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Three lessons for development

Three lessons for development

Analysis
Hal Hill, Jayant Menon and Chun Sophal

Phnom Penh’s changing physical landscape, perhaps best embodied by the 42-storey Gold Tower skyscraper now nearing completion and the flourishing of university and bank complexes, reflects much broader developments in Cambodia, which has been experiencing rapid economic growth – the sixth-fastest in the world in the decade to 2007 – for the first time.

More than 2 million tourists now visit this country of 14 million citizens, a 20-fold increase over figures from the early 1990s. Cambodians have better nutrition and access to education and health services than ever before. Since the cessation of hostilities almost two decades ago, life expectancy has risen by almost a decade, and infant mortality has fallen significantly.

The macroeconomy is stable, with inflation under control, underpinned by high levels of dollarisation, currently about 90 percent. Debt service is almost negligible, and public debt has fallen sharply, to about one-quarter of GDP.

The economy is highly open, with exports plus imports equivalent to more than 120 percent of GDP. The investment climate is welcoming, with generous tax incentives and low tariffs. Aid flows are large, almost $1.1 billion in a $10 billion economy.

So much for the good news. Cambodia also faces many daunting problems. The country ranks 166th and 135th respectively out of 181 countries surveyed in the Transparency International Corruption Perception Index and the World Bank’s Doing Business indicators. Deforestation and what is referred to locally as land-grabbing have been rampant. The local dailies abound with reports of land being awarded to the politically powerful for nominal amounts, and a startling but detailed account is presented in the 2008 study by Global Witness titled Country for Sale. In an ironic but bitter twist, the land-price boom has often made some of the most vulnerable worse off, as they have been evicted or forced off their land. Rather than sharing in the apparent emerging affluence, they have instead become victims of it. Household expenditure surveys report a significant increase in inequality. The country will also miss some of its Millennium Development Goal targets.

These problems are illustrative of the challenges faced by poor transitional economies in the process of opening up, without the institutions to manage the complex process of globalization. In this environment, the recent discovery of oil and gas could complicate things, as articulated in the well-known “natural resource curse” thesis. Hence, the lessons to be learned from Cambodia are of general interest, apart from ensuring that history does not repeat itself.

The central challenge is to achieve growth that is durable, equitable and environmentally sustainable. This in turn requires the development of institutions which, if rudimentary, are effective, trusted and clean. Where to start?

Cambodia has no shortage of laws, especially after its accession to the World Trade Organization in 2004. But businesses view the courts as the most expensive last resort.

Civil service salaries are meagre. A mid-level senior employee with a foreign masters degree receives $70 per month, compared to a private sector alternative of about 20 times this amount. Ministers receive about $500 per month. Official salaries and actual lifestyles may not always bear a close resemblance, however.

The country’s tax effort (its tax revenue as a percentage of GDP) is a paltry 11 percent, despite the introduction of a broad-based VAT. Thus, the country’s infrastructure remains inadequate, despite large aid flows, and notwithstanding recent improvements.

The number of banks has been increasing rapidly due to unfettered entry. The lax prudential supervision carries the possibility of future meltdown.
Shipping a container from factory to port costs about double the regional average owing to facilitation costs.

Five general lessons stand out from the Cambodian experience. Heeding these lessons will be important not only to ensure a brighter future for Cambodia, but also for other late reformers.

First, liberal and open economies cannot function without due respect for property rights, as exemplified by the widespread land grabs. Second, these liberal regimes need adequate regulatory capacity to manage a modernising market economy, as illustrated by the banking example above.
Third, large inflows of foreign aid and natural resource revenues ought to be viewed as transitory, and invested wisely for broad-based development. Fourth, donors need to better coordinate their work, and avoid imposing excessively on a weak bureaucracy. Fifth, civil service reform has to be undertaken early, with clear incentives and disciplines.

Unless these conditions are met, the danger is that in Cambodia, and many similar states, the achievements of the past decade in particular could be undone by economic crises, or civil unrest driven by outrage at political and bureaucratic excesses. Although there are many reasons to be optimistic about Cambodia’s future, meeting these conditions will require changes, and soon.

Hal Hill is professor of economics at Australia National University; Jayant Menon is principal economist at the Asia Development Bank; Chun Sophal is president of the Cambodia Economic Association.

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