ASEAN – The Challenges of Convergence and Integration
First Deputy Managing Director, International Monetary Fund
March 19, 2015
It is an honor to be hosted here in Malaysia and to speak before this gathering of ASEAN central bank governors and officials. You represent an organization whose purpose has evolved tremendously in the nearly 50 years since its founding. But there has been one constant: dynamism and growth.
I would like to thank Governor Zeti for offering me the opportunity to speak tonight. Governor Zeti’s vision and leadership have helped establish Bank Negara Malaysia as one of the most capable and highly-regarded central banks. She has been instrumental in shaping and strengthening Malaysia’s macroeconomic and financial institutions, facilitating strong growth, and encouraging inclusion.
Tonight I will talk about economic convergence and ASEAN’s future. By convergence, I mean the decades-long process by which ASEAN countries will raise their living standards to join the ranks of advanced economies.
This is a timely issue for ASEAN. While your 10 countries and 625 million people are at diverse stages of development, millions have already ascended into the middle class. But there is still much to accomplish. Tonight I will talk about the potential for ASEAN countries to achieve convergence and what it will take to achieve that goal.
Let’s begin by considering our host country. Twenty years ago Malaysia’s GDP per capita was about $3,500, one sixth that of the UK. Last year, GDP per capita had risen to almost $11,000, about one quarter of the UK. Now Malaysia is targeting high income status by 2020, with per capita GDP rising to about $15,000. That goal is within reach. But with a sustained effort to pursue further reforms, an agenda I will outline tonight, Malaysia’s income level in 2040 could surpass that goal, and essentially converge to the UK.
Of course, full convergence with advanced economies is a more distant goal for some other ASEAN countries. The frontier economies aspire to join the ranks of the emerging markets—and this is also an attainable goal.
Needless to say, the challenges of convergence depend on developments in the global economy. So let’s start with a review of where we are right now. Then we’ll turn to ASEAN’s own challenges.
The Global Outlook
You are well aware that global growth has been weaker since the 2008 financial crisis. In fact, we have repeatedly had to revise down our forecasts, and now expect global growth to be 3.5 percent this year, rising to 3.7 percent in 2016.
One key factor, on the minds of many here in Asia, is the slower growth of emerging market countries. China’s deceleration has already had an impact on global demand; and growth is expected to moderate again this year. But many other emerging market countries are seeing growth slow also.
Another factor is the divergence among advanced economies. Europe continues to struggle, although there are signs of strengthening. Japan has experienced only modest growth. But the U.S. is gaining momentum with added support from lower oil prices and Fed policy.
Oil exporters—including some of you—are feeling the pinch of lower prices. But that is giving a lift to oil consumers—and there are more of those in the room tonight. Lower oil prices will reduce pressure on current accounts and inflation. And overall, we expect the impact to be a net positive for the global economy.
Still, there are significant global risks, particularly volatile financial markets, and pressures that could arise from large movements among key currencies, a phenomenon we have not seen for some years in the global economy.
Despite the risks, ASEAN’s recent performance has been impressive. ASEAN has grown 6 ½ percent annually since the 2008 crisis, although growth is now slowing somewhat. Your resilience reflects the dynamism of your urban middle classes, who are driving consumption and investment. ASEAN also remains a magnet for foreign direct investment and portfolio flows, hitting a record high of $125 billion in 2013—9 percent of the global total.
You will all know that your outlook is not without risks. We cannot rule out volatile capital flows related to geopolitical tensions, or uncertainty about oil prices and interest rate policies in advanced economies.
Now let’s relate this back to convergence. Important economic forces have been driving ASEAN convergence. Export-led growth and industrialization have benefited the region, and, more recently, domestic demand. IT innovations are bringing change to manufacturing, infrastructure and services.
No doubt, the process of convergence is a long one; it extends over several decades. Convergence is about raising worker productivity and closing gaps in technology, infrastructure, education and financing. But that will require a range of reforms; for example, scaling up infrastructure investment, raising educational attainment, speeding up structural transformation, and removing impediments to trade and investment.
Let’s take a closer look some of the potential sources of productivity growth and convergence.
Macroeconomic and financial policies
Perhaps the most basic building block is macroeconomic and financial stability. Here your policies have been effective, including expansionary monetary and fiscal policies after 2008. And where the countercyclical response to the crisis raised government debt, fiscal adjustment is now being applied. Some of you are taking advantage of lower oil prices to cut fuel subsidies and responding to declining energy revenue with broad-based taxes like Malaysia’s new Goods and Services Tax. But these fiscal reforms also require targeted support for the needy to ensure equity.
Meanwhile, monetary policies are more accommodative or are on hold, reflecting the weaker global growth and continued unconventional monetary policies in the advanced economies. I know you are well aware that these circumstances could change quickly.
You also have been prepared to defend against volatile capital flows. This is reflected in your successful use of macroprudential policies to address risks from rapid increases of credit and housing prices. At the regional level, there has been progress creating a financial safety net, including the renewal of bilateral swap arrangements, doubling the resources of the Chiang Mai Initiative Multilateralization, and strengthening the ASEAN+3 Macroeconomic Research Office.
So, beyond macroeconomic policy, what are some of the reforms that will contribute to convergence? First is your ongoing structural transformation. This has been led by the expansion of modern farming methods, industrialization and export-led growth. These trends are absorbing surplus rural labor and spurring rapid urbanization, expansion of services, and far-reaching changes in family and social institutions.
The Impact of Structural Transformation
Here in Malaysia, two-thirds of people live in urban areas, and services and industry represent about 80 percent of the economy. But other ASEAN countries still have large traditional farming economies. Thailand has a disproportionately high labor share in agriculture, largely unchanged over the last 15 years.
The second area where reforms can accelerate convergence is closely related: upgrading labor force skills and raising the level of participation in the labor force. In a global economy increasingly driven by technological innovation, a skilled work force is essential. That means that the educational system must keep pace with economic change.
But you will also be confronting demographic headwinds that will accompany convergence. An aging society is already an important policy concern in Singapore. More of you will face this soon. One solution is to raise the participation of women in the work force—an initiative we now see happening in Japan.
Closing infrastructure gaps is the third factor that is key to convergence. The ADB has estimated Asia’s infrastructure needs at $8 trillion over 10 years, of which about $1 trillion is here in ASEAN. Our World Economic Outlook examined this issue last year and found that infrastructure investment can raise potential output and be self-financing when there is substantial slack in the economy. Many countries have the fiscal space to scale up infrastructure investment. But they need public financial management systems to ensure efficient spending.
Encouraging home-grown innovation is the fourth important element in accelerating convergence. Innovation requires talent, funding, and tolerance for risk taking. Also key are protection of intellectual property rights and a level playing field.
Interestingly, despite relatively strong growth and increasingly sophisticated exports, ASEAN’s total factor productivity lags Korea and Taiwan, both climbing toward high-income status. That partly reflects the success of Korean and Taiwanese firms in leapfrogging the frontiers of technology at an early stage of development.
That issue is now being addressed here in Malaysia: the share of R&D spending in the federal budget is being gradually raised, and attention is being paid to creating successful partnerships between universities, the private sector and government ventures. But for these policies to succeed—in any country—there needs to be a balance between support for startups on the one hand, and micromanagement and favoritism on the other. The most successful innovators emerge from an ecosystem in which success happens side by side with failure.
Free trade and economic integration also play important roles in growth and convergence. ASEAN trade is largely free of tariffs. But further progress is needed on non-tariff barriers, especially affecting services, and obstacles to investment. Recently there has been an increase in trade of finished goods within ASEAN.
This intra-regional trade should intensify with further integration and the launch of the AEC. Regional trade agreements such as the Trans-Pacific Partnership and the Regional Comprehensive Economic Partnership should also help reduce non-tariff barriers and promote trade. By some estimates, gains from such agreements range from about 2 percent of GDP for Singapore to over 6 percent for Malaysia and over 12 percent for Vietnam.
There is an important role for the ASEAN Secretariat to play as regional integration advances. The IMF is willing to work with the Secretariat on issues of mutual interest.
Financial Integration and Financial Deepening
Greater financial integration can contribute to growth and convergence. If managed well, it can accelerate financial deepening throughout the region. Larger, deeper, and more liquid financial markets lower the cost of capital. They improve resource allocation and enhance diversification of risks and resilience to shocks. They also lengthen the maturity of financing and improve trading and settlement practices. Financial deepening can help enhance growth, increase employment, spread financial inclusion, and raise living standards.
Greater financial integration could also help you overcome the present fragmentation of national financial sectors caused by national regulations and the absence of mutual recognition and common disclosure requirements. So it is important that the ASEAN Economic Community calls for regulatory harmonization and the strengthening of policy coordination.
Financial integration also will help ASEAN’s less-financially developed economies in their own process of convergence. They stand to gain the most.
But we know there are risks to financial integration. Rapid credit growth that accompanies financial development can negatively affect macroeconomic stability if regulation and supervision do not keep up. In addition, Europe’s experience is relevant in considering the integration path ASEAN chooses to take. An important lesson is that monetary and financial integration without fiscal or political integration is fraught with danger. Over time, ASEAN will be well served by adopting a measured, gradual, and evolutionary approach.
Collaboration and Cooperation
The experience of the past 20 years offers many lessons about the risks of market volatility in a globalized financial system. So we welcome your efforts to strengthen the region’s safety net to address future balance of payments difficulties. Your decision to double the CMIM to $240 billion and ratify a crisis prevention facility was an important initiative.
The IMF is committed to strong cooperation with you and your institutions. Collaboration is being strengthened in the areas of surveillance, liquidity support arrangements, and capacity development. The decision at last May’s ASEAN+3 meeting to endorse guidelines for further cooperation with the IMF was an important step.
ASEAN is one of the success stories of the modern era. In two generations you have risen from poverty to prosperity. In doing this ASEAN has set an example for developing countries around the globe that aspire to economic progress. Steady macroeconomic management, economic reform and liberalization, along with investment and innovation, have already allowed great progress to be made. You now are pursuing the next stage—convergence in living standards to those of the advanced economies—and the IMF looks forward to working with you as you attain this goal.