Globalization and Development in the Mekong Economies

Globalization and Development in the Mekong Economies

Globalization and Development in the Mekong Economies Edited by

Suiwah Leung The Australian National University, Australia

Ben Bingham International Monetary Fund, USA

Matt Davies International Monetary Fund, USA

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Suiwah Leung, Ben Bingham and Matt Davies 2010 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Control Number: 2009941161

ISBN 978 1 84844 482 9

02

Printed and bound by MPG Books Group, UK

Contents List of figures List of tables List of boxes List of contributors Preface PART I

vii viii ix x xi

DEVELOPMENTS IN EAST ASIA AND THE WORLD ECONOMY

1 Globalization and development in the Mekong economies: Vietnam, Lao PDR, Cambodia and Myanmar Suiwah Leung, Ben Bingham and Matt Davies 2 Innovation and economic development: the role of production networks Ben Bingham 3 The rise of China: implications for the Mekong countries Matt Davies 4 Finance, trade and development in East Asia: opportunities for Mekong economies Suiwah Leung 5 How can regional public expenditure stimulate FDI in the Mekong? Pritha Mitra 6 Proliferation of PTAs in East Asia: what does it mean for the Mekong countries? David Robertson PART II

3

7 23

41

58

77

CASE STUDIES OF MEKONG COUNTRIES

7 Vietnam: country case study Ben Bingham and Suiwah Leung 8 The Lao People’s Democratic Republic: growth, reform and prospects Kotaro Ishi

v

91

110

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Globalization and development in the Mekong economies

9 The impact of globalization on economic development in Myanmar Trevor Wilson, Leslie Teo and Masahiro Hori 10 Cambodia: country case study Matt Davies PART III

152

POLITICAL ECONOMY OF REFORM IN THE MEKONG

11 Historical and cultural constraints on development in the Mekong region Martin Stuart-Fox 12 The political economy of policy reform: the future of reforms for the Mekong 4? Hal Hill, Suiwah Leung and Trevor Wilson Index

133

169

190

203

Figures 2.1 2.2 2.3 4.1 7.1 8.1 8.2 8.3 8.4 9.1 9.2 9.3 9.4 9.5 10.1

A pre-globalization scenario Production process before and after fragmentation Changes in relative comparative advantage Disbursed FDI inflows into Mekong economies FDI inflow into Vietnam Lao PDR: real GDP growth and poverty headcount Low-income countries: per capita real GDP growth Real GDP growth by sector Tariff Trade openness measures for Myanmar: official statistics vs. adjusted estimates Foreign direct investment inflows Share of intra-industry trade by region/country Border trade exports in US dollars and its share of total exports Banking sector activities relative to nominal GDP, 1992–2006 Alternative growth scenarios

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13 14 15 48 92 116 117 119 121 134 139 142 143 147 160

Tables 3.1 3.2 3.3

Mekong countries: number of exported products Mekong countries: export similarity indices with China Mekong countries: competition with China in key export markets, 2005 3.4 Mekong countries’ trade with China 3.5 Composition of imports from China, 2005 3.6 Mekong countries: indicators of competitiveness 4.1 Some features of bank systems in emerging market economies 4A.1 FDI in Vietnamese joint stock banks 5.1 Tax incentives 7A.1 FDI inflow into Vietnam: parts and components 8.1 Key economic and social indicators in the middle of the 1980s 8.2 Geography 8.3 Investment and saving balance 8.4 Growth accounting 8.5 Lao PDR’s preferential exports to EU: utilization rate 8.6 Investment-related costs comparison in major cities in Asia 8.7 Cross-section regression dependent variable: total trade as a percentage of GDP 9.1 Selected macroeconomic indicators 10.1 Cambodia: ranking in selected governance indicators, 2006–2007

viii

27 27 28 31 31 36 45 57 67 108 112 117 118 122 124 126 128 138 159

Boxes 2.1 Schumpeterian growth framework 7A.1 Government policies and decisions affecting remittances 8.1 Lao PDR: key reform measures under NEM in the late 1980s 8.2 Lao PDR: the resource sector 12.1 Political economy of trade reform: Indonesia and the Philippines in the 1980s 12.2 Central bank restructuring: Indonesia and the Philippines in the 1990s

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9 106 113 120 194 197

Contributors Ben Bingham: International Monetary Fund, USA Matt Davies: International Monetary Fund, USA Hal Hill: College of Asia and the Pacific, Australian National University, Australia Masahiro Hori: Economic and Social Research Centre, Cabinet Office, Tokyo, Japan (formerly International Monetary Fund) Kotaro Ishi: International Monetary Fund, USA Suiwah Leung: Crawford School of Economics and Government, Australian National University, Australia Pritha Mitra: International Monetary Fund, USA David Robertson: Trade Policy Expert, formerly University of Melbourne, Australia Martin Stuart-Fox: University of Queensland, Australia Leslie Teo: Singapore Investment Corporation Singapore (formerly International Monetary Fund) Trevor Wilson: College of Asia and the Pacific, Australian National University, Australia

The views expressed are solely those of the authors and do not reflect the views of their employers or institutions to which they are affiliated.

x

Preface This book is a result of and has benefited greatly from the international conference entitled Globalization and the Mekong Economies held at the Australian National University, Canberra, in 2008. Regional experts contributing to the conference include Vo Tri Thanh, Doan Quang, Adam McCarty and Ngo Huy Duc from Vietnam, Kem Reat Viseth and Chap Sotharith from Cambodia, Bounleua Sinxayvoravong from Lao PDR, Mya Than and U Myint of Myanmar, and Biswa Bhattacharyay of the Asian Development Bank. Discussants from the Australian National University who are experts in the region include Premachandra Athukorala, Ligang Song, Greg Cutbush and Peter Warr. Although the comments and discussions from these and other participants at the conference are not specifically published in this book, they certainly impacted on the thinking of the authors and the final shape of the chapters. The conference was supported financially by the Australian Agency for International Development (AusAID) and the International Monetary Fund. Organizational and staff support was provided by the Australian National University. As the world economy recovers from a crisis unprecedented since the Great Depression, the lessons of development through global participation remain for the latecomers to industrialization in the Mekong region. The sponsors and organizers are therefore to be thanked for their foresight in supporting policy studies of an important region of developing Asia. Furthermore, as many of the participants are former graduates of Australian universities, this conference and book represent an important activity in furthering the links between Australians and the people in the region. It is through goodwill and exchange of ideas amongst people that world peace and prosperity could be advanced. Suiwah Leung Canberra, Australia

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PART I

Developments in East Asia and the world economy

1.

Globalization and development in the Mekong economies: Vietnam, Lao PDR, Cambodia and Myanmar Suiwah Leung, Ben Bingham and Matt Davies

Post World War II developments in the four Mekong economies of Vietnam, Laos, Cambodia and Myanmar show similarities and differences. All four emerged from colonialism in the late 1940s/early 1950s with varying qualities of physical and social infrastructure. Except for Myanmar, all experienced war and conflict and by the mid-1970s all adopted some form of socialist central planning. Vietnam and Laos implemented Soviet-style central planning. Myanmar embraced isolationism from the West, with its economy under central government control in the hands of the military. Meanwhile, the Khmer Rouge in Cambodia enforced a severe form of central planning, resulting in the destruction of all business and market activities. By the end of the 1980s, four ‘lost decades’ of economic development left the living standards of Mekong 4 citizens considerably below those of the fast-growing outward-looking East Asian economies. With the collapse of the former Soviet Union and the withdrawal of Vietnamese troops from Cambodia in 1989, the Mekong 4 embarked on market-oriented reforms to take advantage of the benefits of trade and investment with the world economy. Vietnam implemented Doi Moi (or ‘Economic Renovation’) in 1989; Laos adopted the NEM (New Economic Mechanism) in 1990; Myanmar began opening up its economy to foreign investment and tourism in 1988, and Cambodia embarked on serious reforms and resumption of relations with international financial institutions in 1993. All four economies became members of ASEAN. With the exception of Myanmar, the initial successes of market reforms soon became evident. Although starting from a low base, Vietnam’s average annual GDP growth (close to 8 percent per annum) prior to the Asian financial crisis of 1997 exceeded that of the ASEAN 5 and those of Laos and Cambodia were approaching the ASEAN 5.1 Inflation rates before 1997 were also declining rapidly. Furthermore, economic growth 3

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Globalization and development in the Mekong economies

has been accompanied by significant reductions in poverty. Even in Myanmar, GDP growth averaged around 5 percent between 1989 and 1998. Inflation, however, remained high (over 25 percent per annum) reflecting deep-seated problems with government finances, resulting in macroeconomic instability, which has continued to plague the economy. Previously, the Vietnamese government showed a strong bias towards the state sector in international trade and investment. In the new millennium, concerted efforts to redress the bias resulted in a strong rebound in economic growth and foreign direct investment (FDI). Vietnam also started more active participation in globalization by embarking on the production and assembly of parts and components of certain manufactured goods that have become the hallmark of the production networks of East Asia. Although economic reform and development in Cambodia and Laos were less advanced than in Vietnam, FDI flows were still robust, albeit to a more limited range of sectors, principally electricity generation and mining in Laos, and tourism and garments in Cambodia. Only in Myanmar have reforms stagnated, with economic policies placing greater emphasis on control and security than on developing a domestic private sector. Consequently, not only did Myanmar have the lowest levels of FDI inflows amongst the Mekong 4 but, in contrast to the other three Mekong economies, the share going to manufacturing in total FDI inflows in Myanmar fell during the 2000s. However, by 2007, even in Vietnam, not to mention the other three Mekong economies, transition was incomplete. In addition to continued bottlenecks in infrastructure and human capital, reform of public institutions lagged behind the needs of an increasingly entrepreneurial and market-oriented private sector. Institutional weaknesses ranged from the need to build stronger macroeconomic institutions (central banks and ministries of finance) to judiciary and public administration reforms. Lack of institutional reform, especially in Vietnam, became a key impediment to improving long-term competitiveness. For the Mekong 4 the need to improve long-term competitiveness increased during the global recession following the financial crisis of 2008. Exports and capital inflows fell sharply, resulting in a slowdown in growth for all of the Mekong 4 in 2009. With limited resources available for fiscal stimuli, it has been difficult for the Mekong 4 to avert the full impact of the global recession, although Vietnam and Laos are currently weathering the crisis better than many of their neighbours in the region. Although distracted by the short-term economic challenges posed by the global recession, countries are again focusing on the longer-term reforms needed to secure new export markets and future investments once the global economy recovers. This is especially true in Vietnam and Laos, where the

Globalization and development in the Mekong economies: overview

5

next set of five-year plans are being prepared for the forthcoming Party congresses in 2011. With this in view, the book is divided into three parts. Part I, Chapters 2–6, canvasses the opportunities and threats of globalization for the Mekong 4. Chapter 2 discusses the opportunities that the production networks of East Asia provide for the Mekong 4 to expand their manufacturing base quickly by utilizing their large quantities of unskilled labour at the component assembly end of the supply chain. It also points out the danger of being trapped at the bottom of the chain, and hence the need to continually improve the economies’ long-term competitiveness, enabling entrepreneurs to move up the value chain. Chapter 3 focuses on China, which is a major participant in the regional production networks, acting both as a competitor and an investor to the Mekong 4. Chapter 4 looks at the globalization of financial services. Despite the 2008 financial meltdown in the US and the EU, the less sophisticated end of the financial services spectrum offers opportunities for the Mekong 4 to open their financial sectors to regional and global foreign direct investment and associated skills transfer. Chapter 5 examines the alignment of fiscal incentives in the region for attracting FDI while Chapter 6 looks at the ‘noodle bowl’ of preferential trade agreements and indicates some guidelines by which the Mekong 4 could navigate through them. Part II analyses each of the four Mekong economies. Chapters 7–10 argue the need for better public institutions to strengthen economic management and enhance the business environment and competitiveness in the longer term. Priorities include modernizing central banks, ministries of finance, and ministries of planning and investment as well as upgrading professional staff. Longer-term judiciary and public administration reforms are needed to address, inter alia, land titling and land use rights, particularly in the ability to use these as collateral for the financing of domestic small–medium-sized enterprises. All countries need to develop financial sectors in a sustainable manner. Judicial reform to protect the rights of lenders and investors in Cambodia should also be high on the policy agenda. With the short-term prospect of reduced growth, increased unemployment and poverty resulting in possible social unrest, the political will to focus on longer-term structural reform will undoubtedly be sorely tested. The political economy of structural reform is the subject of Part III. Chapter 11 examines the political cultures of each of the Mekong 4 economies, while Chapter 12 (the final chapter) assesses the likelihood of reforms being implemented in the medium term future. In addition to the longstanding political objections to globalization, the current global recession has engendered fears of a new wave of protectionist policies on the part of

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Globalization and development in the Mekong economies

industrialized developed countries. These can take different forms ranging from jingoism (‘buy local products’) to protectionist financing policies (‘lend domestically’) to halts in migration (‘jobs for our own people’). This is a difficult context in which to convince developing countries of the benefits of continued globalization. At the same time, the case studies in Part II show that, with the exception of Myanmar, the Mekong economies are already very open economies. Unlike China, they are too small to rely on domestic demand to generate growth. International trade and investment (possibly with China playing a bigger role) will continue to be the order of the day. Only deeper structural reforms will convince domestic and international investors that the Mekong 4 will be truly competitive and business-friendly investment locations. No doubt, the political economy of reforms differs from country to country, with Vietnam judged as having the best prospects, followed by Cambodia and then Laos. It is hoped that the military regime in Myanmar will come to appreciate the benefits to themselves of faster growth and a stronger economy, and will therefore proceed to integrate more with the vibrant region that is Asia today.

NOTE 1. ASEAN 5 comprises Indonesia, Philippines, Thailand, Malaysia and Singapore.

2.

Innovation and economic development: the role of production networks Ben Bingham

1

INTRODUCTION

Recent literature points to the role of ‘economic discovery’ in economic development.1 Hausman and Rodrik (2003) were among the first to suggest that a capacity to discover new economic activities might drive development. Imbs and Wacziarg (2003), and more recently Klinger and Liederman (2006), subsequently confirmed a robust relationship between economic diversification and economic development. This chapter explores the link between economic discovery and the spread of international production networks. The literature (Baldwin 2006; Kimura 2006) suggests that these networks might promote economic discovery in developing countries because production fragmentation increases the potential range of activities in which developing countries have a comparative advantage. A synergy also exists between the desire of advanced economy firms to improve their competitiveness by offshoring activities and developing countries’ interest in promoting economic discovery. Developing countries that recognize these opportunities and exploit them are likely to have a significant edge over those that do not. Thus there may be a link between the rapid pace of economic discovery in East Asia over the past quarter century and the spread of regional production networks. These reflect, in part, greater openness to globalization and the unbundling of production processes. In turn, the development divide within East Asia may partly reflect the fact that the Mekong 42 were slower to adapt to these changes than their more developed ASEAN counterparts. The chapter concludes with a word of caution. While production networks can help start industrialization, it is not a panacea. Escaping the middle-income trap, which implies moving up the value chain, is not straightforward and has stumped many aspiring countries. Moreover, life 7

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Globalization and development in the Mekong economies

on the bottom rung of production networks – the so-called ‘bleeding edge’ – is uncomfortable. Nevertheless participating in production networks does at least appear to provide opportunities for rapid economic discovery that might not otherwise be available for developing countries. Section 2 discusses the incentive to innovate, and its implications for the process of economic discovery. Section 3 discusses how participating in international production might lower barriers to economic discovery. Section 4 discusses some of the determinants that make a country an attractive location for production networks. Section 5 concludes.

2

INNOVATION AND DEVELOPMENT

Imbs and Wacziarg (20003) found that economies become more diversified as countries get richer and that this process continues until relatively late in the development process. This pattern held above and beyond shifts of factors of production from agriculture to manufacturing and on to services and could be observed even within sectors, such as manufacturing. Klinger and Lederman (2006) found the same result in their analysis of export patterns. Both papers point to countries diversifying until they reach a fairly high level of per capita GDP,3 which suggested that discovering a comparative advantage in new activities might be integral to the development process. These findings are consistent with a Schumpeterian view of development in which growth depends on the rate of innovation in an economy. In this case the relevant form of innovation is economic discovery – broadening the economic base through the introduction of new activities. As Aghion and Howitt (2006) demonstrate: long-run growth ultimately depends on the rate of innovation (Box 2.1). 2.1

The Incentive to Innovate

Why are some countries better than others at economic discovery? Or more pertinently, what hinders economic discovery in poorly performing countries? Recent research has focused on the role of the entrepreneur in the innovation process; if entrepreneurs are unwilling to risk investing in innovation new productive activities are unlikely to emerge or only emerge very slowly. The following framework, adapted from Aghion and Howitt (2006), helps explore what drives entrepreneurs to invest in innovation. It illustrate entrepreneurs’ decision framework under two conditions: (i) innovation in activities in which they are potentially competitive (Case A); and

Innovation and development: the role of production networks

9

BOX 2.1 SCHUMPETERIAN GROWTH FRAMEWORK Aghion and Howitt (2006) develop a model in which economic growth depends on the process of innovation. Basic Model The model starts with a production function specified at the industry level: Yit = Ait1 − a K ita

(1)

In this function, Ait is a productivity parameter attached to the most recent technology used in industry i at time t, and Kit is the flow of a unique intermediate product used in sector i, each unit of which is produced one-for-one by capital. Each intermediate product is produced and sold exclusively by an incumbent monopolist who possesses the most advanced technology. If a new entrant improves the technology parameter Ait, then he is able to displace the incumbent monopolist and dominate the industry, until he is displaced by the next technologically dominant new entrant. Aggregate output is the sum of the industry specific outputs Yit, and under certain simplifying assumptions can be represented by a simple Cobb–Douglas aggregate per-worker production function: Yt = A1t − a K at , where At = S Ait

(2)

Innovation and Growth The economy’s long-run growth rate is given by the growth of At, which depends on endogenously on the economy-wide rate of innovation. The theory is flexible in modeling innovation. It encompasses ‘frontier’ innovations that result in a new global technology parameter (A¯ it), where A¯ it = gA¯ it−1, as well as ‘withinfrontier’ innovations that bring domestic technology up to the global frontier.

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Globalization and development in the Mekong economies

Consider a country in which ‘frontier’ innovations take place at frequency µn and ‘within-frontier’ innovations at frequency µm. The change in the economy’s productivity frontier is given by: At+1 − At = µn (g − 1) At + µm(A¯ t − At)

(3)

and, hence the growth rate would be: gt = µn (g − 1)+ µm(at−1 − 1), where: at = At /A¯ t

(4)

Thus long-run economic growth depends on the frequency of innovation and imitation, the impact of innovations on the stock of technology, and the distance of a country from the technology frontier.

(ii) innovation in activities in which they are vulnerable to competition from a technologically superior competitor (Case B). Case A Consider a model in which each sector of the economy has a front-runner who uses the most advanced technology available locally (Ait). There are also followers using slightly outdated technology (Ait−1). The front-runner currently earns a profit π*it = dAit, while followers earn a profit πit = adAit−1, where a