HONG KONG (ILO News) - The social fallout from the sudden unravelling of economic fortunes in East- and South-East Asia is exceeding initial forecasts and risks dramatically worsening, according to a new report ^* , published by the International Labour Office (ILO) today.

The ILO report, entitled The Asian Financial Crisis: The challenge for social policy warns that the deepening economic and social troubles in the region are unlikely to be reversed in the near future and urges governments and policy-makers to take unprecedented emergency and long-term measures, especially establishing unemployment insurance for the mounting number of newly unemployed.

In light of the severity of the crisis, solutions will require "an unusual degree of flexibility in policy making on the part of domestic and international actors, including increased social spending, which may prove unavoidable if countries are to undertake credible efforts to reform and alleviate the worst social aspects of the crisis," said the report's author, ILO economist Eddy Lee.

"Just as the Depression in the 1930s forged a new social contract in industrialized countries in the 1930s, so must the current Asia crisis serve as an impetus to creating a more socially oriented model for development," said Mr. Lee.

Such a social contract must be founded on increased democracy and social protection, including greater respect for the right of workers to form free trade unions, are also essential ingredients to overcoming the effects of the crisis. The ILO analysis insists that "there is no basis for arguing that poor countries cannot afford to implement basic civil and political rights," including freedom of association.

The report finds that one in every five formal-sector jobs in Indonesia has been wiped out this year alone, shattering decades of progress made toward modern, industrial employment in that country, along with the lives of 4 to 5 million Indonesian workers and their families. An additional 20 per cent of the Indonesian population, approximately 40 million people, is expected to fall into poverty this year.

In the Republic of Korea, one in twenty workers lost their jobs during the nine month period from November 1997 to July 1998 and open unemployment in the country is expected to increase threefold, from 2.3 per cent to 8.2 per cent. An estimated 12 per cent of the Korean population is expected to sink below that country's poverty line this year.

In Thailand open unemployment levels are forecast to triple from 2 to 6 per cent this year, with partial information indicating a rapid acceleration in the rate of job losses in the last three months. As access to jobs and income dry up, it is estimated that 12 per cent of the Thai population will sink into poverty this year, adding significantly to the nearly 16 per cent of Thais already living in poverty.

In Hong Kong, China, unemployment rose from 2 per cent to over 5 per cent in the first three quarters of 1998, an estimated net loss of some 75,000 jobs. In Malaysia, unemployment levels are expected to double to 5.2 per cent by year's end. However, both Hong Kong and Malaysia dipped into recession only this year, indicating a relatively rapid rate of job losses in a comparatively short period of time.

But the report finds that unemployment statistics tell only part of the story, citing evidence that "the adverse impact on the labour markets of these countries has been more widespread (...) apart from open unemployment, the number of discouraged workers also seems to have increased."

In the Republic of Korea, for example, the labour force participation rate fell from 63.1 per cent to 61.5 per cent between the second quarter 1997 to 1998: "This represents a decrease in labour force participation of 1.6 million workers compared to what it would have been had the pre-crisis trend in labour force growth continued."

In Thailand, the number of people of working age shown as being "not in the labour force" increased by 600,000 in the 12 months between February 1997 and 1998. In Malaysia, the presence of a very large number of illegal foreign workers in the country may well understate the true extent of job losses. In Indonesia, where estimated unemployment figures range from 7 to 14 per cent, the low estimate assumes that approximately one-half of all displaced workers will be absorbed into the country's large informal and rural sector, a contingency that is remote in light of the widespread poverty and even hunger afflicting both town and county in Indonesia.

Near Term Outlook is Discouraging

The report says that while the region's 1998 economic performance exceeded even the most negative forecasts, prospects for an immediate bounce back are poor. The most optimistic forecasts see the beginnings of a moderate recovery in the second half of 1999, but few observers expect a return to the heady growth rates of the pre-crisis era. Full employment, one of the hallmarks of the last 30 years' Asian economic miracle, is also unlikely to return any time soon.

Even in the event of an upturn in the wake of Japanese, United States and Pacific Rim-sponsored recovery initiatives, the ILO says that Asian social model needs to adapt to the new reality: "Since high and sustained growth can clearly no longer be taken for granted, a significantly greater degree of social protection must be aimed for", Mr. Lee said.

In particular, the ILO report says that unemployment insurance schemes for affected workers are feasible, affordable and increasingly necessary as the economic agenda shifts from crisis management and stabilization to embrace far-reaching financial-sector reform and industrial restructuring. The absence of unemployment benefits "has inflicted unnecessary suffering and hardship."

Among the fore-mentioned countries, only the Republic of Korea provides laid-off workers with any unemployment benefits at all, and these are usually at a low level and of short duration.

While acknowledging that only success in the struggle to restore financial stability and international confidence will rekindle economic growth, "the ultimate basis for salving social wounds", the ILO insists that it would be "foolhardy" to ignore the lessons for social policy that have been so painfully driven home by the crisis: "A fundamental rethinking on the social dimension of economic development is as important as the purely economic and financial issues that currently occupy centre stage." Asia needs, the report says, "a new and better social contract."

Did Cronies Cause the Crisis?

According to the ILO analysis, the Gross Domestic Product of Indonesia, the worst-hit country, will decline by 15 per cent this year. Thailand will decline by 6.5 per cent and the Republic of Korea by 5 per cent. Malaysia and Hong Kong, China are expected to decline by 3-4 per cent. Japan, Singapore, the Philippines, Vietnam and China have all slipped into recession or seen growth forecasts revised sharply downwards. The ripple effect of the crisis is felt worldwide, in Russia and Latin America, as well as on the stock exchanges of the US and Europe.

The report asks how, after decades of spectacular economic performance, so many East and South-East Asian countries fell victim to an economic shock of such unprecedented scope and severity. It examines four of the most widely-touted causes of the collapse: "crony capitalism and the failure of the Asian model; the role of international capital markets; financial liberalization and fragility; and domestic policy failures."

While much post-crash analysis initially amounted to shifting of the onus of responsibility from domestic to international actors and back again, with blame being allocated to a diverse spectrum of agents, ranging from corrupt and inept government officials to predatory investors who simply panicked and fled, the ILO analysis rejects the "pat" notion that the financial collapse resulted from a "panic" on the part of international investors and heavily discounts the impact of "crony capitalism" as a primary cause.

The crisis was caused by many factors, including volatile international financial markets, weak corporate governance and domestic policy failures, but the ILO report says that the "the financial system proved itself to be the real Achilles heel of the pre-crisis Asian economies."

The "crony capitalism" explanation suggests that in spite of their open economic policies and sound macroeconomic management, Asian economies were fatefully undermined by widespread political interference in the market via corruption, sweetheart deals for relatives and cronies of the Government or through directing finance to politically connected enterprises. "These types of interference in the operation of markets are clearly likely to have contributed to the problem of excessive and misallocated investment and a consequent lowering of the rate of return on capital."

The report says that "there can be little doubt that elements of crony capitalism played a role in provoking the crisis, even though not the predominant one some have ascribed to it." The ILO analysis sees crony capitalism as just one in a long list of "inadequacies" that led to a series of domestic policy lapses, which eventually, and suddenly, coalesced in a catastrophic loss of market confidence following the Thai currency crisis of 1996. These policy lapses differed widely from country to country, but in general they fuelled the dramatic loss of investor confidence that engulfed the entire region with surprising rapidity. These inadequacies include:

• Excessive government interference in the market, especially by influencing such factors as the allocation of credit and capital and the creation of monopolies;
• Poor economic policies, notably by building up an excessive reliance on foreign borrowing, which generated excessively high levels of investment and growth and unsustainable current account imbalances;
• Shortcomings in mitigating the impact of the huge surge in capital inflows, leading to exchange rate and interest rate instability;
• Failure to ensure that financial liberalization was accompanied by a sound financial system, which led, notably, to a proliferation of over-leveraged, unhedged, short-term borrowing;
• Inadequate regulation of the banking system combined with a lack of transparency in the operations and soundness of banks.

The ILO report reserves judgement on whether originality or orthodoxy should prevail in monetary and fiscal policy, arguing only that "in situations where professional opinion is seriously divided and where there is a high degree of uncertainty, a greater than usual degree of flexibility in policy implementation would be in order."

It cites the Malaysian decision at the beginning of September to cut loose from IMF orthodoxy on high interest rates as being "of considerable interest" in the effort to halt the economic contraction which took hold of that country's economy at the beginning of the year. But the ILO says that it is still too early to tell what effect this move will have.

What is happening in Malaysia and elsewhere as "a real-world experiment with an alternative set of policies to those, which, so far, do not seem to have succeeded in stemming the crisis." In order to avoid the possible immobility of a policy stalemate, the ILO urges pragmatism and "close monitoring of the unfolding effects of current policies and a willingness to change course when warranted."

Can Prescribed Remedies Cure the Ills?

What is certain is that while the social dimensions of the Asian crisis have been receiving increased attention, "socially provided relief still falls far short of requirements."

While the emphasis has been on stabilization, there has none the less been a significant loosening of fiscal policy, "accompanied by substantial increases in expenditures on mitigating the negative social effects of the crisis", large parts of which take the form of increased foreign aid that is earmarked for social relief. In particular, large social sector loans have been granted to Indonesia and Thailand.

The ILO report says that "not all of the increased expenditure made possible by the larger fiscal deficits has gone into social relief." In Thailand, "social expenditures amount to only half of the projected fiscal deficit of 3 per cent of GDP while in the Republic of Korea the corresponding proportion is 62.5 per cent. It is only in Indonesia that an amount equal to almost 90 per cent of the increased deficit spending will be devoted to social relief."

The report examines what proportion of Asia's needy will be helped by such efforts, concluding that "only a small proportion of the unemployed can expect relief through public employment-creation schemes." In Thailand "only 7 per cent and in Indonesia (at best) only 10 per cent of the unemployed can expect to obtain a job in these schemes." In contrast, "this figure is much higher in the Republic of Korea where approximately 24 per cent of the unemployed are able to count on this form of employment."

The ILO questions whether such schemes and other forms of direct relief on offer "can properly be called social safety nets." The resources deployed thus far "provide relief to only a small fraction of those in need."

The Feasibility of Unemployment Insurance

The ILO report says that in light of current circumstances and prospects, major policy initiatives will be needed, chief among them is the establishment of a meaningful and affordable system of unemployment insurance.

According to the ILO analysis, the potentially constructive role of unemployment insurance in the current reform process is so strong that it is a "puzzle" why no country, apart from the Republic of Korea has introduced any form of employment insurance, and "it is all the more puzzling in the case of Singapore and Hong Kong, China, where per capita GDP is higher than in many OECD countries."

Part of the traditional, pre-crisis objections to unemployment benefits dismissed their utility because open unemployment was so low, a condition that clearly no longer pertains. A second objection, applying mainly to countries with large agricultural and informal sectors such as Indonesia and Thailand, maintained that these sectors could absorb retrenched workers. However the extent of both unemployment in cities and rural poverty as well as the need to modernize agriculture should "sweep away any notions about the adequacy of traditional safety nets."

A related series of objection held that the fiscal costs of unemployment insurance and its administration were too high for developing countries; that benefits risked eroding the work ethic and fomenting social pathologies so inimical to "Asian values; and that unemployment benefits would distort the free market, for example by raising labour costs and reducing the incentive for employers to invest and hire or by raising the costs of much-needed industrial restructuring.

The ILO confronts these arguments, insisting that "one of the side-benefits of an unemployment benefit system is that it facilitates the process of industrial restructuring, since the added economic security it provides reduces the resistance of workers to change."

As to the prohibitive cost, the ILO argues that "an unemployment insurance scheme is, as the name implies, typically self financing" on the basis of contributions from workers, employers or a combination of both. The question of a fiscal cost to governments need not arise "unless the government chooses to subsidize the scheme." Governments would clearly need to intervene to establish a system of benefits and that could make coverage as broad as possible and compensate for the near total absence of private insurance.

"Without state intervention, there would be inadequate provision against the contingency of unemployment; individuals do not provide enough cover on their own and, because private provision is not viable, they cannot surmount this by buying insurance." Government sponsored scheme could be self-financing, with minimal burdens on enterprises and the market.

"In practice, all the evidence points to the fact that the required contribution rate is very low, ranging from 1 to 4 per cent of payroll." Assessments made by the ILO reveal that if the Republic of Korea, Thailand and Indonesia had introduced unemployment insurance in 1991, that is, six years before the onset of the crisis, "the striking result is that an average required contribution rate of between 0.3 to 0.4 per cent of payroll from 1991 to 2000 would have been sufficient to provide all insured job losers over this period, including during the current crisis, with 12 months of benefits."

The basis point of the ILO proposal is that "at very modest levels of required contributions (...) the effects of unemployment insurance on labour costs and hence on the demand for labour would be negligible."

An imaginative response to the new social agenda need not detract attention or resources from other aspects of dealing with the Asia crisis. The ILO report insists that strengthening the financial system is of key importance and "indispensable for ensuring a return to high and stable growth in the post-crisis period."

The ILO report says that "freedom of association and the right to organize are key components of international action to promote democracy and full respect of basic human rights." It rejects the argument that there are distinct "Asian values" (which place communitarian values and social harmony above individual rights) which stand in sharp contradistinction to universally accepted civil and political rights. "There is no evidence that Asian thought and tradition have historically given less importance to civil and political freedoms." It says that the claims for the existence of distinct "Asian values" are difficult if not impossible to make given the size and diversity of cultures in the region and that the case for such values have most often been "articulated by authoritarian regimes" and do not "represent an expression of popular will."

* The Asian Financial Crisis: The challenge for social policy by Eddy Lee. International Labour Office, Geneva, 1998. ISBN 92-2-110850-3. Price: 20 Swiss francs.

Increase in Unemployment Rates (%)
	Pre-crisis	Latest
Indonesia	4.9 (Aug. '97)	15.0*
Thailand	2.2 (Feb. '97)	6.0*
Korea, Rep. of	2.3 (Oct. '97)	8.4 (Sept. '98)
Malaysia	2.6 (end '97)	5.2*
Hong Kong	2.4 (end '97)	5.0 (3 rd quarter '98)
Singapore	1.8 (end '97)	4.5 (Sept. '98)

* Estimate.
Government sources.