Publication year: 2017

In 1997-98, East Asia succumbed to a massive withdraw of foreign capital that resulted in a major worldwide financial crisis, thus altering the political and economic landscape of many Asian nations such as Indonesia, Malaysia, South Korea, and Thailand.  Frequently referred to as the Asian Crisis, this financial catastrophe exemplifies a cyclical trend in international lending that has become more common and more severe since the 1960’s.  Unlike previous debt crises, such as the one that hit Latin America in the 1980’s, which resulted, in part, from excessive government borrowing, the Asian Crisis originated in a weak banking system that was characterized by a lack of financial regulations sufficient to maintain and profit from loan intermediation between domestic and international markets.  As a result, both the scale of the Asian Crisis, and the associated economic and political consequences, were more severe than other recent debt crises, with some East Asian countries suffering economic contractions that rivaled those that occurred during the Great Depression.  Was the cause of the Asian Crisis the result of international political and economic forces that work synergistically to form the foreign economic policies in individual nations, or were domestic forces such as politicians, political institutions, and/or private social actors the cause?  After describing the course, progression, and resolutions of the 1997-98 financial Asian crisis, this paper will analyze it within the confines of four different perspectives on the international political economy: the domestic societal, the domestic institutional, the international political and the international economic.  Doing so will demonstrate that while each perspective offers potentially viable methods for analyzing the Asian financial crisis, none of them sufficiently explicate why it occurred, or who ultimately bore the costs.

Developing countries often fail to attract new private capital largely because private investors fear that the borrower may default, thus resulting in a loss of capital to the investor.  For instance, during the 1980’s, foreign investor confidence levels dropped during the Latin American debt crisis, which in turn led to a worldwide decrease in additional foreign investment that lasted until the structural reform processes that were implemented by the International Monetary Fund (IMF) took hold.  Between the early 1990’s and the middle of 1997, however, investor confidence levels increased, which in turn led to an increase in international private capital flows (bonds and equities) to developing countries, specifically into East Asia, which received nearly fifty percent (roughly $100 billion annually) of all capital inflows.[1]  Also known as hot money because investors can withdraw it quickly via electronic transactions, the nature of these capital inflows (i.e. high liquidity) inadvertently created the potential for increased volatility that might be associated with lower long-term (but high short-term) economic growth rates and a corresponding increase in the frequency of financial crises.[2]  That the ebb and flow of foreign capital changes in relation to confidence levels suggests that international economic forces play a large role in forming an individual nations political economy.

The 1997 Asian financial crisis shares common traits with those of other debt crises, such as Mexico (1994), Brazil and Russia (1998), and Turkey and Argentina (2000-01) in the sense that all of these nations (1) maintained a fixed exchange rate, which helps to support investor confidence; and (2) relied on short-term private capital inflows, which requires continued roll-over of foreign liabilities, which in turn depends on a governments ability to maintain foreign investors confidence by assuring a fixed exchange rate system.[3] In all cases, these governments failed to maintain investor confidence, thus resulting in massive outpourings of foreign capital, thus pushing them into deeper financial crisis.[4]  Notwithstanding its similarities to the previously mentioned debt crises, the Asian crisis differed in the sense that the Asian nations succumbed to a domestic banking system that lacked sound financial regulations (such as appropriate accounting standards and economic transparency), yet attempted to intermediate loan transactions between international and domestic markets.[5]  By borrowing from the international community (where rates tend to be lower) and offering loans domestically at a higher rate, Asian banks profited from the spread between international and domestic rates.[6]  For instance, Asian banks could borrow at 9 percent, and issue loans at 12 percent, thus realizing a 3 percent profit.[7]  During the early 1990’s, Thailand, Indonesia, South Korea, and Malaysia liberalized their financial markets as a means of accessing the international markets; doing so provided the mechanism necessary to facilitate loan intermediation.[8]  The incentive to profit from international loan spreads prompted the Thai government, for example, to create organizations such as the Bangkok International Banking Facility in the hopes that it would become an Asian banking center.[9]  Though initially successful, a lack of sufficient financial regulatory policy contributed to a lack of foresight by several Asian governments vis-à-vis the potential exchange rate and rollover risks associated with loan intermediation.[10]  Typically, short-term loans denominated in foreign currencies that are offered as long-term loans in domestic currencies require a continual renewal, or rollover, of short-term loans, which in turn requires a sufficient level of foreign investor’s confidence.[11]  In addition, if the nation in which the bank is located were to devalue its currency, the bank would face exchange rate risk, which in turn results in higher costs to service the loans.[12]  That the Asian financial crisis differed from other debt crises because of internal problems associated with its financial regulatory system suggests that, in some cases, domestic societal forces, such as the demands of, “individuals, firms, and groups,” (Frieden and Lake, 2004, pg. 9) determines national policy.

Combined with the above-mentioned exchange rate and rollover risks, Oatley (2008) suggests that the primary weakness of the Asian banking system before 1997 was moral hazard, or the risky behavior exhibited by the banks that originated in the belief the government would bail them out and cover their losses if they suffered financial losses due to risky loans.  In short, moral hazard, as it pertains to the Asian Crisis, suggests that the Asian banking community literally had no reason to develop sound banking principles as it pertains to lending because it believed that the government would compensate them if they lost money.  Thus, Asian bankers made high-interest rate loans to individuals who might otherwise not qualify for a loan given their poor credit history and/or a lack of sufficient income necessary to repay the loan.  Exacerbating these behavioral problems were the close relationships between the Asian bankers and the governmental officials.[13]  For instance, in Indonesia, seven government-owned banks controlled approximately fifty percent of all banking assets, while, “close relatives and friends of [former] Indonesian President Suharto controlled several other financial institutions.”  (Oatley, 2008, pg. 339)  Collectively, these relationships resulted in enhancing foreign investor confidence sufficiently to, “lend more money to Asian banks, and Asian banks to lend more to Asian business,” (Oatley, 2008, pg. 339) than either would have done willingly if Asian governments had not rescued banks in the past.  That Asian policymakers developed personal relationships with financial institutions to the point where moral hazard became a threat to the Asian (and worldwide) economy suggests that domestic institutional forces, such as the policies of national policymakers and their associated institutions, play a significant role in determining a nations political economy.

Oatley suggests that financial regulations developed and enforced by a government have the ability to avert moral hazard and ensure sound lending practices.[14]  Nevertheless, before 1997, many Asian governments were unwilling to explore such policy, largely because they believed that doing so might have prevented them from participating in (and profiting from) the global economy.[15]  As a result, many Asian banks issued loans that they simply could not accommodate, and by late 1996, they began to experience debt-service problems (1) because of an appreciating exchange rate in relation to the Japanese yen, and (2) an unexpected decrease in real-estate prices.[16]  According to Oatley, many Asian nations tied their currency to the dollar, and the dollar was appreciating in relation to the yen.  Consequently, the fluctuations in currencies, combined with the increasing debt-service costs facing real-estate developers led to an increase in non-performing loans (loans where interest payments are not made for six months or longer).[17]  Accordingly, the confidence levels of foreign investors began to drop until early 1997 when Finance One, Thailand’s largest bank, announced its insolvency (an accounting condition that exists when liabilities exceed assets).  An ensuing investigation of other Asian banks revealed other insolvency problems, thus sparking the beginning of a massive withdraw of foreign capital from Asia, which created severe economic conditions that prompted the Thai government to float its currency; the Philippine, Indonesian, and Malaysian governments to abandon its fixed exchange rates; and the Taiwan government to devalue its currency.[18]  Moreover, the Hong Kong stock market lost nearly twenty-five percent of its value in four days of panic selling.  Collectively, the affect of currency float, devaluation, and an unprecedented drop in the price of stocks traded on the Hong Kong exchange resulted in a significant drop in foreign investor confidence.  Conceptually, the debt crisis is a form of spillover, where the conditons in one nation influences the ability of other nations to achieve their, “macroeconomic or exchange-rate objectives.”  (Cohen, 2004, pg. 247)  That taking part in the global economy was sufficiently lucrative to Asian governments to the point where they avoided developing sound banking and financial accounting methods suggests that international economic forces play a significant role in forming a nation’s political economy.

The above-mentioned economic conditions and the massive selling of foreign capital caused serious economic strife for several Asian nations, but who ultimately bore the burden of the debt crisis?  When the panic selling ended, and the East Asian nations began to realize the consequences of their actions, many turned to the IMF for assistance.  Typically, the IMF attempts to resolve serious economic issues by providing economic relief to financially distraught nations in exchange for a commitment to reform its macroeconomic policy and restructure its systems.  Such was the case in Asia in 1998, when the IMF gave a total to $117.7 billion (U.S.) to South Korea, Indonesia, Thailand and Malaysia, who in turn promised to reform their financial sectors by closing insolvent banks, recapitalizing weak financial institutions, and improving financial intermediation.[19]  In addition, these Asian nations agreed to structural reformation that included trade liberalization, the end of domestic monopolies, and the privatization of state-owned enterprises.  Accordingly, Thailand restructured its civil service and state owned enterprises, and Indonesia deregulated agriculture.  Nevertheless, economic recession characterized the entire East Asian region, with some countries such as Indonesia experiencing a thirteen percent drop in its economic output in 1998.[20]  Thus, the international financial community clearly bore some of the burden of the debt crisis.

The political affects of the Asian Crisis led to widespread political protests and instability, largely because the poor, who comprised the majority of the population in East Asia, were the most affected by the economic conditions.[21]  According to Oatley, the poverty line nearly doubled in Indonesia in 1998, whereas in South Korea, it nearly tripled.  Thus, the poor clearly bore some of the brunt of the debt crisis.  Accordingly, governments characterized by corruption and favoritism, such as the Suharto government, unsuccessfully defended large-scale protests (some of which resulted in violence and death) designed to remove it from power and install new governmental officials.  Eventually, Suharto resigned and was replaced by a new Indonesian government that was committed to political and economic reform.[22]  Thailand also experienced political unrest because of the Asian Crisis, and in 1997, it drafted a new constitution that was accepted by, “the major societal groups.”  (Oatley, 2008, pg. 342)  Moreover, the Thai government was unable to maintain majority control, and as a result, a new, five-party system replaced it.[23]  Hence, domestic political systems also bear the burden of a debt crisis.  Oatley suggests that in the absence of the Asian financial crisis, the political reform experienced in Thailand would have progressed much slower, thus indicating that severe economic crises can result in governmental change.  The end of the Asian financial crisis (late 1998) marks the beginning of a period of political stability in East Asia, complimented by the resumption of economic growth.  Nevertheless, structural reform as mandated by the IMF remains tentative as many East Asian nations struggle with adhering to their promises.

As demonstrated above, there are many possible causes of the 1997 Asian debt crisis.  For instance, the domestic power of corrupt political leaders such as Suharto, and/or the lack of domestic economic power by the majority collectively contributed to the political-economic conditions that existed in Indonesia before the crisis struck.  Analyzing the Asian Crisis from the domestic institutional perspective suggests that national policymakers such as Suharto play a powerful role in forming a nation’s policies, particularly when they foster personal relationships with financial institutions.  Thus, the relationship between Bank Duta in Indonesia and Suharto, for example, demonstrates how policymakers and the institutions that they are associated with form national policy.[24]  However, Suharto’s relationship with financial institutions (which, according to Oatley exemplifies the conditions in other Asian nations during this period) was only instrumental in forming policy for a short period (only until Financial One announced its insolvency).  After the debt crisis began to unfold, Suharto’s government had virtually no power in forming Indonesia’s policies.  Instead, the power clearly lay in the hands of the majority, who formed massive political protests against Suharto in order to evoke governmental change.  This supports the domestic societal argument vis-à-vis how a nations political economy is formed in the sense that pressures imposed by socioeconomic groups (such as the growing number of impoverished individuals in Indonesia in 1997-98) play a major role in forming national policy.  In the case of Indonesia, once the economy had failed, the power shifted from policymakers and institutions to socioeconomic groups, thus suggesting that neither group maintained power during the entire boon and bust cycle, but rather, each played a significant role at forming policy at various stages of the cycle.  As a result, this paper asserts that neither the domestic societal nor the domestic institutional perspectives offer particularly compelling explanations about how long-term national policy is formed; however, they do offer convincing explanations about how national policy is formed for short periods.

Analyzing the Asian Crisis from an international economic and international political perspective, as compared to the previously mentioned domestic perspectives, yields vastly different conclusions.  For instance, the international economic power associated with hot money, and the importance of foreign investor confidence, added to the volatility that the Asian markets experienced in 1997.  Unlike domestic economic forces that national Asian policymakers were able to control short-term, all of the Asian nations were at the mercy of international economic forces that ultimately decided their fate.  For instance, as mentioned above, the Hong Kong stock market lost roughly one-quarter of its market value in approximately four days after foreign investors lost confidence in the Asian financial system and sold their stocks and bonds electronically.  Thus, from this perspective, any short-term gains secured by the domestic policymakers in Asia before the middle of 1997 were virtually wiped out in a relatively short period by international economic forces.  By analyzing the Asian Crisis from this perspective, it is logical to suggest that while short-term political economic success might lie in the hands of national policy makers, if a nation wishes to participate in the international economy, its long-term success depends mostly on how foreign investors view a domestic policymaker’s ability to maintain a stable financial and political environment.

Analyzing the Asian Crisis from the international political perspective indicates that geopolitical forces created a desire among developing nations to participate in the world’s economy as evidenced by the opportunity to offer financial loans to those nations that wished to participate in the global economy.  Although this could represent an argument for the international economic perspective, this paper asserts that without international political support, foreign investors might experience a level of confidence sufficient to execute financial transactions willingly in developing nations.  Hence, before 1997, the political economy of East Asian nations such as Indonesia, Malaysia, South Korea, and Taiwan were largely influenced by geopolitical forces that worked synergistically with international economic forces to create a lucrative financial environment.

This paper suggests that when a region such as East Asia succumbs to a debt crisis, the burden is borne by everyone.  By analyzing the causes of the 1997-98 Asian financial crisis with the above-mentioned domestic and international points of view, this paper has demonstrated that none of these perspectives comprehensively explain how East Asia went from boon to bust in a relatively short period, but rather, that they work collectively to offer insight into the conditions associated with the Asian Crisis.  While the domestic societal and domestic institutional perspectives provides some insight into analyzing Asia’s short-term success before the middle of 1997, it fails to explicate important factors that are relevant to a nation’s long-term economic success, such as the sustained ability to service its debt, provide sound financial services to its citizens, reduce its poverty levels, and avert political upheavals.  By contrast, the international political and international economic perspectives fail to provide compelling explanations vis-à-vis East Asia’s financial conditions before the middle of 1997.  The notion that geopolitical constrains, or changes in telecommunications, technology, production, and finance necessarily affect a national governments policymaking practices do not fully explain why, for example, the Suharto government (and other Asian governments) refrained from embracing sound financial regulatory practices.  Nevertheless, it is important to understand these issues comprehensively in order to assess accurately a crisis of this magnitude.  Thus, this paper asserts that in order to gain a comprehensive understanding of a notable world event such as the 1997 Asian financial crisis, it is best to incorporate all possible data, rather than focus on only one perspective.  Doing so provides a clearer picture about who ultimately bears the burden of a debt crisis, and provides data on how one might be averted in the future.




Frieden, J. A., & Lake, D. A. (2000). International Political Economy: Perspectives on


            Global Power and Wealth. London: Routledge.


Oatley, T. (2008). International Political Economy (Third ed.) New York: Pearson





[1] Oatley, T. (2008). International Political Economy (Third ed.) New York: Pearson Longman, pg. 340

[2] Oatley, T. (2008). International Political Economy (Third ed.) New York: Pearson Longman, pg. 334

[3] See Stephen D. Krasner, “1 State Power and the Structure of International Trade,” International Political

Economy: Perspectives on Global Power and Wealth (London: Routledge, 2000) for more information

about the effects of capital inflows

[4] See Jeffry A. Frieden, and David A. Lake, International Political Economy: Perspectives on Global Power and

Wealth, pgs. ps. 377-381 (London: Routledge, 2004)

[5] See Joseph E. Stiglitz, and Lyn Squire, “25 International Development: Is It Possible?,” International Political

Economy: Perspectives on Global Power and Wealth (London: Routledge, 2000) pg. 391

[6] Oatley, T. (2008). International Political Economy (Third ed.) New York: Pearson Longman, pg.  334

[7] Ibid.

[8] Ibid.

[9] Ibid.

[10] Ibid.

[11] See Stephen D. Krasner, “1 State Power and the Structure of International Trade,” International Political

Economy: Perspectives on Global Power and Wealth (London: Routledge, 2004) pgs. 19-36 for more

information on the effects of confidence levels.

[12] Oatley, T. (2008). International Political Economy (Third ed.) New York: Pearson Longman, pg.  334

[13] Ibid. 335

[14] Oatley, T. (2008). International Political Economy (Third ed.) New York: Pearson Longman, pg. 339

[15] Ibid.

[16] See John B. Goodman, and Louis W. Pauly, “18 The Obsolescence of Capital Controls? Economic Management

in an Age of Global Markets,” International Political Economy: Perspectives on Global Power and Wealth

(London: Routledge, 2000) pg. 291

[17] Oatley, T. (2008). International Political Economy (Third ed.) New York: Pearson Longman, pg.  339

[18] Ibid.

[19] Ibid. 340

[20] Ibid.

[21] Ibid.

[22] Ibid.

[23] Ibid.

[24] Ibid. 341