There was enough creative destruction to ensure that new competitors and better governance emerged out of the ashes. But we must also admit that there is still a long way to go for Asian standards to meet global standards. Hence, reform in Asia is still a work-in-progress.

Second, to judge whether Asia has made sufficient progress in the last decade, we need to look back from the hypothetical point in the future when Asia overtakes the West in GDP.  What must Asia achieve to attain that goal, recognizing that competition is never static? Indeed, the pain and humiliation that advanced countries are going through may precisely be the spur for structural reforms that they have delayed for years.

Thus, the current momentum of growth in Asia and other emerging markets cannot be taken for granted.  This current Global Financial Crisis is a stark reminder that for all the improvements in macro-economic management, we have not avoided the trade cycle.  Nor must we forget that Asia is still dependent on the advanced countries for exports, innovation and technology. If they slow down further in the next five years and Asia mismanaged this current round of overheating, the next global crisis will again be Asian-based.

What did Asia do right during the Asian crisis, what do the advanced countries do wrong this time round and what should Asia do in the years ahead?

With the benefit of hindsight, the Asian crisis was due to excess leverage in the corporate sector, bad credit management by the banking system and weak macro-management of inconsistencies in handling the Impossible Trilemma — rigid exchange rates, open capital markets and effective monetary policy.  What the crisis revealed was a governance crisis, famously labeled crony capitalism.

Post crisis, there was much effort to make the necessary reforms, assisted by better and clearer international standards. But the key lesson was the higher degree of self-insurance, with larger current account surpluses and higher foreign exchange reserves, so much so that this action was blamed as one of the causes of the Global Imbalance.

Looking back at the intervening years, it was clear that reforms at the international financial architecture were insufficient, because the IMF surveillance mechanism was largely ignored by the advanced countries when it came to their own affairs. No one heeded the real lessons of the Asian crisis that all financial crises are caused by excess consumption financed badly. No one paid heed to frail balance sheets and what was vaunted as sound macro-management was premised on a hope that free markets could discipline financial engineering greed.

Although the real causes of the current global crisis will be debated for years to come, there is sufficient consensus that it was a systemic crisis, bad in diagnosis and flawed in prognosis.  There was flawed macro-economic theory, lax monetary and fiscal policies and weak financial supervision over a turbo-charged finance industry that was subsidized by public guarantees.

Finance had become a political force by being too big to fail, too important to jail.

Have we solved all the root causes of the current crisis? No. This is because there are collective action traps at the national level simultaneously with the global trap. At the national level, there is no willingness to impose higher taxation to dampen excess consumption, relying on more public debt to replace losses in private debt. At the global level, there is no agreement to cede sovereignty to global central banking, fiscal management and financial supervision.  Without leadership and statesmanship, we have a crisis of global fiat money, caused by excessive credit creation with no hard budget constraints.

What should Asia and emerging markets do? Macro-economic management is particularly difficult in a world of highly distorted prices, led by zero interest rates and highly leveraged capital flows.

In my humble view, for Asia to take leadership, Asia must maintain higher standards of fiscal probity, sound money and prudent supervision. If we cannot solve the global gridlock, we should put our own houses in order. Much of the real sector objectives are universal – higher quality of life, sustainable ecology, less inequality and better governance. But there is a difference – finance must remain a servant of the real sector, not its master.

Andrew Sheng is the Chief Adviser to the China Banking Regulatory Commission and a Board Member of the Qatar Financial Centre Regulatory Authority and Sime Darby Berhad, Malaysia. He is the author of From Asian to Global Financial Crisis (2011), Cambridge University Press.

This piece first appeared here, on Emerging Markets, on 5 May 2011.