State Versus Market After the Asian Financial Crisis
By Paul Brothwood
In 2004, I called my dissertation Crisis!
State verses Market in the Asian Financial Crisis. I treated the title almost
like a contest. If governments had distorted lending, protected favoured
companies and defended unrealistic exchange rates, then freer markets appeared
to offer the answer. My conclusion gave that side the victory.
Rereading the work now, the evidence does
not support such a clean division. Governments created serious risks, but
private banks, companies and international lenders responded to the incentives
in front of them. They borrowed, lent and invested on the assumption that
currencies would remain stable, debts would be renewed and important
institutions would receive support. These assumptions linked political choices
to commercial decisions long before the first currency fell.
The crisis developed in the relationship
between public authority and private finance. States wrote the rules, managed
exchange rates and supervised banks. Markets moved capital, set prices and
reacted to new information. Weak institutions connected the two. Once
confidence broke, the same connection spread the damage across borders. The
affected countries were different, but creditors increasingly treated them as
one risk.
The argument I made in 2004
My dissertation used neoliberalism and
rational choice theory to examine three claims. The first concerned the
usefulness of those theories. The second argued that international institutions
such as the IMF could resolve tension between states and markets. The third
examined whether South Korea had failed to implement market-led reform
properly.
That argument had a real evidential base.
Political influence affected lending. Regulation failed to keep pace with
financial opening. Governments encouraged foreign borrowing through managed
exchange rates and assumed guarantees. In South Korea, close ties among
government, banks and the chaebols weakened normal commercial discipline.
My error was the verdict I drew from those
findings. I treated each policy failure as further proof that the state was the
problem and greater liberalisation was the remedy. That skipped a harder
question. What sort of market had the rules created, and why did private actors
find risky behaviour profitable? A market is never a neutral starting point.
Its rules distribute power, information, reward and loss.
Why the market alone was never enough
A financial market does not exist apart
from government. Property rights, company law, accounting rules, banking
licences, insolvency procedures and contract enforcement give it form.
Regulators decide what banks must report and how much capital they must hold.
Central banks shape liquidity and exchange-rate expectations.
Opening a financial system removes
barriers. It does not create skilled supervision, reliable data or credible
enforcement. Those capabilities take time, money and political support. When
capital moved faster than oversight during the Asian boom, liberalisation
increased the volume and speed of weak decisions. It did not improve their
quality. Regulators and foreign creditors lacked a clear view of the currency
and maturity mismatches accumulating inside banks and companies.
The useful distinction is not big state
against small state. It is capable government against weak government. A state
that directs every loan invites political interference. A state that abandons
supervision leaves lenders and borrowers free to transfer risk to others.
Effective government sets credible rules, enforces them and accepts limits on
its own interference.
Government failure was real
Thailand's defence of the baht showed the
danger of official policy creating a false sense of security. Banks and
companies borrowed in US dollars because the exchange rate appeared stable.
When the peg failed, the domestic cost of those debts rose sharply. A policy
intended to support stability had encouraged borrowers to ignore a major risk.
South Korea offered another example.
Government influence over banks and close relationships with large business
groups created an expectation that important borrowers would not be allowed to
fail. Reform then opened parts of the financial system without removing
established privileges. Short-term foreign borrowing grew as supervision
lagged.
Changing a rule was easier than changing
the institutions behind it. Civil servants faced political pressure. Banks
lacked independent risk control. Corporate information remained weak. The
formal policy moved towards open markets, but the behaviour of government,
finance and business still reflected the earlier system. Formal reform
therefore concealed weak implementation. The policy label changed faster than
everyday decision-making.
Private finance also shaped the crisis
International lenders were not passive
observers of poor domestic policy. They supplied large volumes of short-term
credit during the boom and accepted low returns for risks they had not assessed
properly. Stable exchange rates and rapid growth encouraged confidence. The
possibility of official rescue reduced the perceived cost of failure.
When doubts spread, lenders protected
themselves by refusing to renew loans and withdrawing funds. Each decision made
sense to the institution taking it. Together, the decisions produced a sudden
shortage of foreign currency. Falling exchange rates weakened borrowers
further, which gave the next lender another reason to leave. Trouble in
Thailand then changed how lenders judged Indonesia, Malaysia, the Philippines
and South Korea, even where their economic conditions differed.
This does not turn the crisis into a story
of irrational investors. It shows how limited information, short-term
incentives and fear of being last created herding. A state-only explanation
removes agency from private finance. The lenders helped build the exposure,
then accelerated its collapse.
The danger was the incomplete hybrid
One phrase from my dissertation now stands
out. South Korea had become an awkward half-way house between liberalisation
and state-led intervention. That description was stronger than the conclusion I
attached to it. The problem was not that the country had failed to choose a
pure model. No modern economy operates as one.
The danger lay in an incoherent mix.
Controls were relaxed where powerful groups wanted access to cheaper foreign
money. Privileges and assumed guarantees remained in place. Regulators lacked
the authority, information or independence required to restrain risk. Private
gains stayed concentrated, but the losses reached banks, taxpayers, workers and
households.
Sequencing therefore mattered. Foreign
borrowing, bank competition and corporate freedom moved ahead of supervision,
disclosure and insolvency reform. The old controls disappeared before new
safeguards worked. The result was not a transition from state to market. It was
a system in which the weaknesses of each reinforced the other.
Institutions turn rules into behaviour
Institutions are more than official bodies
or written policies. They decide who receives information, who carries losses,
who has authority to intervene and whether rules survive political pressure.
Their quality determines whether a policy changes behaviour or remains an
announcement. Independence on paper means little when a supervisor lacks the
budget, skills or political backing to challenge a powerful bank or company.
The incentives were badly aligned before
1997. Bank executives gained from rapid expansion. Companies gained from cheap
foreign debt. Politicians gained from continued growth and support for favoured
firms. International lenders gained from higher returns. The cost of a shared
failure sat elsewhere and arrived later.
International institutions also altered
incentives. Emergency support reduced the risk of total collapse, yet the
expectation of rescue raised questions about future lending discipline.
Conditions attached to support sought to reform weak systems, yet some measures
deepened the immediate contraction. The next article will examine the IMF's
response in detail.
What years in banking and operations changed for me
My later career in banking and operational
leadership makes this part of the dissertation look different. A policy rarely
succeeds because its design sounds correct. It succeeds when responsibility is
clear, information reaches the right people and the consequences of a decision
sit with those making it.
Before the crisis, responsibility was
fragmented. Governments expected banks to lend responsibly. Banks expected
large borrowers or the currency regime to receive protection. Companies
expected loans to be renewed. Foreign creditors expected national authorities
or the IMF to prevent a severe loss. Everyone relied on a safeguard owned by
somebody else. No conspiracy was required. Ordinary decisions, made against
badly designed incentives, created a shared exposure that no single actor
controlled.
The practical test is therefore simple. Do
the people with authority also carry accountability? Do supervisors have
reliable information and the independence to act? Do rewards favour long-term
value or short-term volume? Those questions reveal far more than a label such
as state-led or market-led.
State or market was the wrong question
The state-versus-market debate helped me
organise a 17,000-word dissertation, but it pushed the conclusion towards a
false winner. The Asian financial crisis did not prove that government
direction was safer than open markets. It also did not prove that removing
government produced stability.
My answer now is less ideological.
Competitive markets allocate capital best when prices reflect risk and failure
has consequences. Capable states provide law, supervision, transparency and
credible limits on political favour. Independent national and international
institutions support liquidity and discipline when ordinary arrangements break
down. Each supports and restrains the others.
The crisis was a failure of that relationship. Governments created distorted incentives. Private finance pursued them. Institutions failed to detect, challenge or contain the result. The lesson is not to choose the state or the market. It is to build rules and accountability at the same pace as financial freedom.
Asian Financial Crisis series
1. What I argued about the Asian financial crisis in 2004, and whatI think now.
2. Why the Asian financial crisis happened.
3. State versus market after the Asian financial crisis (thisarticle).
4. The IMF's controversial response to the Asian financial crisis.
5. South Korea, chaebols and banking failure.
6. What the Asian financial crisis can still teach us.
About the author
Paul Brothwood is an operations manager,
Chartered Environmentalist and sustainability professional based in the West
Midlands. His career has included senior leadership in banking, construction,
public service and electricity distribution. He writes about leadership,
sustainability, motorcycles, travel and lessons from earlier academic work.
This article revisits the dissertation he completed in 2004 on the Asian
financial crisis.
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