as the Mexican crisis in 1995. Taking this view, some of these new ele­ments, such as the sudden and massive shift in sen­timents towards these countries on the part of international financial markets, the relative ineffec­tiveness of efforts so far to stabilize markets, and the general failure on the part of governments, international organizations and markets to anti­cipate the crisis, pose new and difficult problems for analysis. They also raise critical issues of na­tional and international public policy in the con­text of growing globalization of financial markets. Some economists have, however, argued that none of the main elements of the crisis are new or unprecedented. 1 They point out that the bursting of asset bubbles(real estate and stock markets) has been a common feature in economic history. Similarly, the fact that there were no warning signals is also typical of financial crises. They see these features as manifestations of the severe imperfections that characterize financial markets. Foremost among these imperfections is that there is a large problem of asymmetric information in international lending wherein international lenders have limited and poor information about local borrowers. This leads lenders to over-extend credit, including to unsound local banks and com­1. See in particular Wyplosz, C.: Globalized financial markets and financial crises, paper presented at the Conference on Coping with Financial Crises in Developing Countries: Regulatory and Supervisory Challenges in a New Era of Global Finance, Amster­dam, 16-17 March 1998 (Forum on Debt and Develop­ment). On Website: http: // heiwww.unige.ch / ~wyplosz / fondad.pdf. Retrieved on 16 September 1998 . See also Stiglitz, J. E.:»More instruments and broader goals: Moving towards the post-Washington consensus«, 1998 WIDER Annual Lecture(Helsinki, Finland), 7 January and»Bad private-sector decisions«, in Wall Street Journal, 4 February 1998 . 162 Lee, The Debate on the Causes of the Asian Crisis IPG 2/99