How could the widely acknowledged real estate problems of Thailand’s banks in 1996 and 1997 have triggered such a far-reaching debt-and-development crisis?footnote1 The devaluation of the Thai baht in July 1997 was followed by currency crises or financial instability in Indonesia, Malaysia, the Philippines, Taiwan, Hong Kong, Korea, Estonia, Russia, Brazil, Australia and New Zealand. Commodity producers around the world have suffered. Yet there were few signs of impending crisis, such as rising interest rates in the g-7 countries or a sudden suspension of capital flows to developing countries after the baht devaluation. On the contrary, bank lending to Asia actually rose to a record level in the third quarter of 1997. The Japanese government’s de facto credit rating agency, the Japan Center for International Finance, gave Korea one of its highest credit ratings for any developing country in June 1997. The imf and the World Bank lavished praise upon the governments of the region through 1997, including on the Korean authorities as recently as September 1997.

What began as a debt crisis has become a fully fledged development crisis. Throughout this most successful of developing regions living standards are falling as unemployment rises and the effects of huge devaluations work through into higher import prices. Many millions of poor people are at risk, and many millions of people who were confident of middle-class status feel robbed of their lifetime savings and security. It is not a humanitarian tragedy on the scale of North Korea, but the loss of security and productivity is a tragedy nonetheless, almost as cruel as war.

Financial crises—speculative bubbles followed by collapse—have recurred throughout the history of capitalism. In the early 1980s Latin America, another fast-growing developing region, suddenly went into debt-and-development crisis and stopped rising up the world economic hierarchy. The Latin American crisis was due, according to the consensus of analysts, to the combination of bad macroeconomic policies and foreign borrowing by governments. That borrowing was wasteful and corrupt because done by governments rather than by private firms operating in competitive markets. But the Asian crisis has occurred in the opposite conditions. In East and Southeast Asia today most debt is private debt. And prior to the crisis, the macroeconomic ‘fundamentals’ looked fine. The countries in question have had low inflation, budget surpluses or only small deficits, and until recently stable or rising foreign exchange reserves. They have been growing fast. East and Southeast Asia accounted for a quarter of world output, but fully half of world growth over the 1990s and almost two-thirds of world capital spending. Firms throughout the region make products that sell in the most demanding markets—if the exchange rate is right.

There is little agreement on why the magnitude of the crisis has been so large, what can be done to get out of it, who will gain and who will loose, and what changes need to be made in international regimes to reduce the likelihood of repeats. These matters should be the subject of an international debate as important as the Bretton Woods conference at the end of the Second World War.

According to the imf, the solution entails domestic austerity programs to restore the capacity to repay foreign debt, and radical institutional change, including further liberalization of the financial sector. Many analysts have come forward to disagree. Indeed, a new ‘conventional wisdom’ among the imf’s critics has emerged, which goes like this:footnote2 The crisis is a crisis of liquidity more than solvency.footnote3 Creditors have ‘run’ on the currency and on domestic assets, leaving the borrowers unable to continue to finance their loans. It happened parrly because of excessive financial deregulation, including, above all, allowing firms to borrow abroad without any government control or coordination. The crisis has then built upon itself as each lender tries to call in loans and firms try to cut operating costs and sell assets, causing unemployment to rise and asset values to crash.

’Instead of dousing the fire, the imf in effect screamed fire in the theatre’, says Jeffrey Sachs.footnote4 Its insistence on shuttering many banks despite the absence of deposit insurance caused panicky depositors to withdraw their deposits in return for cash. Its insistence on cutting demand and liquidity has caused the bankruptcy or radical devaluation of the value of firms that were efficient and profitable, as well as those that were not. Its push for institutional liberalization in finance, corporate goverance and labour markets convinced creditors that the economics were structurally unsound.

The immediate goal must be to restore confidence, which requires overcoming the collective action problem in which no lender wants to re-finance for fear that others will not. Demand and liquidity must be increased, not reduced, in order to keep firms turning over. The imf should be concentrating its attention on organizing debt rescheduling negotiations and then in helping to erect the structure of financial regulation, especially at the border, that will help to minimize the risks of such a melt-down occurring again.