Is the Lao State Collapsing?

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ASEAN Beat | Economy | Southeast Asia

Is the Lao State Collapsing?

The current economic crisis has hollowed out the capacity of an already weak state apparatus.

Is the Lao State Collapsing?
Credit: Photo 169195858 © Lquang2410 |

It was quite an admission. Late last month, Laos’ Ministry of Energy and Mines said that almost half of the country’s mining companies have failed to meet industry standards and comply with regulations or contractual obligations. Yet, the apparent message was that nothing had been done about it. Why? As the ministry’s report admitted, it currently employs around 1,800 people throughout the country, and the percentage of experienced technicians within that bunch is “limited” and falling. It reckons it needs to hire at least another 700 people by next year just to be functional. It’s a similar story across the Lao government. Because of a sky-high national debt and a financial crisis now in its second year, the state has massively cut back on state-sector workers in a bid to save money. But that has decimated what was already a weak bureaucracy.

Between the 1980s and the late 2010s, the Lao state didn’t really need to be professional or competent. It collected very little tax and provided very few services to the people. The wealthy paid for private schools and clinics. The masses bribed teachers and doctors for low-quality services. The central bank allowed the kip to float against the Thai baht. No questions were asked about where the profits of companies were actually going (most weren’t being stored in Laos). For the most part, the economy produced enviably high growth rates because the state didn’t get involved. The state’s purpose was to sign investment deals with Chinese companies (mainly for dams and mines), introduce reform bills that multinational institutions helped to draft, and distribute enough money between ruling families (the “red aristocrats”) so that the communist party didn’t splinter. Call it a species of feudal-Friedmanism.

However, similar to other developing countries in mainland Southeast Asia, all that should have changed in the 2010s. Managing the economy and society became a more complex affair. The economy is now worth around $15 billion, compared to just $2.3 billion twenty years ago. The population rose from 4.3 million in 1990 to around 7.3 million in 2020. Urbanization (which rose from 31 percent to 37.5 percent between 2012 and 2022) reduced the welfare people got from their community, making them more reliant on the state. Fewer people lived with extended family. The central bank had to manage vastly more foreign currency heading into the country. Regulation became more complex. There was more money flowing around the system to monitor.

How did the Lao state react? Badly. At the same time as it needed to professionalize, it was hollowed out. That was mostly because the communist government chose in the early 2010s to accumulate a national debt now in excess of 125 percent of GDP (if you include arrears and swap arrangements), meaning much government expenditure (around 44 percent now) goes towards repaying the interest, a problem before the COVID-19 pandemic. According to the World Bank, government revenue, already low by regional standards, declined from 22 percent to 16 percent of GDP between 2014 and 2019. State spending on education fell from 3.2 percent of GDP in 2013 to 2.1 percent in 2019 and sits at around 1.4 percent now. Combined public spending on education and health fell from 4.9 percent of GDP in 2013 to 2.3 percent in 2023. Out-of-pocket health expenditure, as a percentage of current health expenditure, fell slightly, but only from 52 percent in 2011 to around 42 percent now. According to the World Bank’s Worldwide Governance Indicators, Laos’ Government Effectiveness ranking fell between 2017 and 2022, while its Regulatory Quality fell between 2012 and 2022. Rule of Law is no better now than in 2012.

Then came COVID-19 and the financial crisis, which brought stagnant wages and crippling inflation and resulted in thousands of civil servants voluntarily leaving their posts. So the state is now trying to do much more compared to a decade ago but with a lot less. Today, the education sector is in freefall. The World Bank recently warned of a “lost decade” of children. The healthcare sector is equally puny. Crime is spiking because law enforcement is corrupt or incompetent – or both. Facebook is littered with stories of how yaba pills, an illegal drug, are cheaper than basic foodstuffs. The illegal scamming industry, run mostly by the Chinese, could be generating the equivalent of between a tenth or half of Laos’ annual GDP. Human trafficking is rife. The administrative side isn’t faring much better. There’s almost no regulation of most industries. The central government apparatus has little control over the provinces. Small wonder the grand anti-corruption campaign promised in 2016 petered out within a year.

The financial crisis since 2022 has shown how the accumulation of incompetency over decades has afflicted the central bank, for instance. The business community doesn’t trust the kip, preferring to keep its assets in baht or U.S. dollars while trying to avoid each of the measures the government imposes to compel them to hold their assets in the kip. Granted, the National Bank of Laos could, as it has repeatedly promised to do over the past three years, crack down on black-market currency trading and force businesses to keep their assets in the local currency. Or, indeed, for companies to deposit their earnings inside Lao banks. That would have swelled the state’s coffers with foreign currency and protected the economy from inflation. But illegal trading remains rife because the central bank cannot enforce its own regulations, so businesses still turn to illicit currency traders, further jacking up inflation and weakening the kip. Last year, the government admitted that only a third of export receipts enter Laos through the banking system. That means that while exports were valued at $8.19 billion in 2022, only $2.7 billion entered the country.

Moving forward, the question isn’t whether the Lao government has the motivation to make tough decisions. Does it, say, massively increase taxation, knowing this might frustrate ordinary people (in a country where they don’t have a meaningful vote) and alienate foreign investors? Does it reform the education system, knowing that this will likely mean higher budget deficits? Does it deter emigration, which would reduce international remittances at a time of a major cost of living crisis but would improve the domestic workforce and (might) attract higher-quality foreign investment?

Instead, the more interesting question is whether the Lao government has the capacity to improve. The debt problem isn’t going away. The IMF, in a report published this year, reckons debt will remain “very high” for the next two decades. In lieu of repayments, the state is actually whittling itself away. The energy grid is now basically controlled by Chinese state-run firms after the Electricite du Laos was sold off in 2020. I’ve argued that China is unlikely to allow Laos to go broke, but all that depends on China not going broke first, which you shouldn’t bet against over the next two decades. Moreover, this policy simply hands over state property to more effective Chinese managers to handle, which makes sense in the short term but isn’t great if you’re actually trying to improve your own bureaucracy. Who knows how many toxic assets are in the financial sector? It’s very unlikely that the central party and government apparatuses can get a handle on what’s happening in the provinces. This is key if the government wants to massively increase revenue collection, the only way out of the problem.

Yes, Laos has demographics on its side, although much of the growing working-age population (an extra 1.6 million people between now and 2050) will probably end up migrating to Thailand, which will lose an average of 400,000 people from its workforce each year until 2050. Maybe Laos could start exporting more to the West, but it would take a decade or so to improve an industry (like garments) that produces goods that the West wants. Forget about tech manufacturing. Agricultural exports to China are fine, but thinking they’re a long-term solution means being happy with Laos as an impoverished breadbasket for its northern neighbor. The fallback is its hydropower exports, but even if they grow, they cannot sustain the entire economy. Meanwhile, the dream of exporting significant amounts of energy to non-neighbors like Singapore could be scuppered if Australia, through its ambitious Australia-Asia PowerLink project, is able to export renewable energy to Singapore, Indonesia, and Malaysia more cheaply and reliably. Moreover, resource dependency is rarely the way to improve bureaucratic competency.