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The Economic Crisis and ASEAN States' Security

Authored by Dr. Sheldon W. Simon. | October 1998

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Introduction

In the late 20th century, no region of the world has been more successful in improving the standard of living of its populations than the Asia-Pacific. If national security is in large part a function of national well-being, then East Asia has enjoyed an increasingly secure existence. Beginning in the early 1990s, both Northeast and Southeast Asia have experienced aggregate annual economic growth rates averaging 7 percent, more than double those of North America and Western Europe. Politically as well, this region seems to be adapting effectively to the post-Cold War. Regional organizations such as the Association for Southeast Asian Nations (ASEAN), which celebrated its 30th anniversary in 1997, and the Asia Pacific Economic Cooperation (APEC) forum provide regular venues for discussions of regional trade, investment, and security issues?dialogues previously unknown for Asia at the regional level.

Nevertheless, this rosy picture has been marred in 1997-98 by a series of financial and economic crises that spread along the Asia-Pacific rim like a contagious disease. Originating in Thailand in July 1997, financial meltdowns spread quickly to Indonesia, Malaysia, and the Philippines, as well as affecting the much stronger currencies of Hong Kong and Singapore. By the end of 1997, currency depreciation averaged 50 percent against the U.S. dollar since July; and the crisis had extended to South Korea and Japan as well.

The ?Asian miracle? was fueled by large scale direct investment from Japan, the United States, and other capital exporters who benefited from favorable production costs in the region. As foreign investment flooded their economies, most Asian states saw the value of their currencies increase relative to the dollar. But, instead of removing some of their currencies from circulation by raising interest rates, the Asian states actually accelerated domestic monetary supply in an attempt to make exports cheaper on the world market. Ultimately, as the dollar kept increasing in value and Asian current account deficits (debt) kept rising, a crisis of confidence in their currencies occurred. For example, Indonesia, Thailand, and Korea? All running large current account deficits and all dependent on foreign investment to fund their trade?became vulnerable to speculative currency attacks. As the value of their currencies fell, the costs of repaying foreign loans rose; and external investors grew less willing to lend more. Hence, the need for official international intervention via the International Monetary Fund (IMF), Asian Development Bank (ADB), World Bank, and the governments of Japan, the United States, and the European Union (EU).

The currency crises exposed inefficient and corrupt national financial institutions closely tied to political leaderships and prominent family-owned conglomerates which kept building industrial capacity even as the global demand for their products declined. Bad bank loans accounted for almost 20 percent of loan portfolios in 1997, making East Asia?s banking system its biggest potential liability. Nor will attempts by political leaders to find foreign scapegoats for their current problems work. As both Malaysian Prime Minister M ahath I r and South Korea?s newly elected President Kim Dae Jung discovered, allegations against foreigners and the IMF only accelerate capital flight from their countries.

Heavy foreign exchange debt?much of it short term? And declining local currency values?which have increased the actual repayment costs?have forced Thailand, Indonesia, and South Korea to seek international bail out arrangements. APEC?s November 1997 meeting in Vancouver endorsed the IMF?s leading role and implicitly its conditions which include increased taxes, higher interestrates, and budget cuts. As a result, a number of high profile construction and infrastructure projects in these troubled economies have been put on hold. Moreover, the IMF and World Bank are also insisting on greater accountability from financial institutions, more responsible lending and investment practices, and a move away from the back-room deals that had brought great wealth to politicians and favored businessmen. By coordinating macroeconomic policies, the ASEAN states are becoming directly involved in each other?s affairs, a situation which heretofore has been assiduously avoided.

The reforms being forced on many East Asian countries could well be a blessing in disguise. In effect, they say that to participate in the global economy, your country must be well managed. And, well-managed countries require political reform. Even the more authoritarian Asian regimes of Indonesia and Malaysia appear grudgingly to be accepting this necessity. If the reforms succeed, Asian economies could emerge even stronger within several years. Fundamental strengths remain. Labor costs continue to be well below those in Japan and the West. Labor forces are hard working and thrifty; and taxes remain well below those of the developed world. However, the crisis demonstrated that countries with basically sound macroeconomic fundamentals can still succumb to overvalued currencies, poorly managed financial institutions, and dysfunctional relationships between political leaders and favored businesses.1

Washington?s delayed recognition of the magnitude of the crisis has elicited a good deal of criticism from Southeast Asian officials.2 The weak U.S. response, combined with the Clinton administration?s apparent inability to convince the U.S. Congress to authorize an additional contribution to the IM F?s capital base, have led some regional elites to conclude that the United States is either indifferent to the region?s plight or, worse, hoping to take advantage of it by both pushing the ?American model? And buying up bankrupt enterprises at bargain rates.

China, so far, has avoided the financial crisis even though its banking system is more strapped with bad debt than any of the Southeast Asian banks. Because its financial markets are not yet open to the outside world, inflation is low, its savings rate high, and its foreign currency reserves buoyant. Beijing has contributed to Southeast Asia?s recovery primarily by not devaluing its currency, thus avoiding setting off any disastrous chain reaction of devaluations.3 Meanwhile, China?s exports remain strong because foreign buyers are not yet returning to Southeast Asia. Regional banks have insufficient funds to issue letters of credit. And Indonesia is avoided because of political instability.

Nevertheless, the IMF foresees a moderate rebound among the ASEAN 4 (Malaysia, Philippines, Thailand, and Indonesia). After an aggregate decline of -2.7 percent in 1998, the Fund projects a growth rate of 2.5 percent in 1999 as investors take advantage of financial restructuring.4 Demonstrating a new sensitivity to Indonesia?s social instability, the IMF relaxed its strictures against government subsidies for rice and fuel in March 1998, though sporadic riots and demonstrations persist. Indeed, IMF-imposed requirements on the lifting of subsidies for daily necessities undoubtedly contributed to the social upheaval in Jakarta and other cities that led to the demise of Suharto?s 32-year presidency in May 1998.

This economic turmoil has obvious security implications. At the local level, primarily in Indonesia but conceivably also in Thailand and Malaysia, rising unemployment and popular frustration could be directed not only against the government but also against indigenous Chinese who make up much of the merchant class throughout Southeast Asia. (In Indonesia this has already occurred with tragic consequences.) The army?s role in containing local outbursts has been particularly prominent in Indonesia with a reemphasis on internal security. The prospect in Indonesia of more than ten million unemployed out of a work force of 90 million, and possibly over one million returnees from otherparts of Southeast Asia, has increased the potential for large-scale violence. In Malaysia, with an estimated 1.2 million Indonesian workers, three-quarters of whom are illegal, large-scale deportations initially led to violence, though the repatriation procedure became more orderly by mid-1998. The situation is similar in Thailand which is home to about one million illegal workers, most from neighboring Burma. Unemployment in Thailand is projected to double to more than two million; and Thai authorities plan to expel some 300,000 foreign workers this year.5

These massive population movements are creating strains both within and between nations. As Malaysian Foreign Minister Abdullah Ahmad Badawi put it: ?It is dangerous to have too many people unemployed. It can cause instability in Malaysia socially and even politically. We have to take care of our own people first; charity begins at home.?6 Thus, in addition to expelling illegals, Malaysia has also mounted a small flotilla of naval vessels to repulse new arrivals. Tension between Indonesia and Malaysia could result from these actions, though both governments are working to avoid that outcome.

Conclusion

For Southeast Asia, the past year has been overhung with dark clouds, literally from the forest fires of Sumatra and figuratively because of the currency crisis that has also spread like wild fire through the region. Once again the prospect of social instability stalks this territory. In Indonesia, armed forces are returning to internal security, while the problems of illegal economic migrants in Malaysiaand Thailand also demonstrate that security problems in Southeast Asia remain for the most part internal.

The defense modernization and arms acquisitions of the past 15 years are now being significantly cut back. Replacement of obsolete systems is being delayed. Overall, modernization has been put on hold as financial resources disappear. Sales to Asia from Europe and North America must now include not only lower prices but an ever larger share of the price in countertrade. Because almost all of the Southeast Asian countries are experiencing economic setbacks together, China?s unimpeded arms buildups appear all the more ominous.

If a disparity in arms balances develops over time between the PLA and ASEAN armed forces, China could be tempted to behave more boldly in the South China Sea. Offensive military actions to occupy largely unpopulated islets against multiple potential adversaries could lead to buck passing among the latter?one of the classic risks under multipolarity.56 ASEAN navies and air forces have not exercised jointly in a scenario against a common adversary in the South China Sea. Nor have they addressed interoperability among their services. And, the more they diversify acquisitions of combat platforms from the United States, Europe, and Russia, the more difficult inter-operability becomes. Competitive pricing from a variety of international suppliers may stretch defense budgets but it also increases the difficulty of collaboration.

Still, there is some evidence that China will not necessarily take advantage of Southeast Asia?s current troubles. Beijing has displayed interest in military confidence-building by co-chairing with the Philippines an ARF Intersessional Working Group on that subject and by signing in 1996 a pre-notification agreement on military exercises and the exchange of military observers?a major concession for the PLA which has always been quite secretive about military maneuvers. China has also responded to a March 1997 ASEAN protest about oil and gasexploration in disputed seas off the coast of Vietnam by removing a PRC ship from the area.57

Thus, there are undoubtedly elements within the PRC leadership who wish to purvey the image of China as a responsible great power prepared to follow the U.N. Convention on the Law of the Sea and negotiate its territorial claims with others. By contrast, however, hardliners?probably found in the Party and the PLA?may be behind China?s straight baseline seaspace claims from the Paracel Islands that invoked a principle most experts consider applicable only to archipelagic states. This PRC claim, if unchallenged, could establish a precedent for claiming much of the South China Sea between the Paracel Islands and the Spratly Islands.

In sum, the signals emanating from Beijing are mixed on whether the PRC will take advantage of the ASEAN states? Economic crisis. For the optimists, China has refrained from exacerbating ASEAN?s export-led recovery strategy by not devaluing the renminbi. Beijing has also shown increasing interest in adhering to the new U.N. Law of the Sea which treats overlapping EEZs as issues to be negotiated. Beijing is also supporting general counter ballistic missiles (CBMs) for the Asia-Pacific. The pessimists, however, see no letup in China?s military modernization and force projection development. With ASEAN arms procurements at a virtual standstill, the timetable for the PLA to catch up with and perhaps surpass its Southeast Asian neighbors may well be accelerated.

Endnotes

1. Shalendra D. Sharma, ?Bitter Medicine For Sick Tigers: The IMF and Asia?s Financial Crisis,? Survival, forthcoming, 1998.

2. Donald Emmerson?s interviews with Southeast Asian officials in January 1998 as cited in ?Americanizing Asia?,? Prepared for the 1998 Chase Emerging Markets Winter Conference, Snowbird, Utah, March 1-4, 1998, p. 5. 22

3. Ronnie C. Chan, ?Asia?s Crisis and China?s Response,? PacNet, Vol. 13, Honolulu: Pacific Forum CSIS, March 27, 1998.

4. ?IMF Sees ?Moderate Rebound? In Asia in 1999 and ?Solid Recovery? In 2000,? Wall Street Journal, April 14, 1998.

5. ?As Boom Fails, Malaysia Sends Migrants Back,? New York Times, April 9, 1998.

6. Ibid.

56. Avery Goldstein, ?Great Expectations: Interpreting China?s Arrival,? !nternational Security, Vol. 22, No. 3, Winter 1997/98, p. 65.

57. Cited in Jurgen Haacke, ?Collective Foreign and Security Policy: The Emergence of an ASEANized Regional Order in East Asia,? Presented to the March 1998 International Studies Association annual convention, Minneapolis, MN, pp. 13-14.