April 5, 2007—Ten years on from the 1997 East Asian Financial Crisis and the region is far wealthier, has fewer poor people and a larger global role than ever before. People’s incomes are well beyond where they were before the crisis and in some countries, like China, Vietnam, Cambodia and Lao PDR, they’re growing at exceptional rates. Over 100 million people across East Asia have left the ranks of the extreme poor since 2000 and poverty continues to fall. Having grappled with the crisis and overcome many of the economic vulnerabilities that led to it, East Asia is fast becoming a middle income region. In fact, when Vietnam becomes a middle- rather than a low-income country – likely to be as early as 2010 – more than 95 percent of East Asians will be living in middle income countries. At current growth rates, fewer than 25 million out of a total of about 2 billion East Asians will be living below the poverty line by 2020. But with this incredible progress comes the next wave of tough challenges which could slow growth if not handled properly. Busting out of the middle income trap Key among these challenges is what’s known as the ‘middle income trap’. History shows that while many countries have been able to make it from low income to middle income, relatively few have carried on to high income. To make the high-income transition, countries have to specialize more in selected areas where they can achieve economies of scale and technological leadership. But this is hard to do when countries find themselves squeezed between low wage competitors in poor countries and cutting edge innovators in rich countries. A lot of complex challenges have to be met, from raising the skills and innovativeness of the labor force, to creating sophisticated financial systems, to maintaining social cohesion, to greatly reducing corruption. Without these sorts of tough policy and institutional changes, countries stay where they are, unable to bust out of middle income. Already within the region, the experience of Japan, Singapore, Taiwan (China), Korea and Hong Kong (China) shows what is possible to move to higher income levels. But the task is not simple. Challenges for China… China’s economic rise – the most important structural change in the world economy in decades – has brought enormous benefits for the global economy. Its growth over the past 25 years has lifted more than 400 million people above the $1 a day income level and seen incomes increase more than seven-fold, from $280 to $2000. China is now the fourth-largest economy in the world, the third-largest trading nation, and the main destination for exports from developing countries of East Asia (it passed Japan in 2004). During the financial crisis, China’s role in maintaining its currency and providing a stable source of demand was critical; its strong and consistent growth since then has been a main driver of the region’s rapid recovery. Now China faces its own middle-income challenges, many of them related to environmental pressure. For example, China is home to 20 of the world’s 30 most polluted cities due largely to high use of coal for energy. Serious soil erosion, acid rain and polluted waterways also affect the lives of millions. The national economy is dominated by manufacturing rather than services, which adds to environmental pressure. To address these and other problems, the government is developing policies aimed at ‘rebalancing the economy’ and ‘striving for a harmonious society’. While maintaining fast growth, the aim is to achieve a shift in production from industry towards services, more reliance on domestic demand and growth that is more equally shared and more environmentally sustainable. …and for the rest of the region The challenges are somewhat different in other parts of East Asia. Several middle- and high-income economies in the region are growing at about 2 percentage points less than pre-crisis. Investment has been weak in these economies and their share of world trade has been under pressure as they adjust to the rapid emergence of China. While China’s emergence is generating tremendous welfare gains for consumers around the world, it is creating intense competitive pressures for other East Asian economies in global markets. World Bank Investment Climate Surveys find East Asian firms rating uncertainty as one the biggest constraints to their operations. Given the wrenching competitive challenges and structural adjustments they are undergoing, that is not surprising. Global competition is not going away. Efforts to strengthen the investment climate are key to creating an environment in which firms can seek out efficient investments and areas of global comparative advantage. An equal share Another big issue for middle-income economies is ensuring that the benefits of greater wealth in the region are shared equitably among the people. While poverty continues to fall, income inequality has also risen -- in some cases sharply. Research suggests that many of the same forces that are contributing to rapid growth and more regional and global integration are also the forces shaping unevenness in growth and creating inequality in incomes. For example, increased technological change and globalization has increased relative demand for skilled workers, pushing up wages for people with education and skills. Then, the rural-urban divide plays its part by rewarding workers in coastal areas and cities where there are good transport links to global markets. Dealing with inequality while encouraging productivity growth and wealth creation, is now one of the biggest policy challenges for East Asia. The shift to cities Added to these vulnerabilities is the fact that East Asia is undergoing the most rapid urbanization the world has seen, with projections indicating that more than 500 million people will move to cities in the region – almost 2 million people a month – in the next 25 years. This is placing huge strains on already inadequate transport, electricity, water and sanitation systems. What can East Asia do? According to the World Bank’s most recent East Asia & Pacific Update – a six-monthly report on the region’s economic and social health, East Asia will need to continue to focus on: The reform of its investment climate Meeting skilled labor shortages Liberalizing the trade in services Investing in infrastructure Deepening and diversifying capital markets, and Building better social protection systems.
The origins of the crisis A number of factors led to the East Asian Financial Crisis. The key vulnerability arose as banks and corporations in the region took on too much short-term, foreign currency external debt. In part this occurred as exchange rates had been effectively pegged to the dollar for too long, creating a false sense of security and encouraging external borrowing that led to excessive exposure to foreign exchange risk in the financial and corporate sectors. Failure to reduce overheating that had been building up in Thailand and many other countries in the region, led to large external deficits and property and stock market bubbles. Lax prudential rules and financial oversight failed to address a sharp deterioration in the quality of banks' loan portfolios.
A crisis unfolds It was the middle of 1997. Suddenly, private investors started shifting their money – a lot of money – out of five East Asian countries: Thailand, Korea, Malaysia, the Philippines and Indonesia. In fact, more than $100 billion was pulled out of the region in both 1997 and 1998, about 5 percent of the region’s GDP each year, leading to recessions, huge currency devaluations, soaring inflation and a crash on stock markets in the five crisis countries. In a matter of months, the number of people without a job in Indonesia had swelled by at least 800,000, in Thailand by 1.5 million and in Korea by around 1.35 million. As currencies dropped, so did people’s wages. Real wages dropped 12.5 percent in Korea by the end of 1998 and in Thailand, by 6 percent. Poverty – which had been dropping across East Asia at an unprecedented rate of 9 percent a year in the five years before the crisis – started spiraling upwards again. Some 19 million Indonesians and 1.1 million Thais fell below the poverty line in 1998. Many thousands of children in Thailand, the Philippines and Indonesia did not return for the new school year in 1998 after their parents lost their jobs and so the ability to pay fees. Reports of deteriorating health among women and children quickly followed as people stopped being able to afford medicines. |
RSS