The Collision of Economics and Politics

Malaysia's responses to the worsening economic crisis in 1997 and 1998 provided the backdrop for a deepening personal and generational political schism between Mahathir and Anwar, Mahathir's deputy prime minister and minister of finance. Their relationship had been long and complicated over decades,²² but despite their differences, Mahathir in 1982 persuaded the young student activist Anwar to join the United Malays National Organization (UMNO), the ruling party. Anwar quickly climbed the ladder of success within UMNO, becoming widely known as Mahathir's presumed successor shortly after maneuvering his way into the party vice presidency in 1993.

But their political alliance did not negate their substantial differences in temperament and outlook, which grew deeper as the economic crisis unfolded. Mahathir is a firebrand nationalist, distrustful of outside institutions and powers as a result of indelible memories of colonial subjugation. Anwar, a generation removed from the colonial era, has a more modern, internationalist outlook and considers the United States a friend. Whereas Mahathir emphasizes such national or regional solutions as "Asian values" or the EAEC, Anwar is more open to Western ideas and orthodoxy, such as free trade and open markets. And as one reporter for The Wall Street Journal observes,

While Mr. Anwar tended to take a laissez-faire view, seeing the downturn as a natural weeding out of inefficient companies, Dr. Mahathir smelled a Western plot to ruin Malaysia's economy.²³

Early sources of tension between the two can be traced to Mahathir's decision to place Anwar in charge of the country as acting prime minister during an unusual two-month vacation he took in mid-1997. In a move that angered Mahathir, Anwar proposed that the Association of Southeast Asian Nations (ASEAN) undertake a critical policy of "constructive interventions" in response to Hun Sen's July 1997 coup in Cambodia. Such a suggestion contradicted ASEAN's long-standing policy of non-interference in one another's internal affairs. Another contentious issue Anwar undertook in Mahathir's absence was the steering of an anti-corruption bill into law, curtailing the power of Malaysia's large conglomerates, which traditionally had been Mahathir's allies.²⁴

The appropriate response to combat the economic crisis was an ever-increasing source of tension between the prime minister and his deputy. As had been the case in Thailand, Malaysia's immediate response to the attack on the ringgit was to intervene in the currency market to defend it. In this early phase of the crisis, Mahathir was preeminent, and his answer to stemming the weakness in the ringgit and the stock market was to impose limited currency controls in August 1997. These controls, designed to halt speculation on the ringgit, limited to $2 million the amount of currency Malaysian banks could swap overseas in non-trade related deals.²⁵ The controls backfired, however, leading investors to abandon the stock market and to a further weakening of the ringgit. The government quickly repealed the exchange controls.

During this initial government response to the crisis, interest rates at first were tightened, perhaps in a bow to the monetarily and fiscally austere Anwar. When the stock market continued its retreat, however, this policy was reversed and rates were eased, setting the stage for a Mahathir-inspired response that combined currency controls with an "easy money" policy, an omen of things to come. The government soon reversed this policy, however, because low interest rates were acting as a downward drag on the ringgit.

Anwar Ascendant
With the government's policy veering back and forth, Anwar stepped forward to try to stem the crisis. Anwar's recommendation was for an IMF-inspired policy of fiscal austerity and high interest rates. Such a policy was anathema to the distrustful, anti-Western Mahathir, who, in ruling out the possibility of receiving IMF assistance for Malaysia, said Malaysians "would rather live in poverty" than receive help from the IMF.²⁶ But despite Mahathir's palpable distaste for Anwar's IMF-inspired austerity plan and his continued insistence on blaming currency speculators for Malaysia's plight, Mahathir eventually was persuaded to go along with the so-called virtual IMF plan.

Anwar moved forcefully to implement the plan, cutting government spending by 18 percent and allowing interest rates to rise in an attempt to attract foreign investment and bolster the value of the ringgit.²⁷ Anwar ultimately implemented other reforms, including tightened provisioning, disclosure, and transparency standards; accelerated mergers of finance companies; the creation of a deposit guarantee; reduced reserve requirements to improve liquidity flows; and increased spending to strengthen the social safety net.²⁸

Although Anwar's reforms were laudable for their economics, they also laid the foundation for his own political demise. His austerity plan--consisting of high interest rates, reduced government spending, and tighter restrictions on lending--greatly reduced liquidity, with the result that the economy contracted by 2.8 percent in the first quarter of 1998.²⁹ Moreover,

despite a 26 percent lending rate, the highest in Malaysia's history, the currency dropped to its lowest level ever against the U.S. dollar--4.88 ringgit compared to 2.5 ringgit when the crisis started in July last year.³⁰

This situation did not please Mahathir's business supporters, who, as is the custom in Malaysia, had become accustomed to receiving cheap loans and government contracts in return for their political support. But Anwar's tight money and fiscal austerity policies effectively shut off the spigot of easy money.

Another disturbing development from Mahathir's perspective was the raft of statements emanating from Anwar's camp decrying "cronyism, collusion, and nepotism,"³¹ the very same charges that eventually forced Indonesia's President Suharto from power in May 1998. In June, Anwar delivered a speech promoting a concept he called "creative destruction," which would "cleanse society of collusion, cronyism, and nepotism. The result will be a leaner and revitalized market economy, based on fairness and competition on a level playing field...and all citizens have equal access to capital and resources."³² Presumably, these were not words Mahathir wanted to hear from his deputy and presumed heir, especially with the memory of Suharto's recent demise so clearly etched in his mind.

Turning the Tables on Anwar
Apparently frustrated by Anwar's economic program and fed up with his seeming insolence, Mahathir embarked on a series of steps that would shift the economic and political balance of power back in his favor. In June, Mahathir appointed Daim Zainuddin, former minister of finance and close Mahathir loyalist, to the newly created post of minister of special functions--with authority over economic matters. This move clearly was intended to limit Anwar's influence as minister of finance.³³ Simultaneously, Mahathir was laying the groundwork for a political--and ultimately legal--challenge to Anwar. This campaign culminated in Mahathir's tacit approval to the publication of an anonymous tract called 50 Reasons Why Anwar Cannot Be Prime Minister. Based on tenuously documented charges that had been circulating for months, the book purported to lay out Anwar's unfitness for high office because of his participation in a series of sexual trysts with a bevy of alleged partners ranging from prostitutes to wives of friends to men. Whereas in months past Mahathir's policy had been to discount the claims against Anwar, suddenly he was choosing to take them seriously.

Anwar's influence was trimmed in July with the introduction of a stimulus package that largely "overturned...Anwar's tight fiscal policies by lowering interest rates and boosting government spending on big, expensive projects."³⁴ Then two pro-Anwar newspaper editors were pressured to resign from government-controlled newspapers in August. On August 28, the announcement came that Malaysia's economy had contracted 6.8 percent in the second quarter. Following on the heels of a 2.8 percent contraction in the first quarter, the news meant that Malaysia now was officially in recession, despite the implementation of Anwar's plan. The next day, the governor and deputy governor of Bank Negara, Malaysia's central bank, resigned. Both had been supporters of Anwar's austerity measures, reportedly resigning over policy differences with Mahathir.³⁵

Currency Controls and Anwar's Ouster
On September 1, the nature of these policy differences became clear when Malaysia implemented sweeping foreign exchange controls and fixed the currency at 3.80 ringgit to the U.S. dollar. In explaining his extraordinary decision, Mahathir remarked, "The free market system has failed and failed disastrously."³⁶

According to officials of Malaysia's central bank, the foreign-exchange controls were intended to contain speculation on the ringgit and to minimize short-term capital flows, thereby allowing Malaysia to reclaim control of monetary policy and insulate its economy from further effects of the economic crisis.³⁷ Specifically, the foreign-exchange controls did the following:

• Banned the trading of ringgit instruments among offshore banks;

• Required that ringgit held outside the country be repatriated within one month or lose its value;

• Required that all trade be conducted in foreign currency;

• Limited the amount of ringgit with which travelers can enter or leave Malaysia;

• Required central bank approval for non-Malaysians to convert ringgit into foreign exchange; and

• Mandated that foreign investors selling Malaysian equity shares not repatriate their proceeds for one year.³⁸

By fixing the currency rate, on the other hand, Mahathir hoped to stabilize the monetary system and allow the central bank to lower interest rates--thereby sparking renewed economic activity--without the threat of lower rates placing downward pressure on the ringgit.

With the economy foundering and Mahathir increasingly fearful of his deputy's political intentions, Mahathir asked Anwar to resign on September 2. When Anwar refused, Mahathir fired him from both his official offices, those of deputy prime minister and minister of finance. The next day, Anwar was expelled from UMNO, with court papers surfacing that accused him of everything from sexual indiscretions to corruption to treason. Mahathir would claim that Anwar was removed from office for "moral misconduct" and not because of any economic or political differences.³⁹

Mounting Popular Protests
Anwar took to the streets, leading a series of demonstrations criticizing "corruption, cronyism, and nepotism" in Malaysia's government and adopting the "Reformasi" mantra of the anti-Suharto movement in Indonesia. Mahathir moved quickly, arresting Anwar on September 20 for disturbing public order after the latter had led a peaceful rally of 50,000 followers in Kuala Lumpur. The fact that Anwar could attract a crowd of 50,000 followers speaks volumes about the undercurrent of dissent bubbling just beneath Malaysia's political landscape. Demonstrations reportedly have taken place across the country. Many of the demonstrators are young and desire greater political freedom. Others are appalled at Mahathir's treatment of his own deputy and wonder what is to prevent them from being treated in the same manner. But whatever the motivation of Anwar's followers, the demonstrations prove two things: First, that Malaysia's economic prosperity had bred the development of an increasingly wealthy and informed populace that was beginning to seek new freedoms; and second, as proved in Indonesia, political repression may be tolerated when economic times are good, but latent hostility and discontent quickly make themselves known when times turn bad.

Abuse and an Unfair Trial
Mahathir had Anwar arrested under the draconian colonial-era Internal Security Act (ISA), which allows for indefinite imprisonment without trial or even the possibility of legal challenge. A few days after his arrest, Anwar was brought to court, his eye blackened and his arm bruised--strongly suggesting mistreatment by his captors. Anwar was charged with five counts each of sodomy (a crime in Muslim Malaysia) and corruption. He eventually was released from ISA detention and remanded into custody without bail. Moreover, the government added additional sex charges on November 1. Anwar faces at least three trials, which are expected to last more than eight months.

Several disturbing signs have called into question Anwar's ability to receive a fair trial. For example, Mahathir has stated publicly that Anwar is guilty and should be convicted,⁴⁰ in addition to labeling his former deputy a "sodomite." Mahathir's potential impact on the trial is no small consideration in a court system that, although once genuinely independent, effectively has been brought under Mahathir's control ever since a 1988 purge of six out of ten Supreme Court judges.⁴¹

The first trial had an inauspicious start on November 2 amid conflicting allegations that U.S. and other diplomats seeking to observe the supposedly open trial had been turned away. Then Mohamed Said Awang, the director of the police intelligence unit known as the Special Branch, revealed in an astounding open court admission that a 1997 Special Branch report submitted to Mahathir concluded that the sexual charges against Anwar were "false and baseless," the product of a conspiracy designed to discredit him.⁴² This revelation--from the prosecution's lead witness, no less--adds tremendous credence to Anwar's consistent claim that the charges against him are politically motivated and brought at the behest of Mahathir himself.

Long-Term Danger

Mahathir's drastic expansion of credit is by far the most serious long-term threat to the stability of Malaysia's economy. In large part, its current difficulties can be attributed to imprudent lending and excessive building. Now Mahathir proposes to overcome the effects of the economic crisis by massively increasing credit and going on a building binge. So, even though it is entirely possible that Mahathir's plan will succeed in sparking GDP growth next year, any such growth will be inflation-induced and of poor quality. Moreover, his plan runs the distinct risk of sparking runaway inflation in years to come. Inflation, in turn, could lead to increased demand for imports, and eventually to a high current account deficit, ⁴⁷ one of the precipitating factors in Malaysia's current dilemma.

Moreover, Mahathir is not undertaking reforms to consolidate debt and strengthen the banking sector. In fact, just the opposite seems to be occurring, as evidenced by Mahathir's relaxed definition of non-performing loans and his willingness to bail out such politically connected conglomerates as Renong, the beneficiary of a $2.76 billion government package.⁴⁸ By continuing cronyism and putting off much-needed reforms, Mahathir places Malaysia at a competitive disadvantage with neighbors that are instituting reforms and emerging from the financial crisis stronger.

Trade Concerns

Malaysia is an important country to the United States. In economic terms, Malaysia was the eleventh largest trading partner of the United States in 1997, with almost $28 billion in two-way trade. Close trade relations are important to both countries: For Malaysia, trade with the United States represented nearly 20 percent of its total trade in 1997; and for the United States, exports to Malaysia provided jobs for more than 150,000 Americans.

Strategic Relations

Malaysia is important to the United States for the pursuit of U.S. interests in Southeast Asia. Geographically, it is close to sea lanes that are vital to global trade and Asia's economic health. Strategically, U.S. cooperation with Malaysia promotes a sense of stability in the region and helps to deter potential outside aggressors, such as China.

Despite Mahathir's verbal attacks on the United States, he has proved that he is willing to work with the United States when common interests dictate. During the Cold War, this common interest was opposition to communism. Following a lengthy and cordial meeting with President Ronald Reagan during a January 1984 visit to Washington, D.C., Mahathir signed a then-secret agreement to strengthen military ties by instituting joint exercise and training arrangements.⁴⁹ U.S.-Malaysia security cooperation grew under the Bush Administration. Under the terms of a 1992 agreement, U.S. Navy ships gained access to repair facilities in Lumut Harbor, an important consideration in the wake of the U.S. departure from Subic Bay in the Philippines. Thus, the Reagan and Bush Administrations were successful in engineering a subtle shift in Malaysia's foreign policy during the 1980s, marking one of the quiet but more notable achievements of U.S. diplomacy in Southeast Asia.

Initially, security relations with Malaysia were cordial for the Clinton Administration, as evidenced by the signing of a $720 million contract in June 1993 for Malaysia to purchase eight F/A-18D Hornet attack fighter aircraft, which became the most capable aircraft in Southeast Asia. But the purchase marked the high-water mark of security cooperation between the United States and Malaysia; relations since that time have become more prickly, although cooperation has continued on issues such as fighting terrorism and narcotics.

What Is Needed

Considering the economic and geo-strategic importance of Malaysia to the United States, it is in the interest of the United States to formulate a feasible relationship with Malaysia that allows continuing cooperation where common interests dictate but still stands up for American principles of economic and political freedom. Such a relationship may not be possible if Mahathir persists on his present course, but the decision lies largely in his hands. If Mahathir insists on pursuing insular economic and repressive political policies, then he is likely to set back or even sacrifice the positive strides that have been made in U.S.-Malaysia relations in recent years.

Although the fate of Malaysia's future lies to a great degree with Mahathir, the United States also has the responsibility to encourage Malaysia to move in a direction that would allow the relationship to progress. On this score, the Clinton Administration does not receive high marks. As with its policy toward the entire Asian economic crisis in general, the Clinton policy toward Malaysia has been passive--as though the Clinton Administration were paralyzed by indecision.

On the economic side, U.S. Secretary of the Treasury Robert Rubin did speak out against Malaysia's imposition of currency controls at the opening of the annual meetings of the IMF and the World Bank on October 2, 1998.⁵⁰ That same day, however, the Clinton Administration extended a $100 million agricultural credit to Malaysia, boasting that the credit would improve "Malaysian access to foreign exchange,"⁵¹ thereby enabling Malaysia to prolong its experiment with the very currency controls that Secretary Rubin would deride as economically unsound. And the Administration has been only elliptical in its criticism of the corruption and cronyism that is at the heart of the economic crisis in Malaysia specifically and in Asia generally.

On the political side, too, the Clinton Administration has the responsibility to speak out in support of American values, at the very least because of Anwar's questionable detention and the beating he endured while in custody. The Administration's response has been particularly disappointing in this regard. After Anwar appeared in court bruised and battered on September 29, the Clinton Administration waited until October 2 before Secretary Rubin and, subsequently, Vice President Al Gore expressed deep concern over Anwar's treatment and the apparent degradation of political freedom in Malaysia.

The Clinton Administration now needs a policy that fosters Malaysia's development as a more suitable partner for the United States in Southeast Asia. Such a Malaysia would be characterized by increased democratic and free-market reforms, and perhaps more fully in agreement with U.S. economic and political principles.

It is quite possible--and perhaps likely--that the United States will be unable to persuade Mahathir that his insular economics and repressive politics are counterproductive and that progress for Malaysia lies on the road of reform. In that case, the resumption of a strong partnership with Malaysia may have to await his successor. This may not necessarily be a long wait, if Suharto's lessons about society's intolerance of corruption and cronyism in difficult economic times are any guide.

U.S. policy toward Malaysia, then, should be one that seeks to advance U.S. interests by helping Malaysians to realize democratic and free-market economic reforms. Such a policy would maximize the chances of improved relations between the United States and Malaysia in the long run if short-term relations prove more problematic.

In order to promote such a U.S.-Malaysia policy while in Kuala Lumpur for the APEC Leaders' Meeting, President Clinton should:

1. Criticize Malaysia's adoption of counter-productive economic policies. President Clinton should stress that Mahathir's recovery program may bring short-term relief, but that it is bound to cause renewed--and perhaps deepened--problems over the long term. He should point out that there are no substitutes for the difficult reforms Malaysia eventually must undertake or risk being out-competed by its reformed neighbors. Such reforms should include stricter regulation and greater transparency in Malaysia's banking sector and reorganization and consolidation of its corporate sector. More fundamentally, President Clinton should stress a greater emphasis on the rule of law, which will be required if Malaysia is to overcome its legacy of cronyism, corruption, and nepotism. And the application of the rule of law will require the restoration of a genuinely independent judiciary.

2. Express concern about the treatment of U.S. friend Anwar. Both in private conversation with other leaders and in public, President Clinton should express the U.S. concern with the brutal treatment of Anwar. The President should urge that Anwar's trial be fair, and that an impartial inquest be conducted into his alleged beating while in government custody. President Clinton or Secretary of State Albright should seek to meet with Anwar and his wife to demonstrate U.S. concern for his well-being.

3. Link U.S. interests with the goals of Malaysia's emerging democratic forces. President Clinton should explain that Americans identify with Malaysians who yearn for greater democratic reform. As he did in China in June 1998, President Clinton should speak out in support of tolerance and individual liberties. He should speak out against the "Asian values" argument, calling it a subtle justification for authoritarianism, and explain that democracy is compatible with the Asian way of life. The President also should urge Malaysia to repeal the anachronistic Internal Security Act and implement genuine political reforms. And he should encourage Malaysian students to come to the United States so that they can witness firsthand the fruits of economic and political freedom and return to their country with that vision.

4. Seek continued strategic cooperation with a Malaysia that is strengthened by economic and political reforms. To maintain a policy of deterrence and to preserve the peace and stability in Southeast Asia are goals that both the United States and Malaysia share. The United States welcomes the continuation of military cooperation with Malaysia and believes that a Malaysia strengthened by economic and political reforms would be a much more deserving partner of the United States in Southeast Asia.