In this section, we draw and summarize policy lessons and implications from our early analysis. We will first discuss the implications of financial market globalization. As discussed in section II, large capital inflows and sudden withdrawal of foreign capital were key features of the crisis, and the management of erratic and volatile movement of short-term capital has become an important policy issue. Then, we review the current social policies and programs in the worst-affected Asian countries and discuss the problems in establishing social safety nets in those countries.

IV.1. Policy Challenges and Lessons from the Globalization of the Asian Financial Markets

The current Asian crisis clearly shows the benefits and risks of the financial market globalization. Capital inflows to emerging markets boost high growth by igniting investment. They also increase the opportunity for risk diversification and consumption smoothing, and help to improve the efficiency of the financial sector by increasing international competition. However, they simultaneously breed a lending boom, asset bubbles and make financial markets more volatile and vulnerable to international capital flows. International financial flows can be reversed abruptly not only by rational causes but also by irrational causes such as the herd behavior of foreign investors. A sudden outflow of foreign capital incurs a strong negative impact on the debtor countries’ investment, growth, and economic welfare.

Globalization can also have significant effects on social welfare in the debtor countries. For the last three decades, Asian economies have demonstrated that there are enormous economic gains in opening international trade and financial markets. The fast and sustained growth of the East and Southeast Asian countries was spurred by increased integration into world markets (Radelet, Sachs, and Lee(1997)). Despite overall economic benefits, however, international integration produces winners and losers within a country and thus possibly increases inequality.²⁹ International trade, for instance, requires a continuous change of industrial structure and shifts of workers from low to high-productivity sectors to maintain international competitiveness. The rising demand for skilled labor and the commensurate decline in demand for unskilled labor could lead to rising inequality among workers.³⁰ A study of seven countries in East Asia and Latin America shows that wage inequality increased after trade liberalization (Robbins (1996)). Increased capital mobility can also put pressure on either wages or working conditions. Concerns remain that multinational firms will exploit workers in developing countries who are desperate to find jobs. Although financial globalization per se promotes higher employment and real wage growth, it might also increase volatility of employment and wage growth in response to external shocks.

Financial market globalization, therefore, provokes various policy issues. Sound macroeconomic management becomes more essential in containing the negative effects of globalization. Policy makers should find effective tools to contain the negative effect of capital inflows. An early warning system for the crisis should be developed. Monetary and fiscal policies consistent with the choice of an exchange rate system become more important. It is well known that free capital mobility has important implications for the effectiveness of macroeconomic policies. As capital mobility increases, fiscal policy becomes more effective while independent monetary policy becomes less feasible. Loose fiscal policy together with real overvaluation of exchange rates is usually known to be very detrimental.

But more than anything else, strengthening the domestic financial system should be the most important policy agenda. The current Asian crisis demonstrates that the downside costs of globalization become magnified when the debtor country’s financial system shows structural weakness. Lack of prudent regulation and supervision of the financial sector can lead to large-scale capital inflows, imprudent lending, consumption booms and asset bubbles, which result in the real appreciation of currencies and the loss of international competitiveness. Consequently, it makes the economy extremely vulnerable to adverse developments. Many policy prescriptions have been suggested for strengthening the financial system. Establishing transparent accounting standards and practices, and the public disclosure of information are important in improving financial infrastructure. Strengthening banks’ profitability and capitalization, restricting connected lending, tightening asset classification, and loan loss provisions are essential elements in the regulatory and supervisory framework. Providing the right incentive structure, such as abolishing implicit government guarantees, is an essential precondition.

In view of the recent Asian crisis, it is natural that the call for restricting international capital flows, especially short-term capital flows, is getting more attention and sympathy. Many think that the most important lesson to be learned from the Asian crisis is that a developing country should be more cautious in opening its capital market. In particular, various measures aimed at regulating the magnitude and composition of international capital flows are proposed. They include the Tobin tax and a compulsory deposit on exchange transactions as introduced in Chile. Considering the pains that the crisis-hit countries are suffering, it is hard to deny that some regulation on short-term capital mobility is necessary for stability.

However, we do not think that raising a barrier to international capital flows or delaying the opening of capital markets is the lesson to be learned from the Asian crisis. We believe that those policy goals cannot be achieved by an individual country's efforts alone. The current experience in Korea is an important example. In the past, the Korean government favored a gradual opening of its financial market to avoid the speculative movement of hot money. Instead of opening capital markets directly to foreign investors, the government chose to do it indirectly. In other words, it allowed domestic financial institutions to borrow from abroad and to distribute the obtained funds in domestic markets. That policy was aimed at securing low-cost financing while preventing speculative capital flows. It was presumed that domestic financial institutions were easier to supervise than foreign hedge funds. However, considering non-performing loans, reckless offshore investment and imprudent foreign exchange risk management of domestic financial intermediaries, we cannot help but doubt the validity of this presumption ex post.

Also, the government did not understand the downside of this indirect approach. Since the domestic bond market was not open to foreign investors, the high interest rates since the inception of the crisis could not deter massive outflows of foreign capital. The adjustment burden thus fell entirely on the foreign exchange market. Only after fully opening domestic financial markets at the request of the IMF did domestic interest rates start to work as a policy instrument for controlling capital flows.

In sum, it is true that financial liberalization exposes domestic financial markets to the possibility of speculative attacks. But the Korean experience shows that a currency crisis can occur even in countries whose domestic financial markets are partially and indirectly open to foreign investors. The Korean experience shows that once a financial market is developed above a certain threshold level, pretending that a small country can control the speed of capital market opening is fantasy. If one country tries unilaterally to restrict short-term capital mobility through the Tobin Tax or a compulsory deposit, foreign capital will switch to other countries without regulation. Therefore, to effectively regulate short-term capital mobility, international policy coordination is essential. Until we have a worldwide system for restricting short-term capital flows, the right lesson one should draw from the Asian crisis is the importance of improving domestic financial infrastructure rather than trying to control capital inflows to prevent a crisis.
 

IV.2. Social Policy Options for the Affected Economies

The sharp increase in unemployment, substantial decrease of real earnings and widening income inequality has led to disastrous social unrest in crisis-hit Asian countries. Since they have enjoyed high growth, low jobless rates, relatively equal income distribution and low crime rates for decades, this sudden social distress has been felt more painfully and impatiently. To make matters worse, most Asian countries have not yet developed meaningful social safety nets. In this section, we review existing social policy programs in the Asian economies and discuss how to contain the social costs of the crisis effectively.

Reviewing the Existing Social Protection System

As the crisis unfolded, it became manifest that the existing social welfare systems in the crisis-hit Asian countries were absolutely deficient in covering the needs of the sufferers. As Table 4. 1 shows, existing social policies and programs in Indonesia, Korea and Thailand provide protection for formal sector workers only to a very limited extent. In Indonesia, old age and disability benefits are limited to firms with more than 10 employees. In Thailand, the pension system covers only 10 percent of the labor force.
 
 

Source: US Department of Health, Education, and Welfare, Social Security Programs throughout the World 1997, August 1997, and Gupta et al.(1998).
 

Indonesia and Thailand do not have unemployment insurance systems, while Korea introduced it only recently. Korea implemented an unemployment benefit scheme in 1995 under the terms of the Employment Insurance Act adopted in 1993, but its coverage and benefits are very limited.³¹ The limited level of social protection in these Asian countries is partly a reflection of policy choices. High economic growth prior to the crisis reinforced the belief that economic growth would effectively alleviate poverty and income distribution problems. Together with a reliance on traditional private support systems through the family, this belief resulted in only limited priority being given to the development of social protection systems.

Table 4.1 also shows that Korea, compared with Indonesia and Thailand, has more developed social safety protections. Korea has public assistance programs such as livelihood protection, medical aid, veteran relief, and disaster relief. Yet even Korea’s social assistance scheme is still quite rudimentary compared with those of developed countries. The majority of employees have not yet had the opportunity to build up any unemployment benefit entitlements. Moreover, the lifetime-job tradition in Korea has meant that workers have relied on welfare programs provided by the firm, rather than relying on a social safety net supported by the government. In normal times, this company-funded welfare system as well as the traditional family-based system can be more efficient than the public social safety net. However, the problem is that they cease to function when the private sector is deeply affected by the crisis, and therefore, public support is the most needed.

Social Policies for Adjustment to the Crisis

Since the existing social programs were not able to cope adequately with the social consequences of the crisis, it is necessary for governments to implement various programs to prevent social unrest. In the short term, the two most damaging problems that arise from the crisis are increases in unemployment and inflation rates. Sudden increases in prices, especially of items mainly consumed by low-income households, hit the poor the hardest. To soften this adverse effect, it might become inevitable to subsidize some essential items such as food, energy, and public transportation.

In dealing with unemployment, there are several alternative approaches. First, some policy measures aim to minimize the extent of unemployment. For instance, workers and employers can negotiate alternatives to lay-offs and cooperate to stabilize employment through redeployment within the enterprise or wage reduction. However, these measures are effective only when the firms face a temporary liquidity crisis rather than permanent insolvency and therefore, the scope of their application is very limited.

The second approach is to create new employment. This job creation policy includes public work programs and schemes promoting self-employment. In Indonesia and Korea, governments have already started public work programs to create temporary job opportunities. (See ILO(1998) for details). They also set up financial programs to provide credits targeted at encouraging self-employment businesses. However, growing unemployment and expected large-scale lay-offs in these countries cannot be sufficiently dealt with by worker-employer voluntary negotiations or public job creation programs.

The third approach is to provide unemployment benefits and other income-support programs for the unemployed. In Indonesia and Thailand, where there exists no formal unemployment scheme, the government must first introduce minimum social safety nets.

In building the social safety nets, our findings in section III.3 have an important implication. In section III.3, we demonstrated that it is marginal workers - young, female, less experienced, and less-educated – who are most severely affected by the crisis. They are more likely to be the long-term unemployed and the people living under the poverty level. Given the reality that only limited resources are available in building up the social safety net, benefits should be directed to this small number of core groups instead of the unemployed in general. In other words, maximizing the number of people covered under the social safety net should not be the top primary concern in designing a new system. Asian countries should learn from Europe’s mistakes. Overly generous coverage of unemployment benefits can discourage displaced workers from searching for inferior jobs. Safeguarding existing jobs for regular workers can inhibit the creation of new jobs.

However, even if it is socially right and efficient, targeting the core unemployed group is politically difficult in reality. In building up the social safety net, the core group does not have a political channel to represent itself. They are usually non-union members not represented by workers’ representatives at the negotiation table. Often, policies adopted under the name of social consensus place an unfair burden on them.³² That is why we have to emphasize the government’s parental role in targeting the worst-affected core group when designing social safety nets. Several techniques can be undertaken in selecting or targeting the beneficiary groups (see UN (1998) p.141). One technique is means testing, which uses an income cut-off point to limit the eligibility of the benefits to persons whose incomes are below certain level. Geographical targeting is another technique in which programs are implemented in areas where the poor are concentrated. A third technique, known as categorical targeting, uses various characteristics of poverty, such as small landowners, joblessness, number of dependants, etc., to identify the poor. The fourth technique, self-targeting, has no direct screening of the beneficiaries but designs programs in such a way that the non-poor have no incentive to join them. For example, public work programs that make payments to the beneficiaries at a rate below the minimum wage discourage persons who might have better opportunities for employment. Thus, self-targeting seems the most efficient way to concentrate the benefit of the programs on the poor group.

Also, the new social safety net should be a very comprehensive one instead of focusing only on unemployment. It should also pay attention to improving the health, nutrition, and education status of the poorest populations. Social security and pension reform; health care policies that provide wider access to low-income groups; and education policies that provide improved labor skills will strengthen social protection. In particular, education factors - higher levels of educational attainment and more equal distribution of education among the population - can make significant contributions to the equality of income distribution (see De Gregorio and Lee (1998)). Furthermore, these social programs should give special attention to vulnerable groups such as children and women.

Another consideration in introducing new social programs is how to finance the necessary expenses. Because these programs entail additional government funds, extra revenue or the reallocation of expenditures is required. However, it is desirable that the expenses for the programs are not fully covered by the government budget. Programs that distribute benefits free of charge to the poor can lead to a moral hazard on the part of the beneficiaries, and they often fail. The programs could be more cost-effective and more sustainable if participants are at least partially charged for the benefits they receive.

So far IMF assistance in these Asian countries has mainly focused on restoring macroeconomic stability and reforming financial markets and has paid relatively little attention to social issues such as human and social protection systems development. But they are important tasks in maintaining social cohesion in the short-run and growth potential in the long run. In this regard, the cooperative and collaborative partnership between a country and international institutions such as the World Bank, ADB, and UNDP seems highly desirable. The expertise in these institutions can play a vital role as advisers and technical supporters in dealing with social issues during the crisis.

V. Concluding Remarks

The unexpected financial collapse in Asia has been followed by massive economic and social collapse. Millions of people have lost their jobs, and the problems of poverty and income inequality have been rapidly aggravated. A substantial part of the gains in living standards that have accumulated in the last decades have evaporated in one year. The lack of adequate social safety nets in the midst of the crisis has led to disastrous social consequences in these countries.

This paper analyzes the social impacts of the crisis in the most-affected Asian countries, including Indonesia, Korea, and Thailand, and tries to draw policy implications for effectively containing its social costs. The paper begins with a general overview of the cause and the evolution of the Asian crisis and highlights the differences as well as the similarities among the Asian countries. It also reviews IMF adjustment programs and analyzes their social impacts. In particular, we analyze the impacts of IMF programs on unemployment, poverty and income inequality using a cross-country data set that consists of all the countries that have received financial assistance from the IMF from 1973 to 1994.

The stylized pattern of employment growth in the previous IMF program countries indicates that employment growth takes more adjustment time compared with other macroeconomic variables. It implies that unemployment is unlikely to be alleviated in the near future in the Asian countries. Also, the paper finds that the crisis exacerbates poverty for a significant period even though it does not have a long-run effect on overall income distribution. This pattern arises because the burden of the crisis tends to be distributed unequally. The poor, less-educated, less-experienced, young and female workers are most severely affected. They are more likely to become the long-term unemployed and to remain below the poverty level even after the economy recovers from the crisis.

This fact has an important policy implication in building social safety nets in Asian countries. In view of the significant deterioration of poverty with the minimal rise in overall income inequality, welfare policy should be targeted to the core group of the poor and the hardest-hit victims instead of trying to maximize the number of beneficiaries. In particular, this core group does not belong to a union and has little political power to represent themselves. One has to be aware that oftentimes, policies adopted under the name of social consensus place an unfair burden on them.

The key features of the Asian crisis are large inflows and sudden withdrawals of foreign capital. It is therefore understandable that the call for restricting international capital flows, especially short-term capital flows, is gaining more support and sympathy. However, this paper argues that unilaterally raising a barrier to international capital flows is not the policy lesson to be learned from the Asian crisis. There is no doubt that managing erratic and volatile movements of short-term capital flows is an important policy challenge. But that goal cannot be achieved by one country’s unilateral effort. The Korean case is a good example: It is fantasy to think a small country can effectively control the extent and the speed of globalization once it opens its financial market partially or indirectly. If one country tries to restrict capital mobility unilaterally, it either has to pay a higher cost for financing or foreign capital will leave that country and flow into another country. Effective regulation of short-term capital flows is possible only through international policy coordination. Until a global financial governance system is developed, improving the domestic financial infrastructure rather than trying to control capital flows seems to be the more practical policy option.

The Asian crisis presents extraordinary policy challenges not only to the affected countries but also to their trade partners and the international community. International partnership among the affected Asian countries, advanced countries, and international institutions is essential in overcoming the current economic and social disaster, in preventing it from spreading to the world, and in ensuring stability in the global capitalist system.
 

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29. There is growing literature that focuses on the distributional effects of globalization both on industrialized and developing countries. See ILO(1996), Rodrik(1997,1998), World Bank (1995), Slaughter and Swagel(1997), Wood (1995), Robbins(1996), Williamson(1998).

30.Globalization can contribute to rising wage dispersion by widening “within industries” wage differentials among workers with different levels of skill and education, as well as by widening the “inter- industry” dispersion of wage. ILO(1996) shows that inter-sectoral wage dispersion has increased within manufacturing sectors in Indonesia and Thailand since the 1970s, though it has decreased in Korea.

31. According to current estimation, it can cover only 22% of job losers in Korea as of April 1998.
    In fact, the findings in section III.4 might be the result of this reality.

32. In fact the findings in Section III.4 might be the result of this reality.