Financial Crisis, Contagion, and Containment: From Asia to Argentina (a review)

In Financial Crisis, Contagion, and Containment: From Asia to Argentina, Padma Desai addresses important concerns about emerging market economies’ compatibility with inherently volatile global financial markets. Desai is the Gladys and Roland Harriman Professor of Comparative Economic Systems and director of the Center for Transition Economies at Columbia University. She adopts a comparative center–periphery framework for exploring both the origin and resolution of financial crises, presenting evidence from the United States, Japan, the European Union, and various emerging market economies. The book’s nontechnical form will appeal not only to scholars and students but also to practitioners.

Desai’s comparative perspective highlights the differences between larger developed economies and smaller emerging market economies. For example, she states that “the lack of institutional and structural readiness of the borrowing economies in the periphery for absorbing capital inflows can best be contrasted by examining the preparedness of the economies in the center for voluntarily attracting these flows and maintaining stable economic growth.” Throughout the book, Desai expresses provocative criticisms of International Monetary Fund (IMF) policy prescriptions in its attempt to sustain free capital mobility for crisis-ridden economies.

The book provides a critical account of the financial and economic crises that negatively affected Southeast Asia, Russia, Latin America, and other regions following the July 1997 devaluation of the Thai baht. Retracing the history of the 1997–98 East Asian financial crisis, also called the “Asian contagion,” Desai argues that the region’s opening to the free flow of capital was encouraged by private and institutional lenders in the global economy’s US-led developed center. Financial turmoil eventually ensued in the smaller, vulnerable peripheral economies. The dislocations included Russia’s default on its government debt and devaluation of the ruble in August 1998, Brazil’s devaluation of the real in February 1999, and the 1998–2002 Argentine Great Depression.

Desai’s panoramic theme contains four key propositions. First, some economies, such as that of the United States, are better prepared to recover from a slowdown or recession than smaller, peripheral economies.

Second, the economic problems of the 1990s in the developed center were homegrown and their resolution domestically driven. In contrast, peripheral economies’ financial crises originated from outside their borders.

Third, the premature opening of emerging market economies to capital flows from the developed center relied on the assumption that these peripheral economies had similar absorptive capacity to developed ones. The developed center overlooked emerging economies’ lack of necessary institutions and corporate practices for investors and borrowers to benefit in the long term from capital flows.

Fourth, the IMF's preference for capital flows into emerging market economies; its standard prescriptions of fiscal and monetary austerity in crisis-swept economies; its lack of flexibility in initiating country-specific policy responses; and its insistence on such arrangements as a floating exchange rate, free capital mobility, and monetary policy independence all create a negative view of its policy agenda with respect to capital account liberalization in emerging market economies. According to Desai, the 1990s crises represent the costs of extending financial globalization that peripheral economies must undergo in order to reap its eventual benefits.

Unlike developed economies, the emerging market economies discussed in the book facilitated financial and currency crises from destabilizing foreign capital flows. These economies struggled with IMF-led policy prescriptions, which intensified the downturns induced by short-term capital outflows. The author presents models showing the effects of volatile short-term capital flows in initiating financial crises and causing contagion.

Desai argues that emerging market economies with weak institutions and political maneuverability cannot be expected to grow crisis-free in a world of unrestricted capital mobility and floating exchange rates. The book focuses on financial crises while recognizing that the IMF has a questionable record in rescuing crisis-ridden economies. Desai contends that financial globalization is a complex process that can be destructive. She outlines an alternative approach whereby lenders from developed countries and borrowers in peripheral economies can benefit from the collective gains of global capital flows.

The book concludes with three recommendations for the IMF:

• Tailor a flexible policy framework based on the IMF’s monitoring of borrowing countries’ financial sector shortcomings.
• Adopt floating exchange rate regimes, supported by selective capital account controls, that will confer monetary policy autonomy on emerging market central banks.
• Resolve debt settlement on a case-by-case basis through either formal IMF engagement in the bailout funding or, preferably, informal backdoor negotiations.

The IMF-led external pressure embedded in crisis bailout packaging with free capital mobility has not resulted in rapid reform of financial sector inadequacies in peripheral economies. These shortcomings will disappear with varying speed in different countries as governments recognize that the new practices and institutions of the Anglo-American-style market economy are worth modifying and destroying traditional arrangements that constrain collective gains from the free flow of global capital.

In summary, Financial Crisis, Contagion, and Containment is thought-provoking for economic and financial practitioners who want to better understand financial crises and the IMF’s attendant policy responses. Although originally written in 2003, the book remains relevant today. Practitioners will benefit from increased awareness of the causes, similarities, differences, and potential remedies relating to these financially devastating events.

—M.K.B.