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Logo of Phnom Penh Post newspaper Phnom Penh Post - How smuggling and graft sap a nation's economy

How smuggling and graft sap a nation's economy

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With the general election now out of the way, donors are hopeful the next five years

will see the government focused on reform and economic growth. That is just what

a Cambodian People's Party (CPP) poll victory would guarantee, Minister of Commerce

Cham Prasidh told the Post as he queued to vote in Siem Reap.

Some 4.1 million tons of rice paddy is produced each year, but milling capacity is only 1.3 million tons, a deficit of 2.8 million tons - and a potential loss of $731 million in export revenue each year.

Prasidh has led the charge on the country's entry to the World Trade Organization

(WTO), which is expected to become official on September 11. But joining the trade

body brings a variety of risks, not least because little has happened in the way

of concrete reform of the economy, and foreign investors are staying away from the

Kingdom in droves.

At the moment Cambodia relies on just a few industries that are barely competitive

in the world of unprotected trade that WTO will usher in. A new study from the World

Bank, Toward a Private Sector Led Growth Strategy for Cambodia, gives one indication

of just how far the economy is lagging because of the high official cost of doing

business, the lack of an integrated 'supply chain' in most sectors, and what the

report euphemistically calls 'unofficial costs'.

The study of just six sectors of the Cambodian economy found potential losses of

almost a quarter of a billion dollars to Gross Domestic Product (GDP) every year

due to "market and administrative distortions".

Given that GDP is only $3.5 billion, that $226 million represents a huge lost opportunity

and also represents forgone activity that would generate around $28 million annually

in government revenue.

Those distortions include huge military-run smuggling schemes, a myriad of officials

who use their government positions to line their pockets, and labyrinthine customs

and port charges.

For instance, the report documents more than $2,300 in 'unofficial costs', charged

by everyone from the Ministry of Labor to the police, to ship a single 40-foot container

from a garment factory in Phnom Penh via the port at Sihanoukville. Those fees add

around 35 percent to the cost of each container.

Opportunities are also lost because, for most industries, only one or two stages

of production occur locally. While the garment industry creates a huge demand for

cotton and fabric, that demand is almost always filled by imports. The report notes

that imported raw materials account for nearly 63 percent of the cost of garment

production.

That is despite the fact that local cotton is actually slightly cheaper than imported

cotton. The problem is that there is not enough cotton of sufficient quality produced

here to satisfy the garment industry. An integrated supply chain would make the garment

industry more competitive and provide employment for local farmers and processors.

Cotton and textiles was one of a selection of six products and commodities the study

examined. The others were rice, garments, motorcycles, tobacco and canned milk.

In rice production alone, some 4.1 million tons of rice paddy is produced each year,

but the country's milling capacity is only 1.3 million tons, creating a deficit of

2.8 million tons. Theoretically, the study states, the lack of investment in commercial

standard milling capacity contributes to a potential loss of $731 million in export

revenue each year.

The lack of milling capacity also provides a strong incentive to export unprocessed

rice illegally. Officially the country exports 60,000 tons of milled rice, but illegal

exports of unmilled rice are as high as 450,000 tons.

The study identifies various barriers to economic growth and concludes that unpredictable

conditions force enterprises to take a short-term view, and deter foreign and domestic

investors.

That is a worrying sign for the poor. The International Monetary Fund's resident

representative, Robert Hagemann, recently contended that the economy needs to grow

at more than 6 percent a year to make any inroads on poverty alleviation.

That is not yet happening. CDRI, a local research body, reported that real GDP growth

was just 4.2 percent last year. The World Bank report notes that the workforce is

growing at an annual rate of 3.2 percent, some 228,000 people. To provide work for

all, the country will need to add the equivalent of a new garment industry to the

economy each year.

The study states that the government is aware that "opportunities afforded by

the WTO will not result in the growth of productive employment unless business environment

constraints are removed and market-supporting institutions built".

Sok Siphana, secretary of state at the Ministry of Commerce (MoC), told a gathering

of journalists at the World Bank on August 7 that the ministry would turn its attention

to the report as a matter of priority.

"Once the new government is in place, addressing the supply chain issues is

probably at the top of the agenda," Siphana said.

But that will be a tall order given the vested interests in even Siphana's own ministry.

The report calculated that MoC charges make up 13 percent of the 'undocumented administrative

charges' associated with the production of garments. The Ministry of Transport and

the Ministry of Finance take even larger chunks, with the former accounting for 44

percent of the charges and the latter swallowing 30 percent.

Diversification

The economy currently relies on a few sectors. The garment industry accounts for

12.4 percent of GDP and employs 220,000 workers. Ninety percent of cultivated land

is used for rice, and 80 percent of people are employed in agriculture. The report

notes that success will require a shift away from such a narrow economic base.

"Diversifying into alternative economic activities will be crucial in Cambodia's

post WTO world," the report said.

It adds that there are good reasons for investors to avoid coming here, with the

"high opportunity cost of an opaque system of governance on short and long term

capital flow to both the public and private sector".

If diversification is one problem, another is illustrated by the motorcycle assembly

industry, which shows the difficulties of competing in the current opaque environment.

Although it is cheaper to assemble motorbikes here than in neighboring Vietnam, only

two manufacturers-Honda and Suzuki-actually do so.

The reason is simple: a 100cc motorbike sold legally in Phnom Penh should cost $900,

with sales tax and import duties included. The problem is that a smuggled one costs

only $600. Little wonder, the author notes, that smuggled second-hand bikes outsell

new legal ones by a factor of five to one.

Dodgy deals and graft mean that legal importers are also squeezed. After paying both

official fees and bribes to government officials, the Bank estimates that motorbike

dealerships are left with a profit margin of less than 1 percent. Meanwhile systemic

motorcycle smuggling flourishes on the Thai and Vietnamese borders.

From the Thai side, a driver will bring a motorbike across the border to a waiting

truck. He is paid $30, returns to Thailand and makes the trip again, sometimes up

to five times a night. One manufacturer interviewed by the report's author witnessed

nearly 200 motorcycles crossing the Thai border this way in a single night.

The difficulties involved in stamping out practices that crush local industry are

apparent in the study of the canned milk market. In an operation run by the Cambodian

military, between five and eight truckloads of canned milk made in Thailand, the

Philippines and Malaysia enter the country each day. As a consequence, a company

like Nestlé ends up competing against its own products. And no sooner is a

system developed to stamp out the contraband trade, than a new way of getting around

it is developed.

The report notes that two official customs stamps are now required for each case

of canned milk, but finds that "such stamps are readily available for purchase

by local distributors". The surprisingly large loss to the economy brings a

relatively modest gain to the smugglers.

"Some insiders suggest that the military is making a mere $7,000 a month on

contraband milk, while companies like Nestlé forego as much as $500,000 a

month in sales thanks to the sales of contraband products," it states.

The bright spot: Tobacco

Much vilified internationally, tobacco is the sole bright spot-a shining example

of the country's first 'fully integrated supply chain'. The country has more than

20,000 hectares under tobacco, and although production is small by global standards,

it is still a $50 million business here. The industry employs over 50,000 people,

accounts for 2 percent of GDP and nearly 30 percent of government revenue.

The ten tobacco companies that operate locally distribute high quality seeds to farmers

and advise them on how to grow the leaf. That includes controversial advice on the

use of dangerous pesticides.

But according to the report, a three hectare tobacco farm can earn between $3,227

and $5,377 per season, well above what a typical rice farmer would bring in. And

while the cigarette filters and casings must still be imported, manufacturing is

done locally.

"There is ample capacity for cigarettes to become a major export commodity for

Cambodia," the report states.

For the MoC's Siphana, entry into the WTO will help to eradicate those practices

that currently make Cambodia such an unattractive place to do business. Noting that

"trade is a means to generate growth and employment", Siphana says the

government is now eyeing up the potential in exporting goods to such giants as China

and India.

Those export markets may well develop, but to have an impact on poverty, the supply

chain will need to link to growers and producers in rural areas where the vast majority

of people live.

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