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– E X T R A C T –

Southeast Asia: One year after the Outbreak of the Financial Crisis, and Policy Implications for the United States

by David G. Brown

Through the courtesy of the Asia Program of the Woodrow Wilson International Center for Scholars and Amb. Ron Palmer, we present in this issue excerpts from the Center’s report dated November 1998. Following are the executive summary, introduction, and an overview account of a discussion session that took place at Washington, DC, earlier that year. At the end of this extract, we provide information about the author and the composition of the Southeast Asia Working Group.~ Ed.

In the summer of 1998, the Asia Program of the Woodrow Wilson International Center for Scholars organized a group of distinguished scholars, analysts, diplomats, and government and business representatives to form a “Wilson Center Working Group on Southeast Asia.” The working group met four times to discuss the financial crisis in Asia and policy implications for the United States. Ambassador Ronald D.F. Palmer, former U.S. ambassador to Mauritius (1986-1989), Malaysia (1981-1983), and Togo (1976-1978) and currently a professor of the practice of international affairs at the Elliott School of International Affairs of George Washington University, was invited to organize the working group with Li Zhao, program associate for Asia of the Center.

The Woodrow Wilson Center was created by Congress as a living memorial to honor Wilson’s accomplishments as the 28th President of the United States. Since the Center’s earliest days, its hallmarks have been scrupulous nonpartisanship, an abiding belief in the unity of knowledge, an emphasis on historical and comparative approaches to public affairs, and a commitment to building a bridge between scholarship and public policy.

This report, written by David G. Brown, was produced based on the discussions. Views expressed in the report are those of the working group participants and do not necessarily reflect the views of the Center.

Having fought two wars in Southeast Asia in recent history, the United States now has a large stake in preserving the stability and prosperity that the region has enjoyed in the past twenty years.

Before the financial crisis, the countries of ASEAN were the fourth largest and fastest growing market for U.S. exports. Contributing wisely to financial reform and economic recovery in Southeast Asia will benefit American jobs and exports.

The countries of ASEAN, with 450 million people, straddle the sea routes linking East Asia and the Middle East, which are important to America’s strategic and commercial interests.

The financial crisis threatens the regions gradual progress toward democracy, challenging young democracies while generating pressures for change in authoritarian regimes. America has a large stake too in assisting democratic forces weather the economic crisis.

Southeast Asians are looking to America for leadership, which others can not provide.

The U.S. response to ASEAN’s crisis has not, however, been commensurate with our interests and is not seen as adequate by Asians.

U.S. policy has emphasized internal financial reform. A broader policy is needed, one that better embodies America’s concern and compassion and that advances global financial reform.

President Clinton’s September 14 speech outlining a comprehensive strategy on the now global financial crisis contains proposals for debt relief and social safety nets that are specifically directed at Southeast Asia’s problems.

The crucial challenge is for the U.S. to play a leading role in restoring the flow of private funds to Southeast Asia so that debt-burdened companies and economies can resume growth.

There is a critical need for greater American humanitarian assistance to Indonesia.

The Treasury Department has played too prominent a role in U.S. policy formation. Given the broad interests at stake, the Secretary of State should be visibly involved in defining and implementing U.S. policy. The Secretary should visit the most affected countries. In a time of trial, it is important, as Secretary of Defense Cohen has said, that the U.S. be actively engaged to demonstrate that it is not just a fair weather friend to ASEAN.

Introduction 1997-1998: Southeast Asia’s Annus Horribulus

Queen Elizabeth II called 1992 an annus horribulus—a horrible year. The past year in Southeast Asia also merits that description.

The collapse of the Thai currency in June 1997 set loose tectonic forces that have shaken the political and economic foundations of both Malaysia and Indonesia. Singapore, Hong Kong, Beijing and Tokyo have been buffeted also. These events pose daunting challenges for the United States and raise six questions.

1. What caused the miraculous Southeast Asian model to flounder?

Thailand’s case showed the surge of capital into that country after the Cold War overcame the absorptive capacity of local banking and financial institutions. Crony capitalism directed the money of over-eager foreign investors into empty enterprises that lacked transparency. Money flooded the private sector. Regulations and regulators could not cope with the situation. Political paralysis set in. The economy spun out of control, attracting the attention of the currency speculators.

Thailand sought to defend the baht and failed. IMF help was solicited and obtained, as was US assistance. Subsequently, Thailand has fought valiantly to regain financial stability. Moreover, Thailand has made a positive reform-oriented political response to its problems. The Thai promulgated a new constitution. The military went back to its barracks. Prime Minister Chuan Leekpai was returned to power with a reformist mandate. With difficulty, he still leads Thailand a year later. Thailand is clearly engaged in meeting its problems head-on. The process will not be easy or quick but Thailand has demonstrated commendable political will and economic determination and the Kingdom appears on its painful way to recovery.

2. Are existing political structures inadequate to deal with the rapid changes caused by globalization?

The Thai example indicates that efforts to reform political structures can be effective.

Indonesia continues to confront political changes that have wrenched President Suharto from power and have weakened the role of the Army in the political system.

The Habibie Government and perhaps the entire regime suffer a lack of legitimacy and the upcoming May 1999 Indonesian parliamentary elections seem unlikely to provide either necessary legitimacy or stability. Meanwhile, rioting is spreading.

Malaysia has defiantly resisted political change, 73-year old Prime Minister Mahathir has fired Deputy Prime Minister Anwar Ibrahim, the third Deputy in his 17-year rule, and is seeking to shield Malaysia from the effects of the globalized economy. The Mahathir effort seems designed to hold the present political structure of crony capitalism in place. The success of this strategy cannot be predicted. Political volatility in Malaysia may grow.

3. What is the feasibility of achieving greater transparency and better regulation of domestic banking and other financial institutions?

The present unsettled situation in Southeast Asia makes achievement of these goals difficult to attain.

4. What are the implications of events in Indonesia and Thailand? What effects are they likely to have on other ASEAN countries?

These events open at least two lines of possibilities. One is that the others may follow the path Thailand is marking out. That does not seem to be a likely short-term prospect.

Another possibility is that financial and political disorder in Indonesia may spread and even affect its national unity. A disordered, possibly anarchic, Indonesia would pose serious problems for its neighbors.

5. What future changes will be necessary to deal with the types of weaknesses that have been revealed in the political economy of Southeast Asia?

The question of future changes in the Southeast Asian political economy presupposes that the present crisis in Indonesia, Thailand and Malaysia will be relatively short-lived. However, these economies are contracting and in recession. They face grave problems of recapitalization and mounting unemployment. These problems will have to be overcome to regain economic momentum and growth. This will not be a quick or orderly process.

Malaysia presents an interesting challenge to conventional thinking. Mahathir has denounced the free market and free market ideology, imposed capitol controls and opted out of the international economy. These moves have drawn sympathetic comments by some Southeast Asian leaders. What is the future of the free market in Asia?

6. What are the implications for US policy of Southeast Asian developments?

There are, indeed, problems in Southeast Asia but the extraordinary people of one of the most dynamic regions in the world can solve these problems. They will need the help of their American partner in doing so.

We are witnessing a time of change, a period of historic evolution, which will be a key epoch in the defense and promotion of US interests in 21st century Asia. This passage into uncharted post-Cold War waters will be one of the most important tests of the capabilities of the present generation of US policy makers. They will need the help and support of all who care about Asia.

Ronald D.F. Palmer
Professor of the Practice of International Affairs
George Washington University

Session One: An overview of U.S.-Southeast Asia Relations, June 26, 1998

Panelists: David Denoon, Alan Tonelson
Moderator: Ronald D.F. Palmer

The purpose of our discussions will be to look at developments in Southeast Asia in order to draw appropriate lessons for making recommendations for future U.S. policy.

What will be the long-term effects of this financial and strategic crisis? What impact, if any, will it have on the balance of power in Asia? What role should the U.S. play in pursuing its own interests while seeking to foster stability?

Several trends seem apparent in contemporary Southeast Asia. ASEAN=s confidence has been shaken and its doctrine of non-intervention is being questioned. There is strong support for economic and political reform at present. China’s role in the financial crisis is being praised; Japan’s role is criticized. The U.S. is seen as arrogant and only partially involved. Nevertheless, the crisis has highlighted the crucial role of the U.S. The U.S., however, will have to exercise deft diplomacy.

The key challenges relate to the long-term recovery of the Southeast Asian economies. Before addressing them, we need to understand what has happened.

Looking back, there were three problems common to the countries most seriously affected by the crisisKorea, Thailand and Indonesia. First, financial liberalization came before domestic banks were well capitalized and a sound regulatory regime was in place. The U.S. and IMF had been pushing financial sector liberalization too hard. Second, government subsidies and favoritism combined with a massive inflow of foreign capital distorted their financial systems. The problem was not bad macro-economic policy, but massive private foreign short-term debt. Third, extremely weak accounting standards and lax rules on corporate management produced inadequate and misleading financial information.

Seven factors will shape the prospects for long term recovery of each economy: their relative strategic importance, the political environment, the condition of their banking system, macro-economic policies, the adaptability of labor, the speed of resource reallocation and their relative openness to foreign investment. These factors are not easily influenced by U.S. policy.

Indonesia will get more attention because it is more important strategically than Thailand. While the Thai political environment is relatively stable, political instability is a major impediment to recovery in Indonesia. Efficiency in resource reallocation and openness to investment will be the most important variables that the countries themselves can control. Thailand is in a better situation on both than Indonesia. While Thailand is quite open to investment, the serious problems confronting Thai firms inhibit investors.

What are the strategic implications of the financial crisis? If China can avoid an economic crash, its absolute and relative influence will increase. If Japan remains stagnant or in recession, its relative power will decline vis-a-vis all its neighbors. Such a shift in regional roles will strain ASEAN, with Thailand drawn to China while other ASEAN members will be increasingly concerned about Chinese influence. Potential splits within ASEAN could have important long-term strategic implications.

The conventional wisdom is that the causes of the Asian crisis were financial and that, therefore, the solutions should be financial. This is reflected in the IMF’s prescriptions and in U.S. policy. However, the Asian problems are really a sign of serious and unsustainable imbalances in the global trading system. It is vitally important to the United States and the rest of the world that these imbalances be redressed.

Southeast Asia is a major factor in the global imbalances because it produces and exports far more than it imports. With their colonial memories still fresh, Southeast Asian governments have not been willing to let market forces alone determine patterns of trade. Believing in export-led growth, Southeast Asian leaders have promoted investment and restrained domestic consumption. The resulting excess capacity in key industries especially electronicscontributed significantly to the economic crisis.

As Japan and China are relatively closed and export-oriented as well, they do not serve as significant customers for Southeast Asia. Consequently, the regionlike many othershas become overly dependent on the U.S. market. This harms American workers though not necessarily multinational companies. Just as important, it results in ever higher U.S. trade deficits and mounting pressure on the dollar that creates dangerous problems for its role as the major international currency.

All else being equal, recovery from the crisis will further intensify competition for the American market, though this has been slow to develop because of trade finance problems. The IMF strategy, which focuses on financial issues and envisages an export-led recovery, can only restore the unsustainable pattern of trade imbalances. A more comprehensive policy is needed.

In the security field, the Administration says the aim of U.S. policy is to preserve stability in Southeast Asia. The crisis reveals that U.S. policy has been inadequate. Maintaining 100,000 forward-deployed troops is irrelevant to many of the biggest sources of instability in the region, which are economic, social and political.

Because of the crisis, Southeast Asia is becoming a smaller market for U.S. exports of finished goods and hence less important for the U.S. strategically as well. The U.S. approach to the region needs to adjust to this change and focus on the principal American interest that should be maximizing the benefits from doing business at Southeast Asia’s natural level of economic activity, not artificially inflating this level.

Discussion: Is Southeast Asia Important?

Southeast Asia is important to the U.S. for a variety of reasons, not just as a market for American products. Despite its economic problems, the region will not be less important for the U.S. militarily, strategically or diplomatically. Asserting that the U.S. need not remain involved would imply a willingness to see Southeast Asia become a Chinese sphere of influence, which would not be in the U.S. interest.

Trade and American Workers
Trade is not a win-lose proposition and is more complicated than just the impact of imports on jobs. The U.S. economy and American workers have benefited immensely from the expansion of trade, including that with Southeast Asia. It is not just that our economy is doing well now, standards of living in the U.S. have risen substantially over the years. Our economic policy should seek mutually beneficial win-win outcomes.

Win-win solutions are not always possible. Southeast Asia’s over capacity problems are a case in point. The U.S. government is not paying enough attention to this issue. Economics tells us that eventually markets will clear this over-capacity, but it is important whose industries survive. Southeast Asian governments will not leave the outcome to the markets to decide. The lack of a U.S. policy on this issue is dangerous.

While the economy has done well, the benefits to American workers are questionable. Over the past 25 years, the average real wages of American workers have declined.

China’s Future Role
Assessing the relative roles of China and Japan correctly is crucial. Chinese leaders have a clear long-term strategy for enhancing China’s influence and have had remarkable success in pursuing it in recent years.

Nevertheless, it would be wrong just to assume a straight-line development for China. Ten years ago, the Japanese economy was seen mistakenly as an unstoppable juggernaut; now many view China in the same way. However, the Chinese economy is facing daunting challenges in restructuring state-owned enterprises and dealing with the problems in its financial system, which are greater than those faced by other Asian countries. Unemployment is a growing problem that could have disruptive social and political implications. That said, the dangers of an economic crash are less in a relatively closed economy. It seems more likely that China will be able to avoid a financial crisis and continue to grow.

The impact of China on Southeast Asia is complex. China and Southeast Asia compete in export markets. China’s growth will elicit contradictory responses in Southeast Asia, where attitudes toward China are very ambivalent. Each of the major powers is changing as we move into the 21st century, and the way China changes will have important implications.

China in Burma
Southwestern China in particular looks southward for opportunities in Southeast Asia. Chinese influence in Burma is substantial. Immigrants from China’s Yunnan province constitute roughly 20 percent of the population of Mandalay. India is concerned that the Chinese presence in Burma threatens its interests in Northeastern India and in the Indian Ocean.

There were several reasons why ASEAN brought Burma into its membership. A primary one was to counterbalance Chinese influence that several ASEAN states saw as contrary to their interests.

Impact of Domestic Politics
Political factors have had a significant impact on the way countries in Southeast Asia have responded to the financial crisis. The impact of politics is most obvious in Indonesia. The political transition in Indonesia is far from over and political uncertainty will continue to have a major influence on investor confidence in Indonesia.

However, it is wrong to think political problems are confined to Indonesia. The financial crisis has increased tensions between Malaysian political leaders. The political situation in Burma remains unresolved. If Thailand encounters new problems in the course of its recovery, political problems could resurface there. There are hints of new political pressures in Brunei.

In Indonesia, the opposition has attractive personalities, but it has no leader and no practical program. Political problems will continue to affect Indonesia’s recovery. As long as Indonesia is weak, ASEAN will be weak.

Financial Liberalization
The point that trade liberalization occurred before banks were well capitalized and regulatory regimes were adequate is particularly important. Banks and financial systems are weak everywhere in the developed world.

The lesson should be for the U.S. to reduce the pressures for early financial sector liberalization. However, this is not occurring. For example, USTR believes that China has concluded that it must complete financial sector reform before further liberalizing. Nevertheless, in our WTO negotiations with China, USTR continues to press for financial liberalization.

Who is Following the Japanese Model?
It is mistaken to state that the countries of East or Southeast Asia are following the Japanese model for economic development. The only country that has closely followed Japan is South Korea. The influence of family-based businesses among overseas Chinese is strong throughout Southeast Asia. Although Malaysia has looked toward Japan, it relies heavily on foreign direct investment that is inconsistent with Japan’s practice.

Limits on Governmental Action
Governments have been frustrated in their ability to deal effectively with the Asian financial crisis. This has been so for the governments directly affected, for outside players such as the U.S. government and for the IMF and World Bank. Non-state actors – global markets, international investors, and domestic firms – have had a decisive influence on the course of events. In this sense, the Asian financial crisis is representative of the new challenges to foreign policy at the end of this millennium.

This frustration has provoked some popular as well as governmental resentment in the region, which is part of the broader anxiety about globalization. The resentment has been aimed in part at the United States.

The role of markets is a global phenomenon that cannot be addressed in a sub-regional Southeast Asian context. The policy implications include the need to strengthen the IMF, improve international standards and consider the need for new institutions.

The American Role and U.S. Policy
An argument was advanced that the fundamentals of U.S. policy toward the region should be re-examined and that the U.S. need not play a leading role in order to obtain the economic benefits, which are the most important U.S. interest in the region.

The majority view was that the U.S. has important strategic, diplomatic, economic and other interests that require an active leadership role by the U.S. In addition, our historical role in decolonialization and our support for national development and the region’s efforts to define its own constructive role in the world are major assets upon which the U.S. should build. The U.S. will suffer if it does not recognize its ability to assist the region to operate independently, free of unwarranted Chinese or Japanese influence.

The making of U.S. policy toward the region has become increasingly complex as more actors enter the policy debate, many representing particular interests such as labor, the environment and human rights. American business is an important element in the U.S. role in the region. However, by its nature, the American business community does not have a coordinated approach to its own role.

The Administration and Congress have difficulty focusing on more than one policy issue at a time. For example, when the President was preparing for his China trip, little attention could be directed to Southeast Asia. These are practical constraints on formulating policy toward Southeast Asia.

In responding to the Asian financial crisis, the U.S. has relied too heavily on economic officials. The problems and their solutions are more complex and include social and political factors.

Humanitarian considerations have become important and will need to be a major focus of U.S. policy in the near term. This is the case now in Indonesia where inflation is pricing daily necessities beyond the means of growing segments of the population. A need for humanitarian assistance may also develop in the Philippines and Thailand.  

About the Southeast Asia Working Group

Organizers of the Working Group:
Li Zhao, Woodrow Wilson International Center for Scholars
Ronald D.F. Palmer, George Washington University

Participants in the Working Group:
William Becker, George Washington University
Judith Bird, US Department of State
Aurelia Brazael, US Department of State
Lyall Breckon, Center for Naval Analyses
John Bresnan, East Asian Institute, Columbia University
David Brown, Asia Pacific Policy Center
Fred Brown, Foreign Policy Institute, SAIS, Johns Hopkins University
Paula Causey, US Department of State
James Clad, Georgetown University
Warren I. Cohen, Woodrow Wilson International Center for Scholars
Donald Crone, Scripps College
Catharin Dalpino, the Brookings Institution
David Denoon, New York University
Thomas Fingar, U.S. Department of State
Larry Hoffman, U.S. Department of State
Karl Jackson, Global Alliances
Joel Kuipers, George Washington University
Robert Manning, Council on Foreign Relations
Edward Masters, US-Indonesia Society
Marvin Ott, National War College
Doug Paal, Asia Pacific Policy Center
Nitya Pibulsonggram, the Royal Thai Embassy
Stanley Roth, U.S. Department of State
Michael Samuels, Samuels International Associates
Adam Schwarz, Council on Foreign Relations
Sheldon W. Simon, Arizona State University
David Steinberg, School of Foreign Service, Georgetown University
Paul Taylor, Smithsonian Institution
Alan Tonelson, USBIC Educational Foundation
Danny Unger, Georgetown University


David G. Brown is a senior associate at the Asia Pacific Policy Center, a non-profit institution in Washington, DC. Mr. Brown had a thirty-year career with the U.S. Department of State before joining the Asia Pacific Policy Center in October 1996. His government career focused on Asia and included assignments to Tokyo, Beijing, Taipei, Hong Kong, Vietnam, Vienna and Oslo.

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