13 March 2003

Economic Development and Asian Security[1]

Dr. Leif Rosenberger

Economic Advisor

US Pacific Command

Introduction

At first glance, Asian economies appear to be performing well. Asia's economic performance looks poised for sustainable economic recovery. Exports are rising, consumer demand is picking up, currency reserves are healthy, inflation is non-existent and interest rates are low. Does this mean Asia has recovered from the Asian economic crisis? Are the Asian economic development strategies solid and on track? Are the economic reforms complete? Unfortunately, many of the key economies in the region have unimpressive economic development strategies. Others have adequate blueprints but can not implement economic reforms. Worst of all, the Asian economic superstructure rests on too much financial quicksand.

In this paper we will start by taking a conceptual and historic look at economic development. Then we'll look at two strategically important countries in the region: China and North Korea. China is currently enjoying strong economic growth but is struggling with financial problems that could undermine its long-term economic development. North Korea's economy is failing and is resorting to nuclear brinkmanship in an attempt to coerce economic concessions out of the international community. In the last section we conclude with thoughts on the links between economics and security.

Competing Models of Development

Many years ago David Ricardo explained why it was in the comparative advantage of two countries to engage in free trade even if one country had an absolute advantage in the producing the two products these countries are considering trading.[2] In other words, Ricardo's model explains why free trade is a positive sum game in which both sides gain from trade and enjoy what former US Secretary of Treasury Lawrence Summers used to call "shared prosperity." In contrast, Raul Prebisch and his dependency theory argued that free trade hurt the economies of developing countries. Prebisch advocated an inward-looking economic development strategy in which developing countries would pursue a protectionist strategy, in which they would frequently substitute local production for imports.

For a few years after World War II, the four Asian tigers -- Hong Kong, Singapore, South Korea and Taiwan -- ignored Ricardo and tried import substitution economic development strategy. Their national economic performance was dismal. In the 1970s the Asian tigers began to open up their economy to freer trade and foreign investment.[3] Their economic growth was so impressive that the World Bank called it an economic miracle.[4] The World Bank attributed their impressive economic performance to an economic strategy that basically embraced globalization (or the free movement of goods and capital).

China is another example of a country that pursued globalization, albeit in a less complete way. Like the Asian tigers, China successfully followed an export-led growth strategy.[5] In just two decades China reduced poverty and raised its living standards by opening its doors to the global economy. Back in 1975 570 million Chinese were living on less than $1 a day. Just over two decades later China showed spectacular results. By 1998 China had reduced poverty to 220 million people.[6]

In contrast to China's open door policy, India followed the Raul Prebisch ideas and pursued an inward-looking economic development strategy that kept its doors closed to globalization. It thoroughly discouraged international trade and the free flow of capital. Such protectionism was a dismal failure. In 1975 India had about 400 million poor people living on less than a dollar a day. Two decades later India had about the same number of poor people it had when it began import substitution industrialization. In short, a globalizing China strengthened its economic security and a protectionist India weakened its economic security.

2^nd Generation Reforms

Unfortunately, China and many other Asian countries have been resting on their laurels. After doing the "easy" economic reforms of opening up to the world, they have failed to implement its microeconomic reforms fast enough to replace the old industrial and banking institutions with free market institutions. As a result, they are struggling to climb to the next plateau of economic security.

To help us understand the need for second generation economic and financial reforms, it might be useful to understand the nature and extent of the conceptual problem. Let's begin with a simple strategy, context, and performance analytical framework. While generalizing is always dangerous, it's clear that too many Asian countries start with the social context. They seek social harmony. That means overly rigid labor markets and little stomach for corporate bankruptcy. They follow financial socialism to achieve social harmony and to allow SOE losers to save face. The core problem boils down to banks recklessly allocating money, which in turn produces a mountain of bad loans. Too many bank resources are channeled toward inefficient, loss-making companies. The banks make soft loans to their favorite corporate losers with little or no expectation SOE borrowers will ever repay the loans. In the process, national savings and wealth are destroyed. The mountains of NPLs have now caused a credit crunch (no money for private sector) and a hot political issue all across Asia.

To solve this mess, there must be a fundamental overhaul in the core philosophy that's used to allocate capital. In a nutshell, creative destruction and risk taking must replace financial socialism and moral hazard. Asian countries must stop bailing out insolvent banks that reject a commercial credit culture. That merely rewards and perpetuates bad behavior, enriches failing bank managers and shareholders and punishes the innocent and beleaguered taxpayer. Healthy, market oriented private banks and corporations need to replace the 4 deadbeat state run banks. NPLs should be sold at true market value (a few pennies on the dollar) to viable domestic or foreign banks. SOE borrowers that cannot turn a profit need easy exit and access to prompt bankruptcy procedures to allow assets to be transferred to greener pastures. That lets banks give money to those entrepreneurs with a fighting chance of making money and creating new and commercially viable jobs.

Of course each Asian economy is somewhat unique. Therefore it is important for us to have a clear appreciation for the social and political context in which economic decisions are made in each country. To capture this uniqueness, we'll look at two strategically important economies: China and North Korea. We'll take a look at the economic strategies that drove the economic performance. We'll analyze what went right and what went wrong with these strategies. In the case of North Korea, we'll suggest more promising new economic strategies to generate growth. In the case of China, we'll suggest ways to avoid financial turmoil and sustain China’s current prosperity.

China

China’s is struggling with strategic uncertainty. On the one hand, China's economy is currently performing well. FDI is pouring into China, exports are strong, GDP is rising and coastal manufacturing is booming. Unfortunately, this visible economic success is arguably not sustainable. That's because the economy rests on financial quicksand. The banking crisis is potentially worse than Japan's. A fiscal crisis also is looming not far down the road. Unemployment and social unrest are rising in rural and urban areas. Corruption is pervasive throughout the society. A communist dictatorship shows no signs of solving these problems.

On the positive side, China is the world's workshop. Foreign investors have rapidly shifted a large chunk of global manufacturing capacity to China. In many ways, China is capable of producing almost anything. What's the attraction? Why manufacture in PRC? For starters the quality and dedication of the labor force is superb. In addition, the supply of this labor force also appears virtually inexhaustible. 150 million migrant workers seek jobs in booming cities along the coast. About half the 400 million people employed in farming are surplus to requirements and are available for manufacturing in the future.

This surplus labor supply drives down wages. Chinese manufacturing workers make $ 150 a month, a fraction of what their counterparts make in Singapore, Malaysia, & Mexico. Due to low wages, Chinese goods – toys, textiles, consumer electronics, semiconductor chips, etc. – are now cheaper than anywhere else in the world. But China's not just “a low-tech sweatshop.” It's also high-tech. IBM, Intell and other foreign R & D companies are migrating in large numbers to China. That’s because Chinese intellectual talent is second to none. China is emerging as a research and development hothouse in such fields as information technology and automation. So is it time to celebrate the economic strength and power of China as a rising economic superpower?

Unfortunately, Beijing still has a long way to go to abandon the old communist economic system. The impressive economic superstructure cited above rests on financial quicksand. Technically insolvent state owned banks continue destroy wealth by transferring the savings of Chinese workers to sick and inefficient state owned enterprises (SOEs) which frequently produce goods nobody wants. While Beijing has closed some SOEs, it has not systematically created the essential foundation (i.e. free market laws and institutions) necessary to transfer millions of unemployed workers from the old state run economy to a new entrepreneurial capitalistic economy.

Fixing the collapsing financial system is arguably the greatest challenge for the Communist Party leadership. The banking crisis endangers PRC achievements from 20 plus years of reform. Failure to clear a massive overhang of bad loans and halt further risky lending invites a banking crisis that threatens economic growth. Healthy banks are crucial to maintaining shift toward a free-market economy and safeguarding the deposits of hundreds of millions of hard-working savers.

For the leadership, this is far from an arcane, abstract economic debate. Survival of the Communist Party political leadership is at stake. A financial meltdown would be a catalyst for political and social upheaval. For foreigners, a banking crisis at the very least would endanger an accumulated $450 billion in foreign investments in China. What's needed is a "big bang," drastic overhaul of the financial system.

China's alarming non-performing loan (NPL) problem in its state run banks is arguably even worse than Japan's NPL problem. In Japan bad loans are estimated at 8% to 10% of GDP. In China bad loans in China are estimated at 37% to 50% of China's GDP.[7] Half the loans for PRC state run banks go to insolvent SOEs. Worse still, such Chinese financial instability appears to be worsening. China is adding to the NPL stocks at a significant and alarming rate.[8]

To get another sense for the magnitude of the Chinese bad loan disaster, let's compare PRC's bad loan mess with the S $ L debacle in the US. S & P says NPL disaster will cost China some $ 518 billion or 43% of China's 2002 GDP to clean up. In stark contrast, the US S & L bailout a decade ago only cost $ 160 billion or just 3% of US GDP. Only the worst cases such as Indonesia after the Asian economic crisis even approach the scale of China's current problems. Beijing feels is has little choice but to inject more capital to bail out the banks at a time when govt. debt is ballooning to sustain high short term growth.

If we add huge welfare and pension payments, Beijing's financial liabilities are over China's $1.1 trillion annual GDP. The ratio of real public debt to GDP has already climbed to about 139%.[9] That’s over twice what the Maastricht alarm bell (debt to GDP ratio of 60%) says is financially unstable.

In addition to the mountain of bad loans in the banking system, China faces a daunting list of other spending demands. These include:

· Standing up a costly welfare/unemployment system to accommodate rural unemployment that has soared to over 100 million and urban unemployment that has risen to 16 million to 18 million.

· Creation of an expensive pension system for an aging population (90 million people over 65 by 2003).

· Sharply increasing infrastructure spending that is required for developing the impoverished western part of the country.

Most bad loans are to state-owned enterprises (or SOEs) that can't or won't repay their borrowings. Credit continues to flow to insolvent SOEs and the mountain of bad loans keeps growing despite official claims that NPL levels are declining. In essence, Beijing cannot fix the banks until it either helps out major borrowers or cuts them off. So private business, the economy's future, is being starved of bank credit.

One clear signal that the leadership senses danger is that Beijing is signaling that the big 4 state-run banks are going to a huge capital injection. Will it work? Beijing has tried to clean up the banking system twice before. Both bailouts failed. Why? AMCs are mostly just redistributing the problem, not solving it. AMCs resolved less than 15% of their portfolios, often through dubious debt-for-equity swaps that do little to change management behavior.

Unfortunately, Beijing is reluctant to take a "big bang" approach to banking reform. Drastic action to halt lending to delinquent borrowers and foreclose on SOEs would lead to a surge in unemployment, a risk the party can't afford. Since 1998, Beijing has been willing to lay off as many as 30 million state workers. To avert financial crisis, it would have to lay off millions more. It feels it cannot risk the social chaos and political instability that might spring from halting soft loans that keep insolvent state enterprises from collapse. Despite private sector rhetoric at 16^th Party Congress, Beijing still believes in its unshakable responsibility to have the state run banks support SOE losers. So it's unrealistic to expect that a genuine credit culture -- in which the criteria for lending are commercial rather than social -- will emerge in China. Thus NPLs are likely to pile up.

The problem is this financial socialism is not sustainable and can not deliver enough commercially viable jobs in the private sector. As long as China grows at a 7% clip, it can create 8 million new jobs. Sound good? Not in China. China must create 20 million new jobs in the urban sector alone each year for the next 4 to 5 years.

In a market society, consumer sovereignty provides the demand for manufactured goods, which in turn define the number of manufactured jobs that are needed to produce the goods. But in China, things work differently. The communist party plans how many jobs are needed, regardless of market demand. As a result, the government pays for the millions of redundant SOE jobs with tax revenues and bank credit. The government feels that high fiscal deficits and high non-performing loans are a "necessary evil" or the price for societal stability.

But the day of reckoning is fast approaching for this financial socialism. And the dominos are starting to fall. Surplus jobs are causing an over-supply of almost everything. That causes price wars, which in turn creates deflation. The deflation reduces corporate profitability and increases the # of bad loans in the banking system. As bad loans rise, the chances of financial meltdown also rise unless decisive action is taken to avert the turmoil.

DPRK's Nuclear Brinkmanship

At first glance, the North Korean nuclear stand off with the US amounts to a dangerous non-proliferation issue. But the nuclear crisis is not simply about the spread of weapons of mass destruction (WMD). The crisis is also a North Korean struggle for economic survival.[10] As North Korea ratchets up its game of nuclear brinkmanship, it is seeking concessions -- such as a non-aggression pact and normalized relations -- from the US that it considers vital to its fledgling program of economic reforms and its effort to keep its economic development strategy afloat.

Fact is North Korea is a failed state. And the DPRK may well be reaching the end of its economic muddling through period. Its economy is on the verge of collapse. Up till now, DPRK has tried to muddle through with donor aid. It's now clear to Kim Jong il that this approach no longer works. Much of the population remains malnourished. Infant mortality has soared. Life expectancy has shrunk. Because of aging machinery and energy shortfalls, factories are barely operating.

In an effort to improve a weak economy, Kim Jong il took a number of bold steps towards a market economy back in July 2002. The economic reforms increased prices for rice, diesel, and other staple goods and ended rationing for some products, devalued the foreign exchange rate, legalized private farmer's markets and made state owned enterprises responsible for their own profits and losses.

On the positive side, the reforms are a de facto NK admission that the old system is a loser. DPRK is trying to change. Unfortunately, NK is clueless about free market economics. The economic reforms actually made economic problems worse by unleashing runaway inflation. Worst of all, DPRK premature and hasty economic reforms actually increases NK economic vulnerabilities and makes a systematic collapse (economic chaos) more likely.

In this regard, Kim Jong il is totally in the dark about the pace and sequence of economic reforms as the economy moves from a planned economy to market economy. DPRK has started to liberalize prices and privatize some farms. But it has failed to create essential free market laws and institutions to orchestrate such things as macroeconomic stabilization (tightening up the fiscal and monetary policies). As a result, too much money chasing too few goods and services is creating runaway inflation, making it even more difficult for the NK people to afford enough food to survive. In other words, DPRK has done too much, too fast in the areas of liberalization and privatization without a) a solid framework of free market laws and institutions and b) macroeconomic stability.

To be sure, the donor community has provided lots of energy and food aid in the past to DPRK. But Pyongyang has always seen this donor aid as emergency assistance to avert an economic crisis that would threaten South Korea's economy. Donors would give the North Koreans just enough aid to avoid an economic collapse but never the kind of developmental aid to strengthen the economic foundation of the DPRK economy.

It's time for the international community to seriously consider going beyond emergency assistance to avoid DPRK collapse. It's time to open the door for the International Financial Institutions (IFIs) -- IMF, World Bank and ADB -- to work with the North Koreans to formulate the long-term economic development of the DPRK economy. The IFIs would be helping DPRK with economic transition to the free market and help rebuild the North/South infrastructure. In this regard, North Korea may even consider moving troops to building special economic zones. The vision is to turn swords into plowshares.

The first step would be for Washington to take North Korea off the terrorism list. That would open the door for IFI intervention. The USG and the IFIs could transform the nuclear crisis into an opportunity to --

· Shape the pace and sequencing of economic reform in North Korea and thus strengthen their sustainability,

· Work with South Korea to strengthen Korean economic integration and

· Make sure the process is done the way the Chinese did it (economic reform without threatening the NK regime’s survival).

In this sense, Korean unity is more like European integration (surrendering economic and financial sovereignty without threatening political sovereignty) than it is German unification, which created political unity as well as economic and monetary unity.

Of course, economic development is not a silver bullet. A US non-aggression pact and normalization of relations with NK would also have to accompany the economic development initiative. But interestingly enough, the non-aggression pact would also have an economic objective to it. The US security guarantee would allow NK to reduce defense spending, which has placed an enormous burden on its economy. Plans would include cutting its 1.1 million strong military by 300,000 soldiers. ROK says the former soldiers would be employed to man factories in the proposed special economic zones supported by foreign investment.

In any event, steady movement toward more economic freedom in North Korea is a noble goal even if the military issues cannot be resolved. But as we use economic relations to build a reservoir of goodwill with DPRK, (as France and Germany did in the ECSC, EC, etc., after WW2), the USG finally has a fighting chance of solving mutual problems across the board. Economic/diplomatic relations with North Korea will not guarantee success. But it's unrealistic to think that the USG can solve the difficult nuclear stand-off and other contentious military issues with DPRK in a diplomatic and economic vacuum.

If no action is taken, the teetering North Korean economy could well collapse. The costs of such a "policy of drift" would be staggering. The question of an economic transition from a planned economy to a free market economy would become a here and now issue for any new North Korean leadership and/or the South Korean government. To minimize the costs of North Korea's economic transition, thought must be given to the pace and sequencing of economic reforms. The phasing of the economic reforms can be divided into four broad sequential categories:

a) Macroeconomic stabilization,

b) Redefining the role of the state,

c) Liberalizing prices and

d) Restructuring ownership and privatization.

Macroeconomic stabilization is a prerequisite for most of the other reforms. Successful stabilization comes from balancing total domestic demand with total domestic production so as to keep prices relatively constant and predictable. In the North Korean context, this means curbing both hidden inflation (which manifests itself in long lines and shortages), as well as the overt inflation that has recently been unleashed in the country. An effective stabilization plan consists of tightening fiscal and monetary policy. The growth of the money supply needs to be curbed and budget deficits need to be less than 3% of GDP.

The role of the state needs to be redefined. North Korea must create, virtually from scratch, a network of modern laws and institutions, without which a market economy cannot function. In this regard, North Koreans need to learn good commercial and businesslike practices. Old politically motivated investments in NK that lack a basic economic and commercial logic must be scrapped. An unemployment and pension system must also be created to absorb surplus labor and curb potential social unrest.

A free market oriented economy also requires a strong financial and legal foundation. Frankly, the legal and financial infrastructure for economic cooperation is just as important as the money. Over time, technical assistance to help develop more modern capabilities in these areas and many others will be an important part of the strategy to realize the future vision articulated at the Summit. To a large extent, the success or failure of North Korea’s economic transformation will also turn on how the International Financial Institutions (IFIs)—IMF, the World Bank and the Asian Development Bank—interact with the key countries that play pivotal roles on the Korean peninsula.

Once essential legal and institutional changes are in place, North Korea must go beyond their limited price reform and dismantle the complex system of centrally controlled prices and allowing them to reflect relative scarcity. Prices also have to be "imported" from the world economy though trade liberalization. Finally, external sector liberalization is not complete until the new NK leadership takes decisive steps toward currency convertibility. The exchange rate is heavily overvalued, which undermines the competitiveness of North Korean exports. The official exchange rate is about 2 Won to the dollar, while the unofficial rate is 200. Without proper pricing, it will be impossible to proceed very far with real economic rehabilitation or cooperation with potential trading partners.

Freeing prices in North Korea produces signals that tell the economy how its resources can best be used. But unless those resources (e.g. productive assets) are privately owned, those signals will be ignored. Therefore, privatization of state owned enterprises and liberalization are inseparable. In addition, private entrepreneurs have incentives to preserve and hopefully enhance the value of their assets. In contrast, the managers of NK state enterprises faced no financial discipline because a soft state budget could always bail out inefficient state enterprises.

A new North Korean leadership that would arise after the collapse would likely welcome these economic reforms. But the NK leadership will also be under enormous popular pressure in both Koreas for at least social and economic integration. Even if political unity could be postponed, the costs of economic integration would arguably be much higher for South Korea than they were for West Germany. The South would have to absorb a population of poverty-shattered, malnourished Northerners at a cost of tens of billions of dollars annually for a decade or more -- rolling back the South's standard of living by more than 10%.

That said, the new NK leadership could minimize these costs if they avoid the same pitfalls the Germans fell into at the time of German unity. For instance, Bonn pandered to East German consumers, overvalued the Ostmark (East German currency) at the time of monetary conversion, created virtual wage parity between East and West Germans, and destroyed the competitive position of all East German producers. These mistakes, in turn, triggered huge subsidies for collapsing East German industries. The West Germans over-borrowed to pay for unity mistakes, opted for an irresponsibly loose fiscal policy (high budget deficits), which was inflationary. The Bundesbank offset inflationary pressures with high interest rates (monetary death grip), which in turn triggered a deeper recession in Europe, European financial chaos and political disunity in Europe.

In short, the hasty, hysterical German unification process was initially what Bundesbank President called a "a disaster." To avoid a similar macroeconomic disaster, Seoul and Pyongyang must do two things: opt for a realistic monetary conversion rate and keep NK wages realistically low.

Given the fact that a North Korean economic collapse would catapult the transformation of the North Korean and Korean economic integration from a distant thought to a here and now issue, every effort should be made to avoid a haphazard process. If key actors choose to procrastinate planning for economic transition and economic integration, the USG could find itself both flat-footed and reacting hysterically. That would be a recipe for economic disaster for Korea and the rest of Asia -- as it was in Europe at the time of German unity. If that occurs the world would look to the USG for the distasteful job of crisis management. A better strategy would have been careful and early planning for economic integration and policy coordination as a means of crisis prevention.

Economics and Security

Economic and financial weakness is a serious political/military source of concern for four at least reasons.

1^st, this economic and financial weakness makes these economies more vulnerable to financial turmoil.

2^nd, the economic insecurity can rapidly lead to social and political instability.

3rd, the economic weakness makes these economies more vulnerable to geopolitical shocks.

4^th, economic weakness might convince the leadership of a failed state that it has no stake in globalization and the status quo and has nothing to lose by attacking its neighbor (as was the case when Iraq attacked Kuwait in order to garb Kuwaiti oil fields).

Therefore it's important to keep in mind the connections between economics and defense. Economic developments often drive military decisions. At the same time, economic prosperity can not take place in a war zone. If the events of 11 September have taught us anything, they have brought home the fact that economics and security are inexorably linked. For instance, money provides the oxygen for terrorist operations. We must block the funds to curb terrorist attacks. In addition, we must address the environment that makes terrorism possible. Too often, poverty is a breeding ground for terrorism.

The primary mission of the U.S. military is always to fight and win America's wars. But we can never fall back into a reactive mode, waiting passively for the next conflict to break out. We have a vested interest in preventive defense. Reducing poverty and investing in social and economic development strengthens comprehensive security. Through PACOM theater security cooperation programs, we form partnerships with other Asian countries and other organizations to provide humanitarian assistance, disaster relief and other building blocks for economic reconstruction and development. This economic instrument of power helps to reduce the social and economic injustice that in turn fans incendiary conditions for military conflict. In this sense, building prosperity and creatively avoiding military conflict via preventive defense is far better than the most decisive military victory.

Terrorism in SE Asia

For the past year the risk of radical Islamic terrorism against western embassies and corporations in SE Asia has been rising. The car bombing of a Bali nightclub on 12 October 2002 punctuated the nature and extent of the terrorist threat in SE Asia. The Bali blast also exposed a new front emerging in the fight against Islamic extremism in the region. The Bali blast raises anxiety levels. In economic terms, this amounts to a terror tax on the Asian economy.

In this regard, the increased fear of terrorism adds to business costs. So the costs for insurance and corporate security go up. The threat to energy firms means increased security around production facilities and pipelines. Consumer confidence falls. So consumers take fewer trips to the mall. Business confidence falls. Foreign buyers of Indonesian textiles, shoes and furniture like to visit these factories without fear of terror attacks. Unemployment rises. If foreign buyers lose confidence in Indonesia as a safe and reliable supplier importers would buy fewer goods. Indonesians would lose jobs and social unrest could ensue. Terror hurts the investment image of SE Asia as a whole. So foreign investors get jittery and look for greener pastures elsewhere. Tourists stay away, thus worsening the slump of an embattled travel industry still reeling from 9/11.

While the USG case for war against Iraq is persuasive at the White House, Malaysia's Mahathir and many other moderate Asian leaders - who provide strong support to US led GWOT -- view a US led war against Iraq as tantamount to a US war against Islam. This pervasive misperception that a war against Iraq is tantamount to a US war against Islam undermines the GWOT in 2 ways:

· The terror threat rises in SE Asia as increasing #s of moderate Moslems turn more radical and support extremists.

· At the same time, pro-US Moslem governments in SE Asia weaken and may well lose the political will to collaborate with the US in the GWOT.

The US could increasingly find itself isolated in GWOT, with US CT forces spread too thin to be effective. We need stronger and more credible IO to disconnect the perceived linkage between a US war against Iraq and the "US war against Islam" misperception.

The Primacy of Oil

Fear of terror and fears of a war with Iraq has contributed to the spike up in the price of oil to almost $40 a barrel (in March 2003). Any prolonged US led war against Iraq would trigger an even higher spike up in global oil prices. Asia is woefully exposed to any spike-up in oil prices. In fact, no other region of the world is as vulnerable to soaring oil prices as Asia.[11] Why? Asia relies more heavily on energy-consuming manufacturing for its growth than the West. A war driven increase in the crude oil price, say a 40% and would depress world growth. A US led war against Iraq and the likely spike-up in oil prices would therefore have a negative impact on the economic interests of most the countries in the Asian region. The energy price hike could pose a high opportunity cost, by forcing oil-consuming Asian states to boost energy spending at the expense of investment. The net effect of an oil spike up could well pose a long term-drag on Asian productivity.

In addition, the oil spike up eats away at consumer spending power. Depressed consumer spending could dampen corporate earnings. The worry is that falling corporate earnings could eventually take almost 2% off overall profit growth. While a persuasive case can be made for the US led war against Iraq for national security reasons, US allies and friends see an economic down side. A US led war against Iraq would threaten growth prospects around the world, but especially in Asia. The following factors would hammer Asian economies: a higher oil price, greater investor risk aversion and a downturn in US demand for Asian exports. In particular, war against Iraq would undermine business and consumer sentiment in the US. That would be transmitted up the export supply chain. To make matters worse, the rising terror in SE Asia and a possible war against Iraq takes place at a time when a faltering US economy is likely to drag down Asian economies.

Conclusion

Successful economic development strategies are necessary to attain a peaceful security environment in Asia. The failure of North Korea’s economic development strategy and its nuclear brinkmanship are grim reminders of how quickly arcane economic matters can threaten regional security. In contrast, China’s successful transition from Maoism to a large stake in the global capitalist economy strengthens peace in the region. But China’s serious financial problems are a painful reminder that prosperity can never be taken for granted. Finally, fear of terrorism since 9/11 and fears of war against Iraq show us how an unstable security environment undermines prosperity.