The three major economies in Northeast Asia have not escaped damage from the Atlantic-centered financial crisis and Great Recession. Japan has suffered the most in terms of employment and economic growth, which is ironic because it is less open to trade and investment than either Korea or China. China seems to be handling the crisis best, but appearances would be deceiving if nascent asset bubbles and the credit boom are not arrested. Korea has navigated the Lehman credit panic and is well positioned for a steady, sustainable recovery.

The financial sectors in these three Northeast Asia economies are better posi- tioned to intermediate savings and extend credit that can foster an economic recovery than those in the United States or the European Union (EU). That is obvious. But it also is worth noting that this is because banks, regulators, and corporations have learned from mistakes made in the 1997 Asian financial crisis. Stress tests conducted by Moody’s suggest that asset quality will deteriorate from the fallout of the global crisis, but only marginally in the central case scenario. And even in a worst-case scenario, each system will not be materially damaged. Large-scale government intervention will not be necessary. Banking sector consolidation on the scale seen in the wake of the 1997 crises in Japan and Korea is not in the cards. And in another contrast with 1997, Chinese banks, instead of hunkering down, are expanding internationally even as some Western banks have been forced to undo their expansion in the world’s fastest-growing and soon to be second-largest national economy.

The government’s balance sheet is not a constraint on recovery in 2010 for Japan, China and Korea, but it is a risk for Japan over the longer term. However, the greatest challenge to sustainable recovery to previous trend growth rates may not lie within the three large Northeast Asian economies; instead, it may be external. As the United States tightens its belt to live within its financeable means, global rebalancing would disrupt the export-led or -dependent economies in the near term and dampen their growth over the long term.