In its Analytical Chapter accompanying the World Economic Outlook report, the IMF provides some interesting analysis comparing the Asian financial crisis of the late 1990s against a similar crisis in the Euro area that has been unfolding in recent years.
Per IMF: “The experiences of the stressed euro area economies during the recent euro area sovereign debt crises stand in contrast to those of the Asian market economies during the Asian financial crisis of the late 1990s.”
This is simultaneously surprising and intuitive.
Surprising, because the two sets of economies are very different in terms of structural vulnerabilities. Asian economies hit by the crisis in the 1990s were heavily reliant for growth on external sources of funding and required much higher rates of economic growth to compensate for the relatively lower level of economic development. These economies, in contrast with the Euro area ones, also had to rely on unpredictable commodities markets and less specialised modes of economic production to get them out of the crisis than the well-established, highly-developed Euro area economies.
The predictable bit comes from the realisation that unlike Euro area economies today, Asian economies in the 1990s had at their disposal the right tools for dealing with the crisis: access to capital controls and currency devaluations. They were also younger, more dynamic and more eager to grow demographies.
Thus, the IMF finds that “the difference between these two groups in their patterns of adjustment is stark: East Asian economies were able to rely on demand-switching effects to a much greater degree than have the stressed euro area economies and thereby avoided the prolonged contraction in output that has afflicted the latter.” In other words, Asian economies in the 1990s were quicker to respond by switching consumption away from imports toward domestic substitutes, by cutting back consumption faster and investment less rapidly. They also responded by rapidly devaluing their currencies to sustain the demand effects mentioned.
Financial crises that started in July 1997 triggered severe recessions in Indonesia, Korea, Malaysia, and Thailand (the “East Asia–4”). Starting from 2008, similar growth collapse was triggered in four euro area economies — Greece, Ireland, Portugal and Spain (the “stressed euro area–4”).
Per IMF: “The experiences of the two groups of economies share some important similarities and differences”:
The second point is striking: in East Asia, peak contraction took place within 1- 2 years of the crisis, while in the case of Euro area stressed economies, peak contraction took some 5-6 years to manifest. As IMF notes, “as a result, output in the stressed euro area–4 remains firmly below 2006 projections and has yet to recover.”
These differences are more than academic. Take domestic demand, defined as the sum of Government spending on current goods and services and investment, and private consumption and investment. “In the East Asia–4, average real domestic demand growth plummeted to –18 percent in 1998 before recovering the following year. The corresponding drop in the stressed euro area economies was not as great, at about –6 percent in 2009. In the Euro area economies, demand is yet to recover, seven years from the onset of the crisis.
Title: Real Domestic Demand Growth (Percent)
Source: IMF WEO Chapter 4
Note: The horizontal axis depicts years with 0 = 1996 for East Asian crisis and 2006 for the Euro area crisis.
And external balances (trade and investment) also under performed in the case of the stressed euro area–4 compared to East Asia–4.
Title: Current Account Balances (Percent of Regional GDP)
Source: IMF WEO Chapter 4
Note: The horizontal axis depicts years with 0 = 1996 for East Asian crisis and 2006 for the Euro area crisis.
Almost all of the above differences were down to one simple fact: East Asia– 4 rapidly devalued their currencies, delivering real exchange rate declines that were both more dramatic and reliant on currency devaluations. Stressed Euro area-4 economies opted to pursue (or were forced by the EU to pursue) internal revelations, which means decreasing workers’ earnings and increasing taxes. Thus, real effective rate depreciation in East Asia–4 ranged between 15% and 50% depending on the country and came in early in the crisis. Effective rate depreciation in stressed Euro area-4 peaked at just 2.5% in 2010 and again in 2012.
In the end, stressed Euro area-4 household and businesses are simply paying the price for sustaining what is a superficial common currency area. Economics, made subservient to politics, rarely results in prosperity and certainly does not provide for a good hedge against adverse shocks and crises.
Dr Constantin Gurdgiev is the Adjunct Assistant Professor of Finance with Trinity College, Dublin
IMF World Economic Outlook Report – http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/c4.pdf
