Mexico Redux? Making Sense of the Financial Crisis of 1997-98
Grabel, Ilene, Journal of Economic Issues
Beginning in May 1997, financial crisis swept across Southeast Asia and extended to Brazil and Russia. These events are notable because the crisis took investors and International Monetary Fund (IMF)-World Bank officials completely by surprise, and especially because they occurred after the IMF had implemented what were heralded as important safeguards, embodied in the "Special Information Dissemination Standard," following the events in Mexico in 1994-95.
My paper is motivated by the parallels in the conventional wisdom on the causes of the current and the earlier Mexican crises. In the Mexican case, what I elsewhere termed the "Mexican exceptionalism thesis" contends that the crisis was largely an aberration stemming from the country's "peculiarities" (viz., economic mismanagement, corruption, and instability) [Grabel 1996a, 1996b]. An interesting feature of the current crisis is the ubiquitous claim of exceptionalism that is again being invoked by neoclassical economists to explain these events. In the Southeast Asian cases, much is being made of the seemingly newly discovered - yet deeply rooted - patterns of corruption, real estate speculation, and misguided government policies.
My paper presents arguments against the exceptionalist explanations of the current crisis. I argue that the current crisis is principally a result of the failed neoliberal policy regime that embraces the ideology of free capital flows. In efforts to attract private foreign capital flows and as a consequence of domestic and international political pressures,(1) governments in emerging economies have over the last decade pursued programs of internal and external financial liberalization.(2) Liberalization created incentives and opportunities for the private sector in Southeast Asia to rely excessively on hard-currency denominated foreign loans, while also opening the economy to speculative inflows of portfolio investment. In the absence of sufficient foreign exchange reserves and mechanisms to control foreign capital flows, the reliance on these two types of private capital flows rendered these economies vulnerable to the self-reinforcing cycle of investor exit, currency depreciation, and financial crisis. I refer to the vulnerability to exit and currency risk as the "problem of increased risk potential." Once this increased risk potential was realized and the crisis emerged, governments found that they were unable to implement non-neoliberal economic policies insofar as the IMF explicitly precluded these alternatives. I call this the problem of "constrained policy autonomy." Paradoxically, the pursuit of further liberalization and of continued financial opening has introduced problems of greater risk potential to these economies and has also induced serious recessions. In concluding the paper, I offer some thoughts on the types of preventative measures that policymakers in emerging economies should consider in order that history not repeat itself (again).
Stylized Facts of the Crisis of 1997-98
During the late 1980s, inward portfolio investment to Southeast Asian (and other emerging) economies increased dramatically because of the opportunities presented by financial liberalization. These portfolio investment inflows helped fuel the boom in speculative activities across the region. Private lending to and within Southeast Asia also grew dramatically during this period, as increased international financial integration (made possible by financial liberalization) gave domestic banks and borrowers access to hard-currency denominated loans. This high degree of leveraging of the private sector was also made possible by the region's real estate boom, which inflated collateral values.
By mid-1996, the region began to show outward signs of difficulty. The decline in property and hence collateral values posed problems for the domestic banking industry. Moreover, as the Japanese economy's difficulties deepened, Japanese foreign direct investment (FDI) and lending slowed. …