Countries and Regions

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p. 2 of 7 BACK | NEXT Executive Summary I. Development Agenda II. ADB's Development Experience III. ADB's Strategy IV. Operational Approach V. Three-Year Assistance Program VI. Performance Monitoring and Evaluation

Country Strategy and Program 2002-2004: Lao People’s Democratic Republic

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I. Development Agenda

Key Features of the Lao People’s Democratic Republic

1. Natural Resources

1. The Lao People’s Democratic Republic (Lao PDR) has a rich resource base and unique biological diversity, and is the least densely populated country in Southeast Asia. Some three quarters of the population are involved in agriculture. Forests still cover more than one third of the country. Natural resource-based economic potential includes agriculture, forestry, fishing, tourism, mining and hydropower. Natural resource-based development is accelerating and could help achieve economic growth with equity, provided the poor (including ethnic minorities and rural women) have equitable access to resources and economic opportunities. However, much of the country is uncultivated and environmentally fragile. Deforestation and shifting cultivation remain major problems. Unexploded ordnances are a problem in up to half the districts. Some hydropower projects have had unintended environmental and social costs. Poverty must be reduced to discourage unsustainable shifting and poppy cultivation and thus ameliorate environmental pressures. Sustainable natural resource-based development requires adequate, enforced social and environmental safeguards.

2. Diverse Ethnic Groups and Cultures

2. The small population includes more than 70 ethnic groups ² . This diversity enriches the culture, but also has implications for development. Well-designed participatory approaches are particularly important to reflect ethnic differences. Language, livelihood patterns and other culture-specific issues need to be considered when providing social services, infrastructure and economic opportunities to ethnic groups. Targeting ethnic groups may increase costs, but may also be more cost-effective in reducing poverty in the poorest areas where ethnic minorities live.

3. “Land Link” to Major Subregional Economies

3. The Lao PDR was once an isolated, landlocked economy, with limited and high-cost access to foreign markets. The Government has adopted more open economic policies and a development strategy that emphasizes the country’s location at the hub of trade routes linking emerging regional economies. The Government recognizes that regional cooperation offers significant opportunities for the Lao PDR as a land link in the Greater Mekong Subregion (GMS). Infrastructure must be improved to realize the potential economic benefits of the Lao PDR’s geographic location. Complementary policy and administrative reforms are needed to facilitate the cross-border movement of goods, people, and investment.

4. Mountainous Terrain and a Fragmented Domestic Market

4. Mountainous terrain, remote settlements, and low population density are barriers to access and the cost-efficient delivery of social and other services. Physical constraints, including a lack of direct access to seaports, poorly developed infrastructure, and a small domestic market, increase business costs and discourage commercial investment. Per capita infrastructure costs are high due to the sparse population. Weak public administration has exacerbated these constraints. A strategic approach is needed to reform institutions and the organizations required to provide critical rural services and infrastructure. The viability of many socioeconomic development investments will depend on the extent of internal and subregional economic integration.

5. Transitional Economy

5. The country is in transition to a market-oriented economy. The public sector still plays a major role in industry, the financial sector, and some services. Frequent policy and institutional changes, bureaucratic interference in business decisions, and administrative discretion add to business costs. Institutions are weak in terms of protecting property rights, enforcing contracts, and providing professional and financial services. Institutional weaknesses and severe public sector budget constraints inhibit the delivery of public services, and limit capacity to maintain physical infrastructure, reducing the development impact of past public investments and official development assistance (ODA). In some sectors, improving the quality and sustainability of public investments and services is more urgent than increasing public investment, and will require reforms in public administration and ODA delivery. Alternative arrangements for delivering services are being tested, including the increased involvement of local authorities, private enterprise, and civil society.

6. Underdeveloped Human Resources

6. Key indicators of human development, including life expectancy, infant and maternal mortality, and education levels, are among the lowest in the region. The United Nations Development Programme’s (UNDP) human development index gives the Lao PDR a rating of .484 and a ranking of 140 out of 174 countries, making the Lao PDR one of the poorest developing member country in the region³ Low education, health, and nutrition standards are major constraints to productivity growth. The education and health status of women is particularly disappointing. Women’s potential contribution to development is weakened by their limited participation in higher value-added economic activities. UNDP’s gender-related development index gives the Lao PDR a rating of .469 and a ranking of 117 out of 143 countries. Some 70 percent of the workforce has not completed primary school, and poor technical and management skills discourage business investment. Accelerated human development is an important goal in itself, but is also essential to achieve sustainable economic growth and reduce poverty.

B. Current Political, Macroeconomic, and Social Trends

1. Political Trends

7. Political stability has been sustained over the last 25 years by the one-party state. The newly appointed political leadership is committed to pursuing reforms and reducing poverty through (i) sustainable social and economic development, (ii) balanced and equitable development, (iii) administrative and political development, (iv) external cooperation, and (v) national security. Fulfilling these commitments and the emerging aspirations of a changing society—which has an increasing proportion of well-educated young people—will require accelerated public sector and economic reforms. Decentralized development activities through greater community participation is important. However, implementation capacity remains weak, and much remains to be done to ensure that local institutions are accountable. The recent decision to transfer public service management responsibilities from the Lao People’s Revolutionary Party to the Government is an important initial step to improve public sector professionalism.

8. The Lao PDR’s commitment to regional integration is reflected in the country’s membership in the Association of Southeast Asian Nations (ASEAN) since 1997, commitment to the ASEAN Free Trade Area (AFTA), and active involvement in other regional initiatives such as the GMS Program and Mekong River Commission. The Government is also investigating possible membership in the World Trade Organization. Despite these positive developments, challenges remain in meeting the existing and proposed commitments and in developing the capacity and policy environment to maximize national gains from regional integration.

2. Macroeconomic Trends.

9. In 1997–1999, the country suffered macroeconomic instability, triggered by expansionary fiscal policy and the regional financial crisis. From 10–20 percent before the crisis, inflation rose to 87 percent in 1998 and 134 percent in 1999. The kip sharply depreciated by about 80 percent against the dollar between 1997–1999. Capital spending increased from approximately 50 percent of total government expenditures to approximately 75 percent during the crisis, mainly because the Government invested heavily in irrigation systems. Depreciation of the kip also increased the kip-denominated amount of externally funded projects. Inflation eroded the value of recurrent expenditure, particularly government salaries.

10. Tighter fiscal and monetary policies since mid-1999 and the recovery of neighboring economies have helped restore stability in the Lao PDR economy, which grew by 7.3 percent in 1999 and 5.9 percent in 2000. Agriculture (particularly paddy crops), manufacturing (primarily textiles), and tourism all contributed significantly to economic growth. Inflation is expected to be below 10 percent in 2001. The exchange rate has stabilized at around KN8,000 to $1. The fiscal deficit is still high at around 9 percent of gross domestic product (GDP). Tax revenues have gone up from 10.6 percent of GDP in 1999 to 14.0 percent in 2000. The Government is taking steps to restore the balance between capital and recurrent spending. Capital spending now accounts for about 65 percent of total government expenditures. Exports have grown by about 8 percent since 1998, and the balance of payments, although in deficit, is improving. Tourism, textiles, and electricity are key exports. The current account deficit was less than 6 percent in 1999 and 2000, a substantial improvement from previous years when the deficit was 10–20 percent.

11. In April 2001, the Lao PDR and International Monetary Fund (IMF) entered into an agreement to permit the country to borrow under IMF’s Poverty Reduction and Growth Facility. The agreement is an important endorsement of the country’s commitment to economic reform. Macroeconomic management priorities include strengthening domestic resource mobilization to reduce the economy’s heavy dependence on external assistance, and increasing current expenditure allocations (especially for social services). Reforms in fiscal management and the financial sector are critical. Achieving targeted annual growth rates of 6-7 percent⁴over the next five years will require additional reform of state-owned enterprises and the financial sector, and continued commitment to opening the economy. Given limited public resources and weak public sector management, an active private sector is critical. To maintain the inflation rate at less than 10 percent, the Bank of Lao should keep its commitment to not financing future budget deficits by printing money.

3. Social Trends

12. Progress has been made in social development. The adult literacy rate increased from 50 to 74 percent in the last decade, infant mortality declined from 104 to 75 per 1,000 births in 1995–2000, and life expectancy increased from 50 years in 1995 to 55 years in 2000⁵. However, rural areas have improved much more slowly than urban areas, and have gender disparities in education and employment. The disparity is growing between Mekong river basin communities and those in the uplands and highlands. The lowland population is increasingly involved in market economy activities, including growing trade with Thailand. Lowlanders generally have better education and health services, and better access to physical infrastructure. New transport and electricity infrastructure is resulting in rapid expansion of settlements and micro- and small business activity in some larger provincial towns. Most uplanders, however, still live in a largely nonmonetized economy, and have poor access to health, education, transport, power, and markets.

C. Current Developments

1. Poverty Situation

a. Assessment

13. The 1997/98 expenditure and consumption survey reveals a decline in poverty incidence from 45 percent in 1992/93 to 39 percent in 1997/98. The incidence of poverty varies considerably across regions and provinces as well as between urban and rural areas (Table 1). The incidence of the poor and ultrapoor 6 is highest in the northern provinces and lowest in Vientiane Municipality, which also enjoyed the largest decline in poverty, from 24.4 to 12.2 percent of the population. In contrast, poverty in the northern region declined only slightly from 58.4 to 52.5 percent. Consequently, the estimated Gini coefficient for per capita consumption increased from 0.29 in 1992/93 to 0.36 in 1997/98. While consumption inequality may not be as high as in many other Asian countries, it has increased markedly in the last five years. According to participatory poverty assessments, poverty in the Lao PDR is generally influenced by livelihood systems, including agriculture and forestry production, rural infrastructure, basic education, and primary health care. The burden of poverty is disproportionately borne by women (Box 1).

Pro-Poor Growth

14. Economic growth has done much to reduce poverty in the Lao PDR, but has not done so equitably, especially in reducing the number of ultrapoor. Based on the preliminary findings⁷, the elasticity of poverty incidence relative to growth⁸ for 1992–1998 was 0.21: that is, for every 1 percent increase in growth, poverty incidence declined by about 0.21 percent. Growth has benefited the better-off more than the poor, and inequality has increased. The population just above the poverty line is considered vulnerable to external shocks. Given the scattered and remote population, which lives largely outside the monetized economy, specific pro-poor growth polices must be developed to build the capacity of the poor and empower them to partake of economic growth.

c. Governance

15. Recent participatory poverty assessments⁹ found evidence of links between good governance and poverty reduction. The poorest areas have generally had little contact with the Government and limited access to basic public services such as health, education, transport, power supply, or markets. The assessments identified insecure land tenure and lack of transparency in land titling as among the most pressing problems of poverty. At the local level, full participation of village leaders and their constituents in decision making for development projects has been key to poverty reduction (Box 2). The poor need to have strong ownership of efforts to improve their lives. Effective governance and accountability require mechanisms and capacity to work with all stakeholders, including established village leadership structures, to identify needs and help develop and deliver solutions. Institutional and regulatory weaknesses result in limited accountability, administrative discretion, and ambiguity, which reduce the efficiency of public service delivery, invite corruption, and discourage investment. Red tape particularly constrains small, labor-intensive enterprises, which are essential to the Government’s development strategy. The capacity of public sector agencies should be improved by enhancing officials’ professionalism.

d. Social Development

16. Urban areas are more developed than rural areas, and the uplands have less access to health, education, transport, electricity, and markets than the Mekong corridor. Uplanders (often ethnic minorities) see migration as a way to prosperity and as one of few options to improve living standards. Rural women are especially disadvantaged. They are traditionally primary production managers, small-enterprise traders, primary cash earners, small-credit users, and key agriculturists, and play key roles in education and health. However, they suffer from lack of access to and control of economic resources and opportunities as well as from poor health and education. Balanced social development is a goal as well as a prerequisite for sustained acceleration of economic growth. Mountainous terrain, remote settlements, ethnic diversity, and low population density are barriers to access and add to the cost of delivering socioeconomic services. A recent participatory poverty assessment found that poor villagers view education as unavailable, unaffordable and/or secondary to securing their livelihood. Much remains to be done to develop and establish appropriate institutional arrangements for expanding basic services to rural areas where livestock is often the only form of social insurance.

2. Private Sector Development

17. The private sector produces most agriculture output and some 75 percent of service sector output. The private sector is also increasingly active in handicrafts and manufacturing (mainly small-scale agricultural processing, timber, and textiles). The next five years may see large private investments: Nam Ngum 2 and 3, and Nam Theun 2 hydropower projects; gold and copper mines in Sepon and Xaisomboun Special Region; and plantation forestry. However, the state remains dominant in some sectors, including energy, and many private enterprises depend on close links with the state sector to remain viable. Cumbersome bureaucratic requirements and procedures (e.g., lengthy procedures for business licenses); poorly developed market institutions (property rights, land titling and access to land, contract enforcement mechanisms, professional services, business legislation, financial institutions, etc.); and lack of transparency in tax collection and law implementation remain major constraints to private investment. An often inconsistent and frequently changing regulatory framework clouds the investment environment. Corruption adds to business costs and discourages private investment. Regular consultative mechanisms between business groups and high authorities are immediately needed to continuously identify and address institutional constraints to private sector investment. Throughout Asia, including the People’s Republic of China and Viet Nam, small and medium-size enterprises (SMEs) play a vital role in reducing poverty and generating employment and income growth.

3. Environment

18. Most of the population (especially the poor) rely on natural resources for their livelihood. Population growth, limited cultivation area, and poor soil conditions force the rural poor to engage in shifting cultivation, with detrimental consequences to the environment, long-term productivity, and rural incomes. The Government aims to replace shifting cultivation of upland rice with sedentary farming by providing improved rural infrastructure and other services. Social concerns should be fully considered during implementation of the Government policies. There is also a need to address environmental issues such as the unsustainable commercial exploitation of forests and adverse environmental impacts of infrastructure projects.

4. Regional Cooperation

19. The Government recognizes that regional cooperation can help narrow the gap between the Lao PDR and other regional economies, and that active membership in ASEAN and AFTA will enable Lao PDR to strengthen its role as a land link, at the center of the GMS . It is important to explore policy, administrative, and public expenditure options to maximize national benefits from regional cooperation, and to ensure their equitable distribution. Potential areas for expanded regional development cooperation include transport, tourism, power transmission, telecommunications, trade and investment, HIV/AIDS and other disease prevention, prevention of human and drug trafficking, environmental management, and river basin development.

D. Development Priorities and Outlook

1. Objectives and Priorities of the Lao PDR

20. Government development priorities are presented in its strategies for socioeconomic development from now to 2020 and 2010 and fifth five-year socioeconomic development plan (2001-2005). The Government’s ambitious targets are to (i) reduce the proportion of poor families by more than half and stop poppy cultivation by 2005; (ii) basically eradicate poverty and stop shifting cultivation by 2010; and (iii) graduate from the status of least developed country by 2020 by becoming a natural resource-based industrialized economy. The strategic approach is to fight poverty through human development, rural development, and people’s participation by focusing on (i) agriculture and rural development, (ii) education, (iii) health, and (iv) road infrastructure. The Government is preparing a national poverty reduction strategy, which will take its focus from the Socioeconomic Plan (2001-2005). The Government wants to facilitate greater people’s participation in development, and recently adopted a decentralization policy that focuses on provinces as strategic units, districts as planning and fiscal units, and villages as implementing units. The Government established the urban development administration authorities (UDAAs) to decentralize urban development. Accelerated human and institutional developments is the prerequisites for national development. The Government recognizes that “governance is a vital link between economic growth and poverty reduction” and that “environmental sustainability is a prerequisite for continued sustained economic growth…[and]…poverty alleviation.”¹⁰

2. Public Finance and Investment

21. The biggest barrier to realizing development goals is inadequate domestic resources to finance recurrent expenditures for social development and maintenance of physical assets. Weak tax collection, public expenditure planning, and management, and an overreliance on ODA financing of public expenditure (about 80 percent of capital expenditures) remain major concerns. The turnover tax, excise taxes on luxury goods, and trade taxes account for around 50 percent of Government revenue. The property, income, and profit taxes account for less than 20 percent of total revenue. A large percentage of taxes are collected from trade. As the Lao PDR joins the world economy, the country will need to diversify its tax base and depend more on domestic sources. Notwithstanding recent improvements in tax collection, Government revenue is still only around 14 percent of GDP. The Government is thus considering introducing the value-added tax system. Private investment must also be encouraged to provide appropriate public services and invest in commercial business to help bridge the domestic investment and savings gap and finance the ambitious development agenda. The Government stresses the need to step up domestic resource mobilization and improve the quality and efficiency of publicly financed services and infrastructure. With the provinces now accounting for approximately 30 percent of total public investment, the Government strategy recognizes that public expenditure efficiency requires building local administrative capacity.

3. Role of External Assistance

22. External assistance has (i) filled the financing gap by providing up to 80 percent of public investment in recent years, (ii) helped expand physical infrastructure, and (iii) increased per capita incomes and improved key indicators of human development. The Government recognizes that it needs external assistance to finance the ambitious development agenda. At the same time, the Government is concerned about (i) its capacity to maintain and fully utilize recently developed physical assets, (ii) the cost-effectiveness of some assistance, and (iii) the fact that human development indicators have not satisfactorily risen despite substantial external assistance for human development. Given the rising external debt, the Government stresses the need for more efficient and effective ODA-financed initiatives through decentralization and greater stakeholder participation at all stages of the project cycle. Development partners have expressed similar concerns through the round table meetings (RTMs), most recently in November 2000. The Government hopes to use RTMs to address remaining constraints to effective ODA delivery.

4. ADB’s Assessment of the Development Agenda

23. ADB endorses the Government’s emphasis on poverty reduction, human resource development, and equitable delivery of social and economic services. ADB welcomes the Government’s emphasis on increasing stakeholder participation, decentralization, and public service efficiency. The Government development agenda is ambitious, and will need to be phased in and perhaps further prioritized to reflect limited financial and human resources. Past heavy reliance on ODA contributed to disproportionately high capital expenditure at the expense of current expenditure, especially in the social sectors as well as in operations and maintenance (O&M) of assets. Better domestic resource mobilization and more current expenditure allocations for social services are prerequisites for ADB support for the development agenda. Domestic resources should be the primary source of development funding, with external resources playing a supplementary role in financing the resource gaps. The financial sector should be deepened from its currently low level of 18 percent of GDP. Economic growth of 6–7 percent per annum is planned for the next five years. Past performance and regional experience suggest that such growth is achievable, but sustainable acceleration of economic growth requires (i) a competitive and open market economy, (ii) high labor productivity through improved health and education, and (iii) sustainable management of natural resources.

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