The paradox of thrift is defined as “ a change in the amount household wish to save at each income leads to a change in equilibrium income, but no change in equilibrium saving, which must still equal planned investment” (Begg, Fisher, Dornbusch, 2009). Increase in savings is actually the consumption foregone by the consumer. Domestic saving increases investment in a country which fuel the economic growth. But could savings be a cause for the financial crisis in Asian countries? As told by Dr Zhou Xiaochuan, Governor of the People’s Bank of China, “ the East Asia countries are influenced by Confucianism, which value thrift, self-discipline, zhong yong or Middle Ground (low-key), and anti-extravagancy” ( 2009). Could this Confucius value be one of the reasons behind the financial crisis that occurred in 1997?
On July 2, 1997, Asian countries were struck by waves of financial crisis when the Thai baht was devalued (Delhaise, 1998). The unexpected crisis of Thai’s economy has caused several other nations’ currencies to depreciate as shown in figure 1. Why did it happen? However, before we begin to analyze the cause of crisis, let’s look at why was the crisis contagious. Radelet and Sachs (1998) as cited in Sharma (2003) have contributed their opinion. With the advance in technology, investors are able to obtain information on macroeconomic data, asset prices and exchange rates. Technology is used in capital market in order to move the funds to increase the rate of return. However, unconvincing news about health of financial institution or country will lead to down fall of the capital market. For example, it may trigger a rational investor to withdraw funds with just a click on the computer screen.
In support of this, Calvo (1996) as cited in Sharma (2003) highlighted that the economy is vulnerable to a herd mentality among investors. Investor has to take into consideration of the state of an economy at his/her own costs even though it’s costly. This will cause a rational investor to retreat from capital market if there is a problem. As every investor begin to follow other investor abroad in pulling out their funds, this herd behaviour pushes the related countries into recession.
The total capital flows to developing countries were about $50 billion in 1990. (see table 1.3). Asian countries received half of it and one third of capital flow went to Latin America. Within 3 years time, total capital flow reach $160 billion. This large portion in which Asian countries receive less than 40% (in the form of direct investment) and the rest went to Latin America (in the form of portfolio investment).( Ito,1999)
From 1990 to 1995, only eight countries have received more than $15 billion in net long- term private capital inflow: China (more than $160 billion), Mexico (more than $80 billion), Brazil ($60 billion), Korea ($50 billion), Malaysia, Argentina, Thailand, and...