not just at the consequences for their own financial system, but for the financial stability of the capital - receiving country? one obvious lesson is that, in evaluating the “ fundamental health ” of countries, we should widen the greenspan ( 1998, p. 10 ). scope of the assessment of “ fundamentals ”, to embrace an assessment of the health of the financial system and the effectiveness of prudential supervision. much more controversial would be any proposal to restrain capital flows. one of the important initiatives to come out of the imf ’ s meeting in hong kong in september 1997 ( i. e. shortly after the crisis broke ) was to develop an amendment of the imf articles of agreement to make the liberalisation of international capital flows one of the purposes of the fund. there is the potential for vigorous debate on this. some argue that the problems of capital flow were caused by “ half - way liberalisation ”, and things would have worked better if financial markets had been deeper, with a greater range of instruments and greater liquidity. the prescription that follows from this is, of course, to proceed with speed and vigour towards more financial deregulation. the counter argument is that prudential supervision and the general apparatus of administering big capital flows need to develop pari passu with the process of financial deregulation, and it is very clear that this did not occur over the past ten years : financial development greatly outpaced the development of the prudential framework. in this view, financial deregulation should only occur as and when the appropriate prudential safeguards can be put in place. whatever the outcome of this debate, i suspect that these countries will be much less ready to welcome short - term capital flows, and the enthusiasm for developments such as the bangkok international banking facility ( which acted as a frictionless conduit for thai business people to borrow overseas ) has been dampened. there is unlikely to be much enthusiasm for vigorous financial deregulation if this means encouraging the sort of free - wheeling, non - bank institutions which were not only eager to sign up borrowers for foreign currency loans, but then turned around and sold this debt into banks elsewhere in the region, with disastrous consequences for both borrower and lender. how quickly will the recovery occur? as the crisis unfolded in the second half of last year, it might have been argued that the best guidance on the likely evolution of these three countries was the mexican crisis of 1994 / 95

relatively soon? they still have many of the attributes that gave them fast growth. there is still plenty of potential to feldstein ( 1998 ). will financial markets accept something short of root - and - branch reform of indonesian governance? who can tell? but we know that they worked happily enough with these problems for thirty years. - 11 - link technology with relatively cheap labour, with all the productivity boost that this implies ( to put this point differently, they are still well back from the technological frontier in many areas ). that said, it is not going to be easy. as garnaut has put it : “ two of the pre - conditions of growth in the old east asian style have obviously been lost for the time being : a reasonable level of macro - economic stability ; and political coherence around the growth objective. ” 23 what have we learnt about our economic paradigm? the text - book model envisages continuous adjustment of prices and quantities as the system gropes towards equilibrium. good models acknowledge mis - starts and false cues along the way. but none of this seems to fit the process we see underway in asia. exchange rates started modestly over - valued, and are now dramatically under - valued. current account deficits may have been too large, but these countries are now running surpluses : thailand has gone from a deficit of 8 per cent of gdp to the prospect of a surplus, this year, of 4 per cent of gdp. this is being achieved ( if that is the right word ) through a fall in domestic spending ( not through exchange - rate - boosted export growth ). the main manifestation of the crisis - the falls in currency - have not been the principal equilibrating mechanism, but are producing unfortunate ( to say the least ) side effects and collateral damage - not just inflation, but enormous damage to bank and commercial balance sheets, to saving, and are distorting relative prices. what is underway here is not an equilibrating process of adjustment, but one of economic collapse, where markets are no longer operating to provide sensible price signals. it is, in the words of david hale, an “ unnecessary crisis ”. the loss of faith in markets is likely to colour future policy - making ( making these governments probably more likely to be tempted by very interventionist policies ). foreign markets are likely to be even more uncertain about their relationships with these countries, particularly their investment relationships. the other side of the coin is that these countries have