Financial System Reform and the Currency Crisis in East Asia

Abstract

The 1997 crisis, including the collapse of currencies, stock, and real estate prices, may have far-reaching implications for financial reform-and more generally for the nature of capitalism-in a region that until recently was often believed to offer a superior alternative to the Anglo-Saxon model of liberal capitalism. In the wake of the crisis, South Korea, Thailand, Malaysia, and Indonesia have all announced that they will adopt financial reforms that were either mandated by the International Monetary Fund (IMF) or at least follow along similar lines. It is generally, though not universally, agreed that weak financial systems were a common factor in the currency, stock market, banking, and real estate collapses that collectively are known as the Asian Crisis. This article assumes that this is so, and goes on to examine the implications. Financial system reform has been high on the list of prescribed remedies for the crisis, but there is considerable disagreement about how to go about such reforms. The experience of Japanese financial reform may inform other cases in Asia because it helps policy makers to understand whether financial system reform is more likely to be successful if it is attempted in good times or bad. There are two competing views about this question. The first suggests that reform is politically painful; therefore, it should only be attempted with a strong economy and in the absence of problems such as, say, an existing banking crisis. Reform should be deferred if these conditions do not hold. Japanese economic policy since 1991 clearly has been informed by this mindset. The government has made increasingly desperate attempts to reflate the economy before pushing ahead with financial reform. According to the second view, financial system reform is politically very painful, therefore it can