REPORT ON THE PROCEEDINGS OF THE 19TH ANNUAL NATIONAL DEFENSE UNIVERSITY PACIFIC SYMPOSIUM

Co-Sponsored by the National Defense University and the U.S. Pacific Command

May 5-6, 1998

Fort McNair, Washing D.C.

Prepared By

Robert Manning

Senior Fellow Council on Foreign Relations

 

EXECUTIVE SUMMARY

1. Observations on the Crisis

More than a year after the collapse of the Thai Baht initiated a spiral of events leading to a protracted and deepening East Asian economic meltdown, what began as a currency crisis has become perhaps the most severe economic turmoil since the 1930s. What some view as the first crisis of the 21st Century has illuminated the imperfections of globalization as much as the fault lines in East Asian politico-economic systems.

A wide array of Asian economies (Indonesia, South Korea, Thailand), are contracting substantially in 1998, or facing recession (Japan, Hong Kong, Malaysia), and few signs of upturn are on the horizon. The IMF has lowered its 1998 world growth forecast from 4.3% to 3.1%, a hint of the global impact of Asia’s predicament. An engine of global growth has become a drag on the world economy. The specter of a prolonged Asian recession -- perhaps even depression -- has shattered the assumptions, confidence and buoyancy surrounding what was known as the Asian "economic miracle," and with it, conceits about "Asian values" and an "Asian way of capitalism."

Indeed, longstanding assumptions about development, finance, politics and security have all been called into question. For nearly a quarter century, all discussion of Asia-Pacific security was premised on sustained, dynamic economic growth, which has been the central pre-occupation of all major players in the region. The legitimacy of many governments -- dramatically illustrated by Suharto’s Indonesia -- has been in large measure, performance-based. The notion of an East Asian economic miracle was taken for granted. It generated the hope of an emerging Pacific community and the nascent regional institutions designed to foster such a sense of community. The impact of the Asian financial malaise on domestic body economic and politic now appears to be of a structural and long-term nature. Already there have been four changes of governments (Thailand, South Korea, Indonesia, and Japan). The impact of the Asian recession on regional security is only beginning to be felt in multifaceted and unexpected ways yet to fully play out.

Genesis of the Crisis

Fathoming why and what caused the hiatus -- if not demise -- of the economic dynamism so central to regional stability, turning Asia overnight from miracle to morass, is essential to understanding its implications. There were differing emphases on the various factors that precipitated the crisis. But Asia’s predicament is more than a problem of corrupt politicians, banks too easily lending and greedy companies all linked together. It virulence and duration suggest more powerful forces at work.

Economic historians will be debating the relative weight of various causal factors well into the future. But with 20/20 hindsight, there was something approaching consensus that several factors precipitated the crisis that accentuated and brought into sharp relief fault lines in the political economy of many East Asia societies. In sum, the causal factors were the intersection of excessive capital flows misallocated in the affected countries; fixed exchange rates; and over-guaranteed, under regulated and untransparent domestic financial markets. These elements led to a contagion snowballing after the Thai crisis, producing an over-correction by panicked global financial markets:  

Capital flows. The protracted, dynamic, export-oriented growth in East Asia attracted international investors, with the region becoming a magnet for lending and direct investment. China alone has received nearly one-third of global foreign direct investment during the past several years. During the 1990s, by the time of the Thai crisis, Asian developing economies had accumulated some $420 billion in net capital flows. A large proportion of this was short-term money in cases such as South Korea. Much of this money was lent in local currencies, via poorly supervised and untransparent, dirigiste financial institutions. It led to overvalued property and stock markets, lavish investment in property development, (30-40%) and created excess capacity and intense competition amongst regional exporters.

Exchange rates. East Asian economies operating on exchange rates fixed to the dollar and in an environment of open capital markets were trapped by the unprecedented –and unanticipated--Yen-dollar shifts from 1995 to 1997. In that space of time, the dollar rose 60% and the Yen fell 60%, developments profoundly affecting global competition. In addition, the Chinese 1994 devaluation of the renminbi was a factor precipitating the Thai crisis, as it undercut Thai exporters in labor-intensive export industries. That in turn hit other Southeast Asian currencies. Korean, Thai and Indonesian banks and companies were hit by the currency shifts that eroded their national wealth.

Weak financial sectors. The structural weaknesses of financial sectors and misallocation of resources in rapidly modernizing economies were also a contributing factor. In affected countries, banks tended to be largely instruments of industrial policies. Lack of transparency, accountability camouflaged tight links between the finance sector, business and government and tended to facilitate high-risk lending. This made it more difficult to attain ‘early warning’ of unsustainable current account deficits, and the dependency on such capital flows to maintain political equilibrium led to a tendency of governments to deny burgeoning economic problems. These structural weaknesses in the financial sector, business culture and government policies were accumulating inefficiencies brought into sharp relief by the pressures of globalization.

Contagion. The synergy between these first three factors produced the fourth: contagion on the part of international financial markets. The Thai devaluation, in retrospect, appears to have served as an alarm bell leading international creditors to reassess their posture towards other Asian debtors with similar weaknesses as a result of fixed exchange rates, poor quality loans, large deficits and underdeveloped financial institutions. The result was capital flowing out of the region as rapidly as it had flowed in during the 1990s. Restoring the confidence of investors is a key challenge to the East Asian recovery.

Into the second year of the economic crisis, large-scale injections of capital from the International Monetary Fund (IMF) have not stabilized the situation. Alterations to initial IMF reform prescriptions were made in a host of cases, particularly Indonesia, but also in Thailand and South Korea. It has become apparent that in assessing the socio-economic impact of the crisis, prospects for recovery, and consequences for regional security, it is necessary to differentiate among affected countries. It also appears that the sum of factors producing East Asia's predicament is more than its parts.

The Social and Political Impact

The prevailing current reality is that of a protracted Asian recession, if not depression.

Whatever weight is assigned to each causal factor, the net effect has been to shatter the sense of confidence and buoyancy flowing from the region’s economic dynamism. In Korea, and the ASEAN states an atmosphere of rising expectations and self-confidence has been shattered. In its place are frustration, disillusionment, and anger, as the tears in social fabrics threaten cohesion. For example, the crisis has complicated and injected a new sense of urgency into China’s efforts to complete the next wave of modernization. In effect, old social contracts no longer apply and new ones are in the process of being created as structural adjustment unfolds.

The social dislocation has been substantial: emerging middle classes have seen wealth and hopes evaporate as currencies shriveled. Record numbers of businesses face bankruptcy. Thousands of trans-national migrant workers are sent home and recent urban immigrants are forced to return to their respective rural areas. What political manifestations internally in affected countries and in ASEAN inter-state relations such new realities will generate is still uncertain:

The pressure of coping with these new realities is testing nascent democracies in Thailand and South Korea. The crisis is affecting domestic politics, forcing choices on what economic and social models to pursue. It is evident that the inherent legitimacy of electoral mandates in Bangkok and Seoul has bolstered both nations’ ability to absorb the economic shock and provide mechanisms for orderly political change. Nonetheless, economic restructuring of financial institutions, and more broadly, altering the business culture that produced "crony capitalism," means, in effect, redefining the social contract in crisis-affected countries.

The extreme case of Indonesia underscores the need to differentiate between countries in assessing the Asian crisis. Indonesia, for example, has been engulfed in both a financial and political crisis simultaneously. Both create a negative synergy, feeding off each other, and have led to a breakdown of authority and order. This in turn, impedes financial markets from re-engaging in Indonesia, encourages centrifugal forces. The reality of a political system emanating outward from one authoritarian figure has rendered it more difficult to foster a succeeding political system. Moreover, because of Indonesia’s size, as the world’s fourth largest nation, and its geography, it is a determining factor in the future of ASEAN.

Both economic and non-economic relations between those countries acutely affected by the crisis and the wider region are likely to change in a manner different from the pre-crisis patterns of sustained economic growth-external liberalization- internal democratization. The capacity to absorb economic and social shocks has been sharply diminished.

The role of the military in affected states, particularly in Indonesia is unlikely to remain unchanged. In Indonesia, the political aspect of the dwi fungsi (dual function) concept already appears to be diminishing. Political change in Indonesia is a prerequisite for economic recovery. As a post-Suharto new political system emerges, ABRI’s political role is can be expected to recede further from view.

As the largest capital exporter (nearly 40% of bank loans to Southeast Asia), trading power and economy (some two-thirds of East Asia’s economy) Japan’s ability to restructure its financial system and resume a trajectory of sustained economic growth will be an important-- if not critical-- factor shaping the pace and scope of the East Asian recovery.

The Political/Military Impact: Security Consequences

The regional political consequences of the economic crisis may be as far-reaching as the domestic impact. There is still a large measure of uncertainty regarding the depth and duration of the economic recession. Most immediately, the crisis has fostered an inward-focus and overriding preoccupation with their respective domestic concerns along with a sense of uncertainty on the part of all Asian actors that at least into the medium-term, will have consequences for regional cooperation and emerging institutions. In this vein, the distinction in security dynamics and political patterns between Northeast and Southeast Asia is becoming more pronounced. The impact of the Asian recession on security has several dimensions, affecting the pace and scope of military modernization, procurement, force structure, military operations and the respective capacity for cooperation, the development of regional institutions, and may be raising a new set of security concerns:

One obvious consequence is a deferral and slowdown of military modernization that has been a feature across the region. This can be measured in cancelled weapons systems procurement, from AWACS in Korea, to F-18 fighterjets in Thailand, in Japan's first reduction in defense spending in recent memory. In Southeast Asia, the crisis has halted the trend towards acquisition of newer military hardware and more sophisticated technology;

Military forces in the region whose wherewithal has been reinforced by off -budget government support and/or by private commercial activities will see cutbacks. The crisis puts new constraints on governments to provide "off-budget" money, and more transparency in the enforcement of IMF rescue packages will further reduce such funding methods;

In the near-term this may be a positive factor enhancing stability, as some modernization was driven less by strategy and/or doctrine and more by the reality of a buyer's market in arms for countries with cash to spend, real, if amorphous fears about the future, and armed forces lacking all but extremely modest air and sea capabilities. The deferral of military modernization, particularly in Southeast Asia, is likely to trigger a rethinking of procurement plans;

The reduction in military modernization –in some cases in absolute terms, in others in the rate of modernization -- throughout East Asia suggests that over the near to medium-term the U.S. balancing role will loom more important and the attractiveness of military cooperation with the U.S. is likely to be enhanced;

The protracted economic and political turmoil in Indonesia, the dominant power in Southeast Asia, casts a large shadow over the near-term future of the Association of Southeast Asian Nations (ASEAN) and its possible role in regional economic and political affairs;

Japan’s stagnant economy and financial morass have thus far not had any substantial impact on its defense force capabilities, but is likely to slow the pace of investment and procurement of new weapons systems. One measure of how defense decisions might be affected by the economic crisis is an expected decision this fall on whether to participate in research and development for the U.S. Navy theater-wide ballistic missile defense system;

The relative slowdown in China’s economy has not yet had a discernible impact, on the force structure and modernization trajectory of the Chinese People’s liberation Army (PLA), but the planned acceleration of economic reform will reduce PLA commercial business ventures.

Korean Peninsula

On the Korean Peninsula, South Korea’s economic crisis has made Seoul appear less intimidating to Pyongyang and reduced the latter’s’ fear of absorption by the South-- something that was problematic in the best of circumstances. Korean President Kim Dae Jung’s call for a period of peaceful coexistence reflects the new realities on the Korean Peninsula. But the crisis also reduces the capacity of South Korea to assist North Korea;

It is possible that the economic crisis might serve as a catalyst for both North and South towards reducing the military confrontation and the burden of sustaining large military forces. It North Korea has any interest in reviving its economy, such a course would be to its advantage, particularly if it could in the process reduce what it perceived as a threat from the South (and vice-versa), thus in this sense North-South reconciliation is a test of DPRK intentions;

On the potentially negative side, Korean and Japanese funding for the two Light Water Reactors to be built for North Korea under the 1994 Agreed Framework KEDO funding could be at risk if the economic crisis both face deepens and becomes protracted into the next century.

Military Operations

The new and unanticipated reality of severe constraints on resources allocated to military forces across the region has had an impact on the respective military forces beyond cutbacks in the procurement of new military hardware. One aspect of this trend is that, while it varies from case to case, the economic crisis has put new stresses and strains on military forces in the region, and in their respective relations with each other and allies:

In the case of Indonesia, the impact on its military may be the most profound, beginning with its political role, a diminishing of its defense production capacity, and a reduction in maintenance and operational tempos. There are additional problems such as in acquisition of spare parts that are already a source of concern in the civilian sector and has the impact of this problem has begun to impede ABRI’s communication and transport capabilities, which in turn effect its ability to facilitate humanitarian relief and/or food distribution;

Military forces in the region are tending to focus on immediate (and in some cases new) operational requirements which include maintaining social order and the distribution of food and humanitarian relief;

One casualty of the economic crisis has been a reduction in emphasis on long-term force structure planning and more immediately, training;

The impact of decreased training has a spillover effect onto military-to-military relations, as it reduces the amount and scale of joint training and exercising both bilaterally and regionally.

Economic Crisis and Security Problems

In the near term, the Asian economic crisis has had some salutary effects on regional security. Two trends have, for different reasons, had a positive impact on the security environment—the abrupt halting of military modernization and a decidedly inward-focus on the part of affected countries pre-occupied with the challenge of coping with unprecedented social and economic problems. At the same time, however, some new security issues have been generated or exacerbated by East Asia’s economic predicament:

The narrow, inward focus -- and new imperatives of internal security and stability -- diverts limited resources, attention, and commitment away from regional cooperation and institution-building. This may portend increased nationalism and tension with economic competitors in the region all competing for similar export markets;

Labor migration has become a more pronounced problem, particularly in Southeast Asia. Tens of thousands of migrant workers in various ASEAN countries have been forced by the crisis to return home, compounding economic and social problems in their respective homelands. Indonesia has been a victim disproportionately to this problem;

Problems that require concerted regional cooperation, in particular, that of the haze and forest fires in Indonesia and elsewhere in Peninsular Southeast Asia become more pronounced as ASEAN "consensus" ideology and more constrained resources makes such cooperation more problematic. Piracy which has been concentrated in the South and East China Seas and the Strait of Malacca may grow in current economic circumstances;

If, as is increasingly feared, the economic downturn in East Asia is in some instances, not a 1 to3 year problem, but something defining the Asian landscape over a protracted 5 to7 year timeframe, the danger of a rise in nationalism may complicate inter-state relations within the region and U.S. ties with many in the region. There is a risk of a nationalist backlash, and possibly an upsurge in protectionism and/or retreat from financial liberalization against what is perceived as US-backed IMF pressure and American triumphalism that could impact U.S. alliances and access arrangements.

Regional Institutions

The economic crisis has brought the limits of nascent regional institutions into sharp relief. Neither ASEAN, nor the ASEAN Regional Forum, nor APEC has had any appreciable role thus far in managing the economic crisis or its effects. Perhaps the most positive contribution has been APEC’s ability to sustain its commitment to expanding free trade. Nonetheless, the crisis poses new challenges and offers new opportunities:

The torrent of events –the economic crisis, migration problems, the forest fires, the crisis in Cambodia – have forced a debate within ASEAN about rethinking the "ASEAN way" of consensus and non-intervention in internal affairs. This could presage either increased tensions and conflict between ASEAN states or evolve towards more of an operational sense of integration and community;

ASEAN has grown in an environment of dynamic economic growth since the end of the Vietnam War, but now faces new challenges in an inhospitable economic environment. These include maintaining its commitment to expanding free trade within ASEAN and more broadly in the Asia-Pacific, developing an early warning system against future financial crises, and altering its political culture to permit more assertive cooperation on a range of cross-border problems in the sub-region;

At a practical level, financial constraints in most affected countries appear to be generating a reduction in participation in both ASEAN and the ARF;

The deepening economic and political crisis in Indonesia renders that dominant actor seriously constrained in exercising leadership or sense of direction as ASEAN seeks to adapt to the new circumstances in the region;

Prominent ASEAN analysts have generated a debate, arguing that the organization must move beyond a state-to-state relations-based organization to more of a functioning community, abandoning the principle of non-intervention for that of "constructive involvement," and moving from consensus as the basis of decision-making to that of majority rule in regard to all but fundamental issues such as membership;

Similarly, some in ASEAN countries are arguing that ASEAN must begin to more functionally institutionalize the way it operates. This might involve more systematic coordination among ASEAN ministers in regard to finance and/or the environment, and also involve enhancing the capabilities of the ASEAN Secretariat;

In Northeast Asia there are no official multilateral relationships, but increasing attention to the triangular relationship between the US, Japan and China. It is clear that the three bilateral relationships – U.S.-Japan, U.S.-China, and China-Japan have an impact on each other. However, there was less clarity as to whether there can be said to be an operative triangle as existed in the US-USSR-China relationship during the Cold War;

The large question, which has only begun to be addressed, is that of defining China’s role in the security architecture of the region. There was a sense that how China evolved, its political character as a global actor would be key to deciding that role, with a significant impact on U.S. alliances, particularly, the U.S.-Japan security relationship, and broader defense relationships in the region.

APEC has yet to demonstrate any role in ameliorating the regional economic crisis beyond maintaining a commitment to free trade;

The ARF has operated as a loose forum for general dialogue on political and security issues, but to date, there are few signs of its evolving into a more basic pillar of the regional security architecture in the new post-crisis security environment;

Track Two diplomacy, as exemplified by the Northeast Asia Cooperation Dialogue and the Council for Security Cooperation in the Asia-Pacific (CSCAP) have played important catalyst roles in providing fora for new thinking about security. But support for Track Two activities both from governments and private sector faces reductions.

U.S. Challenges and Opportunities

In the near term, the importance of the U.S. security role in the Asia-Pacific in underpinning stability has been reinforced by the crisis. The appeal of the U.S. as a security partner appears enhanced by the crisis, as states in the region are unsettled by their unfamiliar and difficult new economic circumstances.

The economic crisis is likely to have an effect of deepening the U.S. economic stake in the region as American firms pursue new investment opportunities resulting from the crisis.

	There was discussion of the risks of a nationalist backlash in some countries against the West (e.g. IMF) is inducing pain, while U.S. companies are perceived to be dominating local economies.
	There was also concern that as countries seek to export their way back to health, this could generate a protectionist backlash within the United States, particularly if the Asian crisis is viewed as triggering a recession here.

There was a strong sense that how the U.S. responds to the crisis will play an important role in shaping Asian attitudes. Though the U.S. was initially seen as caught offguard by the Thai crisis, by the end of 1997, the U.S. was correctly perceived as proactive, focussed on stabilizing South Korea, and pressing Japan to restore growth. The challenge it to be proactive without appearing hectoring, triumphalist or dictatorial.

Conclusions

There was a sense that in the economic and security realms, we are in terra incognita in East Asia. There were far more questions than answers and the East Asian predicament, but much of the uncertainty can be reduced to three basic questions:

Will the U.S. lead and do so responsibly?

Will Japan be part of the solution or part of the problem?

Will China do the right thing, and place its emphasis on accelerating reform and domestic-led growth or yield to the temptation of devaluation?

Finally, there was an underlying, long-term optimism. This lay in the view that many of the characteristics that led to the region's success -- high savings rates, emphasis on education, hard work, prudent fiscal and monetary policies – have not disappeared. This is cause for optimism that as structural reforms in the 1998-2000 period, East Asian economies will re-emerge as more competitive and renew their trajectory of economic growth. Such an economic environment would enhance the prospects for a stable security environment closer to that which has been familiar over the past two decades, albeit one with new dynamics and new challenges.

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