Growing Pains: ASEAN's Economic
and Political Challenges

Manuel F. Montes
Kevin F. F. Quigley
Donald E. Weatherbee

December 1997

The Oversold Miracle

The Roots of Liberalization

It is easy to forget that Thailand had a major financial crisis in 1984, with an overextension of credit like that of 1997, which also necessitated a drastic and initially controversial devaluation of the baht. In 1983, with international petroleum prices falling, Indonesia confronted an economic crisis that inaugurated four years of economic uncertainty, two devaluations, and a treadmill of adjustment of economic policies. Singapore faced a major economic slowdown in 1985, characterized by sharp reductions in foreign investment inflows and extreme drops in domestic property prices. In 1984ó85, with its export revenues falling as a result of steep declines in international commodity and oil prices, Malaysia suffered a crisis when external financing for its current transactions disappeared as a result of financiers' loss of confidence about the country's ability to service its future debt obligations. Malaysia had to face the possibility of being unable to obtain international financing to cover its trade deficit. As a result, its ambitious industrialization program had to be scaled back drastically in order to regain international confidence. The Philippines, in the waning years of the Marcos regime, had the deepest crisis of all, becoming the lone Asian participant in the international debt crisis of the 1980s, in which countries that had borrowed heavily from international private banks in the 1970s to finance trade deficits spawned consumption spending and ambitious investment programs, then found their credits suddenly cut after the near default of Mexico in 1982. The adjustment to the sudden loss of financing caused deep recessions and employment cutbacks. Vietnam's economic crises in 1984 and again in 1988 forced drastic cutbacks in employment (up to 20 percent of the urban labor force between 1989 and 1990) and sharp devaluations of the dong.

The year 1988 would be the appropriate point from which to date the recent growth spurt in Southeast Asia, with Singapore beginning its expansion in 1986 and Philippine recovery beginning in 1993. It was also the year Japanese companies began to significantly relocate production facilities offshore as a result of the currency realignments decided among the G-7 finance ministers under the Plaza Accord in 1985, designed to boost the value of the Japanese yen vis-à-vis the world's major currencies. Labor-intensive operations began to move out of Korea and Taiwan in 1988 as well, as a result of their own currency realignments, undertaken in response to U.S. pressure. With China still in the early stages of its move to the market, Southeast Asia became the main beneficiary of these relocations. The inflow of new production facilities enabled the receiving Southeast Asian economies to grow faster. The incoming resources financed larger trade deficits.

Trade liberalization. In the eyes of the world, the Southeast Asian nations maintain a strong outward orientation. In fact, trade liberalization is a relatively new phenomenon in the region, with the exception of Singapore. Before the late 1980s other Southeast Asian nations, while being vigorous commodity exporters, had followed classic industrial policies, such as protecting manufacturing activities from foreign competition. Brunei, Indonesia, and Malaysia have been petroleum exporters and, like the other economies, have channeled resources to industrial development. In fact, the Philippines initiated the first trade-reform program in 1980, under one of the original structural adjustment loans for this purpose from the World Bank. Trade liberalization in the other Southeast Asian countries accelerated only in the second half of the 1980s, partly in response to their own economic crises, but mostly as a result of increased confidence in outward orientation made possible by the foreign investment flows from Japan, Korea, and Taiwan.

The reform of industrial policy remains an uncompleted task. In Indonesia and Malaysia, for example, car manufacturing development programs, characterized by expensive government subsidies for domestic production of cars and by protection from car imports, still exist. Vietnam's market reforms, which consisted of removing all state controls on prices and reducing subsidies for state companies, have avoided extreme falls in output as in the European transitions, but its domestic companies continue to rely heavily on a trade regime riddled with regulatory restrictions and credit subsidies from the banking system. Nevertheless, the trade liberalization and production relocations created new export industries in light manufactured goods, such as garments and canned food, and in electronic components and consumer goods.

Financial liberalization. Like trade liberalization, the liberalization of domestic financial systems began in most of these countries in the late 1980s. These efforts were made partly to accommodate the needs of foreign investors for modern banking services such as international remittance and payment facilities and currency hedges for their imports and exports. The desire of international banks and investment funds to invest in Asia provided tie-ups for domestic banking companies and funds to start up activities in new areas, such as brokering investment from abroad into domestic stock markets, and in currency trading. The availability of external funds in the process of liberalization played an important role in softening the impact of liberalization on the domestic banking system. Normally, such a process involves gainers and losers, as the less-regulated market rewards those with large asset bases, extensive networks, and perhaps greater financial agility, though the last is difficult to measure objectively. With external financing, unequal distribution in the liberalization process could be avoided. Entrants could compete with established banking institutions based on their wits and tolerance for risk.

With greater confidence in the availability of international financing, easing of regulations over international movements of capital accelerated after 1992. By 1994, when the Mexican external crisis erupted, Southeast Asian countries were well on their way toward completing the twin liberalizationsñof their domestic banking systems and in opening their capital accounts. Opening capital accounts consisted of guaranteeing that nonresidents could easily withdraw their investmentsñthat is, without having to obtain permission from authorities to convert their local currencies into foreign exchange. (Given that a significant proportion of nonresidents could actually be nationals of the country, opening the capital account effectively eased outward foreign investment restrictions and limitations on foreign asset holdings of nationals.) This new guarantee encouraged investments in short-term domestic assets, such as foreign currency deposits and domestic bonds, and in the local stock market. These kinds of investment were very different from that associated with production relocations. In the first place, they were enticed by higher returns in domestic markets as opposed to lower production costs. Second, these could be withdrawn easily (unlike production facilities) if the returns on the investment, which consisted of the interest on the asset plus the currency appreciation, were lower than returns on investments elsewhere. In hindsight these efforts set the stage for the 1997 currency crisis.

Development Weaknesses

The haze problem affecting most of the region manifests many underlying development issues that Southeast Asian economies have not adequately addressed. It is not just an environmental issue; problems of income distribution and development strategy are also involved. The proximate cause has been the change in the weather pattern caused by the onset of El Niño, which causes drought in many parts of the region. The long-term underlying cause is the process of land clearing in the sparsely populated Sumatra and Kalimantan provinces, which the Indonesian government has been keen on, especially in the last decade. Large plantation companies and farmer settlersñwho come from the more densely populated provinces of Indonesia and are provided homesteads in these provincesñhave joined the traditional shifting cultivatorsñwho have lived in the area for a long time, clearing small sites for planting crops until the soil's nutrients have been depleted and then moving to other sitesñin using fire as the most economical way of preparing forestland for cultivation. For the villagers and residents of the small towns nearby, the burning and smoke are seasonal features of life. The drought means, first of all, a worse inconvenience than usual and, second, the opportunity for faster land clearing, since tropical forests are ordinarily difficult to set alight.

Spurred by returns from plantation cropping, wholesale clearing of forested land for cultivation took place in the mid-nineteenth century in the Philippines and early this century in Malaysia. That the same process is occurring in Indonesia today says much about the disparity in development among ASEAN economies. The extent of Southeast Asian development ranges from the high-rise buildings in each of the capital cities in the regionñwired for global business activities in the case of Singaporeñto the subsistence levels of life in remote areas. Among the ASEAN countries, the development gap is enormous: Singapore's per capita income is 100 times larger than that of Vietnam. There are also significant disparities in government capabilities as well as in the capacity and sophistication of the domestic private sector.

In the international area ASEAN countries have consistently defended their right to use their natural resources to further economic development, as did the industrialized countries before them. In 1989 ASEAN acted as a group to overturn proposals to sharply reduce the export of tropical wood to Europe, even as the Philippines and Thailand had already slipped from being exporters to net importers of wood. The implicit position of the resource-endowed countries in the region has been to accept the trade-off between natural resource preservation and economic development. The spreading of the haze through the region has brought up the point that perhaps the trade-off is not as stretchable as commonly supposed and even immediate growth prospects can be undermined by environmental performance.

The elevated economic growth rates from the late 1980s have also resulted in a widening of income disparities in almost all the economies in the region. All growth spurts tend to widen income disparities because of differences in human skills and training among a population. However, in the three years preceding the crisis, Southeast Asia's growth spurt increasingly depended on the bidding up of asset and property prices, as opposed to the more customary expansion of output and exports. The current asset crisis can almost be interpreted as a blessing in disguise for workers who were being priced out of the market for homes.

Higher wages and increased competition from countries such as China and India in world markets for labor-intensive goods are forcing ASEAN governments to wrestle with the industrial and technological upgrading of their economies. Singapore and Malaysia, with strong commitments to education and successful in attracting high-technology companies from abroad, have made notable progress in this regard. But even with those economies, there is a sense of disquiet regarding uncertainties and the costs of the technological revolution. There are immeasurable uncertainties involved in deciding which technologies to support and subsidize, since it is impossible to know beforehand which will become commercially viable in the end. In both these countries, intense efforts to attract the relocation of research and development facilities are being undertaken. Malaysia's Multimedia Super Corridor project, which seeks to attract research operations in multimedia development from the world's leading information companies, such as Microsoft, is a good example. Singapore has been spending about 1.3 percent of its gross domestic product (GDP) on research and development, followed by Malaysia at about 0.4 percent. Singapore recognizes that its short supply of research scientists and engineers (much of its talent is absorbed by higher paying jobs in manufacturing and business) is a major obstacle to technological upgrading.

Thailand, whose per capita income puts it in the same bracket as Malaysia, has a more acute technological upgrading problem: education. The proportion of Thailand's youth enrolled in secondary education in 1993 was lower by 3 to 4 percentage points than the corresponding proportion Vietnam had achieved by 1980. A decade and a half of real budget cutbacks in education and consequent emigration as teachers left for better paying jobs abroad have weakened Philippine educational institutions considerably. Vietnam's move to the market involved the introduction of school fees in the mid-1980s, which caused a noticeable drop in primary and secondary enrollment; this trend has since reversed, as incomes have increased and families have begun to afford the fees, and enrollment rates have remained stable but have not increased since 1988. The best of Vietnam's primary and secondary teaching corps are leaving for better jobs in the large cities and the private sector.

The Recently
Oversubscribed Miracle

In a rough chronology, one might consider 1988 to 1994 as the years when Southeast Asian economies grew on the basis of foreign direct investment inflows. These inflows did not require the liberalization of financial markets because the domestic assets they normally install are not as easily withdrawn as investments in domestic stock and bond markets.

Southeast Asia's growth since the Mexican crisis of 1994 relied increasingly on the more liquid (and in hindsight, more volatile) portfolio and equity investments from abroad. Malaysia reported a total capital inflow equivalent to 20 percent of its GDP for that year; in January 1994 alone Malaysia had to manage $30 billion in external capital buying into its stock and bond markets. For Thailand external capital inflow peaked at 12.3 percent of GDP in 1995; 95 percent of these inflows were not direct foreign investment related and therefore consisted of portfolio and equity placements. The other ASEAN economies experienced inflows of the same magnitude as Thailand.

In each of the ASEAN economies, but most intensely in Thailand, the twin liberalizations in banking and capital account enabled domestic financial units to offer any interest rate they deemed fit in order to obtain funds. Previously, domestic banks could not offer interest rates higher than legal ceilings; with the ceilings removed, these banks could offer foreign funds interest returns higher than those available in the industrial economies. The ability to set interest rates on the lending side reduced local banks' dependence on lending to the government, which meant that they needed to quickly establish the capability to evaluate projects and judge creditworthiness, which was never important before. It also meant that monetary authorities immediately had to learn how to supervise and monitor the soundness of the lending practices of the burgeoning number of financial institutions.

Financial liberalization freed local banks from the strictures of credit ceilings and government credit allocation rules. These freedoms, spurred on by the government's encouragement of more diversified financial activitiesñits principal motive behind liberalization of the domestic banking systemñencouraged rapid lending for property development. (There is a contrast here with Mexico, where the growth in consumer lending outstripped property lending in the years before the Mexican crisis.) In Thailand, Indonesia, and the Philippines lending for property development was growing at annual rates of 20 to 35 percent before these governments reimposed controls in mid-1996. In early 1996 Singapore imposed high tax surcharges on property resold less than three years after purchase to curb credit expansion to the property sector. This has initiated a moderation of increases in property prices.

The liberalizations also instituted an arena of intense competition in the domestic financial system, in which eventual financial dominance depended on the outcome of a "race to the swift" in expanding lending portfolios, generating offóbalance sheet transactions (less subject to prudential supervision), and the proliferation of quasibanking operations. As had happened in Japan and the Scandinavian countries during their financial deregulations in the 1980s, there were many cases of banks establishing finance companies devoted to lending for property development, whose debt instruments the mother company would in turn purchase.

Especially in Thailand, these liberalizations created a volatile mix. Nonresident portfolio investors provided the fuel, taking equity positions, participating in bond flotations, and lending to finance companies based mainly on projected higher returns. As in Mexico before 1994, following the crowd of other nonresident investors often substituted for detailed research and the monitoring of uses of loans. The strong peg of the baht to the dollar seemed to exempt nonresident investors from the currency risk. From mid-1996, when the dollar steadily appreciated against the yen and major currencies, purchasing a baht asset from a yen position almost immediately provided returns from the currency appreciation. The oxygen for the volatile mix was provided by the accelerating rise in property values and, before 1996, domestic stock market prices on which further lending and the prices of initial public offerings of stocks could be pegged.

A currency attack on the baht in May 1997 was successfully curtailed through coordinated intervention among some of the region's central banks by purchasing the Thai currency. But the underlying problem lay in the Thai financial sector. The crisis was sparked when Thai authorities sought to weaken the peg against the dollar on July 2, 1997. Uncertainty over the sustainable exchange value of the baht became tantamount to doubts about the serviceability of Thailand's liabilities to nonresidents, who responded by withdrawing their placements, further escalating uncertainty over the baht's equilibrium exchange value.

Since the other Southeast Asian economies also had recently liberalized their banking sectors and capital accounts, the soundness of their domestic financial systems was called into question, triggering investment withdrawals and the drawdown of currency values. The general uncertainty has obscured the widely varying situations in the Southeast Asian economies. Just like the smog problem, generated by one ASEAN country, the currency markets are ironically imposing an unwanted common identity upon the ASEAN economies, all of which had long sought a positive international image.

There are important qualitative and quantitative differences in the financial situations of the ASEAN economies. Vietnam did not undertake the twin liberalizations before the crisis. Singapore has always maintained very tough currency controls on its own dollar and had implemented strong measures early to curb property lending. Brunei, whose currency is on par with the Singapore dollar, has significant international reserves. Despite some expansion of property lending in the Philippines, financial supervision has been of high quality, coming out of the banking crises of the 1970s and 1980s. Indonesia has had its share of bank failures and insider lending, which have been dealt with quickly. Quantitatively, the extent of expansion and diversification in the Indonesian financial sector pales in comparison with that in Thailand. As in Indonesia, large business groupings dominate the private sector in Malaysia. But Malaysia had been quite successful in limiting the dependence of the growth in domestic lending on short-term flows in the two years preceding the crisis and was generally expected to be the most immune from currency attack. In the year before the crisis, the Malaysian ringgit was commonly considered to be undervalued in the context of strong international investment interest.

Eight weeks after the crisis began, Southeast Asian currencies and asset markets continued to experience weaknesses. Malaysian prime minister Mahathir Mohamad's testy denunciations of the inordinate power of private currency markets to set countries' exchange rates, the most important price for any internationally open economy, raised fears about the reinstatement of curbs on currency trading and provoked further investment withdrawals. It is a measure of the enforced common identity that when the Malaysian ringgit experienced a currency attack, the stock markets and currencies of the economies considered to be weakerñthe Philippine peso, the Indonesian rupiah, and the Thai bahtñalso came under attack. It is also a measure of the fickleness of these markets that official pronouncements to the media, which even in normal situations are susceptible to misquotation or the faulty transmission of context, have such an enormous impact on exchange rates.

The continuing devaluations threaten to spawn a second round of crisis. Weaker currencies mean that more domestic income has to be devoted to service the same amount of external debt; this, by itself, weakens banking portfolios, which are already under a cloud of uncertainty. In September 1997 Hong Kong hosted the joint annual meeting of the World Bank and the International Monetary Fund (IMF), a meeting that was supposed to celebrate Asia's growth and success in the context of its recent liberalization efforts. Instead, the meeting came to be dominated by soul-searching over financial liberalization. Calls to set up a $100 billion Asian fund to respond to such crises became a prominent nonagenda item of the meeting. Such measures have to be considered in the context of heading off a second round of domestic banking crises, such as those that can be sparked by the too rapid fall in the country's exchange rate.
The modalities of such a currency stabilization fund, however, for the original crisis would have been questionable, since in that case resources would have been squandered to sustain an unsound financial system in Thailand; only a strict reform program would have justified the use of such a fund. In fact, Thailand itself drew down its own reserves and borrowed heavily in an initial futile attempt to defend the baht.

The Underpricing of
Southeast Asia

If, as many believe, Southeast Asian currency values have overadjusted downward, it is only another indicator of the extent to which Southeast Asian economic prospects are being undervalued at the end of 1997. The elevated growth rates in the 8 to 12 percent range seen in Southeast Asia since the late 1980s are a thing of the past. The current economic turmoil reduces private investment demand and forces governments to announce cutbacks in their own investment intentions. This will translate to losses in economic growth rates of 1 to 2 percentage points in the coming year. As had happened during the debt crisis of the 1980s, these investment reductions also have the potential of inducing a boomerang effect of reducing exports of investment goods by the United States and other industrial economies.

In the case of Thailand, investment cannot restart until an approach for resolving the noncollectible loans overhang is in place. This process shares the same kind of complications as Japan's asset bubble or the savings-and-loan collapse in the United States. It will take Thailand at least two years to recover normal rates of growth, which is the amount of time needed to clean out the bad loans and restore confidence in the banking system, even though it is unlikely Thailand will experience negative rates of growth.

It would have been foolhardy, however, to have believed that the elevated growth rates in the last half decade were a permanent feature of Southeast Asian economies. As earlier stated, the production relocations from Japan and the newly industrialized Asian economies from the late 1980s responded to currency realignments and would end when most of the labor-intensive operations in these economies had relocated. The double-digit export growth rates of the early 1990s certainly owe a lot to these relocations. In the 1990s savings assets from the industrial economies financed portfolio flows into the region. There would have been a stock adjustment as financial paper from the region became part of asset portfolios, then the volume of the new inflows would have abated. The tragedy is that these portfolio investments have now withdrawn in a routñor, perhaps, in recrimination. The Southeast Asian currencies, after all, disappointed portfolio investors by failing to maintain stable values, but then this happened mostly as a result of the panicky withdrawal by these portfolio investors themselves, who threaten to come back later to inflict unsustainable currency appreciation again.

The Southeast Asian economies might have maintained these elevated rates if they had upgraded their technological capacities in time. This would have meant shedding labor-intensive export sectors and increasing the weight of more advanced industrial production in the economy. But, within a time frame of a little over five years, this would have been feasible only for economies that had been previously industrialized. Moreover, as labor shortages begin to appear and real wages increase, overall economic growth rates will moderate.

A return to normal growth rates in the 5 to 7 percent range would still be the envy of both developing and developed economies. The situation of the Southeast Asian economies before the crisis, the opportunities provided by the crisis itself, and factors external to the region all indicate a rapid return to the development process, unless the currency turmoil turns into a self-fulfilling process. Here are a few reasons for optimism.

High savings rates and robust public finances. In the 1990s Singapore's gross national savings rate has hovered at 49 percent of GDP, Thailand's and Malaysia's from 35 to 38 percent, and Indonesia's at over 30 percent. The Philippines at 20 percent of GDP and Vietnam at 18 percent had lower savings rates, but even these levels would be considered respectable among developing economies.

In the years before the crisis, Southeast Asian economies' public finances were extremely healthy. Troubled Thailand ran eight consecutive years of government surpluses, on the order of 2 to 3 percent of GDP, except during the export slump of 1996, when the government budget surplus fell to 1 percent. Since the 1970s, Indonesia's budgetary system has ensured a balanced budget, with explicit coordination with external donors in identifying financing for government investment projects. The Philippines and Vietnam had been strengthening their fiscal systems. The Philippines basically balanced budgets in the last three years, and Vietnam's central government budget deficit has shown a declining trend to about 1 percent of GDP in 1996. In Vietnam state enterprise subsidies from the budget drastically fell from 7.9 to 0.5 percent of GDP between 1987 and 1994.

What the robustness of savings rates and fiscal finances means at the current juncture is that, barring further gratuitous depredations from the private currency markets, these economies have strong domestic resources to address weaknesses in their financial systems. (The typical situation in developing economies is that banking crises occur along with weakened government fiscal finances, which necessitates even more external financing to address banking asset write-downs.)

The question therefore is not one of insufficient resources but whether each of the affected economies can launch programs, even if only to diminish the haze clouding international perceptions, to repair weaknesses in their banking systems. Such reforms are difficult to implement because they require the rapid recognition of potential banking losses, which involves questions of judgment, valuation, and public authorities' supervisory capacity and access to information from the private sector. The implementation of these programs almost always has a political edge as well, since key players in the financial system are normally politically prominent. The point bears repeating, however, that the financial weaknesses in the Southeast Asian economies, possibly including Thailand and Indonesia, cannot be presumed to be any more serious than those of most other developing or transitional countries.

One tragedy of the situation is that Thailand must now show an even more healthy fiscal standing, despite its sound situation before the crisis and the unmet demands for public financing in infrastructure and education. The phenomenon of excessive borrowing before the crisis came only from the private sector; the Thai public sector had been running budget surpluses before the crisis. Another misfortune is that in order to maintain confidence in the currency markets, Southeast Asian governments are delaying or cutting back on their investment projects, with an implicit objective of attaining current account deficits on the order of 3 percent of GDP. Because of the region's established export industries, the higher-than-world-average growth of its productivity, and its relative success in attracting more stable inflows of direct foreign investment, current account deficits higher than 3 percent (a developing country benchmark) can be sustainable in the region. It appears, however, that currency markets, whose players seem to be just as laggard in doing their homework during the currency crisis as before, will continue to try to force down Southeast Asian currency values if they maintain higher-than-benchmark current account deficits. Each of the Southeast Asian economies demonstrated during their individual crises in the 1980s the capacity to carry out drastic expenditure cutbacks and, unlike many other developing or transitional countries into which emerging funds have been rushing, can point to this track record.

Export competitiveness. It is a cliché that the Southeast Asian currencies have robust export sectors dominated by manufactured exports. Eighty percent of Singapore's exports are from the manufacturing sector, and the percentages are 76 percent for the Philippines, 73 percent for Thailand, 70 percent for Malaysia, and 53 percent for Indonesia.

In many Latin American economies currency devaluations tend to be offset by immediate wage adjustments and domestic inflation, inducing an increase in the price of exported goods to the point of offsetting the price advantage provided by the devaluation. Southeast Asian economies have managed to engineer devaluations that were not offset by domestic inflation, as they did in the 1980s during their economic difficulties, and by lowering their international prices they have improved the competitiveness of their exports. These export sectors are poised to respond to the currency devaluations of mid-1997. Thailand, the most troubled of the economies, is also blessed with an export-oriented agricultural sector, giving the currency adjustment the potential to actually improve rural incomes, alleviating the normally adverse distributional impact of a devaluation.

The currency devaluations will lower the international prices of ASEAN's manufactured exports, further strengthening many already internationally competitive export industries. It will also ease the pressure for these economies to upgrade their domestic manufacturing technology, since their existing exports can once again compete with those from China and India. If the currency flows do not reverse suddenly and cause currency appreciation, this should provide the ASEAN economies, notably Malaysia and Thailand, the breathing room to upgrade the skills of their domestic work force. The problem is that Thai resources for education will be severely restricted in the next few years as a result of the tight fiscal restraint that is the key component of its crisis response program.

Open external regimes. As mentioned earlier, except for Singapore, which has had an open trade regime since the early 1970s, the economies of the region have embarked on extensive liberalization of their trade regimes since the mid-1980s. Early programs involved dismantling quantitative import restrictions, reducing maximum tariff rates, and consolidating the number of applicable tariff rates into a few levels. Except for transitional economies (Laos, Myanmar, and Vietnam), the foreign investment regimes in the region have been liberalized, and most are based on an exception list. While there are no new indications of a fresh direct investment spurt into the ASEAN economies, the currency devaluations have restored the attractiveness of the region as a location for direct foreign investment for enterprises from Japan and the newly industrialized Asian economies.

The establishment of the ASEAN Free Trade Area in 1993 signaled that trade liberalization would be a constant agenda item in years to come. AFTA originally provided for the removal of tariffs and nontariff barriers in 15 years; the time frame was shortened to 10 years in 1994. Product coverage has also been extended to include most unprocessed agricultural products. For long-term international investors AFTA can represent a single investment area, with ASEAN's development diversity as the means by which different parts of the production process can be located where costs are most competitive.

Intra-ASEAN trade represents only about 22 percent of the ASEAN countries' trade. Such trade used to be dominated by petroleum products but has decisively shifted to manufactured goods, particularly in the electrical and electronics industries. In 1980, for example, energy products accounted for 33.6 percent of Malaysia's exports to ASEAN; by 1990, this proportion had dropped to 11.1 percent. Between 1980 and 1994 the proportion of Malaysia's imports from Thailand consisting of electrical machinery increased from 8.1 percent to 25.2 percent, while exports also increased from 6.1 percent to 15.1 percent. Philippine exports of electrical machinery to ASEAN increased from 2.9 percent of total exports in 1980 to 19.0 percent in 1994; imports rose from 2.0 to 8.8 percent. Singapore's imports from ASEAN of electrical machinery constituted 11.2 percent of its imports in 1980; by 1994, this had increased to 39.4 percent.

In July 1995 Vietnam joined ASEAN, with much trepidation on all sides about whether Vietnam's socialist trade regime could adjust rapidly enough. In December 1995 Vietnam acceded to AFTA and provided a program of trade liberalization. Vietnam will have 10 years to reduce its tariffs to 0 to 5 percent, beginning on January 1, 1996, and ending on January 1, 2006. Vietnam implemented its first package, which included 857 tariff lines, for the tariff reduction scheme as scheduled in January 1996. If Vietnam is able to meet its targeted commitments, more than 92 percent of its tariff lines will be in the scheme by 2003.

In July 1997 Laos and Myanmar joined ASEAN. Myanmar is a longtime member of the WTO. Laos and Myanmar also will have 10 years to satisfy AFTA obligations and will begin their program on January 1, 1998, and conclude on January 1, 2008. Agreement has been reached on a slower pace of accession for these economies.

ASEAN has played and will continue to play an active role in international trade liberalization programs. ASEAN-member Indonesia chaired the 1994 meeting at which APEC declared its commitment to establish free trade in the Asia-Pacific. In 1996 Singapore hosted the first ministerial meeting of the WTO. At this meeting ASEAN joined the United States and other APEC members in obtaining the liberalization of international trade in computers and information technology as suggested by APEC during its annual meeting in Manila a few months earlier.

A healthy world economy. The expected reduction in growth rates in the Southeast Asian economies will reduce intraregional exports. However, the region's principal markets have always been outside the region. The world economy is not in a recession and not about to enter a slowdown. The Western economies and China are expected to remain robust markets (even while recent indications suggest an unexpected slowdown in Japanese growth).

In 1996 a worldwide slump in the electronics industry, mostly resulting from excess inventories in semiconductor products, hurt Southeast Asian economies. In the case of Thailand, this translated into a zero export growth rate in 1996, as even its other exports, such as garments, came under increasing competition from China, India, and other lower cost exporters. In 1994 and 1995, Thai merchandise exports grew at rates of 22 and 25 percent. The growth rate of Singapore's exports, which reached 25 and 22 percent in 1994 and 1995, fell to 7 percent in 1996. Malaysian exports grew by 23 and 26 percent in 1994 and 1995 and grew by only 4 percent in 1996. The world electronics markets have rebounded sharply, and the impact on the region's exports is evident in 1997 first semester results.

Key Economic Challenges

Underneath the cloud of uncertainty, there are strongly rooted structures that can ensure Southeast Asia's continued development success. Nevertheless, this survey suggests that there are specific challenges the economies of the region must face to sustain growth.
Recovery from the currency crisis. I have indicated that macroeconomic weakness is not at issue; it is the restoration of the soundness of domestic financial systems, especially in the eyes of foreign fund managers. The unwanted common identity of the region's economies can be addressed by volunteering more information about the state of the banking system and government investment projects and improving the transparency of stock markets and disclosure requirements.

Recent events suggest the indispensability of closer consultation among ASEAN countries. Efforts to deepen coordination efforts among the monetary and fiscal authorities in the region to respond to the 1997 crises and similar ones in the future are expected to accelerate. Prior private notice of intended drastic policy changes among central banks in the region seems to be critical. Increased frequency of meetings among central bank and treasury officials would establish the confidence to underpin these prior notice arrangements.

It is particularly important to avoid the exigency of competitive devaluations among the ASEAN countries. Efforts to increase information sharing among prudential and regulatory authorities in the region, particularly in order to minimize regulatory evasion, need to be supported. These efforts should involve the source countries, Japan and the United States in particular.

Thailand's recovery program will see the loss of jobs in the urban areas, especially in the sectors heavily dependent on imports and in the financial sector. The effort to stage an economic recovery takes place during a process of constitutional change, many elements of which hold the promise of enhancing government representation through electoral regulations, for example. The crisis has heightened public sensitivity over the economic rewards enjoyed by the politically connected during the growth years and strengthened the constituency in support of constitutional change. The conspicuous participation of businesspeople and professionals characterized late-October protests in Bangkok over the economic crisis. In early November the government of Prime Minister General Chavalit Yongchaiyudh resigned. The new prime minister, Mr. Chuan Leekpai, whose party coalition relies more heavily for political support on the urbanized areasñas opposed to the rural areas on which more traditional politicians had reliedñmust implement an austerity program at least as severe as that outlined under the previous government. The party comes into office with the image of a professional team to tackle the recovery program, with more popularity in the urban areas, which must bear the brunt of the economic adjustment.

Developing the "social-ware" for efficient private markets. As the Philippines, traditionally the most private economy in the region, has found time and again, liberalization and deregulation programs have treacherous waters to traverse in dealing with elite networks and politicized government policy. In both the transition of the former Soviet Union and the financial meltdown in Thailand, insider exploitation of the marketization process has been an important obstacle to the establishment of efficient markets. Economists often excuse policy failures of this type as cases of incomplete liberalization, but the problem is deeper than the issue of the speed and sequencing of reforms. It has to do with the creation of the information and accountability systems on which efficient private markets depend. To varying degrees, all Southeast Asian countries share these problems, but the Thai case provides the best illustration at this time.

First of all, the emergence of information-generating incentives, which are critical to well-functioning markets, is not guaranteed by government withdrawal from private markets. Thailand had a well-established tradition in conservative macroeconomic management and a relatively independent monetary authority that used to generate the required information for the macroeconomy. The deregulation process weakened these two traditions.

Professional civil servants joined the growing Thai private banking sector for better pay; well-known Thai technocrats also joined the boards of many of the prominent private financial firms. As in the transition economies, staff capacity in the government was declining just as there was a more complicated private sector to oversee prudentially. But more important, the overall stance of the government to encourage rapid diversification and growth in the financial sector, as the Mexican government did before the Mexican crisis, made strict oversight unfashionable, despite reports of debates among Thai monetary authorities about how to respond to overaggressive behavior (of some of their former colleagues) in the private sector. Therefore, information on which to sustain the traditional conservative macroeconomic stance and to supervise the banking system became unreliable and politicized as the liberalization process proceeded.

Second, there are rough waters to traverse in establishing economic and political accountability. Three years ago Thailand saw the first few financial companies running into difficulties. Economic accountability would have demanded the suspension of these companies. They were not only politically well connected, they counted well-respected professionals on their boards or among their staff. Deciding whether their difficulties were normal mistakes, acceptable parts of the financial development process, or egregious became a judgment call. The decision making was complicated by Asian styles of business that run counter to normal Western prudential approaches. Asia also has a tradition of family businesses, which can be problematic since, for example, relatives may borrow in their family's name, then divert loan proceeds to other parts of the family business. Rescuing the first few firms meant that authorities had to attempt to stand behind subsequent potential failures.

As has often been the case elsewhere, a political democratization process was taking place in Thailand in the same period as the deregulation and economic liberalization. Democratization creates policy debates and policy ambiguity, but this is the least worrisome aspect, even though it has delayed Thailand's ability to design a program in response to the crisis. The more important aspect is political accountability.
Economists presume that when political democratization is completed, political accountability will engender economic accountability. Even in fully democratized countries this is not necessarily the case; but if it were, what might be done until democratization is complete? In the Philippines changes in administration have typically meant that a new group of businesspeople could obtain special advantages from government programs. Coalition formation was a key element in the Thai democratization process. Opportunities to create new ventures in the private economy made possible by the liberalization programs had to accommodate all the members of the coalition. More frequent changes of administration in Thailand also mean space for more new players in the private economic sphere has to be provided. For these reasons the standards for entry into the Thai financial sector could not be raised too high.
Addressing the environment trade-off. Except for Singapore, which began addressing issues in its physical environment early, the Southeast Asian economies have tended to take a "frontier" view of their natural resources. (Although, in Malaysia, the Philippines, and Thailand in recent years local environmental groups have become active in resisting this view and defending natural assets directly connected to the livelihood of local communities.) Tropical timber has been a controversial issue for the region for a long time, but other environmental concerns, such as the management of shared fishing grounds and now airborne pollution, are only a few of the issues that will increasingly draw public and worldwide attention.

Environmental agencies in all the ASEAN governments have a high place in the governmental organizational structure but suffer from weak political support. Except for Vietnam, there has also been considerable modernization in environmental standards and regulations in the last ten years, partly supported by activities from the ASEAN secretariat. However, greater attention to the environment is costly to the region's governments in two ways. First, the costs of monitoring and enforcement in remote forest areas and over long coastlines and waterways is prohibitive, not to mention the cost of cleanup when environmental disaster occurs. Second, the political cost can be high; well-connected businesspeople exploit the environment, as in the case of forest burning for plantation clearing, not to mention the political and economic expedience of letting poor communities fend for themselves by using local natural resources. In each of the ASEAN countries the emergence of more active environmental policies waits for external pressures, as in the case of criticisms from abroad about tropical timber exports and internal pressures from local groups. The smog problem from the forest burning illustrates that some of these external pressures can come from other ASEAN members.

Addressing poverty and equity. Southeast Asia has an enviable record in poverty alleviation. In 1976 official Indonesian statistics indicated that 40.1 percent of the population fell below the poverty line; this had dropped steadily to 11.4 percent by 1996. Based on these numbers, the absolute number of people living in poverty in Indonesia declined from 54 million in 1976 to 23 million in 1996. These statistical approaches to measurement are controversial but standard nevertheless. Declines of slightly smaller proportions are evident in the other Southeast Asian economies, except for the Philippines, where the absolute number of people in poverty increased by 2.2 million since 1975.

However, in all of these economies, including the socialist ones, regional rates of growth are highly concentrated, and there are strong indications that income inequality has been increasing significantly. Malaysia, through its New Economic Policy, has a large targeted national anti-poverty program; but in recent years, income inequality measures for Malaysia have begun to increase.

Future growth in the region, including the socialist economies such as Vietnam, has the potential of permanently leaving behind some areas and some parts of the population. The countries of the region have neither extensive social welfare systems (and the ones in the socialist economies are being reformed) nor traditions in targeted anti-poverty programs. To avoid increasing the strain on the social fabric of these societies and ensure an orderly democratization process, Southeast Asian economies must increasingly be conscious about developing outlying areas, improving labor protection and labor rights, and addressing ethnic and gender inequalities. Except for the first item, these are rather new issues on the social agenda.

In Conclusion

Especially since the mid-1980s, the ASEAN economies have embraced and appear to have successfully exploited globalizing trends in production and finance. Their policies of trade and financial liberalization led to growth, the restructuring of their exports and manufacturing sectors, and the expansion of their banking systems. As a country grouping, ASEAN became diplomatically active in efforts to liberalize trade internationally and formed its own free trade area. With the accession of less internationally connected Vietnam, Laos, Myanmar, and, in intention, Cambodia, ASEAN expanded, confident that after a period of adjustment, these economies would partake of ASEAN's preferred international imageña grouping of globally competitive economies that have a significant influence on the world trading system. The spread of the instability in financial asset prices beyond the region is evidence of the international significance these economies have attained.

Among the members of ASEAN, the currency crisis and smog problem have created an awareness of common vulnerabilities in the areas of financial liberalization and the environment. In early November the central banks of Japan and Singapore collaborated in buying the Indonesian rupiah in order to boost its international value to levels they considered to be more consistent with the nation's export capability and to prevent the further weakening of Indonesia's domestic banking system. The intense efforts of Asian governments, including those of ASEAN and Japan, to create joint institutions for responding to currency attacks as well as the possible creation of an Asian fund suggest that lessons concerning the instability of portfolio financing are being learned quickly. At this writing, news reports hint that such a collaborative venture might be announced as early as mid-December 1997. There are also signs that the IMF has adopted a more open attitude toward the issues that had been raised principally by Malaysia regarding the instability of international currency markets and that ASEAN will be consulted in discussions about improving international institutions, which might reduce the volatility of these markets.

In the aftermath of the forest burning experience, it will be considerably easier for parties inside and outside ASEAN to raise common environmental and resource-use problems. Nevertheless, the region remains a conspicuous exporter of tropical wood, and it remains to be seen whether heightened environmental awareness will affect the rate of forest harvesting or enhance more sustainable forest use.

With the currency devaluations, the economies of ASEAN have actually strengthened their already considerable export competitiveness. Recent events also highlight the policy responses that ASEAN governments have initiated in response to the crisis, which will reduce their vulnerability to volatile capital flows. Except for Thailand, which will have to complete the workout of bad loans in its banking system, and as long the world economy does not tip into a recession (something that can be triggered by the currency crisis that has spread beyond the region), most of the ASEAN economies, chastened and more sensitive to sources of international instability, are poised for a return to their development process.