ECONOMIA

Laos: Power Trumps Reform
Ronald Bruce St John | December 28, 2006

There is broad agreement today that a market economy works well within a Western democratic system, but there is much less consensus over whether it can function effectively in an authoritarian state. The contemporary political economy of the Lao People's Democratic Republic (Lao PDR) provides an excellent case in point. The Lao experience since the Communist takeover in 1975 suggests real limits to a development model that combines single party rule with market economics.

Checkered Economic Reforms

At the end of the Vietnam War, the Communist leadership of the newly formed Lao PDR inherited a bankrupt state. The new regime naturally viewed the suppression of the laissez-faire economy in the former Royal Lao Government zone as a critical step in consolidating its socialist revolution. But the ruling Lao People's Revolutionary Party (LPRP) wisely delayed radical socioeconomic transformation, pursuing gradual change. Economic reforms in the first years of the revolution focused on marketing and distribution, property rights, and agricultural taxation. The Lao PDR had little option but to introduce taxation to replace the subsidies provided earlier by the United States. Nevertheless, the levy of agricultural taxes, without a determined effort to explain their necessity, soured relations with the very peasantry the government claimed to represent.

After three years in power, the Lao government in 1978 suddenly announced an ambitious program of agricultural collectivization, a move precipitated by a decision in Hanoi to accelerate the pace of Vietnamese collectivization. There was some limited rationale for such a policy in southern Vietnam. However, there was no possible justification for its introduction in Laos beyond the ideological conviction of the Communist leadership in the superiority of the socialist mode of production. Opposition to collectivization was widespread, and within slightly more than a year, both Soviet and Vietnamese officials were advising a rethink. In response, the Lao government abruptly suspended the forced creation of agricultural cooperatives in 1979. By 1980, as few as 65 of some 2,800 cooperatives organized after 1978 retained any organizational basis.

When minor reforms introduced after 1980 were ineffective, the LPRP leadership in 1986 launched a new round of economic reforms. The New Economic Mechanism (NEM) called for the decentralization of administrative controls on pricing, production targets, and wages. The one market-one price principle, which abolished virtually all administered prices as well as the multi-tiered exchange rate, was the most far-reaching policy adopted under the rubric of the New Economic Mechanism.

The Lao PDR continued to encourage private holdings in agriculture after 1986. Consequently, private ownership by the early 1990s had become the dominant form of property rights in the agricultural sector. The situation in the industrial sector was somewhat different, but private activities here also expanded with the privatization of state enterprises and the emergence of new private firms. Unfortunately, the laws and regulations necessary to support market institutions and private property rights trailed the implementation of market-oriented reforms. The government didn't pass contract, inheritance, and property laws until mid-1990, and laws covering the settlement of commercial disputes, bankruptcy, and liquidations passed only in 1991.

The financial crisis that hit Thailand in mid-1997 had a serious ripple effect in Laos in 1997-98. Thailand was the principal trading partner and major source of investment in Laos, and the macroeconomic instability the former experienced triggered a sharp depreciation in the Lao kipand a general loss of confidence in the Lao economy. Lax macroeconomic management and weakening domestic reform in Laos aggravated the situation. The Asian financial crisis also exposed a major weakness in the Lao political system. Where the political stability inherent in a one-party state facilitated reform policy in the initial stages of the transition process, it became a hindrance later when more balanced economic development was required.

Macroeconomic conditions improved at the beginning of the current decade, and the Lao economy began a slow recovery in progress today. Even as it regained some control over fiscal policy and followed a tighter monetary policy, however, the Lao PDR remained reluctant to implement needed structural reforms in areas like the state banking system. Instead, interventionist policies continued to prevent free market forces from reaching their full potential, and government policies too often proved counterproductive.

Aid Dependency

Laos has enjoyed a long history of aid dependency since it achieved independence in 1953. From 1968 to 1973, the Royal Lao Government received over $74 million in aid annually, making Lao nationals in the Vientiane-controlled zone among the highest per capita aid recipients in the world. In the same period, guerrilla leaders in the Pathet Lao-controlled zone presided over a primitive economy that received large quantities of commodity assistance from China, the Soviet Union, and North Vietnam. Aid dependency continued unabated after the fighting stopped. The total value of commodity aid received by Laos in 1975-78 was estimated at more than $100 million, with project aid and technical assistance worth an additional $126.5 million.

Ironically, the sources of revenue for the Lao PDR, as early as 1977, mirrored those of previous regimes in that foreign aid accounted for 81% of the total. Some 60% of multilateral aid came from the United Nations with the remaining 40% sourced largely from OPEC financial agencies. The socialist states after 1975 were the primary sources of bilateral aid, with the Soviet Union and its East Bloc allies the dominant contributors. Sweden was the most prominent Western donor with Australia, France, Japan, the Netherlands, and the United Kingdom also contributing aid in the early years of the revolution. The United States donated modest amounts of food aid to Laos in 1977-79, despite the government's socialist orientation.

The Lao PDR remained heavily dependent on foreign aid throughout the early 1980s with external assistance in 1982 estimated to be some 80% of annual revenue. In the first half of the 1980s, the International Monetary Fund (IMF) became the most important multilateral donor, providing both technical and financial assistance. With U.S. law prohibiting all but humanitarian aid, the United States dispatched occasional shipments of food and medicine to Laos, often in support of efforts to recover the remains of U.S. servicemen. Vientiane was thus successful in replacing Washington with Moscow and its socialist allies as primary donors. Nevertheless, it continued to experience difficulty in absorbing aid and achieving the self-generating growth envisioned in successive five-year plans.

Largely due to external events, the Lao aid picture changed dramatically in the second half of the 1980s. The withdrawal of Vietnamese troops from Laos in 1987 gave the Lao PDR greater latitude to develop closer ties with neighboring states, especially China and Thailand. Laos also continued its close relationship with the Soviet Union, the source of approximately half the economic assistance it received in 1988. In turn, Moscow continued to criticize Vientiane for its inefficient use of Soviet assistance. The Soviet Union later welcomed increasing Western influence in Laos at the end of the decade because it offered a means to reduce Soviet investment at minimal political cost.

With the subsequent collapse of the Soviet Union in the early 1990s, Japan assumed the position of principal bilateral donor to Laos, extending annual economic assistance approximating $50 million. And Australia, France, Germany, and Sweden remained significant Western donors. With the death in November 1992 of President and LPRP Chairman Kaysone Phomvihane, a long-time Vietnamese ally, the Lao PDR expanded commercial and diplomatic ties with China. While Beijing provided aid, arms, and trade to Vientiane, its most important role was to validate the path of the LPRP. If China could succeed in pursuing market reforms and private ownership while preserving one-party rule, why couldn't the Lao PDR do the same?

In the wake of the Asian financial crisis, Vientiane pursued closer relations with neighboring authoritarian regimes, expanding its ties with China as the latter moved to increase its influence in Southeast Asia. The Lao PDR also turned to Vietnam, its traditional patron, for guidance and aid. The most disappointing result of government economic policy in the aftermath of the Asian financial crisis was its continuing dependence on foreign aid. In June 2003, Russia agreed to write off 70% of the loans outstanding from the Soviet era; nevertheless, the Lao external debt remained at nearly $2 billion in 2004. Moreover, a significant shift in the composition of aid to Laos occurred with grants accounting for a smaller share and loans a larger one, threatening the creation of yet another debt-strapped Third World state.

At the multilateral level, the IMF and the Asian Development Bank (ADB) continued to provide economic assistance. And the World Bank, in conjunction with the ADB, eventually approved the highly controversial Nam Theun 2 hydroelectric project. Scheduled for completion in 2010, the project will feed electricity to energy-hungry Thailand and become a source of cash for the Lao PDR. Over the course of the first 25 years of operation, Nam Theun 2 will earn an estimated $2 billion. The extent to which the Lao government will use this windfall for promised social and economic development remains to be seen.

Cosmetic Political Reforms

Since 1975, the Lao approach to reform can be described as perestroika without glasnost, or economic change without political reform. As the LPRP cast off Stalinist economic doctrines and took tentative steps toward market reforms, it refused to share political power. Its approach here again mirrored that of its mentor, the Communist Party of Vietnam, in that it offered the Lao people increased economic openness and prosperity in return for continued Communist control of the political system.

At the Sixth Party Congress, held in March 1996, LPRP members advocating a slower reform path with greater control over the effects of reform policy succeeded in reinforcing their position in the Party. According to one observer, it was a victory of “reformers by necessity” over “reformers by conviction.” The Sixth Party Congress also reaffirmed the authority of the LPRP as Party leaders successfully argued that departure from one-party rule could lead to the political instability often associated with countries in transition.

At the Seventh Party Congress, which opened in March 2001, the LPRP adopted vague statements in support of market-friendly reforms and improved governance to placate the international donors financing some 80% of development expenditures. The Old Guard, however, retained its firm grip on political power. In the National Assembly elections held in April 2006, LPRP members won 114 out of 115 parliamentary seats. At the same time, democracy and human rights groups in the West, like Amnesty International, Freedom House, the Heritage Foundation, and Human Rights Watch, regularly condemned the absence of basic freedoms in the Lao PDR.

Revolution, 30 Years On

Thirty years after the Lao People's Revolutionary Party seized power, the Lao People's Democratic Republic remains a Lesser Developed Country (LDC). According to the World Bank, Laos is the poorest and least developed country in East Asia with more than three-quarters of its population living on less than $2 a day and about four-fifths of the people engaged in subsistence agriculture. In this milieu, economic and social inequalities are enormous and getting worse. The poorest 10% of the population receives less than 4% of national income while the richest 10% takes over 30%. With around 80% of the people working the land, the economic fruits of the limited reforms to date are concentrated in urban areas because urban Lao are best positioned to take advantage of new economic opportunities. Poverty alleviation has long dominated international discourse on Laos and probably made the Nam Theun 2 project inevitable, but which elements of the population stand to gain from hydroelectric revenues remains a subject of debate. In a word, Laos is poor, and the bulk of the population looks set to remain that way. The Lao government boasts of plans to escape LDC status by 2020; however, its performance over the last two decades suggests this goal is unrealistic.

In most countries, economics and politics are intrinsically related dimensions of a single social reality, and the Lao PDR is no exception. The economic crisis in Laos today is largely about how the country is governed. Although the Communist Party has used economic performance to retain governing legitimacy for over three decades, this development model has real limits, as the experience in Vietnam and elsewhere suggests. At some point, increased respect for human rights and religious freedoms, in conjunction with real democratic reforms, are certain to become a precondition for Party survival. Until that time, foreign aid dependency, and the corrupt and wasteful use of the aid extended, appear to have become permanent features of the Lao political economy.

Ronald Bruce St John, an analyst for Foreign Policy in Focus (www.fpif.org), has published extensively on Southeast Asian issues for almost three decades. He is the author of Revolution, Reform and Regionalism in Southeast Asia: Cambodia, Laos and Vietnam (Routledge, 2006).