Institutional change in Southeast Asia

Sjöholm, Fredrik (Ed.); Tongzon, Jose L. (Ed.) Book Institutional change in Southeast Asia European Institute of Japanese Studies, East Asian Economics & Business Series, No. 6 Provided in Cooperation with: Taylor & Francis Group Suggested Citation: Sjöholm, Fredrik (Ed.); Tongzon, Jose L. (Ed.) (2005) : Institutional change in Southeast Asia, European Institute of Japanese Studies, East Asian Economics & Business Series, No. 6, ISBN 978-0-203-69463-3, Routledge, London, https://doi.org/10.4324/9780203694633 This Version is available at: https://hdl.handle.net/10419/251160 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/4.0/ Institutional Change in Southeast Asia Institutional Change in Southeast Asia examines the institutional changes taking place in, and challenges facing, the region since 1997. Southeast Asia’s economic development over the last decades has been impressive. Most of the region achieved consistently high growth rates accompanied by significant structural transformation and industrialization, poverty alleviation and improvements in their overall standard of living as indicated by such social indicators as greater longevity, more widespread delivery of basic education and lower infant mortality rates. However, the crisis that struck Southeast Asia in 1997 had severe economic, social and political consequences. It also threw into doubt the future economic prosperity of the countries in Southeast Asia and raised intriguing questions about the quality of their institutions and their approach to economic development. This book argues that the economies of Southeast Asia need to reform their institutions if the previous rapid development is to continue and focuses on the determinants of, and implementation of, such reform. Against the backdrop of Southeast Asia’s importance in the world economy, it is hardly possible to overestimate the need to understand this process of change. Fredrik Sjöholm is Associate Professor at the Stockholm School of Economics and works mainly in international economics and development economics. Jose Tongzon is Associate Professor at the Department of Economics, National University of Singapore, and specializes in trade and development with a focus on the economies of Southeast Asia. European Institute of Japanese Studies, East Asian Economics & Business Series Edited by Marie Söderberg Stockholm School of Economics, Sweden THE EUROPEAN INSTITUTE OF JAPANESE STUDIES STOCKHOLM SCHOOL OF ECONOMICS This series presents cutting edge research on recent developments in business and economics in East Asia. National, regional and international perspectives are employed to examine this dynamic and fast-moving area. 1 The Business of Japanese Foreign Aid Five case studies from Asia Edited by Marie Söderberg 2 Chinese Legal Reform The case of foreign investment law Yan Wang 3 Chinese-Japanese Relations in the Twenty First Century Complementarity and conflict Edited by Marie Söderberg 4 Competition Law Reform in Britain and Japan Comparative analysis of policy network Kenji Suzuki 5 Financial Liberalization and the Economic Crisis in Asia Edited by Chung H.Lee 6 Institutional Change in Southeast Asia Edited by Fredrik Sjöholm and Jose Tongzon Institutional Change in Southeast Asia Edited by Fredrik Sjoholm and Jose Tongzon Routledge % THE EUROPEAN INSTITUTE OF ' Francis 6% JAPANESE STUDIES LONDON AND NEW YORK STO~KHOLM~CHOOLOF ECONOMIQ First published 2005 by RoutledgeCurzon Published 2017 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN 71 1 Third Avenue, New York, NY 10017, USA Routledge is an imprint of the Taylor & Francis Group, an informa business First issued in paperback 2012 Copyright O 2005 Fredrik SjBholm and Jose Tongzon, editorial matter and selection; the contributors, their chapters Typeset in Baskerville by Wearset Ltd, Boldon, Tyne and Wear The Open Access version of this book, available at www.tandfebooks.com, has been made available under a Creative Commons Attribution-Non Commercial-No Derivatives 4.0 license. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Libraly of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 978-0-415-33871-4 (hbk) Contents List of figures vi List of tables vii List of contributors x Series editor’s preface xi Acknowledgments xii Abbreviations xiii Introduction FREDRIK SJÖHOLM AND JOSE TONGZON 1 1 Institutional transition and transition cost: a methodological consideration JANG-SUP SHIN 8 2 Educational reforms and challenges in Southeast Asia FREDRIK SJÖHOLM 25 3 Technological governance in ASEAN—failin g s in technolo gy transfer and domestic research JON SIGURDSON AND KRYSTYNA PALONKA 44 4 Interest rate policy and its implication on the banking restructuring programs in Indonesia REZA Y.SIREGAR 64 5 Crisis, social sector and income distribution in Singapore and Thailand PUNDARIK MUKHOPADHAYA 81 6 Effects of a crisis? Institutional adjustment and pro-poor growth in Thailand PERNILLA SJÖQUIST RAFIQUI AND ÖRJAN SJÖBERG 113 7 Singapore’s extra-ASEAN free trade agreements and their implications for ASEAN JOSE L.TONGZON 133 8 Prospects for Asian monetary cooperation: pipedream or possible reality? PETER WILSON 149 Index 177 Figures 4.1 Nominal exchange rate of Indonesian rupiah against the US dollar, January 1997 to December 2001 71 4.2 GARCH (1, 1) volatility rate of Indonesian rupiah against the US dollar, daily observations, 1 August 1997 to 12 June 2002 72 4.3 Interest rate spread (working capital rate and 6-month deposit rate), and the SBI-1 month rate in Indonesia, July 1997 to December 2000 73 4.4 Banking industry in Indonesia, profits before tax (Rp trillion) 77 4.5 Gross non-performing loans in Indonesia, in percent of total loans 78 5.1 Unemployment rate (unadjusted) in Singapore, 1995–1999 87 5.2 Unemployment rate in Singapore, per person aged 15 years and older in resident private household, per decile, in percent 87 5.3 Real incomes by origin in Thailand, 1997–1999 89 5.4 Incomes at various education levels in Thailand 90 5.5 Changes in government real recurrent expenditure per student in Singapore, 1995–1999 (S$) 93 5.6 Changes in enrollment at various educational levels in Singapore, 1996–1999 94 5.7 Changes in drop-out ratios in secondary schools in Thailand 97 6.1 Institutions, policies and outcomes 118 Tables 1.1 Cross-border M&As and FDI inflows in Malaysia and Korea 1991–2002 (US$ million) 16 1.2 Trend of NPLs in Malaysia and Korea, 1997–2001 18 1.3 External financing of the corporate sector in Korea (billion won) 20 2.1 Exports, current account balances and exchange rates in some Southeast Asian countries 26 2.2 Educational expenditures in Southeast Asia 27 2.3 Educational expenditures per pupil, 1996 28 2.4 The availability of teachers in Southeast Asia 29 2.5 Literacy rates and mean years of schooling in Southeast Asia 30 2.6 School enrollment ratios in Southeast Asia 31 2.7 Distribution of tertiary students over field of study in Southeast Asia, in percentage of students by field of study, 1996 32 2.8 Income per capita in Southeast Asia and UNDP’s education index, 1999 33 4.1 Banking credits outstanding in Indonesia, 1996–2001 65 4.2 GDP growth rate in Indonesia, in percent, by industrial origin at constant market prices, 1995–2001 66 4.3 GDP growth rate in Indonesia, in percent, by expenditure category at constant market prices, 1995–2001 67 4.4 Recapitalized bonds in Indonesia, at the end of 2001 (Rp trillion) 69 ECB European Central Bank EDB Economic Development Board, Singapore EFTA European Free Trade Association, comprising Iceland, Liechtenstein, Norway and Switzerland EMS European Monetary System; also electronic manufacturing services EMU European Monetary Union ERM exchange rate mechanism EU European Union FDI foreign direct investment FLC forward-looking criteria FTA free trade agreement GAB General Arrangements to Borrow GDP gross domestic product GEL general exclusion list GNP gross national product GRI government research institute HDB Housing Development Board, Singapore HDD hard disk drive IBRA Indonesian Banking Restructuring Agency ICs integrated circuits ICT information and communication technologies IL Inclusion List IMF International Monetary Fund IT information technology ITC industrial technological capabilities JNTO Japan National Tourist Board JSFTA Japan-Singapore Free Trade Agreement KBE knowledge-based economy LDC lesser developed countries M&As mergers and acquisitions MAS Monetary Authority of Singapore MDC Multimedia Development Corporation, Malaysia MERCOSUR free trade association in Latin America, comprising Argentina, Brazil, Paraguay, Uruguay and associate members Bolivia and Chile MNC multinational corporation MoPH Ministry of Public Health, Thailand MPKSN Malaysia National Council for Scientific Research and Development MSC Multimedia Super Corridor, Malaysia NAFTA North American Free Trade Agreement, comprising Canada, Mexico and the USA NBFI non-bank financial institution NEER nominal effective exchange rate NESDB National Economic and Social Development Board, Thailand NGO non-government organization NIC newly industrializing country NIFA National Innovation Framework for Action, Singapore NISTPASS National Institute of Science and Technology Policy and Strategic Studies NPL non-performing loan NSDB National Science and Development Board, the Philippines NSTB National Science and Technology Board, Singapore NSTP National Science and Technology Plan, Singapore NTB non-tariff barriers NWC National Wage Council, Singapore OCA optimum currency area OECD Organization for Economic Cooperation and Development PAS Parti Islam SeMalaysia PIDS Philippine Institute of Development Studies QR quantitative restrictions R&D research and development REER real effective exchange rate REMU Regional Economic Monitoring Unit RSE research scientist and engineer S&T science and technology SBI rate Central Bank of Indonesia security rate SMEs small-to-medium enterprises SOE state-owned enterprise SPSB Singapore Productivity and Standards Board STAND Science and Technology Agenda for National Development, the Philippines STB Singapore Tourism Board STMP Science and Technology Master Plan, the Philippines TEL temporary exclusion list UAP unprocessed agricultural products UMNO United Malays’ National Organization UNDP United Nations Development Programme UNESCAP United Nations Economic and Social Commission for Asia and the Pacific UNESCO United Nations Educational, Scientific and Cultural Organization WTO World Trade Organization Introduction Fredrik Sjöholm and Jose Tongzon Southeast Asia’s economic development over the last decades has been impressive. Most of the region has achieved consistently high growth rates accompanied by significant structural transformation and industrialization, poverty alleviation and improvements in the overall standard of living as indicated by such social indicators as greater longevity, more widespread delivery of basic education and lower infant mortality rates. However, the crisis that struck Southeast Asia in 1997 had severe economic, social and political consequences for many countries in the region, particularly in the hardest-hit economies of Thailand, Indonesia and Malaysia. It also threw into doubt the future economic prosperity of countries in the region and raised intriguing questions about the quality of their institutions and their approach to economic development. Economic growth is driven by factor accumulation and technological progress; the more factors of production that are available in a country or the more efficiently these are combined, the higher the country’s level of income. Factor accumulation and investment in new technology are in turn dependent on a host of factors often referred to as a country’s institutions. The term “institutions” can be broadly defined as the formal and informal rules that shape the nature and extent of human interactions (North 1990). There are also narrower definitions of institutions that focus on specific organizational entities, procedural devices and regulatory frameworks. At a more intermediate level, institutions are defined in terms of the degree of property rights protection, the degree to which laws and regulations are fairly applied, and the extent of corruption. Protection of property rights and enforcement of contracts are referred to as market-clearing institutions, and markets either do not exist or perform very poorly in their absence. Long-term economic development also requires efforts to build three other types of institutions to sustain the growth momentum, build resilience to shocks, and facilitate socially acceptable burdensharing in response to such shocks. These are market-regulating institutions (those that deal with externalities, economies of scale and imperfect information), market-stabilizing institutions (those that ensure low inflation, minimize macroeconomic volatility and avert financial crises) and market-legitimizing institutions (those that provide social protection and insurance, involve redistribution and manage conflicts). All these different forms of institutions are presumably important to ensure sustained economic growth (Keefer and Knack 1993). The importance of good institutions for economic development is confirmed in a number of empirical studies, where the level of economic development, as measured by per capita income, is closely related to differences in the quality of institutions (Keefer and Knack 1993, North 1995, Barro 1997). The reason seems to be, again, that good institutions increase factor accumulations and technological change. By the same argument, institutional deficiencies will reduce investment and the ability of countries to, for instance, absorb technological advances from abroad. Without institutional advances, countries will have a slower economic growth rate. Southeast Asia’s experience confirms the importance of good institutions for economic development. It seems fair to say that government involvement in institutional development in the Southeast Asian countries has been more pronounced, and sometimes also more efficient, than in most other developing countries (MacIntyre and Jayasuriya 1995).1 Most governments in the region have developed market-clearing institutions, opened up their economies to international trade and capital, and limited domestic price distortions. It is of course important to stress the heterogeneity of Southeast Asia, and the nature of government involvement has differed substantially between countries in the region. For instance, government involvement was for a long time excessive, and economically inefficient, in the former centrally-planned economies in the region. The liberalization starting in Vietnam in the mid-1980s, and later followed by Laos and Cambodia, has made these countries converge towards the market-based economies. However, the market-based economies in Southeast Asia are characterized by a relatively large degree of government involvement. As an example, Singapore, the most developed country in Southeast Asia, has a government that actively manages the economy and society to an extent that is not seen in any other high-income country in the world. Government involvement in the region is not restricted to institutional aspects, but often includes a relatively greater participation in production through state-owned enterprises as well as an active role in the allocation of resources to sectors that are regarded as important or strategic. How successful such policies have been is highly debatable. The main success of the governments in the region has presumably been a reasonable maintenance of law and order and the formulation and implementation of policies to achieve macroeconomic stability. The foundation of such stability seems to have been a major factor behind the strong economic performance of Southeast Asia (World Bank 1993). However, the Asian crisis revealed that many of the institutions that enabled Southeast Asia to grow and develop rapidly in the initial stages of economic development were not adequate for providing sustained growth in the midst of increased globalization and competition, and as the countries’ levels of economic development increased (Kokko and Sjöholm 2002). Paradoxically, the crisis was partly caused by the same factors that previously fuelled the high growth and development. For instance, the supply of credits increased drastically, partly as a consequence of a deregulation of the financial markets: domestic banks were allowed to expand their credit stocks and foreign capital began to flow into the region on a large scale. Hence, globalization contributed to an increased supply of credits, which in turn spurred investments, industrialization and economic growth. Unfortunately, various institutional weaknesses meant that some of the capital was allocated to speculation on land and stocks rather than being invested in more productive activities. More specifically, weak regulations and inadequate supervision of financial markets in the region, together with poor corporate governance, made it difficult to detect the emerging bubble. The strong links between government and business interests have been one important aspect of Southeast Asia’s industrialization. For instance, the close ties reduced the impact of market failures and the cost of credits, and made it possible for countries to mass mobilize resources at an early stage of development. However, it also led to irresponsible firm behavior, since it was widely assumed that the government would bail out the companies if they ran into problems. Institutional Change in Southeast Asia 2 Similar problems were present in the financial sector, which suffered from “crony capitalism” and was the sector most seriously affected by the crisis. The financial sector’s development did not keep pace with industrial and technological growth and countries in the region lacked correcting market mechanisms and transparency in business transactions. Consequently, much domestic investment was allocated to economically unsound projects backed by politically well-connected domestic investors. Also equity markets were poorly regulated and did not require high levels of corporate disclosure or strong prohibitions against insider trading and other unfair practices. Other institutional weaknesses also contributed to the emerging crisis. For instance, there was a general inability to restrain the overheating economies by use of restrictive fiscal and monetary policies. Moreover, the exchange rate arrangement with fixed or semi-fixed currencies, which had previously served the countries well by providing stability in their export expansions, made it also increasingly difficult for them to compete when their currencies appreciated together with the US dollar in the 1990s. The slow-down in exports in 1996 seems to have triggered the crisis by making foreign investors aware of the structural problems in the region. As a result, foreign banks and investors stopped rolling over loans, which, together with the capital flight from domestic actors, forced through the depreciations of the regional currencies. The depreciations triggered, in turn, a severe debt crisis since firms often had a large amount of loans in foreign currencies. The crisis affected the Southeast Asian countries differently. The hardest hit countries were Thailand and Indonesia, but most countries suffered economically from the crisis: the gross domestic product (GDP) decreased, and unemployment and poverty increased. In addition to economic consequences, the crisis also led to great political changes such as the end of Suharto’s long rule and the subsequent democratization process in Indonesia, and the power struggle between Anwar Ibrahim and former prime minister Mahathir, as well as the increased support for the Islamic opposition in Malaysia. Finally, the crisis was presumably one cause of the increased ethnic and religious tensions in, for instance, the Philippines and Indonesia. The transition economies of Cambodia, Laos, Myanmar and Vietnam did relatively well, partly because some of them were not fully integrated into the global economy with, for instance, liberalized capital markets.2 Singapore was perhaps the country in the region that managed the crisis best. It seems that Singapore avoided excessive debt and asset bubbles because of its adequate financial disclosure, its well-developed procedures allowing unsuccessful businesses to fail, and its accumulation of enough foreign exchange reserves to finance its international trade (Cheng et al 2000). The crisis is over but it will presumably continue to affect the region’s economic development. For instance, the crisis has underlined the importance for the countries of continuously upgrading and improving their economies. Unfortunately, a number of external as well as internal factors currently cast doubts over Southeast Asia’s ability to repeat its past success. Externally, the slow-down in the world economy, the over-supply of electronics, Japan’s difficulties in stimulating its economy, and the apparent rise of China as a strong competitor, do little to help Southeast Asia resume its position as a region of very high economic growth. Internally, many countries in the region have failed to recover and restructure fully from the Asian financial crisis. The affected countries have addressed their institutional Introduction 3 weaknesses in different ways, with varying degrees of success. One reason is that various interest groups have sometimes obstructed the reforms. It is also clear that the governments themselves are frequently opposed to reforms that diminish their own influence; some governments realized the need for reforms, but there were also several instances where reforms were only initiated after (turbulent) political changes. Moreover, part of the institutional adjustment has been due to external pressure from, for instance, the International Monetary Fund (IMF) and foreign banks. The government’s role after the crisis is likely to decrease in some areas as a result of privatizations, trade liberalization and market deregulations. However, it is also clear that the govern-ment’s role will increase in areas such as surveillance and regulations of markets. The economies of Southeast Asia need to reform their institutions if the previous rapid development is to continue. In the early stages of a country’s development, growth can presumably be achieved despite relatively weak institutions. However, the need for good institutions increases as countries develop and growth becomes more dependent on technological progress rather than on factor accumulation. As noted by North (1995), however, creating a flexible institutional system that adjusts to evolving technological and demographic changes as well as to shocks to the system is not an easy task for any society, especially if this is to be carried out in a short period of time (Kokko and Sjöholm 2002). Moreover, the new institutional matrix that will emerge in Southeast Asia is not likely to replicate the Anglo-American or any other existing system, but will instead be based on the region’s own unique culture, tradition and experiences. Against the backdrop of Southeast Asia’s importance to the world economy, it is hardly possible to overestimate the need to understand this process of change. However, whereas the literature on the economies of Southeast Asia in general, and on the Asian crisis in particular, is extensive, few studies have examined institutional changes in the region since the crisis in 1997.3 This volume contributes to the literature by examining the institutional changes taking place and the challenges facing the region since 1997. The book focuses on determinants to the adjustments and implementation of the changes, and various differences between countries in the region. It also re-examines the implications of the crisis for economies and institutions, and evaluates the key challenges facing these countries in the aftermath of the crisis. The book is organized as follows. Chapter 1 introduces the book’s main theme by highlighting the important role of transitional costs in the context of institutional adjustments and transformation. It concludes that an institutional transition can only be justified if the reduction in transaction costs more than compensates for transition costs involved and that many institutional reforms fail because they ignore or underestimate the aspect of transition cost. Chapter 2 evaluates the educational reforms and challenges facing Southeast Asia. By focusing the analysis on the experiences of Singapore, Malaysia and Indonesia, this chapter highlights the urgent need for these countries to move up the production ladder in the context of growing international competition and rising labor costs. More precisely, as Southeast Asia’s traditional export of relatively low-skilled products is facing increased competition, there is a general need to upgrade the production in the region, requiring a more skilled and educated labor force. Historically, education has not been emphasized in Southeast Asia but there are indications that this is about to change. This chapter starts with a general discussion on education in the region and then continues Institutional Change in Southeast Asia 4 with a close look at some of the obstacles to reform, such as financial or political constraints, that are present in the countries in focus. Chapter 3 highlights the importance of technological development for sustainable growth and development in Southeast Asia. It describes the shortcomings that existed in the technology regimes before the Asian crisis and the changes in these regimes after the crisis. While a debate is raging on the relative importance of factors that contributed to the financial crisis, a major line of thought is that many countries lacked a solid basis for sustained economic development by primarily relying on expanding inputs of more capital and labor. The corollary is that technological development was neglected and this chapter analyzes the problem in two sections. First, it highlights some of the characteristics in science and technology regimes in the region, with a particular focus on the Philippines, Indonesia, Vietnam, Malaysia and Singapore. A second section discusses the shortcomings that existed in the technology regimes and the changes which have taken place since the financial crisis. The analysis focuses on the interaction between the public and private sectors, as seen in the context of an ongoing globalization process. Chapter 4 assesses the effectiveness of Indonesia’s monetary policy in the post-crisis period. It is argued that an ineffective monetary policy seems to have been one reason for the slow recovery process in Indonesia. The chapter continues to discuss the implications of the three possible policy choices—exchange rate policy, interest rate policy and base money policy—still the source of policy debates in the country several years after the crisis. The objectives of the different policy choices and their implications on the overall macroeconomic agenda of the domestic economy are analyzed. Finally, the chapter evaluates the implications of the choices on the overall restructuring process of the banking sector. Chapter 5 examines the social impact of the crisis, drawing on the results of studies in two countries, Singapore and Thailand. The crisis interrupted three decades of economic growth that had been accompanied by remarkable progress in poverty reduction and an improvement in social indicators like health and education. It is seen that absolute poverty became more acute in Thailand after the crisis. Moreover, with increased unemployment and decreased real wages, income inequality increased both in Singapore and Thailand. This chapter also examines the effects of the crisis on other social indicators, such as school enrollment and health. It concludes that the crisis has exposed significant limitations in the ability of social safety nets to cope with a negative shock of this magnitude, and manifested the need for better targeting to help households tide over their difficulties. Chapter 6 continues on the poverty theme by examining the role of institutions in safeguarding the capabilities of the poor in Thailand, during the time of economic distress that followed the Asian financial crisis. Unlike previous literature, which tends to focus on the macro-level, this chapter addresses macro-micro linkages in pro-poor policies. Similarly, while the social consequences of the crisis have been explored in chapter 5, this chapter examines the institutional environment for pro-poor growth. Chapter 7 assesses the implications of Singapore’s initiatives to forge extra-ASEAN free trade agreements for the future of ASEAN economic integration. It addresses the question of whether the recent crisis and the resulting economic difficulties undermined ASEAN’s resolve to deepen their level of economic integration. It also tries to shed light on Singapore’s current initiative to forge free trade deals with countries outside the Introduction 5 region and its likely implication for the region’s economic integration. The perception by some members in ASEAN that these bilateral free trade deals can be used as a “backdoor” entry into the ASEAN markets is a matter of serious concern, which could threaten the very existence of ASEAN as a regional economic grouping. Chapter 8 re-assesses the prospects for greater monetary integration in Asia. The Asian crisis highlighted the absence of well-developed supranational institutions in Asia to either prevent or deal with currency and balance of payments problems. The chapter discusses a number of initiatives since 1997 to enhance monetary cooperation in the region including Japan’s proposals for an Asian Monetary Fund, the Chiang Mai Initiative at the ASEAN+3 meeting in May 2000, the Kobe Research Project, and the currency swap agreements and surveillance machinery initiated at the Asian Development Bank Meeting in Honolulu in May 2001. It argues that the economic preconditions for further integration are not as daunting as one might expect, but that it seems unlikely that the institutional structures and political will in Asia are strong enough to provide the basis for significant monetary integration in the forseeable future. Notes 1 The government involvement might have been even larger, or at least of different character, in Northeast Asia (MacIntyre 1994, Rodan et al. 1997). 2 However, they were affected by the crisis indirectly through their trade and investment linkages with the other crisis-hit countries in the region. 3 For books on the economies and institutions in Southeast Asia see, for example, Tongzon (1998), Barlow (1999), Woo et al. (2000) and MacIntyre (2003). See also Drysdale (2000) for a description on some reforms taking place in East Asia after the crisis. References Barlow, C. (ed.) (1999) Institutions and Economic Change in Southeast Asia: The Context of Development from the 1960s to the 1990s, Northhampton, Mass.: Edward Elgar. Barro, R. (1997) Determinants of Economic Growth: A Cross-country Empirical Study, Cambridge, MA: MIT Press. Cheng, Y.S., Chia, S.Y. and Findlay, C. (2000) “Governance in the city-states: HongKong and Singapore”, in P.Drysdale (ed.) Reform and Recovery in East Asia, London: Routledge. Drysdale, P. (ed.) (2000) Reform and Recovery in East Asia, London: Routledge. Keefer, P. and Knack, S. (1993) “Why don’t poor countries catch up? A crossnational test of an institutional explanation”, Working Paper No. 60, Center for Institutional Reform and the Informal Sector, University of Maryland at College Park. Kokko, A. and Sjöholm, F. (2002) “Economic recovery in Southeast Asia”, Stockholm: Stockholm School of Economics. MacIntyre, A.J. (1994) “Business, government and development: Northeast and Southeast Asian comparisons”, in A.J.MacIntyre (ed.) Business and Government in Industrializing Asia, St Leonards: Allen & Unwin. ——(2003) The Power of Institutions: Political Architecture and Governance, Ithaca: Cornell University Press. MacIntyre, A.J. and Jayasuriya, K. (1995) The Dynamics of Economic Policy Reform in South-East Asia and the South-West Pacific, Kuala Lumpur: Oxford University Press. Institutional Change in Southeast Asia 6 Khan defines transition cost as “the political cost faced by initiators of new institutions” (1995:81), or “the political cost which potential losers from a proposed institutional change can impose on the proponents” (1995:82), and argues for placing the concept of transition cost at the center of the analysis of institutional change. For Khan, the most important determinant of transition cost is political settlement, which is “the balance of power between the classes and groups affected by…[a given] institution” (1995:77), because the cost depends critically on the “intensity and extent of resistance” by losers. But it is difficult to measure the cost quantitatively because it is often “inflicted on a specified group by political events such as physical violence or defeats in elections” (1995:82). The size of transition cost is also institution-specific because political settlement is diverse across countries and therefore costs arising from resistance to proposed institutional change are different due to differences in the existing political settlements in question. In this situation, the best an initiator of a transition can do is to make “the [subjective] ranking of composite bundle of costs” associated with alternatives in hand, and to choose a strategy for transition accordingly (1995:83). In this process, the strategies that could incur too high transition costs are eliminated from the list of feasible options. Khan (1995) illustrates this point with the case of the unsuccessful attempt by the Pakistani government to establish a developmental state in the 1960s.9 Acknowledging the existence of transition cost makes a great difference in understanding and designing institutional transitions. Above all, it leads us to the fact that no institutional change can be undertaken independently of the country’s history. Countries have differing historical backgrounds and transition costs involved in their path changes will inevitably differ among them. Modeling idealized institutions or bestperforming institutions (in the real world), therefore, does not necessarily bring about better performance for individual countries. Economic transition cost: a comparison between Korea and Malaysia While Khan proposes the concept of transition cost mainly in relation to political costs involved in institutional change, I will add here an economic dimension to transition cost. This is mainly because economic institutions of a country are also products of their own historical development, and therefore closely intertwined with other related components of the economy such as composition of industries, developmental stage and the historical heritage of the country, which cannot be changed overnight. When a radical institutional change is attempted, it is therefore possible that it may conflict with other related components of the economy, resulting in economic costs. I will illustrate this point below with a comparison of institutional transitions in Malaysia and Korea after the 1997 financial crisis by focusing on the risk-taking mechanism at the economy level. Both countries encountered a financial crisis and recovered from it almost at the same time. In the process of combatting the financial crisis, however, they employed diametrically opposed approaches to institutional transition. Korea called on the International Monetary Fund (IMF) for intervention and carried out far-reaching institutional reforms, following the idealized Anglo-American model. By contrast, Malaysia rejected the IMF program and revived the economy in its own way by Institutional transition and transition cost: a methodological consideration 13 introducing selective capital controls and maintaining its major economic institutions, although it had to undertake some institutional adjustments to deal with bad loans accumulated in its economic system. Radical institutional changes in Korea under IMF stewardship involved a fundamental shift in the country’s risk-taking mechanism. The earlier system in Korea can be characterized as a state-mediated one; the state controlled cross-border financial flows by use of discretionary policy measures. It also managed financial risks in the domestic economy not only by regulating financial institutions but also by regulating industrial corporations with industrial policy tools. However, the IMF-sponsored reforms after the crisis instituted a system in which the state confines itself to financial supervision by adopting the so-called global standard financial regulations like forward-looking criteria (FLC), the Bank for International Settlements capital adequacy ratio (the BIS ratio) rules and so on; the market, in particular the foreign investors and domestic financial institutions, plays a central role in the risk management of the economy. In this system, complete liberalization is a target and the Korean government abolished almost all of the remaining regulations over crossborder financial flows. Gaining investor confidence was also regarded as crucial in reducing the financial vulnerability of the economy and the Korean government endeavored greatly to provide foreign investors with favorable investment environments. It was also thought that domestic financial institutions would become as healthy as possible if they could make independent financial decisions. For this purpose, the Korean government attempted to dispose of non-performing loans (NPLs) in the financial institutions as quickly as possible. In contrast, Malaysia did not undertake this kind of radical system change. The state maintained its role as a financial risk manager in its economy. In fact, it strengthened its controlling power over cross-border financial flows by introducing selective capital controls. Although it began publishing statistics on NPLs according to the IMF’s 3months classification standards in a move to increase transparency in its financial system, it still used the earlier 6-months classification standards as a major indicator of NPLs. Moreover, the soundness of the financial sector itself was not given exclusive attention and the disposal of NPLs was not carried out in haste. The overall focus of Malaysia’s restructuring policy lay in preserving values of its own assets and maintaining employment. Despite initial skepticism and criticism of the Malaysian approach from international organizations and many scholars, Malaysia’s recovery from the crisis was as complete as Korea’s. The two economies experienced a sudden contraction in 1998 and showed rapid expansion in 1999 and 2000 before slowing down with the global recession in 2001. Korea’s average gross domestic product (GDP) growth rate during the recovery period (7.7 percent) was certainly higher than that of Malaysia (4.9 percent). However, this should not be read as an indication that the Korean approach to institutional change was superior to that of Malaysia. For the difference is mainly due to Korea’s stronger Keynesian reflation-ary policies, including monetary and fiscal expansion, to combat deflationary pressure after the financial crisis.10 However, Malaysia achieved this recovery with much less cost to its economy than Korea. It seems that the radical institutional transition in Korea created a vacuum in the risk-taking function at the level of the economy, resulting in a large transition cost. Institutional Change in Southeast Asia 14 Malaysia, by contrast, did not need to pay these transition costs because it maintained its previous institutional structure, even though it had to spend a substantial amount of money to deal with the financial troubles in the wake of the financial crisis. I will discuss these differences in transition costs between the two countries under the following headings: Costs in managing open capital account, Costs in selling domestic assets to foreign investors, and costs in disposing of NPLs outside the financial system. Costs in Managing open capital account If a country opens its capital account to cross-border international financial flows, maintaining large foreign reserves is the last resort to protect its economy from possible currency attacks. Considering the number of currency transactions in the international financial market, foreign reserves themselves can never be a safeguard against currency speculation. However, it is necessary for an economy to increase foreign reserves as it becomes more vulnerable to possible currency attacks once it abandons regulatory measures to control financial flows. Malaysia did not need to beef up its foreign reserves because it insulated its economy from possible speculative currency attacks by introducing capital controls. Malaysia’s total foreign reserve only increased from US$269.2 billion at the beginning of 1997 to US$304.7 billion at the end of 2001. In contrast, Korea had to increase its foreign reserves enormously by completely liberalizing its capital account following the IMF program. Its total foreign reserves, which stood at US$317.4 billion at the beginning of 1997, more than tripled to US$1,027.5 billion at the end of 2001. Whether this large sum of foreign reserves made Korea less vulnerable to currency attacks than Malaysia would be an open question, and, to my knowledge, there is no convincing proof of this. However, the opportunity cost of maintaining larger foreign reserves should be counted as a part of the transition cost involved in Korea’s institutional transition towards full-fledged financial liberalization. Costs in selling domestic assets to foreign investors Malaysia was able to overcome the crisis by selling fewer assets to foreign investors compared with Korea. Since Malaysia also faced a severe liquidity crunch during the crisis, it had to sell some of its own assets to ease financial constraints. Reflecting this, Malaysia’s asset sales through mergers and acquisitions (M&As) jumped nearly threefold after the financial crisis compared with before the crisis. The annual average of M&A sales, which was US$336 million during the pre-crisis period (1991–1997), rose to US$927 million during the post-crisis period, 1998–2002 (see Table 1.1). However, these figures look pale when compared to those of Korea. Korea’s annual average of M&A sales was US$324 million in 1991–1997 before the crisis, smaller than that of Malaysia. But it increased by more than 18 times to US$5,901 million during the period after the crisis, 1998–2002. This is because the Korean government and the IMF put great emphasis on the inflow of foreign money as a sign of regained investor confidence, which they thought shattered with the financial crisis, and applied enormous pressure on Korean corporations and financial institutions to sell their assets to foreign investors.11 Institutional transition and transition cost: a methodological consideration 15 Although the Korean government and the IMF paint these asset sales, which constituted most of the foreign direct investment (FDI) inflows during the post-crisis period, as a great achievement of their reform program, they Table 1.1 Cross-border M&As and FDI inflows in Malaysia and Korea, 1991–2002 (US$ million) M&Asa FDI inflowsb Malaysia Korea Malaysia Korea 1991 128 673 3,998 1,180 1992 46 0 5,183 727 1993 518 2 5,006 588 1994 443 1 4,342 809 1995 98 192 4,132 1,776 1996 768 564 4,672 2,325 1997 351 836 6,323 2,844 1998 1,096 3,973 2,714 5,412 1999 1,166 10,062 3,895 9,333 2000 441 6,448 3,788 9,283 2001 1,449 3,648 554 3,528 2002 485 5,375 3,203 1,972 Pre-crisis average (1991– 1997) 336 324 4,808 1,464 Post-crisis average (1998– 2002) 927 5,901 2,831 5,906 Source: UNCTAD (2003) World Investment Report 2003, Annex Table B.1 and B.7. Notes a The acquisition of an equity stake of more than 10 percent by foreign investors. Figures here are on gross basis. They are also those concluded and announced each year. It is therefore possible that the amount of M&A sale in a year, say, in 1999 in Korea, can be greater than that of FDI inflow, if some M&As concluded were paid in later years. b Including equity capital investment, reinvested earnings, and intra-company loans or debt transactions. Figures here are calculated from the countries’ balance of payments statistics on the net basis where debits of capital transactions between direct investors and their foreign affiliates were deducted from credits between them. can hardly be regarded as of much benefit to the economy in themselves. It can only be beneficial to the economy if these changes in the ownership of assets are translated into better performance of the economy as a result of the infusion of advanced technologies and management practices. But this potential positive effect of FDI to the economy is not yet in sight. Moreover, if these assets were sold at heavily discounted prices as a result of distress sales in a crisis situation, the difference between their real value and their sale prices should be counted as costs to the economy, regardless of the size of FDI inflows involved. There is of course no objective way to measure the extent of the distress discount in the sales value of assets. However, it is a common situation after a financial crisis that domestic companies and financial institutions need to sell their assets as Institutional Change in Southeast Asia 16 quickly as possible to overcome severe liquidity constraints, while foreign investors are in no hurry to buy those assets and can take their time. Considering this asymmetry in negotiation power between domestic institutions and foreign investors, it is more natural to suppose that the assets domestic institutions can sell in a crisis situation will be either those with exceptionally bright prospects or those with bargain prices, or both. In this respect, a substantial part of asset sales in Korea could be regarded as transition costs borne by the country in shifting its economy, which had drawn its investment funds primarily from domestic resources and foreign debts, towards one relying on foreign investment. One may argue that Malaysia’s reduction in the volume of FDI inflows after the crisis is a negative consequence of capital controls and other unorthodox policy measures that made foreigners hesitant to invest in Malaysia. If we simply compare figures of FDI inflows between Malaysia and Korea, this observation may look plausible. In Table 1.1, the annual average FDI inflow in Malaysia was nearly halved during the post-crisis period (US$2,831 million, 1998–2002) compared to the pre-crisis average (US$4,808 million, 1991–1997) whereas that in Korea more than quadrupled during the post-crisis period (US$5,906 million) from that during the pre-crisis period (US$1,464 million). However, the FDI figures for the two countries should be interpreted with great care. As pointed out above, most FDI inflows in Korea after the crisis were accounted for by asset sales and greenfield investments were minimal. It can be even argued that the heavy reliance on asset sales in fact hindered greenfield investments in Korea. During the precrisis period, M&As (US$324 million) accounted for just over 20 percent of FDI inflow (US$1,464 million). However, M&As amounted to almost 100 percent of FDI inflow during the post-crisis period.12 In contrast, Malaysia was able to attract a large number of greenfield investments even after the crisis, though its volume was considerably reduced from before the crisis. Considering this difference in composition of FDI inflows, one cannot simply say that the performance of Korea was better than that of Malaysia in terms of attracting FDI after the crisis. Moreover, the stagnation of FDI inflows after the crisis was a common phenomenon in the Southeast Asian region overall, not simply confined to Malaysia. As China continued its explosive economic growth and maintained its open-door policy, the Southeast Asian region appeared to be losing out in competition with China in attracting FDI inflows. On the other hand, the structure of the Korean economy was more advanced than Malaysia or China, and there was less direct competition with China in attracting FDI. In this respect, the stagnation of FDI in Malaysia can be better regarded as a consequence of the overall deterioration of the regional competitiveness of Southeast Asia, not as a result of a negative impact on investor confidence by Malaysia’s rejection of the implementation of neo-liberal institutional reforms. Costs in disposing NPLs outside the financial system Malaysia recovered from the financial crisis by creating fewer NPLs within the economy than Korea. When considering NPLs, most studies only focus on NPLs within the financial sector. The latter is certainly a measure of the soundness of the financial sector; if financial institutions are swamped by NPLs, they have difficulty in functioning as Institutional transition and transition cost: a methodological consideration 17 neurons of the economy. It is necessary to limit the level of NPLs in the financial sector for the smooth running of the economy. However, the reduction in NPLs within the financial sector itself cannot be regarded as a successful achievement of economic restructuring after a financial crisis. For the reduction can be simply achieved by shifting NPLs to outside the financial sector by purchasing them with public funds or selling them to private investors. If we want to evaluate a restructuring process, we need to investigate what happened to the overall number of NPLs at the level of the economy. Table 1.2 Trend of NPLs in Malaysia and Korea, 1997–2001 NPLs in the financial sectora (RM bil & Won tril.) (A) NPLs ratio to total loans (%) A ccumulate NPLs disposed outside the financial systemb (RM bil. & Won tril.) (B) B/GDP (%) Accumulate NPLs in the economy (RM bil. & Won tril.) (A+B) (A+B)/ GDP(%) Malaysia 1997 35.7 (25.0) 8.5 (5.9) – – 35.7 12.6 1998 76.9 (52.4) 18.6 (12.7) 14.7 4.9 91.6 30.4 1999 65.5 (46.8) 16.6 (11.8) 29.8 8.7 95.3 27.8 2000 64.2 (49.0) 15.4 (11.8) 46.5 13.9 110.7 33.1 2001 76.8 (61.7) 17.8 (14.3) 63.1 17.5 139.9 38.7 Korea 1997 86.4 (43.6) 13.2 (6.7) 28.9 6.5 115.3 25.9 1998 102.7 (60.2) 17.7 (10.4) 131.6 27.3 234.3 48.5 1999 66.7 11.3 284.2 54.5 350.9 67.2 2000 64.6 10.4 442.6 80.3 507.2 91.9 2001 32.0 5.4 586.8 98.4 618.8 103.7 Source: Bank Negara Malaysia, Monthly Statistical Bulletin, various issues; Danaharta, Operations Reports, various issues; PFOC, White Paper on Management of Public Funds, various issues; FSC, The Current Status of Non-Performing Loans in the Financial Sector, various issues. Note a Figures in parentheses are based on 3-months classification of NPLs. In Malaysia, supervisory regulations over NPLs are based on 6-months classification, although the Bank Negara Malaysia announces figures based on 3-months classification simultaneously. In Korea, the financial authority changed its NPL classification system to that of 3 months from the end of 1999 and no longer announced NPLs based on 6-months system. b The Malaysian figures were calculated by applying 55 percent of discount rate, which was an average during 1999–2001 for NPLs purchased by Danaharta. The Korean figures were calculated by applying 38 percent of discount rate, which was an average during the period November 1997 and June 2001 for NPLs purchased by the Korean government (PFOC 2001:138, table 3–34). Institutional Change in Southeast Asia 18 Korea’s performance in reducing NPLs within the financial sector is indeed remarkable. NPLs in the financial sector, which jumped to 136.3 trillion won (US$113.5 billion), or 21.8 percent of total loans at the height of the financial crisis in June 1998, were reduced to 66.7 trillion won (US$55.5 billion or 11.3 percent) at the end of 1999, and to 32.0 trillion won (US$26.6 billion or 5.4 percent) at the end of 2001 (see Table 1.2). In the banking sector, the NPL ratio fell dramatically to 3.4 percent at the end of 2001 (FSC website). As far as numerical measures indicating the soundness of the financial sector are concerned, Korea achieved more than what the most optimistic analysts would have forecast. The performance of Malaysia looks sluggish compared with Korea’s. The amount of NPLs in the Malaysian financial sector hardly changed even after the economic recovery. The figure was RM76.9 billion (US$20.2 billion) in 1998, the year when the economy had reached the bottom, and still stood at RM76.8 billion (US$20.2 billion) in 2001, if one applies the 6-month standards. The NPLs ratio to total loans also did not improve, changing only slightly from 18.6 percent in 1998 to 17.8 percent in 2001. However, these figures conceal the amount of NPLs created in the economy. As Table 1.2 shows, the accumulate NPLs in the Korean economy, which include both those remaining within the financial system and those disposed outside the financial system, were 618.8 trillion won (US$479.3 billion) in 2001. This means that, during 1998–2001, 503.5 trillion won (US$390.0 billion) of new NPLs, equivalent to 84.4 percent of the country’s GDP in 2001, was reported in the Korean economy. By contrast, the value of those in the Malaysian economy during the same period was RM104.2 billion (US$27.4 billion), equivalent to 28.8 percent of the country’s GDP in 2001. The figures show that Korea recovered from the financial crisis by creating a lot more NPLs in its economy than Malaysia, although its financial sector may look much healthier than its Malaysian counterpart. It is of course impossible to determine objectively how much of the increase in NPLs in the economy was due to ex post realization of latent troubles in the economy accumulated before the crisis, or to difficulties created in the process of overcoming the financial crisis. The reformers in Korea, including the Korean government and the IMF, tend to attribute most of these new NPLs to the former. However, this view seems far fetched. To be correct, one should be able to say that the Korean economy had been plagued by a much larger scale of hidden financial troubles than the Malaysian economy before the outbreak of the currency crisis in 1997. However, there is no convincing evidence that the scale of latent NPLs in Korea could be as much as over three times that of Malaysia. It would be more plausible to attribute such a big difference in the size of newly accounted NPLs between Korea and Malaysia to their different approaches in dealing with the financial crisis. In this regard, we need to draw attention to the financial conditions in Korea during the period when the country was carrying out the radical institutional reforms. Table 1.3 shows the financial flows from the financial sector to the corporate sector. A remarkable trend in Korea after the crisis was the abrupt depletion of external funds available for the corporate sector. Even during the period of rapid economic recovery in 1999 and 2000, the external funds for the corporate sector amounted to only around half of that available in 1997, and the situation became worse in 2001. Institutional transition and transition cost: a methodological consideration 19 Table 1.3 External financing of the corporate sector in Korea (billion won) 1996 1997 1998 1999 2000 2001 Total 118,769 118,022 27,664 51,755 66,531 51,939 Indirect financing 33,231 43,375 −15,862 2,198 11,391 1,185 From banks 16,676 15,184 259 15,525 23,348 3,381 From NBFIs 16,555 28,191 −16,550 −13,267 −11,997 −2,377 Direct financing 56,097 44,087 49,496 24,792 18,996 36,838 CPs 20,737 4,421 −11,678 −16,116 −1,133 4,210 Stocks 12,981 8,974 13,515 41,137 20,806 16,504 CBs 21,213 27,460 45,907 −2,827 −2,108 11,761 Foreign borrowing 12,383 6,563 −9,809 11,537 15,765 2,283 Others 17,059 23,997 3,839 13,228 20,380 11,633 Source: BOK, Flow of Funds, various issues. Notes “NBFIs” are non-bank financial institutions; “CP” is corporate paper; “CB” is corporate bond; “Others” include corporate loans, government loans and so on. The main culprit here was the fall in indirect financing, i.e. borrowing from financial institutions. In 1998, at the height of the crisis, financial institutions withdrew 15.8 trillion won of loans from the corporate sector. Although indirect financing slowly began to recover, its level fell far short of the pre-crisis level. The amount of external financing available in 1999, at 2.2 trillion won, was only about 5 percent of the 1997 level of 43.4 trillion won. In 2000, it was still only 26 percent (11.4 trillion won) of the 1997 level. As the economy began slowing down sharply in 2001 along with the recession in the world economy, indirect financing shrank dramatically again to 2.5 percent (1.2 trillion won) of what was available in 1997. This continued credit crunch even after the recovery was mainly because the radical institutional transition in Korea created a vacuum in its risk-taking function. In the new institutional framework, the financial sector should have acted as the major agent to assess and take risks in loan provisions. But its capability to do so was severely constrained. First, since financial institutions themselves were in the process of ongoing reorganization and many of them were placed under government ownership, their primary concern was to meet newly-introduced supervision standards like BIS ratios and forward-looking criteria (FLC), which generally penalize corporate lending. They had little incentive to take high risks in corporate lending in the new regulatory environment. Second, related to the above, managers in financial institutions had little incentive to help resolve the financial problems of companies. If they let those troubled companies fail now, the failure would be considered as a result of poor lending decisions by their predecessors; whereas the managers themselves would be held responsible if the firms to which they extended new loans should fail. In this situation, they tended to underestimate the value of currently ailing firms and preferred to liquidate them rather than exert efforts to turn them around. This incentive became stronger if the assets related to the ailing Institutional Change in Southeast Asia 20 firms were already classified as NPLs and therefore provisions against them had been made.13 In contrast, Malaysia did not experience such a prolonged credit crunch in the corporate sector as in Korea. One major reason why the Malaysian government introduced capital controls in September 1998 was to ease the credit crunch brought about by the financial crisis and a short experiment with the “virtual IMF regime”. Contrary to its Korean counterpart, the Malaysian government eased financial regulations and encouraged financial institutions to extend loans to corporations. It also focused its policies on restructuring loans and turning around corporations, and “only resort[ed] to foreclosures and sale of collateral as a last resort” (Ariff et al. 2001:79–80). In short, Malaysia attempted to overcome the financial crisis by creating a financial environment more favorable to corporate lending and helping domestic corporations survive financial troubles. As mentioned above, NPLs in the Malaysian economy also increased substantially due to financial troubles after the crisis. However, their size was much smaller than that of Korea because Malaysia maintained its risk-taking mechanism and let it work. In the above, I have attempted to compare transition costs involved in institutional transition in Korea and non-transition in Malaysia. Of course, this is no more than a rough picture and the actual size and contents of transition costs can be controversial. However, the comparison at least shows that Korea paid much higher transition costs than Malaysia. This suggests that the Korean government and the IMF neglected or underestimated transition costs involved in a radical institutional transition, whereas the Malaysian government was more concerned with transition costs in refusing to adopt the IMF program.14 Conclusion Acknowledging and considering the existence of transition cost is disconcerting to researchers. The nature and size of transition cost differ according to the context within which an institutional transition is attempted. This therefore makes our analysis more complicated rather than simplified, and it becomes harder to draw general implications. However, this is a fact of life we have to face rather than avoid. I have argued that North’s transaction cost analysis avoids this complexity by resorting to residual analysis and reductionism, and it therefore provides little help towards meaningful understanding and designing useful programs for institutional change. I have also demonstrated, with a comparison of institutional transitions in Malaysia and Korea, that it is possible for a country to pay much higher costs than expected in an institutional transition if it does not pay enough attention to possible transition costs. When we consider future institutional changes in Southeast Asia, this aspect of transition cost should be given due consideration. We can certainly learn from existing theories and the experiences of other countries. However, if we want to derive a useful program for institutional transition for individual countries, we should go one step further. The theories and lessons from other countries should be interwoven with careful analyses of the real challenges faced by each country, the available alternatives, the costs and benefits involved in those alternatives, and so on. Institutional transition and transition cost: a methodological consideration 21 The only universal lesson that we can derive from our discussion above would be that there is no panacea for institutional management and institutional change. A one-size-fitsall solution often results in huge transition costs. Reality is full of gray areas determined by the contexts in question, which suggests to us that there are many middle roads for institutional transition. What is important, therefore, is to find what middle roads are suitable for the countries concerned. Notes 1 For the contents and the origin of the Washington consensus, refer to Williamson (1993, 1997) and Gore (2000). 2 For discussions on the different stances of the institutionalists, refer to Langlois (1986:1–25), Hodgson (1991), Matthews (1986), Boulding (1957) and Dorfman et al. (1963). 3 In this context, Khan (1995:74) points out that “the gap between the neoclassical production function and reality can always and tautologically be attributed to transaction cost”. 4 North (1990:86) argues as follows: “A change in relative prices leads one or both parties to an exchange, whether it is political or economic, to perceive that either or both could do better with an altered agreement or contract. An attempt will be made to renegotiate the contract… Over time, the rule may be changed or simply be ignored and unenforced. Similarly, a custom or tradition may be gradually eroded and replaced with another.” 5 For discussions on the “second-best theorem”, see Bohm (1987), and Boadway and Bruce (1984:131–136). 6 Level effects refer to once-and-for-all changes that raise or lower balanced growth paths without affecting their slope, whereas growth effects refer to changes in parameters that alter growth rates along balanced paths. 7 Refer to Freeman (1987), Lundvall (1992) and Nelson (1993). 8 See Kuisel (1981). 9 The Ayub Khan regime was a “strong state” equipped with the oppressive power comparable with its counterparts in East Asian countries like Korea or Taiwan and instituted a similar developmental strategy. However, “[t]he experiment was abandoned after the uprising of 1969–71 and a civil war in which possibly a million people died” (Khan 1995:85). For Khan, this failure was mainly due to attempting an institutional transition without fully considering costs from resistance to the proposed change. He argues that other strategies of transition would have been preferable to attempting to establish an East Asian-type developmental state. 10 For details, refer to Shin (2003). 11 For details, see Shin and Chang (2003). 12 It is not precise to compare them directly because figures for M&A sales are reported on gross basis and those for FDI inflows are reported on net basis in World Investment Report. However, the comparison advanced here at least provides a rough picture of the relative share between M&A sales and greenfield investments in the FDI inflow of individual countries. 13 This was well reflected in creditor banks’ preference of selling Daewoo Motors and Hynix to foreign buyers than turning them around with their own initiatives. 14 It should be noted that, apart from transition costs discussed here in relation to the risk-taking mechanism in the economy, Malaysia experienced far lower economic and social costs from unemployment in overcoming the crisis. Its unemployment rate only rose from 2.4 percent in 1997 to 3.2 percent in 1998 and 3.4 percent in 2000, a level regarded as a full employment rate in most countries. The average unemployment rate during the post-crisis period, 1998– 2001, was 3.4 percent, only slightly higher than the pre-crisis average of 3.1 percent during 1991–1997. By contrast, Korea experienced a larger scale of unemployment by adopting Institutional Change in Southeast Asia 22 availability and number of schools, and other such factors. Whereas the quality of education is difficult to measure, we can observe basic indicators such as school enrollment rates, mean years of schooling and literacy rates. Table 2.5 shows the adult literacy rates in 1999 and the mean years of schooling between 1970 and 2000. Most Southeast Asian countries have literacy rates above the 73 percent average in developing countries. The exceptions are Laos and Cambodia. The situation in Laos is particularly troublesome with a literacy rate of only 47 percent, which is very low also in an international comparison. The literacy rate is above 90 percent in Singapore, Thailand, the Philippines and Vietnam. This is a rather strong achievement, especially in the latter two relatively poor countries. On the other hand, the literacy rate in Singapore is less than in other countries on a similar income level. For instance, the OECD has a 100 percent literacy rate despite an average income similar to Singapore’s. All countries have seen a relatively large increase in the mean years of schooling between 1970 and 2000, but there are big differences among the countries. For instance, Vietnam, Indonesia and Myanmar all had fewer years of schooling than the average among developing countries; this is probably true also for Laos and Cambodia, for which figures are not available. The population of Myanmar has particularly few years of schooling; the median figure is less than three years in 2000. On the other hand, Malaysians seem to spend many years in school, about the same number as their wealthier neighbors in Singapore and at an average OECD level. Table 2.4 The availability of teachers in Southeast Asia Teachers per 1,000 nonagricultural labor force Primary school pupil-teacher ratio Secondary school pupil-teacher ratio 1990 1996 1990 1996 1990 1996 Singapore 18 18 26 21 21 20 Malaysia 41 41 20 19 19 19 Thailand 50 na 22 na 18 na Philippines 38 35 33 35 33 32 Vietnam 55 53 35 32 18 29 Indonesia 65 56 23 22 13 14 Laos 78 75 27 30 12 17 Cambodia 53 42 33 46 15 18 Myanmar 38 36 48 46 13 16 Japan 25 26 21 19 na 14 Hong Kong 20 18 27 24 21 20 South Korea 25 23 36 31 26 25 China 55 50 22 24 15 17 Source: UNESCO (2001). Educational reforms and challenges in Southeast Asia 29 Table 2.5 Literacy rates and mean years of schooling in Southeast Asia Mean years of schooling Country Adult literacy rate 1999 1970 1980 1990 2000 Singapore 92.1 7.5 8.5 9 9.5 Malaysia 87.0 6.3 8 9.2 9.4 Thailand 95.3 4.1 4.4 5.6 6.5 Philippines 95.1 4.8 6.5 7.3 8.2 Indonesia 86.3 2.9 3.7 4.0 5.0 Vietnam 93.1 na na 3.8 na Laos 47.3 na na na na Cambodia 68.2 na na na na Myanmar 84.4 1.4 1.6 2.5 2.8 Japan 100.0 7.5 8.5 9.0 9.5 Hong Kong 93.3 6.3 8.0 9.2 9.4 South Korea 97.6 4.9 7.9 9.9 10.8 China 83.5 na 4.8 5.9 6.4 Developing countries (average) 72.9 na 3.9 4.9 na OECD (average) 100.0 7.3 8.6 9.1 9.6 Source: UNDP (2001). The mean years of schooling is related to the school enrollment ratios, which are shown in Table 2.6. Almost 100 percent enrollment in primary school was achieved by 1990 in all of the included countries. The figures for Malaysia and Singapore are affected by the possibility of teaching the children at home; in other words, whereas primary school education is compulsory in these countries, attendance in a school is not. The figures for secondary and tertiary education show much larger differences. For instance, Malaysia, Singapore and the Philippines have secondary enrollment rates above 60 percent, whereas the rates in Laos, Cambodia and Myanmar are only 30 percent or less. Interestingly, the enrollment rate in Cambodia has actually declined for both primary and secondary education between 1990 and 1996. Tertiary education shows low enrollment rates in the poorer countries but also surprisingly low in Malaysia. Singapore, the Philippines and Thailand have rather high tertiary enrollment rates although lower than in Japan and South Korea. Institutional Change in Southeast Asia 30 Table 2.6 School enrollment ratios in Southeast Asia Primary school gross enrollment rate (%) Secondary school gross enrollment rate (%) Tertiary school gross enrollment rate (%) Countries 1990 1996 1990 1996 1990 1996 Singapore 104 94 68 74 19 38 Malaysia 94 101 56 64 7 12 Thailand 99 87 30 56 na 22 Philippines 111 114 73 77 28 29 Indonesia 115 113 44 51 9 11 Vietnam 103 113 32 47 2 7 Laos 105 112 25 28 na 3 Cambodia 121 110 32 24 1 1 Myanmar 106 121 23 30 4 5 Japan 100 101 97 103 30 40 Hong Kong 102 94 80 73 19 na South Korea 105 94 90 102 39 68 China 125 123 49 70 3 6 Source: UNESCO (2001). Not only tertiary school enrollment rates differ between the Southeast Asian countries, but also the structure of higher education. Table 2.7 shows the percentage of students in four different fields of higher education. The main difference is between a country such as Singapore, which has a large proportion of the students in the sciences and engineering faculties, and Thailand, where most tertiary students can be found within law and the social sciences. The large share of Singaporean students in engineering is the result of a deliberate policy that goes back to the early years after independence in 1965. The government was worried about wide-spread unemployment of white-collar workers if higher education was generally expanded rather than closely directed to the skills demanded by the foreign multinational companies. The focus became, and has remained, to supply skilled technicians and engineers, whereas higher education in arts and social sciences has been deliberately restricted. Educational reforms and challenges in Southeast Asia 31 Table 2.7 Distribution of tertiary students over field of study in Southeast Asia, in percentage of students by field of study, 1996 Coun tries Educa tion Hum anities Law and social sciences Natural sciences, engineering and agricultural Medical sciences Singapore 7 33 in Humanities 58 3 Malaysia na na na na na Thailand 9 4 60 21 6 Philippines 15 6 31 28 19 Indonesia 17 6 46 28 2 Vietnam na na na na na Laos 28 7 13 38 11 Myanmar 0 42 22 37 na Cambodia 26 2 29 23 20 Japan 8 56 in Humanities 23 8 Hong Kong 9 9 34 42 4 South Korea 6 17 25 34 5 China 16 6 9 53 9 Source: UNESCO (2001). Note Law and social sciences are included under the humanities in Singapore and Japan. We have seen a number of educational indicators and the overall picture suggests that the differences are large within the region and that rich countries put more emphasis on education than poor countries do. Still, there are variations also between countries on a similar income level. One way to summarize the educational standard in the countries is to use an index by the UNDP (2001:240). The index in Table 2.8 is based on school enrollment rates and literacy rates and should, because of its limited number of criteria, be interpreted with caution. The higher the value on the index, the better the country performs in the area of education. The index shows that the Philippines actually performs best, followed by Singapore, Thailand and Vietnam. Laos and Cambodia have lower values on the index than the average among developing countries. A more detailed discussion It has been widely argued that all the high performing Asian economies shared a strong emphasis on education and skill upgrading (World Bank 1993, Campos and Root 1996). As seen from the discussion above, this is, in fact, not typically the case for Southeast Asia. On the contrary, Ann Booth has convincingly showed that Southeast Asia has traditionally been neglecting education rather than promoting it (Booth 1999a, 1999b). Taking all of the different measures on education into account, it seems clear that there is one group of countries which performs reasonably well in promoting education. This Institutional Change in Southeast Asia 32 group includes Singapore, Malaysia, Thailand, the Philippines and perhaps also Vietnam. There is also a group of Southeast Asian countries where educational standards seems low. This group includes Laos, Cambodia, Myanmar and perhaps Indonesia. Moreover, even among the countries that do relatively well according to the discussed figures, a more detailed look reveals various problems and shortcomings. Table 2.8 Income per capita in Southeast Asia and UNDP’s education index, 1999 GDP per capita (1999, PPP US$)UNDP’s education index Singapore 20,767 0.87 Malaysia 8,209 0.80 Thailand 6,132 0.84 Philippines 3,805 0.91 Indonesia 2,857 0.79 Vietnam 1,860 0.84 Laos 1,471 0.51 Cambodia 1,361 0.66 Myanmar 1,027 0.75 Japan 24,898 0.93 Hong Kong 22,090 0.83 South Korea 15,712 0.95 China 3,617 0.80 Developing countries 3,530 0.69 OECD 22,020 0.94 Source: UNDP (2001). For instance, Singapore might be the best educational achiever in Southeast Asia, but it still lags behind Northeast Asia and the OECD despite having a similar or even higher income level. The reason is that the official emphasis on human resource development has only in recent years been matched by actual improvements in education. As late as 1997, almost 25 percent of the labor force had, at most, only a primary education (Booth 1999a:296). The lack of appropriate skills in the local labor force has forced Singapore to rely on a large number of foreigners to achieve the necessary upgrading of production. Thailand and Malaysia are two other countries that seem to perform reasonably well in supporting education, but these countries also suffer from various problems. The standard of education in Thailand was for a long time the worst in the region. Access to higher education was limited and even provision of basic education was arbitrary in the rural areas. The neglect of education created bottlenecks that in the late 1980s seemed to threaten the country’s continued economic development. As a result, the government introduced a compulsory nine-year schooling and increased expenditures on education. The expansion of secondary education, in particular, was rapid with the enrollment rate in lower secondary education increasing from about 32 percent in 1987 to 66 percent in 1996 and in upper secondary education from about 24 percent to about 40 percent, according to Booth (1999a). Still, large problems remain, such as the low number and poor quality of science and technology students (Brimble 2001). As seen in Table 2.7, there are few students studying natural sciences or engineering. As a result, Thailand only Educational reforms and challenges in Southeast Asia 33 had 119 engineers and scientists per million population before the crisis, compared to, for instance, 350 in China. A combination of an archaic university system, low salaries for teachers and insufficient funds from the government caused the poor quality of higher education. The low salaries, in particular, led to the low qualifications of university teachers in science and engineering; only about 55 percent of these teachers have a master’s degree and 27 percent a PhD. Malaysia has traditionally been spending more on education than other countries in the region, at least in relation to its level of development. One reason is the effort to stimulate the ethnic Malays to continue in higher education, and thereby to diminish the large income differences between different ethnic groups. One cannot, however, escape the impression that Malaysia has not received sufficient economic returns on its large investment in education. One reason is that some of Thailand’s problems seem to be present also in Malaysia. Employers complain about the difficulties in finding skilled workers (Rajah 2003). The reason seems to be that although education has been expanded, an insufficient share has been allocated to science and engineering. Malaysia has only about 2 percent of secondary students in technical education compared to, for instance, 19 percent in Korea and 12 percent in Indonesia. This lack of skilled employees has been one major problem for upgrading production and has led to difficulties for “high-tech” projects such as the Multimedia Super Corridor outside of Kuala Lumpur. The relative poor performance of Indonesia may come as a surprise since Indonesia has often been singled out as a successful example of how developing countries can achieve widespread improvement in the provision of basic education. The Indonesian reputation stems from the dramatic expansion of education that started after the large increases in oil revenues in the 1970s. More than 60,000 new schools were built, real expenditures spent on education more than doubled, primary education was made compulsory and school fees were abolished (Duflo 2000). As a result, a near 100 percent enrollment ratio was achieved in primary education by the 1980s, and secondary school enrollment increased from 35 to 48 percent for male students and from 23 to 39 percent for female students between 1980 and 1993 (Thee 1998:121). However, as seen from the discussion above, this initial achievement has not been matched by the provision of higher education or by improvement to the quality, and not only the quantity, of basic education. The government’s expenditure on education is lower than in almost all neighboring countries. Moreover, the quality at all levels of education remains poor.2 For instance, 9–10-year-old Indonesian school children perform below the international average in comparative tests (World Bank 1997:120). Moreover, most university graduates in Indonesia require months of extensive on-the-job training before they can contribute to production (Booth 1999a:301). There are additional problems with tertiary education. For instance, the tertiary system seems to emphasize relatively cheap education rather than be guided by the economy’s need for people trained in science and engineering. This has resulted not only in a weak skill base, but also in high rates of unemployment among university graduates. In addition, the 44 state universities, 24 state polytechnics, and 5 state fine arts academies have been far from successful in meeting the demand for higher education (Mukhopadhaya 2001). Instead, more than a thousand private institutes have been established to meet this demand, but the minimal monitoring of their activities has resulted in widespread quality problems. Institutional Change in Southeast Asia 34 Reforms, progress and obstacles To sum up the previous discussion, the standard of education in Southeast Asia differs between countries, but there seems to be a widespread need for reforms and improvements. Most countries in the region have recognized this need and various initiatives have been launched to improve the situation. We will look closer at some of these attempts, and also some of the obstacles, in three countries, Singapore, Malaysia and Indonesia. Singapore Singapore has had an exceptionally high economic growth over the last 30 years. Large investments, rapid growth of the labor force and large inflows of foreign multinational companies (MNCs) contributed to the high growth. However, politicians and policy makers seem to agree that Singapore needs to upgrade its production, increase technological innovation, and enhance creativity and entrepreneurship to secure future growth. The reasons are twofold. Firstly, growth through factor accumulation will be difficult to maintain with an investment rate that is already about 50 percent of GDP, and with an aging population. Instead, future growth has to rely more on technological progress.3 Secondly, the large reliance on foreign firms might also be difficult to maintain since the competition for inward FDI has increased substantially during the last decade. One indication is that inflow of FDI to Singapore decreased from 15.2 percent of GDP in 1980 to 8.2 percent in 1999 and the decrease seems to continue (UNDP 2001). Hence, a greater reliance on domestically owned firms is necessary. The Singaporean government is addressing both concerns and both have bearings on the educational system. More specifically, the government is attempting to encourage creativity, risk-taking and entrepreneurship through educational reforms. Creativity is to be encouraged through a new curriculum that encourages critical thinking and discussions rather than memorization. All levels of education are said to face this change of focus, but the exact nature of the changes is still not clearly defined. Suggestions include a broader set of criteria for university entrance than only grades from the A-level exam. However, there are also clear signals that many of the present characteristics of Singapore’s education will remain unchanged. The most important part is the early streaming process of school children into different educational programs. This takes place continuously and starts after primary three when a small number of the highest achieving students are invited to a special program.4 The streaming continues after primary four when the remaining students are divided into three different groups according to their academic capability. The outcome of the streaming is important for the children since it is difficult to get back to the “fast track” or the “main stream” once you have been found suitable for the “slow track”. The next streaming occurs with the public exam after primary six. The result of the public exam determines which secondary school the children can attend, which is often said to be of importance for their future careers. The importance of streaming has encouraged students to study very hard. For instance, children of age 10–12 years spend about 3 hours a day studying after school, and 70 percent of them receive extra tuition.5 Moreover, parents frequently take several weeks or even months off from their jobs in order to prepare their children for the more important Educational reforms and challenges in Southeast Asia 35 exams. The positive aspects of the system are clear from international comparisons of school children’s knowledge of mathematics and science where Singaporean children are always among the best performers. However, it has frequently been argued that the system might not encourage creativity since students are too focused on preparing for exams rather than developing their own interests, reflecting upon their knowledge, or taking part in activities outside of school. To develop a system that encourages creativity without sacrificing the high average standard is not easy, but it might be desirable to at least postpone the streaming until a later age, which would take some of the pressure off the youngest children. There is also much discussion about how to “educate for entrepreneurship” in Singapore. So far, there have been few specific policies, but initiatives include the possibility for university students to spend time in foreign high-tech centers, such as Silicon Valley, and programs in technopreneurship. One crucial issue is whether it is possible to teach students to become entrepreneurs. A core element of entrepreneurship is risk-taking, which is not present in the government-sponsored visits to foreign centers of excellence. Other factors than education are presumably more important for developing creativity and entrepreneurship in Singapore. For instance, Singapore lags behind many other East Asian countries in the pace of political liberalization. Whereas countries such as Korea, Taiwan, the Philippines and Indonesia have achieved or been moving towards democracy in recent years, Singapore still limits the freedom of media, cultural expression, civil society, trade unions and political activities. This has resulted in a society where people are said to be cautious about expressing their own ideas and views and where most people opt for the safe strategy of following officially sanctioned paths.6 A society that oppresses alternative views obviously does not encourage independent thinking and creativity. It is also uncertain if the government seriously expects people to think independently and to be creative in some selected areas such as in science or business, without allowing them to express independent views on, for instance, politics. Entrepreneurship also depends on factors other than education. For instance, the economic literature stresses the importance of incentives in the formation of a strong entrepreneurial community (Baumol 1990, Murphy et al. 1991). People will allocate their talent where the returns are the highest. Depending on the institutional setting, the returns could be highest in, for instance, entrepreneurial activities or in the government sector. The latter seems to be the case in Singapore. The Singaporean government and public bureaucracy pay high wages, among the highest in the world. In addition, the government, the public sector and the government-linked companies are closely connected. People move frequently between these three sectors, which enlarge the possible career path for people in the government sphere (Hamilton-Hart 2000). The government has explicitly stated that the reason for the high government wages is to attract the most talented Singaporeans. The policy has provided a highly skilled and efficient bureaucracy that has allowed the country’s economy to catch up quickly to the developed world. However, it is uncertain if the most talented people will continue to be of best use in the government sector at a time when Singapore has to rely on domestic innovations and entrepreneurship. Increased entrepreneurship is likely to require changes to the relative rewards of joining the public sector versus setting up own businesses. However, the government may not be too willing to lower its own relative rewards. Institutional Change in Southeast Asia 36 A final and related issue is that many of the brightest Singaporean students are financing their university studies through bonded government scholarships. These scholarships are distributed by various government ministries and require the students to serve with the ministry for a period of about five years after graduation. Again, it is doubtful whether the brightest students are put to best use by being employed in the government rather than in the private sector. The scholarships have recently been hotly debated in Singapore since many scholarship holders feel unhappy with the bond. However, the government has made it clear that the bond will remain. Malaysia Malaysia witnessed racial riots in 1969 when an election weakened the ethnic Malays’ hold on power. As a result of the riots, the government launched an economic program to favor ethnic Malays—the bumiputera policies.7 These policies aimed at decreased economic inequality between different ethnic groups by favoring the bumiputeras’ access to jobs in the civil administration, by forcing firms to form joint-ventures with bumiputeras, and by setting up special government agencies and financial institutions that served bumiputera interests. One consequence of the policies was that the traditional capitalists in Malaysia, the ethnic Chinese, became reluctant to make long-term investments. Instead, Malaysia had to rely on increased amounts of FDI (Drabble 2000). The FDI contributed significantly to production and exports of manufactures but, as previously mentioned, they tended to be in labor-intensive and low-skilled industries and there has been little upgrading over time. As a result, Malaysia relies today on large inflows of foreign workers to maintain the labor-intensive production. Moreover, competition from low-cost producers such as China is increasing rapidly and there are frequent reports on how foreign electronic firms are closing down their plants in Penang and instead expanding their activities in China. To upgrade production requires, among other things, improved education of the workforce, which is directly affected by the bumiputera policies. University admissions are on the basis of ethnic background and the bumiputeras are typically granted about 55 percent of the total admissions quota. This admissions policy seems successful in improving access to education for the traditionally low-income groups; however, it discriminates against the ethnic Chinese students who are usually the best performers with the highest grades. Some estimates claim that as little as 10 percent of the intake would go to bumiputeras if there were no quotas.8 As a result of these quotas, a large number of ethnic Chinese students are not allowed into Malaysian tertiary education despite having higher grades than their bumiputera classmates. Many ethnic Chinese students go abroad to study and work, which has contributed to a brain-drain from Malaysia. The problem of losing talented students is a major concern for the government and there are, from time to time, government attempts to lure the overseas Malaysians back home, but these attempts have not been very successful. In addition, the easy access to university for bumiputeras has presumably made them exert too little effort on their studies, resulting in a relatively low standard of university graduates. Former Prime Minister Mahathir made frequent threats to abolish the quota system. He argued that the bumiputeras were misusing their favored situation and therefore do not deserve to be sheltered. It seems that the present government is also concerned about Educational reforms and challenges in Southeast Asia 37 the situation, but it is unlikely that the quota system will be changed. The reason is the political threat from the ethnic Malay-based Parti Islam SeMalaysia (PAS). PAS has in recent years acquired a large part of the bumiputera electorate that used to support the United Malays’ National Organisation (UMNO), the main party in the coalition government. PAS has gained support by advocating a more Islamic governance of Malaysia, and PAS also strongly supports a continuation of the bumiputera polices. Hence, to abandon the bumiputera policies means that UMNO would further weaken its own political power base. The increased Islamic consciousness among the bumiputeras has had an additional effect on Malaysia’s educational system. An increasing number of children are joining Islamic schools rather than secularized ones. These schools place a greater emphasis on religious studies, including memorization of parts from the Koran. It is also said that this focus has partly been at the expense of other subjects. As a consequence, only about 25 percent of the students from Malaysia’s religious schools qualify for university.9 This has led to a situation where many universities are not able to fill their bumiputera quota but they are still not allowed to increase the quota for other ethnic groups. Hence, the universities are operating below their capacities, explaining part of the low tertiary enrollment rate shown in Table 2.6.10 The present popularity with religious schooling is therefore likely to have a negative effect on the populations’ skill in areas such as science, languages and mathematics. Needless to say, it is these types of skills, rather than religious training, that are typically required in industrial upgrading. An additional but related problem is that unemployment seems to be on the rise among bumiputera university graduates. For instance, the National Economic Action Council recently reported that 44,000 Malaysian recent university graduates were unemployed. Ninety-four percent of them were bumiputeras and most had studied arts and Islamic studies. A large group of ethnic Malays attend Middle Eastern universities for religious studies, and these graduates also face great difficulties in getting work once they return to Malaysia. For instance, 1,200 Malay graduates from the Middle East have been unable to find jobs after returning to the state of Kelantan in 2002.11 Indonesia As previously stated, Indonesia managed to expand its basic education rapidly in the 1970s and the enrollment in primary school increased from only about 60 percent in the early 1970s to almost 100 percent in the late 1980s. Secondary school enrollment rates also increased accordingly. However, education in Indonesia is still plagued by various problems. For instance, even if almost all Indonesians enter primary school, there are still some 30 percent who never finish it. Hence, the dropout rate is high and there are also widespread quality problems. Most of these problems are due to poor financing; Indonesia spends less than two percent of its GNP on education (Table 2.2). Consequently, teachers’ salaries are low, classes are large, books are of poor quality and 20 percent of all school buildings are in a deteriorating state (Jones and Hagul 2001). Because of the economic crisis, public spending on education is not likely to increase. In fact, the economic problems in Indonesia will presumably lead to less public expenditure on education since the government is starved of resources and spends about one-third of its total revenues on servicing an exploding foreign debt. In addition, the Institutional Change in Southeast Asia 38 This chapter will focus on two things. First, it will highlight some of the characteristics of the science and technology policies of selected ASEAN countries, namely the Philippines, Indonesia, Vietnam, Malaysia and Singapore. Second, it will discuss the shortcomings of the policies and examine the changes in technology systems which have taken place after the financial crisis. The analysis will focus on the interaction between the public and private sectors, as seen in the context of an ongoing globalization process. Technological opportunities are opening up on a global scale and can be seen as parallel and complementary priorities in global companies and governmental industrial policies. The key to improving technology performance, as stated in OECD (1997) in a study of national innovation systems, dwells in the understanding of the linkages between the actors involved in innovation. Such an insight requires a broad and systematic knowledge of the domestic innovation system, of the systems in other countries, and of the increasingly interlocking character of large global companies. Without such intelligence, realistic national objectives cannot be formulated. Even so, goals and instruments still have to be constantly modified in light of the changes within a national innovation system that is increasingly taking on global characteristics. The countries selected for this study, the Philippines, Indonesia, Vietnam, Malaysia and Singapore, not only exemplify countries at very different levels of economic development but also illuminate the very policies and conditions for their implementation. The Philippines has been weak in both formulation and implementation of policies, with rudimentary infrastructure and institutions for technological development, and has been less able to attract foreign direct investment (FDI). Indonesia has pursued a two-pronged policy of developing high-technology sectors and actively encouraging FDI. Both policies are partial failures because the infrastructure, institutions and human resources have been lacking. Vietnam has, in recent years, moved from a planned economy with well-developed institutions towards a market economy, which requires completely different policies and institutions. From its early success in attracting FDI of increasing sophistication, Malaysia has moved towards a selective development of high-technology sectors, for which clustering is an important policy instrument. Singapore decided at an early stage that it would integrate the nation with the global economy and has become a heaven for FDI in specific sectors. The success made Singapore into a high-wage country, which prompted a policy shift towards turning it into a knowledge-based economy. However, with the partial exception of Singapore, technology has not made as significant a contribution to the economic development of the countries as might be expected. Skeptics may ask whether science and technology matters that much to the low income economies discussed in this chapter. On the other hand there is confirmation that the most sustainable growth is to be observed in the countries with a strong focus on knowledge-based economy (KBE) according to OECD (2001). The term KBE refers to the main drivers of growth in all the sectors of economy, not only those usually called “high technology”. Four policy dimensions within KBE are identified as crucial for sustainable growth. They are: (1) innovation supported by a national innovation system; (2) human resource development; (3) information and communication technologies (ICT), efficient infrastructure for all businesses and individuals; and (4) legal and economic policies which take the business environment into account. Technological governance in ASEAN 45 The liberal market forces are no doubt insufficient to solve the above issues. Effective government measures have to be implemented—thus the term “political economy of technological development” came into existence. Political economy of technological development2 Technological change has been accelerated by globalization, as markets opened up and competitors looked to innovation as a means of gaining market advantage. The everincreasing effects of globalization have raised several fundamental issues for developing countries. First, national policy makers aiming to catch up to more developed countries have to formulate science and technology programs that are in tune with the rapid technological development. Second, national governments are still keen to assist their own national companies, but it is no longer clear which companies are national as the identities of firms are increasingly blurred by the crossborder process of mergers and acquisitions. The first issue requires close interaction with a global system of innovation, with active science, technology and education policies. The second issue prompts a shift in policy focus from the micro to the macro level, where governments seek to influence the performance of firms and industries through the use of an active industrial policy. The world economy shows broad inequalities that arise from globalization. A widening of disparities in technological capability between the more and the less technologically advanced countries is an important political issue of technological development. Many multinational companies have globalized their production, but few have shifted research and development capabilities or corporate headquarters away from their traditional home bases. An important reason for this situation is that technology, in terms of machines and blueprints, has become extremely mobile while the technological competence embodied in capable humans is much less so. Furthermore, it is recognized that the capacity to innovate is cumulative, as innovation gives birth to more innovation. A firm may shift its production facilities plant and machinery overseas, but people tend not to move. Knowledge and skills acquired over time by people who work in research remain key factors and it is not easy to pick up new, state-of-the-art technologies without the knowledge and the skills required for making good use of them. This pattern of technological development has powerful political effects. Countries and firms that start with less sophisticated technological competence may be left behind and often find it very difficult to catch up. More intense competition between more firms pushes forward the development of ever more sophisticated technologies. This means that the process of competition reinforces the advantage of those in the lead and takes them further along the learning curve. The tendency for technological development to reinforce existing competitive advantages has powerful repercussions, well-illustrated by the development of the Internet, which has created a wide gap between industrialized and developing countries. A further change in the political economy of research and technological development arises from new industrial structures. Nation states are scarcely able to influence the activities of large, oligopolistic multinational companies (MNCs) whose businesses and internal structures are global in scale, and can easily be shifted to new production sites. Simultaneously many MNCs with globalized activities have decentralized their Institutional Change in Southeast Asia 46 productive and distributive capacities. The phenomenon is usually referred to as networked organizations and is constantly increasing in scope and scale. Countries must therefore develop catch-up policies with foundations strongly based on facilitating the access to new technologies and promoting foreign direct investments.3 Technologies diffuse more readily if they are embraced widely by citizens in democratic societies. However, the historical perspective of the last half of the 20th century in East Asia proves that strong but enlightened political regimes were more successful in imposing development-oriented catch-up policies than weaker governments. Technology policies, which have traditionally been producer-driven, have to consider thoughtfully the demand side today. A broad and similar lesson may be drawn from the cases of nuclear power in the 1970s, cattle growth hormones in the 1980s and gene technologies in the 1990s. Technologies will not catch on unless they are viewed by citizens as safe, ethical and consumer-friendly. Thus successful diffusion depends just as much on social attitudes as it does on technology. While examining the governmental structures of the selected countries, one finds a variety of state agencies with special responsibilities for education, technology and science. On the very top level there are the examples, as in the Philippines, of secretaries of the president’s cabinet responsible for the area, corresponding in other countries to a respective ministry in the prime minister’s office. The following summary is a first attempt to highlight the character of technology policy and technology development in five ASEAN countries by focusing on inherent features, perceived shortcoming and significant changes that have taken place during the past few years. The Philippines: the shortcomings of S&T policies The Philippines rank low in several research and development (R&D) indicators such as the ratio of R&D expenditure to GNP, which is very low. Similarly, the country ranks low in terms of number of personnel engaged in R&D. A study from the Philippine Institute of Development Studies (PIDS) states that the number of scientists and engineers per million inhabitants was only 152 in 1992. However, the composition of the national cabinet shows at least two bodies responsible for science and education, the Secretary for Education, Culture and Sports, and the Secretary of Science. The Secretary of Science leads the Department of Science and Technology (DOST). The country’s educational system produces few graduates in science and engineering, even though the number of students at the tertiary level is actually quite high in the Philippines. PIDS points out that there is a great demand for technical and engineeringrelated graduates by local industries but that the private tertiary schools primarily train non-technical students. An important reason for this mismatch is that the private colleges are unable or unwilling to invest in costly laboratory equipment. This mismatch continues at the next level of education and PIDS reports that more than 50 percent of R&D personnel with PhD degrees in government agencies, and state universities and colleges have their degrees in the social sciences. The Philippines has failed to use technology to gain competitive advantage. Resourcebased exports such as timber or copper are basically in raw material or unprocessed form. Traditional agricultural exports, such as coconut, sugar and banana are also exported Technological governance in ASEAN 47 without infusing technology-based processing in the valued-added chain. The overall assessment of the state of science and technology in the Philippines is at the level set by UNESCO for less developed countries. In terms of human resources, the Philippines has only 155 R&D scientists and engineers per million inhabitants, far below the UNESCO target of 380 for Asian lesserdeveloped countries (LDCs). The Philippines needs to strengthen its education in science and engineering by updating the curricula, finding qualified teachers and procuring laboratory facilities. The Philippine government created the National Science and Development Board (NSDB) in 1958 to formulate and implement science and technology (S&T) policies, and to co-ordinate S&T agencies. In 1974, a national science development plan was incorporated in the Medium-Term Development Plan: 1974–1977. All succeeding Medium-Term Development Plans contained a chapter or sections related to S&T policies, plans and programs. The Department of Science and Technology (DOST) introduced the Science and Technology Master Plan (STMP) in 1990 which set the goals and objectives for the S&T sector, and provided a framework for the effective coordination of S&T projects and programs consistent with national development policies. The Comprehensive Technology Transfer and Commercialization (CTTC) program was initiated to disseminate and commercialize locally developed technologies. But there was a lack of locally developed, commercially viable technologies. In 1993, DOST introduced the Science and Technology Agenda for National Development (STAND) as a successor to STMP. STMP had three main strategies: (1) modernization of the production sector through massive technology transfer from domestic and foreign sources; (2) upgrading of R&D capability through intensive activities in high priority sectors; and (3) development of S&T infrastructure, including institution building, manpower development and development of S&T culture. STAND’s objective was to help realize the vision of the Philippines during the 2000s by focusing S&T activities on export niches identified by the private sector. The renewed attempt to formulate industrial policy is a reiteration of the vital role of industrial progress to sustain future economic growth. However, ad hoc or de facto industrial policies have not stressed the need for active promotion of technology to build up a strong foundation for industrialization. The major thrust of the Philippine S&T policy has recently been subjected to contrasting recommendations. One view recommends that the universities and research institutes focus on the basic sciences and advanced technologies to provide the foundation for sustained technological development. This view is popularly called “supply-push” or “technology-push”. The other view argues that it makes more sense for the government to provide an environment which enables the private sector to purchase the technologies that it needs. The most reasonable conclusion that can be drawn is that neither STMP nor STAND can be implemented. Therefore DOST must effectively address the following problems: (1) shortage of high-quality S&T manpower; (2) dependence on technology importation; (3) low level of private sector participation in R&D; (4) low level of basic research in core, strategic and emerging technologies such as biotechnology, new materials science, robotics and information technology; (5) lack of a technology data bank and information network; (6) absence of science programs for the younger generation; and (7) insufficient financial resources for S&T development. Institutional Change in Southeast Asia 48 In the 2000s DOST undertook new initiatives under a new Science Secretary. The Medium Term Plan for 1999–2004 outlines the vision and priority goals for establishing a competitive science community. As a result, the department supported some 15,000 students and trained 1,635 teachers in science and mathematics in the year 2001. DOST also started the Philippine Research Education and Government Information Network, offering over 15 different technological assistance programs for small to medium enterprises (SMEs) through different DOST offices and agencies in the country. There are about 16 offices willing to help the local entrepreneur, among them the Technology Training Center, DOST-Academe Technology, Global Technology Search, Municipal S&T Program, Intellectual Property Rights Program and others. DOST also advertises and supports successful innovative initiatives via a well-designed website. These new actions are too recent to be assessed; however, they are proof that the government is aware of the importance of country-internal visions of development in confrontation with dramatic cuts in FDI inflow in the late 1990s. To improve the Philippine R&D delivery system, the authors suggest the following measures: (1) reorganize the government-supported R&D institutes into a new corporate structure that gives them flexibility and autonomy; (2) strengthen the network of schools or consortia to maximize the use of resources and to develop core competence; and (3) promote the development of S&T culture. Indonesia: the dominance of FDI Indonesia is one of the poorest countries in the region. It also has the most complicated ethnic structure and consequently, serious political problems. The manufacturing sector in Indonesia has sustained a high rate of growth for a number of years and both its share of GNP and exports have increased rapidly. New industrial sectors include electronics and transportation equipment, and the textile industry has become highly competitive through modernization. The above-mentioned phenomena can be attributed to the significant inflow of FDI. The government organization in Indonesia is relatively complicated with broad prerogatives given to provincial governors. However, at the state level, there is an office of Minister for National Education responsible for the overall science and education policy. The technological foundation of the country is weak, as the capital goods sector is underdeveloped. The country’s ability to absorb and improve imported technologies is also weak, particularly when it comes to complex technologies. A number of successful export industries controlled or propelled by FDI have remained concentrated in laborintensive assembly or resource processing activities. Moving away from this pattern of development will require a significant reorientation of the country’s technology strategy. Almost all R&D activities in Indonesia are carried out in government research institutes (GRI), although there is an increasing demand for industrial R&D due to the rapid expansion of the industrial sector. This poses a challenge for reform as the GRI activities very rarely correspond to the needs within the industrial sector, in either their orientation or research results. Since 1997 Indonesia’s economic policy-makers have primarily concentrated their efforts on dealing with the most serious financial and economic crisis the country has Technological governance in ASEAN 49 faced since its independence in 1949. However, once macroeconomic stability is restored, the Indonesian economy will once again be facing the same challenge as before the onset of the crisis, namely how to sustain the growth of Indonesia’s manufactured exports. Sustaining growth of the manufacturing sector is crucial, as it has emerged as the major engine of growth as well as the major source of foreign exchange earnings since the end of the oil boom era in the early 1980s. Indonesia can no longer continue to rely on its traditional sources of comparative advantage, namely its cheap but low-skill labor and its natural resources. Instead, it will need to develop a more sustainable base of comparative advantage, just like the first tier newly industrializing countries (NICs) in East Asia. FDI is generally the major vehicle for the transfer of technology and other resources, such as capital, managerial and marketing know-how, and access to world markets, from the advanced to the developing countries. To what extent FDI leads to the development of local technological capabilities depends a great deal on the economic policies pursued by the host government as well as on the local absorptive capability, that is, the availability of adequately skilled human resources. Singapore, Japan and South Korea and, to a lesser extent, Taiwan, all pursued highly restrictive policies towards FDI, prioritizing the promotion of indigenous enterprises and deepening local technological capabilities; Indonesia, however, has not been very successful in using FDI to promote the development of local technological capabilities, despite the fact that it has been receiving large amounts of FDI since the late 1960s, at least until the severe economic crisis of 1997 virtually halted the inflow of new FDI. This failure has been caused by the fact that the Indonesian government has not taken a more pro-active approach to attracting the kind of FDI the country needed for promoting its industrial technology development. Findings from some recent firm-level studies on the impact of FDI on Indonesia’s industrial technology development within its manufacturing sector indicate serious shortcomings. Surveys indicate that in joint ventures the interest of the foreign investors in technology transfer was mainly limited to production engineering, that is, the smooth operation of the plants. As the foreign-controlled firms mostly relied on the designs developed by the parent company, their design capability is also low; the same can be said of the industrial engineering capabilities of the joint ven-tures. Also, during the period of import-substituting industrialization in the 1970s and early 1980s, many foreign investors used obsolete technologies, specifically outdated capital equipment, as even with these technologies they were able to sell their products in the highly protected Indonesian domestic market. The technological development in Indonesia has shown that in most joint ventures, the technology transferred from the MNCs to the local employees has been limited to the very basic technological capabilities required for the early stages of industrialization, which is the skills and knowledge required for the efficient operation of the plant. Other factors which have hampered Indonesia from taking greater advantage of its FDI to promote technology transfer and diffusion have been the shortage of an adequately skilled labor force and the weakness of its few supporting supplier industries. The development of industrial technological capabilities (ITCs) such as operational (production), acquisitive (investment), adaptive (minor change), and innovative (major change) capabilities, is essential. In order to obtain greater technological benefit from FDI than it has so far, the Indonesian government must pursue sound macroeconomic policies and pro-competition policies to ensure a competitive business environment. The Institutional Change in Southeast Asia 50 country must also pursue a much more consistent and transparent policy to attract the FDI that it now needs, more than ever, for its economic recovery and subsequently for sustaining its economic growth and export-oriented industrialization. To achieve this, the Indonesian government needs to continue dismantling its cumbersome regulatory framework in order to further reduce the high facilitation costs associated with setting up a new plant or office. No less important, it needs to prioritize developing its human resources in order to raise their capacity to absorb, assimilate, modify and improve the imported technologies, whether transferred through FDI or purchased through technical licensing agreements. For a developing country such as Indonesia, which still lags behind its East Asian neighbors in industrial development, industrial technology development does not primarily involve the costly development of new technologies. The development of industrial technological capabilities should, in the first instance, focus on developing the capacity to select, diffuse and build on imported technologies. A favorable incentive system conducive to industrial technology development should include policies which are macroeconomically sound as well as outward-looking and procompetition. This would motivate and encourage manufacturing firms to undertake the necessary but risky longterm investments in industrial technology development. The training of skilled people and improvements in the educational sector is, as in the Philippines, of crucial importance. Recent research by Okamoto and Sjöholm (2003) on technological development in Indonesia summarizes the situation in the following five assumptions. First, S&T policies that target specific high-technology industries will fail when the technological, managerial and institutional infrastructures are underdeveloped, and micro-level intervention cannot achieve desired objectives. Second, FDI is essential for technological development to offset constraints in domestic structures. However, FDI does not automatically generate technological spillovers and linkage effects, which require complementary actions and resources in the domestic economy. Third, systematic efforts are needed in the public sector to acquire, upgrade and disseminate technology and knowhow when a country moves up the technological ladder, and will require direct government intervention. Fourth, external sources of technology are not only important but also essential in the early stages of industrial development and require efficient channels of transfer, which must be accompanied by openness to trade, investment and skilled labor. Fifth, the focus to the role of FDI in the globalization process has exposed the important but relatively unexplored issue of its link with human capital development. Indonesia must, like other developing countries, formulate efficient policies that can exploit the shift in demand for labor market that comes with increased FDI. Vietnam: top-down S&T system The supply of scientific and technical expertise is of critical importance for Vietnam. Industrialization and economic growth have been at the forefront of the country’s development strategy for a long time, although much attention has not been paid until recently to reforms and strategy in the domain of science and technology policy. Within the national government there are the Ministry of Science and Technology4 and the Technological governance in ASEAN 51 Ministry of Education and Training. The two powerful institutions managing research and technology policy on the state level are the Central Institute for Economic Management (CIEM) associated with the Ministry of Industry and Trade, and the National Institute of Science and Technology Policy and Strategic Studies (NISTPASS) affiliated with the Ministry of Science and Technology. These two institutions promote state programs and co-operate actively with foreign institutions. The science and technology policies in Vietnam have been designed to encourage and support the acquisition of new technologies. However, taxation laws and the tax collection systems imposed constraints on the process of acquiring technology for enterprises, especially for the private ones.5 The new law for private enterprises, implemented in 2002, has changed the situation and doubled the number of SMEs in Vietnam into 70,000, amounting to some 45 percent of the whole economy. The majority of the firms in the private sector, however, are located in agriculture and consist of socalled family-household activities. The situation has become more critical as information and communication technologies have become more pervasive at the same time as the economy of Vietnam has taken on an outward orientation. Given the opportunities of a know-ledge-based economy, there is an immediate need to identify the necessary structural reforms in the science and technology sector as the country is being integrated into the international economy. Remaining competitive in international markets will require the introduction and upgrading of technologies that will reduce the effect of rising labor costs. After the exodus of the French in the late 1950s the science and technology system in Vietnam acquired a socialist stamp, with a direct and strong influence from the USSR and other socialist countries in Eastern Europe. These countries provided training and education for engineers, doctors and administrators and most Vietnamese S&T programs were based on models from USSR and Eastern Europe. As a consequence, science and technology activities were almost completely isolated from the rest of the economy. Innovative activity was controlled from the top by decrees and prioritized capital goods and defense equipment. However, the economic reforms that were introduced in 1986 and the subsequent reforms have provided a policy orientation of cautious liberalization and decentralization. Furthermore, a fiscal crisis has been affecting the R&D institutions in Vietnam. As a result, the state no longer monopolizes S&T activities and serious budget constraints have forced government agencies to decentralize, privatize and even abandon a number of S&T programs. The National Center for Natural Science and Technology exemplifies this new situation. The Center has come to rely extensively on contract research and consultancy, without which it would cease to exist, with a consequence that it has oriented itself towards applied research and the demand of industrial firms. Another change is growing collaboration with foreign partners. The Foreign Investment Law and the Law on Science and Technology of 1995 are of particular importance as they include rules for the protection of industrial property rights, copyrights and also a legal framework to govern technology transfer.6 It is important for Vietnam that efficient mechanisms are established for a systematic monitoring of the technical change that is taking place in other countries. Only then is it possible to identify the appropriate means for obtaining, adapting and diffusing already available technologies to be utilized in Vietnam. However, the S&T sector in Vietnam Institutional Change in Southeast Asia 52 lacks the dynamic character that could boost the country’s economic development, and the reasons are manifold. First, many research institutes are still dependent on government funding, which usually is insufficient due to budget constraints. Second, the linkages between enterprises and research institutes remain weak, or are almost nonexistent, which reflect the lack of an articulated demand within the enterprise sector, which is still dominated by state-owned enterprises. Third, the opportunities for advanced overseas training have been quite limited since the 1980s, whereas many of the older generation of scientists and engineers received their training and higher education in the socialist planned economies. Fourth, there is a need for high-level training in areas like policy formulation and implementation, not only for science and technology, but also in other areas such as labor, environment, finance and macroeconomics. Finally, the state sector dominates the economy in Vietnam but is unlikely to be an engine of growth during the present decade. An important reason is that the state-owned enterprises (SOEs) will not generate enough jobs to absorb a significant share of the new entrants into the labor market, which is estimated to be in the region of 1.2–1.4 million persons per year.7 Thus, private SMEs, and joint ventures with FDI partners, will play an increasingly important role in the country’s economic development. During the past few years Vietnam has been experiencing serious political and economic difficulties in its transition from a centrally planned economy to an economy based on risk-taking and incentives, where the government’s role should be limited to general guidance and encouragement. Under these circumstances, it is critical that Vietnam develop a capability to analyze the country’s scientific and technological environment, both domestically and internationally. This capability should be brought forward to include advanced skills to formulate and implement a science and technology policy that is appropriate to a constantly changing environment. A recent report by Kang (2001) says that there seems to exist a strong commitment to integrate the science and technology system with national social and economic objectives, and also to make S&T an integral part of the country’s industrialization efforts. The innovative idea of establishing a private education system in Vietnam is welcomed in engineering sciences but meets some resistance in the social sciences.8 There have been a number of policy changes to make research demand-driven and create more autonomy for research institutes. However, the half-hearted implementation of these policy changes remains the major hurdle for the efficient use of science and technology resources in Vietnam. Malaysia: technology modernization In its long-term visionary plan for 2020, Malaysia strongly emphasized the role of R&D for technological development. This is also reflected in its Action Plan for Industrial Technology (TAP 1990), and is also underlined in the Third Outline Perspective Plan 2000 prepared by the Economic Planning Unit (2000). The Malaysia National Council for Scientific Research and Development (MPKSN) plays an important role in coordinating and developing the country’s resources for R&D. Among government ministries there are the Ministry of Education and the Ministry of Science, Technology and Environment. Technological governance in ASEAN 53 In a first inventory taken in 1994 of Malaysia’s human resources in R&D, it was found that the number of researchers per 10,000 people is only 2; the corresponding figure for Singapore is 40. The GDP per capita expenditure on education places Malaysia in second place after Singapore among the five analyzed countries in this study. The low number of tertiary students is considered a consequence of the huge numbers of Malaysian students being educated abroad.9 Malaysia has substantial industrial activities in the electronics industry, in particular in packaging integrated circuits (ICs); basically all global manufacturers of ICs have a portion of their activity located in Malaysia. This reflects the fact that Malaysia has been perceived as an attractive location for economic and other reasons. The latter factors include the country’s political stability, the welcoming attitude of the Malaysian government as expressed in a number of favorable government policies, good infrastructure in urban areas, a highly productive labor force, and well developed financial and banking sectors. Following its earlier emphasis on FDI as an instrument for employment generation, Malaysia has substantially upgraded its technological capabilities, which has encouraged existing FDI to expand into more sophisticated production. MIGHT was set up in 1993 as an independent non-profit company providing a platform for government and industry collaboration. Organizationally it is located under the office of the Science Advisor in the Prime Minister’s Department and led by a joint industry-government board. In the words of its chief executive, Dr Ahmed Tasir, MIGHT is, “[i]n a nutshell,…a symbiotic relationship between the private and public sectors of Malaysia for the pursuit of a common goal of heralding a new era of technology-led development in the country”. MIGHT’s activities are focused on the following sectors earmarked for national development: aerospace, advanced materials, low emission vehicles, telecommunications, road haulage, pharmaceuticals, and housing and construction. Malaysia has, under the leadership of its former Prime Minister Dr Mahathir Mohamad, taken a bold visionary initiative in establishing a Multimedia Super Corridor (MSC) close to Kuala Lumpur. “The Multimedia Super Corridor (MSC) is Malaysia’s gift to the world”. On this note almost all presentation materials on the MSC commence, making clear that the MSC initiative, launched in 1996, is an open invitation to the global multimedia community. The MSC is a 15 km by 50 km “green corridor” approximately the same size as Singapore, stretching from the Kuala Lumpur City Center in the north to the new Kuala Lumpur International Airport located in the south. Two new cities are taking form within the MSC: Putrajaya, the new administrative seat of the federal government, and Cyberjaya, the new IT city. The latter will consist of enterprise, commercial and residential precincts and will also include public and recreational areas. Cyberjaya is to be the core development zone of the MSC, and will have an estimated population of 240,000 (90,000 residents) and will have some 500 IT and multimedia companies by the year 2020. Unfortunately the financial crisis and a bigger than threefold drop in FDI have drastically curtailed the forecast results for MSC, as “Silicon Valley of Southeast Asia”. The MSC remains so far in a state of infancy and it is therefore not possible to make any evaluation of the project. The task of leading the management and development of the MSC is handled by the Multimedia Development Corporation (MDC), a government-appointed and governmentInstitutional Change in Southeast Asia 54 process goes a long way to ensuring better public accountability. It is therefore not surprising that technological projects have greater public accountability in those countries where the media has a high degree of freedom. Notes 1 This chapter is partly based on a project, “Technological Mapping of Asia Pacific”, that was started in 1998 with partial results appearing in Sigurdson and Cheng (2001b). 2 This section is based on a discussion in Peterson and Sharp (1998). 3 The issue is strongly stressed by APEC (2000), where KBE status indicators are recommended. 4 Until mid-2002 it was called the Ministry of Science, Technology and Environment (MOSTE). 5 This problem is highlighted in IDRC (1998). 6 The new Science and Technology Law came into existence in 2002 with more autonomy for research institutions and individuals. It also covers the intellectual property rights issue. 7 CIEM (2002:124–125). 8 Australia’s Royal Melbourne Institute of Technology has a newly established branch campus in Ho Chi Minh City and Harvard University and Connecticut College are initiating training programs and academic exchange, according to Far Eastern Economic Review (2002). 9 See Chapter 2, “Educational Reforms and Challenges in Southeast Asia”, by Fredrik Sjöholm in this book. 10 Bioinformatics is an interdisciplinary research area that may be broadly defined as the interface between biological and computational sciences. It involves solving complex biological problems using computational tools and systems. It also includes the collection, organization, storage and retrieval of biological information and databases. 11 Interview with Manager in Charge of Marketing at Lifan & Honda in Chongqing, China, 9 June 2000. References and Bibliography APEC Economic Committee (2000) Towards Knowledge-based Economies. Blomström, M. and Kokko, A. (1998) “Multinational corporations and spillovers”, Journal of Economic Surveys, 12(3): 247–277. CIEM (2002) Vietnam’s Economy in 2001, Hanoi: Central Institute for Economic Management and National Political Publishers. Dodgson, M. (2000) “Policies for science, technology, and innovation in Asian newly industrializing economies”, in L.Kim and R.R.Nelson (eds) Technology, Learning, and Innovation: Experiences of Newly Industrializing Countries, Cambridge: Cambridge University Press. EPU (2000) Third Outline Perspective Plan 2000, Kuala Lumpur: Economic Planning Unit, Government of Malaysia. Far Eastern Economic Review (2002) “Open minds open doors”, 28, 1 August 2002. Funston, J. (ed.) (2001) Government and Politics in Southeast Asia, Singapore: Institute of Southeast Asian Studies. Hill, H. and Thee, K.W. (eds) (1998) Indonesia’s Technological Challenge, Singapore: Institute of Southeast Asian Studies. Technological governance in ASEAN 61 Hobday, M. (1999) “Understanding innovation in electronics in Malaysia”, in K.S. Jomo and G.Felker (eds) Technology, Competitiveness, and the State: Malaysia’s Industrial Technology Policies, London: Routledge. ——(2001) “The electronics industries of Pacific Asia”, Asia-Pacific Economic Literature, l5(1): 13–29. IDRC (1998) Vietnam at the Crossroads: The Role of Science and Technology, report of the International Mission, Toronto: International Development Research Council. IMD (2000) World Competitiveness Yearbook, Lausanne: International Institute of Management Development. Jomo, K.S. and Felker, G. (eds) (1999) Technology, Competitiveness, and the State: Malaysia’s Industrial Technology Policies, London: Routledge. Kang, O.H.-K. (2001) “Science and technology strategy review in Vietnam”, EIJS Working Paper No. 133, European Institute of Japanese Studies, Stockholm School of Economics, October 2001. Kynge, J. (2002) “China’s reverse shock”, Financial Times, 7 June 2002. Lall, S. (1998) “Technological capabilities in emerging Asia”, Oxford Development Studies, 26(2): 213–244. ——(1998a) “Technology policies in Indonesia”, in H.Hill and K.W.Thee (eds) Indonesia’s Technological Challenge, Singapore: Institute of Southeast Asian Studies. Lee, C.H. (2001) “The state and institutions in Asian economic development”, EIJS Working Paper No. 127, European Institute of Japanese Studies, Stockholm School of Economics, June 2001. McKendrick, D.G., Doner, R.F. and Haggard, S. (2000) From Silicon Valley to Singapore: Location and Competitive Advantage in the Hard Disk Drive Industry, Stanford: Stanford University Press. Mathews, J.A. and Cho, D.-S. (2000) Tiger Technology: The Creation of a Semiconductor Industry in East Asia, Cambridge: Cambridge University Press. NSTB (1997) National Science and Technology Plan, Singapore: National Science and Technology Board. ——(2000) National Survey of R&D in Singapore, 1999, Singapore: National Science and Technology Board. Nihon Keizai Shimbun (2002) “Minolta shifts production of key products to China”, 1 April 2002. OECD (1997) National Innovation Systems, Paris: Organization for Economic Cooperation and Development. ——(2001) The New Economy—beyond the hype, Paris: Organization for Economic Cooperation and Development. Okamoto, Y. and Sjöholm, F. (2001) “Technology development in Indonesia”, EIJS Working Paper No. 124, European Institute of Japanese Studies, Stockholm School of Economics, published as Okamoto, Y. and Sjöholm, F. (2003) “Technology development in Indonesia”, in S.Lall and S.Urata (eds) Competitiveness, FDI and Technological Activity in East Asia, London: Edward Elgar. Peterson, J. and Sharp, M. (1998) Technology Policy in the European Union, London: Macmillan Press. Ramstad, E. (2003) “Venture with Thomson gives TCL global role—lo-key Chinese company emerges as world leader with deal to make TV sets”, The Wall Street Journal (Europe), A5, 4 November 2003. Rasiah, R. (1999) “Malaysia’s national innovation system”; in K.S.Jomo and G. Felker (eds) Technology, Competitiveness, and the State: Malaysia’s Industrial Technology Policies, London: Routledge. Sigurdson, J. and Cheng, A.L.-P. (2001a) “Introduction”, A New Technological Landscape in Asia Pacific, special issue of the International Journal of Technology Management, 22(5/6). ——(eds) (2001b) A New Technological Landscape in AsiaPacific, special issue of the International Journal of Technology Management, 22 (5/6). Institutional Change in Southeast Asia 62 Sigurdson, J. and Persson, O. (1998) “The new technological landscape in Pacific Asia: an enquiry into the dramatic changes in patenting and scientific publishing”, Research Evaluation, April: 31–38. Soesastro, H. (1998) “Emerging patterns of technology flows in the Asia-Pacific region: the relevance to Indonesia”, in H.Hill and K.W.Thee (eds) Indonesia’s Technological Challenge, Singapore: Institute of Southeast Asian Studies. Taiwan News (2002) “MAC backs restrictions on China-bound tech workers”, 9 April. Thee, K.W. (1998) “The determinants of Indonesia’s industrial technology”, in H. Hill and K.W.Thee (eds) Indonesia’s Technological Challenge, Singapore: Institute of Southeast Asian Studies. The China Post (2002) “Taiwan needs science tech protection laws to safeguard security”, 10 April. Witty, A. (2001) “Discovering drugs in Singapore”, Far Eastern Economic Review, 5 November. Wong, P.K. (2001) “From leveraging multinational corporations to fostering technopreneurship: the changing role of S&T policy in Singapore”, in L.Low and D.M.Johnston (eds) Singapore Inc: Public Policy Options in the Third Millenium, Singapore: Asia Pacific Press. Technological governance in ASEAN 63 4 Interest rate policy and its implication on the banking restructuring programs in Indonesia1 Reza Y.Siregar Introduction The impact of the 1997 financial crisis on the economic activities of the East Asian economies proved to be considerably more severe than expected, both reflecting and revealing weaknesses in domestic financial and corporate institutions, and inappropriate government policies. Output in the most affected economies of Southeast Asia fell dramatically in 1998 (CEIC Database). External borrowing, particularly by the private sector at the outset of the crisis, has often been cited as one of the key factors responsible for the severity of the crisis (Bhagwati 1998, Corsetti et al. 1999, Kawai 2002, Rajan and Siregar 2002). In Indonesia, corporations were the principle borrowers from foreign sources, while in South Korea banks were the primary borrowers from the external markets. Despite the varieties in the patterns of borrowing among the crisis-affected economies in East Asia, the combination of rigid exchange rate policies and high domestic interest rate policy was, however, inarguably an important factor for massive offshore borrowing by the domestic financial institutions, particularly in the late 1980s and early 1990s. To deal with the economic crisis, a number of recovery programs have been drafted and signed jointly by the government of Indonesia and the International Monetary Fund (IMF) since late 1997.2 Restructuring the banking sector is one of the most urgent challenges facing Indonesia after the 1997 crisis. Both private and state banks saw their credits take a sharp dive after 1997, contributing to the overall drop in the banking credit outstanding by more than 50 percent in 1999 (Table 4.1). Private banks have always been the largest credit providers to the domestic industries and households from the early 1990s until the start of the 1997 financial crisis. In 1999, domestic private banks saw their total nominal credit outstanding drop most dramatically, contributing to more than 52 percent of the total credit decline in the banking industry. Though subsequently the credit outstanding has increased steadily in 2000 and 2001, the amount in 2001 was still less than 70 percent of the amount in 1997. The fall in the supply of bank loans has been found to be responsible for the “liquidity crunch” reported during the post-crisis period (Siregar 2003). Despite the development of other financial institutions, such as the capital market and the non-banking financial institutions, the dependence of the private sector on the domestic banking sector has always been very high in Indonesia (Pangestu and Habir 2002). Most firms, particularly the small and medium-sized enterprises, continue to rely on the domestic financial institutions. To oversee the restructuring programs of the banking sector, the Indonesian Banking Restructuring Agency (IBRA) was established in January 1998. Table 4.1 Banking credits outstanding in Indonesia, 1996–2001 1997 1998 1999 2000 2001 State banks (a) Total in Rp billion 153,266220,747 112,288 102,061 117,104 (b) Growth rate in percent 40.7 44 −49.1 −9.10 14.8 Private banks (a) Total in Rp billion 176,262199,931 62,805 92,531 117,291 (b) Growth rate in percent 12.7 13.4 −68.6 47.3 26.8 Total banking credits outstanding in Rp billion 378,184 487,466 225,171 269,036 307,628 Growth rate of total in percent 29.1 28.9 −53.8 19.5 14.3 Source: World Bank (2003). Other cornerstones of the agreements between the IMF and the government of Indonesia include efforts to stabilize the domestic currency and to adopt a tight monetary policy (Johnson 1998, Soesastro and Basri 1998). These two programs were recognized as particularly critical for managing inflationary pressures in the country during the crisis period (Siregar and Rajaguru n.d.). The tight monetary policy program specifically required the government of Indonesia to limit the growth rate of its broad monetary aggregate (M2), to be achieved through controlling base money (M0) quarterly growths. Given the limited choice of monetary policy instruments, the Central Bank of Indonesia largely resorted to a high interest rate policy to achieve those targets of a stable rupiah and base money during most of the period after 1997. However, despite a number of changes in the leaderships of the IBRA3 and in the policy approaches adopted by the country to restructure the banking sector, the progress has been less than impressive. In its recent report on Indonesia, the IMF (2002) underscores four key factors that explain the low asset recovery rates under the management of the IBRA: (1) the high degree of impairment of transferred nonperforming loan assets; (2) overvaluation of pledged shareholder assets when originally transferred to IBRA; (3) weaker conditions in Indonesia’s financial and property markets than originally anticipated; and (4) depreciation of assets since they were transferred to IBRA, in part due to poor management of these assets by IBRA. The report also stresses the fact that the IBRA has had only limited success in enforcing its claims through the courts or by using its quasi-judicial powers. By the end of 2001, IBRA had processed 2,400 litigation cases, of which 2,125 cases were through the civil courts and 68 cases were brought to the bankruptcy court. Of the total, only 230 were settled as of the end of 2001, with IBRA mostly on the losing side (IMF 2002).4 This study will show that the selection of policy measures adopted by the monetary authorities during the financial crisis has also adversely affected the performance of the restructured banks, and thus further deteriorated the face value of the assets. In particular, we will show that the high domestic interest rate policy adopted to stabilize the local currency and to keep a tight growth of base money has not been an effective measure. Interest rate policy and its implication 65 Instead, this policy has arguably worsened the environment for reforms and raised the costs of the bank restructuring. The outline of the chapter is as follows. We will briefly highlight the severity of the impact of the financial crisis on various parts of the economy by presenting a number of key economic indicators, including the high cost of bank restructuring in Indonesia. This is followed by a discussion and an analysis of trends and policy debates on the three key monetary indicators (the domestic interest rate, the nominal exchange rate of the rupiah against the US dollar and the base money). Empirics are then presented to investigate the effectiveness of the interest rate policy in achieving its objectives of a stable rupiah and base money, and the final section presents evidence of the adverse consequences of the interest rate policy on selected performance indicators of the restructured banks. Brief concluding remarks end the chapter. The meltdown of the Indonesian economy In this section, we highlight the economic impact of the 1997 financial crisis in Indonesia. To start with, a set of key macroeconomic indicators will be presented to portray the overall meltdown of the economy. Brief notes on the cost of financing the bank restructuring in the country will then be presented in the last subsection. Macroeconomic conditions The collapse of the financial sector The Indonesian economy reported its worst growth rate in 1998, contracting by around 13 percent (Table 4.2). It was the most profound economic Table 4.2 GDP growth rate in Indonesia, in percent, by industrial origin at constant market prices, 1995– 2001 19961997 1998 1999 2000 2001 GDP 7.8 4.7 −13.1 0.8 4.9 3.3 Non-oil GDP 8.2 5.2 −14.2 1.0 5.3 4.0 1. Agriculture, forestry and fishery 3.1 1.0 −1.3 2.2 1.7 0.6 2. Mining and quarrying 6.3 2.1 −2.8 −1.6 5.1 −0.6 3. Manufacturing 11.6 5.3 −11.4 3.9 6.1 4.3 4. Electricity, gas and water 13.6 12.4 3.0 8.3 8.8 8.4 5. Construction 12.8 7.4 −36.4 −1.9 5.5 4.0 6. Trade, hotel and restaurant 8.2 5.8 −18.2 −0.1 5.6 5.1 7. Transportation and communication 8.7 7.0 −15.1 −0.8 9.4 7.5 8. Financial, rentals and business services 6.0 5.9 −26.6 −7.2 4.3 3.0 9. Services 3.4 3.6 −3.8 1.9 2.2 2.0 Source: World Bank (2003). Institutional Change in Southeast Asia 66 collapse to affect any significant market-oriented economy in decades (Evans 1998). At its peak in 1998, the crisis was felt in all sectors of the economy. With the exception of the electricity, gas and water industries, all industries experienced contraction. The four pillars of the economy, namely the manufacturing, the construction, the financial, and the trade, hotel and restaurant sectors, experienced a sharp decline in output. As expected, the financial services were among the worst hit industries. A modest recovery was reported in various industries in 1999, with the overall GDP growth rate reported at less than 1 percent. From the numbers reported in Table 4.2, it is clear, however, that the financial sector remained the worst affected sector in the economy. By 1999, the output of the banking sector, in particular, was only around 50 percent of its level at the end of 1997. Reflecting the painfully slow progress in the restructuring of the banking industry, the output by the banking industry grew very modestly in 2000 and 2001, by less than 5 percent per annum. Investment and private consumption: the contrasting facts of the crisis From the expenditure side of the gross domestic product (GDP), it is clear that the economy was experiencing a severe fall in investment (Table 4.3). Private consumption, on the other hand, emerged as the driving force of the economic recovery since 1999. It was the only category on the expenditure side that had in fact reported a positive growth rate from the level reported in 1997. After showing a significant drop of around 6 percent in 1998, the household consumption level managed to grow Table 4.3 GDP growth rate in Indonesia, in percent, by expenditure category at constant market prices, 1995–2001 19961997 1998 1999 2000 2001 GDP 7.8 4.7 −13.1 0.8 4.9 3.3 Private consumption 19.1 7.8 −6.2 4.6 3.6 5.9 Government consumption 0.7 0.1 −15.4 0.7 6.5 8.2 Gross fixed investment 12.9 8.6 −33.0 −19.4 23.7 4.0 Exports of goods and non-factor services 9.1 7.8 11.2 −31.8 26.1 1.9 Imports of goods and non-factor services 17.2 14.7 −5.3 −40.7 21.1 8.1 Source: World Bank (2003). annually between 4 and 6 percent in 1999–2001. On average, the household consumption contributed at least around 70 percent of the total GDP in 1999, 2000 and 2001, compared to only around 60 percent of the total GDP in 1995 and 1996. By 2001, the level of household consumption had increased by about 8 percent from its level in 1997. In contrast, the gross fixed investment contributed on average less than 20 percent of GDP in 1999–2001, a significant decline from its 30 percent average annual share of the GDP in 1995 and 1996. The level of gross fixed investments declined by about 30 percent in 1998, and 19 percent in 1999. By the end of 2001, the gross investment level was less than 70 percent of the level reported in 1997. The decline in investments and the Interest rate policy and its implication 67 collapse of the financial sector resulted in a dramatic contraction of the trade figures, by at least 30 percent in 1999. Even by the end of 2001, there were few domestic and local investors (World Bank 2003). More importantly, a gloomy investment climate has been reported in the manufacturing sector since the outbreak of the financial crisis. Corruption, bureaucratic inefficiency, poor tax and customs administration, labor tensions, decentralization, and inexperienced local governments were some of the key factors contributing to the deteriorating investment climate in Indonesia (World Bank 2003). The small number of investments indicates that the much-needed realized capital or investment in the economy will likely remain very modest in the near future. Mounting domestic and external debt overhang The accumulations of both domestic and external debts have reached dangerous levels since 1998 (Bank of Indonesia Database, Indonesia Central Bureau of Statistics, World Bank 2003). With the collapse of the corporate and financial sectors, the government has been borrowing heavily to finance the restructuring of those industries and at the same time to stimulate the economy. Most of the foreign debt accumulated by the government during the post-crisis period has been used to cover the routine deficit, to finance development projects, and to provide loans to state-owned enterprises. By the end of 2000, the government external debt amounted to over 70 percent of the country’s total external debt, and close to 80 percent of the GDP. In contrast, the external debt of the government in 1996 was less than 40 percent of the country’s GDP. At its peak in 1998, the external debt-to-GDP ratio (or the vulnerability ratio) reached well over 120 percent, a significant rise from the rate of less than 60 percent in 1996. After 1997, the ratio has been averaging well over the 80 percent “high risk” threshold of the debt-to-GDP ratio (World Bank 2003). The total external debt has declined in 2000 and 2001, but the external vulnerability ratio remains well above 90 percent of the GDP. A similar assessment can be made for the domestic debt. The domestic debt has reached well over Rp650 trillion, roughly around 50 percent of GDP in 2000. As will be elaborated further, around 65 percent of the domestic debt comprised bonds issued to recapitalize banks that became insolvent during the crisis. Although the domestic debt-toGDP ratio declined marginally in 2001 from its level in 2000, the nominal value has risen since 1999. Brief notes on financing bank restructuring in Indonesia5 By the end of 2001, IBRA was reported to have received the assets of restructured banks with a face value of roughly Rp550 trillion, or around 43 percent of the country’s GDP in 2000 (IMF 2002). Receipts from the management and disposal of the asset sales will help to offset the Rp650 trillion in public sector debt issued towards recapitalizing the state and private banks. Out of this total amount of domestic bonds issued, approximately Rp435 trillion was in the form of bank recapitalization bonds (Table 4.4). Roughly around 65 percent of the total recapitalized bonds were spent to deal with bad loans in the state banks, whereas only about 4 percent were channelled to the private banks. Furthermore, it is important to Institutional Change in Southeast Asia 68 note that almost 70 percent of the total recapitalized bonds were disbursed into the 11 main domestic banks (four state banks and seven private banks) (Table 4.5). Interest payments on these bonds continue to rise and impose a heavy burden on the government budget. For instance, about 20 percent of the total revenue posted in the 2002 budget had to be allocated for the interest payment of the bonds. In addition to financing the bonds, the government of Indonesia had also committed itself, on 27 January 1998, to provide “a blanket guarantee” on all deposits and liabilities of national banks (other than shareholders’ funds and subordinated debt) for an initial period of two years. This Table 4.4 Recapitalized bonds in Indonesia, at the end of 2001 (Rp trillion) Total bonds Percentage of total Fixed rate Variable rate Hedge Recapitalized bonds 435.38 100.00 180.90 219.48 35.0 State banks (4) 282.1 64.79 127.1 120.01 35.0 Private banks (7) 17.68 4.06 3.33 14.35 Others 135.6 31.15 50.47 85.12 Source: Bank of Indonesia Database. Note Others include private banks being taken over by the government, and regional development banks. Table 4.5 Eleven main recapitalized banks in Indonesia, bonds and total assets, at the end of 2000 (Rp trillion) Banks Assets Bonds Ratio (%) State banks Mandiri 232.6 181.2 78 BNI 114.3 61.8 54 BRI 54.0 29.1 54 BTN 20.5 9.8 48 Private banks BCA 96.9 59.6 62 Danamon 60.5 47.5 79 Niaga 17.6 9.5 54 BII 40.1 6.5 16 Lippo 21.8 6.0 28 Bali 5.7 5.3 94 Universal 11.3 4.2 37 Source: Bank of Indonesia Database. Note The ratio captures the percentage share of the bonds on the overall assets of the banks. Interest rate policy and its implication 69 measure had to be taken to deal with depositor panic and international banks not accepting letters of credit issued by Indonesian banks. The provision of this high-cost policy, however, went beyond the initial two-year target. Only in August 2002 did the government reveal its plan to phase out the blanket guarantees (Citibank and Solomon Smith Barney 2002). Base money, exchange rate and interest rate Base money On 1 November 1997, the day after the signing of the first IMF agreement, the government of Indonesia announced the liquidation of 16 banks. Although this had been foreshadowed, the decision created shock waves that resulted in a total loss of confidence in the Indonesian banking system (Soesastro and Basri 1998). One of the aftermaths of the closure of the banks was the rise in the levels of monetary aggregates during the last few months of 1997 and first seven months of 1998. The expansion reflected the liquidity support provided to troubled banks and the impact of depositor runs on banks. The consequence of the banking sector bailouts prompted an increasing use of seigniorage, and would eventually require infusions of liquidity to prevent systemic runs. Within a month after the announcement of the closures of the 16 banks, the level of base money had grown by more than 36 percent. By the end of July 1998, the base money had experienced an unprecedented increase of more than 115 percent from its level in November 1997 (Bank of Indonesia Database). For the sake of comparison, between 1991 and 1996, the annual growth rate of base money in Indonesia had been averaging around 25 percent, with the highest growth in 1996 at 38 percent and the lowest in 1991 at around 15 percent. Rupiah: to float or not to float In August 1997, the monetary authority of Indonesia floated the rupiah and immediately the Indonesian currency experienced a 16.8 percent depreciation against the US dollar (Figure 4.1). However, the worst fall occurred only in the first six months of 1998. Right after being floated in August 1997, the nominal exchange rate was at Rp3,035 per 1US dollar. By June 1998, the local currency was traded at 1US dollar for Rp14,900. Corsetti et al. (1999) argue that the nominal depreciations of Asian currencies in 1997 were in fact consistent with the expected inflationary consequences of banking and financial bailouts. In addition to the massive depreciation, the uncertainty and the volatility of the rupiah had further worsened the economic conditions during the crisis. The spread between the buying and the selling rate of rupiah against the US dollar had widened from Rp100 during the first few months of 1997 to more than Rp1,500 in February 1998, reflecting the rise in the risk premium for holding rupiah (Central Bureau of Statistics). Despite the return of political stability in late 2001, the spread rate continued to be wider than the pre-crisis rate. Another most commonly used measurement to evaluate the uncertainties in the foreign exchange market is the volatility index. To estimate the Institutional Change in Southeast Asia 70 of the crisis. The lending or working capital rate, on the other hand, could not rise as much to prevent further defaults on the loans. In particular, the greater uncertainty and the bankruptcies in the key industries had caused a sharp decrease in the demand for working capital by the end of 1998. Consequently, as the deposit rate exceeded the lending rate in early 1998, the domestic banking sector in Indonesia experienced a costly period of negative-interest rate spreads (Figure 4.3).12 The rise in the deposit rate implied a rising cost for the bank, whereas a higher lending rate meant an increasing interest return for the banks. From January 1998 to December 1998, the six-month deposit rate was on average around 7 percent higher than the lending rate. In October 1998, the negative spread was at a staggering 19 percent. The negative spread continued during the first seven months of 1999, with the average spread rate of 2.2 percent. In turn, the negative spread further deteriorated the performance of the banking sector. Overall, the banking industry in Indonesia experienced a total gross loss of as much as Rp178 trillion by December 1998 (Figure 4.4).13 Consistent with the end of negative spread rates in early 2000, the banking industry started to post positive gross profits in 2000 and 2001. Reflecting the improvement in the profitability of the banking industry, the percentage of the gross non-performing loans over the total loans of the banking sector improved to the level of 18 percent at the end Figure 4.4 Banking industry in Indonesia, profits before tax (Rp trillion) (source: Bank of Indonesia Database.) Interest rate policy and its implication 77 Figure 4.5 Gross non-performing loans in Indonesia, in percent of total loans (source: Bank of Indonesia Database.) of 2000, from the worst level of 50 percent reported between December 1998 and March 1999 (Figure 4.5).14 Conclusion Given the problems and the level of corporate distress, as well as the continued lack of good governance over the process, the recovery of the banking and corporate sectors, and therefore the recovery of the East Asian economies, will take more time (Claessens et al. 1999). As briefly discussed, previous papers have highlighted other factors responsible for the slow progress in the restructuring of the problem banks in Indonesia. This study evaluated the monetary policy adopted by the Indonesian government, and found that the high interest rate policy in particular hampered the progress of the bank restructuring process. The empirics suggest that the high interest rate policy was an ineffective monetary instrument in dealing with both the volatile local currency and the rapid growth of base money, particularly during the height of the financial crisis in 1998 and 1999. Furthermore, the high interest rate policy was responsible for the negative interest spread that had partly caused the overall banking sector to experience a negative profit. From the experience of Indonesia, it is clear that for monetary policy to be an effective recovery instrument, it must consider and incorporate other macroeconomic objectives of the country, as well as take into account the fragility of the banking and corporate sectors. Notes 1 The author thanks Anton H.Gunawan for his insightful comments on various issues and also for his valuable updated data series. Institutional Change in Southeast Asia 78 2 The first three Letters of Intent (LOIs) between the government of Indonesia and the International Monetary Fund were signed in October 1997, January 1998 and March 1998. 3 As of the end of 2001, IBRA’s chairmanship has been changed at least seven times since its establishment in 1998. 4 For cases brought by IBRA against the top 21 obligors, as of mid-February 2002, IBRA had won 7 out of 25 cases in the bankruptcy court, and none of the four cases in the civil court (IMF 2002:42). 5 Numerous studies and reports have highlighted the details of the restructuring process of the banking sector in Indonesia, such as Johnson (1998), McLeod (2000), Enoch et al. (2001) and Pangestu and Habir (2002), to name a few. Given those early studies, this section will only summarize a few key policies. The objective of this section is to highlight the heavy cost of the restructuring programs undertaken by Indonesia. 6 The GARCH (1, 1) test results are available upon request to the author. 7 For instance, the changes in the domestic interest rate may influence the movements of the rupiah, and reciprocally, the fluctuations in the domestic currency could have been a major reason behind the changes in the domestic interest rate. 8 For the sake of brevity, the Augmented Dickey-Fuller unit-root test results are not posted in the chapter. However, they are available upon request to the author. 9 These numbers of lags were chosen to ensure that we have enough degrees of freedom. We experimented with other lags, but the results did not change. For reporting purposes, we only show the results of the 30 days lag. 10 Azis (2001) shows that the effectiveness of the interest rate policy depends on the economic and political risk factors in Indonesia during the 1997 financial crisis. When the country was facing a politically turbulent period, the rising interest rates only led to further depreciation of companies’ values and investments, and triggered greater expectations of a further weakening of the local currency. 11 We applied three different lags, 1, 2 and 3 months, but the overall conclusions are the same. 12 The negative spread is calculated by subtracting the deposit rate from the lending rate. 13 Given the nominal exchange rate at an average of 1US$=Rp7,600 for the month of December 1998, this implies that the banking sector was experiencing a total loss of around US$23.4 billion. 14 Given the limited sample observations, and hence degrees of freedom, for the gross profit number and the non-performing loans, we cannot run any regression tests to statistically show that the negative spread in the interest rate has significantly influenced the performance of the banks. References Azis, I. (2001) “Modelling crisis evolution and counterfactual policy simulations: a country case study”, Asian Development Bank Institute Working Paper No. 23. Bank of Indonesia. Database. Online. Available at: <http://www.bi.gov.id/> (accessed 15 August 2003). Bhagwati, J. (1998) “The difference between trade and widgets and dollars”, Foreign Affairs, 77(3): 7–12. Central Bureau of Statistics, Indonesia. CEIC. Database, Hong Kong. Citibank and Solomon Smith Barney (2002) Indonesian Rupiah Bond Weekly, 7 August 2002. Claessens, S., Djankov, S. and Klingebiel, D. (1999) “Financial restructuring in East Asia: halfway there?”, Financial Sector Discussion Paper 3, Washington, D.C.: The World Bank. Interest rate policy and its implication 79 Corsetti, G., Pesenti, P. and Roubini, N. (1999) “What caused the Asian currency and financial crisis?”, Japan and the World Economy, 11:305–373. Enoch, C., Baldwin, B., Frecaut, O. and Kovanen, A. (2001) “Indonesia: anatomy of a banking crisis, two years of living dangerously 1997–1999”, IMF Working Paper/01/52, International Monetary Fund, Washington, D.C. Evans, K. (1998) “Survey of recent developments”, Bulletin of Indonesian Economic Studies, 34(3): 5–36. Furman, J. and Stiglitz, J.E. (1998) “Economic crises: evidence and insights from East Asia”, Brookings Papers on Economic Activity, 2, Washington, D.C.: Brookings Institution. Hernandez, L. and Montiel, P. (2001) “Post-crisis exchange rate policy in five Asian countries: filling in the ‘hollow middle’?”, IMF Working Paper/01/170, International Monetary Fund, Washington, D.C. IMF (2002) “Indonesia: selected issues”, IMF Country Report, 02/154, Washington, D.C.: International Monetary Fund. ——(various years) International Financial Statistics, Washington, D.C.: International Monetary Fund. Johnson, C. (1998) “Survey of recent developments”, Bulletin of Indonesian Economic Studies, 34(2): 3–60. Kawai, M. (2002) “Bank and corporate restructuring in crisis-affected East Asia: from systemic collapse to reconstruction”, in G.de Brouwer (ed.) Financial Markets and Policies in East Asia, London: Routledge. McKinnon, R. (2000) “The East Asian dollar standard, life after death”, Economic Notes, 29. McLeod, R. (2000) “Survey of recent developments”, Bulletin of Indonesian Economic Studies, 36(2): 5–41. Pangestu, M. and Habir, M. (2002) “The boom, bust and restructuring of Indonesian banks”, in G.de Brouwer (ed.) Financial Markets and Policies in East Asia, London: Routledge. Radelet, S. and Sachs, J.D. (1998) “The East Asian financial crisis: diagnosis, remedies, prospects”, Brookings Papers on Economic Activity, 1, Washington, D.C.: Brookings Institution. Rajan, R. and Siregar, R. (n.d.) “Private capital flows in East Asia: boom, bust and beyond”, in G.de Brouwer (ed.) Financial Markets and Policies in East Asia, London: Routledge. Siregar, R. (2003) “Interest spreads and mandatory credit allocations: implications on bank loans to small businesses in Indonesia.” Mimeo, Department of Economics, Adelaide University. Siregar, R. and Rajaguru, G. (n.d.) “Base money and exchange rate: sources of inflation in Indonesia during the post-1997 financial crisis”, Journal of Economic Integration (forthcoming). Soesastro, H. and Basri, M.C. (1998) “Survey of recent developments”, Bulletin of Indonesian Economic Studies, 34(1): 3–54. World Bank (2003) “Indonesia maintaining stability, deepening reforms”, Report No. 25330-IND, Washington, D.C.: The World Bank. Institutional Change in Southeast Asia 80 5 Crisis, social sector and income distribution in Singapore and Thailand Pundarik Mukhopadhaya Introduction A vast body of literature is now available on the post mortem of the financial crisis that hit East Asian economies during 1997–1998.1 The economic slump caused by the crisis has caused widespread social distress in the worst-affected countries, Thailand, Indonesia and the Philippines, and even the least affected countries, such as Singapore, also experienced a reduction in the government expenditure on various social sectors. A fall in output and incomes was invariably accompanied by massive job losses, due to bankruptcies and cutbacks in the production sectors. This led to a sharp rise in unemployment, fuelled by the rise in inflation which exerted a further toll on real wages and incomes. The combined effect increased the incidence and severity of absolute poverty and worsened the distribution of income. The main objective of this chapter is to explore the effect of the financial crisis on the distribution of income and poverty. Two countries are considered for analysis: Singapore, one of the least affected countries, and Thailand, where the crisis started and had a very adverse effect. During the crisis it was feared that economic and financial reversals would impose severe hardship on the social welfare of the populations of the countries concerned. Beyond the employment and wage impacts, it was anticipated that government social programs would be cut back and the prices of key social commodities such as imported medicines would escalate. It was also assumed that families would reduce their expenditures for health and education, and that those services would be beyond reach to a growing number of impoverished families. We will make an effort to analyze briefly the effects of the crisis on the education and health sectors of Singapore and Thailand. The structure of the chapter is as follows: we will first consider the backgrounds of Singapore and Thailand, then analyze the profile of income inequality and poverty during the crisis in Singapore and Thailand, discuss the effects on the education and health sectors, and examine the various government actions to protect the most vulnerable during the crisis, summarizing in a conclusion. Overview of the economy and the social sector: Singapore and Thailand Singapore, a city state of a little over three and half million people, recorded the world’s ninth highest GNP per capita of US$29,610 in the list of 174 countries covered in the World Bank (2000/2001). Singapore has been among the fastest growing economies in East Asia. Its average rate of growth (in per capita real GNP) was 6.4 percent during the 1980–1990 period and 8.7 percent during the first half of the 1990s. With the increasing growth in national income, there was a prominent increase in the total labor force in Singapore. Over the span of 25 years from 1970, the labor force almost trebled, the increase in female labor force being the most prominent. The doubling of the female labor force participation rate is a clear indication of increased educational attainment.2 Over the past 30 years, real per capita gross domestic product (GDP) tripled in Thailand. Between 1980 and 1995, growth averaged 6.4 percent annually. The rapid growth rate has been accompanied by a steep decline in poverty and an increase in inequality. With rapid economic growth, disparities between urban and rural areas and between well-educated and lesser educated households increased. In 1992, a household whose head had received a basic education at either elementary or junior secondary school was 60 percent less likely to be in poverty than in 1975 (Ablett and Slengesol 2000). If the household head had little or no education, that household was only 38 percent less likely to be in poverty. Life expectancy increased by 12 years to 70 between 1975 and 1998. Illiteracy fell to 6.2 percent of the population in 1995. While Singapore made better progress in the health sector than Thailand, it could not catch up with the latter’s high educational expansion rate; thus Singapore’s illiteracy rate is higher than that of Thailand. Looking at Table 5.1, it is quite clear that Singapore enjoys the advantages of a fully urban state and its per capita GDP is almost four times that of Thailand. The World Bank (1993) included both Singapore and Thailand in its list of miraculous economies because of their very high growth rate and low inequality. Thailand offers a great contrast to Singapore. The land area of Thailand is more than 1,300 times that of Singapore and thus it has great regional diversity. The mean per capita income of Bangkok in 1990–1999 is more than twice that of the Central region and four times that of the Northeast region. However, a decomposition analysis showed that this regional divergence does not have much effect on the income distribution scenario.3 It is noted that educational divergence is the main cause of the high income inequality in Thailand. Unlike in Singapore, basic education is free in Thailand and a constitutional right of the Thai people. By investing heavily in the education sector, the Thai government was able to increase the enrollment rate at both the primary and secondary levels of education.4 In the decade prior to the crisis, Thailand made remarkable progress in expanding education with the gross enrollment ratio increasing significantly at most levels of education. According to the statistics published by the Office of National Education Commission, near universal enrollment in primary education has been achieved. Gross enrollment ratios at the lower secondary level increased from 40 percent in school year (SY) 1990–1991 to 72 percent in SY 1997–1998. Upper secondary and Institutional Change in Southeast Asia 82 vocational enrollment ratios almost doubled to 47 percent. With the decline in poverty between 1992 and 1997, the number of school dropouts decreased (ONEC 1999).5 The Child and Youth Survey6 reveals that over 3 million more pre-primary to secondary school students attended school in 1997 than in 1992. Table 5.1 Various indicators in Singapore and Thailand Singapore Thailand Life expectancy at birth (1998) (M; F) 75; 79 70; 75 Infant mortality rate, per 1,000 live births (1980; 1997) 12; 4 49; 29 Adult illiteracy rate (M; F) 4; 12 3; 7 Public education expenditure (% of GNP) (1980; 1997) 2.8; 3.0 3.4; 4.8 HDI rank (1997; value) 22; 0.888 67; 0.753 Average annual growth rate (GNP per capita) (1980–1990; 1990–1995)a 4.7; 6.7 5.9; 7.5 Average annual rate of inflation (1998)b −1.5 8.7 Public expenditure on health (% of GDP) (1990–1998) 1.1 1.3 Total unemployment (% of labor force) (1991)c 1.9 2.7 Gini coefficient (1971–1980; 1981–1990)d 0.45; 0.41 0.37; 0.37 Head-count index (1975; 1985; 1993; 1995)e Nil 8.1; 10.0; <1.0; <1.0 Urban population (%) 100 20.6 Per capita GDP (1997 US$ PPP) 28,460 6,690 Illiteracy rate (1980; 1985; 1990; 1995) (%)f 17.0; 14.3; 11.0; 8.9 12.6; 9.8; 6.6; 6.2 Sources: a World Bank (1997, 1999/2000); b Human Development Report (UNDP 2000); c World Development Indicator CD ROM (World Bank 2000); d World Bank (1993); e Estimated from Ahuja et al. (1997); f UNESCO Statistical Yearbook, various years; all other variables are taken from World Bank (2000/2001). Poverty is another aspect to be addressed in the case of Thailand. Data from the Socioeconomic Survey (SES) shows a sharp decline of poverty from 1988 to 1996. The head count ratio declined from 32.6 percent to 11.4 percent, while the poverty gap ratio declined from 10.4 percent to 2.8 percent.7 During this period the average income grew very rapidly and the poverty rate decreased due to the high migration rate from poor areas of the Northeast to Bangkok and the Central region, where unskilled and semi-skilled manpower was in great demand in the construction sectors of the rapidly growing cities. As a consequence the school enrollment increased at the primary and the lower secondary level. Education is an important predictor of poverty. In Thailand, the poverty level decreased rapidly owing to the enormous expansion in education. Crisis, social sector and income distribution 83 The regional dimension of poverty in Thailand is extremely pronounced. The Northeast has been the poorest region with 48 percent of the population living below the poverty line in 1988, while in the South there were 33 percent, in the North 32 percent and in the Central region 27 percent. The incidence of poverty was lowest in Bangkok where 6 percent were below the poverty line in 1988; this was further reduced to 1 percent during 1996. For the same year, the percentages of the population living below the poverty line in Northeast, South, North and Central were 19, 12, 11 and 6 percent respectively. This shows that the decline in poverty is greater in the more affluent regions. The dimension of rural poverty is quite severe in Thailand. In 1988, 40 percent of the population in the rural areas lived below the poverty line while the corresponding figure for the Sanitary and Municipal areas were 22 percent and 8 percent. Rural poverty Table 5.2 Government expenditures on social and community services in Singapore and Thailand Thailand: Government expenditures by sector (year ending 31 December) (%) Year/ period Total General public servicesa Education Health Social security and welfare Housing and community amenitiesb 1995 38.28 8.38 16.91 5.57 3.05 4.37 1996 47.21 10.53 20.12 6.66 3.84 6.06 1997 52.92 10.85 22.78 8.01 3.93 7.35 1998 54.14 10.57 25.42 7.70 4.75 5.70 1999 53.11 10.65 24.96 7.18 4.89 5.43 2000 54.89 11.15 25.19 7.39 6.01 5.15 Singapore: Government’s share of operating expenditure in social and community services (%) Total Education Health Environment Public housing Others 1995 37.85 24.60 6.29 2.52 1.51 2.93 1996 35.81 23.25 5.73 2.36 1.22 3.25 1997 34.75 22.12 6.46 2.00 1.28 2.89 1998 36.84 23.33 6.55 2.24 1.17 3.56 1999 34.94 21.34 6.29 2.31 1.22 3.79 2000 32.00 20.65 5.24 1.89 0.98 3.24 Singapore: Government’s share of development expenditure in social and community services (%) Total Education Health Environment Public housing Others 1995 43.77 16.69 7.00 6.05 10.66 3.37 1996 45.30 9.34 5.14 7.52 14.76 8.54 1997 26.37 8.49 2.49 6.06 6.70 2.62 1998 40.45 13.04 2.19 8.59 13.97 2.65 1999 47.08 13.63 1.02 9.48 20.64 2.32 2000 42.16 16.92 1.36 6.36 15.02 2.51 Sources: For Thailand, computed from ADB, Key Indicators of Developing Asian & Pacific Countries; for Singapore, computed from Yearbook of Statistics, Government of Singapore. Notes a Includes Public Order and Safety. b Includes recreation, culture and religious activities. Institutional Change in Southeast Asia 84 decreased to 15 percent in 1996, while only 6 percent and 2 percent in the Sanitary and Municipal areas respectively lived below the poverty line (World Bank 2001). To investigate the reason for the poverty, the World Bank (2001) identified a strong positive correlation between the incidence of poverty and household size, and the relationship was found to become stronger over time. In the 1990s it was found that the incidence of poverty is highest among farm workers, then among farm operators (including tenants), general workers, production and construction workers. The lowest level of poverty was found among professionals, technical staff and managers. There is a slightly higher incidence of poverty among clerical, sales and service workers and among entrepreneurs, trade and industry people.8 Let us now provide a brief account of the pattern of the government expenditure on social and community services, starting with Singapore. There are two types of government expenditures in Singapore: (1) operating expenditure, a larger expenditure that refers to expenditure on manpower, etc.; and (2) developing expenditure, a smaller expenditure that excludes loans to statutory boards, and industrial and commercial enterprises. The largest portion of the operating expenditure is spent on education9 and health, while most of the development expenditure goes to education and housing. In Singapore, only the destitute, disabled or chronically ill, and those with no independent means of financial support, are entitled to welfare assistance (Lim and Tay 1991). The Central Provi-dent Fund (CPF) is regarded as an effective means to look after the poor and the retired (see Table 5.2). Thailand’s public budget was large10 and for many years the government paid a great deal of attention to the social sector, increasing the Ministry of Public Health (MoPH) budget by over 10 percent annually. In the 1990s, the MoPH budget increased more than fourfold, in real terms. The proportion of the health budget in the overall government budget increased from 4.2 percent in 1989 to 7.7 percent in 1998. However, a large portion of the budget was earmarked for investment activities, e.g. new buildings and sophisticated medical equipment. The MoPH capital expense category went up to 38.7 percent in 1997, the highest in the last 35 years.11 Effects of the crisis on income distribution and poverty Singapore The Department of Statistics, DOS (2000), noted that while the Gini coefficient of household income for Singapore in 1990 was 0.436, it increased to 0.444 in 1997, rising slightly in 1998, and increasing to 0.467 as an effect of crisis in 1999.12 The Gini coefficient provides the normalized aggregate of relative deprivation, which is measured by the difference in incomes of the people in the state. This deprivation or the Gini coefficient might increase due to several reasons. Two factors were noticed for the increase in inequality in Singapore during 1999. Firstly, the number of lower-income households increased; households with monthly incomes below S$3,000 increased to 42 percent in 1999, from 40 percent in 1998 (DOS 2000).13 Secondly, there was a decline in the income of all households, except the top 10 percent, and the lower income classes were worst hit. Crisis, social sector and income distribution 85 Table 5.3 shows that during 1998–1999 the average household income of the bottom decile decreased by 48.4 percent, while this decrease for total households was only 2.7 percent. Figure 5.1 shows the trend in unemployment rate: note that the unemployment rate started rising from June 1998.14 During this time the unemployment rate was 3.2 percent reaching a peak at December 1998 to 4.6 percent, dropping to 3.8 percent in March 1999, and up again in June 1999 to 4.6 percent. Figure 5.2 shows that in general the unemployment rate is very high among the bottom 10 percent of the residents and the unemployment rate for this group increased from 28.2 percent in 1998 to 44 percent in 1999, an increase of about 56 percent, while for the total labor force the increase was 42 percent. Along with job losses, all the top five occupations at the bottom decile experienced a pay cut of 13 to 34 percent (DOS 2000). Thus the increase in inequality in Singapore during the crisis is an effect of unemployment, which is more prominent at the lower deciles, generally composed of less skilled and educated workers; there are wage cuts at the lower deciles and wage increases in the upper deciles. It is quite perplexing to note that during the crisis, most of the top occupations in Table 5.3 Average household income from work in Singapore, by decile Annual change (%) 1990 1998 1999 1998 1999 Total 3,076 4,822 4,691 1.6 −2.7 Bottom 10% 370 258 133 −21.1 −48.4 Next 10% 934 1,332 1,172 −1.5 −12.0 Next 10% 1,321 2,005 1,853 0.1 −7.6 Next 10% 1,686 2,647 2,470 1.3 −6.7 Next 10% 2,075 3,305 3,137 1.6 −5.1 Next 10% 2,541 4,097 3,900 1.9 −4.8 Next 10% 3,116 5,034 4,828 1.9 −4.1 Next 10% 3,897 6,271 6,023 2.9 −4.0 Next 10% 5,151 8,221 7,937 3.2 −3.5 Top 10% 9,669 15,053 15,451 1.1 2.6 Source: DOS (2000). the top decile experienced salary increases (DOS 2000). This is mainly due to the fact that the Singaporean economy depends on foreign expatriate labor. When the Singapore dollar depreciated against the US dollar during the crisis, more attractive salary packages were offered to the expatriates, to prevent foreign expertise from leaving Singapore. The skilled labor shortage is the reason for the high inequality in Singapore and during the crisis the labor-short economy acted in a way to secure the skilled labor, which had an adverse impact on inequality.15 No Institutional Change in Southeast Asia 86 Table 5.5 Singapore government’s real expenditure on education, 1995–1999 1995 1996 1997 1998 1999 Total 35,613 39,007 46,016 50,187 59,135 Recurrent expenditure 27,740 30,994 34,620 32,755 35,289 Primary schools 6,719 7,901 8,582 8,466 8,600 Secondary schools and junior colleges 8,598 9,765 10,540 10,063 10,906 ITE 1,134 1,168 1,286 1,246 1,146 Tertiary 9,309 10,335 11,727 10,455 11,482 Polytechnics 3,505 4,071 4,439 4,340 4,198 Development expenditure 7,874 8,012 11,396 17,432 23,846 Source: The Budget, Republic of Singapore, various issues, and author’s calculations. Figure 5.5 Changes in government real recurrent expenditure per student in Singapore, 1995–1999 (S$) (source: Yearbook of Statistics, Government of Singapore, various years.) Crisis, social sector and income distribution 93 Enrollment With the structural change from the mid-1980s the Singaporean economy needed skilled manpower and Singaporeans realized the existence of skill-premiums in terms of salaries. The government’s initiative to expand education created an upward trend in enrollment rates at all levels of education.21 The total change in enrollment (Figure 5.6) during 1997– 1998 is slightly lower than the years preceding and following it, due to a decrease in enrollment at the secondary level. At the secondary level, enrollment decreased by 4.3 percent and 3.3 percent during 1997–1998 and 1998–1999 respectively. The university enrollment has increased, without any doubt, from 1996 and onwards. The increase in university enrollment is due to the expansionary government policies which started in early 1999. Also many students from the region, who were unable to go to the US, the UK or Australia due to the adverse exchange rate situation, entered universities in Singapore instead. There is no evidence in Singapore, however, that students already enrolled at overseas universities had to transfer to Singaporean universities owing to the financial crisis. The increase in enrollment at the Institute of Technical Education (ITE)22 was spectacular. Singaporeans on the whole expected that the Figure 5.6 Changes in enrollment at various educational levels in Singapore, 1996–1999 (source: World Bank 2001.) crisis would be short-lived and utilized the crisis period, when the opportunity cost of skill development was low, to gather some extra skills from the technical institutes. The government also took some initiatives at the beginning of the massive retrenchment phase to retrain the adult workforce. The S$15 million Skill Development Center started in early 1999 with the aim to provide as many opportunities as possible for Singaporeans to Institutional Change in Southeast Asia 94 retrain and upgrade their skills.23 The funding came from the S$20 million grant provided by the government to expand training places under the skill redevelopment program. The decrease in secondary school enrollment starting in 1998 is not an effect of the crisis, but due to the decrease in the birth rate, caused by the expansion of education and the increasing numbers of women joining the workforce.24 Household budget The loss of employment in the household has both income and substitution effects on the demand for the consumption basket. The immediate income effect reduces the quantity demanded for the same consumption basket and households might reallocate the consumption basket and go for the item of primary importance, so-called substitution. If higher education is an item of priority consumption or investment, the household is expected to readjust its budget to protect the expenditure on education. Empirical evidence shows that the reaction of households depends upon the country-specific situation.25 Also there could be variations within the same country.26 Education is a highly subsidized sector in Singapore. Also, the Singaporeans expected the crisis to be an extremely short-lived phenomenon. The average household income of Singapore is also quite high compared to other Southeast Asian countries. The Department of Statistics (DOS 1997/1998) indicates that the loss of income as a result of the crisis hardly had any effect on the education expenditures of the Singaporeans.27 Thailand There have been substantial gains made in the Thai education system. Enrollment at most general education levels and in vocational and technical training schools has grown rapidly. Education has been made compulsory through grade nine. The literacy rate for all age groups is estimated at 90 percent.28 Let us now examine the effect of the crisis on the Thai education system. Government expenditure The Thai government kept public expenditure on education at a constant level during the crisis. The nominal planned education spending in fiscal Table 5.6 Education expenditure of Thailand, 1995–1999 (million baht) 1995 1996 1997 1998 1999 Education budget 135,308 164,560 202,864 206,944 207,316 Nominal actual spending 129,496 157,866 201,625 218,211 Real actual spending 122,420 141,015 170,536 170,771 Source: World Bank (1999). Crisis, social sector and income distribution 95 year 1998 stood at 207 billion baht, comprising 24.9 percent of the total budget, up from the 21.9 percent share in the previous year. The 1999 fiscal year budget allocated 207.3 billion baht (Table 5.6). At the micro level the government expanded the scholarships29 and loan programs30 with special emphasis on the needs of unemployed parents. Anticipating increased unemployment after the crisis, parents are allowed to pay tuition fees in installments and schools are permitted to waive tuition fees on a case-by-case basis. Also private schools are encouraged to extend payment deadlines and are prohibited from increasing tuition fees. The government also provided vouchers to private school children in the Bangkok metropolitan area to allow them to continue at those schools, and encouraged local and international schools to accommodate students returning from overseas. Enrollment The demand for education, thus, increased because of the various government programs, in spite of the decrease in real incomes. The National Statistical Office (various issues) concludes that the crisis had a very limited negative impact on overall enrollment. There was a marginal decrease in the number of students at the pre-elementary and the lower secondary levels, but an increase in the elementary and upper secondary education levels. A comprehensive study by the Asian Development Bank (ADB)31 notes, however, a high drop in enrollment ratios from Grade 1 to Grade 2—9.4 percent from 1996–1997 to 1997–1998, and 8.2 percent from 1997–1998 to 1998–1999. The decrease in the vocational school enrollment in the years after the start of the crisis, 1998–2000, is quite dramatic, by 50,000 students. This is a stark contrast to the Singaporean situation. Dropouts With rising unemployment and rising prices reducing the household income, it is natural to expect an increase in dropout rates. To analyze the case of Thailand, two studies are available: the World Bank study using SES (1996, 1998) and the ADB sample survey on 220 schools. The ADB survey reports the highest rise in school leavers in the school year (SY) 1997–1998:23.6 percent for lower secondary and 35.9 percent for upper secondary. During SY 1998–1999, there was a decrease in the dropout rate: 20.5 percent in lower secondary and 33.1 percent in the upper secondary. The World Bank finds that the ratio of children not attending lower secondary school declined from 7 percent in SY 1996– 1997 to 6.7 percent in 1998–1999. SES (1998) observes that the largest decline in dropouts occurred in the pre-school age group (3–5 years); at the primary level the dropout rate declined by 2 percent. For the upper secondary the dropout rate was 32.7 percent in 1996, and declined to 29 percent in 1998. The dropout rates between 1996 and 1998 declined in both rural and urban areas, implying that the adverse effects of the crisis on education were not pronounced. Dropout rates decreased at all education levels in all regions of the country with one exception: in the Central region the dropout rates increased slightly at the lower secondary level; in particular there is a significant increase in dropouts in Bangkok and nearby areas. This is perhaps because parents who lost their jobs moved with their children from the metropolitan Bangkok area to other regions. Institutional Change in Southeast Asia 96 A further analysis of the SES data by the World Bank reveals that although there was an overall improvement in school attendance, the poor households remained disadvantaged. At the primary age group the dropout rate among the poor is almost twice that among the non-poor. At a higher age the divergence is much greater. The Office of the National Education Commission also collects data on dropouts. They define the dropout rate as the number of students who do not advance from one grade to the next grade each year, as well as those Figure 5.7 Changes in drop-out ratios in secondary schools in Thailand (source: Asian Development Bank, World Bank.) who are enrolled in the final year but do not graduate. With this definition it was found that, as a percentage of the school age population, dropouts increased from 5.5 percent in SY 1997–1998 to 6.7 percent in 1998–1999. From the observations above, we cannot draw conclusions on the changes in the dropout rate during the crisis. One would have expected that with the loss of employment and the decrease in income, poor parents would withdraw their children from school in order to supplement the family income. The Labor Force Survey of Thailand (1998, 1999) reveals, however, that there was no increase in child labor (children aged 13–17, not attending school as they are in the workforce or working at home) during the crisis. Moreover, the unemployment rate of children aged 13–17 increased substantially during the crisis period, which worked as a disincentive to the parents to withdraw their children from schools. Household budget When faced with rising inflation, declining incomes and loss of employment, irrespective of level of income, people made similar changes to their expenditure patterns. The largest Crisis, social sector and income distribution 97 increase in real spending was found in education, while households significantly decreased their expenditures on alcohol and tobacco, food and beverages, apparel and footwear, transportation and communications, and recreation (National Statistical Office). At the level below tertiary school, the expenditure per child attending school increased from 262 baht per month in 1996, to 297 baht per month in 1998. However, the average monthly expenditure per child attending public school decreased from 67 baht to 59 baht during the same period (World Bank 1999), as a result of the government’s policy to waive tuition fees for the needy. This resulted in increased enrollment rates at public schools. Thus, two effects of the decrease in household income have been identified. Firstly, households changed their consumption basket by spending more on highly preferred goods, such as education, and cutting the budget on non-essential consumption, and to some extent reducing food and medical costs.32 Secondly, cheaper quality goods were substituted for more expensive ones, such as transferring children from private to lowcost public schools.33 Health sector We have seen that over the last 25 years both Singapore and Thailand have achieved spectacular progress in terms of health. It was feared that the effectiveness, affordability and equity of the health care supply would be affected by the increase in the cost of drugs and other imported items, and the decrease in funding of the public health care services. However, the governments of both Singapore and Thailand were quite conscious of the health care provided to their peoples. Thailand In Thailand the cut in public health expenditure was limited when compared with the previous years. Health expenditures were 8 percent lower in 1998 than 1997, and 14 percent lower in 1999.34 The adjustment in 1998 was effected in the following way: in nominal terms, the budget for capital investment decreased by 38.5 percent between 1996 and 1998, while the budget for salaries and for operating expenses both increased by 9 percent and 8.3 percent respectively (Mokoro 1999). Because of the unavailability of data it is not possible to judge the effect on the poorest people, those in the bottom decile in the country. However, from Table 5.7 it can be seen that the household budget portion for medical expenditure decreased during 1997–1998. In Thailand, 80 percent of the population is covered by the health insurance scheme (Wibulpolprasert 1999), which means that 20 percent of the population, mostly selfemployed people of low and middle income, is uninsured. During the crisis this percentage increased. The crisis witnessed the expansion of the publicly subsidized voluntary health card scheme and the social welfare health insurance scheme. The coverage of the social welfare scheme increased from 43.9 percent in 1996 to 45.1 percent in 1998 and the health card scheme increased from 7.8 percent in 1995 to 13.9 percent in 1998 (Wibulpolprasert and Pengpaiboon 2001). Despite the decrease in overall MoPH budget during the crisis, the budget for social welfare health insurance increased Institutional Change in Southeast Asia 98 25.6 percent in real terms from 1997 to 1999 (Wibulpolprasert 1999). In 1995, a program to increase the number of doctors in rural areas was launched; after the crisis, the number of students in this program increased. In 1998 the MoPH had a net loss of doctors of only 3.6 percent of the new recruits as compared to Table 5.7 Government budgets for the health sectors in Thailand and Singapore, 1995–1999 Thailand (million baht) Singapore (S$ million) 1995 52,372.7 13.56 1996 63,452.2 11.44 1997 72,406.0 12.14 1998 66,455.2 12.33 1999 62,546.3 11.40 Source: Wibulpolprasert (2002) and computed from The Budget, Republic of Singapore, various issues. 30.2 percent in 1997 (Wongwatcharapaiboon et al 1999) and the doctor-to-bed ratio decreased from 1:15.3 in 1998 to 1:14.6 in 1999 (Phokpermdee et al. 1999). To reform drug management, a collective provincial procurement system for all districts and provincial hospitals was implemented nationwide (Na Songkhla et al. 1999). In 1999, a 27.7 percent savings was achieved with 336 million baht saved by the collective drug purchases. This cost reduction occurred in spite of the fact that drug prices increased from 1997 to 1999 by 22.85 percent for imported drugs and 20.63 percent for locally produced products (Wibulpolprasert 1999). Most of the private hospitals in Bangkok had substantial foreign currency loans and confronted serious repayment problems in the wake of the steep devaluation of the baht. The newly opened private hospitals suffered the most. The WHO (1998) reported that about 33 percent of the private facilities were expected to close over the next 2–3 years. Singapore In Singapore, health care, pensions and housing are managed through the Central Provident Fund (CPF) scheme. CPF contribution rates were 40 percent (20 percent for the employer and 20 percent for the employee) in July 1992, with a maximum monthly contribution of S$2,400. The rate was reduced to 30 percent in January 1999 to cope with the 1997 economic crisis, with a monthly maximum contribution of S$1,800. People in the labor force above 55 years of age are subject to a lower rate of contribution since July 1988. This is designed to partly unlink wages from seniority, and to reduce the cost of hiring older workers (CPF Board Annual Reports, various years). The CPF contributions are channelled into three separate accounts, Ordinary Account, Special Account and Medisave Account. Ordinary Account For those younger than 55 years, between 72.2 and 61.1 percent of the contribution is channelled into the Ordinary Account depending on age, with the proportion decreasing with age. Balances in this account can be used for housing, preretirement investments and other purposes. Crisis, social sector and income distribution 99 Special Account For those younger than 55 years, between 11.1 and 16.7 percent of the contribution is channelled into the Special Account, with the proportion increasing with age. However, those aged over 55 years do not contribute to this account. Although the balances in this account are for retirement purposes, recent reforms have permitted them to be used for certain “safe” investments. It should be noted that the government has specifically created this account so that people would have sufficient money to look after themselves after retirement. Medisave Account The Medisave Account can be used to pay for hospital and selected outpatient services; and for the catastrophic health care insurance premium under the Medishield35 (and Medishield Plus)36 Scheme. Unlike the other two accounts, the selfemployed must contribute to this account. The contributions are channelled into Medisave with the proportion increasing with age. For those younger than 55 years, between 16.7 and 22.2 percent is channelled into this account, but for those above 55 years this proportion varies from 43.2 to 100.0 percent. The amount in this account cannot be fully withdrawn until the death of the account holder, and it is then distributed to the beneficiaries of the member. This enforced saving ensures that Singaporeans will be able to finance their medical care even after retirement. However, it must be noted that the health insurance schemes Medishield and Medishield Plus have inadequate coverage, with more than a third of the population not covered by either scheme. The schemes have narrow scope, not covering many illnesses, including pre-existing illnesses, and pay only a small proportion of the total hospital bill, typically between 25 and 40 percent. The rapid accumulation of Medishield balances suggests that the premiums are levied on the basis of over-conservative assumptions in relation to the benefits actually paid (Asher and Karunarathne 2001). Thus in 1999, the insurance premiums under Medishield were S$95 million while the payments were only S$47 million.37 Nevertheless, Singapore has integrated health care finance with retirement finance. While the gross contribution to the CPF has been impressive, the existence of a large number of pre-retirement withdrawals, particularly for housing, has meant that the net contribution has been rather low. During 1987–1999, about 70 percent of the contributions were withdrawn during the year. Such a high level of withdrawals for nonretirement purposes, particularly for housing, has adversely affected the accumulation of balances. Thus in Singapore, in spite of high contribution rates and rapid economic growth, the retirement balance is inadequate.38 Thus it is observed that the health sector of Thailand experienced budget cuts and due to the loss of demand and currency devaluation, private hospitals closed down. However, some of the government programs were able to bring some equity in the health care system during the crisis. In contrast, the budget cut in the health care provision for Singapore was marginal and the government did not take any specific measure to protect the vulnerable, as the poorest members of the population are mostly protected by a well designed system of wages. Institutional Change in Southeast Asia 100 The government’s action to protect the vulnerable It has been observed that due to the crisis-generated job losses and the decrease in real wages, income distribution worsened for both Singapore and Thailand, and the number of people below the poverty line increased. Even in Singapore, the crisis mainly affected the most vulnerable members of society: the elderly, the unskilled and less educated workers, and women. Both governments have developed several mechanisms to target social assistance, to select the allocation of the scant resources available. It has been observed in the literature that proper targeting is a very complex issue. In low-income countries, less than 10 percent of the total population is covered by some social protection, while in middle-income countries this percentage tends to be between 40 to 80 percent.39 Most of the studies do not address this problem for developed countries with high incomes. In this section we will consider our sample countries to check various social protection measures offered by their governments. Singapore We have seen that due to factors related to the reduced growth rate, the income distribution of Singapore worsened during the crisis. In the National Wage Council (NWC) Guidelines of 1998, companies were asked to cut down on the wage cost using the flexible wage system. The employers’ contribution to the CPF was also reduced, from 20 to 10 percent for people below 55 years, from 7.5 to 4 percent for the age group 55 to 60, from 7.5 to 2 percent for people 60 to 65 years of age, and from 5 to 2 percent for those above 65. This reduction strikes the older people rather unfairly. However, it should be noted that despite the reduction of the employers’ contribution, there was no change in the Medisave contribution for the elderly workers. During the crisis, the Singaporean government had implemented various measures to help individuals and households to combat the difficult situation. One of those was the personal tax rebate. A one-off tax rebate of 5 percent was granted for all resident tax payers for the year 1998 and 1999. A tax relief (effective from YA 1998) for children who live with their aged parents in the same household was raised from S$3,500 to S$4,500. This is on the premise that the working children will look after their parents. On 24 November 1998, a S$134 million package of rebates on Housing Development Board (HDB) rents, service and conservancy charges, utilities and public transport was announced to help the poor people to cope with reductions in CPF accounts and bonuses.40 1 Rebates on services and conservancy charges and HDB rents were introduced in 1994 to help lower-income families to offset the impact of the general standard tax (GST). The rebates were due to expire in March 1999, but after looking at the effect of the crisis on the lower deciles, the government extended the rebates for two more years, at a cost of S$22 million. 2 HDB residents living in 4-room flats and smaller units have been given utility rebates for two years, to offset the increase in water and electricity tariffs. Those living in 3room flats or smaller received S$100 rebates, while 4-roomers received S$50 rebates. Crisis, social sector and income distribution 101 Grants for service and conservancy charges were also given for 4-rooms and smaller HDB flats. To note that people living in 3-rooms or smaller HDB flats are people from the lower income group; thus this grant is mostly aimed at the poorer section of the society.41 3 The government announced a year-long rebate and discount for public transportation for the year 1999.42 4 Hospital bills were trimmed by 5 and 10 percent for class B2 and C patients respectively from January 1999. Class C patients were also allowed to apply for help from Medifund, if they were unable to pay their bills. 5We have mentioned that a large portion of the CPF is used for home mortgages. After the CPF cuts, 18 percent of the members did not have enough in monthly contributions to their ordinary accounts to pay their housing installments. They were allowed to use funds from the Special Account to meet the shortfall.43 It must be noted that these sorts of measures are not direct attempts to protect the most vulnerable people during the economic downturn. A simulation analysis by DOS (2000) showed that the tax relief measures could only marginally reduce the inequality. The government of Singapore believes in a more pragmatic approach to welfare, compared to a welfare state with properly developed social safety net. No specific provision was made for the aged or the less educated, who were the first to be affected by economic setbacks. No particular effort was made for women, who were generally the hardest hit by the crisis in these groups. Thailand The crisis highlighted the importance of providing an effective social safety net. To the world organizations, Thailand became the arena where the new social strategies were implemented. In this section we will discuss the various social programs implemented during the crisis and their effectiveness. The information was gathered from SES (1999); this is a special survey and thus it was not possible to compare the results with previous years, but we could examine the programs in terms of reaching the target population group.44 Low-income health card The low income health card, which is issued for 3 years, is a means-tested program45 which entitles the poor in the 13–59 age group to free health care at hospitals and public health centers. The program provides 273 baht per head. During the crisis period this program was extended to the unemployed if they were registered at the Ministry of Labor and Social Welfare. It should be noted, however, that the identification of the poor is quite arbitrary and made by the community head. SES (1999) notes that 10 percent of the population had the low income health card, out of which only 38 percent were from the bottom quintile. This shows that the program could have been better targeted. The data on regional distribution of the low income health card shows that the poorest region, the Northeast, received half of the total distributed card (see Table 5.8). Institutional Change in Southeast Asia 102 42 This rebate costs the government S$40 million. 43 Those who have depleted the funds in both these accounts can apply to the Bridging Loan Scheme, which provides loans at a concessionary interest rate pegged at the CPF interest rate plus 0.1 percent. 44 A different type of discussion can be found in Tangcharoensathien et al. (1999). 45 The income ceiling is 2,000 baht for a single person and 2,800 baht for a family. 46 The Miyazawa fiscal stimulus package started in April 1999, creating employment for low skilled workers in rural areas, and to some extent for skilled workers in computer-related fields. 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World Bank Thailand (2000) Thailand Social Monitor: Social Capital and the Crisis, Bangkok: The World Bank. Ziderman, A. (1999) “The student loan scheme in Thailand: a review and recommendations for efficient and equitable functioning for the scheme”, report prepared for UNESCO, Bangkok as part of the ADB Social Sector Program Loan. Institutional Change in Southeast Asia 112 6 Effects of a crisis? Institutional adjustment and pro-poor growth in Thailand1 Pernilla Sjöquist Rafiqui and Örjan Sjöberg Introduction To the social scientist, perhaps the most eye-catching accomplishments of the East and Southeast Asian countries over the past few decades are an enviable record of economic growth, and the changes that this has wrought. Not least worthy of note is the fact that the great majority of the inhabitants of the countries concerned have been able to share the fruits of growth. “[R]apid growth and reduced inequality”. The World Bank (1993:27) noted about a decade ago, “are the defining characteristics of what has come to be known as the East Asian economic miracle”. In most countries not only have the poor as a share in the total population diminished, the absolute number of poor has declined as well (e.g. Ahuja et al. 1997). As a result, the enabling policies of the East and Southeast Asian economies have attracted much attention, as have the institutions that these countries based their economic activities on. While there has been little agreement on the exact nature of these policies and institutions, nor for that matter on the role of politicians and other stakeholders shaping or influencing it, it is fair to say that, as the process of economic development unfolded, less attention came to be devoted to the obstacles and constraints that were also part of the picture. The crisis of 1997 proved instrumental in changing this focus on the positive lessons to be learnt. Across the region, the crisis resulted in substantial reductions in real output and challenged the pattern of high economic growth that many observers had come to take for granted. In particular, it revealed various structural and institutional weaknesses among the countries most severely hit, Thailand and Indonesia being two cases in point. It comes as no surprise therefore that the debate has been intense. One strand of this debate has focused on the reasons why the crisis came about in the first place. The natural focus has been on institutions and structural arrangements at the macro or policy level. Institutional structures relating to financial markets, issues of corporate governance and the nature of corporate-government relations, and the lack of democratic self-correcting mechanisms are a few examples. Important questions include the extent to which such variables can explain if not the arrival of the crisis, then at least its impact on and consequences for economic growth. The negative effects on economic growth have also led to a second and equally important strand of the discussion, that is, the impact of the crisis on poverty and unemployment in the region. Even though the gains from economic growth since the beginning of the Asian miracle have not been wiped out by the 1997 crisis, the social impact of the crisis has been substantial (Warr 2000a). Initially, the impact on the number of people who live below the poverty line was central to this debate, and much effort has been put into estimating and evaluating the effects of the crisis in terms of numbers and head counts. Preliminary findings indicated that the oftentimes very gloomy predictions for Indonesia, Thailand and Malaysia have (fortunately) not been met (e.g. Jones et al. 2000), even though the number of poor people increased by several percentage points compared to 1996 in all three countries. Booth (1999) argues that this is due to poverty estimates being driven primarily by changes in real consumption expenditures, while the first round of findings indicate that the serious reduction in GDP will have a greater effect on investment rather than on consumption expenditure. Moreover, available evidence points to the crisis having affected various groups of poor people differently, one big discrepancy being between rural and urban areas. Data from Indonesia and Thailand identify regions specializing in cash crop production for export as having gained from the devaluation of the rupiah and the baht. However, increases in nominal income in rural areas have partly or fully been offset by increased costs of living, at least in the case of Indonesia. High inflation in the aftermath of the crisis in Indonesia has adversely affected the poor since food prices have risen faster than other prices. Some studies argue that inflation is the cause of much of the increase in number of people below the poverty line in Indonesia, while for Thailand, Malaysia and South Korea, rising unemployment has been the main source (e.g. Lee 1998; cf. Warr 2000a); it can be noted, however, that also in face of rapidly increasing inflation, nominal money wages for unskilled workers decreased as result of the crisis (Warr 2001:119). This has of course been widely understood in the countries so affected and measures have been taken to rectify the problems encountered. As a result, the discussion on the effects of the crisis on poverty has been broadened somewhat to incorporate the social impact of the Asian crisis in terms of education and health care, as well as poverty alleviation strategies and social security provision. Evidence so far indicates that school drop-out rates increased in Indonesia and that concerns over poor families taking children out of school to economize on school fees and other related costs may be well founded. For Thailand some observers argue that the loss of job opportunities for unskilled young people in construction and manufacturing has rather led to a net increase in school enrollment in that country (Booth 1999). Indonesia, worried over the effects of a drought that coincided with the crisis, rushed to implement a number of food-for-work programs, making use of administrative procedures that were already in place. These have largely been deemed unsuccessful in reaching the poor, but had the benefit of bringing the issue of social insurance networks for poor people to the forefront of the policy agenda. Unfortunately, the analysis regarding poverty often stops at evaluating governmentinduced employment programs and emergency assistance projects that were launched in response to the crisis. In particular, there is so far little in the literature on the impact of institutional reforms implemented at the macro level on the constraints and incentives facing the poor at the micro level. It may very well be the case that unless poverty alleviation was part of the reform design, poor people in Southeast Asia are just as vulnerable to major shocks to the economic system today as they were before the crisis. The present chapter aims to examine the consequences and effects of institutional changes made in response to the Asian Crisis of 1997 on the poor of Southeast Asia. Institutional Change in Southeast Asia 114 Indeed, can institutional change be seen to address the needs of pro-poor growth at all? Using a framework inspired by institutional analysis, we attempt to shed light on the constraints on the capabilities of poor people. As institutions and the context (history, policies, contingencies) that shape them are typically national in scope, we shall illustrate this by recourse to a case study on one of the countries most severely affected by the crisis, Thailand. Institutional analysis and pro-poor growth Institutions change Even a superficial acquaintance with economics will reveal that the institutional framework as an analytical category is gaining ground. It is evident not least from the growing body of work investigating the relationship between institutions and economic development (Lin and Nugent 1995). This has been triggered by a number of recent events. One is the disappointment with many structural adjustment programs in Africa and elsewhere; whatever their merits, they simply do not compare well with developments in regions where economic growth has been successfully achieved, the economic boom of the so-called Asian Tigers prior to 1997 being the most prominent example. Although attempts were made to accommodate the Asian experience with the ideas underlying structural adjustment programs, perhaps most prominently in the World Bank’s The East Asian Miracle (1993), the Asian experience with high and sustained economic growth provided a forceful rationale for bringing up issues such as legal structures, policies and value systems rather than maintaining an exclusive focus on deregulation and price reform. Other events, such as the collapse of the Soviet Union and the emergence of China as a major economic power, also served to underline the importance of not only macro-economic stability, but also the institutional set-up of economies. Not least, and somewhat paradoxically, the Asian financial crisis of 1997 revealed the necessity to seriously consider the institutional underpinnings of market based economies. As Rodrik (2000:4) puts it, “[t]he question before policy makers therefore is no longer ‘do institutions matter?’ but ‘which institutions matter and how does one acquire them?’”. Although a consensus of sorts on the importance of institutions has emerged among economists and, more broadly, among social scientists, there are still several question marks. From the point of view of research, as opposed to policy and application, the difficulty of connecting theory to empirical outcomes has proved to be a major stumbling block. One reason for this is the very nature of the concept itself; it is not particularly precise, and efforts to address this lack of precision as likely as not reduce not only its scope, but also its applicability. It is nevertheless useful to introduce some basic distinctions. Institutions, broadly speaking, are in this chapter thought of as the existence of a number of written and unwritten behavioral constraints that together make up the societal context within which people interact and make decisions. One useful definition reads: Effects of a crisis? Institutional adjustment 115 [A] set of humanly devised behavioral rules that govern and shape the interactions of human beings, in part by helping them to form expectations of what other people will do. In so constraining behavior, institutions may be reflected in the appearance of certain behavioral regularities or norms. Lin and Nugent (1995:2306–2307) Lin and Nugent make a further useful conceptual distinction between institutional arrangements and institutional structure. The former refers to “a set of behavioral rules governing a specified domain”, while the latter is used to cover “the totality of institutional arrangements in an economy, including its organizations, laws, customs, and ideology” (Lin and Nugent 1995:2307). Moreover, they claim that the term institutional change usually refers to a change in one institutional arrangement, rather than to a change in all arrangements in the structure. However, since there is usually a high degree of dependency between institutional arrangements, institutional change in one domain may very well be affected by, or affect, other institutional arrangements. Arguably the Asian crisis, with its initial and often exclusive focus on institutions supporting the financial market, is an example of this. The definition of institutions as behavioral rules may at first seem quite removed from the every day use of the term, which usually refers to well-established and important organizations (or people) in society. Yet the term frequently refers to an organization plus “something more”, where the “something more” part tries to capture the structural importance of the organization in question. Financial institutions or various legal and governmental institutions may serve as examples. In real life there is a high degree of interdependence between institutions and organizations as both provide structures to human interaction. But, as argued by North (1990), conceptually the two are very different and in order to understand economic growth, in particular long-term growth, it is important to keep them apart. In line with the definition above, North lets the term “institutions” refer to “the humanly devised constraints that shape human interaction” or in short, the rules of society. These can be formal, such as written policies, laws and regulations, or informal, such as customs, traditions and conventions. “Organizations”, on the other hand, denote “groups of individuals bound by some common purpose to achieve objectives”.2 Using an analogy to the world of sports, he lets “institutions” indicate the rules of the game, and “organizations” represent the teams or players that play the game (North 1990:5).3 Given the significance of institutions as an explanatory variable for economic growth, it becomes important to understand how they change and evolve over time. Here North argues that it is essential to try to discern the rules governing a situation (i.e. the institutional framework) from the strategies of the players in it (i.e. the interests and actions of the organizations). The process of institutional change can, in a simple fashion, be described as a bargaining process in which the party (individual, groups of individuals, organizations) who stands to improve his or her position if the institutional arrangement is altered may very well set aside resources to attempt to do so (North 1990:86). Relative price changes and changes in preferences are, according to North, the basic sources of institutional change, that is, the re-negotiating process over the prevailing institutional arrangement. Institutional Change in Southeast Asia 116 Institutions and policy Even though this might sound straightforward enough, it is potentially a rather complicated story. The costs associated with institutional change, in economic, social and political terms, are in most cases substantial. A complex web of formal rules vested in a hierarchy, where each level is more costly to change than the previous one, and informal constraints with a persistent ability to survive, as they have become part of habitual behavior, help to stabilize the institutional framework. What is more, given the process of negotiation, agents with strong interests will put substantial resources into securing the structure that fits them the best. Hence, there is nothing in the way institutions emerge and evolve that ensures allocative efficiency in the resulting institutional arrangement. One possible result may be a pattern of institutional change characterized by “institutional lock-in”, in which inefficient institutions (e.g. property rights) survive even in the long run. In short, the distinction between institutions and organizations exposes a pattern of interaction between the two that impacts the direction of institutional change. From a policy perspective, the story is much the same. We have to distinguish between the policies that are aimed at changing or adjusting institutions from those that are not. The latter, however, may influence not only organizations but also the long-term viability of institutions. What is more, policies may or may not be implemented in the manner intended, and outcomes may, as a result, differ from those anticipated or hoped for. Such differences may depend on which type of policies, or the type of institutions, that are in focus. In fact, distinguishing between institutions that are operational at the macro-economic level and those that address micro-economic issues proves useful (Rodrik 2000). As indicated in Figure 6.1, the former may include policy measures introduced to improve, change or safeguard sound macro-economic development. The latter are those that are addressed to the smooth running of markets, for instance property rights, competition policy or measures directed at other forms of market failures. Also industrial policies would find their way into this category. Both sets of policies aimed at institutional adjustment are national in scope. National policies, however, do not necessarily result in nationally homogeneous and consistent implementation, nor in nationally homogeneous outcomes. We would therefore need to consider also developments at a sub-national level where not only the locally or regionally differentiated implementation or outcomes can be assessed, but also contingency and context can be accommodated. Indeed, some of the phenomena that Rodrik includes under his micro-economic heading, such as local knowledge, are best considered here. A few additional comments on Figure 6.1 are in order. The local/regional scale can also be conceived of in terms of individuals, households or communities (as does, for instance, Booth 1999). In the micro column, that is, in the lower right panel, this can be translated into livelihoods, participation and strategies, none of which is particularly amenable to generalization. Consider, for example, the fact that the peoples of northern Thailand were long denied Thai citizenship, such that they were “unable to travel beyond the district and therefore denied the opportunity to search for work” (Rigg 1997:119). Although this was by no means the norm for Thailand, it was a powerful mechanism of exclusion for entire communities in some parts of the country. Although to the analyst Effects of a crisis? Institutional adjustment 117 such variation across the national landscape comes at a cost, namely at the cost of the ability to generalize, a focus on the micro level Economic policies Macro-economic Micro-economic National Fiscal, monetary policy and associated institutions Regulatory policies Industrial policy Scale of Analysis Local/ Regional Implementation and/or outcomes (including actions taken) Implementation and/or outcomes (including actions taken) Figure 6.1 Institutions, policies and outcomes. affords the benefit of assuming a bottom-up perspective. On the other extreme, it is in the upper left panel of Figure 6.1 that the “blueprints”-approach to the acquisition of institutions (Rodrik 2000) is possible; already as we move to the upper right hand panel, context and contingency—now in the form of the nationally specific—threaten to get in the way of a “clean” implementation process. It is at the grass roots level, however, that this difficulty of generalization is the most likely to be of concern to the analyst. An institutional approach to pro-poor growth Lin and Nugent (1995:2307ff) argue that institutions perform two basic functions in the economic system: an economizing function and a redistributive function. The economizing function aims at Pareto improvements through the means of production enhancements (by taking advantage of internal and/or external economies of scale, and specialization), the collection of more and better information, and risk reduction. Property rights arrangements are prominent among economizing institutions. The re-distributive function addresses the non-neutrality of economizing property rights with respect to the allocation of gains from specialization and exchange. The redistributive function may be a primary function or motive for many institutional arrangements, and it may or may not include the poor. Moreover, if the distribution of the power to impose rules is highly skewed and there are few alternative institutional arrangements, it may very well dominate the economizing function. Thus, to the extent that pro-poor growth is about achieving economic efficiency gains while assuring that these gains also benefit the poor, institutions are at the heart of the subject. What are the implications of such a line of reasoning? For now, suffice it to note that an institutional approach lifts into the foreground the formal and informal behavioral constraints that limit the action space of poor individuals. It thus helps in setting the poor at the center of a systematic contextual analysis. In this regard the institutional paradigm is close to the manner in which scholars have thought of livelihoods. Livelihoods focus on the set of assets (financial, real and human) available to the individual, the strategies of combining those adopted by the individual, and the outcome of the resulting livelihoods. The institutional framework is essential in determining both constraints in the form of availability of assets, but also in the sense of imposing limits on the strategy set of the poor. In addition, their ability to influence the institutional arrangements, by way Institutional Change in Southeast Asia 118 Also, health measures to protect the poor were at the top of the agenda (NESDB 1998). Programs targeting women and children were to be given priority, while the provision of health services in rural areas was also identified as a major task for the authorities. Redeployment of staff from urban to rural areas and increased budgets for the Public Assistance and Voluntary Health Care schemes were also foreseen. Increased health sector competition and privatization of some health care facilities were also part of the long-term measures to be implemented; this was seen as a means of making health budgets sustainable over the longer term. The combined effects of these programs are, generally speaking, much more difficult to pinpoint than the measures per se. The decentralization of the decision-making power and the responsibility for implementation appears as a major departure, but whether this implies any change in practice remains to be seen. It should be noted, however, that prior to the crisis, decision-making was decidedly centralized. This included not only issues related to budget expenditure and program implementation but also resource use at the local level, the latter of which often had to yield to perceived national priorities, including industrial or export interests. By way of an example, the environmental consequences of such priorities have been widely documented and the ruthless exploitation of natural resources has been a common theme in the criticisms levelled against the Thai economic policies by media, civil society organizations and academic circles alike. The fact, for example, that Thailand’s National Environmental Quality Act of 1992 is comprehensive is of little consequence as long as it is not properly enforced. Yet it is quite clear that some of the resources meant for the poor actually were used for their direct benefit. In rural areas, for instance, some of the money disbursed from the Miyazawa fund set up by the Japanese government in response to the crisis was used for communal projects such as road building and the maintenance of irrigation works (Molle and Thippawal 2000:359), thereby generating temporary income for those employed on the projects. The extent to which this helped the poor is unknown, although it is easy to appreciate that it served as a useful stopgap measure. The effectiveness of the programs is thus difficult to gauge, but it must be underlined that many of the changes made in favor of those adversely affected by the consequences of the crisis were of a short-term nature. As stop-gap measures go, they can be questioned on grounds of sustainability; after all, they were not intended as permanent solutions. If anything, these measures, as well as the process of fiscal decentralization begun in the early 1990s, have contributed to the increasing budget deficits seen in Thailand in the wake of the crisis (Kanokpan 2002). On the other hand, from the perspective of institutional adjustment, welfare programs, to the extent that they are being introduced on a more permanent basis, may have the beneficial effect of providing automatic stabilizers. These are likely to prove costly from a purely fiscal point of view, but may, on the other hand, cushion the effects of external or domestically generated macro-economic shocks. If so, this has the potential of reducing the vulnerability of the poor, both through the safety net itself and through the ability to maintain aggregate demand in face of adversity. However, there is a risk that such spending may run up against the provisions of the Budgetary Law, first promulgated in 1959. Stipulating that planned spending may not exceed planned expenditure by more than 20 percent, the law has served as an effective and automatic fiscal stabilizer (Warr 2000c:131). Although it has subsequently been relaxed to allow for another 8 percent Effects of a crisis? Institutional adjustment 125 used for the repayment of the principal of public debt, it may, if honored and applied in tandem with the above welfare spending, imply a decisive shift of expenditure in favor of the less affluent segments of the Thai population. The victory of Thaksin Shinawatra and his Thai Rak Thai Party at the polls in late 2000 has changed little in this respect. The policy declaration that incoming Prime Minister Thaksin delivered to the National Assembly on 26 February 2001 included the following pledges: (1) the “Village and Urban Revolving Fund”, a central pillar of his election platform, where each village or local community was to receive one million baht (then about US$ 23,000); (2) the farmers’ debt suspension program, where a three-year grace period was offered on loans taken by small farmers in order to allow them to weather the crisis; (3) the establishment of a “People’s Bank”, “to ensure better and improved access to banking facilities and resources for low income citizens to enhance their capacity to increasing their income from self employment and thus reduce their dependence [on] unorganized and punitive money market sources” (Thaksin 2001), as well as a similar organization for small and mediumsized enterprises; and (4) a universal health insurance, with a hospital visit costing no more than 30 baht and where equality of access was guaranteed. The village fund, which takes the form of a revolving fund, has had the salutary effect of being available when banks withdrew their normal lending to farmers in the aftermath of the crisis. By providing credit, or allowing farmers the advantage of not having to turn to informal sector finance (i.e. moneylenders), the fund is indeed to be considered a positive intervention on behalf of the poor. Not everyone is impressed however, and Wipaphan Korkeatkachorn (2002) from the NGO Thai Action on Globalization noted that: The One Million Baht Village Funds, for instance, are supposed to be a kind of transfer payment by the government to the disadvantaged sector of the population. Each village fund, however, is to provide loans to community members under the supervision of a village committee. One objective of the loans is to create jobs and income but a preliminary assessment of the loans reported that 80 percent of the US$158,000 disbursed so far was used by villagers to pay back old debts. It seems likely that funds will create more non-performing loans in the rural sector. It is also, however small, a part of the generally expansionary policies that Thaksin has been pursuing since assuming power, thereby contributing to the overall credit expansion and the attendant risk of increasing inflation and generating bubbles. Similarly, the 30 baht hospital fee scheme can be seen as a cap that is low enough to be within the reach of the poor, indeed insuring them from fees that are well beyond their means. Under this scheme, every visit or treatment at one’s home health care center is supposed to cost no more than 30 baht. On the other hand, a flat fee, as opposed to one based on income or paying capacity (which of course would be much more expensive to run) means a proportionally higher subsidy for those that can afford higher rates. This may matter less if gains are seen in absolute rather than relative terms, but to the extent that geographical distribution and accessibility of health services are regionally or locally differentiated, or to the extent that excess demand strains capacity, this scheme may still Institutional Change in Southeast Asia 126 raise doubts on its pro-poor qualities. Similarly, to the extent that health providers depend on fees, as opposed to budgetary transfer (which in turn raises fiscal issues, in particular as low fees may create excess demand), the quality of services accessed are likely to reflect the low fees now charged. While the village funds and the 30 baht cap both are fully operational, other promises have taken quite some time to reach the stage of implementation, in part because of the virtual standstill that dominated government work up to August 2001 (Bangkok Post 2002). But also, if the pledges made are eventually to be honored, the question of sustainability remains an issue of some consequence. Similarly, the ambition to by-pass the traditional centers of power in formulating, implementing and monitoring these programs has met a fair amount of skepticism. Institutions beyond the realm of economics: political reform To a considerable degree, the skepticism would seem to stem from the openly populist character of Thaksin’s approach to politics, a criticism that could equally well be levelled at a number of governments pre-dating that dominated by the Thai Rak Thai party (Pasuk and Baker 2000). No matter the stand we take on this issue, it serves to highlight the insufficient attention typically devoted to political issues in the institutional analysis of the sort advanced by adherents of the New Institutional Economics. As a sympathetic critic of economics drawn from the ranks of political science has noted, while “‘[p]olitical facts’ thus lurk just beneath the surface of the new institutionalism”, it fails to embed its analysis “within the study of politics” (Bates 1995:42). In particular, Bates goes on to suggest, the issue of power is given short thrift, as are also the effects of party politics and the political system or setting as such. These are factors that not only are likely to have an impact on the structure and efficiency of economic institutions, but may also provide “explanations for the direction and magnitude of the departures from the status quo that economic institutions make possible” (Bates 1995:44). In short, noneconomic factors and institutions of both a systemic and contingent nature should be taken into account; as a heuristic device, the new institutionalism fails to do precisely that. This remark is particularly apposite relative to Thailand, where the developments discussed above have run in parallel to constitutional reform (Prudhisan 1998, Funston 2000, Pasuk and Baker 2000). In fact, it is only a slight exaggeration to suggest that the shock of the crisis in 1997 paved the way for a successful completion of the process initiated already in response to the military coup in February 1991, and in particular following the pro-democracy demonstrations in May 1992, to make Thai politics more transparent and more directly answerable to the electorate. Institutional changes of this magnitude, especially since it was deliberately designed to undermine the entrenched, privileged positions of the few, could be expected to meet strong opposition from vested interests, and indeed it did. In October 1997 the “Peoples’ Constitution” was promulgated and, in the words of the Chairman of the Constitutional Drafting Assembly, “returned power to the people” (Prudhisan 1998:270). However, the very fact that a plethora of new courts, government agencies and ombudsmen are supported by the Constitution, many of which have a mission precisely to protect and promote the interests of the electorate, indeed all citizens, could possibly provide the means to circumvent or ignore the new Effects of a crisis? Institutional adjustment 127 provisions. The new Constitution might simply prove too ambitious to allow for transparency, clear priorities and consistency in implementation. Although it is fair to say that the Constitution marks a major break-through in the realms of post-crisis institutional adjustment, it is not the only instance of the electorate or population at large moving its positions forward. Pasuk and Baker (2000:115, 232) also note that technocrats saw their positions dented, while in general civil society increased its activism. As a result, corruption and nepotism came under increased attack. A National Counter Corruption Commission was set up in early 2000, and many politicians found themselves on the slippery slope, being ostracized for their self-serving actions. As the Constitution also contained provisions to stamp out vote buying, the timehonored practice of godfather politics was dealt a blow. In that sense the Constitution and the crisis returned a measure of power to middle class urbanites. As the Thai Rak Thai was elected to power, however, a partial reversal set in and, as Pasuk and Baker (2000:235) remark, the results at the polls in 2000 “offered a mix of old and new”. Indeed, casual observation suggests that this was something of a setback to the institutional adjustments induced by the crisis. In this context it is telling that it is only with the highly visible effects of the current government’s expansionary economic policies that the middle class has warmed towards Prime Minister Thaksin—for however long as this may now last. Conclusion The overall conclusion of the above survey of measures taken by the Thai government in the wake of the Asian crisis of 1997 is one of limited institutional change. Other than the new constitution, which marks a major departure from the past, but which the current Prime Minister seems content to undermine to the best of his abilities, there are few indications that the institutional structure of Thailand has been made subject to anything but rather marginal adjustment. At the level of institutional arrangements, however, the impact of the reforms launched is both more far-reaching and more transparent. This is true both with respect to regulatory reform targeting the financial sector, and social sector programs. Whether these changes to the institutional arrangements will survive for long, or are profound and well designed enough to serve the purposes they were designed to meet, remains to be seen. From the perspective of this chapter, the benchmark is not only sustainability, both as reforms and as seen from a macro-economic perspective, but if they indeed serve the purpose of pro-poor growth. Welfare systems, rudimentary as they are, are primarily intended to target the poor, and may therefore fall within this category, provided, of course, that they are implemented as intended. To the extent that they may also serve as automatic stabilizers for the economy in a downturn, these changes can be said to mark a major departure from the point of view of institutional arrangements. However, welfare benefits of this type are primarily of the re-distributive rather than efficiency-increasing variety. As this analysis has operated at the national level, there is clearly scope for a regional and local approach to the research into the institutional arrangements as such and the effects thereof. Similarly, rather than focusing solely on those areas where reform has Institutional Change in Southeast Asia 128 already taken place, research is needed on those spheres that were not directly affected by the crisis, but where reform is needed if the situation of the poor is to be improved. There is thus room for a more comprehensive analysis focusing on both formal and informal institutional constraints facing the poor in the wake of the Asian crisis. This is all the more true if, as the World Bank (2000/2001, 2002) argues, markets are important to the poor as markets can be used as a lever to mobilize resources that the poor command, thereby releasing their capabilities. If so, the obvious questions to answer include, how do institutions affect markets and what institutions are necessary for giving the poor access to markets? Indeed, capabilities and freedoms, pace Sen (1999:6), are important to the poor, but both are shaped by the various institutional constraints that may exist. Greeley (2000:3) therefore suggests that “the development of local opportunities through relaxing of the institutional constraints that prevent the efficient functioning of markets” is a priority in formulating pro-poor policy. This should also be reflected in any study intent on extending the line of analysis pursued here. All in all, the above raises important analytical and methodological questions, and may have important policy implications. For one, it may imply moving away from national representation based on averages, to representation based on cases, that is, the equivalent to the lower right panel in Figure 6.1 above. However, this is not sufficient. Also the micro-macro linkages have to be explored in a systematic fashion. This could take the form of a micro-based approach such as the livelihoods approach, and amending it to include an analysis of macrolevel formal structures, such as legal provisions. Alternatively, or in parallel, it can be approached in the manner suggested by Lin and Nugent’s (1995) term “institutional arrangement” as introduced above, the domain in question embracing both the macro and micro scales, be it within the sphere of macroeconomic or micro-economic policies. Notes 1 In the bibliography and annotations we follow the Thai usage for Thai names, i.e. authors are arranged by first name followed by the family name; citations are by the first name. 2 Organizations thus include political, economic, social and educational bodies. 3 See Eggertsson (1990) and Rutherford (1994) for assessments of the New Institutional Economics (NIE) school of thought, and Lin and Nugent (1995) for an overview of the NIE approach to development. On the latter, see also North (1995) and Toye (1995). 4 Kakwani uses an index, the pro-poor growth index, to find out. He also introduces the notion “immiserizing growth”, which is growth that actually hurts the poor rather than being to their benefit. References ADB (2001a) Asian Development Outlook 2001, Manila: Asian Development Bank. (2001b) Key Indicators 2001, Manila: Asian Development Bank. Online. Available at: <http://www.adb.org/Documents/Books/Key_Indicators/2001/%20default.asp> (accessed February 2002). Effects of a crisis? Institutional adjustment 129 (2001c) Thailand Country Strategy and Program Update (2002–2004), Manila: Asian Development Bank. Online. Available at: <http://www.adb.org/Documents/CSPs/THA/2001/default.asp> (accessed February 2002). (2003) Key Indicators 2003, Manila: Asian Development Bank. Online. Available at: <http://www.adb.org/Documents/Books/Key_Indicators/2003/default.asp> (accessed December 2003). Ahuja, V., Bidani, B., Ferreira, F.H.G. and Walton, M. (1997) Everyone’s Miracle?, Washington, D.C.: The World Bank. Bank of Thailand (various years) Key Economic Indicators. Online. Available at: <http://www.bot.or.th/bothomepage/databank/EconData/KeyEcon/index_e.%20htm> (accessed February 2002). Bangkok Post (2002) “Year-end economic review 2001”. Online. Available at: <http://bangkokpost.net/yearend2001/> (accessed February 2002). Bates, R.H. (1995) “Social dilemmas and rational individuals: an assessment of the new institutionalism”, in J.Harriss, J.Hunter and C.M.Lewis (eds) The New Institutional Economics and Third World Development, London: Routledge. Booth, A. (1999) “The social impact of the Asian crisis: what do we know two years on?”, AsianPacific Economic Literature, 13(2): 16–29. Deininger, K. and Squire, L. (1996a) “Deininger and Squire data set: a new data set measuring income inequality”, Washington, D.C.: The World Bank. Online. Available at: <http://www.worldbank.org/research/growth/dddeisqu.htm> (accessed February 2002). (1996b) “A new data set measuring income inequality”, World Bank Economic Review, 10(3): 565– 591. Deolalikar, A.B. (2002) Poverty, Growth, and Inequality in Thailand, ERD Working Paper Series, 8, Manila: Asian Development Bank. Eggertsson, T. (1990) Economic Behavior and Institutions, New York: Cambridge University Press. Funston, J. 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Institutional Change in Southeast Asia 132 7 Singapore’s extra-ASEAN free trade agreements and their implications for ASEAN Jose L.Tongzon Introduction Perhaps there are two major developments since the inception of the ASEAN Free Trade Area (AFTA) which have seriously tested the resolve of the ASEAN countries to bring this vision into reality: the recent economic crisis of 1997–1998 and Singapore’s current foray into bilateral free trade agreements with non-ASEAN countries.1 The crisis of 1997–1998 has significantly stalled the economic progress experienced by ASEAN countries and set back the economic and social gains achieved in the past decades. The tragic terrorist attacks of 11 September 2001 have further exacerbated their economic problems and dampened the outlook for greater trade liberalization within the framework of the ASEAN Free Trade Area (AFTA). The recent initiatives by the Singapore government to forge bilateral free trade agreements (FTAs) with other countries outside ASEAN have also put further into question the future and effectiveness of ASEAN as a viable regional organization. The lack of a coordinated approach to the recent crisis and the lack of an immediate response to it have already put into question the effectiveness of ASEAN as a rallying point. Against this backdrop, this chapter will analyze whether the recent crisis has undermined the ASEAN countries’ resolve to push ahead with the AFTA vision and whether, or to what extent, Singapore’s recent initiatives to form bilateral free trade agreements with other countries outside the region will undermine ASEAN’s future economic integration. The recent crisis and the future of AFTA The recent crisis has had negative implications for the future of ASEAN cooperation. Trade liberalization entails short-term adjustment costs resulting from a reallocation of human resources consistent with the principle of comparative advantage. During the transition period, workers that cannot retrain themselves with the appropriate skills may find themselves structurally unemployed. In countries such as Indonesia and Thailand, where unemployment and poverty have already risen from their pre-crisis levels due to the crisis, the costs of adjustments would become more severe and difficult.2 Corollary to this is the issue of division of gains and costs. The crisis has reinforced the fear that trade liberalization would only benefit the more developed and competitive member countries at the expense of surrendering one’s national priorities and autonomy in policy setting. For example, despite its recent official agreement to accelerate AFTA’s implementation, there were indications that Vietnam’s pace of implementation of its trade liberalization commitments has further slowed during and after the crisis. Vietnam’s economic development strategy for 1999 emphasized agricultural development with domestic market orientation and the importance of the state-owned enterprises (The Economist 14– 20 November 1998). This indication was confirmed by Vietnamese officials’ admission that the regional crisis has slowed down their economic reforms and forced them to be more inward-looking (Dow Jones International News 2 January 1999). Vietnam has not made any reference to their efforts to join the World Trade Organization (WTO) or their commitment to tariff reductions until recently with the signing of the historic USVietnam bilateral trade accord and the impending membership of China in the WTO. The crisis, by causing greater debt servicing commitments and exchange rate instability, has also accentuated the major concern that countries with higher levels of protection, such as Indonesia, the Philippines, Thailand and Vietnam, will have to give up more in terms of tariff revenue loss, current account deterioration and job losses, than countries with lower levels of protection such as Singapore, Brunei and Malaysia. It has highlighted the question of mutuality of external trade and investment gains from AFTA. It has also intensified intra-ASEAN competition for non-ASEAN export markets and foreign investments, and could further raise this longstanding question of division of external gains among the ASEAN countries. Table 7.1 ASEAN6 average CEPT tariff rates, in percent, 1997 Country 1996 1997 1998 1999 2000 2001 2002 2003 Brunei 1.58 1.58 1.21 1.16 0.90 0.87 0.87 0.84 Indonesia 9.05 8.53 7.05 5.82 4.92 4.61 4.20 3.72 Malaysia 4.62 4.04 3.41 3.01 2.58 2.41 2.27 1.97 Philippines 9.22 9.20 7.71 6.79 5.45 4.96 4.68 3.72 Singapore 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Thailand 14.41 13.10 10.46 9.65 7.29 7.27 5.93 4.63 Total ASEAN6 6.68 6.08 4.97 4.41 3.52 3.35 2.93 2.48 Source: ASEAN Secretariat (1997). Note All figures are mutually agreed tariff commitments, except for 1996 and 1997, which are actual CEPT tariff rates. Despite these negative implications, the crisis seems to have strengthened the countries’ political will and resolve for closer economic integration. The crisis has invoked the ASEAN sense of “shared destiny” and thus, reinforced their sense of determination to forge a greater level of economic cooperation; further, the contagion effect of the financial crisis has further demonstrated their high degree of economic inter-dependence, and therefore, highlighted the need for some policy coordination. It can be argued that the crisis has not at all derailed the implementation of their AFTA commitments; the progress made in meeting their AFTA commitment has been well on track. As Table 7.1 shows, in the area of the Common Effective Preferential Tariff (CEPT) commitments, Institutional Change in Southeast Asia 134