Catalog

Ten years after the crisis:
The facts about investment and growth

Introduction

Ten years have passed since Asia's twin currency and banking crises. In many ways, an air of normality has returned. Per capita incomes in the crisis economies now surpass their precrisis peaks, social indicators are improving, and the region is again enjoying growth that is the envy of many parts of the developing world (Figure 1.4.1).

But despite welcome recovery, the effect of the crisis has not been completely erased. Growth has settled on a lower trajectory. Comparing the period 2000-2006 with 1990-1996, growth has slipped by an average of 2.5% a year in the five countries that were most directly affected (Indonesia, Korea, Malaysia, Philippines, and Thailand). The persistence of such a gap implies large permanent losses of income compared with precrisis trends. Indeed, if the impacts of the crisis on income levels are to prove transitory, a period of faster than "normal" growth would be required to compensate for the output "lost" during the crisis years.

An important question, then, is what explains the slowing of output growth: Is the deceleration simply an artifact of the precrisis boom and a shift to something more sustainable? Or is it symptomatic of deeper constraints that may be preventing output from matching its potential? This chapter of the Asian Development Outlook 2007 looks more closely at these questions by examining the experiences of the five countries that were in the front line of the crisis.

Data on the evolution of growth in the five crisis countries are presented in the next section, Has the crisis slowed growth? These confirm that "trend" growth has fallen relative to precrisis "norms. "A growth accounting framework is then used to dissect growth in the third section, Proximate causes of slower growth. In only two of the five countries has there been a slowing in the rate of growth of employment and the impact of this on GDP growth has probably been quite small. A sharp deceleration in the rate of fixed capital formation, particularly by the private sector, is likely to have had a more pronounced impact on output growth. On a number of measures, investment rates now seem "too low. "

In the following section, Why investment has tumbled, possible reasons for the decline in investment are aired. Some of the factors that held investment back immediately following the crisis have receded. For example, it seems unlikely that financing constraints are important or that there is still significant underutilized capacity. Likewise, the idea that investment has been redirected from the crisis countries to competitive export platforms in the People's Republic of China (PRC) and Viet Nam does not bear closer scrutiny.

Another idea is that "optimal" investment rates have come down. In the precrisis period, countries relied too heavily on investment for growth, and to a significant extent investment spending was wasted (see, e.g., Crafts 1999). But as a result of extensive policy and institutional reforms, saving is possibly now being allocated more efficiently, generating faster growth for a given investment rate. Although it is possible that the "optimal" investment rate is lower, this would not explain why output growth as well as investment is in a lower gear.

Perhaps the crisis has shaken beliefs about the ability of countries to sustain growth over the long term? Certainly, governments have lowered their ambitions on growth (as outlined in various planning documents) and, through rapid reserves accumulation, have revealed strong precautionary instincts. Likewise, private sector investors, rattled by losses and allergic to risks, and perhaps taking their cue from government, may have scaled back on what once would have been considered viable projects. There is also evidence to suggest that private investors have been busy fortifying their financial defenses by reallocating surpluses from "hard" investments to capital reserves and other liquid assets.

As expectations and confidence can exercise a decisive impact on behavior and outcomes, the penultimate section, Risk, uncertainty, and investment behavior, asks whether there is any evidence to support the idea that perceptions of uncertainty and risk have increased.

The last section presents conclusions, and suggests that the challenge of lifting investment and investor confidence lies in lighter but more effective regulation, improved governance, exposing sheltered activities to more competition, and building modern and efficient financial systems.