The Second World War had just ended. Even though the Axis powers had lost, one could argue that all of humanity was the loser. Millions of people had been killed, wounded or displaced. Assets worth billions of dollars were lost and socio-economic infrastructure in various countries was in tatters. The war, directly or indirectly, also contributed to the freedom of various colonies in Asia. But the question remained was that how these former colonies would prosper economically after being completely decimated by a war between their colonial masters? It would require a miracle, no less.

And a miracle it was. Between 1965-90, the East Asian Economies and the High Performing Asian Economies (HPAEs) grew at an average of more than 5% per annum. Their growth rate was three times faster than Latin America and South Asia, and five times faster than Sub-Saharan Africa. During the same period, their real income per capita more than doubled. It was clear that this group of economies, which included Indonesia, Malaysia, Thailand, South Korea, Japan, Hong Kong and Singapore had clearly outperformed the rest of the world in terms of economic growth and development. Some analysts and economists have argued that these seven economies shared some common economic characteristics which set them apart from the rest. Even though these seven countries were highly diverse in population, culture, economic policy, natural resources and types of governance, there were some characteristics common to all of them which led to the growth story of these highly diverse economies.

Textbook Economics

For starters, public policy played a major contributing role in the rapid development of these economies. These countries were simply able to get the basics right. The governments of these economies were able to provide a stable macroeconomic environment, a sound legal framework, limited fiscal deficit, and moderate and predictable inflation. They also invested extensively in education, infrastructure and technological know-how. They welcomed investment both in terms of domestic savings and Foreign Direct Investment (FDI) by providing a favourable environment which included high and steady interest rates and lax tax policy. These initiatives by the government boosted growth and development in the economy along with human capital.

The workforce forms the base of any economy. And government-financed education led to an increase in the literacy rate of these economies. The pains taken by the government in the field of education bore fruit: all these countries had a strong, educated and dedicated workforce. These economies also followed a unique and creative approach while dealing with labour problems and unions. Instead of giving in to the demand of labour unions to increase wages, the government focused on job creation. The increase in the number of jobs led to an increase in the demand for labour which automatically increased the productivity as well as the wage of labour.

To rapidly develop their economies, the governments focused on infrastructure development, leading to a booming real estate market. And this (keeping in mind the high wages) ensured housing for the population which once again kept the people happy. The governments ensured that the investment coming from domestic as well as foreign investors was fully utilized. They also specifically invested in particular sectors so as to gain a comparative advantage in that sector (example, South Korea in the electronics sector). This extra effort paid its dividends as there was a rapid increase in the number of MSMEs and full-scale industries, which led to an increase in total output and increased exports. East Asia was a beautiful car ride where everyone was happy.

International Illiquidity

However, as it is said, all good things must end. As already mentioned, these governments had kept high-interest rates and kept on encouraging FDI. Soon, it was seen that the amount of short-term foreign debt obligations which these economies had to pay in the international market far exceeded their foreign exchange reserves. This type of a situation in which the amount of short-term foreign debt obligations exceeded the total reserves of foreign exchange is called international illiquidity.

International illiquidity became one of the main factors contributing to the fall of these economies in the Asian Financial Crisis of 1997. These countries had excessively liberalized their financial structure to attract more foreign investment. Foreign loans kept piling up as late as May 1997 before someone took notice of it. But alas, it was too late to notice. The ratio of short-term debt to foreign reserves rose to about 7 in Indonesia and Korea, and 4.5 in the Philippines. In other East Asian Economies of Malaysia, Bangkok, Singapore, and Japan, this ratio was well above 1. The government policies of these East Asian Economies to increase investment by moving towards a freer, more market-oriented financial system came to bite them back.

As it happened, most of these economies kept a fixed exchange rate to maintain real interest rates and to woo investors. They maintained the exchange rate by buying up foreign exchange in case of excess supply and selling foreign exchange in case of excess demand. However, as the short-term debt was well over the amount of foreign exchange these economies had, the economy would not be able to meet all the short-term debt obligations if they came at the same time.

At the same time, on the other half of the globe, the US Federal reserve started increasing the interest rates on US Treasury Bonds to woo investment and revive America from the 1990-91 recession. As this increase in interest rates was not matched by these East Asian Economies, the investors started pulling out investments from these economies and started investing in risk-free US Bonds.

Let the Speculation Begin…

On May 14 and 15, 1997, the Thai Bhat was hit by speculative crisis and investors started pulling out their investments. As feared, the economy ran out of forex reserves to maintain the exchange rate and it was forced to devalue the Bhat. Consequently, the Thai Bhat lost more than 60% of its value in a single day of trading. The news spread like wildfire in the international community and the sentiment of the investors turned against the East Asian Economies. As markets are run on sentiments, investors viewed these economies to be highly volatile and started pulling out their investments. In a span of few days, the Indonesian Rupiah, the Malaysian Ringgit, the Philippine Peso, and the Korean Won were also devalued. These currencies were losing as much as 85% of their face value in a single day of trading.

This devaluation of currency led to an increase in the nominal value of loans which these economies had borrowed from the international market. As the economy had taken these loans in hard currency and loaned the general public in local currency, this burden could not be passed on to the general public. Therefore, the economy and private banks had to take this hit and sell off their assets in order to repay these loans. An increase in the supply of assets in the markets led to fall in the price of these assets in the markets. And the banks were not able to raise enough funds to pay back these loans to the international community.

One Thing Leads to Another…Again

Therefore, a large number of banks and financial institutions collapsed in these economies. Thousands of jobs were lost, there was a fall in nominal GNP per capita, a fall in income per capita, a fall in purchasing power parity, and a fall in economic growth rate. Moreover, the economy had little to no funds to undertake developmental projects and provide subsidies and concessions. The real estate market, MSME sector, education sector, human resource sector, and others, which depended on government aid and support, crashed terribly. As a result, economic growth and prosperity of these countries almost came to a standstill. It is believed that more than 10,000 people committed suicide in Hong Kong, Japan, and South Korea as a result of this crisis.

What started as a blessing for these East Asian Economies and helped them undertake rapid growth in a span of 30 years took all it gave in a matter of few months.

Were the East Asian Economies able to bounce back in the international community and reach the pinnacle of growth and prosperity? Or, was this setback the final nail in the coffin and led them to a period of economic darkness? The second part of this story in the next article.