Cisco Capital Asia Pacific

Asian Economies Need to Focus on R&D

Asian Economies Need to Focus on R&D, Build Human Capital, and Strengthen Financial Institutions

During the 2014–18 period, 12 Asian economies are expected to grow at nearly 7% per annum, according to the findings of a recently concluded study.

Titled Economic Outlook for Southeast Asia, China and India 2014: Beyond the Middle-Income Trap, the study concludes that these economies would remain resilient in the next five years, riding on increasing domestic demand.

The report published by the Organisation for Economic Co-operation and Development (OECD) covers Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand (ASEAN-6); Cambodia, Lao People’s Democratic Republic or Laos, Myanmar and Vietnam (CLMV); besides China and India.

The study projects an overall annual growth of 6.9% in the medium term, lower than the 8.6% in 2000–07. It attributes the slower rate—compared to the years before the global financial crisis—to the moderate growth in China and India.

Domestic Demand Is Up

According to the study, domestic demand will drive growth in the region. Wages and private consumption will continue to rise. Government policies too, will play a critical role in promoting private consumption. Governments will continue to invest in infrastructure spending, while private-public partnership projects will play a greater role in the sector.

The average real GDP growth among countries in Southeast Asia is expected to be 5.4% per annum. Indonesia will lead with a projected annual growth of 6%, followed by the Philippines with 5.8%. The two countries will benefit from the strong growth in domestic demand, besides major investment in infrastructure and implementation of structural economic reforms. Similarly, thanks to increasing domestic demand, real GDP in Malaysia and Thailand are poised to grow annually by 5.1% and 4.9%. Singapore, which already enjoys a strong economy, is estimated to see a growth rate of 3%.

Laos is projected to grow annually by 7.7%, while Cambodia and Myanmar will be close to 7%. In Vietnam, annual growth is likely to be 6% during 2014–18, as against 7.6% in 2000–07. This is due to slower demand from advanced economies and weak macroeconomic management policies.

Between 2000 and 2007, China’s economy grew at a blistering pace, recording an annual real GDP growth of 10.5%. By 2012, the rate moderated to 7.7%, and is projected to remain so over the medium term. In comparison, India’s growth rate is expected to be lower, at 5.9% (7.1% in 2000–07). India’s growth had declined to 3.7% in 2012, but may go up to 6.1% in 2018.

Foreign Investment on the Rise

The study makes note of the increasing focus on ‘quality of growth’ in countries like Thailand, the Philippines, Indonesia and Cambodia. It also acknowledges that the climate for foreign investment has improved in Cambodia and Myanmar.

The region is also likely to see strong FDI inflows. While most ASEAN-6 countries are likely to retain current account surplus, CLMV countries will suffer from a current account deficit. Fiscal deficits will be lower in most countries.

China, India, Indonesia, Malaysia, the Philippines, Thailand and Vietnam are poised to join the list of high-income countries, provided they can sustain their rapid growth. Malaysia (2020) is set to reach that goal the fastest, while India is likely to enter the league only in 2059.

Asian Economies Need to Focus on R&D

Need to Cross Hurdles

Even as the economic outlook is robust, these countries must overcome several challenges that threaten to block further progress. The study suggests that the ASEAN-6 economies should improve their capacity to provide education and job skills and member countries should aspire for a regional common market by 2015.

While Malaysia has displayed resilience amid global uncertainty, there is a need to address several structural challenges such as a narrow tax base with unsatisfactory tax compliance standards. Further, SMEs in the country suffer from low productivity and the quality of education is another area of concern. Similarly, teaching standards and national curriculum in Thailand require a review. Thailand’s agriculture sector can benefit from modernization, but there is a lack of awareness regarding the benefits of adopting an environmentally sustainable economy.

Like Malaysia and Thailand, Indonesia can benefit from reforms in the education sphere. Its social protection provision, too, may need a relook. Indonesia and the Philippines are vulnerable to natural disasters; efforts to contain the damage will have a positive impact on the economy. Investment in manufacturing and services can boost Brunei’ economy, and reduce dependency on the oil and gas sectors. Unlike its neighbours, Singapore enjoys a more advanced stage of economic development. However, an ageing population is a key hurdle in its march towards sustainable growth.

In India and Indonesia, capital inflows have been inadequate. Current account deficits in these two populous countries are significantly high. India has experienced strong growth in sectors such as ICT. In recent years, however, high inflation, coupled with rising fiscal and current account deficits, have caused widespread concern.

China is looking to rebalance its growth model, with domestic consumption as the key driver. A rising middle class will ensure increased spending in education and healthcare, appliances and vehicles. Sustainable growth in consumption, however, will require institutional reforms and streamlining of administrative efficiency. In the past, the Chinese economy was highly dependent on exports of manufactured goods, while making significant progress in enhancing productivity.

In CLMV countries sustainable development of natural resources and agriculture is a challenge, while in Vietnam, public and private enterprises lack a level playing field and there is a need to urgently reform its monetary policy framework. Indicators reveal comparative weaknesses in insolvency regimes in Indonesia, the Philippines and Vietnam. Intellectual property rights, protection of minority shareholders, corporate governance, labor market efficiency, corruption and red tape are a concern in several countries.

Investment in Human Capital, R&D

The study notes the efforts made by China, India, Malaysia, Thailand and the Philippines to develop their innovation capabilities. It emphasizes on the need to invest in promoting research and development (R&D), strengthening educational institutions, and imparting vocational skills. It calls for a strong link among universities, research institutions and industries.

The OECD study recommends strengthening of banks and other financial institutions, besides development of capital markets. SMEs getting easier access to finance, pepping up the services’ sector, enhancing productivity and greater use of technology are among other measures listed in the report.

To sustain development beyond the middle-income trap, the regions need to shift away from growth that is driven primarily by factor accumulation. They should make substantial changes in economic structures and build institutional capacity in human capital.

The OECD study identifies common challenges that confront 12 Asian economies, while pointing out country-specific concerns. It makes recommendations to overcome these hurdles and boost growth. The study concludes that regional initiatives will contribute to sustain national development in these countries, simultaneously taking them closer to the goal of becoming high-income advanced economies.