The Crisis of Success and Feedback Quality in Managing Economic Crisis

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Xiaokai Yang

Department of Economics, Monash University and
Center for International Development at Harvard University

May, 2000

I am grateful to Steven Radelet, Jeff Sachs, and Monchi Lio for helpful discussion. The remaining errors are solely of mine.

Abstract

Having investigated the trade-offs between positive network effects of a larger network of division of labour on aggregate productivity, coordination reliability of the network, between positive effects of insurance on the coordination reliability and moral hazard caused by insurance, and between sensitive feedback and stability of the feedback mechanism, the paper shows that moral hazard alone is not enough for explaining Asian financial crisis. It is argued that successful economic development will increase aggregate risk of coordination failure of an expanding network of division of labour. The increasing risk is an efficient balance of the trade-off between positive network effects of enlarged network of division of labour on aggregate productivity and reliability of the network. A general equilibrium cobweb model with endogenous network size of division of labour is developed to analyse quality of crisis management that efficiently trades off sensitivity against stability of the feedback mechanism.

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