Financial Crises in 1997 – 2001 Shortcomings of the International Financial Architecture

What economists and policy-makers for a long time had considered as virtually impossible has happened: except for North America and Europe, since 1997 the world financial system has moved with dazzling speed from crisis to crisis. Major countries in Asia, Europe and Latin America collapsed or fell prey to the contagiousness of the crisis. It all started in Thailand in the summer of 1997, quickly spread to other South-East Asian countries, dragged down Japan, infested Russia and spread to Latin America. The starting point in South East Asia is all the more remarkable as these economies were admired world-wide for their achievements and the World Bank – surely a very involved and knowledgeable institution – wondered in a publication of 1993 about explanations for the "Asian miracle". And, indeed, these countries had accomplished the miracle of lifting themselves out of poverty during the last 20 –30 years. Their success was sustained for several decades. And this success was achieved despite or because of, a social organisation in opposition to Western values: all these countries had limited democracy and, instead, substantial oligarchic structures with widespread corruption and extensive import protection and state involvement. But they were successful. Hence the search for "Asian values" to understand the "Asian miracle". Had the crisis –with a major financial turmoil including currency collapse, widespread bankruptcy of the banking and corporate sector, drop in GDP – been linked to Asia one could have argued that special Asian factors (excessively rapid growth, corruption, fixed exchange rates, etc…) were at work. But in the meantime the list of victims of financial turmoil lengthened: Russia, Brazil, Argentina and Turkey. And whilst Korea and Malaysia came out of the crisis relatively unscathed, Indonesia is still on the brink. Are there lessons to be drawn? The first lesson of the crisis is that there is much more systemic risk than previously admitted. In 1997 and 1998 lenders and investors had reconsidered emerging market risk as a whole and changed tack abruptly, without a clear change in fundamentals. The second is that the IMF's surveillance does not work as well as assumed and that the IMF has difficulties in effectively stemming an unfolding crisis. The world markets have become more global, but international institutions have not kept pace. The official mission of the IMF is to assist countries with a balance of payments problem. But in fact the IMF is expected to carry out surveillance to prevent financial crises and their spreading to other countries and to assist countries with international liquidity problems. It would be unreasonable to expect the IMF to deal well with all these expectations for which it was not set up. This paper argues that the IMF, more often than not, has made the severity of a crisis worse.