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Are Asian Economies Prepared for Higher Growth in 2014?

January 8, 2014

As all eyes turn to Brazil for the World Cup this summer, and to India and Indonesia for two of the world’s largest democratic elections, 2014 may as well be called the “Year of the Middle-Income Country.” Last year saw several economies make steady gains, including powerhouse China (albeit no longer at double-digit pace but at a still enviable 7.6% growth rate), and countries such as Sri Lanka, Thailand, Malaysia, Philippines, and Vietnam continuing their climb toward middle- and upper-middle income status.

India Construction site

Laborers at a construction site in Gurgaon, a rapidly growing financial and industrial center southwest of New Delhi. India and Indonesia, two of Asia’s largest economies, show some weakening in underlying fundamentals, currently running large account deficits and high inflation. Photo/Conor Ashleigh

In 2014, those steady gains are projected to continue apace. The outlook for the global economy is generally positive compared to 2013, and in 2014, the IMF predicts that Asian countries will continue to make steady gains as a result of the “gradual pickup in exports to advanced economies and resilient domestic demand.” The region as a whole will experience 5.25 percent growth in 2014, and emerging Asia is projected to grow at an even higher pace of over 6 percent. China’s structural changes are expected to move it to a lower (but more sustainable) growth plane, with growth forecast at 7.3 percent in 2014. Meanwhile, the economic policies (“Abenomics“) of Japan’s prime minister, Shinzo Abe, have reignited the nation’s lagging growth in 2013.

However, these steady gains will be undermined by a number of challenges in the coming year, from structural impediments and delays in economic reform, to fiscal vulnerabilities and high inflation in some countries. Growing inequality and political unrest in places like Thailand, Bangladesh, and Cambodia, as well as persistent corruption and the under representation of women in the economy, continue to ensnare Asian economies in often inefficient allocation of goods, services, resources, and human talent. In addition, the difficulties some countries have experienced in changing their growth paradigm to a higher productivity economy in order to remain competitive, indicates that the economic threat of the middle-income trap (MIT) may have its roots in a deeper political reality.

Addressing Middle-Income Country Challenges

The MIT occurs when economies stagnate at middle-income levels and fail to graduate to upper-middle or high-income levels. Recent IMF research found that, compared with other regions, Asia’s risk of growth slowdowns arises from particular threats, such as poor communications infrastructure, as well as ineffectual institutions and weak educational and research capacities. Within Asia, the risk of the middle-income trap, or, if not of a trap, of reduced competitiveness and new slowdowns in growth, in Malaysia, the Philippines, and China arises more from poor institutions, while in Vietnam, India, and Indonesia, that risk stems more from a poor transport and communications infrastructure.

Recommendations on policy reforms and focused investments that will help countries avoid the MIT are well known. In its 2014 economic outlook report, the OECD advises that further development of institutional and human capacities, infrastructure, and innovation must be central to Asia’s development strategies. But the political economy dimension of the MIT, as well as the fundamental role of good governance in making technical solutions effective, must also be taken into account.

As the region pursues policies that improve its institutions, infrastructure, and human capital, it must continue to invest in regional economic integration and cooperation as a potent strategy for growth. Indeed, Asia is already well-positioned for mitigating the risk of growth slowdowns through increased trade and cross-border flow of goods, services, and labor. Regional integration and vertical supply chains in Asian middle-income countries – even for India and Indonesia, which lag behind the other Asian middle-income countries in this category – “compare favorably” to other parts of the world, such as Latin American and the Middle East. The OECD shares this view: “Growing regional integration both among emerging Asian countries and with the broader Asian region would be a major asset in their efforts to rise into the high income ranks.”

Cautious Optimism in the New Year

Although broad trends indicate a positive direction overall for lower and middle-income country growth across Asia, there are country-specific challenges that will have to be addressed by individual governments and policymakers in order to sustain continuous economic growth and development.

Political uncertainty in Bangladesh, Thailand, and Cambodia is causing concern over social and economic stability at both a domestic and regional level. The adverse impacts on the economies of these nations cannot be underestimated. Elections marred by violence in Dhaka are deepening tensions in South Asia, which has a grim history of political violence. Similarly in Thailand, political protests and uncertainty have resulted in tourism being affected negatively (estimates show that the political situation reduced the influx of inbound tourists from mid-November to mid-December by an estimated 300,000 people or 8 percent compared with the number expected) and investors hesitant to invest in large-scale projects. In Cambodia, political unrest and protests over garment factory wages are causing strain in a country still trying to gain its economic bearing. Whether justified or not, political instability occurring in these countries compromises the region’s ability to both address conflict resolution and maintain economic growth. The extent of threat to the region’s growth remains to be seen, but political leaders are being urged to resolve tensions swiftly through open dialogue and policy reform.

Cambodia street protests

Political uncertainty in Bangladesh, Thailand, and Cambodia is causing concern over social and economic stability at both a domestic and regional level. Above, protesters march in Cambodia’s capital, Phnom Penh. Photo/Véronique Salze-Lozac’h

Macroeconomic factors are also undermining many Asian economies. India and Indonesia, two of Asia’s largest economies, show some weakening in underlying fundamentals, currently running large account deficits and high inflation. Lower-income countries like Sri Lanka and Vietnam also face worries about persistent inflation. Malaysia has concerns about its fiscal position, while Thailand, Philippines, and ASEAN overall have concerns about credit growth. Overall, stricter macroeconomic policies are urgently needed to reduce vulnerabilities, including improving tax collection by broadening the tax base, rationalizing expenditure to address priority social spending and investments, and stronger financial sector supervision. Countries will also have to continue to adapt to the wage pressure. Manufacturing is likely to continue to shift from China to countries like Bangladesh, Vietnam, and Cambodia, as Chinese wages are forecast to rise by 10 percent or more in 2014. In India, wages are set to rise by 11 percent in nominal terms, but high inflation will erode this to around 2 percent. Among smaller economies, Bangladesh’s government recently mandated a 77-percent increase in the minimum wage for the garment industry, and recently, garment workers in Cambodia have also begun to stage demonstrations demanding higher wages. Across Asia as a whole, salary rises of 7 percent are expected.

As Asia is still at the forefront of the global growth engine, much emphasis will be placed on governments and policymakers to overcome these challenges in 2014. The capacity of Asian economies to implement sound macroeconomic policies at the national level and to pursue increased regional cooperation and integration will be determinant if Asia is to achieve high, sustainable growth over the medium term and continue to climb the ladder toward upper-income status.

Véronique Salze-Lozac’h is The Asia Foundation’s director for Economic Development Programs based in Bangkok, Syed A. Al-Muti is associate director for Economic Development Programs in Dhaka, Katherine Loh is a senior program officer in San Francisco, and Ka Wai Wong is the Foundation’s Australian Youth Ambassador for Development in Bangkok. Salze-Lozac’h can be reached at veronique.salze-lozach@asiafoundation.org. The views and opinions expressed here are those of the individual authors and not those of The Asia Foundation.

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