This summer marks the 10th anniversary of the 1997 Asian
financial crisis. The 1997 crisis triggered extensive economic and
political unrest in emerging Asian markets, sending many countries
from Thailand to South Korea into recession. At the time, one
common interpretation was that the crisis debunked the "Asian
Miracle." Capitalism and globalization were repudiated and blamed
for the bursting of currency and property bubbles and the resultant
The 10 years since the crisis have shown that this
interpretation was exaggerated. The countries that were most
affected by the crisis have been recovering by embracing the free
market and globalization. Asia is once again the most dynamic
region in the global economy. In hindsight, the 1997 crisis was
nothing more than a regional recession, a transitory setback that
spurred more openness and transparency.
Continuing economic recovery will depend critically on
further strengthening of the institutional framework of the
regional economy. Advancing economic freedom is the way
forward, not only to reduce vulnerability to future crises, but
also to establish the institutional infrastructure essential for
dynamic and sustainable economic growth. It is in America's
interest to pursue policies that encourage such progress in
these countries. Indeed, it should be a strategic, integral
part of U.S. foreign policy in Asia.
Asia's economic environment has changed dramatically in the
past 10 years. Most noticeably, China has catapulted itself onto
the global stage by flexing its economic and political muscles. In
this new environment in which some fear that American economic
and trade leadership in Asia is fading, Washington should seize the
opportunity to reinforce its vision of economic freedom and
prosperity in the region.
The 1997 Crisis and Subsequent
The Asian financial crisis began in Thailand in July 1997 and
then spread to neighboring countries, including Malaysia,
Indonesia, and South Korea. In general, a period of financial
turmoil in foreign exchange markets eroded investor
confidence, triggering sharp drops in currency values. Rapid
and sharp capital outflows resulted in further currency
devaluations, stock market crashes, soaring inflation, and a
severe economic recession.
A number of complex factors appear to have contributed to the
financial crisis. Most diagnoses center around a combination of
factors, including overreliance on short-term foreign capital,
excessive investment in real estate, inadequate financial
supervision, and politically motivated credit allocations that
resulted in a massive non-performing loan problem.
Whether measured in terms of output, investment, or jobs,
the crisis caused considerable economic distress in the
affected countries. Nervous investors moved over $100 billion out
of the region in 1997-1998--about 5 percent of the region's annual
gross domestic product (GDP). In a matter of months, the number of
unemployed workers increased by over 800,000 in Indonesia, 1.5
million in Thailand, and about 1.35 million in South Korea. As
currency values plummeted, people's effective wages also dropped.
By the end of 1998, real wages had dropped by 12.5 percent in South
Korea and by 6 percent in Thailand.
The impact of the financial crisis went beyond the economic
landscape. While Thailand and South Korea went through peaceful
changes in their governments, other countries experienced
political upheavals after the economic dislocation.
However, as painful as it was, the crisis has also given
affected countries the incentives and political momentum needed to
make their economic systems more open and transparent. Over
the past decade, these countries have attempted to repair the
structural defects that led to the crisis. Unlike previous
economic crises in Mexico and Latin America, the Asian crisis was
not caused by excessive government spending or unmanageable
public debt, but instead was mainly rooted in the private sector.
To their credit, most Asian governments have taken steps to
address their problems by reforming financial sectors, improving
transparency of regulations, strengthening corporate
governance, and opening their markets to more competition. In
addition, they have continued to promote their economic
advantages by embracing foreign trade and seizing opportunities to
integrate themselves into the global trading system. (See Chart 1.)
Their overall total trade with the world has increased despite
Although it took time for post-crisis reforms to restore
investor confidence, the subsequent recovery was stronger and
swifter than has been typical in other emerging-market financial
crises. Ten years after the financial crisis, the
Asian countries are rebounding. Real GDP per capita in the affected
countries has passed its pre-crisis level. (See Chart 2.)
Production fell sharply in 1997 and 1998, but positive growth
resumed almost immediately. Most countries had bounced back to the
same point by 2003 and are now even more "miraculous" than
During 1998, the validity of Asia's economic success in
previous decades was questioned. One interpretation of the
economic disturbance was that the Asian Miracle was a mirage.
According to The Economist, some observers argued that
"the Asian miracle was always a sham" and predicted "a decade of
lost growth in East Asia, like the one that Latin America went
through after its debt crisis in the early 1980s."
Yet the economic recovery after the crisis has proven that
reports of the Asian Miracle's demise were premature. In
hindsight, the crisis was just a temporary setback. The late Milton
Friedman stated that the "Asian Miracle is real" and observed
that the thought that "one crisis discredits three decades of
growth is allowing the headlines to overwhelm history." As the
recovery has shown, Friedman was correct in predicting that the
Asian economies would fix their problems and get back on track.
Indeed, the temporary setback provided needed momentum to
adjust their economic systems to the constantly changing
The aftermath of the 1997 crisis also generated accusations
against market capitalism and globalization. Much of this criticism
centered on the notion that free-market fundamentalism not
only caused the economic crisis, but also exacerbated and
spread it. Yet the backlash against globalization in the region was
neither strong nor widespread. Instead, the affected countries
continued to embrace globalization and the free-market system
rather than withdraw from them, and this has made their relatively
swift recoveries possible.
The renewal of the Asian Miracle is especially relevant to
China, which avoided the regional recession. The view that free
markets were the core problem is especially popular among China's
elites, who still believe that strong economic central
planning is superior to free markets. China's leaders would do
well to note that most of the post-crisis economies are now more
prosperous than they were before the crisis in terms of per capita
income and that the supposed debunking of capitalism was itself a
Challenges and Tasks Beyond the
Beyond celebrating the economic recovery from the crisis, the
governments of the affected countries should use its 10-year
anniversary as a time to strengthen the ongoing recovery by
bolstering their commitment to greater economic freedom. They
should guard against complacency and be steadfast in providing
unambiguous policy direction to deal effectively with reform
fatigue. Lingering uncertainty is one of the biggest
constraints on entrepreneurial activities in their
Today's economic growth and prosperity depend on maintaining and
improving an environment in which entrepreneurial activities and
innovation can flourish. Investment capital and entrepreneurial
talent will flow toward economies with low taxes, secure
property rights, sound money, and sensible regulatory policies.
Countries with higher degrees of openness and flexibility benefit
from the free exchange of commerce and thereby enjoy
sustainable economic growth and prosperity.
This relationship is documented in the Index of Economic
Freedom, published by The Heritage Foundation and The
Wall Street Journal, which measures economic freedom around the
globe. The Index identifies the strong
synergies among the 10 key ingredients of economic freedom, which
include (among others) low tax rates, low tariffs, low levels of
regulation, limited government intervention, strong property
rights, open capital markets, and low levels of corruption. For the
past 13 years, the Index has demonstrated that economic
freedom is crucial to economic development and sustained
prosperity in an increasingly integrated global market.
Why would economic freedom contribute to economic growth and
prosperity? In a framework of economic freedom, people are free to
use their abilities and have a better chance of success when
trying their innovative ideas and starting new entrepreneurial
activities. With more opportunities and the prospect of greater
returns, people are more willing to invest. As a result, the level
of investment and innovation increases.
This is how virtuous cycles of expanding prosperity are
created. The experiences of Hong Kong, Ireland, and Chile have
shown that forces of economic freedom encourage
entrepreneurship and boost productivity. Simply put, around the
world, countries with a higher degree of and strong commitment
to economic freedom enjoy higher standards of living and
The empirical findings of the Index confirm this.
Countries with greater economic freedom are more prosperous than
are those with less economic freedom. Chart 3 clearly shows
the statistically positive relationship between economic freedom
and GDP per capita. Economies built on greater economic freedom are
inherently and fundamentally stronger.
Asia's economies follow the same pattern. Chart 4 shows the
positive relationship between economic freedom and prosperity in
the region. This relationship holds for the countries that
were most affected by the Asian crisis.
Economic Freedom in the Four Most
Progress toward greater economic freedom in the countries most
affected by the Asian crisis still faces lingering obstacles. While
economic freedom in South Korea, Thailand, and Malaysia is above
the global average, none of them has a truly "free" economy.
(See Chart 5.) Indonesia's economy is classified as "mostly
unfree," and its level of economic freedom is lower than the world
average. Slow and sometimes inconsistent reform
continues to hold these countries back from reaching their true
This may explain why their investment rates have stagnated
despite their relatively swift economic recovery after the
crisis. According to the Asian Development Bank, the
countries' economic growth in recent years "has settled on a
lower trajectory." From 1990-1996 to 2000-2006, the bank reports
that their economic growth rates have slowed by an average of
2.5 percentage points per year. Their investment rates, which
plunged after the financial crisis, have not returned to pre-crisis
Table 1 shows the status of overall economic freedom and each of
the 10 freedoms in the four countries. Each country has reasonably
good scores in some of the 10 key factors of economic freedom, such
as fiscal freedom, monetary freedom, and freedom from government,
which measures government spending, but needs to improve
significantly in other key areas.
South Korea. After the financial meltdown, South
Korea implemented many reforms to correct the weaknesses that led
to the crisis. Nonperforming loans have been dealt with
effectively through extensive financial reforms. The banking sector
has been strengthened. Today, South Korea's economy is 68.6
percent free and ranks as the world's 36th freest.
Yet South Korea still has room for improvement in economic
freedom. For example, although its regulatory process has been
improved, bureaucracy and lack of transparency still hinder
entrepreneurial activities. South Korea's labor freedom (57.7
percent free) is constrained by inflexible employment
regulations that hamper growth in employment and productivity
despite the reforms that have been made.
Malaysia. In response to the financial crisis,
Malaysia imposed capital controls and restrictions, but the
government has since removed them. Malaysia's economy is
rated 65.8 percent free in the 2007 Index and enjoys high
levels of monetary freedom and labor freedom, but the
dominance of state enterprises in several sectors restrains
investment and limits business opportunities. Although it has
gradually withdrawn from direct participation in enterprises, the
government still retains large industrial and commercial
Investment freedom and financial freedom are the two weakest
areas. Malaysia encourages foreign direct investment in
export-oriented manufacturing and high-technology industries, but
the state maintains considerable discretionary authority over
individual investments and restricts foreign investment in
Thailand. After the 1997 financial crisis,
Thailand implemented significant reforms to achieve fiscal and
monetary stability, strengthen economic governance, and boost
incentives for increased competition. According to the 2007
Index, Thailand's economic freedom is 65.6 percent, with
relatively high degrees of labor freedom and business freedom.
Despite economic reforms made over the past few years, Thailand
still needs to enhance market transparency and implement several
structural reforms in the financial sector. Weak investment
freedom, financial freedom, property rights, and freedom from
corruption still limit Thailand's overall economic
Greater policy uncertainty also looms. Thailand had been
negotiating a free trade agreement (FTA) with the U.S. that could
have locked in ongoing reform efforts to enhance its economic
freedom. However, negotiations were suspended after the coup in
September 2006. Private investment growth has been declining in
recent years, and the Thai Cabinet's recent amendments to the
Foreign Business Act are viewed as more restrictive.
Indonesia. Indonesia's economy is 55.1 percent
free, which is lower than the world average. Overall progress on
reform has been slow. Commitment to economic freedom has not been
strong enough to bring tangible improvements to the lives of
ordinary Indonesians, and this sense of drift is undermining
confidence in economic reforms. The government still plays a
significant role in economic activities, and 158 state-owned
enterprises dominate many sectors of the economy. The state also
controls prices on several basic goods, including fuel, rice, and
Unemployment and lack of economic opportunity remain serious
problems, and labor market reforms have been abandoned in the face
of strong trade union opposition. As indicated by its low
score on property rights, Indonesia also continues to suffer
from a weak and non-transparent judicial system. The
commercial courts, although equipped with a new
bankruptcy law, have proven ineffective.
In each of these four countries, a stronger commitment to
economic freedom is needed to reinforce the ongoing economic
recovery and respond positively to constant changes in the global
economy. As the Index findings show, countries that
implement partial measures to avoid short-term pain run a high risk
of sacrificing long-term prosperity, falling behind innovation
elsewhere, and making themselves more vulnerable to economic
Changing Asia's Economic
For their countries to evolve into more competitive and
dynamic economies, Asian governments should bolster their
commitment to and perseverance in advancing economic freedom. Similarly, the U.S.
should pursue policies that encourage this progress, especially in
This is becoming more of a strategic necessity for U.S. foreign
policy in Asia, where the economic environment is very different
from the environment that existed 10 years ago. Most noticeably,
China has catapulted onto the global stage with an average annual
economic growth rate of more than 10 percent over the past
decade. China's economic diplomacy in the region
has intensified dramatically since 1997, when China began its "soft
power emergence" by receiving credit for not devaluing the
yuan. Accession to the World Trade Organization
in December 2001 increased the momentum for China's economic rise,
shifting patterns of world trade, particularly in Asia.
In this new environment in which some fear that America's
economic leadership in Asia is fading, the U.S. should seize the
opportunity to reinforce its vision of economic freedom and
prosperity in the region. However, growing protectionist sentiment
in Congress will only undermine U.S. economic diplomacy in Asia,
which is home to many vital U.S. allies. More important, the
growing perception that the U.S. is turning against free trade will
negatively affect long-term U.S. interests.
To strengthen American leadership in Asia, expand economic
freedom in Asia, and counter China's growing economic influence in
the region, Washington should:
- Support countries' efforts to increase their economic
freedom. Economic engagement with South Korea, Malaysia,
Thailand, and Indonesia should incorporate the broader goal of
upgrading their economic systems with greater economic
freedom. While a bold entrepreneurship has played a key role in
their tremendous economic success, their systems perpetuate
barriers that limit entrepreneurial opportunities. These countries
need strong political leadership to address the more difficult
issues that keep them from achieving truly free economies.
- Encourage further trade and investment liberalization
by renewing the President's trade promotion authority.
Liberalizing trade and investment would help these countries to
upgrade their economic systems with greater economic freedom. Three
of the four countries have pursued FTAs with the U.S. in recent
years. The U.S. and South Korea recently concluded an FTA, but
Congress has not ratified it. The U.S. has been negotiating an FTA
with Malaysia and was negotiating an FTA with Thailand until the
coup in September 2006. Finally, Indonesia has expressed great
interest in negotiating an FTA with the United States.
Accelerating the liberalization of free trade and investment would
help to lock in these countries' reform efforts and to foster
continued economic stability. However, by not renewing the
President's trade promotion authority, Congress is
undermining U.S. economic leadership and missing an opportunity to
strengthen economic freedom in the region.
In hindsight, the 1997 Asian crisis was just a regional
recession, a temporary setback that spurred reform that created a
more open and transparent economic system. Ten years after the
financial crisis, the countries that were most affected by it
are recovering, but continued economic recovery will depend on
further strengthening of the institutional frameworks of their
economies to enhance economic freedom.
Improving and maintaining economic freedom is the only reliable
way to generate positive cycles of economic growth and enduring
prosperity. America should pursue policies that support this
progress and reinvigorate U.S. economic leadership by
reaffirming its vision of economic freedom and prosperity
in this rapidly changing region.
Anthony B. Kim is a Policy
Analyst in the Center for International Trade and Economics at The
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Capital controls imposed by the Malaysian government in September
1998 have not yielded major benefits. For a comprehensive analysis,
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Economist Intelligence Unit, "Country Monitor," November 27,
TPA expired on July 1, 2007.