Unexpected Outcomes

How Emerging Economies Survived the Global Financial Crisis

Carol Wise, Leslie Elliott Armijo, Saori N. Katada, Carol Wise, Leslie Elliott Armijo, Saori N. Katada

• Publisher: Brookings Institution Press
• Year: 2015
• Print ISBN: 9780815724766
• eBook ISBN: 9780815724773
• Edition: 1
• Topic: Politik & Internationale Beziehungen
• Subtopic: Entwicklungsökonomie

This volume documents and explains the remarkable resilience of emerging market nations in East Asia and Latin America when faced with the global financial crisis in 2008-2009. Their quick bounceback from the crisis marked a radical departure from the past, such as when the 1982 debt shocks produced a decade-long recession in Latin America or when the Asian financial crisis dramatically slowed those economies in the late 1990s. Why?
This volume suggests that these countries' resistance to the initial financial contagion is a tribute to financial-sector reforms undertaken over the past two decades. The rebound itself was a trade-led phenomenon, favoring the countries that had gone the farthest with macroeconomic restructuring and trade reform. Old labels used to describe ""neoliberal versus developmentalist"" strategies do not accurately capture the foundations of this recovery. These authors argue that policy learning and institutional reforms adopted in response to previous crises prompted policymakers to combine state and market approaches in effectively coping with the global financial crisis.
The nations studied include Korea, China, India, Mexico, Argentina, and Brazil, accompanied by Latin American and Asian regional analyses that bring other emerging markets such as Chile and Peru into the picture. The substantial differences among the nations make their shared success even more remarkable and worthy of investigation. And although 2012 saw slowed growth in some emerging market nations, the authors argue this selective slowing suggests the need for deeper structural reforms in some countries, China and India in particular.

1	CAROL WISE, LESLIE ELLIOTT ARMIJO, and SAORI N. KATADA
	The Puzzle

One of the more surprising features of the 2008–09 global financial crisis was the comparative ease with which emerging economies in Asia and Latin America rebounded. That rebound was a radical departure from the effects of previous crises on these regions, be it the decade-long recession wreaked on Latin America by the 1982 debt shocks¹ or the financial crisis that dramatically slowed Asian economies in the late 1990s.² The quick recovery of emerging economies in 2010–12 was, moreover, instrumental in deterring a full-blown global depression. The lingering phenomenon of the “Great Recession” has largely been limited to the wealthier members of the Organization for Economic Cooperation and Development. Most emerging economies, with the notable exception of those in Eastern Europe, weathered the crisis reasonably well.

The resilience of the emerging economies (EEs) in Asia and Latin America in surviving the global financial crisis (GFC) is all the more striking when one considers the substantial differences that exist among the countries both within and across these regions. The EEs that we consider in this volume differ in terms of size, endowment factors, and the domestic institutions that frame economic policymaking. Taking their diversity into account, this introductory chapter summarizes the commonalities and differences among the reforms that they had undertaken before the GFC and the policies that they pursued on the path to recovery in its aftermath. Our focus in this book is on the Pacific Rim, the definition of which we expand to include the important emerging economies of Brazil, Argentina, and India.

This introductory chapter suggests, first, that the ability of these countries as a group to resist the initial financial contagion was due in considerable part to the substantial macroeconomic, financial sector, and trade reforms that EE governments throughout Asia and Latin America had undertaken over the previous two decades. Second, a timely rebound was supported by the implementation of countercyclical policies in major emerging economies.³ Third, EEs also benefited from some countervailing conditions in the international economy, including high commodity prices since the early 2000s; these conditions were fortuitous, not the result of conscious prior policy choices. Fourth and perhaps most important, old labels used to distinguish neoliberal (market-based)⁴ from developmentalist (state-oriented)⁵ strategies do not accurately describe the foundations of EE recovery. We argue that policy learning and reforms adopted in response to previous crises prompted EE policymakers to combine both state and market approaches in coping with the GFC.⁶ Policy pragmatism trumped ideological rigidity.

In the Wake of Crisis: What Do the Data Tell Us?

Since the 1980s, calls for financial market deregulation in the United States have arisen on both sides of the political aisle. One result was the passage by Congress of the Financial Services Modernization Act of 1999, which repealed the Glass-Steagall Act of 1933, which had prohibited mergers among investment banks, commercial banks, and insurance companies.⁷ The bursting of the dotcom bubble in 2000 followed quickly on the heels of that deregulatory legislation, as did the 9/11 attacks on the United States. Those double recessionary shocks prompted the Federal Reserve to maintain low interest rates from 2000 to 2004, which pumped massive liquidity into both the U.S. economy and global markets.⁸ At the same time, newly merged mega-institutions like Citicorp and the Goldman Sachs Group began offering a range of innovative, if not always sound, financial instruments that spurred an unprecedented boom in credit card, personal, and mortgage debt.⁹ In 2005 alone, around US$1trillion was issued in interest-only “subprime” mortgages, which were one of the key financial instruments generated in the new low interest rate environment. However, many of those flexible-rate mortgages fell into default after the Federal Reserve began gradually raising interest rates in 2004–05. The global financial crisis of 2008–09 originated in this high-risk, subprime segment of the U.S. housing market, and it was exacerbated by the creation of various mortgage-backed financial instruments and unregulated derivatives that had attracted investors in the United States and Europe.¹⁰

Once the U.S. housing bubble burst, the defaults affected heavily leveraged hedge funds as early as the summer of 2007. The crisis quickly spread from the United States and Europe to other parts of the world, driven by massive runs on excessively leveraged private assets, the withdrawal of investments, the sudden collapse of export markets in the advanced economies, and a sharp but temporary decline in commodity prices.¹¹ As a consequence, according to the World Bank, global growth fell by approximately 5 percentage points from its pre-crisis peak to its trough in 2009, nominal world trade (in U.S. dollars) fell by around 30 percent year-on-year in the first quarter of 2009, and trade volumes fell by more than 15 percent. The magnitude of the losses made this the worst global economic crisis since the 1930s, when the Great Depression spread throughout the world.¹² But the results and pattern of global contagion in this crisis differed from those in previous financial crises in recent decades. Despite initial fears, the emerging economies as a group had a relatively easy go of it and recovered rapidly.

One piece of the puzzle is the fact that poorer countries were already growing faster than those with higher per capita income. Economic theory has long predicted that backward economies, which have considerable absorptive capacity and could ostensibly benefit from imported new technologies, investment capital, and relatively abundant supplies of cheap labor, should grow faster than mature industrial economies; however, for many decades they did not.¹³ Yet by the late 1990s developing country growth rates were up to the extent that some argued that a “great convergence” was finally under way.¹⁴ Subramanian and Kessler report that, on average, developing countries’ growth surpassed that of the United States by about 3.25 percent annually from 2000 to 2007.¹⁵ Table 1-1 shows that in the immediate pre-crisis years of 2005–07, the advanced industrial economies had steady average annual GDP growth of 4.0 percent—but the developing economies grew at an average annual rate of 7.7 percent. Nonetheless, the near universal assumption was that growth in developing economies was both fragile and volatile. Common wisdom held that as long as these economies lagged behind in the implementation of deep structural reforms and remained highly dependent on financial inflows from overseas markets, financial crises would continue to plague them. Any subsequent disruptions were expected to be just as severe as those witnessed, for example, in Mexico (1994); Indonesia, Malaysia, Thailand, and South Korea (1997–98); Russia (1998); Brazil (1998–99); and Argentina (2001–02).

Table 1-1. Crisis and Recovery: Aggregate GDP Growth, Various Economies^a

Percent

Sources: Data from International Monetary Fund, World Economic Outlook, April 2013.

a. Compound annual growth rates, using purchasing power parity GDP, with aggregates weighted by countries’ economic size.

Instead, it was the advanced industrial economies that suffered a deep contraction during and long after the global financial crisis. Average annual GDP growth for the countries in the Organization for Economic Cooperation and Development fell to –1.3 percent in 2008–09; the equivalent figure for the G-7 major advanced economies was –1.5 percent. The burden of maintaining global growth had shifted decisively to the developing countries, which grew by an average of 1.6 percent annually on the same GDP-weighted basis in 2008–09. Even Latin America and the Caribbean—which includes Mexico, Central America, and the Caribbean Basin countries, all of which were closely tied to the hard-hit U.S. economy—shrank less than half a percentage point in 2008–09. These patterns hold not merely in the aggregate but for most of the major economies among the advanced industrial, Asian developing, and Latin American developing countries. Among the 14 large emerging economies shown in table 1-2, only Venezuela—which has been the least inclined to implement modernizing reforms since the debt crisis of the 1980s—failed to recover on par with the countries shown in table 1-2.¹⁶

Nonetheless, this collective emerging market resistance to the 2008–09 shock has not yet resulted in the recuperation of pre-crisis growth rates, and growth recently has slowed in a number of emerging economies in our sample, including Argentina, Brazil, China, India, and Korea.¹⁷ Although this selective slowing confirms the need for deeper structural reforms in several countries,¹⁸ it does not negate the unprecedented achievement of developing and emerging economies as a group in rebounding from the global financial crisis. Moreover, although EE post-crisis growth rates have not yet recovered, they remain well above those in the advanced industrial countries when growth is measured both by aggregate rates weighted by economic size (as in table 1-1) and by simple group means (as in table 1-2). Subramanian and Kessler calculate that in 2010–12 the mean growth rate of developing economies as a group remained about 3 percent above the U.S. growth rate.¹⁹ What explains the resilience of most emerging economies in the face of the most daunting financial crisis to hit the global economy in more than seven decades?

Table 1-2. Crisis and Recovery: National GDP Growth, Various Countries^a

Percent

Sources: Data from International Monetary Fund, World Economic Outlook, April 2013.

a. Compound annual growth rates, using purchasing power parity GDP, with unweighted means.

b. The Asian 7 countries include China, India, Indonesia, Korea, Malaysia, the Philippines, and Thailand.

c. The Latin American 7 countries include Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.

The Missing Crisis: Contending Explanations

Both Latin America and Asia have had their share of tough times in recovering from earlier disruptions. Most fresh are memories of the “lost decade” in Latin America, which was triggered by the 1982 debt crisis, and the massive downturn in the Asian economies in the aftermath of the Asian financial crisis of the late 1990s.²⁰ In each case, major internal policy debates took place in economic ministries in Latin America, Asia, and beyond over what went wrong and what could be done to restore stability and growth in these crisis-ridden countries and regions. The standing explanations of these crises in the literature differed with respect to the weight given to domestic/institutional and international/systemic variables as causes of the crises. The domestic/institutional explanation, for example, faulted sovereign borrowers for failing to properly channel funds lent by foreign commercial banks into the kinds of macro-stabilization and microeconomic restructuring projects for which they were ostensibly borrowed; the international/systemic explanation stance blamed private international financiers for imposing the costs of their own poor lending decisions almost solely on borrowers.²¹

The subsequent prescriptions for policy reform offered by each camp were, unsurprisingly, quite different. They also reflected the usual divide between neoliberals, who called for economic opening and more market-based solutions to crises, and developmentalists, who called for more targeted public policies and strategic state intervention. In the end, the need for massive International Monetary Fund–backed bailout packages in both regions—Latin America in the 1980s and Asia in the 1990s—meant that market liberalizers, who dominated the international financial institutions (IFIs) and could impose obligatory conditions on borrowers, prevailed. Most countries were induced to adopt austerity measures in order to make balance-of-payments adjustments. It is that time-worn recipe that gradually morphed into what has been termed the “Washington Consensus,”²² a package of measures based on liberalization, privatization, and deregulation that by the late 1990s had been implemented in varying degrees throughout the developing and post-communist world.

In recent debates over the missing crisis in the emerging market countries both during and after 2008–09, both sides seem to be claiming victory. Market-oriented analysts point to the success of prior neoliberal reforms in preparing emerging economies to defend their financial sectors from the kinds of contagion that spread so quickly across emerging markets when the Mexican peso collapsed in 1994 and the Thai baht crashed in 1997.²³ The fact that the recent contagion emanated from the United States and subsequently from Western Europe makes the continued macroeconomic stability and growth within the emerging market countries all the more impressive. Although the global financial crisis highlighted massive market failures in the OECD bloc, the pro-market chorus has been quick to claim the EE rebound as a victory of its own. Meanwhile, those with a more heterodox bent argue that EE staying power in the 2000s rests just as much on strategic interventions and innovative public policies.²⁴

Our approach to sorting out some of these claims is intentionally eclectic, drawing on both quantitative and qualitative evidence from the now vast secondary literature and from our case studies. What such a methodology loses in parsimony it gains by bringing together contending explanations that are seldom considered jointly. A second novel element of our analytical strategy is our intentional focus on the experiences of larger emerging economies. Rather than following the typical econometric practice of considering each country's experience as a single observation and assigning equal weight to each in arriving at eventual research findings, we argue that there are both economic and political reasons to pay particular attention to regional leaders and larger economies. Given that regions such as East Asia and South America have trading patterns that are somewhat intraregionally integrated and that economic ideas and practices also diffuse intraregionally, it makes economic sense to focus on the bigger economies. In addition, our interest in evaluating the causal role of pre-crisis government policy choices leads us to concentrate on those countries whose material, cultural, and political capabilities tend to make them sources of regional policy innovation and diffusion.

We have generated three broad hypotheses drawn from the long-running debates over the virtues of policies that lean more heavily toward the market (“neoliberal”) and those of more proactive policies undertaken by the state (“developmentalist”). We also consider a...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Foreword
• Acknowledgments
• 1. The Puzzle
• 2. Chinese Financial Statecraft and the Response to the Global Financial Crisis
• 3. Koreas Victory over the Global Financial Crisis of 2008-09
• 4. Indias Response to the Global Financial Crisis: From Quick Rebound to Protracted Slowdown?
• 5. Southeast Asias Post-Crisis Recovery: So Far, so Good
• 6. The Global Financial Crisis and Latin American Economies
• 7. Macroprudence versus Macroprofligacy: Brazil, Argentina, and the Global Financial Crisis
• 8. Mexicos Recovery from the Global Financial Crisis
• 9. Lessons from the Country Case Studies
• Contributors
• Index
• Back Cover