In the 1-year period from 6 2021 to 6 2022, there was a country where crude oil prices more than doubled: Laos. Compared with the global average crude oil price over the same period, which rose by about 1.5 times, the surge in Laos was especially steep. Prices of other daily necessities such as food, clothing, and medicines have also risen sharply across the board. The people of Laos are now being forced to endure hardship. In this article, we look at how this situation came about, together with its links to underlying issues of poverty and politics.

Gas station in Laos (Photo: Ilya Plekhanov / Wikimedia [CC BY-SA 3.0])

Overview of Laos

Laos is a landlocked country in Southeast Asia with a population of about 7.5 million. It is a multiethnic state composed of people who identify as Lao, an ethnicity that accounts for more than half of the population, and about around 50 other ethnic groups. In terms of industrial structure, while about around 70% of the population works in agriculture, by GDP composition the service sector accounts for about 40%, and in recent years rapidly expanding hydropower and mining can be considered mainstays.

Another notable point is the current political system often described as a “dictatorship,” and we briefly review the history that led there. In the 14th century, the first unified dynasty was established, and thereafter various kingdoms arose amid clashes with neighboring countries. In the 19th century, France advanced into the region and made it a protectorate, but after World War II, the 1953 France–Laos Treaty was concluded and Laos gained independence as the Kingdom of Laos. In the 1970s, momentum to abolish the monarchy increased.

During the Cold War, Laos was caught up in the ideological confrontation between the United States and the Soviet Union, and right- and left-wing forces also fought domestically. Specifically, when the Vietnam War began next door, Laos was subjected to large-scale bombing by the United States, and the U.S. military provided military support to right-wing forces. This appears to have been aimed at containing the rise of communist leftist forces within Laos. In 1975, the Vietnam War ended with the withdrawal of U.S. forces, and in Laos the leftist forces won this struggle as well, giving birth to the Lao People’s Democratic Republic as a socialist state. Since then, the Lao People’s Revolutionary Party has maintained a one-party dictatorship.

A creeping shadow

Before turning to the main topic of the economic crisis, we will explain the elements that led to the current crisis: namely, that Laos had a fragile economy and a closed, repressive political system. There are three main components of economic vulnerability: poverty, external debt, and unexploded ordnance (UXO).

First, a large share of the population in Laos was poor and the economic base was fragile. Specifically, looking at the share of people living on the ethical poverty line (Note 1) of US$7.4 per day or less, as of 2019 it was about 82%, indicating that a large majority of the population lived in severe poverty. Even so, compared with 2009, when the share living under the ethical poverty line was about 93%, some improvement can be seen. However, a serious problem of widening domestic income inequality has accompanied this. Indeed, looking at the Gini coefficient, which expresses inequality on a scale from 0 to 1, it was 0.36 in 2012 but had grown to about 0.39 by 2018. It has also been pointed out that the economic and educational levels of minority groups, who make up about half of the population, are below the national average.

Next is the external debt problem. The Lao government’s external debt has gradually increased since around the 1980s and has risen sharply since the mid-2000s upward. In particular, after 2013 China’s Belt and Road Initiative began, Laos embarked on railway development and incurred huge debts. As a result, external debt increased from about US$7.3 billion in 2013 to about US$16.1 billion in 2020. There is an estimate that in 2021 such government debt amounted to about 88% of GDP, which had become a serious issue. Notably, about half of external debt is owed to China. Some argue this is a “debt trap” through which China gains leverage over debtor countries that struggle to repay, while others contend there is no evidence that China’s lending to low-income countries constitutes a “debt trap.” In any case, given the level of foreign exchange reserves, which represent funds typically used for forex intervention and external debt service, Laos lacked room to service its debt smoothly, and confidence in its currency, the kip, appears to have deteriorated.

Third is the UXO (unexploded ordnance) problem. Between 1964 and 1973, Laos suffered about 580,000 U.S. bombing sorties. About 30% of the bombs dropped failed to detonate, and victims are still being harmed today. UXO not only directly threatens human safety, it also weakens the economy today. First, funds are spent on UXO clearance and on treating people injured by UXO. As of 2017, only 2% of UXO had been cleared. In addition, UXO-contaminated soil is difficult to develop, delaying land development and infrastructure, which in turn hinders economic growth. For example, data indicate that 37% of farmland is at risk from UXO. In fact, there is a connection between the presence of UXO and poverty: of the 46 districts with the most severe poverty, 42 are widely contaminated with UXO. Thus, the UXO problem not only hampers economic growth at the national level, it can also be a driver of poverty at the local level. For more on UXO, see GNV’s article “Laos: The most heavily bombed country in the world.”

Banknotes of the kip, Laos’s currency (Photo: Axel Drainville / Flickr [CC BY-NC 2.0])

Next, the political system. In short, Laos has a one-party dictatorship, and political activity, protests, and press freedom are very limited. Examples of repression of political activity include the arrest and torture of demonstrators in 1999, the disappearance of an activist in 2012, and the detention in 2019 of activists who criticized the government or planned pro-democracy gatherings. On press freedom, the annually published “World Press Freedom Index” by Reporters Without Borders ranks the country 161st out of 180. In practice, foreign media are not allowed a permanent presence, and the government exercises strict control and surveillance of the internet.

We also touch on the economic system under this political regime. After independence in 1975, Laos pursued a centrally planned economy modeled on the Soviet Union. However, the country had already been exhausted by the earlier conflict, and the planned economy foundered. In 1986, an opening policy called the New Economic Mechanism (NEM) was implemented, and since then the country has achieved an annual GDP growth rate of around 6%. Nonetheless, as noted above, poverty remained severe, so not everything went smoothly. For example, the government’s focus has been on capital-intensive industries such as hydropower and mining, which did not lead to significant job creation.

Beyond resource-export businesses that earn foreign currency, investing in areas such as agriculture, education, and healthcare could have potentially generated longer-term returns alongside productivity gains, but the Lao government did not build such foundations. Moreover, even after liberalization under NEM, many large state-owned enterprises remain, and despite being state-owned, chronic losses due to weak management and embezzlement have been a major problem.

The Lao government has also had internal issues, namely political corruption. In the “Corruption Perceptions Index,” Laos has shown a modest improving trend, but in 2021 it ranked 128th out of 180 countries. In practice, wealth has been concentrated among political elites through corruption and opaque networks, and there are reports that over about 6 years since 2016, corruption caused losses of about US$7 hundred and 6,700 ten-thousand, indicating the need for improvement.

A scene from Vientiane, the capital of Laos (Photo: Philip Roeland / Flickr [CC BY-NC-ND 2.0])

Three triggers of the economic crisis

From here, we look at the current economic crisis in Laos through three factors: COVID-19, global price increases, and rising U.S. interest rates. First, the impact of the COVID-19 pandemic that spread worldwide from 2020 was immense. As noted above, Laos had continued to grow in GDP terms, but in 2020 it recorded -0.4%. The main factors likely included the hit to exports—previously supported by electricity, minerals, and rubber—suffering a decline, and a fall in remittances from overseas migrant workers.

The next factor is the global surge in prices. As mentioned at the outset, the prices of many items, especially fuel, have risen markedly higher. There are three main reasons for this. First, the COVID-19 outbreak strained supply chains for all kinds of goods. Second, amid signs of recovery from the downturn, companies raised prices and earned excessive profits. Third, Russia’s invasion of Ukraine since February 2022 and the resulting sanctions have driven up crude oil prices. Laos appears to have been particularly exposed to these price increases because its top imports include petroleum and automobiles.

Lastly, the rise in U.S. policy interest rates has increased the relative value of the U.S. dollar, causing the value of Laos’s own currency (the kip) to fall—another factor driving the economic crisis. In the background is that, as in the two points above, inflation in the United States has advanced, and to curb it the Federal Reserve (FRB) raised interest rates. This boosted demand for dollars and increased its relative value, while, as noted, for Laos—which carries substantial external debt—the burden of debt service likely grew.

A large bus in Laos (Photo: hiroo yamagata / Flickr [CC BY-SA 2.0])

Impacts of the economic crisis

We have discussed the factors that made Laos economically vulnerable and the factors that directly triggered the economic crisis. Here we summarize the current crisis. The two major problems are rapid inflation and the risk of default. Given the background and factors mentioned above, Laos is experiencing sharp and severe inflation, with prices of many items, especially fuel, soaring and people being forced into economic hardship. Moreover, with insufficient foreign exchange reserves, the combination of a global downturn, inflation, and a weakening kip has brought Laos to the brink of default, compelling the government to respond.

As medium- to long-term impacts, poverty in Laos may worsen. There is a view that this crisis especially affects low-income groups in urban areas. In addition, about 20% of farmers are unable to operate machinery to till their fields due to soaring fuel costs. This could not only widen inequality but even increase the number of poor, reversing previous development progress.

Furthermore, as inequality widens, it could create problems for Laos’s political system. Nominally, Laos aims for an equal and just society based on socialism, yet inequality is widening—an inherent contradiction. This could fuel dissatisfaction with the current political system. In fact, Laos has a traditional political elite and a structure in which wealth is concentrated. Indeed, there have been voices of discontent from the public regarding the government’s fiscal response during the COVID-19 pandemic.

The Presidential Palace in Vientiane (Photo: David McKelvey / Flickr [CC BY-NC-ND 2.0])

A way out of the crisis?

Finally, we consider directions for escaping the current crisis. Regarding external debt, while we noted the possibility of default above, there is a view that China cannot allow Laos to default and will press for performance. In this regard, the Lao government may seek debt restructuring. As for rapid inflation, in June 2022 the central bank announced revisions to the reserve requirement and policy rate. This monetary policy aims to stabilize the value of the domestic currency and curb inflation. Even so, the effectiveness of such domestic monetary policy against the current inflation is seen as limited.

In the long term, it is necessary to make the economy itself more robust. On poverty, the government needs active efforts to raise labor productivity in agriculture and create jobs in non-agricultural sectors; at the same time, given that the average age in the country is a very young 24.4 years, future development that leverages this strength can be expected. Regarding political issues, even if a change to the system itself is difficult, improvements in curbing corruption and responding to citizens’ demands will be required. Still, there are limits to what the Lao government can do alone. In particular, on the UXO problem, the bombing country—the United States—should further strengthen support, and greater attention and intervention from organizations are needed. Moreover, unless global inflation and U.S. interest rate increases ease, the strain on Laos will continue.

Note 1: At GNV, we adopt the ethical poverty line (US$7.4 per day) rather than the World Bank’s extreme poverty line (US$1.90 per day). For details, see the GNV article “How should we interpret the state of poverty in the world?”