Senior Officials' Meetings — SOMs in the language of APEC — were and are the engine of APEC. It is at these meetings that operational decisions are made that provide momentum for the organization; it is here that Senior Officials make policy recommendations to their Ministers. The five SOMs leading up to the Seattle Ministerial Meeting were defining moments for the Secretariat. In speeches, I often described the Senior Officials as my Board of Directors, and it was at the SOMs that we received feedback on our current performance as well as instructions for the Secretariat's future course. The first SOM at Washington in December 1992 provided our original charter, but the second SOM, in February 1993, was our proving ground.

The First Senior Officials' Meeting,

Washington, D.C., 2–4 December 1992

The first SOM took place at the Department of State before I left for Singapore. Its main tasks were to approve the proposed arrangements for setting up the Secretariat and the operational and administrative budgets (about US$1 million each), and to agree to a budget cycle. The SOM approved the proposed organization plan with little debate; it was evident that the Senior Officials were pleased that the United States had assigned a senior diplomat to the Executive Director position. This set a pattern and my successors also held the title of Ambassador when they took over. In Asia, where protocol and rank are especially important, these designations helped give the new organization credibility.

There were some pleasant surprises. When I met the co-leader of the Japanese delegation, Ambassador Nobutoshi Akao, at the U.S.–Japan bilateral session, we both had the feeling that we had met before. We finally remembered that we had been on a raft together as part of a crew of diplomats and business people on a 1989 Whitewater rafting trip down the Salmon River in Idaho.

Vietnam

The best news for Vietnam during 1993 was the withdrawal of the U.S. veto on multilateral lending. Although the embargo on bilateral U.S.-Vietnam economic relations was renewed, U.S. firms are now allowed to take part in projects funded by multilateral aid. Vietnam can at last look forward to assistance to build its infrastructure. A meeting of donor countries in November resulted in pledges of US$ 1.86 billion, more than what was expected. The World Bank gave a glowing report of the economic reforms implemented so far and the way Vietnam's economy has performed since the cut-off of Soviet assistance.

As the influx of foreigners increases with the start of lending by multilateral agencies, there is heightened concern over the negative social consequences of reform and liberalization. There is frustration at the top levels of the party over its inability to improve law enforcement and stem evils such as corruption and smuggling, which are undermining reform. These matters, together with the related issue of declining party membership and morale, are expected to feature prominently in the first ever midterm party conference now rescheduled for January 1994. The conference is likely to see leadership changes, though these will probably not be major. Some Central Committee members may be purged and there may be a few additions to the politburo.

Also expected to feature at the mid-term conference would be the relationship between party and government and the role of the party in economic life. This is because entrenched party interests have been frustrating attempts at reform. The problem is a pervasive one because there are over 12,000 state enterprises and what happens to them touches on political nerves everywhere.

1. Ministers from Australia, Brunei Darussalam, Canada, Indonesia, Japan, Malaysia, New Zealand, the Philippines, Republic of Korea, Singapore, Thailand and the United States met in Singapore on 29–31 July 90 to continue their discussions on the process of Asia–Pacific Economic Cooperation (APEC). The ASEAN Secretariat, the Pacific Economic Cooperation Conference (PECC) and the South Pacific Forum (SPF) were present as observers. A full list of Ministers and Observers attending the Meeting is attached. (Annex A).

2. The Meeting was co-chaired by Mr Wong Kan Seng, Minister for Foreign Affairs and Minister for Community Development and BG (Res) Lee Hsien Loong, Minister for Trade and Industry and Second Minister for Defence (Services).

3. Ministers recalled Prime Minister Lee Kuan Yew's keynote address in which he set forth the tone for the next two days' meetings:

4. Ministers also noted that without strong economic performance, democratic institutions cannot flourish, nor can social justice be promoted. Strong economic growth therefore promotes security in the region.

5. Ministers discussed a range of topics including:

1. a. World and Regional Economic Developments/Regional Economic Outlook

2. b. Global Trade Liberalization — GATT Uruguay Round

3. c. APEC Work Projects

4. d. Future Participation.

6. Ministers reiterated their appreciation for the important contribution that ASEAN and its dialogue relationships have continued to play in the development of APEC and stressed that the enhancement of Asia–Pacific Economic Cooperation would complement and strengthen the constructive role played by ASEAN. Ministers reaffirmed that APEC was outward-looking and did not aim to form a trading bloc, thereby contributing to further development of the world economy.

Introduction Policy makers in Indonesia have placed great emphasis on the provision of credit to small-scale entrepreneurs in farming, manufacturing and trade. This has led to government interventions (often supported by donors) such as nationwide targeted credit programs, the establishment of specialised development finance institutions, and numerous credit projects providing cheap loans to specific groups in particular locations. Few of the institutions, programs or projects have been too successful if measured by their ability to provide credit on a continuous basis at a cost affordable to government or donor. This experience is not unique to Indonesia, however, as there is a worldwide persistent lack of success of similar interventions aimed at providing subsidised credit to small entrepreneurs.

The universally negative experience with subsidised, targeted credit, and the massive amount of government funds involved, triggered a global debate. Initially the analysis focused on the consequences of intense government interference in interest rate determination and lending policies for the effectiveness and viability of financial institutions. The rise and fall of subsidised, targeted credit programs has been extensively analysed (e.g. Von Pischke et al. 1983). The discussion has since broadened to include the performance of the financial sector overall and the specific characteristics of credit transactions in rural financial markets (Hoff and Stiglitz 1990; Besley 1994).

The new insights gained resulted at the macro level in a more favourable attitude towards financial liberalisation and a redefinition of the government's role—away from participation and intervention and towards providing a climate in which banks can perform their task as intermediaries in channelling funds from savers to investors, guided by market forces. At the micro level, there is a growing realisation among policy makers that small entrepreneurs are not well served by credit programs which operate for a few years; rather, they require permanent access to financial services. These can only be provided by financial institutions that combine the original focus of projects and programs on small entrepreneurs with the basic objective of all banks: financial viability, expressed in the capability to mobilise funds and to provide credit services profitably.

As the weight of East Asia and the Pacific in world affairs continues to increase, the commitment to the old verities of liberal trade in this region could be crucial in holding back the new tides in the old, North Atlantic industrial countries.

Continued growth in East Asia is likely to be the primary influence on world trade and economic growth in the next quarter century and beyond, just as it has been in the last. The emergence of East Asia has had a dramatic effect on the structure of world output, and even more so on the structure of world trade. Charts 1 and 2 illustrate these huge shifts in the structure of world production, trade and global economic power.

East Asia accounted for just over 17 per cent of world production in 1980; at the end of the century it can be expected to be over 28 per cent. Already the region accounts for a fifth of world trade, a larger share than North America, and by the year 2000, East Asia's share is expected to be closer to one-third of world trade. These ratios will not stop changing at the millennium. One consequence is that, in the future, the rest of the world will find itself reacting to the forces of economic policy-making in East Asia, as it has done to those of the United States for the past half century.

In East Asia in recent years, structural change and growth have been mutually reinforcing; providing new markets, and an increasingly sophisticated and dynamic regional economy.

There has been extensive unilateral market opening and deregulation in most Western Pacific economies. Their remarkable growth performance has confirmed the prediction of economic theory that the greatest benefit from unilateral trade liberalization accrues to those who undertake it. The benefits have been multiplied by the fact that many neighbouring economies have taken similar unilateral market-opening decisions.

Introduction A commercial banker recently described his bank's predicament as having to play in a field that has shrunken due to increased competition and, at the same time, having to perform with his hands tied behind his back ever more tightly, as a result of stricter central bank soundness requirements. The consequence, at least for the time being, has been a decline in the banking industry's profitability, most notably among the state banks. External market factors as well as stricter soundness regulations have both contributed to this trend. As improving soundness imposes certain costs, the dilemma for regulators is how to impose regulations that will improve bank soundness, without cutting too deeply into the banks’ profitability. Although a profitable bank might not necessarily be healthy, a healthy bank needs to be profitable.

In this paper, the challenges faced by banks are categorised into two areas. The first is external market conditions, highlighted by an increasingly competitive market as a result of the government's deregulation measures; these began in 1983, but had their strongest impact from 1989. The second is the stricter central bank regulations, introduced in 1991, designed to strengthen the soundness of banks. It is important to put the latter topic into better perspective, by touching first on the rapidly changing market environment faced by banks. The banks’ responses to these challenges are then discussed, and the paper concludes by noting various current trends, and those which might be expected to emerge in the near future.

External market conditions

Three market developments that had a major impact on banks during 1989-93 were: deregulation, that significantly increased competition among banks; the increasing importance of, and activity in, the capital market; and, as inflationary fears grew in the early part of the period, the government's tight monetary policy launched in 1991, which slowed bank asset growth considerably.

Background

A little over a decade ago, I wrote a survey of Indonesia's financial sector, in which I emphasised the extent to which its development had been repressed, and drew attention to its domination by state- owned institutions. I asserted that ‘[t]here have been no major changes … in the kinds of policies adopted concerning money and finance’, and predicted that the future only promised ‘more of the same’—even going so far as to say that government interventions could ‘be expected to be extended’ (McLeod 1984:106-107). These words were actually written in 1982 and, to my embarrassment, the predictions had been proven totally wrong several months before the paper even was published. For me, this experience has reinforced the idea that economists should be content to restrict themselves to the safer tasks of analysing and explaining what has already happened, and avoiding the temptation to foretell the future!

Indonesia's financial sector in fact has been totally transformed in the decade or so since a wide-ranging package of deregulatory measures for the banking sector was introduced on June 1,1983. The obvious success of that package—'Pakjun’ as it was known—together with the awareness that many significantly counterproductive regulatory interventions were still in existence, emboldened the government to introduce an even more radically deregulatory package a little over five years later, on 27 October, 1988. It seemed natural to dub this ‘Pakto’, but the Indonesian penchant for coining new words using selected syllables from small groups of words such as ‘Paket Oktober’ would soon be tested by the increasing frequency with which new policy packages were beginning to appear, and the fact that there are only twelve months in the year. The collection now includes Pakjan, Pakfeb, Pakmar, Pakmei, Pakjun, Pakjul and Pakto, as well as Pakdes I and II.

In the early 1980s, the contribution of Indonesia's financial sector to the development process remained exceedingly modest. The sector was almost totally dominated by the banking system which, in turn, was dominated by a small number of very large state-owned institutions.

In the fall of 1992, my wife, Ingrid, and I had returned from an ambassadorial stint in the Marshall Islands, and I was working as a Senior Advisor in the Bureau of Oceans, International Environmental and Scientific Affairs (OES).

One day, Lynn Pascoe, an old friend and the Principal Deputy of the Bureau of East Asian and Pacific Affairs, called up and asked, “How would you like to go to Singapore for a year?” Lynn explained that the Asia–Pacific Economic Co-operation (APEC) forum was going to establish a permanent Secretariat in Singapore, and that an American would be the first Executive Director. Lynn and his boss, Bill Clark, wanted to ensure that the Executive Director built a strong, small and efficient staff. My experience as an Ambassador and as Consul General of the largest consulate in the world (Frankfurt, with 600 employees) convinced them that I had the qualifications they wanted.

Although the prospect of leaving again just six months after my return to the United States was daunting, I could not help but be intrigued (and flattered) by Lynn's offer. After a sleepless night and a long, soul-searching conversation with Ingrid, I told Lynn I was interested. Lynn then suggested that I speak with Bill Clark and Deputy Assistant Secretary Sandy Kristoff. I did not know Sandy, but she had been involved in APEC from the beginning, serving in the office of the U.S. Trade Representative (USTR) before coming to the State Department. She probably knew more about APEC than anyone else in the U.S. Government. Speaking to Bill, it was clear that he was very keen for me to go to Singapore to set up the Secretariat and would give me full support. I also interviewed with Deputy Under-Secretary for Economic Affairs Bob Fauver, who was Sandy's mentor and who followed APEC closely. I think the interview went well, but everything was put on hold until after the U.S. presidential election, which was then only weeks away.

Many economists have argued that if the government of a country with a tightly regulated economy undertakes a large-scale process of deregulation, then the sequence in which regulations are relaxed is important. Two propositions are so widely accepted that they are referred to here as the ‘orthodox view’. The first is that in a country in which there is rapid inflation because a substantial budget deficit is being financed by money creation, the relaxation of controls on capital outflow, or on domestic financial markets, can lead to an acceleration of inflation; and since the avoidance of hyperinflation appears to be a precondition for the success of any other reforms, the relaxation of these controls may actually be harmful, unless it is preceded by fiscal reforms which reduce the role of inflationary finance to relative insignificance. The second ‘orthodox’ proposition is that controls on international capital inflow should not be removed until after the completion of most other major reforms, including the liberalisation of controls on imports and exports, and the deregulation of the domestic financial sector. Although it is widely accepted, some economists have disputed this second proposition; for example, in their survey of Indonesia's financial development, Cole and Slade (1992) suggest that ‘an open capital account both incites and requires good macroeconomic management.’ Their conclusion is that if, as in Indonesia, the country is capable of ‘reasonably sound macro policies’, then early deregulation of the capital account may be optimal.

This chapter begins by summarising and appraising the theoretical analysis and empirical evidence used in support of the orthodox propositions. It then summarises Indonesia's experience with economic deregulation. The last section collects together the earlier results to answer two central questions: are the orthodox propositions on sequencing correct, and is Indonesia's experience consistent with them?

Is macroeconomic stability a pre-requisite for the success of all other reforms?

For a labour-abundant country like Indonesia, those parts of current industrialisation strategy which seek to develop labour-intensive and, in particular, export-oriented industries seem the most appropriate, as it is not clear that the government's present strategies as a whole can guarantee absorption of sufficient numbers of people into the production process. The manufacturing sector can be sub-divided into modern and traditional sectors, in which different technologies are employed (Thee 1993). Thus in 1986, medium and large enterprises (MLEs) accounted for 82 per cent of total value added, but employed only 33 per cent of manufacturing employment. On the other hand, the household and cottage enterprise sector (HCE) and the small enterprise (SE) sectors contributed only 11 per cent and 7 per cent, respectively, of total manufacturing value added, and yet employed no less than 53 per cent and 14 per cent, respectively, of manufacturing workers.

To achieve a more balanced pattern of industrialisation, financial policies to promote SEs and HCEs should go hand in hand with support for the development of efficient, labour-intensive MLEs. Government assistance is required to improve the productivity of SEs and HCEs, and thus to increase their competitiveness in the market. The challenge of creating a more efficient manufacturing sector overall is daunting.

One key factor confronting the nation in its efforts to improve productivity in SEs and HCEs is the low level of educational achievement generally, and the shortage of technological and managerial know-how in particular. To overcome this handicap, huge government investments are required in education and health, for both the urban and the rural populations. These long-term investments will create a more productive workforce, which is an indispensable prerequisite for a modern industrialised society.

Overcoming financial constraints

A second major handicap for SEs and HCEs is their lack of capital, which is aggravated by banks' reluctance to finance this sector. In several surveys of small enterprises, lack of working capital has been cited frequently as one of the most pressing constraints on their development (Kilby and Liedholm 1986; Wickramanayake 1988).