Commodore Frank Bainimarama, the head of the Republic of Fiji Military Forces, the appointed Prime Minister (PM), and the Minister for another half a dozen ministries in his government, presented his vision for Fiji in an address to the nation on July 1st.  The Commodore espouses to have Fiji realise her potential, and possibly by September 2014 when the nation is gifted democratic rule.  Achieving the vision is a tall order, believing that Fiji is on the path to the above taller still.

There are many positives in this address titled the ‘strategic framework for change’.  For a start, the Prime Minister has covered hitherto uncharted economic territory.  Issues ranging from the deteriorating conditions within the global economy to the floods of February that had a devastating impact on sugarcane crop were canvassed.  Mention was made of the improving monetary and credit conditions to an ‘open skies’ policy to increase tourism inflows.  The PM emphasised that the focus of his government for the following three years would be the economy.

Amongst the specific economic reforms proposed were: (i) fast tracking of divestment from state-owned enterprises (SOEs) including the closure of non-performing SOEs; (ii) the amalgamation of different government departments and entities; (iii) outsourcing of service provision to the private sector; and, (iv) rehabilitation and rejuvenation of the deteriorating road-infrastructure.  Pro-growth and pro-poor reforms also got a mention.  The prescriptions for the economy are consistent with that from the manual of any international financial institution.

The PM is learning economics fast.  The heat is on him given the rapidly deteriorating economic conditions and his role, amongst many others, as the Minister for Finance and National Planning.  Foreign reserves at FJD660 million as of June have recovered, by FJD132 million at current value of the FJD, since the devaluation of 20 percent last April.  This improvement, however, is due to a larger fall in imports compared to exports since the devaluation.  The former was expected, but the latter is a disappointment.

While the proposed reforms are praiseworthy, a lot more may have to be done if an economic crisis is to be averted.  Furthermore, considerable donor support would be required to bring any of the reforms to fruition.  Most important, a revival of the economy requires a return to the rule of law at a minimum and to democracy preferably.

The Commodore has called for the building of bridges, appealing to the international community to lend a hand in him realising his vision.  He has urged the private sector and the wider community to work together in exploiting the investment opportunities on offer.  Private investments remain lethargic.  It is here that the difficulties begin to emerge.

Many long standing reforms remain unattended.  Land reform heads this list.  Some 90 percent of Fiji’s land mass is under customary (group) title.  Much of this land is under-utilised.  Realising the potential of the nation means drawing this idle resource into production.  Given the political sensitivities of land reform, the PM has been cautious, announcing that the current system of land-ownership will be retained whilst tenure secured and provided long term to entice private enterprise.  This could be a hard high wire balancing act for the PM; get it wrong and the fall could be fatal.  Law and order remains a perennial challenge.

Other than reiterating his determination to rid the nation of ethnically polarised politics through the introduction of a ‘true democracy’ by September 2014, the address was light on exactly how this would be achieved.  All we know is that work on a new constitution will begin in 2012.  Why so late?

Pronouncements of future socio-economic bounties, and before transfer to democratic rule, are meaningless unless realised.  Bringing reforms to fruition requires widespread community engagement and support.

The difficulty for Commodore Bainimarama, as that for any dictator, is to prove his benevolence.  Absent that, his plans will not stick; not to the domestic constituency, and nor to the international community.

1. Fiji and The Forum
2. The politics of constitutionalism in Fiji
3. Preventing Fiji from becoming the pariah state of the Pacific

Fiji was suspended from the Pacific Islands Forum on Saturday, the 2nd of May 2009. This decision was anticipated given that the military regime in Fiji had made clear of its intention not to pay heed to the ultimatum given by the Leaders’ following their meeting in Port Moresby last January.

The decision by the Forum, while understandable, is unfortunate. Fiji was a founding member and the late Ratu Sir Kamisese Mara an instigator of South Pacific Bureau for Economic Cooperation, the predecessor to the Pacific Islands Forum. The Secretariat is located in Suva. Fiji’s suspension is evidence of the fact that the Forum family has fractured.

The political problems in Fiji are hurting. Hurting Fiji foremost, and her neighbours next. Fiji’s GDP contracted by 6.6 per cent in 2007, and was close to stagnant in 2008. Poverty in the two years since the December 2006 coup is likely to have risen by a minimum of 8 percentage points. As of 2002, some 33 per cent of the population were poor. The figures for 2009 would certainly be above 40 per cent.

Government revenues are falling. So is the stock of foreign exchange reserves. The Fiji dollar was devalued by 20 per cent on the 15th of March. This will help dampen import demand, but on its own is unlikely to revive exports. D-Day will be the 14th of September 2011 when the government will need to roll over foreign debt to the tune of US$150 million.

Fiji’s economic fortunes have a bearing on the island Pacific. The central location, superior infrastructure, and Suva being home to several regional organizations make Fiji’s problems those of the regional too. But there is still hope for Fiji.

Fiji politics is in a stalemate. The Bainimarama regime is holding on to power with the backing of the military forces. Their opponent, the Qarase regime that was ousted in the 2006 coup, claims the backing of the majority of voters. Neither will give in so long as their support bases remain intact.

This stalemate, however, will get resolved; and, by the fortunes of the economy. If the economic managers succeed in pulling the economy out of its current nosedive, then they would have saved the military government. Otherwise, an economic crash could precipitate a political crisis. Neither of the above would be a disaster for Fiji, however.

The Commodore has indeed promised to turn the economy around. His is a vision of Fiji as the ‘Singapore’ of the Pacific: a laudable ambition indeed. If he fails to realise this vision then the approaching D-Day (of September 2011) will force the two political combatants to a dialogue with a view to reviving the economy.

A return to the rule of law would be the minimum necessary for such a revival. The best compromise would one that establishes a true democracy in Fiji. And then the solution to Fiji’s political problems would have come from within the nation.

The international community can help with the transition. Further isolation of Fiji would be a mistake, as would be a premature foreign intervention. Open trade, migration, and communication channels are all likely to reduce the adverse effects of the political strife on the ordinary folk in Fiji.

1. Preventing Fiji from becoming the pariah state of the Pacific
2. Dilemmas facing Australia’s Fiji policy
3. The Fiji Water saga

Fiji’s prime minister and military commander Frank Bainimarama has given his first extended interview to the Australian media since his dramatic seizure of complete power a few weeks ago.

On April 10, following a court ruling that his 2006 military coup was illegal, he abrogated the constitution, dismissed Fiji’s entire judiciary, declared a state of emergency, ordered soldiers into Fiji’s media newsrooms as censors, and said there would be no elections until September 2014.

Pictured in The Australian newspaper with a bowl of the traditional Fijian drink kava, and surrounded by his grandchildren, Bainimarama is engaged in a public relations exercise. He has called for an immediate face-to-face meeting with the prime ministers of Australia and New Zealand, Kevin Rudd and John Key, who, he says, do not understand what he is doing for his country. They are highly unlikely to accept his invitation.

Beneath the geniality, and the offer to put relations right with Australia and New Zealand, Bainimarama is threatening them with a loss of influence as he turns to alternative aid donors, China and India.

China in particular, represented in Fiji by Ambassador Han Zhiqiang, has increased its development assistance to Fiji considerably in recent years, and a Chinese company Sino Hydro Corporation is building a major hydro-electricity project at Nadarivatu. Bainimarama is making no concessions about his program to transform Fiji, insisting again that elections will be deferred for five years. Even five years, he says, is a short time, suggesting he may believe a longer period of military rule is needed before the return of democracy.

Bainimarama is under more pressure at home and abroad than at any time since he took control of Fiji in December 2006.

At home he has been deserted by Mahendra Chaudhry, a former Labour prime minister who welcomed his coup and served until August 2008 as his Finance Minister. Chaudhry, who has a strong following among Fiji Indians, has denounced him as autocratic and called for early elections. Support for Bainimarama among the majority population of indigenous Fijians, weak in the first place, is now weaker than ever as prices rise in the wake of the recent devaluation of the Fiji dollar, the economy slumps and jobs are lost.

Abroad he has lost UN support for the participation of Fijians in new UN peacekeeping missions. Those missions were responsible for expanding the troop strength of the Fiji Military Forces in the first place, and offered the overseas experience that makes it such a formidable holder of political power in Fiji today. Above all, UN peacekeeping has given Fiji’s soldiers good money in a country where it is hard to find.

Now Fiji has become the first Pacific country to be expelled from the Pacific Islands Forum. The Forum, which Fiji helped to found in 1971, brings together the 16 independent and self-governing states of the Pacific Islands and is the leading regional organization. Forum leaders threatened Fiji with expulsion if Bainimarama did not set a date for elections by May 1, 2009, and hold them by the end of the year. Earlier coup regimes in Fiji have easily survived expulsions from organisations such as the Commonwealth, but this action is an unprecedented regional rebuff, which, added to Fiji’s other troubles, is likely to further undermine domestic support for the country’s self-appointed prime minister.

1. Preventing Fiji from becoming the pariah state of the Pacific
2. Fiji and The Forum
3. A year of greater entrenchment for Fiji’s military regime

The October 2008 decision of the Fiji High Court which provided support for the continued rule of Commodore Frank Bainimarama and the military was roundly condemned, especially by lawyers and academics. There was vociferous encouragement for a legal challenge to the country’s Appeal Court, although the capacity of members of this court to over-turn the decision and pronounce against the country’s military rulers was itself questioned.

Only a few people, including myself through this Forum, publicly warned that the legalistic condemnation was unwise. The reasoning behind the warning was that attacking the High Court’s decision in order to defend the over-turned government headed by Laisenia Qarase and the sanctity of the 1997 Constitution was not politically sound.

On April 9, 2009 the critics of the earlier judgment received what they had asked for. The Appeal Court over-turned the previous decision and advised the President to appoint an interim government. In the words of the judgment, such a government should be headed by a ‘distinguished person independent of the parties to this litigation as caretaker Prime Minister’.

Immediately sections of the press, some lawyers and academics hailed the decision. Rowan Callick lauded the ‘three gutsy Australian judges’ who comprised the Appeal Court. The same paper’s front page news report pointed out that the judges do not live in Fiji and left the country immediately after handing down their decision.

However the decision, wrapped up in all its legal niceties, left others in Fiji’s ruling circles to take responsibility for what could follow from the actions of the three departed judges. Immediately Fiji’s President did so, at the same time as the military and police acted to re-assert their authority.

Abrogating, finally discarding the 1997 Constitution, the President has appointed himself as Head of State, the military chief Bainimarama as interim PM and promulgated a new Public Emergency Regulation. The possible date for elections has been pushed out to 2014. It appears as if all members of the judiciary have been removed but it is uncertain what this will mean for the operation of any of the country’s courts. In short, whatever remained as liberal democratic in the country has been at best further weakened.

The international condemnation has already begun, from the USA, Australia and New Zealand, which is hardly surprising, and from within Fiji. The local objections show how difficult it would have been to find a neutral ‘distinguished person’ where all politics reflects the deepening split in the country’s commercial and political elite. Equally predictable are the terms of the protests, that the former President, now Head of State should be defending the 1997 Constitution and ‘the rule of law’. Why exactly this flawed document and some of the institutions which flowed from it should be defended is rarely explained in the cacophony of outrage.

Many years ago the silly claim that sport and politics can and should be kept separate was demonstrated to be patently false. Now, once again, three judges and their backers have tried to pretend that the law and politics are separable, not tied together. The appeal against the High Court’s decision has been shown to be foolhardy, and the 1997 Constitution is gone: where now for the bulk of the Fijian population who have to live with the consequences of attempts to defend the indefensible?

1. Qarase v Bainimarama: Fiji’s Constitution under fire
2. The politics of constitutionalism in Fiji
3. Bainimarama’s high-stakes game

East Asia contains three of the world’s semi-presidential democracies (as pointed out in the latest APEC Economies Newsletter here) : Taiwan, Mongolia, and East Timor. Each of these countries is an unusual case of democratisation: Taiwan is one of East Asia’s famous ‘tiger’ economies and the world’s only Sinitic democracy, but faces an ongoing crisis of nationhood; Mongolia is one of the few unambiguous cases of a successful transition to democracy and a market economy in the post-Communist world; while East Timor is both Asia’s poorest nation and its newest democracy. Prior to their democratic transitions, each was also under the influence of a large foreign power — be it Russia in relation to Mongolia, Indonesia in East Timor, or China’s claim to sovereignty in relation to Taiwan. This is not a propitious starting point for a transition to democracy; indeed, in different ways, each country seemed to lack some of the essential preconditions for successful democratisation.

Nonetheless, each has succeeded to the extent that successive free elections and peaceful changes of power have now occurred.As part of their transitions to democracy, East Timor, Mongolia and Taiwan each chose semi-presidential constitutions. Semi-presidentialism is an increasingly popular constitutional model which combines a directly elected president with significant powers as well as a prime minister chosen by the legislature. France and Portugal are long-standing examples, along with many new democracies in Eastern Europe and Southern Africa. In Asia, East Timor, Mongolia and Taiwan are all clearly semi-presidential in the sense of having ‘a popularly elected, fixed-term president existing alongside a prime minister and cabinet who are responsible to parliament’.

However, their presidential powers of each differs considerably: Taiwan’s constitution grants extensive powers to the president, while in East Timor the president is largely a symbolic figure whose most important power is as supreme commander of the armed forces — a provision that was to have great importance during the internal conflict in East Timor in 2006. Mongolia sits somewhere between these two in terms of the scope of its presidential powers.

Despite their status as competitive electoral democracies, national politics in each of these countries has been hampered by recurrent problems of gridlocked government, political instability and politically-motivated violence during periods of ‘divided government’ when the president and the majority of the legislature come from different political parties. These pathologies are due, in part, to their semi-presidential constitutional structures, particularly the propensity of such systems to deliver periods of political cohabitation. These ‘split majorities’ have had a pronounced negative impact on political stability and effectiveness, weakening the consolidation of democracy in each of these three cases.

For significant periods of their recent democratic experience, the phenomenon of divided government placed immense pressures on the developing political systems of Mongolia, Taiwan and especially East Timor. One reason for this is that in each case, the initial period of divided government came early in the country’s democratic experience, and many of the political actors had no real sense of how to deal with it. Moreover, divided government brought with it a series of political problems that undermined political institutionalization, turning national politics into a competition between powerful individuals. This led to familiar patterns of political polarization, instability and violence emerging in each country, although a markedly different levels. While the severity of these differed considerably – the crisis in East Timor, for instance, was clearly of a different magnitude from that of Taiwan or Mongolia – the incidence of these problems of political polarisation, instability and violence can be compared to those times when unified governments were in place in each country.

Mongolia had the shortest period of divided government, with cohabitation lasting four years, from June 1996 to July 2000. East Timor’s period of divided government can be assessed as lasting from April 2002, when Xanana Gusmão won the country’s first presidential election with a massive 87 per cent of the popular vote, through to Mari Alkatiri’s resignation and replacement by Jose Ramos Horta as prime minister in July 2006. Taiwan’s experience of divided government was a constant throughout Chen Shui-bian’s presidency, from 2000 to 2008, as his Democratic Progressive Party controlled executive power but the opposition ‘pan-Blue’ coalition, led by the formerly-ruling Kuomintang, maintained a majority in the legislature.

One way of illustrating the problems of political stability in these semi-presidential countries is the World Bank’s Governance Matters database, which includes an aggregate measure of ‘political stability’ for all states drawn from a combination of public and private sources. This ‘political stability’ measure combines indices of politically-motivated internal and external violence in a given country with a separate measure of government durability, that is the government’s ability to carry out its declared programs, and to stay in office. As shown in Figure 1, which compares these indicators for each of the three country cases over the past decade, political stability tends to decline during periods of divided government.

Source: Kaufmann D., A. Kraay, and M. Mastruzzi 2007: Governance Matters VI: Governance Indicators for 1996-2006

In Mongolia, for example, the stability measures were at their lowest during the 1997–2000 period of cohabitation, but have risen since the resumption of single-party rule, at least until the aftermath of the 2008 parliamentary elections. In Taiwan, too, stability measures were at their highest in the late 1990s but declined with the election of President Chen Shui-bian in 2000 which ushered in Taiwan’s period of divided government, with the lowest levels reached in 2006. In East Timor, stability declined sharply between 2000 and 2002 as the UN administration prepared the country for independence, and have since declined considerably further, with the lowest levels reached in 2006 when the standoff between Prime Minister Alkatiri and President Gusmão came to a head.

These indicators help illustrate a key point: while semi-presidentialism has its benefits, it places unusual strains on new democracies. In particular, periods of divided government can put great stress on the stability of countries which have not yet developed established practices of political coexistence. In addition, the uncertainties of constitutional law in situations of shared power create their own problems: in these three country cases, disagreements over which particular office would exercise which particular constitutional powers was a recurring source of conflict. No constitution can codify all situations which office-holders are likely to face, meaning that even the most thorough constitutional text will inevitably leave some grey areas unspecified. This is a particular problem for semi-presidential constitutions, as it is precisely those grey areas of uncertainty which can provide the basis for ongoing conflict.

1. Is Thai democracy really so bad?
2. What’s still wrong with Indonesian democracy
3. The East Asia Summit: ASEAN’s forum for maintaining peace

Much has been said about the financial crisis and its potential impact on PNG. Both the Minister for Finance and Treasury and the head of one of the country’s major superannuation funds say that the economy will be relatively immune.

Yet, the Secretary of the Treasury and now the Bank of PNG have voiced concerns about the negative impact of falling GDP growth, reduced export and Government revenue, and a reduction in foreign investment. What should we make of the situation in PNG, and how is this crisis likely to affect the country over coming months and even years?

The good

Things are not all doom and gloom. Many domestic policy makers are even talking positively about the affects of the crisis.

The positive interpretation is partly justified by the huge volumes of foreign exchange reserves built up over the past 6 years meaning that the economy is unlikely to suffer a repeat of the foreign exchange shortages of the 1990s. It is also widely thought that a slowdown in the global economy may help to cool off Government revenue growth, which has been increasing at a dramatic rate since 2002. This would require the Government to consolidate on its recent revenue gains and also help to dampen inflation which has recently reached double digit levels. PNG is also much less dependent on both remittances and tourism revenue than other countries in the region. These two ‘advantages’ mean that it is unlikely to feel any significant pain from a drop in earnings from both activities.

In terms of the stock market, the initial phase of the crisis also left the POMEX relatively unaffected – despite some sensationalist headlines in local newspapers. The small decline which did occur during August and early October resulted mainly from those stocks which are double listed on both the POMEX and ASX markets, and the corresponding falls in their Australian listing.

A significant Kina appreciation against most of PNG’s major trading partners over the last two months will also help to curb rising domestic inflation a large portion of which has been from imported sources. The Kina has appreciated against the Australian Dollar by as much as 45 per cent since August this year. This change will also help lower the Governments foreign debt repayment obligations.

And the global drop in oil and gas prices will be warmly received by many in PNG who have been struggling with higher fuel and energy costs.

The bad

But the argument that PNG is immune from the current crisis overrates the resilience of the economy. The exchange rate appreciation has dramatically reduced the competitiveness of PNG exports; particularly exports of labour-intensive products from manufacturing and agriculture (coffee, copra and oil palm). Stagnation in these sectors will dampen the already minimal employment creation from the recent commodity boom.

If global oil and gas prices continue to remain low, or decline further, question marks may begin to emerge on the viability of the PNG gas pipeline project. The project entails over US$1 billion of investment by the Government, and a cancellation or delay in the project would be a disaster for current fiscal policy and future revenue growth.

Perhaps the most important impact of the crisis however relates to PNG’s ever fluctuating foreign exchange reserves. Concerns about falling foreign exchange earnings have been dismissed on the basis of current earning levels and the large stock of reserves which have been built up since 2002. This is certainly true. PNG currently has record levels of foreign exchange and any drop in earnings would have to be large and sustained for any negative side effects to emerge. But this underestimates how quickly circumstances can change in the land of the unexpected.

A large portion of PNG’s foreign exchange reserves are currently invested by a number of international investment firms. A portion of these asset values have declined substantially over the past months both from exchange rate revaluation and share price losses. Central Bank Governor, Wilson Kamit, has also highlighted the potential impact that the crisis may have on the earnings of PNG’s superannuation funds. Both Nambawan Super and Nasfund have approximately 20 per cent of their assets invested in off-shore equities. The affects of this on their balance sheets will also be combined with a loss in value of many of PNG’s dual listed companies, which have recently begun to fall prey to the crisis.

Potentially, the biggest risk to reserve levels will be if, over the longer term, PNG’s key export markets, Asia in particular, begin to implode. As the ADB recently announced in its latest Pacific studies series, ‘PNG’s commodity price boom is over’. Profits for a number of major mining companies are expected to decline substantially this financial year and this will have obvious consequences on both government revenue and export earnings. The true extent of these effects will be difficult to tell until the BPNG releases its Annual Monetary Policy Statement at the end of the year.

The ugly

Even more worryingly, despite its initial resilience, in the last week the PNG stock market has begun to feel the fallout from the global turmoil. In one week the share market dropped 13 per cent as Oil Search shares plummeted by K3.40 (34 per cent) amidst expectations of a slowing global economy. While share prices recovered in the following week, this volatility demonstrates that PNG is not immune from the crisis and almost certainly reflects the markets’ increased understanding of the consequences of a sustained downtown in the global economy.

Liquidity is not a major issue in the region at present, though the Bank South Pacific with a credit rating of B+ (S&P) could in future face a ‘run to quality’ given the AA (S&P) ratings of its major competitors, ANZ and Westpac. The recent deposit guarantee provided by the Australian PM to the latter two may exacerbate these pressures with a flow of funds out of the Pacific towards safer Australian shores.

Tighter global and regional credit markets will also increase the cost of obtaining international finance and are likely to reduce private investment flows to PNG. Higher borrowing costs in turn will limit potential funding for new projects. The fall in global commodity prices will make many commodity-based projects appear less profitable, further restricting growth across a number of sectors of the PNG economy.

Easily the biggest threat to PNG’s continued economic expansion, however, is that the regulatory and institutional environment raises costs prohibitively, in particular for small scale investments. PNG now ranks second last out of ten Pacific Island countries in the World Bank’s 2009 Cost of Doing Business index, sliding back from position 89 to 95 in the world over the last year. For the most part, medium to large scale investment activities have overcome the high costs of operating in PNG’s regulatory and institutional environment by obtaining tax concessions and operating subsidies from the Government. These options are generally not accessible to smaller scale entrepreneurs who face the full cost of the PNG business environment. This has dramatically limited the flow on or ‘trickle down’ effects of PNG’s post 2002 economic boom which has been driven by large scale enclave development in mining and resource extraction. Without broad based growth and a diversification of export and government revenue sources away from mining and resource extraction PNG will continue to remain highly vulnerable to external shocks to the global economy.

Conclusion

PNG has made significant gains in its macroeconomic and fiscal position over recent years, and the risks to macroeconomic stability in the short to medium term are in all likelihood not that large, provided Asia holds up. But a sustained slow down in the global economy is a large longer term risk for PNG and the brunt of the current crisis is likely to be felt most heavily by rural and agricultural workers who find that they are no longer competitive in international export markets.  The impact of a global slowdown will be on the poor.  Those at the margins risk falling into poverty.  The plight for the already poor will get a lot worse.

A reduction in commodity prices will significantly cut government revenues and Secretary Tosali’s concern about the potential impact of the crisis on PNG’s fiscal position is real. Fiscal belt tightening, and more importantly, prioritization of expenditures towards productivity enhancing sectors will be required to help lessen adverse impacts of the global slowdown.

Until the PNG Government addresses the structural constraints on growth by reducing the formidable costs of doing business in PNG the gains from episodic resource booms will continue to remain fragile.  This is one reason why the much talked about macroeconomic improvement has failed to translate into improvement in the wellbeing of the population at large.

1. Chinese Growth and the Financial Crisis
2. China not immune from the US financial crisis
3. India: Confronting the Global Financial Crisis

The third and final element of my proposal for assisting the Pacific achieve improved development outcomes involves underwriting law and order via the South Pacific Forum. Specifically, I am proposing a short-term, a long-term, and a bridging strategy to improve law and order within the island-pacific. The short-term strategy entails members of the Pacific Island Forum, as a collective entity, under-writing law and order in each of its member nations. This will require members first agreeing to a regional external intervention should laws of any state be usurped. This does not tread on their sovereignty since each individual state has the right to form its own laws; but then has to abide by these laws which have already been approved and legislated by its own legislature.

Credibility is critical for this strategy to deliver on intent. Multilateral commitment would be necessary for the above. The South Pacific Forum is the natural home for such an agreement.If credible, the Agreement could be cost effective in instilling law and order and insuring against coups in the region. Australia, as the largest and richest member of this Forum, would have a pivotal role in this initiative. A credible multilateral commitment to restoring law and order if and when it breaks down in any member state could be enough to deter civil disruptions in the first place. Australian backing to such a commitment and her willingness to lead a mission should the need arise, is critical for this strategy to deliver on its intent. The long-term strategy is that of creating the conditions for voluntary compliance with the laws of the state by the majority of her citizens. The incentives for such compliance has to be founded in the belief that the rewards of complying with the rules and regulations of society, even without the threat of punishments by outsiders, far outweigh the costs of doing anything less. This requires raising the prospects of development for the region such that the incentives are for value-adding effort rather than those for predation.

If economies grow sufficiently to absorb those requiring work and be in a position to provide opportunities for sustainable livelihoods for the majority, then prosperity would be the girder on which peace and stability could rest. Furthermore, a sufficiently large tax base would allow the nation state to control criminals with its own resources. While under-writing law and order in the individual states will lower the risk premiums for private investors, the increased investment will be realised only after investors are convinced that the commitment will withstand the test of time. Thus, the rise in growth of income and jobs from an assurance that law and order will prevail can only be a long-term strategy. Temporary access to jobs in Australia for those in need of the above together with improved access to training and healthcare at home (as argued in (i) & (ii) above) has the potential to ‘jump-start’ the process of job creation and growth of production.

1. Interventions to assist the Island Pacific
2. South China Sea developments at the ASEAN Regional Forum
3. Japan’s aid to the South Pacific and the China factor

The level of access to basic services such as primary education and basic healthcare varies considerably across the nations of the Southwest Pacific. PNG ranks low, if not the last, on this count. Its geography in the form of the rough terrain and archipelagic nature, history in terms of a highly fragmented and sometimes strongly divided society, and climatic conditions which makes malaria (and other vector-born diseases) endemic to the nation is major handicaps to universal and effective delivery of basic services. The recent arrival and galloping spread of HIV compounds the problems many fold.

Education is critical for development. The international community, via the 2nd Millennium Development Goal (MDG), committed itself to achieving universal access to primary education by 2015. This same MDG also targets the elimination of gender disparities in primary and secondary schooling. While this goal may be achieved at the global level, the same is unlikely to be true for the Pacific region. Australia, moreover, will carry some blame for this failure. Any progress on MDG#2 within the Pacific Islands requires significant improvements in enrolment rates and primary school completions in Papua New Guinea. This is so for three reasons: (i) PNG is the largest country within the island- Pacific, accounting for some 6 million of the 8 million inhabitants for the region as a whole; (ii) PNG lags the most in terms of school enrolments; and, (iii) gender disparities are the largest for PNG. Primary school enrolment statistics from the National Department of Education (NDOE) and population census from the National Statistics Office (NSO) show that only 53 percent of children in the 6-14 year age cohort are in primary school. This means that some 680,000 children of school age are not enrolled in school. Girls comprise 45 percent of children in elementary and primary school. But only 29 percent of girls who enter grade 1 complete primary schooling. And gender disparities widen as students move up the education ladder. Furthermore, the quality of education delivered is poor. A recent survey reported that some 37 percent of primary school graduates were unable to read or write. Australia shares some responsibility for the above.

PNG is the largest recipient of Australian aid. A significant proportion of this aid is channelled to the education and health sectors. PNG, as of 2006-07, accounted for approximately 30 percent of total Australian ODA. Education and Health sectors received some 10 and 11 percent, respectively, of the total. In terms of progress made on the second MDG, that of universal access to primary education, the most recent data – that of 2004 – reveals PNG ranking last within the Pacific Islands and only marginally above Nepal within the Asia-Pacific region. The reality could be worse since some recent updating of the data suggests that the initial estimates may have been optimistic. Australian aid is being scaled up. Some of this rise will flow on to PNG, and to the poorly performing island nations within Australia’s neighbourhood. We could, with these additional funds, do more of the same old programs and projects. This would be a risk-averse strategy. Much of the efforts to date have been targeted at funding teachers, school buildings, road, etc; the focus, in short, has been on increasing inputs with the assumption that bumping up inputs will lead to increased outputs and improved developmental outcomes. Hindsight suggests that the assumption of a tight relationship between inputs and outputs is flawed.

I propose that we can be more ambitious in getting better value from our aid. Specifically, aid funds can be used to directly purchase outputs from individual suppliers. The analogy of coffee shops takes us far on this proposal. Good coffee gets supplied wherever there is a market for the above. Could a similar model be used to improve access to quality primary education in PNG? Some experimentation and learning would be necessary to make this work with ODA. I propose a Progress Education Fund (PEF) that will ‘buy’ progress on primary school completions and in terms of the number of students passing the national exam in the graduation year.

This proposal has its genesis in the Cash-On- Delivery (COD) mechanism that has several advantages over the current system of input subsidisation. Five of these are enumerated below. (i) It uses existing machineries of the PNG Government, thus will strengthen existing delivery mechanisms. (ii) It takes resources to the frontline of service delivery, thus bypasses the centre. (iii) It is administratively low maintenance as the requisite data for PEF is already collected by the provincial authorities. (iv) The risks of gaming the system is contained by the fact that exams are set and administered nationally. (v) The proposed scheme is consistent with the 2005 Paris Declaration that seeks to increase local ownership of aid-funded programs, is focused on results (with flexibility on mix of inputs used for the deliverables), is aligned with Government priorities, and delivers funds on a predictable basis. The PEF pays for progress made in terms of throughput from primary schools and the quality of education delivered. The emphasis is on standards and outputs while structures to deliver the above are left to the discretion of local suppliers of the service.

1. Evidence-based policy for basic education in the Philippines
2. Interventions to assist the Island Pacific
3. Local versus central governance in China: Providing basic public services

Just like the 1990’s trust accounts are shaping up to be a defining component of how PNG manages its resource revenues in this decade. Unlike the 1990’s however current revenues are being channeled into numerous smaller trust accounts instead of the single consolidated Mineral Resource Stabilization Fund (MRSF). Has PNG learnt from its mistakes or is it heading towards a repeat of the past? To answer these questions it is necessary to understand why these trust accounts have increased so much in prevalence over the last few years and what implications this has for fiscal management.

Some Background

Trust funds have played a significant role in the management of fiscal resources in PNG since independence, especially in relation to absorbing the volatile revenue streams generated by mineral and resource extraction. With the commencement of the Panguna Copper Mine in Bougainville the Government created the Mineral Resource Stabilization Fund (MRSF) with legislation coming into force in 1974. The MRSF was designed to receive all of the Government’s revenue derived from mining taxes rather than having them flow directly onto the Budget. The Fund was then used to distribute these revenues to ensure a smoother allocation of resources over time and so that they could be used more effectively.

Despite a promising start the MRSF was however notoriously mismanaged. Even prior to the closure of Bougainville Copper in 1989, moves were made to relax the provisions of the Act in 1986 to give Government greater discretion in making withdrawals from the Fund. By 1998, the draw down from the MRSF to the public account totalled K330.1 million comprising 18 per cent of the government’s domestic revenue. Then in 1999 a decision was made to draw down the entire remaining balance of the fund (a total of almost K1 billion) to cope with a looming public debt crisis.

In addition to withdrawing excessive amounts from the Fund, successive governments paid little attention to providing processes and policy settings to ensure revenue was spent on building infrastructure or other productivity and capacity enhancing projects. Following the emptying of the Fund a decision was made to repeal the MRSF legislation, which became effective in December 2000.

Current Trust Account Usage

This situation is now having consequences for the current fiscal management of resource revenues. Government held trust accounts are held by agencies across the PNG public sector and were initially established to hold counterpart funding between PNG and donor agencies but their roles have varied over the years. The Department of Finance holds upwards of 29 accounts, the most important of which are the Supplementary Budget accounts where funds are transferred when revenue receipts are above those estimated in the Budget – which has been the case since 2002.

By the end of 2007 windfall revenues in Trust which had been designated for future investment reached about 17 per cent of GDP. As of 31st May for example the 2006, 2007 and 2008 Supplementary Budgets had appropriated K476.9 million to the health sector. Of this just 28.6 million (6 per cent) had been spent with the remaining K354.3 million paid into trust. Similar figures exist in the education and law and justice sectors. In total, if total unspent funds were treated as savings for the 2007 Budget this would have raised the estimated budget surplus to 11.4 per cent of GDP.

Is this sensible economic policy?

Why are Trust Accounts becoming so important to PNG Fiscal Management?

The major advantage of using these trust accounts is that they allow the Government to smooth their expenditures over time. This limits the impact of the current revenue boom on the already stimulated levels of aggregate demand, helping to curtail inflationary pressures which have recently reached double digits.

A slower release of mineral funds also improves the ability of the bureaucracy with its limited implementation capacity to focus on the quality of expenditures as well as limit the amount of economic rent seeking occurring within the economy. Another advantage of these trust funds over a consolidated fund such as the MRSF is that they allow additional unspent revenues to be allocated to a specific purpose whereas expenditures financed from the MRSF tended to fund general government consumption.

Domestic politics places a high priority on allocating available funds to particular activities. A number of political difficulties would arise if the Government was seen to be ‘holding on’ to these revenues without any plans for their expenditure. Specific purpose trust funds are also much less visible than a consolidated fund which history has shown tends to attract a large amount of pressure for higher expenditures making it more difficult for inter-temporal expenditure smoothing. In essence, these trust funds are allowing the Government to allocate funds without actually spending them which is appealing in both an economic and a political sense.

What Issues has this created for Fiscal Management?

The first and most obvious disadvantage of this approach is that holding such a large amount of revenues in trust for extended periods is clearly a second best policy to simply repaying the declining, but still high, levels of Government debt. New borrowing into the future would then allow inter-temporal expenditure smoothing and forego current debt repayment obligations.

The political reality of PNG fiscal management however suggests that this would be a difficult approach. The Government is already allocating a large portion of its resources to debt repayment in line with the Medium Term Debt Strategy, and it must be seen to be making new large scale productive investments in the physical and human capital of the country. Trust funds allow the Government to do this whereas debt repayments do not.

Another issue to be considered is that the opportunity cost of keeping this money in trust accounts is high. The numerous accounts which these funds are being held in also means that they have limited potential to generate higher rates of return from a more diversified portfolio base. Ex-Treasurer and now Opposition leader, Bart Philemon picked up on this issue in his reply to the Somare Government’s 2008 Budget. In it he highlighted that a total of K4.67 billion in public money was sitting in various trust accounts ‘doing nothing’. This included K515 million in the Bank of Papua New Guinea, K400.9 million in the Bank South Pacific, K197.1 million in ANZ (PNG) Ltd and K186.6 million Westpac (PNG) Ltd.

Perhaps the most important issue to be raised by the dramatic increase in the usage of these trust funds is the unclear management responsibilities and governance arrangements which surround their usage. In the 1990s and early 2000s trust accounts were the source of widespread misuse and extortion of government funds. During this period there were an estimated 3,000 separate accounts which combined with poor financial controls meant that it was difficult to trace or prevent illegal activities. Following a review in 2004, Treasurer Philemon declared a large portion of these to be redundant and the number was brought down to an estimated 300. Whilst the reduced number of accounts and improved financial controls will help prevent further misuse, confusion over their number, size and management still exists and may reduce their effectiveness and create further bottlenecks in financial control.

Some progress has been made in terms of transparency with the publishing of trust account details in the 2007 Mid Year Economic and Fiscal Outlook (MYEFO) but this is not a legal requirement and in the event that politicians wished to start hiding activities could be easily stopped. The Government’s Medium Term Fiscal Strategy (2008-2012) also places a limit on spending from trusts with total expenditures not too exceed 4 per cent of GDP. This may help to limit a potential raiding of these accounts but the threshold has not been reached yet and therefore whether it is binding has not been tested.

Finally, the Government has not articulated a strategic policy to address the implementation bottleneck in the system of government. Whilst holding onto revenues to limit their inflationary impact is important, much of the current lack of disbursement almost certainly reflects limited public sector capacity. For this to change a more competitive system of public sector employment conditions needs to be implemented so that the bureaucracy is more capable of managing productive investments which expand the supply of physical and human capital in the economy.

Concluding Remarks

Government held Trust accounts are playing an increasingly important role in the fiscal management of PNG. This approach of smoothing expenditure allocations from the current revenue boom offers a number of advantages but is probably the second best option in lieu of simply repaying government debt and borrowing into the future. The development of this approach has also been relatively ad-hoc at best and the management responsibilities are still unclear and need considerable improvements. If trusts are going to hold such a significant portion of government revenue then they need to improve their transparency and much of the confusion around their governance and accountability structures needs to be clarified, both to Parliament and bureaucrats.

1. Managing the boom in mineral revenue in Papua New Guinea
2. Papua New Guinea: from economic boom to gloom?
3. Papua New Guinea: The informal economy and the resource boom

A recent report by the CIS, describes the emergence of a dual or ‘bi-polar’ Pacific where two groups of islands have displayed markedly different demographic characteristics and different employment social and educational outcomes. The conflict in the Solomon Islands, Fijian coups, raskol gangs of Papua New Guinea, and stagnation of Vanuatu are contrasted with the relatively high growth success stories of Cook Islands, French Polynesia, Guam, New Caledonia and Samoa..

So what can be done to help the Pacific correct its ‘bi-polar’ tendencies?

In a recent Submission to the Australian Senate I proposed three specific interventions which would assist in this regard. The first is to encourage a freer trade in goods and factors of production including labour from the neighbourhood. The second is support for improved access to basic healthcare and universal access to primary education; and, the third is to under-write law and order within Pacific states by cooperating with the members of the South Pacific Forum.

I shall discuss the first of these in more detail now and leave the remaining two issues for future blogs.

There is considerable consensus within the economics profession that freer international trade improves economic prospects for the participating economies. Australia’s own lessons with a century long experimentation with trade protection and productivity growth is instructive in this regard. The Closer Economic Relations Agreement (CER) with New Zealand is a stark and recent reminder of the above. I submit that serious consideration should be given to extending the CER facility to PNG and the rest of the island nations in the Southwest pacific. This can happen progressively over time with continuous fine-tuning of policies.

The recent shift to allowing guest workers from the islands into Australia for fruit picking jobs under a pilot project, is a first step. The economic case demands a lot more. An open and deep market such as that founded on the CER arrangement will allow for two-way flows of goods, services, workers, investors, etc. I would like to see goods flow between the region as freely as workers, investors, retirees, and tourists (but bearing in mind security implications, such as terrorism, some regulation will be required). Australia can initiate this unilaterally, possibly on reciprocal basis, but doing so multilaterally – say on the Most Favoured Nation (MFN) principle – could be even better. I am arguing for progression, with Australian leadership, towards a single economic market for the Pacific; and, solely on its economic merits. The ensuing political and security gains would be a bonus to the above.

1. Interventions to assist the Island Pacific
2. Fairtrade and its (unexpected) consequences for the Pacific Island Countries
3. Glimmers of hope for the Pacific?