Information about Asia and the Pacific Asia y el Pacífico
Chapter

II Setting of Economic Reform

Author(s):
Ichiro Otani, and Chi Pham
Published Date:
May 1996
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Information about Asia and the Pacific Asia y el Pacífico
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The Country at a Glance

The Lao P.D.R. is a landlocked, largely mountainous country in the center of the Indochina peninsula. Rugged terrain and elevations separate the country from Myanmar to the northwest and China to the north, and much of the Annamite chain stretching along its eastern flank acts as a natural barrier to Vietnam. The Mekong River, however, has served traditionally as a connecting link to Thailand to the west and Cambodia to the south.

The country is characterized by pronounced ethnic, cultural, and linguistic diversity. Reflecting primarily the altitudinal stratification of settlement, one classification differentiates the Lao people roughly as Lao Loum (“valley Lao”), Lao Tai and Lao Theung (“mountainside Lao”), and Lao Soung (“mountaintop Lao”). The Lao Loum, often referred to simply as “Lao,” originated in southern China and settled along both sides of the Mekong River and its principal tributaries. Forming the largest single group, with a share in total population estimated at between one third and one half, the Lao Loum have traditionally played a significant role in culture and politics.

With an area of about 237,000 square kilometers and a population estimated at some 4.5 million (Table 2), the Lao P.D.R. is as large as the former Federal Republic of Germany or the United Kingdom, but it is sparsely populated—particularly in the mountainous north and east—in comparison with neighboring countries or the rest of Asia. Most of the people live in farming areas in the lowlands. However, spurred by the Vietnam War and an extended period of internal political struggle, urbanization has been proceeding rapidly. Whereas just 8 percent of the population was urbanized in the mid-1960s, today about 20 percent of the Lao people live in cities, notably the capital of Vientiane, which contains roughly half of the urban population.

Table 2.Economic and Social Indicators: Lao P.D.R. and Neighboring Countries
CambodiaChinaLao P.D.R.Myanmar1ThailandVietnam
Area (in thousands of sq. km.)1819,561237677513332
Agricultural land (in percent of total)21537164721
Population (in millions)91,1765455971
Density (persons per sq. km.)511231966115214
Urbanization2122720262420
Agricultural employment (in percent of total)5686655772
GDP per capita (in U.S. dollars)19436735832,102166
Exports per capita478521562240
External debt per capita46010312144957
Share of state enterprises in nonagricultural employment (in percent)39651319
Life expectancy at birth5 (in years)516951606967
Infant mortality61163197722636
Child (under age 5) mortality6169381581003144
Access to safe water27829337250
Adult illiteracy765274219712
Female illiteracy783867281016
Primary school enrollment ratio125101102114103
(Average 1990–93 growth, in percent)
Population2.51.22.92.21.52.3
Urban4.82.26.33.44.43.2
Real GDP6.811.45.73.67.87.4
Agriculture3.90.9-4.33.03.03.8
Industry11.48.012.43.811.410.8
Consumer price index123.38.19.828.54.439.8
Broad money74.929.641.631.117.941.7
Exports (in U.S. dollars)4.613.943.412.216.918.1
Real effective exchange rate8-4.46.023.6-0.43.9
Sources: Lao authorities; and World Bank and IMF staff estimates.

Data refer to fiscal years starting April 1.

In percent of relevant population.

Per capita income was $1,232 at the official exchange rate and $66 at the parallel market rate.

Excluding debt to the nonconvertible area.

Based on 1992 data.

Per 1,000 live births.

Based on 1990 data; in percent of relevant population.

Positive entry indicates appreciation.

Sources: Lao authorities; and World Bank and IMF staff estimates.

Data refer to fiscal years starting April 1.

In percent of relevant population.

Per capita income was $1,232 at the official exchange rate and $66 at the parallel market rate.

Excluding debt to the nonconvertible area.

Based on 1992 data.

Per 1,000 live births.

Based on 1990 data; in percent of relevant population.

Positive entry indicates appreciation.

About 60 percent of the country is estimated to be covered with dense tropical forests, and only about 10 percent of its area is considered arable. Actual cultivated area is just under 15,000 square kilometers, including some 6,000 square kilometers classified as “shifting cultivation” land. The transportation system is generally weak, and major areas remain virtually inaccessible during the rainy season. Agricultural production is, therefore, still largely subsistence oriented. Furthermore, because only a fraction of the arable land is irrigated and most farmers lack access to improved inputs and essential technology, yields are low and depend heavily on the weather. Rice is by far the most important crop, accounting traditionally for over 80 percent of planted acreage. The country is, however, barely self-sufficient in food production and has repeatedly had to resort to imports.

The proportion of forests that are largely intact in the Lao P.D.R, is one of the highest in Asia. Forestry products were, therefore, traditionally among the few major foreign exchange earners. During the past 25 years, however, forest resources have declined rapidly. The rate of exploitation accelerated in the second half of the 1980s, when demand from neighboring Thailand for these resources rose steeply following that country's imposition of a logging ban. To reverse this trend, the Lao Government has recently reduced the number of logging permits drastically. (For a discussion of environmental issues in the Lao P.D.R., see Box 2.)

Box 2.Environmental Issues

Owing to the modest size of the industrial and mining sectors, environmental concerns in the Lao P.D.R. are chiefly related to the agricultural and forestry sectors, particularly in four areas: (i) forestry resource management; (ii) biodiversity conservation: (iii) land resource management; and (iv) water resource management.

Forestry resource management. The Government has been experiencing increasing difficulty in forest resource management as it has been unable to control effectively the depletion of forest resources. Although forest coverage in the Lao P.D.R. remains one of the highest in the world, forest depletion took place at unsustainable rates in the 1970s and 1980s, as wood extraction and encroachment by the farming population increased rapidly. In addition, returns from such depletion only partially accrued to the Government, owing to widespread illegal logging, clandestine exports, and inadequate pricing. Thus the Government, with World Bank assistance, now aims at striking a balance between sustainable wood production and environmental protection, particularly in areas in which watersheds and biodiversity are at risk.

Biodiversity conservation. Although the vast areas of intact forest in the Lao P.D.R. still allow one of the richest original habitats in the world, forest depletion had an increasingly damaging impact on the nation's rich biodiversity. Only recently did the Government approve legislation for wildlife protection and for the creation of a system of 17 protected areas, and the approach taken so far suggests that the legislation still relies primarily on command-and-control policies. The Government plans to place an increasing emphasis on providing proper incentives for the indigenous population to participate in conserving biodiversity. In order to secure the long-term support from the international community for conservation activities, the Government will consider steps to establish a conservation trust fund.

Land resource management. Even though the scarcity of land resources is not a pressing issue, use of land in the Lao P.D.R. is suboptimal. In the northern regions of the country (the uplands), population pressures on marginal land and the decrease of rotation periods are the root causes of land erosion and degradation of soil fertility. In the south, the lack of an integrated research and extension system constrains land yields to well below potential. Overall, irrigation facilities are not well developed in the lower uplands. The optimal regional and geographical specialization of agriculture—food production in the lowlands and tree plantations in the uplands—appears far away.

As in the case of forestry management, community-based resource management will be increasingly emphasized. At the same time, efforts will be made at the national level to provide policymakers with a better mapping of the overall land resources available, including the status of degradation and provisions for best land use. Concurrently, land legislation would allow a flexible allocation of land to farmers, based on land characteristics, labor availability, and possible uses, rather than maintain fixed upper limits.

Water resource management. The Lao P.D.R. is endowed with the highest per capita availability of renewable fresh water in Asia. However, with the development of hydropower schemes and increased urbanization, two serious problems may develop. First, the power projects may endanger the water catchment. Second, because of ineffective water management, coupled with insufficient resources devoted to water supply and sanitation, particularly in urban areas, water may become hazardous to public health. To deal with such potential problems, the Government is reviewing the overall environment assessment of hydroelectric projects and of comprehensive plans for water supply and sanitation improvements.

Combined with forestry, agriculture is estimated to employ 90 percent of the labor force and to account for 60 percent of GDP. Indirectly, agriculture accounts for even more of GDP, as much of the Lao P.D.R.'s small industrial sector processes agricultural products. Besides agricultural processing, the hydropower industry, which is another major foreign exchange earner, and the nascent garment industry, which thrives on foreign investment seeking to surmount textile quota hurdles, contribute significantly to the economy. The entire industrial sector accounts for little more than 15 percent of GDP.

In contrast to many other low-income countries with estimated GDP per capita of about $300, the Lao P.D.R. is well endowed with natural resources. It has untapped reserves of agricultural land, large forests, hydropower potential, and mineral resources that, when efficiently exploited, could contribute substantially to economic progress. However, the country also faces very serious disadvantages. Its landlocked position, rugged terrain, low population density, and widely dispersed settlements generate high transportation and communications costs and render broad, equitable improvements in social and economic infrastructure expensive. Furthermore, the country continues to suffer from the adverse impact of the war, including the loss of lives and the exodus of a large number of skilled laborers. Therefore, the authorities face the difficult task of promoting economic development aimed at spreading benefits evenly throughout the country.

Brief Political History

The written history of the Lao P.D.R. begins in the fourteenth century with Fa Ngoun, called the Conqueror, who, with Khmer assistance, conquered the small states of the present-day Lao P.D.R. and much of northeastern Thailand. In 1353, he united these territories into the Lao kingdom of Lan Xang (“million elephants”), then one of the largest states in the region. Fa Ngoun established Buddhism as the state religion, but this had initially little effect on the animistic majority of the population. After years of constant warfare that exhausted his people, Fa Ngoun was eventually driven into exile. His successor, a devout Buddhist, consolidated the administration, built schools and temples, and succeeded in making Lan Xang an important center of trade. Struggles with Siam and Burma began. Except for a brief period of anarchy and Burmese domination, however. Lan Xang's territory and power continued to grow until the end of the seventeenth century. Its rise culminated in the long reign of Souligna Vongsa, from 1637 to 1694, at times called the golden age of the Lao P.D.R.

After Souligna Vongsa's death, the kingdom disintegrated into three separate states: a kingdom based in Vientiane but under the suzerainty of Annam; an initially independent kingdom established at Luang Prabang; and a third kingdom, Champassak, which controlled the southern provinces along the Mekong but increasingly fell under the influence of Siam. After the occupation of Vientiane by Siam in 1778, both the kingdoms of Vientiane and Luang Prabang had to pay tribute, if only symbolic, to Siam. Later, the two kingdoms also had to pay tribute to the emperor of a rising Vietnam. The decline accelerated in the early 1800s as Vientiane engaged in a disastrous war with Siam, which eventually led to the destruction of the capital city, the forcible resettlement of its inhabitants, and the virtual depopulation of much of the central Mekong region. Additional Siamese campaigns also depopulated vast areas between the east banks of the Mekong and the Annamite chain.

After first recognizing Siamese suzerainty over the Lao region, France responded to a request by the court of Luang Prabang for protection toward the end of the nineteenth century by pressuring Siam to renounce all claims on territories east of the Mekong. About 1900. France unified the administration of the main Lao principalities in Vientiane and allowed only the royal house at Luang Prabang to retain its title and prerogatives. Laos, as it was called, remained a French protectorate virtually through the end of World War II. At war's end, however, France recognized Sisavang Vong, who had been ruling Luang Prabang since 1904, as king of an autonomous Laos. In 1947, elections to form a constituent assembly were held, and the country's first Constitution was promulgated. Two years later, Laos became an independent associate stale of the French Union and was eventually granted full sovereignty in October 1953.

From the onset, the newly independent country faced serious political and military difficulties. The Royal Government, headed by Prince Souvanna Phouma, encountered opposition from the Neo Lao Haksat (the Lao Patriotic Front), a dissident, communist-supported movement chaired by Prince Souphanouvong, a half-brother of Souvanna Phouma. The Pathet Lao, the military arm of the Patriotic Front, gradually seized control of the northeast provinces bordering North Vietnam, and, despite numerous attempts to reconcile the warring parties, Laos was de facto partitioned by the mid-1960s. As the Ho Chi Minh Trail ran through Pathet Lao territory, both sides were deeply drawn into the Vietnam War, and it was only in the context of the 1973 Paris peace agreement that a cease-fire in Laos was concluded. In April 1974, a new coalition Government was formed, and Prince Souvanna Phouma retained the post of Prime Minister while Prince Souphanouvong was appointed Chairman of the Joint National Political Council. However, in the ensuing months, the Patriotic Front steadily increased its power base by enlarging the Pathet Lao-controlled zone. Following the fall of Phnom Penh and Saigon in the spring of 1975, the Patriotic Front gained full control. When it won the elections in November 1975, King Savang Vatthana abdicated, and Prince Souvanna Phouma resigned.

Convening in December 1975, the National Congress of People's Representatives abolished the monarchy, changed the country's name from Laos to the Lao People's Democratic Republic, and elected a 45-member legislative body, the Supreme People's Council. Souphanouvong was appointed President of the Republic and of this council, and Kaysone Phomvihane, a leading figure of the Lao People's Revolutionary Party, became Prime Minister.

The Stage for Economic Reform

In the mid-1970s, the Lao economy shared many characteristics of centrally planned economies. However, certain special factors in the country's political and economic background both set the stage for economic reform and heightened its urgency.

Inheriting a war-torn and extremely underdeveloped economy in 1975, the leadership was faced with the formidable task of reconstruction and development. The crisis was heightened by the abrupt termination of U.S. aid and the disruption of cross-border trade resulting from the economic blockade of neighboring Thailand, the country's major trading partner and a key source of basic foods. At the same time, the Government experienced various setbacks in implementing measures designed to lay the foundation of the “socialist transformation” of the economy. For instance, the introduction of taxation and the collectivization of agriculture met with considerable peasant resistance, and adverse weather compounded the agricultural problems. Furthermore, as regulations increased, traders, entrepreneurs, professionals, and capital fled abroad. At the same time, a growing fiscal deficit and rapid monetary expansion, coupled with acute shortages, resulted in high inflation. The balance of payments position also deteriorated, reflecting the limited export expansion and the total dependence on bilateral agreements for import financing.

Thus, the first few years of the communist regime—the second half of the 1970s—offered little respite from falling living standards, stagnant or declining production levels, growing financial instability, and increasing internal resistance. Recognizing the inadequacy, if not total failure, of the economic measures patterned on the model of other centrally planned economies, the Government initiated a gradual move toward comprehensive economic restructuring, without abandoning its Marxist philosophy or adopting multiparty democracy, to tackle the nation's serious economic problems. Indeed, consistent with Marxist orthodoxy, the capitalist system was accorded a special transitional role and was viewed as a necessary intermediate stage on the path to socialism.

Early Reform Years (1979–88)

In December 1979, faced with a steadily worsening economy and under pressure from its creditors, the Government took its first tentative steps toward economic reform. The new policies stressed the need for increased efficiency and production, and assigned an important role to market forces and the private sector. Among the most important measures implemented were the removal of various restrictions on internal and external trade, the substantial devaluation of the national currency, the kip, and the dramatic adjustment of official prices, especially agricultural ones. The authorities hoped to draw unauthorized activities back into official channels and to revitalize the state sector. By restructuring, in particular, the grossly distorted agricultural price system, they also hoped to lay the basis for the country's First Five-Year Plan (1981—85), which aimed at reaching food self-sufficiency and promoting a balanced and diversified agricultural structure.

However, it was with the introduction of the New Economic Mechanism (NEM) in 1985 that the reform process gathered momentum. Public enterprise reform was marked by the granting of operating autonomy to enterprises, which allowed them to determine production levels and product mix, investment, employment, and wages. Thus, the system of economy-wide production targets set by the Government was abandoned. Domestic and foreign private investors were given a major role in the economy. Private sector activity was allowed in most sectors, including rice production, and restrictions on internal trade were abolished.

In addition, the Government introduced changes in financial policy. Taken in isolation, these changes were hardly revolutionary, but they marked the beginning of a series of far-reaching policy reforms in virtually all relevant economic areas during 1985–88, as the country's development strategy shifted toward more of a market orientation and a liberalization of the economy.

Price Liberalization

The dramatic adjustments in official retail and wholesale prices, starting with a ninefold increase in the price for basic rice rations in April 1985 and continuing with an average 360 percent increase in most other controlled prices throughout the remainder of the year, initially changed little in the underlying system. Repealing essentially the pattern of the adjustment at the end of 1979, the 1985 price adjustments were just sufficient to bring official prices temporarily in line with free market prices. But as the latter continued to rise—fueled in part by the necessary increase in public sector wages—the gap between the two prices soon began to widen again (Chart 1).

Chart 1.Excess of Free Market Prices over Official Prices, 1976–95

(In percent)

Source: IMF staff estimates.

1Using the weights in the basket of civil service rations.

The two-tier price system of market prices and generally much lower official prices continued to exist in 1985–89. The official prices were, in principle, set to reflect production costs plus margins, but owing to political and social considerations or inadequate accounting practices—including the application of a grossly overvalued official exchange rate—they often involved substantial subsidies. The subsidy element of the official price system grew even larger when vouchers redeemable at state shops were increasingly used for public sector payments in lieu of cash. For instance, during the period from mid-1985 to mid-1989, as much as 90 percent of public sector salaries and wages were paid in the form of so-called salary coupons that could be redeemed at state shops. Also, roughly 60 percent of official procurement purchases were made by issuing vouchers redeemable at state or cooperative shops.

The fundamental reform of public sector pricing came through a decree issued in June 1987. This decree abolished the practice of “cost plus” pricing for state enterprises by stipulating that prices had to be market determined and that, notwithstanding regional differences, there should in principle be but one price in a given market. More specifically, the decree stated that prices, except those of a few utilities, public services, and several key industrial products, should be freely negotiated between the parties to a transaction without interference from the Administration. As the basic consumer goods sold through state shops were not among the listed exceptions, the decree also signaled an end to the many related subsidies. However, in order to cushion the impact on civil servants and because an appropriate solution to their compensation still had to be formulated, the sale of subsidized goods to these employees continued until it was phased out over the period March-October 1988.2

The price reform also greatly affected agricultural procurement. After years of increasing use of barter transactions and payment with vouchers, procurement agencies had again to monetize their transactions. More significantly, however, the transition from cost plus pricing to market-oriented pricing implied substantial increases in procurement prices for most crops.

Trade Reform

Throughout the decade to the mid-1980s, the Government had sought to increase its control over domestic and foreign trade: as a result, the public distribution system had become increasingly dominant and exceedingly complex. At the national level, the Lao Trade Corporation was in charge of official external and wholesale trade, as well as rice distribution.3 At the local level, procurement and distribution operations were handled by provincial offices in accordance with quotas established by provincial planning committees and at prices that, since 1982, partly reflected local conditions but also had to stay within limits set by the central authorities. At the retail level, the distribution system relied on an extensive network of state stores and cooperative shops that continued to expand through 1986.

Notwithstanding substantial unrecorded trade outside official channels, the state sector also dominated foreign trade. The state had reserved a monopoly on virtually all major exports and also on most imports, with the exception of imports made by so-called sociélés mixtes (joint public and private companies) or a few state enterprises that were authorized to retain a portion of their foreign exchange earnings. In view of the small share of free foreign exchange earned through untied exports, the allocation of foreign exchange turned inevitably into a complicated exercise that had to comply with the provisions of numerous bilateral trade and foreign assistance arrangements, leaving little room for flexibility.

In advance of the sweeping price reforms decreed in July 1987, the Government also liberalized the domestic and external trade system. In early 1987, the intricate web of state trading companies was consolidated, and administrative units were barred from engaging in, and interfering with, trade transactions. Shortly thereafter, provincial trade restrictions, most notably those relating to the movement of rice, were eliminated, and transportation, previously a monopoly of state and provincial enterprises, was opened to the private sector. Restrictions on foreign trade were also relaxed as, subject to licensing by the Ministry of Commerce, joint and private companies were permitted to trade and transport all but specifically listed “strategic” commodities.4 Most of these restrictions disappeared during 1988 with the effective decontrol of prices and the liquidation of the Lao Food Corporation, which had monopolized the procurement of rice and shared its distribution with the Lao Trade Corporation.

Exchange Rate Reform

The exchange rate system for transactions in convertible currencies, like the implicit exchange rate system for transactions with the nonconvertible area, was complicated. With the introduction of two further rates in 1985 and early 1986, there existed seven different exchange rates. These included a symbolic official rate of KN 10 per U.S. dollar; a commercial rate of KN 95 per U.S. dollar, at which most transactions by state enterprises were made; and several rates close to the then-prevailing parallel market rate of roughly KN 400 per U.S. dollar, which applied to transactions by the sociétés mixtes or the prefecture of Vientiane.

Reform of the exchange rate system initially lagged behind other reforms. In September 1987, the number of exchange rates was reduced to four. While the overall spread between the highest and lowest rates was not narrowed, this first step brought the exchange rates applicable to most transactions very close to the parallel market rate. Reassured by the stability of the kip in the parallel market during the months following these initial steps—it even appreciated slightly—the authorities then moved quickly to unify, effective January 1, 1988, all rates at one very close to that prevailing in the parallel market.

Public Enterprise Reform

Prior to the adoption of the NEM in 1985, state enterprises were run along the standard model of a command economy, with virtually no room allotted for managerial flexibility or autonomy. Selling and input prices, salaries, investment, reinvestment, financing, product mix, and output targets were all determined by central or provincial authorities in accordance with the plan, the budget, or the stipulations of a supervisory ministry or provincial authorities. All operating surpluses, if any, and most of the depreciation allowances had to be transferred to the budget,5 which, in turn, provided most of the financing for the necessary working capital and investment. As a result, little distinction was made between state and public enterprise assets, and virtually no incentive existed to improve financial performance, let alone earn a reasonable return on investment.

The first attempts to accord Lao state enterprise managers at least some degree of autonomy were made as early as 1983 at four of the most important centrally supervised enterprises.6 Two municipal enterprises and another two enterprises under provincial supervision were added to the experiment in 1985. Initially, greater autonomy at these enterprises meant merely the permission to retain 40 percent of profits and, in the case of the Lao Wood Industry Corporation, also most of its depreciation allowances. But gradually greater autonomy was accorded to other public enterprises, which, in turn, were expected to become financially self-sufficient. By the end of 1987, roughly 75 percent of all centrally owned enterprises were thus granted a considerable degree of operational freedom, as long as they conformed with the two main targets established for each enterprise under the plan: output and payments to the budget. As funding through the budget for such enterprises had been discontinued by that time, the annual plans gained additional significance as the principal basis for justifying requests for credit from the banking system.

Fiscal Reform

Even though a tax system had been in place before the public sector reforms began, the principal source of domestic budgetary revenue used to be negotiated transfers from slate enterprises. As increased financial autonomy was extended to a greater number of state enterprises, the revenue system had to be adjusted: accordingly, the authorities announced in a decree of June 1986 that the largely inoperative tax system would be overhauled and simplified.

The tax reform was implemented with the 1988 budget. Contrary to the initial intention, however, the new tax system turned out to be complicated and highly differentiated. Depending on the type of activity, the flat tax on commercial and industrial profits derived from domestic sales ranged from 20 percent to 85 percent, while profits derived from export activities were to be taxed at rates ranging from 0 percent to 80 percent, with some activities subject to a lower rate and others subject to a higher rate than the corresponding domestic activity. Like the profit tax, the turnover tax and the new import tariff system, which came into effect in March 1988, were highly differentiated, with rates ranging from 1 percent to 15 percent and from I percent to 70 percent, respectively. Moreover, wages and salaries of Lao citizens working for Lao employers remained untaxed, while the agricultural income and profits tax was maintained (although its rates were slashed again, to a yield-dependent rate of 4–5 percent in the case of paddy7 and to 6 percent for all other agricultural production).

Parallel with the attempts to adjust the revenue system, efforts were made in 1988 to reorder expenditure priorities. As subsidies to civil servants and other consumer subsidies were gradually phased out, civil service wages were raised, although not in step with the resulting price increases. At the same time, and helped by an early retirement scheme and the introduction of separation payments, a substantial retrenchment of central government staff began.

Banking and Financial Sector Reform

Reform of the financial system lagged far behind those in other areas. In October 1988, the separation of central and commercial banking activities of the State Bank started. The Nakhoneluang Bank became autonomous, and two large branches of the State Bank in Vientiane were split off one year later as independent commercial banks. The process continued with the creation of several other commercial banks.

Interest rate policy, which was still within the authority of the Council of Ministers (the cabinet of the Lao Government), also changed little. In October 1988, the traditionally low deposit rates were raised by 20—50 percent, and the lending rates were roughly doubled. At this time, the authorities also abandoned the distinction between private and public sector with regard to credits and deposits and terminated the extension of preferential terms to the public sector. Most interest rates remained negative in real terms, and deposit rates, in particular, proved too low to enable the newly founded commercial banks to compete effectively with rates offered in the curb market.

Summary of Structural Reforms and Macroeconomic Developments

The implementation of major reforms during 1979–88 represented substantial progress in moving toward an open and market-oriented economy. The reforms helped to reactivate private sector activity and improve the quantity and range of goods available in the domestic market. The services sector was the quickest to respond to the improved incentives: private and public transport operators took advantage of the removal of internal trade restrictions, while enterprises involving handicrafts and consumer services (repair shops, tailors, and restaurants) quickly emerged as a result of the liberalization of private activities.

This favorable impact on macroeconomic performance was, however, largely offset by several adverse developments. In the late 1980s, the dismantling of the system of transferring surpluses of public enterprises to the budget caused a drop in revenues and an increase in government dissaving, while the decentralization of decision making was followed by local governments' action to provide large wage increases financed by bank credit. Accentuated by the effects of a prolonged drought in 1988, these developments triggered a surge in inflation, a large current account deficit, and the depletion of foreign reserves. The authorities were unable to manage the new system effectively because of the absence of the necessary policy tools, including indirect means of monetary management control and an adequate institutional framework.

Clearly, much remained to be accomplished in the transformation process, as subsistence farming and barter continued to characterize the agricultural sector and the public sector still dominated the monetized economy. Moreover, despite sizable public investments during the late 1970s and early 1980s, economic and social infrastructure remained inadequate, and the existing capital stock was poorly maintained and often obsolete. Domestic saving remained low, as the private sector made only limited use of the banking system. On the external side, exports, which covered only one third of imports, were narrowly based, while foreign reserves were low.

Sales against salary coupons ended effectively in March 1989, when state stores were ordered to exchange the remaining coupons for cash. Many of the state stores were consequently closed.

Rice distribution was carried out jointly with the Lao Food Corporation, which was established in 1982.

These commodities comprised a number of major exports that were initially reserved for state trading agencies so as to comply with bilateral trade contracts with the nonconvertible area.

Because actual operating surpluses frequently diverged from the plan, these transfers were often effectively financed by the banking system.

These were the tobacco and beer factories, the electricity company, and the Lao Wood Industry Corporation.

Although the agriculture tax was generally progressive with respect to yield, its rate structure was highly regressive at both ends of the yield spectrum.

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