Professional Documents
Culture Documents
53
State, Capital, and Investments in Korea
among the l owest i n the worl d. Until recently, before the Korean fi rms
became credit worthy enough to be able to borrow in the international
capi tal market, al l the foreign l oans were underwri tten by the govern
ment
'
and as a resul t had to be approved by t he government . Whi l e
there were some wel l - known cases of failed proj ects financed by foreign
l oans, in general the government can be credited for havi ng put empha
si s on the ( di rect and i ndi rect ) foreign- exchange- generati ng abi l ity of
the proj ects when approving foreign borrowing. This contri buted to the
country's survival of the debt cri si s hy keepi ng the debt - servi ce ratio
l ower than other l arge debt or countri es.
Whi l e the forei gn borrowing story i s i nteresti ng enough, the more
i nteresti ng part of the Korean investment governance regime l i es in i ts
pol icies toward FDI ( forei gn di rect investment) , especially given the cur
r ent ent hus i as m about gl obal i zat i on and the r ol e of t r ansnat i onal
corporati ons, or TNCs ( for criticisms of t he globalization thesi s, see Hirst
and Thompson 1 996, Wade 1 996, Evans 1 997, and Chang 1 998a) . Unlike
some ot her devel opi ng countri es, whi ch ost ensi bl y pursued " t echno
l ogi cal self- sufciency" only to end up reproducing obsol ete technologies
imported decades ago in the absence of independent R and D ( research
and devel opment) capabi l i ti es, Korea has always been keen on gaini ng
access t o t he most advanced t echnol ogi es that they can handl e. The
country' s pol i cy makers have been of the view, though, that accepting a
"package" of fnance, technol ogi es, managerial skills, and other capabi l i
ties offered by TNCs is not as good for l ong- term industrial development
as encouraging nat i onal fi rms to construct their own packages, usi ng
t hei r own managerial skill s-obvi ousl y wi th some necessary outsourcing
( for further detail s, see Chang 1 998c) .
Thus , t he Korean government i mposed rest ri ct i ons on t he areas
where TNCs coul d enter. And even when entry was al l owed, it encour
aged j oi nt ventures, preferabl y under l ocal maj ori ty ownershi p, i n an
attempt to facil i tate the transfer of core t echnol ogi es and manageri al
skil l s. For exampl e, unti l the mi d- 1 980s, even in sectors where FDI was
al l owed, forei gn ownershi p above 50 percent was pr ohi bi t ed except
where FDI was deemed to be of "strategi c" i mportance, whi ch covered
onl y about 13 percent of all the manufacturi ng i ndust ri es ( EPB 1 98 1 .
70) . " As a result of such pol i ci es, by the mi d- 1 980s only 5 percent of TNC
subsi di ari es i n Korea were whol ly owned, whereas the correspondi ng
fi gures were 50 percent for Mexi co and 60 percent for Brazil, countri es
which are often bel i eved to have had much more "anti forei gn" pol i ci es
than Korea ( Evans 1 9B7, 20B) .
54
State, Capital, and Investments in Korea
Table 3 The Ratio of FDI Infows to Gross Domestic Capital Formation for
Various Regions and Selected Countries (annual average in %)
! 9! -5 ! 9BO ! 9B! 5 ! 9B-9O ! 99! -93
/``Coc^las ^ a ^ a 2 3 4 ! 3 B
0ava`o,aJ ^ a ^. a 2 2 4 3 3
cco,aa^J^o^ ^ a ^ a 2 5 9 5
/csla ! B O 9 ! 3 ! 5 ! 5
?^ ! B ! 9 2 O 4 !
0a1a^y 2 ! O B ! 2 2 O ! 4
\al^a`a^Js ! 4 5 ! ! 3 3 ! O
SwaJa^ O O 5 ! 4 O 9 5
J / 3 B 4 5 ! 4 ! O O
SwLa|`a^J ^. a ^ a 2 3 5 3 3 !
JS/ O 9 2 O 2 9 9 3 2
Ca^aJa 3 ! ! O 5 B 4 3
Ja,a^ O ! O ! O ! O O O !
0ava`o,^g ^ a ^ a 3 3 3 2 5
/l ^ a ^ a 2 3 3 5 4
cal^/1a|ca ^ a ^ a 4 ! 4. 2 5
Aa^|^a O ! 2 ! 5 O ! ! ! 3
Baz ` 4 2 3 9 4 3 ! ! 5
C^ ` a - 3 4 2 2O B 5
Vat co 3 5 3 5 O 5 B
/s a ^ a ^ a 3 ! 2 B 5 5
Ba^g`aJas^ ^ a ^ a O O O ! O 2
C^ ^a O O O ! O 9 2 ! ! O4
do^g/o^g 5 9 4 2 9 ! 2 9 5
' ^J a O 3 O ! O ! O 3 O 4
'^Jo^asa 4 2 4 O 9 2 ! 4 5
/oa ! 9 O 4 O 5 ! 2 O
Va` ays a ! 5 2 ! ! 9 ! O B ! ! 24
a\sla^ O 5 O 9 ! 3 2 3 3 4
^ ` ,, ^as ! O O 9 O B 4
S^gap ! 5 O ! ! 4 35 O 3 4
Tawa^ ! 4 ! 2 ! 5 3 2
T^a`a^J 3 O ! 5 3 O 5 4
Tc|\ay ^ a ^ a O B 2 ! 3 2
caslacco,a ^ a ^ a O O O ! ! 2 2
SOURCE: U NCTAD, World Irwestment Report, 1 993, annex tabl e 3 ( for the 1 97 1 -1 980 data) and
World Inllestmellt Report, 1 995, annex table 5 ( for the rest) . Reproduced from Chang ( forthcomi ng) .
Pol i cy measures other than the ones concerni ng entry and owner
shi p were al so used t o control the acti vi ti es of TNCs. Fi rst of al l , the
technol ogy that was to be brought i n by the investing TNCs was care
55
State, Capital, and Investments in Korea
fully screened, and checked whether it was not overly obsolete or whether
the royalties charged on the local subsidiaries, if any, were not excessive.
Secondly, there were measures to maximize technology spillovers. Those
investors who were more willing to transfer technol ogies were selected
over the others who were not, unless they were t oo far behind techno
l ogically.6 Finally, l ocal content requirements were quite strictly imposed,
i n order to maximize t echnol ogi cal spillovers from TNC presence. We
shoul d note, however, that the targets for l ocalization were set realisti
cally, so that they woul d not seri ously hurt the export competitiveness
of the country-in some i ndustries, they were less strictly appl ied to the
products desti ned for the export market-and that supporting pol i ci es
that facilitate l ocalization ( e. g. , support for R and D) were al so provi ded.
Some Puzzles
Accordi ng to conventi onal wisdom, the ki nd of investment gover
nance system that we find in Korea is an i deal recipe for disaster as i t
creates i neffi ci ent resource al l ocati on due t o i nformati onal probl ems,
and is l i abl e to expl oitati on by self- seeking bureaucrats, and gives ri se
t o rent - seeking and corrupti on. I f these probl ems are real , how coul d
Korea sustai n a spectacul ar economi c performance wi th its regi me of
investment governance? Trying to answer t hi s question may allow us to
draw some useful l essons as t o what shoul d be t he i ngredi ent s of a
successful investment governance system in a devel opi ng country.
Informational Problem
One common obj ecti on to government i nterventi on in investment
deci sions is that the government does not possess the necessary infor
mati on to make i nt el l i gent i nvest ment deci si ons. Whi l e i t cannot be
deni ed that the Korean state has made a substanti al number of " bad"
investment deci si ons, it is al so true t hat many of its investment deci
si ons have been hugely, if unexpectedly, successful . Korea's deci si on to
enter i nto steel maki ng and shipbuilding i n t he 1 970s faced criticism
both at home and abroad, i ncl udi ng obj ecti ons from the World Bank.
Thi s suggests that t he i nformati onal probl em usually taken as i nsur
mountable by opponent s of state i nterventi on may not actually be so
seri ous ( for further el aborati on, see Chang 1 994, ch. 3) .
First of all, we should not forget that insufcient information does not
prevent us from planning our future economi c l i fe. Actually, the uncer
tainty of the fture i s exactly the reason why we plan for the fture, though
given our " bounded rati onal ity, " we should not have excessive trust i n our
56
State, Capital, and Investments in Korea
ability to control our future through planning. And i ndeed, overcomi n
uncertainty is one of the most important functions of business manage
ment , especi al l y in l arge modern cor porat i ons ( Ri chardso n 1 960 ,
Williamson 1 975, Stinchcombe 1 990) . I t i s inadequate t o argue that the
state should not attempt to plan the future of the national economy be
cause of insufficient information, when firms can and do plan their Own
future despite-or rather, precisely because of-insufficient informati on.
Second, we need to question t he widespread belief that t he informa
tional probl em for intelligent state i nterventi on is so great as t o make
intervention ineffective, while frms do not suffer from such a probl em.
In fact, entrepreneurs themselves often operate on the basi s of " informed
guesses" or "animal spirits" in making investment decisions. Moreover,
much of the information used by the firm to make investment decisions
( e. g. , esti mates of present and future demands, the availability of best
practice technology) are readily available to anybody, and not j ust to the
frm itself. I t should also be noted that a large part of the i nformati on
used by the firm is acquired from external sources, such as consultants,
research i nsti tutes, and state agenci es ( e. g. , central statistical bureau) .
In addition, the common assumpti on that those who are "doing the
business" have " better" information than those who are trying to inter
vene from " hi gh above" shoul d not be bl i ndly accept ed. Behi nd this
argument l i es the assumption that " local " i nformati on is always better
than "gl obal " i nformati on because i t is more fi nely meshed. However,
peopl e with " localized" i nformati on may make a substantively less ra
ti onal deci si on than those with more "gl obal " i nformati on, due t o the
"subgoal i denti fication" probl em (the term is from Simon 1 979) . I f the
aim of government policy is to improve the effi ci ency of the economy
as a whol e, it may actually be better, under certain circumstances, not to
be affected by the "l ocalized" information possessed by the firm. Particu
larly when the decision involves externalities which are not borne out by
the frm, the state can make a better decision solely due to the more global
nature of its obj ective, and not because it is a superior being.
Last but not least. the problem of identifing good investment oppor
tunities is far less serious for late- developing countries than for the countries
on the frontier of world technological progress. This is because late devel
opers have the "second- mover advantage, " by which we mean that they
can watch the frontier countries and learn from their experiences. 7 Even in
a country like Japan, which was pretty close to the fronti er of i ndustrial
development even during its postwar catch-up period, it is recognized that
"setting pri ori ti es, pi cking the next likely winners, has not been di fficult
57
State, Capital, and Investments in Korea
throughout the postwar period when the obj ectives of policy were prima
rily ' catching up' obj ectives" ( Dore 1 986, 1 35) . In the case of Korea, which
lagged even farther behi nd, the probl em has been even l ess.
Bureaucratic Self- Seeking
Another argument that is frequently empl oyed against an i nterven
ti oni st approach to i nvestment governance i s that, whether or not the
bureaucrats have the ability to make intelligent decisions, these decisions
should not be left wth them because they would pursue their own selfsh
obj ectives in making such decisions. And indeed we can obsere this kind
of behavior-such as maximizing the budget they control rather than public
welfare-even in the most renowned bureaucracies, including that of Korea.
How, then, was it possible that bureaucratic self-seeking did not have such
an adverse impact i n the Korean case?
First of all, it needs to be emphasized that, while i t contains an impor
tant grain of truth, the sel f- seeki ng-bureaucrats argument i s based on a
misconception of human motivation ( for further details, see Chang 1 994,
ch. 1 ) . Bureaucrats, l i ke any other individual , can and do act i n a fashi on
that is not solely self- interested, and they often thi nk of themselves, rightly
or wrongly, as the guardians of the public (or national) interest and act to
promote it. It is another matter entirely whether their perceptions of the
public interest are correct ones. One such reason is that "public spiritedness, "
altruism, and so on are often hel d as genuine principles, and not as a thin
veil to disguise self- interest. If whatever moral concerns peopl e have are
si mply described as peculiar forms of sel f- i nterest, then the self- interest
hyothesis will in fact become empt Secondly, as demonstrated by modern
experimental psychol ogy, deci si on frameworks do i nfuence peopl e's de
cision ( Tversky and Kahnemann 1 986) . Bureaucrats usually face questions
put in terms of public interest, which wl invoke a preference ordering that
di ffers from what i s used in private deci si on- making si tuati ons.
Even with such qual i ficati ons, it cannot be deni ed that bureaucrats
have the tendency to expl oit the power conferred on them by their ofces
in order to pursue their own interests. This makes the organizational structure
of the bureaucracy quite important, as it wll shape the incentive structure
for the bureaucrats. However, the success of a bureaucracy in controlling
sel f- seeking by its members goes much further than setting formal rul es
against such behavior. As Simon ( 1 99 1 ) argues, a successful organizati on
has to be one that musters organizational l oyalty among its members, as
otherwise the organization would have to spend an enormous amount of
time and resources in bargai ni ng and monitoring thei r performances. I n
58
State, Capital, and Investments in Korea
this context, the remark from a top executive of the l arge Japanese steel
company, Kobe Steel, whom I encountered in a World Bank conference, is
instructive. The executive claimed that given the diversity and complexity
of the company's operations, there was no way he and others sitting on
the board could make an informed decision about most of t he proj ects put
forward to them by their subordinates. He argued, however, that they are
not worried because they believe that most of their company empl oyees
are doi ng their best to advance the i nterest of the company. This would
sound like a non sequitur to those who bel i eve i n the neocl assi cal view
of human nature, but this i s essenti al ly how a successful bureaucracy
operates-be i t the privat e- sector busi ness bureaucracy of Kobe Steel or
t he respected government bureaucraci es of Korea, France, or Britain.
The exi st ence of a "good" bureaucracy that has the organi zati onal
structure and organizational cul ture that can prevent bureaucrati c sel f
seeking has frequently been singled out by many peopl e as one of those
conditions that enabled Korea (and other East Asian countries) to success
fully pursue an interventionist approach to investment governance. While
I absolutely agree with this view, I would like to warn the readers against
believing that the existence of such a bureaucracy was, to borrow a popu
lar but obfuscating phrase, a benefcial " initial condition" that the country
possessed for hi stori cal reasons. Contrary to the popul ar bel i ef, the Ko
rean bureaucracy in the early postwar years was suffering from bad orga
nization, compromised meritocracy, and lack of technical expertise-it was
sending its bureaucrats for training to the Philippi nes and Pakistan until
the late 1 960s. Thus the countr had to spend a l ot of time and energy in
reforming the organizational structure of the bureaucracy and training the
bureaucrats before it coul d establish the kind of bureaucracy that it has
now ( Cheng et al. 1 996) . B
Rent - Seeking and Corruption
One popular argument against state intervention in investment deci
si ons is that it can l ead to rent-seeking and corruption ( for a comprehen
sive criticism of the theory of rent - seeking, see Chang 1 994, chs. 1 -2) . In
the current policy discourse, it is common to equate rent - seeking and cor
ruption (or more precisely, bribing) with each other, but these two need
to be clearly distinguished (Chang 1 994, 29-30) . Strictly speaking, what are
known as "rent- seeking costs" are essentially transaction costs arising from
the diversion of resources from other "productive" activities to "unproduc
tive" l obbying activi ti es ( based on the i mportant but frequently i gnored
assumption that the economy was previously in a state of full employment
59
State, Capital, and Investments in Korea
and thus the diverted resources had already been productively employed
el sewhere) . Bri bi ng, on the other hand, is essenti ally a resource transfer
to the holders of publ i c ofces and thus has no ( or very little) transaction
cost implications. However, does the fact that bribery is a transfer mean that
corruption does not matter? Of course not, because there are important " in
direct" ways in which bribery matters for t he effci ency of t he economy.
Corruption and Capital Accumulation
One i mportant way in which transfer of weal th through bribing can
have an impact on the economy is by transferring wealth between groups
with different savings l in vestments propensiti es. I f the wealth was trans
fer r ed from an i ndi vi dual ( or a group) wi t h a l ower cons umpt i on
propensity t o another i ndividual ( or another group) with a higher con
sumpti on propensi ty, the economy may suffer i n the l ong run, as this
may reduce investment.
I t i s not i mpl ausi bl e that those who are bri bed ( i . e. , pol i ti ci ans or
bureaucrats) have a typi cally higher propensity to consume than those
who bri be ( i . e. , busi nessmen) . However, the di sti ncti on between busi
nessmen and politicians / bureaucrats i n t hi s regard i s somewhat spurious,
because many of the l atter, especi ally i n devel opi ng countri es, doubl e
as busi nessmen, i f only as "sl eepi ng partners. " I f those who are taking
bribes do not have a higher propensity to consume than those who are
giving bribes, the presumed negative effect of corrupti on on investment
and capi tal accumulation may be negl i gibl e. Actually, thi s may be one
cl ue to how such a "corrupt " country as Korea ( as well as some other
countries in Asi a, such as Japan or Indonesi a) experienced a rapid capi
tal accumulation. All in all , without knowing the exact circuit of corruption
money in a particular country, it i s not possi bl e to predict how corrup
ti on will affect capital accumulati on.
However, there i s another reason why corrupti on may lower capital
accumulation that is quite separate from differential consumption propen
sities. Wealth made out of bribes i s more likely to be shipped out of a
country than other forms of wealth ( as thi s will reduce the chance of
detection for corrupt dealings and will make it easier for t he bribe recipi
ent to fee the country in the worst case) . I f such capital fight occurs,
domestic accumulation will have been harmed by corruption, even when
the corrupt official has the same savings propensity as the businessman
who gives the bribe. In a country like Korea, therefore, the exi stence of
capital control may have been more important than is often supposed in
ensuring high capital accumulation, given the high level of corruption. "
60
State, Capital, and Investments in Korea
Corruption and the Quality of Government Decision Making
The real trouble with corruption is not simply that it transfers money
to publ i c offi ci al s but that i t i s i ntended to i nfuence the substance of
decisions by those officials. At this poi nt, we should note that the i nfu
ence of bribery on government decisi on making i s not entirely negative.
Bri bery may have posi tive indi rect effi ci ency consequences when it i s
used as a "signal " for one's superior ability as a producer to make profit
(as heavy adverti si ng may be used as a " si gnal " for superi or - product
qual ity) . Of course, the t roubl e i s t hat t hi s signal i s not noi se- free, as
there i s no necessary correl ati on between someone' s abi l i ty as a pro
ducer i n t he par t i cul ar i ndus t ry wher e he or s he i s t ryi ng t o get
government support and hi s or her ability to mobilize funds i n general .
For exampl e, a person may be able to mobilize a l ot of money because
of his ability to make arbitrage gai ns, but that does not prove that he will
be a good manager of the industrial frm for which he is hopi ng to get
a l icense. If this is the case, the positive nature of the signaling functi on
of bri bery may be severely l i mi ted. I ndeed, someti mes the exact pur
pose of bri bery is to " j am the si gnal " so t hat one coul d conceal one' s
(relative) incompetence in the area i n which one wants to be chosen for
government favor by usi ng the money from other areas where one i s
more competent.
Then how can we explain the fact that a corrupt country l i ke Korea
could maintain a high degree of rationality i n government deci si on mak
ing? There are a few possibl e explanations, although none of them can
be supported by robust empirical data, given the nature of the subj ect.
Fi rst, there has been some minimum threshol d of busi ness competence
that a frm has to possess before it can enter the " bri bery market. " In the
Korean case, this has been achieved by ( implicitly) confining the poten
ti al recipients of state- created rents to a small group of congl omerates,
namely the chaebol s, with already proven busi ness track records , and
thi s way t he most effi ci ency- damagi ng cases of corrupt i on coul d be
structurally prevented. Second, it can be argued that corruption i n Korea
is confi ned to certain sectors that may not be so i mportant for interna
t i onal compet i t i venes s . As is the cas e i n many ot her count r i es ,
nontradabl e sectors like defense, constructi on, urban pl anni ng, among
others have been the most popular areas of corruption i n Korea, whereas
corrupt i on s eems t o have been l es s i n t radabl e sect ors where poor
performance can be qui ckly exposed. ' o Thi rd, i t i s wi del y accept ed i n
Korea that there has been l ess corrupti on i n t he cri ti cal " technocrati c"
part of the government where many substantively i mportant deci si ons
61
State, Capital, and Investments in Korea
are made, whereas it is quite widespread among the top pol iticians and
the lower- l evel bureaucrats. Fi nally, the publ i c commi tment of succes
si ve Korean pol i t i cal regi mes t o productivity growth and catchi ng up,
mani fested i n nati onal and sectoral pl anni ng exerci ses, seems to have
put certain limits to the degree of "distortion" that bri bi ng can have on
bureaucrati c deci si ons.
Political Functions of Corruption: Implicit Wages,
Redistribution, and Legitimacy
Another possible explanation for the apparently weak (if not exactly
nonexistent) negative effect of bri bery on the economy i n countries like
Korea is that a substantial portion of bribery is i n the form of what is called
tukkap (literally, "money for rice cakes") . It is not pai d to particular public
ofcial s i n relation to a particular proj ect, but is pai d to most (if not all)
of the infuential politicians and bureaucrats to keep them "sweet. " l l
To the extent that bribery takes the form of tukkap and does not result
i n specifc instances of favoritism, it is a pure transfer which does not even
have the "signal j amming" efect that we mentioned above. I propose that
this kind of bribery is better understood as an element of " implicit wages"
for the politicians and bureaucrats who are bribed. Indeed, many Korean
bureaucrats and politicians claim that they would not take the bribes if
they were getting salaries comparable to what they could get if they were
employed i n the private sector-of course, taking into account the higher
social status that government jobs carry. Indeed, one reason why Singapore
has little corruption seems to be that it pays its public fgures salaries that
are competitive with private sector salari es.
One addi ti onal i nteresti ng twi st to this story i s that i n Korea, as in
many devel opi ng countri es, a l arge part of the tukkap- styl e bri bery di
rected to the politicians ( i f not the bureaucrats) ends up being transferred
to their constituents, especially the poorer ones. Indeed, many politicians
claim that the need for this further transfer to their consti tuents is the
biggest reason why they take tukkap. And to the extent that this is t
.
rue, this
kind of bri bery works as a channel for i ncome redistributi on.
Then the obvi ous questi on is why countries l i ke Korea cannot raise
extra taxes from busi nessmen equival ent to the tukkap they are paying
anyway, and then use the money, frst, to raise wages for pol iticians and
bureaucrats to take care of the " i mplicit wages" el ement, thus reducing
their needs to take bribes; and second, to set up a decent welfare state so
that the politicians do not need to take bribes for redistributive purposes
and make the redistributi on l ess subj ect to things l i ke party l oyalty and
62
State, Capital, and Investments i,} Korea
personal connections. This way, the businessmen will pay exactly the same
amount of money i n increased taxes rather than i n bri bes ( or even l ess,
as they do not have to pay the "risk premium" to those who are taki ng the
bribes) , the pol i ti ci ans and the bureaucrats wi l l get all the money they
used to get illegally or semilegally as a part of their l egitimate salaries now,
and the poor will get the same amount of transfer from the rich, but now
through institutionalized welfare schemes rather than dependi ng on thei r
attractiveness to particular pol iticians.
However, there are many pol i ti cal and i deol ogi cal obst acl es to such
obvious reforms i n Korea, many of which al so apply to other countri es.
First of al l , regarding the " implicit wage" function of corruption, it shoul d
be noted that the prevailing Confucian i deol ogy regarding publ i c service
requires that the public ofcials pursue a life of "clean poverty" (chungbin) ,
making it diffcult to raise salaries for the politicians and the bureaucrats
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
i deol ogy and of the pol itical coalitions to back it means that the Korean
government's power to raise taxes for redistributive purposes is l i mi ted.
Moreover, pol i ti ci ans who currentl y run " l ocal welfare states" have an
incentive to keep discretion over the exact manner of redistributive trans
fer, which will be threatened by giving everyone an entitlement to a certain
level of i ncome through the welfare state. And those who are paying the
tukkap also prefer to have their money redistributed through the pol i ti
ci ans, rather than di rectly to the poor, as this wil l i ncrease thei r overal l
infuences on the pol i ti ci ans.
The inability of the Korean society to accept the function of corrupti on
as a channel to provide i mpl i ci t wages to publ i c sector empl oyees and as
a channel of income redistributi on to the poor has meant that the sorely
needed reforms of the taxation system, the publ ic sector sal ary structure,
and the social welfare system that wl l institutionalize the existing transfers
have not happened (or even been di scussed widely) . Thi s, i n turn, h as
meant that the whole system of "corrupt" transfers persists because many
peopl e need it. The probl em is that the wi despread corruption has l ed to
a legitimacy crisis for the country's pol itical system, because accordi ng to
the formal rul es that currently govern the processes of i ncome generation,
transfers, and entitl ements, most of the "pol itical transfers" that are going
on now are i l l egal . Indeed, this i nherent vul nerabil ity to l egiti macy crisi s,
rather than i ts effect on capi tal accumul at i on or gover nment deci s i on
rati onal i ty, may be the bi ggest pr obl em wi th corrupt i on i n t he Korean
society ( and in many other societies that suffer from a si mi l ar probl em) .
63
State, Capital, and Investments in Korea
The Demise of the "Traditional" Regime of
Investment Governance, 1 993-1 997
Since the l ate 1 980s, but especially from 1 993, when the Kim Young
Sam government took power, the Korean regime of investment governance
underwent i mportant changes i n more " l i beral " di rect i ons-the most
important changes being t he abolition of the pl anning ministry (the Eco
nomi c Pl anni ng Board) , the severe weakeni ng of i ndustri al pol i cy, and
l arge- scal e financi al l i beral ization ( more on these l ater) . What were the
forces driving such changes?
First of all , as the Korean economy approaches the worl d's technologi
cal frontier, the informational beneft that the government can derive from
the country's late- devel oper status ( see above) has been diminished. And
as a resul t , there has been a growi ng opi ni on i nsi de and out si de the
government that it is not so simple anyore to decide where to push invest
ments as it used to be, and therefore more and more things have to be "lef
to the maket." Of course, it is not clear whether this argument is convincing.
Korea is still some way away from the worl d's technological frontier except
i n a few industries, and thus the loss of " latecomer's advantage i n govern
ment intervention" is still not so complete. And the experi ence of Japan
shows that even in a highly advanced economy there are a lot of positive
things that the goverment can do in terms of physica investment coordina
tion or promotion of cooperative R and D investments. Nevertheless, by the
mid- 1 990s, the belief that the Korean economy fnally reached a stage where
government orchestration of investment is at best redundant and at worst
harmful had establ i shed i tsel f strongly among the Korean elite ci rcl es.
Second, the past (and present) association of the interventionist state
with pol i ti cal authori tari ani sm and corrupti on has lent strength to the
opinion that a l ess interventionist state i s needed to rid the country of such
undesirable features. Needless to say, such a simplistic view of state inter
venti oni sm i s not warranted. For exampl e, the Pi nochet regime i n Chile
combi ned a hi gh degree of economic l i beral ization with pol itical repres
sion. For another exampl e, corruption in the Korean context cannot be
el iminated without some structural reforms that I suggested in the previ
ous secti on, which may actually require an increased role of the state at
least in certain areas (such as taxation and social welfare) . Even so, the grip
that this opinion has over the public mind had been very strong, and gave
i mpetus to a general ized attack on state i nterventi oni sm.
I n addi ti on, duri ng the l ast several years , Korea has wi tnessed the
tremendous ri se of free- market i deol ogy, strongly i nfuenced by its ascent
64
State, Capital, and Investments in Korea
on the world scal e. The limits of neol i beral free- market reforms are too
well known to di scuss here, but the sway that the free- market i deol ogy i s
holding in the country during the l ast several years has been truly remark
able. Especi ally with their growing financial muscles and their increasing
outward investments, the chaebol s have become much more aggressive
i n asserting their bel i ef i n a free market-the best manifestati on of thi s
bei ng the 1 997 document from the research i nsti tute attached to thei r
association ( Korean Federation of Industries) , which was hastily withdrawn
after publ ic uproar i n response to its call for a radical reduction of state
activi ti es ( e. g. , to abolish all government ministries except defense and
foreign afairs, to cut the number of government employees by 90 percent,
to deregulate ever market i maginabl e, etc. ) Y
Added t o all these had been the increasing external pressures for lib
eralizati on. During the last decade or so, following the Korean success in
international markets, the US and the European Union have been engaged
i n active " trade di pl omacy" with Korea, whi ch involves demands for do
mestic deregulation to enhance market access as well as trade liberalization.
The signing of the World Trade Organization ( WIO) agreement has also
rei ned i n Korea's pol i cy freedom more than before, although we shoul d
not forget that the ol d General Agreement on Tariffs and Trade ( GATT)
system did not necessarily allow much more freedom to developing coun
tries than now, except perhaps i n the area of TRIPs (trade- related intellectual
property rights; for more details, see Ayuz et al . 1 998) . Korea's accession
to the Organization for Economic Cooperation and Development ( OECD)
has al so obligated the country toward greater liberalization, especially of
the capital market.
All the above factors have conspired to bring about important changes
i n the i nvestment governance regi me of Korea si nce 1 993. Whi l e there
were al so changes, such as the narrowing of the defi ni ti on of "stabi l ity"
(and thus more narrow concern for infation) and the increasing relaxation
of lUXUry consumpti on control regi me, the two most i mportant changes
were the fnancial liberalization program that vastly reduced the state control
on capital i nfows (and outfows to a l esser extent) and the abol i ti on of
national and sectoral pl anni ng exerci ses, epi tomized by the abol i ti on of
the Economic Planning Board ( EPB) . This chapter argues that contrary to
conventional wisdom, it was these changes rather than the persistence of
the "traditional " regime of investment governance that l ed to the 1 997 cri si s
( for further detail s, see Chang 1 998b and Chang et al . 1 998) .
First of al l, the financial l i beralization program that was implemented
in 1 993-partly as a response to US pressure and partly in a bi d to quali f
65
State, Capital, and Investments in Korea
for OEeD membership-was wide- ranging in its scope, proposing, among
other things, to deregulate interest rates, abolish "policy loans, " grant more
manageri al autonomy to the banks , reduce entry barri ers to fi nanci al
markets, and, most important, liberalize the capital account. The ultimate
result of these changes was the now well - known huge foreign debt build
up, where the country's foreign debt nearly trebled from $44 billion in 1 993
to $ 1 20 billion in September 1 997 ( although it fell slightly to $ 11 6 billion
by November 1 997) . 1l The probl em wi th this debt bui l d- up was not pri
marily with i ts scal e but wi th i ts maturity structure, where, exploiting more
l ax regul ati ons on short - t erm l oans, the share of short- term debt ( debt
with l ess than a year's maturity) rose from an already high 43. 7 percent i n
1 993 to an astonishing 58. 3 percent at the end of 1 996 ( BAl , 1 998) . 1 4 When
the "contagi on effect" from the Southeast Asi an cri si s and a number of
hi gh- profi l e corporate fai l ures ( st eel - maker Hanbo and car- maker Ki a)
shook international investor "confi dence" i n Korea i n the last quarter of
1 997, such poor maturi ty structure of forei gn l oans meant t hat i t was
i mpossi bl e for the country to stem the outfow of foreign exchange.
The abolition of national and sectoral planning was also a critical factor
in the making of the 1 997 crisi s. Soon afer it came to power i n 1 993, the
Kim Young Sam government, in a gesture to show its commitment to free
market refor m, abol i shed t he EPB, whi ch had t i l l then orchest rat ed
government economi c pol i cy si nce 1 96 1 . I t al so turned the ambiguous
attitude that the previous Roh Tae-Woo government showed toward sectoral
i ndust rial pol i cy i nto an outri ght aversi on, and practi cally termi nated
sectoral industrial pol i ci es, except in the form of technol ogy support i n a
few hi gh- tech i ndustri es. Now free from the government coordination of
investments to avoi d "duplicative" investments, the chaebols went for an
i nvestment spree fuel ed by foreign borrowng, whi ch resulted in the build
up of excess capacity i n a number of maj or i ndustri es ( semi conductor,
steel . automobi l e, et c. ) that hurt export prices and corporate profitability.
At the same time, the abolition of pl anning, despite the i nitial expectation,
made the corrupti on probl em worse. As revealed graphically through the
corrupt i on scandal that surrounded the meteori c ri se and the dramati c
col l apse of Hanbo Steel . the aboli ti on of pl anning now exposed even the
core manufacturing i ndustri es to corrupti on, by eliminating the "rati onal "
cri teria that put clear l i mi ts on how i nfuential politici ans and bureaucrats
coul d extend favors to t hei r "payi ng customers" ( see above) .
Thus seen, t he changi ng economi c, pol i t ical , and i deol ogical condi
t i ons t hat prevai l ed i n Korea si nce the l at e 1 980s, and especi al l y si nce
1 993 , had l ed t o s i gni fi cant changes i n Korea's regi me of i nvestment
66
State, Capital, and Investments in Korea
governance. The unfortunate thing is that. even from the poi nt of view
of t hose who thi nk the tradi ti onal regi me had more or l ess out l ived i t s
useful ness ( a viewpoi nt I do not not share) , i t can be sai d t hat s ome
critical el ements of this regime were abol i shed without put ti ng al t erna
tive mechanisms i n pl ace to take over what were regarded as l egi t i mate
funct i ons. For exampl e, l i beral i zi ng i nternati onal capi tal fl ows wi t hout
establ i shi ng proper mechani sms for fi nanci al supervi si on was a cri t i cal
mistake that resulted i n t he debt crisis. I n another exampl e, abol i ti on of
sectoral pl anni ng without establ i shi ng mechani sms through which the
manufacturers themselves coul d coordinate investments ( as it happened
i n Japan especi ally between the 1 950s and the 1 970s) resul ted i n dupl i
cative i nvest ment s that brought about corporate col l apse and export
probl ems that contri buted to the 1 997 cri si s.
Conclusions
What concl usi ons can we draw from our di scussi on?
First of al l , our discussion shows that investment governance is a subj ect
that spans an array of issues much wider than what the current discussions
of the subj ect typi cally cover: infati on, regulat i on, property right s, and
social infrastructure. I n the case of Korea, it involved controls on the extents
and the forms of capital infows and outfows, disciplining the recipients
of state- created rents, and even controlling l uxury consumpti on, all of which
were achieved through the use of a wide range of policy measures regard
ing taxation, credit allocati on, ownership control , local contents requi re
ment, and so on. I t even has an i mportant pol itical dimension, as it i n
volved the construction of the sense of the national "community" through
controls on lUXUry consumption or restri cti ons on capital fli ght.
Second, the Korean experi ence shows that, whi l e there are obvi ous
problems wi th an interventionist regi me of investment governance ( such
as i nformati onal constrai nt, bureaucrati c abuse, rent - seeking, and cor
rupti on) , such probl ems are by no means i nsurmountabl e. Our di scus
si ons suggest that there are a l ot of mi sconcepti ons and exaggerati ons
i n the currently popular discourses on these probl ems. At vari ous poi nts,
we argued that the origins of t hese probl ems are much more compl ex
than what i s usually suggested. We al so argued that these probl ems cannot
be remedi ed in Korea, as in most devel opi ng count ri es , by the means
t hat are usual l y sugge s t ed ( e . g. , abo l i s hi ng r egul at i ons and di s e m
powering the bureaucracy) , but require a fundament al i nst i t ut i onal re
form and the abandonment of the hypocri sy about t he nature of publ i c
servi ce. I ndeed, we poi nt ed out t hat t he fai l ure t o make s uch i nst i t u-
67
T
I
State, Capital, and I nvestments in Korea
ti onal and i deol ogi cal changes might seri ousl y damage the vi abi l ity of
the Korean regi me of i nvestment governance.
Third, our di scussi on of t he Korean case shows that a "nationalistic"
governance of investments can be very successful , contrary to what many
proponents of the currently popular gl obalizati on thesis argue. Pol i ci es
to prevent capi tal fi ght and keep the capi tal invested at home, govern
ment interventi ons to di rect investments to "nati onally" desirabl e areas,
the creation of a sense of nati onal community with a common purpose
through ( al though not si mply by) control s on lUxury consumpti on, and
the control s on the extents and t he forms of foreign di rect investments
are all elements of such a regi me. We poi nted out that the globalizati on
thesi s i s, at least as yet, far too exaggerated, and that there is sti l l a l arge
scope for nati onal pol i cy aut onomy. Perhaps i t may sound t oo cyni cal
to suggest that the el i te i n many countri es are now usi ng gl obalizati on
as a convenient excuse for thei r abandonment of any attempt at bui l d
i ng a nati onal communi ty and pursui ng a nat i onal agenda, tasks that
would require certain sacrifces on their part. However, i n a worl d made
up of rather tightly bound national political uni ts, the failure to construct
a regime of invest ment governance that i s fi rmly nati onal i n i ts basi c
scope can onl y l ead to economi c stagnati on and a fundamental desta
bi l i zati on of the pol i ti cal uni ts i n the l ong run.
Fi nal ly, our analysi s of t he recent changes i n t he Korean regime of
i nvestment goverance and i t s contri buti on to t he country's 1 997 for
ei gn debt crisis shows the difi cul ti es involved i n i nsti tuti onal reforms.
Even accepti ng that Korea really needed the large- scal e fi nanci al l i ber
alization ( especially capital account liberalizati on) and the abandonment
of sel ective i ndustri al pol icy i t undert ook aft er 1 993 (a view I do not
agree with, as ment i oned above) , i ts recent experi ence cl early shows
how unwise i t was t o make these changes wi thout putti ng i n pl ace a
devel oped fi nanci al s upervi s ory sys t em and i nt erfi rm coordi nat i on
mechanisms that can take over the functi ons that the government con
t r ol of t he fi nanci al syst em and sel ective i ndustrial pol i cy have pl ayed
in the Korean investment governance regi me. Even when some compo
nents of the investment governance regime ( or for that matter any regime
of governance) are becomi ng l ess effective and are creati ng more un
desi rabl e si de effects than before, radical changes to t hem shoul d not
be made until the possibl e consequences of such changes for t he work
ings of the overall regi me have been thought through.
68
CHAPTER FOUR
GOVRNANCE AND INVESTMENT IN CHINA
Shuhe Li and Peng Lian
One of the most challenging pol iti cal - economi c puzzl es of the 1 990s
i s how to explain the coexstence of large- scale foreign direct investment
( FDI) and widespread corruption i n China. On the one hand, according
to the I nternati onal Monetary Fund ( IMF) , Chi na has been ranked sec
ond aft er the Uni ted Stat es as a host country for FDI si nce 1 993 ( see
t abl e 1 ) . Chi na's FDI i nfl ow- GDP ( gross domest i c product) rati o was
al so ranked second only to Singapore i n 1 994 ( see tabl e 2) . I On the other
hand, Chi na i s generally regarded as one of the most corrupt countri es
i n the worl d. Accordi ng to a survey of the Pol iti cal and Economi c Ri s k
Consultancy (Asian Intelligence 1 995) , Chi na was rated by foreign man
agers as the most corrupt among eleven Asian countri es, including I ndi a
and I ndonesi a. China was also ranked by Transparency Internati onal as
one of the most corrupt countries i n the world i n 1 996 ( see ch. 2 ) . Some
estimate t hat one- third to one- half of al l deal s si gned in Chi na invol ve
some form of corruption, with bri bes hovering between 1 -1 0 percent of
sal es, and "there are probably as many types of corrupti on as there are
types of t ea" ( Kei j zer 1 995) .
The Chi nese devel opment experi ence seems to defy the pres umed
wisdom as stated by the president of t he World Bank: " We need to deal
wi th the cancer of corrupti on. . . . We can give advi ce, encouragement,
and support to governments that wish to fight corruption-and it is these
governments that, over t i me, wi l l attract the l arger vol ume of i nvest
ment. "2 Cl early t he coexistence of wi despread corruption and fast- growing
FDI i n Chi na i s an intriguing puzzl e for students of economi c devel op
ment. As known, FDI will occur when there ar e hi gh transacti on costs
69
Governance and Investment in China
Table 1 Foreign Di rect Investment Annual I nfow in Reporting Economy
Table I continued
(Millions of us dollars)
Greece 52 ,JJ5 , 35 , 44 9 9 , J53
Country 959 9 99 92 93 J 95 I cel and 2 3 3 4 5 4
I rel and 8 , Jc2 ,435 , 3 93 2, 3
Asi a 4,2c9 5, 42 2J, 9 25, 59 +,9J 52, 5 5 c3,223
I tal y 2, cc c,4 2, 4J 3, 95J 4, 353 2, c3 4, 59
Afghani stan, I . S. of N/ A N/ A N/A N/A N/A N/A N/ A
Netherl ands 5, 5c3 2, 39 c,3 c , 9J , cc 5, c c J, 225
Bangl adesh N/ A 3 4 4 2
Norway , 5 9 , JJ3 395 c 2, JJ3 c23 N/A
Cambodi a N/ A N/A N/A 3 5 6 5
Portugal , 3 2, c J 2,445 , 53 , 53 ,2J 6
Chi na, Peopl e' s Republ i c of 3, 393 3,45 4, 3cc , 5c 2,5 5 33,5 35, B9
Spai n 5,425 3,9B 2,493 3,2c 5, 44 9, 359 c, 25J
Fi ji 9 8 5 5 2 6 c
Sweden , 5 2 , 952 c, 35 5 3, J5 c, 24 4, 23
I ndi a N/ A N/A N/A N/ A N/ A N/A N/A
Switerl and 2, 52 4, 9c 3, 5 ,249 89 4, J 2,cJJ
I ndonesi a 2 , J93 ,452 , 2, JJ4 2, J9 4, 35
United Ki ngdom 3J,553 32,42 c, 2 3 c, 35 5,54 J, 295 32, 2J5
Ki ri bati N/ A N/A N/A N/ A - N/A N/A
Korea , 5 B 5J 2 58 8 , c
SOURCE: I MF Balallce ofPayments Statistics Yarbook 1 996, 58, 59.
Lao Peopl e' s Democratic Republ i c 4 c 5 4 42 7
Mal aysi a , cc5 2, 332 3, 995 5, 53 5, JJc 4, 35 N/ A involved in exporting or licensing a product to a foreign company. In other
Mal di ves 4 c N/ A N/A words, unlike trade, FDI typi cally involves l ong- term and asset - specifi c
Mongol i a N/ A N/A N/A 2 5 J
agreements . I n additi on, foreign investors typi cally have l ess information
Myanmar 5 c 2 2 N/ A N/ A N/A
and connection to the host nati on. How could the uncertainties and costs
Nepal N/ A N/A N/A N/ A N/A N/ A N/A
of transacti ons reSUl ti ng from opportuni sti c behavi or and the hol d- up
Paki stan 2 J 2^4 25 3 3 4 9 N/ A
probl em be reduced i n an environment of corrupt l egal and administra-
Papua New Gui nea 2J3 55 2J3 2 2 5 4
Phi l i ppi nes 5 5 54 225 , 235 , 59 ,45
tive systems? In parti cul ar, given the fact that the s tate i tsel f coul d be
Si ngapore 2, 55 5 55 4, 55 2,2J4 4, c5c 5, 45J c, 9 2
predatory, how coul d Chi na make credibl e commitments to attract FDI ?
Sol omon I sl ands 2 J 5 4 N/A N/A N/A This puzzle is certainly not unique to China. In fact, it has been ob-
Sri Lanka 2 4 4 23 9 N/A served i n ot her Asi an countri es, such as I ndonesi a ( see ch. 2 ) , where
Thai l and , 5 2444 2, J 4 2, 3 , 5J4 , 3cc 2, Jc5
corruption and FDI were both remarkably high before the recent fnancial
Tonga N/A N/ A N/A 2 N/ A N/A
crisis occurred. In his discussion of economic transition, Robert Hall high-
Vanuatu 9 3 25 Z Z I 3
lights this puzzle as follows: " It is axi omatic that contract enforcement is
Western Samoa N/ A N/ A N/ A N/A N/ A N/ A N/ A
Asi a ( not speci fi ed) , J4 45J , 49 , 39 , 2 2, J25 2, 95c
a key to successful Eastern European l i beralization . . . . It i s noteworthy
I ndustri al Countries cc 5 4 c9, cJ4 2, 9 , c9 3c,459 39, 5 3 2J5, 9J9
that the most rapi d growth in the worl d in the past decade has been
United States c 3J 4, 9 5 22 J J , 55J 43, J 4 4c, cJ cJ,23J
achi eved in Asi an countri es where contractual relati ons are l ess hi ghl y
Canada 5 J29 , 555 2, 4J 4, 5 4, 99 , 299 J, 5c
developed and enforcement is less reliable . . . . It is a fascinating topi c for
Austral i a 5, 29 c,452 4, J3 5, J35 3, JJ5 4, J5 3, J
additional research to figure out why Asian countries have been so suc-
Japan JJ , cJ , 295 2, c Z 9c 5 cessful " ( Weri n and Wij kander 1 992, 34 1 ) .
New Zeal and c2 , 35 , 29J 2, J5c 2,4c9 2, 524 2, 5J9 This chapter attempts to provi de some i nsi ghts into the corrupti on-
Austria 6 3 9 9 , 3 35
FDI puzzle in China. In the next section we submit a framework, the LCM,
Bel gi um-Luxembourg , J2J 5, J4 9, 3c3 ,25c J, 5J ,43 N/A
whi ch hi ghl i ghts three mechani sms: l ocal i nformati on and i nformati on
Denmark J9J , 32 , 553 J 3 5 JJc 4 39
intermediaries (L) , cross- regional competi ti on ( C) , and market- preservi ng
Fi nl and 49 52 233 39 8 , 49c 59
authori tari ani sm ( M) at the i ndi vi dual , regi onal and national l evel s , re-
France J3J4 3, 53 5 53 2 ,5J 2J, 5 c,c25 23 35
Germany 52 2 532 4 J5 2, c2 , 5 5 5 5 5, 935
spectively. When it is too costly and too uncertai n to use a corrupt l egal
Conti nued
system, such mechanisms can help enforce agreements and property rights.
70
71
-
Governance and Investment in China
Table 2 FOI! GDP and FOI ! GNP in 1 994 ( ')
Country FDI 1 1 GDp2 FDI 1 IGNp3 Country FDI 1 I GDp2 FDI 1 IGNp3
Asi a 2 59 J 5 Westem Samoa N A N A
Afgrl ani stan, I . S , of N/ A N A Asia (not specified) N A N A
Bangladesh J J4 J J I ndustrial Countries J J J 5
Camboi a N/ A N A United States J J J 9
Chi na, Peopl e' s Republ i c of 4 3 Canada 3 25
Fij i N A J 4 Australia 42 4
I ndia N A N A Japn J J2 J J3
I ndonesia 2 J 3 New Zeal and 4 9 4 >
Kirbab N A N A Austria J J M
Kora J 2 J 5 Bel gi um-Luxemburg 3 25 3.5
Lao Peopl e' s Oem, Republ i c N A N A Denmar 3 43 4 M
Mal aysi a 2 2 Fi nland 53 52
Mal di ves N A N A Frnc 25 4
Mongol i a J 9 N A Germany N A J J5
Myanmar N A N A Greec 2 J 5
Nepal N A N A I cl and N A N A
Pakistan J 5 J Ireland 9 9
Papua New Gui nea -JJ9 -J I tal y J 2 J 2
Phi l i ppi nes 2 45 J 5 Netherands J 9
Si ngapre .95 53 Norway J 5 J 2
Sol omon I sl ands N A N A Portugal 4 J
Sri Lanka .42 J 29 Spain 94 . 4
Thailand J 95 J 3 Sweden 3. 5 4 4
T
a
N A N A Switerland 55 2 33
Vanuatu N A J7 United Ki ngdom J J 95
ScJ lll FS OF BASI C DAI ,\:
1 , I MF, B(l I(l l ce o(Paymell ls Stalislics Yeariook 1 996, 58, 59,
2, The World Bank, World Delleiopmell l Report 1 996, 2 1 0, 2 1 1 ,
:, The Worl d Bank, World Delleiopmenl Report 1 996, 1 88, 1 89, 222 ( PPP based GNP) ,
After that, we speci fi cal ly expl ore the Chi nese case. We argue that
overseas Chi nese capi tal i st s, fi scal decentral i zati on and pos t - Mao r e
gimes primarily facilitate t he three mechanisms, respectively, and hence
contri bute to the l arge- scal e i nfow of FDI . At the same ti me, however,
government control and regional publ i c ownership without an indepen
dent j udici ary system have provi ded a hotbed for corrupti on in China's
transi ti on economy. As nonowners of publ i c assets but with signifi cant
control rights, Chi nese i ndustrial bureaucrats have both i ncentives and
opportuni ti es to take bri bes from pri vate invest ors ( i ncl udi ng forei gn
investors) i n exchange for giving some publ i c assets to the l atter party,
expl icitl y or i mpl i ci tly. Al though government control and publ i c owner-
72
Governance and Investment in China
sip make corrpti on wi desrad (scope) , corrupti on i s somewhat pre-
di ctabl e, coordmated, and l i mi ted to not easily verifiabl e t l' ans
.
, act I ons
( degree) due to the LCM in Chi na. Partl y as a resul t, the corrupt i on-
ind
.
uced unce
.
rtainti es for
.
the
,
returns to FDI are mitigated, thus making
Chma a relatively attractIve si te for FDL In the l ast secti on, we di scuss
the recent financial crisis in Asia and the implications for China in terms
of state governance and FDL
State Governance, Informal Enforcement, and FDI
In this chapter, corruption is defined as the abuse of public assets or
public authority for personal gai n. 3 By thi s definition, corruption generally
occurs i f publ i c property rights and! or publ i c authority are not well de
fned. The scope of corruption is thus positively correlated with the range
of ambiguity of public property rights and regulatory authority: When there
are more distortions in prices, agreements, and regulations an
'
d more noise,
there are more opportunities for corruption. Corrupt ofcial s can purposely
make confusing rules and change them randomly so as to create oppor
tunities to increase bri be taking and to reduce the ri sk of being detected.
In the case of Chi na, bureaucrat s and managers of st at e- owned
enterpri ses ( SOEs) and township and village enterpri ses ( TVEs) are not
owners of publ i c asset s, yet have si gni fi cant control rights over these
assets. Thus they have both i ncentives and opportunities to take bri bes
from private i nvestors by givi ng some publ i c assets to the l atter party,
expl i ci tl y or i mpl i ci tly. 4 Thi s makes it possi bl e for a private i nvestor to
l ower hi s average cost-the annualized val ue of the "free" publ i c assets
i s greater than the bri be. Consequently, he woul d have l i ttl e i ncent i ve
to reveal the si tuati on. Product competi ti on forces other private i nves
tors to bri be because otherwi se thei r average costs wi l l be hi gher and
they wi l l ose market share.
Given the fact that corruption is widespread in China-fostered bv a
legal system that l eaves much to be desired in terms of enforcing agre
ments and property rights-some informal and semiformal enforcement
mechani sms must have contri buted to the rapid expansi on of FDL We
submit that there are two fundamental forces that help enforce agreements
informally or indirectly: local information ( with partners) and competition
(with rivals) . A person's local information about his business partner con
sists of hi s personal knowl edge about t he partner's identity, credit historv,
reputati on, financial status, and so on. Local i nformation
'
is rel ation- sp
cific, and it is generally accumulated among relatives, town mates, fri ends,
and col l eagues. Two parti es wi th common l ocal i nformati on can reduce
73
Governance and Investment in China
the uncertainties of their transactions and information asymmetry between
them. More important, if two parties do not have mutual l ocal information,
but each of them has mutual local information with a common third party,
then the third party can play the role of an information intermediar. Contract
guarantee and personal recommendati ons are commonly observed ex
amples of informati on intermediaries.
By transi tivi ty, a wi de network may be est abl i shed on i nformati on
intermediaries. \hen such a network is interregional or international , it can
facilitate cross- regional or cross- country agreements. Such private ordering
can help enforce not only the kind of agreements that are not verifi able
by a third party, but also the kind of agreements that are verifiabl e by a
third party but neverthel ess cannot be impartially enforced by law.
\hen it i s too costly or too uncertain to use a corrupt l egal system
to settle disputes, parties to a transaction can resort to l ocal information
and informati on i ntermedi ari es to enforce agreements informally. Local
information shared among business partners can hel p them to conduct
busi ness outside the l egal system, thus functi oni ng as a substitute for
l egal enforcement.
Competition provi des another driving force for contract enforcement.
I n particular, cross- regi onal competition will force each regi on t o reduce
uncertainties and costs of transactions i n its j urisdiction. The initial driving
force may come from product compet i t i on i n a spot market , such as
exchanges of fi nal product s ( especially consumpt i on goods for which
enforcement i s rel atively easy) , and the resul tant taxes that market ex
change gener at es . The r egi ons wi th mor e effe ct i ve enfor cement
mechanisms have competitive advantages, such as l ower costs over rival
regi ons , and thus wi l l at t ract more economi c act ivity. Thus , product
compet i t i on may t ri gger compet i t i on i n t he desi gn of enfor cement
mechani sms. I n equi l i bri um all regi ons or groups may be " forced" t o
adopt effi ci ent ( though i nformal ) enforcement mechani sms . "
However, a proper governance structure i s needed to facilitate these
two forces. Fi rst, for l ocal informati on to be uti l i zed effect ively, it must
be the case t hat i ndivi dual s have economi c freedom to conduct trans
actions and to choose busi ness partners, and that there i s a (minimum)
political order i n the society such that there i s no rampant robbery and
arbitrary confi scati on. " Second, for competi tive forces to be effective. i t
must be t he case that fi rms and regi onal government s have autonomy
to make primary economi c deci si ons in response to compet i t ive pres
sures but cannot erect trade barriers. I n countries where rule of l aw and
democratic pri nci pl es have been i ngrai ned, these condi ti ons are gener-
74
Governance and Investment in China
ally met . In count ri es where they are not , a regi me that i s pol i t i cal l y
more central i zed and economi cal l y more decentral i zed may be a rea
s onabl e al t ernati ve . That i s , ci t i zens may be forbi dden t o organi ze
opposi ti on pol itical parties and to demonstrate on t he streets, but they
are al l owed to trade and i nvest . Local goverments may be granted a
l arge degree of autonomy over economi c deci si on making, though the
ul ti mate pol i ti cal authority i s the central government, and the nati onal
government i s abl e to mai ntai n a common market . '
Cros s - r egi onal compet i t i on i mpl i es t hat regi ons chargi ng mor e
bri bes and givi ng up fewer col l ective asset s wi l l l ose FDI t o ot her re
gions. Hence, in equilibrium, bribes will be l ow enough to keep busi ness
proftabl e. Indeed, from the viewpoi nt of bri be givers, it i s possi bl e that
the value of bri bery- induced favorabl e treatments i s larger than the bri be
i tsel f, and thus the bri be gi ver can be better of as a resul t. This i s be
cause compet i t i on among di ffer ent r egi ons ( br i be t akers) t ends t o
increase the value of favorable treatments and decrease the size of bribes.
Compet i t i on among bri be givers may l i mi t pot enti al i neffi ci enci es
from corrupti on. I n fact, under certai n condi ti ons bri bery i s equival ent
to competitive bi ddi ng ( Beck and Maher 1 986) . I f the bri be taker cares
onl y about the amount of the bri be ( i . e. , he does not di scriminate among
bri be givers) and there is sufi ci ent i nformation, then the most efci ent
bri be gi ver can defeat all others si nce he i s abl e to submi t the l argest
( "profi tabl e" ) bri be. Thus , resources are al l ocated to the most effi ci ent
user despi t e corrupt i on.
I n sum, before democracy and t he rule of l aw are firmly establ ished,
we need a governance structure to ful fi l l three basi c institutional con
di t i ons : fi r s t , hous ehol ds and fi r ms have aut onomy t o make
microeconomi c deci si ons; second, fi rms and l ocal governments are not
able to erect trade barri ers; third, there i s no rampant robbery and ar
bi trary confi scati on. These condi t i ons create an envi ronment that en
courages t he use of l ocal i nformat i on/ i nt ermedi ari es and pr omot es
cross- regi onal competi ti on.
Not e that these are also the condi ti ons that preserve markets. I n Li
and Lian ( 1 999) , we argue that these condi ti ons can be met under market
preseruing authoritarianism ( MPA) .
We defi ne an MPA as follows : A state is authoritarian if there exi sts
a domi nant group of pol i ti ci ans whos e control over the country rests
more upon the obedi ence of the ci ti zens than upon thei r parti ci patory
consent. An authoritarian state in a devel opi ng or i ndustrializing economy
is market- preserving if the fol l owi ng condi t i ons hol d:
75
Governance and Investment in China
Ml . Subj ect to changing internati onal and domesti c constraints, in
particular competitive pressures, senior leaders ( or the dominant
party) perceive that i t i s i n their best i nterests to preserve the
market in order to facilitate catching-up;
M2. Seni or l eaders ( or the domi nant party) are abl e to make thei r
policy on market-based catching-up more credible, i . e. , not easily
subj ect to pol itical whim, by i mposi ng sel f- constraints through
allocating sufcient autonomy (including authority, information,
and resources) to a l arge set of pol iti cal and, more i mportant,
economi c deci si on makers i n an instituti onal i zed way;
M3. Senior leaders (or the dominant party) are able to control agency
problems of bureaucrats and businessmen, as well as other politi
cians, by imposing constraints on them by designing and fostering
institutions, such as incentive schemes, checks, coordinati on, and
enforcement devi ces, i . e. , balancing autonomy and control.
Given the fact that seni or leaders have domi nant power i n an au
thoritarian regime, Ml i s a necessary condition for economic catching-up
under authoritarianism. Ml assures the compatibility of the seni or l ead
ers' i ncentives wi th the preservati on of the market. Both constraints and
experi ences shape the perceived i nterests of pol iti ci ans. Pol iti ci ans will
adopt pol i ci es that are i n their best perceived i nt erest s. I nternati onal
constraints may range from foreign occupati on, military threat, interna
t i onal sancti ons (or support) to economi c competi ti on. 8
To make their commitment t o market-based catching-up policies cred
i bl e, seni or l eaders ( or the domi nant party) i n an authoritarian regi me
have to tie their own hands wi th both international and domesti c con
straints. The former includes signing international treaties and opening up
markets. Violating treaties and reversing open-door policies may rui n the
country's i nternat i onal reputati on and possibl y resul t i n i nternati onal
sancti ons, and thus can be very costly. Open markets provide opportuni
ties for investors to escape should predatory behavior occur. A predominant
means of tying the pol iticians' hands with domestic constraints is to all o
cate sufcient autonomy systematically to a large segment of the population.
This may take the form of allocating authority of pol i cy implementation
to technocrats, autonomy to local governments, and economic freedom to
fi rms and individuals i n an i nstitutionalized way.
Autonomy, however, needs to be counterbal anced with appropriate
control s. Agency problems can be managed through checking and coor
di nat i on devi ces al ong t hree di mens i ons : vert i cal ( or hi erarchi cal ) ,
horizontal ( or cross-function) , and intertemporal ( or cross-ti me) . Examples
76
Governance and Investment in China
of checking devi ces are 0) vertical checking-hierarchical review, moni
toring, graduated controL and regular reporting to a higher authority; ( 2)
horizontal checking-col l ective deci si on- making mechanisms and i nfor
mation exchange/ peer monitori ng of performance through del i berati on
councils; and ( 3) intertemporal checking-term limitations, rotations, and
the exchange of posi ti ons among pol iticians and bureaucrats.
Exampl es of coordination devi ces are ( 1 ) vertical coordinati on-j oi nt
efforts under the guidance of a pi l ot agency or one or more designated
pol i ti cal l eader ( s) ; ( 2) hori zontal coordi nati on-del i berati on counci l s ,
industry- speci fi c and cross- i ndustry busi ness associ ati ons, antitrust and
anti l ocal - prot ect i oni sm regul at i ons, i nformal s oci al networks ; and ( 3)
intertemporal coordination-mechanisms that reduce undesirable policy
swings and shocks and i nduce l ong- term and stabl e cooperation, such
as the smooth and partial replacement of politicians and bureaucrats, as
wel l as meritocratic recruitment of bureaucrats, and a bal anced seni ority
cum merit - based promoti on system in the bureaucracy.
Clearly, an MPA fosters the three i nstitutional condi ti ons: autonomy,
no trade barriers, and political order. This i mpl i es that the two informal
mechani sms ( l ocal i nformat i on and cros s - regi onal compet i t i on) can
funct i on i n an MPA. Fi rst , Ml i mpl i es t hat seni or l eaders have strong
i ncentives to mai ntai n publ i c order and to give firms and househol ds
t he freedom to make micro economi c deci si ons. M2 assures t hat house
hol ds and fi rms wi l l i n fact have autonomy t o make mi croeconomi c
deci si ons ( i n response to competitive pressures) . M3 assures that fi rms
and l ocal governments will not easily be able to erect trade barri ers. It
al so i mpl i es that some modi cum of pol i ti cal order can be mai ntai ned.
An MPA constrains corruption indirectly through facilitating cross- re
gi onal compet i t i on and the use of l ocal i nformat i on mechani sms. As
described above ( M3) , control mechanisms can constrain corruption directly.
For example, appropriately designed arrangements governing recruitment,
promoti on, and conduct within the bureaucracy have been shown to
constrain bribe- taking (Evans and Rausch 1 996) . The same is true of collective
decision- making mechanisms that increase transparency in the proj ect ap
proval process. When a proj ect requires collective approval, it becomes more
difcult for individual decision makers to extract rents unless they can collude.
As anoter example, "graduated allocation of control or authority" at vertical
levels of management ( i n the publ i c sector) places explici t limits to what
is withi n an ofcial 's authorit, which in turn puts upper limits on bri besY
M3 i ncludes cross- checki ng devices, e. g. , appeals courts, anti bri bery
bureaus, party di sci pl i ne commi ttees, that make it easi er to detect court
77
Governance and Investment in China
verdicts that are unequivocably wrong. This i mpl i es that disputes whose
contentions can be easily veri fied by a third party, e. g. , the appeals court,
will be less susceptible to corruption since the j udges would be more hesitant
to bias decisions incorrectly. l O Hence, corruption wl tend to be concentrated
mainly on disputes that are not easily verifable by a third party, e. g. , those
that involve complex technical i ssues. For purposes of di scussi on, we will
call this type of corruption " impl icit " : corrupti on is more l ikely to occur
because of the technical compl exity involved i n the dispute.
Corrupti on varies from sector to sector, tending to be more severe in
sectors where the rents are l arge and where agreements are techni cally
more specifc, making it harder to detect corruption. Such sectors include
aircraft and construction ( Hines 1 995) and new technologies.
I
I Since FDI
from devel oped countri es to devel opi ng 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
i mpl i ci t) may not necessarily i mply serious contract enforcement prob
l ems. Surely the host party, generally, has better l ocal i nformati on and
connection with the l ocal courts. However, it is the foreign investor's de
faults that are often harder to be verifed by a third party, given that typi
cally the foreign investor provides complex technol ogy and the host pro
vi des l and and l abor. The foreign investor does not need to worry t oo
much about breach of contract by the host since this can be easily verifed
by a third party and hence be enforced by a court. Inversely, given i ts
better connection to local courts, the host need not worry too much about
breach of contract by the foreign investor, either. Moreover, as long as the
courts in the host country are only implicitly corrupt, and the contracting
parties have freedom to choose international arbitrati on, FDI agreements
can be i ndirectly enforced by wel l - defi ned mechanisms i n some devel
oped countri es. Thi s i s because ( i nternational) arbitrated awards them
selves can be easily verifi ed by a third party and enforced in the courts of
the host country. I "
We bel i eve that, overal l , more corruption may increase uncertainties
and costs of transacti ons and hence reduce FDI . Wei ( 1 996) reports that
corruption and FDI are negatively correlated and there is no exception for
Eastern Asian countri es. The negative effects of corruption are often exag
gerated, however. Thi s is because bri bes may not only work as ti ps to
speed up bureaucratic procedures and to get around inefficient rul es, but
also as indicated, under certain conditions bri bery is equival ent to com
petitive bi ddi ng. More i mportant, the damage from corruption crucially
depends on the nature and structure of the corruption regime. In the case
78
Governance and I nvestment in China
of China, although corruption is widespread i n scope, its character i s shaped
and its impact constrained by the MPA directly through M3 and i ndirectly
through facilitating cross- regional competition. In addition, si nce an MPA
is a rel atively centralized governance structure politically, it helps "coordi
nate" corrupt i on. Suppose, for i nst ance, there are several government
agenci es that supply compl ementary publ i c goods and act l ike a j oi nt
monopol i st. \ The effect of corruption on private investment would t hen
approximate that of a l ocal tax ( Shleifer and Vishny 1 993) . 1 4
I n the following secti on, we argue that overseas Chinese capitalists,
fiscal decentral izati on, and the post - Mao regi me have pri marily faci l i
t at ed t he t hr ee mechani s ms ( t he LCM) , res pect i vel y, and henc e
contri buted t o t he l arge- scal e fow of FDI i nto Chi na.
The Chinese Case
The Role of Formal Enforcement Devices in FDI
I n the last two decades, Chi na has enacted vari ous l aws and regu
l ati ons t o govern FDI and to curb corrupt i on. There are three maj or
types of FDI i n China and they are governed by the Law of Equity Joi nt
Ventures ( passed i n 1 979 and revi sed i n 1 990)
'
the Law of Whol l y For
eign- Owned Enterprises ( 1 986) and the Law of Contractual Joint Ventures
( 1 988) . Equity j oint ventures are j oint - stock enterprises hel d by Chi nese
and foreign partners with the l atter's share amounti ng to no l ess than
25 percent i n general . Once an equi ty j oint venture is establi shed, chang
ing the r egi s t er ed capi t al woul d r equi r e gover nment appr oval . I n
contractual ( or cooperative) j oint ventures , profits can be di stri buted at
any proporti on agreed upon and each party has separate l i abi l i ty. Typi
cally, t he foreign partner provi des technol ogy and machi nery, while the
Chi nese s i de provi des l and, l abor, and mat eri al s. I n whol l y forei gn
owned enterpri ses, 1 00 percent of t he capital i s provided by t he foreign
investor who hol ds both residual control and residual clai ms; there are
restrictions on such investment in industries as public utilities, transpor
tati on, real estate, i nsurance, and banki ng.
Corrupt bureaucrats may favor j oint ventures more than whol l y for
eign- owned enterprises. In exchange for bribes from foreign investors, the
Chinese party may deliberately underestimate the value of state assets as
shares in equity j oi nt ventures, and agree to a lower state share of profts
i contractual j oint ventures. This prediction is consistent with the obseration
that the proportion of wholly foreign- owned enterprises remained low until
the early 1 990s when legal development began to accelerate ( see tabl e 3) .
79
-
Governance and Investment in China
Table 3 Accumulated Foreign Direct Investment from 1 979 to 1 993
(Value Unit: in US$ billion)
VoJa
Toe`
cqclyJo ^lva^lca
Coo,aalvaJo^lva^lc
w^o``yoag^-lc^JaJc^la,sas
Jo^l0ava`o,1a^l
mc15a ol
o|acls
4, 225
3, 0
2,245
33,M
9
Co^laclca`
' ^vasl1a^l/1oc^l
22 59
O5 29
5 O
55 42
3
SOURCE: Almanac of China' Foreign Relations and Trde 1 994, 48.
/clca`Haa`zaJ
/1oc^l
9
3259
3552
59
3
I t is interesting to assess the impact of the American Foreign Corrupt
Practices Act of 1 977 that prohibits American i ndividuals and corporations
from bribing foreign government offcials. Empirical studies, such as Hines's
( 1 995) and Wei 's ( 1 997) , suggest that this act tends to reduce American
investments i n corrupt countries. We believe such effects are very limited
( as reported by Wei 1 996) , not only because this act may provide a com
mitment device for American investors to say no to foreign demand for
bribery, but also, more i mportant, because there are many implicit ways
of corruption and there is a lack of incentive for people to report on them.
Many American firms get third- party consultancies to do the bribing for
them. In the case of China, " by far the most common form of corruption
is the solicitation of trips abroad . . . . Perhaps the ultimate gif is education
. . . many companies have sponsored individuals whom they met i n the
course of busi ness negoti ati ons" ( Kei j zer 1 995, 1 84-86) . Si nce the act
punishes American investors when they or their partners in the j oint ven
tures bribe l ocal officials, some American investors i n China may prefer
wholly foreign- owned enterprises over j oi nt ventures because of the For
ei gn Corrupt Practices Act.
To safeguard foreign investors' property ri ght s, Chi na enacted the
Economi c Contract Law I nvolving Foreign Interest i n 1 985. I t stipulates
that for matters not covered by the law of the People's Republic of China
(PRC) , international practice should be followed, and that parties have the
freedom to choose the means of dispute settlement: negotiation, media
tion, arbitration, or litigation. The Arbitration Law enacted in 1 994 specifes
that contracting parties have the freedom to choose Chinese or interna
tional arbitration, and the people's courts in China enforce both Chinese
and international arbitral awards ( see also the Civil Procedure Law en
acted i n 1 99 1 ) . China has signed treaties of bilateral protection of foreign
80
Governance and Investment in China
investments with more than seventy countries since 1 982. China is now a
member of the " International Convention of Investment Disputes between
Host Country and Foreign Private Investors. "
To curb corrupti on, Chi na has enacted more than twenty l aws and
regulati ons si nce 1 982. The maj or ones are arti cl es 1 55 and 1 85 of the
Criminal Law (passed in 1 982) , and the supplementary regulations regard
ing the punishment of crimes of corruption and bribery ( passed i n 1 988)
are the maj or ones among more than twenty laws and regulations enacted
since 1 982 to curb corruption. Furthermore, China set up two maj or orga
nizations: the Ministry of Supervision in 1 987, and the Department of Anti
Embezzl ement and Bribery ( within the Mi ni stry of Procurators) in 1 995.
Given t he fact that t he judiciary system i s not independent. it is not sur
prising that such anticorruption agencies are not independent either. 1 5 In
addition, the desi gned framework of l egal procedures i tsel f i s vulnerable
to j udges' di screti on. I t i s not consi dered illegal for j udges to meet pri
vately with litigants or their agents. Some organizations, such as banks and
customs, are not allowed to release evi dence to litigating parties or their
lawyers; thus j udges must gather and can control such evi dence.
Although such "formal rul es" cannot i mpartially enforce agreements
and eliminate corrupti on, they do pl ay two i mportant rol es. Fi rst, they,
along with other checking devi ces, set limits on corrupti on. The poi nt i s
that although government control and publ i c ownership result i n wide
spread corruption, the degree of corruption is l argely implicit. Second, the
formal rules serve as coordination devices among transaction parties, and
as a benchmark for di spute settl ement through negoti ati on, medi ati on,
and arbitration. I n other words, the i nformal and semiformal settlement
of disputes are affected by the formal rules. I t is the j oint functioning of
both i nformal and formal enforcement mechanisms that reduces overall
uncertainties and costs of transactions and contributes to the large infow
of FDI into China. However, as will be el aborated on later, at the outset
of reform. i nformal enforcement mechani sms perhaps pl ayed a more
important role. As reform proceeds. formal enforcement mechanisms have
become i ncreasi ngly more bi ndi ng and efective.
The Role of Local I nformation and Information Intermediaries in FDI
Wank ( 1 996) . in hi s field study of guanxi-Chinese for l ocal relati on
ships. or connections- and market expansion in Xamen. Fuj ian province
i n 1 988- 1 990. exami nes how busi nessmen cul tivate connect i ons wi th
bureaucrats or " invest" in building the connections. and how such connec
tions help reduce uncertainties and facilitate cross- regional exchanges. I n
8 1
Governance and Investment in China
particular, in exchange for bribes, bureaucrats can help businessmen to get
licenses, loans, material s, and projects, and protect businessmen from erup
tive pol icy shocks and di screti onary regulatory abuses. The mechani sm
works between l ocal or forei gn busi nessmen and Chi nese bureaucrats .
Among foreign investors in Chi na, overseas Chi nese capi tal i sts are the
most conspi cuous.
The distribution of sources, as wel l as cross- regional destinati ons, of
FDI i n Chi na cl early support the hypothesi s on l ocal i nformati on and
i nformati on i ntermedi ari es. FDI i n Chi na i s mai nl y from Hong Kong,
followed by investment from Taiwan, especially i n the 1 980s. As shown in
table 4, for accumulated FDI from 1 979 to 1 993, about 68 percent came
from Hong Kong and 8 percent from Taiwan. Even in 1 994, about 60 percent
came from Hong Kong, and 1 0 percent from Taiwan. These figures hol d
despite the fact that the fgures for Hong Kong's investments i n China are
exaggerated for two reasons. Part of Hong Kong's investments in China are
"round trip" investments by mainland investors seeking favorabl e treat
ment for foreign investments. Another i s "stop trip" investments by Western
investors using Hong Kong as an informati on i ntermedi ary.
Table 4 Accumulated Amount of Investment from Major Countries 1 979-1 993
Coc^ly Hag o^} \c15aol /oll^a Co^laclca` /oll^a a-,|o|acl
o|acls Coc^l, s '^vasl1a^l Coc^l|ys ' ^vasl1a^l/1oc^l
To ^JS$5 ` ` o^} Toe` ^JS$! , }
do^g/o^g& Vacao ! ! 4, ! 4 5 5 ! 50929 B0 ! , 320
J S ! 2, 0! ! 9 !442 5 ! ,200
Tawa^ov ^c a 20,9B2 ! 2 0 ! B432 B 3 B0
Ja,a^ , ! B0 4 ! BB95 4 0 ! , 230
0a1a^y 5 0 J 45 0 2, 50
S ^ga,oa 3, ! 22 4 B3 2 2 ! , 550
B|la^ 0 4 3 025 ! 4 4, 9! 0
T^a`a^J ! , 399 0 B 2 095 0 9 ! ,490
/cslaa , 309 0 B ! 24 0 9
Ca^aJa ! , 50 0 9 ! B! 0 B , ! 0
SOURCE: Almanac o(Chi na's Foreign Relations and Trade 1 994, 49.
Western investors ( as wel l as bi g compani es i n Hong Kong) began
si gni fi cant di rect i nvest ment s i n Chi na onl y aft er 1 992 and many of
them i nvest i n Chi na through Hong Kong. I nvestors from Hong Kong
and Taiwan are mostl y Chi nese and most have rel ati ves i n Chi na ( es
peci al l y i n Guangdong and Fuj i anJ . and hence have l ocal i nformati on
82
Governance and Investment in China
i n their hometowns. According to the Australian government 's East Asi a
Analyti cal Unit in Canberra, there are about fifty mi l l i on ethnic Chi nese
resi dents in Southeast Asia, and a maj ority of those are descendants of
southern Chinese. I t i s not surprising, therefore, that FDI i n Guangdong
al one account s for 20 to 30 percent of al l FDI in Chi na.
In hi s study of Hong Kong's production subcontracting activities in the
Pearl River Delta of Guangdong from 1 986 to 1 989, Leung ( 1 993, 284) found
that among forty- seven surveyed agreements, thirteen were through ki n
ship; sixteen were through other Hong Kong frms, who invested earlier in
the delta region and served as information intermediaries; and eight were
through other l arge Chi nese SOEs, who served as intermediaries and to
whom the Chi nese subcontractors were affliated. Of the subcontractors
through kinship, the maj ori ty were i n the hometowns and the rest were
ofen in the contractors' immediate neighboring counties. In general, there
were not many serious disputes between the Hong Kong investors and the
Chinese subcontractors. Only two Hong Kong frms expressed strong dis
satisfacti on. Thus, such informal enforcement based on l ocal information
and i nformation intermediaries seems to be effective.
The geographic di stri buti on of Hong Kong's investment in the del ta
regi on was attributed, accordi ng to Leung ( 1 993) . mainly to the distribu
tion of guanxi, and to a lesser extent to the differences i n l ocation, l abor
cost and quality, and l and avail abi l i ty. In ot her words, factors related to
information and enforcement are pri mary determinants of FDI desti na
ti ons, whi l e the conventi onal factors are secondary.
The investment of Hong Kong-l i sted China Strategic Hol dings ( CSH)
i n Chi na provi des an illuminating case. By the mid- 1 990s CSH had be
come perhaps the second l argest forei gn investor i n Chi na, control l i ng
more than ei ghty compani es and owni ng stakes i n wel l over 1 00 others
( Hsi eh 1 996) . I t s chai rman, Oei Hong Leong, a son of the chairman of
Indonesi a's Si nar Mas, i s a master of l ocal informati on and i nformati on
intermediari es. I n 1 992, he took over forty-one SOEs (including some beer
compani es) i n hi s hometown Quanzhou i n Fuj ian provi nce, and a large
tire SOE i n Shanxi provi nce where he stayed during the Cultural Revol u
tion. In both pl aces, he has good local informati on. Part of his investments
were covered by l oans from Western banks, and the l oans were guaranteed
by his father's Sinar Mas. His father served as an information intermediary
between hi m and the Western banks. In 1 993, Oei l i sted the Shanxi tire
company ( reorganized with some other tire compani es in China) i n the
New York Stock Exchange and Goodyear acquired 24 percent of the shares.
In 1 995, Oei sold 75 percent of the shares of some of his beer companies
83
Governance and Investment in China
to the second largest beer company in Japan. Note that Oei served as an
information intermediary between the Chinese companies and other for
eign companies. A similar case is that of Robert Kuok, a Chinese Malaysian
tycoon, selected as Coca-Cola's exclusive partner i n China because of his
extensive network i n Southeast Asia and China, as well as his extraordi
nary ability to use information intermediaries. 1 6
Cross- Regional Competition for FDI
The distribution of j urisdictional destinations of FOI across different
levels of government is consistent with our hypothesis of cross- regional
competi ti on for FOI , whi ch has mainly gone to the j uri sdi cti ons of re
gi onal and l ocal governments. Among 2998 fi rm- speci fi c operations of
multinational corporations in China, from 1 979 to 1 993 ( Tse, Pan, and Au,
1 996, table 2) , about 30 percent of all operations worked with provincial
governments, about 50 percent with municipal / county governments, and
the remaining 20 percent with the central government. To get around gradu
ated control , a local government often divides a big proj ect into several
smal l proj ects for approval within its own sphere of authority.
To compete for FDI , governments at the provi ncial level and, more
i mportant, at the muni ci pal i ty/ county level , desi gned institutions to re
duce uncertainties and costs of transactions. For instance, to compete with
neighboring counties, Nanhai, Shunde, and Zhongshan i n the Pearl River
Delta of Guangdong, Dongguan county set up an "FOI Service Company"
in 1 984 to serve as a coordinated and organized FDI contract approver as
well as an enforcer. Before this company was set up, a foreign investor
needed to go to more than ten government agencies, such as the Bureau
of Administration for Industry and Commerce, the Commission of Foreign
Trade and Economic Cooperation, and the land bureau and environmental
agency, to have a proj ect approved. Now he only needs to go to the service
company to get all the approvals within a few hours. The service company
also serves as a mediator for contract disputes involving foreign interests.
Such regional development is a result of the restructured capacity and
incentives of local governments in the reform era, which has been part of
the market- preserving authoritarian regime in China since 1 978.
Market - Preserving Authoritarianism
The infow of FOI i nto Chi na started in 1 979 and accel erated after
1 992, mirroring the changing political - economic institutions i n China. l 7 In
this secti on, we apply the MPA framework previously devel oped to ana
lyze China's credible commitment to preserve the market for catching-up
84
Governance and Investment in China
under authoritarianism during the 1 978-1 998 peri od. Correspondi ng to
Ml , M2, and M3 specifed under a market- preserving authoritarianism, We
shall discuss incentive compatibility (competition) , autonomy ( decentral i
zation) , and control ( coordination) , i n turn.
Competitive pressures and experiences (Ml)
After initiating economic reform i n 1 978, Deng Xiaoping and his col
leagues shaped the regi me as market - preserving authoritari ani sm. They
imitated the market-preserving authoritarianism of other East Asian coun
tries such as Taiwan, Singapore, and South Korea from the early 1 960s to
the late 1 980s. Both competitive pressures and experiences led Deng and
other senior leaders to preserve the market in order to facitate catching-up.
In the late 1 970s, China faced a strong military threat from the Soviet Union
as well as economic competition from Japan and the four little dragons.
Economic catching-up was thus vital to the nation and the regi me. Inter
nally, the Deng faction had to compete with the Hua Guofeng faction, which
represented the legacy of Mao. To defeat the Hua clique, Deng had to come
up with more effci ent pol i ci es to mobilize mass support.
At that t i me, the central i zed economi c pl anni ng system had been
practi ced i n Chi na for three decades already and had l ed t o di sastrous
economi c consequences. By this time, market mechanisms adopted i n
neighbori ng economi es, such as Japan and the four l i ttl e dragons, had
brought double- digit annual growth for decades. I S In particular, the sharp
contrast i n performances between mainland China and Taiwan, between
North Korea and South Korea, and between East Germany and West
Germany, confirmed the superi ori ty of the market mechani sm over the
planning system.
Like in other East Asi an countri es, China's strong landlord cl ass had
been wiped out after land reform i n the late 1 940s and the early 1 950s.
Labor unions were restricted, and the military was controlled tightly by the
party and the seni or l eaders. As a result, at the outset of reform, seni or
leaders did not foresee an imminent (internal) threat from a strong interest
group; and by designing proper control devi ces and adopti ng a shared
growth pol icy, they could avoid threats from an emerging strong interest
group i n the process of devel opment. I n addi ti on, seni or l eaders used
various tactics to balance different interests. For instance, Mao analyzed
the balancing of the so- called Ten Great Relationships, such as devel op
ment between agriculture and industry and devel opment between coastal
regions and i nl and regi ons. At the same ti me, devel opment coul d hel p
upgrade mi l i tary technol ogy and better fi nance the armed forces, thus
85
r
I '
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Governance and Investment in China
minimizing external military threats, which were increasingly replaced by
international economi c competition after the end of the Cold War. Mi ni
mi zed external military threats or increased international economi c com
peti tiveness resul ti ng from devel opmental pol i ci es, i n turn, can further
strengthen the position of an authoritarian regime. 1 9 In short, for Deng and
other senior leaders in his faction, it seems that the perceived risk of regime
col l apse resulting from market devel opment and catchi ng-up was suffi
ciently low. On the other hand, they expected the market-based catching
up to strengthen their posi ti ons.
Decentralization ofauthorit and autonomy (M2)
Given that senior l eaders are motivated to adopt market-based catch
ing-up policies, they need to make their poli cies credible in order to achieve
their goas. As discussed previously, for this purpose the senior leaders have
to restrain themselves with both interational and domestic constraints. The
former include the signing of international treaties and the opening up of
markets. For the latter, senior l eaders need to i mpose sel f- constraints by
al l ocati ng suffi ci ent aut onomy to a l arge set of pol i ti cal and economi c
deci si on makers i n an institutionalized way, so that i t i s infeasible or too
costly to reverse. Si nce 1 978 Deng and his col l eagues have gradually but
systematically opened China's door to the rest of the world, and they have
allocated and granted signi ficant autonomy (including authority, informa
tion, and resources) to househol ds, frms, l ocal governments, and mi ni s
terial bureaucrats, whi l e reducing or restricting their own authority.
International constraints. I n 1 978 Deng and his col leagues adopted
an open-door policy. Thereafter China signed dozens of multilateral inter
national treaties and many bilateral agreements. In particular, as indicated,
by the end of 1 994 Chi na had si gned treati es on ( mutual ) protecti on of
foreign investment with sixty-seven countries. At the same time, China has
opened up markets i n an i ncreasi ng number of regi ons and industries .
Si nce 1 993 China has ranked second only to the US in attracting foreign
di rect investment. More recently, in order to meet the requi rements of
j oini ng the World Trade Organizati on, wi der openi ng- up i s under way.
Increasing economic feedom of households and individuals. Fi rst .
t he househol d responsi bi l i ty system was wi del y adopt ed i n t he early
1 980s. Although l and conti nues to be col l ectively owned ( usuall y at the
vil l age level ) , rural househol ds have gai ned al most compl ete l and- use
rights by leasing contracts. Land l eases have been extended from short
term ( e. g. , three to fi ve years) to l ong term ( e. g. , ten to thi rty years) by
nati onal regulati ons. Second, afer the early 1 980s l ocal resi dents began
86
Governance and Investment in China
to directly el ect del egates to the peopl e's congresses at bot h t he town
shi p and county l evel s. Peopl e's congresses have become i ncreasi ngl y
infuential . Beginning in 1 987-1 988, the heads of vil l age commi ttees were
di rectly el ected. The di rect el ecti on of townshi p heads was pl anned i n
the Fi fteenth Party Congress hel d i n 1 997. Thi rd, and more general l y,
i ndi vi dual economi c and ci vi l freedoms have been s i gni fi cant l y ex
panded. I ndivi dual s i n both r ural and ur ban ar eas are i ncr eas i ngl y
allowed to trade, invest, and migrate freel y, and more i mportant , to set
up private enterpri ses . Private busi ness enterpri ses have spread rapi dl y
from craft s, food processi ng, and retai l i ng t o textil es, el ectroni cs , and
raw materi al s , especi al l y after the early 1 990s.
I n 1 993, t he State Administrati on of I ndustry and Commerce i ssued
" Some Poi nts on Enhanci ng the Devel opment of I ndivi dual and Private
Business. " It specifes the following measures to stimulate private business:
l . Resigned and retired party and government officials can conduct
private busi ness;
2. Unl ess speci fied otherwise i n state l aws and regulations, privat e
busi nesses can operate i n any sect or and i n any form;
3. Pri vate ent erpri ses can t ake over st at e- owned and col l ect i ve
enterpri ses.
Thes e measures have great l y enl arged t he aut onomy of pri vat e
enterpri ses and have sped up the devel opment of private busi nesses .
Increasing autonomy of state-owned enterprises. The aut onomy of
(urban) SOEs was expanded in t hree st eps. Fi rst , i n the l ate 1 970s a nd
the early 1 980s, SOEs began t o have some limited operati onal autonomy
and to have t he right to retain some of t he profi ts. Second, from t he mi d-
1 980s to the early 1 990s, more autonomy was i nsti tuti onal i zed i n t he
management contract responsi bi l i ty system ( MCRS) . Under t he MCRS,
i ndustri al bureaucrats and managers si gn contracts speci fyi ng perfor
mance targets , control ri ght s , and compensat i on schemes. The MCRS
became wi despread after 1 987, and by 1 989 most SOEs had adopted the
MCRS. Third, si nce the early 1 990s an increasing number of SOEs as wel l
as TVEs have bec ome share - hol di ng c ompani es or h ave be e n ful l y
privati zed. I n 1 9 78, al most 8 0 percent of t he t ot al nat i onal i ndust ri al
out pu t was deri ved from SOEs. By 1 99 5 , the SOEs' share of t he t ot al
i ndust rial out put had shrunk to onl y one- thi rd ( Chill a Slatistica1 Yenr
book 1 996, 403) . A recent survey esti mates that more than 70 percent of
the small SOEs i n Shandong and several other provi nces have been flly
or partially privati zed ( Chi na Refor m Foundat i on 1 997) .
87
Governance and Investment in China
The mi rror i mage of the expandi ng autonomy of SOEs and other
enterprises and privatization has been the shrinking authority of economic
and industrial bureaus. According to a survey conducted i n 1 995, about
50-60 percent of the surveyed bureaus reported that their authority had
decreased over the previ ous year, and 30-40 percent reported that their
authority remai ned unchanged. 20 I n 1 998 the Fi rst Sessi on of the Ninth
Nati onal Peopl e's Congress adopted a bl uepri nt t o restructure the State
Council drastically withi n three years: some forty ministries and commis
sions have been reduced to twenty-nine; most industry- specific ministries
have been abolished; the number of staff members has been cut by about
hal f. Local governments will be si mi l arly streaml i ned, resul ti ng i n the
significant reduction i n the government's economi c authority.
Autonomy of intermediar business organizations. The autonomy of
enterprises has been strengthened by the forming of various intermediary
business organizations. Enterprises are allowed or encouraged to organize
vari ous enterpri se groups and busi ness associ ati ons. Enterpri se groups
frst began to emerge when the then- State Planning Commission and the
State Economi c Commi ssi on i ssued " Several Poi nts on Establishing and
Developing Enterprise Groups" i n 1 987. 2 1 I n 1 995 the government issued
" Provsional Regulations on the Establishment and Management of Enter
pri se Groups" that set forth the pri nci pl e of vol untary parti ci pati on of
i ndividual enterprises i n enterprise groups. The resultant Chinese enter
prise groups are likely to resembl e the Japanese keiretsu or the Korean
chaebol ( congl omerates) i n the coming decades.
Increasing autonomy of local governments. The autonomy of l ocal
governments has i ncreased through the fiscal revenue- shari ng system,
the 1 982 Consti tuti on, and vari ous other decentral i zati on pol i ci es. The
fi scal revenue- shari ng system was first introduced i n 1 980, renewed in
1 984 and 1 988 with some modi fi cati ons, and conti nued through 1 993 .
Under thi s syst em, l ower- l evel governments had an obl i gati on to sub
mi t a fixed amount or a fixed proporti on of t hei r fiscal revenues to the
government l evel just above them and they were allowed to retain the
remai nder for t hemsel ves . Thus, l ocal government s had the right of
resi dual cl ai ms. The 1 982 Consti tuti on granted provincial - level govern
ments the authority to make broad regi onal economi c regulati ons. The
central government has al so granted control ri ghts over a great number
of state- owned ent erpri ses to l ocal government s. By the end of 1 983 ,
control rights over the maj ority of state- owned enterpri ses were trans
ferred to l ocal governments. By 1 985, state- owned i ndustrial enterprises
control l ed by the central government accounted for only 20 percent of
88
Governance and I nvestment in China
total i ndustrial output of all enterpri ses at or above the townshi p l evel
( Qi an and Wei ngast 1 995) . By 1 994, it was esti mated that l ocal gover n
ments at vari ous levels control l ed about 65 percent of the assets of al l
state- owned ent erpri ses ( Chi na Reform Foundat i on 1 997) .
The decentralizati on policy has granted l ocal governments great au
tonomy to control their economies, including autonomy to establish new
firms, to make investment with "sel f- rai sed funds, " and to manage and
restructure their firms. Consequently, decentralizati on forced local govern
ments to compete \ith one another and helped to marketize t he national
economy. Although local governments may still use some planning mecha
nisms to control their enterprises, they can do business with other regions
only through bargaining, since no one region has authority over the oth
ers. The relationship between provinces, cities, counties, townships, and
villages i s more or less market - ori ented ( for more details on this aspect
of decentralization, see Li , Li , and Zhang 1 998) .
At the early stage of decentral i zati on, many l ocal governments at
tempted to protect thei r enterprises from competition from other regions
by erecting trade barri ers . However, as the si ze of each l ocal economy
becomes smal l er and the number of l ocal economi es increases at lower
government l evel s, the erection of trade barriers by a l ocal government
becomes more cost ly, and hence competi t i on becomes more i nt ense.
Protectioni sm often failed because efficiency gains from exchange si gni fi
cantly exceeded the net benefts of erecting trade barriers, as both informal
and formal arrangements emerged to capture the gains. In the late 1 980s,
l ocal governments began to formulate treaties pl edging to protect each
other's enterprises as their own. For instance, it i s reported that Shanghai
signed agreements for "the protection of the legitimate rights and interests
of enterpri ses" with nine provinces. 22 In 1 99 1 , sixty- four courts from ei ght
prefectures and municipaliti es along the Yangtze River i n Hunan and Hubei
provi nces si gned agreements for the j udi ciary cooperati on of the settl e
ment of cross- regi onal economic disputes. The two hi ghest courts of the
provinces i ni ti ated these agreements to mi tigate l ocal protecti oni sm i n
lower-level courtS. Ll In 1 993, t he central government enacted the " Law of
Anti - i mproper Competiti on, " i n which article 7 prohibi ts local governments
from using administrative means to erect trade barri ers.
Increasing autonomy of technocrats. The autonomy of technocrats
has also expanded signi fi cantly. Bureaucratic el i te transformati on, ai med
at repl aci ng the ol d and l ess educated wi th young professi onal s , hegan
i n t he earl y 1 980s, and was l argely compl eted i n t he early 1 990s by vari ous
forms of mandatory reti rement programs. " " After 1 984, personnel control
89
Governance and Investment in China
was decentralized as the " two- level down management" was replaced by
the " one- l evel down management " at each l evel of government . For
i nstance. t he Central Party Personnel Agency. formerly t he Central Or
ganizati on Department. now directly controls only t he ministers and vi ce
mi ni sters of the central government and governors and vi ce governors
of the provincial governments. I n 1 987. the Thirteenth Congress of the
Chi nese Communi st Party deci ded to set up a civil servi ce system. In
1 993. after experiments i n six bureaus of the State Council. i n Harbin and
i n Shenzhen ( Deng 1 994. 3 ) . a formal civil servi ce system emphasi zi ng
a merit- based sel ecti on ( such as entrance exams) and promoti on system
was i mpl emented. Thus. i n the reform era the bureaucracy has become
i ncreasi ngly stabl e and i ndependent ( as di scussed bel ow) .
Such widely diffused autonomy makes it very costly or infeasible for
seni or l eaders to retrieve the decentralized authori ty from the hands of
such a vast number of households. frms. l ocal governments. and bureau
crats. The public can use the information and resources available to it to
defend and to conceal its vested authority and interests in case of a policy
reversal . The decentralizati on of authority has been further strengthened
by sel f- imposed constrai nts on the seni or l eaders themselves. To make
their market-based developmental policies more credible. Deng and hi s col
leagues desi gned the Central Advi sory Commi ssi on i n 1 982 to restrict the
authority of the powerful first - generation seni or l eaders. including them
selves. Infuential party and military veterans were called to resi gn from
their active posts to become members of the advi sory commission. which
had only symbol i c authori ty. The commi ssi on was abol i shed i n 1 992.
Control devices (M3)
Authority decentralization and autonomy are necessary but not sufi
ci ent for market-based catching- up under authoritarianism. As indicated
i n M3. autonomy needs to be balanced by controf. 2" The key mechanisms
of control include incentive schemes. checking. coordination and enforce
ment devices in governmental agencies. intermediary agencies. and private
agencies. Institutional devices. such as checking and coordination devices.
can be designed along vertical . horizontal. or intertemporal dimensi ons.
Incentive schemes. Performance-based incentive schemes have gradu
ally developed within both the part and the bureaucracy si nce 1 978. They
were parti ally instituti onalized in the "cadre contract responsi bi l i ty sys
tem" i nt roduced in t he mi d- 1 980s. Under t hi s syst em. a hi gher- l evel
government designs and supervises performance- based contracts wi th i ts
i mmedi at e subordi nat e government s. Typi cal ly. such economi c perfor-
90
Governance and Investment in China
mance goal s as output and profi ts are among the key determi nant s of
payments and promoti on. Performance- based i ncentive schemes Wi t hi n
the bureaucracy became more i nsti tuti onal i zed after 1 987 when a c i vi l
service system was advocated. and especially after 1 993 when a civi l sys
t em was formal l y i nt roduced . In t he ci vi l servi ce syst em are gui di n g
principles on rewards and punishment. and on the distribution of rewards
along vertical ( hi erarchy) . horizontal ( cross- functi on) . and intertemporal
( cross- time) dimensions based primarily on ( fifteen) ranks. The distribu
ti on of rewards based on rank i n the civil service system i s taken as a
reference for party and militar officials as well as other staff members in
public agenci es.
Speci fically. the i ncentives for party and government ofci al s have
been structured al ong the fol l owi ng l i nes. Fi rst . overall compensat i on
for officials includes both pecuniary and nonpecuniary rewards obtained
during and after offi ce hours. The rewards include personal income. on
the- j ob consumpt i on. benefits from soci al status and from power ( con
t rol rights) . benefts for their family members. relatives. and friends. and
fture benefits for the officials themselves. When an ofci al l eaves offi ce.
he may be promoted to an upper- level government posi ti on. or he may
become a manager i n an enterprise that was previ ously under his con
t rol . Ei t her way. returns after l eaving offi ce may depend on one's pri or
performance i n offi ce. Second. the fi scal revenue- shari ng syst em pro
vi ded i ncentives for an upper- level of government to adopt performance
based compensat i on schemes for offi ci al s of l ower- l evel government s
under i ts j uri sdi ct i on. Under t he fi scal revenue- shari ng system. a l ocal
government takes the "resi dual " after submi tti ng t he speci fi ed tax rev
enues to the upper- l evel government . Given that tax revenue i s pos i
tively correl ated t o t ot al out put . a l ocal government i s provided wi t h
i ncentives to l i nk the promot i on of l ower- l evel government offi ci al s t o
their economi c performance.
Checking devices. Bot h t he cadre contract responsibil ity system and
t he civil serice system have buil t-in ex ante and interim checki ng devi ces.
Ex ante checking devi ces refer to predesi gned measures to reduce o el i mi
nate opportunities for corruption and mi sconduct. Interim checking devices
refer to monitoring measures in the process. Ex ante and i nteri m checki ng
devices i ncl ude ( 1 ) vertical checking devi ces. such as hierarchical revi ew,
monitori ng. graduated contrl . and regular reporting to higher authori ties;
( 2) intertemporal checking devices. such as term l i mitati ons. rotat i ons, and
the exchanging of posi ti ons amongst pol i ti ci ans and bureaucrat s; (3) hori
zontal checki ng devi ces. such as col l ective deci si on- maki ng mechani sms
9 1
Governance and Investment in China
and deliberation councils (to be discussed i n further detail below) ; and (4)
other checki ng devi ces. such as the "challenge system" ( huibi zhidll) .
Ex post checki ng devi ces are also desi gned to check corrupti on and
mi sconduct after they occur. Such devi ces i ncl ude the Central Party Di s
ci pl i ne Commi ssi on for the party. and the Mi ni stry of Supervision ( estab
l i shed i n 1 949, abol i shed i n 1 959, and restored i n 1 987) , and the Depart
ment of Anti - Embezzl ement and Bri bery ( set up under the Mi ni stry of
Procurators i n 1 995) for the bureaucracy. '" Moreover, there are bureaus
correspondi ng to these organi zati ons at vari ous l ocal government level s.
Such devi ces at the subnati onal l evel s become more effective as cross
regi onal competition i ntensi fi es. Facing economic competition from neigh
bori ng regi ons, each l ocal government i s "forced" to i mprove i ts i nsti tu
ti onal arrangements. i ncl udi ng checki ng devices, to attract investment.
Coordination devices. We now examine the coordination devices within
the party and the bureaucracy. Pol i ti ci ans in China are organized under
t he Chi nese Communi st Party commi ttees at vari ous l evel s. The party
commi ttee at each level di rectly controls the top personnel of the party
committees i mmedi ately below i t. At the national level, the representative
party organization i s the Central Committee, and the main working orga
nization is the Political Bureau. The core organizati on nested in the Political
Bureau is the Political Bureau Standing Committee ( PBSC) , which coordi
nates the seni or leaders. The PBSC serves as a " board of di rectors" of the
Chi nese Communi st Party-a "nesti ng structure" that functions as a verti
cal coordi nati on devi ce.
Starting i n the Deng era. the seven members of the PBSC are supposed
t o represent di fferent maj or i nt erest groups or organi zations, thus func
ti oni ng as a hori zontal coordi nat i on device. The PBSC typi cally consists of
the paramount leader, and two ol d. two medi um- aged, and two relativel y
young seni or l eaders. Each term of the PBSC i s fi ve years and, i n each
successi ve t erm. t he two ol dest members general l y wi l l resi gn and be
r epl aced by t he younger one s . Thi s arrangement funct i ons as an
intertemporal coordi nation devi ce to facilitate smooth transi tion. A similar
"graduated- age- structure" i s also bui lt i nto the ci vil service system to fa
ci l i tate smooth personnel transi ti ons i n the bureaucracy ( Deng 1 994, 5) .
Bureaucrati c agenci es are generally organi zed around a pi l ot agency.
Thi s arrangement funct i ons as a vert i cal coor di nat i on devi ce i n t he
bureaucracy. At t he nat i onal l evel . l i ke i t s count erpart s i n Japan ( t he
Mi ni s t ry of I nt ernat i onal Trade and I ndus try ( MI T! ) ) and Korea ( t he
Economi c Pl anni ng Board) . t he State Pl anni ng Commi ssi on ( SPC) func
ti oned as a pi l ot agency before 1 993. and t he State Economi c and Trade
92
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Governance and Investment in China
Commi ssi on ( SETC) became a pi l ot agency aft er i t s est abl i shment in
1 993, and es peci al l y aft er i t s cons ol i dat i on i n 1 998 under t he maj or
restructuri ng of t he State Counci l . As most i ndustry- speci fi c mi ni stri es
wi l l cease t o exi st , t hei r regul at ory funct i ons will be transferred to the
newly est abl i shed i ndustri al bureaus wi t hi n t he SETC.
Within t he SPC, t he SETe, and other agenci es, important deci si ons are
general l y deci ded col l ecti vel y and i mpl ement ed by i ndi vi dual sY Thi s
mechanism i s known as "collective leadership and individual responsi bility"
or "democratc centralism. " Cross-ministeria j oint decisions are generally made
i n some form of del i beration counci ls. Like the del i beration counci l s i ni
tiated by MITI i n Japan and the export - promotion meetings i n Korea, there
are "joint meetings" ( lianxi huiyi) , "j oint approval meetings" ( huiqian hll iyi) ,
and " State Counci l ofi ci al meeti ngs" (glowuyuan bangolg huiyi) at the
national level, and "on-site ofcial meetings" (xianchang bangong hliyi) at
various local level s i n Chi na. One te of j oint meeti ng is the "state- owned
enterpri se reform j oint meeti ng. " On the average, once per quarter, the
SETC, the SPC, and other agenci es, such as the State Commission for Re
structuring Economi c System (also to be restructured) , the Mi ni stry of Fi
nance, and the Peopl e's Bank of Chi na, j oi ntly di scuss matters regarding
SOE reform. These are exampl es of horizontal coordi nati on devi ces.
The i ntertemporal coordi nati on devi ces i ncl ude t he smoot h and par
tial repl acement of bureaucrats, and t he l ong- term meri t - and- seni ority
based promotion schemes i n the civil service system. The bureaucracy in
China is remarkably stabl e. As shown i n tabl e 5 and 6, the average tenure
of premiers has been more than ten years. Tables 7 and 8 show that when
Li Peng succeeded Zhao Ziyang as premier in 1 988, only about half of the
ministers were replaced, and the vice ministers and bureau heads remained
largely unchanged.
Tabl e 5 The Tenure of Premiers in the State Council of China
Premi er
Zhou Enl ai
Hua Guofeng (Acti ng Premi er)
Hua Guofeng
Zhao Zi yang
Li Peng (Acti ng Premi er)
Li Peng
Zhu Rongji
Tenur
Oct 1 949 - Jan 1 976
Jan 1 976 - Apr 1 976
Apr 1 976 - Sep 1 980
Sep 1 980 - Nov 1 987
Nov 1 987 - Apr 1 988
Apr 1 988 - Mar 1 998
Mar 1 998 -
SOURCE Mal col m Lamb. Direcrory o/Oficia/s (l 1 d Org(l l i:ariolls ill Chilla ( New York: M. F.
Sharpe. 1 994) . 1 67.
93
r
Table 6 Average Ti me in Ofice
Period Duration
Premi er 99 995 4
Secretary General a 9495 995 42
Forei gn Affai rs 99 995 4
State Pl anni ng Commi ssi on 95295 4
State Economi c & Trade Commi ssi on 99395 2
State Commi ssi on for Restructuri ng Economy 95295 3
State Educati on Commi ssi onb 949J 595 4
State Sci ence &
Technol ogy Commi ssi onc 955c, 95 2
Nati onal Defensed 954 595 3
Nati onal Defense Sci ence,
Technol ogy & I ndustry Commi ssi on 95295 3
State Nati onal i ti es Affai rs Commi ssi one 949J 595 3
Publ i c Securi tyf 9493, 595 4
State Secu rity 95395 2
Supervi si on9 94959, 595 5
Ci vi l Afai rs 9595
Justi ceh 94959 993 24
Fi nance' 94954,J95 3
I nternal T rade 99395 2
Forei gn Trade & Economi c Cooperati on 95295 3
Personnel ' 95J54, 5595
Labor* 94954, 5595 2
Geol ogy & Mi neral Resources 95295 3
Construction 95595
Power I ndustryl 9952, 9395 5
Coal l ndustryk 955J 555, 9395 3
Rai l waysl 949J, 595 4
Communi catl onsm 949c5, J95 4
Machi ne- Bui l di ng I ndustry Commi ssi ont 95255, 9395 5
El ectroni cs I ndustryt 95255, 9395 5
Metal l urgi cal l ndustryn 95ccc, J95 3
Chemi cal l ndustryO 95cc2, cc9 595 25
Posts & Communi cali onsP 949J, 395 4
Water Resourcesq 94955, 952 5595 9
Agri cul turer 9495c, 952 5595
ForestryS 94959 9cJ 995 2
Cul ture! 949J 595 4
Radi o, Ci nema & Tel evi si on 95295 3
Publ i c Heal thU 949c 355 3
State Fami l y Pl anni ng Commi sSi on 95 -95 4
State Physi cal Cul t ure & Sports Commi ssi onv 952 95 25
94
No. of
ofcials
4
9
4
2
3
5
2
4
9
2
4
3
c
9
2
4
3
4
3
2
3
5
J
J
3
4
c
4
5
5
3
4
c
Average
ti me i n ofce
5
4 c
c 5
c 4
2
3 25
3 42
9
4 c3
c 5
9 5
4 59
c
4 5
5 c
4
3 33
3 25
3 c
3
4 33
3 5
c
3 5
4
4
2 c
2
5
3 5
4 5
2 53
3 c3
5 3
4 33
4 29
3 5
4
Continued
Table 1 continued
ao,` a sBa^\olC^ ^a
/cJlo-0a^aa` sDeparment
949c4, 395
95395
3
2
J
3
3
4
SOURCES OF R [LI: Director) of Oficials all d Orgal l izations in China, 1 994, An Last (;(1 /(
Book. The GOllemment Ltaders ofPR. China, 1 995, Canada Mirror Books.
Nrm,s:
, Abolished i n 1 954; amalgamated with the newly establ ished Mi ni stry of Labor and Personnel
i n May 1 982 to Apr. 1 988 and restored i n Apr. 1 988.
t Amal gamated wi th the newl y establ i shed Mi ni stry of Machi ne Bui l di ng and El ectroni cs
Industry duri ng Apr. 1 988 to Mar. 1 993 and restored i n Mar. 1 993.
a. Abol i shed i n 1 975 and restored i n 1 978.
b. Abol i shed i n June 1 970 and restored i n Jan. 1 975.
c. Establ i shed i n 1 958 and suspended duri ng the Cul tural Revol uti on; resumed operations i n
Sept. 1 977.
d. No offci al s were i denti fied duri ng Sept. 1 9 7 1 to Jan. 1 975.
e. Abol i shed i n June 1 970 and restored i n Mar. 1 978.
f. No ofci al s were i denti fi ed duri ng Aug. 1 973 to Jan. 1 975.
g. Abol i shed i n 1 959 and restored i n Dec. 1 986.
h. Abol i shed i n 1 959 and restored i n 1 979.
i . No ofi ci al s i denti fed duri ng J une 1 954 to June 1 970.
j . Amal gamated wi th the Mi ni stry of Water Conservancy i n Mar. 1 982-Mar. 1 993 and then
restored.
k. Amalgamated wi th the Mi ni stry of Fuel and Chemicals Industries duri ng Nov. 1 970 to Jan.
1 975 and then restored; became part of the newl y established Mi nistry of Energy Resources from Apr.
1 988 to Mar. 1 993 and then restored.
I. Absorbed by the newly establ i shed Mi ni stry of Communi cati ons i n Nov. 1 970. Restored in
Jan. 1 975.
m. No offci al s were i denti fi ed duri ng 1 966 to 1 969. The mi ni stry absorbed the Mi ni stry of
Rai lways i n Nov. 1 970.
n. No offci al s were i denti fied duri ng 1 967 to 1 969.
o. No offci al s were i denti fied i n 1 963-1 966. Amalgamated wi th the Mi ni stry of Fuel and
Chemicals Industri es i n Nov. 1 970. Restored i n Mar. 1 978 as a resul t of the divi sion of the Mi ni stry of
Petroleum and Chemi cal s Industry.
p. Amalgamated with the Mi ni stry of Rai lways and Mi ni stry of Communi cati ons in 1 970.
Restored i n May 1 973 after the abol i ti on of the di rectorates of Post s and Tel ecommuni cati ons.
q. Amalgamated with the Ministry of Power and formed the Mi ni stry ofWater Conservancy and
Power during Feb. 1 958 to 1 979 and Mar. 1 982 to Apr. 1 988; restored i n Apr. 1 988 si nce the abol i ti on
of the Mi ni stry of Water Conservancy and Power.
r. No offi ci al s were i denti fi ed i n 1 957-1 978 under the name of the Mi ni stry of Agri cul ture.
Absorbed by the Mi ni stry of Agricul ture and Forestry in Nov. 1 970. Restored i n Feb. 1 979 wi th the
di vi sion of the Mi nistry of Agri cul ture and Forestry, renamed and given expanded rol es i n May 1 982.
Between then and Apr. 1 988, the organization was styled Mi ni st r1 of Agri culture, Ani mal Husbandry
and Fi sheri es.
s. No ofcial s were identifed in 1 960-1 966 under the name of the :ni strv ofForestr; absorbed
by Mi ni stry of Agri cul ture and Forestry in Nov. 1 970 and restored i n Feb. 1 979.
.
t. Abolished in 1 970 and restored in Jan. 1 975 after the abolition of the Culture Group under the
State Counci l .
u. No offi ci al s were i denti fed i n 1 967-1 971.
v. No ofci al s were i dentifi ed in 1 9531 970. Recommenced operati ons fol l owi ng the Cul tural
Revol uti on i n June 1 970.
w. No offi ci al s were i denti fi ed i n 1 965-Ma1 1 973.
95
Table 7 Change of Vice Premiers, State Councilors, and Ministers in 1 988
J^Ja
a1 a/^ao 9B}
J^Ja
a1 a. 9BB}
mool,av ocsoNc a` s ^
9BBas/ol l ^alola`^o
ol o1 c a` s ^ 9B
Tola`^ooloca` s Tola`^oolo1ca`s mool,av ocso c a` s
v caa1 as 5 3 2 4
SlalaCoc^c `os 9 2 B B
V ^slas 4 42 24 52
Toe` 6 5 2 45
SOURCE OF RAW DATA: People1 Republic of China Year/wok 1 987. 1 .88 ( Hongkong: Evergreen
Publ i shi ng) .
Table 8 Change of Vice Ministers and Heads of Bureaus in 1 988
V ^ sly/Co11 ss o^ mo olv ca1 ^ slas mo ol^aaJsol5caacs
J^Ja J^Ja mool J^Ja J^Ja mo ol
1a 1a ,avocs a1a 1a ,avocs
Zo . oca`s Zo L oca`s
movB} 0ac BB} ^ 9BB mov B} 0acBB} ^ 9BB
as/ol as/ol
T T mo ol l^aloe`^o T T mo ol l^alola`^o
^o ol ^o ol ,avocs oca`s ^ool ^o ol ,avocs ooa`s
oca`s oca`s oca`s ^ 9B oca`s ooa`s oca`s ^ 9B
Slala` a^^ ^gCo11 ss o^' 2 0 0 435 5 4 2 423
V ^ slyol ^a^ca 5 5 3 0 B J
ao,` a sBa^\olC^ ^a 4 5 4 J 3 3 3 9
V ^slqoloag^TaJa
& cco^o1 cCoo,aalo^ B 5 9 5 BB2
V ^ slyolCo11ace 5 5 3 0 3 4 3 J
SlalaHa^sldo^oll^a
cco^o1yCo11 ss o^ 3 2 0 0 3 2 3 J
V ^ slyolJcslca 3 2 2 J
Ca^la`Baaaaol
` ^Jasly& Co11aca 5 5 5 J 4 4 J
SOl i Ke O RAI D.I.\: Mal col m Lamb. Directory ot(fticia/s a lid Or{(Iiariol l S il l Chilla Ue,
York: M. E. Sharpe. 1 994) .
' I n Apri l 1 988 t he State Economi c Commissi on was abol i shed and much of i ts work was t aken
over by the State Pl anni ng Commi ssi on and provi nci al authori ti es. To make a consi stent compari son,
figures i n November 1 987 i ncl ude offi ci al s of t he St at e Economi c Commi ssi on.
96
Governance and I nvestment in China
Note t hat bes i des servi ng as hori zont al coordi nat i on devi ces , t he
col l ective deci si on- maki ng mechani sms and del i berati on coulci l s al so
functi on as horizont al checki ng devi ces. When deci si ons are col l ect i vel y
made, t he deci si on makers can check on each ot her, and i t becomes
harder to col l ude i n corrupti on when there are more parti ci pants . Col
l ective deci si on making has been adopt ed to curb corrupti on at vari ous
l evels of the party and the bureaucracy i n Chi na. For i nstance, in order
to curb corrupt i on i n maki ng appoi nt ment s , the Central Organi zat i on
Department i n 1 986 speci fi ed a quorum rul e that requires two- thi rds of
the members of the mi ni sterial party group to be present when screen
i ng a nomi nee for a bureau- l evel posi t i on.
The Asian Financial Crisis and I t s Implications for China
Although FDI infow into China has been among the hi ghest i n the
world i n the l ast few years, the stock of FDl i n Chi na i s still small relative
to its economi c si ze. As privati zati on speeds up, more markets become
open, and t he l egal syst em i mproves , there wi l l be more opportuni ti es
and a bet t er envi ronment for forei gn fi rms to i nvest i n Chi na. Thus, a
signifi cant i nfow of FDI into Chi na may conti nue in the comi ng decade.
I n fact, as the regulatory and l egal system improved, FDI agreements i n
Chi na have been evol vi ng from s hor t t erm t o l ong t er m, from smal l
scal e t o l arge scal e, from standard t o s peci fi c, from j oi nt ventures t o
wholly foreign owned, and from coastal to i nl and regi ons i n the l ast two
decades. Yet in Chi na at present , given t he wi despread corrupt i on and
i neffecti ve l egal pr ot ect i on of pr operty ri ght s , es peci al l y i nt el l ect ual
property ri ght s , forei gn i nvest ors are somewhat rel uctant t o i nvest i n
contract- and technol ogy- i ntensive sectors. The ongoi ng privatizati on of
SOEs and TVEs , al ong wi t h t he i mprovi ng l egal syst em, wi l l r educe
corrupti on si gni fi cantly. I t is i mportant to bui l d an effective l egal system
to faci l i tate contract enforcement i n dynamic sectors, such as hi gh- tech
i ndustry, in t he l ong run. A necessary condi t i on for establ i shi ng an ef
fect ive l egal sys t em i s to mi ni mi ze corrupt i on. I n a corrupt count ry,
pol i tical openi ng- up to opposi ti on parti es and economi c openi ng- up to
the world market are eventual l y necessary to mi ni mize corrupti on i n the
l ong run.
More generally, a s noted i n Li ( 1 999) . economi c devel opment i s fun
dament al l y a process of establ i s hi ng i nformal gover nance mechani s ms
and t hen maki ng t he transi t i on t o formal governance structures. Thi s i s
consi stent wi th hi stori cal facts , whi ch had l ong been negl ected by econo
mi st s unt i l very recentl y. Be fore for mal gover nance was es t abl i she d,
97
Governance and Investment in China
European busi ness peopl e duri ng the premodern peri od made agree
ments, to a l arge degree, outsi de t he legal system (Greif 1 994) . Transition
away from personal reputati on i n the Uni ted States occurred only be
t we e n 1 840 and 1 92 0 ( Zucker 1 986) . Dur i ng t hi s t r ans i t i on per i od,
relational banking played an i mportant role in moni toring frms ( Cantillo
Simon 1 998) . I t was t he Gl ass- Steagall Act, the Securities Act, and other
regul ati ons after t he Great Depressi on that essent i al l y ended rel ati on
shi p- based fi nance i n t he US ( J acobs 1 99 1 , 1 43-45) .
2
B
Unfortunately, as argued in Li ( 1 999) , transi t i on from i nformal gov
er nance to formal governance is us ual l y a di s c ont i nuous proc e s s .
Decent ral i zat i on of i nformal governance or change of management
teams can disrupt governance at l east i n t he short run because relations
( l ocal person- speci fic i nformat i on) among ol d players can be weakened,
whi l e rel at i ons wi th/ among new pl ayers or formal rul es are yet t o be
establ i shed. I n particular, when new management teams replace ol d ones,
and new pl ayers enter t he market ( e. g. , due to financi al l i beralizati on) ,
exi sti ng rel ati ons become usel ess or weakened, and rel ati ons with and
between new pl ayers are yet t o be est abl i shed by repeat ed pl ays and
tests. That i s, ei ther exi st i ng rel ati on- s peci fi c i nformati on becomes i n
val i d or bi l at eral monopol y of private i nformat i on breaks down.
The arrival of newcomers makes i t harder for an incumbent to com
mi t to exi sti ng rel ati ons. As a by- product, decentralizati on of i nformal
governance can result i n "corrupti on with i ndependent monopoly. " Before
decentralizati on ( e. g. , pol i ti cal l i beralizati on) , di fferent branches of the
government may j oi ntl y maxi mi ze the value or the t otal bri be across
compl ement ary publ i c goods . I n t he process of decentral i zat i on, t he
rel ati ons between di fferent branches of the government may be cut off.
Subs equent l y, di ffer ent branches become i ndependent monopol i s t s
provi di ng publ i c goods. Thi s may resul t i n severe i neffi ci enci es i f these
publ i c goods are compl ementary, as i ndi cated earli er.
Thus , before formal governance i s es t abl i s hed, t her e may be a
vacuum in the governance structure after market devel opment and l i b
eralizati on have made i nformal governance dysfuncti onal . On the other
hand, there i s no guarant ee t hat a formal governance system can be
establ i shed after l i beral izati on, and when it can be establ i shed i t usually
i nvolves a l ong compl ex process. Transi t i on from aut hori t ari ani sm to
democracy i s hardly smooth, and sufci ent noi se can trigger a war i n the
pr oces s . Some product i ve resources need t o be divert ed t o cover t he
fixed cost of set t i ng up effect ive formal governance. There are " fi scal
external i ti es" in fi nanci ng t he set up; for each tax dol l ar pai d by an i n-
98
Governance and Investment in China
di vi dual , t he s oci al benefi t i s si gni fi cantl y hi gher t han hi s i nd i vi dual
benefi t . To col l ect taxes and to i mpl ement ot her rul es effect i vel y, i t i s
necessary tu devel op i nformati onal i nfrastructure, which i tsel f i s a l ong,
evol ut i onary process.
The di srupt i on of governance aft er l i beral i zati on can possi bl y l ead
to a significant reducti on in trade and investment in the short run. Aft er
drasti c trade l i beral i zation i n 1 987, t he Mexican footwear i ndustry went
through a crisi s. One of the mai n reasons behind the crisis appeared t o
be t he deteri orati on of t he footwear associ ati on's functi on as an enforce
ment mechani sm i n t he open economy. Si mi l arly, t he drast i c capi t al
account openi ng- up i n I ndonesi a and Thai l and, and t he sweepi ng po
l i ti cal openi ng- up i n Korea i n t he 1 990s, mi ght have aggravat ed, i f not
triggered, t he current financi al cri ses i n t hese economi es. The previous
control devi ces ( i n particular coordi nati on devi ces) under a closed capi
tal market or authoritarianism no longer functi on efectively whi l e new
control devi ces under an open capital market or democracy are yet t o
be establ i shed. I n parti cul ar, control devi ces bui l t i n governmental and
semigovernmental agenci es become weakened or nonfuncti oni ng as t he
capi t al mar ket be c ome s ope n or de moc racy phas es i n t o r epl ace
aut hori t ari ani sm. Market and pri vate organi zat i ons wi l l i ncreasi ngl y
repl ace government al and semi government al coordi nat i on devi ces i n
fnancial and ot her industries but the process is likely to be bumpy and
l engthy.
So far, Chi na has been abl e to avoi d a fi nanci al cri si s fol l owi ng the
Asi an crisi s. The maj or reasons are perhaps that Chi na has not yet i mpl e
mented capi tal account openi ng- up or pol i t i cal openi ng- up, and t hat
Chi na has attracted mai nl y FDI , whi l e t he economi es involved i n cri si s
accumul at e d l arge s hor t - t er m forei gn debt s . Event ual ly, : n or der t o
minimize corruption and to establi sh t he rule of law to support techno
l ogi cal progress, both the capi tal market and the pol i ti cal market must
open up i n Chi na, but when and how t o open have profound i mpl i ca
ti ons for economi c growth i n general and for FDI i nfow i n parti cul ar.
To minimize the di srupti on of governance in transi ti on, the Chi nese gov
ernment shoul d consistently but gradually reduce state control and open
up market s, and decentralizing must be accompani ed by coordi nating,
i . e. , mai ntai ni ng necessary exi sti ng relati ons and i mproving the regul a
t ory and l egal framework.
As i n i ts East Asi an predecessors , Chi na wi l l experi ence di srupt i on
of i ts governance structure i n the process of decentral i zat i on. Aft er t he
mi d- 1 990s, governmental withdrawal of i ts control ri ghts from both SOEs
99
Governance and I nvestment in China
and TVEs start ed to accel erate. There have al ready been di srupti ons of
corporate goverance in many privatized firms where i nsi ders or larger
sharehol ders abuse t hei r cont rol rights t o loot mi nori ty sharehol ders.
However, Chi na has t wo advant ages. Fi rst . as a l at e fol l ower, Chi na has
the advantage of l earni ng from bot h t he East Asian miracle and the East
Asian cri si s t o mi ni mi ze the economi c cost s of fi nanci al l i beral i zat i on
and pol i ti cal transi ti on. Second, Chi na can resort to cross- regi onal ( do
mesti c) competi ti on to speed up t he transition from i nformal governance
to formal governance. As di scussed earli er, al t hough pol i t i cal l y Chi na
remai ns very central i zed, economi cal ly it i s al ready much more
decen
tral i zed than many out si de observers have perceived. There are about
thirty provinci al - level j uri sdi cti ons ( most of which are as l arge as mi ddl e
s i z e d count r i e s ) , s ome t wo t hous and c ount i es and fifty t hous and
townshi ps. Local governments have significant i ncentives and autonomy
t o devel op t hei r economi es.
As i ndi cated, cross- regi onal competi ti on can di sci pl i ne each regi on
to i mprove its governance structure to attract investment and limit cor
rupti on. Economi c competi ti on and decentralizati on can eventuallv l ead
t o pol i t i cal compet i t i on and decentral i zat i on. Cross- regi onal copet i
t i on may speed up t he devel opment of t he rule of l aw in Chi na as i t di d
i n t he UK i n t he ei ght eent h cent ury and i n t he US i n t he ni net eent h
century. Current ly, provi nci al - level j uri sdi cti ons can make regi onal regu
l ati ons, and speci al admi ni strative regi ons, such as Hong Kong, as well
as s peci al economi c zones , such as Shenzhen and Hai nan, can make
some regi onal laws . If ot her provi nci al - level j uri sdi ct i ons are grant ed
t he rights to make regi onal l aws i n t he future, cros s - regi onal compet i
t i on i n lawmaki ng wi l l i nt ensi fy.
1 00
CHAPTER FI VE
CENTRALIZATION, POLITICAL TURNOVER,
AD INVESTMENT IN THE PHILIPPINES
Emmanuel S. de Dios and Hadi Salehi Esfahani
Conventional wisdom postulates that systems governed by the formal
rule of l aw are l ikely to perform better than those in which rules may be
arbitrarily changed. This is suggested by Douglas North ( e. g. , 1 997) , who
pointed out, i n his work, the crucial role i n development pl ayed by a clear
defni ti on of property rights and by effect ive mechani sms for the settl e
ment of di sputes. I n recent di scussi ons, however, especi ally fol lowing the
Asian cri si s, "rul e of l aw" has come t o be i nterpreted i n the formal and
hi gh- pol i ti cal sense of conformity with systems found i n Western i ndus
trial democraci es, including the existence of checks and bal ances, regular
and predictable regime successi on, and a formally i ndependent j udi ci ary.
Part of the paradox presented by the rapid growth of the East and South
east Asian countries is that at the ti me of their remarkabl e performance,
few of them confomed to this ideal. I Even countries where levels of corruption
ad potential for arbitrariness were high continued to attract or generate high
levels of productive investments. On the other hand, the Philippi nes has al so
contri buted t o thi s paradox, al bei t i n a reverse manner, namely, as the
exception that validated the rul e. Contrary to what might be expected, the
country's l ong hi story of formal democratic institutions has been associ
ated wi th medi ocre economi c performance ( though in the mi dst of the
Asi an cri si s , it has also been among the l east affected economi cally) .
The quest i ons , therefore, are how goverance and growth may be
related and what some of the mechanisms are through whi ch this relation
shi p emerges. In parti cul ar, thi s chapter seeks to expl ai n how and why
changes i n governance systems in the Phi l i ppi nes ( 1 935-1 972, 1 972-1 986,
and 1 986 to the present) have l ed to di fferent patterns of corrupti on and
1 0 1
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Centralization, Political Turnover, and Investment in the Philippines
an open and stabl e economy, and an effective admi ni strative syst em, a
governance structure with di ffused power is likely to be best for i mpl e
menti ng effi ci ent investment pol i ci es. Political openness and popul ati on
homogeneity coul d reduce the need for power difusi on, but on the whole
such a system should prosper without much concentration of power. This
i s a benchmark that we use to assess appropriate arrangements for other
situations with different characteristics. From such a benchmark, however,
one may proceed to inquire into the signifcance of the costs of restricting
pol i cy di screti on, dependi ng on soci oeconomi c characteristics that make
information processi ng and coordination among interest groups cumber
some. I n particular, the costs of diffused power shoul d tend to ri se with
the six factors that we present below.
1 . Heterogeneit of interest groups in the societ. As the pol ity becomes
more heterogeneous, bargaini ng among representatives of i nterest groups
becomes more cost ly. A hi gher l evel of power concentrati on coul d, i n
pri nci pl e, mitigate thi s probl em. On the other hand, heterogeneity may
also i nduce bi ases i n l eaders' i ncenti ves (as woul d happen i f the gov
ernment was compl etely "captured" ) and afect i ts effcacy. The net effect
on the trade- off, therefore, i s not enti rely cl ear.
2. The frequency and magnitude of economic shocks ( e. g. , adverse
t erms of t rade shocks, nat ural di sast ers, si gni fi cant popul ati on move
ments) . When a country faces signifcant economi c shocks but otherwise
has the same condi t i ons as the benchmark case, the need for t i mel y
policy adj ustment i ncreases. As a result, t he net benefits t urn i n favor of
greater power concentrat i on.
3. The economic system's l ack of openness ( i . e. , market s are more
restri cted) . I f the only departure from the benchmark case is reduced
economi c openness, t he cost of col l ecti ng and processi ng i nformati on
ri ses for i nterest groups and thei r representatives. As a resul t, bargai ni ng
becomes more costly, and power concentrati on, whi ch reduces bargai n
i ng, becomes more benefi ci al at the margi n.
4. Weakness of the administrati ve system ( e. g. , i neffi ci ent administra
t ive organi zat i ons , low qual i t y of per sonnel . low level of educat i on) .
I nabi l i ty of the bureaucracy to col l ect and process i nformati on adds to
the costs of negotiation among i nterest - group representatives. This raises
the marginal net benefi ts of concentrated power. A weak admi ni strative
system al so i mpedes i nformat i on processi ng. I nformati onal i mperfec
ti ons t end to give ri se to "wars of attriti on" i n i nterest- group bargai ni ng,
whi ch can be cost l y i n t erms of resources and del ays i n adj ust ment
( Al esi na and Drazen 1 99 1 ) . I n one sense, concentrati on of power r e-
1 1 2
Centralization, Political Turnover, and Investment in the Philippines
solves this probl em and allows a qui cker and more fexi bl e response to
changing ci rcumst ances, given the avai l abl e i nformat i on.
5. Frequency of leadership turnover ( e. g. , t erm limits and fragmented
party system) . When the likelihood i ncreases that government power will
shift from one group of politicians to another, discretion i n the hands of
l eadershi p can breed pol icy i nstabi l i ty. This calls for i ncreased di ffusi on
of power to the extent that such arrangements can survive political change.
1 1
6. The political system's lack ofopenness (such as more restricted media
and public expression) . Reduced opportunities for political expressi on and
parti ci pati on by broad segments of the popul ati on l i mi t the i nformation
available to interest groups and, naturally, tend to raise the concentration
of power. However, these factors also expand the possi bi l i ti es for oppor
tunistic behavior on the part of the leaders. As a result, some i ncrease i n
power diffusi on may help i ncrease credibility of pol i ci es. Lack of political
openness may also raise the costs of power diffusi on, since it reduces the
avail abi l i ty of publ ic i nformation. However, this i s unlikely to be a maj or
effect compared to the opportuni ti es for favori ti sm that l ack of pol i ti cal
openness presents to l eaders with concentrated power.
Institutions limit policy discretion essentially by conditioning changes
i n policy and policy- making procedures on coordination by a number of
i ndependent agents representi ng di fferent i nterests . Such a di ffusi on of
power can take the form of geographi c decentralization ( e. g. , federal i sm) ,
instituti onal decentralization ( e. g. , i ndependent central bank and regula
tory agencies) , or multiple veto powers ( e. g. , presi denti al - parl i amentary
systems with bi cameral legislature, independent constitutional courts, and
ot her el ect ed or nonel ect ed bodi es hol di ng veto over pol i cy changes) .
Such arrangements can reduce the risk of opportunistic policy changes as
l ong as the represented i nterests are not cl osely aligned. As the number
of i ndependent agents involved i n various pol i cy- making and procedure
setti ng processes di mi ni shes and the degree of al i gnment among those
agents increases, the greater i s the degree of power concentrat i on i n the
government. To be sure, policy commi tment is not an all - or-nothing vari
able. Rather, it i s a variable with a continuum of degrees depending on the
incentives of policy makers, the nature of veto holders for each rul e, and
the extent to which the rules specif the details of pol i cy and restrict the
opti ons for changing the detai l s or the rules themselves.
On t he face of i t s characteri sti cs, t he Philippines is a likely candidate
to benefi t from a strong executive. In parti cular, the economy's proneness
to economi c shocks, its lack of openness and admini strative weakness are
factors that, on the face of it, argue for an increase in the concentration of
1 1 3
r
Centralization, Political Turnover, and Investment in the Philippines
power. There i s no need to deal at l ength with the record of shocks. The
heavy dependence of the Philippine economy on i mported inputs renders
it vulnerable to both externa and internal shocks. Examples of such shocks
that resulted i n critical condi ti ons were the second i ncrease in oil pri ces
i n 1 979, the worl d recessi on of 1 982, and the Gulf War cri si s of 1 990. I n
additi on, natural calamities, such as earthquakes and t he Mount Pinatubo
vol cano erupti on of 1 99 1 , were also si gni fi cant shocks.
Apart from the unsustai nabi l ity of growth under a cl osed economi c
sys t em, t he current framework suggests t hat l ack of openness i n the
economy has another effect, namely, that of raising transaction costs among
di fferi ng i nterest groups . One way of l ooki ng at this i s to say that rent
seeking games are more likely to occur in cl osed, rather than in more open
economi c systems. 1 2 Finally, the weak condi ti on of the bureaucracy i s also
part of the "stylized facts" about the Philippi nes, an observation made long
ago ( e. g. , Corpuz 1 957) but still relevant . The framework, therefore, sug
gests a number of reasons why the Philippi nes shoul d have a "centralized"
system. Indeed, the puzzle for the Philippi nes is how and why, given such
a framework, the experi ment with authoritariani sm has fai l ed.
Extreme Centralization and Bias
Viewed differently, the problem of uncertainty brought about by intra
and i nterregime changes i s the apparent i nabi l i ty of the government as
a whol e to make credi bl e or bi ndi ng commi tments. Commitment essen
ti ally requires that pol i ci es are not amended i n ways that puni sh inves
t ors who make irreversi bl e investments on the basi s of existing pol i ci es.
Thi s can be achieved if the pol i cy makers had t he i ncentive to honor t he
promi ses of past pol i ci es, or if t hei r di scret i on i s constrai ned by estab
l i shed rul es that govern pol i cy change. For appr opri at e i ncent ives t o
exi st , pol i ti ci ans i n goverment ( as i ndivi dual s or as a party when po
l i ti cal parti es are st rong) shoul d expect to have a good chance of bei ng
i n t hat posi t i on i n the future and shoul d value t hei r reputati on among
al l pot enti al i nvest ors. When t he chances of t urnover i n government
l eadershi p are si gni fi cant , t hen commi t ment depends on i nst i t ut i onal
arrangement s for pol i cy amendment .
Until recently, it would have appeared t hat bot h types of uncertainty
r efer r ed to above coul d be r es ol ved by r ecour s e to s ome fo r m of
authori tarianism or dictatorship. After all, assumi ng i t coul d be achi eved,
concentration of power and t he di scouragement of i nsti tuti ons t hat permi t
t he expl i ci t expressi on of i nt erest - group compet i t i on woul d mi ni mi ze
transact i on cost s and uncertai nty. On the other hand, i f frequent turn-
1 1 4
Centralization, Political Turnover, and Investment in the Philippines
overs are associated with pol icy i nstabi lity, then regime l ongevity, ceteri s
paribus, mi ght conversely be associ ated with greater policy consi stency
and s houl d t herefore al l ow for l onger i nvest ment hori zons . I n turn,
i ncumbent rul ers woul d have t he i ncenti ve to t emper corrupt i on de
mands , l eadi ng t o l ower demand for corrupt i on.
The argument i s similar to the ownershi p sol uti on proposed for the
well- known "tragedy of the commons" problem. Free access to a resource
causes its overexpl oitation, which the assignment of monopoly ownership
sol ves , si nce the sol e owner ul t i matel y reaps what he sows and must
therefore take the l ong vi ew. I n the same manner, contenti on for power
and interregime changes among diferent interest groups might be likened
to a one- time open season for public resources. The incentive i s strong i n
such cases for succeedi ng groups to extract as many rents as they can, i . e. ,
"make hay while t he sun shines, " a tendency only somewhat tempered by
the infrequent need to stand for reelecti on. By contrast, security of tenure
i s thought to reduce this need, since i t lengthens the horizon over whi ch
corruption rents may be collected. Before the Asi an fnancial and economic
crisis, a good deal of this analysis certainly seemed to be borne out by the
experi ences of such countri es as I ndonesi a, Mal aysi a, and Si ngapore, in
whi ch long- lived centralized regimes appeared to have facilitated the entry
of capi tal , particularly forei gn.
The recent hi story of pol i ti cal i nsti tuti ons i n the Philippi nes may be
viewed as a process of experi mentati on i n solving the twin probl ems of
i ntraregi me and i nt erregi me i nst abi l i ty, pri marily al ong t he di mensi on
of concentrat i on of power as embodi ed i n t he executi ve. The starti ng
poi nt was t he pre - Marcos regi me governed by t he 1 935 Cons ti t ut i on,
whi ch saw the power of the executive di l uted i n favor of Congress. Thi s
was compounded by frequent turnovers . The broad resul t conformed
with t hat argued by Shl eifer and Vi shny, namely, the emergence of bot h
i nt ra- and i nt erregi me uncertai nty.
On the other hand, the authoritarian Marcos regime may be regarded
as an hi st ori cal experi ment wi th extreme central i zat i on that s ought to
address the probl em on both counts, first by the often brutal suppres
si on of competi ti on among contendi ng facti ons as well as soci al protest
from t he masses and, second, by suspendi ng the turnover that woul d
have resul t ed from el ect i ons. The apol ogi st s of t he regi me were ful l y
aware of the need for j ustifi cati on, and the aleged urgency of preventing
the growing confi ct between the extreme Left and the conservative "ol i
garchy" was ci ted as a reason for a "revol ut i on from t he cent er" that
establ i shed t he di ctatorship.
1 1 5
Centralization, Political Turnover, and Investment in the Philippines
It must be conceded that the early hal f of the Marcos di ctatorshi p
( from 1 972-1 980) was marked by a revival of investment and a respect
abl e rat e of economi c growt h. I nt ernat i onal i nst i t ut i ons, such as the
I nt ernat i onal Monetary Fund and t he Worl d Bank, as wel l as forei gn
( especi ally US) investors appeared to be persuaded at that ti me, and for
t oo l ong a ti me aft er, by t he argument that central i zati on woul d resul t
i n both greater policy coherence and conti nuity. 1 3 Thi s part of the story,
at l east, presents no probl ems. I ndeed, t he anomal ous part of that ex
per i ence, from the t heoret i cal viewpoi nt pursued her e, was that t hat
si t uat i on coul d not be sust ai ned.
Monocausal expl anati ons are always dangerous, however, and whi l e
governance forms are undoubtedly i mportant, they al one cannot be ex
pected to determi ne economi c outcomes. The full set of reasons for the
fail ure of t he Marcos di ct at orshi p's sel f- consci ous attempt t o emul ate
t he authoritarian regi mes i n the rest of the regi on remai ns a wide- open
fiel d of study. An i mport ant el ement t hat can be not ed, however, i s t he
fai l ure of t he Marcos di ctatorshi p to reach t he same l evel of soci al l e
gitimacy as the authori tarian regimes i n the rest of East Asi a. There was
al most no peri od duri ng whi ch the Marcos regi me did not face some
form of chal l enge t o i t s rul e, whet her from el ement s of di spossessed
and di senfranchi sed el i te facti ons, t he Cathol i c Church, the mass move
ment and armed resi stance l ed by the Communi st Party, or t he armed
movement for the i ndependence of Musl i m Mi ndanao. I t i s notabl e that,
ul ti matel y, a confuence of these forces-preci pi tated by a further spl i t
i n t he Armed Forces-woul d bri ng down t he di ctatorshi p i n 1 986. 1 4
Thi s consi derati on poi nts to t he i mportance of i ni ti al condi ti ons i n
assessi ng t he l ong- t erm chances of central i zati on as a sol ut i on to t he
probl em of commi tment . The social basi s requi red t o l egi ti mi ze an au
thoritarian solution to the problem of credible commitment was probably
l ess present in the Phi l i ppi nes than i n other countries which successfully
adopted that soluti on. To begi n with, relative to those other countries, the
Philippines i n the 1 960s and 1 970s was characterized by an economi cally
i ndependent and pol itically powerful elite. I S I t also had a well - developed
worki ng- class and peasant movement, and a population wi th a rel atively
high degree of literacy and political sophisticati on. l Hutchcroft ( 1 99 1 , 1 998)
observes that t he Phi l i ppi ne el i te has hi st ori cal l y been more powerful
relative to the state and the bureaucracy than the elite in other countri es.
I n such circumstances , i t becomes unl i kel y that a si mpl e capture of the
state machinery by a di ctator woul d lead to easy co- opting of the elite. The
upshot is to raise the costs of a dictatorship's bi d for l egitimacy, since both
1 1 6
..
Centralization, Political Turnover, and Investment in the Philippines
lem of instability and credibl e commitment under the current system. At
the very l east, a trade- off between the two must be acknowl edged. On
t he other hand, those who appear correctly to perceive t he probl em of
instabil ity, or what we have called credi bl e commi tment, seek implicitly
t o solve i t not by questi oni ng the i mportance of strong central power,
but i nstead worki ng solely for the suspensi on or extensi on of term l i m
i ts . I n nei ther case i s t he current state of power concentrated i n t he
pres i dency questi oned. By contrast , our framework poi nt s t o st rong
central i zati on i tsel f as an essenti al reason for i nt erregi me uncertai nty
and i nst abi l i ty. The concentrat i on of power i n t he presi dency in t he
Phil ippines i s what makes even predetermined turnovers unsettling and
fraught wi t h uncertai nty. An al ternative proposal t o i nterregime uncer
tai nty, therefore, i s that of weakeni ng presi denti al power. Put another
way, i f presi denti al di screti on and power were much reduced, then the
i ssue of term l i mi ts woul d command much weaker i nterest.
A weakened presidency, to be sure, carries its own consequences. As
already observed, central power emerged also i n response to the "com
mons" probl em. Nonetheless, as against i nsi sti ng on extending term l i m
i ts, reduci ng central power has the advantage of not rai si ng the stakes
of state capture and the risks of extreme bi as. As seen from the resistance
t o the Marcos di ctatorshi p as wel l as the Ramos admi ni stration's fai l ed
attempt to amend the charter, all past efforts to i ncrease central power
and l engthen term l i mi t s have i nvari abl y l ed t o seri ous probl ems of
l egi ti mizati on, provoked deep suspi ci on, and generated massive soci al
opposit i on. It is val i d to ask whether the soci al cost s and goodwill i n
curred i n such efforts can be reasonably recouped by t he putative ben
efi ts of the changes endorsed. I ndeed, i t i s l i kel y that the opposi ti on
provoked by such efforts coul d themselves l ead to the uncertai nty and
i nvestment i nstabi l i ty they had sought to avoi d.
I t i s submi tted here i nst ead t hat credi bl e commi tment to pol i ci es
woul d be best achi eved if i ncumbent s progres si vel y and i rreversi bl y
reduced thei r own scope for di screti onary behavi or, si nce t hat woul d
al so reduce their successors' l eeway for reversi ng such pol i ci es. This i s
one way to understand how privatization and deregulation work in stimu
lating business confi dence; these are commitments to reduce discretion.
cr;
As a corol l ary, a weaker presi dency woul d i mpl y the devol uti on of
more functi ons to other parts of the government, notably the bureau
cracy and l ocal governments. An important reason for pol icy i nstabi l i ty
across regimes is the turnover- related changes in appoi ntment s. Stabi l
i ty of tenure up t o a cert ai n l evel of the government woul d provi de
1 24
Centralization, Political Turnover, and Investment in the Philippines
policy continuity and consi stency, notwithstanding frequent changes i n
admi ni strati on. In t he Phi l i ppi nes t he bureaucracy i s underpai d and
defi ci ent i n trai ni ng and qual i fi cati ons , maki ng i t vul nerabl e both t o
patronage poli ti cs and corrupti on. I t i s common practice i n the country
for wi nni ng candi dates to treat government appointments as spoi l s to
be distributed. While personnel changes i n other countries of the region
extend to two levels, involving those of secretary and undersecretary or
their equival ents, poli ti cal appoi ntees i n the Phi l ippi nes frequently go
down to six levels, affecting positi ons as far as those of regi onal director
and serice director ( World Bank 1 997c, 93) . It is common that upon every
change i n administrati on, new appoi ntees go through a l earning peri od,
while the bureaucracy i tself i s constrai ned to abandon proj ects associ
ated wi th the previ ous admini stration and perforce concoct new ones
more i n keepi ng wi th the tastes of the i ncumbentY Security of tenure,
hi gher pay, and better training woul d go a long way toward i mproving
t he bureaucracy's aut onomy and also ensuri ng pol icy conti nui ty.
Similarly, a frther devolution of central powers to l ocal governments
would reduce the importance of the outcomes of national contests, since
it would remove sole di screti on from nati onal agenci es and vest these
instead to l ocal governments. Local devolution is a process that began in
1 99 1 with the passage of the Local Government Code and may usefully be
carried further. It may be argued, of course, that devolution merely shifts
di screti on from one l evel of the government to another, and that l ocal
tyrants and warlords on their own turf may treat investors more arbitrarily
than a nati onal di ctator woul d. The bi g di ference l i es in that investors
under a decentralized regi me would have choi ces among diferent l oca
ti ons and regi mes, effectively achi evi ng a competi tive regi me. I n such
circumstances, it i s known (again, Shleifer and Vishny 1 993) that rents and
exactions tend to be small, as different l ocal governments compete with
each other for investments. Where authori ty i s redundant or repl i cabl e
(rather than monopolized)
'
corruption rents are minimized, for i f the privi
lege ( e. g. , some l i cense or incentive) cannot be obtained from one l oca
tion, then it may be obtained from another.
This i nsight may be extended to the gl obal setting. To the extent that
a country i s compel l ed to compete for trade and investment on an equal
footi ng with others, there is much l ess room for national authori ti es to
exercise discretion in changing the rules of the game, whether within or
across regi mes, si nce the country must effectively compete wi th others
offeri ng si mi l ar terms. As an upshot , the greater a country's commi t
ments t o gl obal t rade and invest ment rul es, t he l ess the scope for i t s
1 25
Centralization, Political Trnover, and Investment in the Philippines
leaders (no matter how powerful they are internally) to arbitrarily change
these, si nce doing so would mean l osi ng the busi ness. One of the rec
ogni zed benefits of membershi p in such mul ti l ateral organizati ons as
the World Trade Organization ( WTO) , the Association of Southeast Asian
Nati ons (ASEAN) . or Asia Paci fic Economi c Cooperati on (APEC) is that
i t bi nds countri es-regardl ess of changes i n pol i ti cal regi mes-to cer
tain rules and norms of conduct. Though their results are likely to be i n
greater dispute, l oan conditions imposed by the International Monetary
Fund and the World Bank serve the same functi on. As a concrete ex
ample, compatibility with WIO rules has become an i mportant deterrent
t o otherwise resurgent protecti oni sm; attempts to rei mpose nontari ff
measures on some products have been wi thdrawn for bei ng WTO- i n
consistent. I n effect, therefore, governments may choose t o reduce their
di screti onary power by enteri ng into global commi tments; i n this way
they al so bi nd thei r successors, thus ensuri ng pol i cy stabi l i ty.
Finally, even Congress itself could do with some strengthening rela
tive to the presidency. This may seem initially surprising, since folk wis
dom already predicates that Congress has been too intrusive and obstruc
tionist, and sufcient examples exist of shortsighted and inept intervention
on the part of Congress. 28 A proposal to expand these powers relative to
the Executive Branch may only worsen the situati on of overlapping man
dates and gridlock. As argued above, however, the currently observed " ir
responsibility" by other branches of government is more likely part of an
expectational equilibrium, which precludes more rati onal behavior owing
to the assurance that the omnipotent presidency itself will always internal
ize difficulties and repair any damage. The fact that the chief executive
controls budgetary disbursements regardless of what Congress has all o
cated, for instance, makes i t futile for Congress to assume any responsi
bility in the magnitude of expenditures, or in the revenues needed to fi
nance them. It is arguable that the current expectational equilibrium would
change once the other branches of government realized that their choices
al one would deci de fi nal out comes. Hel pi ng this al ong i s a gradually
changing composition of Congress, which now sees an increasing share
of professionals, former civil serants, and new entrepreneurs. 29 Nor is this
experi ence new; it is the same one that compel s more and more local
ofcials 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 for a stronger state.
The demand for a more balanced relati onshi p between the Executive
Branch and the legislature is also consistent with recent game- theor work
1 26
Centralization, Political Turnover, and Investment in the Philippines
on the efects of power concentration and diferentiation, in particular results
obtained by Persson, Roland, and Tabellini ( 1 997) . For these aut hors the
crucial elements for checks and balances are that ( l ) there should be some
adversarial relationship between the executive and the l egi sl ature. and
that ( 2) legislative decision making should require j oint agreement bv both
bodies. Mere separation of powers without the second requi remer;t si m
ply leads to unbri dl ed rent - seeking, which i s analogous to Shl ei fer and
Vishny's i ndependent-monopolists result, where both executi ve and leg
islature seek to draw as much as they can from the "common pool " of
public resources. Superior to this is a more centralized or authori tari an
system (whi ch Persson, Roland, and Tabellini call a "pure presi dent i al "
system without Congress) , si nce then, at l east, the rent - seeki ng is not
competitive and is tempered by t he desire to remain in office. Neverthe
less, it can be shown that even better than a "pure presidenti al " system i s
one where power is separated and checks and balances exist. The present
system in the Philippines is somewhere in between a "pure presidential "
syst em and one wi th genui ne checks and bal ances, al though t he
trivi alization of the legislature and its control by the Executive Branch makes
the current system closer to the former than the l atter. What is certai nly
important in the foregoing, however, is the suggestion that better economi
results may be obtained by taking the design of democratic instituti ons
more seriously, rather than simply abandoning them.
Conclusion
This chapter has argued that Philippine governance i s at a crossroads
in its impact on economic performance. The polity has shi rked from fur
ther costly experi ments with dictatorship and i nsti tuted cl ear r u l es for
turnover and succession, as well as controls on discretionar behavi or. On
the other hand, in recognition of the dangers of policy gridlock and doubl e
marginalizati on, a strong central authority wi t hi n democrati c l i mi t s i s
provided for. Based on the framework developed here, it is clear that such
a halfay house is unlikely to yield spectacular economic resul ts. Hel ativc
to a well - run authoritarian government, the system is li kely to extract mor e
corruption rents and generate greater policy i nstabil i ty among i nvestors.
In addition, policy instability and investment costs across regimes are al so
likely to be greater than those of a "normally functi oni ng" authori tari an
regime, owi ng to the i nfrequency of turnover i n the latter.
Current discussions retlect the perceived tension hetveen a social and
cultural commitment to democratic forms on the one hand and the need
to enhance economic performance on the other. In most national di scus-
1 27
r
Centralization, Political Turnover, and Investment in the Philippines
sions, the latter has been taken to mean a greater enhancement of central
power at the expense of other branches and levels of government, as well
as i ndefinite term l i mi ts for the executive. Not surpri si ngly, these i deas
have been taken to mean an endorsement of authoritariani sm. We have
suggested, however, that the perceived risk of extreme bi as in these or
similar proposal s make any further moves toward authoritarianism non
viable i n t he Philippines . Any such moves would likely l ead to crises of
legitimacy and an intensifcation of interest-based political struggl es, lead
i ng to more erratic private investment behavi or. I nstead, we have sug
gested that the probl ems of i nter- and intraregime uncertainty be deal t
with by reduci ng presi denti al powers and prerogative through a more
determi ned devolution of executive power to the bureaucracy, l ocal gov
ernments, Congress, the courts, and accession to multilateral agreements.
A final word is perhaps in order regarding the country's relative per
formance i n the Asian cri si s. The Phi l i ppi nes has not been as badly af
fected as Thailand or Indonesia, and it may be asked whether the model
presented here can contribute something to an explanation. The technical
reasons for the weaker impact of the Asian crisis are certainly well known,
including the country's smal l er debt- overhang, the shorter run-up to the
crisis, and better supervi si on of financial instituti ons. A more crucial el e
ment that shoul d be taken into account, however, is that the country-in
contrast especially with I ndonesia-did not experi ence a political crisi s.
The obvious difference was that i n t he Philippi nes, unlike i n Indonesi a,
there was a prescribed electoral turnover, which in fact coincided with the
bottom of the crisis in 1 998. The severe impact of the Asian crisis certainly
puts the adequacy and relevance of a country's institutions and system of
entitl ements under scrutiny. It i s an arguable proposi ti on that the crisis
would have affected the Philippines more severely, ceteris paribus, if the
country had conti nued to be under the Marcos dictatorship. As it hap
pened, however, a political crisis was headed off, si nce the country had,
by that time, solved the problem of bias and legitimacy through the insti
tuti on of elections, provi di ng a vent for any popul ar di ssatisfaction.
The framework used here al so suggests that the same institutions that
forestalled a pol itical crisis for the Philippi nes may also prevent it from
recovering rapidly from the crisi s. No changes i n governance in the Phil
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 mlst be said that the same relative freedom of action on the
1 28
Centralization, Political Turnover, and Investment in the Philippines
part of autoritarian regimes that created the opportunities for large gambles
(like i nvestment i n strategic i ndustri es or di scriminati on i n favor of or
against certain groups) also carried the potential for enormous waste. When
large mistakes were made in the form of sectoral overinvestment or social
and economic discrimination, they laid the basis for social conficts. Cen
tralizati on and indefinite tenure, therefore, created the potential for both
huge successes and colossal mistakes. It i s the Philippines' misfortune ( or
l uck, dependi ng on how one views i t) that it has avoi ded both.
APPENDIX
A MODELAND TEST OF INVSTMENT WITH POLITIC UNCERTANTY
1 . Model. Suppose the price of one unit of investment goods is P
I
' and
the margina unit of investment is expected to generate Q units of output.
Assume that Q is declining in the l evel of investment. For simplicity, let Q
~ Z/ l
b
, where b is a positive parameter and Z represents the factors that
afect the profitability of investment, such as fture national income, ex
pected government policy, terms of trade movements, etc. Suppose inves
tors face an infinite horizon of discrete peri ods. I n each period there is a
probabilit p of l osing the returns on investment due to political factors.
Let the discount rate (excluding political risk) be r and the depreci ation
rate be 8 . The tota expected return to the marginal unit of investment is:
T
( l -p ) Q ( l -8 ) ( l -p J 2 Q
+ ----- --
( l + r)
Q
( l + r)
( 1 8 )
( l -p )
+ . . .
I f 8 i s smal l enough, ( 1 ) may b e approxi mated by
T
( l -p ) Q
( r+p )
( 1 )
( 2 )
I f the i nterest rate i s i, the present val ue o f pl aci ng P
I
i n financi al
markets woul d be iP/ r. In equilibrium, therefore, we must have T iP/r.
Combi ni ng thi s with ( 2) and substi tuti ng for Q yi el ds
r ( l -p )
bl og I l og Z - l og P - l og i + l og -
I
( r-p )
1 29
( 3 )
Centralization, Political Turnover, and Investment in the Philippines
The last term shows investment bei ng inversely related to pol itical
risk. Proxes for the frst term are such variables as expected GDP growth,
expected government policy in response to current budget defici t and
i nfati on, expected bal ance of payments or current account condi ti on,
and expected terms of trade. We do not have the data for i, but omission
of thi s variable should not affect the estimated coeffi ci ent of poli ti cal
risk, since the inclusion of the budget deficit and infation in the model
should control for the i nterest rate.
2. Empirical test. For the investment vari abl e, we take total invest
ment as a percentage of GDP over the per i od 1 9 5 1 to 1 992. We are
unfortunately unable to obtain a sufficiently l ong time seri es of private
investment alone; hence, we resorted to running regressi ons of compo
nent s of i nvest ment ( agai n, as shar es of GDP) . that mi ght cl os el y
approxi mate private i nvest ment . These i ncl ude pri vate constructi on
spendi ng and investment i n durable equi pment. We also tried the sum
of these two as a proxy.
To i sol ate the i mpact on investment of a preel ecti on year dummy,
whi ch was our mai n i nt erest , the fol l owi ng vari abl es were regressed
against total investment or components of i t , as a proporti on of GDP:
government defi ci t, accumul ated current account defi ci ts ( a proxy for
forei gn i ndebtedness) . current account defi ci t l agged one peri od, the
terms of trade, the pri ce of investment goods, and proj ected GDP growth.
Tables 1 and 2 in the text show typical results of regressions for three
investment variables (total investment, private constructi on, and private
constructi on pl us durabl e equi pment) . I nfati on, the i ndex for invest
ment goods pri ces, and predi cted GDP growth are generally significant
with the right signs. I n other regressi ons (not included here) the other
variables also generally have the expected signs, and the regressions are
hi ghly si gnifi cant.
More i mportant for our purposes, the coeffi ci ent of the preelection
year dummy is signifi cant and negative for total investment and private
construction, though not quite so for equipment. (It is signifcant, though,
for private constructi on and durable equi pment taken together. ) Most
time seri es included in the model are AR( l ) . and none has a uni t root.
I ncl udi ng an autoregres s ive term i n the regressi ons i s natural si nce
investment is seri ally correl ated-investment proj ects take time to be
compl et ed and usually span over a few years) . Usi ng the Q- test, the
serial correlation of resi dual s is not si gni fi cant.
1 30
CHAPTER SIX
G
OVRNANCE, RENT - SEEKING, AND PRIVATE
INVESTMENT IN MYSIA
lora K S.
This chapter considers governance, rent- seeking, and private invest
ment i n Mal aysi a from the late col oni al peri od, i . e. , begi nni ng i n the
early 1 950s, and focuses on the peri ods si nce the i ntroructi on of the
New Economic Policy ( NEP) in the early 1 970s and the gradual "retreat"
from i t si nce the mi d - 1 980s. It surveys the i nsti tuti onal evol uti on of
postcol oni al economi c governance i n Mal aysi a and its i mpl i cati ons for
investment and growth, particularly noting the changes under the lead
ershi p of Prime Mini ster Mahathi r Mohamad since the 1 980s. I t then
reassesses how the creation of rents and thei r depl oyment under the
New Economi c Pol i cy ( 1 97 1 - 1 990) and under Mahathi r' s l eadershi p
( l 98 1 -present) have been pri marily ori ented toward i nterethni c redi s
tri buti on, but have al so sought to sustai n i nvestment and growth. I n
particular, it shows how Mahathir's policy reforms have sought to mini
mize the apparent incompatibility between these two obj ectives. Finally,
it consi ders how t hese i nsti tuti ons of rent creati on and rent - seeki ng
affected and conti nue to afect Mal aysia's vulnerability to the East Asian
cri ses si nce mid - 1 997.
The Postwar Economy i n a Nutshell
In the post - Second Worl d War peri od, Mal aysi a experi enced rela
tively rapi d growth, parti cularly during the Korean War boom, the oi l
boom of the 1 970s and the rel ocation of East Asi an industry into South
east Asia and Chi na si nce the l ate 1 980s . Si nce 1 955, the same rul i ng
coal i ti on has been conti nuously i n power at the domi nant federal level.
though the nature and degree of state i nt erventi on and publ i c- sector
1 3 1
I
!;
!
Governance, Rent- Seeking, and Private I nvestment in Malaysia
expansi on had changed consi derably, almos t comi ng ful l ci rcl e by t he
mi d- 1 990s from t he si t uat i on fol l owi ng i ndependence i n 1 957.
Mal aya, and t hen Mal aysi a, achi eved i mpressive growth rat es, con
si derable i nfrastructure devel opment, some economi c diversi fi cati on ( see
fi gure 1 ) i n agri cul ture and i ndustry, i mproved soci al s ervi ces, among
others, after i ndependence and parti cularly duri ng t he 1 960s. Pl anni ng
has al so grown i n s ophi s t i cat i on, i n t erms of i nfor mat i on gatheri ng,
preparati on, and i mpl ementat i on, especi al ly with t he growth of t he publ i c
sector and increasi ng state i nterventi on under the NEP The poli ti cal and
economi c i nterests of the domi nant pol i ti cal i nterests have been largely
refected and furthered by devel opment pol i ci es. Devel opment pol i ci es,
pl an all ocat i ons as wel l as i mpl ement at i on have refl ect ed t he nature,
rol e, and or i entat i on of t he st at e, t he domi nant poli t i cally i nfluenti al
busi ness i nt erest s as wel l as t hei r pol it i cal and economi c pri ori t i es.
Figure 1 GDP Shares by Sector i n Malaysia, 1 960-1 995
1 90 1 95 1 970 1 975 1 980 1 985
_ A:a |ae QV Vaala:|a
1 9
Sev :e
1 95
Aft er i ndependence i n 1 957, and i n part i cul ar from t he 1 960s , t he
Mal aysi an economy diversi fi ed from rubber and t i n, the twi n pi l l ars of
the col oni al economy. Hel ped by favorabl e commodity pri ces and some
eary success in i mpor t - subst i t ut i ng i ndust ri al izati on, t he Mal ayan and
1 32
Governance, Rent- Seeking, and Private I nvestment in Malaysia
then Mal aysi an economy sustai ned hi gh growth with low i nfati on unt i l
t he early 1 970s. The average annual growth rate of the gross domest i c
product ( GDP) i n peni ns ul ar Mal ays i a was 5. 8 per cent duri ng 1 957-
1 970 ( Hao 1 976) , whi l e t he GDP for t he whol e of Mal aysi a rose by an
average of 7. 8 percent per year between 1 9 7 1 and 1 980 despi t e greater
i ns t abi l i ty ( Mal aysi a 1 98 1 ) . Mal aysi a' s economy has grown rapi dl y by
i nt ernati onal st andards, wi th gross domest i c product ( GDP) averagi ng
about 7 percent over t he l ast three decades. After experi enci ng unprec
e de nt e d n egat i ve growt h i n 1 9 8 5 , due t o de fl at i onary pol i c i e s i n
res pons e t o fi scal and debt cri ses a s wel l a s t he col l aps e o f pri ces of
several key commodi ty exports , t he Mal aysi an economy has sust ai ned
rapi d expansi on si nce 1 987. Meanwhi l e, i nfat i on has been brought down
bel ow 5 per cent per annum.
Mal aysi a has experi enced generally favorable external ci rcumstances
al though rubber pri ces decl i ned i n t he 1 960s compared t o t he 1 950s .
Ext er nal c ondi t i ons wer e general l y favor abl e dur i ng t he 1 970s . The
overall bal ance of payments ( for both capi tal and current accounts) was
pos i ti ve t hroughout t he decade, des pi t e an oi l - shock- i nduced r eces
si on i n 1 973-1 974. Duri ng thi s peri od, the pri nci pal export commodi ti es
were rubber, ti n, s aved l ogs, pal m oi l , and petrol eum. Pri mary com
modi t i es account ed for 78 per cent of t ot al exports i n 1 970 and for 71
percent i n 1 980, before decl i ni ng to 55 percent i n 1 985 and 1 5. 9 percent
i n 1 996. Si nce the 1 980s, t he ranki ng of pri mary commodi t i es i n t erms
of cont ri but i on to export eari ngs has been petrol eum and gas, t i mber
( sawed l ogs and sawed ti mber) , pal m oi l , and rubber ( the order mi ght
have been t emporari l y transposed i n except i onal years , e . g. , wi t h t he
col lapse of pal m oi l or petrol eum pri ces) . The export ori entati on of t he
Mal ays i a n e c o nomy s i nc e t he l at e 1 9 60 s has be e n s us t ai ne d by
Mal aysi a' s ne w i ndust ri es that are l argel y expor t - or i ent ed.
Pri mary commodity producti on cont i nued to domi nate t he economy
i n t he early years aft er i ndependence. I n fact , Malays i a ext e n ded i t s
col oni al pr eemi nence i n rubber, t i n, and pepper t o pal m oi l and t r opi
cal hardwoods . Pet rol eum grew from t he mi d- 1 970s , and pet rol e u m
gas as wel l as cocoa product i on became i ncreasi ngl y s i gni fi cant from
the early 1 9805. Agri cul ture's share of GDP has fal l en from 3 1 perc ent
i n 1 970 to 1 percent i n 1 996, whi l e manufact ur i ng' s s hare has r i s en
from 1 2 percent i n 1 970 to 35 percent i n 1 996. Economi c l i beral i zati on
and renewed export - l ed growth from t he mi d- 1 980s have al so accen
tuat ed t he opennes s of Mal aysi a' s economy i n recent years. Whi l e t he
economy has l ong been open, t he rat i o of expor t s to GNP has r i s en
1 33
Governance, Rent- Seeking, and Private Investment in Malaysia
from 43 percent in 1 970 to 60 percent i n 1 985 and 82 percent in 1 996.
Meanwhi l e, t he expor t shar e of pri mary commodi t i es has fal l en from
78 percent i n 1 970 t o 1 6 percent i n 1 996, with manufactures' share ri s
i ng from 12 per cent t o 8 1 per cent over t he same ti me per i od ( Bank
Negara Malaysia Annual Report, March 200 1 ) .
Investment Policies
Mal aysi an economi c devel opment has been shaped by the nature of
the ruling regimes and t hei r respective agendas for nat i onal economi c
devel opment . The col onial peri od i s depi ct ed as one of l ai ssez-faire, al
t hough there i s evi denc e of cons i derabl e bi as i n favor of Bri t i sh
i nvest ment s-agai nst ot her forei gn as well as domesti c ( especi ally Chi
nese) investments-particularly in determining access to that crucial asset
of a col oni al economy built on the production and export of rubber and
ti n, namely, land. All regime policies envisaged or at least implied diferent
sources of and rol es for publ i c as well as private investment, i ncl uding
forei gn di rect investment ( FDI ) . Si nce Mal aya attai ned i ndependence in
1 957, i t seems useful t o di stingui sh three di ferent postcol onial regi mes
wit h di fferent development pri ori ti es as well as attitudes toward private
investments, which in turn afcted the nature and consequences of access
to rents. This outline i s followed by a more extensive review that seeks to
hi ghli ght the signifi cant changes i n t he postcol onial era.
Postcolonial Economic Diversifcation
( Tunku Abdul Rahman, 1 957-1 969)
The conservati ve post col oni al Al l i ance government was concerned
wi th checki ng Bri ti sh capi tal di vest ment i n the face of the uncertainti es
of i ndependence as well as t he ongoi ng "emergency" against the com
muni st - l ed i nsurgency. Aft er i ndependence, l ai ssez- fai re pol i ci es were
st i l l generally pursued wi th some effort s at economi c ( i ncl udi ng agri
cultural and i ndustri al ) diversi fi cati on, greater rural devel opment efforts
and rel at i vel y modest but nonet hel ess growi ng ethni c "affi rmative ac
t i on" pol i ci es i n favor of et hni c Mal ays and ot her i ndi genous peopl es
( Bumi put era) . New i nvest ment i ncent ives were offered to " pi oneer i n
dus t r i es " i n l i ne wi t h t he gover nment ' s " mi l d" i mport - s ubs t i t ut i ng
i ndustri al i zati on, whi ch di d not involve much publ i c sect or i nvestment ,
unl ike the experi ence of " i ntermedi ate" regimes in ot her parts of South
eas t As i a. Var i ous gover nment i nt ervent i ons thus cr eat ed rent s t hat
s erved as i ncent i ves t o at t ract i nvest ment s t hat woul d resul t i n eco
nomi c di ver si fi cat i on.
1 34
Governance, Rent- Seeking, and Private Investment in Malaysia
Growing State Intervention (Razak, 1 969-1 976; Hussein, 1 976-1 981 ;
Mahathir, 1 981 -1 985)
I n the 1 970s, the New Economic Policy (NEP) involved increased state
intervention and public sector expansion (increasingly fnanced by petro
l eum revenues) , especi ally for interethnic redi stributi on. From the mi d-
1 970s, some NEP measures deterred private investment by ethnic Chinese
as wel l as FDI . The NEP thus saw the state capturi ng, all ocati ng, and
depl oying rents for its redistributive goals. Meanwhile, the government's
new export- ori ented i ndustrialization pol i cy, mainly involvi ng new pol i
ci es and incentives ( Le. , access to new rents) attracted FDI . I n the early and
mid- 1 980s, the government- sponsored joint ventures with Japanese frms
to devel op heavy i ndustri es i n the face of decl i ni ng private investment
from the mid- 1 970s. Though the NEP was widely seen as predatory and
excl usi onary of the mai nl y Si no- Mal aysi an busi nesses i n the nati onal
economy, FDI continued to be encouraged-partly for countervailing rea
sons, especial l y for the rel atively i nsul ated, i nternati onally competi tive
export - ori ented enclaves, such as free trade zones ( FTZs) .
Partial Deregulation and New Regulation (Mahathir, 1 986-present)
Ringgit depreciation and partial economi c deregulati on from the mi d-
1 980s were accompani ed by privatizati on, improved official support for
the private sect or ( " Malaysi a I ncorporated" ) , i ncreased investment i n
centives, regressive "supply si de- ori ented" tax reforms and ot her policies
that encouraged private investments. The more attractive busi ness en
vironment, i ncl udi ng a new range of i nvestment i ncenti ves , attract ed
FDI from J apan and ot her East Asi an newly i ndustri al i zi ng countri es
( NI Cs) from the l ate 1 980s as wel l as greater domesti c ( incl uding repa
tri ated) private investments. The government al so sought to accel erate
technol ogi cal devel opment besi des contri buti ng t o the sustai ned eco
nomi c boom of t he l ast decade. Once agai n, a new regime defi ni ng the
condi ti ons for access t o rents (known as i ncentives) has been a cruci al
instrument of industrial pol i cy, as in the two earlier postcolonial peri ods
i dent i fi ed above. Fi gure 2 shows the GDP and per capi ta GDP percent
age changes correspondi ng with t he above peri odi zat i on.
Colonial Heritage
Like so many ot her former col oni es, post col oni al Malaysi an hi s
t ory has been shaped by devel opments of t he col oni al era. The col oni al
aut hori t i es i nt roduced the basi c governance framework wi thi n whi ch
the Malaysi an economy conti nues to functi on. Hence, Mal aysi an eco-
1 35
!
, i
Governance, Rent - Seeking, and Private Investment in Malaysia
Figure 2 Real Per Capita GDP and Annual GDP Growth Rates in Malaysia,
1 960-1 995
RM , J5 :e,
% 0oW|^
^ a:e^ae \c ^ae c:o. ea za| o
-0% 0oW| ^e a, 0
nomi c devel opment has been greatl y shaped by t he i nst i t ut i ons of
governance i mpos ed by Bri t i sh col oni al i sm and t he successor post
col onial state, though t he relationship between economi c transformation
and governance has been qui te di al ecti cal .
Mal aysi a's growth record i n the l ast century has been quite impres
sive. During col oni al times, Mal aya was, by far, Britain's most profitable
col ony, credi ted with provi di ng much of the export earni ngs whi ch fi
nanced Bri ti sh postwar reconstruction. The openness of the Mal aysian
economy-hi gh even by devel opi ng country st andards-has been a
feature of the structural transformation it has undergone, especially since
the British col onial period. Only a few types of industries were allowed
t o devel op by the col oni al authori t i es, who general l y consi dered t he
col oni es as suppl i ers of raw materi al s and i mporters of manufactured
goods. Mos t i ndustri es were set up t hen to reduce transport cost s of
exported or i mported goods , such as for refi ni ng t i n ore and bottl i ng
i mported drinks. Local i ndustries devel oped most when economi c rel a
ti ons with the col oni al powers were weak, e. g. , duri ng the Fi rst Worl d
War, the Great Depressi on, and the Japanese occupat i on.
1 36
Governance, Rent- Seeking, and Private Investment in Mal
.
aysla
Mal aysi a's economi c i nfrastructure, such as railways roads
i
.
' al l f
, POr t s ,
ut lties-so CruCI lor pro table capitalist investment-was generall y
more
devel oped than in most other British col oni es. Such i nfrastructure con-
struction was pai d for by taxes levied on the population by t he col oni al
government. Col onial monopol i es thwarted the devel opment of a strong
l ocal entrepreneurial cl ass produci ng for the domesti c market; instfad,
local businesses found it more proftable to engage in production for export,
commerce, and usur Although the Malaysian economy has changed sig
ni fi cant l y s i nce i ndependence, many di fferences refl ect i ng uneven
development can be traced to the crucial formative decades under col o
ni al rule that shaped the economi c structure. Ethni c differences often
coincided wth class and occupational diferences originating i n the colo
ni al economy. Ethnic Mal ays remai ned l argely marginal to the growing
capi tal i st sector, with the Mal ay elite i ntegrated into the col oni al state
apparatus, and the masses remai ni ng i n the countrysi de as peasant s.
Emerging business opportunities were mainly taken by some of the more
urbanized and commerci ally better connected Chinese.
Postcolonial Economic Diversifcation
The format i on of Mal aysi a in Sept ember 1 963-whi ch i ncl uded
Si ngapore, Sabah and Sarawak-was pus hed through by t he Bri t i sh,
al though Si ngapore seceded i n August 1 965. The Merdeka ( I ndepen
dence) Consti tuti on l argely preserved t he col oni al l egal and admini s
trative framework, especi ally t he protecti on of property rights of British
bus i nes s i nt er es t s . Bes i des pr ovi di ng the framework for a l oo s el y
Wes t mi ns t er - s tyl e parl i ament ary sys t em, i t i ncl uded provi s i ons for
"Mal ay privi l ege" for the purpose of ethni c affi rmative acti on, not only
on the basis of the hi stori cal economi c deprivati on of the communi ty,
but al so because of the Mal ay cl ai m to bei ng an i ndi genous peopl e.
The federal admi ni strative framework devolved authority over l and and
other natural resources to the state government s.
With independence, t he Alliance-a coalition of the political elite from
the three maj or ethnic groups-formaly took over state power and politi
cal j urisdiction over postcolonia Malaya. Not unlike other newly indepen
dent countries, the postcol oni al government embarked upon a program
of economi c devel opment emphasizing economi c diversification and i n
dustrialization. I n preparing for this pol i ti cal transi ti on, the Bri ti sh had
ensured that the radical nationalist and l efti st forces who threatened their
economi c interests were contained, while ethnic elite commi tted to pro
tecting British interests were trained to eventually inherit state power afer
1 37
, i
Governance, Rent-Seeking, and Private Investment in Malaysia
i ndependence i n 1 957. A basi cally probusi ness envi ronment was thus
assured. As a result, the postcolonial government continued to promote
private enterprise, while the economic interests of the former colonial power
were protected and greater foreign investment infows encouraged.
Besi des consol i dati ng col oni al property rights i n the postcol oni al
peri od to forestall capi tal fi ght, whi ch had begun in the l ate col onial
peri od in the ffties, the independent Malayan government extended the
framework for governance to complete the transiti on from colonial sta
tus to nationhood, e. g. , with the establishment of a central bank. Various
rural and regi onal devel opment efforts s ought t o s ecure the cruci al
pol itical support of rural Malays for the multiethnic ruling coaliti on, the
Alli ance. New labor legislation replaced the special regulations created
during the emergency against the communist-l ed insurgency ( Jomo and
Todd 1 994) . New l egi sl ati on and institutions were created to promote
i mport - substituting i ndustrialization.
The Alliance government's policies refected t he interests and politi
cal compromise it embodi ed. Consistent with this compromise, the state
pursued a modest development strategy with minimal state intervention
except to diversif the economy and ensure suitable conditions for rapid
capital accumulati on. The postcol onial government was commi tted to
defending British interests i n Mal aya, which also enabled the predomi
nantly Chi nese l ocal busi nesses to consol i date and strengthen t hei r
positi on. The government al so made some modest attempts to promote
the interests of the still nascent Mal ay business communi ty, while un
dertaking more ambitious rural devel opment programs to consol i date
rural Mal ay el ectoral support.
Government agricultural development policies have been essentially
conservative. The main thrust of rural development efforts involved new
l and devel opment by the Federal Land Development Authority ( Felda) ,
other measures to increase agricultural productivity and rural incomes ,
as well as the provision of rural facilities, such as roads, schools, clinics,
irrigation. Rural development was thus constrai ned by the government's
reluctance to act against pol i ti cally i nfuenti al l anded interests . Mean
while, although bi ased and conservative, postcolonial rural development
eforts contrasted with British colonial negl ect, especially in the prewar
peri od. Ini ti ally, such efforts were aimed at consol i dati ng a pol i ti cally
supportive and loyal Malay yeoman peasantry wi thout drasti c redi s
tributive measures.
Economi c di versi fi cati on efforts to reduce Mal aysi a' s overrel i ance
on ti n and rubber were carri ed out on two mai n front s. Pl antat i ons ,
138
Governance, Rent-Seeking, and Private Investment in Malaysia
i ncl udi ng an i ncreasi ng number of Fel da- s ponsor ed schemes, were
encouraged to grow other crops, particul arly oi l palms. The state al so
encouraged manufacturing by offering i ncentives, providing i nfrastruc
ture and ot her supportive economi c measures. The government al so
encouraged industries to manufacture previ ously i mported goods. Most
of these i mport- substituting industries were subsidiaries of foreign com
pani es, finishing goods produced wi th i mported materials for profitable
sale within the protected domestic market. Many of these industries only
repl aced i mports of fi ni shed goods with semi fi ni shed goods ( e. g. , the
automotive assembly industry) . The technol ogy used, usually originally
developed i n foreign conditions, was typically imported from the parent
company abroad, often generating rel atively little empl oyment.
By the mid- 1 960s, it was qui te clear that i mport- substituting indus
trializati on was slowing down, due to the limited domesti c market, and
generati ng little empl oyment owing to the capi tal - i ntensive nature of
the i ndust ri es as wel l as l i mi t ed l i nkages to the rest of the nat i onal
economy. I n the second hal f of the 1 960s, the government moved to
ward export - ori ent ed i ndustri al i zati on, wi th the establ i shment of the
Federal I ndustri al Devel opment Authority ( now the Malaysi an I ndus
trial Devel opment Authority, or MIDA) .
The I ndustrial Incentives Act was passed in 1 968, ofering a different
set of i ncentives oriented to attracting more l abor- intensive export- ori
ent ed i ndust ri es as compared wi th those of the i mport - substi tuti ng
industries developed under the Pi oneer Industries Ordinance of the pre
vi ous dec ade. Labor l egi sl at i on was amended duri ng t he State of
Emergency ( May 1 969) to help create a n industrial relations climate more
attractive to these new industries by l i mi ti ng trade uni on organization
and activity, and allowing women to work around the clock, i . e. , in shif
work. I n the early 1 970s, the Free Trade Zones Act provi ded the l egi s
l ati on for the devel opment of export - processi ng zones. Together with
other new i ncentives, free- trade zones and other facilities were set up for
this purpose. The new export - ori ented i ndustri es seeking cheap l abor
reduced unemployment as well as wages until the fall in unemployment
pushed wages up once again i n the late 1 970s and early 1 980s.
As et hni c Mal ay demands for i ncr eased efforts to economi cal l y
advance the community mounted in the mi d- 1 960s, new institutions were
set up for thi s purpos e, often in the form of publ i c or state- owned
enterpri ses ( SOEs) . However, the private sector- ori ented devel opment
strategy of the 1 960s largely precluded more direct government parti ci
pati on i n proftable activi ti es, whi ch were l eft to private busi ness interests.
1 39
Governance, Rent- Seeking, and Private I nvestment in Malaysia
Hence, a rel atively low proport i on of publ i c devel opment expendi ture
was al l ocated to commerce and i ndustry throughout the 1 960s. Increased
budgetary all ocati ons for educati on partly refected the i ncreased util i
zation of educational expenditure t o create a Mal ay mi ddl e class as well
as meet i ng the human resource r equi rement s of the rapi dl y growi ng
and moderni zi ng Malaysi an economy.
I ncome di stri buti on in the 1 960s saw a growing gap between urban
and rural resi dent s and growing i nequal i ty between the maj or et hni c
groups, wi t h the Malays fal l i ng furthest behi nd. I ntraethni c economi c
i nequality was at i ts nadi r i n 1 957, but by 1 970 was at i ts peak. Rather
than i ncreasi ng cl ass t ens i ons , t he i nequal i ty was perceived i n raci al
terms, in large part because of the increasing pol i ti cal mobilization along
et hni c l i nes. Hence, Mal ay r esent ment of domi nat i on by capi tal was
expressed primarily against ethni c Chi nese, who compri sed the bul k of
busi nessmen, whi l e non- Mal ay frustrati ons were di rected agai nst t he
Malay- domi nat ed st at e.
Such wi despread et hni c percept i ons resul t ed i n et hnopopul i st op
posi t i on t o t he rul i ng Al l i ance government of t he 1 960s . The general
el ecti on resul ts and "race ri ots" of May 1 969 refected the ethnic di men
s i ons of the new pos t col oni al s oci oeconomi c or der. Meanwhi l e, t he
emergi ng Mal ay mi ddl e cl ass, who enj oyed nomi nal pol i t i cal cont rol
aft er i ndependence, perceived the decl i ne of Bri ti sh economi c hegemony
gi vi ng way t o Chi nese ascendance. They became more assert ive from
t he mi d- 1 960s, est abl i shi ng cl ear pol i t i cal domi nance aft er May 1 969.
Increased State Intervention, 1 970-1 985
Fi rst announced i n 1 970, the New Economi c Policy ( NEP) sought to
create the soci oeconomi c condi ti ons for "nati onal unity" aft er the race
ri ots of May 1 969 through massi ve economic redi stri buti on programs to
achieve its twin prongs of "poverty eradication" and the "restructuring of
soci ety. " The NEP's Out l i ne Perspective Pl an ( OPP) envi saged the i nci
dence of poverty decl i ni ng from 49 percent i n peni nsul ar Mal aysi a i n
1 970 t o 16 percent i n 1 990. " Rest ructuri ng soci ety" basi cally refers to
efforts to achieve i nterethni c parity in occupati ons and corporate wealth
ownershi p. The NEP sought to el i mi nate the i denti fi cati on of race with
economi c functi on, pri marily through ethni cally di fferenti ated fi nanci ng
of, and control l ed access t o, tert iary l evel educati on as well as publ i c
s ect or empl oyment . The OPP al so expect ed to rai se t he Bumi put era
( native Mal ay) share of corporate equi ty from 2. 4 percent i n 1 970 to 30
percent i n 1 990.
1 40
Governance, Rent- Seeking, and Private I nvestment in Malaysia
In the mi d- 1 970s, petroleum producti on-off the East Coast of Pen
i nsul ar Mal ays i a-began provi dent i ally, as oi l pri ces soared from 1 973
onwar ds. The federal goverment qui ckly pushed t hrough t he Pet ro
l eum Devel opment Act of 1 974 to ensure i ts capturi ng the l i on' s share
of oi l rents. Under the Federal Consti tuti on, the state goverment s woul d
have gotten t he l i on's share i nstead. Si nce the early 1 980s, petrol eum gas
producti on-al most excl usively for export to Japan-has offered furt her
pri mary commodi ty earni ngs. Whi l e oi l rent s sust ai ned much of t he
publ i c- s ect or expansi on from the mi d- 1 970s unt i l the earl y 1 980s, t hey
have al so been used to salvage and promot e government- owned enter
pri ses si nce t he mi d - 1 980s. Mal aysi a' s l argest bank i n t he 1 980s, Bank
Bumi putera Mal aysi a, was rescued twice-frst i n the mid- 1 980s after t he
Bumi put era Mal aysi a Fi nance ( BMF) scandal i n Hong Kong, and then
again after the mi d- 1 980s recessi on. The government poured l arge sums
i nto presti ge proj ect s, such as the Daya Bumi proj ect i n the mi d - 1 980s
and bui l di ng the worl d's t al l est bui l di ng, the Kuala Lumpur Ci t y Centre
twin towers, i n the mi d- 1 990s.
Devel opment pol i cy i n t he 1 970s aft er t he decl arat i on of t he NEP
s aw great er s t at e i nt ervent i on i n fi scal r esource al l ocat i on as wel l as
publ i c s ect or ownershi p and control of busi ness enterpri ses. Fr om t he
1 960s, and especi ally i n t he 1 970s, t he state establ i shed a large number
of publi c ent er pr i ses i n al l s ect or s , s omet i mes i n col l abor at i on wi t h
private capi tal . The two mai n types of SOEs are statutory bodi es estab
l i shed by speci al l egi sl ati on, and t hose operati ng as private compani es
registered under the 1 965 Compani es Act. The maj or SOEs owned by the
federal , state, and regi onal authori ti es , i n turn, have many subsi di ari es
and j oi nt ventures .
Publ i c or state- owned enterpri ses were first i ntroduced for t he pur
pose of ethnic affrmative action or posi tive di scrimination from t he earl y
1 950s, and had grown modestly from the mi d- 1 960s and very much faster
i n the 1 970s. From ten in 1 957 and twenty- two in 1 960, the number of SOEs
grew to 1 09 by 1 970, 656 by 1 980 and 1 , 0 1 4 by 1 985, before al most ceasi ng
to grow, except for a few privileged proj ects favored by the Executive Branch.
Si nce the mi d- 1 980s, SOEs have been accused of i ncreasi ng the publ i c
debt and, more generally, of i neffi ci ency; t hei r accumulated l osses have
wasted investment resources, i ncreased the government 's fi nanci al bur
den and sl owed down economi c growth ( Kamal and Zai nal 1 989) . From
the mid- 1 970s, there was a rapi d i ncrease in domesti c and external debt;
very seri ous gaps i n the current account bal ance al so started to emerge
because of decl i ni ng commodi ty export pri ces and weak demand for
1 4 1
Governance, Rent- Seeking, and Private Investment in Malaysia
manufactured exports. Private investments outside of the oil and gas sec
tor were negative ( World Bank 1 983) .
Figure 3 Public Sector Expenditure i n Malaysia, 1 966-1 995
HVV ` ` o^
ct,a^Jlca
BJJJJ
J JO
J O
5J JO
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2J O
J O
o
_ 0ava`o,1a^l
ct,a^Jlca
_ ct,a^Jlca
as/ ol00
ct,a^Jlca
as/ ol00
BJ/
J/
J/
5J/
4J/
3J/
2J/
J/
J /
Meanwhile, the publ i c sector's share of GNP rose from 29. 2 percent
in 1 970 to a peak of 58. 4 percent in 1 98 1 , before falling to 25. 3 percent
in 1 993. I n 1 982, public sector expenditure contributed 4. 8 percent to the
GDP growth of nearly six percent, but since 1 984, its contribution to GDP
growth has declined (see figure 3) . The growth of SOEs from the 1 970s,
especially heavy i ndustri es i n the early 1 980s, had been accompani ed
by declining capital productivity in the economy. The average incremen
tal capital- output ratio ( lCOR) rose from 2-3 in the 1 970s to 5-6 i n the
early 1 980s while the publ i c sector ICOR rose from 6-7 in the 1 970s to
1 5-1 6 in the first half of the 1 980s.
Poor coordi nati on and accountability of the SOE sector were very
evi dent. For i nstance, of more than 900 i denti fi ed SOEs in 1 984, t he
Mi ni stry of Public Enterpri ses coul d only report annual returns for 269
enterpri ses, whi ch recorded an accumul ated loss of RM1 37. 3 mi l l i on
( Supi an 1 988) . Their rapid growth has al so involved generally i neffici ent
state i nterventi on, al most si ngul arly commi tted to i nterethni c weal th
redistribution, ostensibly favoring the poli ti cally dominant, but economi-
142
Governance, Rent- Seeking, and Private Investment in Malaysia
cally deprived, i ndi genous communi ty. In effect, however, such i nter
vent i on has pri mari l y advanced the i nt er est s of s el f- aggrandi zi ng,
pol i ti cally i nfuential rentiers i ncl udi ng some non- Bumi puteras, rather
than genuine entrepreneurs, thus preempting achievement of industrial
pol icy 0 bj ectives .
Mal aysi a experienced a severe economi c recessi on during the mi d-
1 980s due to a manifold combination of economic problems. Worl dwide
i nfuences, such as the gl obal recessi on, tighter internati onal l i qui di ty,
higher real interest rates after the debt crisis from the early 1 980s, lower
primary commodity prices, reduced internati onal demand for manufac
tured expor t s ( es peci al l y el ect r oni cs ) and r educed forei gn pri vat e
i nvest ment i nfows woul d have been di ffi cul t enough. Thes e j oi ned,
however, with an overall decl i ne ( l argely due to predatory pol i ci es di
r ect ed at et hni c Chi nese bus i nes s i nt erest s) i n domes t i c pri vate
i nves t ment and concent rat i on of r emai ni ng pri vate i nves t ment i n
non tradeable sectors (e. g. , property, construction) , poorly chosen public
investments concentrated in heavily protected import-substituting heavy
industries ( some of whi ch also fai l ed on techni cal grounds) , as well as
defationary fscal and monetary pol i ci es beginning i n 1 982 ( except for
the pri me mi ni ster' s pri ority proj ects) .
Duri ng t he 1 980- 1 982 i nt ernat i onal r eces s i on, t he gover nment
adopt ed countercycl i cal budgetary pol i ci es ( i ncreasi ng publ i c s ect or
consumpti on, i nvestment and empl oyment) , whi ch undermi ned gov
er nment fi s c al di s ci pl i ne. Whi l e the gover nment may have
underesti mated the nature and gravity of the recessi on, and therefore
thought it could spend its way out of it, the new Mahathir administration
( from mi d- 1 9 8 l ) probably also hoped to secure a new el ectoral man
date through such generous defi ci t spendi ng. Ri ght after wi nni ng the
April 1 982 general electi on, the government announced an austerity drive,
cutting back publ i c spendi ng and abandoni ng the earl i er effort to i n
crease publ i c sector empl oyment.
Duri ng the mi d- 1 980s, private investments dropped from RM1 3 . 3
bil l i on i n 1 984 t o RM 1 0. 1 billion i n 1 986, before rising again t o RM 1 0. 5
bi l l i on i n 1 987. Per haps more si gni fi cant ly, pri vate i nvest ment as a
percentage of GNP had been declining since the beginning of the 1 980s,
from 19 percent during 1 979-1 984 to 14. 4 percent in 1 987 ( Bank Negara
1 988, 2) . Foreign corporate investment declined by 19 percent from 1 984
to RM1 . 7 billion in 1 985, and RM1 . 4 billion i n both 1 986 and 1 987 ( Bank
Negara 1 988, 1 95) . Meanwhi le, public sector investment was constrai ned
by reduced resource availabi l i ty after the profi gacy of the early 1 980s.
1 43
Governance, Rent-Seeking, and Private Investment in Malaysia
Hi gh l evel s of publ i c s ect or i nves tment coul d o nly be sust ai ned by
borrowi ng externally, yet gl obal i nterest rates were hi gh and such bor
rowi ng woul d have resul t ed i n massive ext ernal debt .
Figure 4 Public Sector Employment as Proportion of Total Employment i n
Mal aysia, 1 970-1 995
T^Js
c1,` oyaJ
!
1
J
f
50
40
30
20
! J
J /
0
c1,` oy1a^l P /ol Tola`
/ ol Tola`
c1,` oy1a^l
B/
/
4 /
2/
J/
B /
/
4 /
2 /
J /
m
Very i mportant, by the mi d- 1 980s there was growi ng di ssatisfaction
with the government among some of t he more capabl e Bumi put eras ,
bot h in t he publ i c and pri vate sect ors. I n a hi gh- profi l e conference in
1 987, both private- and publ i c- sect or Bumi puteras cri ti ci zed what they
consi dered unfair government i nt erference in the busi ness worl d. By
thi s ti me, l arge Mal ay- control l ed busi ness groups had already emerged
i n the cor porat e s cene, and s ome were cal l i ng for a l es s regul ated
economy. I ndeed, some of them viewed excessive i ntervent i on as hav
i ng sl owed economi c growt h. and hence count er pr oduct ive t o thei r
i nterests ( Khoo 1 992) . I n other words. the government coul d no l onger
even cl ai m an ethni c Malay mandate for i ts rol e in the economy.
After the second Plaza Hotel meeting in New York in 1 985, the Japa
nese yen began to appreciate greatly against other maj or world currencies,
particularly 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 Malaysian ringgit declined,
even agai nst the US dol l ar. The boom throughout Southeast Asia that
1 44
'
Governance, Rent- Seeking, and Private Investment in Malaysia
policy responses to the cri ses i n Malaysi a ( Jomo 1 998) . More i mportant,
such i nfl uences-real as well as i magi ned-may well have exacerbated
the cri ses and are likely t o continue to undermi ne confdence i n govern
ment effort s, and thus del ay recovery.
There is now l i ttl e seri ous di sagreement that the economi c turmoi l
si nce mid - 1 997 began as currency and liquidity crises. I t i s also i ncreas
i ngly agreed that the cri ses were pri nci pally due t o the undermi ni ng of
previ ous systems of fi nanci al governance due t o deregulati on and other
devel opments associ ated with the growi ng i nfl uence of financi al i nter
ests at both i nternati onal and nati onal l evel s as well as other pressures
for financi al l i beral i zati on and globalizat i on. I t i s now also i ncreasi ngly
acknowledged that the currency and liquidity crises became crises of the
"real economy" mai nl y due t o i nappropri at e government-and I MF
pol i cy responses as the probl ems emerged ( e. g. , Radel et and Sachs 1 998;
J omo 1 998) .
The failure of government to respond adequately and quickly is partly
due to the mismatch between the institutional arrangements in the fnan
ci al sector, e. g. , regul ati ons and the capacity t o i mpl ement and moni tor
performance of banks, and the demands of financi al l i beralizat i on and
globalizati on ( Jomo 1 998) . I t has also been due, however, to the i nsti tu
ti onal inertia of renti er cronyi sm as evidenced by the reticence of govern
ment t o cl ose badly performi ng corporat i ons and cut support for t he
politically infuential ( Gomez and Jomo 1 999) -both of which would have
given the internati onal financial community more confi dence in the will
i ngness and abi li ty of the government to stop the hemorrhage.
1 62
CHAPTER SEVEN
GOVERNANCE AND GROWH IN THILAND
Al len Hicken
Like the other countri es i n this study, Thailand has experi enced rapid
economi c growth and l arge- scal e forei gn di rect i nvest ment ( FDI ) for
much of the l ast two decades. I n fact , between 1 986 and 1 990, Thailand
had the fast est growi ng economy i n the world ( Warr and Bhanupong
1 996) . However, t hi s peri od of i mpressive performance i s bracket ed on
one si de by seri ous economi c probl ems of t he early- mi d- 1 980s and by
the economi c deteri orati on and eventually cri si s of the mi d- l ate - 1 990s.
What expl ai ns t he varying fortunes of t he Thai economy? Certainly, some
of t he expl anati ons can be traced t o factors compl etely outsi de of Thai
land. The oil shocks of t he 1 970s, combi ned with the gl obal recessi on
during the first hal f of the 1 980s, brought tremendous strain t o bear on
the Thai economy. The depreci ati on of the dol l ar relative t o other cur
renci es and a food of FDI from northeast Asia i n the middle of the l ate
1 980s provi ded the fuel for the economi c boom. Fi nally, t he appreci a
ti on of t he dol l ar, combi ned wi th greater competi t i on for bot h foreign
investment and export market s, had negative effects on Thail and's eco
nomi c performance i n t he mi ddl e of the l at e 1 990s.
However, i nt er nat i o nal e c onomi c fac t ors do not ful l y exp l a i n
Thailand's economi c performance over t i me. Policy makers can respond
to changes i n the i nternati onal economi c environment i n a vari ety of
ways-some of which are conducive to investment and growth and some
of which are not . I n the Thai case, the economi c adj ustments i ni ti ated
duri ng t he early part of t he mi d- 1 980s paved t he way for t he subs e
quent hi gh growth, while the fai lure of t he government t o adj ust duri ng
the 1 990s cont ri buted t o t he det eri orat i on and event ual crash of the
1 63
992
5
995
SOlJ R(S: Ecol l oll isl inteiligent Ull il COl / ll tl}' Report: Thai lund ( vari oll s years ) ; report of the
El ect i on to t he House of Representati ves ( vari ols years) , El ect i on Di vi si on. Department of Local
Admi ni strati on, Interi or Mi ni stry.
Thai pol i t i ci ans al so general l y l ack st r ong i ncent i ves t o pr oduce
nat i onal pol i ci es. Thai parti es have general l y fai l ed to l i nk acros s di s
t r i ct s t o form l ar ge nat i onal par t i es and i nst ead r emai n l oc al l y or
regi onal l y bas ed. As a resul t , a party's const i t uency i s s omet hi ng l e s s
than a national consti tuency.
I
I } In addi ti on, the consensus of virtually al l
students of Thai pol i ti cs as well as Thai pol i ti ci ans and party leaders is
that party l abel s are weak. I I Candi dates tend to rel y on personal vot e
get t i ng strategi es when campai gni ng, rather t han campai gni ng on t he
reputati on or pol i cy posi t i on of t he party. Gi ven thi s, we woul d expect
most Thai pol i ti ci ans to be more concerned with channeling benefi ts t o
thei r supporters than with the conduct of nati onal pol i cy. These support
ers can i ncl ude both the voters in a politician's el ectoral district and any
groups or individuals that hel p fi nance campaigning ( busi ness i nterest s.
pol i t i cal patrons , among ot hers) .
To summari ze, Thai pol i ti ci ans l acked strong i ncentives to consi der
i nterests beyond t hose of t hei r l ocal consti tuency and supporters, at l east
pri or to t he new Consti t ut i on. However, even i f some pol i t i ci ans had
such i ncenti ves , pol i cy maki ng woul d remai n di ffi cul t gi ven t he l arge
number of veto pl ayers i n t he Thai pol i ti cal syst em. The expect ati on,
1 69
Governance and Growth in Thailand
then, is that Thailand shoul d have had dificulty del ivering the types of
nati onal poli ci es conducive to l ong- term growth and i nvestment ( e. g. ,
macroeconomic stability, infrastructure, education and training, pruden
tial regulati on) .
The puzzle then is given the pol itical structure j ust descri bed, how
is it that Thailand was able to enj oy such high levels of foreign invest
ment and economi c growth. How does one explain the apparent confict
between expectati ons and outcomes? Relatedly, how does one expl ai n
the deteri orati on of the economy i n the mi ddl e part of the late- 1 990s
after years of strong performance? I n the next section I provide a partial
answer to these questi ons by l ooki ng at ( 1 ) the i nformal i nsti tuti onal
arrangements adopted by the Thai government to overcome some of
the governance probl ems i nherent in the pol i ti cal system, and ( 2) the
erosi on of those i nformal arrangements over ti me.
Prem, Parties, and the Policy- Patronage Compromise
One way pol i cy makers can combat governance probl ems i s by
creating new formal institutions. 1 2 Independent central banks, currency
boards, and i ndependent regul atory agenci es are exampl es of i nsti tu
ti onal tool s created to hel p ensure that policy making and i mpl emen
tation are ti mel y and free from i nterference by pol i ti ci ans and speci al
i nt erest s. I n Thai l and, however, the pri mary sol ut i on to governance
problems during most of the 1 980s came in the guise of informal, though
si gni fi cant, instituti onal arrangements. Speci fi cal ly, a compromi se was
struck between Prime Minister Prem Tinsulanonda and party politicians.
I l abel thi s compromi se the "policy-patronage compromi se. " I will fi rst
di scuss the unique position of Prime Minister Prem, hi s incentives and
capabil i ti es rel ative to most of the prime mi ni sters that followed hi m.
and then turn my attenti on t o the compromi se itself.
Prime Minister Prem Tinsulanonda
Prem became prime minister in 1 980 until 1 988. He was not. how
eve r, an el ect ed member of parl i ament . Dur i ng t hi s per i od, whi ch
Chai - anan Samudavanij a ( 1 989) cal l s "semi democracy, " Thai gover n
ments came t o power via competi tive el ecti ons. Whi l e el ecti ons were
held, the leaders of the various political parties were unable to reach an
agreement over who among them shoul d be the premi er. The heads of
the pol i ti cal parti es al so real i zed that mi l i tary s upport remai ned an
i ndi spensabl e condition for stable government. And so they asked Gen.
Prem Tinsulanonda, commander of the army, to head the government
1 70
Governance and Growth in Thailand
as pri me mi ni st er. 1 3 With hi s mi l i t ary background Prem enj oyed the
support of i mportant facti ons within the mi l i tary. He al so enj oyed the
backing of the king.
As he was not a pol i ti ci an, Prem did not face the same el ect oral
constraints as el ected politicians. He was not directly accountable to the
narrow constituencies that were the focus of party politicians. Numerous
scholars have noted that Prem was abl e to stand above facti onal party
pol i ti cs and take a broader view than the typi cal el ected pol i ti ci ans. 1 4
However, whi l e Prem's i ncentives to provide nati onal pol i ci es may not
have been as weak as other political actors, he still had to work with a
coalition of factionalized parties as part of the pol i cy- making process. I n
other words, there were still mUltiple veto pl ayers in the policy process,
even under Premo This can be seen clearly by l ooking at the number of
l aws passed by the Prem governments compared to other governments.
During Prem's tenure, an average of 2. 7 l aws per month were enacted
by the l egi sl ature. Thi s is comparabl e to the fi gure for Prem's el ected
successor, Chatichai Choonhavan-2. 3 per month-but much l ess than
during that of nondemocratic governments-6. 4 per month (Christensen
and Ammar 1 993) .
In short, the support of elected party politicians could not be taken
for grant ed. I n fact, Prem' s predecessor, General Kri engsak, had been
forced to step down as prime minister in 1 980 due, in part, to hi s failure
to maintain the support of party leaders. I n order to avoid a similar fate,
and find a way around t he governance probl ems associated with mul
ti pl e veto pl ayers, Prem forged a compromi se with political party leaders.
The Policy- Patronage Compromise
Prem and hi s advi sors were aware that they needed the support of
the political parties for stability and l egitimacy purposes. However, they
felt it was necessary to keep politiCians from interfering in certain parts
of the pol i cy- making process-particularly macroeconomic pol i cy. For
their part, pol i ti ci ans were anxi ous to enj oy the spoi l s of government,
but were also keenly aware of the need to maintain the support of the
military. The excesses and instabil ity of democratic governments from
1 973-1 976 had been part of t he j ustification behind a return to military
rul e. The result was a compromise between Prem (and the technocrats)
and the l eaders of the vari ous politi cal parti es. Macroeconomi c policy
woul d be i nsul ated and run by Prem- backed technocrats, and Prem' s
appointees woul d have the abil ity to set some limits on corrupti on and
rent-seeking on the part of the political parties. I n exchange, the pol itical
1 71
r
'
Governance and Growh in Thailand
parti es would be given control of the sectoral mi ni stri es ( e. g . . Commerce,
I ndustry, Educati on) and woul d be all owed to run them with very l i ttl e
i nt erference from the pri me mi ni ster ( Chri st ensen et al . 1 993) . l
I nsulation of Macroeconomic Policy
As di scussed earl i er, the foundati on of Thai land's economi c success
begi nni ng i n the l ate 1 980s was i t s p rudent macroeconomi c pol i cy.
Thai l and was abl e to adj ust to t he ext ernal shocks of t he 1 970s and
1 980s and achieve economi c stabi lity because i t fol l owed cauti ous eco
nomi c pol i ci es and adopted needed reforms ( Warr and Bhanupong 1 996) .
However, it was t he i nformal pol i cy- patronage compromi se that gave
pol i cy makers the pol i t i cal s pace to adopt t hes e caut i ous economi c
pol i ces. Pr em was abl e t o shi el d key economi c offi ci al s from pressures
from those who mi ght oppose reforms, parti cul arly pol i ti cal parti es. I t
i s not a coi nci dence that most of t he pol i ci es desi gned t o combat the
economi c probl ems of the 1 980s were macroe conomi c or fi nanci al
pol i ci es. Macroeconomi c pol i cy under Prem was centralized and headed
by technocrats . 1 6 The budgetary process was al so kept out of the hands
of pol iti ci ans and central i zed i n the Budget Bureau. Four organizati ons
emerged as t he key groups i n charge of macroeconomi c management :
the Budget Bureau, the Nati onal Economi c and Social Development Board
( NESDB) . the Mi nistry of Fi nance, and the Bank of Thai l and. Concerns
over economi c stabi l i ty had l ed previ ous mi l i tary governments to i nsu
l ate these i mportant macroeconomi c agenci es and this pattern continued
under Prem ( Chri stensen et al . 1 997) . Pri me Mi ni ster Prem was directly
over three of t hese agenci es and i ndi rectly over the Bank of Thai l and
( t he head of t he Bank of Thai l and i s appoi nt ed and r emoved by t he
mi ni ster of Fi nance) . 1 7 These organizati ons, typi cally headed by techno
crats and largely i nsul ated from pol i ti cal and el ect oral pressures, were
abl e t o act deci s i vel y t o pr oduce the nat i onal pol i ci es neces s ary t o
overcome t he cri ses of t he earl y- and mi d- 1 980s and l ay t he ground
work for future economi c growt h.
To summarize, t he pol i cy-patronage compromi se essenti ally reduced
the number of veto pl ayers i n the area of macroeconomi c pol i cy and
allowed pol i cy makers wi t h broader i nterests than t he typi cal pol i tician
to set pol i cy. Thus, thi s group had the i ncentives and capabi l i ty t o impl e
ment cos t l y but needed pol i cy refor ms , whi ch wer e oft en st r ongl y
opposed by the mi l i tary, pol i ti cal part i es , and/ or busi ness groups . The
out come of t hi s compromi se was the stabil ization and economi c reform
pol i ci es of t he Prem peri od .
1 72
Governance and Growh in Thailand
The Collapse of the Compromise
The nat ure of Thai pol i t i cs fundamental l y changed i n 1 988 when
Chatichai Choonhavan, MP and head of the Chart Thai Party, was named
pri me mi ni ster. The choi ce of Chatichai marked the first ti me under the
1 978 Const i t ut i on that t he pri me mi ni st er' s pos i t i on was gi ven t o an
el ected pol i ti ci an. 1 H As a pol i ti ci an, Chati chai was under the same pres
sure t o bui l d and mai ntai n a personal el ect oral network as any ot her
Thai pol i ti ci an. For Chati chai and the other members of hi s party, el ec
toral victory ( and future electoral success) stemmed from t hei r abi li ty or
pot enti al t o di rect resources t o thei r l ocal consti tuents and support ers.
In short, as an el ected politician and party l eader, Chati chai had a much
narrower consti tuency than di d Prem and his tenure as prime mi ni ster
depended on t he conti nued support of poli ti ci ans with equally narrow
consti tuenci es.
Chati chai ' s vi ctory al so marked the t ri umph of provinci al poli ti ci ans
i n t he pol i t i cal process. Chati chai 's party achi eved el ectoral success by
convi nci ng many provincial poli ti ci ans to run under the Chart Thai ban
ner. This class of poli ti ci ans, backed by the provinci al busi ness eli te, had
been growi ng i n strength over t he course of t he 1 970s and 1 980s. 1 9 As
a group, the provi nci al pol iticians di d not generally have strong nati onal
pol i cy goal s . I nst ead, t hey were mos t concerned wi th prot ect i ng and
promoti ng t he narrow busi ness i nt erest s of thei r consti tuency, t he pro
vinci al busi ness el i te. Lo Other Chart Thai party l eaders i ncl uded Banharn
Si l pa- archa, t he provi nci al bus i nes s man dubbed " The Mobi l e ATM"
because o f hi s readi ness to extend financi al assi stance t o pol i ti cal can
di dat es, and Pramuan Sabhavasu, another provi nci al busi nessman who
made his fortune i n the constructi on i ndustry and was a maj or financi er
of Chart Thai candi dates. In short, Chati chai 's victory brought to power
pol i t i ci ans who l acked i ncenti ves t o provi de certai n nat i onal pol i ci es.
Thi s was not onl y becaus e t he el ect oral and party sys t ems c ompe l
pol i ti ci ans t o focus on l ocal , narrow i nterests, but also because t he key
members of provi nci al pol iti ci ans' consti tuenci es were oft en ei t her di s
i nt erest ed or opposed t o such pol i ci es.
B es i des undermi ni ng t he nat i onal pol i cy i ncent ives i n t he Thai
pol i tical system, Chatichai 's victory al so i ntroduced addi ti onal veto pl ay
ers i nto the system. First, as party l eader, Chatichai not only had to worry
about keepi ng other parti es in the coal i ti on happy, as Pre
"
m di d, but h
al so had to cont end wi th t he var i ous fact i ons wi t hi n hi s own party.
Second, the pol i ticization of the pri me mi ni ster's ofi ce l ed di rectly to the
1 73
I ,
I
Governance and Growh in Thailand
politicization of the once technocratic and insulated economi c agenci es.
Under Chati chai , vi rtual l y every Cabi net pos i t i on went t o an el ect ed
pol i ti ci an. The Mi ni st ry of Fi nance was no except i on with the finance
portfolio having been given to Chart Thai fnancier Pramuan Sabhavasu.
The Mi ni stry of Fi nance al so became subj ect t o t he i nstabi l i ty charac
teristic of coal i ti on government. During the eight years Prem was prime
minister, there were only three finance ministers. I n the t en years since,
thi rteen men had served as finance mi ni ster-one of whom served two
separate terms.
Further, Chati chai sought t o decrease the i nfuence of the t echno
cratic NESDB i n economi c pol icy making. Under Prem, t he NESDB was
given a central rol e over economi c pol i cy maki ng. Not only was t he
organizati on in charge of economi c pl anni ng but i t was al so given eco
nomi c coordi nati ng and monitori ng responsi biliti es. The secret ary- gen
eral of the NESDB al so sat as the head of the " Economi c Cabi net , " the
Counci l of Economi c Mi ni st ers ( CEM)
'
whi ch was endowed wi th ful l
Cabi net powers. From t hi s posi ti on t he NESDB was abl e t o screen, and
occasi onal l y vet o, t he pork- barrel proj ect s of t he el ect ed mi ni st ers i n
Prem Cabi net s ( Ungpakorn 1 992 , Anek 1 99 2 a) . Not surpri si ngl y, t he
NESDB aroused a consi derabl e amount of resent ment on t he part of
el ected pol iticians. The Chatichai government expel l ed t he NESDB from
t he Cabi net and removed i ts coordinating and moni tori ng responsi bi l i
t i es. The director of the NESDB resi gned i n protest and was repl aced by
" a more pli abl e t echnocrat " ( Pasuk and Baker 1 995, 350) . Fi nal ly, t he
power over government contracts was t aken from the NESDB and pl aced
under t he control of i ndi vi dual mi ni st ri es. In short , by pushi ng asi de
the technocrats, marginalizing the NESDB, and givi ng control over gov
ernment contracts t o i ndivi dual ministers, Chatichai 's government shifted
control of policy and resources from the i nsul ated technocracy t o el ected
pol i t i ci ans ( i bi d. ) . L I As a resul t , macroeconomi c and fi nanci al pol i cy
maki ng began to fall vi ct i m to the same governance constrai nts ( poor
i ncentives and mul ti pl e veto pl ayers) t hat had been t he rule i n t he area
of sect oral pol i cy.
I t is i mport ant to not e that not every government post was com
pl et el y t aken over by el ec t ed pol i t i ci ans aft er 1 98 8 . El ect ed pr i me
mi ni sters have not i nfrequently appoi nted technocrats t o head the eco
nomi c portfol i os in an effort to boost thei r Cabi net "s credi bility in the
eyes of forei gn and domest i c i nves t or s . Even Chat i chai appoi nt ed a
t echnocrat to head t he Mi ni stry of Fi nance l ater in hi s t erm. However.
these technocrats were sti l l accountabl e to el ect ed pol i ti ci ans with nar-
1 74
Governance and Growh in Thailand
row consti tuenci es as opposed to a nonpartisan premi er with a broader
consti tuency. Thus, t hese t echnocrats usual l y l acked t he authority and
autonomy t hat t hei r predecessors possessed. 22
The Consequences of Poor Governance
It is easy to poi nt to the recent crisis as prima facie evi dence of the
governance probl ems characteristic of the Thai political syst em. 23 How
ever, the consequences of poor i ncentives and weak capability coul d be
seen l ong before 1 997. As t wo cri si s comment at ors not ed, "many had
seen [ the cri si s] comi ng for some t i me. But l i ttl e had been done. Eco
nomi c p ol i cy maki ng and fi nanci al cont rol s had l agged behi nd t he
changes in t he nature and t he pace of t he economy. Politics had got i n
t he way" ( Pasuk and Baker 1 998, 94) .
For reasons discussed earlier Thai politicians are focused on attend
i ng to the i nterests of narrow constituenci es. They have very little interest
i n establ i shi ng connecti ons with broader interest groups that might be
concerned with the conduct of "national" pol i cy. They do have relation
ships with busi ness ( bot h rural and urban) and many of the pol iticians
are bus i nes s men t hemselves , but the p urpos e of t he connect i ons is
mai nl y t o raise corrupt i on money, through t he grants of proj ect s and
concessi ons t o i ndividual frms ( Ammar 1 997) . In short, poli ti ci ans are
i nt erest ed in fi r m/ busi ness speci fi c pol i ci es, rather than broader "na
t i onal " pol i cy. Thus, pol i ti ci ans t end t o vi ew t he publ i c t reasury as a
milki ng cow, with t he politicians' j ob bei ng to channel the milk to their
constituents and supporters. Some of this was accomplished via the l egal
use of all ocati on of publ i c resources. In addi ti on, pol i ti ci ans al s o used
t he sect oral mi ni stri es as sources of corrupt i on money.
Sectoral Policy
As ment i oned above, sect oral pol i cy was never organi zed the way
macroeconomi c pol i cy was under Premo Because of t hi s, si gns of t he
mi s management of s ect oral mi ni s t r i es by pol i t i ci ans appeared wel l
before t he macroeconomy began t o suffer. I n 1 990, despi te t he st rong
and growi ng demand for a better educated workforce, Thail and ranked
last among the ASEAN Five in terms of the percentage of the popul ation
enroll ed i n secondary school , and last in terms of t he percentage gradu
ated from secondary i nsti tuti ons ( World Development Indicators 1 999) .
Despi te rhetori c by politicians and a general recogniti on that Thailand's
educati onal system needed reform, in 1 998 Thai l and's basi c educat i on
i nfrastructure st i l l l agged behi nd t he rest of the regi on ( LaB 1 998) . As
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21 4
1
INDEX
Administrative capacity, 1 94n. 7
Agricultural development, Malay
sia, 1 38
Alliance, The, Malaysia, 1 37-38
American Foreign Corrupt
Practices Act of 1 977, 80
Anand, Panyarachun, 1 77
Anand government, 1 77-78
Aquino, Corazon, 1 04, 1 22-23
Aquino administration, 1 2 1
Arbitration Law, China, 80
ASEN. See Association of South-
east Asian Nations
Asian crony capital ism, 1 90n. 28
Asian fnancial crisis: 1-3, 6, 25-26, 40,
1 90n. l ; efect on China, 97-100;
impact on the Philippines, 128
Asian miracl e, 2
Asian val ue, 1 90n. 28
Association of Southeast Asian
Nations, 1 26
Autonomy of local governments,
China, 88-89
Autonomy of technocrats, China,
89-90
2 1 5
Baht devaluation, 1 65
Bangkok Bank of Commerce, 1 79-80
Bangkok International Banking
Facility, 1 77
Banharn, Silpa- archa, 1 73
Banharn administration, 1 80-8 1
Bank Bumiputera, Malaysia, 1 41
Bank of Thailand, 1 65, 1 72, 1 78-
79, 1 97n. 28
BI BF See Bangkok International
Banking Facility
BMF See Bumiputera Mal aysia
Finance
Boonchu Rochanasathian, 1 95n. 16
Bribery, 2 1-22, 60-63, 1 88n. 1 0
Budget Bureau, Thailand, 1 72
Bumiputera, 1 40, 1 44, 146. 1 53.
1 55, 1 57
Bumiputera Malaysia Finance, 1 41
Bureaucracy, 58-59, 1 25
Bureaucrats, 58, 73, 82, 1 94n. 7
Cpital account, Indonesia, 390. 43
Capital accumulation, Korea. 60
Capital control. 1 87n= 9
Index
Capital fight, Korea, 49-50
Capital infow, Korea, 52-56
Central Advi sory Commi ssi on,
Chi na, 90
Central Party Discipline Commis
sion, China, 92
Central Party Personnel Agency,
China, 90
Centralization in government,
Philippines, 1 1 4-22
Chaebols, 52, 61 , 65-66
Chao Pho, 1 96n. 1 9
Chart Thai Party, 1 73
Checks and balances, 1 03-6, 1 27
China, Peopl e's Republic of: 3-4;
corruption in, 73-79; foreign
direct investment, 69-84, 97;
formal governance, 98-1 00
China Strategic Holdings, 83
Chinese Communist Party, 92
Civil Service System, Chi na, 90-93
Cojuangco, Eduardo, 1 9 1 n. 1 0
Commodity producti on, Mal aysi a,
1 33-34
Companies Act of 1 965, Malaysia, 1 41
Congress. Philippi nes, 1 93n. 29
Conglomerates, Korea. See
Chaebols
Constituti on: Philippi nes, 1 03,
1 1 9-20, 1 23; Mal aysia, 1 5 1 ;
Thailand, 1 68, 1 73, 1 82
Coordination devices, China, 92-97
Corruption: 3-5, 1 3-14, 1 84n. 5,
1 87n. 9, 1 88n. 6; and capital
accumulation, 60; and gover
nance, 61-62; and implications
for investment, 1 1-24; model of
predictability, 1 7-24; political
fnctions of, 62-64; survey
questions on, 1 6
21 6
Corrupti on, monopol istic, 2 1 -23
Criminal law, Chi na, 8 1
Cronyi sm, 1 61 -62
CSH. See China Strategic Holdings
Daim, Zainuddi n, 1 48
Daya Bumi project, 1 4 1
De Venecia, Jose, 1 23
Debacle of 1 997, 1 60-62
Decentralization of autonomy, 86- 91
Decentralization of authority, 86, 89
Democrat Part Thailand, 1 94n. 1 0
Democratic institutions, 5
Deng Xaoping, 85-86, 92, 1 89n. 24
Department of Anti- Embezzlement
and Bribery, China, 8 1 , 92
Difusi on of power, Philippi nes,
1 1 1 -1 4
Dual- tract price system, 1 88n. 4
East Asian paradox, 3-5, 1 1-1 4
East Seaboard Development,
Thailand, 1 97n. 24
Economic Contract Law, China, 80
Economic deregulati on, Mal aysia,
1 3 5
Economic diversification, Malay
sia, 1 34, 1 37-40
Economic governance system, 4-
5, 32-42, 46-56
Economic hi story, 25-26
Economic Planning Board, Korea,
64-65
Economic reforms, Thailand, 1 65
Economic stability, Korea, 47-49
Educational system, Thailand, 1 75
Elections, 1 06-9, 1 70, 1 94n. 5
Employment I ndex, Mal aysia, 1 44
Ersatz capital i sm, 1 61
Estrada, Joseph, 5-6, 1 08
Index
Estrada administration, 1 23, 1 91 n. 9
Ethnic Malay. See Bumiputera
Fm Service Company, China, 84
Federal Land Devel opment
Authority, Mal aysia, 1 38
Financial regulati on, Thailand, 1 78
Fiscal policy, Thailand, 1 80
Fiscalizing, 1 90n. 5
Foreign capital infows, Korea, 52-56
Foreign debt, Korea, 1 87n. 1 3
Forei gn di rect investment: Chi na,
69-73, 80, 1 88n. 1 ; I ndonesi a,
28-29; Korea, 54-56, 1 86n. 5;
Mal aysia, 1 35; Thailand, 1 65-66
Foreign direct investment l aws,
China, 73-74, 79-8 1
Free Trade Zones Act, Malaysia, 1 39
GATT See General Agreement on
Tariffs and Trade
General Agreement on Tarifs and
Trade, 65
General Kriengsak, 1 77, 1 9n. 1 3
Gift giving, China, 1 88n. 3
Goverance: 1-2; China, 9B-I00; Phil-
i ppi nes, 1 0 1-2, 1 1 2; Thail and,
1 66-70, 1 75, 1 93n. 3, 1 96n. 22
Government decision making, 61-62
Government intervention on
investment, 56-58, 1 40-47
Government regulati ons, Indone
sia, 33-35
Grameen Bank-l ike Ikhtiar, 1 57
Gross domestic product: 1 7-20 ,
27-28
Guanxi, 81
Hong Kong, 82-83
Hua Guofeng, 85
Illicit wealth accumulation, 46
Indonesia: corruption in, 25-4;
economic conditions in, 3 1-32,
42; institutions, 32-38; invest
ment
'
27-30; legal system, 30,
40-41 , 44; political incentives,
32-38; political system, 43;
private cronyism, 30; systemic
cronyism, 30
Industrial Coordination Act,
Mal aysia, 1 46, 1 57
Industrial Incentives Act, Malaysia,
1 39
Industrial organization theory, 33
I nformal enforcements. See
Foreign direct investment
l aws, China
I nfrastructure devel opment pol icy,
Thailand, 1 76-77
Institute of Strategic and I nterna
tional Studi es, Mal aysia, 1 50
I nstitutional change, 6-7
Instituti ons: 1 83n. 2; and credible
commitments, 38-42; in
Indonesi a, 36-38; and politi
cal incentives, 32-38
I ntermediary business organiza
tions, China, 81 -84, 88
International arbitration, China,
1 88n. 1 2
International Convention of Invest
ment Disputes, 8 1
I nternational Country Risk Guide,
1 83n. 3
21 7
Interational Monetary Fund, 1 1 6, 1 26
I ntraregime investment, Philip
pi ne, 1 03-6
Investment Act of 1986, Malaysia, 1 51
I nvestment governance, Korea, 54,
64-67
Index
I nvestment model, Phil i ppi nes,
1 29-30
ISIS. See Institute of Strategic Inter
nati onal Studi es, Malaysia
Japan External Trade Organiza-
tion, 1 76
Judiciary, Philippines, 1 05, 1 1 9
Keynesian theory, 47
Kim Young Sam government, 64, 66
Korea: capital fight i n, 49-50;
corruption i n, 4, 60-63; and
foreign capital infows, 52-56;
investment i n, 45-49; luxury
consumption in, 50-5 1 ; state
created rents i n, 5 1-52
Korean Federation of Industries, 65
Korean I nvestment Governance
System, 46-56
Kuok, Robert, 84, 1 89n. 1 6
Kuala Lumpur City Centre, 1 41
Law of Equity Joint Ventures,
Chi na, 79
Law of Contractual Joint Ventures,
Chi na, 79
Law of Wholly Foreign- Owned
Enterprises, China, 79
LCM framework, China, 7 1 -73, 79
Legal system: 2-3; of China, 73-74,
97; of I ndonesia, 30, 40-4 1 , 44
Legislature, Philippi nes, 1 1 9-20,
1 26, 1 93n. 29
Local government code, Phili p-
pi nes, 125
Local informati on, 81 -84
Look East policy, Malaysia, 1 47, 1 53
Lopez family, 1 08
Luxury consumption, Korea, 50-5 1
21 8
Macroeconomi c policy: Korea,
47-48; Thailand, 1 7 1-72, 74,
1 77-8 1 , 1 95n. 1 5
Mahathir, Mohammad, 7 , 1 3 1 , 1 35
Mahathir administration, 1 43
Mahathir's Policy Reforms, 1 47-52
Malaysia: 3, 6-7; colonial heritage,
1 35-37; economi c boom i n,
1 60-62; economi c diversifca
tion i n, 1 34-40; economic
infrastructure, 137, 1 54;
economic recessi on, 1 34;
investment policy of, 134;
investments, 1 43-44; postwar
economy, 1 3 1-34; and state
interventi on, 1 40-47
Malaysia Incorporated, 1 47-48, 1 53
Malaysi a Busi ness Council, 1 50
Malaysi a Industrial Devel opment
Authority, 1 39
Manufacturing investments,
Malaysi a, 1 45
Mao Xedong, 85-86
Mao era, 1 89n. 1 8
Marcos, Ferdinand, 1 04
Marcos family, 1 08
Marcos regi me, 1 1 6
Market - preserving authoritarianism,
China, 4, 75-79, 84-86
Merdeka Constitution, 137
MIDA. See Malaysian Industrial
Development Authority
Ministry of Public Enterprises,
Mal aysia, 1 42
Ministry of Finance, Thailand,
1 72, 1 74
Ministry of Supersion, China, 81 , 92
Monopol i es, singl e, 33
Monopol i es, compl ementary, 33
Monopol ies, multitude, 34, 44
Index
Monopolistic corrption, 21 -23, 1 05
MPA. See Market- preserving
authoritarianism
National Devel opment Policy,
Malaysi a, 1 50
Natonal Economic and Social Devel
opment, Thailand, 1 72, 1 74
Nepotism, 1 61 -62
New Aspirati on Party, Thailand,
1 94n. 1 0
New busi ness governance,
Malaysi a, 1 47-52
New Economi c Policy, Malaysi a,
7, 1 3 1 , 135, 1 40, 1 52-53
New Order period, Indonesia, 26, 31
New regulati on, Malaysia, 1 35
Northian framework, 41
OECD. See Organization for
Economi c Cooperation and
Development
OeL Hong Leong, 83-84
OLS regressi on, 1 8-1 9
Organizati on for Economi c Coop-
eration and Development, 13, 65
O- ring corruption, 23-24, 1 85n. 1 1
Outline of Perspective Plan,
Malaysia, 1 40, 145-46
Parity rights, 1 92n. 1 3
Park, Chung Hee, 46
Parliamentary system, Philippines,
123
Party system, Thailand, 1 67-68
Patronage, Thailand, 1 7 1-72
PBSC. See Political Bureau of
Standing Committee
Pearl River Delta of Guangdong, 83
Peopl e Power Revol ution, 2, 5
Petroleum Development Act,
Mal aysi a, 1 4 1
Petroleum production, Malaysia, 1 41
Philippi ne Constitutional Associ a
ti on, 1 93n. 24
Philippine elite, 1 1 6-1 7
Philippine Revolution of 1 896,
1 92n. 16
Philippines: 3, 56; bureaucracy, 1 25;
corrption i n, 1 05; elections,
1 069; governance system, 1 01 -
2, 1 22-27; political economy,
1 02-3; political institutions,
1 15-18; presidency, 38
Pi oneer Industries Ordinance,
Mal aysi a, 1 39
Plaza Accord of 1 985, Thailand, 1 65
Political and Economic Risk
Consultancy, 69
Political Bureau Standing Com
mittee, China, 92
Political business cycle, 1 9 1 n. 7
Political control, China, 90-93,
1 90n. 25
Political economy, Philippines, 1 02-3
Political institutions, Indonesia, 36-38
Political parties, 6, 8, 1 94n. 9
Political Risk and Consultancy
Inc. , 1 83n. 3
Political stability, Korea, 47-49
Political system, Thailand, 1 82
Political turnover, Philippi nes,
1 06-9
Politics of governance, Thailand,
1 52-60
21 9
Pork-barrel politics, Philippi nes,
1 2 1 -22
Poverty reducti on, Malaysia, 1 46
Power, devolution of, 1 24-25
Power, diffusion of, 1 09-1 4
Index
Pramuan, Sabhavasu, 1 73
Prem Tinsulanonda, 8-9, 1 64-65,
1 70-7 1
Pre- martial l aw period, 192n. 23
Presidents, Philippines, 1 09, 1 1 9,
1 20-24
Presidential system, Philippines, 1 04
Prime Minister, tenure of, China, 93
Privatization: Mal aysia, 148-49,
1 54; Philippines, 1 93n. 26;
Thailand, 1 76
Promotion of Investments Act,
Malaysi a, 145
Propert rights, Indonesia, 25-26, 35
Provincial politicians, Thailand, 1 73
Public goods, Thailand, 1 94n. 4
Public investment, Phil i ppi nes,
1 9 1 n. 8
Public sector expenditure, Mal ay
sia, 1 42
Ramos, Fidel V 1 23
Ramos administrati on, 1 2 1 -23
Redistribution of wealth, Mal ay-
sia, 1 55-58
Regime of I nvestment Gover
nance, 1 993-1 997, 64-67
Regulatory agencies, 33
Rent- seeking: 5; Korea, 5 1-52, 59-
63; Mal aysia, 1 55-6 1 ;
Thail and, 1 7 1-72
Rentier cronyism, 1 61
Roh Tae- Woo government, 66
Rule of law, 1 01
Rural development, Mal aysia, 1 38
Sabah, 1 37
Sarawak, 1 37
Second Outline Perspective Plan,
Mal aysi a, 1 50
220
Sectoral policy, Thailand, 1 75-77
Singapore, 1 37
Sixth Malaysia Plan, 1 50
Southeast Asia economi c boom,
1 60-62
SPC. See State Planning Commis
si on, China
Standing Committee of National
Peopl e's Congress, China,
1 89n. 1 5
State intervention, Mal aysia, 1 35
State Administration of Industry
and Commerce, China, 87
State Counci l of Chi na, 93-96
State- created rents, 5 1-52, 1 55
State Economic and Trade Com-
mission, China, 92-93
State in a Changing World, 1 6
State- owned enterpri ses: China,
73, 87-88; Malaysia, 1 41-42,
1 48; Thailand, 1 76-77
State Planning Commission,
China, 92
Stock Exchange Commission,
Thailand, 1 77
Suharto, 3-, 26, 35-38, 40, 42, 1 85n. 2
Systemic cronyi sm, 30
Tariffs, 1 92n. 22
Technocrats, Thailand, 1 72, 1 74-75
Ten Great Relationships, China, 85
Thai party system, 1 69-7 1
Thai pol itical system, 8-9, 1 66-7 1
Thailand: economic condition,
1 63-66; infrastructure devel
opment pol i cy, 1 76; political
structure, 1 66-1 70
Township and village enterprise,
China, 73
1
Index
Trade deregulati on, Phil i ppi nes,
1 20, 1 93n. 26
Trade liberalizati on, 65, 1 20
Transnational corporations, 54-56
Transparency International , 69,
1 83n. 3
Tukkapg 62
Tunku Abdul Rahman, 134
221
UMNO constitution, 1 5 1
Vision 2020, Malaysia, 1 46, 1 50-52
Wage differential, Korea, 1 86n. 4
World Development Report, 1 6
World Trade Organizati on, 65, 1 26