WORLD TRADE
ORGANIZATIONWT/WGTDF/W/7/Add.1
25 July 2002
(02-4114)
Working Group on Trade, Debt and Finance Original:  English
COMMUNICATION FROM OECD 1
Addendum
FINANCIAL CRISES:  IMPLICATIONS FOR TRADE AND TRADE POLICY
I. INTRODUCTION
1. This note is based, in part, on work done at OECD in the aftermath of the 1997-98 Asian
financial crisis.  A number of guiding principles emerged from that work – principles which have
been re-affirmed in more recent analysis but which also drew on much earlier experience, in particularthe economic lessons of the 1930s.  The note, offered as background to the deliberations of the
Working Group on Trade, Debt and Finance, addresses two issues: the effect of financial crisis on
trade (section II) and the role of trade policy in responding to financial crisis (section III).
II. THE EFFECTS OF FINANCIAL CRISIS ON TRADE
2. What would one have expected to happen in the early aftermath of the 1997-98 Asian
financial crisis?
• Important movements in nominal exchange rates throughout Asia would lead to significant
changes in the pattern of relative competiti veness, confusing the price signals on which
international trade depends.   This change would affect both the volume and composition of
international trade flows.  Depreciating currencies in the Asia region would raise relative import
prices, and enhance the competitiveness of domestic producers.  In the case of a real depreciation,
a shift in domestic (or internal) terms of trad e would cause a decline in the demand for imported
consumer goods while increasing the demand for intermediate inputs used in the production oftraded goods.
• In addition, lower spending by consumers and investors in the Asia region would lead to
growing excess capacity in many industries , putting downward pressure on prices.   Thus, even
if the volume of exports increased, declining export prices would still reduce export dollar
revenues.
                                                     
1 This paper has been prepared by Ken Heydon, Deputy-Director, Trade Directorate, OECD, with help
from Nora Dihel, Jean Le Cocguic and Janet West.  The views are those of the author and are not necessarilyshared by Members of the OECD.WT/WGTDF/W/7/Add.1
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3. This textbook response is close to what happened.
• Massive import contractions were recorded for the ASEAN 4 (Indonesia, Malaysia, the
Philippines and Thailand) and Korea markets .  First quarter 1998 imports into Thailand and
Indonesia declined by respectively, 40 and 36 per cent relative to the first quarter 1997;  while
Malaysia and the Philippines posted declines of about 19 and 8 per cent, respectively.  First
quarter 1998 imports into Korea declined by a trade-weighted average of 35 per cent; higher thanaverage proportional declines affected imports from Saudi Arabia, Japan and Singapore; while
lower than average declines affected imports originating from Australia and Kuwait.
• The delay in any export boom triggered by cu rrency depreciation was indeed realised .  The
value of Indonesia's first quarter 1998 exports contracted by 2.5 per cent relative to their level in
the first quarter of 1997, Malaysia's by about 11 per cent and Thailand's by some 5 per cent.
Thailand's volume  of exports grew at an annualised rate of 15 per cent.  However, this volume
increase was more than fully offset by declining export unit values.  The high tradecomplementarity among ASEAN 4 exports, coupled with their drive to expand exports and
market share simultaneously may have contributed to such declines in export prices.  Moreover,
in something of a variation to the textbook response, imports of capital goods and intermediate
products actually declined, further constraining an export-led recovery.
• Meanwhile exports from other parts of Asia remained robust  – China's and Japan's exports
during the first quarter of 1998 grew respectively by 13 and 5 per cent over their first quarter 1997levels.
• The collapse in import demand in the ASEAN 4 plus Korea together with strong export growth
in other parts of Asia, and sluggishness in Japan, was accommodated by a decline in intra-
Asian trade and an increase in im ports in regions outside Asia.  Comparing European Union
imports during the first two months of 1998 with those reported a year earlier for the same period,
imports from the Asia region registered major gr owth rates.  EU imports from Korea increased by
as much as 28 per cent.  Those from the Philippines, Thailand, Chinese Taipei and China
registered growth in the 22 to 25 per cent range.  Imports from Japan experienced a growth rate of
16 per cent between the two periods, and those from Singapore went up by 20 per cent.  UnitedStates imports from Thailand increased by 26 per cent during the period January - July 1998 as
compared with the same period in 1997.  Those originating from the Philippines rose by 18 per
cent; imports from Hong Kong and Malaysia increased by 8 and 4 per cent, respectively.  In turn,
exports from the EU and US experienced a major shift in destination, away from those parts of
Asia in crisis and towards one another and other regions, such as Latin America.
4. There was inherent in this situation a clear risk of a protectionist response:
• from the ASEAN 4 and Korea as they were increa singly strained to service mounting external
debt;
• from the United States, the European Union and other countries facing a surge in imports from
Asia;
• from other regions as they absorbed rising imports from the United States and European Union;
• and for countries highly dependent on commodity exports, as they saw commodity prices fall by
as much as 30 per cent.
Admittedly this protectionist risk was tempered in some OECD economies by improved terms of
trade owing to lower prices for oil and raw materials, and by lower yields in capital markets.
Nevertheless, the risk was there – a risk, in the terminology of the time, characterised as contagion.WT/WGTDF/W/7/Add.1
Page 3
III. THE ROLE OF TRADE POLICY IN RESPONDING TO FINANCIAL CRISIS
5. What lessons – in terms of trade policy – can we learn from this experience?  Three stand out:
• first, it is critically important to resist protectionist pressures and to keep markets open, and for
these efforts to be backed by a continued flow of trade finance;
• second, it is necessary to encourage regulatory reform and liberalization of financial services; and
• third, it is necessary that sound trade policy be accompanied, and bolstered, by a broad reform
agenda.
1. Keeping markets open and trade finance flowing
6. First the negative lesson –  and here we need to look back to the 1930s.  Turning inwards in
the 1930s in response to that financial crisis helped push the world economy into a sustained
depression.  This particular episode in economic history underlines the crucial observation that while
financial crises can be turned around fairly quickly, trade crises can have a prolonged and damagingimpact.
7. But then the positive lesson from the 1997-98 crisis.  Countries did resist the temptation of a
protectionist response.  Indeed, some of the crisis-hit countries opened their markets further.  And
here the role of the Uruguay Round in setting a predictable framework of liberalization commitments
and strengthened trade rules should not be underestimated.  As a result, the crisis economies were –
after the initial lag – able to respond in the way economic analysis suggests they should.  Exports did
respond to the opportunity offered by depreciated exchange rates (the J-curve took effect).  In thisway, continued trade liberalization helped stimulate economic growth while helping restore
macroeconomic stability.
2
8. The ASEAN economic outlook changed dramatically in 1999.  Most of the crisis-affected
countries experienced a faster than expected recovery beginning with the first half of 1999.  This
recovery resulted in large measure from increased exports – led by a surge in world-wide demand forelectronics – together with stimulative monetary and fiscal policy.
9. In 1999, exports from Malaysia and the Philippines increased by respectively, 16.8 and
19.1 per cent relative to 1998, while Thailand's export grew by 7.4 per cent.  Malaysia's export growth
was stimulated by the real depreciation of its currency and the stronger demand for electronic goods,
both within the region and in the United States.  Similarly, the significant improvement in the
Philippine's external sector resulted primarily from export growth in electronics and components.
Among the ASEAN 4 countries, Indonesia's growth rates were lower: as a result of remaining
problems associated with high corporate indebtedness and access to credit.
10. Korea, one of the countries most affected by the financial crisis, led the region with double-
digit economic growth in 1999.  Increased exports (9.9 per cent), increases in private consumptionand investment, and stock rebuilding boosted Korean production to above pre-crisis levels.
11. This positive trend continued in 2000.  Trade data for Malaysia indicate robust export growth
of 16.2 per cent underpinned by the continuing strong growth in the country's main export market (the
United States), increased global demand for electronic goods, and ongoing recovery in Asia.  In
Thailand, the value of exports rose by 18.2 per cent over the 1999 level, playing a major role in the
economic performance of the country.  Indonesia's merchandise exports rose by 27.7 per cent during
the year.  Exports of electrical equipment, textiles, and some natural resource products, particularlyaluminium and nickel played an important role.
                                                     
2 See "Trade Policy Conditionality in Fund-Supported Programs", annex to a Board Paper on
"Conditionality in Fund-Supported Programs", IMF, February 2001.WT/WGTDF/W/7/Add.1
Page 4
12. For this export recovery to work, it was necessary for the overseas markets of the crisis
economies to remain open, but also for their own domestic markets to be accessible, in order to avoid
sparking retaliation elsewhere and in order for them to continue to benefit from imported inputs.3  On
this latter point, another important aspect of keeping markets open was the need to ensure continued
financing of trade in capital goods and intermediate inputs, in order to help maintain export capacityand infrastructure.
13. The importance of trade finance is highlighted by the current situation in Argentina.  The
latest IMF "World Economic Outlook" notes that exports are likely to pick up in response to the
depreciation of the exchange rate but that in the short run much will depend on the strengthening of
trade financing.  Export credit programmes play a critical role in fostering trade flows, whether
through short-term credits to finance the export of consumer goods, raw materials and commodities or
medium- and long-term export credits (i.e. generally involving repayment terms of two years or more)to finance capital goods exports and related services, either on a stand-alone basis (such as for a water
treatment plant or an aircraft) or within a project (for example, turbines for a power plant).  The
amounts involved are considerable.  In 1997, the G7 Export Credit Agencies (ECAs) supported some
$15 billion of short-term credits to Indonesia, Korea and Thailand alone.
14. In the area of export credits, OECD work is related to medium- and long-term business in
respect of which the Export Credit Arrangement sets down guidelines for the provision of official
support. In addition, OECD Members undertake regular exchange of views on export credit policy
and may decide, on a case by case basis, to go further and co-ordinate their export credit policies with
a specific target.  This is what happened in response to the 1998 G7 initiative on export credits in the
context of the Asian financial crisis.  The G7 countries declared on 21 February 1998:
"Given the fundamental long-term strengt h of the Asian economies, the reform
programs being adopted by a number of affected countries, and the commitments
which the ECAs already have in the region, the G7 ECAs believe that there is a
strong case and need to maintain trade finance support to the region (...).
(...) G-7 ECAs have agreed to :-  continue provision of, and where appropriate expand, short-term insurance,
guarantees and reinsurance to creditworthy buyers in the region.
-  increase ECA cooperation among themse lves in addressing the difficulties which
some corporations in the region are facing in managing their existing foreign
currency debt obligations.
-  exchange information on market deve lopments and implementation of reform
measures in the countries of interest recognizing that the resumption of financialstability is crucial to all parties.
In pursuing this multi-lateral initiative, the G-7 ECAs recognize the importance of
working with Asian nations in overcoming current difficulties in order to maintain
trade flows and foster stable long-term growth (...) ".
15. The G7 Finance Ministers, meeting on the same day, welcomed this initiative, in the
following terms:
                                                     
3This is not to deny the right of any contracting party to the WTO, under Articles XII and XVIII:B of
the GATT and GATS Article XII to restrict the quantity or value of imports in order to safeguard its externalfinancial position and its balance of payments.WT/WGTDF/W/7/Add.1
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"Continued access to trade finance will also  be important for economic recovery in
the region.  We welcome the proposals made today by major export credit agencies to
keep trade finance facilities open for countries in the region undertaking the
necessary policy reforms in cooperation with the International Financial
Institutions".
16. As a follow-up to this initiative, the OECD Export Credit Group convened a special meeting
on 2 March 1998 to provide a forum for dialog ue between OECD Member countries and
representatives of four Asian economies (the Philippines, Thailand, Malaysia and Indonesia).  This
session discussed inter alia  the issues related to the provision of support for export credits to those
four countries.  At that meeting, the members of the Export Credit Group confirmed their participation
in the G7 initiative, in effect widening the consensus already reached among G7 ECAs to 25 OECD
Members and confirming their preparedness to "remain open for medium and long-term creditworthybusiness".
4
17. This is not to suggest that the provision of short-term trade finance was fully assured during
the Asian financial crisis.  As mentioned in a WTO Secretariat document prepared for this meeting5,
and as alluded to earlier, financing imports was a problem for Indonesia at the peak of the Asian
financial crisis, as loss of confidence in the local banking system led international banks to refuse tounderwrite letters-of-credit opened by local banks.  It might be suggested, however, that this was
more of a banking problem than one associated with the activities of the Export Credit Agencies.
2. Financial sector reform
18. The Asian financial crisis raised serious concerns over the soundness of the domestic
financial systems of the countries concerned and a recognition that financial sector reform shouldnecessarily involve actions to liberalise financial systems further – to encourage a more efficient
allocation of savings and to facilitate entry by new service supplies, domestic and foreign, in order to
encourage greater competition while creating incentives for prudence and sound banking.  There was
also a recognition, however, that financial services liberalization is not the same as deregulation of
those services.  Indeed, market opening of financial services may need to be accompanied bystrengthened regulation and prudential controls.
19. In the case of Korea, in particular, recovery from the 1997-98 crisis was aided by financial
sector reform.  Korea's financial liberalization addressed a number of financial vulnerabilities and
strengthened the overall competitiveness of its financial sector.  In the banking sector, foreign equity
participation in existing domestic banks helped to raise Korea's external standing.  The inflow of
foreign capital increased demand in the securities markets, thus making it easier for corporations to
raise long-term financing, improve their financial structures and increase profitability.
20. In an interesting study currently in progress, Yun-Hwan Kim of the Asian Development
Bank
6 notes that, unlike other crisis-affected countries, Korea opened its domestic financial services
market more actively in the post-crisis period than in the pre-crisis period while also experiencing
                                                     
4 It should be noted that the activities of the Export Credit Group involve elements of both collective
and individual responsibility.  Hence, the risk-asse ssment in respect of each recipient country – and
consequently its credit rating for medium and long-term ex port credits purposes – is undertaken on a collective
basis under the disciplines of the Arrangement on Export Credits.  However, the consequences that may bedrawn from such common risk-assessment, in terms of cover availability or portfolio management, remains ineach individual Member's hands.
5 The Relationship Between Trade and Finance: A Review of Selected Literature Related to Financial
Crises in the 1990s", WT/WGTDF/W/4, 26 June 2002.
6 Yun-Hwan Kim, "Financial Opening Under the WTO Agreement in Selected Asian Countries:
Progress and Issues", paper presented at the Eighth International Forum on Asian Perspectives organised jointlyby the Asian Development Bank and the OECD Development Centre, Paris, 24-25 June 2002.WT/WGTDF/W/7/Add.1
Page 6
better economic growth than other crisis-hit countrie s.  He raises the crucial question of whether such
better performance encouraged the Korean government to open domestic markets or whether the
opening policy contributed to the fast growth.  Two factors suggest that liberalization helped stimulate
growth: the fact that most of the liberalization measures were taken soon after the crisis erupted and
that foreign banks' lending has been more counter-cyclical than that of domestic banks in Korea.  Kimalso addresses the question of sequencing, sugge sting that the commercial presence of foreign
suppliers should be liberalised ahead of the cross-border supply of financial services given the risks of
free movement of capital without sufficient supervisory mechanisms being in place.
21. The locking-in of financial sector reform in Korea, and more widely, was greatly aided by the
consensus reached in December 1997 by over 100 WTO members to the Agreement on Financial
Services.
22. A recent OECD study, "GATS: The Case for Open Services Markets", draws on experience in
Chile and South Africa of how implementing financial sector reform can strengthen resilience to
external shocks.
• In Chile, reforms of the financial sector resulted in a robust banking system in which suppliers
and consumers operate with greater confidence.  Bank deposits grew from $350 million in 1989 to$12.2 billion at the end of 1997; real interest ra tes decreased from over 40% to approximately 9%
during the same period.  Benefits to society as a whole included improved banking services,enhanced access to loans, more efficient channelling of funds into productive economic activities,
such as agriculture and live-stock, previously considered too risky.  Those two sectors taken
together, for example, received loans of only $54 million in 1990.  In 1997, they obtained loans
totalling $440 million.
• Market expansion in all financial services has expanded employment in South Africa
significantly.  In addition, foreign entrants across all segments of the market have played animportant part in making the country a regional financial centre.  This has happened partly by
using South Africa as a regional base, but also because their entry has improved the
competitiveness of the financial services market by cutting prices, expanding the range of
products and improving service.
23. The current situation in China, where the level of non-performing loans is comparable to that
in many South-East Asian countries after the 1997-98 crisis, is a further reminder of the importance of
financial sector liberalization.  It has been suggested that the benefits of WTO accession in raising
Chinese industrial competitiveness will not be fully realised without reform and opening up of thebanking system
7
3. Putting trade policy within a broad reform agenda
24. Trade policy reform in specific areas, such as financial services, will play an important role in
recovery from financial crisis – and in building resilience against future external shocks.  But trade
policy alone is not a panacea.  Apart from the need for external financing to prevent balance-of-
payments disequilibria from creating pressure for restrictive trade policies – the subject of other
papers – trade policy needs to be backed by other policy concomitants. Keeping markets open andencouraging the liberalization of trade and investment will only be fully effective if supported by
broad-based reform.  This is not a new observation of course.  As we are reminded in the
accompanying paper from UNCTAD, an entire chapter of the earlier proposed International Trade
Organisation was devoted to the need to coordinate trade policy with other aspects of domestic and
external macroeconomic policy.
                                                     
7 "China in the World Economy: The Domestic Policy Challenges", OECD, Paris 2002.WT/WGTDF/W/7/Add.1
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25. This is one of the key lessons that can be drawn from another financial crisis – the Mexican
peso crisis of 1994 – bearing in mind that no two financial crises are quite the same.  The experience
of Mexico suggests that financial crises, and attendant trade problems, need not be of long duration
provided that the authorities act quickly and adopt policies that address the underlying causes of the
crisis.  Following the peso crisis in 1994, Mexico promptly developed and implemented acomprehensive reform programme that addressed all the main elements that had led to the crisis.
Although macroeconomic stabilisation was at the forefront of the programme, Mexico also seized the
opportunity to strengthen structural reforms including the further liberalization of the foreign
investment regime, widening the scope of the priv atisation programme, reforming the social security
system and creating a futures market for foreign exchange.  These reforms allowed the country to
obtain private funds in the international capital markets within a year of having undertaken the
economic reform programme.  In 1996, GDP grew by 5 per cent in real terms as opposed to a 6 percent decline in 1995; the current account also sh owed a marked improvement with the deficit
declining from $30 billion in 1994 to $2 billion in 1996.  Pressure on the financial markets was also
eased within a relatively short period of time as reflected by declining short-term interest rates and
inflation.
26. What are some of the other policy concomitants of trade policy reform?  Drawing on other
recent OECD work, "The Development Dimensions of Trade", there appear to be at least five.  Trade
policy reform – in the context of building resilience against external shocks - needs to be
accompanied by:
• Regulatory reform  – this is particular ly evident in sectors like telecommunications and
transportation where the reduction in regulatory barriers accelerates infrastructure development,
reduces launching and operation costs and helps stimulate export responsiveness.  A moretransparent, predictable and less arbitrary regulatory environment can also reduce corruption in
domestic transactions;
• Trade policy also needs to be accompanied by  institutional mechanisms for dealing with
conflict resolution  – an unavoidable element of external shocks, including financial crises.  As
mentioned earlier, a key element of financial crisis will be a marked shift in the domestic terms oftrade, bringing with it the risk of latent so cial conflict associated with shifts in income
distribution.  The economist Dani Rodrik has identified a number of important elements of the
institutional framework needed for effective conflict resolution:
- property rights;
- institutions, such as anti-trust bodies, to correct information and market failures;
- social insurance or transfer programmes; and
- institutions for macroeconomic stabilisation, such as lender of last resort.
• Sound macro-economic management , more generally, is a vital concomitant to trade policy
reform.  Because exchange rate depreciation, and the attendant upward pressure on domesticprices, is more costly in open economies than in closed economies, such economies have a strong
incentive to avoid excessive money creation and inflation.  Inflation does indeed seem to be lowerfor open economies.
• The ability of trade policy to respond to an external shock will also depend on labour market
flexibility .  If labour markets are functioning poorly, or if labour finds it difficult to move from a
contracting industry into an export-oriented and expanding industry the benefits of exchange rate
depreciation are unlikely to be fully realised.
• For developing countries perhaps the most important concomitant of sound trade policy, and of
necessary efforts to improve market access for exports of particular interest to those countries, isWT/WGTDF/W/7/Add.1
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development cooperation and effective trade-related technical assistance and capacity building .
But this is clearly a topic in its own right going beyond the focus of this particular session of the
Working Group on Trade, Debt and Finance.
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