Economic governance in Thailand Case Study Click on the following links for further information about this case study: Teacher's Notes Student Activities Background For the ten years leading up to 1996, the Kingdom of Thailand enjoyed an annual real GDP growth rate of over 8% based on rapid industrialisation and high rates of savings. This resulted in a reduction in poverty in Thailand from 33% of the population to 11.4%. So impressive was Thailand's progress that Australian aid was to be phased out by 2001. Foreign investment in Thailand however became increasingly speculative, with much of the capital inflow being channelled into real estate and the share market rather than the manufacturing sector. The danger was that Thailand's export capacity was not being strengthened. The Thai Baht was pegged to the US dollar which started to strongly appreciate from 1995 onwards, making Thai exports less competitive in world markets, and the current account deficit started to widen. In mid 1997, in response to internal and external pressures, Thailand floated the exchange rate and the Baht steadily lost value. As the depreciation continued, concern grew about the stability of the banking system, because Thailand's weakly-regulated corporate sector (including the banking and finance sectors) had amassed very heavy foreign debts during the boom and much of this borrowing was short-term, repayable in US dollars and not 'hedged' against foreign exchange rate movements. The currency continued its downward slide, confidence was lost in the foreign exchange and capital markets, which led to a 'flight of capital' out of the country. Thailand's foreign exchange and capital markets collapsed and over half of the financial institutions became insolvent and were unable to continue ordinary business as lenders. The effect on the business sector was devastating and many businesses became insolvent and many defaulted on their debts. Consumers were confronted with rapidly rising fuel prices and interest rates. The currency crisis turned into a severe economic crisis. Thailand fell into a rapid and deep recession with the economy shrinking by almost 10% in the following year as property and other assets prices collapsed, unemployment rose and real wages declined. Poverty increased significantly. Thailand's GDP per capita over the past decade.   The crisis quickly spread to a number of key countries in East Asia as it became obvious that Indonesia and South Korea were in a similar situation to Thailand, and there was a widespread concern that the crisis would spread across the globe. At the heart of the disaster was the ability, in a global economy, to move billions of dollars from country to country at the touch of a button. In 1996, $US56 billion flowed into the booming economies of Thailand, Indonesia, South Korea, Malaysia and the Philippines but in the wake of the crisis, $US27 billion flowed out. One effect of globalisation is that countries (especially small, developing ones) are more dependent on foreign capital and therefore vulnerable to large, destabilising shifts in capital flows. This raises the issue of what role the state should play in the new global marketplace. Re-thinking the role of the state Some countries proved to be more resilient and adaptable than others to the Asian Crisis. Australia, for example, suffered little, while Thailand, South Korea and Indonesia sustained severe structural damage. Whilst debate continues over the causes of the crisis and the reasons for its uneven impact, there is no doubt that the crisis did reveal critical weaknesses in some nations' economic governance, that is, their public institutions were weak and the financial and corporate sectors were inadequately supervised. Following the financial crisis there was an international meeting on developing co-operative responses by aid agencies and governments. The participants agreed that improving governance, particularly the strengthening of institutional and financial systems, was essential to minimise the long-term effects of the crisis. What is good governance? Good, effective governance means managing a country's resources in a way that is: accountable to, and representative of, the community transparent (that is, open and predictable), and efficient and equitable in terms of the use, and distribution of, resources. Why good governance matters Substantial research by the World Bank in recent years has led to the conclusion that the state is central to economic and social development, not as a direct provider of growth but "as a partner, catalyst and facilitator"; concluding that "an effective state is vital for the provision of goods and services - and the rules and institutions - that allow markets to flourish and people to lead healthier, happier lives". (World Development Report 1997). The World Bank has undertaken this important research in an attempt to explain why and how some states do better than others at achieving sustainable economic development, thus being in a position to substantially reduce poverty and lift living standards. It has sought to explain why nations that might have similar resources and social structures have differed markedly in terms of economic development. The conclusion is that different standards of governance play a major role. Good governance reduces poverty A survey of local entrepreneurs in 69 countries by the Bank found that many states were not performing their core functions adequately: property rights were not protected, law and order could not be guaranteed and rules and policies were not being applied predictably. In the most poorly governed countries, which were characterized by endemic corruption, poor control of public funds, lack of accountability, human rights abuses and excessive military influence, foreign aid was often squandered and the situation in those countries did little to attract private investment. A major World Bank Report 'Assessing Aid: What Works, What Doesn't and Why' (1998) found that in some countries aid had been "a spectacular success" whilst in others it had been "an unmitigating disaster". Why? The report found that the state had a key role to play in ensuring that aid was used effectively and that this aid worked best in a good policy environment with sound economic management. In such an environment, 1% of GDP in assistance would translate into a 1% decline in poverty and infant mortality and a US$1 billion increase in aid could lift 25 million people out of poverty. In a weak environment, however, aid would be much less effective. It concluded that improvements in economic and financial institutions in the developing world "are the key to a quantum leap in poverty reduction". The report also found that effective aid could complement private investment: that countries with sound economic management "crowded-in" private investment by a ratio of almost $2 to every $1 of aid. The World Bank and other aid agencies now see good governance as a pre-condition for achieving sustained development. Supporting good governance Promoting effective governance in developing countries is one of the five sectoral priorities of the Australian Government's aid program. Good, effective governance requires government policies that: Encourage and efficiently manage investment and economic growth Support a fair and efficient public sector Strengthen the rule of law Protect human rights, and Foster public participation and representation in decision-making. A key to good governance lies in having strong, capable institutions and this includes government departments and agencies. Much of Australia's aid in the area of governance is aimed at improving the capacity, that is, the ability of public institutions to perform their responsibilities effectively. Assisting economic and financial reform Australia is continuing to support Thailand's economic and social recovery from the crisis. One element of Australia's response to the economic collapse in Thailand has been the Development Co-operation Program. Its main goals are set out below: The stategic direction of Australia's aid program in Thailand.   The Australian Government is assisting Thailand's ambitious program of public sector reforms that are aimed at promoting both good governance and increased competitiveness in many sectors of the economy. Over half of Thailand's financial institutions closed down during the financial crisis and the goal is to rehabilitate both the banking and corporate sectors by making them more resilient and competitive, and thus more able to withstand external shocks. The Thai Government requested Australian technical assistance to strengthen its expertise in prudential and regulatory supervision. Australia has considerable experience and expertise that it can offer to Thai institutions in order to help them improve their ability to operate more effectively. These reforms should increase business and investor confidence. The Bank of Thailand, for example, is being restructured in order to strengthen its independence, accountability and transparency. A strong, capable central bank is essential for the well-being of any economy's financial sector, and these reforms should also boost confidence. Australia is also helping to improve the quality and timeliness of national accounts statistics to assist the Thai Government better understand and monitor the progress of the Thai economy, and to improve the Government's ability to collect an equitable share of tax from the corporate sector. Other capacity-building activities in Thailand include: staff training; assistance with developing legislation, policy and strategic plans; and study visits to, and work attachments in, Australia. Governance reform is, however, a lengthy process of continuous improvement that require new skills, new attitudes and changes to organisational cultures. Australia's aid program can play an important, supportive role in nurturing reform and thus help prevent the emergence of such a crisis again. It can provide new models and ideas for change, as well as training and technical help and this type of aid is in line with current thinking and recent research, which sees the state as a facilitator and regulator. Technical assistance, such as being provided by the Australia and Thailand Development Co-operation Program, can help re-invigorate public institutions and enable governments to work more effectively with the private sector to promote sustainable growth and development.   Top © Commonwealth of Australia