Democracy Lab


Why the Obama Administration is targeting Malaysia and Vietnam in the trans-Pacific trade talks.

Unless you happen to be a trade policy junkie like me, odds are you haven't been following the progress of talks on the Trans-Pacific Partnership, the latest regional group formed out of frustration with the glacial pace of global trade liberalization. But it's worth paying attention. The TPP discussion offers a good excuse to take a closer look at the problematic impact of crony capitalism in Southeast Asia -- and, in particular, at the fate of government monopolies in countries whose leaders are loath to relinquish control to the market.

The TPP negotiations, which should be concluded by the end of this year, are largely the brainchild of Singapore and New Zealand, which launched them, along with Chile and Brunei, back in 2006. Australia, Peru, and the United States have since joined the party. But it's the application of Malaysia and Vietnam -- and U.S. demands on them -- that are causing the biggest stir. For, to its credit, Washington is pressing both countries to agree to "21st century" rules for leveling the international playing field that go far beyond the elimination of tariffs and plain-vanilla government subsidies. The primary target: big state-owned enterprises (SOEs).

For years, SOEs in Malaysia and Vietnam have been criticized for murky business practices that keep competitors at bay and government employees in Mercedes. The idea now is to use the lure of membership in the TPP to persuade the Malaysians and Vietnamese to emulate Singapore -- specifically, the government's giant investment company, Temasek, whose business is both transparent and on the up-and-up.

Don't pop the champagne corks just yet, though. While Hanoi acknowledges that its SOEs have, well, certain problems, the Vietnamese Communist Party is deeply reluctant to cede control of its big enterprises and the patronage that goes with it.

A quick look at how the enterprises in question operate sheds light on why prospects for serious reforms are unlikely. In Malaysia, powerful SOEs cast a long shadow over the economic landscape. Today, these corporations sit astride some 15 percent of the economy, including the key energy, telecommunications, and financial services sectors.

Consider Khazanah Nasional Berhad, the government's investment arm, which dates to 1993 and now owns over 60 corporations. Among its investments are the UEM Group (which dominates highway and commercial construction), financial institutions (including Santubong Ventures), and Integrated Healthcare Holdings (a major hospital operator). Khazanh also holds a 60 percent stake in Malaysia Airports and 36 percent of Telekom Malaysia.

And then there's Petronas, Malaysia's giant oil and gas corporation, which has enjoyed a monopoly since 1974. With profits of $40 billion in 2010 ($10 billion more than ExxonMobil!), Petronas is one of the world's great money machines.

The anti-corruption watchdog Transparency International ranks the Malaysian energy giant at the bottom of its company scorecard both on anti-corruption efforts and organizational disclosure. Petronas probably has good reasons for secrecy; it has only grudgingly launched an anti-corruption initiative that will compel it to share information with the Malaysian Anti-Corruption Commission.

Prime Minister Mohamed Najib has acknowledged the need for broad SOE reforms on the grounds that crony capitalism is discouraging foreign investment. He also pressed for Malaysia's first antitrust law, which went into effect in February 2012. From now on, the SOEs will have to answer to a Competition Commission with wide investigative powers. While the prime minister (who appoints the members of the commission) faces some opposition from within his ruling party, he's positioned to use the TPP talks as an excuse to sustain the effort to rein in state-owned enterprises.

The same cannot be said for Vietnam. To be sure, the Politburo started down the capitalist road as far back as 1986 with the Doi Moi reforms, which were intended to mirror Deng Xiaoping's capitalist-socialist hybrid in China. By 2006, the SOEs' share of GDP had been whittled to "just" 38 percent. But the party and the bureaucracy have since managed to push back, stalling further efforts at privatization or internal SOE reform.

In 2008, a group of Harvard economists who run an advisory program in Vietnam drove the point home with a detailed 56-page analysis of why Vietnam hasn't managed the sort of growth that would put it in the income category of, say, South Korea or Taiwan. The report places much of the blame on the SOEs, which include the country's dominant oil, electricity, railroad, telecommunications, banking, and insurance companies. Not only did the companies lack professional management, the report concluded, but they also failed to focus on improving their ability to compete in international markets. Worse still, the economists said, insiders had used the SOE reforms to build personal fortunes by misappropriating state assets.

While it is a crime in Vietnam to criticize the economic policies of the Communist Party, SOE scandals have occasionally become a matter of public record. Vinashin, the state-owned shipping company that Prime Minister Nguyen Tan Dung once predicted would become the world's fourth-largest shipbuilder, collapsed in 2010 under the weight of $4.6 billion in debts -- a good chunk of which was owed to foreigners. The impulse to use government credit to invest in businesses beyond Vinashin's competence (such as speculating in real estate) had proved irresistible, it seems. (Nine of Vinashin's executives, including its chairman, were recently sentenced to long prison terms.) Post-scandal, Vinashin is now being restructured, but not necessarily reformed. According to Jonathan Pincus, Dean of the Fulbright Economics Teaching Program in Ho Chi Minh City, the government's approach to reform does not involve "tightening corporate governance" or "increasing transparency."

Much the same story can be told about EVN, the state-owned electricity monopoly. Like Vinashin, EVN neglected its core business to speculate in real estate. Of course, investing in anything but power plants may have looked reasonable from EVN's perspective, since the company's owners (the government) required EVN to sell power for less than the real cost of producing it.

In any event, last year Prime Minister Dung ordered EVN to spin off its telecom and banking subsidiaries. But EVN's incentives to mimic the private market are still undermined by the need to keep the party and the bureaucracy happy (and affluent).

Meanwhile, U.S. trade negotiators are making it too easy for the Vietnamese to hang tough: The one carrot that might tempt Hanoi to challenge the stakeholders in the SOEs -- greater access to U.S. clothing and shoe markets, where tariffs run as high as 36 percent -- is off the table. So Washington's ambition to bring trade into the 21st century has effectively been stalemated by its own insistence on what amounts to 18th century protectionism back home. "They are asking us to swallow a lot," one Vietnamese negotiator says, "but we don't want to choke."

Why, you might ask, is the Obama Administration so determined to reform the SOEs in Malaysia and Vietnam? It would certainly mark a step forward in the effort to promote global economic efficiency by expanding trade. But Washington also has a bigger goal in mind: using reforms in Southeast Asia to set an example for China, the world's epicenter of state capitalism.

The auguries are not favorable, at least in the near term. China, like Vietnam, views state-owned enterprises as a means to a political end -- a mechanism for reaping the fruits of growth without sacrificing the perquisites of government power. And nothing that comes out of the TPP is likely to change hearts and minds in Beijing.



Could North Korea Have Struck It Rich?

Kim Jong Il promised that in 2012, North Koreans would witness a new dawn of prosperity. Here's how it could have been done.

Whatever the opposite of the Midas touch is, North Korea's leaders seem to have it. Located in a region where all of its neighbors have experienced remarkable economic growth, the North Korean economy has stagnated for more than two decades. For the last several years, North Korea's leadership has promised a new dawn of prosperity by April 15, 2012, the 100th birthday of the country's founding leader Kim Il Sung. Instead, the country has bounced from an avoidable famine in the mid-1990s to a disastrous currency reform in 2009 to a costly -- and failed -- missile launch earlier this week. The country now has an annual per capita income of about $1,000, roughly the same as Pakistan. Did it have to be this way?

It's not as if the North Koreans haven't thought about development. In 1998, after a famine that killed between 600,000 and a million people, Dear Leader Kim Jong Il rolled out two new concepts that have served as the core ideological and propaganda pillars of the regime ever since: "military first politics" (songun) and the objective of becoming a "strong and prosperous nation" (kang song dae guk). The latter involved achieving ideological and military as well as economic strength. The regime proved its ideological resilience by sticking with socialism and surviving the collapse of communist rule in the Soviet Union and Eastern Europe. Testing nuclear weapons in 2006 and 2009, and a long-run missile this week, was meant to demonstrate military strength.

That left economic growth. North Korea has failed miserably in this area, but we can speculate about what might have been. Other countries in the region, like Japan and China, have sustained economic growth in excess of 8 percent for several decades. Many began in equally inauspicious circumstances: South and North Koreans were on par in the 1950s, but South Korean incomes are now more than 20 times higher.

For North Korea to have succeeded would have required a fundamental change in mindset: greater openness to the international economy, willingness to admit mistakes and seek help, and an earlier recognition of the benefits of trading with China. Above all, the leadership would have had to allow the organic, home-grown market economy more space to develop. If, from the end of the Cold War in 1990, North Korea had started making sensible economic decisions, its per capita income could have tripled from 1990 to the present, putting it in league with Ukraine or Morocco.

That's not, of course, what happened. Heavily dependent on Soviet oil and other inputs, North Korea's industrial and agricultural sectors went into a steep decline after the 1991 collapse of the Soviet Union. Three years later the only ruler the country had ever known was dead. In South Korea and Vietnam, crises have spurred reforms; North Korea would have needed to act with alacrity.

Some, including the Chinese leadership itself, have argued that North Korea should have simply followed the route pioneered by its larger neighbor by providing greater incentives to farmers. Although that would have helped, North Korea's limited arable land and lousy weather mean it wouldn't have gotten the same bump from the agricultural reforms that played a crucial role in the Chinese transition. North Korea should have gone global early, aggressively seeking out foreign investment and expanding exports of manufactured goods and its ample endowment of natural resources.

Such a radical turn in direction seems far-fetched: North Korea derives much of its legitimacy from being the socialist alternative to the South. A rapprochement with Seoul to bring Korean conglomerates such as LG and Hyundai into the country would have looked like capitulation. But the two countries came tantalizing close to détente with a well-crafted North-South political agreement in 1991 that sought to ease tensions on the peninsula. Even a modest and gradual opening to the South would have provided significant gains to the economy in the 1990s when it was hurting the most.

Given the regime's nervousness about the presence of foreign companies, it could have accomplished this objective by establishing export processing zones that were initially isolated from the rest of the economy, like China did in Guangdong in the 1980s, as well as through joint ventures with China, a less threatening partner. Beginning in the early 1990s, North Korea experimented with such zones in the northeast of the country, near the Russian border, but never prioritized them. Moreover, the leadership was surprisingly slow in seeing the benefits of proximity to China, reading Beijing's post-Tiananmen massacre reforms as a sign of right-wing deviationism. China has kept North Korea afloat since 2000, but earlier engagement would have accelerated growth.

North Korea has also had a difficult time understanding that nuclear and missile brinksmanship is not good for business. After the collapse of its Soviet patron, an isolated North Korea toyed with a nuclear option as protection. But instead of funneling scarce capital and manpower into an expensive nuclear option and large conventional forces, it could have achieved the same basic security objective by honing a more minimalist conventional deterrent, like the threat of shelling Seoul. Avoiding the first nuclear crisis of 1992-94 would also have helped jump-start the economy by making North Korea a more appealing investment and trade partner.

Even if all of this had gone right, the early 1990s would have been painful. Like Eastern Europe, North Korea would have suffered from a significant transitional recession. But its famine was avoidable. The World Food Program provides an international social safety net against famine, and North Korea subsequently became a surprisingly large recipient of food aid. Countries, however, have to issue an appeal for humanitarian assistance; North Korea didn't do so until 1995, when disastrous floods provided political cover. If it wanted to remain self-reliant, it could have developed exports to pay for commercial imports of food.

Beginning in 1998, small signs of reform began to appear. In the wake of the famine, the economy had begun to marketize from below as households and work units engaged in trade and barter to secure food. The regime acquiesced, allowing some markets to operate. The government changed the constitution to make at least some room for the market and implemented a major reform package in 2002. These reforms showed some willingness to experiment with a new course, and had an important international dimension as well: The North-South summit of 2000 and rapprochement with Japan and China showed at least some understanding that internal reform and an approach to potential trading partners went hand-in-hand.

This potential breakthrough quickly slammed into the wall of yet another nuclear crisis in October 2002, when the United States discovered that the North was seeking out technology to enrich uranium. Again, a nuclear confrontation diverted attention and resources from economic development, and made North Korea an unappealing location to do business.

From 2005 to the present, North Korean economic policy can best be characterized as "reform in reverse." Markets were opened, then closed, then opened and closed again. A disastrous currency conversion in 2009 confiscated the cash holdings of traders and the savings of households, sending the worst possible signals to those engaged in the market. The missile and nuclear tests of 2009 and the provocations vis-à-vis the South in 2010 all served to underscore the lesson that nuclear brinksmanship is bad for business, except with China. Food shortages since 2008 have been as bad as any time since the great famine.

This period also highlighted another distressing feature of North Korea's economy: the regime's fascination with technological fixes. The regime has channeled resources into missile and nuclear technology and information-technology ventures while remaining unable to feed its population. The problem is the common fallacy that poor countries become rich by acquiring the technological trappings of rich ones. But premature investment in high-tech white elephants diverts from spending on food, consumer goods, and investment in basic health and education. The failed missile launch, meant to signify that North Korea is a "strong and prosperous nation," is only the most glaring manifestation a desire to "leapfrog" rather than focusing on the basics.

North Korea did not have to become laissez-faire Hong Kong in 1990 to succeed. But an alternate North Korea that had adopted a more outward-oriented strategy, avoided nuclear confrontations, rang the famine alarm bells in a timely way, pursued gradual reforms, let private markets work, and avoided the lure of quick fixes would now be celebrating some real successes: not like South Korea, but at least the end of widespread malnutrition and the beginnings of sustained development. 

But that, sadly, is not the North Korea of today.