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Earlier attempts to explain the East Asian crisis of 1997 have overemphasised the importance of contagion, missing the central role of vulnerability. According to conventional accounts, Thailand experienced a financial panic due to such factors as corrupt government and corporate practices, inadequately supervised banks and venal currency speculators. Confidence in the Thai currency and banking system collapsed, provoking capital flight, a float of the Thai currency and a drastic decline in its value. This undermined confidence in the prospects of other East Asian countries, also provoking crises there. This article clarifies the concept of vulnerability and demonstrates its relevance by showing the long-term development of vulnerability in each of the three 'IMF bail-out' countries: Thailand, Indonesia and Korea. By 1996 all three were vulnerable to a currency crisis. Contagion provided the short-term trigger for the crisis but was not its underlying cause. The policy lesson is to avoid vulnerability, not to attempt to avoid contagion.

Earlier attempts to explain the East Asian crisis of 1997 have overemphasised the importance of contagion, missing the central role of vulnerability. According to conventional accounts, Thailand experienced a financial panic due to such factors as corrupt government and corporate practices, inadequately supervised banks and venal currency speculators. Confidence in the Thai currency and banking system collapsed, provoking capital flight, a float of the Thai currency and a drastic decline in its value. This undermined confidence in the prospects of other East Asian countries, also provoking crises there. This article clarifies the concept of vulnerability and demonstrates its relevance by showing the long-term development of vulnerability in each of the three 'IMF bail-out' countries: Thailand, Indonesia and Korea. By 1996 all three were vulnerable to a currency crisis. Contagion provided the short-term trigger for the crisis but was not its underlying cause. The policy lesson is to avoid vulnerability, not to attempt to avoid contagion.

Thailand's performance was often described as an example others might emulate and its principal economic institutions, particularly its central bank, the Bank of Thailand, were cited as examples of competent and stable management. The crisis of 1997 changed all that. Domestically, the economy was in disarray. Output and investment were contracting; poverty incidence was rising; the exchange rate had collapsed, following the decision to float the currency in July 1997; the government has been compelled to accept a humiliating IMF bailout package; and confidence in the country's economic institutions, including the Bank of Thailand, was shattered. Internationally, Thailand was now castigated as the initiator of a 'contagion effect' in Asian financial markets, undermining economic and political stability and bringing hardship to millions of people. Countries as far away as Europe and the United States nervously anticipated the inevitable negative effects on their exports. Japanese banks dreaded the prospect of massive non-repayment of loans. Many of the very commentators who had previously been so impressed by the Thai experience now called it an example to be avoided. What had happened? The structure of this paper is as follows. The core of the discussion is an analysis of the long-term factors that made Thailand vulnerable to a financial crisis. This is contained in Section 2. Section 3 identifies the short-term trigger which led to the expectation of a devaluation which in turn produced the crisis. Section 4 describes the crisis itself and the final section reviews the prospects for the Thai economy in the wake of the crisis.

Thailand's performance was often described as an example others might emulate and its principal economic institutions, particularly its central bank, the Bank of Thailand, were cited as examples of competent and stable management. The crisis of 1997 changed all that. Domestically, the economy was in disarray. Output and investment were contracting; poverty incidence was rising; the exchange rate had collapsed, following the decision to float the currency in July 1997; the government has been compelled to accept a humiliating IMF bailout package; and confidence in the country's economic institutions, including the Bank of Thailand, was shattered. Internationally, Thailand was now castigated as the initiator of a 'contagion effect' in Asian financial markets, undermining economic and political stability and bringing hardship to millions of people. Countries as far away as Europe and the United States nervously anticipated the inevitable negative effects on their exports. Japanese banks dreaded the prospect of massive non-repayment of loans. Many of the very commentators who had previously been so impressed by the Thai experience now called it an example to be avoided. What had happened? The structure of this paper is as follows. The core of the discussion is an analysis of the long-term factors that made Thailand vulnerable to a financial crisis. This is contained in Section 2. Section 3 identifies the short-term trigger which led to the expectation of a devaluation which in turn produced the crisis. Section 4 describes the crisis itself and the final section reviews the prospects for the Thai economy in the wake of the crisis.

Thailand's development strategy has been strongly market-oriented and open to trade and investment flows with the rest of the world. Since the late 1950s, its growth performance has been outstanding. Poverty incidence has declined dramatically, but economic inequality has increased. Economic progress has been reflected in very significant improvement in non-economic indicators of well-being such as life expectancy, infant and maternal morality, and literacy. Nevertheless, the performance of the education system is chronically poor. Environmental problems and institutional failures in resource management are ongoing. Reform is needed in several areas, including political and corporate governance, regulation of industry, and in the education and health systems.

A general equilibrium modeling approach is used to estimate the effects within Indonesia of unilateral and global trade liberalization, including effects on poverty incidence. It is concluded that global reform of trade policy in all commodities is a significant potential source of poverty reduction for Indonesia. The poor rural and urban have a strong interest in global trade policy reform. If Indonesia were to liberalize unilaterally, poverty incidence also will decline but the effect is small. If liberalization is confined to agricultural products, the effects are similar but the declines in poverty incidence within Indonesia are much smaller.