Corruption: The Boom and Bust of East Asia

Corruption: The Boom and Bust of EastAsia Governance and corruption have finalJy come to the fore of the development debate. While interest in governance began to surge in the earl)' 1990s, the East Asian crisis has catapulted the issue to prominence. Analysts and academics. in a spate of anides and books, have added their voices to the chon.s of criticism of the so-called Asian miracle. Their verdict: Bad governance and corruption did the "miracle" countries in. Taking a different perspective. this book asks and attempts to answer how these countries were able

10

attract enormous amounts of

investment and enjoy rapid growth (lver a thirty-year period despite being perceived as hotbeds of corruption As convelllional wisdom would have it. high rates of investment are inconsistent with high levels of corruption. While this may be true in general. the chapters in this volume suggest that we need to look illlO the nature of corruption. Different types of corruption have varying effects On investment.

I. Edgardo Call1IJOS is senior economist in the Strategy Policy Depanment of the Asian Development Bank. I/a-/ooll Clumg is professor at the Faculty of Economics and Politics, Cambridge University. Emmalluel S. de Dios is professor in the School of Economics. University of the Philippines. Hadi Salehi Bfaltalli is professor in the Department of Economics. University of Illinois

at

Urbana-Champaign.

Allell Hickell is assistant professor at the Depanment of Political Science, University of Michigan. lie was previously assistant professor at the Gra(lllatc School of International Relations and Pacific Studies. Departmelll of Political Science, University of California at San Diego. lomo K. S. is professor in lhe Department of Applied Economics, University of Malaya. SI.llhe Li is associate professor in the Depanmelll of Economics and Finance. City University of Iiong Kong. Peng Ua/l is director of Stalistical Research and Analysis. Nllmetrics Management Systems. Santa Clara. California. DO/lflld Lien is professor of economics and finance at the Umvcrsity of Texas at San Antonio. AlLdrew Macilltyre is professor in the Graduate School of International Relations and Pacific Studies, Departmcnt of Political Science. University of California at San Diego. SalLjay PradlulII is senior governance advisor for the South Asia Region at the World Bank.

Ateneo de Manila University Press Kallpunan Avenue. Loyola His Q.C. P.O. Box 154, 1099. Manila .•

9 ISBN 971-550-377-2

CORRUPTION THE BOOM AND BUST OF EAST AsIA

Edited by

J. EDGARDO CAMPos

ATENEO DE MANILA UNIVERSITY PRESS

-

ACKNOWLEDGMENTS

We gratefully acknowledge the financial support of the Foundation

ATENEO DE MANIlA UNIVERSITY PRESS Bellarmine Hall. Katipunan Avenue Loyola Heights. Quezon City

for Advanced Study i n International Develop ment (FASI D ) of Japan and

P.O. Box

the World Bank Institute (WBI) for this manuscript. Special thanks go to

Tel.:

154. 1099 Manila. Philippines (632) 426-59-84 I FAX: (632) 426-59-09

D a n ny Leipziger, fo rmer C h ief o f the Regulatory Refo r m and P r ivate

E-mail: [email protected]

Sector Develo p ment Division of the WBI; Farrukh Iqbal, former East Asia Regi o n al C o o rd i n a t o r fo r the WBI; and M i c h i k o Kakegawa, Program Copyright

2001

Officer for FASID, under whose watch the various research p apers were

by Ateneo de Manila University and J. Edgardo Campos

initiated, and to B rian Levy and Stephan H aggard for their constructive

Cover and book design by J. B. de la Pena

criticisms of the initial drafts of the chapter p apers. We also wish to thank

All rights reserved.No part of this publication may be reproduced. stored in a

participants of the Fifteenth WB IIFASI D Joint Seminar on G overnance

retneval system. or transmitted in any form or by any means. electronic mechanical

;

photocopying. recording. or otherwise. without the written permission of he Publisher

:

and Private I nvestment i n East Asia for their comments and suggestions o n the revised versi o n s o f the chapter papers, H annah M o o re fo r her patient editing of the penultimate version, Alice W. Y. Chan and Rebecca

The National Library of the Philippines CIP Data Corruption: the boom and bust of East Asia I edited by J. Edgardo Campos; with contributions

from Ha-Joon Chang . ..

ADMU Press. c2001

I

et al.

J

- Quezon City:

1 v.

I.

Financial crises - East Asia.

2. East Asia -

Economic conditions. 3. East Asia - Politics and

government - Corrupt practices. I. Campos. J. Edgardo. II. Chang. Ha-Joon. HB3722 332 2001 ISBN 971-550-377-2

POI 1000025

H i fe fo r their research a s s i s tance, D an iele Evans fo r her p a i n s taking effo rts at organizing the works h o p s at which earlier drafts were p re ­ sented and discussed, and Flor Guce fo r making sure the final version co nfo rmed to publicatio n guidelines .

.,.

CONTENTS

INTRODUCTION

]. Edgardo Campos

1

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1

CORRUPTION AND I TS IMPLICATIONS FOR INVESTMENT ]. Edgardo Campos, Donald Lien, and Sanjay Pradhan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1

2 INVESTMENT, PROPERTY RIGHTS, AND CORRUPTION IN INDONESIA Andrew MacIntyre

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

25

3 STATE, CAPITAL, AND INVESTMENTS IN KOREA Ha-]oon Chang

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

45

4 GOVERNANCE AND INVESTMENT IN CHINA Shuhe Li and Peng Lian

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

69

5 CENTRALIZATION, POLITICAL TURNOVER, AND INVESTMENT IN THE PHILIPPINES Emmanuel S. de Dios and Hadi Salehi Esfahani

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

101

6 GOVERNANCE, RENT-SEEKING, AND PRIVATE INVESTMENT I N MALAYSIA ]omo K. S

.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

131

7 GOVERNANCE AND GROWrH IN THAIlAND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

163

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

183

Allen Hicken NOTES

REFERENCES INDEX

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

198 215

INTRODUCTION ]. Edgardo Campos

In this d ay and age, it has become fashionable to talk ab out "go o d governance" a n d i t s importance in stimulating a n d sustaining economic growth. The current heightened interest i n this subject has been stimu­ lated by the enhanced cap acity o f economists and political scientists to m o del m o re rigorously the incentive dynamics within different gover­ nance structures , to quantify the quality of governance, and to measure its impact on economic performance (see, for instance, Kaufmann 1 996, Urata and Kawai 1 99 9 , M auro 1 99 5) . The East Asian financial crisis has heightened the concern not o nly over g o o d governance b u t also over the rel a t i o n s h i p between gove r ­ nance a n d corruption. M any critics of the Asian miracle have argued that the governance structures underpinning the East Asian economies have been largely responsible fo r the crisis. I nterestingly, however, the quan­ titative indices that have been used to rank countries in terms of corrup ­ tion, and more generally rule of law, either did not change much before and after the crisis set in or changed in an "unexpected" direction.! China and I n d o nesia, fo r example, had always been ranked among the m o st co rrupt countries in the world, followed n o t too far down by Thailand and the Philippines . Before the crisis , M alaysia was always ranked among those with better rule o f law. The term "go o d governance" is s o mewhat slip pery and ambiguous as numerous defi n i t i o n s permeate the l i t e rature. Wh ateve r the defi n i ­ t i o n , t h e r e a p p e a r s t o b e a c o n s e n s u s t h a t g o o d gove r n a n c e m u s t

necessarily encompass the protection of property rights. This h a s led to the c o rollary that credible c o ntract enforcement is necessary to attract

Introduction

Introduction

productive inve stments and thus stimulate e c o n o m i c growth. I n d e e d,

is o n the one hand a manifestation o f institutional inertia in the midst

there is n o w r e a s o n a b l e e m p irical evi d e n c e that s u p p o rts this t h e s i s

of a rapidly changing e nvironment, and o n the other a commentary on

( s e e , fo r instance, Keefe r and K n a c k 1995) .

the problems o f transition to a s o ciety gove r n e d by the rule of law.

Implicit in much of the literature on p rivate p r o p e rty rights is the assumption that formal legal institutions, such as an independent judi­

The East Asian Paradox

ciary, are critical to the credible enforcement of c ontracts (see, for instance,

The experience of the six countries presented in this volume-China,

North and Weingast 1 98 9 ; North 1990) and hence for stimulating invest­

Indonesi a, Korea, M alaysia, Philippines, and Thailand-p resents a dif­

ment and growth.2 While not denying the importance of such institutions,

ficult p aradox t o p r o p o nents o f "go o d governance." O n the one hand,

this volume questions the almost theological belief that countries with­

these countries h ave managed t o attract large flows o f p rivate i nvest­

out s u c h i n s t i tu t i o n s are d e s t i n e d to r e m a i n p o o r and e c o n o m i c ally

ment over a very long period (although the Philippines was a latecomer) .

u n d e rdeve l o p e d . To be s u re, i t d o e s not challenge the validity o f the

On the other, with the exception of Malaysia, these countries have fea­

Northian thesis: as many historians have shown, over the very long haul,

tured p r o m i n e n t l y i n t h e " w o r l d 's l i s t" o f m o s t c o r r u p t c o u n t r i e s .3

an economy will eventually stagnate if institutions that promote the rule

More ove r, as c o nventional wis d o m would have it, c o rrup t i o n in these

of law fail to develop. The volume, however, does raise the issue of what

countries is h ighly c orrelated with a perceived weakne s s o f legal insti­

happens in the interim between now and the almost invisible long-term

tutions. Hence, the proponents of "goo d governance" are confronted with

ho rizo n . For b u s i n e s s m e n and p o l icy makers i n develo ping c ountries,

exactly t h e o p p o s i t e of t h e i r rev e r e d g o s p e l : in E a s t Asia, weak l e gal

the No rthian prescription is of little utility as they, their childre n, and

institutions have existed side by side with high levels of investment (not

p e rhaps even their grandchildren will have b e e n d e ad by the time the

t o mention rapid rates o f growth) .

rule of law emerges i n their countries.

The volume attempts to resolve this p aradox. I n different ways, a

East Asia's experience over the p ast thirty years provides a window

number of the autho rs argue that institutions that promote the credible

into the labyrinth between the "now" and North's long haul. As the case

enforcement of contracts have indeed existed in many of these East Asian

studies in this volume maintain, in East Asia info rmal, nonlegal arrange­

countries. These institutions, however, are of the informal, nonlegal variety

ments emerged (over a relatively short period of time) to fill the formal

which the above proponents often perceive (and believe) to be detrimen­

institutional vacuum. These institutions made contracts enfo rceable and

tal t o e c o n o m i c growth b e c a u s e they p r o p agate r e n t - s e e k i n g and

thus encouraged inflows of private (and productive) investment. Indeed,

consequent large- scale corruption. Their assumption is that if institutions

there is now a m o u ntain of evidence indicating large fl ows of p rivate

foster rent-seeking and corruption, then they must be inimical to growth .

investment into East Asia, both domestic and foreign, despite the weak­

By contrast, the authors argue that rents and corruption have been essen­

ness o r even absence of legal institu t i o n s .

tial to the credible enforcement of contracts and thus to the large inflows

T h e A s i a n e c o n o mic c r i s i s h a s brought gove rnance and t h e r u l e o f

of investment. In his chapter on Indonesia, M acintyre makes this p o int

l a w i n t o t h e fo refront o f d i s c u s s i o n s and d e b a t e s about the s o - called

most crisply and vividly. He maintains that special features of the Suharto

Asian M i racle . The c r i s i s, many critics o f the miracle argue, e r u p t e d

regime had allowed it to function much like a joint monopolist trying to

b e c a u s e o f p e rvasive, institutionalized c o rrupti o n made p o s s ible by a

maximize profits across complementary products. Specifically, he argues

dysfunctional, politically malleable legal system. The resulting calls fo r

that Suharto established and nurtured a political structure grounded on

institutional reform have b e e n deafening.

two pillars, corruption and investment. The structure gave Suharto ample

These critics, howeve r, have lost sight of the obvious fact that thirty

opportunity to extract rents, to distribute it systematically across the bu­

years of i m p r e s s ive, ext e n s ively d o c u m e n t e d e c o n o mi c p e rfo r m a n c e

reaucratic and p olitical landscape, and to keep the costs of generating the

p r e c e d e d t h e crisis. T h i s v o l u m e attempts to a d d r e s s t h i s s e e ming d i ­

rents from squeezing out long- term investments. A conscious decision to

choto my. To be sure, t h e volume d o e s not purport to b e another treatise

open the capital account early in the regime's life effectively tied Suharto's

on the crisis. Rathe r, it situates the crisis within the larger c o ntext o f

hands and credibly committed his regime to honoring agreements with

institutional change. A s many of t h e authors argue o r imply, t h e crisis

investors: investors could take their money out if they sensed any u nfa-

2

3

Introduction

Introduction

vorable change in economic policies. Hence, Suharto and his regime had

exchange for investing in pro ductive , exp o rt- oriented activities, (3) p r o ­

strong incentives to ascertain that private investors were not subj ected to

vided implicit ( a n d illegal) wages to relatively poorly p a i d p u b l i c official s ,

independent, uncoordinated rent- seeking, bribe-taking efforts that discour­

(4) provided discretionary funds to lo cal p oliticians to e n a b l e t h e m t o

aged long- term investments. I n sum, while investors might have had to

b u y p olitical s u p p o rt , and (5) l i m i t e d c o rruption flows to s e c t o r s that

fork out considerable rents, whether in the form of bribes or shares, they

were less important fo r international comp etitiveness . Like its counter­

were assured that their investments would be protected from harassment

parts in Indonesia and China, this tightly knit, relatively well- thought-out

and that agreements they had made with the government were adhered

system was glued together by rents and corrupti o n .

to. The rents and associated corruption involved have been the glue that has tied this info rmal sys tem together and has made the system work effectively over thirty years .

Institutional Change and the East Asian Crisis

Highly authoritarian regimes have governed each of the three coun­

Similarly, Li a n d Lian c o nt e n d that the p ol i t i c a l regime in C h i n a

tries discussed above . One is thus tempted to deduce that demo cratizing

b e h aves much l i k e a "j oint monop olist." T h e y present an abstract sys­

these regimes will improve governance and reduce corruption. Economic

tem which they label marke t - p re s e rving authoritarianism ( M PA) , argue

historians indicate that over the long haul this is likely to b e the case.

that China fits this abstraction reasonably well, and then conclude that

Yet if world history is any guide, the transition period is likely to be very

the b a s i c fe ature s of an M PA h ave l e d to a b al a n c e b e tween p olitical

long. And in the transiti o n , things may n o t get b etter until much later.

centralization and economic decentralization that ultimately places con­

De Dio s's and E s fahan i 's study on the Philippines identifies a fun ­

straints o n corruption in order to attract p rivate investment. Among the

d a m e n t a l d i l e m m a t h a t m a y c o n fr o n t c o u nt r i e s u n d e r g o i n g s u c h a

more concrete, China - sp ecific features of an M PA, they identify a set o f

transition. Democratization tends to distribute p ower and political influ ­

internal r u l e s governing recruitment, p r o m o t i o n , and b e h avior within

ence more widely acro s s different group s . This creates more s o - called

the bureaucracy, an economic p e rforman c e - b as e d system of promotion

veto p o i n t s i n t h e d e c i s i o n - making p r o c e s s a n d p o t e n t i ally leads t o

within the Communist Party, collective decision- making mechanisms that

gridlock. I n t h e absence of firmly established demo cratic instituti o n s , it

increase transparency i n the p r oj ect- approval p r o c e s s , a graduated al­

leads to what Shleifer and Vishny ( 1993) call an "independent mono p o ­

l o c a t i o n of c o n t r o l or a u t h o r i t y a t v e r t i c a l l e v e l s o f p u b l i c - s e c t o r

l i s t " regime of rent- seeking a n d corruption that s i gnific antly increases

management-meaning that lowe r - l evel o fficials h ave explicit limits to

transactions costs (including rent- se eking costs and associated levels of

what is within their authority, fiscal decentralization, and a court system,

corruptio n) . A natural , al m o s t knee-j erk response to this has been to

which, while cle arly weak and inadequate, renders imp artial j udgment

maintain a strong executive branch of government, as this is viewed as

in cases where the verdict can b e easily verified by a third p arty.4 Com­

a way to prevent gridlock and keep transactions costs from bursting at

bined with the exi s t e n c e of a large ove r s e a s C h i n e s e capitalist cadre,

the seams. As de Dios and Esfahani argue, this moves the system closer

these fe atures , the authors argue, have led to the adoption of informa­

to a "joint monopolist" regime in which the executive has strong incen ­

tion- revealing mechanisms and the emergence of strong cross- regional

tives to keep rent - s e eking and co rrup t i o n fro m sucking up i nvestment

c o m p e t i t i o n as i n fo rmal means to e n fo r c e inve s t m e n t agre e m e n t s in

and growt h . Unfo rtunate ly, as these co authors s o vividly i l l u s trate in

China, where formal legal institutions are weak, and, as a by- product, to

their analy s i s of the P h i l i p p i n e s ' p o s twar exp e r i e n c e , it also creates a

i n direct means o f co ntaining corruption.5

s e r i o u s credible c o mmitment p r o b l e m : a s t r o n g executive b ranch i n ­

In h i s chapter o n Korea, Chang takes a slightly different route but

c r e a s e s t h e r i s k t o i n ve s t o r s of h a v i n g a g r e e m e n t s r e a c h e d u n d e r a

e s s e n tially arrives at a s i m i l a r c o n c l u s i o n : c o rru p t i o n i s an e s s e n tial

p articular regime "reconstructed" if key p o liticians of that regime fail to

element of an "e c o n o mic" governance sys tem that has b e e n very suc­

win re election or, as in the case of the Philip pines, are restricted by law

c e s s ful at s t i mulating p r ivate investment. The Korean government, h e

to term limits.6 The recent political events in the Philippines-the so- called

argu e s , c o u l d and did set up a system of highly interventionist policies

P e o p l e Power Revolution 2-wh ich has led to the unseating of

that ( 1) made domestic investment much more attractive than consump ­

elected president well within the constitutional term of six years , highlights

t i o n , (2 ) created m o n o p oly rents fo r large domestic firms (chaebols) in

the de D i o s -Esfahani dilemma. The President, Joseph Estrada, exerc ised

4

5

a

duly

Introduction

Introduction

the full p owers vested in him by the Constitution to influence decisions

t i o n , which is a fo rm of t e c h n o l ogical c h a n g e , altered the M al ays i a n

in favor of individuals and groups who could fork out large sums of money

e c o n o m i c l a n d s c a p e s o drastically t h a t instituti o n s c o u l d not p o ssibly

in bribes. While this practice may not have been unique to him, the manner

adapt to the changes quickly enough. The resulting institutional gap, he

in which h e had d o n e s o created c o n s i derable u n c e rtainty among the

conclude s , has b rought fo rth the economic crisis.

business community and eventually shut off p rivate investment. Presiden­

Malaysia's p o stwar history and its experience with the current crisis

tial influence was exercised randomly, with little rhyme or reason, inevitably

exemplify the difficulty of undergoing fundamental institutional change .

affecting existing or proposed co ntractual arrangements; o nly the avail­

Among the six countries in this volume, M alaysia is unique in the sense

ability and size o f p ayoffs seem to have matte r e d . Even the s u p p o s e d

that it has ranked c o n s i d e rably high o n the "rule o f law" scale as re ­

built-in discipline of a "joint monopolist" came to be violated.7 A s Fabella

flected in various international surveys of businessmen (or alternatively,

aptly put it, the president had moved beyond the "Twilight Zone" o f cor­

c o n s i d e r a b ly l o w o n t h e c o rrup t i o n r a n k i n g s ) . A n d y e t , c r i t i c s h ave

ruption and rent - s e eking, i . e . , what could b e tolerated by the economy,

blamed ren t - s e eking and c o rrupt practices fo r the country's failure t o

thereby creating uncertainty and strong negative reactions from the busi­

thwart the A s i a n c o ntagi o n . Jomo's c h a p t e r o ffers a stinging rebuke o f

ness community and eventually from many segments of civil society.s The

such criticisms. Like t h e other authors, he makes a strong case for rent­

dilemma of balancing the need for a strong executive and the potential for

s e e k i n g and c o rr u p t i o n a s b e i n g p a r t a n d p a r c e l of " e c o n o m i c"

gridlock is indeed a very real dilemma for nascent democracies, especially

governance and implicit contract enforcement in M alaysia. He emphati­

those in transition from an authoritarian state.

cally argu e s , h owever, that fin a n c i al l i b e ralizat i o n created a d e e p and

Implicit in de Dios's and Esfahani's argument is the assumption that

w i d e i n s t i t u t i o n al gap t h a t u l t i m a t e l y t r a n s l a t e d i n t o a r g u a b l y t h e

b o th the jud iciary and p olitical p arties are weak. As the experience of

country's m o s t serious p o s twar economic crisis. Financial liberalizatio n

many former communist countries indicates, this is likely to b e the case

required changes in regulat o ry and legal institutions; and these changes

fo r c o u n t r i e s u n d e r g o i n g the t r a n s i t i o n t o d e m o c r a t i c rul e . 9 P o l itical

directly challenged the institutional arrangements that underpinned the

p arties are m o r e likely t o represent t e m p o rary c o al i t i o n s rathe r than

country's economic governance system, i . e . , arrangements that had rent­

ideologically grounded o rganizatio n s and the judiciary to b e hampered

seeking and corruption at the very core of the country's "shared gro\\<1h"

by lack o f experience and resources.

p h e n o m e n o n . H e n c e , the required chang es c o u l d n o t be exp e c t e d t o

The discussion on the Philippines brings us to an inextricably linked topic of this volume, namely, institutional change and the Asian economic

e m e rge q u i c kly. N o t s u r p r i s i n gly, like a b o dy w i t h o u t the natural d e ­ fe n s e s to thwart a viru s , M alaysi a w e n t i n t o c onvuls i o n-the c r i s i s .

crisis . The Asian economic crisis has turned into a convenient instrument

I n fact. J o m o goes further in elabo rating h i s t h e s i s of institutional

for lambasting the absence or weakness of legal institutions in East Asian

inertia. He describes and analyzes in painstaking detail the c o n straints

countries and how these inadequacies have been the principal culprit for

current Prime Minister M ahathir co nfronted in trying to move the sys ­

these countries' current woes. The criticisms, however, have lost sight of

te m away fro m the fo u n d a t i o n s o f t h e N ew E c o n o m i c P o l i c y ( N E Pl.

the fact that most of these countries have experienced rapid growth and

which sought to redistribute wealth toward the econo mically disadvan­

significant reductions in p overty over the last thirty years despite these

taged but politically more influential Bumiputeras at the expense of other

presumed institutional deficiencie s . Through the p ostwar experiences of

ethnic gro u p s , in p articular the Chine s e . To m o c o n c l u d e s that, in the

six East Asian countries, this volume addresses the flaw in the logic un­

final analysis, M ahathir had to build o n the NEP in o rder to bring about

derlying these criticisms and examines an underexplored dimension to

i n s t i tut i o n al change , a gradual p r o c e s s p u s h e d a l o n g by a p o l itic ally

the crisis-institu tional cha n ge as so espoused by N o rth ( 1 981) .

well - i nformed strategy and whi c h took m o re than a decade to unfo l d .

MacI ntyre, Chang, and Li and Lian address this issue in their chap ­

T o h ave exp e c t e d t h e r e gu l a t o ry a n d l e g a l i n s t i t u t i o n s t o re s p o n d

ters. However, it is the chapter on M alaysia that more vividly illustrates

promptly t o the new enviro nment thrust upon them b y financial liber­

the dynamics of institutional change and how the crisis is but a reflec­

alization was thus , in his view, unreal istic.

tion of these dynamics. As N o rth posits, institutions evolve in response

The Thai exp e rience illustrates e s s e ntially the same p h e n o m e n o n

to technological change. Jomo contends that rapid financial Iiberaliza-

b u t with a sl ightly different twist. Hicken contends t h a t financial liber-

6

7

Introduction

Introduction

alizatio n was the proverbial final straw that broke the came l 's back. He

flexibility to fashion macroeconomic policies with little interference fro m

notes, however, that the makings of the crisis likely began a decade earlier.

politicians a n d the p arties would have co ntrol o v e r sectoral ministries

Hicken comp ares the government's response to the macroeconomic

whose mandates were more conducive to generating p o rk barrel projects.

crisis of the early 1 9 80s with its response to the late 1 9 90s macro e c o ­

Prem thus managed to insulate the economic technocracy from political

nomic crisis brought fo rth b y t h e Asian flu. Until t h e recent constitutional

i n t e r fe r e n c e , a p p o i n t i n g ( o r i n fl u e n c i n g the a p p o i n t m e n t of) h i ghly

change, Thai politics was characterized by a weak s e p aration b etwe en

qualified and respectable professionals to key p o s itions in the four key

the executive and legislative branches of government, multiple p olitical

elite economic agencies-the Planning Ministry ( N ES DB) , the Minis try

p arties (each of which tends to be regionally based and includes c o m ­

of Finance, the B u dget Bureau, and the Central B ank.

p e t i n g i n t e r n al fa c t i o n s ) , a n d a n e l e c t o r a l s y s t e m b i a s e d t o w a r d s

Toward the late 1 9 80s and early 1 99 0 s , the p olity began to change

individualistic or personalistic camp aign strategies-as opposed t o strat­

s i g n i fi c antly with a s i g n i fi c a n t m i d d l e c l a s s s l o wly e m e r g i n g . As the

egies based on p arty reputation or a party's p olicy p o sitions. On the one

economy grew and the middle class exp anded, demands for democrati­

h a n d , the fir s t i s c o n d u c ive to the p r o m o t i o n o f welfar e - e nh a n c i n g

zatio n i n c r e a s e d as wel l , leading eve ntually to the first elected p ri m e

national policies a n d to swift responses t o crisis; o n t h e other, t h e s e c ­

minister. As Hicken p oints o u t , however, t h i s o pening up of t h e political

o n d and t h i r d e n c o urage g r i d l o c k , the p a s s age o f n a r r o wly targeted

system had a disastrous effect o n the elite agencies that made up the

p olicies that award p articularistic b e n e fits to a l e gislato r's c o n s titu e n ­

technocratic system. Whereas in the past these agencies were relatively

cies, and t h e diversion of government resources thro ugh corruption t o

insulated fro m p o litical interference, with greater demo cratizatio n they

raise campaign funds. H icken argues that these features did not change

became p art of the spoils that accrued to members of the winning coali­

fundamentally between the two crisis periods, and yet the government's

tion. Hence, each of the elite agencies tended to be controlled by different

r e s p o n s e was m u c h d i ffe r e n t . I n the e a r l i e r p e r i o d , the gove r n m e n t

political parties bonded together by convenience and not by any common

managed to push p olicies that stabilized t h e macro e c o n o my, attracted

political persuasion. This greatly weakened coordination among the agen­

huge flows of private investment, and encouraged economic growth . In

cies and biased economic decision making toward narrow concerns. This

contrast, in the latter p eriod, the government p roved incapable of ad­

l e ft the age n c i e s l e s s c a p a b l e of r e s p o n d i n g to the new enviro n m e n t

dressing the burge o n i n g problems in the financial sector even tho ugh

imposed by rapid financial liberalization which, as t h e M alaysian experi­

there was clear recognition in some corners that these problems would

ence suggests, creates unrealistic demands o n institution s . T h e T h a i experience illustrates once again t h e difficulties of under­

eventually d e rail the e c o n o my. H e p o sits that during the e arly 1 9 8 0 s p olitical p arties n e e d e d the

going a transition fro m an authoritarian to a d e m o cratic setting. The

military's support to maintain political stability. Back then the military

shift to unstable, c o aliti o n - b as e d p o litics has had serious adve rse c o n ­

was still an important (if not the dominant) player in the political arena.

s e q u e n c e s fo r e c o n o m i c m a n a g e m e n t . I n t i m e , n e w i n s t i t u t i o n a l

Moreover, the parties themselves were in co nstant disagreement, unable

arrange m e n t s will likely e m e rge to r e s p o n d to t h e d e fic i e n c i e s . The

to fo rge compromises o n leadership arrange ments. So the military was

passage of the 1 998 Constitution is a step in the right direction. Yet given

seen as a stabilizing fo rce. The result was the a p p o i ntment of General

the Philippines' experience, the evolution to a new, effective institutional

Prem as prime minister ( 1 980- 1 988) with a mandate to get the cou ntry

equilibrium will likely take a long time .

out of the crisis . Being a no nelected PM, Prem was not tied down to the

Indonesia, South Korea, Thailan d, and M alaysia have indeed b e e n

narrow particularistic tendencies of regional politics. Hence, he had some

hit h a r d by a deep e c o n o m i c crisis which began as a financial c r i s i s in

fl exi b i l i ty to p u s h more n a t i o n ally e n c o m p a s s i n g e c o n o m ic p o l i c i e s .

Thailand b u t qui ckly exp l o d e d into a ful l - b lown e c o n o m i c c r i s i s and

However, he (and the military) recognized that he also needed the parties

s p re a d rapidly t o the other c o u n tri e s . Wh i l e s p ared the worst o f the

to help govern the countrys ide; gone were the d ays when the military

problems, the Philippines has not escaped the contagion. China, o n the

was the all - e ncompassing fo rce wh o s e unmis takable presence was felt

other hand, a p p e ars to b e weathering the storm, p o s t i n g a rather re­

throughout the country. This led to what Hicken calls the "policy- patro n­

markable annual GDP growth rate of 7.8 p ercent for 1 99 8 while the rest

age" compro m i s e b etwe en Pre m and the p arti e s : Prem wo uld h ave the

of the region's e c o n o m i e s co ntrac ted or stagnat e d .

8

9

-

Introduction

The striking e c o n o m i c perfo rmance o f C h i n a in the m i d s t of the

CHAPTER ONE

regio n's most serious economic crisis i n the p os twar period is perhaps not surprising. Of the six countries studied in this volume, China is the o nly o ne that still has considerable restrictions on financial markets and these restrictions have insulated the country fro m the financial storm that has ravaged the rest o f East Asia. Its experience thus far p rovides some support to the thesis of o ther authors in this volume: rapid finan­ cial liberalizat i o n is bound to lead to e c o n o m i c crisis. I t also suggests that gradual opening up o f financial markets, rather than the " big bang,"

CORRUPTION AND ITS IMPLICATIONS FOR INVESTMENT ]. Edgardo Campos, Donald Lien, and Sanjay Pradhan

may be the appropr iate approach fo r many develo p i n g countries. I n s t i t u t i o n s d o change but they d o s o very slo wly and usually in resp onse to-or pushed by-technological change. The liberalization of financial m arkets i n the East Asian countries analyzed here represent a m aj o r change in technology that demanded c orres p onding changes in the institut i o n al arrangements governing the public sec t o r and, m o s t important, the rent-extractio n regime. This was not well understood and!

In the last few years , corruption in developing countries has c o me

or well appreciated by the leadership and governments in the affected

to the forefront of develop ment thinking. Tight fiscal situations at home

countries . The result was a sluggish (some would s ay hesitant) response

h ave made d o n o r c o u ntries fo cus m o re o n the impact of their a i d t o

that inevitably led to a full-blown crisis.

developing countries, raising concerns a m o n g bilateral a n d multilateral

been the boom and bust of East Asia.

Unmistakably, corruption has

aid agencies over the effect o f corruption on economic performance. At the same time, the trend towards democratization has made developing

Structure of the Volume

country governments subject to greater scrutiny and accountab ility fro m

The volume is organized into seven chapters. It begins with an econo­

a broader segment o f the general public. The fall of the Bucharam a d ­

metric piece presenting cross- country evidence of the impact of governance

ministration i n Ecuador, the convictions of two former p residents in South

Chapter one, by Campos, Lien, and Pradhan, p resents a

Korea, the c o llapse o f the M o b utu regime i n Zaire, the surprising res ­

on investment.

nuanced argume n t a b o u t the i m p a c t o f "go o d" gove r n a n ce, whether

ignation o f Suharto i n Indonesia, a n d the peaceful midterm ouster of a

through formal or informal mechanisms, on investment. They show that,

demo cratically elected p resident in the Philippines, Joseph Estrada, are

indeed , governance matters, as reflected by the fact that countries with

all tes t i m o ny to the s alience of c o rrupt i o n as a key issue u p o n which

lower levels of corruption do attract higher levels of investment. However,

governments are i n c reasingly being j u dged .

they also show that, given the level of corruption, the "predictability" o f

D e s p i te t h i s , t here rem a i n s a s i g n i fi c a n t degree o f amb ivalence

c o rruption a l s o h a s a s i gnificant effect o n i nvestment. Ceteris p aribus ,

among many p o licy makers about the real impact of corruption o n the

countries in which c o rruption is more p redictable-meaning the likeli­

economy. This les s - than-enthusiastic resp o n se is due in part to the s o ­

h o o d that a p ay o ff will lead to the actual granting o f the illicit favo r

called E a s t Asian puzzle. I n a number of E a s t Asian c ountries , high rates

s ought-tend t o attract relatively higher levels o f investment.

of growth had been sustained over a long period despite high levels of

The rest of the volume p resents six country case studies . I n varying

co rruptio n . A number of independent o rganizations that have conducted

degrees, each illustrates and concretizes the pheno meno n "predictabil­

extensive surveys of businessmen throughout the world, e. g . , Transp ar­

ity o f c o rrup t i o n" and rec o nc iles this phenomenon with the No rthian

ency Internati o n al (TI ) , have ranked C h i n a , Vietnam, I n d o ne s i a , and

thesis. The six follow i n sequence-In d o nesia, South Korea, China, the

Thailand among the most c o rrupt countries. Yet, as table 1 shows , up

Philippines, M alays i a , and Thailand .

till the recent eco nomic crisis, these countries have grown at pheno m ­ enal rates a n d , more important, attracte d a considerable fl o w o f private

10

11

Corruption and Its Implications for Investment

Corruption and Its Implications for Investment

c a p i t a l . This o b s ervatio n h a s p o s e d a real c h a l l e n g e to the r e c e ived

( 1 995) has provided econo metric an alysis and evidence of the negative

wisdom that corruption impedes economic p erformance : it is inconsis­

imp act of c o rruption o n inve stment and growth. More broadly, Keefer

t e n t with t h e t h e ory that weak i n s t i t u t i o n s o f govern a n c e , o f which

and Knack ( 1 995) show empirically that weak institutio ns, as manifested

corruption is a co ncrete manifestation, discourage investments and thus

in p art by the extent of corruption, impede economic growth . In a dif­

constrict growth.

ferent vein, S t o n e et al. ( 1 9 9 6) and Paul ( 1 9 9 5 ) u s e surveys to extract evidence of high transactions costs that accomp any activities commo nly believed to be a s s o c iated with corruption, e . g . , customs . N evertheless,

Table 1

Corruption and Private Investment

this research still fails to exp lain why a number of East Asian countries

Ave. Ratio of Private Country

TI Rankings (1 996)

Ave. GDP Growth Rate

I nvestment to GDP

(Max score: 1 0)

(1 980-1995)"

(1981-1 993)

2.43

1 1 .05 %

n.a. n.a. 24.85 %

China Vietnam

n.a.

Thailand

3.33

B.W 7.86

Indonesia

2.65

6.60

1 6.35

India

2.63

5.41

11 .11

Egypt

2.84

3.78

8.03

Kenya

2.21

3.27

1 1 .01

Brazil

2.96

2.70

1 5.74

Mexico

3.30

1 .07

1 3.68

New Zealand

9.43

2.40

n.a.

persist as outliers . We i ( 1 9 9 7) h a s a t t e m p t e d the firs t e m p ir i c a l analysis t h a t m ore p o ignantly addre s s e s the East Asia puzzl e . He shows that, c o ntrolling for o ther fac t o r s such as GD P ( gro s s d o m e s t i c pro d u c t) I c a p i t a , t h e i m p a c t of corruption o n the fl ow of foreign direct inve stment ( F D I) is no different in East Asia relative to o ther countri e s . 2 The implication is that in East Asia other factors swamp the n egative effect that corruption has o n FDI. This offers a p o ssible explanation for why East Asian coun­ tr i e s h ave gr o w n m or e r a p i d l y d e s p i t e s i gn i fi c a n t l y high l e v e l s of corrup t i o n . Th ere i s , h owever, o n e prob l e m with h i s an alys i s : the in­ flows and outflows of FDI are dominated by countries belonging to the Organizati o n for Economic C o o p eration and Deve l o p ment ( O ECD) . I t is quite p o s s i b l e that t h e results w o u l d b e different if the OECD c o u n ­ tries were excluded fro m t h e s a m p l e as "ho sts" of F D I or, alternatively,

•

From World Development Indicators 1 997.

if the dependent variable used was private investment (both domestic

t

1990-1995 0nly

and foreign) . 3 In fact. other empirical findings of Wei suggest that there is more t o

Scholarly concern over corruption predates the emergence of corrup­ tion as a highly co ntroversial issue among practitio ners . M any scholars, including Rose -Ackerman ( 1 978) . Klitgaard ( 1 988) , and Wade ( 1 982) , have sought to understand b etter the complexities that underpin the existence and persistence of corruption. In fact, much of the intellectual discussion on the implications of rent-seeking activities (Kreuger 1 974; Bhagwati 1 982; Tullock et al. 1 9 88; Murphy, Shleifer, and Vishny 1 993) and the role o f institutions ( N orth 1 9 8 1 a n d 1 990) for e c o n o m i c p erformance touched implicitly on the pote ntial impact of corruption.l However, because this intelle ctual strand has, up till recen tly, not l e d to l arge cro s s - c o u n try empirical testing, it has not been able to co ntribute effectively and con­ vincingly to clarifying the consequences of corruption. With the deve l o p m e n t of b e tter datab a s e s , a n u m b er o f s c h o l ars have managed to undertake much - n e e d e d cro s s - country e m p irical re­ search. I n what i s p r o b ably a seminal piece o f wo rk i n this area, Mauro 12

t h e corrup tion story t h a n m e e t s the eye . H e finds that ethnic ties lead to higher flows of FDI and, in particular, that much of the FDI that flows i n t o C h i n a c o m e s fro m over s e a s C h i n e s e . Wh at t h i s s u g g e s t s is that informal institutions may b e an imp ortant omitted vari able that affects the nature of corruption and thus its impact on investment. It sup p o rts the thesis that in East Asia, informal norms bound inseparably with illicit exchanges help enforce intert e m p o ral transactions that facilitate rela ­ tively larger inflows of F D I . This thesis i s co nsistent with the work of Shleifer and Vishny ( 1 993) . Shle ifer and Vishny analyze different typ es of corruption regimes-m o ­ nopolistic versus independent "suppliers" of bribe- generating pro ducts­ an appro ach that is also evident in Kaufmann's recent work (1996) . This chap ter fo llows thei r line of reasoning. That is, different corrup tion re­ gimes have diffe rent effects on investment. I n particular, we argue and provi de e m p irical evi d e n c e that regimes i n which c o rrup t i o n i s more 13

Corruption and Its Implications for Investment

Corruption and Its Implications for Investment

"predictable" (in the sense that the favor, service, or p roduct being sought

average) fo r c o l l e c t i n g the garb age as o p p o s e d to t r u c k s s p e c i fi c al l y

i s more likely to be granted) , ceteris paribus, h ave a s m aller n egative

d e s i g n e d fo r garbage collection-perhaps e v e n new o n e s .

impact o n investment than those in which it is less p redictable . H o w ­

T h e first situation is what Shle ifer and Vishny refer to as a regime

ever, w e a l s o show that t h e level of corruption matters as well. Given the

with independent "suppliers," the second as one with a monopoly sup ­

s ame degree of p re dictability, lower levels of c o rruption result in higher

plier. The key h e r e , however, is not so much the d i s t i n c t i o n between

levels o f investment. In s u m , we are able to categorize countries into

i n d e p e n d e n t versus m o n o p o l y s u p p l i e rs; i t i s one o f p re d i c t a b i l i ty.

three broad typ e s : (1) those with h i gh l ev e l s o f c o r r u p t i o n a n d low

Co nsider again the s e c o n d case of a s ingle p u b l i c official h aving m o ­

predictability are the worst off in terms of attracting p rivate investment;

nopoly power over the granting of the franchise . That official obtains his

(2) those with high levels but greater predictab ility are better o ff than

power fro m the office he or she holds . Suppose that the politics in the

tho s e in ( 1 ) in terms o f attracting relatively higher levels of p rivate in­

country is such that ruling cliques change ever so often and with each

vestment; and (3) those with low levels of c o rruption and high predict­

change comes a reshuffling o r replacement o f government officials . In

ability are the most well - o ff. East Asia's "puzzling economies" are likely

this case the s i n gle p u b l i c o ffi c ial may be in o ffi c e fo r a very limited

to fall in the s e c o n d catego ry.

time. When his replacement takes over, this individual could decide to

This chapter is divided into three parts . In the first, we present and

terminate the franchise ( o r make it extremely difficult fo r the existing

discuss a more generalized version of the Shleife r / Vishny approach. We

franchisee to operate) . Hence the firm that originally obtained the fran­

then d e s c r i b e o u r d a t a ( in c l u d i n g their limitat i o n s) , the e c o n o metric

chise can never b e certain that it will indeed maintain the rights accorded

m o d e l we u s e d fo r o u r an alysis , a n d present o u r e m p i r i c al fin d i n g s .

to it. It could p o s s ibly pay additional bribes to the new official but this

Finally, we draw some conclusions and make some suggestions for future

only shifts the uncertainty to the cost side of the equation. In either case

empirical research on c o rrupt i o n .

the firm will b e less willing to invest adequately to deliver the s e rvice,

Why Predictability Matters

e . g . , they will provide fully d e p r e c i ated g e n e r al - p u rp o s e dump trucks instead of real and newer garbage tru c k s .

The underlying logic of our approach can be illustrated with a simple exampl e .

4

D o e s Theory Meet Reality?

C o n s i d e r a situation in which s everal firms are c o nfronted

with the n e e d to b r i b e s everal government o fficials in order to obtain

In this section, we explore the implications of a unique database for

a monopoly franchise to p rovide some public s e rvic e . Each of the offi ­

the p articular thesis that we h ave p r o p o s e d above . Specifically, we hy­

cials has veto p ower over a firm's application but n o n e have absolute

pothes ize that the predictab ility embodied in a co rruption regime is as

power to grant the franchise. Suppose further that each of the o fficials

impo rtant as the ext e n t o f co rruptio n . We t e s t this using data fro m a

comes from a different region in the country and each is biased toward

large - scale survey of firms conducted fo r the Wo rld Devel opment Repo rt

helping individuals who come from his or her region. Now contrast this

1 99 7 of the Wo rld Bank. Below, we describe the data, d i s cu s s the vari­

with a situation in which there is a single public official who can decide

abl es we u s e d , and p r e s e n t o u r test results.

o n awarding the franchise and that official has no regional sympathi e s . These t w o s ituati o n s diffe r in t e r m s o f the degree o f u n c e rtainty that

The Data

firms face about the p o s sibility of actually obtaining the franchise should

Though there has been considerable scholarly research o n the issue

it pay brib e s . In the second, there is a much higher degree of certainty­

of corruption, only i n rece n t years have large - s cale cross- country empiri ­

b a r r i n g a n y u n fo r e s e e n i n t e rvent i o n s , t h e fi r m w i t h t h e h i g h e s t

cal studies emerged . The main problem with u ndertaking such a task was

will ingness to p ay will g e t t h e franchis e . I n t h e fi rst, there i s n o such

the ahs e n c e of data on corru p t i o n . Becau se of the nature of the b e as t ,

guarantee. I n all likelihood, therefore, firms will invest less if confronted

g etting direct i nformation o n the extent o f corruption in any country and

with the first situation than when faced with the second, e . g . , the winning

e s p e c ially in deve l o ping coun tries has been elus ive. With t h e adve n t of

firm ends up supplying comple tely d e p reciated general- purpose dump

greater pol i t i c al and e c o n o m i c ope n n e ss worldwide , some i n d e p e n d e n t

trucks (which would make them mechanically more troublesome than

organizatio n s have managed to c o n duct worldwide surveys of busine s s -

14

15

Corruption and Its Implications for Investment

Corruption and Its I mplications for I nvestment

men on a variety of issues, some of which relate to corruption, and have

its field offices worldwide. The survey covered s ixty- nine countries (in­

been compiling and collating data from these surveys. Indeed, the empiri­

cluding nine fro m the O E C D) and drew responses from app roximately

cal work that has emerged in the last few years has made extensive use

3 , 700 companies. The same questionnaire was used in all the countries, an d the target respo ndents in each country were local businessmen.

of databases fro m one o r more of these organizations.s To the b e s t of o u r knowledge, h oweve r, n o n e of these surveys has introduced questions that pertain specifically to the uncertainty surround­

The Variables

ing corruption in respondents' countries. As part of its efforts to prep are

Our basic obj ective was to determine whether or not the " p redict­

and complete the World Development Report 1 997-The State in a Chang­

ab ility" of corruption has a significant impact on economic performance.

i n g Wo rld, the Wo rld B ank c o n ducted a l arge cro s s - c o u n try survey o f

B y predictability, we mean the degree to which firms are confident that

p rivate businesses designed to obtain information o n a number o f i n ­

they will in fact be able to obtain the "product" they are se eking, e . g . ,

stitutional i s s u e s : ( 1 ) the predictability of laws a n d policies, (2) political

a license or a franchise, if they p ay bribes. To quantify a n d encapsulate

instability and s e curity o f prop erty, (3) government-business interface,

"predictability" in variable fo rm, we used the resp onses to questions 2

(4) bureaucratic red tap e , and (5) the efficiency with which government

and 4 in table 2 . Specifi c ally, we calculated a c o u ntry average (acr o ss

provides services. Questions pertaining to the extent and the uncertainty

a l l the r e s p o n s e s fro m individual firms in the country t hat co mplet ed

surrounding co rrup tion were included in (4) ; in fact, of the eight ques­

t h e questionnaire) fo r each questi o n . Then we constructed t he variable

tions, four dealt with corruption. The relevant questions for this chapter

CO R P R D as fol l o ws :

are presented in table 2 . CORPRD Table 2 Survey Questions o n Corruption

1.

get things done." This is true

2.

a lways

(2) mostly

(3) frequenHy

(4) sometimes

(5) seldom

(6) never

"Fi rms i n my l i n e of business usually know i n advance about how much 'additional payment' is." This is true

( 1 ) a lways 3.

(2) mostly

(3) frequently

(4) sometimes

(5) seldom

(6) never

"Even if a fi rm has to m a ke a n 'additional payment' it always has to fear that it will be asked for more, e.g . , by another official." This is true

(1)

a lways

(2) mostly

7 - .5 x (country average for q.2

+

country average for q.4)

We also wanted to test whether the extent of corruption mattered.

"It is common for fi rms i n my line of business to have to pay some i rregular 'additional payments' to

(1)

=

Previous emp irical work indicated that higher levels of corruption im­ pede economic p erformance. M o reover it is p o s s ible that the degree of p redictability may b e of more concern to firms than the extent o f cor­ ruption . " By including a variable that represents the extent of corrup tion, we could t e s t this hypothesis. We u s e d the re s p o n s e s to q u e s t i o n 1 to construct the variable COREXT. Specific ally, COREXT

=

7 -country ave rage fo r q . l .

In order to control for other factors that might affect investment, we u sed the 1 9 90 values of GDP per capita (at p u rchasing power p arity) and

(3) frequently

(4) sometimes

(5) seldom

(6) never

as an alte rnative , s e c o n d ary school enrollment.7 For the dependent vari ables we used the ratio of gro ss investment

4.

"If a firm pays the requi red 'additional payment' the service is usually also del ivered as agreed."

ment variable we used the average over 1 99 0 to 1 994 and had fifty- nine

This is true

(1)

a lways

to GDP and the ratio of p rivate inves tment to GDp'B For the gro ss invest­

(2) mostly

(3) frequenHy

(4) sometimes

(5) seldom

(6) never

o bserv atio n s. Fo r the p rivate-in vest m e n t v a riable , we u s ed b o t h the average fro m 1 9 8 2 to 1 9 9 3 and fr o m 1 9 9 0 to 1 9 9 3 . Id eal l y , the l atter would have been the indepen dent variable o f choice. Unfo rtu n atel y , the

The survey originated and was managed fro m the World Bank's head­

develo ping c o u ntries fo r which we c o u l d o btain a n n u a l d ata on p rivate

quarters in Washington, D.c. , but its implementation was facilitated through

investment flows did not map well o nto the c o untries that were inclu ded

16

17

--

Corruption and Its Implications for Investment

Corruption and Its Implications for Investment

in the World Bank survey.9 Hence, we had fewer observations-between

We undertook a considerable number of alternative regressions based

twenty - o n e and twenty-three.

on potemial problems that in theory could arise. Among others, we tried eq uations that included the cross-product of CORPRD and COREXT, equa­

The Empirical Results

ti o ns u s i n g vario u s p e rmutatio n s with and witho u t one of t h e s e two variables of interest, equations with both GDP per capita and secondary

In table 3 bel ow, we present results o f OLS regre s s i o n s using G D P p e r capita a n d s e c o n d ary enrollment alternatively as c o ntrol variables. In equations ( 1 ) and (4) , we test only for the impact and significance of the extent of corruption and in equations (2) and (5) only fo r the p r e ­ dictability of corruptio n . I n equations (3) and (6) , w e include both the extent and the predictability. In all cases, the extent and the predictabil­ ity variables have the c orrect sign. The predictability variable is significant in all cases at least at the 5 percent level. The extent variable is at best significant at the 5 percent level.

enrollment as controls, and equations with a variable that reflects the degree of policy distortions in the country as the control (or in addition to another control variable) . In sum, we ran a c o n s iderable number of alternative regressions to effectively test the robustness of our findings . Overall, the basic findings held up: CORPRD has the right sign in all regressions and is significant at least at the 5 percent level; COREXT also has the right sign but is at best significant at the 5 percent level and in some cases not sig­ nificant at all. We note, though, that in many cases, where both corruption variables are included, the control variable was not statistically significant.

Table 3 OLS Regression Results

Table 4

G ross I nvestment/G D P as the Dependent Variable

Regression Results

Private I n vestment IGDP a s Dependent Variable

(t-statistics in parentheses) Variables

(1)

(2)

(3)

(4)

(5)

(6)

Variables

(1)

(2)

(3)

(4)

(5)

(6)

Intercept

9.222

3.204

4.046

-1 .679

-9.409

-3.296

Intercept

1 1 .141

5.791

-1 2.081

1 0.575

5.101

-1 2.558

Ln (Enroll)

(1 .397)

(.4808)

(.6220)

2.443t

2.353t

1 .286

(2. 1 1 2)

(2.20 1 )

(1 .0997)

Ln ( G D P )

COREXT

1 .1 69

-4.766t

(1 .053) CORPRD

(-2 .003) 2.987t

(-. 1 47)

(2.779)

(1 .46 1 )

(-.3064) Ln(Enroll)

2.21 3t

2.264'

1 .3 1 3

(2.092)

(2.477)

( 1 .257)

1 .8 1 3

-4.377;

(1 .453)

8.464'

(2. 1 67)

(-.9057)

COREXT

8.532'

(2.675)

(2.869)

CORPRD

(1 .259)

.5096

1 .607

1 .645

(1 .087)

(1 .006)

Ln (GDP)

(-1 .782) 3.877'

(.6402)

(-.9593)

(-.91 62)

2.3W

2.29 1 ;

( 1 .91 6)

(1 .722)

-3.844;

-2.750

-5.792t

-4. 1 6 1 ;

-3.042

-6.837t

(-1 .9 1 0)

(-1 .227)

(-2.297)

(-1 .877)

(-1 .226)

(-2.491 )

3.580

2.446

6.984t

4.085

2.925

8.302t

(1 .209)

(.7825)

(2.30 1 )

(1 .252)

(.8454)

(2.514)

R2

.1719

.0759

.1 306

.0747

. 1486

. 1 951

R2

. 1 546

.2041

.499

. 1 497

.4992

.50 1 4

adj . R2

. 1 423

.0429

.0995

.041 6

. 1 1 82

. 1 51 2

adj . R2

.07

.0784

.41 05

.0647

.3741

.41 34

59

59

59

59

59

59

N o . of Obs.

NOTE: Significant at the

I percent level

( * J . at t h e 5 percent level (tJ . at t h e 1 0 percent level m .

18

NO. of Obs.

23

22

Note: Significant at t h e I percent l evel

21

23

22

21

( * J . at t h e 5 percent level ( t J . at t h e 1 0 percent level (:j:) .

19

Corruption and Its Implications for Investment

Corruption and Its Implications for Investment

In the a b o ve an alys i s , we u s e d gro s s i n ve s t m e n t t o G D P a s t h e

mira cle economies, corruption is said to be well organized and system­

dep endent vari able. We investigated whether o r n o t w e could use t h e

ati c so that the degree of predictability is rel atively high. This c h a p t e r th u S s u g g e s t s t h a t , d e s p i t e h i g h l e v e l s o f c o rrup t i o n , t h e s e m i r a c l e e c o n o m i e s s t i l l m a n a g e d t o a t t r a c t s i g n i fi c a n t l y h i g h e r l e v e l s o f

available d a t a o n p rivate investment to GDP to derive information that would b e consistent with our fi ndings (tho ugh not n e c e s s arily o f any the average of p rivate investment to GDP fro m 1 9 82-1 993 (columns 1-

i n vestment t h a n o t h e r deve l o p i n g c o u ntrie s . T h e result: c o m p a re d t o many developing c o untri e s , t h e s e countries h ave grown faster d e s p i t e

3) and the average fro m 1 9 90 to 1 9 93 (columns 4-6) . These results are

co rrup t io n .

statistical signific ance) . In table 4 below, we present OLS results using

based on a small subset of countries included in the Wo rld Bank survey

However, t h e chapter a l s o p o ints out that whatever t h e degree o f

and for which we could retrieve private investment data. In both sets of

p re d i c t a b i l i ty, m o re c o r r u p t i o n n e c e s s ar i l y m e a n s l e s s inve s t m e n t .

regressions, we used either GDP p e r capita or secondary enrollment as

Hence, to j u stify corruption o n t h e basis o f t h e E a s t Asian p aradox i s

the control variab l e .

misleading.

When G D P p e r capita is u s e d as t h e control variable, both t h e extent

There s t i l l i s m u c h to l e a r n about corruption a n d e c o n o m i c devel­

and predictability variables have the right sign and are significant at 5

opment. Research o n this matter is very much in a nascent stage. One

p ercent. The control variable is also of the correct s ign and significant

issue that definitely n e e d s studying i s the implication of highly orga­ nized (and thus m o r e p r e d i ctable) fo rms o f c o rruption fo r sustaining

at the 10 percent level. B ecause the sample s ize is sm all-twenty- o n e to twenty- three o b ­

high rates of growth . The chapter suggests that countries can b e c l as ­

s e rv a t i o n s i n a l l - t h e s e r e s u l t s m u s t b e i n t e r p r e t e d w i t h c a u t i o n .

sifie d into three categorie s : tho s e with high levels and a low degree of

N evertheless, they p rovide further evidence supporting our hyp o thes e s .

predictab ility i n c o rrup t i o n ; t h o s e with high levels and a high degree of predi ctability; and t h o s e with low levels and a high degree of pre­

Conclusion

dictability. E ast Asia's miracle e c o n o mies fall into the s e c o n d catego ry,

Emp irical evidence indicating that corruption impedes growth and

the developed countries into the third. The implication here is that fo r

investment has begun to emerge, with academics and scholars increas ­

East Asia's miracle e c o n o m i e s to m ove o n to their n ext s t age of e c o ­

ingly devoting more time to study the surrounding issues. These findings

nomic development, they would have to reduce t h e level of corruption.

p arallel the emerging concern of politicians and p o licy makers around

The exp l o s i o n o f the Asian e c o n o mic c r i s i s suggests that this may in

the world about the deleterious effects of corruption on economic per­

fact b e the cas e .

fo rmance and increasing effo rts to try to address its underlying cause s .

T h e rest of t h e volume presents country case studies that elabo rate

Despite these, there remains a lot to learn about co rrup tion: i t s conse­

on this Asian p aradox and suggest why it i s intimately linked to the

quences, its cau s e s , and effe ctive strategies fo r controlling it.

c risis .

T h i s c h a p t e r h a s been m o tiva t e d by a s e e m i n g p a r a d o x in E a s t A s i a : the p o s itive c o r r e l a t i o n b e twe en high r a t e s o f inve s t m e n t a n d g r o w t h w i t h r e l atively h i g h l e v e l s o f c o r ru p t i o n . C o nve n t i o n a l wi s ­

APPENDIX MODELS OF PREDICTABILITY

d o m i n e c o n o m i c t h e o ry s u g g e s t s t h a t w e a k p r o p e r ty righ t s , o ft e n

We present two simple models that encapsulate our notion of pre­

m a n i fe s t e d b y h i g h levels of c o r ru p t i o n , retard inve s t m e n t a n d thus

dictabil ity. In t h e fi r s t , we present a two - p e r i o d m o n o p o l istic regime

e c o n o m i c growt h . East A s i a's exp e r i e n c e h a s p o s e d a s e r i o u s c h a l ­

which captures the effe ct of uncertainty over time. I n the second, we

l e nge to t h i s hypothesis . The chapter attempts to unravel this paradox.

consider an " O - ring" typ e corruption regime. This setup is akin to Shleifer

Specifically, it argues that it is not only the level of corruption that affects

and Vishny's ( 1 9 9 3 ) i n d e p e n d e n t corruption re gime.

investment but also the nature of corru p t i o n . Corruption regimes that a r e more p r e d i c t a b l e - i n t h e s e n s e that th o s e s e e k i n g fav o r s fr o m

" M o n o polistic" C o rruption and Uncertainty

g o ve r n m e n t d o o b t a i n t h o s e fav o r s - h ave l e s s n e gative i m p a c t o n

Consider a firm that p l ans to make an investment over two periods.

inve s t m e n t than t h o s e that are l e s s p r e d i c t a b l e . I n m any o f E a s t A s i a's

A bribe i s needed fo r a single firm to o p e rate successfu l l y. Let u s con-

20

21

Corruption and Its I mplications for I nvestment

Corruption and Its Implications for Investment

sider two scenari o s . In the first, both the period 1 and p eriod 2 brib e s ,

will invest l e s s (if it ever d o e s ) whe n the s e c o n d period bribe p ayment

b l and b z ' a r e m a d e known b eforehand. By c o ntrast, in t h e second, b l i s

is uncertain. l o

known but b z is unknown. We assume that the firm will o p erate in t h e s e c o n d p e r i o d o nly if the b r i b e is affordable; the investment is simply abandoned if the bribe is too high. We can show that less investment will o ccur in the second scenario. The outcome predictability is l ower as the

O - Ring Corrup tion

Now assume once again there is a single firm but this time it needs sep arate approvals from two officials.

II

Unl e s s it obtains b o th a p p rov­

s u c c e s s or failure of a given bribe i n the s e c o n d p e rio d is not known

als, its investment will not b e p ro ductive. We posit two scenarios. I n the

until the s e c o n d p e r i o d .

first, the b rib es o ffered to each official are made known beforehand; in

L e t I b e the investment l evel of a s p ecific firm. T h e cost o f capital

the o t h e r, o n ly one o f t h e b r i b e s i s known b efo reh a n d . M o r e over, i n

i s c (I ) . The inve s t m e n t lasts fo r two p e r i o d s . I t generates an i n c o m e

either scenario, if the s e c o n d required b r i b e p ayment is t o o high, the

stream o f f ( l ) if it is in o p e ration . To b e in o p eration in p eriod i, a bribe

firm simply quits a n d takes the loss e q uival e n t to t h e fir s t b r i b e and

p ayment of b i is required , i = 1 , 2. We b egin with scenario 1 i n which b J a n d b2 are b o th known b efo re h a n d . Here t h e firm 's p r o fit is

o c c u r s u n d e r the s e c o n d s c e n ario.

whatever capital c o s ts i t h a s i n curre d . We s h ow that less inve s t m e n t H erein, bl and b2 are bribe p ayments to the two corrupt official s . The investment will n o t b e i n o p e rati o n u n l e s s b o t h p ayments are m a d e . Again, w e consider two scenario s . I n scenario 1 , both b l a n d b z are known.

where 8 is the discount rate. The resulting first order condition for p rofit

The firm's p r o fit fun c t i o n is given by

m aximization is 1t 1 ' ( l ) = ( 1 + 8 ) / , ( l ) - c '( l ) :<=; o .

The corresp o n ding first o r d e r c o ndition fo r p ro fit maximization is A n interior solution J' satisfying 1t I ' (n = 0 exists if 1t J ' (n ;?: O . Other­ 1t l ' ( l ) = !'( l ) - c '( l ) :<=; O .

wise , the firm will not invest at all. F o r scenario 2 , we assume b l is known but b2 is a random variable. I n this case, the firm will simply quit if b2 is not affordable. The firm's exp e cted p r o fit function is then

A n interior s olution II s atisfying 1t I ' (Id = 0 exists if 1t I (II ) ;?: O . Other­ wis e , n o inve stment will b e undertaken. Under s c e n ario 2 , the firm p ays b l first without knowing the exact

1t A l ) = ( / ( l ) - b d + 8 E [ m a x (f( l ) - b :!, O ) J -c ( l ) .

amount o f b z . If b2 is affordable, it will b e paid and the project will be undertaken . If it turns out that b 2 is large, the firm may then choose to

where E [ . J is the exp ectation o p erator. Let H ( .) denote the p r o b ability

quit and take a l o s s . I n this instance, we assume the firm loses a p o rtion

distribution function of b z . The first order condition fo r expected profit

of the capital cost a c(1 ) as well as the first bribe p ayment b l . The firm's

m aximization is

exp ected p r o fit function is give n by f( l )

1t z ' ( l ) = f' ( l ) + 8

o

f

1t 2 ( l ) = E [ m a x ( f ( l ) - � ( l ) - bl - b 2 , - a c ( l ) - b ] ) J .

!' ( l ) dH ( b 2 ) - c ' ( l ) :<=; O .

An interior solution 1" satisfying 1t z ' W ) = 0 exists if 1t2 W ) ;?: O . Oth­ erwise, the firm will n o t inve s t . T h r o u g h o u t t h e a n alys i s , we a s s u m e f( . ) i s a c o n c ave fun c t i o n

or, more p re c i s e ly,

f

a

B

(f(1 ) - c (1 ) - b l - b z ) dH ( bz )

a n d c ( . ) is a c o nvex fun c t i o n to e n s u r e t h e s e c o n d o r d e r c o n di t i o n s a r e s atisfie d . B e cause

1t z

'

(n :<=; 0 , it follows t h a t 22

[ O :<=;

r. T h a t i s , t h e firm

+

B

f

wh e r e B = f(l ) - ( 1 - a ) c (l ) . 23

( - a c (l ) - b d dH ( b2 )

Corruption and Its Implications for Investment

The resulting first order condition i s

1t2' (l) ::; 0 ,

CHAPTER TWO

that is,

(f(1) - c ' (1)) H e t(I ) ( l - u ) c (1)) - uc ' (1) [ 1 - H (f(I ) - ( l -a ) c (I ) ) ] ::; O. -

An interior solution satisfying

1tz' (Iz)

=

0 exists if

1tz(Iz) ;::: O .

Otherwise,

no investment will b e undertaken. Again, it is easily seen that Ii ;::: lz. That i s , the uncertainty with the second bribe p ayment reduces the inve s t ­ m e n t amount.

INVESTMENT, PROPERTY RIGHTS , AND CORRUPTION IN INDONESIA Andrew MacIntyre

The notion that investors, p articularly p rivate investors, require i n ­ dep e n d e n t and e ffective l e g a l i n s t i t u ti o n s t o c o n t a i n co rrup t i o n a n d secure their p r o p e rty rights e nj oys very w i d e currency i n both the aca­ demic literature (No rth 1 9 8 1 , North and Weingast 1 9 8 9 , Root 1 9 89) and the p o licy community ( World Bank 1 997b and c, RESPONDACON III 1 996, Elliot 1 9 9 6 , Tra ns p arency Internatio n al 1 9 9 7) . I t i s n o t hard to under­ stand why the core idea here has been so widely embraced by economists and p olitical economists from Smith and M arx to the current generation of institutional theorists centering o n D ouglas N o rth. If contracts cannot be enfo r c e d i n a reaso nably o bj ective way and if governments are n o t constrained fro m acting co rruptly o r capriciously, t h e risks to p o t e n tial investors are likely to become very high . And yet, as all students o f East Asia know, there are a number o f c o u ntries in the region that h ave ex­ perienced strong investment and strong e c o nomic growth over s everal decades in an i n s titutional e nviro nment b e aring little, if any, c o m p ari­ S o n to that n o rmally prescribed b y the literatu r e . I n d o ne s i a is o n e o f thes e countri e s . H ow a r e w e to explain s u c h cases? O n e recourse is to highlight the fa ct that fro m the viewp o i n t o f e c o n o m i c h i s t o ry, s everal d e c a d e s are b arely r e m a rkab l e and that over the l o n g e r h a u l the b i t e of N o rt h's institutionalist l o gic will indeed be felt. I n other words, the high - growth e c o n o m i e s of E a s t A s i a will e i t h e r d e ve l o p an a d e q u a t e i n s t i t u ti o n al fr a mewo rk o r their e c o n o m i c p e rfo rmance will fal l away. This may b e so. Indeed, s o m e c o m mentators would have it that this was t h e fun d a ­ m e n t a l l e s s o n o f t h e A s i a n e c o n o m i c c r i s i s o f 1 9 9 7- 1 9 9 8 : l a c k o f 24

25

Investment, Property Rights, and Corruption in Indonesia

transparency, crony capitalism, and co rruption fin ally caught up with the region and, accordingly, the wh ole economic house o f cards collapsed. Yet this is much too simple. Asia's economic crisis was about very much m o re than transp arency and p r o p e rty rights, a s illustrat ed by C h i n a's abil ity to ride out the e c o n o m i c storm rel atively unscathed. I do n o t dispute the n o t i o n that the absence o f reasonably secure p r o p e rty r i ghts i s a s e r i o u s o b s tacle to inve s t m e n t and growth . I do, however, question the notion that this can only be achi eved on the basis of a n i n d e p e n d e n t l e gal sys t e m . B a s e d o n a novel i n t e r p r e t at i o n o f Indonesia's experiences, I suggest that there are other mechanisms that can function as satisfactory alternates in the interim, though their dura­ bility i s limited. In the long run , an independent legal system does seem l ikely to b e the m o s t reliable fo undati o n fo r s e c u r i n g p r o p e rty right s . However, business people, policy makers, and even social scientists have

Investment, Property Rights, and Corruption in Indonesia

a credible commitment about the future p o l i cy environment to the i n ­ ve stment community. I n the next section I will lay out the relevant empirical evidence o n In d o n e s i a's i nve stment r e c o r d and its i n s titutional - setting. T h e s e c t i o n following t h a t c o n t a i n s the core analys i s , p r o c e e d i n g through t h e three stages of the argument outlined above . The fundamental argument here i s that wh i l e a N o rthian logic i s c o m p e l l i n g over the long term, i t has much less to tell us about the short and medium term and may obscure rudimentary alternatives that can substitute effectively fo r a significant period o f time. The final section draws the threads together and reflects upon the current economic collapse and the s adly ironic likelihood that movement to more open and transparent politics i n I n d o n e s i a i s l ikely to l e a d to worse problems of co rrup t i o n and p r o p e rty rights .

m u c h s h o rt e r t i m e h o r i z o n s . F o r t h e m , s u c h a p o s i t i o n is of l i m i t e d immediate utility. I f a country c a n achieve strong investment flows a n d strong economic growth for thirty-odd years without institutional trans­ p ar e n cy and a n e ffe c tive legal framework, then p e o p l e i n t e r e s t e d i n making m o ney, i n making public p o l icy, a n d i n theorizing the interac­ tion betwe en the two, have a strong interest i n understanding how this is possible. T h i s c h a p t e r o ffe r s a t h r e e - s t e p exp l a n a t i o n fo r t h e p u z z l e o f Indonesia's combination o f pervasive co rrup t i o n a n d strong investment

The Empirical Record

The figure for total investment as p e rcentage o f GOP i n Indonesia­ like the c o r r e s p o n d i n g fi g u r e s fo r t h e o t h e r h i g h - growth deve l o p i n g economies o f E a s t A s i a-is n o t p articularly remarkable b y world s t a n ­ dards . As figure 1 shows, t h e average result fo r Indonesia between 1 96 6 a n d 1 994 w a s roughly comp arable ( 2 5 . 0 p ercent) with t h e weighted re­ sult for all o f developing Asia (22 . 1 percent) and all developing countries (2l.4 perce nt) .

under Suh arto. The first i s to point to standard economic factors influ­ encing exp ected rates o f return o n i nves t m e n t . I f there are very l arge p r o fi t s to b e had, i nv e s t o r s are likely to b e will i n g to bear i n c r e a s e d

Figure 1 Average Total I nvestment as a Percentage of GDp, 1 9 66- 1 994

c o s t s a s s o c i ated with b r i b e ry and i n c r e a s e d r i s ks a s s o c i ated w i t h l e s s c e rt a i n p r o p e rty rights . T h e s e are fam i l i a r argu m e n t s , but i m p o rtant nonetheless. The second step in the argument shifts the fo cus in a more p o l i t i c a l d i recti o n . Drawi ng o n the wo rk o f Shleife r and Vi shny ( 1 9 9 3 ) . I argu e that the p revai l i n g p o litical structure in I n d o n e s i a during the N ew Order period 0 9 6 6- 1 9 8 8 ) gave President Suharto the o p p o rtunity

0' fa

a n d , m o re i m p o rtant, the i n c e n t ive to allow c o rru ption to fl ourish but to ensure that its costs did not drive down investment. Key to this was the p re s i d e n t 's ability to m o n i t o r the b ehavi o r o f o ffi c i als and enfo rce his core p references, thereby minimizing agency loss. The third step is to argue that wh ile the i n c e ntives o f p o l i t i c al leaders are an i m p o rtant

I ndonesia

part o f the sto ry, there still remain s a mi s s i n g link needed to reassure investors about the fu ture behavi o r of government. Thi s last piece in the puzzle i nvolves the gove r n m e n t tyi n g its own h a n d s in o r d e r t o make 26

SOlJRCT: IfS Yearbook

All Developing Asia

1 996, 1 5 4 - 5 7 .

NOTE: f i gures fo r reg i o n s are w e i g h t e d averages.

27

All Developing Countries

Investment, Property Rights, and Corruption in Indonesia

I f we fo cus o n private investment, however, we see a quite different story. As figure 2 shows, between 1 980 and 1 994 Indonesia (along with the

Figure 3 Direct Foreign Investment as a Percentage of Total Investment: Indonesia, Taiwan, and Korea, 1 965- 1 994

other high - growth East Asian economies) had a markedly higher average level o f p rivate investment than other parts o f the developing worl d . Figure 2 Average Public a n d Private Investment as a Percentage of G D P, 1 9 8 0- 1 9 9 4

_

25% a)% I n donesia

15%

_ Taiwan

_ Korea

10% Public I/G D P

P rivate I/G D P

5% 0% -5% -10% 1005

%

1 969

1972

1 975

1 978

1 981

1 984

1 987

1 991

1994

SOURCE: IPS, various issues. NOTE: Three-year moving averages.

The surge of F D I into I n d o n e s i a in the late 1 9 60s and e arly 1 9 7 0 s represents t h e return o f " o l d " and "new" capital followi ng the massive capital flight fro m the co untry in the mid - 1 960s. Indonesia

East Asia

South Asia

Latin America Middle East Sub-Saharan & Caribbean & N o rth Africa Africa

Figure 4 Direct Foreign Investment as a Percentage of Total Investment: Philippines, Thailand, and Mal aysia, 1 965- 1 9 94

SOIJHC I : J aspersen. Aylward. and Sumlinski 1 99 5 . N m E: F igures fo r regions are simple averages.

25 % 4) % I f we d i s aggre gate total inve s t m e n t to h i gh l i gh t the contribution o f fo reign capital and l o c al capital, I n d o n e s i a e m e rges as an intermediate case by East Asian standard s . As figures 3 and 4 show, F D I as p e rc entage

15 % 10 %

o f t o t a l inve s t m e n t i n I n d o n e s i a h a s b e e n m a r k e d l y l e s s t h a n i n t h e

5%

m o re o p e n e c o n o m i e s o f Thailand and p ar t i c u larly M alaysia and

0%

Sin gap ore, but greater than in the m o r e restrictive N o rtheast Asian N I C s , Ta iwan and S o u t h Kore a . I f c o n s i s t e n t d a t a s e r i e s w e r e available u p to the outbreak o f the Asian economic cris i s , they would show I n d o n e s i a co ming to resemble the pattern of the Philip p i n e s and Thailand , as fo r­ e i gn i n v e s t m e n t h a s c o n t i n u e d t o rise as a p o rt i o n o f t o tal inve s t m e n t i n t h e last few years . 28

-5 % _ Philippines

-10% 1 005

1 969

1972

_ Thailand

1 975

1 978

SOURCE: IrS. various issues. NOTE: Three-year moving averages. 29

1981

M alaysia

1 984

1987

1991

1994

Investment, Property Rights, and Corruption in Indonesia

Why would p r i va t e investo rs-wh e t h e r l o c a l or fo r e i gn-r i s k t h e i r m o n e y in a s e t t i n g wh ere the l e gal system w a s of such doubtfu l stand­ ing t h a t S u p r e m e C o u rt j u s t i c e s r i d i c u l e d t h e i r c o l l e a g u e s a s b e i n g h o p e l e s s ly c o rr u p t . where t h e p re s i d e n t h i m s e l f acknowl e dges that the l e gal sys t e m was b e s e t w i t h d e e p - s e a t e d p r o b l e m s o f c o rrup t i o n . a n d m o re p o i n t e dl y. where b u s i n e s s p e o p l e l a r g e l y a b a n d o n e d t h e n o t i o n t h a t the legal sys tem w a s an effective v e h i c l e fo r arbitrati n g commercial d i s p u t e s ? Beyond w e l l - r e c o g n i z e d p r o b l e m s with i t s fo rmal legal sys ­ t e m . I n d o n e s i a a l s o h a s a r e p u t a t i o n fo r s y s t e m i c c r o n y i s m a n d c o rr u p t i o n i n t h e a d m i n i stra t i o n o f gove rn m e n t . I n t h e l a t e r years o f Suharto's rule, endless comp l aints were directed at t h e rap acious rentier

Investment, Property Rights, and Corruption in Indonesia Explanations

How then are we t o explain the c o exi s t e n c e i n I n d o n e s i a of strong p ri vate inve s t m e n t a n d growth o n the o n e h a n d , and weak l e gal guar­ antee s o f p r o p e rty rights with widespread c o rruption o n the other? The explanati o n devel o p e d here is in three p arts; the first deals with trad i ­ tional e c o n o m i c fact o r s , whi l e t h e s e c o n d a n d third fo c u s o n p o li t i cal var i a b l e s u n d e r p i n n i n g gove r n a n c e arrang e m e n t s . Economic Conditions a n d R ates o f Return

The recent up surge o f theoretical interest i n governance should n o t

business practices o f h i s c h i l d r e n , grandch i l d r e n , and business as s o c i ­

c a u s e u s t o l o s e s i g h t o f t h e i m p o r t a n c e o f m o r e fam i l i a r- a n d t h u s

a t e s , as w e l l as the o ffs p ring a n d ass o c i ates o f o t h e r s e n i o r officials. Yet

p e rhaps l e s s exc i t i n g- e c o n o m i c var i a b l e s t h a t i n fl u e n c e inve s t o rs ' e x ­

this was s c arcely a new p h e n o m e n o n ; if o n e were to scan the p ages o f

pectations a b o u t rates o f return. T h e e s s ential p o i n t h e r e is simp l e , b u t

t h e p r e s s ten o r twen ty years a g o o n e w o u l d encounter t h e s a m e c o m ­

impo rtant nonetheless. I f t h e expected rate o f return is sufficiently high.

p l ai n t s a b o u t an o l d e r g e n e r a t i o n o f p l aye r s . I n s h o r t , although m a n y

inve s t o r s will be willing t o bear s o m e i n c r e a s e d c o s t s a s s o c i a t e d with

o f the characters surrounding Suharto had changed, the same basic

bribe ry and some increased risk associated with the u n certainty o f fo r­

p attern had b e e n i n p l a c e s i n c e t h e e arly d ays o f t h e r e g i m e . I n d e e d ,

mal property rights. I n Indonesia's case there were a number of impo rtant

t h e literature o n I n d o n e s i an p o l itical economy groans u n d e r t h e weight

fact o rs that c o n tr i b u t e d t o the c r e a t i o n of a b u s i n e s s e nviro n m e n t in

of anecdotal evi d e n c e of p e rvas ive clientelism and corruption ( R o b i s o n

which g o o d rates o f return could b e exp e c t e d . These can b e organized

1 9 8 6 , Pangaribuan 1 99 5 , M a c I ntyre 1 9 9 4 . M u h a i m i n 1 99 1 . Schwarz 1 9 9 4 .

under four broad headings: the p revailing rate o f economic growth, the

Winters 1 994) .

macro e c o n o m i c s e t t i n g . t h e m i c ro e c o n o m i c i n c e ntive s t r u c t u r e . and

P rivate investors o p e rating in I n d o n e s i a-ranging fro m U S t e l e c o m ­

secto r - s p ec i fi c fac t o r e n d owme n t s .

m u n i c a t i o n s c o m p a n i e s , J a p a n e s e c a r m a n u fa c t u r e r s . a n d C a n a d i a n

T h e first o f these is s o o b v i o u s i t can e a sily b e overl o o k e d : growth

goldmining c o m p a n i e s to large I n d o n es i an c o n s truction c o m p a n i e s and

itself b e ge t s furth e r investment. Once solid growth rates were b e i n g re­

s m al l I n d o n esian rice fa r m e rs-all had t o grap p l e with the i m p o rtance

cor ded in Indonesia in the late 1 960s and e arly 1 97 0 s . this in itself became a maj o r factor encouraging further investment. The importance of a gen­

of p o l i t i c al connecti o n s . Altho u gh there was some secto ral variat i o n . in g e n e ral the bettcr o n e 's c o n n e c t i o n s , the gre a t e r o n e 's chances o f secur­ ing t h e plum d e al s , o b t a i n i n g p rc fe r e n t i al r e g u l a t o ry t r e a t m e n t . a n d e s c a p i n g i n c o n ve n i e n t c o n t r a c t u a l o b l i ga t i o n s . C o n v e r s e l y and m o r e wo rryin gly, the weaker o n e 's c o n n e c t i o n s the m o re vul n e rable o n e was to fal l i n g v i c t i m t o the p r e d a t o ry t r a d i n g p r a c t i c e s o f t h o s e wh o were well c o n n e c t e d . Such p r a c t i c e s range fro m fi n a n c i al i m p o s t s to fo rced

erall y sound macro e c o n o mic framework for investors also requires li ttle dis cussion. This has been o n e of the defining and most widely discussed fe atu res o f the New Order ( H ill 1 9 9 6 ; B attacharya and Pangestu 1 9 9 3 ; Woo, Glassburner. and Nasution 1 99 4 ; Little et al . 1 99 3 ; B o o th 1 99 2 ; Wo rl d B ank 1 99 3 a and b ) . By c o m p a r i s o n with the r e c o rd of macro e c o n o m i c man a g e m e n t p r i o r t o 1 9 6 6 . w h a t fo l l o w e d s e e m s s p e c t a c u l a r l y g o o d .

low ranki n g . And yet , as we h ave s e e n . i n s p i t e of the negative effe c t s

The key elements were stable exchange - rate management. a satisfactory i nfl a t i o n ary r e c o rd , a c a u t i o u s a p p r o a c h to s p e n d i n g , a g o o d s av i n g s r ate , and inve s t m e n t in p u b l i c infrastructure and human c a p i t a l .

o n e m i ght e x p e c t t h i s t o h ave o n r i s k a s s e s s m e n t s a n d c a l c u l a t i o n s

S o m e w h a t m o r e a m b i gu o u s , b u t n o n e t h e l e s s i m p o r t a n t . w e r e

mergers and take o v e r s . I t i s s c arcely s u r p ri s i n g t h e n that the i n t e r n a ­ ti onal i n d e x e s of nat i o n al corruption c o n s i sten tly gave I n d o n e s i a a very

a b o u t t h e c o s t o f d o i n g b u s i n e s s , fo r e i gn an d l o c a l fi r m s have c o n t i n ­

micro e c o n o m i c i n c e ntive s . On t h e o n e h a n d . vari o u s rounds o f l i b e ral­

u e d t o i nvest s t r o n g l y i n I n d o n e s i a . T h i s i s n o t what t h e c o nve n t i o n a l

i z i n g t r a d e and i n ve s t m e n t r e fo r m s h av e b e e n w i d e l y h a i l e d as

i n s t i t u t i o n a l i s t wi s d o m wou l d l e a d o n e t o e xp e c t .

e n c o u r a g i n g i n ve s t m e n t by r e m o v i n g d i s t o r t i o n s a n d c r e a t i n g

30

31

a

less

Investment, Property Rights, and Corruption in Indonesia

Investment, Property Rights, and Corruption in I ndonesia

u n even co mmercial p l aying fie l d . O n the other h a n d , and in seeming

this by drawing on and adopting the now widely discussed work on cor­

contradiction, other illiberal microeconomic measures to restrict or elimi­

ruption by Shleifer and Vishny ( 1 993) . They draw an analogy from indus­

nate comp etition in p articular sectors were also p owerful incentives to

trial organization theory to model the consequences of the political and

other investors who stood to capture the rents thus created.

institutional environment on the level of corruption and the extent to which

A final general category of factors that had a significant impact o n

it inhibits investment and economic growth. The underlying model is that

calculations of exp ected rates of return p e rtains to factor endowments.

of Augustin Cournot's ( [ 1 838J 1 9 7 1 ) complementary monopolies, that is, a

The most glaring example of this was of course the o il and gas sector;

contrast between the p ricing decisions of a single monop olist who pro­

the natural resource rents that stood to be captured by investors in this

duces strongly complementary goods and multiple independent monop o ­

sector were very substantial indeed. Similar stories can al so b e told o f

lists, each producing only o n e of t h e strongly complementary goods. The

the timber and mining industrie s , and indeed of the abundance of cheap

single monopolist will have an incentive to price his goods in a concerted

labor for the manufacturing sector.

fashion, b e c ause pushing up the price o f one o f his goods will tend to

To summarize, we n e e d to be clear that traditio n al economic vari­

push down demand for the others since consumers require all. Conversely,

ables b e aring o n p roj ected rates o f return assuredly had an i m p o rtant

where there are multiple independent monopolists , even though the goods

b e aring o n the will i n g n e s s o f p rivate i n ve s t o r s t o c o m m i t c a p i tal to

remain stron gly complementary, they will tend to push up the price of

Suharto's I n d o n e s i a . Alth o u gh n o s e r i o u s e m p i r i c a l m e a s u r e m e n t of

their respective p roducts and all will suffer.

p r o fitability in I n d o n e s i a is presented (such calculati o n s would b e ex­

Shleifer and Vishny take this i n sight and apply it to corruption by

tremely problematic) , a p riori there can be little doubt that conventional

fo cusing on b r i b e ry and the market fo r government regulato ry g o o d s

economic variables play an important part in explaining the strong flow

(L e . , licenses a n d p ermits n e e d e d by fi r m s to do business) . They assume

of p rivate investment over the past thirty years .

t h e r e are m u l t i p l e r e g u l a t o ry g o o d s i n v o l v e d a n d t h e r e is s t r o n g

This much is not difficult to agree upon. However, there remain good

complementarity among them all ( s o that p o tential investors will need

gro unds for believing that this does not provide the whole explanation

a building p ermit, and an i m p o rt license, and employment c o ntracts ,

to our puzzl e . R e c e n t c o m p arative e m p i ri c al works by M auro ( 1 9 9 5 ) ,

etc) . For present purp o s e s , the relevant point is the contrast they draw

Ke e fe r and Knack ( 1 9 9 5 ) , J a s p e r s e n et a l . ( 1 9 9 5 ) a n d the Wo rld Bank

betwee n two stylized m o dels of the market for government regulat o ry

( l 997b and c) point to s o m e correlation b etween the quality of institu­

goods under authoritarian or weakly democratic p olitical conditions and

tio nal arrange m e n t s a n d e c o n o mi c p e r fo r m a n c e . Plai nly, this is very

where corruption is rife (and, by implication, legal institutions are weak) ;

slipp e ry gro u n d , both empirically and theoretically. While these broad­

one highly centralized, and the other much less so. In the first, national

gauge quantitative studies can be regarded as suggestive only, they do at

p o l i t i c al l e a d e rs h i p exe r c i s e s a s u ffi c i e ntly s t r o n g grip on regulato ry

least provide s o m e e m p irical s u p p o rt fo r t h e view that i n s t i t u t i o n a l

agencies that we can think of the relevant sections of the state as func­

weakness will t e n d to p r o d u c e a d r a g o n investment and growth. A n d ,

tioning almost like a s i ngle c e n trally c o o rdinated m o n o p o ly fo r bribe

of course, this is a central tenet of the whole Northian institutionalist logic.

collecting. Strong p olitical leaders are able to p revent regulatory age n ­

Assuming p o o r e c o n o mic governance d o e s i n d e e d exert a s ign ifi ­

c i e s fro m a c t i n g i n d e p e n d ently and to ensure t h a t a h e althy s h a r e o f

cant negative influence o n investment a n d growth o n c e w e co ntrol fo r

b r i b e s c o l l e c t e d fl ows upwards, with the r e m a i n d e r b e i n g distributed

rates of return co nsiderati o n s , the remaining task b e c o m e s o n e of ex­

p r o p o rt i o n ately and p r o m p tly among rel evant o fficials . In s h o r t , o ffi ­

plaining why this has not proven more of a p roblem in Indonesia. It is

c i a l s i n r e g u l a t o ry age n c i e s are u n a b l e to o p e rate i n d e p e n d e n t l y to

to this more interesting challenge that I now turn .

m aximize their own take . Under t h i s m o d e l , if a fi rm is s e e k i n g the necessary permits to establish a factory it acquires secure property rights

I n s titutions and Political I ncentives

The s e c o n d stage o f my explanation fo c u s e s s q u arely o n p o s s i b l e

to the p ackage of regulatory "go o d s " thus p u rchased o n c e i t has p r o ­ vided the approp riate c o rrupt i n d u c e m e n t s .

c o n n e c t i o n s b e twe e n the i n s t i t u t i o n a l environment and the n a t u r e o f

The s e c o n d m o d e l i s o n e i n which p o l it ical control is w e a k e r and

governance, and explores t h e incentives available to p olitical leaders. I d o

less central i z e d . Instead o f a situation a p p roximating a single monopo-

32

33

Investment, Property Rights, and Corruption in Indonesia

Investment, Property Rights, and Corruption in Indonesia

l i s t , there i s a m u l t i t u d e of i n d e p e n d e n t m o n o p o l i s t s s e l l i n g c o m p l e ­

their p r o d u c t ive b u s i n e s s . Note the c o u n t e ri ntuitive result h e r e : u n d e r

m e ntary regulatory g o o d s . B e c a u s e t h e p o l i ti c al leadership is unable to

c o n d i t i o n s o f s t r o n g c e n t ralizat i o n t h e r e wil l b e m o r e b r i b e s c o l l e c t e d

exerc i s e e ffe c t ive c o n t r o l over b u r e a u c ratic age n c i e s , officials ( o r their

a n d h i g h e r t o t a l reve n u e e x t r a c t e d fro m t h e p r ivate s e c t o r, b u t l e s s

r e s p e c tive age n c i e s as a w h o l e ) seek t o maximize their own take b y

d amage w ill b e d o n e t o t h e e c o n o my b e c a u s e t h e b r i b e s w i l l n o t b e

a c t i n g as i n d e p e n d e n t m o n o p o l is t s and p u s h i n g u p p r i c e s w i t h o u t r e ­

priced excessively (that i s , they wi ll not drive down demand significantly) .

gard for t h e effect o n overall demand for government goods. Also, unlike

Shleifer and Vishny's ins ight into the pricing of bribes and, by exten­

the single m o n o p o l i s t m o d e l , i n this s i t u a t i o n the fi rm p u rc h a s i n g all

sion, the security of property rights, i s a p owerfu l one. To o p e rationalize

these government goods can never be sure it has secure property rights

it, however, we need to dissect more carefully the p o litical preconditions

as any agency might s u b s e q u e ntly s e e k to extract fu rther b r i b e s . The

fo r these styli z e d m o d e l s they sketch. To think o f a single m o n o p o l i s t

weaker the p olitical leadership's contro l , the greater the s c o p e fo r i n d e ­

simply as a strong o r centralized government is to s l i d e too quickly over

p e n d e n t and u n c o o rd i n a t e d extrac t i o n by o ffi c i a l s p u r s u i n g their own

key d e t a i l s . A s p e c t r u m o f gove r n m e n t s in the n o n d e m o c r a t i c w o r l d

i n d ividual i n t e re s t s . Mo reover, if the l e a d e r i s not c o n fi d e n t that c o o r ­

wou l d fal l under t h i s heading, and y e t fai l to behave according to exp e c ­

d i n a t i o n can b e enfo rc e d , h i s o r h e r b e s t i n t e r e s t s are s e rved by acting

tati o n s . T h e k e y i s s u e is n o t regime - typ e , but t h e institutional capability

as an i n d e p e n d e nt m o n o p o l i s t as well , and c o m p e ting dire ctly with all

o f the l e a d e r t o m i n i m i z e p r o b l e m s o f agency l o s s-offi c i a l s b e h aving

o t h e r o fficials. ( C r u d e ly, i f y o u can't b e at the m , j o in them . )

i n a manner c o ntrary to the l e a d e r 's wishes. Whi l e t h e re i s a range of

The key p o int t o b e drawn fro m Shleife r and Vishny i s that there may

m e c h a n i s m s by w h i c h a g e n cy l o s s can be a l l e v i a t e d ( Ki e w i e t a n d

be an important analytical distinction to b e drawn b e tween situations in

McCubbins 1 99 1 , c h . 2 ) , in most deve l o ping country contexts monitoring

which corruption i s p e rvasive but the framework of government is tightly

and enfo r c e m e n t are p ivo t a l . Given that n o l e a d e r can d i r ectly c o ntrol

c entralized and thos e where it is l o osely centralize d . I f the leader e nj oys

all decisions o n the sale of regulatory go o d s , his o r her ability t o m i n i ­

strong control over regulatory agenc i e s , then we can think of his or her

m i z e p r o b l e m s of agency loss w i l l depend on t h e leader's abili ty to know

i n t e r e s t s o n the p r i c i n g o f b r i b e s as b e i n g e q u ival e n t t o tho s e o f t h e

whether e rrant behavior is taking place and then to deter it. M any lead­

s i ngle monopolist under conditions of strong complementarity. A s s u c h ,

e rs-p art i c u l arly i n a u t h o r i t a r i a n s e t t i ngs-have a n a b i l i ty t o p u n i s h ;

h e o r she has a d i r e c t i n t e r e s t i n i m p o s i n g c o o rd i n a t i o n and e n suring

m u c h l e s s c o m m o n is a n ability to m o n i t o r effectively. Accordingly, few

that no individual agency enriches itself at the exp e n s e of the system as

p o l itical leaders are in situations which give them the ability-and thus

a wh o l e , and the p o l it i c a l l e ad e rship in p articul ar. O n the other hand ,

the i n c e ntive-to e n fo r c e " c o o r d i n at i o n" a m o n g t h e i r re n t - h a rv e s t i n g

w h e r e t h e l e a d e r e n j o y s o n ly weak c o n t r o l o v e r r e g u l a t o ry age n c i e s ,

agents. Not surprisingly, t h e n , u n p redictable a n d destructive patterns of

official s will b e far l e s s constrain e d . Facing the incentive structure of the

corruption (the multiple independent monopolists) are very common i n

i n d e p e n d e n t m o n o p o li s t s u n d e r c o n d i t i o n s of s t ro n g c o m p l e m e ntarity,

deve l o p i n g c o u n t ri e s .

they w i l l s e e k to m a x i m i z e t h e i r own t a k e s by d r i v i n g u p t h e b r i b e s

I argue that I n d o n e s i a was a b l e to e s c a p e this c o m m o n syn d r o m e

n e c e s s ary t o o b t a i n the p ar t i c u l a r r e g u l a t o ry g o o d s t h a t t h e y c o n t r o l ,

because fo r m any y e a r s t h e p o l itical and instituti o n al framework w a s a

even though this will drive down overall d e m a n d . According to this logic,

rem arkable a p p ro x i m a t i o n of the e c o n o m i cally l e s s d e s t ru ctive singl e ­

s t r o ngly centralized gove r n m e n t will p r o d u c e l o w e r i n d ividual b r i b e s ,

m o n o p o l i s t m o d e l. The p o l i t i c a l fra m ework d e ve l o p e d u n d e r S u h a r t o

but a higher level of overall rent collected ( b ecause m o re bribes w i l l b e

did indeed c e ntralize power heavily a r o u n d t h e p r e s i d e n t and gave him

c o l l e c t e d ) . A l o o s e r, l e s s - c e n t r a l i z e d gove rn m e n t w i l l p ro d u c e h i g h e r

a c r e d i b l e c a p a b i l i ty fo r m o n i t o r i n g the b e havi o r o f h i s agents i n the

individual bribes , but l o w e r overall r e n t collection ( b e c a u s e fewer bribes

b u r e a u c r a c y a n d p u n i s h i n g tho s e that d e v i a t e d s i g n i fi c antly fro m his

will be c o l l e c t e d ) - d e s p i t e p e r v a s i v e c o rru p t i o n i n b o t h . A n d , m o r e

c o r e p re fe re n c e s .

i m p o rtant fro m a n overall e c o n o m i c viewp o i n t , c o r ru p t i o n u n d e r c o n ­

I n t e r m s o f fo rmal gove rn m e n t i n s t it u t i o n s , the constitutional frame­

d i t i o n s o f l o o s e l y c e n t ral i z e d g o ve r n m e n t w i l l b e m o r e i n j ur i o u s t o

work tilted p o w e r m as s ively i n favo r o f t h e president ( M ac I ntyre 1 99 9 b ) .

e c o n o m i c growth b e c a u s e i t wi l l r e d u c e e c o n o m i c a c t i v i t y b y d r i v i n g

Although t h e r e w e r e r e g u l a r e l e c t i o n s fo r t h e l e g i s l a t u r e , t h e gove r n ­

d own demand fo r t h e gove r n m e n t g o o d s n e c e s s ary fo r fir m s to go about

m e n t h a d t h e a u t h o r i t y t o v e t a l l c a n d i d a t e s , i n c l u d i n g p a rty l e a d e r s

34

3S

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Investment, Property Rights, and Corruption in Indonesia

Investment, Property Rights, and Corruption in Indonesia

Elections were managed in an elaborate system that biased things heavily

excessively co rrupt official s-again , this was p lainly far fro m the c a s e .

towards the government party and more p articularly the executive (in­

Si m ply, m y p u r p o s e is to argue that unlike many authoritarian leaders,

cluding appo inting military officers to 2 0 percent of seats) . Not surpris­

suharto did have access to quite extensive information about the behav­

ingly, alth o u gh the l e g i s l ature had the right to initiate and amend or

ior of regulatory age n c i e s and d i d h ave the ab ility to p u n i s h o ffi c i a l s

block legislation, in p ractice it never did. Further, the president had very

who s e b eh avi o r deviated s ignificantly fro m his core p refere n c e s . Suharto did not have to intervene o ften to k e e p t h e system going;

wi d e - ranging decree p owers. The president directly controlled the hiring and firing of those in all

periodic demonstrations were sufficient. A striking illustration was the

senior p o sitions (in all agencies, state enterpri s e s , and the judiciary) in

s u d d e n and d r a m a t i c p r e s i d e nt i a l d e c r e e t o d i s e m p o wer t h e e n t i r e

the civilian bureaucracy-which is the point of sale of regulatory goods.

customs bureau in 1 9 8 5 whe n corruption o n t h e waterfront b e c am e a

H e also had effective formal monitoring mechanisms such as military or

serious problem. Overnight, that bureaucratic function was instead del­

fo rmer military officials (as inspector generals) in all public institutions

egated to a fo reign c o mp any ( N asution 1 9 8 5 , 1 3- 1 4) . I n 1 9 8 6 , when it

who rep orted back to the office of the p residency. The armed forces were

became apparent that the textile industry was being j e o p ardized by an

the most p olitically s e n sitive section of the bureaucracy. Here, too, the

overly gree dy cotton import m o n o p o ly, executive action led to the d i s ­

president had appointment powers for all significant p o s itions (actively

b a n d i n g of the m o n o p o ly and the firing o f s e n i o r officials ( M a c I ntyre

involving h i m s e l f i n d e c i s i o n s at l e a s t as far d o wn the o rganizatio n al

1 99 1 , ch. 4) . I n 1 99 6 , when corruption problems in the transport ministry

hierarchy as colonel) . H owever, precisely b e cause of the central impor­

became too blatant, the minister was ultimately p e rmitted to retain his

tance of the armed fo rces in Indonesian political life , all senior p ositions

position, but o nly after being subj ected to public humiliatio n . N o n e of

were subj ect to regular rotati o n .

the s e i n t e rve n t i o n s was d e s i g n e d to e l i m i n a te corruption-the entire

I n t h e terms of t h e institutionalist literature concerned with agency

regime was built upon maximizing corruption-but all had the effect of

problems, all of these fo rmal monitoring mechanisms were of the " p o ­

curtailing corruption that had become sufficiently costly or disruptive as

l i c e p atro l " variety, t h a t i s , institutions d e s i g n e d to d e t e c t and rep o r t

to pose a serious threat to continued investor confidence in that sector.

violations (McCubbins a n d Schwartz 1 9 84) . L e s s formal, b u t a l s o poten­

Suharto was in a position whereby he could maximize his own interests

tially valuable, were "fire alarm" networks-arrangements in which third

by allowing bounded corruption to flourish. The bounds were what the

p arties could alert the p o litical leadership to an outbreak of problems.

market w o u l d b e ar. A p l e t h o r a o f m o n i t o r i n g m e c h a n i s m s kept h i m

Perhaps the m o s t i m p o rtant of these was the relationship many l o c al

sufficiently informed if serious p r o b l e m s emerged a n d h i s far - reaching

and foreign firms would establish with one or more politically connected

powers e n a b l e d him t o deal with greedy o r u n r e l i a b l e o ffi c i a l s who

i n d ividuals-such as a fo r m e r military o ffi c e r o r s e n i o r o ffi c i al ( l o c al

endangered the sys t e m . To b e sure, the system was neither fo o l p r o o f

fi r m s , b e i n g p r e d o minantly Chine s e , did this fo r p o l itical protectio n ;

nor refined (as illustrated by a n y n u m b e r of anecdotes fro m investors

foreign firms for protection as well a s fo r information) . If a firm encoun­

who did b e c o m e d i s e nchanted) . My c o ntention is that it was a rough

tered seriously capricious action by officials that jeopardized operations,

system of oversight and e n fo r c e m e n t that worked sufficie ntly well to

it could use its connections to convey its grievances to a higher authority

keep a remarkable number of investors sufficiently happy fo r a remark­

through informal mili tary and bure aucratic networks.

ably l o n g p e r i o d of t i m e . T h i s sys t e m p r o d u c e d b o t h we l c o m e a n d

The e m p i r i c a l point to b e made here i s that I n d o n e s ia's p o l itical

unwelcome outcomes: inve stment and economic growth w e r e rem ark­

architecture centralized p ower around the presidency; all relevant play­

ably strong, and corruption penetrated almost every part of the econo my.

ers owed their p o s itions dire ctly to the p r e s i d e n t , and h e maintained

If Indonesia's formal political institutions provided the president with

effec tive m o n i t o r i n g c a p abilities of adminis trative b ehavi o r and, very

substantial monitoring and enforcement capabilities, its informal institu­

c l e a rly, effe c tive e n fo rc e m e n t c a p a b i l i t i e s . This is n o t to suggest that

tions gave him a strong incentive to maximize the flow of rents up to his

Indonesia had a finely tuned and efficiently coordinated bureaucracy­

office. Permeating Indonesia's fo rmal political institutions was a vast i n ­

plainly this was far fro m the case. Nor is it to suggest that these various

formal network of patron-client relationships through which coursed much

oversight mechan i s m s were used fo r the p r imary purp o s e o f detecting

of the lifeblood of political l ife . Suharto was the paramount figure in this

36

37

Investment, Property Rights, and Corruption in Indonesia network. Crucial to the sustenance o f this hie rarchical support network was his abil ity to d i s t r i b u t e patronage, m o s t n o t ably m o n ey. Thu s , in a d d i t i o n to any p e r s o n al accumulat o ry i m p u l s e s , the p r e s i d e n t had a fundamental interest in m aximizing the discretionary resources that flow up to him, as they were critical to his political survival. Institutionally, t h e n , the p o s itio n of Suharto was m uch like that o f t h e singl e m o n o p o l i s t . H e had the ability and i n c e ntive to e n force c o ­ o rdination o n the p r i c i n g o f b r i b e s a n d p r e s e rvati o n o f property rights o f investors. This ensured b o th the maximizatio n o f the rents captured fo r his own use as well as an enviro nm ent o f predictability for investors with regulatory goods being supplied at a price the market would b ear.

Investment, Property Rights, and Corruption in Indonesia North and Weingast ( 1 9 8 9 , 8 0 4 ) argu e : A rule r can establish s u c h commitment in two ways . O n e is by set­ t i n g a p r e c e d e n t of " r e s p o n s i b l e b e h avi o r, " a p p e a r i n g t o b e committed t o a set o f rules that h e o r she will consistently enforce. The second is by being constrained to obey a set of rules that do not p e rm i t l e eway fo r vi o l at i n g c o m m i t m e n t s . We have very s e l d o m o b s e rved t h e fo rmer, in go o d p art b e c au s e t h e pressures and c o n ­ tinual strain o f fiscal necessity eventually l e d rulers to " irresponsible b e h avi o r " and the violation o f agre e m e n t s . Under Suharto, the Indonesian government did both. As noted ear­ lier, at the level o f macroeconomic policy, there was clearly a sustained

I nstitutions and Credible Commitments

effort from the late 1 960s on to maintain reasonably sound and consis ­

The Shleifer and Vishny m o de l o ffers impo rtant insights into why a

t e n t p o l i cy s e t t i n g s . A s o l i d r e c o r d o f r e l a t iv e l y s t a b l e e x c h a n g e

political leader in a strong position has an incentive structure to ensure

management, tolerable inflation, cautious spending, g o o d s avings, and

that the pricing o f b ribes and the incidence of capricious action are tem­

good investment in public infrastructure and human capital all presum­

p e re d by what the market will bear. The existence o f this incentive struc­

ably helped t o encourage inve s t o r confidence over the years. As N o rth

ture is dependent upon the institutional setting. This is the second key

and Weingast p o int out, however, a goo d track record , although helpful,

step i n resolving the puzzle. We now have a p l a u s i b l e explanation fo r

provi d e s n o guarante e a b o u t future b e h avior.

why a leader in p olitical and institutional circumstances, such as those

Of greater importance in terms of p roviding a credible commitment

o f Suharto, had an unusually p owerful incentive to " hold the ring" and

to restrain arbitrary behavio r by state officials and minimize investment­

e nfo rce m o d e rati o n . H oweve r, the fac t that a leader has an i n t e r e s t­

threatening corruption was the decision to open the capital account and

e v e n a s t r o n g i n t e r e st-in a p a r t i c u l a r c o u r s e o f a c t i o n by n o m e a n s

make t h e currency fully c o nvertibl e in 1 9 7 0 . This was c r i t i c a l in two

guarantees t h a t he o r she w i l l consistently follow t h a t c o u r s e o f acti o n .

re s p e c t s . F i r s t , given the c o u n t ry ' s d ismal e c o n o m i c rec o rd u p t o the

Precisely because power in Indonesia was s o heavily centralized, Suharto

mid - 1 9 6 0 s , this m o ve was p r e s u m ably p ivotal in r e a s suring inve s t o r s

was unconstrained by l e gal o r basic p o l i t ical instituti o n s : h e could r e ­

( b o th foreign and l o c al) t h a t t h e y could get m o n e y o u t o f the c o u n t ry

v e r s e d i re c t i o n at any p o i n t . D rawi n g o n Shugart a n d Carey's ( 1 9 9 2 )

if things wen t wro n g . S e c o n d ly, and in the longer run p r o b ably m o re

classification o f the relative powers o f p o p ularly elected presidents, Hadi

important, in adopting this measure (well b e fore most other developing

Esfah ani ( 1 9 9 6 ) has noted that the Phi l i p pine p r e s i d e n cy is one o f the

countries) , the government was effectively tying its own hands. The open

m o s t powe rful ( vi s - a - vi s the l e gi s l a t u r e ) in t h e d e m o cratic world and

capital a c c o u n t created a p owe rfu l e a rly warn i n g system o f inve s t o r

argued that this creates real p r o b l e m s o f c o m m i t m e n t . Even a q u i c k

d i s c o n t e n t t h a t w o u l d e x e r c i s e a p owe rful d i s c i p l i n e o n gove r n m e n t

g l a n c e a t the I n d o n e s i a n s i t u a t i o n r e v e a l s that the I n d o n e s i a n p r e s i ­

b e h avi o r. By a l l owing c a p i t a l to m o v e fre ely, the gove r n m e n t was , i n

d e n cy u n d e r S u h arto w a s e v e n l e s s constrai n e d . Although it may b e i n

effe c t , e n a b l i n g inve s t o rs to punish it i f the b u s i n e s s environment d e ­

th e interest of t h e president to ensure mod e rati o n i n t h e pricing of brib ­

t e r i o r at e d . Unlike o t h e r a s p e c t s o f i t s e c o n o m i c p o l icy b e h avi o r, this

ery and capricious b ehavi o r by o fficials , what c o nfidence can investors

c o m m i t m e n t t o g u a r a n t e e an a c c e p t a b l e b u s i n e s s e n vi r o n m e n t h a d

h ave th at the president will in fact do so fo r the life o f their investment

strong credibility. Although t h e o p e n i n g o f t h e capital account h a d o nly

p l a n s , partic u l arly in a situation wh ere p o we r i s s o massively c o n c e n ­

the status of a decree and was thus, in principle , easily change d , in practice

t J'ated and j u d i cial, legisl ative , and regulatory veto p o ints so scarce? H o w

it would b e extremely c o stly to revo k e . Abando ning it would b e a mas­

c a n investors have c o n fi de n c e that t h e government h a s a fu n d a m e n t al

sive d i s i n c e n t i ve t o fu r t h e r i n ve s t m e n t ; wi t h c o l l a p s i n g i n ve s t m e n t

c o m m i t m e n t to e n s u r i n g a t o l e rable b u s i n e s s e nv i ro n m e n t?

c r e a t i n g ve ry s h a r p e c o n o m i c a n d , u l t i m a t e ly, p o l i ti c a l c o s t s fo r t h e

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Investment, Property Rights, and Corruption in Indonesia

I nvestment, Property Rights, a n d Corruption in Indonesia

government. M o r e than any other single p o licy measure, this signaled

One o f the implication s o f this argument i s that we n eed to qu alify th e very widely accepted N orthian argument that in the abse nce o f solid le gal instituti o n s , economic d evelopment cannot take place . I f we l i mit o u r s e l ve s s t r i c tl y t o a N o r t h i a n framework, as r e fl e c t e d i n e m p h a t i c

a c o mmitment to investors. I t was a nearly irrevo cable act o f self- regu ­ l a t i o n t h a t p r o vi d e d gro u n d s fo r b r o ad c o n fi d e n c e a b o u t t h e overall nature o f the p ol i cy enviro n m e n t . To summarize the argument t h u s far, I have b e e n concerned with the puzzle o f why, for roughly three decades, Indonesia was able to generate strong investment flows and economic growth whe n its legal institutions were s o weak and c o rrup t i o n s o wide s p r e a d . A thre e - p art answer has been presented. First, various standard economic variables combined to create an e nviro n m e n t wh ere h i gh rates o f return c o u l d b e exp e c t e d . Second, building o n t h e logic laid o u t b y Shleifer a n d Vishny, w e c a n s e e that t h e p o l itical a n d institutional circumstanc e s o f Suharto's Indonesia were such that they gave the l e ader a p owerful incentive to ensure that bribes were n o t priced excessively and that arbitrary b ehavior was con­ t a i n e d within t o l e r a b l e l i m i t s ; i n s h o r t , t o e n s u r e that c o rr u p t i o n was c o n d u c t e d i n an o r d e rly fas h i o n within the l i m i t s o f what t h e market

cl a ims, s u c h as "the inability o f s o c i e t i e s t o develop e ffective , low - c o st en forcement o f contracts is the most imp o rtant source o f b o th hist o ric al st agnat i o n a n d c o n t e m p o rary u n d e rdevel o p m e n t in the Third Wo r l d " ( N o rth 1 9 9 0 , 5 4 ) , it is diffi c u l t to a c c o u n t fo r thirty years o f sustai n e d strong p rivate investment a n d economic growth in Indonesia. Indones ia's experience suggests that in the absence of an effective legal framework, private investment can still proceed at a h e al thy pace if there are other factors that allay inve s t o r uncertainty. Given c e rtain p olitical and insti­ tutional conditions, a leader presiding over a highly c o rrupt regime can have b o th the ability and the incentive t o p rovide an attractive environ­ ment fo r i n ve s t o r s . To an e c o n o m i c h i s t o rian three decades o f strong e c o no m i c growth may b e o f little moment, b u t t o s c h o l ars and p o licy

would bear. Note that this economic incentive structure was dependent

makers with shorter time frames this is n o t something that can b e ligh tly

u p o n a p o litical structure and a set of formal and info rmal institutional

set aside.

mechanisms that reduced agency l o s s by p e rmitting effective executive

A n d y e t , h aving taken p ains to develop t h i s alternative argument, i t

oversigh t and p u n itive a c ti o n . This s e c o n d s t e p i n the argu m e n t p r o ­

must a l s o b e recognized that t h e system developed u n d e r Suharto could

v i d e s us with a p l a u s i b l e explanation as t o how and why Suharto was

not last i n d e fi n i t e ly. Eve n i f not d e s t a b i l i z e d by exo g e n o u s fac t o r s , i t

able t o ensure that whi l e c o rrupt practices fl o u r i s h e d , i t d i d s o within

c o n t a i n e d u n avo i d a b l e s o ur c e s o f e n d o ge n o u s b r e ak d o w n . F i r s t , t h e

limits t o l e rable t o inve s t o r s . Yet this s e c o n d step i n the argument also

system c o u l d o nly fun c t i o n fo r s o l o n g as t h e r e are e ffe c t ive oversight

introduces a p aradox: the institutional conditions that underpinned the

and punitive capabilities at the d i s p o s al o f the political leadership. The

president's ability and incentive to maintain orderly and market - co n s i s ­

political and i n s titutional c o n d i t i o n s that provide fo r b o th o f these s i ­

t e n t c o rrup t i o n also m a d e future gove r n m e n t p o l i c i e s u n c e rtain s i n c e

multan e o usly a r e n o t c o m m o n . A n d e v e n where t h e y a r e p r e s e n t , they

t h e y w e r e s o e a s y t o revers e . T h a t i s , the very factors that e n c ouraged

can b e displaced as a result o f a change i n leadership personnel if the

the p r e s i d e n t t o e n s u re m o d e ration also had the p o tential t o increase

new leader is unable to sustain the structures o f his o r her predecessor.

risk fo r inve s t o r s . The third step o f my argu m e n t tackles this p r o b l e m

Mo reover, even if it s u rvives l e ad e r s h i p tran s i t i o n , this sys t e m carries

by fo cusing on alternative i n s t i t u t i o n a l mechanisms fo r promoting i n ­

the seeds o f its own destruction, since sustained investment and growth

vestor c o n fidence about future p atterns o f governance. I n the ab s e n c e

s o o n e r or l a t e r give r i s e to s o c i o e c o n o m i c c h a n g e and p r e s s u r e s fo r

o f an i n d e p e n d e n t l e gal sys tem other fo rms o f guaran t e e s to inve s t o rs

d e m o cratizat i o n wh i c h , in t u r n , will t e n d to u n d e r m i n e t h e e n a b l i n g

a b o u t the fu ture are p o s s i b l e . In I n d o n e s i a's c a s e , t h e o p e n i n g o f t h e

political a n d institutional conditions themselve s . I n short, t h e economic

c a p i t a l account i n 1 9 7 0 p r o v i d e d a p owe rfu l approximation o f such a

success o f the system is likely ultimately to undermine the political and

credible commitment. Consciously or otherwi s e , this quickly came to be

instituti o n al foundations that sustai n it. S e c o n d , while wid e s p read but

a strong constraint o n future policy actio n . B ecause it was such a potent

marke t - t o l e rable c o rruption may b e e c o n o mi c ally acceptable to inve s ­

sym b o l to inve s t o r s , the c o s t s o f reversing the rule b e came extremely

t o r s , i t i s likely, ove r t i m e , t o p rove c o rros ive to the legitimacy o f the

high. Here, then, was a regulat o ry c o mm i t m e n t upon wh ich inve s t o r s could reaso nably b e g i n to plan, since in a fundamental s e n s e , the gov­

regi m e , thus b ringing its stability into d o u b t . Third, and perhaps more i mp o r t a n t , as an e c o n o my matures a n d b e c o m e s m o r e i n t e grated r e ­

ernment was tying its own h a n d s .

gio nally a n d globall y, t h e additional c o s t s associated with o p erating in 40

41

Investment, Property Rights, and Corruption in Indonesia

Investment, Property Rights, and Corruption in I ndonesia this commercial e nvironment that were at one time acceptable are likely to b e c o m e d e c r e a s i n gly s o . A s t h e b ar r i e r s to l o c al a n d fo r e i g n i n ­ v e s t o r s s h ift i n g t h e i r m o n ey t o a n o t h e r ve n u e b e c o m e l ower, t h e s e inve s t o r s a r e l e s s likely to accept added risks a n d c o s t arising fro m this e nvir o n m e n t . N o twithstanding its e c o n o mic utility o v e r a p r o l o nged p e r i o d , I d o n o t propose t h a t the system of e c o n o m i c governance I ndonesia had in place under Suharto can b e viewed as a satisfactory long- term alterna­ tive to a system o f robust and transparent p r o p e rty righ t s maintained through an independent judiciary. I do contend, however, that Indonesia's experience sugge s t s we n e e d to recognize that there may be adequate substitutes that can s e rve for a significant period as an alternative b asis fo r investor c o n fidence and, thus, growth. Crisis, Collapse, and Consequences

As we now know, the system created under Suharto was swept away by e xo g e n o u s fac t o r s b e fo r e it c o u l d c o l l ap s e fo r any of t h e i n t e r n a l r e a s o n s mentioned above . T h i s i s not t h e place for a sustained analysi s o f the A s i a n economic crisis o r the e n s u i n g collapse o f Suharto's rule. l Nonetheless, s o m e brief discussion i s necess ary, fo r although the crisis was clearly about very much more than corruption and prop erty rights, I argue that there was an impo rtant underlying connection b etween the i n s ti t u t i o n a l fo u n d a t i o n s o f t h e sys t e m o f g o ve r n a n c e under Suharto a n d the ext e n t o f e c o n o mic devas tation which ultimately u n fo l d e d . In very s i m p lifi e d terms, what happened i n I n d o n e s i a aft e r a c o n t agion e ffe c t introduced currency instab ility was a c o mplete u nraveling o f i n ­ ve s t o r c o n fi d e n c e . Witho u t d o u b t t h e re w e r e m u l t i p l e fac t o r s at work here. but important among these were the calculations local and fo reign i n ve s t o rs m a d e a b o u t the l i k e l i h o o d of the I n d o n e s i a n gove r n m e n t re s p o n d i n g e ffe c t iv e l y t o t h e m o u n t i n g c r i s i s o f c o n fid e n c e . Wh i l e Suharto's government d i d earn praise from the markets in the e arly phase o f the crisis for its dec isive refo rm action , this was soon reversed as the government action b e c ame increasingly erratic and unpredictab l e . with Suharto reversing promises for reform almost as quickly as he was making them. I n a crisis situation this inconstant b e havio r was highly destruc­ tive, for it suggested that Suharto was no longer co mmitted to m aintaining a more o r less sound e c o nomic po licy environment. This robb e d inve s ­ tors o f that which they craved most-confidence that t h e president would steer a ste ady course t hrough e c o n o m i c t u rb u l e n c e as he had done i n the past. 42

In a p o l itical system as highly c e ntralized as I n d o n e sia's, Suharto's actions were all - important, for there were no institutional constraints o n his p o l i c

?,

b e h avio r. I f h e c h o s e n o t t o p u r s u e p o li c i e s d e m a n d e d b y

nervous Inve s t o r s , t h e r e w a s n o institutional mechanism fo r o p p o s ing h i m . And h e r e , of c o u r s e , w e r e t u r n t o the p r o b l e m e m b e d d e d in Indonesia's p olitical structure discussed earlier: if there were n o institu­ t i o n a l c o n s tr a i n t s on p r e s i d e n t i a l a c t i o n , h o w c o u l d i n ve s t o r s have confidence in his policy promises? I argued above that this fundamental prob l e m h a d b e e n mitigated by a c o mb i n a t i o n of facto rs-a h i gh ex­ pected rate o f return, a track record o f reas o n ably sound macroeconomic p o l i cy, a n d i m p o r t a n t , an open c a p i t al a c c o u n t . This c o m b i n a t i o n of factors, however, was o f little b e n e fit i n these radically altered circum­ s t a n c e s . In the fa c e of c u r r e n c y u n c e r t a i n ty, i n ve s t o r s r u s h e d fo r dollars-thereby negating the restraining by-products of the open capi­ tal account. That i s t o s ay, while potent i n n ormal times, the th rea t of capital rushing out ceased to b e a meaningful constraint o n government b ehavi o r o n c e capital was alre ady rushing o u t . I n short, t h e very institutional conditions that produced s u c h a highly centralized p o litical s ys t e m and u n d e r p i n n e d Suharto's ability to c o n ­ tain corruption a n d arbitrary b ehavior within tolerable limits also ensured that if h e b e h aved e rratically the damage to inve s t o r confidence could be very great because there was no effe ctive means o f constraining him. In such a situation, the only real option for investors was exit. And with no m e a n s of r e m o v i n g h i m fro m o ffic e s h o r t of u p h e aval , I n d o n e s i a c o n t i n u e d t o b l e e d c a p ital t h r o u g h 1 9 9 8 u n t i l t h e e n s u i n g e c o n o m i c hardship fin ally p r o d u c e d a m a s s ive p olitical backl a s h . Whi l e t h e y d o n o t account fo r Suh arto's m otives, w e c a n thus see p o litical institutions as a key factor in the system of governance that produced strong inve s t ­ ment i n fl o w s for m a n y y e a r s , and also a k e y factor contributing to the su dden and m as s ive o utflow o f capital i n 1 9 9 7 and 1 99 8 . 2 Finally, it is worth pausing to reflect o n t h e likely consequences for corru p t i o n a n d the s e curity of p r o p e rty righ t s of t h e massive p o litical changes curren tly u n fo l d i n g in I n d o n e s i a . At the time o f this writing,

�

I d o n e s i a a p p e ars to b e midway through a p r o c e s s o f political tran s i ­ tio n from a highly centralized pattern o f authoritarian government to a n eme rging demo cratic framework o f gove r n m e n t . While there a r e many p o t e n t i al pitfal l s , there i s a good chance I n d o n e s i a will at least get to exp e r i m e n t with d e m o c racy. There are many ways i n which t h i s i s a wel c o m e d e ve l o p m e n t . A n d , if o n e fo l l o w e d an u n q u a l i fi e d N o r t h i a n logic, one might c o n c l u d e that t h i s is a welcome development for inve s 43

Investment, Property Rights, and Corruption in Indonesia t o rs as well , since this represents an important step i n the direction of

CHAPTER T H R E E

m o re t r a n s p a r e n t gove r n a n c e and a m o r e i n d e p e n d e n t legal sys t e m . Here again, however, it is critical to recognize that while this logic holds true fo r the long run , the short- to medium- term outlook is very differ­ ent. In practice, Indonesia's swing from centralized authoritarian rule to more democratic government is likely to b e associated with a decidedly less attractive investment than i n the past. The r o a d t o a truly i n d e p e n d e n t l egal sys t e m i s a very long o n e

STATE, CAPITAL, AND INVESTMENTS IN

KOREA

Ha-joon Chang

i n d e e d , a n d there i s n o reason to expect that I n d o n e s i a will discover a s h o rtcut. F o r the p as t three decades a reasonable investment environ­ m e n t has b e e n m a i n t a i n e d o n the b a s i s o f h ighly c e ntralized p o l i t i c s . This is now all in the process of being swept away. Almost by definition, it is very unlikely that the leaders of Indonesi a's new p o litical framework will h ave the i n s t i t u t i o n a l and p olitical c a p a b i l i t i e s fo r oversight and punitive intervention enj oyed by Suharto. As far as the issues of corrup­ tion and property rights are concerned, Indonesia i s thus l ikely to enter

K o r e a ' s p e rfo r m a n c e in rais i n g i n v e s t m e n t s s i n c e the e arly 1 9 6 0 s

a v e ry u n c e r t a i n i n t e r m e d i at e z o n e-it has p r o g re s s e d b e yo n d t i g h t

h a s b e e n i m p r e s s ive by a n y standard, e s p e c ially given its p o o r p e rfo r­

p olitical centralization, but it is still a l o n g way fro m a truly independent

mance during the earlier p o s twar p erio d . l As we can see i n table 1, until

legal syst e m . I n terms o f t h e t h e o re t i c a l framework d i s c u s s e d e arlier,

the e arly 1 9 60s the share o f investment i n Korea's GDP (gro s s domestic

Indonesia is thus l ikely to shift from a s ituation in which there is a s ingle

product) was very low ( 1 2 . 5 p ercent during 1 95 3 - 1 962) , and only about

monopolist for bribes to the much more distortionary situation in which

one - third o f this was do mestically finance d . The average n ational s av­

there are mUltiple i n d e p e n d e n t m o n o p o l i s t s . I r o n i c ally, t hen, the s h i ft

ings rate during this p eriod was 4 percent, while per capita income was

fro m dictatorship to s o m e semblance of d e m o c racy is l ikely to be a c ­

$82. This c o mpares unfavorably with the p erformances of countries like

c o m p a n i e d by a much more deleterious p attern o f c o rruption. Crudely

Ke nya ( $ 72 ) , T h a i l a n d ( $ 8 8 ) , and S u d a n ( $ 9 1 ) , whi c h , d e s p i t e s i m i l a r

p u t , t h e one t h i n g w o r s e than o rg a n i z e d c o r r u p t i o n is d i s o rganiz e d

p e r c a p i t a i n c o m e s , m a n a g e d 1 5-20 p er c e n t i n ve s t m e n t r a t e s . M o r e ­

corruption.

over, s o m e c o u n tr i e s with even l ower p e r c a p i t a i n c o m e t h a n Ko rea,

I n c l o s i n g , I c e rt ainly d o n o t mean t o suggest that the p r o c e s s o f

such as Tan z a n i a (then Tan ganyika) a n d B u r m a ( b o th $ 5 0 ) , managed

p olitical change i n I n d o n e s i a i s s o mething to b e fe ared o r resisted. Far

higher rates o f inve s t m e n t , altho ugh there were c o u n tries with higher

fro m it. There are many important b e nefits that can come which reach

per c a p i t a i n c o m e s t h a t had l o w e r i n ve s t m e n t r a t e s ( Pa r a g u ay, t h e

far beyo n d the investment environment. We should, however, b e under

Philip p i n e s , a n d C h i l e ) . H owever, t h e Ko rean i n ve s t m e n t rate s t a r t e d

n o illu s i o n s that all go o d things n e c e s s arily come together.

i n c r e a s i n g r a p i d l y b e g i n n i n g the e arly 1 9 6 0 s . B y 1 9 6 6 , i t was already over 2 0 p e r c e n t a n d by t h e m i d - 1 9 7 0 s , i t was n e arly 3 0 percent (the average fo r 1 9 7 4- 1 9 7 8 was 2 9 . 5 p e r c e n t ) a n d rarely fal l i n g below 30 percent thereafter. Wh a t i s e s p e c i ally n o t a b l e a b o u t t h e K o r e a n i n ve s t m e n t p e rfo r ­ m a n c e i s t h a t i t h a s b e e n a c h i e v e d t h r o u gh a h i ghly i n t e rve n t i o n i s t investment governance regime ( even b y t h e E a s t Asian standard s ) , whi c h . according to c o nventional wisd o m . should lead to p o o r investment per­ fo r m a n c e . I n d e e d . fo l l o w i n g the 1 9 9 7 d e b t c r i s i s , i t has b e c o m e fashionable t o argue that i t was precisely b e c a u s e o f t h e ineffi c i e n c i e s

44

45

p State, Capital, and Investments in Korea

State, Capital, and Investments in Korea

and corruption generated by this interventionist investment governance

Policies to Maintain Stability

regime that the country had such a spectacular crash ( Brittan 1 997 and The i m p o rtance o f p o l i tical and e c o n o m i c stability in e n c o ur a g i n g

Krugman 1 9 9 8) . Later in this chapter I shall argue that the recent crisis in Korea owes

inve s t m e n t s i s fr e q u e ntly e m p h a s i z e d i n m a ny i n t e r n a t i o n a l p o l i c y ­

a lot t o the unraveling of the "traditional" interve n t i o n i s t gove rnance

making circles. and a t this level o f generality i t is very diffi cult t o argue

regime that b egan in the late 1 9 8 0 s but accele rated aft e r 1 9 9 3 , rath e r

agai nst such a statement. P o l i t i cal and e c o n o m i c i n s t a b i l ity o b v i o u s l y

than to i t s persistence (fo r m o r e details, see Chang 1 998b a n d Chang e t

shrinks the p o te n tial investors' time h o r i z o n . a n d w i l l d i s c o urage c o m ­

a l . 1 9 9 8 ) . The m a i n a i m o f this c h a p t e r, h owever, is to d e s c r i b e a n d

mitments o f resour c e s to p rojects who s e returns are far in the fu ture and

analyze the workings o f Korea's "traditional" regime o f governance as i t

o ften uncertain but which may be crucial fo r m o d ern industrial devel­

relates to investment, which, despite t h e many lessons t h a t it provides

o p m e n t . T h e Keyn e s i a n n o t i o n of " a n i m a l s p i r i t " a n d t h e n o t i o n o f

fo r other devel o p i n g countries, has b e e n m i s u n d e rsto o d .

" investors' c o n fi d e n c e " fre quently u s e d i n p o l i cy d i s c u s s i o n s i n Korea (and indeed i n other countries) r e t1 e c t such c o n c e r n .

The " Traditional" Korean Investment Governance System, 1 96 1 - 1 993

M o re r e c e n tly. h owever. there h a s b e e n a t e n d e n cy a m o n g m a i n ­

The regime of investment governance that supported Korea's s p e c ­

stream e c o n o m i s t s to interpret t h i s i s s u e o f stability very narrowly and

tacular development w a s established in 1 96 1 , following the coup d ' etat

b a s i c ally reduce i t to the achievement (or o th e rwise) o f very l o w i n t1 a ­

by Gen. Park Chung Hee in 1 96 1 . As soon as it came to p ower, the Park

tion (say, b el ow 5 p e rcent) . A n d in t h i s context t h e E a s t A s i a n countries.

regime nationalized all the b anks, which had initially b e e n confiscated

i n c l u d i n g K o r e a . have o ft e n been p a r a d e d as exam p l e s o f t h e i nve s t

fro m t h e J a p a n e s e c o l o n iz e r s a n d put u n d e r gove r n m e n t own e r s h i p

m e n t b o o s t i n g e ffe c t o f low int1at i o n . However. as s o m e recent s t u d i e s

but w e r e l a t e r p rivatized by the R h e e regime d u r i n g the l a t e 1 9 5 0 s . A t

show, there i s n o s t a t i s t i c al co rrel a t i o n b e tw e e n growth and i n t1 a t i o n

the s a m e t i m e , t h e P a r k regime imprisoned m a n y prominent business­

r a t e i f the l a t t e r i s m o d e rate ( s ay. l e s s t h a n 4 0 p e rc e n t ; s e e Bruno and

men o n the charge of h aving accumulated wealth through " illicit" means

Easterly 1 99 4 ) . Moreover. the East Asian experiences. especially those of

( e . g . , using p o litical c o n n ections) . H e then released them in return fo r

J a p a n and K o r e a d u r i n g t h e i r e a rl i e r p e r i o d s of d evel o p m e n t . d o not

their promises to "serve the nation through enterprise," which basically

l e n d much s u p p o rt t o this argum e n t .

meant building new plants in state - d esignated industries (the s o - called

­

-

From 1 9 6 1 u n t i l the 1 9 8 0 s . the Korean state pursued w h a t can b e

Illicit Wealth Accumulation episode; see Jones and Sakong 1 98 0 , 69-7 0 ,

called a " p r o i nve s t m e n t " macro e c o n o m i c p o l i cy. p u t t i n g e m p h a s i s o n

2 8 1 -8 2 ) .

m a i n t a i n i n g h i g h l evels o f i n ve s t m e n t . e v e n at t h e c o s t o f m o d e r a t e

With t h e s e two s evere b l o w s , the b u s i n e s s c o m m u nity s u d d e nly

i n t1 ati o n . r a t h e r than achi eving s p e c i fi c q u a n t i t a t i v e t a r g e t s r e g a r d i n g

b e c a m e m o rally q u e s t i o n a b le-criminals were p a r o l e d o n the c o n d i ­

i n t1 a t i o n o r b u d g e t d e fi c i t s ( C h a n g 1 9 9 3 ) . Ave rage rat e s o f i n t1 a t i o n

t i o n t h a t they d i d as t h e y were told-and e c o n o m i c ally a p a p e r tiger,

( m easured b y t h e average annual growth o f t h e consumer price i ndex)

devoid of the p ower to make investment d e c i s i o n s , the ultimate capi­

in Korea were 1 7 . 4 percent in the 1 9 6 0 s and 1 9 . 8 p e rcent in the 1 9 7 0 s .

talist prero gative .

h i gh e r t h a n the i n t1 a t i o n r a t e s d u r i n g the s a m e p e r i o d i n many Lat i n

The logic of this system has been analyzed and studied extensively

American c o u n t r i e s ( fo r who s e " t r o u b l e s " int1ation i s o ften blame d ) . "

by a number of scholars ( s e e , fo r instance. Amsden 1 9 89 . Chang 1 99 3 .

Even dur i n g t h e early 1 9 8 0 s . w h e n K o r e a was i n t h e m i d d l e o f i t s

C a m p o s a n d R o o t 1 99 6 , H aggard 1 990) . S o w e shall not delve into this

biggest stabilization exercise since 1 9 6 1 (that i s . until t h e 1 99 7 cris i s ) . the

any fu rther. The i m p o rtant p o i n t fo r this c h a p t e r i s that the sys t e m

government fine-tuned its macroeconomic policy to en sure that i t did not

enabled t h e Korean government to fo rmulat e . implement. a n d enforce

kill o ff investors' confi d e n c e (and thus investm e n t s ) . even if that meant

a set o f interrelated p o l i c i e s that created a gargantuan t i d al wave o f

allowing m ore int1ati o n . D ur i ng this p e r i o d . the i n vestment / CD P rati o in

p r o d uctive inve s t m e n t . T h e s e p o l i c i e s b e c a m e p art and p a r c e l o f t h e

Korea was kept at a level only a fraction l ower than what it achi eved during

governance regime. a t first stemming from it but ult i m at ely fe e din g into

the investment boom years under t h e h eavy and c h e m i c a l i n d ustrializa­

and sustaining it.

tion (Hell program. As we see in tab l e 1 . the investment rate averaged 29.8 46

47

State, Capital, and Investments in Korea

State, Capital, and Investments in Korea percent during the period 1 9 8 1 - 1 986, against 30.8 percent during the 1 974-

Table 1 con tin ued

1 9 79 period, suggesting that the stabilizati o n p rogram in Korea did n o t

1 981

29.9

22 .9

1 7 .6

5.3

6.6

hurt investments ( s e e Chang 1 987, for s o m e detailed analyses of this sta-

1 982

28.9

24.4

1 8. 7

5.7

3.6

1 983

29.4

27.6

20.8

6.8

1 .9

1 984

30.6

29.9

23.4

6.4

1 .5

I nvestment and Its Financing in Korea, 1 9 53- 1 993

1 985

30.3

29.8

23.7

6.1

(As percentage of GNP a t current prices)

1986

29.2

33.7

27.7

6.0

0.9 -4. 3

1 987

30.0

37.3

30.8

6.5

-7.2

1 988

31 . 1

39.3

3 1 .5

7.8

-7.7

bilization experience) . This was unlike similar situations in other countries. Table 1

Year

Gross Investment

Private Savings

National Savings

Government Savings

Foreign Savings

1 989

33.8

36.2

28.4

7.9

-2.3

6.6

1 900

37. 1

35.9

27.4

8.5

0.9 3.0

1 5.4

8.8

1 1 .2

1 954

1 1 .9

6.6

9.3

-2.7

5.3

1991

39. 1

36. 1

28.3

7.8

1 955

1 2.3

5.2

7.6

-2.4

7.1

1 992

36.8

34.9

27.1

7.8

1 .5

1 956

8.9

-1 .9

1 .0

-2.9

1 0.9

1 993 P

34.4

34.9

26.4

8.5

-0. 1

1 957

1 5. 3

5.5

8.6

-3. 1

9.8

1958

1 2.9

4.9

8.0

-3. 1

8.0

1 953

-2.4

1 959

1 1 .1

4.2

6.9

-2. 7

6.9

1 960

1 0.9

0.8

2.9

-2. 1

8.6

1961

1 3.2

2.9

4.7

- 1 .8

8.6

1 962

1 2.8

3.2

4.8

-1 .6

1 0.7

1 963

1 8. 1

8.7

9.1

-0.4

1 0.4

SOURCE: Bank of Korea, NationalAccounts, 1 987 (for t h e series between 1953 a n d 1970) a n d Bank of Korea, Natio nal Acco u n ts, 1 994 (for the series between 1970 and 1993 ) .

NOTES: The series between 1953 and 1970 a n d the series between 1970 a n d 1 993 are n o t fully compatible d u e to changes i n accounting method. p= preliminary estimates

Policies to Control Capital Flight

1 964

1 4.0

8.7

8.3

0.4

6.9

In any country, especially in the e arly stages of development, capital

1 965

1 5.0

7.4

5.7

1 .7

6.4

flight has t o be p reve n t e d i n o rder t o ensure that whatever inve s t i b l e

1 966

2 1 .6

1 1 .8

9.1

2.7

8.5

surplus is generated in the e c o n o my stays in the country and therefore

1 967

2 1 .9

1 1 .4

7.3

4.1

8.8

h a s a greater likeliho o d of being reinve s t e d . The threat of c a p i t a l flight

1968

25.9

1 5. 1

9.0

6.1

1 1 .2

is a common o n e among the developing countri e s , but it was even more

1 969

28.8

1 8.8

1 2 .9

5.9

1 0.6

s e r i o u s fo r K o r e a b e c a u s e o f the c o n s t a n t ( r e al and imagined) threat

1 970

26.8

1 7. 3

1 0.8

6.5

9.3

from N o rth Korea. Even during t h e b e s t o f time s , this would have p r o -

1 970

24.3

1 8. 1

1 2. 1

6.0

6.9

v i d e d a very s t r o n g i n c e ntive fo r c a p i t a l fl i g h t . P e r i o d s o f h e ightened

1 971

24.8

16.1

11.1

5.0

8.5

political tension ( e . g . , t h e l a t e 1 9 7 0 s , right after t h e U S withdrew a maj o r

1 972

20.9

1 7 .3

1 5.0

2.3

3.3

military unit) or macroecon omic instability and general economic down-

1 973

25.2

22.6

1 9.6

3.0

2.2

turn (such as t h e early 1 9 8 0 s ) p rovided even stronger i n c e n t ive .

1 974

31 .8

20.3

1 8. 1

2.1

1 0.6

As a result, the Korean state implemented a very strict regime of capital

1 975

28.6

1 8. 1

1 5.6

2.5

8.9

controls. Every e c o n o m i c transaction involving foreign exchange h a d to be

1 976

26.5

24.2

1 9.7

4.5

1 .1

made through the banks under government ownership and / or contro l , and

1 977

28.3

27.5

23. 1

4.4

major attempts at capital flight could b e punished with a death sentence.

1 978

32.5

29.9

24.7

5.2

1 979 1 980

35.8 3 1 .9

28.5 23.2

22.2 18.1

6.3 5.1

-0. 1 2.1 6 .4 8.5 Co n tin ued

48

The effectiveness of capital control in Korea c a n b e shown b y t h e fact that in the build -up to the debt crisis of the early 1 980s, there was virtually no

capital flight from Korea, then the fourth largest debtor country in the world. In contrast , other maj o r debtor countries in Latin America (except B razil) 49

State, Capital, and Investments in Korea

State, Capital, and Investments in Korea

s u ffe red fro m massive cap ital fl ight, estimated by Sachs ( 1 9 8 4 ) to h ave

exp enditures increased fivefold in three years ( thus suggesting that the low

been sometimes as big as the total debt o f the country. Some countri e s , n o tably Indonesia a n d M al aysi a , have managed to prevent capital flight without strict control of capital outflow. This would not have been possible

expenditure e arlier was not due to any "cultural " aversion to spending as is s o m e t i m e s s u gges t e d ) . O n e d o e s n o t h e a r s t o r i e s a b o u t Korean t o p executives l i v i n g i n two - b e d r o o m flats as i n e arly p o s twar J a p a n ; s t il l ,

in Ko rea until recently, when the growing economic and military power of

anecdotal stories and casual observations confirm that living standards o f

the c o u ntry ( e s p e c ially vis - a - vis North Korea) alleviated the co nfidence

t h e investing class in Korea h ave b e e n l o w by internati o n al standard s . I

problem that the country's investors had fo r a long time.

One i m p o rtant, and u s u ally ignore d , fun c t i o n o f control o n luxury­ goods consumption is in the realm of politics, that is , its role in creating a s e n s e o f " s hared growth" (the term i s fro m Camp o s and Root 1 9 9 6 ) .

Policies to Control Luxury Consumption

Keeping the investible surplus inside the national border through capital controls may h ave b e e n the fi rst s t e p toward guaran teeing its reinve s t ­ m e n t , b u t there i s still a long way to g o before it is actually invested. O n e obvious hurdle is that t h e potential investor classes who control such surplus may consume it in " luxury" goods, rather than invest it. The economics behind luxury consumption is not so simple as to all o w us to say that higher luxury consumption necessarily reduces investments or that restraint of such c o n ­ sumption necessarily requires government intervention.3 T h e issue is more than a mo ral one d e v o i d of e c o n o m i c m e a n i n g , as many m a i n s t r e a m e c o n o mists b e l i eve ( fo r a m o re detailed discussion o n the e c o n o m i c s o f luxury consumption, s e e Chang 1 99 7 ; fo r some p h i l o s o phical d i s c u s s i o n o f the i s s u e . s e e B erry 1 99 4 ) . Particularly i n m a n y deve l o p i n g countries where imports of l UXury go o d s ( o r the p arts and components needed to p r o d u c e them) are in c o m p etition fo r scarce foreign exchange with the capital goods necessary fo r investment, the control o f luxu ry-goods con­ sumption becomes even more important fo r e n c o uraging investment. Whether or not one believes that l uxury-goods consumption has to be controlled at the early stage o f development, it is very clear that there was a deliberate , and very effective , restraint on luxury-goods consumption in Korea ( fo r fu r t h e r e m p i ri c al d e t a i l s , see Chang 1 9 9 7 ) . The c o u ntry h a s

�

imposed heavy tariffs a n d domestic taxes on, a n d s o metimes even b nned the d o m e s t i c production as well as the i m p ortation o f, certain " l uxury"

i

products e s p e cially in the e a rl i e r days of its deve l o p m e n t . For examp e , t h e gove r n m e n t i m p o s e d h i gh taxes on c a r own e r s h i p and gas o l i n e i n o r d e r to discourage passenger-car ownership u n t i l t h e h t e 1 9 80s. Table 2 shows that Korea has had the lowest number of p assenger cars compared with any o f the advan ced and developing countries at c o m p arable levels

By restraining the ext e n t to which the elite could enj oy their wealth fo r p e r s onal p leasure , this control on c o n s u m p t i o n created a s e n s e o f n a ­ tional "community" w i t h a c o m m o n goal, fo r which everyo ne is sharing the burdens and the fruits o f growth i n a " fair" ( i f n o t equal) measure. This in turn c o ntribu t e d t o p olitical s t a b i lity (which indirectly c o ntrib ­ u t e d to inve s t m e n t growth by shoring up inve s t o r s ' confi d e n c e ) -more than the mere existence of "equal income distribution" which has b e e n freq u e ntly c i t e d as t h e s o urce o f E a s t A s i a n p o l i t i c al s t a b i l i ty. Policies to Discipline the Recipients of the State - C reated Rents

H aving ensured that investible surplus stays at home and is not wasted in luxu ry- goods consumption, there still remains the p roblem of e nsuring that the subsequent investments are made productively, as " b ad" inve s t ­ ments will s i m p ly waste r e s o u rc e s . S o m e would a r g u e that t h e market signals will direct the investors into the right areas, but we know that this is simply not true as a general proposition. Especially in the context of late development, industrial development requires the creation of rents by the state to induce investments in industries where there are already estab­ lished producers abroad. However, the statement that the creation o f rents by the state is a necessary condition for development does not mean that it is suffi c i e n t . This is becau s e , once they are awarded the state- created re nts, the investors may have little incentive to raise productivity, as the m arket discipline has been tempo rarily weakened (or sometimes e l i m i ­ n ated altogether) . So it becomes cru cial for t h e state to play t h e disciplinarian ro le. The subject of state discipline has b e e n rather extensively discussed elsewhere, and thus does not require an elaboration; but let us make a few re marks h e re ( fo r fu rther disclls s i o n s , Chang 1 9 9 3 ; s e e also Toye 1 9 8 7 ,

of d eve l o p m e nt-b eat i n g Japan , the runner- u p , by s u b stantial margi n s .

Amsden J 9 8 9 , and Evans 1 9 9 5 ) .

Similarly, fo reign travel w a s banned u n t i l the e a rly 1 9 8 0 5 , and w a s onlv ' liberalized-although there still are restri ctions on the amount of mone

rents c a n b e attrib u t e d a t o n e level to the famously ( o r notoriou sly, d e ­

o n e c a n take ahro ad-in 1 9 8 8 . Aft e r the l i h e ra l i z a t i o n , fo reign t o u r i s 50

� �

The S ll c c e s s of the Korean state in d i s c i p l i n ing the recip i e n t s of i t s p e n d i n g o n o n e 's p o s i t i o n ) e n o r m o u s p owe r t h a t i t w i e l d s ove r 51

State, C apital, and Investments in Korea c o r p o r a t i o n s through its c o ntrol over bank c r e d i t and o t h e r fi nancial sources. However, if it i s to b e u s e d productively, this p ower has to be exercised with a commitment to productivity growth-otherwise it will be a route to "crony capitalism" a la Marcos (Hawes 1 987) . In the Korean case, such commitment essentially stemmed from its brand of developmentalist ideology, which put emphasis on catching up with the West through pro­ ductivity growth. At a more practical level, the success of state discipline in Korea is the result of a number of factors (fo r more detailed discussions, see Chang 1 993) . First of all, the choice of "strategic" industries that were to b e supported by the state was made with a high degree of realism (i.e . , a who l e s ale catch - u p acro s s a l l industrie s , as in t h e c a s e o f I n d i a , was never attempted) even if the choice seemed too risky to many people (e.g., the forays into steel and shipbuilding in the 1 970s) . Secondly, the empha­ sis on exports made it possible for the state to judge enterprise performance relatively "obj e ctively" by watching their performances in the world mar­ k e t , altho ugh it was b y n o m e a n s b l i ndly a c c e p t i n g t h e m as the only p e rfo rmance criteri o n . F i nally, policies were designed o n the b a s i s o f detailed information on the state of the economy and business conditions in state- supported industri e s . This information was collected from man­ datory reports by the state- supported enterprises and by various public and semipublic agencies ( e . g . , the state trading agency KOTRA, together with the embassies, collected information o n exp ort markets) . O n e big contrast b e tween the Korean state and its counterparts i n many deve l o p i n g c o u n t r i e s i s perhaps that i t was willing and able t o d i s c i p l i n e e v e n t h e m o s t powerful co nglomerates . T h i s is confirmed by the fact that until recently there had been a rap i d turnover i n ranking among the top chaebols ( c o nglomerate s ) , whi c h would not b e there if s t a t e - created rents s imply s e rved the function of p roviding l arge firms with a c omfo rtable life as happened in many other countri e s . O nly two of the ten b iggest chaebols in 1 966 were among the top ten in 1 9 7 4 ; o nly five of the top ten in 1 9 7 4 were in the top ten in 1 9 8 0 ; o nly six of the 1 9 8 0 top ten w e r e in the top ten in 1 9 8 5 ( C h a n g 1 99 4 , 1 23 ) . T h i s i s a n impressive r a t e of turnover despite the r e c e n t stabilization in the rank­ ing of the top chaebols (as the top ones grew s o big it b ecame difficult

LO

§ O> �

��

� to

�� �� �� �� � �

to dislodge them-eight of the top ten in 1 98 5 were in the 1 989 top ten; Chung and Yang 1 9 9 2 , tables 1 and 2, appendix to ch. 5 ) . Policies to Control Foreign Capital Inflows

Korea has relied h e avily on fo reign cap i t a l i n flows b u t o nly in the fo rm of l o an s . As we c a n s e e in t a b l e 3 , i t s r e l i a n c e o n F D r has b e e n 52

53

State, Capital, and Investments in Korea

State, Capital, and Investments in Korea among the l owest in the worl d . Until re cently, b e fo re the Korean fi rms

Table 3

The Ratio of FDI Inflows to Gross Domestic Capital Formation for Various Regions and Selected Countries (an n ual a verage in %)

b e c ame credit worthy e n o u gh to b e able to b o rrow in the international capital m arke t, all t h e fo reign l o ans were u n d e rwritten by the govern ­ ment

'

1 971-75

and as a re s u l t h a d to b e app rove d by t h e gove r n m e n t . Wh i l e

t h e r e were some wel l - known c a s e s of failed proj ects financed b y fo reign loans, in general the government can b e credited fo r havi ng put empha­ s i s o n t h e ( d i rect and i n d i re c t ) fo reign - exchange - g e n e rating abil ity of the p roj ects when app roving fo reign b o rrowing. This contributed to the c o u n t ry 's s u rvival o f the debt c r i s i s hy k e e p i n g the d e b t - s e rvice ratio lower than other l arge d e b t o r countri e s . W h i l e t h e fo reign b o rrowing s t o ry is i n t e r e s t i n g e n o u g h , the m o re interesting p art of the Korean investment gove rnance regime lies in its policies toward F D I (fo reign direct investment) , especially given the cur­ r e n t e n t h u s i a s m a b o u t gl o b al i z a t i o n and the r o l e of t r a n s n a t i o n a l corporations , or TNCs ( fo r criticisms o f t h e glob alizatio n thesis, s e e Hirst and Thompson 1 99 6 , Wade 1 99 6 , Evans 1 99 7 , and Chang 1 99 8 a) . Unlike s o m e o t h e r develo p i n g c o u n t ri e s , which o s t e n s i b l y pursued " t e c h n o ­ logical self- sufficiency" o nly to end up reproducing obsolete technologies imported decades ago in the absence o f independent R and D (research and development ) capabiliti e s , Korea has always b e e n keen on gaining access t o t h e most advan c e d t e c h n o l o g i e s t h a t t h e y can h a n d l e . The country's p olicy makers h ave been of the view, though, that accepting a "p ackage" of finance, technologies, managerial skills, and other capabili­ ties offered by TNCs is not as good for long- term industrial development as e n c o uraging nat i o n al fi r m s t o c o n s t ru c t their own pa ckage s , u s i n g t h e i r o w n managerial skills-obvi ously wi th s o m e necessary outsourcing ( fo r fu rther detail s , see Chang 1 9 9 8 c ) . Th u s , t h e K o r e a n g o v e r n m e n t i m p o s e d r e s t r i c t i o n s o n t h e a r e a s where TNCs could enter. And e v e n w h e n entry w a s allowe d , it encour­ aged j o i n t ve n t u re s , p re ferably under l o cal maj o ri ty own e r s h i p , i n an attempt to fac il i tate t h e transfe r o f core t e c h n o l o gi e s and managerial skil l s . F o r examp l e , until the mi d - 1 9 8 0 s , even in sectors where F D I was a l l o we d , fo r e i g n o w n e r s h i p ab ove 50 p e r c e n t was p r o h i b i t e d exc e p t where F D I was d e e m e d to b e o f "s trategi c " importance, wh ich c overed o n l y a b o u t 13 p e rc e n t o f all the manufacturin g i n d u s t r i e s ( E P B 1 9 8 1 . 70) . " As a result of such policies, by the m i d - 1 980s only 5 percent of TNC s u b s i d i aries i n Korea were wh o l ly own e d , wh e r e a s the c o rr e s p o n d i n g fi gures were 5 0 percent fo r M exic o and 60 percent fo r Brazil, c o u ntries which are o ften b e l i eved to have had m u c h m o re "antifo re ign" p o l icies than K o r e a ( Eva ns 1 9 B 7 , 2 0 B ) . 54

1 976-80

1 981--85

1 986-90

1 991-93

All Countries

n.a.

n.a.

2.3

4.1

3.8

Developed European Union Austria France Germany Netherlands Sweden UK Switzerland USA Canada Japan

n.a. n.a. 1 .8 1 .8 2.1 6.1 0.6 7.3 n.a. 0.9 3.6 0.1

n.a. n.a. 0.9 1 .9 0.8 4.5 0.5 8.4 n.a. 2.0 1 .7 0.1

2.2 2.6 1 .3 2.0 1 .2 6.1 1 .6 5.6 2.3 2.9 1 .0 0.1

4.6 5.9 1 .5 4.1 2.0 1 3.3 4.0 14.6 5.3 6.9 5.8 0.0

3.3 5.6 1 .5 7.7 1 .4 1 0.6 9.5 1 0.0 3.1 3.2 4.3 0.1

Developing Africa

n .a. n .a .

n.a. n.a.

3.3 2.3

3.2 3.5

5.7 4.6

Latin America Argentina Brazil Chile Mexico

n.a. 0.1 4.2 -7.3 3.5

n.a. 2.1 3.9 4.2 3.6

4.1 5.0 4.3 6.7 5.0

4.2 11.1 1 .7 20.6 7.5

6.5 37.6 1 .5 8.5 6.8

Asia Bangladesh China Hong Kong India Indonesia Korea Malaysia Pakistan Philippines Singapore Taiwan Thailand Turkey

n.a. n.a. 0.0 5.9 0.3 4.6 1 .9 1 5.2 0.5 1 .0 1 5.0 1 .4 3.0 n.a.

n.a. n.a. 0.1 4.2 0.1 2.4 0.4 1 1 .9 0.9 0.9 1 6.6 1 .2 1 .5 n.a.

3.1 0.0 0.9 6.9 0.1 0.9 0.5 1 0.8 1 .3 0.8 1 7.4 1 .5 3.0 0.8

2.8 0.1 2.1 1 2.9 0.3 2.1 1 .2 1 1 .7 2.3 6.7 35.0 3.7 6.5 2.1

5.5 0.2 1 0.4 5.7 0.4 4.5 0.6 24.6 3.4 4.6 37.4 2.6 4.7 3.2

n.a.

n.a.

0.0

0.1

1 2.2

Eastem Europe SOURCE:

U NCTAD, World Irwestme n t Rep o rt,

World In llestmellt Repo rt,

1 993, a n n e x table 3 ( fo r th e 1 9 7 1 - 1 980 data) a n d 1 995, annex table 5 ( for the rest) . Reproduced from Chang ( forthcoming) .

P o l i cy measures o t h e r than the o n e s c o ncerning entry and owner­ ship were a l s o u s e d t o c o n t r o l t h e activities o f TNCs. F i r s t o f all, t h e

technology that w a s t o b e b ro ugh t in b y the investing TNCs 55

w as

c are

-

State, Capital, and Investments in Korea

State, Capital, and Investments in Korea

fully screened, and checked whether it was not overly obsolete or whether

ability to c o ntrol our future through planning. And indeed, overc o m i n

the royalties charged on the local subsidiaries, if any, were not excessive.

uncertainty is one of the most important fun c tions of busine ss m an age m e n t , e s p e c i al l y in l a r g e m o d e r n c o r p o ra t i o n s ( R i c h a r d s o n 1 9 6 0 ,

Secondly, there were measures t o maximize technolo gy spillovers. Those investors who were more willing t o transfe r technologies were selected over the others who were n o t , unless they were t o o far b ehind techno­

�

Williamson 1 9 7 5 , Stinchcombe 1 99 0 ) . I t i s inadequate t o argu e th at t he state should n o t attempt to plan the future of the national econo my be­

logically.6 Finally, local content requirements were quite strictly imposed,

cause of insufficient information , whe n firms can and do plan their Own

i n order to m aximize t e c h n o l o gical sp illovers fro m T N C pr es en ce. We

future despite-or rather, precisely b ecause of-insufficient informati o n .

should note, h owever, that the targets for l o c alization were set realisti­

S e c o n d , we n e e d to question t h e widespread belief that t h e info rma­

cally, so that they would not seriously hurt the exp o rt comp etitiveness

tional problem fo r intelligent state intervention is s o great as t o m ake

of the country-in some industries, they were less strictly applied to the

intervention ineffe ctive , while firms d o not suffer fro m such a problem.

products destined fo r the exp o rt market-and that supporting policies

In fact, entrepreneurs themselves often operate o n the basis o f " informed

that facilitate localization (e.g., support for R and D) were also provided.

guesses" o r "animal spirits" in making investment decisions. M o re over,

Some Puzzles

( e . g. , estimates o f present and future demands, the availability o f b e s t

much of the info rmation used by the firm to make investment decisions According to c o nventional wisd o m , the kind of investment gover­

practice technology) are readily available to anybo dy, a n d n o t just t o the

nance system that we fin d in Korea is an i d e al recipe for disaster as it

firm itself. I t should also be n o t e d that a large part o f the information

creates inefficient r e s o u r c e allocation d u e t o info rmational p r o b l e m s ,

used by the firm is acquired from external sources, such as

and is l i a b l e t o exp l o itation b y self- s eeking bureaucrats, and gives r i s e

research institutes, and state agencies ( e . g . , c e ntral statistical b ureau) .

consultants ,

t o rent - s e e king and c orrup t i o n . I f these problems are real, h o w c o u l d

In addition, the common assumption that those who are "doing the

K o r e a s u s t a i n a s p e ctacular e c o nomic p e rfo rmance w i t h its r e g i m e o f

business" h ave " b e tter" information than those who are trying t o inter­

investment governance? Trying to answer t h i s question may allow us t o

vene fro m " h igh a b ove" s h o u l d n o t be b l i n dly a c c e p t e d . B eh i n d this

d r aw s o m e u s e fu l l e s s o n s as t o what s h o u l d b e t h e ingre d i e n t s o f a

argument lies the assumption that " lo c a l " information is always b etter

s u c c e ssful inve s t m e n t gove r n a n c e system in a developing country.

than " gl o b a l " i n fo r m a t i o n b e cause it is m o re fin e ly m e sh e d . H owever, p e o p l e with " lo calize d " information m ay make a substantively less ra­

Informational Problem

tional d e c i s i o n than those with m o re " gl o b al " info rmatio n , d u e t o the

O n e c o m m o n o b j e c t i o n to government i n t e rv e n t i o n in investment

"subgoal i d e ntification" problem (the term is fro m Simon 1 9 7 9 ) . I f the

decisions is that the government does n o t possess the necessary infor­

aim o f government p o licy is t o imp rove the e fficiency o f the e c o n o my

mation t o make i n t e l l i g e n t inve s t m e n t d e c i s i o n s . While it cannot b e

as a whole, it may actually be better, under certain circumstances, not to

d e n i e d that the Ko rean state has made a s u b s t antial number o f " b a d "

be affected by the "localized" information possessed by the firm. Particu­

investment decisi o n s , it is also true t h a t m a n y o f its investment d e c i ­

larly whe n the decision involves externalities which are not borne out by

sions have b e e n hugely, if unexpectedly, successfu l . Korea's d e c i s i o n to

the firm, the state can make a better decision solely due to the more global

enter into s t e e l making and shipbuilding i n t h e 1 9 7 0 s fac e d criticism

nature of its o bj ective , and not b ecause it is a superior being.

both at h o m e and abro a d , including o bj e c t i o n s fro m the Wo rld Bank.

Last but not least. the problem of identifying good investment oppor­

This suggests that t h e i n fo r m a t i o n a l p r o b l e m u s u ally taken as insur ­

tunities is far less serious for late -developing countries than for the countries

m o u ntable by o p p o n e n t s of state interve n t i o n may n o t actu ally b e so

on the frontier of world technological progress. This is because late devel­

serious ( fo r fu rther elaboration, s e e Chang 1 99 4 , c h . 3 ) .

opers have the " s e c o n d - mover advantage , " by which we mean that they

First of all, we should not forget that insufficient information does not

can watch the frontier countries and learn from their experiences . 7 Even in

p revent us fro m planning our future economic life. Actually, the uncer­

a country like Japan, which was pretty close to the frontier o f industrial

tainty of the future is exactly the reason why we plan for the future, though

development even during its postwar catch-up period, it is recognized that

given our " bounded rationality, " we should not have excessive trust in our

"setting priorities, p i cking the next likely winners, has not been d i fficult

56

57

State, C apital, and Investments in Korea

State, Capital, and Investments in Korea

throughout the postwar period when the obj ectives of p olicy were prima­

this context, the remark fro m a top executive o f the large Japane se steel company, Kob e Steel, whom I encountered in a World B ank conferen ce, is

rily 'catching up' obj ectives" (Dore 1 986, 1 3 5 ) . In the case of Korea, which lagged even farther b e h i n d , the problem has b e e n even l e s s . Bureaucratic Self- Seeking

Another argument that is frequently employed again s t an interven ­

instructive . The executive claimed that given the diversity and compl exity of the com pany's o p erations, there was no way he and others sitting o n the b o ard could make an informed decision about m o s t of t h e proj e c ts put forward to them by their subordinates. He argued, however, that they are

t i o n i s t approach to inve s t m e n t governance i s that, whether o r n o t the

not worrie d because they b e lieve that most of their company employe es

bureaucrats have the ability to make intelligent decisions, these decisions

are doing their b e s t t o advance the interest o f the comp any. This would

should not b e left with them because they would pursue their own selfish

sound like a non s equitur to those who believe i n the neoclassical view

objectives in making such decisions. And indeed we can observe this kin d

o f human n a t u r e , but this i s e s s e n tially how a s u c c e s s fu l b u r e aucracy

o f behavior-such a s maximizing t h e budget they control rather than public

op erates-be it the privat e - sector business bureaucracy o f Kobe Steel o r

welfare-even in the most renowned bureaucracies, including that of Korea.

t h e respected government b ureaucraci e s o f Korea, France, o r Britain.

How, then, was it possible that bureaucratic self-seeking did not have such an adverse impact in the Korean case?

Th e e xi s t e n c e o f a "go o d " bureaucracy that has the o rganizational structure and organizational culture that can p reven t bureaucratic self­

First of all, it needs to b e emphasized that, while it contains an impor­

seeking has frequently been singled out by many people as one of those

tant grain o f truth, the self- seeking-bure aucrats argument is based on a

conditions that enabled Korea (and other East Asian countries) to success­

misconception of human motivatio n (fo r further details, see Chang 1 994,

fully pursue an interventionist approach to investment governance. While

ch. 1 ) . Bureaucrats, like any other individual, can and do act i n a fashion

I absolutely agree with this view, I would like to warn the readers against

that is not solely self- interested, and they often think of themselves, rightly

believing that the existence of such a bureaucracy was, to b o rrow a popu­

or wrongly, as the guardians of the public (or national) interest and act to

lar but obfuscating phrase, a beneficial " initial condition" that the country

promote it. It is another matter entirely whether their perceptions of the

p o s s e s s e d fo r historical reas o n s . Contrary to the popular belief, the Ko ­

public interest are correct ones. One such reason is that "public spiritedness,"

rean bureaucracy in the early postwar years was suffering fro m bad orga­

altruism, and so on are often held as genuine principles, and not as a thin

nization, compromised meritocracy, and lack of technical expertise-it was

veil to disguise self- interest. If whatever mo ral concerns people have are

sending its bureaucrats for training to the Philippines and Pakistan until

simply described as p eculiar forms o f self- interest, then the self- interest

the late 1 960s. Thus the country had to spend a lot of time and energy in

hypothesis will in fact become empty. Secondly, as demonstrated by modern

reforming the organizational structure of the bureaucracy and training the

exp e rimental psychology, decision frameworks d o influence p e o ple's d e ­

bureaucrats b e fore it could establish the kind o f bureaucracy that it has

cision ( Tversky a n d Kahnemann 1 986) . Bureaucrats usually face questions

now (Cheng e t al. 1 99 6 ) . B

put in terms of public interest, which will invoke a preference ordering that differs fro m what is used in p rivate decision- making s i tuatio n s .

Rent - Seeking a n d Corruption

E v e n with such qualifications, it c a n n o t b e denied t h a t b ureaucrats

One p o p ular argum ent against state intervention in investment deci­

have the tendency to exploit the power conferred o n them by their offices

sions is that it can lead to rent-seeking and corruption (for a comprehen­

in order to pursue their own interests. This makes the organizational structure

sive criticism of the theory of rent - seeking, see Chang 1 994, chs. 1 -2 ) . In

of the bureaucracy quite important, as it will shape the incentive structure

the current p olicy discourse, it is common to equate rent - seeking and cor­

for the bureaucrats. However, the success of a bureaucracy in controlling

ruption (or m o re precisely, b ribing) with each other, but these two need

s elf- seeking by its members goes much further than setting fo rmal rules

to be clearly distinguished (Chang 1 994, 29-30) . Strictly speaking, what are

against such b ehavio r. As Simon ( 1 99 1 ) argues, a successful organization

known as "rent-seeking costs" are essentially transaction costs arising from

has to b e one that musters organizational loyalty among its members , as

the diversion of resources from other "productive" activities to "unproduc­

otherwise the organization would have to spend an enormous amount of

tive" l o b bying activities (based o n the impo rtant but frequently ignored

time and resources in b argaining and monitoring their performances. I n

assumption that the economy was previously in a state of full employment

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State, Capital, and Investments in Korea

State, Capital, and Investments in Korea and thus the diverted resources had already been productively employed

Corruptio n and the Q uality o f Government D ecision M aking

elsewhere) . B ribing, o n the other hand, is essentially a resource transfer

The real trouble with corruption is not simply that it transfers m o ney

to the holders of public offices and thus has no (or very little) transaction

to public o fficials but that i t i s intended to influence the substance of

cost implications. However, does the fact that bribery is a transfer mean that

decisions by those officials. At this point, we should note that the influ­

corruption does not matter? Of course not, because there are important " in ­

ence of bribery o n government decision making is not entirely negative .

direct" ways in which b ribery matters for t h e efficiency of t h e economy.

B r i b e ry may h ave pos i tive indirect e ffi c i e n cy c o n s e q u e n c e s wh e n it is used as a "signal " for one's superior ability as a producer to make profit

Corrup tion and Capital Accumulatio n

(as h e avy adve r t i s i n g m ay be u s e d as a " s ignal " fo r s u p e r i o r - p ro d u c t

One important way in which transfer of wealth through bribing can

quality) . O f c o u r s e , the t r o u b l e i s t h a t t h i s s ignal i s n o t n o i s e - fr e e , a s

h ave an impact o n the economy is by transferring wealth between groups

there i s n o n e c e s s ary c o rrelation b e tw e e n s o m e o ne's ability as a p r o ­

with different savings l investments propensities. I f the wealth was tran s ­

d u c e r i n t h e p a r t i c u l a r i n d u s t r y wh e r e h e o r s h e i s t r yi n g t o g e t

fe r r e d fr o m a n i n d i v i d u al ( o r a g r o u p ) w i t h a l o w e r c o n s u m p t i o n

government s u p p o rt a n d h i s o r h e r ability to mobilize funds in general .

propensity t o another individual ( o r another group) with a higher c o n ­

For example, a person may be able to mobilize a lot of money b ecause

s u m p t i o n p r o p e n s ity, the e c o n o my m a y suffer i n the l o n g run, as this

of his ability to make arbitrage gains, but that does not p rove that he will

may reduce inve s t m e n t .

b e a go o d manager o f the industrial firm for which he is hoping to get

I t i s n o t implau s i b l e that thos e w h o a r e b ri b e d ( i . e . , p o l i t i c i a n s o r

a license. If this is the case, the positive nature of the signaling function

b ureaucrats) h ave a typ i cally higher propensity to c onsume than those

o f b r i b e ry may be s everely limited . I n d e e d , s o m e t i m e s the exact p u r ­

who b r i b e ( i . e . , b u s i n e s s m e n ) . However, the distinction b e tween b u s i ­

p o s e o f b r i b e ry is to " j am the signal " s o t h a t o n e c o u l d c o n c e al o n e's

nessmen a n d politician s / bureaucrats in t h i s regard is somewhat spurious,

(relative) incompetence in the area i n which one wants to b e chosen for

b ecause many o f the latter, e s p e c i ally i n develo p i n g countries, d o u b l e

government fav o r by u s i n g the m o n e y fro m o t h e r areas where o n e i s

as b u s i n e s s m e n , if o nly as " s l e e p i n g p artners . " I f t hose w h o a r e taking

more competent.

bribes do not have a higher propensity to consume than those who are

T h e n how can w e explain t h e fac t t h a t a corrupt country l i k e Korea

giving brib e s , the presumed negative effect o f c o rruption o n investment

could maintain a high degree of ratio n ality i n government decision mak­

and capital accumulation m ay b e n e gl i gibl e . Actu ally, this may b e one

ing? There are a few p o ssible explanation s , although none o f them can

clue to how such a " c o rrup t " co untry as Ko re a ( a s well as some ot her

be supported by robust emp irical data, given the nature of the subj ect.

countries in As i a , s u ch as Ja p a n or Indonesia) experienced a rapid capi­

First, there has b e e n some minimum threshold o f business competence

tal accumulatio n . All in all , without knowing the exact circuit of corruption

that a firm has to possess befo re it can enter the " b ribery marke t . " In the

money in a p articular country, it is not possible to predict how c o rrup­

Korean case, this has been achieved by (implicitly) confining the poten­

tion will affec t capital accumulati o n .

tial recipients o f state - c reated rents to a small group o f c o nglo merate s ,

Howeve r, there is another re ason why c o rruption m ay lower capital

namely the chaeb o l s , with already p roven b u s i n e s s track r e c o rd s , and

accumulation that is quite separate from differential consumption propen­

this way t h e m o s t e ffi c i e n cy - d a m a g i n g c a s e s o f c o rrup t i o n c o u l d be

sities. Wealth made out o f bribes i s more likely to b e shipped out of a

structurally prevented. Second, it can b e argued that corruption in Korea

c o u n try than other fo rms of wealth ( a s this will r e d u c e the chance o f

is co nfined to certain sectors that may not b e s o important fo r interna­

detection for corrupt dealings a n d will make it easier for t h e bribe recip i­

t i o n a l c o m p e t i t i v e n e s s . A s is the c a s e i n many o t h e r c o u n t r i e s ,

ent to flee the c o u ntry in the worst case) . I f such cap ital fl ight occurs,

nontradable s e c t o rs like defe n s e , c o n structi o n , urban planning, among

domestic accumulation will have been harmed by corruption, even when

others have been the most popular areas of co rruption in Korea, whereas

the co rrupt official has the same savings propens ity as the businessman

c o r r u p t i o n s e e m s t o h ave b e e n l e s s i n t r a d a b l e s e c t o r s wh e r e p o o r

who gives the brib e . In a c o untry like Korea, therefo r e , the existence of

perfo r m a n c e c a n b e q u i c kly exp o s e d . ' o Third , i t i s widely a c c e p t e d i n

capital control may have been more important than is often supposed in

Korea that there h a s b e e n l e s s c o r r u p t i o n i n t h e critical " t e ch n o c ratic "

ensuring high capital accu mulatio n , given the h igh level of corruptio n . "

p art of the government where m any s u b s t a n tively i m p o rtant d e c i s i o n s

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State, Capital, and Investments in Korea

State, Capital, and Investments i,} Korea

are made, whereas it is quite widespread among the top politicians and

personal connections. This way, the businessmen will pay exactly the same

the lower-level b ureaucrats. F i nally, the public commitment o f s u c c e s ­

amount o f money in increased taxes rather than in bribes (or even l e s s ,

s i v e Ko rean p o li t i c al regimes t o p r o d uc t ivity growth a n d catching u p ,

a s they do n o t have to pay the "risk premium" to those who are taking the

m a nifested i n n a t i o n al a n d s e c toral planning exe r c i s e s , seems to h ave

brib e s ) , the p o liticians and the bureaucrats wi l l get all the m o n ey they

put certain limits to the d e gree of "distortion" that bribing can have o n

used to get illegally or semilegally as a p art of their legitimate salaries now, and the poor will get the same amount of transfer from the rich , b u t now

bureaucratic d e c i s i o n s .

through institutionalized welfare schemes rather than depending o n their Political Functions o f Corruption: Implicit Wages, Redistribution, and Legitimacy

attractiveness to p articular politician s . However, there are many po liti c al and i d e o l o gical o b s t a c l e s to such

Another p o ssible explanation for the apparently weak (if not exactly

obvious refo rms i n Korea, m any of which also apply to other countri e s .

n onexistent) negative effect o f bribery o n the economy i n countries like

First of a l l , regarding t h e " implicit wage" function of corruption, it should

Korea is that a substantial p o rtion of bribery is in the form of what is called

b e noted that the prevailing Confucian ideology regarding public s e rvice

tukkap (literally, "money for rice cakes" ) . It is not p ai d to p articular public

requires that the public officials pursue a life of "clean poverty" (ch ungbin) ,

officials in relation to a p articular p roj ect, but is p ai d to most (if not all)

making it difficult to raise salaries for the p oliticians and the bureaucrats

of the influential p oliticians and bureaucrats to keep them "sweet. " l l To the extent that bribery takes the form o f tukkap and does not result

in the Singaporean manner. Second, in relation to the "redistributive" func­ tion of corruption, it should be noted that the absence of the welfare state

in specific instances of favoritism, it is a pure transfer which does not even

ideology and of the political coalitions to b ack it means that the Korean

have the "signal j amming" effect that we mentioned above. I propose that

government's p ower to raise taxes fo r redistributive p u rp o s e s is limite d .

this kind of bribery is better understood as an element of " implicit wages"

M o re over, p oliticians w h o currently run " l o cal welfare s t a t e s " h ave a n

for the politicians and bureaucrats who are bribed. Indeed, many Korean

incentive to k e e p discretion over t h e exact manner of redistributive trans­

bureaucrats and p oliticians claim that they would not take the bribes if

fer, which will be threatened by giving everyone an entitlement to a certain

they were getting s alaries comp arable to what they could get if they were

level of income through the welfare state. And those who are p aying the

employed in the p rivate sector-of course, taking into account the higher

tukkap also prefe r to have their money redistributed through the p o l i t i ­

social status that government jobs carry. Indeed, one reason why Singapore

c i a n s , rath e r than directly to the p o o r, as this wil l increase their ove rall

has little corruption seems to be that it pays its public figures salaries th at

influences o n the politicians.

are competitive with p rivate sector salaries.

The inability of the Korean society to accept the function of corruption

O n e addition al interesting twist to this story is that i n Korea, as in

as a channel to p rovide implicit wages to public sector employees and as

many developing countries, a l arge p art o f the tukkap - s tyl e bribery d i ­

a channel of income redistribution to the p o o r has meant that the sorely

rected to the politicians ( i f n o t the bureaucrats) e n d s up being transferred

needed reforms o f the taxation system, the public sector salary stru cture ,

to their constituents, especially the poorer ones. Indeed, many politicians

and the social welfare system that will institutionalize the existing transfers

claim that the need fo r this fu rther transfe r to their constituents is the

have not h a p p e n e d (or even b e e n d i s c u s s e d wide ly) . Thi s , in turn , h as

biggest reason why they take tukkap. And to the extent that this is t rue, this . kind o f bribery wo rks as a channel for income redistribut ion.

meant that the whole system of "co rrupt " transfers persists because m any people need it. The problem is that the widespread corruption has led to

T h e n the obvious q u e sti on is why countries like K orea cannot raise

a legitimacy crisis for the cou ntry 's p olitical system , because accordin g to

extra taxes from businessmen e quivalent to the tukkap they are p aying

the formal rules that currently govern the processes of income generation,

anyway, and then use the money, first, to raise wages for pol iticians and

transfers, and entitl e m ents, most of the "political transfers" that are going

b u reaucrats to take care of the " implicit wages" element, thus reducing

on now are illegal . Indeed, this inherent vul n e rability to legiti m acy crisis,

their needs to take bribes; and second, to set up a decent welfare state so

rather than its e ffe c t on capital ac c u m u l at i o n o r gove r n m e n t d e c i s i o n

that the politicians do not need to take bribes for redistributive purposes

rat i o n a l i ty, m a y b e the biggest p r o b l e m w i th c o r ru p t i o n i n t h e Korean

and make the redistrib ution less subj ect to things like p arty loyalty and

society (and in m any other s ocieties that s u ffer fro m a similar problem) .

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State, Capital, and Investments in Korea

The Demise of the " Traditional" Regime of

on the world scale. The limits o f neolib eral free - market reforms are too

Investment Governance, 1 993- 1 997

well known to discuss here, but the sway that the free - market ideology is holding in the country during the last s everal years has been truly remark­

Since the late 1 98 0 s , but especially from 1 99 3 , whe n the Kim Yo ung

able. Especially with their growing fin ancial muscles and their increasing

Sam government took power, the Korean regime of investment governance

o utward investments, the chaebo l s h ave become much more aggre s s ive

u n d e rwent i m p o r t a n t c h a n g e s i n more " l i b e ra l " d i re c t i o n s-the m o s t

i n asserting their b elief in a fre e market-the best manifestation o f this

important changes being t h e abolition of the planning ministry (the Eco­

being the 1 99 7 d o cument fro m the r e s e arch institute attached t o their

n o m i c Planning B o ard) , the s evere weake ning o f industrial p o l i cy, and

association ( Ko rean Federation of Industries) , which was hastily withdrawn

l arge - scale financial l i b e ralization ( m o re o n these later) . What were the

after public uproar in response to its call for a radical reduction o f state activities ( e . g . , to abolish all government ministries except defense and

fo rces driving such changes? First of all , as the Korean economy approaches the world's technologi­ cal frontier, the informational benefit that the government can derive from

foreign affairs, to cut the number of government employees by 90 p ercent, to deregulate every market imaginable, etc. ) Y

the country's late- developer status (see above) has been diminished. And

Added t o all these had been the increasing external pressures for lib ­

a s a r e s u l t , there has b e e n a growing o p i n i o n i n s i d e and o u t s i d e the

eralization. During the last decade or so, following the Korean success in

government that it is not so simple anymore to decide where to push invest­

international markets, the US and the European Union have been engaged

ments as it used to be, and therefore more and more things have to be " left

in active " trade diplomacy" with Korea, which involves demands for d o ­

to the market." Of course, it is not clear whether this argument is convincing.

mestic deregulation to enhance market access as well a s trade liberalization.

Korea is still some way away from the world's technological frontier except

The signing o f the World Trade O rganization ( WIO) agreement has also

in a few industries, and thus the loss of " latecomer's advantage in govern­

reined i n Korea's p ol i cy fre e d o m more than b e fore, although we should

ment intervention" is still not so complete. And the exp erience of Jap an

not forget that the o l d General Agre e m e n t o n Tariffs and Trade ( GATT)

shows that even in a highly advanced economy there are a lot of positive

system did not necessarily allow much more freedom to developing coun­

things that the government can do in terms of physical investment coordina­

tries than now, except perhaps in the area of TRIPs (trade- related intellectual

tion or promotion of cooperative R and D investments. Nevertheless, by the

property rights; for more details, see Akyuz et al . 1 998) . Korea's accession

mid- 1 990s, the belief that the Korean economy finally reached a stage where

to the Organization for Economic Cooperation and Development (OECD)

government orchestration of investment is at best redundant and at worst

has also obligated the country toward greater liberalization, especially of

harmfu l had established itself stro ngly among the Korean elite circles.

the capital market.

Second, the past (and present) association of the interventionist state

All the above factors have conspired to bring about important changes

with p o l itical authoritarianism and corrup t i o n has lent strength to the

in the inve s t m e n t governance regime of Ko rea s i n c e 1 9 9 3 . While there

opinion that a less interventionist state is needed to rid the country of such

were also changes, such as the n arrowing of the definition o f "stability"

undesirable features. Needless to say, such a simplistic view of state inter­

(and thus more narrow concern for inflation) and the increasing relaxation

ve ntionism is not warranted. For exampl e , the Pinochet regime in Chile

of lUXUry consumption control regime, the two most important changes

combined a high degree o f economic liberalization with political repres­

were the financial liberalization pro gram that vastly reduced the state control

sion. F o r another exam p l e , c o rruption in the Korean context cannot b e

o n capital inflows (and outflows to a l e s s e r extent) and the abolition of

e liminated without some structural reforms that I suggested in t h e previ ­

national and s ectoral planning exerci s e s , epito mized by the abolition of

ous section, which m ay actually require an increased role of the state at

the Economic Planning Board (EPB ) . This chapter argues that contrary to

least in certain areas (such as taxation and social welfare) . Even so, the grip

conventional wisdom, it was these changes rather than the persistence of

that this opinion has over the public mind had been very strong, and gave

the "traditional " regime of investment governance that led to the 1 99 7 crisis

impetus to a generalized attack on state interventionism.

( for further details, see Chang 1 99 8 b and Ch ang et al. 1 99 8 ) .

I n addition, during t h e l as t s everal years , Korea h a s witnessed the

First of all, the financial liberalization p rogram that was implemented

tremendous rise of fre e - market ideology, stro ngly influenced by its ascent

in 1 993-partly as a response to US p ressure and partly in a bid to qualify

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State, C apital, and Investments in Korea

State, Capital, and Investments in Korea

for OEeD membership-was wide- ranging in its scope, proposing, among

governanc e . The unfo rtunate thing is that. even fro m the p o i n t o f view

other things, to deregulate interest rates, abolish "policy loans, " grant more

of t h o s e who think the traditional regime had more o r less o u t l ived i t s

m a n agerial a u t o n o my to t h e b anks , r e d u c e e n t ry b arriers to fi n a n c i al

u s e fu l n e s s ( a viewp o i n t I d o n o t n o t share ) , i t can b e s a i d t h a t s o m e

markets, and, most important, liberalize the capital account. The ultimate

critical elements o f this regime were abolished without putting a l t e r n a ­

result of these changes was the now well - known huge foreign debt build­

tive mechanisms i n p l a c e to take over what were regarded a s legi t i m ate

up, where the country's fo reign debt nearly trebled from $44 billion in 1 993

fun c t i o n s . For exam p l e , l i b e ralizing international capital flows w i t h o u t

to $ 1 2 0 billion in September 1 99 7 (although it fell slightly to $ 11 6 billion

establishing p r o p e r mechanisms fo r financial supervision was a c r i t i c a l

by November 1 99 7 ) . 1l The problem with this debt build - up was n o t pri­

mistake that resulted i n t h e d e b t crisis. I n another example, aboliti o n of

marily with its scale but with its maturity structure , where , exploiting more

s e c t o ral planning witho u t establishing mechanisms through which the

l ax regul ations on short - t e rm l o a n s , the share of short- term debt ( d e b t

manufacturers themselves could coordinate investments (as it happened

with l e s s than a year's maturity) r o s e from a n already high 43 . 7 percent i n

in Japan espe cially b e tween the 1 95 0 s and the 1 9 7 0 s ) resulted i n dupli­

1 993 to a n astonishing 5 8 . 3 percent a t t h e e n d of 1 99 6 (BAl , 1 998) . 1 4 When

c ative inve s t m e n t s that b r o u g h t about c o rp o rate collapse a n d e xp o rt

the "contagi o n effe c t " fro m the Southeast Asian crisis and a number of

problems that c o ntributed to the 1 9 9 7 c r i s i s .

high - p rofi l e corpo rate failures ( s t e e l - maker H a n b o and car- maker Kia) shook internatio nal investor "co nfidence" in Ko rea in the last quarter o f 1 9 9 7 , such p o o r maturity structure o f fo reign l o a n s m e a n t t h a t it was impossible fo r the country to stem the outflow o f foreign exchange.

Conclusions

What c o n c l u s i o n s can we d raw fro m our d i s c u s s i o n ? First of a l l , our discussion shows that investment governance is a subj ect

The abolition of national and sectoral planning was also a critical factor

that spans an array of issues much wider than what the current discussions

in the making of the 1 99 7 crisis. Soon after it came to power in 1 99 3 , the

of the subj ect typ i c ally cover: inflati o n , regulat i o n , prop erty righ t s , and

Kim Young Sam government, in a gesture to show its commitment to free ­

social infrastructure. I n the case of Korea, it involved controls on the extents

m a r k e t r e fo r m , ab o l i s h e d t h e E P B , wh i c h h a d t i l l t h e n o r c h e s t r a t e d

and the forms o f capital inflows and outflows , disciplining the recipients

government e c o n o m i c p ol i cy since 1 9 6 1 . I t a l s o turned the ambiguous

of state - created rents , and even controlling luxury consumption, all of which

attitude that the previous Roh Tae-Wo o government showed toward sectoral

were achieved through the use of a wide range of policy measures regard ­

i n d u s t rial p o l icy i n t o an o u t right ave r s i o n , and p r a c t i c ally terminated

ing t axatio n , credit allocation, ownership control, local co ntents require­

sectoral industrial policies, except in the form of technology support in a

ment, and s o on. I t even has an important p o litical dimensio n , as it i n ­

few high - tech industries. Now free from the government coordination of

volved the co nstruction o f the sense o f the national "co mmunity" through

investments to avo i d "duplicative" investments, the chaebols went for an

controls o n lUXUry co nsumption or restrictions on capital fli ght.

i nvestment spree fueled by foreign borrowing, which resulted in the build­

S e c o n d , the Korean experience shows that, while there are o bvious

up o f excess capac ity i n a number o f maj o r i n d u s t r i e s (semico nductor,

problems with an interventionist regime o f investment governance (such

steel. automobile, e t c . ) that hurt export prices and corp orate profitability.

as info rmatio n al c o nstraint, b u reaucratic abuse, rent - s e eking, and cor­

At the same time , the abolition of planning, despite the i nitial expectatio n ,

rupti o n ) , such problems are by no means insurmountab l e . O u r discus ­

m a d e the co rrupti o n p r o b l e m wo rse. A s revealed graphically through t h e

sions s uggest that there are a l o t of m i s c o n c e p tions and exaggerations

c o rru p t i o n scandal t h a t s u rr o u n d e d t h e meteoric rise a n d the dramati c

i n t he currently p o pular discourses on these problems. At vari o u s points,

collapse of H anbo Steel . the aboli tion of planning now exposed even the

we argue d that the o rigins o f t h e s e p r o b l e m s are much more c o mplex

core manufacturing industries to co rrupti on, by eliminating the "rational "

than what i s usually suggested. We also argu ed that these problems cannot

criteria that put clear limits on how influential politici ans and bureaucrats

b e remedied in K o r e a , as in most deve l o p i n g c o u n t ri e s , by the m e a n s

c o u l d extend favors to t h e i r "paying c u stomers" ( s e e ab ove ) .

t h a t are u s u a l l y s u g g e s t e d ( e . g . , a b o l i s h i n g r e g u l a t i o n s a n d d i s e m ­

Thus s e e n , t h e changing e c o n o m i c , p o l i t ical, and i d e o l o gical c o n d i ­

p owering the bureaucracy) , b u t req u ire a fu n d a m e n t a l i n s t i t u t i o n a l r e ­

t i o n s t h a t preva i l e d i n Korea s i n c e the l a t e 1 9 8 0 s , and e s p e cially s i n c e

fo rm a n d the a b a n d o n m e n t o f the hypo c r i sy a b o u t t h e n ature of p u b l i c

1 9 9 3 , h a d l e d t o s i gn i fi c a n t c h a n g e s i n Ko rea's r e g i m e o f i nv e s t m e n t

s e rvic e . I n d e e d , w e p o i n t e d o u t t h a t t h e fai l u re t o m a ke s u c h i n s t i t u -

66

67

T

State, C apital, and I nvestments in Korea C HAPTER F O U R

t i o n al and i d e o l o gical changes might seriously damage the viabil ity of the Korean regime of i n ve s t m e n t governan c e . Third , o u r discussion o f t h e Korean case shows that a "nationalistic" governance o f investments can b e very successful, contrary to what many p r o p o nents o f the currently p o pular globalizatio n thesis argu e . Policies t o p revent capital flight and keep the capital invested at home, govern­ ment interventions to direct investments to "nationally" desirabl e areas, the creation o f a sense o f national community with a common purp o s e through ( although n o t simply b y ) controls o n lUxury consumption, a n d

GOVERNANCE AND INVESTMENT IN CHINA Shuhe Li and Peng Lian

the controls o n the extents and t h e fo rms o f fo reign direct investments are all elements o f such a regime. We pointed o u t that the globalization thesis i s , at least as yet, far too exaggerated, and that there is still a large s c o p e fo r national p o l i cy aut o n o my. Perhap s i t may s o u n d t o o cynical t o suggest that the elite i n many countries are now using glo b alization as a c o nvenient excuse for their abandonment o f any attempt at build­ i n g a nati o n al c o m m u n i ty and pursuing a n a t i o n al agenda, tasks that

One o f the most challenging political - economic puzzles of the 1 99 0 s

would require certain sacrifices o n their part. However, i n a world made

is h o w to explain t h e coexistence o f large - s cale foreign direct investment

up o f rather tightly bound national political units, the failure to construct

(FDI) and widespread corruption i n China. O n the o n e hand, according

a regime o f inve s t m e n t governance that i s firmly nati o n al i n its b a s i c

to the I nternational M o n e t ary Fund (IMF) , China has been ranked s e c ­

s c o p e can o n l y lead t o e c o n o m i c stagnatio n and a fun d amental desta­

o n d aft e r t h e U n i t e d Stat e s as a h o s t c o u n t ry fo r F D I s i n c e 1 9 9 3 ( s e e

bilization o f the p o litical units i n the l o n g ru n .

t a b l e 1 ) . C h i n a's F D I i nfl ow - G D P ( g r o s s d o m e s t i c p r o d u c t ) ratio was

Finally, o u r an alysi s o f t h e recent changes i n t h e Korean regime o f

also ranked second o nly to Singap ore i n 1 994 (see table 2 ) . I O n the other

inve s t m e n t gove rn a n c e a n d i t s c o ntribution t o t h e c o u n t ry's 1 99 7 fo r­

hand, China i s generally regarded as one o f the most co rrupt co untries

e i gn debt crisis shows the difficulties involved i n institutio nal reforms.

in the wo rld. According t o a survey o f the P o l itical and Economic R i s k

Even accepting that Korea re ally n e e d e d the large - s cale financial l i b e r ­

C o nsultancy (Asian In telligence 1 9 9 5 ) , China was rated by fo reign m a n ­

alization (especially capital account liberalization) and the abandonment

agers a s the most corrupt among eleven Asian countri e s , including I n d i a

o f s e l e c tive i n d u s trial p o l icy it u n d e r t o o k aft e r 1 9 9 3 (a view I d o n o t

and I n d o n e s i a . China was also ranke d b y Transp are n cy International a s

a g r e e with , as m e n t i o n e d a b o ve ) , its r e c e n t exp e ri e n c e c l e arly s h ows

o n e o f the most corrupt countries in the world i n 1 99 6 (see c h . 2 ) . S o m e

how unwise it was t o m ak e t h e s e changes without p u t t i n g i n p l a c e

estimate t h a t o n e - third to o n e - half o f a l l d e a l s s i g n e d in C h i n a invo lve

a

d e ve l o p e d fi n a n c i a l s u p e rv i s o ry sys t e m a n d i n t e r fi r m c o o r d i n a t i o n

some fo rm o f c o rruptio n , with bribes hovering b etween 1 - 1 0 perce n t o f

mechanisms that can take over the functions that the government c o n ­

s a l e s , and "there are probably as many typ es o f corruption as there are

t r o l o f t h e fi nancial sys t e m a n d s e l e c tive industrial p o l i cy have p l aye d

typ e s of t e a" ( Keijzer 1 9 9 5 ) .

in the Korean investment governance regi m e . Even when some c o m p o ­

The C h i n e s e deve l o p m e n t exp e r i e n c e s e e m s to defy the pre s u m e d

n e n t s o f the investment governance regime ( o r fo r t h a t matter a n y regime

wisdom a s stated b y the president o f t h e Wo rld Bank: " We n e e d to deal

of governance) are b e c o m ing l e s s e ffe ctive and are creating more u n ­

with the cancer of corruption. . . .

d e sirable side effects than b e fo r e , radical changes to t h e m s h o u l d n o t

a n d support to governments that wish to fight corruption-and it is these

b e m a d e until the possible consequences o f s u c h changes fo r t h e work­

gov e r n m e n t s t h a t , over t i m e , will attract the larger vo l u m e o f i n ve s t ­

ings o f the overall regi m e have b e e n tho ught through.

ment. " 2 Clearly t h e co existence of widespread corruption a n d fast- growing

We can give advice, encourage m e n t ,

FDI in China is an intriguing puzzle fo r students o f e c o n o m i c devel o p ­ me n t . As known, F D I will o c c u r whe n there a r e high transaction c o s ts 68

69

Governance and Investment in China Table 1

Foreign Direct Investment Annual I nflow in Reporting Economy

(Millions of

us

dollars)

Table I contin ued Greece Iceland

752 -27

1 ,005 3 760 6,41 1 1 2 ,349 1 ,003 2,6 1 0 1 3,984 1 ,982 4,961 32,427

1 ,1 35 33

1 ,1 44 14 1 ,438 3,950 7,790 716 1 ,873 1 3,276 -5 1 ,249 1 6 , 1 35

977 8 1 ,1 1 3 4,383 7,661 2,003 1 ,534 8, 1 44 3,705

981 -1 934 2 , 1 63 5,6 1 6 623 1 ,270 9,359 6,241 4 , 1 04 1 0,295

1 ,053 4 2,3 1 7 4,879 1 0,228

1 989

1 990

1 991

1 992

1 993

1 994

1 995

1 4,269

1 8,421

20,779

25,597

44,970

52,5 1 5

63,223

Afg h a n ista n , I. S . of

N/A

N/A

N /A

N /A

N /A

N /A

N/A

Bangladesh

N/A

3

1

4

14

11

Cambodia

N/A

N /A

N /A

33

54

69

3,393 9

3,487

1 1 ,1 56 51

27,5 1 5

33,787

80

4,366 15

29

65

2 1 51 35,849 67

India

N/A

N /A

N /A

N/A

N/A

N /A

N /A

I ndonesia

682

1 ,093

1 ,482

1 ,777

2, 1 09

4,348

Kiribati

N/A

N /A

N /A

N/A

2,004 -1

N /A

N /A

Korea

788 6 2,332 6

1 , 1 80 7 3,998 7

809

1 ,776

48

42 4,348

77 N/A

involved in exporting or licensing a product to a foreign company. In other

N/A

N /A

wo rds, unlike trad e , F D I typ ically involves l o n g - term and asset - sp e c ific

Mongolia

N/A

N /A

N /A

agreements . I n additi o n , foreign investors typically have less information

Mya n mar

8

161

238

727 8 5 , 1 83 7 2 1 72

588

Ma l d ives

1 ,118 4 1 ,668 4

Nepal

N/A

N /A

N /A

Pakistan Papua New G u i nea

210 203

244 1 55

Philippines

563

Singapore

Country Asia

C h i n a , People's Repu blic of Fiji

Lao People's Democratic Republic M a laysia

5,006 7 8

Ireland Italy Netherlands N o rway Portugal Spain Sweden Switzerland U nited Kingdom

85

2 , 1 66 8,563 1 ,5 1 9 1 ,737 8,428 1 ,812 2,827 30,553

1 ,062 2,401 6,3 1 6 -398 2,448 1 2 ,493 6,351 3, 1 78 1 6,21 3

899

1 5,544

N /A

653

6,250 1 4,273 2,600 32,208

SOURCE: I M F, Balallce ofPayments Statistics Yearbook 1 996, 5 8 , 5 9 .

7

10

N/A

N/A

N /A

N/A

N /A

N/A

N /A

257 203

335

544

2,887 12

5,575 10

4,887 15

1 ,478 6,912

predatory, h o w c o u l d C h i n a make credible commitments to attract F D I ?

N /A

N /A

N /A

This puzzle is certainly not unique to China. In fact, it has b e e n o b -

20

43

48

2,444

2,014

166 1 ,366

s erved i n o t h e r A s i a n c o u n t ri e s , s u c h as I n d o n e s i a ( s e e c h . 2 ) , wh e r e

1 ,775

2,068

N /A

N/A

N /A

N/A

N /A

corruption and FDI were both remarkably high before the recent financial

Tonga

9

13

25

1 94 1 ,804 2 26

N /A

Thailand

228 2,204 14 1 23 2,1 1 3 1 26

419 -5 1 ,591 5,480

N/A

530

347 -2 1 ,238 4,686

II

31

Western Samoa

N/A

N/A

N/A

N /A

N/A

N/A

N/A

Asia (not specified)

1 ,704

1 ,450

1 ,491

1 , 1 39

1 ,2 1 7

2,025

2,956

Solomon Islands Sri Lanka

Vanuatu

Industrial Countries U n ited States Canada Australia Japan New Zealand Austria Belgium-Luxembourg Denmark Finland France Germany

1 66,514 1 69,604 1 1 2,911 67,730 47,9 1 8 22,0 1 0 2,740 7,855 5,029 4,037 6,482 8, 1 29 1 ,298 1 ,760 - 1 060 1 ,290 1 ,735 1 ,627 360 653 587 9,363 8,047 7,020 1 ,553 1 , 1 32 1 ,090 -233 812 490 1 0,304 1 3 , 1 83 1 5 , 1 53 4 , 1 08 2,532 7 , 1 52

294

1 1 7,691 1 7,580 4,5 1 7 5,038 2,761 2,086 947 1 1 ,286 1 ,01 7 396 21 ,840 2,642

453

1 36,459 1 39,51 3 208,909 43,014 46,760 60,230 1 0,786 7,299 4,997 1 3,71 0 4,708 3,008 53 916 1 26 2,509 2,524 2,469 1 ,357 1 ,311 977 N /A 7,464 1 0,750 4, 1 39 5,006 1 ,7 1 3 897 1 ,496 864 20,754 1 6,628 23,735 81 5 8,938 1 ,8 1 8 Co n ti n u ed

70

and connection to the host nation. How could the uncertainties and costs of tran s a c t i o n s reSUlting fro m o p p o rtunistic b e h avior and the h o l d - up problem b e reduced in an environment o f corrupt legal and administrative systems? In p articular, given the fac t that the s tate itself c o u l d b e

crisis occurred . In his discussion of economic transition, Robert H all highlights this puzzle as follows : " It is axiomatic that co ntract enfo rc e m e n t is a key to successful Eastern European l i b e ralization . . . . It is notewo rthy that t h e m o s t rap i d growth in the world in t h e p a s t d e c a d e h a s b e e n achieved in A s i a n countries where c o ntractual relat i o n s are l e s s h i g h l y developed and enforcement is less reliable . . . . It is a fascinating topic for additio nal research to figure out why Asian countries have been so successful " ( We rin and Wij kand er 1 99 2 , 34 1 ) . This chapter attempts to provide some insights into the co rrup t i o n FDI puzzle in China. In the next section we submit a framework, the LCM, wh i c h h i g h l i ghts three mechan i s m s : l o c al i nfo r m a t i o n and i n fo r m a t i o n intermediaries (L) , cro s s - regional c o m p etition (C) , and market-preserving authoritariani s m ( M ) at the i ndividual , regional and n atio n al level s , re spectively. When it is too costly and too uncertain to use a corrupt l egal system, such mechanisms can help enforce agreements and property rights. 71

---

Governance and Investment in China Table 2

Governance and I nvestment in China

�

FOI! GDP and F O I ! GNP in 1 9 9 4 ('Yo)

Country

Country

F D I 1 1 GDp2 F D I 1 IGN p3

F D I 1 I GDp2 F D I 1 IG N p3

Asia

2.89

0.78

Westem Samoa

NA

NA

Afgrlanista n , I . S , of

N/A

NA

Asia (not specified)

NA

NA

0.70 0.70 1 .34 1 ,42 0,02 4,97 0,67 3.28 3.43 1 .53 1 .25

0.81 0,69 1 .25 1 .46 0,03 4,54 0,84 3.65 4,84 1 .82 1 .46 0,05 0,86

Bangladesh

0,04

0,01

Industrial Countries

Cambodia

N/A

NA

U nited States

China, People's Republic of

6.47

F ij i

NA

1 .1 3 0,14

Australia

India

NA

NA

Japan

Canada

Indonesia

1 .21

0,31

New Zealand

Kiribab

NA

NA

Austria

Korea

0.21

0,18

Belgium-Luxembourg

Lao People's Oem, Republic N A

NA

Denmarl<

6,16

2,62

Finland

M alaysia Maldives

NA

NA

France

Mongolia

0,94

NA

Germany

NA

Myanmar

NA

NA

Greece

1 .26

Nepal Pakistan Papua New Guinea Philippines Singapore

NA

NA

Iceland

NA

NA

0.81 -0,09 2.48 7.95

0,16 -0,04 0,87 8,63

Ireland

1 .79 0.21 1 .70 0,57 1 .46 1 .94 3. 1 8 1 ,58 1 ,01

1 .91 0.21 1 .94 0.72 1 .07 1 .74 4,14 2,33 0,98

Italy Netherlands N o rway

Solomon Islands

NA

NA

Portugal

Sri Lanka

1 .42 0,95

0,29 0,34

Spain

NA

NA

Switzerland

NA

077

U nited Kingdom

Thailand Taw Vanuatu

Sweden

ScnJlll FS OF BASIC DAI ,\: 1 , I M F , B(lI(lllce o(Paymell ls Sta lis lics YeariJook 1 996, 58, 5 9 , 2 , T h e Wo rld B a n k , Wo rld Delleiopmell l Repo rt 1 996, 2 1 0 , 2 1 1 ,

:l, T h e Wo rld B a n k , Wo rld Delleiop men l Report 1 996, 1 8 8 , 1 89 , 2 2 2 ( P P P b a s e d G N P ) ,

After that, we s p e c ifi c a l ly exp l o re the C h i n e s e c a s e . We argue that overseas C h i n e s e c a p i t al i s t s , fi s c al d e c e ntralizati o n and p o s t - M ao r e ­ gimes primarily facilitate t h e three mechanisms, respectively, and h e n c e c o ntribute t o the l arge - s cale i n fl ow o f F D I . A t the same time, howeve r, government control and regio nal public ownership without an indepen ­ dent j u d iciary sys t e m h ave p rovided a hotbed fo r c o rruption in China's transition e c o n o my. As n o n owners of public assets but with significant control rights, Chinese industrial bureaucrats have b o th i n c e ntives and o p p o rt u n i t i e s to take b r i b e s fro m p rivate inve s t o r s ( i n c l u d i n g fo reign investors) i n exchange fo r giving s o m e p u b l i c a s s e t s t o the latter p arty,

�

�

s ip make corr p t i o n wides�r ad (scope) , c o rruption is s o m ew ha t p re d i c t ab l e , c o o rd m a t e d , and l i m i t e d to n o t eas ily verifiab l e t l'a , n s a c t I. o n s (degree) d u e to the L C M in C h i n a . Partly as a r e s u l t , t h e c o rr u p t i o n ind uced unce rtainties for the returns to F D I are mitigated , thus m a king . . . , Chma a relatively attractIve site fo r F D L In the last sectio n , we d i s cus s the recent financial crisis in Asia and the implicatio ns for China in te rm s of state gove rnance and F D L State Governan ce, Informal Enforcem ent, and FDI

In this chapter, corruption is defined as the abuse of public assets o r public authority for p ersonal gain.3 By t h i s definition , corruption generally occurs if public property rights and ! or public authority are n o t well de­

fined. The scope of corruption is thus p o sitively correlated with the range of ambiguity of public property rights and regulatory authority: When there ' are more distortions in prices, agreemen ts, and regulation s an d more noise, there are more opportuni ties for corruption . Corrupt officials can purposely

make confusing rules and change them randomly so as to create oppor­ tunities to increase bribe taking and to reduce the risk of b eing detected. In the c a s e of C h i n a , b u r e a u c r a t s and m a n a g e r s o f s t a t e - o w n e d

enterprise s ( S O E s ) a n d township a n d village enterprise s ( TVEs ) are n o t o w n e r s o f p u b l i c a s s e t s , yet h a v e s i gn i ficant c o n t r o l rights over t h e s e

a s s e t s . T h u s t h e y have b o th incentives and o p p o rtunities to take bribes fro m p rivate investors by giving some public assets to the latter p arty, exp l i c i tly o r implicitly. 4 This makes it p o s sible fo r a p rivate inve s t o r to l ower his average c o s t-the annualize d value of the " fre e" public assets

is greater than the bribe. C o n s e qu e ntly, he would have little i n c e n t ive to reveal the situati o n . Product competiti on fo rces other p rivate inves­ tors t o b r i b e b e c a u s e oth erwis e their average c o s t s w i l l b e h i gh e r a n d

th ey will l o s e m a r k e t share .

Given the fact that corruptio n is widesprea d in China-fo stered bv a legal system that leaves much to be desired in terms of enforcing agr e ­ ments and property righ t s-some info rmal and semifo rmal enforcem ent mech anisms must have contribu ted t o t h e rapid exp a n s i o n o f F D L We sub mit that there are two fundame ntal forces that help enforce agreemen ts

�

informally or indirectly : local informa tion (with partners) and competit ion (with rivals) . A person's local info rmation about his business partner c o n ­ sists of h i s personal knowledg e about t h e partner's identity, credit histo rv, ' reput ati o n , financial status, a n d so o n . Local informati on is relatio n - sp ­ cific, and it is generally accumulat ed among relatives, town mates , fri e n d s ,

�

exp l icitly or implicitly. Although gove r n m e n t c o ntrol a n d public owner-

and c o l l e agues. Two parties w i t h c o m m o n l o cal i n formation c a n red u c e

72

73

Governance and Investment in China

Governance and Investment in China

the uncertainties of their transactions and information asymmetry between

ally m e t . In c o u n t r i e s wh ere they are n o t , a regime that i s p o l i t i c a l l y

them. More important, if two parties do not have mutual local information,

more c e n t r a l i z e d and e c o n o mi c ally m o re d e c e n tral ized m ay b e a rea­

but each of them has mutual local information with a common third party,

s o n a b l e a l t e r n ative . T h a t i s , c i t i z e n s m ay be fo rb i d d e n t o o r g a n i z e

then the third party can play the role of an information in termediary. Contract

opposition p o l itical parties a n d to d e m o n strate o n t h e streets, b u t they

guarantee and perso nal r e c o mmendations are c o m m o nly o b s e rved ex­

are allowed t o trade and i n ve s t . L o c a l governments may be gran ted a

amples o f informatio n intermediaries . B y transitivity, a wi d e n e twork may b e e s t a b l i s h e d o n info rmation intermediaries. \'\lhen such a network is interregional or international, it can

l arge degree of autonomy over e c o n o m i c d e c i s i o n making, though the ultimate p olitical autho rity is the central govern m e n t , and the national gove r n m e n t i s able t o maintain a common marke t . '

facilitate cross- regional or cross- country agreements. Such private ordering

C ro s s - r e g i o n a l c o m p e t i t i o n i m p l i e s t h a t r e gi o n s c h a r g i n g m o r e

can help enfo rce not o nly the kind o f agreements that are not verifiable

b r i b e s a n d givi n g u p fewer c o l l e ctive a s s e t s will l o s e F D I t o o t h e r r e ­

by a third party, but also the kind of agreements that are verifiable by a

gio n s . H e n c e , in equilibrium, bribes will b e l o w enough to keep business

third p arty but nevertheless cannot be imp artially enforced by law.

profitab l e . Indeed, fro m the viewpoint o f bribe givers, it is possible that

\'\!he n it is too c o s tly or t o o uncertain to use a c o rrupt l e gal system

the value o f b ribery- induced favorabl e treatments is larger than the bribe

to settle disputes, p arties to a transaction can resort to l ocal information

itself, and thus the bribe giver can b e b e tt e r o ff as a result. This i s b e ­

and informati o n intermediaries to enforce agreements informally. Local

c a u s e c o m p e t i t i o n a m o n g d i ffe r e n t r e gi o n s ( b r i b e t a k e r s ) t e n d s t o

information shared among business p artners can help them to conduct

increase the value o f favorable treatments and decrease the size o f b rib e s .

b u s i n e s s outside the l egal sys t e m , thus fun c t i o n i n g as a substitute fo r l e gal e n fo r c e m e n t .

C o m p e t i t i o n a m o n g b r i b e givers may l i m i t p o t e n tial i n e ffi c i e n c i e s fro m corru p t i o n . I n fact, under certain c o n ditions bribery i s e quivalent

C o mpetition p rovides another driving force fo r co ntract enforcement.

t o competitive bidding ( B e c k and Maher 1 9 86) . I f the bribe taker cares

I n p articular, cro s s - regional competition will fo rce each region to reduce

only about the amount of the bribe ( i . e . , h e does not discriminate among

uncertainties and costs o f transactions in its j urisdictio n . The initial driving

bribe givers) and there is sufficient informatio n , then the m o s t efficient

fo r c e may c o m e fro m p r o d u c t c o m p e t i t i o n i n a s p o t marke t , s u c h as

bribe giver can d e feat all others since h e i s able t o submit the l argest

exchanges o f fi nal p r o d u c t s ( e s p e c ially c o n s u m p t i o n g o o d s fo r which

( "p ro fitabl e " ) bribe. Thus , res o urces are allocated t o the m o s t e ffi c i e n t

enforcement is rel atively e asy) , and the resultant taxes that market ex­

user d e s p i t e c o rrup t i o n .

c h a n g e g e n e r a t e s . The r e g i o n s with m o r e e ffe c t iv e e n fo r c e m e n t

I n s u m , before democracy a n d t h e rule o f law a r e firmly established,

mechanisms have c o m petitive advantages , such a s l ower costs over rival

we need a gove rnance structure t o ful fill three basic institutional c o n ­

regi o n s , and thus w i l l a t t r a c t m o re e c o n o m i c a c t ivity. Thu s , p r o d u c t

ditions:

c o m p e t i t i o n may t r i g g e r c o m p e t i t i o n i n t h e d e s i g n o f e n fo r c e m e n t

micro e c o n o m i c d e c i s i o n s ; s e c o n d , firms a n d l o cal govern m e n t s a r e n o t

fi r s t ,

households

and

fi r m s

h ave

a u t o n o my

to

make

m e c h a n i s m s . I n e q u i l i b r i u m all regi o n s o r gro u p s m ay b e " fo rc e d " t o

able t o e r e c t trade b arriers; third , there i s no rampant r o b b e ry a n d ar­

a d o p t e fficient (tho ugh info rmal) e n fo r c e m e n t m e c h a n i s m s . "

bitrary c o n fi s c atio n . Th e s e c o n d it i o n s create an envi r o n m e n t that e n ­

However, a proper governance structure i s n e e d e d to facilitate these two fo rces. First, fo r local information to b e utilized effe ct ively, it m u s t

c o u r a g e s t h e u s e o f l o c al i n fo rm a t i o n / i n t e r m e d i a r i e s a n d p r o m o t e s cro s s - regio nal c o m p etitio n .

b e the case t h a t indivi duals have e c o n o m i c fre e d o m t o co nduct tran s ­

N o t e that these are also the conditions that preserve marke t s . I n Li

actions and to choose business p artners, and that there i s a (minimu m )

and Lian ( 1 99 9 ) , we argue that these conditions can b e met under ma rket­

p o litical order i n the s o c iety such that there i s n o ramp ant rob b e ry and

preseruing a u th o rita rianism ( M PA) .

arb itrary confiscat i o n . " Second, fo r comp etitive fo rces to b e effective. i t

We d e fine an M PA as fo llows : A state is authoritarian if there exists

m u s t b e t h e c a s e that fi rms a n d regional govern m e n t s h ave auto n o my

a d o m i n a n t group o f p o l it i c i a n s wh o s e control over the c o u n t ry rests

to make prim ary e c o n o m i c d e c i s i o n s in re s p o n s e to c o m p e t i t ive pres ­

more u p o n the o b e dience o f the citize n s than upon their p arti cipatory

sures but cannot erect trade b arriers . I n co untries where rule of l aw and

consent. An autho ritarian state in a developing or industrializing econo my

democratic p r i n c i p l e s have b e e n ingrai n e d , these c o n d i t i o n s are gener-

is market- p reserving if the fo llowing c o n d i t i o n s h o l d :

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Governance and Investment in China

Governance and Investment in China

M l . Subj ect to changing internati o n al and domestic constraints, in

o f checking devices are 0) vertical checking-hierarchical review, moni ­

particular competitive pressures, senior leaders (or the dominant

toring, graduated controL and regular reporting to a higher authority; ( 2 )

p arty) perceive that it is in their best interests to preserve the

horizontal checking-collective decision- making mechanisms and infor­

market in order to facilitate catching-up;

mation exchange / p e e r monitoring o f p e rfo rmance through deliberation

M 2 . Senior l e aders ( o r the dominant p arty) are able to make their policy on market-based catching-up more credible, i.e., not easily subj ect to political whim, by imposing self- c onstraints through

councils; and (3) intertemporal checking-term limitations, rotations, and the exchange o f positions among p oliticians and bureaucrat s . Examples o f coordination devices a r e ( 1 ) vertical coordination-j o int

allocating sufficient autonomy (including authority, information,

e ffo rts under the guidance o f a pilot agency o r one o r more designated

and resources) t o a large s e t o f p o l itical and, more important,

p o l i t i c a l l e a d e r ( s ) ; ( 2 ) h o ri z o n t al c o o r d i n at i o n - d e l i b e r a t i o n c o u n c i l s ,

economic decision makers i n an instituti o n alized way;

industry- s p e cific and cross- industry business associations, antitrust and

M 3 . Senior leaders (or the dominant party) are able to control agency

antil o c al - p ro t e c t i o n i s m regulat i o n s , i nfo rmal s o c i a l n e tworks ; and ( 3 )

problems of bureaucrats and businessmen, as well as other politi­

intertempo ral c o ordination-mechanisms that reduce undesirable p o licy

cians, by imposing constraints on them by designing and fostering

swings and sho cks and induce l o n g - term and stable c o o p eratio n , such

institutions, such as incentive schemes, checks, coordination, and

as the smooth and p artial replacement o f p o liticians and b ureaucrats , as

enforcement devi c e s , i . e . , b alancing autonomy and control.

well as meritocratic recruitment of bureaucrats , and a balanced seniority

Given the fac t that s e n i o r leaders h ave d o m i n a n t p ower i n an au­

cum m e r it - b as e d p r o m o t i o n system in the b u reaucracy.

thoritarian regime, Ml is a necessary condition for e c o nomic catching-up

Clearly, an M PA fo sters the three institutional conditi o n s : auton o my,

under authoritarianism. M l assures the compatibility o f the senior lead­

no trade b arriers, and p o litical order. This implies that the two informal

ers' incentives with the preservation o f the market . B o th constraints and

m e c h a n i s m s ( l o c al i n fo r m a t i o n and c ro s s - r e g i o n a l c o m p e t i t i o n ) c a n

experiences shape the p e r c e ived interests o f p o l itician s . P o l iticians will

fun c t i o n i n an M PA . F i r s t , M l i m p l i e s t h a t s e n i o r l e aders h ave s t r o n g

a d o p t p o l i c i e s that are i n their b e s t p e r c e ived i n t e r e s t s . I nternatio n al

i n c e n tive s t o maintain p u b l i c o r d e r a n d t o give firms and h o u s e h o l d s

c o nstraints may range fro m fo reign occupati o n , military threat, interna­

t h e fre e d o m t o make micro e c o n o m i c d e c i s i o n s . M 2 assures t h a t h o u s e ­

t i o n al sanctions (or s u p p o rt ) to e c o n omic c o m p e t i ti o n . 8

h o l d s a n d fir m s will i n fac t h a v e a u t o n o my t o make m i c ro e c o n o m i c

To make their commitment t o market-based catching-up policies cred­

decisions ( i n r e s p o n s e to competitive p re s s ures ) . M 3 assures that firms

ible, senior leaders ( o r the d o minant p arty) in an authoritarian regime

and lo cal governments will not easily be able to erect trade b arriers. It

h ave to tie their own hands with both international and domestic con­

also implies that some modicum o f p olitical order can b e maintai n e d .

straints. The former includes signing international treaties and opening up

A n MPA c o nstrains corruption indirectly through facilitating cro s s - re ­

markets. Violating treaties and reversing open-door p olicies may ruin the

gi o nal c o m p e t i t i o n a n d the u s e o f l o c al i n fo r m at i o n m e c h an i s m s . As

c o u n try 's internat i o n al reputation and p o s s ibly result i n international

described above (M3) , control mechanisms can constrain corruption directly.

sanctions, an d thus can be very costly. Open markets provide opportuni­

For example, appropriately designed arrangements governing recruitment,

ties for investors to escape should predatory behavior occur. A predominant

p r o m o t i o n , and c o n d u c t within the b u r e au c racy h ave b e e n s h own to

means of tying the politicians' hands with domestic constraints is to allo­

constrain bribe-taking (Evans and Rausch 1 996) . The same is true of collective

cate sufficient autonomy systematically to a large segment of the population.

decision- making mechanisms that increase transparency in the proj ect ap­

This may take the fo rm o f allocating autho rity o f p olicy implementation

proval process. When a project requires collective approval, it becomes more

to technocrats , autonomy to local governments, and economic freedom to

difficult for individual decision makers to extract rents unless they can collude.

firms and individuals i n an institutionalized way.

As another example, "graduated allocation of control or authority" at vertical

Autono my, however, n e e d s to be counterbalanced with appropriate co ntrol s . Agency problems can b e managed through checking and coor­

levels of management (in the public s ector) places exp licit limits to what is within an official 's authority, which in turn puts upper limits on bribesY

d i n at i o n d e v i c e s a l o n g t h r e e d i m e n s i o n s : v e rt i c al (or h i e r a r c h i c a l ) ,

M3 includes cro s s - checking device s , e . g . , app eals court s , antibribery

horizontal (or cross-function) , and intertemporal (or cross-time) . Examples

bureaus , p arty discipline committees, that make it easier to detect court

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Governance and I nvestment in China

verdicts that are unequivocably wrong. This implies that disputes whose

of China, although corruptio n is widesprea d in scope, its cha ract er is shaped and its impact constrained by the M PA directly through M3 and i nd irectly through facilitating cro s s - regional competition . In addition , sin ce a n M PA is a relatively centralized governance structure p olitically, it help s "c oordi­ n ate" c o r ru p t io n . Sup p o s e , fo r i n s t a n c e , there are s everal gove r n m ent

contentions can b e easily verified by a third p arty, e.g. , the appeals court, will be less susceptible to corruption since the judges would be more hesitant to bias decisions incorrectly. lO Hence, corruption will tend to be concentrated mainly on disputes that are not easily verifiable by a third party, e.g. , those that involve complex technical issues. For purposes of discussion, we will call this type o f corruption " implicit " : corrup tion is m ore l ikely to occur because of the technical complexity involved i n the dispute. Corruption varies fro m sector to sector, tending to b e more severe in s e c tors where the rents are l arge and where agreements are technically more specific, making it harder to detect corruption. Such sectors include

aircraft and construction ( H ines 1 995) and new technologies. I I Since F D I

agen c i e s that s u p p ly c o m p l e m e n tary p u b l i c g o o d s and act l ike a j o i nt monopolist. \3 The effect of corruption on p rivate investment woul d t hen approximate that o f a local tax (Shleife r and Vishny 1 99 3 ) . 1 4 I n the following section, w e

argue that overseas Chinese capitali sts, fiscal d e c e ntralizati o n , and the p o s t - M a o regime have p r i marily fac il i ­ t a t e d t h e t h r e e m e c h a n i s m s ( t h e L C M ) , re s p e c t i v e l y, a n d h e n c e contributed t o t h e large - s cale fl o w o f F D I into C h i n a .

fro m developed countries t o devel oping countries generally brings new technologies to the host country, it provides good opportunities for brib ­ ery. However, it is important to note that corruption in this case (which is implicit) may n o t n e c e s sarily imply serious c o n tract enforcement p r o b ­

T h e Chinese Case The Role of Formal Enforcement Devices i n FDI

l e m s . Surely the h o s t party, gene rally, has b etter l o c al information a n d

I n the last two d e c a d e s , China has enacted various l aws and regu ­

connection with t h e local courts. However, it is t h e foreign investor's d e ­

l a t i o n s t o govern F D I a n d to c u rb c o rrup t i o n . There are t h r e e m aj o r

faults that are often harder to be verified b y a third p arty, given that typi­

typ es o f F D I i n China and they are governed b y the Law o f E quity Joint

c ally the foreign investor provides complex technology and the host pro ­

Ventures (passed i n 1 9 79 and revi s e d i n 1 9 9 0 )

vid e s land and l a b o r. The fo reign inve s t o r d o e s n o t n e e d to wo rry t o o

the Law o f Wholly For­ ' eign - Owned Enterprises ( 1 986) and the Law o f Contractual Joint Ventures

much about b reach of contract by the h o s t since this c a n be easily verified

( 1 988) . Equity j oint ventures are j o in t - stock enterprises held by Chinese

by a third p arty and h e n c e be enfo rc e d by a c o u r t . Inversely, give n its

and fo reign p artners with the latter's s hare amounting t o n o less than

b etter connection t o local courts, the host need not worry too much about

25 percent i n general. Once an equity j o in t venture is established, chang­

b reach of contract by the foreign investor, either. Moreover, as long as the

ing the r e g i s t e r e d c a p i t a l w o u l d r e q u i r e g o ve r n m e n t a p p r o val . I n

courts in the host country are only implicitly corrupt, and the contracting

co ntractual ( o r c o o p e rative) j o int ventu res , profits can b e distributed at

parties have freedom to choose international arbitration, FDI agreements

any proportion agreed upon and each p arty has sep arate liability. Typi ­

can b e indirectly enfo r c e d by wel l - defined mechanisms i n s o m e deve l ­

cally, t h e fo reign partner provides technology and machinery, while the

o p e d countri e s . T h i s is b e cause ( international) arbitrated awards them ­

C h i n e s e s i d e p rovi d e s l a n d , l a b o r, and m a t e r i a l s . I n w h o l l y fo re i g n ­

selves can be easily verified by a third party and enforced in the courts of

owned enterpri s e s , 1 00 percent o f t h e capital is provided by t h e fo reign

We believe that, overal l , more corruption may increase uncertainties

restrictions o n such investment in industries as public utilities, transpor­

the host country. I "

investor wh o h o l d s b o th residual control and residual clai m s ; there are

and costs of transactions and hence reduce F D I . Wei ( 1 996) reports that

tati o n , real estate, insuran c e , and b anking.

corruption and FDI are negatively correlated and there is no exception for

Corrupt bureaucrats may favo r j o int ventures more than wholly fo r­

Eastern Asian countries. The negative effects of corruption are often exag­

eign - owned enterprises. In exchange for bribes from foreign investors, the

gerate d , however. This is b e c au s e b r i b e s may n o t o nly work as tips to

Chinese party may deliberately underestimate the value of state assets as

speed up bureaucratic procedures and to get around inefficient rules, but

shares in equity j o int ventures , and agree to a lower state share o f profits

also as indicated , under certain conditions bribery is equivalent to com ­

in contractual j oint ventures. This prediction is consistent with the observation

petitive bidding. More i m p o rtant, the damage fro m corruption crucially

that the proportion of wholly foreign- owned enterprises remained low until

depends on the nature and structure of the corruption regime. In the case

the early 1 990s when legal development b egan to accelerate (see table 3 ) .

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Governance and Investment in China Table 3

Governance and Investment in China

Accumulated Foreign Direct Investment from 1 979 to 1 993

investments with more than seventy countries since 1 982. China is n ow a

( Va l ue Unit: in US$ bi ll ion)

member of the " International Convention of Investment Disputes between Host Country and Fore ign Private Investors . "

Mode Total Equity Joint Venture Cooperative Joint Venture Wholly Foreign-funded Enterprises Joint Development

Number of Projects

Contractual Investment Amount

Actual Realized Amount

1 74,228 1 1 3,041 27,245 33,847

221 .896 1 05.629 57.061 55.442 3.764

61 .797 32.894 1 3.552 1 1 .590 3.761

95

SOURCE: Almanac ofChina 's Foreign Rela tions a n d Trade 1 994, 4 8 .

To curb c o rruptio n, China h a s enacted more than twenty l aws a n d regulati o n s s i n c e 1 9 8 2 . T h e maj o r o n e s a r e articles 1 5 5 and 1 85 o f the Criminal Law (passed in 1 982) , and the supplementary regulations regard­ ing the punishment of crimes of corruption and bribery (passed in 1 988) are the maj o r ones among more than twenty laws and regulations enacted since 1 982 to curb corruption. Furthermore, China set up two maj o r orga­ nizations: the Ministry of Supervision in 1 987, and the Department of Anti ­ Embezzlement and Bribery (within the Ministry of Pro curators) in 1 99 5 . Given t h e fac t that t h e judiciary system is n o t independent. it is n o t sur­

I t is interesting to assess the impact of the American Foreign Corrupt

prising that such anticorruption agencies are not independent either. 15 In

Practices Act of 1 977 that prohibits American individuals and corporations

additio n , the designed framework of legal procedures itself is vulnerable

from bribing foreign government officials. Empirical studies, such as Hines's

to j udges' discretion. I t is n o t considered illegal for j udges to meet p r i ­

( 1 9 9 5 ) and Wei 's ( 1 99 7 ) , suggest that this act tends to reduce American

vately with litigants or their agents. S o m e organizations, such a s b anks and

investments in corrupt countries. We believe such effects are very limited

customs, are not allowed to release evidence to litigating parties o r their

(as reported by Wei 1 996) , not only because this act m ay provide a com­

lawyers; thus j u dges must gather and can control such evidence.

mitment device for American investors to s ay n o to foreign demand for

Although such " formal rules" cannot imp artially enforce agreements

bribery, but also, more important, because there are many implicit ways

and eliminate c o rruption, they do p l ay two important roles. First, they,

of corruption and there is a lack of incentive for people to report on them.

along with other checking devices, set limits on corruption. The point is

M any American firms get third - p arty consultancies to do the bribing for

that although government c ontrol and public ownership result i n wid e ­

them. In the case of China, " by far the most common form of corruption

spread corruption, t h e degree of corruption is largely implicit. Second, the

is the solicitation of trips abroad . . . . Perhaps the ultimate gift is education

formal rules serve as coordination devices among transaction p arties, and

. . . many companies have sponsored individuals whom they met in the

as a benchmark for dispute settlement through negotiati o n , mediati o n ,

c o u r s e o f b u s i n e s s n e g o t i a t i o n s " ( Keijzer 1 9 9 5 , 1 84-86) . S i n c e the act

a n d arbitratio n . I n o t h e r words, t h e info rmal a n d semiformal settlement

punishes American investors when they or their p artners in the j oint ven ­

of disputes are affected by the formal rule s . I t is the j oint functioning of

tures bribe local officials, s o m e American investors in China may prefer

both i nformal and fo rmal enforcement mechanisms that reduces overall

who lly foreign- owned enterprises over joint ventures because of the For­

uncertainties and costs of transactions and contributes to the large inflow

eign Corrupt Practices Act.

of FDI into China. However, as will b e elaborated o n later, at the outset

To s afe guard fo reign inve s t o r s ' p r o p e rty righ t s , China enacted the

of refo r m . i n formal e n fo r c e m e n t m e c h a n i s m s p e rhaps p l ayed a m o re

Economic Co ntract Law I nvolving F o reign Interest i n 1 98 5 . I t stipulates

important role . As reform proceeds. formal enforcement mechanisms have

that for matters not covered by the law of the People's Republic of China

become increasingly more binding and e ffe ctive .

(PRC) , international practice should be followed, and that parties have the freedom to choose the means of dispute settlement: negotiation, media­

The Role of Local I nformation and Info r m ation Intermediaries in F D I

tion, arbitration, or litigation. The Arbitration Law enacted in 1 994 specifies

Wank ( 1 996) . in h i s field study of guanxi-Chinese for local relation­

that co ntracting parties have the freedom to choose Chinese or interna­

ships. or connections- and market expansion in Xiamen. Fuj ian province

tional arbitration, and the people's courts in China enforce both Chinese

i n 1 9 8 8- 1 9 9 0 . exam i n e s how b u s i n e s s m e n cult ivate c o n n e c t i o n s with

and international arbitral awards (see also the C ivil Proce dure Law en­

bureaucrats or " invest" in building the connections. and how such connec­

acted in 1 99 1 ) . China has signed treaties of bilateral p rotection of foreign

tions help reduce uncertainties and facilitate cross- regional exchange s . I n

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Governance and Investment in China

Governance and Investment in China

particular, in exchange for bribes, bureaucrats can help businessmen to get tive p o l icy sho cks and d i s cretio nary regulato ry abus e s . The mechanism

in their hometown s . According to the Australian government 's Eas t A s ia Analytical Unit in Canberra, there are about fifty million ethnic Ch i n es e residents in S o utheast Asia, and a majo rity of those are d e s c e n d a n t s o f

works b e tween l o c al o r fo reign b u s i n e s s m e n and Chinese bureau c rats .

s outhern Chin e s e . I t i s n o t surprising, therefore, that F D I in Guang do n g

A m o n g fo reign inve s t o r s in China, overseas C h i n e s e capitalists are the

a l o n e a c c o u n t s fo r 20 to 3 0 p e r c e n t o f all F D I in C h i n a .

licenses, loans, materials, and projects, and protect businessmen from erup ­

In h i s study o f H o n g Kong's production subcontracting activities in the

most conspicuous. The distribution o f sources, as well as cro s s - regional destinations, o f

Pearl River Delta of Guangdong from 1 986 to 1 989, Leung ( 1 993, 284) found

F D I i n C h i n a cl early s u p p o rt the hyp o th e s i s o n l o cal information and

that among forty - s even surveyed agreements, thirteen were through kin ­

i n fo rm a t i o n i n t e r m e d i a ri e s . F D I i n C h i n a i s mainly fro m Hong K o n g ,

ship; sixteen were through other Hong Kong firms, who invested earlier in

followed b y investment fro m Taiwan, especially in t h e 1 980s. A s shown in

the delta region and served as information intermediaries; and eight were

table 4 , for accumulated FDI fro m 1 9 79 to 1 99 3 , about 68 percent came

through other l arge Chinese S O E s , who s e rved as intermediaries and to

from Hong Kong and 8 percent from Taiwan. Even in 1 994, about 60 percent

who m the Chinese subcontractors were affiliat e d . Of the subcontractors

came fro m Hong Ko ng, and 1 0 p e rcent fro m Taiwan. These figures hold

through kinship, the m aj o rity were i n the hometowns and the rest were

despite the fact that the figures for Hong Kong's investments in China are

often in the contractors' immediate neighboring counties. In general, there

exaggerated for two reasons. Part of Hong Kong's investments in China are

were not many serious disputes b etween the Hong Kong investors and the

"round trip" investments by mainland investors s e eking favo rab l e treat­

Chinese subcontractors. O nly two Hong Kong firms expressed strong dis ­

ment for foreign investments. Another is "stop trip" investments by Western

satisfaction.

investors using Hong Ko ng as an information intermediary.

and information intermediaries seems t o be effe c tive .

Thus , such info rmal enforcement based on local info rmation

The geographic distribution of Hong Kong's investment in the delta Table 4

Accumulated Amount of I nvestment from Major Countries 1 979- 1 993

region was attributed, according to Leung ( 1 993) . mainly to the distribu­ tion o f guanxi, and to a lesser extent to the differences i n location , lab o r

Country (Region)

Number of Projects

Hong Kong & Macao 1 14,147 1 2,011 US 20,982 Taiwan Provincial 7,1 80 Japan Germany 569 3,1 22 Singapore Britain 616 Thailand 1 ,399 Australia 1 ,309 1 ,540 Canada

% of the Country's Total

Contractual Investment (in US$ billion)

% of the Country's Total

Per-project Investment Amount (in US$1 ,OOO)

1 50.929 14.426 18.432 8.895 1 .457 4.843 3.025 2.095 1 .247 1 .81

68.0 6.5 8.3 4.0 0.7 2.2 1 .4 0.9 0.6 0.8

1 ,320 1 ,200 870 1 ,230 2,560 1 ,550 4,910 1 ,490

65.5 6.9 1 2.0 4.1 0.3 1 .7 0.4 0.8 0.8 0.9

c o s t and quality, and land availability. In o t h e r word s , factors related to info rmatio n and e n forcement are primary determinants o f FDI destina­ tions, while t h e c o nv e n t i o n al factors are s e c o nd ary. The investment of H o n g Kong-listed China Strategic H o l dings (CSH) in China p ro vi d e s an illuminating c a s e . By the mid - 1 990s C S H had b e ­ c o m e p e rhaps the s e c o n d largest fo reign inve s t o r i n C h i n a , controlling more than e i ghty companies and owning stakes in well over 1 00 others ( H s i e h 1 99 6 ) . I t s chairman, Oei H o ng Leong, a son o f the chairman o f Indonesia's Sinar Mas, is a m a s t e r o f l ocal information and information intermediaries. I n 1 992, he took over forty-one SOEs (including some beer

950

companies) in his hometown Quanzhou in Fuj ian province, and a large

1 , 1 70

tire SOE in Shanxi p rovince where he stayed during the Cultural Revolu­

SOURCE: Almanac o(Ch i n a 's Foreign Rela tions a n d Trade 1 994, 4 9 .

tion. In both places, he has good local information. Part of his investments were covered by loans from Western b anks, and the loans were guaranteed

We stern inve s t o r s ( a s well as b i g c o m p a n i e s i n Hong Kong) began

by his father's Sinar Mas. His father served as an information intermediary

s i g n i fi c a n t direct inve s t m e n t s i n China only aft e r 1 9 9 2 a n d many of

b e tween him and the Western banks. In 1 99 3 , O e i listed the Sh anxi tire

t h e m inve s t i n C h i n a t h r o u gh Hong K o n g . I nv e s t o r s fro m Hong Kong

comp any (reorganized with some other tire companies in China) in the

a n d Taiwan are m o s tly Chinese and m o s t have rel atives i n China ( e s ­

New York Stock Exchange and Goodyear acquired 24 p ercent of the shares.

p e c i ally i n Guangd o n g a n d Fuj ia n J . a n d h e n c e h ave l o c a l i n fo rmatio n

In 1 99 5 , Oei sold 7 5 percent of the shares o f some of his beer comp anies

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to the second largest beer company in Japan. Note that Oei served as an

un d e r autho ritarianism during the 1 9 7 8- 1 9 9 8 p e r i o d . C o rre s p o nd i ng t o M l , M2 , and M3 specified under a market- preserving authoritarianis m , We

information intermediary b e tween the Chinese companies and other for­ eign companies. A similar case is that of Robert Kuok, a Chinese Malaysian

sh all discuss incentive compatibility (competition) , autonomy (decentr ali­

tycoon, selected as Coca-Cola's exclusive partner i n China because of his

zation) , and control (coordination) , in turn .

extensive netwo rk i n S outheast Asia and China, as well as his extraordi­ nary ability to use information intermediaries . 1 6

Competitive pressures and experiences (Ml) After initiating economic reform in 1 97 8 , Deng Xiaoping and his col­

Cross- Regio n al C o mpetition fo r FDI

The distribution of j urisdictional destinations o f F O I across different

leagues shaped the regime as marke t - p re se rving authoritarianism. They imitated the market-preserving authoritarianism of other East Asian coun­

levels o f government is c onsistent with our hyp othesis o f cross- regional

tries such as Taiwan, Singapore, and South Korea from the early 1 960s to

c o mpetition fo r F O I , which has mainly gone to the j urisdictions o f r e ­

the late 1 980s. B o th competitive pressures and experiences led Deng and

g i o n al and l o c al governments. Among 2 9 9 8 firm - s p ec i fi c o p e rations o f

other senior leaders to preserve the market in order to facilitate catching-up.

multinational corporations in China, from 1 979 to 1 993 ( Tse, Pan, and Au,

In the late 1 970s, China faced a strong military threat from the Soviet Union

1 996, table 2) , about 30 percent of all operations worked with provincial

as well as economic competition fro m Japan and the four little dragons.

governments, about 50 percent with municipal / county governments, and

Economic catching-up was thus vital to the nation and the regime. Inter­

the remaining 20 percent with the central government. To get around gradu­

nally, the Deng faction had to compete with the Hua Guofeng faction, which

ated co ntrol, a local government often divides a big proj ec t into s everal

represented the legacy of Mao. To defeat the Hua clique, Deng had to come

smal l p roj ects for approval within its own sphere o f authority.

up with more efficient policies to m o b ilize mass support.

To compete for F D I , governments at the p rovi n cial level and, m o re

At that t i m e , the c e ntralized e c o n o m i c p l a n n i n g sys t e m had b e e n

important, at the municipality / coun ty level, designed institutions to re­

practiced i n C h i n a fo r three decades already a n d had l e d t o d i s astrous

duce uncertainties and costs of transactions. For instance, to compete with

e c o n o m i c c o n s e q u e n c e s . By this time, m arket mechanisms a d o p t e d i n

neighboring counties, Nanhai, Shunde, and Zhongshan in the Pearl River

neighboring e c o n o mi e s , such as Japan and t h e fou r l i t t l e dragon s , had

Delta of Guangdong, Dongguan county set up an " F O I Service Company"

brought double- digit annual growth for decades. I S In particular, the sharp

in 1 984 to serve as a coordinated and organized FDI contract approver as

contrast in p e rformances between mainland China and Taiwan, between

well as an enfo rcer. B e fo re this comp any was set up, a foreign investor

N o r t h Ko rea a n d South Ko re a , a n d b e twe e n E a s t G e rmany and We s t

needed to go to more than ten government agencies, such as the Bureau

Germany, confirmed the superiority o f the market m e c h a n i s m over t h e

of Administration for Industry and Commerce, the Commission of Foreign

planning system.

Trade and Economic Cooperation, and the land bureau and environmental

Like in other East Asian countries, China's strong landlord class had

agency, to have a proj ect approved. Now he only needs to go to the service

been wip e d out after land reform in the late 1 940s and the e arly 1 9 5 0 s .

company to get all the approvals within a few hours. The service company

Labor unions were restricted, a n d t h e military was controlled tightly by the

also serves as a mediator for contract disputes involving foreign interests.

p arty and the senior leaders. As a result, at the outset o f reform, senior

Such regional development is a result of the restructured capacity and

leaders did not foresee an imminent (internal) threat from a strong interest

incentives of local governments in the reform era, which has been part of

group; and by designing proper control devices and adopting a shared ­

the market- preserving autho ritarian regime in China since 1 9 78.

growth policy, they could avoid threats from a n emerging strong interest

M arket - Preserving Authoritarianism

various tactics to balance different interests . For instance, Mao analyzed

group i n the p r o c e s s o f d evel o p m e n t . I n a d d i t i o n , s e n i o r l e a d e rs u s e d The inflow o f FOI into China started in 1 9 79 and accelerated after

the balancing of the so- called Ten Great Relationships, such as develop­

1 992, mirroring the changing political - economic institutions in China. l 7 In

ment between agriculture and industry and development between coastal

this section, we apply the M PA framework p reviously developed to ana­

regions and inland regi o n s . At the same t i m e , development could h el p

lyze China's credible commitment to preserve the market for catching-up

u p g r a d e military technolo gy and b e t t e r finance the a r m e d fo r c e s , t h u s

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85

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I

Governance and Investment in China

Governance and Investment in China

minimizing external military threats, which were increasingly replaced by international economic comp etition after the end of the Cold War. Mini­

to directly e l e c t del egates to th e p e o p l e's c o n gre s s e s at b o t h t h e town ­ ship a n d c o u n ty leve l s . P e o p l e 's c o ngre s s e s h ave b e c o m e i n creasi n gl y

mized external military threats o r increased international economic com­

in fluential . B e ginning in 1 98 7- 1 9 8 8 , the heads o f vil l age com mitt ees were

p etitive n e s s resulting fro m d evel o p m ental p o l i c i e s , i n turn, can further

directly e l e c t e d . The direct election o f township heads was p l a n n e d i n

strengthen the position of an authoritarian regime. 1 9 In short, for Deng and

the F i ft e e n t h Party C o ngre ss h e l d i n 1 9 9 7 . Third, a n d m o re g e n e ra l l y,

other senior leaders in his faction, it seems that the perceived risk of regime

i n d i v i d u a l e c o n o m i c a n d civil fre e d o m s h ave b e e n s i g n i fi c a n t l y e x ­

collapse resulting fro m market development and catching-up was suffi ­

p a n d e d . I n d iv i d u a l s i n b o th r u ral a n d u r b a n a r e a s a r e i n c r e a s i n g l y

ciently low. On the other hand, they expected the market-based catching­

allowed t o trade, invest, and m igrate fre ely, and more importan t , to s e t

up to strengthen their positions.

up p rivate enterpri s e s . Private b u s i n e s s enterprises have s p r e a d r a p i d l y

Decentralization of authority and autonomy (M2)

r a w material s , e s p e cially aft e r t h e e arly 1 9 9 0 s .

fro m craft s , fo o d p r o c e s s i n g , and retailing t o textil e s , e l e c t r o n i c s , a n d Given that senior leaders are motivated to adopt market-based catch­

I n 1 99 3 , t h e State Administrati o n o f Industry a n d Commerce issued

ing-up policies, they need to make their policies credible in order to achieve

" Some Points o n Enhancing the D evel opment o f I ndividual and Private

their goals. As discussed previously, for this purpose the senior leaders have

Busin e s s . " It specifies the following measures to stimulate p rivate business :

to restrain themselves with both international and domestic constraints. The former include the signing o f international treaties and the opening up of markets. For the latter, senior leaders need to impose self- co nstraints by allocating suffi c i e n t aut o n o my t o a large set o f p o litical and e c o n o m i c decision makers i n an institutionalized way, s o t h a t it is infeasible or too c o s tly to revers e . Since 1 97 8 Deng and his colleagues h ave gradually but systematically opened China's door to the rest o f the world, and they have allocated and granted significant autonomy (including authority, informa­ tion, and resources) to households, firms, l ocal governments, and minis­ terial b ureaucrats , while reducing o r restricting their own authority.

International constraints. I n 1 9 7 8 Deng and his colleagues adopted an open-door policy. Thereafter China signed dozens of multilateral inter­ national treaties and many bilateral agreements. In p articular, as indicated, by the end o f 1 9 9 4 China had signed treaties o n (mutual) protection o f foreign investment with s ixty-seven countries. A t t h e s a m e time, China has o p e n e d up markets i n an increasing number of regi o n s and industries . Since 1 993 China has ranked second o nly to the US in attracting foreig n direct investment. M o re recently, in o rd e r to meet the requirements o f j o ining t h e World Trade O rganizati o n , w i d e r o p e ning-up i s u n d e r way. Increasing economic freedom of households and individuals. Firs t . t h e h o u s e h o l d r e s p o n s i b i l i ty system w a s widely a d o p t e d i n t h e e arly 1 98 0 s . Altho ugh land continues to b e collectively owned (usually at th e se village level ) , rural h o u s e h o l d s h ave gai n e d a l m o s t c o mp l e t e land - u

l.

Resigned and retired p arty and government officials can conduct p rivate b u s i n e s s ;

2.

Unless specified o therwise i n state laws and regulatio n s , privat e b u s i n e s s e s can o p erate i n a n y s e c t o r a n d in a n y fo r m ;

3.

Private e n t e r p r i s e s c a n t a k e o v e r s t a t e - o w n e d a n d c o l l e c t i ve e n t e r p ri s e s .

Th e s e m e a s u r e s h ave g r e a t l y e n l a r g e d t h e a u t o n o m y o f p r i v a t e enterpri s e s a n d h ave s p e d up the d e ve l o p m e n t o f p rivate b u s i n e s s e s .

Increasing a u tonomy of sta te-owned en terprises. T h e a u t o n o m y o f (urban ) S O E s w a s exp anded in t h r e e s t e p s . F i r s t , i n the l a t e 1 9 7 0 s a n d the early 1 98 0 s , SOEs began t o have s o m e limited operational auto n o m y and to have t h e right to retain s o m e o f t h e profits. S e c o n d , fro m t h e m i d 1 9 8 0 s t o t h e e arly 1 9 9 0 s , m o r e a u t o n o my w a s i n s tituti o n a l i z e d i n t h e m a n a g e m e n t c o ntract res p o n s i b i l i ty sys t e m ( M C RS) . Under t h e M C R S , i n d u s trial b u r e a u c rats a nd m a n agers s i g n c o n tracts s p e c i fyi n g p e rfo r ­ m ance targets , c o n trol righ t s , a n d c o m p e n s a t i o n s ch e m e s . T h e M C R S became widespread after 1 98 7 , a n d b y 1 9 89 m o s t SOEs had a d o p t e d the MCRS . Third , since the early 1 990s an increasing n u m b e r of S O E s as wel l a s TVE s h ave b e c o m e s h a r e - h o l d i n g c o m p a n i e s o r h ave b e e n fu l l y p rivati z e d . I n 1 9 7 8 , a l m o s t 8 0 p e r c e n t o f t h e t o t a l n a t i o n a l i n d u s t r i a l o u t p u t w a s d e r ived fro m S O E s . B y 1 9 9 5 , the S O E s ' s h a re o f t h e t o t a l i n d u s t rial o u t p u t had s h r u n k t o o n l y o n e - t h i rd ( Ch illa Sla tistica 1 Yen r­

rt rights by leasing contracts . Land leases have b e e n extended fro m sho by years) term ( e . g . , three to five years) to l o n g term ( e . g . , t e n to thirty b e gan national regulat i o n s . S e c o n d , after th e early 1 98 0 s l o c al residents

the small SOEs in Shandong and s everal other p rovinces h ave been fu lly

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87

book 1 996, 4 03 ) . A recent survey e s t i mates that m o re than 70 p e rc e n t of

o r p artially p rivati z e d ( China R e fo r m F o u n d a t i o n 1 9 9 7 ) .

• Governance and Investment in China The m i r r o r image of the exp a n d i n g auto n o my of S O E s and o t h e r enterprises a n d privatization h a s b e e n t h e shrinking authority of economic

Governance and I nvestment in China total indus trial output o f all enterpri s e s at o r above the town s hi p l e v e l ( Q i an and Weingast 1 9 9 5 ) . By 1 9 9 4 , it was estimated that l o c al gov e r n ­

and industrial bureaus. According to a survey conducted in 1 99 5 , ab out

ments at various levels controlled about 65 percent of the assets o f a l l

5 0-60 p e rcent o f the surveyed bureaus reported that their authority had

state - ow n e d e n t e r p r i s e s ( C h i n a R e fo r m F o u n d a t i o n 1 9 9 7 ) .

d e creased over the p revious year, and 3 0-40 percent reported that their

The decentralization p olicy has granted l ocal governments great a u ­

autho rity remained unchange d . 20 I n 1 9 9 8 the First Session o f the Ninth

tonomy to control their economie s , including autonomy to establish new

Natio n al People's C o ngre s s adopted a blueprint t o restructure the State

firms, to m ake investment with " s elf- raised fun d s , " and to manage and

C ouncil drastically within three years : some forty ministries and commis­

restructure their firms. Consequently, decentralization forced local govern ­

sions have been reduced to twenty-nine; most industry- specific ministries

ments to compete \Nith o n e another a n d helped to marketize t h e national

h ave been abolished; the number of staff members has been cut by about

economy. Although local governments may still use some planning mecha­

h a l f. Local gove r n m e n t s will be s i m i l arly s t r e am l i n e d , resulting i n the

nisms to control their enterprises, they can do business with other regions

significant reductio n in the government's economic authority.

o nly through b argaining, since no one region has authority over the oth­

Autonomy of intermediary business organizations. The autonomy of

ers. The relationship b etween p rovin c e s , cities, counties, township s , and

enterprises has been strengthened by the forming o f various intermediary

villages i s m o re o r less marke t - o riented ( fo r more details o n this aspect

business organizations. Enterprises are allowed or encouraged to o rganize

of decentralizatio n , see Li, Li, and Zhang 1 99 8 ) .

vario u s enterprise gro u p s and b u s i n e s s associati o n s . Enterprise grou p s

At the e arly stage of d e c e n tralizati o n , many l o c al govern m e n t s at­

fi r s t began to emerge when t h e then-State Planning C o mmission a n d the

tempted to protect their enterprises fro m competition from other regions

State Economic C o m m i s s i o n issued " S everal Points on E s tablishing and

by erecting trade b arriers . However, as the size o f each l o c al e c o no my

Developing Enterprise Groups" in 1 9 8 7 . 2 1 I n 1 99 5 the government issued

becomes smaller and the number of l o c al economies increases at lower

" Provisional Regulations o n the Establishment and M an agement of Enter­

government leve l s , the erection o f trade b arriers by a local government

p r i s e Group s " that set fo rth the principle o f voluntary p articipation of

b e c o m e s m o re c o s t ly, a n d hence c o m p e ti t i o n b e c o m e s m o re i n t e n s e .

individual enterprises i n enterprise groups. The resultant Chinese enter­

Protectionism o ften failed because efficiency gains from exchange s i gn i fi ­

prise groups are likely t o resemble the Japanese keire ts u o r the Korean

cantly exceeded the net benefits o f erecting trade barriers, as both informal

chaebol (conglomerates) i n the coming decades.

and formal arrangements emerged to capture the gains. In the late 1 980s,

Increasing a u tonomy of local go vernments. The autonomy o f l o c al

l o c al governments b egan t o fo rmulate treaties pledging to protect each

governments has i n c r e a s e d through the fiscal reve n u e - sharing system ,

other's enterprises as their own. For instance, it i s reported that Shanghai

the 1 9 8 2 C o nstituti o n , and various other d e c e ntralization p o l i c i e s . The

signed agreements for "the protection of the legitimate rights and interests

fiscal reve n u e - sharing system was first intro d u c e d i n 1 9 8 0 , renewed in

of enterprises" with nine provinces.22 In 1 99 1 , sixty- four courts from eight

1 9 84 and 1 9 8 8 with s o m e m o d i ficati o n s , and c o n t i n u e d through 1 9 93 .

prefectures and municipalities along the Yangtze River i n Hunan and Hubei

U n d e r this sys t e m , l owe r - l evel governments had an o b ligation to s u b ­

p rovinces s i gned agre ements fo r the j u d i c iary cooperation o f t h e s e t t l e ­

mit a fixed amount o r a fixed proportion o f t h e i r fis c al revenues t o the

m ent of cro s s - regional economic disputes . T h e two highest c o u r t s o f the p rovinc e s initiated these agre ements t o m i tigate l o c al protecti o n i s m i n

government l evel just ab ove them and they were allowed to retain the r e m a i n d e r fo r t h e m s e l ve s . T h u s , l o c a l gove rn m e n t s had t h e right o f residual claims. The 1 9 8 2 C o nstitution grant e d p rovincial - level gove rn­ ments the autho rity to make broad regi o n al economic regulatio n s . The

lower-level courtS. Ll In 1 99 3 , t h e central government enacted the " Law o f Anti- i mproper Competition," i n which article 7 prohibits local governments fro m using administrative means to erect trade barri ers.

central government has also granted control rights over a great number

Increasing a u tonomy of technocra ts. The auto n o my o f t e c h n o c rats

o f s t a t e - owned e n t e r p r i s e s t o local govern m e n t s . By the e n d o f 1 9 8 3 ,

has also expanded sign i fi c antly. B ureaucratic elite transfo r m a t i o n , aimed

control rights over the m aj o rity of state- own e d enterprises were tran s ­

at replacing the old and l e s s educated with young profe s s i o nals , h e g a n

ferred to local governments. By 1 9 8 5 , state- own e d industrial enterprises

in t h e early 1 9 8 0 s , a n d was l argely co mpleted in t h e early 1 990s b y vari ous

controlled by the central government accounted fo r o n ly 2 0 percent o f

fo rms o f mandatory retirement programs ."" After 1 9 84 , p e rso n nel co ntrol

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89

• Governance and Investment in China

Governance and Investment in China

was decentralized as the " two - level down management" was replaced by the " o n e - l evel down m a n a g e m e n t " at e a c h l e vel of gove r n m e n t . F o r

mance goals as output and p ro fi t s are among the key determ i n an t s o f p ayments and promotion. Performan c e - b ased incentive scheme s W i t h i n

instance. t h e Ce ntral Party Personnel Agen cy. fo rme rly t h e Ce ntral O r ­

the bureaucracy b e c ame m o re i n s t i t u t i o nalized after 1 9 8 7 when a c i v i l

ganization Department. n o w directly controls o nly t h e ministers a n d vice

service system was advocated. and especially after 1 993 when a civi l sys ­

ministers o f the cen tral government and governors and vi c e gove rnors

t e m was fo rmally i n t r o d u c e d . In t h e civil s e rv i c e sys t e m are g u i d i n g

o f the provincial govern m e n t s . I n 1 9 8 7 . the Thirt e e n th C o ngress o f the

principles o n rewards and punishment. and o n the distribution o f reward s

C h i n e s e C o mmunist Party d e c i d e d t o set up a civil s e rvice sys t e m . In

along vertical (hierarchy) . horizontal (cro s s - function) . a n d interte m p o r a l

1 99 3 . after exp eriments in six bureaus o f the State Council. in H arbin and

(cross- time) dimensions b a s e d p rimarily o n ( fifteen) ra n ks. T h e distribu ­

i n S h e n z h e n ( D e n g 1 9 9 4 . 3 ) . a fo rmal civil s e rvice system emphasizing

tion o f reward s

a merit- based selection (such as entrance exams) and promotion system

reference for party and military officials as well as other staff members in

was implemente d . Thu s . i n the reform era t h e bureaucracy has become

public agencies.

i n c r e a s i n gly stable and i n d e p e n d e n t ( a s d i s c u s s e d b elow) .

based o n rank i n the civil s e rvice system i s taken a s a

S p e c i fically. the i n c e n tives fo r party and government o ffi c i al s have

Such widely diffused autonomy makes it very c ostly or infeasible for

b e e n structured along the fo llowing l i n e s . F i r s t . overall c o m p e n s a t i o n

s e n i o r leaders to retrieve the decentralized authority fro m the hands o f

for officials includes both pecuniary a n d nonpecuniary rewards o btained

s u c h a vast number of households . firms. local governments. a n d bureau­

during and after office hours. The rewards include personal income. o n ­

to

the - j o b c o n s u m p t i o n . benefits fro m s o c i al status a n d fro m p ower ( c o n ­

defend and to conceal its vested authority and interests in case of a policy

t r o l rights) . b e n efits for their family members. relatives . a n d frie n d s . and

crats. The public can use the information and resources available to it

reversal . The decentralization o f authority has b e e n further strengthened

future b e nefits for the o fficials themselves. When an official leaves o ffice.

by self- im p o s e d c o nstraints o n the senior leaders thems elves. To make

he may b e promoted to an upper- level government position. o r h e may

their market-based developmental policies more credible. Deng and his col­

b e c o m e a manager in an enterprise that was p reviously under his c o n ­

leagues designed the Central Advisory Commission in 1 9 82 to restrict the

t r o l . E i t h e r way. returns after l e aving o ffi c e m a y d e p e n d o n o n e 's p r i o r

authority of the powerful first - generation senior leaders. including them­

p e rfo rmance i n o ffi c e . S e c o n d . the fis c al reven u e - sharing sys t e m pro ­

selve s . Influential p arty and military veterans were called to resign fro m

vided incentives for an upper- level of government to adopt p erformance­

their active posts to b e c o m e members of t h e advisory commission. which

based c o m p e n s a t i o n s c h e m e s fo r o ffi c i a l s o f l o we r - l evel gove r n m e n t s

had only symbolic authority. The commission was abolished i n 1 99 2 .

u n d e r its j u r i s d i c t i o n . U n d e r t h e fi scal reve n u e - sharing syste m . a local government takes the "residual " aft e r s u b m itting t h e s p e cifi e d tax rev­

Con trol devices (M3)

e n u e s t o the u p p e r - l evel govern m e n t . Given t h a t tax reve n u e is p o s i ­

Au tho rity decentralization and autonomy are necessary but not suffi­

tively c o rr e l a t e d t o t o t al o u t p u t . a l o c a l governm e n t i s p rovid ed wi t h

c i ent fo r market-based catching- up under autho ritarianism. As indicated

ince ntives t o link the p r o m o t i o n o f lower- l evel governm ent o ffi c i al s t o

i n M 3 . a u tonomy needs to b e balanced by con trof.2" The key mechanisms

their e c o n o m i c p e rform a n c e .

of control include incentive schemes. checking. coordination and enforce­

Checking devices. B o t h t h e cadre c o n tract resp o n s ibil ity system a n d

ment devices in governmental agencies. intermediary agencies. and private

t h e civil service syste m have built-in e x ante and interim checki n g devices.

agencies . Institutional devices. such as checking and coordination devices.

Ex ante checking devices refe r to predesigned measures to reduce

can b e designed along vertical . horizontal. or intertemporal dimens i o n s .

nate opportunities for co rru ption and misconduct. Interim ch ecking devices

Incentive schemes. Performance-based incentive schemes have gradu­

refer to m onitoring measures in the process. Ex ante and interim checking

or

elimi­

ally developed within both the party and the bureaucracy since 1 978. They

devices include ( 1 ) vertical checking devices. such as hierarchic al revi ew,

were parti ally institutio n alized in the "cadre co ntract resp o n s i b i l ity sys ­

m onitoring. graduated control. and regular reporting to higher authorities;

t e m " i n t r o d u c e d in t h e mi d - 1 9 8 0 s . U n d e r t h i s syst e m . a h i g h e r - l evel

(2) intertemporal checking devices. such as term lim itations. rotat i o n s , and

government designs and s u p e rvises perfo rmanc e - b ased contracts with its

the exchanging of positio ns amongst politicians and bureaucrat s ; (3) h o ri ­

i m m e d i at e s u b o rd i n a t e gove r n m e n t s . Typ i c a lly. such e c o n o m i c p e rfo r-

zontal checking d evices. such a s c o l l e c t ive decis i o n - m akin g m e c h a n i s m s

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+ Governance and Investment in China

Governance and Investment in China

and deliberation councils (to be discussed i n further detail b elow) ; and (4)

C o m m i s s i o n ( S ET C ) b e c a m e a p i l o t a g e n c y aft e r i t s e s t a b l i s h m e n t in

other c hecking devi c e s . such as the "challenge system" ( h u ibi zh idll) .

1 9 9 3 , and e s p e c i ally aft e r i t s c o n s o l i d a t i o n i n 1 9 9 8 u n d e r t h e maj o r

Ex p o s t checking devices are also designed to check c o rruption and

restructuring o f t h e State C o u n c i l . As m o s t i n d u s try- s p e c i fi c m i n i stries

m i s c o n d uct after they o ccur. Such devices include the Central Party Dis­

will c e a s e t o exi s t , t h e i r regulat o ry fun c t i o n s will b e transferred to the

c i p l i ne Commission for the p arty. and the M i nistry of Supervision (estab­

n ewly e s t a b l i s h e d i n d u s trial bureaus w i t h i n t h e S E T C .

l i shed i n 1 94 9 , abolished i n 1 95 9 , and restored in 1 987) , and the Depart­

Within t h e S P C , t h e SETe, a n d other agencies, important decisions are

m e n t o f Anti - E m b ezzl e m e n t a n d B r i b e ry ( s e t u p u n d e r the M i n i stry o f

g e n erally d e c i d e d c o l l e c tively and i m p l e m e n t e d b y i n d i vi d u a l s Y T h i s

Procurators in 1 9 9 5 ) fo r the bureaucracy.'" M o re over, there are bureaus

mechanism is known a s "collective leadership and individual responsibility"

corre s p o n d i n g to these organizat i o n s at vario us local government levels.

or "democratic centralism." Cross-ministerial joint decisions are generally made

S u c h devices at the s u b n at i o n al levels become m o r e effe c tive as cro s s ­

in some form of deliberation councils . Like the deliberation councils ini­

regional competition intensi fies. Facing economic competition from neigh­

tiated by MITI in Japan and the export - p romotion meetings in Korea, there

b o ring regi o n s , each l o c al government i s "forced" to imp rove its institu­

are "joint meetings" ( lianxi h u iyi) , "j oint approval meetings" ( h u iqian h ll iyi) ,

tional arrangements. including checking device s , to attract investment.

and " State Council official meetings" (gllowuyuan bango llg h u iyi) at the

Coordination devices. We now examine the coordination devices within

national level, and "on-site official meetings" (xianchang bangong h ll iyi) at

the p arty and the bureau cracy. Politicians in China are organized under

various local levels in China. One type of j oint meeting is the "state - owned

t h e Chinese Communist Party committees at vari o u s l e ve l s . The p arty

enterprise refor m j o in t meeting." On the average, once per quarter, the

committee at each level directly c o n trols the to p p ersonnel o f the p arty

SETC, the SPC, and other agencies, such as the State Commission for Re­

committees immedi ately below it. At the natio nal level, the representative

structuring Economic System (also to b e restructured) , the Ministry of F i ­

p arty o rganization is the Central Committee, and the main working orga­

nance, and the People's B a n k of C h i n a , j ointly discuss matters regarding

nization is the Political Bureau. The core organization nested in the Political

SOE refo r m. These are exampl e s of h o rizontal c o o rdination devi c e s .

B ureau is the Political B ureau Standing Committee (PBSC) , which coordi­

T h e intertemporal coordination devices include t h e s m o o t h and p ar­

nates the senior leaders. The PBSC serves as a " b o ard of directors" of the

tial r e p l a c e m e n t of bureaucrats, a n d t h e l o n g - term merit - a n d - s e n i o rity

Chinese Communist Party-a "nesting structure" that functions as a verti­

based promotion schemes in the civil s e rvic e system. The bureaucracy in

cal c o o r d i n ation devi c e .

China is remarkably stable. As shown in table 5 and 6 , the average tenure

Starting in the Deng era. the seven members of the PBSC are supposed

of premiers has been more than ten years. Tables 7 and 8 show that when

t o represent d i ffe re n t m aj o r i n t erest groups o r organizatio n s , thus fun c ­

Li Peng succeeded Zhao Ziyang as premier in 1 98 8 , only about half of the

t i o n i n g as a ho rizontal coordinat i o n device. T h e P B S C typ ically consists of

ministers were replaced, and the vice ministers and bureau heads remained

the param ount leader, and two old. two medium- age d , and two relativel y

largely unchanged.

y o u n g s e n i o r l e a d e r s . E a c h term o f the P BSC is five yea rs a n d , i n ea ch s u c c e s s ive t e r m . t h e two o l d e s t m e m b e rs g e n e ra l l y will resi gn a n d b e r e p l a c e d b y t h e y o u n g e r o n e s . T h i s a r r a n g e m e n t fu n c t i o n s a s an intertemporal coordination device to facilitate smooth transition. A similar "graduat e d - age- structure" i s also built into the civil s e rvice system to fa ­ c i l itate s m o o th personnel transitions i n the bureaucracy ( Den g 1 99 4 , 5 ) . B ureaucratic age n c i e s are g e n e rally o rgan ized aro u n d a pilot agency. T h i s a r r a n g e m e n t fu n c t i o n s as a v e r t i c a l c o o r d i n a t i o n d e v i c e i n t h e

Table 5

The Tenure of Premiers in the State Council of China

Premier Zhou Enlai

Oct 1 949

-

Jan 1 976

Hua Guofeng (Acti ng Premier)

Jan 1 976

-

Apr 1 976

Hua Guofeng

Apr 1 976

-

Sep 1 980

Zhao Ziyang

Sep 1 980

-

Nov 1 987

Li Peng (Acti ng Pre m ier)

Nov 1 987

-

Apr 1 988

Apr 1 988

-

Mar 1 998

Mar 1 998

-

b u r e a u c ra c y. At t h e n a t i o n al l e v e l . l i k e i t s c o u n t e rp a r t s i n J a pa n ( t h e

Li Peng

M i n i s t ry o f I n t e r n a t i o n al Tra d e a n d I n d u s try ( M I T ! ) ) a n d Ko rea ( t h e

Zhu Rongji

E c o n o m i c Planning B o a rd ) . t h e State Planning Commission (SPC) fun c ­ t i o n e d as a pilot a g e n c y b e fo re 1 9 9 3 . a n d t h e State E c o n o m i c a n d Trade 92

Tenure

S O U R C E: M a l c o l m L a m b .

Direcrory o/Officia/s (Il1d Org({ l l i::ariolls ill Chilla (New Yo rk: M .

Sharpe. 1 994) . 1 67 .

93

F.

r

Table 6

Average Time in Office

Premier Secretary Generala Foreign Affairs State Pla n n i n g Commission State Economic & Trade Commission State Commission for Restructu ring Economy State Education Commissionb

Table 1 con tin ued No. of officials

Average time in office

43

4 9 7 7

2 13 41

4 12

1 1 .5 4.67 6.57 6.14 2 3.25 3.42

27 37

3 8

9 4.63

Period

Duration

1 949-1 995 1 949-75, 79-95 1 949-1 995 1 952-95 1 993-95 1 982-95 1 949-70, 75-95

46

42 46

State Science & Technology Commissionc National Defensed

1 958-67, 77-95 1 954-71 , 75-95

National Defense Science ,

People's Bank of Chinaw Auditor-General's Department

1 949-64, 73-95 1 983-95

37 12

10 3

SOURCES OF RAW [HLI: Directo r), of Officia ls alld Orga l l izations in Ch ina, 1 994, Book. The GOlle m m e n t Lt!aders ofPR. Ch ina, 1 995, Ca n ada Mirror Books.

3.7 4 An Last (;(1 /('

Nrm,s: ,

Abolished in 1 954; amalgamated with the newly established M i n i stry of Labor and Personnel

in May 1 982 to Apr. 1 9 88 and restored i n Apr. 1 988.

t Amalgamated with the newly established M i nistry of Mach i n e Building a n d Electronics Industry during Apr. 1 988 to Mar. 1 993 and restored in Mar. 1 99 3 . a. Abolished i n 1 9 75 and restored i n 1 9 7 8 . b . Abolished i n J u n e 1 9 70 and restored i n J a n . 1 9 7 5 . c . Established i n 1 958 a n d suspended during the Cultural Revolution; resumed operations in

Sept. 1 9 7 7 .

d . N o officials w e r e identified d u r i n g Sept. 1 9 7 1 to J a n . 1 9 7 5 . e . Abolished i n J u n e 1 9 70 a n d restored i n M ar. 1 9 78.

Technology & I n d u stry Commission

13

State Nationalities Affairs Commissione

38

1 982-95 1 949-70, 78-95 1 949-73, 75-95 P u b l i c Securityf 1 983-95 State Secu rity 1 949-59, 87-95 Su pervision9 1 978-95 C i v i l Affa i rs 1 949-59, 79-93 Justiceh 1 949-54, 70-95 Finance' 1 993-95 I nternal T rade 1 982-95 Foreign Trade & Economic Cooperation 1 950-54, 88-95 Personnel' 1 949-54, 88-95 Labor* 1982-95 Geology & M i neral Resou rces 1 988-95 Construction 1 979-82, 93-95 Power I n d u stryl 1 955-70, 75-88, 93-95 Coal l n d u stryk 1 949-70, 75-95 Rai lwaysl 1 949-65, 70-95 Communicatlonsm 1 982-88, 93-95 Mach i ne-Building I ndustry Commissiont 1 982-88, 93-95 Electron ics I n d ustryt 1 956-66, 70-95 M etallurgical l ndustryn 1 956-62, 67-69, 78-95 Chem ical l n d ustryO 1 949-70, 73-95 Posts & Commun icalionsP 1 949-58, 79-82, 88-95 Water Resou rcesq 1 949-56, 79-82, 88-95 Agriculturer 1 949-59, 1 967-70, 79-95 ForestryS 1 949-70, 75-95 Culture! 1 982-95 Rad i o , C i nema & Television 1 949-67, 73-85 P u b l i c HealthU 1 981 -95 State Family Planning CommisSion 1 952, 7 1 -95 State Physical Culture & Sports Commissionv 94

44

12 18 17 24 30

2 13 11 12 13 7 5 30

41 41 8 8 35

25 43

19 17 29

41 13 30

14 25

2 4 9 2 4 3 6 9 2 4 3 4 3 2 3 8 10 10 3 4 7 7 6 4 7 8 8 3 7 4 6

6.5 9.5 4.89 6 4.5 5.67 4 3.33 1 3.25 3.67 3 4.33 3.5 1 .67 3.75 4.1 4.1 2.67 2 5 3.57 7.17 4.75 2.83 3.63 5.13 4.33 4.29 3.5 4.17 Con tin ued

f.

N o officials were identified during Aug. 1 9 7 3 to J a n . 1 9 7 5 .

g . Abolished i n 1 959 and restored in D e c . 1 986. h . Abolished i n 1 959 and restored i n 1 9 7 9 . i.

N o o fficials identified d u r i n g J u n e 1 9 54 to J u n e 1 9 7 0 .

j.

Amalgamated with the Min istry o f Water C o ns e rvancy i n M ar. 1 982-M ar. 1 99 3 and then

resto red. k. Amalgamated with the M i n istry o f Fuel and Chemicals Industries during Nov. 1 9 7 0 to Jan.

1 975 and then restored; became part of the newly established M i nistry o f Energy Resources from Apr. 1 988 to M ar. 1 993 and then restored.

I. Absorbed by the newly establ ished M i n i stry of Communications in Nov. 1 9 7 0 . Restored in Jan. 1 97 5 . m . N o officials w e r e iden tified d u r i n g 1 966 to 1 969. The minist ry absorbed the M i nistry o f Rai lways i n Nov. 1 9 7 0 . n . N o o fficials w e r e identified d u r i n g 1 967 t o 1 96 9 . o . N o officials w e r e i d e n t i fied in 1 963- 1 966. Amalgamated with the M i n i s t ry of Fuel and Chemicals Industries in Nov. 1 9 70. Restored i n M ar. 1 978 as a result of the d ivision of the M i n istry of Petroleum and Chemicals Indus try. p. Amalgamated with the M i n i stry of Rai lways and M i n istry of Communications in 1 9 7 0 . Restored i n May 1 9 73 after the abolition of the d i rectorates o f P o s t s a n d Telecommunications. q . Amalgamated with the Ministry of Power and formed the Ministry ofWater Conservancy and Pow er during Feb. 1 95 8 to 1 9 79 and M ar. 1 982 to Apr. 1 988; restored in Apr. 1 988 since the abolition of the Ministry o fWater Conservanc y and Power. r. No officials were identified in 1 95 7- 1 978 under the name of the M inist ry of Agri culture. Ab sorb ed by the M i n i s try of Agriculture and Forestry in Nov. 1 9 70. Restored i n Feb. 1 9 79 with the division of the Min istry of Agriculture and Forestry, renamed and given expanded roles in May 1 982. Between then and Apr. 1 988, the organization was styled Minist r1' of Agriculture, Animal Husbandry and Fish erie s. s . No offi cials were identified in 1 960-- 1 966 under the name of the :vlinistrv of Forestrv; . absorbed by Min istry of Agriculture and Forestry in Nov. 1 9 70 and restored i n Feb. 1 9 7 . t. Abolished in 1 9 70 and restored in Jan. 1 9 75 after the abolition of the Culture Group under the Stat e Cou ncil .

9

u . No officials w e r e identifie d in 1 9 67- 1 971. v. No officials were identified in 1 9 5 3- 1 970 . R e c o m m e n c e d operations fol l o w i n g the C u l t u r a l Revolu tion i n June 1 9 70. w. No officials were i d e n ti fied i n 1 965-Ma1' 1 9 7 3 .

95

Governance and I nvestment in China

Table 7

Change of Vice Premiers, State Councilors, and Ministers in 1 988

N o te t h a t b e s i d e s s e rv i n g as h o ri z o n t al c o o r d i n a t i o n d e v i c e s , t h e c o llec tive d e c i s i o n - making m e c h a n i s m s a n d d e l i b e rati o n c o u ll c i l s a l s o

No. of previous officials in 1 988 as % of the total no. of officials in 1 987 Total no. of officials Total no. of officials No. of previous officials

Under Premier Zhao (1 987)

Under Premier Li (1 988)

function as h o rizo n t al checking d evices. Wh e n d e c i s i o n s a r e c o l l e c t i v e l y m a d e , t h e d e c i s i o n makers c a n c h e c k o n e a c h o t h e r, and i t b e c o m e s hard e r to collude i n corrupti o n when there are more p articipants . C o l ­ l ective d e c i s i o n making h a s b e e n a d o p t e d to curb corruption a t vari ous

Vice Premiers

5

3

2

40

l evels o f the p arty and the bureaucracy i n China. For instance, in order

State Councilors

11

9

2

18.18

to curb c o rrup t i o n i n making a p p o i n t m e n t s , the C e n tral O r g a n izat i o n

Ministers

46

42

24

52. 1 7

D e p artment i n 1 9 8 6 s p ecifi e d a quorum rul e that requires two - thirds of

45.1 6

the members of the ministerial p arty group to be p r e s e n t wh e n scr e e n­

Total

62

54

28

SOURCE O F RAW DATA: People �1 Rep ublic of Ch ina Yea r/wok 1 98 7. 1 .988 (Hongkong: Evergreen Publishi ng) .

i n g a n o m i n e e fo r a b u r e a u - level p o s i t i o n . The Asian Financial Crisis and I t s Implications for China

Although FDI inflow into China has b e e n among the highest in the world in the last few years , the stock of FDl in China is still s m all relative Table 8

Change of Vice Ministers and Heads of Bureaus in 1 988

No. of Vice ministers

Ministry/ Commission

Under Premier

to its e c o n o m i c size. As p r ivatization s p e e d s up, m o re markets b e c o m e o p e n , and t h e l e gal s y s t e m i m p rove s , there w i l l b e more o p p o rtunities

No. of heads of bureaus

and a b e t t e r e nvi r o n m e n t fo r fo reign firms to invest in C h i n a . Thus, a

Under Premier Li (Dec 88)

No. of Under Under No. of previous Premier Premier previous Zhoo officials Zhoo Li officials in 1 988 (Nov '87) (Nov 87) in 1 988 (Dec 88) as % of as % of Tda Tda No. of the total no. Tda Tda No. of the total no. nO. of no. of previous officials no. of no. of previous officials officials officials officials in 1 987 officials officials officials in 1 987

significant inflow of F D I into China may continue in the coming decad e . I n fact, as the regulatory a n d legal system improve d , F D I agreements i n C h i n a h a v e b e e n evo lvi n g fro m s h o r t t e r m t o l o n g t e r m , fro m s m all s c a l e t o large s c a l e , fro m standard t o s p e c i fi c , fro m j o i n t ventures t o wholly foreign own e d , and from co astal to i n l a n d regions in the l a s t two d e c a d e s . Yet in C h i n a at p re s e n t , give n t h e wi d e s pread c o r r u p t i o n and i n e ffe c tive l e gal p r o t e c t i o n o f p r o p e rty r i gh t s , e s p e c i a l l y i n t e l l e c t u a l

State Planning Commission*

23

10

10

43.5

52

49

22

42.3

Ministry of Finance

5

5

3

16

p r o p e rty r i gh t s , fo reign inve s t o rs ar e s o m ewhat r e l u c t a n t t o inve s t i n

00

18

16

100

People's Bank of China

4

5

4

100

contract- and technology- intensive s e c t o r s . T h e ongoing p rivatizati o n o f

34

36

33

97. 1

S O E s a n d TVE s , a l o n g w i t h t h e i m p r o v i n g l e g a l sys t e m , w i l l r e d u c e

& Economic Cooperation

8

11

6

75

17

19

15

88.2

to facilitate c o n tract e n forcement i n dynamic sectors, such as high - tec h

Ministry of Commerce

5

5

3

00

13

14

13

100

i n d u s try, in t h e l o n g ru n . A n e c e s s ary c o n d i t i o n fo r e stab l i s h i n g an e f­

Economy Commission

3

2

0

0

13

22

13

100

p olitical o p e n i n g - u p to o p p o sition parties a n d e c o n o m i c o p e n i n g - u p to

Ministry of Justice

3

2

2

66.7

7

7

7

100

the world market are eventually necessary to minimize corruption i n the

5

5

5

100

4

6

4

100

Ministry of Foreign Trade

corruption significantly. I t is important to build an effective legal system

State Reconstructon of the

fe c t ive l e gal sys t e m i s to m i n i m i z e c o r ru p t i o n . I n a c o r ru p t c o u n t r y,

Central Bureau of Industry & Commerce

l o n g ru n .

S O l iK eE Ol RAI\' D.IT.\: M al c o l m L a m b . D i rec to ry ot()fticia/s a lid 1 99 4 ) .

Or{!,(lII i�ariollS ill Ch illa U";e,,·

Yo rk: M . E . S h a r p e .

' I n April 1 988 t h e State E c o n o m i c C o m m is s i o n was a b o l i s h e d a n d m u c h of i t s work was t a k e n o v e r by the S t a t e Planning C o m m is s i o n and p rovincial a u t h o r i t i e s . T o make a consistent compariso n , figures i n N o v e m b e r 1 98 7 i n c l u d e o ffi c i a l s o f t h e S t a t e E c o n o m i c C o m m i s s i o n .

96

More g e n e rally, a s noted i n L i ( 1 9 99 ) . eco n o mi c deve l o p m ent i s fu n ­ dame n t a l ly a p r o c e s s o f e stabl i s h i n g i n fo rm al gove r n a n c e m e c h a n i s m s a n d t h e n maki n g t h e tran s i t i o n t o fo rmal gove rn ance structure s . T h i s i s consistent with histori cal facts , which had l o ng b e e n neglected by e c o n o ­ m i s t s u n t i l v e r y r e c e n tly. B e fo r e fo r m a l gove r n a n c e w a s e s t ab l i s h e d , 97

Governance and Investment in China

Governance and Investment in China

E u r o p e a n b u s i n e s s p e o p l e d u r i n g the p r e m o d e rn p e r i o d made agr e e ­

divi d u a l , t h e s o c i a l b e n e fi t i s s i g n i fi c a n tly h i g h e r t h a n h i s i n d i v i d u a l

ments, to a large degree , outside t h e legal system (Greif 1 99 4 ) . Transition

b e n e fi t . To c o l l e c t taxes and to i m p l e m e n t o t h e r rules effe c t i v e l y, i t i s

away fro m p e rs o nal reputation i n the United States o c c u rred o nly b e ­

necess ary tu develop informational infra structure, which itself i s a l o n g ,

t we e n 1 8 4 0 a n d 1 9 2 0 ( Z u c k e r 1 9 8 6 ) . D u r i n g t h i s t r a n s i t i o n p e r i o d ,

evo l u t i o n ary p r o c e s s .

relational banking played a n important role in monitoring firms (Cantillo

T h e disrup t i o n o f governance aft e r l i b e ralization c a n p o s s ib l y l e a d

Simon 1 998) . I t was t h e Glas s - Steagall Act, the Securities Act, and other

to a significant reduction in trade and investment in the short run . Aft e r

regulati o n s aft e r t h e Great D ep r e s s i o n that e s s e n t i ally ended relatio n ­

drastic trade l i b e ralization i n 1 9 8 7 , t h e M exican fo o twear industry w e n t

Unfo rtunately, as argu ed in Li ( 1 9 99 ) , transi t i o n fro m informal gov­

b e t h e deterioration of t h e footwear association's function as an enforce ­

e r n a n c e to fo r m a l g o v e r n a n c e is u s u a l l y a d i s c o n t i n u o u s p r o c e s s .

m e n t m e c h a n i s m i n t h e o p e n e c o n o my. S i m i l arly, t h e d r a s t i c c ap i t a l

D e c e n t r a l i z at i o n o f i n fo rm a l g o ve r n a n c e o r c h a n g e o f m a n a g e m e n t

account o p e n i n g - u p i n I n d o n e s i a a n d Thailand, a n d t h e swe e p i n g p o ­

s h i p - b a s e d fi n a n c e i n t h e U S ( J a c o b s 1 9 9 1 , 1 4 3-45 ) . 2 B

through a crisi s . O n e o f the m a i n r e a s o n s b ehind the crisis appeared t o

teams c a n disrupt governance at least in t h e short r u n because relations

litical o p e n i n g - u p i n Korea i n t h e 1 9 9 0 s , might h ave aggrava t e d , if n o t

(lo cal p e rson - s p ecific informat i o n ) among old p layers can b e weaken ed,

triggered, t h e current financial crises i n t h e s e e c o n o m i e s . T h e p revious

whi l e r e l a t i o n s with / a m o n g n e w p l ayers o r fo rmal r u l e s are yet t o be

control devi c e s (in p articular coordination devices) under a closed capi­

established. I n p articular, when new management teams replace old ones,

tal market o r authoritarianism n o longer function e ffe ctively while new

a n d new p l ayers e n t e r t h e market ( e . g . , due to financial l i b e ralizati o n ) ,

control devi c e s under an open capital market o r de mo cracy are yet t o

existing relations b e c o m e u s e l e s s or weake n e d , a n d relations with and

b e establ i s h e d . I n p articular, c o n trol devi c e s b u i l t i n governmental a n d

b etwe e n n e w p l ayers are y e t t o be e s t a b l i s h e d b y r e p e a t e d p l ays and

s e migovernmental agencies b e come weake n e d o r nonfunctioning as t h e

tests. That i s , e i t h e r exi s t i n g relatio n - s p ecifi c information becomes i n ­

c a p i t a l m arket b e c o m e s o p e n o r d e m o c racy p h a s e s in to r e p l a c e

val i d o r b i l a t e ral m o n o p o l y o f p rivate i n fo r m a t i o n b r e aks do w n .

a u t h o r i t a ri a n i s m . M a rk e t a n d p riv ate o rg a n i z a t i o n s will i n c r e a s i n gly

The arrival o f newc o mers m a k e s it h a rder for an incumbent to com­

r e p l a c e gove r n m e n t al a n d s e m i gove r n m e n t al c o o rd i n a t i o n devi c e s i n

m i t to exi s t i n g relati o n s . As a b y - p r o d u c t , d e c e n tralization o f info rmal

financial a n d o t h e r industries but the p r o c e s s is likely to b e bumpy and

governance can result i n "corruption with independent monopoly. " B e fore

l engthy.

d e c e ntralizati o n ( e . g . , p olitical l i b e ralizati o n ) , diffe r e n t b ranches o f the

So far, China has b e e n able to avo i d a financial crisis fo llowing the

g o v e r n m e n t may j o i ntly maximize the value or the t o tal b r i b e acro s s

Asian crisi s. The maj o r reasons are p erhaps that China has not yet imple­

c o m p l e m e n t ary p u b l i c g o o d s . I n t h e p r o c e s s o f d e c e ntraliza t i o n , t h e

mented capital a c c o u n t o p e n i n g - u p o r p o l it i c a l o p e n in g - u p , a n d t h a t

relatio n s b e tween different branches o f the government may b e c u t o ff.

C h i n a has attracted mainly F D I , while t h e e c o n o m i e s involved i n crisis

S u b s e q u e n t l y, d i ffe r e n t b ra n c h e s b e c o m e i n d e p e n d e n t m o n o p o l i s t s

a c c u m u l a t e d large s h o r t - t e r m fo r e i g n d e b t s . Eve n t u al ly, : n o r d e r t o

p roviding public g o o d s . This may result in severe inefficiencies if the s e

minimize corruption a n d to establish t h e rule of law to support techno­

p u b l i c g o o d s a r e c o m p l e m e n t ary, as i n d i c a t e d e arli e r.

logical p rogre s s , b o t h the capital market and the pol itical market must

T h u s , b e fo re fo r m a l g o v e r n a n c e i s e s t a b l i s h e d , t h e r e ma y b e a

o p e n up i n China, b u t whe n and how t o open have profound i m p l i c a ­

vacuum in the governance structure after market d evel opment and lib ­

t i o n s fo r e c o n o m i c growth in g e n e ral and fo r F D I i n fl ow in particul ar.

eralizat i o n have made info rmal governance dysfunctional. On the other

To minimize the disruption of governance in transition, the Chinese gov­

h a n d , there i s n o guara n t e e t h a t a fo rmal gove r n a n c e system can be

ernment should consisten tly but gradually reduce state control and o p e n

established after liberalizat i o n , and when it can b e established it usually

up market s , and decen tra lizing must b e a c c o m p a n i e d by coord i n a ting,

invo lve s a l o n g c o m p l e x p r o c e s s . Tra n s i t i o n fro m a u t h o r i t a r i a n i s m to

i . e . , maintaining n e c e s s ary existing relati o n s and imp roving the regula­

democracy is hardly smooth, and sufficient n o ise can trigger a war in the

t o ry and l e gal framework.

p r o c e s s . Some p r o d u c t ive r e s o u r c e s need t o b e d ive r t e d t o cover t h e

As in its E a s t A s i a n p r e d e c e s s o r s , China will experience d i sru p t i o n

fixe d c o s t o f s e t t i n g u p e ffe c t ive fo rmal gove r n a n c e . Th er e are " fi s c al

o f its governance structure in the p r o c e s s of d e c e n tralizat i o n . Aft e r t h e

externalities" in fi n a n c i n g t h e s e t u p ; fo r each tax d o l l a r p aid by an in -

mid- 1 990s , governmental withdrawal of its co ntrol rights from both S O E s

98

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Governance and I nvestment in China

and TVEs start e d to accelerate. There have already b e e n disruptions of corpo rate gove rn ance in many p rivatized firms where insiders or larger

C H A P T E R FIVE

s h a r e h o l d e rs abuse t h e i r c o n t rol rights t o loot m i n o ri ty s h a re h o l d e r s . H owever, C h i n a h a s t w o advan tages. F i r s t . as a l a t e follower, C h i n a h a s the advantage of learning fro m b o t h t h e E a s t Asian miracle and the East Asian c r i s i s t o m i n i m i z e the e c o n o m i c c o s t s o f fin a n c i al l i b e ralizat i o n and p o l i t i c al tran sition. S e c o n d , C h i n a c a n resort to c r o s s - regional ( d o ­ mestic) competition to s p e e d up t h e transition fro m informal governance to fo rmal gove r n a n c e . As d i s c u s s e d earli e r, a l t ho u g h p o l i t i c ally C h i n a · remains very centralize d , e c o n o mi c ally it is a l r e a d y much more d e c e n ­ tral i z e d than m a n y o u t s i d e o b s e rvers have p e rc e ive d . There a r e a b o u t

CENTRALIZATION, POLITICAL TURNOVER, AND INVESTMENT IN THE PHILIPPINES Emmanuel S. de Dios and Hadi Saleh i Esfahani

thirty p rovincial - level j u r i s dictions ( m o s t of which a r e as l arge as middle­ s i z e d c o u n t r i e s ) , s o m e t w o t h o u s a n d c o u n t i e s and fifty t h o u s a n d townsh i p s . Local governm ents have significant incentives and autonomy to develop their economies. As indicate d , cro s s - regi o n al competition c a n d i s c i p l i n e e a c h region to imp rove its governan c e structure to attract investment and limit cor­

Conventional wisdom postulates t h a t systems governed by the formal rule of law are l ikely to p erform b etter than those in which rules may be

ruptio n . Economic competition and decentraliza tion can eventuallv lead t o p o li t i c al c o m p et i t i o n a n d d e c e ntralizat i o n . C r o s s - r e g i o n al co p e t i ­

arbitrarily changed . This is suggested b y D o uglas North ( e . g . , 1 99 7 ) , who

t i o n may s p e e d up t h e deve l o p m e nt of t h e rule of law in China as it d i d i n t h e U K i n t h e e i g h t e e n t h c e n t ury and in t h e U S i n t h e n i n e t e e n t h century. Curre n tly, provincial- level j urisdictions can make regi o n al regu ­

definition of prop erty rights and b y effe ct ive m e chanisms for the settle­

�

pointed out, in his work, the crucial role in development played by a clear ment of disputes. In recent discussions, however, especially following the Asian crisis, "rule of law" has c o m e t o b e interpre t e d in the fo rmal and

l a t i o n s , and s p e cial ad m i n istrative regi o n s , such as H o n g Kong, as well as s p e c i al e c o n o m i c z o n e s , s u c h as S h e n z h e n and H a i n a n , can make

high - political sense of conformity with systems found in Western indus­

s o m e r e g i o n a l laws . If o t h e r p rovi n c i a l - leve l j u r i s d i c t i o n s are gran t e d t h e rights to make r e g i o n al l aws i n t h e fu ture , c ro s s - regi o n al c o m p e t i ­

and predictable regime succession, and a fo rmally independent judiciary.

t i o n i n lawmaking wil l i n t e n s i fy.

east Asian c o untries is that at the time of their remarkable p e rformance,

trial democracies, including the existence of checks and b alances, regular Part of the p arad ox presented by the rapid growth of the East and South ­ few of them confomled to this ideal. I Even countries where levels of corruption and potential for arbitrariness were high continued to attract or generate high levels of productive investments. On the other hand, the Philippines has also contributed t o this p aradox, alb e i t i n a reve r s e manner, namely, as the exception that validated the rule. Contrary to what might b e expected, the country's long history of fo rmal demo cratic institutions has been associ­ ated with m e d i o c re e c o n o m i c p e rfo rmance (tho ugh in the midst of the Asian crisis , it has also been among the least affected e c o n o m i cally) . The q u e s t i o n s , therefo r e , are how gove rn a n c e and growth m ay b e related a n d what s o m e o f the mechanisms are through which this relation ­ ship e m e r g e s . In particular, this chapter s e e k s to exp l a i n how a n d why changes i n gove rnance systems in the Philippines ( 1 93 5- 1 9 7 2 , 1 9 72- 1 9 8 6 , a n d 1 9 86 to the present) have led to d i fferent p atterns of c o rrupti o n a n d

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Centralization, Political Turnover, and Investment in the Philippines

to better or worse investment outcomes, both within and between regimes.

discretion over a wide sphere. The impliCit goal o f elite struggl e s i s to

Crucial to the explanation are ( 1 ) the reasons fo r uncertainty and (2 ) the

control the state's machinery and resources and to skew their deployment

costs of investment within regimes and across regimes, which we trace to

to favor specific interests. Powerful incentives then work to p ersuade in­

the distribution of p olitical mandates and to the system of political turn­

cumbents to retain p ower indefinitely in order to protect such interest s . Conversely, turnovers-whether electoral c o n t e s t s o r more fundamen tal

over and succession, resp ectively.

challenges to legitimacy, such as attempted coup s-may be viewed as Philippine Political Economy

opportunities to attain or to retain this power.

Various interpretati ons o f Philippine p olitical economy share a com­

The e c o n o mi c costs occasioned by s u ch regimes can be seen to be

m o n emphasis o n the characteristics determining the likelihood o f the

largely a priori. First are the obvious losses from competitive rent- seeking,

"capture" of the state and its instrumentalities by vested interests based on

as factions seek to build up their capacities to compete for dominance. The

p o litical "clans." Notwithstanding a certain amount of dissatisfaction and

l arger the prizes are (which could turn o n the scope of the government's

s u b s e q u e n t ame n d m e n t s , most views h ave d e ve l o p e d fro m an earl i e r

influence over resource allocation) and the more evenly matched factions

tradition i n Philippine political literature t h a t c a m e to b e known as the

are , the greater is the likelihoo d o f dissipation o f resources i n terms of

" factional model" of Philippine p olitics (e.g. , Lande 1 96 5 ) . In that reading,

lobbying, maintaining retinues of followers, and so on.4 These losses from

the economic elite is seen as being divided into various factions formed

classical rent- seeking result from the diversion of resources toward unpro ­

out o f historical alliances b ased o n kinship and p atronage. Factions are

duCtive or purely dissip ative uses, where these could have been invested

thought to be based on the political and economic p ower of the local elite,

o r allocated Dore efficiently.

referring o riginally to agricultural landownership. The resulting patro n ­

Further losses, apart from those occasioned by rent-seeking, may arise

client relations c u t across l i n e s of social class; allied l o c a l interests and

as investment is discouraged by uncertainty. In this respect, two p otential

i n fl u e n c e s were then s u c c e s s ively c o n s o l i d at e d upward and ultimately

effects of democratic , decentralized regimes in raising investment uncer­

found their expression in political factions contending p eriodically for direct

tainty may b e distinguished. One effect owes to the greater challenge to

c ontrol o f government.

authority even in periods between turnovers; in short, internal uncertainty

The only possible significant exception to this characterization is the

among investors bro ught on by the d i ffu s i o n of p ower even with out a

e p i s o d e o f authoritari a n i s m under M a rc o s , dating fro m 1 9 72 t o 1 9 8 6 ,

regime change . Overlapping j urisdictions and systems of checks and bal­

whe n the p ower o f l o c al interests was weaken e d with t h e suppression

ances typically found in formal democracies could lead to gridlock or rents

o f C o ngress and regular elections, which had s e rved as the traditional

or both. O n the other hand, interperiod or interregime uncertai nty results

channels fo r their exp r e s s i o n . 2

from p o s sibly large changes in policies, ranging from reversals o f broad

The p ostdictatorship peri o d , beginning with the restoration of demo­

policy initiatives to alterations of contracts. The threat of victory by hostile

cratic institutions in 1 98 6 , is b roadly regarded as a return to the previous

factions may b e viewed as leading to unsettling changes in policies that

era, although recent changes in economic structure, demography, culture,

further raise the cost and the risk of investing. Potential political challeng­

and the occurrence of e c o n o m i c crises have suggested that clan - based

ers may threaten to reverse the results of transactions accomplished under

patron- client relations could be weakening at the edges.] In p articular, the

the incumbent administration once they come to power. The possible shift

p revious understanding that the indispensable basis for such politics was

in policy consequent to turnover represents additional uncertainty and a

the system of large traditional landholdings has come increasingly under

discouragement to investment. The next two sections discuss these in turn.

question ( e . g . , Sidel 1 99 5 , and from a slightly different viewpoint, Rive ra

1 99 5 ) . M o s t would nonetheless concede that, altho ugh weake ne d, clan ­ b a s e d p a t ro n - c l i e n t relat i o n s that have l o n g i n fl u e n c e d the c o u n t ry 's p olitical economic landscape are still present.

Checks and Balances and Intraregime Investment Uncertainty

A frequently noted source of inve s t m e n t uncertainty in d e m o cratic systems is the challenge to policies arising from checks and b alance s . I n

The intensity of political contests derives from the fact that the gov­

democracies , branches of government differ in their competencies b u t are

ernment d i s p o s e s over a significant amount o f resources and exe rcises

able to exercise countervailing power relative to other branches . Presiden-

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r Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Philippines

tial systems vest the executive function in a s e p arate branch (the exe CL1 tive) while parliamentary systems incorporate legislation and implemen­

but they may b e leveraged with the wide publicity devoted to the m , as

:

Congressio nal investigations by themselves cannot reverse decisions,

tation i n a single body, the p arliament. In all cases, however, the judiciary would be an i n d e p e n d e n t b ranch serving as a last recours e .

well as w i t h a p o s s i b l e ultimate r e c o u r s e t o t h e j u d i c i a ry. S u i t s fi l e d

T h e appropriat e n e s s o f p o l i c y - m aker i n c e n t ives cannot b e guaran ­

a r e almost a matter of cours e . T h e increased leeway fo r Supreme Court

teed in most s ituati o n s , such as when the leaders' expected tenure is not

interve n t i o n i s a p roduct of the p o s t - M arcos exp e rienc e . In an i n n o va ­

before the S u p r e m e Court b y l egislators challenging exe cutive d e c i s i o n s

very long o r when the leaders benefit from the gains o f p articular inter­

t i o n seeking to p revent a repetition of the imposition of martial law that

e s t groups much m o re than t h o s e of others . As a result, restriction o n

p aved the way fo r the Marcos dictato rship, the 1 9 87 Constitut i o n al lows

p o l icy d i s c r e t i o n ( o r d i ffu s i o n o f p o we r ) i s o ft e n n e e d e d t o e n h a n c e

the Supreme Court to review cases involving "grave abuse of discretio n . "

credib ility. Restri cting discretion is n o t c o s t - free, however, s i n c e it makes

This h a s allowed the Court t o i s s u e t e m p orary restrai n i n g orders b i n d ­

policy adj u s t m e n t difficult. When power is diffu s e d , each p olicy change

ing o n the Executive Branch or any o f its agencies. A s i d e fro m electo ral

r e q u i r e s b argai n i n g a n d n e g o t i a t i o n among veto h o l d e r s , which may

contests, therefore, this is another means fo r rivals to mount chall enges

d e l ay p o licy r e s p o n s e s and may p r event s o m e e ffi c i e n t c h a n g e s t h a t

to i n i t iatives fro m the p o li t i cally d o minant fac t i o n s .

w o u l d o th e rwise h ave occurred. A trade - o ff e xi s t s , t h e r e fo r e , b etwe e n

T h e s e examples a r e fully consistent with the " independent monop o ­ lists" model o f corruption described b y Shleife r and Vishny i n 1 99 3 . These

t h e costs a n d benefits of restricting discretion. This trad e - o ff depends o n each country's specific conditions, implying that different levels of p ower c o n c e ntrati o n may be o p timal fo r diffe r e n t c o u n t ri e s . The 1 9 3 5 P h il i p p i n e C o n s t i t u t i o n t h a t w a s i n e ffe c t fro m 1 9 4 6 t o 1 9 72 was patterned largely after that of t h e United States a n d prescrib e d a presidential system of government, with three equal branch e s , namely, t h e E x e c u t ive , L e g i s l a t i v e , a n d J u d i c i ary. T h i s s y s t e m was s u s p e n d e d

authors d i s c u s s the problem o f corru p t i o n i n the provi s i o n o f a s e rvi ce o r i n access to a p u b l i c resour c e . They distinguish b e tween three typ es o f industrial o rganizatio n : ( l ) j o i n t m o n o p olists, where there is o n l y one source o f the s e rvi c e ; ( 2 ) independent m o n o p o lists, where two o r m o re entities can provi d e the s e rvice; and ( 3 ) competition, where s everal entities are e q u ally capable of p rovi d i n g t h e s e rvi c e .

u n d e r t h e authoritarian M ar c o s regime fro m 1 9 7 2 t o 1 9 8 6 , b u t i t was

E s p e c i ally i m p o rtant i n this r e s p e c t i s t h e analytical o b s e rvation­

re instituted, with some i m p o rtant changes to b e d i s c u s s e d later, in the

regarded as impo rtant through anecdotal evidence-that "corruption c o n ­

1 9 8 7 Constitution draft e d during the p r e s i d ency o f Corazon Aquino.

tracts " are n o t e n fo rceable i n c o u r t s , a n d there is m a n y a slip b e twe e n

I n s titutionally, the d i s p ersal o f power inherent in the s e p aration of

t h e bribing transaction and the actual delivery of the good or the s e rvice

p owers and the sys t e m o f checks and balances makes d e c i s i o n s o p e n

involve d " ( B ardhan [ 1 9 9 7 , 1 3 2 4 1 attributes this to B oycko, Sh l e i fe r, and

t o c h a l l e n ge fr o m s e v e ral q u a r t e rs . I n t h e P h i l i p p i n e s , t h e p o wer o f

Vishny) .

Congre s s to c o n d u c t i n v e s t i g a t i o n s , o r i n q u i r i e s , " i n a i d o f l e gislation"

In the case of independent monopolists, concurrence by two or lIl o re entities is requ i red in order to obtain access to public resources or assets . Each e ntity may then act i n d e p e n d e n tly to m axim ize its retu r n s , s ay i n t h e fo rm o f b r i b e s . A s a r e s u l t , t h e a m o u n t s d e m a n d e d o f p o t e n t i a l

i s regarded as particularly potent, given its right to subpoena witn e s s e s , informants , a n d d o c u m e n t s . As may b e expected, the o p p o sition is typ i ­ c ally at t h e fo refr o n t o f t h e c h a l l e n g e t o e x e c u t ive i n i t i a tives w i t h a p ub l i cly accepted role of "fi s c al i z i n g . " " Delavs resulting fro m s u c h political contingen c i e s a d d obvi ous cos ts to p o t e n ial i nve stment p r o j e c t s , so that there would b e some value to avo i d i n g the m . Not surprisin gly, this arrangement can b e p arl ayed into

�

corru p t i o n . In local p o l itical p arlan c e , this m o d u s op eran d i i s known as "1\C - DC" (short fo r "attack and collect, defend and collect" ) , vvh ich refers

inve s t o r s is exc e s s iv e , which l e a d s , o t h e r thi ngs b e i n g e q u a l , to a d e ­ crease i n investment proj ects an d , consequently, t o l ower outpuL" fl e n c e , fo r i n s t a n c e , a deal may b e i r o n e d out with the age n c i e s in the Executive , but t h i s wo u l d n o t guara n t e e its p assage owing t o prior require m e n t s . T h i s s i tuation m ay be c o n t rasted with o n e wh ere there i s o n l y o n e

to the political p ractice of role reversal. arguing alt e rn at ive l y i n favor of o r a g a i n s t certain p roj e c t s , i n exchange fo r s o m e fi n a n c i a l o r p o l i t i c al

brib e - taki n g m o n o p o l i s t , who s e t s t h e rate o f " t ake " so that t o t a l bribe reve nue is maxi m iz e d . This can be att a i n e d , howeve r, only if the rate o f b r i b e s i s not set so high a s to discourage i nvestment unduly. A s a result,

c o n s i d eratio n .

while the total bribe- revenue collected may be higher than the second, the 1 04

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r Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Phi lip pin es

level of investment and output are higher in the first. Indeed, Shleifer and

pear to be preceded by a decline in p rivate investment that cou nt e r ac ts

Vishny ( 1 993 , 6 : 0) speculate dirf'ctly on the effect o f the transition to the

the fisc al exp an s i o n and causes a slowd own . We attribute this b eh av io r

p o s t - Marcos regime: " New governments lose monopoly over bribe collec­

to i n s t i t u t i o n a l characteristics i n the P h i l i p p i n e s a n d argue t h at th e s e factors h ave n o t only added to instability in the e c o nomy but h ave als o c o n s t r a i n e d t h e ave rage inve s t m e n t r ate to l o w leve l s .

t i o n , and as a result multiple agencies take b ri b e s whe r e o nly one did before, leading to a much less efficient collection. I n the Philippines under M arcos , all corruption flowed to the top; since his demise, the number o f

The p r e s e n c e o f o t h e r factors i n fl u e n c i n g inve s t m e n t m a k e s i t dif­

independent b ribe takers has increased, a nd so the efficiency of resource

ficult to o b tain a simple p icture of the influence of political turnover (if

allocation has prob ably d e c l in e d . "

any) o n investment. The only satisfactory way to substantiate this claim

It should b e pointed o u t , h ow£ver, that t h e possibility of challenge and

is to fully specify and estimate a mode l o f investment behavior and test

decision reversals fro m different branches of government would also exist

whe t h e r p r e s i d e n t i al e l e c t i o n s in t h e Philipp i n e s h ave a d i s t i n c t i n fl u ­

even in the case of legitimate contracts. From the viewpoint of investment

e n c e o n t h e l evel o f inve s t m e n t . F o r this p u rp o s e , we t a k e inve s t m e n t

uncertain ty, the distinction b e tween challenges m o tivated by corruption

to depend o n factors affecting profitability, w h i c h i n c l u d e inflat i o n , p re ­

and those that are not is o f secondary importance. The same mechanisms

d i c t e d G D P ( g r o s s d o m e s t i c p r o d u c t ) growt h , t h e s t a t e o f t h e c u r r e n t

that exist for the free prosecution of legitimate social demands are avail ­

a c c o u n t , the t e r m s of trad e , and i n d e b t e dn e s s (represented b y accumu ­

able for vested interests. I n a similar vein, t h e extent to which losses as­

lated current account deficits) , the price of investment goo d s , as well as

so ciated with rent- seeking are n o t themselves inherently associated with

p ol i t : c al r i s k . ( Th e u n d e rlyin g m o d e l is d e s c r i b e d m o re c l o s e l y in t h e

the workings of democratic and constitutional regimes (e.g. , Brecher 1 982)

appendix) . Equations seeking to explain t o t a l investment and a p roxy for

has b e e n questi o n e d . F o r exampl e , that unions should h ave recourse to

p rivate investment are estimated, and the results appear to s u p p o rt the

the Supreme Court is unlikely to raise any obj ections. Yet it is difficult to

initial hyp o th e s i s of presidential elections h aving a distinct influence on

argue that the recourse to the courts should b e o p en o nly to certain en­

investment. I t will b e seen in most r uns that the coefficient of a dummy

tities and not others. A dilemma therefore exists o n whether an attempt to

variable representing preelection years is b o th significant and n egative .

eliminate such rent - s eeking costs does not lead either to the deprivation

This is true for t otal investment, for p rivate construction, as well as fo r

o f access to due process. I t may b e argued that Congress, the courts, and

t h e s u m o f p rivate c o ns t r u c t i o n a n d d u r a b l e e q u i p m e n t , whi c h is t h e

media are the counterbalance to arbitrary seizures and in this sense miti­

p ro xy u s e d fo r p rivate inve s t m e n t . 8 T h e s e r e s u l t s l e n d s u p p o r t t o what

gate the p owers that would otherwise result in extreme bias i n decisions.

casual o b s e rvat i o n would sugges t , n a m ely, that t h e u n c e rt a i n ty g e n e r ­

Elections and Political Turnovers

ment. The evidence is thus b roadly compatible with the factional model

a t e d by p r e s i d e n tial c o n t e s t s n egatively i n flue n c e s the l evel o f invest Less noticeable than intraregime factors, h owever, have b e e n regi m e turnovers as a s e c o n d s ource of uncertainty. T h e impo rtance o f turnover

o f Philippine p o l itical e c o n omy d e s c ri b e d earli e r. The mechanism by which regime turnover affects investment in the

e p i s o d e s i n i n fl u e n c i n g i n ve s t m e n t b e h av i o r is d i s c e r n i b l e t h ro u g h

Philippines is clear. Suppose, for simplicity, there are two contending fac ­

e c o n o metric evi d e n c e . M ov e m e n t s o f macro e c o n o m i c variab l e s i n t h e

tions that s e e k to gain control of government. With t h e electoral outcome

P h i l i p p i n e s over t h e p a s t five d e c a d e s , as i n m a n y o t h e r d e ve l o p i n g

known , the losing faction will tend to restrict its own investment, ceteris

countries, indicate a discernible influence of electo ral cycle s . In particu ­

paribus, either in order to minimize the possibility of being taken over o r

l ar, the budget deficit has had a clear tendency to rise in election ye ars ,

simply as a r e s u l t of b e i n g discriminated agai n s t , fo r exam p l e , thro ugh

whi c h , in the political b u s i n e s s - cycles literature , has b e e n attributed t o

being unduly taxed. The winning faction, on the other hand, may invest

an a t t e m p t by i n c u m b e n t l e a d e r s to b o o s t the e c o n o my and distribute

mo re aggre s s ively, h aving greater assurances regarding its s e c u rity and

public funds under their discretion to strengthen their po litical support.'

privileges. The pe r iod pr ior to the elections, however, is one of uncertainty

Neverth e l e s s , unlike political business cyc l e s o b s e rved in o t h e r d eve l ­

fo r b o t h factions, so that investment by both should be exp e c t e d to d e ­

o p i n g c o u n t r i e s , larger e l e c t i o n - ye a r budget d e fic its in t h e P h i l i p p i n e s

cline. Ultimately, a succeeding administration may often threaten to expose

h ave n o t unambiguo u s ly exp a n d e d the e c o n o my. Rath e r, e l e c t i o n s a p -

and undo l arge deals concluded by its p redecessor." It is important to note

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Centralization, Political Turnover, and I nvestment in the Philippines

Centralization, Political Turnover, and I nvestment in the Philippines

that this is p o s s i b l e , largely b ecause a good p art o f d e c i s i o n s involve a

and V i s h n y d i s c u s s e d in the p re vi o u s s e c t i o n . P r e v i o u s a n d p re s e n t

g o o d d e al of discre t i o n ( e s p e c i ally on the p art of the executive) .

administrations may b e vi ewed a s i n d e p endent monopolists, each s e ek­

This hypothesis is borne out historically. An extreme illustration of the p o ssibil ity of takeover was the stru ggle b etween the Marcos and Lopez

with t h e p re d i c t a b l e r e s u l t that inve s t m e n t i s d i s c ourage d . S o m ewhat

families (McCoy 1 993 ) , with the holdings of the latter, as well as those of other elite fam lies, such as the J acintos and Osmefias, being completely

i

taken over by the M arcoses and the cronies associated with them. These same interests, however, were restored with the ascendancy of the Ramos

ing to maximize its gain s , causing "exc e s s ive" d e mands fo r c o r ru p t i o n , less o b v i o u s i s t h e a d d i t i o nal d i s t o rt i o n r e S U l t i n g fro m p rivate age n t s , anticipating t h e p o ssibility that

a b i a s fo r p roj ects who s e life - s p ans d o

not extend b eyo nd t h e t e r m of a " friendly" administrati o n . The reSU l t i n g t e n d e n c y t o myo p i a wh e n inve s t m e n t s i nvolve significant partic i p atio n

and Aquino administrations, while assets associated with the Marcos fam ­ ily (such a s those of Eduardo Cojuan gco, t h e Romualdezes, t h e Benedictos)

o r c o n c u r r e n c e fro m gove r n m e n t is a n o t h e r source of i n e ffi c i e n cy.

were expropriated or "sequestered , " i . e . , placed under government receiv­ ership, Most recently, the pendulum swung once m o re in the other direc­

result fro m any significant p olicy change, whether o r not these are tar­

Uncertainty and actual l o s s e s fo r exi s t i n g interests wil l . to be sure, geted against narrowly define d factio n s . The shift fro m an inward - l o oking

t i o n as the electo ral victory of Pre s i d ent J o s e p h Estrada in 1 998 o p e n e d t h e d o o r to at least a p artial r e s t i t u t i o n of the i n t e r e s t s fo rmerly allied

t o an o utward - l o oking strategy, o r cutb acks in p u b l i c s p e n d i n g as part

closely with the Marcos fam ily, who were strong Estrada supporters . I O O n a scale less gra n d , even p redictable regime changes under demo­

ing narrow divisions, s i n c e factional divisions are likely to have interests i n e i t h e r. Wh at p r i n c i p ally d i s t i n g u i s h e s one s i t u a t i o n fro m t h e o t h e r,

c r a t i c e l e c t i o n s i n t h e P h i l i p p i n e s c o n t r i b u t e to a g o o d d e al of d i s c o ntinuity and d i s r u p t i o n i n investment ho rizo n s . Almost invariably,

l aw. T h e fac t that not t h e e n t i re class o f i n t e r e s t s but o n l y some are

it has b e e n the p r a c t i c e of s u c c e e ding " unfr i e n dly" a d m i n istrations t o q u e s t i o n and s crutinize c o ntracts and p roj e c t s c o n c l u d e d by their p r e ­

vid e - a n d - ru l e tradition. I n t h e c a s e o f t h e Marcos regi m e , fo r instanc e ,

of a macro e c o n o mic adjustment, for exampl e , are certain to cross exi st­

h owever, i s t h e s c o p e fo r d i s c r i m i n a t o ry o r s e l e ctive applicati o n of the affe c t e d l e s s e n s the likeli h o o d o f m a s s ive r e s i s t an c e , i n t h e classic d i ­

d e c e s s o r s , i n t h e a t t e m p t t o p rove that t h e s e h ave b e e n r i d d l e d w i t h c o rr u p t i o n and are d i s a dvantage o u s t o t h e p u b l i c . O n t h e o n e h a n d ,

t h e target i n g o f c e rtain familie s , s u c h as t h e Lopezes a n d t h e J ac i n to s ,

s u c h ex p o s t t r an s p ar e n cy a n d a c c o u n t ab i l i t y m ay b e v i e w e d a s a n a d v a n t a g e o f p r e d i c t a b l e a n d d e m o c r a t i c c h a n g e o ve r s . O n t h e o t h e r

Ayalas, and the p o sitive favoring of other group s , such as that of Eduardo

han d , the practice u n d o u b t e dly increases the c o s t s a n d u n c e rtainty o f i n ve s t m e n t . and i n d e e d m ay p l ay a p a rt i n t h e i n c u m b e n t 's o w n d e ­

lectivity o f fac t i o n - related expropriations a n d policy reve rsals results i n

m a n d fo r c o r r u p t i o n . I n v e s t m e n t p r oj e c t s b e gu n u n d e r a p r e vi o u s a d m i n i s trat i o n may b e h e l d h o s t age b y a n unfr i e n d l y s u c c e s s or, s i n c e

large - s c a l e systemwi d e c h a n g e s in inve s t m e n t s t ra t e gy.

t h e latter's c o ncurre n c e i s o ft e n n e e d e d fo r t h e i r c o nt i n u a t i o n . This i s m o s t evi d e n t wh e n p u b l i c c o n t r a c t s and paym e n t s are i nvolve d , s u c h

coincided with accommodation of other large families, such a s t h e Zobel­ Cojuangco a n d other c ro n i e s . The high d e gr e e o f arbitrari n e s s and s e ­ gre ater inve s t m e n t u n c e rtainty, in a d d i t i o n t o t h o s e already p re s e n t i n

A Benchmark Comparison

I t is tempting to a s s o c iate the two typ e s of i n vestment u n c e rtai n t y

as t h o s e involvin g p u b l i c infrastructure. In g e n e r a l . h owever, the p r o b ­ l e m a r i s e s t o the ext e n t that a n y signifi c a n t gove r n m e n t action-s uch

p reviously discussed with democracy p e r s e a n d co nclude that th ese are

as fran ch i s e s , taxe s , o r t a r i ff c h a n g e s , s u p p o rt i n g i n frastructure -is a re q u i s i t e c l e m e n t fo r a p rivate p roj e c t 's fut u re viabil ity and the p o s s i ­

however, t h a t massive d i s c o u ragement o f i n ve s t m e n t d o e s not o c c ur i n

b i l i ty exi s t s t h a t t h i s may b e withh e l d , o r t h a t a p a s t a c t i o n may b e reve r s e d . I t is e a s y to s e e t h a t t h i s n e e d fo r c o n t i n u i n g c o o p e r ati o n fro m t h e i n c ll m b e t may, with suffi c i e n t g u i l e , b e p arlayed i n t o a d e ­

�

s p e c i fi c o r inherent to such regi m e s . Even casual o b s e rvati on sugge s t s , more advanced indus trial countries with democratic systems of gove rn ­ ment. In such countries , investment ru l e s and attitudes toward property rights do n o t change dram atically. The question that arises. the refore, is how industrial democracies can

m a n d fo r a d d i t i o n al s i d e paym e n t s , r a i s i n g the costs o f inve s t m e n t . A n alyt i c a lly, t h i s s i t u a t i o n m ay a l s o b e c a s t a s a n i n t e r t e m p o r a l

ment. The answer proposed h e re i s diffu s i o n of p ower. It is easy to see that

i n t e rp r e t a t i o n o f t h e s a m e i n d e p e n d e n t m o n o p o li s t s m o d e l o f S h l ei fe r

in a d e m o c ratic c o u ntry ( s ay, D e n mark) with a h o m o g e n o u s p o pUlat i o n ,

1 08

1 09

exist with these same institutions yet maintain a stable record o f invest­

-

:::::

o

-

-D.01 739 -1 .59386 9.59828 0.909775 0.883042 1 .709 1 78 78.87478 -65.2 1 .875074 1 .284343 1 .680222 34.031 55

-1 .26661 -D.89823 1 .094789

-D.21 232 -2.26607 -1 .50077 2.767731 -D.02 1 32 -1 .94722 1 2.72905 0.91 3489 0.895678 1 .6601 1 4 93.7033 -76.4472 1 .927641 1 . 1 83416 1 .514401 51 .28768

-1 .83723 -D.04989 0.577%8 -2.00992 -1 .35938 2.0023 1 9

-2.746 1 1 -1 .51 797 2.5 1 95

-1 . 1 0202

-D.01 714

-D.63359

9 . 1 6691 2

0.851514

7.91 2428

-D.01 968 -1 .25573 9.1 35093 0.91 0399 0.895039 1 .665 1 92 97 05029 -77 . 1 842 1 .887694 1 . 1 70893 1 .460505 59.27007

-1 .93903 -D.04662 0.636061

0.842237

-1 .86806 -D.97221 1 .668942

-2.91 737 -1 .420 1 6 2.840374

9.07674

t-Statistic

Equation 4 Coefficient

-2. 1 9253 8.6476 1 5 0.901465 0.88778 1 .721 809 1 06.7266 -79.1 8 1 .81 7248 1 .2 1 831 5 1 .466553 65.87077

-1 .78144 1 .529671

-2.60276 -1 .95133 2.482144

1 3.01 752

0.954097

-1 .7726 -D.06364 0.566809

t-Statistic

Equation 5 Coefficient

Regression Equations

1 . 1 56 -1 .523 1 .362 -2 020 1 .540 -0.454 1 .303

0.729 0.001 -D.068 0.043 -D 004 0.023 -D 046 0.730 0.791 0.748 0 . 1 09 0.401 38.069 1 .895 4.270 -3.939 1 8.370

1 . 1 58 -1 .395 1 . 1 53 -1 .993 1 .425 0.214 -0.443 1 . 1 96 0.001 -D.066 0.048 -D.004 0.022 0.000 -D 046 0.700 0.791 0.741 0.110 0.401 38099 1 .881 4.224 -3.851 1 5.629

5.481

t-Statistic

Equation 2 Coefficient 5.325

t-Statistic

-D.004 0.025 0.000 -D.083 0.865 0.783 0.738 0.1 1 1 0.4 1 7 37.269 1 .986 4.232 -3.901 1 7.502

0.001 -0 085

0.804

-1 .749 1 .614 -D.71 7 -0.845 1 .51 7

1 .028 -1 .925

6.789

t-Statistic

Equation 3 Coefficient

1 95 7-1 992)

0.725

Coefficient

Equation 1

(Pri[l(lte colls truction pillS durable equipment,

Adjusted R2 S.E. of regression Sum squared residuals Log likelihood Durbin-Watson stat Akaike info criterion Schwartz criterion F-statistic

R2

elect i o n .

Dependent uariable: Priuate irwes tment proxy as percent of GDP

Private investment proxy (lagged) Accumulated current account deficits Preelection year dummy Govemment construction Inflation Predicted GOP Terms oftrade Investment price index Constant

Variable

Table 2

of GD P ) a c t u allv falls d u r i n g a y e a r i m m e d i a t l'lv p rp c t' d i n g a n

-0.1 02 0.821 0.779 0.742 0.1 1 0 0.423 36.954 1 .971 4.264 -3.975 20.61 9

-D.004 0.023

0.001 -0.084

0.829

-1 .081 1 .458

-1 .798 1 .520

1 .2 1 6 -1 .91 6

7.384

Equation 4 Coefficient t-Statistic

-0. 1 57 1 .041 0.770 0.738 0.1 1 1 0.441 36.085 1 .916 4.270 4 022 24. 1 27

-0.004 0 01 8

-0.077

0.853

-1 .903 1 .940

-1 .902 1 .2 1 2

-1 .753

7.656

Equation 5 Coefficient t-Statistic

value I if the year immediately precedes an election year. Otherwise, it takes on the value O. Its coefficient havin g a negative sign means that investment ( as percent

NOT!': for purposes of the discussion of regression equations, the most salient variable is the d u m my variable for preelection years. This variable takes the

-1 .35973 -1 .00852 1 .23871 2

0.62528 -D.249 -2.32584 -1 .52782 2.637364

0. 1 5 1 025 -D.08453 -1 .93822 -D.061 65 0.686405

-D.01 937 Terms oftrade Price of investment goods -1 .86047 1 1 .87336 Constant 0.91 1 1 1 2 R2 0.880343 Adjusted R2 1 .728786 S.E. of regression Sum squared residuals 77.70627 Log likelihood -04.931 3 1 .855692 Durbin-Watson stat 1 .324973 Akaike info criterion 1 .764839 Schwartz criterion 29.6 1 1 37 F-statistic

-D.01 1 73

-D.86028

-0.01 886

-D.07 1 1 2 -1 .80381 -D.05969 0.706638

0.87694

6. 1 6 1 662

0.830203

t-Statstic

Coefficient

Equation 3

1 95 7-1 992)

t-Stabstic

Equation 2 Coefficient

t-Statistic

Coefficient

Equation 1

(Dependent uariahle: Total inues tment as percent of GDR

Regression Equations

Investment (lagged) Accumulated current account deficits Current account deficit (lagged) Budget deficit Preelection dummy Inflation Predicted GOP

Variable

Table 1

�

c-,

r ,

Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Philippines

an o p e n and stable e c o n o my, and an effective administrative sys t e m , a

solves this p r o b l e m and allows a quicker and more flexible r e s p o n s e to

governance structure with diffu s e d power is likely to b e b e s t fo r i m p l e ­

changing c i r c u m s t a n c e s , given the availab le i n format i o n .

m e n t i n g efficient investment policies. Political o p e n n e s s and p o p ulation

5 . Frequency of leadership turnover ( e . g. , t e r m limits a n d fragmented

homogeneity could reduce the need for power diffusion, but on the whole

p arty system) . Whe n the likelihood increases that government p ower will

such a system should prosper without much concentration of power. This

shift from one group of politicians to another, discretion in the hands of

i s a b enchmark that we use to assess appropriate arrangements for other

leadership can breed pol icy instability. This calls fo r increased diffusion

situations with different characteristics. From such a benchmark, however,

of power to the extent that such arrangements can survive political change. 1 1

one may proceed to inquire into the significance of the costs of restricting

6. The political system's lack of openness (such as more restricted media

p olicy discretion, depending on socioeconomic characteristics that make

and public expression) . Reduced opportunities for political expression and

info rmation processing and coordination among interest groups cumber­

p articipation by broad segments of the p opulation limit the information

some. I n p articular, the costs of diffused p ower should tend to rise with

available to interest groups and, naturally, tend to raise the concentration

the six factors that we present b e low.

of power. H owever, these factors also exp and the p ossibilities for o p p or­

1 . Heterogeneity of in terest gro ups in the society. As the p o l ity becomes

tunistic behavior on the p art of the leaders. As a result, some increase in

more heterogeneous, b argaining among representatives o f interest grou p s

p ower diffusion may help increase credibility of policies. Lack of p olitical

b e c o m e s more c o s t ly. A h i g h e r l evel o f p ower c o n c e ntratio n c o u l d , i n

openness may also raise the costs of p ower diffusion, since it reduces the

p r i n c i p l e , mitigate this p r o b l e m . O n the other h a n d , heterogeneity may

availability of public information. H owever, this is unlikely to be a maj o r

also i n d u c e b i a s e s i n l e a d e r s ' i n c entives (as w o u ld h a p p e n if the gov­

effect compared to the o p p ortunities for favoritism that l a c k o f political

ernment was completely "capture d " ) and affect its efficacy. The net effect

o p e n n e s s presents to leaders with c o n c e ntrated p ower.

o n the trad e - o ff, therefo r e , i s n o t e n t i rely c le ar. 2. Th e freq u e n cy and m agn itude of eco n o m ic s h ocks ( e . g . , adve r s e

Institutions limit p olicy discretion essentially by conditioning changes in policy and p olicy- making procedures on coordination by a number of

t e r m s o f t r a d e s h o c k s , n a t u r a l d i s a s t e r s , s i g n i fi c a n t p o p u l a t i o n move ­

i nd e p e n d e n t agents representing different interests . Such a diffu s i o n of

ments) . Whe n a country faces significant economic sho cks but o therwise

p ower can take the form of geographic decentralization ( e . g . , federalism) ,

has the same c o n d i t i o n s as the b e n c hmark c a s e , the n e e d fo r t i m e l y

institutional decentralization ( e . g . , independent central b ank and regula­

p olicy adj ustment increase s . As a result, t h e net benefits t u r n in favor o f

to ry agencie s ) , o r multiple veto p owers ( e . g . , presidential - p arliamentary

g r e a t e r power c o n c e n t r at i o n .

systems with bicameral legislature, independent constitutional courts, and

3. Th e eco n o m ic sys tem 's l a c k of open n ess ( i . e . , m a r k e t s a r e m o re

o t h e r e l e c t e d or n o n e l e c t e d b o d i e s h o l d i n g veto over p o licy change s ) .

r e s t r i c te d ) . I f the o nly d e p arture fro m the b e n c h m ark c a s e is r e d u c e d

Such arrangements can reduce the risk of opportunistic policy changes as

e c o n o m i c o p e n n e s s , t h e c o s t o f collecting and p r o c e s s i n g information

long as the represented interests are not closely aligned. As the number

rises fo r interest groups and their representative s . As a result, bargaining

of independent agents involved in various p olicy- making and procedure­

b e c o m e s more c o stly, and p ower con centrat i o n , which reduces b argai n ­

s e tting p r o c e s s e s diminishes and the degree of alignment among those

i n g , b e c o m e s m o r e b e ne fi c i al at the margi n .

agents increase s , the greater is the degree of p ower concentrat i o n in the

4. Weakness of the adm in istra ti ve system ( e . g . , inefficient administra­

government. To b e sure, p olicy commitment is not an all - or-nothing var i ­

t ive o rg a n i z at i o n s , low q u al i t y o f p e r s o n n e l . low level o f e d u c a t i o n ) .

able. Rather, it is a variable with a continuum of degrees depending on the

I n ability of the bureaucracy to collect and p r o c e s s i nfo rmation adds to

incentives of p o licy makers, the nature of veto holders for each rule , and

the costs of negotiation among intere s t - group represe ntative s . This raises

the extent to which the rules sp ecify the details of policy and restrict the

the marginal net b e nefits o f c o n c e ntrated p ower. A weak administrative

options fo r changing the details or the rules thems elve s .

s y s t e m also i m p e d e s i n fo r m a t i o n p r o c e s s i n g . I n fo rma tio n al i m p e rfe c ­

On t h e face of i t s characteristics, t h e Philippines is a likely candidate

tions t e n d to give r i s e to "wars of attrition" in interest- group bargaining,

to benefit from a strong executive. In p articular, the economy's proneness

which c a n be c o s t l y i n t e r m s o f r e s o u r c e s and d e l ays i n a dj u s t m e n t

to economic shocks, its lack of openness and administrative weakness are

(Al e s i n a a n d D razen 1 9 9 1 ) . I n o n e s e n s e , c o n c e n tra ti o n o f p o w e r r e -

factors that, on the face of it, argue for an increase in the concentration of

1 12

1 13

r

Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Philippines

p ower. There is no need to deal at length with the record of shocks. The

overs are asso ciated with policy instability, then regime longevity, ceteris

heavy dependence of the Philippine economy o n imported inputs renders

p aribu s , might co nversely b e associated with greater p olicy c o n sistency

it vulnerable to both external and internal shocks. Examples of such shocks

a n d s h o u l d t h e r e fo r e allow fo r l o n g e r inve s t m e n t h o r i z o n s . In t u r n ,

that resulted in critical conditions were the second increase in oil prices

i n c u m b e n t r u l e r s w o u l d have t h e i n c e ntive to t e m p e r c o rrup t i o n d e ­

in 1 9 7 9 , the world rec e s s i o n o f 1 98 2 , and the Gulf War crisis o f 1 99 0 . I n

mands , l e a d i n g t o lower d e m a n d fo r c o rru p t i o n .

addition, natural calamities , such a s earthquakes a n d t h e Mount Pinatubo volcano eruption o f 1 99 1 , were also significant shocks.

T h e argument is similar to the ownership solution p r o p o s e d fo r the well- known " tragedy of the commons" problem. Free access to a resource

Apart from the unsustainability of growth under a clo sed economic

causes its overexploitation, which the assignment of monopoly ownership

s ys t e m , t h e c u r r e n t fra m ewo rk suggests t h a t l a c k o f o p e n n e s s i n the

s o l ve s , s i n c e the s o l e own e r u l t i m ately r e a p s what h e sows and m u s t

economy has another effect, namely, that of raising transaction costs among

therefore take the long view. I n the same manner, contention for p owe r

differing interest group s . One way of looking at this is to s ay that rent­

and interregime changes among different interest groups might be likened

seeking games are more likely to occur in closed, rather than in more open

to a one-time open season for public resources. The incentive is strong in

economic systems. 1 2 Finally, the weak condition of the bureaucracy is also

such cases for succeeding groups to extract as many rents as they can, i . e . ,

p art of the "stylized facts" about the Philippines, an observation made long

"make hay while t h e s u n shines , " a tendency only somewhat tempered by

ago ( e . g . , Corpuz 1 95 7 ) but still relevant . The framework, therefore, sug­

the infrequent need to stand for reelection. By contrast, security of tenure

gests a number of reasons why the Philippines should have a "centralized"

is thought to reduce this need, since it lengthens the horizon over which

system. Indeed, the puzzle for the Philippines is h ow and why, given such

corruption rents may b e collected. Before the Asian financial and economic

a framework, the exp eriment with authoritarianism has failed.

crisis, a good deal of this analysis certainly seemed to b e b orne out by the expe ri e n c e s o f such countries as I n d o n e s i a , M al aysi a , and Singap o r e , in

Extreme Centralization and Bias

Viewed differently, the problem o f uncertainty brought about by intra­

which long- lived centralized regimes appeared to have facilitated the entry of capital, p articularly foreign.

and in terregime changes i s the app arent inability o f the government as

The recent h i s t o ry of political i n stitutions in the Philipp i n e s may be

a whole to make credible or binding commitments . C o mmitment essen­

viewed as a process o f exp erimentation i n s o lving the twin problems of

t i ally requires that p o l i c i e s are not amended in ways that punish inve s ­

i ntrareg i m e a n d i n t e rregime i n s t a b i l i ty, p r i m arily a l o n g t h e d i m e n s i o n

t o r s w h o make irreversible investments o n the b a s i s of existing polici e s .

o f c o n c e ntrat i o n o f p o w e r as e m b o d i e d i n t h e executive . T h e starting

T h i s c a n b e achieved if the policy makers h a d t h e incen tive to h o n o r t h e

p o in t was t h e p re - M ar c o s r e g i m e gove r n e d b y t h e 1 93 5 C o n s ti t u t i o n ,

promises of past p o l i c i e s , o r if t h e i r d i s c re t i o n i s c o n strained by esta b­

which s aw the power of the executive diluted in favor of Co ngre s s . This

l i s h e d rul e s that govern p o l icy c h a n g e . F o r a p p r o p ri a t e i n c e n t ive s t o

was c o m p o u n d e d b y fre q u e n t turnovers . The b r o a d result c o n fo r m e d

exi s t , p o liticians i n gove rn m e n t (as i n d ivi duals o r as a p arty wh en p o ­

with t h a t argu e d b y Shleifer and Vis hny, namely, the emergen c e of b o t h

litical p arties a r e s t r o n g ) should e x p e c t to have a good c h a n c e of b e i n g

i n t r a - and i n t e rreg ime u n c ertainty.

i n t h a t p o s i t i o n i n the future a n d s h o u l d valu e t h e i r reputation among

On the other hand, the authoritarian Marcos regime may b e regarded

all p o t e n t i a l inve s t o r s . Wh e n t h e c h a n c e s o f t u rnover in gove r n m e n t

as an h i s t o ri c al exp e riment with extreme c e ntralizat i o n that s o ught to

l e a d e r s h i p a r e s i g n i fi c a n t , t h e n c o m m i t m e n t d e p e n d s o n i n s t i t u t i o n a l

addre s s the problem on b o t h counts, first by the o ften brutal s u p p r e s ­

arran g e m e n t s fo r p o l i c y a m e n d m e n t .

sion of comp etition a m o n g contending factions as well as social protest

Until recently, it would have appeared t h a t b o t h typ es o f uncertain ty

fro m t h e masses a n d , s e c o n d , b y s u s p e n d i n g the turnover that would

r e fe r r e d to a b o v e c o u l d be r e s o l v e d by r e c o u r s e to s o m e fo r m o f

have r e s u l t e d fro m e l e c t i o n s . The a p o l o g i s t s o f t h e regime we r e fu l l y

authoritarianism o r dictatorship. After all, assuming i t could b e achi eve d ,

aware o f the ne e d fo r j u stification, and the alleged urgency of p reve nting

concentration of power a n d t h e disco urage m e n t of institutions t h a t permit

the growing conflict b etween the extreme Left and the conservative "oli­

t h e e xp l i c i t expre s s i o n o f i n t e r e s t - gr o u p c o m p e t i t i o n wo u l d m i n i m i z e tran s a c t i o n c o s t s a n d u n c e rtainty. O n the o th er ha n d , if fre q u e n t tur n -

garchy " was cited as a reason fo r a "r e vo l u t i o n fro m t h e c e n t e r " that established t h e d i c ta t o r s h ip .

1 14

1 15

T Centralization, Political Turnover, and Investment in the Philippines

It must be c o n c e d e d that the e arly h alf o f the M a r c o s dictatorship ( from 1 9 72- 1 98 0 ) was marked by a revival o f investment and a respect­

Centralization, Political Turnover, and Investment in the Philippines

elite and workin g classes would-as they did-offe r p owerful resistan ce to la rge chang e s in the p olitical r ule i n which they had invested.

a b l e r a t e o f e c o n o m i c g r o wt h . I n t e r n a t i o n al i n s t i t u t i o n s , s u c h as the

Conflict p o t e n tial a m o n g interest g r o u p s i s t h e term u s e d h e r e t o

I n t e r n a t i o n al M o n e t a r y Fund a n d t h e Wo r l d B an k , a s well as fo reign

summarize t h i s condition. I t refers to a situation where there a r e overlap ­

(especially U S ) investors ap p e ared to b e persu a ded at th a t time, a n d for

ping claims on resources by different interest groups , leading to the p o s ­

t o o l o n g a time aft e r, by t h e argume n t that c e ntralization would result

sibility o f s h arp conflict. The c o n d i t i o n i s present whe n ever a situation

i n b o t h greater p olicy c o h e rence and continuity. 1 3 This p art o f the sto ry,

approximates a constant- sum game, which is well known to have no Nash

at l ea s t , presents no p r o b l e m s . I n d e e d , t h e anomalous p art of that ex­

equilibria. This may occur both within and across social strata. A simple

p e r i e n c e , fro m the t h e o r e t i c al viewp o i n t p u r s u e d h e r e , was that t h a t

example would b e a workers' movement with fairly set ideas about entitle­

s i t u a t i o n could n o t b e s u s t ai n e d .

ments, n o t o nly for its own members but for the rest of society as well . 1 7

Monocausal explanations are always dangerou s , h owever, a n d while

In s u c h a s i t u a t i o n , s i d e p ayments are l e s s likely to s u c c e e d , s i n c e t h e

governance fo rms are undoubtedly important, they alone cannot b e ex­

utility of o n e p arty includes the assignment of a p articular level of utility

pected to determine economic outcomes. The full set of reasons for the

for the other. (In contrast to this, one might consider a trade union move­

fail u r e o f t h e M a r c o s d i c t a t o r s hi p 's s e l f- c o n s c i o u s attempt t o e m u l a t e

m e n t b a s e d p ri m arily o n e c o n o m i c d e m a nd s . ) A n o t h e r examp l e is t h e

t h e autho ritarian r e g i m e s i n the rest of the r e g i o n r e m a i n s a wid e - o p e n

conflict b e tween t w o p o l itical c l a n s c o m p e ting for l o c a l electo ral s poils ,

fie l d o f study. An i m p o r t a n t e l e m e n t t h a t can b e n o t e d , h owever, i s t h e

also a winner- take- all situation. The s e examples serve to illustrate the point

fai l u r e o f t h e M ar c o s d i ct a t o r s h i p to reach t h e s a m e l evel o f s o ci al l e ­

that whe n interests are extremely heterogeneous, any assignment is l ikely

gitimacy as the authoritarian regimes in the r e s t o f East A s i a . T h e r e was

to be regarded as biased o r unfair b y s o m e o n e e l s e . I S

a l m o s t no p e r i o d d u r i n g w h i c h the M ar c o s r e g i m e did n o t fac e s o m e

I n the c o ntext o f heterogeneous interests even in the pr e - martial law

fo r m o f c h a l l e n g e t o i t s r u l e , w he t h e r fro m e l e m e n t s o f d i s p o s s e s s e d

p e r i o d , it s h o u l d b e clear that t h e i n s t i t u t i o n alization of e l e c t i o n s , i . e . ,

and disenfranchised elite factions, t h e Catholic Church, the mass move ­

predictable turnover, was a n important factor in p reventing t h e situation

m e n t and armed resistance l e d by the Communist Party, or t h e armed

fro m degenerating into o n e o f c o m p l e t e capture and bias. For this rea­

m ovement for the independence of Muslim Mindanao. It is notable that,

s o n as well, t h e various p arti c i p a n t s , n o t ably c o n t e n d i n g elite fact i o n s ,

ultimately, a confluence o f these fo rces-p recipitated by a fur t h e r split

w e r e c o n t e n t to p l ay the gam e , t h e r e b y avoiding a w a r of attriti o n . The

i n t h e Armed F o r c e s-wo u l d b r i n g down t h e d i c t a t o r s h i p i n 1 9 8 6 . 1 4 This consideration p o i nts to t h e importance o f initial conditions i n a s s e s s i n g t h e l o n g - t e r m c h a n c e s o f c e ntralizatio n a s a s o l u t i o n to t h e

susp e n s i o n o f this process of ritual factio nal capture of the state under the dictatorship was a violation of implicit rules of the gam e , leading to t h e e m e r g e n c e o f s h arp c o n fl i c t .

p r o b l e m o f commitme n t . The s o cial b a s i s required t o l egitimize an a u ­

A good d e al o f the M a r c o s regime's ultimate e c o n o m i c failure l a y in

thoritarian solution to the problem of credible commitment was probably

its inability to consolidate its grip o n p ower and thus address the issue of

less present in the Philippines than in other countries which successfully

interregime uncertainty. The legitimacy of both the substance and meth­

adopted that solution. To b e gin with , relative to those other countries, the

ods o f the l arge - s c al e p r o p e rty reassignments it made were never fully

Philippines in the 1 960s and 1 970s was characterized by an economically

a c c e p t e d by o p p o s i n g elite fac t i o n s , n o r by armed and unarmed mass

independent and politically p owerful elite. IS It also had a well - developed

movements. As the challenge to legitimacy increased, especially after 1 98 2 ,

working- class and p e asant movement, and a p o pulation with a relatively

u n c e rt a i n ty i n c r e a s e d b o t h a m o n g fo reign and dome s tic inve s t o r s and

high degree of literacy and p olitical sophistication. lEi H utchcroft ( 1 99 1 , 1 998)

creditors, leading ultimately to the economic crisis of 1 9 84- 1 9 8 5 .

o b s e rves that t h e P h i l i p p i n e elite has h i s t o r i c ally been more p owe rful

T h e assertion o f wide- ranging autho rity entails a m o r e difficult p r o ­

relative to the state and the bureaucracy than the elite in other countries.

c ess o f legitimization in s o c i e t i e s whe r e p o litical and e c o n o m i c claims

I n such circumstances , i t b e c o m e s unlikely that a simple capture of the

fro m e l i t e a n d fro m working- c l a s s gro u p s overlap and are more c o m ­

state machinery by a dictator would lead to easy co- opting of the elite. The

prehensive, more articulated. A s a n illustration, a society b a s e d predomi­

upshot is to raise the costs of a dictatorship's bid for legitimacy, since both

nantly o n s e l f- sufficient p e asant farming, with c e ntral state institutions

1 16

1 17

Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Philippines

playing only a minor and distant role in economic life , is likely to present

to prevent the reemergence of a pure authoritarian form o f government.

less re sistance to an autho ritarian t akeover o f the state. Much earlier.

It set c l e a r term l i m i t s fo r t h e p r e s i d e n t and s o ught t o d i m i n i s h the

M arx ( [ 1 8 6 9 ] 1 9 7 3 . 2 3 8-3 9 ) o b s e rved the c o n n e c t i o n b etween a b s o l u t ­

executive 's d i s c r e t i o n i n d e c i s i o n making through a clearer p r o c e s s of

ism, o r B o n aparti s m . and the economic isolation and backwardness o f

legislative and j udicial review. Most notably, the Constitution prohibits the

t h e French peasantry. I "

reelection o f the president, although it grants a longer term o f six years;

There are several reas o n s fo r overlapping claims . While o n e may b e

it prescribes l o nger congressional sessions (up from 1 00 d ays to eleven

t e m p t e d to approximate this by the degree o f inequality o f wealth d i s ­

months) to reduce the need for special sessions, whose agenda were thought

tributio n , t h i s is certainly incomplete. I t i s n o t measured i n e quality per

to be more prone to executive manipulation. It also provided for congres­

se that matters. but the lack o f public acceptance o f this inequality. This

sional review of declared states of emergency; and it broadened the scope

in turn depends o n the assertion of divergent rights and alternative legal

for j udicial review of executive acts by constituting "grave abuse of discre ­

frameworks , and the determination that some other s o cial arrangement

tion. " More significantly, it has been noted that the 1 987 Constitution also

i s superior. Educatio n , the s p read o f ideologies. o r familiarity with dif­

restricts the chief executive through detailed specification of rights and

fering s o cial and e c o n o mi c arrangements are i m p o rtant, as well as the

entitlements, some of which are p o tentially in conflict (Sereno 1 99 9 ) .

exi s t e n c e o f unclaimed r e s o u r c e s . As an examp l e , deep divis i o n s over

F o r these reasons, it has almost become part of folk wisdom among

landownership claims in the Philip p i n e s are fo u n d e d o n the assertion

the business c ommunity that the p owers of the legislature and the j u ­

o f rights under differing frames of legitimacy, such as ancient claims o n

diciary h ave become reemphasized at t h e exp ense o f t h e presidency i n

ancestral domains, s i m p l e usufruct a n d physical occupation, as well a s

the postdictatorship regime. Consequently, i t has been thought t h a t t h e

t h e legal titling system introduced under foreign occupation-all of which

p o s t d i c t a t o rship p e r i o d a n d its e c o n o m i c c o n s e q u e n c e s m ay b e a n a ­

are t o some exte n t p u b licly accepted i n varyin g degre e s .

lyzed simply as a continuation o f the system p revailing u n d e r the 1 93 5

In the m o s t general sense. what seems important is the social "space"

C o n s t i t u t i o n . 20 I n t h e i r fam o u s a r t i c l e , S h l e i fe r a n d Vi shny s p e c u l a t e

that government-or those who have captured it-can occupy without in­

broadly t h a t the return o f democratic institutions in t h e Philippines has

truding on preexisting claims or rights . The more numerous and the larger

probably increased the extent o f c o rruption owing to the r e e m e rgence

such spaces are. the less disruptive authoritarianism is. and the less resis­

of mutual veto and deadlock among competing p ower centers. While the

tance it is likely to evoke. This "space" may b e physical , as in the case of

dilutio n o f central p owers has undoubtedly o ccurre d , h owever, it would

unoccupied o r unclaimed public lands that can b e appropriated . I t may

go too far to s ay that the postdictatorship period has simply represented

be in terms of value. such as when the economy grows and the increment

a return t o a p re - 1 9 72 regime o f alternating factionalism. I n s t e a d , the

is disproportionately distributed to favored interests. It may be intellectual

current system must b e understo o d as b earing the marks o f the earlier

and ideological space . such as an uneducated and ideologically unsophis­

p re - M arco s period, the period o f dictatorship, and the reactions to both .

ticated population that i s c o ntent to moderate its claims o n the rest o f

It is important to point out that, while its powers have been dimin­

society. leaving more room for dictators to a s s i g n the l evers fo r t h e cre ­

ished relative to the dictatorship, the presidency has remained a p owerful

ation o f new wealth . In the Philippine experience, however, there appear

office that by and large dominates other branches o f government . Among

to be less of such "empty spaces" for the proj ection of authoritarian forms

the powers o f the p residency that have remained are the item o r p artial

without infringing on p reexisting claims. In such circumstances. conflict

veto and the use of large d i s c r e t i o n a ry fu n d s n o t subj e c t t o c o n g re s ­

resolution is unlikely to b e simple . and the basis o f autho rity itself d i s ­

sio nal appropriation o r scrutiny ( c o ntinge ncy. calamity. a n d intelligence

puted. Those "co nvergent expectations" which Arrow ( 1 9 74. 72) observed

fu n d s ) . N o t ab ly. t h e p r e s i d e n t a l s o w i e l d s a p owerfu l i n flu e n c e over

to be the basis fo r viabl e autho rity will not exist.

Co ngress through bureaucratic discretion over the timing o f the release of funds for projects o f locally elected officials. especially the " p o rk b arrel "

Centralization with Term Limits

M otivated by a desire to check past authoritarian abuses, the framers of the 1 987 Constitution reduced some of the president's powers and sought 1 18

of m e m b e r s o f t h e H o u s e o f R e p r e s e n tative s . 2 1 I n a d d i ti o n . a l t h o ugh admit t edly with n e w r e s t r i c t i o n s , t h e p r e s i d e n t c o n t i n u e s t o a p p o i n t m e m b e r s o f t h e j u d i c i ary and the military. 119

r Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Philippines The scope for executive discretion in matters of licensing, bidding,

While each o f the features mentioned above is a response to a specific

granting of incentives, and other aspects of regulatio n also remains large.

p r o b l e m , t h e i r j uxtap o s i t i o n i s not n e c e s s arily optimal. The p revi o u s

The e n ti r e l i b e ral izati o n and d e r e g u l a t i o n age n d a b e tw e e n 1 9 8 1 a n d

an alys i s s u g g e s t s t h a t c e ntralizati o n via a strong exe c u tive wo uld a d ­

1 99 6 , including t h e revision o f tariffs, was accomplished largely through

d r e s s the i s s u e o f i ntrareg i m e u n c e r t a i n ty b y s o lving t h e " c o m m o n s "

a s u c c e s s i o n of executive orders.22 In general, the executive's d o m i n a ­

problem. O n t h e other hand, whe n centralization is combined with fre ­

t i o n o f the c ivil s e rvice b u r e a u c racy and the m i l i ta ry provides i t with

q u e n t turnovers, t h e p r o b l e m o f c r e d i b l e c o m m i t m e n t r e a p p ears and

access to information that is simp ly unavailable to other branches of the

creates a problem o f interregime u n c e rt a i n ty. The large discretion a l ­

govern m e n t , e s p e c ially the legislature . The n a t i o n al legislative agenda

lowed the executive to change policies-together with observed past use

is built around "priori ty bills" proposed by the president, while legisla­

of that discretion to favor vested interests-makes it rational for inve s ­

tion i n i t i at e d by l awmakers t h e m s elves h a s tended t o be limited a n d

tors to wait out t h e results of impending p olitical contests. T h e already­

p arochial,2l What is m o re , e n a c t e d laws a r e often sketchy and abstract,

documented i m p o rtance o f presidential elections i n influencing inve s t ­

givin g wide latitude to executive agencies i n the formulation o f " imple­

ment b ehavio r i s exaggerated by the c o n t i n u i n g l arge s c o p e of p owers p o s s e s s e d by the p r e s i d e n cy. The i n s t i t u t i o n al p r o b l e m that recurs is

menting rules and regulat i o n s . " Perhaps t h e m o s t telling manifestation o f presidential dominance is

how the incumbent in a p owerful positi o n can make a credible commit­

its influence o n the p attern o f c o alition formation i n the legislature. All

ment t o c e r t a i n p o l i c i e s , give n t h e p o s s i b il i ty t h a t h i s o r her e q u ally

the three postdictatorship administrations (Aquino, Ramos, and Estrada)

p owerfu l s u c c e s s o r m ay s u b s e q u e n tl y o v e r t u r n t h e s e . N o t e that the

exercised heavy influence over C o ngres s , due t o the instability o f p arty

d ifficulty o f making a binding commitment increases all the more with

fo rmations after presidential elections . Broad, heterogeneous coalitions

an increase i n the p rerogatives associated with the p o s i t i o n . Hence the

h ave invariably fo r m e d who s e d e cl ared m a i n p u r p o s e i s t o " s u p p o r t "

p aradox that the s t r o n g e r a p o s i t i o n i s , the weaker i s the a b i l i t y fo r

the i n c u m b e n t executive, p reve n t executive retaliat i o n , a n d t o ensure

i n c u m b e n t s to make b i n d i n g c o m m i t m e n t s . I n p u re authoritarian r e ­

c o n t i n u i n g a c c e s s o f l o c al r e p r e s e n t atives t o n a t i o n al l arge s s e . Whi l e

gimes, this problem is suspended, o r at least p ostponed, since term limits

" t u r n c o at i s m"

also

e xi s t e d

under the

t w o - p a r t y s ys t e m

in

the

predictatorship period, t h e current p ractice is a m o r e cynical a n d wid e ­

are i n d e fi n i t e . Where turnover i s p re s c r i b e d , h owever, the p r o b l e m re ­ curs with predictable regularity.

s pread version, h e l p e d alo n g by the higher trans action costs o f forming

This framework can elucidate some o f the governance factors respon­

stable coalitions under the current multiparty system (see de Dios 1 999a

sible fo r the o b s e rved irregular b e h avi o r o f inve s t m e n t a n d e c o n o m i c

fo r a ful l e r discus s i o n ) .

p erformance in t h e p o s t - M arcos e r a . During t h e Aquino administratio n ,

The system under the 1 9 8 7 C o nstitution is in many ways a curious amalgam of traits fro m both the p remartial law regime and the dictator­ ship, the product o f a remarkable historical evolution. From the latter it

associated with the resolution of the outstanding problem of b i a s . The

retained many elements o f centralization, albeit somewhat reduced. From the fo rmer, it res tored t h e predictabil i ty of t u r n over. Each o f these is m e a n t t o s o lve a p a r t i c u l a r g o ve r n a n c e p r o b l e m . In r e a c t i o n t o th e excesses of the dictatorship, regular turnover is designed to address the p r o b l e m o f extreme bias ; p redictable constitutional turnovers disc o u r ­

the revival of investment immediately after t h e fall of t h e dictatorship was restoration o f c o n fiscated property, the removal o f any further thre a t of dispossession, and the greater social legitimacy of the Aquino government ( 1 986- 1 992) were factors that encouraged the return of investment confi ­ dence. This was shattered o nly b y the threat of military takeovers in 1 989 onward, which gave rise once more to interregime uncertainty. Investment stability during the Ramos administration ( 1 992- 1 998) , on the other hand,

age t h e i n d e fi n i t e ext e n s i o n o f p ower a n d i t s u s e a g a i n s t c o m p e t i n g interest groups, which has in the past led to crises owi ng to high conflict

went hand in hand with a consummate use by the executive of the levers

potential. On the other hand, the implicit tolerance of greater centraliz ed p ower seeks to address the problem of gridlock and the "tragedy of the c o m m o n s" that lead to intraregime uncertainty, an undes irable fe atur e

cessfully managed, underwritten by selective access o f lawmakers to cen­

of the p remartial law re g i m e . 1 20

available to i t . In p articular, coalition p o litics in the legislature was suc­ tral government resources and rents. This use of pork-barrel politics effec­ tively solved the p otential problem o f gridlock and, when combined with executive d i s c r e t i o n over key reform areas, sustained a m o m e n tu m o f 121

1 Centralization, Political Thrnover, and Investment in the Philippines

1 \ .

Centralization, Political Thrnover, and Investment in the Philippines

reforms that helped the country achieve a respectable rate of investment

endorsed Fidel Ramos as her successo r, and also by Ramos who picked

and growth over the period.

Jose d e Ven e c i a to s u c c e e d him. The s u c c e s s i o n practice h a s been fa r

N everthel e s s , the crucial t e n s i o n b e twe e n c e ntralization and turn­

fro m p e rfect, h owever, having worked only once in two instances (Aquino

over w a s n o t e n t i r e l y r e s o l ve d . T h e c l o s i n g y e a r s o f the R a m o s

being succeeded by Ramos) . Obviously the criteria for "anointment" can

administration were taken u p b y t h e recurren c e o f interregime u n c e r ­

vary and m ay have little to d o with what is needed to sustain a credible

tainty, with a subsequent i m p a c t o n investment. T h e very s u c c e s s of the

reform c o mmitment. H e n c e , for i n s t a n c e , a putative s u c c e s s o r m ay b e

R a m o s a d m i n i s t r at i o n r e fo r m s and t h e i r c l o s e a s s o c i a t i o n with t h e

s e l e c t e d m a i n l y i n o r d e r to p r o t e c t the i n c u m b e n t and h i s a s s o ciated

p ol i t i c al p e rs o n a l i t i e s o f t h a t a d m i n i stratio n b r o u gh t up the q u e s t i o n

interests against political retaliati o n .

whether they would b e continued b y t h e succeeding regime. I t i s worth

M o r e ambitious attempts to resolve t h e succession i s s u e h ave taken

r e c a l l i n g that many key r e fo r m s ( s u c h as tariff- r e fo r m s c h e d u l e s , d e ­

the fo r m of s e ek i n g t o c h a n g e the r u l e s t h e m s e l ve s . T h i s was m o s t

regulation of interisland passenger shipping, telecommunications, p ower,

obvious i n t h e initiatives e n c ouraged-if n o t actually initiated-by e l e ­

and water and s ewerage, to name only a few) were implemented through

m e n t s of the R a m o s a d m i n i s t r a t i o n in late

executive or administrative orders, all o f which c o u l d , i n p r i n c i p l e , b e

Constituti o n . The proposed amendments would h ave allowed t h e presi­

1 997 to amend the

revers e d . The threat o f reversal a p p l i e s t o large p r oj e c t s . Exam p l e s o f

dent to run for reelection, removing the present constitutional ban. The

those recently affected b y the transition b e tween t h e Ramos and Estrada

r e a s o n give n b y the p r o p o n e n t s of the m o ve was the n e e d to e n s u r e

a d m i n i s tr a t i o n s i n c l u d e real e s t a t e d e a l s ( P EA-Amari ) , i n fra s t r u c t u r e

continuity i n p o l i c i e s . S i n c e t h e Ramos administration had b e e n singu­

p r o j e c t s ( C B K - I mp s a) a n d e q u i p m e n t p u r c h a s e s ( M o t o r o l a d e a l w i t h

larly s u c c e s s ful i n reviving and sustaining economic growth, i t was fel t

t h e n a t i o n al p o l i c e ) . Furthermore, as a l r e a d y d i s c u s s e d , the a c t u a l o r

by some t h a t it should b e given a chance to continue i t s policies rather

p o ssible corruption attending s u c h transactions makes them vulnerable

than risk change. A variation o n this proposal is the adoption o f a long­

t o d e l ays , c o s t e s c al a ti o n s , o r o u t right c a n c e l l a t i o n by a s u c c e e d i n g

standing proposal to shift to a p arliamentary system, who s e main merit

administrati on, a l l o f which i n turn a r e factored i n t o future d e c i s i o n s .

is seen i n the continuity it allows, since n o statutory term limits are set

I n the l o n g run, the d e m o nstrable s o cial c o s t s arising fro m s u c h a

for a prime minister.24 Moves to amend the charter i n 1 99 7 were aborted

situation are bound to raise calls for a reevaluation of the process, if not

aft e r s t r o n g o p p o s i t i o n by a c ro s s - s e c t i o n o f the p o p U l a t i o n , who r e ­

the system itself. Quite apart fro m the s o cial c o s t s o f such a process, a

garde d the i n i tiatives ( n o t with o u t r e a s o n ) as s el f- s e rving a t t e m p t s o f

strong Executive Branch also creates incentives for current o fficeholders

politicians to extend their tenure. I t d i d n o t help that, in a n obvious case

to p ro l o n g the i r t e r m s o u t of pure s e l f- i n t e r e s t . T h e c r i t i c i s m of t e rm

o f l o gr o l l i n g , i . e . , p o l itical horse trading, the a m e n d m e n t s would a l s o

limits under the current system is summed up in the now- p o p ular adage

have extended t h e terms o f lawmakers w h o would pass on t h e m . N o n e ­

that " s ix years i s too short fo r a good pre s i d e n t and too long fo r a bad

theless, term l i m i t s a n d succession a r e deep structural i s s u e s t h a t refuse

o n e . " The demand fo r turnover ari s e s fro m the danger o f capture and

to go away. The a d m i n i s trati o n of Pre s i d e n t J o s e p h E s trada d e c l a r e d

c o n s e q u e n t b i a s , on w h i c h a c c o u n t o n e w o u l d w i s h fo r r e c al l t o be

itself o p e n to the idea of constitutional change and h a d created a co m ­

possible or for term limits to b e short. Doing the latter, however, would

mission t o recommend amendments for the purp o s e . The Lower House

compromise the s c o p e fo r action and c o ntinuity o f p o licy if the offi c e ­

of Congre s s had, in the meantime, c ontinued to work on a bill to declare

h o l d e r hap p e n e d t o b e exe mpl ary.

Congress a constituent assembly to propose constitutional amendments. I n b o th i n s t a n c e s term limits were certain to l o o m large as an i s s u e .

I mplications for Governance Design

F r o m t h e viewp o i n t o f this c h ap t e r 's an alys i s , re c e n t p o l i t i c a l d e ­

Since the elections of 1 99 2 , political thought and practice have gro p e d ,

b a t e s o n the i s s u e o f term l i m i t s i n the P h i l i p p i n e s a r e u n fo r t u n a t e l y

a l b e i t imperfectly, to s e e k to amelio rate the problem o f succession a n d

b ased o n p l ausibl e but incomplete premises.2s Those o p p o s e d t o c h a n ges

intertemporal credibility of commitment u n d e r t h e existing system. Chief

in p r e s e n t t e r m l i m i t s view t h e p r o b l e m as s i m p l y o n e o f p reve n t i n g a

among this has b e e n t h e p r a c t i c e o f the i n c u m b e n t " a n o i n t i n g " o r of

relapse into d i c t atorship and t h e risk of extreme bias that it e n t ai l s . This

handpicking the p utative s u c c e s s o r, as practiced by Coraz6n Aquino, who

is certainly i nadequate, h o wever, since i t denies o r m i n i m izes t h e p ro b -

1 22

1 23

...

Centralization, Political Turnover, and Investment in the Philippines

Centralizatio n, Political Turnover, and Investm ent in the Philippines

lem of instability and credible commitment under the current system. At

p olicy c o n tinuity and consistenc y, n o twithstand ing frequ ent changes in a d m i n i s t r a t io n . In t h e P h i l i p p i n e s t h e b u r e a u cracy i s u n d e r p a i d and

the very least, a trade - o ff b etwee n the two must be acknowledged. O n t h e other hand, those w h o appear co rrectly to perceive t h e problem o f instability, o r what w e h ave called credible commitment, s e e k implicitly t o s olve i t not by q u e s t i o n i n g the importance o f s t r o n g c e ntral p ower, but instead working s olely for the suspension or extension of term l i m ­ its . I n neither case i s the current state o f power concentrated i n the p r e s i d e n cy q u e s ti o n e d . B y c o n tr a s t , o u r framewo rk p o i n t s t o s t r o n g c e ntralizatio n i t s e l f as an e s s e n t i al r e a s o n fo r i n t e rregime u n c e rtainty a n d i n s t a b i l i ty. T h e c o n c e n t r at i o n of p ower i n t h e p r e s i d e n cy in t h e Philippines is what makes even p redetermined turnovers unsettling a n d fraught w i t h uncertainty. An alternative p r o p o s al t o interregime uncer­ t a i nty, t h e re fore, i s t h a t o f weake n i n g p r e s i d e n ti a l p ower. Put another way, i f presidential discretion and p ower were much redu c e d , then the issue o f term limits would c o mmand much weaker i n t e r e s t . A weakened presidency, to b e sure, carries its o w n consequences. A s

d e fi c i e n t i n t r a i n i n g a n d q u a l i fi c a ti o n s , making i t vu l n e rabl e b o th to patronage politics a n d corruption. I t i s c o m m o n practice in the country fo r winning candidates to treat gove r n m e n t ap p o intment s as s p o i l s to

b e distributed. While personnel changes in other countries of the regio n extend to two levels , involving those of secretary and undersec retary o r their equival e n t s , p olitical a p p o i n t e e s i n the Philip p i n e s fre q u e ntly go down to six levels, affecting p o s itions as far as those of regional director and service director ( World B ank 1 997c, 93) . It is common that upon every change in administrati o n , new appointees go through a l e arning period, while the bureaucracy itself i s c o n s trained to abandon projects a s s o c i ­ ated w i t h t h e p revi o u s administration and p erforce c o n c o c t n e w o n e s m o r e i n k e e p i n g w i t h the t a s t e s o f the i n c u m b e n t Y Security o f tenure, higher p ay, and b e t t e r training would go a long way toward i m provin g t h e bureaucracy's a u t o n o m y a n d also e n s u r i n g p olicy c o n t i n u i ty.

already o b serve d , c e ntral p ower emerged also i n res p o ns e to the "com­

Similarly, a further devolution of central p owers to local governments

mons" problem. Nonetheless, as again s t insisting o n extending term lim­

would reduce the importance of the outcomes of national contests, since

i t s , reducing central p ower has the advantage o f n o t raising the s t akes

it would remove sole discretion fro m n a t i o n al agencies and vest these

o f state capture and the risks of extreme bias. As seen fro m the resistance

instead to local governments . Local devolution is a process that began in

t o the Marcos dictatorship as well as the Ramos administration's failed

1 99 1 with the p assage of the Local Government Code and may usefully be

attempt to amend the charter, all past efforts to increase central p ower

carried further. It may b e argued, o f course, that devolution merely shifts

and l e n g t h e n term l i m i t s h ave invariably l e d t o s e r i o u s p r o b l e m s o f

discretion fro m o n e l evel o f the government to ano ther, and that local

legitimizatio n , provoked d e e p s u s p i c i o n , a n d generated massive s o c i al

tyrants and warlords o n their own turf may treat investors more arbitrarily

o p p o s it i o n . It is vali d to ask whether the s o cial c o s t s and goo dwill i n ­

than a national dictator would. The b i g difference lies in that investors

curred i n s u c h efforts can b e reaso nably recouped by t h e putative b e n ­

under a decentralized regime would have choices among different loca­

e fi t s o f the c h a n g e s e n d o r s e d . I n d e e d , i t i s l i kely t h a t t h e o p p o s it i o n

t i o n s and regime s , e ffectively achievi n g a c o m p e titive regi m e . I n such

p rovoked by such effo rts could themselves lead to the uncertainty and

circumstances, it is known (again, Shleifer and Vishny 1 993) that rents and

inve s t m e n t instab i l i ty they had s o ught to avo i d .

exactions tend to be small, as different local governments compete with

I t i s submitted h e r e i n s t e a d t h a t credible c o m m i t m e n t to p o l i c i e s

each other for investments. Where authority i s redundant or replicab l e

would b e b e s t a c h i e v e d if i n c u m b e n t s p r o g r e s sively a n d irreve r s i b l y re d u c e d t h e i r o w n s c o p e fo r d i s c r e t i o n ary b e h avior, s i n c e t h a t woul d

(rather than monopolized) corruption rents are minimized, for i f the privi ­ ' lege ( e . g . , some license or incentive) cannot be obtained from o n e loca­

also re duce their s u c c e s s o r s ' l eeway fo r reversing such p o l i c i e s . This i s one way to understand how p rivatization a n d deregulation work in stim u ­ cr; lating business confidence; these a r e commitments to reduce discretio n .

tion, then it may b e obtained from another.

As a corollary, a weaker presid ency would imply the devolutio n of more fu nctions to other p arts o f the government, n o tably the burea u ­ c racy a n d local governments. An imp o rtant reason fo r p o licy instabilit y

This insight may be extended to the global setting. To the extent that a country i s compelled to compete for trade and investment o n an equal fo oting with others, there is much less room fo r national authorities to exercise discretion in changing the rules o f the game, whether within o r acro s s regi m e s , since the country must e ffectively compete w i t h others

across regimes is the turnover- related changes in appointment s . Stab i l ­ i t y o f t e n u r e up t o a c e rt a i n level o f t h e gove r n m e n t w o u l d p rovi d e

m e n t s t o g l o b a l t r a d e a n d inve s t m e n t rul e s , t h e l e s s the s c o p e fo r i t s

1 24

1 25

o ffe r i n g similar terms. As an u p s h o t , the gre a t e r a c o u n try's c o m m i t ­

Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Philippines

leaders (no m atter how powerful they are internally) to arbitrarily change

on the effects of power concentration and differentiation , in parti cular results obtained by Persson, Roland, and Tabellini ( 1 99 7 ) . For these aut h o r s th e

these, since doing s o would mean losing the business. One o f the rec­ ognized b e n e fits o f m e m b e rship in such multilate ral o rganizatio n s as the World Trade O rganization ( WTO) , the Association of Southeast Asian Nations (ASEAN ) . or Asia Pacific Economic C o o p eration (APEC) is that it b i n d s c o u ntries-re gardl e s s o f changes in p olitical regimes-to c e r ­ tain rules a n d norms o f conduct. Though their results a r e likely to b e i n greater dispute, l o a n conditions imposed b y t h e International Monetary Fund and the Wo rld Bank s e rve the same functi o n . As a c o n c rete ex­ ample, compatibility with WIO rules has become an important deterrent t o o t h e rwise resurgent p r o t e c t i o n i s m ; att e m p t s t o reimp o s e n o ntariff

crucial elements for checks and balances are that ( l ) there shou ld be som e adversarial relationship between the executive and the l e g i s l ature. and that (2) legislative decision making should require j oint agreeme nt bv both

;

bodies. Mere separation of p owers without the second require mer t sim­ ply leads to unbridled rent - s eeking, which is analogous to Shl e i fe r a n d Vishny's independent-monopolists result, where b o t h executive and leg­ islature seek to draw as much as they can from the "common p o o l " of public resources. Superior to this is a more centralized or authoritarian system (which Pers s o n , Roland, and Tab ellini call a "pure p res i d e n t i al "

m e asures on s o m e p r o ducts h ave b e e n withdrawn fo r b e i n g WTO - i n ­

system witho u t Co ngre s s ) , since then, at least, the rent - s eeking is n o t

c onsistent. I n effect, therefore, governments may choose t o reduce their

competitive a n d is tempered by t h e desire to remain in office. N everthe ­

discretionary p ower by entering into glo b al commitments; in this way they also bind their s u c c e s s o r s , thus ensuring p olicy stability. Finally, even Congress itself could do with s o m e strengthening rela­ tive to the presidency. This m ay seem initially surprising, since folk wis ­ dom already predicates that Congress has b e e n too intrusive a n d obstruc­ tionist, and sufficient examples exist of shortsighted and inept intervention on the part of Congress.28 A proposal to expand these p owers relative to the Executive Branch may only worsen the situation of overlapping man­ dates and gridlock. As argued above, however, the currently observed " ir­ responsibility" by other branches of government is more likely p art of an expectational equilibrium, which precludes more rational behavior owing

less, it c a n be shown that even better than a "pure presidential" system is one where power is separated and checks and balances exist. The present system in the Philippines is somewhere in b etween a "pure presidential " sys t e m a n d o n e with g e n u i n e c h e ck s a n d b a l a n c e s , alth o u gh t h e trivialization of the legislature and its control by the Executive Branch makes the current system closer to the former than the latter. What is certainly important in the foregoing, however, is the suggestion that better economi

�

results may be obtained by taking the design of democratic institutions more seriously, rather than simply abandoning them. Conclusion

to the assurance that the o mnipotent presidency itself will always internal­

This chapter has argued that Philippine governance is at a crossroads

ize difficulties and repair any damage . The fact that the chief executive

in its impact o n economic performance. The polity has shirked fro m fur ­

c ontrols budgetary disbursements regardless of what Congress has all o ­

ther c o s tly exp eriments with dictatorship and instituted clear r u l e s fo r

cated, for instance , makes i t futile for Congress to assume any responsi­

turnover and succession, as well as controls on discretionary behavio r. On

bility in the magnitude of expenditures , or in the revenues needed to fi ­

the other hand, in recognition of the dangers of policy gridlock and dou b l e ­

nance them. It is arguable that the current expectational equilibrium would

marginalizatio n , a s t r o n g central autho rity wi t h i n d e m o c ratic li m i t s i s

change once the other branches of government realized that their choices

provided for. Based on the framework developed here , it is clear that such

a l o n e would d e c i d e final o u t c o m e s . H el p i n g this along i s a gradually

a halfway house is unlikely to yield spectacular economic resul t s . Hel ativc

changing composition o f Congress, which now sees an increasing share

to a well- run authoritarian government, the system is likely to extract m or e

of professionals, former civil servants , and new entrepreneurs.29 Nor is this

corruption rents and generate greater policy i nstability amo n g investors.

experience new; it is the same one that compels more and more local

In addition, policy instability and investment costs across regimes are also

officials to show prudent behavior once central functions and resources are devolved to them. It is in this sense that we argue that a weaker presi­ dency may make fo r a stronger state . The demand for a more balanced relationship between the Executive B ranch and the legislature is also consistent with recent game- theory work 1 26

likely to be greater than those of a " n o rmally fu ncti o n ing" authoritarian regime, owing to the infrequency of turnover in the latter. Current discussions retlect the perceived tension hetvve en a social and cultural commitment to democratic forms on the one hand and the need to enhance economic perfo rmance on the other. In most natio nal discus1 27

r Centralization, Political Turnover, and Investment in the Philippines

Centralization, Political Turnover, and Investment in the Philippines

sions, the latter has been taken to mean a greater enhancement of central

p art of authoritarian regimes that created the opportunities for large gambles

p ower at the expense of other branches and levels of government, as well

(like investment i n strategic industries o r dis criminatio n i n favor o f or

as indefinite term limits fo r the executive. Not surprisingly, these ideas

against certain groups) also carried the potential for enormous waste. When

have been taken to mean an endorsement of authoritarianism. We have

large mistakes were made in the form of sectoral overinvestment or social

suggested, h owever, that the p erceive d risk of extrem e bias in these o r

and economic discrimination, they laid the basis for social conflicts . Cen­

similar prop o s als make a n y further moves toward authoritarianism n o n ­

tralization and indefinite tenure, therefore, created the p otential for both

viable in t h e Philip p in e s . A n y s u c h moves would likely lead to crises of

huge successes and colossal mistakes. It is the Philippines' misfortune (or

legitimacy and an intensification of interest-based p olitical struggles, lead­

luck, depending o n how one views it) that it has avoided both.

ing to more erratic p rivate investment behavio r. Instead, we have sug­ gested that the problems of inter- and intraregime uncertainty b e d e alt with by reducing p r e s i d e ntial p owers and prero gative through a more determined devolution of executive p ower to the bureaucracy, lo cal gov­

APPENDIX A MODELAND TEST OF INVESTMENTWITH POLITICAL UNCERTAINTY

ernments, Congress, the courts, and accession to multilateral agreements .

1 . Model. Suppose the price of one unit of investment goods is

PI '

and

A final word is p erhap s in order regarding the country's relative p er­

the marginal unit of investment is exp ected to generate Q units of output.

fo rmance in the Asian crisis. The Philippines has n o t b e e n as b adly af­

Assume that Q is declining in the level of investment. For simplicity, let Q

fected as Thailand or Indonesia, and it may be asked whether the model

=

Z/lb, where b is a positive p arameter and Z represents the factors that

presented here can contribute something to an explanation. The technical

affect the profitability of investment, such as future national income, ex­

reasons for the weaker impact of the Asian crisis are certainly well known,

pected government policy, terms of trade movements, etc. Suppose inves­

including the country's s m aller debt- overhang, the shorter run-up to the

tors face an infinite horizon of discrete periods. I n each p eriod there is a

crisis, and better supervision of financial institutions. A more crucial ele­

probability p of losing the returns on investment due to p olitical factors .

ment that should be taken into account, however, is that the country-in

Let the discount rate (excluding p olitical risk) be

co ntrast especially with In do n esia-did not exp erience a p o litical crisi s .

rate b e

8.

The obvious difference w a s that in t h e Philippines, unlike i n Indonesia, there was a prescribed electoral turnover, which in fact coincided with the

TC

( l -p ) Q ( l + r)

bottom of the crisis in 1 99 8 . The severe impact of the Asian crisis certainly p uts the adequacy and relevance of a country's institutions and system of entitle ments under scrutiny. It is an arguable propo sition that the crisis

( l + r) ( l-p )

would have affected the Philippines more severely, ceteris paribus, if the

--

c o untry had continued to b e under the Marcos dictatorship. As it hap ­ pened, however, a p o litical crisis was headed off, since the country had, by that time, solved the p roblem of bias and legitimacy through the insti­

If

8

TC

ippines have occurred that suggest that it will henceforth be able to grow at rates shown in the past by high- performing East Asian countries. I nvest­ ment costs are likely to remain as high (and therefore investment just as low) , owing to corruption rents and inter- and intraregime uncertainty. As a corollary, it mllst be said that the same relative freedom of action on the 1 28

( l -8 ) ( l -p J 2 Q + -------'---'-

+

(1)

...

Q -

(1 8) -

( l -p ) Q

(2)

( r+p )

fo restalled a political crisis fo r the Philippines may also prevent it fro m recovering rapidly fro m t h e crisis. N o changes in governance in t h e Phil­

and the depreciation

i s small eno ug h, ( 1 ) may b e a p p roximated by

tuti o n of elections, providing a vent for any p o p ular dissatisfaction. The framework used here also suggests that the same institutions that

r

The total expected return to the marginal unit of investment is:

I f the interest rate i s m arkets would be

iP/ r.

i,

the p r e s e n t value o f placing

PI

i n financial

In equilibrium, therefore, we must have

TC

=

iP/ r.

C o m b i n i n g this with ( 2 ) and s u b s tituting fo r Q yields blog I

=

log Z

-

log

PI 1 29

log i

+

r ( l -p ) ( r-p )

l o g --

(3)

Centralization, Political Turnover, and Investment in the Philippines

The last term shows investment being inversely related to p o l itical

CHAPTER S IX

risk. Proxies for the first term are such variables as expected GDP growth, exp ected government p olicy in response to current budget d eficit and inflation, exp ected balance of p ayments o r current account condition, and expected terms of trade. We do not have the data for i, but omission o f this variable should not affe ct the estimated c o e fficient o f p o litical risk, since the inclusion of the budget deficit and inflation in the model should control for the interest rate.

G OVERNANCE, RENT - SEEKING, AND PRIVATE INVESTMENT IN MALAYSIA

2. Empirical test. F o r the investment variable, we take to tal invest­

lorna K S.

ment a s a p e rcentage o f GDP over t h e p e r i o d 1 9 5 1 t o 1 9 9 2 . We are unfo rtunately unable to obtain a sufficiently long time s e ries of p rivate investment alone; hence, we resorted to running regressions of compo­ n e n t s o f i n ve s t m e n t ( ag a i n , a s s h a r e s o f G D P) . that might c l o s e l y a p p roximate p rivate i n ve s t m e n t . T h e s e i n c l u d e p rivate c o n s t r u c ti o n spending a n d investment i n durable equipment. We also tried the sum o f these two as a p roxy. To isolate the impact o n investment of a preelection year dummy, whi c h was o u r m a i n i n t e r e s t , the following variab l e s were r e g re s s e d against to tal investment o r c o m p onents o f i t , as a p r o p o rtion o f G D P : government deficit, accumulated current account d e ficits ( a p roxy for fo reign i n d e b t e d n e s s) . current acco u n t d e fi c i t lagged o n e p e r i o d , the terms of trade, the price of investment goods, and p roj ected GDP growth. Tables 1 and 2 in the text show typical results of regressions for three investment variables (total investment, p rivate construction, and p rivate c o nstruction plus durable e q u i p m e nt) . I n fl atio n , the index fo r inve s t ­ ment g o o d s p r i c e s , a n d p redicted GDP growth a r e generally significant with the right signs . I n other regressions (not included h ere) the other variables also generally have the expected signs, and the regressions are highly significant. M o re important for our purp o s e s , the coefficient of the preelection year dummy is significant and negative for total investment and private construction , though not quite so for equipment. (It is significant, though, fo r p rivate construction and durable equipment taken together.) M o s t time s e ries included in the model a r e AR ( l ) . and n o n e has a u n i t r o o t . I n c l u d i n g an autoregre s s ive t e r m i n the regre s s i o n s i s natural s i n c e investment is serially c o rrelated-investment projects t a k e time to b e c o m p l e t e d and u s u ally s p a n o v e r a few years ) . U s i n g th e Q - t e s t , t h e s e rial c o rrelation o f r e s i d u a l s is n o t signifi c a n t .

This chapter considers governance, rent - seeking, and p rivate invest­ ment in M al aysia fro m the late c o l o n i al p e r i o d , i . e . , b e gi n n i n g i n the e arly 1 9 5 0 s , and fo cuses on the p e r i o d s s i n c e the introrluction of the New Economic Policy (NEP) in the early 1 970s and the gradual "retreat" fro m i t s i n c e the m id - 1 9 8 0 s . It s u rveys the i n s t i t u t i o n al evo l u t i o n o f p o stcolonial economic governance in M al aysi a a n d its implications fo r investment and growth, p articularly noting the changes under the lead­ ership o f Prime M in i s t e r M ahathir M ohamad since the 1 9 8 0 s . I t then reas s e s s e s h o w the creation o f rents a n d their d e p l oyment under the New E c o n o m i c P o l i c y ( 1 9 7 1 - 1 9 9 0 ) and u n d e r M ah a t h i r's l e ad e r s h i p ( l 9 8 1 -p r e s e nt) h ave b e e n primarily oriented toward interethnic redis­ tributi o n , b u t h ave also s o ught to s u s t a i n investment and growt h . I n particular, it shows how Mahathir's p olicy reforms have sought to mini­ mize the apparent incompatibility between these two obj ectives. Finally, it c o n s i d e r s h o w t h e s e i n s t i t u t i o n s o f r e n t c r e a t i o n a n d rent - s e e king affected and continue to affect M alaysia's vulnerability to the East Asian crises since mid - 1 9 9 7 . The Postwar Economy i n a Nutshell

In the p o s t - S e c o n d Wo rld War p e r i o d , Malays i a exp e r i e n c e d rela­ tively rap i d growth , particularly during the Ko rean War b o o m , the oil boom of the 1 9 70s and the relocation o f East Asian industry into South­ east Asia and China since the late 1 9 8 0 s . Since 1 9 5 5 , the s a m e ruling coalition has been continuously in p ower at the dominant federal level. though the nature a n d degree o f state i n t e rv e n t i o n and p u b l i c - se c t o r

1 30

13 1

I

,

n.,

!;

!

Governance, Rent- Seeking, and Private I nvestment in M alaysia

Governance, Ren t - Seeking, a n d Private I nvestment in Malaysia

e xp a n s i o n had c h a n g e d c o n s i d e rably, almo s t c o m i n g full circle by t h e

then M al aysi a n e c o n omy sustain e d high growth with low inflation u n t i l

m i d - 1 9 9 0 s fro m t h e s i t u at i o n fo llowing i n d e p e n d e n c e i n 1 9 5 7 .

t h e e arly 1 9 7 0 s . T h e ave rage an n u al growth rate of the gro s s d o m e s t i c

M al aya, a n d t h e n M al ays ia, achieved i m p r e s s ive growth rat e s , c o n ­

p r o d u c t ( G D P ) i n p e n i n s u l a r M a l ays i a was 5 . 8 p e r c e n t d u r i n g 1 9 5 7 -

s i d e rable i n frastructure development, some e c o n o m i c d iversification (see

1 9 7 0 ( Hao 1 9 7 6 ) , whi l e t h e G D P fo r t h e wh o l e of M a l ay s i a r o s e by a n

figure 1 ) i n agriculture a n d i n d u st ry, imp roved s o c i al s e rv i c e s , amo n g

average o f 7 . 8 p e rc e n t p e r year b e twe e n 1 9 7 1 and 1 9 80 d e s p i t e greater

o t h e r s , after i n d e p e n d e n c e a n d particularly d u r i n g t h e 1 9 6 0 s . Plan n i n g

i n s t a b i l i ty ( M al ay s i a 1 9 8 1 ) . M a l ays i a's e c o n o my has grown r a p i d l y by

h a s a l s o g r o w n i n s o p h i s t i c at i o n , i n t e r m s o f i n fo r m a t i o n g a th e r i n g ,

i n t e r n a ti o n al s t a n d a r d s , with gro s s d o m e s t i c p r o d u c t ( G D P ) ave ragi n g

prep arati o n , a n d implementat i o n , especial ly with t h e growth of t h e public

about 7 p er c e n t over t h e last three d e c a d e s . After exp e r i e n c i n g u n p r e c ­

sector and increas i n g state i n t e rve n t i o n u n d e r the NEP The p o litical and

e d e n t e d n e g a t i v e g r o w t h i n 1 9 8 5 , d u e t o d e fl a t i o n a r y p o l i c i e s i n

e c o n o mic i nterests o f the d o m i n a n t p o l i tical interests h ave b e e n largely

re s p o n s e t o fis c al a n d d e b t c r i s e s a s w e l l a s t h e c o l l ap s e o f p r i c e s o f

reflected a n d fu rth e r e d by deve l o p m e n t p o l i c i e s . D evelop m e n t p o l i c i e s ,

s everal key c o m m o d i ty e xp o rt s , t h e M al ays i a n e c o n o my h a s s u s t a i n e d

p l a n all o c a t i o n s as w e l l as i m p l e m e n t a t i o n h ave r e fl e c t e d t h e n a t u r e ,

rapi d e xp a n s i o n s i n c e 1 9 8 7 . M eanwh i l e , i n fl a t i o n has b e e n brought down

r o l e , a n d o r i e n ta t i o n of t h e s t a t e , t h e d o m i n a n t p o li t i c ally i n flu e n ti a l

below 5 p e r c e n t per a n n u m .

b u s i n e s s i n t e r e s t s as w e l l as t h e i r p o l it i c al a n d e c o n o m i c p r i o ri t ie s .

M al aysi a has exp erienced g e n e rally favo rable external circumstances alth o u gh r ub b e r p r i c e s d e cl i n e d in t h e 1 9 6 0 s c o m p a r e d t o t h e 1 9 5 0 s . E xt e r n al c o n d i t i o n s w e r e g e n e ra l l y favo r a b l e d u r i n g t h e 1 9 7 0 s . T h e overall b al a n c e o f p aym e n ts ( fo r b o th c a p i tal a n d curren t accounts) was

Figure 1 G D P Shares by Sector i n Malaysia, 1 96 0- 1 9 9 5

p o s i tive t h r o u g h o u t t h e d e c a d e , d e s p i t e a n o i l - s h o c k - i n d u c e d r e c e s ­ s i o n i n 1 9 73- 1 9 7 4 . During this period, the p r i n c i p al exp ort c o m m o d i t i e s were r u b b e r, t i n , s avv e d l o g s , p al m o i l , a n d p e t r o l e u m . P r i m ary c o m ­ m o d i t i e s a c c o u n t e d fo r 7 8 p e r c e n t o f t o t a l exports i n 1 9 7 0 a n d fo r 7 1 p e r c e n t i n 1 9 8 0 , b e fore d e c l i n i n g to 5 5 p e r c e n t i n 1 9 85 a n d 1 5 . 9 p ercent in 1 9 9 6 . S i n c e the 1 9 8 0 s , t h e ranking o f p r i mary c o m m o d i t i e s i n t e r m s o f c o n t r i b u t i o n to e x p o r t e a rn i n gs has b e e n p etroleum a n d g a s , t i m b e r ( s awed l o gs a n d s awed timber) , palm o i l , a n d r u b b e r ( t h e o r d e r m i gh t h ave b e e n t e m p o rarily tra n s p o s e d i n e xc e p t i o n a l years , e . g . , w i t h t h e collap s e o f p al m oil o r p etroleum p ri c e s ) . The exp ort orientation o f t h e M a l ay s i a n e c o n o m y s i n c e t h e l a t e 1 9 6 0 s h a s b e e n s u s t a i n e d b y M alaysi a's n e w i n d u s t r i e s that are largely e xp o r t - o r i e n t e d . Prima ry c o m m o dity p r o d u c t i o n c o n t i n u e d to d o m i n at e t h e e co n o m y i n t h e e a rly y e a r s aft e r i n d e p e n d e n c e . I n fa c t , M a lays i a e x t e n d e d i t s 1 960

_

1 965

Agriculture

1 970

1 980

1 975

1 985

Manufacturing

_ Mining

1 990

1 995

Services

c o l o n ial p r e e m i n e n c e i n r u b b e r, t i n , and p e p p e r t o p a l m o i l and t r o p i ­ cal h a r d wo o d s . P e t r o l e u m grew fr o m t h e m i d - 1 9 7 0 s , a n d p e t r o l e u m g as as well as c o c o a p r o d u c t i o n b e c am e i n c r e a s i n g l y s i g n i fi c a n t fro m the e a rly 1 9 8 0 5 . Agriculture 's share of G D P has fal l e n fro m 3 1 p e rc e n t

, the Aft e r i n d e p e n d e n c e i n 1 9 5 7 , a n d i n p a r t i c u l a r fro m t h e 1 9 6 0 s pillar s o f M a l ay s i a n e c o n omy d ive rsifi e d fro m rub b e r a n d t i n , the tw i n so m e the colonial e c o n o my. H e l p e d by favo rab l e c o m m o d ity p r i c e s and

i n 1 9 7 0 to 13 p e rc e n t i n 1 9 9 6 , wh i l e m a n u fac t ur i n g 's s h a r e h a s r i s e n fr o m 1 2 p e rcent i n 1 9 70 to 3 5 p e rcent i n 1 9 9 6 . E c o n o m i c l i b e r a l i z a t i o n

a n d r e n ew e d exp o rt - l e d g r o w t h fro m t h e m i d - 1 9 8 0 s h a v e a l s o ac c e n ­ tuat e d t h e o p e n n e s s o f M al ay s i a's e c o n o m y i n re c e n t y e a r s . W h i l e t h e

an d early s u c c e s s in i m p o r t - s u b st i t u t i n g i n d u s t r i a l i z at i o n , t h e M al ayan

e c o n o my h a s l o n g b e e n o p e n , t h e r a t i o o f e x p o r t s t o G N P h a s r i s e n

132

1 33

Governance, Rent- Seeking, and Private Investment in M alaysia

fro m 43 p e r c e n t in 1 9 7 0 to 60 p e r c e n t in 1 9 85 and 82 p ercent in 1 99 6 . M e anwh i l e , t h e e x p o r t s h a r e o f p r i m ary c o m m o d i t i e s h a s fal l e n fro m

Governance, Rent- Seeking, and Private Investment in M alaysia Growing State Intervention (Razak, 1 969- 1 9 76; Huss ein, 1 9 76- 1 98 1 ; Mahathir, 1 98 1 - 1 985)

7 8 p e rc e n t in 1 9 7 0 t o 1 6 percent in 1 99 6 , with manufacture s ' share ris­

I n the 1 970s, the New Economic Policy (NEP) involved increased state

i n g fro m 12 p e r c e n t t o 8 1 p e r c e n t over t h e same time p e r i o d (Bank

intervention and public sector expansion (increasingly financed by p etro ­

Negara Malaysia A n n ual Report, March 2 00 1 ) .

leum revenues) , e s p ecially for interethnic redistribution. From the m i d 1 970s, some NEP measures deterred p rivate investment by ethnic Chinese

I nvestment P o licies

M alaysian economic d evelopment has been shaped by the nature of

as well as F D I . The NEP thus saw the state c a p turing, all o c a t i n g , and deploying rents for its redistributive goals. M eanwhile, the government's

the ruling regimes and t h e i r r e s p ective agendas fo r n a t i o n al e c o n o mi c

new exp o rt- oriented i ndustrialization policy, mainly involving new p o l i ­

d evelo p m e n t . T h e colonial period i s d e p i c t e d as o n e o f laissez-faire, al­

c i e s a n d incentives ( L e . , access to n e w rents) attracted FDI. I n t h e e arly and

t h o u gh there i s e v i d e n c e of c o n s i d e ra b l e bias in favo r o f B ri t i s h

mid - 1 980s, the government- sponsored joint ventures with Japan e s e firms

inve s t m e n t s-again s t o t h e r foreign as well as d o m e s ti c ( e s p e c i ally Chi­

to deve l o p h eavy industries in the fac e of declining p rivate investment

nese) investments-particularly in determining access to that crucial asset

fro m the mid - 1 970s. Though the NEP was widely s e e n as predatory and

of a colonial economy built o n the production and export o f rubber and

exc l u s i o nary of the mainly S i n o - M al a ys i a n b u s i n e s s e s in the n a t i o n a l

tin, namely, land. All regime policies envisaged or at least implied different

economy, F D I continued to b e encouraged-partly for countervailing rea­

sources of and roles fo r public as well as p rivate investment, including

s o n s , e s p e cially for the relatively insulated, internationally c o m pe titive

fo reign direct investment ( F D I ) . Since M alaya attai n e d independence in

exp o rt - o riented e nclaves , such as fre e trade zones ( FTZs) .

1 95 7 , i t seems useful t o distinguish three different p o s tcolo nial regimes wit h different d evelo p m e n t priorities as well as attitudes toward p rivate

Partial D eregulation and New Regulation (Mahathir, 1 986-present)

investments, which in turn affected the nature and consequences of access

Ringgit depreciation and p artial e c o nomic deregulation fro m the mid-

to rents. This outline i s followed by a more extensive review that seeks t o

1 980s were accompanied by p rivatizat i o n , improved o fficial sup p o rt for

highlight the significant changes in t h e postcolonial e r a .

the p rivate s e c t o r ( " M alaysi a I n c o r p o rate d " ) , i n c r e a s e d inve s t m e n t i n ­

P o s tcolonial Economic D iversification

that e n c o uraged p rivate inve s t m e n t s . The more attractive b u s i n e s s e n ­

( Tu nku Abdul Rahman, 1 9 5 7- 1 969)

vir o n m e n t , i n c l u d i n g a n e w range o f i n ve s t m e n t i n c entive s , attract e d

centive s , regres s ive "supply side- oriented" tax reforms a n d o t h e r p olicies

The c o n s e rvative p o s t c o l o nial Alliance gove r n m e n t was c o n c erned

F D I fro m J a p a n a n d o t h e r E a s t A s i a n n ewly i n d u s trializing c o u n t r i e s

with checking B ritish capital dive s t m e n t in the fac e o f the uncertainti e s

( N I C s ) fro m the l a t e 1 980s as w e l l as greater d o mestic (including r e p a ­

o f i n d e p e n d e n ce as well as t h e o n g o i n g " e m e rgency" again s t the c o m ­

triated) p rivate investments. The government also s ought to a c c e l e rate

m u n i s t - l e d i n s u r g e n cy. Aft e r i n d e p e n d e n c e , l a is s e z - faire p o l i c i e s were

t e c h n o l o gical d e ve l o p m e n t besides c o n tributing t o the s u s t a i n e d e c o ­

s t i l l g e n e rally p u r s u e d with s o m e e ffo r t s at e c o n o m i c ( i n c l u d i n g agri ­

nomic b o o m o f t h e last decade. O n c e again , a n e w regime d e fining the

cultural and industrial) diversification, greater rural development effo rts

conditions for access t o rents (known as i n c e ntive s ) has been a crucial

a n d r e l a t i vely m o d e s t but n o n e t h e l e s s growi n g ethnic "affirmative a c ­

instrument of industrial policy, as in the two earlier p ostcolonial periods

t i o n " p o l i c i e s i n favor o f e t h n i c M al ays and o t h e r i n d i g e n o u s p e o p l e s ( B u m i p u t e ra) . New i n ve s t m e n t i n c e n t ives were o ffered to " p i o n e e r i n ­

identified above . Figure 2 s hows the GDP and p e r capita GDP p e r c e n t ­ age c h a n g e s c o rr e s p o n ding with t h e a b o v e p eriodizat i o n .

d u s t r i e s " i n l i n e w i t h t h e g o ve r n m e n t 's " m i l d " i m p o r t - s u b s t i t u t i n g i n dustri alization, wh ich d i d n o t invo lve much p u b l i c s e c t o r i nvestm ent ,

C o l onial H eritage

unlike the experi e n c e of " in termediate" regimes in o t h e r parts of So uth­ e a s t A s i a . Va r i o u s gove r n m e n t i n t e rv e n t i o n s thus c r e a t e d re n t s t h a t

t o ry h a s b e e n shaped by d evelopments of t h e colonial era. T h e colonial

Like so many o t h e r

fo r m e r c o l o n i e s , p o s t c o lo n ial M alays i a n h i s ­

s e rv e d a s i n c e n t i v e s t o a t t r a c t i nv e s t m e n t s t h a t w o u l d r e s u l t i n e c o ­

a u t h o r i t i e s i n t r o d u c e d the b asic gove r n a n c e framework within which

n o m i c dive r s i fi c a t i o n .

the M alays i a n e c o n o my continues to fun c t i o n . Hence, M alays ian e c o 1 34

135

�

Governance, Rent - Seeking, and Private Investment in M alaysia

. Governance, Ren t - Seeking, and Private I nvestme nt in M al aysla

Figure 2 Real Per Capita GDP and Annual GDP Growth Rates in M alaysia,

M al ay s i a's e c o n o m i c i n frastructure, s u c h as railw ays ro a d s , POrts, . l' pro fitable capitalist investment-was gen er all y · CruCI' al lor u til lties-so

1 9 60- 1 9 9 5

i RM

'

mo re

%

( 1 978 Prices)

NEP Phase

Alliance Phase

Growth

Econ Liberalization

developed than in most other British colonies. Such infra s tru ctu re c o n struction was p ai d for by taxes levied o n the pop ulation b y t h e c o l o ni al government. Colonial monopolies thwarte d the development of a st ro n g local entrepreneurial c l a s s producing for the domestic market; i n s tf' a d , local businesses found it more p rofitable to engage in production for export, commerce, and usury. Although the Malaysian economy has changed sig­ n i fi c an t l y s i n c e i n d e p e n d e n c e , m an y d i ffe r e n c e s r e fl e c t i n g u n e v e n development can b e traced to the crucial formative decades u n d e r colo ­ n i al rule that s h ap e d the e c o n o m i c structure . Ethnic diffe r e n c e s o ft e n coincided wi t h class a n d occupation al differences originating i n t h e colo ­ nial e c o n omy. Ethnic Malays remai n e d l argely marginal to the growing capitalist s e c t o r, with the Malay elite integrated into the c o l o n i al state ap p aratu s , a n d the masses remaining i n the c o u n trys i d e as p e a s a n t s . Emerging business opportunities were mainly taken by s o m e of t h e more urbanized and commercially better connected Chinese. Postcolonial Economic D iversification

The fo r m a t i o n of M al ay s i a in S e p t e m b e r 1 9 6 3-wh i c h i n c l u d e d -

G D P % G rowth

- Per Cap G D P

n o m i c d e v e l o p m e n t h a s b e e n g r e a t l y s h ap e d b y t h e i n s t i t u t i o n s o f g o v e r n a n c e i mp o s e d b y B ri t i s h c o l o n i a l i s m a n d t h e s u c c e s s o r p o s t ­ colo nial state , though t h e relationship b etween economic transformation and gove rnance has b e e n quite dial e c ti c al . Malaysia's growth record in the last century h a s b e e n quite impre s ­

S i n g a p o r e , S ab ah a n d S a r awak-was p u s h e d t h r o u gh b y t h e B ri t i s h , alth o ugh S i n g a p o r e s e c e d e d i n Augu s t 1 9 6 5 . The M e r d e k a ( I n d e p e n ­ d e n c e ) C o n s ti t u t i o n largely p r e s e rv e d t h e c o l o n i al l e gal a n d a d m in i s ­ trative framework, e s p e ci ally t h e protection of prop erty rights o f British b u s i n e s s i n t e r e s t s . B e s i d e s p r o vi d i n g the fr a m e w o r k fo r a l o o s e l y We s t m i n s t e r - s ty l e p ar l i a m e n t ary s ys t e m , i t i n c l u d e d p r ovi s i o n s fo r "Mal ay p rivilege" fo r the purp o s e of ethnic affirmative acti o n , n o t only

sive. During colonial times, M al aya was, b y far, Britain's m o s t profitable

o n the basis o f the histo rical e c o n o m i c dep rivation of the community,

c o l o ny, credited with p roviding much of the exp o r t earnings which fi ­

but a l s o b e c a u s e of the M al ay c l a i m to b e i n g an i n d i g e n o u s p e o p l e .

nanced B ritish p o stwar r e c o n structio n . The o p e n n e s s of the M al ays ian

The fe deral administrative framework devolved authority over land an d

e c o n o my-h i gh e v e n b y d e ve l o p i n g c o u n try s t a n d ar d s - h a s b e e n a

other natural r e s o u r c e s to the state govern m e n t s .

feature of the structural transformation it has undergo ne, especially since

With independence, t h e Alliance-a coalition of the political elite from

the British colo nial period. O n ly a few typ es of industries were allowed

the three major ethnic groups-formally took over state power and politi­

t o d e v e l o p by the c o l o ni a l auth o r i t i e s , who g e n e r ally c o n s i d e r e d t h e

cal j urisdiction over postcolonial M alaya. Not unlike other newly indepen­

c o l o n i e s as s u p p l i e r s o f r a w materials and i m p o rters o f m anufacture d g o o d s . M o s t industrie s were s e t up t h e n to r e d u c e tran s p o rt c o s t s o f exp o r t e d o r i m p o r t e d go o d s , s u c h as fo r refi n i n g t i n o r e and b o ttling imported drinks . L o c al indus tries developed m o s t when economic rela­ tions with the c o l o n i al p owers were weak, e . g . , during the First Wo rld War, the Great D e p r e s s i o n , and the Ja p a n e s e o c c u p a t i o n . 1 36

dent countries , the p o stcolo ni al government emb arked upon a pro gram of economic development emphasizing economic diversification and in­ dustrializatio n . I n p rep aring fo r this political transition, the B ritish had ensured that the radical nationalist and leftist forces who threatened their economic interests were contained, while ethnic elite committed to p r o ­ tecting British interests were trained to eventually inherit state p ower after 1 37

I

r

, i

Governance, Rent-Seeking, and Private I nvestment in Malaysia

Governance, Rent-Seeking, and Private I nvestment in Malaysia

i n d e p e n d e n c e in 1 9 5 7 . A b a s i c ally p r o b u s i n e s s environment was thus

i n c l u d i n g a n i n c r e a s i n g n u m b e r of F e l d a - s p o n s o r e d s c h e m e s , were

assure d . As a result, the p ostcolonial government continued to promote

enco uraged to grow other cro p s , p articul arly oil palms. The state also

private enterprise, while the economic interests of the former colonial power

encouraged manufacturing by o ffering incentive s , p roviding infrastru c ­

were p rotected and greater foreign investment inflows encouraged .

ture and o t h e r s u p p o rtive e c o n o m i c m e a s u r e s . The gove r n m e n t a l s o

B e s i d e s c o n s olidating c o l o n i al p r o p e rty rights i n the p o s t c o l o n i al

encouraged industries to manufacture p reviously imported goods. Most

p e r i o d to fo restall capital flight, whi c h had begun in the late c o l o nial

of these import- substituting industries were subsidiaries of foreign com­

period in the fifties, the independent Malayan government extended the

panies, finishing goods produced with imported materials for profitable

framework for governance to c omplete the transitio n fro m colonial sta­

sale within the p rotected domestic market. M any of these industries o nly

tus to nationhood, e.g. , with the establishment of a central bank. Various

replaced i m p o rts of finished g o o d s with s e mifinished g o o d s ( e . g . , the

r u r al a n d r e g i o n a l d e v e l o p m e n t e ffo rts s o ught t o s e c u r e the c r u c i a l

auto motive assembly industry) . The technology used, usually o riginally

political support of rural Malays for t h e multiethnic ruling coalition, the

developed in foreign conditions, was typically imported fro m the p arent

Alliance. New labor legislation replaced the s p e cial regulations created

comp any abroad, o ften generating relatively little employment.

during the emergency against the co mmunist-led insurgency ( Jomo and

By the mid - 1 960s, it was quite clear that import- substituting indus­

To d d 1 9 94) . New legislation and institutions were created to p r o m o t e

trializatio n was slowing down, due to the limited domestic market, and

i m p o rt - s ub stituting industrialization . The Alliance government's p olicies reflected t h e interests a n d politi­

generating little empl oyment owing to the capital - intensive nature of the i n d u s t r i e s as well as l i m i t e d l i n k a g e s t o the rest o f the n a t i o n al

cal comp romise it embodied. Consistent with this compromise, the state

e c o n omy. I n the s e c o n d half o f the 1 96 0 s , the government moved to­

pursued a modest development strategy with minimal state intervention

ward exp o rt - o ri e n t e d industrializatio n , with the establish m e n t o f the

except to diversify the economy and ensure suitable conditions for rapid

F e d e ral I n du s trial D evel o p m e n t Autho rity ( n o w the M alays i a n I n d u s ­

cap ital accumulat i o n . The p o stcolo nial government was c ommitted to

trial D evel o p m e n t Authority, o r M IDA) .

defending B ritish interests in M alaya, which also enabled the predomi­

The I ndustrial Incentives Act was passed in 1 968, offering a different

n a n tly C h i n e s e l o c al b u s i n e s s e s to c o n s o l i d a t e a n d strengthen t h e i r

set of incentives oriented to attracting more labor- intensive export-ori­

p osition. T h e government a l s o m a d e s o m e m o d e s t attempts to promote

e n t e d i n d u s t r i e s as c o m p ar e d with those o f the i m p o rt - s u b s ti t u t i n g

the interests of the still nascent Malay business c o m munity, while un­

industries d eveloped under t h e P i o n e e r Industries Ordinance o f t h e p r e ­

d e rtaking more ambitious rural develo p m e n t p r o grams to c o n s olidate

vi o u s d e c a d e . L a b o r l e g i s l a t i o n w a s a m e n d e d d u r i n g t h e S t a t e o f Emergency ( M ay 1 969) to help create a n industrial relations climate more

rural M alay electo ral s u p p o r t . Government agricultural development policies have been essentially

attractive to these new industries by limiting trade union o rganization

conservative . The main thrust of rural development efforts involved new

and activity, and allowing women to work around the clock, i . e . , in shift

land development by the Federal Land D evelo p ment Autho rity (Felda) ,

work. I n the e a rly 1 9 70s, the Free Tra d e Zones Act p rovided the legis­

other measures to increase agricultural pro ductivity and rural incomes ,

lation fo r the d evel o p m e n t o f exp o r t - p ro c e s s i n g zones. To gether with

as well as the p rovision of rural facilities , such as roads, schools, clinics ,

other new incentives, free - trade zones and other facilities were set up for

irrigatio n . Rural develop ment was thus constrained by the gove rnment's

this p u rp o s e . The n ew exp o rt - o ri e n t e d industries s e eking cheap l a b o r

reluctance to act against p olitically influential landed interests . Mean­

reduced unemployment as well as wages until t h e fall in unemployment

while, although biased and conservative , postcolonial rural development

pushed wages up o n c e again in the late 1 9 7 0s and e arly 1 9 8 0 s .

effo rts co ntrasted with British colo nial neglect, e s p ecially in the prewar

As e t h n i c M al ay d e m a n d s fo r i n c r e a s e d e ffo rts t o e c o n o m i c ally

p e r i o d . Initially, such effo rts were aimed at c o n s o lidating a politically

advance the community mounted in the mid- 1 960s, new institutions were

s u p p o rtive and loyal M alay yeoman p e a s a n try without drastic r e d i s ­

s e t up fo r t h i s p u rp o s e , o ft e n in the fo r m of p u b l i c or s t a t e - o w n e d

tributive measures.

enterprises ( S O Es) . However, the p rivate s e ctor- o riented d evel o p m e n t

E c o n o mic dive r s i fi c a t i o n e ffo rts to re d u c e M al aysi a's overreliance

strategy o f the 1 960s largely precluded more direct government p a rtici­

on t i n and r u b b e r were carried o u t o n two main fro n t s . Plantat i o n s ,

pation i n p rofitable activities, which were left to p rivate business interests.

138

1 39

Governance, Ren t - Seeking, and Private I nvestment in M alaysia

Governance, Rent- S eeking, and Private I nvestment in Malaysia

H e n c e , a rel atively low p r o p o rt i o n of p ublic d eve l o p m e n t exp e n d iture

In the mid - 1 9 7 0 s , p etroleum production-off the East Coast of Pe n­

was allocated to commerce and indust ry throughout the 1 9 60s. Increased

i n sular M al ays ia-be gan p rovi d e n t i ally, a s o i l p r ice s so ared fro m 1 9 73

budgetary all ocations fo r education p artly reflected the increased util i ­

o nwar d s . T h e fe d e r a l gove rn m e n t q u i ckly p u s h e d t h r o u g h t h e P e t r o ­

zation of educational exp e nditure t o create a M alay middle class a s well

leum Deve l o p m e n t Act of 1 9 74 to e n s ure its captu r i n g the l i o n 's s h a re

a s m e e t i n g the h u m a n r e s o u r c e r e q u i r e m e n t s of the r a p i dly growing

of oil rents. Under the Federal Constitution, the state gove rn m e n t s wo u l d

a n d m o d e r n i z i n g M alays i a n e c o n o m y.

have gotten t h e lion's share instead. Since the early 1 9 8 0 s , petroleum gas

Income distribution in the 1 9 60s saw a growing gap b e twee n urban

production-al m o s t excl usively fo r exp ort to Jap an-has offe red furt h e r

and rural r e s i d e n t s and growing i n e q uality b e tw e e n the maj o r e t h n i c

p r i m ary c o m m o d i ty e a r n i n g s . Wh i l e o i l r e n t s s u s t a i n e d m u c h o f t h e

gro u p s , w i t h the M alays fall i n g fu rthest b e h i n d . I ntra eth n ic e c o n o m i c

public - s e c t o r exp ansion fro m the mi d - 1 9 7 0 s u n t i l the early 1 9 8 0 s , t h e y

i n equality w a s at its n a d i r i n 1 9 5 7 , but by 1 9 7 0 w a s at its p e ak. Rather

have a l s o b e e n u s e d to s alvage a n d p r o m o t e governme nt- own e d e nte r ­

than i n c r e a s i n g class t e n s i o n s , t h e i n e q u a l i ty was p e rc e iv ed i n r a c i al

prises since t h e m i d - 1 9 8 0 s . M al ays i a's l a r g e s t b an k i n t h e 1 9 8 0 s , B a n k

terms, in large p art b ecause of the increasing political mobilization along

Bumiputera M alaysia, w a s r e s c u e d twice-first in the mid - 1 9 8 0 s after t h e

e t h n i c l i n e s . H e n c e , M alay r e s e nt m e n t o f d o m i n a t i o n b y c a p i t a l was

B u m i p u t e r a M alays i a F i n a n c e ( B M F ) s c an d al i n H o n g K o n g , a n d the n

exp r e s s e d p rimarily again s t ethnic Ch i n e se, who c o mprised the b ulk o f

again after the mid- 1 980s recessio n . The government poured lar g e sums

b u s i n e s s m e n , wh i l e n o n - M alay frus t r a t i o n s w ere d irec ted agai n s t t h e

into p restige p roj e c t s , such as the D aya B u m i p roj e ct i n the m i d - 1 9 8 0 s

M alay- d o m i n a t e d s t a t e .

and b u i l d i n g the worl d 's t a l l e s t b u i l d i n g , the Kuala L u m p u r C i t y Ce ntre

Such widespread ethnic perceptions resulted in ethnopopulist op­

twin towe r s , in the m i d - 1 9 9 0 s .

p o s i t i o n t o t h e rul i n g A l l i a n c e gove r n m e n t o f t h e 1 9 6 0 s . The g e n e ral

D evelo p m e n t p o licy i n t h e 1 9 7 0 s aft e r t h e d e c l a r a t i o n o f t h e N E P

election results and "race riots" o f M ay 1 969 reflected the ethnic dimen­

s aw gre a t e r s t a t e i n t e rve n t i o n in fi s c al r e s o u rc e all o c a t i o n a s w e l l a s

s i o n s o f the new p o s t c o l o n i a l s o c i o e c o n o m i c o r d e r. M e anwh i l e , t h e

pu blic s e c t o r ownership a n d c o n t r o l o f b u s i n e s s e n t e r p ri s e s . F r o m t h e

e m e r g i n g M alay m i d d l e c l a s s , w h o e nj oy e d n o m i n al p o l it i c al c o n t r o l

1 9 6 0 s , a n d e s p e c i ally in t h e 1 9 7 0 s , t h e state established a large number

aft e r independence, p e rceived the decline of British e c o nomic hegemony

o f p u b li c e n t e r p r i s e s i n all s e c t o r s , s o m e t i m e s i n c o l l ab o r a t i o n w i t h

giving way t o C h i n e s e a s c e n d a n c e . They b e c a m e more a s s e rt ive fro m

p rivate capital. The two main typ e s o f S O E s are statuto ry b o d i e s e stab ­

t h e m i d - 1 9 6 0 s , e s t a b l i s h i n g c l e a r p o l i t i c al d o m i n a n c e aft e r M ay 1 9 6 9 .

l i s h e d by s p e cial legislation, and t h o s e o p e rating as p rivate comp anie s

Increased State Intervention, 1 9 70- 1 985

fe d e ral , s t a t e , a n d regional authoriti e s , i n turn , have many s u b s i d i a r i e s

registered under the 1 965 Comp anie s Act. The maj o r SOEs owne d by the First announced i n 1 9 7 0 , the New Economic Policy (NEP) sought to

and j o in t venture s .

create the s o c i o e c o n o m i c c o n ditions fo r "national unity" aft e r the race

Public o r state- own e d enterpris e s were first introduced fo r t h e p u r ­

riots o f M ay 1 969 through mas s i ve economic redistribution p ro grams to

pose of ethnic affirmative action or positive discrimination fro m t h e early

achieve its twin p rongs of " p overty eradication" and the "restructuring o f

1 950s, and had grown modestly from the mid- 1 960s and very much faster

s o c i e ty. " The N E P 's O u t l i n e P e r s p e c t ive Plan ( O P P ) e nvisaged the i n c i ­

in the 1 9 70s. From ten in 1 957 and twenty- two in 1 960, the number of SOEs

d e n c e o f p overty d e c l i n i n g fro m 4 9 p e rc e n t in p e n i n s ular M alaysia i n

grew to 1 09 by 1 970, 656 by 1 980 and 1 , 0 1 4 by 1 985, before almost ceasing

1 9 7 0 t o 1 6 p e rc e n t i n 1 9 9 0 . " Re s t ructuring s o c i e ty " b a s i c ally refers to

to grow, except for a few privileged projects favored by the Executive Branch .

e ffo rts to achieve interethnic p arity in occupations and corporate wealth

Since the mid - 1 9 8 0 s , S O E s have b e e n a c c u s e d of increasing the p u b l i c

ownership. The NEP s o ught to eliminate the i d e ntification of race with

d e b t a n d , m o r e generally, of inefficie ncy; t h e i r accumulated l o s s e s have

economic function, p rimarily through ethnically differentiated financing

wasted investment resourc e s , increased the gove r n m e n t 's fin a n c i al bur­

o f, a n d c o n t r o l l e d a c c e s s t o , tert iary l evel e d u c ati o n as well as public ­

den and slowed down economic growth ( Kamal and Zainal 1 9 8 9 ) . From

s e c t o r e m p l oy m e n t . T h e O P P a l s o e xp e c t e d to r a i s e t h e B u m i p u t e r a

the mid - 1 9 7 0 s , there was a rapid increase in domestic and external debt;

( n ative M alay) s hare o f c o r p o rate e quity fro m 2 . 4 p e rc e n t in 1 9 7 0 to 3 0

very s e rious gaps in the current account b alance al so started to e me rge

p e rc e n t i n 1 9 9 0 .

b e c a u s e of d e c l i n i n g c o m m o d i ty e xp o rt p r i c e s a n d weak d e m a n d fo r 1 40

141

Governance, Rent- S eeking, and Private I nvestment in Malaysia

Governance, Rent - Seeking, and Private Investment in M alaysia

manufactured exports. Private investments outside of the oil and gas sec­

cally d e p rive d , indigenous c o m m u n i ty. In e ffe c t , h owever, such inter­

tor were negative ( World Bank 1 9 83 ) .

v e n t i o n has p r i m a r i l y advan c e d the i n t e r e s t s of s e l f- a g g r a n d i z i n g , politically influential rentiers including s o m e n o n - Bumiputeras , rathe r than genuine entrepreneurs, t h u s preempting achievement o f industrial

Figure 3 Public Sector Expenditure i n M alaysia, 1 96 6- 1 99 5

Expenditure as % of GDP

RM Million Expenditure

80%

80,000

70%

70 000

_

_

Development Expenditure

Expenditure as % of GDP

p o licy

0

bj e ctives .

M alays ia exp erienced a severe economic recession during the mid1 980s due to a manifold combination of economic problems. Wo rldwide influences, such as the global rec e s s i o n , tighter internati o n al liquidity, higher real interest rates after the debt crisis from the early 1 980s, lower p rimary commo dity prices , reduced international demand for manufac­

60%

tured e x p o r t s ( e s p e c i al l y e l e c t r o n i c s ) and r e d u c e d fo r e i g n p ri v a t e

50 000

50%

inve s t m e n t i n fl ows w o u l d h a v e b e e n d i ffi c u l t e n o u g h . Th e s e j o i n e d ,

40 000

40%

30 000

30%

20 000

20%

1 0 000

1 0%

60 000

0%

o

however, with an overall decline (largely d u e to p re d at o ry p ol i c i e s d i ­ r e c t e d at e t h n i c C h i n e s e b u s i n e s s i n t e r e s t s ) i n d o m e s t i c p r i v a t e i n ve s t m e n t a n d c o n c e n t r at i o n o f r e m a i n i n g p rivate i n v e s t m e n t i n non tradeable sectors (e. g. , p roperty, construction) , p o o rly c h o s e n public investments concentrated in heavily protected import-substituting heavy industries ( s o m e of which also failed on technical groun d s ) , as well as deflatio nary fiscal and monetary policies b e ginning in 1 98 2 (excep t fo r the prime minister's prio rity proj e cts) . D u r i n g t h e 1 9 8 0- 1 9 8 2 i n t e r n at i o n al r e c e s s i o n , t h e g o ve r n m e n t a d o p t e d c o u n t ercyclical b u d g e tary p o l i c i e s ( i n c r e a s i n g p u b l i c s e c t o r c o n s u m p ti o n , inve s tment a n d e m p loyment) , wh ich u n d e r m i n e d gov­

Meanwhile, the public sector's share of GNP rose fro m 2 9 . 2 p e rcent

ernment

fi s c al

discipline.

Wh i l e

the

g o ve r n m e n t

may

h ave

in 1 970 to a peak of 58.4 p e rcent in 1 98 1 , before falling to 25.3 percent

underestimated the nature and gravity o f the recession, and therefore

in 1 99 3 . I n 1 982, public sector expenditure contributed 4.8 percent to the

thought it could spend its way out of it, the new Mahathir administration

GDP growth of nearly six percent, but s ince 1 984, its contribution to GDP

( from m i d - 1 9 8 l ) p r o b ab ly also h o p e d t o s e cure a new e l e c t o ral m a n ­

growth has declined (see figure 3) . The growth of SOEs fro m the 1 9 70s,

d a t e t h r o u g h s u c h generous d e ficit s p e n ding. R i g h t after w i n n i n g t h e

e s p e c ially h e avy industries in the early 1 9 8 0 s , had been accompanied

April 1 982 general election, t h e government announced an austerity drive,

by declining capital productivity in the economy. The average increme n­

cutting back public spending and a b a n d o ning the e arlier e ffo rt to i n ­

tal capital- output ratio (lCOR) rose fro m 2-3 in the 1 9 70s to 5-6 in the

c r e a s e p u b l i c s e c t o r employment.

e arly 1 980s while the public sector ICOR rose fro m 6-7 in the 1 970s to 1 5- 1 6 in the first half of the 1 9 8 0 s .

During the mi d - 1 9 8 0 s , p rivate inve s t m e n t s dropped fro m RM 1 3 . 3 billion i n 1 984 t o R M 1 0 . 1 billion i n 1 9 86, before rising again t o R M 1 0 . 5

P o o r c o o rdination and accountab ility of the S O E sector were very

b i l l i o n i n 1 9 8 7 . P e r h a p s m o re s i g n i fi c a n t ly, p r ivate inve s t m e n t a s a

e vi d e n t . For i n s t an c e , of m o r e than 900 i d e n ti fi e d S O E s in 1 9 8 4 , t h e

percentage of GNP had been declining since the beginning of the 1 980s,

Ministry of Public Enterprises could o nly rep o rt annual returns for 269

from 19 percent during 1 979- 1 984 to 14.4 percent in 1 987 (Bank N egara

e n t e r p ri s e s , which r e c o r d e d an accumulated loss o f RM 1 3 7 . 3 m i l l i o n

1 988, 2) . Foreign corporate investment declined by 19 percent fro m 1 984

(Supian 1 988) . Their rapid growth h a s a l s o involved generally inefficient

to RM 1 . 7 billion in 1 9 85, and RM 1 . 4 billion in both 1 986 and 1 987 (B ank

state interve n t i o n , alm o s t s i n gul arly c o m m i t t e d to interethnic wealth

Negara 1 98 8 , 1 95) . Meanwhile, public sector investment was constrained

redistribution, ostensibly favoring the p olitically dominant, but economi-

by reduced resource availab ility after the p ro fli gacy of the e a rly 1 9 8 0 s .

142

1 43

1 Governance, Rent-Seeking, and Private Investment in Malaysia

Governance, Rent-Seeking, and Private Investment in Malaysia

H i gh l e v e l s of p u b l i c s e c t o r i n ve s tm e n t c o u l d o n ly be s u s t a i n e d b y b orrowi n g externally, yet glo b al i n t e re s t rates w e r e h i g h and such b o r ­ rowing w o u l d h ave r e s u l t e d i n m a s s ive ext e rnal d e b t .

Malaysia, 1 9 70- 1 9 9 5

�

Employm ent

_

% of Total

% of Total Employment 1 8%

!m 1m

700

T h e turning p o i n t for governme n t p olicy t h u s o ccurred around 1 98 6 . The m aj o r p ri m a ry c o m m o dity- p ri c e c o l l a p s e ( i nvolving p al m o i l a n d t i n ) and the low p o i n t o f the electronics b u s i n e s s cycle had o ccurred the p revious year. After January 1 98 6 , whe n p etroleum fell to its lowe s t price, b e gan t o r e c o v e r, a l b e i t s l owly. T h e s t r u c t u ral t r a n s fo r m a t i o n o f t h e

300

s e c o ndary and t e r t iary s e ct o r s . Acknowl edging the problems and limitatio n s o f the state - l e d h eavy

6%

i n d u s t ri a l i z a t i o n s t r a t e gy-o ft e n d u b b e d t h e s e c o n d r o u n d o f i m p o rt

2%

1 00

M al aysian e c o n o my h a s accelerat e d , with the p rimary s e c t o r declining in relative significance compared to the much more rapid growth o f the

8%

4%

200

0%

� m

Very impo rtant, by the mid- 1 980s there was growing dissatisfaction with the government a m o n g s o m e o f t h e more c a p a b l e B u m i p u t e ras , b o t h in t h e public and p rivate s e c t o r s . I n a high - p ro file c o n fe r e n c e in 1 9 8 7 , b o th p rivate - and p u b l i c - se c t o r Bumiputeras criticized what they c o n s i d e r e d unfair gove r n m e n t i n t e rfe r e n c e in the b us i n e s s w o rl d . By this time , large M al ay - c o ntrolled business gro u p s had alre ady emerged i n the c o r p o r a t e s c e n e , and s o m e were c a l l i n g fo r a l e s s r e g u l a t e d e c o n o my. I n d e e d , s o m e o f them viewed exc e s s ive i n t e rven t i o n as hav­ i n g slowed e c o n o m i c g r o wt h . a n d h e n c e c o u n t e r p r o d u c t ive t o th e i r interests (Khoo 1 99 2 ) . I n other word s . the government could no lon ger even c l a i m an ethnic M alay m a n d a t e fo r its role in t h e e c o n o my. After the second Plaza Hotel meeting in New Yo rk in 1 9 8 5 , the Japa­ nese yen began to appreciate greatly against other maj o r world currencies , p articularly the US dollar. As the value of the currencies of most East Asian industrializing economies subsequently rose, raising comparative produc ­ tion- especially labor-costs in the process, the M alaysian ringgit declined, eve n against t h e U S d o l l a r. The b o o m thr o u gho u t Southeast Asia that 1 44

businesses b e nefiting fro m , a n d h e n c e s u p p o rtive o f, such liberalizatio n .

14%

400

�

e c o n o my fro m 1 9 8 6 h a s also b e e n a b o o n t o inve s t m e n t s , with m o s t

external demand fo r M alaysian exp o r t s , mainly p ri mary c o m m o d i t i e s ,

1 0%

500

0

rising production costs and tightening labor markets as well as e n fo rcing

1 6%

1 2%

fro

0%

firs t - ti e r E a s t Asian newly industrializing c o u n tries ( N I C s ) exp eriencing stricter environmental restricti o n s . Some d eregulation o f the M alaysian

Figure 4 Public Sector Employment a s Proportion of Total Employment i n

Thousands Employed

followed fro m the late 1 980s benefited greatly from investments from the

s u b s t i t u t i o n - o f t h e e arly a n d m i d - 1 9 8 0 s , t h e g o ve r n m e n t s o u gh t t o e n c o u r a g e p riva t e , i n p ar t i c u l a r fo r e i g n , m a n u fa c t u r i n g inve s t m e n t s , e s p ecially in m o r e technologically s o p h i s ticated, exp o r t - o riented indus­ tries, through t h e enactment o f t h e Promotion o f I n ve s t m e n t s A c t i n 1 9 8 6 . T h e t i m i n g was p e rfe c t , a s m a n u fa c t u r e r s fro m N o rt h e a s t A s i a ( e s p ecially J a p a n . and later, Taiwan) r u s h e d to relocate t h e i r industries a n d t h u s t a k e advantage o f t h e e n h a n c e d i n c e ntive s . r e l a tively g o o d infrastruc t u r e . a n d l a x enviro n m e n t al regulati o n s as well as c o m p a r a ­ tively low production costs due to the new exchange rates. I nitially driven p ri marily by such East Asian exp o rt - oriented manufacturing investments. the M al ays ian e c o n o my recovered signifi c a n tly beginning i n 1 9 8 7 . and has maintained growth rates o f over 8 p ercent p e r annum s i n c e 1 9 8 8 . The p o licy changes o f t h e mid - 1 980s thus appear t o have b e e n suc­ cessful. The subsequent economic turnaround has encouraged the attr i ­ bution o f t h e recovery to t h e policy changes. H owever. as t h e p re c e d i n g account sugges t s , s everal different deve l o p m e nts w e r e o c curri n g a t t h e s a m e tim e , and while a l l m a y well h ave c o n t r i b u t e d to the rec overy, it

� s difficult to

disaggregate their respective contributions. After all, growth

III most economies o f Southeast Asia seems to have accelerated at around

the same tim e , i . e . , fro m the late 1 9 8 0 s . I n 1 99 0 , the twenty-year p e riod o f the Outline Perspective P l a n ( O P P ) fo r Malaysia's N e w E c o n o mic Policy ( N E P ) c a m e t o a n en d . T h e ambi­

tious NEP t argets had been l argely achieved b y 1 99 0 . with the greatest 1 45

II

Governance, Rent- Seeking, and Private Investment in Malaysia

Governance, Rent - Seeking, and Private Investment in M alaysia

p r o g r e s s p r i o r to t h e m i d - 1 9 8 0 s . D e s p i te s o m e c o ntroversy over t h e

p e cts fo r M alaysian gove r n m e n t s u p p o rt m o r e likely-h as b e e n p e r ­

reliability and comp arability of o fficial d a t a , r e d u c t i o n in p overty inci­

ceived as a sign of g o o d faith fro m t h e government that i t is co mmitted

dence h a s b e e n i m p r e s s ive , declining to 1 7 percent i n 1 9 9 0 fro m 49

to re ducing interve n t i o n . Average annual GDP growth hovered around

p ercent in 1 97 0 . By 1 99 0 , ethnic proportions in economic activities and

1 1 - l 3 p e rcent i n the period 1 9 8 8- 1 99 2 . Although fo reign direct invest­

o ccupations bro adly reflected demographic shares except in agriculture

ment l eveled o ff by 1 992, increased domestic investments-inspired by

and government s e rvi c e s , which are predominantly Bumiputera, and in

greater d o m e stic inve stor c o n fi d e n c e-have sustained rapid growt h .

the still Chines e - d o minated who l e s al e and retail trade . For eight well­ remunerated professio nal categories, the Bumiputera share rose fro m 6

Mahathir's Policy Reforms and the New Business Governance

p ercent in 1 970 to 25 percent in 1 99 0 , with inertia alone ensuring con­

S o o n after M ahathir's ascendance t o the prime minister's o ffi c e in

tinued increases in the Bumiputera share there after. Through government

mid - 1 98 1 . he announced his "Look East" policy. Initially, this policy was

regulatio n of business o p p o rtunities and investments as well as p refer­

widely b e l i ev e d t o r e fe r to e ffo rts t o e mu l a t e s p e c i fi c a s p e c t s of the

ential policies for Bumiputera businesses, the Bumiputera share of equity

J a p a n e s e and S o uth Korean success i n e c o n o mi c develo p m e n t , e s p e ­

in publicly listed companies rose fro m l . 5 percent in 1 969 to 1 8 p ercent

c i ally i n d u s trializat i o n . T h e s e i n c l u d e d s t a t e i n t e rve n t i o n t o d evel o p

in 1 983 and 2 0 percent in 1 99 0 . ( Various observers h ave advanced per­

heavy industries (Pura 1 985) , state encouragement of t h e establishment

s u a s ive arguments sugge sting c o n s i d e rable o ffi c i al underestimation of

of Japan e s e - s tyle sago shasha trading agencies (Chee and Lee 1 9 8 5 ) , ef­

the actual B umiputera share o f corpo rate wealth . )

fo rts to get the gove rnment bureaucracy to b etter s e rve p rivate s e c t o r

Yet despite the considerable achievement o f s p e cific o p p targets, it

interests ( S h ah ari 1 9 8 5 ) and even p rivatizatio n . It w a s t h u s s e e n as in­

is far fro m clear whether p ro gress had been made in achieving "national

volvi ng a fairly wi d e - ranging s e r i e s o f i n i t i atives to become a NIC by

u n i ty, " the N E P 's o s t e n s i b l e p u r p o s e , u s u ally i n t e r p r e t e d in t e r m s o f

emulating the Japanese and So uth Korean economic s u c c e s s e s .

imp roved interethnic relati o n s . Relations b etwe e n Malays a n d Chinese

F r o m t h e m i d - 1 9 8 0 s , M ahathir t o o k great p ains to define t h e Look

were arguably tense in 1 98 7 due to the p olitical machinations of certain

East policy more narrowly in terms of a new work ethic, labor discipline,

ambitious government political leaders. With the economy booming again

a n d p r o d u c tivity. Thus, t h e Look E a s t p o li c y l a t e r a p p e ar e d t o be a

by 1 99 0 , ethnic tensions had l argely rec e d e d . However, regional griev­

campaign to boost worker productivity by inducing hard work and pro­

a n c e s-e s p e c i ally in the states o f Sabah, S arawak, and Kelantan-had

m o ti n g m o re e ffe ctive modes o f labor d i s c i p li n e a s s o c i a t e d with the

b e c o m e more p r o n o u n c e d , while ethnic m i n o ri t i e s- b o t h n o n - M alay

Japanese. Looking East has involved more than abstract exhortations to

B u m i p uteras and n o n - C h i n e s e n o n - B u m i p u t e ras-were c l e arly m o r e

work harder as is so metimes suggested. The official emphasis o n a new

marginalized a n d alienated t h a n ever befo r e .

Japan e s e - style work ethic refers to the o fficial desire to induce greater

Confirmation of the ch ange in policy direction since t h e mid - 1 980s

productivity by wage labor in an industrial capitalist context. I n fact. the

came with the adoption of Vis i o n 2020, seen to favor growth, modern­

real thrust o f the camp aign appe ars to b e the promotion o f labor d i s ­

izat i o n , and industrializati o n over the N E P 's emphasis o n intereth n i c

cipline by reorganizing industrial relations to p romote comp any loyalty

r e d i s t r i b u t i o n . Wh i l e fo reign i n ve s t o r s c o n t i n u e d t o b e c o ur t e d , t h e

( e . g . , comp any welfaris m , i n - house unions ) , increase productivity ( e . g . ,

government h a s a l s o l i b e ralized s o m e conditions fo r l o c al C h i n ese i n ­

work ethic, m o r e incen tive p ayments ) , a n d reduce losses ( e . g . , quality­

vestments. C h i n e s e cap ital has also been encou raged by various oth er

control circle s , zero- defect groups) .

refo r m s , s u c h as e a s i e r a c c e s s t o listing o n the stock marke t . greater

At the s a m e t i m e , the M ahathir a d m i n istration al s o advan c e d the

o fficial encouragement of small and medium industries (S M I s l . gove rn ­

" M al ays ia I n c o r p o r at e d " s l o gan in an e ffo rt to imp rove relat i o n s b e ­

ment effo rts t o mitigate t h e Industrial Coordination Act of 1 9 7 5 , a s well

twe en the gove rnment and the p rivate sector. This was des igned t o get

as the overall e m p h a s i s o n m arket . rat he r than regulato ry, measures .

the gove r n m e n t t o re t u r n t o its " t r a d i t i o n a l " r o l e of s e rv i n g p r ivate

More rec e ntly, the o ffi c i al p o l i cy of e n c o u raging l o c al fi rms ( e s p e cially large c o rp o ratio ns) to inve s t overseas-where the scope fo r ob structiv e

b u s i n e s s i n t e r e s t s in place of the h e avy government regulat i o n o f the

or predatory M alaysian government intervention is reduced and the pros-

efforts to curb and rectify "excesses" a s s o c i ated with overzealous imple-

146

1 47

1 9 7 0 s and e a rly 1 9 8 0 s . I n M alays i a , t h e s l o gan soon came t o r e fe r to

r Governance, Rent-Seeking, and Private Investment in Malaysia

Governance, Ren t - Seeking, and Private Investment in Malaysia

mentation of the NEp, especi ally by Malay bureaucratic elements, mainly

•

e s p e cially in the 1 99 0 s , there h ave b e e n growin g signs of government

•

Assisting in reducing the size and presence of the public s e c t or, with its monopolistic tendencies and bureaucratic support, in the

support fo r the p rivate s e c t o r, p r imarily fo r p ol i t i c ally wel l - connected

e c o n o my

Bumiputeras in the domestic e c o n o my, and also fo r n o n - B umiputeras. The growth o f S O E s was reve r s e d fro m mi d - 1 9 8 0 s as the gove r n ­

Stimulating p rivate entrepreneurship and investment . . . to accel­ erate the rate o f growth o f the e c o n o my

re s e n t e d by Chinese b u s i n e s s interests. Later, fro m the late 1 9 8 0 s and

•

Contributing toward meeting the objectives of the New Economic

m e n t i n c r e a s e d m o n i t o ri n g a n d c o n t r o l o v e r t h e s e age n c i e s . P o l i cy

Policy (NEP) , especially as Bumiputera entrepreneurship and pre s ­

changes under the M ahathir administration had reversed the p reviously

ence have imp roved greatly s i n c e the early days o f the N E P and

growing role of the public sector in the economy except for the exp e n ­

are t h e r e fo r e capable o f taking u p their s h are o f the p rivatized

sive heavy- industry p roj ects h e favo red. Even t h e growth of t h e s e were

s e rvi c e s

c h e c k e d in the m i d - 1 9 8 0 s with the w o r s e n i n g e c o n o m i c c ri s e s . F o r M ahathir, SOEs were o n ly to s e rve a s temporary vehicles fo r creating a

T h e o fficial ratio n ale for p rivatization in M alaysia h a s b e e n refuted

Bumiputera entrepreneurial c o mmunity. As M ahathir c o n solidated his

o n many gro u n d s , and there is considerable evidence o f abu s e s i n the

p o s i t i o n i n the late 1 9 8 0 s ( afte r fe n d i n g o ff p o l i t i c a l challenges fro m

implementation o f the p olicy ( Jo m o 1 99 5 ) . Although p rivatization may

ruling p arty colleagues fo llowing the economic d i fficulties of the mid-

enhance enterprise efficiency to increase profits for the p rivate owners

1 980s) , p rivatizatio n increasingly became an imp o rtant means for spon­

concerned, such changes will not necessarily advance the public interest

s o ring, supporting, and subsidizing the emergence and c o n solidation of

or consumers o n the whole. Since a maj o r p o rtion of such activities are

new p olitically well - c o n ne c t e d ( b u t s u p p o s e dly more c o mpetent) and

public monopolies, p rivatization has largely handed over such m o n o p o ­

predominantly, but n o t exclus ively, Malay re ntiers. B u d ge t c o n s traints

l i e s t o p rivate i n t e r e s t s l i k e ly to u s e r e l a t e d adva n t a g e s t o i n c r e a s e

o n S O E s tightened slowly and unevenly, while those deemed profitable

profitability. P rivate interests have o n l y b e e n interested in profitable o r

o r p o t e n tially lucrative s o o n became candidates fo r p rivatization.

p o tentially p r o fitable activities and enterpri s e s , m e a n i n g t h a t the gov­

Privat i z a t i o n i n M al a y s i a was o ffi c i ally a n n o u n c e d i n 1 9 8 3 , aft e r

ernment has been stuck with unprofitable and less p rofitable activities

M ah a t h i r h a d t a k e n o v e r a s p r i m e m i n i s t e r a n d l a u n c h e d h i s h e avy

that will o nly worsen public sector performance, already considered less

industrialization program through j oint ventures between new SOEs and

than efficient. Public sector inefficiencies and o ther problems need to be

p rivate Jap a n e s e and South Ko rean firms. Unlike the Look East p o licy

overc o m e , b u t p rivatization in M al aysia has primarily enriched a few

and the Malaysia Incorporated concept, which were also associated with

with strong p olitical connections who h ave secured and s e e m likely to

M ahathir's administrat i o n a n d ap p e ared to have fad e d in significance

secure the most profitable opportuniti e s , while public welfare becomes

by the mid- 1 980s, privatization achieved new vigor from the late 1 9 80s.

increasingly vulnerable to the p ower and interests o f p rivate business.

I t had the support and encouragement of p owerful international age n ­

Nevertheless, the significance of the policy cannot be underestimated.

c i e s , w a s promoted by D a i m Zainuddin (appointed finance minister in

Perhaps , most important, it signaled the end of the era of public sector

mid- 1 9 84) , and was viewed as a p artial solution to the worsening fi scal

expansion-and possible "crowding out" of private investments. The pol icy

and debt problems of the m id - 1 9 8 0 s ( s e e E P U 1 9 8 5 ) .

also o ffered many lucrative opportunities for investment as state assets

T h e M a l ay s i a n g o v e r n m e n t h a s s u m m e d u p i t s a r g u m e n t s fo r p rivatizatio n in the following five p o i n t s :

were disposed off at handsome discounts or with opportunities to capture huge rents , thus stimulating private investments and promptly strengthen­ ing the Bumiputera commercial and industrial community, or at least those

•

•

Relieving t h e financial and administrative burden of the gove rn­

favored by the Mahathir government. Short-term gains for the government 's

m e n t i n u n d e r t a k i n g a n d m a i n t a i n i n g a vast and c o n s t a n t ly

fiscal balance were also immediately realized. Consumer welfare losses­

expanding network of s e rvi c e s and inve stments in infrastructure

due to increased user charges and the c o nversion of public into p rivate

Promoting c o m p e t i ti o n , i m p roved effi c i e n cy, a nd i n c re a s e d pro­

monopolies-were partially offset by initial public enthusiasm for improved

ductivity of the s e rvices

services as well as the retreat of the bureaucracy and the public sector. 148

149

T Governance, Rent-Seeking, and Private I nvestment in M alaysia

Under M ahathir's leadership since 1 98 1 , and especially since the mid1 9 80 s , the government has been more explicit i n e m p h asizing growt h , modernization, a n d industrialization a s national economic priorities . Due to the Malay political elite's preoccupation with constraining Chinese wealth accumulation and the limited entrepreneurial abilities of the nascent Malay rentiers who emerged under the NEP, M alaysia's industrialization strategy imitates Singapore-more than Taiwan or S o u t h Korea-by relying o n foreign, rather than domestic-led manufacturing growth. At the same time , s i n c e 1 98 6 , t h e p rivate sector h a s b e e n given greater o p p o rtunity at the exp e n s e o f the public sector with p rivatization and some d e regulation of economic investment in addition to new regulati o n s . O n 2 8 Febru ary 1 99 1 , two mo nths a ft e r the end o f t h e OPP p e rio d , M ah a t h i r i n a u g u r at e d t h e M alaysian B u s i n e s s C o u n c i l ( M B C ) with a speech entitl e d " M al aysia: The Way Forward. " In his speech M ah athir set out the national o b j ective o f achieving " fully deve l o p e d c o untry" status by the year 2020. The M B C 's s e c retariat is l o c a t e d i n the gove r n m e n t ­ s p o n s o r e d , b u t n o m i n al l y i n d e p e n d e n t , t h i n k t a n k , t h e I n s t i t u t e o f Strategic and I nternati o n al S t u d i e s ( I S I S ) . I S I S is b elieved to h ave b e e n r e s p o n s i b l e for drafting a n d p ro moting the s p e e c h , w h i c h has t w o d i s ­ t i n c t p a r t s , and " Vi s i o n 2 0 2 0 " as the new n a t i o n a l p u rp o s e . I n the first p art o f the s p e e c h , nine " c e ntral strategic chall e n g e s " were i d e ntifi e d , with a view t o accelerating industrializati o n , growth , a n d modernization .

Governa nce, Rent- Seeking, and Private I nvestmen t in Malaysia

various p o l i t i c al institutio ns and arrangem e n t s at the time of indepen­ dence in 1 957. Mahathir secured a strong endorsem ent for this third "so c i al contract " with his resoundi ng vic t o ry in the 1 9 95 general election .

While a t o n e level Vision 2020 rep resents a reiterati on and refo rmu ­ lation of the Rukuneg ara and the N E p, the a p p arently minor and subtle differenc es a n d t h e n e w context a r e crucial . Its significan ce lies primarily

in its timing ( i . e . , right after the end of the OPP p eriod) its long-term (three­ ' d e c a d e ) p e r s p e c tive and the clear s h i ft in e m p h a s i s a n d p ri o rity fro m interethn ic redistrib ution t o growth m o d e rnization and industria lizat i o n . Understa ndably, there h a s b e e n some enthusia sm, especiall y a m o n g non­ Malays, for the speech's explicit commitm ent to forging a M alaysian nation

(bangsa M alaysia) , transcend ing existing ethnic identities and loyalties and consisten t with M ah a t h i r 's 1 9 89 new U M N O c o n stituti o n . Wh e r e a s the rhetoric of the Rukuneg ara and the NEP emphasiz ed national unity-u su­

ally interpret ed narrowly in terms of achievi ng interethn ic economi c parity b etwe e n M al ays a n d C h i n e s e-Vi s i o n 2 0 2 0 's "d evel o p e d c o u n try" goal implies a narrower , m o re material istic and economi c growth e m phasis.

Thus Visi o n 2020 has a l s o redefined t h e purp o s e and r o l e o f the govern­ ment, and c o n s e q u ently s o ught to transform public - private s e c t o r rela­ tions. Not surprisin gly then, many related policy changes h ave b een ap­ preciated by p rivate business interests , i n cluding: •

In mid- 1 99 1 , the M alaysian government announced its N ational D e ­ vel o p m e n t P o l icy ( N D P ) , w i t h a t e n - ye a r S e c o n d O u t l i n e P e r s p e ctive P l a n ( O PP 2 ) fo r 1 9 9 1 -2 0 0 0 , fo l l o w e d s everal w e e k s later b y t h e S ixth M alaysia Plan (6MP) for 1 9 9 1 - 1 99 5 . H e n c e , while the OPP2 and 6MP are s u p p o s e d to p rovi d e a m e d i u m - term e c o n o m i c p o licy p e r s p e c tive , Vi­

• • • •

sion 2020 p rovides the long- term obj e ctive s . And while it is quite p o ssible that Vision 2 0 2 0 , like many other M ahathir p olicy innovations, may not outlast his stay in o ffice (and may even recede in significance before his

• •

•

ciated with the N E P. In 1 99 1 , it represented an explicit o ffi cial reiteratio n of the p olicy changes introduced by M ahathir earl i e r in h i s tenure. e s ­

•

p e c ially s i n c e t h e mi d - 1 9 8 0 s .

•

Vis i o n 2020 can and has b e e n be interpreted as a reformulation o f t h e R u k u n e g a r a , o r N a t i o n a l I d e o l o gy, a n d t h e N e w E c o n o m i c P o l i cy (NEP) , both announced in 1 97 0 . Its obj e ctives are o ft e n seen as reflect ­ i n g t h e s e c o n d n a t i o n al o r " s o c i al c o n t r a c t , " fo l l o w i n g t h e fi r s t o n e expre s s e d by the M e rd e k a ( I n d e p e n d e n c e ) C o n s t i t u t i o n as well as the 1 50

a depreciat ed ringgit for exp o rt promotio n, and foreign investm e n t: n e w inve s t m e n t in c e n t ive s , e s p e c i ally with t h e P r o m o t i o n o f I n ­

vestment s Act 1 9 8 6 ;

tenure is over) , it has already succeeded in conforming and defining the p olicy shift away fro m the narrow ethnic distrib utional objectives asso ­

a more streamlin ed gove r n m e n t bureaucr acy, m o re re s p o n s ive to inve s t m e n t a n d growth p r o m o t i o n ; restraint o n n o nfi n an c i al p u b l i c e n t e r p r i s e ( N F P E ) exp a n s i o n : lower i n t e r e s t rates ;

•

rai s i n g o f I n d u strial C o o rd i n a t i o n A c t ( I CA ) exe m p t i o n levels : reduction of real wage costs, greater labor flexi b i l i ty and ava i l a i l ­ b ity o f c h e a p migran t l a b o r ; l e s s e m p h as i s o n e t h n i c r e d i s t r i b u t i o n ( i n fa c t a s ll s p e n s i o n o f N E P r e q u i r e m e n t s w i t h t h e Pro m o t i o n of I nv e s t m e n t s Act 1 9 8 6 ) ;

bureau cratic d e regulat i o n ; priva t i z a t i o n of governm ent e n t e r p ri s e s a n d public p ro j ects : a n d c o ntract i n g o u t o f municip al s e rv i c e s to the p rivate s e c to r.

Vi si o n 2 0 2 0 also envis ages a m o re c o m p etitive market , -discipli n ed , o utward - looki ng, dyn amic , rohust, self- reliant, r e s i l i e n t , d ivers i fi e d , b a l ­ an ced , adapt ive , t e ch n o l o gical l y p r o fi c i e n t a n d e n t r e p re n e u rial e c o n o m y 151

Governance, Rent-Seeking, and Private Investment in M alaysia

Governance, Rent-Seeking, and Private I nvestment in M alaysia

with s t r o n g industrial l i nkage s , p r o d u c t ive and knowledgeable human

c o n s i d e r a b l e s u p p o rt fro m the p o l i t i c ally critical B u m i p utera c o m m u ­

resources, low inflatio n , exe m p lary work ethi c s , and with emphasis o n

n i t y ( e s p e cially e t h n i c M al ays ) , w h o w e r e g e nerally s e e n t o b e t h e p r i ­

quality a n d excellen c e . The M B C s p e e ch a l s o recognized various prob ­

mary b e n e ficiaries o f b o t h the poverty reduction a n d interethnic r e d i s ­

l e m s p l a g u i n g M al ays i a n i n d u s tr i a l i z at i o n , i n c l u d i n g m a n u fac t u r i n g 's

trib ution measures associated with it. F o r n o n - B umiputeras w h o did n o t

n a r r o w b a s e , w e a k i n d u s t r i a l l i n k a g e s , i n s i g n i fi c a n t l o c al s u p p l y o f

o p t fo r "exi t " i n the fo rm o f e m i gration o r capital fl i g h t , the c o s t s of a

i n t e rm e d i a t e p r o d u c t s , i n ad e q u at e d e ve l o p m e n t o f i n d i g e n o u s t e c h ­

voice in the fo rm of political o p p o s ition or dissent have o ften b e e n quite

n o l o gy, t o o little value a d d e d , rising production (including labor) c o s t s ,

high. Yet under the ethnic exclusio nary policies often associated with the

i n frastructure b o t t l e n e c k s , s e r i o u s s h o r t a g e s o f s k i l l e d p e r s o n n e l , t h e

NEp, " l oyalty" was h ardly rewarded except fo r a select few i n the p olitical

n e e d fo r p roduct as w e l l a s market divers i ficat i o n , p r o b l e m s r a i s e d by

o r b u s i n e s s elite who were will i n g a n d able t o s u c c e s s fully c o l l a b o rate

p ro t e c t i o n i s m , trade b l o c s , m a n a g e d t r a d e , d o m e s t i c p ri v a t e s e c t o r

with the ethnic M alay elite for their mutual benefit. Most others, includ­

p e rfo rman c e , a n d t h e n e e d fo r agrarian reform as well as resource and

i n g p o li t i c ally u n in fl u e n t i al s m al l and m e d i u m - s iz e d b u s i n e s s m e n , r e ­

enviro n m e n tal p r o t e c ti o n .

luctantly resigned themselves to the N E P as a necessary c o s t o f citizen­

In some important ways, then, Vision 2020 rep resents a p artial return of the p endulum to the relatively pro - p rivate business policies of the first dozen years after independence in 1 957 in contrast to the state interven­

ship, c ivil p e ace, and personal security, i n the aftermath of the traumatic events o f M ay 1 9 6 9 . N o t s u r p r i s i n gly, therefore, M ah a t h i r c o u l d n o t s i m p l y r e p l a c e t h e

tion and public sector expansion of the next decade and a half under the

NEP with h i s own economic agenda whe n h e first came t o l e a d t h e nati o n .

NEP. As noted above, Vision 2020 reiterated the p olicy changes undertaken

The N E P h a d l o n g b e e n the legitimizing i d e o l o gy fo r M al ay hegemo ny,

fro m the mid - 1 9 8 0 s , initially defended as a necessary, but temporary re ­

on which b as i s the ruling U M N O h a d dominated the c o u nt ry since the

sponse to the mid- 1 980s recession. While not involving new p olicy changes,

mid- 1 9 5 0 s . Mo reover, the exp ectations g e n e rated by the promise o f the

Vision 2020 made the recent economic policies already in place more ex­

N E P could n o t b e ignored, e s p e c i ally if M ahathir was to retain p o litical

p l i c i t , coherent, and legitimate. Vis i o n 2020 thus shift e d emphasis away

d o m i n a n c e i n n a t i o n al and p arty e l e c t i o n s . F o r t h e s ake of c o n t i n u e d

fro m interethnic distrib utional concerns without abandoning them al t o ­

legitimacy, h e n e e d e d to fo rmally allow t h e N E P to run its course until

gether. It also prio ritized the challenges of l a t e industrialization without

1 99 0 , although h e quietly announced its suspension in early 1 98 6 , citing

seeming oblivious t o human welfare consid erati o n s . A s t h e reforms were staggered over a number of years during the mid1 980s, it is difficult and potentially misleading to credit these reforms with

the re c e s s i o n a s his p r e t ext fo r d o i n g so. This a l s o p rovi d e d a d e c e n t interval fo r a trans i t i o n p eriod t h a t c o u l d n o t b e denounced as illegiti­ mate as t h e N E P was still offi c ially i n p l a c e .

the subsequent improved macroeconomic p erformance. Supporters of the

N o n e t h e l e s s , m a n y o f M a h a t h i r 's e arly p o l i c y i n i t i a t i v e s fa i l e d t o

refo rms point to a sustained economic boom since 1 9 8 7 as evidence of

g a r n e r w i d e s p r e a d s u p p o rt . F o r ex a m p l e , t h e L o o k E a s t p o l i c y w a s

their success. Critics, h owever, emphasize that the d e flationary refo r m s

ambigu o u s ly r e c e ive d , and eve n t u ally fad e d away. The h e avy i n d u s t r i ­

exacerbated t h e 1 985- 1 986 recession, while t h e subsequent b o o m has been

alizat i o n p o l i c y i s n o w p rivately a c k n o wl e d g e d to h ave b e e n i l l - c o n ­

prim arily due to mass ive increases in fo reign investment from East A s i a

ceived and s o m e t i m e s even unfairly blamed fo r the e c o n o m i c c r i s i s o f

a n d elsewhere as well as restored domestic private sector investor confi ­

the mid- 1 9 8 0 s . The national car p roj ect is still touted as a great success

dence. By the time the Vision 2020 statement appeared, M alaysia was we l l

despite t h e h e avy protection it still requires (and the unlikel i h o o d o f i t

o n the road t o economic recovery, with growth rates o f over 8 percent per

b e c o m i n g i n t e r n a t i o n ally c o m p e t i t ive a n d e c o n o m i c ally vi a b l e i n t h e

annum, in co ntrast to the negative growth fo r 1 9 8 5 . T h e Delicate Politics o f Changing Governance

Vi s i o n 2 0 2 0 sym b o l i z e d imp roved governan c e , wh ich renewed p r i ­

m e d i u m t e r m ) . T h o u gh t h e M al ays i a I n c o r p o rated p o l i c y w a s w e l l r e ­ c e ived b y C h i n e s e a n d fo r e i g n b u s i n e s s i n t e r e s t s , o t h e r s w e r e largely indifferent, and the predominantly M alay bureaucrats dragged their fe e t , p robably c o rrec tly p e r c e iving i t as i m p ly i n g t h e i r resub o r d i n a t i o n .

vate investor confidence i n the M a l aysian government and was preceded

The Executive B ranch under M ahathir wrested control of t h e gove rn­

by i n d i r e c t a n d p ar t i al re p u d i at i o n o f t h e NEP. Th e N E P h a d e nj oyed

ment fro m the bureaucrats during the 1 9 8 0 s . B ureaucrat s , who were i o -

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Governance, Rent - Seeking, and Private I nvestment in M alaysia

Governance, Rent-Seeking, and Private I nvestment in M alaysia

creasingly relied upon in the 1 9 7 0 s , i . e . , the e arly N E P p e r i o d , thus lost

Governance and Rents

much influence under M ahathir who has made much more use of o u t ­

It is useful to consider what go o d governanc e really means for p rivat e inve s t m e n t by c o n s i d e ri n g t h e n a t u r e a n d c o n s e q u e n c e s o f r e n t c r e ­

side (mainly fo reign) c o n s ultants as well as " t h i n k t a n k s " o u t s i d e o f t h e established bureaucratic structure . Bureaucrats, w h o had developed much

ati o n , distrib u t i o n , a n d deployme nt by t h e governm e n t . T h e p r e c e d i n g review suggests a c o m b ination o f at l e a s t t w o diffe r e n t fo rces at work . Rents have b e e n created and all o c a t e d so as to e n c o urage investme nts

administrative clout under the NEp, were being asked to c o o p e rate with t h e very s e c t o r ( t h e e t h n i c C h i n e s e - d o m i n a t e d private s e c t o r ) , whi c h they o n c e l o r d e d ove r. I n c r e a s e d gove r n m e n t i n t e rve n t i o n s i n c e t h e 1 9 7 0 s has also b e e n associated with greater o p p o rtunities fo r c o rruption a n d other fo rms o f ab u s e , w i t h wh i c h t h e p r e d o m i n antly M al ay b u re a u c r at s , p o l i t i c i a n s , and p o l i t i cally i n t1 u e n t i al b u s i n e s s m e n are a s s o c i at e d . T h e r e is also a strong tendency to associate the creation and distribution of rents with the N E P, p ar t i c u l arly with gove r n m e n t e ffo r t s t o c r e a t e a B u m i p u t e r a c o m m e rc i al and i n d u s t r i a l c o m m u nity ( B C I C ) . I r o n i c ally, whi l e i n t e r ­ e t h n i c re d i s t r ib u t i o n e fforts-offic i ally a n d p o p ul arly t e r m e d "restru c ­ turing ( s o c iety) " i n M al aysi a-were strongly associated with t h e exp a n ­ s i o n o f t h e public s e c t o r in the 1 9 7 0 5 , they h ave increasin gly b e e n linked wit h p rivatizati o n in the last decade. H e n c e , although rents created by government interve n t i o n h ave o ften been captured by n o n - B umiputeras, i n c l u d i n g fo reign b u s i n e s s i n t e r e s t s , they are s t i l l g e n e r al ly p e rc e ived i n ethnic terms. O n the other hand , growi n g p o p ular resentment a n d frus trati o n with the public sector co ntributed to p opular acceptance o f p rivatizati o n , i n p articular since employee interests were generally protected in the maj o r p rivatizati o n s . Privat i z a t i o n h a s g e n e rally b e e n r e a s o n a b ly well m a n ­ a g e d by t h e gove r n m e n t t o e n s ure p o pular p ar t i c i p a t i o n a n d enthus i ­ asm ( mainly through d i s p e rs e d and d i s c o u n t e d share i s s u e s ) , although its adve rse c o n s e q u e n c e s fo r consumer welfare and the public i n t e r e s t are i n c re a s i n gly r e c o g n i z e d . I n s o far as privatizati o n has b e e n pursued in conditions o f buoyant growth , some adverse c o n sequences have been o b s c u r e d wh i l e t h e p o l i cy h a s c l a i m e d credit fo r the strength o f t h e e c o n o m i c r e c ove ry. By the t i m e of the announcement of the new p o s t - 1 9 90 p o l i c i e s i n early 1 99 1 , the post- 1 986 econo mic recovery h ad b e e n sustained fo r fou r years . Thus, the economic policy changes of the m i d - 1 9 80s-initially a n ­ n o u n c e d a s necessary compromises i n t h e face of economic crises-we re r e i t e rated and c o n solidated as part o f b r o a d e r s t r a t e gy to b u i l d a n ew Malaysia, i . e . . Vision 2020. What were once po rtrayed as u n avoidable con­ cessions to economic realiti e s h ave since b e e n recast as virtuous p o l i cies i n their own right .

1. 1

1 54

i n new p ro d uc t ive activi t i e s , which have accelerate d the diversific ation o f the e c o n o my fro m its colonial i nheritanc e . Much of this has empha­ sized industrial ization, initially o n the basis o f import substituti on, then

�xport

promotio n, he avy i n dustrializ at i o n , and technolog i c al upgradin g the 1 990s. H owever, constrain ts to better governan ce have meant that h e M al aysian s t a t e has not b e e n c a p a b l e of d e s igning and e ffe c t ively

111

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Imp l e m e n t i n g the kind o f s e l e c tive i n d u s t r i a l p o licy p r a c t i c e d b y the J a p a n e s e and S o u t h K o r e a n govern m e n t s .

T h e ava i l ab i l i ty o f n atural r e s o u r c e r e n t s h a s b e e n very s i g ni ficant fo r growt h , e xp o r t s , gove r n m e n t reve n u e , a n d h e n c e , fi s c al c a p a c i ty, allowi n g the governme nt greater latitude and capacity than m o s t other gove r n m e n t s i n t h e worl d . S u c h re s o u rc e wealth a n d M a l ay s ia's rela­

tively s m al l p o pulation e n abled t h e p u b l i c sector to grow i n the 1 9 7 05 a n d e arly 1 98 0 s with a "soft budget constrain t , " which not o n l y allowe d , but a l s o e v e n e n c o uraged vari o u s extravaga n c e s . S u c h fiscal " irre s p o n ­ sibility" s e e m e d to increase with greater state interventi on (B owie 1 99 1 )

and the availability o f enhanced oil revenues from the mid- 1 9 7 0 s-until the economic and political crises o f the mid- 1 980s brought about gre ater fiscal d i s c i p l i n e a n d tighter budget c o nstraints fo r public e n terp r i s e s . Redistribu tio n , especially alo n g interethni c lines, h a s b e e n t h e other maj o r goal o f rent creation and deployme nt in M alaysia. After increas i n g

Malay bureaucra tic hegemony in the 1 96 0 s , the r o l e a n d influence o f t h e p r e d o m i n antly M alay civil service were significan tly e n h a n c e d w i t h t h e NEp, o nly to give way to an increasin gly assertive Executive B ranch a n d a m o re politically influentia l rentier b u s i n e s s commun ity since th 1 e 9 80 s . P ublic sector expansio n under t h e N E P was also accompa nied by othe r i ntervent ions which h ad a cumulat ive crowdin g-out effect (with p e c i fi c thn i c h u e s ) reflected in significan t capital flight a n d declining p rivate ' mve s t m e n t s fro m the m i d - 1 9 7 0 s , and e s p e c i ally i n the e arly 1 9 8 0 s . S i n c e t h e 1 9 7 0 s , the all o c a t i o n o f rents by the state has o s t e n s i b ly b e e n p r i m a rily i nte n d e d to redistribu te wealth in favo r of B u m i p u t e ra an d to p r o m o t e t h e deve l o p m e n t o f B u m i p u te r a c a p i t a i i s t s . N e p

�

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otism

a nd p o l i t i c al b i as i n fav o r o f c r o n i e s o f t h e s a m e t h n i c g roup are also e 1 55

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Governance, Rent - Seeking, and Private I nvestment in M alaysia

Governance, Rent-Seeking, and Private Investment in M alaysia

l i kely to be p erceived as evi d e n c e o f ethnic b i a s , even though common

o n e can d i s ti n g u i s h a m o n g d e t e r m i n a n t s of a c c e ss-b e twe e n s c h e m e s

ethnici ty may not have b e e n the main consideration for such favoritis m .

equally accessible to a l l from a favo red group, a n d t h o s e i nvolving further

S u c h p e r c e p t i o n s o f e t h n i c b i a s h ave n o t o nly exacerbated eth n i c r e l a ­

c o m p e t i ti o n , s e l e c t i o n , o r all o c a t i o n p r o c e s s e s , wh i c h may e n c o u rage

t i o n s b u t have also d i s c o u raged inve s t m e n t s by t h o s e wh o s e e t h e m ­

re n t - s e ek i n g b e h av i o r.

s elves as l e s s favo r e d o r likely t o b e d i s c r i m i n a t e d agai n s t . H oweve r. although y i e l d i n g h a n d s o m e re turns, t h e b u s i n e s s o p e ra ­

While violating ethnically blind meritocratic principles u n d o u b t e dly b r e e d s e t h n i c fru s t r a t i o n s and r e s e n t m e n t a m o n g t h o s e who p e rc e ive

t i o n s of tho s e b enefiting from state- allocated rents have rarely been " e n ­

t h e m s e l v e s a s d i s c r i m i n a t e d aga i n s t , t h e r e is no c l e a r e vi d e n c e t h a t

t r e p r e n eurial " i n a S c h u m p et e rian s e n s e . I n s t e a d , th ey h ave b e e n p ri ­

g r e a t e r i n ve s t m e n t s a m o n g t h e l e s s a c a d e m i c ally s u c c e s s ful ar e e c o ­

m a r i l y d e r i v e d fr o m t h e r e l a t i v e l y p r o t e c t e d i m p o r t - s u b s t i t u t i n g

n o m i c ally w a s t e fu l , i . e . , that t h e s o c i al r a t e s o f r e t u rn o n e d u c at i o n al

manufacturing s e c t o r, s e rvi c e s , and other " n o n tradeab l e s , " such a s real

investments among the less educationally successful are lower than those

p r o p erty, c o nstructio n , u t i l i t i e s , d o m e s t i c infrastructure, a n d tran s p o r t .

for the more successful. especially since the latter tend to cost more and

O t h e r s have gained fro m m aj o r, o ft e n c o m p l e x financial and other c o r ­

also exp e c t greater r e m u n e ratio n .

p o rate maneuvers rather t h a n fro m significant productivity gains o r other i m p rove m e n t s i n t e r m s o f i n t e r n a t i o n al c o m p e titive n e s s . H e n c e , i t c a n b e argu e d t h a t t h e all o c a t i o n a n d a p p r o p ri a t i o n o f

S o m e redistributive pro grams may also h ave favorable consequences fo r p r o ductive inve s t m e n t s , e . g . , the p rovision of cr e dit with o u t collat­ eral to p o o r p e o p l e by the Grame e n B ank- like I khtiar scheme has facili­

s u c h rents h ave n o t r e q u i r e d t h e e n h a n c e m e n t o f t h e e c o n o my 's p r o ­

tated very p r o d u c t i ve investments reflected in high repaym e n t rates as

ductive capabilities a n d h ave . therefore, contributed little t o t h e M alay­

well as other p o sitive social as well as economic indicators. I t should be

sian e c o n o my. However, i n s o far as t h e s e involve straightfo rward trans ­

stressed that many redistributive interventions h ave made contributions

fers. there i s relatively l i ttle rent dissipation except b y investors incurring

to e n h a n c i n g p r o d u c tivity. F o r exam p l e , e t h n i c ally biased inve s t m e n t s

a d d i t i o nal tran s a c t i o n c o s t s . such as i n tryin g t o i d e n tify and p e rhap s

in human - re s o u r c e deve l o p m e n t h ave c e rtainly contrib u t e d t o p r o d u c ­

even h e l p finance s u i t a b l e B u m i p u t e ra p artn e r s . I n any c a s e . N E P " r e ­

tivity g a i n s , e . g . , b y overc o m i n g vari o u s c o l o n i al , c u l t u r a l , a n d u r b a n

s t r u c t u r i n g " w a s n o t s u p p o s e d t o invo lve " r o b b i n g P e t e r t o p ay Paul "

biases , and facilitating employment i n mo dern e c o n o m i c activities char­

( i . e . . a zero - s u m game ) . b u t to r e d i stribute new wealth created ( i . e . , a

acterized by higher p roductivity, altho u gh i t is unclear what the overall

p o s i tive sum game. o s t e n s ibly with a "win - win" i n t e re t h n i c o u t c o m e ) .

e c o n o m i c e ffe c t s of such ethnic b i a s h ave b e e n .

H e n c e . existing property rights have generally n o t b e e n violated. although

Wh i l e s i m p l e wealth tr ansfe r s d o n o t h ave p o s itive c o n s e q u e n c e s

redi stribution has often been affected by assigning other ( e s p ecially new)

fo r p r o d u c t iv i t y e n h a n c e m e n t , t h e y d o s e e m t o h ave adve r s e c o n s e ­

r i ghts and other claims to rents along ethnic and "political " ( i . e .. by those

q u e n c e s b y d i s c o u r a g i n g i n ve s t m e n t s o t h e r t h a n t h o s e wh e r e t h e r e ­

with p o l i t i c a l p ow e r and i n fl u e n c e ) l i n e s . However, s u c h i n t e re t h n i c

turns outweigh any anticipated wealth transfe r ( t o others ) . F o r exam p l e .

redistribution effo rts-an d the structure of rights thus created-may have b e e n n e c e s s ary to ensure the p o l i tical and e c o n o m i c stability so cruci al

facturing firms beyond a certain size h ave to ensure that at least 30 percent

t o investment, growth , and structural change .

o f e q u i ty is own e d by B u m i p u t e r a i n t e r e s t s - h a s p ro b ab l y a d v e r s e l \'

The economic effe cts of redistributive state interven ti o n have . the re ­ fo re , g e n e rally b e e n q u i t e d i ffe r e n t fr o m t h o s e n e c e s s a ry to e n h a n c e

m u s t have d i s couraged n o n - B u m i p u tera investments i n man ufac t ur i n g

the I n d u s trial C o o rdination Act ( l eA) requirement-that p rivate manu ­

affected the deve l o p m e n t of the manufacturing s e c t o r. Such c o n d i t i o n s

s t ru ctural change a n d e c o n omic d iversifi catio n . However, they have als o b e e n m o r e vari e d . R e d i s t r i b u t i o n has i nvolved r e n t s b e i n g stru c t u r e d

a s inve s t o r s a n t i c i p at e d l o s s e s ( e . g . , fro m d i s c ounte d stock transfers t o

and o ffered by t h e gove r n m e n t i n vari o u s ways to favor certa i n dem o ­ grap h i c g r o u p s o r regi o n s . H e r e , o n e might d i s t i n gu i s h b e twe en t h o s e

as new r i s k s due t o s h a red own e r s h i p . It is l i kely that such inve s t o r s

B u mi putera partners wh o might also eventu ally d e mand m o r e ) a s well wo u l d b e l e s s r e t i c e n t i n m a k i n g inve s t m e n t s i f t h e y d i d n o t h ave to

d i s c ri m i n at o r v m e a s u r e s t h a t e n h a n c e t h e p r o d u c t i v i ty o f e c o n o m i c r e s o u r c es ( e . g , p r o d u c t ive e d u c at i o n . trai n i n g as wel l as i n frastructura l inve s t m e n t s ) and t h o s e that s i m p l y transfe r e c o n o m i c re s o u rc e s . Al s o ,

b u s i n e s s i n t e r e s t s wo u l d have m a d e s li c h s i g n i fi c ant i nro a d s i n t o s e c -

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in cur such additio nal c o s t s and fac e gre a t e r u n c e rtain ty. Without such i n t e rve n t i o n s . however. it is u n l i ke l y that B u m i p u t e ra

Governance, Rent- Seeking, and Private I nvestment in M alaysia

Governance, Rent-Seeking, and Private I nvestment in M alaysia

tors o f the e c o n o my l o n g dominated by ethnic C h i n e s e o r fo reigners. If

tributive measures; most important, p erhaps , the priority given to such

such redistribution has c o ntributed to the greater political and economic

measures has tended to compromise and undermine the efficacy of inter­

s e c u ri ty s o vi tal to sustaining economic inve s t m e n t a n d growt h , i t may

ventions with other obj ectives as well , e.g. , p rivatization ( Jomo 1 995) .

be c o n s i dered a n e c e s s ary c o s t , alt h o u gh t h e re may be o t h e r, c h e a p e r

It is therefore necessary to distinguish b etween redistributive mea­

m e a n s o f attai ning such stability. O n e has to c o n s i d e r whether this was

sures that also enhance productivity and those that merely involve wealth

the cheapest o r most economic option available, given the nature o f the

transfers. Our e arlier review suggests that while considerable rent - s e ek­

p o l i t i cal s et tl e m e n t .

i n g h a s o c c u r r e d i n M al ays i a , not all rents h ave been d i s s i p a t e d by

Altho ugh t h e Malay b u s i n e s s community h a s grown rapidly, with many

s o cially unproductive ren t - s eeking activities. Many of the rents created

e l e m e n ts appearing to have deve l o p e d various degrees o f independence

have actually contributed toward enhancing productive capacity, though

from the state, most retain, cultivate, and ultimately rely o n their connec­

this has generally not o ccurred very efficiently except for a few notable

tions with top UMNO leaders to s ecure continued p atronage while, in tum,

exceptions ( e . g . , the effect of the export duty o n crude p alm oil in induc­

p roviding financi al and other backing for their political p atrons. Such rentier

ing r e fi n i n g c a p a c i ty i n ve s t m e n t s , wh i c h e v e n t u a l l y p r o v e d t o b e

activities have had p ro found implications for M al aysi a's p o litics and busi­

internat i o n ally c o m p e titive) .

n e s s , partic ularly with the ascendance o f business-based p o litical factions

T h u s , s o m ewhat i r o n i c ally, b o th the N E P 's e t h n i c " r e s t r u c t u r i n g "

within UMNo. For all sides, political and business p atronage involving the

a g e n d a a s well as s u b s e q u e n t e c o n o m i c l i b e ralizati o n , e s p e c i ally

state has remained the primary means to consolidate and enhance bu si­

privatization, h ave facilitated significant p rivate capture o f rents by the

n e s s as w el l as p o l i t i c al i n t e r e s t s ( Gomez and J o m o 1 99 7 ) .

politically well - c o nnected, p resumably with some sharing o f the rents

" Re s t r u c t ur i n g " - o r i n t e r e t h n i c redistrib u t ive i n t e rven tio ns-s e e m s

captured with those allocating them. Such appropriation and transfer of

to have been m o s t easily "captured" and a b u s e d , w i t h s o m e unfavorable

rents may w e l l v i o l a t e n o t i o n s of fai r n e s s , i n c l u d i n g t h o s e d e e m e d

c o n s e q uences fo r effi c i e n cy. Such abuse has been facilitated by the l im­

desirable fo r h e althy c o mp etitio n , b u t m ay n o t i n t h e m s e lves b e s o ­

i t e d a c c o u n t ab i l i ty r e q u i r e m e n t s r e q u i r e d by t h e gove r n m e n t a n d en ­

c ially wastefu l s i n c e they e s s e n ti ally o nly invo lve rent transfe r s . H ow­

h a n c e d b y m i n imal t r a n s p arency o f the rent a l l o c a t i o n pro cesses ( "ex­

ever, insofar as expenses may b e incurred in efforts to secure such rents

e c u t ive prero gative s " ) . I t s governance cap acity i n other regards suggests

( e . g . , e l e c t i o n c a m p a i g n e xp e n s e s ) , t h e y w o u l d be l a r g e l y w a s t e fu l ,

that the l a c k o f transp arency and accountability is by choice, and not just

involving dissipation o f the rents create d . Their respective p r o p o rtions

i n s t i t u t i o nally i n h e r i t e d . T h u s , while s o m e s t a t e i n t e rv e n t i o n s in t h e

would b e determined by the n ature of the rent-seeking regime created

e c o n o my-an d t h e r e n t s t h u s c r e a t e d-have e n h a n c e d a c c u m u l at i o n ,

by the i n t e rve n t i o n , and wo u l d h ave c o n s i d e rable b e aring-t o ge t h e r

e c o n o m i c d i versification, and late industrializatio n , n o t all in terventi o n s

with o t h e r relevant facto rs-o n t h e efficiency of t h e n e w rights created

h a ve c o n t ri b u t e d. to p r o d u c tivity e n h a n c e m e n t .

by the interven t i o n .

W h i l e the rat i o n ale fo r most government interve n t i o n in M alays ia i s

T h e m o r e effective linkage of rent access a n d capture to t h e achieve­

o s t e n s i b ly to p ro m o t e d evel o p m e n t . o n e ca n d i s ti n g u i s h i n t e rve n t i o n s

ment of s p e cific p o l icy goals has enhan c e d efficacy in the use of rents

i n t e n d e d to i n duce growth a n d structu ral change from those with red i s ­

as incentives and may, in certain circumstances, have reduced rent d i s ­

tributive a n d p o p ulist politi cal motive s . T h e p o l i t i c al legiti macy, acce p t ­

s i p at i o n . F o r examp l e , allowing t h e c o m p any t o c o l l e c t t o l l s o n t h e

a b i l i ty. a n d p r i o rity o f i n t e re t h n i c r e d i s trib utive e c o n o m i c m e a s u r e s i n

p rivatized N o rth- South H ighway as s o o n as it was built cr eated a n i n ­

M a l ays ia have been e s p e c ially important in shaping p e rceptions of gov­

centive fo r t h e c o mp any to s p e e d u p c o m p l etion o f t h e h i gh way a n d

e r n m e n t i n t e rve n t i o n , e s p e c i ally along ethnic l i n e s . Proponents o f such

thus b e a b l e to collect more in tolls.

re distribut i o n not only emphasize its p rogress ive aspects. e . g . , "comp e n ­

Meanwhile, accumulation in the " i nternationalize d " s e c t o r s o f the

sati n g fo r historical (colonial ) neglect or underdeve l o p m e n t . " but also its

economy has not been significantly undermined by the magnitude and

a l leged s o c i a lly and p o l i t i c ally s t a b i l i z i n g c o n s e q u e n c e s . s o c ru c i al fo r

nature of these rents, and has instead ensured mu ch of the growth and

sustained economic growt h . Critics emphasize various abuses which have

dynamism o f the Malay s i a n e c o n o my. The c o n t i n u e d and recently e n ­

ari sen, particularly in the course of impl e menting o st e n sibl y ethnic redis-

hanced allocation of rents in favor of industrializati o n . e s p e c i ally of the

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Governance, Rent - Seeking, and Private I nvestment in M alaysia

Governance, Rent - Seeking, and Private I nvestment in Malaysia

exp o rt - o ri e n t e d vari ety ( Ra s i a h 1 9 9 6 ) , has e n s u r e d r a p i d growt h , par­

erated had b e e n captured by those in p ower and their business cronies,

t i c u l arly in re cent ye a r s . H owever, this has b e e n mainly under fo reign

who in turn contributed to growth by reinvesting much of their captured

c o ntrol . wh ich rai s e s some d o u b t s about the s u s t a i n ab i l i ty of th e p r o ­

re nts, mainly in the "protected" d o m estic e c o n o my, e . g . , i n i m p o rt - s u b ­

c e s s . R e n t s have effe c tively s e rved as incen tives fo r fo reign i nvestors to

s t i t u t i n g i n d u s t r i e s , c o m m e r c e , s e rvi c e s , a n d p rivat i z e d u t i l i t i e s a n d

relocate exp o rt- oriented production in Malaysia, which has been resp o n ­

infras tru c t u r e . D e s p i t e vari o u s weakn e s s e s , t h i s S o ut h e a s t A s i a n b rand

sible fo r the rapid growth o f most such manufacturing in the 1 9 70s and

of e rsatz capitalism-involving changing forms of ren tier cronyism-had

again since the late 1 9 8 0 s . S o m e govern m e n t policy refo rms-including

s u s t a i n e d r a p i d growth fo r three o r fo u r d e c a d e s .

more effective implementation and enforcement ( e . g . , with the intro duc­

Interestingly, b u s i n e s s organizat i o n s , relations, p racti c e s , and norms

t i o n of " o n e - s t o p a g e n c i e s " ) - h av e r e d u c e d c 1 i e n t e l i s t p ay- o Us to

that had p revi o u sly been credited with h e l p i n g create and s u s t a i n the

gove r n m e n t o ffi c i a l s and p o l it i c i a n s fo r s u c h fi r m s , wh i c h e s s e nt i al l y

S o u th e a s t Asian e c o n o m i c miracle h ave s i n c e been c o n d e m n e d as the

o p erate within the realm of the global, rather than the national econo my.

sources of the d e b a c l e . I t also b e c am e fas h i o nable i n some q u arters to

It n e e d s to be emphasized that M alaysia has n o t really experienced

suggest that such p ractices and developments had their roots in J apanese

t h e kin d s o f very pai nfu l e c o n o m i c p r o b l e m s t h a t o t h e r l e s s fo rtunate

or more generically East Asian culture, where norms and relationships that

economies of the South exp erienced in the 1 98 0 s . F o r instance, M alaysia

i n fl u e n c e relat i o n s b etwe e n the state and the p rivate s e c t o r (as well as

has never really suffered fro m s evere capital shortages , and d i d not bor­

among businesses) that invariably involve welfare - reducing, if n o t down ­

row very heavily fro m abroad u n ti l the e arly 1 9 8 0 s (wh e n liquidity was

r i g h t d e b il i t a t i n g , re n t - s e e k i n g b e h avi o r. I n s o fa r as s u c h r e l at i o n s are

tighter and real interest rates higher) . And unlike some other late borrow­

believed to exclu d e outsiders, their elimination i s b elieved to contribute

ers ( e . g . , India) , its spending-and therefore borrowing binge-came to an

to leveling the playing field and b ringing about an inevitable convergence

end by the mid- 1 980s. M alays ia has also had considerable resource rents

toward s u p p o s edly Anglo -American s tyle arm's - l e n gth market relatio n s .

to c all u p o n , and a relatively small p o pulation to distribute them to.

O n c e i t w a s c l e a r t h a t the regio n's macro e c o n o m i c i n d i c a t o r s were

N ev e r th e l e s s , t h e M al a ys i a n c a s e s u g g e s t s t h a t i m p ro v e d gove r ­

not seriously awry, and in the wake o f the recent debate o n Asian values

n a n c e - i n t h e fo r m o f p a r t i al d e re g u l a t i o n a n d " i n v e s t o r - fr i e n d l y "

and other cultural, institutional, and b e h avioral differences, many com­

reregulation-has b e e n critical fo r t h e chief exe c u t ive's cap acity to qui­

mentators increasingly invoked Southeast Asian cronyism and its alleged

e t l y a b a n d o n N E P- r e l a t e d p o l i c i e s d e s p i t e c o n s i d e ra b l e s u p p o rt and

consequences as new explanation s fo r the crise s . Most such critics c o n ­

exp e c t a t i o n s (wh i c h h e e ffe c t i vely d i s c r e d i t e d by r e fe r r i n g t o t h e m as

d e m n e d s o m e c aricatured image o f r e nt - s e eking i n the r e g i o n-as

part o f a " s u b s idy m e n t al i ty " ) . M ah a t h i r has e ffe c tively used a n d d e ­

retl e c t e d in vario u s all e g e d d e p artures fro m s o m e "market fu n d a m e n ­

ployed t h e enhanced resources a n d powers a t t h e d i s p o s al of t h e Execu ­

tali s t " i d e al-to explain the cri s e s , u s u ally ignoring a l l t h e s u b tl e ty and

tive B ranch to great advantage , bringing about partial and selective eco­

nuance of extant analyses o f rent - s eeking in the regi o n . Thu s , Southeast

n o m i c l i b e ralizati o n favo r e d by b u s i n e s s i n t e r e s t s , i n c l u d i n g fo r e i gn

Asi a's fi nancial turmoil came to h e portrayed as having been induced hy

inve s t o r s . M a l aysian gove rn an c e h a s b e e n e n h a n c e d by s o m e e ffe c t i ve state i n s titutions and capabili t i e s , a u t h o ritarian p owers , abundant e c o ­

alleged crony c a p i t a l i s m and ren t - s e e k i n g i n the regi o n .

n o m i c r e s o u r c e s ( i n cl u d i n g r e s o u r c e rent s ) , and a vi s i o nary a s we l l a s d e t e r m i n e d p o l itical l e a d e rs h i p . H e n c e , the gove rn m e n t h a s b e e n a b l e

capitalism have actually precipitated the crisis or that they can satisfact o ­

to ensur e rapid growth with a h i gh inve s t m e n t rate , and con tai n pote n ­ t i a l ly d e s tabilizing c o n tli c t s , a l b e i t in t h e fac e o f some criticism o f its a b u s e of its p o wers ( C r o u c h 1 9 9 2 ) . The 1 99 7 Debacle

It wo u l d b e diffi c u l t , however, to s h ow t h a t ren t - s e eking and c r o n \" rily explain its b a s e s a n d o r i g i n s . As I have argu e d in t h i s c h a p t e r, t h e arrangements ( o r various incarnations of i t ) which have underpinned ren t i er c ronyi s m h a ve b e e n p art and p a r c e l o f rapid economic deve l o p m e n t i n Malays ia throughout the postwar e r a . To s ay t h a t s u c h arrangements l e d t o t h e crisis is like saying that the exercise that one has been doing to keep healthy all these years i s responsib l e fo r a recent he art attack.

M a l aysi a's , and m o re g e n e r a l l v S o u t h e a s t A s i a's , e c o n o m i c b o o m

What can be s a i d t h o u g h , a n d I h ave d i s c u s s e d t h i s ext e n s ively

h a d b e e n built o n r e n t i e r i n st i tu t i o n s . M u c h o f t h e reta i n e d wealth g e n -

elsewh e r e , i s t h a t cronyism ( a n d n e p o t i s m ) c e rt a i n l y i n fl u e n c e d o ffi c i a l

1 60

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Governance, Rent - Seeking, and Private Investment in M alaysia

p olicy responses to the crises in Malaysia ( Jo m o 1 99 8 ) . More important,

C HA P T E R S E V E N

such influences-real as well as imagined-may well have exac erbated the crises and are likely t o c ontinue to undermine confidence i n govern­ ment e ffo r t s , and thus d e l ay recove ry. There is now little serious disagre e m e n t that the e c o n o m i c turmoil since mid - 1 99 7 b e gan as currency and liquidity cris e s . I t is also increas­ ingly agreed that the crises were principally d u e t o the undermining o f p revious systems o f financial governance due t o deregulati o n a n d other deve l o p m e nts associated with the growin g infl u e n c e o f financial inter­

GOVERNANCE AND GROWTH IN THAILAND Allen Hicken

ests at b o th international and natio n al levels as well as other pressures fo r financial liberalization and globalizat i o n . I t i s now also increasingly acknowledged that the currency and liquidity crises b e c ame crises o f the " r e al e c o n o m y " mainly due t o i n a p p r o p r i a t e gove r n m ent-and I M F­ policy responses as the problems emerged ( e . g . , Radelet and Sachs 1 99 8 ; Jomo 1 99 8 ) . The failure of government to respond adequately and quickly is p artly

Like the other countries in this study, Thailand has experienced rapid

due to the mismatch between the institutional arrangements in the finan­

e c o n o m i c growth and large - s c a l e fo r e i g n d i r e c t inve s t m e n t ( F D I ) fo r

cial sector, e . g . , regulations and the capacity t o implement and monitor

much of the last two decades. I n fac t , b etwe e n 1 98 6 and 1 99 0 , Thailand

p e rfo rmance o f b anks, and the demands o f financial l i b eralizat i o n and

had the fas t e s t growi n g e c o n o my i n the world ( Warr and B h a n u p o n g

glob alizat io n ( Jo m o 1 99 8 ) . I t h as also been du e , however, to the institu­

1 99 6 ) . However, t h i s p e r i o d o f i m p re s s ive p e rfo rmance i s b racket e d o n

tional inertia of rentier cronyism as evidenced by the reticence of govern­

o n e s i d e by s e r i o u s e c o n o mi c p ro b l e m s o f t h e e arly- m i d - 1 9 8 0 s a n d by

m e n t t o c l o s e b adly p e rfo r m i n g c o r p o r a t i o n s and cut s u p p o rt fo r t h e

the e c o n o m i c deterioration and eventually crisis o f the m i d - late - 1 99 0 s .

politically influential ( G o m e z a n d Jomo 1 99 9 ) -both o f which would have

What explains t h e varying fortun e s o f t h e Thai economy? Certainly, s o m e

given the international financial community more confidence in the will ­

of t h e explanations c a n b e trace d t o factors completely outside o f Thai­

ingness and ability of the government to stop the h e m o rrhage .

land. T he oil s ho cks o f t h e 1 9 7 0 s , c o m b i n e d with the glo b al r e c e s s i o n during the first h a l f of the 1 98 0 s , brought tremendous strain t o bear on the Thai e c o n o my. The depreciation o f the dollar relative t o other cur­ rencies and a flood of FD I fro m northeast Asia in the middle of the late 1 9 8 0 s p rovi d e d the fu el fo r the e c o n o m i c boom. Finally, t h e a p p r e c i a ­ tio n o f t h e d o l l ar, c o m b i n e d with gre a t e r c o m p e ti t i o n fo r b o t h fo reign investment and exp o rt market s , had n egative effects on Thail and's e c o ­ n o m i c p e rfo rmance i n t h e m i d d l e o f the l a t e 1 9 9 0 s . H ow e v e r , i n t e r n a t i o n a l e c o n o m i c fa c t o r s d o n o t fu l l y e x p l a i n Thailan d 's e c o n o m i c pe rfo rmance ove r t i m e . Policy makers can res p o n d to changes i n the i n t e r n a t i o n al e c o n o m i c e nviro n m e n t i n a variety o f ways-some of which a r e conducive to investment a n d growth a n d s o m e o f which a r e n o t . I n the Thai c a s e , the e c o n o mi c adj ustments initiated d u r i n g t h e e arly p art o f t h e m i d - 1 9 8 0 s p aved t h e way fo r t h e s u b s e ­ quent high growth, while the failure o f t h e gove r n m e n t t o adj u s t d u r i n g

HI

t h e 1 9 9 0 s c o n t rib u t e d t o t h e d e t e r i o r a t i o n a n d e v e n t u a l c r a s h o f t h e 1 62

1 63

T Governance and Growth in Thailand

Governance and Growth in Thailand

e c o n o m y. T h i s c h a p t e r fo c u s e s on e xp l a i n i n g t h e d i ffe r e n c e in t h e

T i n s u l a n o n d a r e s p o n d e d by i m p l e m e n t i n g c o s t l y b u t n e e d e d p o l i c y

gove r n m e n t 's p o l i c y re s p o n s e d u r i n g t h e s e p e r i o d s . C o n s i s t e n t w i t h

reforms i n several areas , " F o r examp l e , i n the e arly 1 9 8 0 s i n t e r e s t rates

t h i s vo l u m e's t h e m e I e m p h a s i z e the l i n k b e twe e n g ove r n a n c e , inve s t ­

were r a i s e d i n o r d e r to p ro d u c e a p o s i t ive r e a l i n t e r e s t rate and s l o w

m e n t , a n d growth a n d d e m o n strate t h a t t h e q u a li ty of gove r n a n c e i n

capital flight. The b aht w a s also d eval u e d , first i n 1 9 8 1 and t h e n again

T h a i l a n d h a s d e c l i n e d s i n c e t h e late 1 9 8 0 s with p re d i c table e ffe c t s o n

in 1 9 8 4 . F o re i g n bo rrowi ng was curtailed and the Bank of Thailand was

e c o n o m i c p e rfo r m a n c e .

give n gre ater p ower over the fi n a n c i a l s e c t o r. In 1 9 83 a p o l i cy t o l i m i t

The chapter i s organ i z e d as follows: I fi rst b r i e fly review the m a c ­

c r e d i t w a s i n t r o d u c e d and c h i t fun d c r e d i t c o m p an i e s were o u tl awe d .

roeconomic shocks of the 1 9 70s a n d early 1 98 0 5 , t h e i r effe ct on t h e Thai

Govern m e n t s p e n d i n g was a l s o s l a s h e d a n d several large - s c a l e i n fr a ­

e c o n o my and gove rn m e n t 's re s p o n s e t o t h e s e s h o c k s . [ then t u r n m y

structure p ro j e cts were scrapped o r s c a l e d b a c k . Finally, macro e c o n o m i c

attention t o t h e l i n k b e twee n a c o untry's p o litical structure a n d t h e quality

p o licy makin g w a s centralized under the d i r e c t i o n a n d p r o t e c t i o n o f P r e m

of governance, arguing that given Thailand 's political structure, the "go o d

( m o re o n t h i s p o i n t b e l o w ) ,

governance" i n the e arly p art of t h e m i d - 1 980s s h o u l d b e viewed as the

Although these p o licy resp o n s e s by Prem's government were at times

exception rather than the rul e . I explain how Thailand was able to over­

b el a t e d a n d reluctant ( WaIT a n d Bhan u p o n g 1 9 9 6 , 2 ( 9 ) the n e e d e d r e ­

come some of the weakne s s e s inherent in its political sys t e m during this

forms were carried out. [n fact, reforms were implemented even in t h e face

period and thus lay the fou ndation fo r the later economic boom. Finally,

of s t r o n g o p p o s i t i o n fro m p o l i t i cal p ar t i e s , b u s i n e s s gro u p s , a n d m o s t

I d i s c u s s h o w t h e q u al i t y o f g o ve r n a n c e was u n d e r m i n e d i n t h e l a t e

signifi c antly, t h e military. A s a result of t h e s e reforms t h e macroeconomy

1 9 8 0 s and 1 9 9 0 s a n d h o w t h i s h a d affe c t e d p r o s p e ct s fo r growth and

was stabilized. By 1 985 the current account deficit had been reduced fro m

i n ve s t m e n t .

7 . 3 p e r c e n t o f G D P (gross d o m e s t i c p ro d uct) in 1 9 8 1 to 4 p e r c e n t . The

External Shocks and Macroeconomic Adj ustment

As the Thai e c o n o m y e n t e r e d the 1 9 8 0 s i t was struggl i n g to adj u s t to the same external shocks b e s ieging m u c h of the deve l o p i n g w o r l d at the t i m e . The two o i l shocks in the 1 9 70s caused a severe deteriorati o n i n T h a i l a n d 's t e r m s o f t r a d e . R a t h e r than u n d e rt a k i n g p a i n fu l adj u s t ­

currencies after the 1 985 Plaza Accord further strengthened Thailand's terms of trade and led to a current account surplus in 1 986 (see table next p age) . The budget deficit was also brought dov\11 fro m 4 . 7 percent of GDP in 1 982 to 1 . 1 percent i n 1 98 7 , a n d fin ally to a surplus of 1 . 7 percent i n 1 9 8 8 . T h e fru i t of the stru ctural adj u s t m e n t u n d e r P r e m w a s a s t a b l e a n d

m e n t , T h a i l a n d c h o s e to b o rrow i n t e r n a t i o n ally. ] I n i t i ally t h i s strate g\'

restructured m acro e c o n o m y. This p l a c e d Thailand in a p o s i t i o n to take

was attract ive given t h e l owe r i n t e r n a ti o n al i n te r e s t rat e s . However, a �

advan tage of the fl o o d of i nvestment fro m N o rtheast Asia during the l a te

i n terest rates began to c l i m b in t h e l a t e 1 9 70s a n d early 1 9 80s it beca m c c l e a r t h a t bo rrowi n g i n t e rn at i o n al l y c o u l d no l o n ge r s e rve as a s u b st i ­

1 9 8 0 s . As c o m p an i e s in Japan , Taiwan , and H o n g Ko n g s o u ght to m ove more production offshore in response to currency appreciation and risi n g

tute fo r e c o n o m ic ad j u s t m e n t . [ n the meanti m e , Thailand had b u i l t u p

labor costs, Thailand 's sound macro e c o n o m y m ade it an attractive choice

a substan tial debt burd e n . Yet eve n as the debt burde n was growin g, t h e

fo r i n ve s t o r s . B etween 1 9 87 and 1 9 8 8 total fo reign d i re c t inve s t m e n t in

gove rn m e n t 's a b i l i ty to s e r v i c e t h i s d e b t was b e c o m i n g p r o b l e m a t i c .

Thailand m o re than trip led; F D I fro m N ortheast Asia increased more than

N a t i o n a l s av i n gs h a d d e c l i n e d s h a r p l y i n t h e e a r l y 1 9 8 0 s a n d e x p o r t

fo urfo l d . Total and Northeast Asian F D I doubled again betwe e n 1 9 88 a n d

c o m p e t i t i ve n e s s was growi n g w e a k e r. T h e b a l a n c e o f p a v m e n t s a n d

1 990. T h i s D o o d of i nvestment helped fuel the boom in the broader econom\'

p u b l i c s e c t o r d e fi c i t s were large a n d c l e arly u n s u s t a i n a b l e ( Wa rr a n d

over the same period ( see table next pagel .

Bhanupong 1 996) .

Tha i l a n d 's re s p o n s e s to t h e e c o n o m i c c h a l l e n g e s of the e a r l y- a n d

To s u m m ar i z e , as t h e e c o n o m y e n t e red t h e e a rly p a r t o f t h e m i d -

m i d - 1 9 8 0 s , a n d t h e growth t h e s e resp o n s e s m a d e p o s s i b l e , a r e i m p r e s ­

1 9 8 0 s , m aj o r structural adj ustments and e c o n o m i c refo r ms were req u i red

s i ve o n t h e i r o w n m e r i t . J {owever, they are eve n m o re i m p r e s s i v e w h e n

in order to k e e p the p r o b l e m s fro m d e g e n e r a t i n g i n t o a c r i s i s . M a j o r

u

depreciation of the dollar (to which the b aht was p egged) relat ive to other

o n e c o n s i d e rs the p o l i t i c a l s t r u c t u r e wi t h i n wh i c h Th a i p o l i c y m a k e r s

l e n d e r s , i n c l u d i n g t h e Wo rl d B a n k a n d t h e I M E viewed t h e e C O n O ll1\ with growi n g alarm ( D o n e r a n d A n e k 1 9 9 4 ) , T h e g o v e r n m e n t of Pre m

typ ically o p e rate, As d e s c r i b e d b e l ow, Thail a n d 's po l i t i ca l s t r u c t u re oft e n

1 64

1 65

m ak e s " go o d gove r n a n c e" a d i ffi c u l t go a l to a c h i eve ,

r

1

�j

Governance and Growth in Thailand

Governance and Growth in Thailand

features of the political system , particularly the electoral rules and party

GOP Growth (%)

FOI (millions o f US $)

Current Account Inflation Rate Budget Surplus (GOP deflator) Balance (% of GOP) (% of GOP)

system, generate incentives that shape how these choices are made. Cer­ tain electo ral rule s , fo r instance, provide incentives fo r candidates and

1 980

5.2

1 90

1 2.7

-6.4

4.9

voters to place a relatively high value on party label while others encour­

1981

5.9

291

8.4

-7.3

-3.4

age candidate - centered campaigning." The party system, too, affects the

1 982

5.4

191

5.1

-2.7

-6.4

value of party label. Where the party system is made up of political parties

1 983

5.6

350

3.7

-7.2

-3.4

with established electoral histori e s , clear p o licy positio n s , and internal

1 984

5.8

401

1 .4

-5.0

-4.0

cohesion, then party labels will tend to carry weight with voters and can­

1 985

4.6

1 63

2.2

-4.0

-5.2

didates. If, on the other hand, parties come and go from election to election,

1 986

5.5

263

1 .7

0.6

-4.2

candidates switch p arties frequently, and parties are riddled by factional

1 987

9.5

352

4.7

-0.7

-2.2

problems, then the value of party labels is undermined .

1 988

1 3.3

1 ,1 05

5.9

-2.7

0.6

When party labels are weak, candidates must rely on building up their

1 989

1 2.2

1 ,776

6.1

-3.5

2.9

personal reputati ons and p e r s o n al n e tworks of s u p p o rt in order to b e

1990

11 .2

2,444

5.8

-8.5

4.5

elected. This p rovides strong incentives for candidates t o direct b e nefits

1991

8.6

2,014

5.7

-7.7

4.7

(e.g., pork barrel funds and patronage) toward their narrow constituencies.

1 992

8.1

2,1 1 3

4.5

-5.7

2.8

As individual candidates they cannot credibly claim credit for the p rovi ­

1 993

8.4

1 ,804

3.3

-5. 1

2.1

sion of national goods and p o l i c i e s , n o r can they gain much electoral

1994

8.9

P66

5.1

-5.6

1 .8

advantage by claiming to be a member of a p arty that delivered national

1995

8.8

2,068

6.0

-8. 1

2.9

policies, especially when coalition governments are the norm. However,

1 996

5.5

2,336

4.0

-8. 1

2.4

they can claim credit for particularistic goods and services targeted to their

1 997

-0.4

3,745

5.4

-1 .9

-0.9

SOURCE: World Delle/o p mell l Indicators 1 999 (CD - ROM) .

specific constituents and supporters. Indeed, their electoral fates depend primarily upon their ability to deliver targeted benefits to narrow constitu­ encies rather than more general benefits to b roader constituencies. Thai p oliticians are not unique in their focus on narrow co nstituencies. There

Political Structure and Governance

The quality of governance in Thailand, or any other p olitical system , is in part a reflection of two factors : first, the incentives policy makers face,

u

is an extensive literature on the way the electoral and party systems shape the size of a politician's constituency in countries as diverse as Japan, Italy, Taiwan and Brazil (see, for example, Reed 1 994; Cox and Thies 1 99 8 ; Carey and Shugart 1 99 5 ; Lij phart 1 994; and Katz 1 986) .

and second, their capabilities to pursue their p referred policies (Cox and

Whether or n o t the p arties that make up the p arty system are na­

McCubbins 200 1 ) .1 The incentives and capabilities p oliticians have in order

tional p arties also affects p olitical actors' incentive s. Parties that have a

to pursue policies that ( 1 ) bring long-term benefits at short- term costs, or (2) benefit society as a whole, but impose concentrated costs o n small ,

nationwide b a s i s o f s u p p o rt are g e n e rally m o re likely to p u r s u e " n a ­ tional " p o l i c i e s ben efiting a large segment o f society-than a r e p arties

p owerful groups, are important determinants of the quality of governance

with smaller bases of support, such as regionally based parties, or single­

in any country. For purposes of this chapter I label these long-term, broadly

issue p arties ( M ainwaring and Scully 1 9 9 5 ) . " The extent to wh ich the

beneficial types of policies as "national policies . " 4 Examples include such

p arty system is composed of national parties also bears directly on the

po licies as lower tariffs , p rudential regulation, and education reform.

capability of p o licy makers to gove rn, the subject of the next s e c t i o n .

Governance I n c entives

Governa n c e C a pability

Political actors in all systems face choices regarding the types of poli­

The r o a d to hell is p aved with go o d i n t e n t i o n s . Even with t h e b e s t

cies they will p u r s u e and t o which interests they will respond. Certain

of incentives, p o licy makers m ay s t i l l fai l to e n a c t m u c h n e e d e d p o l i c i e s .

1 66

1 67

Governance and Growth in Thailand

For "go o d gove rnance" t o exi s t , p o litical actors m u s t h ave not o nly t h e i n c e nt iv es t o p a s s n a t i o n al p o l i c i e s , b u t a l s o t h e c a p a b i l i ty to do s o . C a p a b i l i t y i s large l y a fu n c t i o n o f t h e n u m b e r o f v e t o p l ayers in t h e system-the larger t h e numb e r o f veto players, t h e more difficult it will be fo r a government to act in a decisive manner ( Tsebelis 1 99 5 , Cox and

Governance and Growth in Thailand

On the o t h e r h a n d . the Thai p arty sys t e m p r o d u c e s m u l t i p l e v e t o p l aye rs . T h e e l e c t o ral r u l e s ( p a rt i c u l arly two - a n d t h re e - m e m b e r d i s ­ tricts ) , c o m b i n e d with t h e weakn e s s o f Thai p o l i t i c al p artie s , p r o d u c e m u l t i p l e p arti e s at t h e district and natio nal levels ( H icken 1 99 8 , 1 99 9 ) . " The result is n u m e rous p arti e s in p arliament and coalition government (see table below) . In additio n, virtually every p arty consists of two or more

M c Cu b b i n s 2 0 0 l ) .

factions in c o m petition with one another. The large number of parties in

I t i s i m p o rtant t o d i s t i n g u i s h b e tween i n s t i t u t i o nal veto points and veto p l ayers . Institutio nal veto p o ints are t b e p o ints i n the po l icy- mak­

the C a b i n e t , c o m b i n e d with the fac t i o n al d i vi s i o n s with i n n e a rly every

ing p r o c e s s where att e m p t s t o change o l d p o l i c i e s o r adopt new o n e s c a n b e overturne d . Veto p laye rs are those actors, collective o r individual,

policy- making p r o c e s s (multiple veto p l ayers ) . This has an obvious i m ­

that sit at the various veto points. The numb e r of veto p o ints is a fun c ­ t i o n o f a country's constitutio nal structure. I s t h e r e a sep aration of p owers

party, m e ans that a large number of actors are typ ically involve d i n the p a c t o n t h e c a p ab ility of the gove r n m e n t to p r o d u c e n a t i o n al p o l i c i e s .

b e twe e n d i ffe r e n t b ra n c h e s or l e v e l s o f gove r n m e n t ? The n u m b e r of v e t o p l ayers is largely a fun c t i o n o f the p arty system-the n u m b e r o f p olitical parties a n d their cohesion. The p arty syste m , i n turn, is shaped b y the electoral system along with elements o f the national institutional structure ( H icken 1 9 9 9 ) . A system might have only o n e institutional veto p o in t ( e . g . , a unitary. u n i c ameral p arliamentary sys t e m without an i n d e p e n d e n t j udiciary) yet b ecause of a multip arty system. have coalition governments. Thus . while s u c h a sys t e m would h ave o nly one i n s t i t u ti o n al veto p o i n t , it would h ave m o re than o n e veto p l ayer. Agai n , the gre ater the number o f veto p l ayers . the less decisive a governm e n t i s expected to be. ceteris paribus . Similarly, a system with mUltiple veto p o i nts ( e . g . , a presidential syste m )

1986

1 988

1 992b

1 995

1 996

Number o f Parties in Parliament

14

15

11

11

11

Number of Parties in Cabinet

4

6

5

7

6

SOlJR(TS: Ecol l o ll7 isl inteiligent Ull il CO l / ll tl}' Repo rt: Tha i lu n d (va r i o ll s years ) ; r e p o rt o f t h e E l e c t i o n to t h e H o u s e o f R e p r e s e ntatives (var i o ll s y e a rs ) , E l e c t i o n D i vi s i o n . D e p ar t m e n t o f L o c a l Administrati o n , I n t e r i o r M i n i s t ry.

T h a i p o l i t i c i a n s a l s o g e n e rally l a c k s t r o n g i n c e n t i v e s t o p r o d u c e n a t i o n al p o l i c i e s . T h a i p arties h ave g e n e rally fai l e d to l i n k acro s s d i s ­ t r i c t s t o fo r m l a r g e n a t i o n al p a r t i e s a n d i n s t e a d r e m a i n l o c al l y o r

might s t i ll b e d e c i s i ve if o n e s t ro n g p arty contro l s all t h e veto p o i n t s . '

region ally b a s e d . A s a resu l t , a p a rty 's c o n s t i t u e n cy i s s o m e t h i n g l e s s

Governance Incentives and Capabilities i n Thailand

students of Thai p o l itics as well as Thai p o l i ticians and p arty leaders is

than a natio nal constitue ncy. I I} In additio n , the consensus of virtually all that p arty l a b e l s are weak. I I Candidates t e n d to rely on p e r s o nal vo t e ­

Both the i nc e n t i ve s to p rovide nat i o n al p o l i cy and the capab i l i t y t o d o s o a r e s o m ewhat l a c k i n g i n t h e T h a i p o l i t i c a l sys t e m as it e x i s t e d prior to the new Constitution o f 1 9 9 7 . T h a i l a n d i s a c o n s t i t u t i o n a l

g e t t i n g strategi e s w h e n campaign i n g , rath e r t h a n camp aigning o n t h e

m o n archy a n d a u n i t a ry, as o p p o s e d to fe d e r a l . s t a t e . Th e k i n g is t il e h e a d o f state and t h e p r i m e m i n i s t e r h e ads the govern m e n t . T h a i l a n d i s a p arliame ntary sys t e m with t h e National As s e m b ly divided i n t o t w o

t h e i r su p p orters than with the conduct o f national policy. These support ­

b o d i e s : the H o u s e o f R e p r e s e n tatives a n d the S e n a t e . T h e S e n a t e d u e s n o t h ave veto power ( e . g . . i t can o n l y d e l ay le g i s l a t i o n ) a n d , u n t i l t h e

1 9 9 7 C o n s t i t u t i o n . was a n a p p o i n t e d b o dy." T o s u m m a r i z e , T h a i l a n d 's p o l i tical sys t e m is characteriz ed by a single i n s t i tu t i o n al v c t o p o i n t . T h e re

re putati on o r p o l i c y p o s i t i o n o f t h e p a rty. G i v e n t h i s , w e w o u l d exp e c t m o s t Thai p o l iticians to be more concerned with channeling b e ne fits t o ers can i n c l u d e both the voters in a p o litician's electoral district and any gro u ps or ind ividuals that help finance camp aigning (business intere s t s . p o l i t i c al patro n s , among o t h e rs ) .

To s u m marize, Thai politicians lacked strong i n c e ntives to c o n s i d e r interests beyond t h o s e of t h e i r local constituency a n d supporters, at least

i ve is no fo rmal separation of powers b e tw e e n t h e E x e c u t i v e a n d l.egi s l at l oc al b ranches as is the case i n the P h ili p p i n e s or K o r e a ; n e i t h e r d o T h a i . ) 8 9 9 1 n o s l e N ( ower p t n a c fi i n g i s e s i govern m e n t s exerc

p r i o r to t h e new C o n s ti t u t i o n . Howeve r, even i f some p o l i t i c i a n s had

1 68

1 69

s u c h i n c e ntive s , p o l i c y m ak i n g wo u l d remain d i ffi c u l t g i v e n t h e l arge number o f veto p l ay e r s i n t h e Thai p o l i ti c a l sys t e m . T h e e x p e c t a ti o n ,

Governance and Growth in Thailand

Governance and Growth in Thailand

then, is that Thailand should have had difficulty delivering the types of

as p r i m e m i n i s t e r. 1 3 With h i s m i l i t ary b ac kgro u n d Prem e nj oye d t h e

natio nal p o licies conducive to long- term growth and i nvestment ( e . g . ,

s u p p o rt of i m p o rtant factions within the military. He a l s o e nj oyed t h e

macroeconomic stability, infrastructure, education a n d training, pruden­

b acking of the king.

tial regulati o n ) .

As he was n o t a p o li t i c i a n , Prem did n o t fac e the same e l e c t o ral

The p uzzle then is given the political structure j ust described, how

constraints as elected p oliticians. H e was not directly accountable to the

is it that Thailand was able to enj oy such high levels of fo reign invest­

narrow co nstituencies that were the focus of p arty politicians. Numerous

ment and economic growth. How does one explain the apparent conflict

scholars have noted that Prem was able to stand ab ove factional p arty

b e tween exp ectations and outcomes? Relatedly, how does one explain

p o litics and take a br o ader view than the typ ical elected p oliti c i a n s . 1 4

the deterioration o f the e c o n o my in the middle p art o f the late - 1 9 9 0 s

However, while Prem's ince ntives to provide national policies m a y n o t

after years of strong performance? I n t h e next section I provide a partial

have been as w e a k as o t h e r p olitical actors, he still h a d to work with a

answer to these questions by l o o king at ( 1 ) the info r m al institutional

coalition of factionalized parties as p art of the policy- making process. I n

arrange ments adopted by the Thai government t o overc o m e s o m e of

other words, there were still mUltiple veto players in t h e p olicy process,

the governance problems inherent in the p o litical sys t e m , and (2) the

even under Premo This can be seen clearly by lo oking at the number of

e r o s i o n o f those info rmal arrangements over t i m e .

laws passed by the Prem governments compared to other governments.

Prem, Parties, and the Policy- Patronage C ompromise

During Prem's tenure, an average of 2 . 7 l aws p e r m o nth were enacted by the l egi s l ature. This is c o m p arab l e t o the figure fo r Prem's e l e c t e d

O n e way p o l i c y m a k e r s c a n c o m b a t g o ve r n a n c e p ro b l e m s i s by

successor, Chatichai Choonhavan-2 . 3 p e r m o nth-but m u c h less than

creating new formal institutio n s . 1 2 Independent central b anks , currency

during that of nondemocratic governments-6 .4 per month (Christensen

b o ar d s , and i n d e p e n d e n t regulatory agencies are exampl e s o f institu­

and Ammar 1 9 9 3 ) .

tional tools created t o help e nsure that p o licy making and implemen­

In short, the support of elected p arty p oliticians could not be taken

tation are timely and fre e fro m interference by p oliticians and special

fo r gran t e d . I n fac t , Prem's prede c e s s o r, G e n e ral Kriengsak, had b e e n

i n t e r e s t s . I n Thai l a n d , h oweve r, the p r i m ary s o l u t i o n t o gove r n a n c e

forced to step down as prime minister in 1 980 d u e , in p art, to h i s failure

problems during m o s t of t h e 1 9 80s came in t h e guise of informal, though

to maintain the support of party leaders. I n order to avoid a similar fate ,

signifi c ant, instituti o n al arrangements. Sp ecifically, a c o mp romise was

a n d fin d a way around t h e governance problems associated with mul­

struck between Prime Minister Prem Tinsulanonda and p arty politicians.

tiple veto players, Prem forged a compromise with political party leaders .

I label this compromise the " p olicy-p atronage compromise." I will first discuss the unique p o sition of Prime Minister Prem, his incentives and c a p ab ilities rel ative to m o s t of the prime ministers that followed hi m . and then turn my attention t o the compromise itself. Prime M inister Prem Tinsulanonda

The Po licy- P atronage C o mpromise

Prem and his advisors were aware that they needed the support of the political p arties for stability and l egitimacy purposes. However, they felt it was necessary to keep politiCians fro m interfering in certain p arts o f the p o licy- making process-p articularly macro econo mic p olicy.

For

Prem became prime minister in 1 980 until 1 9 8 8 . H e was not. how­

their part, p o liticians were anxious to e njoy the spoils of government,

eve r, an e l e c t e d m e m b e r o f p a r l i a m e n t . D u r i n g t h i s p e r i o d , wh i c h

but were also keenly aware of the need to maintain the support of the

C h a i - anan Samudavanij a ( 1 9 8 9 ) calls " s e m i d e m o cracy, " Thai gove r n ­

military. The exc e s s e s and instab ility of d e m o cratic governments fro m

ments came t o p ower via c o m p eti tive e l e c t i o n s . While e l e c t i o n s were

1 9 73- 1 9 7 6 h a d b e e n p art of t h e j u stification behind a return to military

held, the leaders of the various p olitical parties were unable to reach an

rule . The result was a compromise between Prem (and the techno crats) and the leaders o f the various p o liti cal p arti e s . Macro e c o n o mic p olicy

agreement over who among them should b e the premier. The heads of the p o l i t i c a l p a r t i e s a l s o r e a l i z e d that m i l i tary s u p p o rt r e m a i n e d an Prem Tinsulanonda, c o m m a n d e r of the army, to head the gove rnment

would b e i n s u l a t e d a n d run b y P re m - b acked t e c h n o c rats , a n d Pre m's app o intees would have the ability to set some limits on corrupti o n and r ent-seeking o n the p art of the p olitical p artie s . I n exchange, the p o l itical

1 70

171

indispensable condition for stable government. And so they asked Gen .

r ,

Governance and Growth in Thailand

Governance and Growth in Thailand

p arties would be given control o f the sectoral ministries ( e . g .. Commerce,

The Collapse of the Compromise

Industry, Educati o n ) and would b e allowed to run them with very l i ttle i n t e rfe rence from the prime minister ( C h r i s t e n s e n e t al. 1 9 9 3 ) . l �

The n a t u r e o f Thai p o l i t i c s fu n d a m e ntally c h a n g e d in 1 9 8 8 wh e n Chatichai Choonhavan , MP and head of the Chart Thai Party, was named

I nsulation o f M acroeconomic Policy

prime minis ter. The choice of Chatichai marked the first time under the

As discussed earl i e r, the fo undation of Thailan d 's e c o n o mic success

1 9 7 8 C o n s t i t u t i o n t h a t t h e prime m i n i s t e r's p o s i t i o n was given t o an

b e g i n n i n g i n the late 1 9 8 0 s w a s i t s p ru d e n t m a c ro e c o n o m i c p o l i cy.

elected politician . 1 H As a politician, C hatichai was under the same p r e s ­

T h a i l a n d was a b l e to adj u s t to t h e ext e r n a l s h o c k s of t h e 1 9 7 0 s a n d

s u re t o b u i l d a n d maintai n a p e rs o n al e l e c t o ral n e twork as any o t h e r

1 9 8 0 s and achieve e c o n o m i c stability because i t followed cautious e c o ­

Thai politician. For Chatic hai a n d the othe r members of his p ar ty, e l e c ­

n o m i c p olicies a n d adopted n e e d e d refo rms ( Warr a n d Bhanup ong 1 996) .

toral victory ( a n d future electoral success) stemmed fro m t h e i r ability o r

H oweve r, it was t h e i n fo rm a l p o l i cy- p atro n age c o m p r o m i s e t h a t gave

p o t e ntial t o d i r e c t resources t o the ir l o cal c o nstituents and s u p p o rt e r s .

p o l i cy m a k e r s the p o l i t i c a l s p a c e to a d o p t t h e s e c a u t i o u s e c o n o m i c

In short, as an elected p olitician and p arty leader, Chatichai had a much

p o l i c e s . P r e m was a b l e t o s h i e l d k e y e c o n o m i c officials fro m pressures

n arrower c o nstituency than did Prem and his tenure as prime minister

fro m those who might o p p o s e r e fo r m s , particul arly p ol i t i c a l p arti e s . It

depended o n t h e continued s u p p o rt o f p o liticians with e q u ally narrow

i s not a coincidence that most o f t h e policies designed t o combat the

c o n stitu e n c i e s .

e c o n o m i c p r o b l e m s o f the 1 9 8 0 s were m a c ro e c o n o m i c or fi n a n c i a l

Chatichai 's victory also marked the t r i u m p h of p rovincial p oliticians

p o l i c i e s . Macroeconomic policy u n d e r Prem w a s c entralized a n d headed

in t h e p o l i t i c al p r o c e s s . Chatichai 's p arty achieved electo ral s u c c e s s by

b y t e c h n ocrats . 1 6 The budgetary process was also kept out o f the hands

convincing many p rovincial p o liticians to run under the Chart Thai ban­

o f p o l iticians and centralized i n the Budget Bureau. Four o rganizatio n s

n er. This class of p o liticians, backed by the p rovincial business elite, had

e m e rg e d as t h e k e y gro u p s i n c harge o f macro e c o n o mi c manage m e n t :

been growi n g in stre ngth over t h e course o f t h e 1 9 7 0 s and 1 9 8 0 s . 1 9 As

the B u dget Bureau, the National Economic and Social D evelopment Bo ard

a group, the p rovincial p oliticians did n o t generally h ave strong national

( N E S D B ) . the M i n is try o f F i n a n c e , and the Bank o f Thailan d . Concerns

p o l i cy go als . I n s t e a d , t h e y were m o s t c o nc e r n e d with p r o t e c t i n g a n d

over economic stab i l i ty h a d l e d p revious military governments to insu­

promoting t h e n arrow b u s i n e s s i n t e r e s t s o f their constituency, t h e p r o ­

late these important macroeconomic agencies and this p attern continued

vincial business elite .Lo Other Chart Thai p arty l e aders included B anharn

under Prem (Christensen e t al. 1 9 9 7 ) . Prime M i nister Prem was directly

S i l p a - a rc h a , t h e p rovi n c i al b u s i n e s s m a n d u b b e d " Th e M o b i l e AT M "

over three o f t h e s e age n c i e s and in dire ctly over the Bank o f Thail a n d

because o f h i s readiness to extend financial assistance t o p olitical can­

( t h e h e ad o f t h e B an k o f T h a i l a n d i s a p p o i n t e d a n d r e m oved by t h e

didat e s , and Pramuan Sabhavasu , anothe r provincial businessman who

minister o f Financ e ) . 1 7 T h e s e o rganizations, typ ically h e aded b y tech n o ­

made his fo rtune in the construction industry and was a maj o r financier

crats and largely insulated fro m p o litical and e l e c t o ral p r e s s u r e s , were

o f Chart Thai candidates. In short, Chatichai 's victory b rought to p ower

a b l e t o act d e c i s iv e l y t o p r o d u c e the n a t i o n a l p o l i c i e s n e c e s s ary t o

p o l i t i c i a n s who l a c k e d i n c e n tives t o p rovide c e r t a i n n a t i o n al p o l i c i e s .

o ve r c o m e t h e c ri s e s o f t h e e arly- a n d mi d - 1 9 8 0 s a n d l a y t h e gro u n d ­

T h i s w as n o t o n l y b e c a u s e t h e e l e c t o r a l a n d p a rty s ys t e m s c o m p e l

work fo r future e c o n o m i c growt h .

p o liticians t o fo cus o n local, narrow interests, but also b e caus e t h e key

To summarize, t h e p olicy-p atron age compromise essentially reduced

members o f p rovincial p o l iticians ' c o n s tituencies were oft e n e i t h e r d i s ­

the n u m b e r o f veto p l ayers i n the area o f m a c ro e c o n o m i c p o l i cy a n d

interested or opposed to such policies.

allowed p olicy makers w i t h b ro a d e r interests than t h e typ ical p o l i ticia n

B e s i d e s u n d e rm i n i n g t h e n a t i o n al p o l i c y i n c e n t ive s i n t h e T h a i p o l i tical sys tem, Ch atichai 's victory a l s o introduced additional veto play­ e rs i n to the system. First, as p arty leader, Chatichai not only had to worry " about keep i ng othe r p arties in t e coalition happy, as Pre m did , but h

to set policy. Thus, t h i s group had the incentives and capability t o imp l e ­ m e n t c o s t l y b u t n e e d e d p o l i cy r e fo r m s , w h i c h w e r e o ft e n s t r o n g l y o p p o s e d by the military, p o l i t i c a l p a rt i e s , and / o r b u s i n e s s grou p s . T h e o u t c o m e o f t h i s compromise w a s the stabilization a n d e c o n o m i c reform p o l i c i e s o f t h e P r e m p e ri o d . 1 72

�

h

a l s o h a d to c o n t e n d with t h e var i o u s fa c t i o n s w i t h i n h i s own p a rty. Seco nd , the p o l iticization o f the prime minister's office le d directly to the 1 73

l Governance and Growth in Thailand

p oliticization of the o n c e technocratic and insulated economic agencies. I , I

Under C h a t i c h a i , virtu ally every Cabinet p o s i t i o n w e n t t o a n e l e c t e d p olitician. T h e M i n i st ry o f F i n a n c e was n o exc e p t i o n with the fin a n c e p ortfolio having b e e n given to Chart Thai financier Pramuan Sabhavasu.

Governance and Growth in Thailand

row constituencies as opposed to a nonpartisan premier with a broader c o n s ti t u e n cy. Thus, t h e s e t e c h n o crats us ually lacked t h e authority a n d a u t o n o m y t h a t t h e i r p r e d e c e s s o rs p o s s e s s e d . 22

The M i n i s t ry o f Finance also b ecame subj e c t t o t h e i n stability charac­ teristic o f c o alition government. During the eight years Prem was prime minister, there were o nly three finance ministers. I n the t e n years since,

governance problems ch aracteristic o f the Thai p o litical sys t e m . 23 H o w­

thirteen men had s e rved as finance minister-o n e o f whom s e rved two

ever, the consequences of p o o r i n c entives and weak capability could b e

s e p arate t e r m s .

s e e n l o n g b e fo re 1 9 9 7 . A s t w o c r i s i s c o m m e nt a t o rs n o t e d , " m a n y h ad

Further, C h a t i c h a i s o u gh t t o d e c re a se the in fl u en c e o f the t e c hn o ­ cratic N E S D B i n e c o n o m i c p o l icy making. Under Pre m , t h e NE SDB was given a c e n t r a l r o l e ove r e c o n o m i c p o li c y m a ki n g . N o t only was t h e o rganizati o n in charge o f e c o nomic planning b u t i t w a s a l s o given e c o ­ n o m i c c o o rdinating and m o n itoring responsib iliti e s . T h e s e cret ary- gen­ e ral o f the N E S D B also sat as the head o f the " Ec o n o m i c Cab i n e t , " the C o u n c i l o f E c o n o m i c M in i s t e rs ( C EM )

which was e n d ow e d with ful l ' Cabinet powers. F r o m t h i s p osition t h e N E S D B was a b l e t o screen, and o c c as i o n ally ve t o , t h e p o rk- b arrel p roj e c t s o f t h e e l e c t e d m i n i s t e r s in Prem C a b i n e t s ( Un g p a k o r n 1 9 9 2 , Anek 1 9 9 2 a) . Not s u r p r i s i n gl y, t h e N E S D B aro u s e d a c o n s i d e r a b l e a m o u n t o f r e s e n t m e n t o n t h e p ar t o f elected p o l itician s . T h e Chatichai government exp e l l e d t h e N E S D B fro m t h e Cabinet a n d removed its c o o rdinating a n d m o n i t o ring responsibili­ t i e s . The director o f the NESDB resigned in pr o test and was replaced by " a m o re p li a b l e t e c h n o c r a t " ( P a s u k and B ak e r 1 9 9 5 , 3 5 0 ) . F i n al ly, t h e

p o w e r over government c o n tracts w a s t a k e n fro m the N E S D B and placed u n d e r t h e control o f i n dividual m i n i s t ri e s . In s h o r t , by pushing a s i d e the techno crats, marginalizing the N E S D B , and giving c ontrol over gov­ e r n m e n t c o ntracts t o individual ministers, Chatichai 's government shifted c o ntrol o f p o licy and resources fro m the in su l a ted technocracy t o elected p o l i t i c i a n s ( i b i d . ) . L I A s a r e s u l t , m a c ro e c o n o m i c and fin a n c i al p o l i cy making b egan to fall vi c t i m to the s a m e gove r n a n c e c o n s traints ( p o o r incentives a n d multiple veto players) t h a t h ad b e e n t h e rule in t h e area of s e c t o ral p o l i cy. I t is i m p o rt a n t to n o t e t h a t n o t every gove r n m e n t p o s t was c o m ­ p l e t e l y t a k e n o v e r b y e l e c t e d p o l i t i c i a n s a ft e r 1 9 8 8 . E l e c t e d p r i m e ministers have n o t infreq u e n tly appointed techno crats t o head the e c o ­ n o m i c p o rtfo l i o s in an e ffo rt to b o o s t their C ab i n e t "s credib ility in the e y e s o f fo r e i g n a n d d o m e s t i c i n ve s t o r s . E v e n C h at i c h a i a p p o i n t e d a t e c h n o crat to h e a d t h e M i n i s try of F i na n c e l a ter in h is t e r m . However.

1,1 1\

The Consequences of Poor Governance

It is e asy to point to the recent crisis as prima facie evidence of the

t he s e technocrats were s t i l l accountable to e l e c t e d p oliticians with nar1 74

s e e n [ th e crisis] c o m i n g fo r s o m e t i m e . B u t little had b e e n d o n e . E c o ­ n o m i c p ol i c y m a k i n g a n d fi n a n c i al c o n t r o l s h a d l a g g e d b e h i n d t h e changes in t h e n ature a n d t h e p a c e o f t h e e c o n o my. Politics h a d g o t i n t h e way" ( P a s u k a n d B ake r 1 99 8 , 9 4 ) . F o r reasons discussed earlier Thai p oliticians are focused o n atte n d ­ ing to the interests of narrow constituencies. They have very little interest i n establishing c o n n e c t i o n s with b r o a d e r interest grou p s that might be concerned with the conduct of "national" policy. They d o h ave relatio n ­ ships with b u s i n e s s ( b o t h rural and urban) a n d many o f the p oliticians a r e b u s i n e s s m e n t h e m s e lve s , b u t the p ur p o s e of t h e c o n n e c t i o n s is mainly t o raise c o rr u p t i o n m o n e y, through t h e grants o f p roj e c t s and c o n c e s s i o n s t o i n d ividual firms (Ammar 1 99 7 ) . In short, p o liticians are i n t e re s t e d in fi r m / b u s i n e s s s p e c i fi c p ol i c i e s , rath e r than b r o a d e r " n a ­ t i o n al " p o l i cy. Thu s , p o l i ti c i a n s t e n d t o view t h e p u b l i c t r e a s u ry as a milki n g c ow, with t h e p oliticians' j o b b e i n g to channel the milk to their constituents and supporters. Some of this was accomplished via the le gal u s e o f all o c a t i o n of public r e s o u rc e s . In addition , politicians als o u s e d t h e s e c t o ral m i n i s tri e s as s o urces o f c o rr u p t i o n m o ney. S ecto ral Policy

As m e n t i o n e d above , s e c t o ral p olicy was never organ ized the way ma c ro e c o n o m i c p o l icy was u n d e r P r e m o B e c a u s e of t h i s , s i g n s of t h e m i s m a n a g e m e n t o f s e c t o ral m i n i s t r i e s b y p o l i t i c i a n s a p p e a r e d we ll b e fo re t h e macro e c o n o my b e gan t o s u ffer. I n 1 9 9 0 , d e s p ite t h e s t ro n g and growi n g de mand fo r a better educa ted wo rkfo r c e , Thail and ranked last amon g the ASEA N Five in terms o f the perce ntage o f the p o p ulatio n enrol led in s e c o ndary schoo l, a n d last in terms of t h e p ercen tage gradu ­ ate d fro m s e c o n dary institu ti o n s ( Wo rld Devel opme nt Indica to rs 1 999) . D espite rheto ric by p o liticia ns and a gener al rec o gnitio n that Thailand's e d uca tio n a l syst e m n e e d e d refo r m , in 1 9 9 8 Thaila n d 's b a s i c e d u c a t i o n i n fras tructu re s t i l l l agged b e h i n d t h e res t o f the regi o n ( LaB 1 9 9 8 ) . A s 1 75

Governance and Growth in Thailand

Governance and Growth in Thailand

the economic b o o m took on full steam in the late 1 9 8 0 s there was also

fo rce d to grant "concessions" to p rivate companies to undertake maj o r

a recognized gap in the demand for skilled workers and the actual supply

n e w inve s t m e n t p roj e c t s . " Pu b l i c i n t e r e s t w a s the first c a s u alty o f t h e

( T D R I 1 9 8 8 , 1 9 9 2 ) . I n 1 9 9 3 t h e d i r e c t o r of t h e I n d u s tr i al P r o m o t i o n s

sys t e m o f c o n c e s s i o n s that w e r e gran t e d d u r i n g this p e r io d " (Ammar

D e p artment of the J a p a n Ext e r n al Trade Organizat i o n ( J ETRO) warn ed

1 99 7 , 1 6) . The negotiation process was far fro m fair and transp arent and

that if Thailand did not solve its skilled - lab or bottleneck, "Japanese firms

concessions were rewarded to those with good political connections on

(would) increasingly look to places like Vietnam, where you h ave a better­

very favorable c o ntractual terms ( i b id . ) .

educated work force" ( quoted i n B ello et al. 1 99 8 , 5 7 ) . A full ten years had p assed since policy makers first recognized the need to b o o s t the supply

M acroeconomic Policy

o f skill e d l a b o r. D e s p i t e all o f the plans and p r o p o s als over this t i m e ,

The collapse of the p o licy- p atronage compromise in 1 98 8 subj ected

a severe shortage of skilled l a b o r continues to b e a p roblem (Doner and

macr o e c o n o m i c p ol i cy t o many o f t h e s a m e p o l i t i c al constraints t h a t sectoral p olicy h a d operated under. However, the effects of these constraints

B ri m b l e 1 9 9 8 ) . I n frastructure b o ttlenecks, especially in the area of ground transpor­

did not immediately appear for at least three reasons. First, the economic

tation and water, were already a m aj o r c o n c e r n i n t h e l a t e 1 9 8 0 s . Yet

b o o m was j u s t m o v i n g i n t o h i gh g e a r wh e n C h a t i c h a i a s s u m e d t h e

d e s p i t e the s evere and growing d e fi c i e n c i e s i n i n frastructure, t h e gov­

premiership a n d t h e momentum carried t h e economy forward despite the

e r n m e n t has fa i l e d to d e v e l o p a c l e a r i n fr a s t r u c t u r e d e ve l o p m e n t

changes put in place by Chatichai. S e c o n d , the economic b o o m got its

p olicy-one symptom of t h e large number o f veto players and politician's

s e c o n d wind as the financial s e c t o r was lib eraliz e d , a p r o c e s s that was

lack of interests in n ational p olicy. Indeed, even at the l evel of individual

completed by 1 993 with the opening of the B angkok International B anking

infrastructure p roj ects, there has b e e n very little in the way of nationally c o o rd i n a t e d p l a n n i n g (Anu p h a p 1 9 9 7 ) . 2 .'

into the Thai economy that fueled a stock market and real estate b o o m .

Taking transportation as an example, in 1 993 an international traffic congestion team concluded that Bangkok had p o ssibly the worst traffic

Facility ( B I B F ) .26 Financial liberalization b r o u gh t a fl o o d o f new m o n ey A t h i r d r e a s o n fo r t h e

d e l ay e d

onset

o f s ym p t o m s

in

the

macroeconomy can b e traced t o the appointment of Anand Panyarachun

congestion of any similarly sized city in the world ( B ello et al. 1 998) . By

as prime minister aft e r a military coup i n 1 99 1 . Anan d , a highly respected

1 9 9 6 t h e gove r n m e n t had managed t o c o n s t r u c t o nly n i n e ty- o n e kil o ­

d i p l o m a t and b u s i n e s s m a n , was c h o s e n b y the m i l i t a ry t o h e a d two

m e t e rs of expressways-an accomplishment t h a t t o o k thirteen years to

i n t e r i m governm e n t s b etween 1 9 9 1 and 1 9 9 2 . He was not a p o litician

c o m p l e t e ( i b i d . ) . At t h e end o f 1 9 9 8 none o f t h e vari o u s mass transit

and filled the maj o ri ty of his Cabinet with respected technocrats, busi

projects were op erational, although some had b e e n in the wo rks for te n

n e s s m e n , a n d government o fficials rather than politicians. Wit h o u t the

years o r more. Policy- m aking p aralys i s , with diffe r e n t ministries / p oliti ­

electoral, p artisan, o r coalitio nal constraints that most governments fac e ,

cal factions b acking different p rojects, together with wi despread charges

o n e would exp e c t A n a n d 's gove r n m e n t t o b e q u i t e g o o d at p rovid i n g

of corruptio n , led to long delays or the outright cancellation of proposed

nati o n al p o l i c i e s , a s l o n g a s t h e i n t e re s t s o f t h e military were n o t t o o

p roj e c t s . " "

b adly ab u s e d . I n fac t , Anand carried o u t a l o n g l i s t of large - s c ale n a ­

H av i n g fai l e d t o d e v e l o p c o h e r e n t , c o o r d i n a t e d p u b l i c p o licy t o

tio nal p olicy reforms. H e reduced tariffs , c u t taxes, a n d reformed t h e t ax

a d d r e s s t h e e c o n o my 's grow i n g i n frastructure n e e d s , t h e gove rn m e n t

law, and lifted exchange controls. He increased the p ay of bureauc r a t s ,

turned t o selective p rivatization i n the areas o f telecommunicat i o n s a n d

formed the S t o c k Exchange Commission t o oversee the T h a i s t o c k market,

tran s p o rtati o n , hoping the p rivate sector could do what t h e governm e n t

and pushed a p r o p o s al to create the ASEAN Free Trade Area (A FTA) . H e fo rmed an e l e c t i o n monitoring organization ( P o l l Watch) , launche d new i nfrastructure p roj e c t s , set up new rul es fo r screening p r o j e c t s and s e ­ lecting contractors o r concessionaires and opened up the process to

c o u l d not. On i t s face p r ivatization may seem like a " n ational" poli cy. I n p ractice, however, p rivatizatio n policy w a s turned to b e n e fi t t h e n arrow, p rivate interests, rather than the public interest. Instead o f selling o ff th e state enterprises that were in ch arge of telecommunications and tran s ­ p o rt a ti o n , and l e t t i n g t h e m fac e c o m p e t i t i o n , p o l i cy makers o p t e d t o

greater p ublic scrutiny ( Pasuk and B aker 1 99 5 , various n ews sources ) . In short , the Anand government app ears to have acted m o re decisively and

keep their monopolies intact. Instead, state- owned enterprises were

i n r e s p o n s e t o b r o a d e r s o c i etal i n t e r e s t s than h i s e l e c t e d co u n t e rparts .

1 76

1 77

T Governance and Growth in Thailand

D e s p ite Anand's refo r m s , the inab ility of the government t o adj ust t o t h e changing e c o n o my b e ga n t o m a n i fe s t i t s e l f b y 1 9 9 3 . The e c o ­ n o m i c fac t o r s b e h i n d t h e d et e r i o rati o n o f T h a i l a n d 's m a c ro e c o n o my during the 1 99 0 s have b e e n the subj ect o f several studies ( s e e , for ex­ ample, Yos and Pak o r n 1 99 8 o r Pas uk and B aker 1 99 8 ) . Large amounts o f c ap ital inflows , such a s Thailand exp e r i e n c e d i n the late 1 9 80s and 1 99 0 s , p u t the macro e c o n o my u n d e r great strain. Sound p olicies were n e e d e d t o manage t h e fl ow of c a p i t a l a n d its u s e s i n t h e e c o n o my. However, the p oliticizatio n of the technocratic ministries, and the result­ ing increased numb e r o f veto players with narrow c o nstituencies, made it difficult for the government to respond with the requisite p o licies . I n the remainder o f this chapter I fo cus o n t h e way i n which governance problems affected p o licy making in two areas : fin a n c i al regulation and fis c al p o l i cyP This i s e s p e c i ally evi d e n t i n the area o f financial s e c t o r r e g u l at i o n . T h a i l a n d 's fi n a n c i a l a r c h i t e c t u r e a n d r e g u l a t o ry s y s t e m n e e d e d to b e adapted t o m a n a g e the increased fl o w o f fo reign capital. However, the gove r n m e n t failed t o make the n e e d e d refo r m s . E l e c t e d p o liticians had few incentives to push for a clearer accounting by finan­ cial institutions and b o rrowers o n how fun d s were being used. A new regulat o ry framework would b ri n g very little additio n al electoral s u p ­ p o rt fro m voters . On the other hand, regulation was a threat to many of the businesses that were typi c al ly p art o f a p o litician's c o nstituency. I n a d d i ti o n , m u l t i p l e v e t o p l ayers i n t h e p o l i c y p r o c e s s m a d e i t n e arly impossible to find a policy o n which all the relevant actors c o ul d agre e . T h e re s u l t , a c c o rd i n g t o a r e p o r t b y t h e Wo r l d B a n k , was " a p rivate enterprise system where few c o ntrols [were1 i m p o s e d , increased m a t e ­ rial s t a n d a r d s and p rivate gains [we r e ] secured a t an o b s e rvable c o m ­ munal exp e n s e " ( Wo r l d B an k 1 9 9 1 , 6 ) . The agency that h a d the s p e c i fi c r e s p o n s i b i l i ty fo r regulating t h e financial sector was t h e B a n k o f Thailand. I n d e e d , much o f t h e b l a m e for t h e crisis h a s b e e n laid at t h e feet o f t h e Central B a n k . However, eve n its strongest critics acknowledge that the bank's failure to better regul atE' the financial system was due p artly to its loss o f auto n o my from p o l i t i c al i n fl u e n c e s . With t h e c o l l a p s e o f t h e p o l i cy- p a t r o n a ge c o m p r o m i s e , elected p oliticians began t o assert more co ntrol over t h e Bank o f Thai­ land. The gove r n o r 's p o s i t i o n in the b ank was i n creasingly held at t he p l e asure of the elected p o l iticians (Ammar 1 9 9 7 ) ."H The b ank governo r d o e s n o t s e rve a fixed term . I n s t e a d , he is a p p o i n t e d and removed by the m i n i s t e r o f Fin a n c e . T h e Ministry o f F i n an c e 's c o m i n g under t h e influence of elected p o liticia n s led to what Ammar Siamwalla calls "im1 78

Governance and Growth in Thailand

plicit i n t e rve n t i o n s " by s o m e e l e c t e d p oliticians in the p ol i c i e s of the Bank o f Thailand. That is, the governo r would anticipate the preferences o f the F i n a n c e minister a n d follow the current p o l itical l i n e whe n d e ­ signing p o li cy (Ammar 1 9 9 7 , 7 1 ) . O bviously, c o ncrete evidence o f " implicit intervention" is difficult to come by. And even where p olitical interference is more direct, it gener­ ally goes undocumented: there are n o memos fro m p oliticians o rdering a particular action t o b e investigate d . H owever, the way i n which the B ank o f Thailand r e s p o n d e d to fun d a m ental problems in the fin ancial sector i s c o nsistent with a story o f p olitical p ressure and influe n c e . By the m i d - 1 99 0 s the financial sector was i n s e r i o u s t r o u b l e . The lack of oversi ght had allowed cronyism and other imprudent lending practices t o fl o u r i s h , a p o in t driven home b y t h e B angkok Bank o f C o m m e r c e ( B B C ) s c a n d a[ . 29 The s c a ndal involving the B B C hit the headlines in 1 99 6 , whe n an o p p osition p olitician raised the issue o f the b ank and its p o litical c o n ­ nections in t h e c ontext o f a confidence debate. T h e B B C h a d p erpetrated massive fraud involving, among other things , shady land deals, suspect l o a n s , and s t o c k market s p e c ulati o n . In the middle o f the s c a n d al was Group 1 6 , a c o ll e c t i o n o f ambitious p o l iticians who j o i n e d t o gether i n 1 9 9 2 . S o m e o f t h e m e m b e r s o f G r o u p 1 6 h a d s a t o n a p ar l i a m e n t a ry committee charged with investigating s o m e o f the B B C 's business d e al ­ ings. Rather than pushing for stronger b ank regulation o r reform, s o m e m e m b e r s o f t h e gro u p e l e c t e d t o j o i n fo r c e s w i t h the B B C i n a l a r g e n u m b e r o f p y r a m i d s c h e m e s ( P a s u k a n d B aker 1 9 9 8 ) . The B B C 's b a d debts rose steadily in 1 99 2 and 1 99 3 b u t it was n o t until 1 9 9 4 that the B a n k o f Thailand n o t e d that there w e r e t o o many questionable loans. By 1 99 5 , h owever, internal B a n k o f Thailand d o c u ­ ments showed that t h e Central B ank c omprehended t h e s c ale o f t h e B B C m e s s . However, rather than take acti o n s to c l o s e t h e b ank a n d p u s h fo r the prosecution of the B B e 's o fficers, the governor of the B an k o f Thai­ land pulled together over fifty billio n b aht and pumped the fun d s into the b ank, where they then disappeared ( i b i d . ) Even at the end o f 1 99 5 , when b ank regulators reported to t h e governo r that the B B C was techni­ cally bankrupt, that fraud was b eyond question and that the b ank's officers were criminally liable, the governor did not take strong action (ibid . ) . I t was o n ly after someone within the B ank o f Thailand leaked the details o f the scandal t o an o p p osition politician that the affair came to ligh t . There h a s b e e n a g o o d deal o f s p e c u l atio n o n t h e m o tivati o n b e ­ hin d the a ctio n ( o r i n actio n ) o f t h e C e ntral Bank gove r n o r. All egatio n s 1 79

r Governance and Growth in Thailand

Governance and Growth in Thailand

range fro m p e rs o n al c o n n e c t i o n s with B B C o ffi c e r s t o gross i n c o m p e ­

fo r b u s i n e s s s e v e n d ay s a we e k , t w e n ty - fo u r h o u r s a d ay. O n e o f

tence. Nonetheless, the political connection continues t o stand out. Some

Banharn's fir s t a c t i o n s a s p re m i e r was t o increase p l a n n e d b u d g e t ex­

m e m b e r s o f t h e gove r n m e n t c o al i t i o n w e r e w i t h o u t a d o u b t d e e p ly

penditures by 10 p ercent ( Pasuk and B aker 1 998) . A deputy leader of the

involved in the affairs of the B B C . I n a d d i t i o n , there were wid e s p r e a d

Chart Thai p arty a n d s p e ake r o f t h e H o u s e e s t i m a t e d that half o f all

allegations t h a t t h e B B C had helped fin ance the 1 995 electoral victory o f

budget project money was lost to c o rruption ( The Nation, 19 May 1 996) .

Banharn Silp a- archa's Ch a r t Thai Party. As prime minister, Banharn swe p t

Not surprisingly, the budget surplus quickly evap o rated and by late

away a n y lingering vestiges o f an autonomous, technocratic Ministry o f

1 9 9 6 the budget was moving into deficit. F e aring that they would s o o n

F i n a n c e by a p p o inting t w o i n d ividuals w h o l a c k e d exp erien c e in m a c ­

be forced to c u t t h e i r budgets , many d e p artments accelerated the s p e n d ­

r o e c o n o m i c managem e n t o r a n y independent b a s e o f p o l i t i c al suppo rt

ing o f t h e i r b u d g e t allocations ( Pasuk and B aker 1 998) . This c a u s e d one

as minister. B o th w e r e c o m p le tely dependent o n B anharn' s sup p o rt t o

techno crat t o comment that " [p j oliticians want to spend money t o help

r e m a i n i n o ffi c e . The s e i n d ividuals were c h a r g e d with o ve r s e e i n g t h e

the peo ple who elect them. You cannot exp ect them to put stabili ty ahead

work o f the B ank o f Thailan d . I n d e e d , Thail and's t w o m o s t p restigious

o f all e l s e " ( C h a l o n g p h o p Suss angkarn 1 9 9 6 ) . I n s h o r t , p ol i t i c i a n s b e ­

u ni ve r s i t i e s , Thammasat a n d Chulalo n gko r n , expl i c i tly drew t h e c o n ­

came more responsive t o their narrow constituencies than they h a d be e n

nection b e tween t h e Central B ank's failure to regulate a n d direct p olitical

to the b r o a d e r p u b l i c interest.

i n t e rfer e n c e in the weeks aft e r the B B C s c andal broke ( i b id . ) . Conclusion

Whi l e t h e B B C was c e rtainly the highest p r o fi l e c a s e , many o t h e r fin a n c i a l i n s t i t u t i o n s w e r e fe e l i n g t h e b i t e o f p o o r a s s e t q u a l i ty a n d

The r e c e n t e c o n o m i c crisis has brought the issue o f governance to

m i s m a n a g e m e n t d u r i n g t h e m i d - 1 9 9 0 s . U n d e r p o l i t i c al p re s s u r e , t h e

the fo refront. as is ce rtainly true of Thailand . While not all of the blame

B ank o f Thailand o ffe r e d a b u n d an t c r e d i t s t o fin a n c e c o m p an i e s a n d

can b e laid at the fee t of the politicians and the p olitical sys t e m , there

c o m m e rc i al b anks b e tw e e n 1 9 94 and 1 9 9 7 ( Yo s and Pakorn 1 9 9 8 ) . U n ­

r e m 'li n q u e s t i o n s o f why the gove r n m e n t d i d n o t take more c o n cr e t e

fo rtunately, t h e s e r e s c u e attempts were in c o n fl i c t w i t h b r o a d e r macro ­

s t e p s t o p re v e n t t h e c r i s i s , and w h y t h e r e s p o n s e w a s s l o w o n c e t h e

e c o n o m i c o b j e c t i ve s . As t h e e c o n o m y b e g a n t o h e a t u p fro m 1 9 9 3

c r i s i s h it. I t i s als o interesting to comp are the r e c e n t c r i s i s w i t h that of

onward, t h e Central B ank tried to curb inflation by raising interest rates

the ea rl y- and m i d - 1 9 8 0 s . The r e are diffe r e n c e s b e tween the two p e ri ­

and limiting credit. I-Iowever, the funds p umped into the financial sys ­

ods, certainly, but there are some striking p arallels. In b o th time p e riods

t e m by the c e ntral bank t e n d e d to enlarge the m o n ey s u p ply, e n c o u r­

maj o r s t r u c t u ral and fi n a n c i a l adj u s t m e n t s were required t o p re v e n t

a gi n g m o r e s p e n d i n g a n d exacerbating b o th i n fl a t i o n and current a c ­

problems fro m escalating i n t o a crisi s . T h e current account a n d exchange rate were a c o n c e r n in both p e ri o d s as was external indebt e d n e s s . F i ­

c o u n t d e fi c i t s ( i b i d . ) . F i s c a l p o licy a l s o ran c o u n t e r to e ffo rts to s t a b i l i z e t h e e c o n o m y.

nally, t h e country's traditionally strong reputation among fo reign financial

T h i s was e s p e c i ally t r u e d u r i n g t h e B anharn a d m i n i s t r a t i o n . P r i o r t o

institutions and investors was weakening ( D o n e r and Anek 1 994) . H ow­

B anharn t h e budget surplus h a d acted to o ffset capital inflows a n d ec o ­

ever, the gove r n m e n t 's re s p o n s e to the two c r i s e s diffe r e d greatly. The

nomic overheating (Narongchai e t al. 1 993) . Politicians p illaged the public

Prem governments in 1 9 8 1 and 1 9 84 were able to devalue the curre n cy

t r e a s u ry each year b u t reve n u e s were growing fas t e n o u gh to keep up

and c arry o u t o t h e r reforms in the fac e o f strong o p p o s i t i o n fro m t h e

with political demand. This changed with the election o f B anharn's Chart

business s e c t o r, p olitical p ar t i e s , and t h e military.

Thai p a rty i n 1 9 9 5 . B a n h a r n was the p e rs o n i fi c a t i o n of a p ro v i n c i a l

C o ntrary to the Prem gove rnment's earlier decisive acti o n to refo r m

politician a n d h a d been a m e m b e r of Chatichai 's " bu ffet c abinet" of 1 9 88-

t h e e c o n o my, as t h e c r i s i s l o o m e d a n d t h e n b r o k e i n 1 9 9 6 a n d 1 9 9 7

1 9 9 1 . B anharn's Cab i n e t was dubbed the " 7 - eleven" cabinet. Composed o f s even parties and eleven maj o r factions, decisive action in any policy

Thailand's p o l i cy makers faltered ( M a c Intyre 1 9 99a) . 30 Criticisms of t h e govern m e n t 's re s p o n s e o ft e n p o i n t t o t h e lack o f d e c i siven e s s o n t h e

area was unlikely. Howeve r, it quickly b e came app arent that this govern­

p a r t of p o l icy makers a n d t h e i r t i e s to n arrow, special interests. I n d e e d ,

m e n t had no interest in national p o l icy. Instead, i t was in the business

o n e Thai e c o n o m i s t argu e s t h at b e c a u s e s o m any Thais h a d b egun to

o f c o rruption and p atronag e , and, like the convenience st o r e, was open

see their

1 80

gove r n m e n t a s i n c a p a b l e o f fo r m u l a t i n g a n d i m p l e m e n t i n g 181

Governance and Growth in Thailand

the n e e d e d p olicies in response to the crisi s , the I M F intervention was generally regarde d favo rably, at least in the b eginning. The I M F e s s e n ­ tially filled a g a p in autho rity (Ammar 1 997) , as what one would exp ect given the incentives and capabilities of Thai p o licy makers to push fo r national p o l i c i e s . To summarize, t h e interaction of t h e electoral and p arty systems i n Thailand , prior to t h e n e w Constitution, produced a political system filled

NOTES

with mUltiple veto p l ayers who were fo cused o n their narrow constitu­ encies and supporters. The result was a p olitical sys t e m where p o l icy m akers lacked both the strong incentives and the cap ability to pursue national policies. Prem was able to avoid many of the governance prob­ lems a s s o ciated with t h i s p o litical system by agre e i n g to an info rmal compromise with the leaders o f the various p olitical p arti e s . Prem and the technocrats were left alone to manage the macroeconomy while the p olitical parties received the sectoral ministrie s . Whe n the compromise ended i n 1 9 8 8 , the governance problems began to resurface. Multiple veto p l ayers made it d i fficult to fo rmulate p o l i cy r e s p o n s e s promp tly, and the i n c e ntives of p o l icy makers were s u c h that they were m o r e concerned with their supporters' narrow interests than with the interests

Notes to Introduction

1 . See, fo r i n s t a n c e , the annual rankings o f I nternational C o u ntry Risk Guide ( I C RG ) . 2. Note that we use the term " institutions" in North's ( 1 98 1 ) sense: an institution embodies a system of the rules, procedures, and norms, formal

o f the broader e c o n o my. in the wake o f the crisis Thailand adopted a new Constitu ­

and informal, that govern the behavior of a given set of individuals; those

tion. It m akes numerous changes i n the political system, many of wh ich

rule s , procedure s , o r n o rms are formally referred to as institutional ar­

could have a significant impact o n governance. I mention o nly two here :

rangements. A merit-based recruitment and promotion system embodies

the switch to singl e - member districts and the addition of a nationwide

a set of rules and procedures that govern the b ehavior of civil s e rvants .

Finally,

p arty list.3l Over time, singl e - member districts and the p arty list sho u l d

Hence, i t is an institution. An annual performance appraisal requiring both

decrease the number of p arties and, thus, the number of veto players i n

p e e r evaluati o n s and the evaluatio n o f o n e 's immediate superior is an

the sys t e m . The result will b e more decis ive p o li cy making. The pam'

embodied institutional arrangement. The judiciary is an institutio n ; the

lists should also help strengthen p arty labels and broaden the c o n s t i tu ­

rules, procedures, and norms for selecting members of the Supreme Court

e n c i e s o f C a b i n e t m e m b e r s , t h u s giving t h e m a g r e a t e r i n c e n t ive t o

are part of an institutional arrangement. The common fields system i n

p rovide national policies. I n short, given Thailan d 's new institutions and

medieval Western Europ e is an institutio n ; t h e p easant norms embodied

institutional arrangements, there i s some room fo r optimism regard i n g

in this system are an institutional arrangement.

t h e quality of future governan c e in Thailan d .

3. A number o f o rganizatio ns , p rivate o r n o n p ro fit, have p rovided

country rankings b a s e d o n the p erceived extent o f c o rrup tion o f busi­ nessmen: to name a few, Transparency International, International Coun­ try Risk Guid e , and Political Risk and C o n s ulting I n c . 4. The implication of the last is that, under certain circumstances, nascent

formal legal institutions can place limits o n corruption, albeit weak ones. 5 . These refer to kinship ties, local networks of friends and relative s ,

o r intermediaries w i t h intimate knowl e d g e o f both p o tential n o n l o cal investor(s) and p otential local p artner(s) . 1 82

1 83

r Notes to Pages 5- 1 8

6 . For a related. m o re general argument. s e e MacIntyre. " I nstitutions and I n ve s t o r s : T h e P o l i t i c s of the F i n an c i a l C r i s i s i n S o u t h e a s t A s i a" ( u n p u b l i s h e d manus c r i p t . Unive rsity of Califo r n i a . San Diego. 1 9 9 9 ) .

Notes to Pages 23-47

1 0 . In the c a s e o f a c o rn e r s o l u t i o n . the results are ambigu o u s . 1 1 . The analysis here of O - Ring corruption assumes investors are risk­ neutral . I f investors are risk- adverse then greater uncertainty necess arily

7 . Why this h a p p e n e d is a thesis topic in and of itself. Suffice it t o

leads to less investment; if they are risk takers. the results are reversed. If

s ay t h a t the combination o f rent - s eekers w i t h very s h o r t - t e rm h o rizons

they are risk- neutral then under certain conditions greater uncertainty may

surrounding the president. t h e diverse coalition o f gro u p s that brought

in fac t l e a d t o m o r e inve s t m e n t as might h a p p e n by analogy in thinly

him to p ower. and the president's p enchant for repaying favors had much

capitalized markets. The investors in our model (and more typical o f i n­

to c o ntribute to d i s t o rting the d e c i s i o n - making p r o c e s s .

vestors in real capital in developing countries) are not of this type. We are

8 . S e e " Th e J 2 K C r i s i s a n d the E c o n o my " (unpublished manuscript .

grateful to D avid Ellerman for p o inting o u t this problem.

S c h o o l o f E c o n o m i c s . University o f t h e Philip p in e s ) . 9 . I n fac t . t h i s a p p e ar s t o b e t h e m o t i va t i o n b e h i n d S h l e i fe r a n d

Notes to C h a p t e r 2 (In vestmen t, Property Righ ts, and Corruption

Vis h n y 's ( 1 9 9 3 ) s e mi n al p i e c e o n c o r r u p ti o n .

in Indonesia)

N o t e s to Chapter 1 ( Corruption a n d Its Implica tions for In vestment)

paper: E d C a m p o s . S t e p h an H ag g a r d . H al Hill. John M c M i l l a n . B arry

The following p e o p l e h ave all h e l p e d with the deve l o p m e n t of this 1 . The Murphy. Shleifer. and Vishny paper ( 1 993) in fact p rovides much

Naughton. Sanj ay Pradhan. Rizal Ramli. John Sidel. Djisman Simandj untak.

of the theoretical motivations. if not underpinnings. for the now well-known

and Ali Wardhana. I am grateful to them all. Research for the paper was

Shleifer-Vishny p i e c e on c o rruption regimes ( 1 99 3 ) .

made p o s s ib l e by g e n e r o u s fun d i n g fro m the A s i a R e s e ar c h C e n t r e at

2 . The test for the coefficient of the dummy variable for East Asia in h i s regressions are insignificant.

Murdoch University ( Western Australia) and the Wo rld Bank. 1. A substantial body of research is now emerging on this topic. My analy­

3 . M o re over. the c o m p arators that practitioners h ave i n mind when citing the East Asi a p uzzle are other developing countri e s . 4 . For an analytical model of corruption a n d uncertainty. see Campos. Lien. and Pradhan 1 9 9 7 .

sis of the crisis in Indonesia is set out more fully in a forthcoming publication. For other empirically grounded interp retations. see McLeod 1 998. Soesastro and Basri 1 998. Hill 1 998. Robison and Rosser 1 998, Azis 1 998. and Pincus 1998. 2 . The institutional framework permitted Suharto to behave erratically.

5 . M auro ( 1 995) , for instance. u s e d survey data collected annually b y

but it did n o t cause him to do so. To know why Suharto chose to behave

T h e Economist Intelligence Unit. Keefer and Knack ( 1 995) based their find­

in the erratic way he did. we need to know about his political preferences.

ings on survey data conducted annually by the I nvestor Country Risk Guide

There is much speculation on this subject. but little firm evidence. Am o n g

(lCRG) . Other survey-based data are available from Transparency International

t h e most frequently encountered guesses a r e that he was simply unwill i n g

(Geneva) , The World Competitiveness Report (Davos) and Political Risk Con­

to cut back the p rivileges of his children (ef. his willingn e s s to cut b a c k

SUlting. Inc. (Hong Kong) . The data that these surveys contain are still of an

crony privileges in p revious crises) ; t h a t h e suffered from seriously inad ­

indirect nature. It is practically impossible to obtain accurate information of

equate information on the true precario usness of the economic s i tu a t i o n

sufficient breadth on actual amounts of bribes and the like. Hence. the best one

because h i s advisers no longer d a r e d to bring h i m unwel c o m e n ews ;

can do is work with survey responses from individuals affected by corruption.

that he suffered from seriously diminished p olitical judgment through some

6 . I n the extreme case. corruption per s e would represent a pure i n ­

or

combination o f age and hubris.

come transfer or a tax provided it w a s fully predic table . 7. More specifically. we used the natural logarithm of both variables. 8 . Data on per capita GDP. enrollment rates. and investment as a percent of GDP come fro m the Wo rld Development Indicators (vari ous years ) . 9 . The IFC began publishing an an nual report on p rivate investment flows to developing countries in 1 990. To our knowledge. there is no other source of informatio n o n this issue that is as ext e n s ive as this. 1 84

Notes to C h a p t e r 3 ( S ta te, Capital, and In vestments in Ko rea)

1 . Except for those of Korea. the figures cited in the rest of this para­ graph are fo r 1 9 6 1 . and are from Kindleb erger 1 96 5 . table 1 . 1. (per capita income fi gures) and figure 5.2 (inve s t m e n t fi gu r e s ) . 2 . I n t h e 1 9 6 0 s . t h e Korean inflation rate was h i g h e r t h a n t h o s e o f Venezuela ( 1 . 3 p e r c e n t ) B o l ivia ( 3 . 5 p e rc e n t ) . Mexico ( 3 . 6 p e rc e n t ) . Peru 1 85

..

Notes to Pages 47-57

Notes to Pages 59-66

( 1 0 . 4 p e r c e nt ) , and C o l o m b i a ( 1 1 . 9 percent) , and was n o t much lower

8. F o r a discussion of bureaucratic o rganizatio n and reform in East

than that o f Argentina ( 2 1 . 7 p e rc e n t ) . I n the 1 9 7 0 s , i t was higher than

Asia, see Campos and Root 1 99 6 . For empirical analysis of key attributes

those fo u n d i n Ve n e z u e l a ( 1 2 . 1 p e rcent) , E c u a d o r ( 1 4 . 4 p ercent ) , and

o f a well- fun c t i o n i n g bureauc racy, see Evans and Rausch 1 9 9 7 .

M ex i c o ( 1 9 . 3 p e r c e n t ) , a n d was not much lower t h a n those fo u n d i n

9 . D o e s t h i s m e a n t h a t w e n e e d t o u gh c a p i t al c o ntrol i n o r d e r t o

C o l o m b i a ( 2 2 . 0 percent) o r Bolivia ( 2 2 . 3 percent) . S e e Singh 1 99 5 , table

m o d erate t h e negative i m p a c t o f c o r ru p t i o n o n c a p i t al accumulat i o n ?

5, for further info rmati o n .

T h e matter is n o t t h a t simple. I n s o m e countries, corruption is rampant

3 . For example, following M ax Weber's classic work, i t i s widely a c ­

but a lot of capital stays home even without severe capital control ( e . g . ,

c e p t e d t h a t t h e Protestant e t h i c restrained l Uxury c o n s u m p t i o n by the

Indonesia) . Also, there is a reverse feedb ack. I n s o m e countries, c o rrup ­

entrepreneurial class in the early phases of capitalist development in Western

tion is such that there is no effective capital control ( e . g . , Russia) . So we

Euro p e . I thank Chung H. Lee for reminding me o f this important point.

n e e d t o k n o w m o r e ab o u t t h e c o u n try to b e a b l e to say t h a t c a p it a l

4 . A p i e c e of information c o rr o b o rating this i s the extremely small

c ontrol i s necessary, feasible, or effective i n reducing t h e negative effect

wage d i fferential b e tween the t o p managers and the workers that pre­ vails i n Korea. According t o the data collected b y t h e c o n s ulting com­ p an y Tow e r s P e r r i n , of the t w e n ty - t h r e e m e d i u m - s i z e d c o u n t r i e s s u rveyed , Korea h a d t h e smallest wage gap b etwee n t h e t o p managers and the workers (the former being o nly 8 times o f the latter) . C ountries like Venezuela (84 times) , Brazil (48 times) , Hong Kong (43 times) , Mexico (43 times) , Malaysia (42 times) , Singapore (35 times) Argentina (30 times) , U S ( 2 4 times) , South Africa ( 2 3 times) showed h i gh differentials, while c o u n tries like New Zealand (9 times) , Switzerland ( 1 0 times) , Japan ( 1 0 times) , Sweden ( 1 1 times ) , and Germany ( 1 1 times) , showed low differ­ entials. I t i s interesting t o n o t e the high - wage differential i n other East Asian countries, such as Hong Kong, M al aysia, and Singapore. The data was reported i n 1 / 2 August 1 99 8 issue o f t h e Financial Times. 5. These included industries where access to proprietary technology

o f c o rrupt i o n o n accumulati o n . 1 0 . This certainly appears to b e t h e c a s e i n Japan. S e e Okimoto 1 989 for results o f a s u rvey o f government m i n i s t r i e s i n J a p a n . 1 1 . S e e Camp o s a n d R o o t 1 9 9 6 . 1 2 . B etwee n 1 9 9 0 a n d 1 9 9 3 , t h e share o f Korea's o utward F D I as a p r o p o r t i o n o f its G D P was 0 . 4 5 p e r c e n t . While o u tward F D I i n c re a s e d dramatically during t h e l a s t few years (from $ 1 . 2 6 billion in 1 993 to $ 4 . 1 3 b il l i o n i n 1 9 9 6 ) , t h i s i s s t i l l j us t over 1 p e rc e n t o f G D P, whi c h i s well below the O E C D average of 1 . 85 percent ( fo r 1 99 0- 1 993 ) . I n stock terms, Korea's o utward FDI stock was equivalent t o 3 . 1 6 p ercent o f GDP as of 1 99 4 , whi c h is far less than the OECD average of 1 4 . 94 percent. All fig­ ures are fro m K D I ( 1 99 6 ) , exc e p t fo r t h e o u tward FDI figure fo r 1 9 9 6 , which i s fro m Far Eastern Economic Review, 1 M ay 1 99 7 , 44 . 1 3 . The definition of fo reign debt here follows the World Bank d e fi ­

was deemed essential fo r further development o f the industry, and i n ­

nition, a n d therefore is different fro m t h e concept of "external liabilit i e s , "

dustries where the capital requirements and / o r t h e risks involved in the

which i n c l u d e s the o ffshore b o rrowings o f K o r e a n b a nks and overseas

investment were very large. The ownership ceiling was also relaxed if ( 1 )

b o rrowings o f the overseas branches and subsidiaries of Korean b a n k s .

the investments were made i n the free- trade z o n e s ; ( 2 ) the investments

T h e I M F and the K o r e a n government s t a r t e d u s i n g this d e fi n i t i o n fo l ­

were made by ove rseas Kore a n s ; o r (3) the inve s t m e n t s would " d i ver­

lowing their accord o n 2 8 December 1 99 7 . At t h e end of Nove m b e r 1 99 7 ,

s i fy " t h e o ri g i n s o f FDI into t h e c o u n t ry-n a m e ly, i n ve s t m e n t s fro m

Korea's external liabilities amounted to $ 1 5 7 billion, of whic h $ 9 2 b i l l i o n

countries other than the U S and Japan, which had p reviously do minated

w a s o f l e s s t h a n a year's maturity.

the Korean FDI s c e n e . For d e t a i l s , see EPB 1 9 8 1 , 70-7 1 .

1 4 . Kore a's fo reign deb t / GNP ratio was only 2 2 percent in 1 9 9 6 and still arollnd 2 5 percent on the eve of the crisi s . This falls far s hort o f the Wo rld Bank threshold of 48 percent where a country is downgraded fro m

6 . The recent awarding of the con tract for the fast- train project to the Angl o - French j o i n t venture (GEC Alsthom) organized around t h e p r o ­ d u c e r o f French TGV o v e r i t s J ap a n e s e a n d German c o m p e t i t o r s , who o ffe r e d t e c h n o l o gi c ally s u p e r i o r p r o d u c t s , i s a go o d e x a m p l e o f s u c h p o l i c y orientation ( s e e C h a n g 1 9 9 8 a fo r fu rth e r d e tails ) . 7 . N e e d l e s s t o s ay, t h i s h a s t o b e s e t agai n s t t h e " s e c o n d - m o v e r

" less indebted" to "mod erately indebte d , " not to s p e ak of t h e 80 percent threshold where i t qualifies as "severely indebted" (see World Bank 1 99 7 , 1 : 4 9 5 0 , fo r t h e defi n it i o n s ) . T h e fo r e i gn d e b t / GN P ratio at t h e e n d o f

disadvantage, " which means t h a t t h e fi rst movers would reap more rents.

1 995 was 7 0 p e rcent fo r Mexico, 5 7 p ercent fo r Indonesia, 3 5 p e rcent fo r Th ailan d , 33 percent fo r Argent i n a , and 24 percent fo r Braz i l . I n t e r m s o f

1 86

1 87

Notes to Pages 66-79

a n o t h e r c o m m o n i n d i c a t o r of d e b t b u r d e n , K o r e a was s t i l l b el o w t h e Wo rld B a n k " warn i n g t h r e s h o l d " of 1 8 p e rc e n t at 5 . 8 p ercent i n 1 9 9 6 .

Notes to Pages 8 1 -89

1 5 . I n China, the Standing Committee of National People's Co ngre s s ( n o t the S u p r e m e C o urt) i n t e r p r e t s the C o n s t i t u t i o n and l a w s . J u d g e s

T h i s c o m p a r e s v e r y favo r a b l y w i t h t h o s e o f o t h e r c o u n t ri e s s u c h a s M ex i c o ( 2 4 . 2 p e rc e n t ) , B razil ( 3 9 . 7 p e r c e n t ) , I n d o n e s i a ( 3 0 . 9 p e rc e n t ) ,

lack t e n u r e i n o ffi c e . C o u rt s are subj e c t t o t h e c o n t r o l o f C o m m u n i s t

and Thailand ( l 0 . 2 p ercent) in 1 99 5 . All the above figures cited are fro m

1 6 . I n c i d e n t a l l y, R o b e rt K u o k w a s n a m e d t h e w o r l d 's s h re w d e s t

Wo rld Bank ( 1 9 9 7 ) c o u n t ry t a b l e s .

Party c o m m i t t e e s and p e o p l e's c o ngre s s e s i n the s a m e j u r i s d i c t i o n . b u s i n e s s m a n b y Fo rbes ( s e e Fo rbes, 2 8 July 1 9 9 7 ) . 1 7 . This s u b s e c t i o n is drawn fro m Li and Lian 1 9 9 9 .

N o t e s t o Chapter 4

( Go vernance and In vestment in China)

I . The Financial Tim es ( 3 0 April 1 9 9 7 ) s t a t e s that " C h i n a r e c e ived

about

1 8 . During t h e M a o e r a (the 1 9 5 0 s a n d t h e 1 9 6 0 s ) , b o th a planning system and a market system were still at a trial stage in East Asia. M a o

quart e r o f a l l FDI t o d e ve l o p i n g c o u n t r i e s b e twe e n 1 9 7 9 and

did not have p ersonal exp eriences to comp are a planning economy with

1 99 7 , according to the World Bank Global Finance rep o r t , " and that "some

a market e c o n o my. Thu s , h e did not p e rceive that it was i n his interest

200 o f t h e w o r l d 's 500 largest tran s n a t i o n al c o r p o ra t i o n s h ave e s tab ­

t o p u r s u e c a t c h i n g - u p p o l i c i e s b a s e d on market m e c h a n i s m s . U n l i k e

l i s h e d a p r e s e n c e in C h i n a s i n c e 1 9 9 0 . "

Mao, D e n g h a d witn e s s e d a fun c t i o n i n g market e c o n o my in France i n

a

2 . J a m e s D . Wo lfe n s o l m , i n Transition 7 ( S e p t / O c t . 1 99 6 ) : 9 .

h i s e arly y o u t h .

3 . Some gift giving is s e e n as showing respect o r p r e - c o mmunication

1 9 . D u r i n g his famous s outhern tour i n 1 99 2 , D e n g cle arly indicated

i n China and in some o t h e r East Asian countri e s , b u t as corruption in

that if China d i d not d e v e l o p , or d evel o p e d t o o s l owly, rel ative t o i t s

t h e We s t . Thus corrup t i o n in C h i n a , as p e rc e ived by the We s t , may b e

n e i g h b o ri n g c o u n t r i e s , t h e C h i n e s e p e o p l e w o u l d n o t b e s a t i s fi e d

s o m ewhat exagge r a t e d .

with the Chinese Communist Party. H e also indicated that i f the reform

4 . The dual- track price syst e m introduced in 1 984 i s another fact o r c o ntributing to the wid e s p r e a d c o rrup t i o n . S . N o t e that c o m p e t i t i o n a m o n g b r i b e g i v e r s c a n i n c r e a s e b rib e s ,

whi l e c o m p e t i t i o n am o n g b r i b e takers t e n d s to r e d u c e b r i b e . 6 . T h i s implies that t h e degree of corruption is limited; fo r instance, the t ax autho rity cannot arb itrarily tax business activi t i e s . 7 . A n d national elections (if any) m a y be m o r e s u p erficial, a n d local e l e c t i o n s are more s u b s t a n t i a l .

did not i m p r o v e t h e l i v i n g s t a n d a r d s o f t h e maj o rity o f t h e p e o p l e , t h e Chinese C o m m u n i s t P arty might n o t b e able t o survive t h e J u n e 4 I nc i d e n t . 2 0 . State C o m m i s s i o n fo r Restructuring the E c o n o m i c System, " The Role o f Gove r n m e n t i n C h i n a : An Analys is o f a Survey, " i n Almanac of Ch ina's Econ o my 1 996 ( B eij ing: China Statistical Publishing H o u s e , 9 7 6-

8 0 , table 2 . 1 ) . 2 1 . I t w a s o ffi c i ally r e p o r t e d t h a t b y 1 9 9 0 t h e r e w e r e a b o u t 4 3 0

8 . S e e Wa de 1 9 9 0 a n d C a m p o s and Root 1 9 9 6 fo r examp l e s .

enterprise gro u p s . I n 1 99 1 , the State C o u n cil selected fifty- s ix enterprise

9 . I f everyo n e was c o rr u p t a ll t h e w a y t o t h e t o p t h i s , o f c o u r s e ,

groups fo r e xp e ri m e n t a t i o n o n manage rial and re gul atory matters .

creates the pos sibility of an inverted pyramid of co rrup tion: money flows to the t o p with t h o s e at h i gh e r p o s i t i o n s r e c e iving m o r e . 1 0 . B ri b e ry m ay h e l p s p e e d up o r delay t h e p r o c e s s of case settl e ­ m e n t , b u t m a y n o t a l t e r t h e verd icts. 1 1 . For exa m p l e , s e e the s c a n d a l s o f t h e Ta i p e i s u bway s y s t e m , Ko rean urban c o n s t r u c t i o n , and Jap an's Mini s t ry o f C o n s tructi o n . 1 2 . I n t e rn a t i o n a l arbitrat i o n will deve l o p fu r t h e r aft e r C h i n a j o i n s t h e WrG . 1 3 . If they a c t a s i n d e p e n d e n t m o n opolists, t h e n c o rruption will b e s i m i l a r t o r a n d o m ro b b e ry a n d h e n c e have t h e w o r s t c o n s e q u e n c e s . 1 4 . P u t differently, centralized or coordinated corruption is similar to the o rganized robbery o f a stationary bandit in Olson's ( 1 993) terminology. 1 88

2 2 . S e e Ya n g J i s h e n g , " E a s t - We s t D i a l o g u e i n C h i n a , " L i a o wa ll g zhoukan ( O ut l o o k We ekly) , ove r s e a s e d . 9 , 2 7 Feb ruary 1 9 8 9 , 5-7 . S e e

also, D o n al d C . C l a r k e , " Th e C r e a t i o n o f a L e g a l Structure fo r M arket Institutions in China," in Reform ing Asian Socialism: The Growth of Ma rket Institu tions, e d s . John McMillan and B arry Naughton (Ann Arb o r : Un iver­

s i ty of Michigan P r e s s , 1 99 6 ) , 5 1 , 5 6 . 2 3 . Fazh i ribao ( Legal System D aily) , 2 4 July 1 9 9 1 . 1 . 2 4 . As Fairb ank ( 1 99 2 , 409) o b serve d , " During the five years to 1 9 8 5 , m o r e than a million senior CCP (Chinese C o m munist Party) cadres were p e n sio n e d o ff. In S e p t e m b e r 1 9 8 5 , 1 3 1 high- ranking veterans r e s i gn e d . Generally t h e y retain e d t h e i r p e r q u i s i t e s as m e m b e r s o f a n e w C e n tr a l Advi s o ry C o m m i s s i o n o f t h e C C P h e a d e d by D e n g 1 89

.

.

.

M o s t l o c a l o ffi -

Notes to Pages 1 05- 1 4

Notes to Pages 89- 1 04

cials as of 1 9 78 had finished o nly junior middle school. By 1 984 half o f them were college graduates. A m o n g higher o fficials in p a rty a n d gov­ ernment befo re 1 9 8 1 o nly about a quarter, but by 1 9 8 4 , two - thirds or m o re, were college graduat e s . " By 1 9 9 5 , about 90 p ercent of local offi ­ cials were college graduates (see State Commission for Restructuring the Economic System, " Th e Role o f Government in China: An Analysis of a Survey, " in Almanac of Ch ina 's Economy 1 996 [ B eij ing: China Statistical Publishing House] , 9 76-80 , table 1 . 2 ) . 2 5 . Interestingly, o n e of the maj o r slogans of the Chinese Commu­ nist Party under Deng was "yao liang shuo ying" : deepening economic reform on the one hand and consolidating political control o n the other. C entral to the fo rmer is aut o n o my and decentralizatio n and central to the latter is control and c o o rdinatio n . 26. These agencies also design e x ante a n d interim checking devices. 2 7 . The SPC was renamed the State Development Planning Commis­ sion in the 1 998 State Council restructuring. 28. Thus, there is little difference between East and West or betwee n N o rth and S o uth other t h a n b e i ng in different s t a g e s o f developmen t. The p opular media terms ''Asian value" an d "Asian crony capitalism" have little valu e and are misleading.

6 . N o t e that this d o e s n o t mean t h e actual amount o f bribes taken is greatest. The discouragement of investment proj ects also implies that the amount o f bribes collected d e c l i n e s . 7 . The l i t e rature o n p olitical b u s i n e s s cycle s i s vast. Exi s t e n c e o f rati onal p olitical business cycle s h a s b e e n q u e s t i o n e d by a number o f theorists. Several recent studies, h owever, have shown that s u c h cycles can exist whe n incumbent leaders have superior info rmation about the economy o r when s o m e interest grou p s can use c o alition dynamics to extract ren t fro m o thers. Empirically, a great deal of evidence s u p p o rts the exi s t e n c e of p o l itical b u s i n e s s cyc l e s in d e ve l o p i n g c o u n t ri e s , al­ though n o t i n devel o p e d countri e s . 8 . Unfo rtunately, for t h e years prior to 1 970, w e are unable to o btain a series that divides investment n eatly b etwee n p r ivate and pUblic. We therefore add p rivate construction and total durable equipment to con­ stitute a p roxy variable fo r p rivate fixe d inves tm ent and take gove r n ­ m e n t c o n s t r u c t i o n a s a p r o xy fo r p u b l i c fix e d i n ve s t m e n t . T h i s app roximation is j ustifi e d by t h e smaller r o l e that government p l ayed in durable equipment prior to the m artial l aw period when l arge - scale experimentation with public c o r p o ra t i o n s began; prior to that p e r i o d , p u b l i c investment c o n s i s t e d m o s tly o f p u b l i c works . 9 . Recently, the Estrada administration accused the p revious o n e o f

N o t e s to Chapter 5 ( Centralization, Political Turnover, and Investmen t

in the Philippines)

We are d e eply grateful t o J o s e Edgardo C a m p o s fo r s u p p o r t and suggestions but are entirely responsible for the views exp ressed here as well as fo r any omissions and errors. 1 . Indeed, the recent Asian financial turmoiL which devastated hith­ erto rapidly growing economies, has been interpreted j ournalistically as a vindication of the simple superiority of governance systems patterned aft e r those o f Western demo cracie s . 2 . This d o e s n o t include M arcos's first term a s president, which began in 1 9 69 and was due to e n d in November 1 9 7 2 . 3 . S e e , fo r instan c e , d e D i o s 1 9 9 9 a fo r a d i s c u s s i o n o f h o w the s e

changes may affect clan - b as e d relatio n s . 4 . T h i s presumes rent - s e eking- related exp enditu re s by factions a r e strategic complements , t h a t i s , own - s p ending by a n y faction increases with the spending by others. 5 . This l o c al term, " fiscalizing," gives a more constructive connota­ tion to the older political term "filibuster, " which was too o bviously as­ s o ciated with obstructio n . 1 90

granting " b ehest" loans, o r " l o ans o n comman d . " O n e case was t h e land­ reclamation deal mentioned earlier; another was the accusation that the previous administration granted b eh e s t l o an s to interests cl o s e to it. 10. A signal event in the rehabilitation of the Marcos faction has been the election o f Eduardo Cojuangco as chairman of San Miguel Corpora­ tion, one of the largest Philippine con glomerates . Mr. Cojuangco was the most important Marcos crony, and President Estrada ran under the minor­ ity p olitical p a rty Cojuangco headed. Since 1 986, Cojuangco's shares in San Miguel have been under government sequestratio n , and he was pre­ vented from exercising any influence in the corporation. It is significant that the government representatives in the San Miguel board were those chiefly res p o nsible for Cojuangco's return fro m economic limbo. I I . Obviously, there are some typ es o f leadership turnover, such as

coups and revolutions, that tend to concentrate p ower anyway, whether it is diffuse o r not, prior to change. Our focus here is o n more regular leadership changes that l e ave the d e c i s i o n - making process and distri­ b ution of p ower intact. 1 2 . O n e m ay say, h owever, that a s u b s titute fo r this h a s been th e parameters set by conditionality on the p art of t h e I M F and to a lesser 191

-

Notes to Pages 1 1 4-20

Notes to Pages 1 20-66

extent the Wo rld Bank during the 1 9 70s and 1 9 8 0 s . Typi cally e ffective

eral interest were first drafted by the exe cutive branch. Fewer than a

during crisis p e r i o d s , t h e s e p r o grams substituted fo r t h e i n formation

hundred bills were passed each year, and the president had much to say

that o penness to international markets may have p rovided. To that extent,

about which b ecame law . . . . A maj o rity of bills passed by both houses

the lines for the rent- s eeking c o ntests were defined in terms of the al­

were p articularistic; they granted utility franchises for example, created

lowable budgets and taxes that n e e d e d to b e p a s s e d .

barrios, o r changed the names of schools. Congressmen filed thousands

1 3 . An important source of uncertainty for Americans at t h e time was

o f s p ecial interest bills every s e s s i o n , doing favors fo r [their] l o c al p o ­

the impending end of "parity rights, " a legacy fro m the US o c cupation ,

litical liders o r simply trying to impress unsophisticated constituents. As

which gave national treatment t o U S investors, p articularly in the matter

a result, the priorities of the technocrats on the p resident's staff clashed

of asset ownership.

with those of congressmen." This situation, of course, became even more

14. F o r an overview, s e e d e Dios, Daroy, and Kalaw- Tirol 1 9 8 8 .

pronounced under the dictatorship, whe n the legislature either d i d not

1 5 . Another country in a similar situation would h ave b e e n India. I t

exist or was reduced to a rubber stamp. This p ractice is still current, to

is noteworthy that develo p ment theorists writing in t h e 1 950s a n d 1 960s

the extent the p o s t dictatorship p r e s i d e n cy has more p rero gatives than

regarded India and the Philippines as the countries m o s t l ikely to suc­

it had b e fore martial l aw.

ceed i n development terms .

2 4 . This p r o p o sal was also s u p p o rt e d by the reputable P h i l i p p i n e

1 6 . Recall that the Philippine Revolution of 1 89 6 was the first in Asia to be waged o n explicitly Western republican and democratic principles from the French Revolution. The democratic p olitical canon was suspended but not c ontradicted by the U S o ccupation. Indeed, it might have been strengthened by the example o f the Americans' own democratic system. 1 7 . I n the Philippines this broader view is used to distinguish purely e c o n o m i c unionism fro m the i d e o l o gi c al or militant variety. 1 8 . Wry political wis d o m captures this when it states that no one in the country ever " l o s e s " an election, one is o nly always "cheate d . " 1 9 . M arx ( [ 1 8 69] 1 9 83) in a similar vein would write i n frustration

Constitutio n al As s o ciati o n . 2 5 . Admittedly a t least p artially self- s e rving o n t h e p art of incumbent politicians. 2 6 . This is not to deny that favoring p articular interests is also pos­ sible i n the process o f p rivatizatio n and deregulatio n . 2 7 . T h e s e i n e ffi c i e n c i e s include the m i n o r displays o f syc o phancy involved in inventing acronyms for projects that invariably spell out the incumbent p resident's name, i.e., F I D E L under Ramos and E RAP under Estrada. Of course, this also means that these programs must b e scrapped o r redrawn once the administration change s .

that absolutism, or B o napartism, was based o n the b ackwardness o f the

2 8 . E c o n o m i c d e c i s i o n s by the S u p r e m e C o u rt-mo s t r e c ently o n

Fre n c h p e asantry. H e went as far as to doubt whe t h e r they fo rmed a

foreign investment in the M anila Hotel-have p articularly attracted con­

class, noting that they were c o nnected purely locally, with few interests

t rove rsy.

at the national level and n o p o l itical o rganizatio n .

2 9 . A study by the I nstitute for Popular Democracy ( 1 994) o b s e rves

2 0 . This is b y no means unqualified; s o m e authors have pointed t o

that member s of the Lower H o u s e who c a m e fro m oligarchic families

factors which suggest that qualitative changes are possible, if they have

had b e e n reduced fro m 1 69 ( o f a total m e mb ership o f 2 5 0) in 1 9 87 to

not actually o ccurred , owing to economic change s , demographic forces,

1 45 by 1 99 2 .

glo b alizati o n , educati o n , and the emergence o f an o rganized citizenry during the M arcos dictatorship itself ( s e e , e . g . , Ke rkvl i e t and M oj ares 1 99 1 , 10 and d e D i o s 1 99 9 a fo r a discussion) . 2 1 . Fo r a recent d i s c u s s i o n , s e e de Dios 1 99 9 b . 22. Notwithstanding t h e fact that tariffs are part of revenues and, there­ fore, a legislative prerogative, a loophole in the tariff code exists, allowing the president to revise tariffs when Congress is not in session. 23. Wurfe l ( 1 9 8 8 , 8 5 ) p rovi d e s a d e s c r i p t i o n o f the p re martial l aw period that is still relevant when he writes that "almost all bills of gen1 92

Notes t o Chapter

7

( Governance and Growth i n Thailand)

1 . S e e Warr and Bhanupong 1 99 6 fo r a detailed description of the s h o cks and p olicy r e s p o n s e s . 2 . See Doner a n d Anek 1 994 a n d Warr a n d Bhanupong 1 99 6 for more detail s . 3. Other factors certainly affect governance a s well, among t h e m the interests and behavio r of p rivate actors. However, in this chapter I focus primarily on t h e in ce ntives and capabiliti e s o f policy make r s . 1 93

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T Notes to Pages 1 66-69

4. National policies include classic public goods, such as defense, as

Notes to Pages 1 69-73

However, even these p arties draw most of their support fro m one or two

well as goods or p o licies that may look a lot like public goods, but might

regions (the South and B angkok for the Democrats and the N o rtheast for

not meet the strict public g o o d s definition ( n o n rivalrous consumption

the NAP) .

a n d n o nexc l u d ab i l ity) . E d u c a t i o n and currency d eval u a t i o n s are two

1 1 . King ( 1 996) and Albritton ( 1 996) are the lone dissenters that I am

examples o f collective, but not strictly, public goods. In principle, edu­

aware o f. They argue that the weakn e s s o f Thai p arty labels has b e e n

cation is ce rtainly an excludable g o o d-individuals might b e excluded

exaggerated and t h a t p arty labels do m a t t e r to voter s .

o n the basis of their ethnicity, their citizenship status, their income, etc.

1 2 . A well - kn own example comes fro m seventeenth - century England

A currency d evaluation might not meet the n o n rivalrous co nsumption

(North and Weingast 1 989) . The addition of Parliament as a check o n the

criteria. As people "consume" the d evalued currency by p u rchasing it,

English monarch's actions made it more difficult for the Crown to renege

the currency will appreciate over time, ceteris p aribus. The more people

on public debt c ommitments . As a result c o mmitments to repay were

purchase the currency the greater the appreciati o n . 5 . F o r exampl e , electoral r u l e s t h a t require voters to v o t e for p arty lists or that p o o l votes among candidates of the same p arty tend to b e asso ciated with a strong attachment to p arty label o n t h e p art o f both

more credible and England was able to b orrow money at lower interests than would h ave o t h e rwise b e e n p o s s i b l e . 1 3 . Prem actually followed t h e o n e -year t e r m of General Kriengsak, who resigned in 1 9 8 0 .

c a n d i d ates and vo ters . O n the other hand, whe r e voters cast multiple

1 4 . S e e , fo r exampl e , A n e k 1 99 2 a and P a s u k and B aker 1 99 5 .

votes o r where the electo ral rules facilitate intrap arty c o mpetition the

1 5 . I t is important t o note that the " bifurcation" of p olicy c a n actually

value of the p arty label is diminished (Carey and Shugart 1 99 5 , Shugart

be traced back to the Sarit era (see Christensen et al. 1 997) . I n 1 958 the

and M ainwaring 1 99 7 , Cox and McCubbins 2 00 1 ) .

managem e n t of macro e c o n o m i c p o licy was reformed and techno crats

6 . F o r theories o n whe n groups have incentives t o form nationwide

put i n charge o f the p o licy- making p r o c e s s . H owever, management of

p arties as opposed to smaller p arties see Chhibber and Kollman 1 99 8 ,

sectoral p o licy was not reformed and remained a bastion of c orruption

C o x 1 99 9 , a n d Hicken 1 99 9 .

and p atron age (ibid . ) . The uniqueness of the p olicy-patronage compro­

7 . Capability is also a reflection of administrative capacity-namely,

mise under Prem is that electoral p o liticians were given a piece of the

the quality of the bureaucracy (Cox and McCubbins 2 00 1 ) . The bureau­

pie and were able to keep it. (Elected politicians were also appointed to

crats h ave a key role t o p l ay i n the p o licy- making p r o c e s s . They are

s e c t o r a l C a b i n e t p o s ts i n 1 9 7 5 but l o s t c o ntrol of t h o s e p o s t s aft e r a

o ft e n a key source o f info rmation fo r p o licy makers and are also del­

military c o u p in 1 9 76) .

egated the task of p o licy imple mentation. Where administrative capac­

1 6 . A few p o s it i o n s were fill e d up by p o liticians with s t r o n g e c o ­

i ty i s l ow due t o d i vi s i o n s w i t h i n the b u r e a u c r a c y, c o rr u p t i o n , o r

n o m i c b ackgro u n d s . B o o nchu R o c h anasathian, h e a d o f t h e SAP p a rty

incompetence, the capabil ity t o produce and implement go o d policies

and a former bank p resident, was chosen as Prem's first deputy minister

is undermined. The quality of p olitical leadership could also be included

in charge of economic affairs. However, when B o onchu and Prem clashed

in this category.

over stab ilizatio n measures, Boonchu resigned his post and the SAP left

8 . The role of the Senate in p o licy making is an extremely under­

the government c o alition . ( B o o nchu wanted to increase fiscal spending

studied topic and one that deserves more attention (see Chai-anan 1 989

in an effort to try and jump start the economy while Prem and his advisors

fo r some discussion o f the role o f the Senate ) .

p referred a stabilization package) . After B o o nchu and the SAP left the

9 . P arties also fail to fo rge strong links acro s s districts, province s ,

Cabinet, Prem assumed a greater role in e c o n o mic p o licy making and

a n d regions t o fo rm large , natio nal parties, although t h e extent of link­

appointed n o n p arty people, m o s tly technocrats o r retired bureaucrats ,

age failure varies s o mewhat by region and p arty. For a m o re detailed

to t h e k e y e c o n o m i c p o sts (Ane k 1 99 2 b ) .

an alys i s o f l i nkage , t h e number o f parties a n d regional vari ations in Thailand s e e Hicken 1 9 9 9 .

1 7 . F o r m o r e information a b o u t the s p e c ific fu n c t i o n s of e a c h o f these group s s e e A n e k 1 99 2 a , 1 99 2 b a n d Christensen et al . 1 9 9 3 .

1 0 . T h e two p arties t h a t h ave c o m e c l o s e s t to b e c o m i n g national

1 8 . Researchers point to several factors that contri b u t e d to t h e rela­

p arties in recent elections are the Democrat and New Aspiration Parties .

tive decline in the p olitical influence o f the military over the c o u rse of

1 94

195

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T Notes to Pages 1 7 5-82

Notes to Pages 1 73-75

the 1 980s, culminating in the selection of an elected politician as p rime minister in 1 988. These factors include the end o f the communist insur­ gency, splits, and generational shifts within the armed s e rvices, interna­ tional influences, economic development and the growing political power o f economic elite, and an alliance between the new economic elite and p olitical p arties (see for example Chai- anan 1 989, 1 993, 1 99 7 ; Suchit 1 989; Sukhumband 1 99 3 ) . The fact that Chatichai was a retired general also helped facilitate the transition fro m a nonelected to an elected p remier.

enact sound p olicy out accurat e info rmation , policy makers ' capabil ity to advo cates of the st stronge the was furthe r underm ined. Howev er, even t o a c c o u n t fo r need b u r e a u c r a ti c - d e c l i n e exp l a n a t i o n r e c o gn i z e t h e cracy could in politica l factors as well. " Since the failure of the techno hip, it has to be p rinciple b e ultimat ely correct ed by the politica l leaders that leaders hip" deliver to explain ed why the Thai political system failed (Amma r 1 99 7 , 64) . a n c e is t h e o nly 2 3 . This is n o t to s ay, howev er, that p o o r gove r n

encies rather than in ultracompetitive B angkok, sought out the support

reason behind the crisis. develop ment 24. The closest thing to a compr ehensiv e infrastr ucture l o p ment deve e n - field plan was the East S e a b o ard Deve l o p m ent-a gre a n i n d u s t r i a l area, a p r oj e c t c o m p o s e d o f exp o rt p r o c e s s i n g z o n e s , roj ect ran into signifi­ p this even er, telepor t, and a deep seapor t. Howev ). cant difficu lties ( s e e Anuph ap 1 99 7 for more details ment has been 2 5 . Thailan d's perfo rmance in the area of the environ

and assistance o f the p rovincial business elite ( O ckey 1 99 2 ) .

e q u ally dismal .

1 9 . James Ockey ( 1 99 2 , 1 994) and Philip Robertson ( 1 996) are among those who h ave chronicled the rise of the s e p o werful p rovincial b u s i ­ n e s s m e n , o r Chao Pho, and their e ntry i n t o p arty p o litic s . These b u s i ­ n e s s m e n became active supporters of candidates a n d p olitical p arties in an effort to gain more influence i n the p ol i cy p r o c e s s . I t was also the case that B angkok-based p oliticians, p referring to run in rural constitu­

2 0 . The fo rtu n e s o f p rovincial b u s i n e s s elite were o ft e n b as e d o n concessions or monopolies, such a s mining, timber, liquor production and distribution, and petrol distribution, granted by the government ( Ockey 1 992) . One would expect, then, that they would be against any attempts to remove concessions, dismantle monopolies, or make the process of grant­ ing contracts more competitive and transparent. 2 1 . The JPPCC met a similar fate. The JPPCC was created by Prem to b e the vehicle through which urban business interests would influ­

Amma r 1 9 9 7 , 26. For more i nformation o n the BISE see Pakorn 1 994,

a n d Nukul 1 9 9 8 .

h e links b etwe e n 2 7 . T h e r e i s r o o m fo r m u c h m o r e r e s e arch o n t articul arly interes ting politic s a n d p o licy making during t h e 1 99 0 s . A p of the B ank of Thai­ failure questio n i s what role p olitics played in the

7 float. land to devalu e the curren cy p r i o r to the July 1 99 increa se in the de an how of sion discus a for 7 2 8 . S e e Amma r 1 99 nd i t s e l f a l s o Thaila f o k an B the facto n u m b e r o f veto p l ayers within

elected Cabinet ministers (and the p rovincial business interests that they

contrib uted to the deterio ration o f p o licy. tion o n the B B C 2 9 . S e e P a s u k and B aker 1 9 9 8 fo r m o r e info rm a

r e p r e s e n t e d ) to gain m o r e d i s c r e t i o n over e c o n o m i c p o l i cy making.

scandal.

e n c e p olicy. Chatichai redu ced the role of the JPPCC i n a bid to allow

Compared to a nearly monthly meeting schedule under Prem, the JPPCC met only five times in 1 9 8 8 , four in 1 9 89, and twice in 1 99 0 . 2 2 . While t h e incentives a n d capabilities of p oliticians a r e t h e fo cus of this e s s ay, there are c e rtainly o t h e r factors that c o ntributed to the decline in the quality of governan c e . One of the most significant is the

M acIntyre 1 999a, 30. For detaile d accoun ts of the crisis in Thailan d, see 1 99 9 , Warr 1 9 9 8 , and Bhanu po n g 1 99 8 , Amma r 1 99 7 , Pasuk and B aker Laurids en 1 99 8 .

1 99 7 Constit u 3 1 . F o r a closer l o o k a t t h e implica tions of t h e new b. ming tion, s e e Hicken fo rthcom ing a, and Hicken forthco

hollowing out and politicization of the bureaucracy that occurred during the late 1 9 8 0 s and 1 9 9 0 s (Ammar 1 9 9 7 ) . D u r i n g the e c o n o m i c b o o m m a n y o f the m o s t c o m p e t e n t a n d wel l - trai n e d b u r e au c rats l e ft their government j o b s for higher p aying p ositions in the p rivate sector. Col­ lege graduates also b e gan opting fo r high - p aying careers in the p rivate s e c t o r over j o b s i n the bureauc racy. This re duced the cap acity of the bureaucracy to analyze the p o tential problems facing the economy, and to o ffer accurate information and sound advice to policy makers. With-

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INDEX

Administrative

B aht

capacity, 1 94n. 7

Agricultural development, M alay­ sia, 1 3 8

B angkok International B anking

Alliance, The, Malaysia, 1 3 7-38

Facility, 1 77

American Foreign Corrupt

B anharn, Silpa- archa, 1 73

Practices Act of 1 977, 80

B anharn administration, 1 80-8 1

Anand, Panyarachun, 1 77

B ank Bumiputera, M alaysia, 1 4 1

Anand government, 1 77-78

B ank of Thailand, 1 65 , 1 72 , 1 78-

Aquino, Corazon , 1 04 , 1 22-23

79, 1 97n. 28

Aquino administration, 1 2 1

B I B F. See Bangkok International

Arbitration Law, China, 80

Banking Facility

ASEAN . See Association of South-

B M F. See Bumiputera M alaysia

east Asian N ations

Finance

Asian crony capitalism, 1 90n. 28

Boonchu Rochanasathian, 1 95n. 16

Asian financial crisis: 1-3, 6, 25-26, 40,

Bribery, 2 1 -22 , 60-63 , 1 88n. 1 0

1 90n. l ; effect on China, 97-100;

Budget Bureau, Thailand, 1 72

impact on the Philippines, 128

Bumiputera, 1 40, 1 44, 1 4 6 . 1 53 .

Asian miracle, 2

1 55 , 1 57

Asian value, 1 90 n . 28

Bumiputera Malaysia Finance, 1 4 1

Association of Southeast Asian

Bureaucracy, 58-59, 1 2 5

Nations, 1 2 6

B ureaucrats, 58, 73, 82, 1 94n. 7

Autonomy of local governments,

Capital account, Indonesia, 39-40. 43

China, 88-89 Auto nomy o f technocrats , China,

Capital accumulation, Korea. 60

89-90 214

d evaluation, 1 65

Bangkok Bank of Commerce, 1 79-80

Capital control. 1 8 7n . 9 215

Index

Index

Capital flight, Korea, 49-50

Corruption, monopolistic, 2 1 -23

Capital inflow, Ko rea, 52-56

Criminal law, China, 8 1

Central Advisory Commission,

Cronyism, 1 6 1 -62

China, 90

CSH. See China Strategic Holdings

Central Party Discipline Commis­

D aim,

sion, China, 92 Central Party Personnel Agency,

Estrada administration, 1 23 , 1 9 1 n. 9

Illicit wealth

Ethnic M alay. See Bumiputera

Indonesia: corruption in, 25-44;

Fm

economic conditions in, 3 1-32, 42; institutions, 32-38; invest­

Service Company, China, 84

ment 27-30; legal system, 30, ' 40-4 1 , 44; political incentives,

Federal Land Development Zainuddin, 1 48

accumulation, 46

Authority, M alaysia, 1 3 8

Daya Bumi p roject, 1 4 1

Financial regulation, Thailand, 1 78

32-38; political system, 43;

D e Venecia, Jose, 1 23

Fiscal policy, Thailand, 1 80

private cronyism, 30; systemic

Debacle of 1 99 7 , 1 60-62

Fiscalizing, 1 90 n . 5

cronyism, 30

Decentralization of autonomy, 86--9 1

Foreign capital inflows, Korea, 52-56

Chaebols, 52, 6 1 , 65-66

Decentralization o f authority, 86, 89

Foreign debt, Korea, 1 87n. 1 3

Chao Pho, 1 96n. 1 9

Democrat Party, Thailand, 1 94n. 1 0

Foreign direct investment: China,

Chart Thai Party, 1 73

China, 90 Centralizatio n in government, Philippines, 1 1 4-22

Industrial Coordination Act, M al aysia, 1 46, 1 5 7 Industrial Incentives Act, Malaysia,

Democratic institutions, 5

69-7 3 , 8 0 , 1 88 n . 1 ; Indonesia,

Checks and balances, 1 03-6, 1 2 7

Deng Xiaoping, 85-86, 92, 1 89n. 24

2 8-2 9 ; K o r e a , 54-5 6 , 1 8 6 n . 5;

Industrial organizatio n theory, 3 3

China, People's Republic of: 3-4 ;

Department of Anti- Embezzlement

Malaysia, 1 3 5 ; Thailand, 1 65-66

I nformal enforcements. See

corruption in, 73-79; foreign

and Bribery, China, 8 1 , 92

direct investment, 69-84, 97;

Diffusion o f p ower, Philippines,

formal governance, 9 8- 1 00

1 1 1-14

China Strategic Holdings, 83

Dual- tract p rice system, 1 88n. 4

Chinese Communist Party, 92 Civil Service System, China, 90-93

E ast Asian

Cojuangco, Eduardo, 1 9 1 n. 1 0

East Seabo ard D evelopment,

Commo dity production, M alaysia,

p aradox, 3-5 , 1 1 - 1 4

Thailand, 1 97n. 24

1 3 3-34 Companies Act of 1 965, Malaysia, 1 4 1 Congre s s . Philippines, 1 93 n . 2 9 Chaebo ls

Thailand, 1 76-7 7

Economic Planning B o ard, Korea, 64-65

I nstitutional change, 6-7 Institutions: 1 83n. 2; and credible

Trade, 65

cal incentives, 32-38

Governance: 1-2; China, 9B-I00; Phili p p i n e s , 1 0 1 - 2 , 1 1 2 ; Thailand,

I ntermediary business organiza­ tions, China, 8 1 -84, 88

1 66--70, 1 75, 1 93n. 3, 1 96n. 22 Government decision making, 6 1 -62

Internatio nal arbitration, China, 1 88 n . 1 2

Government intervention o n investment, 56-5 8 , 1 40-47

International Convention o f Invest­ ment Disputes, 8 1

Government regulations, Indone­

I nternational Country Risk Guide,

sia, 33-35

1 87n. 9, 1 88n. 6; and capital

Economic reforms, Thailand, 1 65

Grameen Bank-like Ikhtiar, 1 5 7

accumulation, 60; and gover­

Economic stability, Ko rea, 47-49

Gro ss domestic product: 1 7-20 ,

nance, 6 1 -62; and implications

Educational system, Thailand, 1 75

for investment, 1 1 -24; model of

Elections, 1 06-9 , 1 70 , 1 94n. 5

predictability, 1 7-24; political

Employment I ndex, M alaysia, 1 44

1 83n. 3 International Monetary Fund, 1 1 6, 1 26 I ntraregime investment, Philip ­

27-28

pine, 1 03-6

G uanx i , 8 1

Investment Act of 1986, Malaysia, 1 5 1

functions of, 62-64; survey

Ersatz capitalism, 1 6 1

H ong Kong,

questions on, 1 6

Estrada, Joseph, 5-6, 1 08

Hua Guofeng, 85

216

tional Studies, M alaysia, 1 50

Tariffs and Trade General Agreement o n Tariffs and

Indonesia, 3 6-3 8 ; and p o liti­

5, 32-42, 46-56

Corruption: 3-5, 1 3- 1 4, 1 84n.5,

Institute of Strategic and I nterna­

See General Agreement on

Gift giving, China, 1 88n. 3

Economic history, 25-26

Coordination devices, China, 92-97

GATT.

commitments, 3 8-42; in

Economic governance system, 4-

1 1 9-20, 1 23 ; M alaysia, 1 5 1 ;

I nfrastructure development policy,

General Kriengsak, 1 7 7 , 1 9 n. 1 3

sia, 1 34 , 1 3 7-40

Thailand, 1 68 , 1 73 , 1 82

l aws , China

China, 73-74, 79-8 1 Free Trade Zones Act, Malaysia, 1 39

Economic deregulation, M alaysia, Economic diversification , M alay­

Co nstitution: Philippines, 1 03 ,

Foreign direct investment

Foreign direct investment laws ,

Economic Contract Law, China, 80 135

Co nglomerates, Korea. S e e

139

82-83

I nvestment governance, Korea , 54, 64-67 217

Index

Index

M acroeconomic

I nvestment model, Philippines, ISIS.

See

1 77-8 1 , 1 95n. 1 5

Institute of Strategic Inter­

Mahathir, Mohammad, 7 , 1 3 1 , 1 3 5

national Studies, M alaysia

Mahathir administration , 1 43

Japan External Trade Organiza-

Mahathir's Policy Reforms, 1 4 7-52 M alaysia: 3, 6-7 ; colonial heritage,

tion, 1 76

1 3 5-3 7 ; economic b o o m in,

Judiciary, Philippines, 1 05 , 1 1 9

Keynesian

p olicy: Korea,

47-48; Thailand, 1 7 1 -72 , 74,

1 2 9-3 0

theory, 47

See

authoritarianism

N ational

Philippine Constitutional Associa­

Malaysia, 1 50 National Economic and Social Devel­

New Asp iration Party, Thailand,

infrastructure, 137, 1 54;

corruption in, 4, 60-63 ; and

investment policy of, 1 3 4 ;

foreign capital inflows, 52-56;

investments , 1 43-44; p ostwar

inve stment in, 45-49; luxury

economy, 1 3 1-34; and state

consumption in, 50-5 1 ; state ­

interventi o n , 1 40-47

tion, 1 93n. 24 Philippine elite , 1 1 6- 1 7 Philippine Revolution o f 1 89 6 , 1 92 n . 1 6

opment, Thailand, 1 72, 1 74

tion in, 1 3 4-40 ; economic economic recession, 1 34 ;

M alaysia, 1 4 1 Petroleum production, Malaysia, 1 4 1

Development Policy,

Nepotism, 1 6 1 -62

Korea: capital flight in, 49-50 ;

Petroleum D evelopment Act,

Market- preserving

1 60-62 ; economic diversifica­

Kim Young Sam government, 64, 66

created rents in, 5 1 -52

Monopolistic corruption, 2 1 -23, 1 05 MPA.

Philippines: 3 , 5-6; bureaucracy, 1 25; corruption in, 1 05-6; elections, 1 06-9; governance system, 1 0 1 -

1 94n. 1 0

2 , 1 22-27; political economy,

New business governance,

1 02-3; political institutions,

Malaysia, 1 47-52 New Economic Policy, Malaysia,

1 1 5-1 8 ; presidency, 38

7 , 1 3 1 , 135, 1 40 , 1 52-53

Pioneer Industries Ordinance, M al aysia, 1 3 9

New Order period, Indonesia, 26, 3 1

Malaysia Incorp o rated, 1 47-48, 1 53

New regulation, M alaysia, 1 3 5

Plaza Accord o f 1 985, Thailand, 1 65

Korean Federation of Industries, 65

M alaysia Business Council, 1 50

Northian framework, 4 1

Political and Economic Risk

Korean I nvestment Governance

M alaysia Industrial D evelopment

O ECD.

Political Bureau Standing Com­

System, 46-56

Authority, 1 3 9

Kuok, Robert, 84, 1 89n. 1 6

Manufacturing investments,

Kuala Lumpur City Centre, 1 4 1

M alaysia, 1 45

Law of Equity Joint Ventures, China, 79 Law of Contractual Joint Ventures, Law o f Wh olly Foreign - Owned Enterprises, China, 79

OLS regression, 1 8- 1 9

Marcos, Ferdinand, 1 04

Organization fo r Economic C o o p -

1 90n. 25 Political economy, Philippines, 1 02-3 Political institutions, Indonesia, 36-38

eration a n d Development, 13, 65

Political parties, 6, 8, 1 94n. 9

Market -preserving authoritarianism,

Outline of Perspective Plan,

Political Risk and Consultancy

MIDA.

See

Malaysian Industrial

Development Authority Ministry of Public Enterprises, Malaysia, 1 42 Ministry of Finance, Thailand,

pines, 125

Political control, China, 90-9 3 ,

O- ring corruption, 23-24, 1 85n. 1 1

Legal system: 2-3 ; of China, 73-74 ,

L o c a l government code, Phili p -

Political business cycle, 1 9 1 n. 7

Marcos regime, 1 1 6 China, 4, 75-79, 84-86

1 26, 1 93 n . 2 9

D evelopment

Mao era, 1 89n. 1 8

Merdeka Constitution, 1 3 7

Legislature, Philippines, 1 1 9-2 0 ,

mittee , China, 92

Economic C o o peration and OeL Hong Leong, 83-84

LCM framework, China, 7 1 -73 , 79 9 7 ; of Indonesia, 30, 40-4 1 , 44

Organization for

Mao Xedong, 85-86

Marcos family, 1 08

China, 79

Consultancy, 69

See

1 72 , 1 74

Inc., 1 83n. 3

Malaysia, 1 40 , 1 4 5-46

Parity rights,

Political stability, Korea, 47-49 Political system, Thailand, 1 82

1 92n. 1 3

Political turnover, Philippines,

Park, Chung H e e , 4 6

1 06-9

Parliamentary system, Philippines,

Politics of governance, Thailand,

123

1 5 2-60

Party system, Thailand, 1 67-68

Pork-barrel politics, Philippines,

Patronage , Thailand, 1 7 1-72

See

L o c a l info rmation, 8 1 -84

Ministry of Supervision, China, 8 1 , 92

Look East policy, Malaysia, 1 47, 1 53

Monopolies, single, 3 3

Lopez family, 1 08

Monopolies, complementary, 33

Pearl River Delta of Guangdong, 83

Power, devolutio n of, 1 24-2 5

Luxury consumption, Korea, 5 0-5 1

Monopolies, multitude, 34, 44

People Power Revolution, 2, 5

Power, diffusion of, 1 09- 1 4

218

PBSC.

Political Bureau of

1 2 1 -2 2

Standing Committee

Poverty reduction, Malaysia, 1 46

219

1 Index

Index Sectoral policy, Thailand, 1 75-77

Pramuan, Sabhavasu, 1 73

Singapore, 1 3 7

Prem Tinsulanonda, 8-9 , 1 64-6 5 , 1 70-7 1 Pre - m artial law period, 1 9 2 n . 23

Trade liberalization, 6 5 , 1 20

Southeast Asia economic boom,

Transnational corporations, 54-56

SPC. See State Planning Commis­

1 20-24

sion, China

Presidential system, Philippines, 1 04 Prime Minister, tenure of, China, 93

Standing Committee of National

Wage

Transparency International, 69, 1 83n. 3 ,

State Administration of Industry

Promotion of Investments Act, M alaysia, 1 4 5

and Commerce, China, 87

Property rights, Indonesia, 25-26, 3 5

State Council o f China, 93-96

Provincial politicians, Thailand, 1 73

State - created rents, 5 1 -52 , 1 55

Public goods, Thailand, 1 94 n . 4

State Economic and Trade Com-

Public investment, Philippines,

mission, China, 92-93

1 9 1 n. 8

State in a Changing World, 1 6

Public sector expenditure, M alay­

State- owned enterprises: China,

sia, 1 42

73, 87-8 8 ; M alaysia, 1 4 1-42, 1 48; Thailand, 1 76-77 State Planning Commission,

Fidel V. 1 23

Ramos administration, 1 2 1 -23

China, 92

Redistribution of wealth, M alay-

Stock Exchange Commission,

sia, 1 55-58

Thailand, 1 77

Regime of I nvestment Gover­

Suharto , 3-4, 26, 35-38, 40, 42, 1 85n. 2

nance, 1 993- 1 99 7 , 64-67

Systemic cronyism, 30

Regulatory agencies, 33 Rent- se eking: 5 ; Korea, 5 1 -52 , 59-

Tariffs,

63; M alaysia, 1 55-6 1 ; Thailand, 1 7 1 -72

1 92n. 22

Technocrats, Thailand, 1 72 , 1 74-75

Rentier cronyism, 1 6 1

Ten Great Relationships, China, 85

Roh Tae - Wo o government, 66

Thai party system, 1 69-7 1

Rule of law, 1 0 1

Thai political system, 8-9 , 1 66-7 1

Rural development, M alaysia, 1 3 8

Thailand: economic co ndition ,

S abah,

1 63-66; infrastructure devel­ opment policy, 1 76; political

137

structure, 1 66- 1 70

Sarawak, 1 3 7

Township and village enterprise,

Second Outline Perspective Plan,

China, 73

M alaysia, 1 50 220

differential, Korea, 1 86n. 4

World Trade Organization, 6 5 , 1 26

Tukkap 62

Tunku Abdul Rahman, 1 3 4

State intervention, M alaysia, 1 3 5

Thailand, 1 76

Malaysia, 1 46, 1 50-52

World D evelopment Rep o rt, 1 6

1 89n. 1 5

1 54 ; Philippines, 1 93n. 26;

constitution, 1 5 1

Vision 2020,

People's C ongre s s , China,

Privatization: M alaysia, 1 4 8-49 ,

Ramos,

1 20 , 1 93 n . 26

Sixth M alaysia Plan, 1 50 1 60-62

Presidents, Philippines, 1 09 , 1 1 9 ,

UMNO

Trade deregulation, Philippines,

22 1