Globalisation with weak institutions: Cambodia

Author: Hal Hill, Jayant Menon and Chan Sophal

The charming riverside capital of Phnom Penh, home to about 1.5 million inhabitants, has seen a lot in its turbulent history. But nothing arguably is on the scale of its first sky-scraper, the 42-floor ‘Gold Tower’ now nearing completion, not to mention the university and bank complexes mushrooming throughout this ancient city.

This changing physical landscape reflects broader developments in the country, which has been experiencing rapid economic growth – the sixth fastest in the world in the decade to 2007 – for the first time in its history. More than 2 million tourists now visit this country of 14 million, a 20-fold increase over the figure in the early 1990s. The Cambodian people 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 macro-economy is stable, with inflation under control, underpinned by very high levels of dollarisation, currently about 90 per cent. 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 per cent of GDP. The investment climate is welcoming, with generous tax incentives and low tariffs. Aid flows are very large, currently almost US$1.1 billion in a US$10 billion economy. The country’s openness meant that growth dried up in 2009 as the global financial crisis hit. But the economy is now rebounding.

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 entitled ‘Country for Sale’. In an ironic 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. The periodic 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 globalisation. 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.

The central challenge is to achieve growth that is durable, equitable, and environmentally sustainable. This in turn requires the development of institutions which, while they may be rudimentary, are effective, trusted and clean. Where to start? Consider for example the following:

  • – Cambodia has no shortage of laws, especially after its accession to the World Trade Organisation in 2004. But businesses view the courts as the most expensive ‘last resort’ when all else fails. Legal judgements are routinely for sale.
  • – Civil service salaries are meagre. A mid-level senior employee with a foreign masters degree receives US$70 per month, compared to a private sector alternative of about 20 times this amount. Ministers receive about US$500 per month, but some seem to live quite lavishly.
  • – The country’s tax effort (its tax revenue as a percentage of GDP) is a paltry 11per cent, despite the introduction of a broad based VAT. Thus the country’s infrastructure remains inadequate, in spite of the very large aid flows, and notwithstanding recent improvements.
  • – The number of banks has been increasing rapidly due to unfettered entry. The lax prudential supervision carries with it the possibility of a future meltdown.
  • – Shipping a container from factory to port costs about double the regional average owing to widespread ‘facilitation’ costs, a feature apparently of most transactions with the government.

Five general lessons for ‘late reformers’ stand out from the Cambodian experience. 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 other similar states, the achievements over the past decade in particular could be undone by economic crises, or rising civil unrest driven by outrage at the political and bureaucratic excesses.

The authors Hal Hill is Professor of Economics, Australian National University; Jayant Menon is Principal Economist, Asian Development Bank; and Chan Sophal is President, Cambodia Economic Association.

This article first appeared here in the Straits Times (Singapore) on July 23, 2010, as ‘Cambodia: Lessons for ‘late reformers’.’

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