The 1997-98 Asian crisis: a property rights perspective.

• Author: Davidson, Sinclair

In 1997 the "Asian miracle" came to a sudden and dramatic end. A group of East Asian economics that had performed remarkably well over the previous two decades suddenly found their currencies under intense speculative pressure, their stock markets fell dramatically, and their economic growth rapidly declined. The Asian crisis spread to other emerging market economics, notably in Latin America and Russia. Speculation on the causes of the 1997-98 crisis varies from an old-fashioned financial panic (Radelet and Sachs 1998), to poor regulatory environments and conspiracy theories (Krugman 1999). Events such as this call for policy responses and for a reformation of the international "financial architecture," which McKinnon (1996) refers to as "the rules of the game." Irrespective of what the precise rules are, they have common objectives: To foster efficiency in trade of goods and assets; to provide stability; and to provide an equitable, socially acceptable distribution of income and wealth (Swoboda 1999:2).

Free markets appear capable of meeting all of these objectives. F. A. Hayek (1979) argues, for example, that free markets produce lower prices than any other economic system, while Herbert Grubel (1998) provides evidence that market-orientated economies have better human welfare along several categories (unemployment, human development, life expectancy, literacy, poverty, and income distributions). Dani Rodrik (1999) provides evidence that democracies (which are more likely to have market-based economies) pay higher wages, and have lower income inequalities, than nondemocracies. Proponents of altering the financial architecture, however, are not usually known to be free-market economists. Indeed, Alan Walters (1998: 304) has argued that "the most egregious errors ... were due to the neglect of the most simple principles of economies." Given that the underlying basis of all capital formation and economic growth is a well-specified system of property rights, it seems appropriate to investigate the crisis in terms of property rights.

The importance of property rights has long been paid lip service. The theoretical literature has included contributions by Coase (1960) and North (1981, 1990). In recent years, empirical evidence has contributed to our understanding of the interrelationship between property rights and economic development. In this respect, and important for our purposes, Johnson et al. (2000) find that investor protection and enforcement of property rights explain the 1997-98 decline in emerging markets better than standard macroeconomic explanations.

Governments have incentives to involve themselves in economic activity. In order to reduce competition and increase the scope for opportunism, governments often establish an inefficient set of property rights. The set of property rights, however, that maximizes the utility of those in power also exposes the economy to higher risks and penalties in unfavorable states of nature. (1) These property rights structures are proxied by economic, political, and civil freedoms, and by the exchange rate regime. In particular, an inefficient set of property rights will manifest itself as a mismatch between economic, political, and civil rights. This article presents empirical evidence consistent with this expected behavior. Using stock market returns for the 1997-98 crisis as a proxy for performance, the data show that those economies with mismatched economic, political, and civil rights performed poorly. Similarly, those economies with pegged and managed exchange rate regimes performed worse than those with floating exchange rate regimes.

The Grabbing-Hand State, Property Rights, and Exchange Rate Regimes

Neoinstitutional economics posits a "grabbing hand" theory of the state (Shleifer and Vishny 1998). The objective of the state in this type of model is to maximize revenue and influence--and, for those individuals who control the state, to stay in office. The state, however, faces constraints: Internal rivals may attempt to control it, and external rivals may undermine its power and authority. The state does not simply carry out the wishes of a particular elite, nor does it act as an impartial umpire and practice benign neglect once property rights are specified. Rather, the state provides the "internal rules of the game" by establishing property rights that allow individuals to undertake economic activity; it adjudicates disputes but is also a self-interested player of the game.

The internal rules give rise to an economy's "structural production frontier" that defines legal economic activity. Eggertsson (1990) refers to the neoclassical production frontier as the "technical frontier." Technology, technical progress, factor endowments, and the division of labor are direct determinants of the technical frontier. In addition, the structural frontier has an indirect impact on the technical frontier. As is well known, growth (and the structural frontier) is affected by the extent to which social and private cost-benefit ratios converge (North 1981, 1990). Both social and private cost-benefit ratios are determined largely by the economic and political-civil freedoms within an economy, which suggests that, on average, the technical frontier will converge to the structural frontier. (2) In neoclassical theory the structural and technical frontiers always coincide. However, with positive transaction costs, this need not be the case.

Economic and political-civil rights are key determinants of the structural frontier. Indeed, an argument can be made that these two categories of rights are merely two sides of the same coin and are mutually reinforcing (Hayek 1944; Friedman 1962; Barro 1997, 1999). The connection between economic freedom and political freedom, however, is considered to be controversial. At a theoretical level, the relationship is unclear (Barro 1997). The Lipset (1959) hypothesis maintains that political freedom requires a minimum level of prosperity to survive. An alternative interpretation is that political freedom is a luxury for the rich. (3) Under this alternative view a driving force for developing economies is a benevolent dictatorship, which allows for development while restraining interest group polities and inefficient redistributive policies. (4) There are some ex post examples of this type of state: Hong Kong and Singapore are immediately obvious. It is difficult, if not impossible, to establish ex ante conditions for this type of state. Empirical evidence does support the Lipset (1959) hypothesis. Barro (1997) provicles evidence using cross-section panel data. In addition, Farr, Lord, and Wolfenbarger (1998) report that economic freedom Granger-causes economic growth, which in turn Granger-causes political freedom. Specifically, they segment their data into industrial and nonindustrial economies and find no difference in the relationships, undermining the "political rights as a luxury good" view. A benevolent dictatorship is a risky investment...