Southeast Asia: Crouching Tiger or Hidden Dragon?

Friday, July 08, 2011

Southeast Asia: Crouching Tiger or Hidden Dragon?

Thursday, July 7, 2011
Vikram Nehru
International Economic Bulletin
Carnegie Endowment for International Peace

Mention Asia and many people immediately think of China and India—giants that are powering the world economy. But Southeast Asia, a sub-region of ten countries that lives in the shadow of its two large neighbors, is also a thriving trade and economic hub.

At first glance, the countries of Southeast Asia—bound by many regional trade and political agreements—seem to make no sense together. After all, the region includes a small, rich, oil kingdom (Brunei); a post-conflict society (Cambodia); and a wealthy entrepôt economy (Singapore). In addition, there is an autarkic country that has been under military rule since 1962 (Myanmar); a poor, landlocked economy blessed with hydropower and minerals (Laos); and a populous nation whose growth rates rival China’s (Vietnam), not to mention four diverse middle-income economies that aspire to join the ranks of advanced countries (Indonesia, Malaysia, the Philippines, and Thailand).1

Nevertheless, the countries share a strategic location and access to plentiful natural resources. Furthermore, their diversity and increasing integration lie at the heart of the region’s rapid and resilient economic growth. Politically, the region provides stability in a part of the world that is rapidly reshaping the global balance of power. As a result, its continued development—which depends on investments in infrastructure and education, as well as improvements in business climate—is important for the rest of the world.

Economic Promise

Southeast Asia’s ten countries have a combined GDP of $1.9 trillion (bigger than India); a population of almost 600 million people (nearly twice that of the United States); and an average per-capita income near that of China. Over the last decade, the countries have averaged a growth rate of more than 5 percent per year. If Southeast Asia were one country, it would be the world’s ninth largest economy. It would also be the most trade-dependent, with a trade-to-GDP ratio in excess of 150 percent, and one of the world’s consistently good performers.

In the 1970s, several of the region’s countries were singled out for their economic promise. Singapore was deemed an “Asian tiger” (along with Korea, Hong Kong, and Taiwan), while Indonesia, Malaysia, the Philippines, and Thailand were dubbed “tiger cubs.” All five countries have since lived up to those names, with Singapore now a high-income economy and the four cubs all middle-income economies. The latest member of Southeast Asia’s middle-income group, Vietnam, has adopted China’s economic model and enjoyed similarly explosive growth and poverty reduction, albeit combined with episodes of overheating.

Though the 1997–1998 Asian financial crisis briefly stalled their steady progress, the cubs have averaged an impressive 7 percent annual growth rate since 2000. And, despite being hit hard by the Great Recession, the middle-income countries recovered smartly in 2010. In fact, the entire sub-region performed impressively, growing at over 8 percent, as rapid policy adjustments helped soften the blows of the crisis and enabled a quick rebound that also helped the broader global recovery.

Strategic Location, Abundant Resources

In part, Southeast Asia owes its success to geography. The countries sit astride the Malacca Straits, the world’s second busiest shipping channel (after the English Channel) and second most popular oil tanker route (after the Straits of Hormuz). Well over half of the world’s merchant fleet capacity uses the channel each year, and closing the Straits would be highly disruptive and possibly even catastrophic for world trade.

Shipping Routes Around the Straits

The sub-region is also a cornucopia of natural wealth, replete with oil, hydro- and geothermal power, various minerals, timber, rice, palm oil, cocoa, and coffee. Over the centuries, these resources have attracted traders, colonists, and, most recently, foreign investors. The resources have also pushed the region into commodities trading, giving its countries some of the world’s highest trade-to-GDP ratios.2

Southeast Asia’s abundant natural resources also provided the springboard for industrialization in the 1970s and 1980s, especially in the tiger cubs. These countries adopted the export-oriented policies of their successful northern neighbors—Japan, Korea, and Taiwan—helped by trade, finance, and foreign direct investment from the advanced economies. Additionally, sound macroeconomic management, relatively open trading systems, high savings rates, and a rapidly growing, young labor force permitted high levels of investment and sustained rapid growth for three decades. Vietnam’s industrialization started later, in the 1990s. Today, all these economies are part of the famed and highly competitive East Asian production network, along with China.

Southeast Asia’s natural resources have also helped its services sector. Singapore’s location in the Malacca Straits has made it the world’s largest transshipment port, strengthening its logistics, finance, and business services. Meanwhile, the four tiger cubs have developed a large tourism industry, accounting for the bulk of Southeast Asia’s foreign visitors (67 million in 2010, outstripping China’s 56 million). More recently, exciting new services trends have emerged there, with Singapore pushing to become a global biomedical sciences center and Kuala Lumpur, the capital of Malaysia, establishing itself as a global center of Islamic finance.

ASEAN’s Role

In addition, all ten Southeast Asian nations belong to the Association of Southeast Asian Nations (ASEAN)—a 45 year-old regional organization that has promoted economic integration and aims to create an Economic Community—a single market for goods, services, investments, and skilled labor—by 2015. While many observers question the feasibility of this deadline, ASEAN has already lowered trade tariffs and established a Free Trade Area among its members. Ironically, trade within ASEAN has grown less rapidly than ASEAN’s trade with China, a trend that the China-ASEAN free trade agreement, which came into effect in the beginning of 2010, will only accentuate.

Perhaps even more importantly, ASEAN has also played a pivotal stabilizing role in both the region and the world, confounding critics who have periodically predicted its imminent demise since its founding in 1967. Since that time, no war has erupted among its members, as the organization has mediated conflicts.3 The organization has also worked to resolve the dispute over the resource-rich Spratly Islands, which could block U.S. access to the Indian Ocean as China, Taiwan, Vietnam, the Philippines, Malaysia, and Brunei all claim land.

ASEAN’s political and economic usefulness has drawn in other countries. In 1999, China, Japan, and Korea institutionalized their partnership with ASEAN through ASEAN+3. The expanded group’s successes include a new mechanism for providing liquidity during a financial crisis (a reaction to the perceived heavy-handedness of the IMF during the Asian financial crisis) and a pledge to establish a regional 720,000-ton rice reserve facility after the 2011 international food crisis. Both initiatives are important building blocks for enhancing the sub-region’s economic stability. And, by including Japan and China, ASEAN+3 has helped lower the tensions between the two countries.

ASEAN is engaging with even more countries through the East Asian Summit (EAS), first held in 2005, which brings ASEAN+3 together with Australia, India, and New Zealand. This group has been less successful in introducing concrete initiatives, but both the United States and Russia have lobbied hard to join the next summit in October, providing proof of the group’s perceived potential. The United States, in particular, is interested in Southeast Asia, given its potential to help America maintain access to the Indian Ocean and serve as a counterweight to China. Additional reasons include the U.S. role as the sub-region’s largest foreign market and investor, and the pivotal role Indonesia plays in the global war on terror.4

Challenges

Of course, no region is devoid of challenges and risks. For Southeast Asia, China’s emergence in the next two decades as the world’s largest economy poses arguably the biggest challenge. While this will bring enormous opportunities, it will also bring equally important risks. As China confronts economic, social, environmental, and international challenges, Southeast Asia will undoubtedly be buffeted by any instability that may emerge. Equally important, Southeast Asian policymakers view China’s regional dominance as a possible security risk—a concern that has been highlighted by recent incidents near the Spratly Islands.

The tiger cubs’ economic development presents another worry. In the last half-century, few countries have made the transition from middle- to high-income on the strength of their manufacturing and services. They must move up the value chain, but competing with the advanced economies requires many prerequisites—a highly educated and innovative workforce, a culture of excellence, entrepreneurial skills, access to finance and infrastructure (needed especially in Indonesia and the Philippines), and a competitive business environment. Southeast Asia’s middle income economies are gradually putting these in place, but their efforts will need to be more vigorous and coordinated if genuine progress is to be achieved.

Looking Ahead

In the next year or two, Southeast Asian economies will face a bumpy ride as growth slows to a more sustainable 5 percent a year—not just because the international economic environment is becoming more sluggish, but also because inflationary pressures in the sub-region are prompting tighter macroeconomic policies, and commodity prices have become more volatile.

Just as importantly, Thailand and Malaysia are expected to see continuing political tensions. The victory of the Pheu Thai Party in Thailand’s general elections last weekend has opened a new phase of uncertainty there. And Malaysia’s national elections, expected within a year, could bring ethnic and political tensions to the surface again.

Still, Southeast Asia’s overall long-term economic prospects remain bright. The same forces that fueled growth in the past—sound macroeconomic management, open trading systems, favorable demographic trends, and relatively high savings rates—will re-emerge. Rapid and steady growth in India and China will also help. Already, the sub-region is proving to be an indispensable source of energy, raw materials, and parts and components for China’s rapidly growing manufacturing sector, and its production linkages with India are growing apace.

Most importantly, however, the sub-region’s middle-income economies must move up the value chain to further their economic prosperity. If they accomplish this, Southeast Asia, now in the shadow of its two giant neighbors, could well become home to full-fledged tigers and dragons.

Vikram Nehru is a consultant for the East Asia Region of the World Bank and will soon join Carnegie as a Senior Associate.

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1. Timor Leste and Papua New Guinea are not included in our definition of Southeast Asia.

2. Even Myanmar—with its autarkic policies and the trade sanctions imposed on it by Western countries—enjoys a ratio of close to 40 percent, thanks to its borders with China, Thailand, and India.

3. When clashes have occurred, such as the recent Thai-Cambodia border conflict over a disputed temple, ASEAN helped mediate between the two parties and facilitate communication. In addition, ASEAN recently provided Myanmar’s junta with an acceptable framework for engaging with the international community after a cyclone hit.

4. Since Obama took office, the United States has actively re-engaged with Southeast Asia—in part in response to China’s growing influence in the region and in part due to concerns that the Spratly Islands dispute could disrupt America’s access to the Indian Ocean. The Southeast Asian nations have welcomed this re-engagement for varying reasons: some see it as a useful balance against China; others recognize the legitimate interest of the United States in ensuring stability in Southeast Asia as it is the sub-region’s largest market and biggest foreign investor.

The United States is also interested in Southeast Asia because of Indonesia, the world’s largest Muslim country and the setting for several terrorist attacks, some clearly aimed at U.S. interests. Indonesia has been an important ally of the United States and Europe in the global war on terror, and the country’s efforts to establish genuine democracy and decentralized government must continue to deliver economic prosperity, justice, and freedom, and deprive radical groups of the oxygen of hopelessness, injustice, and despair. Indonesia’s recent successes against jihadist groups have reduced the scale but not the frequency of terrorist violence, and such violence could be exported to potential hotspots in Malaysia and Southern Thailand.