In this paper the crisis in Asia is reconsidered using the insights from an earlier modeling exercise by McKibbin and Martin (1998) but focussing on the nature of the likely recovery process in Asia as well as alternative scenarios that could significantly affect that recovery. Subsequent data and events to the crisis and analysis with the G-Cubed (Asia-Pacific) model suggests that the proximate cause of the crisis was revised expectations about profitability of investments and a subsequent increase in risk premiums for Asian economies.
To explore the policy options and vulnerabilities to further shocks eight simulations with the model are run grouped into three sets: short term policy changes, medium term policy changes and the longer term vulnerability of the region to external shocks – both positive and negative. The short term simulations are a monetary stimulus, a fiscal stimulus and a restoration of confidence eliminating the risk premiums on the financial assets of Asian economies. The medium term policy experiments are a round of global trade liberalizations as well as unilateral trade liberalization and a program of microeconomic reform that leads to a boost in productivity growth. The third set of simulations tests the longer term vulnerabilities to a stock market sell-off in the US leading to downturn in that country, another slump in the Japanese economy and a boost in growth in China.
The lesson from these simulations is that Asian economies need not be adversely hit by un-favorable external developments and they can take steps to reduce their own vulnerability to external shocks by judicious policies at home that encourage productivity growth and policies to properly appraise, manage and minimize risk. Now that the worst of the crisis has passed the temptation to not proceed with further reform would be a mistake. Good macroeconomic management, good governance, microeconomic reform and trade liberalization all have a significant role to play in Asia’s recovery and return to long term robust growth.