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GB.274/4/1
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FOURTH ITEM ON THE AGENDA
The ILO's response to the financial crisis in
East and South-East Asia
The Asian Financial Crisis: The challenge for social policy: (1)
Executive summary
1. Grave anxiety has prevailed in global financial markets since the onset of the Asian economic collapse in July 1997, when the contagious effects of a currency crisis in Thailand soon spread to Indonesia, Malaysia and the Philippines and by October 1997 had reached the Republic of Korea and Hong Kong, China. Precipitous currency devaluations of up to 80 per cent and falls in equity and asset prices caused a sharp drop in output, consumption and average incomes. The enormity of the financial shock is captured by the fact that by the end of 1998 real GDP in Indonesia had declined by 15 per cent, in Thailand by 6.5 per cent, in the Republic of Korea by 5 per cent and in both Malaysia and Hong Kong, China by 3-4 per cent. Growth forecasts in Japan, Singapore, the Philippines and Viet Nam have been revised sharply downwards.
2. How did a financial collapse of this severity occur after decades of outstanding economic performance? Post-crisis analysis has generated a variety of explanations. In reviewing these, the book rejects the widely held notion that panic on the part of international investors was the prime cause; it cites other essential elements at fault (including volatile international capital markets, weak corporate governance and domestic policy failures); and it lays most blame on the financial system itself as the real Achilles heel of the pre-crisis Asian economies.
3. There is little doubt that crony capitalism played a role in provoking the crisis, but the stage was shared by a large cast of causes and effects. These included --
- excessive government interference in the market, especially by influencing factors such as the allocation of credit and capital and the creation of monopolies;
- poor economic policies, notably by building up an excessive reliance on foreign borrowing, thus generating excessively high levels of investment and growth and unsustainable current account imbalances;
- shortcomings in mitigating the impact of the huge surge in capital inflows;
- failure to ensure that financial liberalization was accompanied by a sound financial system, which led to a proliferation of over-leveraged, unhedged, short-term borrowing;
- inadequate regulation of the banking system, combined with a lack of transparency in the operations and soundness of banks.
These defects led to a whole series of domestic policy lapses and, in the wake of the Thai currency crisis, a catastrophic loss of market confidence. Although policy lapses differed widely from country to country, their effect was the same: they fuelled the drastic loss of investor confidence that engulfed an entire region of the world in a surprisingly short time. In analysing the causes of the current predicament, the book argues that the relative neglect of basic labour rights contributed to a lack of transparency in economic policies that largely provoked the crisis. This deficiency was also at the root of the underdevelopment of systems of social protection.
4. With respect to the macroeconomic policy response to the crisis, the book reserves judgement on whether originality or orthodoxy should prevail in monetary and fiscal policy, arguing only for a high input of flexibility in policy implementation when professional opinion is either seriously divided or undecided. It cites the Malaysian decision at the beginning of September 1998 to cut loose from IMF orthodoxy on high interest rates as an interesting effort to halt the economic contraction of the country at the beginning of the same year. Malaysia is engaged in a real-world experiment with an alternative set of policies to those which, until late 1998, did not seem to have succeeded in stemming the crisis. However, it is still too early to gauge what effect this move will have. To avoid the possible immobility of a policy stalemate, the book urges pragmatism and close monitoring of the unfolding effects of current policies and a willingness to change course when warranted.
5. Social fallout from the sudden unravelling of the economies of South-East and East Asia is exceeding initial forecasts and risks dramatically worsening. The figures speak for themselves. In Indonesia, one in every five formal-sector jobs was terminated in 1998, shattering decades of progress and leaving 5 million workers with bleak future prospects. In the Republic of Korea, one in 20 workers has been retrenched and open unemployment has increased from 2.3 to 8.2 per cent. In Thailand, open unemployment levels tripled from 2 to 6 per cent. In Malaysia, unemployment levels were expected to double to 5.2 per cent, and in Hong Kong, China in the first three quarters of 1998, unemployment rose from 2 per cent to over 5 per cent -- an estimated 75,000 redundancies. Across the board, mass job losses have reversed the impressive pre-crisis trends in poverty reduction achieved in the economic-miracle years.
6. Adverse developments of this magnitude constitute a substantial shock to any social system, but their effects are amplified in the crisis-affected countries by the absence of a social safety net. In particular, the absence of employment benefits has imposed uncalled for suffering and hardship on job losers and their families, who faced not only a loss of income but also work-related benefits such as health insurance. The harshness of the situation has been moderated somewhat since the early days of the crisis, but socially provided relief is still far short of requirements.
7. The book discusses the social relief strategies that have been adopted and the needs they address (health care, employment, schooling) and argues that the assistance they offer is too limited -- both for stricken recipients in the short term and for the longer term prospects of national economic recovery in these countries. The rise in poverty means damaging material deprivation and increased vulnerability to ill health. Private means to purchase and the public capacity to provide health services are declining sharply under the twin pressures of descending incomes and the spiralling costs of imported medical supplies. Apart from unemployment, the other major factor behind rising poverty is the fall in wages and incomes. Average earnings in the informal sector, already low to begin with, are depressed further by the huge influx of new workers and a decline in demand for the goods and services produced. High inflation erodes these informal-sector earnings, along with the wages of all workers. Wages are unlikely to be protected against inflation because of the weakened bargaining position of labour in the current depressed economic conditions.
8. Initial IMF programmes in Indonesia, Thailand and the Republic of Korea called for fiscal tightening that allowed little room for increased social expenditure. Only the force of subsequent events -- the deeper than anticipated recession, swiftly mounting job losses, and accumulating indications of widespread social distress and unrest -- induced a change in policy. Fiscal targets were revised to allow room for increased social spending, a loosening also motivated by the need for fiscal stimuli to moderate the unexpected depth of contraction in the real economies of these countries (especially since monetary policy could not be eased within the initial macroeconomic framework agreed with the IMF).
9. The ultimate basis for salving current social wounds is economic growth, which means first restoring financial stability and international confidence. An immediate bounce back is highly unlikely, and whether or not economic growth will resume the heady levels of pre-crisis years is an open question.
10. The policy and institutional reforms required for economic recovery include technical measures to correct poor and opaque accounting, lax prudential supervision of banks and the absence of effective bankruptcy laws. Effective instruments are needed to control the degree of exposure to foreign debt by private economic agents, to set prudent limits for debt/equity ratios in the corporate sector and to discourage speculative and unproductive investment. This book cautions that no amount of tinkering with institutions and regulatory mechanisms will produce the desired results unless the contamination of market processes by politics is contained. Emphasis is placed on the need for these countries to rethink some of their standpoints. The strengthening of democratic institutions is central to the post-crisis economic model that is required. Free and fair electoral processes, freedom of expression and public debate, the rule of law, and accountability of elected officials are among the attributes of democracy that are essential to prevent the harmful distortion of market processes by arbitrary government intervention and corruption. The recent crisis underlines the considerable economic and social costs of such arbitrariness. The intrinsic value of democracy, the book observes, is strongly reinforced by socio-economic considerations. Thus, in the development process, it is crucial to foster a strong and free labour movement and to build a solid system of industrial relations.
11. Most of the crisis-affected countries have a relatively poor record here and some political leaders continue to doubt the value of freedom of association and the positive role that trade unions can play. The book stresses that freedom of association and the right to organize are key components of international action to promote democracy and full respect of basic human rights. It repudiates the argument of separate and distinct "Asian values" (which place communitarian values and social harmony above individual rights) on the grounds that there is no evidence that Asian thought and tradition have historically given less importance to civil and political freedoms; that it is difficult to identify values intrinsically common to the large and diverse continent of Asia; and that the case has been articulated by authoritarian regimes and does not therefore represent an expression of popular will. The best way to ensure that economic and social policies are equitable and provide adequate levels of labour and social protection is constant democratic pressure from workers' organizations.
12. The book argues that it would be foolhardy to ignore the lessons for social policy that the crisis has so painfully driven home. A fundamental rethinking on the social dimension of economic development is as important as the purely economic and financial issues that currently occupy centre stage in South-East and East Asia.
13. The book contends that Asia needs a new and better social contract. Just as the Great Depression forged a new social contract in many industrialized countries in the 1930s, so must the current Asian crisis serve as a springboard for the creation of a more socially oriented model for development.
14. Heading the list is unemployment insurance. In the Asian region, the introduction of unemployment insurance has repeatedly met with several objections, all of which the book refutes. In the media-designated "Asian Tiger" years, the rates of open unemployment in Thailand, the Republic of Korea, Malaysia, Singapore and Hong Kong, China were so low that they had rarely been seen elsewhere since the early 1970s. Unemployment insurance was dismissed as superfluous. Countries like Indonesia and Thailand, with large agricultural and informal sectors, maintained that these sectors could absorb any retrenched workers. Perhaps they could have, in the past, but the present extent of urban unemployment and rural poverty, and the modernization of agriculture, bear grim witness to the inadequacy of traditional safety nets.
15. Opposition to employment insurance is based on the grounds that its administration and fiscal costs are prohibitive for developing countries; that unemployment benefits risk eroding the Asian work ethic; that paying them lowers investment and raises the cost of labour. However, the facts are different. One of the many advantages of an unemployment benefit system is that it facilitates the process of industrial restructuring: the additional economic security it provides also reduces the resistance of workers to change. As for prohibitive costs, unemployment insurance (as its name implies) is self-financing, with schemes based on contributions from workers, from employers, or a combination of both. Fiscal costs to government need not arise unless it makes the choice to subsidize. Governments would need to intervene to establish a system of benefits to make coverage as broad as possible and to compensate for the almost total absence of private insurance. With minimal burdens on enterprise and the market, government-sponsored schemes could be self-financing. The book makes the point that at very modest levels of required contributions, the effects of unemployment insurance on labour costs and hence on demand for labour would be negligible. ILO assessments show that if Indonesia, the Republic of Korea and Thailand had introduced unemployment insurance in 1991, that is, six years before crisis onset, an average required contribution rate of between 0.3 to 0.4 per cent of payroll from 1991 to 2000 would have sufficed to provide all insured job losers over this period, including during the present crisis, with 12 months of benefits. According to this analysis, the potentially constructive role of unemployment insurance in the current reform process is so strong that it is puzzling why no country (with the exception of an initially rudimentary scheme in the Republic of Korea) has introduced any form of unemployment insurance. It is all the more puzzling in the case of Singapore and Hong Kong, China, where per capita GDP is higher than in many OECD countries.
Geneva, 21 January 1999.
1. The Asian Financial Crisis: The challenge for social policy, Eddy Lee, International Labour Office, Geneva, 1998.