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ISBN 978-92-64-03943-8 03 2008 04 1 P

Shaping Policy Reform and Peer Review in Southeast Asia INTEGRATING ECONOMIES AMID DIVERSITY The Southeast Asian region has experienced remarkable economic dynamism in the past few decades. An interesting feature of recent developments in the region, is that in spite of its diversity, several initiatives have been launched towards integration.

The peer review mechanism has been a tried and tested instrument for OECD member states to work together successfully over the past decades. This tool could benefit the Southeast Asian region as it helps identify good practices, establish standards and principles and ultimately improve the performance of participating economies.

This publication examines the possible application of peer reviews to address regional and domestic challenges in Southeast Asia. It is a useful and insightful resource for anybody interested in Southeast Asian economies, regional integration and peer review mechanisms.

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Shaping Policy Reform and Peer Review in Southeast Asia INTEGRATING ECONOMIES AMID DIVERSITY

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Shaping Policy Reformand Peer Review

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INTEGRATING ECONOMIES AMID DIVERSITY

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FOREWORD – 3

SHAPING POLICY REFORM AND PEER REVIEW IN SOUTHEAST ASIA – ISBN-978-92-64-03943-8 © OECD 2008

Foreword

The Asian economic crisis started over ten years ago. The SoutheastAsian region has witnessed not only a remarkable recovery, but also arenewed, market-driven dynamism. Interestingly, in spite of its diversity,integration of the region has been accelerating. Together with thisdynamism, an increasing degree of co-operation has emerged at the regionallevel with a strong focus on policy dialogue.

This publication is based on the discussions held at “The OECDSoutheast Asia Regional Forum: Peer Review Mechanism for PolicyReform” organised by the OECD in co-operation with the ASEANSecretariat and the Asian Development Bank, on 23-24 January 2007 inJakarta, Indonesia. OECD member countries, international organisations andregional organisations discussed their experience and shared theiraccumulated knowledge.

A central focus of the forum was on the benefits to be expected from awider use of peer reviews to promote regional integration and domesticpolicy reform and help develop a mutual understanding and common visionof the regional challenges ahead. The peer review mechanism has been ahallmark of OECD working methods for more than 40 years. It currentlycovers a wide range of policy areas and has evolved over time to takeaccount of new developments and new stakeholders, such as civil society. Ithas been a tried-and-tested instrument for OECD member countries to worktogether successfully over the past decades. In light of the forumdiscussions, we are confident that this tool may also benefit Southeast Asiancountries in achieving their regional and domestic policy objectives.

While several countries in Southeast Asia have recently strengthenedtheir links with the OECD, a greater potential exists for the development ofthe co-operation between Southeast Asia and the Organisation. Indeed, inMay 2007, the OECD Council at Ministerial level agreed that in light of thegrowing importance of Southeast Asia and its strategic importance to theOECD, priority should be given to expanding the OECD’s relations withthis region.

4 – FOREWORD


This publication has been prepared under the auspices of the Centre forCo-operation with Non-Members (CCNM) of the OECD. We hope that itwill provide a useful set of references at an important juncture in thedevelopment of the co-operation between Southeast Asia and the OECD.

Eric Burgeat, DirectorOECD Centre for Co-operation with Non-Members

ACKNOWLEDGEMENTS – 5


Acknowledgements

This book was prepared by Kensuke Tanaka, Programme Manager,Centre for Co-operation with Non-Members (CCNM), (currently at theDevelopment Centre), OECD under the overall guidance of Frédéric Langer,Counsellor, CCNM and Eric Burgeat, Director, CCNM who provided manyuseful suggestions and advice.

Many of the chapters in this study are based on the contribution ofauthors who participated at OECD-Southeast Asia Regional Forum inJakarta in 2007. We are most grateful to H.E. Boediono,H.E. Arizal Effendi, H.E. Ong Keng Yong, Kiyo Akasaka, Mochamad S.Hidayat, Worapot Manupipatpong, Masahiro Kawai (Chapter 1), CindyHouser (Chapter 1), Geoffrey Woodhead (Chapter 2), Moreno Bertoldi(Chapter 3), Blair Comley (Chapter 4), Dominique Bocquet (Chapter 5),Niels Thygesen (Chapter 6), Kiichiro Fukasaku (Chapter 7), MohamadIkhsan (Chapter 8), Gil Beltran (Chapter 9), Porametee Vimolsiri(Chapter 10), Dac Thanh Nguyen (Chapter 11), H.E. Patrick Van Haute(Chapter 12), Ryokichi Hirono (Chapter 13), H.E. Tae-Shin Kwon(Chapter 14), Nicola Bonucci (Annex A) and Val Koromzay (Annex B) fortheir useful contributions to this publication. Akira Takahashi made usefulcomments on several chapters.

This publication would not have been provided without the continuousco-operation of the OECD delegations and embassies of ASEAN countriesin Paris, especially Brendan Berne, Cathy Buggenhout, Teiji Hayashi,Taeho Lee, Jean-Jacques Herve, Philip-Xenophon Pierros, SharrinaAbdullah, Phisek Panupat, Rosalita Prospero, Saifudin Hamjuri Samsuri,Adlan Mohd Shaffieq and Nguyen Houng Tra.

We also would like to thank the Indonesian government for hosting theconference and the ASEAN, ADB, ADBI and APEC Secretariats for theiractive co-operation, especially Devi Purwanti, Azmi Mat Akhir andSundram Pushpanathan.

Voluntary contributions from Belgian, Japanese and Koreangovernments for the regional forum and for this publication are alsogratefully acknowledged.

TABLE OF CONTENTS – 7


Table of Contents

Note by the Editor ............................................................................................... 13

List of Abbreviations .......................................................................................... 14

Executive Summary ............................................................................................ 17

Overview. Economic Integration amid Diversity and Peer Reviews in Southeast Asia – Where Do We Stand? ....................................... 21

O.1. Introduction ............................................................................................. 21O.2. Southeast Asia – dynamism and integration ........................................... 22O.3. Economic diversity in Southeast Asia ..................................................... 43O.4. Peer review process: tool for regional co-operation in Southeast Asia ... 52O.5. Conclusion ............................................................................................... 55

Part I. How Can Peer Reviews be Used to Address Regional Challenges? ........................................................................... 63

Chapter 1. Evolving ASEAN+3 ERPD: Towards Peer Reviews or Due Diligence? .............................................................................. 65

1.1. Introduction: regional financial co-operation in East Asia ....................... 651.2. ASEAN+3 finance ministers’ process ...................................................... 671.3. ASEAN+3 Economic Review and Policy Dialogue (ERPD) ................... 741.4. Possible modalities of ERPD: information sharing, peer reviews

and due diligence ...................................................................................... 771.5. The role of private sector assessments ..................................................... 801.6. Enhancing the effectiveness of ASEAN+3 ERPD ................................... 881.7. Conclusion: challenges ahead .................................................................. 92

Chapter 2. The Role of Peer Reviews in APEC ............................................... 99

2.1. Introduction .............................................................................................. 992.2. APEC – membership and Bogor Declaration ........................................... 992.3. IAP peer review ...................................................................................... 1012.4. Conclusion: reflections on the peer review process in APEC ................ 102

Annex 2.A1. Issues Checklist ........................................................................ 104

8 – TABLE OF CONTENTS


Chapter 3. Peer Review, Peer Support and Peer Pressure: The European Union Experience .................................................. 109

3.1. Introduction ............................................................................................ 1093.2. The European Employment Strategy ..................................................... 1103.3. The Study on the Impact of Ageing on Public Expenditure ................... 1113.4. The Lisbon Agenda ................................................................................ 1123.5. The Stability and Growth Pact ............................................................... 1133.6. Conclusions ............................................................................................ 115

Chapter 4. Peer Review in the Context of Regional Integration in Southeast Asia ........................................................................... 117

4.1. Introduction ............................................................................................ 1174.2. Three aspects of peer review .................................................................. 1184.3. Conditions under which peer review works well ................................... 1244.4. Peer review in the context of regional integration .................................. 1244.5. Conclusion.............................................................................................. 126

Chapter 5. Peer Review: A Tool for International Co-operation that Respects Sovereignty and Diversity ..................................... 129

5.1. Introduction ............................................................................................ 1295.2. Co-operation and multilateral surveillance: new trends and

methodological options .......................................................................... 1295.3. Dialogue and peer review: how to make them work .............................. 1325.4. OECD’s experience “from an Asian perspective” ................................. 132

Chapter 6. Comparative Aspects of Peer Reviews: OECD, IMF and the European Union ................................................................ 135

6.1. Introduction ............................................................................................ 1356.2. The evolution of the OECD peer review process ................................... 1366.3. Three frameworks for peer reviews........................................................ 1396.4. Conclusion.............................................................................................. 144

Chapter 7. Integrating Newer ASEAN Members and Peer Review ............ 149

7.1. Integrating newer ASEAN members: what are the challenges? ............. 1497.2. What role for trade-related assistance in promoting integration? ........... 1527.3. Trade-related assistance to Southeast Asia ............................................ 1547.4. Peer review as an instrument to improve aid effectiveness .................... 1577.5. Conclusions ............................................................................................ 165



Part II. Economic Diversity and Policy Challenges in Southeast Asia ....... 175

Chapter 8. Economic Reform under a Democratic Transition Regime and Peer Review in Indonesia ......................................... 177

8.1. Introduction ............................................................................................ 1778.2. Current policy reforms and challenges facing Indonesia ....................... 1818.3. Peer review mechanism: Indonesia and ASEAN ................................... 193

Chapter 9. Policy Issues and Peer Reviews in the Philippines ..................... 199

9.1. Introduction ............................................................................................ 1999.2. Overview of recent economic developments and policy initiatives ....... 1999.3. Current policy challenges ....................................................................... 2049.4. Rationale for ASEAN peer review ......................................................... 2079.5. Assessment of ASEAN peer review ....................................................... 2089.6. The future of peer review ....................................................................... 208

Chapter 10. Thailand’s Economic and Social Development Agenda under the Interim Government and View on Peer Review Mechanism .............................................................. 211

10.1. Introduction .......................................................................................... 21110.2. Economic situation in 2006 and outlook in 2007 ................................. 21110.3. Current economic and social development agenda .............................. 21310.4. Views on the peer review mechanism: Thailand and ASEAN ............. 218

Chapter 11. The Political Economy of Policy Reforms and Peer Review Mechanism: Viet Nam’s Experience .................... 221

11.1. Introduction .......................................................................................... 22111.2. The failure of the centrally planned experiment ................................... 22311.3. Fence-breaking activities ...................................................................... 22411.4. Changes initiated .................................................................................. 22511.5. The economic crisis of 1986-88 ........................................................... 22611.6. The 1989-90 programme to stabilise and liberalise the economy ........ 22711.7. Incomplete transformation: politics-as-usual reforms? ........................ 22811.8. Viet Nam’s experience of the peer review mechanism in

policy reform ........................................................................................ 230



Part III. Experiences of OECD Countries .................................................... 235

Chapter 12. Belgium’s Experience of OECD Peer Reviews ......................... 237

12.1. Introduction .......................................................................................... 23712.2. The 2007 Economic Survey of Belgium step by step .......................... 23812.3. Advantages of the peer review process ................................................ 240

Chapter 13. Japan’s Experience of OECD Peer Reviews ............................. 243

13.1. A history of OECD peer reviews in Japan ........................................... 24313.2. The OECD peer review mechanism in Japan ....................................... 24413.3. The principal findings of some OECD peer reviews of Japan ............. 24413.4. Impacts of OECD peer reviews in Japan .............................................. 24613.5. Japanese domestic benefits of the OECD peer review ......................... 24713.6. How could the OECD peer review process be improved? ................... 24813.7. Some lessons from the OECD peer review mechanism

for non-member economies .................................................................. 249

Chapter 14. Korea’s Experience of OECD Peer Reviews ............................ 251

14.1. Introduction .......................................................................................... 25114.2. What is a peer review? ......................................................................... 25214.3. Korea’s Economic Survey .................................................................... 25214.4. Policy improvements after joining the OECD...................................... 25514.5. Participation in the peer review process as a non-member .................. 25614.6. Conclusion............................................................................................ 257

Annex A. The OECD Peer Review Mechanism: Concept and Function ... 261

A.1. Introduction ........................................................................................... 261A.2. The concept of peer review ................................................................... 261A.3. A related concept: peer pressure............................................................ 263A.4. Peer review in international organisations............................................. 264A.5. Peer review within the OECD ............................................................... 264A.6. The functions of peer review ................................................................. 271A.7. Conclusion: when can peer review and peer pressure be effective?...... 273

Annex B. Peer Review: Example of Economic and Development Review Committee ......................................................................... 278

B.1. Introduction ........................................................................................... 278B.2. Planning of Surveys ............................................................................... 279B.3. Documentation and preparation for the examination ............................ 279B.4. The examination itself ........................................................................... 281B.5. Approval and publication of the Survey ................................................ 282



Boxes

Box O.1. Multi-facetedness of measuring regional integration ................................. 26Box O.2. Money or trade – which comes first? Sequencing of regional

integration .................................................................................................. 42Box O.3. Converging or diverging in ASEAN? ........................................................ 48Box O.4. Why is income inequality persistent? – Some theoretical arguments ........ 51Box O. 5. What can OECD peer review offer? ......................................................... 54Box 7.1. The evolution of trade for aid ................................................................... 153Box 10.1. The Philosophy of Sufficiency Economy ............................................... 214

Tables

Table O.1. Major steps towards ASEAN regional integration .................................. 28Table O.2. Major steps towards EU integration ........................................................ 40Table 1.1. ASEAN+3 finance minister meetings ...................................................... 68Table 1.2. Progress on BSAs under the Chiang Mai Initiative .................................. 70Table 1.3. Regional forums for finance ministries and central banks ....................... 72Table 1.4. ASEAN+3 Research Group activities ...................................................... 74Table 1.5. Current sovereign risk ratings on long-term external debt ....................... 81Table 1.6. Standard & Poor’s sovereign ratings methodology profile ...................... 85Table 1.7. Linkage between CMI and ERPD ............................................................ 89Table 7.1.Trade-related assistance to Southeast Asia by country ........................... 155Table 7.2.Trade-related assistance to Southeast Asia by major category ................ 156Table 7.3.Bilateral and multilateral donors of trade-related assistance

to Southeast Asia ..................................................................................... 157Table 8.1.Indonesia: sources of growth, 1960-2003 ............................................... 180Table 8.2.Micro reform and political landscape ...................................................... 186Table 9.1. Broad-based growth ............................................................................... 200Table 9.2.Exports and consumer spending .............................................................. 201Table 11.1. Growth rate by sector during the second and third five-year

development plans ............................................................................... 223Table 11.2. Major economic indicators during 1986–89 ......................................... 226Table 11.3. Rewards of the reform package ............................................................ 228



Figures

Figure O.1. Economic scale comparison among ASEAN, EU, MERCOSUR and NAFTA ............................................................................................ 23

Figure O.2. Share of intra-regional trade ................................................................... 25Figure O.3. Share of total portfolio investment inflows into ASEAN 2002-2005 .... 27Figure O.4. Progress in tariffs reduction ................................................................... 30Figure O.5. Foreign reserves in selected ASEAN countries ..................................... 34Figure O.6. FDI indicators in ASEAN in 1980-2005 ................................................ 37Figure O.7. Economic diversity in ASEAN .............................................................. 45Figure O.8. Gini index of income inequality in ASEAN countries ........................... 50Figure 1.1. EMBI global sovereign spread vs. credit rating (Indonesia) ................... 82Figure 1.2. EMBI global sovereign spread vs. credit rating (Malaysia) .................... 83Figure 1.3. EMBI global sovereign spread vs. credit rating (Philippines) ................ 83Figure 1.4. EMBI global sovereign spread vs. credit rating (Thailand) .................... 84Figure 8.1. Indonesia’s per capita GDP ................................................................... 178Figure 8.2. Indonesia’s public debt and external debt ratios ................................... 178Figure 8.3. Labour productivity by sector ............................................................... 180Figure 8.4. Percentage of firms considering constraints to be

“moderate”, “severe” or “very severe” in Indonesia ............................. 181Figure 8.5. The rationale of institutional reform ..................................................... 183Figure 8.6. Fiscal policy trilemma ........................................................................... 187Figure 9.1. The Philippines’ growth momentum continues .................................... 200Figure 9.2. Export growth driven by services, electronics, machinery,

and garments, 2004-06 ......................................................................... 202Figure 9.3. Worker remittances jump 19%.............................................................. 202Figure 9.4. Net flows of foreign investment into the Philippines ............................ 203Figure 9.5. Gross international reserves (GIR)........................................................ 204

NOTE BY THE EDITOR – 13


Note by the Editor

The Southeast Asian region is one of the most dynamic areas in theworld; it is also one of the most diverse. This diversity is manifest innumerous ways, including levels of economic development, economicregimes and income levels. Despite this diversity, integration within theregion has also strengthened over recent years.

The issues of integration and diversity appear and reappear throughoutthis publication. The first part of the publication examines how these issuesare tackled in a regional context, based on experiences of the AsianDevelopment Bank, Asia-Pacific Economic Co-operation (APEC) and theEuropean Union (EU), while the second part of the publication illustratesregional diversity, looking at the different policy challenges facingIndonesia, Philippines, Thailand and Viet Nam. Country experiences ofBelgium, Japan and Korea in the third part give examples of how peerreviews are used at the country level.

The peer review – the assessment of the policies and performances of acountry by other countries – is a flexible tool for policy dialogue. As shownin its application in the OECD and other organisations, it can be tailored todifferent situations and objectives. Although the application of the peerreview mechanism in the Southeast Asian region is in its early stages, thebest way to adapt it to the specific needs and circumstances of the regionshould be explored. With the changing landscape of the global economy, inparticular since the late 1990s, Southeast Asian countries are now facing thechallenges of how to remain competitive, move up the value chain andattract investors.

This publication is an initial attempt to discuss the possible applicationof the peer review mechanism to address regional and domestic challengesin Southeast Asia. We believe that this has a strong potential to assist policymakers in Southeast Asia in addressing these challenges.

14 – LIST OF ABBREVIATIONS


List of Abbreviations

ABAC APEC Business Advisory CouncilABF Asian Bond FundABMI Asian Bond Market InitiativeADB Asian Development BankADBI Asian Development Bank InstituteAFAS ASEAN Framework Agreement on ServicesAFTA ASEAN Free Trade AreaAICO ASEAN Industrial Co-operationAPEC Asia-Pacific Economic Co-operationAPRM African Peer Review MechanismASEAN Association of Southeast Asian NationsASEM Asia-Europe MeetingASEAN+3 ASEAN+ China, Japan and KoreaASEAN+6 ASEAN+ Australia, China, India, Japan, Korea and

New ZealandASEAN-6 Brunei Darussalam, Indonesia, Malaysia, Philippines,

Singapore and ThailandBI Bank of IndonesiaBIAC Business and Industry Advisory CommitteeBIMP-EAGA Brunei Darussalam-Indonesia-Malaysia-Philippines East

ASEAN Growth TriangleBIS Bank of International SettlementsBOT Bank of ThailandBSAs Bilateral Swap ArrangementsBSP Central Bank of the Philippines (Bangko Sentral ng Pilipinas)BPS Statistics Indonesia (Badan Pusat Statistik)CEPT Common Effective Preferential TariffCGI Consultative Group for IndonesiaCLMV Cambodia, Lao PDR, Myanmar and Viet NamCMEA Council for Mutual Economic Assistance (Viet Nam)CMI Chiang Mai InitiativeEAS East Asia SummitEC European CommissionECB European Central Bank

LIST OF ABBREVIATIONS – 15


ECSS Executive Committee in Special Session (OECD)EDRC Economic Development and Review Committee (OECD)EMBI Emerging Markets Bond Index (JP Morgan)EMEAP Executive Meeting of Asia-Pacific Central BanksEMS European Monetary SystemEMU Economic and Monetary UnionEPA Economic Partnership AgreementERPD Economic Review and Policy DialogueESAC Economic and Social Advisory CouncilFDI Foreign Direct InvestmentFTA Free Trade AgreementGATT General Agreement on Tariffs and TradeGDDS General Data Dissemination Standards (IMF)IAI Initiative for ASEAN IntegrationIAP Individual Action PlanICT Information and Communication TechnologyIFC International Finance CorporationIMF International Monetary FundIMS-GT Indonesia-Malaysia-Singapore Growth TriangleIMT-GT Indonesia-Malaysia-Thailand Growth TriangleIOSCO International Organisation of Securities CommissionsKKP Economic Co-ordination Minister Office (Kementerian

Koordinator Perekonomian) (Indonesia)LPEM Institute for Economic and Social Research Faculty of

Economics University of Indonesia (Lembaga PenyelidikanEkonomi dan Masyaraka Fakultas Ekonom UniversitasIndonesia)

MCM Ministerial Council Meeting (OECD)MERCOSUR Southern Common Market (Mercado Comun del Cono Sur)MFN Most Favoured NationMNEs Multinational EnterprisesMPDF Mekong Private Sector Development FacilityMRAs Mutual Recognition AgreementsNAFTA North American Free Trade AgreementNEDA National Economic and Development Authority (Philippines)NEPAD New Partnership for Africa’s DevelopmentNESDB National Economic and Social Development Board (Thailand)NPLs Non-Performing LoansNSCB National Statistical Coordination Board (Philippines)NTMs Non-Tariff MeasuresOEEC Organisation for European Economic Co-operationOMC Open Method of CoordinationPSD Private Sector Development

16 – LIST OF ABBREVIATIONS


R&D Research and DevelopmentSCCP Sub-Committee on Customs Procedures (APEC)SDDS Special Data Dissemination Standard (IMF)SEACEN South East Asian Central BanksSEANZA South East Asia, New Zealand and AustraliaSEDP Socio-Economic Development Plan (Viet Nam)SET Stock Exchange of ThailandSEZ Special Economic ZoneSGP Stability and Growth PactSMEs Small and Medium-Sized EnterprisesSOEs State Owned EnterprisesTCB Trade Capacity BuildingUNCTAD United Nations Conference on Trade and DevelopmentUR Uruguay RoundVAT Value-Added TaxVAP Vientiane Action ProgrammeWTO World Trade Organization

EXECUTIVE SUMMARY – 17


Executive Summary

The Southeast Asian region has experienced remarkable economicdynamism. Economic growth has been robust and trade and investmentflows have been soaring as a result of increasing international division oflabour. Southeast Asia, in addition to being one of the most dynamic regionsof the world, is also one of the most diverse. This diversity is manifest in itslevels of economic development and income, economic regimes and policychallenges. Despite this diversity, several initiatives have been launchedtowards integration in the region.

The nature of policy challenges differs across regional, sub-regionaland country levels. At the regional level, the goal is to achieve “a singlemarket and production base” by 2015. To attain this goal, the Association ofSoutheast Asian Nations (ASEAN) is implementing a series of economicintegration measures laid down in the Bali Concord II in 2003. Majorchallenges ahead include how to attain more competitive and attractivemarkets by further strengthening integration, removing cross-borderrestrictions, for instance in trade, investment and finance, and creating afavourable economic environment/institutional framework in differentfields. At the sub-regional level, attempts to stimulate regional developmentby neighbouring countries in the form of “sub-regional economic growthareas” have intensified since the 1990s. Many of these designatedsub-regions need to accelerate the development and the major challengesinclude spurring growth jointly by neighbouring countries. At the countrylevel, the nature of policy challenges also varies among countries. Somemarket economies are opening up even further, while other economies havejust embarked on the path to a market economy.

The peer review mechanism is a tool for regional policy dialogue; itsnon-binding and soft law nature can be an appropriate tool forco-operation in Southeast Asia. The European Union (EU) peer reviewprocess illustrates how relevant peer review can be in a regional context. Inthe European experience, peer review, peer support and peer pressure arekey instruments in the governance framework of a regional economic union,even though these instruments are put to work in different ways in differentcontexts. Moreover, peer review is not a new concept for Asian countries.

18 – EXECUTIVE SUMMARY


Indeed, since the Asian crisis in 1997, peer reviews have beeninstitutionalised as the ASEAN Surveillance Process, although they are stillat an early stage of elaboration.

Different organisations conduct peer reviews in different ways.Asia-Pacific Economic Co-operation’s (APEC’s) individual action plan(IAP) peer review process has proved to be an effective tool to facilitatelearning from each other’s experiences, enhance policy-relevant interactionand encourage participants to progress towards the goals of free and opentrade and investment. In response to the Asian crisis, ASEAN+3 haveadopted the economic review and policy dialogue (ERPD) process as part oftheir efforts towards regional financial co-operation. They have recentlydecided to integrate the ERPD with the regional liquidity support facility,the Chiang Mai Initiative.

The OECD peer review process has several distinct characteristics. TheOECD’s useful role lies in bringing together the independent analyticalcapacities of the secretariat and the policy experience of nationalgovernment officials. As the country examples of Belgium, Japan and Koreademonstrate, the secretariat helps identify the specific issues on which tofocus the review and ensures the quality of the methodological instruments.Peer reviews are implemented in a number of ways within the OECD. Thereis no standardised peer review mechanism as such, but all peer reviewsshare certain structural elements: a commitment to transparency andinformation sharing; an agreed set of principles, standards and criteriaagainst which performance will be reviewed; designated actors to carry outthe review; and a set of procedures leading to the final result. It has beenobserved that where regional integration projects involve deepening legaland economic commitments, it is important to disentangle sanction regimesfrom peer review to ensure that the free disclosure of information isincentive compatible.

Given their flexible nature, peer reviews can be tailored to addressthe regional challenges in Southeast Asia. Peer reviews are a flexible toolin terms of the policy areas and countries to be covered. In the OECD,different methods are used for different policy areas. Peer reviews canconsist not only of country-by-country examinations but can also covercross-country thematic issues or broader issues of regional co-operation.Several Southeast Asian countries identified the importance of the peerreview mechanism and made suggestions as to how this tool could betailored to the region’s need. The information exchange aspect of peerreviews has been recognised as a potentially useful tool for the region as itmay help to bridge the information gap in policy making. Peer reviews canalso be helpful in co-ordinating policies in order to jointly address regionalchallenges. They could also work as an early warning system and provide

EXECUTIVE SUMMARY – 19


input to the government regarding policy reforms. Involvement of regionalorganisations will be helpful in adapting peer reviews to different purposes.

The application of the peer review mechanism to Southeast Asia is stillin its infancy. This publication provides useful suggestions to policy makersin Southeast Asia on how the peer review mechanism could be applied toaddress regional and domestic policy challenges.

OVERVIEW: ECONOMIC INTEGRATION AMID DIVERSITY AND PEER REVIEWS IN SOUTHEAST ASIA – WHERE DO WE STAND? – 21


Overview. Economic Integration amid Diversity and PeerReviews in Southeast Asia – Where Do We Stand?*

O.1. Introduction

The Southeast Asian region has experienced remarkable economicdynamism. While this strong growth path, often characterised as an“economic miracle”, was interrupted by the Asian crisis of 1997, ten yearslater several indicators show signs of a sound recovery. Although the falloutfrom the crisis has not been fully eliminated, economic growth has beenrobust and trade and investment flows have been escalating due toincreasing international division of labour. Southeast Asia has madesignificant progress in integrating into the global economy; at the same timeintegration within the region has also strengthened. An examination ofrecent developments in the region shows that despite regional diversity,several initiatives have been launched towards integration.

The purpose of the present chapter is to provide an overview of the keyissues in the Southeast Asian region based on recent economic debates,focusing on the two issues of diversity and integration – these issues willreappear throughout the publication. It will also discuss the major challenges

* This chapter was written by Kensuke Tanaka, Programme Manger, Centrefor Co-operation with Non-Members, OECD (currently Project Manager,Development Centre, OECD).

The author thanks Akira Takahashi for his useful suggestions and co-operation on an earlier draft. The author also thanks Moreno Bertoldi,Luiz De Mello, Kiichiro Fukasaku, Frederic Langer, Margit Molnar,Charles Pigott, Ahmad Syaukat and Masahiko Tsutsumi for their usefulcomments. The author is grateful for suggestions offered by participants ofthe OECD Southeast Asia Regional Forum held in Jakarta in 2007 and theOECD-ADB joint seminar “Emerging Asian Regionalism” held in Paris in2007.

22 – OVERVIEW: ECONOMIC INTEGRATION AMID DIVERSITY AND PEER REVIEWS IN SOUTHEAST ASIA – WHERE DO WE STAND?


in the process of integration as well as how peer reviews can contribute toaddressing these challenges.

The remainder of this chapter is organised as follows: the next sessionlooks at some features of the recent dynamism and integration in the region;the following section provides an insight into regional disparities bothamong and within Association of Southeast Asian Nations (ASEAN)countries mainly from the viewpoint of income inequality; the penultimatesection examines how peer review mechanism can contribute to addressingregional challenges using the examples of the OECD, Asian DevelopmentBank (ADB), Asia-Pacific Economic Co-operation (APEC) and EuropeanUnion (EU). The final section summarises the major issues of this chapter.

O.2. Southeast Asia – dynamism and integration1

Coupling a market-driven mechanism with an institutionalframework

Southeast Asia is one of the most dynamic regions in the world. It isexperiencing deepening intra-regional integration as it further strengthens itsintegration into the global economy. Compared with other regions, itspresent gross domestic product (GDP) level and trade flows may berelatively small (Figure O.1), but it has a high real GDP growth and largepopulation, indicative of the region’s strong potential.

The integration of international goods and services markets hassignificantly advanced from the second half of the 1980s and SoutheastAsian countries have been fully reaping the benefits of globalisation. Sincethe late 1990s, official initiatives to strengthen this market-driven integrationwithin the ASEAN and with neighbouring countries have intensified.Recently, several new initiatives have reinforced this market-drivenintegration, embarking the region on a distinct path towards integration. Thebest blend of institution building is now under consideration, as evident bythe important recent initiative to move toward a single economy via thecreation of an ASEAN charter.

This section provides an overview of the main features of themarket-driven integration in the 1980s-1990s and recent official initiativessince the 1990s.



Figure O.1. Economic scale comparison among ASEAN, EU, MERCOSUR and NAFTA

Note: ASEAN real gross domestic product (GDP) growth figures exclude Myanmar. EU 25 real GDPgrowth figures include the Czech Republic, Lithuania and Poland from 1990.

Source: GDP: World Economic Outlook, International Monetary Fund (IMF). Trade: World TradeOrganization (WTO). Real GDP growth: World Development Indicators, World Bank. Population:World Economic Outlook, IMF.

Sources of dynamism and market-driven integration. Industrialdevelopment and its effect on strengthening production networks has beenthe main driver of economic dynamism and integration in the region. Sincethe second half of the 1980s, integration of national economies into

b. Trade volume in 2006 (in billion USD)

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

EU 25 NAFTA ASEAN MERCOSUR

d. Population in 2006 (in million)

0

100

200

300

400

500

600

ASEAN EU 25 NAFTA MERCOSUR

c. Real GDP growth (in %)

0

1

2

3

4

5

6

7

8

1987-1992 1993-1998 1999-2004

ASEAN EU 25MERCOSUR NAFTA

a. GDP in 2006 (in billion USD, PPP)

2000

4000

6000

8000

10000

12000

14000

16000

NAFTA EU 25 MERCOSUR ASEAN



expanding international markets in both goods and services has increased.Underlying this globalisation phenomenon is the formation of internationalproduction networks across national boundaries in which multinationalenterprises play a key role in adding value to different segments of theproduction process spanning across countries. Southeast Asian countrieshave become organic parts of global production networks through verticalintra-industry division of labour and trade in parts, components andsemi-finished goods. Several Southeast Asian countries have been amongthe most favourable destinations for industrial location among developingregions and have therefore been able to benefit from considerable businessopportunities arising from ever-increasing fragmentation of the productionprocess.2

Market integration in trade, investment and finance. Industrialnetwork building has generated strong trade and investment flows. SoutheastAsian countries are becoming ever more interdependent due to soaringregional trade. Although intra-ASEAN trade is still a small fraction of worldtrade (1.5% in 2006 as shown in Figure O.2a), this share has almost doubledin the past 15 years. ASEAN’s trade interdependence has been largelydriven by integration of these economies into global production networks.The ASEAN+3 (China, Japan and Korea) group’s share has also beenrapidly increasing, reaching 5.8% in 2006. Although intra-ASEAN trademay represent a small fraction of world trade, it constitutes a quarter of theregion’s total trade, with the share of ASEAN+3 region trade hovering atover 29%, reflecting strong interdependence (Figure O.2b). The pace ofintegration through foreign direct investment (FDI) in the region has beensomewhat more modest than that of trade. According to Urata (2006),although the share of intra-ASEAN FDI has increased by over 50% as ashare of global FDI over 1980-1994, relative to FDI in the entire region ithas risen to a lesser extent. An interesting feature of the integration ofSoutheast Asian countries is the strong trade-investment nexus or mutualreinforcement between trade and FDI (Urata, 2001; Kawai and Urata, 2004).Financial integration has been progressing at a relatively slow pace, laggingbehind interdependence in trade and investment. The literature on measuringfinancial integration (see Box O.1) unequivocally rejected the interest paritycondition among some of ASEAN members.3 Intra-regional portfolioinvestment flows have been steadily increasing, but their share in totalinflows has only increased slightly over the past few years (Figure O.3).



Figure O.2. Share of intra-regional trade

Percentage

0

1

2

3

4

5

6

7

1980 1985 1990 1995 2000 2005 2006

a. In world trade

ASEAN ASEAN+3

0

5

10

15

20

25

30

35

1980 1985 1990 1995 2000 2005 2006

b. In total trade

ASEAN ASEAN +3

Note: Panel a shows the shares of ASEAN-10’s and the ASEAN+3 region’s trade as a percentage ofworld trade, while Panel b shows the percentage of their total trade.

Source: Author’s calculation from Direction of Trade Statistics, IMF.



Box O.1. Multi-facetedness of measuring regional integration

Measuring regional integration is not straightforward. Although there are several ways tomeasure regional interdependence, in general they can be grouped into two approaches.1 Thefirst considers the outcome of economic activity, which can be measured either by(i) quantity2– for example the volume of trade or capital flows, etc. within a region or(ii) price – for example the degree to which the law of one price and the interest paritycondition hold in equilibrium. The other approach is based on regulatory and institutionalmeasures that may hinder interdependence, i.e. barriers to movement of goods, services,capital, people, etc. across national boundaries (for example, legal restrictions on capitalaccounts and tariff barriers). The latter are more difficult to measure but are probably betterindicators since similar economic conditions may lead to “apparent “ integration even whenbarriers to trade and investment are quite high.

The approach selected depends on the purpose and the area. Roughly speaking,quantity-based measures are widely used to measure interdependence in product, labour andfinancial markets, while price-based measures are mainly used to analyse financial linkages.Some areas use more specific approaches. Broader categories may comprise several levels ofsub-categories and the results of any analysis may well depend on the choice of method. Inturn, the choice of method is largely determined by the availability of data.

As pointed out by De Brower (1999), in the case of international financial integration, theextent to which domestic financial integration has occurred is crucial. This can be measured bythe integration of domestic deposit and loan interest rates with domestic money market rates.The extent of such integration is related to the regulatory and competitive structure of domesticfinancial markets. Given that financial markets of ASEAN countries are at different stages ofdevelopment, intra-regional integration needs to be assessed with care.

Notes:

1. There are many other classifications of the methods for measuring regional interdependence. Inparticular, on measuring financial/monetary linkages, see Rajan (2005).

2. The quantity-based measurement further includes the savings-investment correlation and consumptioncorrelations, etc.



Figure O.3. Share of total portfolio investment inflows into ASEAN 2002-2005Percentage

Note: ASEAN includes Indonesia, Malaysia, Philippines, Singapore and Thailand.

Source: CPIS, IMF.

From market-driven integration to the creation of institutionalframeworks

Toward a single market. Regional integration in Southeast Asia hasbeen strengthening both within ASEAN and in co-operation withneighbouring countries under different guises such as ASEAN, ASEAN+3and ASEAN+ 6 (Australia, China, India, Japan, Korea and New Zealand).ASEAN, one of the major engines of regional integration in Southeast Asia,was created in 1967, originally as a rather political entity. During the past40 years, ASEAN has experienced ups and downs in economic cycles andpolitical changes (e.g. end of the Cold War in 1980s) while doubling thenumber of its member countries. For a long time, economic co-operationamong members was relatively limited and attempts in the 1970s-1980s tostrengthen economic co-operation were in general not very successful.4

Starting in the 1990s, owing to accelerating industrial development andthe strengthening of production networks, the market-driven economicintegration among ASEAN members was reinforced through officialinitiatives such as the ASEAN Free Trade Area (AFTA) in 1992 using theCommon Effective Preferential Tariff (CEPT) scheme, the ASEANFramework Agreement on Services (AFAS) in 1995 and the ASEANIndustrial Co-operation (AICO) in 1996 (see Table O.1). In addition,ASEAN as a group is engaged in bilateral FTA negotiations withneighbouring countries, which may help institutionalise the de factointegration.

0

5

10

15

20

25

30

2002 2003 2004 2005

Intra-ASEAN China+Japan+Korea



Table O.1. Major steps towards ASEAN regional integration

Year Event Key agreements and decisions1967 Ministerial Meeting ASEAN established (Bangkok Declaration)

1976 1st Summit ASEAN secretariat established

1977 2nd Summit ASEAN Preferential Trading Arrangements (PTA)1992 4th Summit ASEAN Free Trade Area (AFTA) adopted using CEPT scheme1995 5th Summit ASEAN Framework Agreement on Services (AFAS)

1996 28th AEM Meeting ASEAN Industrial Co-operation (AICO)

1997 2nd Informal Summit ASEAN Vision 2020 presented1998 30th AEM Meeting

6th Summit6th Summit

ASEAN Investment Area (AIA)Hanoi Plan of Action (HPA)ASEAN Framework Agreement on Mutual Recognition Arrangement (MRAs)

1999 3rd Informal Summit e-ASEAN Framework Agreement2000 4th Informal Summit Initiative for ASEAN Integration (IAI)2003 9th Summit Declaration of ASEAN Concord II (Bali Concord II)2004 10th Summit Vientiane Action Programme (VAP)2005 11th Summit Declaration on the Establishment of the ASEAN Charter (Kuala Lumpur

Declaration)2006 38th AEM Meeting* Agreement to bring forward the goal of ASEAN Economic Community to 2015

from 20202007 12th Summit Agreement to bring forward the goal of ASEAN Socio-Cultural Community

and Security Community to 2015 from 2020

Note: AEM meeting stands for ASEAN Economic Ministers Meeting.

Source: Author’s compilation from ASEAN secretariat materials.

In accordance with deepening economic integration in the 1990s, theconcept of an ASEAN community was proposed in 1997 with the end goalof economic integration – a single market and production base – as outlinedin the “ASEAN Vision 2020” statement. Toward this goal, ASEAN isimplementing a series of economic integration measures, laid down in theBali Concord II in 2003, and which rests on three pillars: the ASEANEconomic Community, the ASEAN Socio-Cultural Community and theASEAN Security Community. Recently, ASEAN countries agreed toaccelerate the schedule to achieve these goals by 2015. ASEAN hasendorsed 11 priority sectors for integration including agriculture,electronics, healthcare, ICT, tourism, etc. Mid-term action plans to achievethe goal of an ASEAN community were agreed; the Vientiane ActionProgramme (VAP) covers the period 2004-2010 following the Hanoi Plan ofAction for 1999-2004 (ASEAN, 2004; ASEAN, 2006). More recently, thediscussion of an ASEAN charter has been put on the agenda and thebuilding of rules-based regional institutions has become a key challenge. 5



Major official initiatives in selected areas. The extent of co-operationdiffers according to the sphere of activity. For instance, in the area of trade,as a step towards establishing a full-fledged ASEAN Free Trade Area, theCEPT scheme was established in 1992 and ASEAN member countries havemade progress ahead of schedule in lowering intra-regional tariffs. As aresult, intra-regional tariffs – except for certain commodities – have beenreduced to between 0% and 5%. The average AFTA tariff rate of theASEAN countries has been reduced from approximately 11% in 1993 toapproximately 3% in 2007 (see Figure O.4). The ASEAN-6 aims at acomplete elimination of tariffs by 2010, and in the four new members(Cambodia, Laos, Myanmar and Viet Nam, or shortly CLMV) have until2015. Since 2005, the Temporary Exclusive List (TEL) has been empty andas of 2007, 99% of items to be liberalised by the ASEAN-6 (Inclusive List,IL) have a tariff rate of 0-5%.

As a complementary scheme to AFTA, ASEAN Industrial Co-operation(AICO) aims to promote joint manufacturing activities betweenASEAN-based companies. AICO products, upon their approval, enjoy apreferential tariff rate between 0-5%. At the moment, more than150 projects have been approved for this scheme and involve a number ofcountries: Indonesia, Malaysia, Philippines, Singapore, Thailand andViet Nam.

The Asian crisis in the late 1990s acted as a trigger for enhancedfinancial co-operation in the region. Mutual trust and information sharingare prerequisites for co-operation in this area. With the aim of ensuringadequate liquidity levels to reduce the risk of another crisis, the Chiang MaiInitiative (CMI), a framework of bilateral swap agreements has beenestablished. The CMI is composed of two elements: the expansion of theexisting ASEAN Swap Arrangement (ASA) and the creation of a newnetwork of bilateral swap arrangements (BSAs). The development of anAsian bond market (Asian Bond Market Initiative, ABMI) has also beenencouraged in order to secure longer-term financing. Co-operation hasstrengthened in the area of regional economic surveillance. Economicsurveillance involves not only analyses of economic policies but alsoidentification of vulnerable aspects of economy. The EBRD process is oneof the mechanisms for information sharing and policy dialogue and the firstsurveillance meeting was held in April 2002. In particular, such co-operationhas progressed in the framework of ASEAN+3.



Figure O.4. Progress in tariffs reductionPercentage

a. Average tariff rate under AFTA

0

2

4

6

8

10

12

14

1993 1995 1997 1999 2001 2003 2005 2007

b. CEPT Package – percentage of IL, GEL and SL/HSL

90%91%92%93%94%95%96%97%98%99%

100%

IL GEL SL/HSL

Note: The average tariff rate for 1993-96 is for ASEAN-6 and for 1997-2007 ASEAN-10. Data for2007 is as of July 2007. IL stands or Inclusion List, GEL for General Exceptions List and SL/HSL forSensitive List/Highly Sensitive List.

Source: CEPT Package, ASEAN secretariat.



The Asian crisis gave rise to enhanced co-operation not only in the areaof finance but also with regard to FDI. Creating a favourable investmentclimate is important to attract FDI. With the ultimate aim of makinginvestment barrier-free, ASEAN embarked on a process of investmentliberalisation, facilitation and promotion in 1998. The main intention was toimprove the investment environment in the entire region and to maintaincompetitiveness by removing investment barriers and liberalisinginvestment rules and policies in sectors covered by the agreement.Compared with trade, the progress of this initiative is relatively slow. Underthe ASEAN Investment Area (AIA), investment will be liberalised in allindustries for intra-regional investors by 2010 and for investors from outsidethe region by 2020 with some exceptions.

ASEAN countries are also facing a number of regional challenges inother areas such as intellectual property rights, science and technology,information and communication technology (ICT), energy, food, agricultureand environmental issues.

Challenges ahead: towards more competitive and attractive markets

With the changing landscape of the global economy – marked inparticular since the late 1990s by the integration of global markets, theAsian crisis and the emergence of China – Southeast Asian countries arenow facing the challenges of how to remain competitive, move up the valuechain and attract investors.

A more competitive and investor-attractive region can be achieved by(i) further strengthening integration and co-operation and (ii) creating afavourable economic environment/institutional framework in differentfields. These two aspects will be examined in the following subsections.

Strengthening regional integration and co-operation

Strengthening regional integration is one means of enhancingcompetitiveness and attracting investors. Larger markets – a consumermarket of 560 million – that produce economies of scale are more attractivefor investors. An important benefit of regional integration is the reduction oftransaction costs (for instance, due to the dismantling of tariffs and otherbarriers) that leads to higher efficiency of resource allocation and welfaregains through enhanced competition in the domestic market. The benefits ofintegration should be measured not only by the degree of integration itself(for instance, increase of investment/trade flows) but also by whether thatintegration brings about stability and competitiveness in the region. In



addition to such economic benefits, integration is likely to bring aboutpolitical benefits.

The current integration process in Southeast Asia faces three majorchallenges:

• Institutional framework building to implement existinginitiatives is essential. Having a clear vision of the futuredirection will be a challenge for the region.

• Macroeconomic and monetary co-ordination lags behind otherforms of co-operation and needs to be strengthened to enhancestability in the region.

• Regional integration and domestic reforms are closelyinterrelated. Domestic reforms to adapt to a more open economyare crucial.

Institutional framework building to enhance integration. SoutheastAsia has witnessed de facto economic integration for some time. Decisionmaking in ASEAN is pragmatic, and the case-by-case approach typicallyrepresents the spirit of the “ASEAN way” (Goh, 2003; Severino, 2006).Stronger integration and the growing number of initiatives imply deeperinterdependence and a spill-over effect. There is a growing need to create aninstitutional framework to co-ordinate views between countries and moreeffectively implement/monitor the existing economic initiatives. A well-structured framework will minimise co-ordination costs and help harmonisestandards and procedures. Recent developments to establish a charter showthat ASEAN is in transition to a more rule-based organisation and is nowtrying to develop a new “ASEAN way” (Soesastro, 2005).

From a long-term perspective, a clear image of the direction ofinstitutional building is important. One approach, similar to that taken by theEU, is the creation of a sort of judicial authority to enforce ASEANEconomic Community (AEC) rules; another way is to develop a moresoft-type institutional building.

Macroeconomics and monetary co-ordination. Significant increasesin capital inflows, coupled with the Asian crisis, raised region-wideawareness of financial risk. However, regional co-operation in these areas islimited compared with co-operation in other fields. The three particularissues of capital management, exchange rate regime and foreign reservemanagement should be on the agenda for discussion at the regional level inorder to enhance the economic stability of the region.

The management of capital flows has elicited an animated debate inSoutheast Asia, and countries have adopted capital controls to varying



degrees (Mineane, 2004). Malaysia has long had stringent capital controls,while Thailand re-introduced restrictions after the crisis. The liberalisationof capital movements, on the one hand, reduces transaction costs and leadsto more efficient resource allocation based on market principles. On theother hand, large and sudden capital flows may lead to volatility of theeffective exchange rate and thereby cause disruption in industries heavilyrelying on tradable goods. If the domestic financial system is not adequatelydeveloped, capital account liberalisation should be pursued with caution.There is also a controversial debate on which currency regime should beadopted. The post-crisis experience in Southeast Asia shows thatimmediately after the crisis most affected countries made their exchangerates more flexible: nevertheless, there is a sort of “fear of floating”, asCalvo and Reinhart (2002) pointed out, which subsequently prompted somecountries to opt for a managed float or de facto pegs rather than freelyfloating regimes.6

Although substantially lagging behind the debate on the exchange rateregime, a lively discussion has started regarding the amount of foreignreserves that should be held. After the crisis, many countries began toaccumulate large foreign exchange reserves (Figure O.5a) to levels wellabove the amount of the short-term external debt they held (Figure O.5b), orthe equivalent of three months’ imports (Figure O.5c), measures often usedas a “rule of thumb” for prudent reserve holdings. Given the opportunitycosts of holding reserves, the question concerning the optimal amount ofreserves has arisen.7 Another issue is the use of foreign exchange reserves,with some suggesting that these funds be invested in regional infrastructure.

Domestic reforms to adapt to a more open economy. The removal ofcross-border restrictions lies at the heart of regional integration in SoutheastAsia. The major challenge for the future is the choice of domestic structuralpolicies to adopt to fit this ever more open environment. This would include,for example, building a regulatory/institutional framework conducive to theincrease of productivity and the maintenance of competitiveness in theregion. Domestic regulatory/institutional frameworks may be crucial inorder to reap the benefits of regional integration while inappropriateregulations may hinder the integration process. The removal of cross-borderrestrictions and consistent domestic regulatory reforms are mutuallyreinforcing. Effective implementation of policies is crucial in SoutheastAsia. When designing domestic policies it is important to consider incentivecompatibility, whereby policy makers are fully aware of the benefits ofintroducing reforms despite the fact that these reforms may entail more thannegligible adjustment costs.



Figure O.5. Foreign reserves in selected ASEAN countries

0

50

100

150

200

250

300

350

400

1998 1999 2000 2001 2002 2003 2004 2005 2006

a. Foreign reserves (in USD billion)

Brunei Cambodia Indonesia Laos Malaysia

Myanmar Philippines Singapore Thailand Vietnam

00.5

11.5

22.5

33.5

44.5

Indonesia Malaysia Phillipines Thailand Singapore

b. Foreign reserves/short-term debt ratio in 2006

012345678

Indonesia Malaysia Phillipines Thailand Singapore

c. Foreign reserve/imports ratio in 2006(in months)

Note: Foreign reserves exclude gold in Viet Nam.

Source: Joint BIS-IMF-OECD-World Bank statistics on external debt.



Creating a favourable economic environment/institutional frameworkin the region

Enhancing competitiveness and creating attractive markets are complexissues and require comprehensive approaches. Reflecting the distinctfeatures in the region, the following areas need special attention:

• enhance competitiveness by creating an economic environmentthat promotes industrial co-operation/enterprise developmentand by strengthening production networks;

• maintain the synergy effect between trade and investmentthrough further liberalisation and harmonisation acrosscountries;

• strengthen the financial system and access to credit in order tosupport enterprise development;

• consider upgrading the infrastructure so as to benefit from apossible multiplicative effect on other policies;

• improve environmental and natural resource management forsustainable development;

• enhance innovative capacity and reinforce the quality of humancapital.

Creation of an economic environment conducive to strengtheningindustrial co-operation and production networks. Multinationalproduction networks have largely driven economic growth in SoutheastAsia. Amid the changing economic environment and restructuring of globalproduction networks, Southeast Asian enterprises need to find new strategiesthat reflect their comparative advantages. It is crucial to create an economicenvironment that allows firms to make decisions about the productionprocess and costs in a flexible way and that enables firms to exploit theirpotential. An integrated regional production base would provide greaterscope for industrial efficiency and cost competitiveness in a wide array ofproducts as well as some services. CLMV countries would also benefit frombeing a part of the regional production network.

Many Southeast Asian countries have adopted new strategies. Viet Namhas emerged as a low-cost manufacturing platform, exploiting its advantageof having a large pool of skilled manpower. The Philippines has managed tocarve out a niche in electronics, software programming, back-office andcall-centre operations owing largely to its English-speaking population.Thailand has continued to be a key automobile assembly hub, while



Malaysia’s electronics and semi-conductor industries have thrived.Singapore has further advanced on the value chain, developing newindustries such as biotechnology and strengthening its position as SoutheastAsia’s financial hub. In Indonesia, FDI is recovering gradually from thecrisis and the government is creating a new attractive environment. It iscrucial for the region to adapt to the changing global environment andparticipate in new production networks to enhance its attractiveness forinvestors.

In addition, to promote local firms, it is essential to enhance small andmedium-sized enterprises’ (SMEs’) capacity to penetrate into verticalproduction chains. Inviting foreign SMEs would aid in the formation ofindustrial clusters and gradually strengthen local SMEs.

Trade and investment policies. Maintaining competitiveness inexternal trade and promoting intra-regional trade are important. Tradeopenness and deregulation of FDI results in new technologies, managementknow-how and links to global networks. FDI and trade are mutuallyreinforcing in Asia, therefore maintaining this synergy effect between tradeand investment is crucial.

Attracting FDI is a major challenge for the region. Some ASEANmembers, such as Singapore, Thailand, Viet Nam and Cambodia, have beenaccumulating an ever increasing share of FDI relative to their GDP, whileother countries, such as Indonesia, Laos, Malaysia and the Philippines saw afalling share in the past few years (Figure O.6a). Looking at flows, althoughthe decreasing trend in FDI inflows after the Asian crisis has reversed in thelast few years, its growth in Southeast Asia lags behind that enjoyed byChina (Figure O.6b).

Reducing transaction costs may enhance the attractiveness of the regionfor investors. Efficiency could be raised by reducing unnecessary costsrelated to different product standards, customs procedures and unpredictablepolicy implementation. An important issue related to the proliferation ofFTA/EPA (Economic Partnership Agreement) initiatives in the region, theso-called spaghetti bowl phenomenon (Baldwin, 2006), is how to ensurecoherence across different trade arrangements. In particular, differenttreatment of rules of origin, product standards and exclusion lists can becounter-productive. With the increasing importance of trade in services forthe region, the ASEAN framework agreement on services (AFAS) is animportant step forward to create an integrated market.



Figure O.6. FDI indicators in ASEAN in 1980-2005

Percentage

a. FDI stock as percentage of GDP

0

20

40

60

80

100

120

140

160

180

1980 1985 1990 1995 2000 2005

b. The share of global FDI flows to ASEAN and China

0

2

4

6

8

10

12

14

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

ASEAN China

Source: United Nations Conference on Trade and Development (UNCTAD).



Stable financial system and access to credit. Stable access to creditprovided by an efficient financial system is also pivotal in enhancingcompetitiveness, as financing constraints are one of the most seriousobstacles to a firm’s activity. Given that Southeast Asian economies havemostly bank-based financial systems, the strengthening of prudentialregulations after the financial crisis has largely contributed to improve thestability and efficiency of banking systems. Access to credit is a particularissue for small firms in Southeast Asia and is alleviated by micro-financingand informal financing. For some of the ASEAN members, rural povertyexacerbates access to credit.

Infrastructure development. Infrastructure investment has so farmainly been undertaken at the sub-regional or country level and althoughthere are numerous successful projects, in general there is a shortage ofregional infrastructure in Southeast Asia. Upgrading infrastructure, inparticular in transport and telecommunications, will better link countries andregions into the artery of economic activities and reduce the transactioncosts of trade, investment, etc. From a long-term perspective, infrastructuredevelopment needs to be examined on the basis of risk sharing andtransparency. In parallel with purely public and private initiatives, blendingthe two in the form of public-private partnerships, for instance, can be apromising avenue to explore. Upgrading infrastructure can be a powerfultool to reduce acute regional income disparities in Southeast Asia. Ingeneral, there is a synergy effect between different types of infrastructures;therefore consistent overall planning is crucial.

Environmental and natural resource management for sustainabledevelopment. ASEAN is one of the richest regions in natural resources.Natural resource management in this region is thus crucial not only for theregion but also at the global level. Issues to tackle include global reductionof greenhouse gases and climate change. Regional co-operation should bestrengthened in forest conservation, including preventing illegal logging anddeforestation, and building a safety net for natural disasters. Environmentalmanagement policies need to take into account possible urban populationgrowth in the ASEAN.

Improving the environment is strongly connected to energy efficiency.Encouraging cost-effective clean technologies and using energy-efficientfuel including clean coal technology are inevitable in the region.

Innovation and development of human capital and technologicalcapacity. Promoting innovation not only strengthens enterprisecompetitiveness but also facilitates the formation of new productionnetworks and hence benefits the entire region. As theoretical and empiricalevidence shows, innovation is a major source of competitiveness for which



the appropriate formation of human capital is central. A key issue is humancapital development as countries move from agricultural production tomanufacturing and service-based economies and in the face of the growingcomplexity of technology. In addition to adapting to a new businessenvironment, it is vital to increase access to education, particularly in therural areas. Innovation policy needs to be tailored to the specificcircumstances of individual countries and there is ample room to improveR&D policies (government vs. private, etc.) in Southeast Asia.8 Venturecapital is at an early stage of development, and therefore needs to befostered in order to introduce innovative ideas. The enforcement ofintellectual property rights needs to be considered to stimulate innovation inthe region.

Distinct features of regional integration in Southeast Asia: acomparative view

Compared to the unfolding of the European Economic integration (seeTable O.2), an example of implemented large-scale and multi-domainintegration, the integration process in Southeast Asia has several distinctfeatures, and the institutional structures and the international environmentsdiffer substantially. A comparison with the EU highlights these features andprovides insight into the ASEAN integration process.

A major characteristic shared by the two is that an historical eventprecipitated integration and that prospective members in both regions haddesired closer ties within each region. For Europe, following World War II,a union helped, inter alia, to create an environment in which politicalconflicts were less likely to occur. In Asia, one of the major triggers forco-operation was the Asian crisis, whose consequences in particular calledfor closer financial co-operation in the region. Notwithstanding somecommon features however, there are large differences.

Southeast Asia is characterised by the following features:

• Both the EU and Southeast Asia show diversity, but it is moreevident in Southeast Asia. The huge diversity among SoutheastAsian countries in terms of economic development, institutionalframework, political situation, culture, etc. will produce adistinct path of integration in the region.

• Southeast Asia has experienced market-driven integration basedon enterprise development, while in the EU, the institutionalframework led the integration process.

• Integration among countries in Southeast Asia has advanced inparallel with the region’s deepening global ties, while EU



integration proceeded in a relatively closed economy. Thisdifference will influence the discussion of sequencing theintegration process.

• Political momentum was very strong from the beginning of theintegration process in EU, while political will in Southeast Asiais relatively weak, although it has recently committed to a fasterpace of integration.

Table O.2. Major steps towards EU integration

Source: Author’s compilation from European Commission materials.

Year Key agreements and decisions1951 European Coal and Steel Community (ECSC) established (Belgium, the Federal Republic of Germany,

France, Italy, Luxembourg and the Netherlands)1957 European Economic Community (EEC) and Euratom1965 Executives of the three European Communities (ECSC, EEC, Euratom) merged1967 Merger Treaty of 8 April 1965 enters into force (the three European Communities are hereafter called EC)1968 Customs union completed and common external tariff established1970 Werner Plan on phased attainment of economic and monetary union, named after Luxembourg’s Prime

Minister, is presented to the Council and Commission1972 Currency “snake” set-up1973 EC formally enlarged to nine members (Ireland, Denmark and United Kingdom join). EC granted sole

responsibility for common trade policy1979 European Monetary System (EMS) takes effect1981 Greece becomes the 10th member state1986 Spain and Portugal join the Community, bringing membership to 121987 Single European Act enters into force1988 Commission presents Cecchini report (“The Cost of non-Europe”) quantifying the advantages of a single

market1992 Maastricht Treaty on European Union signed1993 Treaty on European Union enters into force1995 Austria, Finland and Sweden join EU1996 The European Council in Dublin agrees to a stability and growth pact for the economic and monetary

union and the future euro notes are presented to the public1999 Stage III of the Economic and Monetary Union begins and the euro becomes the currency of the

participating EU member states



Market-driven integration and weak institutional base. SoutheastAsian economies have spontaneously formed an economic block as a resultof enhanced trade, investment and financial transactions under a relativelysoft institutional framework. Consequently, and in contrast to the EU,regional integration is being driven essentially by the market rather than byofficial initiatives.9 The institutionalisation of the integration process alsodiffers between ASEAN and the EU, and as such, the issue of regionalsovereignty may also differ.

Intra-regional integration advances in parallel with strengtheningglobal ties. Southeast Asia is advancing its integration process in a globallyopen market environment. For instance, ASEAN strengthened its integrationprocess through reductions in trade barriers due to General Agreement onTariffs and Trade (GATT) / World Trade Organization (WTO) rounds andhuge capital inflows, while the EU was able to push economic integrationbehind relatively closed markets. Initially limited integration in the form ofECSC was widened toward a process of complete integration of theindustrial goods market.

Such differences would lead to different sequencing of the integrationprocess. Europe began with trade integration starting in 1958 and financialintegration was ongoing but accelerated significantly in the 1980s. In the EUintegration process, trade preceded monetary integration, while in Asia, theorder is not so clear (see Box O.2). In addition, in Asia, monetaryco-operation started with co-operation in liquidity provision and bondmarket development after the Asian crisis.

Weak political momentum. European integration started with thepost-war political reconciliation, although this political momentum was fargreater than the ensuing implementation of economic initiatives. There wereboth strong trade ties between original members of EEC and strong politicalmotivation. European economic integration was successful especially fromthe point of view of economic gains. In contrast, in Southeast Asia, politicalmomentum is weak but the economic driving force is strong. The recentcrisis created some momentum to strengthen official commitment toco-operate. In fact, the initiative to achieve a single economy originallyplanned by 2020 was brought forward to 2015.



Box O.2. Money or trade – which comes first? Sequencing of regional integration

One interesting controversy that arises when designing the process of regional integration isits sequencing: should integration start with trade, financial markets or a common currency?Furthermore, is there a prescribed order to follow or should it vary case by case? The growth inintegration initiatives in the Southeast Asian region has brought this debate to the forefront.

With regard to sequencing, the theoretical and empirical literature developed along distincttracks in the two areas of trade and monetary integration, but recently a new stream ofliterature has emerged analysing the connection between the two (Alesina and Barro, 2002;Klein and Shambaugh, 2006). To provide sound policy guidance, however, still moretheoretical and empirical research needs to be done.

On the trade side, the criteria for judging whether countries would be good partners within acustom union have focused on the degree of production networks and cost differentialsbetween prospective partners, the price elasticities of demand and supply for traded goods andservices, the scope of economic gains from a dynamic perspective, etc. Analogous to thetheory of economic liberalisation, the applied international economics literature would suggestthat trade should come first as it needs the fewest prerequisites, followed by financial marketsas it requires, inter alia, efforts to strengthen prudential supervision, adoption of internationalauditing and accounting principles and increase in market liquidity. Monetary integrationshould come last as it presupposes large scale harmonisation across participating countriesincluding in the field of financial structures and economic policies (McKinnon, 1991). The fivelevels of integration – preferential trading arrangements, free trade area, customs union,common market and economic union – used by Balassa (1961) are often interpreted as asequencing pattern of regional integration, thereby suggesting that integration in trade shouldprecede that in finance.

On the monetary side, the modern theory of monetary integration, dating from the seminalpapers by Mundell and McKinnon on optimal currency areas, has focused on the trade offbetween efficiency and macroeconomic flexibility, the degree of factor mobility betweenpartners, macroeconomic trends, the synchronisation of business cycles, the strength of thefinancial sectors of potential members, etc. Some studies emphasise that Asia is unique;countries seem to be reluctant to give up their currencies but at the same time find it inevitableto liberalise their financial markets. Amid such constraints, flexible exchange rates are anatural choice and under such regimes regional financial integration should concentrate onequity rather than debt markets, given that the former are less vulnerable to exchange ratevolatility (Eichengreen, 2006). Plummer and Wignaraja (2006) conclude from theirmacroeconomic and demand supply symmetry analyses that although East Asia may not yet bean optimal currency area, it is moving in that direction, and moreover, with the EU as thebenchmark, it may already be there. Furthermore, monetary integration would reinforceconvergence across countries in the Asian region (Pomfret, 2005).

Reflecting on the recent development in globalisation, a new stream of literature analysingthe connections between trade and monetary integration has emerged and shows increasingevidence that trade and monetary integration are closely connected. In analysing therelationship between the two, it is important to note the “two way” causality. For instance, if



exchange rate stability encourages trade, the formation of an exchange rate union will helpestablish the conditions for a trade agreement. By reducing transaction costs, a single currencymay encourage further trade among partners in the region. By the same token, regional tradeagreements (RTA) may be undermined by exchange rate instability among members. Frankeland Rose (1998) suggest that intra union trade is encouraged by reducing the risk of exchangerate changes and that this in turn increases the degree of synchronisation between businesscycles of countries. Forbes and Chinn (2003) found bilateral trade flows to be an importantdeterminant of cross country financial linkages. In Europe, an initial trade agreement tended tobe followed by increasingly binding constraints on exchange rate policy.

In other regional settings, discussion is taking place on the optimal way of sequencing theintegration process. Cross fertilisation between theoretical/empirical studies and policy makingwill eventually prove to be useful.

While such differences would warrant a different pattern of integrationin Southeast Asia, the experience of the EU could nevertheless offer somelessons.

O.3. Economic diversity in Southeast Asia

Regional diversity is manifest in a myriad of ways including economiccapacity, economic institutions and policies as well as social, political andcultural environments. This section focuses on a major challenge forregional integration – income disparities among countries and withincountries. The former widened after the new members (Viet Nam, Laos,Myanmar and Cambodia) joined ASEAN in the 1990s. Disparity amongcountries can also be observed based on several economic indicators. Tonarrow disparities among ASEAN members, the obvious way is toencourage growth in the less developed members. The latter – disparitieswithin countries – is similarly a serious challenge, as it can be observed inmany Southeast Asian countries. After describing the major features of thesedisparities, some ways to proceed with integration amid disparities will bepresented.

Income disparities “among” and “within” ASEAN countries – growthcum equity?

Income disparities “among” ASEAN countries

Reducing income disparities among Southeast Asian countries have longbeen recognised as a policy priority and the income gap might be anobstacle to integrate economies. Looking at GDP per capita, for instance,there is an over 100-fold difference between the wealthiest and the poorest



member (Figure O.7b). Similarly, there are large disparities among ASEANmembers in terms of GDP (Figure O.7a) as well as attributes of well-being,such as adult literacy (Figure O.7c), life expectancy (Figure O.7d) andunemployment (Figure O.7e) (see Box O.3). Several attempts have beenmade to narrow the income gap among ASEAN member countries.10 Theseattempts show a large variation in terms of their initiators; some werelaunched by ASEAN, some outside of ASEAN, and some jointly byneighbouring ASEAN countries. One of the earlier attempts initiated byASEAN to reduce the income gap between members was theASEAN-Mekong Basin Development Cooperation (AMBDC), launched atthe 5th ASEAN Summit in 1995. The purpose of the AMBDC was tostimulate economic development of member countries located in theMekong Basin and its major project was the Singapore-Kunming Rail Link.A few years later, the 2001 informal ASEAN summit launched the Initiativefor ASEAN Integration (IAI) with the particular aim of reducing disparitieswithin the region (and agreed on its six-year work plan over 2002-2008).The four priority areas of this plan include infrastructure development,human development, information technology and regional integration. TheHanoi Declaration echoed the importance of these four areas.

In addition to the ASEAN initiatives, there have been other bodiesattempting to reduce inequalities in the region. One major initiative was theGreater Mekong Sub-region (GMS) programme of the ADB proposed in1992. It was initially envisaged to focus on transport and energyinfrastructure, but was eventually enlarged to include human development,trade, investment and other areas. The GMS comprises several projects suchas the Phnom Penh-Ho Chi Minh Asia Highway, the Phnom Penh humandevelopment plan and the Greater Mekong Sub-region Business Forum(GMS-BF).



Figure O.7. Economic diversity in ASEAN

a. GDP in 2006 (in billion USD, PPP)

0 200 400 600 800 1000 1200

Vietnam

Thailand

Singapore

Philippines

Myanmar

Malaysia

Laos

Indonesia

Cambodia

Brunei

b. GDP per capita in 2006 (in USD, PPP)

0 5000 10000 15000 20000 25000 30000 35000

Vietnam

Thailand

Singapore

Philippines

Myanmar

Malaysia

Laos

Indonesia

Cambodia

Brunei



Figure O.7. Economic diversity in ASEAN (continued)

c. Adult literacy rate in 2004 (in %)

0

10

20

30

40

50

60

70

80

90

100

d. Life expectancy in 2004 (in years)

0

10

20

30

40

50

60

70

80

90



Figure O.7. Economic diversity in ASEAN (continued)

e. Unemployment rate (in %)

0

2

4

6

8

10

12

Brunei Cambodia Indonesia Laos Malaysia

Myanmar Philippines Singapore Thailand Vietnam

Source: GDP and GDP per capita: World Economic Outlook (WEO), IMF. Adult literacy rate andlife expectancy: UNDP. Unemployment rate: ADB.

There are also multilateral initiatives. Such initiatives create“sub-regional economic zones” based on geographical proximity. Proximityand the sharing of existing infrastructure economise on costs and therebysupport the expansion of economic activities. The formation of “growthtriangles” including the Indonesia-Malaysia-Singapore Growth Triangle(IMS-GT), the Indonesia-Malaysia-Thailand Growth Triangle (IMT-GT)and the Brunei-Indonesia-Malaysia-Philippines East ASEAN Growth Area(BIMP-EAGA) played an important role in boosting growth in therespective regions: The IMS-GT, the largest of the three, was initiated in thelate 1980s with the purpose of creating an investment area including Riauprovince of Indonesia, Johor of Malaysia and Singapore. The developmentof Batam Island was at the heart of this initiative. As a result of thedismantling of investment barriers, in particular on Batam Island, thenumber of investing firms increased 50% and the population doubled in acouple of years. This is considered one of the most successful projects. TheIMT-GT was launched in the early 1990s and includes six north-easternIndonesian provinces, five northern Malaysian provinces and five southernThai provinces (for more details see Vimolsiri, Chapter 11). TheBIMP-EAGA was proposed in 1994 and covers Brunei, the Indonesianprovinces of North Sulawesi, East Kalimantan, West Kalimantan, theMalaysian provinces of Sabah, Sarawak, Labuan and the Philippine islandsof Mindanao and Palawan. The Philippines has long attempted to eradicate



poverty in its poorest region of Mindanao, and the initiative was designed tocontribute to this.

Box O.3. Converging or diverging in ASEAN?

Are ASEAN countries experiencing a convergence of economic growth among them whilebecoming ever more integrated with the world economy? Most studies looking at convergencecheck the existence of either or convergence or of a common deterministic/stochastic trend.The concepts of and capture different convergence processes: convergence examineswhether developing countries will catch up with developed ones and this type of convergencecan be unconditional or conditional, depending on whether additional control variables areabsent or present in the cross section regression. convergence examines income inequalitiesamong countries and it means that the variance of per capita income for a group of economiesis decreasing over time. The two concepts of and convergence are related: a necessarycondition for convergence is the existence of convergence.

convergence is commonly used in growth empirics. This measure, based on Barro andSala I Martin (1992) and Mankiw et al. (1992), makes a distinction between conditionalconvergence (the convergence of countries after controlling for differences in steady states)and absolute convergence (where poor economies simply grow faster than wealthy ones).Concerning this regression framework, Quah (1993) and Friedman (1992) pointed out“Galton’s fallacy problem” and both suggest that convergence should be of interest as itdirectly answers the question of whether the distribution of income across economies isbecoming more equitable.

In parallel with these methodological debates, there have emerged a number of empiricalstudies checking the convergence process in Southeast Asia. Evans and Kim (2005) estimatethe Solow growth model for 17 Asian countries, including most ASEAN members, with therandom coefficients technique and find that there is a convergence of 2% per annum among thesample countries. Lim and McAleer (2004) show that several time series tests for convergencedon’t support income convergence between pairs of ASEAN-5 countries (Indonesia, Malaysia,Philippines, Thailand and Singapore) and Chowdhury (2005) arrives at the same result afterexamining nine ASEAN countries during 1960-2001. As an example of another stream ofliterature, a study by Park (2003) looks at convergence using the simple Theil index. It showsthat incomes since the mid-1970s have been converging in Asia.

These attempts are distinct in that neighbouring countries are jointlyundertaking regional development. These schemes may prove to beeffective, particularly when countries face cross-border problems that aredifficult to solve by an individual country. Moreover, joint efforts may bringabout efficiency gains through the scale effect. There is a large variationbetween sub-regional growth areas in terms of success, but it is expectedthat an appropriate blend with domestic policies would bring positiveresults.



Income disparities “within” ASEAN countries

Sizeable income disparities exist not only across different ASEANcountries, but also across regions within countries, exacerbating thechallenge of regional integration. Moreover, robust economic growth overthe past decades, beside its poverty-alleviating effect, has brought aboutwidening regional disparities in these countries. How do these inequalitiesaffect growth and thereby countries’ capacity to fully reap the benefits ofregional integration?

The link between inequality and growth has been one of the mostdebated issues not only in policy making but also in the context of economictheory. Cordoba and Verdier (2007)11 build a theoretical framework basedon Lucas’s work and conclude that the welfare costs of inequality outweighthe benefits of growth. Recent literature based on theories of incentives(Aghion et al., 1999), however, does not give a clear conclusion as towhether inequality stimulates or deters economic growth, owing in largepart, to different channels through which inequality and growth mayinteract. Similarly, the results of empirical studies are inconclusive and verymuch dependent on the econometric specification, the method and thesample. According to the early literature on the relationship betweeninequality and economic growth, inequality is inevitable at early stages ofdevelopment and should diminish with growth as illustrated by the inverseU-shape Kuznets curve. Banarjee and Duflo (2000) provide a plausibleexplanation why estimates of the relationship between the level of inequalityand growth are so different from one another. They find that changes inincome inequality (in either direction) are associated with reduced growth inthe following period. While this does not explain the relationship betweenthe level of inequality and growth, it sheds light on the non-linearrelationship between the two. The major policy implication of this finding isthat large swings in the income distribution are growth-deterring.

The ASEAN experience – similar to the theoretical and empiricalliterature – is inconclusive on the relationship between inequality andgrowth: all have achieved remarkable growth amid somewhat differinglevels of inequalities. Behind the different inequality levels are historicaland political factors as well as different levels of tolerance towardsinequality in different countries. Moreover, inequality has been persistent incountries that have the highest levels such as Philippines and Thailand(Figure O.8). Box O.4 provides some theoretical explanations for thepersistence of inequality. Among ASEAN-5, Indonesia has traditionally hada low level of income inequality and this level remained more or less stableover the Suharto regime and afterwards.



Figure O.8. Gini index of income inequality in ASEAN countries

a. Persistence of inequalities

0

10

20

30

40

50

60

Malaysia Philippines Thailand

b. Gini index

0

5

10

15

20

25

30

35

40

45

50

Cambodia Indonesia Laos Philippines Thailand Vietnam

Note: Panel a: Years differ by country: Malaysia: 1984, 1987, 1989, 1992, 1995 and 1997, Philippines:1985, 1988, 1991, 1994, 1997, 2000 and 2003 and Thailand: 1981, 1988, 1992, 1996, 1999, 2000 and2002.

Panel b: Latest available year, Cambodia 2004, Indonesia 2002, Laos 2002, Philippines 2003, Thailand2002 and Viet Nam 2004.

Source: United Nations Development Programme (UNDP).



Box O.4. Why is income inequality persistent? – Some theoretical arguments

The recent theoretical debate sheds some light on the challenge of persistent inequality.Many recent works emphasised the role of human capital investment under credit marketimperfections. The usual common feature of the setting of these models is that human capitalformation cannot be financed by issuing claims against a child’s future earnings due to thelack of enforceability of such contracts. This box discusses some variations of this setting.

Banerjee and Newman (1993) argue that owing to capital market imperfections, peoplecan borrow only limited amounts and as a result, occupations that require high levels ofinvestment are beyond the reach of poor people, who have no choice but to work forwealthier people. Wage contracts are viewed primarily as a substitute for financial contracts.The wage rate and pattern of occupational choice are determined by an individual’s wealth.Low wage rates slow down the wealth accumulation of the poor and therefore preserve thehigh initial supply of labour, which in turn reinforces the low equilibrium wage rate. Ghatakand Jiang (2002), however, pointed out that credit market imperfections give rise to rents inoccupations involving set-up costs and these rents may motivate poor individuals to workhard and save to overcome the borrowing constraint. Galor and Zeira (1993) also examinedthe role of income distribution through investment in human capital and pointed out thatpersistence can easily arise when there is credit rationing. They show that with a fixed sizeinvestment technology, inequality can become persistent. Poor agents are unable to afford thefixed size investment that would enable them to accumulate enough wealth to pass thethreshold. As a result, initial poverty persists in the long run.

In a similar vein, Mookherjee and Ray (2003) look at human capital investment as anintra-household decision. Given that it is the parents who decide how much to invest in theirchildren’s education, poor families are unable to catch up owing to their limited means toinvest, while high-income families can easily afford to spend on education. This results inperpetuation of inequality. Durlauf (1996) and Das (2007) analysed the relationship betweenhuman capital investment and neighbourhood choice. Parents affect the conditionalprobability distribution of their children’s income through the choice of a neighbourhood inwhich they live.

In general, the ability of such theoretical models to explain the persistence of incomeinequalities is limited due to their assumptions, but they provide some insight into certainaspects of the phenomenon. It should be noted, however, that given the complexity of thecontinuing income inequality, such inequality needs to be examined from broader aspects.The situation in Southeast Asia is in line with the theoretical model. Credit access is indeed asubstantial problem in the region and several methods have been used to mitigate thisconstraint. For instance, the increasing use of micro-finance in the region indicates that accessto credit is difficult. Improvement in credit conditions is key to the alleviation of persistentincome inequality.



O.4. Peer review process: tool for regional co-operation in SoutheastAsia

How can regional integration be fostered in light of the distinct featuresand challenges facing this region? The peer review mechanism may helpanswer this question.

The peer review mechanism is a tool for policy dialogue (see Annexes Aand B of this publication). Its non-binding and “soft law” nature can besuitable as a co-operation tool in Southeast Asia. The challenge of how toapply the peer review in order to foster regional integration amid economicdiversity in Southeast Asia is the main topic of this publication.

Peer reviews can contribute to regional co-operation in Southeast Asia.The EU peer review process shows how relevant it can be in a regionalcontext. In the European experience, Bertoldi (see Chapter 3) mentions thatpeer review, peer support and peer pressure are key instruments in thegovernance framework of a regional economic union, even though theseinstruments are implemented differently depending on the context.

Moreover, peer review is not a new concept for Asian countries (seeIkhsan, Chapter 8 and Vimolsiri, Chapter 10). Indeed, following the Asiancrisis, peer reviews were institutionalised in the form of the ASEANSurveillance Process (ASP) in 1998, although admittedly this process is stillin its infancy (see Beltran, Chapter 9). The aim of the ASP is to strengthenthe capacity of policy making within ASEAN. Two mechanisms facilitatethis: one is a monitoring mechanism that allows early detection of problemsthat might affect the economy in general, and the financial sector inparticular; the other is a peer review mechanism that identifies policy issuesarising from the monitoring exercises that need to be addressed.12

Different organisations conduct peer reviews in different ways. Forinstance, APEC has been using peer reviews as a tool to achieve thecommon goals of free and open trade and investment in the Asia-Pacificregion (see Woodhead, Chapter 2). These goals, known as the Bogor Goals,were laid down in the Bogor Declaration in 1994. In their path towardsachieving the Bogor Goals, economies prepare individual action plans(IAPs) tracking their progress. These IAPs then become the object of thepeer review process, which has evolved through trial and error. At theoutset, the submission of IAPs for peer review was conducted on a voluntarybasis, but in the early 2000s, the process was made more rigorous. As part ofthe mid-term stocktaking process in 2005, a timetable was set for the reviewof all 21 member economies. The IAP peer review process has proved to bean effective tool to facilitate learning from each other’s experiences,



enhance policy-relevant interaction and encourage participants to progresstowards the goals of free and open trade and investment.

In response to the Asian crisis, the ASEAN+3 adopted the ERPDprocess as part of their efforts towards regional financial co-operation.According to Kawai and Houser (Chapter 1), they have recently decided tointegrate the ERPD with the regional liquidity support facility, the ChiangMai Initiative. In addition, National Surveillance Units have been set up inASEAN+3 countries for economic and financial monitoring. The ultimateaim is to strengthen the Chiang Mai Initiative as a facility independent fromIMF programmes and to transform it into a multilateral arrangement. Thisrequires a more active and effective role for the ERPD, whose major role sofar has been information exchange and co-ordination. Information exchangeis the first evolutionary step of the ERPD and is a prerequisite to peer reviewand due diligence. Information sharing is crucial in the areas ofmacroeconomic development and in support of institutional, legal andregulatory reforms in the areas of foreign exchange and financial markets. Itis argued that for the ERPD to become a more powerful tool, both its peerreview and due diligence features need to be enhanced.

The OECD peer review process has several distinct characteristics (seeBox O.5, Annexes A and B and Thygesen, Chapter 6). The OECD’s usefulrole lies in bringing together the independent analytical capacities of thesecretariat and the policy experience of national government officials. Asthe country examples of Belgium (Van Houte, Chapter 12), Japan (Hirono,Chapter 13) and Korea (Kwon, Chapter 14) show, the secretariat helps toidentify the specific issues on which to focus the review and ensures thequality of the methodological instruments. By adding a detailed discussionwith the relevant national officials when the secretariat’s draft is presentedto the committee, the process facilitates formulations of policyrecommendations that are endorsed by national governments, therebyhelping to build consensus amongst participating countries on the requiredpolicy orientations. Peer reviews are implemented in a number of wayswithin the OECD. Subsidiary bodies of the OECD – committees or workingparties dealing with a particular issue – can decide to undertake peer reviewsas part of their activities, or to carry out a one-time peer review at therequest of a country or a region. The various directorates in the OECDsecretariat constantly adapt and improve the modalities of the peer reviewsto meet the specific requirements of the policy area concerned.



Box O. 5. What can OECD peer review offer?

The peer review mechanism – the assessment of the policies and performances of a countryby other countries – is at the heart of the OECD’s method of work. It is a tried and testedinstrument that helps member countries improve their policy making, adopt good practices andgenerate established standards and principles. This method of international co-operation hasbecome increasingly popular in recent years, even beyond OECD borders. The scope of thepeer review mechanism has expanded rapidly in terms of policy areas reviewed and thenumber of organisations involved. The success with peer reviews has encouraged otherorganisations, such as New Partnership for Africa’s Development (NEPAD), to adopt this tooland the OECD has started to discuss peer review experiences with ASEAN.

Peer reviews can serve as an important capacity-building instrument, since it is a mutuallearning process that allows best practices to be tested and emulated. In many differentsettings, the “soft law” nature of the peer review can prove better suited to encouraging andenhancing compliance than a traditional enforcement mechanism. Based on solid analyticalevidence, the review results in a series of recommendations reflecting the collective wisdom ofparticipants that aim to support the reform efforts of the country under review. Importantprerequisites of peer reviews are the sharing of common values, mutual trust and the analyticalcredibility of the review process. A strong common understanding of the ultimate goals of thepeer review and a high degree of shared confidence in the value and integrity of the process arekeys for its success.

Peer reviews are a flexible tool in terms of the policy areas and countries to be covered. Inthe real operation at the OECD, different methods are used for different policy areas. Peerreview can apply not only to country-by-country examinations but also to cross-countrythematic reviews or to broader issues of regional co-operation. The impact of this exercise canvary according to the practical details of the implementation and the degree of mutual trustamong participants.

Source: Annexes A and B to this publication.

There is no standardised peer review mechanism as such, but all peerreviews share certain structural elements: a commitment to transparency andinformation-sharing; an agreed set of principles, standards and criteriaagainst which performance will be reviewed; designated actors to carry outthe review; and a set of procedures leading to the final result. When regionalintegration projects involve deepening legal and economic commitments,Comley (Chapter 4) stated that it is important to disentangle sanctionregimes from peer reviews to ensure that the free disclosure of informationis incentive compatible.

Given their flexible nature, peer reviews can be tailored to fosterintegration, taking into consideration specific characteristics. Several



Southeast Asian countries (Part II, from Chapter 8 to Chapter 11) identifiedthe importance of the peer review mechanism and made suggestions as tohow this tool could be fitted to the region’s need. Some of the aspects ofpeer reviews that would suit this region include information sharing andco-ordination. Both are expected to be an effective tool.

The following points should be given special attention in the applicationof the peer review mechanism to this region:

• Information sharing. The information exchange aspect of peerreviews has been recognised as a potentially useful tool for theSoutheast Asian region, as it may help to bridge the informationgap in policy making.

• Co-ordination of regional policies and identification ofissues. Peer reviews can also be helpful in co-ordinating policiesin order to jointly address regional challenges. They could alsowork as an early warning system and provide input to thegovernment regarding policy reforms.

• The role of facilitator. A competent facilitator would enhancedialogue and co-ordination and encourage participants to shareviews on regional issues. Involvement of regional organisations(for instance, ASEAN and ADB) will be helpful in adaptingpeer reviews to different purposes. From a long-termperspective, capacity-building to strengthen the role offacilitator is important.

The application of the peer review mechanism to Southeast Asia is stillin its infancy. This publication provides some suggestions to policy makersin Southeast Asia on how the peer review mechanism could be applied toaddress regional and domestic policy challenges.

O.5. Conclusion

This chapter provided an overview of the major characteristics of theSoutheast Asian region from the point of view of its economic diversity andregional integration. It confirmed that the process of enhanced integration isprogressing despite the diversity of participating countries. Southeast Asiancountries now face several challenges: how to blend market-drivenintegration with an institutional framework and how to enhancecompetitiveness and attract investors in the region. The peer reviewmechanism might help to address these issues.



The following chapters address the question of how to adopt peerreviews to the Southeast Asian region in light of its specific characteristics,i.e. what aspects of this mechanism should be retained and what should beadjusted in order to take into account these characteristics and the area ofco-operation.

Various examples of peer reviews in different institutions provide auseful reference to develop the most relevant framework for Southeast Asia.Part I of this publication is based on regional integration experiences of theADB, APEC, the EU and the OECD, while Part II consists of views fromSoutheast Asia. Part III briefly introduces the experiences of OECD membercountries. Annexes A and B present two papers on the OECD peer reviewmechanism and the example of the Economic Development and ReviewCommittee (EDRC). The application of the peer review mechanism to theSoutheast Asian region is still at an early stage and the best ways to adopt itshould be explored.

Notes

1. This section is based on Tanaka and Langer (2007).

2. OECD (2005) discusses this dynamism from the point of view of policycoherence for development in the region.

3. Cheung et al. (2003) and Kawagoe et al. (2005) examined the interestparity condition between selected countries in East Asia and concludedthat countries are converging towards an equilibrium point of interestparity, which implies that their interdependence is deepening.

4. Although the co-operation has advanced in several frameworks, here thefocus will be on initiatives in the framework of ASEAN-10. See Kawaiand Houser (Chapter 1) for the framework of ASEAN+3 and Woodhead(Chapter 2) for APEC for more details.

5. At the 12th Summit in Cebu, the Report of the Eminent Persons Group onthe ASEAN Charter invited ASEAN members to “calibrate the traditionalpolicy of non-intervention in areas where the common interest dictatescloser co-operation.”



6. Some argue that most developing countries should adopt one of the “twocorner solutions”, i.e. irrevocably fixed or fully flexible exchange rateregimes, as these two extreme systems appear to be more immune tocrises owing to their higher policy credibility (Fisher, 2001). According toother views, such as Corsetti et al. (1999) and Williamson (2000),intermediate exchange rate systems are preferable, as fluctuation bands,for instance, provide some flexibility for monetary policy whilemaintaining a certain degree of exchange rate stability.

7. For instance, according to the buffer stock model, the amount held inreserves should decrease with an increase in economic adjustment costsand in the opportunity cost of holding reserves. Aizenman and Marion(2003) and De Beaufort Wijnfolds and Kapteyn (2001) investigatedempirically whether reserves in Southeast Asia are excessively high usingthe buffer stock model and both found a positive answer. Suchtechniques, however, are not able to project the optimal amount ofreserves.

8. See Yusuf (2003) for more comprehensive discussions about innovationpolicy in Asia.

9. Bocquet (Chapter 5) mentioned that Asia is unlikely to embark on thesame path of relatively formal institution building, as did the Europeans50 years ago.

10. See Fukasaku, Chapter 7, for a case study of trade related assistance.

11. Lucas (2004) stresses the overwhelming importance of growth and doesnot attribute a role to redistribution.

12. The Manila Framework Group (MFG) is another mechanism forsurveillance in Asia, with participation of IMF, World Bank, ADB andBank of International Settlements (BIS).



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PART I. HOW CAN PEER REVIEWS BE USED TO ADDRESS REGIONAL CHALLENGES? – 63


Part I.

How Can Peer Reviews be Usedto Address Regional Challenges?

1. EVOLVING ASEAN+3 ERPD: TOWARDS PEER REVIEWS OR DUE DILIGENCE? – 65


Chapter 1. Evolving ASEAN+3 ERPD:Towards Peer Reviews or Due Diligence?*

1.1. Introduction: regional financial co-operation in East Asia

The Asian financial crisis of 1997–98 caused significant damage toeconomies in East Asia. The crisis prompted the region’s policy makers torealise the importance of economic and financial co-operation amongthemselves given the region’s deepening economic interdependence.Following the crisis, therefore, East Asia embarked on various initiatives tomanage such interdependence and achieve stable economic growth. In themonetary and financial area, the finance ministers of ASEAN+3 – comprising the ten ASEAN countries,1 the People’s Republic of China(PRC), Japan, and the Republic of Korea (Korea) – undertook threeinitiatives for regional financial co-operation:

1. establishment of a regional reserve pooling arrangement(Chiang Mai Initiative, CMI),

2. introduction of a regional economic review and policy dialogueprocess (ASEAN+3 ERPD),

* This chapter was written by Masahiro Kawai, Dean, Asian Development BankInstitute and Cindy Houser, Senior Economist, Asian Development Bank.

This is a revised draft of a paper presented at the international conference,“The OECD-Southeast Asia Regional Forum: Peer Review Mechanism forPolicy Reform”, organised by the OECD in co-operation with ASEANsecretariat and the Asian Development Bank, and held in Jakarta on23-24 January 2007. The authors are grateful to Val Koromzay,Niels Thygesen, and other participants in the conference for their usefulcomments and views and to Patricia Decker for editorial assistance. The viewsand interpretations expressed in this chapter are those of the authors alone anddo not necessarily represent the views of the Asian Development Bank, itsInstitute (ADBI), its executive directors, or the countries they represent.

66 – 1. EVOLVING ASEAN+3 ERPD: TOWARDS PEER REVIEWS OR DUE DILIGENCE?


3. development of local-currency bond markets (Asian BondMarkets Initiative, ABMI).

The important objectives of these initiatives are to prevent therecurrence of regional financial crises and to contain such crises effectivelyif and when they occur. The authorities are now studying ways and means tofurther strengthen the reserve pooling arrangement by going beyond thecurrent Chiang Mai Initiative through the multi-lateralisation of bilateralswap arrangements. To function as envisioned, an augmented regionalliquidity support facility with a collective decision-making mechanism willrequire enhanced regional economic surveillance to keep decision makersfully and accurately informed about the health of potential and prospectiveusers of the facility. Thus, a high priority for ASEAN+3 finance ministers isto make their economic review and policy dialogue exercise an effectivesupport process for an augmented CMI.

In this chapter, we focus on ASEAN+3 ERPD as the region’s majoreconomic review and policy dialogue process. Although there are severalother forums in East Asia, ASEAN+3 ERPD is the most advanced. Weexplore the following issues:

• How does the review process in East Asia – particularly that ofASEAN+3 ERPD – work and what are its key features?

• What should be its objectives given the rising importance of CMI?

• How do international financial institutions – such as the AsianDevelopment Bank (ADB) and International Monetary Fund(IMF) – contribute?

• Is there any role for the private sector in East Asia’s review process?

• What are the major challenges for enhancing the effectiveness ofASEAN+3 ERPD?

• Should ERPD evolve along the line of an OECD-type “peer reviewand peer pressure” approach or an IMF-type “surveillance”approach?

The remainder of the chapter is organised in six sections. In Section 2we review the ASEAN+3 finance ministers’ financial co-operation efforts,arguing that ASEAN+3 ERPD is an integral part of the efforts. In Section 3we then focus on key features of ASEAN+3 ERPD and discuss its linkagewith CMI, which would potentially require ERPD to function as a processbeyond a simple economic review process. In Section 4, we discuss threepossible modalities of ERPD: information sharing, peer review and peerpressure, and due diligence. In Section 5 we examine the possible role of the



private sector in ERPD. In Section 6 we provide some preliminary thoughtson enhancing the effectiveness of ERPD by advancing from informationsharing to a combination of peer review and peer pressure, and then to morerigorous “surveillance” with elements of due diligence. Section 7 providesconcluding remarks.

1.2. ASEAN+3 finance ministers’ process

Following the outbreak of the Asian financial crisis, the heads ofstate/government of the ASEAN+3 countries met for the first time inDecember 1997 to discuss regional peace, stability, and prosperity, andurged their finance ministers to nurture regional financial co-operation. Thefirst ASEAN+3 finance ministers meeting was held in Manila in April 1999on the sidelines of the ADB annual meeting, and since then the ministershave met annually, except in 2000 when they met twice.

Table 1.1 summarises key decisions and agreements reported in jointministerial statements of the ASEAN+3 finance ministers’ meetings. It isclear that the finance ministers’ process has been functioning as a forum forpromoting regional financial co-operation and collective policy action toachieve regional financial development and stability. The finance ministershave particularly focused on three major policy initiatives: regional liquiditysupport facility (CMI); regional economic review and policy dialogue(ERPD); and regional local-currency bond market development (ABMI).2 Inrecent years, the finance ministers have focused on how to improve CMIand ERPD.

Chiang Mai Initiative. The hallmark liquidity support facility in EastAsia is the CMI, which was designed to reduce the risk of liquidity crisesand to manage regional currency attacks, contagion, and crises if and whenthey occur. The 1997–98 Asian financial crisis highlighted the importanceof creating an effective financing facility so that governments in the regioncan prevent or respond effectively to currency crises in an increasinglyconnected global economy. With the ASEAN+3 leaders’ recognition of theneed for “enhancing self-help and support mechanisms in East Asia throughthe ASEAN+3 Framework” (ASEAN, 1999), the finance ministers ofASEAN+3 agreed in Chiang Mai in May 2000 to establish a regionalnetwork of swap arrangements for its members, thus launching the CMI. Itconsists of two elements: expansion of the existing ASEAN SwapArrangement (ASA), in both amounts and membership, and the creation of anew network of bilateral swap arrangements (BSAs) among ASEAN+3members.3 By July 2007, 16 BSAs had been concluded in line with the mainprinciples, amounting to a total of USD 83 billion – excluding Japan’s



commitment made for Malaysia under the New Miyazawa Initiative (seeTable 1.2).4 As a result CMI now has the total size of USD 85 billion(USD 2 billion for ASA and USD 83 billion for BSAs).

Table 1.1. ASEAN+3 finance minister meetings

Date Place Key decisions and agreements1st 30 April 1999 Manila • No statement issued2nd 6 May 2000 Chiang Mai • Strengthen policy dialogues and regional co-operation

activities in, among others, the areas of capital flowmonitoring, self-help and support mechanisms, andinternational financial reforms

• Use the ASEAN+3 framework to facilitate the exchange ofconsistent and timely data and information on capital flows

• Strengthen the existing co-operative frameworks amongmonetary authorities through the CMI

3rd 25 Sept 2000 Prague • No statement issued4th 9 May 2001 Honolulu • Update the capital flow situation in each member country and

exchange data on capital flows bilaterally among members ona voluntary basis

• Review the current main principles of the bilateral swaparrangement under the CMI in the next three years

• Establish a study group to examine ways of enhancing theeffectiveness of their economic reviews and policy dialogues

• Continue to exchange views on the early warning systems(EWSs) and work towards developing appropriate EWSmodels for East Asia

5th 10 May 2002 Shanghai • No significant decision or agreement6th 7 August 2003 Makati • Strengthen the current peer review process by implementing

the recommendations made by the ASEAN+3 Study Group toExamine Ways of Enhancing the Effectiveness of EconomicReviews and Policy Dialogue

• Intensify efforts to develop regional bond markets – throughthe Asian Bond Markets Initiative (ABMI)

• Welcome the deputies’ initiative in setting up a voluntaryresearch group – the ASEAN+3 Research Group

7th 15 May 2004 Jeju • The CMI bilateral swap agreement (BSA) network hasreached USD 36.5 with 16 BSAs

• Undertake further review of the CMI (known as the “secondphase of the CMI review”) to explore ways of enhancing itseffectiveness

8th 4 May 2005 Istanbul • Take measures to enhance effectiveness of CMI through:(i) integration and enhancement of ASEAN+3 economicsurveillance into the CMI framework; (ii) clear defining of theswap activation process and the adoption of a collectivedecision-making mechanism (as a first step ofmulti-lateralisation); (iii) a significant increase in the size ofswaps; and (iv) improvement of the drawdown mechanism(the size of swaps to be withdrawn without the IMF-supportedprogramme to be increased from the current 10% to 20%



Table 1.1. ASEAN+3 finance minister meetings (continued)

Date Place Key decisions and agreements9th 4 May 2006 Hyderabad • The CMI BSA network has reached USD 75 billion with

16 BSAs• Successfully complete the strengthening of the regional

liquidity support network initiated in Jeju in May 2004• Adopt the collective decision-making procedure for CMI swap

activation• Launch the Group of Experts (GOE) and the Technical

Working Group on Economic and Financial Monitoring(ETWG) to explore ways for further strengthening surveillancecapacity in East Asia

• Task the deputies to set up a “new task force” to further studyvarious possible options towards an advanced framework ofthe regional liquidity support arrangement (CMImulti-lateralisation or post-CMI)

10th 5 May 2007 Kyoto • The CMI BSA network has increased to USD 80 billion,consisting of 16 BSAs among 8 countries

• Agreement in principle on a self-managed reserve poolingarrangement governed by a single contractual agreement asan appropriate form of CMI multi-lateralisation

• Task the deputies to carry out further in-depth studies on thekey elements of CMI multi-lateralisation includingsurveillance, reserve eligibility, commitment size, borrowingquota, and activation mechanism

Source: Joint Ministerial Statement of ASEAN+3 Finance Ministers’ Meetings, May 2000–May 2007,www.aseansec.org.



Table 1.2. Progress on BSAs under the Chiang Mai Initiative

As of July 2007

BSAs Currencies Effective / Expirationdates

Size

Japan-Korea USD/won or USD/yen 24 Feb 2006 /23 Feb 2009

USD 10 billion (JPN-KOR)USD 5 billion (KOR-JPN)

yen/won or won/yen 27 May 2005 /3 July 2007

USD 3 billion(a) (2-way)

Japan-Thailand USD/baht or USD/yen 10 July 2007 / USD 6 billion (JPN-THA)USD 3 billion (THA-JPN)

Japan-Philippines USD/peso or USD/yen 4 May 2006 /3 May 2009 USD 6 billion (JPN-PHL)USD 0.5 billion (PHL-JPN)

Japan-Malaysia USD/ringgit 5 Oct 2001 / 4 Oct 2007 USD 1 billion(b) (JPN-MYS)China-Thailand USD/baht 6 Dec 2001 / 5 Dec 2004 USD 2.0 billion (CHN-THA)Japan-China Yen/renminbi or renminib/yen 28 Mar 2002 /

27 Mar 2006USD 3.0 billion(a) (2-way)

China-Korea renminbi/won or won/renminbi 27 May 2005 /23 June 2007

USD 4 billion(a) (2-way)

Korea-Thailand USD/baht or USD/won 12 Dec 2005 /11 Dec 2007

USD 1 billion (2-way)

Korea-Malaysia USD/ringgit or USD/won 14 Oct 2005 /13 Oct 2008

USD 1.5 billion (2-way)

Korea-Philippines USD/peso or USD/won 17 Oct 2005 /16 Oct 2007

USD 1.5 billion (2-way)

China-Malaysia USD/ringgit 9 Oct 2002 / 8 Oct 2008 USD 1.5 billion (CHN-MYS)Japan-Indonesia USD/rupiah 31 Aug 2005 /

30 Aug 2008USD 6 billion (JPN-IDN)

China-Philippines renminbi/peso 30 Apr 2007 /29 Apr 2010

USD 2 billion(c) (CHN-PHL)

Japan-Singapore USD/Singapore dollarUSD/yen

8 Nov 2005 / 7 Nov 2008 USD 3 billion (JPN-SGP)USD 1 billion (SGP-JPN)

Korea-Indonesia USD/rupiah or USD/won 27 Dec 2006 /26 Dec 2009

USD 2 billion (2-way)

China-Indonesia USD/rupiah 17 Oct 2006 /16 Oct 2009

USD 4 billion (CHN-IDN)

Notes: (a) The amounts are US dollar equivalents.

(b) The amount excludes USD 2.5 billion committed (on 18 August 1999) under the New MiyazawaInitiative.

Source: Update of Table 5 in Kawai, Masahiro (2005a), “East Asian Economic Regionalism: Progressand Challenges”, Journal of Asian Economics 16:1, February.



One of the important features of the CMI BSA network is that membersrequesting liquidity support can immediately obtain short-term financialassistance for the first 20% of the committed amount. The remaining 80% isprovided to the requesting member under an IMF programme. Linking theCMI liquidity facility to an IMF programme – and hence its conditionality – is designed to address the concern that the liquidity shortage of a requestingcountry may be due to fundamental problems, rather than mere panic andherd behaviour by investors, and that the potential moral hazard problemcould be non-negligible in the absence of tough IMF conditionality.5 Thegeneral view is that, with the region’s currently limited capacity to produceand enforce effective adjustment programmes in times of crisis, linking CMIto IMF programmes is prudent, at least for the time being.6

ASEAN+3 Economic Review and Policy Dialogue. In May 2000,ASEAN+3 finance ministers agreed to introduce an ASEAN+3 ERPD,which became the most important information exchange mechanism oneconomic conditions and policies in East Asia. The purpose of ERPD is tocontribute to the prevention of financial crises through the early detection ofirregularities and vulnerabilities and the swift implementation of remedialpolicy actions. The mechanism is intended to facilitate information sharing,exchanges of views, and collaboration on financial, monetary, and fiscalissues of common interest. The ERPD process encompasses: (i) assessingglobal, regional, and national economic conditions; (ii) monitoring regionalcapital flows and currency markets; (iii) analysing macroeconomic andfinancial risks; (iv) strengthening banking and financial system conditions;and (v) providing an Asian voice in the reform of the international financialsystem. Steps have been taken for co-operation in monitoring short-termcapital flows and developing a regional early-warning system to assessregional financial vulnerabilities. Many ASEAN+3 members have set upnational surveillance units for economic and financial monitoring and aredeveloping their own early warning systems. More recently, the Group ofExperts (GOE) and the Technical Working Group on Economic andFinancial Monitoring (ETWG) were launched to explore ways and meansfor strengthening the region’s economic monitoring capacity. However,there is no single, independent, professional organisation which preparescomprehensive assessments of member countries’ economic performance(including analyses of risks, vulnerabilities, and appropriate policy options)or identifies key issues for discussion.7

There are other forums for regional economic information exchange,analysis and policy dialogue. They include: the ASEAN SurveillanceProcess for ASEAN finance ministers; the Executives’ Meeting ofAsia-Pacific Central Banks (EMEAP), South East Asian Central Banks(SEACEN), and South East Asia, New Zealand and Australia (SEANZA)



for central bank officials; and the APEC finance ministers and theAsia-Europe Meeting (ASEM) finance ministers for trans-regionalprocesses. See Table 1.3 for membership of these groups.

Table 1.3. Regional forums for finance ministries and central banksa

Finance ministries and/or central banks Central banksASEAN(10)

ASEAN+3(13)

MFGb

(14)APEC(21)

ASEMc

(43)SEANZA(20)

SEACEN (16)

EMEAP(11)

Year Established 1967 1999 1997 1994 1997 1956 1966 1991

JapanChinaKoreaHong Kong, ChinaChinese TaipeiSingaporeBrunei DarussalamCambodiaIndonesiaLao PDRMalaysiaMyanmarPhilippinesThailand

Viet NamMongoliaMacaoPapua New GuineaFijiAustralia,New ZealandIndia, PakistanNepal, Sri LankaBangladesh, IranUnited States,CanadaChile, Mexico, PeruRussiaEU-27

Notes: (a) ASEAN = Association of Southeast Asian Nations; MFG = Manila Framework Group; APEC =Asia-Pacific Economic Cooperation; ASEM = Asia-Europe Meeting; SEANZA = South East Asia, New Zealand,Australia; SEACEN = South East Asian Central Banks; EMEAP = Executives’ Meeting of East Asia-Pacific CentralBanks.

(b) MFG included the International Monetary Fund, the World Bank, the Asian Development Bank, and the Bankfor International Settlements. It was, however, terminated in December 2004.

(c) ASEM includes the ASEAN secretariat and the European Commission.

Source: Update of Table 2 in Kuroda, Haruhiko and Masahiro Kawai (2002), “Strengthening Regional FinancialCooperation in East Asia”, Pacific Economic Papers 51, October.



Asian Bond Markets Initiative. East Asian policy makers undertookinitiatives to develop Asian bond markets in view of the need to channel avast pool of savings to long-term investment for growth and developmentwithin the region. This effort reflects the recognition that the financialsystem in East Asia has been too dependent on bank financing domesticallyand on short-term, foreign-currency financing externally, and, hence, needsto become more balanced through the development of national and regionalcapital, in particular bond, markets. Development of well-functioning, localcurrency-denominated bond markets is expected to reduce incentives forborrowers to rely on bank financing and/or short-term external financing. Itis expected to mitigate the “double mismatch” problem (currency andmaturity mismatches) of international capital markets, i.e. borrowing shortterm in foreign currency and lending long term in domestic currency, and tomake national financial markets more resilient, with sound banking sectorsand more developed, deeper capital markets.

The ASEAN+3 finance ministers adopted the ABMI in August 2003 todevelop and deepen local currency-denominated bonds through supply-sidestimulus. The initiative intends to directly increase the supply oflocal-currency bonds and strengthen market infrastructure for local-currencybond issuance and trading. The six original voluntary ABMI working groupswere revised to four groups focused on developing new securitisedinstruments (particularly in multi-currency bonds), establishing a regionalcredit guarantee mechanism, exploring an Asian settlement system, andstrengthening Asian credit rating agencies while raising cross-countrycomparability of their ratings.

In addition to the ABMI, the EMEAP group introduced the Asian BondFund (ABF) project. The idea was to help expand the bond market throughdemand-side stimulus from purchases by central banks of sovereign andquasi-sovereign bonds using foreign exchange reserves. The initial ABF-1was launched in June 2003, and focused on purchases ofUS dollar-denominated bonds. ABF-2 was launched in December 2004,involving purchases of sovereign and quasi-sovereign localcurrency-denominated bonds. ABF-2 consists of two components: aPan-Asian Bond Index Fund (PAIF) and a Fund of Bond Funds (FoBF).PAIF is a single bond fund index investing in local currency bonds, issued ineight EMEAP emerging economies.8 FoBF has a two-tiered structure with aparent fund investing in eight sub-funds, each of which invests in localcurrency sovereign and quasi-sovereign bonds issued in their respectivemarkets. PAIF and the eight sub-funds are passively managed by privatefund managers against a pan-Asian bond index and predeterminedbenchmark indexes in local markets. ABF-2 is designed to facilitateinvestment by public and private sector entities.



ASEAN+3 Research Group. In addition to the three main initiativesoutlined above, a research group was set up in August 2003 to explore waysto further strengthen financial co-operation and promote financial stabilityby soliciting academic inputs from researchers and research think tanks inASEAN+3 countries. Research projects involved collaboration among majorresearch institutes and think tanks for the ASEAN+3 countries, with fundingprovided by the governments of China, Japan, and Korea to finance researchactivities by institutes of their own countries or those of ASEAN countries.Table 1.4 summarises the titles of the group’s research projects, which havevaried over time.

Table 1.4. ASEAN+3 Research Group activities

Year Research projects2003/2004 • Towards a Regional Financial Architecture for East Asia

• An Exchange Rate Arrangement for East Asia2004/2005 • Economic Surveillance and Policy Dialogue in East Asia

• Trade, Investment and Financial Integration in East Asia• Exploring Ways to Enhance the Functions of the Chiang Mai Initiative in the Medium Term• The Role of Private Sector Development in Regional Economic Growth and Financial

Integration2005/2006 • Liberalisation of Cross-Border Capital Flows and Effectiveness of Institutional Arrangements

against Crisis in East Asia• Fostering the Asset Management Industry for the Development of Capital Markets in the

Region• Regional Co-ordination of Policy Measures Forward: Financial Market Liberalisation and

Capital Market Development2006/2007 • Toward Greater Financial Stability in the Asian Region: Exploring Steps to Create Regional

Monetary Units• Financial Conglomeration in the East Asian Region: Recent Trends and Implications for

Regional Financial Market Development2007/2008 • Development of Database on Corporate Credit Information

• Development of Capital Market to Widen and Diversify SME Funding

Source: www.aseansec.org.

1.3. ASEAN+3 Economic Review and Policy Dialogue (ERPD)

Formal processes. The finance ministers’ process began in April 1999,with an annual meeting in which the 13 finance ministers discuss currenteconomic conditions, key policy challenges, and desirable policy actions.The ASEAN Secretary General and the ADB President provide briefstatements and engage in policy dialogue with the ministers. Policy dialoguetends to be spontaneous and often focuses on issues touched upon by thetwo presenters. The finance ministers’ meetings figure prominently in the



ASEAN+3 process because of the importance of their decisions on keyfinancial co-operation initiatives, including CMI and ABMI.

ASEAN+3 finance and central bank deputies hold two-day meetingssemi-annually. At the ERPD session, they exchange their views on global,regional, and individual country economic developments, various types ofrisks affecting the regional economies, and several policy options. ADB andthe IMF provide economic reports, thereby facilitating the deputies’ policydialogue, information sharing, and exchanges of views. External expertsprovide their views on certain thematic issues and engage in dialogue withthe deputies. Policy makers of individual countries provide only selfassessment of their own countries’ economic conditions. They do notconduct “peer reviews,” that is, they do not assess formally other countries’economic conditions and vulnerabilities nor do they recommend desirablepolicy changes of other countries.

The ASEAN+3 ERPD process could be more effective in several waysthat would enhance the quality of the dialogue. First, discussions could bemore frank, with officials freely debating their own and other countries’economic problems, vulnerabilities, and policy options to ensure goodpolicies for the region as a whole. Second, there could be an independent,professional organisation that prepares comprehensive papers for analyses,assessments, and discussion to support the process, while the ADB and IMFcurrently provide their views of the global and regional economy. Third,central bank governors could be more directly involved in the financeministers’ process, not simply and indirectly through their deputies’activities. Fourth, institutions with best knowledge and expertise onparticular issues – like the Bank of International Settlements (BIS) on globalbanking issues, the International Organization of Securities Commissions(IOSCO) on global capital market regulation, global rating agencies onsovereign risks, and other relevant institutions on particular topics – couldbe invited to the process on an ad hoc basis.

Integration of ERPD and CMI. The ASEAN+3 countries began areview of the CMI in May 2004, to consider the adequacy of both the size ofthe facility and the modality of its operation, as well as the appropriatenessof both the IMF linkage and the relationship with ERPD. The total size ofswap arrangements covered by CMI was considered to be small in view ofthe potential size of speculative capital flows and, hence, could provide amore appropriate level of protection if raised substantially. The bilateralnature of CMI was regarded as an impediment to its quick activation and,hence, the facility might be more effective if centralised for prompt jointactivation in the event of a crisis.9 The degree of the CMI’s linkage to IMFprogrammes was considered as tight and, hence, the CMI could be moreresponsive if the linkage were reduced or even eliminated with prudence as



the quality of regional ERPD was improved. Thus, for ASEAN+3 policymakers, CMI and ERPD should be linked, both in operation and inevolution.

In May 2005, a set of major agreements was reached to improve theeffectiveness of CMI and ERPD. These agreements were:

• integration and enhancement of ASEAN+3 ERPD into the CMIframework;

• enunciation of a clear definition of the CMI swap activationprocess and adoption of a collective decision-makingmechanism as a step toward CMI multi-lateralisation;

• significant increase in the size of bilateral swap arrangements;and

• increase in the level of BSA disbursement permitted without anIMF programme from 10% to 20%.

In May 2006, the finance ministers adopted the collectivedecision-making procedure for CMI swap activation, as a step towardmulti-lateralising the CMI. The ministers also tasked their deputies tofurther study various possible options toward an advanced framework forthe regional liquidity support arrangement – that is a multilateral CMI orpost-CMI arrangement. In May 2007, the finance ministers agreed inprinciple on a self-managed reserve pooling arrangement governed by asingle contractual arrangement as an appropriate form of CMImulti-lateralisation. They then instructed their deputies to carry out furtherstudies on the key elements of “self-managed reserve pooling” – includingsurveillance, reserve eligibility, size of commitment, borrowing quota, andactivation mechanism.

As ASEAN+3 continues to move towards developing a financingarrangement of large size that is centrally administered and ultimately moreindependent of the IMF, the nature of regional ERPD must also evolve. Thatis, the analytical capacity of the ASEAN+3 members to conduct effectiveeconomic review must improve substantially as this evolution takes place.Essentially, the region must acquire an ability to accurately assess economicand financial conditions of a country in or near crisis and to draft policyconditions associated with its liquidity support to a crisis country,independently of the IMF. As the capacity to conduct effective ERPDimproves, the nature of CMI may also evolve. There is thus a mutuallyreinforcing relationship between the evolution of ERPD and CMI.



1.4. Possible modalities of ERPD: information sharing, peer reviewsand due diligence

Good economic management requires objective assessments of acountry’s economic conditions and policies, identification of risks andvulnerabilities, analysis of pros and cons of various policy options, andselection and implementation of desirable policies. Any national authorityneeds to go through these exercises. Such a national effort can becomplemented by a joint review mechanism, which involves a group oflike-minded countries that are highly economically interdependent. Frankand candid exchanges of views, with mutual trust among these countries anda strong sense of collective action, can induce good policies that areconducive to national, regional, and global economic growth and stability.

There are three different modalities of ERPD depending on the level ofcommitment on the part of participating countries. These are: informationsharing; peer review and peer pressure; and due diligence. These threemodalities can be considered as evolutionary stages of ERPD in support offinancial co-operation and regional integration as other complementaryframeworks – such as regional financing arrangements and exchange ratepolicy co-ordination – evolve over time.

Information sharing. The weakest form of ERPD is simple informationsharing. Nonetheless, accurate and timely information concerningneighbours’ economic conditions, policy options, constraints, and objectiveswould be valuable; policy makers would be able to make well-informeddecisions. In addition, proactive information sharing would provide anopportunity for mutual learning. One country’s successful or failedexperiences can be useful for others in their policy making. Finally, frequentcontacts and meetings for policy dialogue would nurture a sense of trust andcommunity among participating countries and facilitate future co-ordinationfor possible joint action.

Information sharing is part of any higher-level ERPD because it canfacilitate more intensive policy dialogue, analyses, assessments, policyadvice, peer pressure, and due diligence. The G7 Finance Ministers andCentral Bank Governors process, the OECD processes (Economic PolicyCommittee, the Economic Development Review Committee, and WorkingParty 3), the European Union’s multilateral surveillance process (conductedby Economic and Financial Affairs Council [ECOFIN]), and the global,regional, and national surveillance conducted by the IMF all involveinformation sharing. The type of economic information to be collected andshared may differ depending on the objectives of ERPD. But generallyspeaking, they should include: (i) macroeconomic developments and policy



changes; (ii) financial market developments involving exchange rates,interest rates, capital flows, foreign exchange reserves, and banking sectorperformance; and (iii) institutional, legal, and regulatory reforms.

Peer review and peer pressure. The OECD process uses a frameworkof “peer review and peer pressure”. The OECD describes these concepts asfollows:

“Peer review can be described as the systematic examination andassessment of the performance of a State by other States, with theultimate goal of helping the reviewed State improve its policymaking, adopt best practices, and comply with establishedstandards and principles. The examination is conducted on anon-adversarial basis, and it relies heavily on mutual trust amongthe States involved in the review, as well as their shared confidencein the process. When peer review is undertaken in the framework ofan international organisation – as is usually the case – thesecretariat of the Organisation also plays an important role insupporting and stimulating the process. With these elements inplace, peer pressure tends to create, through this reciprocalevaluation process, a system of mutual accountability.” (OECD,2003)

“Peer pressure” can thus be characterised as the “influence andpersuasion exercised by the peers” during the peer review process (OECD,2003). The peer review process can give rise to peer pressure through, forexample: (i) a mix of formal recommendations by, and informal dialoguewith, the reviewing countries; (ii) public scrutiny, comparisons, and, in somecases, even ranking among countries; and (iii) the impact of all of the aboveon domestic public opinion, national administrations, and policy makers. Itis important to note that peer pressure does not take the form of legallybinding acts, sanctions, or other enforcement mechanisms. In essence, theobjective of “peer review and peer pressure” is, through a means of softpersuasion, to encourage each country to adopt good policies.

A good “peer review” is expected to have several features (Witherell,2004). First, it is a “policy dialogue among equals.” It is a “two-way, open,frank, and constructive dialogue” as opposed to a “one-way lecture” or a“hearing by a superior entity” that might deliver a binding judgment orpunishment. Second, it aims at “transparency”. While the process is“collegial, informal, and confidential” and can involve sensitive issues, thefinal outcome is usually made open to the public so that outsiders mayunderstand the nature of, and make comments on, the process. Third, it is a“non legally-binding” process. This feature is particularly suitable insituations where traditional enforcement mechanisms may, on occasion,



have the unintended and opposite effect of breeding animosity. Fourth, itrequires a high-quality secretariat. An effective peer review process requiresa very dedicated and specialised secretariat to conduct professional,objective, and neutral analyses and assessments and to make effective,realistic policy recommendations. The G7 process relies on the IMF, theOECD processes rely on the OECD, and the European Union process(Monetary Committee and ECOFIN) rely on the European Commission, fortheir respective secretariat functions.

Due diligence. Another form of ERPD is “due diligence”. It involvesassessments of a potential borrowing country through the lens of a potentiallender. The country’s ability to pay – its solvency and credit worthiness – becomes key issues. If an ASEAN+3 member affected by a currency attackand speculation requests short-term liquidity assistance within the CMIframework, the group must agree on whether it should provide liquidityassistance and, if it does, what conditions should be attached to suchassistance. As regional financial co-operation moves toward the creation ofan enhanced CMI that is more independent of the IMF, a moral hazard issueposes a strong case for the due diligence of potential borrowers, and for aclear need of enforcement mechanisms of necessary policy adjustment.

A good potential reference for “due diligence” would be the IMF’sArticle IV surveillance and programme conditions. The objective of IMFArticle IV surveillance is to “examine all aspects of the member’s economythat cause the exchange value to be what it is and to evaluate the economy’sperformance candidly for the entire membership” (Driscoll, 1996).10 Thissurveillance is based on the “conviction that strong and consistent domesticeconomic policies will lead to stable exchange rates and a growing andprosperous world economy.” This consultation itself does not involve anyenforcement mechanism, but every Article IV staff report is submitted forscrutiny and detailed discussions to the Executive Directors’ Board Meetingin Washington, thereby applying peer pressure to the country concerned.11

When a member country falls suddenly into serious economic difficulty or isbelieved to be following practices inimical to the interests of other members,the Managing Director may initiate additional consultations, which caninvolve more intensive assessments of the country. A strong enforcementmechanism sets in once the IMF provides liquidity assistance to a membercountry in a BOP or currency crisis. The IMF demands extensive flows ofinformation to perform “due diligence” and to intensify the monitoring ofthe borrower to ensure compliance with the conditionality during theprogramme period.

A “peer review and peer pressure” mechanism alone may not provide aneffective incentive for countries to commit themselves to such an intenseform of investigation. Possible provision of short-term liquidity assistance at



times of difficulties creates incentives for potential lenders to conduct a highlevel of scrutiny. Its availability provides incentives for potential borrowersto subject themselves to such scrutiny. This type of assessment of a potentialborrower (i.e. a developing or an emerging market economy) should beperformed with the notion that the country in question may be exposed tofuture difficulties or crises that would require liquidity assistance. Thispossibility could make ERPD one of “due diligence.” In contrast, ERPDwith a highly developed country would not be a “due diligence” typebecause chances are small that they would encounter a BOP or currencycrisis and request liquidity assistance. Nonetheless they must be subject tointensive scrutiny and peer pressure so that they pursue good policies thatcan contribute to regional and global economic stability.

Data requirements. Disclosure of adequate and timely information isessential to any successful ERPD. A country may be reluctant to disclose,even among the ASEAN+3 members, sensitive information onmacroeconomic, financial, and external issues. This reluctance must bemitigated. In an early warning system, the provision of timely information iscritical in providing lead times for policy corrections to be effective.Information accuracy is critical in formulating appropriate policy responses.Without adequate, accurate, and timely information, the quality of ERPDcan be severely damaged.

The IMF has introduced the Special Data Dissemination Standard(SDDS) and the General Data Dissemination System (GDDS), andestablished the Dissemination Standards Bulletin Board (DSBB).12 Byparticipating in these initiatives, countries’ ability to collect and disseminatestatistics has substantially improved. However, many low-incomeASEAN+3 countries are not SDDS subscribers. It is important for thesecountries to upgrade capacity to collect important economic statistics. Evenamong more advanced ASEAN+3 economies, standardising key economicindicators across the region is a significant challenge.

1.5. The role of private sector assessments

The ERPD process is intended to include rigorous mutual review andpolicy dialogue. How rigorous it will be in practice can be loosely gaugedagainst the risk assessment activities done by the private sector. That is,knowledge of private sector views is a natural credibility test. The privatesector viewpoint also matters because it can have an impact on economicperformance, especially through its ability to influence borrowing costs andcapital flows. Moreover, as regional economic integration proceeds andpolicy dialogue gradually evolves into policy co-ordination, an independentsupranational surveillance unit or professional secretariat may eventually



become desirable. That evolution can be guided by a greater understandingof the process by which the private sector formulates views on countries’economic health. At the same time, the limitations on use of private sectorinformation for good policy making should be recognised.

Common publicly available private sector indicators. Assessments ofeconomic performance are available to clients from a range of private sectorproviders including those firms that specialise in the provision of economicinformation and those – such as investment banks – for which it is a serviceto financial clients. Two widely available and related summary indicators ofeconomic performance provided by the private sector are the pure sovereignrisk indicator and the more general country risk indicator.13 The latterusually includes some assessment of the private business environment. Themost widely known sovereign issuer ratings are those done by the majorglobal ratings agencies: Standard & Poor’s (S&P), Moody’s, and Fitch.Table 1.5 gives ratings, as of early 2007, for selected East Asian economiesfrom these agencies. These ratings are accompanied by outlook guidance(negative, stable, and positive) that gives some indication of the likelihoodand direction of a ratings change.

Table 1.5. Current sovereign risk ratings on long-term external debt

Investment grade Speculative grade

Singapore Malaysia Thailand Philippines Viet Nam Indonesia

S&P’s AAA A- BBB+ BB- BB BB-

Fitch AAA A- BBB+ BB BB- BB-

Moody’s Aaa (AAA) A3 (A-) Baa1 (BBB+) B1(B+) Ba3 (BB-) B1 (B+)

Note: S&P and Fitch use similar letter systems. Moody’s uses a different system andMoody’s ratings are “converted” in parentheses to their S&P equivalents for this table.

Source: Bloomberg.

In addition, sovereign risk ratings are commonly maintained for internalpurposes by investment banks. Ratings (and rankings) based on an indexconstructed from semi-annual surveys are reported in the InstitutionalInvestor. The September 2006 Institutional Investor Credit Ratings for thecountries in Table 1.1 were Singapore, 91; Malaysia, 68.7; Thailand, 62.0;Philippines, 44.2; Viet Nam, 42.6; and Indonesia, 42.1; with 100 being aperfect credit score. There are several organisations – such as the EconomistIntelligence Unit (EIU) and Global Insight – that provide country riskratings purely as a service for fee. The ratings are usually a part of a largerpackage of economic data, macroeconomic forecasts, and macroeconomic



reports. Industry-specific and other special topic reports are also frequentlyprovided.

Whereas country risk ratings can, in principle, influence directinvestment, sovereign risk ratings more closely influence public borrowingcosts – especially the sovereign spread on foreign debt, which serves as abenchmark for private sector external borrowing. Of course, other factorsalso impact the sovereign spread, which is currently noticeably compressedfor emerging markets because of strong investor demand for higher yields ina low US long-term interest rate environment. In Figures 1.1-1.4, long-termforeign borrowing sovereign ratings and sovereign spread trends are plottedfor four Southeast Asian economies. For Malaysia, both ratings and spreadsare relatively stable. For Indonesia, generally declining, though volatile,spreads are associated with improving ratings. For Thailand, stable spreadshave accompanied improving ratings. In contrast, spread compression in thePhilippines occurred after a ratings downgrade. Thus, a sharply narrowingspread does not necessarily indicate an upgraded private sector view ofcountry-specific economic fundamentals or sovereign financial health.

Figure 1.1. EMBI global sovereign spread vs. credit rating (Indonesia)

0

100

200

300

400

500

600

2-Jan-03 28-May-03 20-Oct-03 16-Mar-04 6-Aug-04 31-Dec-04 25-May-05 18-Oct-05 15-Mar-06 4-Aug-06 28-Dec-06

EMBI Global stripped spread (bps)

S&P Long term sovereign rating

BB

CCC

CCC

B-

B

B+

BB-

BBB-

BB+

A

A-

BBB+

BBB

Source: Morgan Markets and Bloomberg.



Figure 1.2. EMBI global sovereign spread vs. credit rating (Malaysia)

0

100

200

300

400

500

600




BBB-

A

A-

BBB+

BBB

BB

CCC

CCC

B-

B

B+

BB-

BB+


Figure 1.3. EMBI global sovereign spread vs. credit rating (Philippines)

0

100

200

300

400

500

600




BB

B-

B

B+

BB-

BBB-

BB+

CCC

CCC

A

A-

BBB+

BBB




Figure 1.4. EMBI global sovereign spread vs. credit rating (Thailand)

0

100

200

300

400

500

600




BB

BBB-

BB+

A-

BBB+

BBB

A

B-

B

B+

BB-

CCC

CCC


Private sector assessments. Although approaches vary from institutionto institution, there are commonalities. Table 1.6, which provides a list ofindicators used to evaluate sovereign risk by Standard and Poor’s, isillustrative.14

Several observations can be made about the general private sectorapproach: First, if the objective is a risk assessment, then the end result isoften a single probabilistic indicator, rating, or ranking. This is by necessityand is in general contrast to economic review or surveillance activities doneby international organisations such as the ADB and IMF. This simplicity isboth a strength and weakness of the private sector approach to riskassessment. The need for cross-country comparability and demonstrableobjectivity imposes such a simple but systematic approach. At the sametime, users of the end result may miss the depth of assessment that wassimplified into a single number.



Table 1.6. Standard & Poor’s sovereign ratings methodology profile

Political risk Offshore and contingent liabilities• Stability and legitimacy of political institutions • Size and health of non-financial public sector

enterprises• Popular participation in political processes • Robustness of financial sector• Transparency in economic policy decisions

and objectivesMonetary flexibility

• Public security • Price behaviour in economic cycles• Geopolitical risk • Monetary and credit expansion

Income and economic structure • Compatibility of exchange-rate regime andmonetary goals

• Prosperity, diversity, and degree to whicheconomy is market-oriented

• Institutional factors such as central bankindependence

• Income disparities • Range and efficiency of monetary policytools

• Effectiveness of financial sector inintermediating funds; availability of credit

External liquidity

• Competitiveness and profitability ofnon-financial private sector

• Impact of fiscal and monetary policies onexternal accounts

• Efficiency of public sector • Structure of the current account• Protectionism and other non-market

influences • Composition of capital flows

• Labour flexibility • Reserve adequacyEconomic growth prospects Public sector external debt burden

• Size and composition of savings andinvestment

• Gross and net public sector external debt,including deposits and structured debt as apercent of current account receipts

• Rate and pattern of economic growth • Maturity profile, currency composition, andsensitivity to interest-rate changes

Fiscal flexibility • Access to concessional funding• General government revenue, expenditure,

and surplus/deficit trends• Debt service burden

• Revenue-raising flexibility and efficiency Private sector external debt burden

• Expenditure effectiveness and pressures• Gross and net financial sector external debt,

including deposits and structured debt, as apercent of current account receipts

• Timeliness, coverage, and transparency inreporting

• Gross and net non-financial private sectorexternal debt, including structured debt as apercent of current account receipts

• Pension obligations • Maturity profile, currency composition, andsensitivity to interest-rate changes

General government debt burden • Access to concessional funding• General government gross and net (of assets)

debt as a percent of GDP• Share of revenue devoted to interest• Currency composition and maturity profile• Depth and breadth of local capital markets

Source: www.standardandpoors.com.



Second, as with the IMF, the depth of the assessment arises from abroad review of economic performance with several indicators used toassess performance in each category. In the case of country risk ratings, thisalso includes a thorough review of the business environment. In anycategory, a focus on a single indicator could mask vulnerabilities. It isimportant in considering the strength of public finances, for example, tolook at both stock (debt) and flow (deficit) indicators, at contingent as wellas explicit liabilities, and at the flexibility or rigidity of the policy optionsavailable to policy makers to adjust to unexpected events. Take the cases ofIndonesia and Viet Nam, for example, which have similar sovereign riskratings. Indonesia has a higher debt burden but a lower deficit.

Third, the methodology is as standardised as possible but still uses bothquantitative and qualitative assessments. Comparators (similarly ratedcountries) are heavily used to help anchor the qualitative assessment.Nonetheless, the process of internal debate among the staff of the ratingsunit is an important component of the final rating. The collective experienceof the staff is brought to bear as the relative strengths and weaknesses of aneconomy are weighed against its comparators. There is no set formula. Thatthe major ratings agencies usually assign very similar rankings to countriesis perhaps indicative of systematic approaches but that the ratings can differshows that individual judgment still matters. Looking back at Table 1.4, it isthe speculative grade economies in which differences in ratings arise. Forexample, Moody’s is apparently more pessimistic and Fitch more optimisticthan S&P about macroeconomic fundamentals and the health of publicfinances in the Philippines. In instances where risks are higher, professionaljudgment plays a larger role.

Fourth, the focus and emphasis of private sector assessment activitiesvaries. In the case of risk ratings, the analysis is as forward-looking aspossible while remaining anchored to underlying fundamentals rather thanrecent high-frequency trends. Thus, sovereign and country risk ratingsseldom change quickly or sharply – unless in a situation of rapidly changingconditions such as a crisis. However, more general assessments conductedfor reports and provided to clients by investment banks and informationservices can be done with monthly, even weekly frequency and are, thus,continuously evolving. As such, they can provide useful real-time marketviews of economic performance and the expected market impact of eventsand policy changes. However, these reports can also sometimes becomemyopically focused on transitory market trends rather than long-termsustainability.

Fifth, there are no taboo subjects in the private sector. Political risks areexplicitly evaluated precisely because they can heavily influence economicperformance and the probability of default. Perhaps one of the main



strengths of private sector assessments is a greater willingness to attemptobjective evaluations of political processes and their potential impact on thequality of public policy. Here, too, however, a systematic approach is soughtand the empirical link between the political process, policy formation, andmacroeconomic stability is stressed. The uncertainty surrounding animpending election, for example, can increase the risk of default, especiallyif there is a possibility of a sharp adverse change in macroeconomic policy(Manasse and Roubini, 2005). Conversely, the election of a “marketfriendly” government with a decisive majority can reduce perceived risks.More subtly, if sound macroeconomic polices are viewed as firmlyanchored, ratings can be higher relative to countries with similar economicindicators. This was the case in Eastern Europe for countries that were in theprocess of joining the European Union. To a lesser extent, Mexico appearsto have enjoyed higher ratings and lower external borrowing costs as a resultof expectations that North American Free Trade Agreement (NAFTA)would lock in a stable policy framework.

Sixth, in common with the IMF, private sector assessors evaluate thequality of information available and quite often supplement it with their ownestimates. Two examples where there is particular scrutiny are the estimatesof contingent fiscal liabilities and of non-performing loans. Indeed, greatuncertainty about the true level of liabilities can increase the perceived risk.In some cases, the private sector may even overestimate the extent ofvulnerability. Cady and Pellechio (2006) provide evidence that adherence tothe SDDS and participation in the GDDS can reduce sovereign borrowingcosts. This can, in turn, reduce corporate borrowing costs. Thus, not onlydoes the private sector compensate for poor provision of data, it provides apayoff to the public sector for disclosing better information.

Role of private sector in regional ERPD. Regional ERPD activitiescan benefit from inputs from the vast experience of multilateral institutionssuch as the IMF and ADB. These institutions often have access toinformation and opportunities for dialogue with policy makers unavailableto the private sector. Yet, the private sector contribution to regional ERPD ispotentially quite large. The systematic approach to assessment, and theimportance of both quantitative and qualitative professional assessment,especially where risks are high, can be adapted to regional ERPD. Yet, eventhose elements of private sector assessments that would be more difficult toadopt – such as evaluations of political risk, the use of risk ratings andrankings, and the augmentation of public data – can strengthen the regionalERPD process for due diligence. At the same time, the limitations ofprivately provided assessments should also be recognised. In someinstances, the need for concise indicators masks the richness of the analysis.In other cases, the high-frequency nature of the analysis can over-emphasise



temporary trends. Moreover, just as the assessments of multilateralinstitutions are vulnerable to the influence of large members, that of privateagencies might be affected by relations with large clients. With thesequalifications in mind, regional policy makers would benefit from dialoguewith providers of private sector assessments.

1.6. Enhancing the effectiveness of ASEAN+3 ERPD

From “information sharing” to “peer reviews” and “due diligence.”Currently the ASEAN+3 ERPD process is in transition from the informationsharing stage to the next stage of a more rigorous scrutiny stage, which musteventually involve some form of due diligence. Despite improved financialconditions over the last ten years since the 1997–98 crisis, a speculativecurrency attack or crisis contagion can take place at any time in the region.Once an ASEAN+3 member faces a liquidity shortage or currency crisis, itsauthorities are expected to request CMI counterparts for liquidity assistancewithin the current CMI framework. In order to respond to such anemergency event promptly, the group must have a clearly defined procedureof CMI activation and a capacity to draft necessary policy conditions forliquidity assistance within a short period of time. This requirement will begreater as ASEAN+3 is moving to create an enhanced, multi-lateralisedCMI that is more independent of the IMF. It is thus essential that theASEAN+3 group begin to consider how to build its capacity and willingnessto conduct objective due diligence.

As ASEAN+3 is already past a simple information sharing stage, thegroup’s current focus is on strengthening the ERPD process. Key elementsof an effective ERPD are: (i) collection of timely and reliable data – some athigh frequency and others at lower frequency; (ii) conducting objective andneutral analyses and assessments of member economy conditions, policies,risks, and vulnerabilities; (iii) identification and assessments of variouspolicy options to reduce risks and vulnerabilities; and (iv) introduction of amechanism to induce the country in question to take appropriate policyactions. The immediate objective for ASEAN+3 is, in essence, to improvethe quality and effectiveness of ERPD.

Critically, the ERPD process needs to put more emphasis on technicalanalysis and to create an environment for serious policy debate (Grenville,2003). This means adopting an appropriate balance between the traditionalpresumption of non-interference in domestic affairs of another country onthe one hand and the new challenge of rigorously scrutinising economic andfinancial conditions, risks, and policies of the country on the other. Theprocess must encourage frank and candid discussions on the technical



substance without being abrasive and confrontational. The ingredient thatwill nurture this process is mutual trust.

Linkage between CMI and ERPD. Table 1.7 details the manner inwhich progress on strengthening CMI and the effectiveness of ERPD arelinked. If the current CMI – with a strong IMF linkage – is expected toremain as is, the ERPD mechanism may not need to go beyond achieving aneffective economic review and peer pressure stage. However, if the currentCMI is to be transformed into an enhanced CMI—with a centrallyadministered reserve pooling arrangement that is independent of the IMF – the ERPD process must increasingly contain the element of due diligence.The reason is that the ASEAN+3 group must address the generally heldconcern that a financing arrangement that could lend too generously withtoo little conditionality might create moral hazard for the government at thereceiving end as well as for private investors with stakes in the affectedeconomy. To minimise moral hazard, it is essential to put in place aneffective ERPD, improve the capacity to formulate appropriate policychanges in the event of a liquidity crisis, and enforce needed policyadjustment.

Table 1.7. Linkage between CMI and ERPD

Financing arrangement ERPD Needed capacity RecommendationsCurrent CMI (with a tightIMF linkage)

• Informationsharing

• Economicreviews andpeer pressure

Objective, neutralanalyses ofcountry economicconditions,assessments ofrisks andvulnerabilities, andpolicy advice

• Involve central bankgovernors

• Invite other internationalinstitutions and theprivate sector

• Introduce “peer reviews”Enhanced CMI (with aloose IMF linkage)

• Peer reviewand peerpressure

• Elements ofdue diligence

• Develop capacity toformulate independentpolicy conditionality

• Prepare steps to createan independentsecretariat

Independent, centralisedreserve poolingarrangement

• Peer reviewand peerpressure atnormal timesand duediligence atcrisis times

Ability to formulateindependentconditionality

• Establish a full-fledgedsecretariat forfacilitating ERPD anddrafting independentconditionality

Source: Author’s compilation.



Thus, a logical step is to explore the possibility of introducing duediligence to the ERPD process. To initiate this, the group should reviewsome key considerations. First, the establishment of an independentsecretariat, which may be desirable for an effective ERPD, is perhapsincreasingly important for a due diligence mechanism. A professionalsecretariat can produce high-quality country reports, ensuring that allinvolved with lending decisions have a basic, thorough familiarity with theeconomic conditions of potential borrowers. In addition, to draft policyconditions in the event of a member requesting CMI support, substantialinputs from an independent, professional secretariat would be indispensableand desirable for political reasons.15 If charged with regular monitoring ofmember countries, the secretariat would be better able to guard against thedanger of losing sight of long-term fundamental issues in drafting theseconditions – intended to ensure short-term macroeconomic stability – in themidst of a crisis.

Second, a better mechanism needs to be introduced to apply peerpressure on each member country so that each country’s policy makers mayadopt good policies and, if necessary, change policies to reduce economicand financial vulnerabilities. For this purpose, introducing a “peer reviewand peer pressure” mechanism should be seriously considered. A keyelement of a successful “peer review” mechanism is thought to be the abilityto engage in frank discussions among equals with mutual respect and trust.It is inherently a symmetric process. At the same time, an effective “peerreview and peer pressure” mechanism built on trust can facilitate the sharingof common views on best practice policies. Such policies that gainlegitimacy today may be easier to enforce as elements of a programmetomorrow. And, the expectation that a policy package that is needed but ispolitically difficult to be accepted at normal times may be imposed aslending conditions at a crisis time may spur needed action earlier.

Third, the relationship between the “peer review and peer pressure” andthe “due diligence” mechanisms should be carefully considered. While the“peer review” mechanism needs to maintain symmetry among countries, the“due diligence” mechanism introduces possible asymmetry between thepotential lender and borrower. If these mechanisms are used at the sametime, there is a clear need to take a good balance between the two. The keyto ensuring a successful balance between the two is to create an appropriateinstitutional structure. For example, an independent secretariat wouldfacilitate the “peer review and peer pressure” exercise among membercountries at normal times, while it could be directly involved with the duediligence function at crisis times.

Greater institutionalisation. A technically competent secretariat thatsupports ASEAN+3 ERPD might be modest in size initially. In normal



times, the secretariat would monitor regional and country economicconditions, regional capital flows, and financial and exchange marketdevelopments through various tools including early warning indicators. Agood “peer review and peer pressure” mechanism should work effectively.At the time of a crisis or contagion, the secretariat, sometimes workingclosely with the IMF depending on the scale and magnitude of the problem,would make financial needs assessments, produce a policy adjustmentpackage as lending conditionality, encourage the affected country’sauthorities to implement needed policies, and monitor policyimplementation and progress during its intervention.

If and when the modality of CMI becomes more independent of theIMF, the secretariat will have to perform its own functions with greaterindependence, including the production of country review papers, provisionof liquidity assistance, and drafting of policy conditions associated withfinancing. If the regional economies can eventually delegate full authority tothe secretariat to conduct these tasks effectively and if the secretariatacquires adequate capacity to do so, it is reasonable to completely delink theCMI financing arrangement from the IMF. Thus, although the secretariatwould not have to be a highly bureaucratic institution at least initially, itcould be expected to become a more structured organisation as its tasksbecome more demanding over time.16

The ASEAN+3 ERPD process is currently designed for financeministers, while central banks participate only in preparatory meetings – atthe deputies’ level – for ASEAN+3 finance ministers. However, given theimportant operational role of central banks in extending liquidity support attimes of crisis and their potential role in conducting high-quality ERPD,their governors should be fully involved with the ASEAN+3 process,especially the “due diligence” aspects of the process. The experience fromEuropean economic integration suggests that analytical expertise andoperational knowledge of central banks are essential to financialco-operation. Involving central bank governors is useful not only to ensureco-ordination between finance ministers and central bank governors but alsoto strengthen central bank ownership of the process.

While the ADB is the only international financial institution thatconducts policy dialogue with the ASEAN+3 finance ministers, the IMF, inaddition to the ADB, is now a regular policy dialogue partner for theASEAN+3 deputies’ process. Close dialogue with the IMF is particularlyimportant at least initially because of the need to link the CMI disbursementto the IMF at times of crises and contagion (if the disbursement exceeds20% of committed amounts). Even at a later stage, the IMF’s input on theglobal surveillance part is quite useful. In fact, many other institutions andorganisations with international best expertise, such as the World Bank, BIS,



OECD, IOSCO and others, may be invited, as appropriate, at least to part ofthe process for discussions with the finance and central bank deputies. Inaddition, an ASEAN+3 Secretariat may consider having staff join the IMF’sannual Article IV consultation mission as well as the IMF-World BankFinancial Sector Assessment Program (FSAP) mission to the regionalmembers.

At the same time, policy dialogue with private sector analysts would behighly recommended. Indeed, participation of the private sector is essentialto the success of ASEAN+3 financial co-operation, because it is privatesector activity that promotes financial market development and strengthensregional economic and financial interdependence. For this purpose, theprivate sector of ASEAN+3 is encouraged to establish a Private SectorAdvisory Committee (PSAC), modelling after the Business and IndustryAdvisory Committee (BIAC) for the OECD. Being located closely to eachother, the ASEAN+3 Secretariat and the PSAC can intensify mutualdialogue for greater regional integration.

1.7. Conclusion: challenges ahead

Since the Asian financial crisis, the ASEAN+3 group has developed itsfinance ministers’ process supported by their finance and central bankdeputies and various working groups. This process is a forum both forpolicy dialogue among the ministers and among their deputies to achieveregional financial stability, and for concrete collective action to provideregional public goods – through such initiatives as CMI and ABMI.ASEAN+3 ERPD is an important part of policy dialogue and is increasinglybecoming an integral part of the whole financial co-operation processbecause of its recent integration with the CMI framework. ERPD is intendedto encourage good economic policies at the national level through “peerreview and peer pressure” and, at the same time, strengthen the regionalreserve pooling arrangement.

Over the last few years, the quality and depth of ERPD discussions atthe deputies’ level has improved partly thanks to the economic reviewsprovided by international financial institutions – such as the ADB and IMF – and external experts. Nonetheless, ASEAN+3 ERPD is still in its infancystage in terms of “peer review and peer pressure” in comparison to therenowned “peer review” mechanism developed by the OECD – such as theEconomic Development Review Committee (EDRC) and the EconomicPolicy Committee (EPC). It is also in its infancy in terms of “due diligence”in comparison to “surveillance” mechanisms employed by the IMF throughits Article IV consultations.



This chapter has argued that the regional ERPD activities must evolvetogether with the other aspects of regional financial co-operation. Certainly,the region must make a concerted effort to move beyond the “informationsharing” stage to a more rigorous review stage, possibly in the form of aformal “peer review and peer pressure” mechanism. Further, if the CMI is tobe significantly enhanced, the ERPD process must take an additional stepinto a “due diligence” mechanism. In this final stage, assessments of acountry’s economic performance and policies need to be done through thelens of potential creditors – to ensure that the borrowing country will makeappropriate policy adjustment, restore financial stability and health, and beable to repay loans provided during a crisis time. A workable balance willthus need to be found between the equality among the “peer review”participants and the asymmetry of the creditor/borrower relationship under“due diligence”. The challenges along the way are both political andtechnical. Politically, the realisation of mutual benefit must bring aboutgreater mutual trust and willingness to participate in a rigorous process thatincludes discussing sensitive topics and delegating responsibility andauthority to a new institution – a professional secretariat tasked with makingindependent evaluations. Technically, that institution must develop theprofessional expertise to accomplish such a mission and inspire confidencein its assessments. It must also be able to enhance the capacity of lessdeveloped members to provide the appropriate information required to makeadequate assessments and to participate in meaningful dialogues about thoseassessments.



Notes

1. The ten members of the Association of Southeast Asian Nations areBrunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar,Philippines, Singapore, Thailand, and Viet Nam.

2. See Kuroda and Kawai (2002), Bird and Rajan (2002), Henning (2002),Montiel (2004), Rajan and Siregar (2004), Girardin (2004a, 2004b) andKawai (2005a, 2005b) for a review of recent initiatives of ASEAN+3finance ministers.

3. The ASA, established in August 1977 by the members of the original fiveASEAN countries, with a total facility of USD 100 million, wasaugmented to a total of USD 200 million in 1978. Under the CMI, ASAmembership was extended to include all ASEAN members, and itsfacility was further augmented to USD 1 billion. It was agreed inApril 2005 to further augment ASA to USD 2 billion. Note the ASA is amultilateral swap arrangement.

4. In July 1999, the Japanese Ministry of Finance committed to providing upto USD 2.5 billion liquidity to Bank Negara Malaysia, if and whennecessary, through swap transactions between the US dollar and theringgit, www.mof.go.jp/english/if/kousou.htm.

5. The IMF uses “conditionality” in designing its loans and requiresborrowers to meet a set of conditions.

6. Some ASEAN+3 members, such as Malaysia, believe that the CMIshould not be linked to IMF programmes.

7. The ASEAN secretariat provides some logistic support to the ASEAN+3ERPD process. ADB provides a statement and a paper for discussion atthe meetings of finance ministers and of finance and central bankdeputies, respectively. The IMF, which formerly played the role of asecretariat for the Manila Framework Group (MFG), has beenparticipating in the ASEAN+3 deputies’ process on ERPD sinceNovember 2005.

8. These economies are: China; Hong Kong, China; Indonesia; Korea;Malaysia; Philippines; Singapore and Thailand.



9. Rajan and Siregar (2004) go one step further and propose to establish acentralised reserve pooling system.

10. In the IMF’s early years, periodic Article IV consultations weremandatory only for members with restrictions on currency exchange, butsince 1978 the IMF undertakes them with all member countries (Driscoll,1996).

11. The IMF promotes “transparency” by encouraging each member countryto agree to placing the Article IV consultation report on the IMF website.

12. The SDDS was established in March 1996 to guide countries that have, orthat might seek, access to international capital markets in thedissemination of economic and financial data to the public. The GDDSwas established in December 1997 to guide countries in the provision tothe public of comprehensive, timely, accessible, and reliable economic,financial, and socio-demographic data.

13. There is also a large and growing list of more specialised indicatorsincluding indices of economic freedom (e.g. from the HeritageFoundation, www.heritage.org); political risk (e.g. from Political RiskServices, www.prsonline.com); competitiveness (e.g. from the WorldEconomic Forum, www.weforum.org); business environment (e.g. fromthe World Bank, www.doingbusiness.org); and corruption (e.g. fromTransparency International, www.transparency.org).

14. See Standard & Poor’s Sovereign Credit Ratings: A Primer, available atRatingsDirect. A more comprehensive discussion is available in Bhatia(2002).

15. On the other hand, if CMI creditor countries themselves produce“conditionality,” there is a risk that it may be perceived to serve thenational interest of particular creditor countries, rather than the financialand economic stability of the crisis-hit country and the region as a whole.“Conditionality” drafted by an independent secretariat can substantiallyreduce such a risk.

16. Such a secretariat should be established in a qualified host country, whichis politically and socially stable and is well equipped with socialinfrastructure. The location should hence be highly attractive to a largenumber of international experts and professionals in the globalcommunity.



Bibliography

ASEAN (1999), Joint Statement on East Asia Cooperation, ASEAN+3Summit, November, www.aseansec.org.

Bhatia, Ashok Vir. (2002), “Sovereign Credit Ratings Methodology: AnEvaluation”, IMF Working Paper WP/02/170, October, InternationalMonetary Fund, Washington, DC.

Bird, Graham and Ramkishen S. Rajan (2002), “The Evolving AsianFinancial Architecture”, Essays in International Economics 226,February, International Economics Section, Princeton University,Princeton.

Brouwer, Gordon De (2003), “IMF and ADB Perspectives on RegionalSurveillance and Financial Cooperation in East Asia”, inBrouwer, Gordon De and Yunjong Wang (eds.), Financial Governancein East Asia: Policy Dialogue, Surveillance and Cooperation, RoutledgeCurzon, London, Chapter 3.

Brouwer, Gordon De and Yunjong Wang (2003), “Policy Dialogue,Surveillance and Financial Cooperation in East Asia”, inBrouwer, Gordon De and Yunjong Wang (eds.), Financial Governancein East Asia: Policy Dialogue, Surveillance and Cooperation, RoutledgeCurzon, London, Chapter 1.

Cady, J. and A. Pellechio (2006), “Sovereign Borrowing Cost and the IMFData Standards Initiatives”, IMF Working Paper WP/06/78, InternationalMonetary Fund, Washington, DC.

Driscoll, David D. (1996), “What Is the International Monetary Fund”,External Relations Department, International Monetary Fund,Washington, DC.

Eichengreen, Barry (2004), “Hanging Together? On Monetary and FinancialCooperation”, in Yusuf, Shahid et al. (eds.), Global Change and EastAsian Policy Initiatives, World Bank and Oxford University Press,Washington, DC and New York, pp. 25–62.



Girardin, Eric (2004a), “Information Exchange, Surveillance Systems andRegional Institutions in East Asia”, in Asian Development Bank (ed.),Monetary and Financial Integration in East Asia: The Way Ahead,Volume 1, Palgrave MacMillan, Houndmills and New York, pp. 53–95.

Girardin, Eric (2004b), “Methods of Information Exchange and Surveillancefor Regional Financial Cooperation”, in Asian Development Bank (ed.),Monetary and Financial Integration in East Asia: The Way Ahead,Volume 2, Palgrave MacMillan, Houndmills and New York,pp. 331-363.

Grenville, Stephen (2003), “Policy Dialogue in East Asia: Principles forSuccess”, in Brouwer, Gordon De and Yunjong Wang (eds.), FinancialGovernance in East Asia: Policy Dialogue, Surveillance andCooperation, Routledge Curzon, London, Chapter 2.

Henning, Randall C. (2002), “East Asian Financial Cooperation”, PolicyAnalyses in International Economics, No. 68, September, Institute forInternational Economics, Washington, DC.

Kawai, Masahiro (2005a) “East Asian Economic Regionalism: Progress andChallenges”, Journal of Asian Economics 16:1, February, pp. 29–55.

Kawai, Masahiro (2005b), “Regional Economic Integration andCo-operation in East Asia”, in Fukasaku, Kiichiro et al. (eds), PolicyCoherence towards East Asia: Development Challenges for OECDCountries, OECD, Paris, pp. 289–345.

Kuroda, Haruhiko and Masahiro Kawai (2002), “Strengthening RegionalFinancial Cooperation in East Asia”, Pacific Economic Papers 51,October.

Kydd, A. (2000), “Trust, Reassurance and Cooperation”, InternationalOrganization 54:2, spring, pp. 325–357.

Manasse, P. and N. Roubini (2005), “‘Rules of Thumb’ for Sovereign DebtCrises”, IMF Working Paper WP/05/42, International Monetary Fund,Washington, DC.

Manupipatpong, Worapot (2002), “The ASEAN Surveillance Process andthe East Asian Monetary Fund”, ASEAN Economic Bulletin 29:2, April.

Manzano, George (2001), “Is There Any Value-added in the ASEANSurveillance Process?” ASEAN Economic Bulletin 18:1, April, pp. 94–102.



Montiel, Peter J. (2004), “An Overview of Monetary and FinancialIntegration in East Asia”, in Asian Development Bank (ed.), Monetaryand Financial Integration in East Asia: The Way Ahead, Volume 1,Palgrave MacMillan, Houndmills and New York, pp. 1–52.

OECD (2003), “Peer Review: An OECD Tool for Cooperation andChange”, OECD Policy Brief, December, Paris.

OECD (2007), “Peer Review: A Tool for Co-operation and Change”, OECDPolicy Brief, January, Paris.

Rajan, Ramkishen and Reza Siregar (2004), “Centralized Reserve Poolingfor the ASEAN+3 Countries”, in Asian Development Bank (ed.),Monetary and Financial Integration in East Asia: The Way Ahead,Volume 2, Palgrave MacMillan, Houndmills and New York, pp.285-329.

Wang, Yunjong and Wing Thye Woo (2004), “A Timely InformationExchange Mechanism, an Effective Surveillance System, and anImproved Financial Architecture for East Asia”, in Asian DevelopmentBank (ed.), Monetary and Financial Integration in East Asia: The WayAhead, Volume 2, Palgrave MacMillan, Houndmills and New York,pp. 426–458.

Witherell, William (2004), “International Cooperation for DomesticFinancial Reform: A Peer Review Model for APEC/PECC?”, paperpresented to the PECC meeting, June, Santiago.

2. THE ROLE OF PEER REVIEWS IN APEC – 99


Chapter 2. The Role of Peer Reviews in APEC*

2.1. Introduction

Peer review in the OECD has a long history; one that we in APEC havedrawn on as we have developed our peer review processes. APEC,Asia-Pacific Economic Cooperation, was established in 1989 to bringtogether economies around the Pacific to discuss economic co-operation – its inaugural meeting was in Canberra that year.1

In this chapter I will first describe briefly APEC: membership, goals andmeans to achieve these goals. I will then go on to describe the process ofpeer review in APEC, concentrating on how peer review is used to trackthese goals. Finally I will offer a few reflections on peer review and howthis assists regional integration within the APEC context.

2.2. APEC – membership and Bogor Declaration

APEC membership

The Asia-Pacific Economic Co-operation, APEC, was established as aregional forum to discuss matters of economic co-operation. Since itsfoundation in 1989 it has grown to encompass 21 economic entities(“economies” in APEC jargon) with borders around the Pacific SoutheastAsia: Brunei Darussalam; Indonesia; Malaysia; the Philippines; Singapore;Thailand; and Viet Nam: Northeast Asia: China; Hong Kong, China; Japan;Korea; and Chinese Taipei; Russia can also be included in that geographicalterm through its Pacific coastline; Australasia: Australia; New Zealand; andPapua New Guinea; the Americas: Canada; Chile; Mexico; Peru; and theUnited States. As you can see the economies are very diverse – from thevery large in terms of population/gross national product (GNP) to the very

* This chapter was written by Geoffrey Woodhead, Director (Finance),Asia-Pacific Economic Co-operation (APEC) Secretariat.

100 – 2. THE ROLE OF PEER REVIEWS IN APEC


small; from the highly developed through what the Economist likes to callemerging economies to some of the least developed. In terms of peer reviewthis diversity can pose a challenge.

APEC works through its annual meetings of Ministers and, since 1993,its annual APEC Economic Leaders Meetings. There are fora within APECwhich discuss specific areas of co-operation and which through small-scaleprojects attempt to further the goals of APEC.

Bogor Declaration

In 1994 APEC Economic Leaders agreed in the Bogor Declaration to acommon goal of free and open trade and investment in the Asia-Pacificregion – by 2010 for industrialised economies and 2020 for developingeconomies. These targets are known as the Bogor Goals. The BogorDeclaration gave a sharp focus to the vision of regional economicintegration which had driven the creation of APEC. It also reflected thebasic principles of APEC co-operation: voluntary participation,comprehensiveness, mutual respect and consensus-based decision-making.These are very relevant principles in terms of peer review in APEC.

The Bogor Goals are dynamic; the international trade agenda hasbroadened since 1994 and so with it has the scope of the Bogor Goals toinclude not only border issues directly related to trade liberalisation, but alsofacilitation and behind-the-border issues such as standards and conformance,customs procedures, e-commerce and business mobility.

Individual Action Plans

It is important for APEC to track its progress towards the Bogor Goals.Each economy prepares an Individual Action Plan (IAP), a kind ofself-reporting, to mark the steps it has taken and intends to take to achievethe Bogor Goals. The IAPs are quite detailed – in very small font; that forAustralia, for instance, takes up a large box file. The areas covered and theissues chosen for inclusion within the peer review are shown in Annex 2.A1.

The IAPs are updated annually to take account of developments:typically each year each IAP shows improvements in several areas. TheAPEC Secretariat provides members each year with a brief summary of themajor changes. Members can access all the IAPs electronically.



2.3. IAP peer review

In the late 1990s members decided that a peer review process wouldassist in tracking progress on reaching the Bogor Goals as they becamecloser in time. The first round was for members to offer to submit their IAPson a voluntary basis to peer review. In practice this meant that a short timewas set aside at Senior Officials Meetings for the Senior Officials from othereconomies to ask questions of the economy under review. As the roundprogressed it became clear that more rigour was required for the peer reviewprocess to work effectively. Members therefore decided to implement amore rigorous peer review process for the next round (2002-2005).Following a mid-term stock-take of progress towards the Bogor Goalsundertaken in 2005, further measures were put in place to strengthen theprocess – including having in place at the outset a timetable for the reviewof all 21 member economies. Members had decided collectively that theywould each submit to a peer review of their IAP.

Description of IAP peer review process

The IAP peer review process is not adversarial; rather it is an interactiveprocess aimed at providing a mutual learning experience for all APECmembers and individuals involved. The economy under review has theopportunity to learn how others view its policies, programmes andadministrative practices in the context of progress towards achieving theBogor Goals. This exercise is clearly distinguished from the Trade PolicyReview Mechanism of the World Trade Organization (WTO), or any othertrade policy mechanism.

The new IAP peer review process is designed to be more robust,forward looking and providing policy relevant interaction, including agreater focus on what APEC members are doing individually andcollectively to implement specific APEC commitments and priorities. Thenew framework improved process, which includes a three-year cycle for fullIAPs and accompanying peer reviews, aims to reduce the current resourceburden imposed by annual IAPs while maintaining the integrity of the IAPpeer review process.

Changes to IAP peer reviews agreed in 2005 allowed for the reviewprocess, by mutual agreement of the economy under review and the ReviewTeam, to extend beyond issues listed explicitly in the IAPs and include otherissues useful for demonstrating progress towards meeting the Bogor Goals.The new process aims to provide a forward-looking aspect to the peerreview by also allowing for an economy to set out its future policy prioritiesfor reaching the Bogor Goals.



Each review team consists of two experts (independent experts fromacademic institutions or policy research organisations), a moderator (asenior official from an APEC member economy), and an APEC SecretariatProgram Director (PD). Normally, Review Teams should be composed ofpersons from different member economies. In no circumstance should amember of a Review Team come from the economy to be reviewed. TheExecutive Director of the APEC Secretariat (the Executive Director)recommends a list of the Review Team members to SOM (Senior OfficialsMeeting) for senior officials’ approval.

The experts will be expected to comment on the economy’s broadprogress towards the Bogor Goals in their reports, and the peer reviewplenary will assess the economy’s progress since the last review as well asfuture tasks required to meet these goals. The review will also include anassessment of progress towards specified intermediate targets such as theTrade Facilitation Action Plan and APEC Transparency Standards, whichalso contribute to progress towards the Bogor Goals. In preparing the reportthe experts develop a questionnaire based on the checklist in Annex 2.A1.Individual economies and the APEC Business Advisory Council (ABAC)are also invited to ask questions to assist in writing the report and for theeconomy under review to respond to. The experts conduct an in-economyvisit of about three-to-four days talking with government officials – occasionally civil society may be engaged. The role of the secretariatthroughout this process is confined to logistics and facilitation. The report iscompleted after the in-economy visit and shown to the economy underreview with time given for factual corrections to be made. The report is thensent to all senior officials at least one month before the peer review session.There is an opportunity for all senior officials (and ABAC) to offer furtherquestions for written reply. At the review session the experts present theirreport, the economy under review makes a presentation and there is then theopportunity for senior officials and ABAC to ask oral questions. Finally themoderator will sum up. The report, the written questions and responses, thepresentation of the economy under review and the moderator’s summing upare published on the APEC Secretariat website, www.apec.org. A pressrelease is produced and there may be other press activity, such as a pressconference usually by the senior official who is of ambassadorial rank.

2.4. Conclusion: reflections on the peer review process in APEC

The following reflections are personal based on my own knowledge ofthe IAP peer review process in APEC. Within my own economy of HongKong, China I assisted in the late 1990s in the compilation of our IAP andupdates. Wider still I have participated in a WTO Trade Policy Review and



peripherally in Article IV IMF consultations. Within APEC since 2001 Ihave taken part in two IAP peer reviews (the last in Canberra last week) andobserved several others. The timing of this conference means that theprofessional staff member with responsibility for the IAP peer reviewprocess is unable to attend as he is still attending other meetings inCanberra. Nevertheless it is opportune as APEC will be reviewing our peerreview practice in April 2007.

In APEC peer reviews are seen as encouraging economies to makeprogress on economic co-operation. In keeping with the traditions ofvoluntariness there is no prescriptiveness; policy recommendations are notput forward for the economy under review to follow. That sense of a peerreview is absent within the APEC process entirely.

The peer review process may be used to indicate where capacitybuilding may be desirable as economies move towards the Bogor Goals.

As a force for regional integration the IAP peer review process doestrack progress towards the Bogor Goals. Without it, I believe, progresswould have been slower. The voluntary nature of APEC means that the peerreviews are carried out in an atmosphere of trust; this enhances learningopportunities.

The peer review process can be a learning experience for both theeconomy under review and for the senior officials of the other economies.Other speakers at the conference have indicated that peer reviews canprovide evidence of best practice for others to follow; this is certainly truefor APEC. The achievements of others can goad economies to improve theirperformance to keep up with their peers. The presence of ABAC can behelpful in reminding economies under review of the interests of their ownstakeholders.

Notes

1. This year we have returned to Australia: our meetings for the year will behosted in Australia – currently we have a series of meetings being held inCanberra. Last week within that series of meetings we held four peerreviews of individual economy’s Individual Action Plans. This meeting istherefore timely as a review of the way peer reviews are conducted.



Annex 2.A1. Issues Checklist

Introduction

1. Please briefly describe recent economic developments in the economy withreference to relevant statistics as well as major policy initiatives includingstructural reform.

2. Please briefly describe major recent developments in trade and investmentof the economy with reference to relevant statistics as well as major policyinitiatives relating to trade and investment implemented by the economy.

Overview

3. Overall, how far has the economy advanced towards the Bogor goals, sincethe last review was undertaken? What are the economy’s future policypriorities for achieving the goals?

Respective issue areas

On reviewing the respective issue areas, please compare the economy’sprogress at the time of the last review and the most recent year to highlightimprovements since the last review. It is also advisable to clarify the plansof future actions in the respective issue areas. Please provide timetables andreasons for the plans.

Tariffs

4. To what extent has the economy progressively reduced tariffs? What majortariff reductions has it recently undertaken? How significant are they in thecontext of achieving the Bogor Goals? Please compare previous tariffsummary reports provided by the economy with the most recent one.



Non-tariff measures (NTMs)

5. In comparison with the NTMs reported in the last review, to what extenthas the economy progressively reduced NTMs? What NTMs have beenremoved and what new ones, if any, have been introduced? Howsignificant are they in the context of achieving the Bogor Goals?

Services

6. In which sectors has the economy undergone liberalisation which mayaffect market access, national treatment or most-favored nation (MFN) forforeign service providers? How significant are these changes in the contextof achieving the Bogor Goals of free and open trade and investment? Listthose sectors that had total or partial restrictions in the last review andcompare that to the information for the most recent year. Please elaborateon specific areas of interest to other member economies and the businesssector.

7. Please review the economy’s services regime at the time of the last reviewand the most recent year, taking into account the “Menu of Options forVoluntary Liberalisation, Facilitation and Promotion of Economic andTechnical Cooperation in Services Trade and Investment” adopted in 2001.

Investment

8. To what extent has the economy provided MFN and national treatment ininvestment? To what extent does the economy allow for any use ofperformance requirements that distort or limit the expansion of trade andinvestment?

9. Please review the economy’s investment regime at the time of the lastreview and the most recent year, taking into account the “APECNon-Binding Investment Principles” adopted in 1994 and the “Menu ofOptions for Investment Liberalisation and Business Facilitation” adoptedin 1998.

Standards and conformance

10. Are there any problems or other considerations that the economy is facingin promoting alignment of its standards with international standards, aswell as participation in international standardisation activities and MRAs



in both regulated and voluntary sectors? If so, please review how theeconomy is addressing such problems.

Customs procedures

11. Please outline the economy’s current status in implementing each of theSub-Committee on Customs Procedures (SCCP) Collective Action Plan(CAP) items. For those items that are not fully implemented, what is theeconomy’s target completion date?

Intellectual property rights (IPRs)

12. How effectively does the economy implement the various measures andprocedures that have been recently introduced with a view to providing forexpeditious granting of IPRs, and ensuring adequate enforcement againstinfringement of IPRs? Please review the implementation of CAP,establishment of IPR service center and Anti-Counterfeit and PiracyInitiative.

Competition policy

13. Please review the economy’s competition policy and/or laws and theenforcement thereof at the time of the last review and the most recent year,taking into account the “APEC Principles to Enhance Competition andRegulatory Reform” adopted in 1999.

Government procurement

14. Please review the economy’s government procurement regime at the timeof the last review and the most recent year with the “APEC Non-BindingPrinciples on Government Procurement” adopted in 1999, and highlightthe steps taken to improve the consistency with the Non-BindingPrinciples.

Deregulation/regulatory review

15. Please describe some examples of industry or sector specific regulatoryreform where reform may eliminate distortions on trade and investment orrestrictions on competition.



Implementation of WTO obligations and rules of origin

16. For economies which are WTO members: To what extent has the economyimplemented its commitments under UR/WTO?

17. For economies in the process of acceding to the WTO Agreements: Whatvoluntary measures, consistent with the WTO Agreement, has the economytaken to liberalise its trade regime?

18. What measures has the economy taken to ensure the impartial, transparentand neutral preparation and application of rules of origin?

Dispute mediation

19. Please provide an overview of how the economy has settled disputes withother economies with respect to trade and investment, citing a few recentexamples.

Mobility of business people

20. Please highlight some measures as examples that the economy has taken toenhance the mobility of business people. Please review the implementationof the ABTC.

FTAs/RTAs

21. Please provide general information on the Free Trade Agreements (FTAs)and Regional Trade Agreements (RTAs) that the economy has concludedand any that are under negotiation. What would be the impact of theseFTAs/RTAs be on the economy, the signatories of the FTAs/RTAs andother trading partners?

Trade facilitation

22. Please review the economy’s progress with regard to the implementation ofthe APEC Trade Facilitation Action Plan, specifying how these havecontributed to progress towards the Bogor Goals.



The APEC food system (AFS)

23. Please highlight specific actions taken to implement the goals of the AFSwhich aim to improve the efficiency of food production and trade for thebenefit of APEC member Economies.

Transparency

24. Please review the economy’s progress in implementing the APECTransparency Standards, specifying how specific actions have contributedto progress towards the Bogor Goals.

3. PEER REVIEW, PEER SUPPORT AND PEER PRESSURE: THE EUROPEAN UNION EXPERIENCE – 109


Chapter 3. Peer Review, Peer Support and Peer Pressure:The European Union Experience*

3.1. Introduction

Peer review, peer support and peer pressure are key elements ofEuropean Union (EU) governance. As Niels Thygesen states in Chapter 6,“peer review is omnipresent in the EU, but still very difficult to define.”This difficulty derives from the fact that in the European Union, peer review(as well as peer support and peer pressure) is part of a much widergovernance framework and rarely appears as an activity per se. But there isno doubt that peer activities have played and play a very important role inthe spreading of best practices among the member States of the Union and incrafting effective policies at national and community level.

In assessing the European experience, this chapter presents fourexamples in the fields of EU macroeconomic and employment policieswhere peer activities play different roles in the governance process. In thefirst two cases, the European Employment Strategy and the Study on theImpact of Ageing on Public Expenditure, peer activities have a leading rolein comparing experiences and spreading best practices. In the case of theLisbon Agenda, peer activities have also to integrate a strong regional(European) dimension. But there is room for peer activities also in presenceof a structured, rule-based integration framework, such as the EU “rule bookfor national budgetary policies” (Thygesen, Chapter 6). Prima facie, in sucha case, it would seem that there would not be much scope for them, since weare in presence of a clear legal framework, backed eventually by economicsanctions for those violating the rules. However, even in this case, peer

* This chapter was written by Moreno Bertoldi, Head of Unit D2 – EconomicAffairs within the G7 Countries and Related Multilateral Issues, Asia andLatin America, European Commission. The author is grateful toAntonio de Lecea, Declan Costello, Alfonso Arpaia and Martin Larch fortheir valuable comments. The views expressed here are those of the authorand they should not be attributed to the European Commission.

110 – 3. PEER REVIEW, PEER SUPPORT AND PEER PRESSURE: THE EUROPEAN UNION EXPERIENCE


activities can still play an essential role in the effective enforcement of therules by creating incentives that reward countries implementing fiscalconsolidation and by putting pressure on countries whose policy efforts areconsidered as inadequate.

3.2. The European Employment Strategy

The European Employment Strategy comes very close to what isgenerally considered a traditional peer review mechanism. The aim of thestrategy is in fact to monitor and assess national employment policies andidentify best practices. There are no sanctions for countries that would notimplement (or would move very slowly) in the reform process (Arpaia,2005). In this respect, national authorities remain fully in charge ofemployment policies.

The European Employment Strategy, which is now ten years old, can becredited with four major achievements:

• It moved the issue of labour market reform to the top of thepolitical agenda. It may look trivial now, but that was notnecessarily the case in the second half of the 1990s.

• Together with the OECD Job Strategy, it convinced EU policymakers that the focus should shift from the level ofunemployment to the need of raising the rate of participation ofthe population and create new jobs.

• It convincingly countered the so-called “lump of labour fallacy”,i.e. the idea that it is possible to reduce unemployment throughthe reduction of the labour participation rate.

• It helped set a forward looking agenda, so that policies embracechange due to globalisation and to the ageing of the population.In practice, this has helped countries recognise the need toextend working lives and to define dynamic employmentpolicies such as life-long learning.

Progress was more mixed in other areas. Labour market reforms havetaken place in all EU member States, and, although they moved all in thesame direction, the degree and depth of reforms varied significantly amongcountries. As a result their impact on participation rates (as well asunemployment) was uneven and explains in part the still large difference inboth participation rates and unemployment levels between EU countries.



3.3. The Study on the Impact of Ageing on Public Expenditure

The EU Study of the Impact of Ageing on Public Expenditure is acombination of the EU fiscal sustainability process (in the framework of theStability and Growth Pact) and the so-called “open method of co-ordination”(OMC). The open method of co-ordination is a means of spreading bestpractices and achieving greater convergence towards main EU goals. Themethod is designed to help EU member States to progressively develop theirown policies and to achieve co-ordination. However, the method is not ameans to achieve harmonisation (Radaelli, 2003).

The EU study started almost in parallel with a similar OECD study onthe same subject in 1999-2000 (and there was some cross-fertilisation). TheCommission study combined the analysis on fiscal sustainability with theanalysis of pension access and adequacy. The big advantage that the EUstudy had with respect to the OECD was its ability to bring the issue of theimpact of ageing on public expenditure directly into the political arena.Furthermore, while the OECD did not continue the exercise, theCommission was able to ensure that it would become an annual feature ofthe assessment of the budgetary planning of member States.

The analysis of the impact of ageing on public expenditure startedslowly, since there was clear reluctance by a number of member States todiscuss an issue that was of clear competence of national governments.Furthermore, it was also a topic heavily charged in political terms, as itraised complex and sensitive issues related to redistribution (both within andbetween generations).

However, the European Commission analysis showed convincingly thatthe impact of ageing was a major problem for almost all EU countries andthere was a lot to gain by learning about best practices (EuropeanCommission, 2006a). Furthermore, there was room for strong peer support.In fact, if everybody moved in the same direction, domestic resistance toreform would be weakened. This was what happened: even country stronglyin favour of public-defined benefit PAYG (pay-as- you-go) systems realisedthat it was unsustainable over the long run and decided to move towardmixed systems. Even if public-defined benefit PAYG was extremely popularin many EU countries, the fact that practically all European countries wereintroducing reforms of the pension system that went in the same directionplayed a critical role in their acceptance (or, at least, in taming part of theopposition to them) by the population of the various countries concerned.

Although further reform may be needed in a number of countries,pension reforms through an open method of co-ordination within an agreedfiscal consolidation framework represent a clear EU success story. In this



specific case, the open method of co-ordination helped define policysolutions at Community level (for instance, the introduction of asustainability factor, e.g. the evolution of life expectancy, in the calculationof pensions), while respecting national sovereignty. In the co-ordinationprocess, the European Commission worked as a facilitator. Its analysis thatageing was going to become a major problem for public finances served as abasis for discussion. In the following stage, the European Commissionworked closely with member States to prepare long-term projections thatwere used by them to discuss the problem and possible solutions to it.Thanks to this work, EU member States were able to recognise that theyshared many of the challenges (and some of the solutions) related to theageing of the population and that peer support could create importantpolitical resources at the moment of the implementation of pension reforms.

3.4. The Lisbon Agenda

The Lisbon Agenda is an ambitious ten-year programme launched in2000 by the European Heads of State and Government at the EuropeanCouncil in Lisbon. Its aim is to develop a knowledge-based economy able toenhance EU competitiveness and ensure full employment. From the outsetthe Lisbon Strategy set a number of specific targets, to be achieved by 2010,such as a 70% employment rate, a significant increase in the labourparticipation of women and older workers, a 3% level of R&D expenditures,to be attained at the end of the decade. To achieve these objectives, an openco-ordination of national reform policies would be pursued.

Compared to the issue of pensions, the Lisbon Agenda also adopts theopen method of co-ordination, but puts more emphasis on policyco-ordination at European level. In the Lisbon Agenda, policy co-ordinationis justified (i) by important spill-over effects that can be present in areassuch as R&D, (ii) by complementarities at work between product marketreforms (for which the EU is often responsible) and labour market reforms(which are mostly of competence of the member States); (iii) by thepossibility of learning from best practices in other countries (Arpaia, 2005;Pisani-Ferry and Sapir, 2006).

Since the goals are set at European levels, their achievements depend onconcrete decisions by all member States. For instance, the objective of a 3%level of R&D spending by 2010, when some member States spend almost4% of their GDP in R&D and other less than 0.5%, can only be achievedthrough the co-operation of all member States. The objective is not to haveall member States spending the same share of GDP (3%) in R&D, but ratherfavour a general increase in R&D spending, so that it becomes possible to



achieve the target, but without affecting negatively an efficient allocation ofresources.

In its first five years, only limited progress was made. This was partlythe result of the economic slowdown that affected the EU in the period2001-2005, which made difficult for countries to move close to thequantified objectives set at the beginning of the process. With a set ofobjectives too broad and not fully coherent, and an overly “top down”co-ordination process, it was also difficult to develop meaningful peeractivities (for instance it was not easy to exert peer pressure since mostcountries found themselves unable to deliver on their own commitments).

The Lisbon Agenda was revised in 2005 with the aim of increasing itsownership by the member States, which are now called to prepare NationalReform Programmes. These programmes are assessed by the EuropeanCommission and then discussed at the Economic Policy Committee and theCouncil of Ministers. This new procedure provides more room for peerreview, peer support (in particular when the reform programme isambitious) and peer pressure (if instead the reform programme lacksambition). The first results of the new approach are encouraging. TheNational Reform Programmes have a good degree of ambition are muchmore focussed, and detail much more precisely how authorities intend toachieve the objectives, but there is still a lot of ground to be covered beforethe original objectives of the Agenda are attained.

3.5. The Stability and Growth Pact

The Stability and Growth Pact (SGP) defines the fiscal rules for a soundand smooth functioning of the euro area. It is a rule-based framework,where, if need be, sanctions are also contemplated. Therefore, at first sight,it would seem that the scope for peer activities is quite small, if any.However, this is not the case, in particular after its reform.

The original Stability and Growth Pact, whose terms were agreed in thesecond half of the 1990s in preparation to the introduction of the euro, cameunder strain in 2003 because a number of countries were unable to fulfil thecommitment of keeping their fiscal deficit below 3% of GDP. In this casethe peer review mechanism failed: member States did not want to apply it.The rules were criticised even by some governments which had to enforcethem. Because of this lack of ownership of the rules, peer activities couldnot play the role they were supposed to play in the SGP framework.

The SGP was reformed in 2005. Its reform increased the flexibility andeconomic rationale of the euro area fiscal framework. Since its reform, alldecisions and recommendations related to the excessive deficit procedure,



including its launching, are now taken following a comprehensive economicanalysis. In a bid to overcome the volatility of nominal deficit figures, anincreased focus is put on structural fiscal consolidation efforts, rather thanon short-term nominal outcomes. Specifically, all budgetary objectives areexpressed net of cyclical factors and of one-off and other temporarymeasures.

The reform of the Pact was widely criticised because it was interpretedas a weakening of EU fiscal rules. As a result, some prominent economistspredicted that the fiscal deficit of the euro area and its member States wasgoing to increase (see, for instance, Feldstein, 2005 and Calmfors, 2005).However, what has happened so far has been rather the opposite, i.e. thedeficits have gone down in most countries and, in particular, in those withhigh deficits. While, this is partly due to the improvement in the economicsituation of the euro area, the structural budget balances have also improved.

The reform of the Pact is also playing an important role, since itproduced a renewed ownership by its members (European Commission,2006b). This is generating peer support for the countries with large deficitsthat are making big efforts to bring them down and some peer pressure forthe countries which are not doing enough (even in the case where theircurrent deficit is relatively small). Thanks to the SGP new fresh start,governments have been able to compose again with a rule-based fiscalframework and, with the support of their peers, to adopt fiscal consolidationpolicies that, already in 2007, should bring the deficits of all countries of theeuro area (with the exception of Portugal) below the 3% threshold.

Furthermore, thanks to the SGP reform it has become clear thatbudgetary rules should not be judged only on budgetary outcomes. Thefocus of surveillance has shifted to the analysis of the underlying situation(i.e. the economic situation free of the effects of the cycle and of one-offmeasures) and fiscal sustainability. The reform also forced countries to thinkin terms of budgetary rules and the institutions that can implement them.Last but not least, it favoured a public debate on what sound fiscalmanagement should be. All these outcomes create new room for peeractivities, since they imply an active involvement of euro area memberstates in the assessment of the underlying situation and fiscal sustainabilityof the various countries, and the examination of best practices that can helpachieve sound fiscal management in the long run.

Therefore, as a result of the SGP reform, peer review, peer support andpeer pressure are now fully playing a key supporting role in ensuring thatmember States comply with the principles and the rules of the Pact. Therenewed ownership of the Pact, backed by effective peer activities, hastherefore more than compensated the alleged drawbacks of the reform.



3.6. Conclusions

The four examples presented in this chapter indicate that, even in astrongly integrated regional entity as the European Union, peer activitiesremain extremely important. In this respect, peer activities are not simpleinstruments for lower levels of regional co-ordination or integration. On thecontrary, they are key elements in the governance framework of a regionaleconomic union. Even in those fields where the governance is rule-based,like the Stability and Growth Pact, peer support and peer pressure areessential to ensure a proper and effective implementation of the rules.

What ASEAN and other regional frameworks in Asia can learn from theEuropean experience is that, whatever the chosen pattern of economicintegration, peer review, peer support and peer pressure will play in it a keyrole. Becoming accustomed to peer activities is therefore a necessarycondition to promote successful regional integration.



References

Arpaia, Alfonso (2005), “L’Agenda di Lisbona ed il mercato del lavoro”,Italianieuropei, No. 2.

Calmfors, Lars (2005), “What Remains of the Stability and Growth pact andWhat Next?”, SIEP Report, n. 8, Stockholm.

European Commission (2006a), “Long-Term Sustainability of PublicFinances in the European Union”, European Economy, No. 4.

European Commission (2006b), “Public Finances in EMU – 2006”,European Economy, No. 3.

Feldstein, Martin (2005), “The Euro and the Stability Pact”, NBER WorkingPaper 11249, March.

Pisani-Ferry, Jean and André Sapir (2006), “Last Exit to Lisbon” BruegelPolicy Brief, No. 2006/02, March.

Radaelli, Claudio (2003), “The Open Method of Co-ordination: A NewGovernance Architecture for the European Union?”, Swedish Institute forEuropean Policy Studies, No. 1.

4. PEER REVIEW IN THE CONTEXT OF REGIONAL INTEGRATION IN SOUTHEAST ASIA – 117


Chapter 4. Peer Review in the Context of Regional Integrationin Southeast Asia*

4.1. Introduction

In thinking about the topic of this publication it occurred to me that auseful question to address would be: “What, if anything, is different aboutpeer review in the context of regional integration?” In answering thisquestion I will do three things. First, I will outline three aspects of peerreview. These are peer reviews as peer learning, peer preview as support fordomestic stakeholders, and peer review as peer pressure. In outlining theseelements I will argue that peer learning is the core of peer review and thatattempts to more aggressively pursue peer pressure will almost certainlyundermine the process. Second, I will outline the preconditions necessaryfor peer review to work well. Third, I will comment on whether undertakingpeer review in the context of regional integration helps or hindersconstructive peer review. Naturally this last aspect will be heavilyinfluenced by the specific regional integration project, but I think that somegeneral observations can be made.

However, before exploring the detail, I think it is worth stating a keypremise on which I believe peer review is based. This premise is that it is inour own interests for everyone else to be successful. This is true in theeconomic sphere. It is also true with respect to having successful, sound andstable institutions. To economists this is an obvious point that is implicitlyrejected by many mercantilists. Put another way, the objective of peer

* This chapter was written by Blair Comley, General Manager of theAustralian Treasury’s Business Tax Division. From November 2003 to theend of 2006 he was the Minister (Economic) at the Australian Delegation tothe OECD and was Vice-Chair of the Economic and Development ReviewCommittee (EDRC) in 2005 and 2006. This chapter has benefited from thecontributions of Nina Davidson, Terry O’Brien, David Parker andSam Rosevear. The views expressed in this chapter are those of the authorand not necessarily those of the Australian Treasury.

118 – 4. PEER REVIEW IN THE CONTEXT OF REGIONAL INTEGRATION IN SOUTHEAST ASIA


review is to help each other be successful in our own enlightenedself-interest.

4.2. Three aspects of peer review

The term “peer review” is often used to describe a wide variety ofprocesses. However, I would argue that practical peer review combines threemain elements:

• peer review as peer learning (or alternatively peer exchange),

• peer review to provide support for a policy that a country wouldalready like to undertake,

• peer review where the reviewers would like the country to dosomething that they do not want to do.

Peer review can usually be considered as involving the “reviewers”(perhaps a few countries designated to lead questioning and discussion ofthe country under review); that country’s “counterparties” (the officialsrepresenting their government); and the “other parties” to the review,countries which join the discussion led by the reviewers. In addition, wherea permanent secretariat exists, they can play quite an important role.Whether this role is merely one that facilitates the process or leads to afundamentally different outcome depends on the responsiveness of thesecretariat to member countries and to the formal process of clearance forreview documents.1

Peer review as peer learning

Arguably the most important aspect of peer review is genuine peerlearning. This may sound a little counter-intuitive as the phrase peer reviewoften invokes a more inquisitorial process, but I am convinced it is true. Thenature of peer review is that it is process whereby “soft powers” areexercised, and those “soft powers” are the power to convince people thatthere is a policy prescription worth following and to encourage all countriesto think analytically about the lessons for their own national case of thecountry under review. Importantly, the directions in which the informationflows are often from the reviewed country to the reviewer and to the othercountries in the dialogue. In this respect the attitude of the reviewers iscritical. Peer review works best when an atmosphere of constructivedialogue is created. Peer reviewers and other countries should be motivatedby the question “what can I learn from this process” as much as “what can Iimpart.”



Learning from peer review is multidirectional, and “what you get out isproportionate to what you put in.” While the reviewers and thecounterparties may be focussed on the country experience underexamination, the other parties may be wondering (and debating with theirdomestic authorities) “what do country A’s lessons and country B’s lessonshave in common?” or “why does this policy work in country A, but not incountry B?”

This observation is not surprising when one pauses to think about thenature of the peer review processes. It is only natural that the reviewedcountry knows more about their country than the reviewers. Indeed, whilethere may be cases where reviewers are better informed, these are likely tobe the exception to the norm. It is natural that authorities representing acountry will have a much better appreciation of the specific circumstancesof their country than the reviewers.

This last point has become increasingly true given the shift in focus ofmacroeconomic peer review and surveillance. There is now a much greaterunderstanding that macroeconomic analysis is not very useful without stronglinks to structural policy which drive the supply potential growth of theeconomy. The OECD’s Economic Development Review Committee(EDRC) process prides itself on undertaking macro-structural analysis. Thisreflects the clear understanding that the interaction of macroeconomic andstructural policies is the key to understanding an economy. Two examplesillustrate this point well.

• First, the European Central Bank (ECB) is sometimes criticisedfor not behaving more like the United States Federal Reserve.Much of this criticism is unfounded as it fails to take accountthat the Fed faces a very different set of product and labourmarkets than the ECB. A central bank dealing with some areaswith implicit wage indexation and influential unions cannotbehave the same way as a central bank operating in an economywith very weak employment protection legislation andsubstantial inter-regional labour mobility.

• Second, external observers often compare favourably theresilience of the Australian economy to Europe. It is true thatsound macroeconomic policies and a flexible exchange rate playan important role in delivering resilience. But it is also true thathighly competitive product markets, with the implied disciplineto factor markets, play a very significant part in allowing thesmooth absorption of economic shocks – both negative (such asthe global slowdown of the start of this decade) and positive



(such as the commodity-price driven improvement in Australia’sterms of trade).

It is not true that macroeconomic policy lends it self to simplisticone-size-fits all solutions. But it probably is true that macroeconomicexperts can readily discuss the appropriate macroeconomic settings in acountry with recourse to a relatively small set of data. I have certainlyobserved this in the context of the EDRC. Members can easily debate themerits of inflation targeting, flexible exchange rates and centralised versusdecentralised wage bargaining. It takes a lot more homework to debate themerits of the regulatory arrangements around infrastructure or networkindustries. In practice this homework will rely a lot on information providedby the reviewed country.

Furthermore, the scope for peer learning with respect to structuralpolicies is large, particularly where countries face common problems, butthere is no consensus around solutions. For example, many OECD countriesface a common problem of growing numbers of people receiving sickness,disability or incapacity benefits. Many OECD countries acknowledge theproblem and are keen to learn from countries that seem to be makingprogress on the issue. Accordingly, the new approaches that have beenintroduced in Denmark and the Netherlands excite a lot of interest – whenthese countries are reviewed the reviewers are not looking to criticise, theyare looking to learn.

When trying to benefit from peer learning, peer reviewers often have inmind the following question “When I see a policy that looks successful, isthere some country specific factor that means it would not be applicable tomy country?” This is a critical question, and is at the heart of both theinquiring and respectful nature of peer review. It recognises that policiesoften evolve in countries in response to the specific cultural, institutionaland historical context. Policies rarely come into being for no reason. Theflipside of this is that the good peer reviewer does not jump to theconclusion that a particular policy is bad and should be changed withoutcarefully considering the country-specific context. The question that shouldcome into the mind of a good peer reviewer when they see a policy that doesnot make sense to them is “What am I missing, what factor might exist that Ido not understand?” Of course the benefit of peer review is that the reviewercan actually ask this question, and in giving the answer the reviewee mayreflect on whether the current policy is the best policy that can be pursued.

The process of information exchange described above relies on a highdegree of openness. If a country chooses not to disclose key information,then the opportunity for peer learning is significantly diminished.Accordingly, the conduct of the participants is critical. Many have



commented that peer review is a fragile process. This may partly reflect thefact that if one participant acts in bad faith, then it can undermine the spiritof trust that allows free exchange of information and genuine learning.Accordingly, good peer review processes need to be nurtured as anappropriately constructive approach often needs time to develop.2

Peer review as peer support

The second aspect of peer review is peer review that facilitates domesticreform. Reviewed authorities may already wish to implement a particularpolicy, but may need additional support due to political economyconsiderations.

Peer review may be most helpful where a particular policy is in thenational interest, but powerful vested interests stand in the way of itsintroduction. Peer review can assist by providing an independent analysis ofthe facts of the situation, one that may carry more weight in shifting publicopinion than an assessment made from within the country as internalassessments may be perceived to be driven by their own vested interests.

The relevance of this leg of peer review is critically linked to thecredibility and weight given to the particular peer review mechanism. Forexample, it has often been argued that the influence of OECD reviews isinversely related to the size of the reviewed country (partly related to thevibrancy and competitiveness of its domestic marketplace for policy ideas,and the depth of its domestic analytical processes). In the US politicalcontext peer review by an international organisation appears to have littleweight – indeed it may actually be counterproductive to positivelyinfluencing public opinion. Similarly, some countries may view outsideadvice as inappropriate and unhelpful.

In this respect it is important to highlight the role of the counterparty inthe peer review process. Internationally, the counterpart generally representsthe government of the reviewed country. That said, in practice thecounterpart may be a subset of that government that may consult andco-ordinate in varying degrees with other parts of government. Practice inthis area varies considerably.

There may be different country-specific dimensions to this counterpartyvariation. These variations are as numerous as the different forms ofgovernment. However, some of the most notable variations in counterpartiesare:

• Instances where there is a separation of the Executive Branch ofGovernment and the Legislative Branch. The Executive



typically is the counterparty in international peer review andmay have interests that are not aligned perfectly with those ofthe legislature.

• Variations within the Executive Branch of government. Forexample, in some processes the Ministry of Economics may bethe counterparty with the responsibility of representing thegovernment of the reviewed country.

• Variations between levels of government in non-unitarysystems. In federal systems this may involve differencesbetween the interests of the national, provincial and localgovernment levels.

Implicit in this is the fact that the results of the peer review arepublished. Other channels of peer review do not necessarily require theresults to be transparently available. But, as the OECD (2003) notes, “…thegovernment of the reviewed country can also come under pressure fromthe press and the public to accept the recommendations [but] …officialsof the country under review may welcome advice from outside thatsupports unpopular policy changes … which they themselves feel arenecessary for the longer term good of the country.”

Peer review as peer pressure

The third aspect of peer review is where the peer review process seeksto make a country do something that it does not want to do. I would arguethat this rarely if ever works, unless the policy is actually in the interests ofthe reviewed country. This then begs the question “If it is really in theinterests of the reviewed country, then why do they not do it in the firstplace?” It also raises the question “Why would the peer reviewer be betterplaced to know what is in the best interests of the reviewed country?”

There are many ways to think about this question. However, a usefulway to think about this may be to reflect on Yew Kwang Ng’s (1983)taxonomy as to why people disagree. Ng argues that there are three reasonswhy people disagree. First, people can differ in their basic value judgments.Second, people can differ regarding statements of fact. Third, people canmake errors of logic. My belief is that the third category is rarely the reasonfor prolonged differences of opinion, at least at the level of policy.Accordingly, differences are likely to arise over the first two elements.

Turning to the first element, it is possible that different countries maygenuinely seek different objectives. I believe that if this is the case, thenpeer review should respectfully note the different objectives and limit any



comments or suggestions to how these objectives can be met in the mosteffective manner. In this area, one does need to be very careful. It is notuncommon that objectives are stated that are not ultimate objectives. Oncethese objectives are appropriately clarified, generalised and reformulated,then there is often scope for constructive policy dialogue.

For example, OECD (2004) has a very good discussion of policies topromote recycling. Many countries have quantitative targets for the volumeof recycling. If these targets were interpreted as the objectives of policy,then there would be little scope to discuss the merits of the policy. However,if the objective is really to promote environmental amenity, then there isscope for constructive dialogue of whether quantitative recycling targets arethe best instrument for pursuing this broader goal. Indeed, the OECDconcluded, and by a process of consensus the countries accepted, that therewere better ways to achieve the broader environmental goal.3

Ng’s taxonomy relates to why individuals disagree. However nations arenot individuals. Accordingly, an additional related source of difference maybe that different countries place different weights on the importance offurthering different groups, or that political rules may advantage one groupover others. Again, if this is genuinely the case, then peer review shouldrestrict itself to suggesting policies that may better achieve the givenobjective or improving transparency to empower domestic stakeholders withinformation about the effects of current arrangements.

The second element lends itself to exchange of information. In particularcertain country-specific factors may mean that critical facts differ, leading toquite different policy conclusions. For example, I would argue that theextent or product market reform in Australia has meant that labour marketsoperate more efficiently than might be guessed from the state of labourmarket regulation. Product market reform has squeezed economic rents outof the system, requiring labour market actors to behave in a manner that isconsistent with a highly resilient and growing economy. However, I shouldbe wary in applying this lesson of Australian economic reform to othercountries. Some other countries may believe that labour markets should bereformed first as the interaction of liberal product markets with unreformedlabour market institutions may lead to even more restrictive measures beingsought by labour-market actors.

Perhaps more concretely, a Scandinavian may be relatively relaxedabout high marginal tax rates on labour income, judging the internationalmobility and hence the labour supply elasticity of high income earners to below. An Australian or New Zealander may take a different view based on aconcern that the English-speaking labour market provides a powerful pullfactor that cannot be ignored.



With respect to this last point, it becomes clear that peer review as peerpressure may really be just another form of peer review as peer learning.The process of peer review may convince a country that what they thoughtwas in their interest is not. But it must be stressed that the country must beconvinced on the merits of the case unless there are possible sanctionsoutside the peer review process. For the moment I will not pursue this, butmerely note that introducing sanctions in my view takes us out of the realmof pure peer review. Indeed sanctions may significantly hamper peer reviewby inhibiting the free flow of information that is integral to genuine peerreview and support.

4.3. Conditions under which peer review works well4

The foregoing discussion implies a number of conditions that arerequired for peer review to work well:

1. There must be a high degree of trust and respect between theparties to the peer review.

2. Parties must be prepared to share information freely and openly.

3. The peers must have at their disposal sufficient analytical andadministrative capacity to conduct the peer reviews.

4. The peers must be seen to have legitimacy in the eyes ofdomestic constituents.

5. The reviewed country counterparty must be seen as legitimate inthe eyes of the domestic constituents.

4.4. Peer review in the context of regional integration

The premise that I asserted at the start of this chapter was that peerreview is based on the idea that it is in all countries interests for anothercountry to be economically successful. This is true in general, but is an evenstronger proposition in the context of regional economies where economicgeography suggests that interests are more intertwined.

In principle peer review in the context of regional integration is nodifferent to peer review elsewhere. However, depending on the nature of theregional integration project peer review may be more or less difficult toconduct successfully.

I do not want to go through the conditions for successful peer review inan exhaustive manner. Readers will have in mind their own examples ofregional integration projects. Proximity may lead to greater trust and



openness, but it may also mean that long-standing historical differences andgrievances may exist. Near neighbours may be seen as informed andlegitimate reviewers, or to be too coloured by their own national interests toconstructively enter into a dialogue.

There is one issue that I would like to focus on – the role of potentialsanctions in peer review. It is worth looking at the list of conditions forsuccessful peer review and asking “How would the existence of potentialsanctions affect the peer review process?”

My answer to this would be that it would almost certainly diminish theusefulness of peer review. As the OECD (2003, p. 2) has noted “…peerreview is a discussion among equals, not a hearing by a superior body thatwill hand down a binding judgment or punishment a state may be morewilling to accept criticism, and its neighbours to give it, if both sides know itdoes not commit them to a rigid position or obligatory course of action.”Perhaps more importantly, a peer is much less likely to share information ifthey believe that the information may be used against them now or in thefuture. In terms of the taxonomy of peer review, sanctions may cripple peerreview as peer learning and peer review as peer support and leave only theweak limb of peer review as peer pressure. Further, once the voluntary flowof information from the reviewed country dries up, then peers would have toramp up the resources used to conduct the review. This could leave to avicious cycle of limited disclosure, intrusive questioning and even weakertrust. Kanbur (2004, p. 10) makes a similar point when he states that “…IMF reviews work like OECD reviews in rich countries not using IMFresources, but not so in poor countries dependent on them. When a reviewis, or is perceived to be, the ‘only game in town’, or ‘too big a game intown’, the high stakes set up dynamic pressures that can undermine trust.”The same lesson flows from the experience of the World Bank, whereanalysis of desirable policy reform and recommendations are usuallybundled with IDA (the International Development Association) or IBRD(the International Bank for Reconstruction and Development) lendingprogrammes at more or less attractive interest rates. The experience ofrecent decades is that there have been few development successes fromtrying to “buy” reforms through concessional lending and policyconditionality; the key ingredient of success is “country ownership” of theneed to make the reform in question (World Bank, 2005).

One could argue that attempts to ingrain peer review in the EuropeanUnion have been hampered by exactly this issue. Peer review within theEuropean Union cannot escape the fact that the legal structure of the Unionconstrains the actions of the member states. Countries must always be warythat information disclosed in one context may be used elsewhere. The opendisclosure of information is not encouraged. If a country is not prepared to



air its faults, then even well intentioned observers are unlikely to be able tohelp.

Naturally, the European Union is a special case of regional integration.It is a model that has moved well beyond information exchange andco-operation given its myriad common policies and well-developedinstitutional architecture. Accordingly, other experiments in looserintegration projects with the absence of sanctions have less to fear.

In contrast the prospects for peer review in the Asian context do notappear to be hampered by the formal structures of legalistic integration.Accordingly, there appears ample scope for well designed peer review,focussing on respectful peer exchange to contribute to domestic policydevelopment.

4.5. Conclusion

Peer review can be thought of as having three aspects – peer learning,peer support and peer pressure. Durable peer review processes focus on peerlearning and support. Peer pressure rarely works unless countries can beconvinced that a policy is in their national interest. Viewed through this lens,successful peer pressure should best be thought of as another form of peerlearning – a peer learning where the country may initially be unconvinced ofthe merits of the case.

Peer review may be more or less difficult in the context of regionalintegration. In principle peer review could be a useful adjunct to otheraspects of a regional integration strategy designed to bring mutual benefit tothe participating countries. However, where regional integration projectsinvolve deepening legal and economic commitments it is important todisentangle sanction regimes from peer review to ensure that the freedisclosure of information is incentive compatible.



Notes

1. In the EDRC context the role of examiners (lead countries) hasdiminished over time. In practice the examiners act as lead discussantswith the Committee as a whole performing the role of reviewers. Thisevolution may reflect the longstanding nature of the EDRC (it has heldover 1 000 meetings), the frequency of the meetings (around 25 per year)and the continuity of delegates to the meetings. Less well establishedprocesses may need to rely more heavily on a subset of countries ininitiating discussions. Also in the EDRC context, the secretariat is veryresponsive to the collective view of the Committee, partly reflecting thefact that review documents are released under the auspices of theCommittee itself (adopting reports under a consensus rule).

2. This is analogous to negotiation contexts. Some negotiation theoristsdistinguish between distributive and integrative negotiation. Distributivenegotiation seeks to divide a given set of resources. Integrativenegotiation seeks to expand the set of resources for mutual gain. Thatsaid, integrative negotiation can only be achieved if the parties agree toexchange information with a few to finding mutually advantageousexchange. If parties fear that the other party will behave in a narrowdistributive sense, then it will hamper the chances of achieving mutuallybeneficial gains. Peer review is similar. Parties must be prepared to shareinformation in order to achieve mutual gains. However, if parties fear thatothers will behave distributively (for example by using information totheir advantage in a parallel negotiating context), then the benefits of theprocess can be eroded (see Bazerman and Neale, 1992).

3. Comley (2006) provides a fuller discussion of these issues in the contextof reform of environmentally harmful subsidies.

4. Kanbur (2004) outlines three broad criteria for successful peer review:competence; independence; and competition. OECD (2003) outlines fourelements: value sharing; commitment; mutual trust; and credibility.



Bibliography

Bazerman and Neale (1992), Negotiating Rationally, Free Press.

Comley, Blair (2006), “The Political Economy of Subsidy Reform”, inSubsidy Reform and Sustainable Development: Political EconomyAspects, OECD Sustainable Development Studies.

Kanbur, Ravi (2004), “The African Peer review Mechanism (APRM): AnAssessment of Concept and Design”, mimeo, January.

Ng, Yew-Kwang (1983), Welfare Economics, Macmillan.

OECD (2002), “Peer Review: Merits and Approaches in a Trade andCompetition Context”, Trade Directorate, 6 June 2006.

OECD (2003), “Peer Review: A Tool for Co-operation and Change”, OECDPolicy Brief, December.

OECD (2004) “Sustainable Development in OECD Countries: Getting thePolicies Right”.

Pagani, Fabrizio (2003), “Peer Review: A Tool for Global Co-operation andChange”, OECD Observer, January.

World Bank (2005), “Review of World Bank Conditionality, Operations andCountry Services”, September.

5. PEER REVIEW: A TOOL FOR INTERNATIONAL CO-OPERATION THAT RESPECTS SOVEREIGNTY AND DIVERSITY – 129


Chapter 5. Peer Review: A Tool for International Co-operationthat Respects Sovereignty and Diversity*

5.1. Introduction

We are seven years into the 21st century and Asia is trying, like the othercontinents, to resolve a contradiction: on the one hand, co-operation is morenecessary than ever now that economies are increasingly interdependent; onthe other hand, there is a refusal to resort to standard models and adetermination to preserve national sovereignty.

5.2. Co-operation and multilateral surveillance: new trends andmethodological options

A formal or informal approach to regional integration?

It is clear that Asia will never tread the same relatively formalinstitution-building path as did the Europeans 50 years ago, with bindingtreaties and fairly strong legislative, judiciary or executive authorities toimplement them.

This applies even to Southeast Asia, even though its politicalfragmentation is to some extent comparable to that of Europe (with manymedium- or small-sized states). Transposing the EU model to Asia wouldnot work in practice.

The construction of Europe can be traced back to a blueprint which,from the outset, was comprehensive and included long-term goals, apolitical aspiration and a relatively complete set of institutions.

* This chapter was written by Dominique Bocquet, Minister-Counsellor,Delegation of France to OECD and Vice-Chair, Economic Developmentand Review Committee of OECD.

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Two decisive factors were involved: first, the tragedies caused by“nationalist” world wars in Europe (giving birth to a whole generation of“founding fathers” determined to do everything in their power to createunbreakable ties between countries) and; second, a trait of European culture,namely the propensity to rationalise and devise an overarching plan(illustrated by two great landmarks of European civilisation: theRenaissance, with its emphasis on perspective, and the 18th centuryEnlightenment). The path taken by Europe was therefore specific to thatcontinent.

As time goes by, however, Europe is finding it harder to say where it isheading. The construction of Europe has succeeded beyond expectation andcontinues still. But Europe is finding it difficult to agree on a constitution.

I should also like to point out a nuance with regard to the concept ofsovereignty. It would be wrong to believe that the Europeans haveabandoned their sovereignty and are fully agreed that the Union shouldcome before sovereignty. Things are far more complex than that. Attemptsare always being made to reconcile the two, for as long as possible at least.

There have been transfers of competence, even as far as a virtualrenouncement of sovereignty in fields such as national currency orcommercial policy. But there is still a powerful attachment to the notion ofnational sovereignty, even among the founding states (including France),and it is a permanent brake on the process of integration. It has taken twodecades of negotiations and innumerable currency crises to create the euro.So let it not be said that some forms of integration respect sovereignty andothers do not. It is more complex than that.

Multilateral economic surveillance based on rigid rules andautomatic mechanisms, or more flexible approaches?

The notion of peer review covers a wide range of processes. It is right tomake a distinction between surveillance processes that are based on rules,and others based on more flexible assessments.

The nature of a peer review depends primarily on the topics it covers.Some reviews are designed to monitor the implementation of bindingagreements and conventions (including those between private parties) andthis shapes the whole process. Each party will defend its interests bychecking that the others are also complying with the constraints.

In theory, macroeconomic topics, which are characterised by morecomplex relations of cause and effect and in some cases subject to



uncertainty, should give rise to more flexible forms of peer review. Butwithin a given category of topics, there may be different forms of review.

Let us return to the example of macroeconomic surveillance. Somesurveillance processes are rules-based and subject to binding procedures,compounded by relationships of power. One illustration of this is Maastricht(compensation for countries with strong currencies when monetary unionoccurred). The International Monetary Fund (IMF) Reviews (“creditorreviews” in some cases) are another example.

Conversely, in the OECD’s Economic Development ReviewCommittee, the emphasis is on dialogue and the specific issues at stake.Economic development reviews are well suited to issues that are difficult toplace within pre-established rules: structural reform, but also processes ofrapid change, phases of reform and even transition, for which there are norules, not even a guidebook.

Going beyond the particularities and traditions inherent to eachinstitution, the current trend is towards greater pragmatism. Negativeexperiences include the Washington Consensus (one size fits all), the IMF’smanagement of the Asian crisis and the initial version of the Stability Pact.

Globalisation and regionalisation

There is wide range of differing economic backgrounds across countries,differing relations between countries in a given region and differing culturesin the field of international relations. Regional solutions have emerged(ASEAN, Mercosur, NEPAD).

There is, however, a link between the global context and initiatives atthe regional level. The global context may be conducive, and not only in thefield of trade (e.g. the 1950s in Europe, and the 1990s in Latin America andAsia).

In return, regional integration provides more strength to cope withglobalisation. A country that is willing to open up to its neighbours, opt fortransparency towards them and rule out protectionism is going to be lessvulnerable to the rest of the world. Regionalisation can be called a school forglobalisation in the strongest sense of the word “school” (i.e. a place whereindividuals learn to mix and train for competition).

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5.3. Dialogue and peer review: how to make them work

In my view the main feasibility requirements are:

• political requirements: accept mutual transparency andaccountability, justified by externalities and interdependence;

• substantive requirements: share common principles, define adirection (not necessarily on every point);

• procedural requirements: (what has been called the “institutionalsetting”, where the term “institutional” is weaker and lesspolitical);

• technical requirements: (including available expertise, datacompatibility).

The main principles of peer review according to the OECD’s EconomicDevelopment and Review Committee (EDRC) are that no decision isbinding, but then again that no subject is taboo. The trade-off, in opting forinformality, is to talk freely, which is precisely the advantage of informality(freedom to evoke hard facts that might be more difficult to acknowledge ina formal setting where this might be used against you).

Even in flexible reviews, attempts are made to exert pressure (publicopinion, publication of the report). But that pressure varies with the type ofreview.

5.4. OECD’s experience “from an Asian perspective”

Peer reviews as done in the EDRC are a time for dialogue, direct contactbetween the secretariat and member countries, and between the reviewcountry and other members of the committee.

Their main advantages are:

• The tailor-made aspect.

• The coverage of the political economy dimension (that is theway economically desirable reforms can overcome politicalobstacles and gain political support): the political economyissues debated in the committee have included pension reforms,university fees, pharmaceutical prices, tax, or the labourmarket).



In the case of emerging countries, such multilateral surveillance couldusefully be applied to cross-cutting issues such as:

• assessment of debt strategies,

• transition to new modes of regulation (including choice ofsequences, speed of change),

• the issue of the informal sector.

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Chapter 6. Comparative Aspects of Peer Reviews:OECD, IMF and the European Union*

6.1. Introduction

There are different models for conducting peer reviews of economicperformance and policies of individual countries and my main purpose inpreparing this chapter is to compare the current practices in threeinternational frameworks: the OECD, the International Monetary Fund(IMF) and the European Union (EU). Interesting differences between thethree frameworks emerge both in the methods of work and in the rolesplayed by national governments in the peer review processes. Some of thesedifferences can be explained by the main subject matter under reviews,others by the size and cohesiveness of the membership of the internationalinstitution in question. Still others may be more difficult to understand.

This chapter begins with a brief history of OECD bilateral surveillanceas it has evolved towards a peer review process of macroeconomicperformance, with special reference to the contribution of structural reformsto performance. My comments are briefer on the two other, “competing”,frameworks, primarily because I am less familiar with them than with that ofthe OECD with which I have been closely associated since 2000 asPresident of the Economic Development and Review Committee (EDRC)which conducts the regular peer reviews of OECD members.1

The chapter then moves to a more specific comparison of the strengthsand weaknesses of the peer reviews conducted by the OECD in its countryEconomic Surveys, by the IMF in its Article IV Consultation Reports and by

* This chapter was written by Niels Thygesen, President, Economic andDevelopment Committee (EDRC), OECD; Professor of Economics,University of Copenhagen and member of the Delors Committee on EMU1988-89. The author wishes to acknowledge constructive comments byMoreno Bertoldi, Lorenzo Codogno and David Coe as well as from theeditors. He remains solely responsible for the views expressed.

136 – 6. COMPARATIVE ASPECTS OF PEER REVIEWS: OECD, IMF AND THE EUROPEAN UNION


the EU in its major publications, notably the Broad Economic PolicyGuidelines. A final section concludes with special reference to the OECDprocess and the challenges it currently faces as the range of countriescovered expands.

6.2. The evolution of the OECD peer review process

The OECD has by far the longest history among the internationalframeworks for publicly available peer reviews, but both the substantivecontent of the reviews and the methods of work have evolved verysubstantially over the nearly six decades since the OECD – or rather itspredecessor the Organisation for European Economic Cooperation(OEEC) – was set up in 1948.

Until 1960-1961 the focus of work was on the post-war reconstructionof Europe. The OEEC initially monitored the use by its 17 Europeanmembers of the generous loans and transfers from the United States underthe Marshall Plan as a means of advancing trade liberalisation andmulti-lateralisation of payments within Europe. Hence the peer reviewprocess was concentrated on structural policy issues of vital importance bothto the individual participant and to its partners: elimination of the mostobvious barriers to the resumption of economic growth in Europe.

So rapid was progress in the early years in launching a long period ofcatch-up in Europe’s economic performance that the framework was alreadybeginning to be overtaken by events, regional and more global, from themid-1950s. Six European countries signed the Treaty of Rome in 1957 andbegan to develop their customs union and a number of common policies,notably with respect to external trade, agriculture and competition. Otherswere politically less ambitious. In any case the time to modify theEurocentric nature of the OEEC, condoning at times discriminatory policiesvis-à-vis non-European countries, was approaching. The United States andCanada joined the Europeans in forming the OECD in 1961.

While much recent peer review work in the OECD takes US economicperformance as a benchmark – by decomposing the reasons why othereconomies fall short of US levels of per capita income and, occasionally, therate of growth of the latter – the inspiration initially ran also in the oppositedirection. US policy makers wanted to understand the sources of the growthperformance in Europe, and in Japan which joined the OECD in 1965,which continued to outpace that of the United States through much of thedecade of the 1960s. Studies of comparative performance and policiescovered both structural policies, notably in product and financial markets,and demand management policies; in the latter area the OECD conducted



impressive work on the impact of fiscal policy instruments, on thetransmission mechanism of monetary policies and on the inflation process.

In 1961 already the EDRC was set up and began publishing annualEconomic Surveys, subjecting the OECD secretariat’s drafts to a full-day ofdiscussion in the first systematic peer review process in any internationalinstitution. For a long time – most of the first three decades – the Surveysdid not quite reflect the richness of the agenda dealt with within the OECD – and even within its Economics Department. They centred on theshorter-term outlook for a country and the macroeconomic responses to thechallenges posed by that outlook. One reason for this focus was that therewas initially a demand for this type of publication. The IMF’s workremained confidential – Article IV Consultation Reports have only beenpublished since around 2000 and the multilateral World Economic Outlook,available since the early 1980s for a while had very little individual countryanalysis. Private financial institutions which have to day more or less – andvery skilfully – taken over the analysis of shorter-term economic trendsoffered little competition in the 1960s and 70s. National Economic Councilswith independence from governments were set up in many OECD countriesin these decades, but their publications, apart from usually being availableonly in the national language, drew on international experience only to alimited extent. Here a gap remained for the OECD to fill.

But rather than the slow emergence of competing analysis ofmacroeconomic developments it is the gradually changing nature of themain economic challenges that has shaped the OECD peer review process asit is today. The first strong impulse came from the frustrations of traditionalmacroeconomic policies in mitigating the two major energy price hikes of1973-1974 and 1979-1980. The horizon for adjusting to these supply shockshad to be seen as much longer than the usual one. To the credit of the OECDsecretariat it began to mobilise already from 1978 its own diversifiedexpertise and that of its main committees of national officials to define whatwas initially labelled “positive adjustment policies”, the precursor ofstructural policies, in order to step out from stagflation.

There are basically two motives for conducting peer reviews of countryeconomic performances and policies. The first is the interdependence arisingfrom international linkages through trade, financial markets and, possibly,migration. If these linkages are strong, it is important to understand as wellas possible the international spill-over effects of economic disturbances andpolicies. This motive is particularly significant in reviewing the majoreconomies in the international system, but also in a more regional contextwhere spill-over effects are readily evident. The second motive is to learnfrom the experience of a country – both from policies that appear to haveworked well and from less successful initiatives.



OECD peer reviews of its member countries when it was still a regionalinstitution started with a focus on the first motive. Trade liberalisation andmulti-lateralisation of payments are clearly of direct interest to a country’spartners. Over the first couple of decades of EDRC, when the mainemphasis was on shorter-term macroeconomic challenges and the monetaryand fiscal responses to them, it could be argued that the main inspiration inthe peer review process came from the first motive. Country experienceswere examined primarily to gain better understanding of how they fitted intothe international outlook and into the multilateral surveillance of the latter.Obviously spill-over effects are more important from large countries thanfrom small ones, but the principle of symmetric treatment of all membercountries severely constrains any clear differentiation on the grounds of size.

Once one moves to put structural policies as the focus of the peer reviewprocess, the main inspiration in bilateral surveillance necessarily shiftstowards the second motive. While changes in monetary and fiscal policieshave some impact beyond the frontiers of the country initiating themthrough demand and financial market effects, changes in structural policiestend to have longer-term effects – and mainly ones which are bottled upinside the country itself, since both the costs and the benefits of structuralreforms accrue primarily to the residents of the country concerned However,this does not imply that it is uninteresting for other countries to conduct apeer review process of a country’s economic performance and policies. Butthe perspective changes to become focussed on what can be learnt from aparticular national experience. There may be both positive and negativelessons; some policies have worked, others have not (yet). The subjectmatter is interesting for the country’s peers not because of the spill-overeffects, but because of the inspiration or discouragement it may contain.2 Itis, of course, particularly interesting for the country examined to have itsmain longer-term policy challenges and the means of addressing themreviewed in a comparative and, in so far as possible, quantitative framework.

The OECD peer review process has evolved in this direction over atleast the last decade and a half. The first major example was the formulationof the OECD Jobs Strategy. Slow output growth and rising unemploymentrates were recognised as having structural rather than cyclical causes,although the recession of the early 1990s dramatised the challenges. Thecareful digestion of country experiences into an indicator-based analyticalapproach to comparative policy analysis, first set forth with respect to labourmarket policies in the 1994 Jobs Strategy, has since been extended toproduct market regulation and competition and there are now major effortsunderway to draw on indicators of financial market contributions toeconomic growth and to innovation policies. At the same time importantadvances in developing the methodology for evaluating long-term



ageing-related public expenditures – pensions and health – as well as forhuman capital investment at all levels of the educational system have beenmade.

A good peer review process aiming at this ambitious agenda requiresjoint efforts of solid quantitative comparative work and regular testing of theemerging lessons in the specific circumstances and political-economycontext of a country subjected to peer review. We have been working toachieve this cross-fertilisation at the OECD through on the one hand regularcross-country reviews of structural challenges and policy initiatives – theannual Going for Growth publication and the working papers underlying it – and on the other hand the Economic Surveys of individual countries whichin recent times have been published at average intervals of about 21 monthsfor the 30 member countries of the OECD and a few non-members.3

6.3. Three frameworks for peer reviews

In the following I try to highlight three processes of surveillance of thegeneral economic performance and policies of individual countries based onsomewhat different frameworks for the peer reviews. Other internationalinstitutions may also from time to time conduct such reviews, but the IMF,the EU and the OECD appear at present to be the only institutions that havedone so on a regular basis.4 These three frameworks offer interestingcontrasts in focus, in methods of analysis, and in the nature of the interactionbetween the international institution and national governments.

The IMF has a global membership and it is accordingly difficult to finda common denominator for all of its nearly 200 Article IV consultationreports, undertaken at frequencies between 12 and 24 months. If oneabstracts from the role of the IMF as an advisor and longer-term lender todeveloping countries, surveillance of industrial countries and emergingmarket economies has some similarities to that conducted through theEDRC Economic Surveys in their first three decades. Given the IMF’smandate since 1977 to exercise “firm surveillance over the exchange ratepolicies of members” the focus on IMF Article IV Consultation Reports ison such policies and on domestic policies that have a more or less directbearing on the country’s external balance and on its exchange rate. Thatagenda and the relatively high frequency of the Reports – most relevant IMFmember countries are examined annually – directs the attention primarily toshorter-term macroeconomic challenges and the fiscal and monetary policiesdesigned to meet them. Obviously structural reforms may have an importantbearing on macroeconomic performance at times, so an Article IVConsultation Report typically contains some references to such reforms.



Since the Asian financial crisis of 1997-98 the IMF has very substantiallyenhanced its capacity to analyse financial stability, a subject directlyrelevant to the external balance and to the exchange rate of a country. Butapart from this structural area, it still seems fair to say that the IMF staff hasmore limited experience in areas of structural policies, such as labour marketreforms and product market regulation, which require both specialisedanalytical skills – which may well be available – and, not least, deepfamiliarity with the institutional set-up in a country.5

But it is with respect to the peer review element in surveillance that theIMF remains distinct. The role of the peers of an examined country – theIMF Executive Directors assembled in its Board – is circumscribed by theweight of the overall Board agenda and the number of Article IVConsultation Reports before it over a year – approximately 130. In practice,there is little time for discussion in the Board and few incentives to set asidetime, since the relevant officials from the examined country are not present.Exchanges in the Board have increasingly taken the form of the submissionof written comments – so called “greys”, based primarily on input formnational capitals – on an Article IV Consultation Report, and, normally, astatement by the Executive Director representing the country. There isaccordingly no real give-and-take discussion among peers, and only fewchanges are made to the summary record of the Board discussion, preparedin advance by the staff for the IMF Managing Director who chairs Boardmeetings, and in the rather similar Public Information Notice (PIN) preparedfor publication.6 Both the summary record and the PIN are published withthe Report.

This critical view of the peer review process as exercised by the Boardshould not lead to the conclusion that such a process has simply disappearedfrom IMF practice. One might say instead that governments have delegatedto the IMF staff and management to conduct the process. A hint of that isfound already in the practice that the IMF mission to a country normallyleaves behind a Concluding Statement with the authorities of the examinedcountry. That message, usually published on the IMF homepage,foreshadows in some detail the staff appraisal which is the concludingsection of the Article IV Consultation Report to be discussed in the Board acouple of months later.

It may well be impossible for the IMF to organise its surveillance verydifferently from the current pattern. The very large membership and thefocus on somewhat standardised macroeconomic messages may even makethis method the best feasible one. But it does fall short of a full-scale peerreview process, and particularly of one that aims to address a wider set ofpolicies that those that have traditionally been considered as falling withinthe domain of the IMF.



The European Union is more difficult to describe from the viewpoint ofpeer reviews of economic performance and policies. On the one hand somepolicies have moved far beyond the peer review stage, but on the other handsuch a process is strangely subdued in other policy areas. Monetary andexchange rate policies are fully centralised for the (currently 13, soon 15)countries participating in the euro area, while other macro policies for themare little more co-ordinated than for all 27 EU countries, although theexistence of the so-called Eurogroup of Finance Ministers provides apromising beginning of efforts in this direction. A rule book for surveillanceof national budgetary policies was included in the Maastricht Treatyprovisions for Economic and Monetary Union (EMU) and subsequentlytightened up in the so-called Stability and Growth Pact (SGP) of 1997. TheSGP did distinguish euro area members from others by making sanctionspossible only against the former, but the Pact was revised in 2005 to make ita more discretionary negotiation framework for budgetary consolidation. Assuch it now resembles a peer review process more than before the revision,but the discussions still have a somewhat more legalistic orientation than theeconomic one of considering trade-offs between consolidation now or laterthat are at the core of a normal peer review process. However, recentreviews of national budgetary policies, e.g. in the case of France, as well asmore emphasis on long-run fiscal sustainability of public finances, are signsof evolution.

A few other policy areas in the EU have, like monetary policy in EMU,been subjected to joint decision making. In the important areas of externaltrade, competition and agricultural policies the EU member states havedelegated to the European Commission wide-ranging negotiating oradministrative powers. The same applies to areas subject to Single Marketlegislation, whether goods, services or financial services. One could say thatan intensive phase of peer review has preceded each of these major areas oflegislation, and that subsequent processes can focus on the implementationof joint decisions – which is obviously a much firmer basis than is availablefor a normal, open-ended peer review.

In a number of additional policy areas where ultimate responsibility forpolicy has remained national, the EU has tried to develop peer reviewprocesses to improve national economic performance and policies. This isthe case for some policy dialogues, notably on employment policies,developed gradually from the second half of the 1990s. The EuropeanCommission has for a number of years produced a major publication, BroadEconomic Policy Guidelines, which is based on what is in the EU labelled“the open method of co-ordination”. Since 2000 the policies covered arealso discussed by Heads of Government once a year under the heading ofthe Lisbon Strategy. But despite the efforts to focus the Lisbon Strategy on



growth and employment and on areas with an element of EU funding suchas R&D, the peer review process remains cautious and inconclusive. Thereis a heavy reliance on inputs from national governments and even on thelatter’s self-evaluation of their respective structural policies, much of thismotivated by the, in itself laudable, ambition to encourage “nationalownership” of the policy programmes submitted.

There are good reasons for accepting the analysis of the shortcomings ofthe open method of co-ordination presented by independent observers suchas Pisani-Ferry (2006). The method is too decentralised; there is as a resultgreat difficulty in conducting peer reviews on the basis of the veryheterogeneous documents available. Benchmarking – an indispensable toolor good starting point – for comparative policy analysis has beendeliberately downgraded as being too reductionist and intrusive.Unfortunately, these weaknesses have not been offset by gains in thestanding of the national programmes in their respective countries; they haveusually not been subjected to parliamentary or public debates, or been veryvisible in the media. There are currently some improvements underway,particularly through the Economic Policy Committee, in the analyticalmethodology of cross-country structural policies, to some extent drawing onOECD work with which many of the EU national officials are very familiar,but it remains to be seen whether these efforts will be carried through to thepolitical level.

There may well be a simple explanation of this vagueness of peerreviews of the some areas of economic policy observable in the EU.Member countries perceive that they have transferred so much authority inseveral areas of economic policy – notably money, trade, competition andinternal market – that they are not prepared to submit remaining policies tothe scrutiny of a peer review process. This applies even to policy areaswhere the EU has shown the boldness of formulating a quantified target for2010, such as for the employment rate at the aggregate EU level. Anotherexplanatory factor may lie in the position of the European Commission onwhose policy assessments any peer review process would have to be based.The Commission is too strong, through its political credentials in a numberof areas, to be regarded as a secretariat of the kind found in the IMF and theOECD. And yet it is the more detached status of the latter that seems crucialfor organising a constructive dialogue around peer reviews of nationalpolicies.

So the EU remains a paradox in relation to peer review. It has moved farbeyond such reviews in several areas where the degree of politicalcommitment to common objectives are strong, but it falls short of them inothers. There seems to be no easily accessible half-way house between jointdecision-making or commonly-formulated objectives on the one hand and



the vaguer open method of co-operation on the other hand. The EU istherefore a difficult model to copy for regional co-operation in other parts ofthe world, since – paradoxically – it either goes too far or not far enough.But to the extent that other regions, such as the ASEAN member states,were to develop political objectives similar in nature to those in the EU, theEuropean experience obviously becomes of greater relevance.

The OECD is in some ways at an intermediate position between the IMFand the EU. While the IMF has in practice delegated most of the peer reviewto its staff and management, the elements of peer review are indirect. Thenational authorities of an examined country have their main points of viewon specific policy issues reflected in the summary record of the policydiscussion conducted with the staff during missions, but they are notultimately expected to endorse the policy recommendations addressed tothem. Nor are they able to modify or remove themes treated in an Article IVConsultation Report. The EU framework, outside the areas of joint policies,is, on the contrary, heavily influenced by national governments with respectto both the topics treated and the way in which they are treated. The peerreview process for structural policies has been embraced by nationalgovernments in a way that does not at the present time leave much room forcritical peers. There are now moves to strengthen the latter aspect by takingevaluations of national programmes to the European Council, but thereluctance to engage in mutual advice remains strong at the Ministeriallevel.

The OECD peer reviews process is currently – may be by chance,though good efforts at design are certainly visible – in an intermediateposition between its two competitors when it comes to relations withmember governments. Eschewing both the more arms-length relation togovernments of the IMF during the completion of an Article IVConsultation Report and the tight embrace of EU governments in designingand discussing their national programmes as part of the Lisbon Strategy, theOECD fosters an intensive exchange with the authorities of its membercountries both during missions and in the finalisation of its EconomicSurveys. At that latter stage it engages in a full day of intensive debatebetween the visiting national authorities and the EDRC Economic andFinancial Counsellors, sometimes reinforced by officials form capitals,bringing to bear the policy experience of their countries. No subject is offthe table throughout this process, but – since the national authoritiesconcerned have finally to accept the constructiveness of any policyrecommendations – part of the discussion is directed at giving therecommendations such a flavour. The EDRC meeting is followed up byanother one-day meeting between the OECD secretariat and therepresentatives of the examined country to prepare a revised draft for final,



written approval by the committee. The strongly comparative nature of theSurveys with extensive use of benchmarking makes it difficult for a countryto avoid recommendations based on both relatively poor economicperformance and on relatively weak efforts to improve policies in aparticular area.

It is easy to see where the risks in the OECD process of peer review lie.Those familiar with IMF surveillance believe that the messages in OECDEconomic Surveys may often be diluted and some issues fudged because ofthe need to bring also the authorities of the examined country on board.Those familiar with EU processes believe that OECD messages are oftenoverly standardised and pay insufficient attention to national circumstances.

There is no doubt some truth in both of these suspicions. IMF Article IVConsultation Reports are often more concise on topics that also appear inOECD Surveys. Anything else would be strange, since IMF tends toproduce much shorter and crisper documents, while being helped by theIMF tradition that changes to a Report proposed by an examined country beconfined to the removal of “market-sensitive information.” EU documentsare often (even) richer in details than OECD Surveys, but the difficulties ofestablishing a common methodology have made them less accessible. Onbalance, the OECD method of conducting peer reviews seems to be anintermediate practice which not only has its usefulness in tackling issueswith a mixture of objectivity and national government involvement, but alsohas received some recognition from its two “competitors”. Both the IMF andthe European Commission now draw frequently on OECD material inadvancing their respective policy recommendations. Indeed, there is nodoubt that a potentially fruitful interaction is developing between the OECDrole in pioneering efforts in comparative analysis of structural policies andthe ambition of the EU to put such policies more firmly on the politicalagenda of its member states.

6.4. Conclusion

My conclusion is that the OECD peer review process stands out asrelatively successful in comparison to much of the similar work performedglobally by the IMF and regionally within Europe by the EU. In that sensethe OECD experience warrants careful study by the ASEAN countries andpossibly other regional groupings of countries in search of issues beyond theliberalisation of regional trade.

However, the good marks to the OECD depend on several factors thatare constantly evolving and could with time erode the comparativeadvantages currently enjoyed. I mention three such factors briefly.



The first is that work on structural policy reforms is very demanding andlabour-intensive. It needs to be highly systematised and regularly updated tobe manageable. It is surprising that a small-sized OECD secretariat with aslightly shrinking budget year-by-year over the last decade has been able toget as far as it has with this analytically demanding agenda.

The second is that member countries have to continue to take the OECDpeer reviews process seriously by providing experienced national policyofficials to serve as Economic and Financial Counsellors at the OECD,i.e. as well-informed participants in the peer review process, to match thevery considerable expertise brought by the authorities of the country underexamination. At a time of proliferating international commitments and risingdemand for this type of expertise such continued involvement in the OECDcan not be taken for granted.

Finally, the OECD is in the process of enlarging the geographical rangeof participants in its activities. In the EDRC we have already for some yearsconducted Economic Surveys of the largest non-member countries: Brazil,China, Russia and India. The OECD Ministerial Council Meeting ofMay 2007 decided to engage in negotiations on membership for fivecountries: Chile, Estonia, Israel, Russia and Slovenia. This is a source ofpride for all involved in the activities of the OECD, but it does raiseconcerns. The present membership is not particularly homogeneous, but it istoday marked by a certain like-mindedness in approach to policies whichhas greatly facilitated a degree of uniformity in the analysis of policyissues – as well as considerable mutual familiarity with each other’sproblems. Can the professionalism of OECD policy analysis and advice, asembodied in the peer review process, survive a substantial extension in themembership of the Organisation? That prospect will certainly put to the testthe efforts required under the first two points mentioned above.



Notes

1. My limited familiarity with the IMF Article IV process stems primarilyfrom my experience in the evaluation of the effectiveness of IMFsurveillance as a member of the independent expert panel which preparedIMF (2000). I have followed the evolution of EU policy review effortsclosely over the past couple of decades as an interested academic withoccasional participation in official committees, notably on the design ofEconomic and Monetary Union (EMU).

2. See Blair Comley’s contribution to the Jakarta seminar on the concept of“peer learning” in Chapter 4.

3. See Val Koromzay’s contribution to the Jakarta forum (Annex B to thispublication) for a more detailed presentation of the organisation of workaround the country surveys in the OECD secretariat.

4. Recently members of the New Partnership for African Development(NEPAD) have begun to conduct peer reviews, drawing in part oninspiration from the OECD, three country reviews have been published sofar. Potential interest in conducting more systematic reviews of the policyexperiences of members is emerging in ASEAN, may be in APEC.

5. The IMF has recently been discouraged from building up expertise inthese areas by independent evaluations of its surveillance activities; seeIMF (2000) and IEO/IMF (2006). A former Australian IMF ExecutiveDirector used the term “mission creep” to characterise some early IMFefforts to expand surveillance in to structural policies more generally.

6. An IMF staff member recently pointed out that the time spent in actuallydiscussing the many Article IV Consultation Reports for most, but thelargest, members states was about the same as that spent in makingfarewell speeches to departing Board members and senior staff.



Bibliography

Comley, Blair (2008), “Peer Review in the Context of Regional Integrationin Southeast Asia”, Chapter 4 of this publication.

International Monetary Fund (IMF) (2000), External Evaluation of IMFSurveillance, report by a group of independent experts, IMF.

Independent Evaluation Office (IEO) of the IMF (2006), An Evaluation ofthe IMF’s Multilateral Surveillance, IMF.

Koromzay, Val (2008), “Peer Review in the Economic and DevelopmentReview Committee”, presented at the OECD-Southeast Asia RegionalForum on Peer Reviews, Annex B of this publication.

OECD (2007), “Peer Review: a Tool for Cooperation and Change”, PolicyBrief, OECD Observer, OECD, January.

Pisani-Ferry, Jean (2006), “Last Exit to Lisbon”, Bruegel Policy Brief,Bruegel, Brussels.

7. INTEGRATING NEWER ASEAN MEMBERS AND PEER REVIEW – 149


Chapter 7. Integrating Newer ASEAN Members and PeerReview*

7.1. Integrating newer ASEAN members: what are the challenges?

Ten years have passed since the 1997 East Asian crisis which dealt aheavy blow to the member countries of the Association of Southeast AsianNations (ASEAN).1 Having recovered strongly from the crisis, ASEAN hasproven to be one of the most dynamic regions in the world economy.Improved business environments have allowed the countries of this region tobenefit from their increasing integration in the global economy. Growth hasbeen largely driven by strong export and investment activities. The region’senterprises have expanded their participation into global value chains and insome cases managed to move up their technological ladders.

At the same time, it has become clear that ASEAN countries are facingnew challenges. One area of major concern is to narrow the developmentgap between newer and older member countries.2 The aggregated populationof four newer ASEAN members, Cambodia, Lao PDR, Myanmar andViet Nam (collectively known as CLMV countries) corresponded to almost40% of ASEAN-6 (Brunei Darussalam, Indonesia, Malaysia, Philippines,Singapore and Thailand) in 2006. Their trade share amounted to only 7% inthe same year. There is thus a significant divergence between these twogroups in terms of their ability to reap the gains from greater economicintegration at both global and regional levels. To be sure, CLMV countrieshave implemented large-scale reforms in the past years, often associatedwith ASEAN economic integration and the World Trade Organization(WTO) accession process (in the case of CLV). These reforms have enabledthem to attract new investment and benefit from their preferential marketaccess granted by OECD countries. Their industry value added grew at

* This chapter was written by Kiichiro Fukasaku, Head of Regional Desks,OECD, Development Centre. The author is most grateful toClaudia Behrendt and Federico Bonaglia for their excellent assistance inpreparing this chapter.

150 – 7. INTEGRATING NEWER ASEAN MEMBERS AND PEER REVIEW


around 11% a year between 2000 and 2005.3 Despite such robust growth,their per capita incomes are still far below the regional average.4 InViet Nam, the most advanced among the newer ASEAN members, theper capita income was still roughly a fourth of Thailand’s at the currentexchange rates and nearly 40% in purchasing power parities (PPP) terms(World Bank, 2007).

In order to reduce the development gap within the member countries,ASEAN has made special efforts to promote the development of CLMVcountries since the beginning of this millennium.5 At the 4th ASEANInformal Summit in Singapore in November 2000, the ASEAN Leadersagreed to launch an Initiative for ASEAN Integration (IAI). Pursuant to thisdecision, the Hanoi Declaration on Narrowing the Development Gap forCloser ASEAN Integration was adopted at the 34th Meeting of ASEANMinisterial Meeting in July 2001. In the following year the ASEAN Leadersapproved the IAI Work Plan and the list of programmes and projectproposals at their 8th Summit Meeting in Phnom Penh. The current six-yearIAI Work Plan (July 2002-June 2008) for the CLMV countries focuses onfour priority areas: infrastructure development, human resourcedevelopment, information and communication technology and promotingregional economic integration in the CLMV countries. In addition toASEAN-6 countries, 11 donor countries and agencies have also supportedIAI Work Plan projects by providing financial assistance totallingUSD 15.5 million (as of May 2005). Among them, Korea, Japan, India,UNIDO (Norway) and Australia are five top donors contributing 84% oftotal funding by development partners.6

ASEAN efforts to narrow the development gap among its members havebeen recognised as an integral part of realising the ASEAN EconomicCommunity. This is the end goal of economic integration measures asoutlined in ASEAN Vision 2020 which was adopted in 1997 by the ASEANLeaders on the occasion of the 30th Anniversary of ASEAN.7 TheDeclaration of ASEAN Concord II (Bali Concord II) in 2003 reaffirmed that“ASEAN is committed to deepening and broadening its internal economicintegration and linkages with the world economy” to realise this end goal. Italso noted that “deepening and broadening integration of ASEAN shall beaccompanied by technical and development co-operation in order to addressthe development divide and accelerate the economic integration ofCambodia, Lao PDR, Myanmar and Viet Nam …” In the following year, atthe 10th Summit Meeting, the ASEAN Leaders adopted the Vientiane ActionProgramme (VAP) – a six-year plan to deepen and broaden economicintegration, while at the same time reducing the large disparities amongmember countries. The IAI to bridge the development gaps in the VAP has



been broadened to include development efforts not only for the CLMV butalso the poorer sub-regions in the ASEAN-6 countries.

It is important to emphasise in this conjunction that integration into theglobal economy brings about opportunities to access knowledge andmarkets, but also exposes domestic firms and workers to greater competitivepressures. The benefit of economic integration is largely dependent on acountry’s supply-side capacity which is determined by both its human andnatural resource endowments and government policies. A growing body ofliterature highlights that many low-income countries have experienced slowand unsatisfactory responses to trade liberalisation and are struggling todiversify and upgrade their export profiles (see, for instance, Bonaglia andFukasaku, 2003). Commonly observed constraints include high transactioncosts and poor regulatory environments which exacerbate underlyingstructural weaknesses in the productive sectors and limit the opportunitiescreated by dismantling trade and investment barriers (World Bank, 2005;UNCTAD, 2006). Complex rules of origin also reduce the potentiallypositive impact of preferential market access initiatives.8

Sustained economic growth is regarded as a pre-requisite for CLMVcountries to generate better employment opportunities for their young andgrowing populations. Yet, their growth prospects remain highly dependenton such footloose sectors as clothing production and electronic assemblyoperations whose international competitiveness may be jeopardised by theongoing restructuring of international production networks. Naturalresource-base sectors, such as wood and food processing are important too,but poor regulations risk undermining their sustainability.9 Improvedinvestment climate has encouraged local entrepreneurship, but the privatesector remains relatively weak, even in a booming Viet Nam, and mostlyconsists of micro- and small-enterprises, often operating in the informalsector. In most sectors production is concentrated in simple assemblyoperations and depends on imported technology and inputs that are essentialfor domestic production. The development of national technologicalcapabilities remains insufficient to enter into global production networks inmore technologically advanced sectors or move up the value chain.

In the following sections, we review the current donor activities ontrade-related assistance (“aid for trade”) in CLMV countries and discuss theimportance of peer review as an instrument to improve their effectiveness.



7.2. What role for trade-related assistance in promoting integration?

The international community has long recognised the need to providewell-targeted trade-related technical assistance and capacity building (inshort, trade-related assistance or “aid for trade”10) to promote the integrationof developing countries into the multilateral trading system. The issue of“aid for trade” has evolved from one of technical assistance needed toformulate policy, participate in negotiations and implement tradeagreements, to one recognising that (i) trade is part of the overalldevelopment strategies of developing countries; and (ii) it is enterprises thattrade and their capacities are often frustrated by supply-side constraints (seeBox 7.1). Such evolution reflects several important lessons learned fromrecent experiences in poor countries.11

First, simply lowering barriers to trade unilaterally or multilaterally doesnot automatically lead to expected supply responses in poor countries. Nor isthere any automatic positive link between trade liberalisation and povertyreduction. As a consequence, a large number of low-income countries,notably in Africa, are lagging behind in benefiting from greatly increasedworld trade flows arising from globalisation and liberalisation.

Second, strengthening the local ownership of trade reforms is essentialfor their sustainability and successful participation in a growing world trade.Local governments have responsibility for their development processes andallow necessary institutions to develop in a national context. Donors have toprovide assistance in a way that takes this into account, which implies moredemand-driven, long-term capacity building and sector support.

Third, building local productive capacity is a pre-requisite for poorcountries to benefit from trade liberalisation, which requires broad-basedchanges in the way the local economy works and its business environmentfunctions. Deep-seated constraints hamper the ability of local enterprises tocompete with imports on the domestic market and break into export markets,including through greater participation in global value chains. Improvementsare needed all along the domestic value chains as well. While productionand marketing should be left to the private sector, government has animportant role to play to regulate the market and establish suitablesupportive structures. Having recognised these important lessons, growthand private sector development issues, including infrastructure development,have recently had a come-back on the international agenda of developmentco-operation.



Box 7.1. The evolution of trade for aid

The international community has long recognised the need to provide targeted trade-relatedtechnical assistance and capacity building to promote the integration of developing countries,especially the least-developed countries (LDCs), into the multilateral trading system. Donorshave provided substantial support to productive sectors and infrastructure, to varying degrees,long before the emergence of the “aid for trade” concept. What is new is the recognition oftrade as part of the overall development strategies of countries. Moreover, there is increasedawareness in the trade community of the importance of the so-called “supply side” constraintsthat hamper the ability of developing-country enterprises to reap the opportunities created bytrade liberalisation.

The Doha Development Agenda adopted at the 2001 WTO Ministerial meeting reaffirmedthis commitment stressing that the successful trade integration of LDCs “requires meaningfulmarket access, support for the diversification of their production and export base, andtrade-related technical assistance and capacity building” (paragraph 42). Following the launchof the Doha round, the OECD and WTO improved the monitoring of aid flows to strengthentrade capacities, or “aid for trade” (http://tcbdb.wto.org). The creation of the WTO/OECDdatabase on trade-related technical assistance and capacity building in 2002 has made animportant contribution to monitoring and assessing aid-for-trade activities.

In October 2006, the WTO Aid for Trade Task Force has recommended to expand officiallythe aid-for-trade agenda. This implied adding to the “traditional categories” of trade-relatedtechnical assistance (trade policy and regulations and trade development) four new categories:(1) trade-related infrastructure, (2) building productive capacity, (3) trade-related adjustment,and (4) other trade-related needs. The WTO/OECD database provides information on reportedtrade policy and regulations and trade development activities. Infrastructure and buildingproductive capacity are reported in the OECD/Development Assistance Committee (DAC)CRS database.

In May 2007 the WTO/OECD decided to remove the Trade Development category asreported in the WTO/OECD database. In the new CRS categorisation, starting in 2008, it hasbeen suggested that a trade development marker under the Building Productive Capacitycategory is introduced to identify trade-related aid activities within the Building ProductiveCapacity category. As regards Trade-related Adjustment, the WTO/OECD has suggested tocreate a new category under the General Budget Support (GBS). However, neither the TaskForce report nor the WTO/OECD provides any definition of Other Trade-related Needs.

Over 2002 and 2005, global annual aid-for-trade commitments including only the“traditional” categories averaged USD 2.8 billion, at constant 2004 prices. When includingtrade-related infrastructure and merging trade development and building productive capacity,global aid for trade averaged USD 21 billion annually over 2002 and 2005 (with a 54% shareof trade-related infrastructure). With the inclusion of GBS, the average global aid-for-tradevolume accounted for USD 26.2 billion per year over the same period (with a 43% share oftrade-related infrastructure).



Following the recommendations of the WTO Aid for Trade Task Force, a multilayeredmonitoring and evaluation scheme has been established in the WTO: (1) an annual report ofglobal aid-for-trade flows based on the OECD/CRS data; (2) donors’ self-assessment reports;and (3) aid recipients’ in-country assessment reports. The WTO has also set the 2007 roadmap, including three regional reviews in Latin America, Asia and Africa, respectively,scheduled for September-October, in order to conduct a Global Aid-for-Trade Review in theGeneral Council in late November 2007.

Source : Andersson et al., 2007; OECD, 2006a.

Trade-related assistance (or aid for trade) can assist low-incomecountries in their efforts to better integrate into the international economy.According to a recent OECD (2007) review of donor activities, it has playedan important role in raising the awareness of their governments on regionaland multilateral trade policy issues and negotiations and strengthening theirnational dialogue on trade-related issues. Second, it has also made animportant contribution to elaborating export development strategies andimproving investment legislations and the business climate (OECD, 2007).In what follows we take a brief look at recent trends in trade-relatedassistance provided to several ASEAN countries.

7.3. Trade-related assistance to Southeast Asia

Lower-income ASEAN countries have received a sizeable amount oftrade-related assistance in the past years. Table 7.1 provides a snapshot ofsuch aid flows to seven ASEAN countries. Overall the four CLMV countriestaken together received USD 6.9 billion (on commitments basis) over2002-05, or a fifth of total official development assistance (ODA)commitments to the seven ASEAN countries. Viet Nam was the largestrecipient among CLMV countries.

About USD 14 billion were committed to aid for trade in the sevenSoutheast Asian countries over 2002 and 2005. This corresponded to 43% oftotal committed ODA to the region (Table 7.1). Aid-for-trade commitmentsto these countries remained more or less stable in real terms over the periodof 2002-2005. Viet Nam and Indonesia were the first and second largestrecipients of aid for trade in the region, while Myanmar and Lao PDRreceived relatively small support.



Table 7.1. Trade-related assistance to Southeast Asia by country

USD million (commitments) in constant 2004 prices, 2002-2005

2002 2003 2004 2005 Total AfT2002-05

Total ODA2002-05

ShareAfT/ODA

Cambodia 46 202 184 227 660 2 235 30%

Indonesia 613 1 406 1 352 984 4 355 12 979 34%

Lao PDR 91 173 102 137 504 1 160 43%

Myanmar 10 11 10 10 42 482 9%

Philippines 774 173 154 158 1 260 2 835 44%

Thailand 453 85 455 399 1 392 2 108 66%

Viet Nam 1 462 1 130 1 541 1 539 5 672 10 564 54%

Region 3 450 3 180 3 798 3 455 13 883 32 362 43%

Note: AfT = Aid for Trade

Source: WTO/OECD database and OECD/DAC CRS database.

On average, USD 3.5 billion of aid for trade were committed annually tothe region over 2002-2005 (Table 7.2). About two-thirds of the totalaid-for-trade volume was dedicated to support trade-related infrastructure,followed by building productive capacities, while 2% of committed aid fortrade went to finance the trade policy and regulations category. In Thailand,for example, almost 90% of total aid for trade was committed totrade-related infrastructure, whereas 0.4% was spent in trade policy andregulations.

The fact that support to trade policy and regulations is so smallcompared to trade-related infrastructure and building productive capacity isnot unique to Southeast Asia. The similar trend can be observed in othermajor regions as well.12 This is because support to the first category mainlyinvolves technical assistance, which is far less capital intensive than supportto the other categories. Nonetheless, this also points to the importance ofmainstreaming trade policy issues into support to infrastructure andproductive sectors, in order to increase the impact of aid for trade inlower-income ASEAN countries.



Table 7.2. Trade-related assistance to Southeast Asia by major category

USD million (commitments) in constant 2004 prices, 2002-2005 average

Trade policy andregulations

Building productivecapacity

Trade-relatedinfrastructure

Total aid for trade

Cambodia 5 65 96 165

Indonesia 11 267 811 1 089

Lao PDR 11 51 64 126

Myanmar 0 8 2 10

Philippines 4 96 214 315

Thailand 1 46 301 348

Viet Nam 26 422 970 1 418

Region 59 954 2 458 3 471


Over the 2002-2005 period, Japan was the far largest contributor to theregion. Germany and France were the distant second and third donors of aidfor trade to Southeast Asia, followed by Denmark and the United States(Table 7.3). Among the multilateral donors, the IDA, the AsianDevelopment Bank (ADB) and the European Commission (EC) were thethree largest providers of aid for trade to the region between 2002 and 2005.The International Fund for Agricultural Development (IFAD) and the WTOfollowed as fourth and fifth largest multilateral donors in Southeast Asia.Japan, Germany and the World Bank concentrated their support ontrade-related infrastructure, while France, Denmark, the ADB and the ECfocussed on building productive capacity.

Developing-country governments and donors increasingly acknowledgethat a healthy development of private enterprises is a vital component ofeconomic growth and poverty reduction, as they are the most importantsource of innovation and employment generation (see, for instance, ADB,2000; UN, 2004). A vibrant and competitive private sector can alsoempower poor people by providing them with better and cheaper goods andservices. Such increased awareness is reflected in the second-generationPoverty Reduction Strategy Papers (PRSPs). These PRSPs devote greaterattention to issues of trade and private sector development (PSD).13



Table 7.3. Bilateral and multilateral donors of trade-related assistance to Southeast Asia

USD million (commitments) in constant 2004 prices, 2002-2005 average

Total aidfor trade

Trade policyand

regulations

Buildingproductivecapacity

Trade-relatedinfrastructure

BILATERAL Japan Region 2 157 4 267 1 886Indonesia 885 2 163 720Viet Nam 672 1 34 637Thailand 315 0 18 296

Germany Region 160 0 66 94Indonesia 83 0 12 71Philippines 34 0 23 11Cambodia 13 0 5 8

France Region 99 3 72 25Viet Nam 75 1 56 18Lao PDR 7 1 5 2Indonesia 5 0 5 0

MULTILATERAL IDA Region 509 17 170 322Viet Nam 448 17 146 285Indonesia 27 0 16 11Cambodia 18 0 0 18

ADB Region 271 9 176 85Viet Nam 113 0 91 22Cambodia 73 0 36 37Lao PDR 57 9 22 26

EC Region 27 11 17 0Philippines 5 0 5 0Viet Nam 0 0 0 0Lao PDR 0 0 0 0


Aid-for-trade initiatives explicitly recognise that aid and trade policiesare complements; a judicious mix of multilateral trade liberalisation whichleads to improved market access for developing countries and aid spendingby developed countries would be more effective than either policy inisolation. The recent experience of lower-income ASEAN countriesprovides useful lessons regarding how the policies and actions of majorOECD countries in the trade and aid domains had synergy effects, intendedor unintended, on their development outcome. This may deserve furtherwork in the OECD-ASEAN context.14

7.4. Peer review as an instrument to improve aid effectiveness

How can donors and their development partners ensure that aid for tradeis effectively used and contributes to the economic integration of the



recipient countries? Since the adoption of the Monterrey Consensus, donorsand their development partners have agreed that development is a jointresponsibility which requires mutual accountability. In other words,aid-giving and receiving countries must be accountable to each other forprogress in managing aid better and in achieving development results. Onthe one hand, the impact of donors’ interventions depends not only onaid-delivery modalities, but also on a broader set of local conditions, shapedby the recipient country’s resources and policies. On the other hand, asclearly stated in the Doha Declaration, aid for trade cannot substitute formeaningful market access. Therefore, the coherence of donor-countrypolicies is another important yardstick to assess outcomes (Fukasaku et al.,2005).

Furthermore, the WTO Aid for Trade Task Force, which was establishedafter the WTO Hong Kong Ministerial Conference in November 2005,acknowledged in its recommendations the importance of adopting theprinciples of aid effectiveness enshrined in the Paris Declaration on AidEffectiveness of March 2005. The Paris Declaration defines a number ofcommitments on the part of donors and partner countries, and a set ofindicators to measure progress towards 2010.15 The basic principles of aideffectiveness include ownership (developing countries exercise leadershipover their development policies and plans), alignment (donors base theirsupport on countries’ development strategies and systems), harmonisation(donors co-ordinate their activities and minimise the cost of delivering aid)and managing for results (developing countries and donors orient theiractivities to achieving the desired results). As part of these efforts, donorsare increasingly relying on resource pooling to support specific sectors, inline with the priorities identified by local stakeholders (e.g. through basketfunding and sector-wide approaches). In practice, the move towardsresource pooling is much more frequently observed in health and educationsectors than in areas such as trade and PSD.

Are these interventions having a positive impact on the recipientcountries? Standard criteria to evaluate performance include relevance,efficiency, effectiveness, impact and sustainability. Despite considerableefforts at adopting common understanding and methodologies, there arewell-known methodological difficulties in assessing the impact of donorinterventions. Besides the difficulty arising from the lack of clarity in thespecification of objectives, there is the so-called “attribution problem”.Between the disbursement of foreign aid and eventual developmentoutcomes, there is a long causality chain, which makes it extremely difficultto assess aid effectiveness.16 Other difficulties also arise from the specificnature of aid interventions in trade and PSD, that is, the difficulties ofclearly identifying an agency’s trade-related activities (these are sometimes



part of broader aid programmes) and the targeted results (e.g. final outcomessuch as increased or more diversified exports versus intermediary objectivessuch as negotiating or trade policy-making capacities).

Aid for trade has been brought under the spotlight in recent months, andmany observers have pointed to its potential to contribute to a positiveoutcome of the Doha Round as well as other important regional negotiationssuch as the Economic Partnerships Agreement between the European Unionand the ACP (Africa, the Caribbean and the Pacific) countries. Aid for trade,however, is not a silver bullet, and critics have emphasised the risk ofovercharging the aid-for-trade agenda or using it as a carrot to havedeveloping countries fully engage in the current round. A major problemhere is that while developing countries sign trade liberalisationcommitments, which are binding, aid commitments offered by donors arenot binding.

Aid monitoring and peer review

How can then aid effectiveness be ensured in the case of aid for trade? Ajoint process of peer review can be devised between donors and aidrecipients at different levels. In the framework of aid harmonisation, donorsand recipients are devising joint strategies and frameworks with monitoringindicators to improve predictability of aid flows and ensure that both sidesmeet their commitments.17 Three of the CLMV countries are signatories ofthe Paris Declaration on aid effectiveness and two of them – Cambodia andViet Nam – have taken part in the first Baseline Survey on Monitoring theParis Declaration (OECD, 2006b). Lao PDR has yet to join the survey, but ithas established with 22 donors the Vientiane Declaration on AidEffectiveness in late November 2006 (UNDP, 2007).

To increase the credibility of aid for trade, the OECD has advocated theneed to establish appropriate accountability mechanisms to be implementedat three levels, national, regional and global (OECD, 2006a). Following therecommendations of the Task Force report, the WTO has established amonitoring and evaluation function; the focal point of this initiative will bean annual Aid-for-Trade review in the General Council, beginning in theautumn of 2007. In the lead-up to this event, the Committee on Trade andDevelopment (CTD) has been asked to carry out periodic reviews of Aid forTrade (WT/COMTD/AFT/M/1, 4 May 2007). It was recognised that “[t]hechallenge was not to invent a new mechanism, but rather to get the manyexisting mechanisms to work together more effectively” (WT/GC/M/106,1 March 2007, p. 31). A recent background note by the WTO Secretariatalso stated:



“Improved monitoring and evaluation was essential for buildingconfidence that increased Aid for Trade would be delivered andused effectively – and for enhancing the credibility of donors’commitments. Greater transparency was needed to provideincentives for donors and recipients to work together moreeffectively to advance the Aid-for-Trade agenda” (WT/AFT/W/26,29 May 2007, p. 4).

Monitoring and evaluation in the WTO will indeed take place at threelevels. Besides the global review of aid-for-trade flows (based on datacompiled by the OECD/DAC CRS database) and the evaluations of national,regional and multilateral donors’ aid-for-trade activities (based on donorself-assessments), there will be in-country assessments by aid recipients.Meanwhile, the CTD has set up a timetable for its periodic reviews,including three regional reviews for Latin America and the Caribbean, Asiaand the Pacific and Africa, respectively, during the months of Septemberand October 2007, before conducting a Global Aid-for-Trade Review in theGeneral Council in late November (WT/COMTD/AFT/W/2, 8 June 2007).Let us briefly examine these review mechanisms.

Global aid-for-trade reviews

A fundamental requirement for any meaningful review is the availabilityof data. The creation of the WTO-OECD database in 2002 has been asignificant improvement in this respect, as it allows one to identify and trackdonors’ trade-related assistance. Despite this progress, there are seriouslimitations which prevent in-depth evaluations.

Firstly, data recorded in the database are commitments and not actualdisbursements; therefore it is quite difficult to track the flow of aid moneyfrom pledges to commitments and then to dispenses at the country level.Secondly, despite efforts to improve definitions and reporting, there remainlimitations in coverage, which distort the true picture (e.g. the lack ofreporting by several non-DAC donors). Thirdly, from a practical point ofview, it might be extremely difficult to distinguish between trade-relatedactivities which are often part of broader aid programmes. From ananalytical point of view it can also be argued that all support to productivesectors and physical infrastructure is trade-related directly or indirectly byaddressing supply-side constraints to trade development. In this regard, theWTO Task Force has taken a broad stance by suggesting that the types ofinterventions that should be considered as aid for trade are those projectsand programmes that have been identified as trade-related developmentpriorities in the recipient country’s national development strategies(WT/AFT/1, p. 2). Fourthly, the key issue of domestic trade may be



overlooked in this interpretation, since what is explicitly defined astrade-related assistance most typically focuses on international trade.Finally, the recorded aid-for-trade activities are those reported by donors,and as such it is not possible at the global level to have any good idea of theactual demand for or needs of aid for trade in partner countries and to assessthe extent to which their demand and needs are met. There is thus the needto link global reviews and in-country assessments in order to systematicallyidentify such “gaps” at the global level and gauge the effectiveness of thereported activities.

Donors’ self-assessments

Several bilateral and multilateral aid agencies have conducted ownassessments of their aid-for-trade programmes. A recent review of theseevaluations (OECD, 2007) points to some positive outcomes, but alsoidentifies a number of difficulties and weaknesses. One of the mainrecommendations emerging from the OECD report is that donor agenciesshould strengthen their collaboration with relevant stakeholders in therecipient country during the design, delivery and review phases. Activitiesshould be based on a sound, consultative diagnosis, and a result-basedmanagement approach should be adopted; in other words, programmeobjectives and results should be regularly and jointly monitored andassessed. Such consultative process would facilitate the direct link betweenthe assistance provided and the need of the recipient and could also lead tojointly identifying specific monitoring indicators.

Suggestions have been made that the OECD should use the data onaid-for-trade commitments and discuss their effective delivery on theoccasion of its peer review.18 These are periodic assessments conducted bythe Development Assistance Committee (DAC) for reviewing the aid policyof its member governments, with the intention of identifying and sharingbest practices among OECD donors. DAC peer reviews are particularlyfocussed on process and organisation with policy coherence, aideffectiveness and humanitarian aid as special topics for review. Aid for trademight be considered as a special topic as well.

In-country reviews

As discussed before, a majority of developing countries have endorsedthe Paris Declaration and many have developed joint monitoring strategieswith their development partners. This close interaction between donors andtheir development partners is contributing to improving the effectiveness ofdevelopment assistance. However, given the cross-cutting nature of



intervention in trade and PSD, it is often difficult to identify specificindicators pertaining to aid in these areas and bring together all relevantstakeholders. Moreover, though awareness is rising, recipient countries haveonly recently started to pay due attention to trade and PSD in their nationaldevelopment strategies, such as the PRSPs (Fox et al., 2003).

According to OECD (2006b), monitoring at the national/regional levelshould be based on Local Accountability Pacts and bring together all the keydonors and recipient country actors that are active in the aid-for-trade area.The exercise should allow for a better identification of goals and thematching of demand for and supply of aid for trade and provide a jointperformance progress report on achievements. The local review could alsocontribute to improving the statistical work being conducted at the globallevel, by providing better data on effective delivery of aid for trade. In thisway the local assessment could then feed itself into the global reviewprocess, so that the latter can “establish a corrective feedback processenabling the international community to act upon the identified keyconstraints to improve trade capacity …” (OECD, 2006b, p. 72). In view ofdeveloping this in-country process, the OECD is preparing questionnaire foraid recipients and donor agencies that should inform the review at theWTO/CTD.

It may be worth reiterating that delivery of aid for trade must be basedon individual partner country’s own trade strategy, which is itself part andparcel of the overall economic and social development strategy. Yet, only afew poor countries have an adequate policy framework for elaborating sucha strategy and lack clearly identified objectives and priorities. Existing tradeand investment policy review processes can lend support to them. Theseinclude the WTO Trade Policy Review Mechanism (TPRM), UNCTADInvestment Policy Review (IPR) and the Diagnostic Trade IntegrationStudies (DTIS) of the Integrated Framework (IF).19 These processes,however, cannot be substitutes for the country’s own efforts towards theelaboration of a national trade strategy.

For the overall peer review exercise to be meaningful, it is thereforeimperative that aid-recipient countries possess adequate analyticalcapabilities. The reality of many poor countries, including CLMV countries,seems to point to the problem of weak domestic capabilities. Cognisant ofthis problem, donors have promoted national and regional initiatives tosupport developing policy-oriented research – which are also counted as aidfor trade.20



The CLMV experience with multi-donor, trade-related assistance21

The ASEAN region can provide two interesting experiences of donorassistance to PSD and trade capacity building (TCB). On the one hand, theIntegrated Framework is an important undertaking to improve donors’co-ordination around an agenda set by the recipient country and embedded(mainstreamed) into its national development strategy. The Cambodianexperience is one of the most successful examples of country-owned tradeand development strategies and donor co-ordination. The lessons learnedtherein are now being applied in neighbouring Lao PDR. On the other hand,the Mekong Private Sector Development Facility, with its strong orientationtowards developing firms’ capabilities and strengthening institutions that areinstrumental to PSD, and its engagement with local stakeholders, can beconsidered as a very successful model for multi-donor PSD programmes.

The Integrated Framework in Cambodia

In 2001 Cambodia was selected as one of three pilot countries under theRevamped Integrated Framework (IF) scheme. The IF’s aim is to embed(mainstream) the trade agenda into the country’s overall developmentstrategy and ensure that TCB programmes are coherent with the nationaltrade policy priorities. The Cambodian government seized the opportunityoffered under the IF to create consensus and receive support to implementthe reforms necessary to improve its trade policy stance and join the WTO.A key aim of the reform process was to make trade work for povertyreduction.

The government designed a new trade policy framework incorporatingsome major departures from the past and reflecting state-of-the-art thinkingon best practices in TCB, including the OECD Guidelines on StrengtheningTrade Capacity for Development (OECD, 2001). Firstly, the trade strategyhad to be closely integrated with the country’s overall development strategy.Secondly, it acknowledged the need for establishing effective mechanismsfor consultation among the government, the private sector and civil society.Thirdly, it formalised intra-governmental policy consultation andco-ordination.22

As part of the IF exercise, a team of national and internationaleconomists, led by the World Bank, prepared the Diagnostic TradeIntegration Study (DTIS), or Cambodia: Integration and CompetitivenessStudy. This study identified obstacles and institutional development needsnecessary to promote Cambodia’s integration into the global economy. Thefindings were discussed at a national validation workshop in 2001, involvingmajor public and private stakeholders. Based on these discussions, the



government developed a strategy for export promotion, emphasising theneed to improve the overall business environment and strengthen firm-levelcapabilities. The donor community formulated a programme of technicalassistance in line with the need identified by the government, as theyappeared in the IF action matrix.

Cambodia is considered as a successful example of reform and ashowcase for the IF and the importance of TCB programmes. At the heart ofthis success lie a number of factors. First of all, there was a strong politicalcommitment and leadership on the side of the local government. Thegovernment managed to create a strong momentum and exploit the windowof opportunity offered by the IF not only to implement much-needed anddifficult reforms, but also to join the WTO in 2003. A second importantcomponent has been the consultation mechanism with key stakeholders putin place, not only at the central government level, but also at the provinciallevel, which created widespread support for the common goal. The country,which has long been isolated, attached enormous importance to the WTOaccession to regain its place in the international community. At the sametime, the donor community invested considerable resources to show that theIF could work and bring about concrete results.

Are there lessons from the Cambodian experience with the IF exercisethat might be useful for other countries in the region, such as Lao PDR? LaoPDR embarked on the IF in 2005, setting up the IF organisational structures(National Steering Committee, IF Focal Point and an IF Secretariat). In2005-2006 the IF team prepared a draft DTIS with an action matrix, whichwas discussed both in capital and at provincial level. After the NationalValidation Workshop held in September 2006, the government prepared anaide-memoire, highlighting the need to improve co-ordination amongstdonors to avoid duplication and improving co-ordination and mainstreamingof trade within the government itself. Finally, the Cambodian experiencesuggests that although the IF can catalyse donor resources and support thegovernment’s commitment to implement far-reaching reforms, theimplementation and follow-up of activities identified in the DTIS remain akey challenge. 23

The Mekong Private Sector Development Facility (MPDF)

Launched in 1997, the Mekong Private Sector Development Facility(MPDF) is a multi-donor funded initiative set up by the InternationalFinance Corporation (IFC) in Viet Nam, Cambodia, and Lao PDR to reducepoverty through sustainable PSD.24 In particular, the Facility aims topromote the establishment and expansion of commercially viable SMEs, by



providing assistance to “solve common operational and managementproblems and compete more successfully in the global economy.”

MDPF was originally structured around two components: CompanyAdvisory Services – direct provision of technical and financial assistance tocompanies – and Development of Business Support Services – support tointermediary organisations that deliver business services to SMEs. The 2002evaluation concluded that “MPDF has been successful in achieving intendedoutcomes” and that “resources appear to be used in an efficient mannercompared to other project development facilities” (Nexus Associates, 2002).The programme facilitates donor co-ordination in the area of PSD through apublic database of donor programmes which helps to identify gaps andavoid duplications.25

Today MPDF operates through six interrelated programmes to improvethe business environment, develop the financial sector, improve managerialcapacity, and increase sustainable business practices in three key sectors:tourism, agribusiness, and garments. The industry-specific components aimat improving firms’ core capabilities to upgrade their ability of linking up tointernational production networks.

7.5. Conclusions

The greater integration of CLMV countries in the regional and globaleconomy is an important process through which they reduce thedevelopment gap with other ASEAN members, while implementing theirown growth and poverty reduction strategies. For these countries to reap thefull benefits of integration, it is important to strengthen the private sector’sproduction capacities. Aid for trade and PSD – both from OECD donors andemerging donors – can complement and support the country efforts toaddress supply-side constraints and strengthen policy formulation andimplementation capacities.

This chapter has shown how peer reviews can be instrumental inimproving the effectiveness of aid for trade. Since the Doha MinisterialDeclaration, major donors have committed to a process of global monitoringof aid for trade, which allows a better understanding of their activities. Thisprocess has its inherent limitations. Self-assessments and peer reviewswithin the OECD/DAC provide an additional instrument to improvedelivery and favour an exchange of best practices amongst donors. There is,however, a growing understanding that these external reviews are notenough, as they may fail to duly incorporate inputs and needs of localstakeholders and cannot provide an adequate monitoring of in-countryprogress. Aid effectiveness, including in the area of trade and PSD, reflect



country-specific conditions and efforts, as well as donor practices.In-country joint reviews, involving donors and local government hold thepromise of strengthening mutual accountability. The results of the baselinesurvey on aid effectiveness, focussing on aid delivery in general, highlightconcrete progress, as well as significant room for improvement.

The WTO has advocated in-country joint reviews focussing specificallyon aid for trade, which should feed a more general process of (voluntary)peer review within the CTD. These reviews should help to better match thesupply of assistance with the recipient country’s needs and allow a bettermonitoring of results. It is still too early to judge whether these reviews willimprove the current situation. There is, however, some accumulatedevidence contained in donors’ self evaluations as well as in the evaluation ofthe multi-donor aid-for-trade initiatives. As discussed in the previoussection, multi-donor initiatives, such as the IF and the MPDF, have thepotential to catalyse donors’ efforts, reducing duplications, better align themto the recipient country’s priorities and, through the process of needsassessment, contribute to capacity building within the local administration.They are based on in-depth diagnostic studies which involve a broad rangeof stakeholders, identify major constraints and set priority areas for action.Their implementation matrices define measurable objectives, which can beused as a yardstick to assess progress.

The experience of Cambodia (and Viet Nam, although this was not an IFcountry) shows that these initiatives have more chances to produce concreteresults when there is strong local ownership and when they are associatedwith underlying reform processes, such as those involved in the WTOaccession or the negotiation of regional or bilateral trade agreements.

The older ASEAN member nations have been committed to supportingthe catching-up process of the newer members. As several ASEANcountries graduate from the aid-receiving status and emerge themselves asnew donors, there is a need for them to ensure that their aid to CLMV isprovided effectively. Seven of these countries (Indonesia, Malaysia,Philippines, Thailand, Viet Nam, Cambodia and Lao PDR) have signed theParis Declaration on Aid Effectiveness and are putting in place importantefforts to implement it.26 The OECD has launched a structured dialogue withnon-DAC donors, which provides emerging donors with an opportunity toshare their experiences with more traditional ones, and evaluate ways toassess their co-operation policies, including through peer review.

To further promote this dialogue between DAC and non-DAC donors,there is an urgent need for building up mutual trust in this process. In thisconjunction, Chapter 4, a very insightful chapter by Blair Comley,emphasises three aspects of peer review, namely, peer learning, peer support



and peer pressure. Based on OECD experiences, he argues that durable peerreview processes focus on peer learning and support, while peer pressurerarely works. He also states:

“In principle peer review in the context of regional integration is nodifferent to peer review elsewhere. However, depending on thenature of the regional integration project peer review may be moreor less difficult to conduct successfully.”

As the ASEAN is transforming itself into a rule-based institution with acharter, it may be the time to discuss more thoroughly respective roles ofvarious regional integration and co-operation projects and programmes thatare underway in the APEC, ASEAN +3 and the East Asian Summit. Therole of peer review may be defined more clearly in this process. As wediscussed in this chapter, aid policy review involving both DAC andnon-DAC donors in the OECD-ASEAN context could also be an interestingexercise in support of various initiatives aimed at integrating the newermembers of ASEAN.



Notes

1. See Fukasaku et al. (2005, Chapter 1) for a detailed account of the causesof the East Asian crisis and its aftermath. See also ADB (2007a) andWorld Bank (2007) for a more recent review of policy challenges facingASEAN and other countries of the East Asia and Pacific region.

2. ASEAN was formed in 1967 as a regional institution. Viet Nam accededto ASEAN in 1995, Lao PDR and Myanmar in 1997 and Cambodia in1999.

3. Excluding Myanmar. The data for CLV countries were extracted fromWorld Bank’s World Development Indicators on line (10 September2007).

4. See the “Overview” chapter of this publication. See also ADB (2007b) fora detailed discussion on income disparities in ASEAN and other Asiancountries.

5. See Chia (2005, 2006) for further discussion.

6. Two other on-going IAI activities are the ASEAN Integrated System ofPreferences (AISP) and Mekong Basin Development. AISP providespreferential market access for exports originating from CLMV countries,which allows them to benefit fully from trade liberalisation of ASEAN-6under the ASEAN Free Trade Area (AFTA). This scheme has beenimplemented since January 2005 on a voluntary and bilateral basis. Onthe other hand, activities within the framework of Mekong BasinDevelopment include ASEAN-Mekong Basin Development Co-operation(AMBDC) in 1995 and Asian Development Bank-Greater MekongSub-region (ADB-GMS) in 1992.

7. Three existing economic initiatives to move forward the ASEANEconomic Community are the ASEAN Free Trade Area (AFTA) in 1992,ASEAN Framework Agreement on Services (AFAS) in 1995 andASEAN Investment Area (AIA) in 1998.

8. UNCTAD (2003) concludes: “In the case of LDCs, rules of origin havebeen largely demonstrated to be, at both the analytical and empiricallevels, one of the main obstacles to a better utilisation rate of the availabletrade preferences on industrial products” (p. 106).



9. These include, for instance, unsustainable forest management leading todeforestation and declining resources for the wood furniture industry, aswell as ineffective supervision and testing leading to high pesticides andantibiotics residuals in exported farmed shrimps and consequentrejections in OECD markets. See Bonaglia (2006) for further discussion.

10. In this chapter, “trade-related assistance” and “aid for trade” are usedinterchangeably.

11. See Andersson et al. (2007) for further discussion.

12. See Andersson et.al. (2007) for more detailed discussion regarding theglobal distribution of aid-for-trade activities.

13. See Fox et al. (2003). Based on the first 27 PRSPs approved by the WorldBank and the IMF, the study finds that the private sector participated inthe process in most countries and the PRSP treated it as a key factor inachieving long-term poverty reduction. The most serious weakness ofPRSPs was the lack of concrete benchmarks or progress indicators forcommitments concerning the private sector.

14. See Kokko et al. (2006) on Viet Nam as a promising study in thisdirection.

15. For more details see www.oecd.org/dac/effectiveness andwww.aidharmonization.com. Signatories of the Paris Declaration can befound at www.oecd.org/dac/effectiveness/parisdeclaration/members. Outof 31 ODA recipient countries in the Asia-Pacific Region, 18 signed theParis Declaration: Bangladesh, Cambodia, China, Fiji, Indonesia, LaoPDR, Malaysia, Mongolia, Nepal, Pakistan, Papua New Guinea,Philippines, Solomon Islands, Sri Lanka, Thailand, Timor-Leste,Vanuatu, and Viet Nam.

16. These difficulties do not preclude, however, the possibility of informedassessment and improvement of aid effectiveness. As discussed inBourguignon and Sundberg (2007) there is enough accumulatedknowledge on the main links of the causality chain, namely: the linkbetween country policies (macroeconomic stabilisation, regulation, trade,public finance) and final outcomes, the ability of policy makers to makeappropriate policy choices (i.e. governance) and the way aid agenciesprovide funds and technical assistance.

17. The OECD and the UN Economic Commission for Africa have set up in2002 a process of “Mutual Review of Development Effectiveness” in thecontext of NEPAD. This is periodic process of dialogue between Africaand OECD-DAC leaders and policy makers on development progress inAfrica focusing on African and OECD policies and performance. A first



report was produced in October 2005. The second review process isscheduled to start in 2007 and produce a report in 2008.

18. See for instance: “Aid for Trade, an LDC perspective”, paper presented atthe meeting “Financing Economic and Trade Reforms in the Context ofLiberalisation: Conceptualising and Accessing Aid for Trade”, Mauritius,17-18 July 2006(www.gov.mu/portal/sites/ncb/mof/aidfortrade/files/ldc.pdf).

19. A suggestion on this direction was formulated on the occasion of theOECD Regional Workshop on Trade Capacity Building, which was heldin Mombasa (Kenya) on 26-27 August 2002. A summary of theworkshops is available in OECD (2003).

20. Initiatives of this kind include the Asia-Pacific Research and TrainingNetwork (ARTNeT), the Latin America Trade Network (LATN) and theTrade Law Centre for Southern Africa (TRALAC).

21. This sub-section draws heavily from Bonaglia (2006).

22. The policy dialogue and consultation mechanism included the IF SteeringCommittee, the inter-ministerial Council for Social Development, theGovernment-Private Sector Forum and the donors Consultative Groupprocess. The overall process was driven by the Ministry of Commerce,where, with help of the donors, a small group of local experts was createdto strengthen the analytical and institutional capacity.

23. In this respect, donors are considering establishing a multi-donor trustfund to implement the DTIS Action Matrix of Projects and TechnicalAssistance to Promote Export Competitiveness in Lao PDR’ actionmatrix. At the same time, the government is setting up an implementationstructure.

24. Donors are the Asian Development Bank, Australia, Canada, Finland,IFC, Ireland, Japan, New Zealand, Netherlands, Norway, Sweden,Switzerland and the United Kingdom. See www.mpdf.org for moredetails on the various programmes described here.

25. The database (www.mpdf.org/d-psd-activities/d1-psd.jsp) providesinformation on all PSD programmes in the region by country, byimplementing agency and by area of intervention.

26. See, for instance, the workshop organised by the Thai InternationalDevelopment Cooperation Agency in October 2006,www.undp.or.th/publications/documents/AIDEffectivenessReport_Feb_07.pdf.



Bibliography

Andersson, J., et al. (2007), “The International Architecture of Aid forTrade, Development Centre Working Papers, OECD, Paris(forthcoming).

Asian Development Bank (ADB) (2000), “Private Sector DevelopmentStrategy”, available fromwww.adb.org/Documents/Policies/Private_Sector/private.pdf.

ADB (2006), “Regional Cooperation and Integration Strategy”, Manila,July.

ADB (2007a), “Emerging Asian Regionalism: Ten Years after the Crisis”,Manila.

ADB (2007b), “Inequality in Asia,”, Key Indicators 2007, Special Chapter,Highlights, Manila.

Bonaglia, F. (2006), Meeting the Challenge of Private Sector Development.Evidence from the Mekong Sub-Region, Development Centre Studies,OECD, Paris.

Bonaglia, F. and K. Fukasaku (2003), “Export Diversification inLow-Income Countries: An International Challenge After Doha”,Development Centre Working Papers, No. 209, OECD, Paris.

Bourguignon, F. and M. Sundberg (2007), “Aid Can Work”, Finance andDevelopment 44 (1),www.imf.org/external/pubs/ft/fandd/2007/03/straight.htm.

Chia, S.Y. (2005), “Integrating East Asia’s Low-Income Countries into theRegional and Global Markets”, in Fukasaku et al. (eds.), PolicyCoherence Towards East Asia: Development Challenges for OECDCountries, OECD, Paris, Chapter 13, pp. 527-574.

Chia, S.Y. (2006), “Integrating the Mekong Region into ASEAN”, paper forpresentation at the seminar on “Accelerating Development in theMekong Region – the Role of Economic Integration”, 26-27 June, SiemReap, Cambodia.



Comley, B. (2008), “Peer Review in the Context of Regional Integration”,Chapter 4 in this publication.

Fox, J., et al. (2003), “What Is the Role of the Private Sector in PovertyReduction Strategy Papers?”, USAID, Washington.

Fukasaku, K., et al. (eds.) (2005), Policy Coherence Towards East Asia:Development Challenges for OECD Countries, Development CentreStudies, OECD, Paris.

Kokko, A., et al. (2006), “The Harmonisation of Aid and Trade Policies: theCase of Viet Nam”, OECD Development Centre, Paris, available atwww.oecd.org/dac/trade/doha2006/.

Nexus Associates (2002), “Evaluation of the Mekong Project DevelopmentFacility: Final Report”, quoted in Bonaglia (2006).

OECD (2001), “Guidelines on Strengthening Trade Capacity forDevelopment”, OECD, Paris.

OECD (2003), “Trade Capacity Building: Experiences in an AfricanContext”, The DAC Journal 4 (2).

OECD (2004), “Accelerating Pro Poor Growth through Support for PrivateSector Development”, Paris.

OECD (2006a), “Aid for Trade: Making it Effective”, the DevelopmentDimension Series on Policy Coherence, OECD, Paris.

OECD (2006b), “2006 Survey on Monitoring the Paris Declaration”, OECD,Paris.

OECD (2007), “Trade-related Technical Assistance: What do RecentEvaluations Tell Us”, the Development Dimension Series on PolicyCoherence, OECD, Paris.

OECD Development Centre (2007), Business for Development:FosteringPrivate Sector, OECD, Paris.

United Nations (2004), Unleashing Entrepreneurship: Making BusinessWork for the Poor, New York:

United Nations Conference on Trade and Development (UNCTAD) (2003),“Trade Preferences for LDCs: An Early Assessment of Benefits andPossible Improvements”, United Nations, Geneva.

UNCTAD (2006), The Last Developed Countries Report 2006: DevelopingProductive Capacities, United Nations, Geneva.



United Nations Development Programme (UNDP) (2007), “LandmarkForum Launches Vientiane Declaration Aid Plan into Action”, UNDPNews, available at www.undplao.org/newsroom/2007/Vient%20Declar.php.

World Bank (2005), World Development Report 2005: A Better InvestmentClimate For Everyone, Washington, DC.

World Bank (2007), World Development Report 2007: Development and theNext Generation, Washington, DC.

PART II. ECONOMIC DIVERSITY AND POLICY CHALLENGES IN SOUTHEAST ASIA – 175


Part II.

Economic Diversity and Policy Challenges in Southeast Asia

8. ECONOMIC REFORM UNDER A DEMOCRATIC TRANSITION REGIME AND PEER REVIEW IN INDONESIA – 177


Chapter 8. Economic Reform under a Democratic TransitionRegime and Peer Review in Indonesia*

8.1. Introduction

This chapter is composed of two parts. The first part considers thecurrent policy reforms and challenges facing Indonesia, while the secondpart focuses on peer reviews and how they might relevantly apply toASEAN and Indonesia.

Since 2003 the Indonesian economy has shown steady improvement bygradually raising its annual growth rate to between 5% and 6%. Figure 8.1shows that Indonesia’s per capita GDP has regained pre-crisis levels andnow stands at about 28% (PPP USD 2000 in constant prices) above the peaklevel of 1997.

This recovery was driven primarily by private and public consumption,with external demand also making a contribution. Investment showed initialsigns of recovery in 2004 and the first half of 2005, since when it has sloweddown. As a result, Indonesia’s investment rate is still between 4% and 5%below pre-crisis levels, which can be translated into an additional growthrate of 1.5-2%.1

In conjunction, Indonesia’s macroeconomic risks have improvedsubstantially, according to almost all macroeconomic risk indicators. Forexample, both public debt and external debt ratios declined sharply fromabout 100% of GDP in 1999 to below 40% in 2006. They are expected tocontinue to decline further in coming years (see Figure 8.2).

* This chapter was written by Mohamad Ikhsan, Special Advisor, Co-ordinating Ministry for Economic Affairs, Republic of Indonesia and is anextended version of an upcoming World Bank publication on investmentclimate reform in East Asian countries.

178 – 8. ECONOMIC REFORM UNDER A DEMOCRATIC TRANSITION REGIME AND PEER REVIEW IN INDONESIA


Figure 8.1. Indonesia’s per capita GDP

PPP USD, 1995-2006

Source: World Bank, World Development Indicator 2006 and author’s estimate based on StatisticIndonesia.

Figure 8.2. Indonesia’s public debt and external debt ratios

1996-2006

Source: Author’s estimate based on Finance Ministry data.



Similarly, reserves to short-term debt ratio profiles, measured usingoriginal or current maturities, have changed significantly in comparison tothose of pre-crisis 1997 and the 1998-2003 crisis period.2

Indonesia has also been able to regain market confidence, as indicatedby the favourable prices of Indonesian government global bonds and thenarrower spread margin of Indonesian bonds relative to US Treasury bonds.3

Despite these improvements, however, some fundamental problems remain.First, the Indonesian economy is still not able to grow enough to reduceunemployment. It grew only by an average 4.3% per annum between 2000and 2006, compared to over 7% during the pre-crisis period. Slowereconomic expansion will clearly further reduce the ability to create newjobs.

Furthermore, the Indonesian economy’s growth elasticity ofemployment has recently declined.4 Every 1% of economic expansion oncetranslated into about 400 000 new jobs. The correlation between growth andjob creation is weakening. For every 1% of economic expansion, Indonesianeconomy is now able to create only half as many jobs. The implication isthat, with annual growth rates currently standing at around 6% and1.9 million newcomers per annum arriving on the labour market, theunemployment rate will stubbornly remain at around 9%.

The second fundamental weakness is that the job-creation deficit in thelabour market is also characterised by a shrinking formal sector. This isevidenced both by the fall in formal employment from 29 million to26.5 million jobs, and by a significant drop in the number of domestic andforeign enterprises operating in the manufacturing sector (World Bank,2005).

The third area of underlying weakness relates to industry andbusinesses. As Figure 8.3 depicts, Indonesian labour productivity isrelatively weak, even in key sectors. What is more, Indonesia’s capital costsare higher than those of its main competitors, due mainly to itsunder-developed capital market and inefficient banking sector. Logisticscosts are also high, partly because infrastructure and services areinsufficient, inefficient, and seem to have deteriorated, according to a recentinvestment climate survey. As a result of the decline in the formal (andmanufacturing) sector, as shown in Table 8.1, Indonesian total factorproductivity (TFP) has also deteriorated. This decline, coupled with arelatively low investment rate, will make it difficult for Indonesia to achievegrowth as high as those of the past – 6-7% – that would be required toabsorb both the unemployed and new arrivals on the job market.



Figure 8.3. Labour productivity by sector

0

100

200

300

400

500

600

Electronics Textiles Garments

Indonesia

India

China

Source: World Bank.

Table 8.1. Indonesia: sources of growth, 1960-2003

Period Output Output perworker

Contribution ofPhysicalcapital Education Factor

productivity1960-1970 4.10 2.07 0.18 0.58 1.291970-1980 7.87 4.97 2.75 0.35 1.801980-1990 6.38 3.34 2.48 0.56 0.271990-2000 4.21 1.50 1.95 0.47 -0.901960-2000 5.63 2.96 1.84 0.49 0.611990-1997 7.38 4.54 2.51 0.47 1.501997-2000 -2.82 -5.25 0.67 0.45 -6.302000-2003 3.73 1.15 0.38 0.41 0.36

Source: 1960-2000 from Bosworth and Collins (2003) and author’s calculation.

The above factors spell out three clear messages. First, the Indonesianeconomy needs to grow faster and on a broader basis. Second, the formalsector should become the main source of economic expansion. Third,Indonesia must, in the medium term, upgrade its business-friendlyfundamentals in order to improve its competitiveness in an increasinglyglobal economy.

If it is to meet these objectives, Indonesia is obviously required topursue structural and institutional reform to remedy the poor investmentclimate. The most pressing investment issue appears to be the concernamong Indonesian firms prompted by economic policy uncertainties (seeFigure 8.4).



Figure 8.4. Percentage of firms considering constraints to be “moderate”, “severe” or“very severe” in Indonesia

0 10 20 30 40 50 60 70 80 90

Licensing and Permits-National

Labor Regulation-National

Electricity

Licensing and Permits-Regional

Customs and Regulations-National

Customs and Regulations-Regional

Tax Rate

Cost to Financing

Labor Regulation-Regional

Tax Administration

Labor Skill and Education

Transport

Legal and Conflict Resolution

National Corruptions

Local Corruption

Economic Policy Uncertainty

Macroeconomic Instability

ADB 2003 LPEM 2006

Source: LPEM and World Bank

The Indonesian government has placed heavy emphasis on improvingthe investment climate on all fronts. Many problems remain, however,especially at the local level. While political will is relatively good, there aremajor shortcomings when it comes to implementation – particularly at themicroeconomic level – due to the many social, political, and economicchanges which Indonesia is currently experiencing.

8.2. Current policy reforms and challenges facing Indonesia

Let us now explore the efforts that the Indonesian government mustundertake and the challenges it must face in implementing economic reform.We will first identifying the source of policy uncertainties in Indonesia, thenseek to explain any constraints that the government must face, both at policyformulation and implementation levels. The next section will examine



current reform initiatives, followed by a look at some lessons learnt on howto draw up an effective, feasible agenda.

Sources of policy uncertainties

Indonesian policy makers face several sources of uncertainty whenconducting and implementing reform.

The first stems from the political transition to democratic government.No clear majority has yet to emerge and is not expected to do so until thepolitical environment has matured – in another 10-15 years. Indonesia’spolitical fragmentation is likely to limit the capacity of the government toimplement reform initiatives.5

Simultaneously, the country has undergone “big-bang” decentralisation,moving from a highly centralised to a highly decentralised regime in a veryshort time. Implementing big-bang decentralisation while changing thepolitical system will clearly give rise to transition costs. Power goes to thehead of new government agents when they experience it for the first time. Itis a perfectly normal occurrence, but one that makes it very difficult toensure that all agents follow new sets of rules.6

Central government undertook the transition to democracy anddecentralisation when its financial capacity was weak. Thefinancial-cum-economic crisis of 1997-98 had forced it to bail out thefinancial sector. At the same time El Nino had hit the region, damaging therural economy and leaving many of Indonesia’s country dwellers trapped inpoverty.

The government’s response was to pursue a contra-cyclical policy,absorbing all the banking sector’s financial losses and running a fiscaldeficit. As a consequence, Indonesia’s debt-to-GDP ratio increased fourfold.An effort to reduce the debt ratio – and therefore maintain medium-termfiscal sustainability – has severely constrained central government’s abilityto implement many reforms. For example, before the financial crisis centralgovernment devoted approximately 7% of GDP to infrastructureexpenditure. The crisis has reduced that ratio to between 3% and 4%.

As local governments in Indonesia rely heavily on the transfer of fundsfrom central government (they account for 70% of revenue), it is also verydifficult for them to finance many necessary reforms to the investmentclimate. This has often induced the provinces to levy new – and oftenunnecessary – taxes.

Another of source of uncertainty relates to the “missing institution”problem. The process of institution building in the post-Suharto era has been



relatively slow. President Suharto had been like an institution in himself,establishing and enforcing many of the “rules of the game”. Indonesia hastried to establish new institutions since his departure, but it is a process thatneeds time before it can become effective.7

Reform in Indonesia: constraints in implementation

From an economic point of view reforms are intended to bring aboutfundamental, long-lasting changes in the way economic activities areorganised, co-ordinated, and regulated. If properly designed andimplemented, they yield gains in efficiency and better income distribution.8

Figure 8.5 illustrates in simple terms the rationale behind andrelationship between institutional reform at a microeconomic level and gainsin efficiency and growth.

Figure 8.5. The rationale of institutional reform


In contrast to macroeconomic reform, it is difficult both in theory and inpractice to carry out microeconomic reform. One explanation is that,although microeconomic reform produces long-term gains, resourceallocation involves short-term gains for some, but loss for others. The sameargument explains why reforms sometimes fail to achieve their objectivesand are suspended before they produce long-term gains. In the case ofIndonesia, several factors account for the lack of full support formicroeconomic reform.



The first is the time lag between costs incurred and benefits felt. Whilegains usually accrue in the long run, costs hit immediately, before fadinghalf-way through the time horizon. Reforms are more likely to succeed ifbenefits are felt sooner and longer, and costs bite later.

A second factor is that while benefits are spread among many people(e.g. consumers), certain groups or individuals bear most of the costs. Thistrend prompts those who lost out to muster support in their attempts toprevent reform initiatives.

Indonesia is embroiled in a host of situations where cost-and-benefittime lags are further compounded by the unevenly spread cost of reform.One example is the current rice policy. Although numerous studies haveshown that any increase in the price of rice will produce harm than benefit tothe majority of Indonesian family, the government has had great difficulty inits attempts to open up the domestic rice market by allowing the privatesector to import rice. Domestic production has failed to meet demand fromIndonesian households, but when the government decided to import ricenumerous members of Parliament threatened it with a vote of no confidence.To date, the import policy has, in practice, failed. Even the government doesnot offer its economic team full support in the pursuit of a more rationalpolicy.9

A third element that militates against microeconomic reform is thecredibility of reformers. When they are not credible, those people who standto lose out are hard to convince. Building credibility is difficult when thefoundations of trust are weak. The issue of trust is particularly important inIndonesia. Not only do local and central governments often mistrust oneanother, but people often mistrust the government (and vice versa). Taxofficials treat business people like thieves, while business people are wary oftax officials. This lack of mutual trust seriously complicates reform. Evenwhen rules are agreed upon, there is considerable misunderstanding takesplace with regard to notions of authority and responsibility. What occurredduring decentralisation is a case in point: central government gave localofficials authority, but no responsibility. Local governments are nowresponsible for education, which should be reflected in the way theyearmark their budget. However, on receiving their funds from centralgovernment, they regularly allocate education money to other projects.

Factor number four is Indonesia’s experiences of economic reforms.Many people had once gained from reforms, so they would give them theirfull support despite having to bear the costs for the transitional period. Thisexplains why there were no significant initial objections in Indonesia to theInternational Monetary Fund (IMF) and World Bank structural adjustment



programmes in 1998. It also explains why support for reform has declinesharply since the IMF’s programme proved a failure.

The fifth reason is sovereignty, or national pride – an importantnon-economic factor in the economic reform process. Because reformusually gives foreign investors greater access to the domestic market, therehas been widespread fear among nationalists that it will affect ownership,which may, in turn, result in the country losing some of its sovereignty.10

Factor number six is resource constraints, which we described above.They limit central government’s ability to engage microeconomic reformsthat produce positive, immediate impacts (including financial compensationfor the losers). At the same time, people always expect great things fromreform, which includes democratic political reform.11. This imbalancebetween delivery and expectation has become the biggest obstacle faced byall the presidents of the post-Suharto era. As a consequence, it is difficult tofind any microeconomic reform agenda than can be implemented withoutany opposition.

Indonesia also faces political constraints. With direct elections at locallevel, there are many different parties now vying for power, with no clearconsensus on the direction of reform emerging. Whilst political reform iswelcome, it can slow down decision-making as well as complicaterelationships between local and central governments. It is often the case thatwhen regional leaders are from the ruling party, the process of policyimplementation runs smoothly. If they belong to the opposition, it becomescomplicated.

Implementation of reform in Indonesia is hampered by the country’sweak bureaucracy. In contrast with other East Asian countries, its has neverbeen a target of reform in Indonesia. The inefficiency of the civil servicemakes it more difficult to implement economic reform. Many new laws, forexample, have been introduced as part of the reform process; yet they havebeen left without regulations for implementing them, which obviouslycreates uncertainty. Table 8.2 shows the association between investmentclimate component and its significance to investment, productivity andemployment and the main obstacle institutions. It is clear that the civilservice, which is either incompetent or corrupt – or both – has become themain obstacle to reform.



Table 8.2. Micro reform and political landscape

Investment climatecomponent

Ranking* onMain obstacles

Investment Employment Productivity1. Labour market rigidity 1 1 2 Labour union2. Quality of regulation NS NS 1 Bureaucracy and

Parliament3. Policy predictability NS NS 2 Bureaucracy and

Parliament4. Legal problems 3 1 Police, attorney, judges and

Parliament5. Security and law andorder

1 Police and army

6. Cost and lack of access 2 2 3 Lack of competition7. Power outages 3 2 Electricity law and state-

owned enterprises (SOEs)8. Low road density 1 Current regulations and

SOEs

Note: *Based on a quantitative analysis which links productivity, probability of investment, changes inemployment in Indonesia’s manufacturing sector, and investment climate components in World Bank(2005), “Raising Investment in Indonesia: A Second Generation of Reforms”, Report No. 31708 ID,World Bank, Washington, DC.

Source: Author, based on World Bank (2005), “Raising Investment in Indonesia: A Second Generationof Reforms”, Report No. 31708 ID, World Bank, Washington, DC.

To make the reform process successful, Indonesia’s bureaucracy shouldbe a prime element of reform itself. The government has made only partialattempts at reforming the civil service, although it has now initiated freshreform. A commission answering directly to the president has been put inplace with the mandate of preparing a comprehensive strategy on civilservice reform. Meanwhile, partial reform of several ministries, includingthe ministry of finance, and local governments is underway. Results seem tobe promising – although it is too early to draw any conclusions.

On the macroeconomic front Indonesia suffers from a fiscal policy“trilemma”. In order to improve its investment climate it must: (i) reducetaxes, (ii) bring down the public debt-GDP ratio, and (iii) increase publicinvestment in the infrastructure (see Figure 8.6). This is almost impossibleto do simultaneously.



Figure 8.6. Fiscal policy trilemma

Reduce public debt/GDP

Lowertaxes

Increase publicinvestment


Indonesia has chosen to maintain and strengthen its fiscal sustainabilityfirst, before addressing any other fiscal policy factors in the investmentclimate. It made the decision chiefly for two reasons: macroeconomicinstability is the most important factor in Indonesia’s investment climate;reducing taxes requires changing the law and may also harm long-termfiscal sustainability.

On the macroeconomic front Indonesia has been remarkably successful.As we observed above, the country’s macroeconomic risks have declinedsignificantly, particularly in fiscal terms. The public debt ratio had beenreduced from 100% in 1999 to below 40% by the end of 2006. It is expectedto move down to the comfort zone of between 35% and 38% by the end of2007.12 As part of its next set of reform plans, the government has proposedto reduce the corporate tax rate to a level that is comparable and competitivewith those in the rest of East Asia. In addition, thanks to huge savings fromdomestic fuel price adjustment, spending on infrastructure has also graduallyrecovered.

As result, the urgency of the fiscal policy trilemma, which had become atrade-off in microeconomic reform difficulties, has eased. The governmentcan now pursue its institutional and structural reform programme – the mostimportant of all.

A three-pronged microeconomic reform agenda

President Soesilo Bambang Yudhoyono’s administration launched athree-pronged structural and institutional reform strategy in order to reviveinvestment and export in the medium term and increase Indonesia’sproduction capacity in the long term. Those objectives can only be achievedthrough improving competitiveness, increasing the efficiency of Indonesia’s



firms, and lowering macroeconomic risks for the economy as a whole. It isalso argued that structural and institutional reform will also generate positivefeedback on Indonesia’s macroeconomic aggregates, particularly its reducedvolatility, which is still considered one of the main obstacles that Indonesianbusinesses have recently had to contend with.

The first thrust of reform addresses issues facing all firms, especially inareas that come under the general headings of investment climate andinfrastructure. It can take time to bring many investment climate andinfrastructure reforms to fruition, however, so the government has chosen totackle a number of high-profile cases that are important in their own right,but maybe even more so for the perceptions they create. Finally, thegovernment addresses certain issues in the financial sector in order to restartlending and improve the broad structure of capital markets.

The investment climate reform package focuses on several issues. First,it deals with reform of investment legislation and associated rules forimplementing it. The new act is designed to improve legal certainty, ensurethat foreign and domestic investors are treated equally, prevent divestment,and codify international arbitration. The associated implementation ruleswill clarify the foreign investment negative list and improve certainty asregards fiscal incentives. There are hopes that the reform will also cut thetime it takes to start a business from 151 to 30 days.

The next focus area for reform is tax. Proposed reforms to four differenttax laws are designed to gradually reduce the corporate tax rate from 30% to25% and income tax from 35% to 30% by 2010; to improve theadministration of taxation, particularly as regards the perceived imbalancebetween tax payers and tax officials; and to cut regional taxes that distorttrade and business.

A practical example of the changes which reform laws would bringabout concerns local taxation. Provincial governments can currently settaxes and duties which are not proscribed by central government. Under theproposed new law this arrangement would be reversed and local authoritieswould be able to levy only specified taxes and duties. To compensate themfor lost revenues their share of funds from the national budget will be raised.

The government has, in fact, already had some success with its reformof two decentralisation laws. As a result, the powers and responsibilities ofeach level of government are no longer prone to local interpretation, but areclearly defined. What is more, provincial governments also have morepower to co-ordinate their budgets with those of localities within theirjurisdictions.



At the same time Indonesia’s central government now has the authorityto override local regulations (perdas) that impede reform. It has rescindedmany of them since 2001.There is also a plan to reform the taxation systemand limit the power of local officials to create additional taxes. Centralgovernment also hopes to use its funding of the provinces as leverage toimpose more fiscal and regulatory discipline. It is, furthermore, seeking toimprove the monitoring of local regulations by the Ministries of Finance andHome Affairs.

To improve job creation the Indonesian government proposes reforms toimprove the flexibility of the labour market. This requires revisiting suchissues as the size of severance payments, limits on work contracts,outsourcing, and determining minimum wages. Large-scale industrial actionforced the government to retreat from its initial reform plans. Nevertheless,it has taken measures to keep reform of the labour market on the trackwithout actually repealing the legislation currently in force. Its first movehas been to foster bipartite negotiations between employers groups andtrades unions in order to find solutions that satisfy both parties. It is alsoplanning to use government regulations – as it is legally entitled to do – tocontrol industrial action. Such a move bypasses Parliament, so thegovernment does not have to get embroiled in repealing legislation.13

As for infrastructure reform, the main objective is to encourage privatesector participation across the board in order to enlarge and strengtheninfrastructure and improve the quality of services. Some sectors, such aselectricity and telecommunication, have been opened up, but several – likerailways, ports, and airports – are still closed shops. The government hassubmitted privatisation bills to Parliament and is hopeful that they will soonbecome law. Yet it is keenly aware that private sector participation ininfrastructure is relatively new and that, in some countries, private operatorshave pulled out or requested renegotiations of their contracts. Thegovernment of Indonesia’s response has been to agree to share the risks withprivate firms in a case-by-case approach. Policy makers have also agreed toinvest in high-risk infrastructure and important projects that facilitate privatesector participation. For example, if a new airport is to be built, thegovernment will invest in such basic infrastructure as runways, air trafficcontrol towers, and road networks linking the airport to cities, while privatecompanies will build and manage the airport terminal. The government willthus concentrate only on building basic infrastructure that is economically,not commercially, viable. By doing so, it will significantly increase itsinvestment in basic infrastructure, particularly in remote, rural areas.

A central thrust of Indonesia’s reform strategy involves fast-trackresolution of some high-profile test cases. They have to be handledcarefully, both because they are important in their own right and because



they drive perceptions. The government of Indonesia has, for example,adopted a hands-on policy to settle the dispute between Pertamina andExxon Mobil over the Cepu oilfield. As part of a more systematic approach,it has decided that it is prepared to go forward with risk-sharing on selectedinfrastructure projects. It is now reviewing a number of electricity and tollroad projects that have been on hold for years with a view to resolving someof them using this framework.

The final thrust of reform focuses on the financial market so as toovercome problems of access to capital and finance. The three mainobjectives of the reform are to:

1. Diversify the sources of funding available to the real sector,both from financial institutions and capital markets.

2. Stabilise the financial sector’s stability in order to build publicand market confidence in the Indonesian financial sector onceagain, so reducing the risk of any recurrence of the crisis.

3. Promote competition between banks, other financial institutions,and the capital market in order to improve overall efficienciesin the financial sector. If successful, competition will drivedown current inflated margins and, by the same token, the costof finance. The financial sector package, announced on5 July 2006, will help in this process, even though it is aimedprimarily at regulatory and institutional reform.

Another major reform proposal is designed to revitalise specialeconomic zones (SEZs) in Batam and Karimun in order to attract investmentand promote export. Batam and Karimun will be the first special export zonepilot projects funded by the government of Singapore. Should this initiativesucceed, several other locations are slated to become SEZs. To support themthe Indonesian government is drawing up legislation (an act of Parliamentand rules of implementation) and marshalling human resources.

Large-scale reform is also being conducted in the energy sector. Itinvolves introducing incentives and deregulation on the supply side in orderto encourage the production of oil, gas, and renewable energy. Thegovernment also provides subsidies to encourage the development ofbio-energies, including energy self-sufficiency in remote villages. Reformaddresses the demand side, too, with the government seeking to facilitateenergy diversification, particularly in electricity. It is also focusing onmiddle- and lower-income households, encouraging them to use LPGinstead of kerosene for cooking.

So far, however, Indonesia’s efforts to improve its investment climatehave not paid off. According to a survey by the University of Indonesia’s



Institute for Economic and Social Research and the World Bank, the overallinvestment climate improved significantly in 2005 compared to 2003. TheInternational Finance Corporation’s annual Doing Business survey yieldedsimilar results in 2007, showed that it now took only 97 days, instead of151, to start a business.

However, the findings of a survey in June 2006 were much more mixed.Although some indicators, particularly those relating to corruption and localgovernment, continued to show improvement, many infrastructure indicatorspointed to deterioration. Some reasons included:

• The time lag between implementation and outcome.

• Not all reforms were successfully implemented on time, whichcaused further delay in achieving intended outcomes. Somedelays were due to the length of time it took Parliament toapprove new laws, others to bureaucracy.

• The June 2006 survey was carried out just three months after thereform packages were announced. It was therefore too early foreconomic actors to change perceptions.

How to create an effective, feasible agenda

Several general considerations should be kept in mind when formulatinga microeconomic reform agenda based on Indonesia’s experiences. Thefollowing factors should be taken into account during the peer review of aparticular country:

• The political aspect. Yet many reform-oriented economists tendto take the political aspect for granted. It is, therefore, importantto focus on economically and politically executable items whenpreparing reform. Governmental decisions can often haveunintended consequences and open a Pandora’s Box. Forexample, when repealing or amending investment legislation, itis possible for other interest groups to change aspects of it. Inorder to overcome political constraints, it is imperative that thegovernment send consistent signals. Business people payattention to these.

• Reform priorities. It is important to identify priorities forreform, because no single country is able to handle everything atonce. In the past priorities were chosen on the basis of what wasknown as the “Washington Consensus”. But, as argued byHausman et al. (2006), this approach has not always triggeredan adequate supply response. They suggest, therefore, that a



country should focus on the most binding element whenimplementing economic reform. Indonesia has, in practicalterms, adopted this approach by determining priorities based onthe investment climate survey, which helped identify some ofthe most pressing issues.

• The importance of managing expectations. In other words,reform must not be oversold. The potential of privatisation wasoversold, and it became unpopular in many countries. Too muchwas promised: “Privatisation will solve everything.” There isalso a need to pay attention to the reform process itself,balancing it with a results-oriented approach.

• The local factor. This is particularly important in such a diversecountry as Indonesia. What will work in one region may not besuitable in another. So, simply introducing, or developing, newinstitutions may not always be the solution; they may even becounterproductive.

• The pace of reform. Whether they set an incremental or radicalpace of reform, reformists should have full understanding ofsupply responses and political constraints. Engaging radicalchange may be necessary when there is no immediateopportunity for reform. On the other hand, pushing reform toohard can close all windows of opportunity. This author’s ownexperience in dealing with electricity tariff adjustment is a goodexample. Confident in our ability to adjust domestic fuel pricesso that they were close to those of the market, we pushed ourelectricity tariff system toward a more flexible one. However,the Cabinet ultimately rejected the idea – due to politicalconstraint. Had we introduced price adjustment gradually, wemight have obtained a better result.

• An oversight mechanism. It boosts the credibility of reform byensuring independence from traditional insiders (e.g. interestgroups and political lobbies) and maintaining accountability.Oversight mechanisms range from independent committees, toregular public monitoring, and the development of transparencyand accountability systems. Indonesian reformists reported theirprogress regularly to main stakeholders and the public. Theyalso set up an external, independent team with a clear mandateto oversee the progress of reform and advise the government onimplementation and further reform.



• Educating the public. As mentioned above, implementingmicroeconomic reform is difficult, and difficulties can arisesimply because of lack of knowledge. For example, one aim ofthe Indonesian labour reform agenda was to redefineoutsourcing in order to encourage partnerships between SMEsand large firms. The stakeholders – i.e. the SMEs – seemed notto have any real understanding of the main objective of ourreform. As a result, they could not be empowered.

• Reform champion. With Indonesia’s insufficient, inefficientbureaucracy, there is great need for outsiders to champion thereform process and show leadership and skills. The right policycould be to outsource the implementation of reform to theprivate sector, in the shape of a dedicated, competent team thatcan lead and sustain the reform process while ensuringtransparency and accountability.

8.3. Peer review mechanism: Indonesia and ASEAN

This section seeks to provide a rationale for the relevance of OECD-typepeer review mechanism for Indonesia.

The peer review mechanism: what is the relevance for Indonesianow?

The typical peer review mechanism is not new to Indonesia and otherASEAN countries. Indonesia, since the Asian crisis in 1997, has been thesubject of reviews conducted by the IMF and the World Bank. The IMFconducted a quarterly examination into the implementation of its recoveryprogramme during both the programme and the post-programme monitoringperiod. The World Bank also produced an annual report on the state ofIndonesian economy as a background document for members of theConsultative Government for Indonesia (CGI) – a multi-country,multilateral co-ordination forum designed to support Indonesiandevelopment.

Those reports were used intensively by foreign and domestic agents as abasis for economic decision-making. For foreign governments, particularlymajor donors like the Japanese government, or international organisationslike the Asian Development Bank (ADB) or the World Bank, the reportshave been used to assess whether the economic reforms were worthsupporting. Private-sector organisations used the reports to supplement their



decision-making on investing in Indonesia both in terms of foreign directinvestment (FDI) and portfolio investment.

Despite their usefulness these reports occasionally created controversiesover the policies recommended. They were perceived by many in Indonesiaas the work of international interests and pressure groups seeking to coax theIndonesian government into adopting neo-liberal (or WashingtonConsensus-type) policies.

The IMF and World Bank reports are now things of the past. Indonesiapre-paid its balance of payment support last year and the IMF is once againpublishing its Article IV Consultation Reports. The Indonesian governmentthis year abolished the CGI forum, so there was no strong reason for theWorld Bank to produce an annual review of the Indonesian economy, exceptfor a small section in the East Asia Regional Economic Monitoring or theGlobal Development Report.

The most important reason for Indonesia to accept a peer reviewmechanism is to meet the need for an independent external review on theprogress of economic reform – a role previously filled by the World Bankand IMF.

Even if the IMF and World Bank had continued publishing regularreports on Indonesia, their credibility – particularly as regards domesticpolicies – would have crumbled. Many policy recommendations which theIMF supported were not easy to implement without causing domesticpolitical controversies. An OECD-type peer review would therefore be analternative way of providing an independent external audit on the state of theIndonesian economy. It could also act as an early warning system foreconomic agents, enabling them to produce an appropriate policy response.

External peer reviews matter to Indonesia, now that both thegovernment and the private sector rely on the domestic and internationalmarkets for access to finance. The cost of borrowing is now determined byratings agencies’ assessments and the information produced by investors.The more transparent and comprehensive information is, the lower themarket will perceive the risks, and the lower the cost of borrowing will be.

Finally, from the policy maker’s point of view a peer review mechanismcan serve several purposes. It provides important input for governments toformulate and implement reform. They can draw lessons from othercountries’ experiences, given that the implementation of reform – particularly on a microeconomic level – is an art rather than a science.One-fits-all policies have been proven to be failures. Peer reviews can alsoserve as benchmark to assess how far reform has gone. This is particularly



important because many policy makers in Indonesia think they move toofast and fail to realise that other countries have been moving faster.

Peer review: what next?

A review is considered beneficial for a particular country if it ispolitically and economically feasible to implement its recommendations. Itis, therefore, important to find an effective way to do so, particularly forASEAN countries, most of which are in transit to democracy.

Who should conduct the review? The ASEAN secretariat together withthe OECD secretariat, or the OECD alone? In the opinion of this writer, it isimportant to distinguish between the short term and the medium term. If it isa peer review for the short term, OECD member countries and thesecretariat can do the review. To avoid any controversies stemming fromfears that Western nations are seeking to impose their agenda, it is alsohighly strategic to include countries like Mexico or South Korea as a peerreviewer. Including one of them would produce an important impact interms of sharing experience and wide acceptance by ASEAN countries.

The ASEAN secretariat could play the same role as the OECD if thepeer review is a medium-term one. To achieve OECD level both in terms ofcapacity and credibility, the ASEAN secretariat should be strengthened.Reviews could then be conducted in ASEAN low-income countries. To sumup: in the medium term, the OECD can play a dual role, performing peerreviews for a particular ASEAN country and providing technical assistanceon upgrading the capacity of ASEAN secretariat.

On what areas should an OECD review focus? As argued above, itshould be specific to a particular country. If a peer review is to be generallyapplicable to ASEAN countries, it should focus on two issues: first, tradeco-operation, particularly signing up to a free trade agreement, and second,how to strengthen monetary co-operation. For Indonesia-specific peerreview, the focus should be microeconomic, e.g. (i) product-market reform;(ii) how to make the labour market more flexible; (iii) SMEs andentrepreneurship; and (iv) how to develop infrastructure, including transitionfrom a directly government-administered regime.



Notes

1. This low investment-led recovery is also happening in other emergingcountries, with the exception of China. See Kramer (2006).

2. Before the crisis reserves/short-term debt ratios were relatively low – about 60.3%. By the end of 2006, however, that ratio had increaseddramatically to 231%.

3. Indonesian global bonds’ spread margin recently declined to a level thatwas about 100 base points above that of US Treasury bonds andsignificantly lower than 400-700 base point of the 1998-2003 crisisperiod..

4. This phenomenon is not exclusive to Indonesia. All other emergingcountries face a decline in the output elasticity of employment. It may berelated to a new economy phenomenon, whereby labour intensity in manyareas of economic activity has been declining.

5. Desai and Olofsgard (2006) build a simple empirical model to describethe relationship between political constraint and public support for marketreform.

6. Fortunately, despite the many complaints about decentralisationoutcomes, current assessments show that decentralisation as not as bad asmany people had predicted. It has – of course – not reached the ideallevel, but numerous surveys reveal that public services at local levelsindeed show improvement over pre-decentralisation period. Furthermore,another recent survey indicates that the regions are more adaptive to theneed for improving the investment climate than central government.

7. Indonesia established an independent central bank in 1999 and introduceda competition agency as part of anti-monopoly and fair trading legislationin 2000. A new bankruptcy law has been effective since 1999. In order tocreate private-sector participation in infrastructure provision, a modernlaw was enacted that abolished public monopolies in the electricity andtelecommunication sectors. There have been privatisation initiatives inmany other areas of the economy and, although many state-ownedenterprises (SOEs) still exist, their roles have been curbed. A majorsetback to the privatisation programme occurred when the newly



established constitutional court cancelled the electricity law and instructedparliament and the government to draft a new law consistent withIndonesia’s constitution. The decision by the constitutional court is anadditional source of uncertainty because it is multi-interpretative. At thetime this chapter was written, the government had not submitted newlegislation, although the timetable set by parliament had expiredone-and-a-half years previously.

8. From a theoretical perspective, and in accordance with theStolper-Samuelson theorem, reduction of quantitative and qualitativetrade restrictions will induce resource reallocation across the economy,which, in turn, should tend to equalise the relative factor rewards acrosssectors in the long term. However, the Stolper-Samuelson theorem doesnot enable us to determine the exact relationship which may exist betweentrade liberalisation and income distribution. The three main reasons forthis are: (i) the transition from functional to personal income distribution;(ii) the possibility of more than two production factors; (iii) imperfectfactor mobility and the oligopolistic commodity market.

9. Predictably the Minister of Agriculture put up the most opposition. Manygovernors of rice-producing provinces rejected the National Food StockAgency’s policy of rice price stabilisation through open market operationssimply because they were afraid of being attacked by a small group ofpowerful of rice producers who were close to local politicians. The localpoliticians’ position was contradictory, because most of their constituentssuffered from the hike in rice prices, including landless rice farmers.

10. Privatisation of SOEs was a good example. The sale of SOEs in thetelecommunication sector was strongly opposed by nationalists eventhough the performance of the sector improved significantly in the wakeof privatisation. Similarly, efforts to expand services in the electricitysector were hampered by opposition to deregulation of the sector – including selling the electricity SOE to a private operator. Recent turmoilin Thailand is also another good example.

11. Even if there are compensations – the domestic fuel price adjustment is acase in point – opposition is still fierce.

12. The IMF study concludes that given the quality of the country’sinstitutions, the comfort zone of Indonesia’s public debt between 35% and38%.

13. This is certainly not the best solution. One of its weaknesses is to allow aparticular trade union to challenge new government regulations in theSupreme Court. With the judges who currently sit in the Supreme Court,it would be hard to predict the outcome.



Bibliography

Desai, Raj M. and Ander Olofsgrad (2006), “Political Constraint and PublicSupport for Market Reform”, IMF Staff Paper, Vol. 53, Special Issue.

Fengler, Wolfgang (2007), “Spending for Development: Making the Most ofIndonesia’s New Opportunities”, World Bank Conference Report onIndonesia’s 2007 Public Expenditure Review, World Bank, Washington,DC, February.

Hausmann, Ricardo, et al. (2006), “Getting the Diagnosis Right: A NewApproach to Economic Reform”, Finance and Development 43.1, IMF.

Ikhsan, Mohamad (2003), “Economic Reforms and Democracy: the Case ofIndonesia”, mimeo.

Ikhsan, Mohamad (2006), “FDI and Fiscal Incentives in Indonesia”, paperpresented at the International Tax and FDI Conference, HitosubashiUniversity, Tokyo, February.

International Monetary Fund (IMF) (2006), “Chapter V. Asia’s InvestmentDecline” Regional Economic Outlook: Asia and Pacific, WorldEconomic and Financial Surveys, IMF, May.

Kikeri, Sunita, et al. (2006), “Managing Investment Climate Reform: Whatare We Learning”, World Bank Working Paper, April.

Kramer, Charles (2006), “Asia’s Investment Puzzle”, Finance andDevelopment 43, No. 2, June.

World Bank (2005), “Raising Investment in Indonesia: A SecondGeneration of Reforms”, Report No. 31708-ID, World Bank,Washington, DC.

World Bank (2006), “Investing for Growth in Emerging East Asia”, paperpresented at the APEC Finance Ministers’ Process and APEC SeniorFinance Officials’ Meeting, Australia, December, pp. 11-13.

9. POLICY ISSUES AND PEER REVIEWS IN THE PHILIPPINES – 199


Chapter 9. Policy Issues and Peer Reviews in the Philippines*

9.1. Introduction

This chapter can be broken down into two parts. The first part considerspolicy challenges in the Philippines, taking a look at recent economicdevelopment and describing major policy initiatives and their effects. Thesecond part discusses the rationale for peer reviews in the Association ofSoutheast Asian Nations (ASEAN), briefly assesses their benefits, thenlooks at their future.

9.2. Overview of recent economic developments and policy initiatives

The 5.4% growth rate of the Philippine economy in 2006 – up on theprevious year’s 5% – marked the country’s longest period of sustainedgrowth (Figure 9.1). The trend continued in the first half of 2007, theeconomy expanding by 7.3% and gross national product (GNP) by 8%, thehighest level for 20 years.

Growth was broad-based, with all sectors showing rises in excess of 4%(see Table 9.1). Services led all other sectors with a rise of 6.3%, driven bythe continued rapid expansion of business process outsourcing,telecommunications, and financial services. Industry followed with 4.8%,while agriculture put in a good showing at 4.1%, despite the three strongtyphoons that hit the country. Exports of goods and services expanded by12.1%, boosted by the recovery in electronics and the garment trade, as wellas by the continuing rise in machinery.

* This chapter was written by Gil Beltran, Undersecretary, Domestic FinanceGroup and Legislative Liaison, Department of Finance, Philippines.

200 – 9. POLICY ISSUES AND PEER REVIEWS IN THE PHILIPPINES


Figure 9.1. The Philippines’ growth momentum continues

Real growth, %

Source: NSCB (National Statistical Coordination Board).

Table 9.1. Broad-based growth

Growth rates in percentage

2003 2004 2005 2006GDP 6.1 6.2 5.0 5.4Agriculture 3.4 5.8 1.8 4.1Industry 4.2 4.7 4.9 4.8Services 6.1 7.6 6.4 6.3GNP 7.0 6.7 5.8 6.2

Source: NSCB (National Statistical Coordination Board).

Consumer spending, powered by overseas remittances, grew 5.5%compared to 4.8% in 2005 (see Table 9.2). Investment recovered in 2006and grew by 4.6% in the second half of the year, partly offsetting thenegative growth posted in 2005 and the first half of 2006 due to unstable oilprices and the widening fiscal deficit. Investor confidence was triggeredlater in the year thanks to the implementation of major economic reforms,including higher value-added tax (VAT), tariff adjustments in electricity,controls on spending, governance reforms in the government corporatesector, and debt pre-payments and exchange, which reduced the fiscal deficitto 1% of gross domestic product (GDP) in 2006, compared to 2.7% the yearbefore, and brought the consolidated public sector to a surplus position by

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

2002 2003 2004 2005 2006

GDPGNP



end-September. This led to a drop in the national government debt/GDPratio from 71.8% at end-2005 to 63.8% at end of 2006.

Table 9.2. Exports and consumer spending

Growth rates in percentage

2003 2004 2005 2006Consumer spending 5.3 5.8 4.8 5.5Government consumption 1.4 -1.4 1.6 6.1Capital formation 3.8 7.2 -8.8 2.7Exports 6.0 13.7 4.8 11.2Imports 2.6 4.0 0.3 2.5

Source: NSCB(National Statistical Coordination Board).

In 2006 the country’s balance of payments generated a current accountsurplus equivalent to 4.1% of GDP, fuelled by rises of 14.9% inmerchandise exports, 14.5% in services exports, and 19.4% in overseasworkers’ remittances (see Figures 9.2 and 9.3). This performance, coupledwith a 34.7% rise in foreign direct investment (FDI) (Figure 9.4), led togross international reserves (GIR) registering a historical high ofUSD 23 billion at end-2006, equivalent to 4.5 months of goods and servicesimports (Figure 9.5). In subsequent months the increase was even morespectacular, reaching USD 30.3 billion, or 5.6 months of exports. Theexchange rate followed the same trend, appreciating from PHP 55.09/USDin 2005 to PHP 51.31/USD in 2006 and PHP 47.29/USD between Januaryand August 2007. The Philippines’ Central Bank thus pre-paid debts owedto the International Monetary Fund (IMF) and further liberalised foreignexchange transactions.

Following the fall in inflation to 3.9% at year-end, the bellwether91-day Treasury bill rate dropped to 4.8% at the end of November – and3.2% over the first eight months of 2007 – as savings, registered at over29% of GDP for the second year in a row, boosted liquidity in the financialsystem. Capital market development measures were implemented during theyear. They included issues of benchmark bonds by the national governmentand the extension of the Special Purpose Asset Vehicle (SPAV) law, whichenabled banks to sell non-performing loans (NPLs) without paying taxes. Asa result, the NPL ratio of the banking system dropped to 6.2% in 2006 and5.3% in July 2007 from 8.3% the year before.



Figure 9.2. Export growth driven by services, electronics, machinery,and garments, 2004-06Growth rates in percentage

25.2

10.9

7.66.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Services Electronics Machinery Garments

Source: The Government of the Philippines.

Figure 9.3. Worker remittances jump 19%

In USD billion

7.648.6

10.7

12.8

0

2

4

6

8

10

12

14

2003 2004 2005 2006

Source: BSP and POEA (Philippines Overseas Employment Agency).



Figure 9.4. Net flows of foreign investment into the Philippines

In USD million

161

656

1854

2345

0

500

1000

1500

2000

2500

2003 2004 2005 2006

Foreign Direct Investment

-706 -914

2103

2602

0

500

1000

1500

2000

2500

3000

2003 2004 2005 2006

Portfolio investment

Source: BSP, Central Bank of the Philippines.



Figure 9.5. Gross international reserves (GIR)

Levels, in USD billion

4.0

4.1

4.2

4.3

4.4

4.5

4.6

4.7

4.8

4.9

5.0

15

16

17

18

19

20

21

22

23

24

2003 2004 2005 2006

Imp

ort

co

ver

GIR Import cover (months)

Source: BSP.

9.3. Current policy challenges

The Philippines continues to implement economic reforms to furtherstrengthen the country’s competitiveness. A central plank in its reform driveis its fiscal consolidation programme to balance the government’s budgetposition, achieve a consolidated public sector surplus by end-2008, andreduce public debt to less than 50% of GDP by 2010.

Since its inception, the reform package has raised the VAT rate to 12%and extended its coverage in 2005, while adjusting excise on “sin” productsin 2006. It also includes measures to make the taxation system operationmore efficient, with improved tax auditing, automated tax filing andremittance, an extension to the computerised tax registry linked withdata-gathering government units and regulatory institutions, and enhancedcapability to process tax cases.

Reform also targets the efficiency of the civil service charged withadministering taxation. Fiscal responsibility legislation designed to inculcatefiscal discipline at all levels of government is being drafted, as is reform tointroduce a broader monitoring system for government corporations.Additional provisions of the civil service rationalisation programme involve



streamlining government offices and reducing personal service contracts asa percentage of the total budget. Performance metrics and reporting systemswill be introduced in all government agencies, while automatic guaranteesgranted to government corporations under their charters will be removed.

Under deliberation in Congress are measures to rationalise fiscalincentives and remove redundant types of tax exemption, restructure theincome tax collection system so that it covers hard-to-tax groups moreeffectively, and reduce compliance costs.

So far fiscal consolidation has been a success story. By the end of 2006the government deficit had dropped to 1.1% of GDP from an average of4.1% during the five previous years. The consolidated public sector – theaggregate fiscal positions of the national government, government-owned orcontrolled corporations, government financial institutions, local governmentunits and the central bank – generated a surplus of PHP 13.9 billion, or 0.2%of GDP, the first surplus in ten years and in sharp contrast to the 4.5%deficit averaged over the previous five years. Furthermore, the national debtstood at 59.9% of GDP in June 2007, compared to 71.5% the previous year.

The Philippines has also undertaken an array of reform efforts in othercritical policy areas:

• Capital market reform is designed to raise the savings rate andenhance the access of the economic sector to financial services.A further aim is to regulate financial institutions moreeffectively by empowering regulators to enforce rules andimproving their skills. The package also contains provisions toenhance tax neutrality across all types of financial institutions,instruments, and transactions, improve financial literacy, anddevelop credit information, particularly for those sectors withlimited access to it.

Initial results have been positive. By the end of 2006 the savingsrate had risen to more than 29% of GDP for the secondconsecutive year, compared with 17.5% in 1998. At 14.7%, theinvestment rate nevertheless remains low – well beneath thefigure of 20.3% registered in 1998. However, banking systemresources reached 89.4% of GDP in 2006, compared to 79.4% theprevious year. Another encouraging figure was the drop incommercial banks’ NPL/loans ratio from 6.2% at end-2005 to5.7% in May 2007, while stock market capitalisation climbedfrom 109.4% of GDP in 2005 to 127.9% in 2006.

• The infrastructure development reform programme aims toraise government capital outlay to some 5% of GDP by



end-2010. By 2008 it will have risen to 2.9% from 2.5% in2007. Other goals are to develop renewable energy sources,strengthen water management, institute greater transparency inbuild-operate-transfer (BOT) legislation, and establishinter-modal transport systems.

• A trade and investment liberalisation package seeks to easeinvestment restrictions set out in the constitution, amendregulatory charters in order to pave the way for morecompetition and to transfer responsibility for development toother departments so as to avoid conflicts of interest. Otherimportant objectives are to reduce red tape and corruptionthrough the automation of business registration procedures andstrengthen the country’s investment promotion activities.

The Philippines will also comply with its commitments as part ofthe ASEAN Free Trade Area and World Trade Organization(WTO) by furthering lower its tariffs, which now average 5%,and removing quantitative restrictions, which have been pareddown to only a few agricultural products.

• Measures to develop the agribusiness include supplyingproduction and credit support to enhance productivity andapplying science and technology to production processes. Theyalso provide for building a network of farm-to-market roads andcompleting a “nautical highway” between the Philippines’ threemain islands to improve logistics.

• The energy development package will develop biofuels andrenewables like wind, solar, and geothermal energy. It will alsopromote oil and gas exploration, enhance energy conservationthrough the use of energy-efficient technologies, and optimiseprivatisation of the power sector. In 2006 Congress passedPhilippine Biofuels Act that provides fiscal incentives tocompanies producing and selling biofuel-blended petrol anddiesel.

• Governance reforms seek to curb corruption through measureslike lifestyle checks and stronger powers for the ombudsman.Another component of governance reform is to build high-speedinformation networks linking government offices, streamline thedelivery of basic services, and reduce processing time for newbusiness registrations. The governance reform package alsoincludes measures to ensure transparency in procurement,project development, and value formation programmes.



• A government information system that enables the public togain direct access to government services like property and civilregistration, passports and visas, and business and professionallicensing. This area of reform aims to reduce the processing andapproval time for transactions between government offices andthe public. It also introduces electronic data management andstorage to facilitate the retrieval, updating, processing, andsharing of critical data by government monitoring and statisticalagencies. Agencies are, for example, putting in place a systemof agreements to exchange information about potentialtaxpayers.

9.4. Rationale for ASEAN peer review

Peer reviews are important for the Philippines. They afford anopportunity for the country to communicate important information to theinvestor community about its economic development and a mechanism forco-ordinating its economic policies with neighbouring countries.

Peer reviews were institutionalised in ASEAN in the wake of the Asiancrisis. The prime objective was to avoid future crises by making countriesadhere to certain standards of economic governance, thus raising the overallquality of governance in the region. The Asian Development Bank (ADB),World Bank, and IMF participate in the process by providing regionaleconomic assessments and estimating how individual countries are affectedby common threats and common problems.

ASEAN member countries’ adoption of peer reviews is a way ofrecognising that although their economies are mutually interdependent, theyare in different situations and are affected differently by the same factors,notwithstanding the fact that investors tend to “lump them together”.Looking to the future, they hope that their peers’ recommendations willyield ways of detecting and averting crises early. Peer reviews will also, it ishoped, help countries to make their economic data transparent, which willreduce uncertainty and bring an end to the region’s herd mentality. At thesame time, sharing information will lead to improved policy making andmore regional initiatives to enhance growth.

Southeast Asian countries consider peer reviews that involve theirregional peers as acceptable, since they perceive them to be carried out inthe spirit of ASEAN volunteerism and brotherhood. Conversely, theysuspect that peer reviews not conducted by regional neighbours are tingedwith self-interest.



ASEAN countries have a wealth of experience in the economic field,where they have set standards. They have produced development strategies,adopted policies that are different from their neighbours’, and registeredwidely documented economic successes. Their best practices make themhighly acceptable as peer reviewers and their recommendations informulating policies will be welcome.

Furthermore, many ASEAN members are reforming their owneconomies in order to enhance their competitiveness, and every country willbenefit from information-sharing. For instance, the Philippines is continuingto pursue reforms to deregulate its economy, rationalise investmentincentives, strengthen its capital market, and improve its tax system.Neighbouring countries are doing the same thing.

9.5. Assessment of ASEAN peer review

ASEAN peer reviews have yielded very satisfactory results so far. Theydo not require large volumes of data, and most countries, particularly withinthe ASEAN+3 framework, make the necessary data available. The ADB iscurrently helping other ASEAN member states to beef up their economicreports with in-depth analyses and probing questions.

Initial fears that, because Asian culture is non-confrontational, groupanalyses would not be incisive and straightforward have proved unfounded.Discussions have been candid but pleasant. Indeed, ASEAN countries havethemselves volunteered information about weaknesses in their owneconomies. Reviewers have advocated plans and programmes and drawn ontheir own experience and best practices to come up with remedies andrecommendations. Countries under review have demonstrated that they areopen to learning new things and that they appreciate information on howthings are done elsewhere.

Best of all, the ultimate objective has been achieved: no new crisis hasafflicted the ASEAN region.

9.6. The future of peer review

One of the questions that ASEAN faces today is how to improve its peerreview processes. It could seek to learn from the OECD and EuropeanUnion (EU) experiences, but it could also explore regional projects,programmes and policy issues. The ASEAN secretariat could submit paperson ASEAN peer reviews for consideration in meetings. Equally, it couldexplore regional issues that permeate all economies, like free trade



agreements with other countries and regional groupings; energydevelopment; privatisation; capital market development; and investmentincentives and tax competition.

There are joint economic programmes being undertaken in ASEAN,which it would be useful to discuss during peer reviews. ASEAN could alsoproduce regional position papers on economic matters that are being raisedin international forums, like voice issues in the IMF and World Bank,strategies to enhance the WTO agenda, and harmonisation of rules andprocedures.

Elevating peer reviews to higher up on ASEAN’s agenda will requirethe ASEAN secretariat and the country staff involved in the preparation ofdiscussion papers to hone their analytical skills. They can do so byparticipating in seminars organised by multilateral financial institutions,bilateral partners, and institutions like the OECD and EU.

ASEAN could gradually introduce improvements to peer reviews inresponse to its growing needs and in accordance with its skills. There is nohurry to create new institutions or adopt lengthy procedures that requirelarge amounts of data. More frequent contacts between ASEAN policymakers would be more effective. Another useful move would be to learnmore about peer reviews as they are conducted in the OECD, EU, and otherregional groupings. By comparing practices and procedures, ASEAN will beable to adopt those best suited to its needs.

10. THAILAND’S ECONOMIC AND SOCIAL DEVELOPMENT AGENDA UNDER THE INTERIM GOVERNMENT AND VIEW ON PEER REVIEW MECHANISM – 211


Chapter 10. Thailand’s Economic and Social DevelopmentAgenda under the Interim Government and View on Peer

Review Mechanism*

10.1. Introduction

The Thai economy recovered from the Asian economic crisis in 1997with strong economic growth that averaged 5% in 2000-06. Poverty, whichincreased during the turmoil, is now lower than the pre-crisis level.Unemployment is around 1.5%, which is considered a little lower than thenatural rate of unemployment. Economic stability is also strong, asdemonstrated by the current account surplus, high foreign reserves,decreasing public debt, and non-performing loans (NPLs) in the bankingsector. However, since 2005, the country has experienced politicaluncertainty, which led to a military intervention on the 19 September 2006.The interim government subsequently announced that a new election wouldbe held towards the end of 2007.

This chapter briefly reviews the economic situation in 2006 and theoutlook for 2007, followed by a summary of the current economic and socialdevelopment agenda under the interim government. It then concludes withthe author’s view on strengthening and expanding the scope of the peerreview mechanism.

10.2. Economic situation in 2006 and outlook in 20071

In 2006 the Thai economy had to contend with natural disasters andunrest. A drought in the first quarter affected the agricultural sector, while aflood at the end of the year damaged business activities in provinces

* This chapter was written by Porametee Vimolsiri, Senior Advisor, Office ofthe National Economic and Social Development Board. The viewsexpressed are those of the author and do not necessary reflect the officialviews of the institution to which he belongs.

212 - 10. THAILAND’S ECONOMIC AND SOCIAL DEVELOPMENT AGENDA UNDER THE INTERIM GOVERNMENT AND VIEW ON PEER REVIEW MECHANISM


throughout the country. High oil prices prompted a rapid rise in inflation anddomestic political tension added a high degree of uncertainty to the picture.

Inflation continued to increase in 2006, reaching an average of 4.6%over the year. However, the headline inflation rate increased to 6% in thesecond quarter of the year. Core inflation also edged up to 2.6% and lookedas if it would reach the inflation target ceiling which the Bank of Thailand(BOT) had set at 3.5%. BOT responded with a series of interest rate hikes.The policy interest rate, which is a one-day re-purchase rate, was increasedfrom 4.5% in the first quarter to 5% in the second quarter of the year.

Another important development was the appreciation of the exchangerate. The Thai baht strengthened from an average of THB 40.3/USD dollarin 2005 to THB 38/USD in 2006, reaching THB 36.25/USD by the end ofthe year. In the second half of the year it appreciated much faster than othercurrencies in the region. There were signs of increasing short-term capitalinflows into the financial market for speculative purposes. BOT tried to headoff the inflow in order to reduce downward pressure on the baht and startedinstructing commercial banks to control the speculative activities ofnon-resident depositors.

BOT finally decided to enforce strong capital control measures on the18 December 2006. All foreign capital inflow of less than one-year maturitywas subject to a 10% penalty. Investors would have to put down their 30%deposits on capital inflows up-front in order to be reimbursed or charged onoutflow, depending on the ex post maturity of the funds. On the day that itwas announced the measure shocked the stock market. The SET Indexdropped by 15%, the largest one-day plunge in its history. Voices expressedwidespread concern that the move was too stringent and would affect theinflow of good capital. BOT finally conceded and relaxed the measure,exempting most categories of capital inflow and offering hedge funds as analternative to the 30% deposit.

Despite the concern over inflation and the exchange rate, otherindicators continued to show strong economic stability. The current accountwas 0.2% of gross domestic product (GDP) in 2006, unemployment was1.5%, and the ratio of foreign reserves to short-term foreign debt ratio wasfive. Public debt was down to 41% of GDP compared to 57% during theeconomic crisis. Commercial banks’ NPLs accounted for only 4% of totalloans, compared to 47% at the peak of the crisis. The capital reserve ratiosof most banks were well above the Bank of International Settlements (BIS)requirement.

In spite of the difficulties besetting it, the economy grew by 5% in 2006.Growth was driven by export, which rose 17.4%, supported by the strongworld demand for electronic products and China’s surging growth. Domestic



demand, however, slowed considerably due to domestic uncertainty, highinflation, and the rising interest rate. Private investment grew 3.9%,compared to 10.9% in 2005. Domestic consumption grew by 3.1%, against4.3% in 2005. Public spending was constrained by the change ofgovernment, which postponed approval of the 2007 budget from its normalschedule in September (2006) to early 2007.

The outlook for 2007 is still subdued, although it is thought that somefundamentals will fare well. Inflation, for example, is expected to be lower,which, in turn, will allow BOT to reduce the interest rate, and the price of oilshould stabilise. There are hopes that lower interest rates and BOT’s strongstance on currency speculation will keep rises in the value of the baht in linewith other countries in the region. However, there will be constraints onexport demand if, as feared, world economic growth slows down. Regardingpolitical uncertainty, the short-term domestic unrest is over, since themilitary intervention was peaceful. Nevertheless, long-term investors mayprefer to wait and see until fresh elections have taken place and a newlyelected government has stated what its policies will be.

As Thailand’s economic performance in 2007 will depend on export – which may well be affected by world demand – growth is likely to be lowerthan in 2006. Thailand’s National Economic and Social Board (NESDB) hasforecasted that economic growth is likely to be 4.5%, that inflation will fallto 3%, the current account will be in surplus, and export growth will drop to9%. The government plans to provide a stimulus for the economy byapproving a fiscal deficit equivalent to 1% of GDP and boosting investmentin state-owned enterprises. Thailand’s full potential for an investment-ledgrowth from both the private and public sector is now awaiting politicalstability, which the current political reform package and upcoming electionsaim to establish.

10.3. Current economic and social development agenda

Thailand’s current medium-term development framework is its tenthNational Economic and Social Development Plan (2007-11). The country’slong-term objective of balancing economic, social, and environmentaldevelopment is reflected in the plan’s vision of a “green and happysociety” – two aspects of development which seem to lag behind otherdevelopment targets in Thailand’s past achievements.

The five-year plan follows His Majesty King Bhumiphol Adulayadej’s“Philosophy of Sufficiency Economy” (see Box 10.1), which has been theguiding light of national development plans since the economic crisis.



The achievement of the ninth National Economic and SocialDevelopment Plan in solving such crisis-related problems as mountingpoverty, unemployment, and public and private debts, and in re-establishingmomentum for economic growth has enabled the tenth plan to look furtherand longer ahead. In accordance with the Philosophy of SufficiencyEconomy, preparatory work ahead of the plan has involved examining andassessing the domestic and external challenges which Thailand will face inthe future, and devising a strategy to offset their ill effects by building upeconomic, social, and environmental assets, while continuing to embraceglobalisation.

Box 10.1. The Philosophy of Sufficiency Economy

The Philosophy of Sufficiency Economy stresses the middle path as the overriding principlefor the entire people’s appropriate conduct and way of life at individual, family, andcommunity levels. At the national level the philosophy is consistent with a balanceddevelopment strategy to reduce the vulnerability of the nation to shocks and excesses that mayarise as a result of globalisation.

“Sufficiency” means moderation and due consideration in all modes of conduct andincorporates the need for sufficient protection from internal and external shocks. To achievethis prudent application of knowledge is essential. In particular, great care should be taken inthe application of theories and technical know-how and in planning and implementation. At thesame time, it is essential to strengthen the moral fibre of the nation so that all, particularlypublic officials, academics, business people, and financiers adhere first and foremost to theprinciples of honesty and integrity. A balanced approach combining patience, perseverance,diligence, wisdom, and prudence is indispensable for coping appropriately with the criticalchallenges which arise from the fast, wide-reaching socio-economic, environmental, andcultural changes related to globalisation.

Although this brief presentation of the philosophy has been summarised to improveunderstanding, it is important to emphasise its core values, namely: moderation, reason,immunity and resiliency. The core values have to be implemented with two importantconditions namely: wisdom and ethics.



The challenges were explored in relation to the five developmentparadigms. The economic and financial integration paradigm, together withthe technological progress paradigm, indicate that Thailand has strongpotential for gaining economic benefit from the “Asian Century”, led by thehigh growth of the economic powers, China and India. However, Thailandhas to prepare for more competition from lower-cost producers such asChina and Viet Nam. Financial sector governance is also an important issue,since international capital flows and the role of hedge funds are expected toincrease tremendously.

If Thailand is to secure sustainable economic growth, it must addresstechnological change – perhaps the most challenging and crucial aspect ofthe country’s economic transformation. Information and materialstechnologies, and nano- and bio-technology are set to become increasinglyimportant in the economy. Yet Thailand’s technological capability islimited. R&D spending as a proportion of GDP is low, as are the numbers ofits engineers, scientists, and researchers in the workforce. This stems fromprevious industrial development policies, which relied on direct foreigninvestment to provide technology, management, and marketing outlets.Little is required to bring out indigenous innovation in productiontechnology, product design, and branding. There is plenty of local wisdomand home-grown knowledge which constitute valuable intangible assets.The process of commercialisation is, however, still slow. In addition,intellectual property rights protection for Thai-originated knowledge is stillweak, as attested by the many instances of foreigners trying to patent Thaiknowledge abroad.

So, if Thailand is to evolve from being a low-cost assembly plant forforeign companies to being the producer of higher value-added products andservices, it must prepare its people for the advent of the knowledge-basedsociety, with more knowledge workers and technologists. Better knowledgeand innovation systems are needed to create more value in agriculture,manufacturing, and services.

The social change and people mobility paradigms indicate severalchallenges. Thailand will start to feel the effects of an ageing populationin 2010. The right public healthcare system and pension schemes should,therefore, be prepared in advance. The effect of globalisation has opened upopportunities for many culturally related products and services. People nowrealise the importance of “Thai-ness” in creating higher product and servicevalue. At the same time, globalisation and its free flows of information andpeople have threatened to dilute traditional values and belief in Thai society.Social policies will therefore have to strike a balance between adapting toglobalisation and conserving precious traditional values.



The national resources and environment paradigms point to energyefficiency and security being a priority of the tenth National Economic andSocial Development Plan. Better management of national water resource isalso critical, as droughts and floods continue to occur with greaterfrequency. The preservation of biodiversity, the establishment of a naturaldisaster warning system, and climate change issues must equally beaddressed.

The tenth plan has adopted five main strategies to address the followingchallenges:

1. develop the quality of human resources and prepare theknowledge society,

2. strengthen local communities and improve income distribution,

3. restructure the economy to be competitive ahead of the AsianCentury,

4. nurture natural resources and protect the environment fordevelopment based on biodiversity,

5. strengthen good governance as part of a peaceful, orderlysociety.

The interim government headed by Prime Minister, former GeneralSurayud Chulanont, took office in September 2006 in the wake of a peacefulmilitary intervention to depose the then Prime Minister Thaksin’sgovernment. In its policy declaration to parliament on the 3 November 2006,the government clearly indicated that the government adhered to HisMajesty the King’s Philosophy of Sufficiency Economy and that thetenth National Economic and Social Development Plan would be theframework within which government agencies would operate.

In the meantime, the government has been focusing on four importantissues: (i) to maintain peace and restore national unity; (ii) to initiatepolitical reform; (iii) to rebuild a sustainable foundation for the economy;and (iv) to engage legal reform related to the first three issues.

In order to maintain peace, it is important to restore harmony toThailand’s southern provinces. To that end the Southern Border ProvincesAdministrative Centre has been reopened. It had worked well with localpeople and it was only after the previous government had closed it thatconflict began. The government hopes to build dialogue with all sides inorder to solve the conflict in the south.

As for political reform, there is good progress. The ConstituentAssembly was selected and started working in January. Its mandate is to



finish drafting the new constitution within 180 days so that it can besubmitted to the people for approval. It will retain some good aspects of theprevious constitution, while correcting the shortcomings which triggered thediscontent of the Thai people. The new constitution will make checks andbalances more effective, while ensuring the stability and continuity of theelected government. If the people do not accept the draft constitution, thegovernment will adopt a previous constitution in order to organise theelections which it promised to hold before the end of 2007.

The government is also working on building a sustainable foundation forthe Thai economy. It is seeking to expand business opportunities andimprove the country’s productivity in order to assist the business communityin adjusting to the environment of political transition and economicslowdown. Key efforts include:

• Continuing liberalisation of trade in goods and servicesthrough multilateral, regional, and bilateral negotiation withbroad public participation. As regards negotiations with theWorld Trade Organization (WTO), the government has givenhigh priority to securing gains for the Thai farmers. It has alsocommitted to trade liberalisation within the framework ofASEAN+3 (China, Japan, and Korea).

• Increasing public participation in bilateral free tradeagreements (FTAs). The aim is to involve the public moreclosely and enhance its understanding of economic and socialimplications of bilateral FTAs. The Japan Thailand EconomicPartnership has started to go through a series of public hearingsand will be submitted to the Parliament for consultation. Theprocess is scheduled for completion, with the agreement signedby March.

• Continued expansion of economic co-operation withneighbouring countries. The second Thai-Laos Bridge atMukdaharn was opened in December 2006. It will cut journeytime travelling from north-eastern of Thailand along Route 9,through Lao PDR, to the Danang Port in Viet Nam. Theconstruction of Buketa Bridge across the Thai-Malaysia borderis in progress and is expected to open in October 2007, while theThai-Viet Nam Joint Strategic Economic Partnership Plan wassigned in December 2006. In addition, leaders at theIndonesia-Malaysia-Thailand Growth Triangle Co-operation(IMT-GT) Summit in Cebu agreed on a new roadmap fordeveloping four new economic corridors which include theThai-Malaysia border area and other southern provinces.



• New incentives for the manufacture of a low-cost fuelefficient automobile. The ECO car will add to Thailand’sstrong production base, which specialises in pick-up trucks.

• In the energy sector the Petroleum Act will be revised toattract more investments in the exploration and extraction ofpetroleum fuel. The invitation to the private sector to invest innew Independent Power Producers (IPP) will be announced inMarch.

• Continuing infrastructure development. Bangkok’s masstransit system is to be expanded to cover an additional136 kilometres. Like Suvannabhumi Airport it is infrastructurethat is critical to Bangkok’s drive to become an efficientbusiness centre. The authorities are preparing detailed designand feasibility studies. The project will be carried out in linewith the Private Participation in Public Affairs Act, whichguarantees transparency and fair competition for private sectorcontractors. Other high priority infrastructure projects includeone to upgrade the logistics network, which will help reducetransportation costs, and a water resource management projectdesigned to improve protection against floods and droughts.Both projects are in the detailed preparation stage.

• Enforcing fair trading. The interim government hasstrengthened the Competition Act which, after being neglectedfor many years, had become unenforceable. The Act nowcontains a clearly worded definition of “dominant” marketplayer, which enables the authorities to prosecute players whoabuse their positions of power and form mergers which obstructfair competition in industry.

• Planning for long-term development. The government ispreparing the National Productivity Improvement Plan and theNational Intellectual Infrastructure Plan. The emphasis is on thequality of growth and the need to develop the quality of humanresources, physical capital, and technology, and a betterinnovation system to nurture new ideas.

10.4. Views on the peer review mechanism: Thailand and ASEAN

The practice of peer reviews in policy making in Thailand is fragmentedand semi-formal. Peer reviews and peer pressure are possibly at their mostactive in macroeconomic policy making in the core government agencies



like the Ministry of Finance, the Bank of Thailand, the Bureau of theBudget, and Office of the National Economic and Social DevelopmentBoard (NESDB). All have regular meetings to review each other’sassumptions and economic forecasts and to discuss policy direction. Thesesemi-formal arrangements normally involve the senior officials and,sometimes, agency heads.

Another important process is the preparation of the National Economicand Social Development Plan. It is a process in which ordinary citizens areconsulted. The law then requires the draft plan to be reviewed by theEconomic and Social Advisory Council (ESAC). ESAC’s comments aresubmitted, together with the plan, to the cabinet for consideration. ESAC isan independent body enshrined in the Constitution. It has no links withNESDB, which answers to the Prime Minister’s Office. ESAC has100 elected members from different professional groupings and differentparts of the country. When a plan is in force, NESDB monitors itsimplementation and reports on its progress in the annual national seminar,which has around 2 000 participants and submits public comments andprogress reports to the cabinet.

Outside Thailand peer reviews are practised in particular policy areas invarious forums. Examples include trade policy review at the WTO and themacroeconomic policy review at the ASEAN Finance Ministers Meeting.The latter has a very limited focus on the regional financial issue in order toprevent and recurrence of the financial crisis of 1997.

Thailand can benefit from engaging in wider-ranging peer reviews withother countries. Many of the issues which Thailand’s development policiesaddress are of concern to numerous other countries. The informationexchange component of the peer review process would, therefore, be usefulin bridging policy making’s information gap. Peer reviews conducted byoutsiders can also be useful in the event of some political or domestic factorcausing policies to deviate and lose their consistency with the general policydirection. Engaging in the OECD peer review mechanism would also bevaluable, as some issues which affect Thailand are discussed more byOECD countries than by those in the region. What is more, a peer review isa two-way process, which is consistent with Thailand’s declared aim ofbeing more active in the internal arena.

The peer review mechanism should be extended to ASEAN. As ASEANintends to become a community of nations by the year 2015, peer reviewsshould not be confined to macroeconomic and financial issues only. Peerreviews which encompass overall policy coherence and further the commoninterests of the region’s nations should be developed so as to foster a truespirit of community. Peer reviews could become an established part of the



meetings of senior officials of ASEAN’s development planning agencies(ASEAN SOM-DP). The ASEAN secretariat submits reports of thesemeetings to Leaders’ meetings.

Notes

1. The section is based on the Economic Outlook Report, released on the4 December 2006 by NESDB and presented at the forum. A quarterlyupdate of the outlook is available at www.nesdb.go.th.

11. THE POLITICAL ECONOMY OF POLICY REFORMS AND PEER REVIEW MECHANISM: VIET NAM’S EXPERIENCE – 221


Chapter 11. The Political Economy of Policy Reforms and PeerReview Mechanism: Viet Nam’s Experience*

11.1. Introduction

During the 1990s, a large number of countries embarked on fundamentaleconomic policy reforms. Centrally planned economies in Eastern Europeand East Asia, as well as highly protected and inward-looking economieslike India and Brazil, were eager to reduce government involvement ineconomic decision-making in order to ensure macroeconomic stability andopen up to international trade and capital flows. Different countries adopteddifferent approaches and sequences of reform, which led to different policyoutcomes. These experiences provide fertile ground for the politicaleconomy studies of economic reform. They provide considerable materialon critical factors, like the timing, economic necessity, and politicalchallenges of reforms.

Viet Nam’s economic growth and poverty reduction achievements overthe last 15 years have been one of the most spectacular success stories ineconomic development. Its recent socio-economic developments havecaught the attention of international organisations and the global businesscommunity. For the past two years Viet Nam’s economy has grown 8% perannum, the second highest growth rate in the region and the world. Foreigndirect investment reached a new record of USD 10 billion in a decade(World Bank, 2006). In January 2007 Viet Nam officially became the 150thmember of the World Trade Organization (WTO), prompting the interestand confidence of the international business community in Viet Nam’scommitment to economic international integration and its promisingdevelopment prospects.

* This chapter was written by Nguyen Dac Thanh, AssistantDirector-General, Economics Department, Ministry of Foreign Affairs ofViet Nam. The arguments presented in this chapter reflect the author’sopinions only, and not the official views of the Ministry of Foreign Affairsof Viet Nam and/ or the Government of Viet Nam.

222 – 11. THE POLITICAL ECONOMY OF POLICY REFORMS AND PEER REVIEW MECHANISM: VIET NAM’S EXPERIENCE –


From 1986 Viet Nam initiated its well-known Doi Moi, or renovation,policy. It boasted some unique characteristics. Firstly, unlike many EasternEuropean countries where political reform preceded or was concurrent toeconomic reform, Viet Nam delivered remarkable economic policy changeswithout any assistance from international finance institutions and at a lowercost (in terms of the effect on production and standards of living). Secondly,in contrast to China, where reform was the result of a gradual approach withtwo systems long co-existing, Viet Nam introduced a market-orientedeconomy in a series of bold measures in 1989-90 (Riedel and Turley, 1999).Thirdly, the reform in Viet Nam was a protracted process and, in a sense, anincomplete transformation. James Riedel summarised it in these terms:

“A stop-go cycle has developed in which the new incentives andopportunities resulting from reform are sufficient to block broadreversion to earlier phases, but comprehensive advances wouldseem depend on the occurrence of deeply unfavourable shocks.When crisis has seriously undermined performance, leaders haveembraced reform to shore up legitimacy, while in good times theyhave tended to disagree over the long-term risks of reform and howto deal with those risks.” (Riedel and Turley, 1999)

The main purpose of this chapter is to understand the economic andpolitical interactions of the reform process in Viet Nam. We seek to providean explanation of some of the unique characteristics of the reform process.Our main hypothesis is that economic reform in Viet Nam throughout the1990s was triggered by a severe economic crisis. This is consistent withmuch political economy literature as well as with the reform experience inmany developing countries. Economic crisis allows policy leaders to takerisks and adopt bold policies that would otherwise be politically risky. Italso temporally insulates them from powerful interest groups; as a result,policy makers enjoy a degree of autonomy. However, once the economiccrisis has been tamed, the need for reform gradually declines. Powerfulinterest groups re-emerge and veto any reform efforts that could trim theirbenefits. This is one of major factors that explain the pattern of reform inViet Nam.



11.2. The failure of the centrally planned experiment

In 1975, Viet Nam became a united and independent country after morethan 25 years of devastating wars. Inspired by unification, policy makersoptimistically believed that Viet Nam would make the leap from anagriculturally based economy to industrialised country within a generation.It was a belief reflected in the highly ambitious development objectives ofthe second five-year plan (1976-80).

On the economic front policy makers adopted the centrally plannedmodel. The second (1976-80) and third (1981-85) five-year economic planslaid the foundations for a government-led development strategy. Theemphasis was on state ownership in industry, the services, and distribution,and on collective ownership in agricultural production. Foreign trade wasmonopolised and investment channelled into heavy industry to promotetransformation from small- to large-scale production. The south of thecountry saw a mass nationalisation programme put in place. In a depressedmarket 30 000 small retail outlets were closed down and the government setthe prices of most commodities (Fforde and De Vylder, 1996, pp. 128-137).

However, the result was in complete contrast to the vision of policymakers. During the second five-year plan, economic growth fell far short ofits target (see Table 11.1). Although investment was concentrated in heavyindustry, the industrial sector was the one that performed worst, whileagricultural productivity fell to its lowest level since 1960 (World Bank,2006, p. 15). Although endowed with favourable conditions for agriculturalproduction, especially rice, Viet Nam had to import staple foods fordomestic consumption. In the two consecutive years of 1979 and 1980, theeconomy contracted approximately 2%.

Table 11.1. Growth rate by sector during the second and thirdfive-year development plans

1976-80 1980-86Target growth

rate (%)Actual growth

rate (%)Target growth

rate (%)Actual growth

rate (%)National income 13-14 0.4 4.5-5 6.4Agriculture 8-10 1.9 6-7 4.9Industry 16-18 0.6 4-5 9.5

Source: Woo, Wing Thye and Jeffrey Sachs (eds.) (1997), Economies inTransition – Comparing Asia and Europe, MIT Press, Cambridge, MA, p. 191.



11.3. Fence-breaking activities

Poor economic performance led to increasing resentment in society. InSouth Viet Nam farmers resisted the collectivisation programme, while inthe north of the country, where collective farming had been introducednearly two decades earlier, they lacked the incentive to reduce costs andincrease productivity. Newly nationalised firms in the south were unable tooperate because of the foreign trade trade blockade imposed by Westerncountries and the decline of aid from China. The centrally planned systemfailed to provide proper incentives for producers or to mobilise resources foreconomic development.1

The response was the widespread practice of seeking ways to get aroundthe structural impediments caused by rigid central planning. In agriculturesome local authorities, albeit illegally, leased out co-operative farmland tohouseholds. In the industrial sector, state-owned enterprises (SOEs),“illegally” breaking the fence of mandated plans, purchased the inputs theyrequired from local suppliers and sold their products on the free market.2

Some line ministries and local authorities, especially in South Viet Namcolluded or allowed SOEs to engage in foreign commerce in order toprocure essential inputs.

These fence-breaking activities were a challenge to the effective controlof central government. In 1982 a compromise was reached, whereby thegovernment accepted that fence-breaking take place. Output contracts wereallowed in agriculture, while SOEs were permitted to sell part of their outputon the open market. Control over the movement of goods and productioninput between regions was relaxed. However, the government saw thesemeasures as a tactical retreat.

The re-emergence of free-market and commercial contract relationstemporarily eased shortages in the economy. Annual industrial outputgrowth, for example, rose from 0.6% in the second five-year plan to 9.5% inthe third (see Table 10.1). Nevertheless, the co-existence of astate-controlled distribution system and a distorted free market built upmacroeconomic imbalances. The production of essential goods fell far tooshort of rising demand. Taking advantage of these shortfalls, officials in thestate distribution system diverted goods to the free market to gain highermargins. The ratio between the retail and official prices of staple foodswidened from 10/1 in 1981 to 20/1 in 1985 (Fforde and Vylder, 1996), whilesome forms of rent-seeking activities emerged.

Macroeconomic imbalances grew increasingly marked as inflation rose,foreign exchange shortages appeared, and the public sector deficit worsened.From 1980 inflation rate annually exceeded 100% (World Bank, 1993,



p. 248). As SOEs began to engage in trade with countries outside the Sovietbloc, the need for dollars rapidly increased. Exports to the Soviet blocaccounted for the bulk of Viet Namese SOEs’ earnings, but they were notdenominated in dollars. The government had to set up multiple exchangerate regimes to ration scare hard currency, which led to wide discrepanciesbetween official and free market exchange rates. The government budgetwas permanently in deficit, accounting for 20% of total expenditure in therecession year of 1981, and never less than 5% (Riedel and Turley, 1999).By 1985 it was apparent that piecemeal measures were exhausted and couldnot steer the economy along the path of sustained growth.

11.4. Changes initiated

In July 1986 Truong Chinh became General Secretary of the Party.3

Unlike his predecessor, he emphasised the importance of gaining popularsupport from various social groups, especially farmers and workers. Thefailure of two consecutive five-year economic plans had eroded thelegitimacy of the Party. He understood that the only way to regain supportwas to improve economic performance and that there was an urgent need forchange in development strategy and economic management. On a tour of theprovinces in 1984 he listened to the views of frustrated local authorities andcitizens and began harnessing this disparate grassroots pressure into acoherent movement (World Bank, 2006, p. 18). His famous remarks “DoiMoi or die” set the tone for the policy of Doi Moi, or renovation, to whichthe Party committed at its sixth congress in December 1986. The ineffectivecentral planning mechanism was criticised and unrealistic industrialdevelopment objectives were discarded. The Party called for agriculturaldevelopment to be given the highest priority – an obvious attempt to win thesupport of farmers.

However, the Doi Moi reforms approved by the Sixth Congress werehardly radical or bold. Although the role of the market in allocatingresources and meeting the demands of society was acknowledged, there wasno clear agenda for moving towards a market economy. Among policymakers there was fierce debate over whether to free prices and cut allsubsidies and to what extent private enterprises should be allowed todevelop (World Bank, 2006, p. 19). Resistance came from those whobenefited from the status quo that had emerged from fence-breakingactivities – mainly officials involved in the state distribution system,import-export activities, and in rationing scarce hard currency resources.Understandably, they supported and lobbied strongly for maintaining thedual system. Plainly, a big push was needed to launch the reform policy.



11.5. The economic crisis of 1986-88

From 1980 the government budget was permanently in deficit, reflectingthe decline of aid from the socialist bloc and the erosion of state control overthe economy. Publicly owned revenues and assets were siphoned off,creating wealth in the form of rents for a few individuals. In late 1985 thegovernment introduced a new currency and increased state-controlled pricesin an effort to balance the budget.4 The immediate effect was the transfer ofwealth from households to the state, with the rate of net individual savingsturning negative between 1986 and 1988 (see Table 11.2). The measurestriggered a deep economic crisis. They abruptly drove the inflation rate up to570% in 1986, while failing to reduce the budget deficit, since thegovernment subsidised inflation by awarding wage rises to publicemployees. The spiral of price and wage increases fuelled inflation further,forcing the government to print more and more money. Inflation ran out ofcontrol. In three consecutive years, the economy experienced hyperinflation.Table 11.2 provides a picture of the very unstable macroeconomicenvironment that prevailed during the period 1986-89.

Table 11.2. Major economic indicators during 1986–89

1986 1987 1988 1989GDP growth rate (%) 3.3 5.4 6.5 2.0Budget deficit/GDP (%) -5.8 -4.4 -7.1 -11.4National savings/GDP (%) -1.7 -1.1 -2.0 5.1Inflation (%) 568.9 329.2 306.3 76.0Current account deficit (USD million) -655.0 -624.0 -751.2 -587.1Official exchange rate (VND/USD) 18 225 900 11 000Parallel exchange rate (VND/USD) 425 1 270 5 000 10 500

Source: World Bank (1993), “Viet Nam: Transition to the Market”, Report,No. 11902-VN, World Bank, Washington, DC., various tables; Woo, Wing Thye andJeffrey Sachs (eds.) (1997), Economies in Transition – Comparing Asia and Europe,MIT Press, Cambridge, MA, p. 195; Fforde, Adam and Stefan De Vylder (1996), FromPlan to Market: the Economic transition in Viet Nam, Westview Press Boulder,Colorado, p. 300.

Despite its serious consequences, the economic crisis of 1986–1988 wasa blessing in disguise. For one thing, it weakened the coherence of thegroups that benefited from the status quo and selfishly defended it. Inflationand increases in official prices choked off the rents enjoyed by officials incharge of the distribution system. The prices of staple foods in the statedistribution network were gradually increased and by 1989 were on a parwith free market prices (Fforde and Vylder, 1996). Furthermore,hyperinflation inflation made the economy highly inefficient. People



deserted the currency, hoarding goods and valuable assets instead. As aresult, transaction costs increased substantially; everyone was worse off.

Internal problems were fuelled by external difficulties resulting fromcuts in aid from the socialist bloc and less export opportunities. In 1989 theCouncil for Mutual Economic Assistance (CMEA, or Comecon), a tradingblock of socialist countries that had absorbed most of Viet Nam’s exportscollapsed. The country’s balance of payment deficit now reached nearly10% of total GDP, while its foreign exchange shortage was reflected in thegrowing gas between official and free market rates (see Table 11.2). From1991 aid from Socialist countries completely dried up. Due to sanctions byWestern countries, the government was unable to access (InternationalMonetary Fund) IMF and World Bank loans until 1993.

11.6. The 1989-90 programme to stabilise and liberalise the economy

As suggested by Rodrik (1996), economic crises make bold reformmeasures more likely. Hyperinflation may be welfare-enhancing in the sensethat it shortens the time beyond which necessary policy reform can bedelayed. Economic crises reduce the political risk that policy makers have toface when they adopt bold reform measures. Around 1989 the governmentintroduced a bold economic reform package that, qualified as “shock”. Themain purpose of the package was to stabilise the economy and keep inflationunder control. Interest rates were set at a very high level in order to gain thepublic’s confidence in the currency. The government refrained from printingmoney to finance budget deficits. According to IMF, the early introductionand consistent implementation of tight financial policies was a key elementin Viet Nam’s success in bringing inflation under control (Dodsworth et al.,1996). The policy package also incorporated a number of bold liberalisationmeasures. The pricing of most goods was deregulated and exchange rateswere devalued sharply, which complemented the easing of import regimes.Devaluation gave an added boost to exporters and alleviated some of thesqueeze on import-competing groups (Rodrik, 1997).

The economic outcomes of this reform package were impressive.Contrasted with the experience of Central European economies in transitionthat suffered deep contractions in output and standards of living in the earlyyears of reform, Viet Nam’s economy was very responsive to the policyinitiatives. Inflation quickly dropped to two-digit level and economic growthbecame robust. The early half of the 1990s was the golden period ofeconomic development in Viet Nam for many decades (see Table 11.3).Average economic growth in 1991-96 was nearly 9%, while exports grewmore than 30% annually. Foreign direct investment increased ten fold in realterms as the share of GDP doubled between 1990 and 1995 (World Bank,



2006, p. 25). In the trading and service sectors, private business blossomedand largely replaced the state distribution network. In 1994 the governmentagreed to a three-year policy framework with the IMF and World Bank andregained credit with international financial institutions. Observing thesedevelopments, David Dollar commented that “this represents one of themore dramatic turn-arounds in economic history”.5

Table 11.3. Rewards of the reform package

Economic indicators 1990 1991 1992 1993 1994 1995 1996GDP growth (%) 4.9 6.1 8.6 8.1 8.8 9.5 9.3Inflation (%) 67.5 68.1 17.5 5.2 14.4 12.7 7.4Budget deficits (% GDP) -5.8 -1.5 -1.7 -4.8 -1.6 -0.5 N/AExport (USD million) 1 731 2 042 2 475 2 985 4 054 5 198 7 100FDI (USD million) 120 220 260 832 1 048 1 781 2 300

Source: Wolff, Peter (1999), Viet Nam – The Incomplete Transformation, Frank Cass/GermanDevelopment Institute, Berlin; Riedel, James and William S. Turley (1999), The Politics andEconomics of Transition to an Open Market Economy in Viet Nam, OECD, Paris.

11.7. Incomplete transformation: politics-as-usual reforms?

Despite its early successes, the reform package seemed to run out ofsteam in a relatively short period. From 1996 the government showed a lackof political will in pursuing the policy framework that had been agreed withthe IMF in 1994. Although it maintained a conservative fiscal policy, thegovernment in disagreed with the IMF over the pace of structural reform,particularly in the banking and industrial sectors. In early 1997, due to lackof progress in banking and SOE reforms, the IMF decided to suspend thedisbursement of the second tranche of enhanced structural adjustmentcredits (Wolff, 1999, p. 10). By the end of 1996 pledged foreign investmentcapital was stagnating, reflecting the anxiety of foreign investors over thegovernment’s commitment to reform.

The East Asian financial crisis of July 1997 led policy makers to adopt acautious economic stance. Priority was given to ensuring macroeconomicstability and no major reforms were undertaken. Although the governmenthad applied to join GATT/WTO in 1994, it was not until 2001 that it tookserious steps to negotiate its admission. In 1998-99 economic growth fell byhalf to 4-5%, while the flow of foreign investment shrank significantly frommore than USD 2 billion in 1995-97 to USD 600 million in 1999 due to theAsian crisis and the slow-down in Viet Nam’s economic reform (WorldBank, 1999a).



Explaining this absurd result, James Riedel argued that “Economicconsequences of reform changed the political equilibrium that generatedpressures for reform in first place” (World Bank, 2006, p. 28). As forViet Nam’s political leaders, with the crisis over they grew complacent andshowed a lack of incentive in to pursuing bold reform initiatives. And, moreimportantly, the vested interests that had opposed further reforms emerged(or re-emerged). In 1994 the government opted to form dozens of SOEconglomerates,6 despite IMF warnings that the move “may not be consistentwith increasing efficiency and competitiveness.” And, as James Riedelobserved, “Although private banks have been allowed to operate, reforms sofar have been careful not to threaten the dominant position of thestate-owned banks, just as reforms in trade and industrial policy have beencareful not to threaten the privileged position of state-owned industrialenterprises” (World Bank, 2006, p. 32).

What lessons can be drawn from the reform experience in Viet Namover the last 15 years? First of all, it confirms a widely held proposition inpolitical economy literature, i.e. that strong, fast reform emerges in responseto crisis. Without the economic crisis of 1986-88, there would not have beena reform package that fundamentally turned the economy around. Secondly,although economic crisis does not dictate the scope and size of policyreform, stabilisation and trade liberalisation can be implemented moresuccessfully in harsh circumstances, because such there is a degree ofsynergy between them. A successful stabilisation programme facilitates theintroduction of measures to liberalise trade. Conversely, liberalisationmeasures, such as devaluation and import relaxation, go some way toalleviating the burdens caused by stabilisation. A third point is that“big-bang” reform actually offer advantages over the gradual approach: ifinitiating reform is difficult and costly, it is better to introduce as manyreforms as possible in times of economic chaos. The big-bang approachshortens the period of hardship that people must endure and averts rejectionof reform.

Although the success of Doi Moi creates legitimacy for itself andprevents reforms from being reversed, the real question is how to choosefuture directions for continuous reform. In a “politics as usual” environmentthe gradual approach to reform is a better option. Reformists still have roomfor manoeuvre. By fostering the development of the private sector and thestock exchange they will deepen domestic support for accelerating reform ofstate-owned enterprises, for which continuous commitment to internationalintegration and trade liberalisation will provide strong leverage. With therecent admission of Viet Nam into the WTO, there is optimism that themomentum of reform will be stepped up.



11.8. Viet Nam’s experience of the peer review mechanism in policyreform

Viet Nam had periodic experience of the peer review mechanismthroughout Doi Moi. Its achievements in socio-economic development areattributed primarily to efforts by the Vietnamese government and people todraw fully on internal resources. Assistance and support from internationalorganisations and donors were, nevertheless, also significant. In the case ofViet Nam, however, ideas were more important than money. It was notfinancial assistance from international bodies like the IMF and the WorldBank that paved the way for Viet Nam’s stabilisation and liberalisationreform packages. In fact, Viet Nam did not receive any large-scale aidbefore it normalised financial relations with international organisations anddonors in December 1993. The role of the IMF and the World Bank was,rather, to introduce the knowledge and principles of market-basedeconomics through consultation and the training of middle- andhigh-ranking government officials. Towards the end of the 1980s a series ofworkshops and seminars were held in Hanoi and Ho Chi Minh City. Theysaw well-known economists and specialists from the United Nations, theWorld Bank, and the IMF priming Vietnamese officials in principles ofmicro- and macroeconomics.

In December 1993 the first Consultative Group Meeting (CGM) forViet Nam was held in Paris, France. Since then the meetings has evolvedinto an annual fixture and an official consultative mechanism between thegovernment of Viet Nam and the donor community. CGMs provide a forumfor discussion and consultation between the Vietnamese government and itsdevelopment partners on economic policy issues, strategies for reducingpoverty, and the effectiveness of official development assistance (ODA).Vietnamese and international non-governmental organisations (NGOs) aswell as representatives of the Viet Nam Business Forum participate asobservers. The government delegation includes senior representatives fromkey ministries and governmental bodies, including the Ministry of Planningand Investment, the Ministry of Finance, and the State Bank of Viet Nam.The Consultative Group for Viet Nam is co-chaired by the Minister ofPlanning and Investment and the World Bank Country Director forViet Nam.

The CGM held in December 2006 was attended for the first time byPrime Minister Nguyen Tan Dung and five cabinet ministers. Theydiscussed Viet Nam’s development and the objectives of its five-yearSocio-Economic Development Plan (SEDP) with donors. The 2006-10 planis the first that the government has undertaken to be based on extensive,fully participatory consultation with local people, civil society groups,



academics, private sector organisations, and other stakeholders inside andoutside government. The meeting was a huge success. The government ofViet Nam received wide-ranging policy advice on the four pillars of itsSEDP, namely structural reform, social inclusion, environmentalsustainability and good governance. They define the country’s future reformagenda namely. As Mr. Klaus Rohland, the former World Bank CountryDirector for Viet Nam, underlined:

“The SEDP’s goal of Viet Nam becoming a middle-income countryby 2010 is ambitious but attainable. Given its recent performanceViet Nam should aim high. Reaching middle-income status is notonly about income levels, but also about putting in place complexinstitutions. It is about making the delivery of services moredecentralised; it is about increasing transparency andaccountability; it is about building a social protection systemreconciling efficiency with support to the vulnerable. Above all,reaching middle-income country status requires a shift in the role ofGovernment from owning and doing to leading and regulating.”

The significance of the genuine partnership between the government ofViet Nam and the donor community can be highlighted in the way theWorld Bank describes its Country Partnership Strategy with the governmentof Viet Nam:

“The World Bank Group’s relationship with Viet Nam has maturedand grown considerably, from one where the Bank shared itsinternational experience and finance to a newly emerging Viet Namto one where Viet Nam and the Bank are not only partners towardsViet Nam’s development goals, but where Viet Nam alsoincreasingly acts as provider of good practices to other emergingdeveloping countries. Accordingly, the new World Bank GroupCountry Partnership Strategy from 2007 to 2011 is fully aligned toViet Nam’s tenth five year Socio-Economic Development Strategy2006-10.” (World Bank, 2007)

Although Viet Nam has not undergone any full, official peer review, ithas gained from this mutually beneficial exercise. With their frank, open,and equitable mechanisms, peer reviews are expected to be beneficial tomember countries as regards improving policy making and adopting betterpractices on the one hand, and providing credible independent assessmenton policy reforms on the other.



Notes

1. It is interesting to note how severe the incentive problem was. During thisperiod outside co-operative farming provided most of the food supply. Inspite of its collectivisation programmes, the government still allowedfarmers to own small plots of land. This land accounted for 5% ofagricultural land, but provided 95% of staple foods (Wolff, 1999).

2. The terms “fence-breaking activities” was coined by Adam Fforde andJames Riedel to describe the economic activities of SOEs and farmers inthe early 1980s that went beyond what had been allowed by authorities ormandatory plan. Fence-breaking offered one explanation, so-called“reform from bottom”, for economic reform in Viet Nam. For furtherdetails, see Fforde and De Vylder (1996); Riedel and Turley (1999).

3. General Secretary Le Duan who led the country to unification in 1975held the position until his death in July 1986.

4. In July 1985, the government introduced the new Viet Nam dong, tentimes the value of the old one. This meant a 10% tax across-the-board onthe wealth of individuals (Fforde and De Vylder, 1996).

5. Quoted by Riedel in Woo and Sachs (1997).

6. In an effort to consolidate the SOE sector, Prime Ministerial Decisionsnos. 90 and 91 (1994) re-established 19 general corporations that reporteddirectly to the Prime Minister and 70 other large corporations in variousindustries.



Bibliography

Economist Intelligence Unit (EIU) (2001), Viet Nam Country Profile 2001,www.store.eiu.com/product/30000203VN.html?ref=product_detail_list_Country_title, accessed 7 July 2007.

EIU (2006), Viet Nam Country Profile 2006,www.store.eiu.com/product/30000203VN.html?ref=product_detail_list_Country_title, accessed 7 July 2007.

Fforde, Adam and Stefan De Vylder (1996), From Plan to Market: theEconomic transition in Viet Nam, Westview Press, Boulder, CO.

International Monetary Fund (IMF) (1999), “Viet Nam – Selected Issues”,IMF Staff Country Report, No. 99/55, IMF, Washington, DC.

Dodsworth, John, et al. (1996), “Viet Nam Transition to a MarketEconomy”, Occasional Paper, No. 135, IMF, Washington, DC.

Riedel, James and William S. Turley (1999), The Politics and Economics ofTransition to an Open Market Economy in Viet Nam, OECD, Paris.

Rodrik, Dani (1996), “Understanding Economic Policy Reform”, Journal ofEconomic Literature, Vol. XXXIV.

Rodrik, Dani (1997) “The Rush To Free Trade: Why So Late? Why Now?Will It Last?” in Haggard, Stephan and Steven Webb (eds.), Voting forReform: Democracy, Political Liberalization, and Economic Adjustment,a World Bank Book, New York: Oxford University Press, p. 76.

The Economist (2000), “The Longer March”, 30 September.

Wolff, Peter (1999), Viet Nam – The Incomplete Transformation, FrankCass/German Development Institute, Berlin.

Woo, Wing Thye and Jeffrey Sachs (eds.) (1997), Economies in Transition – Comparing Asia and Europe, MIT Press, Cambridge, MA.

World Bank (1993), “Viet Nam: Transition to the Market”, ReportNo. 11902-VN, World Bank, Washington, DC.



World Bank (1999a), “Viet Nam: Preparing for Take-off?”, informaleconomic report of the World Bank Consultative Group Meeting forViet Nam, World Bank, Washington, DC.

World Bank (1999b), “Viet Nam: Country Framework Report on PrivateParticipation in Infrastructure”, World Bank, Washington, DC.

World Bank (2006), “Taking Stock: An Update on Economic Developmentsand Reforms”, Annual Report at the Consultative Group Meeting forViet Nam, World Bank, Washington, DC.

World Bank (2007), Country Partnership Strategy with the SocialistRepublic of Viet Nam for the Period 2007-2011, World Bank,Washington, DC.

PART III. EXPERIENCES OF OECD COUNTRIES – 235


Part III.

Experiences of OECD Countries

12. BELGIUM’S EXPERIENCE OF OECD PEER REVIEWS – 237


Chapter 12. Belgium’s Experience of OECD Peer Reviews*

12.1. Introduction

Peer review systems spring from the grim European experience of theinterwar years between 1914-18 and 1939-45. Throughout the GreatDepression, which first bit in 1929, each and every government in Europesought to export its adjustment costs by implementing such policies ascompetitive devaluation and tariff increases. The outcome was a depressionthat was far worse than it needed to be, because the nations of Europe failedto respond in a co-ordinated manner. By the end of the 1930s it had becomeclear that no government could ever again hope to vanquish economic criseswithout considering what its neighbours could do.

Accordingly, the response of European countries when World War IIcame to a close in 1945 was to rebuild their economies through amultilateral effort. As part of the Marshall Plan, born in 1947, theOrganisation for European Economic Co-operation (OEEC) was foundedwith the purpose of co-ordinating the European Recovery Programme. TheOEEC achieved fine results and in 1961 its membership was widened tonon-European countries: the Organisation of Economic Co-operation andDevelopment (OECD) had come into being. It leveraged and strengthenedthe positive European experience of the 1950s, particularly with regard tothe use of peer reviews. (Incidentally, let us remind ourselves that at thistime the Europeans created their own European Community.) Article 5 ofthe OECD Convention states that the Organisation may makeRecommendations to members – a critical provision of the Convention.Under the terms of Article 5 member states agree to be reviewed, acommitment from which no member may withdraw.

* This chapter was written by Patrick van Houte (a former Ambassador of thePermanent Delegation of Belgium to OECD), Director of ExecutiveDirectorate, OECD.

238 – 12. BELGIUM’S EXPERIENCE OF OECD PEER REVIEWS


Between 1961 and 2007 the OECD has built on 46 years of experience and change, fashioning a peer review mechanism that fits the needs of its member countries. The peer reviews of today did not fall, ready-made, into waiting laps, but have gradually grown, starting with Economic Surveys before coming to encompass many other fields – from energy and development aid to competition and e-government. There was, for instance, a time in 2006 when Belgium was under review in six different policy areas: energy, the environment, economic policy, bribery, money-laundering, and official development assistance (ODA). In each area the process entered into great detail and was, in some instances, actually cumbersome.

A peer review as practised by the OECD is not a process where one country is judge and the other judged. It involves several parties: the review body and examiner countries; the country under review; and the secretariat of the OECD. Each has its rights and obligations. The secretariat drafts the report, the examiners and the reviewed country respond, and there is collective discussion in a plenary meeting of the review body. As an example of peer review, let us consider the 2007 Economic Survey of Belgium.

12.2. The 2007 Economic Survey of Belgium step by step

An Economic Survey is more than a mere discussion among peers; it is a process that takes almost 12 months and comprises 10 steps.

The 2007 Survey got under way in May 2006, when the secretariat sent Belgium an 11-page questionnaire that contained 166 questions. They were very precise and specifically targeted, relating to policy areas like the financial sector, labour markets, tertiary education, and consumer policy. The questionnaire was sent to the Prime Minister’s office in Brussels, where it was keenly awaited. On reception the Prime Minister’s office distributed the questionnaire to the government departments concerned – social affairs, finance, planning, economic affairs, etc. They got to work.

Step number two commenced three weeks later when four representatives from the secretariat paid a first, exploratory, visit to Belgium. They stayed for five busy days – 19 to 23 June 2006 – or 50 hours, during which they engaged in active discussion.

When the on-site visit came to an end, the third step began. The visitors from the secretariat returned to Paris, where they digested and analysed answers to the questionnaire and their own reports of their discussions in Belgium. By the end of August, two months later, they had completed their work and produced a second questionnaire, which they once more sent to



the Belgian Prime Minister’s office, ushering in the fourth phase in thereview process.

The Prime Minister’s office again dispatched the new, shorterquestionnaire, consisting of 4 pages and 60 questions, to the samegovernment departments. The total number of pages of answers to bothquestionnaires added up, in the Belgian case, to 996. Quantity and qualityare not, admittedly, the same thing, but the sheer number of pages reflectedthe energy and input that a country like Belgium had put into the exercise.

In late September a five-strong team paid a second visit to Brussels. Itwas shorter than the first one, lasting three days, or 30 hours, with visitorsmeeting 66 people. The team’s findings led to step number five, which sawthe OECD Economics Department send the draft report to Brussels on20 November 2006. It was 135 pages long and incorporated a 1-pageExecutive Summary and 15 Recommendations spread over 6 pages.

A brief look at the thrust of some Recommendations affords a sense ofjust how sensitive they can be. One called for a balanced budget, whilewarning against the chilling effect of growing surpluses; another advocateda more ambitious fiscal policy with a clear objective. The draft report alsonoted that the labour market was still not functioning effectively, and whileacknowledging that wage moderation was important, it pleaded for morewage differentiation. On a more positive note the financial sector testified toBelgium’s dynamism, although it could perform even better.

Prime Minister’s Office dispatched copies of the entire report to allministries, requesting that they return their amended copies by30 November, ten days later. A co-ordination meeting was then held on7 December to redraft the 92 pages of proposed changes, bringing stepnumber five to a close and initiating the next phase. The EconomicDevelopment and Review Committee (EDRC) met to discuss the draftreport. Proceedings lasted the whole day, with a 15-strong Belgiandelegation led by the Prime Minister’s Economic Adviser submitting to thescrutiny of all the Committee members, particularly the two lead examiners,Portugal and Switzerland.

The following day ushered in the following step, number seven, whichsaw the secretariat and Belgian delegation set to work on drafting the finalreport. One day was insufficient, however, so they concentrated on the fivepages of Recommendations, finalising the rest of the report by submittingwritten drafts to each by e-mail. The approved copy now had to be approvedby the rest of the OECD members involved in the survey, following awritten procedure until they arrived at a consensus on the final text.Consensus requires that all parties involved in an Economic Survey,including the country under review, agree on the report’s final wording.

240 – 12. BELGIUM’S EXPERIENCE OF OECD PEER REVIEWS


The last two steps in this peer review procedure were to translate, in February 2007, the document into the Organisation’s other language and print it, and then to convene a press conference in Brussels on 13 March, at which the Prime Minister of Belgium and the OECD’s Secretary-General presented the review to the Belgian public.

12.3. Advantages of the peer review process

The prime strength of the exercise is that it is, by its very nature, balanced: the scrutinised country which undergoes peer pressure today will tomorrow examine its peers and submit them to pressure. All fully grasp the need not to be adversarial, driven by an in-built incentive to arrive at a shared view of the issues at hand.

What emerges from the description of the review procedure above is that the most important element is less the report published in book form than the whole process. The author would like to illustrate this contention by describing his experience of debates on some highly sensitive issues between the OECD’s visiting team and Belgian political appointees. One such issue was tertiary education tuition fees.

The secretariat wrote in its draft that the Belgian government should dramatically increase university tuition fees and introduce a system of student loans to finance them. Belgian policy is radically different. It has instituted free access to university, with very low tuition fees. Students must sit very difficult examinations at the end of their first year. Sixty percent fail and leave university. But Belgium’s policy and, ultimately, the wish of its people is to ensure free access for all – for the first year of university, at least. The secretariat’s stance on the question was totally different, and there ensured a very lively debate with Belgian officials. The outcome was that the secretariat would write what it wants, while Belgium maintained its university entrance policy, because it believed that it was right. However, the debate raised awareness among Belgian officials that their country’s way of doing things was not the only one; and that because free university access probably came at a cost, it had to be the result of deliberate, positive choice.

Another advantage is that the OECD secretariat does not have to consider upcoming elections, so it is free to dispense long-term advice. Let us take the example of pensions. The OECD pointed out that Belgium’s retirement pension system was secured only until 2030 and that it should explore ways of financing the system thereafter. This is not an issue that politicians like to dwell on. Recommendations are not mandatory, however, and just as OECD member countries are free to implement them or not, so the secretariat is free to be clear in its Recommendations. Indeed, their



neutrality and objectivity are another strength of peer reviews: becauseRecommendations do not come from inside the country being examined,they are often much more plausible.

By way of conclusion let us add that governments of member countriesdo, in fact, look benignly on the OECD peer review process, because it canhelp them to state a case to their public opinions. When political changes arenecessary, which is the whole point of having OECD reviews, interactionbetween secretariat and reviewed country prior to a report’s publication canmove the secretariat to make recommendations that help implement changessubsequently.

13. JAPAN’S EXPERIENCE OF OECD PEER REVIEWS – 243


Chapter 13. Japan’s Experience of OECD Peer Reviews*

13.1. A history of OECD peer reviews in Japan

Among the many OECD peer reviews that have taken place since Japanjoined the OECD on 28 April 1964, Economic Surveys (conducted every18 months and of which there have been 33) and reviews of officialdevelopment assistance (ODA), which take place every 3-4 years and ofwhich there have been 4, are considered the most important and are the mostwidely publicised in Japan. The growing pressures of economicglobalisation have heightened OECD members’ awareness of theimportance of domestic macroeconomic and structural policies and externalpolicy co-ordination, while highlighting the need to learn from othercountries’ experiences and to coax public opinion into support for painfuldomestic reforms that are essential to long-term economic growth and thewellbeing of people in countries the world over.

The OECD’s reviews of Regulatory Reform have also becomeincreasingly important in Japan and other OECD countries, where economicgrowth has come to depend heavily on domestic regulatory and competitionpolicies. Environment-related peer reviews originated in the rapid rise ofindustrialisation in the 1960s and 1970s, which prompted mounting concernover environmental protection in Japan and other OECD member countries,particularly among civil society groups. These worries eventuallyculminated in the OECD’s Environmental Performance Review, now in itssecond country-by-country cycle, and Consensus Documents on purchasingpower parities (PPP).

The annual periodical, Going for Growth, first published in 2005, is nowa well-established policy reform monitoring report, which covers all OECDmember countries, including Japan.

* This chapter was written by Ryokichi Hirono, Professor Emeritus, SeikeiUniversity, Japan. The views expressed in this chapter are those of theauthor alone.

244 – 13. JAPAN’S EXPERIENCE OF OECD PEER REVIEWS


13.2. The OECD peer review mechanism in Japan

OECD peer reviews of Japan follow the standard three-phase pattern of preparation, consultation, and assessment. All address a specific topic, usually a policy area, and are undertaken by examiners who belong to a review body – e.g. a committee or working group – which works in the policy area under scrutiny. The review body will be the Economic Development and Review Committee (EDRC) if the review is an Economic Survey, the Development Assistance Committee (DAC) if it relates to Japan’s ODA, and so on. The OECD publishes its finalised peer reviews as reports; all include progress monitoring.

In the preparatory phase an OECD exploratory mission to Japan carries out background analysis with the assistance of the secretariat. In parallel, Japan drafts a memorandum in which it assesses itself with respect to the topic policy area under review. The secretariat now consults both the Japanese Delegation to the OECD and other experts on and in Japan in order to draw up a questionnaire, which it sends to the competent authorities in Japan. The questionnaire sets the agenda of the next phase, consultation.

An on-site mission, made up of examiners and members of the secretariat, engages in consultation in the course of a week-long visit. They follow an intensive schedule of meetings with the Japanese government and, should they wish, with academics, the business community, and such representatives of civil society as trades unions, farmers’ organisations, and consumer groups. The secretariat prepares a draft of the final report, which includes the examiners’ detailed analysis of Japan’s performance, and sets out conclusions and recommendations.

The third, and final, phase is assessment, which sees the draft report discussed in a plenary meeting of the review body, attended by representatives from all 30 member countries. Consensus usually has to be reached before a final draft can be approved and published.

13.3. The principal findings of some OECD peer reviews of Japan

Economic Survey of Japan, 2006

The 2006 Economic Survey produced some interesting recommendations from Japan’s peer countries. If, for example, Japan was to successfully put in place a new monetary policy framework, it should seek to make of its monetary policy more transparent. Avoiding any significant early rise in long-term interest rates would benefit economic activity, while



scaling back the role of public financial institutions and accelerating theprivatisation of Japan Post would bolster the banking sector.

A second challenge facing Japan, observed the examiners, was fiscalconsolidation. They urged the country to reduce its government budgetdeficit through continued spending restraint and lower public investment. Itwould also need to increase the consumption tax rate as part of a package toachieve a primary budget surplus by the early 2010s.

The 2006 Economic Survey also called on Japan to reduce measuredand relative poverty. It recommended tackling the growing dualism in thelabour market by curtailing regular workers’ employment protection andimproving social spending on such vulnerable groups as single parents.

Another issue to come under scrutiny was how to upgrade nationalinnovation mechanisms in order to promote productivity growth. The surveyadvocated improving the R&D and education systems and strengtheninglinks between public and private research institutions. It also contended thatJapan should foster greater competition, particularly in the networkindustries.

The final overriding issue was the need for Japan to integrate more fullyinto the global economy. Increased import penetration, a greater stock ofinward foreign direct investment (FDI), relaxed controls on foreign workerinflows, and reduced FDI and import restriction, particularly in agriculture,were some of the measures put forward.

Going for Growth, 2006 edition

The “Country Notes” annex to the 2006 edition Going For Growthsingled out a set of key reform priorities.

The first related to ways of furthering service liberalisation. The notesadvocated enforcing competition law more firmly, imposing heaviersanctions, and extending to the whole nation regulatory reform measureshitherto confined to special zones. Another approach was to promotecompetition in network industries, e.g. by raising surcharge rates on sales ofsome goods from 6% to 10%, or increasing the proportion of consumerswho could choose their electricity providers from one-third to two-thirds.

Another recommendation was to reduce farming production subsidies bymaking direct payments to farmers instead of supporting market prices. Inaddition, Going for Growth felt the government should opening theagricultural sector to joint-stock companies nation-wide, as had done in arecent experiment on specially-leased land.



One reform priority concerned the levels of employment protection enjoyed by regular workers. Reforms should seek to relax them by repealing the White-Collar Exemption Act, for example, or revisiting labour laws to ensure that non-regular workers received equal treatment.

Scaling back public financial institutions and compelling banks to address non-performing loan issues were just two suggestions for the financial sector. Another proposal was that banks should be required to strengthen their capital base by halving, for example, their non-performing assets (NPAs) in line with government targets.

Also high priority was the lifting of impediments to FDI inflows. The “Country Notes” recommended pursuing the Japanese government’s own plan to double its FDI stock over five years, e.g. through reform of the Commercial Code to facilitate mergers and acquisitions by foreign companies using their Japanese subsidiaries.

13.4. Impacts of OECD peer reviews in Japan

Environmental Performance Review

Japan has now formally incorporated the Polluter Pays Principle into the body of its environmental, legislation, and has implemented Agenda 21 – adopted by world leaders in 1992 – at national and local levels.

Japan’s commitment to environmental protection was plain to see in 1997, when it took the initiative of hosting a meeting of the United Nations Framework Convention for Climate Change (UNFCCC) in the city of Kyoto. It was there, with strong support from Japan, that the Kyoto Protocol came into being.

Review of Regulatory Reform, 1999

This peer review stimulated Japan to undertake in-depth scrutiny of its domestic regulatory environment in 2002, when it appointed the Comprehensive Regulatory Reform Commission. The Commission’s work achieved some significant outcomes. They included the National Plan for Doubling FDI Inflows, adopted in 2003; the enactment of the law privatising Japan Post in 2006; and a move to empower the Fair Trade Commission to break up monopolies, also in 2006.



DAC Peer Review, 2003

The DAC review played a critical role in Japan’s decision in 2003 tomainstream its pursuit of the Millennium Development Goals (MDGs). Themove was followed three years later by institutional reforms to streamlineODA implementation and to make ODA more efficient by harmonising itsprocedures and practices with other countries and establishing partnerships.

Economic Survey of Japan, 2005

The Bank of Japan moved to end its excessively cautious zero interestrate policy in 2006, while the government has engaged in debate over afaster rate of fiscal reform and higher consumption tax. In 2007 it passedlegislation that enshrined non-regular salaried workers’ right to equaltreatment.

Non-implementation of Recommendations

The Japanese government has found that some recommendations requiremore time before it can translate them into effectively implemented policyreform. They included reducing farm production subsidies and cutting tariffsto increase the share of agricultural imports in domestic consumption. (Theauthorities have already carried out quantitative import restrictions inaccordance with GATT.)

On the competition front it has been no easy matter to introducesubstantial increases in penalties for violating the Fair Trade Act, any morethan it is to broaden the scope of specific road-related taxes for non-roadexpenditure.

There is further hesitation over the streamlining of regulatory provisionsfor purposes other than to promote the telecommunication and informationtechnology markets.

13.5. Japanese domestic benefits of the OECD peer review

One positive impact of the peer review was that government felt morecomfortable and less cost-aware when it came to introducing reforms andpolicy changes based on the tried and tested practices of other OECDcountries.

Additional favourable fall-out for the government from the peer reviewwas that it was able to win support at home for difficult policy decisions andmeasures by showing what other countries were doing, demonstrating that



the peer review policy and institutional recommendations came from a credible, like-minded international organisation, and, finally, by explaining that other international organisations like the European Union (EU), International Monetary Fund (IMF), and World Trade Organization (WTO) also practised peer review. Furthermore, the fact that policy recommendations were not legally binding enhanced the perception the government owned its policies.

Publication of the peer review results saw Parliament, the media, and civil society groups bring pressure to bear on the government, compelling it to seriously address the issues raised in the review and to put their recommendations into practice.

By allowing the Japanese government to join in the peer reviews of other member countries, the OECD peer review mechanism provides further opportunity to learn from policy successes and failures elsewhere and, thus, to co-ordinate domestic policies with the rest of the OECD.

13.6. How could the OECD peer review process be improved?

Monitoring should be more frequent for all peer reviews, along the lines of the European Policy Centre’s annual Economic Policy Reform Paper.

Given the OECD’s financial constraints, the preparatory phase could gain credibility if it were performed in close consultation with the World Bank, WTO, and international organisations, as well as with research institutions in reviewed countries with better policy research capacity. The entire phase could be even commissioned by such a research body.

While the consultation phase is vital to ensuring that both policy analysis and recommendations are satisfactory to the review group and valuable for the reviewed country, it involves much intensive dialogue with many stakeholders both inside and outside the reviewed governments. To reduce the time burden on reviewers and reviewees, questionnaires could be made more concise and focused through the introduction of common standards and indicators suitable to quantitative measurement, e.g. tax revenues, national and external debts, and annual debt servicing as a percentage of gross domestic product (GDP).

In countries like Japan, where English is not the mother tongue, the use of English in OECD peer reviews not only costs the governments of reviewed countries time and money, it may also lead to problems of interpretation. If all OECD countries had to use Japanese or Chinese as a working language, they would soon understand how enormously time-consuming and costly the language issue is. A possible solution would



be for the country under review to choose its language, except when itcomes to the assessment phase, when the OECD needs to be a multi-lingualinstitution.

13.7. Some lessons from the OECD peer review mechanism fornon-member economies

Before a non-member economy can effectively engage in an OECD peerreview, it needs to fully understand what peer review is, how and why itworks, and what the cost-to-benefit ratio is.

Support through bilateral and multilateral ODA for capacity-building inthe country under review is essential in many areas of co-operation if OECDpeer reviews are to meaningful and welcome, e.g. comprehensive economicand social data collection, analysis and publication, and macroeconomic,structural, social and environmental policy formulation, implementation,monitoring and evaluation.

Non-member economies should speed up legislative procedure reformsto introduce practices like free parliamentary debates. And they shouldenable institutional arrangements to allow, for example, wider participationof multi-stakeholders in all OECD peer review processes, particularly in thepreparatory, consultation, and monitoring phases. Non-member economiesneed to feel a sense of ownership throughout the OECD peer reviewprocess, so that the stakeholders in the countries under review find theprocess beneficial to themselves in terms of macroeconomic stability,long-term economic growth, social equity and environmental protection.

14. KOREA’S EXPERIENCE OF OECD PEER REVIEWS – 251


Chapter 14. Korea’s Experience of OECD Peer Reviews*

14.1. Introduction

It is the firm belief of this writer that Asian countries need to participatemore actively in OECD programmes, particularly in the light of Asia’seconomic share of the world economy and its extraordinary dynamism. In1970 its share of world gross domestic product (GDP) was a mere 15%, butby 2004 it had risen to 25%. Similarly, its share of world trade, only 6% in1970, had more than tripled to 21% by 2005.

The Asian region’s active involvement in the OECD is critical to theglobal relevance of the Organisation’s work, while its tremendous expertiseas advisor in macroeconomic and structural reform policies cannot beoverstated. Yet only two of the OECD’s 30 member countries representAsia – Korea and Japan. Sadly, few Asian countries have, to date, showninterest in talks about OECD enlargement.

The OECD is widely known as an organisation committed to promotinggreater sustainable growth for the global economy and expanding worldtrade. It is involved in various economic and social issues, ranging frommacroeconomics and trade, to development, education, science, and labour.It has created such international financial standards as Export and ShipFinancing, Anti-Money Laundering (AML), and Counter TerroristFinancing (CTF), as well as such internationally acknowledged legalinstruments and recommendations as the Anti-Bribery Convention andModel Tax Convention. It encourages governments to implement themthrough a peer review process, as part of moves to establish advancedeconomic systems.

* This chapter was written by written by Tae-Shin Kwon, Ambassador,Permanent Delegation of Korea to the OECD.

252 – 14. KOREA’S EXPERIENCE OF OECD PEER REVIEWS


14.2. What is a peer review?

Peer reviews are regular examinations of one country’s state andpractices by other states. Although the recommendations made by theexaminer countries in OECD peer reviews are not legally binding, thecountry under review nonetheless feels peer pressure keenly enough to makeefforts to implement them. Since joining the OECD in 1996, Korea hasundergone seven Economic Surveys covering areas of macroeconomicpolicy like financial markets, education, and labour markets, in addition toseparate environment and regulatory reform peer reviews. Such peer reviewsplay crucial roles in improving economic systems.

Although the OECD performs peer reviews in many areas, let us focuson those carried out by the Economic Development Review Committee(EDRC), designed to assess countries’ performances against broadeconomic guidelines.

14.3. Korea’s Economic Survey

Korea’s experience with peer reviews will be considered, first, from thepoint of view of the process itself, then from that of the Economic Survey in2005 and finally from the benefits of peer reviews for the Korean economy.

The Economic Survey – the process

The review process involved two visits by OECD secretariat staff toKorea. On their first trip they toured numerous institutions like the Financeand Economy Ministries and the Fair Trade Commission to collectinformation. They also met with staff from the President’s Office, frompublic research institutions like the Korean Development Institute and theKorean Labour Institute, and such private organisations as the Federation ofKorean Industries and the Federation of Korean Trades Unions.

On its second, policy-oriented, visit, the OECD delegation was headedby the Director of the Country Studies Branch of the EconomicsDepartment. They held meetings with senior Korean policy makers frominstitutions that included the Finance and Economy Ministry and with thePresident’s Senior Secretary for Economic Policy.

The OECD secretariat staff drew on their visits to complete the draftsurvey, which was distributed to the rest of the review team in August 2005.The draft report was then discussed at a plenary meeting of the EDRC,which lasted for a whole day. In the light of that discussion and thefollowing day’s meeting between the OECD and a Korean government



delegation, the draft document was revised and amended. In November2005, the Economic Survey of Korea was published under the aegis of theEDRC.

The Economic Survey – the report

Economic Survey final reports generally focus on macroeconomic andstructural reform policies, typically reviewing indicators like inflation,exchange rates, interest rates, and public finance balances. They also analysestructural reforms in the labour, product, and financial markets, and in thepublic sector. Each report, however, also usually gives special attention tostructural reforms in areas which are to the fore at the time.

The 2005 report, for example, highlighted the profound changes takingplace in the Korean economy as a result of its structural reform programmeand increasing integration in the world economy. The same report alsounderlined that if higher sustainable growth was to be achieved, it wouldrequire further progress in public sector efficiency and improvedproductivity through innovation, structural reform, and appropriatemacroeconomic policies.

During the EDRC plenary meeting, many member countries who boast awealth of experience in macroeconomic and structural reform policiesactively participated in the discussions. For each Economic Survey theEDRC selects two of its members to lead the examination proceedings.Australia and Germany played this role for the Korean survey. Their tasksincluded facilitating active discussion throughout the EDRC plenarymeeting.

The two lead examiners and other examiner countries volunteered theiradvice. They suggested that Korea should improve the quality of its highereducation system by channelling greater resources into it. They alsorecommended that it should seek to ease polarisation in its labour market bylessening disparities in the treatment of regular and non-regular workers.Further advice concerned female participation in the labour force, whichKorea was urged to increase as one way of addressing the problem of itsageing population.

Korea considers that comments, suggestions, and recommendationsfrom its member country peers are valuable, and it has used them asyardsticks in policy discussions and government policy statements inrelevant areas.



Benefits of the Economic Survey

Korea’s participation in EDRC peer reviews has greatly contributed tobolstering economic growth and upgrading its systems. Let us consider afew detailed examples of how Korea has benefited from the EDRC peerreview.

In the immediate wake of the 1997 Asian economic crisis Korea had tocontend with a severe economic recession. In January 1998 alone, industrialproduction slumped by 10.3% and unemployment rose by a rapid 1.4%,while the consumer price index rose between 8-9%. The recession can, to alarge extent, be explained by a high interest rate policy and the IMF-backedapproach of balancing public finances.

It was an OECD recommendation to boost public expenditure thathelped Korea on its way to recovery. The Organisation’s adviceconsiderably enhanced the international community’s understanding of andsupport for our fiscal measures. It is, indeed, this author’s belief that had itnot been for the OECD recommendation, the Korean government wouldhave encountered great difficulty in intervening in a timely, appropriatemanner and achieving rapid economic recovery. Let us take some otherexamples of recommendations in areas of structural reform.

The 1994 Economic Survey recommended that Korea should cut thesheer amount of regulations controlling the financial markets and inflows offoreign capital. The 1996 report recommended enhanced flexibility in thelabour market, while the 1998 edition recommended resolving bad loans,improving corporate governance, and enhancing competition as part of apackage to quick recovery.

As readers may well know, structural reform went to the top of theKorean government’s agenda in the wake of the economic crisis. Againstthat background the OECD recommendations cited above were of great helpin introducing efficient structural reform policies and in pushing themthrough with greater confidence. Furthermore, the Economic Survey washelpful in building public support for structural policies and in overcomingopposition from specific interest groups, which is often the biggest obstacleto engaging structural reform.

The OECD has, in recent times, produced ideas that are superior to thoseof any other international organisation for improving our pension system onthe basis of projections and simulations.

Indeed, Korean policy makers and politicians should listen carefully towhat the OECD is recommending, since now is the time to reform ourpension system – before national pension expenditure reaches the limits ofthe system.



The 2005 Economic Survey also contributed to improving theinternational community’s confidence in Korea at a crucial post-crisis time.At the EDRC plenary meeting Korea actively outlined how rapidlyeconomic recovery was taking place thanks to structural reform policies.The result has been a clear improvement in member countries’ faith in oureconomy.

The whole Economic Survey peer review process, which 20 countriesgenerally undergo each year, provides opportunities for capacity-buildingthrough a mutual learning process in which best practices are exchanged.Korea has learned a great deal from member countries’ know-how andexperience in macroeconomic and structural reform policies; so much so,indeed, that it has, to a great extent, replaced the practice of trial-and-error.

14.4. Policy improvements after joining the OECD

Our focus has, so far, been on the EDRC peer review. Let us now turn toan evaluation of Korea’s economic performance and policy developmentsafter it joined the OECD, in order to demonstrate the effect of all the peerreviews, including Economic Surveys, which Korea has undergone.

Macroeconomic development

Korea’s share of the GDP of the OECD economies increased from 2.9%in 1996 to 3.2% in 2004, while over the same period the ratio of its GDP tothe OECD average rose from 65% to 74%%. Over the past decade theKorean economy has deregulated to the extent that its markets are as open asthose of the most advanced countries. It trade-to-GDP ratio rose from 32%in 1997 to 48% in 2004. Domestic stock held by foreigners increased from15% in 1997 to 40% in 2004. Foreign direct investment (FDI) inflows as aproportion of GDP also increased from 0.3% to 1.2% between 1990 and1997.

Finances

Korea has been appraised as having achieved a level of liberalisationequal to that of advanced countries in terms of both financial and capitaltransactions as well as current invisible operations. An OECD index showsthat liberalisation of the Korean financial sector, which stood at 65% in1997, had risen to 85.1% in 2006, a level comparable to that of advancedcountries, such as Japan and the United Kingdom. Some may expressconcern that excessive inflows of foreign capital in addition to marketliberalisation may imperil macroeconomic stability. But it is much more



reasonable to tackle such concerns by promoting overseas investment,opening the foreign exchange market further, and strengthening financialmarket surveillance systems.

Corporate governance

There was a time when corporate governance in Korea was neithertransparent nor efficient. However, by drawing on OECD recommendationsand Principles of Corporate Governance, our country has made considerableprogress. We have, for example, strengthened the rights of minorityshareholders and made boards of directors more accountable, whileintroducing measures to improve disclosure and transparency. It is thisauthor’s sentiment that Korea has now established institutionally fair andtransparent corporate governance practices that are comparable to those ofadvanced countries.

The labour market

Since its accession to the OECD in 1996, Korea has continuouslydevoted itself to reforming its labour laws in line with internationallyaccepted standards. Although it has registered a great deal of progress inmany areas, it must address some remaining issues in order to enhance thelabour market’s flexibility and strengthen employment protection fornon-regular workers.

14.5. Participation in the peer review process as a non-member

As emphasised above, Asian countries need to participate more activelyin OECD programmes. This does not mean that they must join the OECD inthe near future. The point is that, regardless of their feelings about actuallyjoining the OECD, they may take part in its activities as a non-member anddraw great benefit. As we have argued, the OECD peer review process iseffective in stimulating economic growth and upgrading the economicsystems of developing countries. At the same time, the OECD addressesmany issues of interest to developing countries, such as development,official development assistance, trade, and investment. Korea was an activeparticipant in OECD outreach programmes, taking part in EDRC meetingseven before it joined the OECD.

A non-member country’s participation in peer reviews does, of course,require that it should co-operate with examiners and the secretariat by,among other things, making documents and data available, responding toquestions and requests for self-assessment, facilitating contacts, and hosting



on-site visits. However, it should be emphasised that those duties arenothing compared to the invaluable benefits of making a country’sgovernance systems more transparent and efficient.

14.6. Conclusion

In conclusion let us reiterate that if Asian countries wish to make theireconomic systems more efficient and competitive in the globalisedeconomy, they should strengthen co-operative ventures with the OECD.Today is perhaps a particularly good time to seize the opportunity to do so:the OECD is currently putting much effort into expanding its outreachprogrammes. For example, the EDRC proposed the Indonesian governmenta regional economic seminar – in effect, a simpler type of economic survey.The Indonesian government should take advantage of this specialopportunity. International credit rating agencies evaluate sovereign ratingson the basis of factors like the degree to which an economy ismarket-oriented and transparent from an international point of view, theeffectiveness of its industry, labour flexibility, and economic growthprospects. Participation in OECD programmes can have a positive effect onthese factors, resulting in a clear improvement of sovereign ratings.

There are, of course, vehicles for financial co-operation through theASEAN+3 channel. They include the Chiang Mai and Asia Bond MarketInitiatives, economic surveillance through the Economic Review and PolicyDialogue, and the ASEAN+3 Research Group. Successful development ofthese vehicles inevitably requires further strengthening of the peer reviewprocess. In this respect, it is worth noting that participating in OECD peerreview programmes can also bring political benefits, enabling governmentsto provide their citizens with grounds for hope that their economy will growin a sustainable manner, eventually becoming a developed economy. Andultimately, peer reviews can also help when applying to join the OECD inthe future.

ANNEXES – 259


Annexes

ANNEX A. THE OECD PEER REVIEW MECHANISM: CONCEPT AND FUNCTION – 261


Annex A. The OECD Peer Review Mechanism:Concept and Function*

A.1. Introduction

This annex examines the practice of peer review and the related effect ofpeer pressure in the context of international organisations, particularly theOrganisation for Economic Co-operation and Development. It outlines themain features of these two concepts and attempts to establish a model basedon the different peer review mechanisms used at OECD. While there areother documents available that list the peer reviews of the OECD,1 thischapter will provide an analysis of the practice.2

A.2. The concept of peer review

The term “peer review” in the present context has not been rigorouslydefined. However, over the years, the expression has assumed a specificmeaning in the practice of international organisations.

Peer review can be described as the systematic examination andassessment of the performance of a State by other States,3 with the ultimate

* This annex was distributed at the OECD Southeast Asia Regional Forum in2007 as background material to the presentation of Nicola Bonucci,Director, the Directorate for Legal Affairs. This annex was prepared byFabrizio Pagani with the assistance of colleagues of the Directorate forLegal Affairs and has been updated by Ursula Wellen in December 2006. Itbenefited from the contributions of several Services and Directorates, andparticularly of the Centre for Co-operation with Non-members, theEconomics Department, the Development Co-operation Directorate, theEnvironment Directorate, and the Public Affairs and CommunicationsDirectorate. It is released as an unclassified document on the responsibilityof the Secretary-General of the OECD, to bring information on this subjectto the attention of a wider audience.

262 – ANNEX A. THE OECD PEER REVIEW MECHANISM: CONCEPT AND FUNCTION


goal of helping the reviewed State improve its policy making, adopt bestpractices, and comply with established standards and principles. Theexamination is conducted on a non-adversarial basis, and it relies heavily onmutual trust among the States involved in the review, as well as their sharedconfidence in the process. When peer review is undertaken in the frameworkof an international organisation – as is usually the case – the Secretariat ofthe organisation also plays an important role in supporting and stimulatingthe process. With these elements in place, peer review tends to create,through this reciprocal evaluation process, a system of mutualaccountability.

An individual country peer review could relate to economics,governance, education, health, environment, energy or other policies andpractices. Within one or more of those subject areas, a State may beexamined against a wide range of standards and criteria, such as conformitywith policy guidelines, or implementation of legally binding principles. Peerreview can also be carried out thematically,4 where several countries areexamined at the same time with respect to a particular theme. Peer reviewwith regard to an individual State or thematically typically is carried out ona regular basis, with each review exercise resulting in a report that assessesaccomplishments, spells out shortfalls and makes recommendations.

Other mechanisms for monitoring and ensuring compliance withinternationally agreed policies and norms5 may be distinguished from peerreview, as follows:

• Judicial proceedings: unlike judicial proceedings, the finaloutcome of peer review is not a binding act or a legal judgementby a superior body. In practice, peer review may play some ofthe role of a dispute settlement mechanism, by encouragingdialogue among States that helps to clarify their positions andinterests. However, it is not intended to serve as a procedure forresolving differences and peer review never implies a punitivedecision or sanctions.

• Fact-finding missions: independent bodies, such as commissionsof experts from international organisations, carry out on-sitefact-finding missions exclusively to investigate specific eventsor to establish facts. Peer review, on the other hand, is notalways conducted on-site, and it generally goes beyondfact-finding to include an assessment of the performance of theState. Fact – finding can be a part of the peer – review process.

• Reporting and data collection: there are several systems in placefor periodic reporting by States to independent bodies, who then



analyse the submitted reports.6 By contrast, peer review ischaracterised by dialogue and interactive investigation, whichcan comprise the recourse to questionnaires, and it usuallyinvolves no formal reporting by the examined State.

A.3. A related concept: peer pressure

The effectiveness of peer review relies on the influence and persuasionexercised by the peers during the process. This effect is known as “peerpressure”.7 The peer review process can give rise to peer pressure through,for example: (i) a mix of formal recommendations and informal dialogue bythe peer countries; (ii) public scrutiny, comparisons, and, in some cases,even ranking among countries; and (iii) the impact of all the above ondomestic public opinion, national administrations and policy makers. Theimpact will be greatest when the outcome of the peer review is madeavailable to the public, as is usually the case at the OECD. When the press isactively engaged with the story, peer pressure is most effective. Publicscrutiny often arises from media involvement.

Peer pressure does not take the form of legally binding acts, as sanctionsor other enforcement mechanisms. Instead, it is a means of soft persuasionwhich can become an important driving force to stimulate the State tochange, achieve goals and meet standards.

Peer pressure is particularly effective when it is possible to provide bothqualitative and quantitative assessments of performance. Examples ofqualitative assessments are the peer reviews undertaken in monitoringcompliance with the OECD Convention on Combating Bribery of ForeignPublic Officials in International Business Transactions. The quantitativeassessment might take the form of a ranking of countries according to theirperformance, and the drawing of real scoreboards reflecting such rankings.An example is the OECD Jobs Strategy, a programme which sets outprinciples and benchmarks, carries out quantitative analysis and rankscountry according to their performances in reducingunemployment.8.Another example, outside the OECD, of a very effectivescoreboard is the Internal Market Scoreboard, maintained by the EuropeanCommission, which ranks the EU members States according to theirperformance in the completion of the internal market.9 A variation of thissystem is the “naming and shaming” technique, which singles out poorperformers. However, these methods are appropriate and produce positiveresults only when the “rules of the game” are clear and the countries acceptthem. In other cases, this type of approach could risk shifting the exercise



from an open debate to a diplomatic quarrel to gain position on thescoreboard.

A.4. Peer review in international organisations

While peer review as a working method is most closely associated withthe OECD, several other intergovernmental organisations and internationalprogrammes make use of this technique as well.

Within UN bodies and specialised agencies, States use peer review tomonitor and assess national policies in various sectors, from environment10

to investment.11 The IMF Country Surveillance mechanism also has someaspects in common with peer review.12

Peer review has also been developed within the World TradeOrganisation under the Trade Policy Review Mechanism.13 The WTOsystem monitors trade policy and practice in the member States. Adesignated WTO body then meets to review the policy statements presentedby the member under review and a report prepared by the Secretariat. Thisexamination is led by two reviewing countries. The procedure concludeswith the Final Remarks of the Chair, which are published together with thepolicy statement of the country under review, the report of the Secretariatand the minutes of the meeting.

In the European Union framework, peer review is used in several areas.For example, the DG Employment and Social Affairs of the EuropeanCommission has developed peer review for national labour market policiesto identify good practices and assess their transferability.

A.5. Peer review within the OECD

There is no other international organisation in which the practice of peerreview has been so extensively developed as the OECD, where it has beenfacilitated by the homogeneous membership and the high degree of trustshared among the member countries. The OECD has used this method sinceits creation and peer review has, over the years, characterised the work ofthe Organisation in most of its policy areas.14 It is worth noting, in thisrespect, that accession to the OECD is conditional on carrying out an“accession process” which is largely based on peer reviews by a number ofOECD bodies. In the course and by way of this process, the applicantcountry is not only properly evaluated, but will also become familiar withthis particular working method.



Within the Organisation, peer review is carried out in severalsubstantive areas and there is no standardised peer review mechanism.However, all peer reviews contain the following structural elements, whichwill be described further below:15

• a basis for proceeding;

• an agreed set of principles, standards and criteria against whichthe country performance is to be reviewed;

• designated actors to carry out the peer review; and

• a set of procedures leading to the final result of the peer review.

The basis

Peer review within the OECD may proceed on the following bases:

• Decision by or request to an OECD subsidiary body: subsidiarybodies of the Organisation can decide to undertake peer reviewswhich are within their scope of activities. Subsidiary bodies mayalso carry out one-time peer review exercises at the request ofthe country to be reviewed.

• Council/Ministerial Council: for far-reaching programmes ofreview, a decision at Council level is sometimes necessary and,in certain cases, the decision follows directly from theMinisterial Council Meeting. The competent subsidiary bodiesthen implement the programmes. The review on regulatoryreform, for instance, which is based on a 1997 Ministerialrequest16 and successive Council decisions, is carried out by anumber of subsidiary bodies including the Ad HocMultidisciplinary Group on Regulatory Reform, the PublicManagement Committee and its Regulatory Management andReform Working Party.

• International norms: provisions in treaties or in other legallybinding instruments can be the basis for peer review mandates.One of the first systems of mutual review was established by theOECD Codes of Liberalisation of Capital Movement andCurrent Invisible Operations, which have a binding status on allOECD members.17. Another example is the OECD Conventionon Combating Bribery of Foreign Public Officials inInternational Business Transactions, which provides, in itsArticle 12, that “Parties shall co-operate in carrying out aprogramme of systematic follow-up to monitor and promote the



full implementation of this Convention.” This provision hasbeen the basis for the establishment of a rigorous process ofmultilateral surveillance, including peer review, to foster theeffectiveness of the Convention and its related instruments.

Council retains control over the development of peer reviewprogrammes through its examination of the proposed Programme of Workand Budget of the Organisation and regular evaluation of Committee work.

The principles, criteria and standards

The performance of the reviewed State can be assessed againstprinciples, criteria and standards which widely differ in character and scope.These may include:

• Policy recommendations and guidelines: the assessment of theperformance of a country in its implementation of policyrecommendations and guidelines is the most common form ofpeer review. This peer review can also include an examinationof the consistency and coherence with respect to the country’sown policies. It is carried out in many of the Organisation’sactivity areas, including economic policy, education,environment, energy, regulatory reform and developmentassistance. For example, in the peer reviews, or surveys, carriedout by the Economic and Development Review Committee,country performance is assessed in relation to broad economicpolicy principles and best practices that have been developedover the years, the policy orientations of the OECD GrowthProject, as well as specific guidelines such as those contained inthe OECD Jobs Strategy. Similarly, peer reviews carried out inconnection with the regulatory reform process draw on anumber of policy recommendations agreed at the ministeriallevel. The Education Committee also undertakes peermonitoring and assessment of countries on general policyguidelines. The DAC Peer Reviews take into account principlesagreed in development co-operation, such as guidelines(e.g. poverty reduction, conflict prevention) or emerging themes(e.g. policy coherence, harmonisation of donor procedures), inorder to assess the performance of the donor under review.

• Specific indicators and benchmarks: indicators and benchmarksprovide specific and often numerical targets to achieve, and theyare more susceptible than policy guidelines to being assessedaccording to quantitative measures. Indicators and benchmarks



are used, for instance, in the environmental performance review,and in the regulatory reform and development assistancereviews.18

• Legally binding principles: peer review can also be amechanism to monitor compliance with international norms. Forexample, the OECD Committee on Capital Movements andInvisible Transaction assesses, through a peer reviewmechanism, the performance of each member in the applicationof the Codes of Liberalisation and examine its reservations orderogation, in order to progressively limit their scope.19 In theframework of the OECD Convention on Combating Bribery ofForeign Public Officials in International Business Transactions,the Working Group on Bribery assesses the integration of theprinciples of the Convention into the national legislation of theStates, party, and it also evaluates their implementation andenforcement.20 This review creates a sophisticated mechanismfor monitoring compliance with the Convention, and it is widelyregarded as an interesting model for monitoring and improvingcompliance with other international legal obligations. Finally,peer review can also be conducted to assess a country’scompliance with rules contained in its own national legislationor in non-OECD international instruments to which the countryhas adhered.

Within the same peer review, the assessment can be conducted againstall these different measures. For instance, in the Working Party onEnvironmental Performance, the environmental performance of thecountries is reviewed against objectives set out in policy guidelines – suchas the OECD Environmental Strategy for the First Decade of the 21st

Century – and it is also reviewed against benchmarks, national legislationand regulations as well as international conventions.

When a peer review programme reaches a second round of reviews, it isquite common to refer to the conclusions adopted in the previous review ofthe country. The recommendations and the outstanding issues noted in theearlier report become a very important part of the measures against which toassess the progress of the country, and to highlight trends and fluctuations.This process allows also the creation of a shared knowledge base benefitingto all countries via the identification of best practices or policies that work.



The actors

Peer review is the combination of the activity of several actors: thecollective body within which the review is undertaken; the reviewedcountry; the examiner countries; and the Organisation Secretariat:

• The collective body: peer reviews are undertaken in theframework of the activities of a subsidiary body of theOrganisation, such as a Committee or a Working Party. Thefrequency of the reviews depends on the programme of work ofthe body, and it can range from the 6-7 year cycle for theEnvironmental Performance Reviews to the 18 month cycle ofthe Economic and Development Review Committee.

• The reviewed country: usually all countries which are membersof the body are subject to the peer review. Certain peer reviewsare considered an obligation of membership. Moreover, in somecases, officials of the country may have an interest in peerreview, as a means of stimulating reform in their nationalpolicies and practices. Participation implies the duty toco-operate with the examiners and the Secretariat by, amongother things: making documents and data available, respondingto questions and requests for self-assessment, facilitatingcontacts and hosting on-site visits. The individuals responsiblefor participating on behalf of the reviewed country could includecivil servants from ministries and agencies and at differentlevels of government. On several occasions, OECD has alsoreviewed the performances of non-member countries, at theirrequest or with their agreement.21 On occasion, the reviewedcountry contributes to the financing of the review.

• The examiner countries: in the OECD, the examiner role isusually carried out by officials from other countries who areactive in the relevant policy field. Generally, the choice ofexaminers is based on a system of rotation among the memberStates, although the particular knowledge of a country relevantto the review may be taken into account. The role of theexaminers is to represent the collective body in the early stagesof the process and to provide guidance in the collective debateitself. Hence their task includes the examination ofdocumentation, participation in discussions with the reviewedcountry and the Secretariat, and a lead speaker role in the debatein the collective body. In some cases, the examiners alsoparticipate in missions to the country. While individualexaminers generally carry out the reviews in their official



capacity as representatives of their State, certain reviews requirethe participation of examiners in their personal capacity. Ineither case, however, examiners have the duty to be objectiveand fair, and free from any influence of national interest thatwould undermine the credibility of the peer review mechanism.

• The Secretariat: the Organisation Secretariat has the role ofsupporting the whole review process by producingdocumentation and analysis, organising meetings and missions,stimulating discussion, upholding quality standards, andmaintaining continuity as the keeper of the historical memory ofthe process. The independence, transparency, accuracy and theanalytic quality of work of the Secretariat are essential to theeffectiveness of the peer review process. The intensity of theinteraction between the examiners and the Secretariat and thedegree of involvement of the examiners vary widely. In certaincases, the Secretariat works very closely with the examiners,and the division of labour between them is not always welldefined. However, normally the most labour-intensive part ofthe work is carried out by the Secretariat, which may also havethe most expertise in the substantive area of the review.

The procedures

The procedures of each peer review are outlined in documents adoptedby the responsible subsidiary body. The level of procedural detail providedcan vary widely, with certain reviews relying more on well-establishedpractice than on formally adopted rules of procedure.

Although each peer review has its own procedure, it is possible toidentify a common pattern, consisting of three phases:

• The preparatory phase: the first phase of the review oftenconsists of background analysis and of some form ofself-evaluation by the country under review. This phase includeswork on documentation and data as well as a questionnaireprepared by the Secretariat. The questionnaire, which can be asophisticated instrument, is sent to the country for responses bythe competent authorities or as an agenda for a dialogue in thenext phase.

• The consultation phase: the examiners and the Secretariatconduct the consultation with a division of responsibility whichdepends very much on the practice of the body and the topicunder review. During this phase, the Secretariat and the



examiners maintain close contact with the competent authoritiesof the reviewed country, and in a number of cases, they carryout on-site visits (see below). The examiners and the Secretariatare also free to consult with interest groups, civil society andacademics. At the end of this phase, the Secretariat prepares adraft of the final report, which usually follows a standardisedmodel comprising an analytical section, where the countryperformance is examined in detail and individual concerns areexpressed, and an evaluation or summary section setting forththe conclusions and recommendations. The Secretariat, in mostpeer review processes, but not always, shares the report in draftwith the examiners and with the reviewed country and maymake adjustments it considers justified before the draft issubmitted to the members of the body responsible for thereview.

• The assessment phase: the draft report is discussed in theplenary meeting of the body responsible for the review. Theexaminers lead the discussion, but the whole body is encouragedto participate extensively. Following discussions, and in somecases negotiations, among the members of the body, includingthe reviewed State, the final report is adopted, or just noted, bythe whole body. Generally, approval of the final report is byconsensus, unless the procedures of the particular peer reviewspecify otherwise. In some cases, the procedures may call forthe final report to state the differences among the participants. Insome cases, non-governmental organisations also have theopportunity to influence the discussion by submitting papers anddocuments. As already mentioned, the final report andparticularly its recommendations form an important basis forfollow-up monitoring of the performance of the State and,ultimately, for a subsequent peer review. Often, the final reportis followed by a press release, which summarises the mainissues for the media, and press events or dissemination seminarsare organised to publicise the findings of the review.

One of the procedures used more and more frequently during both thepreparatory and the consultation phase of OECD peer reviews are on sitevisits. Primarily, OECD member countries receive on site visits, but – incases where on site missions form part of the peer review process and therespective peer review process also includes selected non-membereconomies – an on site visit will also take place in the respectivenon-member economy.



A number of peer reviews include one or two on site visits; if there ismore than one visit, the first visit is often a shorter exploratory mission witha small team of one or more Secretariat staff members. The main mission ismostly scheduled for about one week; the mission team always includesSecretariat staff members, in a number of cases also external independentexperts and/or peers from other OECD member administrations.

All on site visits usually involve an intensive meeting schedule. Thecounterparts for such meetings are, in the first instance, obviously officialsfrom the respective ministries and other government or public officials(e.g. employees of relevant regulatory agencies). But in many cases,meetings are also held with representatives from areas outside the publicsector, such as industry or other parts of the private sector, NGOs, academicorganisations or research institutions. Costs for the on site visits varywidely, depending inter alia on the scope and content of the review, theduration of the mission, number of parties travelling, travel costs andpreparation time involved. In some instances, these costs are recovered fromthe respective country that has been reviewed by way of voluntarycontributions. Annex A includes further details on the subject of on sitevisits.

A.6. The functions of peer review

Peer review can be used in a broad range of areas, including those notcovered by OECD peer review exercises – for example, human rights anddemocratic governance. In each of these fields, peer review, directly orindirectly, can serve the following purposes:

• Policy dialogue: during the peer review process, countriessystematically exchange information, attitudes and views onpolicy decisions and their application. This dialogue can be thebasis for further co-operation, through, for example, theadoption of new policy guidelines, recommendations or even thenegotiation of legal undertakings.22

• Transparency: the reviewed country has the chance, in thecourse of a peer review, to present and clarify national rules,practices and procedures and explain their rationale. As a result,the Secretariat is usually able to develop documentation and, incertain cases, a database which remains at the disposal of themember countries, and which often is also made available to thepublic and published on the Organisation web site. In the case ofthe OECD Convention on Combating Bribery of Foreign PublicOfficials in International Business Transactions, for example, all



the country implementation reports adopted at the end of thepeer review process are published on the OECD web site.23 Thecombination of these two levels of enhanced transparency – toward peer countries and toward public opinion – contributesto the effectiveness of the peer review and the related peerpressure.

• Capacity building: peer review is a mutual learning process inwhich best practices are exchanged. The process can thereforeserve as an important capacity building instrument – not onlyfor the country under review, but also for countries participatingin the process as examiners, or simply as members of theresponsible collective body. For example, certain methodologiescommonly used in peer review – such as benchmarking orrecourse to quantitative indicators in assessing compliance withpolicies – are unfamiliar to some officials and even to somepublic administrations before they participate in the peer review,and the exercise therefore represents an important learningopportunity.

• Compliance: an important function of peer review is to monitorand enhance compliance by countries with internationallyagreed policies, standards, and principles. However, unlike atraditional legal enforcement mechanism, peer review works asa sort of “soft enforcement” system,24 resulting in non-coercivefinal reports and recommendations rather than binding coerciveacts, such as sanctions. In many contexts, the soft law nature ofpeer review can prove better suited to encouraging andenhancing compliance than a traditional enforcementmechanism. For example, unlike a legal enforcement body,examiners in a peer review have the flexibility to take intoaccount a country’s policy objectives, and to look at itsperformance in a historical and political context. Peer reviewcan therefore assess and encourage trends toward complianceeven among relatively poorly performing countries, whilenoting negative trends in countries that may presently have ahigher performance record. Peer review can also tend toenhance compliance by helping to clarify differences in policypositions among countries, thereby leading to the resolution ofthose differences.



A.7. Conclusion: when can peer review and peer pressure be effective?

The effectiveness of peer review depends upon the combination of anumber of factors, which may be summarised as follows:

• Value sharing: one precondition for an effective peer review isconvergence among the participating countries on the standardsor criteria against which to evaluate performance. A strongcommon understanding on these will prevent uncertainty orbacktracking during the process.

• Adequate level of commitment: peer review can functionproperly only if there is an adequate level of commitment by theparticipating countries in terms of both human and financialresources. Thus, the participating countries must not only placeadequate financial means at the disposal of the Secretariat; theymust also be fully engaged in the process at different times asexaminers, as active members of the collective body, and assubject of the examination.

• Mutual trust: since peer review is, by its nature, a co-operative,non-adversarial process, mutual trust is an important basis for itssuccess. While the peer review process itself can contribute toconfidence building, a large degree of trust and value sharingamong the participants should be present from the beginning tofacilitate, among other things, the disclosure of data,information and documentation which are essential to theprocess.25 The mutual trust requirement would normally call forclosed discussions amongst members. However, this needs to bebalanced with the necessary transparency of the process.Consultations with civil society and other relevant stakeholdersas part of the peer review process are on means of ensuring suchbalance.

• Credibility: the credibility of the peer review process is essentialto its effectiveness, and to its added value in comparison withgovernmental reports or consultants’ certifications. There is astrong linkage between the credibility of the process and itscapacity of influence. To assure this credibility, the approachthat the examiners – with the help of the Secretariat – take in thereview must be objective, fair and consistent. In the same way,the Secretariat must guarantee independence, transparency andquality of work. Credibility can be undermined if the process isflawed by such factors as unqualified examiners, bias stemmingfrom national interests, or inadequate standards or criteria



against which to undertake the review. However, the main threatto the credibility of the process is the possibility of attempts bythe reviewed State to unduly influence the final outcome. Theinvolvement of the reviewed State in the process and itsownership of the outcome of the peer review is the bestguarantee that it will ultimately endorse the final report andimplement its recommendations. However the State’sinvolvement should not go so far as to endanger the fairness andthe objectivity of the review. For example, the State underreview should not be permitted to veto the adoption of all or partof the final report.

With each of these factors in place, peer review can serve as a stimulusto incremental change and improvement. Through the accompanying effectof peer pressure – including both persuasion by other countries and thestimulus of domestic public opinion – peer review can create a catalyst forperformance enhancement which can be far-reaching and open-ended.

Notes

1. For a general list of the peer review mechanisms within the OECD, seeExecutive Committee in Special Session, Monitoring and SurveillanceActivities at the OECD and Co-operation with Other InternationalOrganisations (Note by the Secretary – General), 27 April 1999,(ECSS(99)3. On peer review and peer pressure, especially in the area ofeconomic policy, see also Peer Pressure as Part of Surveillance byInternational Institutions, Discussion led by Mr. Niels Thygesen,Chairman, Economic and Development Review Committee, 4 June 2002(www.oecd.org/pdf/M00031000/M00031293.pdf). For an analytical paperon the use of peer review in a subject area, see Joint Group on Trade andCompetition, Peer Review: Merits and Approaches in a Trade andCompetition Context, 6 June 2002,COM/TD/DAFFE/COMP(2002)4/FINAL.

2. Literature on peer review is scarce. Peer review is sometimes addressed,but always marginally, in the context of the debate on “compliance”, andparticularly within the scholarly dispute “enforcement vs. co-operation”,which opposes the managerial school of international relations to the



institutionalists. See, for example, George W. Downs, David M. Rockeand Peter N. Barsoom, “Is the Good News about Compliance Good Newsabout Co-operation?”, International Organization, vol. 50, no. 3, Summer1996, pp. 379 ff., or George W. Downs, “Enforcement and the Evolutionof Co-operation”, Michigan Journal of International Law, vol. 19, no. 2,1988, pp. 319 ff. For a general introduction to the mechanisms of followup and compliance in international organisations, see N. Blokker & S.Muller (eds.), Towards More Effective Supervision by InternationalOrganizations. Essays in Honour of Henry G. Schermers, Vol. I,Dordrecht / Boston / London, 1994, and more recently, H. Ruiz Fabri,L.-A. Sicilianos, J. M. Sorel (eds.), L’effectivité des OrganisationsInternationales: Mécanismes de suivi et de contrôle, Athènes / Paris,2000.

3. In some contexts, entities other than States participate in peer reviewprocesses. An OECD example is certain reviews of the EuropeanCommunity in the economic, trade and development assistance policies.

4. See, for instance, the thematic reviews in the sector of education. Oneexample is the thematic review on adult learning, see EducationCommittee, Thematic Review on Adult Learning: Proposed Terms ofReference, 19 July 1999, DELSA/ED/WD(99)9/REV1.

5. On this subject, with a particular emphasis on legal obligations, seeA. Chayes, The New Sovereignty. Compliance with InternationalRegulatory Agreements, Cambridge Mass., 1995.

6. See, for instance, the International Labor Organisation review andassessment process. For a general review of these mechanism see Chayes,op. cit., pp. 154 ff.

7. The term peer pressure was used by the social sciences, and particularlyin pedagogy and behavioral studies.

8. See The OECD Jobs Strategy: Progress Report on Implementation ofCountry-Specific Recommendations, OECD Economics DepartmentWorking Paper 196 and most recently Boosting Jobs and Incomes: Policylessons from the Reassessment of the OECD Jobs Strategy, Backgroundpaper prepared by the OECD Secretariat for the Meeting of G8Employment and Labour Ministers, Moscow, 9-10 October 2006.

9. See, for instance, Internal Market Scoreboard, May 2002, n. 10.

10. See, for example, the Environmental Performance Reviews Programcarried out by the UN Economic Commission for Europe, initiated as ajoint undertaking with the OECD Environment Directorate. Severalactivities within UNEP follow peer review mechanisms.



11. Within UNCTAD, there are programmes which submit the investmentpolicies of developing countries to peer review.

12. For a brief description of the IMF Country Surveillance mechanism, seeIMF Annual Report 2001.

13. A more extensive description and evaluation of the Trade Policy ReviewMechanism is contained in Joint Group on Trade and Competition, PeerReview: Merits and Approaches in a Trade and Competition Context, 6June 2002, COM/TD/DAFFE/COMP(2002)4/FINAL. See also SamLaird, “The WTO’s Trade Policy Review Mechanism – From Throughthe Looking Glass”, The World Economy, vol. 22, n. 6, August 1999, pp.741 ff.

14. Officials involved in peer review can be from any level of government,central, regional, local.

15. Executive Committee in Special Session, Monitoring and SurveillanceActivities at the OECD and Co-operation with Other InternationalOrganisations (Note by the Secretary – General), 27 April 1999,(ECSS(99)3).

16. See Meeting of the Council at Ministerial Level, Communiqué, Paris, 26–27 May 1997, SG/COM/NEWS(97)45.

17. See OECD, OECD Codes of Liberalisation of Capital Movements andCurrent Invisible Operations – User’s Guide, Paris, 2003.

18. In development assistance, see the Millennium Development Goals,www.oecd.org/pdf/M00017000/M00017310.pdf.

19. For a detailed description of the mechanism, see OECD, OECD Codes ofLiberalisation of Capital Movements and Current Invisible Operations – User’s Guide, Paris, 2003.

20. See Working Group on Bribery in International Business Transactions, AProcedure of Self – and Mutual Evaluation of Implementation of theConvention and the Revised Recommendation,DAFFE/IME/BR(98)8/REV1.

21. See Executive Committee in Special Session, Monitoring andSurveillance Activities at the OECD and Co-operation with OtherInternational Organisations (Note by the Secretary – General),27 April 1999, ECSS(99)3. An interesting case of peer review specificallydesigned for non-members is the mechanism for their adherence to theOECD Declaration on the International Investment and MultinationalEnterprises. These reviews are divided into three parts. The first consistsin a general assessment of the country’s actual performance in attractingforeign direct investments (FDI). The second involves a review of the



country’s regulatory framework for FDI and domestic businessoperations. The last part consists of an examination of the country’sproposed exceptions to the principle of national treatment as well as of thesteps envisaged to promote the OECD Guidelines for MultinationalEnterprises. This process may lead to the formulation of specificrecommendations to the country on how to further promote the objectivesof the Declaration.

22. On peer review as a tool for convergence and convergence vs.negotiations, see Joint Group on Trade and Competition, Peer Review:Merits and Approaches in a Trade and Competition Context, 6 June 2002,COM/TD/DAFFE/COMP(2002)4/FINAL.

23. Seewww.oecd.org/EN/documents/0,,EN-documents-88-3-no-3-no-88,00.html.

24. On the notion of soft law see the relevant entry in J. Salmon (ed.),Dictionnaire de droit international public, Bruxelles, 2001.

25. In this regard, peer review is an instrument that appears difficult to applyin the context of security and defence.

278 – ANNEX B. PEER REVIEW: EXAMPLE OF ECONOMIC AND DEVELOPMENT REVIEW COMMITTEE


Annex B. Peer Review: Example of Economic andDevelopment Review Committee* 1

B.1. Introduction

In carrying out its mandate in practice, the EDRC has separated,although inter-related, responsibilities:

• to meet and examine the economic developments and policies ofeach member country,2 with the treatment of different countriesto be equitable;

• to review and modify as necessary the draft Survey of eachmember country and approve the final version beforepublication;

• to carry out multilateral surveillance and report whereappropriate to other bodies of the Organisation;

• to consider reviews of non-member economies which itdetermines should be reviewed, although the responsibility forthe publication of such reviews rests with the Secretariat.

The Secretariat prepares a draft Survey for the EDRC for each countrybeing examined. This confidential draft is the responsibility of theSecretary-General. Following the Committee discussions, the report is thenfinalised and the Survey is published on the responsibility of the Committeeitself and as such represents the consensus of all OECD member countries.

* This annex was distributed at the OECD Southeast Asia Regional Forum in2007 as background material to the presentation of Val Koromzay, a formerDirector, Country Studies Branch, Economics Department, OECD.

ANNEX B. PEER REVIEW: EXAMPLE OF ECONOMIC AND DEVELOPMENT REVIEW COMMITTEE – 279


B.2. Planning of Surveys

Country examinations need to take place on a regular cycle in order tocarry out proper surveillance and the maximum period between reviewsshould never, barring exceptional circumstances, exceed 24 months. Ashorter interval should generally be aimed for.

To help prepare the draft Survey, the OECD Secretariat will visit themember country to hold talks with senior officials, experts, and keyeconomic players. There will normally be two missions: (i) a “structuralmission” fairly early on in the preparation process which endeavours toensure that all the necessary information has been garnered and tries toensure some common ground on the analysis of the economic problemsfacing the country; and (ii) a “policy mission” that focuses on key policyissues and discusses the Secretariat’s initial assessment with the authorities.

For the structural mission, the Secretariat will draft a written“questionnaire” to assist the authorities in preparing for these meetings.Wherever possible, the authorities should provide written responses andrelevant background material to the Secretariat before the start of themission. The quality of the Secretariat’s draft Survey is heavily dependenton the co-operation of the authorities in submitting all the relevantinformation in a timely manner.

For the policy mission, the Secretariat will provide a much shorterquestionnaire focusing on the key policy issues. The Secretariat will have aset of preliminary recommendations and would normally find it useful tohave a meeting at ministerial level (perhaps several), in particular to discusshow key issues can most usefully be presented.

B.3. Documentation and preparation for the examination

The Secretariat will prepare the draft Survey which will be madeavailable to the country under examination at the same time as all othermember countries.

The Survey should aim to provide maximum value added to the countrybeing examined, other member countries and the general public, by:

• promoting better understanding of the country’s economicsituation and key challenges;

• enriching the economic policy debate, domestically andinternationally; and

280 – ANNEX B. PEER REVIEW: EXAMPLE OF ECONOMIC AND DEVELOPMENT REVIEW COMMITTEE


• pointing towards ways of achieving better economicperformance.

The Survey should address both macroeconomic and structural aspectsof economic performance, although the balance between macroeconomicand structural issues may vary from country to country and from year toyear, depending on the current situation and key policy challenges. Theinteractions between the macroeconomic and structural issues are importantand should be addressed in appropriate depth especially insofar as theyaffect overall economic performance.

The Survey will generally follow a structure of:

• Executive summary; this will highlight the key messages andpolicy recommendations in the Survey.

• Assessment and Recommendations.

• Key challenges chapter which identifies, assesses and evaluateskey country-specific issues and the interdependence amongthem in the context of overall economic performance and itsresilience in the face of external and internal disturbances. Themaintenance of a sound framework for fiscal and monetarypolicies will normally be reviewed as one such issue. Other keyissues will vary across countries and time and the chapter wouldprovide a diagnosis of these challenges with detailed analysisand recommendations taken up in subsequent chapters.

• Chapters addressing the salient challenges identified in the KeyChallenges chapter (typically one challenge per chapter),focusing on the policy requirements for addressing them.

The new model is that one of the Key Challenges is to be given a morein-depth treatment than the others. Consultations between the Secretariat andthe examined country will seek to identify which challenge to treat in thisway. It will often be useful to focus the work on areas where OECD’seconomic committees have already discussed cross-country analyticalpapers dealing with key economic problems or where it is possible to drawon the expertise of other OECD directorates and committees.

Throughout the Survey, the focus should be on what the authorities cando to improve economic performance. The Survey should concentrate onthose aspects of the policy and institutional framework which are mostimportant for economic performance, even if these aspects are not on thecurrent reform agenda of the authorities.

ANNEX B. PEER REVIEW: EXAMPLE OF ECONOMIC AND DEVELOPMENT REVIEW COMMITTEE – 281


Policy recommendations should be sharply focused, clearly articulatedand constructive and should address the key challenges to economic policy.If second-best solutions are recommended, they should be clearly identifiedas such.

The Survey should explicitly follow up on recommendations made bythe Committee in previous years (especially on structural matters) andoutline the actions taken if any, or propose any changes to the earlierrecommendations that would be appropriate for the Committee to adopt.This follow-up is now typically covered in an Annex on Progress inStructural Reform.

A Questions for Discussion Note is prepared for each examination bythe Secretariat in close consultation with the Chair and the two examiningcountries. It is designed to play a pivotal role in the examination process. Itcould also help to structure the interventions of the examining countries and,more generally, the whole examination as well as the Chair’s summing up(see below).

B.4. The examination itself

The examination has several objectives:

• to assess the key economic challenges and the policies toaddress them so as to provide guidance to the Secretariat forredrafting the Survey to reflect the Committee’s conclusions; inso doing the Committee should establish whether all importanteconomic policy issues have been dealt with in the draft;

• to formulate recommendations on the policies concerned andfollow up on recommendations made in previous Surveys.

If in the Secretariat’s view, economic trouble may be looming, theCommittee expects the Secretariat to be vocal in identifying prospectiveproblems. The membership considers this responsibility to be a fundamentalelement of the surveillance process.

The examination will generally be structured with an opening statementfrom the country under review. After the opening statement the examinationwill normally be organised into two parts: the two part agenda should beagreed by the Chair, the examiners and the Secretariat at the time when thequestions for discussion note is finalised, with some emphasis given to thein-depth chapter and a reasonable balance given to the topics covered ineach session.

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ISBN 978-92-64-03943-8 03 2008 04 1 P

Shaping Policy Reform and Peer Review in Southeast Asia INTEGRATING ECONOMIES AMID DIVERSITY The Southeast Asian region has experienced remarkable economic dynamism in the past few decades. An interesting feature of recent developments in the region, is that in spite of its diversity, several initiatives have been launched towards integration.

The peer review mechanism has been a tried and tested instrument for OECD member states to work together successfully over the past decades. This tool could benefit the Southeast Asian region as it helps identify good practices, establish standards and principles and ultimately improve the performance of participating economies.

This publication examines the possible application of peer reviews to address regional and domestic challenges in Southeast Asia. It is a useful and insightful resource for anybody interested in Southeast Asian economies, regional integration and peer review mechanisms.

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Shaping Policy Reform and Peer Review in Southeast Asia INTEGRATING ECONOMIES AMID DIVERSITY

SOUTHEAST ASIA

POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTRHEAS ASIA


REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM


SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION S




REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA P




POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA

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REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA

REGIONAL INTEGRATION POLICY REFORM SOUTHEAST ASIA REGIONAL INTEGRATION POLICY REFORM SOUTHEAST

SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA

POLICY REFORM SOUTHEAST ASIA REGIONAL INTEGRATION POLICY REFORM SOUT

POLICY REFORM REGIONAL INTEGRATION SOUTHEAST ASIA POLICY REFORM REGIONAL INTEG

SOUTHEAST ASIA REGIONAL INTEGRATION POLICY

REGIONAL INTEGRATION SOUTHEAST ASIA POLICY

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