by

OECD Development Centre

Paris, June 2001

Before the financial crisis hit the region in 1997, several high-performing East Asian economies had enjoyed three decades of steady income growth and attained a remarkable improvement in the well being of the population. Meanwhile, a number of new social issues, such as rapid ageing of the population, migrant workers, income inequality, regional and gender disparities and ethnic conflicts, as well as environmental concerns were beginning to attract political attention in many parts of the region prior to the onset of the crisis. It was, however, the 1997-98 crisis itself that triggered a serious debate within these countries regarding the sustainability of social protection and more broadly the future of Asian societies. Indeed Asian scholars questioned whether the so-called Asian values were an asset or a liability.

No wonder. The financial crisis quickly translated into a drastic contraction in production and employment in Indonesia, the Republic of Korea (hereafter, Korea), Malaysia, the Philippines and Thailand, the five hardest-hit countries. The fall in real GDP in 1998 over 1997 ranged from 13.1 per cent in Indonesia to 0.6 per cent in the Philippines, while the rise in open unemployment rates was most conspicuous in Korea (from 2.6 to 6.8) and Thailand (from 0.9 to 4.4). Such shocks had severe adverse social consequences, bringing the question of social protection to the fore - as a common reform agenda of the region.

Three years after the crisis, there are increasing signs that these crisis economies are getting on the road to recovery, albeit to varying degrees. Yet, uncertainties remain high about the sustainability of policy reform, as social conflicts and civil unrest continue to unfold in some of these countries, most notably in Indonesia. Against the backdrop of these developments, this concluding chapter warns against some pitfalls in comparative development, due to unavailable data (D), inadequate analysis (A) and the neglect of culture (C). It is also intended to highlight several major findings regarding the social consequences of the Asian economic crisis, with main focus on poverty, and to discuss ways of sustaining development and social protection in East Asia.

One response from this policy challenge involves adapting budgetary procedures to the fact that the mechanism of social security common in OECD countries and described, e.g., in Braga de Macedo (1996, especially chapter IV) involves a mix of revenue and expenditure. The adaptation would make social affairs ministers share some of the strategic dominance in the budget process usually assigned to finance ministers, thereby helping horizontal co-ordination with purely "spending" ministries. This is one area where a comparative development perspective (taking due account of the D, A and C pitfalls noted above) can help policy dialogue about institutional change. Since such institutional perspective, drawing on the OECD and EU experience with peer pressure, did not feature in the seminar discussions, we address it first.

The most frequent institutional mix for social protection in the OECD countries: is a universal compulsory public system, financed through a payroll tax and general tax revenue on a pay-as-you-go basis. In addition, the peer pressure mechanisms practised in the OECD and the EU are an effective way to deal with growing international interdependence. The medium-term strategy contained in the 1993 White Paper on Growth Competitiveness and Employment and in subsequent documents does not contain clear arguments for and against tax reform, including social security reform. One reason may be that taxing and spending powers, as well as the design of budgetary procedures, remain with member States. This is why the principle of no bail-out by the Community or by each other contained in article 103 of the Treaty on European Union is the basis of budgetary discipline for all 15 states and not just the 12 members of the eurosystem. The treaty stresses budgetary procedure because the public-sector annual budget helps markets, social partners and taxpayers see the size of the public sector relative to private initiative, and therefore deals with high and rising public debt from below.

European integration will be sustained if policy rules exist to protect the interests of present and future taxpayers. But institutions oriented to the avoidance of excessive future taxation will not take hold unless voters appreciate the unsustainability of current policies. The convergence criteria for the euro and the 1996 Stability and Growth Pact can be seen in this light. Without them, the economic regime remains fragile and subject to policy reversals.

Social partners and taxpayers must understand that spending and borrowing by the Government tend to be higher than what would be socially desirable. There are two reasons for this bias. Spending may be excessive because the marginal cost of financing is not fully accounted for. Debt finance may be excessive because the interests of future taxpayers are underrepresented. A high share of open-ended expenditures (transfers to households, interest payments on public debt and government wage bill) increases the bias. Because they create entitlements, open-ended expenditures make it difficult to sort out the effect of economic cycles and the effect of discretionary policy decisions.

Appropriate procedures must include contingent reductions in expenditure and increases in revenue due to uncertainty in forecasting both sides of the budget. On the whole, appropriate budget procedures ensure that the authority representing the collective interest in the efficiency of public finance dominates over spending agencies, including those responsible for open-ended expenditures. The institutional requirements involve the parliament and the court of auditors, both at the national and at the union level, in addition to the independence of the central bank in matters of monetary policy. Basically, an effective multi-annual fiscal adjustment strategy on the part of each member State is necessary.

Strengthening market institutions also requires devising ways of monitoring the implementation of internal market measures, including financial services, as well as the co-ordination of the implementation of structural measures contained in the White Paper. Structural measures, including tax measures, for removing the obstacles to growth, competitiveness and employment will certainly be part of the process of institutional change for development.

As von Hagen and Harden (1994) have stressed, the annual public-sector budget must be the locus of conflict resolution. Institutions determine fiscal policies to the extent that they determine strategic roles and advantages. Therefore, they create or destroy opportunities for collusion among groups. Budgetary procedures will be appropriate if they facilitate effective and accountable conflict resolution. On the contrary, if the process leads to non-decision or if conflict resolution is removed from the budget, budgetary procedures are not appropriate and fiscal convergence will be impaired. The budget becomes a mere record of prior commitments and off-budget items spread, compounding the inefficiency of the budget process.

A multi-annual fiscal adjustment strategy can thus be seen as a commitment technology that helps to remedy budget illusion. The commitment will not be credible, however, if appropriate budget procedures are not followed. In countries that need to introduce a stable and broadly based tax system that does not encourage widespread evasion, as an important component of structural adjustment, there will be additional uncertainty on the revenue side. In fact, appropriate budget procedures have been successful in bringing some EU economies closer to a sustainable fiscal stance because they ensure that the authority representing the collective interest in the efficiency of public finance dominates. The analysis carried out by von Hagen and Harden (1994) for EU members was applied to EU applicants by Branson, Braga de Macedo and von Hagen (2001).

This implies the strategic dominance by the Prime Minister or the Minister of Finance over spending ministries. It is to be understood that spending ministries include those responsible for transfer payments. Yet the revenues from social security contributions do not suffice in general to make the minister responsible as true a representative of future taxpayers as the Minister of Finance. The tradition of financing unemployment benefits with a payroll tax, thereby de-linking them from contributions, brings important distortions to the labour market, as argued e.g. by Lucena and Braga de Macedo (1996, p. 81). This tradition may be related to the belief that its revenues should be earmarked for social insurance transfers. In addition to complicating the design of the optimal tax, this tradition also makes it more difficult for budgetary procedures to sustain social security policy. Overcoming this tradition would also help social affairs ministers to share the strategic dominance usually assigned to the finance minister. If this is a prerequisite for sustaining social protection in the OECD area, surely it will also be required in East Asia.

Conceptually it is useful to distinguish four direct channels through which the crisis affects negatively the well being of individual households. First, a sharp contraction in production reduces the demand for labour, which results in a reduction in real wage rates and/or an increase in unemployment. Second, a bout of high inflation during the crisis and its aftermath dents real household expenditure. Third, higher import prices as a result of real currency devaluation reduce the purchasing power of household income. Fourth, a substantial loss of property incomes (dividends, capital gains and rents) reduces total household income. Such direct effects of the Asian economic crisis are difficult to measure empirically, as necessary hard figures are often lacking.

In addition, the welfare of poor households will further deteriorate indirectly through the government’s lower spending on education, health care and other social services as a consequence of economic downturns. However, it is even more difficult to predict the social impact of lower government spending on education and health care.

Despite conceptual and technical difficulties, national authorities in the crisis countries and several international and regional organisations have carried out a number of assessments on the nature and extent of the social impact in the aftermath of the financial crisis. Having reviewed the results of some earlier assessments, Booth (1999) concludes that the initial fear over the immediate impact of the crisis in the form of mass poverty and destitution was an exaggeration, though poverty incidence increased substantially in all crisis-hit countries but more dramatically in some countries than others. She also points out that the increase in the head-count incidence of poverty was due largely to the effects of a high rate of inflation in Indonesia, while a surge in open unemployment was the main factor behind the increase in poverty in Korea, Malaysia and Thailand (Ibid., p.21).

Annex Table 1 and 2 present the latest available data on head-count incidence of poverty in the five crisis countries. Poverty incidence is defined here in two ways. One definition used in Annex Table 1 is the percentage of total population below international poverty lines ($1.08 per day and $2 per day at the 1993 PPP, respectively) for all five countries except Korea, where the national poverty line ($7.94 per day at the 1993 PPP) is applied. Another definition used in Annex Table 2 is the percentage of total population below each country’s official poverty line. Distinction is also made between urban and rural areas where appropriate data are available. As regards these two definitions, it is important to note that the international poverty lines provide a useful benchmark as an indicator of global progress in alleviating poverty. These indicators are, however, inappropriate to assess individual countries’ situations that are not affected by international price comparisons.

From these tables there are three general observations that deserve special attention:

• All five countries have made great strides in alleviating extreme poverty (as indicated by the lower international poverty line) over the last ten years. The 1997-98 economic crisis has arrested and reversed temporarily such overall trend.
• The decline of relative poverty (as indicated by the upper international poverty line) has been much slower than that of extreme poverty. Three years after the crisis, the proportion of the "near-poor" stays at very high levels in Indonesia (over 60 per cent) and the Philippines (45 per cent), followed by Thailand (30 per cent).
• The rise in poverty during the crisis, as measured by each country’s official poverty line, differs considerably among the countries concerned: the poverty ratio doubled in Indonesia (1996-99) and Korea (1996-98), while it rose moderately in Thailand (1996-99). On the other hand, this ratio actually declined in Malaysia (1995-2000).

Evidence thus far indicates that the social impact of the crisis was substantial, and more importantly, the impact on poverty was much more severe in some countries than others. Such country differences are due to several factors. One reason is that workers displaced from the formal industrial sector were absorbed in agricultural and (informal) service employment. In other words, much of the adjustment took the form of lower real wages. In the case of Malaysia, it has been pointed out that migrant workers bore the brunt of the adjustment burden more than domestic ones (World Bank 2000, p.117). Another reason was that as in the case of Thailand, agricultural exports have received a positive boost from real currency devaluation, which has contributed to supporting rural household income.

A word of warning about the poverty indicators available, which evokes again the D, A and C pitfalls mentioned above. The indicators at hand can not fully capture the social consequences of the Asian economic crisis, because the poverty phenomena are dynamic in nature. For example, a large number of households that fell below the poverty line during the crisis may have moved up to the non-poor status later on. Such cases of ‘transient poverty’ are not well understood. More importantly, the financial damage incurred on poor households (e.g., lost educational opportunities) may be irreversible, affecting their children negatively over their life spans.

The 1997-98 economic crisis made one thing clear to every Asian citizen: informal, family-based mechanisms on which traditional societies rely as the main form of social protection can not cope with those nation-wide shocks that bring down a great number of households simultaneously. This bitter experience underscores the need to establish more formal mechanisms for managing risk and protecting the poor and vulnerable in society. Four ASEAN country studies commissioned by OECD and the one submitted by a Korean expert highlight that all five crisis countries have been trying to adapt existing institutions to evolving social conditions and establishing new ones, in order to cope with the social impact of the crisis.

Annex Table 3 summarises the latest information available on four major areas of social protection (social assistance, social insurance, employment and community-based schemes) in five East Asian countries. Given the complexity of policy developments, this table should be seen only as an illustrative list of key programmes put in place in these countries. Nonetheless, it can be recognised that the shape of individual country’s social protection regime is greatly influenced by cultural and value patterns and policy developments in the past years.

A case in point is that of Malaysia, where there is no unemployment insurance or benefit that provides a safety net for displaced workers at the time of the crisis. Provision of social assistance in the form of cash transfers is also targeted only to a particular vulnerable group. On the other hand, the country has instituted since 1951 a compulsory saving scheme, called the Employees’ Provident Fund, with a view to providing uniform retirement and other benefits for roughly two thirds of total employees (excluding agricultural workers and casual employees). Similarly, Korea attaches high value to the importance of work incentives: provision of social assistance is conditional upon the acceptance of vocational training and community-based jobs – the programme called "social integration through work (SIW)".

By contrast, sales of subsidised rice and public work programmes have constituted two central pillars of social protection in Indonesia and the Philippines during the crisis. This is presumably because the incidence of poor households is widespread, especially in remote rural areas. In the case of Thailand, a wide range of social insurance, welfare and assistance programmes has been decentralised to the community level.

With respect to policy formulation and implementation of social protection, improvements are required in coverage, targeting and monitoring, as follows:

• Under-coverage has been recognised as a serious drawback to East Asia’s social protection regimes. Workers in the informal sector as well as those in the rural area constitute the majority of the workforce that are the most vulnerable and are often excluded from public social services.
• The design and choice of targeting mechanisms require further study, taking into account individual countries’ particular situations: trade-offs are evident in terms of economic incentives, fiscal objectives and political acceptability. A recent policy paper submitted to the APEC Finance Ministers recognised this point well (Blomquist 2001, Annex 1).

• Involvement of civil society organisations (CSOs) in programme implementation and monitoring is essential to enhance the efficiency and coverage of social protection policy. The question remains about how best to establish a good working partnership between the government and CSOs.

More generally, there is the case for reconsidering the basic approach to social protection beyond the ‘policy patchworks’ in coping with the social impact of the crisis. This is because two longer-term policy challenges that are common to many East Asian economies cast a shadow over the sustainability and workability of social protection schemes in the region. One is a demographic challenge to the health of public finance as a consequence of a rapidly ageing society, and the other a globalisation challenge to cope with greater labour mobility and household income inequality.

As regards the social impact of demographic changes, which requires the reform of social security, "solutions must be incentive-compatible and promote growth". (de Lucena and Braga de Macedo 1996, p.75). Given East Asia’s strong attachment to work incentives, it is important to "avoid creating a culture of dependence" (Blomquist 2001, p.11). Concerning the social impact of globalisation, there is an urgent need for taking a forward-looking approach to social protection policy– an "approach which moves from ex-post poverty to ex-ante vulnerability considerations; an approach which presents SP as a safety-net as well as a springboard for the poor" (Holzmann 2001, p.4).

Overall, seminar participants shared the view that social protection policy is a governance agenda that East Asian countries can not duck in pursuit of sustainable development. To sum up the seminar discussions, we recapitulate a few policy questions, beginning with three pitfalls in comparative development, unavailable data (D), inadequate analysis (A) and neglect of culture (C). The first step towards improved governance could then be captured by the acronym DAC.

Collecting necessary data and information itself poses a major task in the countries and regions that have different cultural backgrounds. Nonetheless, it serves to enhance local capability for better analysis and policy formulation. Consensus has emerged among participants in this seminar that much more investment is needed to improve information gathering and assimilation in the area of social protection.

Even taking the DAC acronym into account, a major difficulty in coping with the social impact of the crisis is related to the question of targeting and monitoring due to the fact that poverty is multi-faceted and dynamic in nature: the poorest, transient poor, near poor, new poor etc. Obviously there is no ‘one-size-fit-all’ solution in this respect, and a case-by-case approach is required according to each country’s socio-economic context.

Finally, many experts and government officials argued during the seminar that the government alone can not cope with the social impact of the crisis. Due to the scale and speed of the impact, involvement of civil society groups and NGOs is necessary to enhance the efficiency and coverage of social protection programmes. Similarly, the role of the private sector should also be properly identified to supplement public services, depending on the development of market institutions (private pension schemes, manpower and training services etc.). In other words, much remains to be done to ensure that social protection in East Asia is sustained and continues to promote the long-term development of Asian societies, especially those hardest hit by the 1997-98 financial crisis.

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